India's banking and finance sector's troubles do not seem to end. In November last year it was the collapse of Punjab and Maharashtra Co-operative Bank, with deposits of about $1.6 billion, and last week India's central bank seized Yes Bank, a major private lender with $47.5 billion in assets. Both events reflect lax regulatory oversight, a lack of accountability and the sector's failure to learn from its mistakes.
Prompted by Yes's repeated failures to raise funds to deal with liquidity pressure from bad loans and low deposit growth, the Reserve Bank of India imposed limits on cash withdrawals and lending operations. This was followed by the arrest of co-founder Rana Kapoor for allegedly receiving bribes for giving loans to a bankrupt housing finance company.
To reassure depositors and investors, RBI told the country's largest state-owned bank, State Bank of India, to buy a 49% stake in Yes Bank for 26.5 billion rupees ($360 million).
The SBI-led rescue plan may help ward off a banking crisis and its contagion through the rest of the economy for the moment. But it does not address the underlying rot in the country's banking system, which is marred by frequent loan defaults, fraud and the underreporting of bad loans, at a time of slowing economic growth and muted credit demand.
That calls for urgent governance reforms to improve transparency and accountability that the country has been postponing for too long.
There are similarities between the crisis at PMC and Yes Bank: indiscriminate lending, concentration of loans to a few large, interconnected borrowers and default by some of them. This led to liquidity pressure, followed by failures to raise capital and eventual collapse.
In the case of Yes Bank, its loan book grew from 550 billion rupees in 2014 to 1.3 trillion rupees in 2017, which was much faster than rivals. Worse, in the last two fiscal years, its loan book zoomed from 1.3 trillion rupees to 2.4 trillion rupees, growth of more than 80%, and that too in a gloomy business environment. That was an invitation for trouble.
Critics argue that instead of forcing SBI to bail out a troubled private lender, Prime Minister Narendra Modi's government should have focused on recovering loans from defaulters. However, that is easier said than done. The lender's top clients include financially stressed companies such as Reliance, DHFL, Essel Group and Vodafone Idea. Jet Airways, another borrower, has already shut down operations.
Internal mismanagement has a major role in cases of defaulting borrowers, but the government and regulators cannot shirk their parts.
Slower regulatory approvals and clearances, including those related to the environment, have made many infrastructure projects unviable and loans to infrastructure companies unrecoverable. The government's exacting financial charges and levies and a price war the sector's regulator tolerated ruined the financials of telecom companies such as Vodafone Idea.
In these circumstances, using the country's largest lender to infuse much-needed capital into the troubled bank appears to be the only viable option, but at the same time it will adversely affect SBI's balance sheet and will encourage undue risk-taking by others. That is likely to create complications in the future.
Regulator the RBI and others in the sector, auditors, rating agencies and independent directors, must admit culpability too in failing to do their jobs properly.
Then there is the question of timing. Why did the regulators and government wait so long to intervene? Yes Bank had been struggling for quite some time.
A combination of internal and external measures can minimize the kind of risks that Indian banks, private or state-owned, are facing.
Lenders should strive to achieve a balance between corporate and retail lending. Only 18% of Yes Bank's loans were lower-risk retail ones, compared with 48% for HDFC. It is no wonder the proportion of bad loans at HDFC is 1.5% against 7.4% at Yes Bank.
Banks should voluntarily avoid too much exposure to one or a few large borrowers in order to minimize default risks. In the PMC Bank fiasco, one large borrower accounted for 70% of its loan book and then defaulted, leading to the collapse of the bank.
Banks must also make better provision for nonperforming loans and not grow their loans much faster than their deposits. The government itself has been pressurizing the banking system to over-lend to stimulate the economy, which has to stop.
Finally, the Indian banking sector cannot afford poor corporate governance any more. It is time to strengthen banks' boards by filling them with competent people with experience in banking and finance, instead of retirees who do not have skin in the game. The government must make auditors and rating agencies accountable by providing for heavy penalties for errors.
This is the most sensible way to achieve a strong banking and financial system.
Ritesh Kumar Singh is chief economist of Indonomics Consulting and a former assistant director of the Finance Commission of India.