Urjit Patel highlights issue of 'creeping banking sector fiscalisation' in his new book

It is no secret that governments be it the United Progressive Alliance (UPA) or National Democratic Alliance (NDA) love to use public sector banks (PSBs) to push credit to certain sections and portray this as government-promoted economic stimulus. These can be either directed lending schemes, restructuring of certain category of accounts or outright loan waivers.

Not many central bankers talk about excessive government intervention in the daily operations of state-run banks. But, in his latest book, Overdraft: Saving the Indian Saver, Urjit Patel has devoted some space to discuss "creeping banking sector fiscalisation" or using ownership of banks as a means for day-to-day macroeconomic management rather than primarily for efficient intermediation between savers and borrowers.

"As successive governments have found their capacity for further fiscal expansion becoming constrained, it has used the banks that it owns to fire up and pump-prime the economy. Hence, the term banking sector-fiscalisation. We have been in the realm of political credit cycles for at least the last decade or so," Patel said.

In India, government controls at least 60 percent of the banking system assets. The government has refused to cede ownership of these banks since the first round of bank nationalisation in 1969. Government ownership also mean interference in the functioning of these banks and using these entities for directed lending to suit their political agenda.

‘Government’ banks In the recent past too, government has used banks to roll out the economic package announced in the backdrop of COVID-19. Most schemes announced as part of the Rs 20 lakh crore package in March was either loan or interest subvention schemes through banks. These include Rs 3 lakh crore emergency loan scheme for micro, small and medium enterprises (MSMEs) and Rs 2 lakh crore concessional credit scheme for farmers.

“Indian finance ministers, somewhat unusually as compared to colleagues elsewhere, declare ‘credit budgets’ on behalf of banks in their annual finance speech; state chief ministers, for their part, announce quinquennial write-offs; in 2008, in the lead-up to elections in the following year, the Union government did both simultaneously!” Patel said in the book.

Even after three decades of banking sector reforms, including entry of private banks, state-sponsored credit creation retains a majority share, Patel said. “Competition in the system has increased, but the large presence of government institutions in all segments – India and China are outliers among large economies in this respect – has meant that they still continue to be, in a manner of speaking, ‘Stackelberg leaders’,” Patel said.

Despite decades after the bank nationalisation, autonomy in business functions remain on paper for state-run banks. Privatisation remains an unfulfilled promise. Government’s both at the Centre and states periodically announce farm loan waivers, which is essentially spoiling the credit culture in large geographies. Back-to-back loan waivers and direct lending schemes impact the asset quality of these banks.

“The public ownership creates an environment where market discipline is perceptibly weak, and where the regulator’s remit is circumscribed,” Patel said.

Issue of dual regulation of PSBs One of the reasons that led to Patel’s premature exit from the RBI is the difference of opinion with the government on the issue of dual regulation of PSBs. The following are Patel’s major arguments on the issue of dual regulation of PSBs. In his book, Patel has highlighted the key areas where dual regulation poses problems for RBI to effectively regulate state-run banks.

- The RBI cannot remove directors and management at government banks as Section 36AA (1) of the Banking Regulation Act is not applicable to GBs.

- Section 36ACA (1) of the BR Act that provides for supersession of a bank board is also not applicable in the case of GBs (and regional rural banks or RRBs) as they are not banking companies registered under the Companies Act.

- Section 10B 6) of the BR Act that provides for removal of the chairman and managing director of a banking company is not operative in the case of GBs.

- The RBI cannot force a merger in the case of GBs as per Section 45 of the BR Act.

The government has constantly denied Patel’s arguments on this and has maintained that the RBI has enough power to regulate PSBs.