Rajan drops a bombshell; Cong in dock, flags MUDRA, farm loan waiver risks too

A brutal exposition of all the warts that adorn India's perilously poised banking system.

New Delhi: Professor Raghuram Rajan, ex CEA and RBI governor, in a devastating critique of India's twin balance sheet problem has slammed UPA's decade long tenure for the burgeoning non-performing assets.

His note written at the behest of chairman of the Parliament Estimates Committee headed by Dr Murli Manohar Joshi and submitted on September 6, 2018 is a virtual tour de force, a brutal exposition of all the warts that adorn India's perilously poised banking system.

At the very outset, former Mint Street sheriff, whose tenure was not renewed by the BJP says that – “I have not seen a study that has unearthed the precise weight of all the factors responsible, but here is a list of the main ones (he then goes on to list the reasons thereof)”.

To his credit, he understood the true extent of the rot and called it. Of course, he may not have been popular with India Inc for giving a timeline to out the bad loans, but if we now know the extent of malfeasance and concealment and ever greening of loans that took place, it is courtesy the war on bad loans by Rajan.

In fact, Rajan during the course of his 17-page note flags another emergent risk when he argues — Both MUDRA loans as well as the Kisan Credit Card, while popular, have to be examined more closely for potential credit risk. The Credit Guarantee Scheme for MSME (CGTMSE) run by SIDBI is a growing contingent liability and needs to be examined with urgency — hinting at MSME loans turning delinquent in the future.

It is in detailing that last point that Rajan has raised the red flag on current vulnerabilities. Launched in 2000 the CGTMSE, now known as UDAAN, has recorded over 25 lakh cumulative guarantee approvals in 2016-17 with an aggregate loan amount of over Rs 1.25 lakh crore, according to information on its website. Suggesting that the government should refrain from setting ambitious credit targets or waiving loans, Rajan reiterated that loan waivers vitiate credit culture and stress state budgets.

Agriculture needs serious attention, but not through loan waivers. An all-party agreement to this effect would be in the nation’s interest, especially given the impending elections.

Rajan has expounded on the reasons that led to a large build up of non-performing assets in India’s banking system, the regulator’s actions and what needs to be done to prevent a recurrence. He then goes onto tear the UPA for the way the banking system was managed and more or less every line is an indictment -


A larger number of bad loans were originated in the period 2006-2008 when economic growth was strong, and previous infrastructure projects such as power plants had been completed on time and within budget. It is at such times that banks make mistakes. They extrapolate past growth and performance to the future. So, they are willing to accept higher leverage in projects, and less promoter equity. Indeed, sometimes banks signed up to lend based on project reports by the promoter’s investment bank, without doing their own due diligence.

One promoter told me about how he was pursued then by banks waving checkbooks, asking him to name the amount he wanted. This is the historic phenomenon of irrational exuberance, common across countries at such a phase in the cycle.

Government Permissions and Foot-Dragging

A variety of governance problems such as the suspect allocation of coal mines coupled with the fear of investigation slowed down government decision making in Delhi, both in the UPA and the subsequent NDA governments.

Project cost overruns escalated for stalled projects and they became increasingly unable to service debt. The continuing travails of the stranded power plants, even though India is short of power, suggests government decision making has not picked up sufficient pace to date.

Loss of Promoter and Banker Interest

Once projects got delayed enough that the promoter had little equity left in the project, he lost interest. Ideally, projects should be restructured at such times, with banks writing down bank debt that is uncollectable, and promoters bringing in more equity, under the threat that they would otherwise lose their projects.

Unfortunately, until the Bankruptcy Code was enacted, bankers had little ability to threaten promoters (see later), even incompetent or unscrupulous ones, with loss of their project. Writing down the debt was then simply a gift to promoters, and no banker wanted to take the risk of doing so and inviting the attention of the investigative agencies.

Stalled projects continued as “zombie” projects, neither dead nor alive (“zombie” is a technical term used in the banking literature). It was in everyone’s interest to extend the loan by making additional loans to enable the promoter to pay interest and pretend it was performing.

The promoter had no need to bring in equity, the banker did not have to restructure and recognise losses or declare the loan NPA and spoil his profitability, the government had no need to infuse capital.

In reality though, because the loan was actually non-performing, bank profitability was illusory, and the size of losses on its balance sheet was ballooning because no interest was actually coming in. Unless the project miraculously recovered on its own – and with only a few exceptions, no one was seriously trying to put it back on track – this was deceptive accounting. It postponed the day of reckoning into the future, but there would be such a day.


How important was malfeasance and corruption in the NPA problem? Undoubtedly, there was some, but it is hard to tell banker exuberance, incompetence, and corruption apart. Clearly, bankers were overconfident and probably did too little due diligence for some of these loans. Many did no independent analysis, and placed excessive reliance on SBI Caps and IDBI to do the necessary due diligence.

Such outsourcing of analysis is a weakness in the system, and multiplies the possibilities for undue influence. Banker performance after the initial loans were made was also not up to the mark. Unscrupulous promoters who inflated the cost of capital equipment through over-invoicing were rarely checked. Public sector bankers continued financing promoters even while private sector banks were getting out, suggesting their monitoring of promoter and project health was inadequate. Too many bankers put yet more money for additional “balancing” equipment, even though the initial project was heavily underwater, and the promoter’s intent suspect.

Finally, too many loans were made to well-connected promoters who have a history of defaulting on their loans. Yet, unless we can determine the unaccounted wealth of bankers, I hesitate to say a significant element was corruption.

Rather than attempting to hold bankers responsible for specific loans, I think bank boards and investigative agencies must look for a pattern of bad loans that bank CEOs were responsible for – some banks went from healthy to critically undercapitalized under the term of a single CEO. Then they must look for unaccounted assets with that CEO. Only then should there be a presumption that there was corruption.


The size of frauds in the public sector banking system have been increasing, though still small relative to the overall volume of NPAs. Frauds are different from normal NPAs in that the loss is because of a patently illegal action, by either the borrower or the banker.

Unfortunately, the system has been singularly ineffective in bringing even a single high profile fraudster to book. As a result, fraud is not discouraged. The investigative agencies blame the banks for labeling frauds much after the fraud has actually taken place, the bankers are slow because they know that once they call a transaction a fraud, they will be subject to harassment by the investigative agencies, without substantial progress in catching the crooks.

The RBI set up a fraud monitoring cell when I was governor to coordinate the early reporting of fraud cases to the investigative agencies. I also sent a list of high profile cases to the PMO urging that we coordinate action to bring at least one or two to book. I am not aware of progress on this front. This is a matter that should be addressed with urgency.

Rajan has offered several suggestions on how such a NPA recurrence can be avoided. Among them, he urged the government to adopt a new approach to NPA resolution, cautioning against old ideas such as bad banks and mergers - We need concentrated attention by a high-level empowered and responsible group set up by government on cleaning up the banks.

Otherwise the same non-solutions (bad bank, management teams to take over stressed assets, bank mergers, new infrastructure lending institution) keep coming up and nothing really moves. Risk averse bankers and governments that drag their feet are why projects have not yet revived, Rajan has said. He also observed that the bankruptcy process is being tested by the large promoters, with continuous and sometimes frivolous appeals.

Pointing out the obvious, that the judicial system is not equipped to deal with every bad loan, Rajan said much loan renegotiation should be done under the shadow of the bankruptcy court, not in it - Banks and promoters have to strike deals outside of bankruptcy, or if promoters prove uncooperative, bankers should have the ability to proceed without them.

On the asset quality review, process which unearthed many of the camels and elephants hidden under the carpet, Rajan postulates on how the bankruptcy code became the guillotine for promoters who never took threats seriously till its enactment. It is only after its enactment that promoters saw a genuine threat of losing their businesses.

Equally, he wants the sanctity and integrity of the process to remain robust for it will be tested by promoters with frivolous appeals - Why have projects not been revived? Since the post-AQR process took place after I demitted office, I can only comment on this from press reports. Blame probably lies on all sides here.

a) Risk-averse bankers, seeing the arrests of some of their colleagues, are simply not willing to take the write-downs and push a restructuring to conclusion, without the process being blessed by the courts or eminent individuals. Taking every restructuring to an eminent persons group or court simply delays the process endlessly.

b) Until the Bankruptcy Code was enacted, promoters never believed they were under serious threat of losing their firms. Even after it was enacted, some still are playing the process, hoping to regain control though a proxy bidder, at a much lower price. So many have not engaged seriously with the banks.

c) The government has dragged its feet on project revival – the continuing problems in the power sector are just one example. The steps on reforming governance of public sector banks, or on protecting bank commercial decisions from second guessing by the investigative agencies, have been limited and ineffective. Sometimes even basic steps such as appointing CEOs on time have been found wanting. Finally, the government has not recapitalised banks with the urgency that the matter needed (though without governance reform, recapitalisation is also not like to be as useful).

d) The Bankruptcy Code is being tested by the large promoters, with continuous and sometimes frivolous appeals. It is very important that the integrity of the process be maintained, and bankruptcy resolution be speedy, without the promoter inserting a bid by an associate at the auction, and acquiring the firm at a bargain-basement price. Given our conditions, the promoter should have every chance of concluding a deal before the firm goes to auction, but not after. Higher courts must resist the temptation to intervene routinely in these cases, and appeals must be limited once points of law are settled.

That said, the judicial process is simply not equipped to handle every NPA through a bankruptcy process. Banks and promoters have to strike deals outside of bankruptcy, or if promoters prove uncooperative, bankers should have the ability to proceed without them.

Bankruptcy Court should be a final threat, and much loan renegotiation should be done under the shadow of the Bankruptcy Court, not in it. This requires fixing the factors mentioned in (a) that make bankers risk averse and in (b) that make promoters uncooperative.

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