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Explained: What Are the Points of Friction Between RBI & Govt?

The crucial meeting of the central board of the Reserve Bank of India (RBI) is now underway amid a public battle over a host of issues ranging from banking regulation to the central bank’s own balance sheet.

The issues, which were presumably brewing behind closed doors, came out into the open when RBI Deputy Governor Viral Acharya highlighted them in a speech focused on central bank independence.

BloombergQuint, through a series of articles, explains some of the underlying issues on which the RBI and the government have differing views.

The Central Bank’s Balance Sheet

The debate over the appropriate level of capital on the central bank’s balance sheet is an old one. The issue was raked up by former Chief Economic Adviser Arvind Subramanian, who argued the Indian central bank is overcapitalised.

The RBI has countered this all along and believes that its reserves need to be strong to enable it to counter any risks that may emerge in the economy. Former RBI Deputy Governor Rakesh Mohan argued that at about 20 percent of GDP, the size of the RBI balance sheet has not changed much over the years.

The government, however, feels the RBI uses too conservative a methodology to arrive at the requisite level of reserves. It thinks the RBI is sitting on excess capital of Rs 3.6 lakh crore.

For more, read this by Ananth Narayan, associate professor - finance at SPJIMR: Understanding The RBI’s Balance Sheet

Also Read: Government hoping resolution on liquidity in RBI's board meeting

Easing Prompt Corrective Action Framework

Prompt corrective action as a tool to prevent weak banks from getting weaker has existed for some time now. Its implementation, though, was whimsical. So, in April 2017, the Reserve Bank of India issued a revised set of benchmarks, with an attempt to move towards a more rule-based framework.

At the time the framework was implemented, the government didn’t raise objections. However, it now feels that it’s hurting the flow of credit in the economy. The RBI, in a speech by Deputy Governor Viral Acharya, argued that it is important to persist with the framework. “Any slackening of the approach in the midst of required course of action is an all-too-familiar and ultimately harmful habit that we must eschew,” Acharya had said in a speech at IIT Bombay on Oct. 12.

The health of these banks remains weak, supporting the need for continuing with the corrective action, showed a recent BloombergQuint analysis. Read that analysis here: PCA Banks Report Nearly Rs 70,000 Crore In Losses Over Last Five Quarters.

Also Read: RBI-Govt Face off Not a Happy Situation: S Gurumurthy

Diluting Basel Norms And Stressed Asset Framework For Indian Banks

The government is also seeking a dilution of the Basel-III norms for India. Government representatives argue that India has prescribed capital norms that are tougher than many other countries.

The government wants the RBI to bring down capital to risk (weighted) assets ratio to 8 percent, in line with Basel III norms, from 9 percent currently. This could help banks save Rs 55,000 crore in capital. The RBI has argued these stronger capital norms are essential to ensure that strength of Indian bank balance sheets is real.

"“The real strength will come from recognising weaknesses in the balance sheet and making provisions for them rather than pretending to believe that the balance sheet is strong,” " - Deputy Governor NS Vishwanathan said at a recent lecture.

In the same vein, the government wants the RBI’s new stressed asset framework, issued in a circular on Feb.12, diluted. In particular, the government wants power assets left out of the ambit of this framework.

Is the government really seeking all these relaxations in public interest. To understand the conflict of interest inherent in the government’s demands, read: RBI-Government Spat: Easier Banking Regulation, In Public (Or Government) Interest?

Tackling NBFC, SME Concerns

Another set of contentious issues pertain to the extent of the RBI’s response to the conditions being faced by non-bank financial companies. The RBI has responded by ensuring that the system is supplied with adequate liquidity. But some in the government argue that more direct intervention may be needed.

NBFCs, over the past few years, have gained more market share in the credit markets. The fear is that if these lenders slow down, credit flow to the economy would be hurt. In particular, there are concerns over small and medium enterprises, which have been hurt by both demonetisation and goods and services tax. Will the credit squeeze hurt them further?

Analysts agree that the RBI can ease liquidity further but most say that the regulator should stay away from any sort of bailout. Read this article to understand the state of the NBFC sector: Does The RBI Need To Lend More Support To India’s Non Bank Lenders?

Talk To Each Other!

Veteran government and central bank officials feel that differences between the RBI and the Finance Ministry are nothing new. What appears to have changed is the extent of communication between the two entities. This break-down in communication is unhealthy and must be corrected, said a number of former RBI and government officials BloombergQuint spoke to.

If back-channel discussions do not help ease tensions between the two sides, matters will need to be resolved at the level of the central board. To understand how the RBI’s central board functions, read this article: Focus On RBI Board Returns Amid Spat Between Government And Central Bank

(This story was originally published on BloombergQuint.)

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