Finance

Andy Mukherjee is a Bloomberg Gadfly columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

With every passing quarter, it's becoming harder to see exactly how India's banking system can be rescued. Maybe the way out is for the country's lenders to turn Chinese.

It's surreal advice, given the explosion of credit in the People's Republic. But then, saner options like recapitalization aren't working.

In the financial year that ended March 31, 11 state-run banks rated by Moody's reported a combined loss of $3 billion. That ate up New Delhi's entire bailout capital of $2.9 billion. Moody's says these banks need $18 billion to become whole. With equity markets shut for them, where to find the money? And why would taxpayers supply more funds only to have most of it go to absorbing losses on past advances?

Meanwhile, the bad loan mess is getting bigger. The central bank, under Governor Raghuram Rajan, keeps pushing lenders to identify and provide for past mistakes. Forbearance, as Rajan recently said, is out of the question, though whether he himself will be in or out after September remains very much a matter of speculation. 

So here's a fix that requires neither much capital nor Rajan's sound counsel.

Like in China, India should push new credit creation toward shadow banks, where the risks can't be seen. Let deposit-taking lenders quietly redirect most borrowers to finance companies, which are already flourishing. More than 400 of them for which Bloomberg has data have doubled their total assets in the past four years, compared with 50 percent growth in the banking system.

Lengthening Gloom
Non-bank financial firms, or shadow banks, are small in India, but growing fast
Source: Bloomberg

As to what banks will do if not lend, it's time to take a leaf from the playbook of their Chinese counterparts, and start shuffling depositors' money into wealth-management products created by shadow banks.    

It's not a completely harebrained proposal. Moody's estimates the Indian state-run banks it rates grew their risk-weighted assets by 4 percent in the 12 months through March. In the four years prior, the average was 14 percent.  Since India's GDP growth rather unbelievably accelerated from 5.6 percent to 7.6 percent in the past three years, just as lenders were hitting the brakes on risk-taking, what could possibly go wrong if they were to cut the growth in their risk-weighted assets to zero?

Risk Plateau
Indian banks' balance sheet growth has slowed in the absence of capital
Source: Bloomberg

Besides, it won't be zero; not really. Banks will be subject to hefty risk-weighting requirements for their exposure to finance companies. But that also means they will need capital, which they don't have.

This is where circular finance can come in handy. Let the non-banks buy new government bonds for the same amount that the banks agree to invest in their wealth-management products; and let the government use the bond proceeds to buy banks' equity. A decade of this, and India will become the next China: a too-big-to-fail superpower with credit-to-GDP of almost 250 percent and nonperforming assets of only 1.75 percent.

China's debt edifice hasn't crumbled despite years of warning by naysayers. India, meantime, is wondering how to fix its deflated lenders. If blowing a new bubble is the only solution, India might as well learn from the experts.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. The slowdown isn't entirely due to volume reduction. Shifting to retail loans, which have a lower risk weighting, is also playing a part.

To contact the author of this story:
Andy Mukherjee in Singapore at amukherjee@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net