Monday, December 22, 2008

In praise of Y V Reddy

Joe Nocera of the New York Times says (with quotes from several top Indian bankers) that the man responsible for Indian banks still being afloat is our "anti-Greenspan", the "irascible" former Reserve Bank of India governor Y V Reddy.

“He basically believed that if bankers were given the opportunity to sin, they would sin,” said one banker who asked not to be named...

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!)
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!

Read the whole thing. I'm not an expert but if it is even partly true, Mr Reddy deserves our thanks and applause. Standing up to the lobbying powers and armtwisting of big businesses in India cannot be any easier than it is in the United States. But unlike Mr Greenspan, Mr Reddy had clearly not been a devotee of Ayn Rand in his youth.

(By the way, if anyone thinks today's Greenspan-bashers are benefiting from hindsight, take a look at this 2000 article by Ralph Nader. Also see this recent article by Arianna Huffington, taking apart the "Who could have known?" argument being thrown about by uncontrite regulators and politicians.)


Dilip D'Souza said...

Rahul, I was talking about this to someone just two days ago, with much the same reaction you have.

In addition to your Ayn Rand remark, there's this line that got my attention: "Seventy percent of the banking system in India is nationalized..."

Much as it bugs me to admit anything good about it -- perhaps the nationalization, with the consequent requirement of regulation as Nocera points out, also worked to keep our banks from collapse.

Rahul Siddharthan said...

Dilip - Interesting point about nationalisation. I wonder how that 70% is measured: number of banks? Number of branches? Number of customers? Size of assets? Whichever way, though, the 30% that is private is still very large, loud and influential -- so it took some courage to stand up to them, in my opinion. And if it's being measured in terms of assets or market capitalisation, I suspect the private banks would account for over 30% today.

Anonymous said...

Several things.

First, I am not a specialist, and am writing from what I can remember and anecdotal knowledge.

Second, regarding the 70% figure. From the horse's mouth: These seem to be quarterly statistics for the quarter ending June 2008, but a quick glance of the March 2008, shows a similar trend.

Incidentally, one can browse similar reports for other quarters too going way back to 1998. (Great site, imho)

As far as deposits go:

"Nationalised Banks, as a group, accounted for 48.6 per cent of the aggregate
deposits, while State Bank of India and its Associates accounted for 22.6 per
cent. The share of Other Scheduled Commercial Banks, Foreign Banks and
Regional Rural Banks in aggregate deposits were 20.1 per cent, 5.8 per cent
and 3.0 per cent, respectively. As

As regards gross bank credit, Nationalised Banks
held the maximum share of 47.6 per cent in the total bank credit followed by
State Bank of India and its Associates at 23.1 per cent and Other Scheduled
Commercial Banks at 19.9 per cent. Foreign Banks and Regional Rural Banks
had relatively lower share in the total bank credit at 7.1 per cent and 2.4 percent respectively. "

It's possible that 70% is as Rahul S suggested, measured in terms of number of branches.

Second, nationalised banks and govt owned institutions do not fail. They are simply recapitalized by the government and rescued ("bailout").
The most spectacular and recent ones were Indian Bank, UCO, United Bank and UTI.
All of them have turned around and are very successful and profitable now.
The CEO of Indian Bank (also the first woman CEO of a major bank in India) has written a book about it.
Several years ago, payouts on a assured returns mutual fund were provided by the govt even though the fund
couldn't afford to do so. US 64 investors were partially compensated.

The NPA books of several other nationalized banks were considered staggering this was considered a large problem some years back.

My uneducated guess is that the high growth (in deposits and credits) over the past few years, the spectacular stock
market growth and easing rules in recovering and disposing distressed assets helped them turn around.
Banks and FIs hold significant stakes in several companies, with much of the shares acquired at dirt
cheap prices fixed by the erstwhile Controller of Capital Issues) and there are
extensive cross holdings as well. Even after the current crash, these holdings would still be hugely profitable.

Also, there were 3 large term lending institutions: IFCI, IDBI, ICICI.

IDBI and ICICI two managed to reverse merge with their subsidiary banks and are doing well.
IFCI is still a problem case, though it has been doing well for the past couple of years and the govt is still trying to sell it off.
The govt had infused large sums of money (bailout) earlier.

Third, only 6% of villages seem to have access to a physical bank office. The banking sector in India is still developing and growing. We don't know how the RBI would function in a situation with near universal banking.

Fourth, all of this is not taking credit away from the RBI and its policies over the past few years, especially, since it faced significant flak from several quarters.
However, paraphrasing Rahul S, RBI did not have the courage to stand up against huge NPAs building up in the banks' books earlier.

Finally, my point is simply this: If the Indian banking sector has not seen spectacular failures, I doubt if nationalization is a reason.
Nationalization was no safeguard against failures some years back, when they dominated the scene
to a larger extent. Better regulation, conservative management and decisions, maybe, but definitely not nationalization.
"Bailouts" have been offered to nationalized banks in the past, though the terminology was different!

From Joe Nocera's article,
"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."
Joe simply underestimates the public appetite for national and political scandals in India! Within the financial/banking sectors,
from Harshad to Ketan, we have seen them all!

To repeat, I am not an expert, but just offering my lay comments.


Rahul Siddharthan said...

Sridhar - thanks for the interesting comment. Regarding this
"However, paraphrasing Rahul S, RBI did not have the courage to stand up against huge NPAs building up in the banks' books earlier."
I suppose in India it is easier to stand up to corporate pressure than to populist politics...

Anonymous said...

Even investment bankers could have figured it out, had they been of sound mind, like Prem Watsa, Fairfax Holdings, Canada:

"Watsa's only sin was in being a little too early with his prediction that the era of credit expansion would end badly. This is what he said in Fairfax's 2003 annual report: "It seems to us that securitization eliminates the incentive for the originator of [a] loan to be credit sensitive. Prior to securitization, the dealer would be very concerned about who was given credit to buy an automobile. With securitization, the dealer (almost) does not care.…And here's the rub! These asset-backed bonds are rated based on their historical loss experience record which will likely be very different in the future--particularly if we experience difficult economic times."

To think he said this in 2003!