The face-off between the government and the Reserve Bank of India (RBI) on a number of issues almost reached the brink of breakdown of the relationship between the two sides. With general elections looming large, the government which wanted more credit for small units, liquidity in the system and more cash from the RBI to boost the economy prodded a reluctant RBI into taking some crucial measures.
The nominees of the Finance Ministry and some independent members on the Central Board pushed for various measures which were earlier stonewalled by the RBI. The Board finally approved many suggestions put forth by the government nominees after lengthy discussions. The highlight of the entire episode was that the RBI Board has finally started evolving. The following are some of the important issues before the RBI Board and how the board tackled them in its meeting on November 19.
The RBI Board, chaired by Urjit Patel, did not consider any issue relating to the RBI’s governance, but sources said it was expected to come up in the board meeting on December 14. It’s to be seen how much the RBI will relent what governance changes it will agree to implement. With the exit of Patel, the fate of the board meeting is uncertain. Governance in the central bank forms part of the agenda of the government. The government is looking for a board-driven consultative process in decision making in a bid to align the overall economic policy framework given the conflict with the central banks over many issues leading to the government invoking for the first time a provision in the RBI Act — Section 7 — to start the formal process of consultation with the RBI Governor on some issues. The government may push for broader changes in the decision-making structure in the RBI. The thinking within the government is the RBI has taken a number of crucial measures which have a bearing on the economy but with less accountability.
An existing committee of the RBI — the Board for Financial Supervision or BFS — will now review the Prompt Corrective Action (PCA) which imposes restrictions on lending on banks which have been hit by bad loans and weak capital. This is expected to lead to a few more of the 11 PSU banks which have been placed under this framework being released from curbs which could help boost lending. BFS meeting last week did not take any decision on lifting the curbs. The RBI imposed tough rules for banks under the PCA framework with curbs on lending and expansion. This affected credit flow to small and medium enterprises, forcing the government to intervene and ask the RBI to relax the PCA rules. However, the RBI refused to budge but the government nominees and some independent directors put pressure on the RBI to remove the curbs on PSU banks.
The RBI Board, while deciding to retain the capital adequacy requirement at 9 per cent, agreed to extend the transition period for implementing the last tranche of 0.625 per cent under the Capital Conservation Buffer (CCB) by one year — up to March 31, 2020. The board’s decision to extend the timeline under Basel capital regulations is likely to reduce the burden of public sector banks (PSBs) this fiscal by Rs 35,000 crore.
The government and its nominees on the RBI Board were pitching for aligning the capital requirement of banks with the international Basel requirement of 8 per cent but the RBI has insisted on 9 per cent. The government’s position was that in most countries, capital of banks is 8 per cent and the RBI’s directive of 9 per cent capital was
resulting in less money with banks. While there are only four internationally active banks in India, all others are domestic banks which need not have more than 8 per cent capital.
The RBI Board did not consider any proposal to boost liquidity for the non-banking financial sector despite a strong pitch by the government nominees. The RBI, which was insisting that there was enough liquidity in the system, may have baulked at such a move on fears that such a facility was likely to be misused. On December 5, RBI Deputy Governor Viral Acharya said liquidity pressure in the NBFC sector and ruled out any special package for the sector. The board was expected to take a view on the liquidity support in the next board meeting on December 14.
When the IL&FS issue rocked the financial sector in August this year, the non-banking financial sector was also hit with the system facing a liquidity shortage of over Rs one lakh crore. The government asked the RBI to open a special liquidity window to provide credit to the NBFC sector. However, the RBI refused to pay heed to the government requests which in turn led to the government looking at an hitherto unused Section 7 under the RBI Act to direct the RBI for a special liquidity window.
The RBI has agreed to work out a loan restructuring scheme for micro, small and medium enterprises (MSME). The RBI board advised that the central bank should consider a scheme for restructuring of stressed standard assets of MSME borrowers with aggregate credit facilities of up to Rs 25 crore, subject to such conditions as are necessary for ensuring financial stability. The RBI was earlier unwilling to consider any loan recast scheme for small units.
One of the reasons for the widening of the rift between the government and the RBI was the initiative by new RBI board member S Gurumurthy to push for more credit to small and medium enterprises which were hit by the demonetisation in November 2016, GST introduction and PCA framework. The RBI was earlier reluctant to open the fund tap more due to fears over fresh creation of bad loans in the SME sector.
On the issue of the Economic Capital Framework (ECF) which governs the Rs 9.6 lakh crore surplus of the RBI, the board decided to constitute an expert committee to examine the ECF structure, the membership and terms of reference of which will be jointly determined by the Government of India and the RBI. The board did not consider transferring any surplus amount but decided that with the RBI central board making it clear that revaluation reserves cannot be paid out. While the government had earlier indicated that the RBI has Rs 3.6 lakh crore as “excess capital” in its reserves and wanted the central bank to transfer more money to it as part of the surplus, this claim would have to be drastically reduced in the wake of the decision not to consider the revaluation gain. Sources said there were differences between the government and the RBI over who will head the committee.
Reserve Bank under Patel: A Timeline
September 4, 2016 : Government appoints Urjit Patel as RBI Governor for a three-year period
June 7, 2017: Signaling that RBI is autonomous, Patel says that monetary policy committee members declined Finance Ministry’s request to meet ahead of panel’s scheduled meet
February 12, 2018: RBI issues a circular on the classification of NPAs and norms of loan restructuring, setting a 180-day deadline for declaring a loan as NPA
February 20, 2018: Finance Ministry questions RBI for any loopholes in the system that could have led to the scam involving jeweler Nirav Modi
March 14, 2018: Patel says RBI’s legal powers to supervise and regulate public sector banks are constrained
April 9, 2018: RBI puts 11 state-owned banks under the prompt corrective action (PCA) framework for poor performance in handling bad loans, restricting their lending capacity
August 30, 2018: RBI releases its annual report saying that 99.3% of the currency notes demonetised by the government have returned to the banking system
October 20, 2018: RBI publishes a dissent note on the proposed Payments Regulatory Board, opposing an inter-ministerial committee’s recommendations for a separate regulator
October 26, 2018: RBI Deputy Governor Viral Acharya goes public to assert RBI’s autonomy, warns of the wrath of the markets if it is not maintained, through a speech.
November 17, 2018: Ahead of RBI board meeting, Finance Minister Arun Jaitley says growth should not be throttled by squeezing liquidity to the needy sectors
November 19, 2018: A 10-hour RBI central board meeting decides to set up a panel on the economic capital framework for RBI and directs it give forbearances to small businesses
December 5, 2018: Governor Urjit Patel refuses to answer queries on frictions between RBI and government, amid reports of truce between the two
December 10, 2018: Patel resigns, citing personal reasons