Hysteria over PNB fraud

The Rs 11,300 crore fraud has create something hysteria over conditions at PSBs. Make no mistake, the sum involved is large and we should be legitimately concerned. However, to use the fraud to make the point that all PSBs are rotten is quite a leap. It's hard to resist the feeling that the fraud is being used to create a case for eventual privatisation of some PSBs and for shrinking the market share of PSBs.

When it comes to frauds, ownership cannot be said to be the crucial factor- think of the colossal frauds that have felled or battered some of the best known banks in the world. And fraud is just one form of violation of regulations and laws. International banks  have been involved in numerous other violations in recent years- LIBOR rigging, exchange rate manipulation, mis-selling of retail products, etc. Public memory may be short-lived but those with long enough memories will recall that some of the principal players in the securities scam of 1992 in India were foreign banks.

More in my article in The Wire, Public sector banks don't have a monopoly over fraud.

RBI's Resolution Framework for Stressed Assets has serious issues

The RBI's revised framework for stressed asset resolution, released on February 12, has serious issues. The intention is to minimise negotiations between lenders and borrowers and to push most cases to the NCLT. This is, in my view, not the best course to  pursue. A negotiated settlement between lenders and borrowers is the best way to salvage valuable assets. Banks face a lethal combination of higher provisions and low recoveries as a result of the RBI's new framework.

My full article in BS:

Resolution framework will crimp growth

T T Ram Mohan


Enough of crony capitalism — that seems to be the tough message of the Reserve Bank of India’s (RBI’s) Revised Framework for Resolution of Stressed Assets released on February 12.

The RBI has scrapped the various schemes introduced over the years, such as Corporate Debt Restructuring, 5/25 Refinancing of Infrastructure, Strategic Debt Restructuring, and S4A. These were all ways of “kicking the can down the road”, that is, giving more time to promoters to make their companies or projects viable while keeping provisioning costs low for banks. The RBI seems to have concluded that these have not delivered — they only enabled promoters to retain control over assets while imposing heavier costs for banks at a later point.

Under the revised framework, bad loans are to be more quickly recognised and provided for. From March 1, for all loans above ~20 billion, resolution must commence within 180 days of default. Where banks and borrowers cannot agree on a plan within 180 days, resolution will happen under the aegis of the National Company Law Tribunal (NCLT). The defaulting promoters will stripped of ownership and control. Their assets will be sold to the highest bidder or simply liquidated.

The RBI is administering strong medicine to rid the banking system of the non-performing assets (NPAs) problem at one go. This is a laudable objective. However, the RBI must ensure that the medicine does not kill the patient. Resolution is best effected when economic growth is buoyant. Borrowers then have a better chance of returning to health and repaying loans. Lenders are better placed to absorb losses. The revised framework runs the risk of undermining the ongoing economic recovery and hence worsening the NPA problem in the very process of resolving it.

Why so? First, NPAs and provisioning in the banking system are bound to rise as more stringent norms kick in. Most of the ~1.53 trillion that public sector banks (PSBs) will get from the government over two years under the recapitalisation plan could end up being absorbed by provisions — and more may be required. There will be no capital to support credit growth.

Secondly, 180 days is too short a period for achieving resolution. The RBI could argue that banks have had enough time over the past two or three years to achieve resolution. But, then, banks lacked the capital to take the hair cuts on loans required to restore viability to projects. The present bank recapitalisation plan should have happened three years ago. Delayed resolution is largely the result of delayed recapitalisation. After providing capital belatedly, expecting bankers to arrive at resolution in 180 days’ time is a bit thick.

Thirdly, the requirement that all bankers should agree on resolution is unrealistic. The RBI must modify the stipulation to state that banks that account for, say, 75 per cent of the exposure must agree. Else, very little resolution may happen at the bankers’ end.

Fourthly, while banks are now free to do whatever it takes to achieve resolution, the old problem remains. Which public sector banker will take large write-offs of loans and risk investigation after retirement? The framework requires resolution proposals to get at least an investment grade rating from rating agencies. How does a banker decide whether he should get a minimum acceptable rating with a low write-off or a better rating with a high write-off?

The cumulative result of factors two, three, and four above will be that the vast majority of bad loans will head for the NCLT. This is bound to clog up the NCLT system. Besides, the NCLT process is yet to be tested. For the sale of assets to be worthwhile for banks, we need a large number of bidders. That is not the experience we have had in the assets so far put up for sale. There are reports of waning interest amongst foreign bidders.

As more and more assets come up for sale, there is every prospect that bidders will dry up. If there are no bidders, assets would have to be liquidated. This would be a disaster for banks — liquidation will fetch them very little. It would also be a tragedy for the economy — huge infrastructure assets that are stalled will amount to nothing.

Growth is the best elixir for an NPA problem. In the early 2000s, India had an NPA problem that was just as bad. We resolved it by growing our way out of it. Large projects that have been stalled for want of funds are an important factor constraining growth in recent years. So is inadequate growth in credit to the MSME sector.

Bank recapitalisation was supposed to be the key to reviving credit growth. In his Budget speech, Finance Minister Arun Jaitley claimed that the recapitalisation bonds of ~800 billion issued in 2017-18 would lead to additional credit of ~5 trillion. The markets cheered because they thought PSBs would grow credit and profits.

What’s happening on the ground is quite different. Eleven PSBs have come under Prompt Corrective Action (PCA). The finance ministry has given some of the PCA banks targets for <i>shrinking<p> their balance sheets in the next couple of years. The stronger PSBs, including State Bank of India, have already been hit by rising provisions. The RBI’s revised framework spells even higher provisions and poor recovery for banks. Credit growth cannot possibly revive under these conditions.

Over the past two years, demonetisation and the introduction of the goods and services tax created short-term disruption while promising long-term gain. Another policy-induced disruption is the last thing we need in 2018-19. The RBI must re-examine its revised framework. The government must plan for higher capital infusion into PSBs and rethink its idea of shrinking some PSBs.

EPW reviews my book on banking crises

EPW carries a review of my latest book, Towards a safer world of banking: bank regulation after the sub-prime crisis, by Sabri Oncu, a well-known scholar and financial economist.

Stalingrad anniversary

February 2 marked the 75th anniversary of the fall of Stalingrad. This was a big event in Russia, of course, with President Putin flying over to Volgograd (as the city is now named) to commemorate the event. But we heard nothing of this epochal event in India, partly, I guess, on account of the media's preoccupation with trivia.

Stalingrad was, perhaps, the decisive turning point of World War II. It showed that the Wehrmacht, the Germany army, was not invincible and that Hitler's opening an Eastern front could pave the way for his defeat. Following Stalingrad, the Wehrmacht lost the initiative and was mostly on the defensive on the Soviet front.

In Stalingrad, the elite Sixth Army of the Wehrmacht came to be decimated. Of around 300,000 soldiers in the city, 100,000 were captured and only around 9,000 made it back after the end of the war, the majority perishing as prisoners of war.

Much has been written about Hitler's conduct of operations in Stalingrad, whether he was right to take the city in the first place, whether the Sixth Army should have hung on after it was encircled by Soviet troops and so on.

Well, Hitler's plan was to seize the oil riches of the Caucus south of Stalingrad. The city was a key junction and supply point and hence needed to be held in order to safeguard the armies that had ventured south.

Hitler's strategy was right but it came unstuck because he had underestimated the strength of the Soviet Union. Hitler thought that once his armies tore into the Soviet Union, the government and its army would simply collapse. This did not happen. Stalin was able to throw endless numbers of troops at the Germans and Soviet industrial capacity was far greater than German intelligence had supposed.
These fundamentals could not be altered and were bound to assert themselves no matter what particular tactics Hitler followed in respect of operations in Stalingrad. The whole controversy about Hitler's ignoring the advice of his professional generals and allowing the Sixth Army to perish is  secondary to the fundamentals.

Russia Today has an interesting article on the subject.

Robert Parry, peerless journalist

Robert Parry, an outstanding American reporter, who fearlessly exposed the wrongdoings of those in authority, passed away recently. Our media is quite insular, so his passing went largely unreported in the Indian media.

Parry worked for the Associated Press and Newsweek among others. He was the man who uncovered the Iran-Contra affair in Reagan's time. This involved Israel selling arms to Iran in exchange for the release of hostages. Some of the proceeds of the sales would be diverted to the rebels fighting the Nicaraguan government. The US could not sell arms directly to arm as there was an arms embargo on Iran at the time.

Parry also exposed how Nixon had struck a deal with the Vietnamese to prolong the fighting so that Humphrey would not win the Presidential elections against him and how the Reagan administration colluded with drag traffickers (of all people). In recent times, he tenaciously questioned the Russiagate affair seeking to implicate Russia in the last US Presidential polls that saw Trump being elected as President.

Parry found himself marginalised in the mainstream US media, which, as everybody knows, works closely with the US establishment and the intelligence agencies to promote the establishment agenda. He had to start his own website in order to carry on with his work.

Here is one tribute to him and here is another.

One journalist paid him this tribute:

I would suggest that it is [an] underlying devotion to the plight of mankind which allowed Robert Parry to become Robert Parry. It wasn’t his connections, his political opinions, his ideas, or even his raw talent; it was the fact that he cared so much. The fact that he couldn’t dissociate himself from the horrors of this world, the evil things humans are doing to one another and the omnicidal trajectory we appear to be headed along. He saw it all, he felt it all, and he let it move him.

This is not typically what you hear about a journalist- from fellow journalists. 

Budget for 2018-19

The budget represents a setback to the fiscal consolidation process, something in which the NDA government has invested a lot. It isn't the revenue side that is a problem although non-tax revenue (dividends from PSUs, transfer of surplus from RBI) has disappointed. The main problem is on the revenue side. RE expenditure is 2.6% of GDP for 2017-18, higher than the projected 1.9%. Government establishment expenditure (such as pensions) is higher than expected. The compensation to states for GST loss is also imposing a large cost and this is to continue for a five year period.

At the end of the day, we are looking at a combination of  around 7% growth and a fiscal deficit of 3.5% of GDP for a three year period starting 2017-18. Not the happiest of situations to be in for the economy especially given that the world economy is buoyant. The situation could get worse if global economic growth is adversely impacted by a fall in asset markets.

So, what's the way out? Well, the budget papers provide a clue. The tax/GDP ratio of 11.6% in 2017-18 after having stagnated at around 10% of GDP since 2008. It is projected to rise to 12% and above in the coming years. Greater tax revenues provide a hope for a a turnaround in the economy- we can spend more while containing the deficit. And increased tax revenues will come not so much from growth as from tax buoyancy- better compliance, more people coming into the direct and indirect tax net, thanks to demonetisation and GST.

If this is how things play out, Modi will have been proved right in respect of both demonetisation and GST- the long-term benefits of these will have outweighed the short-term costs.

More in my article in the Hindu, Goodbye to fiscal consolidation.