Sardar Vallabhbhai Patel warned, “it is a folly to ignore realities; facts take their revenge if they are not faced squarely and well”. India’s banking crisis, a child of many parents, is surely part revenge for a multi-decade disastrous policy of regulatory forbearance in bad loan accounting. The sustained campaign by bankers and defaulters for extending this nonsense yielded results over the last few weeks, with a one-year deferral of Indian Accounting Standards (IndAS) and dilution of provisions for loans to companies in bankruptcy. This sustained campaign by bankers and defaulters — peaking in the parliamentary panel presentation last week — against the February 12 RBI circular that atones for the RBI’s past sins is shameful, dangerous and self-serving.
Shameful: Two sets of accounting books — real and reported — created India’s curse of informality where only 7 million of 63 million enterprises were registered for indirect taxes before GST and only 1.5 per cent of our 1.2 billion citizens paid income tax before demonetisation. Both are up over 50 per cent over the last 24 months. Bankers pushing for accounting forbearance seem to believe that investors and the public are fools who only focus on de jeure (what they report) rather than de facto (what their reality is). India’s poverty is partly a child of our sense of humour about the rule of law; an entrepreneur who follows a rule feels like she missed a deal because of transmission losses between how the law is written, interpreted, practised and enforced. But sunshine is the best disinfectant; Corporate India is already live with IndAS, informality is rapidly reducing in the real economy, and banks should be at the forefront of transparency since they sell trust.
Dangerous: The argument that India’s infrastructure would not be built without accounting forbearance is unverifiable at best, and nonsense at worst. Maybe a bond market would have developed. Maybe more equity would have been raised; large Indian companies with debt defaults have 50 per cent + promoter holding while great entrepreneurs like Sachin at Flipkart, Bhavish at Ola, Jeff Bezos at Amazon, and Jack Ma at Alibaba own less than 20 per cent of their companies. Maybe over-invoicing would not have happened. Maybe more foreign strategic investors would have come. Maybe EPFO would have begun infrastructure investing given its liability profile. Bank recapitalisations crowd out government spending — imagine if we could have used the last Rs 2 lakh crore in primary education, healthcare and apprenticeships. More delays in bad loan resolution will only increase recapitalisation demands.
Self-serving: A telling story about banking comes from the global financial crisis: An American banker responds to his risk management colleague who questions selling a product that would surely explode in a few years with the cryptic email “IBG/YBG” (I’ll be gone, you’ll be gone). Giving money is an unskilled job; the skill lies in getting money back. There are immediate consequences of accounting profitability for banker compensation and careers but the consequences of poor decisions are so far in the future that it’s hard to hold bankers, board directors, and auditors accountable. Nicholas Taleb calls this the Bob Rubin trade in his new book Skin in the Game; heads he wins, tails he shouts Black Swan (an unforeseeable, uncontrollable and rare event). Accounting forbearance never reduces the size of the problem; it gets successors to deal with a bigger problem. Bankers and defaulters currently positioning accounting forbearance as the only alternative to an economy-wide credit drought are hardly being honest, dispassionate or fair.
While the logical sequence for bad loans is revealing, recognising and resolving, India is doing it in reverse order. There is much blame to go around and the RBI cannot — and should not — escape its fair share. But the RBI has begun healing itself. The RBI forcing NCLT filings by banks kicked off a splendid process of resolving that will soon start a stream of good news for 41 big defaults; this technology should be extended to all defaulters above Rs 100 crore. India needs to introspect on banking supervision, governance and human capital — not all defaults are fraud, only a few bankers are corrupt, and Binani withdrawing its Supreme Court petition for insolvency termination last week was positive. But the first stage of Alcoholics Anonymous is acceptance; RBI’s February circular hurts evergreening, deferring and fudging for big defaults (it exempts MSME loans up to Rs 25 crore). The default response of blunting regulatory and accounting actions based on whining by defaulters and bankers needs revaluation; this whining often positions self-interest as national interest. And acting on this whining enables unskilled bankers and defaulters to punish skilled bankers and good borrowers.
Governments everywhere are conflicted between their roles as custodians of financial stability, agents of growth, and shareholders of banks. Notwithstanding the nobility of past motivations, it is now clear that India’s current banking crisis is a child of multi-decade action and inaction by the RBI and the Department of Financial Services in the Ministry of Finance. Cleaning up the banking system and ending crony capitalism now needs them to march together as a team. In the next few years, we must create a public and private banking system with governance, culture and consequences. If we fail, we will all be guilty of stealing from our grandchildren because government finances cannot be on the hook forever for all bank deposits without shrinking education, health, and social security expenditure. Accounting solutions to bad loans deserve the quip that for every complex problem there is a solution that is simple, plausible and wrong. Ghalib said it better “Umar bhar Ghalib yahi bhool karta raha, dhool chehre pe thi, lekin aina saaf karta raha (All his life, Ghalib kept making the same mistake; dust was on his face but he kept cleaning the mirror)”. Fiddling with accounting (the mirror) doesn’t change reality (the dust on bank faces). Let’s end it.