The long-winded RBI board meeting that ended on a fairly cordial note, has the RBI’s winning stamp all over it. Sure, on the face of it, both the Centre and the RBI seemed to have found common ground on contentious issues — setting of an expert committee to examine the Economic Capital Framework of the RBI; the Board for Financial Supervision of the RBI looking into banks’ PCA (prompt corrective action) framework; and yes, the much-awaited respite on capital norms.

But in each of these outcomes, the subtle but clear message is this: the central bank gets to call the shots on important policy matters and justifiably so. Take the case of the RBI’s capital.

Most reports suggest that the panel will only deliberate on future earnings and not the much-debated ₹9 lakh crore of reserves in the RBI’s coffers, which the Centre has been trying to lay claim on. Of course, it is still early days to say in whose favour the balance tilts, as the composition of the committee and its scope are unclear.

But it is the issue of banks’ capital norms and PCA framework that deserved a quick and conclusive verdict, which appears to have been delivered. The RBI, by retaining the 9 per cent capital adequacy requirement for Indian banks — higher than the Basel mandated 8 per cent — has firmly gotten this prickly issue out of the way. Given that public sector banks (PSBs) are still inadequately provided for stressed assets, cutting down the capital requirement would have been catastrophic.

Capital norms

An April 2017 RBI paper on risk-weighting under Basel framework has well-argued the need for higher capital adequacy norms for Indian banks. It found that Indian credit rating agencies’ cumulative default rates (CDRs) and the resultant notional risk-weights were higher than the risk-weights currently prescribed by Basel. This implied that banks ran the risk of being under-capitalised as the risk-weights laid down by Basel (which has more or less been adopted by the RBI) may not reflect the true default risk in loans of Indian banks — a point reiterated recently by Deputy Governor Vishwanathan. Hence by mandating a higher capital ratio for Indian banks, the RBI hopes to mitigate the risk of under-capitalisation.

In any case, given the pace at which PSBs have been guzzling capital over the past two to three years, the need for a stringent capital norm is a no-brainer. Even after the Centre announced its mind-boggling ₹88,000 crore of recap last year, many PSBs have been hardly meeting their capital requirement.

Between September 2017 and March 2018 quarters, Tier I capital ratios for weaker PSBs (placed under PCA) have fallen sharply. This despite a near 8 per cent fall in risk-weighted assets during this period — the lowering of risk profile should have eased up banks’ capital.

The state of affairs as of September 2018 is more dismal. Nearly half of the PSBs do not meet the current total capital requirement (including capital conservation buffer or CCB). Even if the RBI did lower the 9 per cent requirement to 8 per cent, about seven banks would still fail to meet the requirement.

By standing firm on the capital adequacy norms and only tinkering at the margin — extending the timeline to meet the last tranche of CCB — the RBI has sent out strong signals that there will be no compromise on prudential norms.

February circular stays

There is no going back on the February directive on stressed assets either. Despite widespread clamour for leeway for stressed power sector accounts, there was no mention of it in the board meeting.

The restructuring scheme under way for stressed assets of MSMEs appears an extension of the existing relief for banks having exposure to MSME borrowers (up to ₹25 crore) wherein they continue to classify such accounts as standard where dues between September 2017 and December 2018 were paid not later than 180 days (as against the usual 90-day norm).

With this benefit to be withdrawn from January 2019, the RBI appears to have agreed to consider a scheme for hard-hit MSMEs — ‘subject to conditions necessary for ensuring financial stability’. The RBI would do well to pay heed to its caveat and take a cautious look at the sector. But as far as its diktat for large accounts goes, the RBI appears to have had its way and rightly so. After all, the skeletons that kept tumbling out of banks’ restructured accounts had to be flushed out.

PCA agenda

One of the most vigorous debates recently has been around the RBI’s PCA norms. The Centre has been maintaining that the more stringent NPA and capital threshold levels brought in last year have led to a large number of PSBs falling under PCA, crimping credit growth.

There are basically two issues here: One, while it is true that PCA norms in India are more onerous than elsewhere, they are not entirely rule-based as some would argue.

As per banks’ FY17 net NPA, capital and profitability metrics, 16 or 17 PSBs should have fallen under PCA, based on the RBI’s stated thresholds alone. But only 11 banks were placed under PCA, suggesting that the RBI has reviewed the matter on a case-to-case basis.

Two, the PCA framework has been in operation since December 2002. Since then, net NPA and profitability (return on asset) have been a criteria under PCA.

Hence demands by the Centre to do away with these thresholds as they are not in sync with global practices may not hold much water, as they have been in existence for over 15 years now.

So what will the the RBI do? Will it ease up on the thresholds? Based on FY18 financials, 17 PSBs can fall under PCA based on net NPA threshold alone and nine on ROA alone (negative for two consecutive years). Even if one were to revert to the old threshold levels of net NPA and ROA (prior to 2017), about half of the PSBs could be under PCA on net NPA alone and nearly all on ROAs alone. Hence lowering the thresholds may not make much of difference, given that the financials of PSBs have deteriorated sharply in recent years.

The PCA framework will be reviewed by the RBI’s BFS, as put out in the board meeting. The focus is likely to be on getting banks out of the PCA, possibly some leeway in the ROA criteria — reducing two consecutive years of positive earnings to one for pulling banks out of PCA. But given that FY18 was a washout and nearly half the PSBs have reported loss in the September quarter, how much of a difference this would make is anybody’s guess.

The RBI would do well to not entirely dilute the prudential norms and hold its ground. After all the Centre’s myopic view on each of the above issues is intended to serve one purpose alone — wade through the election year with a tidy fisc record. The RBI’s relief on the CCB component of capital will ease up about ₹14,000 crore for the Centre by way of recap plan.

Another ₹15,000-20,000-crore respite, with some tinkering on PCA and other norms, would do the trick. It is another matter that none of these would resolve the festering issues in the banking sector — reviving credit growth being the most critical.

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