Indian economist Raghuram Rajan has cautioned central banks against going overboard with easing or tightening monetary policies, saying both extremes can harm the banking sector.
The former Reserve Bank of India governor said the recent implosion of American banks was rooted in aggressive interest rate hikes after years of stimulus which fed the financial sector with easy money.
Silicon Valley Bank collapsed in March after the California-based lender booked large losses on its investment in long-term bonds. This was followed by the demise of Signature Bank. This week, First Republic became the second-largest bank by assets to collapse in American history after the lender revealed a loss of more than $100 billion in deposits in the first quarter.
Rajan said the money-printing spree and the cash supplied to the financial system through quantitative easing made banks rely excessively on central banks for liquidity.
He compared lenders’ dependence on regulators for cash to “drug addiction” and said the rapid sucking of liquidity from the market to tame inflation led to turmoil in the system.
The Booth School of Business professor, who was once seen as a contender to head the Bank of England, told the Telegraph: “When you try to withdraw it (liquidity) very quickly, you find it’s like a drug addict.”
The system “seizes up” when the same levels of drugs it is used to cannot be provided, the former chief economist of the International Monetary Fund said.
“Almost always the root cause of these systemic risks is monetary policy,” he told the British newspaper, advising policymakers not to “try to do too much”.
According to him, the ongoing banking crisis has not ended yet and “we will see more bankruptcies”.
Rajan, 60, who headed the Indian banking regulator for three years till 2016, admitted to being approached to lead the Bank of England in 2020.
He said did not reply to it because he felt it was a “very political position”.
He said if he had accepted the role, questions about his nationality and his understanding of the UK could have cropped up.
“The last thing you want to introduce is another dimension of ‘this guy’s from another country,” said the outspoken economist who had correctly predicted the 2008 global economic crisis.
Rajan, who has often criticised the policies of the Indian government led by prime minister Narendra Modi, said now stays away from policymaking as “it can get ugly very quickly.”
