Post-Cyprus truth: There is risk in banks, gold, realty


Post-Cyprus truth: There is risk in banks, gold, realty
Arjun Parthasarathy

The average Indian is certain of three things apart from death and taxes. One is that banks in India cannot fail, two is that gold prices cannot fall and three is that real estate prices cannot fall.

Indians have reasons to believe these three certainties of banks not failing and gold and real estate prices not falling. After all banks have not failed in India over the years and those who have failed have been taken over by other banks (Global Trust Bank is one example where RBI made sure it was taken over by a stronger bank, the Oriental Bank of Commerce). Cooperative banks keep failing and RBI cancels their licences frequently.

Depositors are guaranteed Rs 1 lakh of deposits by the DICGC (Deposit Insurance and Credit Guarantee Corporation). Depositors with over Rs 1 lakh in deposits suffer losses but this does not seem to affect the general public who bank with scheduled commercial banks.

Gold prices have gone up steadily over the years with prices increasing by 4.5 times over the last 10 years. It has come off by 11 percent over the last one year but this is seen as a blip to the long term price trend.

Real estate prices have shot up in the last five years (two to three times at least in many geographies) and have been on a steady upward trend over the last two decades. Real estate prices have seen sharp corrections in the mid-1990s as the economy went into a downturn, but all that is forgotten now.

The certainty of banks not failing and gold and real estate prices not falling (for long) is slowly coming undone. Banks are not failing in India, except cooperative banks, but the fact that EU (European Union) leaders forced the Cyprus government to close its second largest bank for a bailout should be a wake up call on a bank's credit risk. Depositors of over €100,000 will be forced to take a hit on the Cyprus bank's closure as the bank does not have money to service its liabilities. Deposit insurance in the EU guarantees deposits up to €100,000, protecting small depositors.

Indian banks are categorised based on ownership. The categories are public sector banks, new private sector banks, old private sector banks, and foreign banks. Public sector banks are government-owned banks and have an implicit safety guarantee of the government. However, the fact is within this category, there are good ones and there are bad ones. Depositors should differentiate between good and bad banks based on credit rating and should demand higher rates of interest for taking risk on the bad public sector banks. One look at how non-performing asset (NPA) levels have gone up in public sector banks should warn depositors on the strength of a bank, irrespective of an implicit government guarantee.

The private and foreign banks have no implicit guarantee but the general feeling is that the RBI will not let any bank go down, as seen in the case of Global Trust Bank. However, in times of extreme stress, the RBI may change its stance and cancel the licences of banks it deems insolvent, as in the case of cooperative banks. Depositors should again demand higher rates for the extra risk they take in placing deposits with lower rated banks.

Gold prices in rupee terms have fallen by over 11 percent over the last one year. In this 11 percent fall, an NBFC (non-bank finance company) that lends against gold as collateral has sounded out investors on losses of around Rs 250 crore on defaults by borrowers. Mannapuram Finance, the NBFC suffering the losses, is not able to recover the loan by selling the collateral, indicating the risks of gold price fall on its business. Gold prices can continue to fall as investors and even lenders against gold dump the asset on worries of further declines in gold prices.

Real estate is seeing a correction though no one will admit to it. The fact that a prominent real estate company HDIL has lost 62 percent of its value over the last three months on solvency concerns is telling on real estate prices in the country. Why should a builder lose money if real estate prices are only going up and investors seem to have endless appetite for real estate? Going round the country one will find corrections in real estate everywhere, be it commercial property in Navi Mumbai or residential property in Hyderabad. Sebi has just closed down a real estate investment scheme that it deemed was not legal and potential losses could run into hundreds of crores for investors.

Indians should be more aware of risks in banks, gold and real estate now and nothing is certain but death and taxes.

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