Managing money in '06 / Dec 26, 2005 / Financial Express
From Indiapensions
Managing money in '06
UMA SHASHIKANT, EXPRESS MONEY
DECEMBER 26: Choices in the retail debt market are set for both quantitative and qualitative changes in 2006. For lenders, who like to earn a decent and stable return on their funds, the choices could narrow down. Despite interest rates moving up, their returns may fall, such is the way the market is segmented. For borrowers, there is the prospect of coming to terms with the market rate and their own credit quality as drivers of their borrowing. There is also the truth about big versus small, where bigger lenders and bigger borrowers move up the curve faster than retail players can manage to. As always, informed decision-making will be the key.
You, the lender…
Let's view the lending side, first. The booming equity markets are compelling conservative investors to question their asset allocation, which is hopelessly skewed in favour of debt instruments. Many will choose hybrids - mutual funds and insurance companies will happily mix equity into debt to showcase the higher return than pure debt.
Even if interest rates rise, the pain of relatively low return from pure debt products can increase. This has more to do with the debt markets being wholesale, rather than retail. Retail investors are not big lenders to the private sector. It is also expensive to raise resources for large projects from retail investors. The conversion of the private corporate bond market into a privately-placed institutional issue market is complete and almost irreversible.
Bank deposits are favourite choices with retail, but may not offer better rates. As banks move into 'transaction-facilitation' mode, rather than 'deposit-mobilisation' drives, they can keep retail funds without having to pay a higher rate of interest. The newer markets for securitisation, where they can sell off their loans to raise money, will open newer, bigger and cheaper sources of funds.
The pass-through certificates, which represent the cash flows behind the loans and are issued to buyers of the loans, are set to get big in 2006, because they can now be listed and traded. But these markets will also be institutional, with mutual funds and other large players dominating. Next year will surely see new products, new markets and larger sized issues of debt products, but most of them outside the realm of opportunities for direct participation by the retail investor. If anything, they could face the prospect of not getting lower, if any, interest on saving bank balances, if RBI chooses to free these rates.
There is of course the recourse to small saving, as has been the case when investors find equity markets risky. Assured return, government-sponsored schemes with high interest rates are corners of cozy comfort. 2006 can see this change as well. While the government has promised to have at least one debt product for senior citizens seeking regular income, it has begun the process of realigning other small saving schemes to market rates.
The first step was to make interest on all of these schemes, except for the NSC, PPF and EPF taxable, and ineligible for tax deduction under Section 80C. The exclusion of all entities other than individuals and HUFs from these schemes is the second step, to wean away large investors taking advantage of these schemes. The creation of the tax information network (TIN), so that interest earned comes under the tax net, is the third step, hopefully complete by 2006. Therefore, effective post-tax return for everyone other than those in the low tax brackets, will be about 5-6 per cent in all these schemes. If the government manages to take the fourth - and the most crucial - step of converting to floating rates, aligned to markets, that would mean even lower effective returns. Left willing, though.
…and the borrower
The prosperous in the 30-50 age bracket with urging incomes can negotiate lower loan rates
Now, on to the individual as borrower. The boom in retail lending in recent years has been driven by both supply-side and demand-side factors, creating a win-win feeling. On the one hand are eager borrowers, empowered by rising incomes and a willingness to spend. On the other are competing lenders, seeking better margins and newer borrowers from retail lending. It's one thing to grow, it's another to sustain growth for a long period of time. Next year should mark the beginning for players in the retail credit business towards sustenance strategies, in their own interest. These will obviously impact borrowers.
The first set of changes should be in the context of predatory tendencies of lenders, who compete aggressively to grow their loan portfolios. In its extreme form, predatory lending disregards credit worthiness norms, and instead focuses on wooing borrowers to take on loans that are difficult to repay. The delink between the selling of loans and its recovery accentuates this situation. In a bid to grow faster, incentives are tuned to acquisition of borrowers and size of borrowing, leading to loan sizes being linked to value of assets, rather than the ability to repay.
As more borrowers are willing to take on bigger loans to fund larger homes, home prices move up on demand from them, creating an asset bubble. Sooner or later, painful defaults and foreclosures will happen. A surge of sharp practices in loan recovery can ensue. Lenders are likely to reduce NPAs and delinquencies in new loans by using the credit information bureaus to consolidate credit history of borrowers. Longer-term players will link recovery rates and loan sales. But to the eager borrower, who overextends himself, the only recourse is to adopt educated and informed borrowing practices, something that would happen at a pace slower than the learning process of the lender. Disadvantage borrower, if you will.
The second possible change in competitive expansion of retail credit has to be the 'flight to quality' or the higher attention to high-quality retail borrowers. Not everyone is falling for the glib talk of the DSA, or overextending the credit card spends desperately converting the outstanding into EMIs at exorbitant rates. The prosperous segment in the age bracket of 35-50 years, which is not seeking home loan or car loans but seeing large surges in income, has to come for special attention. Based on its ability to pay, and lower risk, this high-volume segment may be willing to bite the bait if offered finer rates.
From credit cards to newer loans for children's education, holidays and lifestyle spends, this segment can see differentiated credit at lower rates. Packaging innovative products at attractive prices, and throwing in relationship management to massage egos, will hit a new high. Obviously, there is a large segment that likes to be known in its social circles that it belongs to the 'preferred' category. Segmentation of borrowers in this manner is likely to take away that social feel-good about retail lending, where the big and the small, core and the marginal, historically borrowed at the same rate. Preferred depositor to preferred borrower is where relationship managers may switch.
For individuals then, 2006 should be the year to look for differentiation and figuring out where they can find their deal. Whether investing or borrowing, being informed is the key to making choices. Few things about markets never really change.
