Bad bank loans behind much of India’s corporate woes; Banks must take steps to address shoddy lending practices

December 19, 2013 8:29 am

Bad bank loans behind much of India’s corporate woes

By Henny Sender

Banks must take steps to address shoddy lending practices

In recent months, indebted Indian conglomerate Jaiprakash Associates sold a cement plant in Gujarat to the UltraTech subsidiary of one of the Birla group companies. Highly levered GMR Infrastructure has sold its power plant in Singapore, a stake in an African mining venture and an expressway subsidiary with more sales to come. The deep pockets of Blackstone’s real estate arm in India are being put to work as that firm is in the process of buying and bidding for projects from cash-strapped developers such as DLF and Unitech.At the same time, both the Reserve Bank of India, the central bank, and State Bank of India, the largest of the big, state-owned banks, are voicing determination to go after recalcitrant borrowers as the volume of problem debts, whether acknowledged or not, continues to grow.

It is not clear whether this time is different and the banks are really serious about putting pressure on borrowers who are unable or (in many cases) unwilling to repay the banks. But they should be. There are huge actual and opportunity costs to such practices, among them the fact that each problem loan to unworthy borrowers means less money for those who can really use it.

But all too often, the loans have gone to borrowers not because they were creditworthy or because they had good projects but because they were connected or corrupt. Under-the-table payments to loan officers are a reality in some Indian banks (especially in the public sector) as they were in much of East Asia a decade ago. Politicians regularly put pressure on banks to ensure that favoured applicants have access to credit.

Such poor lending practices also mean that banks will have to charge more for loans to cover the costs of those bad debts. That in turn causes the cost of capital for Indian borrowers to rise when it is already a huge constraint on economic growth and investment in new projects. India’s competitors, notably China, have the competitive advantage of a far lower cost of capital.

The extent of the bad debts in the Indian banking system is striking. Total problem asset levels are now at about 10 per cent and are especially marked in infrastructure and construction companies.

“With the financial health of corporates showing no sign of improvement and rising leverage at stressed corporates we expect corporate asset quality to weaken further,” note analysts at Credit Suisse in a recent report.

In fiscal 2013’s second quarter corporate health overall continued to deteriorate and pressure on corporate India’s finances increased with much of the corporate sector registering drops in cash flow in response to rising inflation, and a huge drop in the value of the rupee. With economic growth under 5 per cent, or half the pace of a few years ago, ambitious plans made in more heady times have to be scaled back.

Many cynics attribute the tough talk to anger at a few egregious cases. Kingfisher Airlines, for example, is among the largest defaulters and today the fleet is grounded. But the airline’s founder and head of the UB Group, Vijay Mallya, continues to live in style while his still unpaid flight crews look for alternative employment.

Do not feel too much sympathy for the banks, either. Sloppy bank practices are as responsible for the mess as irresponsible borrowers. Foreign banks that had careful documentation were able to seize assets (including Kingfisher planes parked at London’s Heathrow airport). But some Indian banks were less careful and found themselves with little recourse.

All too often, a personal guarantee from a firm’s promoter – as Indians style their founders – means little. “The banks look at these guys and say, they are so rich! How can a loan go wrong?” says the head of one securities firm. In other cases, banks lend against shares, which also doesn’t work well because when a company cannot honour its debts, its shares tend not to perform brilliantly either. Moreover, companies tend to lever up at all levels so what appears to be the equity of one subsidiary is actually borrowed money. This is in direct violation of RBI rules, but never mind. Such loans are often made offshore.

Many bankers believe today that India is at the trough and growth will pick up from here. Their sentiment is buoyed by recent local elections which were a sound repudiation of the anti-business sentiments of the Congress party. But if growth is to pick up, India needs to get its infrastructure act together and the private sector has to begin investing again. Both will require financing from the banks. The public sector banks in particular are undercapitalised compared to the magnitude of this challenge. If they were to take a tougher line with their borrowers, it would be at least an initial step in the right direction.