Indeed it must be, for India's banks are already staggering under a mountain of nonperforming loans. Years of lax controls and politically dictated lending have left the banks holding $23 billion in bad debts--more than a fifth of their loan portfolios, according to the government. That far exceeds the 15% ratio for nonperforming loans in the Japanese banking system and the 1.5% ratio common in the U.S. and Western Europe. "The financial system is under threat," says Subir Gokarn, chief economist with top Indian rating agency Crisil. "A few more collapses will take the system beyond the government's capacity to bail it out and make even healthier institutions vulnerable. This is the abyss that we look into."
The bad-loan problem largely afflicts the state-owned banks, which control more than 80% of the country's banking assets. The government has long misused these banks to rescue failing institutions or to funnel money to favored projects--the bailout of a bankrupt steel mill in one state, the construction of an unneeded chemical plant in another--that had little hope of paying off. And in a scathing indictment, a study to be released soon by McKinsey & Co. finds that the productivity of Indian banks is a mere one-tenth that of U.S. banks. "We need a lot of reform, especially on the legislative side, like effective foreclosure laws and an asset-reconstruction company, and more computerization," says IDBI's Doda.
Now, the banking system has become so dysfunctional that it's slowing the economy. Banks are increasingly wary of lending to businesses, starving even promising sectors of capital. Real bank reform could boost economic growth by 1% to 2% a year, according to McKinsey. "These banks have all the symptoms--nonperforming assets, poor productivity, inability to raise capital from the market--that precede a crisis," says Joydeep Sengupta, a partner with McKinsey in India.
Unlike Japan and China, which have been trying to tackle their bad loans for a decade, India has yet to confront its banking problems. Instead, the government routinely bails out the banks that are in the deepest trouble. In February, IDBI asked for, and got, $458 million. Last August, the government organized a $215 million bailout of the Industrial Finance Corporation of India. State-owned banks, in fact, have higher credit ratings than the Indian government because the market is confident that the government will always rescue them.
With no reform in sight, some state-owned banks are trying to fix themselves. They're tightening their lending criteria and strengthening their accounting and corporate governance. Some have created retail subsidiaries that aim to operate like private-sector banks. Industrial Credit & Investment Corp. of India has gone the furthest. Sound enough to list on the New York Stock Exchange in 1999, it has adopted U.S. accounting standards, written off $100 million in bad loans each year, and expanded rapidly into retail banking, setting up 360 branches in 100 cities. But ICICI is very much the exception.
Against this gloomy backdrop, selling the Dabhol plant would be a bright spot. The banks would then get a chunk of their Enron loans back--perhaps as much as 70%, according to Bombay-based Enam Securities. But that won't do anything for the hundreds of other failed projects still festering on the banks' books. By Manjeet Kripalani in Bombay