Bad loans crisis: How Vinod Rai proves Raghuram Rajan wrong

Former Comptroller and Auditor General of India (CAG), Vinod Rai, has hit the bull’s eye by stating that loan defaults by Vijay Mallya-promoted grounded carrier, Kingfisher airlines, and the scam surrounding Bhushan Steel, which bribed banks to get loans, are only tip of an iceberg .

Kingfisher, which is now classified as a wilful defaulter, owes Rs 6,500 crore to a clutch of banks, while Bhushan Steel, which is fighting a trust deficit, owes Rs 40,000 crore to its lenders. To be sure, Bhushan Steel isn’t a bad loan to banks yet.

In his book titled ‘The Dairy of the Nation’s Conscience Keeper - Not Just An Accountant’, Rai has said the problem of huge bad loans at public sector banks can be blamed on ‘cronies’ using connections to borrow money. Of the Rs 2.5 lakh crore bad loans in the banking system, over 90 percent belongs to state-run banks.

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“This is the underlying reason for non-performing assets (NPAs) of public sector banks going up manifold . . . stories of Kingfisher Airlines and Bhushan Steel are only now emerging in trickles,” Rai said.

The former CAG’s observation is painfully correct and critical for India’s banking system and, also raises the question on whether the Reserve Bank of India (RBI), the guardian of the Rs 86 lakh crore banking system, has got the whole problem right yet.

When the Syndicate Bank scam broke out in August, (with the Central Bureau of Investigation (CBI) arresting the bank’s chairman S K Jain for extending unlawful favours to private companies, including Bhushan Steel by accepting bribe) RBI governor Raghuram Rajan had refused to acknowledge that criminality is a major cause of bad loans in the banking system.

In the post monetary policy presser on 5 August, Rajan cautioned against highlighting criminality as the reason for all bad loans ills of the banking system.

“One should not extrapolate this (the arrest of Jain) to the entire public sector banking system and assume that all the problems in the public sector banking system are because of criminality rather than because of other factors,” Rajan said.

The solution to a problem, it is often said, lies in identifying it first. The same can be cited as an explanation to part of the bad loan pile in the banking system, where a total of about Rs 8.5 lakh crore of loans are in the stressed assets category (bad and restructured loans combined). This is about 14 percent of the total loans given by banks.

Rajan is indeed correct in saying that “all the problems” are not because of criminality rather than other factors. A significant part of the bad loan problem could be attributed to the prolonged economic slowdown in Asia’s third largest economy. But a look at the bad loan scenario shows that a sizeable chunk of bad loans can be indeed attributed to the element of criminality.

As Firstbiz noted earlier , the real explanation lies in what defines criminality in a banking transaction.

If the definition of criminality involves diversion of funds borrowed from banks to a non-stated purpose, with or without the knowledge of the banker, then it makes a perfect script for bad loans in many cases.

Similarly, if a rich promoter is hesitant to pay back his banks even when he has the money, the promoter should well be treated as a criminal because he is fooling the banking system, which handles public money. Besides bad loans, as Rai correctly observed, “the amount that has gone into corporate debt restructuring is another story; it contains all the marquee names.”

There has been rampant misuse of loan restructuring facility by corrupt, undeserving companies. In the recent years, there has been a sharp rise in the number of loan accounts that have been pushed to loan restructuring facility, under which banks offer relaxed repayment terms to a stressed borrower.

Loan recasts happen either through the corporate debt restructuring channel or on a bilateral, case-to-case basis between individual lenders and the borrower. Total loan amount recast at this stage is estimated about Rs 5 lakh crore to Rs 6 lakh crore both channels combined.

Even though loan recasts are intended to benefit a firm, which is in genuine stress, many times unworthy borrowers manage to avail this facility using political influence and connections through middlemen. Since these cases aren’t genuine, in most cases, they tend to slip into a stressed asset within no time, adding to the sticky loan pile.

For instance, if banks tag Mallya as a wilful defaulter, that means that he has defaulted not because of genuine reasons but by possible instances of fund diversion or other unlawful means. Remember, banks had restructured Kingfisher’s loans in 2010. In hindsight, a wilful defaulter didn’t deserve that gesture from banks.

In the recent years, banks have tightened rules for firms seeking loan recasts.

But, given that Indian banking system is dominated by state-run banks, which also happen to be more prone to political misuse, the checks and balances in place rarely work when it comes to stopping the unworthy borrowers from misusing the banking system.

Rai’s warning must be taken with the much needed importance by the regulator, so as to begin a corrective course. The earlier the central bank acknowledges the problem, the better.