How bad loans ruined India’s banking system

The Dirty Dozen: India’s Twelve Biggest Corporate Defaulters (Pan Macmillan) by N. Sundaresha Subramanian explores the aftermath of this policy shift, which resulted in India Inc. displaying an avaricious appetite for bank loans, the subsequent piling up of unpaid dues, the political repercussions, and the system’s attempts to sort out the crisis. The book trains its lens on the 12 largest unpaid loans, which were grouped under the moniker “The Dirty Dozen", inspired by the 1967 multi-starrer in which 12 convicts are chosen and trained for a World War II suicide mission. It has acquired an immediacy after the Alipore district court in Kolkata recently denied a request from one of the Dirty Dozen borrowers to grant an ad interim injunction against the book.

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The initial loan orgy, aligning with the government’s policy shift, was focused on entities wanting to invest in physical infrastructure, steel manufacturing, power generation and real estate. The World Bank had then estimated that India would need at least $1 trillion to get anywhere near the acceptable infrastructure levels. Given the inadequate fiscal elbow-room available to the government, the private sector was called to share the national infrastructure responsibility under the public-private partnership (PPP) model.

Thus began the saga of outsized non-performing assets (NPAs), created by private-sector manufacturers and infrastructure investors borrowing much more than their ability to repay. The event, coming on top of the anti-corruption movement, caught the attention of the nation and became a political liability for the government. It may be worthwhile to understand the role of PPPs and how they contributed to the formation of these NPAs.

A gold rush

The PPP model was crafted with the belief that the private sector, compared to the public sector, had better experience and capability in execution of projects. But four structural problems tripped up the private sector’s participation in building out infrastructure projects, such as roads.

First, selection of private-sector partners in infrastructure projects was not based on sector-specific capabilities. This created a sort of gold rush with many private-sector players rushing to snag contracts, even though they had never implemented a large project, especially one with a long gestation period. For example, a television broadcasting company was awarded multiple infrastructure projects to execute which, predictably, dealt a near-fatal blow to the company.

Second, the PPP structure was doomed from the get-go. The fundamental flaw lay in the private party being completely insulated from risks and losses, but having a considerable share in the profits. Infrastructure projects were awarded to and executed by a standalone company—called “special purpose vehicle" (SPV)—with shareholding from the private-sector partner and the government (which, in most cases, came in the form of land). In addition, the SPV structure usually came with a non-recourse clause: in the event of losses or other risks, creditors had no access to the private shareholder’s finances. Consequently, the SPV’s borrowings attracted high interest rates because of the company’s lack of a track record, or credit rating, and lenders being denied access to the sponsor’s balance-sheet. Perversely, this structure encouraged the private-sector partner to discard credit discipline.

Third, given this risk-reward structure, many private-sector players had every incentive to gold-plate project costs and siphon out bank loans, some of which came back into the project as the private promoter’s equity contribution. Or was diverted to other entities. Or to finance political campaigns as reimbursement for award of projects. Since there was no blowback to the parent entity, the siphoning and defaults turned brazen.

The final hitch was the myriad systemic capacity deficits. The first flush of economic reforms saw many Indian financial institutions pivoting from traditional project finance to universal banking. This meant that decades of experience gained in assessing and monitoring credit for long-gestation projects disappeared overnight. So, when the private sector partner submitted loan applications with padded-up project costs, banks were none the wiser. In addition, with India lacking a corporate bond market, infrastructure PPPs or other capital expenditure projects (such as projects for setting up a large steel plant or thermal power project) had to rely mostly on bank financing. This created its own set of problems: banks have access to only short-term deposits, which they deployed in long-term projects, and engendered a lethal maturity mismatch.

Structural problems

All these factors combined to create a mountain of bad loans, which became a rallying point for the 2014 general election. The author does take a magnifying glass to the NPA phenomenon, their genesis, and shortlists the 12 biggest bad loans. The loans and the people behind them—the Ruias of Essar Steel, Gaurs of Jaypee Infratech, Mittals of ABG Shipyard, to name a few—then become the central cast of characters for The Dirty Dozen. As a chronicle of a critical, contemporary policy component gone horribly wrong, the book becomes a manual for understanding how the Overton window can shift in real life. A recounting of all the Dirty Dozen actors and their misdeeds in one place also fills a gap in available literature.

But, thereafter, it fails to address the structural problems leading to NPAs. These bad loans became the hub in a wide circle of singularities, providing an exceptional line of sight into the oddities of India’s political economy. The author could have provided historical analyses of how Indian companies have always managed to influence policy, weakening or diluting rules to suit promoter interests. Instead, his preoccupation with the here-and-now of the Dirty Dozen forces him to ignore the history of bad loans and India’s varied attempts since the 1980s to sort out this devil in the credit market.

Starting with the Board for Industrial and Financial Reconstruction in the mid-1980s, the long arc of the establishment’s attempts to deal with NPAs has faltered at the junction of business-meets-politics. Former Reserve Bank governor Urjit Patel’s 2020 book, Overdraft, demonstrates how the RBI’s attempts to introduce a rules-based system for tackling NPAs in 2018-19 met pushback from both government and industry. This context is necessary to understand the reasons why repeated attempts and contrivances have failed to stem the rot. While the author does provide a list of all the various solutions conjured up by regulators in recent years, he could have provided some analyses of why these failed.

Part of this blame should probably be laid at the publisher’s doorstep. Publishers seem to be increasingly preferring business books with a limited shelf-life, eschewing detailed analysis at the cost of easily-digestible narration of facts. Good reporting is undoubtedly essential for a book that attempts to document business events; but, at the same time, the arrayed facts could appear bald and bland without the accompanying analysis.

Given the insidious nature of India’s credit ecosystem and the recent attempts to sweep the NPA headache under the carpet by encouraging accelerated write-offs, this book provides a clinical insight into the birthing of NPAs. These range from the frailties in the banking system that allowed diamantaire Nirav Modi to rack up huge borrowings, to the cosy nexus between business and politics that let loan defaulter Vijay Mallya flee the country a day before investigative agencies landed up at his doorstep. The one fact that emerges is how, despite all the brouhaha, most defaulters managed to dodge any demonstrable penal action—a telling comment on the hurdles that stand before a nation struggling to dream big.

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The author is a senior journalist and author of Slip, Stitch and Stumble: The Untold Story of India’s Financial Sector Reforms. He posts @rajrishisinghal