Have you wondered why there has never been policy paralysis within banks, notwithstanding the government ownership of 70% of assets? We are taking a sharp fall in loan growth (disclosed every fortnight by the Reserve Bank of India, or RBI) as a proxy for policy paralysis, since lending is the most critical decision for banks to make.
The numbers are eye-opening. In October 2010, two executives of PSU (public sector unit) banks, including one director, and the chief of a housing finance company were arrested on charges of illegal gratification, and led away as petty prisoners in full glare of the media. Systemic loan growth remained the same—19-20%, and even occasionally touched 25% in the next few months.
The repercussions of the global financial crisis in 2008-09 could have shaken the wits out of any banker. But loan growth remained the same, at a fairly strong 25%, during this period. In fact, state-owned banks’ growth handsomely outstripped that of private banks.
For the last two years to November 2012, loan growth has ranged from 15% to 17%. This was a period full of scams, with the consequent revelation of lending to questionable or affected corporate entities and an enormous increase in non-performing loans.
In fact, in all these cases, the subsequent slowdown of loan growth can be easily attributed to cyclical conditions (e.g. cheaper alternative instruments such as commercial paper) rather than bankers’ reluctance. And in any case, even by Indian standards, 15-16% growth is not stasis.
Anyone who has worked in a PSU bank will tell you that bankers are perennially hot under the collar, and just like bureaucrats, do not get paid for taking risks but hauled over the coals for any decision that sours later. Despite that, there are hardly any examples of generalized policy paralysis.
This is something to ponder over. Once we get an inkling of the reasons, we will realize that an occasional, self-inflicted policy paralysis is desirable.
Firstly, incentives are distorted. Generally speaking, large shareholders, including the government, place too much emphasis on growth. The memoranda of understanding (MoUs) that state-owned banks sign with the government may have shifted focus away from growth, but that does not matter in an all-pervasive culture of “window guidance”, which simply means calls to the CEOs (to step up growth, for example). By and large, banks have not been rewarded for consistency of profitability.
Secondly, the perceived cost of capital for PSU banks is zero. All state-owned bank chiefs know that the government will step in with capital at some time, so containing growth is neither a necessity nor an option. Increasingly, most of that capital is coming from deficit financing, which is largely done by the banks themselves through regulatory investment in government bonds. This mutual-benefit syndrome leads to statements such as what a bank CEO made to a rating agency: “Look, it is my job to grow and the government to bring in capital. For a delay in capital infusion, you can downgrade me if you want.”
Thirdly, restructuring. Not bad per se, but postponing recognition of non-performing loans (NPLs) leads to business-as-usual for growth. The good news is that RBI is now all set to plug loopholes that have allowed banks to restructure frivolously.
Why is policy paralysis needed for banks at times? It is a catharsis, a sabbatical to laze around and revitalize oneself. Not doing much for some time can be refreshing.
There have been some micro-examples of policy paralysis in the sector. The most remarkable was ICICI Bank Ltd during 2008-10. It is a tribute to a large organization that can engineer it and cleanse itself. A milder, barely noticeable example was Bank of India under M. Balachandran, who refused to toe the industry line and consistently grew much slower to take the bank to a stronger footing.
There is a more immediate case for a forced paralysis. At least three banks, in public forums, have said recently that rising non-performing loans do not necessitate a restraint on lending growth, because the government wants them to “help the economy”. How an overdose of credit “helps” the economy is baffling. High lending growth has been this century’s most discredited banking phenomenon globally.
Yes, easier said than done. It is tough to look away from a good and expectant borrower, and risk losing him to competition. But in lending, normal, non-paralytic policy in difficult times is a recipe for disaster in future. And fear of losing to competition is somewhat misplaced: as the ICICI phenomenon showed, the “return” of a lender could invite a few smirks, but finally for borrowers, the more the banks in action, the merrier.
It amazes me that our leaders and administrators whose mindsets are still otherwise mired in the Hindu rate of growth have all along favoured strong bank loan growth. I have a good mind to submit this as candidate for the eighth wonder of the world.
Dipankar Choudhury has been a senior research analyst on financial services as well as other sectors at various investment banks, and is currently an independent consultant focusing on banks and financial services.