As the banking regulator, will RBI be responsible and pro-active about NPAs instead of blaming the legal system?
Every public speech of Dr Raghuram Rajan, governor, Reserve Bank of India (RBI) creates a buzz. The 3rd Dr Verghese Kurien Memorial Lecture was no different. It was blunt, thoughtful and devoid of economic jargon. It lucidly explains the gigantic problem of bad loans and how “the sanctity of the debt contract has been continuously eroded in India in recent years, not by small borrowers but by large borrowers.”
The governor spoke of how “too many large borrowers insist on the divine right to stay in control despite their unwillingness to put in new money.” He said, the promoter “threatens to run the enterprise into the ground unless the government, banks, and regulators make the concessions that are necessary to keep it alive. And if the enterprise regains health, the promoter retains all the upside.”
The Indian taxpayer pays the price for the mammoth loan write-off by banks, which added up to 1.27% of GDP at Rs161,018 crore in the past five years. This, said Dr Rajan, would have allowed “1.5 million of the poorest children to get a full university degree from the top private universities in the country, all expenses paid.”
The governor explained how structures such as debt recovery tribunals (DRTs) do not allow speedy recovery of loans, and the ‘draconian’ Securitization and Reconstruction of Financial Assets and Enforcement of Security Interests (SARFAESI) Act, 2002, is only used successfully against helpless small borrowers. What is worse, draconian recovery legislation only acts as a disincentive to innovation.
But the bad loan numbers are truly staggering. Recovery through the DRT route was just 13% in 2013-14 at Rs30,590 crore against the outstanding debt sought to be recovered of Rs 236,600 crore. Dr Rajan blames this sad state of affairs on the long delays in obtaining judgements and, often, incorrect exercise of jurisdiction by courts. The consequence, he points out, is that banks lend at higher rates, charging a ‘credit risk premium’ to compensate for the risk of default and non-payment.
How does Dr Rajan think this situation would change? His solutions focus on three areas.
First, better capital structures, where lenders insist on promoters bringing in more ‘real equity upfront’ and not try to finance mega projects with ‘tiny slivers of equity’ that is borrowed from elsewhere and taken out as soon as the project gets going. Second, a joint lending forum which should prevent borrowers from playing one lender against another. And, third, an improvement in the debt recovery system, including a new bankruptcy law, and provision for structures such as professional turn-around agents.
Why does this masterly assessment of the situation seem to air-brush the real story of bad loans? In fact, Dr Rajan sounds like an outsider standing away from the entire mess of bad loans, when, in fact, as the banking regulator, the buck stops at RBI’s door.
Let’s focus on a few issues in Dr Rajan’s speech. He says, “I have met numerous parliamentarians who are outraged at the current state of affairs.” In fact, the most outrageous cases of reckless lending, over-generous debt-restructuring and mammoth bad loans have happened precisely because bankers are following instructions from politicians, especially when they are also businessmen.
Consider the headline grabbing bad loans of the past two years. Dr Vijay Mallya, whose Kingfisher Airlines alone owes over Rs7,000 crore to banks, is the most prominent.
Mr Mallya, a member of parliament (MP), has used this fact very effectively to build up massive debt.
The Airline stopped flying in 2012; it has not paid its employees and defaulted on various tax payments as well. But it was only on 1 December 2014 that the ministry of corporate affairs (MCA) finally rejected Mr Mallya’s reappointment as managing director, reportedly under pressure from his bankers.
On the very same day, he had to resign from the board of Mangalore Chemicals & Fertilisers after bankers threatened to stop lending. Almost at the same time, shareholders of United Spirit Limited (USL) shot down most of the cosy deals with Mr Mallya’s other companies at a general body meeting. His continuance as chairman is also subject to the absence of defaults by UB Holdings.
Clearly, bankers’ inability to initiate tough recovery measures was due to political pressure and collusion rather than systemic issues. While political will is an important factor that was missing over the past decade, a little help from RBI in nudging the MCA to force a change in management, or find Satyam-like solutions, could have saved many companies and salvaged their loans.
As we go to print, SpiceJet has been cancelling over 50 flights a day, causing extraordinary hardship to people across India. Do we see any signs of urgency on the part of banks to assess the situation, force a change management or make the existing promoters bring in funds before the company goes bankrupt? The politician brothers—Dayanidhi and Kalanidhi Maran—were, indeed, powerful in United Progressive Alliance (UPA) government, but are they in a position to make any threats today?
Then there was the Lanco group of Hyderabad which rapidly grew into a power, construction and engineering conglomerate through generous loans by a consortium of banks. Its chairman, Lagdapati Rajagopal, is a Congress MP famous for using pepper spray on fellow parliamentarians, who he repeatedly described as a ‘mob’. Even after Lanco was in a deep financial mess, banks gave it another Rs9,000 crore as part of corporate debt restructuring (CDR) just before the 2014 general elections.
Lanco is only one of many notorious Hyderabad-based companies that have received special benevolence from nationalised banks. For instance, T Venkattrami Reddy of Deccan Chronicle is allowed to exercise his ‘divine right to stay in control’, despite serious allegations of fraud and criminal conspiracy to cheat investors. Eleven banks have lent over Rs4,000 crore to the group. In 2012, when the charges of fraud surfaced, the company put on a brave front; but, by 2014, many of its bankers had classified the loans as non-performing and may have to make big write-offs.
Didn’t the Reddy’s opulent lifestyle and clear diversion of funds to a cricket team (Deccan Chargers) and luxury aviation enterprise raise the slightest alarm among bankers? Probably not; because, again, the Reddys were politically powerful nephews of high-profile Congress MP T Subbarami Reddy.
This brings us to Dr Rajan’s point about the need for better capital structures and how promoters finance projects with slivers of equity borrowed from elsewhere. Huge padding of project costs and brazen diversion of funds through collusion of bankers has been the basis of growth for many first-generation conglomerates operating in steel, power and infrastructure.
In fact, burgeoning bad loans and frequent debt restructuring is due to such collusion rather than choked up DRTs. Pertinently, only irrecoverable cases land up at the DRT. Government banks have no incentive to hasten hearings and, as long as they can blame the legal system for delay, they have nothing to fear either.
Often, promoters collude with bankers to strip assets so that there is nothing to recover after the case winds its way through the DRT. As Dr Rajan correctly points out, the only victims of the draconian DRTs and SARFAESI Act are small businesses.
The governor’s final point was that a wilful or non-cooperative defaulter must not be lionised as a captain of industry, but justly chastised as a freeloader on the hardworking people of this country. One has to look at Vijay Mallya’s timeline on twitter to know that the public does not lionise defaulters at all.
But, yes, our chambers of commerce do, because the big borrowers negotiate a place on important committees to improve access to politicians. Here, too, a nudge or a hint by RBI and the bankers will work wonders. In fact, a little more responsibility, speed and proactiveness by RBI in its role as banking regulator will make a big difference. Will it ever happen?
(Sucheta Dalal is the managing editor of Moneylife. She was awarded the Padma Shri in 2006 for her outstanding contribution to journalism. She can be reached at [email protected]