Why our banks are timebombs

In a move designed more to buttress her socialist credentials than for any compelling economic reason, Mrs Indira Gandhi nationalised 14 of India’s largest private banks, which held 85 per cent of the country’s deposits, in 1969.

Over the years, these nationalised banks have deepened bank penetration in the rural hinterland and increased credit to agriculture, although some have argued that this could just as well have been achieved by exercising social control over private banks. Meanwhile, the collateral cost to the Indian economy has been enormous as it set in motion a gravy train on which politicians and crony businessmen have taken a free ride ever since. There have been loan melas where banks were forced to extend credit with little chance of recovery, thanks to electorally-dictated populist compulsions. Today, about 65 per cent of India’s banking sector (by deposits) is state-owned, and Indian banks were among the most unprofitable in the world in 2018-19. Run as political fiefdoms and with all the attendant inefficiencies of government-owned businesses, India’s public sector banks (PSBs) are giant black holes sucking in trillions of rupees of taxpayers’ money. The government has spent roughly Rs 3.5 lakh crore in recapitalising PSBs in the past few years. This is the entire outlay for the Jal Jeevan Mission, announced in August 2019 to provide piped drinking water to all households. This August, RBI’s annual report said frauds cost banks Rs 1.86 lakh crore in FY20, of which PSBs accounted for 80 per cent. This figure is six times the government’s intended expense on women and child development. It’s a crying shame that the taxpayer should be bearing the cost of bank malfeasance when the money could be used for more meaningful purposes.

Last month, business circles were rattled by the impending collapse of yet another bank. The RBI stepped in to write off Rs 318 crore worth of debt and Rs 336 crore of equity to bail out Lakshmi Vilas Bank. Mercifully, this was small change, but it drew attention to the looming crisis non-performing assets (NPAs), as bad loans are called in banking parlance, posed. NPAs stood at Rs 9.4 lakh crore as of June 2019. This number, four times India’s entire health budget, now rocks the struggling ship of India’s economy. Most of these loans were extended in the rising tide of India’s economic boom a decade ago when Indian bankers lent indiscriminately, especially to the then-booming money-guzzling telecom and real estate sectors. Of late, however, the existing NPAs are beginning to look like just the tip of the iceberg, with an expanding mass of bad loans lurking below the surface. With the pandemic-dictated and government-mandated moratorium on interest payments, former finance secretary Subhash Chandra Garg estimates that NPAs will increase by an additional Rs 10 lakh crore by the end of this financial year, doubling the existing number. As companies fail to repay banks and their debt balloons, the proverbial iceberg keeps getting bigger. In 2017, the government drew up a plan to infuse Rs 2.11 lakh crore—more than twice the budgetary allocation to education this year—to recapitalise its bleeding PSBs.

Private sector banks are not above reproach either. The examples of ICICI Bank and, more recently, YES Bank, where the promoters were compromised, underline this. The difference is that it is the taxpayer’s money in the case of PSBs, while shareholders bear the brunt of the misdemeanours of private banks.

Over the past six years, there have been enough indications of the rot within the banking sector. The slew of cases began with Vijay Mallya and Nirav Modi, businessmen who epitomised the worst of crony banking. With bad debts of Rs 8.8 lakh crore, PSBs account for nearly 85 per cent of India’s total NPAs. The country’s largest government-owned bank, State Bank of India, alone has Rs 2.23 lakh crore of bad loans. Mounting NPAs mean banks are wary of lending despite sitting on huge cash piles. Public trust in banking, the cornerstone of the business, is severely eroded. Capital, as we all know, is the lifeblood of the economy. Without access to it, businesses cannot grow and, without growth, our economy will continue to teeter on the edge. At a time it is facing one of its worst years on record, rising NPAs mean we could be staring at a crisis of unprecedented magnitude in the coming year.

The banking sector is no doubt in an unholy mess. Riddled with fraud, growing NPAs, sloppy management, and averse to risk, the whole sector is stuck in a quagmire. The government’s half-hearted reform of merging 10 PSBs into four is just window-dressing the problem and kicking the can down the road. Attempts to give PSBs autonomy and appoint more professional management have proved stillborn.

An RBI working group has taken the first step by suggesting that large corporate houses become bank promoters. It’s a move fraught with the risk of connected lending or banks lending to their own holding companies. RBI data shows that PSB market share in loans dipped from 74.3 per cent in 2015 to 59.8 per cent in 2020 while that of private banks surged from 21.3 per cent to 36 per cent. Some private banks have excelled in value creation. HDFC Bank’s market capitalisation, for instance, was Rs 7.79 lakh crore on December 16, more than the combined m-cap of all PSBs (Rs 4.88 lakh crore).

There is a message in this if the government chooses to heed it. The long-term solution demands a complete reform of India’s banking sector. It calls for greater scrutiny and stringent controls on large loans, including asset audits and reviews, and strict checks every quarter. Our cover story, ‘Why Our Banks are Timebombs’, put together by Executive Editor MG Arun, Deputy Editor Shwweta Punj and Senior Editor Anilesh S Mahajan, looks at this very worrying phenomenon and suggests ways out of it.

If the Indian economy is to grow, credit will have to flow without burdensome NPAs. India’s credit to GDP ratio is 56 per cent; China’s is in the 150-200 per cent range. For India to become a $5 trillion economy, credit growth needs to be at 15 per cent for the next five years; it is currently about 8-10 per cent. If the government is serious about economic development, it must bite the bullet of fundamental bank reform. Otherwise, the economy will just blunder along.

(India Today Editor-in-Chief's note for the cover story, Why Our Banks Are Timebombs, for December 28, 2020)

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