Ghost in the Cash Machine

Arun Kumar  Aug 11 2014 : The Economic Times (Bangalore)   The Syndicate Bank incident demands a transparent loan -clearance mechanism in place Is the bribery charge against the Syndicate Bank chairman  and managing director Sudhir Kumar Jain a trailer of what's  in store for perceived standard operating procedure at state -owned banks that are vulnerable to pressure from political  bosses? Or is it a one-off incident? Investment revival in the Indian economy in the short run rides  on the answer to that question. If Jain's arrest leads to a  freeze in lending or loan-restructuring decisions across banks,  projects will remain stalled.Which first-generation promoter in  India has deep-enough  pockets to bring in the equity needed for any large project?  It is common practice to mobilise the promoter's equity contribution also from the loan raised from the bank for the project by inflating the project cost. If the promoters are honest, the gold-plating is 30%. A project actually worth ` . 100 crore would be implemented for ` . 130 crore and banks give a`. 90-crore loan from which the promoters take out ` . 40 crore to bring the amount back as their equity contribution. And this is probably the bestcase scenario. In some cases, this gold plating goes up 50%. And bankers are kept in the loop, obviously for a consideration. Or, at the behest of political masters, across party lines. Such projects are unviable from day one. But the promoters  and bankers work together to defer the impending problem  by delaying the completion of the project to reap two gains.  A company is allowed to capitalise the interest during the construction  period, which means interest payment is part of the project cost.  After commissioning, the project needs to generate enough resources to meet interest obligations, which is often difficult. The longer the period of implementation, the easier it is to take  out the money from the project and convert it as equity. It also  helps in justifying the rise in project cost that further helps the nexus. Once you reach closer to commissioning and the interest meter is  about to start ticking, such promoters start another project. This helps the bank to give a new loan that is diverted to repay the old loan. The cycle continues and the promoters become  bigger and bigger till they become a systemic, multi-billion-dollar  problem. And the bankers involved, having already made crores,  gracefully retire, passing on the headache to the next boss. Why Top-Down Clearance?The majority of Indian banks have a top-down approach to loan  clearance, justified on the grounds of speed and improving market  share. In case a branch manager does not approve the loan, promoters go directly to zonal or regional managers. In case they are reluctant, they go to the general manager, executive director or the chairman-managing director. And every superior justifies the decision on the ground of business  growth but without any transparency or accountability . No wonder  Percy Mistry , who chaired a government panel on financial sector  reforms, chose to call Indian public sector bankers “zombie bankers“. Ban Intermediaries While the Narendra Modi government has banned the entry of corporate lobbyists and liaison agents, financial intermediaries and  chartered accountants facilitating loans flourish in the banking system. “They use their contacts in the corridors of power to raise loans at cheap rates and take a commission of just 2%,“  according to a mid-sized member of the corporate world. What is the role of intermediaries in getting loans from a bank?  Why do bank officials interact with them? Is athird-party structure  used to legalise bribes in the name of commissions? Why not make  the system more transparent for the purpose of internal records? These days, such meetings between bankers and would-be borrowers  could be recorded at an insignificant cost. And everybody should be warned that the proceedings will be on record. Committee Structure Let loan decisions come through a strengthened decision-making pro cess with a committee structure at branch, zonal and headquarter  levels. And everyone should be empowered to give his or her rationale  for supporting or opposing any financing proposal in a time-bound manner. Senior officials are entitled to overrule the decisions of their subordinates.  But they should record detailed justifications. Banks must monitor the implementation of a project regularly and the  end-use of funds. Why not make the branch manager or zonal officer ensure that the money disbursed goes into stated purposes and is not left at the mercy of the promoters? And someone should be held accountable for this before any fresh disbursal of loan is made. Most importantly , there should be a complete ban on executing projects through an in-house company , unless a discount  to third-party executions at an arm's length can be  demonstrated. Finally , let promoters pony up the committed  equity contribution upfront or provide a detailed mechanism  for the purpose, such as how they will raise the equity for  each project and what their backup plan would be in case of any eventuality .  

Know your bankers

Anush Kapadia : The Hindu ;17 Oct 2013

India needs to have development banking that speaks the voice of the people

India’s economic model is broken. The dominant, liberal, economic philosophy fails to answer our defining question: how do we develop democratically? The cookie cutter, laundry list reform agenda is a distraction. We can look nowhere for intellectual bailouts via off-the-shelf solutions. We need our own answers to rescue our system from its lurching stimulus-response.

It now seems clear that the sum total of forces at play, intellectual as well as political, have led our system to an equilibrium that simply cannot hold. The private-sector oligarchs have attempted to carry a load that is beyond them, and the state has been reduced to limply ameliorating the model’s intrinsic harshness. It’s time for a serious rethink.

Much like 1991, our present crisis is the result of the overheating of an internal debt engine and a perilous turn to foreign borrowing at the margin. In the 1980s, the government’s domestic source of borrowing overheated as the nationalised banking system became saturated with government debt, forcing the government to borrow in foreign currencies at short maturities. Staking on thin ice, things duly fell apart with the fall of the Berlin Wall.

This time, it's the private sector that is overleveraged, saturating the capacity of the ill-equipped commercial banking system to lend to large, long-term projects and again resulting in a turn to foreign debt. In the context of a widening current account deficit, this could spill over into a banking crisis as firms buckle, and therefore fiscal strife as bailouts are required.

INSIDERS RULE

Our reality is of course far from liberal. Insiders rule. Yet, by rendering government as merely a fetter, the dominant philosophy unwittingly serves to naturalise oligarchy. There is, it need hardly be said, much government bungling. But if the common sense desires a nightwatchman state, it is not only utopian but functionally undemocratic. This common sense might be leavened with calls for inclusion, but this view blends a noble, ameliorative sentiment with the bad faith of barely-disguised patronage, neither of which have transformative energy.

Stuck between the short-termism of a patronage-fuelled polity and the utopianism of economic liberalism, our system lurched towards a solution: pair the nationalised banking system with the balance sheets of the oligarchs to do heavy-lifting of development. Commercial banks were drafted in to do the work of long-term funding for large projects in infrastructure. When these banks inevitably proved too small, foreign debt filled the gap.

It might well have come off, but the odds were heavily against it. The mushrooming of corruption scandals was a sign that the balance of power between the state, its banks, and the oligarchs was malfunctional for development.

BALANCE OF POWER

In most cases of rapid growth, substantially large banks have invariably driven heavy industrial or infrastructural projects; take German universal banks of the 19th century or the East Asian development banks of the mid-20th. The key was a balance of power between the lender and borrower that enabled discipline and scale. Yet in India, oligarchical power blunts banks' discipline on investment even as banks’ resources were limited by unproductive pre-emption through compulsory government debt purchases.

So the oligarchs came to be overleveraged on two fronts, economic and political. Connections secured projects, and substantial financial leverage was deployed to execute them. But their political bets were far from hedged. Just as central planning failed to insulate economics from politics, the nexus between the oligarchs and the ruling combine — corruption — failed to insulate investment from accountability. The exposure of excessive self-dealing on all sides further slowed things down as the polity raged.

Our economic model now stands exposed. With balance sheets too small to weather the nation’s stormy politics, the leviathans of the private sector have been shown up as having shoulders too narrow to bear the load of development. This of course is the old saw of development planning, now seemingly proved right. Under Indian political conditions, it appears that only the Leviathan of the state has the risk-bearing capacity to do the job.

FOR US

We have come full circle. There are no short cuts through public-private partnerships or other contrivances to insulate economics from politics. Democracy demands getting politics and economics pulling in the same direction. Anachronistic as it may sound, we need to reinvent development banking, and get it right by setting it on the firm ground of popular consensus. We need more than a mere regulatory state; we need a developmental state running a sound development bank.

Our model of development depends on a degree of insider capture that is not only undemocratic but exposes us to the fissile material of global capital. Ironically, even the giants of the private sector are too small to deal with political risk, while the banking system doesn’t have the scale thanks to the debt dynamics of our politics. So we turn outward, and again pay the price. But the people are the real bankers of our government. Now let’s get the government banking for the people.

(Dr. Anush Kapadia is a lecturer in international politics at City University, London.)