In the past two months, Rajan has reduced the statutory liquidity ratio (SLR) by 100 basis points to 22 per cent. Under SLR, banks in India have to invest a large part of their deposits in government securities. This means they have lesser funds to lend to the private sector. Globally, the SLR requirement for banks is less than 10 per cent.
Rajan's move to reduce the SLR is aimed at nudging banks to lend more to the productive sectors of the economy, rather than just parking their funds in government securities.
Rajan, a celebrated global economist, is also putting together a longer-term plan to do away with lazy banking without upsetting the government borrowing programme. The RBI has recently moved to allow a new category of banks-payment banks-to accept public deposits in semi-urban and rural areas with no power to lend to the private sector.
The Payment Banks have to compulsorily invest their entire deposits into SLR securities. This way the gradual reduction in commercial banks' SLR will be compensated by payment banks or insurance and mutual funds as they would also grow in the years to come.
The longer-term plan of Rajan to do way with lazy banking looks credible. But any major reduction in the SLR in the short term could create a problem because the government depends a lot on banks to subscribe to its SLR securities.
In his second bi-monthly review on Tuesday, Rajan reduced the SLR by 50 basis points to 22 per cent with the assumption that the new government under Prime Minister Narendra Modi will be able to adhere to its commitment of meeting the fiscal deficit target of 4.1 per cent of gross domestic product for 2014/15.
But the actual fiscal deficit numbers are already wide off the mark. In the first quarter (April-June) of 2014/15, the fiscal deficit has already reached Rs 2,97,800 crore.
This is 56 per cent of the budgeted estimate of Rs 5,31,000 crore. This shows that the government is spending more than it has budgeted for this year. There is all likelihood of the government exceeding the targeted borrowing of Rs 6 lakh crore to bridge the widening deficit in 2014/15.
If the government springs a surprise by meeting the fiscal deficit target of 4.1 per cent this year, Rajan will surely step on the gas to do way with lazy banking by substantially reducing the SLR in the Indian banking system.