Bad loans on rise: How can banks tackle the menace?

Discussing the same, Economist Haseeb Drabu said the corporate governance in PSU banks is not as strong as private banks and there is lot of involvement and interfering by government officials. Besides, many companies do not disclose impaired assets on time, he feels.

Drabu feels forensic audits are must for all frauds reported in the recent past.

Diwakar Gupta, Former MD & CFO, State Bank of India, said the banks face the problem of governance deficit. There is lack of adequate incentive for PSU banks to take proactive decision.

In a separate interview to CNBC-TV18, VR Iyer, CMD, Bank of India, said the finance ministry has written to all banks asking them to be cautious. She feels the banks will now have to work towards setting all deficiencies right.

Below is the transcript of Diwakar Gupta and Haseeb Drabu’s interview to CNBC-TV18’s Latha Venkatesh and Sonia Shenoy

Latha: The most obvious question first, why is it that public sector banks have suffered more than private sector banks in handling non-performing loans (NPLs) in this down cycle?Drabu: If you look at it from a broader perspective, it points to governance deficit and management deficit. I think the corporate governance in PSU banks is not as strong as it ought to be and the skill set that the management teams must have now in a kind of financial system that is evolving and kind of size and scale of credit particularly in India, the skill set doesn’t really exist at that level. In terms of governance the biggest issue is the separation of ownership and management. The Government of India owns a large chunk of these banks ranging from 50 percent to 85 percent and a lot of people are ex-official members on the board be it the finance secretary or banking secretary depending on the nature, size, class of the bank. There is definitely involvement and interference at that level. Board directors of these banks are favors, they reach out to people with political context, these are in some ways parking slots. So the ideal governance environment and it is a new regulatory environment because if you see we have moved from a control regime to a regulatory regime and the key players there is the board of directors. That is where the real problem starts and then subsequently it becomes an operational issue and so on.

Latha: So two big issues, political interference which is governance issue as well as inability to do as much due diligence, quality of diligence. There are people like NBFCs who believe that due diligence of State Bank of India (SBI) is much better than the quality of bankers in several private sector banks. Why do Bhushan’s happen, why do Winsome’s happen?Gupta: I would agree with Haseeb Drabu that there is governance deficit and that governance deficit is not because credit skills are lacking because today in large advances you have adequate due diligence from very competent people. It is really the fact that in good times you underprice risk, you go overboard, in bad times you want to find a skate board. So if I were to draw an analogy, women in our country for example they are used to comments being passed against them. Only once in a while there is outrage.What we are looking out today is that the reaction is not the root cause of the problem, the root cause of the problem is the fact that in the public sector space there is not adequate incentive for taking proactive decisions which can then get questioned later. Therefore a lot of this problem is happening by default because there is indecision.

Latha: You don't have the guts to be tough because later on you may have a Central Vigilance Commission (CVC) or a Central Bureau of Investigation (CBI) enquiry, is that what you are saying?Gupta: Absolutely. That is what we are questioning about Bhushan Steel. I have known Bhushan not as a direct controller but I know it is a good company. I know there are buyers today who are still asking bankers not to pull the plug on Bhushan because they are willing to buy their entire production. So here is a company, which has seen a downturn, which has not got iron ore, where prices of steel are depressed and where interest costs have gone up. How do you blame a company like that and because it was good, bankers would obviously continue to support it. At some point of time, you have found that support was not sustainable and now you are questioning the same bankers why they threw good money after bad money. I think forbearance is the byword unless there are clear malafieds. I am not aware whether there are clear mala fieds in the case of Bhushan or for that matter even significant diversion.

Sonia: The key question now is how can this malice be cured? What could the government do or what could the banking secretary or the system do in order to remove the bad apples in the pack?Latha: Your logical question is if you are removing the control of CVC and the CBI and the Comptroller and Auditor General (CAG) which Mr Gupta says doesn’t make you a tough banker, how do you hold the public sector banker accountable as well?Drabu: Let me just get back one step and look at this whole issue - I am talking about generally the whole lending pattern in the steel sector for instance. It is not so much that it is only an issue of the controls or whatever, the fact is that if you take the average tenure of loans to the steel sector, term loans, it is as low as 4-7 years. It is a bankers’ issue that they do lend short. All these loans should have been somewhere like 7-10 years or 10-12 years, they have been lending for 7-5 years and even before the project is completed, the working capital is consumed as a term loan which is when the problem starts. So I think there is need to reassess what is the requirement of a growing industrial segment be it basic metal like steel or some other and take a realistic view. This may partially be driven by the fact of asset liability mismatches and stuff like that but it remains a concern that the way the lending has happened is not proper and bankers should take a part of the blame.Number two when you are looking at it from a macroeconomic perspective, it is also a fact that the assets created by companies like Bhushan and others, the replacement value of those is much higher. So if you look at it from a capital perspective then the banker would probably change his perspective on it in terms of how much funding they should do.Third is the equity contribution. You must also understand that the entire industrial sector is debt financed. IDBI has been a venture capitalist, private equity player, debt fund and everything. So in some ways, one needs to look at what is the contribution of the promoter to this and not just in terms of debt equity but debt to contributed equity because a lot of these companies are cyclical businesses, they have made losses. So it is a little more complex than that. But having said that, obviously there has been distress in the system and a lot of blame again is to be placed with the management, the audit committees and the board of directors who don’t declare these impaired assets in time.Today you are looking at stressed assets which are way above what we have seen ever in the system. You are talking of 12-13 percent, how does stress gets managed. I think there is need to look at a process of detecting stress early.