File photograph of Raghuram Rajan, former governor of the Reserve Bank of India. (Photographer: David Paul Morris/Bloomberg)  

Rajan Blames ‘Over-Optimistic Bankers’, Slow Growth For India’s Bad Loans

Over-optimistic bankers, a slowdown in government decision making process and moderation in economic growth mainly contributed to the mounting bad loans, Former Reserve Bank of India Governor Raghuram Rajan said in a note to the Parliamentary panel.

“A variety of governance problems such as the suspect allocation of coal mines coupled with the fear of investigation slowed down government decision making in Delhi, both in the UPA and the subsequent NDA governments,” Rajan said in a note to the Chairman of Estimates Committee Murli Manohar Joshi. Project cost overruns escalated for stalled projects and they became increasingly unable to service debt, he said.

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Rajan said that the continuing travails of the stranded power plants, even though India is short of power, suggest that government decision making has not picked up sufficient pace to date. A larger number of bad loans were originated between 2006 and 2008 when economic growth was strong, and previous infrastructure projects such as power plants had been completed on time and within budget, the former central banker added.

It’s at such times that banks make mistakes. They extrapolate past growth and performance to the future. So, they are willing to accept higher leverage in projects, and less promoter equity. Indeed, sometimes banks signed up to lend based on project reports by the promoter’s investment bank, without doing their own due diligence.
Raghuram Rajan, Former RBI Governor

Citing an example, he said “one promoter told me about how he was pursued then by banks waving cheque books, 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, Rajan said.

Growth does not always take place as expected and the years of strong global growth before the 2008 financial crisis were followed by a slowdown, which extended even to India, showing how much more integrated the country had become with the world, Rajan said.

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He said that strong demand projections for various projects were shown to be increasingly unrealistic as domestic demand slowed down. He also pointed to the loss of promoter and banker interest for the rise in non-performing assets.

Clearly, bankers were overconfident and probably did too little due diligence for some of these loans. Many did no independent analysis, and placed excessive reliance on SBI Caps and IDBI to do the necessary due diligence. Such outsourcing of analysis is a weakness in the system, and multiplies the possibilities for undue influence.
Raghuram Rajan, Former RBI Governor

On the steps required to prevent recurrence of rising bad loans, Rajan suggested that there's need for improving governance of public sector banks and process of project evaluation and monitoring to lower the risk of project non-performing assets. Besides, he also made a case for strengthening the recovery process and distance public sector banks from the government.

The Parliament's Committee on Estimates had invited Rajan to brief it on the matter after former Chief Economic Advisor Arvind Subramanian praised him for identifying the NPA crisis and trying to resolve it.

Rajan, who was RBI governor for three years till September 2016, is currently the Katherine Dusak Miller Distinguished Service Professor of Finance at Chicago Booth School of Business.