RBI, financial stability and central bank independence

 Viral Acharya, the distinguished academic who served as Deputy Governor of RBI from December 2016 to June 2019,  has been vocal on the subject of financial stability over the past several weeks.  

In several interviews and webinars following the publication of his book, Quest for financial stability in India, Acharya has said that lack of concern for financial stability on the part of successive governments has led to recurring problems in the banking system. This, in turn, has resulted to growth getting stalled time and again. 

The book is a collection of speeches Acharya made as Deputy Governor. The highlight is a lengthy introduction that Acharya has written in which he expatiates on the importance of financial stability. Acharya says that during Urjit Patel's tenure as Governor, the RBI made a valiant attempt to defend financial stability but, ultimately, could not stem pressures in favour of faster credit growth at the expense of stability. He suggests that both Patel and he had to quit as they could not reconcile their stand on financial stability with that of the government.

Acharya contends that the root cause of financial stability is what he calls 'fiscal dominance', that is, the imperative of governments having to spend in order to boost growth, no matter what the implications for the fiscal deficit. After a point this becomes untenable.Governments then lean on the central bank to facilitate faster growth through credit expansion. 

This invariably involves sacrificing financial stability in a number of ways- by not recognising bad loans and the associated losses, not recapitalising public sector banks as required, manipulating the yield curve to keep interest rates low so that governments can borrow cheaply, etc. Compromises on financial stability result in banking crises and weak growth down the road. 

The answer, Acharya suggests, is first to ensure that fiscal discipline is practised. Secondly, to ensure that the RBI enjoys greater independence, preferably conferred by law, so that it can resist pressures to compromise financial stability.

There are problems with the thesis. First, it is not true that credit booms and financial crises result exclusively or mainly from fiscal dominance. The global financial crisis of 2007 as well as multiple bank crises in numerous economies in the past several decades did not flow from fiscal dominance.

Secondly, financial stability can result from excessive concern with financial stability at the expense of growth. If you are too focused on inflation and allow growth to weaken, that itself can cause financial stability. If you are not willing to relax regulations in unusual times, such as the pandemic, and insist that defaults should automatically result in loans being categorised as non-performing assets, you are going to create a major banking crisis here and now- in the cause of financial stability. Find me one banker who thinks that the loan restructuring scheme announced recently by RBI is not desirable and that we should accept Urjit Patel's contention that a restructured standard asset is an oxymoron.

Thirdly, conferring independence on the RBI by law is a bad idea. Matters of monetary policy and regulation cannot be decided by technocrats alone. It is the elected government that is accountable to the people for its decisions that must have the final say. This is because monetary policy and regulation involve choices about trade-offs between growth and stability and they have distributional implications. These choices cannot be made by technocrats sitting in Mint Street. If central bankers are not to accountable to the government, how will make them accountable? We need a vibrant media, swift judicial redress and a culture of peer pressure that will ensure accountability once central banks are given independence by law. Those conditions are not satisfied in India today.

Fourthly, it's extremely naive to think that governments make "political" choices while technocrats are utterly apolitical or detached in their approach to questions of public policy. All public policy choices are overtly or implicitly political in nature and central bankers are political animals in their own ways. We know central bankers are not unworldly in their outlook: many have the happy gift on landing juicy positions with private banks after they have demitted office. 

We have to accept that those elected to office have the right to decide matters of public policy. If they make mistakes, the electorate has the choice of voting them out the next time. Pitting the saintly technocrat against the diabolical politician can only undermine democracy and pave the way for the technocracy known as dictatorship. 

More in my column in BS, Technocrats versus politicians

Public sector banks and customer service

I had meant to write something under this heading but couldn't proceed beyond writing up the title because my blog got jammed for several days. The title without any write up itself drew several comments- including one saying that the title in itself was a comment!

Wrong. I had meant to compare the public sector favourably with the private sector when it came to private service, quoting from an FT article:

The sheer inefficiency of UK bank bureaucracies in their domestic operations can be compared with public services at their worst. Public services at their best now outperform the banks – so government ownership could actually improve bank performance. The banks should be made more accountable to the public, as public services already are.

Examples come from my own experience but are matched by that of others. Banks use the internet as little as possible to avoid fraud; instead they use the post, in which letters are lost or stolen, and the telephone, which is overloaded and often fails to give results after interminable waiting times.

My bank has three times posted an unwanted cheque book to me in the past year, in spite of being asked not to after a postal theft led to a £2,500 fraud. Alternatives to the Royal Mail are a delusion, because the Royal Mail still does their doorstep delivery – as often as not to the wrong address.

The author correctly identifies cost reduction and the use of channels other than the traditional bank branch as responsible for the decline in service quality. In many private banks in India, it is impossible to meet anybody to discuss a complaint- you can only discuss with an operative at a call centre.

Secondly, public sector banks find themselves obliged to respond because various public functionaries- such as MLAs and MPs and even municipal corporators- will forward complaints. The customer himself or herself has a strong sense of ownership because it is public sector. And public sector banks still rely on branches for customer interaction.