Demonetisation to bad loans, Urjit Patel navigates choppy waters in 2 years

Urjit Patel also came down heavily on banks hiding their bad debts

If the first year of Urjit Patel's tenure as the Reserve Bank of India (RBI) governor was all about demonetisation, the second year was focused on fighting the bad assets mess in the banking industry, often at the cost of ruffling a few feathers in the North Block and upsetting powerful business lobbies.

Heading to the third year, will he be busy firefighting a currency crisis?

Almost no governor of the RBI managed to evade it and Patel perhaps knows it. He is amongst the first and few central bankers globally to publicly acknowledge that the world is heading towards a currency war. And if so, the Indian rupee is perhaps one of the worst-hit.

So far this year, the local currency has fallen more than 9 per cent, and the exchange rate is already at its lowest level ever, heading fast towards Rs 71 per US dollar.

The total bad debt of the Indian banking system at the end of June 2018 stands at little more than Rs 10 trillion, up from Rs 6.55 trillion two years ago. At least Rs 3.5 trillion of the bad assets are undergoing bankruptcy proceedings, and almost an equivalent amount may head towards National Company Law Tribunal, according to rating agency ICRA Ltd.

Some prominent companies have been sold off by banks to recover their dues under the insolvency code, or are in the process of getting folded up. Many more will be dragged, essentially changing the way business and credit has been run in India thus far. Suffice to say that under Patel, banks have been empowered, but bankers are not happy with the RBI’s inflexibility in providing some leeway when it comes to addressing bad debts, in particular, the Rs 1.77 trillion worth of power sector loans.

“Swift, time-bound resolution or liquidation of stressed assets will be critical for de-clogging bank balance sheets and for efficient reallocation of capital,” Patel said in a speech last year.

While bankers may not like it, some analysts found the RBI’s stance commendable.After the introduction of Insolvency and Bankruptcy Code (IBC) in December 2016, stressed corporates or companies and their outstanding debt have to be resolved according to a time-bound process. However, the banks have incurred heavy haircuts when it comes to resolving their debt exposure.

In the case of power sector loans, the banks pleaded with the central bank, and got some support from the government as well, to extend the stressed asset resolution deadline of August 27. But the central bank showed no sign of budging.

"The RBI has been vindicated by the Allahabad High Court, in terms of its stern stand on the power sector NPAs. The major achievement is that after putting in place a new framework in February, the RBI has stuck to it and ensured that there are no exceptions,” said an economist, who wished to not be named.

“There is pressure on the RBI as banks would like more flexibility in terms of resolving the stress, the government may want more leeway to resolve certain sector specific NPAs, but the RBI has stuck to its guns. This shows a lot of character from the RBI under the aegis of Patel," said the economist. The RBI under Patel also won’t allow some stressed banks to breathe easy.

As of date the RBI has placed 11 commercial banks under its highly restrictive Prompt Corrective Action (PCA) framework, which impairs normal business activities. The banks are capital-starved, but are required to put aside the same amount of capital as required for a healthy bank to take care of their bad loans.

While the aim is to clean up the balance sheets, investors in these banks have long junked the stocks expressing their doubt in the RBI’s prescription.

Patel also came down heavily on banks hiding their bad debts. The divergence found between the reported bad debt and what the RBI auditors found led to the RBI pulling the rug from under the feet of at least one chief executive of a private bank.

The fact that large divergences were observed “has adverse implications on timely recognition of actual risk, trustworthiness and transparency of books of accounts and management effectiveness”, Patel said.

Soon after Patel took charge as the governor, demonetisation invalidated 87 per cent of the cash in the system. After facing some initial hiccups, the RBI and the banks managed the situation well and the shortage of cash was resolved in a few months.

Patel’s tenure is the first at the RBI wherein the country’s monetary policy was set by a six-member Monetary Policy Committee (MPC), headed by the RBI governor.

"The RBI under Patel has conducted its monetary policy functions in an exemplary fashion with the new structure of the MPC, as opposed to the previous regime wherein there were conflicts between what the governor wanted and what the government wanted. Now with the committee approach, decisions are being made more transparently," said a chief economist with a research firm.

Patel also aggressively accumulated foreign exchange reserves, peaking at $426 billion in mid-April. The reserves have come off from their highs, but are still above $400 billion.

Much of the reserves have been spent to fight a rupee slide, which has brought the Indian currency to Rs 71 a dollar, a record low. “Trade skirmishes evolved into tariff wars and now we are possibly at the beginning of currency wars,” Patel said at a post-policy briefing earlier this month.

Relationship with the government

Appearing before the Parliamentary Standing Committee on Finance, which is evaluating the effects of demonetisation and the rising bad debt levels in banks amongst other issues, Patel faced tough questions from Members of Parliament.

He was also questioned on the RBI’s powers of oversight in light of a trade-financing scam of Rs 140 billion at Punjab National Bank, allegedly committed by diamontaires Nirav Modi and Mehul Choksi. He told the committee that the RBI has "inadequate" control over the public sector banks (PSBs) and that the RBI should have more powers to control the government-owned banks.

Patel time and again became vocal in protecting the central bank’s turf.

In a speech in March this year, he said that the central bank's regulatory authority over public sector banks was weaker than that over the private sector banks, and that the "system of dual regulation by the finance ministry in addition to the RBI" when it came to public sector banks was the cause of the sector's bad debt problem.

The government responded by blaming the RBI for not waking up to the scam with Finance Minister Arun Jaitley taking a jibe at the regulator, saying that “politicians are accountable while regulators are not”.

While that statement by the government was made prior to Patel's speech in March, an excerpt offered an appropriate response: "While that can always be said ex post with any fraud, it is simply infeasible for a banking regulator to be in every nook and corner of banking activity to rule out frauds by ‘being there’".

Major Initiatives under Urjit Patel

First year

First Monetary Policy Committee meeting to set interest rates held

Demonetisation and remonetisation of 87 per cent of currency notes

Guidelines set for payment banks and an Enforcement Department formed within the RBI

Rationalisation of merchant discount rates to increase card-payment adoption

12 large stressed corporate accounts sent for IBC proceedings 

Second year

Began background work on public credit registry

Banned users, traders, brokers and entities dealing with virtual currencies

Set up expert committee to look at divergences in banks’ asset quality

Discontinued Letters of Understanding and Letters of Comfort trade-financing facilities

Allowed commercial banks to co-originate loans with non-banking financial companies