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Fallout of the global credit crisis

The turmoil in the global financial markets continues unabated. Starting with the sub-prime segment of U.S. housing market, the problem has transformed into a broader credit market crisis which, as recent events in France and the United Kingdom indicate, has assumed global dimensions. Loss of investor confidence and higher borrowing costs that it entailed for even top-rated companies have been the two principal consequences. In the developed markets, fearing a shortage of liquidity, central banks have pumped in huge sums and encouraged banks and institutions to borrow at rates that were deliberately brought down. A more decisive step was taken by the U.S. Federal Reserve on September 18 when it reduced its benchmark lending rate by 0.50 percentage point, which was more than what the financial markets expected. Even though stock markets everywhere scaled new peaks immediately, there is nothing to suggest that the credit crisis is nearing its end or has even moderated. The U.S. monetary authority’s action, which is bound to be emulated widely, was intended to limit the damage to the broader economy by making available cheaper credit to a variety of borrowers.

For India, the only direct consequence of the crisis has been the extraordinary volatility of the stock markets and this is attributable to the behaviour of foreign institutional investors, hedge funds, and others with direct exposure to the problem loans abroad. If India remains somewhat insulated, it is largely due to the Reserve Bank’s pro-active steps to check reckless bank lending to the housing sector — these included higher provisioning and margin requirements. Secondly, the volume of home loans, despite their growing popularity, is still small and the lending criteria and practices applied in India are more prudent. Besides, securitising home loans and parcelling them out to investors with different degrees of risk appetite are yet to gain wide currency. However, as in the U.S., it is the surfeit of liquidity that prompted home loan providers to take to aggressive marketing and in the process, as the RBI has noted, cut corners in documentation and other crucial requirements. The global credit crisis holds a message to all lenders: stick to the basics of prudent lending.

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