Cleaning the augean stables

In his latest stint Urjit Patel spent five years at the Reserve Bank of India, three as a Deputy to Raghuram Rajan, and then two at the helm of the hallowed institution. He left abruptly in December 2018, a year before his term was to end, citing personal reasons. There was speculation that he was “sacked”, or that his resignation was due to irreconcilable differences with his bosses in Delhi. His resignation was preceded by some very stormy meetings of the RBI Board, which ran well into midnight amid strong disagreements on key issues. Those issues impinged on the autonomy and independence of the Central bank and the debate on these had been brewing for some time.

What you get is a scholarly and coherent account of all that ails banking, and will be of immense value to students of monetary economics.

Patel’s departure raised eyebrows since he was seen as someone who had been handpicked to succeed Rajan, by the Prime Minister himself, and presumably enjoyed the latter’s confidence. Much of this is conjecture since until the publication of his recent book, Patel has been very quiet and consciously away from the public eye. Even while in office as Governor or as Deputy he was known for his reticence and allergy to media appearances. His reticence was in stark contrast to his more expansive predecessor.

Hence his latest book, “Overdraft” was eagerly awaited as perhaps a tell all, a scathing insider’s view of Central banking in India.  That expectation is belied, this ain’t no potboiler. What you get is a scholarly and coherent account of all that ails banking, and will be of immense value to students of monetary economics.  Much of the material in the book is already in the public domain, even as part of the few speeches that Patel gave as Governor.  Even then you can discern the anger, frustration and disappointment about policy failures, inaction, mismanagement or outright fraud. The villains are not named, but that is something astute readers can infer. The subtitle of the book and the dedication is to the “Indian saver” who quietly bears the enormous ultimate cost.

Patel’s writing occasionally goes lyrical, as can be seen in the very first para of the Preface, or the last para of the book, which invokes a Chekov play! It’s a tongue-in-cheek cryptic comment on the futility of bad loan recoveries which often end in loan waivers. But despite the many literary flourishes, the book is not a breeze to read, since it has a lot of technical stuff, data and tables and even an Appendix that has an advanced mathematical model with theorems and proofs.  There are also passages with awkward grammar or unwieldy sentences, and one doesn’t know whether this was caused due to the haste in preparing the manuscript, or the need of the author to pirouette and diplomatically sidestep some issues.  While the author discusses many key recent issues that he tackled as Governor, his book is completely silent on the big event of demonetisation which was executed under his watch.

That was a period of tumult with the RBI having to clarify by issuing as many as 66 notifications in 47 days. Also missing is the debate about “raiding” the RBI balance sheet for fiscal needs, or direct assistance to NBFC’s in the wake of the IL&FS debacle. Maybe that account will have to wait for another book, since this is not the definitive or comprehensive memoir of this Central banker.

The book is organised into sixteen short chapters and two appendices. The chapters themselves are grouped as a backdrop to cleansing the Augean stables in bits and pieces. The bulk of the discussion is on the 8-R’s model of managing the non-performing assets (NPA’s) or bad loans in Indian banking. Basically, it comprises of recognising and recording the scale of the problem, recovering distressed assets and resolution through the bankruptcy process, and finally recapitalising the banks to fund their future growth.

Since Indian banking is dominated by government-owned banks (called GB’s by Patel), this public ownership means that market disciplining is weak. Hence as Patel says, the “regulator’s remit is circumscribed”, and the NPA problem of GB’s is prone to periodic crises, aggravated by lack of effective autonomy in credit decisions. Even then, starting in 2015 the RBI insisted on an Asset Quality Review of bank balance sheets, so as to reveal the true picture of bad loans. That caused the reported NPA ratio to triple thus pointing to the true and daunting scale of the clean-up challenge.

This ratio has gotten even worse thanks to Covid induced stress as pointed out by the recent Financial Stability report of the RBI. This puts an enormous fiscal requirement for equity infusion. A large fiscal overhang is a constant feature of the Indian economy, and constrains RBI’s monetary policy making, and also its regulatory role. Added to this is the government’s periodic propensity to provide loan waivers or disburse credit via de facto loan melas. Patel is harsh on the “no questions asked” Mudra loans, a 59-minute loan approval program which has led to substantial unpaid debts and rising NPA’s.  Patel says India’s finance ministers declare “credit budgets” on behalf of banks in their budget speeches, directing credit, and then State ministers announce write-offs. He calls this the case of Overton’s window in India’s political economy, due to which previously abnormal or unthinkable situations become normal, with the passage of time. This is clearly seen in these Covid hit times, when regulatory forbearance, and relaxing credit discipline have reached newer benchmarks. Covid is the alibi, but the malaise is deeper, structural and perennial.

Patel spends considerable space on the steady dilution of the Insolvency and Bankruptcy Code, a landmark law which promised a clean and transparent resolution mechanism to tackle the problem of NPA’s. The RBI sought to bring a rule-based approach to resolution of bad loans.

Its February 2018 circular mandated that loans would compulsorily be referred to the IBC process if no loan restructuring was done in the stipulated time. This rule was challenged and then struck down by the Supreme Court. Patel’s dismay is evident, and he writes, “..difficult to fully understand ..(how) a transparent rule is untenable, but discretion on a case-by-case approach is kosher”. He calls it a case of “the empire strikes back”, and reform getting derailed by vested interests.  We are back to a case-by-case approach with all the attendant problems of moral hazard and delay. Overton’s window again.

Patel’s short book may sidestep sensitive or controversial personalities or events. But it does give a scholarly and dispassionate analysis of some key issues and problems plaguing India’s banking sector, and an insight into the structural weaknesses.  A must read for policy makers as well as serious students of economics.

(Dr.Ajit Ranade is an economist and Senior Fellow, Takshashila Institution)