The Reserve Bank of India (RBI) has announced a slew of dramatic rule changes and draft rules to liberalise Indian banking and financial sector all in just the first seven days of October. First came the banking sector steps announced on October 1 along with the monetary policy, then the draft rules allowing easier foreign loans (external commercial borrowing or ECB) and finally on October 7, the draft rules on capital to be set aside for various categories of loans.
The purpose of this piece is to assess which of these are much needed long over-due deregulations, which are merely ease of doing business and which can amount to probably a serious leap of faith, that may lead to bad loan decisions in euphoric times.
In the following analysis, we will mark as deep green what is much needed and good reforms; light green for what are merely ease of doing business and amber for those that can result in exuberant loaning.
1. First in the monetary policy came the permission to finance acquisitions, hitherto forbidden to Indian banks. This would clearly qualify as a dark green. I remember an RBI executive way back in 2008, ruing that the Tata Motors purchase of Jaguar Land Rover (JLR) was being funded out of Mauritius. At that time, the argument still was that limited Indian bank finance should be used to expand capacity at home and not help promoters buy each other's factories. But now that savers are preferring to invest in shares and the capital market is providing abundant capital for expansion, allowing Indian banks to fund acquisitions is the right step. To repeat - this change merits a dark green!
2. The other big reform is the risk-based deposit insurance. This could be a dark green and an amber. While it will reduce the cost of deposit insurance for good banks, it may push up the cost for small private sector banks. Considering that in the last five years, RBI had to douse fires in LVB, Yes Bank, RBL and even IndusInd to some extent, this imposition of extra burden on small banks may create problems in future. RBI doesn’t allow banks to sink. So, the higher insurance may well lead more weak banks to fail thus increasing RBI's burden of playing saviour.
3. The cap on total banking sector loans to a group has been done away with. This is again a green plus an amber. The purpose of the cap was first, to encourage growth of the corporate bond market and 2. to reduce risk exposures. Any banking exposure to a conglomerate after the Rs10,000 mark is breached invited higher risk weights under the 2016 rules. This measure was possibly inadequately thought- through. But is it time to remove this rule in its entirety? Goading large corporates to borrow via bonds was a good idea and efforts are still needed to develop a bond market, a Sebi official told me. Separately, this cap discouraged too-big-to-fail entities. Some former RBI executives argued that if Rs 10,000 crore cap was too little, maybe it could have been doubled to 20,000 cr. But doing away with the cap seems drastic. May be in later more exuberant times, this rule will be viewed as amber.
4. Fourth, the ceiling on loans against debt instruments has been abolished. Again, a good market reform, provided we ensure there are alert rating agencies that immediately detect a weakening debt instrument, and deep debt markets, where banks can off load their collateral. Today, even if a bank were to realise that its collateral of debentures against a loan, is getting downgraded, it won't be able to sell off these instruments given how shallow or non-existent the corporate bond market is below AA bonds. This rule should perhaps invite a green plus amber.
5.The reduction of risk-weight on infrastructure loans lent by NBFCs is a red. Infrastructure in our country is a risky business and reducing risk weights is surprising. The only reason why this may not give us sleepless nights is that there are no private infrastructure funders. Almost all are owned by the government. And hence a default won't lead to the usual domino problems.
6. Higher caps on loans against shares, higher IPO financing etc, are par for the course. We hold them light green because these caps were set long ago and RBI is merely adjusting the permissible amount to inflation
7. In quick succession came the draft rules on ECB, which proposes to allow companies to borrow abroad to fund acquisitions and also to finance real estate. The first suspicion is RBI is doing this to counter negativity on the rupee. Rupee has been falling expecting future Trump tariff attacks. By dangling future ECB flows to buy land or to fund mergers, the RBI hopes to counter those weakening rupee fears.
More importantly, the ECB rules also liberalise the list of lenders. Now Indian banks with overseas branches can lend ECB loans. This throws open big business for banks like SBI and Bank of Baroda which have many foreign branches. They can provide rupee and foreign loans to fund acquisitions.
8. ECB in real estate was avoided so as to not make land expensive for the common man of India to buy a house. If this liberalization is very successful, and foreign and sovereign funds are attracted to Indian real estate, then a land price inflation is possible at a future date - hence amber is the colour for now. Let us see the final regulations.
9. The rules aligning capital of Indian banks to Basel 3 were announced a few days back. These reduced capitals required (i.e. risk weight) to back mortgage loans, well rated MSMEs, fully operational infrastructure projects, credit cards. All these are all much needed, even overdue steps. Indian banks are going to find themselves with even more excess capital. But mere banking capital cannot unlock growth. There has to be demand for credit. RBI's steps ensure that when growth picks up, banks won’t be wanting capital. Dark green for this one
10.And finally are the Expected Credit loss rules, which require higher provisioning for loans that show early signs of default, have been long overdue. PSU banks and the government have long resisted it. Now RBI has enforced these welcome rules but given banks five years to meet the new provisions. RBI has, in a way, sweetened the ECL rules, so that they get accepted. May be the acquisition financing was added so that a giant like SBI will complain less about the ECL. Again, dark green.
The bunch of steps have evoked diametrically different adjectives from various quarters. RBI top guns call it merely ease of doing business. But the SBI chairman calls it banking reforms especially the risk-based deposit insurance and the permission to finance acquisitions. The Chairman has a point. Seen along with drastic reduction in CRR, the RBI's mood appears to be make banks business like on the loan side, since on the deposit side they have lost their once lordly status
Time will tell if RBI has taken a leap of faith in some of these "liberalization" steps. Of course, good supervision can always save the day.
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