During the 2008 global financial crisis, Indian policy makers -from the government as well as the Reserve Bank of India -used to tom-tom how the domestic financial system escaped the carnage because of their prudent policies. Turns out it was a bluff.
Few looked through the Indian system at that point when analysts, regulators and investors were all intoxicated by 9% economic growth and they were intent on keeping it high irrespective of the global meltdown as if it was India’s birth right. In fact, the government and the RBI not only turned a Nelson’s eye to the banks’ efforts to paper over the simmering crisis, but also encouraged it. Here is how: Between 2009 and 2013, thousands of crores of loans were restructured without a thought on whether the projects involved were viable. As banks threw good money after bad, the government cheered and the regulator was just a spectator.
Fast forward to 2017. More than half the Indian banking system is technically insolvent because their stressed assets -loans ever-greened to avoid defaults and those where borrowers have defaulted -are more than the capital they own. There may be hundreds of reasons for defaults, but the truth is that depositors’ money is up in smoke. If people were to lose faith, it won’t be long before Indian banks start seeing long queues like those seen in Ireland or Greece during the crisis.
The share of stressed loans in Indian banks is estimated at 16.6% of total, while for state-run banks it stands at 20%. Eight years of kicking the can down the road led us to where we are today . To borrow Warren Buffet’s analogy Indian banks are swimming naked. To persist with the idea that recovery laws and asset reconstruction companies can solve the bad loans problem is foolish. The government alone can rescue the banks.
Bankers are largely blamed for the current mess. Executives from the RBI to bureaucrats have said that credit appraisal process at banks were wanting since they granted loans to leveraged companies with eyes shut. But the question is what was the government doing as a shareholder and why did the regulator bless loans restructuring with periodic easing of rules? It was indeed playing ball with banks till former RBI governor Raghuram Rajan put an end to it with an Asset Quality Review that exposed the true state of the Indian banking system.
After shutting the capital tap on banks, the government may say it is for bankers to put their houses in order. But they are failing as consensus is elusive in large loans because there are more than a dozen banks involved. Even if there is an agreement, it takes six months to get board approvals by which time the market dynamics change.
These agreements which have been few and far between have also come to a grinding halt, thanks to investigative agencies.The CBI arresting five IDBI BankBSE 0.31 % staff including its former chairman in the Kingfisher AirlinesBSE 3.03 % case has frozen the banking system. It is no one’s case that criminal activities and frauds at banks should go unpunished. But is the CBI distinguishing between malfeasance and poor decision-making? In IDBI’s case, the CBI seems to be making credit rating the cornerstone to seek conviction. If ratings alone determined loans, Citibank and Bank of America won’t have been on the verge of collapse in 2008.
Fear and indecision are crippling the banking system. No banker wants to price a bad loan for fear of interrogation five years into his retirement. The RBI needs to come up with a formula to price bad loans. For example, bad loan for one year will have a 20% hair-cut, and 40% for two years and so on. Once the bad loans are valued with the government’s blessings, they can be transferred to the bad bank capitalised with temporary shift of reserves from the RBI. Conservatives may argue that such a move is encroaching on central bank independence. They said it when US treasury secretary Hank Paulson came up with the $700-billion Troubled Assets Relief Programme.
If the government is averse to transfer all the stressed loans to the bad bank, it can shift a portion of it, say top 250 defaulters . Even then the benefits could be huge. On an average, about 50 companies owe `20,000 crore in debt, with 10 companies owing more than `40,000 crore each, the government data shows.
The government and the RBI have as much hand as the bankers have in this bad-loans mess. Banks and the regulator are exhausted. The government alone can save the day.