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Why RBI may have had an impractical idea: it is not banks’ job to run sick firms

The RBI and government must ensure that banks overhaul their loan appraisal process.

Written by P Vaidyanathan Iyer |
Updated: July 29, 2015 3:54:09 am
RBI, bad loans, bad loans recovery,  Non-performing assets, private sector bank, bank bad loans recovery, public sector banks, repayment of loans loans, business news, economy news, indian express explained, ie explained The business of banks is to lend, and lend prudently. That they have not done so far. Recovery is a more difficult job.

About a year ago, a leading private sector bank attached the property of a Surat businessman who had defaulted on a loan. Even though the businessman and his family were living on the premises, the bank sealed it and made its manager the custodian. Within a few hours, police showed up, claiming there were five bottles of liquor in the house. They broke the seal, found the bottles, and arrested the manager. The bizarre chain of events landed the aggressive private bank in a situation it had neither imagined not bargained for.


Imagine now a consortium of more than a dozen banks acquiring 51% in privately-owned Bhushan Power and Steel Ltd, taking over the management, running the company, and then looking for a buyer. BPSL has unviable loans of about Rs 40,000 crore, and to keep these assets viable, banks have topped up lending by another Rs 8,000-odd crore.


To ensure more “skin in the game” of promoters who negotiate massive loans and are unable to repay despite a restructuring of the debt, the Reserve Bank of India on June 8 allowed banks to acquire majority stake in such companies. The banks, RBI advised, should sell the stake “as soon as possible”. The first such action took place on July 27. A consortium of banks will acquire majority stake in Electrosteel Steels, in which their exposure is about Rs 10,000 crore. The company notified to stock exchanges the decision by the lenders to invoke the SDR.

India’s banking history is replete with examples of promoters turning richer as their companies went bankrupt. Companies, often owned by big promoter groups, did not repay loans, were given more loans, but still defaulted. The RBI’s move last month was about enforcing lenders’ rights. And on the face of it, it is difficult to disagree with the principle that shareholders, rather than debtholders, must bear the first loss.

The malaise of loans turning bad, corporate debt restructuring, top-ups despite a rising tide of stressed assets, and banks being taken for a ride, has festered over the years. Non-performing assets have ballooned, and most banks need a capital boost to meet regulatory requirements and continue lending.

Foreign investors looking at India pose this question to nearly every Indian policymaker they come across; union Finance Minister Arun Jaitley wasn’t spared the blushes when he was in the US some weeks ago. Pension funds and FIIs, with combined funds of $ 3 trillion, sought to understand the government’s plan for the banking sector, which is suffering rapid deterioration in asset quality. Gross NPAs rose to 4.45% in March 2015 compared with 4.1%  in March 2014. The capital adequacy ratio declined from 13.01% in March 2014 to 12.7% in March this year. On both these parameters, public sector banks face a far more acute problem.


But the RBI’s plan will only result in a mess. Yes, banks need to be empowered. But allowing state-owned banks to acquire majority stake in companies may only result in breeding a new set of sick mini-PSUs. What else do you call a loss-making company owned and managed by public sector banks? Can government banks be in the business of running companies in such varied sectors as steel, education services or hospitals?

Do banks have the expertise to manage companies in today’s competitive market? Especially when the timeframe for sale of acquired companies has been prescribed in vague “as-soon-as-possible” terms? Even assuming that a bank hires turnaround consultants for a fat fee, effecting a smooth transition will require tremendous effort and, in most cases, active support of the original promoter — who, having just lost control of the company, is unlikely to be enthusiastic.

Also, banks will have to ask themselves if they really want to take on the job of management, which would make them liable to all statutory obligations, and take responsibility for the past sins of the company. The new manager — banks in this case — will be handed over income-tax and service tax notices, will be accountable for payments such as provident fund to employees, and would have to comply with the provisions of the archaic Factories Act of 1948 — none of which are issues they would be familiar with.


Those who might cite the example of the successful turnaround of Satyam Computer Services Ltd after the accounting fraud, must remember that the apparently smooth transition of management to the Mahindra Group was not helmed by banks. The then Prime Minister’s Office monitored the government-appointed management team that superseded the Satyam board — and even after the transition, Tech Mahindra faced no easy task in integrating the human resources and operations of Satyam with its own.

The business of banks is to lend, and lend prudently. That they have not done so far. Recovery is a more difficult job. Here, they have refused to learn from past mistakes. This is because the stakes are so low. For most chairmen of state-owned banks, the chief concern is to ensure that big loans do not turn bad during their tenures. This, in many cases, explains the “evergreening”, or giving more loans to keep the existing ones viable.

Take the steel sector. The total outstanding loan is to the tune of Rs 2,80,000 crore, of which stressed loans are estimated to be at least Rs 2,10,000 crore. Bhushan Power and Steel Ltd is not a one-off case. A recent study by foreign institutional research company UBS suggests that borrowings by stressed firms have risen sharply by almost 85% in the last three years.


Instead of experimenting with ideas that may be impractical, it is time the RBI and government got real — by first asking public sector banks to stop lending to chronically stressed companies. Acquiring companies and running them until a buyer is found is easier said than done. Banks must be willing to take a one-time hit on their exposure and move on. They would be wiser to auction the assets than to find a new promoter. In the case of Electrosteel Steels, a big Indian group was learnt to have been willing to acquire the company provided the banks allowed a 50% haircut. But the banks rejected the offer.

The RBI and government must ensure that banks overhaul their loan appraisal process. Bad loans is a cancer where chemotherapy won’t work. It requires clinical surgery.

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