The bad loan woes and precarious capital positions of public sector banks (PSBs) are hogging the headlines once again. As the Government cobbles together a recapitalisation package to rescue them, there’s a clamour to fix the problem for good, by privatising PSBs.

This week, the CII urged the Government to dilute its controlling equity stakes in PSBs to 33 per cent to help raise capital. This roused the ire of the All India Bank Employees Association, whose spokesperson asked industry groups to repay their loans first. While bank employees may have their own reasons to oppose privatisation, their angst is quite valid.

Lately, privatisation has been presented as a panacea to the many ills plaguing Government-owned banks. But the belief that the public sector equates to sloth, inefficiency and corruption, while private ownership automatically brings with it efficiency, financial prudence and governance, isn’t really borne out by the Indian experience.

A private sector problem

Let’s not forget that it is India’s private corporate sector that has gotten the banking system into its present NPA (non-performing asset) quagmire in the first place. As of end-March 2016, RBI data showed that public sector lenders accounted for over 90 per cent of the ₹5.5 lakh crore gross NPAs with banks. But nearly 100 per cent of those loan defaults were by private borrowers.

In the last three years, as regulatory intervention has forced banks to disclose a closet full of skeletons, PSBs have been roundly criticised for poor lending decisions, inadequate risk controls, throwing good money after bad and most of all, bad governance.

But Credit Suisse’s ‘House of Debt’ reports record in painstaking detail the genesis of bad loan problems at Indian banks. The analysis makes it clear that the present NPA woes of PSBs can be traced directly to the investing excesses of some of India’s top private industrial houses during boom times.

Who created NPAs?

In the post-crisis years from FY07 to FY12, Credit Suisse notes, ten of India’s largest (private) corporate groups were on a debt-fuelled expansion binge. As the who’s who of India Inc (Reliance ADAG, Vedanta, Essar, Jaypee and Lanco to name a few) invested in mega projects in power, metals and infrastructure, believing that high GDP growth rates would sustain, they took on a five-fold expansion in their aggregate debt from ₹1 lakh crore to ₹5.5 lakh crore. Some also made expensive overseas acquisitions. Sold on the India story, domestic banks also went the whole hog on funding these projects. The ten groups saw their share of total bank loans jump from 6 per cent to 13 per cent.

By FY13, the global commodity cycle was in meltdown and the domestic capex cycle was juddering to a halt. Many of the groups may have found it easier to pare debt, had they embarked on asset sales right then. But with regulatory hurdles hitting some projects and scams stalling others, many projects failed to take off. With dwindling cash flows to service debt, these groups landed in a classic debt trap. Though the House of Debt firms made barely enough money to cover interest payouts in FY12, many took on more loans (aggregate debt shot up to ₹7.3 lakh crore by FY15) which eventually turned into NPAs.

Though banks did curtail new loan exposures to the stressed groups post FY13, they continued to restructure old loans and kick the can down the road on disclosing them as NPAs. It was only after the RBI started tightening screws on banks in FY14 that the true magnitude of the problem came to light.

Now, with the benefit of this hindsight, one can certainly criticise banks for their lack of due diligence on projects and concentrated exposure to cyclical sectors. But if the banks are guilty of poor judgement in funding these projects, private promoters are equally culpable for letting their ambitions get the better of prudence and taking on excessive financial risk.

Interestingly, public sector companies in the very same sectors — power, metals and infrastructure — did not indulge in the same excesses as their private peers, during the boom times. NTPC, Coal India, NMDC, Nalco or NBCC for instance emerged from the downturn with much stronger balance sheets than their private rivals. Clearly, private sector ownership doesn’t automatically guarantee good governance.

In the same boat

What about the cases of deliberate oversight, where PSB bosses gave in to political pressure or possibly even accepted quid pro quo to lend to the risky corporate groups? Well, they do exist. Even RBI officials informally admit that phone calls from political bosses played a big role in lending decisions by PSBs.

But then, without an actual forensic investigation into the individual NPA accounts, it is difficult to say what proportion of the bad loan decisions were prompted by political influence and corruption, and what part by mis-judgement.

In fact, recent developments clearly show that PSBs were not alone in extending credit to India’s riskier corporate groups. In the last few quarters, private sector banks lending to industry such as Axis Bank, Yes Bank, RBL Bank and ICICI Bank have revealed rising slippages from their legacy loans. That many of these ‘divergences’ pertain to earlier accounting years and have come up after RBI’s prodding, suggests that these banks have been loath to recognise them. RBI data shows that that 9.3 per cent of the industry loan book for private sector banks was stressed by March 2017, as opposed to 28.8 per cent for PSBs. Thus, the difference between the lending decisions of private corporate banks and PSBs is one of degree, rather than kind.

Why, given that some House of Debt members such as Jaiprakash Industries and Reliance ADAG also feature ECBs and FCCBs on their books, it is apparent that even savvy global investors have made the same mistakes.

What needs fixing

But how does knowing all this help in reforming PSBs? Well, it suggests that PSB reforms must not begin and end with privatisation.

First, the key to tackling existing stressed loans lies in forcing the owners of the distressed corporates to sell their assets and de-leverage. The process is already underway under the new Bankruptcy Code. Two, the screws on India Inc’s governance structures need to be tightened, to ensure greater checks and balances against mis-allocation of capital, borrowings and diversion of funds. This is a work-in-progress. Three, Indian banks need access to early warning systems on imminent default with tighter accounting norms on NPA recognition. Concerted efforts by SEBI, RBI and the Bankruptcy Board are laying the foundations of this change.

Finally, given the public disquiet around bail-in provisions and NPAs, this is a bad time for the Government to moot privatisation of PSBs. But it can certainly distance itself from their top-level appointments and operations by vesting its equity stakes in a holding company, and allowing the Bank Boards Bureau to take independent decisions. It is unfortunate that the Bureau has so far remained a toothless tiger.

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