Future security

The cabinet decision to amend the Securities Contract Regulation Act (SCRA) sounds arcane. Truth is few official decisions can be more homely. Hidden in the jargon is the promise that home loans—and consumer loans—may become cheaper, with obvious, positive consequences for Middle India. The amendment will allow securitised debt to be treated as financial instruments. These can be traded at stock exchanges regulated by SEBI. When traders buy and sell these instruments, they will bring in for aspirational Indians new sources of funding for home loans and car loans. Interest rates will therefore come down.

The significance of this is measured by the gap between those future rates and the high rates charged on home loans and car loans today. The rates are high because banks, which usually do the lending, take on the credit risk of the borrower. Securitisation allows the loans to be clubbed together, to create one large asset. This is then broken up into parts and each sold as a security. When 10,000 home loans are put together in one bundle, the credit risk becomes extremely predictable. This predictability induces lower interests rates. Faced with lower risk, lenders find this instrument to be far more attractive than a single loan. Further, this pool of loans is brokenup into a million small parts, which are traded on stock exchanges. This allows transparency of pricing, and makes it possible for anyone—including pension funds, insurance companies and households—to purchase these assets, thus (effectively) funding home loans and car loans. Banks then restrict themselves to loan services, balance sheet functions are no longer their headache.

Post-SCRA amendment, investors such as insurance companies, mutual funds and households are expected to add these securities to their portfolios. Competition in the sector will push down the interest rates charged for loans to consumers. Investors will be have another attractive asset to invest in. Banks will no longer have to take real estate risk or used-car risk. If everything goes as it should, the gap between Indian financial markets and those of mature market economies will narrow — in the latter, banks play a relatively small role, the bulk of resources flow through securities markets. The gap between home-owning dreams and reality should narrow too.