One reason why consumer demand in India did not collapse like it did all over the world following the Global Liquidity Crisis is that households in India are not highly leveraged like they are in developed economies. Households are major savers in India but, are not major borrowers. Indian households account for more than 65 per cent of the total savings of the country. And, of the total outstanding credit of commercial banks, personal loans account just over 20 per cent. Both, the savings and the borrowings of households are reasonably safe?the risk component in them is limited. The equity component in household savings is small and debt-servicing is not a major component of the monthly household outgo. Most surveys indicate that less than five per cent of the households invest in equity markets. More importantly, equity markets account for less than 7 per cent of the total savings of households. This low exposure to equity markets ensures low volatility of the savings. Most of the financial savings of households can be characterised as of low-risk and low returns.
Thus, the fall in the equity markets in 2008 and the conservative risk management policy of RBI that kept the deposits of the household sector safe together limited the adverse impact of the global liquidity crisis on household finances.
Similarly, most of the household borrowings are backed by household cash flows and debt-servicing accounts for a small proportion of household expenses. But, we may not remain ?like that only?, to borrow a popular Indian phrase and with apologies to Rama Bijapurkar. Indian households are moving down the path of greater leveraged living.
I see two factors playing mutually complementing roles at increasing the level of financial leverage of households. At a macro-level is the egalitarian view of financial inclusion. And, at the micro-level is the entrepreneurial push to increase the size of the retail market for financial products.
That the path towards greater financial leverage of households is strewn with risks for the household sector is understood at a macro, theoretical level. But, the household that exposes itself to such risk rarely appreciates the full import of the leverage. At a macro level, the risk is still low, but at the household level it is significant and can be stressful. This risk need not be acceptable to the household sector unconditionally. The recent global liquidity crisis indicates that it should not be acceptable to society at large as well. We need safeguards against a highly leveraged households sector.
Lenders understand risk. In India, they rarely, if ever, go bust. In the organised sector, RBI forces risk management. The experience during the Asian contagion in the second half of the 1990s and the global liquidity crisis provide evidence that these risk control mechanisms are effective. Unorganised lenders have, arguably, less civil means of risk management and it can be safely assumed that professional money lenders in the unorganised sectors do not go bankrupt because of non-performing assets.
Among the borrowers, risk in corporates is controlled by the lenders as they demand cash flow statements and projections. While risks do prevail among the lenders and the corporate borrowers, these have been contained because firms prepare annual accounts that are audited by professional chartered accountants and used by tax authorities besides the lenders themselves. Even if these are not perfect, they provide some measure of leverage and therefore the means to control risks.
Households do not make balance sheets. Leverage and debt-servicing abilities are thus not measurable by the lenders. There is no institutional mechanism anywhere in the world that measures or controls household financial risk. The aggressive marketing of loans to the household sector thus implies a blind faith. It also leads to the use of risk management methods that are often questionable. This in turn leads to a new form of stress at the household level.
Credit information bureaus cannot help. These can provide the history of payment defaults by households. But the problem is not delinquency. The problem is household leverage. We need to build mechanisms to contain this leverage. One solution is that the lenders must insist on households drawing up their income and expenditure statements and also their balance sheets. A careful study of these will provide lenders a better means of ensuring that credit is only provided to households that are not excessively leveraged.
In the last few years, many households have graduated to filing their income tax returns. Making a balance sheet should be the next logical step. Households need to know their finances. This knowledge itself can help many of them to control their irrational desire to acquire assets that they cannot afford or to use their assets more wisely than they did before the knowledge emerged from the balance sheet.
Banks should facilitate households in drawing up their financial statements. And, while they lend to individuals, they need to appreciate that it is the household that is more important in so far as a banking relationship or retail credit risk management is concerned.
?The author heads Centre for Monitoring Indian Economy