Banking Central | RBI@90: How Mint Street fought many battles to save India from crises

Reserve Bank of India turns 90 this week.

Celebration is in the air at Mint Street as the Reserve Bank of India turns 90 on April 1.

The journey had started on this day in 1935 on the recommendations of the Hilton Young Commission as the central bank of the then British India, with three clear mandates: regulate the issue of banknotes, maintain reserves with a view to securing monetary stability, and operate the credit and currency system of the country to its advantage.

The RBI started operations by taking over from the British government the functions previously performed by the Controller of Currency and from the then Imperial Bank of India, which later transformed into the State Bank of India, the management of government accounts and public debt. With that, the existing currency offices at Calcutta (Kolkata), Bombay (Mumbai), Madras (Chennai), Rangoon (Yangon), Karachi, Lahore and Cawnpore (Kanpur) became branches of the issue department. Offices of the banking department were set up in Calcutta, Bombay, Madras, Delhi, and Rangoon. Burma (Myanmar) seceded from the Indian Union in 1937, but the Reserve Bank continued to act as the Central Bank for Burma till the Japanese occupied Burma and later up to April 1947. After the Partition, the RBI served as the central bank of Pakistan up to June 1948 when the State Bank of Pakistan took its birth.

The RBI, which was originally set up as a shareholder's bank, was nationalised on January 1, 1949 under the terms of the Reserve Bank of India (Transfer to Public Ownership) Act, 1948. It was instrumental in institutional development and helped set up institutions like the Deposit Insurance and Credit Guarantee Corporation of India, the Unit Trust of India, the Industrial Development Bank of India, the National Bank of Agriculture and Rural Development, and the Discount and Finance House of India, to build the financial infrastructure of the country.

With liberalisation, the bank's focus shifted back to core central banking functions like monetary policy, bank supervision and regulation, and overseeing the payments system and developing the financial markets.

Fighting many Battles

Over the years, the Mint Street has fought many battles against challenges from both global and domestic economies.

The forex crisis of 1991: One of the worst headwinds faced by the RBI was perhaps the the balance of payments crisis of 1991. High fiscal deficit, low foreign exchange reserves, and growing current account deficit, compounded by the Gulf War had threatened a body blow to an wobbly Indian economy. India’s foreign exchange reserves hit a nadir to sustain only two weeks of imports. To save the country from this crisis, the RBI had to airlift 47 tonnes of gold to the Bank of England and 20 tonnes to the Union Bank of Switzerland to raise $600 million.

The 2013 currency crisis: In 2013, another major crisis unfolded when the rupee went into a bloodbath. After the taper tantrum of mid-2013, besides other steps, the RBI announced two special swap windows in September 2013. First, it offered to swap the US dollar raised by banks from foreign currency non-resident (FCNR) deposits of maturity of three years and above into Indian Rupee at a concessional rate of 3.5 percent per annum, about 3 percent cheaper than the market at that time. Second, the central bank allowed lenders to raise foreign currency funding and swap them into the INR at a concessional rate of 1 percent below market.

Collectively, the two swap windows brought in $34 billion at a crucial time for India, with $26 billion raised through the FCNR route alone.

“In the afternoon of September 4, 2013, we announced the package of measures. The FCNR(B) scheme drew in $26 billion, more than any of us anticipated. But more importantly, confidence picked up, the rupee continued to firm up beyond when the money came in, partly because the global investor mood as well as Indian electoral projections also changed, and we covered our forward swaps cheaply,” former RBI governor Raghuram Rajan had said in a speech later.

The Covid Conundrum: The biggest of all challenges was, undoubtedly, navigating the financial system through the Covid-19 pandemic that broke out in 2020 and ravaged the world economy. “The outbreak of the Covid-19 pandemic is unambiguously the worst health and economic crisis in the last 100 years during peacetime with unprecedented negative consequences for output, jobs, and well-being,” RBI Governor Shaktikanta Das had said in July 2020.

The central bank announced a host of measures to fight the Covid-induced economic slowdown, including sharply cutting down interest rates to as low as 4 percent, the cash reserve ratio was lowered by around 100 bps, besides announcing an array of liquidity measures targeting small business entrepreneurs and individuals. Also, the central bank announced a moratorium on loans for stressed borrowers. The RBI’s timely crisis helped the banking system withstand the Covid shock and slowly get back to normalcy in the following period.

Tackling bad loan crisis: In the period after the global financial crisis of 2008-2010, Indian banks let loose their purse strings carelessly, pushing credit to anyone who knocked on their doors, creating a major asset quality challenge for the central bank to manage in the following years. This sort of loose lending primarily happened between 2010 and 2013.

The even bigger problem encountered by the central bank was hidden bad debt as banks didn't properly report their non-performing assets. The

lenders found a way not to disclose their actual NPAs, creating an illusion of healthy balance sheets. In 2015, the RBI under the then governor Raghuram Rajan kicked off the asset quality review (AQR), which forced the banks, particularly state-run banks, to disclose their NPAs. As a result of which, the gross NPAs in the banking system shot to double digits.

For the perspective, the gross NPA ratio of public sector banks increased from 3.8 percent at end-March 2013 to 5.4 percent at end-March 2015 and further to 12.5 percent at end-March 2017, while that of private sector banks increased from 1.9 percent to 2.2 percent to 3.5 percent over the same period. But, in the hindsight, the short-term pain was essential for a much-needed clean-up. Indian banks’ healthy balance sheets today are a result of the AQR exercise and subsequent exercises to resolve the large stock of NPA cases either through loan write-offs or recoveries.

RBI-government differences: Along the course of its journey, there have been occasions when the central bank and the government have had differences of opinion. These include issues like dual regulations of state-run banks and the use of RBI’s reserves. There have been occasions when the RBI top officials publicly expressed their displeasure on the issue of the RBI autonomy such as the scathing attack by former deputy governor Viral Acharya on the government in one of his public speeches.

“The risks of undermining the central bank’s independence are potentially catastrophic,” said Acharya, adding that rash moves could trigger a “crisis of confidence in capital markets that are tapped by governments and others in the economy”, he had said in October 2018.

Fight with raging inflation: The central bank’s biggest headache at this point is to manage inflation and gradually create room for the policy to focus on growth worries. Till June 2016, deciding interest rates was largely a one-man show with the governor taking the call on most occasions. But that changed in June 2016 when India formally shifted to Monetary Policy Committee (MPC) model which became the rate-setting panel with the RBI being only one party in the whole process.

In 2015-2016, both the government and the RBI agreed on an inflation target mechanism under which the RBI had to keep inflation between 2 percent and 6 percent. In the event of a failure to keep inflation in the target for three consecutive quarters, the RBI had to write to the government explaining the reasons for failure. And it did happen. The RBI formally failed to meet the target in 2022 and sent a letter to the government explaining the failure. The letter isn’t public so far.

In recent months, the central bank has succeeded in bringing down the headline inflation to below 6 percent but the print remains above the medium-term target of 4 percent. The RBI has clearly stated that till the time inflation doesn’t align to 4 percent in a sustainable manner, it won’t cut interest rates.

Regulatory challenges: Over the years, the RBI has acted swiftly during many bank and NBFC collapses and initiated forced take overs. These include managing the ILFS, DHFL crises, the 2020 Yes bank rescue and DBS takeover of Lakshmivilas Bank. But fresh challenges are emerging from the NBFC space. In the last six months, the RBI has aggressively clamped down on many shadow banks and has initiated scrutiny of a number of entities to assess risks on careless lending.

The RBI has recently acted against at least two non-banking finance companies (NBFCs) - JM Financial Products Ltd (JMFPL) and IIFL Finance - after observing irregularities in lending across certain categories such as gold loans and equity market-related lending. The caution is understandable. It tightened the scrutiny on the NBFC segment in the aftermath of the IL&FS and DHFL crisis a few years ago that kicked off a string of events leading to a tight liquidity situation in the banking system. The central bank had to even allow a special liquidity window for NBFCs to ease the cash shortfall and bridge the trust deficit. The central bank doesn’t want a similar crisis to happen all over again.

Fresh challenges

As the RBI turns 90 and looks ahead, one of the key challenges remains navigating the new crop of fintechs and small banks which are aggressively pushing unsecured loans to vulnerable borrowers, regulating the tricky space of India’s profit-hungry shadow banks, and making sure the Indian banking system is ring-fenced from technology-linked risks, including that from artificial intelligence. Also, the Indian central bank needs to keep a close eye on global risk factors, including those emerging from the Russia-Ukraine war, global commodity price swings. But then, the Indian central bank is no stranger to challenges.

Banking Central is a weekly column that keeps a close watch and connects the dots about the sector's most important events for readers.