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India’s banking sector, dominated by public sector banks, is at the cusp of a systemic stall. At stake is individual trust and institutional interests. The facts are stark. India’s banks, as on May 25, 2018, hold about Rs 110 lakh crore of hard-earned money belonging to the public. Of this, 74 per cent, or around Rs 80 lakh crore, is in 21 government banks. How are the banks doing? In 2017-18, of the 21 public sector banks, 19 reported losses, of Rs 87,357 crore—a sum the Central government will spend this year on the prime minister’s schemes for micro irrigation, rural roads and national missions for drinking water, Swachh Bharat, education and skill development.
Eleven of the 21 banks have been put under “prompt corrective action” (PCA) by the RBI. Essentially every second PSB, its capital eroded, is precluded from normal banking. Nine of the 11 banks have GNPAs of over 15 per cent—IDBI Bank tops the chart at 27.95 per cent. The fourth quarter results suggest that six more could be brought under PCA, taking the score to 17 out of 21.
The NPAs stem from the hubris of 2007, the global financial crisis, the telecom and coal scandals and the UPA II policy paralysis—worsened by banks which rolled over to rollover loans. In March 2018, PSBs held bad loans of Rs 9 lakh crore—close to what was collected as taxes on income from companies and individuals in 2017-18. The swamp of stressed loans is yet being drained and there is the threat of power sector loans going bad. The figure could cross Rs 11,000,000,000,000 aka eleven trillion rupees.
This week, a senior citizen voiced the unstated anxiety of savers. The husband’s savings are in Bank of India and the wife’s retirement benefits in IDBI Bank—both under PCA. Their question: Would the banks survive, would their savings be hit? Deposits in banks are covered by deposit insurance of Rs 1 lakh. As per the Deposit Insurance and Credit Guarantee Corporation of India Annual Report 2016-17 (the latest available), there are a total of 1,884.8 million accounts in all banks, of which it has classified 1,737.2 million as fully protected. In effect, those with less than one lakh, estimated to be around 92.1 per cent of the depositors, are covered.
However, these accounted for only 30 per cent of the money or Rs 30.5 lakh crore in 2016-17 as per DICGC. Almost 70 per cent of the money, about Rs 72 lakh crore—saved by families for education, home, marriages and retirement—is not covered. And pertinently, the Deposit Insurance Fund in 2016-17 only had Rs 70,150 crore to cover protected accounts. Obviously not all banks will fail and not at the same time. There is cause for concern but not panic. Importantly, the faith of the depositors rests on an implicit belief that the government will step in.
The RBI and the government tried a series of ideas—Gyan Sangam, Indra Dhanush, the Bank Boards Bureau and more—which have flattered and disappointed. There has been much rah-rah for the Insolvency and Bankruptcy Code. It does merit applause as it is a big step. But it is not the silver bullet. One year after the RBI referred 12 big NPA accounts to the NCLT, only two have wriggled past the wicket gates of confusion and litigation. There are 2,511 insolvency cases queued at the NCLT, more are expected and at this speed the wait for banks may be longer than promised.
Last week, Interim Finance Minister Piyush Goyal met bankers. Committees were set up to propose measures including mergers and a bad loans bank. Truly, it is the eleventh hour and past the time for committees and reports on bad loans and bad banks. Just do it. The systemic stall calls for a total and immediate overhaul. The government needs to look at a stack of steps—get government out of banking, get loans off banks' books and recapitalise PSBs, and redesign their role.
The first step should be to set up a holding entity, Jan Dhan Investment Fund/Trust/Company, a fund a la Temasek or Bank Investment Company mooted by the Nayak Committee. The government then transfers its ownership and administrative functions to the new entity. The board of the holding entity, like the RBI Board, could represent knowledge and experience. It must be managed by professionals, advised by a collegium of bank chiefs and be accountable to Parliament. Next, the trust should set up a “bad bank” aka an Asset Management Company and buy off the bad loans portfolio of banks at par against deferred payment through long-tenure bonds.
How will this be funded? The start-up capital could come from government, securitisation of assets and equity from stakeholders such as LIC and NIIF and maybe even the RBI. Part of the capital must be used to top up the allocation for recapitalisation of banks. Sequencing is critical. Once the bad loans are off banks’ portfolios, the issue of an ETF and/or issue of shares by banks will fetch better valuation.
The sale of distressed assets will be at a discount and the AMC will take a hit—and there is no running away from it. This could be mitigated if the AMC is issued as a part of the dilution of holdings and if the AMC keeps a part of the equity of distressed assets. As the banks and enterprises turn around, the AMC could gain from the potential upside in valuation by selling the stakes in tranches—a la the Maruti model or STUTI.
Finally, there is merit in the question of whether we need so many PSBs and must all do everything. There is a need for long-term lending institutions and a deeper bond market for wider disintermediation so that banks and savers do not bear the brunt of risks.
The systemic stall in banking comes stapled with economic and political consequences. There are uncertainties and risks. There is a cost for every action and a price to pay for inaction.
Author of Aadhaar: A Biometric History of India’s 12 Digit Revolution,and Accidental India