Last month, senior BJP leader Murli Manohar Joshi-led parliamentary committee had written to former RBI Governor Raghuram Rajan seeking his opinion on the mounting NPAs.
The committee chairman in his letter had said, “the committee admires his (Rajan’s) experience and knowledge and if he is unable to testify to the summons in person, the committee would like a written testimony of his expert view on the NPA crisis, how it has been created and how India should tackle it.”
Yesterday, The Wire made public the detailed 17-page written reply by Dr Rajan. Following are the key observations, excerpts and insights from his reply.
Is RBI to blame for the NPA problem?
Raghuram Rajan elaborated that the role of RBI is of a “referee”, and it can’t micromanage or take banker’s commercial decisions.
He said, “The truth is bankers, promoters and circumstances create the bad loan problem.”
He added, “The important duty of the regulator is to force timely recognition of NPAs and then disclose when they happen, followed by requiring adequate bank capitalization. This is done through the RBI’s regular supervision of banks.”
Did recognition of NPAs slow India’s economic growth?
Dr Rajan called this claim “ludicrous, and made by people who have not done their homework.” He said that he gave a speech in this regard in July 2016 before he left office as he knew “vested interests” will target RBI on the growth issue citing the NPA cleanup as the problem.
He further refuted the claim by comparing the public sector bank credit growth with the private sector banks. Presenting data, he said, “Whenever one sees a slowdown in lending, one could conclude there is no demand for credit – firms are not investing. But what we see here is a slowdown in lending by public sector banks vis a vis private sector banks.”
Giving examples of personal loans and housing loans, in particular, he added that lending by public sector banks in these sectors remained upbeat signalling the banks’ aversion to NPA ridden sectors.
He concluded, “The fact that the public sector bank credit slowdown to industry dates from early 2014 suggests that the bank cleanup, which started in earnest in the second half of fiscal year 2015, was not the cause. Indeed, the slowdown is best attributed to over-burdened public sector bank balance sheets and growing risk aversion in public sector bankers.”
He adds that the “obvious remedy” is to clean the balance sheets of public sector banks and that this method has worked in other countries as well.
“Clean up was part of the solution, not the problem,” says Dr Rajan.
“Blame probably lies on all sides here”
Talking about the mounting NPAs, he pointed out that once the bad loans were disclosed, the banks and the government should have undertaken the “surgery that was necessary to put the projects back on track.”
He added, “A fair amount of the increase in NPAs may be due to ageing rather than as a result of a fresh lot of NPAs.”
Dr Rajan said that he can only surmise based on press reports as to why projects were not revived as he had left office by then. He went on to list a few reasons which include:
- Risk-averse bankers who don’t want to be harassed
- Enacting the Bankruptcy code was much needed, however, some promoters are still trying to play the process.
- “The government has dragged its feet on project revival – the continuing problems in the power sector are just one example.”
He cautioned that the judicial process is “simply not equipped to handle every NPA through a bankruptcy process.” He added, “Bankruptcy Court should be a final threat, and much loan renegotiation should be done under the shadow of the Bankruptcy Court, not in it.”
Could the RBI have done better?
Although Dr Rajan said that “It is hard to offer an objective self-assessment,” he did list some issues. According to him, in 2006-2008, the strong economic growth and timely implementation of major projects till then had filled bankers with optimism and exuberance. This exuberance led to a decline in due diligence which manifested in the form of banks not vetting the credit requests thoroughly. In this light, he said that “RBI should probably have raised more flags about the quality of lending in the early days of banking exuberance.”
He added that RBI should have pushed for a “more rapid enactment of the Bankruptcy Code.” He said that banks had to resort to ever-greening, a bad move in hindsight and in general, but as there were no mechanisms to address this issue so banks could not have done much about it.
He said, “Fortunately, this culture of leniency has been changing in recent years. Hindsight, of course, is 20/20.”
Steps that can be taken to prevent recurrence
- “Improve governance of public sector banks and distance them from the government.”
- “Improve the process of project evaluation and monitoring to lower the risk of project NPAs.”
- “Strengthen the recovery process further.”
Dr Rajan remarked that the PSBs are “still not adequately professionalized”. He advised the government to follow the PJ Naik committee report “more carefully.” He further said that the government should ensure that the banks are not left leaderless and plan to appoint CEOs in advance. Also, an independent entity like the Bank Board Bureau should be delegated the responsibility. He also emphasised the need to get “outside talent” as there is a “talent deficit in internal PSB candidates.” He notes, “There will be internal resistance, but lakhs of crores of national assets cannot be held hostage to the career concerns of a few.”
“Govt should focus on sources of the next crisis, not just the last one”
Dr Rajan cautioned the government from “setting ambitious credit targets or waiving loans.” He pointed out that the RBI had repeatedly said that loan waivers reduce the flow of credit, hamper the credit culture and “stress the budgets of the waiving state or central government.”
He added that the agriculture sector in India needs “serious attention but not through loan waivers.” He further said, “An all-party agreement to this effect would be in the nation’s interest, especially given the impending elections.”
He also cautioned the government about MUDRA and Kisan Credit Card scheme and said that although they are popular, they need to be “examined more closely for potential credit risk.”
Dr Rajan remarked that “Unfortunately, the system has been singularly ineffective in bringing even a single high profile fraudster to book. As a result, fraud is not discouraged.”
Without clarifying which PMO he is referring to, he said, “I also sent a list of high profile cases to the PMO urging that we coordinate action to bring at least one or two to book. I am not aware of progress on this front. This is a matter that should be addressed with urgency.”
It is to be noted that Dr Raghuram Rajan was the youngest chief economist at the International Monetary Fund and the first non-westerner to hold the coveted post. He was also one of the few leading economists who raised concerns about the global banking situation and predicted a “catastrophic meltdown” way back in 2005. However, his concerns were criticised at the time and by 2008/09 the world was in the grips of a global financial crisis.