Rickety banks help India ride out financial storm

Absence of debt instruments served to insulate institutions from the disaster that has struck Western banks.

India's banks are no better than the antiquated Ambassador and Fiat cars that used to trundle along India's roads, while "the rest of the world is using BMWs and Ferraris", a report commissioned by India's finance ministry into making Mumbai an international finance centre concluded last year. Now that India's old-fashioned banking system has saved the country from the worst financial pileup the world has seen in decades, the case for more sophisticated financial machinery looks harder to make.

"Gradualism in reforms is really saving us from crisis to crisis," an executive at the Reserve Bank of India (RBI) said. "We have not made any reforms overnight, we have had a lot of discussions, lots of back and forth, before we make any steps. "If the rupee was convertible then anything could have happened." Gaurav Kapur, a senior economist at ABN Amro India, agrees. "The conservative pace of financial-sector reforms has certainly helped us to remain insulated from what's happening around us. A lot of these problems have been created by those very vehicles India has been criticised for not adopting."

Asian markets which have opened up more fully, such as China, South Korea and the Philippines, look more vulnerable. Percy Mistry, who wrote the report on Mumbai as a financial centre, concedes that had India implemented the reforms he recommended, it would have been more severely hit. "We would have been affected, there's no question about that," he said. "But do you sacrifice a two per cent to three per cent increment in gross domestic product (GDP) every year, simply to avoid a financial crisis every 10 years or so that might cost you five per cent of GDP?"

A century ago, the financial markets of Bombay and Calcutta were as advanced as any in the world. The original fortunes of many of today's business clans were based on trading in opium and cotton futures. But when a controlled economy was instituted in 1950, the country fell behind until India started opening up its economy again in 1993. Since then, reform has proceeded at a snail's pace. It took from 2003 to last year for the RBI to progress from the first to the second drafts of regulations allowing collateralised debt obligations (CDOs). Now, despite the urging of both Mr Mistry's committee and a follow-up report led by the former IMF chief economist Raghuram G Rajan, it looks like CDOs could be on the shelf for years to come.

This absence of debt instruments has arguably prevented Indian banks from getting into difficulties. "The market for securitised paper is still very modest here," said Robin Roy at Standard Chartered Bank in Mumbai. "You don't have layers and layers of securitised paper with different tenors and seniority, so by default the exposures are controlled." The RBI has also imposed limits on the type and quantity of securities that India's banks can buy abroad, preventing them from loading up on mortgage-backed securities.

ICICI Bank's joint managing director, Chanda Kochhar, said on Thursday that ICICI's total exposure to foreign markets was equal to about four per cent of its US$103 billion (Dh378n) balance sheet. ICICI's UK subsidiary held $81 million of senior bonds issued by Lehman Brothers. According to Vaibhav Agrawal, a banking analyst at Angel broking, two-thirds of the $1.5 billion in ICICI's overseas credit exposure relates to the corporate debt of its Indian clients.

The exposure of the state banks, which make up 70 per cent of the sector, is considerably lower. The State Bank of India chairman OP Bhatt said on Thursday that the lender had exposure to just $5 million of Lehmans bonds. India has also avoided the credit bubbles seen in the US and Europe. Mr Kapur said the RBI could take the credit for this. "RBI has been conservative, but they have been prudent in identifying and arresting the build-up of a credit bubble," he said.

In Dec 2006, the RBI took fright at the 30 per cent growth in bank lending seen in 2005 and 2006 and tightened controls on lenders. India's major private banks - ICICI, HDFC and AXIS - are now all conservatively financed, with tier-one capital adequacy ratios of more than 10 per cent. By comparison, Barclays, of the UK, will have a capital ratio of only 5.7 per cent, even after raising $1.4 billion to fund its Lehmans deal. Lloyds-HBoS, after the merger, will have a core tier-one ratio of 5.9 per cent.

Mr Agrawal estimated the off-balance sheet exposures of India's big banks at between 40 per cent and 60 per cent, also lower than most European and US banks. However, according to Mr Mistry, India's escape may paradoxically end up costing the country heavily if necessary reforms are brought to a grinding halt, just as India's escape from the Asian crisis in 1998 killed off the first wave of reforms started in 1993.

"Reforms were proceeding apace until 1998 when the Asian crisis derailed everything," he said. "It's entirely possible that the same may happen again, that people think 'we should go back into our holes and stay with what we've got'. I think that could cost two to three per cent of GDP growth if that happens." Mr Mistry estimated that if India's financial services companies were able to provide a full and sophisticated range of financial services, it would create new business worth at least 1.5 per cent of Indian GDP, while a further 1.5 per cent would be generated by the greater ease with which Indian companies would be able to do business.

"As a committed Indian, I'm terribly worried that in this maelstrom, a whole bunch of arguments have been raised by academics, professionals and the public at large," he said. "Every anti-reformer, everyone who believes in state control, every leftist will be making hay with this for years to come. "It's the same argument that because you have a bullock cart you shouldn't drive an automobile because you might kill people in a road accident."