Flashback 2014: Making progress on banking sector reforms

It was baptism by fire for the celebrated economist Raghuram Rajan when he stepped into the office of the Reserve Bank of India (RBI) governor in September 2013. 

Rajan, whose mandate was to support  growth, control inflation and ensure financial stability as the banking regulator, had no luxury of settling down as the rupee was fast depreciating against the US dollar.

There was also runaway inflation and pressure to reduce interest rates.

By the end of 2013, Rajan managed to stabilise the rupee around 60 against the dollar. But inflation remained his headache for the entire 2014.

At the same time, Rajan came out with a slew of reforms for the banking sector, which was battling with deteriorating asset quality after growth in the economy plunged below five per cent.

Gross non-performing assets (NPAs) were four per cent plus with restructured assets in the range of five to six per cent.

The year 2014 started with the RBI introducing a new mechanism for early detection of NPAs. Rajan's therapy was to act in time rather than waiting for the mandatory 90 days period to declare an asset as NPA.

He introduced a new system of reporting stressed assets when the interest and principal is not paid for 30 days and 60 days onwards.

This reporting by a bank alerts other banks to also act early to protect their money. This new initiative was supported by formation of a central repository of information for large borrowers of more than Rs 5 crore.

The banks were required to share all the default cases to this repository so that other banks will also benefit in terms of timely information.

There are times when banks extend additional funds to a borrower without knowing that he has already defaulted on the dues of another bank.

A month ago, at the third Dr Varghese Kurien Memorial lecture in Gujarat, Rajan said that when a large promoter defaults willfully or does not cooperate in repayment to a public-sector bank, he robs each taxpayer while making it costlier to fund the new investments our economy needs.

"We need a change in mindset where a willful or non-cooperative defaulter is not lionized as a captain of industry but justly chastised as a freeloader on the hardworking people of this country," said Rajan.

The governor is going after defaulters by removing all the routes they use to escape the system.

Next on his agenda is poor governance of PSU banks as many NPAs are linked to it. The RBI is in talks with the government for implementing the recommendations of the PJ Nayak committee.

This RBI-appointed committee has suggested bifurcating the post of chairman and managing director, setting a fixed five-year tenure for both top executives and also professionalizing the board.

The RBI is also in talks to introduce more debt recovery tribunals and bankruptcy laws for speedy disposal of stressed cases.

The second big transformation is in the banking structure itself.

The RBI, under Rajan, has made a big policy change in the licensing of new banks.

The RBI has issued two new licenses to completely different entrants - microfinance institution Bandhan Financial Services and infrastructure lender IDFC.

In addition, the RBI will soon be offering differentiated licenses for small banks and payment banks, which will create new institutions for covering urban poor as well as people in rural and semi-urban areas who are not covered by the banking system.

All eyes are now on reforms like announcing 'too big to fail' institutions in India where big institutions like ICICI, SBI or HDFC will come under a special regulatory regime requiring higher capital.

Rajan is also looking to change the archaic priority sector guidelines. These norms even cover loans for higher education, which according to Rajan doesn't make any sense.

Similarly, the statutory liquidity ratio requirement of 22 per cent is too high, which encourages lazy banking and restricts the ability of banks to lend.

The pace at which Rajan is progressing 2015 will see a slew of reforms and the winner will be the banking sector as it would only improve risk management, capital and profitability.