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

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)

V.S.PATIL

Sep 9, 2015

It is dismaying to note that how the corporate borrower diverts the loan amount to a purpose other than the one for which it is disbursed and also disposes off the property mortgaged to the Banks as collateral security for the loan taken. It is simply beyond one's comprehension how these this could happen in the normal course. What control do the Banks exercise to prevent such things? It is a serious lapse on the part of the Banks. I think it is not at all possible for the Banks to disburse loans without finding all the loan papers in order and also physically verifying the property to be mortgaged and have the title deeds thereof deposited with them with necessary endorsements. Despite all these if the borrower disposes off the property mortgaged without repaying the loan means there appears some criminal connivance of the Bank's officials. There is something fishy in such transactions which prima facie appear to have been will fully overlooked so as to help the borrower. An ordinary person wishing to borrow money from the Banks for housing or any other genuine purpose is asked to submit umpteen records, sureties, execute bond paper et al, big fish are let go. It is nothing but systematic and deliberate attempt to loot and rob the public money. It is a travesty of justice that the affluent promoters are willful defaulters and nothing serious is being done to recover loan from then. Affluent promoters and sick company can not be the order of the day. Such loan are added to the already growing size of the NPAs of the PSU Banks. If those who should and can take remedial action in such cases often seem to be turning a blind eye then who else can and how the situation will improve to better the health of our economy?

Like (1)

shridhar

Sep 9, 2015

Good article sir,

Please let us know In this situation whether our FD are safe

Like (1)

Prasanna Venkatesan

Sep 9, 2015

these big loans becoming sticky and bad, cannot happen without the willing, corrupt officers of banks, prodded by politicians and social big wigs. If a small man borrows, Rs. 10,000/- and cannot pay, he is after the bank, begging time.But if he had borrowed Rs. 10crores, the bank will be after him, begging him to pay.They dare not go to court, because of threats from higher ups and politicians.This MUST STOP. Modi and Jaitley CAN do it, MUST do it. Only then, this swallowing of big moneys of the public, by gangsters, supported by corrupt staff and crooked politicians, will vanish.God save our public deposits and bank funds!

Like (1)

Joginder Pal

Sep 9, 2015

Simple & straightforward answer, nearly all bankers in loan department are involved in huge kickbacks.

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