JOE NOCERA
ESSAY


MUMBAI - I arrived in Mumbai three weeks after the terrorist attacks that killed 200 people. My hope was to learn about the current state of Indian business in the wake of both the credit crisis and the attacks.

But in my first few days in this sprawling and chaotic city what I mainly heard, especially talking to bankers, was about America, not India. How could we have brought so much trouble on ourselves, and the rest of the world, by acting in such an obviously foolhardy manner- Didn’t we understand that you can’t lend money to people who lack the means to pay it back- The questions were asked with a sense of bewilderment - and an occasional hint of scorn. Like most Americans, I didn’t have any good answers. It was a bubble, I would respond with a sheepish shrug, as if that were an adequate explanation. It isn’t, of course.

“In India, we never had anything close to the subprime loan,”said Chandra Kochhar, the chief financial officer of India’s largest private bank, Icici. (A few days after I spoke to her, Ms.Kochhar was named the bank’s new chief executive, in a move that had long been anticipated.)“All lending to individuals is based on their income. That is a big difference between your banking system and ours.”She continued:“Indian banks are not levered like American banks. Capital ratios are 12 and 13 percent, instead of 7 or 8 percent. All those exotic structures like C.D.O. and securitizations are a very tiny part of our banking system. So a lot of the temptations didn’t exist.”

Yet two years ago, the Indian real estate market - commercial and residential - was every bit as inflated as the American market. High-rises were being built on speculation. Housing developments were sprouting up everywhere. And there was plenty of money flowing into India, mainly from private equity and hedge funds, to fuel the commercial real estate bubble in particular. Goldman Sachs, Carlyle, Blackstone, Citibank - they were all here, giving money to developers. So why did the Indian banks stay on the sidelines and avoid most of the pain that has been suffered by the big American banks?

Part of the reason is cultural. Indians are simply not as comfortable with credit as Americans.“A lot of Indians, when you push them, will say that if you spend more than you earn you will get in trouble,” an Indian consultant told me.“Americans spent more than they earned.”

But there was also another factor, perhaps the most important of all. India had a bank regulator who was the anti-Greenspan. His name was Dr.Y.V.Reddy, and he was the governor of the Reserve Bank of India. Mr.Reddy took office in 2003 and stepped down this past September.

Unlike Alan Greenspan, the former chairman of the Federal Reserve who didn’t believe it was his job to even draw attention to bubbles, much less try to deflate them, Mr.Reddy saw his job as making sure Indian banks did not get too caught up in the bubble mentality. About two years ago, he started sensing that real estate, in particular, had entered bubble territory. One of the first moves he made was to ban the use of bank loans for the purchase of raw land, which was going up rapidly. Only when the developer was about to commence building could the bank get involved - and then only to make construction loans.

Then, as securitizations and derivatives gained increasing prominence in the world’s financial system, the Reserve Bank of India sharply curtailed their use in the country. When Dr.Reddy saw American banks setting up off-balancesheet vehicles to hide debt, he essentially banned them in India. Seeing inflation on the horizon, he pushed interest rates up to more than 20 percent, which of course dampened the housing frenzy. He made banks put aside extra capital for every loan they made. In effect, Dr.Reddy was creating liquidity even before there was a global liquidity crisis.

India’s bankers were naturally furious.

“For a while we were wondering if we were missing out on something,”said Ms.Kochhar. Banks in the United States seemed to have come up with some magical new formula for making money: make loans that required no down payment and little in the way of verification - and post instant, shortterm, profits.

As Luis Miranda, who runs a private equity firm devoted to developing India’s infrastructure, put it: “We kept wondering if they had figured out something that we were too dense to figure out. It looked like they were smart and we were stupid.”

Instead, India was the smart one, and the United States was the stupid one.

Y.V.Reddy, former governor of the Reserve Bank of India, saw his job as making sure India’s banks did not get caught up in a bubble mentality. Shoppers throng a market in Kashmir.