To calm the jittery markets, RBI Governor Raghuram Rajan and Finance Minister Arun Jaitley have played down apprehensions about the health of state-owned banks. But the stark reality is that the current stress felt by India's banks could be just the tip of the iceberg, as the problems run much deeper. That's because the RBI-mandated scrutiny of loans for provisioning purposes is just for 150 accounts. While estimates vary about the percentage of their contribution to the total bad assets problem, one safe assumption is that quite a few accounts besides these could fall in the troubled category soon enough - or perhaps already do - going by the sheer number of indebted business tycoons and a long tail of midsize enterprises. For example, according to Credit Suisse AG, financial stress at the top 10 Indian conglomerates has intensified even as some of them cut back on capital expenditure and attempted to sell assets to pare debt. In its update of an earlier report, Credit Suisse said debt at these groups has risen seven times over the past eight years and their loans add up to 12 per cent of the loans in the banking system in India. It can be argued that this has happened because of a rather long period of regulatory eclipse that allowed banks to remain oblivious to several companies raising their debt to unsustainable levels.
The government has now talked about giving state-run banks "adequate" capital to tide over the problem and has also advised them to raise money from the market while retaining the government's control. Unfortunately, the first option will be regarded as a bailout of powerful business groups who continue to remain unpunished for their failure to honour a financial commitment and behave as if deleveraging and repaying loans are the least of their concerns. What is worse, taxpayer's money is likely to be used to recapitalise banks without any linkage to their performance or past record in preventing accumulation of bad loans. The second option is impractical at a time when many banks now quote at a discount of 75 per cent. After all, which state-owned bank will be valued at close to book by the market? Then there is the problem of banks not having the legal muscle to deal with willful defaulters, with the new bankruptcy Bill still pending in an increasingly fractious Parliament. The only real course of action before the government is to take the P J Nayak Committee report seriously and genuinely reduce the role of government. Only a vigilant board led by a chief executive who comes from outside the "system" can stem the rot. The path leads surely to real disinvestment, and loss of government control. Experience shows that the biggest reforms have happened when there has been an acute crisis. It's time for the "surgery" that Dr Rajan talked about the other day.