A senior banker has cited two recent instances of the finance ministry’s interference in their operations. The ministry has sent a note asking banks to restructure loans given to micro, small and medium enterprises (MSMEs) reeling under the steep rise in interest rates and a slowing economy. The ministry has also recently written to the banks, telling them to put in place core banking solution (CBS) in every branch, something the banking regulator has been insisting on for quite sometime now. Once a bank is under CBS, all branches get connected and customers start banking with the bank and not with any particular branch.
Under the ministry’s directive, the banks are required to closely monitor stressed MSME accounts. Many such units have been on the verge of defaulting. If a borrower fails to service loans for a quarter, or 90 days, the account becomes a bad asset and the lender needs to set aside money for it. Unlike large borrowers, MSMEs are not referred to the corporate debt restructuring (CDR) platform, a process under which banks recast loans to distressed borrowers with a repayment holiday, a reduction in interest rates and/or an extension of the repayment period.
Also Read | Tamal Bandyopadhyay’s earlier columns
In the aftermath of the 2008 global financial crisis, Indian banks restructured about 5% of their loans following a directive of the Reserve Bank of India (RBI) and 10-15% of such loans have turned bad for most banks. Some of these loans have, in fact, been recast twice. The idea behind this was to help firms hit by the slowdown in the wake of an unprecedented credit crunch after the collapse of US investment bank Lehman Brothers Holdings Inc.
With many of the restructured loans turning bad, Indian banking industry’s non-performing assets or NPAs grew the fastest in five years in the April-June quarter. The NPAs rose 7.64% over the preceding three months to Rs 65,318 crore, the fastest rise in bad loans in a quarter since July-September 2006. After setting aside money, or provisioning, net NPAs in the April-June quarter grew 9.62% over the preceding quarter to Rs 27,311 crore.
Indian economy grew 7.7% in the first quarter of fiscal 2012, sharply down from the 8.8% in the first quarter of fiscal 2011 but a marginal moderation from the 7.8% growth in the previous quarter and was largely on the expected line. MSMEs have been hit more by the rising cost of money than economic slowdown.
Since March 2010, RBI has raised its key rate by 11 times and the policy rate has risen from 3.25% to 8%. More than the large corporations who have other avenues to raise money, MSMEs are being affected as their capacity to service high cost loans is limited. Indian banks have given at least Rs 4.5 trillion to such firms and their exposure to these units grew 21.5% in 2010-11 from the previous year, when they had grown 17.9%.
Is there anything wrong with finance ministry directing banks to do certain things? After all, the ministry represents the government, the majority owner of the banks. Under law, the government stake in public sector banks—that account for roughly 70% of the Indian banking industry—cannot go down below 51%.
Indeed, the majority owner can exercise its rights but when it is the government there’s a moral hazard. All public sector banks are listed and driven by their boards and the government has its representatives on the boards. So, the best way of communicating with the banks could be through their nominees on bank boards and not through official communications from the ministry as banks are not government departments. Besides, banks are not barred from restructuring any loan as long as they are setting aside money for such assets. They can treat restructured loans as standard assets and do not require to set aside money for them only if RBI allows them to do so. This means, the government directive by itself is meaningless unless it is backed by the regulator’s support.
Who will set up the next private bank? If RBI’s draft licensing norms are anything to go by, very few candidates will qualify. Firms with 10% or more exposure to real estate and brokerage businesses in terms of income or assets are out of the fray; so do others who do not have a “diversified ownership, sound credentials and integrity”, and a 10-year track record. Reactions from the prospective candidates are predictable. More than 10% of Religare Enterprises Ltd’s (REL) revenue is generated from broking business but the firm claims that the promoter group, which will apply for the banking licence through REL, has “well below 10% of its revenue from broking”. Nirmal Jain, chairman of India Infoline Ltd, another brokerage, is surprised by RBI’s move to keep brokerages out of the fray. “When banks can do broking business, how come the reverse is not possible?” asks Jain. Reliance Capital Ltd says it is indeed eligible because only 2% of its income comes from brokerage.
RBI has made it clear that it will give licence on a “very selective basis” and “it may not be possible…to issue licences to all the applicants meeting the eligibility criteria”. A senior professional of an industrial house suggests that if there are too many candidates and all of them technically qualify, RBI should auction the licences.
That may not be feasible as unlike spectrum or iron ore, banking does not deal with raw materials which are in short supply; it deals with public money. But that doesn’t prevent a debate on who should get the banking licence and to what extent RBI should use its discretion while giving its stamp of approval.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as Mint’s deputy managing editor in Mumbai. Please email your comments to email@example.com.