Despite the economy having recovered from the perilous days of 2014, one of the big legacies of the UPA government — Rs 3 lakh crore of non-performing loans (NPLs) and the crippled public banking system — is the biggest hurdle to Union finance minister Arun Jaitley’s efforts at restarting the investment cycle. NPLs are impacting the capacity of public sector banks’ (PSBs’) balance sheets to provide more credit to the economy and the increasing risk aversion to further corporate credit.
PSBs account for more than 70% of India’s loans. They require around $40 billion of fresh capital by 2018 to be in line with the international capital rules. The NPLs of PSBs continue to steeply increase — currently they total Rs 273,600 crore. The ballooning NPL numbers represent a clear danger to the government’s vision to accelerate the economy and job creation through investment.
The crux of the NPL problem is the inversion of liability in banking in India — the larger the loan or political connection, the easier to default; the smaller the loan, the more difficult it is. So resetting this is key. The Kingfisher saga is a good example, with leading PSBs struggling to recover the Rs 7,000 crore loans despite personal guarantees from the billionaire promoter.
It is a result of a decade-long rot within our PSBs with promoters going scot-free and taxpayer funds repeatedly used to bail out government banks when they could be deployed elsewhere for the public good. As Raghuram Rajan says, “We need a change in mindset, where the wilful or non-cooperative defaulter is not lionised as a captain of industry, but justly chastised as a freeloader on the hardworking people of this country.”
So here’s a five-pronged approach to addressing NPLs decisively:
1) PSBs/banks must be able to assume management control of defaulting companies swiftly and non-disruptively, even by appointing management agencies, to run these companies along with their reconstituted board, while pursuing the enforcement of collateral, guarantees and securities in the event of default. PSBs and creditors should work towards consolidating business assets and creating entities that can be targets for M&As for foreign and domestic investors. For example, defaulting power projects clean of any dispute can be put together by creditors and then offered to NTPC or other private companies. Such M&As also offer foreign and domestic investors opportunities to invest in brownfield businesses without the greenfield startup risks about India, which still intimidate many prospective big investors.
2) Stop the practice of masking bad loans through regulatory forbearance, ever-greening or restructuring corporate loans. This masking of NPLs, in turn, hides a growing time bomb that eventually explodes on future taxpayers.
Even schemes like the 5-25 scheme, which allows banks to extend debt on long-lived projects for up to 25 years, with refinancing every five years, could be used for ever-greening.
3) The PSBs are proxies for taxpayers and no borrower must be allowed to dodge contracted liabilities. For banks not to be piggy banks for the rich and powerful, a culture of enforcing contractual obligations must prevail. For this, there’s a need to review and improve the legal process of enforcing securities. Despite SARFAESI (the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act), the process by which banks enforce the borrower’s obligations in terms of security and guarantee is expensive, exhausting and time-consuming.
4) The PSBs have got used to frequent capital bailouts by the government. This is making the taxpayer liable for the corruption or mismanagement in these banks. The current policy to selectively recapitalise banks should be reviewed. This could incentivise weaker banks to hide or mask their problems to qualify them for recapitalisation.
PSBs must now go to the markets and raise capital. For that, they need to transform themselves and be more transparent and professional, and equip themselves with good management and boards, among other things.
5) As a recent article described it: “Many of the troubles that afflict public-sector banks, including political interference, a lack of talent in the boardroom and the herd mentality that encourages them to charge into the same bad bets, stem from majority state ownership”. The Kingfisher example is proof of this, with almost the entire bad debt portfolio held only by PSBs.
Some early reforms like the separation of the posts of chairman and managing director and revamping the selection process are a start. But if PSBs are to be successful and taxpayers to benefit, what is required is to end government control (i.e. political and directed lending). While privatisation may not be politically practical, distancing the bureaucrats of the finance ministry from PSBs is critical, which I have been urging for long. In Budget 2015, Jaitley announced a Banking Board Bureau. This could be the first step towards a holding company for banks.
The boards of the PSBs have to be reconstituted and freed from the practice of loading them with conflicts of interest, and filled with capable/independent directors, making them responsible for their performance.
NPLs have continued to increase in recent months. There will be the usual temptation to pick and choose a few big loans to resolve. There is a significant moral hazard in this and should be avoided.
More than clamour for lower interest rates, success on restarting a deep sustainable investment cycle will be determined by how decisively the government deals with NPLs. This cannot be solved around its edges. It needs to be taken on decisively or it will not be taken on at all. Crisis is always the time for change, the NPL crisis can trigger the right kind of change, get our economy going and create investments and jobs, which was the mandate of Elections 2014.
Rajeev Chandrasekhar is an MP. The views expressed are personal.