Securing autonomy — ball in RBI’s court

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Published: Monday, 26th November 2018

The crucial Nov.19 board meeting of the RBI, which threatened at one point to be an eyeball-to-eyeball confrontation, has passed without any fireworks and that in itself is some good news. At an institution like the RBI, it is never comfortable when the board confronts the Governor and the executive leadership in so direct a manner. The formal RBI communication following the board meeting was short but well drafted and to the point, covering the four points of the dispute – the Basel regulatory capital framework, liquidity for stressed MSMEs, Economic Capital Framework (ECF), and bank health under Prompt Corrective Action (PCA).  The overall direction is welcome and is in the interest of the autonomy of the RBI even though this is what was under challenge in the run up to the meeting. It is now time for the RBI leadership to reflect on why the situation came to this pass and what it must do from here on to ensure that the institution preserves its autonomy while delivering its mandate of growth with financial stability. The RBI leadership, which was criticised for non-transparency and lack of communication during the time of demonetisation, must now ask whether there is something fundamentally wrong in the manner in which it communicates, seeks to build consensus and deliver on its mandate.

The board asking some tough questions and demanding a directional change in the approach of some of the RBI frameworks is not in itself a bad development. S Gurumurthy may be ideologically motivated but the questions he and the board raised are rational, reasonable and demand answers. Independent directors, who have voting rights on the board raising questions is a healthy development though the board’s perceived aggression has been criticised. Equally, we must accept that it is the task of the RBI leadership to convince them and indeed to convince the nation of its approach and its path. This means a fundamental change. The RBI must become more open and must disclose more, engage more and in general talk more. In the past, the RBI has had governors who have spoken freely and those who did not. In the current era, this is not a choice.

It is now time for the RBI leadership to reflect on why the situation came to this pass and what it must do from here on to ensure that the institution preserves its autonomy while delivering its mandate of growth with financial stability. The RBI leadership, which was criticised for non-transparency and lack of communication during the time of demonetisation, must now ask whether there is something fundamentally wrong in the manner in which it communicates, seeks to build consensus and deliver on its mandate.

The issue of the Economic Capital Framework, or ECF, is a good example of how lack of transparency can raise doubts and invite criticism.

Never in more than 80 years of history has there been such a public debate on this issue. There are two much-debated elements in the RBI accounts. One is surplus transfer to the government in the income-expenditure statement and the second is transfer to the following four funds or accounts: (i) Contingency Fund (CF), (ii) Asset Development Fund (ADF), (iii) Currency and Gold Revaluation Account (CGRA) and (iv) Foreign Exchange Revaluation Account (FCVA).  Over the years, these four have aggregated Rs. 9,498.22 billion and forms 26.25 per cent of the total assets. Critics say such capital buffer is unwarranted and a part of this should be transferred to government, which, after all, is the owner. Besides, the demand is that there should not be any provisioning made for the CF and ADF. In 2017-18, as much as Rs.141.80 billion was transferred from its gross income to the CF. RBI made this provisioning to the CF after a gap of consecutive four years (2016-17, 2015-16, 2014-15 and 2014-13), during which time there was nil transfer. Indications are that this was based on the recommendations of the Malegam Committee II.  The report, however, is not in the public domain. This implies that the RBI transferred the entire surplus to the government.

Against the above backdrop, it is important to briefly revisit the history of RBI accounts. The RBI annual report for 1994-95 recognised that “an adequate Contingency Reserve balance is necessary such as to meet any unforeseen liability…” In subsequent years, provisioning was done to make the CF a percentage of total assets to reach the target of 12 per cent from an abysmally low rate of 0.5 per cent as on end-June 1993. Currently, the ratio is 7.05 per cent. Never has this ratio reached 12 per cent. It touched a high of 11.89 per cent as on June 30 2009. Thereafter, there has been a steady decline.

Some important lessons can be learned here. First, the Malegam Committee II report should have been in the public domain. Since it is not, no one is clear whether the stoppage of provisioning was based on a committee report and what caused a return to the practice of provisioning to the CF. Second, since the discontinuation of transfers to the CF was done apparently through a committee report, the return of provisioning for the CF and ADF should have also been guided by a committee.

The board advised the RBI to consider a scheme for restructuring of stressed assets of MSME borrowers with aggregate credit facilities of up to Rs. 250 million, subject conditions that are necessary for financial stability. The board, quite correctly, has not imposed a diktat but made the credit facilities arrangements conditional to financial stability. This has its positive fallouts as the RBI can now become an enabler of policies that can grow lending to the MSME even in the midst of an atmosphere that is not conducive to advancing such credit.

By being inconsistent, the RBI has invited many doubts and questions. It is recognised and accepted that a unilateral decision is invariably suboptimal. RBI has no dearth of technical experts. Now it is the time for the RBI to come out with a well-documented policy, discussions and research on the Prompt Corrective Action (PCA) and ECF.  The onus is now on RBI to change. That is the only way to both ensure and strengthen its autonomy. 

With regard to MSMEs, the board advised the RBI to consider a scheme for restructuring of stressed assets of MSME borrowers with aggregate credit facilities of up to Rs. 250 million, subject conditions that are necessary for financial stability. The board, quite correctly, has not imposed a diktat but made the credit facilities arrangements conditional to financial stability. This has its positive fallouts as the RBI can now become an enabler of policies that can grow lending to the MSME even in the midst of an atmosphere that is not conducive to advancing such credit. However, this will have to be with appropriate caution and due diligence.

The board concurred that CRAR (Capital to Risk Asset Ratio) of banks will remain at 9 per cent, putting an end to the clamour for a reduction to 8 per cent. The extension of the transition period of the Capital Conservation Buffer (CCB) by one year (up to March 31, 2020) could broadly be in line with the Basel regulatory framework guidelines.

The board has shown its maturity and wisdom with the decision to constitute a committee in respect of ECF and examination of PCA by the Board for Financial Supervision (BFS).  RBI performs financial supervision under the guidance of BFS since November 1994. Let the BFS re-examine the PCA framework and suggest an appropriate remedy to prevent further erosion of capital of PCA banks. RBI with its rich experience and high quality research and technical expertise should convince the BFS of the merit of BFS. If RBI cannot convince BFS, how can the RBI convince the people of our country?

In sum, it is possible to look at the crisis as an opportunity that the RBI leadership can seize to secure the autonomy of the institution.  The onus is therefore now on the RBI to ensure its autonomy.

(Pattnaik is a former Central banker and Rattanani is a journalist. Both are faculty members at SPJIMR)