Government Banks: Instrument for managing macroeconomic challenges– at what cost?

 Urjit Patel book, beautifully explained the multidimensional ramifications of the phenomenon, he calls, banking sector fiscalization, wherein Government Banks (GBs) and other financial agencies that it owns, are used for managing day-to-day macroeconomic challenges, than allowing these institutions to be efficient intermediary between savers and borrowers. 

        

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1. We see ample evidence of this phenomenon in Banks being used for liberal credits to boost consumption, Farm loan waivers, support unviable MSME, underwriting of Government disinvestment targets, and sustain employment in Public Enterprises. It dilutes Banks incentive to be market efficient, nor exercise greater risk management discipline, and enhance dependence on Government to bailout, and meet capital adequacy norms, for example.  None of this is disputable or is mostly understood as well.…and this books authoritatively adds more substance (in terms of chronology, instrumentalities and figures) to the appreciation of the collateral damage that banking sector fiscalization has on economy in terms of high instances of NPAs, increased cost of capital, enhanced risk for depositors and overall weakening of economy to manage downturns and shocks.
2. It would have been interesting to know, how effective has Government been in meeting its objectives and overcoming short term socio-political-economic challenges leveraging GBs, and some would say to some extent, but at high long-term cost.  And were there any viable alternatives that were consciously ignored and would have been equally effective and palatable to Government.  Question is that using GBs to deliver its objectives comes as easy and convenient first option or the only the most prudent and viable option for the Government, driven by political needs and for-ever on- election seasons.  While the generic trend may looks to support the first case, it would have been interesting to get insight into options that were available (suggested by RBI) and still not exercised by Government of the day. 
3. Clear highlight of the book, and the most readable one. is the middle section titled as clean the augean stables, wherein Urjit takes us through the financial sector reforms trajectory woven around recognizing, resolving and ring-fencing the NPA mess. with the help of 9R framework.  The establishment of Central Repository of Information on Large Credits (CRILC) in 2014 rightfully marks the start of the journey, for it provided the critical information around the view on borrower-wise and bank-wise exposure, an essential baseline to conduct Asset Quality Review and report realistic assessment of distressed assets. 
4. Early attempts to revitalize distressed assets included schemes like SDR, 5:25, S4A (collectively called alphabet soup!) but with limited success.  May 2016, marked the passing of Insolvency and Bankruptcy Code(IBC), which not only promised time-bound route for resolution of distressed assets but also instill the real fear among promotors of losing their firm/assets to outside bidders and that liquidation is a real possibility at the end of road.  Despite this process being available, there was hesitancy among the lenders (mainly GBs) to push for initiating IBC process for understandable reasons, which meant that RBI has to be empowered, under BR Amendment Act 2017 to issue direction to banking companies to initiate IBC process for default companies on resolution of stressed assets.  We all recall with amazement and sceptism, the declaration by RBI in September 2017, of 41 accounts, with aggregate exposure of Rs 5 trillion (45% of total NPA) to be taken up under IBC process. 
5.  To avoid been perpetually involved in identification of accounts, on case-2-case basis and hence invite criticism, it was prudent on part of RBI (in February 2018)to issues prudential norms regarding account classification as special mention accounts on default of payment and eventual reference to NCLT in six months.  RBI believed that the provision that NCLT can be avoided by undertaking viable restructuring accredited by rating agencies, within six months, would be shot in the arm of bankers to push for improving recognition of asset quality and also work with promotors to revive assets.  However, future events did not endorse the RBIs beliefs.
6. Book recounts set of events and role played by Government, Lenders, Borrowers and their lawyers that led to serious dilution of the IBC effectiveness, most notably by removing timelines and by making the reference to IBC non-compulsory.  Urjit presents, quite convincingly and sometimes regretfully, his understanding of the possible motivations, compulsions and perspectives different stakeholders behind installing the pathway that was so meticulously created by RBI.  Nevertheless there is still credit to be given for resolution of 45% assets identified under first 41 accounts, and in general there is more vigilance and pressure on promotors to take care of quality of assets. 
7. Book asks a very interesting question- if courts had allowed RBI to issue directions for specific accounts, may be RBI could have come with another supplementary list in 2018-19 and continued with the cleaning process case-by-case!  What makes this books narration of the events different, is its complete obliviousness of the actors involved, within the RBI, Government, Banks and third parties. 
8. On the aside, book covers the emergence and subsequent dilution of PCA framework, debate around bad-bank, strengthening of RBI enforcement capabilities to detect operational frauds, recapitalization of Banks, Sector and MSME specific interventions and its impact on health of GBs and overall financial sector stability.
9. Book looks into reasons of high instance of frauds in GMS against that in PBs.  Market induced discipline is very high in PBs as any loss of reputation can lead to run on the bank by the depositors, besides curtailing their ability to raise fund in the market.  In cases where the market mechanism is weak, one would expect regulatory oversight to be stronger, which is actually not the case. 
10. Infact, regulatory disciple imposed by RBI is quite effective in case of PBs, in comparison to GBs.  Banking regulatory powers are not ownership neutral ie to say that RBI does not have / unlikely to have same level of control over GB as in case of PB, especially in the areas of corporate governance.  RBI cannot trigger liquidation, revoke license, force merger, nor remove directors and management at GBs.  Vigilance as source of discipline is effective only in the form of preventive vigilance, while punitive vigilance seems to be quite weak, in case of GBs.  Interestingly there seems to be correlation between instances of fraud and rise in stressed assets problem. 
11. Urjit doesn’t lay much hope of GBs improving in its efficiency and competitiveness and sees PBs increasing their share in banking sector, which he believes is not necessarily a bad thing!