Tag: Retail Loans | Vivek Kaul

28 October, 202028 October, 2020

What’s the Logic Behind Govt’s मांडवली (compromise) on Interest on Interest with Supreme Court?

Three institutions, the Reserve Bank of India (RBI), the Supreme Court and the Department of Financial Services, have spent more than a few weeks in deciding on waiving off the interest on interest on all retail loans and MSME loans of up to Rs 2 crore.

Resources at three systematically important institutions have been used to arrive at something which is basically largely useless for the economy as a whole, is bad for banks and sets a bad precedent which can lead to a major headache for both the government as well as the Supreme Court, in the time to come.

This is India’s Big Government at work, spending precious time on things which it really shouldn’t be. Let’s take a look at this issue pointwise.

1) By waiving off interest on interest on all retail loans and MSME loans of up to Rs 2 crore, for a period of six months between March and August 2020 when many loans were under a moratorium, the government is essentially fiddling around with the contract that banks entered with borrowers. A government interfering with contracts is never a good idea. If at all, negotiations for any waiver should have happened directly between banks and their borrowers, under the overall supervision of the RBI.

2) Some media houses have equated this waiver with a Diwali gift and an additional stimulus to the economy etc. This is rubbish of the highest order. The government estimates that this waiver of interest on interest applicable on loans given by banks as well as non-banking finance companies (NBFCs) is going to cost it Rs 6,500 crore. Other estimates made by financial institutions are higher than this. The rating agency Crisil estimates that this waiver is going to cost Rs 7,500 crore. Another estimate made by Kotak Institutional Equities put the cost of this waiver at Rs 8,500 crore.

Whatever be the cost, it is worth remembering here that the money that will go towards the waiver, is money that the government could have spent somewhere else. In that sense, unless the government increases its overall expenditure because of this waiver, it cannot be considered as a stimulus. Even if it does increase its overall expenditure, it will have to look at earning this money through some other route. The chances are, we will end up paying for it in the form of some higher tax (most likely a higher excise duty on petrol and diesel).

3) Also, the question that is bothering me the most on this issue, is a question that no one seems to be asking. Who is this move going to benefit? Let’s take an extreme example here to understand this. Let’s say an individual took a home loan of Rs 2 crore to be repaid over 20 years at an interest rate of 8%. He or she took a loan in early March and immediately put it up for moratorium once it was offered.

The moratorium lasted six months. The simple interest on the loan of Rs 2 crore for a period of six months amounts to Rs 8 lakh (8% of Rs 2 crore divided by 2).

This is not how banks operate. They calculate interest on a monthly basis. At 8% per year, the monthly interest works out to 0.67% (8% divided by 12). The interest for the first month works out to Rs 1.33 lakh (0.67% of Rs 2 crore).

Since the loan is under a moratorium and is not being repaid, this interest is added to the loan amount outstanding of Rs 2 crore.

Hence, the loan amount outstanding at the end of the first month is Rs 2.013 crore (Rs 2 crore + Rs 1.33 lakh). In the second month, the interest is calculated on this amount and it works out to Rs 1.34 lakh (0.67% of Rs 2.013 crore).

In this case, we calculate interest on the original outstanding amount of Rs 2 crore. We also calculate the interest on Rs 1.33 lakh, the interest outstanding at the point of the first month, which has become a part of the loan outstanding. This is interest on interest.

At the end of the second month, the loan amount outstanding is Rs 2.027 crore (Rs 2.013 crore + Rs 1.34 lakh). This is how things continue month on month, with interest being charged on interest.

At the end of six months, we end up with a loan outstanding of Rs 2.081 crore. This is Rs 8.134 lakh more than the initial loan outstanding of Rs 2 crore. As mentioned initially, the simple interest on Rs 2 crore at 8% for a period of six months works out to Rs 8 lakh.

Hence, the interest on interest works out to Rs 13,452 (Rs 8.134 lakh minus Rs 8 lakh).

Why did I consider this extreme example? I did so in order to show the futility of what is on. An individual who has taken a home loan of Rs 2 crore is not in a position to pay a total interest on interest of Rs 13,452, is a question well worth asking? Who are we trying to fool here? Given that the moratorium was for a period of six months, the average interest on interest works out to Rs 2,242 per month.

Even at a higher interest rate of 12% (let’s say for MSMEs), the average interest on interest works out to a little over Rs 2,500 per month. Are MSMEs not in a position to pay even this?

So, who are we doing this for? No one seems to have bothered asking and answering this most important question.

4) I guess it’s not fair to blame the government, at least for this mess. The petitioners wanted interest on loans for the period during the moratorium waived off. The Judges entertained them and the government had to find a way out so that the Judges could feel that they had done something at the end of the day and not feel embarrassed about the entire situation.

Crisil estimates that an interest rate waiver of retail and MSME loans of up to Rs 2 crore (including interest on interest) would have cost the government a whopping Rs 1,50,000 crore. Both the government and the RBI wanted to avoid this situation and ended up doing what in Mumbai is called a मांडवली or a compromise. Hence, clearly things could have been worse. Thankfully, they aren’t.

5) The case has dragged on for too long. Currently, banks are not allowed to mark any account which was a standard account as of August 31, as a default. The longer the case goes on, the longer it will take the banking system to recognise the gravity of the bad loans problem post-covid. Bad loans are loans which haven’t been repaid for a period of 90 days or more.

Also, this isn’t good news for banks which had provisioned (or set money aside) to quickly deal with the losses they would face due to the post-covid defaults.

Even at the best possible rate, the gravity of the problem facing banks will come out in the public domain only by the middle of next year now. And that’s just too long. Instead of the government, this time around, the Supreme Court has helped kick the bad loans can down the road.

Ideally, banks should have started recognising post-covid bad loans by now and also, started to plan what to do about it.

6) The banks will have to first pass on the waiver to the borrowers and will then get compensated by the government. As anyone who has ever dealt with the government when it comes to payments will assure you, it can be a real pain. Thankfully, the amount involved on the whole is not very large and the banks should be able to handle any delay on part of the government.

7) This is a point I have made before, but given the seriousness of the issue, it needs to be repeated. Interest is nothing but the price of money. By meddling with the price of money, the Supreme Court has opened a Pandora’s box for itself and the government. There is nothing that stops others from approaching the Courts now and asking for prices of other things, everything from real estate to medicines, to be reduced. Where will it stop?

To conclude, India’s Big Government only keeps getting bigger in its ambition to do much more than it can possibly do. The interest on interest issue is another excellent example of this.

26 March, 2018

Corporates Responsible for More Than 80% of Bad Loans of Public Sector Banks

One of the points that we have been making regularly in our columns and Letters is that public sector banks should not be lending to corporates. And now we have found more data to back it.

In a written answer to a question raised in the Lok Sabha, the government provided data regarding the accumulated bad loans across different areas of lending. Bad loans are basically loans on which repayment has been due for 90 days or more.

Take a look at Table 1.

Table 1:

As on March 31, 2017	Industry	Agriculture and Allied Activities	Services	Retail Loans	Other loans
Total NPAs	4,70,084	57,021	84,686	23,795	5,470

Source: Unstarred Question No: 4614, March 23, 2018

It is clear from the above table that lending to industry forms a bulk of the bad loans of public sector banks. The total bad loans of public sector banks as on March 31, 2017, had stood at Rs 6,41,057 crore.

This basically means that lending to industry forms 73.3% of the total bad loans of public sector banks. Or to put it a little differently, lending to industry forms nearly three-fourths of the bad loans of public sector banks. Take a look at Table 2, which basically lists out the proportion of bad loans that have accumulated for public sector banks, from different forms of lending.

Table 2:

Sector (As on March 31, 2018)	Proportion of bad loans in each sector
Industry	73.33%
Agriculture and Allied Activities	8.89%
Services	13.21%
Retail Loans	3.71%

Source: Author calculations on data taken from Unstarred Question No: 4614, March 23, 2018 and Centre for Monitoring Indian Economy

Table 2 tells us very clearly that the industry and services sector are together responsible for 86.5% of the accumulated bad loans of public sector banks. This basically means that Indian corporates (because while lending to the services sector also, banks are lending to corporates) are responsible for more than 80% of the bad loans of public sector banks.

Of course, one can’t just look at bad loans in isolation of the total loans given out by public sector banks in each of the different areas. Take a look at Table 3, which lists the proportion of the overall loans, given to each sector.

Table 3:

Sector (As on March 31, 2017)	Proportion of loans
Industry	37.78%
Agriculture and Allied Activities	13.99%
Services	25.40%
Retail Loans	22.83%

Source: Centre for Monitoring Indian Economy.

Table 3 makes for a very interesting reading. The total lending to industry by public sector banks forms around 37.8% of the total lending. On the other hand, as we can see from Table 2, the lending to industry is responsible for 73.3% of bad loans. This clearly tells us where the problem with Indian banking is.

Now, let’s take a look at Table 4, which basically lists the bad loans of different sectors as a proportion of total lending carried out to that sector.

Table 4:

Sector	Total Bad loans (in Rs crore)	Total loans	Bad loans (in %)
Industry	4,70,084	26,80,025.00	17.54%
Agriculture and Allied Activities	57,021	9,92,387.00	5.75%
Services	84,686	18,02,243.00	4.70%
Retail Loans	23,795	16,20,034.00	1.47%

Source: Author calculations on data taken from Unstarred Question No: 4614, March 23, 2018 and Centre for Monitoring Indian Economy

What does Table 4 tell us? For every Rs 100 that Indian public sector banks have lent to industry, Rs 17.5 has not been repaid. For retail loans, the bad loans rate is 1.47%. This shows the difference between lending to industry and lending to individuals.

Finally, let’s take a look at Table 5, which lists the retail NPAs and the industry NPAs of different banks as on December 31, 2017.

Table 5:

Name of the bank	Retail NPA in%	Industry NPA in %
State Bank of India	1.3	21.9
Bank of India	2.6	27.6
Syndicate Bank	4	16
Bank of Baroda	3.4	16
IDBI Bank	1.4	39.4
Central Bank of India	4.6	23.5
Bank of Maharashtra	4.4	15.3
Andhra Bank	1.8	29.1

Source: Investor/Analyst presentations of banks.

One look at Table 5 makes it clear that public sector banks do a fairly decent job of lending to the retail sector. The retail bad loans are all less than 5% in every case, whereas the corporate NPAs are higher than 15%.

There are multiple reasons for this. There is no pressure from politicians to lend to crony capitalists when it comes to retail lending. The managers can carry out proper due diligence while giving the loan.

There is very little incentive for the manager to crack a deal on the side, with a retail borrower (unlike is the case with a loan given to industry) and give a loan, where he shouldn’t be giving one. This is primarily because the average loan amount is much smaller in case of a retail loan than a loan to industry, and any dishonesty while giving a retail loan is really not worth the risk.

In case of default, the legal system can be unleashed on to the retail borrower, unlike a loan given to industry, which has access to the best lawyers. A retail defaulter is unlikely to leave the country, like has been the case with several corporate defaulters, in the recent past. The asset against which the loan has been given to a retail borrower can be easily repossessed in case of default, unlike is the case with a loan given to industry.

In case of a home loan, which forms a little over 50% of all the retail loans given out by banks, the value of the home against which the loan has been given tends to much more than the outstanding loan at any point of time. This is primarily because banks don’t fund 100% of the value of the home, getting the borrower to put in at least 20% as a down payment. Over and above this, most homes in India when they are bought also involve the payment of a black component and this adds to the margin of safety of the bank.

In comparison, many loans given to industry are gold plated where the borrower essentially fudges the cost of the project, takes a higher loan than he should and then tunnels money out from the project, thus having very little of his equity in the project. In some cases, the value of the asset against which the loan has been taken tends to be lower than the value of the loan.

Narrow banking is the solution. Most of the public sector banks in India, should not be lending to corporates.

It will ensure that Indian public sector banks do not end up in the mess that they currently are in, anytime in the near future. The trouble is the politicians aren’t going to like it because it is the crony capitalists who fund their elections at the end of the day. And where do crony capitalists get their money from?

The other problem is that if banks do not lend for long term projects, what is the alternative arrangement? The corporate bond market in India barely exists. Pension funds, provident funds and insurance companies, prefer to invest in government bonds, and do not really have the expertise to invest in long term corporate projects. The project finance institutions of yore do not exist, having turned themselves into retail banks.

Having said that, the first and the foremost function of a bank is to ensure the safety of the money of the depositors.

To conclude, all these factors leave the public sector banks in India, in an extremely vulnerable space. As far as the government (or should I say governments) is concerned, all it has done is to throw money at the problem, which is never enough to solve any problem.

Some thinking is necessary as well.

The column originally appeared on Equitymaster on March 26, 2018.

26 July, 2017

What a Slowdown in Retail Loans Tell Us About a Slowing Economy

In the recent past a lot has been written about the overall slowdown in bank lending. Take a look at Figure 1. It essentially tells us about the loans given out by banks during the period between May 2016 and May 2017, and May 2015 and May 2016, before that.

Let’s start with non-food credit. These are the loans given out by banks after we have adjusted for food credit or loans given to the Food Corporation of India and other state procurement agencies, for buying rice and wheat directly from farmers at the minimum support price (MSP) for the public distribution system.

Figure 1:

Type of Loan	Total Loans Given Between May 2016 and May 2017 (in Rs Crore)	Total Loans Given Between May 2015 and May 2016 (in Rs Crore)
Non-Food Credit	4,22,001	6,25,975
Loans to industry	-56,455	24,383
Retail Loans	1,94,553	2,27,863

Source: Reserve Bank of India

The total amount of non-food credit given out between May 2016 and May 2017 is down by 33 per cent to Rs 4,22,001 crore, in comparison to the period between May 2015 and May 2016. Hence, there has been a huge overall slowdown in the total amount of loans given out by banks over the last one year, in comparison to the year before that.

Why has that been the case? The major reason for the same are loans to industry. Banks are in no mood to give out loans to industry. During the period May 2016 and May 2017, the total loans to industry actually shrunk by Rs 56,455 crore. This basically means that on the whole the banks did not give a single rupee of a new loan to the industry. During the period May 2015 and May 2016, banks had given fresh loans worth Rs 24,383 crore to industry, overall.

This is happening primarily because banks have run a huge amount of bad loans on loans they had given to industry in the past. As on March 31, 2017, the bad loans ratio of public sector banks when it came to lending to industry, stood at 22.3 per cent. Hence, for every Rs 100 of loan made to industry by public sector banks, Rs 22.3 had turned into a bad loan i.e. the repayment from a borrower has been due for 90 days or more.

Not surprisingly, these banks are not interested in lending to industry anymore. This has been a major reason behind the overall slowdown in lending carried out by banks, as we have seen earlier.

But one part of lending that no one seems to be talking about is retail lending carried out by banks. This primarily consists of housing loans, vehicle loans, consumer durables loans, credit card outstanding, loans against fixed deposits, etc. The assumption is that all is well on the retail loan front.

As far as bad loans are concerned, things are going well on the retail loans front. But what about the total amount of retail loans given by banks? Between May 2016 and May 2017, the total amount of retail loans given by banks stood at Rs 1,94,533 crore. This was down by around 15 per cent to the amount of retail loans given by banks between May 2015 and May 2016. This, despite the fact that interest rates on retail loans have come down dramatically in the post demonetisation era. You can get a home loan now at an interest of as low as 8.35 per cent per year.

A major reason for this slowdown in retail loans are housing loans, which form the most significant part of retail loans. Between May 2016 and May 2017, the total amount of housing loans given by banks stood at Rs 92,469 crore down by 22 per cent in comparison to the housing loans given out by banks between May 2015 and May 2016.

Lower interest rates on home loans haven’t helped much. The only explanation of this lies in the fact that high real estate prices continue to be the order of the day across the country. How do things look with vehicle loans which form a significant part of the retail loans? Between May 2016 and May 2017, banks gave out vehicle loans worth Rs 18,447 crore, 26 per cent lower than the vehicle loans given out by banks between May 2015 and May 2016.

What does this tell us? It tells us very clearly that things have deteriorated even on the retail loans front. People take on retail loans only when they are sure that they will be able to continue repaying the EMIs in the years to come (unlike corporates). The fall in the total amount of retail loans lent by banks over the last one year clearly tells us that the confidence to repay EMIs, is not very strong right now.

This is another good indicator of the overall slowdown in the Indian economy, which has happened in the post demonetisation era.

The column originally appeared in Equitymaster on July 24, 2017.

1 March, 2017

Believe in Indian GDP Growth at Your Own Peril

Yesterday (i.e. February 28, 2017), the Ministry of Statistics and Programme Implementation (MOSPI), published the quarterly estimates of the Gross Domestic Product(GDP) for October to December 2016.

As per this estimate, the GDP grew by 7 per cent for the October to December 2016 period, in comparison to the same period in 2015. In fact, MOSPI estimates that the Indian GDP for 2016-2017 will grow by 7.1 per cent.

What this tells us is that there has been almost no impact of demonetisation on economic growth (as measured by GDP growth), even during the period of October to December 2016, when demonetisation happened.

The question is how believable is this? One way of measuring the GDP is through the expenditure method. Under this method, the GDP is obtained by adding private consumption expenditure, government consumption expenditure, investments and net exports (imports minus exports). The private consumption expenditure forms a bulk of the GDP measured through this method.

The interesting thing is that the private consumption expenditure (at constant prices) for the October to December 2016, rose by 10.1 per cent, in comparison to the same period in 2015. This is the second fastest rise since June 2011. The data for the new GDP series adopted in January 2015 is only available up until then. GDP at constant prices essentially takes inflation into account.

Take a look at Figure 1. It shows the one year growth rate of private consumption expenditure, over the last five years.

Figure 1

The private consumption expenditure grew by 10.1 per cent in the October to December 2016 period. This, as mentioned earlier is the second fastest growth rate over the last five years. This seems unbelievable given that between November 9 and December 30, 2016, the currency in circulation had gown down dramatically, as Rs 500 and Rs 1,000 paper notes were demonetised and suddenly had no value.

Figure 2 shows this.

Figure 2

With the currency under circulation crashing, there wasn’t enough currency going around to carry out transactions. A bulk of the transactions in the Indian economy are carried out in cash. As per a PwC report cash/currency accounts for 98 per cent of consumer payments by volume in India. Take a look at Figure 3.

Figure 3

The Economic Survey of 2016-2017 points out: “The Watal Committee has recently estimated that cash accounts for about 78 percent of all consumer payments.” Hence, cash/currency accounts for bulk of consumer payments in India.

Demonetisation essentially rendered 86.4 per cent of the currency in circulation useless overnight. This made consumer transactions very difficult to carry out. While, the government did replace the money rendered useless with new money, but initially only Rs 2,000 notes made it to the financial system. These notes were very difficult to use because people found it difficult to give change, when almost no new Rs 500 notes were available. Hence, they were as good as useless for most of November and December 2016.

In this environment, how did private consumption expenditure grow by 10.1 per cent, the second fastest since June 2011, is a question worth asking?

One possibility is that people may have borrowed and bought things and in the process private consumption grew. Now take a look at Figure 4. It essentially shows the growth in retail loans given by banks between October and December across several years. Retail loans include loans given by banks to buy cars, two-wheelers, consumer durables, homes, credit card outstanding etc. They are a good measure of how robust the private consumption scene in the country is.

Figure 4

The growth in retail loans between October and December 2016 was almost flat at 0.5 per cent. This isn’t surprising given that most of the retail banking staff of banks was busy dealing with all the cash making it back to the banks because of demonetisation. What the figure also tells us is that the growth in retail loans between October to December 2016 has been the slowest in last five years.

Figure 4 clearly tells us that people did not borrow and spend between October and December 2016. So, the question is where did the growth in private consumption expenditure come about? One theory that has been offered is that many people bought a lot of gold using their old Rs 500 and Rs 1,000. The goldsmiths helped them by backdating their purchases.

This is one of those things that sounds to be true as soon as one hears it. But what does data tell us about this? India does not produce any gold of its own. If a lot of gold has been bought in this way, then the gold import numbers should go up in the months to come. The initial evidence on this front suggests otherwise.

Take a look at Figure 5.

Figure 5

Gold imports were high in November 2016 because of the festive season as well as the marriage season. And typically gold imports are high in November. If a lot of gold was bought by those who converted their black money held in the form of old Rs 500 and Rs 1,000 notes into gold, then gold imports should have picked up in December 2016 and January 2017, but they haven’t. They are considerably lower in comparison to December 2015 and January 2016. This basically puts the gold theory out of the window.

The other theory offered in explanation to private consumption expenditure going up has been that people bought a lot of iPhones after demonetisation was announced. How can the sale of one product push up GDP numbers is beyond my comprehension, but I will not get into that. While Apples sales did go up in October (pre-demonetisation) and November (eight days with no demonetisation), the sales crashed in December because of lack of cash in the financial system.

As a newsreport in The Economic Times points out: “After a cracker of sales in October-November, which heralded strong growth for that quarter, purchases of iPhones dwindled mainly because of the lack of cash, which had fuelled buying before demonetisation. That’s forced Apple to scale down its India revenue target to $2 billion for its fiscal year (October 2016-September 2017) from $3 billion.”

Also, the sales of many consumer goods companies fell during the period. (You can read about it here).

Essentially what all this tells us is that it is very difficult to believe that private consumption expenditure grew by 10.1 per cent during October to December 2016, despite demonetisation. There is something that clearly does not add up here. In fact, take a look at Figure 6. It shows what portion of the GDP is made up by private consumption expenditure.

Figure 6

As can be seen from Figure 6, the private consumption expenditure share in GDP is at very high levels. Also, the kind of jump seen between the period of three months ending September 2016 and the period of three months ending December 2016, has never been seen before.

And given that private consumption expenditure forms a bulk of the GDP, all in all, this tells us that there is something that just doesn’t smell right about India growing by 7 per cent in October to December 2016, when the currency situation was very tight.

The column originally appeared on Equitymaster on March 1, 2017.