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Opinion | The mirror that Raghuram Rajan holds up before us

September 13
23:29 2018

Subir Roy

Raghuram Rajan, the internationally acclaimed academic and former Reserve Bank of India (RBI) governor, has just done India a service — he has sharply taken forward its understanding of how bad loans piled up for banks after the 2008 global financial crisis, why getting them off the balance sheets of public sector banks (PSBs) is proving to be so difficult and, perhaps most importantly, how governance needs to improve if we are not to be periodically revisited by the same malady.

In passing, he has demolished the “ludicrous” attempt by a government economist (“people who have not done their homework”) to blame the post-demonetisation economic slowdown not on that draconian government action itself but the move by the RBI to force banks to come clean on the doubtful assets on their balance sheets.

Through financial 2014-16, PSBs’ non-food credit growth rate fell, even as that of the new private banks rose. Ditto with credit to industry and micro and small enterprises and similar but less pronounced for credit to agriculture. But credit growth for personal loans moved apace for both the PSBs and private banks. So the PSBs slowed lending to sections which they could see were getting into trouble. The credit growth slowdown (from early 2014) antedates the cleanup which began in right earnest from the second half of fiscal 2015 and so cannot be attributed to it.

The juiciest parts of Rajan’s repost (note to Parliament’s estimates committee) are where he brings in the politics. He gave a speech in July 2016 on the issue of non-performing assets (NPAs) and slowdown, “knowing it was only a matter of time before vested interests who wanted to torpedo the cleanup started attacking the cleanup on the growth issue.”

In the process, he has come out with a few asides which tell us what to expect of the central bank, what it cannot do and what it ought to do better. He says the regulator is a “referee”, not a player in commercial lending. The RBI directors on bank boards “have no commercial lending experience”, but only offer “an illusion that the regulator is in control”. Hence the repeated request to government by the RBI governors to allow them to be withdrawn from bank boards.

What it ought to do better in the future follows from what it could have done post-2006 but did not — raise red flags earlier even as it sees exuberance taking hold of bank lending and show less of forbearance in the hope that things will get better with economic recovery. Perhaps most importantly it should have pushed earlier and more forcefully for the tools to fight malfunction — creation of the insolvency and bankruptcy process. This it could have done by starting earlier the move to unearth the malady (NPA) by initiating the asset quality review.

From all these, the key takeaways are: what is peculiar in the Indian system, what kind of animal is the powerful Indian promoter, how he can influence government policy, how you have to make a different animal out of our bankers and what needs doing to give ourselves a healthier system.

You cannot wish away periods of irrational exuberance (2006-08) but you have to learn to get out of it double quick and the government has to act, not dither or be incapacitated. The unearthing of irregular allocation of coal mines led to government inaction in the past, inability to act on stranded power projects is symptomatic of continued government inaction now.

Once projects get delayed and promoters’ equity is eroded, bankers have to restructure project balance sheets and get promoters to bring in more equity, threatening them with loss of control if they do not. Bankers could not do this until they had the weapon of the Insolvency and Bankruptcy Code (IBC).

Bankers fearful of future investigations into debt write-down (restructuring) in the absence of infusion of fresh equity preferred to give fresh loans to pay interest. Promoters then did not have to bring in fresh equity and the government did not have to recapitalise banks providing for NPAs. This way loan accounts were not rendered “irregular” and bank balance sheets continued to look good on paper.

Peculiar Indian features stand out. Too many loans have been given to well-connected promoters with a history of default; the system has been singularly ineffective in bringing even a single high-profile fraudster to book; hence frauds have not been discouraged; and the inefficient loan recovery system has given promoters tremendous power over lenders.

The PSB boards are still not adequately professionalised, and the government, rather than a more independent body, still decides board appointments, with inevitable politicisation. The government could follow the PJ Naik committee report more carefully. The crucial need is to delegate appointments entirely to an entity such as the Banks Board Bureau and not retain it in government. Instead, the recommendations made by its highly-respected first chief, Vinod Rai, have mostly been ignored and he has left after completing his term, rendering the board faceless, already having become toothless.

(Subir Roy is a senior journalist and author. The views expressed are personal)

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