8:06 am - Friday March 29, 2024

Three reasons why bad loans are a bigger challenge than inflation for RBI

534 Viewed Gautam Comments Off on Three reasons why bad loans are a bigger challenge than inflation for RBI

The fourth bi-monthly monetary policy announcement of Raghuram Govinda Rajan on Tuesday, as expected, was a non-event — both for the financial markets and for the common man. A status-quo in rates doesn’t have any immediate implication on bank lending rates.

Rajan kept the key lending rate, repo rate, unchanged at 8 percent and justified it by emphasising that signs of sustainable easing in price levels are absent so far.

Going by the language in the monetary policy, a rate cut could happen, at the earliest, only in the first quarter of financial year 2016, if retail inflation eases on a sustainable manner.

“Monetary policy (from here onwards) will be data contingent,” said Rajan.

The retail inflation has stayed below for three consecutive months (June-August), while wholesale inflation too has slowed. But food inflation, which has about 50 percent weightage on retail inflation, has remained stubborn.

Food inflation hardened to 9.42 percent in August from 9.36 percent a month ago.

It is probably for this reason, the RBI is unwilling to draw comfort from the seeming decline in inflation numbers.

Rajan said he sees upside risks to inflation “from food price shocks as the full effects of the monsoon’s passage unfold, and from geo-political developments that could materialize rapidly.”

Succumbing to the pressure for a lower rate regime without finishing the battle against inflation would be undesirable for the central bank, which has openly declared a battle against price pressures in the economy.

But, Rajan indeed seems to have a got a hold on the inflation situation. In the presser that followed the monetary policy announcement on Tuesday, he repeated that the RBI is on track to achieve the inflation target (8 percent retail inflation by this January and 6 percent by next).

Bad loan pain

One critical issue Rajan and his colleagues acknowledged but has possibly underestimated is the bad loan scenario in the banking system, including the impact of the recent Supreme Court ruling cancelling the allocation of coal blocks since 1993.

The fate of the money, which banks have lent to develop coal mines and the other investments is uncertain at this point. About Rs 1 lakh crore of money has been given by banks, especially state-run banks, to power plants.

Even though any immediate stress on the books of banks is unlikely, a lot depends on how the government will deal with the re-allocation process.

“We have to see how the legacy of the past is dealt with,” said Rajan replying to a question at the presser post the monetary policy announcement on Tuesday.

The RBI has ruled out giving any special dispensation to banks to recast loans given to power/steel companied caught in the coalgate. That makes these loans even more riskier to banks since they will have to make significant provisions on such loans if they choose to recast these accounts.

The stressed asset portion of Indian banks is about Rs 8.5 lakh crore, or 14% of the total loans given by the banking system. This includes Rs 5 to Rs 6 lakh crore restructured loans and Rs 2.5 lakh crore loans that has already gone bad.

To be sure, the RBI, in January 2014, has already laid out a roadmap to check the incremental bad loans in the system. This is done through early recognition of stressed assets, incentivising banks, which act early and punishing the ones that shows laxity with higher provisions. But that doesn’t address the issue of existing stock of bad loans in the financial system.

Here are a few reasons why bad loan fight can get a lot tougher for Rajan:

One, a major chunk of the bad loans in the banking system has emerged from large corporate accounts, where reasons for financial stress do not necessarily pertain to the genuine issues. These loans are often originated by a nexus of bankers, politicians and corporations.

For instance, during the UPA regime, a construction firm run by the daughter of a cabinet minister managed to secure hundreds of rupees worth loans despite the company being in bad shape. The Rs 350 crore loan subsequently turned bad. That is just one case. Tackling cronies is not the job of a central banker but needs political will.

Second, the Indian banking system is severely constrained with legal interventions in the bad loan resolution process. Typically, whenever a bank begins tackling a wilful defaulter, the borrower firm moves to a court and manages to get a stay questioning the decision of the bank.

The latest such instance came when Vijay Mallya, whose now-defunct airline Kingfisher owes approximately Rs 6,500 crore to banks, managed to get a stay from the Calcutta High Court against the decision of United Bank of India to classify the company as wilful defaulter.

Similarly, banks also find it tough to get speedy resolution through debt recovery tribunals on bad loans. Due to the large delays, the quality of the underlying asset worsens, leading to further losses for the bank. This scenario cannot be changed unless a complete overhaul on laws relating to bad loan resolution in India takes place. Again, the RBI has little control on this.

Third, criminality among state-run bankers (from where most number of bad loan cases has emerged) has emerged as a major reason for the generation of sizeable chunk of bad loans in the banking system. The widening compensation gap in the private and public sector banks is a major reason why state-run banks fall prey to bribery in loan-deals.

Salaries in public sector banks are decided through mutual discussions between the Indian Banks’ Association, the industry body of banks, and the bank unions once every five years. In contrast, salaries of top executives at private sector banks are decided by individual bank boards and shareholders with the approval of the Reserve Bank of India.

Bridging this gap requires efforts at the industry level.

The huge chunk of bad loans on the books of banks also mean that the capital burden of the government to feed these lenders also goes up substantially. That has the potential to damage the budget calculations.

For Rajan, it seems, containing bad loans of Indian banks is going to be much more difficult task than tackling price pressures.

Don't miss the stories followIndiaVision India News & Information and let's be smart!
Loading...
0/5 - 0
You need login to vote.
Filed in

RCom to cut debt to below Rs 20,000 cr over 2 years; 4G roll-out in 2015

Amazon CEO Jeff Bezos meets PM Narendra Modi

Related posts