Political Burden in the Banking System – Bad loans have their roots in rotten politics

Most private banks lend short-term, for working capital, leaving the public sector banks (PSBs) to do the heavy-lifting for large projects, including investment for infrastructure, which India sorely lacks. But here is a problem: key appointments at state-owned banks and their lending decisions tend to be stained by the illicit manner in which Indian politics funds itself — by the proceeds of corruption.

Given the political-bureaucratic connections at play, PSBs lend heavily to politically favoured promoters for their inflated investment proposals, and when these turn sour, are more than willing to ‘restructure’ their borrowings by taking haircuts on the money lent. The power sector is crippled by the bad politics that deems power an ideal giveaway. The end result, as the RBI points out succinctly, is to double the amount of bad debt that the banking system carries: from under 5% of total lending to over 11% today. Yet, these warnings from the central bank cannot solve the bigger problem that eats away at the heart of the economy: the rot in political funding.

In India, this is opaque and driven by illicit cash, stashed away by companies and paid in return for political favours, including bank credit, for dodgy projects ranging from infrastructure to mining. Equity investors have burned their fingers and have become risk averse; the RBI can help by deepening and widening the market for corporate bonds. But the most important reform, that should start at the top, is to clean up political funding: once that system becomes clean and transparent, much of the chain of graft leading from parties to babus, crony capitalists, bank officials and bad loans, will be broken.

(Source: Editorial in The Economic Times dated 30-06-2015.)