Many years ago, while I was sitting with the chairman of a Public Sector Undertaking (PSU) bank, a phone call was put through to him. The chairman immediately started talking in Telugu, not realizing that I understand it because it is my native language.

The person at the other end of the call was a minister who was asking the bank to approve a loan to a company whose promoter had doubtful credentials. He also had a terrible record of repayments. All that I could hear from the chairman translated into “it will be done.”

The massive loss of 110 billion rupees (US$1.77 billion) due to an alleged scam by Nirav Modi and associates is a prime example of a deeper rot that exists in India’s banking sector. The PSU banks are milked dry by politicians and their cronies, and while ordinary citizens have to struggle to borrow money, those with connections continue to milk the system.

Many of the current problems in India’s banks and their non-performing assets (NPAs) stem from the collusion and influence-peddling that happen for sanctioning loans. This leads to extensions, moratoriums and restructuring packages. With most banks having directors and even independent directors appointed by the government of India, crony capitalism has its feet firmly stuck in the muck. This is not to say that all NPAs are due to bad intent.

We have now come to a stage where we can no longer look the other way on Ponzi schemes masquerading as debt-restructuring packages. So the central Reserve Bank of India (RBI), in a midnight swoop, changed all the rules regarding any restructuring packages that are granted to corporates that fail to meet loan obligations.

We have now come to a stage where we can no longer look the other way on Ponzi schemes masquerading as debt-restructuring packages. So the RBI, in a midnight swoop, changed all the rules

Most corporates have been using the “Corporate Debt Restructuring Package” or the “Strategic Debt Restructuring” package avoid being tagged as as a loan defaulter. Most of such packages involve changing the original terms of an agreement to avoid a default, thus enabling them to seek loans through newer entities floated by the same promoters. They get fresh loans to repay old loans and garner some interest-rate reductions, converting debt into equity, with moratoriums on payments and even haircuts to banks.

Consider the following cases.

In March 2011, a consortium of 13 lenders, including the State Bank of India (SBI) and ICICI Bank, converted 7.5 billion rupees of debt into an equity of 23.21% stake in Kingfisher Airlines promoted by liquor baron Vijay Mallya at a 61.6% premium over its prevailing share price.

Another group, owned by a minister in the current government, is a great example of how banks continue to finance a loan that should have been called out as bad. The figures on a consolidated basis for the year ending March 2017 were: One company in the group has total current liabilities of 25.69 billion rupees backed by receivables of 24 billion rupees. The total turnover is 16.12 billion rupees. The receivables are 18 months of turnover. And the market cap is 160 million rupees.

Another of the group’s companies, which is into metals, has been renamed, probably to avoid scrutiny. It has total liabilities of 29.24 billion rupees backed by receivables of 21.66 billion rupees and inventories of 2.54 billion rupees. The total turnover is 15.61 billion rupees. The receivables are 17 months of the turnover. The market cap is 430 million rupees.

A third company, also renamed recently, has total liabilities of 34.3 billon rupees and receivables of 20.61 billion rupees. Total revenue is 2.45 billion rupees, and the interest cost alone is 2.93 billion rupees and losses are 4.59 billion rupees. Its market cap is 240 million rupees.

In all, we have a group of companies, owned by a minister in the current government, with liabilities (mostly bank borrowings) of 89.23 billion rupees and a market cap of 930 million rupees!

Another company, Essar Steel, with a debt of close to 45 billion rupees ($704 million) and which went through bankruptcy proceedings, is currently seeing one of its own promoter-related families bidding to buy back the company at $6 billion.

The current move by the RBI will lead to a bloodbath in bank balance sheets over the next six quarters. I suspect that the banks got wind of it over the past few months. Most PSU banks hiked their NPA provisions, forcing 17 of the 23 banks to declare losses for the first time in two decades. This forceful measure by the RBI will increase gross NPAs by at least 50%.

What banks refused to recognize for years, they will now be forced to acknowledge in the next few quarters. There will be less space for the banks to lend and expand credit because of the capital-adequacy ratios. The banks will become more collection agents and loan-recovery officers than lending banks.

The companies with debt on their books will have to come clean in any loan renegotiation. More companies will stand exposed in the next few quarters.

In the short term, the scenario is bleak. But the cleaning up of bank balance sheets and greater transparency were much needed, and is a courageous move by the RBI.

But with the current political bickering, an environment of fear and also a desperate need for investment to make the economy grow, this could have a downturn effect in the next few quarters. It is time to fasten our seat belts as we carry out high-risk maneuvers.