RBI: it bothers only about fellow banks

The Reserve Bank of India calls itself a bank, and bothers only about fellow banks; lenders and financiers whom it has not anointed banks are generally ignored. Some years ago it asked what it calls non-bank finance companies to register themselves, collected a few figures from them, and then forgot them. Finance, however, is a legitimate business, and one does not have to be a bank to do it. The Federal Reserve Board of the United States of America recognizes this; since 1955, it has been conducting a quinquennial census of finance companies, and collecting more detailed information for a sample of them. How it conducted the last (2010) census was described recently by Lisa Chen and two of her colleagues in the FRB in a working paper; it gives a fascinating picture of the industry.

The FRB does not order finance companies to register themselves with it on the pain of being impaled or closed down; America is a free country, at least in this regard, and every American is free to make a business of lending and borrowing without anybody’s permission. The FRB did not advertise in newspapers ordering financiers to let themselves be known to it. Instead, its researchers consulted Dun and Bradstreet and similar organizations that kept a record of businesses, and made a list of all that provided credit to households and businesses. The categories they included give a fascinating picture of the variety of financial businesses in the US. There are businesses that buy and sell commercial paper, instalment paper, accounts receivable and trust deeds, or issue credit cards (a business that is not confined to banks). The two industries which have the largest number of credit providers are automobiles and agriculture. Amongst agricultural credit providers, there are those who specialize in financing equipment, animals or in farm mortgage.

Chen et al sent a questionnaire to all 26, 671 of them, by both mail and e-mail. The post office returned 5,151 letters as it could not find the addressees; neither the letters nor replies came from 17,975 addressees. It is interesting that even in the US, where the internet is most developed, 2,672 replied by post; only 873 replied by e-mail. In a second wave, 19,998 letters were sent. Eventually, Chen et al ended up with 5,732 replies — 4,362 by mail and 1,370 by e-mail. Most of the respondents were thrown out as “out of scope” — out of business, in some other business, subsidiaries of banks and finance companies, duplicates and so on — 2,045 were judged to be relevant.

The final numbers are a bit unclear; but according to one estimate, 2,128 out of 3,833 businesses had assets under $1 million. Only 147 had assets over $1 billion; only 20 had assets over $20 billion. Mortgage providers were more concentrated; only 67 of over 300 had assets under $1 million, and 125 had assets between $1 million and $10 million.

The picture that emerges from these statistics is that finance is what we would call a small industry — an industry with many small businesses. Most of them provide loans against durables such as machinery and vehicles. Automobiles are a quintessentially American industry; the US is still the world’s biggest car and truck manufacturer. Behind this large-scale industry is a cottage industry that gives loans to buyers of cars, buses, tractors, harvestors and so on. The vehicle industry itself is highly concentrated; but it has lots of retailers across towns big and small. These retailers are mainly in the business of taking orders and selling vehicles. But around them are clusters of financiers. When a buyer walks into a retailer’s showroom, identifies a car or tractor he wants to buy and says he does not have ready money, the retailer rings up a moneylender he knows. The moneylender takes the buyer through the paperwork, pays the money, and the buyer drives off with the vehicle.

The business is not so streamlined when it comes to property, whether homes, farms, shops or factories. There the paperwork is more, and the financier ensures a stronger grip on the security before he gives the money. Hence mortgage financiers are fewer and bigger. But their business is also very big. They ran through the easy business some decades ago; all the middle-class people with high or reliable incomes had taken or repaid loans by the 1990s. Mortgage lenders were running out of business; so they went downmarket. They began to lend to people who were too poor to own houses: they relaxed the equity requirements, and the conditions regarding stable income. That might have worked out from their point of view; when the borrowers failed to pay their instalments, they could be thrown out and the house sold to recover the loan. But something unusual happened in the last decade. Interest rates fell to very low levels, thanks largely to Federal Reserve’s policy of stimulating the economy. Low interest rates should raise property prices as a rule since they would induce more people to borrow and buy houses. But property ownership was already high; demand for houses did not go up at low interest rates. And the American poor have been in a bad state; wages have not gone up since the 1970s. The mortgage lenders began to throw people out, but house prices collapsed; the money they had lent could not be recovered. So they too began to renege on their debts. That was the essence of the sub-prime crisis.

This did not happen in Europe because it has better social insurance. Even if people lose jobs, they are supported by government subsidies, which cover their housing. But because they can live fairly well without working, they do not need to work to live; and unemployment insurance is better in Europe. That is why unemployment has been higher in Europe.

High social insurance costs lead to high fiscal deficits; the deficits incurred by the governments of southern Europe are inconceivable elsewhere. And fiscal deficits must be reflected either in higher savings or in lower investment and higher payments deficits. So investment is extremely low in southern European countries, and they are running payments deficits, chiefly with Germany. But they cannot repair their balances of payments by devaluing since they share a common currency with the creditor countries; nor can they raise tariffs since import duties have been abolished in the European Union. So there is only one way in which their balance of payments problem can be resolved: it is by a fall in their people’s incomes, which would reduce their demand for goods and services. Many Greeks, especially in the public sector, have been forced to accept cuts in income; but the rest of the south Europeans have resisted cuts fairly successfully. For them, therefore, there is no end to the agony; they must suffer ever more unemployment. In my view, therefore, the future of the European Union is dire; its economy can only go from bad to worse. But the European Union is as holy to Europeans as the Indian Union is to Indians and the United States to Americans. So it will carry on into a miserable future. The best that Europeans can hope for is a lucky break.