The Reserve Bank of India’s (RBI) move to relax provisioning norms for banks, that too with retrospective effect from 30 September, is not just a regressive move that will have long-term consequences on the style and stability of the banking sector, but is also in obvious conflict with elements of monetary policy, especially on rate hardening.
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It is obvious that while diluting its existing prudential policy stand vis-a-vis bad loans, RBI has acted more as a surrogate owner than an independent regulator—the central bank used to own majority stakes in many public sector banks till it sold them to the government a couple of years ago. For there doesn’t seem to be any apparent reason for the change and its timing.
According to the new norms, two elements of the provisioning policy have been changed: retrospectively from 30 September, banks will not be required to maintain non-performing asset (NPA) coverage of 70%. Operationally, this means for assets that get impaired after that date, banks will just follow the standard capital provisioning requirement: 10% for sub-standard assets and 100% for assets under the “loss” category. True, in 2009, the 70% provisioning norm did eat into banks’ profits. But it also stabilized long-term earnings across different phases of the cycle and reduced spikes and shocks.
The second change is that “surplus provisions” will now have to be kept in a separate account known as the “counter-cyclical provisioning buffer”. During a downturn and with RBI’s approval, banks will be able to draw from this buffer to make specific provisions for their NPAs.
In incorporating these measures, RBI has shown that it continues to be the control freak. Whether a bank holds the provisions in a buffer account or downgrades some of its assets across categories to cover them through specific provisions (say, from doubtful to sub-standard) is an operational matter. As long as the provisions are not used to beef up profits, RBI should not be bothered. But the central bank seems to thrive on making regulation complex and hence difficult to administer.
Let’s take an example. What defines a downturn? Is it macroeconomic or sectoral? Who decides, and on what basis, that a slowdown is a downturn and not a mere inflexion? Consider a bank, which lends heavily to some sectors that are in a trough even as the economy is peaking. How will the stress emerging from this be addressed? In other words, downturns that squeeze banks need not be generalized and macroeconomic. They can be specific and sectoral. Or, for that matter, even spatial.
In 2008, for instance, Jammu and Kashmir Bank approached RBI to relax provisioning or allow rescheduling of impaired assets in the light of six months of civil strife when no business activity had been possible. RBI, taking a macro view, didn’t relax any norms. This caused a 25% increase in the bank’s NPAs that year, which then dropped by 30% next year. The bank was thus subject to avoidable volatility. In response, J&K Bank then decided to increase the NPA coverage to 98%. (Disclosure: This columnist is a former chairman and chief executive of J&K Bank.)
The point is, most banks will have specific issues that will get lost under the general one-shoe-fits-all method of provisioning. As the regulator, it is RBI’s decision to stipulate and ensure that a minimum coverage of bad loans is maintained. The rest must be left to the banks’ operational management.
Institutional investors, especially foreign ones, compare Indian banks with those around the globe. Most of the latter, be they Japanese or Korean or even European, maintain an NPA coverage ratio of almost 100%. From that perspective, RBI’s move could have an adverse impact on foreign investment flows into the Indian banking sector.
Even the timing of RBI’s move is a bit curious. What the new norms do is to reduce the cost of credit for banks. This is at a time when RBI has been making, and continues to make, credit expensive for borrowers. With the cost-based base rate regime now in operation, the reduced level of provisioning will put downwards pressure on the base rate at a time when lending rates are being forced upwards through concerted policy action. The dichotomy makes little sense, and amounts to dampening the impact of the current higher interest rate policy. Indeed, this move further weakens the already weak transmission mechanism of interest rates across the system.
Even if the new provisioning norms were to be seen as a signal from RBI, what actually is being signalled is not so clear. Is the central bank indicating that there will be a rise in NPAs, and is, therefore, protecting the profits of banks by not stipulating a minimum coverage ratio? If this is so, then the new policy will be a disaster.
On the contrary, if RBI is expecting good times, then this should be the time to put more into the provisioning buffer account.
This way, RBI is amplifying, instead of dampening, the impact of the macroeconomic situation on the profits and stability of banks. If anything, it is a counter “counter-cyclical” provisioning policy.
Haseeb A. Drabu is an economist,and writes on monetary and macroeconomic matters from the perspective of policy and practice.Comment at firstname.lastname@example.org