BackOpinion | When private bank owners ape the politician, you get a case like Yes Bank
To do things differently, the political hold over bank loans needs to disappear
PremiumThe rumblings of discomfort had been building up for far longer than we think. When the government and the Reserve Bank of India (RBI) finally pulled the plug on Yes Bank last week, it was to stop the deposit haemorrhage that had been building up over the past few months. That the bank played on the edge of regulation plenty of people in the system knew. That RBI was “uncomfortable" with the bank has also been clear for years. A mix of flamboyance, networking with politicians and bureaucrats across the years was used by the bank, which was also known known to “massage" asset quality at points in time when the disclosures on asset quality were due.
The failure in the Yes Bank story again points to a tardy RBI and the historic lack of effective regulation to contain what has been the biggest open secret in Indian banking—the political use of depositors’ money to result in rich promoters, bankrupt companies and periodic bouts of inflation to “inflate away the debt". Let me unpack this story. Since the nationalization of banks by Indira Gandhi, a bulk of scheduled commercial banking has been owned by the government (this is now about 60% of the deposits). Politicians quickly realized that this was the cheapest, most painless way of using taxpayers’ money to benefit businesses that were political donors. It was a hop skip and jump for the political donors to be replaced by personal wealth creation with the entire chain dipping its beak into the flow of money.
As a political tool for milking the system without the corresponding costs, bank ownership is the best thing ever invented. Imagine that a textile factory goes bust. It’s entire ecosystem of employees, suppliers and customers get affected. Thousands of jobs are lost making it a political nightmare to handle. Now take a bank. Depositors put their money in the bank and get some interest for their money. A part of this money is lent out to businesses and individuals who pay the bank a higher rate of interest that takes care of the bank’s costs, profit and the interest paid to the depositors. If the business does not pay back the money due to business failure, that loan goes “bad" and becomes what is called a non-performing asset. What if the loans given are not really meant for a business but get siphoned off through a web of shell companies and the loan goes bad? Who is to decide if this was deliberate or a real business loss?
Now imagine that these bad loans become so big that they are larger than the margin that banks keep with RBI and the bank’s equity capital. The bank fails since it is not able to pay back depositors. But with the bulk of deposits with government-owned banks, depositors have faith in the banking system that their money is safe. A bank failure would put the entire system at risk and would also mean the future flow of funds for the next round of lending will not come in. So, periodically, public sector banks are recapitalized or taxpayers’ money is used to infuse more equity into the banks. Depositors are unaffected and their confidence in banks remains high—they continue to keep deposits in the banks. The money comes from the taxpayers and from running large deficits—or borrowing from the public. This allows the governments to “inflate away the debt"—large borrowings tend to trigger bouts of inflation that reduces the real value of government debt.
The scale of this game kept on going up and loans to favourite donors and benefactors were “evergreened"—instead of pulling the plug on an unviable business, a fresh round of lending gave more money to chase the bad. The game is old, but what changed somewhere during the end of UPA-1 was the scale of the rip-off. The PM in a speech in Parliament on July 2018, said that the total loans from Independence to 2008 were ₹18 trillion, and then in the next six years they galloped to ₹52 trillion, an average annual growth of 19%. Did these loans trigger massive growth or were they partly siphoned off? I think we all know the answer to that one. We need to look at the Yes Bank story in the backdrop of an overall system of banking that has been compromised by the political system, not that it reduces the crime or the pain the depositors are going through. Or changes the fact that the Modi government has been unable to stem the rot.
What could have been done differently? The political hold over bank loans needs to disappear. Notice that every move to increase the system’s transparency is fought tooth and nail. The FRDI Bill was killed by the lobbyists, leftists and bank unions in 2018. The Bill’s aim was to put in place an early warning system to prevent a financial firm, like a bank, from going to the brink and putting the entire system at risk (read here). Even RBI has not covered itself with glory. Every RBI governor stands proudly over his independence and unwillingness to toe the line of the government. Some even resign over what they say is encroachment on their independence. But no governor has resigned over the misuse of public money for private gain.
The problem of large NPAs and compromised bank loans can be solved by a good bond market where firms borrow for business by issuing bonds. Bonds are listed on the markets and collective market information on a business being in trouble quickly reflects in bond prices. Why India is still struggling with a bond market is another story for another time.
Monika Halan is consulting editor at Mint and writes on household finance, policy and regulation.
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