Thursday, 20 November 2008


The skeletons from the cupboard marked “ sub-prime “ are tumbling out thick and fast. How many are still left is a question, to which even Barrack Obama would prefer to remain silent. Every morning brings with it the crunch faced by a Bank, Insurance Company or a Fund. The crunch some how, with sickening regularity, converts in to a write down before a bankruptcy filing. The “BIG” the “SMALL” are all the same. After all whats in a name? The only thing that seems to matter is a bail out which itself now has become selective and difficult to come by.

It all seems to have begun with the, ‘madness-on-hindsight-multi-layered leveraging’ created out of the housing mortgage market in the US, which at that time was booming. Ultimately as the housing collapse occurred the defaults at different levels made us aware that it was a bubble that had existed then and that it has given us busted feeling now.

The Global Sub-Prime and India

The first waves of sub-prime hit us in the form of FII withdrawal from the Indian equity markets with the simultaneous mad rush for the USD. The whispers about US banking failures appeared distant. We brushed the concern away with our belief in the resilience of the Indian economy and waited for the FIIs to return back, and aggressively too. Infact we still are hopeful of the ‘pull back’ as evident from the fact that the RBI in its policy review in October 2008 has only marginally lowered our GDP growth rate from 8% to between 7.5% to 8.00%.

As the sub-prime keeps unfolding we need to examine and estimate the impact it might have, on our banking and financial systems and the economy, on a continuous basis. Keeping in mind that it was a housing slow down that had triggered the sub-prime crisis it might be interesting and worthwhile to visualize possible heightened default scenario in the Indian housing finance market as well.

The Indian Housing Finance Market

The Indian Housing finance has had a phenomenal growth during the 21st century. From being around 3.5% of the GDP in 2001 it has grown to almost 8.5% to 9.00% of the GDP in 2007. The fact that the GDP itself has grown through these years accentuates the housing finance growth.

The aggressive lending of the Banks in the housing sector is evident from the quantum jump between 2001 and 2005 . A dissection of the retail portfolio of banks also helps in clarifying the position further.
As on 24th November 2008 (as quoted from RBI publications) the advances of scheduled commercial banks stood at around 26.15 lac crores.
Assuming a slightly higher proportion of 15% in 2008 (higher than 12.18% as in 2005) of housing loans in the total advances, the housing loans outstanding in the system accounts for around 4.00 lac crores currently, all repayments etc put together and adjusted for.

The subtle bubble

The housing loan outstanding has grown by around 300% from 1.35 lac crores in 2005 to reach an outstanding figure of 4.00 lac crores (as estimated above) in 2008. It may also be safe to assume that the real estate prices across the country and across different segments have appreciated by around 40% to 50% between the periods of 2005 to 2008.

With the boom going bust now, it may be expected that the real estate prices across the country are likely to correct downwards by around 25%-40% in the course of time. Of the 4.00 lac crores advanced by banks for housing loans, the margins may vary between 10% to 25% across banks and schemes. A margin of 15% can be assumed on an average.

It means that when the property prices corrects by around, say 30%, the original margins on the loans will shrink, not withstanding the fact that a part of the loan might already have been repaid. There might be cases, and may be a majority of them, wherein over financing can emerge.
Literally banks might end up having financed more than what the property actually costs now. Especially so in case where ballooning repayments have been sanctioned. Though the accounts are not technically classified as NPA as the repayments may happen regularly, on closer examination it may be seen that the shrinking value of the property in fact substitutes the effects of faulty repayment. This again gives rise to the fact that the dip in realty prices will give rise to unrecognized risks in the balance sheet for which provisions have not been made. A recognition of the same may result in a higher NPA. These are over and above the actual defaults in repayments, which might occur due to the melt down in the economy. These effects are perceived even currently, as an under current, as is evident for the fact that banks are demanding higher margins as also insisting that the only 45-50% of the take home pay can be considered for repayment currently as against 60-70% earlier. However the realty melt down crisis is not yet recognized at a policy level especially with regard to loans already disbursed where the effect are in a more subtle way.

What ought the banks be doing?

Banks are required to do periodical valuation of the mortgaged properties to ensure that proper security is available for the advances granted. Different banks may have different norms and different frequency of inspection and valuation. Considering the sudden melt down in the property prices it might be advisable for the bankers to do more frequent valuations of the property so as to realistically reflect the market prices on their appraisal forms.

The question however remains as to what to be done in case over valuations are identified. Do we raise the installments thus heightening the probability of default? Or do we reschedule by extending the period of repayment?

Also most importantly, should the banks be asked to recognize the uncovered portion of the housing loans and be asked to make a blanket provision for the excess financing in the housing sector? Remember even a 5% provision on the 4.00 lac crore outstanding will be Rs.20000 crore which is enough to wipe out the combined profits of many an Indian bank put together. Or are they to give the over-financing part a miss, thus allowing the over valued properties to continue in their balance sheets until they are bust by a bubble?

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