The Necessity of Asset-Backed Securities Based on Mortgages in the Modern Economy

Economics and government do not strictly mandate collateral for lending; however, financial institutions require it to ensure the safety and security of their investments. This disjunction between government and financial institutions often leads to discrepancies in loan disbursements. Parametric data and case studies show that loans, especially those pertaining to self-help groups, cooperative societies, and agrarian loans, are sometimes disbursed without requiring collateral. These loans are frequently sponsored by government bodies such as NABARD and regional rural banks. On occasion, influential political figures and bureaucratic interventions facilitate financial assistance to prominent industries, such as the TATA, RELIANCE, and BAJAJ groups. However, these exceptions often arise to expedite economic growth, even at the risk of financial instability.

Requirements for Lending by Financial Institutions

Financial institutions, including banks, NBFCs (Non-Banking Financial Companies), and financing houses, operate under stringent guidelines to ensure prudent lending practices. These institutions must maintain capital adequacy ratios, comply with risk management standards (Basel norms), and adhere to regulatory requirements set forth by the government or central banking authorities. Stricter compliance with these guidelines could mitigate the approximately 2 trillion rupees in non-performing and stressed assets. However, rigid adherence to these rules would likely stifle economic growth and innovation, presenting a delicate balance for policymakers.

The Role of Mortgages as Collateral

Mortgages serve as an additional layer of security beyond the primary asset, thereby reducing the risk of default for banks. While it is possible to sanction loans without mortgages, the risk of default significantly increases. Ideally, regular loan repayment would render mortgages redundant, fostering a culture of financial discipline within the society. To achieve this objective, public awareness and education campaigns must be intensified to promote the benefits of collateral-free loans.

History and Lessons from Leverage and Financial Crises

The global economic crisis of the early 1930s, often referred to as the Great Depression, was partly due to the ability to leverage stock markets to 90%, which allowed the Federal Reserve and its financial partners to instigate the crisis. Similar principles were at play during the current financial crisis, with speculative bets using borrowed money becoming a major factor. The leveraging of bets on assets with sums far exceeding their intrinsic value contributed significantly to the instability of the financial markets.

Historically, regulations such as the Glass-Steagall Act were introduced to address these issues, banning certain forms of leveraging to protect the financial system. It is worth noting that speculation with one's own money is not inherently evil, nor is it evil to speculate with borrowed money if the borrower fully understands the risks. However, the socialization of losses and the avoidance of personal risk through the use of borrowed money for speculative purposes is morally and ethically reprehensible.

Concluding Thoughts

The decision to institutionalize asset-backed securities based on mortgages is a nuanced one. While it can provide an essential layer of security for financial institutions, it also perpetuates a system that can exacerbate debt and financial instability. Balancing the need for robust lending practices with the potential for economic growth remains a critical challenge for policymakers and financial regulators. Educational and regulatory efforts must continue to strike this balance and promote financial literacy and responsible lending practices.