How the stressed asset problem snowballed into a tussle between RBI, govt

An exclusive excerpt from A K Bhattacharya's 'The Rise of Goliath'

Even as the banking sector was trying to come to terms with the various schemes introduced by the RBI to force them to recognize bad loans before they became a bigger problem, the government on its own introduced a set of measures for ensuring early Recognition, Recapitalization of public-sector banks, Resolution of bad assets and Reforms of banks (the four Rs). The implementation of each of these Rs posed new challenges for the financial sector and saw different types of disruption in the economy.

With respect to the first R — recognition of bad loans — a lot of action had already been initiated by the RBI in spite of resistance from banks, promoters who borrowed money from the banks and even from the government. It all started with the introduction of the AQR [Asset Quality Review] process and it was soon supplemented by the PCA [Prompt Corrective Action]….

The government …appeared to be not too happy about the RBI’s strict approach to enforcing its PCA guidelines. There was increasing clamour from industry that a large number of banks were out of business as a result of those strict recognition norms and that this was stifling funds flow to them, needed for making productive investments, which in turn would help the economy achieve higher growth. The case of a clutch of power companies that were in deep financial distress and needed a bank bailout became a bone of contention. The government wanted the RBI to allow some of the public-sector banks to resume lending to the stressed power companies so that they could rescue themselves from a financially tight situation. But the RBI was in no mood to listen to such entreaties.…

[T]here was pushback as well. Within months of the Insolvency and Bankruptcy Code swiftly deciding on liquidation of insolvent companies or their takeover by other business entities, the government began exploring alternative means to soften the blow. It began engaging with the RBI for extending preferential treatment for companies in some sectors that suffered from specific developments forcing them to default on their loan repayment obligation. When the RBI declined to make any concessions on enforcing its stressed assets recognition norms for any sectors, the matter went to court and the government supported the industry’s petition.

But the court asked the government to use provisions under the law to issue a direction to the RBI for making such a concession. That in many ways was the starting point of the RBI-government tiff over what approach should be adopted for resolving the economy’s twin balancesheet problem. Separately, the government framed an alternative stressed asset resolution package for the power sector companies. The alternative scheme was to be implemented outside the purview of the Insolvency and Bankruptcy Code. Fortunately, that scheme did not make much headway. The pushback to the RBI’s initiatives on the resolution of stressed assets came also from the Supreme Court. Borrowers aggrieved by the 12 February 2018 circular of the RBI moved the courts. They were unhappy with the RBI circular that laid down a strict time-bound recognition of stressed assets and their resolution plan. Less than a year later, in April 2019, the Supreme Court ruled that the 12 February circular of the RBI was unconstitutional, even though it stood by the insolvency resolution process under the Insolvency and Bankruptcy Code. … The RBI had no option other than reframing its guideline to address the concerns raised by the apex court of the country.

What complicated the relationship between the RBI and the government was a Rs 11,400-crore credit scam that hit the state-controlled Punjab National Bank, where diamantaires, Nirav Modi and Mehul Choksi, had used the bank’s credit facilities to finance their projects without any collaterals or guarantees. Even as the Bank was engaged in its own efforts to recover dues from Nirav Modi and Mehul Choksi, the government put the blame on lax regulation of banks by the RBI and also introduced a new piece of legislation to facilitate criminal proceedings against economic offenders who became fugitives refusing to return to India and submit themselves to the arms of the law. RBI Governor Urjit Patel responded in defence of the central bank and argued that the extant law had not sufficiently empowered him to deal with the management of public-sector banks in the same way as the law allowed him to do for private-sector bank managements…. 

What was the RBI governor’s prescription to remedy the situation? He asked for suitable amendments in the Banking Regulation Act. And all these speech he delivered in Gandhinagar, Gujarat, on 14 March 2018. Patel had hit the nail on its head. Even the effectiveness of the Insolvency and Bankruptcy Code was likely to be impaired if the government failed to pay heed to the need for improving the governance standards in public-sector banks. Even after the Code helped these banks reclaim a part of their stressed loans, the questions of reforming the public-sector banks’ management structure, giving them functional autonomy and bringing them under a stricter regulatory regime, would continue to arise with alarming frequency.

The government did not come out with any response to the governor’s detailed critique on the weaknesses in the regulatory laws for public sector banks. But it became clear that the relations between the RBI and the government were under stress. What started out as a stressed assets problem, largely for the public-sector banks, had aggravated to become a tussle between the regulator and the government. …

Raghuram Rajan put in place a series of actions to impose greater financial discipline on banks and forced them to recognize stressed assets

Even earlier, when [Raghuram] Rajan was the RBI governor, the government’s relations with the central bank had become strained. On the one hand, Rajan would make public speeches that would criticize the government’s policies on manufacturing or even its performance….The government was not pleased with such statements and their relationship soured even as Rajan left the RBI on the completion of his three-year tenure in September 2016. Even while Rajan was in charge of the central bank, the government would gradually nibble away at the RBI’s powers and autonomy. The setting up of the Monetary Policy Committee was hailed as a bold reform, entrusting the task of formulating the monetary policy with a committee consisting of the RBI governor, representatives of the central bank and a few independent experts. But the task of appointing the independent experts for the committee was left to a government committee, headed by the cabinet secretary with the RBI governor as one of the members. Similarly, the earlier freedom RBI governors would enjoy in appointing their deputy governors was gradually curtailed and brought under the discipline of an official appointments committee.

Strains in the relationship between the government and the RBI began surfacing in other areas as well. Larger questions of the central bank’s autonomy were raised and the government’s approach to the entire issue also came under attack, just as the central bank was criticized for bringing its differences with the sovereign out in the open, without trying to resolve them within the board room or through bilateral consultation with the finance minister. Deputy Governor Viral Acharya delivered a public speech in October 2018, where he forecast a grim scenario for any economy that did not heed the importance of preserving the autonomy of the central bank. Acharya’s speech was interpreted as a direct attack against the government, which had earlier cut short the tenure of one of the directors and appointed one who was politically sympathetic to the government.

The Rise of Goliath Twelve Disruptions That Changed India Author: A K Bhattacharya Publisher: Penguin Pages: 350 Price: Rs 699

The government chose to use Section 7 under the RBI Act to seek consultation with the RBI governor for some of these issues. While truce was called after a few rounds of meetings and no directions were required to be issued under the provision of the law, the relationship between the RBI and the government got strained and the resultant stress was a deeply worrying development. Eventually, on 10 December 2018, RBI Governor Urjit Patel decided to resign, citing personal reasons. The government took just a day to identify Patel’s successor—a retired IAS officer, Shaktikanta Das….

Who were the key disrupters in the financial sector? Clearly, RBI Governor Raghuram Rajan was the primary disrupter. He put in place a series of actions to impose greater financial discipline on banks and forced them to recognize stressed assets as well as undertake corrective steps to resolve them. He may be accused of not taking those steps as quickly as possible, but the disruption he caused to the financial sector is irrefutable. Urjit Patel and Finance Minister Arun Jaitley would also rank among the other prominent disrupters. They changed the way banking stress was tackled, increasing the pressure on the banks and the overall financial system. But in that process they allowed their different approaches and strategies to resolve stressed assets to become a cause for a strained relationship between the regulator and the government. The long-term consequences of such a disruption are not yet known. It will take a lot of effort for future finance ministers and governors of the central bank to amend the relationship, repair the damage inflicted on the perception of a regulator’s independence and ameliorate the impact of the disruption that the economy experienced as a result. 

Reproduced with permission