Banks Up To Tricks with Bad Loans Again?
Last month, the Reserve Bank of India (RBI) organised a conference of the directors of public sector banks (PSBs). In his inaugural address, the RBI governor made some startling comments. He said, "One of the critical areas where the role of directors is very significant is in ensuring the integrity of financial statements…We have come across instances where so-called smart accounting methods were adopted to artificially boost the financial performance of the bank."
 
What had RBI inspectors discovered? In the words of the governor, they had come across tricks "to conceal the real status of stressed loans," such as:
  • Bringing two lenders together to evergreen each other's loans by sale and buyback of loans or debt instruments.
  • Good borrowers were being persuaded to enter into structured deals with a stressed borrower to conceal the stress.
  • Use of internal or office accounts to adjust a borrower's repayment obligations.
  • Renewal of loans or disbursement of new/additional loans to the stressed borrower or related entities closer to the repayment date of the earlier loans.
  • Shockingly, RBI has also come across a few examples, where one method of evergreening, after being pointed out by the regulator, was replaced by another method, said the governor in his speech.
 
Since the governor decided to openly air these charges, I assume it is a serious issue and so I looked around for cases where banks were being punished for these transgressions. Unfortunately, I could not find any. However, I notice that RBI is imposing monetary penalties, mainly on PSBs and many cooperative banks, for various violations. 
 
Indian Overseas Bank (IOB) was fined Rs2.20 crore for non-compliance with income recognition norms, failure to make the minimum mandatory transfer of 25% of its disclosed profit to reserve fund, a divergence between non-performing assets (NPAs), as reported by it, and as assessed by the inspection. 
 
Canara Bank was fined Rs2.92 crore for non-compliance with know-your-customer (KYC) norms and not imposing limited liability on customers in unauthorised electronic transactions, opening several savings deposit accounts in the name of ineligible entities and registering dummy mobile numbers in several credit card accounts. The Bank failed to pay interest on deposits under the daily deposit scheme and prematurely withdrawn accounts, recovered SMS alert charges from the customers, and not on actual usage basis.
 
HSBC was fined Rs1.73 crore for failing to update credit information companies about expired credit cards with zero dues. Indian Bank was fined Rs55 lakh because it failed to undertake KYC measures while opening an account in the name of a sole proprietary firm, and Bank of Baroda got fined Rs30 lakh for breach of stipulated transaction limits and failure to apply prescribed interest rates on term deposits.
 
None of the fines pertain to the far more serious fraudulent activities such as evergreening or concealing bad loans, mentioned by the governor. Maybe it has still to penalise this activity.
 
One is not surprised at the attempts at evergreening; banks are prone to do it. But remember, there is a difference between private banks and PSBs. When private sector banks do it, shareholders pay a price. The stock price eventually reflects how the bank is run. Promoters are ousted and even spend time in jail. When PSBs mismanage their books, nothing happens to bank chairmen, the board of directors or complicit officials, because there have been no core reforms at PSBs. This has important implications for the system.
 
PSBs hold the bulk of people's savings and are the main source of loans to small businesses and farming and act as the main channel for delivery of government schemes, subsidies and pensions. Prudently -run, the banking business ought to make good money. And yet, PSBs have often made losses or meagre profits.
 
To keep them afloat, the government has repeatedly injected capital into these banks, using taxpayers' money. The reason they lose massive amounts of money with regularity as bad loans is because of rampant corruption in lending to dubious projects which fail.
 
The public learns about these losses when fugitives like Mehul Choksi, Nirav Modi, Jatin Mehta, Sandesaras or Vijay Mallya hit the headlines. But tens of thousands of large and small businesses have inflicted mind-boggling bad loans on PSBs.
 
In December last year, the finance minister Nirmala Sitharaman told the Rajya Sabha that scheduled commercial banks have written off Rs10 lakh crore of bad loans in five years and that only 13% of the write-off have been recovered.
 
Separately, the cumulative recovery of bad loans through the Insolvency and Bankruptcy Code (IBC) until September (since the IBC came into existence in 2016) has been just 30.8%. More than 90% of bad loans originate in PSBs. Many loans are designed to go bad. Corruption begins at the sanction stage.
 
When a case is referred to IBC, there are almost no assets left to recover. Bankers have no enforceable collateral, a cardinal sin in banking, especially so, since PSBs always lend against assets and not against cash-flows.
 
Since December 2020, the shares of the better-run PSBs have risen two-three times. There is a consensus that the worst is behind them. Recapitalisation of banks, slow absorption of bad loans in the system, plus normal growth that comes from a growing economy have led us to believe that PSBs are sailing smoothly.
 
Under the Modi government, there is less political interference; it has avoided loan melas for rich and powerful businessmen that we saw between 2005-2014 and earlier in the mid- to late-1990s but had its own loan mela called MUDRA loans.
 
Those who believe that PSBs are in the clear will get a rude shock if the external environment changes and bank officials again feel emboldened to collude with big borrowers to lend indiscriminately. The governor's speech is a timely reminder of this possibility. We would wait to see what action RBI takes to stop it.
 
After all, in the past, it has been totally ineffective, despite close supervision of banks and having directors on bank boards.
 
(This article first appeared in Business Standard newspaper)
Comments
C.George
10 months ago
Governors speech clearly indicate that RBI has come across many such instances of evergreening already. PSBs are yet to invoke adequate interest, as the suitors are always worried about their legacy accounts. Changing of central auditors every year is warranted if the banks are using their pool funds to evergreen NPAs with the support of other corporate accounts.
Kamal Garg
11 months ago
NPA is an extremely deep rotted fundamental problem with all PSBs in India. And no matter, how much you clean and clear the mess, it crops up again despite RBI Governor's warning and stern steps, etc.
Meenal Mamdani
11 months ago
Is it not possible to publicly shame the borrowers by putting the names and amounts owed in newspapers?
Perhaps any unpaid loan more than 10 crore should be dealt with in this manner.
Devara
Replied to Meenal Mamdani comment 11 months ago
I agree, but does public shaming of wrong doers work the same way as it does on Singapore? Big defaulters tend be blatant, in some cases they even show off that they could walk free after breaking law.
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