Raghuram Rajan says bankers’ optimism led to bad loans
Large number of bad loans originated during 2006 to 2008 when economic growth was strong: Raghuram Rajan
New Delhi: Over optimistic bankers, slowdown in the government’s decision making process and moderation in economic growth contributed to mounting bad loans, former Reserve Bank of India Governor Raghuram Rajan said in a note to a Parliamentary panel.
In a note to Chairman of Estimates Committee Murli Manohar Joshi, Rajan said: “A variety of governance problems such as the suspect allocation of coal mines coupled with the fear of investigation slowed down government decision making in Delhi, both in the UPA and the subsequent NDA governments”.
Project cost overruns escalated for stalled projects and they became increasingly unable to service debt, he said, adding, the continuing travails of the stranded power plants showed government decision making had not picked up sufficient pace to date. He further said a larger number of bad loans originated in the period 2006-2008 when economic growth was strong, and previous infrastructure projects such as power plants had been completed on time and within budget.
“It is at such times that banks make mistakes. They extrapolate past growth and performance to the future. So they are willing to accept higher leverage in projects, and less promoter equity. Sometimes bank sign up to lend based on project reports by the promoter’s investment bank, without doing their own due diligence,” according to Rajan.
Citing an example, the former RBI governor said: “One promoter told me about how he was pursued by banks waving chequebooks, asking him to name the amount he wanted”. This was a historic phenomenon of irrational exuberance, common across countries at such a phase in the cycle, he added.
Unfortunately, he said, growth does not always take place as expected and years of strong growth before the global financial crisis was followed by a slowdown, which extended even to India, showing how much more integrated the country had become with the world. Strong demand projections for various projects were shown to be increasingly unrealistic as domestic demand slowed down, he added.
He also pointed to loss of promoter and banker interest for rise in non-performing assets (NPAs). Over malfeasance and corruption in the NPA problem, he said, “Undoubtedly, there was some, but it was hard to tell banker exuberance, incompetence, and corruption apart”.
“Clearly, bankers were overconfident and probably did too little due-diligence for some of these loans. Many did no independent analysis, and placed excessive reliance on SBI Caps and IDBI to do the necessary due-diligence. Such outsourcing of analysis multiplied the possibilities for undue influence,” the note said.
On steps required to prevent recurrence of rising NPAs, Rajan suggested there was need for improving governance of public sector banks and process of project evaluation and monitoring to lower the risk of project NPAs. Besides, he also made a case for strengthening the recovery process and distance public sector banks from the government.
The Parliament’s Committee on Estimates had invited Rajan to brief it on the matter after former Chief Economic Advisor (CEA) Arvind Subramanian praised him for identifying the NPA crisis and trying to resolve it. Rajan, who was RBI governor for three years till September 2016, is currently the Katherine Dusak Miller Distinguished Service Professor of Finance at Chicago Booth School of Business.
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