Indian Banking Let Down By ‘Maximum Government, Minimum Governance’: Viral Acharya

Review of ‘Pandemonium – The Great Indian Banking Tragedy’, by Tamal Bandyopadhyay.

Tamal Bandyopadhyay’s much-awaited book on the Indian banking sector’s perpetually ongoing saga comes at a perfect time. Just this summer, there have been three scathing accounts laying out the fatally flawed arrangement of our banking sector and its governance. But that is now history. We seem to have moved on. Hence, the time is just right for a healthy dose of reminders. What has been happening to our banking system is not something we can so conveniently sink into oblivion; we will have to carry it as heavy baggage into the future unless with some alacrity we set out and act upon a blueprint on how to fix it.

A great storyteller always raises sharp questions for the reader’s mind. Tamal does too:

Has India let down the banking system?

Or is it the other way around?

Who killed Indian banking?

If you haven’t yet figured out the answers to these questions or have already forgotten them, I suggest you go towards the end of Tamal’s book, to Part VI – Charting the Ills – which lays out in a powerfully succinct manner why Indian banks are in a state of Pandemonium.

A Problem Of Staggering Scale

Making up for losses incurred by public sector banks has cost since 2007-08 close to Rs 4 lakh crore, whose opportunity cost (say, you invested it in the Nifty or private bank index) is estimated to be another Rs 3.5 lakh crore; in all, a whopping $100+ billion that could have been put by the public exchequer for relief and repair efforts to deal with Covid-19.

Among G-20 nations, the Indian banking sector bad loans are presently among the highest, with non-performing assets that have not yet been provided for at 8.5% of total assets! This ratio was next only to Russia’s in 2019 (and is projected as of now to be the highest among the G-20 nations in 2020). This isn’t a race we want to win but our victory gets regularly flagged at the IMF-G20 meetings.

These losses are not due to Covid-19; these are mostly from legacy assets, especially due to bad underwriting post the global financial crisis. They are showing up now as forbearance in India is embedded in bank regulation in the form of protracted recognition of losses and highly delayed provisioning for them, by as much as 4-5 years. We are simply not earnest in marking the books of our banks in a timely manner.

And amongst these losses, there are “bad, bad and ugly” contributors – seven banks have non-performing assets ratio between 15% and 28%… The sky is perhaps their limit?

State-Owned Rot

As a result of such a gargantuan quantum of losses that are not provided for, significant parts of the banking system function as chronically under-capitalised. This manifests in their slower credit growth relative to deposit growth.

Just in 2008, another Rs 2.5 lakh crore of bad loans were written off from banking sector balance-sheets. The process trickles on and keeps credit growth at anemic levels. The lion’s share of all this problem sits with public sector banks. In 2019, public sector banks held 61% of total loan advances but contributed disproportionately higher to 78% of the non-performing assets.

Private sector banks have made up for the lack of credit growth in the public sector banking system. Their market-to-book ratios on average have risen sharply, a sign of lack of adequate capital in the public banking system which creates fat intermediation margins for the private banks. This is what Tamal refers to as “privatisation by stealth”.

Incremental advances made by private banks have been 80-120% of the aggregate advances in the last three years. Incremental deposits for private banks have been 80% share of the aggregate in 2019, from being less than 20% in 2009. Incremental assets held by private banks are now at 90%-share of the aggregate in 2019, from less than 20% in 2009.

Do As You Please

With such large losses being footed by the taxpayers, others have made merry too. Fraudulent loan accounts were close to Rs 2 lakh crore in 2019-20, representing a gross failure of underwriting and monitoring of the borrowers, who likely swindled the monies or kept up with their plush lifestyles. With a surfeit of post-demonetisation funds, shadow banking has now also had its boom and bust cycle, benefiting several corporates, housing companies, and their promoters, and as a result, non-bank finance also shows slowing credit growth now.

At least some of the rating agencies appear to be engaging in the rating inflation game as so many corporate borrowers drop straight from A-AA (among the highest credit ratings) to Default status, without experiencing smooth interim downgrades.

And if all this chaos isn’t enough in itself, there is at times a stretch of three-fourth of a year when some public sector banks run around like a headless chicken without a CEO/MD!

A Monumental Failure of Governance

When you make sense of the staggering scale and play-it-again-each-year nature of this pandemonium, laid out in great detail by Tamal, you realize that it is not about a few individual banks or bankers. It is in fact about our weak institutional arrangements for governing them.

Public sector bank governance has failed miserably with each successive government since the global financial crisis. They are just a convenient credit allocation tool with disempowered boards and (at times) helpless Reserve Bank of India as their regulator. We are way short of global best-practices. Government ownership and the interference in banking practices and regulations that comes with it is the root cause of it all.

Some private banks didn’t want to be left out in contributing to the pandemonium. Hence, they have occasionally also gone rogue. Our overall credit ecosystem is so weak and the ability of CEOs to compromise their boards so strong that some such outcomes are unsurprising. While Tamal has woven the salient characters in private banking nicely into his story, the numbers described above convey an unmistakable picture that private banking as a whole has in fact been the saviour for credit growth in the economy over the past decade.

Four former RBI governors have opined in Tamal’s book with significant overlap on what needs to be done, even if they differ slightly on the specific causes. The titles of their priceless interviews are telling in themselves, and the content, as is to be expected, absolutely first-rate. These interviews make Tamal’s book unputdownable.

The Narasimham Committee reports in the 1990s and the PJ Nayak committee report in 2014 had already suggested several implementable remedies to improve the governance of public sector banks, including a dilution of the government stakes significantly below-majority. Not much has happened since except that the Department of Financial Services in the Finance Ministry which was recommended for dismantlement has instead expanded its mandate, scope, and turf.

Who Cares To Bring Change? Of Those That Do, Can They?

All this begs the question as to who, if anyone, cares about reforming our banks and their governance mechanisms on a durable basis? In parts of the world we should aspire to be or surpass, such pandemonium would raise alarm bells; owners and regulators would have sleepless nights until the underlying issues are resolved. Not in India: We are practical, we are accommodating… Golmaal hai bhai sab golmaal hai, par bhaisaab, thoda adjust kar lo!

That is the Great Indian Banking Tragedy described vividly by Tamal – no one seems to care! There is no urgency about banking reforms. The middle class is quick to point out that their deposits are safer with public sector banks. But make no mistake: Kicking the can down the road of our banking malaise is simply a giant ponzi scheme being paid or to be paid for by all of us. As losses of this scheme materialise, they are being met with even more government borrowing. To keep the cost of that borrowing low, you are earning lower deposit rates, you are paying higher taxes at the petrol pump which is generalising into a higher cost of goods all around the country, and worst of all, your children and youth down the line will bear much of the burden of this debt even though they have had absolutely no voice in shaping it.

Reading about this tragedy in Tamal’s book turned my mind to a social satire from Phir Subah Hogi, with Sahir Ludhianvi’s masterful poetry set to a lilting melody by Khayyam:

“Jo bhi hai woh thik hai, jikr kyon kare; Tu hi sab jahaan ki, phikr kyon kare

Jab use hi gham nahin, kyon humein ho gham…

Aasmaan pe hai khuda, aur zameen pe hum; Aaj kal woh is taraf, dekhta hai kam”

I thank Tamal for reminding me of such a beautifully tragic song. Its melody provides me some escapist solace as I reflect on our inability as a society to muster the courage to do the right thing even when repeatedly pointed in the right direction. Two recent governors of the Reserve Bank of India took us on the right path, but we have chosen to regress, and in the spirit of leaving no good deed unpunished, the growth slowdown is often attributed to their efforts.

In summary, I recommend the book highly. Buy it and read it every quarter until the banking pandemonium has ended. If you can, please raise your voice along the way; ask that something be done about it so you can afford to read about something else.

Tamal has provided an invaluable service by conveying his message convincingly and emphatically, not just as a banking correspondent in his columns but also as an author of so many important narratives, particularly this one. More power to him and his tribe!

Viral V Acharya is Professor of Finance at New York University Stern School of Business, author of ‘Quest for Restoring Financial Stability in India’, and former deputy governor at the Reserve Bank of India.

The views expressed here are those of the author, and do not necessarily represent the views of BloombergQuint or its editorial team.