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Rebooting Economy 66: Is India facing credit deprivation to warrant corporation banks?

RBI's database, reports and other evidence show India is credit surplus; large industrial houses have high debt stress, and that easy credit poses serious macro-financial risks to the economy

Rebooting Economy 66: Is India facing credit deprivation to warrant corporation banks?

What compromises the Indian economy further is India's repeated failure to resolve stressed assets over the past few decades

In November 2020, an internal working group (IWG) of the Reserve Bank of India (RBI) recommended that India's large industrial houses be allowed to run banks to increase credit-to-GDP ratio from the current level of 50% to more than 150%, in line with many developed economies, for higher growth. Now Prof. Arvind Panagariya, former Niti Aayog vice-chairman, is claiming that India faces "acute problem of credit deprivation" to support the same cause.  

In an article in a leading national daily, he wrote (co-authored with Rajeev Mantri) last week that India can't solve its credit scarcity "without recourse to investment resources of corporate houses" and hence, corporate entities should be allowed to run banks.  

This suggestion comes after his earlier one about recapitalising public sector banks (PSBs) in advance for facilitating credit was accepted and Rs 20,000 crore allocated in the budget for FY22. Given his immense influence on the government this suggestion is also likely to be taken seriously.

Also Read: Rebooting Economy 65: IBC has failed; will a bad bank succeed?

But is India really facing an acute credit deprivation, as he claims, and is his solution the right one?

Here is a reality check.  

Is Indian economy facing credit crunch?

Going by the RBI reports, India has credit surplus and that is a cause of great concern.  

For example, the RBI's "Monetary Policy Statement, 2020-21 Resolution of the Monetary Policy Committee (MPC) February 3-5, 2021" released on February 5, 2021 said: "Systemic liquidity remained in large surplus in December 2020 and January 2021, engendering easy financial conditions."

What is wrong with "easy financial conditions" and why is the RBI seemingly worried about it ("engendering")? Hasn't the RBI (and the government) pushing for easy credit (more liquidity in the economy) by keeping the interest rate (repo rate) and cash reserve ratio (CRR) low?

Also Read: Rebooting Economy 64: Budget numbers don't add up to 10% or more growth in FY22

The RBI Financial Stability Report (FSR) of January 11, 2021, explained the contradictions.  

It said easy credit posed "macro-financial risks" to the economy and that this was "unintended consequences" of the monetary and fiscal measures pursued to push economic recovery. If India continued on this path (easy credit or excess liquidity), it warned that this would lead to economic impairment and delay the recovery.

This report said macro-stress tests for "credit risks" showed that the Gross NPA ratio of scheduled commercial banks (SCBs) might increase from 7.5% in September 2020 to 13.5-14.8% by September 2021. This would translate to about Rs 15-16 lakh crore of stressed assets in SCBs. (For more read "Rebooting Economy 60: India in a financial mess of its own making ")

It further said if the current emphasis on easy credit continued for a longer period it could lead to (i) further "forbearance" of stressed assets  (ii) "liquidity traps" and (iii) capital buffers in individual banks might fall "below the regulatory minimum" even though SCBs had sufficient capital at the aggregate level.

This is not a new finding. The RBI's FSR of July 24, 2020, had said the same, warning that "credit risks" arising out of easy credit/liquidity might lead to SCB's Gross NPA ratio increasing from 8.5% in March 2020 to 12.5-14.7% by March 2021.

Also Read: Rebooting Economy 63: Budgeting FY22 with critical information gaps

RBI Governor Shaktikanta Das has been at pains to repeat how easy credit has led to stock market booms and how the "disconnect" between the real economy and stock market have "accentuated" recently and "pose risks to financial stability". Back in August 2020, he had explained the stock market boom by saying: "There is so much liquidity in the system, in the global economy, that's why the stock market is very buoyant, and it is definitely disconnected with the real economy. It will certainly witness correction in the future..."

Easy credit/liquidity fuels stock market bubbles that burst eventually, hurting the real economy (loss of business and jobs). This is a global phenomenon. (For more read "Rebooting Economy 38: What makes stock markets and billionaires immune to coronavirus pandemic?")

RBI proposes to tighten credit by raising CRR  

Why is the RBI continuing with low repo rate (at which it lends to banks) and CRR?

The RBI Governor explained this in his statement after the Monetary Policy Committee meeting concluded last week: "The MPC voted unanimously to leave the policy repo rate unchanged at 4 per cent. It also unanimously decided to continue with the accommodative stance of monetary policy as long as necessary - at least through the current financial year and into the next year - to revive growth on a durable basis and mitigate the impact of COVID-19, while ensuring that inflation remains within the target going forward."

Also Read: Rebooting Economy 62: Economic growth for whom and for what?

At the same time, he also said that he would roll-back the CRR from 3% to 4% in two steps by May 22, 2021, signalling curb on credit flow.

A higher CRR means banks would keep aside a larger amount as reserve, thereby curtailing the capital pool to lend. The apparent contradiction in keeping the repo rate low and raising the CRR is a balancing act the RBI is performing because most of the credit it has facilitated is going nowhere.  

Banks are depositing excess credit in the RBI's reverse repo account (which fetches 3.35% interest) daily as the following graph testifies. They are reluctant to lend due to the NPA fear and businesses have no appetite because demand is low and hence, capacity utilisation remains subdued.

Notice how the reverse repo deposits spiked in March-April 2020 when the RBI cut the repo rate from 4.4% to 4% (on May 22, 2020) and CRR from 4% to 3% (on March 28, 2020). Also notice how after a temporary dip the deposits are rising.

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If this is not convincing enough, here is another graph that maps growth in bank credit to 'industry' and its component 'large industry'.

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Easy credit has its downside

The suggestion of the RBI's IWG and Prof. Panagariya defies logic, not the least because if at 50% credit-to-GDP the Indian banking system is in acute distress what would happen when it goes up?

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The banking sector's distress is evident from the fact that since FY04, SCBs have written off Rs 10.9 lakh crore as NPAs - of which Rs 8.7 lakh crore was written off in the past six years between FY15 and FY20. Of this write-off, PSB's share is Rs 8.4 lakh crore (77%).

As past banking practices endure, the problem of stressed assets is also likely to endure.  

Here is how.

Firstly, the pandemic-induced lockdown led to a moratorium on loan repayment and suspension of classifying stressed assets as NPAs. Whoever availed of the moratorium holds the key to the outcomes.  

Here is a disclosure from the largest public sector bank SBI's research paper ("Financial Market Stability & Loan Moratorium: The Angel is in the Details" published on August 3, 2020). It said: (i) 70% of the total moratorium has been availed by corporates which are rated A and above - that is, those who have "comfortable debt-equity ratio" and so can easily pay - and these corporates are spread across pharma, FMCG, chemicals, healthcare, consumer durable, and auto sectors, etc. and (ii) consumer loans declined by Rs 53,023 crore in the current fiscal, but "consumer leverage in lieu of exposure to stock market" increased by Rs 469 crore that could be a potential source of financial instability".

It warned that a blanket extension of moratorium beyond August 31 would "do more harm than good".

Also Read: Rebooting Economy 59: Quantum jump in fiscal spending is what India needs immediately

What did the RBI do? It set up a committee (led by former banker KV Kamath) to look into the restructuring of loans - "ever-greening" of loans, the much-reviled UPA-era mechanism - and followed its recommendation to restructure loans in 26 sectors for the next two years.

Secondly, large industries - which are to run banks as per the recommendations of the RBI's IWG report and Prof. Panagariya - are the ones causing the high-level of stressed assets in banks. The evidence comes from the RBI's "Report on Trend and Progress of Banking in India 2019-20" published on December 29, 2020.

It said: "Large borrowal accounts (exposure of Rs 5 crore and above) constituted 79.8 per cent of NPAs and 53.7 per cent of total loans at end-September 2020."

Thirdly, the global financial services agency Credit Suisse has been repeatedly warning that India's large corporate houses are not only highly indebted, but their debt-stress levels have remained "elevated" for years (at least since FY17). Its "India Corporate Health Tracker" of August 2019 showed that barring a few, all the big private businesses houses figure in the list of "chronically stressed" corporates (interest cover ratio of less than 1 for a period of 1 to 12 quarters).  

Also Read: Rebooting Economy 58: The untold story of India's services sector

The debts of these chronically stressed companies had consistently been rising from Rs 8.9 lakh crore in FY17 to Rs 9.1 lakh crore in FY 18 and Rs 10.2 lakh crore in FY19. Further, these stressed debts are spread across sectors like infrastructure, manufacturing, telecom, power, metals, textiles etc. (For more read "Rebooting Economy XIII: Why Indian corporates are debt-ridden ")

What all this means is that the financial precariousness of India's large corporate houses poses a serious threat to the financial stability of the economy.  

How will they run banks and for what purpose?

India's consistent failure to resolve stressed assets  

What compromises the Indian economy further is India's repeated failure to resolve stressed assets over the past few decades.

India has tried several mechanisms, all of which failed: (i) Asset Reconstruction Companies (ARCs) in private sector registered under the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act of 2002) (ii) Strategic Debt Restructuring (SDR) scheme of 2015 (iii) Sustainable Structuring of Stressed Assets (S4A) of 2016 and (iv) Insolvency and Bankruptcy Code (IBC) of 2016.  

There was yet another earlier mechanism, the Board for Industrial and Financial Reconstruction (BIFR), which gave way to the IBC of 2016 and dates back to 1980s. This mechanism was panned for a recovery rate of 25% of debts. The IBC's recovery rate is far lower at 21%. (For more read "Rebooting Economy 65: IBC has failed; will a bad bank succeed? ")

The IBC regulator, Insolvency and Bankruptcy Board of India (IBBI) says in its latest newsletter (July- September 2020) that 73.48% of the corporate insolvency resolution process (CIRP) ending in liquidation under the IBC were earlier under the BIFR.

Most of the debt claims under the IBC ended in liquidation - Rs 6.8 lakh crore or 59% of the total claims of Rs 10.5 lakh crore. In cases where the liquidation process is complete (Rs 18,916.9 crore), only Rs 280 crore was "realised" - that is, 98.5% or Rs 18,637 crore of bank credits were lost.

Also Read: Rebooting Economy 57: When and how will industry take India to next level of growth?

Liquidation leads to wiping out of the credit; it causes business loss and also wipes out employment that those firms provided.  

Now, this year's budget proposes a bad bank under the ARC (Asset Reconstruction Company) and AMC (Asset Management Company) model in which ARC will aggregate all stressed assets and transfer to AMC for resolution (similar to the ARCs in concept) to resolve stressed assets.

The details are yet to be worked out, but given the failures of private ARCs, political interference in the functioning of PSBs and poor banking governance, it would need a miracle for a bad bank to succeed.

Given the evidence and the state of the Indian economy, how valid are the claims and arguments of the RBI's IWG and Prof. Panagariya?

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