A story of reckless lending

The problem of NPAs points to banks’ vulnerability to political pressure

Written by Jagdeep S. Chhokar | Published:February 12, 2016 12:12 am

P. Vaidyanathan Iyer, in ‘Govt plans to defuse ticking bank bomb’ (The Indian Express, February 01), deserves congratulations for bringing out in public a proposal to set up an asset reconstruction company (ARC) with equity contribution from the government and the RBI, to deal with the mounting problem of non-performing assets (NPAs), particularly in public-sector banks. The proposal, reportedly first mooted eight months ago, has attracted hardly any public debate.

It’s also reported that the government is determined to go ahead with the proposal and has convened a meeting of “experts”, including some from the IMF, despite the RBI’s reservations about the ARC. RBI Governor Raghuram Rajan is reported to have been “not comfortable”, fearing a “moral hazard”, and apparently said something to the effect of “Why should the taxpayer pay for reckless lending by banks in the past?”

This is the crux of the “moral hazard”. A moral hazard, according to 2008 economics Nobel laureate Paul Krugman, is “any situation in which one person makes the decision about how much risk to take, while someone else bears the cost if things go badly.” Another way to look at it — while trying to discourage some action, we inadvertently end up encouraging it.

The accumulation of NPAs has been caused by “reckless” lending. If taxpayers’ money is used to cover this without any impact on the banks, they are likely to do the same thing again, since no discomfort or harm will come their way for reckless lending.

But why is Rajan so worried when all the “experts” see no problem? Some pointers are available in Rajan’s recent public statements. Delivering the Twentieth Lalit Doshi Memorial Lecture in Mumbai on August 11, 2014, Rajan explained why corrupt politicians win elections: “The crooked politician needs the businessman to provide the funds that allow him to supply patronage to the poor and fight elections. The corrupt businessman needs the crooked politician to get public resources and contracts cheaply. And the politician needs the votes of the poor and the underprivileged.”

His end-of-the-year 2015 letter to the RBI staff said, “We do not punish the wrong-doer — unless he is small and weak. This belief feeds on itself. No one wants to go after the rich and well-connected wrong-doer, which means they get away with even more. If we are to have strong sustainable growth, this culture of impunity should stop.”

Now we come to “reckless” lending. In the context of Rajan’s observations, we are faced with two questions: Are the senior managements of banks incompetent or irrational that they make such “reckless” lending decisions? And if they are indeed so incompetent, how did they get to those positions in the first place? The answers are not a secret.

No one needs to be told that “reckless” decisions are made by technocrats under pressure, mostly political.
Rajan has made several suggestions to ease the NPA crisis, such as corporate debt restructuring (CDR), the 5/25 scheme, and strategic debt restructuring (SDR). These require banks to absorb some stress rather than going scot-free. Banks have been lukewarm to these although they would like to reject them outright. They wouldn’t dare do this unless they had the blessing, even tacit, of someone powerful. Who that might be, shouldn’t be hard to guess.
That’s why, merely “Clean[ing] up the books”, as the Indian Express editorial of February 2 suggested, will be only treating the symptoms without taking care of the underlying malady. The editorial does refer to the real remedy, too, when it says “the government has to give its managers a free hand, and a compensation package that attracts global talent.”

While the Troubled Assets Relief Programme (TARP) brought in by the US government to deal with the subprime
mortgage crisis is quoted with approval, we also need to be alive to our real implementation capabilities and limitations.

There have been changes in government,  but our political establishment as a whole remains the same. Its track record over the last 20-25 years doesn’t inspire confidence.

A related issue is transparency, or the lack of it. This matter has been around for eight months but doesn’t seem to have come to the public eye. That should be reason enough for those whose money is at stake — “We, the People” — to be cautious.


The writer is a former professor, dean, and director in-charge of IIM, Ahmedabad. Views are personal