Face-off or glasnost?

It is possible that the RBI governor’s speech in Gandhinagar was an attempt at pushing the envelope on reforms in PSBs

It will be simplistic to describe the recent statement from Reserve Bank of India Governor Urjit Patel on the need to make bank regulation ownership-neutral only as a face-off between the central bank and the Union finance ministry. The implications of what Patel said last week are far more significant than just what a face-off usually means.

It’s true that Patel’s statement was a response to an earlier statement of Finance Minister Arun Jaitley, wherein he had held the regulator accountable for the ~129-billion letters of undertaking (LoU) scam involving state-controlled Punjab National Bank. The minister had also said that the regulator needed to have a third eye to ensure adequate supervision of banks.

But this does not appear to be just a face-off. Instead, this may be a larger manifestation of some sort of glasnost happening in the area of financial sector reforms under the Modi government. A face-off usually results in a deadlock and almost invariably the political leadership wins the battle. But in glasnost, the outcome is different and instead of heads rolling, the reforms agenda can pick up speed. The nature of developments in the RBI and the finance ministry in the coming months will tell us whether this was only a face-off or glasnost.

As of now, there are good reasons to believe that this was not a face-off. Rarely do central bank governors in India make public statements that can pit them directly against the finance minister or the government. The RBI governor, after all, is appointed by the Union government and his autonomy or independent status is largely defined by the fact that he remains in that job at the government’s pleasure. If the RBI governor has a view that is different from that of the government, he usually does not make it public and instead privately discusses those differences with the finance minister or even the prime minister.

It is, therefore, possible that the RBI governor’s speech in Gandhinagar was an attempt at pushing the envelope on reforms in public sector banks (PSB). The finance minister’s candid observation on the role of the regulator and the RBI governor underlining the need for legislative reform to make bank regulation ownership-neutral could well be aimed at creating a climate for more debate on bank reforms so that the political resistance to ownership change can be softened, if not completely overcome.

Remember that soon after the LoU scam hit the nation in the middle of February drawing attention to regulatory failure in enforcing good governance and prudent business practices, the focus of the debate had shifted to the need for ownership change in PSBs that account for about 70 per cent of India’s banking system. In his initial comments, the finance minister had not ruled out privatisation of PSBs, but noted the lack of a political climate conducive to such ownership change.

Even as several experts and bankers debated the pros and cons of bank privatisation, the RBI governor had not spoken on the matter even once. Patel’s lecture last week was his first intervention in this debate. Note that he did not talk about privatisation. Instead, even as he reiterated his commitment to enforcing compliance of business rules by banks, he went a step further by calling for legislative reform to make banking regulation ownership-neutral. What did he mean?

The RBI governor cited amendments in the Banking Regulation Act to state that regulation for PSBs was different from that for other banks in as many as seven areas. RBI cannot remove directors and management at PSBs. It cannot supersede their boards. It cannot remove PSB chairmen and managing directors. It cannot force a merger of a PSB. It cannot revoke a licence for PSBs since they do not need a licence from the central bank. It cannot trigger liquidation of PSBs and a degree of duality of the top management is allowed in PSBs.

So, what did the RBI governor ask for? Arguing that the market discipline mechanism for PSBs is weaker compared to that for private banks, he suggested suitable changes in the Banking Regulation Act so that the RBI enjoyed the same powers with regard to those seven areas for PSBs as well as private banks. Note that the RBI governor has pointed out that the Banking Regulation Act amendments are the “most readily feasible of all options”.

Privatisation of PSBs may be too ambitious a task and even politically risky for the Modi government as it prepares for general elections in about 14 months. Has the RBI governor then prepared the ground for governance reform for PSBs, which are politically less risky and relatively easy to implement? That will be known if and when the government moves ahead with these reforms in the next few months. Till then, the speculation over a RBI-government face-off could take a break.