If NPAs are not curbed effectively, it will not be long before India heads the Greek route. The Ministry of Finance has to necessarily leave micromanagement of the banking sector to the RBI
Dr KC Chakrabary, deputy governor of Reserve Bank of India (RBI) while speaking in the capital on 26th July at an Assocham Conference on Financial Frauds, very rightly rued – “Many of the frauds are wrong sanctions at the highest level of banks. The problem is, we are not able to take definite action in definite period. Banks are indifferent to monitoring large frauds and whatever fraud reporting was happening, was in silos. Some of the reporting in large transactions happened only after they had been recognized as NPAs (non-performing assets)… While the numbers have not gone up significantly, the quantum has increased manifold… Loan-related frauds are a major concern for the RBI. Over the last ten years, there have been 1.77 lakh frauds, amounting to Rs31, 400 crore. In the last 25 years, 61 fraud cases involving Rs50 crore or more have happened through 208 bank accounts and accounted for a whopping Rs13,000 crore. When the times are good, the rich steal. When the times are bad, the poor also steal. But this means that the rich are stealing more.”
This was amply substantiated by the Hindu Business Line study of companies’ latest balance sheets of top distressed debts of banks (Rupees in crores):-
At the meeting of public sector banks and financial institutions on 4 July 2013, the RBI asked the banks to focus on the top defaulters and take action against them. About 30 top non-performing accounts form bulk of bank NPAs – gross NPAs (GNPAs) of banks rose to 39.7% from 34.5% a year ago. For nine public sector banks, GNPAs have gone up by more than 50%, for those of SBI group and PNB have crossed 4%, the GNPAs as a percentage of gross advances has gone up to 3.78% from 2.32%.
In the west, post-Lehman brothers, new financial jargons like bailout for stressed assets have come up. But here in India, they are termed as Non Performing Assets or NPAs, both meaning the same-bad or irrecoverable loans/ debts by whatever name called.
Moneylife had carried a cover page report and a series of articles on bad loans, done by a veteran banking analyst. I wish to add another angle to the analysis, arising out of my experience of over four decades as a Central Statutory Auditor on RBI’s Panel, auditing major banks, both domestic and foreign.
On 16 December 2012, Dr Chakrabarty, the senior most deputy governor in charge of Banking Supervision and a former CMD of a PSB, in an interview to PTI rightly lamented, “Knowingly, you give money to some unviable projects. In many cases, our PSBs have forgotten to say ‘no’, except to small borrowers…The agricultural loans are not as bad as loans to big corporates. The poorer borrowers are subsidizing the rich. It is not the small borrower who is a threat to banking -his track-record is much better than the larger ones. So long as corporates can pay, they all deal with private sector and foreign banks. But when they are vulnerable, they come to the state-run banks. Unfortunately, a combination of factors is responsible for this. Fundamentally, it is a structural and governance issue. The problem of rising bad debts can be attributed to poor administration and low risk management practices.” He cited examples of the PSBs taking bad decisions that resulting in stressed assets and said that lower risk assessment capabilities in comparison to their counterparts in the private sector and foreign banks is their fundamental problem.
In March 2013, the finance minister informed the Lok Sabha that bad loans amounting to Rs68,000 crores were up, to nearly 7,300 accounts by end-March 2012. Leading the pack were SBI, PNB, IDBI Bank and BoI. A financial journalist rightly reported that the data given in support of statements made in the Parliament does not support the statements. The FM’s Parliamentary statement mentioned mechanisms for early detection of signs of distress, prompt restructuring of viable accounts and a loan recovery policy. This includes norms for permitted sacrifice, waiver and other factors like monitoring of write-offs, waiver cases and valuation of securities including collaterals.
It needs to be pointed out that no bank loan goes bad overnight, but happens over a longer period. Some of them commence at the sanction and disbursement stages, to begin with. Loans and Lines of Credit are inadequately and badly appraised, approved by the topmost management and are pushed down to disbursing branches with orders to proceed without proper documentation, securities and guarantees. When they do go sour, inadequacies crop up but it is too late to enforce recovery proceedings effectively. This gives the defaulting borrowers an upper hand.
Next, laxities in monitoring processes followed at the branch level play their role- the incipient bad borrowings arise more out of the branch officials’ negligence towards acting promptly to the red signals, leading to irregularities- borrowers exceeding drawing powers and not submitting inventory or debtors security statements, being one example. If only the branch had curbed them and also reported to the controlling authorities, all these could have been taken as warning signals of impending NPAs. Branches tend to take such operational irregularities lightly, only to wake up when the outstandings mount.
The RBI Panel under its executive director, B Mahapatra, in its report, observes that restructuring amounts to an ‘event of impairment’ irrespective of whether it is asset classification or not, undergoes a downgrade. It has rightly recommended that all loans that are subjected to restructuring should be classified as NPAs, since they are already Sub-standard. This is particularly true when restructuring requires banks to grant concessions like substantial reductions in interest rates, moratorium or elongation of repayment schedule, part waiver of principal and/or interest or converting debt into equity at inflated values a la Kingfisher. There is absolutely no valid justification to make any such distinction that obfuscates the underlying problem of mounting bad debts!
When internationally accepted accounting standards treat restructured advances as impaired, there is no reason for the Indian banking system to deviate from the internationally accepted prudential accounting practices, primarily from the transparency perspective.
The RBI’s suggestion of a two-year “Regulatory forbearance” for withdrawing standard classification benefits has had a change for the better. By recognizing these loans as NPAs, we have kept up with prudent and accepted international accounting practices.
The banks’ statutory auditors, in helping the bank managements to window dress their annual accounts to overstate the profits for the year, have, in my considered opinion, wrongly misinterpreted the RBI guidance for deferrals. This is equally applicable to the RBI guidelines for recognizing and providing for the accrued gratuity and pension liability. The bank auditors are under a wrong impression that they can get away by merely stating in their auditors’ report - “Without qualifying our opinion/report, we draw attention to Note...” This is no qualification, as it does not explicitly state that the liability did and does exist on the date of the balance sheet and that not providing for it impacts the profits for the current year. The RBI’s advisory merely directs them to defer it over a period of time and in no way absolves them from providing for and disclosing the liability from subsisting and existing. The RBI, the banking regulator and the Institute of Chartered Accountants of India (ICAI), the accounting regulator, ought to review this unhealthy practice of window dressing that only results in overstating the profits. The regulatory forbearance certainly cannot exceed its brief!
In the two years between March 2009 and March 2011, the gross NPAs of our banks shot up from around Rs68,000 crore to Rs94,000 crore. By bringing in so-called restructuring, NPAs had wrongly been classified as standard. They have actually soared from just over Rs60,000 crore to almost Rs1.07 lakh crore. According to a statement laid on Lok Sabha in March 2013, gross NPA in 7,295 accounts rose to over Rs1 crore in March 2013 from Rs68,262 crore in March 2012. In March 2011, the figure for 4,589 accounts has risen to Rs34,633 crore from Rs26,629 crore for 4,099 accounts in March 2010.
The Sick Industrial Companies Act (SICA) has been on the statute books for long. Companies are invariably rendered sick by the promoters who themselves continue to remain hale and hearty having skimmed the cream from bank funding. Bankers have been dealing with them with kid gloves, hesitating to make demands on large industrial chronic defaulters. The Securitization & Reconstruction of Financial Assets & Enforcement of Security Interest Act 2005 (SARAESI) empowers lending banks to seize mortgaged assets of recalcitrant borrowers to realise the best prices without having to resort to court sanction. It is most commonly applied to small-time borrowers, who have defaulted on EMIs for home loans, vehicles loans and small time traders-it tantamount to using a sledge hammer to swat a fly and not touch the large chronic defaulters like Kingfisher Airlines.
The big-ticket defaulters manage to keep out bank attachment orders by obtaining court stay orders. This is simply because the banks and the RBI are found to be speaking with forked tongues. They blow hot and cold at the same time and are caught pussyfooting – a case of willing-to-push-but-afraid-to-hurt attitude, not touching big guns, but attaching tiny factory owners or traders. This proves right the good old Hindi adage – Hathi janey dega, magar doom pakad ke baitega - translated letting the elephant pass through only to cling on to its tail.
The standard of toughness of recovery proceedings are high with small retail borrowers, where flats and vehicles are attached with ease. The banks’ attitude generally signifies when one small entity borrows a couple of lakhs from a bank, the borrower will be in trouble, but when one big ticket borrows crores, it is the bank which is in trouble. Banks mollycoddle the big time borrowers to collect their dues.
To minimize NPAs, the RBI needs to direct the banks to put in place, tough measures of going for the defaulters’ jugular. Personal guarantees and not dud corporate guarantees should be insisted upon and the promoter-directors of public companies should also be called upon to sign personal guarantees, similar to what is followed for private unlisted entities. This is because the promoter clan takes the company stakeholders and bankers for a ride after collecting money from IPOs. They should be required to bring in margin money in hard cash and not by pledging shares of group companies and/or providing their equally dud corporate guarantees. They should be asked to cough up not less than 25% of the value of the diminution in the value of securities and/or 10% of the sanctioned limits, before considering any rescheduling / rescue act. The end use of the borrowed money has to be strictly monitored to ensure there is no misuse thereafter.
The rising NPAs call for strong arm-twisting. The RBI should call upon all banks to furnish a listing of their top 100 defaulters with a brief on their ages, causes and steps initiated to effect recoveries. The banks and RBI should make available the listing along with the progress report on the reduction or otherwise, on their websites. Most of the defaulters would be big names with strong pull, right up to the Ministry of Finance, capable of pulling all strings to keep action at bay. The banks should not stop short of opting for strong coercive proceedings under the securitization laws rather than yield to the mirage of corporate debt restructuring.
If NPAs are not curbed effectively, it will not be long before India heads the Greek route. The Ministry of Finance has to necessarily leave the micromanagement of the banking sector to the RBI.
This oversight task is best assigned to Dr YV Reddy, the tough acting former RBI Governor!
(Nagesh Kini is a Mumbai based chartered accountant turned activist.)
In state after state that has tried to ban payday and similar loans, the industry has found ways to continue to peddle them
A version of this story was co-published with the St. Louis Post-Dispatch.
In 2008, payday lenders suffered a major defeat when the Ohio legislature banned high-cost loans. That same year, they lost again when they dumped more than $20 million into an effort to roll back the law: The public voted against it by nearly two-to-one.
But five years later, hundreds of payday loan stores still operate in Ohio, charging annual rates that can approach 700 percent.
It’s just one example of the industry’s resilience. In state after state where lenders have confronted unwanted regulation, they have found ways to continue to deliver high-cost loans.
Sometimes, as in Ohio, lenders have exploited loopholes in the law. But more often, they have reacted to laws targeted at one type of high-cost loan by churning out other products that feature triple-digit annual rates.
To be sure, there are states that have successfully banned high-cost lenders. Today Arkansas is an island, surrounded by six other states where ads scream “Cash!” and high-cost lenders dot the strip malls. Arkansas’ constitution caps non-bank rates at 17 percent.
But even there, the industry managed to operate for nearly a decade until the state Supreme Court finally declared those loans usurious in 2008.
The state-by-state skirmishes are crucial, because high-cost lenders operate primarily under state law. On the federal level, the recently formed Consumer Financial Protection Bureau can address “unfair, deceptive or abusive practices,” said a spokeswoman. But the agency is prohibited from capping interest rates.
In Ohio, the lenders continue to offer payday loans via loopholes in laws written to regulate far different companies — mortgage lenders and credit repair organizations. The latter peddle their services to people struggling with debt, but they can charge unrestricted fees for helping consumers obtain new loans into which borrowers can consolidate their debt.
Today, Ohio lenders often charge even higher annual rates (for example, nearly 700 percent for a two-week loan) than they did before the reforms, according to a report by the nonprofit Policy Matters Ohio. In addition, other breeds of high-cost lending, such as auto-title loans, have recently moved into the state for the first time.
Earlier this year, the Ohio Supreme Court agreed to hear a case challenging the use of the mortgage law by a payday lender named Cashland. But even if the court rules the tactic illegal, the companies might simply find a new loophole. In its recent annual report, Cash America, the parent company of Cashland, addressed the consequences of losing the case: “if the Company is unable to continue making short-term loans under this law, it will have to alter its short-term loan product in Ohio.”
Amy Cantu, a spokeswoman for the Community Financial Services Association, the trade group representing the major payday lenders, said members are “regulated and licensed in every state where they conduct business and have worked with state regulators for more than two decades.”
“Second generation” products
When unrestrained by regulation, the typical two-week payday loan can be immensely profitable for lenders. The key to that profitability is for borrowers to take out loans over and over. When the CFPB studied a sample of payday loans earlier this year, it found that three-quarters of loan fees came from borrowers who had more than 10 payday loans in a 12-month period.
But because that type of loan has come under intense scrutiny, many lenders have developed what payday lender EZCorp chief executive Paul Rothamel calls “second generation” products. In early 2011, the traditional two-week payday loan accounted for about 90 percent of the company’s loan balance, he said in a recent call with analysts. By 2013, it had dropped below 50 percent. Eventually, he said, it would likely drop to 25 percent.
But like payday loans, which have annual rates typically ranging from 300 to 700 percent, the new products come at an extremely high cost. Cash America, for example, offers a “line of credit” in at least four states that works like a credit card — but with a 299 percent annual percentage rate. A number of payday lenders have embraced auto-title loans, which are secured by the borrower’s car and typically carry annual rates around 300 percent.
The most popular alternative to payday loans, however, are “longer term, but still very high-cost, installment loans,” said Tom Feltner, director of financial services at the Consumer Federation of America.
Last year, Delaware passed a major payday lending reform bill. For consumer advocates, it was the culmination of over a decade of effort and a badly needed measure to protect vulnerable borrowers. The bill limited the number of payday loans borrowers can take out each year to five.
“It was probably the best we could get here,” said Rashmi Rangan, executive director of the nonprofit Delaware Community Reinvestment Action Council.
But Cash America declared in its annual statement this year that the bill “only affects the Company’s short-term loan product in Delaware (and does not affect its installment loan product in that state).” The company currently offers a seven-month installment loan there at an annual rate of 398 percent.
Lenders can adapt their products with surprising alacrity. In Texas, where regulation is lax, lenders make more than eight times as many payday loans as installment loans, according to the most recent state data. Contrast that with Illinois, where the legislature passed a bill in 2005 that imposed a number of restraints on payday loans. By 2012, triple-digit-rate installment loans in the state outnumbered payday loans almost three to one.
In New Mexico, a 2007 law triggered the same rapid shift. QC Holdings’ payday loan stores dot that state, but just a year after the law, the president of the company told analysts that installment loans had “taken the place of payday loans” in that state.
New Mexico’s attorney general cracked down, filing suits against two lenders, charging in court documents that their long-term products were “unconscionable.” One loan from Cash Loans Now in early 2008 carried an annual percentage rate of 1,147 percent; after borrowing $50, the customer owed nearly $600 in total payments to be paid over the course of a year. FastBucks charged a 650 percent annual rate over two years for a $500 loan.
The products reflect a basic fact: Many low-income borrowers are desperate enough to accept any terms. In a recent Pew Charitable Trusts survey, 37 percent of payday loan borrowers responded that they’d pay any price for a loan.
The loans were unconscionable for a reason beyond the extremely high rates, the suits alleged. Employees did everything they could to keep borrowers on the hook. As one FastBucks employee testified, “We just basically don’t let anybody pay off.”
“Inherent in the model is repeated lending to folks who do not have the financial means to repay the loan,” said Karen Meyers, director of the New Mexico attorney general’s consumer protection division. “Borrowers often end up paying off one loan by taking out another loan. The goal is keeping people in debt indefinitely.”
In both cases, the judges agreed that the lenders had illegally preyed on unsophisticated borrowers. Cash Loans Now’s parent company has appealed the decision. FastBucks filed for bankruptcy protection after the judge ruled that it owed restitution to its customers for illegally circumventing the state’s payday loan law. The attorney general’s office estimates that the company owes over $20 million. Both companies declined to comment.
Despite the attorney general’s victories, similar types of loans are still widely available in New Mexico. The Cash Store, which has over 280 locations in seven states, offers an installment loan there with annual rates ranging from 520 percent to 780 percent. A 2012 QC loan in New Mexico reviewed by ProPublica carried a 425 percent annual rate.
“Playing Cat and Mouse”
When states — such as Washington, New York and New Hampshire — have laws prohibiting high-cost installment loans, the industry has tried to change them.
A bill introduced in Washington’s state senate early this year proposed allowing “small consumer installment loans” that could carry an annual rate of more than 200 percent. Though touted as a lower-cost alternative to payday loans, the bill’s primary backer was Moneytree, a Seattle-based payday lender. The bill passed the state senate, but stalled in the house.
In New Hampshire, which banned high-cost payday loans in 2008, the governor vetoed a bill last year that would have allowed installment loans with annual rates above 400 percent. But that wasn’t the only bill that high-cost lenders had pushed: One to allow auto-title loans, also vetoed by the governor, passed with a supermajority in the legislature. As a result, in 2012, New Hampshire joined states like Georgia and Arizona that have banned triple-digit-rate payday loans but allow similarly structured triple-digit-rate auto-title loans.
Texas has a law strictly limiting payday loans. But since it limits lenders to a fraction of what they prefer to charge, for more than a decade they have ignored it. To shirk the law, first they partnered with banks, since banks, which are regulated by the federal government, can legally offer loans exceeding state interest caps. But when federal regulators cracked down on the practice in 2005, the lenders had to find a new loophole.
Just as in Ohio, Texas lenders started defining themselves as credit repair organizations, which, under Texas law, can charge steep fees. Texas now has nearly 3,500 of such businesses, almost all of which are, effectively, high-cost lenders. And the industry has successfully fought off all efforts to cap their rates.
Seeing the lenders’ statehouse clout, a number of cities, including Dallas, San Antonio and Austin, have passed local ordinances that aim to break the cycle of payday debt by limiting the number of times a borrower can take out a loan. Speaking to analysts early this year, EZCorp’sRothamel said the ordinances had cut his company’s profit in Austin and Dallas by 90 percent.
But the company had a three-pronged counterattack plan, he said. The company had tweaked the product it offered in its brick-and-mortar outlets, and it had also begun to aggressively market online loans to customers in those cities. And the industry was pushing a statewide law to pre-empt the local rules, he said, so payday companies could stop “playing cat and mouse with the cities.”
Jerry Allen, the Dallas councilman who sponsored the city’s payday lending ordinance in 2011, said he wasn’t surprised by the industry’s response. “I’m just a lil’ ol’ local guy in Dallas, Texas,” he said. “I can only punch them the way I can punch them.”
But Allen, a political independent, said he hoped to persuade still more cities to join the effort. Eventually, he hopes the cities will force the state legislature’s hand, but he expects a fight: “Texas is a prime state for these folks. It’s a battleground. There’s a lot of money on the table.”
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