"In family feuds, what is important is not who has won; but that nobody lost" This was the sage counsel given to the hero in the Tamil movie Tamiraparani by his mentor when the former is distraught with the feud in the family. I remembered this while pondering the current feud between the Reserve Bank of India (RBI) and the Government of India (GOI) who are part of the public governance family. Monetary and Financial Stability Policy, and Fiscal Policy are products of these respective institutions and they need to operate in a mutually supporting and coordinated way.
Opinions, viewpoints, perspectives and priorities, and weightage assigned to options, of course, do vary between these institutions. Therefore, there are institutional arrangements, both formal and informal, to resolve differences. Communication, besides adherence to conventions, is critical in preventing the escalation of differences into open fights. The current situation indicates that there has been a stark break here.
Instead of examining how the feud evolved or who is to blame, it is time to resolve it. While the RBI’s Board would be attempting this on November 19, I wish that they try exactly what I began with, i.e. that nobody loses. The trick is to recognise the compulsions and limitations of each party and then find a middle way, which both will see as a common minimum. To help them achieve this, let me present a few ideas:
NBFC liquidity
Non-banking Financial Companies, by definition, are required to raise capital and debt with higher risk appetite by paying the right risk premium price. When they do encounter funding difficulties, the central bank should not be the first resort; players who paid incorrect premia will have to learn and pay the right price. Since that phase is over and yields have stabilised at higher levels, an assurance of standby liquidity to the sector as a whole, (which is also in the lending space) will be in order. As the central bank cannot assess the credit risk of individual NBFCs, the standby arrangement will have to be through banks who will be in a better position to evaluate them. Hence, RBI should establish a standing refinance window for banks against their NBFC exposure.
PCA banks
The medicine administered by RBI so far to return PCA banks to the pink of health is ‘narrow banking’; RBI can now agree to change the medicine, based on certain diagnostic tests, to ‘small finance banking’. The tests could include certain minimum improvements in asset quality, profitability and capital since the commencement of ‘narrow banking’. Improved banks could be allowed to underwrite only ‘small finance’.
MSME Finance
Adequacy of funds, in times of need and at affordable rates, is the ever-present demand of MSMEs, besides stress relief. While the former could be addressed by RBI, the latter will have to be addressed by GOI. RBI could enhance funding lines to SIDBI for MSME refinance. For MSME NPA resolution, GOI should provide banks subsidies to offset haircuts.
Reserves transfer
The current focus has been on what should be the appropriate level of Contingency Reserves (CR) for RBI. It should be left to RBI to determine what CR it needs. Instead, the focus of GOI should be shifted to the asset side of the RBI balance sheet. As CR is a non-monetary liability, the part beyond a core CR could be held in the form of eligible assets other than standard assets of government securities, foreign securities and gold. These other eligible assets could be the support RBI extends to NBFC and MSME sectors, besides its non-voting capital contribution to PSBs and their Tier-2 instruments (with appropriate provisions for swapping these instruments into government securities, in case of extreme contingencies).
PRB
GOI should stick to the recommendations of the Watal Committee and make the proposed Payment Regulatory Board, a part of RBI. GOI cannot keep PRB separate from RBI and still expect RBI to implement its decisions. Payments are an integral part of monetary system and should remain within RBI’s regulatory ambit.
Board composition
GOI should continue the convention of having healthy consultation with RBI and there should be no surprises.
Basel or Basel Plus
RBI should classify banks (alternatively banks can elect themselves) as internationally and nationally active banks. The former should comply with Basel Plus and the latter could comply with even Basel 1 or 2. Further, nationally active banks should become Category 2 Authorised Dealers.
If these are agreed in principle in the November 19, RBI Board meeting, details could be worked out to the mutual satisfaction of both parties. This way, neither would have lost.
(The author is a former deputy governor, RBI. Views expressed are personal. )