Principles of Sound Judgment: RBI edition

I link context (banking regulation) to concept (sound judgment). And give credit where it’s due.

Hullabaloo over a recent RBI paper bugged me enough to stray outside my domain in my previous essay (https://buggyhuman.substack.com/p/last-refuge-of-license-raj). In this follow-up, I try to link it back to my domain: judgment under uncertainty.

Messy world is mostly unknowable. Even with best of intentions and ability, consequences of decisions are indeterminable. Given context and constraints of a governmental regulatory body dealing with a casino-like sector, decision making becomes dicier. Over the years, I have found a few philosophical tenets that aid messy-world decision making in such contexts.

1. Incremental over disruptive

With leverage and propensity to assume undue risk, bank failures are inevitable and costly. Any change is high risk. An incremental change that impacts the system in a small way or a small part of the system ensures that failures are manageable and don’t take down the system. Tinkering is preferred over step changes. This is analogous to companies considering M&A, where odds are notoriously poor. Then, our counsel is usually “Keep it small, so that failure won’t sink it all”.

Empirically, RBI has followed an approach of thoughtful gradualism. I was glad to hear RBI governor recently say “Capital account convertibility is a journey, not an event”. In a non-disruptive manner, constraints have been relaxed. New entrants, formats and entities allowed. New technologies assimilated. Fault lines addressed.

(More generally, I believe that a majority of messy world is better served by an evolutionary approach to progress, since no one knows how decisions will pan out. However, majority doesn’t mean 100%. There are ring-fenced parts of the system that are specifically designed for revolutionary attempts. Start-up and venture capital ecosystem is an example, funded by patient equity. Fundamental research or parts of R&D also qualify. However, these are a small and special part of the overall pie. While established companies innovate too, better ones treat it as an ongoing journey over decades, rather than as bet-the-company changes made all at once.)

2. Better-worse over good-bad

I have called many things bad, but that’s not helpful. By definition, anything buggy and messy will have lots of bad in it. That’s all of humanity and our social world. A more useful way to think about actionable decisions is in terms of better and worse, not good and bad. In a messy world, we choose better options, not unambiguously good ones. That too, on an all things considered basis. Since incrementalism implies that we can’t directly jump from bad to good, the central question is whether tinkering makes things better after weighing all costs and benefits. If we get better long enough, we may even reach good. In a specific proposal, asking what’s bad isn’t too helpful. Picturing a hypothetical, extreme bad consequence at the exclusion of all else is especially unsound (“Mallya will own a bank, bribe himself for a loan and siphon it”). A better question is, weighing good and bad, will it make things better? Is it better than the alternative, which may well be status quo? A recognition that bad and better can coexist is central to sound real-world judgment.

I think RBI has made things better over time, even if inevitable bank screw-ups make it feel like two steps forward, one step back. We’ve seen material progress on digital payments. Financial inclusion. NPA recognition. Handling bank failures. Even PSU banks are better now than before. Egregious excesses in lending against real estate or coal blocks are behind us. RBI’s proactive response to covid-lockdown has made terrible times less bad.

3. Flexibility over planning

Since consequences are unknown and failure is inevitable, open-mindedness and course-correction matter more than pretentious planning of the kind our eponymous commission used to do. Flexibility is key. As an illustration, a less noticed aspect of recent RBI paper is their walking back on payment banks. It was a tinkering effort that didn’t quite pan out. In easing exit route for incumbent payment banks, RBI seems headed towards closing this chapter. Another example: with a legacy of mediocre players in a risky sector and inability to shut down an entity with millions of depositors, flexibility in handling failure is very valuable. A diverse set of potential suitors will help avoid ‘single bidder’ scenarios or shotgun weddings that erode credibility. Arbitrary constraints that limit flexibility can be counter-productive. RBI’s proven flexibility feeds back into our better-worse evaluation, since scenarios are dynamic, not static. An incremental change that doesn’t pan out as intended will likely be tweaked or reversed, well before it becomes catastrophic.

4. Actions over words

A key difference between academic evaluation and real-world judgment: credibility scores over words. At the extreme, words are meaningless, like a lifelong corporate crook promising to turn over a new leaf. Credibility is in turn based on past actions. Since there’s subjectivity in translating proposals into actions, words have to be framed against the context of historical behavior. RBI has booted out crooked promoters. Insisted on external hires in clean-up cases. Vetoed unsuitable bidders for banks, whether it be via front or back door. It’s not only been about damage control. RBI has supported internal succession in good banks. Allowed timely forbearance to deal with a force-majeure crisis, without a free pass on loan loss provisioning. Wiped out equity holders (which is the point of equity), while finding a new owner who’ll take care of depositors. Been reasonable in recent licensing rounds. In light of these, it’s unfair to interpret words in a manner that assumes mala fide intent. If at all, evidence suggests the opposite, that any policy will be enforced prudently with safeguards.

These tenets are valid beyond this specific context. I use them if one of my portfolio companies proposes a change of scope (e.g. product, market, manufacturing, distribution, organization). I wouldn’t second-guess them as it’s their prerogative. However, as an interested party, I assess if proposals are generally in line with these tenets. I still can’t predict consequences, but I can gauge reasonableness and favorable odds.

Last two tenets imply that viewing paper-plans in isolation and hyperventilating is silly. What matters more is whether protagonists have a history of acting reasonably, being flexible and making things better through gradual changes that don’t endanger the system. And whether current set of proposals are in line with what’s been done over time.  

I view RBI’s actions over the years as generally consistent with these tenets. Despite contextual challenges, tinkering has made the system better. While it’s easy to criticize and not pretty to watch, RBI has salvaged nasty blow-ups in a fair manner. They’ve shown flexibility, whether in handling failures, responding to crises, or tweaking their own policies. They seem like decent people doing their best in an unenviable job for no credit and plenty of blame. I doubt if any critic can do better than the men in the arena.

RBI’s recent paper is just another step in a journey of gradual improvement. They’ve made reasonable suggestions in line with above tenets. Changes will be a small part of the system, with a proven willingness to course-correct if required. A track record of responsibly translating words into actions precludes extreme hypotheticals that can make anything look bad. RBI has more than earned the right to pursue these initiatives. Just as when credible companies propose incremental changes within their domain, I am a supportive outsider who doesn’t second-guess intent or competence.