'By not letting bankrupt banks fail, we have discouraged ordinary folk from taking precautions while choosing their bank or at least when they hear bad news about their bank,' says S Muralidharan, former managing director, BNP Paribas.
Illustration: Dominic Xavier/Rediff.com
In poker there is a maxim: Go Big or Go Home.
In other words, bet big and bluff your opponent into submission (If you can't bet big, don't come to the poker table).
The government seems to be playing poker with our nation's banks.
In response to the loan quality problems of our banks, which are threatening to sink some if not most of them, some interesting solutions have been outlined. They range from the far-out bizarre to outright infeasible.
Most meet the criterion of being utterly senseless.
All seek to prettify the banks even as the cancer that afflicts them rages inside. In the following paragraphs I shall throw some light on a couple of favourite ideas doing the rounds.
To set the context, I refer the interested reader to my take on what got us into this mess in the first place.
To those with no appetite for a lengthy discourse, and with limited attention span, I summarise my conclusions in that column in the following lines:
1. Loans fail, because businesses fail, period.
Fortune magazine revealed in 2014 that of the 500 top American companies of 1955, a full 88% were no longer in the list, having gone bankrupt, or been taken over or had simply scaled down dramatically in order to survive.
It is the natural law: All living things die except in India where expired ideologies, personalities, parties and even businesses are kept on oxygen long past their normal or 'useful' life.
2. Businesses fail when disruptive technologies emerge.
Our postal system is a pale shadow of its former glory, thanks to the emergence of the courier system and e-mail.
3. Bankers make mistakes -- they do bad appraisal, poor monitoring and fail to call it quits before it is too late.
We Indians are well-known for staying in 'bad marriages' for all sorts of reasons and we bring the same sensibilities to banking.
4. Political influence almost invariably creates bad loans. Needs no explanation, speaks for itself.
5. Administrative meddling in banks forces the management to 'manage up' and distracts them from managing the business of banking.
6. Bankers strayed into areas beyond their capabilities: Starting the late 1990s commercial banks started financing infrastructure and such long-term projects without the specialist skills those areas demand.
7. Structural changes in banking saw specialised long-term lenders metamorphose into retail banks leaving a void for 'commercial banks' to fill, with the result that 6 above happened.
8. Indian businesses are predominantly debt-financed as opposed to equity-financed.
Long story short, the 'promoters' effectively had little or no stakes in their business. Business gains remained private but losses were public's.
9. Senseless and even malign laws which claimed to do one thing but had the exact opposite effect.
So what have the Netas, Mandarins, Bankers, and Lalajis come up with?
The current favourite seems to be the good banks/bad bank paradigm.
In short, this involves taking the bad loans of all PSU banks and putting them into a pot called Bad Bank.
With the bad loans gone, all the banks become good banks.
The big assumption -- and it is a mere assumption -- is that the Led Zeppelin of Good Banks will merrily ascend up the Stairway to Heaven, divested of the dead weight of bad loans.
Then all will be well and we can all sing all the way to (offshore) banks.
Banks can go on lending, again, to their hearts' content until they are bloated, again, with bad loans like the airship Graf Zeppelin was with hydrogen gas; we know how to that one ended.
The good bank/bad bank idea has gained a lot of traction in recent times.
Government proposed it, mandarins promote it, banks agree with it, CII is pushing hard for it.
When such traditionally disparate interest groups come together to sing the hosannas for anything, it must be a bad idea.
It is.
In a recent column the economist and business columnist Omkar Goswami explains how the Bad Bank idea has only worked in certain specific circumstances.
To paraphrase him, these have only worked in the case of bad residential mortgages.
It is not difficult to see why: Mortgages are small loans, well secured by specific assets whose values are well-known and which are highly marketable despite being 'lliquid'.
Resolution by Bad Banks of corporate loans across the world have met with abject failure.
For the Bad Bank model to work, there are some preconditions:
1. The troubled assets will find buyers, if not ready, at least in reasonably quick time.
2. The troubled banks must be able to expeditiously sell these loans at the discount demanded by the Bad Bank.
3. The buyer must be able to control the businesses whose loans he has acquired and eject the old management and install new management as deemed fit by him.
4. There must be a ready market for the business as a whole or its divisions -- selling the assets is not a viable option notwithstanding its value on paper.
5. The business must be fixable through all or some of the following: Injection of more finance, management and operating skills, and reduction in input costs like interest, supplies and labour.
6. Availability of skilled deal makers who can wring a great deals involving steep discounts.
7. A politico-legal framework which not only allows all the above, but actually facilitates them.
How realistic is it to expect that the above conditions are favourable in the Indian context?
1. Prior experience suggests that the corporate loan resolution through good bank/bad bank separation has not worked anywhere in the world.
That is because a corporate loan is everything a mortgage loan is not: it is bespoke, tailored to specific company and industry and the so-called security is mainly on paper and highly unrealisable.
Corporations are great so long as the business is humming along, but the moment there is a whiff of bankruptcy, the inventories are worth nothing, debtors don't pay up, machinery is found rusted and even land titles are found defective.
Buyers would claim they could create twice the capacity at half the cost with none of the legacy issues like labour, overdue taxes, environmental liabilities and so on.
2. PSU banks selling off bad loans at bilaterally negotiated steep discounts is not feasible, subject as they are to vigilance commission and so on. I do not see any PSU banker, fearing a visit from the CBI and trial by media, embracing this idea.
3. What is the guarantee that after the one-time resolution, the good banks will continue to be good?
Do the bankers have the skills to appraise possible future bad loans and the integrity and strength to resist creating new ones in these times of crony capitalism?
Nothing we have seen so far indicates that they will be able to keep bad loans at bay through skilful judgements and imperviousness to various pressures that will be brought to bear on them.
After all, they are answerable to the Mandarins and the Netas.
4. Corporate loans cannot be as easily be sold off as mortgages can be.
Notwithstanding one or two recent successes in which the ailing companies were taken over lock stock and barrel at a reduced value, expecting that this will be the norm across the board is unrealistic.
5. It is a big assumption that businesses can be turned around by infusing additional wads of cash and concessions from banks and creditors et al, and one without any precedent. It assumes a passive or 'mechanical' model of business, that if we put the right ingredients in place, they will somehow combine to make a great success.
This assumption does not value the business acumen and the magic that successful entrepreneurs bring to their businesses.
This is also the reason that the earlier resolution mechanism through SICA and BIFR failed.
6. The flip side of 2 above is availability of skilled deal-makers who can take over the bad loans at significant discounts which can then be flipped for a hefty profit.
The profit needs to be hefty to justify this highly risky manoeuvre or the investment will turn to manure.
Admittedly there are private investors today looking for above-average returns who can provide the funds. However, the returns expected will have to take into account losses that are bound to be much more frequent than not.
Which in turn determines the discount on face value, which brings us to the question if such steep discounts and negotiated deals will be 'safe' to do in our context without adverse consequences to the persons involved. I am inclined to be extremely sceptical.
7. We today have some form of legal framework to facilitate this sort of negotiated takeovers of loans. But the so-called promoters still find it possible to delay and stymie the process through legal action.
If we are to be successful in this endeavour and if we are to succeed in resolving our bad loans problems now and in the future, we have to look at some form curtailment of promoters' rights in such cases.
This might sound draconian, but in the light of the great cost incurred by society at large it is a necessary pain that must be borne by the privileged who misused their privilege or in the least failed their stakeholders.
Will it fly? I have doubts that it will, requiring as it does the coming together of a broken polity.
Even if by some miracle the lefty loonies, the dynasts and their sycophants, the opportunists, the bloody-minded and the simply corrupt all come together with the saffron order to put in place the legal framework, there are the 'technical' issues that I haven't even got started on.
Will it be a 'private' entity or will it be another government-owned ARC, headed by a babu?
Who will regulate it, yet allow it freedom enough to do the job that must be done?
Suffice to say that the more one looks at it, the more it looks implausible.
What of the so-called 'good banks' that will result from this exercise, assuming that somehow we are able to get it all going?
Are they good for ever?
How will they plug the holes in their balance sheets -- conservatively estimated at 10% to 15%?
The very reason for considering a bad bank is because the government lacks the resources with which to recapitalise these banks for the nth time.
If that be the case, how will the balance sheet holes be plugged?
Will there be more ReCap bonds or will the bonds be offered to the public?
Why will the latter invest in them, when there is no history of such a thing around the world?
The only option is the sham capitalisation that has been followed hitherto: Government will infuse additional capital, but since they do not have the cash, the banks will buy the bonds and give them the cash.
This is nothing more than an accounting trickery and not even a sophisticated one at that.
It is a fudge and a fraud on the public.
An alternate idea that has got much traction in recent days is the proposed merger of banks. Enthusiastic proponents and supporters of this idea have been the PSU bankers themselves.
Is it a good solution or a bad idea? I have never heard of anything more daft.
There are two possibilities: The Strong-Weak merger and the Strong-Strong merger (the latter will leave behind weak banks to be dealt with).
By merging a weak bank with a strong one, we are only weakening the latter.
What will we do with the weak banks which are left over from strong-strong mergers?
I am amazed at this obsession with mergers as a solution to banking problems displayed by two successive governments, otherwise at diametrically opposite positions on every conceivable issue.
The government hopes that with SBI beginning to see benefits of a merger with its associate banks, the same formula can benefit to other mergers too. SBI shared the same IT platform with its associate banks, which is not the case with other banks.
The biggest problem for me is this obsession with creating large banks.
For most of the decade of 1980s, the top 10 global banks were all Japanese or French.
Obsessed with topping the league tables, they were bulking up while the American banks were taking a break after binging on sovereign loans to Latin American countries.
Each and every one of those top 10 banks of 1980s met serious trouble in the 1990s and some had to be bailed out (all the French ones were privatised).
In solving one banking problem, do we want to sow the seeds of a future crisis? What is the compulsion?
Banks will get into trouble and will fail.
The trick is not to buck this economic law, but to allow them to fail but minimise the adverse impact of the failure through systemic measures while providing a safety net for the most vulnerable customers.
By not letting bankrupt banks fail, we have created a false sense of security and discouraged ordinary folk from taking normal precautions while choosing their bank or at least when they hear bad news about their bank.
We have also created a culture of dependency; dependence on government to do everything for us.
Large size also makes banks more centralised, alienates the customers, more bureaucratic, more rule bound and less compassionate and so on.
The solutions to future problems before they arise is to let the banks shrink or at any rate don't make them bigger.
There is another component to the solution: Let the State get out of banks altogether.
The State has a poor record in business: STC, MMTC, Air India, HMT, IDPL, Photo films, Scooters....I can go on and on till your patience or my ink runs out.
It need not exit with a bang, perhaps, but in a phased manner.
With the cash thus raised they could genuinely capitalise the 'weak' banks so they can be brought to health and sold off.
We could begin with selling the State's 31% stake in Axis Bank. This can fetch approximately Rs 40,000 crores, a tidy sum to begin with.
We can come up with out of the box solutions like auctioning bank licences to new entrepreneurs, consumer cooperatives or foreign banks.
Existing banks can thus consolidate their operations while at the same time raising capital by selling branch licenses.
This will have the added benefit of creating new competition.
Continued government ownership of banks amounts to perpetuating crony capitalism and economic distortion.
There is no reason at all that government should own banks other than to favour its friends, allies and well-wishers.
What we are seeing is the first taste of many crises that will follow as night follows day unless we take steps to stop that.
The time is NOW.
Keep them smaller, keep them nimble, keep them responsive, keep the State out.
2019 will mark the 50th anniversary of nationalisation of banks which we all know was born of a Big Lie.
Let us celebrate it with the symbolic start of its dismantling.
S Muralidharan retired as the managing director of BNP Paribas after serving the bank for 20 years.
