governance, political economy, institutional development and economic regulation

Posts tagged ‘NPAs’

Retribution – the missing R for resolving bad loans

Courtesy Arvind Subramanian, India’s Chief Economic Advisor, the 4R (reform, recognize, recapitalize, resolve) approach to manage the corporate bad loans problem, has captured public imagination. But he soft peddles a fifth R, that of retribution. The big stick must be wielded for reform to be credible.

jail2

Public sector banks – flabby, politicised ATMs providing easy money to elites

Banks are flush with money. But “liquidity” for borrowers, even those who have a “special relationship” with banks, is low. The shadow of stressed loans – missed loan repayments and interest payments- makes the usual, clubby way of doing business suspect. Banks operate on big margins – between interest paid on deposits and interest received on commercial loans – of up to 5 percent, in our cartelized banking architecture, dominated by publicly owned banks. But, despite high margins, public sector bank ratings suffer. The more loans they give, higher is the volume of bad loans.

Bad loans are an outcome of shoddy risk appraisal followed by poor loan account oversight. The ugly habit of kicking the can down the road by rolling over bad loans has been the norm.  On average, only around 26 percent of bad loans and accumulated interest are recovered. Using this metric, banks stand to lose around Rs 9 trillion (6 percent of our GDP) by recognizing and resolving bad loans of around Rs 12 trillion.

If corporate loans were recovered like consumption loans for cars, there would be no problem

Once a loan becomes stressed there is little a bank can do, except to recover as much as it can from the borrower; divert the proceeds to a better borrower and black list the delinquent borrower. But Indian banks rarely operate on this “sunk cost” principle. A long history of covert support to keep diseased loans and borrowers alive, under the guise of retaining jobs, has not helped. The spectacularly unsuccessful, Board of Industrial and Financial Reconstruction was still alive till January 2016. Unfortunately, so were hundreds of companies ripe for corporate euthanasia. We now have a new Insolvency and Bankruptcy Act, January 2016. But its effectiveness remains to be established.

RBI oversight of banks comes up short

Disappointingly, the Reserve Bank of India, instead of taking the bull by the horns and directing banks to start bankruptcy proceedings for bad loans, has taken the soft approach – giving banks time, till the end of 2017, to resolve the stressed loans themselves. Amusingly, to nudge bankers into doing unfamiliar, unpleasant things, extraordinary measures are being taken, to provide them administrative cover, from ex-post facto audit, vigilance and CBI investigations. Clearly, retribution against those bankers, who approved and over saw the dud loans, is not contemplated.

Loan waivers without retribution for the complicit create moral hazard

Economists, including RBI Governor caution against the problem of “moral hazard” that loan waivers create in the context of agricultural loans being written off by state governments. Apparently, forgiveness without retribution, is bad for rural borrowers, but ok for corporate borrowers. Sadly, retribution is sorely needed for commercial borrowers too, who account for 75 percent of the bad loans.

80% model borrowers, 20% delinquent addicts of “easy money”

home

The reality is even more nuanced. The bulk of borrowers, across sectors, are gold standard risks. Despite gross mismanagement of large corporate loans, 83 percent of the bank loans, valued at Rs 63 trillion, are serviced on time by borrowers. Moral hazard affects borrowers selectively in India. This is because retribution is also selective. Access to bank finance for small borrowers is cut off if they become delinquent and recovery proceedings are harsh. For large borrowers and the influential, more favourable terms apply.

Are only babus to be held to account?

handcuffs

Last month, a retired Secretary of the Coal Ministry and two other senior colleagues, were convicted for criminal conspiracy, by a trial court. The charge and the punishment meted out was completely out of proportion to their misdemeanors – less than adequate diligence in discharging their duties. Why this double standard for holding public officials to account? Rs 12 trillion of accumulated stressed loans against annual loan approvals of between Rs 3 to 5 trillion, indicates a deep rooted “conspiracy of silence” within public sector and co-operative banks; their patrons in government and the borrowers themselves.

These stressed loans, whether in industry or in agriculture, must be taken off the books of banks. But the concerned loan sanctioning and account oversight chain, whether present or retired, must be held to account on a standardized, transparent metric to establish active connivance to cheat the bank or lack of adequate diligence. This is the only way to delink quick resolution of the stressed loans from the problem of “moral hazard”.

Blacklist actively negligent founders

Second, deals need to be urgently struck with borrowers to resolve loans without access to the lengthy judicial review process. These can only happen if the big stick of sanctions is available to the negotiators. Founders, actively negligent in servicing loans, should be made to exit management positions, as a precondition for future access to bank finance. Delinquent individuals, who have been given opportunities earlier, to reform, via “greening” or rolling over of loans, should be debarred from access to bank finance.

Hold banks to account for bad loans

The argument against sanctioning bankers is bogus. It is feared bankers will stop taking decisions if sanctioned, thereby freezing the lending cycle. Till two decades ago, bank trade unions, routinely used the threat of striking work, to stop computerization or extract better wages. It was the Supreme Court which defanged them in 2003 by ruling that the right to strike is not absolute, particularly in the case of public services. No need to turn the clock back.

Stringent action against the bureaucracy has not adversely affected the functioning of government. Enshrined bureaucratic safeguards are most often the refuge of the incompetent or the corrupt. Those working transparently, in the public interest, rarely need such support. There is no reason why banks should be different.

Needed an empowered financial sector, “clean up” champion, to wield a long broom

Jaitley grimace

“Moral hazard” in bad loan resolution becomes a problem, only if we do not deal equitably and transparently. Elitist cliques, spanning politics, business and agriculture, must be weaned-off, the vice of bank financed “easy money”. Swift, impartial, standardized resolution of bad loans, with judicious retribution, can drain this vicious whirlpool, which saps national wealth and reeks of inequity.

Adapted from the authors article in TOI Blogs, June 23, 2017 http://blogs.timesofindia.indiatimes.com/opinion-india/retribution-the-missing-r-in-resolving-bad-loans/

 

Indian budget in the eye of a fiscal storm

Finance minister Arun Jaitley’s third Budget signals the mid-point of this government’s tenure till 2019. At the best of times, the honeymoon period would have ended by now.

jaitley jostled

Photo credit: in.news.yahoo.com

But it is unfortunate that the FM has to face a perfect storm of snowballing, fiscal liabilities in public sector banks; drought induced low agricultural productivity; international economic head winds; the additional cost of securing India in an increasingly insecure world and the consequences of populism- primarily the wholly unnecessary increase of 23 percent in government pay and pensions and the outcome of delayed reforms in subsidy.

Running out of fiscal resources

In comparison, the government’s budget kitty is woefully inadequate even without meeting the long standing demand for spending more on health and education; developing infrastructure; boosting rural incomes; extending the patchy system of social protection and enhancing long neglected defence preparedness.

cash box

Photo credit: Dreamstime.com

Consider that the total annual capital budget of the Union government last year was just Rs 2.4 lakh crore (just 1.7 percent of GDP). State Governments spend a similar amount. But public investment at just 3.4 percent of GDP does not compare well with the thumb rule for developing countries of at least 8 percent of GDP especially when you are also running a fiscal deficit of 4 percent also in the Union budget alone.

The mess in government banks

More worryingly, even this meagre public investment may not actually be possible if the fiscal mess emanating from public sector banks is to managed. Loans worth Rs 3.5 lakh crore in government owned banks are acknowledged as non performing (the borrowers have defaulted on repayments). Some provisioning for writing off these loans has been done but not enough.

The real risk is that a whopping Rs 2.7 lakh crore of loans have been dressed up by “restructuring” them. In essence rolling over non-performing loans (NPA) so that they exit the NPA classification. But whether the favoured borrowers can support future repayments is unclear. The RBI has come down heavily on such practices and directed banks to start provisioning against all stressed assets. Hence the spate of losses recorded in the quarter ending December 2015 by government owned banks.

Another worry is that government banks will need an additional Rs 1.8 lakh crore of equity infusion to comply with the Basel III capital adequacy norms. This takes the total capital requirement of government banks to Rs 6 lakh crores- just under 4.5 percent of GDP.

Even if the entire capital budget of the government is diverted for re-capitalizing government banks — it will still take two to three years before they get a healthy balance sheet. And what is there to stop the cycle of irresponsible lending from being repeated? After all, these non-performing assets were built up over the past several years. But none of the top honchos of these banks — present or past — have been called to account for this colossal deception.

Poor credibility of corporate governance in government banks

ATM

Jugaad trumps systems; Photo credit: Alamy.com

Today, government bank equity is deeply discounted. The credibility of corporate governance in government banks has been dented. Worse still, there is no clear path for restoring stability. The direction preferred by the government is to retain the governance architecture of government owned banks with notional changes to enhance bank autonomy. Privatization of select government banks – a sure mood lifter for domestic and international investor community- has never been a preferred policy option.

Government ownership has benefits. For one, it notionally reassures depositors that their money is safe. Possibly this is why there is no run on deposits in government banks, unlike what was seen in Greece recently. Depositors and bond holders view government banks through the filter of sovereign credit. It helps that India has an impeccable record on meeting all its financial commitments.

But one trigger, which could escalate the financial risk sharply could be if oil prices start firming up subsequent to the production freezing agreements between Saudi Arabia, Russia and other top oil producers. This will stoke inflation in India; keep domestic interest rates high, thereby impacting investment and worsen the current account deficit. Add to this that sharply reduced public investment- a consequence of possible diversion of capital to clean the balance sheets of government banks, will also impact growth, jobs and incomes.

The poisoned chalice of trade offs

Government has a poisoned chalice it needs to sip from. If it brushes deep, bank restructuring under the carpet, it can postpone the day of reckoning- but only at significant medium term economic cost. A broken government banking system, which caters to 70 percent of banking needs, cannot sustain rapid private sector growth.

One option for maintaining fiscal stability, is for the government to access multilateral support from the International Monetary Fund (IMF) for restructuring government banks. IMF support reassures investors because it comes with a programme of structural and governance reform, including broad basing the share-holding of banks to non-government investors; professionalizing their boards and embedding oversight mechanisms to insulate them from succumbing to politically motivated loan melas or dodgy, private projects.

Government should shed the muscular stance

The down side is that going cap-in-hand to the IMF does not fit the muscular India story, which is the leitmotif of the BJP government. The BJP will worry that it will have negative political consequences in the forthcoming state elections in West Bengal, Assam, Tamil Nadu and next year in Uttar Pradesh (UP). This is true. But none of these states offer credible political gains for the BJP in any case, except UP. The muscular approach can be abandoned without much grief. Its marginal utility is diminishing and reduced dividends are already visible.

One hopes that the government’s brand managers are reading the tea leaves correctly. This is not the time for soaring rhetoric or proclaiming achievements loudly. Far better to adopt a humble posture, point to the depressing state of the world and outline an agenda for dealing with adverse circumstances.

humble jaitley

The FM can be charming if he tries. Photo credit: freepressjournal.in

Three big steps out of the fiscal mess

First Mr. Jaitley must guard against 2016 becoming India’s 2008 “Lehman Brothers” moment. Lehman Brothers was a global financial services firm that filed for bankruptcy protection. This sparked off a domino effect which exposed deep financial irregularities across the banking sector. It also triggered the Occupy Wall Street movement. Ordinary citizens, disgusted by the extent of malfeasance in the financial world, took New York by storm and shut down the financial district. At the best of times, Indians are suspicious of big business and are quick to come out on the streets in protest. This is not the time to risk an “Occupy Dalal Street movement”.

Government must regain credibility by coming out strongly against all those who have connived to build up this huge quantum of non- performing loans — bank managers who were in decision-making roles, large corporate borrowers and those within the political establishment who may have turned a blind eye to such maladministration. Mr. Jaitley must also share publicly how deep is the rot and what steps the government proposes to manage the fall out.

Second, government should take this opportunity and opt for only a “holding budget” for 2016-17 — an accounting exercise to rationalize and consolidate past initiatives. The bottom line is to insulate income support for the poor and allocations for agricultural production from the fiscal mayhem. Health, drinking water and sanitation and education allocations should be held at 2014-15 levels relative to projected GDP.

Finally, the government must increase gross tax collection over the next two years from the low of 10 percent in 2014-15 to 12 percent of GDP- last achieved in 2007-08. The GDP growth projections of 7.5 percent lack credibility when triangulated with the ground realities. Lower growth will impact tax revenues negatively. Services tax is a progressive tax, which primarily affects the well off. Raising the rate by 2 percentage points could generate an additional Rs 30,000 crore. Taxing capital gains from the sale of equity and the receipt of dividend beyond a threshold level, is another option for reducing income inequality and plugging a big hole in the tax net.

Government already spends more than it earns on revenue expenditure. We still run a revenue deficit of nearly 3 percent of GDP, which we fund by taking loans. Hence, the increasing burden of interest payment. Trade-offs will have to be made if the unwise commitment – amounting to Rs 100,000 crore – on the 7th Pay Commission recommendation is implemented.

So are we in the eye of the storm? And could we be on the cusp of a potential financial emergency? We should act before a flash point triggers this eventuality. A modest budget for 2016-17, enhancing tax collection by selectively increasing the effective tax rates and sharply focused allocations for value enhancing public expenditure, is the only way out of this mess.

storm

A storm brews around Rajpath, New Delhi. Photo credit: gizmodo.com

Adapted from the authors article in Swarjyamag February 24, 2015 http://swarajyamag.com/economy/indian-budget-in-the-eye-of-a-fiscal-storm

Tag Cloud

%d bloggers like this: