The Great Indian success story has gathered a few rust spots lately. As a Financial Economist I have seen kinks in a good story in places near and far; I am not worried about a cyclical slowdown. More injurious were decades when economic growth routinely fell behind what needed to keep the same quality of life, when human capital was thought more of liability, and, when private capital, and initiative, was abjectly subservient to whims of the know-all central planners and politicians. Risks of a reversion to bad old days are too high, and too disruptive, which precludes one from sitting around and doing nothing. This pause is an opportunity to re-architect some of the bigger, structural, bottlenecks.
Transition from informal sector to the formal one remains the biggest challenge, and opportunity, for Indian Economy. Informal sector continues to employ 9 out of 10 Indians who work, and account for only half of India’s economic output. Simply moving a production facility from informal to formal side of the ledger improves its productivity manifolds – thanks, among others, to better access to credit. It is obvious why the big push of Modi government is to push businesses to formal sector. Anybody who has dealt with the transition will tell of a chicken-and-egg situation. Existence in formal sector presupposes access to a line of credit, which is not available in the informal sector.
Hotel room aggregator Oyo has made it billion dollar business to provide in-kind credit to informal players in hospitality industry. Oyo story also makes it clear that it is possible to enforce formal-economy discipline to informal sector players for a win-win outcome. It is conceivable that a specialized Non-Banking Financial Companies (NBFC) will fill the void in a niche area. These NBFC’s can be capitalized with private capital, and they will be allowed to create their own standardization programs, letting competing ideas battle it out. They can choose to keep the loans on balance sheet, thereby exposing owners, or they can securitize, letting investors bear most of it.
Securitization can help improve liquidity to residential mortgage market as well. The Great Depression saw the US charter Government Sponsored Enterprises (GSE’s) to stabilize and expand home ownership in the US. In spite of Conservatorship post 2008 crisis, GSE’s have been able to make mortgage within reach even for the weakest of borrowers; it is even argued that conservatorship has been profitable to the Treasury in the long run. To reiterate, the GSE’s managed to do this even without explicit guaranty from US Treasury (Ginnie Mae, a GSE, does have explicit guaranty for a specialized segment).
It may not have been advisable for GSE’s to take tail risk – thus exposing Treasury to catastrophic loses. It was a convenient solution to have the biggest pocket player take up catastrophic risk, thus helping increase market size unsustainably. Assumption of first loss would have prevented market forces from disciplining errant players early enough and would be poor use of a deep pocket. A reasonable solution would have these GSE’s assume a middle-layer which is beyond the reach of a reasonably big player, but very unlikely in normal economic cycle for most participants. Tail Risk – Catastrophic and “act of God” – outcomes are too injurious to be spread to the wider economy, it might be better to let new business models emerge from the ruins of one who just crashed and burned.
Differences between US and India might prevent adopting GSE model as is. Credit scoring is still in its infancy in India, and barely there for most businesses, same is true for home appraisal and lien registry. It is a fool’s fantasy to wait for all these to materialize before testing waters. I believe entrepreneurial minds can take the plunge, diversify exposure, price and reprice constantly, and be willing to take some hits till maturity emerges.
Borrowing on GSE story, what GoI can do is to create a series of Chartered Enterprises to accept the middle layer of exposure. Banks and NBFC’s can extend credit to the informal sector ad be free to devise their own engagement rules within a guideline to be developed by the GSE’s. GSE’s then buy these loans, freeing up NBFC capital for redeployment. GSE’s will securitize these loans at prices set by the market. Any single Bank or NBFC can go belly up (and should be allowed to) if losses from their portfolio enter the unprotected tail zone. GSE’s will be to free to mix and match loans from different sources and sectors for diversification. Private Capital should be allowed to be part of GSE capital base, e.g., via listing on the exchanges. GSE’s will be forced to accept more costly capital once their own capital is depleted, because Government backing is explicit and limited. GSE’s can price their services through fees and/or through management of their investment portfolio.
Using GSE’s will help free up liquidity, bring innovation to provision of credit to informal sector and to residential mortgage. Both of them help those bottom of the Pyramid the most. As importantly, they act as force multiplier with limited use of Government supervision or capital.
[Partha Chakraborty, Ph.D., CFA is an entrepreneur in Blockchain and Wealth Management in US and India. Dr. Chakraborty spent two decades in all parts of the Investment Management value chain globally; he lives in Southern California with his family. All opinions are of the Author alone, and do not necessarily represent that of any organization he may be part of. The author alone is responsible for any error or omission.]