Larger number of bad loans originated in 2006-2008: RBI ex-chief

A significant portion of India's non-performing assets (NPAs) originated during the country's high-growth period between 2006 and 2008, when banks became overly optimistic about economic and project performance, former Reserve Bank of India Governor Raghuram Rajan has said.

In a note submitted to Parliament's Estimates Committee on NPAs in public sector banks, Rajan said banks often based lending decisions on the assumption that strong growth would continue. This led them to accept higher levels of project debt and lower promoter equity.

"A larger number of bad loans originated in 2006-2008 when economic growth was strong," Rajan said, pointing out that earlier infrastructure projects, including power plants, had generally been completed on schedule and within budget.

According to him, the subsequent global economic slowdown, unrealistic demand projections, project cost overruns and delays in government decision-making combined to weaken the financial position of several large projects.

Rajan said some banks also relied too heavily on project reports prepared by investment banks hired by promoters instead of conducting independent due diligence before approving loans.

As projects were delayed, their costs increased and their ability to generate sufficient revenue to repay loans declined. He noted that the problems became particularly severe in the power sector, where several projects remained stranded despite India's continuing demand for electricity.

Rajan also highlighted governance-related issues, including the controversial allocation of coal mines and concerns over investigations, which contributed to delays in government decisions during both the United Progressive Alliance and subsequent NDA governments.

He said that when projects remained stalled for long periods, promoters with little equity left in them could lose interest in completing them. In such cases, he suggested that banks should consider restructuring the projects, writing down debt that was unlikely to be recovered and requiring promoters to bring in additional equity.

The former RBI governor also warned that potential credit risks associated with schemes such as MUDRA loans and Kisan Credit Cards should be examined more closely. He further described the Credit Guarantee Scheme for MSMEs, operated by SIDBI, as a growing contingent liability requiring urgent attention.

On agricultural loan waivers, Rajan cautioned that repeated waivers could weaken the country's credit culture. With elections approaching at the time, he called for an all-party understanding on the issue, arguing that predictable repayment behaviour is important for the health of the banking system.

The issue of NPAs had become a major political flashpoint, with the Congress and BJP trading accusations over the accumulation of bad loans in public sector banks. The Congress had also been pressing the government to announce loan waivers for farmers.

Rajan acknowledged that fraud and corruption contributed to the NPA crisis but said these factors did not explain the entire problem. He observed that bankers had at times become overconfident and failed to conduct adequate due diligence.

While fraud in public sector banking had been increasing, he said it remained relatively small compared with the overall volume of NPAs. However, he expressed concern about the inability of the system to bring high-profile financial fraudsters to justice, saying this lack of accountability could fail to deter future wrongdoing.

Rajan said the RBI had established a fraud monitoring cell during his tenure to improve coordination and ensure that suspected fraud cases were reported to investigative agencies at an early stage. He also said he had sent details of four high-profile cases to the Prime Minister's Office seeking coordinated action.

Another major concern, according to Rajan, was India's weak loan recovery mechanism. He noted that banks were able to recover only around 13 per cent of the amount involved in defaulted loans, giving promoters considerable leverage over lenders.

Rajan's assessment highlighted that India's NPA problem was not the result of a single factor but developed through a combination of aggressive lending during the boom years, weak due diligence, project delays, rising costs, governance problems, fraud and an inefficient recovery system.