In the Cold War era, they called it détente (a French word that meant a release from tension): but 19 November was not for the first time that there was an easing in the strained relations between the Reserve Bank of India (RBI) and the government.
That was on 7 February this year when at the RBI’s monetary policy meeting, some forbearance from the repayment of bank loans for small borrowers was announced — a ‘window’ of 180 days. The abolition of loan limits for medium, small and micro-enterprises (MSMEs) was also announced, in alignment with the launch of the government’s MUDRA programme. The feeling of camaraderie lasted only till mid-February when the Nirav Modi-Punjab National Bank fraud came to light.
In his remarks at The Economic Times Global Business Summit on 23 February, Finance Minister Arun Jaitley was quoted as saying, “Unfortunately in the Indian system, we politicians are accountable, but regulators are not.” That message was not lost on the central bank.
Fast forward to 19 November, which did not quite turn out to be the day of reckoning that many people thought it would be. At the RBI board meeting on that day, neither side actually blinked on the issue of transferring reserves from the RBI to the government’s accounts; the risk of another face-off between the government and the central bank hasn’t been lowered.
Sure enough, on 24 November, headlines in two business newspapers heightened the perceptions of the rising temperature: The Economic Times reported that there would be government representatives on the Board of Financial Supervision (BFS), one of the key functions under the RBI’s oversight of financial system stability. Another headline, this time in The Financial Express, cited SC Garg, economic affairs secretary at the finance ministry, calling for a review of the governance of the RBI.
But let’s go back to the outcomes of the 19 November meeting for context. Four key points emerged: (i) a committee would examine an economic capital framework (ECF) for the central bank; (ii) a certain amount of additional relief for small borrowers would be considered by restructuring SME loans up to Rs 25 crore; (iii) a possible review of the prompt corrective action (PCA) framework would be undertaken by the BFS, and (iv) the deadline for banks to meet the capital conservation buffer (CCB) requirement under Basel III norms would be extended till 2020.
Economic capital is arrived at not through accounting but via a risk estimation approach based on on-ground economic conditions, expected losses, their frequency, and amounts lost; so economic capital is an assessment of how much capital a central bank needs to hold to absorb anticipated losses. At the end of the year, say, if the expected losses do not materialise, then the central bank has excess capital which can then be transferred to the treasury or finance ministry.
The ECF is about arriving at a formula that will decide how much of the RBI’s ‘profits’ should be transferred to the government every year without compromising the financial strength of the central bank (hopefully). It may involve a change in accounting policy and the treatment of unrealised gains (or losses). Before that, of course, the ECF will arrive at a number for the ‘right’ economic capital level and perhaps transfer the current ‘excess’ to the government’s coffers.
Here’s the kicker though: If it turns out that some of the revaluation reserves end up being transferred to the government that can probably be done by selling some of the RBI’s foreign investments, or gold, and maybe by reducing the foreign exchange reserves accordingly. For that much bandied-about figure of Rs 1.5 lakh crore, that will be about $21 billion in reserves.
How will the committee arrive at the ECF? How appropriate will that framework be? What will that minimum or initial level of capital be? Important questions, which we hope the committee will answer.
Will the restructuring of small SME borrower loans actually help them? Or the banks, for that matter? According to a report prepared by TransUnion CIBIL, the ratings agency, for SIDBI Ltd (formerly the Small Industries Development Bank of India) the value of all loans to MSMEs with a loan exposure of up to Rs 25 crore was Rs 12.6 lakh crore at end-March 2018.
After the regulatory forbearance announced in February 2018, Rs 81,000 crore was classified as non-performing assets or NPAs. There is another Rs 11,000 crore that is partial NPAs, meaning that one or two lenders may have classified them as NPAs, but others treated them as standard assets.
MSME loans are classified on a scale of 1 to 10 — denoted by CIBIL MSME Rank or CMR — depending upon riskiness. The report — MSME Pulse June 2018 — estimates that by the end of March 2019, another Rs 16,000 crore will be added to the pile of NPAs: Up by 20 percent. New loan growth in this segment is about 15 percent. If that wasn’t enough, the report points out that Rs 1.2 lakh crore falls in the CR-7 to CMR-10 ranks or high-risk loans. While the estimate of Rs 16,000 crore in fresh NPAs seems reasonable, it could be higher.
The PCA framework has no doubt caused some serious heartburn among the public sector bank managements; as the owner of these banks, the government is worried too. The problem is, the stressed asset/NPA problem may get worse before it gets better; from the revisions over the last two quarters, it’s not clear if the NPA problem is fully recognised.
The PCA is a strong medicine, but should it be withdrawn before an adequate degree of cure has been effected? What about the signalling effect to the banks? The PCA was implemented after all else had failed. Then look at the National Company Law Tribunal (NCLT) that has so effectively moved against the largest borrowers. Compromising on the seriousness of that process isn’t advisable. Some people worry that an NCLT review could be next (look at the suggestion about putting government nominees on the BFS, which also raises a question about conflict of interest).
The last item on the 19 November board meeting list does not look like a big deal, and probably isn’t. Indian banks have a capital adequacy ratio that is higher than the Basel III requirements already. And it’s only a shift in the deadline. Perhaps that is a reasonable concession to make. Here’s the question though: Why not also apply an economic capital framework for the banking system?
The Cold War détente was first set in motion when then-US President Jimmy Carter initiated the Strategic Arms Limitation Talks, or SALT, with the erstwhile USSR to limit the growth of nuclear weapons arsenals. When President Ronald Reagan was elected in 1980, he jettisoned SALT, and replaced it with another set of arms limitation negotiations a Strategic Arms Reduction Treaty, or START. The rest, as they say, is history.
People and markets now await the second – or third – détente in the RBI-finance ministry face-off. The RBI is what is called an institution with an economic purpose. The outcome of this set of negotiations will define how well it fulfills its purpose.
(The writer is a senior journalist and communications consultant)
Updated Date: Nov 27, 2018 12:53 PM