On 5th May, president Pranab Mukherjee gave his assent to an ordinance to amend Section 35 of the Banking Regulation Act, 1949, empowering the Reserve Bank of India (RBI) to tackle bad loans of public sector banks (PSBs). Since details of the ordinance were not available at the time of writing this piece, it remains to be seen if the government has, finally, found the magic potion that will make the Rs6.46 lakh crore mountain of bad loans (at the end of December 2016) disappear. Expectations from the new ordinance are running so high that bank stocks have shot up 30%-50% in a few weeks. The run up started long before news of the legal amendment became public.
A newswire reports that the legal change will allow RBI to offer specific, case-by-case solutions, including relaxation of terms when required. Moneycontrol.com reported that the new law may empower banks to force corporate defaulters to “forego ownership and voting rights in their companies, allowing lenders to induct new management leadership mandated to turn around these entities within a specified time frame.” It is also reported that the ordinance would ring-fence bankers from scrutiny of their actions against chronic defaulters.
Will This Solve the Bad Loan Problem?
There is nothing in the past two decades to suggest that the sphinx-like RBI will suddenly turn into a dynamic organisation that goes after defaulters. On the contrary, enacting one statute after another—whether SICA (Sick Industrial Companies Act), SARFESI (The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest) or the Insolvency and Bankruptcy law—has not made any difference, as yet. In fact, the global financial crisis turned into an opportunity for the nexus of banks-crony capitalists-bureaucrats to engineer a sharp spike in bad loans.
At this time, when the government is figuring out ways to recover bad loans, the three biggest stakeholders of banks are extremely unhappy. Bank employee unions are furious with every trial balloon that the government has floated in the media (bad bank, re-privatise or de-nationalise banks, mergers), the freeze on recruitment and having to bear the brunt of all the extra work during demonetisation and after.
Bank depositors are angry that banks have been shoring up their profits by levying newer and more unconscionable charges on them while RBI watches in silence. Investors, who bet on public sector banks (PSBs) after the prime minister took the unusual step of engaging with senior management in person at a special retreat called the Gyan Sangam, launched Indradhanush, a seven-point programme to clean up banks, and set up the bank Board Bureau (BBB), are completely perplexed. The BBB has quickly turned into a shell with no voice or powers, while the Gyan Sangam has not even translated to efficient appointments or better accountability at banks in the past three years of the NDA government. Instead, PSBs have been dancing to the tune of the prime minister’s office (PMO)—first, to open millions of Jan Dhan accounts and then struggling to cope with demonetisation since November last year.
A speech on 28th April by RBI’s newest deputy governor, Dr Viral Acharya, made some important points on the bad loan issue. Citing the Global Financial Stability Report of the International Monetary Fund (IMF), he said, the “Indian industrial sector is now among the most heavily indebted in the world in terms of the ability of its cash flows to meet its bank loan repayments.” Also, that the Indian banking sector is worse than those in other emerging economies in terms of how little capital it has set aside to provide for losses on bad loans, primarily given to the industrial sector.
Dr Acharya made no bones about the fact that recapitalisation essentially amounts to “throwing more money after the bad.” He pointed out that, after the global financial crisis of 2008-09, “Banks that experienced the worst outcomes received the most capital in a relative sense. Most of these banks need capital again.” He contends that allocation of capital must not be so poor that it becomes ‘Heads I Win, Tails the Taxpayer Loses’, and sows the seeds of another lending excess.
Many of us had followed what happened then under the UPA government. Corporate India lobbied hard and furiously for help and, eventually, prevailed on the government to offer a huge relaxation on repayments. This quickly triggered a series of shady accommodation deals and banks made no effort at recovering the loans even after the crisis had blown over, leading to a sharp spike in bad loans from 2010-11 onwards. The All India Bank Employees Association (AIBEA) has put out enormous amounts of data about how bad loans spiralled after 2007-08 and how the top 50 borrowers owe over Rs40,000 crore to PSBs. AIBEA has published the names of these corporates and released them to the media, even while RBI has been acting coy and disclosed the names to the Supreme Court, in a sealed envelope. The top names in AIBEA’s list, which is a couple of years old, predictably include Vijay Mallya’s UB Group, Winsome Diamonds, Forever Precious Jewellery, Electrotherm India, S Kumar group, Zoom Developers, Sterling Biotech and Surya Vinayak Industries. Many of these promoters are unknown to the public and still managed to ditch loans in excess of Rs1,000 crore each. None of this has happened without the complicity of senior bankers or under duress from their political masters.
The employees’ union pointed out that provisions made for bad loans, in the five years from 2008 to 20013, were a whopping Rs1,40,000 crore. Also, in the four years from 2009 to 2013, PSBs piled on fresh bad loans of Rs3,15,465 crore.
So what is the solution to the problem? Dr Viral Acharya offered five options but only one of them really hit the headlines and triggered a spate of protests from bank unions.
1) Healthier PSBs should raise private capital through deep discount rights and share the government’s burden of recapitalising banks.
2) The better PSBs should sell non-core assets, insurance subsidiaries, market-making divisions, foreign branches and raise funds for recapitalisation.
3) Bank consolidation through mergers should be used as a way to create healthier banks. This could be a precondition to further recapitalisation, he suggests.
4) Tough prompt corrective action (PCA), under RBI’s new guidelines, which “should entail no further growth in deposit base and lending for the worst-capitalised banks” and eventually “encourage deposit migration away from the weakest public sector banks to healthier public sector banks and private sector banks.”
5) Re-privatising some of the nationalised banks to reduce the overall amount that the government needs to inject as bank capital and help preserve its hard-earned fiscal discipline.
Dr Acharya’s suggestions sound good but have little chance of being accepted by prime minister Narendra Modi who is clearly a believer in using the public sector alone to implement his policies. Dr Acharya himself would agree that merely raising private capital will not lead to better lending decisions, unless there is a drastic change in the appointment, remuneration, accountability and audit rules for the top management of PSBs. This has to be an important precondition to re-privatise banks or even consolidation through merger of weak banks with strong ones, as suggested by Dr Urjit Patel.
But the angry opposition to Dr Acharya’s ideas from bank unions was equally to be expected. AIBEA has a point when it says that loans given to the private sector account for ‘97% of bad loans’ and RBI must find a way to catch the defaulters and recover the money, instead of pushing the burden on “on to the shoulders of banks or the nation at large.”
At the time of writing, we do not know whether the ordinance will help put together an effective plan to make wilful defaulters pay up without using a slew of existing statutes and a slow judiciary.