Debate: Should banks bail out companies?

Ashvin Parekh
National Leader, Global Financial Services, Ernst & Young

"Though macro-economic conditions are challenging, banks are resilient enough to survive sector-specific shocks"

The Indian economy faced tough conditions over the past 12 to 18 months.

Persistent high inflation forced the monetary policy to be aligned to growth-inflation dynamics.

The prolonged high interest rate regime (the Reserve Bank of India started increasing the policy rates in March 2010) and slowing growth prospects (according to RBI, FY12 growth is expected to be at 7.6 per cent) are exerting increasing pressure on industry, leading to stressed assets for banks.

Banks' base rates have risen from about eight per cent when they were introduced in July 2010 to nine to 10 per cent currently.

Sectors such as aviation and infrastructure are facing the risk of increasing non-performing assets.

According to RBI's latest Financial Stability Report, the year-on-year growth rate of NPAs stood at 30.5 per cent and slippages (fresh accretion to NPAs) grew at 92.8 per cent as on September 2011, with the priority sector, retail, real estate and infrastructure being major contributors.

In the infrastructure segment, power and telecom sectors saw a rise in impairments and restructuring.

With economic growth facing headwinds, the asset quality is likely to worsen.

The high policy rate regime has had an effect on inflation, which is likely to moderate.

However, the corporate sector seems to have faced the brunt of the high rate regime and slowing economic growth.

The weakening global economy and high prices of crude and other commodities have compounded the problem.

Businesses continuously move in business or economic cycles and banks are the primary intermediaries through which governments and central banks try to sustain these economic cycles.

Credit and interest rates are used to stimulate or dampen business cycles, which are a characteristic feature of market-oriented economies and will become a prominent feature of the Indian economy.

Although the condition of the Indian industry needs to be continuously monitored so that the banking sector is not adversely affected, care should be taken to not cut off the lifeline.

The financial stability report also points out that the gross NPAs of the banking sector grew from 2.3 per cent in March 2011 to 2.8 per cent in September 2011, while the net NPAs rose from 0.9 per cent to 1.2 per cent in the same period.

However, the level is not alarming, though it is expected to deteriorate and put pressure on banks' margins and profitability.

Non-food credit growth has been sufficiently robust at 19.6 per cent as on November 2011, despite high interest rates.

However, given the economic situation, it is expected to moderate.

With a further slowdown in the credit cycle, managing deteriorating asset quality would be a major challenge.

The liquidity situation has also worsened in the last quarter, doubling from an average 0.7 per cent of aggregate deposits in October 2011 to 1.5 per cent in December 2011.

The Indian banking sector is sufficiently resilient to withstand sector-specific shocks in isolation.

However, a deterioration of the global and domestic economic environment or spreading of the resulting economic stress to other sectors would pose significant challenges for banks.

Banks will have to closely monitor their sector exposures and assess credit risks.

They would also need to monitor and examine exposures that are on the margin and at risk of slipping, and arrive at a restructuring solution in a worst-case scenario.

Experience during the recent global credit crisis showed that governments and central banks in the developed economies had to take over 'toxic assets' to prevent widespread recession.

There might be some casualties but the larger economy would need to be rescued at a much larger cost.

These observations have been reinforced by the experiences of the current   euro-zone crisis.

The regulator and banks would need to work out an acceptable plan for restructuring term loans and managing working capital loans as the high interest burden and moderating cash flows start to hurt businesses.

The Indian banking sector should support the industry provided the health of banks is not affected and they are able to absorb the shocks to their bottom line.

This by no means implies that undue risks taken by industry should be cushioned by banks.

However, a reasonable solution to the problems would create

sustainable economic growth cycles.

Prakash Reddy

Convenor of the Occupy Dalal Street movement*

"If banks start offering bailout packages, there is a danger of companies misusing even those funds and going bankrupt"

My answer is an emphatic no.

The question itself raises more queries.

First, what are troubled companies? Second, how do they get into 'trouble'? And third, what is the banks' role under these circumstances and in general?

The answer to the first question is that troubled companies are the ones that show losses year after year and cannot repay their loans.

Some of these companies ultimately go bankrupt.

The answer to the second question varies according to interested parties and, thus, it becomes necessary to come to an objective understanding.

Usually, promoters of troubled companies try to shirk their responsibilities by putting the blame on government policies, the global financial situation and economic trends that are beyond their control.

However, this sort of reasoning is flimsy because companies or corporate houses enter a business being fully aware of the trends and risks involved in it.

And so, if they get a lion's share in case all goes well, they should also be ready to bear the responsibility when things go wrong.

There is also a tendency to hold unions, workers, strikes, overstaffing and employees responsible for poor performance.

But even these excuses are questionable.

These days, we are seeing that strikes are on the decline and there is a reverse trend of managements resorting to lockouts.

In this context, it would be good to bear in mind a late-seventies study by the Reserve Bank of India on the key factors behind the closure of a company.

This was the time of the so-called militant era of trade unions in which well-known leaders like Datta Samant were accused for factories being closed.

The study showed that 78 per cent of the companies were closed as a result of wrong policies of and the difference within the management.

Only in three per cent of the cases did labour troubles lead to the closure.

Also, nowadays companies keep minimum staff and that, too, on a contract basis.

So, the cost of employees' salaries is usually very low.

However, remuneration packages of top managements and promoters remain high.

There is a tendency to pay top managements and CEOs exorbitantly even if they are responsible for continuous losses.

The 2008 bailout package funded by US tax payers to save big banks is a case in point.

Reportedly, the nine banks that received a total equity capital injection of $125 billion in phase-I of the bailout plan had reserved $108 billion during the first nine months of 2008 in order to pay for compensation and bonuses.

Goldman Sachs set aside $11.4 billion during the first nine months of this year -- a sum that is slightly more than the firm's $10-billion gift from the US government -- to cover bonus payments for its 443 senior partners, who are set to make about $5 million each, and other employees.

A government watchdog has launched some 20 criminal investigations related to the $700-billion financial bailout programme, according to a report to the US Congress.

There are instances in the US in which CEOs and other top management bosses used the bailout money to buy themselves helicopters.

International media is full of reports that point to such rampant misuse.

Some companies also get into trouble because of their own misdemeanours.

There are recent examples of frauds in initial public offerings, false accounting and auditing, insider trading and so on.

Why, then, should these companies be bailed out? Instead, their management and promoters should be punished.

At present, non-performing assets of public sector banks are estimated at Rs 3 lakh crore (Rs 3 trillion) mainly due to the non-recovery of loans from wilful defaulters -- mostly companies and corporate houses.

If banks start offering bailout packages, there is a danger of these mismanaged companies misusing even those funds and going bankrupt eventually.

This throwing of good money after bad will only compound the troubles of banks and increase their NPAs.

Bailouts are no solution, these will only derail the economy.

Instead, troubled companies should be nationalised and redrawn into the national planned economy.

Their assets, like land and offices, can be absorbed into the planned economic development of the nation instead of being used for personal profit and corporate greed.

* The author is also a member of Maharashtra Executive Committee, Communist Party of India