Amid crisis in banking, fresh risk for the RBI

In any economy, the banking system is the steel frame that holds it all together. Banks can go bust when depositors withdraw their money in panic, or more commonly, when the companies or people to whom they give loans are unable to return them. The system is in crisis when the bad loans equal or exceed the capital of the banks. It in only saved when the government bails out the banks by putting in more money to “recapitsalise” them.

The banks, especially the nationalised ones, in India have been in a perpetual state of crisis for several decades. The bankers on instructions (a phone call) from powerful politicians extend loans to dodgy company promoters. The rot starts with top appointments that are made in deals in which both top managers and their political bosses share the cut. The practice has been going on for so long that, until RBI governor Raghuram Rajan clamped down, it became part of business lore.

The crucial factors are the percentage of loans that are “non-performing”, the infusion of public money needed to save the banks, the pressure that can be put on promoters to return the money, and the effect of all this on the economy. The June 2016 Financial Stability Report (FSR) brought out by the RBI quantifies the crisis and how it has changed in the recent past.

In the measured tones of a government report, the FSR ventures: “Risks to the banking sector increased significantly during the second half of 2015-16 due to deteriorating asset quality and lower profitability the system could become vulnerable if the macroeconomic conditions were to deteriorate sharply.”

This was because the gross non-performing advances (GNPAs or bad loans) of banks “sharply increased to 7.6 per cent of gross advances from 5.1 per cent between September 2015 and March 2016.” Besides this, the banking sector’s GNPAs showed a sharp increase year-on-year of 80 per cent despite the low growth of credit and deposits.

The growth of bad loans was not evenly distributed. While the household sector loans for buying property, and loans given to small and medium industry were nearly always paid back, the large borrowers do not. The ratio of bad loans of large borrowers increased sharply from 7.0 per cent to 10.6 per cent during September 2015 to March 2016 and their “share in GNPAs also increased to 86.4 per cent” from March 2015 to March 2016.

Moreover, “there was a sharp increase in the share of GNPAs of top 100 large borrowers s from 3.4 per cent in September 2015 to 22.3 per cent in March 2016.” The crisis in the banking system is thus largely a result of the big borrowers’ inability or unwillingness to pay. One recalls the ever-flamboyant Vijay Mallya, who did not settle his dues to the banks and took refuge in the UK, where much of his money was already transferred.

The debt owed by some of the biggest companies in the power, transport and steel sectors made for compelling reading in a report “The House of Debt” by merchant banker Credit Suisse, first published in 2012, most recently revised in September 2015. The report mentioned 10 top debtors. The total debt of these 10 groups was Rs 7.32 lakh crore (or trillion). The debt of these groups has risen seven times over the past eight years and some of these groups are carrying an interest burden that exceeds their earnings before interest and taxes. This makes them an even more risky bet for the banks.

Not all these loans are bad, and many of these business groups are selling part of their assets to reduce their debt. Still, around Rs 4 trillion will be needed by the government if it is to recapitalise the banks to make them healthy again, until they are made sick once again by the corrupt disbursal of loans.

The pumping of money into banks comes from the government’s budget expenditure. This would increase the fiscal deficit and in the last budget was cleverly sidestepped. But this cannot continue. A recent Bloomberg report says the government has revived a proposal to dip into the RBI’s emergency fund to recapitalise banks hurt by rising bad loans. The plan involves taking Rs 4 trillion from the RBI instead of taking it from the expenditure budget. This is not how it is done in any major economy in any of the banking crises that rocked them. In every case the government’s fiscal authorities inject capital into ailing banks and not central banks. The Modi government plans to piggyback on the RBI’s balance sheet to avoid showing a deterioration in its budget deficit.

The Narendra Modi government has tried to cleverly fudge the GDP figures. Now its intent is to make the RBI sick, throw the economy into a tailspin and turn the RBI into a tool to hide its failures. While doing this it would also protect its friends in industry from the strict action needed against them, and put a further burden on the taxpayer to bail out its friends.

The writer is a Mumbai-based freelance journalist