Centre, RBI face-off could’ve been avoided

The ongoing tussle between the Centre and the RBI could have been let off as yet another everyday skirmish between the powers that be. After all, this is not the first time that the Centre has thrown around its political weight to have its way or the central bank to have donned the ‘autonomy’ hat to wisely turn down the Centre’s requests. But events of the past few days suggest that the stand-off between the Centre and the RBI is not your run-of-the-mill scuffle.

What had soured matters more were reports suggesting that the Centre has invoked Section 7 of the RBI Act — that allows the Centre to give directions to the RBI, after consultation with the governor, in public interest. Given that there has been no instance so far of the government having exercised its reserve powers to issue a directive, doing so now, seriously undermines the RBI’s autonomy. Of greater concern is that since the said Section has never been invoked, its implications are unclear and forbidding.

But the RBI, too, has much to answer for. The central bank’s myopic view on inflation, lack of clarity on monetary policy actions, and casual dismissal of key issues such as rupee depreciation, NBFC crisis and growing macro imbalances have not done much for its credibility in recent times. Importantly, by assenting to step into banks’ shoes to clean up the bad loan mess last year —‘under the authorisation of the Centre’ — the RBI had already raised worrying questions on its autonomy.

From what is known in the public domain, the Centre prodding the RBI to ease up on prompt corrective action (PCA) norms for public sector banks, grant relief to troubled power firms, bump up dividends (dipping more into RBI’s reserves) and provide liquidity to NBFCs have been key issues on which the RBI and the Centre have been at loggerheads.

The NBFC crisis aside, each of the other issues link up to one underlining concern — capital crunch at public sector banks (PSBs) and the Centre’s inability to infuse massive capital given its fiscal constraints.

It is well known that the PCA framework is not a new animal. It has been in operation since December 2002. Then why the hullabaloo? This is because the RBI revised the PCA norms in April last year, which brought in more stringent NPA and capital threshold levels, that led to as many as 11 banks slipping into the PCA category.

That said, the Centre’s argument that these banks slipping into PCA has stifled credit growth, is overdone. Data suggest that most of these banks had in any case seen their loan books shrink between FY15 and FY17. Also, corrective action does not limit the normal operation of the banks. The RBI can place restrictions on credit to un-rated borrowers or expansion of high risk-weighted assets, but there is no complete ban on lending.

What’s the real issue?

When the Centre announced its big bank recap plan last year entailing a massive infusion of ₹88,000 crore into PSBs, it believed that it would ease up the enduring issue of capital within PSBs. But unfortunately, that has not been the case. Large haircuts and higher provisioning on accounts under IBC (Insolvency and Bankruptcy Code) have eaten into banks’ earnings.

But these were known devils. What caught banks and the Centre offguard was the RBI’s February circular forcing banks to accelerate the NPA recognition exercise. PSBs reported loss of ₹62,000 crore in the March quarter alone, and an NPA increase of around ₹1.2 lakh crore.

The RBI’s February circular, which essentially did away with all the old restructuring schemes, requires banks to report even one-day defaults and draw up resolution plans within 180 days, failing which they will have to refer the case for insolvency under IBC.

This has been a niggling worry for banks that are saddled with large stressed power sector accounts as a chunk of them will probably take the insolvency route. Structural issues plaguing the power sector will make it difficult to find buyers (34 identified stressed power projects by the Standing Committee on Energy, with an outstanding debt of ₹1.74 lakh crore) under IBC, leading to liquidation. The sheer size of the accounts would lead to large haircuts, and in turn huge erosion in banks’ capital.

Hence the earmarked ₹65,000 crore for capital infusion this fiscal appears grossly inadequate, which is a growing worry for the Centre. The hasty amalgamation of three PSBs (BOB, Vijaya and Dena Bank) clearly points to the Centre’s growing edginess in this matter.

Easing the PCA norms or providing leeway on the February circular would no doubt offer some breather to the Centre. But the RBI does not approve of it and rightly so.

Despite the asset quality review exercise in late 2015 — that added a whopping ₹2.7-lakh crore or so of bad loans to the system in the 2016 fiscal — banks continued to report sharp slippages from their restructured accounts last fiscal. Reports based on the RBI’s annual risk-based assessment that came with a lag of two to three quarters, did not serve much purpose and watered down the impact of sharp divergences.

Hence the RBI in a bid to flush out the rot out of banks’ books, axed all restructuring schemes. Going back on this diktat would only do more harm than good.

After all, wasn’t it the Centre that hastened the ordinance last year to tackle the NPA issue and directed the RBI to step into banks’ shoes to clean up the bad loan mess?

Independent regulator?

This brings us to the core issue of the RBI agreeing to don overalls and dirty its hands on the shop-floor. The NPA ordinance (two new insertions made in the Banking Regulation Act last year — Sections 35 AA and 35) empowered the RBI — under the authorisation of the Centre — to instruct banks on how to tackle specific accounts.

This had already raised questions on the central bank’s ability to act as a prudent and independent regulator after it involved itself with bank decisions.

There are several other issues that have raised questions over the RBI’s credibility. Its reluctance to acknowledge growing concerns over the rupee and liquidity (within the NBFC space) crises has been worrying. NBFCs have played major role in credit-supply in recent years, funded by banks and mutual funds. With the liquidity tap drying up post the IL&FS issue, credit crunch within the NBFC space is a grave matter, which the RBI needs to acknowledge and address immediately.

The RBI’s narrow focus on inflation amidst growing macro imbalances has also been a cause for worry. Importantly, as concerns over fiscal slippages, falling rupee and tightening of global liquidity take centre-stage, the RBI letting its guard down has not gone down well with the markets too.

Getting on board

Amid the ongoing power struggle, the Finance Ministry recently issued a statement acknowledging that the autonomy of the RBI is an ‘essential and accepted governance requirement.’ While this has soothed the market, it will be imperative for the Centre to truly acknowledge the sanctity of the RBI’s position as an independent regulator.

Also, rather than looking at quick-fixes, the Centre should address the structural issues within the power sector. The RBI, on its part, should also acknowledge that there have been regulatory and supervisory gaps — be it the PNB scam or the recent IL&FS crisis. Hence it cannot take a high moral ground and avoid accountability to the elected government.

Above all, none of the issues known to have stirred up the upheaval (unless there are some greater differences) warrant this kind of public brawling from either the Centre or the RBI. It’s time for both to get on board and resolve their disagreements in the public interest.

COMMENT NOW