I DO WHAT I DO- BOOK REVIEW

From the very beginning, Raghuram Rajan had a great clarity, pragmatism and
perspective on the issues at hand. He set the stage perfectly and set the ball rolling
for what was going to be a great phase for Indian economy. We will pick some
instances from the book and talk about their implications. We will also talk about what
they demonstrate about his personality and what can be learnt from them.
He was open to changes and decided to actively change the perception of the
RBI from conventional and short sighted to that of adaptable, transparent, long
sighted and self-assured. He understood the need to send the right signals to
the market.

Portrayed RBI as a symbol of stability, transparency in the volatility of market

to assure the investors as well as general public. Clearly expressed that no
surprises will be given.

He clearly enunciated the primary purpose of stability and secondary purposes

of rural financial inclusion. He addressed both stakeholders i.e. people as well
as banks

He expressed his clear commitment for financial inclusion, new licenses and
lazy banking. This gave a clear message that he meant business and wasnt
beating around the bush.

He also emphasised his commitment to loan recovery. While addressing the

issue, He mentioned that he will try his best to ensure that rational decisions
are taken and peoples interests are protected as best as possible. This attitude
of not just working like a machine but having a human touch is something that
has really helped in building a positive and popular image of Mr Raghuram
Rajan in the public eye.

At every step he held his predecessors i.e. Mr Subbarao, Mr Bimal Jalan, in

high esteem. Also, he addressed his subordinates with an equal respect. He
kept talking about involving respective departments and committees and their
involvement. Overall the entire speech gave a vibe of positivity, trust
interdependence and inclusion. This was exactly what the stakeholders needed
at that time, so it was very wise of Mr Raghuram to assess the mood precisely
and address it head on rather than being evasive on issues.

Speaking about the foreign currency Non-resident (FCNR) deposits, he frankly

discusses that he was against it initially and had dismissed it, thinking of it as a
selfish motive by bankers. Later on he carefully analysed its plus and negatives,
and ultimately ended up changing his decision. This shows the need to take
 objective decisions based on merit and removing biases and pre conceived
notions from our mind while taking decisions.

He did a quantitative balance of risks and assessed that this was the cheapest
option available to them so he grabbed it by both hands.

He mentioned that this scheme was surely meant to make money for bankers,
drain money from RBI, but it was also going to make the country better so he
decided to go by that calculated risk. Later on his risk did pay off. This particular
instance provides a learning that sometimes taking risks is compulsory but we
can try our best to keep them rational and minimal by proper assessment.

A major part of Mr Raghurams persona as a governor cannot be talked about

in entirety without his public image. He was being called a lot many positive
names and had a certain heroism attached to himself. In his own words, he
quite early on assessed that this heroism has some positives as well as
negatives. This can be attributed to the fact that certain expectations were being
attached. Therefore he specifically tried to separate himself from his public
image and tried to do his duties as a governor rather than taking much notice
of the media talk

His guiding principles or the 5 pillars for RBIs financial sector policies are:
1. Clarifying strengthening the policies
2. Focussing on new entries, branch expansion, new types of bank, better
regulation of foreign banks.
3. Broadening the markets and increasing their liquidities to decrease risk
4. Expanding to small, medium enterprises, financial inclusion of the poor,
unorganised and the deprived.
5. Dealing with corporate distress and financial institution distress, debt recovery.
As we can clearly see there is an emerging structured way of thinking there. He started
by bringing changes to the existing structures then focusing on new avenues. Post
that he expanded to new inclusions and then focussing on what can be done better to
tackle the issues that arise (distress). This was a wonderful and exhaustive way of
thinking.
Speaking about inflation, he decided to focus on the issue by not getting into
the discourse of the complex reasons but tackling the basic reason i.e.
increased demand first. For this he ensured that the burden is not on the poor
and allowed some concessions and more time to them.

His perspective on financial inclusion was very exhaustive and clear. He didnt
want the financial inclusion to be limited to only opening bank accounts for poor,
rather he stressed about the need to understand the social implications behind
it. So a lot of stress was laid on trust building and recognising special needs of
the rural people.
 On dealing with stress he showed a very pragmatic approach. Rather than
complaining about the things that were wrong or unavailable he shifted his
focus on the things which he actually had a control over. Moreover he
mentioned that rather waiting for miracles to happen during distress, it is better
to detect the issues early. This is a perfect example of a person who believes
in doing things rather than just talking about them.

HAWKS, DOVES OR OWLS

The naming of this chapter refers to the response given by Rajan, to a question asked
by a reporter after the Jan 2014 monetary policy review meeting. RBI had raised the
policy interest rates by 25 basis points. A reporter asked RBI governor why RBI had
acted like a hawk and spoken like a dove. Rajan replied that RBI had acted neither a
hawk nor a dove, but an owl.
One of the primary focus of Raghuram Rajan during his initial days as RBI Governor
was on inflation. He leveraged the Urjit Patel Committee Report to give legitimacy to
RBIs consequent actions on inflation front. Based on the Reports recommendations,
RBI took the following steps:
Moved from targeting Wholesale Price Inflation (WPI) to Consumer Price Inflation
(CPI)
Inflation targeting: RBI decided to move on a glide path to bring down inflation to
the target of 4% with a band of +/- 2% around it, with targets set for each year. A
formal inflation management agreement with the government was also signed
Liquidity operations were modernized with the intent of deepening money markets.
Term repos and term reverse repos were introduced and practice of keeping
banking system in liquidity deficit was changed to making it liquidity neutral
Framework for designing an independent monetary policy committee was
decided with the government
The parameters of RBIs fight against inflation were delineated by Rajan in a speech
to Fixed Income Money Market and Derivatives Association (FIMMDA) in Feb 2014.
The excerpts are as given below:
Best way to foster sustainable growth is through monetary stability i.e. by
bringing down inflation over a period of time
Industrialists always insist the RBI to reduce interest rates. However a lower
interest rate wouldnt hardly give the industrialists an incentive to invest. The
primary reason holding them to invest is not high interest rates. Second, even if the
RBI reduced interest rates, banks would not follow with a similar rate cut because
their costs of deposit would still be high. Depositors expect high inflation and thus
wouldnt tolerate a lower interest on their deposits
There are also calls from some quarters for the RBI to do a Volcker and increase
interest rates rapidly. However, while that may lead to less demand and thus bring
 down inflation quickly, that would do damage to a developing economy like India
which wont be in the same position as a resilient economy like the US
Medium term inflation targeting means the monetary policy committee would fight
against inflation in the medium term, concerned about both high as well as low
inflation
Food inflation: Many commentators feel that the real problem is food inflation and
how would RBI bring that down through policy rate. Core inflation, which excludes
food and energy, had also been relatively high. Bringing that down is within RBIs
primary ambit. However, monetary policy is not irrelevant in fighting food inflation
as well, which can be explained in the following points:
o Role of food prices in the high inflation of recent years: Food inflation
has a weight of 47.6% in the CPI index and had remained in double digits
from 2012 to Jan 2014. Now, why have food prices remained high?

Growing prosperity & dietary shifts: Even though share of food in

overall share of food in overall consumption has been declining
during the last decade, it has done so at a milder pace than the
significant relative increase in food prices. This suggests that
demand is relatively less elastic to price changes. Also, there has
been a shift to a more protein rich diet where there has been higher
inflation within the food basket
 Minimum Support Price: Higher MSP over the past few years has
also been a factor in high food inflation. But when we look at the
ratio of changes in input cost over the changes in the output price of
agricultural commodities received on the basis of CACP data, it has
remained flat, indicating that the gains from MSP increases have
not accrued to the farm sector in full measure because the costs of
inputs have been rising. One reason could be that higher MSPs
also drive input costs. Another could be that since MSP is mainly for
rice & wheat, it distorts production towards these 2 cereals and thus
creates inflation in the other food categories. However, there have
been increase of other input costs as well, such as sharp spike in
rural wages from 2008-09 to 2012-13 as compared to increase from
2004-05 to 2007-08. Now, why have rural wages been growing so
much?
 MGNREGA: Rural wages have seen sharp spike after enactment of
MGNREGA in 2005. This Act gave guarantee of 100 days of
manual labor and remuneration for the same. Thus the bargaining
power of rural laborers has gone up.

Rural liquidity and credit: The flow of credit to agricultural sector

has increased over the recent years. Thus more funds are available
to farmers to be paid to laborers which may have pushed up rural
wages.

Labor shifting to construction: There has been a trend of

agricultural labor shifting to construction labor in the years leading
up to 2014. Thus the agriculture labor declined from 259 million in
2004-05 to 231 million in 2011-12
 Female participation: Female participation rate in agricultural
activities is down in all age categories. Increased prosperity and
greater proportion of girls being enrolled for education have led to
declining participation of females

o Food inflation can thus be fought through the following measures:

Limit the rise in wages elsewhere so that relative wages in
agriculture can increase without too much increase in overall wages
Limit the unwarranted rise in wages of agriculture labor and other
input costs
Limit the pace of increase in MSPs
Reduce the role and power of middlemen in agriculture (amend
APMC Act)
Improve farm productivity through technology extension, irrigation,
etc.
 o RBI has a role in acting on points 1 and 2 by slowing the demand for labor
and anchoring inflation expectations, thereby moderating wage bargaining

What should be the ideal level of inflation that the RBI should target? Why 2-6% and
why not a moderate level like 7-10%
1. Even if inflation is at moderate level like 7-10% it disproportionately affects
the poor daily wage worker. While industrialist may benefit from high
inflation, the workers wont increase
2. Inflation is more variable at higher level. This raises the chance of
breaching the inflation target range if set at higher level
3. Inflation could feed on itself at higher levels higher the inflation, more
chances of it entering regions where it could spiral upwards
Arguments against RBIs policy in fighting inflation
1. Focus on the wrong index of inflation: But this is misguided. Focus on
WPI is wrong on two fronts. One, common man only experiences retail
inflation. Thus, if the RBI has to manage expectations of inflation it has to
target CPI. Two, WPI contains a lot products that are internationally traded
and whose prices are determined internationally and hence RBIs
monetary policy will play very little part in changing that.
2. RBI has killed private investment by keeping interest rates too high:
This again is misleading argument because a large component of the
interest rate that many industrialists pay for is the credit risk premium that
banks charge them
3. Supply constraints: Monetary policy has no effects on inflation when the
economy is supply constrained. Even though food inflation has contributed
significantly to CPI inflation, inflation in services like education &
healthcare have also played a part. While govt. has the main role to play in
containing food inflation, RBI can control inflation for more discretionary
items in the consumption basket through tighter monetary policy
4. Fiscal dominance: Central bank has little effect over inflation when
government spending dominates. The possibility of fiscal dominance,
however, only means that given the inflation objective set by the
government, both the government and the RBI have a role to play. If the
government overspends, the central bank has to compensate with tighter
policy to achieve the inflation objective. So long as this is commonly
understood, an inflation-focused framework means better coordination
between the government and the central bank as they go towards the
common goal of macro stability.

Financial Inclusion
At the National Seminar on Equity, Access, and Inclusion, on July 18,2016 Governor
Raghuram Rajan delivered a speech on The Changing Paradigm for financial
Inclusion in India which effectively encapsulates his thoughts on the topic and the
underlying principles that governed his decisions during his tenure.
He defines financial inclusion as:
1. The outreach of financial services to those people and businesses who do not
have access to this sector
2. The strengthening of financial services for those who have minimal access
3. Increasing financial literacy so that consumers can make better choices and
increased consumer protection
His justification for Financial inclusion is based both on moral and economic stands.
To give everyone the access to the services that he enjoys seemed morally correct
instinctively and the economist in him argued that more financial services outreach
would create more output, growth and economic prosperity.
But he also was mindful of the impediments to financial inclusion which have been a
hindrance up until now. The primary one that he mentioned was the lack of profitability
in servicing the poor across the world. He has characterised these impediments into
three categories (acronym IIT) :
1. Information
2. Incentives
3. Transaction Costs

IIT
The marginalised may live in remote zones or may have a place with groups or
portions of society that attempt economic activity informally they don't keep up
records or have marked contracts or documentation. They frequently don't possess
property or have consistent built up sources of wage. Therefore, a broker, particularly
if as is typical, he isn't from the neighbourhood locale, will experience issues getting
adequate data to offer budgetary items.
A second concern is incentive. For instance, advances are effortlessly accessible only
if the lender thinks they will be repaid. At the point when the legitimate framework does
not authorize reimbursement rapidly or economically, and when the borrower does not
have any guarantee to promise, the lender may believe that its hard to get
reimbursed.
The third obstruction is transaction costs. Since the extent of exchanges by poor
people, or by micro farmers or SMEs is little, the fixed expenses in executing are
generally high. It requires as much investment helping a customer fill out the forms
and to give the essential documentation in the event that he is applying for a credit for
Rs. 10000 as it takes to enable another to get Rs. 10 lakhs. A financier who is aware
of the main issue would normally concentrate on the huge customer in preference
to the minor one.
How does the local moneylender manage?
One of the essential inspirations for the nation to push for financial inclusion is to free
the marginalised from the grasp of the moneylender. How does the moneylender
actively give out loans where no broker sets out to? Since he doesn't endure similar
obstructions! Being a local citizen, the sahukar is well educated on what everybody's
sources of income are, and the amount they can repay. He is very equipped for utilizing
merciless techniques to implement reimbursement. Additionally, the borrower realizes
that in the event that he defaults on the sahukar, he loses his moneylender of final
resort. So, the borrower has solid impetuses to pay. Lastly, on the grounds that the
sahukar lives close-by and utilizes negligible documentation all things considered,
he wouldn't utilize the courts to enforce reimbursement - advances are effectively and
immediately gotten. In a crisis or if the poor need to acquire consistently, there are no
options more promptly accessible than the moneylender. No big surprise he has such
large number of marginalised citizens in his grasp.

How then should public policy approach this problem? He describes three approaches:
mandates and subventions, transforming institutions, and moving away from credit.

Approach 1: Mandates and Subventions

One approach is to push formal institutions into connecting with the marginalised,
regardless of the possibility that it is unrewarding. This is the reason, for instance, RBI
orders that banks allocate a specific part of their loans to the "priority segment" and
that they open 25 percent of their branches in unbanked areas. There are likewise
interest subventions that are made accessible for loans to specific sectors. Besides,
banks have been encouraged to open bank accounts for all under the Pradhan Mantri
Jan Dhan Yojana (PMJDY), while today they are being admonished to make loans to
small companies under the Mudra Scheme.

Since there are sure social advantages to financial inclusion that are not caught by the
service provider(what financial experts call "externalities"), such mandates are
sensible from a societal viewpoint. For example, the higher familial and group status
a farm worker gets starting her own poultry homestead and adding to the family salary
may, on net, exceed the costs the bank brings about on making the loan. The bank
can't monetize the status benefits, yet the government can choose those advantages
merit producing and mandate them.
In a similar vein, there may be network benefits from universal access for instance,
direct transfer of benefits is easier when the vast majority of beneficiaries have a bank
account, and the accounts themselves will be used heavily when account to account
transfers are made easier through mobile phones via the soon-to-be-introduced
Unified Payment Interface (UPI). Mandated account opening essentially creates the
universal network with its associated positive network externalities.
There are, however, a number of risks emanating from mandates. The first is that there
is no market test of usefulness, and indeed, these may not be possible how does
one measure the value of the enhanced social status of the poultry farmer? So,
mandates are driven by the beliefs of the political leadership, and may persist a long
time even if they are not effective. Furthermore, some vested interests may benefit
from specific mandates and push for their perpetuation long after they have ceased
being useful. Bankers themselves, seeing little profit in obeying the mandate, will try
and achieve it at least cost by targeting the most accessible and least risky in the
eligible category, and even mislabelling normal activity so that it fits in the eligible list.
Finally, some mandates fall primarily on the public-sector banks. As competition
reduces their profitability, their capacity to carry out mandates and still earn enough to
survive diminishes.
Mandates are not costless. Rather than forcing banks to recover costs by overcharging
ordinary customers, or by demanding recapitalisation by the government, better to
bring the costs into the open by paying for the mandate wherever possible. So, for
instance, accounts or cash machines opened in remote areas could attract a fixed
subsidy, which would be paid to anyone who delivers them. Not only will the cost of
the mandate become transparent and will be borne by the authorities, thus
incentivising them to make sensible decisions about how long to impose the mandate,
the mandate can be delivered by the most efficient service providers, attracted by the
subsidy. This is why the RBI today explicitly subsidises cash recyclers set up in
underserved areas, and why central and state governments are paying banks for
maintaining and servicing specified accounts. Going forward, narrow targeting of
mandates to the truly underserved and explicit payment for fulfilling the mandate so
that they are delivered by the most efficient should be the norm.
Approach 2: Creating the Right Institutions
As mentioned before, the moneylender is especially effective on the grounds that he
knows the area and its kin, and can make a decent appraisal of who is credit worthy.
A large national bank with a local branch suffers from two infirmities. In the first place,
the branch administrator has ordinarily been enrolled through an all-India exam, is
from another state, and regularly isn't personally acquainted with the nearby
individuals. While numerous great branch directors do in fact find out about the group,
some don't. The higher financial status of bank officers additionally makes a barrier
between them and the poorer fragments of the group, and their high pay makes many
branches in remote territories monetarily unviable regardless of the possibility that they
could solicit business intelligently. Finally, given that the marginalized don't have
formal records, bank managers in large banks with bureaucratic unified methodology
think that its difficult to give viable service how can one pass on to head office the
justification for an advance to an astute energetic tribal who needs to set up a little
shop, however who has no formal instruction or reputation?
Local financial institutions, with local control and staffed by knowledgeable local
people, could be more effective at providing financial services to the excluded. HDFC
Bank, for example, has been very successful growing its loan portfolio in Kashmir by
recruiting local youth as loan officers. Certainly, this is also the obvious lesson to be
drawn from the success of micro finance institutions, who combine their local
knowledge with stronger incentives for repayment through peer pressure and frequent
collection of repayments. Indeed, this was also the rationale for local area banks,
regional rural banks, and is a strong feature in the cooperative movement.
Yet, while there have been some grand successes among these institutions, each form
has some deficiencies. Micro finance institutions do not have access to low cost
deposit financing, though securitisation of loans has been a growing avenue of
finance. Local area banks could not expand out of their local area, exposing them to
the geographical concentration risks. Regional rural banks agitated for parity in salary
structures with parent scheduled commercial banks, and having achieved parity, find
that their costs are not optimally suited for the clientele they need to service. There
are some very successful cooperative banks, on par with any universal bank, but far
too many suffer from governance problems. The RBI has been engaged in bringing
stronger governance to urban cooperative banks, but split supervision with state
authorities limits how much it can do.
To provide an alternative institutional avenue for these categories of institutions to fulfil
their mission, the RBI has created a new institution called the small finance bank,
where small refers to the kind of customer the bank deals with, not its size. With 75%
of the loans mandated to be below 25 lakhs, the small finance bank is intended to
provide services to the excluded. Thus far, the licenses have been largely given to
micro-finance institutions and one local area bank, but there is no reason why these
cannot be given to regional rural banks and co-operatives in the future. The hope is
that these institutions will maintain a low-cost structure, augmented by technology, to
provide a menu of financial services to the excluded.
Approach 3: Dont Start with Credit
RBI has been striving for quite a long time to extend credit. RBI has concentrated
considerably less on easing payments and remittances, on expanding remunerative
savings vehicles, or on providing easy-to-obtain insurance against crop failures. In the
developing monetary consideration worldview, the Government and the RBI are
endeavouring to expand inclusion by empowering these different products, enabling
credit to follow them instead of lead. Without a doubt, numerous organisations working
with the poorest of the poor endeavour to motivate them to set aside some cash as
reserve funds, regardless of how little, before giving them loans. Some of the self-help
groups (SHGs) work on this principle. Not only does the savings habit, once taught,
enable the client to deal with the weight of reimbursement better, it might likewise
prompt better credit allocation.

Easy payments and cash out will make formal savings more attractive. Today, a
villager who puts money into a bank has to either trudge the last miles to the bank
branch to take out her money, or wait for an itinerant banking correspondent to come
by. RBI is engaged in strengthening the network of banking correspondents; by
creating a registry of banking correspondents, giving them the ability to take and give
cash on behalf of any bank through the Aadhaar Enabled Payment System (which will
also give them adequate remuneration), and requiring that they are adequately trained
in providing financial services. Cash-in-cash-out points will expand soon as the Postal
Payment Bank and telecom affiliated payment banks make post offices and telephone
kiosks entry points into the financial system. Perhaps most interestingly, transfers from
bank account to bank account will become easier in a few weeks via mobile through
the Unified Payment Interface. A villager needing to pay a shopkeeper only needs to
know the latters alias say Ram@xyzbank.psp. He feeds that into his mobile app,
writes the payment amount, puts in his password, and presses send and the payment
is made, with both getting messages to that effect. Neither needs to visit the bank to
take out or deposit money, no point of sale machine is needed. With the price of
smartphones falling sharply, RBI is on the verge of solving the last mile problem.

Strengthening the Debt Market

Raghuram Rajan, in his book, writes his expectations from the Indian Debt market and
how he plans to make those a reality.
Debt markets and associated derivatives
Why we need them to be deep and liquid,
Why, in addition to central and state governments, we need riskier firms and
projects to be able to access the bond markets for funds,
Why we need to encourage product innovation,
And finally, the dilemmas that regulators like the RBI face
He mentions three key reasons why debt markets have become a lot more attractive
in the recent months:
1. Firstly, we finally have a set of regulations that commits us to low and. stable
inflation. Market participants know that Monetary Policy Committee has to
maintain low and stable inflation, certainly over next 5 years for which tis remit
has been set. This lowers inflation risk premium and thus reduces nominal
fixed interest rates for everyone.
2. Secondly, reluctance of both public and private sector banks to fully pass
through past policy rate cuts into bank lending rates. Short term market rates
have seen full pass through, leading to highly rated firms bypassing banks to
borrow from Commercial Paper markets. But what of lower rated firms?
Unfortunately, the difficulty of debt recovery in India has meant that Credit
spreads are wider than elsewhere. This is where the third notable development
comes in.
 3. Recent reforms of SARFAESI Act and Debt Recovery tribunals in the short term
and Bankruptcy code in the medium term should help reduce defaults and lower
credit risk.

Given these developments, what should be the objectives of fixed income market
regulation?
RBI is concerned about three facets of the debt market:
1. Markets can be affected by speculators who can move the price away from
what the fundamentals imply. RBI must act to prevent any concerted effort from
speculators and must ensure that all participants are price-takers.
2. Markets can turn into source of competition for Institutional investors, who as
mentioned previously have moved from Banks to Debt markets thereby forcing
banks to lend to high-risk projects and end up with more NPAs on their balance
sheet as opposed to NBFCs who have more long-term commitments.
3. Worry about unbridled innovation that tries to circumvent the prudential norms
and ends up creating systemic risk like the derivatives and CDSs around
housing mortgage pools that led to the financial crisis of 2008.
The broader point is that a measures and well-signalled liberalisation of fixed income
and derivative markets will allow us to reap benefits of a deeper and more liquid market
while minimising the above mentioned three risks of speculation, competition and
innovation.
Participation:
Greater participation adds greater liquidity and Raghuram Rajan has over the years
tried to enhance participation through his policies as governor.
Increasing access of institution dominated screen-based NDS-OM market to
retail investors so that they can trade G-Secs and use their de-mat accounts
Foreign Portfolio Investors will now have direct access to variety of markets
including NDS-OM, corporate bond trading etc.
Increased bank open position limits
Innovation:
Financial innovation can slice or dice risk so that it is placed on the right shoulders.
 CPI based Inflation Indexed Bonds, Tax Protected Gold Monetisation Bonds
First version of Interest Rate futures was not attractive but second version
was highly successful
Setting up of Financial Benchmarks India Pvt. Ltd (FBIL) which is building a
series of market benchmarks.

Managing Distress

Financial distress has been one of the major concerns of the Indian banking
industry. The most recent problems have their roots in the period of 2007-09, when
high economic growth led to increased demand. However, this was followed shortly
by the financial crisis. Lack of recovery instruments only worsened the scene. Banks
have been ineffective with collections and need to be better equipped with more tools
to counter the problem.
Traditionally, lenders in our country have always been seen in a bad light.
However, today, the lenders are not selfish sahukaars and the borrowers are not
illiterate peasants. Despite the fact that the industrial borrowers default and leave
banks helpless creating a hole in the countrys economy and costing taxpayers hard
earned money, the mindset has still not changed much.
One of the reasons this distress has become a major problem to both, banks
and the economy as a whole, is the protection offered by the system to the large
borrowers. While banks face the downside risk in any transaction, the borrowers enjoy
the gains completely during good times and flee during the bad times shifting the entire
burden on the banks. The promoters keep stalling the recovering agents and sell off
their enterprises in the meantime. One key reason for the same is that we currently
have 37 Debt Recovery Tribunals and only 5 Debt Recovery Appellate Tribunals,
which creates a major bottleneck in the system, giving promoters with expensive
lawyers sufficient time to flee.
Two major consequences of the above-mentioned problems are:
Borrowing becomes costly for the entire industry if one of the members defaults.
Stricter laws discourage small business from borrowing and drive down
innovation.
The solution to the problem is to give more control to the lenders during bad
times and taking more from the promoters. A better balance between the two parties
can be ensured by the following initiatives:
Better Capital Structures: Ensuring that the projects are not highly leveraged
and that the promoters too have a considerable stake ensures the sincere
involvement of the promoters as well. Banks also need to ensure that the
promoters do not take their money out once the funding is secured and stay
involved in it. Inefficient project monitoring also leads to major problems down
the line.
Joint Lending Forums: In order to ensure faster action and give more power to
the lenders, RBI came up with JLFs that are banks that come against a common
 defaulting promoter. To give them more agility, the RBI has incentivized quicker
decisions and reduced the minimum voting requirements.
A better legal infrastructure: The Government has plans to expand the DRT and
DRAT network. The move needs to be accompanied also by improved laws,
more trained personnel and more effective implementation.
Asset Reconstruction Companies: The Government needs more ARCs and
turnaround agents that can step in in place of promoters and improve the
financial health of the company so that it may repay the debt at some point of
time. In addition, these ARCs need to be more effective not act as mere
liquidators.
Bankruptcy law: A properly structured, well-documented bankruptcy law would
reduce the uncertainty on part of the lenders as well as the shareholders in
times of distress. We will also need accompanying bankruptcy courts for better
results.
There has been a decline in the growth of credit over the years and it has been
largely because of the stress on the public sector banks. To boost the growth, cleanup
of the balance sheets is necessary. It involves recognizing the problem, resolving the
bad loans, and recapitalizing the banks.
Since 2014, the non-food credit growth for the public sector banks has been
falling as compared to credit growth for the private sector banks, which denotes
slowdown in lending. One could say that the firms are not investing, hence no demand
for credit but actually, the lack of capital or the level of interest rates is not the problem.

Banks are reluctant to give out loans to areas of high credit exposure, specifically to
industry and to small enterprises because of mounting distress on their past loans,
that leads to shrinkage. Private sector banks cannot substitute fully for the slowdown
in public sector bank credit.

There are two sources of distressed loans

1. The fundamentals of the borrower not being good
2. The ability of the lender to collect being weak

When the borrower has bad fundamentals, we see phenomenon of irrational

exuberance, strong demand projections for various projects were shown to be
increasingly unrealistic as domestic demand slowed down. In some cases, undue
influence was used in getting loans, or actual fraud was committed by diverting funds
out of a company, through over-invoicing imports sourced via a promoter-owned
subsidiary abroad or exporting to related shell companies abroad and then claiming
they defaulted

These problems become severe with inefficient loan recovery system. It does not
follow careful documentation and perfection of collateral, or assets backing promoter
guarantees are not registered and carefully tracked. In such situations, knowing that
banks would find it hard to collect, some promoters double-up by expanding the scale
of the project, even though the initial scale was unable to service debt.

CLEANING UP THE BANKS: PRINCIPLES

 1. Debt outstanding does not define the viability, but it depends on economic
value. It becomes important for banks to write down the debt to correspond to
a value that is viable.
2. Infuse capital in projects that are viable and lead them to completion.
3. Contrary to the second point, the banks should not throw more money in a bad
project after careful analysis, hoping that the debt will soon become
serviceable.

BANK MORAL HAZARD:

Managers, when believe they have short tenure, tend to postpone recognizing losses
for their successors to deal with. Sometimes, they refuse to lend for the fear that the
investigative agencies will not buy their rationale for lending. In addition, in cases of
insincere documentation, loan evaluation and monitoring practices by banks, the
outcome are distressed loans.

THE REGULATORS DILEMMA

RBI wants that banks:
recognize loan distress and disclose it,
be realistic about the projects cash generating capacity
continue lending to viable projects

Steps taken by RBI:

1. RBI created a large loan database (CRILC) for loans over Rs 5 crores, displaying
the status of each loan
2. Formation of Joint Lenders Forum (JLF) was done to help the lenders coordinate
amongst themselves. RBI also ended the ability of banks to restructure projects
without calling them NPA in April 2015.
3. Strategic Debt Restructuring (SDR) scheme was launched, under which bank
displaces the weak promoters by converting debt to equity until a new promoter is
found.
4. Asset Quality Review, completed in October 2015, post which banks have classified
existing distressed loans appropriately, and since March 2016 are looking at their
weak but-not-yet-distressed portfolio for necessary actions
5. Scheme for Sustainable Structuring of Stressed Assets (S4A) framework using
which sustainable debt level for a stressed borrower is determined, and outstanding
debt is bifurcated into sustainable debt and equity/quasi-equity instruments. This is
helpful in case of capable-but-over-indebted promoters

Effects:
Banks are getting into the spirit of the clean-up, and pursuing reluctant promoters to
take the necessary steps to rehabilitate projects. Indebted promoters are being forced
to sell assets to repay lenders.

Fraud:
RBI coordinated with SEBI to increase penalties for willful defaulters and establish
measures for quick and effective investigation
Banks are now showing the promoters alternatives to repayment can be harsh
BANK RISK AVERSION

Bad loans could be a result of bankers sloppy attitude or lack of due diligence or poor
loan monitoring techniques, but not always. Instead of suspecting bankers of
malfeasance, look for a pattern across loans sanctioned.

RBIs Responsibility

RBI believes that the onus of bad loan problem lies on bankers, promoters, and
economic environment. RBI neither can make commercial decisions on behalf of the
bankers or micromanage them. Even investigation of such deals while they are being
made is difficult. RBI tries to help by warning the banks about poor lending practices,
and demanding banks to hold adequate risk buffers.

Because of these measures, the banks have not been lending indiscriminately and
focusing more on reducing the size of distressed loans or NPAs. Contrary to the
popular belief, easing the monetary policies does not help curb the problem of distress.

Government Initiatives:

1. Indradhanush initiative
Breaking up the post of Chairman and Managing Director, strengthening board and
management appointments through the Banks Board Bureau, decentralizing more
decisions to the professional board, finding ways to incentivize management, all these
will help improve loan evaluation, monitoring and repayment improve the governance
of public sector bank

2. Infuse bank capital

Governments are sometimes reluctant to infuse bank capital because there are so
many more pressing demands for funds. RBI should capitalize public sector banks.
Issue the banks Government Capitalization Bonds in exchange for equity.

International Issues & Concerns

Raghuram Rajan wanted to focus on unconventional monetary policies which includes
policies that hold interest rates at near zero for long
balance sheet policies such as quantitative easing or exchange intervention
that involve altering central bank balance sheets in order to affect certain
market prices.
He emphasized that quantitative easing and sustained exchange intervention are in
an economic equivalence class and they should be conditioned by the size of their
spillover effects rather than by any innate legitimacy of either form of intervention.
Roles for unconventional monetary policies
Central bankers do have to think innovatively when markets are broken or grossly
dysfunctional. Central banks eased access to liquidity through innovative programmes
such as
Term Asset-Backed Securities Loan Facility (TALF)
Term Auction Facility (TAF)
Troubled Asset Relief Programme (TARP),
 Securities Market Programme (SMP)
Long-Term Refinancing Operation (LTRO)
Central banks restored liquidity to a world financial system by lending long term without
asking too many questions of the collateral they received, by buying assets beyond
usual limits, and by focusing on repairing markets.
Concerns- In his book he mentioned four major concerns regarding monetary policies
Is unconventional monetary policy the right tool once the immediate crisis is
over? Does it distort behaviour and activity so as to stand in the way of
recovery? Is accommodative monetary policy the way to fix a crisis that was
partly caused by excessively lax policy?
Do central banks become the only game in town for policies from being
implemented?
Will exit from unconventional policies be easy?
What are the spillovers from such policies to other countries?
Exit from unconventional policies concerns & recommendations
Unconventional policy is worth pursuing even if the benefits are uncertain as prolonged
unconventional policy in industrial countries has low costs, provided inflation stays
quiescent. However, economists have raised concerns about financial sector risks that
may build with prolonged use of unconventional policy. Asset prices may not just revert
to earlier levels on exit, but they may overshoot on the downside, and exit can cause
significant collateral damage. Leverage may increase both in the financial sector and
amongst borrowers as policy stays accommodative.
Channels- a boost to asset liquidity leads lenders to believe that asset sales will
backstop loan recovery, leading them to increase loan to value ratios. When liquidity
tightens, though, too many lenders rely on asset sales, causing asset prices and loan
recovery to plummet.
Another possible channel is that banks themselves become more levered, or
equivalently, acquire more illiquid balance sheets, if the central bank signals it will
intervene in a sustained way when times are tough because unemployment is high.
Leverage need not be the sole reason why exit may be volatile after prolonged
unconventional policy.
Investment managers will hold a risky asset only if it promises a risk premium
(over safe assets) that makes them confident they will not underperform holding
it.
A lower path of expected returns on the safe asset makes it easier for the risky
asset to meet the required risk premium, and indeed draws more investment
managers to buy it.
Ultra accommodative monetary policy- It creates enormously powerful incentive
distortions whose consequences are typically understood only after the fact. The
consequences of exit, however, are not just felt domestically, they could be
experienced internationally.
Spillovers-When monetary policy in large countries is extremely and unconventionally
accommodative, capital flows into recipient countries tend to increase local leverage;
this is not just due to the direct effect of cross-border banking flows but also the indirect
effect, as the appreciating exchange rate and rising asset prices, especially of real
estate, make it seem that borrowers have more equity than they really have.
Exchange rate flexibility in recipient countries in these circumstances sometimes
exacerbates booms rather than equilibrates. Ideally, recipient countries would wish for
stable capital inflows, and not flows pushed in by unconventional policy.
Once unconventional policies are in place, however, they do recognize the problems
stemming from prolonged easy money, and thus the need for source countries to exit.
But when source countries move to exit unconventional policies, some recipient
countries are leveraged, imbalanced, and vulnerable to capital outflows.
Recipient countries are not being irrational when they protest both the initiation of
unconventional policy as well as an exit whose pace is driven solely by conditions in
the source country. Having become more vulnerable because of leverage and
crowding, recipient countries may call for an exit whose pace and timing is responsive,
at least in part, to conditions they face.
International monetary policy coordination
Raghuram Rajan call for more coordination in monetary policy as it would be an
immense improvement over the current international non-system. International
monetary policy coordination, of course, is unpopular among central bankers. He
propose that large country central banks, both in advanced countries and emerging
markets, internalize more of the spillovers from their policies in their mandate, and are
forced by new conventions on the rules of the game to avoid unconventional policies
with large adverse spillovers and questionable domestic benefits
He suggest that central banks reinterpret their domestic mandate to take into account
other country reactions over time (and not just the immediate feedback effects), and
thus become more sensitive to spillovers.
Economists generally converged on the view that the gains to policy coordination were
small provided each country optimized its own policies keeping in mind the policies of
others. The domestic and international aspects were essentially regarded as two sides
of the same coin.
Factors- First, domestic constraints including political imperatives of bringing
unemployment down and the economic constraint of the zero lower bound may lead
monetary policy to be set at levels different from the unconstrained domestic optimal.
Second, cross-border capital flows can lead to a more dramatic transmission of
policies, driven by agency (and other) considerations that do not necessarily relate to
economic conditions in the recipient countries.
Arguments-One argument is that if some large country adopts unconventional and
highly accommodative sub-optimal policies, other countries may follow suit to avoid
exchange rate appreciation in a world with weak demand. As a result, the policy
equilibrium may establish at rates that are too low compared to that warranted by the
global optimal.
Another argument is that when the sending country is at the zero lower bound, and
the receiving country responds to capital inflows with aggressive reserve
accumulation, both may be better off with more moderate policies. Despite these
arguments, official statements by multilateral institutions such as the IMF continue to
endorse unconventional monetary policies while downplaying the adverse spillover
effects to other countries.
By downplaying the adverse effects of cross-border monetary transmission of
unconventional policies, he see two major dangers.
One is that any remaining rules of the game are breaking down.
The second danger is a mismanaged exit will prompt fresh distortionary
behaviour
Market participants conclude that recipient countries, especially those that do not
belong to large reserve currency blocks, are on their own, and crowd devastatingly
through the exit.
Lesson some emerging markets will take away from the recent episode of turmoil is
(i) dont expand domestic demand and run large deficits
(ii) maintain a competitive exchange rate .
(iii) build large reserves, because when trouble comes, you are on your own.