ANTIFRAGILE - ARE WE?

Nicholas Taleb in his book “Anti Fragile” writes about systems which can withstand shocks and emerge better after such shocks.

He, in fact, advocates that systems should be subjected to regular stress agents to improve their capabilities and robustness.

Two very important developments happened in the Banking system in the Feb 2018.

1. The RBI decided to not allow banks to roll over NPAs by cosmetic changes in their books.

2. They debarred the practice of Debt Restructuring which was practiced by a lot of fancy sounding names such as strategic debt restructuring, a scheme for the sustainable structuring of stressed assets etc.

These schemes were nothing but machinations by the banks to keep rolling over bad assets on their books and keep fooling the shareholders. In other words, complete lack of accountability. RBI has now ruled all such cases to be referred to the Bankruptcy courts without delays.

Challenging the intellect of the investors

Now, this was a malaise which has essentially plagued the Indian Economy. Banks are the custodian of the National Money or Small Depositors’ Money.

The businesses usually used to OVER INVOICE purchases for setting up of plants, factories etc and then siphon off the funds to other avenues such as Capital markets, Real Estate, Offshore accounts etc.

This activity has essentially two effects

• It made the survival of the underlying business difficult
• It bloated the other asset classes with easy liquidity.

Additionally, access to easy and unaccountable credit resulted in businesses in being careless and throwing basic diligence and caution to the side.

 Can strictly regulated advances move Indian economy to be less corrupt?

Yes. Now with much more stringent regulatory intervention, the above things would undergo a paradigm shift.

Indian Banking system and by extension Indian Economy will be less corrupt. 

The PSU banks which hitherto used to provide a lot of discretionary powers to its executives will become much more process driven rather than “links” and “relationship” driven.

Hence, though in the short run the NPAs and the liquidity crunch would hurt but would, in the long run, be very beneficial. The criminal waste and organized loot of National wealth would get checked, up to some extent.

Is our banking system fail-proof?

Another event which has raised the hackles of everyone and got extensive media coverage is the “Nirav Modi - PNB” fraud. Without getting into the details, it suffices to say that even this event will act as a stress, or as something which will further strengthen the banking system.

As an analogy, it is like every viral attack ensures that the body becomes immune to a similar viral attack in future.

This is not to say that we can now rejoice that our Banking system is fail-proof. On the contrary, there would be repeated attacks on the system from fraudsters always;

Such is the lure of easy money.

What would be the ramifications?

The short-term, 1-3 years, consequences of these events would broadly be as follows.

• Low liquidity in the banking system. Due to higher provisioning, the banks would be short on liquidity. Hence credit offtake would be slower.
• Interest rates not going down due to pressure on the available capital to earn more for meeting the liability side.
• Slower and cautious lending resulting in proposals getting approved with a time lag. Would hamper business confidence.
• Political instability as the incumbent government will have to bear the brunt and get accused of failure.
• Lot of capital-intensive industries such as Infrastructure, Bulk Commodities (Steel, Cement etc), and Real Estate etc will be stressed due to Capital shortage.Following will be the constructive results

Though the above mentioned would be the short-term pains, in the long run, some of the beneficial outcomes would be as follows:

1. Improvement in credit appraisal process and loan advancement procedures. More responsible lending will create a comparatively more level playing field.
2. Entrepreneurs will be made to provide more margin money, ensuring more “Skin in the game”. Hence every time the business fails, the promoter goes down along with it. This will make the risk-taking more prudent and reduce speculative intent. Also, the corrupt element of over-invoicing should get reduced if not altogether removed.
3. Chances are collaterals sought would be more tangible and not “Brandnames” etc which have no resale value. This should make lending more secure.
4. The cost of capital over the long run will decrease as Capital erosion will stop and result in Capital Formation. This will, in turn, ensure cheaper loans for both businesses and private consumption. The much-needed boost to the economy.
5. Due to short-term capital inadequacy,there could be a merger of weaker banks into stronger entities. This will further improve Capital adequacy ratios and improve the depth of banking.
6. The mergers would also improve working capital ratios by reducing redundant manpower. This should result in leaner cost structures. For a bank beside interests on deposits, manpower is the next biggest cost.
7. A case could also be made for privatization of banks which is a further welcome step to make banking more effective and efficient.
8. The stabilizing of “Bankruptcy” procedure would ensure that in the event of genuine business failure the creditors and debtors both get quick and less painful relief. The establishment of the Bankruptcy procedure is a very positive development and will provide depth to the Indian business environment.

Conclude to long-term benefits

Hence, in conclusion, it would not be wrong to say that these and similar events, though loss-making in the present, would prove to be beneficial in the long term.

These are like those tremors which do cause some destruction but ultimately result in the construction of stronger and more quake-resistant buildings. Although, prudence demand continuously being diligent to create buildings which can withstand stronger tremors, as they will continue to occur given the nature of things.