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Delivering the third Verghese Kurien lecture at the Institute of Rural Development Anand (Irma) on Tuesday, he added in recent years, the sanctity of the debt contract had been continuously eroded in India by large borrowers. The reality, he said, was too many large borrowers saw the lender, typically a bank, as a holding, not a senior debt claim that overrode all other claims when the borrower was in trouble.
“In India, too many large borrowers insist on their divine right to stay in control despite their unwillingness to put in new money. The firm and its many workers, as well as past bank loans, are hostages in this game of chicken — the promoter threatens to run the enterprise into the ground unless the government, banks and regulators make the concessions necessary to keep it alive. And, if the enterprise regains health, the promoter retains all the upside, forgetting the help he received from the government or the banks; after all, banks should be happy they got some of their money back,” he said.
Clarifying he didn’t intend to cast aspersions on most Indian businesspeople, who treated creditors fairly, Rajan said he wanted to warn against the uneven sharing of risk and returns in enterprise, against all contractual norms established globally — promoters with a class of “super” equity that retained all the upside in good times and very little downside in bad times, while creditors, typically public sector banks, held “junior” debt and got none of the fat returns in good times, while absorbing much of the losses in times of distress. The obvious reason for this, he said, was the system protected large borrowers and their right to stay in control, rendering bankers helpless vis-a-vis large and influential promoters.
The central bank governor criticised a few laws which, he said, were draconian. Though these were meant to be ammunition for banks to recover loans, these failed in practice, he added. “The promoter enjoys risk-less capitalism— even in these times of very slow growth, how many large promoters have lost their homes or have had to curb their lifestyles despite offering personal guarantees to lenders?”
The government’s plan to increase the number of debt recovery tribunals and debt recovery appellate tribunals was timely and would be effective if accompanied by an expansion in facilities, trained personnel and electronic filing and tracking of cases, as suggested by the Supreme Court, Rajan said.
Total write-offs of loans by commercial banks in the past five years stood at Rs 1,61,018 crore, 1.27 per cent of gross domestic product (GDP). Though some of this amount will be recovered, given the size of stressed assets in the system, there will be more write-offs to come. “To put these amounts in perspective, 1.27 per cent of GDP would have allowed 1.5 million of the poorest children to get full university degrees from top private universities in the country, all expenses paid,” Rajan said.
Promoters misusing the system, he said, ensured banks charged a premium for business loans. Today, the average interest on loans to the power sector is 13.7 per cent, while the policy rate is eight per cent. Largely, the difference, also known as the credit risk premium, of 5.7 per cent is the compensation banks demand for the risk of default and non-payment. “Even comparing the rate on power sector loans with the average rate of 10.7 per cent available on home loans, it is obvious even good power sector firms are paying much more than the average household because of banks’ worries about whether they will recover loans. Reforms that lower this 300-basis-point risk premium of power sector loans vis-a-vis home loans will have large beneficial effects on the cost of finance, perhaps as much or more than any monetary policy accommodation,” Rajan said.
The RBI governor was critical of lenders that often tried to postpone bad-loan classification. He indicated the central bank wouldn’t extend regulatory forbearance on restructured assets, as sought by banks. From April 1, 2015, any restructured loan will attract the provisioning required for non-performing assets. Currently, banks have to make five per cent provisioning for standard restructured assets, while sub-standard asset provisioning is 15 per cent for secured loans.
“This is short-sighted (asking for regulatory forbearance), especially on the part of the banks. Today, the market does not distinguish much between non-performing loans and restructured loans, preferring to call both stressed loans and discounting bank value accordingly,” Rajan said.
He added the government was working on a new bankruptcy law. “Properly structured, this will help bring clarity, predictability and fairness to the restructuring process.”
He promised to be more flexible as far as restructuring norms for projects were concerned. “Banks have been asking the regulator for greater flexibility to restructure loans so as to align them with the project’s cash flows and for the ability to take equity for some upside in distressed projects. These are more legitimate requests, as these imply a desire to deal more effectively with distress,” Rajan said, adding in the past, RBI had been reluctant to afford banks this flexibility because it had been misused by managements of banks.
“RBI is exploring ways to allow banks more flexibility in restructuring. This is a risk we are prepared to take if it allows more projects to be set on the track to recovery,” he said.
Answering questions by Irma students, Rajan said non-performing assets in education loans were increasing, adding there was a need to take a closer look at such loans. “We need to look at whether it is because people are not getting jobs or incentives to repay are getting low,” he said.
On getting black money back to India, Rajan said apart from the issue on tracking down individuals holding black money abroad, it was also important to consider how the upper middle class could be incentivised against taking recourse to black money. “Let’s cut it off at the source. Let’s stop people from utilising outside channels,” Rajan said.
“While on the positive side, tax rates have been brought down to 30 per cent, we should also make hiding money harder. We should require a PAN (Permanent Account Number) and an Aadhaar ID for a variety of transactions so that you don’t have the ability to take the money outside the country and a lot of transactions are vetted,” he added.
Read the full speech
