Tackling the banking camel: Financial Express: 16th September 2008

Dr Subbarao takes over as governor of RBI at an interesting stage, when he has to cast the dice in favour of either growth or inflation. Also, banking is on the threshold of some new challenges that have to be taken head-on. The now familiar acronym of CAMEL in banking parlance takes on the following form: capital, asset quality, monetary policy, emerging banking scenario and lending.
Subbarao was once the secretary of the PM's Economic Advisory Council, a group that put our growth at 7.7% for the year. He now heads an institution that has been more optimistic at 8% in its target. On the face of things, this should not matter because a 0.3% growth in GDP is just around Rs 10,000 crore. But, psychologically the number of 7.7% looks satisfactory while 8% seems impressive.
The other reason why this difference matters is that the overall monetary stance will depend on whether we pitch for 7.7 or 8%. If we are speaking of 8%, the governor has to think hard before increasing the pressure on the brakes and may have to consider a loosening of the strings. But, if 7.7% is acceptable, then he will be satisfied with the current state of affairs.
The fact that he was in the PM’s advisory council also means an ostensible shift from a government official who looks at the politics of Economics to an Economist at the Central Bank who should ideally give greater weight to Economics. With an election in the vicinity, this will mean a focus on tackling inflation. The fact that the prices of commodities are softening and that past monetary measures should start delivering from October means that there is comfort to be had.
All governors have gotten typecast for certain actions. Dr Reddy had favoured a CRR intervention while Dr Jalan had the knack of coming in when no one expected RBI action. It will take some time before the media and the market start typecasting this governor.
The banking sector will need to be prepared as per Basel II. One of the biggest challenges is capital for further expansion. Fund requirements will be especially enormous because our 8% growth model is dominated by infrastructure, industrial and construction sectors. Presently, the banking system is compliant on this score, with a large number of banks having capital adequacy ratios of over 10%. In 2009 we will see the banking sector open up to greater foreign participation, which will mean more competition. Skeptics are saying we should not hurry on this front. Privatisation of public sector banks also needs to be tackled with a new perspective. How do public sector banks start disinvesting their equity? Should they be sold to the public or other banks, and do the latter include foreign and private banks? Will private sector banks survive in this competitive set up?
Against the background of the sub-prime crisis, the RBI also has to take a deeper look at asset quality. A US-like situation is not really visible in the Indian context, but home loans have been growing even as interest rates on them have risen from 8% to 12-14%. The RBI will need to be alert.
The elections will also demand a balancing act between loan waivers and inclusive lending. Inclusive lending tends to be associated with higher NPAs, which have also been part of the waiver story. While the burden of waivers is being borne by the government, there is a new moral hazard, which incentivises defaults. The banks would have to take the stick and this also has to be addressed by the RBI.
So, Subbarao has very interesting challenges ahead of him, and the fact that he has been part of the government will amplify his political compulsions. On the other hand, being one of the better economists, he will be aware of these pitfalls and their solutions. This story should unfold in the next year or so.