Crony capitalism and Indian banks

A rising share of non-performing assets (NPA) of Indian banks, in particular the public sector ones, has become a cause for concern in recent months. Unfortunately, the search for explanations have been limited to standard reasons like poor governance in public sector banks and priority sector lending needs arising from populist political compulsions. But while these factors have undoubtedly played a part, I am inclined to believe that this time around crony capitalism may have a bigger contributory role. In fact, India's public sector banks may have become the most important channel feeding illegitimate business-politics linkages.

Before, further analysis, consider these figures. The operating margin of public sector banks for the first quarter of 2013 and for the fiscal 2012-13 rose 0.52% and 5% respectively. In stark contrast, for the private banks, the profits rose 25.41% and 25.65% respectively. In 2012-13, the NPAs of the 38 listed banks, private and public, grew by 51% from Rs 61000 Cr to Rs 92500 Cr, with that of private banks growing by 35% and of public banks by 52%. As this Livemint article indicates, the NPAs of Indian banks at 3.2% is the highest among all Asian economies. 

Further, if the Rs 2.2 trillion corporate debt that has so far been restructured through the debt recast cell and an estimated equal amount that has been restructured through bilateral deals between banks and borrowers is taken into account, 11% of all loans are under stress. The rating agency ICRA has estimated that once the RBI's revised norms on bad asset classification comes into force by June 2015, the NPAs will rise to 5.5-6.5%. 

The last decade saw a boom in construction and infrastructure investments. In the absence of a deep and liquid long-term debt market, a major share of the financing for these projects came from banks. Since the public sector banks dwarf the private ones, it was natural that the major share of these loans come from them. Today, we have a situation where most banks, public and private, are heavily exposed to sectors like power, mining, and roads, close to or exceeding their regulatory limits - 20% of capital funds to a single borrower and 50% to a single borrower group. In fact, a major portion of the debt in private domestic financing that has come as public private partnerships (PPPs) have been from public sector banks. In other words, a major part of PPPs have been just backdoor public financing.  

For sure, many of these projects have suffered from delays in regulatory approvals and inertia in decision making within the government bureaucracy. But from hindsight, as recent events have shown, many of these projects were also conceived on shaky foundations themselves. Contracts were awarded without competitive bidding and as part of rent-seeking transactions, firms bid aggressively at commercially unviable terms, bidders did not have sufficient professional expertise, and so on. 

Clearly, many of these loans were disbursed without the basic due diligence. Given the stakes involved and the environment in which these were approved (the large-scale instances of egregious corruption that have been exposed in the same decision making systems), it is not a stretch to imagine that the same negative factors influenced these loan decisions. The State Bank of India (SBI) alone has nearly Rs 3200 Cr worth exposure to Kingfisher, whose business model and corporate governance was questionable from the beginning. Similarly, for the past four years, the same bank has exceeded the credit exposure limit to a single borrower, Reliance Industries Ltd. The Finance Ministry cannot absolve itself off responsibility for these problems.  

In the circumstances, the recent outspoken comments by senior officials on governance standards in public sector banks is surprising. It is well-known that the government exercises considerable influence, if not complete control, both formally and informally, on all public banks. Apart from the appointments of all officials and boards of banks, the government is represented on their boards by senior officials of the Finance Ministry. It is inconceivable that large loans could have been extended, especially those which are now under stress and have undergone restructuring, without the tacit approval of the Government. Nothing would have prevented the government nominees from putting their foot down on the build up of such bad assets and excessive exposures. 

A CAG audit of the public sector banks could easily expose another large scam, and incriminate the Finance Ministry itself, apart from the bank regulators. Large banks have become a facade for governments to extend patronage to big business groups and deepen the unhealthy relationship that has developed in recent years between big business and politics.

It is indeed surprising why this issue has not received anything remotely close to the attention it deserves, either in public debates or academic research. Elsewhere too, especially in the East Asian economies in late nineties, state-owned banks played a critical role in cementing crony capitalism. Much the same appears to be playing out in India too. Reforming this has to go beyond debt restructuring and regulatory oversight, to far-reaching changes in the manner of control exercised by the Finance Ministry itself.