Flaws in Indian Financial
System
The economy is slowing down ,
consumer activities are declining , corporates earning going down and that is
bringing the risk of defaults . I read one research report some days back which
stated that almost 40% of the corporates who have borrowed from banks their
interest coverage ratio is 1:1 ( EBIT = Interest payment ) . Don’t know if this
figure is correct or a bit exaggerated but it can not be totally wrong .
Already we are seeing some
corporates under stress and promoters finding problem in paying back loans. The
reason is very clear we are having a flawed financial system .
Long back ( early 2000) when I
was in UTI Kolkata I remember there was one major corporate which used to invest
in UTI schemes . One day I got a call from the CFO of that company and he in
anguish expressed that most of his investment was not performing well . When I
checked the investment I found big amounts invested in equity funds and this
was the time after IT bubble market had tanked . In fact they had major
investment in UTI IT fund also. I went and said very humbly to him , Sir when you
have mobilised resources from small investors through your debt schemes ( FDs )
who are looking for safe , assured return how you invested that money in equity
schemes .
The same mistake is happening .
Banks are lending FD money to whom ? to those who are chasing growth . They are
buying properties ( flats , residential premises ) or consumer items ( cars , luxurious
items ) . Bank is lending to corporates who are looking for aggressive growth (
expansion, for increasing the size of market and their own market share as well
) . Nothing wrong in it . If India has to grow , there has to be clear growth
strategies and approach . But every
growth has some limit . I think somewhere this is being overlooked .
Right from promoter/ entrepreneur
to top management to consumer everyone have been running a blind race looking
at others and not on own capabilities and limitation .We are living in
integrated and relative world so any growth in isolation is unsustainable in
long run.
Consider this – Lets say today
all car companies make 10 lakh car and it is sold , next year they will increase
the sales target and make 1.2 lakh and if that is also sold next year even more
and process continues . If most car are bought on loan then most people living
on leverage money ( debt ) . Add to this home loan , shopping and dining
through credit card . So proportion of debt is increasing in our life . We all
leverage our expense on assumption of increasing salary /income . But from
where that is coming again ? from the increasing corporate earning or employers
earning growth . there will be stage when interest payout will affect normal
living and from there only problem starts . Suddenly there will be less
consumer activities , less spending and now car manufacturers and other
corporates stranded with inventory . Defaults happens , bail out exercise
happens .
Banks are recapitalised by lakhs
of crores to make their balance sheet look healthy . This money which could
have been spent on construction of dam
and other infrastructure related projects gets diverted . So we will continue
seeing people suffering from floods in Bihar , UP etc . Agriculture gets
affected and so does consumer spending .
I am not an economist but I
always remember and value what our elders said – “ Utni hi paav pasariye jitni
lambi chadar ho “ ( Extend your legs only which fits the size of the blanket ) .
So growth is not bad but growth rate has
to be sensible and sustainable . Leveraging ( use of debt ) is not bad but how
much you should leverage that is important ?
But excessive greed ( greed of
growth ) is killing the economy . Promoter want growth , Management want growth
as that will help them get more salaries and bonus and down the line they keep
putting pressure of sales target without realising the limits .
They day our banks and corporates
learn to go for sustained , achievable , realistic growth on year to year basis
the problems of default and slowdown will not be so visible as what seen today
.
So the message is know your limit
and take risk of borrowing , leveraging accordingly . Its better to go for
economic development rather than economic growth . Businesses are failing today
because combined cost of all outputs are not matching with the combined all consumer
incomes . Both are interdependent and inter-related and so growth from both
side has to happen simultaneously to maintain the proper balance .
Government should look at these
aspects and come with right regulation :
·
Corporates should keep a minimum percentage of
reserve and surplus at any point of time . Presently it’s a management decision
and nothing binding.
·
Corporates should not be allowed to borrow
beyond a minimum level of debt considering business volume and conservative
growth prospect . This has to be evaluated on year to year basis . Again its
all in theory ( Debt – Equity ratio ) not followed religiously. If business
slowdown they should deleverage ( reduce debt ) using reserves and surplus .
·
Corporate lending from Banks should be maximum
for 5 years even though fund requirement is for 10,15 ,20 years . This will put
pressure on the Management for effective utilisation of borrowed money . Review
every year and after 3 years of initial borrowing next lending again for 3-5
years .
·
Banks should have a sustainable profit target
based on deposit base and not uncontrollable lending targets . Risk averse
people will keep investing in bank FD but how much of it is productive and how
much is default ? Loan base and loan growth should not be the basis of bank
efficiency but sustained profit on that lending should be the key efficiency parameter.
·
Treat every adult / workable age citizen as an
asset and judge his economic productive value . No freebies , no subsidy . Let
all work for their minimum normal living.
