Parliament panel seeks answers from PMO, banks on Rajan report

Rajan in his note to the parliamentary panel had cited over optimism on the part of bankers, slowdown in government decision making process and moderation in economic growth as the main causes of mounting bad loans.

The committee has asked lenders as to how the NPAs — estimated at Rs11lakh crore — piled up over the years, what was done to contain them and, most importantly, who should be controlling bank credit.

The committee also asked the PMO to explain what action the government has taken on a list of large corporate houses that have amassed NPAs. The list was part of Rajan’s submissions to the committee.

"A variety of governance problems such as the suspect allocation of coal mines coupled with the fear of investigation slowed down government decision making in Delhi, both in the UPA and the subsequent NDA governments," according to Rajan.

The committee turned to Rajan after examining former Chief Economic Advisor Arvind Subramanian who pointed to the work done by Rajan in this regard. Rajan, in a 17-page reply has detailed how big business houses were given a free pass by the government and the banking system. 

Rajan’s report traced the origin of a number of bad loans to 2006-08, when there was “over-optimism” because the economy was strong, and infrastructure projects had been completed on time. This led overconfident banks to lend more and make mistakes. The global financial crisis, which followed also contributed to NPAs, it said.

"It is at such times that banks make mistakes. They extrapolate past growth and performance to the future. So, they are willing to accept higher leverage in projects, and less promoter equity. Indeed, sometimes banks signed up to lend based on project reports by the promoter's investment bank, without doing their own due diligence," he said.

Project cost overruns escalated for stalled projects and they became increasingly unable to service debt, he said, adding the continuing travails of the stranded power plants, even though India is short of power, suggests government decision making has not picked up sufficient pace to date.

Citing an example, he said, "one promoter told me about how he was pursued then by banks waving cheque books, asking him to name the amount he wanted".

This is the historic phenomenon of irrational exuberance, common across countries at such a phase in the cycle, he said.

Unfortunately, he said, that growth does not always take place as expected and the years of strong global growth before the global financial crisis were followed by a slowdown, which extended even to India, showing how much more integrated the country had become with the world.

Strong demand projections for various projects were shown to be increasingly unrealistic as domestic demand slowed down, he said.

He also pointed to loss of promoter and banker interest for rise in NPAs.

Over malfeasance and corruption in the NPA problem, he said, "Undoubtedly, there was some, but it is hard to tell banker exuberance, incompetence, and corruption apart".

"Clearly, bankers were overconfident and probably did too little due diligence for some of these loans. Many did no independent analysis, and placed excessive reliance on SBI Caps and IDBI to do the necessary due diligence. Such outsourcing of analysis is a weakness in the system, and multiplies the possibilities for undue influence," the note said.

On steps required to prevent recurrence rising non-performing assets (NPAs), Rajan suggested that there is a need for improving governance of public sector banks and process of project evaluation and monitoring to lower the risk of project NPAs.

Besides, he also made a case for strengthening the recovery process and distance public sector banks from the government.

The Parliament's Committee on Estimates had invited Rajan to brief it on the matter after former Chief Economic Advisor (CEA) Arvind Subramanian praised him for identifying the NPA crisis and trying to resolve it.

Rajan, who was RBI governor for three years till September 2016, is currently the Katherine Dusak Miller Distinguished Service Professor of Finance at Chicago Booth School of Business.