Saving the stressed Indian lender In public perception, India is a country rife with crony capitalism. Big borrowers, mostly industrialists, borrow money, spend it poorly and then walk away from bad debts. The bigger the borrower, the easier it is to escape. Conversely, small borrowers”from farmers to middle class households”have nowhere to run. The fate of Kingfisher Airlines and the UB group are synonymous with this kind of bad behaviour. The other side of this perceptions story is that banks collude with these borrowers. This is no longer stuff of allegations and conspiracy theories. In recent years, restructured loans”simply bad loans whose recovery is postponed to the futureâ”exceeded the non-performing assets both in number and the amount involved. Why is this happening? The governor of the Reserve Bank of India (RBI), Raghuram Rajan, explained this in a lecture on Tuesday. Put simply, in India today, the debt contract, where the debtor promises to pay back the lender and the latter can recover his money in case things go wrong, is being violated systematically. Rajan hit the nail on the head when he said that,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 reason why so many large borrowers are able to default with impunity is not hard to find. The government, the judicial system and the banks are locked in a game of chicken. Once a borrower decides to treat a bank loan as junior debtâ”where banks dont have the first claim on the borrowers assetsthe lending institution is effectively forced to kneel and take whatever is on offer. The statistics should be an eye opener. The outstanding due to be recovered by banks was Rs. 2.37 trillion in 2013-14. The sum that was recovered was just Rs. 30,590 crore, barely 13% of what was due. In the last five years Rs. 1.61 trillion of debt1.27% of Indias gross domestic product”had to be written off by banks. Is there are way out of this bad equilibrium where large borrowers are able to thieve away taxpayers money? Rajan alluded to the game of chicken. Conventional wisdom has it that there is only one equilibrium: big borrowers hawk away with money and banks dove their losses. This is misleading and textbookish even if governments in the past one decade have encouraged this behaviour. A close observation of the Chicken game as it unfolds over time (instead of simultaneous play) shows there is one more equilibrium: if the lender and the government simply deviate from dovish behaviour and turn hawks, they can recoup their losses and penalize the recalcitrant borrower. In practical terms this requires that three conditions be met. One, banks close the doors for regulatory forbearance. Loans should not be restructured or postponed. If the distinction between bad loans and restructured loans is not enforced rigidly, then banks balance sheets will have meaningless numbers and in reality they will continue to make losses. The road to recovery thus requires a strict end to the practice of restructuring loans. Two, for the banks to have adequate spine to do this, they need the support of RBI and the government. At the moment, there are signs that this condition may be met. Under Rajans watch there are clear signs that RBI is against forbearance and the new Union government may be serious about cleaning up the regulatory mess. The third condition may well be the most important: preventing defaulters from getting judicial support. Cases decided by debt recovery tribunals should only go to the specialized appellate tribunal and high courts should not entertain any appeals on this score. Further, the process of appeals should be expensive: a significant fraction of the debt should be deposited before the appeal can proceed. India is on a knifes edge today. It is one of the few countries in the world that has economic advantages that others can only dream of: good demographics, a relatively lower level of public debt and institutions that can still work. But these can disappear quickly if basic behavioural norms such as fair risk sharing between borrowers and lenders are not maintained. The world is full of countries that could have been great but succumbed to cronyism. India should try avoiding that fate.
Posted on: Thu, 27 Nov 2014 06:38:31 +0000
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