Rajan attacks banks for 'outsourcing' of risk assessment

Central bank governor Raghuram Rajan has urged Indian lenders to begin "rooting out the bad apples" amid rising corruption worries over public sector institutions, while calling for a shake-up in bank infrastructure lending.

Speaking in Mumbai, Mr Rajan said state-backed institutions needed to co-ordinate more closely to target graft, and criticised lenders for "outsourcing" their assessments of creditworthiness in large infrastructure projects, where frequent delays have left India's financial system facing a rising tide of bad debts.

In India many banks lending to infrastructure projects often rely on credit advice provided by external organisations such as consultancies or rating agencies, or assessments made by other banks, analysts say.

Confidence in state lenders, which control around three-quarters of assets, was shaken last month by a bribery scandal following the arrest of the head of Syndicate Bank, a mid-tier lender, on allegations of soliciting payments from a private sector steel company.

"There is a suggestion that there could be malfeasance," Mr Rajan said. "We do need to fully benefit from the strengths of the [public sector] system by rooting out the bad apples, the bad practices and the weak capabilities in the system."

With bad loans continuing to rise, Mr Rajan also called on banks to "take lessons" from past mistakes by introducing far-reaching changes to infrastructure lending practices, in anticipation of a ramp-up of "trillions of dollars" in new spending under Prime Minister Narendra Modi.

In particular the RBI governor criticised banks for "outsourcing" evaluation of major projects, rather than conducting analysis in-house, potentially leading institutions to miss early warnings of project delays or signs of corruption.

"Early recognition of project distress, or potentially of diversion of funds, needs co-ordinated responses among the banks," he said.

India is set to miss by a wide margin a target set by its previous government to plough $1tn into infrastructure over the five years to 2017, but most analysts expect investment to rebound as Mr Modi pushes forward with a range of Chinese-style investment projects.

Indian banks have traditionally funded sectors such as power and road development, given the country's shallow and under-developed corporate bond market, placing strain on lenders when projects are delayed.

Mr Rajan also reiterated his desire to push through a range of reforms to public sector bank governance, including splitting the traditionally powerful role of bank chairman to include a chief executive, and strengthening the role of bank boards.  

On Monday rating agency Fitch said India's banks would need more than $200bn in fresh capital by 2019 to meet Basel III capital requirements, while levels of stressed assets in Asia's third-largest economy would only peak next year.

Indian non-performing and restructured loans rose to 14 per cent of total loans at the end of the last financial year, up from 8 per cent in March 2011, according to Ambit, a Mumbai-based brokerage, using a measure combining non-performing and restructured assets. 

The ongoing rise in problem loans now threatens to choke off India's tentative economic recovery, as undercapitalised lenders stop offering fresh loans, analysts say.

Saurabh Mukherjea, head of institutional equities at Ambit, predicts "sluggish" credit growth of 14 per cent this financial year, compared with 22 per cent in the year ending March 2011.

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