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US Banking Crisis: Why Lehman, Silicon Valley Must Boost India’s Preparedness

Even though Indian banks have made some really big mistakes that have hurt the economy, there are saving graces.

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It was in 'Wall Street'—the 1987 movie directed by Oliver Stone that Michael Douglas playing Gordon Gekko gave a speech with the cult line: "Greed, for lack of a better word, is good." Apparently, this captures the evolutionary spirit. That's so very America in love with its roller-coaster adventurism. We could now turn that on its head in India by using the classic stock market opposite of the term. "Fear, for lack of a better word, is good."

Is it, really? I would say yes if fear means a proxy for wisdom that restricts investors and bankers from rushing where angels fear to tread.

There is a fine line dividing calculated risk that has a downside from reckless casino capitalism that leads to downfall of the kind faced by the Lehman Brothers in 2008 and more recently, the Silicon Valley Bank(SVB) in the US.
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Is India Immune to the Global Banking Crisis?

Meanwhile, in Europe, Credit Suisse is on the verge of a humiliating rescue by UBS and the Swiss government after a fall that experts link to overindulgence in the declining fortunes of investment banking. Credit Suisse was only a short distance away from the big bets on the bond market by SVB that went awry or Lehman's gambles with sub-prime securities and complicated financial derivatives that led to financial disaster in 2008 on Wall Street.

Is it time for India to say we are a safe haven? That depends on who you are talking to, but this much is clear: though Indian banks have made some really big mistakes that have hurt the economy, there are saving graces in both the benign effect of the much-hated bureaucratic or parliamentary control and the fear of scrutiny that public sector bankers live with. Financial infection is common in India, but contagion is not.

The much-hated nationalisation of banks in 1969 and 1978 did lead to public sector banks presiding loan melas, loan waivers, and a mountain of bad loans aka Non-Performing Assets (NPAs) that have bled their balance sheets, and corporate frauds of the kind that hit Indian Bank. But overall, the system has held steady, thanks in no measure to a hue and cry in public, talk of moral hazards in unreturned loans, and the iron grip of the Reserve Bank of India and North Block babus who like to breathe down the necks of lenders.

This is not to say that banks have not gone bust. Since 1991, when India began an economic reform programme to boost private banks and reduce the emphasis on the public sector, we have seen the fall of the small-sized Bank of Karad during the 1992 "Harshad Mehta scam" days, Global Trust Bank that had a shady romance with diamond traders, and more recently, the PMC Bank and Yes Bank.

Lessons for Indian Banks Amid Financial Flux

The IL&FS crisis is a special case as it involves a private yet public sector-funded "Shadow bank." The Infrastructure Leasing & Financial Services group has defaulted on Rs 94,000 crore loans given to infrastructure projects that were tied indirectly to commercial banks. This is the closest India has come to a complicated default scenario resembling the Wall Street crisis of 2008.

It must be added that IL & FS also caused a mini-contagion as fellow Non-Banking Financial Companies (NBFCs) faced turmoil while its defaults jeopardised the work of banks and mutual funds associated with IL&FS, and sparked panic among equity investors. The IL&FS crisis is one in slow motion and drags on. Falling between the two stools of the stock market and the RBI and involving a clutch of companies and ventures, this is a messy tangle.

Former Punjab and Maharashtra Cooperative (PMC) Bank saw a run by depositors, the closest in recent years that India came to the SVB crisis after it fraudulently concealed bad loans of Rs 6,500 crore involving Housing Development and Infrastructure Ltd (HDIL) that led to the Reserve Bank of India taking control of the bank in 2019. After six months under the RBI, it was eventually merged into Unity Small Finance Bank, thanks to the central bank's effort that was innovatively "soft touch" in nature: there was no state control but the RBI played a creative broker-supervisor for the Centrum Financial Group to acquire PMC through the setting up of Unity SFB. A startup White Knight, as it were.

Months later, the more high-profile Yes Bank was on the brink of collapse after an unbearable burden of bad loans, but the RBI moved in fast to assuage panicking depositors by superseding its board of directors. Much like the SVB, Yes Bank, India's second-biggest private bank, was decorated with awards and accolades.

Thin ice is a common feature in financial institutions. The Yes Bank crisis hit home nearly three years after the RBI had removed founder-CEO Rana Kapoor from Yes Bank. You could say RBI was a bit lax but was not exactly sleeping on the job. The State Bank of India's buying 49% stakes in Yes Bank, but with no merger envisaged, was a disguised version of a taxpayer bailout.

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Notably, loans to HDIL caused the run on PMC Bank while loans to home lender DHFL led to the Yes Bank crisis— and both realty firms were linked to separate sections of the same business family. Allegations of political connections of the Wadhawan family show clearly that crony capitalism may be to India what casino capitalism is to the West, a bleeding mechanism in which absolute power corrupts absolutely.
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Frauds, Scams, Defaults: How Indian Economy Survived It All

We have had a high-profile bank fraud in the Punjab National Bank with fugitive diamond merchant Nirav Modi as a poster boy. We have also had scams involving companies like ABG Shipyard, Bhushan Steel, Amtek Auto, and Rotomac Pens that between them have bled banks through fraudulent and/or otherwise unreturned loans. The lost amounts in all involve tens of thousands of crores in rupees. Banks are bled by lax regulation, disguised account books, fraudulent collusions, and a state of drift in which bankers just hope things will turn around.

Each case is unique, but in scale and culture, none in India has been big enough to trigger visibly widespread financial pandemics. The NPA problem that has haunted India for the past decade or so had the character of a widespread disease but not enough to bring banks down. The arrival of a carefully-crafted Insolvency and Bankruptcy Code (IBC) has now put in place a safety valve mechanism of sorts for the sale of bad loans to keep banking ships from sinking easily (hopefully).

What is common in all this is the fact that taxpayer bailouts, if any, have been so elegant in India that it is called "recapitalisation" of public sector banks, or as in the case of Yes Bank, a de-facto temporary takeover mounted with the blessings of the RBI.

Like India's famous arranged marriages, a government-blessed system has the virtue of parents playing counsellors in moments of discord. Loan defaults of a fraudulent kind are often ring-fenced as criminal scams though there is a fine line dividing some business-linked defaults from wilful acts of fraud.

Strangely enough, if India has learned lessons, it also offers one for financial leaders: the State is not necessarily evil and paternal oversight can be a good thing. Boyish irrational exuberance can cost dearly through a knock-on effect.
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Bureaucratic Mismanagement Also a Key Player in Distress

India's problem is that in addition to scams, we have had at least two finance ministers Palaniappan Chidambaram and Nirmala Sitharaman telling state-controlled banks to go forth and lend. The Indian Bank scam of 1992 led to public sector bank chiefs being wary of lending, and the PNB fraud saw the scene repeat itself two decades later. For finance ministers, it hurts to see fear restricting the expansion of loan books that fuel economic growth.

In India's case, greed linked to public sector banks has largely taken the shape of fraudsters and smart Alec borrowers taking the system for a ride. This is not as quick and in-your-face as the Western bank collapses. State controls have been both a blessing and a curse as the fear of punishment can cause ignominy in India while in a 'greed-is-good' kind of capitalism, there is hardly any stigma attached to flaming failures where risk-prone CXOs take down with them banks that are sometimes dubbed "too big to fail."

Between the devil of political corruption and the deep sea of casino-style risk-taking, India and the West have had their crises of confidence in the banking system. What is clear, however, is that central banks need to be vigilant enough to know that bank collapses imply an inherent threat of contagion. It is forever amber if you are a central banker or financial policymaker. It ought to be that way.

(The writer is a senior journalist and commentator who has worked for Reuters, Economic Times, Business Standard, and Hindustan Times. He can be reached on Twitter @madversity. This is an opinion piece and the views expressed are the author's own. The Quint neither endorses nor is responsible for his reported views.)

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