As a result of the RBI’s strong track record, it has become one of India’s key public institutions, like the Election Commission, the Finance Commission and the Supreme Court, mainstays of the nation that research has repeatedly found to be critical for long-run economic development.

That it has a good reputation, however, does not mean it is always right. For years, the RBI was unable to grasp the seriousness of the loan repayment problems or identify the prolonged frauds of Nirav Modi. Now, with the recent shenanigans involving IL&FS being revealed, this failure seems to have encompassed not just commercial banks but also non-bank financial companies. For these failures, the RBI needs to be held accountable.


Vijay Mallya, Nirav Modi, Chanda Kochhar, Rana Kapoor, Ravi Parthasarathy. Hearing this roll call of names is to be reminded of India’s “stigmatised capitalism”. It also suggests, to paraphrase from Shakespeare, that “something is rotten in this state of Indian banking” for having allowed stigmatised capitalists to survive and thrive for so long.

Where do we stand on the Twin Balance Sheet challenge in late 2018? What is the way forward? To answer these questions, we need to go back to the 5 Rs – recognition, resolution, recapitalisation, reform and regulation – that constitute the necessary actions that must be taken:

  • banks must value their assets as close as possible to their true value (recognition);
  • once they do so, their capital position must be safeguarded via infusions of equity (recapitalisation);
  • the underlying stressed firms must be sold and/or rehabilitated (resolution);
  • future incentives for the private sector and corporates must be set right (reform) to avoid a repetition of the problem; and
  • finally, check-ins and oversight of the banking system must be in place to ensure that the shenanigans we have seen over the last several years from Vijay Mallya to Nirav Modi to ICICI Bank to IL&FS are minimised; they can never be fully avoided (regulation).

Consider the current status of these 5 Rs.


After years of denial by the RBI and government, despite credibly grave warnings starting as far back as 2011, we have finally come a long way in publicly admitting the magnitude of the problem. The RBI’s Asset Quality Review, initiated in late 2015, played an important role in this regard. Today, total stressed assets are about Rs 13 lakh crore or about 15 per cent of total lending; of this about Rs 11 lakh crore are in the PSBs, amounting to nearly 20 per cent of their loans. But there is what I self-referentially call the Subramanian Iron Law of Non-Recognition: despite the progress, we know in our bones that the amount of stressed assets is always and everywhere at least 20-25 per cent more than what people believe and what the RBI claims. I say this not because I am a doom-monger or know something that others don’t. Rather, the law is based on knowing that banks are always trying to hide bad loans to paint a rosy picture of their finances. For example, until IL&FS began to default, its problems weren’t even on anyone’s radar, and their bad loans certainly weren’t included in the estimates of stressed assets. So, it would only be prudent to assume that we still have not identified all the stressed loans, especially amongst non-bank financial companies which would also feed back into the banking system; we should plan for matters being worse than they currently are.


Here, too, after serious delays, the government undertook a truly major – potentially transformational – reform. In the budget of 2016-17, the government passed a new bankruptcy bill, the IBC, which provides a legal framework for the timely resolution of companies unable to pay their debts. For reasons I have discussed earlier – essentially, the inability and unwillingness of the government to take tough decisions on write-offs – the Bad Bank approach to resolution had had to give way to a more judicial approach, which is what the IBC offers.

The RBI followed up decisively by identifying, on June 13, 2017, twelve loan accounts to be taken up under India’s new bankruptcy law with its tight deadlines and well-specified resolution process. These loans account for about 25 per cent of the current NPAs (not the overall stressed assets) in the banking system. Another thirty to forty cases have since been added to the list, and if settlement does not take place, they may also enter the bankruptcy process.

In the summer of 2018, India’s economic history reached a milestone. For the first time, a major industrial firm, Bhushan Steel, was declared bankrupt and was sold in auction to a new owner, Tata Steel. As of end-October 2018, another four companies have been successfully sold under the bankruptcy process. These transactions have demonstrated that “exit” is possible, that it can be done through the legal system, and that banks can recover substantial sums in the process. In other words, the sale showed that the new insolvency and bankruptcy code is working.

At the same time, these cases demonstrated the limits of the IBC. They revealed that the process is going to take far longer than originally envisaged: for example, at the current rate of disposal of cases by the National Company Law Tribunal (NCLT), it could take another five to six years for the most important cases to be settled. They suggested that the corporate insolvency resolution process (CIRP) may not be suitable for some assets. Moreover, there is now a serious risk that the process is getting overloaded, with too many cases being thrown into the bankruptcy process.


The government has injected a considerable amount of money since 2015 – first under the “Indradhanush” programme and then in late 2017 and again in the budget of 2018 – into public-sector banks, amounting to nearly Rs 2 lakh crore. The aim is to ensure that all banks are in compliance with the capital adequacy standards laid out by the Basel Committee (the minimum amount of equity a bank must have relative to the size and riskiness of its assets).

The longer it takes to resolve the stressed assets issue, the lower their value will be when they are finally sold. Consequently, the larger will be loss to the PSBs, and the greater the amount the government will need to spend to recapitalise them. Meanwhile, the resources available for this task have shrunk, since PSBs will not be able to raise the planned amounts (about Rs 60,000 crore), owing to their recent poor performance and the consequent sharp drop in their share prices. So, it is almost certainly the case that more money will be needed to make banks healthy and, for the good ones, healthy enough to be able to provide enough credit when the economy starts picking up again. It is possible that the government will need to provide anywhere between Rs 3-5 lakh crore – in addition to the amounts already spent – to restore the fundamentally viable PSBs to health.


As if the foregoing problems are not enough, another has become apparent. Recent scandals have underscored that there are fundamental governance problems in the PSBs which need to be addressed. There is currently no strategy in place to do this. Nor is there a clear path forward for the smaller, less viable banks. About eleven PSBs have been placed by the RBI under the Prompt Corrective Action (PCA) framework (some more might follow), which will have the salutary consequence that their growth will be capped until they reform, forcing them to cede market share to better-run banks. The RBI deserves credit for maintaining the integrity of this PCA process, amidst pressures from the government to dilute it, for example, by having unsound banks resume their expansion immediately.

In addition, two sets of bank consolidation exercises have happened, one involving SBI in 2016 and another now involving Bank of Baroda. We must be very clear. Merging bad banks with tolerably good banks does not improve the health of the overall banking system in any way. Consolidation is at best a Band-Aid for the system, and at worst a distraction for management from their key priority of dealing with their bad assets.

Meanwhile, there is still no serious consideration of privatising some of the major public-sector banks.

Regulation and Supervision

Perhaps the most problematic area has been bank (and non-bank) supervision. Over the past few years, egregious problems have been revealed in the banking system, ranging from exceptionally poor lending practices, to deceptive accounting practices that hid the loans that had gone bad, to a spate of scandals that involved a breakdown in control procedures (as in the Nirav Modi affair at Punjab National Bank [PNB]). None of these problems were prevented by the regulator, nor were they detected by bank supervision in real time. Instead, they were discovered long after it was too late to prevent substantial losses. Clearly, the record of the RBI as supervisor – along with that of the government as owner of public-sector banks – has not been pretty.

The RBI has reacted to these failures by taking a much tougher approach to banks. It has questioned bank accounting practices more closely, sanctioned banks that were found “cooking the books”, and removed executives at private-sector banks who had allowed such practices to take place. All the same, the central bank has not fundamentally overhauled its supervisory organisation, or its procedures, in part because it hasn’t been held accountable for its failures. Meanwhile, on the government side, the Banks Board Bureau (BBB) was introduced to improve governance at public-sector banks, but it has so far had very little impact.

Excerpted with permission from Of Counsel: The Challenges of the Modi-Jaitley Economy, Arvind Subramanian, Penguin Random House India.