Mystery of Indian Banking Blues
(Author: Amaan Ahmad Ansari)
This entire story will be divided
into three parts. The first part is "Fear and Growth," which will
cover the period from 2000 to 2008. The second part is "Hiding the
Baby," which covers the period from 2008 to 2013. The last part is
"Feeding the Child," which covers the period from 2013 to 2020.
Fear and Growth
In the early 2000s, the Indian market experienced
three major shocks. The first was the Ketan Parekh scam, in which Ketan
manipulated the prices of certain stocks and caused a loss estimated at over 40,000 crores. The second
shock was the burst of the dot-com bubble in 2000, which caused IT companies
all over the world to crash, including Microsoft (which crashed by 50% to 60%),
Amazon (which crashed by 90%), and Apple (which crashed by 70%). The last shock
was the collapse of the UTI mutual fund, which included their famous scheme
US64. After these incidents, it became difficult for normal citizens to trust
the market, and people began to keep their savings in banks instead of
investing in the market.
By 2008, 50.4% of household
savings were in bank deposits, which was a significant increase from 33%
between 1991 and 1997 (see fig. no.1). This increase in deposits meant that banks had a large
amount of money to lend, which led to fast lending growth. From 2001 to 2006,
lending growth increased from 17% to over 35% (see fig. no.2). Banks were lending more to the
industry, which had also increased lending overall. For example, in 2001, banks
were lending to the industry as a percentage of GDP of 10%, but in just 10
years, this figure had increased to over 20% (see fig no.3). Interestingly, non-public sector
banks were lending less to the industry compared to public sector banks.
The
reason for this lending growth was the GDP growth, which averaged 8% from 2003
to 2007. This growth was the highest since 1989, and organizations and analysts
were predicting even higher growth. However, as we all know, the financial crisis
hit in 2008, causing a significant market downturn worldwide. The Sensex in
India fell by 50% from December 2007 to December 2008.
Hiding The Baby
Due to the 2008 financial crisis,
the entire world went into recession, and there were massive layoffs seen in
the US and other major economies. During this time, Mr. Subbarao was appointed
as the Governor of RBI. In June 2008, inflation, as measured by the WPI
(wholesale price index), stood at close to 9%. The WPI helps track inflation in
industries, while CPI (consumer price index) helps measure the inflation burden
on normal citizens, and CPI is usually higher than WPI. So India's CPI
inflation for the same period in June 2008 would have definitely been higher
than 9%.
Mr. Subbarao reduced interest
rates from 9% to 5% for only three months by December 2008 to ensure liquidity
in the entire economy. Moreover, the government's fiscal deficit, which was 2.7%
in 2007-08, reached 6% in the 2008-09 budget. A fiscal deficit is a difference
between the government's revenue and expenditure. For instance, if the
government's revenue is 100 rupees, and the expenditure is 106 rupees, then the
fiscal deficit would be 6 rupees.
While all this government
spending and the era of easy money helped revive growth, it also fueled high
inflation in the economy. When interest rates were raised to control inflation,
industries' projects became unviable. Ultimately, all this came together to
create a massive amount of bad loans on the books of PSBs and banks.
In 2013, there were many issues
for overleveraged companies (companies that had taken more loans than their
capacity), such as invalid double-digit revenue growth forecasts, interest rate
hikes on loans, and a significant drop in the value of the rupee. For instance,
at the beginning of 2008, the rupee was at Rs 40 against 1 dollar, but by
mid-2013, it had crossed Rs 65, approximately 62% depreciation. This negatively
impacted companies that had taken loans in dollars.
Feeding The Child
In September 2013, Mr. Raghu Ram
Rajan was appointed as the Governor of RBI. He realized that the problem with
banks' loans was worse than everyone thought. For example, when a borrower could
not repay the loan, banks would restructure it instead of showing it as a bad
loan, and on top of that, they would give the lender an additional loan. This
was like fanning the fire.
Mr. Rajan took some corrective
measures to address this problem, which made the bad loans of public sector
banks more visible. Bad loans occur when banks give loans to borrowers who are
unable to repay them. For instance, if a bank gives a loan of 100 rupees but
only gets back 95 rupees, then the difference of 5 rupees becomes a bad loan.
In just 3-4 years, bad loans
increased threefold for banks. In the period between 2012-13, bad loans were
approximately 164000 crores, but by 2015-16, this number had crossed 5 lakh
crores. The bad loan rate, which was 2% for PSBs in 2012, crossed 10% in just a
few years, meaning PSBs had a bad loan of 10 rupees for every 100 rupees
loaned.
So why were companies defaulting,
and what were the reasons? The reasons were:
1) The deep slowdown in the steel
sector: From 2010-2011, China's growth rate slowed down, leading to a crash in
steel prices. In June 2011, the price of steel was around 5000 yuan per tonne,
but it crashed to 1700 yuan by 2015, resulting in significant losses for steel
companies. During this period, China started dumping its steel in India at a
discounted price, further affecting the industry. Eventually, the government
intervened and introduced a minimum import duty in February 2016 to safeguard
the domestic industry.
2) Bank frauds: During this period,
bank frauds and wilful defaults increased significantly, with some famous names
such as Nirav Modi and Vijay Mallya being involved in frauds worth
approximately 12500 crores and 9000 crores respectively. The government did not
take major action against these frauds, sending a negative message to society
and leading to an increase in frauds and scams. As a result, private banks were
rapidly gaining market share over public sector banks.
What has Government Done?
The Indian government has taken
several measures to address the issue of bad loans:
1) Insolvency and Bankruptcy Code
(IBC): The Indian government enacted the Insolvency and Bankruptcy Code (IBC)
in 2016 to provide a framework for the resolution of NPAs in a timely and
efficient manner. The IBC allows for the resolution of NPAs through the sale of
assets, merger, or liquidation of the borrower company.
2) Asset Reconstruction Companies
(ARCs): The government has also encouraged the formation of Asset
Reconstruction Companies (ARCs), which are specialized companies that purchase
bad loans from banks and work on resolving them. This has helped banks to
reduce their NPAs and transfer the risk of loan recovery to the ARCs.
3) Recapitalization of Public Sector
Banks (PSBs): The government has provided capital to PSBs to help them address
the issue of NPAs and strengthen their balance sheets. This has helped PSBs to
write off bad loans, and provide fresh credit to the economy.
4) Ease of Doing Business: The
Indian government has been working to improve the ease of doing business in the
country, which is expected to encourage investments and help in the resolution
of bad loans.
5) Credit Information Companies
(CICs): The government has also been working to improve the credit information
system in the country by setting up Credit Information Companies (CICs) that
maintain records of credit information of individuals and corporate borrowers.
This has helped in reducing the flow of bad loans in the banking sector.
6) Project Sashakt: The government
launched Project Sashakt in 2018 to address the issue of NPAs in the banking
sector. Under Project Sashakt, five alternative mechanisms were created for the
resolution of NPAs, including the setting up of ARCs, the use of the SARFAESI
Act, and the IBC.
Overall, the Indian government
has been taking a multi-pronged approach to address the issue of bad loans in
the banking sector. While some measures have been successful, the problem still
persists, and more needs to be done to tackle it effectively.
Thank You for Reading it. This article would not have been written successfully without the book called, BAD MONEY by Vivek Kaul.
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