The second feature of the crisis is the clever attempt by the apologists and sympathisers of the GTB management to paint the RBI as the villain de piece in the unfolding melodrama. Touting the well-worn argument that the RBI has converted an illiquidity crisis into an insolvency one, these well-wishers tried to deflect public wrath away from the real perpetrators of the crisis. To an impartial observer, the facts are quite clear. The regulator has been trying to stave off the insolvency and salvage depositors interests by a temporary suspension of liquidity. The merger of GTB with the OBC should put the depositors legitimate fears to rest and restore public confidence in the RBIs ability to handle the situation.
Every crisis generates an exhaustive discussion on the causes leading up to it. Enthusiasts of private banking (and their numbers are legion), have their pet theory blame it on priority sector lending. Unfortunately, data give a lie to this theory. Of GTBs total NPAs of Rs 1,500 crore, priority sectors such as agriculture and small industries together account for 22.5 per cent (agriculture less than 1 per cent and small industries 21.5 per cent). The bulk of NPAs, viz. 77.5 per cent, is accounted for by non-priority sector lending. GTB had an exposure of about 52 per cent of its advances to the stock market, (a blatant flouting of RBI directives) so that a part of the problem must have come about from erosion in the value of investments.
Basically, any bank crisis (in the absence of systemic adverse macroeconomic shocks) stems from two allied sources flawed risk management systems and governance deficiencies. The risk management systems in most private Indian banks leave much to be desired. Lacking in-house specialised expertise to develop value-at-risk models, banks resort to importing such models from foreign consultants. These are then applied uncritically, without adaptation to Indian conditions, with the result that credit risks are often seriously underestimated. The fact that inadequate provisioning was a key feature in GTBs turn of fortunes, seems to reinforce this supposition. But faulty risk management is only half the story. The other half relates to the issue of governance.
Part of the reason for the stability and respectability of the Indian banking system has been the arms length relationship traditionally characterising banks dealings with corporates. The mid-1990s, however, witnessed an abandonment of this salutary principle in favour of a more intimate relationship. Industry representatives were inducted in large numbers on the boards of public and private sector banks, in the name of professionalisation. In the absence of adequate accountability, safeguards and deterrent provisions against misuse of authority, this has led to a deterioration in loan quality as well as monitoring. It is well known that in recent years banks have been increasingly investing in corporate bonds (rather than lending directly to the corporate sector). This kills two birds with one stone it saves them from taking on additional priority sector lending while facilitating evergreening of corporate loans. It would be really instructive to investigate on a case-by-case basis each of the 20 biggest NPAs in every bank.
If the recurrence of such crisis is to be minimised in the future, a four-point programme is necessary. First, an overhaul of existing risk-management practices in banks, with emphasis on value-at-risk models explicitly tailored to local and bank-specific conditions. Second, a reworking of the deposit insurance scheme, with premia related to performance criteria such as the CRAR, NPAs etc. Third, a stricter enforcement of equity market exposure norms. Finally, inducting public and depositors representatives on the board would go a long way in making banks affairs more transparent to its most important stakeholders.
The writer is a senior professor at the Mumbai-based Indira Gandhi Institute of Development and Research