‘RBI should have pushed earlier for enactment of the Bankruptcy Code’

The Reserve Bank of India should probably have raised more flags about the quality of lending in the early days of banking exuberance, said former Governor Raghuram G Rajan.

With the benefit of hindsight, Rajan said the RBI should probably not have agreed to forbearance, though without the tools to clean up, it is not clear what the banks would have done.

“Forbearance was a bet that growth would revive, and projects would come back on track. That it did not work out does not mean that it was not the right decision at the time it was initiated,” the former RBI Governor said in a note prepared at the request of Murli Manohar Joshi, Chairman of the Parliament Estimates Committee.

Also, the RBI should have initiated the new tools earlier, and pushed for a more rapid enactment of the Bankruptcy Code. If so, it could have started the asset quality review (AQR) process earlier.

“Finally, the RBI could have been more decisive in enforcing penalties on non-compliant banks. Fortunately, this culture of leniency has been changing in recent years. Hindsight, of course, is 20/20,” said Rajan, who is now the Katherine Dusak Miller Distinguished Service Professor of Finance at Chicago Booth.

Referring to bankers, promoters, or their backers in government sometimes turning around and accusing regulators of creating the bad loan problem, the professor underscored that “the truth is bankers, promoters, and circumstances create the bad loan problem.

“The regulator cannot substitute for the banker’s commercial decisions or micromanage them or even investigate them when they are being made. Instead, in most situations, the regulator can at best warn about poor lending practices when they are being undertaken, and demand banks hold adequate risk buffers.”

He observed that the RBI is primarily a referee, not a player in the process of commercial lending. Its nominees on bank boards have no commercial lending experience and can only try and make sure that processes are followed.

“They offer an illusion that the regulator is in control, which is why nearly every RBI Governor has asked the government for permission to withdraw them from bank boards,” explained Rajan.

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