An open letter to the new RBI governor

An open letter to the new RBI governor
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First Published: Sun, Sep 07 2008. 10 58 PM IST

Updated: Mon, Sep 08 2008. 10 11 AM IST
Dear Dr Subbarao,
When I dropped in at your office in the first week of August for a no-agenda meeting, my first question was whether you would be the next Reserve Bank of India governor. You told me that no one had approached you. My next question was more direct: Would you like to be governor? And you said that given a chance, you would love to take up the challenge. That, I thought, was a rare display of intellectual honesty from an Indian bureaucrat.
I also found that you have a Gmail address printed on your name card while most bureaucrats in North Block prefer the official email address such as or You are different.
And that’s not my impression alone. After finance minister P. Chidambaram announced your appointment last week (I can’t think of any other occasion when an RBI governor’s appointment was announced by the finance minister), one banker narrated to me an incident from 1997 when you, as finance secretary of Andhra Pradesh, made a presentation at a closed-door meeting of bond dealers in south Mumbai. It was a roadshow for a forthcoming bond issue by the southern state. Those days, all state government paper were fixed-coupon bonds and sold at a uniform price irrespective of the financial health of the states. And, there were not too many takers for them. At the meeting, I was told, you discussed why state government bonds should be auctioned, allowing states that enjoy better financial health to raise money at cheaper rates. No wonder the subject of your doctoral thesis was “fiscal reforms at the state level”.
You have said that your immediate priority is tackling inflation, but I am sure that once this is done, you will turn your sights to reforms in the Indian financial sector. I am not writing this letter to tell you what should be your agenda as the RBI governor—I wouldn’t dare do that. But I want to flag certain issues in the financial sector that need your attention.
The first thing that comes to mind is market reforms. Currency futures have recently been introduced and I hope that they do not face the fate of interest rate futures. Introduced in June 2003, interest rate futures failed to take off as market participants were extremely uncomfortable betting on futures with a theoretical spot curve. The pricing benchmark was also not clear.
Similarly, STRIPS (separate trading of registered interest and principal of securities), or zero-coupon securities, never took off. As STRIPS allow investors to hold and trade the individual interest and principal components of bonds as separate securities, it lends great depth to the bond market.
Short-selling of bonds can also add to market depth. Sometime back, RBI had allowed bond dealers to short-sell, but this is a limited facility and the market is not excited about it. You would need to look into this if you want to deepen the debt market. Currently, it’s primarily a one-way market for government bonds where players thrive only when interest rates drop. Finally, the retail investor’s presence in India’s government bond market is zero. If the equity market can attract hordes of retail investors, why can’t the debt market?
The scene in the corporate bond market is no different and this is primarily because of the turf war between two regulators—RBI and the Securities and Exchange Board of India. Besides, the repo facility is not yet available in the corporate bond market.
Let’s shift our focus to commercial banks. They are not allowed to dabble in commodity futures, or futures and options in the equity market. Indeed, state-run banks that account for about 70% of the industry do not have the expertise to enter such businesses, but RBI should not play the role of a custodian of public sector banks. Let them learn the tricks of the trade while you open up new business avenues for all.
You will probably need to take a closer look at the entire architecture of the banking sector. Interest rates on savings bank accounts are still regulated. Banks now pay a uniform rate (3.5%) on savings accounts when all other deposit rates are freely set. If it’s left to the banks, their cost of funds could drop. Even if you don’t want to deregulate savings bank rates completely, you can fix a ceiling and allow banks to offer lower rates, if they wish to. In rural pockets where transaction costs are higher, banks can offer less than what they offer to urban depositors. Similarly, public sector banks should be allowed to price their loans in accordance with their cost of funds. The cost of intermediation of Indian banks is probably the highest in the world. This is because they don’t have any say on the cost of a portion of their deposits liability and even on the wages of their employees. They are bound by an industry wage pact that the government plays an active role in brokering. A Mumbai-based bank employee gets the same salary that a counterpart living in a remote village of Orissa gets even though the cost of living in these two places is radically different.
Our banks need freedom. So does RBI. And, nobody knows this better than you. As finance secretary of India, you have seen very closely the differences between the government and the banking regulator on crucial issues such as the direction of interest rates and aspirations for growth. I hope they will be history now.
With best wishes,
Yours sincerely.
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Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as the Mumbai bureau chief of Mint. Please email comments to
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First Published: Sun, Sep 07 2008. 10 58 PM IST