If Raghuram Rajan had his task cut out when he assumed office as the Governor of RBI in September 2013, it was no walk in the park for his successor, Urjit Patel, to step into his shoes in August 2016. Not only was Patel left to take on the legacy of badly-battered bank finances, but was also caught in the eye of the storm, triggered by the Modi government’s demonetisation move. If the deteriorating state of affairs at banks with growing instances of steep bad-loan divergences had investors worried, questions about the RBI’s independence and credibility after demonetisation were raised by critics of the old school.

The RBI’s infamous ‘February’ circular this year not only led to one of the worst performances by banks, but also rankled the Centre that was banking on its ₹88,000-crore mega recap plan to pull banks out of the morass of huge losses. Perceptible regulatory and supervisory gaps on the RBI’s part – be it the PNB scam or the recent IL&FS crisis – only made matters worse.

To cut a long story short, the two-year tenure of Urjit Patel had been riddled with challenges, with the constant nit-picking by the Centre, which only added to the Governor’s woes. But after all the public brawling between the Centre and the RBI, should it have come to this? Undoubtedly not. The Centre should have acknowledged the sanctity of the RBI’s position as an independent regulator. In public interest, the differences should have been resolved and not taken such a nasty turn.

Divergences and more

In the two quarters following the asset quality review (AQR) in December 2015, when Rajan was Governor, quarterly slippages mounted to about ₹1-1.5 lakh crore. But despite this massive clean-up, the RBI embarked on another Swachh Banks Mission under Patel. The central bank’s circular on ‘Disclosure in the Notes to Accounts to the Financial Statements – Divergence in Asset Classification and Provisioning’, in April 2017 (though its reference was made in the September 2015 policy), led to huge divergences being reported by banks – private sector banks more or less remained unscathed by the RBI’s AQR exercise.

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In FY17, close to a year after Patel took charge, about ₹1.3 lakh crore of bad loans were added to the banking system. Credit growth had slumped to a multi-year low of 5 per cent.

The biggest blow to banks came from the RBI’s February circular this year which essentially did away with all the old restructuring schemes. Banks had taken a one-time hit on account of this in the March quarter. The upshot of this was that after the AQR exercise added a whopping ₹2.7 lakh-odd crore of bad loans to the system in fiscal 2016, the February circular led to a much higher ₹3 lakh crore accretion of bad loans in fiscal 2018. Public sector banks reported a massive ₹85,000-odd crore of losses in FY18.

After peaking in the March quarter, while bad loans have slightly come off in the September quarter, banks are still not out of the woods. Slow progress on IBC cases, uncertainty over the ₹1.74-lakh-crore of power sector stressed assets, rising interest rates, and not-so-heartening pick-up in credit growth, have set a tough pitch for Patel’s successor.

In the November board meeting of the RBI, it was decided that an expert committee be formed to look into RBI’s reserves (Economic Capital Framework-ECF). But with reports suggesting some friction in the constitution of the panel, it was not expected to be smooth sailing. At the heart of the issue is the RBI’s reserve of ₹9.23 lakh crore, consisting of contingency fund (₹2.2 lakh crore) and Currency and Gold Revaluation Account (CGRA) of ₹6.9 lakh crore. Given that the earmarked ₹65,000 crore for capital infusion into PSBs this fiscal appears grossly inadequate, the Centre is likely to push forth the constitution of the panel to lay its claim on the reserves.

Looking ahead

The appointment of the next Governor will be crucial to restore the credibility of the RBI. After the flak faced by Patel at the time of demonetisation, the NPA ordinance last year had also raised questions on the central bank’s ability to act as a prudent and independent regulator. The PNB and IL&FS crises only made matters worse.

Importantly, it needs to be seen if Patel’s decision to hold ground on capital norms, the PCA framework, and the February circular in the November board meeting are not overturned by the incoming Governor. Any compromise on these prudential imperatives will be a huge setback.

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