To
Smt Nirmala Sitharaman
Union Finance Minister
Dear Smt Sitharaman,
In my letter dated 26-8-2022 addressed to RBI Governor (https://countercurrents.org/2022/08/reports-on-highly-leveraged-debt-based-operations-of-the-adani-group-calls-for-a-closer-look-from-the-psu-banks-point-of-view/), I had specifically referred to the risks the public sector banks (PSBs) face from loans given to large private groups of companies, excessively dependent on over-leveraged debt, with little equity contributions of their own, aggressively expanding their activities into new areas in which they have little experience. Unless the RBI makes a periodic assessment of such risks and takes timely corrective action, including adoption of tighter corporate exposure ceilings for the banks, they can adversely impact the health of the PSBs and the stability of the financial system.
In this context, one has to appreciate the larger picture of how the PSBs are forced by the successive governments to lend more and more to big private groups, as a result of which their loan portfolios are undergoing an adverse change that will further add to their risks.
In this connection, I invite your attention to the perceptive observations made recently by an eminent economist, Dr Pronab Sen, who was former Secretary, Ministry of Statistics & Programme Implementation, on the “massive asset-liability mismatch” in the banks, that could explode anytime (https://www.business-standard.com/article/finance/banking-sector-at-enormous-risk-of-asset-liability-mismatch-pronab-sen-122082400891_1.html). His observations not only add strength to what I had earlier observed in my letter to the RBI Governor but also enable one to see the larger picture of the increasing risks faced by the PSBs.
The following broader issues arise in this connection:
- On the liability side, the banks in India are by and large dependent on deposits from their customers, as the predominant source of funds, whose average tenure is around 2 1/2 years, whereas the average tenure of their assets i.e. their lendings, mostly covered by term-lending to borrowers, is 9 years. In other words, there is a potential asset-liability mismatch risk lurking ahead, which can create serious problems, when a crisis is triggered by an internal or an external event.
- So far, such a crisis has not been experienced, as most of the banks are in the public sector and they enjoy the backing of the sovereign.
- About two decades ago, the share of long-term borrowing (to big corporate groups) for projects in the banks’ portfolio was only 10%, whereas it has now reached a disturbing level of 45%, a proportion that will further increase, as a result of the government exhorting the PSBs to extend more and more loan assistance to big businesses, whether it is for development of auctioned mineral blocks, for infrastructure projects in sectors such as power, ports, airports etc., or for commercialising the auctioned telecom spectrum bands, or even projects undertaken by the corporate groups in other countries etc. In other words, the banks portfolios will get more and more skewed towards term lending and the asset-liability mismatch, which is typical of such term lending, will therefore correspondingly increase and pose an escalating risk to the PSBs in the coming years, unless corrective steps are taken immediately.
- As stated in my letter to the RBI, in an environment in which the PSBs are under pressure from the government to give more and more term loans for projects, largely those undertaken by the private groups, the latter have resorted to borrow heavily from the banks, over-leverage the borrowed funds to enlarge their activities in an unsustainable manner, which in turn has exposed the PSBs not only to the risk of some of those loans turning into non-performing assets (NPAs) but also to the risk of an increasing asset-liability mismatch.
- This trend has got further reinforced by the PSBs, who instead of dealing with the NPAs by enforcing the statutory recovery procedures, have often shown undue munificence by imprudently allowing concessional debt restructuring facilities, tacitly endorsed by the RBI, which in turn has further encouraged the private groups to take it for granted that they could nonchalantly depend on more and more debt, which has compounded the NPA crisis, rather than mitigate it. Such a free-for-all environment has also encouraged some private groups to divert the loan amounts for unauthorised activity, a matter that calls for a thorough investigation as it could involve outright fraud.
- Often, taking the government for granted, private corporate groups are known to lobby for sops in borrowings and repayments (https://m.economictimes.com/news/economy/finance/rbi-wary-of-easing-capital-rules-for-loans-to-infra-companies/articleshow/93843054.cms), which lead to inefficiencies and wrong doings in the use of funds, which the government and the RBI should resist.
- The Financial Stability Reports of the RBI tend to paint a rosy picture of the PSB NPAs by showing a decline in their level in proportion to their gross advances, by reducing the same by the amounts written off in a given year for the purpose of making a provision in their financial statements, an exercise of cosmetic window-dressing. Since the amounts written off do not take away the banks’ obligation to recover them, for the purpose of a realistic assessment, they need to be reckoned as a part of the NPAs. If one were to recalculate the NPAs on that basis, taking into account the information available in the public domain (https://www.cenfa.org/a-dint-on-the-psbs-npa-management/), the gross NPAs which were 9.11% of the gross advances in 2016-17 increased to 14.6% in 2019-20 and 11.7% in 2020-21. Thus, the NPA problem has not really improved; instead, it continues to cause a serious concern for the PSBs. The bulk of such NPAs arise from loans given to the larger groups of private companies.
- Earlier, the banks used to provide a greater proportion of their loans to the MSMEs, but their share in total lending continues to come down steeply, as the banks perceive such lending to be risky.
- Privatisation of the PSBs will enhance the risks, not mitigate them, as it will mean that the entire deposit and loan portfolios of the lenders would then go to a private entity, without government support, which would have been available for the PSBs. Since private banks will also have to depend mostly on deposits from their customers, the asset-liability mismatch referred above, compounded by the absence of sovereign support, will accentuate the risks.
- There is a suggestion that the existing banking laws should be realigned to permit the banks to raise money from the capital market. In our case, the capital market continues to remain shallow and speculative. Allowing the banks to raise funds from the capital markets is likely to endanger the interests of the depositors.
- The collapse of the Global Trust Bank (GTB) in the private sector, which exposed its depositors to enormous risks, was traceable to some extent to the capital market scam that took place at that time. Ironically, in order to safeguard the GTB depositors’ interests, the RBI had no other alternative than to force a PSB to take over its operations in 2004, a typical example of “privatising profits, socialising losses“. In a way, this also demonstrates the pivotal importance of the PSBs.
- To address the asset-liability mismatch risk faced by the banks and also to mitigate the NPA problem of the PSBs, the large private groups should be persuaded to seek funds for their long-gestating projects, not from the PSBs, but from domestic bond market, which will force them to conform to stricter prudential norms. External commercial borrowings entail the risk of exchange rate variation.
When banks were nationalised in the late sixties, the then government had assured the Parliament that the PSBs would promote the State’s welfare role as mandated in the Directive Principles. In addition, the government had also assured the Parliament that nationalisation would lead to “severing the link between the major banks and the bigger industrial groups (which had so far controlled credit) …the interests of the depositors of the banks which have been nationalised, will not only continue to be fully safeguarded but will now have the backing of the State itself“.
It is unfortunate that the successive governments should totally renege on that assurance by forcing the PSBs to increase their exposure to the big businesses and now, as the present government is planning to do, even to privatise the PSBs and consequently place the depositors’ fate in the hands of the big businesses.
Against the above background, a prudent course of action for the government would be to
- Ask the RBI to make a quick assessment of the magnitude of the risks faced by the PSBs in respect of loans given to big businesses, especially those reported to have become excessively dependent on debt and have over-leveraged their operations, so that corrective steps may be initiated before they pose a threat to the stability of the financial system
- The present practice of the banks allowing concessional debt restructuring facilities to private corporate groups is an imprudent one, as it encourages the private borrowers to resort to inefficient and even wrongful use of the loans taken. In fact, this practice has resulted in an all-round collusion among several rating agencies and auditors with the promoters of the private groups, as evidenced by several cases of corporate fraud that came to light in the recent times.
- Impose tighter exposure ceilings on banks’ term lending to big businesses and incentivise the banks to restructure their loan portfolios to move away from term lending and increase their share of lending to MSMEs and other priority sector groups. This will have a two-fold benefit for the banks. First, it will progressively correct the asset-liability mismatch. Second, it will progressively mitigate the problem faced by the banks in dealing with the NPAs of large corporate groups.
- Keeping in view the fact that privatisation of the PSBs would amount to withdrawing sovereign backing for the depositors, there is a need for dropping the proposal altogether. Permitting the banks to invest in the stock markets for returns would not be prudent, as the latter are still shallow and speculative, which in turn would expose the depositors to a great deal of risk.
- There has been a suggestion that the banks should co-partner with NBFCs. Many NBFCs in India are owned indirectly by the private groups, who are reported to be using that route to intrude into an area that legitimately belongs to the banks. They bring very little of their own funds, appropriate funds from the banks and act merely as an intermediary to slice away a share of the banks’ market. There have also been complaints that the NBFCs, the regulation over which is fragile, are charging usurious rates and exploiting the unwary customers. Therefore, any co-partnership between the banks and the NBFCs may prove to be counter-productive,
Instead of viewing privatisation of the PSBs as the panacea for all ills, which is evidently not so, the Ministry of Finance should, in consultation with the RBI and the SEBI, move quickly on the above lines and bring about changes that will safeguard the depositors’ interests in the long run, improve the health of the PSBs and minimise the risks that exist to the stability of the financial system.
Regards,
Yours sincerely,
E A S Sarma
Former Secretary to Government of India
Visakhapatnam
