Beware a lending freeze: PSBs need a structural change in loan-giving

The Reserve Bank of India (RBI) is reportedly planning to ask several public sector banks (PSBs) under the prompt corrective action (PCA) framework to restrict their exposure to fresh credit and freeze staff recruitment. This instruction has already been issued to Dena Bank and Allahabad Bank; it may be extended to several others whose results for the January to March quarter have shown little improvement in terms of the level of non-performing assets (NPAs) or returns. While the NPA ratio of Dena Bank is 19.56 per cent, those of others range from over 15 per cent to 24 per cent. Quite a few others, which are not in the PCA framework as yet, are not far behind. The problem of NPAs thus cannot be seen as being restricted to only a subset of small PSBs.
 
Clearly, the banking regulator is unwilling to continue to be patient, or to either weaken the process under the new insolvency and bankruptcy code to the advantage of troubled banks or to wait for the process of bankruptcy and asset recovery to completely wind its way through the system. Initial optimism about the speed of the asset recovery programme under the new code now seems unwarranted. It has to be recognised that a bank that can no longer extend credit is essentially one that is not operational. These are banks, therefore, that are in effect being told to suspend operations — to shut down. Yet, of course, these are also banks with a large base of retail account-holders whose interests must be protected and employees who are politically influential. What amounts to a shrinking of the public banking sector may well be overdue, but will require careful management. But aside from these issues there is the larger question of the macroeconomic impact of banks becoming unviable. For better or worse, as of now lending to medium-sized business has been the province of PSBs. If many of them are no longer able to do that, who will fund an investment and growth revival? An overall re-examination of the movement of credit in India is required. If bad PSBs are starved, and middling PSBs turned into narrow banks that do minimal lending — which is the only real alternative to privatisation — then non-bank financial corporations will have to pick up the slack in terms of corporate lending. Thus the government and the RBI’s approach to cleaning up NPAs, while continuing to be stringent, must take into account the need to reform the credit system overall, and preserve the ability to take the risky decisions required for lending to the private sector.
 
The government, however, should tread cautiously on moving against bank officials on grounds of mere suspicion as it is likely to have a debilitating impact on the decision-making process in Indian banks. The decision of the Central Bureau of Investigation (CBI) to file a chargesheet in the Nirav Modi case that names top bank officials does not inspire confidence because of the investigative agency’s poor track record.  If public and private sector bank officers anticipate criminal investigation by the CBI for conducting routine business, they are unlikely to take any decision. An economy-wide freeze in lending because of a fear factor is not in anyone’s interest.