One Spanking New (Banking) Ordinance To Solve it all

In the wee hours of May 3, 2017 a sudden news flash.

On May 4th, a shiny new convention is born.

After that, silence.

To put it simply, an incredibly significant law was passed by the President through the Ordinance route which is supposed to solve the BIGGEST and MEANEST and DEADLIEST problem this government is facing at this point of time. This problem is why our manufacturing numbers are showing red. This problem is why no new loans are being given out and lending rates have tanked like the scariest rollercoaster drop ever invented by mankind. It is at a 60 year low! The Prime Minister’s jibes of “nothing happened in 60 years” is actually becoming a reality.

So, what is this problem?

Rs 6.3 lakh crore worth of bad loans. Our Public Sector Banks (PSBs) are in major major shit and, this time, it looks like it’s all getting very real. To make you understand the SCALE of this problem, let me point out that the total amount of demonetised currency was Rs 15.5 lakh crore.

In this week’s column, I’m going to scare you. I’m going to make you realise why we need to pay attention to what is going on and why the government is running around like a person with their head on fire.

via GIPHY

Oh, and I will also tell you who you can blame for this situation. (It’s not who you think it is)

NPAs… what?

(If you want to understand banking in n00b terms, I recommend you watch this nice video)

Non-Performing Assets (NPAs) are simply loans-a-bank-will-not-get-back. Loans whose three consecutive monthly installments are not paid, are classified as NPAs. After an NPA or bad loan is declared, the bank can initiate the process of recovery and restructuring of that loan. It will try to get new management to run projects, auction off stuff that the defaulter owns and try to recover the amount. I must point out here, that the auctioned off stuff is rarely equivalent to the amount of loan given. Especially in case of big loans.

The current bunch of loan defaults are mostly by big corporates. Our Economic Survey for this year says that the top 10 defaulters owe Rs 40,000 crore EACH. The report lovingly calls it: The Festering Twin Balance Sheet Problem.

So between them, that comes to Rs 4 lakh crore. Again, to give you an idea of the scale, let me point out that the assigned budget for the National Rural Employment Guarantee Scheme for the whole country FOR THE ENTIRE YEAR was Rs 48,000 crore. Similarly, top 50 companies owe Rs 20,000 crore each on average. Which is kinda crazy, no?

“Modiji, PLISS. HELP US!” ~ Banks

Way back in February 2015, our erstwhile good-guy RBI Governor, Raghuram Rajan, got up one day and said to himself, “Huh. I think we should do something about the festering bad loans in our banks.” He sent out notices to all banks asking them to declare bad loans on their balance sheets. Till that point, the banks were sneakily hiding the NPAs as “stressed assets”. Basically, loans which *might* become defaults but haven’t really become defaults yet. Kinda like a midway situation.

So after Rajan’s notices, a whole muck of leechad loans came out. Mind you, this is mere 7 months after the new Bharatiya Janata Party Government came to power. The bankers went to our prime minister to apprise him of the situation. Rajan was like, ‘All these claims about banks being in a bad situation are exaggerated. This deep surgery is much required. Band-aids won’t do anymore”, dropped the mike and left.

Not kidding. He literally left. Like, he stopped being Governor without actually finishing this deep-surgery he started. He handed over the surgical tools to a fumbling government which then handed it over to Urjit Patel who then helped demonetise 86% of our currency. (It’s all connected. Read: Connecting the Demonetisation Dots)

So, after Rajan ordered a bank book cleanup, the NPA Ratio goes bonkers, as evidenced by this fascinating graph also taken from The Economic Survey.

What did the government do about these big bad loans?

The only real and quick way to solve this crisis is to recapitalise the banks. One familiar word: Bailout. The government did try this by infusing Rs 70,000 crore into PSBs in three installments via a scheme they called “Indradhanush” to calm things down. They have already infused Rs 60,000 crore till now and the final installment of Rs 10,000 crore will be given next year. But we’re talking about Rs 6 lakh crore worth bad loans. If you compare the NPA growth from last year, it has been quite a lot.

Till March 2016, the Gross NPA with PSBs was Rs 4.7 lakh crore, according to this reply given in Parliament.

Now, it has gone up to Rs 6.3 lakh crore in just a year. The recapitalisation amount went POOF.

This amount did not help banks deal with the problem in totality, but was a temporary measure to ensure they don’t just collapse under the weight of NPAs.

But does that government have enough money to spare to save the banks?

Nope.

They have to prioritise and spend a bunch of money on infrastructure, railways (even a Bullet Train), smart cities, further installments of One Rank, One Pension & 7th Pay commission. And, of course, defence. In fact, only last week, the Army Chief said he wants MORE money.

The revenue, on the other hand, doesn’t seem that peachy. The government has kept the fuel prices high to get excise duty on it. In fact, nearly 57% of the price of a litre of petrol and 48% of the price of a litre of diesel goes towards excise, VAT, cesses and dealer margins. The Finance Minister has been saying this is being done to reduce our fiscal deficit, which is fair. But then in that case where will the money for “capital infusion in banks” come from? Even the bumper cash bonanza which the government was expecting after extinguishing old demonetised currency did not work out as planned… to put it mildly.

At one point, they even brought in the extremely long titled and 140-character-unfriendly legislation – “The Enforcement of Security Interest and Recovery of Debt Laws and Miscellaneous Provisions (Amendment) Bill, 2016.” (Read about it here: ‘The Voldemort of bills got passed, and you didn’t know’)

Through this bill, they tried to coax Asset Reconstruction Companies to buy out these bad icky loans and try to sort it out, while freeing the banks from giving out loans again! Which, again, did NOT work out as planned… to put it mildly.

The Finance Ministry officials must be like…

via GIPHY

In comes THE Ordinance

After doing all of this, in what seems like a last-ditch effort, the government decides to do what is a little unorthodox: TAKE OVER THE RESERVE BANK OF INDIA.

Well, sort of.

First, quickly a little bit about what an Ordinance is, because this is crucial. An Ordinance is a law that is directly passed by a President order when the Parliament is not in session. It does not require the approval of our elected leaders. But once the Parliament reassembles for a session, the government has to bring it in as a Bill which goes through the usual legislative process. From the passing of the Ordinance till the next session of Parliament, this is an active law. The next session is likely to reassemble sometime at the end of June or beginning of July. So, from this point on, the Government is going to be in a race against time to solve the bad loan situation of top 50 defaulters.

Here’s what the Banking Regulation (Amendment) Ordinance, 2017 says:

In the earlier version of the Banking Regulation Act, 1949, there was no mention of the Central government having to do anything with loan default resolution. Well, not anymore. Now, the Central government can issue and authorise RBI to take stringent steps to solve the bad loan problem.

Till now, the RBI was acting as a regulator, which means it can issue directions from time-to-time to banks who have given out big loans. It could ask them to take steps to resolve the crisis, but RBI itself would not really do anything. Now, the big bad central bank gets a seat at the resolution table, with the Central government putting a firm hand on its back and telling it to do what needs to be done.

The biggest fear our dear adventurous bankers had when it comes to dealing with bad loans was that *they* are the ones who have given them to companies. Many times, and as it often happens, banks were not doing their homework about the company they were giving out loans to. Now that NPAs have hit the fan, they’re scared that the vigilance department will launch an investigation against them and drag them to jail for not doing what they were supposed to do: Give loans ONLY to companies that showed promise of repayment. What’s more, because of the situation they are in, the banks are not giving out loans anymore.

The government which promised development and even more development is not at all pleased with this situation. So they passed this law in a crazy hurry which begs a question: Why now? What is this hurry? Is the situation that bad?

One reason might be that we, as a country, are about to enter the Goods & Service Tax age. There is going to be a lot of turmoil in the market as businesses try to adjust themselves with the new tax regime. If that is coupled with almost negligible funds coming in from banks, we are most definitely heading for disaster. And our government is (hopelessly) scrambling to fix it as soon as possible.

Who do we blame for this horrible situation?

This problem, unfortunately, cannot be pinned down on a single person or party. So I’ve made a list.

1) Raghuram Rajan

The banks have been more or less forced to declare these loans because Rajan sent notices telling them to clean up their balance sheets. He did this, so that the banks can start a fresh cycle of loan disbursements to boost investment in the country. It was probably a good move in the long term, but it all depended on whether the banks were able to handle the burden. Even the Supreme Court pulled up the RBI to ask WTF is happening.

They asked RBI to submit a list of defaulters with loans over Rs 500 crore. To which the RBI replied:

“The required information is not available with us. Banks are required to report the bad loans on a consolidated basis.”

This response is really strange because a periodic reporting of big loans is made to both the Finance Ministry and RBI. How can they ask the banks to waive off write-off loans worth lakhs of crores without having an estimate of who the big defaulters are?

Last week, yet again, the RBI refused to reveal the names of defaulters. Maybe that was one more reason why the Ordinance was so rushed.

2) Previous UPA Government

If anyone is to blame, it’s them. These loans which are being declared NPAs were given during their time. They could have taken measures to ensure the banks are being prudent when handing out money, but they didn’t. So they have left this huge crumbling mass of debt which is all coming out. Like pus from a wound. Ugh.

Small illustration of how this crisis extends way before 2014.

3) Narendra Modi / Present NDA Government

If this new crazy Ordinance fails and the economy gets into trouble, the NDA government will be definitely blamed for it. The whole point is that they are now in power and they have to clean up the mess even if they want to blame the previous government for it. The people will not forgive the present government for a major (possibly catastrophic) economic downturn, no matter who is responsible for it.

The PM has projected himself, right from the beginning, as the saviour of the economy. Now that the economy is facing a challenge, he can’t afford to point fingers at UPA. But he will, he most definitely will. Rightfully so, but I feel like that won’t help matters at all. Especially three longs years after coming to power.

4) The Banks

Aah yes. These frikkin’ ban?kers. The biggest culprits are the bank managers who are responsible for due diligence before disbursing loans. If there is an NPA in a particular bank branch, the manager is held responsible for it. In case of big loans, the top management has to give approvals and they are also held responsible.

Through some clever book-keeping and financial witchcraft, the managers have been sitting on this pile of rotting loans. They didn’t have any reason to tell the higher ups about the terrible situation they were in. Until Rajan sent them that notice and forced them to declare these bad loans.

Then they were like –

via GIPHY

5) Big Corporates

The usual suspects. They will benefit immensely from this loan write-off and (possible) bailouts. Just like Vijay Mallya did, while the new management and smaller investors got into trouble. The big corps have, in the past decade or so, taken a lot of loans which are now proving to be bad assets for the banks.

There are legit defaulters too, though (not all of them are crooks). Some projects haven’t taken off due to land acquisition issues, infrastructure problems and environmental clearances. There is limited investment coming in from abroad. Therefore, the government is so eager to push GST and all of these investment-driving schemes for the past three years. Didn’t really work out as they had planned. Even if they manage to pave the way for these pending projects, the corporations are known to delay and milk them for maximum profits. God bless crony capitalism!

Now that we have this list, it remains to be seen how this Ordinance plan works out. Some questions about what the government intends to do through the RBI need to be asked. After all, the political parties might have changed, but the benefactors remain the same.

The process has already begun…

The author can be contacted on Twitter @Memeghnad