The financial sector in India is being improved rather than overhauled
India’s biggest banks tend to have official-sounding names, worthy of a central bank. There is State Bank of India, Union Bank of India, Bank of India and even Central Bank of India (the actual central bank is called the Reserve Bank of India, or RBI). That is because, starting in 1969, the entire financial system was nationalised. Although the government has grudgingly permitted private-sector banks over the past 20 years, the 27 public-sector banks (PSBs), which are listed but majority-owned by the government, still account for 70% of lending. That is a worry, because the PSBs are in terrible shape, having lent freely to companies that cannot pay them back. In response, both the government and the RBI are imposing various reforms—but not the most obvious one.
Indian banks dodged the global financial meltdown in 2008. But they promptly embarked on a frenzy of lending to big companies, sowing the seeds of a home-made crisis. The PSBs gleefully funded infrastructure projects that never got the required permits, mines with an output made much less valuable by slumping commodity prices, and tycoons whose main qualification was friendship with government ministers. PSBs have tried to gloss over the problem for years, but the RBI is now forcing them to admit the true extent of the damage.
The reckoning has been brutal: 3 trillion rupees ($44 billion) of loans have been recognised as “non-performing” by banks in the past two quarters, the vast bulk of them at PSBs; 17% of all loans there have either been written off, provisioned for or categorised as impaired, according to Credit Suisse, a bank. More losses are in the pipeline. The revelations have driven the combined market capitalisation of the 27 PSBs down to that of a single well-run private lender, HDFC Bank, founded in 1994.
Tidying up a mess on this scale is never easy, but it is proving particularly tricky in India. The absence of a bankruptcy law (one was enacted in May but it will take months, if not years, to become operational) leaves bankers powerless in the face of defaults. Indian lenders recover just 25% of their money from delinquent borrowers on average, and only after four years of haggling, compared with 80% in America in half the time. A creaky judicial system piles delays upon delays.
Worse, as quasi-bureaucrats, Indian bankers are loth to do the one thing that would help a recovery, which is to sell iffy loans to outside investors and move on. Such investors exist, albeit in limited numbers, but doing business with them can be treacherous: if the borrower’s fortunes recover after a sale and it pays back the new owner of the loans in full, bankers fear government auditors will accuse them of selling the distressed loans on the cheap. Best for the bankers to do nothing, and hope that the situation somehow improves.
The government wants to change this dynamic. A new “bank board bureau”, headed by an unimpeachable former government auditor, has been created to insulate bankers from government meddling, and so give them cover to sell assets at less than face value. Much of what it suggests is sensible: giving longer terms to PSBs’ bosses, for example, and ensuring they are not judged merely on how quickly they increase the bank’s loan book—part of the reason the PSBs ran into trouble before. The government also wants to halve the number of PSBs through mergers.
That is not enough to solve the PSBs’ problems, however. By almost any measure, they lag behind their private counterparts. Costs gobble up 57% of their revenue, compared with 43% at private banks. Net interest margins, the difference between the rate a bank pays depositors and the one it charges clients, stand at 2.4% in PSBs and 3.9% in the private sector. No PSB is valued at more than the value of its assets minus debt (some trade closer to 20% of their book value), unlike almost every private bank. Less than 5% of private banks’ loans have soured, compared with the 17% figure at the PSBs.
The state-owned banks’ defenders point out that private-sector banks, by and large, focus on consumer loans, which have done better than corporate lending. That is as much a matter of skill as luck, however. The largely untroubled private banks are steadily gaining market share, making 58% of new loans last year despite accounting for just 30% of the existing stock, according to Credit Suisse. The corollary is that lending to industry (excluding infrastructure), which the PSBs dominate, has all but stalled (see chart). That bodes ill for the economy, especially since India’s capital markets are too puny to take up much of the slack.
Analysts estimate that PSBs will need $30 billion-50 billion in fresh capital. To date the government, which is trying to cut the budget deficit, has offered just $11 billion spread over several years. A heftier package will come later, an official says, when banks are in better shape. The shortage of capital makes it harder for banks to sell dud loans, since the losses involved might push some below the minimum levels. Meanwhile, struggling PSBs are not passing on the central bank’s interest-rate cuts to consumers in full.
The government may sell down its stakes in PSBs to raise extra capital, but is determined to remain a majority shareholder. That means their staff will remain de facto bureaucrats, subject to elaborate rules on hiring and firing and limited to government pay scales. Arundhati Bhattacharya, the well-regarded boss of State Bank of India, the biggest PSB, makes $35,000 a year in pay and bonuses. (The boss of US Bancorp, which is of a similar size to SBI, made $11.6m last year.) The obvious solution is full privatisation—but that would require parliamentary approval the government is unwilling to fight for.
Source: The Economist
