Signs Of Trouble In The Financial Sector

Updated: Jul 30 2004, 03:29am hrs
The collapse of the Hyderabad-based Global Trust Bank (GTB) and the proposed bailout by the government-owned Oriental Bank of Commerce (OBC) has again brought into sharp focus the health of the Indian financial system and the use of taxpayers money to backstop it. While India is getting kudos for a good financial system as compared to China, the GTB fiasco shows that we still have a long way to go before we claim any level of comfort with the state affairs.

Leaving the insurance sector and the capital markets aside, there are three segments to the financial sector and unfortunately, all of them have their share of problems. These are the term lenders, the government-owned banks and private banks. GTB was a private bank promoted by a leading banking professional Ramesh Gelli in the early 90s under the liberalised licensing norms of the government. From the beginning, GTB was aggressive in its banking style. It lent large amounts to stock market players. While there is, in principle, nothing wrong in doing so, banks that do that type of lending have excellent risk control systems in place. Obviously GTB did not and the effect was a huge pile up of bad debts. There was a change at the top the promoter was sidelined and professionals were brought in. This has not worked and the bank went down. The authorities are bringing in OBC and at least for now damage control has had its effect.

On hindsight, the experience of new private banks has been mixed. Those which were promoted by powerful government-owned or quasi-government entities like IDBI Bank, ICICI Bank, HDFC Bank, UTI Bank have survived and prospered. The other ones have not had such a smooth ride. GTB has been a failure. Times Bank promoted by a media group came with a lot of fanfare but the owners realised that staring a bank is tougher than starting an FM channel playing remixes! Thankfully, they allowed themselves to be taken over by the aggressive but well run HDFC Bank. IndusInd Bank is a little understood bank where the presence of the controversial Hindujas (of Bofors fame) always gives a feeling of unease. Centurion Bank, promoted by the mercurial Dev Ahuja, has had problems from the word go. The leasing company which was a part of the group was merged with the bank and nobody knows whether the dowry that was brought in was good or bad. Anyway now theres a huge restructuring on and the jury is still out on whether the new takeover artists can handle the dirt in the balance sheet. So the story of the new private banks like the curates egg is at best good in parts.

The story of our government banks is so complicated that one can only guess whether they are in good health or not. For years till 1991, they were used as instruments of social development or, to put it more bluntly, as cookie jars where politicians could get money for their pet projects. They were all in a bad shape. After reforms, they were recapitalised in a big way from taxpayers money. Along with that, they were given a fair degree of freedom. They were also allowed to enter the capital market and allowed to raise money from the public. This not only led to better capital backing but the discipline that the market imposes in terms of reporting and transparency. The big fall in interest rates over the last few years helped these banks considerably by boosting the investment gains. In fact, they have stuffed themselves with government paper far in excess of the statutory requirements and benefited from it. They have also used the windfalls to write down their bad loan portfolios. Having a government umbrella has ensured that depositors have had no ugly surprises.

GTB fiasco shows that we have a long way to go for a good financial system
Like the curates egg, the story of new private banks is at best good in parts
Budgets focus on agriculture smacks of a return to the days of garibi hatao
Long-term institutions were badly hit by reforms. Many of their clients just could not handle the opening up of the economy and bad loans went up dramatically. Among the three, ICICI was first to realise the gravity of the situation and agreed to be bought over by its own banking progeny ICICI Bank. In the case of IFCI, the problem is so bad that finding a bank to run it is itself a problem. Punjab National Bank is the obvious choice in terms of size and culture. PNB can take big hits and its culture is similar to that of IFCI as both are part of the Delhi milieu. But this has not happened. The third institution, IDBI, is also planning an ICICI type of bailout by merging itself with IDBI Bank. Soon we may not have any term lender in the country. So much for spurring long-term investment. Where do you get money to start projects the industry spokesmen wail.

One would need to be a brave man to predict the future of Indias banking sector. The post reforms pressure has definitely eased but there are new problems. Two of them appear worrying. The first is the rising interest rates. This means that the cash cow called investment gains is no longer available and in fact first quarter numbers of many of the banks are showing a negative under this head. This will make any further balance sheet adjustment tough. Also, the recent Union budget talks of using banks to push agricultural credit and infrastructure. This smacks of a return to the garibi hatao days of Mrs Indira Gandhi when bank officials were reduced to doling out the savings of people to vote banks. Hopefully, with the experience of the last 10 years, the government will not succumb to the temptation of directed lending. But one can never say. As the saying goes The way to hell is paved with good intentions and the populism contained in the budget is worrying.

The next one year will be very interesting for the sector. Credit growth will help the bottomline to offset the loss of investment income. Household names like IDBI and IFCI may disappear. Infusion of private capital into the sector may get badly hit by the recent RBI draft guidelines on limiting private ownership. Hopefully the sector, which is huge and often compared to an elephant in terms of size and speed, will show enough dynamism to adjust itself to the changing environment. The country can ill-afford another GTB.

The author is a Delhi-based investment banker and Convenor of the BJP Central Economic Cell. The views expressed herein are personal. He can be contacted at