Last Updated : Nov 20, 2018 12:56 PM IST | Source:

Opinion | In RBI-govt compromise, central bank gives more than it takes

Some of the steps the RBI will undertake as part of the agreement with the government will undo the progress made in the banking sector.

Ravi Krishnan @writesravi

Ravi Krishnan

Moneycontrol News

The government and the Reserve Bank of India (RBI) have stepped back from the brink of disaster after an unseemly public quarrel. The terse press release (and news reports emerging from the central bank’s board meeting) suggests that the RBI responded to government concerns and the latter in turn respected the operational autonomy of the central bank.

However, while RBI seems to have saved face and stood its ground on certain issues, it has conceded space to the government, or at least to the board on operational matters. That does not augur well.

Yes, the mandate of the board is to govern the affairs of the central bank, but its role should more of an adviser and guide on overall policy direction. Operational matters are best left to management, especially as the board also has external directors wearing different hats such as industry captain or ideologue, which could lead to conflicts of interest.

Now, under government pressure, the central bank has agreed to extend the transition period for implementing the Basel III framework by one year to March 2020. It has also agreed to consider – on the advice of its board - a restructuring scheme for stressed loans in the medium, small and micro enterprises (MSME) space for credit facilities up to Rs 25 crore. Similarly, the central bank has agreed to review the prompt and corrective action (PCA) framework for weak banks.

Yes, RBI stood firm on not diluting the Basel-III norms; the minimum capital adequacy ratio stands at 9 percent, one percentage point higher than the Bank of International Settlement (BIS)-recommend standards. Similarly, it has forestalled any government raid on existing reserves. A committee will be set up to decide on an economic capital framework which will be applied to future surplus accruals. This is the right away to approach such a complex, arcane issue.

Still, the fact of the matter is that political expediency has scored. In getting the central bank to cede space on operational matters – banking supervision, capital adequacy, forbearance, etc. – the government gets to focus on its agenda of boosting growth in an election year without compromising on the fiscal deficit and earning the ire of global ratings agencies.

While the press release had the phrase the RBI would decide things “subject to such conditions as are necessary for ensuring financial stability”, the fact remains that some of these will steps will undo the progress in the banking sector in terms of recognising bad assets and improving credit culture.

As ratings agency Moody’s puts it, such relaxations “have largely been unsuccessful in addressing the underlying stress.  On the contrary, keeping stressed loans in the standard category has led to an underestimation of the extent of underlying asset quality issues by bank managements, and consequently the severity of the actions that they need to take to address the issue.”

At the end of the day, RBI is supposed to act as a check and balance to the government. That might no longer happen. All over the world, there are tensions between central banks and governments. These tensions are necessary, even healthy, because they lead to debate, discussions and then some sort of consensus. However, the government getting a say in operational matters best left to technocrats sets a bad precedent.

Does this mean that things are always best left to technocrats and that they have no accountability? Of course not. The RBI management should be answerable and held accountable through proper institutional mechanisms. Independence here doesn’t mean complete independence to do anything but within parameters set by the elected authority.

The best example of this is the comply-or-explain framework for inflation targeting. If inflation is outside the 2 to 6 percent band for more than two quarters, RBI has to explain to the central government, the reasons for failure, proposed remedial measures and the timeframe for implementing said measures.

It’s time that the laws are amended to define RBI’s functions within a proper framework that will not only clearly delineate the central bank’s autonomy in operational matters, but also hold it accountable if policy objectives set in consultation with the government aren’t met.

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First Published on Nov 20, 2018 12:56 pm
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