Our Very Own Banking Crisis — Big Bad Loans

This article is the fifth section of a larger series that weighs up the reasons given for the demonetisation of 86% of Indian currency, and also seeks to uncover the true compulsions behind the monumental action.

The entire study can be viewed as one article. Link below.

Throughout this article, we’ll be dealing with all kinds of large number in lakhs, crores, million & trillions & everything in between. To help with quick conversion, here’s a ready reckoner for reference.

Beneath the rosy headlines of (somewhat suspect) 7.something GDP growth rate, India was on the brink of a mini-financial crisis — similar to the 2007–08 ‘Sub-prime Mortgage Crisis’ that brought on the global recession. Only it wasn’t housing loans that were going to do us in.

Our Banks, government-owned public-sector banks (PSBs) mainly, have gotten themselves into a bit of a quagmire. They are sitting on humongous piles of very bad loans. Loans which aren’t coming back anytime soon. Which, if not sorted out, threaten to drag them into insolvency — implications of which being, their customers could lose their hard-earned deposits.

Source: The Telegraph, India.

Well of course, unless someone comes and bails them out… like ummm… the government.

Basically, if you compare the estimated black money recovered against the colossal shady loans, write-offs & bail-outs given out to fly-by-night operators/corporate giants — it’s a no contest.

Have a look at a larger picture.

Source: Financial Times, Credit Suisse, DNA, The Wire.

Why exactly is this such a bad situation?

Because, large companies essentially lobby/bribe/arm-twist the government into ordering poorly-run PSBs to give out these loans with few, or dodgy, background checks. Besides the money spent on actual projects, a significant part of the loan — which was created out of your small deposits — is then fissioned off into top-rung salaries, to relatives, shell companies or overseas ventures. Most of it, never to return again.

A few years later, when interest payments stop coming in, the loans are declared Non-Performing Assets (NPAs). Next, companies request ‘re-structuring’, or bargaining for more time & lower rates. Eventually, when payment falls through, the loans are ‘written-off’ by the banks and the proceedings are moved to our speedy courtrooms. Inevitably, these companies declare themselves bankrupt. Some measly properties are then seized by the banks, yet individuals responsible — sitting cozily in their hideaways “ring-fenced” from real financial harm — are rarely ever brought to book, or even ‘named and shamed’.

If I owe you a pound, I have a problem; but if I owe you a million, the problem is yours.” — John Maynard Keynes

When was the last time you took a loan, failed to repay it, and got away scot-free? Or have you even heard of someone who was? Of late, I’ve seen and read many articles about farmers being hounded for being unable to repay their loans. Whereas, on the other hand, the debt owed by Adani, Essar, Vedanta & Cos. well exceed the ENTIRE farm-loan debt in this country.

Source: LinkedIN, Dailyo, All Figures in Crores

Now, you mustn’t think that this is an attempt to lay the blame for this entire crisis on the current govt. The previous govt. too had its fair share of crony capitalists and the bulk of these loans were given out during their tenure. However, 2013–2016 saw the largest corporate debt write-offs in Indian history — 1.99 Lakh Crores.

And in defence of this current govt., to facilitate the process of recovery from defaulting borrowers, they have armed the banks with the new Insolvency and Bankruptcy code, which was notified on May 28, 2016.

To help those unfamiliar with these terms and the workings of the banking system, below is a table with definitions and a few numbers for perspective.

Source: The Global Economy, The World Bank, Wikipedia

Okay, so the banks were in a mess. What about deposits?

Things get a bit complicated here on, but this unravelling of the banking system makes for wonderful reading too.

Besides the out-of-control bad loan problem, the banks had also been refusing to lower interest rates on loans as they were too busy setting aside cash to — cover the risk of defaults, and thereby — erase the various bad loans from their books. Meanwhile interest rates on deposits were being disproportionately slashed since mid-2014.

The result was that people slowly stopped putting their money in the banks. 
Although inflation had come down, inflation expectation among the public had not. Aggregate growth of deposits fell to single digits — the lowest since 1962–63 (over 50 years).

People were choosing to invest their their money in gold, real estate, the stock market, just keeping it under the mattresses, or sending it abroad in large amounts — after the current govt. twice raised the slab for Liberalized Remittance Scheme from USD 75,ooo annually to USD 250,000, or Rs. 2 Crore, per individual.

Source: Economist.com

At the same time, growth of bank credit to the commercial sector (corporate loans) — which is how banks really earn their living — had fallen to 5%, a 20-year low.

Credit growth is closely linked to the pace of overall economic growth — growing at 2–3 times the real GDP growth in recent decades.

To pile on the woes, job growth in the formal economy had almost ceased in 2015–16.

Unemployment was on the rise. The demographic disaster was looming large.

Vikaas, or development — particularly industrial — is central to the Modi government’s sales pitch. Without real growth there is only so long one can get by with switching GDP-calculation methods and other general fudging of numbers.

In plain words, behind the cosmetic GDP figures, the economy was spluttering. It needed a jump-start — a strategy to reduce interest rates and get corporate credit back on track.

So how does Demonetisation tie-in to this entire equation?

There are two ways of dealing with a bad loan epidemic. One is to make money readily available to satisfy the demand thereby allowing inflation, which naturally raises spending and increases sales revenue for companies — which helps them to repay the loans.

The second, is to freeze cash into bank deposits such that capital ratios improve and loan interest rates reduce and companies can be offered better terms. This isn’t a great option and was tried out by Cyprus in 2013 with disastrous effects.

Now if you can successfully attach a reason — something emotive like that of corruption & black money — to your prohibition of cash, you end up killing two birds with one stone. Next, add the cashless angle to the moral crusade against physical cash (buy 2 get 1 free), and you have an (almost) foolproof plan. At least, one that wont get scuttled by this miserable opposition.

And if the fabled ‘dividend from extinguished liabilities’ becomes a reality — all the more cash for re-financing the banks.

The only problem they didn’t anticipate in their unshakeable self-confidence was that the severe & continuing shortage of cash could lead to an economic downturn that would shave 1–2 points off the GDP and as a consequence, a significant chunk of stressed or restructured loans could still turn bad.

Aha! Almost a win-win situation for them then?

Yes, we’ll all have to wait and see how the economy plays out. But lo & behold, economic recovery & the moral high-ground is not all they have to gain. There’s also the small matter of the UP Elections, which just happens to be round the corner.

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