Regulators Should Think Twice Before Busting India's Banks
(Bloomberg) -- India seems intent on cleaning up a banking sector that’s plagued by bad loans and high-profile scams. The question is how damaging the cure will turn out to be.
On Monday, federal investigators went after Usha Ananthasubramanian, currently the head of state-run Allahabad Bank, filing formal charges over her alleged involvement in a multi-billion dollar fraud involving celebrity jeweler Nirav Modi. She’s accused of not sufficiently implementing central bank rules on inter-bank transfers while at Punjab National Bank — also state-run — thus allowing officials there to divert some $1.8 billion to Modi and his associates.
What’s really causing palpitations in bank boardrooms across India, though, is the Reserve Bank of India’s crackdown on public-sector banks that are carrying too many bad debts. One, Dena Bank, has already been told that it should stop lending and hiring. More may follow. The books of as many as 11 of the 21 state-controlled banks look shady enough to draw the RBI’s wrath.
Such punishments would in effect shut down a good portion of the Indian banking sector. After all, what’s a bank that can’t lend or grow? In the age of mobile phones, no one needs a bank merely to take deposits and dump them into government securities.
Both Ananthasubramanian’s indictment and the tightening noose around state-owned banks could be considered welcome signs that bad habits aren’t going to be tolerated any longer. The picture, however, isn’t so clear-cut. One of India’s most prominent female bankers, Ananthasubramanian oversaw Punjab National Bank only from 2015 to 2017; by then, the con job run by mid-level officials had been in place for years. She could be forgiven for feeling like she’s being made a scapegoat.
Worse, the charges against her appear to reflect yet another iteration of a dreadful Indian disease: the tendency to under-regulate and then over-punish. For years, the RBI sent out querulous notes about how best to supervise inter-bank transfers. Very few banks responded with internal reforms. In one of them, fraud took place. And now, in response to a public outcry, the cops have turned up and demanded to arrest everyone from the chairperson on down.
This is the kind of thing that rightly gets bankers worried and makes them decide that scrupulously adhering to a long and contradictory rulebook is the safest course of action. Even junior bankers will now wonder: Should I lend to anyone on the basis of a relationship with them if I can be arrested for that decision in a few years?
As for blocking banks from lending, it’s absolutely true that state-owned banks have been massively mismanaged in India. In many of them, crony capitalism reigns supreme: They lend money to politically connected businesses and lose it. In all of them, the demands of their primary shareholder — the government — are prioritized over the returns of deposit-takers.
State-owned banks are thus forced to lend to dangerous or risky sectors, such as small-scale agriculture, for political reasons. Then they have to deal with the fallout when the government forgives those loans in hopes of winning farmers’ votes. These banks arguably should have been shut down ages ago.
But if state-owned banks aren’t going to be lending any more, who will? In India, companies depend almost entirely on bank finance. Perhaps larger conglomerates will be able to borrow abroad. Most small and medium enterprises, however, are still dependent on bank credit — particularly from state-owned banks, since private-sector banks tend to avoid lending to companies.
That supply of credit has already been shrinking as banks deal with provisioning for their bad assets; last financial year, personal loans represented 96 percent of new bank advances. Now that the RBI is cutting off banks and the cops are intimidating bankers, there’s not much chance that credit growth will recover sufficiently to support India’s nascent growth revival.
Nor are there many alternative sources of funding. It’s not as if India has a real corporate bond market; the government borrows so much that the selling and buying (mostly by state banks) of government securities has pretty much crowded out corporate bonds. Few companies have the sort of cash on hand that would allow them to make big, economy-shifting investments.
So, before they celebrate the demise of India’s scandal-marred banks, Indians might want to ask: What’s going to take their place?
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