Letters: The business of politics | Business Standard Letters

Letters: The business of politics | Business Standard Letters

The Context*:

RBI Governor Dr Rajan’s views on


 RBI Governor Dr
Raghuram G Rajan delivering the Third Dr Verghese Kurien lecture on November
25, 2014 at IRMA, Anand spoke extensively on “Saving Credit” somewhat reminding
his own phraseology “Saving Capitalism from Capitalists” as the focus was on saving
banking from unscrupulous borrowers. Excerpts:
Dr Kurien created
a uniquely Indian model that has brought millions out of poverty. A man of
strong convictions, determination, and integrity, he truly is a giant of
post-independence India. Dr. Kurien showed people the way to remunerative
livelihoods, perhaps the best form of economic inclusion. I have little
expertise on the technologies and institutions he pioneered, so I will not
opine on them. Instead, I want to focus on another instrument for expanding
human wellbeing, credit.
The Debt Contract
The flow of credit
relies on the sanctity of the debt contract. A debt contract is one where a
borrower, be it a small farmer or the promoter of a large petrochemical plant,
raises money with the promise to repay interest and principal according to a
specified schedule. If the borrower cannot meet his promise, he is in default.
In the standard debt contract through the course of history and across the world,
default means the borrower has to make substantial sacrifices, else he would
have no incentive to repay.


Why should the
lender not share in the losses to the full extent? That is because he is not a
full managing partner in the enterprise. In return for not sharing in the large
profits if the enterprise does well, the lender is absolved from sharing the
losses when it does badly, to the extent possible. By agreeing to protect the
lender from “downside” risk, the borrower gets cheaper financing, which allows
him to retain more of the “upside” generated if his enterprise is successful.
Moreover, he can get money from total strangers, who have no intimate knowledge
of his enterprise or his management capabilities, fully reassured by the fact
that they can seize the hard collateral that is available if the borrower
defaults. This is why banks offer to finance your car or home loan today at
just over 10 percent, just a couple of percentage points over the policy rate.

Violating the
Spirit of Debt

The problem I want
to focus on in this lecture is that the sanctity of the debt contract has been continuously
eroded in India in recent years, not by small borrower but by the large
borrower. And this has to change if we are to get banks to finance the enormous
infrastructure needs and industrial growth that this country aims to attain.

The reality is that too many large
borrowers see the lender, typically a bank, as holding not a senior debt claim
that overrides all other claims when the borrower gets into trouble, but a
claim junior to his equity claim.


The Debts Recovery
Tribunals (DRTs) were set up under the Recovery of Debts Due to Banks and
Financial Institutions (RDDBFI) Act, 1993 to help banks and financial institutions
recover their dues speedily without being subject to the lengthy procedures of
usual civil courts. The Securitization and Reconstruction of Financial Assets
and Enforcement of Security Interests (SARFAESI) Act, 2002 went a step further
by enabling banks and some financial institutions to enforce their security
interest and recover dues even without approaching the DRTs. Yet the amount
banks recover from defaulted debt is both meagre and long delayed. The amount
recovered from cases decided in 2013-14 under DRTs was Rs. 30590 crore while
the outstanding value of debt sought to be recovered was a huge Rs. 2,36,600
crore. Thus recovery was only 13% of the amount at stake. Worse, even though
the law indicates that cases before the DRT should be disposed off in 6 months,
only about a fourth of the cases pending at the beginning of the year are
disposed off during the year – suggesting a four year wait even if the
tribunals focus only on old cases. However, in 2013-14, the number of new cases
filed during the year was about one and a half times the cases disposed off
during the year. Thus backlogs and delays are growing, not coming down.

he Consequences
Let me emphasize
again that I am not worried as much about losses stemming from business risk as
I am about the sharing of those losses – because, ultimately, one consequence
of skewed and unfair sharing is to make credit costlier and less available. The
promoter who misuses the system ensures that banks then charge a premium for
business loans. The average interest rate on loans to the power sector today is
13.7% even while the policy rate is 8%. The difference, also known as the
credit risk premium, of 5.7% is largely compensation banks demand for the risk
of default and non-payment.

Some lessons
The fundamental
lesson of every situation of banking stress in recent years across the world is
to recognize and flag the problem loans quickly and deal with them. So
regulatory forbearance, which is a euphemism for regulators collaborating with
banks to hide problems and push them into the future, is a bad idea. Moreover,
forbearance allows banks to postpone provisioning for bad loans. So when
eventually the hidden bad loans cannot be disguised any more, the hit to the
bank’s income and balance sheet is larger and more unexpected. This could
precipitate investor anxiety about the state of the bank, and in the case of
public sector banks, leave a bigger hole for the government to fill. These are
yet more reasons to end forbearance. Or put differently, forbearance is ostrich-like
behaviour, hoping the problem will go away. It is not realism but naiveté, for
the lesson from across the world is that the problems only get worse as one
buries one’s head in the sand.

At the same time,
the banks have also been asking the regulator for greater flexibility to restructure
loans so as to align them with the project’s cash flows, and for the ability to
take equity so as to get some upside in distressed projects. These are more
legitimate requests as they imply a desire to deal more effectively with
distress. The regulator has been reluctant to afford banks this flexibility in
the past because it has been misused by bank management.

Perhaps the reason
we have been so willing to protect the borrower against the creditor is that
the hated moneylender looms large in our collective psyche. But the large
borrower today is not a helpless illiterate peasant and the lender today is
typically not the sahukar but the public
sector bank – in
other words, we are the lender. When the large promoter defaults wilfully or
does not cooperate in repayment to the public sector bank, he robs each one of
us taxpayers, even while making it costlier to fund the new investment our
economy needs.

The solution is
not more draconian laws, which the large borrower may well circumvent and which
may entrap the small borrower, but a more timely and fair application of
current laws. We also need new institutions such as bankruptcy courts and
turn-around agents. Finally, we need a change in mindset, where the wilful or
non-cooperative defaulter is not lionized as a captain of industry, but justly chastised
as a freeloader on the hardworking people of this country. I am sure that is a
change in mindset that Dr. Verghese Kurien would approve of.

*Submitted version of excerpts published in The Global ANALYST, December 2014
M G Warrier


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