Some proposals might need tweaks for the sake of systemic stability

The RBI governor’s public address after each bimonthly MPC meeting usually deals also with banking regulation and financial market issues, which do not fall within the jurisdiction of the MPC.

This time, however, the regulatory component dominated the address, with 22 new initiatives announced to strengthen provisioning by banks against loss, align capital adequacy norms with the revised Basel III guidelines, revise norms for credit risk weights, and announce the final version of the draft circular issued in October 2024 on prudential regulation of “forms of business.”

Starting with the last, the October 2024 draft stipulated “no overlap in the lending activities undertaken by the bank and its group entities” (Item No. 4(a)iii in the Annex to the draft circular). This restriction is proposed to be removed in the final guidelines, as stated at the MPC announcement, on the grounds that the strategic allocation of business streams among group entities is best left to the wisdom of bank boards.

The ‘no overlap’ stipulation is actually quite sensible from a ringfencing perspective, and does not prima facie intrude on the jurisdictional latitude of bank boards.

I have never been on the board of a commercial bank, but from what I have seen of other boards, they might not always prove to be collectively wise. The time allocated for board meetings is usually insufficient for the issues listed on the agenda.

On an important issue like this, there is often death by PPT—a power-point slide show with so many excruciating and often irrelevant details that the board members present are often ready to agree to anything after the last slide.

There must surely be many studies by now of corporate board behaviour. Bank boards in particular might have attracted research focus, or should have, after the bank-fuelled global crisis of September 2008. In India, there is an organization named Excellence Enablers, which issues a monthly newsletter on corporate-governance issues of the day. I have learnt a great deal from those newsletters about the fallibility and limitations of boards.

On the issue at hand, my own predilection would be to retain the regulatory restriction on overlapping business streams pursued by a bank and its group entities. But since removal of the restriction has already been announced (the final version of the circular does not yet seem to have been issued), it might be fruitful to have an amendment requiring bank boards to make a public announcement if such an overlap is allowed.

Moving on, the new (draft) Standardised Approach for Credit Risk, promised by the governor as part of the move towards the revised Basel III capital adequacy norms applicable from 1 April 2027, was issued on 7 October. It would be nice to go back to the earlier practice of inserting the date of issue of these circulars in the upper right-hand corner.

There are some good features, such as the much greater differentiation of risk weights on individual home loans according to loan-to-value (LTV) ratios, the size of the loan and the number of home loans taken by a borrower. But at 20%, the floor of the new range dips a little too much below the present floor of 35%.

At the other end, a risk weight of 60% for a third housing loan (to the same borrower), even with an additional 5% surcharge on loans above ₹3 crore, is much below the present weight applicable of 100% (the same as for commercial housing loans). It will enhance the trend towards cornering of house ownership, leading to local monopolies at the lower end of the rental market. The structure of risk weights needs to encourage diversification in house ownership.

The draft credit risk circular improves on previous regulatory circulars by being shorter and sharper, with more tables and less prose, and therefore easier to comprehend. It even carries information, here and there, on the incremental change from the pre-existing situation, but this information is not uniformly provided.

In general, regulatory norms and proposed changes need to be easily understood by the median borrower, so that they are not at the mercy of interpretations by bank staff (which can vary even within a bank, let alone across banks).

Among the other regulatory changes proposed in the governor’s address is a proposal to withdraw restraints on lending to large single borrowers by the banking system as a whole, introduced in 2016 to guard against excessive systemic capture of bank credit.

The governor announced that concentration risk would henceforward be dealt with through macroprudential tools. Maybe the discomfort generated by that withdrawal will be dispelled when the actual circular gives some idea of what those macroprudential tools might be. The limits to concentration risk at the individual bank level will remain as presently applicable.

The author is an economist.