A battle to end zombie lending in India

There has been much discussion around zombie firms and zombie lending in recent times.  In India, the term has been used (and was referred to again last week by the RBI Deputy Governor N.S. Vishwanathan) in connection with the way loans have been dished out and restructured and kept rolling, giving us ballooning Non-Performing Assets (NPAs) that erode confidence in the banking system and threaten financial stability.  This is a figure of the order of Rs.10 lakh crore, and it is not only the magnitude that is the problem but the culture that it builds, the signals that it sends out and the economic costs it entails in the longer run.  In sum, the Indian system is a living example of that famous quote that reads thus: “Borrow a little and if you can't pay it back, it's your problem. Borrow a lot and if you can't pay it back, it's the lenders problem.” Today, large borrowers are the nation’s problem.

It’s a battle to bring to an end the game of restructuring of bad loans, or what has been called ever greening of loans and the so-called “zombie lending”, which allows banks to postpone the hit on the balance sheet, to keep accommodating large borrowers and the resultant increase in the exposure of banks with even higher risk of default on a larger loan going ahead. This is not how banking is supposed to work.

Make no mistake – the battle (as is being reported) between the Reserve Bank of India (RBI) and the government is nothing short of a battle to change this culture that has come to define the way large borrowers and bankers work, taking the money of the ordinary people of India into projects and proposals that are kept alive long after their economic rationale is lost. It’s a battle to bring to an end the game of restructuring of bad loans, or what has been called evergreening of loans and the so-called “zombie lending”, which allows banks to postpone the hit on the balance sheet, to keep accommodating large borrowers and the resultant increase in the exposure of banks with even higher risk of default on a larger loan going ahead. This is not how banking is supposed to work.

The latest speech by Deputy Governor N.S. Vishwanathan at XLRI Jamshedpur on Oct. 29 puts it very well: “Banks are not supposed to be shock-absorbers of first resort of the difficulties faced by their borrowers as banks do not have the luxury of delaying payments to their depositors. Of course, a bank can renegotiate terms of a loan if circumstances warrant, but this must be for a good reason and the bank should recognise the consequent risks. This renegotiation of terms should be an exception rather than the rule, as resorting to it often would endanger the safety of deposits, dent a bank’s ability to lend further and imperil its existence as an intermediating entity.”

The example of Japanese banks in the 1990s, cited by the RBI leadership in other speeches, on sham loan restructurings that kept credit flowing to otherwise insolvent borrowers, or zombies, makes the purely economic costs of this exercise clear. The “congestion created by the zombies reduces the profits for healthy firms, which discourages their entry and investment…zombie-dominated industries exhibit more depressed job creation and destruction, and lower productivity.”

What is the road ahead for India? It is okay for the finance minister Arun Jaitley to blame the Congress for the rise in NPAs. It is true that the problem has its roots in the over enthusiasm of banks during 2006-2008. They bet too much on the future. They were lax in their due diligence. And given the Indian system and how projects are financed, a lot more passed under the radar and set in motion the lending that has brought us to where we are now. If one did it, everyone joined in the party. Raghuram Rajan, the former RBI Governor, has in fact been quoted as saying how one promoter told him how he was pursued by banks “waving cheque books”, asking him to name the amount he wanted.  Rajan calls it “the historic phenomenon of irrational exuberance, common across countries at such a phase in the cycle”. The reality is that in India it meant a lowering of governance standards that were in any case not at their best.  However, in repeating all of this, Jaitely and this government cannot pave the road ahead. That must come through a set of policies and a strict adherence that can slowly set the stage for recovery of our ailing banks.

The Prompt Corrective Action imposes restrictions, stricter oversight, caps on spending, expansion of credit, offices and spends. These are all the right signals that the management of the bank must be subjected to, not only to fix the problem but also to let the eco system know that there is a price to pay for not honouring the loan contract. If the current efforts of the government are not to restrict lending by these banks, then that is a wrong signal that tells the banks and the borrowers that their loans can continue to holiday. 

The following 12 banks are now under the provisions of what is called Prompt Corrective Action, or PCA: United Bank of India, Indian Overseas Bank, IDBI Bank, UCO Bank, Dena Bank, Central Bank of India, Bank of Maharashtra, Oriental Bank of Commerce, Corporation Bank, Bank of India, Allahabad Bank (all public sector banks) and one in the private sector, Dhanalakshmi Bank. Bank of India is the worst, with Gross NPAs of Rs.60,604.46 crore (16.66 per cent) and net NPAs of Rs. 27,932.25 crore (8.45 per cent) as of June 2018. The total Gross NPAs of the 11 PSUs in the list as of June 2018 are of the order of Rs. 3.5 lakh crores, and total Net NPAs are to the tune of Rs. 1.7 lakh crores. The NPAs of all these PCA banks are marginally down over the previous quarter, except in the case of IDBI Bank, where the NPAs are slightly up.

Should these banks be allowed to continue lending as usual? The Prompt Corrective Action imposes restrictions, stricter oversight, caps on spending, expansion of credit, offices and spends. These are all the right signals that the management of the bank must be subjected to, not only to fix the problem but also to let the eco system know that there is a price to pay for not honouring the loan contract. If the current efforts of the government are not to restrict lending by these banks, then that is a wrong signal that tells the banks and the borrowers that their loans can continue to holiday.  Add to that the much talked of RBI circular of Feb. 12, 2018, which makes it mandatory for defaults to be referred to the Insolvency and Bankruptcy Code (IBC) with 180 days of default, and the cycle of tightening the screws should be complete. Any government support to the suggestion, particularly by the power companies, that the 180 days limit is too stiff sends the wrong signals to the banks and the borrowers.

At the end of the day, the issues are not so complex. Banks have lent to big business the money of the people to draw up projects that will power India’s infrastructure for the future, grow the economy, provide jobs. Where these projects have failed, the money of the people must be secured. Wilful default must face the full force of the law. Others must move out for better people to manage the projects. This should be plain and simple for any government to see and help execute.

(The writer is a journalist and a faculty member at SPJIMR)