Whose money is it anyway?

Funds with the RBI, the government and public sector institutions belong to taxpayers, bank depositors and insurance policyholders

Breaking-news media stories usually have a lifetime of about 48 hours. The underlying reasons and subsequent developments are often not investigated or tracked. As the calendar year 2018 draws to a close, one attention grabber was the sacking of the Infrastructure Leasing & Financial Services (IL&FS) board by the central government on September 30. The other was the resignation of the Reserve Bank of India (RBI) governor on December 10. This article tries to persuade readers not to take their eyes off how the government and regulators address and remedy the worrisome causalities which led to both events.  

The specific reasons for the RBI or the credit rating agencies not picking up on IL&FS’ liquidity and solvency problems are not available in the public domain. Life Insurance Corporation (LIC), State Bank of India (SBI) and Central Bank of India hold 25.3, 6.4 and 7.7 per cent equity, respectively, in IL&FS. These add up to nearly 40 per cent public shareholding in IL&FS, which may have lulled everyone into an irrational sense of security about this “large and systemically important non-banking financial company (NBFC)”. The role of internal and external auditors needs to be investigated by the new board since it appears that some out of the hundreds of IL&FS subsidiaries misrepresented their numbers. Next, how much of IL&FS' total debt of Rs 910 billion was mistakenly or deliberately rated triple-A? The Securities and Exchange Board of India (Sebi) should publicise how it will get rating agencies to be accountable about their ratings in the future. 

LIC and SBI are the country’s largest insurance company and scheduled commercial bank, respectively, and their chairpersons were on the IL&FS board until it was replaced by a government-appointed board on September 30. Each of the many IL&FS subsidiaries had its own management and often separate boards. The chairpersons of LIC and SBI, as well as the Insurance Regulatory and Development Authority of India (IRDAI) and the RBI, should explain why they were oblivious to the highly risky manner in which IL&FS was managed. The past IL&FS board members do not seem to have ever questioned the extremely luxurious working styles and flashy cars of the IL&FS senior management. The new board should make public whether the LIC and SBI investments in IL&FS over the past few decades, which involved much higher risk, even matched the return on risk-free government debt securities. 

A Supreme Court ruling of December 15, 2015, had directed the RBI to provide names of defaulters in a few specific cases to the chief information commissioner (CIC). A former governor of the RBI has recently stated publicly that a list of high-profile non-performing asset (NPA) cases was provided by the RBI to the Prime Minister’s Office (PMO). Why did the RBI write to the PMO instead of the Ministry of Finance (MoF) unless it felt that the head of government's approval was needed to proceed in default cases which involve well-connected promoters? Market participants and taxpayers need to know if the subject matter of the RBI governor’s letter to PMO was discussed with the finance minister or at an RBI board meeting and what action was taken, if any. The government should make the substance of this letter public and ask RBI why it has not complied with a three-year-old Supreme Court ruling to provide names of defaulters to the CIC. 

Illustration by Binay Sinha

The RBI’s prompt corrective action (PCA) norms have meant that currently, 11 public sector banks (PSBs) cannot lend since they do not have adequate risk capital. RBI’s circular of February 2018 directs banks to recognise defaults within a day which is consistent with international best practices. Contrary to misleading media reports, RBI does not require banks to tag defaults with the non-performing asset (NPA) label within a day. According to this much-needed circular, the clock on the 180-day timeframe by which NPAs have to be referred to a National Company Law Tribunal (NCLT) starts from Day One of the default. However, the spurious distinction between default and wilful default has not been dropped by the RBI. 

Was it lack of risk evaluation capacities in PSBs or was it crony capitalism which led to high levels of impaired assets held by PSBs? Clearly, there were shortfalls in anticipated cash flows because projects were held up due to lack of environmental/land acquisition clearances or because prices of inputs went up unexpectedly. In some instances, contractual obligations resulted in the pricing of final output below the cost of inputs as in the case of power generation. 

It was hoped that with the Insolvency & Bankruptcy Code (IBC) and the setting up of NCLTs and the Insolvency and Bankruptcy Board of India (IBBI), the interminable delays caused by the Board for Industrial and Financial Reconstruction (BIFR) would be a thing of the past. However, NCLTs are clogged with cases, big and small. This needs to be remedied by setting apart a few NCLTs to deal only with cases of, say, Rs 200 billion and above. It would be a travesty if the PCA framework and the February 2018 circular were to be diluted in any way. 

The answer to the question posed in the title of this article is that funds available with the RBI, the government and public sector financial institutions belong to taxpayers, bank depositors and insurance policyholders.  The pointless controversy about the quantum of reserves the RBI should transfer to the government is a red herring since in the final analysis, they have a common balance sheet. The crucial issue is whether in providing support to PSBs, the government ends up allowing/encouraging them to lend to those who have a proven track record of diverting funds to themselves and their political patrons. 

The recently released book Keeping At It: The Quest for Sound Money and Good Government by former chairman of the US Federal Reserve Paul Volcker is about sound central banking and responsible governance. In a nutshell, Volcker says it is all about “strength of character”. Is that a tall order for the Indian government and the RBI? Hopefully, they will both rise to the occasion in 2019. 

The writer is a former Government of India and World Bank official

Email: j.bhagwati@gmail.com