Who Robs India’s Banks?

The unsustainable pattern of corporate finance has been riddled further by unprecedented recurrences of fraudulent activities in the financial sector.

The unfolding of multiple frauds in India’s banks reminds one of the book by William K. Black, “The Best Way to Rob a Bank is to Own One: How Corporate Executives and Politicians Looted the S&L Industry”.

The systemic pattern emerging in the related frauds also remind us what was highlighted last year, in the official Economic Survey, as a ‘Twin Balance Sheet’ (TBS) problem. The concerns related to the large non-performing assets (NPAs) with banks and the inter-related high leverage and default ratios of corporates have assumed even larger proportions today, with fraudulent deals, corporate defaults and the piling up of bad loans posing serious threats to India’s financial system.

The ease with which corporate firms have been misusing the credit facilities of banks suggests that the alliances between the two are much deeper than what has already surfaced. The diversion of Rs 12,700 crore or more borrowed by the Nirav Modi and Mehul Choksi group of jewellers as prepayments against imports of precious stones to affiliate concerns – money which they had no intention of paying back – tells a story which is close to ‘robbing’. And that too by nearly ‘owning’ the bank operations.

Extending the analogy further, with the current official controls or regulations still having no impact so far on the ‘loot’ which has already surfaced, the nexus between finance and corporate industry seems to be within the purview, if not an arrangement, of the ruling Indian state.

As per estimates put out by Crisil-Assocham, the gross NPA of banks is expected to increase from Rs 8 lakh crore from a year ago to Rs 9.5 lakh crore by March 2018. This will mean that NPAs will be about 10.5% of total bank advances, in addition to Rs 11.5 lakh crore in their stressed assets. As for public sector banks alone, their GNPA, according to the Reserve Bank of India, rose from 12.5% to 13.5% between March and September 2017. With public sector banks alone owning 70% of banking assets and responsible for 16% stressed loans, the situation in the financial sector is of more than grave concern for the economy.

The parallel processes of fraudulent practices at the level of banks and their corporate clients make it necessary to look closely into the links between two. As reported in the media, quoting the Financial Stability Report on firm-level Prowess data, 50 of those corporates were found responsible for nearly 85% of NPAs held by the banks while receiving more than 56% of the gross bank advances by the third quarter of  2016.

Moreover, as many as 41% of those companies had interest liabilities exceeding their respective EBITs (earnings before interest and tax payments). It was thus natural that more than one-third of those large companies have failed to meet the interest liabilities on their debt for at least four quarters by Q3 of 2017, in terms of data from the same sources.

One also needs to look at the pattern emerging in the deployment of funds by the corporate sector, especially when it concerns the choice between the real expansion and speculation on financial assets. In a paper we published recently in Review of Keynesian Studies, some noticeable tendencies were observed on the part of corporates in India which seemed to prefer investments in short-term financial assets as against the creation of physical assets.

Enforcement Directorate officials inspect a jewellery store in Mumbai during a raid in connection with the Punjab National Bank scam. Credit: PTI

We observed, using Prowess data sources, a declining share for industrial securities as a proportion of the aggregate investments for a large number of companies, dropping from around 40% in 2002-03 to around 15%  or even less by 2011-12 and the following years.

This goes with the rising share of financial securities, from 60% or less to over 70% during the same period. With the typical volatility in the market, affecting the prices as well as the returns on financial assets, the rising share of the financial assets in corporate portfolios failed to generate growth rates in corporate assets.

Thus, growth rates of around 6,700 corporate firms, according to Prowess data, dropped from a 3.1% rate in 2011 to 0% in 2012 and further down to (-)6% in 2013. The low asset growth rates provide a clue as to why corporates also are saddled with large NPAs in their balance sheets. We also observed the pattern of fund disbursements by those corporate firms, using borrowed funds to meet the current liabilities which include interests, dividends and the likes, thus generating an unsustainable Ponzi-like situation.

The unsustainable and growth-retarding pattern of corporate finance mentioned above has been riddled further by what can be observed today as unprecedented recurrences of fraudulent activities in the financial sector. The surfacing of some of those instances has led the state to announce some quick measures like the revised RBI norms (to require banks detect and identify stressed loans and report payment lapses between 61-90 days to the Central Repository of Information on Large Credits); the Fugitive Economic Offender’s Bill (to confiscate properties of economic offenders involving Rs 100 crore or above fleeing the country); the National Financial Reporting Authority or NFRA (to oversee and investigate the professional misconduct by accountants and auditors) and finally the Financial Resolution and Deposit Insurance Bill (empowering banks to use the deposits  liabilities beyond Rs 1 lakh to avoid a possible collapse).

While the last item of a possible ‘bail-in’ has been shelved for the time being due to public concerns over the security of their savings with banks, the other option of a bail-out seems to be in the air, notwithstanding both its infeasibility as well as regressive pattern in the Budget.

Such has been the knee-jerk reaction of the elected government in India. With current events indicating the break-down of  prevailing legal safeguards and contractual obligations in the country, we identify a simultaneous erosion and failure of institutional norms at every level, which includes the state.

Sunanda Sen is former professor, Centre for Economic Studies and Planning, Jawaharlal Nehru University, New Delhi. She can be reached at [email protected]

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