Saturday, December 20, 2008

India's Anti-Greenspan or How India Avoided a Financial Collapse In It's Banking Sector

Woke up this morning and reluctantly (all the bad news) turned to the business section of the NYTimes, and was intrigued by this piece....
Talking Business: How India Avoided a Crisis By JOE NOCERA.
As the financial crisis and the real estate bubble here imploded I wondered how India was doing for it has been growing by leaps and bounds lately. Did they avoid this? How did they?
This article does provide some insights on this. India has been rightly critiqued for it's excessive regulatory policies (and rightly so at times) but this does appear to be a good example of perhaps what Alan Greenspan should have been doing.

Snippets from the article below...
“What has taken a number of us by surprise is the lack of adequate supervision and regulation,” Rana Kapoor was saying the other day. “This was despite the fact that Enron had happened and you passed Sarbanes-Oxley. We don’t understand it. Maybe it’s because we sit in a more controlled economy but ....” He smiled sweetly as his voice trailed off, as if to take the sting off his comments. But they stung nonetheless.
Yes because enough fools believed that the free market can correct or regulate itself. An unregulated free market was to make all of us rich!

Yet two years ago, the Indian real estate market — commercial and residential alike — was every bit as frothy as the American market. High-rises were being slapped up on spec. Housing developments were sprouting up everywhere. And there was plenty of money flowing into India, mainly from private equity and hedge funds, to fuel the commercial real estate bubble in particular. Goldman Sachs, Carlyle, Blackstone, Citibank — they were all here, throwing money at developers. 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?

Part of the reason is cultural. Indians are simply not as comfortable with credit as Americans. “A lot of Indians, when you push them, will say that if you spend more than you earn you will get in trouble,” an Indian consultant told me. “Americans spent more than they earned.”
So why did the Indian banking system not fail?
But there was also another factor, perhaps the most important of all. India had a bank regulator who was the anti-Greenspan.
Heh!
“He basically believed that if bankers were given the opportunity to sin, they would sin,” said one banker who asked not to be named because, well, there’s not much percentage in getting on the wrong side of the Reserve Bank of India. 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. 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. (Guess who wound up financing the land purchases? United States private equity and hedge funds, of course!)

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. 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.
Did the bankers in India like it? No of course not!

Did India’s bankers stand up to applaud Mr. Reddy as he was making these moves? 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 me 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.
And do we have something to learn from the Indian example?

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. None have required the kind of emergency injections of capital that Western banks have needed. None have had the huge write-downs that were par for the course in the West. 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?

When I asked Mr. Kapoor for his take on what had happened in the United States, he replied: “We recognize it as a problem of plenty. It was perpetuated by greedy bankers, whether investment bankers or commercial bankers. The greed to make money is the impression it has made here. Anytime they wanted a loan, people just dipped into their home A.T.M. It was like money was on call.”

So it was. And our regulators, unlike theirs, just stood by and let it happen. The next time we’re moving into bubble territory, perhaps we 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.
Yes our regulators let it happen and the door was opened starting with the Clinton era and continued thru the Bush years (no surprise there). And American tax payers are left holding the bag.

4 comments:

White Magpie said...

Very true. All things said and done, I was extremely surprised to see that none of the banks knew the total amount of CDOS in their portfolio. The valuation was also internally managed. The securitization has taken a big hit but hopefully it should start rising up in 2009. If not, the next 2-3 years would be extremely tough.

Sanjay said...

WM, thanks for stopping by to comment. Greed rules man. They were all trying to make money out of nothing. Once the CDOs got bundled no one had a clue what was in them.
I think 2009 will be a down year and things won't improve before then.
I liked this article because it shows how a better, sensible regulatory approach would have worked.

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