Irrational exuberance before Lehman collapse responsible for bad loan woes
NEW DELHI/MUMBAI: The Indian banking system may have escaped relatively unscathed from the Lehman Brothers collapse in 2008 but the ‘irrational exuberance’ shown by bankers in aggressively lending to big projects in the boom period has caught up with the economy—it’s the origin of the current massive ₹10 trillion stockpile of bad debt.
The Lehman collapse impacted the repayment capacity of Indian corporates as well as Indian banks who had been lending indiscriminately to firms starting 2006 and were now staring at a huge pile of stressed loans. At the same time, the increasing integration with the global economy meant India could not escape the slowdown in global growth despite a loose money policy followed by the central bank and a fiscal stimulus package rolled out by the government. The government’s aggressive push to infrastructure coupled with a rapidly growing economy saw Indian banks lend aggressively to firms without adequate due diligence.
In the five years from 2006 to 2011, credit growth was in excess of 20% year on year, data collated by the Reserve Bank of India (RBI) shows. Also, credit growth to industry was consistently higher than the overall credit growth till 2013-14 before slowing down. Lending by bankers to corporates despite high levels of leverage is what is US Federal Reserve chairman Alan Greenspan called “irrational exubermarch ance” in the 1990s.
All this added to the stressed assets reported by Indian banks though regulatory forebearance enabled these banks to classify these accounts as ‘restructured accounts’ and delay their classification as ‘non-performing loans’, thus enabling banks to set aside less funds as provisioning.
A few years down the line, these accounts turned non-performing as large infrastructure projects failed to take off due to delays and lack of permission, and promoters failed to service the debt. A shadow over the allocation of coal mines, coupled with a slowdown in decisionmaking for fear of a probe by investigative agencies, worsened the climate.
Arundhati Bhattacharya, former chairperson of the country’s largest state-owned lender State Bank of India admits that banks should have followed tighter underwriting standards and anticipated crony capitalism.
“A lot of emphasis was given by the government on funding infrastructure and core sector. Because the banks had liquidity and things were going well, the standards of underwriting which should have been much tighter and should have anticipated many scenarios that subsequently played out were not followed,” she said.
She added that banks did not anticipate many potential scenarios. “The scenario that gross domestic product would halve was not anticipated and neither was the scenario that certain approvals would take very long. The scenario that the approvals given will be cancelled by judiciary was not anticipated.”
Indian banks are still dealing with huge level of NPAS. Gross NPAS in the banking system were at 11.6% of gross advances as of end March 2018. Taking into account the restructured standard advances, stressed assets in the Indian banking system were at 12.5% as of March 31, the highest in the 10 years since Lehman. The gross NPA ratio for the industry sector is understandably higher. It was at 22.8% as of 2018, as against 19.4% as of March 2017. The stressed assets ratio was at 24.8% as against 23.9% in the year earlier. RBI expects the gross NPAS for the banking system to further worsen to 12.2% by March 2019.
Karthik Srinivasan, Senior vice president at ICRA Ltd said a large part of the current asset quality problem can be linked to the period of euphoria when banks lent money for various infrastructure projects that subsequently got into stress for a variety of reasons. “The country needed huge investments around that time to improve the infrastructure and being a bankdriven economy, a large part of the same was funded by banks, especially the public-sector ones. The leverage levels for the PSBS had increased sharply to over 2 times for many of them,” he said.
But banks also chose to delay the recognition of the problem rather than addressing it head on. In a note to Parliament’s estimates committee, former RBI governor Raghuram Rajan pointed out : “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 recognize 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 were ballooning because no interest was actually coming in.”