India’s banking sector is frequently under the spotlight, and usually for unflattering reasons—from an insupportable pileup of loans gone bad (non-performing assets or NPAs in banking parlance) to outright fraud to cronyism or worse. The rot is endemic, has hit banks small and big—including some well-regarded names—and is by no means limited to the public sector. If government-owned banks like Punjab National Bank (PNB) and State Bank of India (SBI) have embarrassed themselves, names like YES Bank and ICICI Bank in the private sector have also made headlines for the wrong reasons. The list of banks of dubious honour is long, including, most recently, Lakshmi Vilas Bank (LV Bank), which the RBI (Reserve Bank of India) had to step in to bail out.
The Covid-19 pandemic has aggravated the crisis by another order of magnitude, with the government-mandated moratorium on interest payments (it expired in September) and state-guaranteed loans threatening to further increase the already humongous NPA pile (at Rs 9.4 lakh crore as of June 2019, nearly four times India’s health budget). This has created an unprecedented crisis of capital in the banking system.
It’s not a crisis the government or the central bank have missed or ignored, but the proposed solution, many experts fear, could lead to a fate even worse than the current problem. An RBI internal working group has suggested an amendment to the Banking Regulation Act, 1949, to allow large corporate houses to become bank promoters. Broadly, those in favour argue that this is a way of recapitalising the banking system, and possibly the only way to fund India’s growth ambitions, while those ranged on the other side flag the risks of ‘connected lending’ (a phenomenon where banks promoted by existing corporate houses with other businesses end up favouring their own group businesses). It’s a knotty problem, and to correctly assess if privatising public sector banks is the panacea adherents of the idea think it is, we must first scrutinise the myriad co-morbidities of the larger banking system—including NBFCs (non-banking financial companies) and cooperative banks.
THE NPA/ NBFC QUAGMIRE
In a report published on October 29, research consultancy Capital Economics issued a dire warning—that India’s banking sector, which had been in poor shape even before the pandemic began and suffered further balance sheet damage from the coronavirus crisis, warrants extreme concern. ‘[India’s banking] sector is entering a slow-burning crisis, where bad debts will eat into profits and restrict lending, holding back recovery [through] the decade’, wrote economists Shilan Shah and Simon MacAdam. They predicted that, relative to its potential, the Indian economy would see one of the weakest recoveries among major economies. As much as 65 per cent of India’s banking sector in terms of deposits is state-owned, says RBI data. Capital Economics reckons the sector was one of the most unprofitable in the world in 2018-19.
₹`9.4 LAKH CRORE
TOTAL NPAs IN THE INDIAN BANKING SECTOR AS OF JUNE 2019
`₹`1.85 LAKH CRORE
THE AMOUNT BANKS LOST TO FRAUD IN 2019-20
For over a decade since the global financial crisis in 2008, sparked off by the collapse of Lehman Brothers, the Indian banking sector has been on a roller-coaster ride. To escape the crisis, India entered one of the most extravagant phases in its financial history—involving a splurge of central spending, a loose monetary policy to lower interest rates and aggressive lending by banks. This phase saw Indian companies take on big loans and amass assets in money-guzzling sectors like infrastructure and telecom. While the spending did lead to a quick recovery, over a longer term, it left the banking sector saddled with NPAs, eroded the health of public sector banks (PSBs) and, as a consequence of the bad debt pile, led to sluggish lending.
HOW HEALTHY ARE OUR BANKS?
The problem of bad loans is certainly worse in the public sector. Of the total Rs 10.35 lakh crore worth of NPAs as of March 2018, 85 per cent or Rs 8.8 lakh crore are on PSB accounts, with SBI alone accounting for Rs 2.23 lakh crore (21.5 per cent) in 2017-18. Gross NPAs have risen from 2.3 per cent of total loans in fiscal 2008 to 9.3 per cent in fiscal 2019; well-run banks in the private sector tend to have gross NPAs below 5 per cent. Bad debts constrain a bank’s ability to continue lending: with its assets unable to generate enough income, the bank’s ability to issue further credit diminishes. “The challenge with public sector banks is that there are many internal organisational issues that are not being addressed or resolved,” says Ashvin Parekh, a financial advisor. “The whole system has been in gradual decay over the years.”
The Covid-19 crisis has made things worse. With the RBI announcing a moratorium on repayment of retail loans in March, as well as the financial pressure of the Centre’s Rs 3 lakh crore of collateral-free loans, the stress on PSBs has increased manifold. The consequences of these will unfold over the next few years—former finance secretary Subhash Chandra Garg says NPAs resulting from the coronavirus crisis could be as high as Rs 10 lakh crore. This complicates a long-standing problem. In late 2015/ early 2016, to come to grips with the NPA issue, the RBI, under then governor Raghuram Rajan, instructed banks to identify loans that could potentially turn sour, and set aside capital to hedge against the possibility. This threw up bad loans amounting to about Rs 10.4 lakh crore, but as a side-effect of this clean-up, banks became wary of lending. Sanjeev Kapoor, a Delhi-based chartered accountant, says he has been advising his clients to keep their money in established banks even if they are giving lower returns on fixed deposits because, he says, this indicates they are not desperate for deposits and, therefore, are in good financial health. “We will know the actual state of banks in March, but defaults have already begun. I don’t know what other regulations will come in on withdrawals.”
BANK FRAUD: CHINKS IN THE ARMOUR
As much as 80 per cent of bank frauds took place in state-owned banks
Number of frauds Fraud amount (At end-March; Rs crore)
Figures for frauds of Rs 1 lakh and above. The figures reported by banks and financial institutions are subject to change based on revisions filed by them. Frauds reported in a year could have occurred several years prior to year of reporting. Amounts involved reported do not reflect the loss incurred; depending on recoveries, the incurred loss reduces. Further, the entire amount involved is not necessarily diverted. Source: RBI
The RBI has since made several interventions to address the NPA mess. These have not always had the desired effect. For instance, on February 12, 2018, under governor Urjit Patel, the RBI set a six-month deadline for banks to resolve NPA cases valued at Rs 2,000 crore or more, failing which they would have to immediately refer such cases to the NCLT (National Company Law Tribunal) for insolvency proceedings. This order, which required banks to report a default to the RBI for even a single day’s delay in repayment, was widely criticised, with several petitions filed in courts across the country, mainly from companies in the power, textiles and shipbuilding sectors. Petitioners alleged that the RBI order did not consider sector-specific issues and that it was arbitrary and discriminatory; in April 2019, the Supreme Court struck it down, saying the order exceeded the RBI’s authority.
Over the past four years, PSBs have written off about Rs 6.66 lakh crore of bad debt, with the Centre repeatedly bailing them out—in her budget speech this year, finance minister Nirmala Sitharaman said the Centre had infused about Rs 3.5 lakh crore into PSBs in the past few years. A former PSB chief tells india today that there is an urgent need for structural
changes. “Else,” he says, “PSBs will remain a black hole into which taxpayers’ money will have to be pumped in at regular intervals.” Nonetheless, the Centre has said it will continue to support the banking sector—a statement from the Prime Minister’s Office in July this year was explicit that the government would take any necessary steps to do so.
Janmejaya Sinha, chairman (India) of the Boston Consulting Group explains that a major issue is credit supply, saying, “The real challenge for the Indian economy is the need for more credit. [India’s] credit-to-GDP ratio is about 60 or 70 [per cent], while the ratio for China would be double that. We need a more robust and vibrant banking sector to improve credit flow.” According to Viral Acharya, former RBI deputy governor, India’s credit-to-GDP ratio is 56 per cent; in China, it is in the 150-200 per cent range. And as the economy recovers from its worst recession in decades, access to credit will be crucial.
The stress in the banking sector has taken its toll on NBFCs as well, which accounted for 30 per cent of all retail loans in fiscal 2019. The RBI’s annual inspection report for 201415 red-flagged infrastructure funding firm IL&FS (Infrastructure Leasing & Financial Services), whose net-owned funds had been wiped out. On October 1, 2018, the Centre replaced the board of the beleaguered firm in an attempt to calm financial markets after it defaulted on its loans. Though the government tried to stabilise matters by appointing a six-member board led by Uday Kotak, chairman of Kotak Mahindra Bank, the ripple effect of IL&FS’s fall shook the entire sector, triggering defaults by other major NBFCs such as Dewan Housing Finance Limited (DHFL), which also went into insolvency; its promoters were arrested in a money-laundering case related to YES Bank. As part of its Rs 20 lakh crore stimulus announced in
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