It’s Not Just About Mallya: PSU Banks Lose Money Even In Profitable Projects

It does not need a failed business to skim the fat off public sector banks. For every Vijay Mallya who moves abroad bag and baggage spectacularly when they are on the wrong side of a bank loan, there are more promoters who stay back, do well and yet short change the state-run banks.

An almost classic rip off in this genre occurred during the United Progressive Alliance’s second term. It was the souring of the loan for the Delhi-Gurgaon Expressway. That loan too was by a consortium led by the public sector Punjab National Bank.

It was for a project which did not need even high school math to demonstrate itself as a powerful revenue stream. There was (still is) a demand for a good link between the two cities and the Expressway fulfilled the need. Car owners too were willing to pay for it (until the waiting time at the Sirhaul toll plaza on the Delhi-Gurgaon border) went into hours.

This was the first project in the roads sector where the government had received a premium from the operator. Effectively it meant that the government did not have to provide any risk payment to support the construction. Yet, from being a showcase public-private partnership road project, the Delhi-Gurgaon Expressway became a showcase for failure.

Of the Rs 1,600 crore that the banks lent for it, more than 80 percent is lost if the courts support the road regulator’s contention that the project should be terminated.

The promoter, in this case, DSC Ltd, has walked away with a profit.

There must be something inherently wrong in the way state-owned banks run themselves if they lose money both in a successful and unsuccessful venture. The list of projects that fill up the Rs 400,000 crore buckets of non-performing assets of these banks consequently does not end only at loss-making ones. Several of them are losses for the banks but profitable for the entities which ran them.

So, what gives? At the heart of the problem is the process of credit appraisal in these banks and that, in turn, is linked to their political ownership. I am not referring to plain vanilla cases of frauds in credit appraisal like that of Sudhir Kumar Jain. As the chairman and managing director of public sector Syndicate Bank in 2013, Jain was arrested by the CBI for allegedly taking bribes to offer fat loans to Prakash Industries and Bhushan Steel. There have been other worthies from other banks along with him.

It is all about the incentives these banks offer to those who make credit appraisals. The appraisals leak because there is a tremendous shortage of smart people who can make sound appraisals of projects.

This shortage is because the banks provide no incentive for people to become good appraisers, since even if a person is good at her job she will still rise through the ranks at just the same speed as her colleague who has done protocol duty through most of her career. (I am not being fatuous, a chiefs of one of these banks did just that through a good part of his career).

On the other hand, the officers who specialize in credit appraisal run an asymmetrically higher risk of facing a vigilance probe. This is borne out by data. Among the officers of 34 types of government-run or supported organizations investigated by the Central Vigilance Commission in 2014, bank employees make up the largest cohort at 31 percent of the cases; over 80 percent of those were related to credit disbursal. (see here)

Consequently, it makes sense for officers to move out of this risky charge if they want to arrive at the interview room for an executive director without spots on their resume.

The options, then, are pretty limited. Hamstrung by the lack of specialists, these banks outsource their appraisals to the consultancy firms.

Exactly a year ago, the Reserve Bank of India ticked off the banks for this trend. “They cannot afford to outsource their responsibility of credit appraisal which is a basic function to a third party. Lending is the most critical of banks’ functions and that cannot be outsourced”, deputy governor S.S. Mundra said in a speech at Assocham.

In response, the public sector banks have begun to aggressively recruit officers specializing in credit from the market. (Though they have total officer strength of about 600,000.) The recruitments tell you that credit to firms like those of Mallya’s Kingfisher was simply based on a wing and good hope.

It comes back, then, to the banks themselves. The only way this army of officers can ensure that Vijay Mallya or DSC Ltd play ball is to make them responsible for their appraisals. And that can only come if the shareholders insist on it. Obviously that shareholder cannot be the government.

There’s been plenty of baying at the banks this season. In the din, a small but remarkable change planned by this government has gone unnoticed. It is the plan to reduce government stake in IDBI Bank to below 51 percent It is just a coincidence that IDBI led the pack which approved Mallya’s Kingfisher restricting proposal.

It is not a coincidence that the government has begun the process of reversing bank nationalisation, a relic of the Congress’ high noon of economic disaster at the right time.

RBI Governor Raghuram Rajan has begun the harsh task of mandating banks — mostly public sector – of bringing out their dirty linen in public within April 2017. One should hope the Modi government too will, in the same time period, throw out the dirty linen of political mismanagement that the Congress era has smothered these banks with.

Only then would India get a functioning financial sector.