Monday, June 28, 2010

Bank regulation

Bloomberg reports that the rules for tighter capital requirements and liquidity requirements by banks could get delayed. They are to be discussed by the G 20 in November and implemented from 2012 on. But as Mario Draghi the Governor of Bank of Italy and the Chairman of the Financial Stability Board - a global coordination body, which works closely with Basle Committee put it - it is better to delay the standards put in rather than weaken them. My only concern is that as public memory is short, time might prove a weakening factor in itself. So the fond hope is that delay is not too long.

The norms - detailed by a consultative paper released by BIS in 2009 December - apart from other areas - are on two major fronts
a) Capital - particularly, what can constitute Tier 1 capital and if there can be a minimum floor level of Tier 1 that can be stipulated.

b) Liquidity - reserves which are liquid and can handle short and medium term volatility.

The powerful banker's lobby ( The Institute of International Finance ) and other bodies had predictably painted a bleak picture for the economies if the Basle proposals are implemented - and have also indicated that the recovery would get jeopardized if they are put in place now. The lobby in the US has succeeded in diluting some of the recommendations in the reform package - largely on the liquidity front and in part on the capital front - that will be soon cleared by the Obama administration.

Thankfully in India RBI has had a significant amount of forethought - and the IBA - dominated by PSBs is not also unreasonably strong. I am not surprised to see several positions made by BIS - including counter cyclic capital stipulations - have already been implemented in India. The norms for classifying instruments is relatively tighter in India and we do have a floor at 6 %. There is no concept of Tier 3 in India. The SLR and CRR requirements have also helped maintain the required amount of liquidity comfort in the banking system. No wonder we have a resilient banking system !

Super Fund and Disaster Liablity

The compensation 'settled' with Union Carbide ( a 50.9% subsidiary of Union Carbide - with the remaining portion coming from some Indian investors including Mr Keshub Mahindra) for the Bhopal tragedy was USD million - abysmally low for the amount of damage that the company has done. What is ridiculous is this. After the disaster , UCC offered USD 350 Million - the insurance amount. Indian Government claimed USD 3.3 Billion and settled for USD 470 Million !!!!! ( which was the insurance amount with interest). Wonder in whose Interest the Government was working for ! The site still has hazardous wastes and UCC's new owner Dow is refusing to clean it up.

Following the uproar after the recent pathetic judgment , the GoM has rushed with a INR 1500 Crore compensation - which is a really thoughtful gesture - particularly considering that it is funded by tax payers money !

And now what is more ridiculous is - the Government is pushing a civil nuclear liability bill capping the liability at USD 100 Million (which even the paragon of free economy - 'The Economist' says is low by international standards. And it does'nt require one to be a nuclear scientist to know the potential damage of a nuclear disaster.

The US corporate sector has an unrivaled record of polluting - NY Times says there are over 1200 sites waiting to be cleaned up and of this half are what are called orphan sites - where ownership and responsibility is difficult to establish.

The basic principle in handling disasters should be that the polluter should pay ( not the tax payer). One significant and relevant development in this is that the US Environment Protection Agency has asked the Congress to reinstate Superfund taxes. This was first introduced by the Carter Administration in 1980 and abandoned by the Republicans (naturally !). This fund was essentially built over time by excise and taxes on oil, chemical and certain other industries and was used to clean up contaminated ( and abandoned ) sites. In some cases, however, it was hard to pinpoint responsibility because sites had changed hands over the years or the owners had gone bankrupt. So Congress created an “orphan fund” financed by corporate excise taxes to clean sites where the polluter could not be clearly identified.

Representative Earl Blumenauer, Democrat of Oregon, has introduced a bill that would raise about $19 billion over 10 years by imposing excise taxes on oil producers, refineries, chemical manufacturers and a few other industries. It remains to be seen if the Industry lobby will let is pass.

This is one lesson we urgently need to learn - if we want US companies or probably after British Petroleum's contribution to pollution - every company that wants to do business in India - in addition to fixing a liability amount on every company, we will need to have a Super fund - which will be generated from taxes on certain industries - like oil, chemicals and of course nuclear power - to handle damages to men and worksites they could possibly pollute , plus also contribute to clean up the mess and redress damages that their counterparts cause(d).

Wednesday, June 23, 2010

Why borrow from the World Bank ?

Bloomberg quoting World Bank's country director Roberto Zagha reports that the Bank's lending to India will increase to USD 9.3 billion this year (to be disbursed over a period of time), as the Government has sought financial help to support the country's planned development investments - recapitalizing public sector banks, cleaning the Ganges , build roads and rehabilitate villages affected by floods.

I find this borrowing business rather strange.

We have been talking of cleaning the Ganges for ages now - and to my mind what holds up the effort is lack of will and willingness - not the lack of funds. There are several ways to fund road projects - which in any case is now mostly on BOOT basis ...and I am not sure if we are anticipating floods - or are we planning to rehabilitate people who were affected by last year's floods. I don't really see why we need to borrow from the Washington based lender to recapitalize our banks.(That component is just USD 1 Billion ).

While India's external debt is position is not alarming and there is nothing wrong in borrowing to invest per se - the quantum, stated purpose and timing - all appear perplexing, particularly after the Government raked in over Rs 1 lakh crores from 3G and broad band auctions and the additional money it can and will rake in with its planned 'increase in public shareholding' in PSUs.

On the Base Rate

There is a lot of hype and noise about banks being advised to switch from the BPLR system to the base rate system. After the PLR system, the benchmark rate system and the benchmark PLR system which failed to bring in the 'much needed transparency' in pricing of loans, this is RBI's latest well meaning attempt. The key points of this move and its likely impact are

1. RBI has given banks the freedom to determine the base rate. It just wants it to be consistent and available for supervisory review.

The likely impact : I share the expectation of most analysts that the Base rate of PSBs and most large Pvt sector banks will hover around the rates that SBI sets - which many expect to be around 8%. Foreign banks may keep it lower. I dont rule out the possiblity of cartelization .
Now this BR will be the floor. What is likely to happen - which is in any case welcome - is that this will be market determined and banks will need to work backwards and tweek their cost structures. For the borrower though - particularly the SME, Retail customers - I am not sure if there will be any effective positive impact as banks are free to load fee structures over and above the base rates and there is no cap on the mark up over the Base rate.

2. All loan prices will need to be linked to this base rate ( with some exceptions).

The likely impact: The practice of quoting on treasury advised rates for short term buckets - say 30 days , 90 days, 180 days etc will be affected. Essentially well rated corporates will find this market closed - and they would move to the commercial paper market ( in which banks will again be their largest source of funds). That's a nice way to invigorate the short term corporate debt market !!!

3. External benchmarks are allowed , provided they are equal to or above Base rate at the time of sanction or renewal.

The likely impact : The MIBOR linked short term facility market for large corporates will vanish. However, banks and corporates may circumvent and innovate in the CP market

4. Current cap of BPLR as lending rate for loans upto Rs 2 lakhs is withdrawn

The likely impact : I ( hope to )see banks getting very active in the Micro Finance segment. I have been skeptical of the way MFIs do purely commercial business (more recently rather ruthlessly) in the guise of social inclusion and women empowerment. The major reason why banks - which are surely several shades better in their commercial activities - was this cap on lending rates. The operating costs in this space are rather high and now with this cap gone, if banks get their act right, the largest beneficiaries will be the small SHGs and entrepreuners.

5. The interest rate on rupee export credit has been deregulated

The likely impact : Increased transparency . Nothing more. Banks were anyway charging customers over and above the caps by way of charges under various names.

Net net ...

This move may bring in additional transparency - if the guidelines are followed in letter and spirit ( though it is common knowledge that it is followed in letter only). My guesstimate on the impact on the bank's profitability - NIL

Monday, June 21, 2010

Deregulation of interest rates on SB account

Those who clamour for deregulation of interest rates on savings accounts found a new supporter in the Deputy Governor of RBI , who said that RBI was keen on deregulating all rates - including SB rates. ( The Business Line , without naming him reports that he was vehemently against deregulating SB rates, when he was CMD of a bank which had a large SB base !!! ..well they say the only thing that is constant is change !!)

Banks have always competed for current accounts which are non interest bearing and savings accounts which are low interest( 3.5% pa) bearing - as these are the cheapest source of funds for banks. Some nationalized banks because of their large presence and some private sector banks , because of their deliberate strategy have a larger share of these accounts than others. The have nots - if I can call them thus, had to compete with the haves on all parameters - except interest rates. With this ( likely ) move, they would also be able to compete on interest rates.

Most banks already segment their customers based on the balances they maintain in their savings account. In my view, the higher end segments might get another 50 to 100 bps more for their account balances. The lower end segments may lose out - that is if one considers 3.5% interest rate to be a number of any value - particularly considering the current inflation rates !. I also expect banks to step up charges for deposit related services and penal charges for non maintenance of stipulated balances. At the end of the day, I dont see the net adverse impact on the bank's financials to be more than say 25 bps.

The usefulness of this move in asset liability management is, in my view, stretching things a bit too long. Currently 10 % of the SB balances are considered volatile and withdraw-able and are bucketed in the 'next day', 2-7 days and 8 to 14 day bucket. The rest of it is bucketed as core deposits in the long term bucket. I dont see how a 50 to 100 bps change will impact this bucketing significantly.

Thursday, June 17, 2010

Making banks manageable

The Future of Banking Commission report co-authored by Vince Cable, a Liberal Democrat Politician in the UK and currently its Business Secretary in the UK , has placed a set of 39 recommendations to the Government . One thing that caught my eye was that fact that it has endorsed the idea that large banks may have to be broken up.

Following the crisis, several economists have suggested that banks should not be allowed to become too big to fail - requiring compulsory bail out with tax payers money , in case of failure caused by reckless business decisions. I for one agree with this view for two reasons

a. I believe that notwithstanding the best in class systems and processes put in place, it is humanly impossible to manage beyond a particular size.

b. I don't think tax payers need to bail out shareholders. That is not logical.

However, this is one suggestion that has been conveniently ignored.

Now, the same thing coming from somebody , who is now high in the Government and that too from UK makes it interesting. Knowing the power of the finance lobby though I know it is going to be a very difficult task - and banks have experts in circumventing rules - so I wont be surprised if they find a way around this one too - should it become a rule. I wish Vince Cable the best of convincing ability !!

Monday, June 14, 2010

On equality

In one of my early blogs I pointed out a verse from Vivekachoodamani of the Ekanmavadha philosopher - Adisankara. . You may say 'Halt ! Everybody knows that Adisankara as the proponent of Advaidhic philosophy or the Vedanta philosophy 'what is this Ekanmavadha....Hmmm....let me explain

a. Vedanta i.e., Veda + anta - literally means the end portion of the Vedas and hence Upanishads.
b. Advaita i.e A + dvaita - literally means - Not two or non dual. Sankara interpreted this as one. There are different interpretations. We will come to this point later. For the moment we will stay with Adisankara's.

Vedanta philosophy is hence the philosophy of the Upanishads . Adisankara's is one of the many interpretations of this philosophy - not the only one and not necessarily the correct one too ! There are other philosophers who raise lot of questions on Sankara's interpretation.

Advaita has also been interpreted differently by different philosophers. And here too Sankara's is not necessarily the only one and not necessarily the correct one.

To call it properly, Sankara's philosophy is the philosophy of monism or Ekaanmavadha - or the agrument of one soul. It is that there is only one thing material - i.e., brahmam or the supreme one. The world and individual souls are merely transient and illusory. The soul , according to his philosophy , is identical with the infinite reality of the universe the brahmam.

It is not my intentition to question the interpretation of Adisankara here. I would however like to examine if he has been consistent in his interpretation and followed what he preached. In his Vivekachoodamani, verse 2, Sankara says

''For all beings a human birth is difficult to obtain, more so is a male body; rarer than that is Brahmanahood; rarer still is the attachment to the path of Vedic religion; higher than this is erudition in the scriptures; discrimination between the Self and not-Self, Realisation, and continuing in a state of identity with Brahman – these come next in order. (This kind of) Mukti (Liberation) is not to be attained except through the well-earned merits of a hundred crore of births.''

The inconsistencies glare: While on one side everything is supposed to be one 'Sarvam Brahma mayam '
a. Why is the human being considered superior to other living things ?
b. Why is the male considered superior to the female ?
c. Why is a brahmin considered superior to others ?
And assuming for the sake of an argument that brahminhood is superior - what was the necessity to preclude the so called Shudras from vedic practice and attain brahminhood ( Please read Sankara's interpretation of the Brahmasutras ).Can this classification of varnas be based on birth ? How is this classification sensible ? if on birth - on the birth of what ? - the soul is supposed to be eternal and hence it cannot be born. Then birth should be of the body . But body is transient and illusory - a product of Maya. On what basis is this classification done - and how just is this ? Where goes Sankara's wonderful monistic philosophy ?

How elite and magnimous can a person be who does not agreed to the equality of man and man and man and other living beings. What a hypocracy ? Or is this conspiracy ?.