Ever since the Indian banking sector was hit by the huge non-performing assets (NPA) mess, there has been a blame game going on at the political level. Since most of the loans given out by the public sector banks to sectors such as infrastructure and steel were extended during the boom period of 2004-08, when the UPA was in power, it became easy for the current NDA government to point fingers at its predecessor for the sorry state of affairs.
This is not surprising, as, one, there is an element of truth in it and two, political parties never shy from taking pot shots at each other. But the reality is, as always, more complex.
In perspective
Former RBI Governor YV Reddy has put things in perspective. At a recent speech given at Shivaji University, Kolhapur — which surprisingly didn’t quite get the media coverage it deserved — he said that the current NPA mess can be traced back to the 2008 global financial crisis which was triggered by the collapse of Lehman Brothers. Figures for NPAs are available only from 1996-97 and Reddy says that from that period to 2008-09, NPAs as a percentage of gross and net advances were brought down. But by 2013-14, the NPAs had gone up again.
Reddy says this was largely due to the impact of the measures that the government had taken to deal with the 2008 global financial crisis. The country had seen massive fiscal and monetary stimulus to deal with the crisis, coupled with what Reddy calls “regulatory forbearance”. These include higher exposure limits to corporates. Reddy is candid in saying that the government went too far and the measures perhaps, in hindsight, were “more than needed and continued for longer period than necessary”.
He says banks were encouraged to lend to the infrastructure sector, which was not their core competency, and directly contributed to the NPA mess. Since much of all this happened during the UPA regime, it must take the blame for it.
Unbiased view
But Reddy doesn’t spare the current NDA government. He is very critical of the proposed Financial Resolution and Deposit Insurance Bill 2017, which has since been deferred thanks to the huge outcry against it. He says that this Bill equates depositors with creditors and is glad that it has been dropped. But he adds, thanks to the Bill, “to an extent some permanent damage has been done to the trust in safety of bank deposits”.
Reddy was also critical of how some rich individuals managed to defraud the banking system by willfully defaulting on the massive sums they had borrowed. Indirectly referring to the Nirav Modi-PNB scam, he says that in, this case, the owner of PNB, which is the government, “stands to lose the most”. The government must be worried about the directors it nominated and how they let such a massive scam to take place. The government should also be worried about the “system of monitoring and control of its own investment”.
Reddy does not spare the RBI either — as the banking regulator, its main responsibility is financial stability and depositor protection. He says the PNB scam has hit the credibility of RBI, and it must reassess “its own regulatory and supervisory practices”.
Though the government has taken steps to bring the guilty to book, Reddy says that there is no confidence that they will actually be convicted.
Solutions to the problem
Going forward, he suggests five measures for solving the NPA mess. Crucial among them are government support for the RBI, which will enhance its “effectiveness”. Given the perennial shadow boxing between the Finance Ministry and the RBI, this is a telling comment.
Reddy also calls for clarity from the government on the issue of “public ownership of banks”. For good measure, he adds that “simplistic comparisons with private banks must be avoided”. This, again, is telling in the backdrop of the clamour for privatisation of public sector banks led none other than Chief Economic Advisor Arvind Subramanian.
He also calls upon the State governments to promote and strengthen urban cooperative banks as they cater to the needs of the small businesses and trading class.
The Indian banking sector is clearly at a crossroads. It is in dire need of systemic change as well as massive capital injection. Given the public ownership of most banks and the “client-patronage” links that exist between the political and business classes in the country, it is not surprising that the banking crisis has assumed a deeply political hue.
The former RBI Governor has to cut through the fog to assess the extent of rot in the banking system in the country and has shown the way forward in a subtle manner, without actually taking the names of any political parties.