In the memorable American Christmas fantasy drama film “It’s a Wonderful Life” starring James Stewart, there arises a bank run in a small town and the protagonist (James Stewart’s character George) uses his own money to stop the institution from dissolving. Released in 1946 and directed by Frank Capra, based on the short story and booklet The Greatest Gift, by Philip Van Doren Stern “It’s a Wonderful Life” is now considered one of the greatest films of all time. It was nominated for five Academy Awards, including Best Picture, and has been recognized by the American Film Institute as one of the 100 best American films ever made.
Fast forward to 2019. On September 23rd, the Reserve Bank of India placed Punjab and Maharashtra Cooperative (“PMC”) Bank, an urban co-operative bank under what is known in banking parlance as ‘Directions.’ Under these Directions, depositors could withdraw only up to Rs.1000 from their respective accounts. Much angst, trepidations and apprehensions later, the withdrawal limit was increased to Rs.50,000 on the 5th of November thereby alleviating the concerns of a greater part of 78 percent of the depositors.
Vivek Kaul is a writer who has worked at senior positions with the Daily News and Analysis (DNA) and The Economic Times. Also, the author of the Easy Money trilogy, Mr. Kaul’s latest book, “Bad Money” is an arrestingly compelling discourse on the burgeoning Non-Performing Assets (“NPAs”) that have racked India thereby causing immense stress to the banking eco system. As per Mr. Kaul, as of 31 March 2019, the overall bad loans of banks stood at a staggering Rs 9,36,474 crore. These bad loans were primarily the result of defaults by corporate borrowers – the biggest of them being Bhushan Steel, which had defaulted on over Rs 56,000 crore.
To maintain the health of this flailing banks, the Reserve Bank of India over a period of 8-9 years invested Rs 2,91,504 crore by way of ‘recapitalization’ into these ailing banks. But what is it that results in the accumulation of such an incredible proportion bad loans by the banks in general and by Public Sector Banks (“PSBs”) in particular? Mr. Kaul attempts to answer this fundamental question and in this endeavour takes his readers back in time to the formation, constitution and birthing of the banking eco-system in India. With a view to put a check on the proliferation of professional and unscrupulous moneylenders, the then government decided to nationalize the erstwhile Imperial Bank of India and establish the State Bank of India (SBI). SBI was established on 1 July 1955, with all the assets and liabilities of the Imperial Bank being transferred to it.
The second and the most controversial phase of bank nationalization occurred in the year 1969 when the then Prime Minister Indira Gandhi, unilaterally decided to implement a programme of nationalizing private banks. As Mr. Kaul highlights, “On 18 July, Gandhi met I.G. Patel, who was then the Economic Affairs Secretary in the central government. She asked him if banking was under his charge. He said that it was. After this, as Patel recalls in ‘Glimpses of Indian Economic History: An Insider’s View’, Gandhi told him: ‘For political reasons, it has been decided to nationalise the banks. You have to prepare within 24 hours the bill, a note for the Cabinet and a speech for me to make to the nation on radio tomorrow evening. Can you do it and make sure there is no leak?’. Patel told her that what she wanted would be done. At the same time, he offered her two suggestions. The first being that foreign banks should not be nationalized and the second being that there was no need to nationalize all the banks – only banks which accounted for 85–90 per cent of the total banking business should be nationalized. Gandhi agreed, and told him that she would leave the details to him. An ordinance to nationalize six more banks was issued on 15 April 1980. The six banks that were nationalized were Andhra Bank, Corporation Bank, New Bank of India (which was merged into PNB after it ran into trouble later), Oriental Bank of Commerce, Punjab & Sind Bank, and Vijaya Bank (since merged with Bank of Baroda).
Mr. Kaul reveals in a fascinating and jaw dropping manner the excesses in lending practices resorted to by the PSBs under various Government directives following a report submitted by the Gadgil Study Group which identified huge credit gaps prevalent in key sectors like agriculture. Under the garb of “priority sector lending”, the PSBs were directed to disburse loans with gay abandon with nary a need for either due diligence or credit worthiness assessments of the borrowers. Extravagant “loan melas” were organized under which loans would be distributed to the public at mass gatherings. To quote Mr. Kaul, “one politician who really pushed for loan melas organized by PSBs was Janardhana Poojary. Poojary was the minister of state for finance between December 1984 and 1987. A magazine profile of him written in 1987 said: ‘To watch Poojary at a loan mela is to see the actor merge with the politician.’” It came as no surprise when defaults soon became the norm necessitating loan waivers. “The first nationwide loan waiver was announced by the then deputy prime minister, Devi Lal, who was himself a large farmer, in 1989. It was done through the Agricultural and Rural Debt Relief Scheme (ARDRS), 1990.” With the liberalization of the Indian economy in 1991, the trajectory of the growth rate took pointed northwards and this positive optimism further boosted the lending practices of the banks in India. “In 2003–04, the total bank lending to industry had stood at Rs 3.35 lakh crore. This jumped to Rs 26.16 lakh crore by 2013–14 in a decade. This was a jump of 681 per cent.” The financial recession of 2008 however dampened the Keynesian animal spirits and projects began to be abandoned or shelved. In February 2008, Finance Minister P. Chidambaram announced a farm loan waiver, which eventually cost the nation around Rs 71,680 crore. Since November 2008, the central bank pumped Rs 3,00,000 crore into the financial system.
Mr. Kaul exposes the nexus between the banks and the crony capitalists by providing two powerful examples. The first example takes the form of regulatory forbearance. Forbearance means to hold back, to show restraint. “In the normal scheme of things when companies were not able to pay the loan, the banks should have seized the collateral and sold it to recover the loan.” Instead, the RBI came up with myriad restructuring programmes. At one point in time, as Mr. Kaul highlights, there were twenty-eight different circulars on various forms of loan restructuring. “In fact, by March 2015, the total corporate loans subject to restructuring had stood at Rs 5,28,538 crore. It had stood at just Rs 10,210 crore in 2006–07. In fact, to some extent this was also a case of what behavioural economists call the sunk cost fallacy. The fallacy shows up in many areas of life. Right from trying to finish a boring book to remaining in a bad marriage or an abusive relationship for that matter. Nobel prize winning psychologist Daniel Kahneman in his book Thinking, Fast and Slow defines this fallacy as ‘the decision to invest additional resources in a losing account’.”
Another key reason for bank defaults is the unfortunate separation between knowledge and power. Bankers were doling out funds to industrialists with bare minimum due diligence preceding such disbursements. “In fact, many did not even do their independent analysis and depended on SBI Caps and IDBI to do the necessary analysis. Any such analysis introduced a weakness into the system and multiplied ‘the possibilities for undue influence Bankers chasing industrialists. This practice resulted in the borrowers gaming the system by resorting to a practice referred to as “gold plating.” Paraphrasing Mr. Kaul, “let’s say a business promoter approached a bank for a loan of Rs 20,000 crore to build a steel mill. Of the total project cost, the bank would give a loan Rs 15,000 crore and the promoter would bring in Rs 5,000 crore. So far so good. The thing is that the promoter knows that the mill can be built for as low as Rs 10,000 crore. This is the gold plating. The promoter has passed off a project which costs Rs 10,000 crore at best as something which costs Rs 20,000 crore. He gets a loan of Rs 15,000 crore against it. The difference between the loan amount and the actual cost of the project is the amount that the promoter can pocket.154 In this case, it works out to Rs 5,000 crore. This Rs 5,000 crore is also his investment in the project. By pocketing Rs 5,000 crore of the loan amount, the promoter basically has not invested any of his money in the project. Hence, the risk that he has in the project is zero.”
In March 2007, just ten large conglomerates owed the Indian banks a jaw dropping sum of Rs.99,300 crores. This constituted approximately 5.7% of the total disbursements by the banking system! These ten defaulters were Adani, Essar, GVK, GMR, Lanco, Vedanta, Reliance ADAG, JSW, Videocon and Jaypee. Mr. Kaul also raps the RBI on its knuckles for being blissfully reticent about the issues faced by the banks in the form of an unhealthy accumulation of bad loans. A classic example being the case of Infrastructure Leasing & Financial Services (IL&FS). “In October 2018, the government superseded the board of the company, which was believed to be in a financial mess. By the time, IL&FS and its subsidiaries started to default, its problems were not on the radar of the banks which had lent money to it. The entire IL&FS group had a debt to equity ratio of close to 17:1 and a total debt of a little over Rs 91,000 crore as on 31 March 2018. In a report, the RBI found that IL&FS had not declared bad loans in a period of four years up to 31 March 2018.”
Mr. Kaul also acknowledges certain concrete measures that were instituted by the RBI to inculcate a semblance of discipline into the lending practices of the banks. The Insolvency and Bankruptcy Code (“IBC”) of 2016 was preceded by an Asset Quality Review in mid-2015, which forced the banks to recognize bad loans in their books. The government also introduced the Indradhanush reforms under which the post of the chairman and managing director of a PSB was split. A Banks Board Bureau (BBB) was set up. The BBB, it was said, would be a body of eminent professionals. The former Comptroller and Auditor General Vinod Rai was appointed as its first head. The IBC itself as Mr. Kaul demonstrates has made some tangible progress. “…on 13 June 2017, recommended that ‘12 accounts totaling about 25 per cent of the current gross NPAs [bad loans] of the banking system would qualify for immediate reference under IBC.’309 These twelve companies which had defaulted on a huge amount of banks loans were Essar Steel, Monnet Ispat and Energy, Bhushan Steel, Bhushan Power and Steel, Era Infra Engineering, ABG Shipyard, Jaypee Infratech, Amtek Auto, Alok Industries, Jyoti Structures, Lanco Infratech and Electrosteel Steels. Candidates. Between December 2016, when it came into force, and September 2019, a total of 2542 defaulting companies have been admitted into the corporate insolvency resolution process (CIRP) adjudicated by the NCLT. Of this, a resolution plan has been approved in 156 cases. Given that 1045 cases have been closed, in nearly 15 per cent of the cases a resolution plan has been approved. The total claim of the lenders stood at Rs 3,32,087 crore. Of this, Rs 1,37,919 crore, or around 41.5 per cent, has been recovered. This is clearly better than the recovery which was happening in the pre-IBC era. Also, if these firms were to be liquidated, the liquidation value would have come to Rs 74,997 crore. So, clearly, the recovery through CIRP looks much better.”
But there is still a long way to go before the mess that is bad loans can be reasonably cleaned up. One significant spoke in the wheel according to Mr. Kaul is an excessive degree of Government intervention. The P.J. Nayak Committee had in an earlier study commented that: ‘Governance difficulties in PSBs arise from several externally imposed constraints. These include dual regulation, by the Finance Ministry in addition to the RBI; board constitution, wherein it’s difficult to categorise any director as independent; significant and widening compensation differences with private sector banks, leading to the erosion of specialist skills; external vigilance enforcement though the CVC (Central Vigilance Commission) and CBI (Central Bureau of Investigation); and limited applicability of the RTI Act. A more level playing field with private sector banks is desirable.’ The top brass of the Public Sector Banks, unlike their counterparts in the private sector are incredulously insulated from any wrongdoings or malpractices. The RBI made Rana Kapoor, one of the founders and the managing director and CEO of Yes Bank forcefully retire when it was found that Yes Bank had under reported its bad loans by Rs 10,470 crore in 2015–16 and 2016–17. In October 2017, the RBI had fined the bank Rs 6 crore for breaching standards on bad loans recognition. And yet when the unscrupulous diamond magnate Nirav Modi coolly deceived the then second largest PSB in the country, making it poorer by a whopping Rs 12,646 crore loss, nothing happened to the MD and CEO of the bank.
Mr. Kaul’s book is meticulously researched, and the reader must contend with a phalanx of tables and a waterfall of numbers. However, the language employed is easy on the eye and explains every fact with a clarity that is refreshing. “Bad Money” would make for a handy primer for the expert as well as the uninitiated and would be a great refresher for every economics student and policy maven.