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The conundrum of corporate loans

The conundrum of corporate loans

The conundrum of corporate loans
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By Latha Venkatesh  Apr 16, 2018 9:36:47 AM IST (Updated)

Since PNB reported its 13,000 crore Nirav Modi fraud on February 14, the de-nationalization argument against public sector banks strengthened. But since mid-March the ICICI-Videocon issue has mired the discourse creating a feeling that bankers – both public and private – are to blame for the bad loan mess.

Banking remains in the news for all the wrong reasons. Until mid-February banks were in the news for the rising load of bad loans. The share of bad loans was clearly more with public sector banks and hence public discourse was about whether the ownership and governance in public sector banks needs to change.

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Since PNB reported its 13,000 crore Nirav Modi fraud on February 14, the de-nationalization argument against public sector banks strengthened. But since mid-March the ICICI-Videocon  issue has mired the discourse creating a feeling that bankers – both public and private – are to blame for the bad loan mess.
THE LEGAL SYSTEM
Such simplistic conclusions are wrong and harmful. Firstly, the problem appears to be the borrowers rather than the lenders. Home loans and retail loans given by private and public sector banks see relatively  few defaults or NPLs (non performing loans). Loans given to large corporates, especially for infrastructure have a very  high percentage of bad loans, whether the loans come from private or public banks. Short point, something or everything is going wrong with corporate and infra loans.
Digging further, the trouble here clearly lies, or at least lay with the legal-judicial system. Despite three decades of experimenting , first with the Debt Recovery Tribunal Acts (1993) and then with the SARFAESI Act ( of 2003)  banks have found it very hard to posses assets of defaulters, especially if the defaulter has the ability to drag the banks to courts. Most corporates have that kind of money and hence have stymied recovery by using the endless adjournments that the legal system grants.
In response, banks resorted to ever greening loans. Realising that the time value of money will be more than lost by waiting for the courts, banks resorted to “settlements” with the large borrowers, giving them capex loans in the form of working capital and vice versa. With the onset of the economic slowdown post Lehman, the  pace of rotting of loans and hence of evergreening only increased. But the core of the problems has always been the legal system that stymied quick resolution.
NO MARKET DISCIPLINE
A second major very Indian reason for the large scale generation of NPAs is the public ownership of 70% of the banking system. This is not to mean that public sector bankers are more incompetent or more corrupt. This merely means that the public ownership of the banking system prevents market from operating as a self correcting mechanism. For instance, if all banks –IDBI, Dena, IOB, BOI, United Bank, UCO – were all private banks, will the courts have cancelled 20 years of coal blocks or cancelled all 2-G licences because some licences smelt of fraud. At the first instance of NPAs touching 10%, depositors would have rushed to withdraw their funds from the said banks and courts and government will have tried to sort out the tangles in coal or telecom rather than give sweeping judgments and sit on the problem.
Political parties too have been able to treat public sector bank deposits as part of the fisc because these banks are owned by the government. They have brazenly set priorities for banks –like  infrastructure or farm loans or MSMEs – rather than leave this to the commercial judgment and bandwidth of the banks.
LONG-TERM FINANCE
A third major problem with the Indian political economy has been that it has been unable to find a way to fund long-term infra projects. In developed countries of the West and the communist behemoths of the east, the government directly funded a large part of the infrastructure. India started with the fisc building steel plants and irrigation projects in  the 1950sand 1960s. A seminal mistake on hindsight. At least some of these sectors like steel should have been left to the private sector. By the seventies the state was maimed by fiscal deficits and shrinking tax kitties. It nationalized private banks on the one hand and mooted  development financial institutions (IDBI, IFCI, ICICI) on the other hand,  to lend long term funds.  The DFIs were allowed to even issue tax free bonds to fund infrastructure. As the cash proved inadequate these DFIs were listed and the pressure of the market forced the DFIs to become banks and lend to retail to compensate losses in the corporate loans. With DFIs vacating the infrastructure space, nationalized banks were summoned by their political masters to lend long term. The PSU bankers didn’t have that skill from the word go, and their liabilities (deposits) were strictly short term. Provident funds and insurance companies ought to be able to lend long, but given the first two problems, trustees of EPFOs and insurance fund managers are wary of investing their funds in anything lower than  AA companies.
Of these three problems, the Insolvency & Bankruptcy Code is probably resolving the first (though it is too early to tell). The other two problems remain: one, the country has not cracked how to lend long term funds and two, as long as nationalized banks dominate, all arms of government - legislature executive or judiciary – will take liberties with the financial system.
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