How India Avoided a CrisisBy JOE NOCERA
MUMBAI
How could USA has brought so much trouble on Americans, and the rest of the world, by acting in such an obviously foolhardy manner?
Didn’t USA banking system understand that they can’t lend money to people who lack the means to pay it back?
Like most Americans, I didn’t have any good answers. It was a bubble.
Chandra Kochhar, ICICI“In India, we never had anything close to the sub-prime loan,”
“All lending to individuals is based on their income. That is a big difference between USA banking system and ours.”
“Indian banks are not levered like American banks. Capital ratios are 12 and 13 percent, instead of 7 or 8 percent. All those exotic structures like C.D.O. and securitizations are a very tiny part of our banking system. So a lot of the temptations didn’t exist.”
Deepak Parekh, HDFC“We don’t do interest-only or subprime loans. When the bubble was going on;
we did not change any of our policies.
We did not change any of our systems.
We did not change our thought process.
We never gave more money to a borrower because the value of the house had gone up.Citibank has a few home equity loans, but most banks in India don’t make those kinds of loans.
Our nonperforming loans are less than 1 percent.”
So why did the Indian banks stay on the sidelines and avoid most of the pain that has been suffered by the big American banks?
Cultural Reasons:
1. Indians are simply not as comfortable with credit as Americans.
2. A lot of Indians, when you push them, will say that if you spend more than you earn, you will get in trouble. Americans spent more than they earned.
3. Savings are important as Joint families exist. When one son moves out, the family helps them. So you don’t borrow so much from the bank.
Banking Regulation:
1. Even mortgage loans tend to have down payments in India that are a third of the purchase price, a far cry from the United States, where 20 percent is the new norm.
2. But there was also another factor, perhaps the most important of all. India had a bank regulator who was the anti-Greenspan.” Dr. V. Y. Reddy, The governor of the Reserve Bank of India.
Sense of Duty:
Mr. Reddy, who took office in 2003 and stepped down this past September, it had exactly the right man in the right job at the right time. “He basically believed that if bankers were given the opportunity to sin, they would sin,” For all the bankers’ talk about their higher lending standards, the truth is that Mr. Reddy made them even more stringent during the bubble. Unlike Alan Greenspan, who didn’t believe it was his job to even point out bubbles, much less try to deflate them, Mr. Reddy saw his job as making sure Indian banks did not get too caught up in the bubble mentality. About two years ago, he started sensing that real estate, in particular, had entered bubble territory.
Attack on Land/Real Estate Loan:
One of the first moves he made was to ban the use of bank loans for the purchase of raw land, which was skyrocketing. Only when the developer was about to commence building could the bank get involved — and then only to make construction loans.
Restriction on Derivatives:
Then, as securitizations and derivatives gained increasing prominence in the world’s financial system, the Reserve Bank of India sharply curtailed their use in the country.
Restriction of Off Balance sheet Adjustments:
When Mr. Reddy saw American banks setting up off-balance-sheet vehicles to hide debt, he essentially banned them in India. As a result, banks in India wound up holding onto the loans they made to customers. On the one hand, this meant they made fewer loans than their American counterparts because they couldn’t sell off the loans to Wall Street in securitizations. On the other hand, it meant they still had the incentive — as American banks did not — to see those loans paid back.
Increase in interest rate and other measures on Real estate Loan:
Seeing inflation on the horizon, Mr. Reddy pushed interest rates up to more than 20 percent, which of course dampened the housing frenzy. He increased risk weightings on commercial buildings and shopping mall construction, doubling the amount of capital banks were required to hold in reserve in case things went awry.
Capital adequecy Norms:
He made banks put aside extra capital for every loan they made. In effect, Mr. Reddy was creating liquidity even before there was a global liquidity crisis.
Did India’s bankers stand up to applaud Mr. Reddy as he was making these moves?
Indian Bankers Opinions:
Of course not. They were naturally furious, just as American bankers would have been if Mr. Greenspan had been more active. Their regulator was holding them back, constraining their growth! Mr. Parekh told that while he had been saying for some time that Indian real estate was in bubble territory, he was still unhappy with the rules imposed by Mr. Reddy. “We were critical of the central bank,” he said. “We thought these were harsh measures.” “For a while we were wondering if we were missing out on something,” said Ms. Kochhar of Icici. Banks in the United States seemed to have come up with some magical new formula for making money: make loans that required no down payment and little in the way of verification — and post instant, short-term, profits.
Outside India Manager's Opinion:
As Luis Miranda, who runs a private equity firm devoted to developing India’s infrastructure, put it: “We kept wondering if they had figured out something that we were too dense to figure out. It looked like they were smart and we were stupid.” Instead, India was the smart one, and we were the stupid ones.
Now what they Says :
Ms. Kochhar said that the underlying risks of having “a majority of loans not owned by the people who originated them” was not apparent during the bubble. Now that those risks have been made painfully clear, every banker in India realizes that Mr. Reddy did the right thing by limiting securitizations.
“At times like this, you tend to appreciate what he did more than we did at the time,” said Mr. Kapoor.
“He saved us,” added Mr. Parekh.
The ultimate Result:
1. As the credit crisis has spread these past months, no Indian bank has come close to failing the way so many United States and European financial institutions have.
2. None have required the kind of emergency injections of capital that Western banks have needed.
3. None have had the huge write-downs that were par for the course in the West.
4. As the bubble has burst, which lenders have taken the hit? Why, the private equity and hedge fund lenders who had been so eager to finance land development. Us, in others words, rather than them. Why is that not a surprise?
Mr. Kapoor, Yes Bank: on “what had happened in the United States then” , he replied:
1. “We recognize it as a problem of plenty.
2. It was perpetuated by greedy bankers, whether investment bankers or commercial bankers.” 3. “The greed to make money is the impression it has made here.”
4. “Anytime they wanted a loan, people just dipped into their home A.T.M.”
5. “It was like money was on call.”
6. So it was. And USA regulators, unlike Indians, just stood by and let it happen.
lesson Learnt:
The next time USA moving into bubble territory, perhaps they can take a page from Mr. Reddy’s book — sometimes it’s better to apply the brakes too early than too late. Or, as was the case with Mr. Greenspan, not at all.
