Risky business

Written by Subhomoy Bhattacharjee | Updated: Sep 7 2014, 07:59am hrs
On September 1, United Bank of India issued a willful defaulter notice against Vijay Mallya for allegedly not paying up on a R350-crore loan from the bank taken out for Kingfisher Airlines. This is not the first case of willful default in India, but a rare high-profile one in the Indian banking space.

Even in this case, though the consortium of lenders is led by the State Bank of India, the notice was sent out by a bank with a much smaller exposure. It did seem more like testing the waters before the bigger bankers jumped into the sea. There is a reason there.

Stress in Indian banking has built up quite unlike the way it did in the US and Europe. At one level, it is similarloans did not get repaid. But the sub-prime crisis, where millions of home loan buyers defaulted on their repayments as interest rates climbed up in the US, did not occur in India. The stress factor in India is the political support to loan default built over decades. The barons have earned it by aligning with political parties; Mallya was a Congress MP for a long time. The poorer borrowers have earned it by transferring their votes to the parties which supported them.

To get to the chief ministership of Andhra Pradesh, N Chandrababu Naidu promised a waiver of all agricultural loans in the new state. The RBI has warned against it, but the effects are already visible. Canara Bank chairman RK Dubey told this correspondent that agricultural loan recovery from the state has already dropped to zero in June this year. This bank made the mistake of building up the largest agricultural loan portfolio in the state in a bid to get away from over-dependence on corporate loans of the sort Mallya took out.

Both Mallya and the farmers of Andhra Pradesh have a long favourable history to quote from, to counter the argument made by RBI governor Raghuram Rajan. They are not the first ones, and conceivably not the last either.

The risk for the Indian banking sector is this. But the impact has now built up to massive proportions. Despite the open cheque from the government of India to bank roll 74% of the sectors advances, these banks are finding it difficult to mobilise additional capital to liquidate their bad loans.

The pressures on the Indian banks are captured by the stress test RBI conducts on them. The latest Financial Stability Report issued in June 2014 notes that the present provisioning level of various bank groups (including public sector) do not seem to be sufficient to meet the expected losses if the economy nose dives. And within them, public sector banks are more exposed. The impact of credit shocks (on them) is more pronounced, it notes and then goes on to assess the degree of risk. These risks are primarily politically induced.

The system of taking a temperature check on banks was a fallout of the global financial meltdown of 2008. One of those who were in the thick of things, Timothy Geithner, has appropriately enough titled his book Stress Test. Reading the book, one invariably wonders if the stresses building up in the Indian banking system will melt just because the economy will pick up, or have we passed the point where the faith in the financial system has just edged lower than the tipping point

In the US, the crisis gathered speed as the government refused to stand behind the private sector entities. But later, no matter what Washington did, the faith seemed impossible to restore. In India, has the government gone too much in the other direction, refusing corrections, as the stress has built up, coming finally to a situation where the sovereign support has got so debased that it ceases to be an effective currency As the government asks these banks to now take on financial inclusion on an unimaginable scale, it is worth wondering if these possibilities have been thought through.

But the former US treasury secretary has nothing to say about India and even about China, a sort of shorthand measure of how insular US financial policies and the larger domain of financial markets became about emerging markets, post the meltdown. This is surprising, considering this was the same period when President Obama was vigorously courting India to open up its insurance sector as an insurance against the flagging fortunes of US-based companies.

Geithners few engagements with India occur as he recalls his school days when his father, as a Ford Foundation employee, stayed in New Delhi for some time, and in the epilogue of his book. He says YV Reddy presented him a book about the crisis that afflicts the life of a young surgeon and remarked on the parallels it holds with financial crisis management. Geithner agreed. I could relate to the complex problem solving, the inevitable complications, the team sitting around a table debating diagnosis and treatment. Thats financial crisis management, more or less.

Unlike Hank Paulson, his predecessor at the US treasury, Geithner does not gloss over any episode from this period, even if it is inconvenient for him. It is painstakingor is it rather too much

Of course, as a former Fed Reserve of New York chairman and as secretary in the Obama administration, he was not expected to write purple prose. But the book is heavy reading. As a reference material for the period, it is, however, just unsurpassable.

In a typically frank assessment, he notes: Before the (2008) crisis, I didnt push for the Fed in Washington to strengthen the safeguards for banks, nor did I push for legislation in Congress to expand the safeguards to non-banks. I also could have tried to use the indirect channel of supervision more aggressively to rein in other parts of the shadow banking system that were connected to banks. The key events, as the way he narrates them, is how a democratic system with the best experience in the world continued to remain behind the curve even after emerging from the blitzkrieg of 2008 and always chose the second-best alternative.

India has continued to believe our financial system will not face a challenge, like the one US did. Sure, we will not. But for sure we will face one of our ownit had seemed unthinkable in 2008 that Indian banking will face the crisis it does today. Geithners book is a reminder of how painful that recovery can be from a financial crisis and the political toll it takes.