The risks that the once safe PSU banks pose...

Aug 4, 2014

In this issue:
» Poverty has been reduced to a number game
» Should we expect a rate cut from RBI?
» Jim Rogers supports the case to invest in gold
» Taxes on unsold real estate inventory could benefit buyers
» ...and more!

Remember 2008? After the Lehman crisis...depositors, including corporate like Infosys, started withdrawing deposits from private sector banks to put them into PSU ones. The reason being that the depositors considered government owned banks to be safer than their private sector and foreign counterparts. However, a lot seems to have changed since then.

We have often written about the NPA mess in the Public sector banks. The bad loans in the banking sector, especially in public banks set one of the toughest challenges for the economy. And while some of us would like to attribute these to the slowdown in the economy, a lot of it is the making of the managements of the PSU banks.

The shocking incident of arrest of the Chairman cum Managing Director Mr. SK Jain of Syndicate Bank by CBI in bribery case has brought to the limelight the loop holes in the Public banking system and their management. When top management indulges in such wrong doings, what can one expect at lower rungs of banking system? The less said, the better. After all, culture in an organization infiltrates from the top.

The event has led to erosion in the wealth of the shareholders of the bank as the Syndicate Bank share price plunged after the incident was reported. Not to mention, the erosion in value of shares of Prakash Industries and Bhushan Steel that have been accused of offering bribe. Well, this is not the first time such an incident has happened. Last year, a senior executive of SBI was arrested for similar reasons. As such cases continue to become the norm, it is time we find out where the rot originates and do something to stem it.

One must note here that the biggest share of bad loans comes from big corporates and not the retail sector. Another interesting point to note is that it is the Public sector banks that account for most of the bad debt situation in the economy. The appointment of the management for the same falls under the purview of the Government. All this suggests to some extent that corruption in Public sector banks finds roots in crony capitalism.

The recent event is a case of bribery to increase credit limits. Often, allegations have surfaced that banks have restructured loans at lesser costs or extended loans and increased loan limits for undeserving candidates. The latter are mostly big private companies. Lack of management autonomy and political pressure on the bank management, along with promise of a flourishing career, a monetary 'cut' on such shady loans, and other incentives to bank officials are the tools often used to facilitate such deals. At times, even appointments for top management posts involve lobbying for a person who can smoothen such transactions. Thus, from private players to politicians, all have been alleged of playing a part in the corruption story. With such linkages between politicians, capitalists and corrupt bank officials, the entire banking system has been compromised. And a corruption web has been woven in which the country lies trapped.

What is more scary is that what we already know could be the just the tip of the iceberg. How deep the racket runs and what are the stakes involved could be anybody's guess. One must note that exposing such risks also involves huge conflicts of interests for the regulator. For such a thing can shake the foundations of the economy and can lead to contagion.

Bankers are supposed to be guardians of public money. For an economy where around 70% of the banking system is accounted for by the Public sector, such incidents deal a harsh blow to the public confidence. Banking sector is the spine of an economy. A dent in the system can cripple the whole economy and as such poses a huge systemic risk. The ultimate victim of which will be the stakeholders such the depositors in the bank, shareholders and tax payers in the economy.

Hence, it is time to review the ownership patterns and Governance structures for Public sector banks and ensure market discipline. In a scenario when people who operate the system have dubious ethics, no overhaul in the capital adequacy norms, stress testing or improvement in the appraisal systems can make a difference. Unless urgent steps are taken, the very notion that government owned banks are safe for depositors will undergo a permanent change. And without depositor trust, the PSU banks that reach out to more than 2/3rd of the country's population, will find it impossible to help in the economic growth.

Do you think corruption and mismanagement in Public sector banks poses huge risks to the economy? Let us know in the Equitymaster Club or share your comments below.

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 Chart of the day
The poverty rate in India is likely to decline substantially. Not because of some architectural government intervention but for the change in the definition of poverty line by the World Bank. Readers may note that the benchmark is set at US$ 1.25 per day at present. But this is based on purchasing power parity (PPP) which has 2005 as base year. And with the base year about to get changed the poverty rate in India is likely to decline dramatically. As can be seen in today's chart, if there is a change in base year, the poverty number would fall from 400 m people to about 99 m people in case of India. In fact, not just India, almost all regions would experience a fall in poverty figure. However, the impact would be highest for India with the fall being in the region of 75%.

While such statistics are of little use they form a basis for debates that happen in poverty elimination programs. Changing the definition has already resulted in huge decline in poverty rate statistically. This would cause many to believe that poverty is declining in the world and would be eradicated by 2030 as envisaged. However, statistics differ from truth. The fact is that no one can survive with US$1.25 a day. Eliminating poverty is not just about survival. It is more about providing better living standards to the destitutes. We reckon governments of all countries should view poverty in this light rather than making it a statistical number game for self validation.

Poverty Reduced To A Statistical Number Game

The Reserve Bank of India will announce its bi-monthly monetary policy tomorrow, 5th August. All eyes will be on Governor Dr. Raghuram Rajan. Will India Inc finally get what it wants from the RBI? Is a rate cut on the cards? We do not believe so. For one thing, Dr Rajan has proved beyond any doubt that he is his own man. It is unlikely that he will pay heed to the calls for a rate cut. The other thing is that inflation is still not under control. The RBI has implicitly moved closer to an inflation targeting stance ever since Dr. Rajan took over last year. The RBI may not officially acknowledge it but it is clear that the central bank is moving in that direction.

Dr. Rajan has raised rates thrice since assuming office and has accepted the CPI as the best indicator of inflation. Although the CPI has fallen below 8% recently, it does not reflect a genuine fall in consumer prices. The rainfall deficit has also caused some concern this year regarding agricultural output. If there is any shortfall in food production, it is bound to adversely affect consumer inflation. On top of all this, crude oil prices have also remained stubbornly high. Thus in such an uncertain economic situation, we believe that it would be inappropriate to expect a rate cut from the RBI. We wouldn't be surprised if the Indian central bank maintains a status quo on interest rates in the monetary policy.

War is probably the most destructive thing mankind has invented. It causes irreparable loss of life and property. It can do no good to anyone, except investors who hold real assets. Confused? Veteran globetrotting commodity investor Jim Rogers explains this better than anyone else. When there is war and political turmoil, investors tend to be become increasingly risk averse and rush towards real assets such as oil, gold and such other real commodities. It is important to note these insights in light of the ongoing turbulence in Gaza and Ukraine. Of course, Rogers doesn't seem to see a third world war in the offing. But if history is anything to go by, we have seen wars and political tensions driving commodity prices sky high. This is also the reason why Indians have been compulsive gold bugs for thousands of years. We believe that having at least 5-10% of your total investment portfolio parked in the yellow metal can a reliable hedge for certain times.

A real estate developer's key role is to construct properties and sell them. But when sentiments are poor, more often than not the unsold inventory starts to pile up. So should the developer be taxed on these unsold properties, even if these are not rented out? Well, the major response would be 'no'. However, as mentioned in the Economic Times, the government is considering asking builders to pay taxes on unsold stock, which would be computed on the basis of annual letting value. What this could lead to is realtors taking up measures to clear off the inventory which would include reducing property prices, something that seems required in India. However, whether this will be implemented or not remains to be seen as the Finance Ministry is considering this proposal. It may be noted that there are over 760,000 apartments that remained unsold at the end of June this year. Bringing in such a move would be a major setback for developers, but a positive for buyers.

When we talk of management integrity the Vedanta Group is hardly going to score any points. And a latest development with respect to this group only further reiterates this fact. Cairn India, in which Vedanta is a majority stakeholder, has given a US$ 1.25 bn loan to its parent Sesa Sterlite for 2 years. Interestingly, LIC, which is the second largest shareholder with 9% holding, has asked for more clarity from the management regarding this move. LIC opines that this is not in interest of minority shareholders when Cairn itself would need these funds for its own expansion plans. LIC in the past has not been particularly well known for being vocal on protecting shareholder rights. Hence its move to seek clarification is notable in that sense. The other bone of contention is that even if Cairn were to not use these funds for expansion, it could have parked this money in fixed deposits which would have fetched it a return of 9-9.5%. This is much higher than the 3.5% that it is getting after loaning the money to Sesa Sterlite. The Cairn management so far has not been able to give a convincing explanation to all investors concerned. So, whether LIC will be satisfied with the response that it gets remains to be seen.

There are risks that galore in the medium and long term. Especially if one is looking at bond markets in the US. Little wonder that renowned bond fund manager Bill Gross believes that short term bonds are the only 'safe haven'. According to Moneynews, Gross, who manages funds at PIMCO, sees crises in Russia, Argentina etc making the longer tenure too risky for bond investors. The global mini trade wars with Russia and government debt default in Argentina have already shaken investor confidence. There is also the possibility of the US Fed starting to raise interest rates later this year. With so many moving parts, investors are unlikely to buy into the logic that the US economy will recover in the longer term. We certainly agree with Gross' logic that for investors to bet on long term bond yields is indeed a challenging task. However, in India, the bond markets may react more to domestic factors like inflation and policy reforms than global risks.

The Indian stock markets ended the day in the green. At the time of writing, BSE-Sensex was trading higher by 242 points (1.0%). Majority of the sectoral indices were trading in green with consumer durables and software stocks being the major gainers. The Asian stock markets were trading mixed with Singapore leading the losses. However, Korea and Taiwan markets were trading positive. European markets opened the day on a mixed note.

 Today's investing mantra
" Time is on your side when you own shares of superior companies." - Peter Lynch

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27 Responses to "The risks that the once safe PSU banks pose..."

P V Samuel

Jan 2, 2015

While corruption, no doubt, is a major issue with all PSBs, varying in degree; the most common cause for deterioration in the quality of their loan portfolio is very casual approach to supervision and monitoring of the release and conduct of loans. If credit administration is toned up, there would be discernible improvement. A 'proprietory' approach is needed, as seen in Private Sector Banks. Effective supervision, financial discipline and timely action would benefit the banks, the borrowers and other stakeholders.



Aug 7, 2014

Apart from the rich and the business people, even the common man in India is depositig his meagre money is in the public sector banks believing that his money is safe hands. It will be catastrophe for him and his future if his hard earned money vanishes. It is therefore important that the Government takes immediate action to bring very strong measures, covering all angles and loopholes, so that public sector banks do not go astray because of unscrupuloua people at the helm of affairs. Constant monitoring is necessary and anyone found guilty is punished severely.


A. Ramamurthy

Aug 5, 2014

Black sheeps are there everywhere. But that does not make the entire system corrupt. The system has to be cleaned up by giving exemplary punishment to the guilty. Media should also highlight the good work done in many institutions and not continue to present a pessimistic forecast. By and large Indians have a strong character and can steer thru periods of trials and tribulations.



Aug 5, 2014

This is NOT ONLY the SYNDICATE BANK but almost all PSU banks one or the other way involved. The Practical Example of SBI is - No sooner you apply for Housing loan, within couple of days N'number of Mediators/Service Providers will call to to get it sanctioned for charges ranging from 2% to 5%. In Metro cities various Organisations are well Organised to sanction you Loan to any Amount.

With submission of FAKE Balance Sheet & P & L accounts RAMPANT manipulations prevails for Obtaining the Loan to the tune of several Crors.

Hypothecations by showing STOCKS on paper and obtaining the Loan on it is very common practice prevails in every nuck & Corner.

Dummy OR Fake submissions of relevant documents is other Pronominal which also well practiced.

Managers, Regional Managers, GM's along with family & friends are well entertained including 5 STAR luxury Tours, Gifts of Gold & Diamonds ornaments' are worth to be explored.

As stated IT IS ONLY TIP of Ice Burg, the depth touches to sea ground.


M Ram Mohan Rao

Aug 5, 2014

why are public sector banks corrupt today. when they were in private sector there were hardly any such cases. whenever any one was found to be corrupt such a person was quickly sent home. there was always a fear that indulging in corruption is we have long winding procedures for dealing with such cases. it is ineffective. If we desire to eliminate corruption we must eliminate the role of the govt in managing the banks.right from appointing the cmd to the day to day management the beaurocrats and politicians should be eliminated from playing any will see complete change. m ram mohan rao



Aug 5, 2014

Dear sir,

It is true that Loans availed by Big People/ Corporate's have become bad because of pressure exerted by the them on account of their contact with Top Management / bureaucrats /politicians. The principal cause is the window dressing done by auditors in financial statements, the failure of banks to meticulously check the facts,remittances in account, cross verify the facts with the mandatory statements to be filled with other statutory bodies.All other financiers who ever is funding the defaulters or their group concerns should obtain the banker's opinion.
The bank officials should be regularly informed about the bank frauds. The bank officials should be trained by experts from industry about financing.
Yours truly,



Aug 5, 2014

The banks are running in a way that they do not have any transparency and accountability. The Audit reports of the banks do not show the clear picture and NPA's are huge. NPA's needs review every 2 years and system for recovery needs to be looked into. Possibly RBI needs to tighten the screws immediately

Thanks and Regards



Aug 5, 2014

PSU Banks were always unsafe. Mainly due to political risks. Having been an SBI Officer for several years, I have seen the Banks plundered by Politicians and Bureaucrats for the profit and pleasure of themselves, their cronies, connections and vote fodders like any other Public Sector Unit. It was only a matter of time before the officers of the Banks, festooned with concealed non performing assets adopted the corrupt ways of their masters. Hovering over all this is the very heavy tax of inflation that India's Quota-Corruption Neta-Babu-Milard-Copocracy use to finance their profligacy and malfeasance.


mohammad anis

Aug 5, 2014

The corruption in the banking industry is peculating from top to bottom. Branches are being allotted as Thana. Persons who can serve their Masters well are being posted at the potential branches. The controlling offices are looking deep into the statements of fresh disbursement for the purpose of 'SHARE',instead of the quality of the advance. Bad advances are being put under the carpet, in connivance with the controlling offices. The solution is that the Regional Head and the Branch Head should be
responsible equally for such advances.



Aug 5, 2014

only honest and efficient men should head the psu banks.thorough scrutiny should be made before appointment.

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