Raghuram Rajan’s appointment as governor of the Reserve Bank of India (RBI) has elicited exuberant response ranging from plain optimism to wishful thinking. His brilliant opening speech has further fuelled positive sentiments.
Rajan’s first policy move, on Friday, a small hike in policy rates, surprised markets. However, overall liquidity will go up because some of the steps to prop up the rupee have been rolled back. And banks now need to hold slightly lower reserves for prudence.
Expectations, bordering on irrational, could set some commentators up for disappointment. We should calibrate our hopes. Let’s not expect a revolution in monetary management. The critical dependence on fiscal management by the government is evident to all. That should help us rein in our dreams.
But one does dream of a new paradigm in the regulatory and supervisory role of RBI. It is here that RBI is in full control of what it does and Rajan can bring a revolution. It will not be easy. The proud and traditionally conservative RBI has to be transformed by the new governor to deliver in a short time-span.
First, some background on a new paradigm in regulation. What is the biggest weakness of Indian banking, we recently asked the corporate sector in a survey. Innovation stood out as the single, resoundingly prominent, gap. Discerning companies were echoing a sentiment often discussed in the context of development in Indian banking.
We need innovative solutions for some complex issues like the massive extent of financial exclusion, perennially underfunded and poorly supported small enterprises, or the slow uptake of electronic banking, especially on mobile phones.
DAMNED IF YOU DO…
Innovation is a tricky topic in banking across the world. Banks are heavily regulated. It is argued that conservative regulations come in the way of innovation or, at least, offer a very convenient excuse to banks for not innovating. Regulators do not have much incentive to pitch for innovation. They are often held publicly accountable if things go wrong.
But they hardly get any appreciation for development and innovation in the banks they supervise. Rajan aspires to change this. In his report A Hundred Small Steps published in 2009, Rajan wrote, “…we need skilled regulators who encourage growth and innovation even while working harder to contain risks. The shift in paradigm, if implemented, could usher in a revolution in the financial sector…” His opening speech on September 4 is true to this vision.
The shift in paradigm is no easy task. RBI is justifiably a proud institution. Its prudent policies ensured that Indian banking was unscathed even as many banks the world over got singed in the financial crisis.
It has a strong institutional memory of past failures. And it has to its credit significant advancements in banking sector health, in our payment system’s quality and customer service. However, RBI has to reset from just being a respected and clean institution that has managed system stability at the cost of some innovation and inclusion. It has to open up to digital technology, create new capabilities in its staff and change mindsets. Raghu Ram Rajan has 16,248 people like on Facebook