He said that global slowdown, project cost overruns and government decision-making were among the factors that contributed to the process.
"A larger number of bad loans originated in 2006-2008 when economic growth was strong, and previous infrastructure projects such as power plants had been completed on time and within budget. It is at such times that banks make mistakes. They extrapolate past growth and performance to the future. So, they are willing to accept higher leverage in projects, and less promoter equity," he said.
In a note to Parliament's Estimates Committee on Non-Performing Assets (NPAs) of public sector banks, Rajan called for examining MUDRA loans and Kisan Credit Cards more closely for potential credit risk.
In the note prepared on request of committee Chairman and BJP leader Murli Manohar Joshi, the former RBI chief said that the Credit Guarantee Scheme for MSME run by SIDBI is a growing contingent liability and needs to be examined with urgency.
Rajan pointed out that the loan waivers vitiate the credit culture and an all-party agreement to this effect would be in the country's interest in view of impending elections.
Rajan said that years of strong growth before the global financial crisis were followed by a slowdown which extended to India and demand projections for various projects were shown to be increasingly unrealistic.
He said that a variety of governance problems such as suspect allocation of coal mines coupled with fear of investigation slowed down government decision-making in Delhi, both in the United Progressive Alliance and its successor NDA governments.
"Project cost overruns escalated for stalled projects and they became increasingly unable to service debt. The continuing travails of the stranded power plants, even though India is short of power, suggests government decision-making has not picked up sufficient pace till date," he said.
Rajan said that once the projects get delayed promoters with little equity left in the project loses interest.
"Ideally, projects should be restructured at such times, with banks writing down bank debt that is uncollectable, and promoters bringing in more equity, under threat of losing their project otherwise."
Referring to malfeasance and corruption as a factor in the NPA problem, Rajan said: "Undoubtedly, there was some... clearly, bankers were overconfident and probably did too little due diligence for some of these loans."
However, he said, the size of fraud in public sector banking has been increasing though it still is small relative to overall volume of NPAs.
"Unfortunately, the system has been singularly ineffective in bringing even a single high-profile fraudster to book. As a result, fraud is not discouraged."
Rajan said the RBI set up the fraud monitoring cell during his Governorship to coordinate early reporting of such cases to the investigative agencies.
"I sent a list of four high-profile cases to the PMO for coordinated action to bring at least one or two offenders to book. I am not aware of the progress. This is a matter that should be addressed with urgency," he said.
Rajan pointed out that bank recovery rate on defaulted loans was only 13 per cent of the amount at stake... the inefficient loan recovery system gave promoters tremendous powers over lenders," he said.
(This story has not been edited by Business Standard staff and is auto-generated from a syndicated feed.)