M G Warrier's article on RBI: The Global Analyst, 1/2020

The Global Analyst, January 2020
Reserve Bank of India
Handful of Tasks or Hand Full of Tasks?*
M G Warrier
“Repeated government allusions to a $5 trillion economy by 2024, which would necessitate steady real growth of at least 8-9 percent per year starting from now, seem increasingly unrealistic.”
-Dr Raghuram Rajan, former RBI Governor in India Today, December 16, 2019
The quote above is not for dampening the enthusiasm in celebrating the first New Year after the installation of Modi 2.0 government in Delhi. The purpose is to take on record the timing and selective nature of release of information by economists to pad up the stories they want to build up. Dr Rajan, perhaps for the first time, has also spoken at different forums about the legacy inherited by the Prime Minister Narendra Modi’s government in 2014 from UPA II. He had this to say, in his article published in India Today:
A large number of infrastructure projects had stalled because of difficulties in land acquisition, lack of inputs like coal or gas, or the slow pace of obtaining government clearances. Existing power producers were running into difficulties as heavily indebted power distribution companies delayed payments or stopped buying. India experienced the absurdity of surplus power capacity even as power demand went unmet. As more promoters ran into financial distress, bad loans on bank balance sheets increased, slowing the flow of new credit.
The agricultural sector was also in a mess. In part, this resulted from decades of misguided government intervention such as distorted pricing and subsidies -- which resulted in anomalies such as a water-short nation exporting water-thirsty rice. In part, this resulted from neglect; successive governments did little to eliminate the hordes of middlemen who took their cut as food travelled from the farm to the fork; instead, governments spent scarce resources on loan waivers, a form of misdirected cash transfer, rather than on improving farmer access to new technologies, seeds or land. Prime Minister Modi was elected, not just because his record in Gujarat suggested he would resolve these legacy issues, but also because he promised reforms that would enhance growth and employment.”
Just as fiscal policy measures impact central bank’s monetary policy, the legacy issues flagged by Dr Rajan had a lot to do with the chaotic situation in which the Indian Financial Sector in general, and the Public Sector Banks (PSBs) in particular landed in recent times. We must thank the former RBI  governor for taking interest in the progress of reform measures he initiated during his stay in India and sharing his views which have the backing of his experience gained in India and abroad on policy formulation and implementation.
As RBI governor Dr Raghuram Rajan had mentioned the following as principal reasons for rising NPAs while deposing before the Public Accounts Committee:
·       Domestic and global slowdown.
·       Delays in statutory and other approvals’ especially  for projects under implementation.
·       Aggressive lending practices during upturn, as evidenced from high corporate leverage.
·       Laxity in credit risk appraisal and loan monitoring in banks.
·       Lack of appraisal of skills for projects that need specialized skills, resulting in acceptance of inflated cost and aggressive projections.
·       Willful default, loan fraud and corruption.
Have we forgotten traditional principles of banking?
Kautilya in Arthashastra incorporated risk and uncertainty to the levels of profit and interest. He had indicated that the higher level of risk and uncertainty must be rewarded by higher profits and interests. He prescribed the allowable profits on imports to be twice of that on domestic goods. Allowable profits on imports was 10 percent whereas it was 5 percent on domestic products. The reason behind this was clear. In those days, the importers of foreign goods had to face great danger of being robbed and looted at the time of shipment of the products from other states. Kautilya’s concept of profit is quite similar to the modern days profit theory which states that profit is the reward of uncertainty. Kautilya favored charging interests on loans but the rate of interest was regulated by the state. According to him, rate of interest should be determined by two factors- risk involved and productivity of the capital. The rate of interest was higher for the traders however, it was lower for the personal purpose, such as, marriage or funeral etc. purposes. Furthermore, interest rate was different for different types of trades depending on the riskiness of the venture. Hence it is observed that determination of interest rate considered both elements – risk and productivity of the loan. Human consideration of interest payment was also observed. Certain groups of people, such as, inability to pay, students etc. were exempted from paying interest. However, they had to come through proper legal system to avail such exemption. Hence, differentiated interest rate structure depending on the purpose of loan were prevailed at that time which is very much similar to modern days borrowing and lending system of banks and financial institutions ( Source: Kautilya’s Arthashastra, Sarkar, 2000).
Though the numbers may undergo change, the principles of banking and economics enunciated by Kautilya in Arthashastra hold good even today. We need to revisit the rationale and evolution of banking in India, perhaps over centuries and in more detail the relevance of money lenders during the last century to set right the house of banking in order.
Till deregulation of interest rates, there was some method in madness, in the factoring-in of the principles of cross-subsidization in prescription of interest rates. Post-deregulation, while interest rates on deposits went by the principle of ‘demand and supply’, there was inadequate application of mind in deciding interest rates on loans. Those who borrowed heavily, in thousands of crores, influenced, to an extent interest rates policy also and some banks failed to charge higher interests or prescribe conditionalities making mid-term reviews a professional tool to monitor end-use of loans.
Social control and the nationalization of bigger banks that followed gave an impression that banks are another armof government to implement welfare measures. Professionalism took aback seat.
Institutions in the financial sector
We need to have a relook at the institutional system in the financial sector in India. We have, during the last one year discussed in some detail the problems faced by commercial banks including public sector banks. At this stage, let us initiate some discussion about cooperative banks and “Non-Banks” which are also facing stressful situation.
Cooperative banks
The approach to regulating the banking business of cooperatives has been half-hearted ever since 1966 when certain provisions of the Banking Regulation Act 1949 were made applicable to cooperative societies by incorporation of Section 56 in the B R Act.
More than five decades have passed without any serious effort to diagnose and treat the inherent inadequacies in the administrative and supervisory/regulatory architecture that sustains the cooperatives in India. The laxity on the part of legislators in regulating cooperatives professionally is attributable to the vested interests of political parties and local landlords in managing the multiple activities of village level to high profile national level cooperatives.
Since the beginning of last century when cooperative movement emerged on the Indian scene, cooperatives have been playing a proactive role in the economic development and social life in this country. Attempts by vested interests to capture and manage cooperative institutions and resultant efforts to circumvent regulatory and supervisory requirements did affect the growth of this ideal institutional system, off and on, since certain provisions of the Banking Regulation Act, 1949 were made applicable to cooperative societies. The problems faced by cooperative banks during demonetization (2016), the present state of affairs at  the Mumbai-based multi-state PMC Bank and the genesis of the ambitious proposal to set up Kerala Bank  can be traced to inadequacies in managing cooperatives.
The present initiatives to overhaul cooperatives should, inter alia, keep in view the following:
·       Need to separate banking business from other activities undertaken by cooperatives and ear-marking administrative, regulatory and supervisory responsibilities to appropriate agencies. This is necessary as both central and state governments are involved in the administration of cooperatives.
·       To retain the cooperative character with members’ participation, examine whether Multi-state urban cooperative banks should be made federations of state level units.
·       Consider whether it would be advantageous to convert urban cooperative banks, like the proposed Kerala Bank which want to expand business and go commercial and do universal banking as banking companies.
The present challenges add to GOI’s and RBI’s responsibility to ensure that the dual control (state government having a major role in management matters and RBI’s regulatory and supervisory role) does not adversely affect the cooperative institutions’ smooth functioning.
 For most of the ills in the financial sector, of late, it has become fashionable to blame the Reserve Bank of India(RBI). The role of “Non-Banks” affecting the smooth functioning of the financial system is much more today than, say, a decade before. The IL&FS and DHFL debt default imbroglio and even the failure of Punjab an Maharashtra Cooperative (PMC) Bank can be traced to exploitation of banking system through back-door by “Non-Banks”. This issue is being addressed by RBI by prescribing a liquisityrisk management framework for NBFCs and core investment companies (CICs). Simultaneously, RBI has relaxed end-use stipulation under external commercial borrowing framework for corporates and NBFCs.
RBI’s role
Everyone knows inflation-fighting is not and should not be the principal business of Reserve Bank of India. But certain developments during the decade that is coming to an end gave such an impression in the public mind. This feeling was reaffirmed by the legalization of Monetary Policy Committee (MPC) with a given mandate of keeping inflation at 4 plus or minus 2 percent. One cannot blame RBI for its December 2019 MPC decision not to touch base rates, as the inflation was moving nearer to the upper limit of 6  percent. RBI was also aware that, after cutting the policy repo rate by a cumulative 135 basis points in the previous five bi-monthly policy reviews beginning February 2019, the rate transmission down the layers was not to the level expected and it was prudent  to pause and watch.
As discussed last month RBI has woken up to the task of infusing order into the institutional system in the financial sector. The statement on Developmental and Regulatory Policies issued along with the Monetory Policy Statement in December 2019 gives sufficient indications to this effect (See excerpts in the Box).

Excerpts from the Statement on Developmental and Regulatory Policies issued by Reserve Bank of India on December 6,2019 (Source: RBI)
Primary (Urban) Co-operative Banks – Exposure Limits and Priority Sector Lending
With a view to reducing concentration risk in the exposures of primary (urban) co-operative banks (UCBs) and to further strengthen the role of UCBs in promoting financial inclusion, it is proposed to amend certain regulatory guidelines relating to UCBs. The guidelines would primarily relate to exposure norms for single and group/interconnected borrowers, promotion of financial inclusion, priority sector lending, etc. These measures are expected to strengthen the resilience and sustainability of UCBs and protect the interest of depositors. An appropriate timeframe will be provided for compliance with the revised norms. A draft circular proposing the above changes for eliciting stakeholder comments will be issued shortly.
Primary (Urban) Co-operative Banks - Reporting to Central Repository of Information on Large Credits (CRILC)
The Reserve Bank has created a Central Repository of Information on Large Credits (CRILC) of scheduled commercial banks, all India financial institutions and certain non-banking financial companies with multiple objectives, which, among others, include strengthening offsite supervision and early recognition of financial distress. With a view to building a similar database of large credits extended by primary (urban) co-operative banks (UCBs), it has been decided to bring UCBs with assets of 500 crores and above under the CRILC reporting framework.
Comprehensive Cyber Security Framework for Primary (Urban) Cooperative Banks (UCBs) – A Graded Approach
The Reserve Bank had prescribed a set of baseline cyber security controls for primary (Urban) cooperative banks (UCBs) in October 2018. On further examination, it has been decided to prescribe a comprehensive cyber security framework for the UCBs, as a graded approach, based on their digital depth and interconnectedness with the payment systems landscape, digital products offered by them and assessment of cyber security risk. The framework would mandate implementation of progressively stronger security measures based on the nature, variety and scale of digital product offerings of banks. Such measures would, among others, include implementation of bank specific email domain; periodic security assessment of public facing websites/applications; strengthening the cybersecurity incident reporting mechanism; strengthening of governance framework; and setting up of     Security Operations Center (SOC). This would bolster cyber security preparedness and ensure that the UCBs offering a range of payment services and higher Information Technology penetration are brought at par with commercial banks in addressing cyber security threats..
NBFCs- Peer to Peer Lending Platform (NBFC-P2P)
The Reserve Bank had issued directions for Non-Banking Financial Company-Peer to Peer Lending platform (NBFC-P2P) on October 4, 2017. At present, the aggregate limits for both borrowers and lenders across all P2P platforms stand at 10 lakh, whereas exposure of a single lender to a single borrower is capped at 50,000 across all NBFC-P2P platforms. A review of the functioning of the lending platforms and lending limit was carried out and it has been decided that in order to give the next push to the lending platforms, the aggregate exposure of a lender to all borrowers at any point of time, across all P2P platforms, shall be subject to a cap of 50 lakh. Further, it is also proposed to do away with the current requirement of escrow accounts to be operated by bank promoted trustee for transfer of funds having to be necessarily opened with the concerned bank. This will help provide more flexibility in operations. Necessary instructions in this regard will be issued shortly.
Baseline Cyber Security Controls for ATM Switch application service providers of RBI regulated entities
A number of commercial banks, urban cooperative banks and other regulated entities are dependent upon third party application service providers for shared services for ATM Switch applications. Since these service providers also have exposure to the payment system landscape and are, therefore, exposed to the associated cyber threats, it has been decided that certain baseline cyber security controls shall be mandated by the regulated entities in their contractual agreements with these service providers. The guidelines would require implementation of several measures to strengthen the process of deployment and changes in application softwares in the ecosystem; continuous surveillance; implementation of controls on storage, processing and transmission of sensitive data; building capacity for forensic examination; and making the incident response mechanism more robust.
New Pre-Paid Payment Instruments (PPI)
Prepaid Payment Instruments (PPIs) have been playing an important role in promoting digital payments. To further facilitate its usage, it is proposed to introduce a new type of PPI which can be used only for purchase of goods and services up to a limit of 10,000. The loading / reloading of such PPI will be only from a bank account and used for making only digital payments such as bill payments, merchant payments, etc. Such PPIs can be issued on the basis of essential minimum details sourced from the customer.
* Detailed guidelines, where necessary will be issued by December 31, 2019.

 *This is submitted version. Published version is a formatted/edited one with ullu station etc.

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