On your balance sheet

Indian companies as well as banks have been asking the RBI to lift the ban on banks guaranteeing loans raised by corporates in global markets. Given the abundant foreign exchange reserves, the policy might well change.

Doing so would be a bad idea. So far, one of the reasons why the Indian banking sector has remained isolated from Latin American types of currency crises is that corporates haven’t borrowed too much overseas and, to the extent they have, it has been on the strength of their own balance sheets, not those of their bank.

Allow banks to guarantee overseas debt, and they will have to struggle with asset-liability mismatches, not just in rupees, but also in different currencies, with all the attendant risks associated with currency movements.

In any case, the guiding principle should not be whether the country has abundant foreign exchange reserves to carry out such an adventure, but whether the company which seeks to do the borrowing has enough credibility to borrow the money.

If foreign lenders think the Indian company being lent to is a sound one, they should take the risk based on the company’s balance sheet; why should Indian banks be guaranteeing such loans?

Anyone familiar with the kind of bad loans made by Indian banks should know there’s a serious probability that such guarantees will be given without much by way of due diligence.

It’s one thing for a bank to give a dud loan in Indian rupees, and quite another to subject the country to a currency risk as well. In any case, the RBI allows companies full freedom to raise money abroad for takeovers or business expansion, so the case for further changes in the policy is weaker today.

While the Reserve Bank is yet to make up its mind on the matter, a similar issue on which the Bank appears to have made up its mind is that relating to allowing foreign banks to take over banks in India. Though allowing such takeovers is certain to be viewed as “pro-reforms”, it too is a bad idea.

While there is nothing wrong with allowing foreign banks to expand in India, this has to be done as branches of the global parent so that, in the case of a problem, the Indian public has recourse to the bank’s global balance sheet.

Allowing foreign banks to take over Indian banks will mean that if the newly-owned bank gets into the kind of misadventures that Global Trust Bank did for instance, thanks to the limited liability laws, the foreign bank’s liability will be restricted to just its equity in the bank it has taken over.

Depositors in the bank will once again get left in the cold, putting pressure on the government to come to the rescue—as it has in the case of GTB. Why should Indian taxpayers’ funds be used to provide a cushion to foreign banks?

This has been the RBI’s unstated policy so far, and it would not change something so sensible.