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Ponzi scheme and Indian bank loans By Dr. Bobby Srinivasan and Dr. Sudhakar Balachandran

April 22, 2016 | Posted by bobbysrinivasan << back to blog

Traditionally, it is generally believed that our Indian banks are extremely conservative in lending practices. Almost all the time, before these banks lent they will look at the real value of collateralized assets, borrowers’ track record, purpose for borrowing and possible payment schedule and evaluate the probability of default. These days, when we look at the increasing non-performance assets, we doubt as to whether the banks have dramatically changed their practices. According to the data published by the credit information bureau (India) as of December 2015 banks and financial institutions have filed over 12300 cases in respect of loans above 1 crore. Defaulters in these cases owed banks Rs.1.8 Lakh Crore as of December 2015 more than double the amount in the previous year. This is a conversation between a student and his professor.

 

Student:          Professor, it is distressing to read that NPA is piling up. What is in store for us?

 

Professor:        The bank management in India to say the least is totally incompetent. They have become adventurous by lending money to unsuitable customers. They threw the risk away to winds and took aggressive steps in lending. There is no penalty for them. All these lending could be conveniently grouped under poor judgement and lack of skill in assessing the risk.

 

Student:          Professor, you sound angry and disappointed. Why should their inefficiency bother you?

 

Professor:        You asked the right question. The shares of public sector banks have literally crashed in value. Once their reputation is spoiled who will buy their shares except the government who will use the tax payers money to bail them out. Banks take 15 years in some cases to recover their money. This way shareholders are taken to the cleaners by the creditors to the bank which is facilitated poor and unethical the bank management. It appears like some kind of Ponzi is going on.

 

Student:          What is a Ponzi scheme?

 

Professor:        It is like this. In the early stages of a business cycle, money is available only to credit worthy customers whose investment income can meet the principal and interest on the debt. As the cycle marches on, lenders finance borrowers whose income will cover interest payment but not the principal. Finally to lenders whose investment income will neither cover neither interest payments nor the principal. The lenders then wait for the price appreciation of asset values to service the debt. This is the phase known as Ponzi finance. The cycle ends when the supply of money slows or stops. The banking sector is trapped in such a way that debt redemption becomes almost impossible. The world is running up debt to repay debt. How long will this game go on? In summary the next global growth economic crisis has sown all the seeds and waiting to happen. Can you save these banks? It has become the nation’s fiscal responsibility. Of course, in due course the government will bail them out with tax payers’ money.

 

Student:          It looks like a grim situation. Thanks, Professor.

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