Scary Banking: A Tale of Rotten Credits and High Interest Rates

1. For every rupee that banks in India have lent in the nine months to December 2013, 13 paise has turned bad  – RBI data
2.   Stressed assets among PSU banks have reached alarming proportions of approximately 112% of equity – PWC (May 2014)
3.    The cost of cleaning up banks’ balance sheets could be as high as 4 per cent of GDP — slightly larger, in relative terms, than Wall Street’s bail-out. – The Economist
4.    As much as half of the stressed loans in the system falls in category of credit, promoters have siphoned off for personal use – Ambit Research

Jagdish Verma (42), a professional, still frets about how he had missed last cycle (2002 to 2007) of cheaper home loans. That was the best ever time period to buy a house in India. Seven years on, although his income has gone up but real-estate prices have skyrocketed beyond his means. He is impatiently waiting for the time when a sub-10% home loan rate will be a reality again. Anil Gupta (50), an entrepreneur, is worried that he will have to cut down the size of expansion project for his midsize engineering company if cost of credit doesn’t come down in near future. Since energy and other costs are rising and margins are under pressure, low-cost credit is the only hope for him to go ahead with investments in full throttle.

As Indian economy is wriggling hard to bottom out from the five years old deep recession and consumers are rejuvenating dreams of better living, India’s banking is hit by a double whammy. Public sector banks, majority owner of nation’s banking services, are gripped by crisis of rotten credit and decaying credibility. While a time bomb of whopping Rs 5.91 trillion of rotten credit is ticking inside the banking system, recent revelations of bribe for credit, evergreening of stressed assets and corporate-banker nexus have made nation’s top banks highly scary. At a time when proactive and aggressive banking was needed at the most, hounding CBI sleuths, cronies-laden governing boards and nose-diving profits have become the signposts of Indian banking. India’s last phase of high economic growth (2003-2007) had been fuelled by low cost credit, a universal prerequisite for the possible economic upturn. However, with a massive pile of bad loans and perennial capital famine, Indian banking industry is just not able to reduce the interest rates on loans, mandatory for the revival of investment and consumer spending.

Surviving on Prayer
Public sector banks are sending chill down the spines of India-bullish global investors and rating agencies. CBI’s crackdown on Syndicate Bank for bribe to enhance credit limit and preliminary enquiry against IDBI Bank for sanctioning a loan to debt-laden Kingfisher Airlines have revealed the grotesque face of corporate-bankers nexus. While, a sharp 26.8 percent fall in total net profit of all public sector banks (PSBs) for the fiscal ended March 2014 over the previous year has made things worse for the industry.

Banks loans are usually classified as either performing or non-performing by the yardstick of their servicing by the borrowers. Gross NPAs of the Public sector banks for March 2014 stood at Rs 2.43 trillion, up 34.41% from Rs 1.8 trillion a year ago. Bad debt problem has worsened after a new portfolio of loans labeled as “restructured” came into being. In 2008, RBI permitted the use of an intermediate category of restructured loans under relaxed terms in order to give some breathing space to borrowers against the global recession. Indian firms have misused this temporary window and piled up Rs 76,479 crores restructured assets (RA) with the banks. That is how the stressed assets (GNPA+RA) reached Rs 5.91 trillion i.e. 10.2% of total bank credit. Fitch Ratings expects stressed assets to reach 14 percent of loans by March 2015. While Ambit Capital report points out that weak provision (building up reserves against potential loss) coverage ratios may add woes as banks will need to make even higher provisions on the restructured assets from 2015-16.

Lending to black holes
NPA accounts with banking industries can be classified into three categories: a) genuine cases hit by economic slowdown b) diversion of funds by promoters to other ventures, impacted by slowdown c) Promoters siphoning off funds for personal use. The money lent to the third category of NPAs, clearly, is money lost with no assets backing it. A research report from Ambit capital states that this segment probably accounts for as much as half of the stressed loans in the system.

The list of top defaulters to the Indian banks has remained a closely guarded secret among Indian banking industries as bankers hardly share inside tales alluding to banking secrecy laws. The All India Bank Employees Association (AIBEA), the largest union in the banking sector, has revealed the secret list of the country’s top 406 loan defaulters in May, 2014. This is the only major list of top defaulters owing a whopping Rs 70,300 crore to public sector banks.  Vijay Mallya’s Kingfisher Airlines  is topping the list with a bad loan of Rs 2,673 crore. Others creditors who owe  more than Rs 1,000 crore debt  include Winsome Diamond & Jewellery Co. (Rs.2,660 crore) Electrotherm India (Rs.2,211crore), Zoom Developers Pvt. Ltd. (Rs.1,810 crore), Strerling Bio Tech (Rs.1,732 crore), S. Kumars Nationwide (Rs.1,692 crore), Surya Vinayak Industries (Rs.1,446 crore), Corporate Ispat Alloys (Rs.1,360 crore), Forever Precious Jewellery & Diamonds (Rs.1,254 crore), Sterling Oil Resources (Rs.1,197 crore) and Varun Industries (Rs.1,129 crore). This revelation has forced the government and bankers to take a note of top defaulters, although a comprehensive and authenticated list of defaulting accounts is still under wraps.
Willful defaulters are another tough nut to crack due to vacuum of a strong legal framework. Although, RBI and SEBI are toughening norms for ‘non-cooperative defaulters’ and bankers are getting proactive against them, to boot. Even though a large number of cases are stuck in the legal system, bankers feel that the newly strengthened Debt Recovery Tribunals are going to provide some relief.

Every high growth phase leaves behind the trail of bad loans. The credit growth in Indian banking sector during 2002-08 was in excess of 22%. Slackening of economic growth has resulted in lower credit demand as well as rise of stressed assets in banking industry. As per the RBI data, majority of stressed assets are in the infrastructure segment including power, telecom, textile, iron and steel. Industry is in favor of RBI’s likely move to cap large scale borrowings to a single group to avoid big defaults.  This is likely to put a check on easy loans for inconsequential companies under prominent flagships.

Crony bankers
India’s public sector banks have highly dismal record of corporate governance. As demand for cleansing of PSB boards from political cronies is on the rise, the government is working on fresh guidelines for senior-level appointments. This may include splitting of CMD post and inclusion of independent directors in the boards of public sector banks. Though the present government has been slow to fill up top echelons of PSU banks but they have been more cautious and seems to be working in this direction so far.

Former SBI chief Bhatt feels this move will not cut ice as long as a complete overhaul of selection process does not take place. “If you were to look at the appointment of Board Directors differently, or to split the post of the CMD, it would serve no purpose if the selection criteria and the selection process are not changed simultaneously”, he said. RBI has preferred to stay quiet in the debate of murky Bank Board appointments. But questions are likely to knock their door as well. “Board-level appointments are made after RBI’s approval. The selection committee for appointment of chairmen and managing directors (of PSBs) and executive directors is headed by the RBI governor. RBI is also responsible for top appointments”, a senior banker lamented on condition of anonymity.

Double whammy

Banking crises have emerged at a time when industry and consumers are looking for softer interest rate and quick credit. Piles of stressed assets and acute capital crunch will not allow banks to reduce interest rate effectively.  Moreover, it would be highly difficult to kick start investment cycle with debt laden corporate balance sheets. As infrastructure is now a stressed sector for banks, financing to core infra projects is likely to remain slow and tardy. Bank’s hunt for willful defaulters and enforcement agencies chasing erring bankers may prove a dampener to investment revival.

Big Bang Reforms !
The report of the committee headed by former Axis bank CEO Mr. P J Nayak has initiated a fresh debate on banking reforms with its radical recommendations. It says banks should be incorporated under companies’ act with a total repeal of all acts related to the government’s governance functions regarding PSU banks. This report suggests constitution of a holding company (Holdco) to take all the rights and holdings of PSU banks under its command to divest them later. In order to attract the professional CEO and staff, government will have to incentivize them on the market rate, thus making banking boards free from political cronyism.

However, analysts are a bit skeptical. “PJ Nayak Committee recommendations, if implemented, could be one of the radical reforms in Indian banking space. However, we do not expect it to pass in current form given underlying challenges and diverse involvement of stakeholders, said Nilesh Parikh, Associate Director and Banking Analyst Edelweiss Securities. Saurabh Mukherjea, CEO-Institutional Equities, Ambit Capital, points out, “Other than the rottenness of the banks, which the NDA cannot be blamed for, the real issue today is that NDA is mystifying inability to provide clarity on how the banking sector woes will be fixed. Absent such a plan, GDP growth in FY 16 will struggle to reach 6%.”

PSU banks require massive capital infusion by the government (which owns 63% of PSBs) to meet global norms of healthy banking. The P J Nayak Committee estimates that after taking into account the impairment for stressed assets and growth requirements, PSU banks will need capital support of US$40-100bn over FY15-19. This is 2.1-5.4% of India’s FY14 GDP. It is just impossible for government to fund this need from deficit loaded central budget.

If analyst could be believed, Public sector banks are at the precipice of second major debt write-off in last 10 years. Government may go for temporary measures such as creating a bad bank, (American TARP model) to buy stressed assets of the banks or it can ask PSU banks to take a haircut and a subsequent privatization of PSBs. But, it would be an invitation to a bigger crisis in near future.

Cost-effective and easy credit is the bottomline of economic growth and consumer spending. Providing banking services to un-banked population has the potential to add on it. This requires an efficient, robust and transparent banking, while government seems to be satisfied at the moment with cosmetic restructure of banking boards or a plain vanilla divestment.

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