By Ajay Chhibber
Indias banking crisis has been on a slow burn for the last three years. But just like a slow fuse Diwali firecracker, the blast will inevitably come. Unfortunately, the more the delay, the bigger the blast will be.
Experience globally shows that banking crises end up costing more if strong upfront actions are not taken. The latest banking Ordinance gives the appearance of action. But it will delay the inevitable resolution, ending up with a much bigger bill for the Indian economy.
The crisis was not created during the Narendra Modi governments tenure. The United Progressive Alliance (UPA) government can take the credit, exacerbated further by the global economic crisis of 2007-2008. But what the Modi government can be accused of is not addressing the issue seriously
Lend me your fears
Gross non-performing assets (NPAs) have been growing steadily since the global economic crisis as pressure has come on banks to classify troubled assets properly. In March 2014, the revealed gross NPAs valued at Rs 2.73 lakh crore. By December 2015, they crossed Rs 4 lakh crore mark.
Some three years since the Modi government came to power, NPAs are now estimated to be Rs 6.80 lakh crore. They could be as high as Rs 12 lakh crore about 8% of GDP if stressed loans are added to the revealed NPAs. With growing NPAs, the banking sector has reduced lending sharply. Bank loan growth that averaged around 18% growth a year during 2011-14 fell to under 12% in 2014-15, stayed at about 10% in 2016, and is now running at 5% in 2017. Some of the recent drop can be attributed to demonetisation. But much of the earlier drop is due to the growing bad loan problem.
Investment issues
The real side effect of the banking sector crisis is a sharp drop in private investment, especially corporate investment, which has fallen by around 7% of GDP. This has hurt growth and further reduced demand for credit. Despite being flush with liquidity after demonetization, the banking sector has no borrowers and no great desire to lend.
Falling real credit growth has resulted in this drop in investment. This has led to a drop in GDP growth by about 1%. With a GDP in 2016-17 of around Rs 150 lakh crore, delays in resolving banking sector problems cost the economy about Rs 1.5 lakh crore a year in lost economic output. A delay of five years would cost almost Rs 7.5 lakh crore, in addition to the hole in the banking system estimated to be around Rs 12 lakh crore.
The government’s solution
India’s government waved its hands at the problem. It initially set up the Indradhanush scheme and tried to bring in more professional management to banks. It then set up a Public Sector Bank Bureau, which had no real powers or money to deal with the issue. It set aside piddling amounts only Rs 10,000 crore in Budget 2016-17 to fix the problem.
The new banking sector ordinance allows the Reserve Bank of India (RBI) to push banks to take stronger actions. Along with the new bankruptcy law, it may help resolve some of the bad loans, especially in cases where coordination among multiple lenders is needed to take tough decisions on haircuts. But it is unlikely to make a major dent in the growing NPA problem.
The real and quick solution to the NPA problem was already proposed in India’s Economic Survey: the Public Sector Asset Rehabilitation Agency (PARA). But such an approach requires upfront funding of around at least Rs 9-10 lakh crore to transfer the assets and fill the hole in the public sector banks (PSBs). The survey proposed that this be financed either by issuing government bonds or transferring government securities from RBI, increasing its equity holdings.
The aim is bond
Both options pose risks. Government bonds of that magnitude would need to be absorbed by the market, drying up liquidity for new lending. In the second case, it would pose substantial risks to the RBIs balance sheet. Borrowing from the International Monetary Fund (IMF) would be another option. But this would be politically damaging, as it would need to accept tough IMF conditionalities.
Injecting new money will not be enough if the same banking management and structure remain intact. Some PSBs should be merged with others. Some should be privatised. By presenting this as a twin balance-sheet problem, a case is being made by some to use taxpayer funds to save corporates. The corporate borrowers should be fully penalised for the bad loans to the maximum extent possible. The cleaned-up banking system will then look for new lenders and not put more good money to the same wilful defaulters.
Some tough decisions are needed. Allowing the problem to persist until after the 2019 elections will add at least another Rs 3 lakh crore in costs of foregone GDP and probably another Rs 2-3 lakh crore in additional NPAs. It is time to stop delaying the inevitable and find a solution.
This article was originally published in the Economic Times on May 22, 2017.
Ajay Chhibber is a distinguished visiting professor at the National Institute of Public Finance and Policy in New Delhi.
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