This refers to Sumita Kale’s article: ‘The missing link’, January 23. The Bank for International Settlements (BIS), to protect the viability of its members, introduced capital adequacy norms to ensure that the tendency to expand uncontrollably was curbed by avoiding excess leveraging. Simultaneously, it also introduced income recognition norms to ensure that banks only booked real profits and were not carried away by the ballooning effect of the customers they serve.
This vanilla-type of banking relied upon the bankers’ ability to gauge the health of their customers with their experience. However, the investment banking model introduced in the 1940s combined interest and profit for risk-taking as a single factor to increase the return for the investors. As competition grew among the investment bankers to show more returns for their clientele, they started inventing more and more products that are variations of mortgaging of the debts already contracted, and to roll over the same to be able to get more income. This mortgage model of financing camouflaged the real nature of the ultimate securities about which nobody had any clue.
Though a late entrant to the BIS-based Basel norms, it is to the credit of Indian banks and its regulator, the Reserve bank of India, that this model was not allowed to be replicated in India notwithstanding the temptations to adopt it to improve bank profits. It is because of this cautiousness that Indian banks, except the liquidity crunch induced by global factors, are not facing the survival problem their western counterparts are.
P Esakki Muthu, Mumbai
