Banks at 'poverty line' of capital will stay poor: RBI executive director

The 12-minute speech by Sudarshan Sen focused on why all banks, not merely internationally active ones, should maintain a higher minimum capital than what is prescribed under the Basel framework

Public sector banks (PSBs) need to maintain the minimum regulatory capital despite sovereign backing in a bid to avoid losing market credibility and keeping off a moral hazard, and for a level-playing field, Reserve Bank of India (RBI) Executive Director Sudarshan Sen said on Thursday.

“I am sure you will agree that when the going gets tough, it’s the banks with capital that will get going, and those without it will be punished by their ecosystem,” Sen said, while delivering the keynote address at the Business Standard Annual Banking Forum 2018 held here.

Sen was referring to an argument that said PSBs should not hold the minimum regulatory capital because they had the comfort of an implicit government guarantee.

The government recently had petitioned the RBI to lower the minimum regulatory capital requirement for PSBs from 9 per cent of their risk-weighted assets (RWAs) to 8 per cent in line with the recommendations of the Basel framework. However, the RBI’s central board, which has top finance ministry bureaucrats as representatives, decided to stick with its regulations in the nine-hour-long meeting held on November 19.

He quoted research studies to say the minimum core capital ratio should be in the range of 9-53 per cent with a median of 13 per cent. “Banks which choose to operate at the poverty line where capital is concerned are condemned to stay poor,” Sen added.

The 12-minute speech by Sen focused on why all banks, not merely internationally active ones, should maintain a higher minimum capital than what is prescribed under the Basel framework, and sought to settle the debate on why the RBI had set a stricter regulatory regime for banks than other regulators in the world.

He based his arguments on the low level of recovery by Indian banks compared to their international peers and a lower level of provisioning of bad loans in their balance sheets.

“We did a comparison of India with emerging economies and the world and found that India is one of those countries which has the highest unprovided NPAs (non-performing assets) in relation to the capital,” Sen said.

He highlighted how the Basel framework had three pillars, of which two are linked to capital requirements. 

“The pillar II of the Basel framework is the supervisory programme for assessment of risk and capital. The RBI’s supervision team annually computes capital for all the banks but we don't enforce it. They don't even communicate it,” Sen emphasised.

He said if pillar-II capital norms set by Basel were enforced, it would lead to an additional capital requirement of more than Rs 2 trillion for banks. 

“And this is a number we are not pulling out of our hat. The supervisory programme for risk capital has been independently validated and, therefore, it is possible that in times to come banks will be required to hold supervisory capital,” the RBI’s executive director said.

Sen pointed out how globally banks, which are required to maintain the regulatory capital at 8 per cent, operated at levels of 14 per cent or higher. “So the meaningful debate would be on what should be the optimal level of capital for banks in India, given the ground realities. And not on whether the poverty line should be 8 or 9 per cent. Because that's not where we want to be,” he said.