Can Damodaran save IDBI?

Last week, the government earned a pat on its back by announcing the successor of Industrial Development Bank of India chairman Padmanabh P Vora, 72 hours before he was slated to step down. This is indeed an achievement.

On earlier occasions, successive incumbent chiefs had to wait till late evening on the last day in office staring at the fax machine and waiting for a few lines from North Block asking them either to stay on till the next chief is identified or to hand over the charge to the senior most colleague in the organisation. The government took seven months to identify Vora.

But it's too early to celebrate the Centre's "fast track" appointment policy for IDBI. M Damodaran has been made IDBI chairman and managing director for an "interim" period but how interim is this interim period, no one seems to know.

Is it an arrangement till the government is able to persuade Damodaran to take over IDBI on a permanent basis (the grapevine says he is not too keen to take up the assignment) or till a willing soul is identified?

It could even be an interim arrangement till Damodaran's successor in the Unit Trust of India is appointed (so that he can be made the permanent head) or the IDBI (Transfer of Undertaking and Repeal) Bill, 2002 is passed in Parliament transforming the institution into a bank.

Meanwhile, with every passing day, IDBI is sinking deeper in the quagmire of a shrinking balance sheet, rising non-performing assets (NPAs), eroding profitability and fleeing top-rated corporate clients as well as skilled professionals.

The paradox is: since IDBI is not a triple-A-rated entity, it cannot have top-rated customers in its portfolio as their cost of funds is cheaper than that of the institution. It has lost the businesses of the old economy outfits of the Tatas, Birlas, Ambanis and some of the premier public sector undertakings over the past few years. Larsen & Toubro, Associate Cement Company and Gujarat Ambuja are also not with IDBI any more.

When did the rot start? In 1995-96, IDBI's net profit crossed the Rs 1,000-mark to reach Rs 1,007 crore (Rs 10.07 billion). The following year, it rose to Rs 1,144 crore (Rs 11.44 billion) and in fiscal year 1998, net profit zoomed to Rs 1,501 crore (Rs 15.01 billion). That was the end of the heady days. Net profit slumped from Rs 1,259 crore (Rs 12.59 billion) in fiscal year 1999 to Rs 401 crore (Rs 4.01 billion) in 2003.

Sanctions and disbursements of the institution have also been on a downslide. For instance, over the last three years, sanctions dropped by over 87 per cent from Rs 23,178 crore (Rs 231.78 billion) in 2001 to Rs 2,889 crore (R 28.89 billion) in 2003 and disbursements dropped by close to 78 per cent from Rs 17,747 crore (Rs 177.47 billion) to Rs 3,924 crore (Rs 39.24 billion).

The only rise has been seen in IDBI's NPAs. The gross NPA during the three-year period went up from Rs 9,849 crore (Rs 98.49 billion) to Rs 16,006 crore (Rs 160.06 billion) and despite huge provisioning, the net NPA in percentage terms is going up (from 13.44 per cent in fiscal 2001 to 14.16 per cent in 2003) as the asset base in shrinking (from Rs 71,783 crore in 2001 to Rs 63,115 crore in 2003).

Does that mean all is lost for IDBI? It may not be fair to dub it as yet another stretcher case going the IFCI way. It has been slowly consolidating its balance sheet over the last two years. The weighted average cost of funds for the institution has dropped from 11.8 per cent in 2001 to about 9 per cent now.

This has been done by replacing the old high cost debt to new low cost borrowings. The incremental cost of funds has come down from 11 per cent to 6.25 per cent. It has also been steadily raising its provisioning to clean the balance sheet.

The aggregate provisioning has risen from Rs 4,800 crore (Rs 48 billion) in March 2001 to close to Rs 9,000 crore (Rs 90 billion) in June this year. As a result of this, NPA coverage has risen from 36.7 per cent in 2001 to around 58 per cent now.

By doing all this, IDBI has been able to take care of its profit and loss account but not the balance sheet. It has managed to remain profitable (its net profit in Q 1 of fiscal 2004 rose to Rs 51 crore (Rs 510 million), up from Rs 33 crore in Q 1, last year) while the asset base is rapidly eroding.

At any given point of time, it now holds a liquidity kitty of around Rs 5,000 crore (Rs 50 crore) because it is unable to deploy the funds. Project finance is virtually dead. When it comes to the business of extending short-term loans, IDBI has a Hobson's Choice. On one hand, being an AA+ rated financial institution, it cannot offer fine rates to the triple-A-rated corporations; on the other, it can't run the risk of lending money to weaker entities for the fear of increasing NPAs.

The only solution to the problem is conversion of IDBI into a bank. But not the type of bank that has been suggested by the Parliamentary Standing Committee on Finance, which examined the IDBI Bill under a microscope. The business model suggested by the committee is as faulty as the model of a development financial institution, which has outlived its utility.

The committee wants IDBI to be converted into a bank but to stay away from retail business. At best, this will make IDBI a development financial animal in a bank's skin which cannot fend for itself in the jungle of the Indian financial system.

The idea to enable the new entity to raise cheap liabilities in the form of savings bank account and current accounts to drop its cost of funds is fine. But this benefit will be of no use if it's not allowed to build retail assets.

First, with big corporations shying away from raising money from banks, the retail sector is the engine of growth for banking activities and any ban on creation of retail assets will only continue IDBI's agony of stunted growth. Secondly, it is not easy for a bank to retail liabilities when it is not offering home loans, car loans, education loans and other personal loans.

IDBI wants to sort out this problem by teaming up with its banking subsidiary IDBI Bank. The plan is to exploit the synergies and offer both long-term and short-term loans as well as other banking needs of companies together.

But this is not possible because IDBI will have to divest its stake in IDBI Bank once it becomes bank, because the Banking Regulation Act will not allow it to hold a substantial stake in another bank. The standing committee also ruled out the merger of IDBI Bank with IDBI. So, even after the Bill is passed in the winter session of Parliament, the nightmare will continue for IDBI.

The search for the right kind of business model for IDBI started six year ago in 1997 when former chairman S H Khan appointed Booz, Allen & Hamilton to chart out a recast course. In 1999, next chairman G P Gupta appointed Mrityunjaya Athreya to a take a relook at the institution.

In 2001, Boston Consulting Group had walked in for another realty check. Last week, McKinsey, IBM, PricewaterhouseCoopers and Tata Consultancy Services made presentations to the IDBI board charting out the possible course of its conversion into a bank. But no external agency can save IDBI from sinking unless the government finds the right business model for it without losing time.

It should either allow IDBI to function as a full-fledged bank without any restriction on business activities or preserve it as a boutique DFI with facilities like access to cheap long-term funds and so on. That is, if it feels that DFIs still have a role to play in the Indian financial system. Any half-way measure can only delay the inevitable for IDBI. Even Damodaran may find it difficult to save it.

This article was written before the finance ministry announced that IDBI's assets would be split

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