A flawed rescue act

A flawed rescue act
The banking regulation ordinance puts its seal of approval on corporate subsidy at the cost of public banks

The buck stops with the Reserve Bank of India (RBI)! This is the crux of the Banking Regulation (Amendment) Ordinance of May 4, 2017, which empowers the RBI to take decisions on the settlement of non-performing assets (NPAs) and a consequent cleaning up of bank balance sheets.

With this direct intervention in the decision-making domain of banks, the RBI is now rewriting the script for the Indian banking system. Surprisingly, despite the severity of the NPAs crises, the business of banking is very much in demand. The RBI recently granted bank licences to 23 applicants which included Aditya Birla Nuvo, Reliance Industries, Tech Mahindra and Vodafone M-pesa and Airtel. These corporates need to invest ₹100 crore each to gain entry into the banking sector. Ironically, the RBI has assigned public sector banks the role of lambs awaiting sacrifice at the altar of development and financial sector reform.

Banks in India are in possession of ₹6,11,607 crore worth of NPAs as of March 31, 2016. According to a recent Credit Suisse estimate, there could be a default on 16-17% of total bank loans by March 31, 2018. The current food and non-food credit stands at approximately ₹75,00,000 crore. This would translate to about ₹12 lakh crore of NPAs. This is equivalent to approximately 75% of the demonetised (₹500 and ₹1,000 notes) currency in the entire Indian economy during November-December 2016. The ordinance correctly acknowledges the unacceptably high level of stressed assets in the banking system. Indeed, banks are sitting on a huge pile of scrap.

Corporate borrowers

Most of these bad loans are the result of largesse by public sector banks to large corporate groups, given without any consideration to the principles of sound lending. Hence, the resultant inability of the banks to recover either interest or the principal sum lent.

In India, corporates rely on banks as the main source for funds. The February 2017 International Monetary Fund (IMF) report states that 65.7% of Indian corporate debt as of March 31, 2016 is funded by banks. The December 2016 Financial Stability Report states that large borrowers account for 56% of bank debt and 88% of their NPAs. A recent Credit Suisse report highlights the inability of top Indian corporates to make timely interest payments by stating that about 40% of debt lies with companies with an interest coverage ratio of less than 1. The 2017 IMF report also states that about half of the over all debt is owed by firms who are already highly indebted (debt-equity ratio more than 150%). These borrowers are simply not earning enough to meet their interest commitments.

The Reserve Bank cannot feign ignorance of or express surprise at the crises facing the banks. As stated in the August 2016 Financial Sector Assessment Program (FSAP) report: “The Reserve Bank is aware that group borrower limit in India is higher than international norms. However, it also needs to be recognized that some of the major corporate groups are key drivers of growth of the Indian economy. As the corporate bond market is not yet matured in India, bank financing is crucial for such corporate groups”.Thus, granting loans to corporates that lacked capital as well as expertise (in sectors that were once the sole preserve of the government) was obviously a decision made at the behest of the RBI and the government with little regard to the best interest of the bank. Being a corporate entity itself, the bank should have aimed at maximising the wealth of its equity shareholders and customer-depositors whose money the bank lends.

Corporate borrowers are a privileged lot whose loans are not backed by sufficient value of security. A glance at the share prices of borrower companies is a useful exercise.

How much less?

A resolution implies settling for less but the dilemma for the banker is ‘how much less’. “Haircut” is the seemingly benign term for a waiver of a part of the loan without inviting criticism of poor financial discipline! Herein lies the reason for the difficulty of closure on resolution. The ordinance puts its seal of approval on corporate subsidy at the cost of survival of public sector banks.

If the writing off of ₹36,359 crore worth of agricultural loans in Uttar Pradesh was bad economics, then the resolution of corporate NPAs is much worse. The former can still find justification as a welfare measure that benefits 21 million small farmers but there can be no justification for rewarding the top 30 corporate groups for their poor business acumen.

The 2017 Economic Survey rightly referred to NPAs as the festering twin balance sheet problem. It is eerie that while banks are being coerced into resolution and imminent insolvency, bailouts from State governments and public sector undertakings are being considered to fix corporate balance sheets. It appears to be designed to send public sector banks into autoimmune, self-destruct mode.

It was for the sake of development that the RBI encouraged banks to lend to corporates. Now, for the same reason, resolution is being thrust on banks. Ostensibly, the RBI is ensuring financial stability in the banking sector. But who are these beneficiaries of financial stability? Is it the majority equity shareholder, the government (using taxpayer money) whose worth is going to be wiped out? Is it the customer whose money is lent by the bank? Is it the elite corporate borrower who passes his losses to the banking system? Or is it the new bank waiting for the collapse, ready to acquire a readymade set of customers and good assets? Will the ghost of Lady Macbeth come to haunt the RBI and the government?