Suppose there’s a hospital with many patients suffering from gangrene. Limbs have to be amputated but the surgeons refuse to operate because they’re worried about malpractice suits and they have no insurance. The hospital’s reputation and its finances are suffering because the doctors are scared of operating. What do the hospital owners do? Do they offer the surgeons insurance? Nope. Instead, they tell the hospital administrator to direct the surgeons to remove the limbs. That, in a way, is similar to what the ordinance on bad loans does. It authorizes the Reserve Bank of India (RBI) to “direct banking companies to resolve specific stressed assets.” If the commercial banks can’t do their job, so goes the reasoning, the banking regulator must do it for them.
Much depends on what kind of directions the RBI will give. If it’s just deadlines to resolve individual cases, that is fine, although why they couldn’t tell the banks that earlier is somewhat of a mystery. But if the intention is that the central bank will decide how the loan is to be resolved, the amount of haircut needed, the assets to be sold, the amount to brought in by promoters, then that assumes the Reserve Bank knows more about commercial banking than the banks, a dubious proposition given that legions of RBI inspectors have been inspecting bank books for decades, with little to show for it.
Why haven’t bankers been able to resolve the bad debt problem, in spite of being empowered by an alphabet-soup of initiatives like the AQR, the ARCs, the SDR, the 5/25, the S4A? Arvind Subramanian’s Economic Survey has an excellent chapter telling us why. The Survey lists four reasons: banks’ reluctance to recognize losses; a lack of coordination between consortium lenders, because different banks have different levels of exposure; skewed incentives, with bankers fearing investigations and inquiries if they write down losses; and the fact that banks’ capital position, already strained, will be further eroded if large write-offs are required.
How much needs to be written off? The Survey paints a grim picture. It says, “about 33 of the top 100 stressed debtors would need debt reductions of less than 50 percent, 10 would need reductions of 51-75 percent, and no less than 57 would need reductions of 75 percent or more.” Which public sector banker, scared of being questioned as to his motives by Big Brother, would dare to sign off on such huge write-offs? And even if we find such a Superman, how much of the bank’s capital would be eroded when such write-downs are taken?
The ordinance throws up more questions.
If the ordinance is supposed to provide protection to bankers against the fear of witch-hunts in future, it begs the question: are RBI officials not public servants too? If they are, then they too run the risk of being investigated if somebody complains that they have favoured certain companies or promoters when resolving their bad loan cases. When investigating agencies can target Securities and Exchange Board of India (Sebi) officials, they can very well inquire into the motives of other regulators too. The problem is merely being shifted from commercial bankers on to central bankers. If the problem is one of fear of being unfairly targeted by investigators, surely what needs to be done is to remove that fear from all public officials, instead of protecting commercial bankers by making central bankers liable? And it is by no means certain that the ordinance will get commercial bankers off the hook, since they lent the funds in the first place.
The rationale for oversight of public sector bankers by investigative agencies is that public funds are involved. Well, private banks too deal with public funds but let’s leave that aside for the moment. Some reports say that several “oversight committees” will be set up, which will go into the individual cases of bad loans. These committees will apparently be staffed by experts who understand the industry. In other words, the fate of the public funds that have been lent to these companies will be decided by private individuals who the RBI thinks are experts. They will sit in judgment on how much to write-down, how much debt to restructure and on what terms. Isn’t there a contradiction here? Will these experts really know more about the loan accounts than the lenders? Will they not, if they force through resolutions against the will of some banks, be seen as favouring some banks against others? Will the investigating agencies leave these experts alone?
Much has been made of public sector bankers’ fears of the investigative agencies. But if it is this fear that inhibits them from recommending write-downs of loans, why did it not prevent them from granting these loans in the first place? Was it because, in many instances, their arms were twisted to grant these loans to promoters with friends in high places? Even if the loans were not expressly granted to crony capitalists, they may have been forced to lend to infrastructure as part of government policy. And if state-owned banks are vulnerable to political pressure, then surely the problem lies with state ownership of banks and with the proclivities of the politically powerful?
Perhaps bankers are carried away on a wave of optimism during good times, with public sector bankers being most prone to such herd-like behaviour? To quote Keynes: “A ‘sound’ banker, alas! is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional and orthodox way along with his fellows, so that no one can really blame him.” If so, the bad debt problem is likely to recur time and again. Will the RBI be called upon every time to pull the banks’ fat out of the fire? In other words, does this ordinance mean that bad loan resolution is now the RBI’s responsibility and lenders can sit back and wait for RBI to take the initiative?
To sum up, the ordinance does nothing to remove the constraints that banks face while taking commercial decisions about their loan accounts. As the Economic Survey said, “the road to resolution remains littered with obstacles, even for the most ordinary of bad debt cases.” The difference is that now it is the regulator who will be responsible for surmounting those obstacles, rather than the lenders. Franz Kafka would undoubtedly have been amused.
Manas Chakravarty looks at trends and issues in the financial markets.
To read Manas Chakrvarty’s earlier columns, click here.