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What ails India’s banking sector?

Two dramatic events have shaken up the Indian banking system this month: on August 2, the Central Bureau of Investigation (CBI) arrested the chairman and managing director of Syndicate Bank for allegedly accepting a bribe to enhance the credit limit of a private company.

Then, on August 20, the finance ministry ordered forensic audits of the Oriental Bank of Commerce and Dena Bank for allegedly misappropriating Rs. 436 crore of deposits belonging to private and public sector companies.

The Indian banking system is reeling under the burden of high non-performing assets (loans that borrowers have defaulted on repaying) amid allegations of corruption in high-level appointments and inadequate systemic safeguards.

Bad loans of banks rose almost 30% to Rs. 2,45,809 crore in 2013-14 from `1,83,854 crore in 2012-13, which itself was 30% higher than the figure of  Rs. 1,37,102 crore in 2011-12.

“NPAs have increased as the economy has slowed down in the last two years… But there are many people whose intentions are not good. They do not want to repay their loans,” finance minister Arun Jaitley recently said.

RBI governor Raghuram Rajan has emphasised the need for better governance in India’s state-owned banks. “We need to again look at the governance of the public sector bank and understand the deficiency there and try and improve it,” he said recently.

TM Bhasin, chairman, Indian Banks Association, which represents all major banks in India, said: “The government, RBI and banks are in sync and are collectively fighting the battle of NPA. Stringent action would be taken against wilful defaulters.”

The RBI annual report for 2013-14 says sectors such as infrastructure, iron and steel, aviation and textiles account for more than 50% of total stressed assets though their share of loans is only 24%.

“This implies that the stress rate of infrastructure, which was much less than the average, is now over twice that of the overall portfolio. About a fifth of all infrastructure advances are stressed,” the annual report says.

As the finance minister pointed out, a large part of the rise in NPAs can be attributed to the crippling slowdown in the economy, which has grown at under 5% in each of the two previous years. This has played havoc with earnings projections and prevented many bona fide borrowers from servicing their loans.

Then, the policy paralysis of the last three to four years, problems in acquiring land, environmental concerns and the associated ban on mining iron ore and coal in many states and the non-availability of promised coal and gas has turned many otherwise potentially viable projects – especially in the road, power and iron & steel sectors – sick.

Many of these projects can return to good health once the business cycle turns or when the administrative roadblocks currently holding them up are removed.

“While the slowdown of the economy is a factor contributing to the rising NPAs, there are other factors as well. Indian banks, especially public sector lenders, are weak in identifying defaulters and distinguishing between those that are willful and those that are not,” Ashvin Parekh senior adviser, EY, and managing partner, Ashvin Parekh Advisory Services, said.

In many instances, as in the case of Kingfisher Airlines, the collateral pledged by the borrower does not cover the value of the loan, making it impossible for lenders to recover their dues.

Such cases, as well as ones where credit limits have been enhanced or debts restructured in violation of prudent banking practices, point to either weak risk management systems or, in some cases, to corruption.

The rot, in many cases, starts at the top of public sector banks. CBI chief Ranjit Sinha has recently written to the finance ministry pointing out irregularities, and the role of middlemen, in senior-level banking appointments.

CMDs and EDs are appointed on the basis of their annual confidential reports (ACRs), which are their annual appraisal reports, and an interview. Some candidates were reportedly selected for these coveted positions despite doing badly in their interviews.

Jaitley has written to Rajan and Cabinet secretary Ajit Seth to review some of these appointments.

“We are looking into the issue and will tighten the system to bring in more transparency and accountability,” GS Sandhu, secretary, financial services told Hindustan Times, adding that the Central Vigilance Commission could also be given more teeth to deal with frauds in future.

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