Taxpayers will have to Pick-Up the Final Bill of the Mess in Govt Banks



In a column I wrote last week I said that I was happy that the profit of the State Bank of India, the country’s largest bank, had fallen by 62%. Along the same lines I need to say that I am happy that the Bank of Baroda has made a loss of Rs 3342 crore, for the period October to December 2015. This is the biggest loss ever made by any Indian bank. In fact, the losses would have been higher if not for a Rs 1,118 crore tax write-back that the bank got.

Over the years, banks have not been recognising bad loans as bad loans. This process that has started now and is bringing out the real state of the Indian public sector banks and that is a good thing. In case of Bank of Baroda, the gross non-performing loans (or bad loans) of the bank jumped by 152% to Rs 38,934 crore, in comparison to as on December 2014. In percentage terms, the bad loans as of December 2015 stand at 9.68% of total lending in comparison to 3.85% in December 2014.

What this clearly tells us is that the Bank of Baroda, like the other public sector banks, had been under-declaring its bad loans up until now. This can be easily said from the fact the bad loans as a percentage of total loans, as on September 2015, had stood at 5.56%. By December 2015, this had jumped up by 412 basis points to 9.68%. One basis point is one hundredth of a percentage.

The situation could not have become so bad over a period of just three months. This clearly tells us that the bank had not been putting out the correct situation of its loans earlier. But now that it is, the stock market is clearly happy about it, with the stock rallying by 22% to Rs 139.55 as on February 15, 2016.

It needs to be pointed out here that the public sector banks are finally getting around to presenting the right set of accounts because the RBI led by Raghuram Rajan has pushed them to do so, by unleashing the asset quality review on to them.

As Rajan pointed out in a recent speech: “ With markets generally in decline, the decline in bank share prices has been more accentuated. However, part of the reason is that some bank results, mainly public sector banks, have not been, to put it mildly, pretty. Clearly, an important factor has been the Asset Quality Review (AQR) conducted by the Reserve Bank and its aftermath.”

This leads to the question as to what was the RBI doing all these years, especially in the pre-Rajan years given that such a huge build-up of bad loans couldn’t have happened overnight.

Also, it needs to be clarified here that a bad loan doesn’t mean that the bank has lost all the money. This seems to be the general understanding and is incorrect. A loan is typically declared to be a non-performing asset (or a bad loan), 90 days after the borrower starts defaulting on the interest and principal payments. When this happens a bank can no longer continue to accrue interest on the portion of the loan that remains unpaid. It has to start making provisions i.e. start keeping money aside.

This basically means that the bank starts keeping money aside so that if the loan is totally defaulted on or partially defaulted on or the bank cannot recover enough money from the assets that it has as a collateral, then enough money has been set aside to meet the losses.

Along these lines, the Bank of Baroda has increased its provisioning. For October to December 2015, the bank set aside Rs 6,165 crore. This is an increase of 389% in comparison to the money it had set aside for September to December 2014.

The question is even with this huge jump in provisioning, is the bank setting aside enough? The Reserve Bank of India(RBI) Master Circular on Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances: “Banks should build up provisioning and capital buffers in good times i.e. when the profits are good, which can be used for absorbing losses in a downturn. This will enhance the soundness of individual banks, as also the stability of the financial sector. It was, therefore, decided that banks should augment their provisioning cushions…and ensure that their total provisioning coverage ratio…is not less than 70 per cent.”

The provisioning coverage ratio is defined as the total provisions set aside by a bank as on a particular date divided by the total gross non-performing assets (bad loans) of the bank as on the same day.

The RBI wants banks to maintain a provision coverage ratio of 70%. But that doesn’t seem to have happened. In fact, as a recent news-report in The Indian Express points out: “An analysis of provisioning coverage ratio data of 20 public sector banks for March 2011 to March 2015 shows a steady fall in the coverage ratio. It has dropped from an average of 72 per cent for the group of 20 banks in the year-ended March 2011 to 57 per cent for the year-ended March 2015.”

In fact, for Bank of Baroda, the provisioning coverage ratio as on March 31, 2015, had stood at 64.99%. Since then, despite the absolute jump in provisioning, the provisioning coverage ratio of the bank has fallen to 52.70%. So, the bank clearly is not setting aside enough money against its bad loans, even though its setting aside more money in absolute terms, than it has done in the past.

How do things look for other banks? Let’s take the case of Punjab National Bank, the second largest public sector bank. The provisioning coverage ratio of the bank as on March 31, 2015, was at 58.21%, since then it has fallen to 53.85%. The same is the case with the State Bank of India. The ratio has fallen from 69.13% to 65.23%.

So none of the bigger public sector banks are fulfilling the provisioning coverage requirement of 70% as required by the RBI. What this tells us is that if the banks work towards achieving this ratio in the coming quarters, the losses of these banks will only go up. This would also mean eating into the capital of the bank.

Also, it is worth asking here what portion of the bad loans will the public sector banks be able to recover? The answer is not encouraging if we look at the numbers of the two biggest banks—the State Bank of India and the Punjab National Bank.

During the course of this financial year, the State Bank of India has managed to recover loans of Rs 2,761 crore. During the period its bad loans jumped up from Rs 56,725 crore to Rs 72,792 crore.

How do things look for Punjab National Bank? During the course of this financial year, the bank has managed to recover loans worth Rs 6,382 crore. During the same period, the bad loans of the bank have jumped from Rs 25,695 crore to Rs 34,338 crore. For both, State Bank of India as well as Punjab National Bank, there has been a huge jump in the loans recovered in comparison to April to December 2014. Nevertheless, the total amount of bad loans has gone up as well, in effect negating the recoveries. And this doesn’t augur well for the banks.

My guess is that public sector banks losses will eat into their capital in the months and years to come and the government (i.e. the taxpayer) will have to keep coming to their rescue by infusing fresh capital into these banks. Since 2010, the government has pumped in Rs 67,734 crore into public sector banks. It will have to put in a lot more money in the days to come.

As Michael Pettis writes in The Great Rebalancing: “Traditionally the cost of a banking crisis is borne directly or indirectly by households. Whether it is in the form of foregone deposits, government bailouts funded by household taxes…Households always foot the bill for banking crisis.”

The situation in India will be no different.

The column was originally published in the Vivek Kaul Diary on Equitymaster on February 16, 2016

Some new old lessons on black money

Credit Suisse released the Global Wealth Report earlier this month. The report had some very interesting data points in the Indian context.
As the report points out: “Measured in domestic terms, wealth has grown rapidly in India since 2000 except during the global financial crisis. Annual growth of wealth per adult in rupees has averaged 8% over 2000–2015.” This is a clear reflection of the strong economic growth India has experienced since the turn of the century.

There are some other interesting data points in the report as well. “As in many other developing countries, personal wealth in India is dominated by property and other real assets, which make up 86% of estimated household assets,” the report points out.

It further points out “a very small proportion of the population (just 0.3%) has a net worth over USD 100,000. However, due to India’s large population, this translates into 2.4 million people. India has 254,000 members of the top 1% of global wealth holders, which equates to a 0.5% share.”

Let’s look at the second point first. So India has 254,000 members in the top 1% of the global wealth holders. It is worth remembering here that in his February 2013 budget speech, the then finance minister P Chidambaram had estimated that India had only 42,800 people with a taxable income of Rs 1 crore or more.

Between 2013 and 2015, the number of people with a taxable income of Rs 1 crore or more must have gone up a bit. No new data is available and given that we can assume that the number is perhaps around 50,000.

So, India officially has 50,000 individuals with a taxable income of Rs 1 crore per year. At the same time there are 254,000 members in the top 1% of global wealth holders. There is a huge dichotomy here. The total global wealth as per the Credit Suisse report stands at $250.1 trillion.

Income on which tax has to be paid and accumulated wealth, are two different things. Nevertheless, wealth cannot be built unless an income is earned. And if an income is being earned, some tax needs to be paid on it.

What this tells us is that many Indians are earning incomes, building wealth, but not paying any income tax. A bulk of the “black money” on which tax has not been paid is parked in real estate. And that explains the fact that 86% of personal wealth in India is in real estate and other real assets. In fact, if we look at the 2010 report, the number was at 90%.

This is not surprising given that real estate remains the best parking space for black money. As a FICCI study on black money released in February 2015 points out: “About a third of India’s black money transactions are believed to be in real estate…The real estate sector in India constitutes for about 11 % of the GDP15 of Indian Economy, as these transactions involve high transaction value. In the year 2012-13, Real Estate sector has been considered as the highest parking space for black money.”

The Modi government up until now has been concentrating on chasing black money that has left the shores of the country. After a huge failure on that front, now they have been talking about domestic black money. The finance minister Arun Jaitley wrote on his Facebook page sometime back that “the bulk of black money is still within India”. That should have been obvious from the day the government decided to focus on black money, given that the bulk of black money gets invested in real estate.

Justice (retired) Arijit Pasayat, the vice-chairman of special investigation team (SIT) on black money said something along similar lines recently: “The volume of black money stashed in India is much more than it is now in the foreign countries. If the generation of black money is stopped, its flow to the foreign countries will be substantially reduced.”

The surprising thing is that it took the Modi government nearly 17 months since being elected to power in May 2014 to figure out where the bulk of the black money was inside India and not outside it, something that should have been obvious from day one.

Another interesting thing the report points out is the distribution of wealth among Indians. The top 1% owns nearly 53% of India’s wealth. The top 5% owns 68.6%. And the top 10% owns 76.3%. So what this clearly tells us is that 90% of the country’s population owns less than 25% of its wealth.

Black money has helped increase this inequality. Those who have black money have invested it in real estate and seen their wealth grow at a fast rate. French economist Thomas Piketty calls this the “principle of infinite accumulation” in his book Capital in the Twenty First Century.

Piketty defines the principle of infinite accumulation as the “inexorable tendency for capital to accumulate and become concentrated in fewer hands, with no natural limit to the process.”

This has also led to a situation where all the black money floating around in real estate has led to very high prices of homes, making them unaffordable for those who want to buy homes to live in.

The column originally appeared on The Daily Reckoning on October 21, 2015