Domestic banks, which have the highest bad loan pile in the world, pose a huge risk to the recovery of the pandemic-ravaged economy unless the government rescues them, four former Reserve Bank governors warn in a soon-to-be-released book.
While Raghuram Rajan blames excessive investments by companies and the exuberance of bankers, coupled with inability to act fast as the prime causes for NPAs (Non-Performing Assets), Yaga Venugopal Reddy opines that the bad loans are not only a problem but a consequence of other problems.
Duvvuri Subbarao sees NPAs as a big and real problem that needs to be contained, and Chakravarthy Rangarajan blames the lingering real sector problems, partly policy-driven most recently seen with demonetisation, aggravated the crisis.
"Yes, the bad loan problem is big and real," says Subbarao, who was the governor for five years from September 2008 to September 2013, in the book by senior journalist Tamal Bandyopadhyay titled 'Pandemonium: The Great Indian Banking Tragedy'.
The author has interviewed the four former governors for the book that will soon be launched by Roli Books. And all of them say what is also big and real is the fiscal constraints of the government, pointing to its very weak finances crippled by the pandemic.
State-run banks are in bad shape despite getting Rs 2.6 lakh crore in fresh capital in the past few years alone. But the government could set aside only a paltry Rs 20,000 crore for recapitalisation this year as its finances are scuppered, as against what many analysts peg at USD 13 billion (around Rs 1 lakh crore).
According to the latest RBI data, gross NPAs may scale past 12.5 percent by March -- the highest in two decades -- as the pandemic has put a great strain on the financial sector.
"In a way, fiscal problem spills over into banking and then financial sector problem with a feedback loop into the real economy," warns Reddy, who was the governor during 2003-08.
"In brief, NPAs are not only a problem but a consequence of other problems," he explains and points to the unplanned and controversial decision note ban in November 2016 cancelling over 76 percent of the currency in circulation overnight.
"The continuance of real sector problems, partly policy-driven in the most recent period such as demonetisation, has aggravated the banking situation," says Rangarajan, who steered the RBI from December 1992 to November 1997. According to him, the note ban was "an economic crisis".
Though these past governors differ on how the pile of bad loans came to be created and what needs to be done to prevent a recurrence, all of them are on the same page when it comes to consolidation, governance and government ownership of banks.
All of them also agree that consolidation is no panacea for the banking sector's ills and that governance is the elephant in the room and the government must pare down its stake in state-run banks.
Rajan who steered the banking sector through the taper tantrums for three years from September 2013 and waged a pitched battle against NPAs, lists excessive investments by corporations and exuberance by banks, coupled with the slowdown as the prime cause of NPAs and says the inability to act fast also contributed to the pains. The solution, according to Rajan, is timely recognition of bad loans, recapitalisation, and focus on governance.
Subbarao traces NPA problem to high-growth years before the 2008 global financial crisis, continued through it and even afterwards.
"At least one of the causes of the bad loan problem is the extraordinary liquidity infusion after the collapse of Lehman Brothers," says Subbarao and readily shares the blame for this and also liberally credits Rajan and Urjit Patel for arresting the problem and preventing it from exploding into a crisis.
Reddy also blames the forced lending for the trouble. When the pressure on banks increased both for social banking and infrastructure banking, credit growth for working capital was choked.
Bank credit has not been expanding after the 2015-16 asset quality review but the economy has been expanding. Someone was providing money to replace bank credit. In the first round, it was mutual funds; in the next round, the NBFCs. This way, the NPA problem spilled over from banks to mutual funds and, finally, the NBFCs, says Reddy but does not find any problem with the government ownership per se but he is concerned with behaviour of the owner.
On the ownership of banks, Reddy says the problem is how the owner behaves and how much they own per se.
"My limited point is that what ails the banking system does not lie only in the banking system; it is, to some extent, a reflection of the economic, political and social system, in particular, government departments and public enterprises," says Reddy.
Rajan also says there was a strong incentive for them to kick the can down the road by evergreening the loans. The net result was bad loans festered, piled up and reached explosive proportions.
"I think there are many reasons but what happened can really be attributed to quite a few things. One, what Alan Greenspan referred to as irrational exuberance. We were coming after a time in 2007-08 when lots of investments had been made and they had paid off. That is the time when generally banks make mistakes," he says.
"It was basically a story of more lending as well as less equity. I think the promoters saw an opportunity to essentially reduce their equity stake by sometimes even borrowing the equity they were putting in. These were very thinly capitalised ventures. And, there was a lot of exuberance.
"The second issue was the slowdown, both in terms of the economic slowdown (the years after 200708 were much worse in terms of economic growth) as well as the slowdown in government clearances.
"Put all this together and you have the beginnings of the crisis," Rajan concludes.