superb write-up as usual! it does seem difficult for banks who will be lending and investing, interesting to see this. Maybe banks will scratch each other's backs by investing in a bank's fund which hasn't lent to that borrower.
BANK A invests some money in AIF Fund which inturn invests in Company B ( Which is struggling because it could not pay back money to lenders ). Note this struggling part
Now what happens is the bank loses money on 2 fronts even if it gets back the money from company B.
1 Low quality of investment by bank which could have invested in other good companies
2 Liquidity shortage which affects the DEPOSITS.
Add to this as you said even more burden of maintaining the provisions.
This all seems like bad thing for banks and customers on the whole. Its like im lending 10 rupees, and investing 10 more rupees to get back the initial 10 rupees, It resulted in loss of time and money.
Pls correct if am wrong!
Agree on your point though that penalising the banks which does evergreening..
> If a bank makes a loan that goes bad, it has to then put the same amount of money in a vault that it can’t touch and give it a fancy name (“provisions”)
I am sorry I am quite ignorance of such things, but what is the justification for making banks do this?
It's a risk mitigation measure! If a bank lends say ₹100 to someone and that person doesn't pay it back, someone has to! The vault that I'm referring to here (called "provisions") is like the bank paying itself back for its failed loan. Something like, "Sure, my borrower didn't give me back the money I lent them but here is some money that I'm setting aside assuming I can never recover it again."
So if there is ever a bank run, for instance, the bank can use this money to pay back depositors.
As I mention in the footnotes though, there are some nuances to this. Not all bad loans have to be provisioned entirely. Typically, a 70% Provision Coverage Ratio is considered to be acceptable. That is, if a bank has made bad loans worth ₹100, it has to set aside ₹70.
In the bank's books the loan wouldn't be bad. But in reality, the bank would still have lent money to a borrower that is likely to default on their loan. It's just pushing away the problem for later hoping that it goes away.
The underlying issue of this is also that RBI doesn’t want to make lending conditions a bit more stringent.
Most western banks won’t lend without a collateral
In the financial crises of 2008, the collateral was house price which they assumed and also overinflated but you don’t see a lot of business loan failures
The svb bank failure was due to them not hedging their interest rate exposure and even then the regulators had been warning them apparently
The second issue that faces not only this sector but probably the entire business and probably other sectors is the means to solve debt issues on courts at a faster pace. Sure countries like US and U.K. have a backlog but they have atleast put in place systems to tackle that
The problems we face are more structural in nature. Most countries would benchmark and adopt best working practices. In fact after Brexit when U.K. was required to renegotiate trade deals, they realised that they didn’t have a team with experience to head this area. So the entire international trade negotiation was awarded to an Australian citizen.
In India people would come on the streets if other than cricket and sports, we would take an external consultant for a key government area
The decision from RBI is not an isolated case. Many times these decisions are taken unilaterally with absolutely zero consultation with companies or people they will affect.
Somehow the lessons taught in IIM although helps the corporate world, the benefits of that brainpower and experience have to find a way into government.
superb write-up as usual! it does seem difficult for banks who will be lending and investing, interesting to see this. Maybe banks will scratch each other's backs by investing in a bank's fund which hasn't lent to that borrower.
I think you are missing one point.
Lets say BANK A has lent money to company B.
Now Company B has not given back money.
BANK A invests some money in AIF Fund which inturn invests in Company B ( Which is struggling because it could not pay back money to lenders ). Note this struggling part
Now what happens is the bank loses money on 2 fronts even if it gets back the money from company B.
1 Low quality of investment by bank which could have invested in other good companies
2 Liquidity shortage which affects the DEPOSITS.
Add to this as you said even more burden of maintaining the provisions.
This all seems like bad thing for banks and customers on the whole. Its like im lending 10 rupees, and investing 10 more rupees to get back the initial 10 rupees, It resulted in loss of time and money.
Pls correct if am wrong!
Agree on your point though that penalising the banks which does evergreening..
> If a bank makes a loan that goes bad, it has to then put the same amount of money in a vault that it can’t touch and give it a fancy name (“provisions”)
I am sorry I am quite ignorance of such things, but what is the justification for making banks do this?
It's a risk mitigation measure! If a bank lends say ₹100 to someone and that person doesn't pay it back, someone has to! The vault that I'm referring to here (called "provisions") is like the bank paying itself back for its failed loan. Something like, "Sure, my borrower didn't give me back the money I lent them but here is some money that I'm setting aside assuming I can never recover it again."
So if there is ever a bank run, for instance, the bank can use this money to pay back depositors.
As I mention in the footnotes though, there are some nuances to this. Not all bad loans have to be provisioned entirely. Typically, a 70% Provision Coverage Ratio is considered to be acceptable. That is, if a bank has made bad loans worth ₹100, it has to set aside ₹70.
wait but if the money go into a fund partially/completely going into bad loan then it would still be ok? on the book speaking
In the bank's books the loan wouldn't be bad. But in reality, the bank would still have lent money to a borrower that is likely to default on their loan. It's just pushing away the problem for later hoping that it goes away.
The underlying issue of this is also that RBI doesn’t want to make lending conditions a bit more stringent.
Most western banks won’t lend without a collateral
In the financial crises of 2008, the collateral was house price which they assumed and also overinflated but you don’t see a lot of business loan failures
The svb bank failure was due to them not hedging their interest rate exposure and even then the regulators had been warning them apparently
The second issue that faces not only this sector but probably the entire business and probably other sectors is the means to solve debt issues on courts at a faster pace. Sure countries like US and U.K. have a backlog but they have atleast put in place systems to tackle that
The problems we face are more structural in nature. Most countries would benchmark and adopt best working practices. In fact after Brexit when U.K. was required to renegotiate trade deals, they realised that they didn’t have a team with experience to head this area. So the entire international trade negotiation was awarded to an Australian citizen.
In India people would come on the streets if other than cricket and sports, we would take an external consultant for a key government area
The decision from RBI is not an isolated case. Many times these decisions are taken unilaterally with absolutely zero consultation with companies or people they will affect.
Somehow the lessons taught in IIM although helps the corporate world, the benefits of that brainpower and experience have to find a way into government.
Who was this Australian citizen who was entrusted with the entire international trade negotiation of a G7 country?