Centre unjustified in lashing out at RBI

For a few weeks now, the Indian media has witnessed some intense activity, probing deep into the reported rift between the central government and RBI on certain policy issues. If the stories that have appeared in this regard are anything to go by, the rift has almost come to a boil after the much-publicised speech by a top RBI official on October 26, on the one hand and the happenings in the last meeting of the central board of RBI, on the other. There is even some speculation that the government is about to issue a first-ever directive to RBI under section 7 of the RBI Act, 1934. Perhaps to dispel the confusion and uncertainty that could be caused by this, the government issued a statement on October 31, asserting that it views the RBI’s autonomy as essential and indicating that it will continue to engage in consultations with the RBI on all outstanding issues.

The prompt corrective action (PCA) norms imposed on eleven public sector banks (PSBs) and one private sector bank, as per the version of the norms adopted by RBI in April, 2017 (which included leverage as an additional regulatory trigger apart from certain pre-defined levels CRAR, NNPA and RoA) are seen by the government as unduly harsh and causing an impediment to credit flows to certain sectors of the economy.

Fortunately, the financial markets in India have taken this development in their stride and a section of the foreign portfolio investors have viewed this positively, terming it as a case of ‘constructive disagreement’.  If anything, they were net buyers of debt securities over last few days.    

No smoke without fire

Following the dictum that there cannot be any smoke without fire, one discovers that there are a number of issues on which the government of the day does not see eye-to-eye with RBI: One, the prompt corrective action (PCA) norms imposed on eleven public sector banks (PSBs) and one private sector bank, as per the version of the norms adopted by RBI in April, 2017 (which included leverage as an additional regulatory trigger apart from certain pre-defined levels CRAR, NNPA and RoA) are seen by the government as unduly harsh and causing an impediment to credit flows to certain sectors of the economy. Two, the government feels that the abolition of restructuring of NPAs announced by the RBI in its February 12 circular and the time limit of 180 days given to banks for the resolution of NPAs before the borrowers are compulsorily placed under IBC have nixed the chances of revival of many power sector companies. Three, the government wants special dispensation on NPA recognition and provisioning norms for MSME borrowers in the interest of growth and employment generation. Four, the government thinks that the RBI should infuse liquidity to the NBFC sector in the aftermath of the IL&FS default. Five, the RBI is strongly apprehensive that the government’s move to create a separate regulator for the payment system is a direct attempt to curtail RBI’s legitimate regulatory domain and standing.

PSBs under PCA

By most indications, the reported rift on PCA is the most contentious and, hence, the subject merits a comprehensive analysis and informed public discourse and debate. At the heart of the rift is an uneasiness and some alarm in the bureaucratic and the political circles that PCA will accelerate the loss of market share and cause further decline of the position of the PSBs in the financial system in favour of private banks and foreign banks. An influential ideological wing of the ruling establishment is of the view that the end of the dominance of PSBs can have adverse implications for the country’s sovereignty and security as well. RBI has been of the consistent view that the financial health of weak and loss-making banks can be restored only by following a timely, structured and disciplined corrective process in line with the best international standards and practices in this regard. The central focus of PCA framework is to limit further deterioration of financial health and conservation of capital.             

An interesting piece of information in the context of PCA has not been reported so far. Ask the board of any PSU bank under PCA that has received capital from the government under the recapitalisation package of INR 2.11 trillion for PSU banks announced in October, 2017 and they will say that they have signed a memorandum of undertaking as prescribed by the government containing conditions and deliverables very much similar to PCA norms.

There is hardly any global instance ever where banks with GNPA exceeding 20% are treated as solvent or viable. In India, we have long been in denial about this reality, which has cost the country’s taxpayers dearly. The fact that PBSs are majority-owned by the government is providing support only to their fund-raising by way of deposits.

A few important facts and data on the 12 banks under PCA will put the things in a better perspective. First and foremost, there is no blanket ban on credit expansion on them, excepting Dena Bank, which is now tipped for merger with a large PSU bank. Second, the headline restriction on credit expansion for the rest of them is that they cannot lend to borrowers that are not investment grade. Third, there are no restrictions on their liabilities side, excepting that they are not permitted to take bulk deposits at high cost.  Four, the PCA framework is not intended to constrain the normal operations of the banks to the general public.  

The share of 12 PCA banks in advances and deposits of the entire banking system as on March 31, 2018 was 18.5% and 20.8%, respectively. The GNPA and NNPA of PSBs under PCA as on March 31, 2018 were about 21% and 12% respectively. As per the latest financial stability report of RBI, their GNPA could rise to 22.3% by March 31, 2019. Both the GNPA and NNPA of PSBs under PCA have risen rapidly over the last few years, leading to fall in their CRAR, RoA and leverage ratio. Quite obviously, some of the PSBs under PCA have higher GNPA and NNPA than the average. For example, GNPA and NNPA of United Bank of India as on March 31, 2018 were higher at 22.73% and 15.17% respectively.  In the case of Bank of India, the corresponding numbers were lower at 16.6% and 7.66% respectively. 

Credit growth of PSBs under PCA – a reality check

The yearly growth rate of the credit of eleven PSBs under PCA was largely similar to other PSBs till fiscal 2014-15, after which it diverged and became negative in 2015-16. Since the imposition of PCA on them in 2017, there has not been any further marked decline and in 2017-18 it was (-) 3.29%, compared to 8.13% of other PSBs. Again, the eleven PSBs under PCA is a mixed bag, as can be seen from the annual credit growth rates of four among them over the last four fiscal years in the table below:

The upshot is that those PBSs which registered a fall in their credit portfolio subsequent to the imposition of PCA in 2017 had a lacklustre credit growth even prior to that event. One important point that needs to be borne in mind here is that a good number of PSBs under PCA are already insolvent if realistic provision is made on their GNPA. There is hardly any global instance ever where banks with GNPA exceeding 20% are treated as solvent or viable. In India, we have long been in denial about this reality, which has cost the country’s taxpayers dearly. The fact that PBSs are majority-owned by the government is providing support only to their fund-raising by way of deposits. On the assets side of their business, the quintessential logic of risk seems to be at work: a bank cannot take credit risk which is better than its own. The fact that many of the PSBs under PCA feel constrained by not being permitted to give loans to non-investment grade borrowers is a confirmation that they themselves are non-investment grade. And the RBI is right in insisting that they must not lend to junk borrowers. Allowing them to do so, or relaxing the NPA recognition and provisioning norms for any category of borrowers will have a proverbial time inconsistency problem, and, hence, should be avoided. In the short run, these measures may have some positive consequences for PSBs under PCA and for the economy, but over a longer timeframe of say, 5 years, there will almost certainly be another fresh burst of NPAs. The banking system is still suffering from the excesses of 2009-14 and the unprecedented regulatory forbearance in respect of restructured assets.          

Both the government and RBI will have to decide on what kind of a vision for the banking system in India will work for the future. For a long time, the PSBs were seen as providers of public financial services or some equivalent of utility companies in the financial arena and not as competitive intermediaries of public savings. This is essential to resolving the NPA problem.

Since 2005, the government of India has infused more than Rs. 2,300 billion (1.37% of 2017-18 GDP) in PSBs, more than half of which has gone into banks currently under PCA.  Of this, Rs. 635 billion has been infused in PSBs under during 2017-18 and so far in 2018-19. A ‘business as usual and as before’ policy towards PSBs under PCA will almost certainly mean higher fiscal cost for their recapitalisation again in future.   

Postlude

The decline of the PSBs in terms of their share of deposits and loans had begun in the early 2000s. The global financial crisis of 2008-10 had given them some respite in the midst of heightened credit risk concerns on the part of depositors and investors. But the PSBs have again been losing their position since 2013-14. Right now, they are in a crisis situation, and any policy directed at ensuring the viability of the weakest of them will be unsustainable. Both the government and RBI will have to decide on what kind of a vision for the banking system in India will work for the future. For a long time, the PSBs were seen as providers of public financial services or some equivalent of utility companies in the financial arena and not as competitive intermediaries of public savings. This is essential to resolving the NPA problem. Otherwise, if the Japanese instance of policy vacillation and loss of strong political direction for resolving its banking crisis of the 1990s is any guide, India can also face a prolonged period of suboptimal growth due to the problems that ail its PSBs and NBFCs.

(Himadri Bhattacharya is a former central banker and consultant to the IMF)