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Too Big - The ones who will bail

Oct 29, 2009

You take a loan to buy a house.
You cannot afford to pay the loan.
You call your banker and say, "Sorry, sir, I cannot repay my loan. Please can we talk about it?"
Chances are there will be a muscle-man holding your teeth with a pair of rusted pliers while you try to talk.
But not if you are TBTF.
Then the government comes to help you.
In USA. In Europe. In India". This was written by Ajit Dayal in the third issue of The Honest Truth in October 2007. Things have definitely changed since then. In India. In the US. Badly bruised by the collapse of large financial institutions and at the receiving end of taxpayers' fury over expensive bailouts, the US government seems to be in the mood for some corrective action. As per a draft legislation proposed by the US Financial Services Committee, in future, banks, hedge funds and other financial firms that hold more than US$ 10 bn in assets would pay to rescue companies whose collapse would shake the financial system.

While the legislation has been termed as a tough and sound response to the Too Big To Fail (TBTF) institutions, the exact modalities have been left unclear. Nonetheless, the plan would shift the onus of rescuing defaulting firms from taxpayers to large entities. Particularly given that US taxpayers bore the cost of funding a US$ 700 bn bailout last year after the near collapses of Bear Stearns and AIG. The move may not stop large financial entities in the US from taking additional risks. Nevertheless, it will atleast get the large entities to keep a hawk eye on the ones that pose a risk to the system as a whole.

In India, meanwhile, the government has yet to figure out how to 'bell' the TBTF candidates. The last time they escaped lucky because of the relatively un-matured markets here and a good governor. They may not be as lucky the next time.

The RBI nevertheless smells rat in real estate loans. And there is reason enough. Between May 2008 and May 2009 the non-agricultural loans given by banks grew by 18% YoY. This was nearly 50% lower than the RBI's target for this fiscal. At the same time, the loans extended to real estate grew by more than 52%!

What worries RBI even more is that while the lending to the commercial real estate sector has accelerated most, in the restructuring of loans by banks, the commercial real estate accounted for more than 10%. This is at a time when the commercial real estate prices have still not adjusted as there has been no fall in prices despite plenty of vacant places. Keeping with its proactive reputation, the RBI has made loans to the sector costlier in a bid to ensure that banks are more cautious in their lending.

While there may be several Big institutions in India that have so far been generously lending to the real estate sector so as to outshine their peers in terms of margins, they now have to tread with fear. For neither the Indian government has the funds to bail them out (thanks to burgeoning deficit position) nor will the RBI allow them to 'rest in peace'.

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