More banks doesn't mean more banking: Y V Reddy

Nobel laureate Joseph Stiglitz once said that if America had a central banker like YV Reddy it wouldn't have been in such a mess. High praise has been showered on this former RBI Governor for the manner in which he regulated banks, raised rates and reserve requirements, imposed provisions and risk weights to shield the economy and the banking system from over heated asset markets. The tough task was to do it against wide spread opposition.

It comes as no surprise then that CNBC TV18's Banking Awards jury selected YV Reddy this year for the highest honour for lifetime contribution to the Indian financial sector.

Below is an edited transcript of his interview. Watch the accompanying videos for more.

Q: Despite hanging your boots from policy making, you are very much in the central banking and the policy making circuit. What is your understanding of the sovereign debt crisis in Europe? Do you think it gets resolved without an accident?

A: At the onset I would say there is a bit of a mislabeling in that diagnosis. It's not entirely a sovereign debt crisis. Even the southern countries which are having a 'sovereign debt problem', it gives an impression that it was fiscal mismanagement. In the case of Greece, yes, but if you see in Ireland, fiscal management was very responsible but it's the banking crisis which brought about a fiscal problem.

So, not all countries which are facing fiscal problems are facing it because of fiscal mismanagement. Quite a lot of countries are facing fiscal problems because of the sins of the financial sector. Secondly, how did these countries get to that position, because they are funded by the financial sector of Northern Europe? In a way if these countries had the option to restructure their debt then the irresponsible lending by the North European banks will come to light. So, yes, there is a sovereign debt problem but it is as much a financial sector problem.

Q: Is it in that sense an easier crisis to solve?

A: No, it is not. A financial crisis is tough but ultimately that is how it comes on to the sovereign debt crisis. When you keep labeling that it is a sovereign debt crisis, people think that every country which is involved in this has indulged in fiscal mismanagement. There are only two countries where you can positively say that there was a fiscal mismanagement in particular Greece which had the benefit of advice of the famous Goldman Sachs. Even there you can go back to the advice of the financial sector.

In a way, the European problem is three fold. There are three legs on which the problem rests and therefore the solution will have to be on all three legs. One is the debt problem where the fiscal position is not comfortable either because of fiscal mismanagement or because of the problems of the financial sector which have come on to the fiscal situation, so there is a problem, particularly, a sovereign debt problem.
 
The second leg is the financial sector problem in the sense the banks in Northern Europe are over exposed to toxic assets. This is on top of pretty low capital adequacies. So to start of they are not good enough and then they indulge in giving debt and it is inconceivable that they did not know the real fiscal position of the countries within the eurozone.

It is inconceivable that if you are a reasonably good financial sector person you should have enough analysis done. Obviously, there was not so responsible lending. The stress is on the balance sheets of the Northern European banks though there is some spillover into the US also.

The third leg is the institutional structures in Europe. The institutional structures when it was conceived in the eurozone are that there is a common currency and common monetary policy but multiple Fisc. So there is no central fiscal authority.

Q: If they can't get the central fiscal authority does it mean the euro has to demise?

A: How do you handle it? It is a very unique problem and therefore I would say you must think of unconventional measures. Why is this taking place? It is because it is not a technical solution. What we are looking at is burden sharing. Who bears how much burden? Those in the North would like to say that it is Southern Europe's fiscal mismanagement. You tax your people and you come up with a plan whereby you pay for your past sins of mismanagement, is the view of Northern Europe.

Q: But their banks you say are equally to blame?

A: Southern Europe actually benefitted. You went from in terms of growth in your economy because there they are incurring expenditure without productivity whereas you are able to export. Germany and France could not have grown the way they have grown. The question now is how do you distribute the burden?

There are three types of burdens which are to be distributed - as between different countries, as between the financial sector and the government and the third and most important thing is how do you institutionalise and you have to convince each government. Therefore, all this calls for enormous political management. It is not a technical economic problem but it is political management. In terms of political management, most of those countries are heading towards elections next year. There is an underlying socio-political commitment to maintain Europe.