The RBI board meeting was probably the most awaited event as it was to address the major difference of opinion between the central bank and the government of India. With the RBI board having two new nominees that were selected by the government, a different view was expected. The result was reconciliatory with some issues being referred to committees while others were addressed upfront. Two contentious issues, however, have not found mention in the release made by the central bank.

The two definite announcements made by the RBI raise some interesting possibilities. The first relates to the extension of the time line for meeting the capital conservation buffer to 2020 with a relaxation of 0.625%. This basically means that banks have to keep less capital aside than was earlier mandated which, in turn, will enable them to lend more. This sounds good provided banks had excess capital or were just about at the threshold. For those which have eroded net worth like some of the PCA banks, this may not make much of a difference.

Was this a good thing? The external rating agencies are never happy when such compromises are made not because it reflects something amiss given that our standards are already higher than those globally, but because they signal a kind of weakness in the system.

The other issue on restructuring of SME loans is interesting because it comes just at the time when the banks have revealed higher NPAs in their books over the last two years, precisely because the system allowed for restructuring of loans especially in infra, steel, power, textiles, etc. SMEs are a touchy subject in India as they account for a large level of employment (100 mn), 40% of industrial output and exports which are short of institutional funding. Over time, they have become as vulnerable as farmers, and hence, the ideology of inclusive banking reaches out to them in a big way.

A fundamental question is whether banks, which are commercial entities, should be continuously taking up national causes which can be infra building, sector specific growth, SMEs, farmers etc. This is important because when such loans fail, bankers are blamed. And interestingly, as these compulsions fall normally on PSBs, the private banks tend to do better as they are not pressurised. Now that the decision is taken, the commercial banks will have to be careful when they tread on this territory as an adverse asset portfolio is not built.

Two other issues have also gone to committees. The one relating to PCA banks – those under this framework have restrictions in terms of their operations including lending. Allowing them to operate like the others without getting their houses in order is risky as the weak performance gets exacerbated.

As it will be an internal committee that will be looking at this aspect, it can be assumed that the recommendation will be linked with performance so that any movement out of the framework is calibrated with improvement in specific areas. For this to work, the government has to provide capital because the problem with these banks is that high NPAs have led to high provisioning and negative profits which has eroded their net worth. The only way out is to have more capital coming in.

The fourth issue is on the reserves of RBI and a clarification that has come in is that the committee will look only at incremental reserves rather than the existing level. This is prudent because drawing down on existing reserves creates distortions in terms of either printing more currency or dropping the level of forex reserves or selling GSecs which can depress the bond market. Having a policy to transfer all new reserves can still be defended on being viewed as a transfer of funds for public use. Here again, linking the same to the budget for financing the deficit may not be viewed positively by the rating agencies.

The contentious issue of assets being classified as NPAs when they default for one day was expected to be taken up, too. It has been kept in abeyance presumably because any dilution in this norm will also vitiate the government’s initiative of ushering in the IBC. The idea was to go in for insolvency proceedings in case the case cannot be resolved between the lenders and borrowers.

Also, the pressure that was there to ease liquidity for the NBFCs has not found mention probably because the situation has improved. The RBI has already opened windows of credit enhancement, relaxation in the liquidity cover ratio when lending to NBFCs and access to ECBs to provide additional liquidity facilities for these units. This goes beyond the regular open market operations and repo facilities.

It can be assumed that the future road to policies in the banking sector would be more collaborative with the government also playing a very important role in their formulation. This should eschew the controversy created in the latest episode which has had a reconciliatory ending.

Madan Sabnavis is a chief economist for CARE Ratings.
Views are personal.

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