Apart from going over the reasons which led to the NPA crisis, Rajan discussed various aspects of the crisis in terms of policy-making from the government and the Reserve Bank.
Here are some of the highlights of Raghuram Rajan's letter:
1. Reasons which led to the NPA crisis
The letter begins by listing out several reasons which led to the NPA crisis. Rajan claims that a large number of bad loans were originated in the period 2006-2008 when economic growth was strong. He says that it is at this time that bankers become over-optimistic and make mistakes. This economic growth was followed by a financial crisis of 2008 which added to the crisis. Rajan also mentions the contribution of banking frauds to NPAs. "The size of frauds in the public sector banking system has been increasing, though still small relative to the overall volume of NPAs".
Rajan adds that the RBI during his tenure had set up a monitoring cell to check bank frauds to coordinate the early reporting of fraud cases to investigative agencies. "I also sent a list of high profile cases to the PMO urging that we coordinate action to bring at least one or two to book. I am not aware of progress on this front."
"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," Rajan adds.
2. RBI's attempts at restructuring debt
During his tenure at RBI Rajan realised, he says, that bankers had very little power to recover debt from large promoters. Even with Debts Recovery Tribunals (DRT) and The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interests (Sarfaesi) Act, 2002, the amount banks recover from defaulted debt was both meagre and long delayed. Laying out the gravity of the situation he gives figures reflecting the crisis. For instance, he says the amount recovered from cases decided in 2013-14 under DRTs was Rs. 305.90 billion, while the outstanding value of debt sought to be recovered, was a huge Rs 2,366 billion. Thus recovery was only 13 per cent of the amount at stake.
3. Did the RBI create the NPAs?
Bankers, promoters, and circumstances create the bad loan problem. The regulator cannot substitute for the banker’s commercial decisions or micromanage them or even investigate them when they are being made. Instead, in most situations, the regulator can at best warn about poor lending practices when they are being undertaken, and demand banks hold adequate risk buffers.
4. Why Asset Quality Review?
Banks were not recognizing bad loans. They were not following uniform procedures – a loan that was non-performing in one bank was shown as performing in others. They were not making adequate provisions for loans that had stayed NPA for a long time.
5. Did NPA recognition slow credit growth?
The RBI has been accused of slowing the economy by forcing NPA recognition. Rajan in a speech in July 2016 had said it was only a matter of time before vested interests who wanted to torpedo the clean-up started attacking the RBI on the growth issue. "Simply eye-balling the evidence suggests the claim is ludicrous and made by people who have not done their homework," Rajan says.
6. How a recurrence of such a crisis can be avoided
See full letter here:
Improve governance of public sector banks and distance them from the government.
Improve the process of project evaluation and monitoring to lower the risk of project NPAs.
Strengthen the recovery process further- Both the out of court restructuring process and the bankruptcy process need to be strengthened and made speedy.
Government should focus on sources of the next crisis, not just the last one. In particular, the government should refrain from setting ambitious credit targets or waiving loans. Credit targets are sometimes achieved by abandoning appropriate due diligence, creating the environment for future NPAs. Both MUDRA loans as well as the Kisan Credit Card, while popular, have to be examined more closely for potential credit risk. The Credit Guarantee Scheme for MSME (CGTMSE) run by SIDBI is a growing contingent liability and needs to be examined with urgency.