RBI Is Ahead Of The Curve; Govt And Bureaucracy Behind: Viral Acharya

A year after he left the Reserve Bank of India (RBI), months before his three-year tenure finished, Viral Acharya, former deputy governor, in his latest book `Quest For Restoring Financial Stability in India’, has described how fiscal dominance is the biggest bane of the banking system in India. In a candid interview, Acharya says why some weak public sector banks should be “re-privatised”, foreign banks should be allowed a larger play and large corporations should not get an entry into banking. 

Edited excerpts:

You have said the RBI had lost its governor (Urjit Patel) on the altar of financial stability. What about you? You too left six months ahead of the end of your term. Along with Patel, you had put up a big fight with the government for the RBI’s autonomy. Aren’t you too a victim?

You have delivered the first ball of the Test match with a bouncer. Let me duck it even though I am wearing a helmet. What I wanted to stress throughout the book and the message I am trying to send is that it’s not so much about personalities … There are deeper, underlying forces at work and we need institutional arrangements to guard against them. I do think the central bank was under pressure, especially when the horizons of the government got short. Resistance was put up when some of us were keen to avoid the excesses and we were trying to prevent those from occurring again … It came at a cost to many of us.

We ought to focus on why, even after acknowledging that the problem is there, having put in place the Insolvency and Bankruptcy Code (IBC), the system, instead of moving forward, has regressed in terms of making policy and cleaning up.

Individuals along the way are not so important. Many of us would do it all over again if we have to because I think we were really putting in place the foundations of financial stability for India for the next several years -- if not decades. If we had a shot at it again, I think we would go about it to preserve it all over again.

So you are admitting that you too were a victim. You said “some of us” and not the governor alone ...

No, I don’t think I said that. I had in mind certain things I wanted to accomplish as a central banker. I had my diagnosis of what was ailing the Indian financial sector. It has always been that it is not just the state of the banking sector but also fiscal arithmetic that is playing a critical role.

I had to take a call on what the best way was to raise these messages on the right platform for an open debate. If we had to move ahead with financial stability, given the resistance that we had put up -- and clearly if you need institutional reform on the fiscal side -- it requires a significant public debate, which is not going to happen overnight. So, I had to ask myself what the best role I could play was and from where?. And, of course, I had to factor in my personal circumstances.

It started with D Subbarao, and then Raghuram Rajan, Y V Reddy, and finally Patel and you. Indian central bankers have started writing books after laying down office. Of course, each book is different. While Reddy’s is an autobiography, Subbarao and Patel have focused on their tenures, and Rajan and you have compiled the speeches given during your stints, with a preface. Why do all of you decide to do this? To vent your frustrations, which you couldn’t while in office?

I would not say it is a way to vent our frustrations. Most of us are reasonable people in the sense that we expected there would be resistance to what we were trying to accomplish. It is not easy anywhere in the world to be a gatekeeper of financial stability.

What has changed over the last two-three decades is that initially you know India was essentially a nationalised country. For all practical purposes, even though government deficits were large, they were being funded through the financial repression of our banks by means of an extraordinary high statutory liquidity ratio. It was easy for the RBI to guarantee financial stability because you could just engage in financial repression and the private sector didn’t own much asset, either. Securing financial and macroeconomic stability required we move away from these things.

Looking at the friction over time, what is coming home to me is that the central bank is ahead of the curve -- ahead of the rest of the system in terms of securing the foundations of financial stability we need for long-term growth. The government and the bureaucracy continue with what is suitable for a more nationalised economy of the past. They are not yet embracing the migration to a market-based economy as substantially and as fully as we might have liked.

I see my book as one more attempt to raise in public what I think are important issues for India. It doesn’t matter whether I am in the term or outside of the term. If the issues are there and they are relevant for India, they need to be raised in some way or the other.

You came as deputy governor in charge of monetary policy but your sole focus was cleaning up the banks’ books. How did that happen? It was a mandate from the governor or your own choice?

A good question. This is, in some sense, my core strength, my expertise. This is what my research is all about: What conditions does a financial sector need to provide healthy intermediation to the economy? I had studied this in the context of public sector banks in India and how Europe has responded. It was very natural for me to be the spokesperson to create that moment of change, get the system warmed up towards what was required.

Governor Patel perhaps had these issues in his term as deputy governor. Deputy Governor (N S) Viswanathan played a very central role; he was the pillar of the foundations we were trying to put in for financial stability.

The central theme of your book is fiscal dominance and how it is affecting the banking system. Is it something unique? Isn’t that the story the world over?

You are spot on. What that observation reveals is that when growth is slow, governments -- and governments all over the world have myopic horizons -- think short-term. They try to do the quick thing, which is to get credit flowing, and create a credit-based consumption stimulus. And, for that, they start leaning on the central bank to relax the rules.

The reason why these issues are more important in India is we are yet to clean up the banking sector from the excesses of the past decade. We have not yet completed these exercises. We were moving forward but then we regressed in several steps, as a result of some of these pressures.

Then, many of these countries that we are talking about are still safe heavens. They have institutional arrangements in place and their currencies are internationalized. Therefore, during times of shocks they have automatic stabilizer in their borrowings. Actually, money floods their bond market when uncertainties rise rather than it being a problem. We don’t have that luxury; we are not a safe heaven.

The fact that our fiscal is stretched exposes us to potential sources of vulnerability. Whenever growth slows down… the pressure starts spreading down the line to the banks and the central bank gets caught up in this and is forced to relax the bank regulations.

Let’s get into some of the micro issue that you have raised in the book. You have said even the monetary policy committee (MPC) is under pressure from the government for easing the policy. And, protecting the balance sheets of public sector banks is the RBI’s responsibility. Tell us a little more.

The details are not important. Tomorrow it may happen in some other form. Pressure is pervasive. It is not that just one aspect of central banking policy is under pressure.

I would highlight when pressure is on the monetary policy front, it is a lot easier for those applying the pressure to not get their way because now there is an institutional framework under which the MPC has to function. 

Some other areas don’t have this institutional fabric. If you ask me to explain why we took a particular decision or why we relaxed accounting rules in the middle of the year, I would say it is because of the public sector banks …

The government is trying to keep the recapitalisation bill down; they have a tendency to come up with intrusive issues such as how to account for mark-to-market gains or when to recognise losses. These quarter-end things I mentioned in my book are some of the most glaring interventions … Why should accounting for bank balance sheets change mid-year? This is because you want to show a particular kind of numbers.

These banks are publicly traded. We must respect the integrity of the markets, the minority investors… Some of the pressures are really unfortunate. They are really suitable only for an era in which everything was basically, what Dr YV Reddy has said, the Hindu undivided family.

Talking about state-owned banks … India has gone for consolidation, reducing the number of these banks from 21 to 12. And there has been talk of privatisation. What’s your take on this?

Consolidation is not enough. The only reason why I have not been against consolidation is because there have been so many times when positions of managing directors and board members have been empty for long ... we need to inject capital into these banks. It will have to come from the government but the headroom for that is limited. So, we have to divest government stakes in these banks.

I would really focus on the business objectives of those relatively weak banks. They have no business to do universal banking; they should be serving the objectives of development and financial inclusion.

I think that some re-privatisation should be on the table.

We have a repressive financial system and we need banks with deep pockets. Is it time to allow large “fit and proper” corporations to float banks?

I would say no. From our experience with IBC (Insolvency and Bankruptcy Code) I know that entities are very powerful and they have the capacity to alter the rules of the game. If you let them into banking, you magnify the conflict of interest -- the root cause of our banking issues -- many fold. Those who are reluctant to let them in have exactly the right concerns.

The better examples in my view are the microfinance institutions. Some of them have done exceedingly well in their goals of providing inclusion and making money at the same time. They have developed profitable franchise as you know making a small loan at the grassroots requires not just underwriting quality but also ability to collect. You have to create incentives for the borrowers to repay so the next time when they come, they want a larger, longer maturity loan.

All this requires a lot of expertise and you can’t just derive that from being a corporate that has deep pockets. You need to start small and then as these microfinance entities grow they may now want to access to deposit base; they may want to give larger loans to some of the entities they are lending to. These should be brought into the banking fold.

I also think we could potentially open up Indian banking more to foreign banks, which will bring in expertise in underwriting, fintech and risk management practices.  Right now, we have opened up but we want them to meet the kind of rules and restrictions that we impose on domestic banks but we can’t apply that criterion because they have to bring in capital from outside.

The question they are going to ask themselves is: Can we generate return on assets in India like we do in some other parts of the world? If we want some foreign capital to come in, we have to think carefully through how do we make banking in India attractive to foreign banks. Foreign banks will always bring in a lot of expertise in underwriting, fintech and risk management practices…I think that should also be on the table.

You see a problem in the RBI being the debt manager of the government. But historically, the Indian central bank is very possessive about this function – it resisted any move to snatch it away.

I have very mixed feelings of this. What happens is that when RBI is the debt manager, it cannot remove its focus from the prices of the government bonds… It can also influence the participations in the auctions, sometimes calling up the banks to pick up (the bond). It also starts getting into the liquidity management framework and indirectly therefore into the functions which relate to monetary policy. It is very hard for the senior management to maintain Chinese wall and separate the roles of just being placement agency or auctioneer of the debt from someone who can also influence the prices of these bonds.

If the government were to take it seriously, it should put in place the technology and the human capital infrastructure and find some ways of committing not to simply call up public sector banks and large insurance companies to buy the bonds.

The RBI is a full-service central bank. The regulation of housing finance companies has been taken over by the RBI. It is also the sole regulator for cooperative banks. Does it have the bandwidth to play so many roles?

After the global financial, the emerging view on this has been that it’s better for a central bank to be a full service bank and reinvent itself to perform these functions. Take the example of UK where the supervision of the authority was separated and then there was not much coordination between the central bank as the lender of the last resort and the supervision authority.  A lot of the seeds of the global financial crisis in the United States were sown by the highly fragmented regulatory structure over different financial institutions that were in place. 

Having said this, there is definitely a need for more supervisors at the RBI. Those who come from outside are surprised at the relatively small strength of the RBI supervisory cadre, relative to the needs of the country and the needs of the financial sector. There is also a need for much greater specialization in supervisory skills.

You have said even the best-rated corporations do not service bank loans on time. On what basis you’re saying this? The bankers don’t say this. Does the CRLIC data reveal that? Shouldn’t the RBI share the data at least with the rating agencies?

My understanding is that there are some restrictions on supervisory data being shared outside of the institution. It violates certain parts of the RBI Act… A single-day default needs to be reported by the securities regulator at least for all publically listed companies. This is now required on bonds and marketable debts. Single-day default disclosure is still not required on bank loans.

A public credit registry would solve the problem rather than supervisory data being shared with rating agencies, if there are legal hurdles. We could have a public credit registry where this information is gathered and that could be shared with the banks.

How did you get to know this?

I know it from variety of sources. I would like to highlight that one advantage of being a faculty member is that you have very loyal students who give you correct information from being in the darkest corners of the financial markets and they give you insights without any sort of facing any conflicts… As you know in India, Guru is always respected a lot by his students...

Is this the norm or are such instances an exception?

I don’t know it. I didn’t do a full fledge study to know what percentage of borrowers resort to this  but one would not expect a high investment grade company to be missing its payments. Let’s put it in very stark simple understanding of what an investment grade rating is supposed to be. Any missing of payment is a default ... Even IBC says that missing of any payment is a default. So, IBC can be triggered for such a default... the law itself allows the creditor to trigger the IBC if any default has happened on a promised payment.

The legal basis of a debt contract is that once you have been given a time and an amount to pay that is the time the payment has to be made; otherwise it’s default and materially relevant information to all the other stake holders in the system.

You are recommending to make the asset quality review an annual ritual and cover the Non-banking financial companies (NBFCs) as well. They are playing a critical role in meeting consumer demand. What should be done for their healthy growth?

When you know that there are entities that might be in trouble, I think the right thing to do is to at least gather the intelligence. Stress tests and asset quality reviews are necessary … The sooner you do it, the better it is. We have given them enough time. The NBFC sector has been stabilised directly or indirectly through liquidity injections and lending by banks.

At some point, we have to actually ensure that an NBFC is fulfilling the intermediation function for which it is present. I would not be averse to some NBFCs going down the route of IBC as has been arranged because that is the contract. They are not banks; they are not being asked to meet certain requirements and that’s because they are supposed to be resolved through market mechanisms…

There is a feeling that the RBI is a weak supervisor. To cover up its weaknesses, it focuses on stricter regulations and the economy suffers ... Your comments?

That’s certainly one of the views … My diagnosis has been that massive failures happened because of the supply push on credit, which the government wanted, explicitly or indirectly, through public sector banks. Every regulator gets some supervisory functions wrong at some points of time ... (As a central banker) I would introspect, try to reinvent the quality of supervision, and make it as principle-based as possible. I think the RBI has been steadily moving in that direction … We made a very big push and there is no reason why bank regulation can’t go in that direction.

Finally, and this is a very rude question, some feel “imported” central bankers such as Rajan and you do not have enough skin in the game. You come on a lien and go back to academia. You see the world of Indian banking through a different prism …

My favourite song is “Kuch to log kahenge …”

Do we have enough skin in the game? Do we know the system enough? We are not the only ones in the RBI; there are a lot of other people. The value we bring in is precisely because we are not necessarily building long-term careers here and we have a certain level of independence in our thinking. We are happy to call the shots when they need to be called.

It’s not that we don’t study India, it’s not like we don’t have India within us. Lastly I would say that we bring skill sets from having observed how things work in different parts of the world, which is valuable for India.

We bring skill sets from having observed how things work in different parts of the world which is valuable for India to learn from. I am not saying India set doesn’t require own policies but there is no harm in learning the good practices of other countries. We bring those to the table. We need a healthy mix of foreign trend and domestic trend economist. To me, it’s irrelevant where you reside. The question is: Are you are right person for the job?

It’s great to see that your book royalty will all go towards Pratham India: Every Child in School & Learning Well and Pratham USA

I am very glad Tamal that you have actually figured this out. I am deeply committed to the cause of promoting education for the underprivileged children in India. If we can actually deliver on this on a sustained basis, it may be one of the biggest strengths of the economy because if you have the right mind you can figure out the right things to do.

Pratham has been doing excellent work in responding to Covid pandemic. It already had a lot of digital content that has been shared with 14 states all over the country… It has been using all kinds of dissemination mechanisms, including the good old radio because there are parts of the country where you can’t send things digitally as there are no Ipads, computers or laptops. Contributing my part of the royalties to Pratham is just a small way of supporting the cause.

This interview first appeared in Business Standard.

To read Tamal Bandyopadhyay's columns, log onto www.bankerstrust.in

The writer, a Consulting Editor with Business Standard, is an author and a Senior Advisor to Jana Small Finance Bank