New Delhi: The former governor of the Reserve Bank of India (RBI) Raghuram Rajan had red flagged “a list of high profile fraud cases of non-performing assets to the Prime Minister’s Office for coordinated investigation” and noted how the over-invoicing of imports by “unscrupulous promoters” was used to inflate the cost of capital equipment.

Incredibly, the “Rajan list” did not set alarm bells ringing.

Though Rajan does not mention the date he wrote to the PMO– setting off speculation in a section of the media that the prime minister who had been derelict was Manmohan Singh and not Narendra Modi – the Hindustan Times had reported in April 2015 that Rajan had written to the Modi PMO wanting action on bank frauds worth Rs 17,500 crore.

“The bank accounts cited by the RBI belong to Winsome Diamond and Jewellery, Zoom Developers, Tiwari Group, Surya Vinayak Industries, Deccan Chronicle Holdings, First Leasing Company of India, Biolor Industries, Surya Pharmaceuticals, Prime Impex / Prime Pulses and a person identified as Shivraj Puri”, the HT said, quoting unnamed sources.Of these, Winsome Diamond was finally booked by the CBI only in April 2017.

Rajan has referred to his attempt to sound the alarm on NPA fraud in a detailed 17-page reply to the estimates committee of parliament which, under the chairmanship of Murli Manohar Joshi, had sought his views on the NPA crisis.

Though the committee believes Rajan is referring to the incumbent when he said “PMO”, it is now considering asking him for the date he wrote to the PMO. At the same time, a committee member said this was not so relevant as the responsibility for action in fraud cases is clearly on the incumbent. “We are looking at the PMO as a continuum.”

Reason for NPAs

The former RBI governor said “a larger number of bad loans were originated in the period 2006-2008 when economic growth was strong, and previous infrastructure projects such as power plants had been completed on time and within budget. It is at such times that banks make mistakes. They extrapolate past growth and performance to the future. So they are willing to accept higher leverage in projects, and less promoter equity…. This is the historic phenomenon of irrational exuberance, common across countries at such a phase in the cycle.”

When growth slowed down following the global meltdown of financial markets in 2008, bank loans quickly came under stress.

Compounding the problem, said Rajan, was official foot-dragging on clearances. “A variety of governance problems such as the suspect allocation of coal mines coupled with the fear of investigation slowed down government decision making in Delhi, both in the UPA and the subsequent NDA governments… The continuing travails of the stranded power plants, even though India is short of power, suggests government decision making has not picked up sufficient pace to date.”

The absence of a proper bankruptcy code in this period made it difficult for banks to write off debt by penalising the debtor; the end result was the ever-greening of bad loans. However, malfeasance and fraud were also factors, said Rajan, and the reluctance of the system to act is a serious problem:

“The size of frauds in the public sector banking system have been increasing, though still small relative to the overall volume of NPAs. Frauds are different from normal NPAs in that the loss is because of a patently illegal action, by either the borrower or the banker. Unfortunately, the system has been singularly ineffective in bringing even a single high profile fraudster to book. As a result, fraud is not discouraged. “The investigative agencies blame the banks for labeling frauds much after the fraud has actually taken place, the bankers are slow because they know that once they call a transaction a fraud, they will be subject to harassment by the investigative agencies, without substantial progress in catching the crooks. The RBI set up a fraud monitoring cell when I was Governor to coordinate the early reporting of fraud cases to the investigative agencies. I also sent a list of high profile cases to the PMO urging that we coordinate action to bring at least one or two to book. I am not aware of progress on this front. This is a matter that should be addressed with urgency.” (emphasis added)

Bankruptcy process

In his reply to the committee, Rajan minced no words, writing that the “bankruptcy process is being tested by the large promoters with continuous and sometimes frivolous appeals.” Pointing out the obvious – that the judicial system is not equipped to deal with every bad loan – Rajan writes that “much loan renegotiation should be done under the shadow of the bankruptcy court not in it”.

In a scathing indictment of the huge NPAs racked up by the big defaulters, Rajan writes, “Banks and promoters have to strike deals outside of bankruptcy or if promoters prove uncooperative bankers should have the ability to proceed without them.”

While noting that the “culture of leniency” towards defaulters is changing in recent years, Rajan has cautioned the estimates committee against two much fancied ideas of the Modi government – a bad bank and mergers. He writes, “We need concentrated attention by a high level empowered and responsible group set up by the government on cleaning up the banks. Otherwise the same non-solutions (bad banks, management teams to take over stressed assets, bank mergers keep coming up and nothing really moves).”

The estimates committee has been tasked with identifying the reasons behind India’s nearly Rs 9 lakh crore bad loan pile.

Rajan has identified several reasons for this and says “writing down the debt is simply a gift to promoters and no banker wanted to be seen doing so and invite the attention of the investigative agencies.”

Rajan points out the malfeasance in the NPA problem and writes “unscrupulous promoters who inflated the cost of capital equipment through over invoicing were rarely checked. Public sector bankers continued financing the promoters even while private sector banks were getting out. Finally too many loans were made to well-connected promoters who have a history of defaulting on their loans”.

“How important was malfeasance and corruption in the NPA problem? Undoubtedly, there was some, but it is hard to tell banker exuberance, incompetence, and corruption apart,” writes Rajan, adding, “Unfortunately, the system has been singularly ineffective in bringing even a single high profile fraudster to book. As a result fraud is not discouraged.”

The problem of evergreening of loans is bluntly dissected by Rajan, by saying the “asset quality review was meant to stop the evergreening and concealment of bad loans and force banks to revive stalled projects. Until the Bankruptcy Code was enacted, promoters never believed that they were under serious threat of losing their firms. Even after it was enacted some are still playing the process hoping to regain control through proxy bidder at much lower price.”

Authoritative sources have confirmed that the PMO and Ministry of Finance received Rajan’s list, but no action was taken. Why Modi would not act on the “fraud NPAs” is a serious question which the government should not duck, says a member of the estimates committee.

Interestingly, Rajan had written back to the committee saying that as he was without secretarial help in the US, he would like some time to reply. Joshi granted him two weeks and Rajan used the time to provide the committee a guide to the NPA crisis.

Sources say that the parliamentary committee will now ask the principal secretary to the prime minister, Nripendra Mishra, and finance secretary Hasmukh Adhia to depose before it on why no action was taken on Rajan’s fraud list. Adhia has already deposed before the committee once.

The committee has also asked current RBI governor Urjit Patel to testify.

The biggest defaulters in India include Bhushan Steel, which has a loan default of Rs 44,478 crore, and Essar Steel promoted by the Ruia brothers which has loan default of Rs 37, 284 crore.

The full text of Raghuram Rajan’s note is appended below

Parliamentary Note – Raghuram Rajan by The Wire on Scribd

Note: In the first version of this article, published at noon, the headline said ‘Rajan gave Modi a list’. This headline was edited at 1 pm to say ‘Rajan gave PMO a list’ as he served two governments as RBI governor and his note does not specify whether Manmohan Singh or Modi was the prime minister at the time. Estimates Committee sources told The Wire they assume Rajan means the present PMO but in the light of confusion about the timing, are considering seeking further clarification from him about the date of the letter. The sources, however, insist the responsibility to act clearly carries over to the incumbent.

Note: This story has been updated at 17:38 on September 11, 2018 with details of the Hindustan Times report from April 2015 of the letter Rajan wrote to the PMO at the time.