WHO KILLED OUR BANKS?
Rs 9.5 lakh crore is a lot of NPAs. And India’s public sector banks account for nearly 80% of it. How did it come to this? And what kind of systemic fixes will it take to break the endless cycle of bad debts and bailouts?
The bad loans crisis has brought to light many unresolved issues in India’s moribund public sector banking system
By 2009, a Rs 8,000 crore hole had appeared in India’s finances, courtesy beer baron Vijay Mallya’s stab at commercial aviation. Then, as Kingfisher Airlines went down in metaphorical flames, two catchphrases rose to prominence. One was ‘NPA’—a debt that remained unpaid despite repeated attempts by the lender to collect payment. The other was ‘absconding billionaire’.
In 2018, those titles made the news together once more, thanks to diamond merchant Nirav Modi. This time, not only was the NPA larger—over Rs 11,400 crore—it was ‘created’ through outright fraud. However, if even that were the worst of the current NPA crisis, it wouldn’t have been so bad. A loss of Rs 20,000 crore can break a bank, but won’t wreck a banking sector as big as India’s. NPAs are also a fact of (financial) life—every single loan cycle in history has contained a percentage of cases in which the money was never repaid. That said, the Modis and Mallyas are a bare scrape of the full problem.
According to the latest Reserve Bank of India (RBI) data, the current total of gross NPAs with listed banks is over Rs 8.5 lakh crore. With RBI reporting norms becoming ever tighter, that number is ex-
pected to rise. Financial ratings agency ICRA said the total could soon cross Rs 9.25 lakh crore, while its peer, Crisil, estimated it at Rs 9.5 lakh crore. That is more than India’s defence and infrastructure budgets combined, and close to twice Sri Lanka’s GDP. And since the 21 public sector banks (PSBs) owned by the government comprise roughly 80 per cent of the Indian banking sector, it is ultimately liable for the lion’s share of debt being dealt with.
When it comes to causes, the trials of UCO Bank offer a good starting point for the analysis. In April, the CBI registered a case against Arun Kaul, a former chairman and CEO of that bank, alleging that he aided Era Infra Engineering India chief managing director Hem Singh Bharana in defrauding UCO of over Rs 600 crore. News reports say the loans were taken with the stated intention of paying off existing debts, but were instead siphoned off for other purposes—with chartered accountants forging paperwork to disguise the scam. Kaul’s case is not unique. For instance, just 10 days before that investigation was announced, the CBI filed a case against another UCO Bank employee, former branch manager K.R. Saroja, alleging involvement in a loans fraud of
Rs 19 crore. Incidentally, UCO has a miserable track record, as highlighted by an RBI report, in recovering
NPA-related debt.
A government paper on weak PSBs noted that UCO (along with United Bank of
India and Indian Bank) were especially good at losing money, writing,
‘Even after [the] infusion of Rs 6,740 crore
[into] these three banks over the last seven years, basic weaknesses persist. Unconditional recapitalisation from the Government of India has proved to be a moral hazard, as no worthwhile attempt has been made by the banks to gain adequate good business or to reduce costs.’ That paper was written in 1999.
Even so, in 2018, recapitalisation is once again the plan. Last October, a Rs 2.1 lakh crore ‘liquidity infusion’ into banks was announced, along with suitable threats of consequences if acts were not cleaned up and warnings that this is ‘definitely the last and final time’ that the public will bail out India’s banking sector. Historically speaking, that is not credible—and, as the RBI noted in its December 2016 Financial Stability Report (FSR), ‘has justifiably initiated a debate as to whether it will be another episode of throwing good money after bad’.
This is an old debate. PSBs have, since the early 1990s, repeatedly needed bailouts, cash infusions, equity dilutions, or some other form of financial help from the state. One report estimated that between 2000 and 2015, over Rs 81,000 crore was spent on bank recapitalisation, some Rs 70,000 crore from 2010-14 alone. Last October’s announcement of Rs 2.1 lakh crore is essentially the same strategy yet again. When bailouts become a recurring feature, they possibly need to be reconsidered.
The trials of UCO Bank are common among PSBs, but the problem does not simply boil down to fraud. Another major problem comes from such banks being essentially beholden to the government of the day. PSB priorities often depend on policy requirements rather than providing efficient banking services. For instance, the government’s plans for financial inclusion—such as the Pradhan Mantri Mudra Yojana—means that PSBs have to divert staff and resources to running credit fairs. Demonetisation was another major hijacking of the HR pool of PSBs. Despite the fact that the NPA crisis was already in full bloom at the time, PSBs were forced to spend months dealing with the crowds, anger, delays and note-counting that were the practical reality of demonetisation. These priorities, thrust upon PSBs, do worsen their inefficiency.
Then, there are a host of critical oversight and specialisation issues. Loans for projects of the scale that the Central and state governments are initiating today—and which India badly needs—are not simply a matter of more zeros on a cheque. To meaningfully protect our economy against
THE TRIALS OF UCO BANK ARE COMMON AMONG PSBs, BUT IT’S NOT ALL ABOUT FRAUD; BEING TIED TO THE GOVERNMENT OF THE DAY IS A PROBLEM TOO
NPAs, public sector banks need modern credit risk assessment departments: industry experts from various fields, legal teams (the expensive kind) and chartered accountants, not to mention the will to thoroughly investigate a deal with an Ambani or a Dhoot. On that count, there are innumerable reports of failure at all levels of PSB management, from loans being issued without collateral or equity or for amounts inflated well over official project costs. An analysis by the finance ministry revealed road projects in which money was disbursed before environmental clearances had been obtained and power projects that began before firms had decided where to buy coal from or who would buy the electricity.
But none of this is news. In 2014, an RBI committee to review bank governance wrote, “[Bank] boards are disempowered, and the selection process for directors is increasingly compromised. Board governance is consequently weak. The onus of remedying this situation through radical reform lies primarily with the Union government. In the absence of such reform or if the reform is piecemeal and non-substantive, it is unlikely that there will be material improvement in the governance of these banks. The fiscal cost of inadequate reform will therefore be steep.” Though the recommendations were partially accepted—including the setting up of the Banks Board Bureau (BBB)—the situation today suggests we are still bearing said fiscal costs.
There are other reasons too for the NPA crisis. For instance, an unstable policy environment, in which laws can
even be passed with retrospective effect can be expensive. As Rajnish Kumar, chairman of State Bank of India (SBI), put it in an interview with india today, “Credit decisions are made on certain assumptions. There was an issue regarding coal mine [allocations] which were retrospectively cancelled. If somebody had invested in 1995-96 based on [those] allocations, and a bank had financed that project… should banks have said ‘coal mines are involved, so we won’t finance the project’?”
One oft-suggested solution to the problem of inefficient PSBs is privatisation. However, this idea is often a non-starter, no matter how grave the situation. For instance, the government’s chief economic advisor, Arvind Subramanian, said in April that the question of privatisation required a ‘costbenefit analysis’. “Public sector banks have invested a lot into infrastructure. We must reward them for that. We must do a cost-benefit analysis of whether what we have built using this money can offset the NPAs.” More revealingly, he continued: “But to say that we will still be able to give privatised banks a ‘direction’ won’t work. If they are private, they will work for private incentive.” (This is despite the fact that Subramanian has himself pitched for privatisation.) BBB chief Vinod Rai had a similar perspective: “Without PSBs, infrastructure wouldn’t have got the kind of support it [did]. Whether it is
A SOBERING REMINDER OF THE POWER OF COMPETITION: TODAY, HDFC BANK’S MARKET CAP IS GREATER THAN THAT OF ALL PSBs, INCLUDING SBI, COMBINED
roads, ports, airports, power or telecom, all these sectors have been majorly supported by PSBs.” Kumar says it more baldly, if less persuasively: “The socioeconomic conditions in India, as of now, are not ripe for large-scale privatisation of banks. Maybe we will reach that stage of development in [the] next 50 years, if we continue to grow at the pace at which we are growing,”
One way to look at this is the question of control. Subramanian’s statement is the closest those in power will come to stating the obvious: private banks simply cannot be controlled in the same way public banks can. “If you can’t change the risk management framework, can’t give autonomy, then the government should privatise [PSBs]. If the government is able to improve governance and give autonomy, then there is no need to privatise,” says K.C. Chakrabarty, a former RBI deputy governor.
For its part, the BBB is not entirely averse to “the government losing control of PSBs”. Rai was recently in the news for his public spat with the finance ministry over the lack of feedback from the government on the Board’s recommendations, including the ones on the appointment of PSB board members. In mid-March, he reportedly demanded to know why the government was sitting on a slew of recommendations by the BBB if the finance ministry saw the urgent need to tackle the NPA crisis. Rajiv Kumar, secretary, department of financial services, had this reply: “Not even one appointment has been made without the BBB’s consent. In fact, they
recommended the removal at IDBI, which was accepted.”
The BBB would arguably take a more professional view of bank appointments than the finance ministry—giving greater weightage to demonstrated skill over political considerations— which should have a positive effect on governance. However, the power to appoint the board members of PSBs means influence over 80 per cent of the Indian banking sector. It will not be easy, however necessary, to convince the finance ministry of the merits of the above argument.
The main argument in favour of privatisation is, to put it simply, Efficiency. One reason PSBs fare so poorly compared to their private sector counterparts is that they simply do not have to work as hard to survive. That goes as much for the banks as their employees. A sobering reminder of the power of competition is that today, service quality aside, HDFC Bank’s market capitalisation is greater than that of all public sector banks, including SBI, combined.
Truth be told, this crisis is bringing to light many buried issues in India’s moribund public sector banking system. Should PSBs be privatised? What is the role of public sector banking in 2018? Should the government reduce its stake in such banks, but retain nominal control? Should there be as
many as four banking acts regulating the sector? Is the RBI on target in highlighting political interference in public sector bank operations as a cause of concern? Initiatives like the recently minted Insolvency & Bankruptcy Code (IBC), pushing defaulters to pay up or face action, give hope that things might improve. But, this being India, there’s always at least one more layer. In this particular case, as a government official puts it, one associate cause of everything that eventually leads to an NPA is a troubling fact of life: “PSBs are a bureaucracy, not a business.”