This piece by Joe Nocera basically lauds the RBI for taking crucial steps over the last couple of years in order to avoid a financial crisis in the Indian economy. Going by this piece, its scary to think of what would have happened without RBI's activism in the financial sector.
Related to the points the author makes about securitisation, I wonder how IFMR Trust's Guarantee Company fits into the story. How is the ITGC safeguarding itself from the possible dangers that have caused some of the mightiest jugglers to bite the dust?
2 comments:
Thanks for raising this important issue Suvojit. At the IFMR Trust Guarante Company (ITGC), we are working hard to internalise the learnings from the crisis, but here are some immediate thoughts:
1. In a financial system characterised by the presence of specialised originators of loans who are continuously selling portfolios/transferring risk to third parties, it is paramount that this process of risk transfer happens in an orderly way. Also, we want to make sure that the originator screens for risk and continues to monitor the quality of the portfolio on an ongoing basis. At ITGC, we will embed these aspects typically using the instrument of a first loss default guarantee to ensure "skin in the game" for the originator
2. There is simply no substitute for careful under-writing and risk monitoring. The fact that sub-prime lenders like Self Help ((http://www.self-help.org), in the US survived the crisis is testimony to this. ITGC has published a set of under-writing guidelines to ensure that processes to manage risk are in place. This is especially key when the loan sizes are significant relative to income.
In addition to Bindu's observations, a couple of points:
While lenders with lax underwriting standards and poor risk monitoring systems spawned the subprime crisis, financial intermediaries cannot escape a substantial part of the blame. ITGC, as an intermediary, not only intends to make sure that lenders comply with certain standards of loan origination and risk monitoring, it also wants to make sure that its incentives are aligned with those of capital markets investors who will buy these assets. As an intermediary, ITGC will not only look to structure and place securitized paper in the market but also hold on to a "second loss" tranche or subscribe to a portion off the notes. The originator and the intermediary must both be incentivized through "skin in the game."
Another area that will be crucial to developing a safer securitization market will be transparency of originators and intermediaries. As of now, atleast as far as small loan originators are concerned, there appear not to be clear norms for transparency and disclosure. For eg. analyzing the financial statements of most loan originators it is very difficult to identify what the off-balance sheet exposures of the entity are. As a first step, ITGC has already made its underwriting guideliens publicly available, and in the future intends to make its risk management policies and asset exposures public. ITGC will require higher standards of transparency (off balance sheet exposures, credit appraisal policies, periodic reporting after securitization) from institutions it partners with.
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