Arrest warrant out, what new ruse will Subrata Roy come up with?

subroto-roy (1)Vivek Kaul 
George Orwell in his 1945 classic Animal Farm said that “all animals are equal, but some animals are more equal than others.” Sahara bossman Subrata Roy, clearly belongs to the second category.
On February 20, 2014, the Supreme Court of India had directed Roy to be present in court on February 26, 2014, to explain the failure of two Sahara group companies to refund an amount of a little over Rs 24,000 crore, raised from investors, by selling optionally fully convertible debentures (OFCDs).
Roy did not turn up in Court and
 his counsel Ram Jethmilani told the Court that “His mother is dying and he is required to be by her side holding her hand.”
To buttress their point further, the Sahara Group even attached a medical statement by doctors attending to Roy’s mother at the Sahara Hospital in Lucknow. Interestingly, along with Roy, the Court had directed Ashok Roy Choudhary, Ravi Shankar Dubey and Vandana Barghava, three directors of Sahara India Real Estate Corporation Limited (SIRECL) and Sahara Housing Investment Corporation Limited (SHICL) to be present on February 26, 2014. SIRECL and SHICL are the two companies that had issued the OFCDs.
Only Roy did not turn up citing his mother’s illness. The other three did. This did not go down well with the Court.  “The arm of this court is very long. We will issue warrants. This is the Supreme Court of the land. When other directors are here, why cannot he be here?
” asked Justice KS Radhakrishnan.
After this, the Court issued non bailable arrest warrant against Roy and directed that he be arrested and produced before it, on March 4, 2014.
The Sahara group has been testing the patience of the Supreme Court for a while now and on Wednesday (i.e. February 26, 2014), the apex court in the country simply ran out of it.
Sahara is a finance to reality conglomerate with huge para-banking operations in the states of Uttar Pradesh and Bihar. In July 2008, the Reserve Bank of India ordered the group to shut-down its para-banking operations. This, after it found several discrepancies in the books of Sahara. Sahara used to run the para-banking operations through the Sahara India Financial Corporation. The group raised a large amount of money from people who did not have bank accounts. It even collected small amounts on a daily basis.
The deposits funded the many businesses (like media, films, real estate, hospitals, hotels and even airlines) that the group was into. The Reserve Bank hit at the heart of Sahara’s business model by prohibiting it from running a para-banking operation. The central bank banned Sahara from raising fresh deposits beyond June 30, 2011 and at the same time asked Sahara to repay all its depositors by June 30, 2015.
It is easy to see that most of the businesses that Sahara was into were highly capital intensive. Hence, it was important for the group to keep raising deposits. But with the RBI clamping down on its para-banking operations that was not possible.
To get around the RBI directive, the Sahara group started issuing housing bonds through SIRECL and SHICL. These bonds were technically referred to as OFCDs. The Sahara group noted that these bonds were being issued to “friends, associates, group companies, workers/ employees and other individuals associated/affiliated or connected in any manner with Sahara India Group of Companies.”
Given this, the group felt that the issuance did not amount to a public issue, and did not require compliance either with the Companies Act, 1956, or the Securities and Exchange Board of India(Sebi) Act.
As per Section 67 of the Companies Act, 1956, an offer of shares or debentures made to 50 persons or more is construed to be a public offer. It is estimated that the Sahara group sold the housing bonds or OFCDs to around 2.96 crore investors and raised over Rs 24,000 crore.
Given this discrepancy, KM Abraham, who was a whole-time member of Sebi, issued an order dated June 23, 2011, 
in which he asked Sahara to “refund the money collected by the aforesaid companies[i.e. SIRECL and SHCL]…to the subscribers of such Optionally Fully Convertible Debentures with interest of 15% per annum from the date of receipt of money till the date of such repayment.”
In this order Abraham also pointed out that “The first proviso to section 67(3) inserted by the Companies (Amendment) Act, 2000 with effect from 13.12.2000 sets at rest the question by stating that if an invitation to subscription is made to 50 or more persons, it ceases to be a private.”
Hence, the OFCDs sold by Sahara constituted a public offer and given that needed to be listed on a stock exchange, which they were not. As Section 73 of the Companies Act points out “Every company intending to offer shares or debentures to the public for subscription by the issue of a prospectus shall, before such issue, make an application to one or more recognised stock exchange for permission for the shares or debentures intending to be so offered to be dealt with in the stock exchange.” The OFCDs of Sahara were not listed on any stock exchange.
Sahara challenged the Sebi order in court. This started a series of events which finally led to the Supreme Court judgement as on August 31, 2012. In this judgement, the Court directed the Sahara group to refund Rs 24,029 crore that it raised through OFCDs to the investors by the end of November 2012. The order had directed that Sahara to pay this amount to Sebi,which would in turn refund the money to the investors.
The group was given more time to refund and directed to deposit Rs 5,120 crore immediately. Rs 10,000 crore was to be deposited with Sebi in January 2013 and the remaining amount in February 2013. The Sahara group handed over draft of Rs 5,120 crore on December 5, 2012, and hasn’t paid anything since then.
In fact, it has since maintained that it has already returned the money to investors and paying money to Sebi would amount to paying twice. 
As a November 2013 report in the Business Standard puts it “Its(i.e. Sahara’s) top lawyers have argued that it was not the intention of the court to pay investors twice and that the regulator has to first check several truckloads of documents pertaining to the millions of investors before coming to ask for the balance.”
But there are some basic loopholes in the argument. If Sahara was in the process of repaying its investors, why was fighting a case with Sebi in the Supreme Court?
The group claims that it refunded Rs 16,177 crore to investors in May and June 2012. 
This led to Justice Kehar, one of the judges on the bench hearing this case, to wonder “The whole of May and June, they were fighting before us. Why would they do that if they were already refunding?”
In January 2014, the Supreme Court had directed the Sahara group to file bank statements and documents to prove that it had refunded the money to its investors in 2012. 
A Business Standard report dated February 14, 2014, quotes Arvind Dattar, the Sebi counsel as saying “They have filed five volumes of documents. These contain everything except what we want.”
Datar also asked that how could Sahara return money that it had collected over a period of three years in just two months. The money Sahara has repaid to the investors who had bought OFCDs has come through transactions within the group. 
The group has told the Supreme Court that Sahara India Cooperative Credit Society and Sahara Q Shop bought real estate assets worth thousands of crores from SIRECL and SHICL, the two companies that issued OFCDs, to bail them out. This money was then used to repay the investors.
The question is where did Sahara India Cooperative Credit Society and Sahara Q Shop get the money from? The Sahara Group told the apex court that the money to buy these assets was raised from numerous investors through its big branch network of 4,700 branches.
The money from this transaction was used to repay the OFCD investors in cash. The group explained that it put in place the cash policy after hundreds of cases of “snatching, robberies, injuries and even death faced by its workers while carrying money between branches and banks.” But wouldn’t that still be applicable, if it repaid its investors in cash? Wouldn’t its agents have to carry cash around to repay it’s investors?
In a statement issued earlier this month the Sahara group claimed that almost 98% of its investors had put in amounts ranging from Rs 500 to Rs 19,000 into the OFCDs. The average investment was around Rs 8,000. The group further said that these people do not go to banks and wanted their money back in cash.
The Supreme Court in a hearing this month asked if payments of such huge amounts of cash was legally allowed. The Sebi counsel Datar explained that “Under Section 73 of the Companies Act, refund has to be made only by cheque. Even the Sebi ICDR (Issue of Capital and Disclosure requirements) regulations mandate that payments have to be made through banking channels only.”
To conclude, basically, Sahara and its lawyers have been playing the delaying game and keep coming up with a new theory every time there is a hearing. It will be interesting to see what new theory they come up with on March 4, 2014, when Subrata Roy will have to appear in court.
We haven’t seen the last of this case. Watch this space.

The article originally appeared on on February 27, 2014
 (Vivek Kaul is a writer. He tweets @kaul_vivek) 

Fasten your seatbelts: Not only United Bank, a major part of banking is in trouble

 indian rupeesVivek Kaul 
In an editorial today (i.e. February 26, 2014), on the troubled United Bank of India, The Financial Express asks “Wasn’t anybody watching?”. “It is amazing that things could have been allowed to come to such a pass without action being taken to stop it,” the pink-paper points out.
In fact, The Financial Express should have been asking this question about the Indian banking sector as a whole, and not just the United Bank in particular. As of September 30, 2013, the stressed asset ratio of the Indian banking system as a whole stood at 10.2% of its total assets.
This is the highest since the financial year 2003-2004 (i.e. the period between April 1, 2003 and March 31, 2004) point out
Tushar Poddar and Vishal Vaibhaw of Goldman Sachs in a recent report titled India: No ‘banking’ on growth.
Interestingly, the public sector banks are in a worse situation that their private sector counterparts. As the latest
RBI Financial Stability Report points out “Among the bank-groups, the public sector banks continue to have distinctly higher stressed advances at 12.3 per cent of total advances, of which restructured standard advances were around 7.4 per cent.”
The stressed asset ratio is the sum of gross non performing assets plus restructured loans divided by the total assets held by the Indian banking system. What this means in simple English is that for every Rs 100 given by Indian banks as a loan(a loan is an asset for a bank) nearly Rs 10.2 is in shaky territory. The borrower has either stopped to repay this loan or the loan has been restructured, where the borrower has been allowed easier terms to repay the loan (which also entails some loss for the bank) by increasing the tenure of the loan or lowering the interest rate.
The restructuring of a loan happens through the Corporate Debt Restructuring(CDR) cell. The Goldman Sachs analysts point out in their report that
85% of restructured loans were restructured during the last two years (i.e. financial year 2011-2012 and 2012-2013).
What makes the situation even more precarious is the fact that the stressed loans could keep increasing. Goldman Sachs projects that among the banks its research team covers stressed loans could go up by as much as 25% in 2013-2014 (i.e. the period between April 1, 2013 and March 31, 2014). Also, some of the troubled loans have still not been restructured or classified as bad loans by banks. Hence, the situation is worse than what the numbers tell us.
As Akash Prakash of Amansa Capital wrote
in a recent column in the Business Standard “Most investors believe that many of the problem assets are yet to be recognised by the system. These banks continue to increase their exposure to the problem areas of power and infrastructure.”
Five sectors, namely, Infrastructure, Iron & Steel, Textiles, Aviation and Mining, have the highest level of stressed advances. “At system level, these five sectors together contribute around 24 percent of total advances of SCBs [scheduled commercial banks], and account for around 51 per 
cent of their total stressed advances…The share of above mentioned five sectors in the loans portfolio of Public Sector Banks,” the RBI Financial Stability Report points out. Hence, the public sector banks are in greater trouble than their private counterparts.
Of the five sectors the infrastructure sector has contributed around 30% of the total stressed assets even though its share of total loans is only about 15%.
The banks have also not been provisioning enough money against stressed loans. “Moreover, provisions for stressed assets are still low, and the lowest in the region. For public-sector banks under its coverage, our Financials Research team assesses the provision coverage ratio for stressed loans at only 24%,” write Poddar and Vaibhav.
What this means is that the banks are not setting aside enough money to deal with prospect of a greater amount of their stressed loans being defaulted on by borrowers and turning into bad loans. And to that extent, banks have been over-declaring profits. That wouldn’t have been the case if they had not been under-provisioning.
Despite the under-provisioning the capital adequacy ratio of banks has fallen dramatically in the recent past. “The Capital to Risk Weighted Assets Ratio (CRAR) at system level declined to 12.7 per cent as at end September 2013 from 13.8 per cent in as at end March 2013…At bank-group level, PSBs recorded the lowest CRAR at 11.2 per cent,” the RBI Financial Stability Report points out. In fact, since September 30, the capital adequacy ratio of the entire banking system would have fallen even more, given that bad loans have gone up. The capital adequacy ratio of a bank is the total capital of the bank divided by its risk weighted assets.
In the days to come, the banks, particularly public sector banks (given their falling capital adequacy ratio), will have to raise more capital to have a greater buffer against the mounting bad loans. The RBI estimated in late 2012 that banks need to raise around $26-28 billion (or around Rs 1,61,200 crore – Rs 1,73, 600 crore, if one dollar equals Rs 62) by 2018.
This is a huge amount. “The capital raising requirement could increase to US$43bn [Rs 2,66,600 crore] under a stress scenario where gross NPLs[non performing loans] and restructured assets rise to 15% of loans, the previous historical high,” estimates Goldman Sachs.
So where is this money going to come from? For the financial year 2014-2015 (i.e. the period between April 1, 2014 and March 31, 2015). the finance minister P Chidambaram has set aside only Rs 11,200 crore for capital infusion into public sector banks. This is simply not enough.
So should government pump in more money into the banks? It simply doesn’t have the capacity to do so. As Akash Prakash writes “There is no way the government can fund this; there is simply no fiscal capacity. Nor do investors want to stand in front of this freight train, since the capital needs for most banks are greater than their current market capitalisation.”
Let’s take the case of the United Bank of India. The current market capitalisation of the bank is around Rs 1442 crore(assuming a share price of Rs 26). The government has decided to pump in Rs 800 crore into the bank. Given that, the market capitalisation of the bank is around Rs 1442 crore, which private investor would have been ready to pump in Rs 800 crore? Also, when the State Bank of India tried to sell shares worth Rs 9,600 crore to institutional investors recently, it failed to raise the targeted amount and had to be rescued with the Life Insurance Corporation pitching in and picking up its shares.
If the biggest public sector bank in the country, which accounts for nearly 20% of Indian banking, is unable to sell its shares completely, what is the chance for other public sector banks being able to do so?
Given these reasons, Indian banking is in for a tough time ahead. Fasten your seatbelts. 
The article originally appeared on on February 26, 2014. 
(Vivek Kaul is a writer. He tweets @kaul_vivek) 

Why merger of United Bank with another bank makes no sense

Vivek Kaul
Nothing works like the formula. And the formula to rescue a bank which is in trouble is to merge it with another bank. Reports in the media seem to suggest that there might be plans to merge the troubled United Bank of India with the Union Bank of India.
In fact, on February 24, 2014, the share price of United Bank jumped by 13.75% on this possibility, in the early morning trade. It finally closed the day 6% higher at Rs 25.8 , from its closing price on February 21, 2014.
As has been reported before, the United Bank of India is in major trouble. For the period of three months ending December 2013, the bank reported a loss of Rs 1,238 crore. This, after it had provided Rs 1,858 crore against bad loans.
During the period, the bank’s gross non performing assets (NPA) increased by a whopping 36% to Rs 8,545.5 crore. This amounted to nearly 10.8% of the total loans given out by the bank. In fact, in December the Reserve Bank of India(RBI) had asked United Bank not to give a loan of greater than Rs 10 crore to any single borrower.
A recent report in the Mint newspaper points out that the bank has issued an internal directive not to make any fresh loans, unless they are backed by the mortgage of fixed deposits.
In this scenario it is not surprising that there is speculation of the bank being merged with the Union Bank of India. Having said that, the United Bank has denied any such possibilities.
But given the past record of the government merging a bank in trouble with another bank, the merger of the United Bank with the Union Bank(or any other public sector bank) is a possibility that remains. The troubled Global Trust Bank was merged with the state run Oriental Bank of Commerce in 2004. In 2002, the Benares State Bank was merged with the Bank of Baroda. Before this, in 1988, the Hindustan Commercial Bank was merged with the Punjab National Bank. The Punjab National Bank also came to the rescue of Nedungadi Bank in 2003.
So there is a clear trend of a failing bank being merged with an existing bank. In the examples given above, all the failing banks were private sector banks and they were taken over by public sector banks. The United Bank of India is a public sector bank in which the government has a stake of 88%.
This makes it even more likely that the government will try and do everything to save the bank. The total assets of the United Bank as on March 31, 2013, amounted to Rs 1,14,615 crore. The Union Bank is around 2.7 times bigger and has total assets of Rs 3,12,912 crore.
If the banks had been merged on March 31, 2013, the total assets of the new bank would amount to around Rs 4,27,527 crore. The assets of the United Bank would form around 26.8% of the merged entity. Given this, the erstwhile United Bank would form a significant part of the merged entity.
Hence, with nearly 10.8% of its total loans being classified as gross non performing assets, it is possible that the bad loans of United Bank may dramatically pull down the performance of the merged entity.
Let’s take the case of Oriental Bank of Commerce. In August 2004, the Global Trust Bank, which had run into trouble due to bad lending, was merged with the Oriental Bank of Commerce. For the year ending March 31, 2004, the Oriental Bank of Commerce had reported a profit of Rs 686 crore.
The merger destablized Oriental Bank of Commerce and the net profit fell to Rs 557 crore for the year ending March 31, 2006 and took a few years to recover.
A similar thing will happen with the Union Bank of India, if the United Bank is merged into it. Also, it is worth pointing out that most public sector banks are already in trouble, given the mounting amount of bad loans on their books.
As the latest RBI Financial Stability Report points out “Among the bank-groups, the public sector banks continue to have distinctly higher stressed advances at 12.3 per cent of total advances, of which restructured standard advances were around 7.4 per cent.”
So, merging United Bank with Union Bank or any other public sector bank for that matter means destablizing the Union Bank as well and in the process creating more trouble for the entire banking sector.
It will also bring to the fore the issue of “moral hazard”. Before we get into discussing this, it is important to understand what moral hazard means. As Alan S Blinder writes in
After the Music Stopped “The central idea behind moral hazard is that people who are well insured against some risk are less likely to take pains ( and incur costs) to avoid it. Here are some common non financial examples: …people who are well insured against fire may not install expensive sprinkler systems; people driving cars with more safety devices may drive less carefully.”
Given this, insurance companies must take into account the fact that insurance may induce people to take on more risk. “In financial applications, moral hazard concerns arise whenever some third party—often the government—intervenes to insure against or lessen the consequences of, the risk of loss,” writes Blinder.
In fact, the American economy is a great example of all that can go wrong because of moral hazard. Since the 1980s, scores of financial institutions in trouble have been rescued by the government. The signal this sends out to the participants in the financial system is that they can take on more and more risk, and if something does not work out well, the government will come to their rescue.
This is precisely what happened in the United States, where banks took on more and more risk, confident of the fact that if something went wrong, the American government would come to the rescue.
If the United Bank is merged with the Union Bank (or any other public sector bank), this is the signal that will be sent out. Hence, it is important the United Bank not be rescued by the government.
This does not mean that the bank should be allowed to fail. The government needs to protect the depositors of the bank.
As has been suggested before here the government should look to sell the bank to any private businessman for Re 1, who can then run it. Also, India currently has 21 public sector banks, and one less public sector bank will really not make much of a difference to the overall financial system.
The article originally appeared on on February 25, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek) 

Crony capitalism: The truth about Indian banking is finally coming out

indian rupeesVivek Kaul  
One of the well kept secrets about the fragile state of the Indian economy is gradually coming out in the open. The Indian banks are not in great shape. The Financial Express reports that the chances of a lot of restructured loans never being repaid has gone up. It quotes R K Bansal, chairman of the corporate debt restructuring (CDR) cell, as saying that the rate of slippages could go up to 15% from the current levels of 10%. “The slower-than-expected economic recovery and delayed clearances for projects will result in a higher share of failed restructuring cases,” Bansal told the newspaper.
When a big borrower (usually a company) fails to repay a bank loan, the loan is not immediately declared to be a bad loan. The CDR cell is a facility available for banks to try and rescue the loan. Loans are usually restructured by extending the repayment period of the loan. This is done under the assumption that even though the borrower may not be in a position to repay the loan currently due to cash flow issues, chances are that in the future he may be in a better position to repay the loan. Or as John Maynard Keynes once famously said “
If you owe your banka hundred pounds, you have a problem. But if you owe a million, it has.” 
As of December 2013, the CDR cell had restructured loans of around Rs 2.9 lakh crore. Of this nearly 10% of the loans have turned into bad loans with promoters not paying up. Bansal expects this number to go up to 15%. Interestingly, a Reserve Bank of India (RBI) working group estimates that nearly 25-30% of the restructured loans may ultimately turn out to be bad loans.
And that is clearly a worrying sign. There is more data that backs this up.
 In the financial stability report released in December 2013, the RBI estimated that the average stressed asset ratio of the Indian banking system stood at 10.2% of the total assets of Indian banks as of September 2013. It stood at 9.2% of total assets at the end of March 2013.
The average stressed asset ratio is essentially the sum of gross non performing assets plus restructured loans divided by the total assets held by the Indian banking system. What this means in simple English is that for every Rs 100 given by Indian banks as a loan(a loan is an asset for a bank) nearly Rs 10.2 is in shaky territory. The borrower has either stopped to repay this loan or the loan has been restructured, where the borrower has been allowed easier terms to repay the loan (which also entails some loss for the bank).
The RBI financial stability report points out that this has happened because of bad credit appraisal by the banks during the boom period. “It is possible that boom period[2005-2008] credit disbursal was associated with less stringent credit appraisal, amongst various other factors that affected credit quality,” the report points out. Hence, borrowers who shouldn’t have got loans in the first place, also got loans, simply because the economy was booming, and bankers giving out loans felt that their loans would be repaid. But that hasn’t turned out to be the case.
Interestingly, Uday Kotak, Managing Director of Kotak Mahindra Bank recently told CNBC TV 18 that the current stressed, restructured or non performing loans amounted to nearly 25% of the Indian banking assets. He put the total number at Rs 10 lakh crore of the total loans of Rs 40 lakh crore given by the Indian banking system. This is a huge number.
Kotak further said that the Indian banking system may have to write off loans worth Rs 3.5-4 lakh crore over the next few years. When one takes into account the fact that the total networth of the Indian banking system is around Rs 8 lakh crore, one realizes that the situation is really precarious.
Interestingly, a few business sectors amount for a major portion of these troubled loans. As the RBI report on financial stability points out “There are five sectors, namely, Infrastructure, Iron & Steel, Textiles, Aviation and Mining which have high level of stressed advances. At system level, these five sectors together contribute around 24 percent of total advances of SCBs (scheduled commercial banks), and account for around 51 per cent of their total stressed advances.”
So, five sectors amount to nearly half of the troubled loans. If one looks at these sectors carefully, it doesn’t take much time to realize these are all sectors in which crony capitalism is rampant (the only exception probably being textiles).
Take the case of L Rajagopal of the Congress party (who recently used the pepper spray in the Parliament). He is the chairman and the founder of the Lanco group, which is into infrastructure and power sectors. As Shekhar Gupta
 pointed out in a recent article in The Indian Express, Rajagopal’s “company got a Rs 9,000 crore reprieve in a CDR (corporate debt restructuring) process just the other day. His bankrupt companies were given further loans of Rs 3,500 crore against an equity of just Rs 239 crore. Twenty-seven banks were involved in that bailout.”
Here is a company which hasn’t repaid loans of Rs 9,000 crore. It benefits from the restructuring of those loans and is then given further loans worth Rs 3,500 crore. So, if the Indian banking sector is in a mess, it is not surprising at all.
As bad loans mount, banks will go slow on giving out newer loans. They are also likely to charge higher rates of interest from those borrowers who are repaying the loans. This is not an ideal scenario for an economy which needs to grow at a very fast rate in order to pull out more and more of its people from poverty. If India has to go back to 8-9% rate of economic growth, its banks need to be in a situation where they should be able to continue to lend against good collateral.
So is there a way out of this mess? A suggestion on this front has come from Saurabh Mukherjea from Ambit. He suggests that the bad assets be taken off from the balance sheets of banks and these assets be moved to create a “bad bank”. This would allow the good banks to operate properly, without worrying about the bad loans on its books. As he writes “This would, in effect, nationalise the bad assets of the Indian banks and the taxpayer would have to bear the burden of these sub-standard loans.”
The government had followed this strategy to rescue Unit Trust of India (UTI). All the bad assets were moved to SUUTI (Specified Undertaking of the Unit Trust of India). The good assets were moved to the UTI Mutual Fund, which has flourished over the years. The government also has gained in the process.
The trouble here is that even if the government does this, there is no guarantee that it might be successful in reining in the crony capitalists. Over the last 10 years crony capitalists like Rajagopal, who are close to the Congress party, have benefited out of the Indian banking system. Given this, it is but natural to assume that after May 2014, the crony capitalists close to the next government (which in all likeliness will be led by Narendra Modi) will takeover. And that is the real problem of the Indian banking sector, for which there can be no solution other than a political will to clean up the system.
The article originally appeared on on February 25, 2014

 (Vivek Kaul is a writer. He tweets @kaul_vivek)