Lessons for India from US

Tue, 12 Jul Pre-Open

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Fannie Mae and Freddie Mac were sponsored by the US government to support the US housing finance. For years, they were the leaders in lending money to Americans who wanted to buy a house. However, as 2008-09 crises came to light, it turned out that a lot of these loans were given to people who could not repay the loans. The clients defaulted. Fannie Mae and Freddie Mac had to be rescued by the US government effectively making them wards of US treasury.

This episode tells us about the excesses in the system that was indirectly promoted by the government. These companies benefited from the implicit government guarantees that helped the companies to raise debt. They later ended up lending carelessly to the people who couldn't afford to buy a house. In a way they speculated on the prices of the property.

Unfortunately, there are many similarities between the government sponsored entities (GSEs) like Fannie & Freddie and the public sector banks (PSBs) in India. As with GSEs, the PSBs own more than 70% of the banking assets in India. Affordable home ownership goals set by the US government are similar to the discounted housing schemes and 'priority sector lending norms' in Indian banking. The US home ownership goals gave birth to these GSEs who gave loans to the people not worthy of it. Similar can be the case in Indian housing and agriculture loans in India. With teaser rates on housing loan and compulsory lending to agriculture, there is a good chance that money will find its way to the people who might not be able to repay.

It should be noted that much of the growth faced by the PSBs in the past is a result of the government guarantee attached with them rather than the ability of the PSBs. Unfortunately the government is yet to recognize and understand this fact. So far, it has done a good job by controlling the PSBs and making them lend to areas which the government wants them to. However, continuing with the same methods of subsidizing the interest rates will creatively destroy the private banking system. Surely, this is not what the government wants. Instead, the government should have a clear plan to divest its stake in the PSBs in a slow and steady pace. Too much control can end up being bad. We have already seen it happen in US. Let us not hope for a repetition in India.