(Photo: Mint)
(Photo: Mint)

Opinion | Some macroprudential policies to help kick-start a credit boom

The government should use the banking crisis as a chance to fix the inequities that policies create

Last week, this column said that it was time for the Reserve Bank of India (RBI) to consider three regulatory measures to allow bank credit to start flowing again. One was differentiated risk weights for assets. Two, the use of a countercyclical capital buffer as a two-way mechanism and not just in one direction, i.e., increasing it during times of credit boom. Third was a suggestion to re-examine the application of Basel III capital adequacy norms since these were minimum capital requirements for internationally active banks.

The day after the column was published, RBI announced its monetary policy decision. It had cut its main policy rate—the repo rate—by 35 basis points. In addition, the central bank did reduce the risk weight for consumer credit, excluding credit card receivables. Now, according to data from the Bank for International Settlements, credit (from all sectors and not just from banks) to households and non-profit institutions serving households grew in the four-year period from March 2014 to March 2018 at an annual rate of more than 17%, in rupee terms. Indian household savings rates peaked around a decade ago and have not recovered yet.

The household savings rate (as a percentage of gross national domestic income) stood at 16% in March 2017 according to the RBI Annual Report 2017-18. It was 25.2% of GDP in March 2010. The household sector savings rate was 17.2% of GDP as of 2017-18. Under these circumstances, encouraging the flow of credit to consumers might be a short-term fix with potentially adverse consequences in the medium term.

A former central banker drew my attention to paragraph 21 in the Narasimham Committee Report of 1991. The said paragraph delineates a structure for the Indian banking system: (a) 3-4 large banks that could become international; (b) 8-10 national banks with a network of branches throughout the country engaged in “universal" banking; (c) local banks whose operations would be generally confined to a specific region; and (d) rural banks, including regional banks, whose operations would be confined to rural areas and whose business would predominantly be the financing of agriculture and allied activities.

Capital adequacy norms should be different for each category. This also means that commercial banks in India must be relieved of their burden to undertake long-term lending. That creates a deposit-loan mismatch. Term-lending institutions need to be revived. The Union budget gave a boost to the corporate bond market, but evidence that capital markets do a better job of capital allocation for the long term is conspicuous by its absence.

Further, in the short run, the current RBI governor can take a leaf from what Y.V. Reddy did in the run-up to the 2008 crisis, in the light of a domestic credit boom precipitated by strong capital inflows. He pre-emptively hiked risk weights on particular asset classes and made major adjustments to the recognition of profits on securitization of vehicles that prevented the accumulation of risks. He had outlined them in a speech, “Global financial turbulence and the financial sector in India—a practitioner’s perspective", delivered in Manchester, UK, on 1 July 2008. The governor should study it carefully and do the reverse, as appropriate, for the circumstances are diametrically opposite.

In his comments on the paper, The Great Leveraging by Alan Taylor, Y.V. Reddy made the concomitant point that the challenge for policymakers was to simultaneously encourage structural growth in credit while containing the cyclical upward and downward movements of the desired secular growth in credit. That is where a countercyclical capital buffer kicks in. In the same speech, he made a distinction between risk weights for the housing sector and for the infrastructure sector. Finally, he suggested that the regulator could exercise judgement in granting special dispensation to certain banking institutions that demonstrate expertise in relevant sectors and had satisfactory risk management systems in place. These are in the realm of macroprudential roles well before the term “macroprudential" became acceptable in the West.

Finally, it is important to bear in mind that the Union government is the dominant owner of the banking system. Government policies (input prices, raw material linkages and power tariffs, for example) cripple the financial viability of bank borrowers. When the government breaches its contractual obligations, the money it saves is eventually not saved as it goes towards recapitalizing banks to close the capital shortage created by bad debts. Thus, the burden that had to be borne by certain specific consumers becomes the general burden of taxpayers. This is both inequitable and inefficient.

What the NDA government has not done in the five years is use the banking crisis as an opportunity to fix the many distortions and inequities that government policies create. It must use the ample political capital it now has to take decisions that the economy needs. The central bank can then complement its efforts with pragmatic cyclical policies as outlined above.

V. Anantha Nageswaran is the dean of IFMR Graduate School of Business, Krea University

These are the author’s personal views