RBI succeeded where Fed failed

Hindustan Times | ByBS Srinivasalu Reddy, Mumbai
Aug 22, 2007 09:25 PM IST

The central bank had foreseen a bubble in the real estate sector, and acted decisively, reports BS Srinivasalu Reddy.

When the RBI raised interest rates and hiked risk weights for real-estate loans, there were howls of protest. The real-estate lobby even hinted that the apex bank was throwing a spanner into the works of a well-oiled economy. Home loan borrowers were equally upset, as mortgage rates shot up.

HT Image
HT Image

In hindsight, though, these steps may well have saved the country from a meltdown similar to the one in the US. Was the RBI right in doing what it did? MV Nair, CMD, Union Bank of India, said: “Absolutely. We have a regulator who had appropriately foreseen an emergent bubble in the real estate sector, took a view and acted by raising provisioning requirements and risk weights.”

“Without these measures in time, it would have become a cause for concern. However, there was a lot of financial engineering that contributed to the US sub-prime crisis,” Nair added. Quite in line with iconic former US Federal Reserve chief Alan Greenspan’s view that monetary regulators must foresee such bubbles and take appropriate measures.

Prudence pays

THE RBI has been conservative in allowing bank exposure to capital market and real estate sectors for quite a few years now
THE CENTRAL bank had identified an evolving real-estate boom as early as October 2005 and taken measures in the form of raising rates, provisioning requirements and risk weights

But the Fed, the RBI’s American counterpart, appears to have failed this time around though. The US sub-prime market was funded through bank loans provided to borrowers with dubious credit records. The unbridled expansion of sub-prime loans has ravaged the US financial sector. The Fed had to throw in a lifeline in the form of a 0.5 per cent cut in discount rate (at which banks can borrow from it). The fall-out of sub-prime crisis in the US is now being felt in capital and other markets across the world for over a week now.

However, analysts argue the Fed has not failed, and the blame for the crisis is now being laid on Wall Street firms, hedge funds, and some foreign banks that invested in the sub-prime market via their subsidiaries.

Back home, the RBI had identified an evolving real-estate boom as early as October 2005 and taken measures in the form of raising rates, provisioning requirements and risk weights later, to nip the nascent boom over nearly 18 months.

Several banks were seen unleashing herds of direct selling agents to push loans to the clients in 2005 and 2006. Banks were almost chasing the prospective customer, leading to credit growth shooting up by 30 per cent.

The RBI virtually “talked” the asset-price inflation, as it was called, down. RBI governor Dr YV Reddy refused to state that an asset bubble was in sight, but admitted that the intention was to “sensitise” banks on the potential danger of such a prospect. For quite a few years now, the apex bank has been conservative in allowing banks an exposure to the capital markets and real-estate sectors.

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