Regaining trust

The Indian Express, June 27, 2017

By Pradeep S Mehta and Amol Kulkarni

RBI must use the banking ordinance to deal with its credibility crisis. It must require rating agencies to make their processes transparent, objective and subject to public scrutiny.

Since November 8 last year, the Reserve Bank of India (RBI) has been facing a credibility crisis. It had to deal with a barrage of accusations for toeing the government line on demonetisation. Even six months after the decision, its refusal to disclose minutes of the fateful meeting in which the demonetisation decision was taken has made several ardent RBI fans to sit up and notice, with some concern.

The RBI has defended its decision on the grounds of national/economic interest, without expounding how such interest is served with its action. It has used similar rationale for refusing to make public the list of loan defaulters with public sector banks. In effect, the RBI is asking us to put our complete and unquestionable faith in it, which is further eroding public trust on it. This situation needs to be quickly addressed before it is too late.

These are times when any question or dissent against government decision runs the risk of being labelled as anti-national. As a result, while the intelligentsia is increasingly becoming sceptical about government functioning, in some cases, the government is repeatedly resorting to excessive delegation and allowing the unchecked use of discretion by the executive and regulators.

A recent example is the Banking Regulation (Amendment) Ordinance, 2017. The ordinance empowers the central government to authorise the RBI to issue directions to banking companies to initiate insolvency. It also empowers the RBI to issue directions to banking companies for the resolution of stressed assets. However, the ordinance fails to provide any indication on the process which the government or the RBI need to follow to arrive at a decision and presumes good faith on the part of the officers in the government and the regulator. It trusts that such officers will arrive at the right decision. It has been reported that this mechanism is to facilitate unfettered decision making without the fear of the 3Cs: CBI, CVC and CAG.

Consequently, commercial decisions like haircuts taken by banks, taking over of management/ resolution reference of corporate borrowers and the restructuring of loans, will be guided by the government and no longer be subject to stringent scrutiny they deserve. While government officers might work with best intentions, trusting individuals over processes can never be a wise option.

The RBI promised to develop a framework to facilitate an objective and consistent decision-making process for resolution reference. It constituted an internal advisory committee, which recently recommended accounts with an outstanding amount greater than Rs 5,000 crore with 60 per cent or more classified as non-performing on March, 31, 2016, for reference under the insolvency and bankruptcy code. It is not clear why a cut-off date of 2016 was chosen. Substantial provisioning would have already been done for such accounts. These cases are expected to get priority at the National Company Law Tribunal. The mechanism for according such priority treatment is not clear.

A better alternative would have been promoting transparency in the decision-making process. A standard operating procedure must be developed through comprehensive stakeholder consultation and released in the public domain for arriving at decisions and for recording the rationale and process adopted. Decisions where clear rationale is absent or lacking the necessary transparent process run the risk of ruining market confidence and denting the country’s growth story.

The RBI has recently issued an action plan to implement the ordinance. It is primarily to nudge the consortium lenders in a joint lenders forum to arrive at a decision regarding corrective action plan, which involves restructuring. Henceforth, it will become easier to refer stressed assets to the corrective action plan, and approval of special majority of bankers (by value) will no longer be necessary. This is not necessarily the best way out, and must be debated. Alternatives requiring time-bound decision making, backed by sound rationale could be considered.

In addition, the action plan envisages a greater role for credit rating agencies. Given the conflict of interest concerns, the RBI is exploring the feasibility of rating assignments being determined by itself and paid from a fund to be created out of contribution from the banks and the RBI. While such a mechanism could partially deal with the moral hazard of the rating business being incentivised by banks, it does not deal with the core concerns of a sub-optimal rating process, as highlighted in the aftermath of the transatlantic financial crisis.

The RBI must require rating agencies to make their processes transparent, objective and subject to public scrutiny. Further, in the proposed mechanism wherein the RBI makes part payments to rating agencies, it may find itself conflicted between the need to obtain a cost-effective and a high quality credit rating. Consequently, alternatives like independent bodies to select credit rating agencies could be explored.

Hitherto, the RBI has adopted an incremental approach in dealing with the bad debt issue and offered several lifelines to the banks and borrowing companies. Unfortunately, this has not borne fruit. The RBI must use its enhanced powers under the ordinance to adopt a transformational approach to deal with bad debts, and regain trust in the regulator. This can happen only when it takes hard decisions including designing transparent decision-making process, fixing accountability, and punishing non-compliance, especially its own officers. It must encourage the culture of dissent and debate, promote public disclosures, and welcome scrutiny to regain its credibility and public confidence.

The writers work for CUTS International

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