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Is Your Banker with You or with Corporates?

Jan 22, 2016


What is the purpose of a bank? Any bank?

It is to match lenders with borrowers.

It is to take the savings of people (i.e. deposits) by offering a certain rate of interest and then lend it out at a higher rate of interest, and in the process make a reasonable profit.

Is that all there is to it? No.

The bank also has to ensure that the deposits that it lends out are fully repaid. This means carrying out a proper "due diligence" of the borrower, before lending money. It also means lending only to those people it expects will repay.

It also means not lending to people and companies who are already in trouble. It 'basically' means not putting the depositor's savings at risk.

These are the basic tenets of banking, which the Indian banks, in particular banks owned and run by the government, have broken over the past few years, and continue to do so.

Take the case of the 5/25 scheme which banks have been using in order to restructure loans which borrowers have had trouble repaying. What is the 5/25 scheme? There are many physical infrastructure projects which have long gestation periods of up to 25 years. The trouble is that companies which have borrowed money to build such projects need to repay the principal amount of the loan in a period of around five years.

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And this creates a problem simply because in a short period of five years, physical infrastructure projects like roads do not start to throw up money which can be used to repay the loan that has been taken on.

In this scenario defaults start to happen even though the project continues to remain economically viable. It's just that a period of five years is too short a time for the project to start throwing up money which the corporate can use to repay the loan that it has taken on. Having said that, such a loan could perhaps be easily repaid over a period of 25 years.

The Reserve Bank of India has allowed banks to restructure such loans by allowing corporates to delay making principal repayments of the loan. In some cases, interest repayments have also been delayed.

As Suresh Ganapathy and Sameer Bhise of Macquarie Research write in a recent research note titled Apocalypse Now: "RBI has allowed that going forward, banks can restructure loans such that they can finance the projects for 5 years and at the time of structuring the contract, stipulate an explicit condition that at the end of 5 years, loans will be rolled forward for the next 20 years and define milestone payments at the end of every subsequent 5-year period."

A loan restructured under the 5/25 scheme is not treated as a bad loan. Further, only loans of Rs 500 crore or more can be restructured under this scheme.

All this sounds good on paper. The trouble is this rule is being used by banks to postpone the recognition of bad loans. Take the case of Essar Steel. As Ganapathy and Bhise write: "For example, in case of Essar Steel-an account that HDFC Bank already classifies as a non performing loan and on which the bank has already taken 40% provision-other banks have instead refinanced their loan. According to the terms agreed by the consortium of bankers led by State Bank of India, Essar Steel needs to pay just about 9% of the principal loan in the initial 7 years, and the remaining 91% will be due for refinancing at end-2022."

What does this tell us? HDFC Bank probably the best managed bank in the country has classified Essar Steel as a bad loan. Other banks led by State Bank of India have refinanced the loan. Refinancing essentially means giving a new loan so that the older loan can be repaid, and a new loan can be started on better terms for the borrower.

The question is why are banks refinancing a loan to a company in the steel sector, which is currently in a mess and is unlikely to recover any time soon. The prospects of the sector remain largely subdued over the next five years.

Also, what explains HDFC Bank categorising the loan as a bad loan, and other banks giving Essar Steel a fresh loan? It is not surprising that HDFC Bank as on March 31, 2015, had a net non-performing assets ratio (one representation of bad loans) of 0.20% of its total advances. In case of State Bank of India the number had stood at 2.12%. This is a clear case of what the RBI governor Raghuram Rajan had called "extend and pretend" that all is well.

Now let's take the case of Bhushan Steel. Loans of the company amounting to Rs 40,000 crore were restructured under the 5:25 scheme in February 2015. As Parag Jariwala and Vikesh Mehta of Religaire Institutional Research write in a research note titled SDR: A band-aid for a bullet wound: "Under 5:25, Bhushan Steel's loan repayments have been postponed for the first four years and thereafter are to be made in a staggered manner in the next 21 years. Management stated that the company may face small repayments of Rs 500 crore per annum which in all probability will be funded by the current set of banks."

Between 2015 and 2019, Bhushan Steel need not make principal repayments on the loans worth Rs 40,000 crore. Over and above this, it is not in a position to repay even the small repayments of around Rs 500 crore per year. The banks will give it new loans so that it can pay these dues. Jariwala and Mehta point out that the company can generate only up to Rs 200 crore of free cash flow during the course of this financial year. Hence, it is not in a position to repay Rs 500 crore. The company also has interest dues of close to Rs 4,000 crore during the course of this year.

The question is if a company is not in a position to repay Rs 500 crore currently, will it really get around to being able to repay Rs 40,000 crore over a period of time?

In fact, the loans given to many big business groups are being restructured under the 5:25 scheme. As Ganpathy and Bhise point out: "As the table below shows, several cases are now being considered for 5:25 refinancing, which also explains why some of these large groups are not currently classified as non-performing loans. Close to 1.7% of system loans are under consideration or already being implemented for 5:25 refinancing. Another issue is that banks may have lent fresh loans to these groups to cover interest payments on older loans."

What does this mean? It means that the banks will be able to further delay recognising bad loans as bad loans for the next few years. As Zariwala and Mehta write: "Banks are likely to restructure such accounts through SDR/5:25, which would delay non-performing assets recognition as well as increase the likely losses due to additional funding." To conclude, it is safe to say that the banks are clearly with companies and not with depositors whose hard-earned money they have lent.

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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7 Responses to "Is Your Banker with You or with Corporates?"

manmohan khetan

Mar 22, 2016

Hats off Vivek for enlightening us. PSB banks must have to follow private banks policy for extending credit to corporate houses & core industry.



Jan 26, 2016

PSU Bankers would have been major lenders for the company mentioned and they will go for one-time settlement at heavy discount. with such quality of lending (which will never improve) which investor will invest in PSU banks.


k.v.subba rao

Jan 24, 2016

The article " is your banker with you or with corporates' is very analytical and down to earth.
But who is interested in the safety and welfare of the small depositors money?? government- ? banks- ? ; except probably to some extent present RBI governor- no body seems to consider the interests of small depositors of Banks while taking decisions like reduction of deposit rates etc. It is fully controlled by powerful lobby of politicians -cum- industrialists

Further, in order to safeguard any erosion in their quantum of deposits , banks have presently started applying pressure on Govt to reduce interest on Post office saving deposit schemes.

I feel all the bank depositors form a body and file a PIL in the supreme court - that is the only hope.

Any how, I welcome such analytical and factual articles from the pen of Mr Vivek kaul in future also.

k.v.subba rao



Jan 23, 2016

Thank you Mr.Vivek.Your article is simply brilliant.But pl provide a safe alternative for retired people who have trusted these Public Sector banks and put their money , simply because they are backed by the Govt.I once again thank you for putting things so elegantly simple.



Jan 23, 2016

Promoters should be forced to bring in more equity. If promoters are not confident about their own businesses, why should banks put in our good money after bad money? Government should facilitate additional equity by promoter or take over of the sick companies or its liquidation. Let better managements run such businesses. Commodity prices in India have not fallen. Only price fall would provide further stimulus to the economy. Government should not try to hold the prices at current artificially high levels to protect industrialists. Only when prices fall, other strong businessmen might get interested in acquisitions.

Like (1)

Chintan Taunk

Jan 23, 2016

1. I find SBI more prudent here when they are taking advantage of the 5-25 scheme if it as per within the RBI Guidelines.
2.The reason HDFC Bank has less NPAs is that it hardly lends to the Corporates or finances infrastructure projects in the country. It lends to Corporates who hardly utilise money. One more utility of banks is to shape the economy of the country by undertaking infrastructure projects and partner with Government.
3.Why refinance??? I believe it is always better to refinance projects as the interest outflows in such projects are humongous and extend the repayments so that the company has the legroom to honour such payments in future.
4. There is no bravado in recognising NPAs, true test is how you can help the borrower to come out of the gut who will eventually contribute to the economy- without risking the deposits of your customers.

Like (1)

Girish Patkar

Jan 22, 2016

Not only are banks restructuring the loans but are also giving more money. Some of the names you have mentioned are Groups which believe only in debt finance. The is never equity left in the project. Also they are repeat defaulters and surprisingly Indian banks keep lending to these borrowers.
The only way out is to replace the promoters as is being done in case of electro steel recently.

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