Flaws in Indian Financial System

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.