One of the reasons why the ordinance amending the Insolvency code is needed is because for very long Indian governments have treated the public sector banks like an extension of the fisc
Latha Venkatesh
A fund manager asked me an interesting question the other day: would we have needed the ordinance amending the Insolvency code if India had only private sector banks and if no public money was needed to recapitalize the banks? Would it not have been a private haggling between a private lender and a private borrower?
There is no easy answer to this question. Can we be sure that India’s NPA situation would not have reached this state if we didn’t have any or many PSU banks? This question is too hypothetical. First, we have to visualize the Indian economy without public sector banks. An Indian government without public sector banks would perhaps have been far less socialist and allowed a far greater play for market forces. Probably the bond market would have developed and financed infrastructure. On the flip side, probably many infra loans would have turned dud post the global financial crisis, creating a run on some banks. Alternatively, so many steel and infrastructure projects would never have been financed if we didn’t have any PSU bank. Why? We may not even have had such a vast mobilisation of savings deposits with only private banks.
Imagining such hypothetical situations doesn’t help at all. But the question “would we have needed the IBC ordinance if we had only private banks?” throws up some other questions:
Firstly, it is quite possible that the NPA mess could have arisen even with only private banks. The RBI’s asset quality review and annual inspections found Indian private banks as guilty of ever-greening and equally responsible for the mountain of bad loans. In fact, RBI deputy governor Viral Acharya, pointed out recently that private banks in other countries like Japan and Europe, too, turned into “zombie” banks, ever-greening loans to weak companies when they were faced with deteriorating assets and inadequate capital.
And if RBI of this hypothetical India (comprising only private banks) found a bunch of large private banks ever-greening NPAs by giving fresh loans to pay back old loans, it would have had to intervene, first to ensure that public deposits are not endangered and secondly to ensure that funds are available for new healthy projects. In short, an NPA mess and an asset quality review by the RBI may have happened even if there were only private banks.
But the fund manager is right that an ordinance barring promoters may not have been needed if we had only private banks. The ordinance is needed more because the Indian government could not appear to be capitalising banks with tax payer money merely to bail out profligate promoters. What’s worse, with the government having literally sent one defaulting promoter to exile, it could not legitimately be seen to be capitalising banks with tax payer money so that other equally defaulting promoters are allowed to keep their companies and that too with loan haircuts.
The ordinance is also needed because of the governance structure of Public Sector Banks. Under the current dispensation, PSU bankers don’t get the support they need from their boards when commercial decisions go wrong. Public sector bankers have to answer to the vigilance commissions, the comptroller & auditor general and the investigative agencies. PSU bankers would probably have resisted taking decisions altogether. The ordinance would have been probably needed just to remove the moral hazard and enable them to arrive at a solution to the NPAs that won’t be questioned by investigative and vigilance bodies.
The ordinance is also needed because for very long Indian governments have treated the public sector banks like an extension of the fisc. They are given set farm loan targets, and shortly even SME loan targets, bankers are individually cajoled, even pressurised by politicians to fund friendly businessmen. Politicians themselves turn businessmen and businessmen, politicians. The ordinary Indian thus identifies the PSU bank with the government and vice-versa. And it was a moral hazard for the government to be seen to be giving a loan hair cut to a defaulting businessman, even without the haunting shadow of Mallya.
But the fund manager’s question also raises other uncomfortable questions. If the Indian banking system was entirely privately-owned, could the government have issued telecom licences in contravention of all tenets of fairness, and then set up a trial court that cancels all those licences. Would it not have been dragged to court by the private banks who financed these telcos, or worse, seen a run on these "private” banks?
Likewise, if Indian banks had been entirely privately-owned, would it have been possible for the state and central governments to sell coal blocks to crony capitalists and expect private banks to fund such companies? Would it have been possible for any court to cancel coal blocks issued 20 years ago, again without risking a run on the banks that financed these mining or steel companies.
The fund manager’s question thus throws up some fundamental truths: that the Indian economy has paid a huge price for keeping its banks in the public sector. That this public sector character of the banks has allowed the governments and the courts to get away with sometimes corrupt, sometimes whimsical decisions, because it freed them from the discipline of the market.
The fund manager’s question forces us to recognise that future NPAs cannot be reduced only by putting an ordinance of this nature in the statue books to scare away crony capitalists. It forces us to recognise that future NPAs can be lessened if banks are largely privatised and if governments, bureaucracies are forced to accept market discipline. But looks like that nirvana is a distance away. The finance minister has firmly stated that political opinion is not in favour of privatizing PSU banks.
