Bank reforms can't be shots in the dark: Rajan

Rate cut hopes can wait as RBI annual report says inflation still at upper limits

Reserve Bank of India (RBI) has warned that the slow pace of reform in the banking sector will lead to greater risk.

“Reforms cannot be shots in the dark, subjecting the economy to great uncertainty and risk,” RBI Governor Raghuram Rajan wrote in the overview of the central bank’s annual report for 2014-15, released on Thursday.

He also wrote: “Wherever possible, we have to move steadily but firmly, ever expanding the scope of reforms, while always limiting the uncertainty they create.

“The Chinese term ‘Crossing the river by feeling the stones’… is an appropriate metaphor to guide our own reforms.”

The governor stressed the need to put reforms of the banking sector, reeling under asset quality pressure, on the fast track.

Stressed assets — gross non-performing assets and restructured advances — in the banking segment were above 11 per cent of their total advances as on March end.

 

“The current stress in the banking system suggests that the real economy will not wait for the banking system, and a slow pace of reform could lead to greater, rather than lower, risk residing in the banking system,” Rajan wrote.

The government has recently announced some reforms in the banking sector such as setting up of a Bank Boards Bureau for appointments and splitting of the chairman and managing director’s post.

While welcoming the move of the government to allocate higher capital to public sector banks than what was budgeted, Rajan said the central bank will look forward to the legislation of the bankruptcy code and the Financial Resolution Authority for addressing the distress of financial institution.

The central bank also dashed hopes of any steep interest rate reduction in the future as it feels inflation will inch up to the upper band of its comfort zone.

While retail inflation — the central bank’s main gauge for price increase — dipped to a record low in July, it is expected to increase from September, as a favourable base wanes.

“Inflation projections for January 2016 are still at the upper limits of the RBI’s inflation objective,” he said. The annual report pointed out that household inflation expectation returned to double digits in the June quarter.

The central bank has targeted six per cent inflation for January.

“Inflation developments will warrant a close and continuous monitoring as part of the overall disinflation strategy that required inflation to be brought down to five per cent by January 2017,” the RBI governor said.

On economic growth, the central bank said it was still below what the country is capable of but the outlook for growth is improving gradually.

Indications from the first four months of the current financial year show RBI’s baseline projection of output growth of 7.6 per cent for FY16, up from 7.2 per cent in the previous financial year, in on track.
WHAT THE REPORT SAYS

Balance sheet

• RBI balance sheet expanded 10.1% in FY15 on rising foreign currency assets
• Transfers Rs 1,000 crore to reserves for infusing capital in NHB1

Monetary policy

• Modern monetary policy frameworks focus on price stability
• Heavy dependence of banks on retail deposits hurts monetary transmission
• Base rates are sticky and impeding monetary policy transmission
• Banks unwilling to cut base rates
• Benefit from debt management agency is small as govt on fiscal consolidation path

Asset quality

• Judicial process tends to hamper the ability of creditors to collect their dues
• Some large promoters take advantage of a bank's fear of an asset turning into a NPA

Human resource

• Public sector banks’ efforts to get talent hampered as they are not able to pay enough

Profitability

• Public sector banks’ public interest activities not fully compensated
• Govt payments should route through Jan Dhan accounts; remunerate banks appropriately

Digital & customer service

• Average value of mobile transaction beats credit, debit card
• Reviewing if banking ombudsman system should be extended to other institutions