RBI-Government Spat: Easier Banking Regulation, In Public (Or Government) Interest? 

The three letters sent by the government to the Reserve Bank of India seek consultations on nearly a dozen items. Prime among them is the scuffle over the RBI’s reserves, which if done without adequate consultation, will be seen as a raid on the central bank’s balance sheet.

Another set of demands—pertaining to looser regulations for banks—are equally noteworthy. Each of those demands have individual objectives linked to them, but when taken collectively, represent the conflict of interest inherent in government ownership of nearly 70 percent of the banking sector.

Consider the three demands being put forth by the government:

• Loosening the prompt corrective action framework.
• Diluting the Feb. 12 directive to allow relief for some sectors like power.
• Adopting a less stringent form of the Basel capital regulations.

Diluting The Prompt Corrective Action Framework

Prompt corrective action, as a tool to prevent weak banks from getting weaker, has existed for some time now. It’s implementation, though, was whimsical. So, in April 2017, the Reserve Bank of India issued a revised set of benchmarks, with an attempt to move towards a more rule-based framework. To be sure, there continues to be some discretion in the implementation of these rules, but by and large lenders which meet the criteria of weak banks are currently under the PCA framework.

At the time the framework was implemented, the government didn’t raise objections. In fact, in Oct. 2017, when the government announced the mega Rs 2.11 lakh-crore bank recapitalisation plan, the belief was that while the weak banks will get regulatory capital, the growth capital will go to the stronger banks. The idea was that stronger, better managed banks should take the lead in the next credit cycle.

What changed? And why is the government pushing for the PCA framework to be diluted?

Earlier this week, rating agency Crisil said public sector banks will need Rs 1.2 lakh crore by March 2019 just to meet regulatory requirements. This is Rs 21,000 crore more than what is left under the Rs 2.11 lakh-crore package. The rating agency also said that the Rs 1.12 lakh crore already infused has only helped cover the Rs 1.3 lakh crore in losses incurred by public-sector banks over the last three fiscal years.

Now, the government once again finds itself in a position where it needs to put money into these banks. The PCA framework—which insists that weak banks raise their levels of provisioning and bring down net NPAs before they grow their books—further increases the need for funds.

In arguing for a relaxation in the framework, the government says that it is hurting the flow of credit to the economy. But with bank credit growth running above 12 percent, in line with nominal GDP growth, that argument is tough to defend.

The real reason for the push to dilute the framework may lie at best in the reluctance to put in more capital into these banks and, at worst, to cater to needs of certain cross-sections of the economy ahead of national elections.

Carve Outs From The Feb. 12 Circular

The second demand is the attempt to keep power sector assets out of the RBI’s Feb. 12 circular, which asked banks to start resolution of accounts after even one day of default. If not resolved, large accounts would need to referred for insolvency proceedings under the Insolvency and Bankruptcy Code.

The concern, as bankers have highlighted, is that there may not be demand for these power assets and liquidation of a large amount of power capacity is not in the interests of the economy.

But does the solution lie in diluting not just a rule-based regulatory framework but also the expanse of the insolvency code? Would it not be better for the government to consider a fiscal response to the problem? This could be done by setting up a national asset reconstruction company, suggested a while ago by RBI Deputy Governor Viral Acharya. This ARC would then hold on to these assets and wait to sell them at an appropriate time. The problem is that the government would have to cough up the money for such a solution. Which it either doesn’t have or doesn’t want to use.

And so, it appears to want to take the cheaper way out. Even if it means a dilution of a rule-based insolvency regime.

Reducing Basel Capital Needs

A third demand is to reduce the capital requirements set forth under the implementation road map of the Basel-III norms. It has been argued that India has adopted a needlessly stringent version of the capital requirements.

The road map for the full implementation of the Basel-III norms was adopted by India in 2013. The process will be completed by March 2019. As part of that road map, the RBI prescribed overall capital requirements of 9 percent of risk weighted assets, with the common equity tier 1 capital of 5.5 percent as against 8 percent and 4.5 percent, respectively, required under the Basel norms.

Explaining this decision in a recent speech, RBI Deputy Governor NS Vishwanathan said that India’s experience of higher cumulative default rates and loss-given-default rates had led the regulator to prescribe higher capital requirements. As the need for repeated recapitalisation has proved, banks in India need to aspire to have higher capital levels, Vishwanathan argued in his speech.

To be sure, there’s no reason to take the regulator’s view as the gospel truth. It can be argued that the RBI’s view isn’t the correct one. The problem, once again, lies in the timing of the demand to dilute the Basel regulations. And that brings us right back to the need to put more capital into government banks and the lack of availability of that capital.

In Public Interest?

The government in pushing for these demand has cited “public interest”.

However, the government is also the owner of 70 percent of the banking system. It could be easily argued that theses demands are being pushed not so much in the interest of the “public”, but more in the interest of the owner of these institutions — the government. The two aren’t necessarily the same.

Cleaner, healthier banks are in public interest. Pushing back that process of repair of bank balance sheets may be in government interest.

Ira Dugal is Editor - Banking, Finance & Economy at BloombergQuint.