Indian banks are too stressed out - Outside View by S.S. TARAPORE

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Indian banks are too stressed out
Jan 9, 2016

The RBI's elegant technical analyses on bad debts is all very well, but it needs to shake up the system

In recent years, the Reserve Bank of India, not without good reason, has combined the statutory Report on Trend and Progress of Banking in India (T&P) required under Section 32 (2) of the Banking Regulation Act 1949, and the Financial Stability Report (FSR) which has a much wider coverage of the entire Indian financial sector against the backdrop of global developments.

The T&P for 2014-15 and the FSR for December 2015 are not reports to be consigned to the archives but benchmark reference documents which should be used as a lexicon by policymakers as also operators.

The report pithily sums up the performance of the banking sector in 2014-15.

First, there was a slowdown in balance-sheet growth, and bank credit expansion fell to single digits.

Second, while profits increased, it was because of a decline in growth of operating expenses rather than a rise in growth of income.

Third, the return on assets (RoA) showed no improvement and, in particular, the profitability of public sector banks (PSB) declined significantly.

Fourth, asset quality declined, particularly for PSBs, and there was a rise in the volume and proportion of stressed assets.

In a nutshell, the report points to a worrisome situation, albeit in a global context. India does not appear to be an exceptional under-performer.

Some concerns

While comprehensive measures have been taken to de-stress the banking sector, the PSBs, which account for over 70 per cent of the banking system, reflect concerns about profitability, asset quality, capital position and governance. While the government has set out an Indradhanush (seven-point action plan), with a Rs. 70,000-crore recapitalisation programme up to 2019, serious doubts have been expressed by opinion-makers as to whether the provision for recapitalisation is adequate.

The RoA for PSBs at 0.46 per cent is less than one-half of what is internationally considered as adequate, and compares unfavourably with the RoA of private sector banks RoA which is 1.68 per cent.

Political economy imperatives point to the non-negotiable position that the government will continue to hold a minimum shareholding of 51 per cent in PSBs.

The way the allocation of the Rs. 70,000 crore is being done is a cause for worry as bank-wise recapitalisation would be need-based. In other words, the weaker banks would get a larger proportion of the recapitalisation.

Hence, all the PSBs would grow at more or less the same pace and the system would veer to further weakening.

FSR pointers

The FSR indicates that apart from the Indradhanush initiative, PSBs will have to review their business models and examine strategic decisions such as capital structure and dividend policy.

Ideally, the government should use a cast in stone rule that the extent of recapitalisation of each bank would be strictly limited to the dividend paid to the government. If this is followed, the stronger PSBs would grow faster and the weaker PSBs would grow at a slower pace.

If the political economy override is that the 51 per cent minimum government ownership is not negotiable, there is no option but to regulate the weak banks to become Narrow Banks. Since the Narrow Banking concept appears to be unacceptable to the authorities, the PSB system is bound to remain in an impasse.

The FSR assesses the Indian financial system against the backdrop of the global financial crisis. In this context the FSR needs to be commended for setting out that "when current wisdom does not offer solutions to extant problems, old wisdom can sometimes be helpful" (Box 1.1, page 4 of the report). The Minsky hypothesis (1992) is that debt accumulation by the non-government sector is the key to economic crisis.

Again, Lawrence Summers draws attention to Alvin Hansen's secular stagnation hypothesis (1939) to explain that with the zero lower bound on nominal interest rates and excess savings it may be difficult to bring the economy back to full employment for many years.

Return to old wisdom

In my writings from the early 1990s, when I was still in the RBI, I have tried, unsuccessfully, to persuade Indian policymakers to 'search for old wisdom' in the Hayekian analysis, under which monetary tightening should be undertaken well before the upper turning point of the cycle.

John Hicks referred to the concept of creeping along the ceiling of growth and to use monetary policy to ensure that the limit to growth is not exceeded.

Hicks in his Critical Essays in Monetary Theory (1967) has a chapter on the Hayek story wherein he refers to the Hayekian analysis being more relevant in developing countries, but in the heat and dust generated by the Third and Fourth Plans, no Indian economist dared refer to the Hayekian analysis.

VKRV Rao, in the 1940s and 1950s, argued that the Keynesian approach was not relevant to India and his slogan was "work harder and save more". It is time we in India turned to these Great Masters.

The FSR provides yeoman service by emphasising that given the correlation between growth in world trade and corporate earnings, sluggish trade growth is likely to have an impact on corporate earnings in emerging markets and developing economies.

The PSBs' stressed assets (gross non-performing assets plus restructured standard assets) amounted to 14.1 per cent of gross assets in September 2015.

The FSR undertakes an in-depth analysis of the stressed assets and while an appreciation of this work needs a high degree of technical knowledge, it should be ringing alarm bells in policy and operational circles in the RBI and the government.

The situation is critical and the authorities need to accept the hard options.

Regulators and supervisors need to be hard-nosed and unforgiving of lapses by banks as also borrowers, especially large borrowers.

Please Note: This article was first published in The Hindu Business Line on January 08, 2016.

This column, Maverick View is authored by Savak Sohrab Tarapore. Mr. Tarapore, is an economist and he runs his own Multi-Language Syndicated Column. Mr. Tarapore's other column, which appears in The Freepress Journal, is titled Common Voice.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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