Reserve Bank Governor Raghuram Rajan has come down heavily on large defaulters for continuously eroding the "sanctity of the debt contract" in the country. When the large promoter defaults willfully or does not cooperate in repayment to the public sector bank, he robs each one of us taxpayers, even while making it costlier to fund the new investment our economy needs, Dr Rajan said at the Dr Verghese Kurien Lecture in Anand on Tuesday. (Read the full speech here)
Here are 10 big takeaways from his speech:
1) In India, promoters have a class of "super" equity which retains all the upside in good times and very little of the downside in bad times, while creditors, typically public sector banks, hold "junior" debt and get none of the fat returns in good times while absorbing much of the losses in bad times.
2) This happens because the system protects the large borrower and his divine right to stay in control. In cases of defaults, the large borrower can command the finest legal brains or has the influence to obtain stays from local courts. Faced with this asymmetry of power, banks are tempted to cave in and take the unfair deal the borrower offers.
3) In 2013-14, the amount recovered from cases decided under Debt Recovery Tribunals was Rs. 30,590 crore, which is just 13 per cent of the outstanding value of debt sought to be recovered at Rs. 2,36,600 crore.
4) The promoter enjoys riskless capitalism - even in these times of very slow growth, how many large promoters have lost their homes or have had to curb their lifestyles despite offering personal guarantees to lenders?
5) Taxpayers pay for this one way bet large promoters enjoy. The total write-offs of loans made by the banks in the last five years is Rs 1,61,018 crore, which is 1.27 per cent of GDP. This money would have allowed 1.5 million of the poorest children to get a full university degree from the top private universities in the country, all expenses paid.
6) The promoter who misuses the system ensures that banks then charge a premium for business loans. The average interest rate on loans to the power sector today is 13.7 per cent even while the policy rate is 8 per cent.
7) Since the unscrupulous promoter hides among the scrupulous ones, every businessperson is tainted by the bad eggs in the basket. Even good power sector firms are paying much more than the average household because of bank worries about whether they will recover loans.
8) Draconian laws to force payment impact the small entrepreneur who does not have the wherewithal to hire expensive lawyers or move the courts. The small entrepreneur's assets are repossessed quickly and sold, extinguishing many a promising business that could do with a little support from bankers.
9) When some businessmen enjoy a privileged existence, risking other people's money but never their own, the public and their representatives get angry. If the resolution of these issues is taken out of the realm of the commercial into the realm of the political, it will set back industrial growth. Reforms therefore assume urgency.
10) The solution is not more draconian laws, but a more timely and fair application of current laws. We also need new institutions such as bankruptcy courts and turn-around agents. Finally, we need a change in mind set, where the wilful or non-cooperative defaulter is not lionized as a captain of industry, but justly chastised as a freeloader on the hardworking people of this country.