In 2004, the finance ministry first told banks where to lend their money and how much. This was followed up by fixing the interest rates for such loans. Finally, the third act of this absurd drama was scripted in Budget 2008, with the largest ever loan waiver.
Agriculture credit doubled in the first two years of the United Progressive Alliance’s rule after finance minister P. Chidambaram directed banks to do so. In the current fiscal that ends this month, banks will disburse Rs2.4 trillion of farm loans and the target for FY09 is Rs2.8 trillion. On government directive, banks extend such loans at 7% interest.
Despite this, the indebtedness of Indian farmers is rising. The government wants to address this through a Rs60,000 crore loan waiver. The scheme covers all loans disbursed by commercial banks, regional rural banks and cooperative credit institutions up to March 2007 and not paid till December. Small and marginal farmers won’t have to pay anything and big farmers will get a 25% discount on loan repayment. The scheme will be implemented in four months.
There is no budgetary provision for the loan waiver and Chidambaram, in his post-Budget interface with media, spoke about “liquidity” support to banks in the next three years. The banks are not aware of the nature of the liquidity support, but seem happy as this will help them clean their balance sheets and the government will bear the burden.
The stock market, too, seems to have been convinced of this theory. Almost all bank stocks that were in the red when Chidambaram was reading out the Budget proposals in Parliament on Friday, bounced back before the market closed after bankers and analysts started explaining how the loan waiver will actually help the system by cleaning up bad credit. But if the scheme is to be implemented by June, why would banks need to wait for three years to get their dues? Will they get cash or bonds? Will they get money even for the loan write-offs done, or provisions already created for stressed agriculture loans? As yet, nobody knows the answers to these questions.
But that’s not surprising considering the fact that normally public sector banks do not question the wisdom of the government, which owns a majority stake in them. And many of the critical decisions taken by their CEOs are equally baffling. For instance, State Bank of India (SBI), India’s largest lender, and Canara Bank, cut their benchmark prime lending rates by 50 basis points in two stages last month. Other banks, such as Bank of Baroda, Bank of India, Union Bank of India and Punjab National Bank, have cut their rates by 50 basis points at one go, but after SBI and Canara Bank announced the rate cuts. What happened between 11 February and 20 February? During this time, market rates actually went up. For instance, the yield on the benchmark 10-year paper rose from 7.44% to 7.62%. And the yield on five-year government bonds rose from 6.68% to 8.95%. So, there was reason to raise rates and not pare them. Still, why did they do this? The answer: pressure from the government. The finance ministry does not believe only in telling banks to cut rates; it also decides on the quantum of the rate cut.
This makes government interference the biggest risk for the state-run banks, which account for close to 70% of the Indian banking industry. No wonder the government features prominently among the risk factors cited by SBI in its offer document for a rights issue that is currently on. Let me reproduce a couple of risk factors from the document, verbatim:
*As the bank’s majority shareholder, the government controls the bank and may cause the bank to take actions which are not in the interest of the bank or of the holders of the equity shares…. The government, after consultation with the (RBI) and the chairman of the bank, may issue directives on matters of policy involving public interest, which may affect the conduct of the business affairs of the bank.
* The legal requirement that the government (must) maintain a majority shareholding interest in the bank of at least 55% may limit the ability of the bank to raise appropriate levels of capital…. As the Indian economy grows, more businesses and individuals will require capital financing...the bank will need to accrete its capital base, whether through organic growth or…capital market financing schemes.
Other risk factors cited in the document include SBI’s inability to attract and retain talent as it cannot offer market related salary and its “significant” exposure to the farm sector: “The loan portfolio contains significant advances to the agriculture sector, amounting to Rs38,140 crore, or 15.9% of net bank credit as on 30 September 2007. The government’s proposed agriculture lending plans may contemplate state- owned banks…lending at below market rates in the agriculture sector… The market may perceive the exposure of (the) state-owned banks to the agriculture sector to involve higher risks, whether or not the government mandates lending. This may…affect the risk-adjusted returns or state-owned banks and…State Bank’s business, future financial performance and the trading price of the equity shares.”
The point to note is that SBI is talking on behalf of all government-owned banks.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as the Mumbai bureau chief of Mint. Please email comments to email@example.com