Government meddling in RBI affairs may hit Indian banking system: S&P

Global rating agency Standard and Poor's (S&P) has said the increasing involvement of the government in affairs of the central bank could undermine the hard-fought improvements in the banking system over the past few years. 

In particular, S&P Global Ratings views as credit negative the circumstances leading to the recent resignation of Urjit Patel as governor of the Reserve Bank of India (RBI). 

"We await any changes to banking system regulation at the next RBI board meeting in January 2019. At this time, we see no material change in the central bank's level of independence, especially with regards to its adoption and implementation of prudent policy.", S&P said in a statement.

The RBI has traditionally shown greater independence than many regional peers, and a robust institutional culture. But sustained and intense external pressure from the Indian government risks eroding these settings over time.

The rating agency said it could also undermine the long-term financial stability in the country. This is particularly a risk because the central bank was focusing on "four R's"--Recognition, Recapitalization, Resolution, and Reform--to restore the health of the financial sector. 

The RBI's actions in recent years have materially improved accountability and transparency in the banking system, since asset quality reviews were introduced by former governor Raghuram Rajan. 

However, this is off a low base and continues to face headwinds.

Recognition of stressed assets significantly improved following the RBI's circular on February 12, 2018, which eliminated previous schemes for restructuring. This simplified recognition and associated provisioning for stressed assets. 

Recapitalization has continued for both public and private sector banks. More needs to be done to recapitalize public sector banks in general.

The RBI's Prompt Corrective Action to rebuild capitalization at distressed banks is appropriate given the fundamental issues these banks face. Resolution of stressed assets is likely to occur within the next 12-18 months, particularly given the new bankruptcy framework and courts, it added.

"We view this system as a positive step to reduce the time and potentially increase recoveries associated with stressed assets. We believe the restrictions on the RBI's authority to reform governance of public sector banks as a weakness in its mandate", S&P added.

The central bank has demonstrated a willingness and ability to reform governance at private sector banks, which we see as a healthy check-and-balance that supports accountability and renewal of leadership. Our assessment of India's banking system continues to factor in its relatively weak governance and transparency, it added.