Former RBI Governor Urjit Patel Warns Govt Against Over- Lending, Pump Priming Economy

Former Reserve Bank Governor Urjit Patel has warned the government against pushing public sector banks to over-lend and pump prime the economy and boost preferred sectors, stating it would lead to higher bad loans and fiscal deficits.

In his first comments after quitting as RBI Governor last December, and coming on the eve of the Union Budget, Patel said as the government’s “headroom for running higher fiscal deficits is (virtually) exhausted, government banks are nudged to (over-)lend to pump prime the economy/ boost preferred sectors.”

According to Patel, who made a presentation at Stanford’s Annual Conference on Indian Economic Policy on June 3-4, “this leads to higher non-performing assets (NPAs) over time, which requires equity infusion from the government, and eventually adds to the fiscal deficit and sovereign liabilities in due course.” The copy of his keynote was released only on July 4, a day before the Union Budget.

With the economy powering down down and GDP growth rate posting its slowest growth in 17 quarters at 5.8 per cent during January-March 2019 compared with 8.1 per cent in the same period last year, the government is looking for steps to boost the economy.

Patel, who suddenly quit as the RBI Governor in December 2018 after many differences with the government, and nine months ahead of his three-year tenure, said the decline in share of PSU banks in the banking sector should not be resisted as the “market mechanism is working”.

“Tax payer has to decide how much of government revenues are earmarked to infuse capital into government banks (GBs) – this will determine GBs market share. The government has to assess whether return on its equity investment in GBs is value for money since its shareholding in GBs continues to increase. Ditto for LIC (Life Insurance Corporation),” he said.

Patel differed with the government on several issues including the RBI’s reserves, liquidity issue in the financial sector, small sector lending and curbs on banks.

The Union Budget, he said in his presentation, usually has announcement of ‘credit budgets’ (for example, agriculture), on behalf of banks. “Majority of large universal commercial banks are government owned for diverse (legacy) reasons,” he said, adding, “… (it’s for) quasi fiscal reasons, most recently the Mudra scheme for MSMEs (also 59-minute loan approval programme launched in late 2018).”

Patel has blamed the all stakeholders — banks, the government and the RBI – prior to 2014 for the mess in the banking sector, stating that the “government did not fully play its role as principal shareholder and manager of economy’s health” while the “supervisor (RBI) failed to acknowledge and rectify the public sector banks’ inability to identify poor performing assets” or bad loans. He also slammed the “risk management policies and over-lending” of banks.

“Prior to 2014 all stakeholders failed to play their role adequately. The RBI failed to restructure and react quickly to improve recovery or cut losses (for example, iron and steel companies, airlines, generators and real estate),” Patel said. The regulator failed in gauging when extant assumptions were getting stretched and needed revision. A number of government banks did not have senior management in place, and governance suffered, he said.

In a stinging criticism of the government’s banking policies, Patel said, “principal (dominant) owner didn‘t question risk controls in government banks even as it was receiving significant dividends.” The government “encouraged government banks to help pump prime economy for higher growth (in the realm of political/ electoral credit cycles over the last decade), under the guise of “capital deepening, sensitive sectors etc”, he said.

Warning the government, banks and the RBI that “short cuts/ sweeping the problem under the carpet is unlikely to work”, Patel said it “will only delay unlocking of capital, and come in the way of financing future investment efficiently.”

He said in recent years, NPAs in India have been one of the highest amongst major economies, inducing a negative risk perception. “It could be that the funding model is gradually/ grudgingly becoming more discerning now. GBs have high ratio of non-operating expenses to earnings compared to private banks. High cost structure of GBs is borne by economy. (This) may be impinging transmission of policy rate changes,” he said.

Patel said PSU banks also marred by higher incidence of frauds owing to poor operational risk management/ internal audit. “As many as 90 per cent of frauds occurred in GBs while share of private banks is about 10 per cent. Most frauds are related to advances/loans. Quantum has quadrupled in the five years since 2013/14,” he said.

On the Insolvency and Bankruptcy code (IBC), Patel said, “belated response did not work in the area of resolution. Banks were not forthcoming with required action in respect of large stressed accounts. Part of the inertia was due to the typical (and severe) agency and (aggravated) moral hazard problems of not resolving NPAs when the banking sector is majorly government -owned.” In effect, inaction against large defaulters was undermining credibility of IBC 2016, Patel said.