The recently promulgated banking ordinance authorises RBI to set up oversight committees and issue directions for resolution of the festering twin balance sheet problem. This relates to public sector banks (PSBs) which are saddled with large amounts of bad loans (NPAs), and over-leveraged corporates. The genesis of the crisis is a decade old, when the global economy was buoyant. India was fast emerging as the second, if not the fastest, growing economy in the world. The rate of economic growth was 9.3%, 9.2% and 10.2% in FY06, FY07 and FY08, respectively. In FY08, gross domestic savings and investment accounted for 36.8% and 38.1% of GDP. This produced certain irrational exuberance amongst both borrowing firms and PSBs that made them under-value the risks infrastructural projects faced.
Lakhs of crores was invested in sectors like power, telecom and steel. Although some private banks too were exposed, generally speaking, they were more conservative in managing risk and were able to resist the forces that were prodding PSBs to lend. What happened, however, was by no means unusual; the same unhealthy optimism was seen in East Asian countries before the crisis of 1997; and in the US, just before the sub-prime crisis of 2008. By FY13, the growth rate of the economy slipped down to 4.8%. Inventories of firms began to increase; and there was very little incentive left to make fresh investments.
Those who had done so in the past were now finding it difficult to repay loans. Initially, both lenders and borrowers hoped that time would heal their wounds. Borrowers were granted time for repayment of the principal. By FY16, however, RBI started conducting asset quality reviews (AQRs) and found that its darkest fears stood confirmed. The figure of total stressed assets including gross NPAs, restructured loans and unrecognised NPAs stood at over `12 lakh crore or 16.6% of all advances; and PSBs accounted for 80% of NPAs. From a corporate perspective, the situation was equally bleak: 40% of the debt was owed by companies who could not even earn enough annual profit to cover the interest cost of the loans they had taken.
Seeing that the problem could not be wished away by just waiting and watching, RBI has time and again taken a number of steps to nurture the system back to health: however, asset reconstruction companies (ARCs) and joint lender forums have failed to take off. Measures such as the strategic debt restructuring (SDR) and Sustainable Restructuring of Stressed Assets hardly led to any resolution. Banking ordinance is the latest initiative. One can hope it will succeed, as failure to resolve the problem has affected private investment sharply. If the problem is not addressed immediately, economic growth is bound to be adversely affected. Addressing the problem involves banks making huge write-offs, but perverse organisational incentives and disincentives in PSBs make it difficult for managements to take such haircuts. Earlier schemes failed only because bankers failed to do what was expected of them on account of this fear.
But the ordinance will involve RBI in the internal decision-making of banks in order to protect officials against witch hunts. This would not be desirable for two reasons: when managements grapple with large NPAs, they have often to decide whether to accept a negotiated settlement or invoke the bankruptcy and insolvency code. Because it is essentially regulatory bureaucracy, RBI is not equipped to handle this function. Two, if it starts getting involved in banks’ internal decision-making, it will not be able to perform its regulatory functions impartially.
Twenty years ago when the CVC drafted the Special Chapter on vigilance management in PSBs (I headed this committee), it assured the latter that risk taking formed an integral part of their business; every loss caused to the organisation need not necessarily be the subject matter of a vigilance enquiry. But this as well as other assurances appear to have convinced no one, as bankers continue to shy away from taking hard decisions. The government must now find fresh means to develop an effective leadership, preferably with the help of the Banks Board Bureau. Ultimately, PSBs must be accountable only to professional, empowered, independent boards of directors. If this means dilution of governmental control, so be it!