Beware! Tight money days ahead

Two days ago, I got talking to the head of a foreign bank in India. I asked him, inevitably, how he was currently viewing the whole sub-prime meltdown. The question partly stemmed from the fact that just a week before, Swiss banking giant UBS had announced a first quarter loss of $10.5 billion. To add to the over $320 billion already written down the world over.
According to him, the problems were known and the recapitalisation efforts had started so to that extent the situation was under control. However, on the other hand, the bad news he said was that the bottom was yet to be found.
Banks like HSBC (which said it would make a $4.6 billion provision for bad debts on Monday) too are saying that a recovery in the US housing market is unclear and a comeback, if any, can be expected only in 2009. A late 2009 recovery seems to be the consensus now.
Meanwhile, risk aversion is becoming higher all over. "Bank A will not lend to Bank B and that creates a liquidity problem as well," the banker said pointing to the Bear Stearns collapse, where the Federal Reserve had to step in to bail it out by providing emergency loans.
After Bear Stearns, most banks globally were more wary, he said. How would all this impact India? According to him, what the sub-prime crisis had clearly done was to force all banks to carefully relook all their international operations.
The relook, he predicted, would result in several banks recasting, downsizing or selling off pieces of their operations or investments. Actually, this has already begun to happen.
The problem, it turns out, will not just be with foreign banks with operations in India. Many bankers I have spoken to in recent days say the same recklessness in disbursing loans that partly triggered the mortgage market crisis in the US has been visible in India, though obviously not at the same scale.
For instance, there are several cases where individuals have used credit cards from some banks - given out on somewhat weak documentation - to get loans and access to other financial products from the newer and aggressive finance companies.
As it happens, one bank typically gets blamed here but my sense is the competitive forces have caused all credit card issuing banks to behave similarly. It's not that this was not known all this while, it's just that the sub-prime crisis puts it in context.
All this, as I understand it, is coming to roost. While there is no credit blowout being predicted at this moment, the banks themselves are realising the need to tighten the screws, at least in some cases. It appears at this moment that some of the foreign banks who have been active in the retail space will lead the effort but Indian banks will not be too far behind.
Which should be good news. Unfortunately, it comes at a somewhat bad time. Because this is the way it's going to play out. First, banks with a somewhat larger retail spread will (actually they already have in some cases) start weeding out the low-margin, low-volume customers.
This could mean that those at the bottom of the pyramid will find it difficult to leap onto the consumption bandwagon as they were, or hoping to, in the last few years. The weeding out moves could extend to savings bank accounts in the case of some banks.
Second, it would mean that smaller enterprises who are already fighting a losing battle on various fronts will see credit tightening. The banker I spoke to tells me this is already happening. "You see the big companies and their large balance sheets and think this is a blip on the growth curve. That's true but what you don't see in the headlines are the stories of the smaller companies who will start fighting for survival."
So a smaller company has to reckon with tighter credit, higher interest rates and of course massive inflationary pressures on everything from raw material prices to people. Add to the fact that your bank may be telling you that it may either not lend to you or reduce the quantum and you are in somewhat difficult times.
As an individual or an enterprise who has just about starting getting access to credit, you might be forced back to the informal market. The banks themselves will fight this through.
Interestingly, once again the industry is buzzing with predictions on which bank with a recent retail thrust would call it quits, either because of domestic or international pressures.
The fact is that one or two will put up their hands in surrender is almost a foregone conclusion. But on the institutional side, business continues to be strong. The big companies continue to grow, albeit a little slowly and Deal Street is still buzzing.
So some parts of the consumption economy could be in for a slowdown, if that is not evident already. The latest Index of Industrial Production has fallen substantially, from 14.8 per cent in March 2007 to just 3 per cent for March 2008. This may be an aberration, maybe not. But one reason is tightening credit.
We were speaking about bankers and finances, though. My conversation with the bankers leads me to conclude they are focused on two factors. First, when the current global and domestic economic cycle will play out in its entirety and, second, who will replace Y V Reddy when he retires as the Reserve Bank governor on October 1. Some are also hoping he gets an extension.