9th anniversary of Lehman Brothers bankruptcy and Indian banking
RBI’s ultra-loose monetary policy and massive loan restructuring following the Lehman Brothers bankruptcy and the Great Recession had sown the seed of bad loans, which continues to grow even now
The ninth anniversary of Lehman Brothers Holdings Inc. filing for bankruptcy was rather muted last week. With every passing year, articles in newspapers and discussions on TV channels looking back at the changes in global financial world in the wake of the collapse of the US’s fourth-largest investment bank have been tapering off even as we grapple with new realities.
On the day Lehman Brothers filed for bankruptcy, the chief executive officers of six large commercial banks in India assembled at Mint’s Annual Banking Conclave at a south Mumbai hotel to debate a topic close to every foreign banker’s heart—“Should India open up the financial sector?” Y.V. Reddy, a Reserve Bank of India (RBI) governor widely known for his views against opening up the sector, had retired just 10 days before the collapse in September 2008.
His successor D. Subbarao, a former finance secretary, was to be the chief guest at the conference but he excused himself because in his new role, he could not have expressed his views on the subject. The mood at the conference was sombre and even the traditionally aggressive foreign bankers, who always blamed the Indian banking regulator for keeping the doors closed, were restrained in their arguments. The beer tasted flat that evening, the food stale, and a few panellists, including ICICI Bank Ltd’s then managing director and CEO, K.V. Kamath, did not wait for the dinner and left immediately after the discussion was over.
The exposure of ICICI Bank, then India’s largest private sector lender, to Lehman Brothers was $83 million, less than 0.1% of its consolidated balance sheet, but investors rushed to sell the bank’s stock. A few other banks, including State Bank of India and Punjab National Bank, two large state-owned banks, had a small exposure to Lehman Brothers in various forms.
At a meeting with the executives of Lehman Brothers’ India arm and local banks, V. Leeladhar, an RBI deputy governor then, told the US investment bank to close all transactions with Indian banks within 24 hours. Its broking arm, Lehman Brothers Securities Pvt. Ltd, was taken over by Japan’s Nomura Holdings Inc. Nomura also took over Lehman Brothers’ back office operations.
Parachuted from the finance ministry, Reddy’s successor Subbarao responded to the crisis by flooding the financial system with money and bringing down the policy rate to a historic low. The first rate cut was announced on 20 October 2008 when the overnight inter-bank call money rates soared and the commercial banks ran dry.
Banks stopped lending to individuals as well as firms because they were not confident that liquidity would remain in the system and they were hoarding money by paying very high rates to depositors. It took about six months to restore the confidence of the financial system and convince banks that liquidity would be maintained. RBI did that by bringing down its policy rate from 9% to 3.25% (less than the savings bank rate), cash reserve ratio or the portion of deposits that commercial banks need to keep with the central bank from 9% to 5% and the floor for banks’ government bond holding from 25% to 24%.
Subbarao’s predecessor Reddy had sensed the trouble ahead of others and ring-fenced Indian banks from the global turmoil. He had raised the risk weight on banks’ exposure to commercial real estate, housing loans to individuals against mortgage of properties, consumer credit and capital market exposures. Higher risk weight calls for more capital and makes money more expensive. The idea was to discourage banks from aggressively disbursing such loans. RBI also started jacking up the provisions for standard assets for these loans progressively from 2005 and clamped down on banks borrowing from other banks.
The Indian economy was resilient; growth dropped below 5% for only one quarter—March 2009—and bounced back fast. After three successive years of 9% plus growth, India’s economic growth sagged but to a relatively healthy 6.72% in 2009 even as the rest of the world struggled with the Great Recession. For the next two years, the growth rose further—8.59% and 8.91%, respectively.
Do all these mean that India could insulate itself from the Lehman effect and the 2008 “global crisis” has not been “global” in nature? Is it actually a “transatlantic crisis”, as some of the economists describe it; giving it a “global” tag was part of the propaganda of the developed markets to dilute their responsibility?
There is no simple answer to these questions but Indian financial system is still reeling under the Lehman impact. Banks were allowed to restructure repeatedly those loans that had gone bad. It helped borrowers—affected by demand recession globally and the collapse of the exports markets—who were not in a position to pay back to the banks. Indeed, India could stage a sharp, V-shaped recovery but the ultra-loose monetary policy and massive loan restructuring had sown the seeds of inflation and creation of bad assets. The inflation genie was bottled only after Subbarao’s successor, Raghuram Rajan, launched a war against it, but the bad assets pile has still been growing, leading to banks’ reluctance to lend. Among others, this has played a role in crimping the economic growth.
In the new monetary policy architecture, RBI has got the mandate for flexible inflation targeting and governor Urjit Patel is firm on tackling inflation which erodes the value of money, but fighting the rise in bad loans is a long haul. Two Indian banks now have almost one-fourth of their loan portfolios turning bad and many of them are staring at balance sheets with more than 15% bad loans. RBI has curbed lending activities of at least half a dozen banks under the so-called “prompt corrective action.”
By the 10th anniversary of Lehman collapse next September, some of the state-owned Indian banks may become completely irrelevant.
Tamal Bandyopadhyay, consulting editor at Mint, is adviser to Bandhan Bank. He is also the author of A Bank for the Buck, Sahara: The Untold Story and Bandhan: The Making of a Bank. His Twitter handle is @tamalbandyo.
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