Of banks and books

Reserve Bank of India Governor Raghuram Rajan is correct in that banks do require “deep surgery” on their asset portfolios to weed out bad loans. He is, however, perhaps being a tad optimistic in hoping that banks will have “clean and fully provisioned” balance sheets by the end of the next financial year. The impaired assets in the banking system (gross non-performing assets combined with restructured and written-off assets) have risen to 17 per cent of the system’s loan book by the end of the second quarter of FY 2015-16. However, even this conceals the true picture. With banks having taken advantage of the RBI’s recent regulations by going in for strategic debt restructuring as well as reviving some stressed loans through the 5:25 refinancing scheme, the amount of bad loans will be much larger. Add assets sold to asset reconstruction companies (ARCs), where the underlying risk if for unrecoverable loans still rests with the banks, and the task of fully cleaning up the books seem even more difficult. In fact, an estimate by India Ratings puts the potential wipe-out at ₹1 lakh crore, of which public sector banks alone would account for ₹93,000 crore. The sharp fall witnessed over the past two days in the stock prices of public sector banks reflects this uncertainty.

Finance Minister Arun Jaitley’s solution — of bringing in a strong bankruptcy law and empowering banks with more powers of recovery — addresses only a part of the problem. While ensuring better and speedier recovery of loans is undoubtedly important, deeper structural reforms and systemic changes are needed to ensure that the newly cleaned balance sheets are not again awash in red. The RBI’s prudent assent quality review, which has led to the present clean-up in bank books, is a good first step. But unless public sector banks are freed up to take decisions based purely on commercial considerations, and unless the governance structure of PSU banks is made free from political interference, the cycle is bound to repeat itself.

This is something neither the Centre nor the economy can afford. India Ratings estimates that the as much as 0.4 per cent could be shaved off the GDP growth rate over the next three years on account of the additional capital that would have to be infused by the Centre into PSU banks. Cleaning up bank books is costing scarce capital that would have been better deployed in productive investments. It will require political will to break the cozy nexus between lenders, powerful borrowers and vested political interests. The Budget provides a handy opportunity to take some bold measures.

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