Ra­jan drops a bomb­shell; Cong in dock, flags MU­DRA, farm loan waiver risks too

Former RBI Guv tears apart UPA for way bank­ing sys­tem was man­aged

Financial Chronicle - - FRONT PAGE - FC BUREAU

Pro­fes­sor Raghu­ram Ra­jan, ex CEA and RBI gov­er­nor, in a dev­as­tat­ing cri­tique of In­dia's twin bal­ance sheet prob­lem has slammed UPA's decade long ten­ure for the bur­geon­ing non-per­form­ing as­sets. His note writ­ten at the be­hest of chair­man of the Par­lia­ment Es­ti­mates Com­mit­tee headed by Dr Murli Manohar Joshi and sub­mit­ted on Septem­ber 6, 2018 is a vir­tual tour de force, a bru­tal ex­po­si­tion of all the warts that adorn In­dia's per­ilously poised bank­ing sys­tem.

At the very out­set, former Mint Street sher­iff, whose ten­ure was not re­newed by the BJP says that – “I have not seen a study that has un­earthed the pre­cise weight of all the fac­tors re­spon­si­ble, but here is a list of the main ones (he then goes on to list the rea­sons thereof)”. To his credit, he un­der­stood the true ex­tent of the rot and called it. Of course, he may not have been pop­u­lar with In­dia Inc for giv­ing a timeline to out the bad loans, but if we now know the ex­tent of malfea­sance and con­ceal­ment and ever green­ing of loans that took place, it is cour­tesy the war on bad loans by Ra­jan.

In fact, Ra­jan dur­ing the course of his 17-page note flags an­other emer­gent risk when he ar­gues — Both MU­DRA loans as well as the Kisan Credit Card, while pop­u­lar, have to be ex­am­ined more closely for po­ten­tial credit risk. The Credit Guar­an­tee Scheme for MSME (CGTMSE) run by SIDBI is a grow­ing con­tin­gent li­a­bil­ity and needs to be ex­am­ined with ur­gency — hint­ing at MSME loans turn­ing delin­quent in the fu­ture.

It is in de­tail­ing that last point that Ra­jan has raised the red flag on cur­rent vul­ner­a­bil­i­ties. Launched in 2000 the CGTMSE, now known as UDAAN, has recorded over 25 lakh cu­mu­la­tive guar­an­tee approvals in 2016-17 with an ag­gre­gate loan amount of over Rs 1.25 lakh crore, ac­cord­ing to in­for­ma­tion on its web­site. Sug­gest­ing that the gov­ern­ment should re­frain from set­ting am­bi­tious credit tar­gets or waiv­ing loans, Ra­jan re­it­er­ated that loan waivers vi­ti­ate credit cul­ture and stress state bud­gets. Agri­cul­ture needs se­ri­ous at­ten­tion, but not through loan waivers. An all-party agree­ment to this ef­fect would be in the na­tion’s in­ter­est, espe­cially given the im­pend­ing elec­tions.

Ra­jan has ex­pounded on the rea­sons that led to a large build up of non-per­form­ing as­sets in In­dia’s bank­ing sys­tem, the reg­u­la­tor’s ac­tions and what needs to be done to pre­vent a re­cur­rence. He then goes onto tear the UPA for the way the bank­ing sys­tem was man­aged and more or less ev­ery line is an in­dict­ment -


A larger num­ber of bad loans were orig­i­nated in the pe­riod 2006-2008 when eco­nomic growth was strong, and previous in­fra­struc­ture projects such as power plants had been com­pleted on time and within bud­get. It is at such times that banks make mis­takes. They ex­trap­o­late past growth and per­for­mance to the fu­ture. So, they are will­ing to ac­cept higher lever­age in projects, and less pro­moter eq­uity. In­deed, some­times banks signed up to lend based on project re­ports by the pro­moter’s in­vest­ment bank, with­out do­ing their own due dili­gence. One pro­moter told me about how he was pur­sued then by banks wav­ing check­books, ask­ing him to name the amount he wanted. This is the his­toric phe­nom­e­non of ir­ra­tional ex­u­ber­ance, com­mon across coun­tries at such a phase in the cy­cle.

Gov­ern­ment Per­mis­sions and Foot-Drag­ging

A va­ri­ety of gov­er­nance prob­lems such as the sus­pect al­lo­ca­tion of coal mines cou­pled with the fear of in­ves­ti­ga­tion slowed down gov­ern­ment de­ci­sion mak­ing in Delhi, both in the UPA and the sub­se­quent NDA govern­ments. Project cost over­runs es­ca­lated for stalled projects and they be­came in­creas­ingly un­able to ser­vice debt. The con­tin­u­ing tra­vails of the stranded power plants, even though In­dia is short of power, sug­gests gov­ern­ment de­ci­sion mak­ing has not picked up suf­fi­cient pace to date.

Loss of Pro­moter and Banker In­ter­est

Once projects got delayed enough that the pro­moter had lit­tle eq­uity left in the project, he lost in­ter­est. Ide­ally, projects should be re­struc­tured at such times, with banks writ­ing down bank debt that is un­col­lectable, and pro­mot­ers bring­ing in more eq­uity, un­der the threat that they would oth­er­wise lose their projects. Un­for­tu­nately, un­til the Bankruptcy Code was en­acted, bankers had lit­tle abil­ity to threaten pro­mot­ers (see later), even in­com­pe­tent or un­scrupu­lous ones, with loss of their project. Writ­ing down the debt was then sim­ply a gift to pro­mot­ers, and no banker wanted to take the risk of do­ing so and invit­ing the at­ten­tion of the in­ves­tiga­tive agen­cies. Stalled projects con­tin­ued as “zom­bie” projects, nei­ther dead nor alive (“zom­bie” is a tech­ni­cal term used in the bank­ing lit­er­a­ture). It was in every­one’s in­ter­est to ex­tend the loan by mak­ing ad­di­tional loans to en­able the pro­moter to pay in­ter­est and pre­tend it was per­form­ing. The pro­moter had no need to bring in eq­uity, the banker did not have to re­struc­ture and recog­nise losses or de­clare the loan NPA and spoil his prof­itabil­ity, the gov­ern­ment had no need to in­fuse capital. In re­al­ity though, be­cause the loan was ac­tu­ally non-per­form­ing, bank prof­itabil­ity was il­lu­sory, and the size of losses on its bal­ance sheet was bal­loon­ing be­cause no in­ter­est was ac­tu­ally com­ing in. Un­less the project mirac­u­lously re­cov­ered on its own – and with only a few ex­cep­tions, no one was se­ri­ously try­ing to put it back on track – this was de­cep­tive ac­count­ing. It post­poned the day of reck­on­ing into the fu­ture, but there would be such a day.


How im­por­tant was malfea­sance and cor­rup­tion in the NPA prob­lem? Un­doubt­edly, there was some, but it is hard to tell banker ex­u­ber­ance, in­com­pe­tence, and cor­rup­tion apart. Clearly, bankers were over­con­fi­dent and prob­a­bly did too lit­tle due dili­gence for some of th­ese loans. Many did no in­de­pen­dent anal­y­sis, and placed ex­ces­sive re­liance on SBI Caps and IDBI to do the nec­es­sary due dili­gence. Such out­sourc­ing of anal­y­sis is a weak­ness in the sys­tem, and mul­ti­plies the pos­si­bil­i­ties for un­due in­flu­ence. Banker per­for­mance af­ter the ini­tial loans were made was also not up to the mark. Un­scrupu­lous pro­mot­ers who in­flated the cost of capital equip­ment through over-in­voic­ing were rarely checked. Pub­lic sec­tor bankers con­tin­ued fi­nanc­ing pro­mot­ers even while pri­vate sec­tor banks were get­ting out, sug­gest­ing their mon­i­tor­ing of pro­moter and project health was in­ad­e­quate. Too many bankers put yet more money for ad­di­tional “bal­anc­ing” equip­ment, even though the ini­tial project was heav­ily un­der­wa­ter, and the pro­moter’s in­tent sus­pect. Fi­nally, too many loans were made to well-con­nected pro­mot­ers who have a his­tory of de­fault­ing on their loans. Yet, un­less we can de­ter­mine the un­ac­counted wealth of bankers, I hes­i­tate to say a sig­nif­i­cant el­e­ment was cor­rup­tion. Rather than at­tempt­ing to hold bankers re­spon­si­ble for spe­cific loans, I think bank boards and in­ves­tiga­tive agen­cies must look for a pat­tern of bad loans that bank CEOs were re­spon­si­ble for – some banks went from healthy to crit­i­cally un­der­cap­i­tal­ized un­der the term of a sin­gle CEO. Then they must look for un­ac­counted as­sets with that CEO. Only then should there be a pre­sump­tion that there was cor­rup­tion.


The size of frauds in the pub­lic sec­tor bank­ing sys­tem have been in­creas­ing, though still small rel­a­tive to the over­all vol­ume of NPAs. Frauds are dif­fer­ent from nor­mal NPAs in that the loss is be­cause of a patently il­le­gal ac­tion, by ei­ther the bor­rower or the banker. Un­for­tu­nately, the sys­tem has been sin­gu­larly in­ef­fec­tive in bring­ing even a sin­gle high pro­file fraud­ster to book. As a re­sult, fraud is not dis­cour­aged. The in­ves­tiga­tive agen­cies blame the banks for la­bel­ing frauds much af­ter the fraud has ac­tu­ally taken place, the bankers are slow be­cause they know that once they call a trans­ac­tion a fraud, they will be sub­ject to ha­rass­ment by the in­ves­tiga­tive agen­cies, with­out sub­stan­tial progress in catch­ing the crooks. The RBI set up a fraud mon­i­tor­ing cell when I was gov­er­nor to co­or­di­nate the early re­port­ing of fraud cases to the in­ves­tiga­tive agen­cies. I also sent a list of high pro­file cases to the PMO urg­ing that we co­or­di­nate ac­tion to bring at least one or two to book. I am not aware of progress on this front. This is a mat­ter that should be ad­dressed with ur­gency.

Ra­jan has of­fered sev­eral sug­ges­tions on how such a NPA re­cur­rence can be avoided. Among them, he urged the gov­ern­ment to adopt a new ap­proach to NPA res­o­lu­tion, cau­tion­ing against old ideas such as bad banks and merg­ers - We need con­cen­trated at­ten­tion by a high-level em­pow­ered and re­spon­si­ble group set up by gov­ern­ment on clean­ing up the banks. Oth­er­wise the same non-so­lu­tions (bad bank, man­age­ment teams to take over stressed as­sets, bank merg­ers, new in­fra­struc­ture lend­ing in­sti­tu­tion) keep com­ing up and noth­ing really moves. Risk averse bankers and govern­ments that drag their feet are why projects have not yet re­vived, Ra­jan has said. He also ob­served that the bankruptcy process is be­ing tested by the large pro­mot­ers, with con­tin­u­ous and some­times friv­o­lous ap­peals. Point­ing out the ob­vi­ous, that the ju­di­cial sys­tem is not equipped to deal with ev­ery bad loan, Ra­jan said much loan rene­go­ti­a­tion should be done un­der the shadow of the bankruptcy court, not in it - Banks and pro­mot­ers have to strike deals out­side of bankruptcy, or if pro­mot­ers prove un­co­op­er­a­tive, bankers should have the abil­ity to pro­ceed with­out them.

On the as­set qual­ity re­view, process which un­earthed many of the camels and ele­phants hid­den un­der the car­pet, Ra­jan pos­tu­lates on how the bankruptcy code be­came the guil­lo­tine for pro­mot­ers who never took threats se­ri­ously till its en­act­ment. It is only af­ter its en­act­ment that pro­mot­ers saw a gen­uine threat of los­ing their busi­nesses. Equally, he wants the sanc­tity and in­tegrity of the process to re­main ro­bust for it will be tested by pro­mot­ers with friv­o­lous ap­peals Why have projects not been re­vived? Since the postAQR process took place af­ter I demit­ted of­fice, I can only com­ment on this from press re­ports. Blame prob­a­bly lies on all sides here.

a) Risk-averse bankers, see­ing the ar­rests of some of their col­leagues, are sim­ply not will­ing to take the write­downs and push a re­struc­tur­ing to con­clu­sion, with­out the process be­ing blessed by the courts or em­i­nent in­di­vid­u­als. Tak­ing ev­ery re­struc­tur­ing to an em­i­nent per­sons group or court sim­ply de­lays the process end­lessly.

b) Un­til the Bankruptcy Code was en­acted, pro­mot­ers never be­lieved they were un­der se­ri­ous threat of los­ing their firms. Even af­ter it was en­acted, some still are play­ing the process, hop­ing to re­gain con­trol though a proxy bid­der, at a much lower price. So many have not en­gaged se­ri­ously with the banks.

c) The gov­ern­ment has dragged its feet on project re­vival – the con­tin­u­ing prob­lems in the power sec­tor are just one ex­am­ple. The steps on re­form­ing gov­er­nance of pub­lic sec­tor banks, or on pro­tect­ing bank com­mer­cial de­ci­sions from sec­ond guess­ing by the in­ves­tiga­tive agen­cies, have been lim­ited and in­ef­fec­tive. Some­times even ba­sic steps such as appointing CEOs on time have been found want­ing. Fi­nally, the gov­ern­ment has not re­cap­i­talised banks with the ur­gency that the mat­ter needed (though with­out gov­er­nance re­form, re­cap­i­tal­i­sa­tion is also not like to be as use­ful).

d) The Bankruptcy Code is be­ing tested by the large pro­mot­ers, with con­tin­u­ous and some­times friv­o­lous ap­peals. It is very im­por­tant that the in­tegrity of the process be main­tained, and bankruptcy res­o­lu­tion be speedy, with­out the pro­moter in­sert­ing a bid by an as­so­ciate at the auc­tion, and ac­quir­ing the firm at a bar­gain-base­ment price. Given our con­di­tions, the pro­moter should have ev­ery chance of con­clud­ing a deal be­fore the firm goes to auc­tion, but not af­ter. Higher courts must re­sist the temp­ta­tion to in­ter­vene rou­tinely in th­ese cases, and ap­peals must be lim­ited once points of law are set­tled.

That said, the ju­di­cial process is sim­ply not equipped to han­dle ev­ery NPA through a bankruptcy process. Banks and pro­mot­ers have to strike deals out­side of bankruptcy, or if pro­mot­ers prove un­co­op­er­a­tive, bankers should have the abil­ity to pro­ceed with­out them.

Bankruptcy Court should be a fi­nal threat, and much loan rene­go­ti­a­tion should be done un­der the shadow of the Bankruptcy Court, not in it. This re­quires fix­ing the fac­tors men­tioned in (a) that make bankers risk averse and in (b) that make pro­mot­ers un­co­op­er­a­tive.

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