NPA recovery in India

On December 28, 2018, RBI released the ‘Statistical Tables Relating to Banks in Inda, 2017-18′. I just quickly browsed the table-headers online and looked at NPA recoveries in India :’ NPAs of Scheduled Commercial Banks Recovered through Various Channels’. The trend has not been good. In that sense, the implementation of the Insolvency and Bankruptcy Code (IBC) has been very timely. It may have initial troubles, changes and resistance, etc.

Which momentous change would go unchallenged or has gone unchallenged by entrenched interests? The table below shows the percentage recovery (col. (2)); percentage recovered through SARFAESI Act (Col. (3)) and the fourth column is the amount referred to the various sources for recovery – Debt Recovery Tribunals, Lok Adalats and SARFAESI Act. The recovery % are proportions of these amounts (Col. (4)).

Source: RBI

Let us see how these numbers evolve in 2017-18 and later, after IBC becomes accepted and established. Clearly, the table shows that IBC had not come a day too soon!

Finance and Federal Reserve

In my first column for MINT for 2019, I dealt with the issue of the Federal Reserve backtracking on its rate hike trajectory. Methinks it is sustained pressures from ‘financial market types’ that led the Fed chairman to cave in. I don’t buy the argument that he is tightening on two fronts: federal funds rate and quantitative tightening. So what? One acts through the banking channel (from the overnight lending rate to bank loan rates) and one acts through the capital markets channel – through the yield curve. All the rates, across the yield cuve, were depressed extraordinarily – in magnitude and for an inordinately long time. So what if all points in the yield cuve were rising? Financial conditions still remained accommodative.

This was the burden of my column. I was not impressed with the arguments of Stanley Druckenmiller and Kevin Warsh nor was I impressed with the arguments of John Mauldin. My friend Gulzar Natarajan had urged me to read his ‘Thoughts from the Frontline’. I read the last four of them last evening. You can read two of them – pertaining to the discussion of Fed monetary policy – here and here.

Nor did Gavyn Davies impress me with his arguments. So what if the Federal Reserve were triggering an economic recession? Recessions must be welcomed after excesses have built up in so many areas – from corporate debt to leveraged loans to market concentration in tech firms

‘Wrath of the financial markets’ that Viral Acharya (RBI Deputy Governor) invoked in a speech in October is felt more by central bankers than governments and that too not in public interest but in self-interest of the financial community.

Dean Baker has a list of ‘facts’ or resolutions to improve debates on economic policy in 2019. Item no. 6 is about finance. His list is about the ‘facts’ that are often obscured in economic policy debates:

6) A large financial sector is a drain on the economy
The financial sector plays an important role in a modern economy. It allocates capital from savers to those who wish to borrow. A poorly functioning financial sector is a drag on growth. The same is true of a bloated financial sector.

The financial industry is an intermediate sector, like trucking. This means that it does not directly provide benefits to households, like a housing, health care, or education. For this reason, we should want a financial sector that is as small as possible for carrying through its function, just as we would want the trucking sector to be as small as possible to deliver the goods in a timely manner.

Over the last four decades the narrow financial sector (securities and commodity trading and investment banking) has more than quadrupled as a share of the economy. It would be difficult to argue that capital is being better allocated or that savings are more secure today than 40 years ago.

This means we have little to show for this enormous expansion of the financial sector. It would be comparable to seeing the size of the trucking sector quadruple with nothing to show in the form of faster deliveries or reduced wastage. Finance is of course also the source of many of the highest incomes in the economy.

These facts make for a strong case for measures that reduce the size of the sector, like financial transactions taxes, reduced opportunities for tax gaming, and increased openness in pension fund and endowment contracts. In any case, it is important to recognize that a big financial sector (as in Wall Street) is bad for the economy, not the sort of thing that we should be proud of.

Reducing the size of the financial sector will also mean that its influence on monetary policy will come down. About time.

Are India’s ‘shadow banks’ a bigger risk than China’s?

Well, that is what Andy Mukherjee thinks or his editorial team thinks, if one went by the header of the article that he has written.

Now that New Delhi has replaced an independent-minded technocrat at the Reserve Bank of India with a former finance-ministry bureaucrat, it’s reasonable to expect that shadow banks will be encouraged to expand again.

That is quite a loaded sentence. Airbrushes or ignores a lot of other issues with Mr. Patel.

T.T. Ram Mohan offers an alternate perspective that is well worth a read. This paragraph is worth noting:

Thirdly, the particular suggestions from the government that have led to tensions with the RBI cannot be construed as attempts to infringe the autonomy of the central bank. Take, for instance, the issue of the appropriate level of reserves for the RBI. This is a technical matter on which reasonable people can legitimately differ. It is entirely appropriate to refer the matter to an independent committee. This would not have happened had the government not pressed its point vigorously.

He ends on this note:

Will New Delhi be prepared to pull the rug from under the non-bank lenders if they push things too far? On that count, hold no hope. China’s shadow banking may be a lot bigger than India’s, but India’s is already too big to fail.

May be, he is right. But, I think he is far too dramatic here. Banks are being recapitalised and lending has picked up. So, I am not sure if India’s NBFCs are ‘too big to fail’.

A dispassionate look at RBI revaluation reserves and other demands of GoI

On November 19, the Board of Directors of the Reserve Bank of India met and agreed to constitute an expert committee to determine the appropriate level of economic capital that the central bank must hold. So, now, all of us have the time to evaluate the issue more objectively.

Niranjan Rajadhyaksha (former Senior Editor at MINT and a good friend) wrote a column in MINT which basically gave the following message:

  1. The equity plus contingency reserves have hardly increased
  2. Revaluation reserves have reflected growing FX holdings
  3. Comparisons with other countries is really not useful unless we understand the specific institutional arrangements.
  4. The government has really not given us a solid argument other than RBI has more capital as a proportion of BS than other CBs.

Few days later, just on the day of the RBI Board Meeting, MINT published an excellent interview with economist Indira Rajaraman. 

She said the following:

I think in a lot of what RBI does, there is this sense—I am not attributing it to the present governor—an institutional sense that there are things that have to be done in public interest which the public cannot quite comprehend. That has to go. I think there has to be a sense that the public can understand if they are made to understand.

The questions that North Block is raising exhibit a fairly nuanced understanding of a number of issues. Let’s say the 12 issues that were raised by the government in the three letters to RBI. I was quite surprised at the depth of understanding in North Block of the various issues and in particular on the reserves issue. I think it was time the question was asked and RBI was made to defend its particular level of reserves.

Mr. Malegam, who is considered a high priest on the reserves issue as he has been on the board for so many years and has chaired a couple of committees on it, has said that under Article 58 of the RBI Act, there is no provision for transfer of reserves to the government. I do not agree with him there.

Yes; of course, in Article 58, there is no explicit provision for transfer of reserves, but then again, there is no provision that reserves must not be transferred. There are a lot of things unsaid in the legislation and for the government to have identified that hole and to say that there is possibility of transfer and tell us why you cannot transfer. 

In addition, there have been many regulatory lapses during the last year which have led to a sense among the ministry of finance and educated watchers that the regulatory plumbing needs to be overhauled.

For instance, the RBI annual report is a submission of the board of RBI to the ministry of finance and not of the RBI management to the ministry of finance as was the general impression.

The annual report used to be placed in the draft form for a 15-minute examination by the board before it was pulled away for finalization. I used to speak up and tell my board members that this is going from us and we should read this. In the four years, I was probably the only one who insisted on a draft and having a video link with RBI in Mumbai with my comments on every page of the draft.

I am sure I was considered a nuisance but I took my responsibilities seriously as a board member of RBI and wanted that the annual report should be accurate portrayal of RBI’s functioning.

The board for a long time was not aware of its powers. In a certain sense, this confrontation has brought to the fore the role of the board, its powers and responsibilities and made the management more aware that they are accountable.

RBI has to engage as its actions impinge on everyone in the country. There has to be more transparency and more willingness to talk to people who do not understand the intricacies but are still in need of an explanation.

I don’t think they are just motivated by the fiscal concern. There is the liquidity concern also which could be termed as in the public interest.

The important thing is that RBI has to look into each issue on its merit.

For instance, on the liquidity issue, the government asking for a calculation of the liquidity squeeze, or asking why does the central bank think that liquidity is adequate; I think the ministry of finance is perfectly justified in it. [Link]

Given her intellectual depth and breadth of experience, her own previous association with RBI and her final wish for this institution to be nourished and cherished lend her criticism of RBI a far greater authenticity and credibility than that of the many unthinking, reflexive defences of RBI.

Revaluation Reserves:

Revaluation Reserves are gains accruing from the rise in the value of the foreign currencies and gold agaisnt the Indian rupee. That is why it has swelled to about 25% of the Forex and Gold Reserves.

In general, for India, the revaluation reserve will only keep rising. The rupee has a history of depreciation and for the right reasons. India is productivity and scale challenged. Hence, it is export-challenged and hence, it is current-account challenged.

Therefore, the risk that a sharp appreciation of the rupee will erode the value of the foreign currency assets that RBI holds and hence, it should be adjusted against the revaluation reserves is rather remote for the foreseeable future.

Revaluation reserves have reflected growing FX holdings – that is factually correct. Revaluation profits will keep occurring with a currency that is a ‘depreciating unit by default’. India’s revaluation reserves at about 26% of RBI’s Foreign Currency and Gold Reserves is too high.

Bank of Brazil’s revaluation reserves are a very tiny portion of its foreign exchange reserves. Indeed, Bank of Brazil’s overall equity (capital + reserves) is rather modest. [Link]

In contrast, Bank of Russia’s capital is nearly 37% of its balance sheet size! Bank of Russia does not give breakdown of its capital into capital and reserves.

People’s Bank of China Balance sheet for 2017 shows that the bank has far too tiny a capital base and no revaluation reserves.  The Chinese yuan does appreciate more often and in greater magnitude than the Indian rupee does. It has a huge cache of foreign exchange reserves which loses value whenever the yuan appreciates. Yet, they do not have revaluation reserves. See here.

So, the question arises as to why India has such a large revaluation reserve of around 26.2% of its total foreign assets (INR6916.41 billion against total foreign securities of INR7983.89 billion + INR18366.85 billion as of June 30, 2018). On top of this, there is a contingency reserve of INR2321.08 billion. [Link]

There is an interesting article in ‘India Express’ (ht Usha Thorat, former RBI Deputy Governor) published on November 19, 2018, written by P. Vaidyanatha Iyer:

In June 1994, while finalising its balance sheet, the RBI realised it was unable to provide for the exchange loss liability on account of a foreign currency deposit scheme offered by banks since 1975. …

The scheme was called the Foreign Currency Non-Repatriable Deposit Scheme, or FCNR-A, and was introduced to attract capital inflows and help finance deficit in the current account. Prodded by the government, banks offered interest rates higher than what they offered on local deposits. These deposits ballooned in the 1980s.

The RBI had agreed to provide exchange guarantee on these deposits. It didn’t think too much into the future then, and had a simple rationale: the dollars were added to foreign currency assets, these were revalued when the rupee depreciated, and so the revaluation gains would be available for meeting losses during repayment of principal. The interest to be paid on the FCNR-A deposits would be met through earnings on the dollars invested abroad.

But then, India was hit by a Balance of Payments crisis in the late 1980s. According to sources familiar with the developments then, the forex assets depleted fast and even the $1.1 billion of assets in 1991 represented dollars sold forward under a separate swap arrangement with State Bank of India. The losses from 1991 till 1994 were met by drawing from the Exchange Equalisation Account and the Contingency Reserve of the RBI. By 1994, both these reserves were fully depleted, and there was no source for providing for exchange losses on $10-billion worth dollar liabilities under the FCNR-A scheme.

The FCNR-A liabilities comprised $5 billion in principal and $5 billion in accrued interest. The average rate at which these dollars were bought was about Rs 16 a dollar. In 1994, the exchange rate was almost double at Rs 31.37, meaning the RBI had to bear a loss of Rs 15 more on every dollar. The total loss added up to Rs 1,500 crore. [Link]

Now, we understand the situations for which the revaluation reserves and contingency reserves were put to use, earlier.  But, since then, RBI does not offer exchange rate guarantees. Commercial banks bear the risk when they attract dollar deposits.

The ‘Usha Thorat Committee’ had recommended a total of 18% of assets for both revaluation reserves and contingency reserves. Actually, the denominators are slightly different. The ‘Currency and Gold Revaluation Reserve Account’ of 12-13% is calculated against foreign curency assets and gold holdings whereas the Contingency Reserve of 5% is on overall assets. Foreign currency assets constituted roughly 73% of total RBI assets as of June 30, 2018.

I understand from reliable sources that contingency reserves are held by the Reserve Bank of India for the following reasons:

  • when market intervention operations cost more than the anticipated;
  • for shortage in deposit insurance fund;
  • for any cyber security risk;
  • for ‘lender of last resort’ function and
  • if there is no transfer to GoI because of above contingencies, then it could affect fiscal math -hence some minimum profit transfer to GoI had to be assumed by RBI each year for better fiscal management by the Government

The Economic Survey of 2015-16 had recommended that total reserves be 16% of RBI assets, reduced from 32% (Box 1.6, Chapter 1, p. 19, Economic Survey 2015-16) and wanted the ‘excess reserve’ be used for bank recapitalisation. [Link]

So, even if the government fiscal math was behind the recent clamour for RBI’s ‘excess’ reserves, it is not unreasonable because the fiscal math was not undone by any reckless spending on the part of the government but because of the introduction of Goods and Services Tax, because of the failure of investment cycle to kick in, leading to higher economic activity and tax revenues, etc. Further, although bank recapitalisation charges were not reckoned with for fiscal deficit calculations, interest paid on the amounts would be added to the government expenditure.

Indian newspapers today have flagged a recent Bank of America – Merrill Lynch report which mention the excess reserves that RBI could potentially transfer to the Government of India. The report puts the figure between 1,00,000 crores of rupees and 3,00,000 crores of rupees (INR 1.0 trillion to INR3.0 trillion). See here.

So, there is a case for cooler heads and some transfer of excess reserves from the Reserve Bank of India to the Government of India.

How does RBI pay this to GoI?

My proposal is this:

Let a certain portion of the Revaluation Reserves be written back to the Income Statement every year, over 3 to 5 years. Then, it can be paid along with the profits for the year to GoI. To be sure, during this period, the revaluation reserves may increase if the rupee depreciates. Then, the duration may get lengthened. So, be it. Amortizing the payment to GoI over a period is the least-disruptive way to reduce the Revaluation Reserves from its current ‘excessive’ level to a comfortable level and also avoid the accusation that it is a short-term expedient for the present Government.

What about the other demands of the Government of India?

Ananth Narayan has neatly listed the government demands in his latest article in ‘Economic Times’:

  • The government wants the RBI to relax lending restrictions on the notionally weak banks that are under RBI’s Prompt Corrective Action (PCA) framework.
  • It wants RBI to provide forbearance (in other words, to close its eyes) on stressed loans, particularly to the power and micro, small and medium enterprise (MSME) sectors.
  • It wants to access the capital on RBI’s balance sheet.
  • Finally, it wants the RBI to provide relief to stressed non-banking financial institutions (NBFIs).  [Link]

We have dealt with no. 3 in the list in this blog post.

On the other three demands, my suggestion is that the Government should bite its lips and not interfere with the central bank’s current stances. After all, they are the extension of the structural reforms that the Government itself had undertaken – willingly or otherwise.

It did demonetisation; it introduced the Goods and Services Tax; it enacted the Insolvency and Bankruptcy code and it passed the Real Estate Regulation Act. All these mean discontinuity with the status quo that had prevailed for the previous sixty-seven years. Similarly, regulatory forbearance has been the practice of the previous sixty-seven years. In these areas, RBI is wanting to signal a change. It is welcome. It is painful in the short-term. The government has to bite its lips and face the short-term growth disruption and the complaints of its core constituencies who might be affected.

To offset the political damage, the government must take the case to the people, as it did in the case of demonetisation. It must market itself as the champion of long-term structural reforms for the good of the nation, sacrificing its own personal and political interests in the short-term for the good of the nation.

Not easy but do-able. 

What should RBI do on its part?

It must come off its high horse and admit to failings in its regulatory architecture and practice. It should listen to Indira Rajaraman. As Dr. Y.V. Reddy said in a speech in February, it must come out with a white paper on non-performing assets, detailing its own failings. It must accept to regulatory shortcomings with respect to detecting frauds such as the one that happened in Punjab National Bank. The case of IL&FS highlighted failures in the regulation of non-banking finance corporations. It must be candid; admit to its inadequacies and failures, resolve to address them and outline steps it will be taking to do so, with clear timelines. It must report to the public on the progress of the redressal measures and close them within a reasonabel time-frame. 

As importantly, it must use the opportunity to address consumer issues as highlighted by Debashis Basu in this article in ‘Business Standard’ recently.

Desirable deleveraging and inevitable growth slowdown

Late last night, a good friend sent me a link to a news-story. The Vice-Chairman of NITI Aayog has blamed Raghuram Rajan, former Governor of RBI, for India’s economic growth challenges, notwithstanding the fact that India recorded a 8+% real GDP growth (y/y) in 2018Q2 or 2018-19Q1. I do not believe in the latest CSO numbers post 2011-12 base year change and other revisions to the methodology made. The new GDP numbers are as problematic as the old one is, except in different ways.

In theory, deleveraging can reduce economic growth and it does. As a factual statement, it is correct. As a ‘pass the buck’ statement, it is problematic. But, if one listened to the actual clip (barely 85 seconds), he does not blame. He states the deleveraging matter-of-factly.

However, Andy Mukherjee sent me the link to his interview to ‘’ wherein he blames the former RBI Governor more directly:

“When you give crocin to an ill person every two hours instead of the prescribed eight, then the person will become comatose,” said Kumar. [Link]

The clip that is available on the site does not feature this comment, however. Perhaps, there is a fuller clip elsewhere which has this comment. But, he is right that the economy was slowing down already before demonetisation happened.

Below are the growth rates from the quarter ending March 2016 to September 2017. He is right about the slowdown having set in before demonetisation. But, will it have continued to drop further but for demonetisation? Hard to prove one way or the other.

9.3 8.1 7.6 6.8 6.1 5.6 6.3

I would like to draw the attention of the readers of this blog to my column published in August 2017 on Mr. Rajiv Kumar’s views on foreign and local talents for policymaking posts.

Before I could write a blog post, Andy Mukherjee had deconstructed the imputed statement of the Vice-Chairperson of NITI Aayog.  Andy Mukherjee makes the point that commercial credit was growing at 10.8% (y/y) when Raghuram Rajan demitted office in September 2016. But, Rajiv Kumar, in the ANI clip, mentioned industrial credit growth and he had got his facts right.

Industrial (overall) credit growth in Sept. 2016 was 0.9% (y/y). Growth in credit to micro&small, medium and large industries were -1.2%, -2.6% and 1.4% respectively, in September 2016.

Perusing BIS statistics on Credit-to-GDP gap (actual-trend), one notes the following, for India:

2012 2013 2014 2015 2016 Q4 16 Q1 17 Q2 17 Q3 17 Q4 17
1.6 -0.1 -3.2 -3.8 -8.1 -8.1 -6.3 -9.0 -8.0 -8.7

India’s credit-GDP gap (actual-trend) had turned negative in 2014 and it remains negative up to 2017Q4 (latest data available in BIS). Therefore, the credit growth had slowed well before Dr. Rajan ordered AQR and directed banks to come clean. Banks had turned cautious because they knew that they were sitting on a problem and the borrowers too had severe credit indigestion. It was a demand as well as a supply issue.

So, the real problems were not the essential deleveraging nor the directive to clean up the balance sheet. Both were needed. Rajiv Kumar was not portraying the former Governor in a bad light. In fact, he does say to Jyoti Malhotra at ‘’, that it was a ‘heroic attempt’ by Dr. Rajan to clean up the banks.

Indeed, the real reason for the credit growth slowdown (desirable) and economic growth slowdown (inevitable) was the unsustainable credit and economic growth up to 2011. The Prime Minister was right to draw attention to the ‘phone-a-loan’ scam under the previous government.

So, in that spirit, if I were the Government, I would have put out the following press release after the RBI Annual Report came out, showing the return of the majority of demonetised currency notes to RBI:

“We undertook the demonetisation exercise to either smoke out black money and to gather precious information. The fact that 99.3% of the currency notes came back is not a source of disappointment to us but a source of information. Together with technology and returns being filed under GST, we are on the path to ensuring that more citizens pay their legitimate tax dues to the government, without harassing them, such that development priorities get the funding they need.

We sanctioned and fully stood behind RBI to facilitate Asset Quality Reviews at Banks and we backed the attempts to get to the bottom of the problem of Non-Performing Assets. Those efforts are paying off now. We implemented the Insolvency and Bankruptcy code to allow ease of exit of businesses and creditors as much as the Government was focused on Ease of Entering and Doing Business and we introduced the Goods and Service Tax to make India an efficient and an integrated market, scaleable for businesses and employment generation.

All of these would entail short-term sacrifices. But, we have put India on a higher growth path. Recent IMF review of the Indian economy has put India’s economic growth potential at 7.25%, capable of rising to 7.75%.

In 2012, India’s growth potential had dropped to 6.6% We have, with all these structural measures, raised it back above 7%. With our steadfast attempts at cleansing our banks, to be followed by a better framework for their future management, with our focus on creating hard infrastructure and with the financial inclusion measures we have undertaken, we are confident that India’s potential growth will rise to 8% and beyond that.

All important victories are hard-earned. Nothing worth cherishing comes easy or handed to us on a platter. We were handed a poisoned chalice in 2014. We have worked hard to make it a nectar. That involves short-term growth and even political sacrifices. We are happy and proud we did not flinch from taking the necessary and short-term unpopular decisions. Our efforts are paying off. The economy is on a solid growth path. We have achieved over 8% growth in the first quarter of the current financial year. Better times lie ahead.

We have had a good monsoon. We are now focusing on redressing the enduring concerns of our farmers and the fundamental priorities of the farm sector, in general. We are empowering farmers. That is our priority. At the same time, we are not losing sight of medium-term economic stability as we approach the elections next year. Thank you.”

When I shared the above draft government ‘press release’ with a friend, he told me the following:

Governments prefer to be hated for the wrong reasons than speak the wholesome truth, which admits errors of judgement in good faith. And they will never understand that people value honesty so much that they forgive honest mistakes!

Brilliant! Could not have put it any better.

Pro-cyclical finance

Eric Cinnamond, a blogger, I discovered recently wrote:

As the current expansion marches on, I’ve been thinking more and more about business cycles and how I incorporate cyclicality into my valuation process. [Link]

He cautioned against extrapolation of current record earnings and the need to normalise earnings for cycles.

But, a recent Wall Street Journal article on how financial institutions are ramping up personal loans now is an eye-opener for those who are not convinced of the cyclicality of finance:

American Express Co. , Goldman Sachs Group Inc., LendingClub Corp. and Social Finance Inc. are among those behind an onslaught of unsolicited mailings offering unsecured loans, known as personal loans, as large as $100,000. In the first half of this year, lenders mailed a record 1.26 billion solicitations for these loans, according to market-research firm Competiscan. The second quarter marked the first period that lenders mailed out more offers for personal loans than credit cards, a much bigger market, according to research firm Mintel Comperemedia. [Link]

The increase in personal loans as the economic cycle has matured is amazing. Once again, lenders are taking on more risk at the peak of the cycle and are also persuading borrowers to take on more risk at this late stage in the economic cycle. The chart embedded in the article offers telling evidence of that.

personal loans

This should not be surprising at all:

Now, as the market gains momentum, borrowers who took out personal loans more recently are falling behind on payments at a faster rate, according to TransUnion, and several lenders are reporting higher losses.

This should be very worrying, of course:

Last year, more than 1.5 million personal loans were given to people with credit scores below 601, on a scale that tops out at 850, according to TransUnion. That is the highest number in more than a decade. Currently, borrowers with credit scores considered prime or better account for just over half of personal-loan balances, according to TransUnion.

But, newspapers that were responsible once upon a time are focusing on the wrong finance problem: campaign finance of the President of the United States of America!

A tragedy and a travesty if…

In today’s MINT, Ajit Ranade argues clearly and convincingly against the Government or the Parliament diluting RBI’ norms issued in February for recognition of non-performing debt. He is right and I agree with him. I had written on this right after RBI came out with its NPA recognition norms in February 2018.

This story in MINT on how the ICICI Bank had made an accounting rule change that enabled it to keep its non-performing loan ratio low and that too without disclosing the rule change to shareholders only strengthens the RBI directive issued in February.

It is all about a culture of accountability that is sorely lacking in India. It is missing almost everywhere, especially in public space.

It will be a travesty and a tragedy to dilute RBI norms issued in February.