Sunday, July 24, 2016

Loan Melas, Loan Waivers and TBTF

These are the days of "Acronyms" and SMS language. The extensive use of acronyms that was monopolized by Advertising and Marketing industries has now firmly engulfed Banking as well. Acronyms used to have only letters earlier, but now numerals are also added up. There was "Brexit" as a subject of worldwide debate and we had our own "Rexit" following it strongly. The press endlessly debated half a dozen names as the most likely next Governor of RBI. Then suddenly another two names have surfaced and there were articles in the pink press approving one of them as a perfect substitute. Final word has not been heard yet. Everyone is appointing their own choice as Governor except the one with real authority to do so. Reserve Bank of India has come out with S4A scheme which is acronym for "Scheme for Sustainable structuring of Stressed Assets". It is a clear admission that the structuring or restructuring of stressed assets attempted earlier were often found to be unsustainable! Hence there is a need for a scheme of sustainable structuring of such assets now. We believe in learning from our mistakes. Not committing mistakes means blocking chances of new learning. Hence we continue to commit mistakes, even if they are the same ones, again and again. 

In a way, it is not proper to say that numerals have made entry in acronyms only now. The earlier generation knows that there was one Y2K, which was "Year 2000". Y2K was used to signify the trouble brewing when all computer programs and systems were expected to crash as the dates shifted from year 1999 to 2000, on 1st January 2000. Many steps were taken to prevent the problem. Those were the days when computerization had not reached today's levels; yet it created a huge scare. It was like the "Skylab" falling on our heads from up above the sky. For those who do not know about "Skylab", it was a Space Station launched by USA that orbited the earth from 1973 to 1979. It finally fell in the areas of Westren Australia, southeast of the city of Perth, with almost no damage and resulting in a fine of an amount of 400 Australian Dollars (!) on NASA for throwing debris in the area.

There are new acronyms in banking now. The one that attracts immediate attention is TBTF.  TBTF simply means "Too Big To Fail". It was originally considered as an economic theory which underlined the systemic risks that followed the failure of large corporations. After the meltdown of markets in 2007-08, economies world over are worried over the risks to the financial system that may arise due to failure of large banks and financial institutions. As it happens with any other theory, this theory has its proponents and opponents. Paul Krugman, who won the Nobel Prize for economics in 2008, led the proponents whereas the former Chairman of the Federal Reserve, Alan Greenspan led the opponents of the theory. It may be noted that Alan Greenspan was chairman of the FED for 20 years continuously from 1987 to 2006 without any Grexit problem! Proponents of TBTF theory are of the view that large institutions are to be protected against their failure by giving all support to them. Not doing so would result in chain reaction and the damage does not confine to their exit alone. It would damage the entire system. Opponents of TBTF theory like Greenspan have held that any support to the too big to fail institutions will only result in their deliberately taking high-risk-high-return positions, safe in their status as TBTF. Support is definitely going to come, they would assume. Opponents of the theory strongly advocate that it is advisable to deliberately break down such too big to fail institutions into smaller ones.  

On 31st August last year, RBI identified two Indian Banks as "Systemically important" in our own version of TBTF. SBI and ICICI bank have been marked for closer supervision and higher Capital Adequacy requirements on this account. The recent steps initiated for absorbing the subsidiaries of SBI with the parent is to be viewed in this background. In the urge to create big universal banks in the country to compete with the bigger ones in the globe, we are creating a bigger TBTF bank. This is happening when a considerable section of economists are advising deliberately splitting large banks into smaller ones to prevent systemic risks their failure may bring in. Once this is done, there is going to be a further disappearance of many banks in the country which have their own history, culture, importance and identity.

RBI's revised guidelines for classification of NPAs and cleaning of balance sheets of banks brought in a plethora of loss making banks. It was as if there was a competition about declaring losses. Banks with unblemished profitability records too showed record losses, shaking the confidence of the general public. Though one more year was available for cleaning, at the end of the financial year 2015-16, we were assured that many balance sheets have been fully cleaned and things will only look up now. Bank shares reached record lows. Their prices have recovered by 30 to 50 percent within the last three to four months, even when there are indications that cleaning is to go a long way. There is no logic in either these valuations going down or going up. At least in their going up sharply when cleaning process is still far away.

What is the root cause for this NPA problem? Many factors are blamed for the present mess. It is not that the malady has set in overnight. What we are reaping now it is not a short term crop, but a plantation crop. Lending and soundness of the banks revolve on two basic tenets; following lending discipline and honoring the repayment requirement. The seeds were sown when these two basic pillars were damaged systematically. Principles of commercial lending have been continuously sacrificed at the altar of political expediency and popular appeal. Loan melas brought in extraneous considerations while lending. Loan waivers brought in dilution of honoring repayment obligations. It is always true that there has to be some consideration while lending to desired groups to bring social equality. But that cannot be at the cost of lending discipline. Similarly, there have to be cases of relief to the debt ridden sections of the society. But that cannot also be a wholesale let-off and has be to be on case to case basis. Relief is to be given to the identified needy ones and funds for that should go directly to them for discharging debt obligations. Blanket loan waiver schemes have ensured that borrowers always look for the next loan waiver scheme. We are now reaping the fruits of these twin plantation crops. These trees are going to be around for long. Their roots have gone deep inside the banking grounds. 

An article by Shri J Mulraj in Business Line two days ago has coined two more acronyms - TBTR and TFTE. TBTR is for Too Big to Rein-in and TFTE for Too Foolish To Explain to Central Banks. It refers to the various efforts made by Central Banks all over the world to boost consumption and investment. The article points out that investment banks which are too big to fail have devised increasingly complex and deadly derivative products which are growing every day. The fact that 2008 crisis was basically due to securitized mortgage loans and collaterized debt obligations, which too were derivative products, appears to have been forgotten. Central Banks are printing more money to bring in feel good factor and make stock markets and other markets start looking up. The idea is to induce higher spending. It mentions that Bank of Japan is now among the top 10 shareholders of 90% of Japan's largest companies. Investors are buying bonds from market using borrowed money and making a profit by selling it to the central bank, which continues to buy these bonds. A large European bank alone has an exposure of 49 trillion dollars of derivative trades. The opinion is that these policies of central banks will cause the next crisis. These are too complex issues for many of us to understand. But the time bomb appears to be ticking.

It is not that we should keep looking for the next crisis and feel depressed now itself. Financial world has seen many crisis in the past and come out of them after a new equilibrium has been reached. It is to be remembered that there is a limit to getting returns on investments. Fantastic returns for some always means that there are fanatical loss for some others. Greed often overtakes wiser counsel. A control on such greed is what is required today.

Historians say that the easiest way to destabilize a country is to corrupt its language. Once the language is spoilt, hurting the land's identity and culture becomes easy. In the same vein, destroying the financial system is easy if its lending systems and repayment integrity is damaged. What is required now is neither consolidation of banks nor their fragmentation. Restoring the integrity of lending process and bringing back the culture of encouraging prompt repayment is the need of the hour in our country. Exemptions can be there, but these must be the basic rule. These are the pillars on which the future of the financial system are to be restored.

17 comments:

  1. What a wonderful article written lucidly.Hats of to Keshav Murthy. I feel that I am physically listening to Keshavmurthy's conversation in this article.Keep writing more on Banking developments

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  2. I read Mulraj's article the other day, and was appalled at the goings-on in the large fiancial and corporate institutions, like the apparent foolishness of Bank of Japan you have referred to. The two sentences in bold letters at the end capture the essence of today's situation. Banks have to go "back to basics", which was a slogan BOB adopted for its annual policy guidelines a few years ago. Your article makes, as usual, very interesting reading, with issues like language and acronyms creeping into the text and merging seemlessly, and not as a diversion.

    S Natraj

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  3. Intrigued and informed. A very heady reading indeed . For a layman like me its extremely interesting to read about the banking world from this perspective. Thank you Sir for this magnificent piece.

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  4. fantastic article sir!!!
    I keep telling the students in my class that demand and supply are pseudonyms coined by economists for greed and fear.. :)

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  5. Very well written! Kudos to you again.

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  6. You make complex subjects to easy ones

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  7. M ChandrasekaranJuly 25, 2016 at 5:06 AM

    A wonderful article on the current scenario of the Banks and their woes neatly given! kudos to you sir

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  8. True, the art of making things simple and to be understood by all though looks simple, is the most difficult thing, thanks for your continued effort in this direction

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  9. Lucid and accurate description of today's condition of Banks in India. Added to this is that entire Board is appointed by the biggest investor, namely Govt. of India. Is it really corporate Governance.

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  10. Very informative and beautifully written..... waiting for the next article :-)

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  11. Well said. The system needs to be set right independent of political interference.

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  12. This article was awesome sir keep on sending ur knowledge to us 😃..thank u sir

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  13. After all comments, I can say thanks only.

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  14. Your article is TGTI (Too Good To Ignore). The characteristic sense of humour is all over there. While I do agree with you on your diagn . I am sure that when the infrastructure and industrial activities pick up, a large number of stressed accounts would turn to perform - as has happened in the past. In a developing economy like our country, the socio economic cost-benefit of bank lending should also be kept in perspective. Let us hope that based on the lessons learnt PSBs will quickly be back on corrective course. Nevertheless, the article highlights an important aspect of bank functioning.
    Kudos

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  15. Daniel S MahantyJune 16, 2017 at 4:20 AM

    "Fantastic returns for some always means that there are fanatical loss for some others." Very true.

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