Banks alone not to blame

Over the last fortnight there has been a great deal of concern about the declining asset quality of the Indian banking system, particularly of public sector banks that account for the largest chunk of business in the country.

At the BANCON meet, central bankers perhaps stunned bank chiefs with stinging criticism of the rising proportion of troubled assets in state owned banks. With linguistic inventiveness, a Deputy Governor expressed his righteous indignation by preferring to talk not of the banks of the future, the theme of the conference, but of the “future of banks”. Other central bankers too joined in with less rhetorical concerns about rising NPAs, the trouble with debt recasting and poor appraisal systems.

RBI’s focus shifts

The conference provided a curtain raiser for the subsequent Report on Trends and Progress in Banking in India 2012-13 that lays bare in some detail the character of NPAs and the reasons for the troubled assets of Indian banks.

The findings are significant, for they raise some troubling questions about non-performing assets. It used to be argued that agriculture and small enterprises were the breeding ground of sickness in bank loans. The report tells us that the NPA ratio in the priority sector was “consistently higher than the ratio in the non-priority sector (but) the deterioration in asset quality in 2012-13 was primarily on account of the non-priority sector.”

Why this slide?

The report also offers fresh insights into this deterioration. Overall economic slowdown and delays in regulatory approvals (those darned environmental clearances!) are assigned their obligatory weight among the causes for the slide in quality of bank assets. But the RBI blames no less, the concentration of credit in certain sectors, poor credit appraisal monitoring by banks and higher leverage among firms.

The combination of the latter two factors creates its own logic, whereby banks simply roll over the loans endlessly, adding to the troubled assets.

Banks appeared rather generous with retail loans (all forms of personal loans). Also, credit to the sensitive sectors, real estate, stock markets and commodities too picked up in this period of overall credit deceleration. “In the past, growth in credit (to such sectors) generally followed a pattern similar to overall credit growth. However, in 2012-13, growth in credit to sensitive sectors almost doubled primarily on account of credit to real estate. This expansion needs to be seen in light of the steep rise in housing prices in all Tier I cities and several Tier II cities.”

Clubby networks

The RBI’s diagnosis of troubled assets seems to confirm what various studies have already analysed as the pattern of growth in the post-millenium decades.

In this configuration of growth, the focus is on not just industry but services, and in particular real estate and capital markets and commodities. All these sensitive sectors are not just inflation-prone but also speculative in behaviour. Exposure of bank credit to such fields of essentially non-productive activities heightens the dangers of troubled assets.

Studies have also shown the high level of private corporate debt, both domestic and dollar denominated. Payback time hasn’t yet arrived for the external credit acquired so recklessly by Indian firms even in the recent past; but neither has it for domestic debt added so easily through a banking system that, by the RBI’s admission, has had poor credit appraisal and monitoring systems.

Weak market churning

At the heart of the problem is not just the monitoring mechanism of banks but the lack of that competitive spirit of entry and exit, of creative destruction that capitalism’s theorists point to as its driving force. Economic Darwinism — that enjoins and celebrates the survival of the fittest as the means by which markets sustains themselves — should have inspired Indian policymakers to ensure banks and the eco-system were not made to carry the weight of reckless enterprise management, or the failure to respond fittingly to market caprices.

Backdoor nationalisation

Yet why should one point to just Indian banks for letting troubled assets stain their books? Indian market economics is not known to champion Darwinism; monopolies are a way of life for the private sector economy. That is why innovation in India is a farce, as is the RBI’s castigation of bank tolerance of troubled assets.

But isn’t capitalism as its enthusiastic founders envisaged it stillborn all over the world? In the US and Europe, governments bend over backwards to keep it alive through public money institutions and firms. In America, Lehmann Brothers was allowed to fall and so was Bear Stearns; the tax payers’ money was divided between those with stronger influence over their contemporaneous lawmakers.

Ways abound to ensure that the inefficient but powerful continue on drip. The employment issue is one. A firm that should be allowed to die carries on, even though increasing numbers stop getting salaries.

The other is the inefficiency of laws that do not allow the bank to recover its dues from firms, except through laborious processes like the Debt Recovery Tribunals; and, of course, the rather cosy relationship between governments and capital ensures the survival of the non-fittest.

It is easy for RBI officials to castigate banks for lax monitoring and poor recovery processes. But credit appraisals and monitoring systems are also a responsibility of the RBI that can help push credit monitoring systems into shape.

It’s not the future of banks that is at stake; it’s the future of market economics.