Subprime in India: Probability and sustainability

The idea came after reading one blog (and receiving on email from friend).

During late 90s and early 2000, interest rates fell dramatically because of excess liquidity and prices of homes rose sharply which influenced average Americans to unlock this wealth by taking mortgage loans. People took two advantages; obtained liquidity at very high price (of homes) but with relatively lowest interest rate (count bracket for past 20 yrs). This resulted to sharp rise in money flow in market, consumer spending and global growth.

[Problem identified] : Banks didn’t calculated correct inventory cost before offering mortgage loans. US and other countries standard GAAP (Generally Accepted Accounting Principles) says "Inventories are valued at cost or market, whichever is lower [ARB No. 43, Chapter 4, Para. 8] - http://accountinginfo.com/study/inventory/inventory-150.htm" But banks in greed to earn out of booming market and in hurry did this mistake. Now the property is almost worthless to them.

Something can happen in Indian context also.

Moving further, inflationary pressures led to a gradual hike in interest rates and house prices went down when demand decreased w.r.t. availability and most of them could not provide cover for the mortgage loans. The extra liquidity gradually vanished (to India / China) and above proposal became riskier.

[Problem] Risk analysis; says that return to risk factors should have been considered in better way before offering quick loans. In India too, maximum loans are with either NRIs or IT/ITES employees; all too direct/indirect/outsourced US economy dependent employees. When the global slowdown is prevailing and people are loosing jobs, cost cutting is buzzword every where then who will pay the loan with such inflated interest rated EMIs? Price is drastically decreasing, sometime builders' lobby cushion this to save them selves but no one can deny the 25-30% downfall of price in Bangalore and Navi Mumbai despite current 12% inflation with 12.5% interest rate. So in reality the current real estate price devaluation is of around 50%.

So above factors signals India’s slow move towards sub prime crisis alike US but after 1-2 yrs from now when crisis axis shifts to developing nations like us as ripple effect.

So what should be learning from Sub Prime Crisis for us:-

1. Robust banking practices: One of the root causes of the sub prime mortgage is the unsound credit practices. Housing loan frauds are not exceptions in India and the aggressiveness with which housing loans are being sold by violating sound credit practices cannot be ignored. Personal loans and overdue credit cards are the other areas which the regulators and bankers should handle carefully because they also have the equipotent to plunge the Indian banking sector into a crisis.

2. Limited investment by Indian companies abroad: Do prudent investment abroad, reckless investment in the derivatives market by banks and financial institutions has to be controlled.

In the recent crisis, BNP Paribas of France and Macquarie Bank of Australia got affected because of such overseas investments. Indian banks' exposure to the sub prime crisis of US is minimal (except to ICICI).

I personally feel many Tata (and other India Inc.) M&A deals of yr 2007 can be bracketed in heavy risk zone, at least for short duration i.e. ~ 5 yrs, which if could have been delayed would have yielded better.

3. Controlled Derivatives market: Derivatives are financial instruments, which can spread the default risk attaching to loans. Derivatives lead to such a chain reaction that it will be nearly impossible to quantify the risk of exposure to bad loans and advances subsequently. RBI and GOI should prohibit indiscriminate use of such derivatives if they intend to introduce such products in India.


4. Quality Inward Investment: FDI should be given priority over FIIs as history has shown that flight of capital in case of FDI is low compared to that in respect of FIIs. Due to their stable nature, FDI can help in the growth of the country's infrastructure in much better way.