During the height of the Wall Street Crisis American banks were hit by non performing housing loans and did not have money to lend out. At the time the Federal Reserve Chairman Ben Bernanke made an important statement while asking the US Congress for a USD 700 bn bailout package.
He said, “The 1930’s depression may have started with a stock market crash but what hit the general economy was a disruption of credit. Average citizens were unable to borrow money, unable to do anything-buy a home, start a business, and stock their shelves. Credit has the ability to build a modern economy but a lack of credit has the power to destroy it swiftly and absolutely. If we do not act boldly and swiftly we will only replay the depression of the 1930’s, only this time it will be far, far worse. We also won’t have an economy by Monday.”
Though it may have seemed to be far-fetched a few months ago there are chances that Bhutan’s credit crisis could turn into a financial crisis if no action is taken.
Bhutan took its first step towards a credit crisis after the Royal Monetary Authority in April 2012 applied new restrictions on banks and strengthened old ones leading to a virtual credit freeze. This was based mainly on the perception that the excessive credit had fueled the rupee crisis.
There are already some early warning signs that this credit freeze could lead to a financial crisis.
Some senior bank officials say that already there are an increasing number of companies big and small and also individual building owners defaulting on the monthly loan installments as they can’t get additional credit to complete their business or make it viable. As a result financial institutions are in the process of seizing more collaterals and assets like cars, half constructed buildings, land etc.
To recover the loan money banks have to auction these assets but since nobody has money due to the credit crunch the banks could be stuck both with bad loans and bad assets.
The rapidly falling price of land which is a popular and highly valued collateral with banks should send some alarm bells ringing. There are many people desperate for money willing to sell their land up to 50% below the market value but are still unable to find buyers in a cashless market.
The rupee crisis could be blamed on several factors like excessive credit, excessive government spending, auxiliary demand, RMA’s reserve management and etc. However, a possible financial crisis will be to the credit of the government and RMA if they don’t recognize there is a problem and deal with it.
Financial Institutions can also not be absolved for the risky financial situation as for years they have been heavily over exposed to sectors like construction, manufacturing etc.
Of the overall credit of Nu 47.5 bn in December 2011, 25.3% of the credit portfolio was allocated to the building and construction sector, followed by manufacturing sector (17.5%); others include personal loans (19.4%), and trade and commerce (14.3%).
Construction companies admit that with the current credit freeze many of them are on the brink as they need huge Overdraft loan accounts to function. In case of the large housing market, Thimphu is dotted with many half completed buildings that are not able to progress further due to lack of credit but still have to pay a large interest on the earlier loan. This is dangerous as the Wall Street crash took place after house owners could not payback their loans.
Reports indicate that an increasing number of big manufacturing companies are missing their loan installments. Some don’t have the money while others want to intentionally default as they are unsure when they would get access to cash again.
The downside of the credit crisis in Bhutan is that apart from curtailing spending it is encouraging or forcing individuals and businesses to default on their loans with banks. If a sizeable amount of loan default is seen then Bhutanese banks could face the nightmarish scenario of a huge amount of bad or Non Performing Loans followed by a ‘run’ on the banks with banks unable to pay back panicked depositors.
The irony here is that unlike in the case of the Wall Street crisis Bhutan can easily prevent this by at least easing credit to ensure that ongoing business and housing ventures don’t fail and the economy does not come to a standstill.
It is important to control excess spending in light of the rupee crisis but not to the extent of creating an entirely new crisis.