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The 'O' word Mr Rajan won't utter

July 04, 2016 11:02 IST
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The single most important issue in public sector banks is corruption, flowing from government ownership, for which nobody is accountable. RBI knows this better than anyone else, says Debashis Basu.

On June 22 Reserve Bank of India Governor Raghuram Rajan gave a speech at Bengaluru, which defended his interest-rate policy.

With his characteristic data-driven approach, he showed that it was not high interest rate that held back bank lending.

Private sector banks continued to lend and even the lending of public sector banks (PSBs) to consumers was strong.

Only the lending by PSBs to businesses is down, he explained with numbers. However, while discussing the problems of PSBs, his speech soon slipped into impressionistic arguments. According to Mr Rajan, “a number of these loans” (he does not say what proportion of bad loans) were made in 2007-2008, at the zenith of economic boom.

“It is at such times that banks make mistakes … Indeed, sometimes banks signed up to lend based on project reports by the promoter’s investment bank, without doing their own due diligence. One promoter told me about how he was pursued then by banks waving chequebooks, asking him to name the amount he wanted. This is the historic phenomenon of irrational exuberance, common across countries at such a phase in the cycle.”

  • Mr Rajan hangs an academic explanation of this startling anecdote on the general feature of cyclical booms. It is too benign and only raises many questions. A small sample:
  • Why were private sector banks not running amuck chasing private sector promoters with dubious projects?
  • Bankers are supposed to be sober people. PSB employees are government officers without much of an incentive to lend or to recover. What drove these officers to chase the promoters waving chequebooks?
  • Since it was a time of extraordinary boom when mistakes happen, what was the role of RBI’s banking supervisors and RBI’s nominee directors on PSB boards when bankers were being irrational?
  • Y V Reddy, as the RBI governor was alarmed at the irrational exuberance and did his best to dampen it. If, in spite of repeated RBI warnings and risk-control measures, PSBs went berserk and lent irrationally, isn’t there a huge fundamental issue somewhere that Mr Rajan has avoided talking about?

    The answer to all these questions is simple: corruption flowing from government ownership.

But Mr Rajan’s 4,000-word speech did not once mention the word ‘ownership’.

Indeed, Mr Rajan goes on to blame several peripheral factors for the ballooning bad loans: increasingly unrealistic demand projections, “governance problems”, fear of investigation which slowed down bureaucratic decision-making in Delhi, and slow permissions for infrastructure projects.

This led to project cost overruns and industrialists became increasingly unable to service debt, he explains.

Mr Rajan’s narration of events and analysis contradicts what the RBI itself has argued in the past - in my view, correctly.

In a paper, titled ‘Management and Governance Issues in Public Sector Banks’ presented to the government in March 2014, the RBI had said that the sharp rise in bad loans cannot be just because of the downturn in the economy. It blamed PSBs for the problem. As always, data shows us the way.

The ratio of gross non-performing assets to total loan book rose from 6.8 per cent in 2009 to 12.1 per cent in 2013.

In the same period, the ratio for new private banks fell from 6.6 per cent to 5.3 per cent. Why? The ‘O’ word again.

The finance ministry argued back that most private banks had stopped lending after the global financial crisis in 2008 and so PSBs emerged as the only providers of big-ticket loans.

Who asked them to collectively do this patriotic duty? The majority owner. It was the government’s instructions to provide financial support to manufacturing and infrastructure companies in order to give a boost to the economy, argued the ministry.

In short, unlike what Mr Rajan argues, they were not dealing with a downturn. India’s economic growth was actually strong in the 2010-12 period and they were “supporting” that growth.

But owners’ instructions to support dubious projects for growth is still a small part of the story. No PSB officer will lose his job if he refuses to back an unviable project.

The single most important issue in PSBs is corruption, flowing from government ownership, for which nobody is accountable. RBI knows this better than anyone else.

Mr Rajan did come somewhat close to discussing corruption, but superficially.

He said: “I am not saying that there was no malfeasance…cases such as those where undue influence was used in getting loans, or where actual fraud has been committed by diverting funds out of a company… I am saying that, typically, there were factors other than malfeasance at play, and a number of genuine committed entrepreneurs are in trouble, as are banks that made reasonable business decisions given what they knew then.”

Unfortunately, once again, there is no data here. This is glittering generality. Arguments like this can be made for or against any issue.

PSBs occupy more than 70 per cent of the banking space and contribute substantially to financial frictions.

Customers are unhappy with the services they get and PSBs need periodic recapitalisation because they create huge bad loans through inefficient and corrupt lending practices.

A public intellectual who has spoken his mind about many peripheral issues, would have done us a favour by pointing a finger, backed by data, at where the real blame lies for this huge mess: government ownership.

The writer is the editor of www.moneylife.in.

Photograph: Manjulkumar/Wikimedia Commons

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