Amid a raging controversy over capital levels of Indian banks with the government wanting lower capital requirement, Reserve Bank of India Deputy Governor N. S. Vishwanathan defended the central bank’s decision to stick to stiffer capital norms.
The government wants the capital adequacy ratio of banks to be at 8% as per Basel norms, but RBI has prescribed 9%. On complaints over ‘unnecessary’ high capital requirements, Mr. Vishwanathan said prudential capital regulations aim to enable banks to sustain unexpected losses without defaulting on its obligations, especially deposits, by maintaining adequate levels of bank capital.
Better credit appraisal
“Further, higher levels of capital increases the skin in the game for shareholders, thus potentially leading to better credit appraisal and screening,” he said in a speech on October 29, which was put up on the RBI website on Friday.
Though higher capital involves costs, the Deputy Governor argued that “there is no free lunch” but the costs to the economy are offset by the savings made in the form of potential losses avoided in averted banking crises.
“Unfortunately, banks in India remain one of the most under-provisioned ones, though there has been an improvement in this regard in the last few quarters,” he said. As the equity component in a bank goes up, the leverage goes down, and make banks safer, he said.
“The holy grail for banking regulators is to find the sweet spot for capital prescriptions for banks where the benefits are equal to or slightly outweigh the costs involved,” he said.
He said there was a misconception that capital was a pile of money stacked away as some sort of “rainy-day fund” and that the economy was deprived of that money.
“The reality couldn’t be farther from the truth – the capital maintained by banks would have already been deployed on its balance sheet towards creating assets, including loans,” he said.
The banking regulator said the current levels of provisions maintained by banks may not be enough to cover the expected losses, so there is a need to build adequate buffers to absorb the expected losses.
He said while the argument that higher capital requirement leads to lower credit growth is ‘mathematically correct’ but cited data to show credit growth in the economy is in line with nominal GDP growth. He also warned that in the past, high levels of credit growth due to ‘supply push’ have resulted in high corporate leverage and consequent NPAs in the banking system.
“Secondly, to make sure that the banking system is resilient enough to support higher credit growth going forward, it should have higher capital levels,” he said.
He also clarified on the ‘oft repeated view’ that public sector banks need not be subject to prudential capital regulations as they are owned by the sovereign. He said since most banks are active in overseas business with foreign banks, the overseas lenders look at Indian banks soundness to doing business with them.
“Any slackening of the prudential norms may result in a reset of their credibility/standing in the international markets. Such a reset could increase the cost and ease of doing business for their clientele and their clientele may need to migrate to other banks which are compliant with Basel standards,” he added.
Published - November 02, 2018 11:25 pm IST
