The RBI has decided to get involved in the nitty-gritty of the bad loans problem at both ends—acting against defaulters as well as helping the government figure out which banks deserve capital. The banking regulator has shown courage in taking on the rentier* networks in Indian finance.

May 2017: The Narendra Modi government empowers the Reserve Bank of India (RBI) through an ordinance to instruct banks to take action against large loan defaulters. The Indian central bank subsequently forces lenders to take powerful companies to bankruptcy court. These moves against large defaulters are unprecedented in India.

June 2017: The six members of the RBI’s monetary policy committee (MPC), which includes governor Urjit Patel, refuse to meet representatives of the finance ministry just before the new interest rate policy is to be announced, despite being asked to do so in a formal letter from New Delhi. The MPC holds its ground despite pressure from the government to cut interest rates.

December 2017: Governor Patel says in a press conference that the release of funds for bank recapitalization will be linked to internal reforms in public sector banks, so that the fresh capital is not used to seed the next boom-and-bust credit cycle. Such an allocation of capital should hopefully reduce the old problem of moral hazard.

There are three broad lessons to be gleaned from these recent developments.

First, the RBI has decided to get involved in the nitty-gritty of the bad loans problem at both ends—acting against defaulters as well as helping the government figure out which banks deserve capital. The banking regulator has shown courage in taking on the rentier networks in Indian finance.

Purists may baulk at the prospect of a central bank that gets involved in the details of the resolution process rather than designing the wider rules of the game, and some critics even wonder whether India is now just a few steps away from the days when the central bank directed credit to specific parts of the economy. These fears have been exaggerated, but the RBI needs to assure critics that its recent decisions on bad loans and bank capital should be seen as catalysing actions—given the inertia of bankers—rather than a permanent state of affairs.

Second, the decision of the Indian central bank to dive deeper into the complicated bad loan resolution process comes at a time when the institution is at a crossroads. The job of setting interest rates is now no longer the sole prerogative of the RBI governor. The task is done jointly by the six members of the MPC. It is worth speculating whether the other tasks of the central bank—financial stability, managing government debt issues, regulating banks and maintaining currency stability—will grow in relative importance.

This is not to say that the core monetary function will cease to matter. Other global central banks with monetary policy committees—which basically means every central bank that matters—continue to influence monetary policy, especially since they control the instruments to manage liquidity in the money market as well as regulatory powers over lenders. But a shift in relative importance is possible.

Third, the role of Patel in these transitions is important. He began his tenure with a wave of criticism after demonetization, but has been very influential in shifting the course of the bad loan resolution process in the right direction. Patel deserves credit for initiating bold moves that have not gone down too well in corporate boardrooms.

He has also done well to nurture the MPC system in its initial months, and there are growing signs that the committee is now settling down, with each member having an identifiable set of concerns. His public reticence—either purposefully or accidentally—has ensured that the voice of the governor does not dominate that of other MPC members in the public discourse on monetary policy. This is an important achievement given the new monetary policy framework.

There are two possible explanations for the reticence. One, Patel wants to normalize the role of the RBI governor to what it was about two decades ago—as a policymaker rather than a public figure. Two, he feels that the avoidance of friction with the government under the full glare of media attention offers him useful bargaining space in private meetings with the finance minister. It is hard to pick from these two explanations, but enough has happened in recent months to undermine the belief that the RBI has abandoned its quest for operational independence over the past year. The three examples given at the very beginning of this editorial are proof enough.

Source: Livemint

*a person or entity living on income from property or investments