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Giving the Reserve Bank of India more powers to tackle NPAs is not enough

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The Reserve Bank of India (RBI) seal is pictured on a gate outside the RBI headquarters in Mumbai, India, 2 February 2016. (Photo: Reuters/Danish Siddiqui).

In Brief

Recent amendments to the Reserve Bank of India (RBI) Act have drawn plausible fears that the RBI will micro-manage commercial banks, especially public sector banks (PSBs).

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The RBI possesses neither the expertise for appraising the potential and prospects of non-performing projects across sectors, nor the capacity to evaluate turnaround strategies. But these criticisms miss the underlying purpose of the amendments.

Reforms aim to shield commercial banks, especially PSBs, from the vagaries of the 3Cs — the Comptroller and Auditor General (CAG), Central Vigilance Commission (CVC) and Central Bureau of Investigation (CBI) — that have completely paralysed decision-making in public sector banks. The fear of retroactive open-ended enquiries by the CAG, CVC and CBI makes decision-making, especially for accepting losses, an anathema for PSB managements.

PSB managements have no desire to accept responsibility for non-performing assets (NPAs). The chief concern for the head of a PSB is to have a peaceful retirement, hopefully as an independent director on several well-paying private company boards. Nobody wants 3C officials knocking on one’s doors a few years into retirement. This is irrespective of the adverse impact a build-up of NPAs may have on a bank’s balance sheet, on sector prospects or even on the state of the economy.

Amendments to the RBI act try to break this logjam by effectively asking the RBI to take the lead and onus of ordering bankruptcy proceedings against defaulting borrowers. PSBs can then claim to be working strictly on the orders of the regulators and can be shielded from future penal actions.

The RBI, along with the relevant commercial bank, is in turn protected from possible attack from the 3Cs which can come on its own basis or be instigated by public interest legislation. ‘Sector committees’ will determine the actual size of the ‘haircut’ to be taken depending on the economic state of the sector in domestic and external markets, the financial strength of the original borrower and presumably the chances of revival under renewed management.

It is hoped that in being led by the RBI, commercial banks — especially PSBs — will now move ahead to resolve these festering NPAs. On last count they had mounted up to a massive Rs 7 trillion (US$108 billion), choking the flow of commercial bank credit to industry, which is now beginning to look for investment funds after a lull of nearly four years.

But amendments to the RBI Act may unfortunately not break the NPA-credit stoppage. Even a fleeting knowledge of established institutional practices, procedures and hierarchies in the RBI will reveal that the urgency needed for handling the current situation may not be possible. And time is of the essence if growth momentum is to be sustained.

The RBI will have to induct substantial sector-specific talents into these committees and also perhaps reinforce its banking supervision department in order to oversee and monitor the bankruptcy proceedings and concomitant decisions on losses to be taken by PSBs. This can be a rather involved process and carries with it the inherent risk of distracting the RBI from its crucial regulatory mandate.

In the face of the RBI’s shortcomings, should the government, as the majority owner of PSBs, not directly shoulder the responsibility of dealing with the NPAs — and the related issues of mergers, closures, privatisation and recapitalisation of PSBs? This could well supplement the RBI’s efforts.

Specifically, the government could have shielded PSBs from the 3C afflictions by establishing a holding company as recommended by the Nayak Committee. Such a holding company would make the decisions on losses to be borne and haircuts to be taken, without exposing individual PSB managements to 3C traumas. The holding company could also have set up sector committees under its aegis, whose monitoring would have been far more effective than the RBI’s given its multiple responsibilities.

It is time for the government to recognise the responsibilities that come with ownership of 76 per cent of the Indian banking sector and take measures to set it on the right course.

In the absence of the holding company, the department of financial services would do well to establish an empowered cell that will work with the RBI in addressing the NPA crisis. The cell will identify the 100-odd large borrowers in sectors that are well-known for concentrations of NPAs. The empowered cell would then lay down the conditions under which particular PSBs could expect to be recapitalised or alternatively be privatised or merged.

As the owner of PSBs, the government has to bite the bullet. Given the extreme reluctance of PSB managements to take precipitate action on NPAs, they will have to be goaded in the right direction. The RBI with its substantial persuasive powers as a regulator can assist. But as the owner, this is principally the government’s call.

Rajiv Kumar is the director of the Pahle India Foundation, Delhi, and Chancellor of Gokhale Institute of Politics and Economics, Pune.

A version of this article was first published here in Mail Today.

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