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As the high-decibel slug-fest over the fugitive promoter of the now-defunct Kingfisher Airlines plays out in the headlines, it is instructive to turn back to the RBI's financial stability report (FSR) of June, 2012. Here, the RBI voiced its concern about the relatively large loan exposure of a comparatively small set of PSU banks to the airlines sector: The words were clear and sharp: “Asset quality of banks’ credit to the airlines industry came under some stress in recent periods, driven largely by the performance of some specific airline companies. Sharp increases in impairment and restructuring in the sector saw the share of this sector in aggregate banking system NPA and restructured assets rise disproportionate to its share in banking sector credit. There was significant concentration discernible in distribution of credit to the airline sector as ten banks accounted for almost 86 per cent of total bank credit to this sector. As at end-March 2012, nearly three quarters of the advances of banks, which have an exposure of above Rs. 10 billion to the airline industry, were either impaired or restructured. PSBs accounted for the major share of these exposures.”
To bring in some perspective, while the loans to the airlines sector was barely 0.8 per cent of total loans of banks, the sector's restructured loans were 12 per cent of the total restructured loans of banks. Also, the loans to all airlines companies were not impaired/restructured. Only “some specific airlines” were involved. This careful choice of words notwithstanding, the whole world knew who the restructuring largesse was aimed at.
As at end-March 2012, nearly three quarters of the advances of banks, which have an exposure of above Rs. 10 billion to the airline industry, were either impaired or restructured. PSBs accounted for the major share of these exposures.
Extension of restructuring to airlines sector
That this concern was raised barely 18 months after RBI had permitted in August, 2010, at the instance of the then government, a generous recasting of loans to a few airlines companies on the pretext of being sensitive to the latter's requirement is enlightening. It also alludes to the internal tension, conflict and ambiguities that RBI as the banking regulator and supervisor must have faced in the wake of the massive forbearance in the name of restructuring of overdue loans that began in 2008. Put differently, it laid bare the pitfalls of banking regulation and supervisions being under one roof.
Adverse implications of restructuring for banking supervision
One obvious casualty of widespread restructuring was the supervision of banks. The examiners of banks never had a clear idea on what to do with the so-called restructured loans, particularly in respect of medium and large enterprises, which were indistinguishable from NPAs. Or, for that matter how restructuring was different from ever-greening. This was important because each full-scale annual examination of any bank involves, among others, calculation of its net worth, based on realistic and independent assessment of provisions required for bad loans. It is highly possible that the examiners of SBI in 2011, for example, raised the issue of a huge shortfall in provisioning in respect of Kingfisher Airlines. How this issue was finally resolved within RBI can at best be a matter of conjecture for outsiders. But what is almost certain is that in the years following the introduction of generous restructuring, supervision of banks was largely “kind-hearted”, something that the former Deputy Governor S. S. Tarapore had cautioned against many years back. And one can say with the benefit of hindsight that had RBI examiners been successful in recognising Kingfisher as an NPA then, recovery efforts could have started in time.
The standard and quality of supervision post-2008 dropped significantly, as evidenced by the fact that it required a special exercise in the form of Asset Quality Review(AQR) years later in 2014-15 to begin a process to reveal the true extent of NPAs in banks. Even afterwards, banking supervision was involved in a sort of “cat and mouse game” in unearthing NPAs in a few private sector banks.
In the years following the introduction of generous restructuring, supervision of banks was largely “kind-hearted”, something that the former Deputy Governor S. S. Tarapore had cautioned against many years back. And one can say with the benefit of hindsight that had RBI examiners been successful in recognising Kingfisher as an NPA then, recovery efforts could have started in time.
Suffice it to say that banking supervision lost its moorings during these years, and its leadership seems to have done little to correct the situation. This adversely impacted credit discipline and governance in banks, in general. Foreign portfolio investors (FPI) have often wondered if there were any objective and rule-based provisioning norms for banks in India. This does not mean a benign inquisitiveness on their part, since the market makes its own estimate of the provisioning shortfall which gets reflected in the price of banks' equity, which in respect of most PSU banks have been trading at discounts to their respective book values for quite some time now.
Lessons learnt at a cost
Fortunately, the lessons arising out of the politically-inspired and directed “restructuring” of overdue loans have been learnt and this term has been purged out of the regulatory lexicon in February this year. But what a costly lesson it has been! By some estimate, the true amount of NPAs is close to 10 per cent of India's GDP. Given that the most optimistic recovery wouldn't exceed 20 per cent of the loan amounts due, the deadweight loss to the country's economy is around 8 per cent of the GDP. This is unprecedented and will have negative welfare implications for India's common citizen.
Way forward
A high level review of the supervisory function of RBI should be undertaken, with emphasis on the efficacy, independence and professional standards and rigours of off-site and on-site supervision of banks, NBFCs and urban cooperative banks and necessary measures in the light of its findings ought to be taken.
In the aftermath of the collapse of Lehman Brothers exactly 10 years back, a loaded issue was raised by a top RBI official in a speech- “Does the financial sector impose a tithe on the economy?” If the Indian experience alone is any guide in this regard, the answer is “yes it did, in a broader sense”. And one takes into account not just the present humongous recapitalisation needs, but also the consistent low return on equity generated by most PSU banks. However, as with most episodes in history, there was nothing inevitable about it. The three most important steps that the Indian authorities need to take for preventing its recurrence are:
(a) All directions from the government to RBI in matters relating to regulation of banks, financial institutions and markets under RBI's oversight should henceforth be formally done, invoking the provisions of section 7(1) of the RBI Act, 1934.
(b) The Board for Financial Supervision (BFS) should be recast through an amendment to the RBI Act to provide it a statutory status a la the Monetary Policy Committee. The objective here is to ensure its independence, professionalism and accountability.
(c) A high level review of the supervisory function of RBI should be undertaken, with emphasis on the efficacy, independence and professional standards and rigours of off-site and on-site supervision of banks, NBFCs and urban cooperative banks and necessary measures in the light of its findings ought to be taken.
(Himadri Bhattacharya is a former central banker and consultant to the IMF)