Some corporate entities’ high indebtedness and deeply over-leveraged operations pose a serious threat to the stability of the financial system!

To

The Governor,

Reserve Bank of India

Shahid Bhagat Singh Road,

Fort, Mumbai-400001

Dear Sir,

Dated: 06.09.2022

Subject: Some corporate entities’ high indebtedness and deeply over-leveraged operations pose a serious threat to the stability of the financial system, health of the PSU banks and safety of depositors’ funds– Urgent intervention required.

We wish to raise our serious concerns about the increasing risks to which the banks, especially the public sector banks (PSBs) are getting exposed and their impact on the stability of the financial system and the security of people’s money deposited therein.

Asset-Liability mismatch of banks:

At the outset, we would refer to the caution on the “massive asset-liability mismatch in the banks, that could explode anytime” by Dr Pronab Sen, former Secretary, Ministry of Statistics & Programme Implementation, Government of India. (https://www.business-standard.com/article/finance/banking-sector-at-enormous-risk-of-asset-liability-mismatch-pronab-sen-122082400891_1.html).

Such an asset-liability mismatch arises as the banks depend predominantly on depositors’ funds, the average tenure of which is around 2 to 2.5 years, whereas, on the side of the banks, the average tenure of the assets is around 9 years since the loan portfolios stand heavily skewed in favour of term loans given to corporates. While the RBI is fully aware of this and has been taking steps to correct the mismatch, over the years, the share of term loans in the banks’ loan portfolios has increased, accentuating the mismatch, rather than correcting it. Such a mismatch can pose serious liquidity risks to the banks and burden on the tax payer since most banks in India continue to be in the public sector and are fully backed by the sovereign. The private banks are not as exposed as the public sector banks to corporate borrowings.

The position will change if the public sector banks (PSBs) are to be privatised. If that were to happen, the depositors’ funds in the banks would become subject to private control, without their having sovereign backing, exposing the depositors to enormous risk. The collapse of the private bank, Global Trust Bank (GTB) about two decades ago, which endangered the depositors’ interests is a case in point. The RBI had then persuaded a PSB to take over the operations of GTB, which ultimately safeguarded the depositors’ funds and prevented a run on the bank. The basic difference between a private bank and a PSB is that the former functions exclusively on its promoters’ commercial/profit motive, whereas a PSB functions more for a social purpose to extend banking services to rural and remote areas, and to the disadvantaged sections of society, in furtherance of the welfare mandate of the Constitution as enjoined in the Directive Principles of State Policy.

Under the Banking Regulation Act RBI has the statutory responsibility of regulating the operations of the banks in order to safeguard the interests of the depositors and the equity holders. RBI is also duty bound to provide security and guarantee to the depositors by regulating the business of banking. In our view, the RBI should act decisively to safeguard the interests of millions of depositors in the country and also to maintain the stability of the financial system.

Over-leveraged, debt-driven expansion by some private corporate groups:

We have just come across a disturbing report on a large corporate group’s finances, on the basis of an assessment carried out recently by CreditSights, a credit assessment unit of the Fitch Group, which points to the group’s high indebtedness, deeply over-leveraged operations and debt-driven expansion into highly capital-intensive projects in a wide range of new sectors. According to that report, “excessive debt and over-leveraging by the group could have a cascading negative effect on the credit quality of the bond issuing entities within the group and heightens contagion risk in case any entity falls into distress”.

We request the RBI to ascertain the validity of the CreditSights report and place its own assessment in the public domain so as to keep the public fully informed.

This is not the first time that reports on over-leveraged operations of large corporate groups have come to light. For example, a well-analysed report on the extent of over-leveraging of one such group’s activities appeared in the press around 3 years ago (https://scroll.in/article/923201/from-2014-to-2019-how-the-adani-group-funded-its-expansion). The report highlighted the complex web of subsidiaries set up by that group to carry on its operations in diverse sectors and pointed to excessive debt-dependence and leverage among the Group’s subsidiaries. The group’s combined borrowings seem to have jumped 40.5% to a mind-boggling level of Rs 2.21 lakh crore in the financial year 2021-22, compared to Rs 1.57 lakh crore in the previous financial year (https://www.news18.com/news/business/adani-groups-debt-up-40-to-rs-2-21-lakh-crore-in-fy22-adani-enterprises-sees-highest-rise-5370031.html).

The group’s expansion seems to be driven largely by borrowings, not as much by its own funds. This has led to some of its subsidiaries operating on high debt-equity ratios, which may not be sustainable for long. For example, according to a Bloomberg report, one heavily debt-dependent company has a debt-to-equity ratio which has reportedly reached an unsustainable level of 2,021. [https://www.bloomberg.com/news/articles/2022-08-24/adani-green-s-2-021-debt-equity-ratio-is-second-worst-in-asia]. The normal debt–equity ratio prescribed for banks is only 1:1.5. RBI is expected to monitor these lendings which can lead to default of the loan.

Of course, we would request the RBI to get these findings independently verified so that there may be a more authentic understanding of the risks to which the banks are exposed. Such levels of debt, over-leveraged operations and indiscriminate expansion of large business groups, unless negated in the RBI verification, poses a threat to the stability of the financial system and the health of the PSU banks that lend funds to the Group.

One of the factors that seem to have encouraged big business houses in India, to saddle the banking system with huge debt liabilities, is the continuing munificence of the PSU banks, which have been imprudently extending concessions such as “greening the debt”, a euphemism for giving them new loans to repay the existing debt and deferring repayments of the existing debt. Such lenience on the part of the banks, passively endorsed by the RBI, has encouraged fraudulent diversion of the loan amounts by several borrowers to other unauthorised activities, at the cost of the banks, which explains to some extent the NPA crisis faced by the banks at present. To some extent, the problem of the corporates borrowing heavily from the banks could also be attributed to the government’s continuing exhortation to them to extend credit for developing infrastructure projects, commercialising telecom spectrum bands, developing privatised mineral blocks and so on, which has exerted pressure on the banks and encouraged the corporates to borrow, often resulting in prudential norms being underplayed.

The Financial Stability Reports of the RBI tend to paint a rosy picture of the PSBs’ NPAs by showing a decline in their level in proportion to their gross advances, by reducing the same by the amounts written off in a given year for the purpose of making a provision in their financial statements, an exercise of cosmetic window-dressing. Since the amounts written off do not take away the banks’ obligation to recover them, for the purpose of a realistic assessment, they need to be reckoned as a part of the NPAs. If one were to recalculate the NPAs on that basis, taking into account the information available in the public domain (https://www.cenfa.org/a-dint-on-the-psbs-npa-management/), the gross NPAs which were 9.11% of the gross advances in 2016-17 increased to 14.6% in 2019-20 and 11.7% in 2020-21. Thus, the NPA problem has not really improved; instead, it continues to cause a serious concern for the PSBs. The bulk of such NPAs arise from loans given to the larger groups of private companies.

Though the RBI has been exhorting the banks to cap their exposure in line with the prescribed sector-wise/ group-wise limits, it has not prevented the corporates from borrowing heavily from the banks, especially the PSBs. When corporate groups bring in little of promoters’ funds, over-leverage the amounts borrowed from the financial institutions and indiscriminately expand their operations, in the long-run, such operations will become unsustainable, forcing the corporate borrower to default on repayments. This is the primary factor that has caused a steep increase in the NPAs, which in turn has adversely impacted the banks, especially the PSBs. In turn, when the government is forced to “recapitalise” the PSBs for that reason, it is the public exchequer that takes the losses.

The RBI had earlier announced in August 2016, that it would move to cap the exposure of banks to large borrowers while also taking steps to deepen the Corporate Bond Market. RBI stated that starting from the fiscal year 2017, banks will have to set aside higher provisions for incremental lending to borrowers who have a certain amount in outstanding loans from the banking sector.

The banking regulator further proposed the creation of a new segment of borrowers called ‘specified borrowers.’ A specified borrower was defined as anyone who has an aggregate fund-based limit, (ASCL) of Rs.25000 cr in 2017-2018, Rs.15000 cr in 2018-19 and Rs.10000 cr from the first April 2019 onwards.

If a specified borrower was given more loans than suggested above, the bank will have to keep higher provision as the risk is higher. The banks were allowed to subscribe to bonds issued by the corporate houses which could be divested at any time.

This decision was taken based on the outstanding loans of big corporates.  As of March 2015, outstanding loans of top 10 corporates was Rs.7,31,000 cr and the outstanding of 12 to NPAs was Rs.3,45,000 cr. Since then, the position with regard to excessive borrowing by the corporates and the magnitude of the NPAs has not improved significantly, largely as a result of the RBI norms not being enforced fully.

We feel that it is high time the RBI implements its own decision strictly, as more of the corporate debt as it exists to date is likely to become NPA and create a crisis for the entire banking system. In recent times, several of the corporates that became excessively dependent on debt have since become NPAs. The banks were forced to write off their loans in their books. They were also forced to lose heavily once the cases of such defaulting corporates had been referred for adjudication by the National Company Law Tribunal (NCLT). It has been reported that the rates of recovery of bad loans have been around 10-11% only.

Debt-rescheduling facility for the corporates, not for priority sectors:

It is ironic that the banks should rarely display the same kind of generosity to millions of farmers who, despite the vagaries of the weather, put in their sweat and toil into producing enough food grains for the country to remain self-sufficient. In the absence of any such debt restructuring facility available, the farmers faced with spiralling input costs and unremunerated crop prices, depend on the occasional, but unpredictable loan waivers granted by the government, more by way of political patronage than as an entitlement. Loan waivers to farmers are insensitively called ‘revadis or freebies’ these days, whereas the debt restructuring facility, complimented by tax and other concessions extended to business houses are treated admiringly as promoting “ease of business“! Not all debt-ridden farmers are fortunate to benefit from such loan waivers. It is they who commit suicide.

Similar treatment is being meted out by banks to Micro, Small and Medium Enterprises that are the job creators and are the backbone of the industrial economy. Any default on their side-willing or otherwise is ruthlessly dealt with under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 with their assets, including collaterals seized and sold and the entrepreneurs thrown on the street.

Unlike big corporate borrowers in whose case, payment default by even one borrower can significantly impact the banks’ finances, MSMEs, farmers and other priority sector borrowers are more diversely distributed, spreading the risks thin. Moreover, since bank loans to them are given in furtherance of the welfare mandate of the State, defaults/ losses attributable to them need to be fully backed by sovereign guarantees reflected by way of transparent budgetary transfers to the banks.

The RBI has the statutory responsibility of regulating the operations of the banks in order to safeguard the interests of the depositors and the equity holders under the Banking Regulation Act. RBI circulars have prescribed a ceiling on the limit to corporate credit and infrastructure credit which seems to have been violated by the banks and needs immediate intervention. We propose that the RBI should immediately conduct an Asset Quality Review.

The RBI has introduced a scheme that the banks should co-lend with NBFCs. Many NBFCs in India are owned indirectly by private groups, who are reported to be using that route to intrude into an area that legitimately belongs to the banks. They bring very little of their own funds, critically depend on funds from the banks and act merely as an intermediary to slice away a share of the banks’ market. There have also been complaints that the NBFCs, the regulation over which is fragile, are charging usurious rates and exploiting unwary customers. Therefore, any co-lending partnership between the banks and the NBFCs may prove to be counter-productive (refer to our letter to RBI at https://reclaimtherepublic.co/2022/01/16/demand-to-reverse-the-sbi-adani-capital-deal/)

Many States have been dealing with large private corporates, in matters such as setting up projects for renewables etc. They may not be fully aware of the financial risks associated with some such corporates. The RBI should therefore alert the States of the debt problems faced by private corporate groups so that they may remain vigilant in dealing with such business houses.

Against the above background, we request the RBI to:

• Conduct an urgent Asset Quality Review for each bank, with special reference to large corporate groups and, where corporates have borrowed heavily, put a stop to any further borrowing by them from the banks
• Implement the RBI decision to have a ceiling of Rs 10,000 Crores borrowing by an individual corporate group
• Increase lending to MSMEs, Agriculture, and disadvantaged sections of society with subsidies and the costs fully covered by the government through transparent budgetary transfers to compensate the banks
• Revoke the scheme of banks getting into co-lending arrangements with NBFCs
• Revisit the proposal to private any PSB in view of the risks that such privatisation still poses to the depositors.

V P Raja

Joint Convener

People’s Commission

About Peoples’ Commission on Public Sector and Public Services (PCPSPS): Peoples’ Commission on Public Sector and Services includes eminent academics, jurists, erstwhile administrators, trade unionists and social activists. PCPSPS intends to have in-depth consultations with all stakeholders and people concerned with the process of policy making and those against the government’s decision to monetise, disinvest and privatise public assets/enterprises and produce several sectoral reports before coming out with a final report. Here is the first interim report of commission- Privatisation: An Affront to the Indian Constitution.