CIRCUIT BREAKER. Far too mollycoddled, frankly

There’s growing public disenchantment with the Indian banking system’s cavalier treatment of consumers. A petition on change.org urging the RBI governor to protect customers from patently unfair practices such as arbitrary charges, one-sided loan contracts and mis-selling, has garnered over 31,400 supporters in short order. Despite the rants, however, the RBI and the Government seem to be preoccupied with a diametrically different issue. They’re busy thrashing out a bailout for the same banks from a bad loan mess of their own making!

Anyone familiar with the recent history of Indian banking shouldn’t be surprised by this turn of events. Over the last two decades, the banks and successive central governments have been engaged in a cosy game of quid pro quo , where one covers up for the shortcomings of the other, with consumers footing the bill.

At a press conference this week, banking doyen Uday Kotak pegged the total stressed loans in the banking system at ₹14 lakh crore. That’s equal to the entire tax revenues of the Government in its latest Budget. Of this, ₹4 lakh crore may be written off, while proposals are doing the rounds for the remaining ₹10 lakh crore to be bought off the banks’ books by a public entity, so that they may resume lending with a ‘clean slate’. While hopes are high that the banks will emerge reformed and well-governed from this exercise, bailouts in the last two decades have not yielded this happy result.

In the seventies and eighties, a nexus between the newly nationalised banks and industrial houses led to a large stockpile of bad loans and a sharp dent to the profitability of banks. It was a ₹2000-crore capital infusion from 1985 to 1990 that helped shore them up. In the nineties, after a rural expansion spree, PSBs again ran up NPAs amounting to 23 per cent of their advances. This left them with a capital shortfall of ₹14,000 crore. A government infusion of over ₹20,000 crore between 1994 and 1998 saved the day.

By 2003, banks’ gross NPAs finally showed some recovery, falling to sub-10 per cent levels. But we now know that it was in the next four years that the current NPA mess took shape. If PSBs are recapitalised, private ones are quietly rescued through mergers with healthier rivals.

The flaws in the banking system that contribute to the frequent reappearance of NPAs are well-known. Weak appraisal and risk management systems, lack of accountability for top managers, politically directed lending and a dysfunctional recovery mechanism are all to blame. But when it comes to a choice between letting the worst-managed banks face the music, and citing ‘systemic stability’ to bail them out, successive governments have invariably chosen the latter.

While banks seem to give their corporate borrowers a pretty long rope, retail customers are at the receiving end. Globally, in most financial products, regulators step in to ensure that players do not overcharge retail consumers or subject them to one-sided contracts. But the Indian banking system is a study in contrast.

For instance, two decades after liberalisation, the pricing of bank loans is still decided by a regulatory formula. Over the years, by subjecting banks to Prime Lending Rates, Base Rates and recently the MCLR, the RBI has actually set a floor on the rates at which banks can lend. Even an ambitious or competitive bank cannot stray from the formula to undercut its rivals.

Deposit rates offered by different banks also show little evidence of competitive forces. The savings and deposits rates of all the leading banks huddle in a narrow range, and move up or down in tandem. Despite deregulation of savings deposit rates a few years ago, most Indian banks (except for a few private sector newbies) still stick to a 4 per cent rate. This number changes neither with inflation nor with market interest rates.

While banks expect depositors to lock into fixed rates, they cheerfully pass on rate risks when they extend long-term loans. Retail borrowers bear the brunt of these risks, because most home loans are on floating rate contracts. Whenever other financial product firms — such as NBFCs, small savings schemes or liquid mutual funds — have shown the ability to lure bank customers with better deals, the banking lobby has succeeded in spiking their efforts through regulation or tax tweaks.

Many of these anti-consumer practices would have diminished if the sector saw a disruption to the status quo through new entrants. But the RBI’s parsimonious approach to issuing new bank licences has, until recently, kept competition at bay. With limited-window licensing, the two decades of liberalisation from 1994 to 2014 saw just half-a-dozen new banks enter the market. Yes, thanks to former RBI governor Raghuram Rajan’s efforts, in 2014, the RBI opened a new window for payments banks and small finance banks, and has issued over 20 licences. But universal bank licences are still subject to onerous conditions.

Of course, one big reason for the Government to repeatedly bail out beleaguered banks has to do with safeguarding the interests of depositors. As the lion’s share of household financial savings is parked with banks, it is probably worried that rumblings of trouble even at smaller banks can shake public confidence.

But the symbiotic relationship between the banks and the Centre is also a reason for this tolerance. The Centre has always relied heavily on the banking system to act as a captive financier for its massive borrowings. The Statutory Liquidity Ratio and Cash Reserve Ratio require banks to park nearly 25 per cent of their deposits in government securities. The flood of household savings into banks ensures a steady supply of money for the Government.

Banks also come in handy for budget-constrained governments at the Centre and the States to indulge in populist give-aways. All banks are statutorily required to deploy 40 per cent of their loan book in specified ‘priority sector’ loans with stringent penalties for non-compliance. This apart, when governments announce farm loan waivers, affordable housing, deposit schemes for poor or even overnight surgical strikes on black money, banks are automatically co-opted as its partners. Banks are expected to throw commercial considerations to the winds and function as extended social arms of government.

Therefore, it is hardly surprising that the Indian banking system has been successful in wangling favourable deals from the Government. Recent events suggest that the Modi regime too is falling prey to this pressure. But it is early days. If it can break from its predecessors and cut the apron strings with banks, it would have earned the gratitude of thousands of savers and borrowers.