The world is now seeing an unprecedented weakness in lending flows ? be it mortgage lending or unsecured lending. A silver lining in a rather gloomy market condition is that in the current year financial institutions are witnessing a marginal growth in their business and not a decline as was seen in 2008.

The global retail lending market shrank by 2 percent in 2008 to $27,500 billion. However, the global retail lending market is forecast to have a value of $32,750 billion by 2013, an increase of 19 percent since 2008. Mortgage lending dominates the market with just over 80 percent of the market share in value terms and America accounts for 50.4 percent of the global market value. The measures taken by Americans to revive the mortgage portfolio are closely watched as their revival is key to reverse the present sagging sentiments.

There are largely two main players in the act of revival ? government and regulators. The actions of these players would help the industry and economy turn around. There is no one best solution for the problem and the problem itself is not the same in all countries; and so each country adopts a different strategy to address the crisis. Secondly financial institutions, anticipating the reactionary behavior of these players, will survive and emerge as leaders in the long term.

Some Measures for Revival of Economy
Deposit insurance is one such special measure for revival, and as a concept it is as old as banking. Deposit insurance helps prevent run on banks and thereby in controlling the short term liquidity crisis. Major economies have raised the limits on the deposit insurance to boost the investor’s confidence to stem the runs on the banks.

Stock markets are the pulse of financial markets and the barometer on the health of an economy. The positive sentiments of the stock market help in improving the general sentiments in an economy. Restrictions in short selling are one such measure to restrict and control the bear sentiments in the market, thereby reducing the investor anxiety.

It is a catch 22 situation for many banks. The banks’ balance sheets are skewed with delinquent assets portfolio on one side and on the other they do not have the capital to sustain lending. Banks’ sources of funding have dried up as investors have lost confidence, and hence the governments are stepping in to help some of the major banks by providing capital infusion.


There is a limited way in which a government can participate in direct capital infusion. Hence, for other banks the government has introduced a debt guarantee scheme wherein, based on the government guarantee, the banks get additional funds to source their tier-1 and tier-2 capital requirements from the market.

Asset purchase of the banks improves the liquidity position. There are two implications, in case the purchase is higher than the book value it results in shoring up the capital, and in cases it is below the book value it helps in improving the balance sheet of the banks.

Asset guarantee provides an assurance to the creditors on the quality of the portfolio of assets of the bank. Thereby the creditors do not withdraw funds as they are covered from risk of default.

Nationalization is the harshest measure to shore up the confidence of investors and depositors and boost their sentiments. This measure is adopted only when the failures of such banks have very high impact on the financial system and the government anticipates that it may lead to chaos and mayhem in the financial market circles.

Regulators play an important role in bringing back trust and buoyancy in the economy. Recessionary periods are challenging times for regulators, on one hand they need to encourage banks to lend and on the other they need to ensure that there is no further deterioration of asset quality. In addition to the special measures, other measures usually taken at macro and micro levels by regulators are:

• Stabilizing interest rates
• Stricter guidelines on exposure to single line and segment of businesses
• Greater mandatory disclosures and scrutiny of their businesses and practices
• Moving away from the regime of self regulation and voluntary disclosures for financial institutions
• Regulating the entry of new banks
• Strengthening corporate governance and increasing accountability
• Heightening requirements to improve quality of credit

The initial support provided by the regulators ensured that the financial systems did not collapse; and by supporting the immediate funding requirements of the banks they ensured that the trust was not lost and there were no unprecedented defaults. These were important short term measures, but for the financial system to sustain and operate independently it requires infusion of long term funds.

The central banks have provided debt guarantees to usher in long term funds, though this is not a sustainable funding mechanism. Private equity investors have been the source of long term funds for the banks for a long time now but they weren’t forthcoming to invest more, fearing the potential undisclosed losses. These guarantees may not hold water in the long term unless disclosures are complete.

Impaired asset portfolio management is one other area that has brought sleepless nights to regulators. The regulators came up with special measures such as providing insurance for losses or purchase of assets. Secondly, guaranteeing of debt by government may not work, as sovereign ratings of many countries have fallen.


We have seen the various measures taken to revive the economy; however, the outcome of all these measures on the lending behavior and their impact on various economic factors governing the growth of economies such as budgetary deficits and fiscal structures are to be observed.

Budgetary deficits are expected to rise; however, controlling the interest rates becomes very important. The countries having healthy public debt finances will come out of the woods earlier than others. India is projected to have a reasonable budgetary deficit of 6.8 percent at the end of the year as against a 12.3 percent budgetary deficit in the US. This shows that economies such as India would come out of the recession faster than many other developed nations such as the US.

Secondly, some fiscal measures such as tax cuts may be taken in the coming year, resulting in stimulating the demand of the household sector. This could potentially increase the disposable income in the hands of the consumers, but in the current market conditions consumers have limited or no access to credit, which causes them to hoard cash. To encourage savings consumers can expect, as a one time measure, lenient approach by banks on lending to individuals based on credit ratings and providing them with access to credit.

In the long run, the challenge will be for the government and regulators to withdraw the stimulus packages that are being offered to the financial institutions. The timing of this exit is as important as its beginning; it cannot be too early as that may lead to recurrence of the problem and cannot either be too late since the continued dependence of financial institutions on the stimulus packages for their survival would be disastrous for the system.


All the funds that are being pumped into the market are to stimulate demand and provide temporary resources to banks to lend. Presently, the banks are not being forced to take losses on the balance sheet and dispose a delinquent asset, which means that the results shown by them in the ensuing quarters may not be a true depiction of their financial status. This is one of the main concerns of the investors: undisclosed delinquent assets and this, in the near term, may lead to stagnation. It is very interesting to watch the effect of these and the counter measures the governments will take to address this problem in the long run.

The present economic situation will trigger mergers and acquisitions in the financial services sector in the near and medium terms. We have not seen much of M&A happening in the recent past as the banks and government have adopted a policy of wait and watch. It is a matter of time before we see this happening.

To conclude, the effects of the measures will vary based on time, country, and overall sentiments. A sustainable measure would be to create separate institutions to handle such assets and fund them directly and or through consortiums. Consumers and businesses should expect further monetary and fiscal measures coming their way to make this turnaround a reality. Banking is the backbone of global economy and will not perish on account of cyclical changes but will only bounce back with greater resilience.


References
Bank of England - Trends in Lending
Bernanke B (2009) - Federal Reserve programs to strengthen credit markets and the economy.
Fabio Panetta and others (2009): BIS Papers 48

The author is Lead Consultant, Finacle, Infosys Technologies