Sunday Thoughts :
Yet again a bit of thoughts which has become a much regular feature....
Indian banking system and US banking collapse:
Some months back we had lot of voices about RBI tinkering on growth with CRR , repo rate ,restrictions on FDI etc etc as measures which would de-rail growth . Although my belief was CRR and such measures are good for the long run and used it for buying as over-reaction from markets giving a bounce after making panic lows. Now lets c US scenario the free credit and that too leveraged credit was exactly opposite.
Although I know hardly about the banking system but would try to sum up things from what i get from peers in the domain and their views. Will list down some positives or differences which may be due to fortunate circumstances or RBI or because Indian banking system is not yet that developed. If there is something wrong people can comment !!!
1) US sub-prime loans
While going thru wikipedia - or second chance lending is a term used for it. Higher interest rates gave these lenders a better profit ratio and gr8 bonuses to the big-wigs but the high risk involved led to a major crisis in US financial institutions. Out here in India RBI does have strict regulations even on pvt banks , home finance and other institutions which curtails over-exposure or leverage for banks. PSU banks, PSU financial firms conservativeness keeps them safer.
2) Mortgage , Securitization and Complex derivatives.
This is where the real crisis started as the above terms were highly mis-understood or presented differently. Mortgage , Home finance was given at 100 % to value which left a big risk for banks. Further to alleviate the problems banks started packaging mortgage/loans into securities and complex derivatives which were sold to create liquidity and good returns for corporates which were entirely speculative but complexity hided the fact.
Indian banks have still not developed much on the mortgage portfolio of loans , and majority of the chunk is used for business financing. Also the indian mentality of not mortgaging assets will take time to make a shift for that portfolio of loans to grow. Also securitization , complex derivatives have not yet grown to a big extent but yes they have made their big scratches on profits but still away from asset detoriation like US.
3) Real Estate Slump Kills the system.
The US banking system was majorly flowing on the real estate prices booming which made the leverage and exposure of banks go higher and higher. The securitization and complex derivatives package made banks/corporates takes big exposures as speculative gains were enormous with real estate price upmove. I would give it a new term "" Liquid real estate "". The securities sold by Banks created liquidity for them to give out more loans and to buyers it gave a chance to make profits out of a real estate growth with a liquidity to find buyers. So the demand kept the liquidity higher and the realization of the risk far -away. Suddenly the real estate bubble blew and the crisis grew. The complexity of securitization and derivatives took a lot of time for the banking system to realize !!! and killed the system.
Luckily or can be termed unfortunately that the real estate deals are done at 20-50 % cash or black money. On that banks give only 80 % of the white amount. So this gives a buffer of safety to the banking system. Also the mortage/securitization/complex derivatives are not a grown market to make the system over-leverage. Although this can create a buffer on assets but the aggressive pvt banking sector is seeing lots of revenue/profits coming down and also losses due to defaults and increasing NPAs.
According to a brief calculations say 100 rs flat . 60 rs agreement cost . loan given 50 rs loan given. till the price doesnt fall below 60-70 rs on combined deal the loan-owner would prefer to settle the loan !! and get some money back of the Cash payment. So a brief calculation says a drop more then the extent of 30-40 % or even more could lead to major defaults but still it may not heard that deeply into assets as it does for US or other banking systems.
4) Collapse / Bankruptcy like Nine pins- I-Banks
Its an old saying it takes years to building but 4 dynamites to break them in days. This same applies to institutions which may have been 160 years but doesnt take much time for them to collapse. The banking system depends on the or money frm the market in the core principle. The profits arise only after working out ratios like CRR, PLR etc . But when liquidity crunches the balance goes haywire if the system is not kept ready for a mad rush from depositors and unavailability from money market. The mad rush doesnt take much time so the process of banks falling in line should not take a big period . Thats the prime reason why we are seeing every week a new foreign bank on the newspapers, many of them being investment banks. The dream job at an I-bank is now a nightmare. Suddenly Goldmans want to become retail banks for the same reason of control, regulation.
In India luckily or unfortunately whichever way one takes it Investment Banking has not grown and is in nascent stages so ideally great lessons being learnt !!!. Apart from that retail-commercial banking has strict guidelines/restrictions and regulations to be followed so that a mad rush may be encountered much more easily. CRR cuts were done to reduce the liquidity but at the same time it reduced the leverage for banks and the RBI can definitely arrange for liquidity if required !.
All in all Indian banking is in trouble but not in CRISIS like the US banking system. So India could ideally be learning lessons which if used could lead to a much stable banking structure in the future. Consequences being faced by US banks are severe but as i have been saying the mad rush and collapse is quick so as before my expectation remains for an economic data peaking out in September/October and would term it very close to the peak !!!! NOW.
Sunday Thoughts :