Banks seek fig leaf for bad loans

Source :Nidhi Nath Srinivas :ET; 6 Feb 2012

Yarn, fabric and clothing companies are in a sweet spot. They owe banks so much that now it is their lenders’ job to ensure they survive. With wild enthusiasm, banks have lent the textile industry Rs 2,50,000 crore over last 12 years. Till 2008, the going was good. Now companies say they can’t even pay interest on Rs 50,000 crore in working capital loans. Upto 15 per cent of loans to this industry are stressed and the number is rising fast.

In today’s precarious times, such a gaping hole could be the last straw for banks. Usually banks extend the payback period in such cases. But here is the googly. Most of these loans have already been ‘restructured’ once in the last two years. If payments fall behind a second time, the account has to be classified as a ‘Non Performing Asset’ on the bank’s balance sheet. Banks have to put aside money from their profits to make good these losses.

Each NPA shows a bank’s error in choosing credit-worthy customers. Given that loan risk assessment is the bread-and-butter of high-street banks, there can be no explanation except incompetence or lack of foresight from the account manager upwards. Reluctant to have their errors of judgment made public, in December, a dozen banks asked the RBI to relax the rules on declaring bad loans and let these twice restructured loans remain standard. Because such relaxation flouts international prudential and accounting norms, quite sensibly, RBI refused. Moreover, it believes such relaxation won’t solve the industry’s problems.   

But the situation is too grim to be left at that. Banks have now asked RBI to allow relaxation for at least loans above Rs 100 crore so that only the smaller accounts are re-classified. It’s a desperate attempt to find a fig leaf. Hopefully, the RBI will stick to its guns at the second round of talks this week. Banks lent to each company with eyes wide open. Unlike loans to farmers and small business, there was no pressure to lend.   

In their defence, banks and companies say the current distress stems from the decline in demand for clothing in 2010 and cotton’s extraordinary price volatility in 2011, which no one could predict. This does not wash. Common prudence should have made bankers also study scenarios where raw material becomes expensive and demand tanks. Ultimately, it is a question of efficiency. The biggest players, with enough backward and forward integration to ride out the storms, continue to make money. Those in distress today were clearly unworthy of large loans in the first place and should now be written off. There is no reason why RBI should encourage banks to hide this truth from shareholders by changing norms four weeks before the fiscal ends.   

Textile companies themselves are hardly deserving of a second chance. Promoters greedily took loans to profit from a government interest subsidy scheme even if it made little business sense. Few would have dared to expand capacity so rapidly with loans at market rates. Three-quarters of the capital employed today is borrowed. Such high leverage leaves companies susceptible to the slightest tremors.       

Companies complain they are in a fix because China is not buying enough yarn, while USA is buying more clothes from Bangladesh and Vietnam. Within India, they pin the blame on price volatility, government policies and slow demand for branded clothes. In short, it’s not their fault. This is hard to swallow. Poor financial results and falling market share are never the problem but a symptom of the problem. The real issue is that Indian textile companies are small, labour-intensive, non-integrated spinning, weaving, finishing and apparel-making outfits. Only 3% are large composite mills.

Today's world demands economies of scale.  Indiscriminate government subsidies in the name of job creation further encouraged promoters to use public money for creating more such fragmented capacities that are inevitably idled at first signs of trouble. There is no way the market can give them 14% post tax returns necessary to service loans.

Any bank with such expectation is chasing fool's gold.  Banks, industry and government are equally culpable in creating this crisis that threatens to leave lasting scars on the lending system. Yet this is also an opportunity to create future growth. It is a mirage that the textiles industry is too big to fail. On the contrary, its myriad small units have outlived their utility. Their exit will occur only when banks face the consequences of their actions. All textiles sector subsidy schemes should end. Individual livelihoods can't be protected by industrial dinosaurs.