Regulatory Supervision: Is it part of central bank autonomy?

 Regulatory Supervision: Is it part of a central bank’s autonomy?

On 13th May 2024, Business Line published excerpts of its interview with Shri Duvvuri Subba Rao, Governor RBI: 2008-13, (Shri Rao) on his latest book "Just a Mercenary?". I am yet to read the book fully, though I had a cursory glance of the book, purchased through amazon yesterday. From the interview, it appears that the book dealt at length on (i) the need to demystify the union budget for a better understanding by the common man (ii) the author’s views on the CAG's decision to go into the question of "presumptive loss” that arose due to the 'first come first served' tender process followed and (iii) the importance of not compromising on the central bank’s (RBI's) autonomy. I read the author’s first book titled "Who moved by interest rate?", in which he narrated elaborately on the pressures faced from the central government in RBI's  monetary policy decisions, particularly on the liquidity management and repo rates. 

I. I thought it fit to quote a few instances mentioned in his first book, which centred around the issue of central bank autonomy.

1. His appointment as the Governor of RBI: Shri Rao, who was made the Finance Secretary to the Government of India in April 2007, explains in detail, how the then Finance Minister (FM) Shri P. Chidambaram (PC) was instrumental in making him the Governor of RBI in September 2008 to succeed Dr.Y.V. Reddy. He is quite frank in admitting that Shri Rakesh Mohan, the then Dy. Governor of RBI, originally tipped for the said position and about whom Dr.Y.V. Reddy had a favourable inclination, was left out in the process. He also shares, as a matter of information, that by accepting the invite for the Governor position in RBI, he missed out becoming a cabinet secretary, which was within striking range after becoming the finance secretary in 2007 and his superannuation becoming due only in 2009.

2. Measures taken during the Global Financial Crisis 2008: Shri Rao had narrated quite beautifully, how the central bank handled the global financial crisis through its liquidity management measures and the policy rate changes. Repo rate was reduced from 9.0% to 4.75% in a matter of six months (from Oct 2008 to April 2009), Cash Reserve Ratio (CRR) reduced substantially, refinance facilities to the development financial institutions like NHB, NABARD, SIDBI were expanded to ease up liquidity, etc. All the measures were aimed to flush the market with rupee and forex liquidity and keep bank loan interest rates lower so that the credit delivery is on track to sustain the credit growth and thereby maintain the GDP growth. No major differences appeared during this phase, since both the government and central bank aligned with each other so as to keep the country's economy immune from the global financial crisis. Interestingly, one finds some or all of the above measures were resorted to by RBI  during the latest COVID crisis in 2020 also.

3. Relationship with the FMs/PM: 

• FM Shri P. Chidambaram (FM/PC): Within a month after assuming charge as the Governor of RBI, he had his first unpleasant experience, when the then FM, suo moto, constituted a liquidity management committee, without consulting RBI. This resulted in RBI deciding to not to participate in the said committee. This, according to the author, set the tone for what turned out to be an uneasy relationship with the finance ministry in the last 13 months of his term, when PC returned as FM in August 2012. He narrates the smart ways of the then FM to convene analysts' meet just in time, before monetary policy review meeting of RBI was held and convey his opinion - one being "I sincerely hope everybody read the statement and take note that growth is as much as a concern as inflation". When Shri Rao decided on a ‘pause’ in the repo rate in Oct’ 12, the then FM made the famous statement "If the government has to walk alone to face challenges of growth, we will walk alone". The author is of the firm view that denial of two years extension to Shri Subir Gokern, when he was eligible for reappointment as a deputy governor of RBI in Dec’ 12, was the price paid for RBI not falling in line with the government.

• FM Shri Pranab Mukherjee (FM/Pranab): Shri Subba Rao is candid in saying that Shri Pranab’s stance was straightforward expecting easing of interest rates to support growth, unlike PC, who was more nuanced to expect RBI to cut rates in acknowledgement of his fiscal consolidation efforts. He mentions the embarrassments faced by him due to the announcement made by Pranab to the business chamber of Delhi that "the governor will shortly give you good news", even before RBI conveyed its decision to reduce the repo rate by 50 bps later in the day. He also conveys his disappointment that he cut the rate by 50 bps instead of 25 bps in April 2012 on the assurance given by the FM that the government will be pruning the fiscal expenses, going forward. Even the extension of his term as Governor of RBI for two years from Sep 2011 was not conveyed to him by the FM and he came to know only after seeing the TV news. According to him, non extension of the term of Smt.Usha Thorat as deputy governor of RBI for two years during Pranab's period as FM, was the price paid for some of the regulatory actions taken by Smt.Thorat, which were not to the liking of the FM.

• Relationship with the PM: Shri Rao believes that his extension for another two years in 2011 as the Governor of RBI was due to the blessings of the then PM  Dr. Manmohan Singh. From the notes made in the book, I feel that he had a cordial relationship with the PM, who silently supported his firm stand and also understood his plight. 

II. I also present an issue, which also reflects on the autonomy of a central bank on regulatory supervision.

Lack of regulatory supervision on quality of loan assets of banks, (the growth of which more than doubled during 2008-13), did not find a mention in both the books: Just  prior to Shri Rao joining as Governor,RBI, the regulator relaxed the prudential guidelines on restructuring of advances thereby permitting existing asset classification category on all advances restructured, except those extended to CREs, Capital market exposures and personal/consumer loans. This regulatory forbearance (of not degrading the loan account by one notch after restructuring) enabled the banks to retain the standard asset status for a majority of restructured accounts, make existing provisions that are applicable for standard assets, continue the principal of accounting interest on accrual basis (irrespective of credits received) and create funded interest term loans (FITLs) in standard asset category. The banks booked bumper profits and also reported ‘healthy’ growth in advances. More and more number of ineligible accounts, which were stamped with diversion of funds later on, were added to the list year after year. The working group under Shri R. Mahapatra set up in 2012, to review the existing prudential guidelines on restructuring of advances, observed that the percentage of restructured advances to gross advances went past gross NPA percentage since March 2010 and was nearly double the percentage of gross NPAs in March 2012. The CDR mechanism was followed by SDR, 5/25 and S4A, but none of the schemes succeeded in bringing  out the real issue. Only the AQR (asset quality review) of 2016 revealed the “evergreening” resorted to by the commercial banks and there was capital erosion across all the banks. The government infused equity in majority of the PSBs, since 2017, through its innovative “recapitalisation bonds” scheme.

The above illness, which started in March 2009, continued well beyond 2013. I am tempted to say that RBI was fully aware of the issue, which centres around the autonomy enjoyed by it in regulatory supervision. One wonders, why Shri Subba Rao (Governor RBI 2008-13) did not find it fit enough to discuss this issue in both the books authored by him?

Regards

V. Viswanathan

19th May 2024