Proposed reforms to India’s financial system are welcome but insufficient
BANKS are usually reliable
barometers of the health of the economies they help finance. So news in recent
days that India’s lenders have lost over 200 billion rupees ($3 billion) in the
most recent quarter sits oddly with zippy growth in GDP of 7.9%. A revving
economy may help the banks overcome their weakness. Far likelier is the
opposite outcome: that the Indian economy ends up being damaged by its lenders.
Most of the
trouble lies in India’s state-owned banks, a network of 27 listed but
government-controlled entities that account for 70% of India’s banking system
by assets (see article). Their share prices have tumbled
ever since the Reserve Bank of India (RBI), the central bank and regulator,
sensibly forced them to confess to past mistakes. A staggering 17% of the loans
they made in a mini credit boom around 2011 have either had to be written off or
are likely to be.
Corporate lending, particularly to
powerful Indian conglomerates, is at the root of the problem. Some of the dodgy
loans have soured because of bad luck: mining projects have been hit by
slumping commodity prices. Some reflect bad judgment: loans to infrastructure
developers have proved bankers to be wildly optimistic about the ability to get
stuff built in bureaucratic India. And some reflect bad faith: politicians in
the previous government leant shamelessly on public banks to supply money to
their cronies in business.
To its credit, the government of
Narendra Modi, in office since 2014, has cracked down on this kind of
corruption. Along with Raghuram Rajan, governor of the RBI, it has been willing
to air the financial system’s problems. A recently passed (but not yet
operational) bankruptcy law will give banks power to foreclose on defaulting
borrowers, many of them tycoons who have historically run rings around their
bankers. The government even wants to consolidate the 27 banks into less than
half that number, over the objection of trade unions.
It needs to be still bolder. The
priority is to be more scrupulous about cleansing the financial system of sour
loans. The option of setting up a “bad bank” to remove the dud assets from
ailing lenders’ balance-sheets has been ruled out. The funds earmarked to
recapitalise the banks, which now have the most threadbare equity cushions in
Asia, are insufficient. Credit-rating agencies are warning that the banking
miasma is a threat to India’s sovereign rating.
Muddling through is a
tried-and-tested strategy when it comes to struggling banks. Europe is a past
master at this approach and the result is a banking industry that has been
unable to support growth. This ossification may be starting in India, where
loans to industry are growing by a meagre 2% a year. By contrast, America
forced recapitalisations on its banks after the 2007-08 financial crisis—a
painful exercise for all sides, but one that was rewarded with a swift return
to health. America is the example for India to follow. An early confirmation of
a second three-year term for Mr Rajan, who will otherwise depart in September,
would send the right message.
Banks, not bureaucrats
A government that describes itself
as “pro-market” should also lay out a path to the privatisation of state-owned
lenders. It is no coincidence that private-sector banks have experienced only a
small fraction of the losses of state-backed rivals. Mr Modi should also aim to
scrap socialist-era rules that force all banks to make a fifth of their loans
to support farming and that dictate where they can open branches. The
government has made some welcome changes. But until it abandons its belief that
a state-owned banking system is the right way to allocate credit, India’s banks
will hold the economy back.
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