RBI board shouldn’t dictate terms to management: Raghuram Rajan

The change in the role of the RBI board is worrisome, former Reserve Bank governor Raghuram Rajan told ET NOW’s Supriya Shrinate in an interview. The board should not intervene in operational decisions of RBI but, instead, bridge differences.

The use of Section 7 of the RBI Act would be worrying, Rajan said, adding that RBI has been entrusted with the responsibility of ensuring financial stability. He also expressed concern that non-performing assets (NPAs) in the micro, small and medium enterprises (MSME) sector may be higher than estimated. The relationship between the government and RBI has been fraught with tension in the recent past with deputy governor Viral Acharya sounding a warning about the risk of undermining RBI’s autonomy late last month.

The government has cited the hitherto unused Section 7 in letters sent to the regulator detailing the key areas in which it wants to see action by the central bank, which the latter has resisted. These issues are expected to come up for discussion at the November 19 meeting of the RBI board.

ON RBI BOARD’S ROLE

I would rather hope that people take the right lesson from what has happened so far and back off from the cliff edge. Both sides have to listen to each other but there has to also be a respect of each one’s turf. What to my mind is most worrisome is the change in the role played by the RBI’s board in all this.

The RBI’s board is not an operational board. It is not led by professional supervisors or central bankers. These are all people from different walks in life whose main role is to play the wise people to advise, to counsel, to play a Rahul Dravid, to coach in some sense but not to make operational decisions and certainly not be loud like Navjot Sidhu. This is really what I am very worried about — the change in tenor.

‘Board’s Role not Interventionist’

There are still very good people on those boards and I would hope that they would come together to bridge these differences and reduce some of the noise. The government appoints people on the board to ensure that the governance of the institution is in the direction that the country desires, to give them guidance about what different people from different walks in life think. I think that is the role of the board rather than to intervene in operational decisions and to substitute their judgement for the judgement of the professionals who actually manage RBI.

ON THE GOVERNMENT-RBI RELATIONSHIP:

Let us back off a little from the current controversy and just think a little bit about what really is the relationship between the central bank and the government. Viral Acharya gave the analogy of T20 and a Test match (in his October 26 speech). But a good analogy is a central bank is a seatbelt for the government, which is the driver. The driver may not put on the seatbelt but the seatbelt is useful in times of a crash.

Think of the central bank as thinking about that crash and saying I want to protect financial stability because I do not want that to be a terrible event and of course the driver is thinking about the process of normal driving and says well I want to be relatively free of constraints. But when they talk to each other, they realise there is some value to putting on that seatbelt. If you want to extend the analogy further, one can think of Acharya’s speech as basically being that warning which comes on when you do not put on your seatbelt.

The historic relationship between the government and RBI has been based on the fact that the government naturally and correctly thinks about pushing growth and for that it wants maximum freedom to be given to all the entities responsible for growth. While RBI focuses on financial stability and says here is the amount of growth I can allow without impinging on financial stability. The government always pushes.

There were innumerable letters on my table coming from the government saying relax this, relax that, relax something else, and they knew that we would look at the letter carefully, take a view but that view would be saying, how can we maximise growth while protecting financial stability and then, when we said no, they would go away and say okay, fine. They would think about it and two days later, another letter would come on some other issue and they would keep trying to push the boundary. Ultimately, financial stability is RBI’s responsibility and, if we failed on it, we would be held to task.

The government appoints the governor, appoints the deputies but ultimately goes by their views knowing these are professionals, they are not doing it for political reasons or for their own self-interest. They are doing it because they have taken a view on the ultimate stability of the country.

ON SECTION 7:

Let me put it this way. First, Section 7 has not been invoked. That is the good news and I do believe that when the relation gets precarious, it has to be invoked, we have to be very worried. That said, the dialogue between the Reserve Bank and the government is always an ongoing one. Sometimes there are disagreements but ultimately it works based on respect. It is when you encroach on each other’s territory that it becomes problematic and I would hope that respect gets established.

ON PROMPT CORRECTIVE ACTION (PCA) FOR STRESSED LENDERS:

Let me not go into the direct details of the PCA norms. While it is true that on some issues Basel (norms) may be a little more flexible than the Indian situation, there are many other places where the Indian situation is much more flexible than Basel. Ultimately, if we go strictly by Basel, we will get accused of being in the thrall of foreign hands and so on. On the other hand, if we do something based on the Indian situation, you are accused of not following Basel, especially when it is tighter than Basel. What you have to ask is what are the Indian conditions that require a certain level of precaution? RBI is a professional institution and should be trusted if it can explain why that level is needed.

ON MSMEs:

Now on the MSMEs, go to any country in the world, find an MSME which says it is not starved for funds. The reality is MSMEs are hard to lend to, which is why they are always clamouring for more funds. The right way to get more funds to them is to improve the formalisation, the kind of business environment they operate in. But simply opening the tap wider for them or saying less provisioning on this, runs the risk of creating loans that then come back to roost as higher NPAs.

We have to do a proper assessment of the loans we have already made. What has been the experience with the Mudra scheme? What has been the experience with other MSME lending? My worry is that NPAs there are far bigger than we think especially because there is a constant clamour to say do not declare it an NPA. That suggests that we should be more rather than less worried. The government is right in going on a move to expand the possibilities of MSMEs. The right way to do that is to improve the business environment and the credit process, but not to relax credit standards. That is an important distinction, which we should keep in mind.

ON THE CIC NOTICE TO RBI SEEKING NAMES OF DEFAULTERS:

These are two separate issues. One is the issue of fraud, which is not necessarily the same as wilful default. A wilful defaulter is somebody who does not want to pay but who has not necessarily run away with the money. On the issue of frauds, the full force of the law should be employed to bring these frauds to book and to essentially show that the Indian law enforcement structure is capable of doing that. That certainly is a work in progress. Separately, there is the issue of a number of business people who the banks believe are not paying them when they have the ability to pay and eventually through a quasi judicial process declare them wilful defaulters. I am not well versed enough in the law to understand why those names cannot be made public after they have been through a judicial process. But this is something that belongs to the legal realm rather than something I have expertise in.

ON PUNISHING BIG DEFAULTERS:

I will go by the noises that are made and it certainly seems to be that there is an intent to bring these people to book but I do think that from the longer-term perspective if fraud goes unpunished, it simply encourages more fraud. It would be good if there is a sense that there is no place on earth where you can hide because the long arm of the Indian law will come after you. This message needs to be sent if we have to protect our banking system. Ultimately you cannot prevent fraud, but you can ensure that it does not pay.

ON RBI’S POWERS OF SUPERVISION OVER PUBLIC SECTOR BANKS:

You can always enter into an endless debate about this process. Let me just say that there is room for improvement on all sides on the governance of banks, both in the private sector as well as in the public sector, both in the role the government plays as well as the role RBI plays. We have to recognise that the level of NPAs in both the public sector as well as the private sector is not by any means a level to be proud of.

We have to all examine what went wrong and do what is necessary to put the banking system on a healthy turf because going forward, the amount of lending we need to get to that 9-10% growth that we must have in order to employ all the people that are coming into the labour force, we need a healthy banking sector. Every side has to contribute and there is really not much value pointing fingers at each other, there is plenty of work for everyone to do.

ON THE GOVERNOR-FINANCE MINISTER RELATIONSHIP:

It is possible to disagree but still be respectful of each other’s territory and I think certainly in my relationships there were many disagreements but I hope there was an understanding that this was not because of bloody-mindedness but because there was a worry and they knew when RBI said yes, it meant we were taking responsibility for the financial stability consequences and we always try to maximise the potential for growth while keeping that financial stability concern.

Of course, RBI is essentially an agency of the government and of course, it has to respect the overall concern and objectives of the government but the government has entrusted it with the responsibility for financial stability and therefore it has to as a well responsible entity carry out that responsibility.

ON LIQUIDITY INFUSION:

I do not want to get into the specifics of the case because there is more information than I have on the specific frailties of NBFCs. But generally, in a situation where there is financial stress, the central bank has to figure out whether it is ultimately a liquidity problem that is infusing liquidity into the market will resolve some of those issues or is it a solvency problem that is some of these entities have taken on really bad assets and really they are decapitalised.

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