The Hindu : LEVERAGED LIVING

Online edition of India's National Newspaper
Tuesday, Dec 23, 2003

Opinion

Opinion - Editorials

LEVERAGED LIVING

A RECENT EXHORTATION by a highly placed Reserve Bank of India (RBI) official to banks to be cautious in expanding their home loan portfolio is significant. Although there has been no official regulatory warning so far, it is obvious that banks and housing finance companies need to put in place correctives immediately so that there is an orderly growth of the business. The danger of a financial bubble fuelled by hype and unbridled expectations has always existed in the Indian financial sector, most noticeably in the share market. After every bubble burst there have been catastrophic consequences for the entire financial sector. No one has suggested as yet that the present housing loan scenario is a bubble waiting to burst. Yet if the RBI's concerns are anything to go by, banks and loan providers might already be guilty of not doing enough to safeguard their interests and, equally importantly, those of their growing number of customers. The central bank has said banks have been tardy in documenting loans and are in danger of getting locked into these 10 to 20 year loans without a mechanism to hedge risks. Unlike in the West, banks and other home loan providers cannot easily shed their loans by parcelling them out to retail investors. More serious is the suspicion that the home loan providers, which now offer both flexible and fixed interest rate options, have not mastered the technique of forecasting interest rate movements over such long periods. Finally, with delinquency rates in the segment climbing steeply and beyond the earlier projections, it is questionable whether banks can make a profit in lending at these levels, even assuming interest rates remain stable.

The growth of the home loans business has been one of the significant achievements of the reform era, catering to the aspirations of a growing middle class. Aided by generous tax incentives and the general decline in interest rates, housing loans have become affordable to a very wide section. Equally importantly, there is a distinct change in the middle class mindset. More and more salary earners and interestingly the younger among them are not averse to borrowing as a means to acquire an asset, be it a home or a car. Even the mainline banks, long averse to financing consumption, have responded by fashioning several consumer-friendly schemes. Retail banking (including credit cards) has become the high growth area at a time when cash rich banks are unable to increase lending to the manufacturing sector, their most traditional activity. Around 80 per cent of the new assets created through bank loans over the past few years have come from the retail segment. Home loans alone account for 80 per cent of the incremental growth.

The explosive growth of home finance and consumption loans is to be welcomed in a broad sense because consumption-led demand is a crucial determinant of GDP growth. However, it will be prudent to note the pitfalls ahead before one endorses a strategy that might have fitted the developed economies but still remains untested for an economy such as ours. From a consumer's perspective, the availability of a variety of loans is not an unmixed blessing. There is increasing evidence of many middle class consumers falling into a debt trap. Just as the finance providers have been warned against recklessness, it is time consumers are made aware of the risks inherent in leveraged living.

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