Blog Post

Bite the bullet on banks

Rajiv Kumar 12 May 2017

Recent amendments to the RBI Act have drawn expected flak. The criticism that a central bank is only a regulator, and not responsible for handling a crisis, is patently misplaced. Central banks have led the way for addressing banking sector crisis over time and across countries.

The plausible fear is that these measures may draw the RBI into micro-managing commercial banks, especially public sector banks (PSBs). RBI possesses neither the expertise for appraising the potential and prospects of non-performing projects across sectors, nor the capacity for evaluating any turnaround strategy that may have been already put in place.

These criticisms miss the underlying purpose of recent amendments. This is aimed to shield commercial banks, especially PSBs, from the vagaries of the 3Cs that have completely paralysed decision-making in public sector banks. The fear of post-facto open-ended enquiries by the CAG, CVC and CBI makes decision-making, especially for accepting losses, an anathema for PSB managements. Accepting responsibility for non-performing assets (NPAs), which they might well have inherited, and taking the proverbial 'haircut' is a complete 'no-no' for PSB managements, irrespective of the adverse impact this may have on the bank's balance sheet, on sector prospects or indeed on the state of the economy. As the head of PSB, the chief concern is to have a peaceful retirement, hopefully as independent director on several well-paying private company boards. Nobody wants 3C officials knocking on one's doors, few years into retirement.


These amendments try to break this logjam by effectively asking RBI to take the lead and onus of ordering bankruptcy proceedings against defaulting borrowers. PSBs can then claim to be working strictly on orders of the regulators and can be shielded from future penal actions. The RBI, along with the relevant commercial bank, is further protected from possible ‘attack’ by 3Cs either on suo motu basis or instigated by a PIL, by the provision of setting up 'sector committees' that will determine the actual size of the 'haircut' to be taken depending inter alia on the economic state of the sector in domestic and external markets; the financial strength of the original borrower; and presumably the chances of revival under renewed management. Thus, it is hoped that led by the RBI, commercial banks, especially PSBs, will now move ahead to resolve these festering NPAs. On last count they had mounted up to a massive 77 lakh crore, choking the flow of commercial bank credit to industry, which is now beginning to look for investment funds after a lull of nearly four years.

However, these amendments may unfortunately not break the NPA-credit stoppage-logjam. Even a fleeting knowledge of established institutional practices, procedures and hierarchies in the RBI will reveal that the urgency needed for handling the current situation may not be possible.

And time is of essence if growth momentum has to be sustained. RBI will have to induct substantial sector-specific talents in these committees and also perhaps reinforce its banking supervision department to oversee and monitor the bankruptcy proceedings with their concomitant decisions on volume of losses to be taken by PSBs. This can be a rather involved process and carries with it the inherent risk of distracting the RBI from its crucial regulatory mandate. That could be sub-optimal.

Therefore, should the government, as the majority owner of PSBs, not directly shoulder the responsibility of dealing with the NPAs and the related issue of mergers, closure, privatisation and recapitalization of PSBs? This could well supplement RBI's efforts. For example, the government could have shielded PSBs from the 3C afflictions by establishing the holding company as recommended by the Nayak Committee.


It would take the decisions on losses to be borne and haircuts to be taken, without exposing individual PSB management to 3C traumas. The holding company could also have set up sector committees under its aegis. Its monitoring could presumably be far more effective than the RBI's given its multiple responsibilities and despite all its technical capacities.

The Banks Board Bureau (3B) is not answer to the problems created by 3C! Hence the amendments one presumes. 3B is not a substitute for the holding company which would have been legally empowered to take decisions and not merely be a part-time recommendatory body like 3B with neither the writ nor the capacity to design and execute strategies for revamping PSBs. Having a part-time chairman, who has other onerous jobs, does not help in any case. It is time for the government to recognise the responsibilities that come with ownership of 76 per cent of the Indian banking sector and take precipitate measures to set it on the right course.


In the absence of the holding company, the department of financial services would do well to establish an empowered cell that will work with RBI in addressing the NPA crisis on a mission mode. The cell will identify the 100-odd large borrowers in sectors that are well-known for concentration of NPAs. The empowered cell would then lay down the conditions under which particular PSBs could expect to be recapitalized or alternatively be privatised or merged. It would thus supplement RBI's efforts.

As the owner of PSBs, the government has to bite the bullet. Given the extreme reluctance of PSB managements to take precipitate action and constantly kick the NPA down the road, they will have to be goaded in the right direction. Yes, the RBI with its substantial persuasive powers as a regulator can try doing that. But as the owner, this is principally the government's call. It should take steps that will change the incentive structure for PSB managements. Moreover, the government can also ensure that 3Cs don't work in complete isolation from the economy's overall interests.

The author is founder director of Pahle India Foundation and Chancellor, Gokhale Institute of Politics and Economics.