Scare the Living Daylights
Market-led solutions, not coercion, must be the cure for our bad-debt headache
On Monday, February 20, the heads of 10 top public sector banks (PSBs), led by Arundhati Bhattacharya, chief of India’s largest lender, State Bank of India (SBI), met finance minister Arun Jaitley. The official reason for this meeting, organised by the Indian Banks’ Association, was to talk about the pile of bad debt on banks’ books, and how to lower the level of these so-called ‘non-performing assets’ (NPAs). This is, indeed, a huge, dark cloud over India’s financial system and the entire economy.
Estimates say by end-December 2016, bad loans were 12.5% of total lending in the system. To see how appalling this number is, it makes sense to compare it with the same number for China. China’s breakneck, 40-year growth race is slowing, and as it does, bad loans have grown. In May last year, China reported that these have climbed to 1.75% of total lending.
Hounds Shouldn’t Dog
Chinese authorities are worried about a less than 2% level of toxic debt. Our bankers, regulators and government have every right to be alarmed. But on Tuesday, this newspaper reported that there was another, equally scary subtext to the discussion. This was the threat of harassment of bank officers and management by income tax, enforcement, the Central Bureau of Investigation (CBI) and other sleu- ths, for loans made in the past that have subsequently soured.
This is not paranoia. In January, the CBI arrested a former chairman of IDBI Bank, Yogesh Aggarwal, and three other officers. The CBI wanted to know why they had lent .₹ 950 crore to Vijay Mallya’s now-defunct Kingfisher Airlines.
This arrest sent shock waves through banking circles. It has also led to a near-paralysis in lending for new projects. No banker now wants to stick her neck out lending to projects that look good on paper, but that could run aground in future due to some glitch that can’t be anticipated today.
Thisisahugeproblem,whichstock marketsseemtohaveblithelyignored. On the same day the bank chiefs met Jaitley, brokerage Credit Suisse published a note on banks, which pointed out the disconnect between the real health of PSBs and the froth generated around their stocks by funds that ought to know better.
It looked at a large number of sectors, represented by the 500 companies in the BSE 500 index. Credit Suisse found that over the last 12 months, PSB stocks had jumped an astonishing 76%. It is the second-fastest growing sectoral stock, just behind metals, which grew 98%, and was far ahead of the BSE 500 overall growth of 30% over 12 months.
Do these bulls know something about state-owned banks that the rest of us are missing? The folks at Credit Suisse clearly think otherwise. Their paper lists a number of things that should be apparent to any bank analyst.
One, for the last six years, the net interest margin — roughly, the gap between lending and deposit rates — has been narrowing for all banks.
This margin, essentially denoting how profitable banks are, has fallen from 2.8% in 2011 to 2.6% now. It mig- ht not look like much. But in the cutthroat world of retail banking, it’s a sharp fall, and it’s headed consistently south for six years.
Two, private banks have fared far better than state-owned ones in the same period. In these six years, their margins have actually grown from 3.1% to 3.4%. Meanwhile, state-owned banks’ margins have collapsed — from 3.2% to 2.2%.
Pop Goes the Reason
Given these numbers, I’m scratching my head trying to figure out the reasons for the bull run in state-owned bank stocks. It looks dangerously like a bubble and we know what happens when those things go pop.
In the panic after the arrest of Aggarwal and his former colleagues, lending froze up. Indeed, at 5% till December 2016, the growth of lending by banks is at a multi-decade low. It is way off its December 2004 peak of 35%plus, in the aftermath of the victory of the first UPA regime.
The real fallout of hounding banks will be on the economy as a whole. State-owned banks are India’s largest lenders to businesses of all sizes. Without their finance, most new investments and projects will grind to a halt. Remember, for every rupee investors bring in as equity, they raise .₹ 3 as loans. With loan growth crawling at 5%, and bankers in panic, growth will be hit.
Demonetisation, announced by Prime Minister Narendra Modi on the evening of November 8, has been a blow. Cash-strapped medium and small firms cannot pay back dues. Banks have been too busy collecting old notes and replacing them with new to perform their usual function of collecting deposits and lending them on.
Instead of sending sleuths to hound lenders, the government must give the latter confidence to resume their normal activity.
Liquidity must return to the system. If loans go bad, banks should invoke the new bankruptcy code, quickly seize company assets and sell these to asset reconstruction companies, which can then auction these to the highest bidder. Market-led solutions, not coercion, must be the cure for our bad-debt headache.
Clarice, why had your banker father lent so much to a business that later went bust?