In fact: Chronicle of a bank collapse foretold — and lessons that endurehttps://indianexpress.com/article/explained/in-fact-chronicle-of-a-bank-collapse-foretold-and-lessons-that-endure/

In fact: Chronicle of a bank collapse foretold — and lessons that endure

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In 1988, in what was then Madras, a top law enforcement agency raided the residence of an executive director of a state-owned bank. Late that night, the report on the raid was pulled out of a newspaper at the last minute. Two days later, the executive director became the chairman of a bank in that city. In the years that followed, the decision was to hurt the bank as well as the taxpayers who had to underwrite the bill for reviving it — and a few other banks as well.

Halfway through the economic liberalisation programme launched by the Narasimha Rao government, the central bank, following an inspection in 1992, sounded out both the Prime Minister’s Office and the Finance Ministry about reckless lending by Indian Bank, including dubious loan melas. Yet, the bank’s chief, M Gopalakrishnan, managed to secure several extensions through a seven-year tenure, as the bank, which had operations in Singapore and Sri Lanka, disbursed funds to several businesses, allegedly with strong political links to the Tamil Maanila Congress, the breakaway group of the Congress led by G K Moopanar. In 1995-96, Indian Bank’s losses mounted to Rs 1,727 crore, wiping out its entire capital base. Over the next couple of years, the losses multiplied, as bad loans reached over 40% of its loanbook.

In the east, UCO Bank and United Bank of India too had piled up bad loans, given the inherent weakness in their region, with many cyclical industries going through trouble and operational inefficiencies. By 1999, when the Atal Bihari Vajpayee-led NDA government came to power, a large portion of the loans of both UCO Bank and United Bank of India too had soured, and the performance of all three banks had slid further — even though in the seven years prior to that, the government had sunk a total Rs 6,740 crore in the form of capital in them. For a government struggling with its finances and with a global slowdown, pouring in more capital wasn’t an option. Nor was shuttering a bank, given the political sensitivities. That was when, after discussions, RBI Governor Bimal Jalan suggested to Finance Minister Yashwant Sinha that a committee be formed to work out a restructuring plan for weak state-owned banks. The man chosen to head the advisory group was M S Verma, who had finished his term as chairman of State Bank of India in 1999, had a good rapport with Jalan, and was known to Sinha, having gone to the same college as the Minister. After the advisory group was formed in October 1999, M Damodaran, who had completed his five-year tenure in the government as Joint Secretary in charge of banking operations, too was brought in.

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The advisory group didn’t recommend any merger, closure or privatisation of these three weak banks. The cost of restructuring would have been prohibitive, and raising capital a huge challenge. A CII group’s recommendation that the banks be shut triggered strong reactions. Instead, operational changes were suggested: lowering the cost of operations, resolving the bad loan mess, closing down unviable branches including subsidiaries of Indian Bank, selling assets of overseas branches to other state-owned banks, governance changes, pruning staff through golden handshakes, appointing strong and competent chief executives, induction of technology, financial restructuring through capital-based on conditions, and signing of agreements between the government and bank managements, board, staffers and employees unions on the goals to be achieved.

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At Indian Bank, a three-year restructuring plan was worked out, and Ranjana Kumar, who was heading Canara Bank, was brought in with a clear mandate to ensure the plan worked. Loan recovery was pursued aggressively, as the bank served over 700 notices on hundreds of borrowers. Even during this phase, these banks didn’t lose out on deposits, given the backing of the sovereign — rather, over the three years beginning 1999, deposits swelled. There were quite a few who then advocated that these banks be allowed to engage only in narrow banking — just investing the money they raised in government bonds or securities, and living off it. The efforts paid off not just in the case of Indian Bank, but also the other two lenders — and by 2001-02, these banks were back to reporting modest profits. (Rs 33 crore for Indian Bank.) It helped that the government had provided capital to Indian Bank, and as interest rates fell sharply during that period, many banks, including the three weak ones, were able to gain on the portfolio of bonds on their books. More importantly, by 2003-04, the economy had recovered, providing a boost to banks.

While this clean-up was on, some institutional and structural changes too were carried out. More benches of Debt Recovery Tribunals were announced, and a new SARFESI law came into force. For governments running deficits, one of the challenges has been infusion of capital for banks. While the clean-up of these banks was under way, the government decided to introduce a law in 2001 to lower its holding in state-owned banks to 33% to provide headroom for raising capital from the market. But the move failed, and in the face of political resistance, the Vajpayee government withdrew it.

15 years later, there is a sense of déjà vu — through it appears to be a far more systemic issue now. And the solutions on offer aren’t vastly different either: capitalisation, governance changes, a more publicised crackdown against defaulters. During that period of stressed assets, bank employees’ unions had put out a list of defaulters when the government and the regulator had declined to do so citing confidentiality clauses. Then too, the Verma Committee had suggested an Asset Reconstruction Fund or ARF, owned mainly by Indian financial institutions, which would buy out the bad loans from banks — which wasn’t accepted by the government. As was the case then, the structural and institutional changes now under way will work in the medium term, but the key would be revival of growth and an environment which fosters lending.