How India Avoided a Crisis
By JOE NOCERA
MUMBAI
?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.
Mr. Kapoor is an Indian banker, a former longtime Bank of America executive with a Rutgers M.B.A. who, along with his business partner and brother-in-law, Ashok Kapur, was granted government permission four years ago to start a private bank, which they called Yes Bank. In the United States, Yes Bank is the kind of name a go-go banker might give to, say, a high-flying mortgage lender in the middle of a bubble. (You can even imagine the slogan: ?Yes is part of our name!?) But Yes Bank is not exactly the Washington Mutual of India. One news release it hands out to reporters who come calling is an excerpt from a 2007 survey by The Financial Express: ?#1 on Credit Quality amongst 56 Banks in India,? reads the headline.
I arrived in Mumbai three weeks after the terrorist attacks that killed 200 people ? including, tragically, Yes Bank?s co-founder Mr. Kapur, who had served as the company?s nonexecutive chairman and was gunned down while having dinner at the Oberoi Hotel. (His wife and two dinner companions miraculously escaped.)
My hope in traveling to Mumbai was to learn about the current state of Indian business in the wake of both the credit crisis and the attacks. But in my first few days in this grand, sprawling, chaotic city, what I mainly heard, especially talking to bankers, was about America, not India. How could we have brought so much trouble on ourselves, and the rest of the world, by acting in such an obviously foolhardy manner? Didn?t we understand that you can?t lend money to people who lack the means to pay it back? The questions were asked with a sense of bewilderment ? and an occasional hint of scorn. Like most Americans, I didn?t have any good answers. It was a bubble, I would respond with a sheepish shrug, as if that were an adequate explanation. It isn?t, of course.
?In India, we never had anything close to the subprime loan,? said Chandra Kochhar, the chief financial officer of India?s largest private bank, Icici. (A few days after I spoke to her, Ms. Kochhar was named the bank?s new chief executive, in a move that had long been anticipated.) ?All lending to individuals is based on their income. That is a big difference between your banking system and ours.? She continued: ?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.?
And when I went to see Deepak Parekh, the chief executive of HDFC, which was founded in 1977 as the country?s first specialized mortgage bank, practically the first words out of his mouth were these: ?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.?
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.?
Mr. Parekh said, ?Savings are important. Joint families exist. When one son moves out, the family helps them. So you don?t borrow so much from the bank.? 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. (Let?s not even think about what they used to be.)
But there was also another factor, perhaps the most important of all. India had a bank regulator who was the anti-Greenspan. His name was Dr. V. Y. Reddy, and he was the governor of the Reserve Bank of India. Seventy percent of the banking system in India is nationalized, so a strong regulator is critical, since any banking scandal amounts to a national political scandal as well. And in the irascible 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,? 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.
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. 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? 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.
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.
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.
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.
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None of this is to say that the global credit crisis hasn?t affected India. It certainly has. I?ll be back after the holidays with more columns from India, including how Sept. 15 ? the day Lehman Brothers defaulted ? changed everything, even here, on the other side of the world.
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