GOOD TIMES, BAD HABITS
As the Indian economy signals a rebound, the Reserve Bank of India warns banks not to indulge in irrational exuberance. EPISODE #128
Dear Reader,
A very Happy Monday to you.
Last week the Reserve Bank of India Governor Shaktikanta Das cautioned private banks as they readied to service the visible increase in demand for bank credit. Significantly, this warning came amidst a chorus of analyst reports arguing that Indian economy had crossed the tipping point.
Accordingly, this week I explore the Governor’s warning to banks to not fall back on bad habits—that plunged the financial sector into a crisis in the last decade—in good times. Do read and share your feedback.
The cover picture this week is taken by Lena Polishko and sourced from Unsplash.
A big shoutout to Balesh, Vandana, Premasundaran, Gautam, Aashish and Ajeet for your informed responses, kind appreciation and amplification of last week’s column. Once again, grateful for the conversation initiated by all you readers. Gratitude also to all those who responded on Twitter and Linkedin.
Unfortunately, Twitter has shut down amplification of Substack links and content—perils of social media monopolies operating in a walled garden framework. I would be grateful therefore if you could spread the word. Nothing to beat the word of mouth.
Reader participation and amplification is key to growing this newsletter community. And, many thanks to readers who hit the like button😊.
DAS COMMANDMENTS
The Reserve Bank of India governor Shaktikanta Das is very measured in his public uttering. He is not won’t to rhetorical flourishes. As a result, when the governor raises a red flag everyone sits up and takes notice.
In this instance all the more, since the Indian economy is very clearly shaking off the overhang of the unprecedented inclement challenges brought about by the once in a century pandemic, the Russia-Ukraine war and the aggressive actions of the United States Federal Reserve.
Addressing the Conference of Directors of Banks last week, he cautioned banks from abandoning prudence, especially at a time when things are beginning to look up for the Indian economy as well as its financial sector:
“Today our banking sector stands out as strong and stable with CRAR (capital to risk weighted asset ratio) at 16.1%, Gross NPA (non-performing assets) at 4.41%, Net NPA at 1.16% and Provision Coverage Ratio at 73.20% at the end of December 2022.
It is in times such as these that complacency may set in. We have to bear in mind that risks often get overlooked or forgotten when things are going well.
Therefore, Boards of Directors of Banks and their senior management should maintain constant vigil on external risks and build-up of internal vulnerabilities, if any.”
Though it was an event hosted for public sector banks, the statement was directed equally at private banks.
It is clear that for some reason RBI is worried about the governance norms of commercial banks. It could either be that they are spooked after what went down in the US (the Silicon Valley Bank meltdown) or their routine oversight has thrown up red flags.
The governor’s 10 commandments make this most apparent. I will share a few. (If you wish to check out all of them please read the transcript of the entire speech; scroll upto the third paragraph—I have shared the link.)
Flagging governance and stability he said:
“It is, however, a matter of concern that despite these guidelines on corporate governance, we have come across gaps in governance of certain banks, with the potential to cause some degree of volatility in the banking sector.
While these gaps have been mitigated, it is necessary that Boards and the managements do not allow such gaps to creep in.
We have been engaging with some of you on these issues at the individual level, but I thought it would be more effective if we engage with all the Directors together. It is the joint responsibility of the Chairman of the Board and the Directors, both whole time as well as non-executive or part time Directors, to ensure robust governance in banks.”
On the need to build and preserve public trust, the governor said:
“The importance of public trust in the banking system, as exemplified in the recent bank failures in the United States, also needs to be appreciated. This was a classic case wherein public trust in certain banks evaporated suddenly.
Further, in this digital age, it took only a few hours to transfer billions of dollars held as deposits in a bank to other institutions, leading to a severe liquidity crisis. The monitoring of information appearing in various media, including social media, has therefore become very important for any bank.
In fact, such cases have been observed in India, too, in a few Banks in the past. We had to advise the CEOs to interact with the media immediately to set out the facts correctly. There have been instances when the Reserve Bank had to issue press statements to assuage concerns and prevent potential panic.
In this kind of milieu, it is upon the Banks and their Boards to assiduously build sound corporate culture and value system within the organisation.”
The governor did not mince words when he said that supervisory process revealed attempts to mask bad loans using ingenious means. Flagging these errors of commissions, he said:
“During the course of our supervisory process, certain instances of using innovative ways to conceal the real status of stressed loans have also come to our notice.”
And then added:
To mention a few, such methods include bringing two lenders together to evergreen each other’s loans by sale and buyback of loans or debt instruments; good borrowers being persuaded to enter into structured deals with a stressed borrower to conceal the stress; use of internal or office accounts to adjust borrower's repayment obligations; renewal of loans or disbursement of new/additional loans to the stressed borrower or related entities closer to the repayment date of the earlier loans; and similar other methods.
We have also come across a few examples where one method of evergreening, after being pointed out by the regulator, was replaced by another method.
Such practices beg the question as to whose interest such smart methods serve. I have mentioned these instances to sensitise all of you to keep a watch on such practices.”
The banks may have forgotten the recent history of financial carnage—one that almost brought down the Indian economy. Clearly, RBI, going by the governor’s 10 commandments to banks, has learnt its lessons.
The bad debts or NPAs had accumulated during the heady phase of growth in the first decade of this Millennium—when growth averaged 9% and investment (as a proportion of gross domestic product) touched a record 38%.
Banks gave short shrift to prudence and embraced growth. Which meant that companies over-leveraged. Corruption in high office by a clutch of politicians, bureaucrats, bankers and corporates, enabling loans against weak balance sheets only made a bad situation worse.
The wheels came off the wagon when the global financial crisis struck in 2008. Even companies with plans that were kosher faced a contraction in their business.
The obvious happened: firms were unable to honour the debts owed to banks. The cumulative net NPAS touched a record 4.50 lakh crore—this is nearly five times the annual budget of the rural employment guarantee scheme.
Deja Vu?
The table above sourced from a Parliament document visually captures the sorry story of NPAs—a saga of serial errors of omission and commission. It is clear that the fiscal sins of the growth years caught up with a vengeance. Clearly, RBI wants to avoid a repeat.
Coincidentally, once again, the Indian economy is on the upswing, having managed to shrug off the back-to-back setbacks of covid-19 pandemic, Russia-Ukraine war and the aggressive actions of the US Fed.
And these glad tidings are coming from global investment banks.
Like it did last November, Morgan Stanley, the global investment bank, went out on a limb and sent out a note to its clients that India has undergone a dramatic makeover in the last decade, setting the stage for an explosive phase of growth.
And, this in a period that has been racked by unprecedented back-to-back global setbacks.
Its report titled ‘How India Has Transformed in Less than a Decade’ said:
“This India is different from what it was in 2013.
In a short span of 10 years, India has gained positions in the world order with significant positive consequences for the macro and market outlook.”
And, then added:
“We run into significant scepticism about India, particularly with overseas investors, who say that India has not delivered its potential (despite its being the second-fastest-growing economy and among the top-performing stock markets over the past 25 years) and that equity valuations are too rich.
However, such a view ignores the significant changes that have taken place in India, especially since 2014.”
Morgan Stanley is not alone.
Amundi Institute, the research arm of Amundi, the European asset manager, just published an equally bullish report on India’s prospects.
Their report, titled, ‘Building bridges to India’s future investment opportunities’, argues:
“India’s macro fundamentals are well positioned for a multi-year improvement in economic output and earnings.”
Clearly, the central bank does not want a repeat of what played out in the first decade of this Millennium. Exactly why the Das Commandments lay down the guardrails for banks as they ready to service the next phase of growth of the Indian economy.
Recommended Viewing
Sharing the latest post of Capital Calculus on StratNews Global.
Last week I put the spotlight on the upcoming awards ceremony in London (14 June) hosted by Central Banking—the global repository for all news on central banking.
While Shaktikanta Das will receive the governor of the year award, SecurEyes, a home grown Indian cybersecurity firm with a global footprint, is being acknowledged for its marquee product: RegTrac (an application software used by a few central banks to monitory regulatory compliance.
The awards are a tacit acknowledgement of two things:
One, regulatory compliance is now driven by sophisticated technology and involves collating information from multiple sources.
Second, it is a nod to India’s regulatory framework—a precondition for India to transition to a rules-based regime.
I spoke to Seemanta Patnaik, the Chief Technology Officer, SecurEyes, to unpack the implications. Do watch and share your thoughts.
Sharing the link below:
Till we meet again next week, stay safe.
Dear Anil,
Very well researched and comprehensive article!!
A very well articulated write up, containing important information and some encouraging news, with a note of caution. All this has been a result of fiscal prudence which has transformed a cash economy into a growing digital transactions economy. The government has courageously pursued it's goal and mopped up the required revenue to emerge in a relatively comfortable position. Wherever unscrupulous people in power, will conspire, fresh cases of big NPAs will occur but the recent legal action against some responsible officials in high places, may act as a deterrent. Congratulations Anil, for writing this article that has covered a critical area of economic growth 👏