India banks picking up the pieces after boom and bust

Vikas Gupta, the chief investment officer at ArthVeda Capital, the global asset management firm, talks about Indian banks and bad debt.

Why is India facing such a major problem with bad loans?

It is a result of the excesses during the 2003 to 2008 economic boom. There was optimism and a lot of new projects were launched. This was especially the case in the infrastructure sector. The global financial crisis put a dent into these growth numbers due to the funds flow into India slowing down. Further, sentiment also became negative. All of this was compounded by a severe lack of adequate due diligence for large infrastructure projects which might not have been viable in the first place.

Similarly, projects from other sectors too started becoming unviable because of the slowdown in the global and dom­estic economy. Under such circumstances it is not too surprising that there are lots of bad loans. This is a natural outcome after every economic boom. The due diligence process in the banks while granting loans to these unviable projects could also be an issue.

What is the impact of this on the banking sector and the Indian economy?

Banks will face capital ade­quacy issues. This will give them little flexibility to grow their balance sheets, thus slowing down credit growth. But one good thing is that the deposits for the banks will continue growing and hence as long as they have enough equity capital to allow growing the balance sheets, the additional leveraged capital will not be an issue. This will allow the banks to continue lending, albeit most likely at a slower rate.

If credit growth is slower there is some likelihood of a slower economic growth. But slower growth is not a given. Economic growth will be hampered for the stressed corporates. But the government is spending and also new companies will start taking up the slack and bidding for new projects.

What steps are being taken to solve the issues?

The first step is to make sure that the bad assets are recognised and cleaned out of the balance sheets. A number of steps are being taken on that front by both the central bank and the government. Once bad assets are out of the balance sheet, it becomes important to capitalise the banks. The government has already earmarked 25,000 crore rupees (250 billion rupees, or Dh13.8bn) for that. Further, that capital can be boosted through capital markets or private placements. Mergers of smaller banks into larger ones could also allow optimisation of the capital and leverage. The government has already taken steps to improve the corporate governance processes of the public sector banks. The central bank is working with banks to improve the due diligence and monitoring processes.