Banking & Reconstruction in India: The elision of debtors & creditors

If you want to be sure about GDP growth, look at credit growth as that is clearly the leading indicator. India however moved from one method of accounting GDP to another and we would notice that the GDP had a healthy boost, while credit growth has moved sideways. The current NPA malaise has moved the credit growth southwards. These are challenges of an economy that moved across a range of growth drivers, from core to service industries, but the current global rout in commodity prices seem to be doing more harm than good; at least for credit growth this seems more real.

There is much talk on interest rates, but that seems a no-brainer given that the banking fraternity could not pass-through these cuts, given their balance sheet issues and many other factors. The inflation on the other hand looks rock-solid & stable but low by our standards, but most of it was commodity led; monsoon is one small unknown in the very current. So the focus returns to credit growth.

More time must be dedicated to ensure that we increase credit, but in a creditable manner. The banker as an intermediary is matching supply with demand, just as any logistician would do, but with a huge difference, the risks the banker carries on its non-performing assets mire the prospects of further lending. The process of reconstructing some of these non-performers has much to be desired, at least in India.

A banker is trusting a small time depositor to keep his deposit entrenched for a lock-in period as specified in the contract. The same banker trusts a debtor with a sum for which the debtor is obligated to pay back with an interest. If both the sides of this transaction are not well oiled, we have a crisis; such are the simple perils of banking.

To increase credit in the banking environment we must set the rules right. The debtors must be credit worthy or we must have collaterals that could match the risks that the banker is taking. For individuals this is comparatively easy, for corporations this may not be that simple; the complexities of the business are better understood by the experts not necessarily coming from the banking system, but the risks are never fully visible until they are full blown as in a crisis.

The asymmetry in the payoffs, that sparked off the global crisis in the first place, even holds good now; on a rainy day when a cloud-burst is not envisaged, the speculation could well be met with a deluge of margin-calls. The shareholder would have no clue as some of the risks could be off-balance sheet and the whole edifice of bank capital rests on assets and liabilities in the balance sheet. 

The Indian banking system has some very excellent safe-guards; the government holds up to 60% of the equity in most public sector banks and is virtually the backstop. Off balance sheet transactions are under powerful scrutiny, no wonder the NPAs touched 10% in some of the worst cases. But that is where the balance is somewhat lost.

Indian banks score high on transparency but low on its ability to set a reconstruction process to its NPAs. To clean the balance sheet, either you knock off these NPAs as losses or you take them off the balance sheet by selling these to investors with a plan of remediation.

The problem with the first is that you are taking a time-out from getting into anything risky and that is where the credit growth numbers speak for themselves. The second approach would mean that somewhere the buck must stop and finally the government must be prepared to convert debt into equity. But with the 60% limit set by RBI, that route is closed.

The Chinese have a solution, but not all Chinese solutions can work here. But one such solution is to sell assets in the bank through an ABS program, where investors could buy anything from receivables of mortgage payments to some of the risky debts currently locked in the balance sheet. The demand for such securitized assets is not small but the hurdles must be crossed. These are definite approaches that must be pursued instead of just asking for increase in capital where the government could have limitations. The recent infusion of $3 Billion as new capital from the government is not enough as an equivalent amount got lost in the last two quarters from the public sector banks. So we returned to where we were.

The asset quality has no signs of deteriorating, at least in India, with a demography that can hardly have any parallel and with a rising middle-class consumption patterns, the demand side is pretty solid. The problem is always with the supply and that is where reforms step in and while we made some progress with the bankruptcy codes, we must now turn our attention to the stream lining of processes around selling of asset backed security. The size of this space is huge going by the risk appetite of global investors.

The extreme cases of default mire the prospects of reconstruction. The most prominent default has been hogging the limelight in such great details that no investor would be willing to come forward to participate in reconstruction efforts in other less onerous areas.

We must not neglect the role of the judiciary in this. This role so far has been more reactive, after the gross violation has been committed. It needs to be proactive.

The bankruptcy judge has an onerous task that of making a judicious distribution, almost like the cake as in the Idea of Justice. Before the bankruptcy, the distribution is so lopsided, but sanity checks in with the judge in the driver's seat. The distribution of spoils, that are orchestrated by careful manipulation better be nipped in the bud; justice cannot always be served after every crime is committed under the aegis of reforms and regulation.