RBI-govt tiff: All’s well that ends well

[dropcap]T[/dropcap]he RBI and the government managed to pull back from the brink in the nick of time by showing understanding for each other’s positions, thus avoiding a clumsy confrontation that at one stage appeared inevitable.

After a marathon meeting lasting nine hours, the RBI board of directors agreed to work out a loan restructuring scheme for SMEs for loan exposures of up to Rs 25 crore. The board, however, advised that the scheme should be subject to such conditions that are necessary to ensure financial stability. This marked a clear climb down by the apex bank, which was averse to considering any change in the stringent conditions for financing small units on the ground that the banking sector is already reeling under the impact of toxic assets.

RBI also agreed to review the Prompt Corrective Action framework under which the weaker banks were restrained from lending to small and medium businesses. As per the new decision, RBI’s board of financial supervision (BFS) will ease some of the stringent conditions on 11 public sector banks that had been identified as weak in view of their bad loans. Also being relaxed are the prevailing norms on the Capital Conservation Buffer, which is the extra capital banks hold above their mandatory capital, and this is expected to make more money available to the banks to lend.

The reaching of common ground was helped by backroom efforts by the two sides, which were preceded by occasional bouts of aggressive posturing by the two sides, including the unprecedented step of invoking sections of the RBI Act, which enabled the government to make effective intervention to influence the policies to be followed by the banking supervisor. Governor Urjit Patel had at one stage even threatened to quit if the government forced the issue, but good sense prevailed after the two sides expressed appreciation of each other’s points of view.

Simultaneously, the Modi government had turned up the heat by changing the character of the RBI Board by packing it with members who would do the government’s bidding. There have been widespread protests that the government was destroying the integrity and independence of the RBI by inducting members who held views similar to the known positions of saffron outfits. And some of these members, particularly, S Gurumurthy, had embarked on a build-up in favour of the government ahead of the crucial RBI meeting.

In the event of a confrontation, the board was heavily skewed in favour of the government and this would have definitely played on the minds of the governor as well as other directors backing him. It is indeed satisfying that the two sides have managed to avert a crisis, which would have adversely affected all the parties involved, including the financial markets, which have been closely watching the developments.