The Centre will do well to take heed of a slew of measures suggested by the International Monetary Fund (IMF) to strengthen the RBI’s role as a regulator of the financial system. The proposals include strengthening its powers through legislation over state-owned banks in both enforcement and supervision. The RBI, for instance, cannot remove government-appointed bank directors, force mergers and revoke licences. Most important, the IMF has suggested the Centre’s current extensive powers to override RBI decisions be curbed by amending banking laws.
Two important issues form the backdrop to the IMF’s suggestions. The first is the ill-conceived decision in November last to demonetise high-value notes that sucked out 86 per cent of the currency in circulation. It created a huge artificial shortage of cash, killed small businesses and slowed the economy. The decision was rammed through by the finance ministry in disregard of the advice given by the previous RBI Governor Raghuram Rajan. The second has been the ongoing friction between the RBI and Centre over interest rates. While the Centre has been pushing for interest rate cuts, already at a seven-year low of 6 per cent, to encourage investment and growth, the RBI has been resisting such moves for fear of stoking inflation. However, after Rajan’s departure last September, the Centre seems to have had its way.
The IMF has also proposed a few important measures to make the banking system more efficient and less exposed to risk in the light of the galloping overhang of bad debts, euphemistically called non-performing assets (NPAs). By the end of the June quarter, NPAs of the 38 listed banks had risen to `8 lakh crore. To meet the crisis, the IMF has suggested that the loan classification and provisioning rules should be reviewed to ensure they reflect observed losses; and special loan categories, a synonym for ‘politically-inspired’ lending, be reduced. The government’s response to these suggestions will be both interesting and important.