Should PNB, India’s second largest govt bank, be in banking business?

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Punjab National Bank (PNB), India’s second-largest government-owned bank, recently declared a loss of 134.2 billion rupees (US$1.97 billion) for the period January to March 2018.

This is the largest loss ever declared by an Indian bank.

It in essence shows that the sordid story of increasing bad loans of Indian banks continues. Bad loans are basically loans on which repayment has been due for 90 days or more.

The total bad loans of PNB as of March 31, 2018, stood at 866.2 billion rupees, a jump of 50.6% from 575.2 billion rupees as of December 31, 2017. The ratio of bad to performing loans of the bank has reached 18.4%.

But what happened in the three-month period that led to this disastrous results? Nirav Modi for one. This man, who supposedly sold diamonds, allegedly defrauded the bank of 126.5 billion rupees. Of this, the bank recognized 75.8 billion rupees (what is calls the Brady House fraud, referring to the bank branch in Mumbai where the scam happened) as a bad loan.

This means more than 50 billion rupees of the alleged Nirav Modi fraud still needs to be recognized as a bad loan. The question is, why didn’t the bank recognize the entire fraud amount as a bad loan? The answer lies in the fact that this would have led to the capital adequacy ratio of the bank falling below 9%, the minimum level of capital that Indian banks need to maintain as per the requirements set by the Reserve Bank of India (RBI).

Also, given that the capital adequacy ratio of the bank is so close to 9%, the government, the owner of the bank, will have to invest more money in it, in times to come, to shore up its capital. This will mean more taxpayer money going down the drain. Of course, if the bank is done recognizing bad loans, and makes a profit in future quarters, then this may not happen.

But there are no signs of the bank having finished recognizing its bad loans as bad loans.

Having said that, the Nirav Modi case alone was not responsible for the more than 50% jump in the bad loans of Indian banks. In February, the RBI did away with myriad restructuring schemes that allowed public-sector banks to kick the can down the road, and which allowed banks to keep postponing the recognition of their bad loans as bad loans.

This change has forced PNB to recognize 102.4 billion rupees of loans as bad loans. There have been more loans that have been recognized as bad loans over and above this as well. 
The larger point is that the bank is still not finished recognizing bad loans.

There are a few questions that crop up here. First, a bank that is losing most of what it lends should have seen a run by now. The depositors should have queued up to withdraw their deposits. 
But the deposits of the bank continued to grow over the last financial year.

In that period, the global deposits of the bank grew by 3.3% to 6,422 billion rupees. The domestic deposits grew even faster, by 6.2% to 6,004 billion rupees. The overseas deposits fell by 25.5% to 418 billion rupees.

The faith of the domestic depositors in the Punjab National Bank remains intact, despite the bank floundering over the years. This faith basically comes because of the bank being government-owned. Nevertheless, this faith is irrational given that there are better government-owned banks out there where people can deposit their money.

It shows the lackadaisical attitude a large section of the Indian population has toward money.

The second question that we need to ask is whether a bank like PNB should be in the business of banking at all.

A bulk of these bad loans have come from lending to corporates that have defaulted on the loans they had taken on from the bank. The recovery rate of these loans remains very low.

The Insolvency and Bankruptcy Code (IBC) initiated to recover these loans has just gotten going. with Tata Steel buying the biggest defaulter firm, Bhushan Steel, and repaying part of the outstanding loans. It will take some time for the IBC to work its way through.

PNB borrows deposits at 4.84% per year. It is able to lend them at 6.52%. At the same time, the investment portfolio of the bank has generated a return of 7.27% per year. A bulk of this portfolio consists of government securities.

The total investment portfolio of the bank rose by 28% between March 2016 and March 2018, to 2,034 billion rupees. During the same period, the total advances of the bank rose by 8.9% to 4,713 billion rupees.

Clearly, the bank also realizes that it is better for it just to raise deposits and use them to buy government securities, instead of lending the money out. Lazy banking is the way out for it, at least until it sorts out the bigger problems.

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