Why Indian banks are immune to the US disease

Why Indian banks are immune to the US disease

As the global financial crisis deepens, rumours continue that Indian banks could eventually be faced with similar problems. Such speculation needs to end because it has no basis in fact.

The situation that has developed in the US has little similarity to the reality in India. The root cause of the problems the US banks face is simply that a large number of Americans were enticed by mortgage lenders into taking unrealistically high housing loans, which represented 100% and more of the value of the houses, and that they did not have the wherewithal to make the necessary repayments.

With slowing economic growth and growing mortgage defaults, the underlying asset value of housing in America went into decline. In too many cases, this has resulted in loan values exceeding the market value of the properties.

In such a situation, the financial incentives for householders to continue to pay mortgages on properties—where the loan value exceeds the value of the property—are very low. As a result, homeowners started voluntarily defaulting on repayments.

For primary lenders and others holding these debts on their books, this has meant that they have been unable to recover the full value of the housing loans, leading to huge business losses.

This is not the situation in India for three reasons. The first is that almost 90% of the national housing stock is owned outright. This means that the aggregate exposure of lenders in the country to residential mortgage debt is modest by American standards.

Second, for the minority of homes in India financed partly by loans, the equity householders have in their homes is typically high. This is because mortgage lending norms in the country are more conservative and generally require borrowers to have a savings history and the ability to self-finance house purchases to the tune of at least 20% of the value of the house at the time of purchase.

In a typical case, therefore, buyers entering the housing market have a sensible equity stake in the property at the point of purchase that insulates the value of their equity should house values fall.

In other words, the financial incentives for Indian borrowers to voluntarily default on housing loans is low because the possibility of the loan value exceeding the market value of the property is remote.

Also, Indian banks generally ensure that borrowers have the financial capacity to make the necessary loan repayments before agreeing to lend and this better assures that involuntary defaults on loan repayments is minimized.

In addition, Indians have a preference to buy assets with the money they have rather than taking a loan. This means the general orientation of Indian consumers, unlike their US counterparts, is to minimize rather than maximize credit exposure.

The fundamentals of the lender-borrower relationship, in terms of risk-sharing is, therefore, sound.

The third reason is that Indian banks hold only a part of the aggregate housing mortgage debt. Traditional borrowing practices are still strong, with a significant number of loans being sourced from informal channels and not banks. In 2006-07, for example, at least 40% of house buyers borrowed from informal sources, including friends and relatives.

The current situation, therefore, is that there is no need for anxiety that Indian banks will find themselves in the same situation as banks in the US.

But it does produce a paradox of sorts. Shoring up sagging residential housing demand is one strategy that can be considered to ensure a softer landing for the Indian economy in a slowing global growth scenario, and to achieve that, some easing of bank housing mortgage interest rates rather than any anxiety to limit mortgage exposure could be a desirable step.

Christopher Butel is chairman of IIMS Dataworks. The article is based on findings from the Invest India Incomes and Savings Survey 2007. Respond to this column at feedback@livemint.com