Not Taking Risk is a Greater Risk

When I was heading CPC (Credit Processing Centre) in 2008 at Mumbai, I was getting requests from various branches linked to my CPC for sanctioning loans to Kingfisher Airlines (Vijay Mallya).

It was not unusual, as it was a sunrise industry at that time. In order to increase the profitability of the branch, such big ticket advances are preferred. Though I couldn’t sanction any loan to Kingfisher, as our administrative office had already crossed the prudential limit.

Now the question arises what happened to Kingfisher, whose loan amount exceeded Rs 9000 crore and whose owner escaped from the country in March, 2016 and now living in UK as a fugitive. But why should banks in the first place have gone to give loans to this company?

Let me add here. When I was in Commercial branch, we received a proposal to grant loan to the tune of Rs 4250 crore to Mukesh Ambani’s Reliance for immediate family settlement of division with his younger brother, Anil. We got proposals from different banks to the tune of more than 12000 crore, and as a consortium leader, it was very difficult to satisfy all banks and finally we accepted offers from 5 banks only.

Now see the difference between the two cases mentioned above. For good companies like Tatas, Birlas etc, there is no dearth of loans, as these companies are considered safe and less risky. नाम ही काफी है (Name is enough).

Before granting a loan, a bank assess its own risk appetite as also the risk grade of the borrower. When there is low risk, loans are given expeditiously, and on lower interest rate. But nobody knows what is hidden in the womb of future. That’s why, it’s safely assumed that almost 8 to 10 percent of loans turn bad in the next 15 years.

During the course of business, companies encounter problems like mismanagement, government regulations or even embezzlement or diversion of funds, as we saw in cases of Electrosteel, ABG Shipyard, Firestar Diamond, Winsome Diamonds and Jewellery etc.

Now the question is why banks’ monitoring and supervision go for a toss. Yes, it happens in some cases, but banks are vigilant enough to assess the incipient sickness in the accounts well in time. Take for example, Kingfisher Airlines and Vijay Mallya, the King of Good Times.

Corporate ethics were compromised in the merger between Kingfisher Airlines and Deccan Aviation Ltd, which was already incurring losses. It was compounded with adverse government policies and failure of aviation engines. After these developments, it was into a complete shambles, and banks started declaring it as NPA in 2011-12 itself, but due to the government’s interference, its transactions continued even thereafter.

Now talking about government’s interest, it may be sometimes genuine to help out a beleagured company or it may also be a simple conspiracy to defraud banks. This is precisely the reason why public sector banks account for a major share of the amount involved in banking frauds compared to private sector banks.

In this context, a simple question arises, why such big chunks of loans are waived or written off, while others are pressurised to pay loans well in time. First of all, waiver or write off is a misnomer here. It’s simply an accounting entry, by which a bank transfers an item from the active book of accounts to written off account to receive a tax deduction from the loan value, but the bank still pursues the debt recovery by means of selling the assets or by arresting the culprit with court intervention.

Finally, one more question arises, “Why banks give loans, when it’s so risky?” Banks take deposit from customers, and if they don’t lend, they won’t be in position to pay interest on deposits. Yes, it’s a risky affair, but banks have to play with risks. Not taking risks is a greater risk.

–Kaushal Kishore

19 Comments

    1. Thank you for your kind words. I agree, but RBI issues broad guidelines only. Risk Assessment models and micro procedures like fixing of risk grades and prudential limits etc are to be devised by the respective banks as per their SWOT analysis.

      Liked by 1 person

    1. There is no guesswork. There is clear grading of potential borrowers as per credit risk model. If permissible as per risk appetite, only then banks go ahead. Thank you.

      Liked by 2 people

      1. Yes, Sanjeet, you are right. Credit risk models are statistical techniques used by credit officers of banks to measure credit risk using different parameters like credit history, rating agency data, probability of default (PD), loss given default (LGD) and inputs from own economic stress scenario to determine the expected losses the bank may suffer if loan is given to a particular borrower. This helps bank in deciding go or no go.

        Liked by 2 people

  1. Thank you, Kaushal, for explaining bank practices and the reason for risk-taking.
    I know that if we did not take any risks at the beginning of the human endeavor, we would still be sitting on the trees or living in caves.

    Joanna

    Liked by 3 people

    1. Very well said, Joanna, that is the basic reason to take risk. Lending in itself is a risky business, but if we don’t go for it, the very existence of banks would be jeopardised. Thank you so much for your kind words!

      Liked by 1 person

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