In­dia's banks need the tools to get tough

The Pak Banker - - OPINION - Dhi­raj Nay­yar

That In­dia's banks are groan­ing un­der a pile of bad loans is no se­cret. Non­per­form­ing as­sets ac­count for an es­ti­mated 11 per­cent of their to­tal loan port­fo­lio, sig­nif­i­cantly lower than reel­ing Greece's 32 per­cent but around the same level as cri­sis-prone Por­tu­gal (11 per­cent) and Spain (9 per­cent). The fact that state-owned banks ac­count for 70 per­cent of all loans in In­dia makes this the gov­ern­ment's prob­lem to solve.

To its credit, Prime Min­is­ter Naren­dra Modi's ad­min­is­tra­tion has sought to ad­dress the is­sue more than once, most re­cently with a string of an­nounce­ments last Fri­day. Yet it's con­cen­trated mostly on in­ject­ing public funds to re­cap­i­tal­ize state banks. The amounts pro­vided -- $1.1 bil­lion in the most re­cent round - - are con­strained by the gov­ern­ment's own fis­cal pres­sures, though it could al­ways sell off part of its share­hold­ings to raise more money.

The real is­sue, how­ever, isn't money -it's the ap­par­ent in­abil­ity of In­dia's banks to take decisive ac­tion against de­fault­ers. Bad loans are most of­ten writ­ten off, in­def­i­nitely re­struc­tured, or, in rare cases, con­verted to eq­uity on terms fa­vor­able to the de­faulter. The cost of de­fault­ing -- of­ten will­fully -sim­ply isn't high enough, thus cre­at­ing a sys­temic moral haz­ard.

There are two ways to at­tack this prob­lem. First, In­dia needs a mod­ern bank­ruptcy law that can break the cy­cle of con­tin­u­ous restruc­tur­ing and give com­pa­nies fac­ing tem­po­rary dif­fi­cul­ties a means of sur­viv­ing and even­tu­ally re­pay­ing their loans. Com­pa­nies that aren't vi­able must be shut down and banks should be able to con­fis­cate col­lat­eral to bal­ance their books. Un­for­tu­nately, while Modi's gov­ern­ment promised in Fe­bru­ary to craft just such a law, the on­go­ing grid­lock in the coun­try's Par­lia­ment means it's un­likely to see the light of day any­time soon.

Mean­while, banks must go af­ter de­fault­ers more strin­gently and seize their as­sets -in­clud­ing per­sonal as­sets. That's the only way to de­ter own­ers who think they can get away with run­ning shabby busi­nesses while keep­ing their jets and lav­ish Mum­bai flats, ex­ploit­ing what are ul­ti­mately tax­payer-funded bailouts.

Of course, for state-owned banks to have that free­dom, they need to be lib­er­ated from po­lit­i­cal con­trol and in­flu­ence. While Modi's gov­ern­ment has ruled out full pri­va­ti­za­tion, it's taken some welcome steps in this di­rec­tion. In one of last week's an­nounce­ments, it de­clared that it would set up an in­de­pen­dent hold­ing com­pany -- called the Bank Board Bureau -- to take over the share­hold­ing of all public-sec­tor banks. In the­ory, this com­pany would have in­cen­tive to ap­point top-class man­age­ment and to fol­low best prac­tices in the banks it con­trols.

In prac­ti­cal terms, the ex­act con­tours of the Board re­main fuzzy. If the hold­ing com­pany turns out to be an ad­junct of the gov­ern- ment, staffed by bu­reau­crats, any changes may be su­per­fi­cial.

Still, the gov­ern­ment is at least think­ing cre­atively. More thought should also be put into the role of banks in the In­dian econ­omy. A sig­nif­i­cant pro­por­tion of stressed loans come from lend­ing in the in­fra­struc­ture sec­tor. Com­mer­cial banks are a poor in­stru­ment for in­fra­struc­ture lend­ing since most of their bor­row­ing is short-term (de­posits) while lend­ing for in­fra­struc­ture is very long-term, with un­cer­tain re­turns.

The gov­ern­ment needs to de­velop al­ter­nate av­enues of fi­nanc­ing for in­fra­struc­ture. Of course, fund­ing projects di­rectly is one op­tion. But what In­dia re­ally needs is a vi­brant bond mar­ket -- some­thing it lacks be­cause a state that bor­rows and spends too much has crowded out the pri­vate sec­tor from that space. Now that the gov­ern­ment has gained some con­trol over its fis­cal deficit, it should move to lib­er­al­ize the bond mar­ket. For a start, it must hand over the task of reg­u­lat­ing gov­ern­ment se­cu­ri­ties from the cen­tral bank to the se­cu­ri­ties reg­u­la­tor, so that there's a uni­fied reg­u­la­tor for all bonds. Re­cap­i­tal­iz­ing banks is nec­es­sary. But un­less the gov­ern­ment si­mul­ta­ne­ously at­tacks the root causes of the bad-loan prob­lem, In­dia's bank­ing sys­tem will con­stantly re­quire new bailouts. The rot runs too deep for half mea­sures.

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