[DEBATE] : How India Avoided a Crisis By JOE NOCERA

[Miles Teg]

How India Avoided a Crisis By JOE NOCERA

MUMBAI

“What has taken a number of us by surprise is the lack of adequate 
supervision and regulation,” Rana Kapoor was saying the other day. “This 
was despite the fact that Enron had happened and you passed 
Sarbanes-Oxley. We don’t understand it. Maybe it’s because we sit in a 
more controlled economy but ....” He smiled sweetly as his voice trailed 
off, as if to take the sting off his comments. But they stung nonetheless.

Mr. Kapoor is an Indian banker, a former longtime Bank of America 
executive with a Rutgers M.B.A. who, along with his business partner and 
brother-in-law, Ashok Kapur, was granted government permission four 
years ago to start a private bank, which they called Yes Bank. In the 
United States, Yes Bank is the kind of name a go-go banker might give 
to, say, a high-flying mortgage lender in the middle of a bubble. (You 
can even imagine the slogan: “Yes is part of our name!”) But Yes Bank is 
not exactly the Washington Mutual of India. One news release it hands 
out to reporters who come calling is an excerpt from a 2007 survey by 
The Financial Express: “#1 on Credit Quality amongst 56 Banks in India,” 
reads the headline.

I arrived in Mumbai three weeks after the terrorist attacks that killed 
200 people — including, tragically, Yes Bank’s co-founder Mr. Kapur, who 
had served as the company’s nonexecutive chairman and was gunned down 
while having dinner at the Oberoi Hotel. (His wife and two dinner 
companions miraculously escaped.)

My hope in traveling to Mumbai was to learn about the current state of 
Indian business in the wake of both the credit crisis and the attacks. 
But in my first few days in this grand, sprawling, chaotic city, what I 
mainly heard, especially talking to bankers, was about America, not 
India. How could we have brought so much trouble on ourselves, and the 
rest of the world, by acting in such an obviously foolhardy manner? 
Didn’t we understand that you can’t lend money to people who lack the 
means to pay it back? The questions were asked with a sense of 
bewilderment — and an occasional hint of scorn. Like most Americans, I 
didn’t have any good answers. It was a bubble, I would respond with a 
sheepish shrug, as if that were an adequate explanation. It isn’t, of 
course.

“In India, we never had anything close to the subprime loan,” said 
Chandra Kochhar, the chief financial officer of India’s largest private 
bank, Icici. (A few days after I spoke to her, Ms. Kochhar was named the 
bank’s new chief executive, in a move that had long been anticipated.) 
“All lending to individuals is based on their income. That is a big 
difference between your banking system and ours.” She continued: “Indian 
banks are not levered like American banks. Capital ratios are 12 and 13 
percent, instead of 7 or 8 percent. All those exotic structures like 
C.D.O. and securitizations are a very tiny part of our banking system. 
So a lot of the temptations didn’t exist.”

And when I went to see Deepak Parekh, the chief executive of HDFC, which 
was founded in 1977 as the country’s first specialized mortgage bank, 
practically the first words out of his mouth were these: “We don’t do 
interest-only or subprime loans. When the bubble was going on, we did 
not change any of our policies. We did not change any of our systems. We 
did not change our thought process. We never gave more money to a 
borrower because the value of the house had gone up. Citibank has a few 
home equity loans, but most banks in India don’t make those kinds of 
loans. Our nonperforming loans are less than 1 percent.”

Yet two years ago, the Indian real estate market — commercial and 
residential alike — was every bit as frothy as the American market. 
High-rises were being slapped up on spec. Housing developments were 
sprouting up everywhere. And there was plenty of money flowing into 
India, mainly from private equity and hedge funds, to fuel the 
commercial real estate bubble in particular. Goldman Sachs, Carlyle, 
Blackstone, Citibank — they were all here, throwing money at developers. 
So why did the Indian banks stay on the sidelines and avoid most of the 
pain that has been suffered by the big American banks?

Part of the reason is cultural. Indians are simply not as comfortable 
with credit as Americans. “A lot of Indians, when you push them, will 
say that if you spend more than you earn you will get in trouble,” an 
Indian consultant told me. “Americans spent more than they earned.”

Mr. Parekh said, “Savings are important. Joint families exist. When one 
son moves out, the family helps them. So you don’t borrow so much from 
the bank.” Even mortgage loans tend to have down payments in India that 
are a third of the purchase price, a far cry from the United States, 
where 20 percent is the new norm. (Let’s not even think about what they 
used to be.)

But there was also another factor, perhaps the most important of all. 
India had a bank regulator who was the anti-Greenspan. His name was Dr. 
V. Y. Reddy, and he was the governor of the Reserve Bank of India. 
Seventy percent of the banking system in India is nationalized, so a 
strong regulator is critical, since any banking scandal amounts to a 
national political scandal as well. And in the irascible Mr. Reddy, who 
took office in 2003 and stepped down this past September, it had exactly 
the right man in the right job at the right time.

“He basically believed that if bankers were given the opportunity to 
sin, they would sin,” said one banker who asked not to be named because, 
well, there’s not much percentage in getting on the wrong side of the 
Reserve Bank of India. For all the bankers’ talk about their higher 
lending standards, the truth is that Mr. Reddy made them even more 
stringent during the bubble.

Unlike Alan Greenspan, who didn’t believe it was his job to even point 
out bubbles, much less try to deflate them, Mr. Reddy saw his job as 
making sure Indian banks did not get too caught up in the bubble 
mentality. About two years ago, he started sensing that real estate, in 
particular, had entered bubble territory. One of the first moves he made 
was to ban the use of bank loans for the purchase of raw land, which was 
skyrocketing. Only when the developer was about to commence building 
could the bank get involved — and then only to make construction loans. 
(Guess who wound up financing the land purchases? United States private 
equity and hedge funds, of course!)

Then, as securitizations and derivatives gained increasing prominence in 
the world’s financial system, the Reserve Bank of India sharply 
curtailed their use in the country. When Mr. Reddy saw American banks 
setting up off-balance-sheet vehicles to hide debt, he essentially 
banned them in India. As a result, banks in India wound up holding onto 
the loans they made to customers. On the one hand, this meant they made 
fewer loans than their American counterparts because they couldn’t sell 
off the loans to Wall Street in securitizations. On the other hand, it 
meant they still had the incentive — as American banks did not — to see 
those loans paid back.

Seeing inflation on the horizon, Mr. Reddy pushed interest rates up to 
more than 20 percent, which of course dampened the housing frenzy. He 
increased risk weightings on commercial buildings and shopping mall 
construction, doubling the amount of capital banks were required to hold 
in reserve in case things went awry. He made banks put aside extra 
capital for every loan they made. In effect, Mr. Reddy was creating 
liquidity even before there was a global liquidity crisis.

Did India’s bankers stand up to applaud Mr. Reddy as he was making these 
moves? Of course not. They were naturally furious, just as American 
bankers would have been if Mr. Greenspan had been more active. Their 
regulator was holding them back, constraining their growth! Mr. Parekh 
told me that while he had been saying for some time that Indian real 
estate was in bubble territory, he was still unhappy with the rules 
imposed by Mr. Reddy. “We were critical of the central bank,” he said. 
“We thought these were harsh measures.”

“For a while we were wondering if we were missing out on something,” 
said Ms. Kochhar of Icici. Banks in the United States seemed to have 
come up with some magical new formula for making money: make loans that 
required no down payment and little in the way of verification — and 
post instant, short-term, profits.

As Luis Miranda, who runs a private equity firm devoted to developing 
India’s infrastructure, put it: “We kept wondering if they had figured 
out something that we were too dense to figure out. It looked like they 
were smart and we were stupid.” Instead, India was the smart one, and we 
were the stupid ones.

Ms. Kochhar said that the underlying risks of having “a majority of 
loans not owned by the people who originated them” was not apparent 
during the bubble. Now that those risks have been made painfully clear, 
every banker in India realizes that Mr. Reddy did the right thing by 
limiting securitizations. “At times like this, you tend to appreciate 
what he did more than we did at the time,” said Mr. Kapoor. “He saved 
us,” added Mr. Parekh.

As the credit crisis has spread these past months, no Indian bank has 
come close to failing the way so many United States and European 
financial institutions have. None have required the kind of emergency 
injections of capital that Western banks have needed. None have had the 
huge write-downs that were par for the course in the West. As the bubble 
has burst, which lenders have taken the hit? Why, the private equity and 
hedge fund lenders who had been so eager to finance land development. 
Us, in others words, rather than them. Why is that not a surprise?

When I asked Mr. Kapoor for his take on what had happened in the United 
States, he replied: “We recognize it as a problem of plenty. It was 
perpetuated by greedy bankers, whether investment bankers or commercial 
bankers. The greed to make money is the impression it has made here. 
Anytime they wanted a loan, people just dipped into their home A.T.M. It 
was like money was on call.”

So it was. And our regulators, unlike theirs, just stood by and let it 
happen. The next time we’re moving into bubble territory, perhaps we can 
take a page from Mr. Reddy’s book — sometimes it’s better to apply the 
brakes too early than too late. Or, as was the case with Mr. Greenspan, 
not at all.

•

None of this is to say that the global credit crisis hasn’t affected 
India. It certainly has. I’ll be back after the holidays with more 
columns from India, including how Sept. 15 — the day Lehman Brothers 
defaulted — changed everything, even here, on the other side of the world.

Copyright 2008 The New York Times Company

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