Former Indian Reserve Bank Deputy Governor Viral Acharya talks about how to restore depositors’ confidence and faith in the Indian banking system, blames the disputes between govt and RBI for short-term growth, and calls for an independent fiscal council to review the govt’s spending and budget.
In recent years, the faith and trust of people in the Indian banking System have been shaken. The answer given for this by Acharya was, there are two ways of building trust. One is that the banks have got a blanket deposit policy, which means, no matter how large the deposits are, there’s a government department to back it up. Government resources are minimal, and thus deposit insurance is not at the highest standard possible. And second, therefore, the banks have to establish private deposit insurance to replace public depositing insurance. Also, this generates huge quantities of equity capital in the bank, such that the ability to absorb losses is immense. Therefore, the onus on the regulator is to maintain very high rates of bank capital at all times.
Second, we need adequate levels of bank capital, and after the global financial crisis, the global best practice here is that you have to do a stress test. we need to visualize: the bridge will withstand or collapse cyclonic wind speeds. Similarly, you need to visualize what kind of macroeconomic stress, sectoral stress, or stress on asset quality can arise, and banks can withstand it. we need to shore up the capital levels high enough to withstand the stresses without destroying the whole house.
And thirdly, given these interventions, if the losses still occur, we have to respond to the bank balance sheet deterioration ahead of depositors turning up and asking for their money. The regulator will also take proactive measures to bring the bank into what can be considered as a kind of repair. This may entail selling the bank to a new group of equity owners who can put in the money, may require a change in the bank’s management, may include limits on the bank’s ability to lend before certain underwriting and risk-management procedures are enforced.
The biggest difference between deficit funding and market borrowing is that there would be no signs on at what expense you borrow money from the economy. Since the central bank does so effectively as an off-market sale, or purchases such bonds from the government. In my view, the need for the balance sheet of the central bank stems primarily from this myopia and wanting to claim that we are achieving short-term goals. Yet in the end that is the accumulated public exchequer debt.
