Borrowed Prosperity
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.