An investigation by the Indian Express has found that beginning December 2008, a web of transactions between Venugopal Dhoot of the Videocon Group, Deepak Kochhar, husband of ICICI Bank MD and CEO Chanda Kochhar, and ICICI Bank have raised questions of impropriety and conflict of interest. The RBI has asked ICICI to explain what happened, and SEBI is also reportedly looking into it.
The bank has backed Kochhar. It has argued that the loan was part of an arrangement wherein a number of banks gave loans together, and ICICI Bank’s share was less than ten percent. The lending decision was taken by a Committee, which also had independent members. The Bank has also argued that Kochhar did not recuse herself from the Committee as the borrowing company itself had not helped her husband, but this argument works only if conflict of interest is defined very narrowly. Only an investigation can reveal the truth.
As on December 31, 2017, ICICI Bank’s bad loans were reported to be 7.82 percent of total loans, but its capital adequacy ratio was 18.01 percent – well above the requirement.
Although its stock has taken a beating in the last two months, it is still trading well above the book value. Most analysts are bullish on the bank’s stock. All this would suggest that the bank is not in serious financial trouble, and even though the investors have revised its valuation downwards, it is not seen to be close to failure. This equilibrium rests on trust in the bank’s numbers.
Proactive approach required
Unfortunately, the allegations have surfaced at a time of increasing uncertainty in Indian banking. While bad loans have been rising for years, the latest spate of big ticket frauds and recurring reports of under-reporting of bad loans has created a perception that we don’t know how bad things really are. This uncertainty is fertile ground for trouble.
In 2016, the Supreme Court ruled that even private sector bankers are public servants under the Prevention of Corruption Act, 1988. If law enforcement agencies take abrupt actions such as conducting raids, this may diminish trust in the bank’s governance and management, and may lead to a panic among depositors and investors.
The law enforcement authorities usually do not have visibility over the full systemic consequence of their actions, and they cannot be expected to take those consequences into account. So, even while performing its public duty, an enforcement agency could trigger a bigger crisis.
Even if this does not happen, rumours may be deliberately spread. Speculation is already rife on social media. ICICI Bank is a RBI-designated systemically important bank, and its troubles can spread to the entire financial system. It is up to the RBI to take proactive measures to reduce uncertainty.
If there is nothing to the story, a clearly worded statement must be issued at the earliest. If there is some truth in the allegation, there must be swift and decisive action by RBI that dispels uncertainty. The RBI has the powers to take necessary action, if required. Meanwhile, law enforcement agencies may need to be discreet in their investigation to protect the larger public interest.
Lacunae in the system
This is yet another illustration of how demanding banking can be for a country’s institutional environment. When the going is good, institutions appear to be robust. But when things go wrong, the problems in the system reveal themselves — the weaknesses of bank supervision, absence of a sound bankruptcy resolution system for banks, and the risk of sudden actions by law enforcement agencies diminishing public confidence.
Since public sector banks comprise three-fourths of the banking system, it is largely kept safe by the implicit promise of taxpayer-funded bail-out. This promise, which has already cost more than Rs 2 lakh crore in the present crisis, is far from ideal. On the other hand, in private banks, even small problems can be used to trigger a panic. This is more so because in times of uncertainty, depositors can flee from a private bank to public sector banks looking for government-backed safety.
While privatising public sector banks will help reduce the reliance on taxpayer-funded bailout, to ensure that this does not increase overall fragility in banking, we need institutional reforms. We need to transition to a system where trust in banking comes from sound regulation and, when a bank fails, this trust is maintained by orderly bankruptcy resolution coupled with substantial deposit insurance protecting depositors without relying on taxpayer-funded bail-out.
The Financial Resolution and Deposit Insurance (FRDI) Bill, which is being reviewed by a Parliamentary Committee, is a step in this direction. It proposes continuous monitoring, early identification of failure, and orderly resolution of failing banks by a Resolution Corporation. The resolution is mostly to be done by merging a failing bank with a healthy bank willing to take it over.
Ironically, this same Bill is being cited to to create panic by spreading rumours about the “bail-in” instrument (conversion or extinguishing of a liability to recapitalise an insolvent bank) in the Bill. Media reports suggest that this rumour has led to a bank run in parts of Andhra Pradesh and Telangana.
Actually, the provision in the Bill is very different from what the rumours suggest. A liability can be bailed-in only if regulations in advance have notified that such liability is eligible for bail-in, and if the liability-holder has contractually agreed to a bail-in clause. The Bill also says that while bailing-in, equity, unsecured loans (other than deposits) and certain other claims of a bank must first be wiped out.
This means that the chances of deposits ever being affected are negligible. The Bill provides bail-in as a last resort before liquidation, because liquidation of banks may lead to bigger losses. Overall, if it becomes law, the Bill may enhance the protections available for depositors by creating a system of early, quick and orderly resolution of a failing bank. It could do so without using taxpayer money, which is better utilised on other priorities.
All this nuance is hard to give in simple social media messages, while rumours can spread easily. This shows that the pathway from today’s system to a more robust and efficient banking system will not be an easy one. It will require considerable political and administrative skills to make the transition.