India's Prime Minister Narendra Modi. REUTERS
India's Prime Minister Narendra Modi. REUTERS

New Delhi — India’s messy banking system has long been a source of friction between the Prime Minister Narendra Modi’s government and the central bank. But even the collapse of the nation’s fourth-largest lender isn’t spurring any urgency to clean things up.

The 72.5-billion rupee ($980m) rescue of Yes Bank — the nation’s biggest-ever banking failure — has refocused attention on the Reserve Bank of India’s (RBI) regulatory autonomy. While analysts have highlighted the need for the government to fast-track long-delayed legislation to tackle bad loans, while allowing banks to fail without inducing system-wide panic, no legislation is imminent.

“The government will try to bring in some mechanism to resolve insolvencies and bankruptcies in financial institutions,“ said Gopal Krishna Agarwal, a spokesperson for Modi’s ruling Bharatiya Janata Party (BJP), who defended the speed at which the Yes Bank crisis was resolved. Still, he said, new reforms “may not happen in the current parliamentary session”.

The central bank’s seizure of Yes Bank last week and sudden moratorium on cash withdrawals surprised depositors and investors alike. Although the RBI sought to confirm the safety of deposits by inviting the nation’s largest lender to make a confidence-building share purchase, the crisis shows the stress facing India’s financial system.

The economy is already set to decelerate to an 11-year low and the coronavirus outbreak threatens to delay a revival. There’s also rising investor discomfort over the government’s focus on its social agenda that’s caused widespread religious tensions at the expense of stoking economic growth amid a string of failures at banks and shadow lenders as stressed assets climbed to $190bn — among the highest in the world.

Modi needs to resolve these legacy problems, including that it’s not clear whether the government or the central bank holds the main responsibility for regulating the banks, according to NR Bhanumurthy, senior economist at New Delhi-based National Institute of Public Finance and Policy, who advises the government on economic policy.

“There needs to be a decision, once and for all, over who really supervises Indian banks — the government or the RBI,” said Bhanumurthy, noting that, legally, the RBI is still under the ministry of finance. “There is a need for a method in the way policy measures are taken. Banking regulation remains an issue.”

Blame game

An earlier attempt to introduce a bill that would have allowed the sale of one bank to another and created a Resolution Corporation — similar to the Federal Deposit Insurance Corporation in the US — to take over failing banks, was withdrawn in 2018 after facing opposition.

The tussle over reforms that started after former central bank governor Raghuram Rajan tried to get state lenders to recognise and provide for soured loans resulted in his resignation after just one term amid criticism from Modi’s allies for keeping lending rates too high and stifling growth. His successor, Urjit Patel, also clashed with the government over its demands to ease lending curbs on state-run banks and hand over more of the RBI’s capital to the state.

Patel abruptly quit before his first term finished, shortly after raising the problem of dual regulation following a $2bn fraud case at Punjab National Bank, one of the biggest state-run lenders.

Shaktikanta Das, one of the key officials helping carry out Modi’s controversial cash ban in 2016, has taken a more conciliatory line since he was appointed governor in December 2018.

Rebuilding trust

Finance minister Nirmala Sitharaman said last week that the exposure of Yes Bank to some stressed corporates occurred before the Modi government came to power. Yet even the BJP’s ideological partners agree that more needs to be done.

“The government has worked to improve the trust of people — they have done everything right in rescuing Yes Bank,” said Ashwani Mahajan, co-convenor of the Swadeshi Jagran Manch, affiliated to the ruling party’s ideological parent, the Rashtriya Swayamsevak Sangh. “But more needs to be done to improve trust. Because once trust is gone, it’s gone.”

Mahajan says Modi has tried to resolve “legacy issues” but needs to strengthen state-run lenders.

Yet, while the government defends its handling of banking failures, foreign portfolio investors withdrew investments worth $1.8bn from India in the first six days of March, BloombergQuint reported.

“The Modi government is facing a crisis of credibility in the political as well as economic sphere,” said Nikita Sud, an associate professor at the University of Oxford’s department of international development. “Instead of listening to expert opinion, or building solid institutions, the rulers have pushed through flawed, knee-jerk decisions.”

Now is the time to bring in a law to handle the financial failure of banks to help restore investor faith, according to Suyash Rai, political economist at Carnegie India. “They need to give a signal that they are serious about reforms — put in place legal provisions to handle bank insolvencies and bring back the reforms lying on the back burner.”