KFA: A CASE STUDY IN THE MAKING?

KFA: A Case Study in Making?*

M G Warrier

The unfolding Mallya story is being used by media for asking more questions and digging up more dirt to throw at banks and corporates. Here we try to learn from ‘Vijay Mallya episode’ a couple of lessons for the future. This is not the end of the road. India has survived the impact of two World Wars, Bengal Famine, 1962 War with China and Harshad Mehta Scam (list illustrative) and this ‘testing time’ too will pass…In all probability ‘KFA’ will have a much longer shelf-life as a case study on lending to corporates, perhaps because of the unconcealed and ‘innocent’ arrogance in the body language and lifestyle of an individual and his ‘admirers’.

On December 16, 2003, Vijay Mallya, Rajya Sabha member, asked the government (Unstarred Question No. 1,438) whether it was “aware of various write-offs of principal loans made by Public Sector Banks operating in the United Kingdom”. The government promised to table the information. I have not accessed the information tabled by the government. Quoted this question here because the mind-set behind the question is relevant in the analysis of the journey of Vijay Mallya to today’s ‘Mallya’ (somewhere media has dropped his first name!).

Mallya is still Rajya Sabha MP and according to media reports, has left India even as public sector banks moved the Supreme Court to recover dues of up to Rs. 9,000 crore from him. His conduct will now be scrutinised by the Ethics Committee of the Rajya Sabha chaired by Karan Singh. Other members of the committee include Satish Chandra Misra (BSP), Avinash Rai Khanna (BJP), Sharad Yadav (JD-U), Sitaram Yechury (CPI-M), Mukul Roy (Trinamool Congress), Neeraj Shekhar (Samajwadi Party), A. Navaneethakrishnan (AIADMK) and Devender Goud T (TDP).

Meanwhile, the Enforcement Directorate, probing money laundering charges against Mr. Mallya, has expressed worries that attaching his assets may be a problem as the CBI’s primary charge of breach of trust (Section 409) does not come under its ambit. Section 409 of IPC does not come under the offences listed in the schedule of the Prevention of Money Laundering Act, which empowers the Directorate to attach proceeds of crime. The CBI has registered its case under Section 409 (criminal breach of trust) read with Section 120 B (criminal conspiracy) of the Indian Penal Code and other provisions of the Prevention of Corruption Act against unknown IDBI officials pertaining to abuse of office to extend favours allegedly to Kingfisher Airlines. Section 409, a stringent provision that prescribes a maximum of life sentence, does not come under the Prevention of Money Laundering Act, which empowers the Directorate to attach proceeds of crime. Let the sleuths go deeper into the provisions under which cases have to be charged. Mallya has been summoned by Enforcement Directorate to make a personal appearance before its investigating officer in Mumbai on April 2, 2016 in connection with its money laundering probe in the Rs900 crore IDBI loan fraud case.

Raghu Mohan, writing in Business World wondered, “Now that the King of Good Times has flown the coop, what happens to the nearly Rs 10,000 crore he owes to banks?” and mentioned that ‘you need to have a peculiar kind of disposition to think it will ever be recovered fully’. Going by the past experiences, he has articulated the concerns of any citizen in the given situation. Analysts are working overtime and media is full of articles and analyses about what went wrong with KFA and why Mallya is behaving the way he is behaving.

According to one estimate, Mallya had a domestic unencumbered net-worth of more than Rs5000 crore in companies, in which he has a stake alone, in the first week of March 2016. Though I do not subscribe to the ‘too big to fail’ theory for individuals or institutions or countries for that matter, expediency lies in allowing Mallya to survive the present crisis; and in all likelihood, he will. That may not make him a good boy as de-addicting a person from the influence of the united spirits of good times has been near impossible in recent history. But, the present government, the regulators and the enforcement authorities in India are capable of mustering the courage to show the world that past performance do not guarantee future ‘vulnerability to pressures’.

I base my above inference on the commitment given by Finance Minister Arun jaitley on March 17, 2016, which has come not long after RBI governor Dr Rajan in his deposition to the Standing Committee of Parliament on Finance said, “We have to go after corrupt bank management as well as corrupt promoters.  There is no doubt that we need to do it… We do not have enough teeth. There are these promoters who have diverted funds. I would say plainly that they have stolen the funds, and we cannot go after them. It takes too long.”  FM said, ‘banks will recover every penny of loan given to Mallya and investigative agencies will take strong action against the liquor baron wherever he is found to have violated the law’. The combined will of enforcement agencies, regulators and judiciary uninterrupted by usual political influences exerted through the government limbs, will take this episode to a logical end which will remain a reference point whenever unethical financial practices surface in future. With this pious wish, let us leave the Mallya story for a moment.

Growing ‘stressed assets’ with banks

On August 24, 2015, speaking on ‘Strong growth for the Indian Economy’, RBI governor Dr Raghuram rajan made the following observations:

“ In dealing with stressed bank assets, RBI has been focused on getting the underlying real project back on track. There are a number of impediments here. The stigma as well as the provisioning (and the associated fall in profitability) attached to a loan being labelled “non-performing” makes banks eager to avoid the label. In some cases, they ignore the reality that existing loans will have to be written down significantly because of the changed circumstances since they were sanctioned (which includes extensive delays, cost overruns, and over optimistic demand projections). The Debt Recovery Tribunal system has not been speedy, which also emboldens uncooperative promoters and keeps them from accepting their share of the losses. Regulatory forbearance, where RBI makes it easy for banks to “extend and pretend”, is not a solution. Since no other stake-holder – such as the promoter, tariff authorities, tax authorities, etc. -- contributes to resolution, the real project limps along becoming increasingly unviable.

Meanwhile, analysts grow increasingly suspicious of bank balance  sheets and the growing volume of “restructured” assets. Also, some large promoters take advantage of banker fears about assets turning non-performing to extract unwarranted concessions, without any sacrifice in the value of their stake. Regulatory forbearance therefore ensures that problems grow until the size of the provisioning required to deal with the problem properly becomes alarmingly large – which then prompts calls for yet more forbearance. Forbearance is also a disservice to the bank’s owners (which may include the Government) who, instead of being faced with a small problem early and being given the opportunity to apply corrective action, are faced with large problems suddenly when they cannot be pushed into the future any more.”

 Protecting Indian banking system

Unlike their fellow-travellers in the corporate sector, banks are targeted mercilessly for all systemic irregularities and the failures in the economy. The main reasons for this include the transparency with which the banking regulator (RBI) functions and the constant public interaction by GOI in their capacity as owners of PSBs with RBI and banks. This is admittedly a healthy trend and will help initiating timely corrective measures. The Indian banking system is presently through one such phase.

 In his address at CII’s first Banking Summit on February 11, 2016, referring to cleansing of bank balance sheet as ‘deep surgery’,  RBI governor observed:

“…to do deep surgery such as restructuring or writing down loans, the bank has to recognize it has a problem – classify the asset as a Non Performing Asset (NPA). Think therefore of the NPA classification as an anaesthetic that allows the bank to perform extensive necessary surgery to set the project back on its feet. If the bank wants to pretend that everything is all right with the loan, it can only apply band aids – for any more drastic action would require NPA classification.

Loan classification is merely good accounting – it reflects what the true value of the loan might be. It is accompanied by provisioning, which ensures the bank sets aside a buffer to absorb likely losses. If the losses do not materialize, the bank can write back provisioning to profits. If the losses do materialize, the bank does not have to suddenly declare a big loss, it can set the losses against the prudential provisions it has made. Thus the bank balance sheet then represents a true and fair picture of the bank’s health, as a bank balance sheet is meant to. Of course, we can postpone the day of reckoning with regulatory forbearance.”

Now the process of cleansing banks’ balance sheets with a timeframe extending up to March 2017 is on and there will be more cases of wilful defaulters, not necessarily as bad as KFA, surfacing and creating scare. But once the regulator (RBI) and GOI are on the same page as regards the need to handle the two categories of loan defaulters, wilful defaulters from whom recovery need to be effected by invoking securities and guarantees and those needing support in restructuring their loans and the modus operandi to get things done, banks will wake up and rise to the occasion.

 While the profitability of some banks may be impaired in the short run, the system, once cleansed, will be able to support economic growth in a sustainable and profitable way. The economic assets of our public sector banks, such as the trust they are held in by the population, their knowledgeable employees, their location and reach, and the low-cost funding they have access to, can then be fully realized. The need of the hour is to recognise that banking is not just ‘social service’ and like any other business is a commercial activity in which every transaction has to be seen from the angle of cost and benefit. Just as every rupee of deposit need to be repaid with interest at contracted rates, every rupee advanced has to be recovered with interest. Defaults will have to be made good by insurance and other means of securing repayment in cases of delay or failure of projects/purposes financed.

It may look tough for anyone to rescue public sector banks (PSBs) from the shameful situation they have been dragged into by government policies or to defend the high level of bad loans they have accumulated. Since nationalisation, political leadership has been meddling with the working of PSBs, using the ‘assumed’ ownership rights, with immunity. The miraculous survival of PSBs including SBI (State Bank of India) can be attributed to the high net interest margins (NIMs) banks in India were privileged to enjoy continuously. During the current ‘Rajan era’, even at times of near ‘cartelisation’, RBI has been merciful when it comes to passing on the benefits of lower resource cost by reducing lending rates.

Judging the performance of banks with reference to the bad loans accumulated or the support they need from the owners, by itself, is not rational. Comparison is always with private sector banks. To get a clear picture, one has to remember that Public sector Banks’(PSBs) share in banking business is three times that of private sector banks. What prevents the private sector banks from increasing their share in business is a riddle that policy-makers and regulators should solve, at least at this stage, before succumbing to the pressure to again ‘privatise’ PSBs. 

It may be recalled that banks were nationalised because of the refusal of the private sector to plough back deposits mobilised from small savers to sectors that benefited inclusive economic development. The residual and new private sector banks continue to be selective in providing credit; the social responsibility of the banking system was largely met by PSBs. The corporates, which did not want to follow the banking discipline, used their influence to get credit from PSBs. All these, together, resulted in differential treatment for public and private sector banks. Given a level playing field and semblance of functional autonomy, the future of Indian banking is safe in the hands of PSBs.

Epilogue

We, the common citizens of India who do not have access to the ‘goings on’ behind the scenes or trust the daily dose of ‘news and views’ dished out by media, are being taken for a ride. In my 2014 book “Banking, Reforms & Corruption”, writing about corruption, I had observed “The current decade is an opportunity for India to come to terms with the real problems and bring about a change in direction, not allowing back-seat driving by external influences, making a path motorable for coming generations and showing the world that the country’s inherent strengths and vision are in tact. To make this possible, the fourth pillar of democracy, the people, should play their role effectively. The greed of the rich  and the powerful is preventing this from happening” (page 92 of the book). I find, change is on the way. As government, regulators and enforcement agencies in India are now on the same page, ready to handle unethical practices impairing the financial system and economy like cancer, restoring normal health of the economy has become a possibility.

The unfolding Mallya story is being used by media for asking more questions and digging up more dirt to throw at banks and corporates. This is not the end of the road. India has survived the impact of two World Wars, Bengal Famine, 1962 War with China and Harshad Mehta Scam (list illustrative) and this ‘testing time’ too will pass…In all probability ‘KFA’ will have a much longer shelf-life as a case study on lending to corporates, perhaps because of the unconcealed and ‘innocent’ arrogance in the body language and lifestyle of an individual and his ‘admirers’.

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*Submitted version of an article(Can the Banking Sector Survive the 'Beer' Hug?: It Seems It Can) published in April 2016 issue of The Global ANALYST.