Banks are not Uncle Scrooge, they raise deposits to lend: RBI Deputy Governor Vishwanathan

In another scathing attack on the government's demand for capital relaxations and increasing credit flow to borrowers, the Reserve Bank of India (RBI) has come to the defence of banks saying they are not flush with their own money like Uncle Scrooge, a fictional comic character, who is the richest duck in the world.

This time around the attack came from RBI Deputy Governor NS Vishwanathan while delivering a speech at XLRI, Jamshedpur on October 29 and comes amid growing public disagreements between the government and the banking regulator and days after a speech by Deputy Governor Viral Acharya calling for 'effective independence' of the central bank.

“It is not that banks have a huge coffer like that of Uncle Scrooge from which they make loans, but it is funds they raise through deposits that are used for making loans. Banks are not supposed to be shock absorbers of the first resort for difficulties faced by their borrowers as they do not have the luxury of delaying payments to their depositors,” said the speech on RBI website.

Given the aggressive demand from the government to infuse liquidity into non-banking financial companies (NBFCs), Vishwanathan said, “Bank credit to NBFC sector, where there is a perception of inadequate bank credit flow, grew 17.1 percent in H1 FY19 and 48.30 percent YoY (year-on-year) as on September 30 on the back of a strong base.”

On the government's growing demand to relax prompt corrective action (PCA) norms, he said, “We must guard against any push for dilution of standards in the name of aligning them with international benchmarks because that will be cherry-picking and will result in our banks being strong in a make-believe sense and not in reality.”

He defended the RBI’s decision to resist such temptations, saying: “We will build a financial system that is lot stronger than today, with which you will be proud to be associated as future entrepreneurs, depositors and investors.”

On arguments seeking a lower capital to risk weighted assets ratio (CRAR) as higher capital requirement leads to lower credit growth, the RBI Deputy Governor said, “High levels of credit growth due to ‘supply push’ have resulted in high corporate leverage and consequent NPAs (non-performing assets) in the banking system.”

Also Read: Govt should back RBI but latter should communicate more

Capital risks
By nature, banks are susceptible to risks: credit, market, liquidity etc.

In India, Basel III capital regulation has been implemented from April 1, 2013 onwards in phases and will be fully implemented by March 31, 2019. Basel rules are an internationally accepted regulatory framework providing minimum standards to be met by banks.

Overall capital requirements for banks are prescribed at 9 percent of risk weighted assets and common equity Tier 1 capital at 5.5 percent as against 8 percent and 4.5 percent, respectively.

According to Vishwanathan, if banks don’t have adequate capital, losses erode into deposits. Banks have to maintain adequate capital to ensure that probability of deposits being eroded is close to zero.

Dismissing the government's oft repeated view that public sector banks need not be subject to prudential capital regulations, he said, “Conformity to an internationally accepted regulatory regime provides required credibility to the Indian banking system, which helps Indian corporates access international markets (both financial and real) on the strength of the support provided by Indian banks. Many Indian banks also access international markets for their own capital and funding requirements.”

He added that a resilient banking system should have higher capital levels to support higher credit growth going forward.

Resolution for stressed assetsCommenting on the February 12 circular on ‘Revised Framework for Resolution of Stressed Assets’, he said its most important objective is to alter the balance of power in favour of creditors. "For long, the balance of power in our country was in favour of debtors. This changing debtor-creditor equation disturbs the status quo and it is only natural that it is facing resistance."

The earlier debtor-friendly environment made it possible for the defaulting debtors to secure moratoriums and force write-downs on debt repayment, while retaining management control over the borrowing units or thwart banks efforts to realise their dues by indulging in serial litigations.

The out-of-court restructuring mechanisms too suffered high failure rates, resulting in borrowing entities continuing to indulge in repeated defaults, confident that the balance of power remained with them.

He also hit back at the idea of allowing a resolution plan by the defaulting management saying, "While payments offered by the existing management are usually spread over a long period, new investors mostly come up with upfront cash payments rather than ‘illusory future payments’."

Vishwanathan concluded his speech by stating that a strong and stable banking system is essential for the development of the economy. "The real strength will come from recognising weaknesses in the balance sheet and making provisions for them rather than pretending to believe that the balance sheet is strong. As our insolvency and bankruptcy regime matures, many aspects of debt recovery and asset quality in the Indian financial system will match global standards. Then, our probability of default will also come down to global levels. Hopefully, those days are nearer than we think,” he added.