The Billionaire Raj

by James Crabtree

  At the time, official data showed around a tenth of India’s bank loans had gone bad, one of the worst records in Asia. The figures were weaker still at the public sector lenders, which controlled about three quarters of India’s banking market, and also dominated lending to larger industrial companies. That many of these banks were in a state of some financial disrepair was no secret. Rajan had moved into the RBI governor’s mansion, just down the street from Mukesh Ambani’s Antilia on Altamount Road, only a few weeks after the release of the second “House of Debt” report, which made clear enough the parlous state of many of the banks’ balance sheets. But for years Mumbai insiders gossiped that the true extent of the banks’ problem was actually much worse: the result, it was said, of a system in which industrialists often simply bribed their lenders to provide them with new loans, while barely worrying about whether they could actually be repaid. If things went awry, the tycoons could always use their connections in New Delhi, applying political muscle to pressure their lenders to go easy on repayments, or to begin generous restructuring of existing loans, or to swap debt for equity on favorable terms. At its worst this was known as “ever-greening,” a ruse by which companies struggling to repay one loan from a bank would simply be given another, and quietly use the money from the second to repay the first, delaying their financial day of reckoning until some far-off future date.

  In his earliest days at the RBI, Rajan asked P. J. Nayak, a soft-spoken former India head of Morgan Stanley, the US investment bank, to lead a commission examining why the state banks were so badly run. Nayak’s report, published in mid-2014, painted a grim picture of uncompetitive, capital-starved institutions, led by cautious bureaucrats and hobbled by political interference.16 India’s bad-loan problems were likely to get worse, Nayak argued, requiring yet more emergency capital to be pumped in by the government to keep them afloat. Yet without drastic changes to the way the banks were run, even this recapitalization would simply mean throwing more good money after bad.

  Inside the RBI, Rajan’s main weapon to monitor the banks was a small army of inspectors: assiduous bureaucrats who kept tabs on financial institutions, making sure they weren’t getting into trouble. After Nayak’s report, he told his inspectors to look more carefully at the banks. The inspectors began to dig, pressing executives for answers about the state of their books. Their findings revealed a distressing picture. Many big loans, officially in good shape, had actually gone bad and were never likely to be repaid. Meanwhile major industrial projects that were officially said to be in good shape were in fact stuck in some political logjam or other, while bleeding money for their bankers and owners alike. “I got a sense that the numbers were hiding a darker problem,” Rajan admitted. “And that was when we said we really needed to uncover the size of the hole.”

  By this time a sense of hope had returned to India’s economy, as the market panic of 2013 petered out and business newspapers hailed a “Rajan rally” in honor of the country’s sure-footed central bank chief.17 More important was Narendra Modi’s election in mid-2014, and the hopes for reform he brought with him. Optimists predicted a shake-up of the banking system, with its public sector laggards put under new management, or perhaps even placed into private hands. But despite this, the underlying bad-loans problems only grew worse. Hopes that Modi would restart moribund power and steel projects—two major sources of bad loans—proved illusory. With each passing quarter these loan problems ticked up. To get a grip on the issue, Rajan launched an innocuous internal project the following year, known as the asset quality review. A special team scoured the bank’s loan books, forcing them to reveal their problems, and building for the first time a complete picture of the bad loans on their books. Yet even having steeled himself, Rajan was stunned. “It was at least two or three times what I expected, it was quite shocking,” he told me. “Then we had the issue of how to get them [the banks] to “fess up that this was there.”

  Part of what Rajan’s team discovered was problems of outright corruption. From time to time a scandal would erupt in which police caught a financier accepting cash. The chairman of Syndicate Bank, an undistinguished midsized lender, was arrested in 2014, on charges of accepting a bribe in exchange for giving a loan to a struggling steel tycoon, before being released on bail.18 (The case remained pending at the time of writing). These public cases were rare, but the wider system was thought to be riddled with similar smaller examples, from managers accepting fancy watches to executives finding clever ways to restructure old loans or offer new ones in exchange for cash.

  “Typically a corrupt [bank] boss uses senior executives…for sanctioning loans to undeserving borrowers and pockets a small portion of the loan amount,” Tamal Bandyopadhyay, a finance expert, wrote after another bank chairman was charged with accepting bribes in 2016.19 I was often told that the country’s cleverest industrialists found ways to parachute pliant bankers into positions where they could help them get loans approved. This was hard to verify, but given the generous terms on which many loans were given to otherwise hopeless businesses, it didn’t seem entirely far-fetched. “I met with a number of retired chairmen of banks, and the kinds of stories they told me about dishonesty in the banks were really extraordinary,” P. J. Nayak told me later, talking about the research process for his report. “There is corruption in the system, and there is no point pretending otherwise.”

  Yet, as Rajan explained, graft was not the real problem facing India’s financial system. Instead, it was the subtler but more significant power imbalance between creditors and the tycoons to whom they lent. It was not just that the banks were run badly. Rather, it was that they lacked the tools that financial institutions in most other countries deployed to keep their borrowers in line. One problem was information, given that lenders were unable or unwilling to dig into the overall condition of the conglomerates themselves, or to find out whether their owners were shifting debts around between companies. India also had no functioning bankruptcy rules, which made it all but impossible to kick out owners at a failing company and sell off its assets. Capital was expensive in India largely because it was so hard to get it back if things went wrong.

  In most countries, entrepreneurs who hit a rough patch were forced to plead with their bankers to keep their companies, and would therefore take whatever deal their lenders offered. But in India the deals worked the other way round. “The essential game was that if you were an industrialist, and you got into trouble, then you don’t have to pay back unless you want to,” Rajan told me. “And the only reason you want to pay up on one loan, is if you want to get more loans in return.”

  Battles Half Won

  Rather than poring over their balance sheets, just walking into a branch gives a clear sense of the weaknesses of most Indian public sector banks. Syndicate, the lender whose chairman was arrested in 2014, had a ramshackle outlet just next to my office in southern Mumbai, with an ATM I used to use from time to time. The bank’s orange logo featured an Alsatian dog and the slogan “faithful and friendly.” Inside it was all shabby furniture, piles of yellowing paper, and slow-moving clerks. The single cash machine normally did not work. Barely half of Indians had bank accounts, but those that did mostly used branches like this, attracted by their safe and sober reputations.

  Institutions like Syndicate were not run directly by the government: they tended to be listed on stock exchanges, but with the state holding most of the shares. But the government still exerted control via thickets of rules put in place after Indira Gandhi’s bank nationalization in 1969. Although they were inefficient, savers thought these public banks reliable, with implicit public backing if things ever went wrong. Entry-level positions were much sought after, offering lifetime job security and reasonable benefits. Senior managers were paid poorly compared to the private sector: Arundhati Bhattacharya at State Bank of India, the largest lender, earned roughly $45,000 a year.20 But these jobs were prestigious, and came with
other perks, like free fancy bungalows. The system overall rewarded safe pairs of hands. It even had its own name: “lazy banking,” a term used to mock bankers who fled from risk and happily placed most of their capital in ultra-safe government bonds.21

  This ultra-cautious reputation made the reckless lending spree that India’s bankers had begun all the more surprising. “I remember talking to one of the well-known construction promoters, and he told me that he had these guys [the bankers] running after him with checkbooks,” Rajan recalled. “They were begging to lend.” The banks had found it easy to raise money, with global interest rates during the 2000s at unusually low levels. But times looked good domestically too. Most of the big projects built in the early 2000s had done well, and their loans had been easily repaid. The assumption had been that this could now be repeated on a far larger scale.

  The industrialists were exuberant about India’s future, showing an enthusiasm that soon infected supposedly risk-averse bankers too. Vijay Mallya’s Kingfisher was one obvious example. When things began to go wrong, the banks restructured the tycoon’s loans and gave him more time to fix his finances, while also swapping debt for equity at generous rates.22 When it became clear that Mallya was not going to be able to repay, they were stuck. They had no legal means to take control of Kingfisher, or even to force Mallya to repay what he could. The power imbalance between lender and debtor was too great.

  Despite this, Rajan’s efforts did begin to have an effect. There were a few high-profile examples, notably Mallya himself, where banks gradually moved to seize assets, including his villas and planes. The sight of a tycoon of Mallya’s stature being pressed for repayments had a chilling effect on others with heavy debts. In private, the industrialists complained of a witch-hunt. “The promoters ran to Delhi…and started complaining, and to Delhi’s credit, they said, ‘You have to deal with it yourself,’ ” Rajan recalled. Prime Minister Modi showed little enthusiasm for a radical banking shake-up, and ruled out privatization, but he did promise a new era of “no interference” by politicians in bank lending.23 In New Delhi, Jayant Sinha, Rajan’s former classmate, had been given a portfolio that included pushing for banking reform. He helped Modi’s government develop a new package of banking reforms, which included a new bankruptcy bill, injections of extra capital for struggling state lenders, and the promise of new management. The idea was to solve three issues at once: force the banks to admit their problems, give them more money to get through them, and help them grapple with their debtors; “recognition, recapitalization, and resolution,” as Sinha put it.

  Yet to put the system right, Indian bankers needed to act more like lenders in other countries: writing down debts, forcing companies to sell assets, and getting tough and kicking out their management. Every step of this chain proved difficult, however. Banks that wrote down debts risked being accused of cronyism, for in effect letting an indebted tycoon off the hook. Attempts to remove a promoter by force would end up in court. “The legal challenges could just tie you up in knots,” Arundhati Bhattacharya told me in 2014.

  Potential purchasers of distressed assets, from power projects to toll roads, were wary too, fearing that they would run into bureaucratic hurdles, or end up in disputes with the previous owners. Even lenders who did want to act forcefully had their hands tied, because Indian banks tended to lend in groups. Vijay Mallya’s debts, for instance, were spread over a consortium of no fewer than seventeen lenders, all of whom had to agree on how to chase the tycoon down. In theory this spread risk, but mostly it provided an excuse for inaction. “They [the banks] have been a little bit like deer in the headlights, paralyzed by the risk,” Rajan told me. “They have this powerful incentive to think, why should you upset the apple cart when maybe you are three months away from retirement, and this will get everyone so upset?”

  During 2016, Ashish Gupta flew to New Delhi to give a private presentation to officials in the Finance Ministry. In it he hinted that the bad-debt problem would end up close to twenty percent of all loans, a staggeringly high number. Even then, many troubled projects still had not been recognized as “nonperforming,” meaning that their debts were never likely to be repaid. Many of these projects were delayed, or had simply run out of money, meaning that the tycoon had also lost interest, given that such equity as they had put in was now worthless. Much of the Rs390 billion ($6 billion) in debts built by Lagadapati Rajagopal at Lanco was yet to be classified as bad, for instance. Even in cases like these, banks and borrowers still tended to claim that things would come good. Yet this was normally an illusion used to justify giving the debtor more time to repay—an approach known as “extend and pretend.”

  This slow progress reflected deeper political problems, as Arvind Subramanian, the government’s chief economic adviser, later explained to me. Almost everyone involved knew that some kind of deal was needed to fix India’s broken industrial economy. Pain had to be shared: banks needed to write down debt; companies needed to sell assets and raise new funds; and the government needed to help companies with stuck projects and give extra capital to state banks. The problem was that any action seen to be doing favors for tycoons was politically toxic. Once big investment deals went off the rails, there was no easy way to recover the money and no legal means to kill off debt-laden zombie companies. This predicament marked, Subramanian argued, a shift in India’s economic development. Under the old socialist system, companies were unable to enter new markets, either because private players were banned or because complex licenses protected incumbents. Liberalization changed that. But now, in a host of sectors—power, steel, construction, aviation, and even banking itself—capital was stuck inside struggling enterprises. India had moved from “socialism with restricted entry to capitalism without any hope of exit,” as Subramanian put it. Creative destruction was not being allowed to work. The system was stuck.

  Mild-mannered by temperament, Rajan was an odd figure to try and break all this open. His was an establishment background: although he did not know it as a child, his father was one of India’s most senior spies, and a founding member of the equivalent of America’s Central Intelligence Agency, or Britain’s MI6. Before leaving for America, he had studied at the Indian Institute of Technology in Delhi, then the Indian Institute of Management in Ahmedabad, the twin training grounds of the country’s corporate elite. Although inventive, his economic views were fairly orthodox, with a faith in markets and a suspicion of government. Yet his distaste for cronyism also had a clear moral edge. “Some people in India were very rich not because they were good businessmen but because they knew how to work the system,” he told me. “I wanted to bring capitalism back, which is a system where you get the rewards if you take the risks, but not more than that.” Before moving back to India he coauthored a book that summed up his intellectual views: Saving Capitalism from the Capitalists.

  The problem in the end was not that Rajan lacked the temperament for the fight, but that he lacked the time. India’s central bank governors typically serve two terms of three years each. But one Saturday afternoon in June 2016, Rajan issued an unexpected statement saying that after “due reflection” he would quit after only one.24

  The news sent India’s hyperactive rumor mill spinning. Rajan offered no explanation, beyond saying it was time to return to academia. Friends hinted at the special interests that had been stacked against him. “Though it was the right thing, this policy has produced collateral damage,” wrote Luigi Zingales, a coauthor and colleague at Chicago, suggesting that Rajan’s battle against crony capitalism had been in some way responsible for his departure, and blaming “those Indian oligarchs who had enjoyed easy credit.”25 Rajan’s habit of giving politically tinged speeches had also caused disquiet in New Delhi, irking some hard-line Modi allies. But media reports pondered whether anxious industrialists had also pressed for his sacking. Whether they did or not, the bankers and tycoons were surely glad to see him go. Worse, le
ss than a month after Rajan’s exit, Jayant Sinha was shifted too, shunted aside to a different junior ministerial post in a cabinet reshuffle.26 Together, the duo had tried to reform India’s broken banking system and bring the worst excesses of its cronyism back under control. Their departures left that job at best half done.

  Sinha put a gloss on what had been achieved. “India is on a journey to a new system of capitalism, in which the cronyism of old is being swept away,” he told me, after he had switched jobs. “The prime minister [Modi] is fully committed to this, and while that journey is not completed yet, there is no going back.” By the time he and Rajan departed, the banks’ problems were at least out in the open, even if the debt problems were far from fixed. The basic structure of the old state-dominated banking system also remained in place. Most state banks remained in financial trouble; indeed, having finally confessed to the true extent of their bad loans, many were actually in worse shape than when Rajan arrived. Most of the fixes suggested by P. J. Nayak’s commission were ignored. “In my report, we said, ‘If you don’t act quickly and radically the problem will get much worse,’ and it has got much worse,” Nayak told me in 2017. The culture of inaction among India’s public banks remained. Even today, it still seems unlikely that the cautious banker Rajan gently mocked in his story—the man who punished an errant tycoon by timidly cutting his credit line—would have acted more boldly.