4 min read.Updated: 20 Jun 2016, 05:46 PM ISTIra Dugal
From converting RBI into a inflation targeting central bank to forcing a long overdue clean up of the banking sector, Rajan's term has packed a punch
Mumbai: Raghuram Rajan will step down as the 23rd governor of the Reserve Bank of India when his term expires on 4 September, he said in a message to his staff, which was put out on the central bank’s website.
Rajan’s decision to leave will come as a surprise to the markets and investors who have become accustomed to Rajan’s quick and decisive style to tackling issues plaguing the economy and the banking sector. From converting the Reserve Bank of India into a inflation targeting central bank to forcing a long overdue clean up of the banking sector, Rajan’s three year term has packed a punch.
Here are some the key decisions and reforms undertaken during Rajan’s tenure:
Right after taking over as the governor, Raghuram Rajan appointed a committee headed by deputy governor Urjit Patel to review the monetary policy framework. The committee recommended that the RBI formally move towards making the consumer price inflation index as the nominal anchor for monetary policy in the country.
In February 2015, the RBI and the government signed a new monetary policy framework agreement which laid down an inflation target for the central. As part of this framework, the RBI was to bring down inflation to 6% by March 2016 and 5% by March 2015. Over the medium term, the RBI now has a target of bringing inflation down to 4% (+/- 2%).
While the inflation targets are in place, the second phase which includes the setting up of a monetary policy committee is still underway. The committee, which will be headed by the RBI governor, is expected to be put in place during the course of the current fiscal year.
The clean-up of bank balancesheets will undoubtedly go down as one of biggest achievements of Rajan’s tenure. The fact that the Indian banks have been sitting on a pile of undisclosed bad loans has been the worst kept secret for years. A clean-up, however, was never an easy task due to the pressures it puts on the system and also due to the weak capital position of banks. Rajan knew it needed to be done and he undertook the mammoth task starting the second half of fiscal 2016.
A first of its kind asset quality review conducted by the RBI last fiscal forced banks to classify visibly stressed assets as non performing assets (NPAs). This led to a surge in reported bad loans which now stand at more than ₹ 5.8 trillion.
The RBI has also provided banks with a number of tools to tackle bad loans. Among them is a provision announced last week which allows the banks to convert at least half of the bad loans into long-dated equity instruments. The strategic debt restructuring rules also allow banks to turn over the management of a company should the lenders need to.
While the process of licensing another round of universal banks was kicked off during D. Subbarao’s tenure, Rajan’s tenure saw two new banks (IDFC Bank and Bandhan Bank) being licensed. The more significant step in this context, however, was the licensing of differentiated banking entities.
Rajan introduced the concept of payment banks which have the potential to significantly increase the penetration of financial services in the hinterlands. 11 payment banks were given an in-principle approval and at least eight of them will launch operations by early next year. In addition, ten small finance banks were also given in-principle licences. These are entities which will serve the needs to small borrowers, particularly small businesses. Rajan has also floated the idea of wholesale banks and custodian banks although guidelines for these entities are yet to be released.
On 6 May, the RBI put out a draft framework for on-tap universal bank licensing. This is a first for India which has always followed a stop and start policy for licensing new banks. The policy bars conglomerates from running banks but leaves the door open for smaller business houses to enter the sector.
Market development has been top of the agenda for Rajan as well. One such measure was the introduction of term repo operations to infuse liquidity. These term repos, which are conducted for different periods such as 7 days and 14 days, have allowed for better pricing of credit in the markets and has allowed a yield curve to develop.
The RBI, under Rajan, has also for the first time put in place a framework for foreign investor participation in the bond markets. In September 2015, the RBI said it will increase the foreign investment limit in central government securities to 5% of the outstanding stock of such securities by March 2018. The RBI has also opened up the state government bond market to foreign investors for the first time and will allow foreign investors to hold up to 2% of state development loans by March 2018.
On Thursday, Mint reported that the RBI may start accepting corporate bonds as collateral for its liquidity operations. If the central bank introduces this provision, it will help increase liquidity for high rated corporate bonds.