Nine Key Points: A Deep Dive Into RBI's Latest Banking And Capital Reforms With Prof Prasanna Tantri

Professor Prasanna Tantri, Associate Professor of Finance and Executive Director at the Centre for Analytical Finance at the Indian School of Business, was the guest on the latest episode of Swarajya's "What This Means" podcast. In this episode, the Professor discussed RBI's recent policy announcements, warning of potential pitfalls amid seemingly progressive banking reforms.

1. The Big Picture: Easing Credit Flow

The Reserve Bank of India's latest banking and capital reforms package presents a mixed bag of opportunities and concerns.

According to Professor Tantri, the underlying theme is clear: the RBI wants to ease the flow of credit to various sectors while reducing regulatory restrictions. The reforms also aim to improve ease of business for lenders and make life easier for savings account holders.

However, he cautions that while many proposals are sensible, some measures — particularly those related to capital market funding — could have detrimental impacts.

2. The Repo Rate Pause: A Prudent Decision?

The RBI maintained its repo rate at 5.5 per cent, resisting calls for another 50-100 basis point cut. Prof Tantri agrees with this cautious approach, though not without acknowledging past mistakes.

"Core inflation, which excludes food and fuel, remains at 3 per cent and has been quite stable. It hasn't fallen." While he acknowledges the RBI's previous delays in repo rate cuts cost India at least 1 per cent in growth and numerous jobs, he believes the current pause is justified given that monetary policy changes take time to transmit through the economy.

The professor emphasises that headline inflation's volatility is primarily driven by food prices, which are supply-side issues rather than monetary phenomena. This volatility works both ways; today's food-driven deflation could quickly reverse to 5 per cent inflation, making aggressive rate cuts risky.

3. Risk-Based Deposit Insurance: Reform Or Potential Chaos?

The introduction of risk-based deposit insurance has been touted as a reform coming six decades after the flat-rate system in place since 1962. While Prof Tantri supports the principle — risky institutions should pay higher premiums than safer ones — he raises critical implementation concerns.

"Banking is optimally opaque," he notes, referencing academic research. The problem lies in how transparency might undermine banking's fundamental function. "Suppose tomorrow you see that your bank's insurance premium has gone up. You will start inferring there is something wrong with the bank, and then you will start running out of it."

He illustrates this with a thought experiment: imagine if coffee shops accepted cheques differently based on the issuing bank's perceived risk. "If I give you a cheque from Yes Bank, they might say, 'Give me 200 rupees.' If it's from SBI, then 'give 150 rupees.'" This would fundamentally break the system where bank deposits function as money.

The key question remains: will premiums be truly market-determined or simply based on regulatory formulas that sophisticated accountants can manipulate?

4. Credit Flow To NBFCs And Microfinance: A Welcome Change

Prof Tantri is more optimistic about measures reducing risk weights on bank loans to Non-Banking Financial Companies (NBFCs). Large banks aren't well-suited for small-ticket lending to street vendors or small retailers — that's where specialised NBFCs and fintechs excel.

"The role of a large bank is identifying which NBFCs or fintechs are good and lending to them so that they go and lend to these smaller borrowers," he explains. Bank branch managers aren't incentivised to make 10,000 or 50,000 rupee loans, but NBFCs can use community information, references, and alternative data effectively.

Why Are MFI Interest Rates On The Rise?

The recent increases in microfinance interest rates have little to do with RBI policy and everything to do with reckless lending during the post-COVID period. "Easy Venture Capitalist (VC) money flowing into fintechs" led to a culture where startups valued on sales rather than profitability extended credit to questionable borrowers just to boost numbers, Prof explains.

The cleanup from this period has now largely occurred, and rates should normalise now regardless of RBI actions.

5. The Expected Credit Loss (ECL) Framework: Form vs. Spirit

The implementation of the Expected Credit Loss model for banks represents a significant shift from the incurred loss approach. But Prof Tantri's enthusiasm is tempered by practical concerns.

"NBFCs have it already," he points out. "All that they do is take some credit rating agency's views." This defeats the purpose — banks know their borrowers better than rating agencies do.

The global financial crisis demonstrated the limitations of relying on external credit ratings. The ideal ECL implementation requires banks to proactively monitor borrowers, intervene when things go wrong, and provision before defaults occur — not months before, but well in advance.

"If you have very good governance at the banking level, then even if you don't impose ECL, people should do ECL anyway," he argues. The real issue isn't the accounting method — it's governance. "Are we willing to appoint people who are unlikely to toe the line that the CEO or the government wants?"

He cites the recent NBFC crisis, which occurred under ECL rules, as evidence that form matters less than substance. The focus should be on improving governance rather than changing accounting standards.

6. M&A Financing: Removing Artificial Barriers

The creation of a framework for banks to finance corporate acquisitions is one reform Prof Tantri unequivocally supports. Artificially restricting banks from lending for acquisitions makes little sense.

"If there is a company which can be managed better than the current management is doing, you should be able to raise money to go and acquire that company. That is how markets work. That's how creative capitalism works," he explains.

However, he quickly adds a reality check: lack of bank funding has rarely been the binding constraint for mergers and acquisitions in India. He cites the Religare case, where the Burmans (owners of Dabur) took two years to acquire a company at fair market price — not because of funding issues, but because management used regulatory hurdles across multiple agencies to delay the inevitable.

"Unless we solve these ease of doing business issues, I don't think tomorrow morning there will be like 10 M&As announced because now SBI is willing to lend."

7. The Capital Market Funding Disaster: "Pouring Oil On Fire"

Here, Prof Tantri pulls no punches. The increase in lending limits against shares (from Rs 20 lakh to Rs 1 crore per person) and IPO financing limits (from Rs 10 lakh to Rs 25 lakh) represents what he calls "pouring oil on fire."

"This is one area where I agree a lot with the chief economic advisor, V Anantha Nageswaran, who's been warning about this," Prof Tantri says.

"My question is why do you ban Dream11 but allow banks to lend for IPO speculation? Let me do Dream11; I can select cricket teams and then lend for that also."

The problem extends to the Systematic Investment Plan (SIP) frenzy. Indians have been told for 15-20 years that long-term equity always makes money, but Prof Tantri challenges this narrative: "Globally, there is no such thing as equity that will always make money over a 10-year or 15-year period. Look at China — the economy can keep doing well while equity does not."

The current situation creates perverse incentives. Mutual fund managers know SIP investors will keep contributing regardless of performance. "If a billionaire wants to get out of a stock which is going to fall, I will allocate 5 per cent of my money and bail out that guy," he explains. "I will use your money to prop up IPOs, to provide nice exits to FIIs."

The narrative that retail investors are somehow more informed than foreign institutional investors (FIIs) is absurd. "If retail people know better than institutions, then retail should invest directly. Why are you giving money to institutions?"

Prof Tantri recommends the book Manias, Panics and Crashes by Charles Kindleberger, which documents how people have sold houses to speculate on tulip bulbs.

He adds: Even Sir Isaac Newton wasn't immune. Newton invested in the South Sea Corporation, made 20-30 per cent returns, got tempted by further price increases, invested more, and then lost heavily when the bubble burst. His famous quote afterward: "I can calculate the motions of heavenly bodies but not the madness of people."

"The sad part is many of these SIP investors aren't greedy — they've been told it's like yoga or diet, just something you do," he observes. "It's an unconditioned SIP. You don't ask questions."

8. The Real Problem: Confusing Liquidity With Savings

A fundamental misunderstanding underlies many of these policies: conflating lack of liquidity with lack of savings.

"Savings is real in terms of goods and services. Liquidity is money," Prof Tantri clarifies. "These measures can only improve liquidity. They don't improve investments. For that, savings has to improve, or you have to get FDI from abroad."

Throwing more money at the same goods and services only leads to inflation, not investment. This is particularly problematic given India's manufacturing ambitions, which require substantial capital investment. "China has a 50 per cent savings rate. Manufacturing is the most capital-intensive thing you want. Where are you going to get capital from?"

He laments that no policymaker is currently talking about improving savings rates — the focus is entirely on consumption.

9. Time-Inconsistent Preferences: Why Society Should Care

Why should regulators care if individuals borrow to speculate and lose money? Prof Tantri points to research on "time-inconsistent preferences" — people do things they regret later.

Unlike building a house or funding education, where people work for 20 years to repay loans without regret, gambling losses are different. "There's a lot of evidence which shows that these people cut down on healthcare, these people cut down on children's education. If somebody loses money and cuts down on their children's education, that's where society has a role to play."

This is why encouraging speculation through easier lending is particularly problematic for lower-income groups.

The Bottom Line

The RBI's reforms package contains genuinely positive elements: easing credit flow to NBFCs, removing artificial M&A financing barriers, and potentially implementing ECL if done with proper governance focus. Minor provisions improving savings account convenience are welcome additions.

But will these reforms dramatically change India's investment rate? Tantri is unequivocal: "Absolutely not, because investment is not a liquidity problem. It's a productivity and savings issue."

The capital market funding measures, however, represent a significant policy error — one that could have consequences far beyond what current enthusiasts anticipate. As Prof Tantri concludes with a driving analogy: "You may drive blindly at 200 kilometers per hour and survive. There will not always be an accident. But theoretically, driving at 200 kilometers/hour is not a great idea."

The reforms may look progressive on paper, but the devil— as always — lies in the implementation, the incentives created, and whether policymakers understand the difference between liquidity and real capital formation.

Note: You can listen to the full episode on  Spotify and Apple podcasts.