RBI board meeting concludes on positive note: Mature solution is good news for financial markets

The Reserve Bank of India (RBI) board meeting which went on for a dramatic nine-hour session has reached a mature solution which is acceptable to all the concerned parties. The irony, of course, is that all this could have been decided behind closed doors which would have eschewed the strong views expressed by the government in the last few weeks.

The RBI press release is succinct and to the point. There are four points made each of which is a referral to a committee thus deferring a solution which will be based on discussion.

Let us look at the capital issue. There will be a joint committee that will work out an ideal ratio for the central bank. One can suppose that it will also talk about two things. The first is the modality of transferring the excess funds which are notional. Will currency be printed or forex reserves and GSecs sold? One can hope that the committee will spell the pros and cons of the same. The fear of excessive monetisation has to be addressed.

The second is whether the committee states the purpose of use of these funds. Can it be for budget financing or for recapitalisation of banks? This is important or else the funds can be used for financing deficits through the back door.

File image of RBI Governor Urjit Patel. AFP

File image of RBI Governor Urjit Patel. AFP

The second issue of Prompt Corrective Action (PCA) of certain banks will be referred to an internal committee. This will mean that there will be further discussion on how much leeway can be given to these banks. Ideally, a roadmap should be in place which gives concessions in the framework to banks which perform.

To ensure prudence, this should be matched by capital infusion by the government so that the banks are able to stand on their legs. Any sudden withdrawal will drive the banks into a possible reckless position from where there can be no going back.

The third issue is on capital adequacy where banks have to still stick to 9 percent. This is good for the system. However, the capital conservation buffer of 0.625 percent can be achieved by 2020. Hence, in a way, both sides should be happy. Ideally, having strict rules on capital is advisable to ensure the credibility of the system.

High capital norms have kept the banks in a position of strength and dilution should ideally be the last resort. It will be interesting to see if this is permitted for all banks or just the weaker banks.

Last, on the micro, small and medium enterprise (MSME) sector there will be a careful review on restructuring standard non-performing assets (NPAs) for exposures of Rs 25 crore. SMEs like agriculture are an emotive issue in India as it is associated with weaker groups and hence comes under financial inclusion. One should hope that this is done in a judicious manner and does not turn out to be a loan mela type of exercise.

Also, one should remember that the NPA issue has swelled up due to a similar thought process going behind restructured assets where NPAs of infra, steel and power, in particular, were forgiven for some time under this large umbrella. The default rates of SMEs has been high in other developing countries and hence one needs to have safeguards to ensure that there is a strong rationale provided for allowing such restructuring with a time-bound programme for recovery. The onus will be on banks or else there can be a replay of the NPA story with a difference.

There has been no mention of Insolvency and Bankruptcy Code (IBC) and NPA recognition. In a way it reaffirms the RBI decision to remain firm which is not good for the concerned sector, especially power. This could come up in the next meeting. The issue is critical as the IBC is the innovation of the government which has been given teeth by the RBI.

The truce declared is good news for the market and should be good for the markets. Interestingly, the liquidity issue to non-banking financial companies (NBFCs) did not find mention in the RBI Press release. One can assume that the central bank was able to convince the board that the situation was not pervasive or systemic and that it had already taken enough steps to increase liquidity to banks and given them the incentive to lend more to worthy NBFCs. Besides, market signals indicate that this issue may be behind us.

It is a positive signal too for markets, global rating agencies and multilateral financial institutions. The various committees will provide further guidance on all these issues. It will hopefully be business as usual for the financial sector from now onwards.

(The writer is Chief Economist, CARE Ratings; and author of Economics of India: How to fool all people for all times)

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Updated Date: Nov 20, 2018 08:01:26 IST

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