RBI, govt find middle ground but jury on financial stability yet to be out

A lot has been spoken about the marathon nine-hour board meeting of the Reserve Bank of India that ended in a truce between the central bank and government, diffusing tensions on several important issues for now.

Some suggest the government tamed the RBI to give up decision making on many issues, while others believe the central bank stood up to maintain its autonomy on certain issues.

The central board of directors of the RBI including some nominees from the central bank and the government struck a middle ground and issued a 175-word statement late evening on November 19.

The meeting has evoked a debate on decision making in the higher echelons.

Since India’s independence, said Ashvin Parekh, Managing Partner of Ashvin Parekh Advisory Services, several important decisions have been made through committees and cannot be attributed to a particular institution.

“But in the process, the level of tolerance that government has to show to the institutions has reduced,” he said.

The key takeaway of the meeting on November 19 was that the RBI and the government would set up an external committee to look into the transfer of RBI’s balance sheet surplus to the government, extend the implementation deadline for the Basel-III capital framework by a year, and consider a restructuring scheme for loans to micro, small and medium enterprises (MSMEs) by up to Rs 25 crore.

Further, the much-discussed prompt corrective action (PCA) framework of the central bank will be examined by the Board for Financial Supervision (BFS).

“Based on the existing norms, almost 17 out of 21 PSBs would come under the PCA framework, even though only 11 of them are formally placed under PCA. With the PCA framework now to be examined by the BFS of RBI, one may explore scenarios for a faster exit of banks from PCA framework,” said Karthik Srinivasan, Group Head- Financial Sector ratings, ICRA.

Also Read: Is the system ready to relax PCA norms?

Although this may seem a win for the government, Parekh believes a lot of accountability will certainly be lost given a committee will take a lot of decisions and maybe not RBI.

In essence, no one person will now take responsibility for the decision.

“So if the government's mission is to improve the governance and reduce governing, then that is blatantly killed over here,” he said.

On the committee formation, Parekh insisted the knowledge on the subject within the members will matter. “If we do have mature committee members, it could manage the outcome well. More than the side they are representing, their respect and knowledge for the other views will matter."

The government also refrained from raising the subject of invoking the historically unused Section 7 of the RBI Act.

A chief executive officer of a large public sector bank said he expected no sparks from the meeting and “the sovereign has always been higher in authority than the banking regulator. This meeting also proved that."

The fissure between the Finance Ministry and the RBI first came to light when Governor Urjit Patel’s speech in March this year spoke about the lack of regulatory powers with RBI to govern public sector banks.

The anxiousness of the market ahead of the board meeting was led by the sharp outburst by Deputy Governor Viral Acharya in October-end calling for RBI’s “effective independence”.

Reports also floated about the possible resignations of the two RBI executives ahead or on the day of the board meeting.

Meanwhile, the government was constantly pushing to ensure more credit flow and support MSMEs and the board ‘advised’ the RBI to consider the restructuring scheme for stressed standard assets in the MSME sector, subject to conditions that will ensure “financial stability”, the RBI statement said.

Parekh said, “While many feel RBI had to cow down a little, my view is that this is the first time after so many years, a regulator stood up to point out his point of view. In the process, of course, the government is taking away a lot of independence from the RBI. Now the decision making is given to the committee.”

The government has given a task to the regulator to keep the financial sector sound and stable for which regulator decides some surplus to be kept aside. “Now, if the government is looking to withdraw a part of it and also wants RBI to maintain the stability it may contradict.”

RBI stood firm on its point to retain the capital ratio requirement by banks at nine percent and also agreed to examine the Economic Capital Framework (ECF) through a committee, "the membership and terms of reference of which will be jointly determined by the government of India and the RBI,” the central bank statement said.

On the surplus transfer demand, experts feel much of the macroeconomic dynamics have changed over the past six months based on just two issues of oil prices and rupee depreciation. Bad loan situation is also yet to see the desired success under the insolvency and bankruptcy code while the law is still evolving.

Therefore, the jury is still to be out on what surplus is needed for financial stability.

For now, the mutual agreement to disagree is something to cheer about.