A decade on from the Global Financial Crisis

by Dasarathi Mishra

In the preface of his bestseller “FREEFALL- America, Free Markets and Sinking of the World Economy” ( 2010), Joseph E Stiglitz, a noted economist and Nobel Laureate succinctly put, “In the Great Recession that began in 2008, millions of people in America and all over the world lost their homes and jobs”.

It is hard to pinpoint when the financial crash of 2007 began in USA. Its roots arguably trace back a good 12 years. It was in 1995 that Bill Clinton’s administration delivered a laudable affordable-housing agenda through amendments to the Community Reinvestment Act.

To fuel its rapid growth it spurned the traditional, hard-grind funding method of gathering deposits, relying instead on fashionable new “securitisation” structures, which wrapped up parcels of mortgages for resale to Wall Street investment banks and, in turn, to investors around the world. The market for mortgage-backed securities (MBS) and even more complex “collateralised debt obligations” (CDOs) boomed.

Before the crisis, in 2005 Jackson Hole Conference Dr Raghuram Rajan, then IMF Chief Economist presented a paper titled “ Has Financial Development Made the World Riskier?”. He pointed out to “Credit Default Swaps” which act as insurance against bond defaults could be immensely painful if default occurs. He questioned an ubiquitous  practice why did financial firms make loans to people who had no income, no jobs and no assets ( NINJA) loans ?

New Century was America’s biggest independent subprime mortgage lender, granting tens of billions of dollars of mortgages a year. To fuel its rapid growth it spurned the traditional, hard-grind funding method of gathering deposits, relying instead on fashionable new “securitisation” structures, which wrapped up parcels of mortgages for resale to Wall Street investment banks and, in turn, to investors around the world. The market for mortgage-backed securities (MBS) and even more complex “collateralised debt obligations” (CDOs) boomed.

So great was investors’ appetite for these high-yielding MBSs and CDOs that mortgage companies lowered their underwriting standards to feed the securitisation sausage machine. Fatally, as loan quality was deteriorating, the Federal Reserve was simultaneously raising interest rates amid concern about consumer inflation. Soon subprime borrowers were defaulting en masse.

If there was one moment when Wall Street knew that a crisis was looming, it was on April 2, 2007, when New Century filed for bankruptcy. Over the months that followed, a wildfire spread around the world. Funds set up to invest in the securitisations — so-called structured investment vehicles, or SIVs had to be bailed out by the banks that had created them.

Market nervousness turned to panic. Banks stopped their usual practice of lending to each other overnight, unsure of who held what on their balance sheets. They found themselves unable to issue new securitisations or even mainstream bonds. And with that, the fate of Northern Rock, which relied for an unprecedented 70 per cent of its funding on these “wholesale markets”, much of it very short-term money, was sealed.

In its  financial stability report, the Bank of England highlighted Brexit, excessive consumer debt and China as risks to beware. Governor Mark Carney sees China, where the total debt-to-GDP ratio has soared above 300 per cent, as a serious danger. “It is the biggest risk to financial stability,” says one expert , pointing out that many of the pre-crisis practices in the west, such as the creation of Sivs to invest in high-risk assets, are commonplace in China today.

The Institute of International Finance said in June that global debt hit a record $217 trillion , up by $70 trillion in a decade, with much of the growth centred on China and other emerging markets. At the same time, investors are seeking “yield” wherever they can find it, pushing up the value of a range of investments. So-called asset bubbles are everywhere as a result.

When the 2007 crisis broke, fingers of blame were pointed in all directions. At subprime mortgage companies for selling loans inappropriately; at  borrowers for taking on too much debt; at investment bankers for creating and marketing irresponsible  products. And at policy makers for presiding over an environment of low interest rates and lax regulation  that allowed a crisis to ferment.

CRISIS and INDIA

According to Dr YV Reddy, former Governor, Reserve Bank of India “ India has undoubtedly, emerged stronger and more resilient after the crisis.  Perhaps, it is good that the crisis happened before India went irrevocably in the direction of excesses in the financial sector. The macro-balances that were judiciously maintained and pragmatic policies that were adopted, have earned appreciation globally”. ( Page 17 : Global Crisis , Recession and Uneven Recovery”, 2011).

Mr. Dasarathi Mishra is a former Chief General Manager, Reserve Bank of India. He had got extensive exposure to the banking regulations, supervision, international banking, foreign exchange, WTO agreement in financial services, regulation of NBFCs and core central banking functions. He is a founder and Managing Partner of ‘Abhyutthana Financial Learning Centre’ with objective of spreading financial education in schools/colleges.

 

Financial Inclusion Initiatives in India – RBI’s medium term path

by Dasarathi Mishra

Reserve Bank of India, (RBI) in July 2015, appointed the Committee on Medium-term Path on Financial Inclusion with the primary objective of working out a “medium term (5 years) measurable  action plans”  for financial inclusion.  The Committee was headed by Deepak Mohanty, Executive Director, RBI.

The Committee has made a large number of significant recommendations so that by 2021 over

90 per cent of the hitherto unserved sectors of the population get a better access to financial services and thus would be important stakeholder in the country’s economic progress. It visualizes that with the trinity of Jan Dhan, Aadhaar and Mobile ( JAM)  taking firm hold in our country, there is an opportunity that the three can seamlessly integrate to serve the population and add to  efficiency.

A cross-country study shows that India does not compare favourably in the area of financial inclusion even with other emerging economies. In 2014, over 50 per cent of the Indian adult population held an account in a financial institution, compared to over 70 per cent in various BRICS countries. India’s ATM penetration at 18 ATMs per 1,00,000 adult population is much lower than 65 in South Africa and 180 in Russia. The Committee observed that despite improved financial access, usage remains low as technology has not been optimally leveraged.

Around 60 per cent of the population of India depends on agriculture for living.  The committee is of the view that agricultural credit must go to the actual cultivator class for which land records need to be digitized. States may change their statute so that Credit Eligibility Certificate can be issued to the tenants who till the land facilitating the landless cultivators obtaining bank loans.

Innovations in Government–to-People (G2P) payments could prove to be a game-changer. Mobile banking can be used for G2P payments very efficiently. There is enormous scope to implement direct bank transfers ( DBT)  to a bank  account.

The Committee highlighted  the linkages among financial inclusion, financial literacy and customer protection. The US sub-prime crisis validated that unbridled financial inclusion sans financial education and consumer protection is a folly. In such a milieu, the financial distress created, can disrupt financial stability in a country and can spread globally through trade, investment channels. Therefore,  central banks in the globalized world place lot of premium on financial stability.

Mr. Dasarathi Mishra is a former Chief General Manager, Reserve Bank of India. He had got extensive  exposure to the banking regulations, supervision, international banking, foreign exchange, WTO agreement in financial services, regulation of  NBFCs and core central banking functions. He is a founder and Managing Partner of ‘Abhyutthana Financial Learning Centre’ with objective of spreading financial education in schools/colleges.