Not Such A Rock Anymore!

It’s been three weeks since I posted the last one. The past weeks have seen lull in capital markets In India followed by a slight rally. The budget is a bit of red herring really; I am still punting on a non-populist budget; (there is another one next year before the Country goes to polls, I reckon the populism would be saved for then!)
Across the frontiers, the world of finance especially Banking is passing through quite a turbulent time; what with trouble brewing both sides of English Channel!
On the English side the saga seems to be nearing completion with the Chancellor taking the decision to nationalize the troubled Rock.
Such nationalization is quite rare in England that has taken pride in its Darwinian traditions and in the past has let the most prestigious symbols of British finance to die when it became clear that their death would not have any systemic effects; (remember Barings). Two issues need to be high lighted.
Firstly does Northern Rock have a claim over the assets it hived off to Granite via a securitisation deal?
While nationalization undoubtedly hurts the shareholders ( it should), if the nationalized institution does not have strong portfolio, it pinches the tax payer as well. (In the case of Northern Rock, the Government is all along maintaining that the mortgage lender has a strong asset base- A Claim that might not stand scrutiny. In fact, the bank has hived off its best assets to SPV Granite through securitisation. Which means that entity is bankruptcy remote and it cannot be affected by the bankruptcy of Northern Rock, the originator). If its a true sale, (such transactions generally are) the entire port folio is lost; although technically, the SPV has no assets to manage and is a mere conduit. Equitable doctrines might thus fetch Northern Rock its strongest portfolio.

There is an additional perspective to State intervention, the one having anti trust implications- If Northern Rock is going to run by the state, this acts as an incentive for the depositors to park the funds with it. This has anti competitive effects and tends to create a monopoly for the bank as the “ State Run” tag acts as an implicit Credit enhancement. Clearly other mortgage lenders are not amused. To my mind, it does look that the Authorities might find themselves foul of the “Promote Competition” covenant of EU law.

Clearly we are not through yet. Watch this Space!

Is YV A Party Pooper?

Hmm, I am posting this a good 13 days after the last post. So, there is a lot to talk about. In the meantime, "Big Bull Bernanke" has cut interest rates ( confirming that the United States is indeed in a recession cycle), Y.V. Reddy has maintained them steady; Societe Generale has been given a lesson by " Leeson II"; and the UK treasury is considering a law that will obligate Bank Of England to provide secret liquidity to Banks in the red so that any possibility of a bank run is foreclosed.

This post am goin to talk about the recently unveiled review of monetary policy of the Reserve Bank. The policy came " against the run of play" so to speak, everone including the Finance Ministry wanted the Bank to cut rates and many punted that YV would go the "Big Ben" way. But as with most central Bankers, the Governor is a cautious man. There was no rate Cut; instead the Bank adopted a policy of moral suasion to convince Banks to lend more.( at present excess liquidity that Banks have is invested in low yield low Risk government securities).

The message is clear enough.Inflation is low because of the artificial suppressing of oil prices. Inflationary tendencies and curbing them is topmost priority. With the OPEC indicating thst it would oppose any demand for more oil in the markets, oil prices will continue to spiral and money would be required to service that.

In the process, the central Bank also underlined its autonomy from pressures of the Finance Ministry ( populist measures like Rate cuts will win you votes and Brownies, but "its the Economy stupid!"that is more important) and its emphasis to fashion itself based on Indian conditions. Yours truly also thought that the Bank would take a leaf out of fed's book but was (thankfully) proved wrong.

That does mean lull in Realty and Banking stocks. ( these are rate sensitive industries) hitherto the former has been providing momentum. But this is small price to pay for a more stable financial system in the long term.

So, is YV the party pooper? Only a fool would say that.

Should Central Banks Be Generous?

These posts have spoken earlier about the Sub Prime Crisis and how bearish Central Bank made sure we remained insulated from the Crisis. ( how far the De Coupling theory stays true is anyone's guess however!). the Sub Prime Crisis is a Black Swan event and like all Black Swan events, it has brought winds of change in public policy in general and banking regulation in particular. it is time that we reflect on these winds of change and so this post I revisit a related issue;
Should Central Banks act pro-actively to save banks and other Financial instiutions from goin down under? Are there good reasons to intervene and inject liquidity in a failing bank? The answer to the first question till last year would have been a straight No, but after the battering systems received last year, the present system seems to be leaning towards interventionism.

So should we have a system where the Bank Of England or the Reserve Bank intervene and inject liquidity, the moment it sees a bank is in the red? or should we have a system where decisions are taken by Central banks on a case to case basis, intervening only when it foresees that failure of banks has systemic effects. It is interesting to note that the Central Banks Of England and United States till very recently followed a " systemic effect" intervention policy in keeping with the laissez faire nature of the economy in those states while bank regulation in our Country has been based on a multi factor test, inter alia including Depositor interest and public interest and stability of banking system.( These factors cannot be simulataneously balanced; indeed some are antithetical to each other. for example, a particular bank might not be systemically important and so it might not be in public interest to bail it out; however acting in public interest here is directly prejudicial to depositor interest as they stand to fail if the bank is not protected).
the recent Crisis has however as i earlier pointed out brought out interventionist thought in laissez faire thinking.( See how Mervyn King did a volte face and decided to bail out Northern Rock; his early speeches were an eulogy to " systemic effect intervention").

My understanding however is that this change in policy does not augur too well for the Economy. the Economics of bail out suggests that the tax payer pays for share holder apathy. and a sustained policy therefore subsidises risk taking by unscrouplous bank Boards and incentivises further apathy by the share holders. In the long run , market discipline suffers and no one is happier. Rather all Central Banks should return to the " systemic intervention" plank and restrict their altruism to that factor alone. that way owners will monitor banks effectively, agents will have less incentives to self deal substantially reducing agency costs.

It is not my case that the intervention policy is wrong; it is however emphatically my case that it must only be followed this one time; till the crisis is over.

Darwin was not a evil man was he?

Should Banks be Held Liable For Excesses Of Recovery Agents?

These posts have hitherto been talkin about the macroeconomic policies that India ought to follow. So, this post I take a break and talk about a problematic issue in microeconomic area.the problem of recovery agents and the excesses they commit in the course of recovery of loans from retail borrowers has been in news of late. Recently, the National Consumer Commission delivered a verdict that held a reputed private bank responsible for the excesses committed by its recovery agents. the Bank was held responsible for "deficiency in service". the media generally welcomed the judgment and the general consensus was that it was a welcome step that struck a blow for consumer movement in the Country.

this post I look at whether banks should be so held responsible for the excesses committed by its recovery agents. Of Course, if we take a " law as principle" approach inspired by worthy notions like justice, there are no two ways about it. the judgment puts the onus on the banks to ensure that recovery practises are fair; and indeed the liability is rightly , a few would argue, upon the person who has the resources to avoid the damage.
Scratch the surface however and a different pixture would emerge. here's how!

Banks and other financial Institutions forever grapple with the Problem of "sticky assets". Loans that go bad and do not pay returns. The problem is compunded by the fact that the country has no proper restructuring mechanisms and there is government intervention by way of compulsary priority Sector lending. Couple that with the fact that the CRAR ratio-the Capital Adaquecy ratio that they have to maintain is 9%- 1 % higher than the Basel standards that are globally accepted.

let us look at the fall out of this judgment-
banks will be ultra conservative in lending practices. Credit would not be cheap; so,if you are a 20-sth. looking to buy that first house, you buy credit at a higher rate. and you need collaterals and guarantors. The Sub Prime class in India that currently buys credit with the interest rates that range from 25-60% would be the worst hit. I have a belief that these borrowers would be denied credit absolutely. Already poor in terms of income, they would have no recourse to capital.

Additionally, holding banks responsible for the excesses of their agents has reputation costs. Retail borrowers would be less inclined to approach banks for fear of recovery agents; and also because, they are any way not entertained there. They would then look to specialised loan providers like say housing finance Companies and other less prudent entities to finance their needs. these institutions are not diversified (hence risky) and rely on specific sectors for asset creation. Increased sub prime load on their balance sheets mean they become prone to failures themselves.

Thus, while banks have responsibility in ensuring that fair recovery practices are followed, the problems compound when they are held liable. the problem needs policy instruments like Securitisation and more leeway to banks in terms of managing their port folios. Hap hazard innovations by the judiciary will only stall the momentum of the India growth story!

SWF II - Answering the Naysayers

Last week, through these posts I suggested how the surplus reserves that India possesses could be harnessed to further strategic and commercial objectives. this week we will have a look at the likely problems that might arise in the establishment of such SWF in our country. The following are the principal issues that we have to address before the establishment of a SWF.

Administration and Management of the Fund
Going by the precedent, each State has an independent fund manager for the SWF that takes decisions based on policies formulated by the Board. In India, we can have an independent vehicle ( Corporation) with the Board taking policy decisions. In my opinion, the Board ought to be as follows:

(a)The Governor of the Reserve Bank or his nominee; will make sure that the invesment is consistent with Forex policies,
(b)the Finance Minister or the Secretary of Finance; to ensure political costs in the event of mismanagement,
(c)Representative of the MEA; to leverage the stretegic potential,
(d)CAG, the Comptroller And the Auditor General; to ensure transparency.

The Current Account Deficit.
This bit is standard. All the States that are investing through the SWFs have a current Account Surplus. We have a Current Account Deficit. So, the argument goes, we do not have the liquidity that other funds enjoy. I agree that this is one of the principal diffrences between us and the rest; and yet this ought not to hinder or freeze our investment options. the solution lies in investing in a relatively diversified portfolio and relatively liquid assets that can be summoned as demand for the dollars increases here. Also, as the Chinese have shown even one-fifth of foreign reserves are enough for the SWF. It is not my case that chunk of the foreign reserves are to be locked-in. this solution clearly implies that the Current Account deficit argument does not pan out.

Corporate Governance
hmm, this seems to be the buzzword these days. And much of the issues sorrounding SWFs stems from the fact that barring Norway, none of the funds have had transparency in its operations. However Capital in the hands of Government that are Democratically chosen have inherent " checks and balances". the Board Composition that I suggested above has the Comptroller as a watchdog and the Finance minister as its members; that would ensure a Parliamentary check on the Fund. As I pointed out above, this Composition would ensure that there are political costs of mis management and the knowledge thereof would make the Fund transparent ex ante. we may follow the Norwegian lead in this regard.
As we usher in the New Year and celebrate India Inc.by cutting the Cake for Tata Motors acquring Jaguar-Rover, A New Year resolution of SWF by the North Block may just be the icing!

Does India Need a Sovereign Wealth Fund?

The last piece i spoke about how we must raise a toast to socialists and bearish Regulators for insulating us from the Sub Prime crisis. This piece i speak of a related dvelopment and another one that regulators in India mght have to mull about- that of using the huge forex reserves that India is currently sitting on and the best way to utlise them.

From a country that had balance of payment issues in the 1990s, we have indeed come a long way in terms of forex reserves! in fact we have reached the other extreme end of the continuum and the bank regulator is tryin to suck up the excess dollars in the system by such measures as market stabilisation bonds. but we have not seriously at any rate, tried to reap out of the surplus reserves that we possess.

In other words, does India need a Sovereign Wealth Fund( SWF)?In my opinion seems a very lucrative and strategic solution to the surplus reserves problem.

The gulf nations sitting on their " Oil Dollars"have shown how to use an invesment vehicle strategically as well. it may be noted that CITI was bailed out by the Abu Dhabi fund and chances are that the Gulf states would make more hay in the recession hit US market. the Chinese with their Chinese Investment Corporation that has a 30% stake in Blackstone would also try and place themselves as investors in strategic areas of key competing states- as we speak Temasek- the Singapore Government fund is in talks with Merill Lynch for fund injection in the latter. and it already has stakes in Barclays and StanChart. The Fund has invesments in everything to biotechnology to port operations- port operations! there you have a whiff of huge strategic potential of the SWFs!

The macro? more and more government are using reserves to build up strategic positions in key areas of other states. And i suspect it is time for India to follow suit. The Surplus reserve Problem would be solved and Economics of the SWF will inform Politics going by the aforementioned data.

That is not to say we want to have an absolute " Laissez Faire"; obviously the hunters all stand the risk of becoming the hunted in the current scanario. So, India stands the risk of " exposing" its key sectors to Foreign governments. there are transparency issues as well. Apart from the Norwegian SWF, the most transparent of SWFs, ( it debarred "Vedanta Technologies" from being part of it because of the latter's shady Environmental rights record), no one knows where the money in the SWFs of States is coming from.

So, obviously some key issues have to be regulated. A best Practises code needs to be hammered out - by a " basel-like" system. Certain sectors, key to each state would have to be protected and multilateral reciprocal arrangements would have to be put in to place to keep those areas "beyond bounds", but i suspect, as the old brokers say, 'Capital would find its way!'

Are the Mint Street and the North Block listenin?

the Next Time You make A killing On the Stock Exchange, think Of Marx!

Socialists are a sorry lot these days. with the inflows and the Projected growth of the indian Economy pegged at around 10 per cent, i would be called a fool if a i were to say that Socialists are partly responsible for the Economic growth. Sounds Silly ? read on then !

Any one keen on financial scene will tell you that the Northern Rock going down in the Sub Prime crisis was one of the most disturbing news of 2007. (Citibank was only recently bailed out by the cash rich Abu Dhabi SWF and DSP Merill Lynch had to "pink Slip" a few of its top execs)

Of Course the depth of the Sub Prime Crisis is still not known but its pretty much clear that the Banks granting loans reposing faith on easy interest rate regime ( not for nothing is Ben Bernanke called " the big Bull") were one of the factors responsible for the Sub Prime Crisis; in other words, cheap availability of Credit and excessive liquidity in the markets lulled the lenders in underestimating the Credit Histories of their borowers precipating the Crisis. So when the Fed or the Bank Of Japan suddenly upped the interest rates, there was relative credit Squeeze and the banks and other lenders tripped because suddenly the assets were not yielding like before. the macro? less regulation was responsible for the Sub Prime Crisis.

And what was the scene in India ? Compared to say the UK where interest rates fluctuate between 5-5 and a half, we are a nation consistently ranked highest in terms of high interest rates,Cash reserve ratio and the statutory liquidity ratio ( in a nutshell these instruments are a like a banking tax) that translated in less liquidity in the market and a conservative lending approach. the Macro? more regulation saved the India Growth Story from being stalled.

the next time you make a killing on the Stocks, remember marx!