The stock market is understandably jittery over a bribes-for-loans scandal among a clutch of State-owned banks and a mortgage lender. The arrests of eight executives, including the chief executive of LIC Housing Finance, the mortgage arm of insurance behemoth LIC, have unravelled a web of dodgy loans to real estate companies and sleuths are turning their attention to the promoters and parent companies of those that bribed their way into housing credit. The government is at pains to explain the latest instance of graft as an isolated incident that does not threaten India's financial system. The investor — and increasingly it's the foreign investor — doesn't seem to be buying this argument. Since the Central Bureau of Investigation announced the arrests last week, the fortunes of small-cap companies like the real estate developers that are being probed, have taken a nosedive on the bourses.
The reactions of the market and the government to the development are out of line. Yes it's true that Indian banks have watertight rules on how much they can lend to a particular industry or a business house. Banking regulations err on the side of caution to prevent an economy-wide meltdown. On the other hand, the latest scam re-establishes the lack of policing on the ground. India has rules, but it is relatively easy to bend them. This poses as grave a systemic risk for investing in India as a regime less vigilant about contagion. The foreign investor can't overlook one side of the India story in which the economy barrels on at 9%, but he cannot afford to take his eye off the chronic corruption that bedevils the system.
Neither can the government continue to ignore the issue of wage disparity among bankers. State-owned banks do the bulk of lending in the country but pay their employees a fraction of what private banks do. The State Bank of India can swallow the top five private Indian banks without a burp, but the members of its board are far removed from the seven-figure salaries or eight-figure bonuses of private bankers. Policing becomes so much more difficult when we have a powerful argument like lopsided pay at work. In a decade from 1969, when banks were first nationalised and told to go to the villages, the Hindu rate of growth crept up from 3.5% to 5%. Since then, as bank branches sprouted in every nook and cranny, our growth rate has sprinted as more Indians put their savings in banks. A lot rides on India's public-sector banking system. The vigil must be tighter.