Mumbai: While the Reserve Bank of India (RBI) has tightened liquidity to protect a depreciating rupee, the government has been easing foreign direct investment, or FDI, norms in a few sectors to ensure flow of funds from overseas. Viral Acharya, C.V. Starr professor of economics at New York University’s Stern School of Business department of finance, said growth needs to pick up in India quickly. He said in an interview that policy reforms are needed, especially with regard to infrastructure and FDI limits need to be removed in some more areas to attract foreign capital. Edited excerpts:
Can you throw some light on your research into regulatory failures in the Indian context?
My research has focused on the fact that while there were market failures based on the originate and distribute model, and induced deterioration of mortgage underwriting quality, there were signals to the regulators on the collective housing market exposure building up on bank balance sheets, especially in most of the Western economies, notably in the US. This was a regulatory failure in that the collective housing exposure was building up despite the (apparently) strict capital requirement regime that regulators had for banks.
If you contrast this with India, you could argue that the Indian regulators did recognize in 2006-07 that retail mortgage lending was becoming a collective exposure of the banking system and by revising sectoral capital requirement on retail mortgage lending, the regulators averted a significant housing market boom and bust.
I would say in some sense there was regulatory success in India in that particular episode but, of course, the broader issue is that we simply do not have enough markets, such as various types of non-government bond markets and various kinds of derivatives. These are not yet developed to a point where corporations and banks can manage and hedge their risks much better.
How do you react to the Financial Sector Legislative Reforms Commission’s proposed regulatory architecture where the central bank is the monetary authority, the banking regulator and the payment system regulator and there is another unified regulator for the rest of the financial sector?
I would say there is both a plus and minus of having a unified regulator. Unified regulator allows you to take a holistic view of the system, not just a banking view or an insurance view or a markets view. A unified regulator typically does consist of representatives from different regulatory agencies and they all can come together and take a holistic view.
The downside is if this unified regulator becomes overly authoritative, then you might see little regulatory innovation, which is often necessary because, as the institutions and markets change, the regulators have to evolve their policies. Such evolution usually works better with decentralized regulators rather than with a single central regulator.
Your research deals with market failure caused due to inability by banks to roll out short-term debt. There are also few recent reports of asset-liability mismatches among Indian banks. Should it concern us?
I think it is going to be an interesting episode.
Historically, banking problems have been dealt with some support from central banks and in the case of state-controlled banks, direct fiscal support to these banks. Right now the difficulty is that the government itself is trying to reduce its fiscal deficit and if banks get into the region of substantial capital needs, it is going to be difficult to provide government financing.
The only way out is that growth has to pick up in India fairly quickly and for that some basic policy reforms need to be put in place, especially in infrastructure, and FDI restrictions need to be removed in some more sectors to attract foreign capital.
That would be a better fix for the problem than having a hard lending for banks and the government having a need to inject capital.
Would the issuance of inflation-indexed bonds discipline the government?
Given that the government is on a decent fiscal path for the last 18 months, right now is not a bad time to start thinking about issuing these bonds. Prior to that there was a lack of clarity on what the government’s fiscal plans were.
Even now, there are some bills which look fairly expansionary as far as fiscal deficits go. So, there is still some concern but in the current environment it is a much better time to issue them than 18 months back. The risk of a downward spiral from exploding inflation and mounting borrowing costs from inflation-indexed bonds has much reduced.
RBI plans to give licences to a set of new banks soon and our finance minister has expressed his desire to see more banks to merge among themselves to form large global entities. Do we need more banks or big banks?
We need both. We need large banks that can deal with both loan books as well as bond books or market books, and we also need many smaller banks to reach out to rural India.