Victims of crony capitalism

After the news of the Nirav Modi fraud broke out, many analysts, economists and businessmen, have suggested that the business of the government should not be business, and it should use this fraud as an opportunity to get out of business. I have been suggesting the same for the last half a decade. In fact, one of the points that I have been making over the years is that the Government of India does not need to own 21 banks (27 earlier, before the Bhartiya Mahila Bank and the five associate banks of the State Bank of India (SBI) were merged with it). At best, the government can own five or six of the biggest banks to implement its social agenda.

Of course, this hasn’t gone down well with many people, which includes the chairman of State Bank of India, Rajnish Kumar. Kumar has said: “They all [ie, private sector companies] default and sit in the front rows of the industry associations. That is the reality today. So, when somebody is preaching, preach… for sure, but also look at the reality.”

Kumar has basically mixed up private banks and private companies here. There are other critics who have said that the defaults of private banks are also going up. Let’s take these points one by one. As of September 30, 2017, the total bad loans of public sector banks (PSBs) amount to around Rs 6,89,806 crore. The bad loans rate was at 13.5 per cent, ie, of every Rs 100 lent by PSBs, Rs 13.5 had not been repaid by the borrowers.

In comparison, private banks had a total bad loans of Rs 86,281 crore. The bad loans rate of private banks was at 3.8 per cent, ie, for every Rs 100 lent by private banks, Rs 3.8 had not been repaid. The private banks may still not have come clean on all their bad loans, but they are way behind PSBs on this front. So, yes private banks also suffer from bad loans, given the nature of the banking business. But these bad loans are much less than those of PSBs.

PSBs had 87.25 per cent of the overall bad loans of Indian banks, even though they own only 68.9 per cent of the total assets. So, clearly PSBs are much more inefficient when it comes to bad loans and lending in comparison to private banks. This basically answers those who have raised doubts about the fact that private banks also face bad loans. Of course, they do, but their bad loans are their problem and not the problem of the Indian taxpayer, as is the case with PSBs.

The other point that needs to be answered here is the one raised by SBI Chairman Kumar, when he said that the private sector companies default and then preach that PSBs should be privatised. If we look at data as of March 31, 2017, the total bad loans of PSBs were at Rs 6,19,265 crore. Of this around 69 per cent or Rs 4,24,434 crore, was on account of lending to corporates.

So, yes, Kumar is right; corporates are the main defaulters of loans given out by PSBs. The question is why? Let’s take a look at numbers put out by SBI as of December 31, 2017, in order to understand. The bad loans rate of overall corporate loans of SBI stood at around 22 per cent. For the mid-corporate companies, the default rate was 27.5 per cent whereas for large corporates it was at 17.4 per cent.

Now compare this to the default rate on retail loans like home loans and auto loans. The default rate on home loans was 1 per cent and that on auto loans was 1.4 per cent. Why is the difference so huge? The answer to this is fairly straightforward. While making a loan to a retail customer, the bank manager making the loan does a proper due diligence and then decides whether to give the loan or not. In this case, the manager has the necessary knowledge to make the decision and is allowed to make the right decision. In case of a corporate loan, while the manager may do proper due diligence, given the other factors at play, he is not allowed to make the right decision. 
The major other factor is the nexus that prevails between politicians and crony capitalists, with politicians forcing PSBs to give loans to crony capitalists, who have no intention of repaying the loans.

How does one break this nexus? One way of breaking this nexus is to privatise the PSBs, and get the holding of the government down to 33 per cent. Of course, the government will have to be careful about which companies buy these banks. The RBI has done a reasonably good job of issuing bank licenses till date and should be trusted here as well. The other, and the more workable option, is to get most PSBs out of corporate lending. A bank borrows money for a period of one to five years by borrowing through fixed deposits, and given this it should not be lending to risky corporate projects, greater than 10 years. Narrow banking is the way forward.

The writer is the author of India’s Big Government—The Intrusive State and How It is Hurting Us