Indian, Chinese banks plunge at
different rates By Chan Akya
What's the difference between falling 20
meters and falling 60 meters? Well, in the first
instance you go "thud, aaaaaarrrggghhh", and in
the second you go "aaaaaarrrggghhh, thud". That
crude comparison could well illustrate the
difference between the Indian and Chinese banking
systems.
In the long run, I believe the
Chinese banking system poses greater dangers and
is more likely to collapse from the sheer weight
of its problem loans. Foreign banks looking to
enter both markets must do so with eyes wide open.
Legend has it that Chinese bankers keep a
shredder handy in their office for the express
purpose of destroying business cards
of
their borrowers. You see, they never intend to
call them back about the loans, as that's the
responsibility of a different department.
The latest gross domestic product (GDP)
figures from China should make the the People's
Bank of China nervous, as indeed it has. (The
central bank announced further restrictions to
lending on July 21.) While export-oriented growth
remains high on the back of Americans being too
lazy to manufacture anything themselves, the
sector's profitability continues to decline.
Using official data from both the United
States and China, it is easy to calculate that the
average price of Chinese goods sold in the US has
been falling the past few years, despite rising
input costs (copper, for example). That puts
manufacturers in a quandary, as the good old
Chinese maxim of "work hard, be successful" simply
doesn't work in practice.
So they do the
next best thing - ie, borrow from banks and
speculate in the local asset markets, particularly
property and stocks. Walk around the Pudong
district of Shanghai and you can see
the impact of a building boom, with great
monuments to corporate success all around you.
More troubling, you will see the same sights
greeting you in downtown Guangzhou, Shenzhen,
Chengdu and, of course, Beijing.
China is
a manufacturing economy, and the proportion of
Grade A office space thus appears far higher than
is economically warranted. This is, however, also
the reason for the Chinese GDP to ramp up nicely,
as all the infrastructure and building activity
adds to recorded economic growth.
Banks,
trying to recover their money from companies'
manufacturing operations, find themselves having
to support such speculation to improve their
chances, echoing the "ever-greening" scandal of
Japanese banks in the 1980s and 1990s. The party
comes to an abrupt halt once liquidity is drained
away from the system. This is precisely what the
central bank is now doing with hikes in lending
rates and, more important, by issuing policy
diktats aimed at removing bankers' temptations to
lend.
When an essential condition for
banking crises does not occur, namely a wary
central bank, why then do I express pessimism
about the longer-term outlook? Quite simply
because politics makes an essential difference.
China's leaders owe their legitimacy to the
continuation of strong economic conditions and, at
the very least, substantial employment.
A
continuation of restrictive banking policies
reduces the country's ability to absorb the people
being thrown off by public-sector companies, as
the sector aims to achieve profitability. With
profits unlikely to improve any time soon, as the
export sector remains fiercely competitive, this
means further job losses are unavoidable. When
economic growth slows, China's government will
have much to worry about, and will likely instruct
the central bank to reduce or withdraw its
restrictions. In effect, this would push the
resolution of any asset bubble to the longer term,
which would obviously also cause a manifold
increase in the costs of dealing with the
problems.
I believe that rather than the
end game being forced on the Chinese banks by
their own central bank, extraneous forces are more
likely to cause the adjustment. Some possible
examples include a recession in the US and Europe,
uncovering of other banking scandals in China and,
of course, internal disquiet in the country. When
the reckoning does come, expect also to see a
large-scale increase in problem loans from the
retail sector, as was observed in the case of the
various international trust and investment
corporations that were shuttered in the late
1990s. Chinese people will take every opportunity
to avoid paying back their loans, and a bank
failure presents the perfect opportunity to do so.
The resulting avalanche of bad loans will cost the
country about 20% of its GDP, in my opinion.
Meanwhile, legend has it that becoming an
Indian banker is the cherished dream of the middle
classes, but defaulting to banks is the path to
riches for India's upper classes.
The
Indian banking system is a relatively small part
of the economy, with banking assets to GDP barely
crossing a third, and with nationalized banks such
as the State Bank of India group making up a large
portion. That said, private and foreign banks have
an increasing role to play in the system, far
higher than their command of banking assets would
suggest. India's banks face losses on so-called
priority loans as well as the long workout process
that problem loans are subject to. However, these
loans are isolated, with a few leading
public-sector banks absorbing a bulk of these
exposures. Also, and quite unlike in China,
India's political establishment is not very
sensitive to the level of interest rates, and is
therefore unlikely to oppose the Reserve Bank of
India's judgment in the matter.
Indian
banks have been profitably lending to the middle
classes for centuries now, as banking goes back a
few generations, particularly in the richer parts
of the country such as the north and the west. The
explosive growth rate in personal and mortgage
finance in recent years, however, bears close
watching. A number of Indian middle-class
borrowers have tapped the willingness of
commercial banks to lend money, a development over
the past 10 years that destroyed the dominance of
the Housing Development Finance Corp in the
sector.
With new private-sector and
foreign banks leading the charge in innovation,
even the moribund public sector has had to catch
up. By and large, even with large economic risks
looming - for example, borrowing by individuals
working in call centers and information technology
- companies could become substantially more risky
if a downturn hits these sectors. Similarly, the
central bank is worried about inflation causing
further rate hikes, which I believe will pressure
quite a few of these young borrowers and lead to
bad debts climbing above 5%.
In terms of
skill sets, though, unlike in China, Indian
bankers go through years of credit training, with
cross-department exposure available to all
officers in nationalized banks. This has allowed
the nationalized banks to dominate the market for
large corporate lending. Changes in the mid-1990s
allowed for specific banks to assume the lead
position in banking consortiums, thereby reducing
the ability of large corporate borrowers to
"borrow from Peter to pay Paul". Larger
consortiums, particularly those comprising
non-nationalized banks, have been shown to have
lower loan losses. This experience is vastly
different from that of China.
This leads
us to the main causes of banking losses in India,
namely corruption, a slow legal process and
government meddling. The ruling Congress party
started the fashion for open house loans (known
locally as loan mela), wherein banks tend to lend
small amounts of money to a large number of poor
peasants. Most of these loans have led to losses.
The second area of losses is due to the
prevalence of corruption, particularly at the
heart of the second-tier nationalized banks such
as Indian Bank. These losses have usually revolved
around single banks taking on the total exposure
of politically connected corporates that find
themselves in dire financial straits for various
reasons. The process of declaring bankruptcy and
imposing financial restructuring is overly long,
and usually contributes to higher losses given
default.
The worst-case scenario comes
about if the Reserve Bank of India hikes rates
even as a slowdown bites into the export-oriented
sectors. Resulting losses from this scenario would
cross 5% of GDP in my opinion, even after
considering the lower severity of default.
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