Raghuram Rajan was in the middle of a clean-up of massive bad loans at state-run banks when he demitted office in September, 2016. Through his tenure, Rajan warned against recklessly exuberant lending, and finally launched the Asset Quality Review to force banks to square their books. Critics blamed the move for a slowing of credit from public sector banks. In his new book ‘I do what I do’, which strings together some of his speeches as RBI chief with insightful introductions and post scripts, Rajan reveals the key people behind the first major exercise to clean up bank balance sheets and the challenges he faced. Here are some excerpts:
In the absence of a functioning bankruptcy code, the RBI put together a number of schemes to facilitate bank resolution of distress. We repeatedly re-examined the schemes to see how they could be tweaked to facilitate resolution. Unfortunately, with the exception of a few hard-charging and conscientious bankers, the general mood among the bankers was to continue to extend and pretend. They feared they would be held accountable for any concession they made, and constantly (and perhaps understandably) avoided taking decisions. In this environment, the idea of a bad bank, funded by the government, that would take the loans off their books, kept cropping up. I just saw this as shifting loans from one government pocket (the public sector banks) to another (the bad bank) and did not see how it would improve matters. Indeed, if the bad bank were in the public sector, the reluctance to act would merely be shifted to the bad bank. Why not instead infuse the capital that would be given to the bad bank directly into the public sector banks? Alternatively, if the bad bank were to be in the private sector, the reluctance of public sector banks to sell loans to the bad bank at a significant haircut would still prevail. Once again, it would solve nothing.
As we found banks reluctant to recognize problems, we decided not just to end forbearance but also to force them to clean up their balance sheets. The Asset Quality Review, initiated in 2015, was the first major exercise of this nature in India, ably led by Deputy Governor Mundra. I would especially highlight the role of two extremely polite and self-effacing but tough-as-nails ladies, Chief General Manager Parvathy Sundar and Executive Director Meena Hemchandra, who really energized their staff and assured them of their support at every turn. The young team they put together was tireless, and made me aware once again of what we are capable of if we put our minds to it.
Every situation of banking sector stress I have ever studied was fixed only by recognizing the problem, resolving the bad loans, and recapitalizing the banks. India was no exception, but once again there were a bunch of critics who claimed that cleaning up the bad loan problem was what led to the slowing of credit by the public sector banks. In a speech in June 2016 in Bengaluru, I made the case for the clean-up once again by asking these critics to actually look at data, which showed the slowdown started before the clean-up, probably as banks became aware of the magnitude of the problem.