Is India in Governance Crises? (Chapter 16)

Classic example of poor governance.

Do you know what is the best business in India? It is Banking. You have an assured profit margin of no less than 5%. Depending on operations, this profit can reach 11% to 39%. Banks borrow from the Reserve Bank at 5.5%. They take public deposits at 4% to 6%. Then they re-loan this money at huge spreads:

• Housing loans at 10.5%. This is the most secure lending with the least default.

• Commercial loans at 16%.

• Car loans and personal loans at slightly lower rates.

• Credit cards at an eye-watering 39% interest.

India has 1.4 billion people hungry for credit. Here, commercial banking is an engine that prints money. It is inherently profitable. It can swallow decades of catastrophic losses. It writes off bad loans completely. Yet it still reports thousands of crores in quarterly profit. IDBI Bank is living proof.

The Global Reality of Profit Spread

Look at the rest of the world. Banks in advanced economies do not enjoy such unearned spreads. In mature markets, banking is a disciplined, low-margin business.

In Germany and the Eurozone, residential mortgage spreads are tiny. A 10-year fixed mortgage spread over ECB benchmarks is barely 1.15% to 1.5%. Bank Net Interest Margins hover around 1.5% to 2%. Prime corporate lending operates on spreads below 1%. Even for risky borrowers, the spread rarely exceeds 2.5% to 3%. In Japan, decades of near-zero rates crushed spreads. Japanese bank spreads often stay below 1%. Average margins languish around 0.7% to 0.9%.

In the United States, prime mortgages carry modest spreads. A 30-year fixed mortgage spread over 10-year Treasuries is around 1.8% to 2.1%. Commercial bank margins average around 3.0%. Even high-yield corporate loans trade at risk spreads of only 3% to 3.5%. In the UK, fixed mortgage spreads are just 1.2% to 1.8%.

In Western economies, high bad loans cause immediate failure. If non-performing assets touch even 5% to 7%, banks collapse. Silicon Valley Bank and Credit Suisse showed this clearly. On tight spreads of 1% to 2%, bad underwriting is fatal.

Now look at India. Banks take savings deposits at 2.7% to 3.5%. Fixed deposits pay around 6.5%. Then banks lend for home mortgages at 9% to 10.5%. They pocket an astounding 3.5% to 5% spread on secure collateral. They lend to commercial businesses at 14% to 16%. That is a massive spread of 7% to 10%. On credit cards, banks charge 36% to 42%. That is a 30% to 35% spread over funding costs.

Indian banks operate inside a protected goldmine. This absurdly wide margin cushions monumental mismanagement.

The Fiasco of "Industrial Development"

IDBI was launched in 1964 as a Development Financial Institution (DFI). It was set up under an Act of Parliament. Its mandate was not retail banking. It was created for state-directed "Industrial Development". It funded heavy industries, power projects, and infrastructure.

That entire investment business was a gross failure. For decades, public money flowed to politically connected promoters. Corporate oligarchs and favored conglomerates took huge sums. Projects stalled and costs escalated. Promoters siphoned capital while factories rusted. The loans were never repaid.

Economic liberalization ended cheap government funding. IDBI was left sitting on a mountain of toxic corporate debt. Around 15 years ago, the institution ran out of money. It had no distributable profits. It was unable to pay back its preference shareholders. It was effectively broke. Four decades of failed industrial project lending had destroyed it.

Bad Loans Write-Off

To survive, IDBI merged and became a commercial bank in 2004. Yet putting up a commercial banking sign cured nothing. The old bureaucratic lending habits continued.

By September 2018, the crisis peaked. IDBI Bank’s Gross NPAs surged past 31%. Nearly one out of every three rupees lent was officially dead. The Reserve Bank of India stepped in. It placed IDBI under Prompt Corrective Action (PCA). The bank was banned from fresh lending.

Fast forward to today. IDBI Bank’s Gross NPA is down to around 2%. Its Net NPA is a fraction of a percent. Financial media calls this a masterclass in turnaround.

Look closely at the arithmetic. The bad loans were never recovered. Defaulting corporate titans never wrote cheques. Debt recovery tribunals and insolvency courts recovered almost nothing. Instead, the bank wiped out the losses by writing them off. Tens of thousands of crores in corporate debt were written off year after year.

Who paid for those write-offs? The ordinary retail customer paid for them. The huge spread on home loans and credit cards generated massive operating profit. This cash flow absorbed the write-offs. It decontaminated the balance sheet. IDBI emerged as a profitable powerhouse. Commercial banking is wildly lucrative. It washed away half a century of failed industrial lending.

A Confession in Fairfax Deal

Now the Union Cabinet has approved the sale of IDBI Bank. It is selling a 60.72% majority stake to Fairfax Financial Holdings. Fairfax is a Canadian multinational led by Prem Watsa. The total consideration is Rs 52,878 crore. Under the approved structure:

• The Government of India sells 30.48%.

• LIC sells 30.24%. (LIC had bailed out IDBI in 2019 using policyholders' money.)

• The Government and LIC retain a residual minority holding of 34%.

• Total management control shifts to the Canadian firm.

This is not a distressed asset sale of a sinking company. The balance sheet is clean. Bad corporate debt was already written off. Gross NPA is down to around 2%. Capital adequacy is restored. The retail franchise generates thousands of crores in profit.

Selling this profitable bank is an official confession of governance failure. It proves the government cannot run commercial operations. It cannot run even an inherently profitable bank. The state is making a clear admission:

1. Its industrial development lending created massive bad loans.

2. Commercial banking spreads wiped out those losses.

3. Yet the state cannot be trusted to run the bank.

4. Political interference and crony lending would cause another crisis.

5. To protect a profitable bank from the government, it must be handed to a Canadian firm.

It is also a tacit message to Canada that India is open for business. An olive leaf extended in advance while the negotiation on free trade deal are going on.

The Anatomy of the Crisis

The crisis of Indian governance reveals its deepest hypocrisy. The public pays the price of mismanagement of a bank at every stage. As customer and as a taxpayer. The government does not have means to provide corruption free management. This further clear when the Government explained that decision of disinvestment is a continuous process continuing from 2003 itself.

The state sells the bank because it cannot govern it. Commercial banking in India remains the best business in the country. Yet running a commercial business requires competence and accountability. It requires restraint from using bank funds for political patronage. Indian governance lacks all three. Therefore, it must sell what it cannot manage.

There is another previous investment bank turned into retail bank which can be looked at as example. How its corrupt management made government lose its faith. That is ICICI Bank and we shall discuss it in next chapter.

References:

1. Decision is a continuous process from 2003

2. The Industrial Development Bank Of India Act, 1964

Disclaimer

1. I may have advised IDBI Bank in a professional capacity about some legal issue in the past.

2. I may have small shareholding interest in IDBI Bank.