No hoodwinking the banks

The Finance Ministry has instructed public sector banks (PSB) to bring all borrowers with individual credit limit of more than Rs 150 crore under a Joint Lending Arrangement (JLA).

The directive, issued last week, virtually ends the party for freeloaders who were benefitting from so-called multiple banking arrangements, wherein each bank lent individually to the same borrower based on separate documentation; at best, they would seek no-objection certificates from the other banks for sharing of security.

With the new directive being made applicable to all PSBs, who enjoy a combined market share of close to 75 per cent in loans and advances by the Indian banking industry, it is now curtains for the free-for-all masquerading as multiple banking.

Multiple banking arrangements were basically the product of the first flush of liberalisation in 1996, when the Reserve Bank of India (RBI) abolished the system of mandatory consortium arrangements for loans above Rs 50 crore. The RBI had hoped that the move, by giving flexibility to corporates to borrow on differential terms, would promote competition.

A game without a referee

Instead, over the years, multiple banking has degenerated into a game without any referee, no ground rules and not even proper boundaries.

The consortium lending arrangement at least had the benefit of periodical meetings of lenders, exchange of information, comparison of notes on the borrower's performance, conduct of accounts, joint inspection of borrowers' units and assessment of credit limits.

Multiple banking, on the other hand, gave a go-by to credit discipline altogether.

Though the RBI has issued detailed instructions on sharing of information among lenders even under multiple banking — going to the extent of specifying the formats for sharing of information on loan accounts — there were gaps in compliance. These were exploited by borrowers by playing one bank against the other, especially the PSBs. In the process, credit discipline got diluted, with deleterious consequences for monitoring, follow-up, and loan recoveries.

As promoter and the largest share-holder of PSBs, the Finance Ministry has been naturally concerned about this state of affairs. A couple of incidents of fraud reported to the Chief Vigilance Commissioner, wherein borrowers had exploited the lack of timely and adequate exchange of information among banks, is apparently what steeled its resolve to bring some method to the disorder, as it were.

It is not merely the top-rated corporates who climbed on to the multiple-banking bandwagon to enjoy a joy-ride. This writer has come across borrowers with weak financials — highly leveraged balance sheets, sputtering cash flows and stressed debt-servicing capacity — who would confidently say they “will not borrow” under a consortium.

As for the banks, the rush to lend, mainly on the part of PSBs, led to arbitrage for borrowers not exactly amounting to healthy competition. It actually resulted in ‘adverse selection', as no bank had complete information on the borrowers' accounts in the absence of a formal mechanism for information-sharing with other banks.

Club deals

There is enough international evidence showing information asymmetry among lenders to be a major cause for increased loan defaults. To address the problem, the standard global practice is for corporations to borrow — and conversely, for banks to lend — through ‘syndicated' loans akin to consortium arrangements, rather than through the “bilateral” route. This is particularly so for large credit tranches.

Even where the borrowings sizes are small, the loans are raised through syndicated arrangements called ‘club deals'. The number of lenders in these cases being limited, they do not involve formal launch of syndication or invitation to other banks to participate.

The latitude given to the market by the RBI in 1996 was misused by corporates, especially the larger ones, who took additional advantage of the often timid or non-assertive public sector bankers.

Take, for instance, the concept of ‘assessed bank finance' for working capital needs of borrowers. Under multiple banking, each bank arrives at its own assessment of the requirement of the same borrower and sanctions loans.

This has led to situations, where corporates go on a borrowing spree and even existing lenders come to discover these new loans only when requests for sharing of security on a pari passu basis arrive at their door-steps!

Making matters worse is the absence of any firm tradition or practice among India banks of prescribing ‘covenants' for borrowers regarding the maximum leverage, debt-service coverage ratio, interest service coverage ratio and the like, which would impose prudential limits on borrowings. Even where these are formally prescribed, compliance levels are abysmally low.

‘credit commotion'

The missive from the Finance Ministry, in a sense, seeks to address what may be termed ‘credit commotion' that prevails under the guise of multiple banking.

In prescribing the new JLA system, the Ministry had quite rightly noted: “Most large borrowers having multiple banking relationships have independent arrangement with each lending institution, the security offered to each institution is separate and no formal understanding exists between different lenders financing the same borrower.

Further, lenders usually sanction loans/limits on different terms and conditions. This arrangement, however, goes contrary to principles of credit discipline, which require that a wholesome view of entire operations of a customer must be taken by the lender and the assessment and monitoring of credit needs be also done in totality”.

The objective, hence, is to tighten norms “in the background of some high value frauds coming to light after the withdrawal of regulatory prescriptions regarding conduct of consortium arrangement. The Central Vigilance Commission and other authorities had expressed concerns and had attributed the incidents of frauds mainly to lack of effective sharing of information about the credit history and conduct of account of the borrowers amongst various lending institutions”.

The only reservation one might have about the directive is regarding the norm that if any account of a borrower with any of the JLA member-bank turns a non-performing asset (NPA), all other members would have to classify their individual exposures under the JLA as an NPA (even if the borrower has not defaulted on their loans per se).

That would certainly fly in the face of the regulatory standards for asset classification laid down by the RBI, which is based on the ‘record of recovery' with individual banks.

Barring this caveat, the Finance Ministry's instructions are entirely in order and, perhaps, overdue. Supporters of laissez-faire would, of course, cry foul about the latest move. But then, we are a country where, even if someone were to beat up one's own mother, the TV channels would still debate the pros and cons!

(The author is with the State Bank of Mysore. Views expressed are personal.)

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