The bull’s eye in banking reforms

By Roopen Roy Jan 20 2015

Tags: Op-ed

There is plenty of good news about the Indian economy. Inflation has moderated. The slide of the rupee against the dollar has been arrested. Oil prices have tumbled. The stock market is at an all-time high. GDP growth is slowly picking up. But amidst all this euphoria, one should not lose sight of a time bomb that is ticking: the potential loan losses in the portfolio of public sector banks. We fondly call them non-performing assets (NPAs). How much? As much as 5 per cent of the aggregate loans of PSU banks have become NPAs. We need to inject Rs 4,00,000 crores by 2018 to meet Basel III norms. I have not estimated this mind-boggling figure. The Reserve Bank of India (RBI) has published it. It means rupees one lakh crore of additional capital every year.

Why are the borrowers not repaying? In some cases, the stalling of infrastructure projects has created stress. About 35 per cent of the NPAs are in the infrastructure sector. But the whole truth is: not all of them relate to stranded projects. We are being told that if more loans are extended, the companies will come out of the woods. It is also being claimed that if RBI drops the interest rate by a 100 basis points (it has already done so by 25 basis points), then happy days will be here again. One more steroid is being prescribed. The government should disinvest a large part of its shares in PSU banks. By doing so, we will be solving our NPA problem in one stroke. The sale proceeds of these shares to re-capitalise and clean the PSU bank books of the NPAs. The reduction in the holding of the government of India in PSU banks will also inject private ownership efficiency and all will be well.

I don’t fully understand the concept of private ownership efficiency. Singapore Airlines is a perfect example of an efficient enterprise owned by the government. Air India, in the same industry, is a classic example of a loss-making enterprise known for shoddy services. Therefore, ownership may not be the differentiator. Singapore Airlines operates in an empowered and accountable manner. Air India has been meddled with in the most blatant fashion. The mess that Air India is can be attributed to the bad behaviour of the owners. It had very little to do with the form of ownership. Kingfisher Airlines was, on the other hand, privately owned. Its private ownership did not save it from bad management; instead it actually exacerbated it.

Truth be told, I am not against privatisation of banks. Let us do so, if it helps us improve the governance and management of banks. In our system, political interference can, perhaps, be minimised if we place the banks under the discipline of a community of owners called shareholders. But the bank unions are already up in arms. Ours is probably the only nation, where the employees demand a veto on who their employers can be. Given a chance, they will also want to take away the right of the employers to hire employees of their choice or fire them for just cause. But the real issue is not ownership. The devil, as always, is in the detail.

The governor of RBI is a brilliant economist and an insightful analyst. He has seen the game up close. He has made a number of speeches on crony capitalism. Why? Well, all the NPAs in the system are not due to stalled infrastructure projects or slow-down in the global economy. Dishonest, crony capitalists have created a large chunk of these NPAs. We have to understand NPAs by putting them into two distinct buckets: the WISE (wealthy impresario sick enterprise) and the ROBE (ruined owner bust enterprise). In the WISE case, while the enterprise has declined in performance, the owner has increased his own assets and wealth in India and abroad. There may indeed be a connection between the enterprise’s decline and the impresario’s growing prosperity.

We are demanding more flexible exit laws for labour in a country that has almost no social security safety net. To be fair, we ought to work equally hard to amend our bankruptcy and insolvency laws. Let terminally sick enterprises die. Make dishonest owners whose enterprises go bust face the consequences. If in a WISE case, it is found that that the owner has diverted borrowed funds or milked the company to enhance his personal assets, there ought to be strict criminal laws that can bring forth swift justice that is exemplary. On the other hand, there are ROBEs as well. In such cases, with the failure of the business, the owner is also financially ruined. That is how the cookie crumbles in a free market economy. In a capitalist nation, if you take risks and fail, you carry the can — before the bank or the taxpayer. With one caveat of course — if you are so big that you can bring the economy down with you, you qualify for TARP (troubled asset relief programme).

In our mixed economy, there are instances where the same promoters and owners who ruined many enterprises are permitted to continue for years. These NPA creators must be tackled with a firm hand as an example to others. The mythological hero Arjuna was asked by his teacher Drona before an archery contest, “What are you looking at?” Arjuna famously said, “ I am only focusing on the eye of the wooden bird”. The bird’s eye is akin to the bull’s eye in the west in a shooting contest. To fix our banking system, we have to bring a slew of reforms. But the unwavering focus should be on the tackling of the NPAs head-on without fear or favour. That is the bull’s eye, make no mistake.

(The writer is managing director of Deloitte

Consulting, India. These are his personal views)