Banks are there to lend.
What do they do if they are told not to? When Prime Minister Narasimha Rao ushered in economic liberalisation in the early 90s, the Industrial Development Bank of India (IDBI) was at the forefront of funding projects, from Reliance Industries’ refinery to Essar Steel’s plant to Enron’s power projects. It had a share of the pie in every major project. Less than three decades later, its market-era avatar — IDBI Bank is told by the regulator not to do what it was founded for — lending for projects. If it did so without getting its house in order, it won’t be able to survive.
That’s the Reserve Bank of India’s (RBI) style of protecting a bank from sinking with a programme that it calls — the Prompt Corrective Action.
Fortunately, for IDBI, and unfortunately, for the economy, it is not alone. Nearly 11 other banks are in the same category and at least 5 more are staring at getting into the emergency ward. That is half of India’s listed state-run banks. No wonder, Piyush Goyal, who has been given temporary charge of the finance ministry, is a worried man. The government and state-owned Life Insurance Corporation of India (LIC) have thrown in more than Rs 2.15 lakh crore in capital over the last decade, data from ratings firm ICRA shows. Another Rs 65,000 crore is waiting to be infused by the government in what appears to be a bottomless pit.
Recently, the minister promised to pull these banks out of the problem. but he didn’t reveal any concrete plan. Is this yet another case of false promise? “It will be difficult for PSU banks to recover from this crisis,” says Karthik Srinivasan, head-financial sector ratings at ICRA. “In near term, the pain for PSBs is going to continue, given that the RBI had already started issuing directive to banks to stop incremental credit. Unless recoveries come up, their situation is expected to worsen.”
The RBI, after the March quarter financials release of banks, ordered Dena Bank to completely halt lending and imposed restrictions on Allahabad Bank to stop lending to risky assets and raising high-cost deposits. Some of the other banks also face a similar fate, as their financials deteriorate. While the RBI may be firing the only tool from its arsenal when it comes to state-run banks, the move may push them into a deeper rut as their staying out of lending pushes away customers, creating a negative business loop.
RAY OF HOPE?
Fixing troubled state-run banks has been an elusive mission, thanks to political interference in business of lending in the past and the temptations of earlier governments to use it as an extension of treasury.
Indian banking system now has bad loans of Rs 9.80 lakh crore, of which state-run banks account for 88%. While lax underwriting standards were part of the problem, directed lending to political patrons caused the remaining.
“The reason we are in so much distress right now relates to governance and it is not just banks, but the way PSBs are structured,” says Krishnamurthy Subramanian, professor of finance at the Indian School of Business in Hyderabad. “One set of blame has to go to the bureaucrats, the way they have, through directions over decades, essentially made banks clones of each other.”
While state-run banks have been a ward of the government since nationalisation in 1969, things started to change since Narendra Modi came to power in 2014. One of the earliest promises he made was that none from New Delhi would interfere in business. While there is no hard data, bankers say Modi has lived up to his promise.
Although the Modi government has thrown record money into banks as capital, it has been trying to make banks accountable where it laid down performance parameters in the first edition of Gyan Sangam, a brain storming session of bankers in Pune in 2015.
Subsequently, it said in its sevenpronged programme Indradhanush plan that those banks which meet the financial metrics would alone get capital. They were appointments, Banks Board Bureau (BBB), capitalisation, destressing, empowerment, framework of accountability and governance reforms.
While these were ambitious steps, bureaucratic sclerosis made BBB ineffective, appointments meddled with, and bankers’ lethargy and fear held back destressing and revitalisation. “Actions of several fronts have been taken to revive PSBs,” says R Gandhi, former deputy governor at the RBI. “The government has agreed to provide capital, narrow banking has been compelled on them through PCA and the IBC resolution process has started to bear fruit … we have to allow this process to work its way through.”
PCA: PROBLEM OR SOLUTION
The Prompt Corrective Action (PCA) framework came into being in December 2002 after the previous round of bad loans to industries sank Indian banks in the 1990s. Among the various trigger points, capital levels and bad loans were the benchmarks. The first of several restrictions under PCA is enforced when a bank’s capital falls below 10.25% or net bad loan goes past 6% of total loans. At different stages, different rules regarding hiring and expansion come into force. Although the regulator may believe that PCA helped banks turn around after the previous crisis, bankers say that the economic growth tide lifted all boats. Bankers say that PCA goes against every grain of banking economics. A bank has multiple cost-centres like employee cost. For example, its largest cost is interest expense and the income is interest income, which it gets from loans and fee income. Now, if a bank stops lending, the contraction of the bank balance sheet aggravates, because you can’t earn more, but your interest expense and other costs remain the same. The process of recovery is also cost-intensive so your expense actually increases … now, if a bank is not lending at all, its position deteriorates.
The share of state-run banks in the commercial lending market dropped to Rs 31.1 lakh crore at the end of December 2017 from Rs 32 lakh crore in March 2016. During the same period, the share of private sector banks grew to Rs 10.9 lakh crore from Rs 9.1 lakh crore, while for NBFCs, it grew to Rs 3.9 lakh crore from Rs 2.2 lakh crore, data from CIBIL shows. The use of CIBIL data has also led to early disclosure of systemic risks which was not the case earlier. Thanks to the PCA restrictions and bad loan troubles, even HDFC Bank, which till now stayed away from project lending, is stepping in to grab the market.
LIFE BEYOND CAPITAL
Capital is the raw material for banks. Even if the government manages to invest capital, can these banks withstand the competition. Do they have skills, leadership to take these banks to the next level? If the previous crisis is an indication, there’s hardly any hope.
IDBI, ICICI and IFCI were birds of the same feather. While ICICI thrived, the rest faltered and the difference was its chairman N Vaghul and CEO KV Kamath who adopted a formula— drive the denominator if you can’t reduce the numerator. That translates into grow the loans if you can’t bring down bad loans. Furthermore, ICICI was pulled out of the clutches of bureaucracy and government which IDBI and IFCI leaderships failed to.
Consolidation of state-run banks is a formula being suggested as a solution, but that may end up being blind leading a blind. “I am comfortable seeing that in the next few years the space of these inefficient smaller and poorly governed PSBs shrinking and will be taken over by small finance banks, payment banks and NBFCs,’’ says ISBs Subramanian.
Source: Economic Times, May 30,2018