Banks clean-up: do as Rajan says

After having failed to retain the services of Raghuram Rajan as governor of RBI at a crucial moment, just as he was beginning to clean-up public sector bank (PSB) balance sheets, the next best thing the government can do is to listen to his advice now. In a succinct note to the estimates committee of parliament, Rajan has given a clear idea of how banks came to be burdened with a huge load of non-performing assets and, importantly, what needs to be done to ensure that this does not recur. First, banks need to evaluate far better project finance proposals in which their funds will be tied up for a long time. Even then, it will be impossible not to fall prey to irrational exuberance, a common phenomenon across the world in times of fast growth. The way to minimise the downside of this is to apply the brakes as soon as the underlying economic condition changes and not wait till losses have eaten away most of the promoters’ equity.

Bankers have also to keep their ears close to the ground on how individual projects are faring and the solvency of their promoters. Banks should be able to sense without delay when the wind has changed. One reason why they frequently fail to do so is that they are constantly second-guessing the mind of the political masters of the day as large and powerful Indian promoters are invariably politically well-connected. Rajan does not say this but the malaise runs deeper: powerful promoter groups try and do influence the choice of top managers in India’s public sector. Bank chief executives beholden to their key borrowers for their positions can hardly be expected to read the riot act to the recalcitrant among them.

The solution to this systemic malady is obvious and Rajan has spelt it out in forthright terms: “improve governance of public sector banks and distance them from the government” and “delegate appointments entirely to an entity like the Banks Board Bureau.” The government did create the bureau, but having set it up, chose to ignore all its advice. Now that Rajan has raised concerns over what else is failing — the bankruptcy process is being played by defaulting promoters; Mudra loans could be heading for defaults next, etc — and has charted out a clear roadmap to clean up bank balance sheets and reform PSBs, the government must take note and act. The question is, does the Modi government, facing elections in a few months, have the time, the political courage and capital to do any of these? Given all this, the future of PSBs will remain bleak despite any write-off and recapitalisation that may happen.

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