Unlike Alan Greenspan, who didn’t believe it was his job to even point out bubbles, much less try to deflate them, 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? US private equity and hedge funds, of course!)
Then, as securitizations and derivatives gained increasing prominence in the world's financial system, RBI sharply curtailed their use in the country. When 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, Reddy pushed interest rates up to more than 20%, 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, Reddy was creating liquidity even before there was a global liquidity crisis.
Did India’s bankers stand up to applaud Reddy as he was making these moves? Of course not. They were naturally furious, just as American bankers would have been if Greenspan had been more active. Their regulator was holding them back, constraining their growth! 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 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 Kochhar. Banks in the US 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.
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 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 Kapoor. “He saved us,” added Parekh.