Public Sector Banks

George Soros’ theory of reflexivity explains the rut in public sector banks

george-soros-quantum-fund
Public sector banks continue to remain in a big mess. In a recent research note Crisil Research points out: “ Asset quality remained under pressure with gross non performing assets rising by 45 bps[basis points] to 5% of advances because of continuing stress across sectors such as infrastructure, construction and iron and steel. Also, restructured assets for public sector banks as a proportion of advances increased by 70-100 bps to around 7-8% as of December 2014.” One basis point is one hundredth of a percentage.
What this means in simple English is that for every Rs 100 given by Indian public sector banks as a loan(a loan is an asset for a bank) nearly Rs 12- 13(Rs 5 worth of non performing assets plus Rs 7-8 worth of restructured loans) is in shaky territory.
The borrower has either stopped repaying the 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. Crisil Research expects gross non-performing assets to remain at the current high levels, during the period January to March 2015, results for which will soon start coming out.
The question is how did the Indian public sector banks end up in this state? The simple answer as explained above is that they gave loans to borrowers who are no longer repaying them. The next question is whether the due diligence carried out by banks was adequate? This is where things get interesting.
A major portion of the loans which are now not being repaid were given out during the period 2002 and 2008. This was the period when the stock market in India was in the midst of a huge rally. The economy was also doing well.
This had created a massive “feel good” factor which ensured that corporates where willing to borrow and banks were willing to lend. Between end December 2001 and end December 2007, the lending by banks went up at a rapid rate of 26.8% per year. To give a sense of comparison, the lending by banks between December 2007 and December 2014 went up at the rate of 16.8% per year, which is significantly lower. If we consider a much shorter period between December 2011 and December 2014, the lending by banks went up by just 13.4% per year.
What this clearly tells us is that the growth in bank lending between December 2001 and December 2007 happened at a very rapid rate. This rapid rise was a reflection of the era of “easy money” that existed during that period due to the stock market and the Indian economy both going from strength to strength.
And this is where things started to get messy. Before we go any further it is important to understand, the theory of reflexivity proposed by hedge fund manager George Soros.
As Soros writes in The New Paradigm for Financial Markets: “The crux of the theory of reflexivity is not so obvious, it asserts that market prices can influence the fundamentals. The illusion that markets manage to be always right is caused by their ability to affect the fundamentals that they are supposed to reflect.” Reflexivity refers to circular relationships between cause and effect
Typically, the price of a stock is expected to reflect the underlying earnings potential of a company (or the kind of money that the company is expected to make in the days to come) or what analysts like to refer to as fundamentals of a company. What Soros implies through the theory of reflexivity is that the stock price of a company also impacts its earnings potential. Or to put it simply stock prices can have an impact on the fundamentals of a company.
In the feel good and easy money era that prevailed between 2001 and 2007, the stock prices of companies rallied at a rapid rate. This gave the companies the confidence to borrow a lot of money from banks, in the hope of expanding and earning much more money. But they bit more than they could chew and a few years down the line the interest that they paid on their outstanding debt was a major part of their total expenses. This had an impact on their profits. Hence, the stock price of a company ended up having an impact on its earnings.
As companies started defaulting on their interest payments and loan repayments, banks started becoming a part of this mess as well. They had to write off loans as well as restructure them. This has now led to a situation where the stressed assets of public sector banks are now close to 12-13%. In this way, a rapidly rising stock market ended up having an impact on the performance of banks. Also, in many cases the public sector banks were forced to lend to crony capitalists by politicians.
“High GNPAs will restrict growth in net interest income to 5-7% year on year, in spite of lowering of deposit rates by some of the banks,” points out Crisil.
To conclude, the bad habits are usually picked up during good times. And that is precisely what happened to public sector banks in India.

The column originally appeared on The Daily Reckoning on April 15, 2015

The mess in public sector banks will not be easy to sort out

rupee
The finance minister Arun Jaitley met the chiefs of public sector banks yesterday for a quarterly review of performance. Media reports suggest that among other things the banks were also asked to cut interest rates on their loans.
The Reserve Bank of India (RBI) has cut the repo rate by 50 basis points to 7.5% during the course of this year. Repo rate is the rate at which the RBI lends to banks. But banks haven’t passed on this cut to their end consumers.
There are multiple reasons for the same. Typically when the RBI increases the repo rate, the banks match the increase very quickly. But the same thing is not seen when it comes to a scenario where the RBI cuts the repo rate. Banks are normally very slow to pass on cuts to consumers.
As Crisil Research points out in a research note: “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.”
But there is a little more to it than just this. The balance sheets of public sector banks are in a big mess. As thelatest 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.”
What this clearly shows is that public sector banks are not in great shape. 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.
Also, as the following table from Credit Suisse shows, 46% of public sector banks have a tier I capital of less than 8% and un-provided problem loans greater than 100% of their networth. 

62% of PSU banks have Tier-I < 9% and
Un-provided problem loans > 100%

Source: Company data, Credit Suisse estimates


What this clearly tells you is that banks many public sector banks do not have enough money to cover their losses. 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.
Further, banks do not have enough capital going around. Take the case of Tier I capital mentioned
earlier. It is essentially sort of permanent capital that the bank has access to andincludes equity capital and disclosed reserves.As the RBI master circular on this points out: “Tier I capital consists mainly of share capital and disclosed reserves and it is a bank’s highest quality capital because it is fully available to cover losses.”
As the following table shows the average tier I capital of public sector banks is less than 8%. While this is the more than 6% tier I capital that banks are required to maintain under current norms, it is very close to the 7% tier I capital that banks will have to maintain under the Basel III norms, which need to be fully implemented by March 31, 2018.

Average Tier-I for PSU banks is less than 8%

This lack of capital has and will continue to constrain the ability of the public sector banks to lend and keep growing. The PJ Nayak committee report released in May 2014, estimated that between January 2014 and March 2018 “public sector banks would need Rs. 5.87 lakh crores of tier-I capital.”
The report further points out that “assuming that the Government puts in 60 per cent (though it will be challenging to raise the remaining 40 per cent from the capital markets), the Government would need to invest over Rs. 3.50 lakh crores.” In the next financial year’s budget the finance minister Arun Jaitley has committed just Rs 7,940 crore towards this. 
As analysts Ashish Gupta, Prashant Kumar and Kush Shah of Credit Suisse point out in a recent research note: “The amount allocated is almost the same as our estimate of total dividend likely to be paid by all PSU banks to the government in FY16. This indicates that government capital infusion going forward could be a function of only the profit generation ability of PSU banks.”
Also, by allocating a very small amount to towards public sector banks recapitalization, the message that the government seems to be giving the banks is that they are on their own. This in a way is good, given that the government clearly is not in a position to commit the kind of money required to recapitalize the public sector banks.
Nevertheless, many public sector banks are not in a position to raise money on their own, given the mess their balance sheet is in. As the Credit Suisse analysts point out: “Smaller/weaker PSU banks with limited ability to raise capital from markets will be worst affected as there is very little likelihood of getting capital next year as well.”
So what is the way out? The only way out for the government is to sell off the weaker banks. There is no reason that the government of India should be running more than 20 banks. It simply doesn’t make any sense. Mergers of the weaker banks with the stronger ones is not a feasible option for the simple reason that it will tend to pull down the well performing banks as well. 
Of course politically this will be difficult to implement. But that is the kind of strong governance that Narendra Modi promised the people of this country. It is now time to deliver.

The column originally appeared on The Daily Reckoning on Mar 12, 2015

The one assurance that Narendra Modi needs to give bankers…

narendra_modi
Vivek Kaul

The ministry of finance has organised a two day retreat for public sector banks in Pune over January 2 and 3, 2015. The retreat is being attended by the RBI governor Raghuram Rajan and the deputy governors as well. It will end today with brief presentations being made to the prime minister Narendra Modi. After the presentations the the prime minister will interact and address the gathering.
A press release issued by the ministry of finance basically outlined four objectives for this retreat, which are as follows:
(i) To create a platform for formal and informal discussions around the issues which are important for banking sector reforms.

(ii) To achieve a broad consensus on what has gone wrong and what should be done both by banks as well as by the government to improve and consolidate the position of PSBs.

(iii) To get some out of box ideas from prominent experts in the field as also from the top level managers attending the retreat.

(iv) The final objective would be to prepare a blue print of reform action plan once adopted which could then be implemented by the banks as well as by the government.

On paper this sounds like a good idea. It shows that the government is serious about figuring out what is wrong with the banking sector in India and working on it, instead of just letting things drift. Nevertheless, the retreat shouldn’t boil down into an excercise of exerting pressure on the public sector banks (PSBs) to lend more. With officials of ministry of finance attending the retreat as well, there are chances of that happening.
The total amount of loans being given by banks have slowed down in the recent past. Data released by the RBI shows that in November 2014 loans to industry increaed by 7.3% in comparison to November 2013. The loans had increased by 13.7% in November 2013 in comparison to November 2012. “Deceleration in credit growth to industry was observed in all major sub-sectors, barring construction, beverages & tobacco and mining & quarrying,” a RBI press release pointed out. Loans to the services sector grew at 9.9 per cent in November 2014 as compared with an increase of 18.1 per cent in November 2013.
The finance minister Arun Jaitley has time and again blamed high interest rates for this slowdown in bank lending as well as economic growth. In a speech he made on December 29, 2014, Jaitley said: “The cost of capital…I think in recent months or years…is one singular factor which has contributed to slowdown of manufacturing growth itself.”
This and other statements that Jaitley has made over the last few months tend to look at credit (or banks loans) as a flow. But is that really the case? As James Galbraith writes in The End of Normal: “Credit is not a flow. It is not something that can be forced downstream by clearing a pie. Credit is a contract. It requires a borrower as well as a lender, a customer as well as a bank. And the borrower must meet two conditions. One is creditworthiness…The other requirement is a willingness to borrow, motivated by the “animal spirits” of business enthusiasm. In a slump, such optimism is scarce. Even if people have collateral they want security of cash.”
Further, as Jeff Madrick points out in Seven Bad Ideas—How Mainstream Economists Have Damaged America and the World: “Business investment is not just affected by the supply of national savings but by the state of optimism. If consumer demand for goods is not strong, a business will have little incentive to invest, no matter how great profits are or how low interest rates are on bank loans.” These are very important points that the mandarins who run the ministry of finance in this country need to understand.
So how good is the creditworthiness(or the ability to repay a loan) of Indian companies? The answer for this is provided in the recent Mid Year Economic Analysis released by the ministry of finance. As the report points out: “More than one-third firms have an interest coverage ratio of less than one (borrowing is used to cover interest payments). Over-indebtedness in the corporate sector with median debt-equity ratios at 70 percent is amongst the highest in the world.”
Interest coverage ratio is the earnings before income and taxes of a company divided by the interest it needs to pay on its debt. If the ratio is less than one what it means is that the company is not earning enough to repay even the interest on it debt. The interest then needs to be repaid by taking on more debt. This works just like a Ponzi scheme, which keeps running as long as money being brought in by new investors is greater than the money that needs to be paid to the old investors.
In this situation it is not surprising that the bad loans of banks, particularly public sector banks have gone up dramatically. As the latest financial stability report released by the RBI points out: “The gross non-performing advances (GNPAs) of scheduled commercial banks(SCBs) as a percentage of the total gross advances increased to 4.5 per cent in September 2014 from 4.1 per cent in March 2014.”
The stressed loans of banks also went up. “Stressed advances increased to 10.7 per cent of the total advances from 10.0 per cent between March and September 2014. PSBs 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 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 question that crops up here is why is the stressed asset ratio of public sector banks three times that of private sector banks? The financial stability report has the answer for this as well. As the report points out: “Five sub-sectors: infrastructure, iron and steel, textiles, mining (including coal) and aviation, had significantly higher levels of stressed assets and thus these sub-sectors were identified as ‘stressed’ sectors in previous financial stability reports. These five sub-sectors had 52 per cent of total stressed advances of all SCBs as of June 2014, whereas in the case of PSBs it was at 54 per cent.”
As is well known that these sectors are full of crony capitalists who were close to the previous political dispensation. This forced the public sector banks to lend money to these companies and now these companies are either not in a position to repay or have simply fleeced the bank and not repaid.
The report further points out that the public sector banks have the highest exposure to the infrastructure sector: “Among bank groups, exposure of PSBs to infrastructure stood at 17.5 per cent of their gross advances as of September 2014. This was significantly higher than that of private sector banks (at 9.6 per cent) and foreign banks (at 12.1 per cent).”
Public sector banks haven’t been able to recover these loans from businessmen who have defaulted on them. Given this, if there is one assurance that Narendra Modi needs to give to public sector banks, it has to be this—he needs to assure them that there will be absolutely no pressure on them from his government to lend money to crony capitalists who are close to the current political dispensation.
This single measure, if followed, will go a long way in improving the situation of public sector banks in this country. It will be one solid move towards the promised acche din.

The article originally appeared on www.equitymaster.com as a part of The Daily Reckoning on Jan 3, 2015

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)

The great Indian debt time bomb

time bombVivek Kaul

On November 17, 2014, Adani Enterprises put out a statement saying: “Adani Mining, the Australian subsidiary of Adani Enterprises, and the State Bank of India (SBI), the country’s largest lender, have today signed an MOU in the aftermath of the successful Brisbane G20 Summit…The MOU provides for a credit facility of up to $1 billion USD subject to the detailed assessment of the company’s mine project at Carmichael, near Clermont in Western Queensland.”
This MOU was questioned in the media. The basic question asked was: Should Adani Enterprises, a company already having a lot of debt, be allowed to raise more debt? Further, the environmental concerns around the mine were highlighted as well.
As on September 30, 2014, the total debt of the company stood at Rs 72,632.37 crore.  It had shot up by Rs 7653.33 crore from where it was on March 31, 2014.
The total operating profit of the company over the last four quarters was at Rs 8,999.92 crore. The interest that it paid on its debt was Rs 5,733.77 crore. This means an interest coverage ratio of around 1.57.
Interest coverage ratio is essentially the earnings before interest, taxes and exceptional items (or operating profit) of a company divided by its interest expense. It tells us whether the company is making enough money to pay the interest on its outstanding debt.
If we look quarterly data, the situation becomes more interesting. The interest coverage ratio of the company was 2.67, for the period of three months ending March 31, 2014. It fell to 1.58 as on June 30, 2014. And for the period of three months ending September 30, 2014,it stood at 1.12.
An interest coverage ratio of close to one basically tells us that the company is making just about enough money to keep paying interest on the debt that it has. Clearly, a worrying situation. Ideally, the interest coverage ratio of a company should be over 1.5.
What this tells us is that Adani Enterprises isn’t in the best financial shape. After some criticism in the media, Arundhati Bhattacharya, the chairman of SBI, said that the loan will go through “proper due diligence both on the credit side as well as on the viability side.” She also said that the board of SBI had yet to take a call on the loan. “The board will take a call and then only the loan will be sanctioned,” Bhattacharya said.
Bhattacharya further clarified that a new loan to Adani Enterprises will be given only after the company had repaid portions of the earlier loan given to them by SBI. After that had happened, the fresh lending to the company would work out to only $200-400 million.
As far as environmental concerns went, Bhattacharya said that she had been assured by the Queensland government (where the Carmichael mine is located) that there were no environmental issues around the project.
News-reports appearing in the media clearly suggest otherwise. There seem to be environmental concerns around the mine, as the project is adjacent to the Great Barrier Reef. A recent news-report in the British newspaper The Guardian said that the Rainforest Action Network, a US environment group, had written commitments from US banking giants Citigroup,Goldman Sachs, and JPMorgan Chase, to not back the project.
Before this several British banks had also ruled out funding the project. The news-report pointed out that “several avenues of finance have already been shut off to the $16.5bn project. Deutsche Bank, Royal Bank of Scotland, HSBC and Barclays all ruled out funding the development, before the US banks’ refusal.”
Another recent report in The Guardian points out “construction of Australia’s largest ever mine[i.e. the Carmichael mine] will be well underway before its impact upon the environment is known, with a requirement to replace critically endangered habitat razed by the project pushed back by two full years.”
So, clearly there are environment concerns around the mine, irrespective of what Bhattacharya has been told by the Queensland government. Nevertheless, it was nice to see Bhattacharya come out in the open and clarify that SBI would go through proper due diligence before deciding to give Adani another loan.
If other public sector banks had done that in the past, they would not be in a mess that they currently are in. In August 2014, the finance minister Arun Jaitley had told the Parliament that bad loans in the banking system had risen to 4.03% of the advances in 2013-14. The number had stood at 3.42% in 2012-13 and 2.94% in 2011-12.
In fact, the situation is much worse for public sector banks. As on March 31, 2013, the gross non performing assets (NPAs) of public sector banks had stood at 3.63% of the gross advances. By September 30, 2014, this had jumped up to 4.80% of the gross advances. During the same period the gross NPAs of private sector banks has been more or less stable at 1.8% of gross advances.
This is something that the Reserve Bank of India points out in the Financial Stability Report released towards the end of June 2014, as well. The stressed advances of the Indian banking system stood at 9.8% of the total advances. For public sector banks the number stood at 11.7%. What this means in simple English is that for every Rs 100 given by Indian banks as a loan nearly Rs 9.8 is in shaky territory (for public sector banks the number is at Rs 11.7) 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 report further points out that “There are five sub-sectors: infrastructure (which includes power generation, telecommunications, roads, ports, airports, railways [other than Indian Railways] and other infrastructure), iron and steel, textiles, mining (including coal) and aviation services which contribute significantly to the level of stressed advances.”
These sectors (especially the infrastructure sector) are dominated by crony capitalists, who were able to get loans from public sector banks, and are now unable to repay them.
An excellent example here is that of Lanco Infratech. As on March 31, 2014, the company had total loans amounting to Rs 34,877 crore. Against this the company had a shareholders’ equity of Rs 1,457 crore. This means the company had a debt to equity ratio of around 24. Not surprisingly for the period of three months ending September 30, 2014, the company had an operating profit of Rs 317.23 crore and finance costs of Rs 773.02 crore.
What this clearly tells us is that the banks giving loans to this company did not do any due diligence or were simply under pressure to hand out loans. This is not surprising given that its founding Chairman L Rajagopal was a member of parliament from Vijaywada on a Congress Party ticket, in the last Lok Sabha.
There are many other companies run by crony capitalists which are in a similar situation and are unable to repay the loans they had taken on. This has led to trouble for banks, particularly the public sector banks.
Uday Kotak, Executive Vice Chairman and Managing Director of Kotak Mahindra Bank, in a television interview earlier this year had estimated 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.
To conclude, it is worth recounting here what the economist John Maynard Keynes once said “If you owe your bank a hundred pounds, you have a problem. But if you owe your bank a million pounds, it has.”
The modern day version of this quote was put forward by the Economist magazine when it said “If you owe your bank a billion pounds everybody has a problem.”
The point being that any bank has to be very careful when giving out a large loan. Indian public sector banks seem to have forgotten that over the last few years. And now we have a problem.

The article originally appeared on www.equitymaster.com on Nov 24, 2014