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Jet Airways Crisis: Moral Hazard of State-Run Banks and Why Taxpayers are Forced to Cover for Blunders of Businessmen

Moral hazard is the risk that a party has not entered into a contract in good faith. In Indian context, it ends up involving the government since banks like the SBI are state-run.

Ravi Shanker Kapoor |

Updated:April 22, 2019, 12:29 PM IST

Several arguments, all of them valid, have been made for the denationalisation or privatisation of public sector banks (PSBs). This will free banking from the stranglehold of politicians and bureaucrats, give them more autonomy, make them more efficient, enhance enterprise value, and so on.

But few, if anybody, have pointed out that the privatisation of PSBs will also remove the moral hazard that state-run banks pose to not just big companies but also banking per se, indeed to the entire economy. The fall of Jet Airways underlines this fact.

“Moral hazard,” defines www.investopedia.com, “is the risk that a party has not entered into a contract in good faith or has provided misleading information about its assets, liabilities, or credit capacity. In addition, moral hazard also may mean a party has an incentive to take unusual risks in a desperate attempt to earn a profit before the contract settles. Moral hazards can be present any time two parties come into agreement with one another. Each party in a contract may have the opportunity to gain from acting contrary to the principles laid out by the agreement.”

In the Indian context, moral hazard often, and most importantly, involves a third party: government. Even when it is not involved in the original contract. Its occurrence and functioning is very simple.

Consider a successful restaurateur who has decided to start a chain, for which he needs money. If he is able to convince an investor, private equity or PE fund, etc., to finance his project, those putting in money would do due diligence and take a call. If everything goes well, everybody makes profit; if it doesn’t, everybody suffers in proportion of the exposure they have taken.

There’s nothing unusual about it; it should be like that only. And, to be sure, it’s like that in most cases in India. But most, not all.

When big projects and big companies are involved, the third party, government, gets involved — willingly or unwittingly, directly or indirectly. As J Paul Getty, the American tycoon who was the richest private individual in 1966, once said, “If you owe the bank $100 that’s your problem. If you owe the bank $100 million, that’s the bank’s problem.”

The government comes into the picture not just because big industrialists can manage it, but also because most banks are owned by it. Hence moral hazard, the burden of which is borne by the taxpayer, for ultimately it is he who has to pay for the bad decisions and profligacy of our business magnates.

This is also the reason that while in our country industries go sick, industrialists continue to thrive. So, when Jet was flying high, so was Goyal, appearing in the Forbes 2005 list as the 16th richest Indian with a net worth of $1.9 billion. Now that Jet is gasping for breath, there is nothing to show that he is anywhere near bankruptcy.

Perhaps the government was forced to what has been called “a backdoor nationalisation of Jet Airways Ltd”, for most lenders are PSBs. In effect, now the taxpayer has to bear not one but two ‘national carriers’. National because the nation carries them rather than the other way around!

When a big company goes down, it’s not just the shareholders and employees who get hurt, but many more. It also leads to, what former chief economic adviser Arvind Subramanian called, the twin balance-sheet problem: along with the falling firm fall its bankers. It’s not a case of Humpty Dumpty falling from a wall; it’s the wall falling under the weight of Humpty Dumpty.

The State Bank of India, Jet’s biggest lender, is the country’s biggest bank, so it can absorb a lot of shocks. But hurt it does get; for instance, the day Jet stopped operations indefinitely, the SBI’s stock fell by 2.4 per cent, the biggest intraday drop in weeks.

A few days ago, the SBI-led consortium of lenders expressed optimism about getting a buyer for Jet. “The lenders, after due deliberations, decided that the best way forward for the survival of Jet Airways is to get the binding bids from potential investors who have expressed EOI (Expression of Interest) and have been issued bid documents on April 16,” they said in a statement.

“Lenders are reasonably hopeful that the bid process is likely to be successful in determining fair value of the enterprise in a transparent manner.”

One hopes that this happens; this will save taxpayer money and thousands of jobs. But this will be succour for one company and those whose interests are involved in it, not a cure banking; it will continue to suffer such convulsions till moral hazard is eliminated; and this cannot be done without bank privatisation.

(The author is a freelance journalist. Views are personal)

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| Edited by: Nitya Thirumalai
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