Lessons unlearnt

Lessons unlearnt

Raghuram Rajan’s explanations for NPA crisis provide a template for banking reforms.

Raghuram Rajan, governor of RBI between 2013 and 2016, has triggered a political debate between Congress and BJP while communicating his views on India’s bad loan, or NPA, problem to a parliamentary committee. This is not surprising as the NPA issue is sensational grist for election season. It encompasses crony capitalism, fraud, fugitives, all of which are financially underwritten by taxpayers. The gist of Rajan’s explanation covers familiar territory. Seeds of the NPA problem were planted between 2006 and 2008, tail end of the boom years, and NDA’s introduction of insolvency code is a big step in changing lender-borrower dynamics for the better.

Rajan’s explanation spans fundamental flaws in the banking architecture, particularly the lack of incentives to bank heads to be transparent about NPAs, and governance challenges in public sector banks. These problems remain unresolved in important ways. According to Rajan, some of NDA’s pet lending schemes such as Mudra may be sources of another bad loan crisis. From the standpoint of the economy, the essence of Rajan’s views is that India may not have learnt some important lessons from the last banking crisis.

The health of a banking system depends crucially on the incentives bankers have in being mindful of risks and transparent about the true state of affairs. Governance-related tinkering in public sector banks after the NPA problem exploded have yet to bring about meaningful change in incentive structures. The fear of investigative agencies and need to follow government’s credit directions at the cost of prudence remain unchanged. While recapitalisation of public sector banks cannot be delayed any further, there isn’t a commensurate sense of urgency in improving their governance. To that extent, systemic flaws of the last decade remain.

The insolvency code is the single most important reform of the Narendra Modi government, as it has for the first time brought a sense of balance between banks and large borrowers. But if this is to truly transform the borrowing landscape, it is important that all stakeholders, including judiciary, enhance capacity. Finally, government should begin the process of putting a credible institutional structure as an intermediary between itself and banks. Given the easy option of using tax money to offset banking problems, the biggest risk to the financial system remains state control of banks. Unless that is addressed in a meaningful way, banking crises are fated to recur and the taxpayer will be endlessly drained.