New bank capital rules pose India dilemma: Subbarao

New global capital rules for banks will come at the expense of growth in India, which poses a dilemma for a country that needs to fund $1 trillion in infrastructure and bring more people into the financial system, India's central bank governor said. 

Reserve Bank of India Governor Duvvuri Subbarao, who last week raised interest rates for the fifth time this year in order to battle surging prices, also said on Monday that inflation will determine the future course of monetary policy action. "The essence of 'Basel III' is to tighten regulation, which is to make it costly for banks to lend money. Benefit of Basel III will probably be less frequent crisis, less severe crisis," Subbarao said, referring to the new bank capital rules. 

The new rules would require global banks to more than triple the amount of top-quality capital they must hold in reserve, although banks have a long lead time to make the adjustment. Indian banks on average have Tier 1 capital ratios of around 7.5 to 8 percent, which meet the proposed Basel III requirements. "As much we make it more costly for banks to lend, there is a sacrifice in growth. The question for us: where is the balance for India? We have to fall in line with Basel III, but where do we strike the balance," he said. 

Indian bank loans were up nearly 20 percent in late August from a year earlier. "We need to further financial inclusion, at the same time, raise the cost of banking and also make sure banking meets all the growth needs that we have, and that indeed is the dilemma for the Reserve Bank and the government," he said in a speech. The RBI last Thursday extended its fight against inflation, but signalled that a tightening cycle may be nearing an end, saying that monetary policy had been brought back close to normal. 

Headline inflation in India was in double-digits in the five months through June, but has been on a downward trajectory and came in at 8.5 percent for August. Subbarao said inflation will drive monetary policy action in future. "Going forward as we have said in the September policy statement, it is going to be not so much bringing policy rates to neutral level but inflation which is going to determine our policy action," he said on the sidelines of the event. "That dimension of bringing them (policy rates) to normal level is now relegated and more more dominant concern would be inflation management," he said