Lack of liquidity, dodgy loans and the lack of a central government guarantee is a sure fire recipe for a collapse. The question is not whether there will be more runs on small banks like Jiangsu Shenyan Rural Commercial Bank. The question is whether there will be enough of them to metastasize and affect the entire Chinese financial system
Recently something happened that should not have. A bank in China experienced a run. Last month, China had its first bond default. Now rumours started that the Jiangsu Shenyan Rural Commercial Bank was on the verge of collapse. Lines formed outside one of its branches as depositors were desperate to withdraw funds.
The bank did all it could to reassure depositors. It promised to operate 24 hours to serve customers. It piled up stacks of money in the windows to prove it was solvent. The governor of Shenyang County, north of Beijing, promised the depositors that their money was safe. Finally the People’s Bank of China (PBOC) stepped in to assure that they would back up the bank.
The immediate crisis passed, but the problems still persist. The customers of the bank did have cause for concern. A few local credit cooperatives and loan guarantee companies have gone bust in Shenyang this year. They lost a total of Rmb 80 million ($13 million).
It would be easy to brush aside the bank run and the collapse of some lightly regulated rural credit companies. You could look at it as a purely local problem due to mismanagement. It could be dismissed as a tiny part of a much greater whole. Shenyang Bank managed only Rmb 12 billion ($2 billion). This represents just 0.01% of the total assets in the Chinese banking system.
If the problems were merely limited to one town and one bank, there wouldn’t be a cause for concern. But it isn’t. The troubles at Shenyang bank are just the most recent sign of a financial system under stress.
The stress is neither local nor small, because it stems from the same cause. Like every other government, China’s reaction to the 2009 recession was to provide massive stimulus. Unlike other governments, China did not use taxpayer money. It put lending quotas on state owned banks mandating loans mostly to local governments and state owned industries.
But there was another problem. The recession threw 20 million migrant labourers out of work. Unemployed workers returning back to their villages might have caused social unrest. So, the Chinese government, needed a way to get the stimulus money out into rural areas.
In 2009, there were only 100 rural banks, seven rural lending companies and 11 credit cooperatives in China. The number of banks increased ten folds to 1,027 by 2011. The number of rural cooperatives exploded to about 5,000 today. Firms originally began as micro lenders were allowed to become banks, if their non-performing loan ratio was under 2%, and they had profits for two years. In addition, the Ministry of Finance provided subsidies of 2% to healthy rural banks. Since this is China, these new banks provided loans to the lowest levels of local governments.
The rural lending institutions not only proliferated, they grew far faster than their urban counterparts. While the five largest state owned banks, Bank of China, Agricultural Bank, ICBC, China Construction Bank, and Bank of Communications, grew by 270% over the past ten years, the rural banks grew at 440%. They now make up 10% of the total Chinese financial system.
Like other Chinese financial institutions, the rural banks lent to local governments, but ultimately to the wrong local governments. The rural cooperatives and banks provide the bulk of credit to hundreds of millions of local farmers, but they also have close ties to financially strapped local governments below the provincial level. Many of these loans were made again as part of the 2009 stimulus packages. As the loans come due, many of these smaller government entities will have difficulty repaying.
The problem was highlighted by a regulation issued 8th March by the China Banking Regulatory Commission (CBRC). The CBRC’s latest regulation prohibits rural banks from providing fresh funding either directly to local governments or by purchasing investment vehicles issued by them including bonds, bills or trust products. This is going to be a major problem for the local governments since many will need to refinance those loans to keep current.
The size of these rural lenders and their main clients increases exponentially, the probability that they will be allowed to fail. The central government would certainly bail out a large national lender. The top 30 banks might be able to rely on provincial governments. But the smallest lenders are probably out of luck.
But problematic loans are not the only issue that concerns rural banks. They also have problems with the other side of the equation: deposits. Qichun County is in the province of Hubei near the city of Wuhan. It is rural county and its economy is based on growing herbs. It has a population of 1.03 million, but only a fraction of the population still farms. About 80% of the working age population migrates to the coastal cities in Guangdong and Fujian. They don’t bank at the local banks in Qichun. They have debit cards issued from banks in large coastal cities, which allow them to transfer funds back home. The local banks also do not have savings books products.
Without a steady deposit base, rural banks have to rely on the interbank market. The rates in this market have been exceptionally volatile since the People’s Bank of China (PBOC) started tightening interest rates last year.
The interbank market is far more expensive for the rural banks. It is partially funded by new money market products provided by Yu’E Bao, or “Leftover Treasure”. Yu’E Bao was created by internet giants like Alibaba. It’s growth exploded. It now has 81 million depositors and Rmb 500 billion ($81 billion) assets under management. The reason is simple. It gives savers 6% far above the 3.3% capped interest provided by the state banks. Rural banks therefore can tap the interbank markets, but at interest rates that eat into their margins. They cannot take advantage of the capped rates that help subsidize the large state banks.
Lack of liquidity, dodgy loans and the lack of a central government guarantee is a sure fire recipe for a collapse. The question is not whether there will be more runs on small banks like Jiangsu Shenyan Rural Commercial Bank. There will be. The question is whether there will be enough of them to metastasize and affect the entire financial system.
(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first-hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages.)
RBI must reconsider the present applicants and, possibly, have specific discussions in areas of operation and how soon they can achieve the goal of ensuring opening of branches and making available banking operations in small villages and towns, across the country
After a nine month wait, the Reserve Bank of India (RBI) delivered two babies in the form of approvals, for IDFC and Bandhan Financial Services to start private banks. This is valid for 18 months within which both institutions have to comply with all the RBI formalities, as laid down, for new banks. Once these are met, a regular banking licence will (or may?) be issued by RBI, until which time, both cannot do any "banking operations" as such!
Effectively, two new banks with "universal" banking operations may start functioning somewhere around April 2016, give or take couple of months!
IDFC (Industrial Development Finance Corporation) was set up in 1997, based on the Expert Group on Commercialization of Infrastructure Projects, by Rakesh Mohan Panel, based in Chennai, with offices now in Mumbai, Bangalore and Delhi. During the transition process, most of IDFC's assets will be transferred to the bank, which will be called: "IDFC Bank", now that the approval has been received from RBI.
From what has appeared in the press, IDFC are not likely to grow the loan book in the next 18 months! Rather, they would concentrate, in the first three years to stabilise, comply and experiment for the work ahead. In the next three years, IDFC Bank will consolidate, learn and start to prepare for scale of operations ahead; and finally three years will be spent returning to growth and retaining it.
It may be recalled that IDFC issued its initial public offering (IPO) in 2005. It employs over 500 people, and for the financial year ending March 2013 the total income is reported at Rs8,148 crore with a net profit of Rs836 crore. The gross loan book amounted to Rs56,895 crore with gross approvals at Rs26,567 crore and a disbursement of Rs17,656 crore. It is heavily concentrated in the infrastructural development projects and operates from four main cities in the country.
What about the ownership composition at the moment? Government owns 17.24% in IDFC while 51.39% is held by foreign interests. So, when the final licence to operate as a bank is issued to IDFC Bank, the stock-holding will also undergo a suitable change.
In 2003-04, both Kotak Mahindra Bank Ltd and Yes Bank Ltd were licensed to operate as private banks, and, as we know them today, they are doing well.
The current guidelines require new banks to set up at least 25% branches in unbanked rural locations with a population up to 9,999 people. For a start, as far as IDFC are concerned, they have a herculean task before them; first to make a drastic change in their outlook to cater to the needs of the “aam aadmi” by going rural. Second, by retaining the parent IDFC organization, they may continue to do infrastructure financing, which involves crores of rupees, tune themselves to finance smaller operations running to just couple of thousand rupees here and there! It will be tough going!
In so far as Bandhan Financial Services are concerned, luckily, they have the inherent advantage of being the largest microfinance institution in the country with 22% market share. Since their inception in 2001, as a credit financing operator, they have enormous experience in empowering women, who form the bulk (55 lakh) borrowers, but whose loan repayment rate of 99.5% speaks well of the organisational acumen. It appears from the press reports, that Bandhan currently sells priority sector loans to commercial banks.
However, the company currently borrows from commercial banks at 12.5% to 13% and lends it at nearly 23% to these women entrepreneurs’, who gladly pay this rate, considering the whopping rate of 200% to 300% charged by the exploiting moneylenders in the rural areas. To a great extent, Bandhan has been able to reduce this menace of moneylenders in the Eastern states in the country, where they operate extensively. Thus, as a commercial bank, they hope to obtain bank deposits at a relatively cheaper rate as this will enable them, in return, to lower their lending rates to these women, who are likely to be their main customers.
And yet, transfer of microfinance business to the proposed new bank is not going to be easy, according to Chandra Sekhar Ghosh, CMD of Bandhan, who hopes to achieve all the essential qualities of good banking by savings, credit, insurance and remittance. But for Bandhan, which currently operates in 22 States and four union territories, with 12,961 employees, it will not be a difficult task.
RBI governor Raghuram Rajan's assurance that banking licence will now be made available on tap, and that, the rest of the applicants could reapply again for RBI to consider. This assurance may be "soothing" but does not serve the purpose, which, initially, and even now stands unchanged at making "banking service" available to one and all, particularly in rural areas. About 50% to 60% of the people in the country still do not have access to banks. Even if applications to open accounts are made available in two/ three languages, these serve no purpose because of the literacy factor. Most money lenders in rural areas, apart from charging exorbitant rates, also get land-ownership documents "signed" by obtaining thumb prints (whoever has this little benefit of ownership), and for rest of the lifetime, the borrower only pays this interest, with loan capital remaining intact!
Anyway, in arriving at the conclusion that both IDFC and Bandhan are the most suitable candidates to set up banks, obviously, the Jalan committee ought to have employed a system of grading (marks?) in assessing the applications. We do not know the details, but, whatever is the methodology applied, it would appear that there would be at least a few more in the first five or seven "prospective" candidates who are also just as qualified, in terms of their integrity, approach and vision.
While, IDFC has literally a 9-year programme ahead to be able to reach its targeted clients; Bandhan has already a strong base of 55 lakh borrowers in rural areas who repayment track record is admirable. So, Bandhan has much better chance to succeed in making it possible for "banking facilities" as such to reach rural folks, sooner than later.
Based on the above premise, RBI must reconsider the present applicants and, possibly, have specific discussions in areas of operation and how soon they can achieve the goal of ensuring opening of branches and making available banking operations in small villages and towns, across the length and breadth of the country.
If five institutions are selected, simply in order of grades, with IDFC and Bandhan being No: 1 and No: 2, RBI could pick No: 3 to No: 7 and make this offer, there would be a giant step forward in making true the hope of banks reaching the rural areas in the next three years. If the intentions are to go through such longish processes, it will be probably another five-seven years before new banks can come into operation.
RBI needs to rethink on these issue, and they have economists and experts who can modify such proposals to suit the national needs!
India Post has a terrific advantage of being everywhere, but does not have the required banking expertise. Why not they be linked with someone like State Bank to be their mentor and after a 7/10 year "understudy'' experience become independent operator?
(AK Ramdas has worked with the Engineering Export Promotion Council of the ministry of commerce. He was also associated with various committees of the Council. His international career took him to places like Beirut, Kuwait and Dubai at a time when these were small trading outposts; and later to the US.)
When asked how Nilekani-led UIDAI could let foreign companies get their hands on the data, we are told that they had no means of knowing that they are foreign companies! Why, then, are there those who mourn the disintegrating and, hopefully, the demise of this project?
Here is a question for those who retain their faith in the unique identification (UID) project: what is it about the project that has them believe that it should, somehow, be salvaged?
In December 2011, the parliamentary Standing Committee on Finance (SCoF) returned the National Identification Authority of India Bill 2010, and recommended that the UID project be sent back to the drawing board. On 23 September 2013 the Supreme Court directed that no one may be denied any service only because they do not have a UID number; and, when the order was deliberately disregarded, the Court ordered the government to withdraw the instructions that made the UID mandatory. That was on 24 March 2014. On 21 February 2014, the Petroleum Ministry delinked the UID from LPG subsidy. That is, all three organs of state – the Parliament, the judiciary and the executive - have been remarkably unenthusiastic about this project.
The project was marketed as an innocuous game changer. It would provide an identity to every person, especially the poor; and that would lead to plugging leakages and curbing corruption. The touching innocence of this claim has not managed to keep off questions about the consequences of databasing an entire citizenry, the implications of not having a law that covers the project, privacy and personal security, surveillance, data security, flawed processes, unrestrained outsourcing, the unseemly ambitions it provokes in police agencies to get the data into their hands ….. the list keeps growing.
By now it is plain that the Unique Identification Authority of India (UIDAI) has had little patience with either process or law. Here are some illustrations:
The UIDAI was not established to create a database of its own. It was “to limit its activities to creation of the initial database from the Electoral Roll/ EPIC data and verification and validation of the same through BPL and PDS data and updation of electoral rolls.” This was the decision of the EGoM, which met on 4 November 2008 to decide what would be in the notification dated 28 January 2009 that set up the UIDAI. There are multiple databases within the government that carry identity information, and the UIDAI was to work at building a cleaned up identity database from existing databases. The EGoM was categorical: that the “UIDAI may not directly undertake creation of any additional database….”
Yet, once Nandan Nilekani had been appointed Chairperson of the UIDAI in July 2009, a Cabinet Committee on the UID was formed with the Prime Minister as the Chairperson, which gave him the go ahead to create his own data base, independent of other governmental data bases. First, it was allowed 100 million enrolments; then 200 million. Then in an inexplicable, and still unexplained, twist after the Home Minister had found their process faulty and unreliable, it was extended to 600 million. In the first four years, any time that either Mr Nilakeni or RS Sharma, the UIDAI’s first Director General, was asked where they got the legal authority to take the personal data of people, they would point to the 2011 notification as the source of legality for this exercise. This was, of course, not true at all. They were in fact breaching the boundaries the notification had set for them. It is also interesting that Mr Nilekani had started proclaiming, very early in the exercise, even before he had been given the mandate, that the UIDAI would enroll 600 million people by 2014.
Mr Nilekani was a man in a hurry. What resulted was rampant outsourcing, untested processes (including the introducer system), brushing aside concerns about the possibilities and improbabilities of biometrics across a population and across time, and doing away with the imperative of legality. He says he has got his 600 million people. May be. And, again, maybe not. But should such callous discarding of the process and law not matter because it was Nandan Nilekani? Should corporate icons not be restricted by law or process? These are not just rhetorical questions, but arise from the extraordinary treatment given to a collateral entrant into government.
Nandan Nilakeni used three terms to describe the UID project – unique, universal, ubiquitous. Uniqueness was dependent on biometrics. The decision to use fingerprints and iris was made before the UIDAI had any means of knowing whether biometrics could work in India. This is what they said in the “notice inviting applications for hiring of biometrics consultant” in January/ February 2010 after they had decided on fingerprints and iris: “While the National Institute of Standards and Technology (NIST) documents the fact that the accuracy of biometric matching is extremely dependent on demographics and environmental conditions, there is a lack of a sound study that documents the accuracy achievable on Indian demographics (i.e., larger percentage of rural population) and in Indian environmental conditions (i.e., extremely hot and humid climates and facilities without air-conditioning).” In fact, it went on, “we could not find any credible study assessing the achievable accuracy in any of the developing countries.”
Two years later, Mr Nilekani was to say, in his talk at the World Bank in April 2013: “nobody has done this before, so we are going to find out soon whether it will work or not”.
But Brutus is an honourable man.
If the UID number will be on a range of databases, and it can act as a bridge between different silos of information, what does it do about intrusive curiosity? This is how Nandan Nilakeni thinks the UID number should be deployed. In a conversation with Vinod Khosla, and as reported on the NASSCOM website, he said: “There can be an entire Aadhaar- based reputation system in the country”, adding that “besides a credit history, the UID number could also help build health or skills records of Indians”. And this is just the beginning.
The UIDAI says enrolment is `voluntary’ while working to make it mandatory – that will swell its data base, fast. It has gone to the Court in the cases that challenge the project and iterated and reiterated the claim that it is voluntary; but, when the Court said, okay, then we will just say that it is voluntary, the UIDAI pleaded with the Court that agencies be allowed to `insist’ on the UID.
The UIDAI sounds like it will be providing a service, but it is openly pursuing a revenue model which will profit from our data. There is talk of security of data; but the data is handed over to be managed by companies that are close to the CIA, Homeland Security and the French government. And, when asked how they could let foreign companies of such provenance get their hands on the data, we are told that they had no means of knowing that they are foreign companies!
Why, then, are there those who mourn the disintegrating and, hopefully, the demise of this project?
You may also want to read…
(Dr Usha Ramanathan is an independent law researcher and has been critically following the policy and practices of the UIDAI since 2009)