Chief Economic Advisor Krishnamurthy Subramanian on Tuesday said that the financial sector must acknowledge the problem of crony lending and take the responsibility to ensure capital is allocated optimally.

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“Crony lending is the elephant in the room that we have to acknowledge. Financial sector in India has to take responsibility that it is the ultimate arbiter of capital and ensure optimal capital allocation,” the chief economic advisor said, adding that avoiding crony lending like plague has to be the mantra for the financial services sector.

Subramanian said that the quality of lending has remained the key challenge for the banks since the early 1990s, especially when it came to large loans in the infrastructure sector.

“Banks need to ensure that capital allocation to the infrastructure sector is to creditworthy borrowers. Crony lending has been a problem in the banking system. The Economic Survey also highlighted that the banking sector’s problems originated from large loans that were not necessarily lent to the most creditworthy borrowers. This problem gets far more accentuated in the context of infrastructure. Financial institutions especially need to be working on this,” he said.

Speaking at a FICCI event on ‘Distressed Debt in Indian Infrastructure Sector – Special focus on EPC’, Subramanian said that the country is now focusing on growth through infrastructure in a sustained manner. “This is the time when the financial sector should take the leadership role and assume the onerous responsibility for infrastructure growth. For the macroeconomy, the financial sector plays a very critical role,” he added.

The chief economic advisor suggested that the compensation of senior management in banks must be linked to the quality of credit, and there should be a claw-back provision in instances of ever-greening of loans or zombie lending.

“The board of directors cannot be asleep at the wheel,” he said, adding that auditors are the first line of defence on this. "Auditors cannot say this is something they cannot do. Data analytics can do. Zombie lending and evergreening should be avoided as they lead to suboptimal capital allocation," Subramanian said.

Subramanian said the size of the financial sector remains very small compared to the size of the overall economy on any parameter. “That is mainly because of the financial sector as a whole is still to figure out a model to make large corporate loans and large infrastructure loans, which is a subset of that, in a way that does not lead to non-performing assets," he noted.

Banks lack the specialised expertise required for infrastructure lending, Subramanian said, adding that financial institutions need to be extra careful now that India is once again in a period of forbearance, referring to the one-time restructuring scheme allowed by the Reserve Bank of India.

Non-performing assets in the infrastructure sector remain high, with gross bad loans estimated at around 18 percent of the total loans in the sector. Subramanian said while the government has made a big push towards infrastructure in the budget, banks need to shoulder the responsibility of optimal capital allocation to the sector.

(Edited by : Aditi Gautam)

First Published:Mar 9, 2021 5:20 PM IST