Banks up to tricks with bad loans again?

Last month, the Reserve Bank of India (RBI) organised a conference of the directors of public-sector banks (PSBs). In his inaugural address, the RBI governor made some startling comments. He said: “One of the critical areas where the role of directors is very significant is in ensuring the integrity of financial statements … We have come across instances where so-called smart accounting methods were adopted to artificially boost the financial performance of the bank.” What had RBI inspectors discovered? In the words of the governor, they had come across tricks “to conceal the real status of stressed loans”, such as:

*Bringing two lenders together to evergreen each other’s loans by sale and buyback of loans or debt instruments;

*Good borrowers were being persuaded to enter into structured deals with a stressed borrower to conceal the stress;

*Use of internal or office accounts to adjust a borrower’s repayment obligations.

*Renewal of loans or disbursement of new/additional loans to the stressed borrower or related entities closer to the repayment date of the earlier loans.

*Shockingly, the RBI has also come across a few examples, where one method of evergreening, after being pointed out by the regulator, was replaced by another method, said the governor in his speech.

Since the governor decided to openly air these charges, I assume it is a serious issue and so I look around for cases where banks were being punished for these transgressions. Unfortunately, I could not find any. However, I notice that the RBI is imposing monetary penalties, mainly on PSBs and many cooperative banks for various violations. Indian Overseas Bank was fined for not complying with income-recognition norms, failure to make the minimum mandatory transfer of 25 per cent of its disclosed profit to the reserve fund, and divergence between non-performing assets (NPAs), as reported by it and as assessed by the inspection. Canara Bank was fined Rs 2.92 crore for non-compliance with Know Your Customer (KYC) norms and not imposing a limited liability on customers in unauthorised electronic transactions, opening several savings deposit accounts in the name of ineligible entities, and registering dummy mobile numbers in several credit card accounts. The bank failed to pay interest on deposits under the daily deposit scheme and had prematurely withdrawn accounts, recovered SMS alert charges from customers not on the basis of usage, etc. HSBC was fined Rs 1.73 crore for failing to update credit information companies about expired credit cards with zero dues. Indian Bank was fined Rs 55 lakh because it failed to take KYC measures while opening an account in the name of a sole proprietary firm, and Bank of Baroda was fined Rs 30 lakh for breaching stipulated transaction limits and failure to apply prescribed interest rates on term deposits. None of the fines pertains to the far more serious fraudulent activities such as evergreening or concealing bad loans mentioned by the governor. Maybe it has still to penalise this activity.

One is not surprised at the attempts at evergreening; banks are prone to do it. But remember there is a difference between private and PSBs. When private-sector banks do it, shareholders pay a price. The stock price eventually reflects how the bank is run. Promoters are ousted and even spend time in jail. When PSBs mismanage their books, nothing happens to bank chairmen, the board of directors, or complicit officials, because there have been no core reforms at PSBs. This has important implications for the system.

PSBs hold the bulk of the savings of the people and are the main source of loans to small businesses and farming and act as the principal channel for delivery of government schemes, subsidies, and pensions. Prudently run, the banking business ought to make good money. And yet, PSBs have often made losses or meagre profits. To keep them afloat, the government has repeatedly injected capital into them, using taxpayers’ money. The reason they lose massive amounts of money with regularity as bad loans is because of rampant corruption in lending to dubious projects that fail. The public learns about these losses when fugitives like Mehul Choksi, Nirav Modi, Jatin Mehta, Sandesaras, or Vijay Mallya hit the headlines. But tens of thousands of large and small businesses have inflicted mind-boggling bad loans on PSBs. In December last year, Union Finance Minister Nirmala Sitharaman told the Rajya Sabha that scheduled commercial banks had written off bad loans of Rs 10 trillion in five years and that only 13 per cent of the write-off had been recovered. Separately, the cumulative recovery of bad loans through the Insolvency and Bankruptcy Code (IBC) until September (since the IBC came into existence in 2016) has been just 30.8 per cent. More than 90 per cent of the bad loans originate in PSBs. Many loans are designed to go bad. Corruption begins at the sanction stage. When a case is referred to the IBC, there are almost no assets left to recover. Bankers have no enforceable collateral, a cardinal sin in banking, especially so since PSBs always lend against assets and not against cash flows.

Since December 2020, the shares of the better-run PSBs have risen two-three times. There is a consensus that the worst is behind them. The recapitalisation of banks, the slow absorption of bad loans in the system, and the normal growth that comes from a growing economy have led us to believe that PSBs are sailing smoothly. Under the Modi government, there is less political interference; it has avoided loan melas for rich and powerful businessmen that we saw between 2005 and 2014 and earlier in the mid to late 1990s but had its own loan mela called MUDRA loans. Those who believe that PSBs are in the clear will get a rude shock if the external environment changes and bank officials again feel emboldened to collude with big borrowers to lend indiscriminately. The governor’s speech is a timely reminder of this possibility.

The writer is editor of www.moneylife.in and a trustee of the Moneylife Foundation; Twitter: @Moneylifers