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The Rediff Business Interview / Prof Sanjiv Ranjan Das

'Mark NPAs to market or merge weaker banks with strong ones'

An alumnus of the Indian Institute of Management, Ahmedabad, Prof Sanjiv Ranjan Das, has been working as assistant professor (finance), Graduate School of Business Administration, Harvard University, since 1994.

Earlier, he had worked as vice president (investment banking division, Asia-Pacific region) at Citibank, North America. Prof Das did his M Phil and Ph.D in finance from the New York University. He is also a cost and works accountant and specialises in credit derivatives and mutual fund research, and has won awards for his work on bond markets and securities.

He is currently working on investment models for environments with systemic risk. Prof Das was recently in Bombay to address a seminar on money and banking organised by Tata Consultancy Services. He spoke to Sunita Wadekar-Bhargava.

Indonesia's non-performing assets crisis hit its economy very hard. Do you think Indian banks are geared to handle such a situation if it were to explode here?

As far as Indian systems go, we have recognised the (NPA) problem very early and now we are dealing with it. There are several solutions.

One is we mark-to-market (to value a position or portfolio at current market prices) these portfolios and bite the bullet right now, so it is clean starting out by New Year's or whatever.

The other option is to merge the weaker banks with the better banks and that is a very good solution.

It's been done in other parts of the world so it is totally feasible to do that.

The third thing is that Indians, by and large, understand risk fairly well. We are not a bunch of people who don't understand risk. What we don't have is a hard-nosed regulator.

And it is not an endemic crisis because some banks are very profitable and some banks are weak and this is not different from every other developed country. Half the banks are bad in every other developed country as well. Half of them are good. And the bad ones are rescued by the good ones and the system rolls forward in a cleaner fashion.

Is the Indian system too bureaucratic or regulatory for some of these reforms to work?

No, I don't think so. Right now the Indian banking system is not very different from those in other countries. What we don't have is a tougher accounting regime where we have got to recognise these losses and book them. See, the mistake we are making now is the NPAs. You got to mark them to market and take the loss. Then the rest of the capital is good capital because now the assets that remain are good assets.

What we are saying today is, 'We got so many NPAs we got to hold more capital.' Which is throwing good capital after bad capital, which is a wrong solution. The sooner we realise the wrong solution and fix that we will have a cleaner banking system.

So I don't think we are in a crisis or anything of that sort. The market is down but that's a natural cycle now. We are not immune from the global markets.

By and large, we have had a lot of bad things happen from 1994, the Harshad thing onwards. The Indian banking sector is recovering from that and it has done a fair job of managing through the crisis. So I'm not pessimistic about the banking system.

Is the government doing enough to lead the way towards banking and financial services reforms?

I think what the government is doing is putting in more regulatory controls of the sort that may not always work. Exactly like this: putting more capital requirements when we should be taking the losses, which is a sort of flawed policy.

The second thing that is being done is increasing capital adequacy requirements on banks that are not profitable. This is not the right thing to do in an economy where banks don't take many risks.

Capital adequacy requirements are requirements that are used to control banks' risk-taking. And banks today are really not taking risks. The only risks they took were giving loans to people who do not pay them back.

The capital adequacy requirements are very sensible requirements but I don't think we need to raise these requirements when actually lowering these requirements may improve banks profitability and may help them get out of the mess.

The reason you want high capital adequacy is when you think a bank will take all kinds of crazy risks. And in India we don't see that. Whatever problems have happened have been because of things like securities scams rather than a systemic problem where banks are just taking too many risks.

A lot has been said about improving services in banks, about making them customer-friendly. Is the time ripe for a complete overhaul?

I think credit cards have already helped. The credit card companies have learnt how to be service-friendly in some sense. We don't have a service culture in India so it is not a banking problem. It is a problem we have with the whole economy. But it is beginning to change.

A lot of the banks have computerised now. They have made huge investments in computerisation. And the shareholders of banks and the government are asking, 'What are you going to do with this big investment?'

One thing the banks can do is to improve service quality by using the computers to make automated utility payments, bill payments, those kinds of things. I see a general trend towards getting there.

The Internet is very big in India. This surprised me. It's much bigger than I thought it would be.

A lot of the banking services in the US are actually done over the Internet. So we can have the same thing done here with very little cost because we have deregulated telecom. Line capacity is very high in India now so there is going to be a pressure to use those lines. Which means consumer services are going to be added on to those things.

As academics you help formulate a lot of theory but in the Indian context does this theory get translated into practice?

I have tried to show (at the TCS seminar) that derivatives are not complicated. We don't need fancy theory. The concepts are simple, the mathematics might be complicated. But since the concepts are simple, we can actually implement a lot of this.

The only bar to implementing today is that we are not allowed to do it. So as long as the regulators say, 'Yes, go ahead, and do these instruments,' every company here is going to run out and buy them (derivatives) because they know it is useful for them.

So theoretically I think the use of derivatives to what we call complete markets is a valuable theoretical tool that is ready to be used in India.

The other theoretical tool, for example, is electronic clearing and marketing. The theory of markets deals with better execution. People see the National Stock Exchange as a wonderful example of the execution of a theory like that. They have just reduced transaction costs, made clearing and settlement simple, made information freely available. And that is just pure, open market theory which says capital markets can produce all the information you want if you don't regulate them too much. And you can see that with the NSE.

Are government regulators moving fast enough to implement some of the banking reforms especially when there is an awareness of the problems that abound in the industry?

A lot of people in public sector banks say, 'We have a lot of these problems and we don't know what to do with them and the government is not moving.'

The right people to make the reforms are the heads of the public sector banks. They are all really good people who understand the problems really well and know what to do. But the main problem they have is they cannot take a chance because, as they say, they get raided by the government's investigative arms for anything they do that is seen to be a little more enterprising.

They have been beaten by the system enough that they have lost a lot of their initiative to do it. But they are the right people, not the regulators. The regulators should be telling the heads of public sector banks that, but the latter's hands are tied.

What we need is an environment where the persons who do bad things get punished and the persons who take a chance are encouraged to do it. If those people get bonuses for improving profitability of banks, they would be thinking about it.

Right now they get fired if profitability drops. They don't get anything if it increases. You can't have all punishment and no carrot. And that is exactly what is happening here today. You got to give these guys incentives.

Isn't the Indian banking industry ready for a shakeout and consolidation like what happened in the US in the late 80s and 90s?

We will have the same thing. The only difference is the government will bring about these marriages rather than happening freely in the market. Because the mergers and acquisitions is not a market we are seeing being encouraged by the government. But that's what they need to do. Because that's the thing that reallocates badly used resources as quickly as possible to the best use, the fact that bad companies get taken over and their assets get re-deployed.

The big problem there is unions, labour problems. Most often, a merger actually takes half that labour head count and moves them away. And I think if we allow that to happen, the assets will get re-deployed, these guys will get re-employed.

I notice now that the telephone guy who comes to fix the phone doesn't play funny because he knows that there are three people behind him who want his job. So I think the labour market is beginning to shakeout, the equity market is beginning to shakeout. The two things together will give us after a long time something like we see in the US where assets get re-deployed.

In today's market, how do you think are financial institutions like ICICI faring?

They are doing very well. I am very upbeat on those guys. One of the things we lack, if we look at the heads of public sector banks, is that while the heads are very good, we don't have a depth of management all the way down. And what I see at ICICI is they have an incredible intellectual capital base.

Today the Indian economy has changed from seniority to merit-based, so you are going to need talented people down the line. Also licensing is gone.

Like K V Kamath (the ICICI chairman and managing director) said, it's patronage versus performance. So people who hired well like ICICI and all the boutique banks have done a good job of building the right capital in humans and they are going to have huge benefits from it which the public sector banks don't see.

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