Leave the banks alone: Financial Express: 8th August 2014

The idea of waiving of loans sounds specious as it appears that we are not doing the right thing. But if we are espousing the ideology of financial inclusion, then loan-waivers may not look out of place as they can be justified as being an extension of the same concept. In fact, it is mandatory for banks to lend 18% of their total advances to the farm sector. There is also an interest rate subvention scheme for agriculture where the banks are compensated from the budgetary allocations for the difference. Therefore, the debate is about whether or not there is a contradiction in our stance on waivers when there are sops being provided through other channels even though, prima facie, it appears to be something that should be eschewed. The issue has surfaced again as the Andhra Pradesh and Telangana governments have spoken of waiving farm loans (which might total nearly R1.2 lakh crore), and RBI has voiced concern as this is not a prudent practice. The earlier government at the Centre had announced a major debt-waiver scheme in 2008 before the general elections which amounted to nearly R50,000 crore. The way the scheme worked was that banks and FIs would waive off loans of marginal farmers fully and partly for 'others' who repaid 75% of the loan on a one-time-settlement basis. The government then passes this amount on to the banks through budgetary allocations over a period of time. Writing off loans for farmers is popular, especially from the political standpoint, as it helps curry favour with the electorate. The rationale always given is that the farmers are not able to repay their loans on account of unfavorable monsoon and consequent poor yields; therefore, they need to be helped out. But then, shouldn't that hold for any borrower who cannot repay loans for certain genuine reasons? Normally, most defaults are due to economic conditions turning unfavorable if we leave aside the cases of mismanagement or business failure. The argument goes that if industry can be provided with options like restructuring since projects get affected due to extraneous reasons, farmers too should be entitled to some benefits, where waivers are one option. The counter argument then is that how does one tackle loans that cannot be repaid by SMEs, which also constitute a part of the priority-sector? These loans are too small to be restructured but also require affirmative action from the government. If this argument is acceptable, then where should we draw a line and stop giving relief? The argument against any kind of relief either in the form of restructuring or write-offs is that it impinges on the operations and credibility of the financial system. Bankers would be in a quandary on whether or not to lend and could also dilute their standards knowing well that there are options available to avoid classifying such defaults as NPAs. Therefore, RBI needs to ensure that this credibility is not diluted in any way. The problem with loan-waivers is that they invariably create a moral hazard of two varieties. The first concerns the farmer given there is an incentive to default with the hope of a waiver. It also, in a way, punishes those who repay their loans on time as they would never benefit from waivers and hence forces them to also become deviants. It becomes a risky game as there is a good reason to not repay as there is no retribution. In case of personal loans, any default on credit card or mortgage installment automatically gets recorded in the centralised registry which disqualifies one for future loans. This does not happen in case of farm loans. Hence, loan waivers should also carry a stick along with the carrot when invoked or else default can turn into a habit. The second is that once it becomes a political game, there will be competitive waivers, especially before elections. Usually such waivers come from the Centre but if states also indulge in such activity, then it will mess up the system. But once it is done, not promising or announcing such programmes could cause the electorate to look for alternative parties which promise the same. This is a credible fear as it has been felt that the present case of waivers from AP and Telangana may not be based on desperate circumstances such as drought but more on a political considerations. The CAG, in its audit of the 2008 loan-waiver scheme, found faults with the implementation which are now ubiquitous in the case of almost all state-sponsored schemes. The real beneficiaries tend to get left out and those who do not qualify for the same are provided the benefit. Very often, rich farmers, capable of repaying, are covered and small borrowers get left out. Also, waivers have been given to MFIs when they did not qualify for the same. Further, there are delays in the banks being paid by the government which affects their own liquidity. This becomes a problem as liquidity of banks is affected by such delays. Given that this is not a good practice as it makes light of the concept of appraisal processes which are the raison d'etre for financial intermediation, how can this be reconciled with financial inclusion? Today, banks, per force, have to lend to the agriculture sector a fixed proportion of their resources and charge a lower interest rate. Further, when these loans are not serviced there is a case for waiver which, though helpful for the borrowers, denudes the efficacy of banking. The concept of waiver should be done away with by the central bank and the government needs to look at other ways of compensating the borrowers in times of stress like providing jobs under NREGA so that they are ultimately able to service their debt. The major threat we have today is that there is too much focus on financial inclusion which actually clashes with the basic tenets of commerce where banks are being forced to lend in a desired direction. The fact that for the system, the targets are just about met and not exceeded indicates that on their own volition, it may not be the first choice for banks. With pressures on capital, quality of assets, inclusive banking on the savings side, banks are already faced with challenges. Governments should try and avoid bringing in politics through loan-waivers or else we will be vitiating the system.