RBI is compromising on financial stability, need to recapitalise system, says Viral Acharya

MUMBAI: The Reserve Bank of India has been diluting some of the toughest measures prescribed for financial stability and its surplus liquidity policy has weakened inflation-targeting and shifted the goal post, former deputy governor Viral Acharya has said.

“We are certainly showing signs of willingness to accommodate and compromise,” Acharya told ET in an interview. “Look at the number of forbearances we have rolled out. The real question is, now that IBC (Insolvency & Bankruptcy Code) is not producing resolutions in a timely manner, suppose that debt moratorium expires, when payments are not made — at that point, will the central bank do an asset quality review? That is the real test. The RBI should use the Financial Stability Report’s stress test right now to recapitalise the system.”

Acharya returned to the New York University to teach in 2019, prematurely ending his term after a tussle with the government over the RBI’s autonomy. He, along with governor Urjit Patel and his predecessor Raghuram Rajan, cleaned up the banking system and introduced tough rules to ensure unscrupulous borrowers don’t game the system.


‘Some tough measures rolled back, others diluted’
But Acharya fell out with the government that was struggling to revive economic growth and wanted some of these strict conditions relaxed.

A tough default clause that made banks begin talks on resolution even if the borrower falls behind in payments by a day, restricting lending by weakly capitalised banks, recognition of bad loans as per global standards and a national credit registry to monitor borrowers were among the tough measures that ruffled the corporate world.

“Some of these were important to ensure that whatever happens the system doesn’t become vulnerable to short-term pressures,” said Acharya. “Some of these things have been rolled back, some of it has been diluted. We are still not ensuring timely capitalisation of banks based on forward-looking stress.”

A crusader against inflation, Acharya is critical of the RBI’s decision to move its liquidity stance to ‘surplus’ from ‘neutral’, which makes the key policy rate — the repo rate at which the RBI lends to banks — ineffective.

“If the MPC (Monetary Policy Committee) is controlling the policy rate, then the system has to be in ‘deficit’ mode, or in a small surplus,” he said. “What the central bank is doing is, on paper, it wants to say that the rate is controlled by the MPC, but in execution it wants to be in control of interest rates.”

“Given the large surplus, all the rates in money markets are hugging the reverse repo rate or lower. I think they have completely given up, inexplicably, on how to use the liquidity in sync with MPC to achieve money market rates that are in line with what the policy rate of the central bank is. I think the policy rate can become completely irrelevant if the central bank wants to just manage the yield curves entirely on its own,” said Acharya.

Flooding the market with excess liquidity has forced banks to park more than Rs 5 lakh crore daily with the RBI at the reverse repo rate of 3.35%. Even some overnight borrowing rates are far lower than the repo rate of 4%, making the MPC rate setting meaningless.

Acharya said recognising bad loans and resolving bankruptcies in a timely manner are among measures to revive economic growth post the Covid freeze. Only adequately capitalised banks can ensure growth, not the weak ones, he added.

“Lack of capital can produce so much risk-aversion,” he said. “The problem with recapitalisation of PSU banks is the lack of fiscal discipline. We are unwilling to accept that if you want to own banks, if you want them to lend, you have to put up some capital for this activity. You want to own, but you don’t want them to be a burden on the exchequer. These are incompatible.”

(All of Dr.Viral Acharya’s share from sale of his book 'Quest for Restoring Financial Stability' would go to Pratham India: Every Child in School & Learning Well to fund digital education for under privileged children)