As someone said, this crisis was too valuable to waste. I, for one, learnt many lessons on crisis management and leadership. By far the most important lesson I learnt is that the primary focus of a central bank during a crisis has to be on restoring confidence in the markets, and what this requires is swift, bold and decisive action. This is not as obvious as it sounds because central banks are typically given to agonizing over every move they make out of anxiety that failure of their actions to deliver the intended impact will hurt their creditability and their policy effectiveness down the line.
There is a lot to be said for such deliberative action in normal times. In crisis times though, it is important for them to take more chances without being too mindful of whether all of their actions are going to be fully effective or even mildly successful. After all, crisis management is a percentage game and you do what you think has the best chance of reversing the momentum. Oftentimes, it is the fact of the action rather than the precise nature of the action that bolsters confidence. Take the Reserve Bank's measure I wrote about earlier of instituting exclusive lines of credit for augmenting the liquidity of NBFCs and mutual funds (MFs) which came under redemption pressure. It is simply unthinkable that the Reserve Bank would have done anything like this in normal times. In the event of a liquidity constraint in normal times, the standard response of the Reserve Bank would be to ease liquidity in the overall system and leave it to the banks to determine how to use that additional liquidity.
But here, we were targeting monetary policy at a particular class of financial institutions-the MFs and NBFCs-a decidedly unconventional action. This departure from standard protocol pushed some of our senior staff beyond their comfort zones. Their reservations ranged from: 'this is not how monetary policy is done' to 'this will make the Reserve Bank vulnerable to pressures to bail out other sectors'. After hearing them out, I made the call to go ahead. Market participants applauded the new facility and saw it as the Reserve Bank's willingness to embrace unorthodox measures to address Specific areas of pressure in the system. In the event, these facilities were not significantly tapped. In normal times, that would have been seen as a failure of policy. From the crisis perspective though, it was a success inasmuch as the very existence of the central bank backstop restored confidence in the NBFCs and MFs, and smoothed pressures in the financial system.
Similarly, the cut in the repo rate of one full percentage point that I effected in October 2008 was a non-standard action from the perspective of a central bank used to cutting the interest rate by a maximum of half a percentage point (50 basis points in the jargon) when it wanted to signal strong action. Of course, we deliberated the advisability of going into uncharted waters and how it might set expectations for the future. For example, in the future, the market may discount a 50 basis-point cut as too tame. But considering the uncertain and unpredictable global environment and the imperative to improve the flow of credit in a stressed situation, I bit the bullet again and decided on a full percentage-point cut.
Managing the tension between short-term pay-offs and longer-term consequences is a constant struggle in all central bank policy choices as indeed it is in all public policy decisions. This balance between horizons shifts in crisis times, as dousing the fires becomes an overriding priority even if some of the actions taken to do that may have some longer-term costs. For example, in 2008, we saw massive infusion of liquidity as the best bet for preserving the financial stability of our markets. Indeed, in uncharted waters, erring on the side of caution meant providing the system with more liquidity than considered adequate. This strategy was effective in the short-term, but with hindsight, we know that excess liquidity may have reinforced inflation pressures down the line. But remember, we were making a judgement call in real time. Analysts who are criticizing us are doing so with the benefit of hindsight. Another lesson we learnt is that even in a global crisis, central banks have to adapt their responses to domestic conditions.
I am saying this because all through the crisis months, whenever another central bank, especially an advanced economy central bank, announced any measure, there was immediate pressure that the Reserve Bank too should institute a similar measure. Such straightforward copying of measures of other central banks without first examining their appropriateness for the domestic situation can often do more harm than good. Let me illustrate. During the depth of the crisis, fearing a run on their banks, the UK authorities had extended deposit insurance across board to all deposits in the UK banking system. Immediately, there were commentators asking that the Reserve Bank too must embrace such an all-out measure. If we had actually done that, the results would have been counterproductive if not outright harmful. First, the available premium would not have been able to support such a blanket insurance, and the markets were aware of that.
If we had glossed over that and announced a blanket cover anyway, that action would have clearly lacked credibility. Besides, any such move would be at odds with what we had been asserting-that our banks and our financial systems were safe and sound. The inconsistency between our walk and talk would have confused the markets; instead of reassuring them, any blanket insurance of the UK type would have scared the public and sown seeds of doubt about the safety of their bank deposits, potentially triggering a run on some vulnerable banks. Finally, an important lesson from the crisis relates to the imperative of the government and the regulators speaking and acting in unison. It is possible to argue that public disclosure of differences within closed doors of policymaking could actually be helpful in enhancing public understanding on how policy might evolve in the future.
For example, a 6-6 vote conveys a different message from a 12-0 vote. During crisis times, though, sending mixed signals to fragile markets can do huge damage. On the other hand, the demonstration of unity of purpose would reassure markets and yield great synergies. The experience of the crisis from around the world, and our own experience too, showed that coordination could be managed without compromising regulatory autonomy. Merely synchronizing policy announcements for exploiting the synergistic impact need not necessarily imply that regulators were being forced into actions they did not own.
1. What 'crisis' is the author referring to, in the above passage?
- Financial crisis of 2008
- Currency crisis of 1997
- Balance of Payment crisis of 1991
- De-monetization crisis of 2016
2. According to the author, what is the typical response of central banks in times of crisis? Answer with reference to the passage.
- Central banks are proactive in their approach and are quick to respond to crisis
- Central banks take risks and are aggressive in their response to crisis
- Central banks are deliberate in their approach and respond cautiously to crisis
- Central banks analyse different policy issues and then respond to crisis
3. Why does the author say "...even in a global crisis, central banks have to adapt their responses to domestic conditions"? Answer with reference to passage.
- Central banks do not have sufficient knowledge or expertise with regard to global conditions and cannot apply them to domestic conditions
- Only World bank has the information and expertise to deal with global conditions and help countries deal with domestic conditions
- Domestic conditions are typical to every country and applying solutions from other countries creates confusion
- Central bank policies are different for different countries and government permission is required to apply them in domestic conditions
4. With reference to the above passage, what is the role of government and regulators in times of crisis? Select the most appropriate response with reference to information provided in the passage.
- In times of crisis the government and regulators play the role of check and balance to provide safety to financial systems of a country
- In times of crisis regulators have to become more strict with government to prevent misuse of power and compromising regulatory anatomy
- In times of crisis the government has to exercise control on the regulators so that they do not become too powerful and exploit the financial systems
- In times of crisis the government and the regulators have to work on common ground and avoid any conflicts to prevent instability and confusion
1. The given passage deals with dealing with economic crisis. The author shares his experience in handling as the head of the Reserve Bank of India. During this process he has mentioned the year 2008 a number of times. This clearly hints at the financial crisis.
2. Refer to the lines ‘This is not as obvious down the line” in the first para of the passage.
3. Refer to the UK example the author has cited in the 3rd and the last paragraph of the passage. The author discusses in detail how emulating ‘the UK model’ of ‘deposit insurance across the board’ would have probably been a real disaster in the Indian context.
4. Refer to the lines ‘During crisis times, though…yield great synergies’ in the last paragraph of the passage.