Are banks' bad debts bigger than what is stated?

Aug 21, 2012

In this issue:
» Large corporates account for larger chunk of loans
» No criminal charges against Goldman Sachs!
» Here's a bigger scam than the 2G scam
» Facebook has lost nearly half of its value
» ...and more!

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The global financial crisis did not affect Indian banks the way it impacted global banks. The major reason for this was the strict set of Reserve Bank of India (RBI) regulations that these banks had to adhere to which prohibited extensive use of securitization and derivatives. But that does not mean that Indian banks are completely out of the woods. Indeed, they are facing problems of another kind. Notably that of bigger bad debts.

The Economist points out that India has a bigger bad debt problem that is not in line with what is stated by the rather stable level of banks' official 'non-performing' loans. But the quantum of this debt is difficult to judge because many have been labelled as 'restructured'. This means that the terms of the debts have been softened, but they are not formally recognised as bad debts. These restructured loans were estimated at US$ 43 bn in March this year amounting to around 2% of India's GDP. Restructuring loans by itself is not such a problem simply because the borrower has not defaulted but simply requires easing of the terms of repayment. But the important thing to note here is that this facility should not be misused. For instance, take the case of struggling airlines such as Air India and Kingfisher Airlines. Both of them are saddled with massive debt. While they may not have technically defaulted so far because of restructuring of these debts, they are certainly in no position to service or repay the debts.

Also, the burden of these debts has been greater for public sector banks than their private peers. The Economist has estimated that 93% of restructured loans are on the books of public lenders. They tend to be in poorer shape than their private rivals on account of lower capital levels, lower profitability, higher bad debts and lower provisions held against those bad debts.

However, it would be too early to presume that the problem of restructured loans could blow into something very big. At least we hope that the central bank which has been rather vigilant so far will ensure that this issue does not blow out of proportion. Moreover, since Indian banks (even PSUs) are comparatively better capitalized as compared to their Western peers, they are in a better position to tide over difficult times. Having said that, a consolidation in the sector cannot be ruled out. Overall, what banks need to ensure is that they do not stop lending to genuine borrowers just because they have been bitten by a few bad ones.

Do you think that restructuring of debts will turn out to be a bigger problem for Indian banks? Share with us or post your comments on Facebook page / Google+ page.

 Chart of the day
It is well known that the auto sector is cyclical as its performance is largely dependent on the growth of the Indian economy. But the degree of cyclicality within segments tends to vary. Today's chart of the day shows that commercial vehicles (CVs) are the most cyclical as compared to either passenger vehicles or 2 wheelers. And in CVs, the medium and heavy CVs (MHCV) are more cyclical than LCVs. This is largely because MHCVs are largely used for the transportation of various goods across the as well as in construction acitivities and so the performance of these sectors have a large bearing on how the CV industry operates. Indeed, in FY13 so far given the slowdown of the Indian economy, MHCVs have faced the maximum brunt as can eb evined by the dip in volumes.

Data Source: SIAM

The future, as we all know, is highly uncertain. Therefore, it always helps to incorporate a sufficient margin of safety whenever we are performing the task of valuing an asset or collateral. However, this simple concept was perhaps ignored by most of India's banks. What else would explain the more than five-fold increase in loans to large corporate groups over the past five years? Yes, that's correct. As per a Credit Suisse report quoted by livemint, in FY12, over 20% of the incremental loans came from the 10 large corporate groups in India. These now account for 13% of the total bank loans and 98% of the net worth of the Indian banking system. Clearly, not the kind of statistics that can be taken lightly. However, the question that first needs answering is what possibly could have let the exposure of banks to go up to such high levels? The illusion of safety we believe. The banks kept pouring loans onto the firms hoping that the bull market of 2006-07 would continue unabated, thus enabling firms to repay loans from their strong cash flows. But as is evident now, the rally was not backed by strong fundamentals. This has thus led to a lot of big ticket projects finding themselves not only in trouble but also saddled with great deal of debt. Of course, this is not to say that most of them would turn into NPAs. But some degree of pain will certainly come the way of the banks we believe.

Bringing the culprits to book seems like an age old story! Of late proceedings and punishments for criminal economic offenses have either been absent or extremely long drawn. Whether it is the corrupt practices of corporates, politicians, banks or others. Take our very own Comptroller and Auditor General. Despite unearthing scams by the dozen, it has hardly been successful in keeping the culprits behind bars. Even those booked for the CWG and telecom scams are now scot free! Hence it is hardly surprising to find the judiciary in the US turning a blind eye to the offences of Wall Street biggies. Goldman Sachs' denial of participation in the US subprime bubble is well documented. The investment bank showed little regret even after being accused of selling bad investments to its clients. Its CEO Lloyd Blankfein said he's doing 'God's work'. But the biggest irony is that even the US judiciary has bought its story. The US Justice Department won't be pursuing criminal charges against Goldman Sachs or its employees. Hence that puts an end to one of the most prominent criminal proceedings for the subprime crisis. The policy makers, regulators and judiciary are as much to blame for such lack of justice. The only consolation is that the details of Goldman's appalling behavior and role in the financial crisis will live on forever in the public record.

If you thought the 2G scam was enormous in size, here is an even bigger one. We are referring to none other than the coal blocks allocation scam. As per the Comptroller and Auditor General (CAG), private companies gained about Rs 1.86 trillion on account of non-transparent coal block allocation. CAG had earlier pegged the number at Rs 10.67 trillion. However, it must be noted that this figure included public companies as well.

The CAG report raises some important questions. Why was the introduction of the competitive bidding process for coal block allocation delayed? Had the process been operationalised, it could have contributed significantly to the national exchequer. But there is one more worrying aspect to this scam. For most of the period when the allocation of coal blocks was done, the coal ministry was headed by none other than Prime Minister Manmohan Singh. This has created a furor in the Parliament with the Opposition demanding the PM's resignation. Besides coal, the CAG report on power has accused the government of favouritism and benefitting companies such as Reliance Power and Tata Power.

The most talked about IPO of the year was that of social media giant Facebook. Investors were so optimistic about its future that they kept revising valuations upwards. Basically implying that whatever the valuation, the stock was worth getting into. But just three months since its listing, the same investors would be kicking themselves. For the stock has lost nearly half of its value. The big question that now haunts everyone is what next? Should they continue to hold on to the stock for the 'big story' to play out? Or should they sell? Unfortunately for these investors there is no correct answer to solve their dilemma. The big investors of Facebook seem to be cashing out on their holdings. Till now something that prevented a big fall in the share price was the lock-up period. When a large portion of these shares came off the lock-up period (earlier this month), the stock saw a steep decline. Come November, another 1.2 bn shares would come off the lock-up period. This may cause a mass exodus of investors who would be looking at cutting their losses. Whatever it is investors of Facebook are looking at bad times ahead. Pity they did not think about the company's fundamentals before they invested in it. If they had they would have realized that the valuations were nothing but a hype. And that underlying fundamentals just did not justify them.

The Indian equity markets traded well above the dotted line throughout the day so far. At the time of writing, the BSE-Sensex was trading higher by 0.5%. Gains were led by heavyweights from the IT sector with Infosys leading the pack of gainers. The sentiments seemed similar for other major Asian stock markets as China and Hong Kong ended the day higher by about 0.5% and 0.1% respectively. Japan, on the other hand, ended lower by 0.2%.

 Today's investing mantra
"Understanding how to be a good investor makes you a better business manager and vice versa" - Charlie Munger

Click here to read our series on 'Lessons from Charlie Munger'

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3 Responses to "Are banks' bad debts bigger than what is stated?"

Ankur Jain

Aug 22, 2012

I would be really worried about my investments in such stocks. Hope the stock analysts don't just look at the published results but also take in to account the future risks associated with such loans. Are the banks mandated to disclose such loans in their ANNUAL REPORTS??? How is the general public supposed to know of such events and make their investing decision on an informed basis???

Like (2)

sunil gandhi

Aug 21, 2012

Yes I apprehend it to be an astronomically high figure. Since almost all top managements of perhaps all the banks spend time in putting the things under wraps and busy in window-dressing their balance sheets. They despite knowing the willful defaulter continue to pamper them, they are breaching the trust of all their stakeholders be it the shareholders, depositors, govt and public at large. They just try to pass on the buck to the professionals and just complete the paperwork. Some serious introspection is required . The Central Bank is also keeping its eyes closed, it just wakes up when the water goes over the head.

Like (2)


Aug 21, 2012

The restructured accounts are deleberate by the concerned authporities to hide the financial truth of the Banks and FIs. Most of the accounts even up to 95% will go bad debt provided they are not restructured on one or the other pretex. I am of the opinion, that all such restructured accounts must be screened by RBI high level committee to be headed by CAG to find out that "whether restructuring is becasue of genuine reasons and projected cash flow and fund flow is realistic or not". I not then why and who?

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