Cards, Cars and Gold Czars

"Lucky you; a Credit Card in hand fresh off the boat!" or words to that effect. Thus went the refrain, notably from friends having made a similar India-to-US move mid-career; and thereafter grappled with the task of rebuilding a financial profile from scratch.

Fact is that, absent a Bureau score, many of us who wash ashore have to face the rather mortifying experience of credit denial(s). Some are forced to resort to Secured cards to build payment history. Therefore, the modest $1500 limit from BofA (I had higher in my first credit card as a mere student graduating from IIFT 20 years ago) felt like an occasion to celebrate!

Part of the distress, to be fair, comes from the dissonance between the erstwhile financial standing in India (while no HNW, one had the pick of financial products; and a feeling of being chased rather than chasing) to newbie status in the US of A. Mind you, this would be equally true even with a global bank; one you had used in India for years; and carried some priority status. Your creditworthiness is reset perforce.

So, with prospective landlords looking askance and utilities insisting on bank auto-debit of monthly bills, a credit card felt much like being granted the Moon. Why not use your India plastic, you ask? Unfortunately, that would be akin to kicking the can down the road. Even if you found a way past the international usage surcharge with an appropriate card, it would still not solve for the need to have usage and payment history domestically to build your credit profile (circular logic, did you say?).

Thankfully, there is a potential hack, and a doubly sweet one at that. AMEX, as I found out last week, could give you a charge card based mostly on your India relationship (albeit driven more by their customer service ethic than hyper-connectedness of the world)! Equally, this 'no limit' card saves me from needing to pre-pay my original credit card multiple times intra-month (when paltry limits meet large household set-up expenses). Note, therefore, my unequivocal endorsement for the 'Gold' in its name!

Next pit-stop in the finanical reset journey, is a car. Once again, as I shortlist, it is evident that usurious rates of interest await me on the loan. Neither will the humbling experience end quite there. Given recency of relocation, a lack of intimacy with domestic stocks is only to be expected. Ergo, I have miles to go to attain the next goal (of high-conviction stockpicking ideas). Till then, we soldier on, as we must.

Bigger, Better CIRcle

One of the more fulfilling assignments in my career was in a role managing consumer debt in the Indian banking and financial services industry. I had started in mid-2007, when signals of stress were unmistakable in our portfolio, and were enough to discern similar trends across the sector. They were the direct consequence of indiscriminate lending and immature borrowing practices that had been rampant earlier in the decade. Naturally, the resultant losses led to tighter credit policies and general house-cleaning, with varying degrees of success, across all players.

Though mandarins at FinMin and the RBI downplayed it, this improved hygiene had a major hand in ensuring that our country emerged from the 2008 GFC relatively unscathed. Thus, while capital flows and liquidity hit a reset globally, one of its key facets, namely burgeoning consumer debt and subsequent borrower impact, largely gave India a miss. I argued too, with a ringside view, that the rise of credit bureaus was one of our most far-reaching gains from this period ("CIRcle of Life"). They emerged from the shadows in those days beset by uncertainty and churn, and have remained a vital cog in the industry’s wheel ever since.

The GFC is now but a distant memory (save for some of us). Credit offtake has reached or exceeded pre-crisis levels in most economies globally. Consumer indebtedness is not yet a concern, including in India. Everything points to business-as-usual. Hence, it is vital that we address any gaps in credit management before the lessons of 2008 and its aftermath are entirely forgotten.

The most visible of these is our weak credit reporting framework. Despite having moved marginally away from Indian consumer finance (in a work sense), I still hear enough stories of inaccurate reporting of defaults, especially around old write-offs that have simply been misrecorded. A chunk of these are false positives from identity mix-ups by CIBIL and/or the lender in question. Equally, there are instances of bad data like closed credit card annual fees, collection agency fraud, and disputed charge write-offs etc.

No less worrisome is the imbalance of power that puts the onus for data clean-up entirely on the consumer. Processes to do so in a few banks are reasonably unfriendly too. Most important, though, is the opportunity cost. Almost all cases I know come to light when the consumer applies for fresh credit, often for big life events like a home purchase. In at least a couple of cases (till my advice to the contrary), folks were even willing to honour an incorrect demand in order to get a “clean CIBIL” (motivated by the math of the charge being in the hundreds versus a credit need that is much larger). This is hardly kosher.

It goes without saying that the issue needs a fix at source. Banks must be taken to task for irresponsible reporting, with a threat of monetary compensation to disincentivise laxity. In most mature markets, this is secured by legislation (FCRA. CCA, Privacy Act, etc). If needed, the government must consider similar consumer protection laws in India as well.

This brings us to the issue of coverage, notably the recurring demand to expand consumer behaviour monitoring to telecom and other utility payments. The rise of wallets and payment solutions is blurring the lines here in any case. Yet, this could well be an après moi, le déluge moment. The dimensionality of credit data — volume, churn, nature of disputes, etc — would multiply overnight were this to happen. This makes it incumbent to establish firm ground rules now, with a sharply defined financial services scope.

Crises, as students of economics know, are cyclical by their very nature. Hence, we must act now, so as to be better prepared when the next unforeseen one strikes. Lest history judge us differently.

2B Or Nought 2B

A degree in Economics and early years trading commodities mean that the markets hold me in an enduring thrall. I mostly restrict my passion to delivery trades, though; F&O action is rare. Equally, those with whom I talk equities classify more as investors than traders. This means margin speculation resides around the fringes of my stock-picking existence.

I was, however, greatly intrigued by JP Morgan Chase's massive derivative trading losses last quarter. For one, the initially reported figure was an obscene $2B (frankly, my imagination runs short when faced with such astronomical sums, for reasons not entirely unrelated to my humble circumstances)! Rumours abound, too, that the actual hole to be at least twice that ungodly number (phew).

Of course, financial markets are replete with instances of mind-numbing losses. I was in college when Nick "I'm Sorry" Leeson brought down Barings. He was neither the first nor last in a long line of market operators whose avarice or ambition — though rarely outright ineptitude — delivered similar rude shocks. Indeed, the trail of destruction in their wake invariably claimed more than a fair share of humble retail investors alongside the institutions themselves.

Naturally, it raises the question of how organizations of considerable repute come to such massive grief. These failures are difficult to reconcile with the high calibre of internal talent on display (for instance, Jamie Dimon himself has long been a star in an industry under intense public scrutiny). Equally, we ought to understand the process or technical inadequacies that led to a failure to detect and correct the exposure in time.

In the current instance, we can rule out derivatives themselves as the primary culprit. Targeting the financial instrument is like blaming steel for knife-wounds in street crime. That out of the way, the picture is no less turbid, with mismanaged hedges at JPMC's London Treasury at its core. The sequence unfolded as follows:

JPMC, like any commercial bank holding vast client deposits, must balance returns (by investing in long-term, high-quality bonds) against liquidity (through the overnight money market, yielding near zero in a QE regime). Excessive liquidity lowers the net interest margin; holding too little invites cash shortfalls. Moreover, bond portfolios need protection, since prices vary inversely with interest rates. When rates rise, the bank faces a double whammy: its bond portfolio suffers capital losses while funding costs escalate due to higher deposit payouts. Banks routinely hedge this exposure, including through Credit Default Swaps.

By all accounts, JPMC's Treasury in London was running huge positions. This forced them to trade aggressively in a relatively small, illiquid CDS market as a hedge strategy. This created price distortions that drew hedge funds and institutional traders seeking arbitrage opportunities. Continued pressure from the 'London Whale', however, meant that the pricing skews grew larger — spread valuations swung an unprecedented 50% in three months. Stresses on CDS market players mounted: the game was becoming relentlessly capital-intensive. They were squeezed, but could do little in an unregulated market with the Whale running amok.

If this were bad, it soon turned worse. Perhaps realizing the limitations of the original CDS hedge strategy, Whale & Co devised new plans. Defying all logic, they pivoted into related but riskier instruments, escalating their exposure to volatility. Hedge funds started to sense the desperation and waited for the position to crack.

Meanwhile, this had rung alarm bells within JPMC too. Reinforcements from the core i-banking unit were sent to the London Treasury. It did not take them long to figure out how untenable and inherently risky JPMC's position was. They wanted out, presenting the perfect revenge opportunity to hedge funds and CDS market punters. To liquidate the trades, these players wanted their price. $2B, or more, was this pound of flesh.

Perhaps I am guilty of over-simplification (for more gory details, refer to an excellent article on the Whale at Seeking Alpha). Regardless, the episode yields several striking conclusions. The most critical is the imperative for oversight across bespoke, illiquid derivatives markets. Another lesson is the limitations of relying on rigid, narrowly defined quantitative models to mitigate risk.

In an 'Occupy Wall St' backdrop, it is worth noting that this was not a case of i-banking excesses that have fired up public imagination and invited lawmaker attention lately. In fact, the scene of crime at Chase commercial bank Treasury in London is far removed from JP Morgan i-bank. Of course, the starring role for CDSs is a familiar echo of the GFC, but other than an 'ought-to-regulate', that is where the parallel ends.

Unless you own JPMC stock, therefore, the pall of gloom and hyper-suspicion is somewhat ill-founded. A sigh of relief may not be out of line either. Until, of course, the next quake strikes.
(bankruptcy-protection instruments)

CIRcle of Life

Generally speaking, from the universe of my acquaintances in my thirty-some years on the planet, the set from school would constitute the oldest and most valued relationships. To boot, a majority of this group would rate higher than average in terms of cerebral acumen as well as worldly success. Hence, when no fewer than three such friends seek me out in the space of a few weeks with queries on financial products, all centred on the theme of credit history, something does seem amiss in the State of Denmark!

Proceeding under the assumption that a general outbreak of penury has not gripped the Class of 1991 (and the financial transactions intended certainly pointed in the opposite direction!), the spate of enquiries was telling in the extreme. My working hypothesis was our collective lack of appreciation for credit bureaus and their rapidly expanding sway in India's financial system. (Incidentally, using the plural is half accurate — while only Credit Information Bureau India Ltd or CIBIL is completely operational, Experian is slated to be the second, and more are in the pipeline.) A quick primer, therefore, seems in order.

Simply put, a Credit Information Company or credit bureau is a repository of credit histories of individuals and companies. It is premised on the principle of pooled information — all member banks and FIs share credit line and payment data with it — intended to facilitate better credit decisions for lenders as also appropriate terms for borrowers. Bureau data is formatted into a Credit Information Report (CIR), which can be accessed by member institutions and concerned consumer or commercial entities. This CIR is being increasingly leveraged to assess creditworthiness in India as we speak — a decades-long practice in the developed world.

Therein, of course, lies the rub. Widespread usage of the CIR is a relatively recent phenomenon and customer awareness about it has been pitifully inadequate. Combined, this has severely limited consumer motivation to keep bureau data accurate and updated. As such, a sizeable section of borrowers end up not-so-pleasantly surprised by their CIR's contents — and that at the very cusp of a loan (hence calls to folks like me). Nor are the bureaus much to blame — not only are their credentials impeccable (CIBIL, for instance, was cofounded by SBI and HDFC, along with Dun & Bradstreet and TransUnion, both experts in their domains), but inaccuracy of information strikes at their very raison d'être.

Similar vested interest in veracity may have been presumed for banks and FIs. Unfortunately, in CIBIL's nascent days, a chunk of members were curiously over-protective of their data and loath to share vital information with others. This futile stance changed significantly only with the 2008 Crisis, when the industry woke up to the dangers of one-upmanship. Historically, there may have been infrastructure issues in data capture or storage too, especially with PSU players. All this — exacerbated by customer tardiness in closing seemingly trivial issues and occasional wilful default — culminated in countless unfairly sullied CIRs.

As things stand, the CIR is now part of life (common misconception: only delinquent accounts get reported to bureaus — not so; they carry all). In fact, consider it only a function of time when CIR usage shall transcend lending decisions to encompass utilities and other facets of one's financial identity. Note too that its capture, portability, and permanence will be in a different league post-Aadhaar implementation. Neither should it be thought impossible for the CIR to become an input for employment decisions (in BFSI, company directorships etc), nor, at some point in the future, indirectly impinge on social contracts, or even public office.

Meanwhile, for those with current or future borrowing needs — that is, virtually everyone in India's emerging consumerist paradigm — and at all concerned with credit availability and terms (obviously, pricing; equally credit delayed can be credit too late — ask those forgoing cash discounts when purchasing a new house), an impeccable credit history is highly desirable. Even as you get disciplined in future payments, cast an eye on your CIBIL report now and going forward (rectify errors, if any, via your bank or FI that has reported them). Procrastination is perilous.