What two recent books by former RBI governor Urjit Patel and deputy governor Viral Acharya say about the problems plaguing the country’s financial sector
Former RBI deputy governor Viral V Acharya believes that cricketer Rahul Dravid should be the role model for a central bank. “He was such an important batsman for the Indian team — steady, middle-order [and someone who] had to solidify the entire innings,” says Acharya during a recent interaction with Mirror. “I always believe that a central bank should perform that functional role in an economy.” When in doubt, Acharya says he would watch a Dravid innings. “I would think, what would Dravid do if this was the situation in a Test match? And that always helped me find the right path,” he says.
For a time in 2017, it seemed like the Reserve Bank of India had found its Dravids. Urjit Patel had taken over as governor in September 2016, and Acharya joined as deputy four months later. The two, along with deputy governor NS Vishwanathan, Acharya says, were a “formidable team” to bring fiscal reform and clean up a beleaguered banking system. “We brought different skills to the table but had close alignment in our understanding,” says Acharya. “We didn’t always agree, even though from the outside it seemed that way. We used to have heated discussions but we were focused on financial stability in the medium to long term as our overarching goal for the Indian financial system.”
Our approach to banking has been to kick the can down the road rather than recognise that when there are losses, you need to clean up and ensure banks have loss-absorption capability
Viral V Acharya
It was a short-lived time of promise and possibility. Both Patel and Acharya left the RBI well before their terms ended — Patel in December 2018, and Acharya in July 2019. While neither has talked about this, it’s widely believed that irreconcilable differences with the government — mainly over the latter’s attempts to dilute the newly-instituted bankruptcy reform, the Insolvency and Bankruptcy Code (IBC) and continue to extend loans to favoured companies who were likely to default — severely undermined the authority and autonomy of the RBI and its top leadership. It left Patel and Acharya with no choice but to go.
Neither banker talks about it in his recently-published book either. In Overdraft: Saving the Indian Saver (Harper Collins), the reticent and media-wary Patel — who often refused interviews to the press even while in office — begins with a teaser: “I have been in the news; while it lasted, the contretemps made good theatre. It ended when I stepped down. The theatre of eminences has been going on for centuries and will continue for many more; eventually, everyone is forgotten.” (Despite requests, Patel could not be reached for a comment).
Those looking for more dirt on his exit will, however, find only a trail of breadcrumbs. All Patel says on the matter is: “The disposition with respect to the IBC or, more generally, in the conviction in the pathway, perceptibly changed — conceivably on defensible grounds — in mid-2018. Instead of buttressing and future-proofing the gains thus far, an atmosphere to go easy on the pedal ensued. Until then, for the most part, the finance minister and I were on the same page, with frequent conversations on enhancing the landmark legislation’s operational efficiency…” Patel’s indictment of a meddlesome and overreaching government finds more substantiation in another chapter, where he holds everyone — from the government, to banks, to corporate lobbies and business associations that influence policy- making — culpable for the poor state of India’s banking sector.
Despite public interest, Patel does not touch upon the reasons for his exit from the RBI in his book
Acharya’s book, Quest for Restoring Financial Stability in India (SAGE India) — a compilation of speeches delivered during his tenure at the RBI — is a more academic work that explores why financial stability and fiscal stance are imperative for a healthy economy. “The main problem [with India’s banking system] is that the loans extended by some of our banks have been non-performing, and have led to losses,” he says. “A healthy banking system is one in which the banks, at the time of underwriting the loan, do their due diligence and lend to healthy borrowers rather than firms who have already defaulted. This ensures we don’t throw good money after the bad.”
Banks need to be bolstered with adequate loss absorption capacity as well, through the availability of equity capital, so that despite losses, they don’t become risk averse.
The Indian banking system, says Acharya, is “always catching up, as far as loss absorption is concerned. Even when loss absorption capacity is promised by the government [by way of infusions] for public sector banks, it is not provided for ahead of time”. Sometimes, that capital goes to weaker public sector banks instead of those with better underwriting standards. “Our approach to banking has been to kick the can down the road rather than recognise that when there have been losses, you need to clean them up and ensure that banks have loss-absorption capability by creating additional buffers of capital,” he says. “What I’m trying to say in the book is that you need to proactively provide for losses ahead of time so that the system stays resilient.”
Sweeping problems under the carpet is unlikely to work; it will only delay the unlocking of capital, hold back growth and come in the way of financing future investment efficiently
Indian banks, Acharya suggests in the book, should be subjected to a stress test — much like a human treadmill test — to gauge their health. “You don’t just want to know is a bank is fine now, but also whether it can withstand significant stress in the future,” he says. This may also provide pointers for how to recapitalise the banks. “The US undertook difficult recapitalisation measures and recovered well,” adds Acharya. “Now its banks are healthy and lending well, despite the significant Covid shock.”
Acharya and Patel worked closely to deploy the IBC and provide a faster resolution of assets so that banks could get recoveries on bad loans. “We made a push for a recapitalisation of the banking sector so that healthier banks had growth capital to make newer loans to households and corporations, and were not averse to lending to them,” says Acharya. “We tried to put in place corrective action, based on a framework rooted in the US system, that when a bank starts showing signs of stress, you prevent it from lending to defaulted and distressed borrowers and put it on a path to recovery. Those were some of the critical ingredients for providing financial stability to the Indian economy, and I think we made a good effort with such economic reforms.”
Readers have latched onto a statement in Acharya’s book where he says that “the RBI lost its governor on the altar of financial stability” to indicate the difficulties faced by Patel during his governance. “It was not meant to be a controversial statement but a matter-of-fact description,” says Acharya. “We were trying to put in place financial stability but the headwinds [referring to the government’s interference] were very strong. We need to have a healthy public debate about these pressures and their origins.” Indeed, Patel advocates similar things in his book, referring to rule-based decision-making, public debate and a democratic accountability of the RBI’s actions. He echoes Acharya’s thoughts when he writes: “We have to be vigilant that U-turns don’t usher a serial bout of ever-greening and zombie borrowers; otherwise victory over crony capitalism will, at best, be short-lived, and that the limited progress so far could turn out to be a false dawn….” Patel also points out that “direct stakeholders, in particular savers, have to be vigilant against risks emanating from creeping regulatory and policy complacency. Shortcuts or, worse, sweeping problems under the carpet is unlikely to work; it will only delay the unlocking of capital, hold back growth and come in the way of financing future investment efficiently”. Later he remarks that “speedy and time-bound resolution, even liquidation, can help boost growth as it will inhibit the atrophy of capital stock that comes about from the emergence and prolongation of zombie firms and sectors”.
Both Patel and Acharya have, of course, moved on. Patel is currently chairman of the National Institute of Public Finance and Policy, while Acharya has gone back to teaching credit risk at the New York University Stern School of Business. He admits that he hasn’t been tracking every action of the regulatory bank but is still connected to India through his philanthropic activities (proceeds from the sale of his book will go to the non-profit, Pratham). “We need a set of reforms and a path for the economy so that in 10, 20 or even 30 years, we make further progress in the eradication of poverty, skilling of youth and creation of high-skilled jobs. I think that is what ultimately matters,” says Acharya.