A crisis in the financial sector is the last thing an industry already handicapped by the slowdown and weak global markets needs, but that's what India Inc. is set to face, and it's partly its own making.

By Ashish Gupta and Roshni Jayakar

This necessitated suggestion (sic) of loan loss provision of Rs 484.71 crores as well as de-recognition of accrued interest amounting to Rs 166.18 crores... The gross and net NPA went up to 21.98 per cent and 17.94 per cent as against the reported level of 16.62 per cent and 13.40 per cent.
From the report of an inspection of IDBI carried out by RBI between October 9, 2000 and December 13, 2000

The FI had utilised special/general reserves and declared net profit of Rs 23.50 crore and Rs 59.37 crore in the two years (1998-99 and 1999-2000). The assessed level of losses suffered by the FI would be much higher after taking into account the additional provisions of Rs 1,427.19 crore suggested by the inspection
From the report of an inspection of IFCI carried out by RBI between November 6, 2000 and January 5, 2001.

In February 2000, Vinay Rai was in Master-of-the-Universe mode. The market capitalisation of his infotech services company ITIL (Information Technologies India Ltd) had touched Rs 15,000 crore, and Forbes had listed him in its annual listing of billionaires with an estimated wealth of Rs 200 crore. Then, it all came crumbling down.

At the time of GoIng to press on September 20, ITIL's stock was trading at Rs 22.10, nearly 98.96 per cent off its peak price (Rs 2,131.50 on February 23, 2000); its net profits, for the quarter ended May 31, 2001, were, at Rs 3.20 crore, 85.53 per cent lower than those for the same quarter last year (Rs 22.12 crore); and it was one of the companies, named by the Central Bureau of Investigation's (CBI) report, when it chose to file three cases against Vinay Rai, his brother Anil Rai, and an assorted bunch of executives for conspiring to cheat financial institutions (FIs).

The CBI's allegation? That the brothers Rai, some of their employees, and some officers of IFCI, IDBI, and LIC conspired to divert money to the tune of Rs 95.83 crore from Malvika Steel, Usha Ispat, ITIL, Koshika Telecom, and Usha India to shell companies like Polite Seamless and Sapphire Alloys. The money, the CBI alleged, would then travel through a clutch of shell companies before finding its way back to the Rais. BT learns that the Rais defence may be built around the fact that the company has enough assets that can be attached to recover the loans.

Where do the victims-and that includes IDBI and IFCI-fit into this? Well, in March 2000, the Industrial Finance Corporation of India (IFCI), which was already owed Rs 990 crore in principal and interest payments by Malvika Steel, loaned the company an additional Rs 50 crore, throwing, if one were to read into IFCI head honcho P.V. Narasimham's response, good money after bad. ''(We did this) with a view to prevent investments already made in the project from becoming infructuous.'' He believes that the project can still be saved. The man's statement may have something to do with the fact that he wants a quiet exit-he is to retire on September 30, just around the time this issue hits the stands.

If Narasimham's reply sounds specious, then that of P.P. Vora, his counterpart who's just taken over at IDBI, is downright blasé: ''I am not unduly worried about the NPAs in IDBI; they will have to be tackled on a long-term basis,'' says the former chief executive of the National Housing Bank. He should be: IDBI's NPAs (Non-Performing Assets) amount to a staggering Rs 10,879.7 crore. And it's not just the issue of one or two FIs.

''NPAs of the FIs (Rs 18,000 crore) and the banks (Rs 61,000 crore) are just the tip of the iceberg,'' explains a senior CBI official who spoke to BT on the condition that he not be named. ''There's also the issue of the fudging of the NPAs by the FIs and banks to show healthy profits.'' It is exactly this ''fudging'' that the RBI's inspection reports have highlighted (See IFCI and IDBI Snapshot).

The real magnitude of the NPAs of the banks alone, contest some CBI officials, could be as high as Rs 1.9 lakh crore. In one of those purely numerical coincidences, that number is close to the GoI's total revenue earned (2000-01) from both direct and indirect taxes-Rs 1.94 lakh crore.

The genesis of the malignancy

The malaise that ails the FIs is partly a function of the times. Development Financial Institutions (they have since dropped the d) were creations of the GoI's pre-1991 economic philosophy. If access to capital was the biggest hurdle to private enterprise, the thinking went, then the dfis would address the problem. Since 1991, though, capital hasn't really been a constraint.

A company seeking to raise money can do so from a variety of sources: the stockmarkets, despite their recent dismal performance, bonds, private-equity placements, venture capital, external currency borrowings, and the issue of American and global depository receipts.

Banks and financial institutions make money by lending money to companies (and, to a lesser extent, individuals in the case of banks). The lesser the quantum of money they lend out, the lesser that of their revenues.

Competition, then, could well have forced them to fund projects without appraising them adequately, a hypothesis that the CBI is now putting forth. ''Banks and FIs just do not have the competence to appraise all kinds of projects, from steel to cement to software,'' says one investigator with the bureau.

Vora himself believes the root of the problem lies not in the ability of FIs and banks to evaluate the viability of projects, but in changes in the economic environment, like globalisation. ''In certain sectors, global supply has outstripped demand.'' Narasimham toes a similar line. ''None of the FIs could have foretold a global recession over the last three years.'' Three years? That's the first we're hearing of it.

There are some takers for this explanation, like Crisil CEO R. Ravimohan who says: ''From a generic point of view, we had a high-risk financing system that become even riskier with liberalisation.'' Put simply, the FI's evaluated projects after factoring in Indian competition; they sort of overlooked competition from global companies.

It is conceivable that the FIs are just victims of a bad bounce, but the RBI report on IDBI says the FIs ignored ''important factors that could have a bearing on the viability of the project...rescheduled loans without any requests from customers...and sanctioned fresh assistance without a commensurate increase in borrowers' scale of operations''. Expectedly, between 1997-98 and 2000-01, the proportion of NPAs to total assets for IDBI increased from 10.1 per cent to 14.8 per cent; that for IFCI from 20.04 per cent to 21.44 per cent. The fault, then, lies as much in the management practices of the FIs as it does in macro-economic changes beyond their control.

It is increasingly becoming clear that the way in which the FIs themselves and the GoI deal with this issue will have a bearing on the health of the entire finance sector in the country. For, between 1997-98 and 2000-01, the value of gross NPAs of 27 nationalised banks increased from Rs 50,851 crore to Rs 54,482 crore (the proportion of NPAs to total assets did decrease from 14.4 per cent 1997-98 to 13 per cent 2000-01, but that's small consolation). Today, the value of gross NPAs of these banks is estimated at Rs 61,000 crore.

''The problem in the banking system is slightly different (from that with FIs),'' says Ravimohan. ''Project finance isn't the cause for their woes; their problems have to do with priority lending, and an appraisal system that's weaker than those of the FIs.'' And, unless the government works out a formula to deal with NPAs the country could be headed for a crisis that makes the malaise in the Japanese banking system look like a minor attack of laryngitis.

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