THE BANKRUPTCY CODE CAN SET ‘NAAMDARS’ STRAIGHT

The prime minister’s recent statement blaming the crisis in the banks on naamdars, or influential people, arranging loans for industrialists by phoning a bank reminds me of an experience my former colleague Satish Jacob had. Satish went to his bank manager for an extension of his mortgage because he had retired. The manager said very firmly, “Mr Jacob you know that is not allowed under the rules.” Satish asked how the bank could bend the rules to fund corporate debts but couldn’t to help a humble retail customer. The manager replied, “You know, the telephone.” In his new book The Billionaire Raj, James Crabtree, for five years Financial Time correspondent in Mumbai, writes of the timidity of bankers ‘when faced with tycoons’ demands. He quotes the former governor of the Reserve Bank Raghuram Rajan saying , “They (the bankers) knew these guys had so much more power relative to them and more influence in the corridors of power.”

Although the Insolvency and Bankruptcy Code will hopefully draw a line under the loan mela that created the banking crisis it is important that its excesses are remembered so that the government and bankers are aware of all the tricks corporate borrowers can get up to. James Crabtree’s book will serve as a reminder. The heart of the book is the chapter called The House of Debt. It tells the story of credit flowing all too freely creating billionaires with huge holes in their balance sheets which they papered over, and financial information hidden by opaque corporate structures. Banks lent money for over-valued investments which enabled promoters to avoid investing their own money and to pocket some of the banks money. This became known as gold-plating. Then there was ever- greening – borrowing money from one bank to service a debt to another bank. Bills were inflated well beyond the real value of the goods or services supplied and the proceeds were shared between suppliers and the customer.

At the corporate level, billion dollar debts were being greened by breaking banking rules while at the grassroots bank officials were enforcing rules on customers with the customary zeal of Indian minor bureaucrats . The manager of a branch in a small Karnataka town told me he could not lend a farmer money unless the farmer got certificates from all the local branches of other banks stating that he didn’t owe them any money. The manager admitted that the farmers would have to pay for each certificate.

Why didn’t the holes in the corporates’ finances show up on their audited balance sheets? That was a question I put to a small group of chartered accountants over lunch. They pointed out that auditors can only audit the documents companies show them. One said “If a document is created through collusion to give an impression of reality it’s very difficult for the auditor to discern that”. Companies can collude with constructors over the cost of a plant they are building, there can be collusion with valuers over the value of stock, and there can be collusion with suppliers over invoices. I was told that auditors drawing up a bank’s balance sheet have to depend on the audits of individual branches or clusters of branches. They don’t supervise those audits so there can be collusion between managers and auditors at the branch level. I was reminded by one that Nirav Modi had conducted most of his business with one comparatively small branch of a bank.the accountants summed up our discussion with a judicial verdict , “an auditor can only be a watchdog not a bloodhound”. Bankers can’t be bloodhounds either. But at least now when they pick up the telephone they can warn naamdars and the promoters they represent that the new Bankruptcy and Insolvency Code means those who can’t repay may well lose their companies.