Gurumurthy fuels a vigorous debate

You have to hand it to S Gurumurthy, chartered accountant, co-convenor of the Swadeshi Jagran Manch and member of the central board of directors of the Reserve Bank of India (RBI).

By vigorously articulating his positions at the RBI board as well as in the print and social media, Mr Gurumurthy has got people thinking on a range of issues — capital adequacy norms for banks, the Prompt Corrective Action (PCA) framework, expanding credit to Small and Medium Enterprises (SMEs), the economic capital required for RBI, the role and powers of the RBI board and, most recently, the printing of money to meet the government’s requirements.

True, it’s the government that raised all but the last of these issues in the first instance. However, without Mr Gurumurthy’s powerful advocacy of a change of course in his capacity as RBI board member, it’s doubtful that the debate would have proceeded as far as it has.

By the time these lines appear in print, the outcomes in respect of the issues in dispute will have become known. Nevertheless, it’s worth touching upon some of these in order to understand where Mr Gurumurthy is coming from. Does he have a conceptually sound case? Or is he simply pushing the agenda of a government that is focussed on immediate outcomes in the run-up to general elections in 2019?

Let’s take the issue of capital adequacy norms for banks. The Basel norms devised by the Bank of International Settlements specify a minimum 8 per cent capital adequacy norm for banks. The RBI requires capital adequacy of 9 per cent, one percentage point higher than the Basel norm.

According to some estimates, public sector banks (PSBs) will soon require an additional ~1 trillion to comply with the RBI’s requirements. That’s a tall order for the government. If India’s capital adequacy requirements were reduced to the Basel level, most of the additional capital would not be required.

Mr Gurumurthy sees no reason why the RBI should set capital requirements for banks higher than the Basel norms. For his part, RBI Deputy Governor Viral Acharya points out that many banks worldwide choose to have capital well above the Basel minimum. This is true of private banks in India as well. The better-performing private banks operate at a capital adequacy of 15-16 per cent. Why? Because more capital spells more stability and a higher valuation in the stock market.

Now, this may be true of private banks. However, it need not apply to PSBs that have an implicit sovereign backing. The stability of PSBs is not in doubt. For PSBs, earnings growth may be more crucial to valuation than a higher level of capital. Earnings growth at PSBs is driven primarily by loan growth. A lower capital adequacy requirement would facilitate higher loan growth. There is a case, therefore, for lowering the capital adequacy requirement in India to the level required by the Basel norms.

The disputes about loans to SMEs and the PCA framework also have to do with enhancing credit flows. SME loans require a lower allocation of capital. But the RBI’s definition of SME exposure is more stringent than the Basel norms. Relaxing the RBI’s definition (without necessarily matching the Basel norms) would facilitate higher inflows of credit to SMEs.

Mr Gurumurthy argues that the PCA framework elsewhere is based only on capital adequacy whereas the RBI uses two other criteria for the purpose: Return on assets and the level of non-performing assets (NPAs). Relaxing the PCA framework could again translate into badly needed flow of credit. Mr Gurumurthy underlines the fact that SMEs form the backbone of the economy. If they are starved of credit, the economy suffers. This could translate eventually into suffering for larger enterprises and healthier banks. There are thus systemic implications to regulatory norms that inhibit expansion of credit at PSBs.

One could argue about how much relaxation in norms would be prudent. One could make the point that increased lending at PSBs must go hand in hand with improved risk management and governance. However, it’s hard to dismiss Mr Gurumurthy’s contentions out of hand.

Mr Gurumurthy has made another proposal that will have many recoiling in horror. He wants the fiscal deficit to be financed by printing money. Monetisation of the deficit has long been regarded as being beyond the pale. Well, no longer. Adrian Turner, an investment banker turned former head of the UK’s Financial Services Authority, made out a strong case for monetising deficits in his book, Between Debt and the Devil, which came out in 2016.

Mr Turner argued that in a world where neither fiscal policy nor conventional monetary policy was working, printing money needed to be considered seriously. He suggested it could be have three uses: Putting money in the pockets of citizens, writing off government debt held by central banks, and recapitalising banks.

Mr Turner emphasised that the creation of money happens through the creation of credit by banks. What happens when banks are not creating enough credit and, therefore, there is not enough liquidity in the system? That is the question Mr Gurumurthy is posing. Answering the question may well require new thinking of the sort Mr Gurumurthy urges.