Tag: Banking | Vivek Kaul

3 April, 2018

India’s Banking is Getting Privatised Without the Govt

Indian_ten_rupee_coin_(2008_Reverse)
“Should public sector banks be privatised?” is a question that is being thoroughly debated these days. Arguments have been offered from both sides.

Those against the idea of public sector banks being privatised like to say that private sector banks also make bad lending decisions and end up with bad loans. Of course, that is true. In the business of banking, some loans are bound to go bad. A bad loan is essentially a loan on which the repayment has not been made for 90 days or more.

Nevertheless, the more important point is what proportion of the loans have gone bad. As of March 31, 2017, the total bad loans of public sector banks stood at Rs 6,41,057 crore. In comparison, the total bad loans of private sector banks stood at Rs 73,842 crore.
Hence, the bad loans of private sector banks amounted to around 11.5% of bad loans of public sector banks. But just looking at bad loans in isolation isn’t really the correct way.
We also need to look at the total advances or loans of these banks.

As of March 31, 2017, the total advances of public sector banks stood at Rs 55,57,232 crore. The total advances of private sector banks stood at Rs 22,19,563 crore, or around 40% of advances of public sector banks.

If the private sector banks were doing as badly as public sector banks on the bad loans front, there bad loans should also have been around 40% of the total bad loans of public sector banks. But that as we saw is clearly not the case. The bad loans of private sector banks are at 11.5% of the bad loans of public sector banks.

This basically means that the private sector banks operate much more efficiently than public sector banks. Hence, the argument that public sector banks should not be privatised because private sector banks also accumulate bad loans, doesn’t really hold.

But that isn’t the major point that I wanted to make in this column. What people who suggest that public sector banks should not be privatised do not realise is that the banking sector in India is getting privatised on its own, even though the government continues to own 21 public sector banks. Take a look at Table 1.

Table 1:

Total advances As on March 31	Public Sector Banks	Private Sector Banks	Ratio (Total advances by private sector banks to total advances by public sector banks) (in %)
2012	38,77,307.31	9,66,402.95	24.92%
2013	44,72,844.65	11,43,248.58	25.56%
2014	51,01,053.95	13,42,934.61	26.33%
2015	54,76,249.54	15,84,311.86	28.93%
2016	55,93,576.78	19,39,339.43	34.67%
2017	55,57,231.63	22,19,563.01	39.94%

Source: Author calculations based on data from Indian Banks’ Association

Now what does Table 1 tell us? As on March 31, 2012, the total advances of private sector banks were around a fourth of the total advances of public sector banks. By March 31, 2017, this ratio had increased to 40%.

This basically means that as public sector banks go slow on lending because of their bad loans, the total loans given out by private sector banks are growing at a much faster pace. Hence, as far as the overall banking sector is concerned, it is getting privatised, irrespective of what the experts and the government think about privatising public sector banks.

In fact, the situation is not very different from other sectors which the government has opened up for private companies over the years. Take a look at what happened to the airlines sector. Air India and Indian Airlines (before they were merged) had 100% of the market (along with Vayudoot, another government owned entity). Now Air India (in which the erstwhile Indian Airlines has been merged) has 13.8% of the market share. This has benefitted the consumers tremendously.

Similar stories of privatisation, without the government privatising public sector enterprises, have played out in the telecom and pharmaceutical sectors, respectively, and even in education, to some extent.

The telecom sector had two players BSNL and MTNL. Over the years, the market share of these two government owned companies, has come down dramatically, while the government continues to own them.

Over the years, various ministers have referred to public sector enterprises as family jewels. The trouble is that in sector after sector, these family jewels have lost their lustre and a tremendous amount of value has been destroyed.

Along similar lines, public sector banks have reached a stage where it will be difficult to find buyers for many of these banks, even if the government makes a decision to privatize them (which in the first place seems very difficult).

The 1997 Committee on Banking Sector Reforms (better known as the second Narasimham Committee) had recommended that the government reduce its holdings in PSBs to 33 per cent and, in the process, give increased autonomy to these banks. The Committee had also recommended no further recapitalisation of public sector banks by the government. But that is not how things have eventually turned out.

And more than two decades later, now we have reached a stage where most of the public sector banks are as dead as a dodo.

The column was originally published on Firstpost on April 2, 2018.

6 November, 2017

The Real Brave-hearts are Those Who Still Have Deposits in IDBI Bank

IDBI-Bank-Careers-Mumbai-3
IDBI Bank is the worst performing public sector bank when it comes to its gross non-performing advances or bad loans. Bad loans are essentially loans in which the repayment from a borrower has been due for 90 days or more.

As on September 30, 2017, the bad loans rate of the bank stood at 24.98 per cent. This basically means that the borrowers have defaulted on nearly one-fourth of the loans given by the bank. Now take a look at Figure 1. It plots the bad loans of IDBI Bank over the last three years.

Figure 1:

The bad loans rate of IDBI Bank has jumped from around 5 per cent to around 25 per cent, over a period of just three years. What is happening here? What this tells us is that initially the bank did not recognise bad loans as bad loans. It probably did that by restructuring loans (i.e. giving the borrowers more time to repay or decreasing their interest rate or by simply postponing their repayment) or by issuing fresh loans to borrowers in a weak position, so that they could repay the loans that were maturing. In the process, the recognition of bad loans as bad loans was avoided.

Of course, any bank can’t perpetually keep kicking the can down the road, and after a point of time must do the right thing. IDBI Bank is now doing the right thing of recognising bad loans as bad loans and given this it has such a high bad loans rate. Given that, one-fourth of the loans advanced by the bank have been defaulted on, it is worth asking whether this bank should be in the business of banking at all.

Nevertheless, the more important issue here is how do depositors view this bank. The best way to find this out is to look at the total amount of deposits the bank still has. Take a look at Figure 2, which plots that.

Figure 2:

What does Figure 2 tell us? The total deposits of the bank have fallen after peaking in December 2016. Nevertheless, the total deposits with IDBI Bank are still higher than they were three years back. Hence, the conclusion that we can draw here is that while bad loans of the bank have gone up from 5 per cent to 25 per cent over a period of three years, the total deposits with the bank are still at the level they were.

Why is this the case? Why would you continue banking with such a bank? First and foremost, this faith comes from the great faith in the government. The government will not allow any bank to go bust. Fair enough. But why wait for that to happen? Typically, when a bank lands up in major trouble, the government tends to merge it with a bigger bank and thus the depositors continue to be safe. Nevertheless, such a merger is never smooth and there might be a brief time period when the full money deposited in the bank cannot be withdrawn. Hence, liquidity can become an issue.

Also, it is worth remembering here that IDBI Bank is not a small bank. It is a relatively big bank and had total assets of close to Rs 3,61,768 crore, as on March 31, 2017. This means that if the government were to decide to merge it with another bank, the balance sheet and the profit and loss account of the combined entity, will be another big mess.

Secondly, many people are simply unaware of how badly the bank is placed. This lack of knowledge about their financial activities is a general trend among many people in this country. We spend more time gossiping and worrying about the state of the nation, than the state of our own finances.

Thirdly, many people locked in their fixed deposits at high interest rates, a few years back. In the aftermath of demonetisation, interest rates have crashed as banks have been flush with funds that were deposited and at the same time their lending has crashed. Given this, even if some individuals understand the riskiness of the situation, they really can’t do much about it. In case they were to break their fixed deposits and move it to other banks, they would earn a much lower rate of interest.

And at that lower rate of interest, they would simply not be in a situation to meet their monthly expenses. This is another negative impact of demonetisation at play, with people having to continue to bank with risky public sector banks, which includes IDBI Bank.

While, some people are simply stuck with IDBI Bank, there are others who can easily move their money to other public sector banks, like State Bank of India, Vijaya Bank, Indian Bank, Syndicate Bank etc., which are in a comparatively much better position.

But given that they have chosen not to, they are the real brave-hearts.

The column originally appeared on November 6, 2017.

5 January, 2016

When it comes to bad loans of banking, the big boys are the bad boys

The Reserve Bank of India(RBI) released the Financial Stability Report on December 23, 2015. One of the key themes in this report was the fact that large borrowers are the ones who have landed the banking sector in trouble. As the RBI governor Raghuram Rajan wrote in the foreword to the report: “corporate sector vulnerabilities and the impact of their weak balance sheets on the financial system need closer monitoring.”

That is a euphemistic way of saying that corporates are essentially responsible for the rising bad loans of banks. As on September 30, 2015, the bad loans (gross non-performing advances) of banks were at 5.1% of total advances [i.e. loans] of scheduled commercial banks operating in India. The number was at 4.6% as on March 31, 2015. This is a huge jump of 50 basis points in a period of just six months. One basis point is one hundredth of a percentage.

What is the problem here? The inability of large borrowers to continue repaying the loans they have taken on in the years gone by. As on September 30, 2015, loans to large borrowers made up 64.5% of total loans. On the other hand, bad loans held by large borrowers amounted to 87.4% of total bad loans.

What this means is that for every Rs 100 of loans given by banks, Rs 64.5 has been given to large borrowers. At the same time of every Rs 100 of bad loans, large borrowers are responsible for Rs 87.4 of bad loans. Hence, large borrowers are clearly responsible for more bad loans.

As on March 31, 2015, bank loans to large borrowers made up 65.4% of total bank loans. At the same time, the bad loans of large borrowers constituted 78.2% of the total bad loans. What this means is that for every Rs 100 of loans given by banks, Rs 65.4 was given to large borrowers. At the same time of every Rs 100 of bad loans, large borrowers were responsible for Rs 78.2 of bad loans. This has since jumped to Rs 87.4 for every Rs 100 of bad loans.

What these numbers clearly tell us is that in a period of six months the situation has deteriorated big time and large borrowers have been responsible for it. As the RBI Financial Stability Report points out: “While adverse economic conditions and other factors related to certain specific sectors played a key role in asset quality deterioration, one of the possible inferences from the observations in this context could be that banks extended disproportionately high levels of credit to corporate entities / promoters who had much less ‘skin in the game’ during the boom period.”

What does this mean? Banks gave loans to corporates/promoters who had put very little of their own money in the project they had borrowed money for. Banks essentially gave more loans than they actually should have, given the amount of capital the promoters put in. And this is now proving to be costly for them.

In fact, lending to industry forms a major part of the stressed loans of banks. Stressed loans are essentially obtained by adding the bad loans and the restructured loans of banks. A restructured loan is a loan on which the interest rate charged by the bank to the borrower has been lowered. Or the borrower has been given more time to repay the loan i.e. the tenure of the loan has been increased. In both cases the bank has to bear a loss.

As the RBI report points out: “Sectoral data as of June 2015 indicates that among the broad sectors, industry continued to record the highest stressed advances ratio of about 19.5 percent, followed by services at 7 per cent. The retail sector recorded the lowest stressed advances ratio at 2 per cent. In terms of size, medium and large industries each had stressed advances ratio at 21 per cent, whereas, in the case of micro industries, the ratio stood at over 8 per cent.”

Lending to the retail sector (i.e. you and me) continues to be the best form of lending for banks. The stressed loans ratio in this case is only 2%. This means that for every Rs 100 lent by banks to the retail sector (home loans, car loans, personal loans and so on), only Rs 2 is stressed.

Why is this the case? For the simple reason that it is very easy for banks to go after retail borrowers who are no longer in a position to repay the loans they have taken on. Further, there is no political meddling when it comes to loans to retail borrowers, hence, the lending is anyway of good quality.

In comparison, lending to industry has a stressed loans ratio of 19.5%. This means for every Rs 100 that the banks have lent to industry, Rs 19.5 is stressed i.e. it has either been defaulted on or has been restructured. Interestingly, even within industry, the situation with the micro industries is not as bad as the medium and the large industries.

The large industries have a stressed loans ratio of 21% i.e. for every Rs 100 lent to large industries by banks, Rs 21 has either been defaulted on or has been restructured. In case of micro industries, the number is at 8%. This is because banks can unleash their lawyers on the small industries in case the loan is in trouble. They can’t do the same on large borrowers. And even if they do it does not have the same impact.

Five sectors have been responsible for a major part of the trouble. These are mining, iron & steel, textiles, infrastructure and aviation. These “together constituted 24.2 per cent of the total advances [i.e. loans] scheduled commercial banks as of June 2015, contributed to 53.0 per cent of the total stressed advances.” “Stressed advances in the aviation sector6 increased to 61.0 per cent in June 2015 from 58.9 per cent in March, while stressed advances of the infrastructure sector increased to 24.0 per cent from 22.9 per cent during the same period.”

To conclude, when it comes to the bad loans of banking, the big boys are the bad boys who are responsible for a majority of the mess.

The column originally appeared on The Daily Reckoning on January 5, 2016

25 February, 2014

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

Vivek 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)

28 November, 2013

Decoding why running a bank did not make sense for Tata Sons

Vivek Kaul
Tata Sons, the holding company of the salt to software Tata group, has decided to withdraw its application for a banking license. So you won’t see a Tata Bank anytime soon.
The reason for the Tatas withdrawing the application for a banking license can be best explained through a line that Walter Bagehot, the great editor of The Economist wrote in his 1873 classic Lombard Street: A Description of the Money Market. As Bagehot wrote “the main source of profitableness of established banking is the smallness of requisite capital.”
Among other things that the Tata group would have needed to do to run a bank would have been to consolidate all the financing companies in the group under a non-operative financial holding company (NOFHC).
This would also mean bringing the non banking finance companies(NBFCs) of the group like Tata Capital under the umbrella of the NOFHC. And this is where the entire business model of the Tata Bank would have started to become unviable.
The Tata Bank would have had to maintain a statutory liquidity ratio of 23%. For every Rs 100 that a bank raises as deposits, it needs to compulsorily invest Rs 23 in government bonds. The bank would also have to maintain a cash reserve ratio of 4%. Rs 4 out of the every Rs 100 that a bank raises as a deposit needs to be parked with the Reserve Bank of India(RBI).
Over and above this, the bank would also have to loan 40% of its money to what the Reserve Bank calls the priority sector. This includes lending to certain segments like agriculture, retail traders, self employed individuals etc, which can be pretty risky.
These requirements make it difficult for corporates like Tata Sons which run large NBFCs, to turn themselves into banks. If it wants to convert itself into a bank it will have to park 4% of its time and demand deposits with the RBI as CRR. It also needs to invest 23% of its deposits in government securities to maintain the SLR.
An NBFC does not need to do this, but a bank does. This immediately means a higher capital requirement for a bank. The banks do not earn any interest on the money they park as CRR with the RBI.
While the risk involved in investing in government securities is low, the returns are low as well.
Hence, the increase in profit will not be commiserate with the higher capital that will have to be deployed to run a bank vis a vis an NBFC. And this goes against Bagehot’s basic principle of banking.
Over and above this, if an NBFC wants to become a bank it needs to ensure that 40% of its lending is to the priority sector. The trouble is that the existing loan book of an NBFC may not meet this requirement. And in order to become a bank it may have to rejig its loan book substantially. Now that, may or may not be financially viable. It may also increase the riskiness of the overall lending. Further, for an NBFC to become a bank it would have to convert each of its branches into a bank branch over a period of 18 months. It would also have to ensure that 25% of its branches would be in rural areas with populations under 10,000 and without existing bank branches. This is another provision which would require an NBFC wanting to become a bank to invest a substantial amount of capital in setting up branches and other infrastructure. But this wouldn’t lead to immediate returns.
The norms require that the bank promoter list his business within three years and bring down his shareholding to 40%. This has to be further whittled down to 20% by the 10th year and 15% by the 12th year. As explained, any NBFC looking to become a bank will have to invest a lot of capital to get the business up and running. But the returns against this money invested will not come immediately. Hence, it is unlikely that when the bank has to list itself three years down the line, it will get a great valuation.
Given these reasons, running a bank did not make much sense for Tata Sons. The group also felt that running a bank would come in the way of international operation, which account for 64% of the revenue. A Tata Sons spokesperson explained the reason behind this to several newspapers. As he put it “The operating companies with overseas operations at times need to provide financing solutions to their customers. Since all financing companies in the group need to be under the NOFHC, there could be situations, wherein a given country is not a priority for the proposed bank but extremely important for an operating company.”
The Tata group however did not rule out their interest in entering the banking sector in the time to come. “The company shall continue to monitor developments in this space with great interest and looks forward to participating in the banking sector at an appropriate time,” Tata Sons said in a statement.
The group can look to enter the banking sector in the years to come, given that the RBI is now looking to provide banking licenses to domestic aspirants on tap. In a discussion paper titled Banking Structure in India—The Way Forward released in August 2013, the RBI has proposed issuing banking licenses on tap. “There is a case for reviewing the present ‘stop and go’ or ‘block’ bank licensing policy which promotes rent seeking and considering ‘continuous authorisation’ of new banks. Such entry would increase the level of competition, bring new ideas and variety in the system,” the paper said.
Foreign banks looking to enter India do so through the continuous authorisation process. But domestic aspirants till now have had to wait for the RBI to open the license window. The RBI issued 10 new banking licenses in 1994. It followed it up with two more licenses in 2004.
The article originally appeared on www.firstpost.com on November 28, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)