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How bank denationalisation can be a solution to tackle slowdown woes

By Gurbachan Singh

To tackle the economic slowdown, RBI has, in a phased manner, reduced the repo rate to 5.15%. With the mandated inflation target of 4%, the real repo rate stands at 1.15%. Any further cuts will hurt the interest income of depositors including the retirees. In any case, the transmission is quite weak. RBI can only make liquidity available, but cannot ensure lending. So, monetary policy has become quite ineffective. What about the fiscal policy?

The government has made a large cut in the corporate tax rate. It will lose anywhere between Rs 63,000 crore to Rs 1,45,000 crore of tax revenues annually. Thus, it will be hard to meet the 3.3% fiscal deficit target. If we were to refer to Reinhart and Rogoff 's suggested metric deficit to tax ratio instead of the metric deficit to GDP ratio to size up the fiscal condition, the situation is far worse. Also, considerable borrowing has been carried out through public sector undertakings. There are contingent liabilities due to guarantees provided by the GOI. Furthermore, the latter has been using disinvestment proceeds primarily for revenue expenditure. There are difficulties in the finances of the state governments as well.

Given these constraints, it is becoming hard to use an expansionary fiscal policy. The GOI has already violated the spirit of the FRBM Act. Should we now dump the Act itself, as TN Ninan has suggested? That may not be advisable. The FRBM Act has served as a prudential safeguard.

The answer, therefore, lies in the banking policy. Banks despite having deposits, have limited capital. Given the Basel capital adequacy norms, they are constrained. That indicates to a problem of supply of credit. But, do we have enough demand for credit?

During a slowdown the credit market is sluggish. From April-September, 2018 to April-September, 2019, the flow of funds from banks to the commercial sector has collapsed from (+) Rs 1,85,083 crore to Rs 1,28,760 crore, reflecting a fall of Rs 3,13,843 crore. The correlation between economic slowdown and credit is clear, the causality is not. So, does low credit cause a slowdown, or is it the other way round? Let us consider both possibilities. In the first case where low credit causes a slowdown, there is an obvious reason for restoring the supply of credit so that the slowdown is tackled.

But what if the economic slowdown causes low credit? For a given group of borrowers, the demand for credit in a slowdown is indeed less than what it was in normalcy or in times of a boom. This, however, does not imply that there is no demand or even little demand among other groups. We are all familiar with the extent to which there is a sellers' (or lenders’) market in so far as credit availability is concerned. Now even if due to an economic slowdown there is less demandthat does not imply thete is little demand for credit. More so when the growth rate of GDP is still positive, even if it is less than 5%.

In fact, many private banks are still lending even in this phase of slowdown. But the public sector banks (PSBs) have, for a while, not been meeting that demand adequately. It can be that they were or still are capital constrained. Alternatively, they are just unwilling to lend. I will come to the latter possibility later. Let us for the moment deal with the issue of capital constraint among the PSBs. The GOI is fiscally constrained and reluctant to recapitalise as and when banks are short of capital. For one, it encourages moral hazard in loss making PSBs. However, it has the fear that if it does not recapitalise, lending will fall and an economic slowdown will result or worsen. So, it eventually tends to give in; in the meantime, there is a slowdown! But what is the way out?

Simply put, the GOI can denationalise the PSBs-in a phased manner, transparently, at a reasonable price, and under the condition that the sale proceeds are used for 'aam aadmi'. Of course, social and macro-prudential regulation needs to be strengthened so that the objectives of social justice and macro-financial stability can be met through appropriate regulation of banks. There are reasons to believe that the ruling party has enough control or influence in the Parliament to make suitable amendments that pave the way for denationalisation.

The general argument for denationalisation has been well articulated by others like Arvind Panagariya. But how does denationalisation help in dealing with the current slowdown or possible future slowdowns? After denationalisation, it is expected that banks will have less NPAs. They will not be every now and then short of capital, they can meet the Basel norms, and lend on a large scale. The fiscally constrained GOI will not need to recapitalise at any stage, what are now, the PSBs. It is true that this policy suggestion does not rule out the need to recapitalise some bank(s) in an occasional major financial crisis but it does rule out somewhat regular bail-outs of PSBs.

It is true that not all PSBs are constrained by capital adequacy requirements. Some of them are not lending anyway-they are lazy or fearful. It is important to understand the meaning of fear here. What this means is that the managers are fearful that they may be penalised for taking a wrong decision, which they may take if they do not do enough home work in assessment of risk. But this is again basically a case of lazy banking, not quite fearful banking. This is true of not just some PSBs but it applies to even some private banks. How to deal with this issue?

Note that if banks are getting deposits but they are not lending adequately, they are clearly holding excess reserves or government securities. So, this is where we need to find a solution.

We are familiar with a minimum cash reserve ratio (CRR) requirement and a minimum statutory liquidity ratio (SLR) requirement. Now we need another regulation. There should be, as some others including Professor Dasgupta (Dalhousie University) had suggested, a regulation for maximum CRR and maximum SLR as well. The reason is simple. With the new regulation, banks cannot sit on too much liquid assets; they will need to lend more actively (though judiciously). This will avoid negative externalities that take the form of aggravating, if not causing, an economic slowdown.

What about shadow banking and the slowdown? That is a different story.

(The author is Visiting Faculty, Indian Statistical Institute, Delhi)