Corporates Responsible for More Than 80% of Bad Loans of Public Sector Banks

One of the points that we have been making regularly in our columns and Letters is that public sector banks should not be lending to corporates. And now we have found more data to back it.

In a written answer to a question raised in the Lok Sabha, the government provided data regarding the accumulated bad loans across different areas of lending. Bad loans are basically loans on which repayment has been due for 90 days or more.

Take a look at Table 1.

Table 1:

As on March 31, 2017 Industry Agriculture and
Allied Activities
Services Retail Loans Other loans
Total NPAs 4,70,084 57,021 84,686 23,795 5,470

Source: Unstarred Question No: 4614, March 23, 2018 

It is clear from the above table that lending to industry forms a bulk of the bad loans of public sector banks. The total bad loans of public sector banks as on March 31, 2017, had stood at Rs 6,41,057 crore.

This basically means that lending to industry forms 73.3% of the total bad loans of public sector banks. Or to put it a little differently, lending to industry forms nearly three-fourths of the bad loans of public sector banks. Take a look at Table 2, which basically lists out the proportion of bad loans that have accumulated for public sector banks, from different forms of lending.

Table 2:

Sector (As on March 31, 2018) Proportion of bad loans in each sector
Industry 73.33%
Agriculture and Allied Activities 8.89%
Services 13.21%
Retail Loans 3.71%

Source: Author calculations on data taken from Unstarred Question No: 4614, March 23, 2018 and Centre for Monitoring Indian Economy 

Table 2 tells us very clearly that the industry and services sector are together responsible for 86.5% of the accumulated bad loans of public sector banks. This basically means that Indian corporates (because while lending to the services sector also, banks are lending to corporates) are responsible for more than 80% of the bad loans of public sector banks.

Of course, one can’t just look at bad loans in isolation of the total loans given out by public sector banks in each of the different areas. Take a look at Table 3, which lists the proportion of the overall loans, given to each sector.

Table 3:

Sector (As on March 31, 2017) Proportion of loans
Industry 37.78%
Agriculture and Allied Activities 13.99%
Services 25.40%
Retail Loans 22.83%

Source: Centre for Monitoring Indian Economy. 

Table 3 makes for a very interesting reading. The total lending to industry by public sector banks forms around 37.8% of the total lending. On the other hand, as we can see from Table 2, the lending to industry is responsible for 73.3% of bad loans. This clearly tells us where the problem with Indian banking is.

Now, let’s take a look at Table 4, which basically lists the bad loans of different sectors as a proportion of total lending carried out to that sector.

Table 4:

Sector Total Bad loans
(in Rs crore)
Total loans Bad loans
(in %)
Industry 4,70,084 26,80,025.00 17.54%
Agriculture and Allied Activities 57,021 9,92,387.00 5.75%
Services 84,686 18,02,243.00 4.70%
Retail Loans 23,795 16,20,034.00 1.47%

Source: Author calculations on data taken from Unstarred Question No: 4614, March 23, 2018 and Centre for Monitoring Indian Economy 

What does Table 4 tell us? For every Rs 100 that Indian public sector banks have lent to industry, Rs 17.5 has not been repaid. For retail loans, the bad loans rate is 1.47%. This shows the difference between lending to industry and lending to individuals.

Finally, let’s take a look at Table 5, which lists the retail NPAs and the industry NPAs of different banks as on December 31, 2017.

Table 5:

Name of the bank Retail NPA in% Industry NPA in %
State Bank of India 1.3 21.9
Bank of India 2.6 27.6
Syndicate Bank 4 16
Bank of Baroda 3.4 16
IDBI Bank 1.4 39.4
Central Bank of India 4.6 23.5
Bank of Maharashtra 4.4 15.3
Andhra Bank 1.8 29.1

Source: Investor/Analyst presentations of banks. 

One look at Table 5 makes it clear that public sector banks do a fairly decent job of lending to the retail sector. The retail bad loans are all less than 5% in every case, whereas the corporate NPAs are higher than 15%.

There are multiple reasons for this. There is no pressure from politicians to lend to crony capitalists when it comes to retail lending. The managers can carry out proper due diligence while giving the loan.

There is very little incentive for the manager to crack a deal on the side, with a retail borrower (unlike is the case with a loan given to industry) and give a loan, where he shouldn’t be giving one. This is primarily because the average loan amount is much smaller in case of a retail loan than a loan to industry, and any dishonesty while giving a retail loan is really not worth the risk.

In case of default, the legal system can be unleashed on to the retail borrower, unlike a loan given to industry, which has access to the best lawyers. A retail defaulter is unlikely to leave the country, like has been the case with several corporate defaulters, in the recent past. The asset against which the loan has been given to a retail borrower can be easily repossessed in case of default, unlike is the case with a loan given to industry.

In case of a home loan, which forms a little over 50% of all the retail loans given out by banks, the value of the home against which the loan has been given tends to much more than the outstanding loan at any point of time. This is primarily because banks don’t fund 100% of the value of the home, getting the borrower to put in at least 20% as a down payment. Over and above this, most homes in India when they are bought also involve the payment of a black component and this adds to the margin of safety of the bank.

In comparison, many loans given to industry are gold plated where the borrower essentially fudges the cost of the project, takes a higher loan than he should and then tunnels money out from the project, thus having very little of his equity in the project. In some cases, the value of the asset against which the loan has been taken tends to be lower than the value of the loan.

Narrow banking is the solution. Most of the public sector banks in India, should not be lending to corporates.

It will ensure that Indian public sector banks do not end up in the mess that they currently are in, anytime in the near future. The trouble is the politicians aren’t going to like it because it is the crony capitalists who fund their elections at the end of the day. And where do crony capitalists get their money from?

The other problem is that if banks do not lend for long term projects, what is the alternative arrangement? The corporate bond market in India barely exists. Pension funds, provident funds and insurance companies, prefer to invest in government bonds, and do not really have the expertise to invest in long term corporate projects. The project finance institutions of yore do not exist, having turned themselves into retail banks.

Having said that, the first and the foremost function of a bank is to ensure the safety of the money of the depositors.

To conclude, all these factors leave the public sector banks in India, in an extremely vulnerable space. As far as the government (or should I say governments) is concerned, all it has done is to throw money at the problem, which is never enough to solve any problem.

Some thinking is necessary as well.

The column originally appeared on Equitymaster on March 26, 2018.

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Electoral Bonds Do Not Address Key Issue of Lack of Transparency in Political Funding

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010

In the budget speech, the finance minister Arun Jaitely made in February 2017, he said: “Even 70 years after Independence, the country has not been able to evolve a transparent method of funding political parties which is vital to the system of free and fair elections.

He further added: “An amendment is being proposed to the Reserve Bank of India Act to enable the issuance of electoral bonds in accordance with a scheme that the Government of India would frame in this regard. Under this scheme, a donor could purchase bonds from authorised banks against cheque and digital payments only. They shall be redeemable only in the designated account of a registered political party. These bonds will be redeemable within the prescribed time limit from issuance of bond.”

If one were to summarise the above two paragraphs what Jaitley basically said was that the government of India proposed to introduce electoral bonds to make transparent the method of funding political parties in India.

Eleven months later on January 2, 2018, the Narendra Modi government notified “the Scheme of Electoral Bonds to cleanse the system of political funding in the country.” The press release accompanying the decision listed out the various features of these bonds. They are:

1) Electoral bonds would be issued/purchased for any value, in multiples of Rs 1,000, Rs 10,000, Rs 1 lakh, Rs 10 lakh and Rs 1 crore, from specified branches of the State Bank of India (SBI).

2) The electoral bond would be a bearer instrument in the nature of a promissory note and an interest free banking instrument. A citizen of India or a body incorporated in India will be eligible to purchase the bond.

3) The purchaser would be allowed to buy electoral bonds only on due fulfilment of all the extant KYC norms and by making payment from a bank account.

4) It will not carry the name of payee.

5) Once these bonds are bought they will have a life of only 15 days. During this period, the bonds need to be donated to a political party registered under section 29A of the Representation of the Peoples Act, 1951 (43 of 1951) and which secured not less than one per cent of the votes polled in the last general election to the House of the People or a Legislative Assembly.

6) Once a political party receives these bonds, they can encash it only through a designated bank account with the authorised bank.

7) The electoral bonds shall be available for purchase for a period of 10 days each in the months of January, April, July and October, as may be specified by the central government. An additional period of 30 days shall be specified by the central government in the year of the general election to the House of People.

So far so good. There are a number of points that crop up here. Let’s discuss them one by one:

1) The finance minister Jaitley in his budget speech last year had talked about electoral bonds introducing transparency into political funding. These bonds will not have the name of the person buying the bond and donating it to a political party. The question is how do anonymity and transparency, not exactly synonyms, go together? This is something that Jaitley needs to explain.

2) The electoral bonds continue with the fundamental problem at the heart of political funding—the opacity to the electorate. With the KYC in place, the government will know who is donating money to which political party, but you and I, the citizens of this country, who elect the government, won’t. This basically means that crony capitalists who have been donating money to political parties for decades will continue to have a free run. The electoral bonds do nothing to break the unholy nexus between businessmen and politicians.

3) For these bonds to serve any purpose, they should have the name of the person buying the bond. And these names should be available in public domain, with the citizens of the country clearly knowing where are the political parties getting their funding from.

4) Supporters of the bonds have talked about the fact that anonymity is necessary or otherwise the government can crack down on those donating money to opposition parties. This is a very spurious argument. With the KYC in place, the State Bank of India will immediately know who is donating money to which political party. And you don’t need to be a rocket scientist to conclude that this information will flow from the bank to the ministry of finance. Hence, we will be in a situation where the government knows exactly who is donating money to which political party, but the opposition parties don’t. If the government of the day can know who is funding which political party, so should the citizens.

Now what stops the government (and by that, I mean any government and not just the current one) from going after the citizens or incorporated bodies for that matter, donating money to opposition parties. The logic of anonymity clearly does not work.

The structure of the electoral bonds seems to have been designed to choke the funding of opposition parties, more than anything else. Also, it is safe to say, given these reasons, cash donations will continue to be favoured by crony capitalists close to opposition parties.

5) There is one more point that needs to be made regarding political donations as a whole and not just the recently notified electoral bonds. Earlier the companies were allowed to donate only up to 7.5 per cent of their average net profit over the last three years, to political parties. They also had to declare the names of political parties they had made donations to. This was amended in March 2017. The companies can now donate any amount of money to any political party, without having to declare the name of the party.

To conclude, electoral bonds do not achieve the main purpose that they were supposed to achieve i.e. the transparency of political funding. All they do in their current form is to ensure that the ruling political party continues to consolidate its position, at the cost of the citizens of this country. Of course, given the marketing machinery they have in place, they will spin it differently. Given this, the WhatsApp wars on this issue have already begun.

The column was originally published in Equitymaster on January 5, 2018.

If PM Modi could sell Notebandi why not Bankbandi? Many banks do not deserve fresh capital

rupee

One of the examples of Big Government I have in my book India’s Big Government is that of government owned public sector banks. (The good news is that the book is available at a huge discount on Amazon till Friday, 27th October. The Kindle version is going at Rs 199, against a maximum retail price of Rs 749, and the paperback is going at Rs 499, against a maximum retail price of Rs 999).

When I wrote the book, the Indian government owned 27 public sector banks. As of April 1, 2017, the Bhartiya Mahila Bank and the five associate banks of State Bank of India, were merged with the State Bank of India. Due to this merger, the number of government owned banks fell to 21. This merger has pulled down the overall performance of the State Bank of India and is just a way of sweeping problems under the carpet. Over the years, the government plans to use mergers to reduce the number of banks it owns to anywhere between ten to fifteen. This as I have said in the past is a bad idea.

Yesterday afternoon, the finance ministry announced a plan to invest more capital in public sector banks, which are saddled with a massive amount of bad loans and restructured loans. The government plans to put in Rs 2,11,000 crore over the next two years, “with maximum allocation in the current year”.

Where will this money come from? Rs 18,139 crore has been allocated from the current financial year’s budget. Banks are expected to raise capital by issuing new shares. This is expected to raise around Rs 58,000 crore.

This leaves us with around Rs 1,35,000 crore. Where will this money come from? This money is expected to come in through recapitalisation bonds. How will this work? The government hasn’t specified the details of how these bonds will be issued. (This makes me wonder as to why have a press conference in the first place, when the most important part of the plan, has not been decided on).

From what I could gather speaking to people who understand such things, this is how it is supposed to work. The banks have a lot of liquidity because of all the money that has come in because of demonetisation. A part of these deposits will be used by public sector banks to buy recapitalisation bonds issued by the government.

The money that the government thus gets will be used to buy fresh shares that the banks will issue. Thus, the banks will be recapitalised.

Now on the face of it, this sounds like a brilliant plan, where money is moved from one part of the balance sheet to another and a huge problem is solved. But is it as simple as that?

a) By issuing recapitalisation bonds the debt of the government will go up. Over and above this, interest will have to be paid on these bonds. Both the debt and the interest will add to the fiscal deficit of the government.

b) Given that the debt of the government will go up, this would mean that the taxpayers will ultimately pick up the tab because the debt will have to be repaid. It makes sense to always remember that there is no free lunch in economics. The corollary to this is that there is no free lunch especially when something feels like a free lunch. Of course, the taxpayers aren’t organised and hence, they are unlikely to protest. And given that they finance all bailouts.

c) It remains to be seen what the banks do with this extra capital. Will they use it to write off restructured loans of corporates? Will this dull their enthusiasm (not that they had enough of it in the first place) to recover bad loans? As the situation changes, so will the behaviour of bankers.

This will also bring to the fore the issue of moral hazard. And what is moral hazard? As Mohamed A El-Erian writes in The Only Game in Town: “[It] is the inclination to take more risk because of the perceived backing of an effective and decisive insurance mechanism.” If the government bails them around this time around, the banks know that they can count on the government bailing them out the next time around as well. And this means that they can follow fairly loose standards of lending, in order to lend money quickly.

d) As I keep saying, bank lending among other things is also a function of whether there is demand for such lending. The public sector banks have gone slow on lending to corporates (in fact they have contracted their loan book) because of a lack of capital. Or so we are told. But this lack of capital doesn’t seem to have hindered their lending to the retail segment. Now that they will have access to more capital, will this reluctance to lend to corporates go away? I am not so sure.

e) Also, some of the banks are in such a bad state, that they really don’t deserve this capital. They shouldn’t be in the business of banking in the first place. Take a look at Table 1. Table 1, lists out the bad loans ratio of all the public sector banks. Bad loans are essentially loans in which the repayment from a borrower has been due for 90 days or more.

Table 1:

Name of the bank Bad loans ratio (in per cent)
IDBI Bank 24.11
Indian Overseas Bank 23.6
UCO Bank 19.87
Bank of Maharashtra 18.59
Central Bank of India 18.23
Dena Bank 17.37
United Bank of India 17.17
Corporation Bank 15.49
Oriental Bank of Commerce 14.83
Allahabad Bank 13.85
Punjab National Bank 13.66
Andhra Bank 13.33
Bank of India 13.05
Union Bank of India 12.63
Bank of Baroda 11.4
Punjab and Sind Bank 11.33
Canara Bank 10.56
State Bank of India 9.97
Syndicate Bank 9.96
Vijaya Bank 7.3
Indian bank 7.21

Source: www.careratings.com 

As can be seen from Table 1, only two public sector banks have a bad loans ratio significantly lower than 10 per cent (Actually its four, but State Bank of India and Syndicate Bank are very close to 10 per cent).

Eight out of the 21 banks have a bad loans ratio of greater than 15 per cent. This basically means that out of every Rs 100 of lending carried out by these banks, at least Rs 15 is no longer being repaid.

Some of these banks with extremely high bad loans are way too small to make any difference in the overall lending carried out by banks. Take a look at Table 2.

Table 2:

Name of the Bank Total advances as a percentage of gross advances of banks (as on March 31, 2017) Bad loans rate (as on June 30, 2017)
United Bank of India 0.82% 17.17%
Dena Bank 0.90% 17.37%
Bank of Maharashtra 1.18% 18.59%
UCO Bank 1.48% 19.87%
Central Bank of India 1.73% 18.23%
Indian Overseas Bank 1.74% 23.60%

Source: Author calculations on Indian Banks’ Association data and www.careratings.com 

These public sector banks have now reached a stage wherein there is no point in the government trying to spend time and money, in reviving them. It simply makes more sense to shut them down and sell their assets piece by piece or to sell them, lock, stock and barrel, if any of the bigger private banks or any other private firms, are willing to buy them. But what the government is doing instead is using taxpayer money to maintain its control over banks.

f) Also, recapitalising banks does not take care of the basic problem at the heart of public sector banks, which is that they are public sector banks. Allow me to explain. Let’s take the example of the State Bank of India, the largest public sector banks. As of June 30, 2017, the bad loans ratio of the bank when it came to retail lending was 1.56 per cent. At the same time, the bad loans ratio when it came to corporate lending was 18.61per cent.This basically means that State Bank of India, does a terrific job at retail lending but really screws up when it comes to lending to industry. What is happening here? Thomas Sowell, an American economist turned political philosopher, discusses the concept of separation of knowledge and power, in his book Wealth, Poverty and Politics.

How does it apply in this context? In public sector banks, managers who have the knowledge to take the right decisions may not always have the power to do so. Take the case of retail lending. The manager looks at the ability of the borrower to repay a loan, and then decides to commission or not commission one. This explains why the bad loans ratio in case of retail lending is as low as 1.56 per cent (in fact, it was just 0.55 per cent before the merger). A proper process to give a loan is being followed in this case.

But when it comes to lending to corporates, there are people out there (or at least used to be) who are trying to influence the manager’s decision; from bureaucrats to ministers to politicians. In this scenario, the manager ends up giving out loans even to those corporates who do not have the wherewithal to repay it.

The separation between knowledge and power has led to a situation where bank loans were given to many crony capitalists who have defaulted, and what we are seeing now is a fall out of that. In many cases, the corporates have simply siphoned off the loan amounts by over declaring the cost of the projects they borrowed against.

Of course, as long public sector banks continue to remain public sector banks, this risk will remain. But this government (and the ones before it) likes the idea of owning banks, and because it gives some relevance to ministers and bureaucrats.

Also, the employee unions of public sector banks have a huge nuisance value. No government has had the balls to take them on, in the past. Neither does this one. And this basically means that taxpayers will have to continue rescuing the public sector banks.

The column originally appeared on Equitymaster The column originally appeared on Equitymaster with  a different headline on October 25, 2017.

The one assurance that Narendra Modi needs to give bankers…

narendra_modi
Vivek Kaul

The ministry of finance has organised a two day retreat for public sector banks in Pune over January 2 and 3, 2015. The retreat is being attended by the RBI governor Raghuram Rajan and the deputy governors as well. It will end today with brief presentations being made to the prime minister Narendra Modi. After the presentations the the prime minister will interact and address the gathering.
A press release issued by the ministry of finance basically outlined four objectives for this retreat, which are as follows:
(i) To create a platform for formal and informal discussions around the issues which are important for banking sector reforms.

(ii) To achieve a broad consensus on what has gone wrong and what should be done both by banks as well as by the government to improve and consolidate the position of PSBs.

(iii) To get some out of box ideas from prominent experts in the field as also from the top level managers attending the retreat.

(iv) The final objective would be to prepare a blue print of reform action plan once adopted which could then be implemented by the banks as well as by the government.

On paper this sounds like a good idea. It shows that the government is serious about figuring out what is wrong with the banking sector in India and working on it, instead of just letting things drift. Nevertheless, the retreat shouldn’t boil down into an excercise of exerting pressure on the public sector banks (PSBs) to lend more. With officials of ministry of finance attending the retreat as well, there are chances of that happening.
The total amount of loans being given by banks have slowed down in the recent past. Data released by the RBI shows that in November 2014 loans to industry increaed by 7.3% in comparison to November 2013. The loans had increased by 13.7% in November 2013 in comparison to November 2012. “Deceleration in credit growth to industry was observed in all major sub-sectors, barring construction, beverages & tobacco and mining & quarrying,” a RBI press release pointed out. Loans to the services sector grew at 9.9 per cent in November 2014 as compared with an increase of 18.1 per cent in November 2013.
The finance minister Arun Jaitley has time and again blamed high interest rates for this slowdown in bank lending as well as economic growth.
In a speech he made on December 29, 2014, Jaitley said: “The cost of capital…I think in recent months or years…is one singular factor which has contributed to slowdown of manufacturing growth itself.”
This and other statements that Jaitley has made over the last few months tend to look at credit (or banks loans) as a flow. But is that really the case? As James Galbraith writes in
The End of Normal: “Credit is not a flow. It is not something that can be forced downstream by clearing a pie. Credit is a contract. It requires a borrower as well as a lender, a customer as well as a bank. And the borrower must meet two conditions. One is creditworthiness…The other requirement is a willingness to borrow, motivated by the “animal spirits” of business enthusiasm. In a slump, such optimism is scarce. Even if people have collateral they want security of cash.”
Further, as Jeff Madrick points out in
Seven Bad Ideas—How Mainstream Economists Have Damaged America and the World: “Business investment is not just affected by the supply of national savings but by the state of optimism. If consumer demand for goods is not strong, a business will have little incentive to invest, no matter how great profits are or how low interest rates are on bank loans.” These are very important points that the mandarins who run the ministry of finance in this country need to understand.
So how good is the creditworthiness(or the ability to repay a loan) of Indian companies? The answer for this is provided in the recent Mid Year Economic Analysis released by the ministry of finance. As the report points out: “M
ore than one-third firms have an interest coverage ratio of less than one (borrowing is used to cover interest payments). Over-indebtedness in the corporate sector with median debt-equity ratios at 70 percent is amongst the highest in the world.”
Interest coverage ratio is the earnings before income and taxes of a company divided by the interest it needs to pay on its debt. If the ratio is less than one what it means is that the company is not earning enough to repay even the interest on it debt. The interest then needs to be repaid by taking on more debt. This works just like a Ponzi scheme, which keeps running as long as money being brought in by new investors is greater than the money that needs to be paid to the old investors.
In this situation it is not surprising that the bad loans of banks, particularly public sector banks have gone up dramatically. As the
latest financial stability report released by the RBI points out: “The gross non-performing advances (GNPAs) of scheduled commercial banks(SCBs) as a percentage of the total gross advances increased to 4.5 per cent in September 2014 from 4.1 per cent in March 2014.”
The stressed loans of banks also went up. “Stressed advances increased to 10.7 per cent of the total advances from 10.0 per cent between March and September 2014. PSBs continued to record the highest level of stressed advances at 12.9 per cent of their total advances in September 2014 followed by private sector banks at 4.4 per cent.”
The stressed asset ratio is the sum of gross non performing assets plus restructured loans divided by the total assets held by the Indian banking system. The borrower has either stopped to repay this loan or the loan has been restructured, where the borrower has been allowed easier terms to repay the loan (which also entails some loss for the bank) by increasing the tenure of the loan or lowering the interest rate.
What this means in simple English is that for every Rs 100 given by Indian banks as a loan(a loan is an asset for a bank) nearly Rs 10.7 is in shaky territory. For public sector banks this number is even higher at Rs 12.9.
The question that crops up here is why is the stressed asset ratio of public sector banks three times that of private sector banks? The financial stability report has the answer for this as well. As the report points out: “Five sub-sectors: infrastructure, iron and steel, textiles, mining (including coal) and aviation, had significantly higher levels of stressed assets and thus these sub-sectors were identified as ‘stressed’ sectors in previous financial stability reports. These five sub-sectors had 52 per cent of total stressed advances of all SCBs as of June 2014, whereas in the case of PSBs it was at 54 per cent.”
As is well known that these sectors are full of crony capitalists who were close to the previous political dispensation. This forced the public sector banks to lend money to these companies and now these companies are either not in a position to repay or have simply fleeced the bank and not repaid.
The report further points out that the public sector banks have the highest exposure to the infrastructure sector: “Among bank groups, exposure of PSBs to infrastructure stood at 17.5 per cent of their gross advances as of September 2014. This was significantly higher than that of private sector banks (at 9.6 per cent) and foreign banks (at 12.1 per cent).”
Public sector banks haven’t been able to recover these loans from businessmen who have defaulted on them. Given this, if there is one assurance that Narendra Modi needs to give to public sector banks, it has to be this—he needs to assure them that there will be absolutely no pressure on them from his government to lend money to crony capitalists who are close to the current political dispensation.
This single measure, if followed, will go a long way in improving the situation of public sector banks in this country. It will be one solid move towards the promised
acche din.

The article originally appeared on www.equitymaster.com as a part of The Daily Reckoning on Jan 3, 2015

Crony capitalism: The truth about Indian banking is finally coming out

indian rupeesVivek Kaul  

One of the well kept secrets about the fragile state of the Indian economy is gradually coming out in the open. The Indian banks are not in great shape. The Financial Express reports that the chances of a lot of restructured loans never being repaid has gone up. It quotes R K Bansal, chairman of the corporate debt restructuring (CDR) cell, as saying that the rate of slippages could go up to 15% from the current levels of 10%. “The slower-than-expected economic recovery and delayed clearances for projects will result in a higher share of failed restructuring cases,” Bansal told the newspaper.
When a big borrower (usually a company) fails to repay a bank loan, the loan is not immediately declared to be a bad loan. The CDR cell is a facility available for banks to try and rescue the loan. Loans are usually restructured by extending the repayment period of the loan. This is done under the assumption that even though the borrower may not be in a position to repay the loan currently due to cash flow issues, chances are that in the future he may be in a better position to repay the loan. Or as John Maynard Keynes once famously said “
If you owe your banka hundred pounds, you have a problem. But if you owe a million, it has.” 
As of December 2013, the CDR cell had restructured loans of around Rs 2.9 lakh crore. Of this nearly 10% of the loans have turned into bad loans with promoters not paying up. Bansal expects this number to go up to 15%. Interestingly, a Reserve Bank of India (RBI) working group estimates that nearly 25-30% of the restructured loans may ultimately turn out to be bad loans.
And that is clearly a worrying sign. There is more data that backs this up.
 In the financial stability report released in December 2013, the RBI estimated that the average stressed asset ratio of the Indian banking system stood at 10.2% of the total assets of Indian banks as of September 2013. It stood at 9.2% of total assets at the end of March 2013.
The average stressed asset ratio is essentially the sum of gross non performing assets plus restructured loans divided by the total assets held by the Indian banking system. What this means in simple English is that for every Rs 100 given by Indian banks as a loan(a loan is an asset for a bank) nearly Rs 10.2 is in shaky territory. The borrower has either stopped to repay this loan or the loan has been restructured, where the borrower has been allowed easier terms to repay the loan (which also entails some loss for the bank).
The RBI financial stability report points out that this has happened because of bad credit appraisal by the banks during the boom period. “It is possible that boom period[2005-2008] credit disbursal was associated with less stringent credit appraisal, amongst various other factors that affected credit quality,” the report points out. Hence, borrowers who shouldn’t have got loans in the first place, also got loans, simply because the economy was booming, and bankers giving out loans felt that their loans would be repaid. But that hasn’t turned out to be the case.
Interestingly, Uday Kotak, Managing Director of Kotak Mahindra Bank recently told CNBC TV 18 that the current stressed, restructured or non performing loans amounted to nearly 25% of the Indian banking assets. He put the total number at Rs 10 lakh crore of the total loans of Rs 40 lakh crore given by the Indian banking system. This is a huge number.
Kotak further said that the Indian banking system may have to write off loans worth Rs 3.5-4 lakh crore over the next few years. When one takes into account the fact that the total networth of the Indian banking system is around Rs 8 lakh crore, one realizes that the situation is really precarious.
Interestingly, a few business sectors amount for a major portion of these troubled loans. As the RBI report on financial stability points out “There are five sectors, namely, Infrastructure, Iron & Steel, Textiles, Aviation and Mining which have high level of stressed advances. At system level, these five sectors together contribute around 24 percent of total advances of SCBs (scheduled commercial banks), and account for around 51 per cent of their total stressed advances.”
So, five sectors amount to nearly half of the troubled loans. If one looks at these sectors carefully, it doesn’t take much time to realize these are all sectors in which crony capitalism is rampant (the only exception probably being textiles).
Take the case of L Rajagopal of the Congress party (who recently used the pepper spray in the Parliament). He is the chairman and the founder of the Lanco group, which is into infrastructure and power sectors. As Shekhar Gupta
 pointed out in a recent article in The Indian Express, Rajagopal’s “company got a Rs 9,000 crore reprieve in a CDR (corporate debt restructuring) process just the other day. His bankrupt companies were given further loans of Rs 3,500 crore against an equity of just Rs 239 crore. Twenty-seven banks were involved in that bailout.”
Here is a company which hasn’t repaid loans of Rs 9,000 crore. It benefits from the restructuring of those loans and is then given further loans worth Rs 3,500 crore. So, if the Indian banking sector is in a mess, it is not surprising at all.
As bad loans mount, banks will go slow on giving out newer loans. They are also likely to charge higher rates of interest from those borrowers who are repaying the loans. This is not an ideal scenario for an economy which needs to grow at a very fast rate in order to pull out more and more of its people from poverty. If India has to go back to 8-9% rate of economic growth, its banks need to be in a situation where they should be able to continue to lend against good collateral.
So is there a way out of this mess? A suggestion on this front has come from Saurabh Mukherjea from Ambit. He suggests that the bad assets be taken off from the balance sheets of banks and these assets be moved to create a “bad bank”. This would allow the good banks to operate properly, without worrying about the bad loans on its books. As he writes “This would, in effect, nationalise the bad assets of the Indian banks and the taxpayer would have to bear the burden of these sub-standard loans.”
The government had followed this strategy to rescue Unit Trust of India (UTI). All the bad assets were moved to SUUTI (Specified Undertaking of the Unit Trust of India). The good assets were moved to the UTI Mutual Fund, which has flourished over the years. The government also has gained in the process.
The trouble here is that even if the government does this, there is no guarantee that it might be successful in reining in the crony capitalists. Over the last 10 years crony capitalists like Rajagopal, who are close to the Congress party, have benefited out of the Indian banking system. Given this, it is but natural to assume that after May 2014, the crony capitalists close to the next government (which in all likeliness will be led by Narendra Modi) will takeover. And that is the real problem of the Indian banking sector, for which there can be no solution other than a political will to clean up the system.

The article originally appeared on www.firstbiz.com on February 25, 2014

 (Vivek Kaul is a writer. He tweets @kaul_vivek)