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Bank Without Reserves

Bank Without Reserves

It has finally happened. Barely a few weeks ago, this journal had expressed its concerns over the widening rift between the Reserve Bank of India and the government. The media reports had termed the last board meeting as crucial considering the speculations that the government might invoke Section 7 of the RBI Act to force the apex bank to accept its directions. Some reports also said that RBI governor Urjit Patel might resign in case he was forced to dance to the whimsical tunes of the government.

Surprisingly, the meeting went off well with the government and the RBI taking decisions unanimously on certain contentious issues. It seemed that both the parties had used their prudence to discuss and resolve them.

It was certainly surprising to know about the resignation of Patel a few weeks after the meeting. While it was perfectly normal for the government and the RBI to have different views on certain key issues affecting the economy even before Narendra Modi came to power, the way the tiff was reported this time was unprecedented.

It all started with RBI deputy governor Viral Acharya going public on the difference of opinion between the two parties over certain issues. Of course, the words that Acharya used had a strong tone with an inherent warning.

Lo and behold, all ranging from the economic affairs secretary to the finance minister criticised Acharya for his statement. To an extent, finance minister Arun Jaitely held Urjit Patel responsible for the words used by Acharya.

The government’s differences with the RBI mainly centred on four issues -– it wanted an eased liquidity to ward off credit squeeze, relaxation in capital requirement for the lenders and also prompt corrective action rules (PCA) made for banks struggling with a huge pile of non-performing assets (PCA) and support for micro, small and medium enterprises.

One of the ways that the government wanted to ease liquidity was to dig into the reserves held by the RBI by amending its economic capital framework. Many speculated that the government’s demand for a higher share in the reserves was mainly to reduce its fiscal deficit in an election year. The matter was discussed at the last board meeting and it was decided to form an expert committee to examine the economic capital framework. The committee would decide on the amount of reserves that the RBI must hold and the balance can be transferred to the government.

Likewise, on relaxation of PCA rules for banks with NPAs, it was decided that the matter would be examined by the RBI’s board for financial supervision. Eleven of the 22 public sector banks are under the PCA framework, which scrapped the powers of the banks to restructure loans when it becomes NPA. The framework also made the one-day default rule. Before the implementation of PCA, the companies had a period of 90 days before the loan was classified as NPA. The new rules say that the borrower would be considered a defaulter even if it missed one day of its repayment schedule.

The resignation of Urjit Patel and the appointment of Shakti Kanta Das were seen as signs that the government was not comfortable with independent regulators. The fact that the new appointment was made within 48 hours of the resignation of Urjit Patel showed that the government was prepared for his resignation. It also showed its desperation in appointing a person who, perhaps, had the only qualification of being a yes man. In fact, he was the one who backed the government’s idea of demonetisation.

India is not the only country which had such a tiff with the apex Bank. In the US, president Donald Trump criticised the Fed recently and the Japanese Prime Minister Shinzo Abe forced the Bank of Japan to fall in line with his policies. What makes the Indian scenario different is the way the investors react to Patel’s resignation and Shakti Kanta’s appointment.

In case the move is seen as RBI losing its share of reserves to the government, the investors may start pulling out money from India, which is right now seen as an emerging market. This may send negative signals to the international fraternity as well. The International Monetary Fund had already raised its concerns over the independence of the RBI.

Besides it may raise questions on the bank’s ability to defend the Rupee. This was one of the reasons why the RBI defended its claim to have higher reserves at a time when India didn’t have an AAA rating.

While the expert committee would take its own time to find out the value of reserves that the bank might hold, a recent paper co-authored by former Chief Economic advisor Arvind Subramanian and three other economists had established that the RBI had substantially excess capital. The paper was published in the weekly journal Economic & Political Weekly and it was titled “Paranoia or Prudence: How much capital is enough for the RBI?”

The authors had used various methods of calculating the minimum reserves that the RBI should hold taking into account the balance sheet figures of the bank as on June 30, 2018. The authors had estimated that the RBI held a minimum of Rs. 4.5 lakh crore excess capital if calculation was made following the traditional methods. However, in case, the choice was made by following the benchmark established by other central banks, the RBI appeared to have an excess capital of a minimum of Rs. 5 lakh crore. The paper suggested that if an alternative cross country econometric analysis was used, then the excess capital was in the range of Rs. 5.7 lakh crore and Rs. 7.9 lakh crore.

Despite the fact that the paper spoke volumes about the excess reserves, it had also given a word of caution. In case the government transferred the reserves to its coffers, the money should not be used for meeting the routine fiscal deficits. Rather it should be used for recapitalising the ailing banks.

The paper would certainly give an impetus to the government’s claim and might even influence the decision of the expert committee. Be that as it may, what transpired at the RBI, does not evoke confidence in the government.

The government has also been trying to interfere in other functions of the bank. The finance minister has repeatedly said that unlike regulators only politicians were truly accountable to the general public. In a recent interview with one of the leading financial dailies, the economic affairs secretary, Subhash Garg, made it clear that the RBI board shall have a larger role in the functioning of the central bank. It clearly reinforces the government’s idea of having a less-independent central bank.

Worse, the government is advocating bad economics and policy. Under the previous governments, the public sector banks had been lending relentlessly, something that has been criticised by the current government, when cases like the PNB scam or the Vijaya Mallaya case comes up for discussion.

True, the RBI also allowed that to happen for various reasons. However, Patel came up with a strict regime of lending. While enforcing PCA rules, the RBI checked lending and ensured that the public money is not taken for granted. The borrower, instead of claiming restructuring plans and shifting its liability from one year to the other, is compelled to make payments as per the repayment schedule.

The government now wants the RBI to relax the NPA rules for the power and the telecom sector. But this would also weaken the insolvency and bankruptcy code as others may also demand the same treatment. Ironically, the government claims this code as one of its biggest achievements.

In its desperation to control each and every institution, it seems the government itself is not clear what it actually wants – a sound economic plan, which should be the same for everyone or a convenient stand that suits its tastes or those whom it wants to serve.

(The writer is a company secretary and can be reached at

(Published on 24th December 2018, Volume XXX, Issue 52)