Worries on big businesses owning banks

When the house is on fire and the situation looks hopeless, any maverick action can be sold as good. That is one way to look at the report of an internal working group of the RBI that has recommended that large corporate and industrial houses be allowed as promoters of banks. The recommendation has invited sharp reaction from two RBI seniors who have quit and are back at their academic jobs – Governor Raghuram Rajan and Deputy Governor Viral Acharya. The report recognises the risks when large corporates, whose fuel is money for projects, also begin to run banks, whose job it is to lend money for projects, and says “it will no doubt be necessary to significantly scale up the supervision capacity before” making the change.

In this country of hardworking savers and careful buyers, the banking system runs with gross non-performing assets (GNPAs) that were reported at Rs. 9,36,474 crores for 2018-19, with Rs. 1,83,391 crores written off that year only by the public sector banks

In a line, the RBI group is telling us that banks can be run by corporate houses if supervision is good. Which begs the question: what is the quality of bank supervision in India and where has it landed us? Everyone knows the answer to that question. Indian banking is in the doldrums – of that there is little doubt. Look around the Indian banking scene and it should not be difficult to see signs of decay if not worse. India is not a banana republic, at least not yet. This is culturally also not a country known for reckless spends by ordinary citizens living today on bills that will have to be paid tomorrow. In fact, the ordinary depositor is a hefty saver, a loyal customer and a stickler for paying bills on time. It is this ordinary citizen’s money that runs the bank. That is culturally the profile of the typical Indian customer at a bank counter. This profile is changing but the moorings and anchors are still there.

In this country of hardworking savers and careful buyers, the banking system runs with gross non-performing assets (GNPAs) that were reported at Rs. 9,36,474 crores for 2018-19, with Rs. 1,83,391 crores written off that year only by the public sector banks, according to the last RBI Trend and Progress of Banking in India report of December 2019. In its Financial Stability Report, the RBI noted that large borrowers accounted for over half of all loans given, and more than three-fourths (78.3 per cent) of GNPAs in March 2020. Both these shares have declined since March 2018, which might indicate that the disease is spreading to smaller borrowers slowly but surely. Numbers such as these are alarming, looked at from any perspective.

The recent story of Yes Bank is another saga of supervision gone bad. It looks like we were historically bad in supervision, we continue to be bad, and we want to relax some norms and plan for supervision that will magically turn good once rules are even more relaxed!

                                                  Banking 101

Money is the base for the functioning of a bank. A bank facilitates two important functions of money – a) as a medium of exchange, and b) as a store of value.

A bank collects money from ordinary citizens, who may place their surplus cash in a bank just around the corner – for convenience, ease of use and with the faith that the money will be available when they demand it.

Millions of such ordinary consumers give the bank enough to keep in its vaults, for its operations and to loan it out to those who need money – for business operations, to buy a house or a car, or for other needs.

These loans are the bank’s assets – they will be paid back, with interest, in due time.

Deposits are usually short term while loans are given out for the long term.

Typically, a bank pays lesser interest on deposits; it collect higher interest on its loans. The difference is the earning of the bank.

The system works because not all depositors come calling for their money at the same time. And loans are usually paid back.

But what happens when a large amount of loans not only don’t earn interest but don’t come back. This is the bad loan, the NPAs in the system, and as we can see, it breaks the very idea of how banking might operate.

Soon, the bank will need to infuse capital as its assets get wiped out. In PSBs, this comes from the government, which is using public money to make good the losses on loan accounts issued to large private entities.

That’s bad enough and has left our banking system in the doldrums currently. Now, think what could happen to your money and mine if the large private entities did not just obtain loans from the bank, but they owned the bank themselves.

They look worse when we know that none of this is caused by the ordinary citizen but every bit of it is financed by the ordinary citizen. The money that the bank lends comes from the ordinary everyday saver. When it disappears, the government is asked to shore up the capital of banks, as it did recently. To quote figures given in Parliament in July last year, the government has infused over Rs 3.15 lakh crore into public sector banks in the 11 years through 2018-19, which, again, is the money of the people to fill a hole that the people did not create.

The NPAs we read about are just the reported numbers, and a lot of rot remains on the balance sheet, undisclosed and unreported. So much for oversight. The recent story of Yes Bank is another saga of supervision gone bad. It looks like we were historically bad in supervision, we continue to be bad, and we want to relax some norms and plan for supervision that will magically turn good once rules are even more relaxed! Call it by whatever name, but this is logic that does not hold. It may indicate that a major change is coming and that the government is preparing for a new policy path that will carry significant ramifications and open new doors to guard at a time too many are open and left unguarded in the banking sector.

As a CRISIL report has noted, GNPAs in the banking system would have touched this fiscal-end to a two-decade high of 11.5%, up from 9.1% in 2018-19, but for the RBI one-time accommodation given because of the pandemic. 

It is true that a lot of our problem of bad loans originated in the hey days of the rocket-like growth that the Manmohan Singh government gets credit for. We yearn for that growth even today, particularly because the current administration has only given us declines, self-inflicted like it was with demonetisation, and the “act of God”, as the finance minister called it, in the case of the pandemic that continues to cause deaths and distress. Under these circumstances, the already bad situation of NPAs can only get worse, which raises even more alarm at the timing of the proposed changes and relaxations. As a CRISIL report has noted, GNPAs in the banking system would have touched this fiscal-end to a two-decade high of 11.5%, up from 9.1% in 2018-19, but for the RBI one-time accommodation given because of the pandemic. The accommodation is in reporting the numbers and providing for them – the actual NPAs aren’t going away and are only growing on the books meanwhile.

How much of public money was pocketed and by whom is not something that the GDP growth celebrators have ever bothered about. Governance and sustainability and viability of growth was not considered topics glamorous enough to focus on.

Ordinary citizens can contrast this to how the banks or credit card companies come after them at the first sign of default of much smaller amounts.

It is worth noting that despite having a political incentive to probe and bring to book anything that is separate from a genuine business failure, the current administration has been unable to send strong signals and hold any of the guilty to account. One must wonder at how a collapse of this monumental proportions can occur, even after taking into account explanations like a turn in the business cycle, or particular sectors not taking off, or that land acquisition failed or the courts issued stay orders. The fact remains that the problem is wholesale, across sectors, and all at a similar time. Look again, and you’ll hear stories of the kind Raghuram Rajan once cited: “One promoter told me about how he was pursued then by banks waving checkbooks, asking him to name the amount he wanted.”

India needs to crack the whip on this one. Instead we have had pussyfooting. Consider the following: There isn’t one single place where the NPA numbers are highlighted and updated live, where the defaulters are named and platforms made available for people to report further possible complaints. There is no attempt to investigate or run forensic audits on the biggies – even Al Capone was jailed first on a charge of contempt of court, and finally sent to long years in prison not for murders and mafia rackets but on issues of income tax, and was brought down by a determined administration. In India, it is an accepted fact that gold plating on projects is common. A single, small thread of violation can begin an inquiry that can send the signal that defaults are not taken lightly in the Indian system. Raghuram Rajan is on record as having said: “Unscrupulous promoters who inflated the cost of capital equipment through over-invoicing were rarely checked…too many loans were made to well-connected promoters who have a history of defaulting on their loans.” In such a system, can these well-connected entities own and operate banks on the money of ordinary citizens?

The government has infused over Rs 3.15 lakh crore into public sector banks in the 11 years through 2018-19, which, again, is the money of the people to fill a hole that the people did not create

This government has gone after all kinds of enemies, political, imaginary and others, but failed to act on NPAs. It can be accused of going soft on big business. The Insolvency and Bankruptcy Code, IBC, is in place but in its infancy still; the strict deadline of 180 days to resolve or monetise whatever can be salvaged has rarely worked in India for a variety of reasons. And recoveries are at very low levels. Haircuts are high. This messages the system that defaulters can get away. Ordinary citizens can contrast this to how the banks or credit card companies come after them at the first sign of default of much smaller amounts.

In sum, banking is about credibility, trust and building confidence and being held to account for any malicious the decisions the bank takes. None of this holds for our banking system – which has more banks and branches than we can handle. Bringing new banks with corporate connections and controls will not solve this problem but only exacerbate it. Yet, we must all prepare for the new Imperial Bank of India, in service of the modern-day versions of the East India Company.