Coming Age Of Default

Traditional banks in the West never thought twice about lending to their rich clients. They understood that rich people’s incomes went up or down while their desires brooked no waiting. If a country house caught a client’s eye or he felt like sailing to Grenada with his paramour, all he had to do was to take his banker out for lunch; everything could be settled in an hour. Though not so readily at their clients’ service, Indian banks took an equally benign view.

That suddenly changed after the 1971 nationalisation. Favours to personal clients came to be frowned upon, and close relationships with them looked on with suspicion. Nationalised bankers soon learnt the lesson, that they were serving the great socialist god and must finance projects of national development. Consumption was evil; financing it was treason. An occasional overdraft might be given after an old depositor had kowtowed suitably and given solid collateral; but it must be recovered before too long.

This new patriotic morality was first diluted when the government issued licences to a few private banks in the early 1990s. They found it difficult to penetrate the longstanding relationships between nationalised banks and their clients; few businessmen would have dared to enrage the government bank that had been his principal source of credit for ages and move to an untried little private bank. Thus frustrated, some of the private banks started to consider personal loans against solid security.

The 1990s were also the time when credit cards began to catch on in India; and since the Reserve Bank made it difficult for others to enter the business, banks captured the credit card business. It involved personal credit, but under restrictive conditions. Most of it was for less than a month; if a customer did not pay in time, he would soon find his credit card cancelled.

Then came the slowdown of 1997 and after; business borrowings could no longer keep up with banks’ lending capacity. Businesses stopped repaying loans. The hard way was to write off bad debts; banks naturally preferred the soft way, which was to give more loans — they brought down the ratio to credit of ‘nonperforming assets’, in other words, bad debt.

In the late 1990s, the balance of payments began to improve, and foreign exchange reserves started rising. As they rose, domestic money supply increased. Businesses’ cash balances went up, and they needed to borrow less. The government grew more relaxed, and allowed businesses to borrow abroad; so they needed domestic banks less. As business loans slowed down, banks began to give personal loans. The growth in personal credit was phenomenal. Its share in new loans was roughly a quarter in the early 1990s. It went up to a third by the end of the decade. By 2005-06, it had risen to an astonishing two-thirds. Its share in total credit rose from about 9 to 23 per cent.

That was the time the government dismantled the barriers it had created in the financial markets, which had reserved housing loans for specialised institutions. Banks took to housing loans with relish; their fervour increased when the housing boom began in 2002. By 2005-06, half of the banks’ personal credit was going to real estate. Car loans also caught on, though banks faced competition from the car manufacturers, who set up their own car finance arms.

The number of credit cards has gone up from 3.7 million in 2000-01 to 27 million. But the business remains relatively small. Indians are typically cautious borrowers. They are aware of the extortionate interest banks charge on credit card debt. Most of them got credit cards from obscure sales agents who make themselves scarce once they have collected their commission; and credit card holders are scared of unauthorised collection agents. So they borrow little on credit cards.

Now, a downturn is beginning. If the economy turns down, bad debts cannot be far off. As early as in 2007, there were stories of banks engaging hooligans to repossess cars; the courts frowned on them, and they seemed to have slowed down. But personal loans will turn bad as surely in the coming slump as business loans did in earlier downturns; and banks will find it even more difficult to deal with personal borrowers than they did with businessmen. For there are many more personal borrowers, and being more numerous they are more difficult to pursue and have more political influence. Amongst those who worry about this is Asset Reconstruction Corporation of India, which has prepared a white paper on retail lending. Good luck, Arcil!
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