Viral Acharya Raises Critical Points For RBI & Govt

Viral Acharya Raises Critical Points For RBI & Govt

Former RBI Deputy Governor Viral Acharya in his latest book “Quest For Restoring Financial Stability In India”, says that fiscal dominance in India has become a mainstream practice that hinders the growth of banks and eventually results in the slow growth of the nation. His critical views on RBI’s functioning and the central bank’s relationship with the government have become the talk of the town. Let us simplify them and understand.

Crux of the Matter

Acharya on Fiscal Dominance
Viral Acharya is a former RBI Deputy Governor and currently a professor at NYU Stern. He has mentioned that Fiscal dominance is hampering the growth of India. Fiscal dominance is a situation in which the government has high debt and deficit. Because of limited funds, the government is unable to recapitalize public banks when they have to recognize bad loans in the books. Instead, the government pressurizes RBI to ease credit norms so that banks can avoid NPA recognition. This is like keeping the house clean by shoving al the dust under the carpet. Acharya said that it is not too late to infuse capital into banks and NBFCs.

On Non-Performing Assets
In an interview with India Today, Acharya said that growing NPAs during Covid-19 would be a concern. NPAs are expected to rise to ~12.5%, i.e. of the ₹100 loans given by a bank, ₹12-13 would be unrecoverable and banks will have to set aside a provision for the bad loan.

NPAs are loans that cannot be recovered. Viral Acharya also criticized the practice of evergreening of loans in India. Let us understand it through an example what it means and what are its implications:

Mr. A took a loan of ₹10 lakh but is now unable to pay back the principal amount and/or interest. Now, Mr. A may take an additional loan to pay off the interest, or principal and interest both. Banks allowed this practice because that particular loan would not have to be categorized as an NPA and hence, no provision amount needed to be set aside.

On RBI’s Autonomy
Acharya writes in the book that RBI’s autonomy was being compromised and hinted that he left for the same reason. Acharya left the post before the completion of his tenure. He also pointed out that Former RBI Governor Urjit Patel would have also left for a similar reason.

The government was trespassing on the autonomy of the regulator, rowing back on prudent measures and making unreasonable demands.

Viral Acharya, Former RBI Deputy Governor

Urjit Patel’s Resignation
Urjit Patel possibly resigned amidst the government trying to dilute the clause of Prompt Corrective Action. PCA is a framework under which banks with weak financial metrics are put under watch by the RBI. Besides that, the government wanted RBI to formulate policies to help it borrow more and ease up on defaulters. It also wanted the RBI to transfer surplus funds in the form of an interim dividend a few months before the 2019 Lok Sabha elections. All these factors might have caused Patel’s exit.

Also Read: Changes In RBI Accounting Year To Put Curbs On Contentious Interim Dividends

  • “Yaadon Ke Silsile” is a music album by Viral Acharya. The funds raised through the album were funneled into charity – Pratham – which works to educate children.
  • “The Third Pillar: How Markets and the State Leave the Community Behind” is a book by Raghuram Rajan. The book was shortlisted for the financial times and McKinsey business book of the year award 2019.
  • As of January 2017, Viral was appointed to serve a three-year term as a Deputy Governor of the Reserve Bank of India. He resigned from the post in July 2019 with 6 months left for his completion of a term.

SC and RBI Face-off over Interest Waiver

SC v/s RBi on interest waiver

On May 22, the RBI allowed banks to allow an additional 3-month moratorium from June 1 to August 31, 2020, on all outstanding loans while banks have continued to charge interests, sparking a face-off between RBI and SC that is hearing a plea on interest waiver.

Crux of the Matter

Moratorium is a time period in which you don’t have to pay your EMIs and for which you’ll not be penalized nor your credit score would be affected. A moratorium is simply a deferment of the payment to provide relief to borrowers facing liquidity issues and is not any form of concession.

What Is The Issue?
Though the RBI has extended the moratorium period for another 3 months, it has not waived the interest that will be charged. Which simply means that though the banks will not deduct interest from your account, the interest that has been deferred will be added to charges payable later and thus there will be interest on the interest which is the primary issue.

For instance, you have an outstanding loan of ₹5 lakh on which 10% interest is charged annually. Annual interest amount comes to ₹50,000. Interest amount for 3 months (in case of moratorium for 3 months) is equal to ₹12,500. This interest will not be deducted from your account but will be added to your outstanding loan amount. You will be charged interest effectively on the amount of ₹5,12,500.

Once you fix a moratorium, it should serve the desired purpose. Customers are not opting for it because they know they are not getting any benefits.

Supreme Court

Supreme Court v/s RBI & Government
A three-judge bench of the Supreme Court on 17th June heard the plea that sought a waiver of interest on loans during the moratorium period. SC calling for centre’s intervention said that ‘charging interest on loans during the period of the moratorium would defeat the very purpose of the scheme.’

The State Bank of India filed an intervention application in the SC against the interest waiver plea and presented a joint view of all the banks that interest for the six months of moratorium cannot be waived. The apex court has also sought inputs from the Indian Banks’ Association (IBA) on whether new sectoral guidelines could be issued to give benefits to extremely distressed sectors.

Defending the government Solicitor General Tushar Mehta opposed waiving off interest on interest citing impacts which would push the banking system towards financial instability and said that banks also have to pay interest to depositors.

SC has sought clarifications from the central government whether banks can charge interest during the moratorium period. The central government will be holding a meeting with the finance ministry and RBI to formalize a view and reply to SC which has deferred the hearing to the first week of August on request of IBA and SBI.

What Does Moratorium Mean For The Banks?
According to RBI, lenders will lose ₹2 lakh crores if interest is waived during the moratorium period. According to data available from large banks namely State Bank of India, ICICI Bank, Kotak Mahindra Bank and Axis Bank, nearly 30% of their outstanding loans come under moratorium. Whereas the banks like Bandhan Bank, Ujjivan Small Finance Bank and Equitas Small Finance Bank catering to small scale businesses have nearly 70%-90% of loans under moratorium.

While moratorium gives much-needed relief during the lockdown period we see the banking sector taking a hit to their NPAs which were seen to be coming down in 2020. Banks would inevitably seek to cover their potential or actual loss of interest income through further cutbacks in the deposit interest rates and thus the depositors would be severely hit if a waiver on interest rates is allowed.

  • Jyske Bank, Denmark’s third-largest, launched the world’s first negative interest rate mortgage – handing out loans to homeowners where the charge is minus 0.5% a year. Negative interest rates effectively mean that a bank pays a borrower to take money off their hands, so they pay back less than they have been loaned.
  • On 20 February 1980, a black bronze sculpture of 210 cm (6 ft 11 in) height was installed in the lawn of the Supreme Court. It portrays Mother India in the form of the figure of a lady, sheltering the young Republic of India represented by the symbol of a child, who is upholding the laws of land symbolically shown in the form of an open book. The sculpture was made by the renowned artist Chintamoni Kar.
  • The Supreme Court building is shaped to symbolize scales of justice with its center-beam being the Central Wing of the building comprising the chief justice’s court, the largest of the courtrooms, with two court halls on either side. The foundation stone of the supreme court’s building was laid on 29 October 1954 by Dr. Rajendra Prasad, the first President of India.

RBI’s New Banking Reforms

Covid-19 has crippled the global economy and it is inexorably headed to a recession wherein central banks have to answer the call to the frontline in defence of the economy. This crisis is likely to shift scenarios and provide new dimensions to the economies and bring banking reforms worldwide.
Complete Coverage: Coronavirus

Crux of the Matter

India has a history of bringing in reforms during the periods of crisis and following the pandemic, the Reserve Bank Of India is making unprecedented monetary and regulatory banking reforms to provide relief and ensure liquidity funds flow to the affected sectors.

RBI reduced the repo rate by 40 basis points or 0.4% to 4%. The reverse repo rate stood at 3.35%. Moreover, it extended the moratorium on term loans by 3 more months till 31st August. RBI has announced other measures in four broad categories: Measures to Improve the Functioning of Markets, Measures to Support Exports and Imports, Measures to Ease Financial Stress, and Debt Management.

Firstly, a refinancing facility for Small Industries Development Bank of India (SIDBI) for funding requirements of the MSME and secondly, Investments by Foreign Portfolio Investors under the Voluntary Retention Route (VRR) shall offer operational flexibility in terms of instrument choices and certain regulatory exemptions. These market improvement measures are intended to ease constraints on market participants and channel liquidity to various sectors of the economy.

Under the second category, the RBI has increased the Export Credit from 9 months to 15 months and also provided an extension of time for payment for imports. Along with that, RBI will also be providing additional assistance and liquidity facility for Exim Bank Of India in order to promote international trade.

The third category is the most important as it will mitigate the burden of debt servicing, prevent the transmission of financial stress to the real economy, and ensure the continuity of viable businesses and households. RBI has permitted a 6-month moratorium on all term loan installments and it has also allowed a deferment of interest on Working capital facilities. The RBI will also undertake Long Term Repo Operations (LTRO) which will allow additional liquidity with the banks.

The central bank has further brought in changes in the Asset Classification, Resolution Timeline, and the Group Exposures under the Large Exposures Framework to ease financial stress. Finally, for effective debt management: guidelines have been relaxed in the Consolidated Sinking Fund (CSF) of state governments.

Global Financial Crisis of 2008
The bankruptcy of Lehman Brothers in the US unfolded the Global Financial Crisis in 2008. It was understood that there is a high amount of risks involved when banks give loans of the entire value for a property assuming that the cost will rise and it will be easily repaid. When a number of banks did so, the banking sector and the economy saw the consequent effects leading to the global crisis.

The Indian banking sector remained largely unaffected but India was compelled to shift its credit demand from external sources to the domestic banking sector. Even though India’s financial system was less developed at that time; it did face serious consequences as the crisis led to the sharp decline in exports and fall of GDP to 6.72% in 2008-09 from 9.32% in 2007-08, giving rise to the expansion of fiscal deficit and extensive Public sector lending.

Due to lack of a framework for bankruptcy, India faced a risk of a large private sector bank going bankrupt with no legal way of dealing with it other than to force a public sector bank to buy it out, an approach that generally weakens the banking system. A number of expert committees recommended banking reforms, changes in regulations, and new frameworks like the Indian Bankruptcy Code. However, following different political scenarios and the legislative framework they could not be brought in which lead to the crisis of NPAs.

NPA Crisis
The 2008 crisis laid the foundation for much of today’s non-performing loans which have plagued the Indian banking sector. A loan given by a bank is classified as a Non-Performing Asset (NPA) if the borrower has stopped making interest or principal repayments for over 90 days. As of 2018, the gross value of NPAs stands at Rs. 10.35 lakh crores, out of which 85% is of Public sector banks.

Post-crisis the public sector banks were under tremendous pressure to lend large amounts to steel, power, and infrastructure projects and the euphoric lending led to a rise in bad loans and the NPA crisis. A number of scams came to the forefront wherein businesses borrowed under shell companies to execute projects in other countries; later the foreign banks invoked guarantees and domestic banks were obligated to pay and they could never recover their money.

NPAs have lowered the bank’s profitability and made them vulnerable to adverse economic shocks and consequently put consumer deposits at risk. This also led to India’s Twin Balance Sheet problem, wherein both the borrower and lender i.e. corporate sector and banking sector come under financial stress.

Thus, to avoid the snowballing effects leading to insolvency and NPA crisis, liquidity management has been given a priority by the RBI while bringing back normalcy in financial markets post Covid-19.

  • The Reserve Bank of India, which was established on April 1, 1935 during the British Rule, modeled its official emblem after the double mohur of The East India Company. The logo originally featured a sketch of the Lion and Palm Tree but it was later decided to replace the lion with a tiger to represent India better.
  • Ex RBI governor, Raghuram Rajan predicted the 2008 financial crisis in 2005. In his 2005 paper titled ‘Has Financial Development Made the World Riskier?’, Rajan predicted that a financial crisis is in the making and going to hit the economy in the next 3-4 years.
  • The oldest continually operating bank in the world is Banca Monte dei Paschi di Siena, which has been operating as a bank in Italy since 1472. The bank is on record as the first official bank in the world, although the practice of banking has been traced back for several centuries.

RBI’s Measures to Inject Liquidity

RBI Governor Shaktikant Das addressed the nation on 17th April and announced a plethora of measures to boost liquidity in the country and assist India Inc to restart functioning.
Complete Coverage: Coronavirus

Crux of the Matter

Assessment of the Economic Situation
While assessing the current economic situation, Das said that the International Monetary Fund (IMF) has projected India’s growth in the coming fiscal to drop to 1.9% – the highest among G20 nations. He added that the World Trade Organisation expects global trade to fall by 13-32% in 2020. On the domestic front, India’s Kharif crop production was up by 37% as compared to last year. Even, the Meteorological dept forecasted a normal monsoon.

Manufacturing Purchasing Managers’ Index (PMI) in March was at 4 months low after the February industrial output accelerated to be at 7 months high. India’s exports reduced by a massive 34.6%, However, foreign exchange reserves were standing strong at $476.5 billion as of April 10, 2020. ATMs operated at 91% capacity. RBI had injected fresh currency of ₹1.2 lakhs since March 1. RBI also conducted a targeted long term repo operation (TLTRO) to inject about ₹75,000 crores in the economy.

Step II Measures
Das announced fresh measures to maintain liquidity in the economy – ensuring enough cash is available to the consumers; ease the financial stress caused because of the halted economy; to grease the market before it begins normal functioning; and incentivise bank credit flows.

  • Firstly to inject liquidity, RBI announced Targeted Long Term Repo Operations (TLTRO) 2.0 worth ₹50,000 crores.
  • Financial Institutions that provide finance to agriculture and small business will receive refinancing funds.
  • National Bank for Agriculture and Rural Development (NABARD) would receive ₹25,000 crores to refinance Regional Rural Banks (RRBs); Small Industries Development Bank of India (SIDBI) to get ₹15,000 crores; National Housing Bank (NHB) to get ₹10,000 crores to assist housing finance institutions.
  • Reverse Repo Rate reduced by 25 basis points (0.25%) to 3.75%. This would incentivize banks to lend more, creating more credit in the economy.

Regulatory Measures

  • The 90-day norm for categorizing Non-Performing Assets (NPAs) in banks will exclude the moratorium period granted by banks.
  • All scheduled commercial banks and cooperative banks shall not make dividend payments until further notice.
  • Liquidity Coverage Ratio (LCR) of banks is reduced from 100% to 80%, so as to allow banks to lend more. It will be restored to 90% on 1st October 2020, and 100% on 1st April 2021.

Das expects the Indian economy to show a sharp turnaround and return to pre-COVID and pre-slowdown projection for 2021-22 fiscal – growth at 7.4%.

  • Reverse repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of India) borrows money from commercial banks within the country. It is a monetary policy instrument that can be used to control the money supply in the country.
  • Decreasing Reverse Repo means commercial banks will now earn less when they put their liquid cash with RBI and as a result, they will invest or lend this liquid cash to other places which should result in more liquidity in the economy.
  • Other than reverse repo rate, other instruments that can be used to adjust liquidity in an economy are adjustment of Cash Reserve Ratio (CRR) or buyback of government securities (Open Market Operations).
  • In order to keep the economy cash-rich, the government is also going to refund pending Income Tax and GST refunds amounting up to ₹5 lakhs. 14 lakh taxpayers will benefit from it.

Understanding RBI’s New Sovereign Gold Bonds Scheme

The Government of India announced that it will go ahead with the issue of the Sovereign Gold Bonds (SGBs) to domestic investors in 6 tranches that begin on 20th April 2020.

Crux of the Matter

What are SGBs?
It is government security that is a promissory note backed by Gold. Buying these gold bonds is like owning gold, not physically, but on a piece of paper. And because it is backed by the Indian government (or by any government), it is called a ‘sovereign’ bond. These bonds can be purchased via banks, designated post offices or online. The bonds have a maturity period of 8 years. These are the 6 windows or tranches in which you can buy the SGBs:

  • April 20-24, 2020; Date of Issuance (DoI) April 28, 2020
  • May 11-15, 2020; DoI May 19, 2020
  • June 08-12, 2020; DoI June 16, 2020
  • July 06-10, 2020; DoI July 14, 2020
  • August 03-07, 2020; DoI August 11, 2020
  • Aug.31-Sept.04, 2020; DoI September 08, 2020

Here are some important things that one should know about while buying these bonds:

  • The denomination of the bond is in grams of gold.
  • Minimum investment permitted is 1 gram of gold.
  • An individual can buy a maximum of 4 kilograms of SGBs. It would include purchases made from the tranche as well as purchases from the secondary market.
  • These bonds will give an interest of 2.5% every year. It will be paid semiannually and added to the investors’ income and taxed according to their income level.
  • The price of the bond will depend upon the simple average of the closing price of 999 purity gold in the last three working days. This means that the redemption price of the price at which you want to sell back to the government will also depend on the simple average of the last three working days.
  • The bonds will be tradable on the exchange after a week of the date of issuance.
  • These 8-year bonds will have an option of exiting after 5 years.
  • If investors buy these bonds online or through digital mode, they get a discount of ₹50/gram.
  • If you hold these bonds till maturity, then the capital gains would be tax-free.
  • These bonds can be used as collateral for loans.

Is There any Upside to Buying SGBs?
If your grandmother or mother emphasized on buying gold from savings, then they probably understood that investing in gold could be the safest investment that time has taught. However, storing huge quantities of gold is risky. If you have bought these bonds, there is no risk of your gold getting stolen. Compounded annual return on gold has been nearly 10% as compared to return from Dow Jones, 8.4%.

Gold seems to be one of the best bets around at a time when the coronavirus pandemic is creating havoc. However, one’s portfolio should not have too much of gold investment, 10% of the portfolio seems good enough. One aversion that investors might have while buying SGBs could be the price trend of gold. Although the future of gold seems promising, you never know. For instance, gold prices in 1979 rose by 120%, and then 29% in the following year. However, the year after, it lost 32% and never rose to the previous level until 2006 – 26 years later.

  • A commodity-backed bond is an investment whose value is directly related to the price of a specified commodity(in this case, GOLD). Unlike most bonds, a commodity-backed bond will experience fluctuations in value because of its basis on the price of the specified commodity.
  • On February 20, 1895, J.P. Morgan & Co. led a bond offering that helped rescue the United States from a severe two-year economic depression. In an effort to shore up the U.S. gold reserves, J.P. Morgan & Co. formed a syndicate in 1895 to sell $65 million in gold bonds for the U.S. Treasury.
  • At Berkshire’s 2018 annual meeting, Warren Buffett compared $10,000 invested in stocks and gold in 1942 (the first year he invested in stocks). That money invested in an S&P 500 index fund (there were none at the time, he noted) would’ve been worth $51 million in 2018 while a gold investment would’ve been worth only $4,00,000.