The default line

Rajeev Jayaswal in Chandigarh

India could brave the global financial tsunami about a decade ago because of its resilient economy and the robustness of its financial institution. This was backed by most experts who had explained the meltdown of 2008. Finance ministry’s carefully calibrated policies and prudent functioning of Indian bankers under the watchful eyes of the banking sector regulator, the Reserve Bank of India, were credited for the financial stability.

Experts said commercial banks of India were saved from the subprime crisis that saw collapse of several global financial institutions as they operated in a conservative policy environment, backed by prudent financial norms and sound institutional mechanisms. During that period, India’s scheduled commercial banks had Rs 68,220 crore of gross non-performing assets (NPAs). The paradigm shifted dramatically in less than a decade and the banking system was found under severe stress.

The symptoms

The NPAs grew to Rs 10,35,528 crore by March 31, 2018, an unprecedented 2,000 per cent jump in 10 years. The industry apprehends that this figure would have already surpassed the Rs 11,00,000-crore mark. So, what happened to the government’s conservative banking policies and the RBI’s firewall that had protected the domestic financial institutions in the 2008 rout?

Apparently, the muck was always there, albeit under wraps through accounting jugglery. Banks abused tools like strategic debt restructuring scheme to postpone their problems of bad loans and make their books look clean.

This phenomenon was explained by the then RBI governor, Dr Raghuram Rajan, at an industry function in 2016: “In 2008-09, after the global financial crisis, the Reserve Bank agreed to forbear on certain kinds of stressed loan restructuring, hoping that this was a temporary need pending stronger growth. Unfortunately, for a variety of reasons, the stress has not been temporary, and growth in these sectors has proved elusive. Therefore, early in the process, the Reserve Bank set about giving banks the tools to deal with stressed loans, including information about the degree of the borrower’s collective indebtedness from the system and more effective ways to reduce the project’s financial stress, such as the joint lender’s forum, the strategic debt restructuring mechanism and the 5/25 mechanism. In a way, the RBI has been trying to create a functioning resolution process in a situation where the existing bankruptcy system functions poorly.” According to Rajan, the tools were used not to resolve a problem, “but also perversely, to avoid it”.

The diagnosis

The ailing banking system started showing pathological symptoms. They were manifested in a disgraced Vijay Mallya, absconder Nirav Modi and fugitive Mehul Choksi. They publically exposed the rot that had plagued the banking system for more than a decade. In fact, the rot was detected internally much before Mallya fled the country in March 2016. It happened in April 2015, after the RBI initiated the Asset Quality Review (AQR) aimed at cleaning up the balance sheets of banks. Interestingly, banks approached the court to prevent the wilful defaulter from leaving the country only one week after his escape. Some rogue elements within the banking system might be more loyal to the client than to the bank for obvious reasons. This should be a matter of interest for agencies probing cases of bank frauds. The AQR revealed high incidence of NPAs. Stressed loans, earlier concealed under the RBI’s tools for flexibility, were reclassified as NPAs. The regulator acted. It withdrew all schemes for restructuring stressed loans. Despite that, the gross NPAs of scheduled commercial banks increased from Rs 3,23,464 crore on March 31, 2015 to a stagerring Rs 10,35,528 crore in just three years.

The surgery

The surgery that was done under the AQR in 2015 did expose hidden bad loans, but failed to check the rising number of NPAs. The phenomenon was quickly justified through an alibi created around two key factors: stressed banks and strained corporate. It was a fit case for the “twin balance sheet” problem. Corporates invested profusely to over expand their businesses during boom time, but failed to service their debts that created NPAs for banks. This is how the balance sheets of both parties got stressed, squeezing the room for any fresh investment, adversely impacting growth.

It is logical for experts from within the system to find justifications to protect institutions and individuals. Aggressive lending practices, wilful defaults, loan frauds, corruption and economic slowdown have been cited as reasons for the spurt in NPAs. However, no institution or individual was found to be responsible for the systemic lapses. Custodians of banks have neither been questioned nor have they revealed the motive behind hiding stressed loans.

Despite all justifications, it is hard to believe that offenders like Vijay Mallya, Nirav Modi, Neeraj Singal and Mehul Choksi embezzled thousands of crores from banks without any internal or external help. While these conmen stand exposed, hundreds of defaulters have been kept in the safe house of investigative agencies on the grounds that revelation of their names would hamper commercial interests of banks and adversely impact the investors’ sentiment.

All culprits, directly and indirectly involved in bank frauds, may never be brought to book, more due to the lack of political will than commercial concern. However, the wide publicity given to the bad loan issue has forced the government to take definite steps to clean up the mess.

The recovery

In February, the RBI issued a revised framework to the banks for dealing with stressed assets in a time-bound manner. To recover old dues, banks are now armed with the Insolvency and Bankruptcy Code, 2016, which has been enacted to resolve stressed assets in a time-bound manner.

The RBI, in June last year, issued the first list of a dozen large defaulters (outstanding amount over Rs 2,00,000 crore) and directed the lenders to initiate bankruptcy proceedings against the firms, including Essar Steel, Bhushan Steel, Bhushan Power & Steel, Monnet Ispat, Alok Industries, ABG Shipyard and Jyoti Structures. Subsequently, names of several defaulters have been listed for action by the RBI. Since the first list, cases of four defaulters in the list of ‘Dirty Dozen’ have been resolved. The RBI is prodding lenders to recover old dues, which is a good sign. But, the rising level of NPAs is a cause of concern. Unless the regulator takes prompt action to contain fresh accumulation of bad loans, health condition of banks could relapse.