How to break the banker-promoter nexus
You must have seen the popular TV advertisement campaign for a men’s deodorant brand where different sets of people casually ask each other, “kya chal raha hai?” (‘what’s going on?’). The reply, always, is: “Fogg chal raha hai” (Fogg is very popular these days, referring to the brand). Newspaper headlines and prime time TV discussions over the past fortnight may encourage us to rephrase this: “kya chal raha hai?” “Fraud chal raha hai.”
This spring, bank frauds are the flavour of the season in India.
The nation’s premier investigating agency, the Central Bureau of Investigation (CBI), is awfully busy dealing with banking frauds. Fraudulent transactions worth an additional Rs1,300 crore involving Punjab National Bank (PNB) and the jeweller uncle-nephew duo of Nirav Modi and Mehul Choksi have been discovered, increasing the estimated size of the alleged fraud to Rs12,700 crore now. CBI has registered a case against another jeweller, Delhi-based Dwarka Das Seth International Pvt. Ltd, for involvement in a Rs389.85 crore bank fraud. This time, the lender is state-owned Oriental Bank of Commerce (OBC), which has also been allegedly defrauded by Simbhaoli Sugars Ltd of Rs97.85 crore. CBI has also registered a case against pen maker Rotomac Global Pvt. Ltd and officials of various banks, on a complaint by Bank of Baroda, in connection with an alleged Rs2,919 crore loan fraud. And, there is a case against Kolkata-based RP Info Systems Pvt. Ltd, the maker of Chirag brand of computers, for defrauding a group of lenders of at least Rs515 crore.
Amid all these, the only piece of good news is: Rotomac promoter Vikram Kothari, a wilful defaulter, has no plans to leave India!
The Reserve Bank of India (RBI) data, which Reuters obtained through a right-to-information request, show that the government-owned banks have reported 8,670 “loan fraud” cases, totalling Rs61,260 crore, over the past five financial years up to 31 March 2017. The speed at which banks are filing fraud cases, the current financial year could eclipse that.
The latest available data with India’s premier credit information bureau puts the figure of wilful defaulters—the companies that have the capacity to pay up but refuse to repay loans—at 9,339 and the money involved at Rs1.12 trillion. The government-owned banks have the lion’s share of this—some Rs93,357 crore, involving 7,564 borrowers as of September 2017. Only those defaulters’ names are in public domain against whom banks have filed suits for recovery of loans.
Along with investigating agencies, both the banking regulator and the government—the majority owner of 70% of India’s banking industry—have swung into action. Many bankers are being questioned and a few arrested even as the banks have been directed to do many things—ranging from integrating the core banking system with SWIFT to checking all bad loans worth Rs50 crore and more for possible frauds to consolidating their foreign operations, among others—to get their house in order.
All these are welcome, with a rider—public trial of bankers will erode both confidence of the bankers (for giving loans) as well as people’s trust in the banking system (for keeping deposits in banks), something which India can ill-afford when growth is returning to the economy. Quite a few old fraud cases are being reported now, adding to the cacophony.
As the money involved in multiple fraud cases is large, we run the risk of missing the forest for a few trees. The lump of Rs10 trillion bad loans in the banking industry is a far bigger sum. We can’t afford to lose focus on cleaning up banks’ books and breaking the unholy promoter-banker nexus, which has been throwing sand in the wheels of operational risks. India’s government-owned banking industry is a classic story of corporate capture with tacit political overtone. Both the government and the RBI seem determined to break the promoter-banker nexus.
The cleansing process had started before people were saying, “Fraud chal raha hai.” And, the 12-February midnight directive of RBI could finally nail it. All existing frameworks for addressing stressed assets have been withdrawn and the joint lenders’ forum (JLF), an institutional mechanism that was overseeing them, has been dismantled. Now, the banks have no choice but to classify all large loans worth at least Rs2,000 crore as non-performing assets (NPAs) immediately when they restructure it. The clock started ticking from 1 March 2018.
Such an NPA should be resolved within 180 days, failing which the account gets referred to the Insolvency and Bankruptcy Code (IBC) court. Simply put, when a borrower fails to pay a bank loan in time, it becomes a defaulter, unlike in the past when the account was classified as “stressed” – often an excuse for the banks to postpone the inevitable.
The postponement was done, in many cases, by giving fresh loans—“evergreening” in banking parlance—to help the borrowers service an old loan. There have been many reasons behind this, including a banks’ reluctance to take the hit on its balance sheet. This also symbolized the cosy relationship between the banks and their borrowers, and was the genesis of many frauds.
Resolution platforms such as corporate debt restructuring (CDR), strategic debt restructuring (SDR) and the scheme for sustainable structuring of stressed assets (S4A), among others, left the job of cleaning up bad loans to the banks. Now, RBI, backed by the government, has stepped in.
Introduced in June 2015, SDR gave banks the power to convert a part of their debt in stressed companies into majority equity; it didn’t work because promoters delayed the restructuring, dangling the promise of bringing in new investors. Before that, in February 2014, RBI had allowed a change in management of stressed companies. The idea was to force the shareholders (not the lenders) to bear the first loss and the promoters must have more skin in the game. This was done as the CDR mechanism, put in place in August 2001, failed to alleviate the pain of the lenders. The S4A scheme allowed the banks to convert up to half the loans of stressed companies into equity or equity-like securities. Not much has, however, got resolved under this scheme either.
War Against NPAs
The war against NPAs started with the so-called asset quality review, or AQR, in the second half of 2015 under which RBI inspectors checked the books of all banks and identified bad assets. Bankers were directed to come clean and provide for all bad assets by March 2017. On top of that, the central bank started forcing banks to disclose the divergence between RBI’s assessment of the loan books and the banks’ recognition of bad assets in the notes to accounts to their annual financial statements to depict “a true and fair view of the financial position” of each bank.
An ordinance was promulgated in 2017, amending the Banking Regulation Act, 1949, giving powers to the central bank to push the banks hard to deal with bad assets. It authorized RBI to direct the banks to invoke the IBC against the loan defaulters. The RBI Act empowers the central bank to do this, but the ordinance was necessary to demonstrate to the corporate world that the government was backing the move. Armed with this, RBI forced banks to push 39 bad accounts into IBC in two phases in 2017 which collectively have around 40% shares in the industry’s bad assets.
Unlike in these cases where banks had to provide for 50% while invoking the insolvency code for resolution, for new references to IBC, banks do not need accelerated provisioning. Still, they will be hit hard. When an account becomes “sub-standard”, the first level of bad asset, banks need to set aside 15% as provision. A year down the line, the provision requirement rises to 25% (when the asset becomes “doubtful”) and, on top of that, the portion of loan not backed by securities needs to be provided for fully. However, the progressive rise in provision is of mere academic interest. In the new framework, banks must report a bad loan after 180 days to IBC when they fail to resolve it. The time frame for settling a case at IBC is 180 days, with a cushion of 90 days. This means banks must clean up all large bad loans in 15 months, or five quarters. There could be around 1,500 such accounts and the money involved is not less than Rs2 trillion.
Indian banks have been carefully nurturing the so-called special mention accounts, or SMA-1 (where principal or interest payment of a loan are not paid between 31-60 days) and SMA-2 (principal or interest not paid between 61-90 days). Now, there is no escape from moving such cases to IBC, including the SMA-0 category loans where a borrower has not paid for 30 days, or one instalment, if banks cannot restructure them within 180 days.
Also, from now on, banks need to report all default cases involving at least Rs5 crore every week (at the close of business hours every Friday) to a central repository of information. The first such report was submitted on 23 February, amid all the din and bustle on frauds.
On top of all these, the Securities and Exchange Board of India, or Sebi, is reportedly planning to revisit the proposal of making listed firms disclose defaults on their loans on a real-time basis.
What India’s government-owned banks are going through now is called purgatory in Roman Catholic theology—a condition of suffering and purification that leads to union with God in heaven. Only those banks that can endure this phase will come up trumps. After this, they will be wiser and never offer kid-glove treatment to the high and mighty corporate borrowers.
Tamal Bandyopadhyay, consulting editor at Mint, is adviser to Bandhan Bank. His latest book, From Lehman to Demonetization: A Decade of Disruptions, Reforms and Misadventures has recently been released.
His Twitter handle is @tamalbandyo.
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