Former RBI Governor Raghuram Rajan's response letter to the Parliamentary Committee on Estimates regarding NPAs, apart from his views seemingly demystifying various topics over which there has recently been much deliberation, also contains a number of suggestions for action on NPAs and on other banking matters.
1. On Fraudsters: The RBI set up a fraud monitoring cell when I was Governor to coordinate the early reporting of fraud cases to the investigative agencies. I also sent a list of high profile cases to the PMO urging that we coordinate action to bring at least one or two to book. I am not aware of progress on this front. This is a matter that should be addressed with urgency.
2. The NPA problem's solution: In sum, the Indian evidence, supported by the experiences from other parts of the world such as Europe and Japan, suggests that what we were seeing was classic behaviour by a banking system with balance sheet problems. We were able to identify the effects because parts of our banking system – the private banks -- did not suffer as much from such problems. The obvious remedy to anyone with an open mind would be to tackle the source of the problem – to clean the balance sheets of public sector banks, a remedy that has worked well in other countries where it has been implemented. This is not a “foreign” solution, it is an economically sensible solution. It is something that has been repeatedly flagged by the government’s own Economic Survey, under the guidance of the respected Dr. Arvind Subramanian. Clean up was part of the solution, not the problem.
3. On recapitalisation of PSBs: The government has not recapitalized banks with the urgency that the matter needed (though without
governance reform, recapitalization is also not like to be as useful).
4. Do's and Don'ts with regards to promoters involvement in Bankruptcy code proceedings: The Bankruptcy Code is being tested by the large promoters, with continuous and sometimes frivolous appeals. It is very important that the integrity of the process be maintained, and bankruptcy resolution be speedy, without the promoter inserting a bid by an associate at the auction, and acquiring the firm at a bargain-basement price. Given our conditions, the promoter should have every chance of concluding a deal before the firm goes to auction, but not after. Higher courts must resist the temptation to intervene routinely in these cases, and appeals must be limited once points of law are settled.
5. Bankers should be able to proceed without promoters: Banks and promoters have to strike deals outside of bankruptcy, or if promoters prove uncooperative, bankers should have the ability to proceed without them. Bankruptcy Court should be a final threat, and much loan renegotiation should be done under the shadow of the Bankruptcy Court, not in it. This requires fixing the factors that make bankers risk averse and that make promoters uncooperative.
6. High-level empowered and responsible group on cleaning up banks: We need concentrated attention by a high level empowered and responsible group set up by government on cleaning up the banks. Otherwise the same non-solutions (bad bank, management teams to take over stressed assets, bank mergers, new infrastructure lending institution) keep coming up and nothing really moves. Public sector banks are losing market share as non-bank finance companies, the private sector banks, and some of the newly licensed banks are expanding
7. (In Hindsight) What the RBI should have done: The RBI should probably have raised more flags about the quality of lending in the early days of banking exuberance. With the benefit of hindsight, we should probably not have agreed to forbearance, though without the tools to clean up, it is not clear what the banks would have done. Forbearance was a bet that growth would revive, and projects would come back on track. That it did not work out does not mean that it was not the right decision at the time it was initiated. Also, we should have initiated the new tools earlier, and pushed for a more rapid enactment of the Bankruptcy Code. If so, we could have started the AQR process earlier. Finally, the RBI could have been more decisive in enforcing penalties on non-compliant banks. Fortunately, this culture of leniency has been changing in recent years. Hindsight, of course, is 20/20.
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8. On appointments to PSBs: Public sector bank boards are still not adequately professionalized, and the government rather than a more independent body still decides board appointments, with the inevitable politicization. The government could follow the PJ Naik Committee report more carefully. Eventually strong boards should be entrusted with all decisions but held responsible for them.
(He adds) It would be good for the old CEO and the successor to overlap for a few months while they exchange notes. All the more reason to delegate appointments entirely to an entity like the Bank Board Bureau, and not retain it in government
9. On bringing in outside talent to PSBs: Outside talent has been brought in very limited ways into top management in Public Sector Banks. There is already a talent deficit in internal PSB candidates in coming years because of a hiatus in recruitment in the past. This needs to be taken up urgently. Compensation structures in PSBs also need rethinking, especially for high level outside hires. Internal parity will need to be maintained. There will be internal resistance, but lakhs of crores of national assets cannot be held hostage to the career concerns of a few.
10. Other risks: Risk management processes still need substantial improvement in PSBs. Compliance is still not adequate, and cyber risk needs greater attention.
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11. On project evaluation: Significantly more in-house expertise can be brought to project evaluation, including understanding demand projections for the project’s output, likely competition, and the expertise and reliability of the promoter. Bankers will have to develop industry knowledge in key areas since consultants can be biased.
12. On risk mitigation and contractually sharing risks: Real risks have to be mitigated where possible, and shared where not. Real risk mitigation requires ensuring that key permissions for land acquisition and construction are in place up front, while key inputs and customers are tied up through purchase agreements. Where these risks cannot be mitigated, they should be shared contractually between the promoter and financiers, or a transparent arbitration system agreed upon. So, for instance, if demand falls below projections, perhaps an agreement among promoters and financier can indicate when new equity will be brought in and by whom.
13. On incentivising promoters: Promoters should be incentivized to deliver, with significant rewards for on-time execution and debt repayment. Where possible, corporate debt markets, either through direct issues or securitized project loan portfolios, should be used to absorb some of the initial project risk. More such arm’s length debt should typically refinance bank debt when construction is over.
14. Real-time project monitoring and appraisal: Financiers should put in a robust system of project monitoring and appraisal, including where possible, careful real-time monitoring of costs. For example, can project input costs be monitored and compared with comparable inputs elsewhere using IT, so that suspicious transactions suggesting over-invoicing are flagged? Projects that are going off track should be restructured quickly, before they become unviable.
15. An incentive structure for bankers: The incentive structure for bankers should be worked out so that they evaluate, design, and monitor projects carefully, and get significant rewards if these work out. This means that even while committees may take the final loan decision, some senior banker ought to put her name on the proposal, taking responsibility for recommending the loan. IT systems within banks should be able to pull up overall performance records of loans recommended by individual bankers easily, and this should be an input into their promotion and pay.
16. On making the NPA resolution process speedy and on protecting bankers' decision-making ability: Both the out of court restructuring process and the bankruptcy process need to be strengthened and made speedy. The former requires protecting the ability of bankers to make commercial decisions without subjecting them to inquiry. The latter requires steady modifications where necessary to the bankruptcy code so that it is effective, transparent, and not gamed by unscrupulous promoters.
17. On abandoning due diligence to meet credit targets: Credit targets are sometimes achieved by abandoning appropriate due diligence, creating the environment for future NPAs. Both MUDRA loans as well as the Kisan Credit Card, while popular, have to be examined more closely for potential credit risk. The Credit Guarantee Scheme for MSME (CGTMSE) run by SIDBI is a growing contingent liability and needs to be examined with urgency.
18. On loan waivers: Loan waivers, as RBI has repeatedly argued, vitiate the credit culture, and stress the budgets of the waiving state or central government. They are poorly targeted, and eventually reduce the flow of credit. Agriculture needs serious attention, but not through loan waivers. An all-party agreement to this effect would be in the nation’s interest, especially given the impending elections.