Narrow Banking: Public Sector Banks Should Not Be Lending to Corporates Vivek Kaul's Diary

Narrow Banking: Public Sector Banks Should Not Be Lending to Corporates - 
Vivek Kaul's Diary
Wed, 21 Feb 2018

One of the good things to have happened because of the jeweller Nirav Modi's fraud of $1.8 billion, is the focus that the mainstream media has been giving to public sector banks.
News channels which did not have any discussion on the bad loans of Indian public sector banks touching almost Rs 7,00,000 crore, are now staging fist fights with the prospect of Rs 11,400 crore ($1.8 billion in rupees) being further added to the overall bad loans of these banks.
Bad loans are essentially loans in which the repayment from a borrower has been due for 90 days or more.
So what's the problem facing public sector banks? It's clearly not the aam aadmi, i.e. individuals who take on loans from banks, or what in banking parlance is referred to as the retail loan business. That has been working just fine. The aam aadmi has been taking loans and paying his EMIs on time.
The problem is with the fat cats, the seths, the big businessmen, the corporates, who have made a habit of taking bank loans and not repaying them. Nirav Modi is just another addition to that long list.
Take a look at Table 1. It basically lists corporate bad loans as a proportion of corporate lending, for public sector banks other than the State Bank of India. It also lists out overall bad loans of these banks.
Table 1:
YearCorporate bad loans (in %)Total bad loans (in %)
Source: Author calculations on data from Rajya Sabha Unstarred Question No: 278 and
As can be seen from Table 1, by 2016-2017, nearly one out of every five rupees of corporate loans that India's government owned banks had given (except the State Bank of India) had been defaulted on. For the State Bank of India, the situation was a little better with a default rate of 13.7% (for mid corporate and large corporate loans).
While Table 1 tells us what the problem is, it does not show us the enormity of the problem. For that we need to look at data in a slightly different way. The question that we need an answer to is: what portion of the total bad loans do corporate bad loans make up for?

As of March 31, 2017, corporate bad loans made up for nearly 69% of overall bad loans of public sector banks. Take a look at Table 2. It basically lists out, the total corporate bad loans along with the total bad loans, of each public sector bank, for 2016-2017.
Table 2:
Name of the bankCorporate bad loans (in Rs crore)Total bad loans (in Rs crore)Corporate bad loans as a proportion of total bad loans
Allahabad Bank17,19820,68883.13%
Andhra Bank14,23717,67080.57%
Bank of Baroda21,15342,71949.52%
Bank of India32,78652,04563.00%
Bank of Maharashtra11,90417,18969.25%
Bharatiya Mahila Bank Ltd.5054.9990.93%
Canara Bank22,41834,20265.55%
Central Bank of India19,32327,25170.91%
Corporation Bank13,06317,04576.64%
Dena Bank8,39512,61966.53%
IDBI Bank Limited33,07044,75373.90%
Indian Bank7,6919,86577.96%
Indian Overseas Bank23,08135,09865.76%
Oriental Bank of Commerce18,46622,85980.78%
Punjab & Sind Bank4,0946,29865.01%
Punjab National Bank38,44155,37069.43%
Syndicate Bank9,81517,60955.74%
UCO Bank15,21622,54167.50%
Union Bank of India21,35733,71263.35%
United Bank of India7,68310,95270.15%
Vijaya Bank4,9146,38277.00%
State Bank of India*80,0791,12,34371.28%
*large corporates plus mid corporates
Source: Indian Banks' Association, Analyst Presentation SBI, March 2017 and Rajya Sabha
Unstarred Question No: 278, July 2017
Table 2 does not paint a very pretty picture. As can be seen, a bulk of the bad loans of public sector banks are loans which haven't been repaid by corporates. Corporate bad loans account for more than three fourth of the bad loans of many public sector banks.
Given the massive amount of bad loans of public sector banks, the banks need to regularly keep writing off loans. Between 2004-2005 and September 30, 2017, the public sector banks have written off loans worth Rs 3,81,549 crore, with a bulk of this amount having been written off in recent years. The loans are written off against the capital of the bank.
With a very low rate of recovery of bad loans, this means that the government, as the major owner of public sector banks, has had to keep infusing fresh capital into these banks to keep them going. From 2007-2008 onwards and by the end of 2017-2018 (the current financial year), the government would have infused a total capital of Rs 2,19,718 crore, to keep the public sector banks going.
Long story short-public sector banks keep sucking taxpayer money to basically finance Indian corporates who default on the loans. This needs to stop. As we have been advocating for a while, the government does not need to own 21 public sector banks, as it currently does. Nevertheless, given that privatisation is a difficult option in the Indian scenario, what is the other way out? (Dear Reader, here is another solution!)
The other way out is narrow banking. Public sector banks other than the top 5 public sector banks, should not be lending to corporates, given that the defaults on corporate loans make up for the bulk of bad loans.
This is not to blame the loan officers and managers in public sector banks, who commission these loans. This is more on account of the nexus that prevails between politicians and businessmen in this country and because of which the public sector banks over the years have been forced to give loans to businessmen and businesses, not in the habit of repaying. One way to break this nexus is to ensure that the government gets out of the banking business, lock, stock and barrel. There is another way as well.
Banks finance their loans by raising deposits, which typically tend to have a fixed tenure of one to five years. With these deposits, banks, at times, finance corporate projects which have a term of more than a decade. There is a clear mismatch here. Long term financing needs specialised project finance institutions. It needs a stronger corporate bond market. It needs pension funds which have access to money for long tenures and are willing to invest money for the long term.
Public sector banks should not be in the long term corporate lending business. Neither is the solution to replace them easy nor can it be implemented overnight. Having said that, most problems do not have readymade solutions. Solutions also need to be built into place. The Nirav Modi fraud has given the Narendra Modi government an opportunity to set things right at India's public sector banks. It can either privatise them or get them out of lending to corporates.
Warm Regards,

Vivek Kaul
Editor, Vivek Kaul's Diary

1 comment:

SUBBIAH said...

This is a simplistic view of a major issue that is a cause of concern. Corporates are also part of the economy. Just because our operators are inefficient and corrupt we cannot blame the system. We may have to rectify in situations.