Taking a punt

 DNA Friday, 4 April 2014 


The in-principle approval for setting up a bank granted to a microfinance organisation could have implications for a sector that has come under heavy fire

Almost exactly four years after then-finance minister Pranab Mukherjee spoke of the need to increase access to banking services and the possibility of new bank licenses to private sector players, the RBI has delivered in the most conservative manner possible. This is not particularly surprising; caution has been the through line of every policy it has implemented since the 2008 economic crisis. In light of the public mood with regard to corruption and governance, and given the fact that it’s election season, it would have been naïve to expect it to be generous. Nor are the stakes as high this time around for the 23 applicants that didn’t make the cut. The upcoming shift to a license on tap policy takes away the one strike and you’re out urgency of the previous rounds of bank licensing in 1993 and 2001. The surprise is elsewhere —  namely, in microfinance firm Bandhan Financial Services (BFS) being preferred to well-established, larger corporate entities.

Microfinance hasn’t been a polite word in financial circles since 2011, its subcontinental annus horribilis. That was the year the Bangladesh Supreme Court ruled against Noble laureate Muhammad Yunus, the godfather of microfinance and founder of Grameen Bank, the institution a good many Indian organisations have modelled themselves on. The Bangladeshi government’s charge that microlending victimises poor people found an echo in Andhra Pradesh where severe problems in the functioning of microfinance organisations had led to the setting up of the RBI’s Malegam committee. The committee report led to additional safeguards and checks in the sector, but problems remained.

A lack of access to low cost deposits was at the heart of many of these problems. In order to remain commercially viable in the absence of these deposits, a number of organisations had instituted interest rates that were close to extortionate. That was partly the cause for widespread loan defaults in the state, perpetuating the high interest cycle. High transaction costs factor into this as well; these costs remain a constant even when the size of the transactions is relatively small. Add it all up and the result is that microfinance organisations haven’t entirely succeeded in their primary purpose: reaching the poor who are outside the ambit of traditional banking. Andhra Pradesh, Tamil Nadu, Kerala and Karnataka — the four states with the densest networks of commercial bank branches —  also account for about half of all microfinance beneficiaries. Meanwhile, the North-East is severely underserviced despite having limited penetration when it comes to commercial banks, and India’s seven poorest states, encompassing north and east India, account for just about a quarter of microfinance clients.

Seen in this context, the RBI’s granting BFS an in-principle approval is a litmus test. If the organisation is able to meet the stipulated conditions by the time the 18-month deadline rolls around, its funding situation will improve considerably via low-cost deposits. The implicit deal, of course —  particularly in light of the licensing process’s stated goal of improving access to banking services —  is that BFS won’t migrate entirely to a broader, more profitable market but scale up its operations and offer better terms in the microfinance niche. Differentiated licenses play into this as well. If the BFS experiment works out, it makes it more viable to grant other organisations in the sector —  that may not have the wherewithal to function as full-fledged banks —  licenses for specific functions that will enable them to scale up operations. It’s something of a punt. But if it pays off, it could show the way back to growth for microfinance institutions.

Bank rolling a constituency, F M Style

Banks often rush to the finance minister’s LS constituency. Jangipur in West Bengal saw a flurry of banking activity when Pranab Mukherjee was finance minister. 

Vidhya Sivaramakrishnan, Sangeetha Kandavel & Atmadip Ray, ET Bureau 17 JAN 2014

 More than 50 years ago, a group of Indians arrived in the deepsouth Indian town of Sivaganga in Tamil Nadu. Some of them had lost everything — money, wealth, even near and dear ones. These Indians, who had fled Burma (as it was then called) after the Japanese invasion in 1942 with almost nothing, reached the town traumatised after a hellish journey over treacherous mountain passes and thick jungles.

But, within a short span of time, they rebuilt their fortunes and helped industrialise a backward state. The resourcefulness of the Chettiar community and others who made this region their home, and their hair-rising adventures on the flight back home have became a part of folklore.

These days, Sivaganga is again a centre of attraction. But the people flocking to the town are not war refugees, but polished, urbane bankers. They come to open and staff bank branches, ATMs and perform numerous other functions public sector bankers are often called upon to do for the home constituency of the country's finance minister Palaniappan Chidambaram.

Before Sivaganga, most bankers' port of call was Jangipur in West Bengal — the constituency of former finance minister Pranab Mukherjee. As ministers come and go, the fate of a constituency oscillates like a pendulum.

Public sector banks have now dumped Jangipur, and are making a beeline for Chidambaram's Sivaganga. Apart from opening ATMs and branches, these banks hold credit camps with huge promotional spending as they fawn over the country's financial boss. It is another matter that lending through these camps have turned out to be the main source for NPAs. But few bankers will admit this publicly.

Reports from Chidambaram's local office suggest banks are going the extra mile to serve customers. An official at the office reels out statistics in favour of his leader. "Banks in the area have been a boon for local people. From 2004 to 2013, about Rs 900 crore has been disbursed as educational loans. About 50,000 students have benefited so far. Of the Rs 75,000-crore farm loans waived, Rs 70 crore was from Sivaganga and close to 35,000 families have benefited," he says. Karti Chidambaram, the 41-year-old son of P Chidambaram, is more blunt. "Mr P Chidambaram has been, and continues to be, a very proactive and conscientious MP (member of Parliament). His seven victories is a testament to his performance. As far as industrial development is concerned, the question should be posed to the two Dravidian parties that have continuously ruled TN (Tamil Nadu) for the last 46 years."

In the four years from 2009, Chidambaram has visited Sivaganga 95 times! The town has around 200 bank branches; many other similar localities are still struggling due to the lack of brick-and-mortar financial intervention. "Normally, banks chase growth centres. But in Jangipur or Sivaganga, it's the other way round. Opening so many bank branches led to some development with deployment of government subsidies and disbursement of loans," said former Uco Bank executive director Virendra Kumar Dhingra.

In the last three years, banks have reached nearly 74,000 villages across the country with a population of more than 2,000 to cater to a vast but hitherto unbanked population. About 10% of this is done through the brick-and-mortar channel and the rest by business correspondents. Typically, banks open branches in towns and business centres, and remote villages continue to suffer as private money lenders continue to rule. Bank customers in Raghunathganj in Jangipur, for instance, have never been so pampered before even though many villagers had lost their life savings to the Saradha chit fund scam. Bankers in this small town have been on their toes to offer the best services as holding back customers and getting new business is the biggest challenge they face in this fiercely competitive market where bank branches are perhaps more in numbers than grocery stores. But villagers in the interiors of Murshidabad continue to face almost the same ordeal like they faced many moons back. They still travel a long distance to reach a bank branch. Not many of them have heard about business correspondents.

Before 2004, Jangipur, too, was like Murshidabad and many other backward areas in the country with minimal social and physical infrastructure. It was also bereft of any special attention from the who's who in politics and business. It was one of the most financially excluded territories, with just about 20 bank branches for some 18-lakh people! That meant one branch per 90,000; RBI prescribes that no branch should entertain more than 10,000 customers.

It needed a Pranab Mukherjee, the close confidante of the Gandhi family and the Congressheavyweight for 30 years, to represent Jangipur for things to change. He won the Lok Sabhaelections in 2004 and in 2009 from the constituency, and when he became the finance minister for the second time in 2009 after 27 years, the district saw a dramatic flurry of activities with bank captains falling head over heel to impress him. Between 2009 and 2011, it was like a ritual for Mukherjee to visit Jangipur almost every Saturday. Bank branches were opened indiscriminately at the hands of him with bank chiefs at his side. Banks opened as many as 21 branches in Jangipur's main business hub Raghunathganj alone. Before that, in five years, 35 mainstream commercial bank branches had opened in Jangipur. "It would have been better if banks spent money in opening more branches in the interiors," said Ismail Shaikh, secretary with S-Usha, a local NGO working for self-help group-bank linkage programme. The demand for brick-and-mortar presence gets louder if one goes deeper.

The challenge of financial inclusion

Illustration by Jayachandran/Mint

Live Mint ; Wed ;25 Dec 2013

A degree of realism is necessary if finance is to benefit India’s poor

Inclusion is likely to top the agenda of Indian finance in 2014. Reserve Bank of India (RBI) governor Raghuram Rajan has indicated that financial inclusion will be a key priority. The central bank has constituted a committee headed by Nachiket Mor, which is expected to submit its recommendations shortly. The move by RBI to devise a new framework for issuing bank licences has also been greeted by calls to consider alternative banking models that can target the needy more effectively.

While financial inclusion appears as a noble goal in itself, recent history shows that efforts to drive financial inclusion can be counterproductive unless handled well.

The subprime mortgage crisis in the US that wreaked havoc on the global financial system had its origins in the forced drive for inclusion. It led government-backed agencies to lend to customers with limited ability to repay.

India’s microfinance crisis is another such example. The fact that microfinance institutions (MFIs) operated in under-served areas led to regulatory forbearance in the initial years, leading to excessive lending before the eventual bust.

The dangers of reckless credit expansion in the name of financial inclusion should serve as a cautionary tale for policymakers today. Financial inclusion can be a worthy goal only insofar as it helps reduce poverty levels sustainably. Given that the roots of poverty often lie outside the realm of finance, easing access to credit without addressing real economy constraints is unlikely to either boost growth or help fight poverty. Efforts to drive greater financial inclusion can, in fact, end up harming rather than benefiting those in whose name such efforts are launched: the poor and the vulnerable.

It is better to err on the side of caution in the case of financial inclusion because the empirical evidence on the impact of inclusionary policies is quite mixed. A recent report on financial inclusion by the World Bank shows that the impact of financial inclusion strategies has been quite modest globally. While access to basic financial services does help the poor, throwing easy credit at them rarely raises prosperity in a sustainable way.

The history of the microfinance industry illustrates the limited potential of credit interventions. Studies that assessed the impact of MFIs in recent years found very little impact of microfinance loans on either the growth of microenterprises or on poverty levels. In contrast, the so-called social banking model of yore, involving state-directed credit interventions in developing countries such as India seemed to have had a greater impact both in raising growth and in denting poverty.

The problem with such state-directed efforts, as India discovered, is that lending becomes highly politicized. As a result, while such a model can help in mobilizing savings, it adversely affects asset quality of state-owned banks, posing a threat to the stability of the financial system.

There are thus no easy short-cuts to financial inclusion. Ambitions for financial inclusion need to be tempered because the financial system can grow only as fast as the rest of the economy. Given India’s income levels, it is not doing either much worse or much better than its peers as far as key parameters of financial inclusion are concerned. A cross-country survey by the World Bank shows that 7% of Indians reported taking a loan from a financial institution in the past year and 11% reported saving at a formal financial institution. These figures are roughly similar to the average of lower middle-income countries. The proportion of persons taking formal financial loans is roughly the same across the developing world but the proportion of savers is more skewed, with richer developing countries such as China having a much larger ratio of savers.

Given the low proportion of people who save regularly, India must turn its attention to access to savings. A microsavings account offers the poor a viable alternative to the sundry agents of shadowy financial institutions. It can also boost their ability to invest in their farms or enterprises. In the Philippines, for instance, farmers using commitment savings accounts, which involve relinquishing the use of the deposits for a certain period of time, reported improved use of inputs and better crop sales, according to a recent study. If well-designed inflation-indexed products are available, that can also help boost the savings rate even while lowering gold and real estate investments.

To be sure, credit products can also benefit from innovations. But many of the problems plaguing India’s credit markets lie outside the realm of finance. Better land titling systems and digitization of land records, for instance, can open up access to credit much more than any financial innovation can. It seems far safer and sensible to focus on designing and delivering better savings products to the poor.

India’s ambition of financial inclusion can do with a dose of realism about what the financial sector is capable of achieving.

Lending to MSMEs by banks: Some bitter truths

Money life :  Vivek Sharma 9 Dec 2013

MSMEs being the backbone of economy have been in need of funds to grow themselves but banks have adopted an approach which has failed to meettheir needs

When it comes to lending for business activities, banks tend to prefer large business entities to small players. This bias comes from the fact that big businesses have better assets and the possibility of failure of these businesses is less compared to small business enterprises. In order to gauge this preference of banks conversations with a small business enterprise, often referred to as micro, small and medium enterprises (MSMEs) says it all. For a micro and small business, to get loan from a bank is nightmare. This has been happening in spite of dedicated MSME branches set up by various banks and MSME lending being a part of priority sector lending.

 

RBI data in this regard is an eye opener. More than 92% MSMEs run their business on self-finance and have no source of institutional finance. The chart below shows that:
 

It is obvious that small businesses require funds as they have limited source of self-financed capital. Idea of schemes such as Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) came from this but somehow could not acquire acceptance from the banks in general. Though loans were given under CGTMSE, the number has been very insignificant compared to the size and scale of MSME business operations.

But this is not all.

There has been always a demand and supply gap in lending to MSMEs. MSMEs being the backbone of economy have been in need of funds to grow themselves but banks have adopted an approach which has failed to meet their needs. The chart below shows the demand supply gap which seems to be narrowing in days to come but still very sizeable by any stretch of imagination:
 

What is extremely surprising is that MSMEs don’t perform badly compared to the big business houses when it comes to performance on the payment of loans. The data available in this regard shows that percentage of impaired assets have been rising for medium and large business while it has been relatively stable for micro and small business.
 

So, there is no apparent reason for banks to show preference for large businesses as their performance on impaired asset front has been growing bad to worse. What is it that is preventing banks from lending to MSMEs? Most apparent reason is that banks to play safe and don’t want to add to their non performing assets (NPAs). The unfounded fear comes again from the fact that small business will default. But this logic gets weakened in some cases. Even in cases when credit guarantee is available through CGTMSE, banks are wary of funding of MSMEs because of the fact they don’t want any hassle in claiming guarantee benefit in event of a default by a micro or small enterprise.

 Recently, while delivering a keynote address at the Training Workshop on Credit Scoring Model with support from IFC for MSE Lending in Mumbai on 29th November, Dr KC Chakrabarty, deputy governor, Reserve Bank of India (RBI) said that credit scoring modelwill go a long way in promoting credit facility to MSMEs. 

But the key question is can lack of will to fund MSMEs will addressed by a strong statistical model. There is a need to fix accountability for lack of funding of MSME business by banks. For instance every bank can be asked to offer collateral free lending first to MSMEs under CGTMSE before the bank asks for security for any lending.

Last but not the least, let MSMEs also understand their responsibility towards lending done by banks. They must act with full responsibility to ensure that loans are paid on time on them and wilful default does not become order of the day.
 

(Vivek Sharma  has worked for 17 years in the stock market, debt market and banking. He is a post graduate in Economics and MBA in Finance.He writes on personal finance and economics and is invited as an expert on personal finance shows.)

The “remaking” of Indian banking

The Hindu :CPChandrasekar Nov 29 ,2013

Reserve Bank of India governor Raghuram Rajan has declared that he intends to launch on a “dramatic remaking” of Indian banking.

 In fact, his case for a ‘remake’ had been made as far back as 2009 through the Committee on Financial Sector Reforms that he chaired. 

But with far less influence and power then, that case was for reform through “a hundred small steps”. Since taking over as RBI governor he has been far more enthusiastic.

It must be noted that there is little innovation in the nature of the remaking Rajan recommends. What is being done and what is planned to be done are all proposals that have been unveiled in the past, by a series of “committees” (from Narasimham I and II, through Tarapore and Mistry, to Rajan) that were set up to launch the trial balloons that would test the political and public response to various kinds and degrees of financial sector “reform”. They are also proposals that have been adopted, in almost tiresome fashion, in one or other developing country seeking to remake its financial system in the image of the post-1980s Anglo-Saxon ‘model’, which still rules despite being discredited by the global financial crisis.

Rajan’s contribution lies in the fact that he has, since taking over as governor, begun implementing in right earnest the different proposals and initiatives that were in process. There has been substantial advance in two areas. One is the set of measures that give foreign banks greater access to and more freedoms in the domestic banking space. The other is the issue of new private bank licences, for which applications have been entertained from domestic corporations and business groups as well. The latter had been kept out of this space since bank nationalisation. But now, with the committee to examine and decide upon the applications in place, expectations are that one or more business group would re-enter Indian banking. The Rajan machine seems to be working, facilitated by substantial media support, and possibly the fact that Parliament has hardly functioned and now elections would occupy the nation’s political attention.

But from the point of view of those expecting much from the current governor, the big test is still to come, and that is the promise to ‘shake-up’ the state owned banks. Thus far, the government’s post-reform attitude to public banks has been contradictory. One the one hand, banks have been prodded (and not just encouraged) into lending to areas such as the retail sector and infrastructure, resulting in a rising volume of non-performing loans and a growing volume of restructured corporate debt. While restructuring has helped conceal the extent of implicit default and dress up the financial accounts of banks, even the RBI’s recently released report on trends in banking expresses concern about the state of public bank balance sheets.

On the other, the RBI and the government appear committed to ensuring that Indian banks meet the increasingly stringent capital adequacy requirements set by the reformed Basel guidelines. There are three consequences flowing from this commitment. First, since the early 2000s, the government has been forced to infuse capital into the public banking system to strengthen their balance sheets and bring them into conformity of globally recommended standards. As the accompanying chart shows, the government has thus far infused Rs.743 billion into the public banking system, with much of it having been provided since 2010. But even this is far short of estimates of what the banks would require if Basel III has to be complied with. One estimate places the requirement at Rs.5000 billion over the next five years.

Second, with the government still looking to the banks to provide the credit that would finance private investment (in areas varying from housing to power) and consumption (of automobiles and much else), non-performing loans are bound to increase. Hence, expectations are that the sums required for recapitalising increasingly weak bank balance sheets would increase.

Third, since the process of recapitalisation started, the kind of capital required to beef up the Tier I (or best and least committed) capital on bank balance sheets has changed. Increasingly what is required is tangible common equity capital. If this has to be ensured while keeping the government’s equity holding in public banks constant, much public resources would be required. The previous governor of the RBI, D. Subbarao, had estimated that the government, which owns 70 percent of the banking system, will have to pump in Rs. 90,000 crore equity to retain its shareholding in the Public Sector Banks (PSBs) at the current level to meet the norms.

If the government is to meet this requirement it will not be able to do it with off-budget measures such as issue of recapitalisation bonds as it did before 2010. It must now provide resources in the budget to buy into equity, with attendant implications for expenditures. If revenue increases cannot finance those expenditures, the fiscal deficit will widen, which goes against the self-imposed targets of the government. This has set off a demand that public sector banks should sell new shares in the open market to finance recapitalisation. But there could be one problem. Current law requires that the government should hold at least 51 per cent equity in public sector banks. A case is being made that reducing public shareholding from current levels to 51 per cent will not yield adequate capital for recapitalisation that permits realisation of Basel III standards. Subbarao, for example, is reported to have argued that “fiscal constraints pose significant challenges” to the effort to re-capitalise banks and ensure they meet Basel III norms, but bringing down government holding to below 51 per cent can resolve the problem. The case for recapitalisation has been converted into a case for privatisation.

Thus the call for privatising public banks also predates Rajan. The Narasimham Committee on Banking Sector Reforms had as far back as 1998 called for a reduction of the government holding in ‘public’ banks to 33 per cent to make them more dynamic. The Percy Mistry Committee had gone further to argue that privatisation is needed because state-ownership had adversely affected the quality of financial intermediation. The only change now is the case is being built on the grounds that privatisation is needed to ensure capital adequacy.

Thus, when delivering on public bank segment of his agenda to ‘remake’ Indian banking, Rajan would only have to implement a policy that has been pushed for quite some time now. But implementing this feature of the financial reform agenda is more difficult, since it requires changing the law, which in turn needs political support. That may be difficult to garner. But Rajan’s brief clearly is that he must give it a try.

Not CBI: FM needs to free the real ‘caged parrots’ — PSU banks

The main reason why we have undifferentiated banking in India is the heavy hand of government. Combine that with regulatory over-caution, and you will only get clones of the same banking business model. Reuters

by  FP :R Jagannathan Nov 18, 2013

Last Friday (15 November) at the annual Bankers’ Conference (Bancon) in Mumbai, Finance Minister P Chidambaram called for more innovative business models in banking. As the man who controls more than 70 percent of the Indian banking system – the public sector banks – one would have thought he should be asking himself this question: why are public sector banks unable to innovate?

Chidambaram said: “I sincerely hope that when new bank licences are given out, they are given to people with innovative models. It will be a pity if the new banks are clones of existing banks…..We need different kinds of banks to cater to different segments of Indian society.”

He’s right, of course, on this observation, but wrong is presuming that he has not contributed to this atrophying of innovation. The main reason why we have undifferentiated banking in India is the heavy hand of government. Combine that with regulatory over-caution, and you will only get clones of the same banking business model.

Before we discuss the issues raised by Chidambaram more fully, it is worth pointing out that banking models have indeed been innovated upon ever since the private sector was allowed in in the 1990s. Internet banking and seamless trading, any branch banking, and large scale retail banking are all innovations brought about with the entry of private competition. Today, thanks to technology, almost any financial or physical product can be bought or financed by the click of a mouse, and banks today are the biggest custodians of investor wealth, having seamlessly integrated banking, broking and demat accounts.

Chidambaram should be asking why his own public sector banks were so slow to adopt technology that private sector banks easily walked away with their best customers.

A related issue is how will the unbanked get banked, if all banks follow the same net margins-based model based on “class” banking? How is it that the public sector banks, once the pioneers in mass banking after nationalisation, are also aping the private banks?

The answer is simple: government ownership is the biggest barrier to innovation. It is impacting the pace of innovation even in private sector banks because competition is weak from public sector banks. Private sectors banks look super efficient primarily because public sector banks are so poorly run. The latter are racking up huge amounts of bad loans based on politically mandated lending to favoured sectors, with crony capitalists being indulged endlessly.

Public sector banks need high spreads between lending and borrowing rates to hide bad loans, and the private sector is happy to use this same spread to make super profits. When super profits can be earned in the shadow of inefficient public sector banking, why should private banks take risks with innovative business models?

Government ownership also comes with low levels of financial and managerial autonomy. Consider State Bank and HDFC Bank. Since its inception, HDFC Bank has had only one CEO, Aditya Puri – that’s nearly 20 years at the helm. As against that, SBI has had around 10 chairmen weaving in and out since 1994, and, with one exception (OP Bhatt), they had tenures ranging from as little as two months to an average of two-three years. Which SBI Chairman will think of anything innovative if he (or she) has just a two-year entitlement to the chair? Forget innovation, even long-term vision will go out of the window.

To make matters worse, Chidambaram himself has been making arbitrary announcements and decisions that make nonsense out of bankers’ autonomy.

For example, a new form of inclusive banking took hold when non-bank finance companies started lending against gold. The Reserve Bank and Chidambaram banned banks from selling gold and curtailed lending against it, killing off growth in this business. Is it the FM’s business to decide which businesses banks should do or not do?

In his last budget, Chidambaram announced the creation of a women’s bank – without any thinking on why women need a separate bank.

Chidambaram has also been pressuring banks to cut lending rates at a time when inflation is still high. Is it his business to tell banks what to do?

If banks are told how much to lend and to whom, at what rate to lend and for what tenures, where is the scope for innovation?

The only way to ensure innovative banks is to do the following.

One, start reducing government holdings in banks to below 51 percent. At 51 percent, public sector banks will always be under the thumb of the finance ministry – and hence will be unable to innovate. The Bank Nationalisation Act has to be amended to privatise government banks one by one.

Two, we need sharp, but differentiated, regulation. If we need different kinds of banks with different models, we need differential regulation too. India already has a large variety of banks – from commercial banks to cooperative banks to regional rural banks to urban banks – but regulation is either the same or diffused. We need wide banks (that do everything) and narrow banks (that only collect deposits), we need urban banks and rural banks, we need wholesale banks and retail banks, and we need non-bank financial institutions – the works. We also need a path of migration from one form of banking to another – and back.

Three, the new banks to be created in the public sector – the women’s bank and the Post Bank of India – can be used to create innovative models. For example, why can’t the Post Bank, instead of trying to be a full-fledged bank be a narrow banks that merely collects deposits and sells financial products? It can then lend wholesale money to those who need it. Why can’t the women’s bank be a focused lender to women’s self-help groups and women entrepreneurs? Women even today no problem in saving money with banks; it is in receiving loans they may be discriminated against – if at all.

Many ideas are possible, but innovative thinking must start at the finance ministry – which has been unwilling to let go of its control of banks. Chidambaram himself may be happy to privatise a few public sector banks, but his government is a dyed-in-the-wool believer in public ownership.

Like the CBI, our public sector banks are “caged parrots” answerable to different masters – politicians, the RBI, investors, and North Block, among others.

 Little wonder, there is little innovation.

Why public sector banks underperform

 

Subir Roy  BS  

November 19, 2013 Last Updated at 21:44 IST

The poor performance of public sector banks is ultimately a governance issue. They would present a different picture if they were professionally run by managers with the right attributes

Indian banks are not in good shape. This is understandable during an economic slowdown - when the overall economic growth rate has dropped to around half of what was achieved in its heyday. As is inevitable in a slowdown, non-performing assets of banks are rising faster than the banks' ability to provide for them, which is leading to falling provisioning coverage for stressed assets. Balance sheet health is declining.

But what is more worrisome is that public sector banks, which have a 76 per cent market share, are worse off than the rest. In the last financial year, 2012-13, the new private sector banks provided a return on assets of 1.74 per cent, whereas public sector banks were nearly a full percentage point behind, at 0.78 per cent.

Things have gone worse in the current financial year, setting alarm bells ringing for the banking regulator, the Reserve Bank of India (RBI), which has promised new guidelines for recognition, resolution and recovery of loans in trouble. The easing of asset classification norms after the 2008 global financial crisis has "killed credit quality," says one central banker. "Things are quite out of control," says another, pointing to the volume of restructured loans.

Public sector banks have been likened to venture capital funds because of the large amounts they have lent to firms where the owners' stake is small. The RBI governor has specifically referred to bank chiefs with short tenures (that describes public sector banks well) seeking to evergreen troublesome loans and leaving it to their successors to bell the cat.

If there is a core infirmity, it is the practice of corporate debt restructuring, through which companies' troubled loans are restructured by giving a moratorium on repayment, easing interest rates and allowing a bit of a write-off. Through this, banks enable promoters of such companies to continue to exercise control. The total value of restructured corporate loans has gone up two and a half times to Rs 2.7 lakh crore, or around 2.5 per cent of GDP, in a little more than two years.

The RBI has done the right thing in making these warnings, but it has to take a major share of the blame for allowing things to come to such a pass in the first place. For a decade or more (Pradipta Bagchi first wrote about this on this page in the mid-nineties), we have witnessed a familiar pattern in the quarterly results of public sector banks. They usually peak as an incumbent nears the end of his term. Then there is a sharp decline as soon as the new incumbent comes in and seeks to begin with a clean slate and unearth what has been swept under the carpet. The numbers keep improving thereafter until the incumbent's tenure is over, after which the whole cycle is repeated with the next incumbent. This raises the question as to whether the quarterly results of banks tell us the truth about their health.

Since corporate debt restructuring is a key area of trouble, it is worth noting what is widely discussed and believed to be true. Companies often lobby on behalf of individual officials for key posts. If a candidate wins, there is obviously a payback. In the case of public sector concerns, this can happen through the awarding of tenders or orders. In the case of banks, either a loan is given or a loan that has become non-performing is restructured - this gives both a financial leg-up and a breather to the promoter, who does not lose control of his business.

Alongside this is the case of the criteria for the positions of executive director and chairman-cum-managing director being periodically altered, which creates the impression that this is done to enable particular candidates to sail through. It is enough that there are a few questionable appointments among many that are deserving for a cloud of suspicion to hang over the entire situation.

As with a lot else that is pulling down the performance of the economy, the poor performance of public sector banks is ultimately a governance issue. They would present a different picture if they were professionally run by managers with the right attributes - and reasonable tenures, which could both promote accountability and enable an incumbent to produce results. The RBI can keep tweaking rules and issuing long circulars - it should certainly not let drift persist - but at the end of the day, governance issues can only be addressed by the owners (in this case, the political executive of the day). The bad news is that micro-management from behind has returned after a respite.