Urjit Patel’s banking blind spot

A regular blogger on economic issues, @mostlyeconomics, had a fair criticism to make of the media’s coverage of Urjit Patel’s appointment as the next governor of the Reserve Bank of India (RBI). Most of us, this writer included, chose to see the decision as a vote for continuity. The fact that Patel was the author of the report that pushed India towards a flexible inflation targeting regime convinced most that the handover from Raghuram Rajan to Patel will be smooth.

Few of us did a deep-dive into Patel’s actual strengths and, equally importantly, his weaknesses. One such weakness could be the perception that Patel may not be able to match up to Rajan’s experimental approach towards the financial sector.

There are a lot of balls up in the air in the banking sector at present. Over the past three years, Rajan has initiated a number of changes in the sector. Many of these remain work in progress and it is up to the incoming governor to ensure that these balls are juggled deftly.

Consider the issue of bad loans. According to the latest figures, cited by deputy governor S.S. Mundra this week, stressed assets across the system hit 15.4% at the end of June. While we are all relieved that banks have been forced to recognise troubled loans, this is only the first part of the process. The second (and perhaps tougher) part of the process is to find a resolution for the ₹ 6.3 trillion in bad loans.

To do this, Rajan handed banks a number of tools. The ambitious strategic debt restructuring (SDR) mechanism was one such tool. However, as Mint’s Vishwanath Nair reported last week, of the 21 cases where the provision has been invoked, only two cases have been closed successfully.

Recognizing the practical difficulties that banks were facing in implementing SDR, the RBI introduced another scheme called the S4A (Scheme for Sustainable Structuring of Stressed Assets). Reports suggest that bankers are seeking some tweaks in this scheme as well.

Meanwhile, the expectation that private asset reconstruction companies (ARCs) will play a large role in taking stressed assets off the books of banks has also materialised so far.

There are a dozen registered ARCs and a handful of more that are on the way. However, the core mismatch in pricing and return expectations of the sellers of bad loans (banks) and the buyers of bad loans and assets (ARCs and stressed debt funds) has not gone away. Patel, along with deputy governor Mundra, must continue to look for ways to resolve these issues.

Patel’s banking agenda can’t end there.

Banking structures are changing rapidly. In the next few months, we will see at least a few payment banks being rolled out. These entities will have access to a lot of previously unbanked clients. They will also be looking to turn a profit from their very tightly regulated business models. In the midst of this, could customer protection be compromised?

The RBI will have to keep its ears very close to the ground as these new entities roll out to ensure that the model succeeds but in a safe way.

The small finance banks (SFBs) that have already started rolling out are presenting a different set of challenges. Remember that most of these SFBs were microfinance firms before they converted. In their previous avatars, their lending was subjected to restrictions on how much their clients could borrow. These restrictions don’t apply to SFB clients or bank clients. It would appear that this is creating an uneven field for different entities operating in the same market. At the same time, with an increasing number of entities lending to the bottom of the pyramid, Patel would do well to keep a close watch on levels of indebtedness.

That brings us to technology led innovations in the banking sector. This is perhaps the biggest challenge for regulators worldwide and the RBI is no exception.

Over the past three years, Rajan has been hands on in monitoring and encouraging some of these technology led innovations. The Unified Payment Interface (UPI), a best in class payment system which is now ready for roll-out, is one such example. Can the RBI now take this a step further and use Aadhaar and the NPCI (National Payments Corp. of India) to make account number portability a reality? Mundra has mooted the idea openly and Patel would do well to back him on this.

Another deputy governor, R. Gandhi, recently called on banks to work closely with the RBI established Institute for Development & Research in Banking Technology (IDRBT) to look for ways in which technologies like Blockchain can be put to use in the banking sector.

Does Patel understand these looming challenges and opportunities? Or is banking his blind spot? Unfortunately, we just don’t know. Patel would do well to use his early public interactions to help us answer those questions.

Ira Dugal is deputy managing editor, Mint