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Companies Are Wary of Borrowing
Oct 17, 2017


Richard Thaler recently won the Nobel prize for his thesis on behavioral economics.

Behavioral theories don't just explain how investors think - they point out flaws in human thinking. Economists like Adam Smith and John Maynard Keynes have believed for centuries that human behaviour is too tricky to model with math. By simplifying it, you can get a much more scientific-looking model. And being obsessed with predictions, models and math is all that financial markets want.

I first encountered the term behavioral economics when I read Charlie Munger. Munger's 1995 speech on the Psychology of Human Misjudgment was a turning point: It explained why investors behave the way they do.

Munger's explanation of 'cognitive biases' has helped many investors create AND safeguard their wealth. Years ago, dear reader, my team laid out an easy-to-digest version of Munger's system of human psychology in a special series, that you can read here.

Today again I'm talking about behavioral theories because these theories can also help us tell apart great business from disastrous ones...multibagger stocks from losing ones and...and super investors from unsuccessful ones, over the next decade.

This is particularly true in one sector that is very responsive to economic behaviours of people and institutions...as much as it is to central bank regulations, interest rates, GDP growth and employment: The Indian banking sector.

This sector offered loans to the tune of Rs 71 trillion in 2016-17. This was nearly 60% of our GDP.

Most of the 93 commercial banks, weak or strong, grew their loan book in double digits in the last decade. Real estate boom, consumption boom, financial inclusion and the boom in housing loans, all acted as tailwinds.

The good part is that despite the fast-paced growth, the sector managed to retain its sanctity. The regulator, RBI, ensured that our bank lending never went berserk. And none of the banks pose systemic risks.

The sad part is that the disbursement of loans has lately fallen to a four-decade low. And the total quantum of non-performing (irrecoverable) loans has never been as high as they are now.

So where is behavioral theory in this?

Well, the business of banking is dependent on the psychology of the bankers - they decide how much to lend and to whom - and of the customers - the savers and borrowers decide how much to save, borrow, and whether to repay on time. The borrower psychology remains the same for both individuals and large corporate entities.

On the one side, thanks to all the non-performing assets they are saddled with, bankers have become biased against corporate loans. As a result, most loans in recent years are neither generating much income or creating asset. Now, with property prices unstable, even asset-backed home loans look like trouble. So bankers have developed cold feet and minimized lending.

Are the Loans Creating Assets or Stoking the GDP?
FY10 Share of credit FY17 Current share CAGR
Home loans 3,009 9.9% 8,600 12.1% 16%
Commercial Real Estate 921 3.0% 1,855 2.6% 11%
Personal Loans 5,856 19.3% 16,200 22.8% 16%
Vehicle Loans 637 2.1% 1,705 2.4% 15%
Credit Card Outstanding 201 0.7% 521 0.7% 15%
Businesses (Small and large) 13,114 43.1% 26,800 37.8% 11%
Source: RBI

On the other side, the borrowing companies are wary of putting off their shareholders with high debt on their books. Plus, the interest payments are a drag during times of low profitability. So, their bias against borrowing has taken the demand for loans to the lowest in a decade.

Hopefully, over time some banks be able to avert the biases and grow even as their margins and asset quality stay intact. And, with technological innovations, attract retail and corporate customers wary of plain vanilla banking products.

The takeaway for you, dear reader, is that your favourite banker may change in the coming years. And the banks you have invested in could be either creating or destroying a lot of wealth! You might want to ensure that you are on the right side of the equation.

Data Source: Ace Equity

This Chart Of The Day was published in The 5 Minute WrapUp - This Rs 71 Trillion Business Could Make or Break (Your) Wealth in the Next Decade

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