Do Numbers Always Tell the Truth?

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The writer Gregg Easterbrook once said: “Torture numbers, and they’ll confess to anything.” Allow me to explain with an example, on how numbers can be used to muddle the truth.

Nirav Fraud has defrauded the Punjab National Bank of Rs 12,645.97 crore. This is the loan amount that the diamond merchant has defaulted on. On its own the number sounds like a pretty big number, which it is.

But now let me show, how even a number as big as this, can be made to look small, by someone who is looking to muddle the truth.

The question is how big is Nirav Modi’s fraud vis a vis the accumulated bad loans of Punjab National Bank. His fraud is ultimately going to add to the bad loans of the bank.

Bad loans are loans where the borrower has stopped repaying for 90 days or more. The accumulated bad loans of Punjab National Bank stood at Rs 57,519 crore as on December 31, 2017.

Hence, Nirav Modi’s default will add around 22% more to the bad loans number of Punjab National Bank. At this level, the default still seems big. Let’s go a little further.
Now let’s take a look at the bad loans of all banks (i.e. public sector banks + private banks + foreign banks). This stands at around Rs 9,00,000 crore, as on December 31, 2017. Nirav Modi’s default amounts to just 1.4%, which is very small in the overall scheme of things. A big default number now suddenly seems very small.

Let’s look at this in one final way. The average size of a fraud in the case of Indian banking, where the borrower willfully defaulted, was around Rs 3 crore, between 2012-2013 and 2016-2017, a period of five years. In case of Punjab National Bank, the average size of a fraud amounted to Rs 9.6 crore.

When we compare Nirav Modi’s fraud with these figures, we realise how big his fraud is, in the context of borrowing frauds. And this is how Nirav Modi’s fraud needed to be looked at and which is how, thankfully, it is being looked at.

The context is the most important point when trying to make sense of a number. The good thing is that nobody tried to muddle the truth in this case, and it was clear from day one that Nirav Modi’s fraud was a big fraud, from day one. But that is not always the case.

Few years back, in the days after Nirbhaya was battling for her life, I remember reading a news item which suggested that Sweden had one of the highest incidences of rape in the world. The Indian scenario was much better, the newsreport suggested.

Of course, the newsreport totally missed out on the context and muddled the truth. As Hector Macdonald writes in Truth—How the Many Sides to Every Story Shape Our Reality: “Sweden is said to have the second highest incidence of rape in the world, with more than 60 cases reported per 100,000 inhabitants each year (the rate for India is 2 per 100,000). Yet this reflects not only Sweden’s better reporting of sexual crime but also a broader definition of rape.” In India, other than fewer rape victims coming out in the open, the system also works to protect the rapists in many cases.

Or take the case of rates of kidnapping. As Macdonald writes: “Canada and Australia have the highest rates of kidnapping in the world. Really, it’s true. Not because they are more dangerous than Mexico and Colombia but because their governments include parental disputes over child custody in kidnapping statistics.”

The broader point here is that before believing a number, it is important to look at the overall context in which it is being used. As Macdonald writes: “When someone tries to persuade you that a number is especially significant, the first thing to do is to translate it into a more revealing truth that incorporates relevant context.”

Now that of course is, easier said, than done.

The column originally appeared in Bangalore Mirror and Mumbai Mirror on April 11, 2018.

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Let’s Move Beyond Nirav Modi, Bad Loans Are Bleeding India

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Nirav Modi, Nirav Modi, where have you been?” is a question that the bankers at the Punjab National Bank (PNB), must be asking themselves these days.

Media reports suggest that Nirav Modi is in New York, and has no plans of coming back to India. His operational fraud is expected to cost PNB Rs 12,646 crore. PNB is the second largest public sector bank in the country and as of December 31, 2017, had accumulated bad loans of Rs 57,519 crore. A bad loan is a loan which hasn’t been repaid for a period of 90 days or more.

The one good thing that has happened since Nirav Modi’s fraud came to light is the relentless focus of the mainstream media on the operations of India’s government owned public sector banks.

The total bad loans of the public sector banks as of December 31, 2017, stood at Rs 7,77,280 crore. This forms 86.4% of the total bad loans of scheduled commercial banks (i.e. public sector banks + private sector banks + foreign banks).  This basically means that the total bad loans of scheduled commercial banks as of December 31, 2017, would be around Rs 9,00,000 crore.

Hence, Nirav Modi’s fraud of Rs 12,646 crore is just a drop in this ocean of bad loans. But his fraud has put a face to the sad state of affairs that prevails at public sector banks and has thus elicited interest from the mainstream media and the common public.

Before Nirav Modi came long, the bad loans of public sector banks was just an issue which with the business press was concerned about. Now even the TV channels in different languages are having discussions around the issue.

Nevertheless, the fundamental issue at the heart of the bad loans of India’s public sector banks continues to remain unaddressed. Who is responsible for this mess and what should be done about it?

The government released some interesting data earlier this month in an answer to a question raised in the Lok Sabha. As per data from the Reserve Bank of India (RBI), the total bad loans from the “industry-large” category of loans, as of December 31, 2017, stood at Rs 5,27,876 crore. This was for scheduled commercial banks as a whole. The RBI defines a large borrower as a borrower with whom the bank has an exposure of Rs 5 crore or more.

Such borrowers are essentially responsible for a bulk of the bad loans of the banks in India. They are responsible for around 59% of the bad loans (Rs 5,27,876 crore expressed as a percentage of Rs 9,00,000 crore) of scheduled commercial banks. Bank loans to large industrial borrowers formed 59% of the bad loans, even though the total lending by banks to such borrowers formed only around 30 per cent of the total loans given by banks.

Public sector banks accounted for Rs 4,64,253 crore or 88% of bad loans in this.
In fact, the much criticised public sector banks do a pretty decent job of lending to the retail sector. Take a look at Table 1, which basically compares proportion of retail loans which turn bad with proportion of loans to corporates which turn bad, for a few public sector banks.
Table 1:

Name of the bank Retail bad loans
( in %)
Corporate bad loans
(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.    

Table 1 clearly shows that corporate bad loans are much higher than retail bad loans. The question is why? The answer perhaps lies in what economists call regulatory capture. As Noble Prize winning French economist Jean Tirole writes in his book Economics for the Common Good: “The state often fails. There are many reasons for these failures. Regulatory capture is one of them. We are well aware of the friendships and mutual support that create complicity between a public body and those who are supposed to be regulating it.”

How does one interpret this in the Indian case? While it would be totally unfair to suggest that the RBI, which regulates banks in India, is pally with corporates, but it would be totally fair to say that Indian politicians are very pally with Indian corporates. This is where the problem for public sector banks in India lies.

While giving out retail loans, the managers running public sector banks, can make right lending decisions, the same cannot be said when they carry out corporate lending, given the political pressure that prevails on many occasions.

In this scenario, it is worth asking whether all the 21 public sector banks in India should actually carry out corporate lending and put public deposits at risk, over and over again? This is a discussion that we should now be having as a nation and the mainstream media is where this discussion should be happening.

The column originally appeared on The Quint on March 22, 2018

Let’s Say Thank You to Nirav Modi

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As of September 30, 2017, the total bad loans of Indian public sector banks stood at Rs 6,89,806 crore. A bad loan is a loan which hasn’t been repaid for a period of 90 days or more.

Nirav Modi’s fraud, as of today, will add another $2 billion (around Rs 13,000 crore assuming $1=Rs 65) to the overall bad loans of the public sector banks, assuming that the banks are unable to recover any amount. This doesn’t seem to be the case given that the government has moved quickly and attached many assets of Nirav Modi.
Long story short, Nirav Modi’s fraud isn’t going to add much to the overall bad loans of public sector banks. A percentage or two more, isn’t going to change the situation, which is grave, much. Given this, we have been wondering, why has Nirav Modi got Indians so worked up.

Over the last few days, everyone we have interacted with, from Kaali Peeli drivers, to other cab drivers, to guest house attendants, to journalism school students and faculty, to people who edit the different publications that we write for and even the guy who collects trash in the building where we live, have had a thing or two to say about Nirav Modi.

But Nirav Modi’s fraud of around Rs 13,000 crore is small change when compared to the bad loans of public sector banks of Rs 6,89,806 crore. Why haven’t we seen anyone talk about the overall bad loans of public sector banks, up until now? The defaults on corporate loans make up for around 69% of overall bad loans of public sector banks. Why hasn’t this disturbed people enough, up until now?

Or to put it simply, why have people now started talking about the fact that when they default an EMI on a retail loan, the bank comes after them with great speed and purpose, whereas businessmen like Nirav Modi are allowed to commit a huge fraud, and leave the country comfortably.

Why are businessmen defaulting on loans treated differently by banks than individuals defaulting on etail loans?

Why are there only sick companies and no sick businessmen?

What is it that explains this dichotomy? As Nobel Prize winning economist Jean Tirole writes in Economics for the Common Good: “Psychologists have identified our tendency to attach more importance to people whose faces we know than to other anonymous people.”

Take the case of the distressing picture of a three-year-old Syrian child, who was found dead on a Turkish beach in 2015. This forced Europe to pay attention to the refugees coming in from Syria.

As Tirole writes: “It had much more impact on Europeans’ awareness than the statistics about thousands of migrants who had already drowned in the Mediterranean.”

Or as Joseph Stalin, the Soviet dictator, once said: “The death of one man is a tragedy. The death of million men is a statistic.”

This phenomenon works in advertising as well. As Tirole writes: “An advertising campaign against drunk driving has a more powerful effect when it shows a passenger flying through a windshield than when it announces the annual number of victims (a statistic that provides, however, far more information about the consequences of drunk driving).”

As far as India goes, let’s take the case of the Bhopal Gas Tragedy which happened in December 1984. A bulk of English speaking and reading India woke up to the tragedy only once the India Today magazine put the picture of an unknown child being buried, in the aftermath of the tragedy, on its cover.

An issue really becomes an issue in the minds of people, once they can visualise it in terms of an individual. A good example of this in the Indian case is that of the anti-gutka campaign that was run a few years back, and which featured an individual named Mukesh Harane, who died of oral cancer in October 2009.

He was addicted to gutka. After his death he became the face of the anti-tobacco message which was delivered to the people of this country through an audio-visual clip (shown regularly in cinema halls) as well as a print campaign.  It showed Mukesh talking about the ill-effects of eating gutka, with a feeding pipe going into his nose.

It was a fairly disturbing video, but it really drove home, the ill-effects of chewing gutka.

Along similar lines, like Mukesh Harane, Nirav Modi has become the poster boy for corporate India looting the public sector banks, over the years. And given this, while the Rs 6,89,806 crore of bad loans did not make much of an impression in the minds of people (in fact very people would even be aware of the largeness of this number), Nirav Modi’s Rs 13,000 crore fraud, clearly has.

And nothing works better on the government than public pressure. The government has reacted quickly and seized the assets of Nirav Modi. It is also trying to push in long due reforms. Today’s edition of The Times of India reports that the government is planning a new regulator, called National Financial Reporting Authority(NFRA), to regulate the chartered accountants and auditors.

It will take away the review and disciplinary functions the Institute of Chartered Accountants of India (ICAI). This is something which has been long due and only the Nirav Modi fraud has pushed the government towards considering this reform, seriously. The ICAI is a part of the deep state that runs India, and clearly needs to be reined in.

Further, banks have been directed to check for the possibility of fraud on all bad loans of Rs 50 crore or more. Many corporate defaults run into hundreds if not thousands of crore. The question is where did all this money that was raised to fund projects, go? Over the years, there has been a lot of talk about corporates overstating the cost of projects, borrowing a larger amount and then tunnelling money out of the project.

This is something that should have been investigated as soon as the defaults had started to happen. But, again, nothing was done on this front. Now thanks to Nirav Modi, this exercise has been initiated.

Above all this, the Nirav Modi fraud, raised enough stink, leading to the mass media writing, reporting and discussing about the mess that prevails in India’s public sector banks. A large section of the population came to know about the mess, only because of the Nirav Modi fraud. This wasn’t happening earlier. And this is very important in a democracy.

This has also led to analysts asking the government, as to why does it need to own 21 public sector banks. Or for that matter, should public sector banks be lending to corporates at all? Some sort of debate has been initiated on this front.

And for all this, in a very screwed up sort of way, we need to thank Nirav Modi.
The icing on the cake will be, if we are able to get Nirav Modi back to India, and the law of the land is allowed to catch up with him.

The column was originally published in Equitymaster on February 28, 2018.

The Nirav Modi Fraud Tells Us That the Business of Govt Should Not Be Business

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The government of India owns 21 public sector banks. We have been advocating over the years that the government doesn’t really need to own so many banks. It just adds to the economic mess.

In the aftermath of the Nirav Modi fraud, many other economists, businessmen and analysts, have been making this rather obvious point.

The finance minister Arun Jaitley ruled this out recently, when he said: “This (privatisation) involves a large political consensus. Also, that involves an amendment to the law (Banking Regulation Act). My impression is that Indian political opinion may not find favour with this idea itself. It’s a very challenging decision.”

The total bad loans of public sector banks as on September 30, 2017, were at Rs 6,89,806 crore. The bad loans rate was at 13.5% i.e. of every Rs 100 lent by public sector banks, Rs 13.5 had not been repaid by the borrowers.

The Nirav Modi fraud is pegged at $1.8 billion (or around Rs 11,400 crore). If the total Rs 11,400 crore is assumed as a bad loan, then the total bad loans of public sector banks will be a little over Rs 7,00,000 crore. Hence, the fraud is simply a drop in the ocean of bad loans of public sector banks.

This means that the problem is somewhere else. If we look at data as of March 31, 2017, the total bad loans of public sector banks were at Rs  6,19,265 crore. Of this around 69% or Rs 4,24,434 crore, was on account of lending to corporates. And this is where the problem lies.

One Nirav Modi and his companies are not the problem, it is the corporate sector as a whole which has been abusing the public sector banks in the country.

Of course, with such a huge amount of bad loans, the government has to constantly keep infusing capital into the public sector banks, in order to keep them going.

The hope is that with the government infusing money into these banks, they will gradually get back to full-fledged lending and in the process help the economy. Of course, there is nothing wrong with this hope but the economic incentive it creates for politicians, is totally different.

As Thomas Sowell writes in Basic Economics—A Common Sense Guide to the Economy: “Nothing is easier than to have good intentions but, without an understanding of how an economy works, good intentions can lead to counterproductive, or even disastrous, consequences for a whole nation. Many, if not most, economic disasters have been a result of policies intended to be beneficial—and these disasters could often have been avoided if those who originated and supported such policies had understood economics… [There is a] crucial importance of making a distinction between intentions and consequences. Economic policies need to be analysed in terms of the incentives they create, rather than the hopes that inspired them.”

Long story short—while implementing an economic policy, we need to be able to differentiate between what the policy hopes to achieve and the economic incentives it creates. It is ultimately, the economic incentives that are created which will decide how people react to the policy, making it effective or ineffective.

A major reason why politicians love the idea of owning public sector banks (or public sector enterprises for that matter), is that it allows them to bestow favours on their favourite industrialists (read crony capitalists).

In terms of public sector banks, this means forcing them to give out loans to businessmen, who either are not in a position or do not have any intention of repaying the loan. Hence, the government may be recapitalising banks with the hope of letting them operate at their full strength, but the real incentive for the politicians is somewhere else.

The only way of breaking this nexus between businessmen and politicians, is to privatise a bulk of the banking sector in India. If that is not possible due to regulatory hurdles (as Jaitley talked about), a bulk of public sector banks should not be lending to corporates. There activities should be limited to raising money as deposits and lending them out in the form of retail loans.

This “narrow banking” model is likely to work better simply because with a bulk of public sector banks not being allowed to give corporate loans, the politicians will not be in a position to direct lending towards their favourite corporates. With this taken out of the equation, public sector banks might just about manage to operate much more efficiently.

Also, with politicians having one lesser issue to deal with, they might just pay more attention to the other major problems that the country faces and get their heads together on tackling them.

The trouble is that the decision to get public sector banks out of lending to corporates, is to be made  by politicians. And as we saw in the column, they do not have an incentive to do anything like that. How do you deal with a problem like that?

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

 

Why the Nirav Modi fraud is much more than just a fraud

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During the course of the last one week, the hottest news-story in India has been that of a jeweller named Nirav Modi, allegedly defrauding one of India’s largest government owned banks, the Punjab National Bank (PNB).

PNB is India’s second largest government owned bank (with assets of around Rs 7,203 billion ($111.7 billion, assuming $1 = Rs 64.5) as on March 31, 2017). The total amount of the fraud has been estimated to be at $1.8 billion (or around Rs 114 billion). News report suggest that Modi (no relation to the current prime minister of India Narendra Modi) fled the country in early January. His immediate family also left India, during the course of the month.

Nirav Modi is believed to be holed up in a luxury hotel in New York and was last seen in Davos, as a part of a business delegation which got a picture clicked with the prime minister Narendra Modi. Before Nirav Modi, Vijay Mallya, another businessman, who hasn’t repaid loans worth Rs 90 billion ($1.4 billion) due to Indian banks, fled the country.

The latest fraud basically involves PNB guaranteeing loans issued to Nirav Modi by issuing a letter of undertaking (LOU). Every time a loan became due, Nirav Modi got PNB to open another LOU equivalent to the loan amount plus the interest that was due on it. The money from the new LOU was used to pay off the loan and the interest due on the previous LOU. In the process, Modi never repaid the loan.

Currently, it is being suggested that he was helped in the process by two employees of PNB. That such a huge Ponzi scheme could be run without the top or the middle management of the bank knowing about it, is a little difficult to believe.

Thus, Modi managed to operate a Ponzi scheme, with money from the new LOU being used to pay off the previous one. Of course, like all Ponzi schemes, Nirav Modi’s scheme collapsed as well. And before the authorities came after him, he left the country, along with his family.

How does Nirav Modi’s fraud look in light of the other frauds that Indian banks face? In July 2017, the ministry of finance had shared some interesting data in this context.

Between the years 2012-2013 and 2016-2017, the banks in the country had seen a total number of 22,949 frauds, with total losses to banks amounting to Rs 698 billion ($10.8 billion). The average loss on a fraud thus amounted to Rs 30.4 million ($0.47 million). The interesting thing here is that of the 78 banks on the list, PNB faced the highest losses when it came to frauds. Over the five-year period, the bank faced 942 frauds with losses of Rs 90 billion ($1.4 billion). The losses amounted to around 12.9% of the total losses faced by the Indian banks due to frauds.

In fact, the average loss for PNB due to frauds stood at Rs 95.5 million ($1.48 million), which was three times the total average of Rs 30.4 million. Also, more than that, PNB faced more frauds than the State Bank of India, the country’s largest bank, with an asset base which is 4.6 times that of PNB.

What this tells us is that PNB’s control systems were in bad shape and hence, the bank got defrauded significantly more than the other banks did. Having said that, the average fraud at PNB between 2012-2013 and 2016-2017 had cost the bank Rs 95.5 million. In Nirav Modi’s case, the size of the fraud is around Rs 114 billion, which is much bigger than the size of the average fraud PNB has faced in the recent years.

What this tells us is that Nirav Modi’s case is more than a petty bank fraud. It is basically more along the lines of a large bank loan default; which many of India’s crony capitalists specialise in.

India’s government owned banks have been facing a huge pressure of corporate loan defaults over the last few years. As of September 2017, the bad loans ratio of these banks stood at 13.5%. This basically means that of every Rs 100 of loans given by these banks, Rs 13.5 had been defaulted on. A bad loan is a loan which hasn’t been repaid for a period of 90 days or more. The corporate default rate has been even higher.

Largely due to corporate loan defaults, the Indian banks have had to write off loans worth around Rs 2,500 billion ($38.8 billion) for the period of five years ending March 31, 2017. Nirav Modi’s bank fraud will only add to this.

To keep these banks going, the government of India has to regularly keep infusing capital in them. In fact, an estimate made by The Times of India suggests that the government has infused Rs 2,600 billion ($40.3 billion) in the banks that it owns, over the last 11 years. Every rupee that goes into these banks is taken away from more important areas like agriculture, education, health, defence etc.

The reason why many Indian businessmen blatantly default on loans is because they know that given India’s slow judicial system and their closeness to politicians, their chances of getting away with a loan default are very high. Nirav Modi is just a small part of this significant whole.

No wonder, former governor of the Reserve Bank of India, Raghuram Rajan, in a November 2014 speech had said that, India was a “country where we have many sick companies but no “sick” promoters”.

A slightly different version of this column appeared on BBC.com on February 20, 2018.

For their size, Public Sector Banks Have Had Fewer Frauds Than Private Sector Ones.

 

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A lot has been written on the jeweller Nirav Modi defrauding Punjab National Bank to the tune of $1.8 billion (or Rs 11,400 crore). One line of thought that has been pursued is that of the difference between the public sector banks and the private sector banks.

The logic offered here is that frauds happen only in public sector banks and not private sector banks. And even if they happen at private sector banks, the taxpayer does not pick up the tab. The taxpayer did pick up the tab when the private Global Trust Bank went belly up and had to be merged with the Oriental Bank of Commerce. If the bank is big enough and is going bust, the government has to ultimately come to the rescue, irrespective of whether it is privately owned or government owned. No bank of any significant size can be allowed to go bust.

Now let’s look at the first point I raised, whether public sector banks are defrauded more?

In a recent answer to a question raised in the Lok Sabha, the ministry of finance pointed out that between 2014-2015 and 2016-2017, the total number of bank frauds were 12,778.
Of these 8,622 frauds happened in public sector banks and the remaining 4,156 at private sector banks. The ratio of the total number of frauds at public sector banks to the total number of frauds at private sector banks is 2.07.

The ratio of the average assets of public sector banks to the average assets of private sector banks, between 2014-2015 and 2016-2017, is 2.95. If the ratio of frauds between the two types of banks were to be the same at 2.95, the total number of frauds at public sector banks would have amounted to 12,260 (4,156 multiplied by 2.95). This is not the case. The number of frauds is significantly lower than that. Hence, this basically means that public sector banks are having fewer frauds in terms of their size in comparison to their private sector counterparts in India.

Having said that what is true about public sector banks in general may not necessarily be true for the Punjab National Bank in particular. Punjab National Bank is the second largest public sector bank in the country. As of March 31, 2017, it had total assets worth Rs 7,20,331 crore.

In July 2017, the ministry of finance had provided some very interesting data points with regard to bank frauds. Between 2012-2013 and 2016-2017, a period of five years, the Punjab National Bank faced 942 bank frauds with losses amounting to Rs 8,999 crore.
The only other public sector bank bigger than Punjab National Bank, is the State of Bank of India. As of March 31, 2017, it had assets worth Rs 33,23,191 crore, making it significantly bigger than the Punjab National Bank.

Between 2012-2013 and 2016-2017, the State Bank of India, faced 2,786 frauds with losses amounting to Rs 6,228 crore. Even though the State Bank of India faced more frauds, its total losses were 30.8% lower than that of Punjab National Bank.

Further, of the 78 banks that data was offered on, the Punjab National Bank faced the highest losses due to frauds. It’s average loss on a fraud was also three times the overall average loss on a fraud.

This tells us very clearly that the control systems at the Punjab National Bank were weaker than in comparison to the other banks, and that allowed bigger frauds to happen. In comparison, other banks were placed better than Punjab National Bank. Does this mean that if the bank had better control systems, Nirav Modi wouldn’t have been able to defraud the bank, to the extent that he did? On that your guess is as good as mine.

The column originally appeared on Firstpost on February 20, 2018.