BackRBI needs new clothes
In the 80 years since RBI was created, we haven't got time to consider a monetary standard suitable for India
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In January 2014, Reserve Bank of India (RBI) governor Raghuram Rajan ran the Mumbai marathon. Rajan, a former International Monetary Fund (IMF) chief economist, was hardly five months into his assignment at the Indian central bank then.
The pace at which he has moved since taking up the job as India’s chief money man, in trying to change the way banking is done in India, makes Rajan seem more of a sprinter than a long-distance runner. There are two ways to interpret this—one, Rajan, who took over as the 23rd governor of RBI on 4 September 2013 for a period of three years, is a man in a tearing hurry; and, two, his predecessors hadn’t done much by way of reforming the banking system.
Both could be partly true. Rajan’s three immediate predecessors—D. Subbarao, Y.V.Reddy and Bimal Jalan—had all been bureaucrats. Of the three, Subbarao walked into the RBI straight from the North Block, where he was finance secretary; Jalan was member-secretary at the Planning Commission before taking up his RBI assignment, and Reddy had a stint as an executive director at the IMF before becoming RBI governor, having served as a deputy governor in the past. All three contributed to the growth and development of the banking system in their own ways, but their common, over-arching theme was to maintain price stability and financial stability and making credit available to the productive sector at an affordable price.
Unlike them, Rajan had spent his career in banking and finance until he became chief economic adviser to the Indian government in August 2012. His approach to central banking is very different. Going beyond the basic tenets of central banking, Rajan is also taking a long, hard look at the financial sector’s architecture and trying to make some fundamental changes in Indian banking.
Within days of taking over as governor, Rajan set up two committees, headed by former banker Nachiket Mor and RBI deputy governor Urjit Patel. The committee under Mor has made some seminal recommendations on how to spread banking services in a country where, going by a 2012 World Bank working paper, only 35% of the adult population has access to formal banking services. The panel under Patel has suggested inflation targeting as the main objective of the monetary policy. The government is yet to give its approval to this but that hasn’t stopped Rajan from informally adopting inflation targeting as the central bank’s dharma. Indeed, he is a man in a hurry. He doesn’t stop at merely setting up committees. He sets them a deadline to submit their reports and once they are ready, he tries to implement them in real earnest.
Former finance minister Pranab Mukherjee had announced that India would open up the banking sector to more private entities in his February 2010 budget speech, but until Rajan took over as RBI governor in September 2013, the central bank did precious little barring releasing guidelines and seeking applications. Within seven months of taking over, Rajan handed out the licences. One can certainly argue about why the licences were limited to just two, but there is no denying that Rajan means business. And while licensing the two new entities, Rajan indicated that RBI would offer bank licences on top and introduce differentiated licensing, such as small banks and payment banks
New finance minister Arun Jaitley, too, seems to be cut from the same cloth. He has rolled out the government’s biggest-ever financial inclusion plan and, going by the newspaper reports, drafting the blueprint for consolidation in a highly fragmented banking sector. Do we really need consolidation when vast tracks of India remain unbanked? This is a relevant question, but let’s give Jaitley his due—he appreciates the importance of the role that the banks can play in lifting economic growth that slumped in the past two years to sub-5% levels.
Public sector banks account for about 70% of the banking industry assets and they are in a serious need for a recast, burdened with weak boards, weaker governance structures, rising bad loans and a shortage of capital to support the India growth story when the economy recovers. The attention that the banking sector is getting both from the regulator and the finance ministry is overdue, but instead of a piecemeal solution, what Indian banking needs is a comprehensive policy to overhaul the sector. This means that things need to be approached in a different way. For instance, should the RBI free the existing banks from the burden of mandatory bond buying (the so-called statutory liquidity ratio under which banks need to invest at least 22% of their deposits in government bonds) and reserve requirement (banks keep 4% of their deposits with RBI on which they don’t earn any interest) for infrastructure financing or create a new set of banks for this purpose—banks that are governed by different norms? Only a comprehensive policy under which norms are not discretion-based can change the way banking is done in India.
The RBI also needs to change itself. In his budget speech, Jaitley said, “It is…essential to have a modern monetary policy framework to meet the challenge of an increasingly complex economy," adding, the “government will, in consultation with the RBI, put in place such a requirement." One hopes that the consultation starts soon. The RBI is governed by an Act put in place in March 1934, thirteen-and-a-half years before Independence, when the world was still under the shadow of the Great Depression.
In fact, the preamble of the Act said, “…it is expedient to make temporary provision on the basis of the existing monetary system, and to leave the question of the monetary standard best suited to India to be considered when the international monetary position has become sufficiently clear and stable to make it possible to frame permanent measures."
It also clearly said, “in the present disorganisation of the monetary systems of the world it is not possible to determine what will be suitable as a permanent basis for the Indian monetary system."
Eighty years have passed since RBI was created but we haven’t got time to consider a monetary standard suitable for Indian economy. One hopes that the Rajan-Jaitley duo gets to the task without delay. The RBI needs new clothes.
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