Bad Loans

Why banks are not cutting interest rates

ARTS RAJAN
The Reserve Bank of India (RBI) presented its last monetary policy statement for this financial year, yesterday. It decided not to cut the repo rate which continues to be at 7.75%. The repo rate is the interest rate at which the RBI lends to banks and is expected to act as a sort of a benchmark to the interest rates at which banks carry out their business.
The RBI deciding not to cut the repo rate was largely around expected lines. I had said so clearly in my column dated January 16, 2015. The RBI had cut the repo rate by 25 basis points (one basis point is one hundredth of a percentage) a day earlier, on January 15, 2015.
There was a straightforward reason for this—the RBI had said in the statement released on January 15, that: “Key to further easing are data that confirm continuing disinflationary pressures.” Between January 15 and February 3 no new inflation data has come out. Hence, there was no way that the RBI could figure out whether the fall in inflation (or what it calls disinflation) has continued. Given this, there was no way it could cut the repo rate, unless it chose to go against its own guidance.
The more important issue here is that despite the RBI cutting the repo rate on January 15, 2015, very few banks have acted on it and passed on the rate cut to their consumers. Reuters reports that only three out of India’s 45 commecial banks have cut their base lending rates since the RBI cut the repo rate last month. The base rate is the minimum interest rate a bank is allowed to charge to its customers.
This has happened in an environment where growth in bank loans has slowed down substantially. Every week the RBI puts out data regarding the total amount of loans given out by banks. As on January 9, 2015 (the latest such data available), the total lending by scheduled commercial banks had grown by 10.7% over a one year period. For the one year period ending January 10, 2014, the total lending by banks had grown by 14.8%. This clearly shows that the bank lending has slowed down considerably over the last one year.
In this scenario theoretically it would make sense for banks to cut their interest rate so that more people borrow. As Rajan put it while addressing a press conference yesterday: “To get that lending they will have to be more competitive, which means they will have to cut base rate. I am hopeful it is a matter of time before banks judge that they should pass it on.”
But as I have often explained in the past cutting interest rates does not always lead to more people borrowing because the fall in EMIs is almost negligible in most cases.
As John Kenneth Galbraith writes in The Affluent Society: “Consumer credit is ordinarily repaid in instalments, and one of the mathematical tricks of this type of repayment is that a very large increase in interest brings a very small increase in monthly payment.” And vice versa—a large cut in interest rate decreases the monthly payment by a very small amount. So interest rate cuts do not always lead to people borrowing more.
Hence, the banks run the risk of cutting the base rate and charging their existing customers a lower rate of interest and at the same time not gaining new customers. This will be a loss-making proposition for banks and given that only 3 out of the 45 scheduled commercial banks have cut their base rates since January 15, 2015.
Banks increase their lending rates very fast when the RBI raises the repo rate. But they take time to cut their lending rates particularly in a situation where the RBI has reversed its monetary policy stance and cut the repo rate after a long time.
As Crisil Research points out in a research note released yesterday: “Lending rates show upward flexibility during monetary tightening but downward rigidity during easing. Between 2002 and 2004, while the policy rate declined by 200 basis points, lending rates dropped by just 90-100 basis points. Conversely, in 2011-12, when the policy rate rose by 170 basis points, lending rates surged 150 basis points.”
So when the RBI is increasing the repo rate, banks typically tend to match that increase, but the vice versa is not true. “Lending and deposit rates also move in tandem in times of policy rate hikes, while the gap between them widens when rates fall. Base rates of banks have been steady around 10-10.25% over the last 18 months, while deposit rates started coming down in October 2014 by about 20- 25 basis points because of ample liquidity.,” points out Crisil Research.
This is something that Rajan also talked about yesterday, when he said: “Many [banks] have been relatively quick to cut their deposit rates, but not so quick to cut their lending rates, I presume some are hoping they can get the spread for a little more time to repair banks’ balance sheets.”
When a bank cuts the interest rate it pays on its fixed deposits and at the same time does not cut its lending rate, it earns what bankers call a greater spread. This essentially means more profit for the bank.
Rajan in his statement also talks about banks repairing their balance sheets. This is particularly in r reference to the bad loans of public sector banks. As the latest financial stability report released by the RBI in December 2014 points out: “PSBs[public sector banks] continued to record the highest level of stressed advances at 12.9 per cent of their total advances in September 2014 followed by private sector banks at 4.4 per cent.” The situation hasn’t really changed since then, if the latest quarterly results of public sector banks for the period October to December 2014 are anything to go by.
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. 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.
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 10.7 is in shaky territory. For public sector banks this number is even higher at Rs 12.9.
The public sector banks are hoping to recover some of these losses by cutting their deposit rates but staying put on their lending rates. And this leads to a situation where even though the RBI has cut the repo rate once, it hasn’t had much impact on the lending rates of banks. “High non performing assets curb the pace at which benefits of lower policy rate are passed on to borrowers. Data shows periods of high NPAs – such as between 2002 and 2004 (when NPAs were at 8.8% of gross advances) – are accompanied by weaker transmission of policy rate cuts. This time around, NPA levels are not as high as witnessed back then, but still remain in the zone of discomfort,” Crisil Research points out.
In this situation, banks will cut lending rates at a much slower pace than the pace at which the RBI cuts the repo rate.

(The column originally appeared on www.equitymaster.com as a part of The Daily Reckoning, on Feb 4, 2015) 

It’s time big business stops blaming Rajan and RBI for everything

ARTS RAJAN

Vivek Kaul

When small children don’t get enough attention from their parents, they cry. And until they get attention, they keep crying.
Big business in India is a tad like that. For the last one year it has been crying itself hoarse in trying to tell the Reserve Bank of India(RBI) to cut interest rates. But the RBI led by Raghuram Rajan hasn’t obliged.
In the monetary policy statement released yesterday, the RBI decided to maintain the status quo and not cut the repo rate, as big business has been demanding for a while now. Repo rate is the interest rate at which RBI lends to banks.
The lobbies which represent the big businesses in India reacted in a now familiar way after the monetary policy. The Confederation of Indian Industries said that the economic recovery was still fragile and a decision to cut interest rates would have helped the small and medium enterprises (SME) sector, which is credit starved currently. The lobby further added that if interest rates would have been cut businesses would have borrowed more.
On the face of it this sounds like a very genuine concern. But Raghuram Rajan explained the real issue with SMEs not getting enough loans in a recent speech. The bad loans of Indian banks, in particular public sector banks, have gone up dramatically in the recent past.
As on March 31, 2013, the gross non performing assets (NPAs) or simply put the bad loans, of public sector banks, had stood at 3.63% of the total advances. Latest data from the finance ministry show that the bad loans of public sector banks as on September 30, 2014, stood at 5.32% of the total advance.
Why have bad loans gone up by such a huge amount? “The most obvious reason,” as Rajan put it was “that the system protects the large borrower and his divine right to stay in control.” Who is the large borrower? Big business.
As Rajan explained: “The firm and its many workers, as well as past bank loans, are the hostages in this game of chicken — the promoter threatens to run the enterprise into the ground unless the government, banks, and regulators make the concessions that are necessary to keep it alive. And if the enterprise regains health, the promoter retains all the upside, forgetting the help he got from the government or the banks – after all, banks should be happy they got some of their money back.”
Banks have tried to repossess assets offered as collateral against these loans in order to recover their loans, but haven’t been very successful at it. As Rajan put it in his speech: “The amount recovered from cases decided in 2013-14 under debt recovery tribunals was Rs. 30,590 crore while the outstanding value of debt sought to be recovered was a huge Rs. 2,36,600 crore. Thus recovery was only 13% of the amount at stake.”
Big businesses have been able to hire expensive lawyers and managed to stop banks from repossessing their assets. The small and medium enterprises haven’t been able to do that. Rajan said just that in his speech:“The SARFAESI [ Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest] Act of 2002 is, by the standards of most countries, very pro-creditor as it is written. This was probably an attempt by legislators to reduce the burden on debt recovery tribunals and force promoters to pay. But its full force is felt by the small entrepreneur who does not have the wherewithal to hire expensive lawyers or move the courts, even while the influential promoter once again escapes its rigour. The small entrepreneur’s assets are repossessed quickly and sold, extinguishing many a promising business that could do with a little support from bankers.”
Hence, small and medium enterprises have had to face problems because big businesses have decided to borrow and not to repay.
The CII further suggested that if RBI had cut interest rates businesses would have borrowed more. It needs to be clarified here that interest rates are not simply high because the repo rate is high at 8%. There are other reasons for it as well.
Big businesses have defaulted on such a huge quantum of loans that banks have had to charge the borrowers who are repaying a higher rate of interest. As Rajan put it in his speech “The promoter who misuses the system ensures that banks then charge a premium for business loans. The average interest rate on loans to the power sector today is 13.7% even while the policy rate is 8%. The difference, also known as the credit risk premium, of 5.7% is largely compensation banks demand for the risk of default and non-payment.”
This when the average home loan in the country is being given at 10.7%. Hence, a home loan to an individual is being given at a lower rate of interest than loans to power companies. And only big businesses defaulting on their loans are to be blamed for it.
Rana Kapoor who is the President of a business lobby called Associated Chambers of Commerce and Industry of India said: “RBI has obviously overlooked strong demand from the industry for a cut in the interest rates. The industry’s demand for lower interest rates was fully justified.”
Kapoor is the founder managing director and CEO of Yes Bank. It needs to be pointed out here that the bad loans of Yes Bank for the period of three months ending September 30, 2014, went up by 178.3% to Rs 54 crore in comparison to the same period last year.
What is surprising here is that a banker whose bad loan book has exploded is demanding a rate cut. I am sure Mr Kapoor understands how credit risk operates.
Also, business lobbies and businesses tend to totally ignore the fact that the RBI cannot do much about creating economic growth beyond a point. As economist Tim Dudley puts it: “As long as people have babies, capital depreciates, technology evolves, and tastes and preferences change, there is a powerful underlying (and under-appreciated) impetus for growth that is almost certain to reveal itself in any reasonably well-managed economy.”
The phrase to mark here is “well-managed economy” and that is largely the government’s prerogative. Rajan acknowledged this in the latest monetary policy statement. As he said towards the end of the monetary policy statement “A durable revival of investment demand continues to be held back by infrastructural constraints and lack of assured supply of key inputs, in particular coal, power, land and minerals. The success of ongoing government actions in these areas will be key to reviving growth.”
Criticising or trying to tell RBI what it should be doing, is not going to help big business much. If they have to criticise, it is the government they should be criticising. But that as we all know is not going to happen any time soon. Meanwhile, the RBI will continue to be the favourite whipping boy of big business.

The article originally appeared on www.FirstBiz.com on Dec 4, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

What Arun Jaitley can learn from Rajan’s IRMA speech

ARTS RAJANVivek Kaul

A few days back I wrote a piece questioning the logic of the State Bank of India entering into a memorandum of understanding with Adani Enterprises to consider giving it a loan of up to $1 billion. My logic was fairly straightforward—Adani Enterprises already has a lot of debt (around  Rs 72,632.37 crore as on September 30, 2014) and is just about earning enough to service that debt.
Several readers wrote in on the social media saying what was the problem if Adani was offering an adequate security against the loan? Raghuram Rajan, the governor of the Reserve Bank of India, answered this question in a speech yesterday. Rajan was speaking at the third Dr. Verghese Kurien Memorial Lecture at IRMA, Anand.
As Rajan said “The amount recovered from cases decided in 2013-14 under DRTs (debt recovery tribunals) was Rs. 30,590 crore while the outstanding value of debt sought to be recovered was a huge Rs. 2,36,600 crore. Thus recovery was only 13% of the amount at stake. Worse, even though the law indicates that cases before the DRT should be disposed off in 6 months, only about a fourth of the cases pending at the beginning of the year are disposed off during the year – suggesting a four year wait even if the tribunals focus only on old cases.”
So, just because a bank has a collateral does not mean it will be in a position to en-cash it, as soon as the borrower defaults on the loan. As big borrowers (read companies and industrialists) have defaulted on loans over the last few years, the non performing assets of banks, particularly public sector banks have gone up.
As on March 31, 2013, the gross non performing assets (NPAs) or simply put the bad loans, of public sector banks, had stood at 3.63% of the total advances. Latest data from the finance ministry show that the bad loans of public sector banks as on September 30, 2014, stood at 5.32% of the total advances. The absolute number was at Rs 2,43,043 crore. During the same period the bad loans of private sector banks was more or less constant at 1.8% of total advances. Interestingly, public sector banks accounted for over 90% of bad loans in 2013-2014 (i.e. between April 1, 2013 and March 31, 2014).
All these points have several repercussions. The first is that banks need to charge a higher rate of interest in order to compensate for the higher credit risk (or simply put the risk of the borrower defaulting on the loan) they are taking on. As Rajan said in the speech “The promoter who misuses the system ensures that banks then charge a premium for business loans. The average interest rate on loans to the power sector today is 13.7% even while the policy rate is 8%. The difference, also known as the credit risk premium, of 5.7% is largely compensation banks demand for the risk of default and non-payment.”
Simply put, those who default in effect ensure that those who repay have to pay a higher rate of interest. The irony is that banks give out home loans to individuals at 10-11%. This shows that lending to individuals is a better credit risk for them than lending to infrastructure companies.
As Rajan put it “Even comparing the rate on the power sector loan with the average rate available on the home loan of 10.7%, it is obvious that even good power sector firms are paying much more than the average household because of bank worries about whether they will recover loans.”
Also, a report in the Business Standard today suggests that the RBI is “mulling action in terms of limiting loan-sanctioning powers of banks with stressed asset ratios.”
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. 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 Business Standard report carries a list of 14 public sector banks that have a stressed asset ratio of 12% or more. Central Bank of India has the highest stressed asset ratio of 20.49%, followed by the United Bank of India at 19.7%.
If the RBI decides to limit the loan-sanctioning power of these banks, it will do so in the backdrop of the finance minister Arun Jaitley asking banks to lend more. A few days back Jaitley said “We have asked banks to go out there and lend without any fear. They should do proper appraisals of projects and provide loans to infrastructure projects.” Like in almost everything else, he was following the tradition set by his predecessor P Chidambaram.
The stressed assets of many public sector banks did not cross 12% because they did not carry out proper project appraisals. It crossed such high levels because the banks were forced to lend to crony capitalists close to the political dispensation of the day i.e. leaders of the previous United Progressive Alliance (UPA).
Take the case of GMR Infra. For the period of three months ending September 30, 2014, the company paid a total interest of Rs 845.04 crore on its debt. Its operating profit was Rs 101.14 crore. The company had a total debt of Rs 39,187.45 crore as on March 31, 2014. What this clearly tells us is that the company is not earning enough to pay the interest that it has to, on the total debt that it has managed to accumulate.
This is true about many other companies as well particularly in the infrastructure sector, which is dominated from crony capitalists. These companies borrowed much more than they should have been allowed to in the first place. Also, many promoters got away without putting much of their own money in the business.
As Rajan said “The reason so many projects are in trouble today is because they were structured up front with too little equity, sometimes borrowed by the promoter from elsewhere. And some promoters find ways to take out the equity as soon as the project gets going, so there really is no cushion when bad times hit.” This could not have happened without the tacit support of the political dispensation of the day.
And this perhaps led Rajan to quip that India is “a country where we have many sick companies but no “sick” promoters.” “In India, too many large borrowers insist on their divine right to stay in control despite their unwillingness to put in new money. The firm and its many workers, as well as past bank loans, are the hostages in this game of chicken — the promoter threatens to run the enterprise into the ground unless the government, banks, and regulators make the concessions that are necessary to keep it alive. And if the enterprise regains health, the promoter retains all the upside, forgetting the help he got from the government or the banks – after all, banks should be happy they got some of their money back!” Rajan added.
Another implication of the massive increase in bad loans for public sector banks has been that the law has become “more draconian in an attempt to force payment.” As Rajan put it “The SARFAESI (Securitization and Reconstruction of Financial Assets and Enforcement of Security Interests) Act of 2002 is, by the standards of most countries, very pro-creditor as it is written. This was probably an attempt by legislators to reduce the burden on DRTs and force promoters to pay. But its full force is felt by the small entrepreneur who does not have the wherewithal to hire expensive lawyers or move the courts, even while the influential promoter once again escapes its rigour. The small entrepreneur’s assets are repossessed quickly and sold, extinguishing many a promising business that could do with a little support from bankers.” This leads to a situation where upcoming entrepreneurs do not want to take the risk of growing bigger by taking on more loans and may choose to continue to remain small.
To conclude, Rajan’s speech at IRMA was an excellent summary of all that is wrong with the Indian banking sector. He also made suggestions on how to set it right. The promoters should not try and finance mega projects with tiny slivers of equity, he suggested. Banks needed to react quickly to borrower distress. And the government needed to set up more debt review tribunals. These are simple solutions that need political will in order to be implemented.
Arun Jaitley has been asking the RBI to cut interest rates for a while now. He has also asked banks to lend more. Nevertheless, it’s not as simple as Jaitley thinks it is. First and foremost the government needs to ensure that big borrowers cannot just get away with defaulting on loans. This in itself will have a huge impact on interest rates.
As Rajan put it “It is obvious that even good power sector firms are paying much more than the average household because of bank worries about whether they will recover loans. Reforms that lower this 300 basis point risk premium of power sector loans vis-a-vis home loans would have large beneficial effects on the cost of finance, perhaps as much or more than any monetary policy accommodation.”
This is something that Jaitley should be thinking about seriously in the days to come, if he wants banks to genuinely bring down lending rates.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

Why merger of United Bank with another bank makes no sense

unitedlogo
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 www.FirstBiz.com 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 www.firstbiz.com on February 25, 2014
 (Vivek Kaul is a writer. He tweets @kaul_vivek)