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Everyone belonging to India's middle and upper classes
has experienced its effects, but there are few analysing
its implications. The country has been through a retail
credit transition, making it a haven for the would-be
borrower relentlessly pursued by the would-be lender
through the media, the cell phone, mailers and direct
contact. Near-100 per cent credit with no guarantees
required and interest rate rebates on larger loans of
longer duration is almost the norm.
Compared with the situation a decade or more earlier,
this is a complete turnaround. During those days, small
sums were put away in recurring or fixed deposits and
allowed to accumulate till the capital required for
buying the much-coveted consumer durable or automobile
was garnered. Those with secure employment and inherited
or previously accumulated valuables were luckier: they
could borrow against the security of their savings meant
for retirement or offer their wealth as collateral or
even get away with a personal guarantee, when choosing
to buy today what you can afford only tomorrow. All
that has changed in the aftermath of the retail credit
explosion. Armed with credit cards, PAN cards or similar
accoutrements and a desire to shop, individuals are
borrowing their way to prosperity. Durables, modcons,
automobiles and apartments are acquired early in life
and upgraded subsequently, using debt seen as warranted
by the expected profile of future incomes. Those among
the young burdened with vestiges of the earlier psychology
of thrift are neutralised by the demonstration effect,
the need to keep up with their peers and by the persuasive
powers of financial firms who have made retail credit
their mission.
There are three effects of this retail credit transition
that are especially noteworthy. First, there has been
a rapid growth in credit provision in the country to
an extent where banks are reaching the limits of their
credit creating capacity based on the deposits they
receive. Bank credit grew by 36 per cent (Rs. 396,045
crore) in 2005-06 after a 37 per cent (Rs. 311,425 crore)
rise in 2004-05. This has taken the ratio of credit
to deposits from around 64 per to 72 per cent between
the beginning and the end of financial year 2005-06.
The second effect is the growing share of retail credit
in the portfolios of financial firms. According to reports,
the retail loan assets of individual banks grew by between
40 and 70 per cent, with the credit flow into the retail
sector amounting to more than 50 per cent of the increase
in credit. Third, as a result of this credit-financed
consumption boom, the leading sectors growing on the
basis of domestic demand are those where such demand
is fuelled with retail credit or those which are input
suppliers to the same industries. This implies that
manufacturing growth tends to be lopsided and focused
on a few sectors.
In the event, the economy is currently characterised
by buoyancy in manufacturing supported by a growing
credit overhang in the housing, automobile and consumer
finance markets. This is being viewed with increasing
concern by the Reserve Bank of India and the Finance
Ministry, not merely because it implies a diversion
of credit away from the productive sectors, but also
because of the possibility of an increase in debt default,
which can in turn affect the viability of some banks
with excess exposure to the retail loan market. In fact,
the RBI has been issuing advisories in the past especially
with regard to the burgeoning of housing finance. But
this does not seem to have tempered the passion for
such lending characterising some segments of the financial
sector.
An overhang of personal debt, inadequately backed with
collateral, is a problem not just because it could be
misused by unscrupulous clients. It is more of a problem
because both the offtake of such credit and its provision
is based on optimistic expectations regarding the future
income profile of clients. Even honest borrowers must
be ''expecting'' that the profile of incomes they would
earn during the life of the debt or debts they incur
would be adequate to meet their interest and repayment
commitments. Lenders too must believe that the expected
future income profile of their clients would be adequate
to meet those commitments, even though they may not
be privy to information on the total debt of their individual
clients.
Such expectations may be warranted if the nature of
employment of the borrower is such that there is an
implicit guarantee of lifetime employment. But such
guarantees do not exist even in the case of those employed
by the organised private sector, let alone those who
are employed in the informal sector or are self-employed.
Since it is the latter kind of employment which is growing
at the margin, the possibility of default even by an
honest borrower is real. Thus, the recent surge in retail
credit involves speculative bets influenced by some
version of the ''feel good'' factor, which makes both
borrowers and lenders believe with some certainty in
the expected profile of incomes of the former.
It could, of course, be argued that the kinds of items
purchased with retail credit-homes, cars and consumer
durables-are themselves the collateral hypothecated
to the lender. The difficulty with this view is that
it presumes that the resale values of these items would
closely correspond to their depreciated purchase values.
However, if individuals have the option of constantly
renewing their purchases with credit, the market for
second-hand products would be characterised by excess
supply, with a consequent dampening of resale values.
Further if an economic downturn results in a degree
of generalised default, prices in the resale market
where the assets concerned would have to be liquidated
would crash.
Banks are indeed conscious of such a possibility and
its implications for their financial viability. But
they continue to lend, because they can if they choose
to get credit risk off their balance sheets by transferring
such risk to non-bank entities at a price. They can
take on the role of creating assets in the form of retail
credit of different kinds, bundle these assets and sell
them to a third party ready to carry default risk in
return for a share of the interest proceeds.
Among the ways in which credit risk can be transferred
are the sale of credit derivatives and credit insurance
products. Globally, the Bank of International Settlements
(BIS) has estimated that even by 2002, non-bank financial
companies had bought into credit protection to the tune
of $2 trillion. The problem is that it is not always
easy to identify where the transferred credit risk rests
or how much of it has resulted in losses because of
default. This is partly because these losses were being
borne by insurance companies, which would be treating
them like any other casualty loss so that they cannot
be separately identified. The BIS sees this as being
the inevitable result of the rapid spread of the practice
of credit-risk transfer-the shifting of risk from banks
on to the buyers of securities and loans, and on to
the sellers of credit insurance.
The practice has reached India as well, with banks varying
from Citgroup to the conservative State Bank of India,
resorting to it in recent years. Indications are this
trend is likely to be strengthened. For example, Euler
Hermes, a part of the Allianz group, has tied up with
Bajaj Allianz General Insurance to offer credit insurance
products in the country. Clemens von Weichs, Group Chief
Executive Officer, Euler Hermes has been quoted as saying
that: ''The (Indian) credit insurance market currently
has the potential of 35 million euros annually (Rs.
190.8 crore). But in the next five years we see this
figure growing to 140 million euros (Rs. 763.5 crore).''
With mutual funds and insurance companies willing to
sell credit protection, the savings of individual buyers
investing in mutual fund and insurance products are
contributing to the credit risk being carried by banks,
making them even more willing to lend retail. So be
aware that the next time you choose a savings product
you might be buying into somebody's debt-maybe even
your own.
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