The Strategist

Where is the Root of Indian Bad-Debts Problem?

06/10/2015 - 18:13

In July 1969, Prime Minister Indira Gandhi sacked Minister of Finance and herself started to carry out the work. The next day she ordered to take complete control of the state's 14 largest private banks in India. Indian people greeted the nationalization of financial institutions with rejoicing in the streets - at the time, banks were perceived as servants of the rich, who have ignored the needs of the poor
Yet, India, should look for the roots of the banking sector’s current problems (in part of the whole economy) in Gandhi’s drastic step.

Today, the country's state-owned banks are in dire straits and do not hear the cheers and applause of the people. Lending has almost stopped.

A significant portion of loans, granted to companies during the investment boom that ended in 2012, will not be paid off. Problem loans in the state banking sector (for which no payments were paid for six months or more, and whose conditions are modified to facilitate repayment) represent 12% of total assets.

The fact that state-owned banks account for more than 70% of all loans issued in the country is of particular concern. In addition, due to the large amount of "bad" assets, banks are just not able to finance a new investment cycle.

The regulator - the Reserve Bank of India (RBI) – is worried about the situation too. June 2, it lowered its key rate by a quarter per cent (for the third time this year) to 7.25%, despite the fact that the growth of the Indian economy was 7.5% in the I quarter of 2015.

Commenting on this, RBI expressed concern about weak growth in bank lending and a small investment that could push up inflation, which is now a little less than 5%. The central bank also encourages attract more capital into state-owned banks to increase lending, says the British magazine The Economist.
Narendra Modi’s government is also trying to solve the problem of "bad" debts. After the January summit, which was attended by senior officials of the Ministry of Finance, RBI and heads of banks, Modi promised to stop the country's tradition of political interference in the work of the banks.

A few weeks after the forum, the government again made it clear that the failures in the financial institutions will no longer be ignored, and the additional capital will be provided only to those banks that have reached a satisfactory level of profitability.

Currently, only 9 of the 20 state-owned banks can meet these requirements.

In February, during the budget speech in parliament, Finance Minister Arun Dzheytli promised to prepare and adopt a new law on bankruptcy within a year, which will facilitate the process of transferring control of pledged assets defaulter to banks.

In addition, he said, the government is going to create a special independent office which will be responsible for the appointment of state-owned banks heads to advise on strategic issues and help with raising capital.

Despite all these initiatives, the situation in the sector remains tense. Thus, some analysts fear that the so-called scheme of "5-25" (the recent RBI’s proposal, which allows banks to extend the term of the debt to long-term projects for an additional 25 years with "gaps" to refinance every five years) would hide the poor quality loans.

At least 800 billion rupees ($ 12 billion) of bad loans can be restructured under the scheme just for the period from 2015 to 2016, - CRISIL rating agency predicts.

In turn, the government's program of selective bank recapitalization could force the weaker financial institutions to conceal problem assets to their capital does not fall below the required level control.

The delay in the establishment of the Banking Bureau has led to the fact that some state-owned banks do not have heads at all.

According to experts, the banking sector in India can effectively develop only after it ceases to be interfered by the government.

In a report published last year, the former RBI high-ranking official and banker Phangan Nyack proposed a three-stage reform: the abolition of laws that require specialized management structures for state-owned banks; involvement bankers, having experienced and independent views, to boards of directors, as well as reducing the state share in banks to minor size.  

The last part is especially important, said Nayak, as it will allow banks not to follow the rigid instructions for state-owned companies, which limit the size of the salary for employees, require specific procedures for recruitment, as well as the control of the anti-corruption agencies.

Nyack’s offers was welcomed at the January summit of the bankers. But the government seems to prefer a milder version of reform.

Despite the obvious fact that private banks have higher profitability and market value, India seemingly has no desire to doubt the need for state-owned banks.

The business conditions, established by Indira Gandhi, are changing with difficulty. As long as the banks are in the hands of the government, the revival of the banking sector will be slow and uneven, what, after all, will limit the growth rate of the Indian economy.