Money & Banking

‘We are trying to change the governance process of banks’

Beena Parmar | Updated on January 22, 2018 Published on December 01, 2015

Reserve Bank of India Governor Raghuram Rajan

Reserve Bank of India Governor Raghuram Rajan

As far as the fiscal deficit goes, clearly, both the quantum as well as the quality matter, says RBI Governor



Reserve Bank of India Governor Raghuram Rajan hit the pause button for the fourth time in the current calendar year. During the course of the year, he also cut the policy repo rate four times, cumulatively by 125 basis points. The reasons for keeping the policy repo rate unchanged in the fifth bi-monthly monetary policy review include the expected normalisation in interest rates from near zero levels by the US Fed and the uptick in retail inflation for the third month in a row. In a post-policy announcement interaction with the media, Rajan spoke on a wide range of issues, including the need to be vigilant on inflation, implications of the Pay Commission’s proposals, economic recovery, and clean-up of bank balance sheets by March 2017. Excerpts from the media interaction:

On the one hand you emphasise on vigilance, on the other you are being tentative on accommodation. What will be your future policy stance and how much will US Fed’s decision be a factor?

First, we are still accommodative. I think that is very clear. We are always vigilant. So, this is not anything new. There are, obviously, both upside and downside risks to consumer price inflation. We have highlighted some of the sources of risks going forward. One could imagine that there could be downside risks from, say, commodity prices, especially oil. But, of course, given where the oil is produced, there are also potentially upside risks if there are political events that constrain the supply of oil. So, vigilance is always needed.

When times warrant it we are always prepared to move off-cycle (to change interest rates). But when times normalise, we prefer staying with the policy cycle rather than move off-cycle.

Of course, when we use the words ‘external developments’, one of them is what happens to the Fed policy rate hike…There are some residual uncertainties about what the Fed will do. But my sense is, as I have said before, after an initial bout of volatility, we probably should see the Indian markets stabilise and come through. So, it is not, as I have said before, the central factor in our deliberations going forward.

Will you consider the fiscal deficit number of 3.6 per cent or the quality of fiscal consolidation? Also, what is the RBI’s assessment of impact of the 7{+t}{+h} Pay Commission on inflation?

As far as the fiscal deficit goes, clearly, both the quantum as well as the quality matter. And that is an issue that the government is fully seized of. I am hopeful that while maintaining the fiscal consolidation path, the government can also enhance the quality of the Budget. So, it is clearly an issue that they and we would both be looking at.

On the 7{+t}{+h} Pay Commission, in the broad sense, yes, there is going to be additional expenditure but it will be offset, presumably, by either additional revenue raising or cuts elsewhere so that the fiscal consolidation path is maintained. So, in that sense, we don’t feel there will be a significant effect on aggregate demand provided, of course, you maintain the fiscal path.

Of course, investment in some ways may be of higher quality than certain kinds of spending.

And, therefore, one would hope that you would uncover space elsewhere for the public investment which we really need. And I think the government has taken a number of these (factors) into account while anticipating the consequences of the Pay Commission proposals. So, let us wait and see what happens.

What is the RBI’s assessment of the latest GDP data? Do you believe growth has taken place or is there still a disconnect?

We are in the midst of a recovery. There are places where rural demand is weak and non-durable consumption is weak. Capital growth and public investments are growing strongly…so there are some sectors growing, with areas of weakness elsewhere. Construction may start picking more strongly.

What will be the factors for further transmission of interest rates by banks?

I think if you look at one- to three-year deposits, then banks have already cut significantly more than has been transmitted through the base rate. In that sense there is room building up for the banks to transmit more as these costs flow through. What the marginal cost pricing does is it makes the costs flow through into lending rates faster. The intent, at least for a time, is banks will be able to make incremental loans at marginal cost pricing while their historical or legacy loans will be on the base rate.

What is your take on cleaning up of balance sheets by banks? Do you think reforms, such as the SDR and the 5/25 scheme, are helping in reducing bad loans?

Our approach to bad loans has been very systematic. The first part of the process was to give banks more power and flexibility to deal with them and the idea was to put the real asset back on track with whatever needs to be done. Those were the first steps with things like the strategic debt restructuring (SDR), 5/25 (refinancing), bringing in new promoters, and so on. Given that banks have more powers we can now be a little more careful about recognition. The first step was to do away with forbearance from April 1, the next step is that what should be classified (asset classification) as A is classified as A and not B.

We are in constant dialogue with banks and are looking at how the existing facilities are being used. This process is ongoing and my hope is as the banks recognise more of what needs to recognised and they deal with the stressed assets (remember stressed assets is a important part of bank balance sheet and they will be able to bring that down and not just by provisioning but also by putting some of these assets back on track) so that they might be elevated to performing assets in time.

This is what is underway…as you know more of the problem is in public sector banks which went into infrastructure investment where many of the difficulties are. I want to put something like March 2017 on the table as when we hope that a clean-up will have been done.

How crucial are the banking sector reforms? Are you happy at the pace of banking sector reforms? PJ Nayak submitted his report 15 months back.

A number of actions, including splitting the position of Chairman and CEO of banks, appointing some private sector players as CEOs, a process of appointing new bank board members who are typically more professional, have taken place. The Bank Board Bureau is being set up. My sense is these are being quite positive and these things play out over time, but let us see how things move.

Bank reforms are absolutely crucial because I think if you take the broader process, what we are trying to do, together with the government, is first change the governance process of the bank, move towards cleaning up the bank balance sheets and provide appropriate recapitalisation and then they will be in a position to do the kind of lending that the economy will need as the recovery starts.

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Published on December 01, 2015
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