RBI Governor Raghuram Rajan has issued renewed warnings from Davos that the bad loans in the banking sector could spin out of control if action is not taken with a sense of urgency. If anything the problem of bad loans in the banking system is worsening as the economy runs the risk of getting caught in a new global deflationary cycle in 2016. Rajan was unusually forthright in Davos and suggested that just a handful of businesses have borrowed massive amounts from banks and are actually choking credit to the rest of the economy because of their inability to pay back the loans. In an obvious reference to Vijay Mallya of the Kingfisher Group, the RBI Governor said big defaulters who have not paid back bank loans must refrain from holding expensive birthday bashes. Mallya had recently organised his 60th birthday bash with great pomp in a super deluxe hotel in Goa. His company has been formally declared a debt defaulter by the State Bank of India.
Mallya’s default is only the tip of the iceberg. There are bigger corporate groups, with immense political clout, who are also in default but they have technically avoided being declared defaulter through what is called “ever-greening” of loans. Ever-greening essentially involves making fresh borrowing from banks to simply pay interest. By doing so, the corporates, which don’t have enough cash to even pay interest, avoid being officially declared defaulters and the banks too develop a vested interest in showing that the loan hadn’t gone bad in their balance sheets by offering these companies fresh loans which immediately come back as interest payment. It is a mere book entry, really. As per the RBI norms, a corporate default
in interest payment beyond two quarters requires the concerned bank to make provisions — setting aside funds as cover for a full default in the future — which is charged to current profits. Indeed, if strict provisions for interest default were to be made by banks, they may end up showing huge losses. Consequently, banks also have a vested interest in ever-greening loan accounts. By doing so, banks and corporates merely postpone the problem of loans gone bad.
By a rough estimate, the 10 top indebted business groups – they are well-known names who have thrived in both the UPA and NDA regimes – have about Rs.7.3 lakh crore of loans in their books and are struggling to meet their interest payment obligations. Most of these companies are heavily invested in infrastructure sectors such a power, roads and telecom or in the commodities like steel where world prices have collapsed.
Governor Rajan sent out fresh warnings recently about the deepening crises in the financial sector, especially in public sector banks, because the stock market has begun to read the real rot within, even if banks are trying to hide it. For instance, the share prices of public sector banks have collapsed to such an extent that they have begun to quote below their book value. The book value of a company is simply the real net worth (equity capital plus reserves accumulated over the years) as shown in the balance sheet. In the case of the public sector banks the share prices are so low that they have fallen even below the book value, clearly suggesting that the net worth mentioned in the balance sheet is overstated. This had happened to some of the large American banks after the 2008 global financial crisis. Before massive Fed Reserve bailouts arrived, the stock prices of US banks too had fallen well below their book value.
Worse, the market capitalisation of 40 plus Indian PSU banks put together has fallen to about Rs. 2.4 lakh crore which is less than the market value of just one private sector bank,HDFC! Such has been the destruction of the market value of PSU banks. So the stock market is clearly signalling that the rot in PSU banks is much deeper than what has been disclosed so far. This prompted Raghuram Rajan last month to up the ante and force the banks to make full disclosure and provision for bad loans where interest is not paid for over two quarters. Rajan has emphasised in the past that India’s crony capitalists ( read big business groups that actively fund elections) never seem to pay for the bad decisions they make and practice virtually “risk free capitalism”.
Recently, a reputed research firm Credit Suisse gave alarming data for 10 severely indebted groups in the infrastructure and commodities sectors which are facing the brunt of the current deflationary storm originating mainly from China. The aggregate gross debt in the books of these corporate groups – Essar, Reliance ADAG, GMR, GVK, Adani, Lanco, Videocon, Vedanta, Jaypee – is of the order of Rs.7.3 lakh crore. Of this, Credit Suisse estimates that about Rs.3 lakh crore of loans are severely stressed! Private credit rating agencies have assigned these severely stressed loans near default status. But banks are nowhere close to recognising them as non-performing assets. It is largely these stressed loans that Rajan is talking about when he tells banks to be bold and make full provisions for loans where interest payment has all but stopped. Overall, about 15% to 20% of all outstanding bank credit of about Rs.65 lakh crore is considered to be suffering various levels of stress.
Politically, Rajan has touched a raw nerve and both PM Narendra Modi and finance minister Arun Jaitley will be tested on this count in the months ahead. How PM Narendra Modi and FM Arun Jaitley deal with large quanta of stressed loans in these big corporate groups is being closely watched by the opposition parties. The other day, a BJP spokesperson admitted on CNBC Awaaz channel that it is a challenge for the government to distinguish loans which are going bad because of genuine business failure from the ones which have elements of wrong doing in them. Many of the corporate groups listed by the Credit Suisse are known to have got entangled in scams during the UPA regime and are also notorious for their crony capitalist links. Any relief to them will open Prime Minister Narendra Modi to fresh charges of treating big business with kid gloves. Indeed, this is the biggest challenge the NDA economic managers face.
The nature of the deepening crisis in the banking sector was brought out by Uday Kotak, Chairman of Kotak Mahindra bank, who minced no words in Davos last week by stating upfront that banks can no longer afford to just wait for the global commodity prices to recover in the hope that their loans turn good from bad. Uday Kotak supported Rajan’s assertion that banks must quickly disclose the magnitude of bad loans in their balance sheets by March 31.
Significantly, Kotak argued that prominent Indian businesses today don’t have the confidence to deal with a further slowdown in 2016. These businesses were full of confidence in 2008 when the world was hit by a recession. Back then, both big corporate groups and banks had good balance sheets. The difference today, according to Kotak, is that businesses are highly leveraged on debt and the flip side of it is banks are sitting on huge non-performing assets.
Finance Minister Arun Jaitley made a counter argument that India’s economy is far more resilient today than it was in 2008. Jaitley probably knows, not many in Davos would have agreed with him.