Crisis in Indian Banking Industry

Summary

Published on 15 October 1991 as a Forum of Free Enterprise pamphlet and reproduced from a booklet issued by the Special Assistance Programme of the University Grants Commission’s Department of Commerce at the University of Rajasthan, Jaipur, this essay by Dr. Dharmendra Bhandari — Chartered Accountant, Assistant Professor of Accountancy at Rajasthan University, and at the time a sitting Director of a nationalised bank — presents a forensic crisis diagnosis of the Indian public-sector banking system in the wake of the 1991 economic emergency.

Bhandari opens with unambiguous figures: of the Rs. 73,308 crores advanced by 20 nationalised banks as of March 1990, at least Rs. 35,000 crores were blocked in non-performing advances; a genuine stock audit of realisation values would place accumulated bad debts at no less than Rs. 20,000 crores. Aggregate deposit growth in all scheduled banks had already slowed from 9.4 per cent (April–September 1989–90) to 7.4 per cent in the corresponding 1990 period. Deposits in nationalised banks stood at Rs. 1,28,999 crores as of March 1990 — a sum the Reserve Bank could protect only by printing notes, making technical solvency a fiction. Recovery rates in agriculture and small-scale industry ranged from 15 to 50 per cent of advances raised.

The essay then moves through four structural pathologies. First, banks lack the legal right to take forcible possession of hypothecated security without a civil court order — a process so slow and expensive (court fees of up to 10 per cent of the claimed amount) that securities routinely deteriorate or are transferred before judgment; Bhandari calls for a provision in the Banking Regulation Act equivalent to Section 29 of the State Financial Corporations Act, empowering branch managers to attach and auction assets directly. Second, Health Code classification (the RBI’s 8-tier system for loan quality) is systematically manipulated to defer provisioning: banks keep loans in Health Code 4–5 rather than filing suits (Code 6), allowing fictitious interest income to be credited. Third, bank balance sheets since 1949 have been structured to conceal bad debt provisions, with the number of notes on accounts rising from 46 to over 300 since nationalisation; Bhandari compares this unfavourably with US, Canadian, and Western European disclosure norms. Fourth, parliamentary oversight is effectively neutered: financial committees have been denied recovery data outside the agriculture sector for over a decade despite repeated requests, with successive Finance Secretaries citing confidentiality; the Comptroller and Auditor General has been excluded from conducting supplementary audits of nationalised banks despite two Rajya Sabha committee recommendations (1983 and 1984) urging such inclusion. Bhandari’s overarching warning is that without immediate legislative and accountability reform, the credit squeeze will tip inflation into triple digits with one bad monsoon.

Key points

• Of Rs. 73,308 crores advanced by 20 nationalised banks (March 1990), at least Rs. 35,000 crores were non-performing; a realistic stock audit would place actual bad debts at Rs. 20,000 crores or more — enough to wipe out the capital and reserves of all 20 banks several times over.

• Deposit growth in scheduled banks had already decelerated from 9.4 per cent to 7.4 per cent year-on-year by mid-1990; Bhandari warns that unchecked inflation and eroded confidence could trigger a bank run the RBI could only address by printing currency.

• Recovery rates in agriculture and small-scale industry ranged from 15 to 50 per cent, and recovery data for medium and large industry was withheld from Parliament — which Bhandari attributes to the figures being “alarmingly poor”.

• Banks lack the statutory right to take forcible possession of hypothecated security; suits for recovery can attract court fees as high as 10 per cent of the claimed amount, and by the time cases are heard, assets are often sold or stripped by the borrower.

• Health Code classification is systematically manipulated: banks defer suit-filing (Health Code 6) and keep non-performing loans in Codes 4–5 to continue crediting fictitious interest income; the number of notes on accounts concealing this grew from 46 to over 300 since nationalisation in 1969.

• India’s bank balance-sheet format has been unchanged since the Banking Regulation Act of 1949; provisions for bad debts are not disclosed as separate line items, in contrast to US, Canadian, and Western European banking standards.

• The CAG has been excluded from supplementary audit of nationalised banks despite two parliamentary committee recommendations (1983 and 1984) specifically calling for such inclusion; the Government’s stated justification — that the CAG lacked actuarial knowledge — is treated by Bhandari as a pretext.

• Bhandari calls for branch managers to be granted the legal power to attach and auction debtors’ assets without external recourse, modelled on the tax-collection powers of assessing officers, as the only way to avert systemic collapse.