The Indian banking system is facing a crisis which triggered a fear among the people, especially after a limit was imposed on the depositors of YES Bank & PMC Bank in the last two years, and very recently, on the Lakshmi Vilas Bank. To encounter the bad loan problems in Indian banks, experts suggested the creation of “bad banks”. India’s Finance Minister, Nirmala Sitharaman, accepted the idea in the recent budget session. I will try and answer the following questions in this blog:
- What is a bad bank?
- Will it succeed as many experts believe?
- Will other banks end up in the same situation as PMC or LVB?
- What can a depositor do to ensure that his money remains safe?
All this will be in a language that everyone can understand. But, first let’s look at the problem in the Indian banking system.
As the 2008 global crisis began, India responded to the situation by going easy on lending. It was accompanied by fiscal stimulus by the government. While giving the second stimulus, it was made clear that it will be the last one. But, soon Pranab Mukherjee became the Finance Minister who announced the third stimulus. This was when the then Prime Minister Dr. Manmohan Singh had to undergo his coronary bypass surgery. The third package fuelled the demand and resulted into a very high inflation. Ultimately, pressure from the opposition, populist politics, and corruption charges on the ministers turned a near- successful fight against the global crisis into a ‘policy paralysis’. The corporates, which had over borrowed thinking that the economic boom that prevailed before the 2008 crisis will remain forever, started to default on their loans due to the lack of clearances in the period of policy paralysis. And this was the beginning of the banking crisis. While the UPA government can be blamed for the start of this problem, the Modi government refused to look at this problem for many years. So, to sum up the problem in a single line, Indian banking crisis is because of the high default rates on loans which happened for a variety of reasons including the government of the time providing easy loans in the aftermath of the 2008 global crisis, and the upcoming government failing to resolve it in the initial years itself. Now, let’s talk about what bad banks are and how are they supposed to solve the problem.
Nirmala Sitharaman said in her budget speech:
The high level of provisioning by public sector banks of their stressed assets calls for measures to clean up the bank books. An Asset Reconstruction Company Limited and Asset Management Company would be set up to consolidate and take over the existing stressed debt and then manage and dispose of the assets to Alternate Investment Funds and other potential investors for eventual value realization.”
This basically means that Non- Performing Assets (NPAs) of the banks will be sold to an Asset Reconstruction Company (ARC) at a discount rate. NPAs are the loans which have not been repaid for a period of 90-days or more. It will be done so that banks could perform its function of raising deposits and giving loans without thinking much about the bad loans. This is referred to as the ARC-AMA model of bad bank. However, the Finance Minister made no mention of the term “Bad Bank” in his speech. The idea of bad bank was originally written in the economic survey 2016-17 where it was termed as the “Public Sector Asset Rehabilitation Agency (PARA).” The problem is that there are already many private ARCs in India which have failed to achieve its purpose. As the Economic Survey 2016-17 itself points out:
Many ARCs have been created, but they have solved only a small portion of the problem, buying up only about 5 percent of total NPAs at book value over 2014-15 and 2015-16. The problem is that ARCs have found it difficult to recover much from the debtors. Thus they have only been able to offer low prices to banks, prices which banks have found it difficult to accept.
But of course, the model proposed by the government this year will be quite different from the existing ARCs. As of today (3rd February 2021), we don’t know how it will be rolled out, so let’s go back to the survey which decided the “broad outlines” of bad banks. The survey said:
It would purchase specified [Bad] loans (for example, those belonging to large, over-indebted infrastructure and steel firms) from banks.
Then specialists will work with those companies to provide a solution which is ‘value- maximising’. The idea behind it was told by Arvind Subramanian, the then Chief Economic Advisor (CEA), who believed that other than businessmen with political connections who had taken loans thanks to these connections and later defaulted, there were also corporations who defaulted only because of the economic slowdown. But, as Vivek Kaul writes in his book Bad Money:
While this may have been true from the point of view of an economist, the common man… wouldn’t look into this issue [like that]… If an individual defaults on a home loan, he feels the entire weight of the bank system unleashed on him… In this scenario, we had [the CEA]… of the country saying that… loans to large, stressed companies be written off, because they had over borrowed and weren’t in a position to repay these loans.
Other than this, since the bad bank model in the budget is closely connected to the ARC model, I don’t see why it will succeed when ARCs didn’t, even after 7 years of its existence.
Amidst all this, Covid-19 has exacerbated India’s problem. At a time when our economy saw the first ever contraction in many years, the bad loans are expected to double. The Supreme Court has asked the banks to avoid the recognition of bad loans as bad loans till its judgment on loan moratorium imposed during the pandemic doesn’t come out. Therefore the bad loans will increase big time 90 days after the judgment arrives.
Now what can one do to avoid this crisis and keep their money safe? I am picking some of the personal finance advices from Kaul’s book Bad Money. One should definitely read it. (I have also written the book review here)
1)As the line goes: Don’t put all your eggs into one basket. Diversification is the key to financial stability. Keep your money in 3-4 banks, so that even if moratorium is placed on one, you can have access to major portion of your money.
2) Other thing is to regularly keep a check on your bank. Banks release a report every few months on their website. You just have to check ‘Gross NPA’ in it. Anything above 10% is a big red signal for you.
3) Generally, don’t keep money in cooperative banks because there are so many of them that RBI can’t have a look at each one. Also, they are not very transparent in their functioning. Even if you do for some reasons, don’t keep your life’s savings in it.
4) The most important is your attitude towards your own money. It is your money at the end of the day. As kaul writes, “The attitude that just because money is in a bank it is safe really needs to be dispensed with. There is always a certain amount of risk attached to the money that is invested.”
Well, it is said that something is better than nothing. The government has tried to do something about the banking problem – turned – crisis, but I’m a little doubtful if this was the best possible way.
Hai Dil Dildaara Mera Teli Ka Tel Kaudi Kaudi Paisa Paisa Paise Ka Khel - Sukhwinder Singh, Vishal Dadlani, Robert Bob Omulo in Kaminey