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No beating about the bush.
Bank union, AIBEA, demands that banks recover bad loans from wilful defaulters
Trade unions are usually quick to announce protests to demand higher wages or better working conditions. This time, however, the All India Bank Employees Union (AIBEA), one of the biggest employees unions in India, has decided to turn into a powerful whistleblower. On 5th December, AIBEA gave a call to ‘stop the loot of public funds’ and start recovery of bad loans. This is a welcome development. I have always held that the destruction of giant entities, such as Air India, Unit Trust of India, and giant public sector entities in telecom and engineering, is as much due to employee apathy as it is due to the loot by politicians and bureaucrats. AIBEA has signalled that it will name and shame defaulters, if necessary, to force banks to start acting tough and recover bad loans. The Reserve Bank of India (RBI), as the banking regulator, is fully aware of what is going on; but now, the unions are asking it to move from rhetoric to action. The AIBEA cites the overused quote about India having sick industries but no sick industrialists. It also quotes RBI governor, Dr Raghuram Rajan, who recently told banks, “You can put lipstick on a pig but it doesn’t become a princess. So dressing up a loan and showing it as restructured and not provisioning for it when it stops paying, is an issue. Anything which postpones a problem (rather) than recognising it, is to be avoided.” AIBEA points out that the top four bad loan accounts add up to a massive Rs22,666 crore, which include Kingfisher Airlines and Winsome Diamond and Jewellery Co. Will RBI stop the “systematic loot of public money” by recognising these as pigs with lipstick?
The data collated and released by the AIBEA is a frightening indictment of the banking regulator and the finance ministry. While the government has been boasting about India having escaped the global financial crisis, how does it explain the four-fold increase in bad loans—from Rs39,000 crore in 2008 to Rs164,000 crore today? The creation of new bad loans is a mind-boggling Rs495,000 crore, according to AIBEA. And, corporate debt restructuring through provisioning, concessions, waivers, write-offs, concessions, one-time settlements (which are done multiple times), compromise proposals, etc, add up to a massive Rs325,000 crore.
Write-offs of bad loans by PSU banks in the past seven years amount to a massive Rs140,000 crore. If we include the bad loans of private banks and foreign banks and other financial institutions, the total bad loans are more than Rs2,50,000 crore, says the AIBEA statement. Worryingly, it says, things have reached a point where management is making banks vulnerable by reducing the provisioning of bad loans. RBI has pointed out, and is aware, that the provision coverage ratio of India’s banking system has dropped from 55% to 45% as against a global average ratio of 70% to 80%.
AIBEA’s demand will resonate with depositors who are being asked to pay higher charges for every service, to ensure higher profits for banks every quarter. AIBEA, for once, is on the same side as two big stakeholders of banks—bank customers and shareholders. Clearly, the call to publish the names of defaulters, to make wilful default a criminal offence, investigate collusion between banks and borrowers and the demand not to ‘incentivise corporate delinquency’, will find huge support among ordinary people.
MSMEs being the backbone of economy have been in need of funds to grow themselves but banks have adopted an approach which has failed to meet their needs
When it comes to lending for business activities, banks tend to prefer large business entities to small players. This bias comes from the fact that big businesses have better assets and the possibility of failure of these businesses is less compared to small business enterprises. In order to gauge this preference of banks conversations with a small business enterprise, often referred to as micro, small and medium enterprises (MSMEs) says it all. For a micro and small business, to get loan from a bank is nightmare. This has been happening in spite of dedicated MSME branches set up by various banks and MSME lending being a part of priority sector lending.
RBI data in this regard is an eye opener. More than 92% MSMEs run their business on self-finance and have no source of institutional finance. The chart below shows that:
It is obvious that small businesses require funds as they have limited source of self-financed capital. Idea of schemes such as Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) came from this but somehow could not acquire acceptance from the banks in general. Though loans were given under CGTMSE, the number has been very insignificant compared to the size and scale of MSME business operations.
But this is not all.
There has been always a demand and supply gap in lending to MSMEs. MSMEs being the backbone of economy have been in need of funds to grow themselves but banks have adopted an approach which has failed to meet their needs. The chart below shows the demand supply gap which seems to be narrowing in days to come but still very sizeable by any stretch of imagination:
What is extremely surprising is that MSMEs don’t perform badly compared to the big business houses when it comes to performance on the payment of loans. The data available in this regard shows that percentage of impaired assets have been rising for medium and large business while it has been relatively stable for micro and small business.
So, there is no apparent reason for banks to show preference for large businesses as their performance on impaired asset front has been growing bad to worse. What is it that is preventing banks from lending to MSMEs? Most apparent reason is that banks to play safe and don’t want to add to their non performing assets (NPAs). The unfounded fear comes again from the fact that small business will default. But this logic gets weakened in some cases. Even in cases when credit guarantee is available through CGTMSE, banks are wary of funding of MSMEs because of the fact they don’t want any hassle in claiming guarantee benefit in event of a default by a micro or small enterprise.
Recently, while delivering a keynote address at the Training Workshop on Credit Scoring Model with support from IFC for MSE Lending in Mumbai on 29th November, Dr KC Chakrabarty, deputy governor, Reserve Bank of India (RBI) said that credit scoring model will go a long way in promoting credit facility to MSMEs. But the key question is can lack of will to fund MSMEs will addressed by a strong statistical model. There is a need to fix accountability for lack of funding of MSME business by banks. For instance every bank can be asked to offer collateral free lending first to MSMEs under CGTMSE before the bank asks for security for any lending.
Last but not the least, let MSMEs also understand their responsibility towards lending done by banks. They must act with full responsibility to ensure that loans are paid on time on them and wilful default does not become order of the day.
(Vivek Sharma has worked for 17 years in the stock market, debt market and banking. He is a post graduate in Economics and MBA in Finance. He writes on personal finance and economics and is invited as an expert on personal finance shows.)
RBI's approach on too big to fail gives more weightage to factors such as securities issued and bought by banks in India and overlooking risky assets and growing NPAs of the lenders
The financial crisis that hit the world economy at the beginning of the year 2008 was an eye opener. It showed how fragile the entire financial system was and how systemic risks arising from weakness of financial institutions could easily spill over to the real sector. The crisis also highlighted the need to have a re-look at the financial institutions and monitor risks posed by these financial institutions. Many large financial institutions, which looked infallible before financial crises, failed during the crisis giving rise to the fear that such financial institutions require closer monitoring and could pose serious systemic threat in future. With the crisis in the background, the concept of, “too big to fail” gained significance. Though the term, “too big to fail” was used in earlier crises as well, it assumed significance post-2008 crisis. Federal Reserve Chair Ben Bernanke defined the term in 2010: "A too-big-to-fail firm is one whose size, complexity, interconnectedness, and critical functions are such that, should the firm go unexpectedly into liquidation, the rest of the financial system and the economy would face severe adverse consequences.”
Basel Committee on “too big to fail”: Post financial crisis of 2008, the Basel Committee on Banking Supervision (BCBS), adopted a series of reforms to improve the resilience of banks and banking systems. In order to ensure that banking system has enough resilience, the committee started working on two key areas which included assessment methodology for globally systemically important bank and how these banks can develop additional loss absorption capacity.
BCSB came out with an indicator-based approach to identify systemically important banks. The selected indicators are chosen to reflect the different aspects of what generates negative externalities and makes a bank critical for the stability of the financial system. The advantage of the multiple indicator-based measurement approach is that it encompasses many dimensions of systemic importance, is relatively simple, and is more robust than currently available model-based measurement approaches and methodologies that only rely on a small set of indicators. The selected indicators reflect the size of banks, their inter-connectedness, the lack of readily available substitutes for the services they provide, their global (cross-jurisdictional) activity and their complexity.
As per Basel Committee’s indicator based measurement approach, 20% equal weightage has been given to five critical factors which are cross-jurisdictional activities, size, interconnectedness, substitutability and complexity which is explained in the chart below:
For each bank, the score for a particular indicator is calculated by dividing the individual bank amount by the aggregate amount summed across all banks in the sample for a given indicator.The score is then weighted by the indicator weighting within each category. Then, all the weighted scores are added. For example, the size indicator for a bank that accounts for 10% of the sample aggregate size variable will contribute 0.10 to the total score for the bank (as each of the five categories is normalised to a score of one). Similarly, a bank that accounts for 10% of aggregate cross-jurisdictional claims would receive a score of 0.05. Summing the scores for the 12 indicators gives the total score for the bank. The maximum possible total score (ie if there were only one bank in the world) is 5.
Additionally in order to find out this category of bank, BASEL approach says that banks need to be identified from list of 75 largest banks based on leverage ratio prescribed by Basel. Banks can be added in this list depending upon descretion used by national supervisor.
RBI approach on “too big to fail”: Based on the Basel approach, the Reserve Bank of India (RBI) has also decided to identify banks which are domestic systematically important. The RBI draft document says, “The banks will be selected for computation of systemic importance based on the analysis of their size (based on Basel III Leverage Ratio Exposure Measure) as a percentage of GDP. The banks having size as a percentage of GDP beyond, 2% will be selected in the sample of banks. As foreign banks in India have smaller balance sheet size, none of them would automatically get selected in the sample. However foreign banks are quite active in the derivatives market and so the specialised services provided by these banks might not be easily substituted by domestic banks. It is therefore appropriate to include a few large foreign banks also in the sample of banks to compute the systemic importance. The total assets of the banks selected for the sample would constitute 100% of the GDP. For this purpose, latest GDP figure released by Central Statistical Office, Government of India will be used”.
The broad comparison between RBI and Basel approach is given in the table below.
While cross-jurisdictional activity is considered as a key factor for determining the risks posed by globally systemically important banks, for domestic banks size has been given a higher weightage by RBI. Cross jurisdictional activity has been given a weightage by RBI in sub-indicators and it has replaced level 3 assets by cross jurisdictional factors. RBI prescribes additional capital requirements for too big to fail to banks as follows:
Apparently RBI’s approach on too big to fail gives more weightage to factors such as trading books of the banks in India. Under all three heads of interconnectedness, substitutability and complexity, the focus is more on market securities which include securities issued by the banks as well as securities which banks have purchased. The key aspect of core banking business is not explicitly mentioned. Banks in India in the current scenario face threat from rising non performing assets which pose threat to the banking operations. Risky assets in the books of most of the banks such as exposure to real estate sector or lending to various corporate also pose threat to the banking industry. The quality of assets of a bank should definitely be a key criteria in identifying too big to fail status. Also, with banks in India spreading wings across world, cross-jurisdictional liability should have been given a higher weightage.