In 2008, India imported Wall Str-eet's credit crisis through its ports, not its banks. Three years later, as Europe struggles to shore up its ailing banks in an attempt to avert a currency crisis, the most likely route for the contagion to spread to our shores remains trade in merchandise and services. India borrows little from the rest of the world and lends even less. Most of Indian debt is held by Indian banks, which are anyway being recapitalised to conform to new, tighter banking regulations that are being drawn up after Lehman Brothers collapsed. State Bank of India, the country's largest lender, is a case in point. The fact that it was downgraded earlier this week by credit rating agency Moody's had more to do with its owner, the government, being late in expanding its capital base than with any doubts about its loan book. For what it's worth, the downgrade does little to State Bank's capital expansion plans: less than 6% of its borrowings are from the international credit market.
Indian banks present a picture of temperance because State ownership and a tight vigil have kept them from excessive risk taking that felled their far bigger counterparts in the US and Europe. Some of the new rules the world is adopting for the banking industry have been at work in India for decades. This may have slowed their growth, but Indian banks have demonstrated their ability to withstand wide systemic risks, and ought to be able to do so again if Europe fails to get its act together. That, however, does not mean that they would pass stress tests if they were to operate in an open environment that most western banks do. Indian banks are minnows by international standards and they have been relatively sheltered by capital controls alongside stiff entry barriers for foreign banks. As India's economic heft increases, its banks will have to swim out of the lagoon into the sea.
The travails of American and European banking will have informed the Indian industry before it ventures out, as they must. At some point, India's growth will require it to borrow, or lend, big time in the global capital market. Its financial sector will have to be more open to foreign players. Its regulatory mechanism robust enough to spot and pop the next bubble. All of this must be preceded by providing millions of people access to banking services. Indians save over a third of their income, but this number means little unless most of the household savings enters the financial market where it gets farmed out for investment into factories, highways and ports. In a decade from 1969, when banks were first nationalised and told to go to the villages, the Hindu rate of growth crept up from 3.5% to 5%. Since then, as bank branches fanned out across the country, and more Indians put their savings in banks, the growth rate has sprinted to 9%.