Uncle Scrooge is the latest metaphor being used to explain what Indian banks may not be. This may appear as a deviation from ongoing in the past fortnight that involved reports claiming a rift in communication between the Centre and the Reserve Bank.
The Reserve Bank's Deputy Governor, NS Viswanathan while delivering a lecture on Monday at XLRI Jamshedpur clarified saying, "banks may not have huge coffers like Uncle Scrooge."
For those unaware of Disney's delightful character, Uncle Scrooge aka Scrooge McDuck is associated with money. Characterized as a miser, Uncle Scrooge's favourite pass-time is a swim in his gold and US-dollar bill stashed pool.
Viswanathan's statement may seem like a retort or a jab to a sarcastic tweet made by a superior ranked ministry official. It may also seem like a continuation of a lecture delivered by another Deputy Governor (Viral Acharya).
However, a careful reading suggests it is neither a jab nor a continuation. The lecture is important from the perspective of understanding that banks indeed serve an important purpose. Viswanathan spoke on the role of banks, the need of an insolvency and bankruptcy code, the framework for resolution of stressed assets (RBI circular dated February 12). The introduction to his lecture revolved around a much larger question- Do we need banks?
It is in the context of speaking on the need for banks in the current economic fabric that Viswanathan made the comparison with Uncle Scrooge.
The deputy governor said, "Banks bring together the liquidity surplus agents in an economy with the liquidity deficit agents by establishing an intermediation channel, thus aiding the flow of savings in an economy towards investments. The banking licence issued by the regulator allows these institutions to raise uncollateralised funds from the public in the form of demand deposits."
"It is primarily from these deposits that banks give out loans to the borrowers. Thus, it is not that banks have a huge coffer like that of Uncle Scrooge, holding their own money, from which they make loans, but it is the funds that they raise through deposits that are used for making loans."
Do we need banks?
In the digital-age, it may look seemingly easier for deposit-savers to start lending on their own. Viswanathan said, "Why the savers cannot directly lend to the borrowers, and why we need an intermediation infrastructure. The answer is that the information asymmetry inherent in such relationships makes direct monitoring by individual savers of borrowers both costly and inefficient."
He added in his lecture, "Through specialised skills in project appraisals and risk monitoring, banks are expected to contain default by a borrower and thus play the useful role of delegated monitors (Diamond, 1984) in an economy, at substantially lower cost than direct monitoring by agents."
Monitor of Loans
While speaking on the covenants and expectations from banks, Viswanathan adds "banks need to be exacting in their role as monitors of loans."
"This in turn would force the other actors to perform their roles diligently. Say, for example, if banks go easy on a particular borrower because the borrower has been affected by delays in receipt of his claims from his client, the delays at the level of the client would never get addressed, and in fact, may get accepted as the norm. When banks perform their monitoring roles properly, the borrower would be forced to take up his case with his client for timely realisation of his claims. Banks are not supposed to be shock-absorbers of first resort of the difficulties faced by their borrowers as banks do not have the luxury of delaying payments to their depositors."
Insolvency Code and Portrayal:
"The next time we hear about a bank making efforts to recover loans from borrowers, we should all note to remember that it is essentially trying to get back the depositors' money. In this context, the most important objective of the Revised Framework for Resolution of Stressed Assets is to alter the balance of power in favour of creditors. For long, the balance of power in our country was in favour of debtors, especially for debtors."
"The enactment of the IBC is a watershed event, which has completely changed the legal framework governing the insolvency regime in the country."
Speaking on the IBC and its portrayal, Viswanathan said, "The Bankruptcy Law Reforms Committee (2015) has observed and I quote:..."
"When creditors know that they have weak rights resulting in a low recovery rate, they are averse to lend. Hence, lending in India is concentrated in a few large companies that have a low probability of failure. Further, secured credit dominates, as creditors rights are partially present only in this case. Lenders have an emphasis on secured credit. In this case, credit analysis is relatively easy: It only requires taking a view on the market value of the collateral. As a consequence, credit analysis as a sophisticated analysis of the business prospects of a firm has shrivelled."
He highlighted the need to correct portrayal of lending as "public interest".
He said, "When banks take recourse to legal remedies available to them when a borrower defaults on his debt servicing, including that of security enforcement, they are essentially trying to recover the depositors’ money from a defaulting borrower, whatever be the reasons for default. However, the defaulting borrowers portray such an action by banks as a case of a ‘ruthless big bank’ taking over the assets of a ‘hapless borrower’. This is the kind of portrayal used even by the large corporates. Here, one needs to distinguish between a private moneylender lending his own money for making a profit and a bank, which to a large extent uses depositors’ money (and tax payers’ money, in case of public sector banks). A correct portrayal of the situation would be: public interest (i.e., depositors + taxpayers) vs borrowers’ interest"
To summarize, the DG said, "A strong and stable banking system is essential for the development of the economy. This strength should be real and inherent. The real strength will come from recognising weaknesses in the balance sheet and making provisions for them rather than pretending to believe that the balance sheet is strong. Everything that the Government of India and the Reserve Bank of India have been doing in the recent past is to provide India with a clean banking system. This is a work in progress, which has started yielding results."
At a time when opinions and reports on banking have been biased, Viswanathan's lecture hits the right note- teaching the fundamentals of banking.