Banks need an au­ton­omy stim­u­lus

The Pak Banker - - OPINION - Ashima Goyal

AT a time when banks are in trou­ble glob­ally, re­cent re­ported losses heighten the ten­dency to put In­dian banks in the same bas­ket. But global bank shares are fall­ing be­cause of an ex­pected fall in bank earn­ings as in­ter­est rates be­come neg­a­tive. In In­dia, how­ever, in­ter­est rates are firmly pos­i­tive. In In­dia, re­ported bank prof­its are soft be­cause pro­vi­sions are be­ing made for weak as­sets. Tack­ling a prob­lem at the root bodes well for the fu­ture. U.S. banks whose bal­ance sheets were cleaned up are do­ing bet­ter than Euro­pean banks where only cos­metic liq­uid­ity was pro­vided.

More­over, the as­set qual­ity prob­lem af­fects only a part of the bank­ing sys­tem, and only a par­tic­u­lar type of loan. Non-per­form­ing as­sets (NPAs) that have stopped pro­duc­ing in­come are con­cen­trated in pub­lic sec­tor bank (PSB) loans to large cor­po­rates. There­fore the prob­lem is lim­ited in size and funds re­quired to re­store health are not ex­ces­sive.

The sharp rise in emerg­ing mar­kets' (EMs) cor­po­rate debt from 45 per cent of gross do­mes­tic prod­uct (GDP) in 2005 to 74 per cent in 2014 is a ma­jor source of global risk. It also rose in In­dia, but is only 14 per cent of GDP. Debt is con­cen­trated in large in­fra­struc­ture firms, but even so av­er­age debt-equity ra­tios re­main at around unity since they are low for other firms. Ig­nor­ing lo­cal de­tail leads to a blind echo­ing of global fears - a rel­a­tive per­spec­tive di­min­ishes In­dia's debt-re­lated risk.

Caps on ex­ter­nal debt re­duced fluc­tu­a­tions in In­dian in­ter­est rates com­pared to more open EMs. A me­chan­i­cal sell-off of EM as­sets oc­curs in pe­ri­ods of ris­ing global risk, as liq­uid port­fo­lios are sold ir­re­spec­tive of a coun­try's own prospects. But the In­dian ex­pe­ri­ence in 2008, 2011 and 2013 is that they tend to re­turn if prospects are ro­bust. In the cur­rent cy­cle there are signs that do­mes­tic in­vestors are us­ing for­eign exit to come in at a good price - a sign of ma­tur­ing mar­kets with a wider base. In­dian re­stric­tions on short-term debt have re­duced chances of large cu­mu­la­tive cy­cles oc­cur­ring as cor­po­rate bank­rupt­cies cre­ate NPAs and stressed banks stop lend­ing.

In ad­di­tion, PSBs have demon­strated the abil­ity to com­pete ef­fec­tively and earn prof­its in the past. They did un­ex­pect­edly well af­ter the 1990s re­forms, and even over­took pri­vate banks on some pa­ram­e­ters. They out­per- formed dur­ing and im­me­di­ately af­ter the global fi­nan­cial cri­sis. NPAs fell to 2.4 per cent in 2009-10 from 12.8 per cent in 1991. A sim­i­lar re­cov­ery is pos­si­ble now, even as gaps in re­forms are closed.

The prob­lems of PSBs now are partly due to govern­ment in­ter­fer­ence but also to er­rors of judg­ment and to ex­ter­nal shocks. The first two led them to par­tic­i­pate much more than pri­vate banks in in­fra­struc­ture fi­nanc­ing. They came from a his­tory of hand-hold­ing large cor­po­rates in or­der to en­cour­age de­vel­op­ment. The onus fell more on them af­ter de­vel­op­ment banks were shut. They did not fore­see the gov­er­nance and ad­min­is­tra­tive prob­lems that de­layed projects that were ex­pected to be vi­able un­der high growth. In­ter­est rate hikes, fol­low­ing the 2011 in­fla­tion peaks, also hit PSBs. A loan-based sys­tem is highly sen­si­tive to a rise in in­ter­est rates.

Mean­while, pri­vate banks con­cen­trated on more lu­cra­tive and less risky retail lend­ing. They did well in this pe­riod, and their mar­ket cap­i­tal­i­sa­tion over­took that of listed PSBs in 2011. But their di­verse strate­gies did re­duce risk for the In­dian bank­ing sec­tor as a whole.

NPAs were ex­pected to come down as the econ­omy re­vived. But ex­ter­nal shocks and do­mes­tic political log­jams con­tinue to de­lay re­cov­ery. Cap­i­tal ad­e­quacy regulation should ideally be coun­ter­cycli­cal with buf­fers built up in good times. But re­cov­ery is tak­ing too long. More­over, loan growth from PSBs is the slow­est, pos­si­bly be­cause of a larger share of stressed as­sets. There­fore it is nec­es­sary to clean up bank bal­ance sheets. The onus is on the govern­ment as the largest share­holder. The Bud­get has made a con­tri­bu­tion to­wards re­fi­nanc­ing PSBs. There is lit­tle risk for de­pos­i­tors or of sys­temic spillovers.

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