A treatment for the bad loan disease

There is a depressing similarity between the Vijay Mallya and Nirav Modi cases. Both of them cheated the Indian banks of over ₹22,000 crore and are enjoying their ill-gotten gains after fleeing India. But to put the matter into perspective ₹22,000 crore is a small fraction of the total Non-Performing Assets (NPAs) of banks that runs into lakhs of crores.

The figures are astronomical and mind boggling. A very large percentage of these NPAs are loans to corporates. Defaults by retail borrowers are small. From this it is obvious that the banking system is being exploited by willful defaulters — mainly large borrowers — capable of “pulling strings’’ to get their loans passed without a thorough scrutiny or project appraisal. These unscrupulous borrowers either exploit the inefficiencies in the banking system or collude with bank officials to defraud the system.

It may not be possible to completely eliminate NPAs. But structural reforms in two areas could definitely improve the situation significantly: One, the management of PSBs, and two, handling of cases of bank frauds by investigating agencies. The scope of this article is limited to suggesting five steps which, if implemented, would go a long way in reducing NPAs over a period of time.

Selection criteria

First, the system of selection and appointment of top officials — executive directors, board members and chairperson — in banks needs a complete overhaul.

The person at the helm of the affairs can make or break an organisation. The quality of top management is one of the main problems in PSBs. There is political interference in the selection process. Merit is seldom considered as the main criteria. Expecting an official who paid for his or her promotion to be upright or righteous is asking for too much. His or her priority would be to recover the cost with interest and make as much as possible for the future.

Such officials would also be compelled to advance loans whenever ‘a request’ is received from his or her mentors in ‘Delhi’, often without an appropriate credit appraisal. Inevitably many such loans become NPAs and at some stage have to be written off.

The accountability systems in banks are practically non-existent, which works to the advantage of all concerned — the borrower, senior officials and the powers to be in Delhi.

The country has had very competent and honest bankers such as RK Talwar, former Chairman of SBI, who stood their ground notwithstanding the consequences. Since he refused to toe the line, he was shown the door. But he chose to go rather than hurt the interests of the organisation he served. But Talwar was an exception.

So, the first reform should be to put in place a mechanism to ensure selection of competent and honest bankers.

Skilling senior staff

The second step should be to ensure that senior bankers are well trained in project appraisal. Project finance requires different skill sets than those acquired by bankers in routine banking operations. Earlier, development financial institutions such as ICICI and IDBI had strong project appraisal departments. Large international banks have specialised set-ups for every industry where employees are trained in assessing long-term trends and the viability of the project for which the loan is proposed to be advanced.

The public-sector banks have no institutional mechanism to develop such skills.

Most of the financing is, therefore, balance sheet financing which come with their associated problems. In some cases, branch managers or officers, whose careers are mostly spent at the branch level, clear large loans. Without the required skill sets, even with the best of intentions, these loans will turn NPAs.

In the context, it is relevant to recall what SS Nadkarni, another brilliant banker, said on project financing: “I never finance a balance sheet; I finance a project and the people behind the project.”

Strengthening vigilance

The third step would be to strengthen the vigilance departments. There is no effective vigilance mechanism in PSBs. The vigilance department manages to net only the small fry, where many mid-level or junior officers are punished for small procedural lapses.

Even if the vigilance finds any lapses on the part of top officials, they are seldom reported. An effective vigilance department would be able to detect a ‘quid pro quo’ in awarding a loan or a nexus between a bank official and a rogue borrower in flouting the norms.

Time-bound probe

Fourth: There is a need for time-bound investigations. Some cases of large NPAs which are in the public domain or there is evidence of willful default are referred to Central Bureau of Investigation (CBI). The agency takes years to conclude a case, by the time many witnesses would have retired and forgotten the details of the case or even be dead. It should be made mandatory that every case should be concluded in two years. In exceptional (more complicated cases) situations, it could be extended to three years.

Raising accountability

Fifth: The government is the majority owner of PSBs and it has a big say in their management. Usually, the government is represented on bank board by bureaucrats from the Ministry of Finance. These officers often come with little experience or knowledge in banking. They may be brilliant officers but by the time they learn the elementary lessons in banking and financial services their term usually ends. But being the representatives of the owner as well as being closer to the political powers, they exercise a disproportionately large influence on the decisions taken by the Board. Yet the irony is that they are never held responsible for the decisions which they foist upon the Board.

So the system needs to change. One way could be to appoint officers for a longer period of time in the same ministry and provide them with training in banking and financial services. Another option could be to induct of professionals from the industry who could bring in necessary expertise.

Finally, the regulator — the Reserve Bank of India — has a major role in safeguarding the health of banks. It cannot absolve itself from this responsibility just by ` announcing quick-fix-measures immediately after a fraud is unearthed. The RBI has enough powers even to replace a bank board when it comes to safeguarding the depositors’ money.

The rot in the Indian banking system is deep but it can be treated. Unless the measures suggested are implemented effectively, the banking system would continue to be a cash cow for the politicians, bureaucrats, and businessmen. And the people of India, including the poorest of the poor would continue to pay the price.

The writer is former Financial Director of Shipping Corporation of India

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