SA Raghu is a banking and economics commentator based in Chennai. He is an economist and CFA by training and his professional career of over 30 years has spanned central banking, project financing and banking technology. He writes for financial newspapers on banking, economics and finance
The limping curtains on the tussle between the RBI and the government should hopefully put an end to the hype around the issues, because the overtones of turf supremacy and autonomy have obscured and even exaggerated the issues at stake. There are several, but it is useful to consider two which got the most attention the reserves of the RBI and the issue of dealing with non-performing banks.
On the RBI’s reserves, the simplistic view can be that of shareholders demanding higher dividends from the company they own, except that in this case the reserves did not represent accumulated profits and payouts have greater significance than for a private shareholder. But now it is clear that the so-called excess reserves are largely accounting entries (unrealised gains), which makes it all the more mysterious as to why a bid was made in the first place.
A difficult fiscal situation in an election year is reason enough, but it would have also been obvious that encashing the RBI’s foreign currency assets or printing money through its Issue Department – the two ways it could have generated cash – would have been counterproductive, with the latter course akin to financing the fiscal deficit.
Apparently the current revaluation reserves (which form over 75 per cent of the total) are not in contention now and the issue has moved on to determining the mechanics of how future reserves can be shared, which in turn will depend on what is considered an appropriate level of reserve for the RBI.
The government thinks this should be in the range of 12-18 per cent of assets, against the present level of 28 per cent, which gives out the magic number of about Rs 3.6 lakh crore that is being bandied about. But the mechanics of sharing – whether assets will be sold off or new money printed – will continue to be problematic.
Thus, without appearing to yield, the government seems to have reserved its right to a portion of the future reserves by getting the RBI to agree to refer the issue to an expert committee, the surest way to postpone a decision on the problem. The problem relating to the Prompt Corrective Action (PCA) framework is on a different footing and needs more explaining. Briefly, eleven distressed public sector banks were put under a regime of PCA by the RBI, based on capital erosion levels, asset quality and profitability, with the objective of “preventing further deterioration” in their position.
The measures included, amongst a host of measures, restrictions on lending and business expansion, which is what came to bite. The debate now seems framed as a tradeoff between financial stability (the health of banks) and economic growth, which makes it difficult to find a middle ground, although the government seems to think that it is too high a price to pay for sacrificing economic growth. Again, the political compulsions of an election year cannot be ignored.
The RBI’s defence that it was not as harsh as, say the US PCA norms, appears to be a response to the government’s contention that the restrictions exceeded international norms.
If viewed purely as a ratio management exercise, the programme could succeed, simply because lower business growth is seen as translating into lower NPA ratios as well as better capital ratios.
But that would be like claiming air safety record had improved after restricting flying! The merits in the opposite argument arise only from the fact that the financial position of these banks has not improved while restrictions had cramped both credit and liquidity, at a time (read election year), when government was hoping to revive the economy.
But the RBI disputes this argument too, stating that overall credit growth has risen with healthier non-PCA banks more than making up for the PCA banks, as should rightly be the case. Further, the credit problems that NBFCs and small and medium units faced came more from a reluctance of banks to lend to these sectors than from any shortage of funds.
The government wants the RBI to bring at least a few banks out of the PCA, based on criteria other than profits (which was the RBI’s criterion), but this issue has also been referred to the RBI’s Board For Financial Supervision which is reviewing the performance of the PCA programme. But the latest financial results of these banks do not hold much hope as all the banks continue to incur losses and the aggregate losses of the eleven banks in fact have doubled (from around Rs 9,500 crore in September 2017 to over Rs 20,000 crore in September 2018), bad loans have jumped by over 15 per cent in spite of a decline in lending by 8 per cent.
Clearly, drop in lending did not reduce NPAs. The problems with bank profitability run deep, which the RBI seems to acknowledge but pleads a lack of power to administer harsher medicine, such as selling or merging banks or even replacing their management. But this does not also mean that these banks could be set free to lend as in the past. The causes behind NPAs, losses and poor return on assets of public sector banks are not all addressed by the PCA framework.
It is also ironic that while at one level, the RBI stuck to its guns on the PCA, citing banks’ capital ratios, it yielded to the pressure on another capital issue, by agreeing to postpone the increased capital requirement mandated to kick in by March 2019, only because the government would not be able to find the money to fund the banks’ capital (estimated by some at Rs 1.2 trillion).
The problem of capital for banks becomes a problem of the government’s fiscal deficit, because banks simply will not be able to raise capital from the markets on their current strength. Herein is the rub - the problems of the banking sector are really those of the public sector.
Consider this: The government owns, on an average, over 70 per cent of the equity of public sector banks, which constitute over 70 per cent of the total financial system. But public sector banks account for over 90 per cent of the NPAs in the system (Rs.10 lakh crore at last count) not to speak of the loan scams and frauds, and also clocked an aggregated loss of over Rs 85,000 crore last year.
The fragile health of our banks, especially public sector banks, has been a recurring theme in every discussion of the state of the economy. Nevertheless, it is highly unlikely that any government will be keen to privatise banks not just because its borrowing programme has traditionally depended on public sector banks who hold a 45 per cent share of the G-sec market, but also because it will be a near impossible task. Public sector banks employ over half a million workforce, hold over half of the 140,000 bank branches in the country and most importantly, are the only banks willing to finance large industry, medium and small units, infrastructure and agriculture, since private banks traditionally have shunned these sectors, preferring retail and consumer credit.
Even in the case of the mandated priority sector lending, many private banks have gotten over the hurdle by the soft option of investing in priority sector lending certificates rather than lend directly to these sectors.
It is this aspect that is at the crux of the forbearance sought for public sector banks from the PCA norms, because while overall credit may have grown, as the RBI states, it was more of consumer and retail financing, while the key segments of the economy such as industry or NBFCs, which were dependent on public sector banks, were starved of credit.
It thus looks like the public sector cannot be wished away in a hurry, even if it also happens to be the source of the problems. But ownership need not matter if it can be reformed and that’s the larger issue by being blasé about its inability to run banks efficiently, the government creates the perception of being an unconcerned owner, which in turn fosters a lack of accountability that seems all pervasive in the system. Clearly, larger reforms are required and Basel norms or PCA norms only scratch the surface.
There were a few other decisions that raised eyebrows, simply because it marked a departure from the past. One relates to the management style, with RBI appearing to have agreed to being more board-led with separate board committees looking after different aspects such as banking regulation, risk management, supervision and so on; this is viewed by many as the government getting a toe hold into RBI’s decision-making process.
The other decision on the proposed MSME debt restructuring scheme to help distressed small and medium units is also somewhat surprising, coming as it does at a time when the RBI had itself wound up all forms of debt restructuring for large borrowers, virtually pointing out the insolvency route to them.
The mechanics of the scheme will be watched with interest but this seems more a token relief measure than anything substantial.