The governor and the Goldilocks equation: Malhotra's first-year reforms

Sanjay Malhotra has made structural changes to banking regulation to bring down costs and increase efficiency. Plus, he kicked off a benign interest regime. But there are challenges ahead

During his second monetary policy press meet in April this year, Reserve Bank of India (RBI) governor Sanjay Malhotra observed that while his name is Sanjay, he is not the Sanjaya of Mahabharata to be able to predict the future. “I do not have that divine vision that he had, but we will jointly try to manage the growth and the inflation dynamic in our country,” he said when asked if monetary policy has to do the heavy lifting to support the economy.

 

What he did not mention was his understanding of macro-economic conditions and financial sector challenges.

 

When he took over as the 26th RBI governor on 11 December, data released days before he joined showed growth for July-September quarter (FY2024-25) had plummeted to a seven-quarter low of 5.4 per cent (revised later to 5.6 per cent). Interest rates in the economy had stayed elevated as the policy repo rate had not been cut for close to five years. Bank credit growth was 10.6 per cent year-on-year, down from 20.7 per cent a year ago.

 

You did not have to be seer to see the challenges that lay ahead.

 

Malhotra, a career bureaucrat who had graduated in computer science and engineering from the Indian Institute of Technology, Kanpur, and done his Master’s in public policy from Princeton, took the bull by the horn. Over the next one year, the monetary policy committee, which the governor chairs, cut the policy repo rate by 125 basis points (bps) — the most recent 25 bps in the first week of December.

 

The central bank also ensured ample liquidity in the system, which turned into surplus from late March-early April — a factor which was necessary for monetary transmission. The cash reserve ratio requirement of banks was reduced by 100 bps — in four equal tranches — during the June policy when the repo rate was also cut by 50 bps to ensure banks passed on the benefits of lower rates in the economy. 

 

This ensured interest rates on fresh deposits fell 102 bps between February and September, while the interest effect — a new concept introduced by the RBI to measure the impact of policy repo rate cut on lending rates —on fresh rupee loans was negative 73 bps. 

 

Regulatory norms

 

Around this time, the Indian banking sector was staring at increased regulatory costs because of a range of regulations that were forthcoming. From liquidity coverage ratio to project finance and expected credit loss (ECL) norms for loan loss provisioning, these could have dented banks’ capital and profitability.

 

That there are no free lunches and every regulation comes at a cost became evident in Malhotra’s first monetary policy announcement in February this year. 

 

The RBI decided to take a fresh look at those regulations while taking feedback from stakeholders. The final norms on liquidity coverage ratio actually freed up capital, which, in turn, was expected to boost loan growth. The project finance norms also brought relief to banks as provisioning requirements were eased significantly.

 

The draft ECL norms, which came out in October, proposed a four-year period for smoothening the onetime impact of additional provisioning requirements — again a huge relief to banks.

 

During the October review, Malhotra announced 22 measures aimed at strengthening the resilience and competitiveness of the banking sector, improving credit flow and, importantly, promoting ease of doing business.

 

“The regulatory approach towards the banking sector is determined by the conditions, in terms of the growth, (and) in terms of asset quality,” C S Setty, chairman of State Bank of India told Business Standard during an interaction earlier this month. “Once you know that, the banking system is in a shape, or in a position to take certain steps, which, earlier probably would have been difficult. That is what I think the RBI is aligning to that reality.”  

 

“So many of these 22 announcements are a reflection of the strength of the banking system today,” Setty said, adding that there could not have been a better moment to roll out the ECL norms — with comfortable liquidity, capital buffers, and healthy asset quality.

 

The cost-benefit trade-off of regulations having been established, next on the agenda was to make it easier for the regulated entities to follow those norms. This resulted in consolidation of over 9,000 directions into 244 ‘master directions’, a move that is expected to ease compliance costs for banks and other regulated entities.

 

Vidushi Gupta, partner, Khaitan and Co. said, “In the near term, banks, NBFCs and fintechs will see tangible savings in cost and time… Over time, this sharper regulatory regime will lower entry barriers for new and smaller players that do not have large compliance teams, strengthen risk management for mid-sized institutions, and help attract higher-quality, long-term capital into the sector, including from global investors who place a premium on regulatory clarity.”

 

“He has been more market-friendly and more pragmatic and less of a ‘regulation is the mantra’ (person),” said an analyst who tracks the financial sector, adding Malhotra has not taken his eyes off on financial stability, which continues to be a key priority for the central bank. 

 

Exchange rate and bond market challenges

 

The RBI’s foreign exchange intervention policy was facing criticism from several quarters for maintaining the exchange rate within a tight range.

 

There has been a visible change in foreign exchange management in the last one year. The rupee has been the worst performing currency in Asia this year so far, depreciating about 4.75 per cent on the back of outflows, with the 50 per cent tariff imposed by the US on Indian exports weighing in. The rupee crossed the psychological barrier of 90 to the dollar in early December.

 

“RBI governor Malhotra does not appear to be particularly concerned about the fall in the rupee, noting that it was expected given the inflation gap between India and advanced economies,” foreign exchange analysts at Barclays said 

 

in a note earlier this month after the rupee hit 90. While revising the 2026-end rupee forecast to 94, from 92, the analysts added that should the fall in the rupee become more rapid, the RBI has plenty of ammunition via its reserves to intervene if needed.

 

Malhotra always maintained that the central bank does not target any particular level for the rupee and intervenes only to curb volatility. When asked whether the RBI has a greater tolerance for volatility, he said, “We do not think that there has been any conscious attempt to change our tolerance towards volatility.”

 

The irony of the policy repo rate cuts is that while industry and retail segments reaped the benefit of lower rates, the government’s borrowing cost did not show a similar impact. This is because transmission in the bond market has been an Achilles’ heel for the central bank, unlike transmission in the credit market, which has been effective. Sovereign bond yields actually hardened post a surprise 50 bps rate cut in June. The change in stance to neutral from accommodative, within two months, baffled the market.

 

The course correction since then has been evident with communication from the central bank becoming more nuanced. The governor assured the market that they will provide sufficient durable liquidity in the banking system.

 

“The RBI has been very open to market feedback, and this can be seen in the change in communication as well as how it conducts its liquidity operation,” said Gaura Sen Gupta, chief economist, IDFC First Bank.Under Malhotra, the RBI has infused around ₹5.5 trillion of primary liquidity so far. Another ₹1 trillion via open market operations is scheduled in December. And there is a $3 billion dollar-rupee swap scheduled for next week, which will also inject primary liquidity.

 

“In terms of communication, the governor clearly communicated that there is space to ease rates in the October policy due to the sharp fall in inflation. Even in the December policy, the RBI has kept the policy outlook open-ended, stating that the RBI will remain data-dependent,” she said, adding that the RBI has been on the front-foot on infusing durable liquidity.

 

Customer service and grievance redressal is an area which Malhotra flagged early in his tenure, which was followed up by action. “Let us keep customer-centricity at the heart of our endeavours and work towards providing seamless and user-friendly services,” Malhotra wrote to his colleagues in his 2025 New Year’s Eve message.

 

In his December monetary policy announcement, he reminded regulated entities “to keep customers central in their policies and operations, improve customer service and reduce grievances”. A two-month campaign has been announced from January 1, 2026 with an aim to resolve all grievances pending for more than a month with the RBI ombudsman.

 

The Goldilocks equation 

 

The challenge for Malhotra going ahead will come when the present Goldilocks period, which he alluded to during the December policy statement — a period of low inflation and high growth — reverses. 

 

Not to forget the pressure on the rupee. The MPC can look through this, as inflation is its main objective, but the central bank has a wider mandate. In the current scenario, as well as looking ahead, a sharp depreciation in a short period, followed by many second order effects, may have implications for financial stability. 

 

As the Mahabharata’s Sanjaya could have foretold, the good times don’t last forever.