There is a growing public perception that all NPAs are the result of fraudulent practices. This is not true. Mortality is part of enterprise. In the Silicon Valley, only one out of ten firms is successful. The culture of venture capital accepted failures as standard; these were not stigmatized. In the US Silicon Valley start-ups had the backing of very strong ideation from Stanford’s academic institutions.
The brilliant economist, Dr. Raghuram Rajan, as the RBI Governor, took several drastic steps to get the banking system back on rails. His efforts through tightening regulation and directing banks on much larger provisions for doubtful debts gave the public the true picture of humongous non-performing assets (NPAs).
Arun Jaitley as finance minister provided the brilliant legislative back-up through the Insolvency and Bankruptcy Act (IBA). He also, through a massive infusion of capital, attempted to clean up the mess. But a sluggish economy, combined with an aversion for taking risks and lags in competencies, continued to keep banking in distress. In this background, the address of R Seshsayee (RS) on Toning up the Banking System unde the aegis of the Triplicane Cultural Academy, was a brilliant exposition on the present state of Indian banking with solutions for moving forward.
In recent months several policymakers, both past and present, with profound insights into government’s working, recommended privatisation of public sector banks. These include M S Ahluwalia who has had long stints with the finance ministry and the Planning Commission and Arvind Subramanian, Chief Economic Advisor, known for his analytical briliance. Seshasayee dealt with this issue also, but with a measure of caution. He has handled banking from either side: as a large borrower as also as a large lender, a somewhat unique experience.
Excerpts from his address at TCA. – Ed.IE.
The crisis in banking…
There is a crisis in banking. Three main aspects affect the banking system: not enough credit made available; inadequacies in the ability and competence to deliver quality credit and willingness to support economic growth.
Indian banking is dominated by the public sector that accounts for 70 per cent of the total banking business. Banking in the private sector is growing faster gaining more significant shares.
For years the capital adequacy ratio of Indian banks was higher than the Basel norms. There is a need for a continuous infusion of capital to meet this norm. This becomes difficult due to NPAs of Rs 2.4 lakh crore that account for more than 11 per cent of total credit. The NPAs eat the vitals of PSBs. Corporate loans account for a bulk of the NPAs.
Not all NPAs are fraudulent
There is a growing public perception that all NPAs are the result of fraudulent practices. This is not true. Mortality is part of enterprise. In the Silicon Valley, only one out of ten firms is successful. The chairman of a giant conglomerate admitted that only six out of ten of his investment decisions proved successful. Failure is part of a market economy. Creative disruption ensures the survival of the fittest.
Earlier, we had development banks that acted as venture capitalists. They created entrepreneurs. The gearing (debt: equity) was high at 3:1 and even 4:1. Regulations were much less. Still, NPAs were lower because we were not in a market economy; demand was far more than supply. Enterprises were not allowed to die. Today the market economy results in the swift death of weak enterprises. These cause NPAs legitimately.
Risk-averse
Firstly, there was the exuberance of expansion during 2004-05 to 2011. The world was on a trip. There was a significant focus on infrastructure. Growth was expected to continue at 9-10 per cent. What was not factored are the deficiencies in the regulatory regime, environment issues and the global economic slowdown. Integrity was missing.
The second factor related to competency. For long, banks shied away from funding infrastructure projects. A long-term bond market was not developed. Now the banks had to do this. But they were not equipped. There was no dearth of talent in banking. But their primary responsibi-lity to the shareholder was overwhelmed by the need for social lending.
Thirdly, the market cap of PSBs, a measure of value for an investor, is much lower than the market cap of private banks. For instance, the market cap of IndusInd Bank is much larger than that of SBI which is 10-12 times bigger.
With a high level of NPAs, there is an aversion to taking risks. We witness today an almost total ban on investments in the power sector. There is no reward for taking risks.
Big bang model not suited to India
There are several financial needs of the people to be addressed by the policymakers. Financial inclusion has taken substance through several welcome measures like the Jan Dhan and Aa-dhaar. There are micro-financing institutions which extend micro-credit; these have high-quality management and hence low levels of NPAs. The much-maligned Pakoda enterprise is an excellent example of a micro-enterprise at the bottom of the pyramid.
In the US, the Silicon Valley start-ups had the backing of very strong ideation from Stanford’s academic institutions. The culture of venture capital accepted failures as standard; these were not stigmatized. The big bang model cannot take root in India; Germany thrived on medium and small enterprises as did several ASEAN countries. Luckily, the reach of banking in India has been extended to the lowest level and today access to credit is widespread.
Welcome new norm: not condoning even a day’s delay
There is a welcome acknowledgment of the size of the problem. There is no shying away from this. As a consequence, firm decisions are taken. There is a new norm that stipulates that even a one-day delay in sticking to the rules would result in declaring the loan as non-performing. There is sharp criticism on this. But I believe we have started restoring a culture of honouring commitments; this should be welcome. Why should we not create a culture of paying the dues, a day in advance?
How to address the NPA problem? China had an even more severe NPA crisis. In a short time, that country has been able to come out of this. Managing credit risks is essential. The quality of appraisal and doing it quickly is crucial.
The government should reconcile progressively to privatising the PSBs. There are a few steps to do this gradually.
Few steps towards privatisation
• Need to change the present asymmetry of control between public and private sector banks.
• Consolidate the shareholding of PSBs to a single body and empower it to get the right kind of talent for PSBs.
• Compensation levels are important as talent finds its way.
• Clean up the present system, ensure competitiveness that will help ensure higher valuation of PSBs and then dilute the shareholdings.
• The regulator needs to be vastly superior. There is scope for relaxation of the current level of regulation and control.
• Guide banks to adopt and absorb technology to take care of internal controls. Cyber security requires talent. Artificial intelligence can be employed to manage risks.
• The regulator should ensure instruments of governance are fully in place.
Ultimately banking is about trust. Everything must be done to focus on this. – R Seshasayee
