<p><strong><em>By Raj Liberhan</em></strong><br><br>The Finance Minister is now worried that the Non Performing Assets of the state run banks have reached 'unacceptable levels'. It is not unusual for Finance Ministers to be worried given that our financial architecture is rather fragile. As the guardian of the nation's strained treasury, he must have sleepless nights. His predecessors have been worried too, but besides exhorting the bankers to clean up their appraisal abilities and obtain substantive collaterals before sanctioning loans, very little action gets taken to compel the state run banks to run on prudential norms. An extra dose of recapitalization has also been promised, something like Rs 70,000 crore over the next four years to help the banks to get the needed muscle to leverage more funds for their business as well as get close to the capital adequacy norms. The NPA affliction also extends to the public financial institutions whether owned by the Central or state governments but that is another story.<br><br>To get an idea of the size of the non-performing assets, it has been stated by the Reserve Bank of India that these are 5.2 per cent of the total advances at the end of March, this year, up by nearly a percent over the previous year. In percentage terms, the figures do not seem alarming but translated into numerals, the NPAs stand at a whopping Rs 3.07 lakh crores!! This level of non-performing assets are ascribed to 'partly because of indiscretion and partly because of inaction..' This pronunciation should lead us to actually quantify NPAs amounts due to indiscretion, amounts due to foolishness, amounts due to stupidities and perhaps amounts due to political pressure. Sadly no such statistics are maintained, either by the Finance Ministry or its associate banks. At the very least it can be safely assumed that these bad debts are the result of poor and misguided investment decisions.<br><br>Banks, public or private, are in the business of money to make money. It is a simple and a complex business. They invite deposits and pay a rate of interest, attractive enough for the depositor as the interest earned adds to his income. To pay the promised interest, the bank has to lend this amount to an entrepreneur at a rate of interest that will cover the amount to be paid to the depositor and meet the costs of doing business by the bank. The bank also hopes to glean a certain amount of profit on the transaction to satisfy its promoters and investors. The bank being a trustee of the depositor's money, has to ensure that when it lends to a borrower, the credentials of the borrower measure up to essentially one standard: his ability to pay back the amount borrowed with interest. To secure this end, the bank will insist that the borrower produces a collateral, or a guarantor in the shape of an owned asset which is at least equal in value or a human being with amounts of deposit in the bank which can be pledged as a surety. This works well when the amounts of borrowing are small.<br><br>But bankers would not be bankers if they did not play in the big league. How do you lend to businesses which need thousands of crores to put up a power project or an infrastructure project or an airlines venture? It is the prospect of big incomes from these lendings that the profits and gains for the banks really accrue. So you have financial and technical wizards to appraise the costings and the revenue streams and the tenure in which the project goes functional. If the latter two features are compatible with the tenure of the borrowings, it makes for a good case for the bank to make the loans. At least that is the theory of lending. Lend and be happy.<br><br>What actually happens is that the costing of the project is over padded intelligently, the revenue stream is brighter than reality and the time frame is off by 30-50 percent of the stated time lines. We now have a well-made recipe for default on the loan installments. And when it does happen, as it will for sure, our bankers then have a programmed response by instantly proposing to 'restructure the loan' which in plain language means that the time to pay back the loan gets extended. A de facto default of loan repayment becomes a functioning asset once again just by pressing the extend button. This is not the only rescue initiative that the bank undertakes. Invariably, the costs of the project have escalated, which is true of 100 percent cases in our country, so they provide further loans to meet the escalation of costs. The bank is happy as it can recognize legitimately the loan income and the favoured borrower is happy as he has found the fountain of eternal wealth in his hands. Extend and be happy.<br><br>Money is a complex business for sure. But the banking trade has to function within the frame of prudence. Unscramble the complexity and we discover that money does not tolerate mismanagement at the fundamental level. If the NPAs are being ascribed to 'indiscretions' then clearly there has been mismanagement, at the very least. Criminality is not very far from an act of indiscretion particularly when the act has the consequence of a loss of multiples of thousands of crores. The primary duty of the lender is to assess the credibility and creditworthiness of the borrower. It has to be followed up with a severe evaluation of the project costs and the time frame for completion and the hazards to completion. No appraisal can be complete unless the borrower's equity is estimated to show a serious involvement of his own skin in the project for which funds are being sought. Invariably, the costs of the project are padded up to take care of inflation, escalation in prices of inputs and likely time overruns. The skill of the lender lies in getting a fair idea of the padding intended to cover likely escalation in costs and not to help siphon the promoter's equity which is the case all the time in our country. The subtly nuanced 'indiscretions' in reality, are the deliberate oversight of the risks and a willing acceptance of the generously projected revenues by the funding institution.<br><br>The list of indiscretions in lending by the public banks is long and varied. Some of the significant reasons are the burden on the banks because of the compulsion to give credit to fulfill social sector needs. Given that this would only be a small drop, the bulk of the credit is attributable to downright bad investment decisions in real estate, power sector, infrastructure sectors with long gestation periods, lendings with no planned exits at appropriate tenures and credit under political pressure are the real culprits. Failure to recall loans at the first sign of trouble and reluctance to encash collaterals and replace promoters, are all illness symptoms that became terminal. Nonetheless, we have not seen any bank management being held to account. Only an occasional reprimand or a stern reference to the NPAs at a public function is considered good and sufficient corrective and then it is business as usual till the next alarm bell rings. This belief is engendered by the ability to pretend that all loans get ultimately paid back, sooner or later, a belief that has no basis in fact. The fiction of comfort is created by the euphemism called restructuring of corporate debt, at best a normal banking practice. Yes, then display transparency and show the restructured debt as a distinct item on the balance sheet. Otherwise, pretend and be happy that you have revived a patent loan default.<br><br>All bubbles are evolutionary. They build up slowly till they go burst as all bubbles must. The banker's skill and the warning systems he installs are meant to recognize the first signs and insulate his portfolio from disaster. The regulators have to be awake all the time too and pull the stops before the bank goes overboard. Re-capitalisation is like a heavy dose of steroids, funded by the taxpayer to revive the strength of the public sector banks, failing which they will go under. After all, this capitalization and recapitalization story is a familiar script for most state undertakings. And that is a cause for mental seizures, which is a trifle beyond being merely worried. In caution should banks trust for the world of finance functions only on ethics and sound arithmetic, and never on speculation. A punter places his bets on presumed logic, while a good banker must hedge his bets against all risks. Finance Ministers have to believe that as well.<br><br><em>The author is Director, India Habitat Centre</em></p>
