An internal working group (IWG) of the Reserve Bank of India (RBI) has suggested that large corporate/industrial houses may be allowed to promote banks. Does this huge leap of faith being made by the Indian central bank, given their current extremely cautious and conservative approach, make sense? Let’s try and understand.
Why should large corporates be allowed into banking?
The IWG feels that allowing large corporates to promote banks can be an important source of capital. In a capital starved country like India this makes sense. Further, these corporates can bring “experience, management expertise, and strategic direction to banking”.
The group also noted that internationally “there are very few jurisdictions which explicitly disallow large corporate houses”. All these reasons make sense, but there are major reasons as to why the RBI in the last five decades hasn’t let large corporates enter the banking sector in India. At the heart of all this is the conflict of interest it would create.
Why have large corporates not been allowed into banking?
The IWG spoke to experts on the issue: “All the experts except one [said] that large corporate/industrial houses should not be allowed to promote a bank.” The corporate governance in Indian companies isn’t up to international standards and “it will be difficult to ring fence the non-financial activities of the promoters.”
There will be a risk of promoters giving loans to themselves. Before bank nationalisation in 1969, some of the private banks were owned by large corporates. As Professor Amol Agrawal of Ahmedabad University puts it: “Since the private banks were run by big industrialists, they gave loans to themselves.”
What does history have to say in this regard?
As Pai Panandikar, an Advisor in the Finance Ministry, wrote in August 1967, regarding these banks : “Internal procedures… vest large discretionary powers in the Boards of Directors who have often acted as sources of patronage in deciding credit matters.”
A survey showed that 188 individuals served as directors on boards of 20 leading banks and held 1452 directorships of other companies. These individuals had directorships in 1100 companies.
What did these large discretionary powers lead to?
In an October 1967 report commissioned by politician Chandrashekhar, then the Secretary of the Congress Party, it was found that of the total bank loans of Rs 2,432 crore in 1966, Rs 292 crores was the debt due from the bank directors and their companies.
In fact, if indirect loans and advances were included, the actual debt-linked to directors was Rs 600-700 crore. There is a danger of something similar happening even now given the weak corporate governance structures.
*As of March 31, 2018. Source: Rajya Sabha Unstarred Question No: 1492, Answered on 18 July 2018.
What does this mean in the current scheme of things?
As of March 2018, the domestic bad loans of Indian banks peaked at Rs 9.62 lakh crore. Of this, around 73.2% or Rs 7.04 lakh crore, were defaults made by industry.
The corporates have been responsible for a bulk of the mess in the Indian banking sector. Given that, handing over banking licenses to them is not a sensible idea, especially when the ability of banks to recover bad loans is limited.
As of March 31, 2020, the total bad loans of public sector banks stood at Rs 6,78,318 crore. This is a drop of 24.3% from a peak of Rs 8,95,600 crore as of March 2018. Bad loans are largely loans which haven’t been repaid for a period of 90 days or more.
So how did bad loans of public sector banks come down by nearly a fourth? First and foremost, as of March 31, 2018, IDBI Bank, the worst performing bank when it comes to bad loans, was a public sector bank. From January 21, 2019, the bank was categorised to be a private bank. Accordingly, its bad loans moved to the overall bad loans of private banks. But we need to remember IDBI Bank is owned by the Life Insurance Corporation of India, that makes it as close to being a private bank, as Indian Chinese food is close to the real Chinese food.
As of March 31, 2020, the overall bad loans of IDBI Bank were Rs 47,272 crore. If we add this to the bad loans of public sector banks, the real bad loans of public sector banks work out to Rs 7,25,590 crore (Rs 6,78,318 crore + Rs 47,272 crore). This means that the real fall in bad loans of public sector banks in the two-year period has been around 19% and not 24.3%, as we originally calculated.
So, bad loans worth Rs 47,272 crore came down, simply because IDBI Bank got recategorised as a private bank.
Let’s move to the next point. Take a look at the following chart, which basically plots the bad loans of public sector banks over the years. The bad loans of IDBI Bank are included in this chart.
Source: Centre for Monitoring Indian Economy and Indian Banks’ Association.
As I elaborate in detail in my book Bad Money, the RBI practiced regulatory forbearance between 2011 and 2014 and did not force public sector banks to recognise their bad loans as bad loans, even though they had started to appear by then. In simple English, regulatory forbearance, essentially means the central bank looking the other way from the problem.
An asset quality review (AQR) was launched in mid 2015 and this forced banks to recognise their bad loans as bad loans. As you can see in the chart, the overall bad loans of public sector banks take a huge jump post 2014-15. This was the AQR at work.
Now loans which have been bad loans for four years can be dropped from the balance sheet of banks by way of a write-off. Hence, many loans which had been categorised as bad loans in 2015-16 would have spent four years on the balance sheet by 2019-20.
Accordingly, they got written off from the balance sheet of banks. Of course, before such bad loans are written off, a 100 per cent provision needs to be made for these bad loans. This means that banks need to set aside money to meet the losses arising from these loans. This essentially led to the overall bad loans of banks coming down as well.
And over and above this, the banks would have managed to recover a portion of the bad loans (which includes bad loans that have been written off as well). The overall recovery rate for banks through various recovery channels during 2018-19 was around 15.5% of the amounts involved. (Numbers for 2019-20 aren’t currently available or at least I couldn’t find them anywhere).
In fact, a bulk of the current accumulated bad loans will disappear from the balance sheets of public sector banks over the next two to three years, thanks to the fact that bad loans can be written off after they have spent four years on the balance sheet.
Nevertheless, the question is: even after this can the public sector banks operate in a healthy way where they don’t need to be constantly recapitalised. In fact, once public sector banks get around to identifying post-covid bad loans early next year, their balance sheets are likely to come under stress again.
But the basic problem of public sector banks remains interference by the government. This interference can take several forms. As Viral Acharya and Raghuram Rajan write in a research paper titled Indian Banks: A Time to Reform?: “Interference, including appointing favoured candidates to management, expanding lending just before elections, or directing banks to lend to favoured borrowers is obviously harmful.” (Again, something I discuss in great detail in my book Bad Money).
This remains a difficult decision politically. Also, in an economic environment like the one prevailing, there will be fairly limited number of firms looking to buy government banks saddled with a huge amount of bad loans and a section of employees not used to the idea of working.
Further, unlike other public sector enterprises, the government has to be even more careful while selling a bank. As Acharya and Rajan write:
“The experience in other countries with allowing corporations to own banks is that it increases the possibility of self-dealing within the group – the bank is used to make risky loans to failing group entities, and the bill is paid by the tax payer when the bank is eventually bailed out.”
They further say that the Indian industry is already heavily concentrated. As a recent McKinsey Knowledge Centre report titled India’s turning point An economic agenda to spur growth and jobs points out: “Our analysis shows that just 20 of the country’s roughly 600 large firms contribute 80 percent of the total profit of large firms.” The report defines large firms as firms with an annual revenue of more than $500 million.
If India’s large corporates end up buying its banks, the industry is likely to get even more concentrated. Hence, while privatisation of public sector banks remains a good idea over a long-term, currently, the government can initiate the reform process through the Axis Bank model, wherein the government is an investor in banks rather being a promoter.
The Committee to Review Governance of Boards of Banks in India (better known as the Nayak Committee, after its chairman, PJ Nayak) which presented its report to the RBI in May 2014, suggested the Axis Bank model.
Axis Bank was originally called UTI Bank. It was set up in 1993. It was owned by the Unit Trust of India (UTI) and a clutch of public sector banks. Even though ownership was 100 per cent in the public sector, the bank got a licence to operate as a private sector bank. The bank was listed on the stock exchanges in 1998. UTI Bank was later renamed Axis Bank.
Even at that point of time, the public sector shareholding continued to be the majority shareholding. In early 2000s, when the Unit Trust of India ran into trouble, the government broke it down into two parts. One part became the UTI Mutual Fund and the other was the Specified Undertaking of the Unit Trust of India (SUUTI).
In February 2003, the shareholding of UTI in the bank was transferred to SUUTI. UTI Bank was later renamed Axis Bank.
As the Nayak Committee Report pointed out:
“The Government-as-Investor stance has characterised the control of the Bank, with SUUTI acting as a special purpose vehicle holding the investment on behalf of the Government. The CEO is appointed by the bank’s board, and because the bank was licensed in the private sector, it sets its own employee compensation, ensures its own vigilance enforcement (rather than being under the jurisdiction of the Central Vigilance Commission), and is not subject to the Right to Information Act. SUUTI appoints the non-executive Chairman and up to two directors on the Board, and there is no direct intervention by the Finance Ministry.”
This means that the bank has been run as a proper banking business, without much intervention from the government. Between March 2003 and March 2014, the share price of Axis Bank rose thirty-two times. Over the years, the government has been able to sell its stake in the bank to raise a decent amount of money.
The point being that even though, as per its shareholding, Axis Bank ‘was for many years a public sector bank’, but ‘fortuitously, the bank was licensed at the commencement of its business as a private sector bank’.
The Nayak Committee Report suggests that the government should look at public sector banks as an investment and not as a business it has to run, and follow the Axis Bank model. This essentially means the government reducing the stake in these banks to less than 50 per cent, and letting the bank’s management and its board do their job, like in the case with private sector banks.
But then as the oft-repeated cliche goes, public sector banks are not just about making money. They also need to keep the social objectives of the government in mind. This is something that even Prime Minister Narendra Modi had suggested at the First Gyan Sangam in 2015 (a meeting of bureaucrats, bankers and insurers). As Modi had said on that occasion, while “government interference was inappropriate, but government intervention was needed to further public objectives”.
It’s this line of thought has driven India’s public sector enterprises for seven decades now and gotten them nowhere in the process.
R C Bhargava, the current Chairman of Maruti Suzuki, who was also an IAS officer for a very long time, writes the following in his book Getting Competitive: A Practitioner’s Guide for India:
“The USSR was the pioneer in attempting industrialization along with creating a communist society. It did not succeed. On the other hand, Japan became a highly competitive and industrialized nation and has a high degree of equality and social justice. The policies for regulating and promoting industrial growth do not have any social content in them [emphasis added]. Social equality was a result of the political and industrial leadership understanding that manufacturing competitiveness would be enhanced if there was greater equality and the bulk of the people were enabled to become consumers of manufactured goods.”
What Bhargava, who has worked for long periods of time, both for the government and the private sector, is basically saying is that social objectives of the government shouldn’t become objectives of its enterprises.
This does not mean that the government should do away with meeting its social objectives. Not at all. But what it should do instead is incentivise banks on this front.
As Acharya and Rajan write:
“Perhaps a better approach would be to pay for the mandates (such as reimbursing costs for maintaining branches in remote areas or opening bank accounts for all) so that both private banks and public sector banks compete to deliver on them. This will distance the public sector banks a little from the government. While public sector banks may be given a slightly different set of objectives than private banks (for example, they may put more weight on financial inclusion), their boards should have operational independence on how to achieve the objectives.”
Competition and incentivisation goes a much longer way in delivering services than a government diktat.
The question is, where will the money for all this come from? Allow me to throw a few numbers at you, before I answer this question.
The market capitalisation of the State Bank of India, India’s biggest bank and the biggest public sector bank, is Rs 1.67 lakh crore. The total assets of the bank as of March 2020 were at Rs 41.97 lakh crore. Now compare this to Kotak Mahindra Bank. Its market capitalisation is at Rs 2.53 lakh crore. The total assets of the bank as of March 2020 stood at Rs 4.43 lakh crore.
Hence, in comparison to the State Bank of India, the Kotak Mahindra Bank is a very small bank. But its market capitalisation is almost Rs 86,000 crore more. Why? Simply because Kotak Mahindra Bank is run like a proper bank and the stock market gives it a proper valuation for the same.
Or take the case of HDFC Bank, which has a market capitalisation of Rs 5.80 lakh crore, which is more than all public sector banks put together. Both these well-run banks have much lower bad loans than public sector banks. The overall bad loans of private banks, Yes Bank notwithstanding, are significantly lower than public sector banks even after adjusting for their size.
The point I am trying to make here is that if public sector banks end up being much better run than they currently are, the stock market will give them a higher market capitalisation. And the government can then finance its social objectives by gradually selling the shares it owns in these banks.
Of course for anything like that to happen, the Department of Financial Services in the Finance Ministry which controls the public sector banks, needs to take a backseat. As Rajan writes in I Do What I Do: “Unless PSBs are run like normal corporations, they will not be competitive in the medium term. I have a simple metric of progress here: We will have moved significantly towards limiting interference in PSBs when the Department of Financial Services (which oversees public sector financial firms) is finally closed down, and its banking functions taken over by bank boards.”
But as we all know, bureaucrats don’t take backseats.
Oh and politicians. Let’s not forget them here. Back in 2000, the Atal Bihari Vajpayee government tried to push through the move and dilute the government stake in PSBs to 33 per cent. And it failed. Why?
Vajpayee’s finance minister, Yashwant Sinha, had introduced a bill to reduce the government’s stake in PSBs to 33 per cent. It never saw the light of day. In a 2018 interview, Sinha said: “The parliament and the people were not prepared for such [a] kind of step”.
In fact, all these years down the line, we are still grappling with the same issue.
The Supreme Court is currently hearing the loan moratorium case. Arguments have been made from different sides, on whether banks should charge an interest on loans during the moratorium and if an interest should be then charged on that interest.
I wanted to discuss a few arguments being offered by lawyers who are representing borrowers of different kinds in the Supreme Court. Either their understanding of interest rates is weak, or even if they do understand, they are just ignoring that understanding in order to make a powerful argument before the Supreme Court.
Let’s look at the issue pointwise. Also, this piece is for anyone who really wants to understand how interest rates really work. Alternatively, I could have headlined this piece, Everything You Ever Wanted to Know About Interest Rates But were Afraid to Ask.
1) Appearing for the real estate sector, Senior Advocate C A Sundaram told a bench of Justices Ashok Bhushan, R S Reddy and M R Shah: “Even if the interest is not waived, then it must be reduced to the rate at which banks are paying interest on deposits.”
What does this mean? Let’s say a real estate company has taken a loan of Rs 100 crore from a bank. On this it pays an interest of 10% per year. For the period of the moratorium the company doesn’t pay the interest on the loan. At the end of six months, the interest outstanding on the loan is Rs 5 crore (10% of Rs 100 crore for a period of six months). In the normal scheme of things this outstanding interest needs to be added to Rs 100 crore and the loan the builder now needs to repay Rs 105 crore. Of course, in the process of repaying this loan amount, the company will end up paying an interest on interest. If it wants to avoid doing that it simply needs to pay the outstanding interest of Rs 5 crore once the moratorium ends and continue repaying the original loan.
What Advocate Sundaram told the Supreme Court is that even if the interest on the loan during the moratorium is not waived, the interest rate charged on it should be lower and should be equal to the interest rate that banks are paying on their deposits.
The question of not charging an interest rate on loans during moratorium is totally out of question. Banks raise deposits by paying a rate of interest on it. It is these deposits they give out as loans. If they don’t charge an interest on their loans, how will they pay interest on their deposits?
Bank deposits remain the most popular form of saving for individuals. Imagine the social and financial disruption something like this would create.
Even the point about banks charging an interest rate during the moratorium which is equal to the interest rate they are paying on their deposits, is problematic. Other than paying an interest rate on deposits, banks have all kinds of other expenditures. They need to pay salaries to employees and off-role staff, rents for the offices and branches they operate out of, bear the cost of insuring deposits and also take into account, the loan defaults that are happening.
If the banks charge an interest rate on loans equal to the interest rate they pay on deposits, how are they supposed to pay for all the costs highlighted above?
2) More than this, I think there is a bigger problem with Senior Advocate Sundaram’s argument. Allow me to explain. Interest on money is basically the price of money. When a bank pays an interest to a deposit holder, he is basically compensating the deposit holder for not spending the money immediately and saving it. This saving is then lent out to anyone who needs the money. This is how the financial intermediation business works.
If real estate companies could today ask the courts to decide on the bank’s price of money, the banks could do something similar tomorrow. They could approach the courts with the argument that real estate companies need to reduce home prices, in the effort to sell more units, so that they are able to repay all the money they have borrowed from banks.
If courts can decide on how banks should carry out their pricing, they can also decide on how real estate companies should carry out their pricing. This is something that needs to be kept in mind.
3) This is a slightly different point, which might seem to have nothing to do with interest rates, but it does. The real estate industry is in dire straits and hence, wants the government, Reserve Bank of India (RBI) and the Supreme Court, to help. (I am going beyond what Advocate Sundaram told the Court).
In fact, banks and non-banking finance companies, have already been allowed to restructure builder loans. Former RBI governor Urjit Patel refers to the commercial real-estate-sector as the living dead borrowers in his book Overdraft.
The real estate sector had a great time between 2002 and 2013, for more than a decade, when they really raked in the moolah.
While they did this, they obviously kept the after-tax profits with themselves and they didn’t share it with anyone else. So, why should they be supported now? Why should their losses be socialised? And if losses of real estate sector are socialised, where does the system stop? This is a question well worth asking.
If these losses are socialised, the banks will try making up for it through other ways. This would mean lower interest rates on deposits than would otherwise have been the case. This would also mean higher interest rates on loans than would otherwise have been the case. There is no free lunch in economics.
4)Senior Advocate Rajiv Datta said that banks should not take the moratorium as a default period to charge interest on interest to individual borrowers, including those repaying home loans. As he said: “Profiteering at the cost of individual borrowers during a pandemic is like Shylock seeking his pound of flesh. Individual borrowers were not defaulting.”
While I have no love-lost for bankers, but generations of bankers have had to suffer thanks to the way the William Shakespeare portrayed a Jewish money lender in his play The Merchant of Venice.
The question is why is everyone so concerned only about the borrowers. What about the savers? The average fixed deposit rate is now down to 6%. This, when the rate of inflation is close to 7%. The savers are already losing out. Why should they lose more?
5) Another argument was put forward by Senior Advocate Sanjay Hegde, where he said that banks never passed the benefit of lower repo rate to consumers in the whole of 2019 to garner bigger profits. “When there is a pandemic, they should not think of profiteering and pass on the benefits granted by the RBI to borrowers by lowering the interest rate on loans,” he said.
This is a fundamental mistake that many people make where they assume a one to one relationship between the repo rate and loan interest rates. Repo rate is the interest rate at which the RBI lends money to banks. The idea in the heads of people and often portrayed in the media is that the repo rate is coming down and so, should loan interest rates, at the same pace.
In December 2018, the repo rate was at 6.5%. Since then it has been reduced to 4%. There has been a cut of 250 basis points. One basis point is one hundredth of a percentage. During the same period, the weighted average lending rate on outstanding loans has fallen from 10.35% to 9.71%, a fall of a mere 64 basis points.
So is Senior Advocate Hegde right in the argument he is making? Not at all. As I said earlier, the link between the repo rate and the lending rate is not one to one. The reason for that is very simple. Banks raise deposits and lend that money out as loans. For lending interest rates to fall, the deposit interest rates need to fall.
The weighted average deposit interest rates since December 2018 have fallen from 6.87% to 5.96% or a fall of 91 basis points. We see that even the deposit interest rates do not share a one to one relationship with the repo rate.
Why is that the case? If a depositor invested in a deposit at 8% interest three years back, he continues to be paid that 8% interest, even when the repo rate is falling. Further, even though banks reduce the interest rate they pay on new fixed deposits, they cannot do so on the older fixed deposits. The fixed deposit interest rates are fixed and that is why they are called fixed deposits.
If the repo rate and the fixed deposit interest rates need to have a one to one relationship, meaning a 25 basis points cut in the repo rate leads to a 25 basis points cut in deposit rates, which translates into a 25 basis points cut into lending rates, then banks need to offer variable interest rate deposits and not fixed deposits. Again, that is a recipe for a social disruption.
If we look at fresh loans given by banks, the interest charged on them has fallen from 9.79% in December 2018 to around 8.52%, a fall of 127 basis points, which is much higher than the overall fall of just 64 basis points. This is primarily because the interest rate on fresh fixed deposits has fallen faster than the interest rates on fixed deposits as a whole.
This still leaves the question why has the overall lending rate fallen by 64 basis points when the overall deposit rate has fallen by 91 basis points. One reason lies in the fact that banks have a massive amount of bad loans and they are just trying to increase the spread between the interest they charge on their loans and the interest that they pay on their deposits, by not cutting the lending rate as fast as the deposit rate.
This will mean a higher profit, which can compensate for bad loans to some extent. Over and above this, there is some profiteering as well. But the situation is nowhere as bad as the lawyers are making out to be.
The reason for that is simple. There is a lot of competition in banking and if a particular bank tries to earn excessive profits, a competitor can easily challenge those profits by charging a slightly lower rate of interest and getting some of the business.
To conclude, allowing banks to set their own interest rates is at the heart of a successful banking business. And no one should be allowed to mess around with that. Also, for the umpteenth time, interest rates are not just about the repo rate.
We have extensively written about how corporate loan defaults have screwed up the state of banks in general in India, with public sector banks in particular.
This can be made out from the fact that the aggregate domestic corporate lending non-performing assets (or bad loans) of scheduled commercial banks, as of December 31, 2017, stood at Rs 6,63,877 crore. Bad loans are loans on which repayment has not been made for 90 days or more.
The total domestic bad loans of scheduled commercial banks on December 31, 2017, stood at Rs 8,31,141 crore. This means that the corporate bad loans account for 80% of the overall bad loans of banks.
Having said that, it doesn’t make much sense to paint all the corporates with the same brush. Borrowing is an essential part of corporate growth and that cannot suddenly go out of the equation.
Care Ratings has carried out a very interesting study on corporate borrowing and how the different kinds of borrowers (as per the total amount of borrowing) are placed in their ability to repay bank loans, at this point of time.
Care Ratings took a sample of 2,314 companies, which excludes banks and other finance companies. The total borrowing of these companies stands at Rs 20.02 lakh crore as of March 31, 2017.
The interest coverage ratio of these companies stood at 3.92. Interest coverage ratio is basically obtained by dividing operating profit of a company (or companies) by interest payments that need to be made on outstanding loans, during a particular period. This ratio fell to an almost similar 3.9 for the period April to December 2017.
This tells us that on the whole, the corporates are making enough money to keep servicing the interest that is due on their debt. But averages as usual hide the real story, which starts to change, as soon as we start to dig a little more.
Let’s look at this in detail one by one:
For the period April to December 2017, 578 companies in the sample with an outstanding debt of Rs 4.78 lakh crore, which amounted to 24% of the total debt, had an interest coverage ratio (ICR) of less than 1. This basically means that companies which have taken on one fourth of the corporate debt (as per the sample used) are not earning enough money to keep servicing the interest payments on their debt.
When the interest coverage ratio is less than one, the operating profit made by the company is less than the interest payment that is due. In such a situation, neither the company, nor the bank is left with many options. If the company’s situation does not improve, it is more than likely to default on the bank loan.
How has the situation changed when we compare the financial year 2016-2017 with the period April to December 2017? In 2016-2017, 524 companies with total debt amounting to Rs 5.42 lakh crore, had an interest coverage ratio of less than 1.
What this means is that in April to December 2017, more companies ended up with an interest coverage ratio of less than one. Nevertheless, a smaller amount of money was at stake.
Let’s take a look at Table 1:
Table 1: Distribution of companies and ICR according to debt sizeTable 1 makes for a very interesting reading. Let’s start with the large companies with a debt of Rs 5,000 crore or more. There are 68 such companies. Their interest coverage ratio has come down from 3.22 to 3.08. But this fall is not huge.
Further, there are 23 companies with a total debt of Rs 2.82 lakh crore, with an interest coverage ratio of less than one. This basically means that large companies form a bulk of the debt of Rs 4.78 lakh crore of companies, with an interest coverage ratio of less than one.
This basically means that the banks haven’t seen the last of corporate defaults and more defaults will happen in the time to come.
The companies with a debt of Rs 2,500-5,000 crore are in the worst possible space. The interest coverage has fallen from 2.26 for 2016-2017 and to 1.73 during the period April to December 2017, respectively. Clearly the positon of these companies on their ability to keep paying interest on their debt has come down.
There are 56 companies in this bracket. Of these 22 companies have an interest coverage ratio of less than one. These companies have a total debt of around Rs 75,000 crore. These companies (along with large companies with an interest coverage ratio of less than one) primarily operate in the steel, engineering and textiles sector. Take a look at Table 2.
Interestingly, companies with lower levels of debt seem to be better placed on the interest coverage ratio front.
The study further shows that the companies with higher levels of outstanding debt have seen sharper declines in their interest coverage ratio during April to December 2017, in comparison to 2016-2017. As Madan Sabnavis and Rucha Ranadive, the authors of this report put it: “A combination of declining interest coverage ratio and interest coverage ratio less than 1 is a good signal to identify debt service failure.”
To conclude, what these data points tell us for sure is that the banks haven’t seen the last of corporate defaults. There is more to come.
“You don’t get bored writing about bad loans of public sector banks?” asked a friend, a few days back.
We honestly told them, we don’t, simply because new details keep coming out, and we keep writing about them. And most of these new details show how messy the situation has become.
Yesterday, while digging through the questions raised by MPs in the Rajya Sabha, we came across another interesting data point, which again shows how messy the bad loans problem of public sector banks actually is and why it is not going to end anytime soon, irrespective of what analysts and politicians have to say about it.
Bad loans are essentially loans which have not been repaid for a period of 90 days or more.
After a point banks need to write-off bad loans. These are loans which banks are having a difficult time to recover.
When banks write-off bad loans, the total bad loans of the banks come down. At the same time, these bad loans are written-off against the operating profits of banks.
In an answer to a question raised in the Rajya Sabha, the government gave out the details of the total amount of bad loans which have been written off by public sector banks, over the last few years.
Take a look at Table 1: Table 1:
Loans written off (in Rs Crore)
* Up to December 31, 2017
Source: RAJYA SABHA
UNSTARRED QUESTION NO: 3600
TO BE ANSWERED ON THE 27th MARCH, 2018
Table 1 tells us that between April 1, 2014 and December 31, 2017, the public sector banks wrote off loans worth Rs 2,72,558 crore. Hence, the profits of the bank have been impacted to that extent and so have the dividends that these banks give to the government every year.
Nevertheless, this is a point that we have made in the past. In this column, we hope to make a new point. While the loans that are written off are those that are deemed to be difficult to recover, there is still a certain chance that these loans may be recovered by the bank (given that loans are made against a collateral). How do the numbers stack up on this front? Take a look at Table 2.
Loans recovered(in Rs Crore)
* Up to December 31, 2017
Source: RAJYA SABHA
UNSTARRED QUESTION NO: 3600
TO BE ANSWERED ON THE 27th MARCH, 2018
From Table 1 and Table 2 we can conclude that over the last four years, Rs 29,343 crore of the bad loans that have been written off (Rs 2,72,558 crore) have been recovered by public sector banks. This basically means that the rate of recovery is 10.8%. Or 89.2% of the bad loans which are written off are not recovered.
Hence, technically there might be a difference between a write off and a waive off, but in real life, there isn’t. A write off is as good as a waive off with the banks failing to recover a bulk of the bad loans. Also, in case of a waive off, the government compensates banks to that extent. As we have mentioned in the past, loans to industry amount to 73% of the overall bad loans of public sector banks, whereas loans to the services sector amounts to another 13%. This basically means that corporates are responsible for more than 80% of bad loans of banks. And this explains why public sector banks have a tough time trying to recovering the bad loans they have written off.
A bulk of these bad loans are because of corporates who have access to the best lawyers as well as politicians and banks find it difficult to recover these bad loans by selling the collateral against which these loans have been made.
While, public sector banks have written off loans worth Rs 2,72,558 crore over the last four years, the total bad loans outstanding of public sector banks stood at Rs Rs. 7,77,280 crore, as of December 31, 2017. So, public sector banks aren’t done writing off bad loans as yet. There is more to come.