 "Bad debts responsible for low credit growth: RBI guv")
Reserve Bank of India governor Raghuram Rajan on Wednesday said stress in public sector bank books, rather than high interest rates, have forced the lenders to go slow on disbursing credit and the regulator should not be held responsible for the current mess.
“Bankers sometimes turn around and accuse regulators of creating the bad loan problem. The truth is bankers, promoters, and circumstances create the bad loan problem,” Rajan said at an interactive meeting with industry and trade in Bengaluru, organised by Assocham.
“The regulator cannot substitute for the banker’s commercial decisions or micromanage them or even investigate them when they are being made. Instead, in most situations, the regulator can at best warn about poor lending practices when they are being undertaken, and demand banks hold adequate risk buffers,” said Rajan.
The slowdown in credit growth “has been largely because of stress in public sector banking and not by high interest rates. As such what is required is a clean-up of the balance sheets of public sector banks, which is what is underway and needs to be taken to its logical conclusion.”
Had high interest rates been responsible for lower growth, private sector banks also would have gone slow on credit growth. Rather, credit growth in private banks is at a healthy clip compared with the public sector lenders because the private banks do not have to deal with as much stress as government banks have to, Rajan argued.
And lack of capital in public sector banks is not an excuse as lenders are aggressively giving loans to the personal and housing sector, indicating that banks are wary of lending to industry and to small enterprises.
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“The more appropriate conclusion then is that public sector banks were shrinking exposure to infrastructure and industry risk right from early 2014 because of mounting distress on past loans,” Rajan argued.
However, private sector banks cannot continue to fund the large businesses owing to their smaller balance sheets and therefore, “we absolutely need to get public sector banks back into lending to industry and infrastructure, else credit and growth will suffer as the economy picks up.”
“There are two sources of distressed loans — the fundamentals of the borrower not being good, and the ability of the lender to collect being weak. Both are at work in the current distress.”
In fact, a number of these bad loans were made in 2007-08, when economic growth was strong and projects were getting completed on time. Banks could have extrapolated past growth and performance to the future and thus making the same mistakes of “irrational exuberance”.
Rajan also blamed the slow decision making process of the government behind the current mess.
“Moreover, a variety of governance problems coupled with the fear of investigation slowed down bureaucratic decision making in Delhi, and permissions for infrastructure projects became hard to get. Project cost overruns escalated for stalled projects and they became increasingly unable to service debt.”
Even as there could be cases of malfeasance in the process, there were “factors other than malfeasance at play, and a number of genuine committed entrepreneurs are in trouble, as are banks that made reasonable business decisions given what they knew then.”
The bad recovery process of banks, which was dragged down further by inefficient recovery architecture of the country dragged down public sector banks’ books.
“Knowing that banks would find it hard to collect, some promoters encouraged them to “double-up” by expanding the scale of the project, even though the initial scale was unable to service debt,” Rajan said, adding: “Cleaning up bank balance sheets are, therefore, more important than anything else to spur credit growth in the economy.”
The incentive structure of banks and the short tenure of managers, however, complicate the loan recovery process and such distorted incentives lead to overlending to or “ever-greening” unviable projects.
“Unfortunately, also, the taint of NPA immediately makes them reluctant to lend to a project even if it is viable, for fear that the investigative agencies will not buy their rationale for lending.”
Rajan also defended the RBI’s stance in introducing various schemes and the constant tinkering of the schemes, stating that the central bank has to do so in the absence of an effective bankruptcy system.
“We have had to tinker, since each scheme’s effectiveness, while seemingly obvious when designing, has to be monitored in light of the distorted incentives in the system. As we learn, we have adapted regulation. Our objective is not to be theoretical but to be pragmatic, even while subjecting the system to increasing discipline and transparency,” he said.
To prevent fraudsters and willful defaulters from taking the banking channel for a ride, it was important that banks do not use the new flexible schemes for promoters who habitually misuse the system or for fraudsters.
“For fraudsters, quick and effective investigation by the investigative agencies is extremely important. We should send the message that no one can get away, and I am glad that the Prime Minister’s Office is pushing prosecution of large frauds.”
“And for those who have diverted money out of their companies, especially into highly visible assets abroad, a stern message sent by bankers sitting together with investigative agencies should help send the message that the alternatives to repayment can be harsh.”
Rajan took on his critics proposing easier monetary policy, but he argued that for the heavily indebted promoter, “easier monetary policy will typically bring no relief,” as even with lower policy rates, the bank has no incentive to reduce the interest rate.
“And few banks are competing for that borrower’s business, so there is no competition to force down loan rates. The bottom line is that easier monetary policy is no answer to serious distress, contrary to widespread belief.
To overcome the present problem of low credit growth and low recovery environment, the government must speed up the debt recovery process, and create a new Bankruptcy system.”
On an urgent basis, governance of public sector banks should be improved, which the government has demonstrated through its Indradhanush initiative, sending out a clear signal that it wants to make sure that “public sector banks, once healthy, stay healthy.”
However, banks should be infused with more capital fast, with some of the infusion related to stronger performance, so that better banks have more room to grow.
“Capital infusion into weak banks should ideally accompany an improvement in governance, but given the need for absorbing the losses associated with balance sheet clean up, better that government capital be infused quickly,” Rajan stressed.
In this regard, the suggestion of economic survey to use RBI’s reserves for bank capitalisation was “non transparent,” Rajan argued.
“The Economic Survey has suggested the RBI should capitalise public sector banks. This seems a non-transparent way of proceeding, getting the banking regulator once again into the business of owning banks, with attendant conflicts of interest,” the RBI governor said.
Better, is to pay the government the maximum dividend that the central bank can and that’s what the central bank has been doing, he said.
“Alternatively, a less effective form of capital, if the government cannot buy bank equity directly with cash, is for it to issue the banks “Government Capitalisation Bonds” in exchange for equity. The banks would hold the bonds on their balance sheet. This would tie up part of their balance sheet, but would certainly be capital.”