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Loans for wedding or for your next iPhone or household consumption continue to be strong in India, but this consumption has come through leveraging.
The fastest growing category on the asset side of the banking system has been personal loan.
Other non-bank intermediaries are actually growing this lending faster than banks.
What could go wrong It’s about time we dusted our lessons from Lehman crisis.
After all, it is the 10th anniversary and as per Seth Clarman, the lessons we learnt are now forgotten.
The last article is the correlation I have drawn between Kondratiev winter and ILFS default, which came out of the blue for most investors.
Hope, this would be enough to tickle your grey cells over the weekend.
Happy reading.
I reiterate that this is only a sampling of some of the best content I read through the week, with a dash of my own thoughts.
Indian consumption rising consumer leverageAccording to the Reserve Bank of India (RBI) data, total outstanding personal loan amount with banks stood at Rs 5.89 lakh crore in May, 2010.
This amount rose to Rs 19.33 lakh crore in June, 2018.
Consumer durables loans' as of May, 2010 stood at Rs 8,138 crore, and rose to Rs 20,300 crore as of June, 2018.
The outstanding amount on credit cards was Rs 19,579 crore as of May 2010, and grew to Rs 74,400 crore on June 2018.
These are all unsecured loans, i.e., you do not have to give collateral to borrow.
As of June 2018, the total number of credit cards outstanding was 3.93 crore against 1.76 crore in June 2011.
Since 2010, a number of banks have changed their strategies and started focusing more on retail lending.
"The size of their retail loan books has gone up due to this change in strategy.
Categories like mortgage and auto loans are not much of a worry, because they are collateralised with fixed assets.
The miscellaneous category is of interest, as it is large in size and needs some degree of monitoring.
These are generally unsecured loans, which are usually taken for purposes like marriage and festivals.
According to Crisil, a large number of customers taking personal loans, consumer durable loans are working class in the age group of 25 - 45 years.
In terms of geographic split, metropolitan cities (population greater than 10 lakhs) accounted for 80 per cent of the credit card customer base in FY17.
However, the share of metro cities has been declining continuously from close to 99 per cent in FY12 to 80 per cent in FY17.
This has been the biggest driver of India’s growth and the above data is only from the banking system.
NBFC, HFC, P2P and other fintech company-related consumer lending is not captured in the data.
The two components in the equation of C+I+G+ ( X-M)= GDP, which have worked wonders for India are government spending and consumption.
Indian household’s leverage is low compared with emerging economies, but needless to say, it is rising very fast.
My concern is that rising consumer leverage will be met with stagnant salaries/wage (except for govt employees) and we may start to see stress on consumption and consumer balance sheets in the next couple of years.
Read more The Forgotten Lessons of 2008Seth Klarman describes 20 lessons from the financial crisis, which he says, “were either never learned or else were immediately forgotten by most market participants.” One might have expected that the near-death experience of most investors in 2008 would generate valuable lessons for the future.
We all know about the “depression mentality” of our parents and grandparents who lived through the Great Depression.
Memories of tough times coloured their behaviour for more than a generation, leading to limited risk taking and a sustainable base for healthy growth.
Yet, one year after the 2008 collapse, investors have returned to shockingly speculative behaviour.
One state investment board recently adopted a plan to leverage its portfolio – specifically its government and high-grade bond holdings – in an amount that could grow to 20 per cent of its assets over the next three years.
Those who were paying attention in 2008 would possibly think this is a good idea.
Below, we highlight the lessons that we believe could and should have been learnt from the turmoil of 2008.
Some of them are unique to the 2008 meltdown; others, which could have been drawn from general market observation over the past several decades, were certainly reinforced last year.
Shockingly, virtually all of these lessons were either never learned or else were immediately forgotten by most market participants.
20 investment lessons of 20081.
Things that have never happened before are bound to occur with some regularity.
You must always be prepared for the unexpected, including sudden, sharp downward swings in markets and the economy.
Whatever adverse scenario you can contemplate, reality can be far worse.
2.
When excesses such as lax lending standards become widespread and persist for some time, people are lulled into a false sense of security, creating an even more dangerous situation.
In some cases, excesses migrate beyond regional or national borders, raising the ante for investors and governments.
These excesses will eventually end, triggering a crisis at least in proportion to the degree of the excesses.
Correlations between asset classes may be surprisingly high when leverage rapidly unwinds.
3.
Nowhere does it say that investors should strive to make every last dollar of potential profit; consideration of risk must never take a backseat to return.
Conservative positioning entering a crisis is crucial: it enables one to maintain long-term oriented, clear thinking, and to focus on new opportunities while others are distracted or even forced to sell.
Portfolio hedges must be in place before a crisis hits.
One cannot reliably or affordably increase or replace hedges that are rolling off during a financial crisis.
4.
Risk is not inherent in an investment; it is always relative to the price paid.
Uncertainty is not the same as risk.
Indeed, when great uncertainty – such as in the fall of 2008 – drives securities prices to especially low levels, they often become less risky investments.
5.
Do not trust financial market risk models.
Reality is always too complex to be accurately modeled.
Attention to risk must be a 24/7/365 obsession, with people – not computers – assessing and reassessing the risk environment in real time.
Despite the predilection of some analysts to model the financial markets using sophisticated mathematics, the markets are governed by behavioral science, not physical science.
6.
Do not accept principal risk while investing short-term cash: the greedy effort to earn a few extra basis points of yield inevitably leads to the incurrence of greater risk, which increases the likelihood of losses and severe illiquidity at precisely the moment when cash is needed to cover expenses, to meet commitments, or to make compelling long-term investments.
7.
The latest trade of a security creates a dangerous illusion that its market price approximates its true value.
This mirage is especially dangerous during periods of market exuberance.
The concept of “private market value” as an anchor to the proper valuation of a business can also be greatly skewed during ebullient times and should always be considered with a healthy degree of skepticism.
8.
A broad and flexible investment approach is essential during a crisis.
Opportunities can be vast, ephemeral, and dispersed through various sectors and markets.
Rigid silos can be an enormous disadvantage at such times.
9.
You must buy on the way down.
There is far more volume on the way down than on the way back up, and far less competition among buyers.
It is almost always better to be too early than too late, but you must be prepared for price markdowns on what you buy.
10.
Financial innovation can be highly dangerous, though almost no one will tell you this.
New financial products are typically created for sunny days and are almost never stress-tested for stormy weather.
Securitization is an area that almost perfectly fits this description; markets for securitized assets such as subprime mortgages completely collapsed in 2008 and have not fully recovered.
Ironically, the government is eager to restore the securitization markets back to their pre-collapse stature.
11.
Ratings agencies are highly conflicted, unimaginative dupes.
They are blissfully unaware of adverse selection and moral hazard.
Investors should never trust them.
12.
Be sure that you are well compensated for illiquidity – especially illiquidity without control – because it can create particularly high opportunity costs.
13.
At equal returns, public investments are generally superior to private investments not only because they are more liquid but also because amidst distress, public markets are more likely than private ones to offer attractive opportunities to average down.
14.
Beware leverage in all its forms.
Borrowers – individual, corporate, or government – should always match fund their liabilities against the duration of their assets.
Borrowers must always remember that capital markets can be extremely fickle, and that it is never safe to assume a maturing loan can be rolled over.
Even if you are unleveraged, the leverage employed by others can drive dramatic price and valuation swings; sudden unavailability of leverage in the economy may trigger an economic downturn.
15.
Many LBOs are man-made disasters.
When the price paid is excessive, the equity portion of an LBO is really an out-of-the-money call option.
Many fiduciaries placed large amounts of the capital under their stewardship into such options in 2006 and 2007.
16.
Financial stocks are particularly risky.
Banking, in particular, is a highly lever- aged, extremely competitive, and challenging business.
A major European bank recently announced the goal of achieving a 20% return on equity (ROE) within several years.
Unfortunately, ROE is highly dependent on absolute yields, yield spreads, maintaining adequate loan loss reserves, and the amount of leverage used.
What is the bank’s management to do if it cannot readily get to 20% Leverage up Hold riskier assets Ignore the risk of loss In some ways, for a major financial institution even to have a ROE goal is to court disaster.
17.
Having clients with a long-term orientation is crucial.
Nothing else is as important to the success of an investment firm.
18.
When a government official says a problem has been “contained,” pay no attention.
19.
The government – the ultimate short- term-oriented player – cannot with- stand much pain in the economy or the financial markets.
Bailouts and rescues are likely to occur, though not with sufficient predictability for investors to comfortably take advantage.
The government will take enormous risks in such interventions, especially if the expenses can be conveniently deferred to the future.
Some of the price-tag is in the form of back- stops and guarantees, whose cost is almost impossible to determine.
20.
Almost no one will accept responsibility for his or her role in precipitating a crisis: not leveraged speculators, not willfully blind leaders of financial institutions, and certainly not regulators, government officials, ratings agencies or politicians.
(Read more at https://fs.blog/2010/03/the-forgotten-lessons-of-2008/)Kondratiev winter and ILFS defaultNicolai Kondratiev was 46 when he was executed.
Nikolai (sometimes written Kondratieff) died in 1938 in the Russian gulag.
So who was he and why would he even be thought about today
Kondratiev was a Russian agriculture economist who, while working on a five-year plan for the development of Soviet agriculture, published his first book, The Major Economic Cycles, in 1925.
Over the following years he carried out more research during visits to Britain, Germany, Canada and the United States.
In his book and in a series of other publications he outlined what later became known as “Kondratiev Waves”.
These were observations of a series of supercycles, long surges, K-Waves or long economic cycles of alternating booms and depressions or of periods of strong growth offset by periods of slow growth in capitalist societies.
These waves or cycles were at the time calculated to last from 50 to 60 years, or roughly a human lifetime in those days.
Kondratiev applied his theories to capitalist societies, most notably to the US from the time of the American Revolution.
His undoing came in 1928 when he published his Study of Business Activity in the Soviet Union that came to much the same cycle conclusions for the Soviet economy that he had noted for capitalist societies.
He fell out of favour with Josef Stalin, who saw his treatise as criticism.
Kondratiev was arrested and following a series of trials he was banished to the gulag, where he died.
The four stages are of Kondratiev winter represented in the chart below.
The fourth part "WINTER" reminds me of ILFS default.
Read moreLike four seasons and four stages of Life which happens on clockwork, "WINTER" is the part of Kondatriev cycle which every economy goes through.
Years of easy global liquidity by central bankers did not allow the debts to be purged, on the contrary more debt is taken for unviable investment creating systemic risks and when one part of this credit chain is broken it spills over to entire financial system.
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What I read this week: Risk of rising consumer leverage 20 lessons from Lehman collapse
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