The real story behind the bad loans of Indian banks

Sep 9, 2015

- By Vivek Kaul

Vivek Kaul
In several previous columns in The Daily Reckoning newsletter, I have talked about the bad loans that are accumulating with banks in general and government owned public sector banks in particular. A major portion of these bad loans is from corporates who had borrowed and are now not repaying the loans.

A standard explanation from the corporates is that these are tough times for the economy and given that they are not in a position to repay. The trouble is that this is not always true. As a recent research brought out by EY and titled Unmasking India's NPA issues - can the banking sector overcome this phase? points out: "While corporate borrowers have repeatedly blamed the economic slowdown as the primary factor behind it[i.e. defaulting on bank loans], periodic independent audits on borrowers have revealed diversion of funds or wilful default leading to stress situations."

Nevertheless, despite many wilful defaults, banks don't declare such defaulters as wilful defaulters. The RBI defines "wilful default" as a situation where a borrower has defaulted on the payment/repayment obligations despite having the capacity to pay up. Or the borrower hasn't utilised the loan amount for the specific purpose for which the loan was disbursed and diverted the money for other purposes. Or the borrower has siphoned off the funds. Or the borrower has defaulted on the loan and at the same time sold off the immoveable property which acted as the collateral against which the loan had been granted.

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The EY report explains quoting bankers, why banks and bankers don't declare borrowers as wilful defaulters: "It is more or less certain that if we declare a borrower a "wilful defaulter," he will approach the court. Then it becomes our responsibility to justify our action with supporting evidence. It is not always possible to establish that the borrower has siphoned off the money or used it for a purpose other than the one which loan has been taken. Hence, we need to be extremely cautious before we declare someone a "wilful defaulter." Otherwise, we will not only lose the case, but we will also let the defaulter off the hook." What the survey does not point out is that unlike the corporate defaulters, public sector banks do not have the best lawyers on their speed dial.

As on December 31, 2014, the top 30 defaulters accounted for nearly one third of the bad loans of close to $47.3 billion, which is clearly worrying. Also, many high value loans have gone bad. And they keep piling up. In fact, in a survey carried out by the EY Fraud Investigation & Dispute Services found that 87% of the respondents that included bankers stated that diversion of funds to unrelated business through fraudulent means is one of the root causes for the NPA crisis.

Also, 64% of respondents believed that these bad loans resulted primarily because of lapses in the due-diligence carried out by banks before the loans were sanctioned. In fact, the report also talks about third party agencies that banks need to depend on while figuring out whether a borrower is good enough to be lent money to, as well as what he is doing with that money, once the loan has been given out.

As the report points out: "Third party agencies such as surveyors, engineers, financial analysts, and other verification agencies, etc., play a critical role in assuring financial information, proposals, work completion status, application of funds, etc. Lenders rely significantly on the inputs issued by such third parties."

The trouble is that the system can and is being manipulated. "Reports are made as a routine, with little scrutiny. In some situations, the reports may be drafted under the influence of unscrupulous borrowers," the EY report points out.

For the entire process of loan disbursal as well as monitoring mechanism to work well, the third party system needs to work in a transparent manner, which it currently doesn't. As per the EY survey, two out of the three respondents agreed that third party reports could be manipulated in the favour of the borrower. Further, 54% of the respondents attributed the bad loans to the inefficiencies in the monitoring process, after the loan had been given out.

And if all that wasn't enough 72% of the respondents claimed that the crisis in banking because of bad loans is set to worsen before it becomes better. The reason for this is very simple-many loans which have gone bad have not been recognised as bad, and instead have been restructured i.e. the borrower has been allowed easier terms to repay the loan by increasing the tenure of the loan or lowering the interest rate.

As the EY report said quoting the bankers who had participated in the survey: "The stressed accounts that have been hidden till now would keep the NPA [non-performing asset] level rising at least for the next 2-3 years." In simple English what this means is that many restructured loans will turn bad in the years to come, as borrowers will default.

The EY report further pointed out: "The reported numbers are quite high, and there are fresh additions every quarter, leading to further deterioration in asset quality. The portfolio of restructured accounts is adding to the problem at hand, thereby resulting in crisis."

In fact, the corporate debt restructuring numbers have jumped up big time over the last few years. The number of cases has jumped from 225 to 647 between 2008-09 and December 31, 2014. This is a jump of 187%. In fact, in terms of the amount of loans, the jump is 370% to over Rs 450,000 crore.

The bankers that EY survey spoke to made several interesting points. Several borrowers go through the corporate debt restructuring mechanism just to ensure that they can drive down the interest rates on their loans or increase the repayment period. Also, even in cases where the borrower is in trouble nothing really comes out of the restructuring scheme. As the report points out: "These schemes are often used to soften the pricing terms, elongation of repayments, without improving the basic viability of the business."

What all this clearly tells us is that the Indian banking system will continue to remain in a mess over the next few years, as restructured loans keep turning into bad loans.

Stay tuned and watch this space.

Publisher's Note: Vivek Kaul, the India Editor of the Daily Reckoning, just made a bold call - Real Estate prices are headed for a fall. Well, if you are someone who is looking to buy real estate, or is just interested in the space, I recommend you read Vivek's detailed views in his just published report "The (In)Complete Guide To Real Estate". To claim your copy of this Free Report, just reconfirm your Free subscription to the Daily Reckoning...

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. Vivek is a writer who has worked at senior positions with the Daily News and Analysis (DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. The latest book in the trilogy Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System was published in March 2015. The books were bestsellers on Amazon. His writing has also appeared in The Times of India, The Hindu, The Hindu Business Line, Business World, Business Today, India Today, Business Standard, Forbes India, Deccan Chronicle, The Asian Age, Mutual Fund Insight, Wealth Insight, Swarajya, Bangalore Mirror among others.

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14 Responses to "The real story behind the bad loans of Indian banks"

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rajesh

Dec 7, 2015

sir,

I have gone through the comments for NPA in banks but none of you have exactly know how the NPA grows inside the banks and how it can be dealt. Who are corporates and how they are grown to such a level in banking business. my self experience can reveal this mass accumulation of BAD loans and NPA'S can be taken into consideration for controlling such mishaps in the economy. I am writing this since my own experience has lot to tell openly to public.

THANKS

Like (3)

Subodh Agarwal

Sep 16, 2015

The real story behind ths NPA is the intention & willingness of the borrowers which is supported by the lawyers throuh courts.I as ex-bank employee has an experience how borrower behaves---
1. When RBI anounced OTS way back in 2001, we dispatched the postcards to borrowers/guranters for availing the benefit under the scheme, the first person turned up for availing the benefit was a meat seller , who settled his account the same day.
2.I had a privillaged to recover full amount from a borrower whose case had been decreed in 1976 (wherein both borrower/gurantor expired) in 2001 under the scheme, this had become possible when a highcourt ordered that recovery certificate can also be issued in case of cash credit accounts, as banks issues in case of goverenment sponsored scheme.

Now to make recovery in NPA account government should issue guidelines for issue of recovery certificate as in the case of government dues and financial defaulters should be categorised under criminal offence.

To prevent the rising NPA government should make it mandotary that a person can either be a director in a company or a proprietor/partner in a firm i.e.a person can perform number of activity in one unit instead of running number of companies(units)/firms in different capacities.

As per court cases, in different court at different time there is no issue regarding the principal amount.therefore that should be diposited with the bank before filing an appeal in the court otherwise the borrower/guarantor should be treated in the manner as SUBROTO SAHARA is facing since March 2014.

Like (3)

RGV

Sep 11, 2015

Another reason for the build up of NPA' is the various court judgements, which go more in favor of the corporate than in favor of banks. It is not only due to the PSU banks not having the where withal to employ good lawyers compared to that of Corp orates, is the Corporate bias of the courts. How many, landmark judgements have we heard in favor of banks, when in many other cases courts have given judgements through out of the box thinking and have corrected several wrongs- but the same does not happen in the case of NPA's. Even if the banks cannot give evidence of fund diversion to courts, not paying back loans at the appointed time itself, courts should put such corporates to task or if Corporates plead financial problems- courts should appoint appropriate authorities to examine whether this is really so.

Like (2)

A.T.Poonawalla

Sep 10, 2015

The amount of $ 47.3 bn accounting for 1/3 of bad loans by 30 top defaulters as on 31 Dec. 2014, would mean that the total of bad loans @ Rs 64 to a Dollar is Rs 9,01,160 crores a staggering figure, which is increasing. Wonder
whether any of the players in the whole gamut of the banking system has any real concern about the interest of the Depositors and public shareholders. There is no easy solution except the exercising of vigilance at the time of granting the loans, proper monitoring to see that the purpose for which the loan was granted is not being vitiated, the interest and repayments are recovered on
time, frivolous appeals for reconstruction, extension, and softening of terms of interest is not easily allowed.
Interference of any kind in the functioning should be
stamped out stringently and strong action taken against
personnel found guilty of dereliction of duty. This
needs the unstinting support from the top government
level for the situation to improve in a time bound manner.

Like (2)

MANJUNATHAN BELLUR

Sep 10, 2015

NPA Stories of banks are more complex than seen outside .
Each NPA tells a different story . To generalise is only will trivialise the reasons . Is NPA percentages are more than the failure percentages of enterprises which have done business on their own capital ? I didn't find an answer for the question in the article . If so how much more ? The answer will throw light on how much NPAs could have been controlled by the banks through better monitoring . If economy itself is not doing well and if entrepreneurs are failing in their genuine efforts or taking higher risks than they can manage , bankers can do little through mechanism of monitoring . However bankers can do / have to do much more to prevent diversion ,
frauds etc if NPAS are mainly due to ethical failures on the part of borrowers as well as other monitoring agencies including bank staff , chartered accountants , lawyers etc . Sometimes failures because of the first reason are postponed to be identified using second method of fraud . But to differentiate NPAs on these lines and to find solution in each case is easier said than done . Even attaching "wilful defaulter " tag has been misused by the concerned .Real wilful defaulters should be punished expeditiously and put behind bars to give warnings for others . Hardly we find any such instances happening . Until that time , banks continue to be taken for ride
MANJUNATHAN BELLUR

Like (2)

Shrinivas Moghe

Sep 9, 2015

Experience is a mother of improvisation. Banks should learn from their experiences and make improvement. For monitoring large loans, bank can compose its own audit team to cross check reports of third party inspectors. This will put pressure on the third party inspectors for remaining truthful to their responsibility. Diversion of loan amount is not possible, unless the banker is party to it. If the Corporate has borrowed from more than one bank, chances of manipulation are more. This must be discouraged. Its easy to monitor loans disbursed for acquiring assets, but its rather very difficult to do so for loans, for the purpose of Working. I feel that banks should concentrate more on giving smaller loans to smaller clients. Corporate should raise funds from share market. Banks can exercise better control on smaller clients. NPA from small and medium scale Units, are easy to tackle as compared to large scale Industry.

Like (2)

G Darad

Sep 9, 2015

I don't know what is your motive behind this real story, but I know for sure that you are very late. Manipulation of the system and it's modus operandi is a matter of common knowledge and no any particular section is to be blamed for it. In fact, all of us, politicians, bureaucrats, bankers, professionals have a sound mutual understanding in this regard. What's new in this is that after learning their most significant lessons from the American sub-prime, corporates have become smartest of the lot and are the first to pluck the fruits of liberalization. Long live the market ! Now please take care of your subscribers and protect their hard earned money. Balance sheets don't tell everything. While looking for value, we also mean values of the management. Subjectivity can't be dispensed with altogether.

Like (2)

Charan Rawat

Sep 9, 2015

What E & Y has also not highlighted is the fact that Charteerd Accountants are not being completely ethical when the certify the so called statutory accounts, basis which bankers assess a company.

THe malaise of various professional service providers not being completely ethical in expressing their professional opinions is also a major cause of over valuation of securities / erronweous or fabricated legal evaluation reports etc. Are these professional bad apples penalsied by the banks or reported to the profioessional bodies for debarrign them from further practice.

Like (2)

Manish Shah

Sep 9, 2015

How can the system improve or things change unless the third party agencies are also held accountable ( by way of civil and criminal penalties) because as you have very rightly pointed out decisions of Bank depend very significantly on these agencies inputs. But i doubt very much that this can happen because this is a Big fraud scheme of very powerful people and Lobbies of taking the money from Banking system and make Government pay for the same from Tax payers money by way of recapitalisation of the Banks.Pray why should the money of honest tax payers like me be used to recapitalise the banks for the Bad loans created out of fraudlent collusions? amend the Laws/rules ( like SARFESAI Act) to identify and take over the properties of people involved in collusion ( whether in their name or in other names ) to recover the money and at same time jail them also. You will then see the improvement very very fast.

Like (1)
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