Two words for property in Urdu — Amaanat and Jagir — have very different connotations. Amaanat implies trusteeship (you don’t own it but are a temporary custodian tasked with passing it on safely to future generations) while Jagir implies ownership (you have absolute rights with no expectations of prudence). Society allows banks to raise up to 20 times their equity as loans because we expect banks to be run, governed and owned by prudent custodians who treat our money like their own. Unfortunately, our Rs 10 lakh crore plus in bad loans arise from a past where shareholders, policy-makers, regulators, board directors and management treated banks like Jagir rather than Amaanat. But putting poverty in the museum needs a banking system that is bigger, safer and boring. Seven policy moves over the last few years — unusual courage by the RBI management and finance ministry — nudge us in that direction because they are not a passing shower but climate change for banks.
The history of bank policy-making is important. In 1957, the governor of the Reserve Bank of India (RBI) resigned when the finance minister told him to follow orders because “the RBI is not even a department but a section of the finance ministry”. In 1969, after overruling objections of the RBI governor to bank nationalisation, government banks were exempted from important banking regulation and policy began sliding. In the 1970s, the process of appointing bank board members and management assassinated meritocracy and consequently killed integrity, culture, and governance. In 1981 the RBI governor supported the second round of bank nationalisation. In the 1980s loan melas — subsidies masquerading as credit — began. Over the next 30 years silly bad loan accounting, poor bank governance, and regulatory forbearance began a slippery slope that enabled a reckless expansion of credit from Rs 18 lakh crore in 2008 to 54 lakh crore in 2014.
Seven big changes in the policy environment for banks began in April 2016 with the government passing the Insolvency and Bankruptcy Code (IBC). This historic reform ended bank impotency, confronted crony capitalism, and enabled asset redeployment. In April 2017, the RBI refurbished its decades-old prompt corrective action framework with mandatory three-tier action on troubled banks based on a transparent matrix of capital, asset quality, profitability and leverage. In June 2017 the RBI directed banks to refer all accounts with total outstanding loans greater than Rs 5,000 crore, with at least three-fifths (60 per cent) classified as non-performing as on March 31, 2016 to the IBC. In January 2018 the government amended the IBC to exclude defaulting promoters from participating in the bankruptcy process. In February 2018, the RBI atoned for decades of forbearance in bank loan accounting by issuing a circular that made NPA recognition timely, real, and unavoidable. In March 2018, the RBI signaled a new enforcement regime by forcing a bank to not only reverse rule violating treasury profits but imposed its biggest ever fine (Rs 58.9 crore). Actions over the last few months signal that individual accountability for bank managements is being restored. Finally, last week’s move on the ILFS signals that the government will work swiftly, decisively and together to tackle problems.
Bank nationalisation was done “to give credit to farmers, small enterprises, and the self-employed”. Not only did these people not get loans, but a pathetic 50 per cent credit to GDP ratio continues to be a binding constraint for poverty reduction (this number masks massive regional differences with Arunachal at 1 per cent, Bihar at 16 per cent, and Mumbai at 120 per cent). Banking regulation has a complicated relationship with politics globally because of its peculiar ability to defer bills; the 2008 financial crisis arose partly because American politicians were compensating for lower growth with a debt fuelled consumption and housing binge. But India’s recent policy-making shift from what the law is to what it ought to be needs more.
We should end ownership-based bank regulation. We need a stronger voice of capital and skin in the game for shareholders (in government banks the management is often powerless; in private banks the shareholders are too fragmented to be powerful). The Bank Board Bureau must become an independent government bank-holding company focusing on strategy, culture, governance, accountability and growth. We need more accountability for board chairs, independent directors, auditors, etc. We need thoughtful and long-term solutions to balance central bank independence and accountability. We cannot have situations like the Allahabad High Court case with the government on the other side of the RBI and IBC in pursuing defaulters. We should invest massively in technology, human capital and specialisation in banking supervision, regulation and enforcement. Most importantly, we need higher but sustainable competition in banking to reduce spreads; any Indian bank can be highly profitable just by taking deposits and making risk-free sovereign loans.
Historically, the word Jagir implied permanence (The nawab of Hyderabad granted jagirs with the preface Takei ami shamse khamar; Yours till the sun and moon exist) and lack of accountability (the ruler of Cooch Behar spent more than 30 per cent of the state income on himself). But banks were meant to be Amaanat not Jagir and change was overdue. This shift, still incomplete and patchy, started in corporate India a decade ago. There is honour, if not glory, in doing your best in a difficult job and these seven changes represent teamwork between the finance ministry and the RBI management team. Their courage and persistence deserves our duas, respect and gratitude.
But Indian banking continues to operate way below its potential and must remember poet Iqbal’s admonition “Tu shaheen hai parvaaz hai kaam tera; You are a falcon and it is your duty to fly”. More policy teamwork and bankers thinking like trustees will strengthen India’s infrastructure of opportunity by giving every deserving individual or enterprise access to credit. And this is an important ingredient in the recipe of putting India’s poverty in the museum it belongs to.