Transcript Better incentives to service debt

Improving
Indian Banks’
Performance
by
James A. Hanson
Overview
• India liberalized credit markets to support the real
reforms/more credit for the private sector.
• Benefits but increasingly limited by
– Crowding out from public debt and deficits
– Weak Incentives for debt service, related to weak judicial,
informational and institutional incentives
• Weak incentives in public banks, not generating enough
capital for growth, especially of private credit.
• Need to focus on incentives for principal agents (banks)
• Regulators face New Challenges
• Resolution of problems more urgent now that other
sources of private sector finance drying up.
India Started bank liberalization in 1992
Focus on Markets: price, alloc., competition
• Reduced directed credit allocation (SLR)
• Gradually liberalized interest rates, even on priority credit
• Increased competition
– Let clients switch banks, Reduced RBI lending control
– Licensed new private, quasi-private and foreign banks
– Non-bank intermediaries grew until the 1997 crisis
– Liberalized the capital market
– Allowed offshore borrowing and capital inflow.
• Strengthened regulation and supervision, unlike most
liberalizing countries
• Liberalization largely completed by 1997-98
Reforms Restarted Dep. Growth
Figure 1
India: Money(M3 in Sept.): GDP,
Deposit Rate & Inflation
M3/GDP
70.0
M3+NBFCs % of GDP
35.0
60.0
30.0
Ave. M3/GDP, 1987-92
40.0
Interest Rate
20.0
1 yr. Deposit
Inflation (CPI)
30.0
15.0
20.0
10.0
10.0
Free
Rate
5.0
2001
1999
1997
1995
1993
1991
1989
1987
1985
1983
1981
0.0
1979
0.0
M3 (% of GDP)
25.0
50.0
1977
Interest Rate and Inflation (%)
40.0
Other Sources of Private Credit Grew
•
•
•
•
NBFCs
Equity—easier rules and entry of foreign players
Bonds and Private Placements
Offshore borrowing.
But
• NBFCs have declined since 1997 crisis
• New inflows and demand for offshore funds drying up.
• India’s capital market is one of largest but it is down
India is still bank dominated: Banks assets more than
double market capitalization. Banks are critical
Private credit growth, bank performance
were not up to expectations. Why?
1. Crowding out by Government Debt
2. Large Role of Public Sector Banks
3. Large NPLs
–
–
Weak judicial and informational framework
Public banks lack incentives
4. Profit Squeeze on Banks limits internal
capital generation, raises risks.
Crowding out: Gov. debt absorbed much of
bank growth, reflecting its large deficit; credit
grew slowly
Figure 2. India: Banks' Government Debt, Credit, and Investments
Selected Years (percent of GDP)
60%
50%
40%
30%
20%
10%
0%
85-86
90-91
Credit
Gov. Debt
95-96
98-99
Other Elig. Invest.
Other Investments
00-01
Gov. Debt/Dep. , 2000, Percent (IFS)
Korea
Chile
Thailand
Malaysia
Peru
S. Africa
Czech Rep.
China
Egypt
Venezuela
Bangladesh
Poland
Colombia
-3.6
-3.1
1.4
2.3
3.2
4.9
4.9
6.0
7.8
8.2
10.9
14.8
16.4
Philippines
Hungary
Pakistan
Morocco
Argentina
India
Russia
Brazil
Mexico
Algeria
Indonesia
Turkey
Average
22.7
23.0
24.6
26.5
30.8
34.6
35.3
43.3
48.8
50.6
56.3
64.7
21.4
Gov. Debt is attractive but it must
held even if it weren’t attractive
• Gov. Debt has low risk, low capital weight, no
priority sector obligation, making it attractive
• But macroeconomic constraints mean that Gov.
debt has to be held, if not by banks, then by the
public, meaning less deposits, so still crowding out
• Crowding out is now by interest rates, not by fiat,
but it is still crowding out.
• Attractiveness of Gov. debt simply determines
interest differential between public and private
debt.
Large Public Sector Bank Role
Figure 3. Asset Shares of Commercial Banks by Type
New Private Banks
100%
Old Private Banks
Foreign Banks
Reg. Rural Banks
90%
80%
70%
60%
Nationalized Banks
50%
40%
30%
20%
State Bank Group
10%
0%
1993-94
2000-01
Large Public Sector Bank presence
associated with slower financial and
economic development, worldwide
• Weak incentives for sound lending and collection
Credit Misallocation (bad lending & collection processes)
Borrowers develop culture of non-payment.
• Weak Governance:
–
–
–
–
Multiple Conflicting Goals
Political Interference
Lack of clear incentives to staff, who become an interest group.
Weak Information/non transparency
• Lower effective lending rates crowd out private banks
• Difficulties in Regulation & Supervision
• Result is often costly “skeletons” for governments
Credit Misallocation: Banks’ Gross
NPLs High by International Standards
Figure 4
India:Non-Performing Loans by Bank Groups
(% of Loans)
20.0
Public Sector
15.0
10.0
5.0
0.0
12.4
11.1
Old Private
6.8
Foreign
5.1
New Private
1997
1998
1999
2000
Source: RBI, Trend and Progress in Banking, various years.
2001
NPLs represent misallocation
• Either borrowers are getting credit they
cannot repay—poor selection of borrowers
Or
• Defaults mean someone must bear the cost,
other borrowers (higher rates), depositors
(lower rates), or taxpayers (bailout).
Q. Why are NPLs High?
A. Poor Incentives.
1. Weak legal (judicial) framework
– Slow Judicial Proceedings, BIFR
– Debt Tribunals have not been enough
– Will new ordinance become law and make a
difference?
2. Poor information on borrowing
1. And 2. Mean Poor incentives:
– Why pay?
– No credit record to maintain.
Why are NPLs high (cont.)?
• Public sector banks have NPL problems
worldwide. In India worse than even “old”
private banks, which have similar clientele.
• In Public sector banks, what are incentives
– To choose borrowers well?
– To collect promptly?
– To use good contracts?
Competition has pushed down
bank margins
Average Interest Margins
4.5
4
Percent of Assets
3.5
3
2.5
2
1.5
1
0.5
0
95-96
96-97
public banks
97-98
private banks old
98-99
99-00
private banks new
00-01
foreign
Public Sector banks face a squeeze from
competition, poor lending, and high costs
Figure 6
India: Costs, Provisions and Net Profits (Sum= Net Revenue)
2000-2001
Oth
Costs
7
Percent of Assets
6
0.93
5
4
0.42
3
0.62
Provis.
0.81
Provis.
Other
Costs
2
1
Net
Profits
2.03
Wages
0
public sector banks
old private banks
Source: RBI, Trend and Progress in Bank ing, 2000-2001
new private banks
foreign banks
Profits have fallen
Figure 7. India: Net Profit by Bank Group
1995-96 to 2000-01
2.00
1.50
% of Assets
Foreign
1.00
New Pvt.
Old Pvt.
0.50
Public
0.00
95-96
-0.50
96-97
97-98
98-99
99-00
00-01
Need more profits to
•
•
•
•
Write-off bad loans
Keep pace with growth
More private lending
Stronger regulation and supervision
– Best Practices
– Basel II
• Privatize?
More Profits require:
• Better lending
• Lower costs
Or
• Larger spreads (lenders pay more,
depositors get less)
Or Gov. will have to add capital
Prerequisite to more private
credit
Reduce Crowding Out
Better Performance(1):
Better Legal & Judicial Framework
Better incentives to service debt
• New bankruptcy law will help/BIFR
revamping.
• Debt tribunals need
– more support,
– faster deliberations, and
– penalties for willful default and delay
• New ordinance: will it work?
Better Performance (2) :
Better Information Framework
Improve incentives to service debt,
select borrowers better.
• Credit registry
– who will manage it?
– include non-banks and small
borrowers.
Better information improves
Access
• Small have asset: good credit rating
• But system must go down to small loans
• Which institutions can best provide access?
• Currently, priority sector loans getting
bigger, and rates constrain small lending.
Better Performance (3)
Cutting Costs in Public Banks
• VRS will help, but needs to be managed
• Computerization needed, but funds are
lacking. Why can’t India export banking
services?
• Reducing or selling branches
• Mergers
Needed: An Exit Policy for Banks
Better Performance(4)
Better Incentives for Better Lending
• Public banks need to improve incentives for
– Selection of sound borrowers
– Collection of debt service
• Privatization:
– Few examples of public banks that work well.
– But low profits and lack of interest by foreign
investors may make privatization difficult.
Challenges to Reg & Supervision
• Private Banks and Moral Hazard
• Deposit Insurance levels
Strengthening of Regulation & Supervision to
Best International Practices
For example, exposure limits, connected lending,
income recognition, provisioning, and prompt
corrective action.
Particularly important for private banks without
a reputation to protect.