Govt’s Ire Over RBI Curbs on Banks Under PCA Framework Makes Little Sense

The government has been crying hoarse about the flaws in the Reserve Bank of India’s latest framework to deal with those public sector banks which are stressed. The RBI implemented the strict Prompt Corrective Action (PCA) norms at the beginning of this fiscal, as Indian banks’ bad loan situation worsened and currently, 11 of the 12 banks in the new framework are PSU banks.

The banks under PCA face lending restrictions and some other curbs by the RBI to eventually make them stronger. There are only two ways to resolve the crisis India’s banks face presently — either force more mergers of weak and strong banks or get the seriously stressed ones under the PCA framework. The former method won’t work in all cases since mergers need more than adequate capitalisation and the sector as a whole must be well-capitalised. Which is why the PCA framework is being implemented for those banks whose existence could come under jeopardy.

The PSU banks under PCA are IDBI Bank, Indian Overseas Bank, Bank of Maharashtra, United Bank of India, Dena Bank, Corporation Bank, UCO Bank, Central Bank of India, Oriental Bank of Commerce and Bank of India. Three in four banks in India are public sector banks, so inclusion of such a large number of PSU banks in the PCA framework impacts the sector as a whole. And the 11 PSU banks under PCA account for one-fifth of all deposits and almost 19% of advances by banks.

RBI’s move to put in place this revised PCA framework is what has riled the government the most. And as the recent skirmish between the government and the central bank continues to dominate headlines — the back and forth started after RBI Deputy Governor Viral V Acharya spoke at length about threat to the autonomy of the RBI in the public lecture last week — unnamed government officials have indicated that the RBI’s intransigence over the revised PCA for PSU banks is a leading cause of its unhappiness. The central bank is unhappy with government arm-twisting, the government is upset with the scant regard its wishes are shown by the RBI.

Officials have alleged that neither was the government consulted by the RBI before it framed the revised PCA norms, nor were suggestions by government representatives in subsequent meetings on relaxing lending restrictions for the PSU banks under PCA heeded.

The government seems convinced that the PCA norms are killing the 11 PSU banks, not enough lending is allowed to be done by such banks and the RBI has acted in an arbitrary and authoritarian manner while dealing with these delinquent banks. But the government may be missing the woods for the trees, if what Acharya himself said at another public lecture in the beginning of October is any indication.

In that speech, the Deputy Governor explained at length why the PSU banks under PCA are placed under lending restrictions (there is no bar on retail deposit taking), how this has not impacted the overall banking sector lending, that there continues to be healthy growth in credit flow from the banking sector as a whole and how the implementation of PCA norms is already helping stressed banks.

So is the RBI right or is the government’s insistence on relaxing norms a correct approach? The government has been citing requests by the banks impacted by PCA — these banks want permission to restart lending despite their weak balance sheets and the government concurs, believing lending restrictions are stifling growth. Remember, PCA applies when the capital available with banks has fallen below the required threshold, when they have unusually large NPAs or bad loans and a balance sheet clean-up has been forced on them, which essentially means they are now forced to recognise those NPAs which they were probably earlier sweeping under the carpet.

If a bank has a mountain of unsustainable loans, doesn’t have enough capital backing and still wants to lend, wouldn’t this be akin to a death wish?

In his remarks at IIT-Bombay earlier this month, Acharya not only spoke strongly in favour of the efficacy of the revised PCA framework, he also explained in detail how restrictions have already begun showing positive results. An important objective of the PCA is to first and foremost limit further losses and prevent erosion of bank capital, creating a platform of stability for the bank, and in turn, setting the stage for structural interventions to be implemented and pushed through, said Acharya and then went on to demonstrate with data how banks under the PCA framework have already improved on several indices.

He also acknowledged that advances by these banks are in the negative territory now, adding that this was the intended purpose, “the required medicine to prevent further haemorrhaging”.

Acharya has also rubbished the suggestion that imposition of the PCA has starved the Indian economy of credit, saying, “There is little factual basis for this assertion, either for the overall economy or at sectoral level… the reduction in lending at PCA banks is being more than offset by credit growth at healthier banks. This is indeed what one wants — efficient reallocation of credit for the real economy with a financially stable distribution of risks across bank balance sheets. Indeed, the funding for the economy as a whole has become diversified over this period, also due to the growth of capital markets.”

Responding to calls for more lending by PCA banks to large industries, Acharya said many of these industries were heavily indebted to start with and were anyway going through a deleveraging process under the IBC. The PCA banks are de-risking the asset side of their balance sheets by moving away from riskier sector loans to less riskier ones and government securities; the first and foremost priority is to limit (effectively, taxpayer) losses at PCA banks and prevent further erosion of their capital.

So in essence, the bitter pill being administered to PCA banks is working not just for these banks but also benefiting the entire banking sector as also you and me, the Indian taxpayer. Why should the government quarrel with this simple fact?

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