Banks must be kept healthy and solvent

By Roopen Roy Nov 10 2015

Tags: Op-ed

Very often one hears that a high rate of bank interest in India is the devil, which is holding up our economic growth. Despite several measures by the Reserve Bank of India (RBI), the grumbling has not cea­sed. May I venture to suggest that the fault, dear Brutus, is not in our RBI, but with the borrowers?

According to the rating agency ICRA, the gross non-performing assets (NPAs) of banks may rise to 5.9 per cent of total advances during 2015-16 against 4.4 per cent during 2014-15. That is an alarming signal, considering that NPA is an Indian euphemism for loans that may not be repaid.

A recent joint study by the National Institute of Bank Management and Assocham estimates that Indian banks will require Rs 5 trillion in the medium term to meet internationally accepted capital adequacy norms. The report says, “Given the credit gro­wth expected in the short-to-medium term, the capital requirement of Indian banks would cross a huge level of ₹5 lakh crore while meeting the globally mandatory Basel III banking norms by March 31, 2019.” If the banks wish to raise some of this capital from the market, their balance sheets must be clean and robust.

In order to keep the books clean and earnings healthy, the banks need to keep their spreads (difference between borrowing costs and lending interest rates) high so that they can absorb the provision or write-off of these bad loans. Thus, their ability to reduce interest rates to the end-customer, without tackling the problem of NPAs, is limited.

They would also need to recapitalise to meet with international solvency norms like Basel III. Recapitalisation implies that vast sums of the taxpayers’ funds must be transferred to banks as equity capital by the government to shore up the net assets damaged by loans, which are not being repaid by borrowers. These del­inquent borrowers are mostly large companies, wh­ich are themselves in dire financial condition.

The entire exercise of recapitalisation of banks engenders is a serious matter. The honest taxpayer pays money into the coffers of the government. But because the incompetent or the dishonest borrower is not returning the borrowings with interest, the banks are financially distr­essed and the government is bailing them out. What is happening to the owners of business who are causing this huge damage to the economy? Up until now very little.

If a business becomes sick, the employees suffer, the st­atutory dues are not paid and creditors and banks end up taking a haircut or shave. Yet, not only do the owners remain healthy most of the time, they often remain in the saddle of company despite their dismal record of mismanagement or, even worse, flagrant dishonesty.

A comprehensive reform is necessary with a tough set of actions to strike at the root cause of NPAs. It is important to hold to account delinquent and dishonest borrowers. As a pleasant surprise, the winds of change seem to be blowing from an unlikely source. The RBI has announced a strategic debt restructuring (SDR) scheme, which will allow banks and term-lending and refinancing institutions to convert their loans into equity. This scheme can be very powerful.

Let us assume that a promoter has put in equity capital of Rs 20 crore and borrowed Rs 80 crore from, say, publicly owned banks. If it is delinquent in repaying the loan, the bank can convert the Rs 80 crore loan into equity and remove the existing owners and sell the business to a third party through a transparent auction process. If the SDR scheme is allowed to be implemented, the threat of the owners being removed and the company taken away from their clutches will vastly improve corporate behaviour. However, the real issue is whether the political masters of the banks will allow the use of this weapon against delinquent owners.

There are safeguards in the scheme: First, lenders can use their powers of conversion only with the approval of 75 per cent of lenders in value and 60 per cent in number. Secondly, the scheme mandates that the banks will sell the equity as soon as possible to a third party following a transparent process.

The climate will change quickly. Even before the banks swing into action, we can see a number of instances where promoters are selling a part of their stake or are going through friendly acquisitions. If the ba­nks begin acting, many owners, in order to keep the golden goose, will find the money to repay the loans. Where the weapon is used, a change of regime may usher in better management and pave the turnaround of sick businesses.

While the SDR is a powerful weapon, it is important that we also take a relook at the bankruptcy process. If circumstances warrant, Indian companies should be dissolved easily. Secondly, regulations to deal with delinquent borrowers and dishonest promoters must be made tough and justice must be fair and swift. In the US, if a businessperson siphons money from a bank or perpetrates fraud, he is almost sure to land up in jail. In India, he may or may not be convicted, and it sure takes a long time to bring him to justice.

No less a person than the RBI governor Raghuram Rajan in his third Dr Verghese Kurien lecture had this to say, “The solution is not more draconian laws, which the large borrower may well circumvent and wh­ich may entrap the small borrower, but a more timely and fair application of current laws. We also need new institutions like bankruptcy courts and turnaround agents. Finally, we need a change in mindset, where the wilful or non-cooperating defaulter is not lionised as a captain of industry, but justly chastised as a freeloader on the hardworking people of this country.” I rest my case.

(The author is founder and CEO of Sumantrana,a

strategic advisory firm)