This refers to your editorial “Banker’s balance” (February 2). I hold a candle for nobody but the edit seems to be more concerned with journalistic point-scoring (usually absent in your edit pages) than with an economic analysis of incentives.
In brief, the theory of adverse selection states that institutions offering loans at high rates attract borrowers with doubtful creditworthiness since creditworthy people have access to credit at cheaper costs. So teaser loans, which reset to normal interest rates after a pre-defined period, will generally attract the most creditworthy borrowers, not the least creditworthy ones. So when Mr Bhatt says non-performing assets (NPAs) in housing loans are much lower, he is merely affirming the economic rationale of adverse selection.
All the same, didn’t the US crisis occur because of teaser loans? In the weakest part of the editorial, you seem to conflate US teaser loans to the kind being offered in India but this amounts to comparing apples and oranges. In the US, conforming mortagages are eligible for fixed-rate 30-year mortgages unlike in India where mortgages of this kind are generally floating, teaser or no teaser, so bankers have to factor in borrowers’ capability to pay rates 1 to 1.5 per cent higher than current rates. The teaser loan in the US applied to non-conforming mortgages, generally implying that these are offered to people with a dubious credit history and/or documentation issues. In India, it appears from the reaction of bankers like HDFC that teaser loans are being targeted as a tool to acquire the most creditworthy customers. That is what Mr Bhatt was alluding to and that is what seems to have upset private sector competitors. And a 1 per cent teaser offer on a floating rate benchmark that moves 1 to 1.5 per cent relative to the mean is not as teasing as it seems.
On the question of policy response, therefore, applying increasing risk weights on standard “teasing” assets amounts to getting the wrong end of the analysis. The other problem with such risk weights is that it doesn't distinguish between a 100, 150 or 50 basis point tease nor does it distinguish between the tenors for which the teaser loans are applied (one year, three years and so on).
That is not to say that everything is hunky dory with teaser loans. To the extent that it subsidises interest rates, it is a drag on net interest margins. A better way to capture this drag would have been to look at the diminution of the fair value of loans on account of such discounts and let the bank create provisions for them. Such a solution is proportional, symmetric and appropriately captures the profit and loss dimension.
What about competitive concerns? Well, the theory of industrial organisation teaches us that the dividing line between competitive concerns and consumer welfare is often thin and so long as the cost of such policies are captured in the balance sheet, it is better for the regulator to keep a prying eye from the sidelines.
I Chakraborty, on email
