Macroscan . The vulnerability of private banks warrants concern

It has been known for some time that YES Bank is beset with problems. Even so, the sudden decision to supersede its restructured board and hand over control to the State Bank of India has ignited concerns that there is much that ails India’s private banks. These concerns relate in particular to the new private banks, created after the liberalisation of the bank licensing policy that allowed for new entry. Unlike the old private banks, that were seen as remnants of a bygone era, the new ones were expected to induce new dynamism into the banking sector.

Unfortunately, the experience with new private banking does not inspire confidence. The first spurt in new private banking was triggered in 1993, when private banks were allowed either to emerge out of existing financial institutions or to be set up anew. The banks that emerged from that first round of licensing included ICICI Bank, HDFC Bank, UTI Bank (which later became Axis Bank), Global Trust Bank, Times Bank and IndusInd Bank. Of these, Global Trust Bank failed because of suspect transactions involving the stock market and other sensitive sectors and had to be merged with the state-owned Oriental Bank of Commerce. Times Bank decided to opt out of the game shortly after its establishment and merged with HDFC Bank.

The second spurt in new private banking was after 2004, when Kotak Mahindra Finance Ltd was permitted to convert itself into a bank and YES Bank was granted a licence. YES Bank has now turned insolvent, requiring a large infusion of capital from and takeover by the State Bank of India.

The third round of new private bank growth is much more recent, with licences being granted to IDFC Bank and Bandhan Bank. Thus, with the public sector SBI taking over YES Bank, of the 10 new private banks mentioned above, only seven remain in operation; two of these are yet to establish themselves on a firm footing.

Rise in credit

Given this disappointing record of new private banking over more than a quarter of a century, it is not surprising that the YES Bank implosion has sparked larger concerns. The case for such concern has been strengthened by the evidence on the operations of these banks, highlighted by YES Bank’s short history.

Among the features pointing to potential vulnerabilities in this segment of Indian banking is the unusually rapid growth in credit advanced by the new private banks. It is now known that, facilitated by financial liberalisation and an easy liquidity situation resulting from large foreign capital inflows, the economic expansion in India’s high growth years between 2004 and 2008 was driven by a sharp rise in credit advanced by the scheduled commercial banking system.

While crisis year 2008-09 saw a temporary halt in this trend, it revived immediately thereafter. As Chart 1 shows, between 2008-09 and 2013-14, credit outstanding more than doubled in the case of both public and private (new and old) banks, with the figure rising by 2.2 and 2.4 times, respectively.

We also know now that the credit boom resulted in lending to entities that could not meet the interest and amortisation payment commitments, leading to repeated defaults despite large-scale debt restructuring.

Much of this lending, especially in the case of the public sector banks, consisted of large loans to big corporates in capital-intensive and long-gestation projects.

Private-bank lending

Recognising that this trajectory was not sustainable, as loan restructuring had merely resulted in under-reporting of non-performing assets (NPAs), public sector banks eventually slowed down their lending. Over the next five-year period from 2013-14 to 2018-19, the volume of credit outstanding in the case of public sector banks rose only 1.29 times (Chart 1).

However, private banks seem to have behaved differently, and exploited the partial lull in public bank lending to hugely expand their loan books. The volume of credit outstanding in the case of private banks rose by 2.64 times during this more recent five-year period (Chart 1). The result was that the share of private bank lending in the total public plus private bank lending rose from 19.9 per cent in 2008-09, to 21 per cent in 2013-14, and a huge 35.2 per cent in 2018-19 (Chart 2). Private-bank lending expanded even when economic growth began to decelerate.

Among private banks, the new banks drove this credit splurge. As Chart 3 indicates, while credit expansion ratios in the case of all private banks rose by 2.4 per cent and 2.5 per cent during 2009-14 and 2014-19 respectively, the ratios were much higher in the case of the new private banks, with IndusInd registering figures of 3.4 per cent and 3.5 per cent, Kotak Mahindra 3.2 per cent and 3.9 per cent and YES Bank 4.4 per cent and 4.5 per cent respectively.

Thus, while YES Bank was definitely an outlier, its behaviour reflected a tendency that seems to hold for a range of new private banks.

Liberalised environment

It has been argued that the problem of NPAs in the public banking sector is a result of their ownership, with the state using its control over these banks both to drive infrastructural investment without adequate due diligence, and to support a crony capitalist environment. But such influence of the state cannot hold for private banks, which function in a more liberalised environment.

The fact that they too behave in a similar manner speaks to the consequences of neoliberalism, which does away with conventional modes of financing capital investment such as tax- and debt-financed state expenditure and loans from development finance institutions, creating a space for banks to enter this area.

Besides, neoliberalism, through its privileging of monetary over fiscal policy and by opening up the economy to cross-border capital inflows, also results in a significant increase in liquidity in the system. Exploiting that “opportunity”, private banks seek to expand rapidly, especially as restrictions on their operations are liberalised as well.

Liberalisation also allows for regulatory forbearance of the kind seen in the case of YES Bank. Such forbearance has obviously resulted in stressed assets and weakness resulting from overexposure to particular sectors and borrowers being ignored for long. In addition, it has enabled malpractice and fraud aimed at benefiting private banks’ promoters and the borrowers they choose to collude with.

It is clearly time to revisit the policy of promoting new private banks and rethink the overly liberal regulatory framework within which they are allowed to function.

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