The state of the economy of any country is reflected in the health of its banks and financial institutions. The impact of any economic or financial crisis is that Non Performing Assets (NPA) or bad loans shoot up. If the bad loans do not get resolved very quickly, banking system becomes credit averse and the economy of a country starts slowing down. Weak banks and financial institutions start collapsing This is what we are witnessing in India. Indian banks are not willing to lend. The last few years has seen many banking and NBFC (Non-banking financial company) failures. In September 2018, IL&FS, the infrastructure lending NBFC giant collapsed, followed by PMC Bank and Yes Bank, DHFL, a housing loan NBFC, was put on the block and recently Lakshmi Vilas Bank was taken over by DBS after RBI superseded the board. When a bank collapses, it causes a lingering instability in the financial system. To arrest this instability, RBI has been ensuring the takeover of any large bank or financial institution that has collapsed such as IL&FS, Yes bank and the recent kid on the block, LVB. Recently, RBI’s internal working group came up with a proposal to allow corporates to run banks. While RBI is yet to respond to this proposal, the proposal has been met with strong criticism.
NPAs and the banking sector
To help the banking sector in spreading credit availability, 14 banks were nationalized in 1969. In 1980, six more banks were nationalized. With this, more than 70% of the banking sector became state owned. After the 1991 economic reforms, RBI started providing banking licenses to private entities. According to the latest data of RBI, the market share of Public sector banks (PSBs) has been dipping and the private sector bank’s share have been surging in both loans and deposits. This has been attributed to the rising number of Non-Performing assets (NPAs) in the balance sheets of the PSBs. A lot of NPAs are attributed to mid-2000s period, when the economy was booming, and loans were available more easily. Post 2008 crisis, after economic growth stagnated and corporate profits decreased, the repayment capability of the corporates decreased. This caused the banking sector to come under duress. The proportion of NPAs went from 2% in 2008 to over 10% in 2018. As seen below, private sector banks have lesser NPA as a percentage to their loan books as opposed to PSBs.
The government has infused over 3 lakh crores in the last decade to help PSBs deal with NPAs. The pandemic is expected to increase NPAs. Although the Indian economy has witnessed a significant improvement by narrowing down from 23.9 % contraction in the April -June GDP Quarter (Q1) to 7.5 % contraction in the July-September GDP Quarter (Q2), demand from corporate sector is still muted, hence credit offtake has remained stagnant. Gross NPAs may jump 8.5 % in March 2020 to 12.5 % by end of the current fiscal year according to RBI.
In 2019, 10 PSBs were merged into 4 entities in order to increase the global competitiveness of the banks. There have been calls for privatization in the light of increasing NPAs several scams coming into light over the last few years. It is argued that if the government equity is reduced to less than 50% in PSBs, senior management of PSBs will have more autonomy and will function like private sector banks. The largest bank of India, SBI, has a balance sheet four times the size of HDFC bank yet its market capitalization is just 1/3rd of HDFC’s, perhaps reflecting the state of management of PSBs vis-à-vis Private sector banks.
Corporates in Banking
Corporates were not given banking licenses because of fears of connected lending, lack of supervisory mechanism for the corporates, but they have a good presence in NBFCs, in fact the NBFCs run by corporate houses like Bajaj, Tata are counted as part of the top 10 Indian NBFCs. In November 2020, an internal working group of RBI, recommended that large corporate houses/industrial houses may be permitted to run banks. It also recommended that large NBFCs with an asset size of above Rs 50,000 crores be allowed to convert themselves into a bank. This recommendation has received backlash from central bankers and economists. This proposal comes when India’s banking and financial sector has been passing through choppy times.
In a joint article, former RBI Governor, Raghuram Rajan and former Deputy Governor, Viral Acharya, called this proposal a ‘bombshell’. Opposing it vehemently, they argued that a conflict of interest would emerge (i.e, an industrial group borrowing from its own bank) and this would cause the weakening of bank’s due diligence which could eventually cause rise in bad lending (NPAs). In the case of borrower defaulting, there could be a contagion effect (as both the borrower and lender are from the same industrial house in this case). They point to how PSBs were forced to lend to government entities against conventional banking practices and how it has affected them. Also, this would result in concentration of economic power in certain entities. They also added that PSBs should not be sold to large corporate houses and instead should be professionalized and made more robust.
S&P, the global rating agency said, it was skeptical of allowing corporate ownership in banks given India’s weak corporate governance and pointed out the same risks stated by the former central bankers. But, it also added that the conditions in the proposal, i.e., minimum paid up capital of Rs 1000 crores for setting up a bank, would enable only deep pocketed corporates to set up such a bank and that would provide stability in the capitalization of the banks. It also added that top NBFCs have a head start in converting themselves into banks.
Yay or Nay
The larger picture that emerges from the opinions of the central bankers and S&P is, that a conflict of interest emerges. A bank run by an influential corporate would come under pressure to lend to them even if the lending is against the interests of the banks. Even the PSBs have faced allegations of lending to influential corporates under directives from their political masters. India’s top business groups have faced allegations of corporate mis governance and giving banking licenses will raise a few eyebrows. No changes in corporate governance has been felt that such a time tested strategy of not allowing corporates in the banking sector can be changed.
The recent banking collapses and the scams such as PNB have raised questions over the effectiveness of RBI’s supervision itself. It is generally accepted that RBI is one of the least autonomous Central banks despite having enormous powers. Before such a proposal is accepted, RBI must be given more supervisory bandwidth and it must tighten its oversight on banks.
India’s corporate governance, although relatively weaker than US’s and Europe’s, has kept evolving for the better. India does need more banks, despite the bank nationalization, setting up of Regional Rural Banks, increasing number of NBFCs, introduction of niche banking like payment banks, financial inclusion has remained low. The government’s decision to limit public sector entities to just four in critical sectors means the role of PSBs will decrease in the future and as it is, private sector banks are stealing a march over the PSBs. The banking sector bears the brunt of any economic or financial crisis. It is important to keep this in mind before making changes to the banking sector especially in a country like India.
– From Shubhang Sunkara (Editor, TJEF)