Impact Of Rupee Exchange Rate On Business Opportunities In India

We published a research paper titled "Impact Of Rupee Exchange Rate On Business Opportunities In India" in the IOSR Journal of Economics and Finance and the paper can be accessed here: Link to the journal

In this paper, we have presented the impact of Rupee exchange rate on business opportunities in India from a macro economic perspective considering the indicators such as Consumer Price Inflation, Gross Domestic Product and Index Of Industrial Production.

Abstract: In this paper, we present an analysis of the macro economy in India with respect to the exchange rate of the Rupee and de regulation of oil prices. These 2 factors have been critical in deciding the business competitiveness of the economy and their individual effects are studied. Various business competencies arising from strong and weak Rupee as well as de-regulated prices of oil are discussed. 

In continuation with the analysis expressed in this paper, we would like to share the following analysis:

The Rupee exchange rate in India is linked to the trade deficit (imports - exports). Higher trade deficits lead to a weaker Rupee. Considering an economy which has certain total imports x and certain total exports y, if the exports start dropping and imports (of consumer goods) start increasing, it might be a cause of concern (on the competitiveness of the economy). A currency depreciation might boost the exports in the short run, by making them cheaper. 

But consider the case of India. Here the primary imports are all in energy: oil, natural gas and coal. When the imports increase, we are importing more energy, and that is because the economy is doing well  and we are producing and selling more (domestically and internationally). In this case, should the Rupee depreciate with increased imports? Think about it.

(Petroleum accounts for 34% of India's imports. Data source at tradingeconomics.com)

On another note, Japan manages to import energy (oil) to meet 42% of its energy needs, but does not see any inflation even if the Yen depreciates from 75 to a US Dollar to 100 to a US Dollar. This is not the case with India. As is evident from the above research paper, a depreciation of the Rupee vs US Dollar will lead to higher inflation in the country (data from 2010 to 2014).

The below graph shows the energy imports in India as a percent of total (Data from: tradingeconomics.com)

source: tradingeconomics.com

BITCOIN AND RELATED BUSINESSES

This presentation was prepared for the E-BUSINESS COURSE taught by Prof. Vijay Shrotriya. This presentation covers the regulated aspects of the bitcoin currency. There is a large shady marketplace for bitcoins that is unregulated and exists outside of USA and Australia. Regulating the dark market is difficult due to the decentralized nature of the bitcoin. However, proactive and corrective actions such as those taken in USA and Australia are necessary to check the growth of the dark markets which are unregulated. Turning a blind eye to these dark exchanges is not going to solve the problem of money laundering using the bitcoin which is often time used by drug dealers and terrorist networks.

A Hundred Small Steps: Creating Liquid and Efficient Markets

This blog post is in continuation of my series of blog posts on RBI Governor Raghuram Rajan's report titled "A Hundred Small Steps" published when he was with the Planning Commission of India.

This post focuses on Chapter 5 of the report, which deals with establishing Efficient and Liquid Markets. This section of the report delves into what could be changed in the structure of the financial markets in India to make them more resilient and liquid. I will try to describe the contents of the report here, with my analysis where possible.

First the definitions. Market efficiency is the degree to which information and forecasts about the future are impounded into financial prices. Liquidity pertains to the ability to transact with low transaction costs. Liquidity has 3 aspects: immediacy, depth, and resilience. Immediacy refers to the ability to execute trades of small size immediately without moving the price adversely (also called low impact cost). Depth refers to the impact cost suffered when doing large trades. Resilience refers to the speed with which prices and liquidity of the market revert back to normal conditions after a large trade has taken place.

The concepts of efficiency and liquidity are linked. In order for markets to be efficient, market participants who obtain information have to be able to trade on that basis and impound that information into the prices. For economic agents to have an incentive to expend resources in information processing and forecasting, markets must be liquid, else any profits from the activity will be dissipated in transaction costs alone. Expensive or infeasible transactions reduce the profits from successful forecasting.  This (in turn) inhibits the investments made in information processing and forecasting. Market liquidity is thus a critical precondition for market efficiency. In turn, market efficiency assures uninformed participants that market prices are up to date and reflect fundamentals, so they can trade safely. This in turn provides volumes that ensure liquidity.

The below table highlights the state of the Indian markets from the 3 aspects of liquidity:

A particularly important point to note here is the lack of progress. In the period from 2003 to 2008, 3 elements have come through the onset of immediacy with near money options on index and liquid stocks, the onset of immediacy and depth on the interest rate swap market, and the onset of immediacy on some commodity futures products. 

The main reason why so many markets are illiquid and inefficient are listed as follows: 

1. Banning of products and markets: Currency futures and commodity options are banned in India. A missing market can hamper the efficiency of other markets also. The absence of interest rate futures can hurt the treasury market. 

2. Rules that impede participation of firms and individuals in certain markets for reasons other than sophistication. eg. domestic individuals cannot participate in currency markets (outright ban), banks are prohibited from adopting long positions in interest rate futures (regulatory restrictions on some kinds of activities), all FIIs put together have to keep their ownership of corporate bonds below $1.5 billion (quantitative restriction)

3. Inadequacies of financial firms arising out of their ownership, size and other reasons. The institutional structure of market participants is shaped by the forces of competition and regulation. When firms face competition from market share, they are forced to find new ways of serving customers. It is this pressure that, over time, creates highly competitive companies that are able to bring down costs through technological innovation and better management of resources. The inadequacies of Indian financial institutions can be traced at least partly to the forces that restrict competition. 

State ownership of financial institutions is a major factor that inhibits competition. A second factor is restrictions on ownership and shareholding. This applies especially to banks and exchanges, clearing corporations, and depositories. Limits on how many shares an individual can hold and limits on foreign ownership make it difficult for new institutions to be started. This reduces the competition pressure on incumbents, and slows down the pace of development of market institutions. 

In short, the deficiencies in Indian financial markets stem from missing markets and missing actors. The way to address this issue is to open the markets, equalize market rules for all participants, and in removing rules that ban specific players only from certain activities. The second problem is deeper and requires more long term efforts, that of improving the capabilities of financial firms. The way to do this is to increase the competitive pressures in the market ecosystem by removing constraints in the way of entry of new players.

4. A silo model of regulation  and the structure, incentives, and staffing, of regulatory institutions that results in barriers to innovation and competition.

There are 2 factors of consequence here: 

1.  India uses a silo model where financial markets are broken up across 3 agencies: SEBI, RBI and FMC. There are are hard constraints that separate firms and players in one silo from operating in other silos. These constraints reduce competition, hamper economies of scale and scope, and impede the flow of successful institutional arrangements and ideas from one part of the financial markets to the other. 

2. Steep barriers to innovation are in place. New ideas are banned unless explicitly permitted. A great deal of what would be considered ordinary activities in the world of global finance is incompatible with existing laws and subordinate legislation. 

5. Frictions caused by taxes:

Different tax treatment is applied to different types of investments and transactions. Taxation plays an important role in determining the returns generated by trading. When transaction taxes are high, liquidity disappears when the markets go down. 

Suggested reforms:

To achieve true economic benefits, we need:

1. The availability of complete markets where agents are able to trade and hedge all the risks that they need to manage, and the existence of adequate liquidity in all these markets.

2. A regulatory structure that protects customers from fraud, but without imposing undue costs and without creating barriers to entry, innovation, and competition.

The reforms that would achieve these objectives have 3 broad elements:

1. Reforms within existing legal and institutional framework.

2. Capital account liberalization.

3. Merger of regulatory and supervisory functions for all organized financial trading into SEBI and strengthening the legal foundations of market regulation.

4. Implement the Debt Management Office.

I will describe these proposals in the upcoming blog posts.

Link to the previous blog post in this series: A Hundred Small Steps: Part 7

Next blog post in this series: A Hundred Small Steps: Part 9

IT STRATEGY CASE STUDY FOR BANKING INDUSTRY IN INDIA

This case study was prepared as a part of the IT Strategy course taught by Prof. Sanjiv Mehta at SICSR

BACKGROUND:

Industrial Credit and Investment Corporation of India was formed in 1955 at the initiative of the World Bank, the Government of India and representatives of Indian industry. The principal objective was to create a development financial institution for providing medium-term and long-term project financing to Indian businesses.

ICICI Bank was originally promoted in 1994 by ICICI Limited, an Indian financial institution, and was its wholly-owned subsidiary.

In the 1990s, ICICI transformed its business from a development financial institution offering only project finance to a diversified financial services group offering a wide variety of products and services, both directly and through a number of subsidiaries and affiliates like ICICI Bank. In 1999, ICICI become the first Indian company and the first bank or financial institution from non-Japan Asia to be listed on the NYSE.

CASE FOR IT STRATEGY:

Analytic technology was not relevant for the old ICICI but it is now central to the banks growth and success. In the next decade, retail banking is expected to be one of India’s fastest growing markets.  Nearly 70% of the population is under 35 years of age according to the 2003 government census and banking services are a new phenomenon for most of the population.

ICICI is aiming to be in the domestic urban and rural markets where 70% of the population lives and to be the bank of choice for Indian’s living abroad in North America and Europe. ICICI is using analytics and information technology to accelerate new customer growth and manage its risk exposure. It has positioned itself as a high tech innovator with cost effective and convenient banking through online banking, ATMs and mobile phone banking.

 

HOW WAS IT STRATEGY IMPLEMENTED:

ICICI was the first bank in India to offer internet banking. In 2008 ICICI introduced iMobile banking wherein customers connect to the internet using their mobile phones to do transactions with the bank. With the growth in e-channels, branches are now more valuable to ICICI as points of sale for products.

Credit Analytics:

When ICICI created its first in-house analytics team in 2001, there were only 25 analysts whose sole responsibility was to track market conditions and delinquencies. India did not have a credit bureau until 2005, so when ICICI began developing its first predictive models, it had no external source of data on consumer credit behavior. Moreover because ICICI was new to the consumer banking market, it also did not have internal data. Therefore the first in house score cards were constructed without data.

Now ICICI has large internal databases and has refined its internal score cards which are used in credit card services, mortgage, auto and 2-wheeler bicycle lending. Better customer segmentations increase the banks precision and agility in monitoring delinquencies and adjusting credit lines. Segmentations are also used for transactions based target marketing programs and to forecast accurate foreclosure rates. New segmentations are being developed based on consumer behavior rather than static attributes.

Analytics has also been a powerful tool for ICICI to expand pre-approved credit line offers. An ATM based overdraft service for checking accounts is one of the bank’s most novel services. ICICI has also developed scores to monitor the risk behaviors of a single customer across multiple products. ICICI and other Indian banks have an edge over the foreign global banks competing for their slice of the new urban consumer class. The domestic banks advantage is even more pronounced in rural areas. Using technology and imagination, ICICI is coming up with radically different retail services for a radically different client.

Rural Lending:

Rural lending might include loans for growing crops or buying a buffalo as well as for education, health care and mortgages. Because there is no data, ICICI has been creative in characterizing the rural segments. For example, an affluent farmer is someone who purchases hi-tech equipment and has a large land holding whereas a normal farmer owns small plots of land and is often employed by an affluent farmer. ICICI is developing its micro-finance lending for as little as $100 and terms of payment are also personalized. For example, for a farmer it might be adjusted to the milk yield of a single buffalo.

ICICI is constantly investigating other ways to proliferate their banking presence. In fact, one of the key challenges for the future is how to create more convenient and low-cost access points for rural customers. Some ideas include partnering with the Indian postal service to place ATMs within their extensive infrastructure and integrating ATMs with vending machines.

Rural Kiosks:

ICICI has now set up additional partnerships with EID Parry, n-Logue, ITC e-Choupal and BASIX to take advantage of the rural kiosk network they each have established. Each partnership is designed to build on the unique strengths of each organization and to truly leverage their experience and relationships. These partner organizations receive in return the backing of the second largest bank in India to help expand their kiosk network. ICICI envisions setting up many more partnerships with MFIs and NGOs that have the expertise and passion for serving the rural poor.

Rural ATM:

The rural ATM machine, to be placed in the kiosks, is a simplified version of a regular ATM. With a simple interface and multiple languages, the rural ATM will be accessible by all and will be the conduit through which ICICI delivers banking services to the remote Indian countryside. It is currently in development in the lab of Dr. Ashok Jhunjhunwala and is expected to cost a meagre 3000 rupees or USD 600 versus the 80,000 rupees or USD 16,000 that it costs for a normal ATM machine. ICICI envisions placing this rural ATM in the kiosks their partners have already implemented.

Mobile ATM:

ICICI also is investigating the possibility of building a mobile ATM. The ATM machine would be installed in an ICICI-branded truck that would circulate through a number of villages on a specified, pre-determined route. Rural villagers would know when the ATM was coming to their village and would be able to take care of their banking needs on that day. With the mobile ATM, ICICI could serve a number of villages with limited capital outlay.

Smart Cards:

ICICI is also researching the possibility of implementing a smart card based payment system in order to eliminate the costs associated with cash handling. “The two key challenges that must be overcome to extend banking to the rural poor population are elimination / reduction of cash handling and innovation of low cost delivery channels.”  Smart cards effectively harness the technology advances of the new economy and apply it to the old economy. “By combining the features of a handy credit / debit card with the advantages of storage capacity, the smart card provides secure identification, a store of value and an ability to function off line while maintaining an audit trail of all the transactions.”

Smart cards were launched by ICICI in October 2000 by ICICI at Infosys Campus in Bangalore and at Manipal Academy of Higher Education to create a cashless economy. However, many problems exist with smart cards, such as high cost and lack of technological infrastructure for widespread adoption. The high cost is especially amplified at the rural level. However, ICICI is watching closely what BASIX is doing currently with smart card technology to see if it is cost effective and viable.

New Rural Initiatives:

With new initiatives such as rain insurance, venture capital, mobile ATMs and derivatives, ICICI is always testing, rolling out and then scaling up innovative ways to profitably serve the BOP.

ICICI Bank Pockets:

“Pockets” is a new offering from ICICI Bank and it offers all the features of an e-wallet with some additional features as well. 'Pockets' is a mobile application, which can be used to send money, pay utility bills, book movie tickets, send gifts and share expenses. One can use this service even if one doesn’t have an ICICI Bank account. With this app, one can also open a zero-balance account.

The Reserve Bank of India (RBI) is in the process of deciding on payments bank licenses, for which it has 41 applications.

Payments banks can accept deposits up to Rs.1,00,000, offer current and savings account deposits, issue debit cards and provide internet banking.

Explaining the rationale for calling it the ‘first digital mobile bank’, Rajiv Sabharwal, executive director, ICICI Bank said, “We have called it a bank because it can do much more than what an e-wallet does. It can actually function as a bank account. Going ahead, we are going to be adding a lot more features and services that are available in a bank otherwise.”

According to RBI regulations, the maximum amount a consumer can keep in the e-wallet is Rs.10,000. The upper limit on a transaction set by the bank is Rs.5,000.

With Pockets, ICICI Bank plans to target the youth segment and first-time banking customers. Currently, 50 per cent of the bank’s customers transact via the digital medium.

Between April-October, ICICI Bank has recorded transactions worth Rs.7,400 crore on its mobile banking platform.

USP OF IT STRATEGY:

The IT strategy at ICICI has been designed with the end customer in mind. They have tried to penetrate both the urban and the rural markets in India, designing specific products for both. They have been consistent first movers in the segment. They were first to offer internet banking, phone banking and mobile wallets. Their rural initiatives are also pioneering.

KEY OUTCOMES:

A product of India’s liberalization policies in 1990s, today ICICI has come a long way. ICICI is India’s largest private sector bank in market capitalization. It is India’s second largest bank in terms of assets. It is a growing international competitor with presence in 18 countries. In 2000, ICICI’s consumer banking business had a fewer than a million customers. By June 2006, that number had risen almost 10 fold to 9.5 million. Its asset base grew from around USD 2.5 million in 1996 to USD 80 billion in 2006 and to almost USD 100 billion by the end of March 2008. As of 2007, ICICI had a 30% market share overall in retail financing products including credit cards, mortgage lending and personal lending.

FUTURE IT STRATEGY:

Going in line with the customer segments that ICICI has developed, the future IT strategy could be divided into these segments:

Urban Retail Customer:

Analytics on a customer’s credit card spending could lead to a better understanding of the customer behavior and needs, helping the bank design customized credit offerings.

Rewards points on the use of credit cards could be en-cashed through petrol and diesel payment receipts (as is done by CITIBANK.)

Microcredit facilities for school and college drop-out students could help them in starting new business ventures.

 

Rural Retail Customer:

Linkages with AADHAR and RUPAY will help in reducing fraud and also in mobile payments in rural India. Government is experimenting with Direct Benefits Transfer with RUPAY linked bank accounts. This would overcome a significant hurdle in rural banking with regards to payments and receipts.

Investment Banking:

Develop algorithmic trading platforms for automated online trading based on mathematical models.

Develop high speed trading platforms for large organizations to trade.

International Markets (USA and Europe):

Explore the BITCOIN market and study its feasibility as a payment system.

OTHER TOP FIN-TECH DISRUPTORS:

HDFC Bank has started automatic loans processing through the use of machine learning and big data algorithms.

TradeLab (http://tradelab.in/)

Algorithmic trading platform, high speed trading platform and paper trading on simulated market competition

Metamako

Low latency trading platform. Metamako is a technology company that specializes in solutions for latency sensitive businesses. It was founded by Scott Newham, Dave Snowdon and Charles Thomas who have a background in ultra low-latency hardware, software and trading. 

Klarna

Klarna is one of Europe’s leading providers of payment solutions for e-commerce. 
Klarna separates buying from paying by allowing buyers to pay for ordered goods after receiving them, providing them with a safe after-delivery payment solution. Klarna also assumes all credit and fraud risk for e-stores, providing assurance to sellers that they will always receive payment. Klarna’s vision is to enable trust and to offer a frictionless buying experience to buyers and sellers across the world.

Square, Inc.

Square, Inc. is a financial services, merchant services aggregator and mobile payments company. The company markets several software and hardware products and services, including Square Register, Square Reader and Square Order. Using a free credit card reader on their iOS and Android device, Square Reader allows anyone to accept credit cards anywhere, anytime for a low transaction rate per swipe and no hidden fees. Square Register is a full point-of-sale system that allows businesses to accept payments, manage items and share menu and location information. Square Order lets people place orders for pickup from local businesses eg. shops and restaurants.

Kreditech

Kreditech uses big data and complex machine-learning algorithms to serve a simple mission: make faster, better credit decisions. Via its consumer platforms Kredito24 and Zaimo, individuals can apply online, mobile or via SMS and receive funds into their bank account, credit card or at an ATM in under 15 minutes. Kreditech's technology identifies and scores individuals in seconds based on 15,000 dynamic data points. Customers can apply for short or long-term loans and other financial products in seven countries worldwide.

Xero

Xero is the emerging leader in online accounting software, providing business owners with real-time visibility of their financial position in a way that’s simple, smart and secure. At its core Xero is an easy-to-use but powerful online accounting platform designed from the ground up for the cloud, not adapted from desktop software. For advisors such as accountants and bookkeepers, Xero forges a trusted relationship with clients through online collaboration.

REFERENCES:

1. Case study on ICICI Bank by Todd J. Markson and Michael Hokenson, University of Michigan Business School (Research Paper)

2. The Deciding Factor by John Nash and Larry Rosenberger (Book)

3.  Pockets: ICICI Bank’s answer to payments (The Business Standard)

http://www.business-standard.com/article/finance/pockets-icici-banks-answer-to-payments-banks-115021000859_1.html

4. FINTECHINNOVATORS.COM

A Hundred Small Steps (contd. Part 7)

This blog post is in continuation of the previous blog posts on Raghuram Rajan's report titled "A Hundred Small Steps" written in 2008 whilst he was with the Planning Commission of India.

The next section of the report describes " The Macroeconomic Framework and Financial Sector Development."

The section discusses the impact of capital flows and Real Effective Exchange Rate (REER) on the economy in India.

We have published a paper titled "The Impact Of Rupee Exchange Rate on Business Opportunities in India" in the IOSR Journal of Economics and Finance that describes the effects of a rapidly depreciating Rupee as was seen in 2012-14 period.

The paper can be downloaded here: IOSR Journal of Economics and Finance: "The Impact Of Rupee Exchange Rate on Business Opportunities in India"

Link to previous blog post in this series: A Hundred Small Steps: Part 6

Next blog post in this series: A Hundred Small Steps: Part 8

A Hundred Small Steps (contd. Part 6)

This blog post is in continuation of the previous blog posts on Raghuram Rajan's report titled "A Hundred Small Steps" written in 2008 whilst he was with the Planning Commission of India.

The third section of the report focuses on "Creating a robust infrastructure for credit."

Proposal 29: Expedite the process of creating a unique national ID number with biometric identification.

The AADHAR Unique Identification number brings us one step closer to this ideal. However there are serious concerns over the integrity and confidentiality of the data in the AADHAR database as is highlighted in this story from CIO.IN: Reduce your risk by refusing to link AADHAR to any databases.

Proposal 30: The Committee recommends movement from a system where information is shared primarily amongst institutional credit providers on the basis of reciprocity to a system of subscription, where information is collected from more sources and a subscriber gets access to data subject to verification of ‘need to know and authorization to  use’ of the subscriber by the credit bureau.

We could introduce a FICO style credit rating system found in USA with access to credit scores provided to businessess on consent of the individuals' consent. FICO scores are used for setting interest rates on home and car loans for individuals in USA.

Proposal 31: Ongoing efforts to improve land registration and titling—including full cadastral mapping of land, reconciling various registries, forcing compulsory registration of all land transactions, computerizing land records, and providing easy remote access to land records—should be expedited, with the Centre playing a role in facilitating pilots and sharing experience of best practices. The Committee also suggests the possibility of special law courts to clear the backlog of land disputes be examined.

Here I would like to mention an article by Dr. Anupam Saraph in MONEYLIFE on 10 digital solutions that can make India the best governed nation. One of the 10 ideas is to protect the country from land mafia. The suggestion is as follows: 

"There is no public directory or map of all the survey numbers of the 32.87 lakh square km across the 595 districts in the country. There is no account of the changes happening in land use across the country. Land records and property records are not standardized across the country. Requiring that all survey maps be geo-tagged, or their exact location on the district map be shown based on latitude and longitude, and display the survey land-use, ownership details, and any legal issues on a single website survey.gov.in will change the way land use happens across the country. Requiring that the North East point of every property have an official GPS device on it will alert a land use information system of any movement of this point."

Proposal 32: Restrictions on tenancy should be re-examined so that tenancy can be formalized in contracts, which can then serve as the basis for borrowing.

The GPS markers suggested above could be used for unique identification of land plots and these could be coupled unique identities for individuals to generate unique land contracts.

Proposal 33: The powers of SRFAESI (Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002)  that are currently conferred only on banks, public financial institutions, and housing finance companies should be extended to all institutional lenders.

ARCs have additional powers such as step-in rights and the ability to change management, and the right to sell or lease the business. Given these additional powers, it is important that a number of ARCs flourish so that no single ARC has excessive power. There is really no sensible case to keep foreign

direct investment out of ARCs. The kind of risk capital as well as the kind of expertise foreign investors bring is useful in the economy, and can help provide a valuable buffer. From an economic perspective, capital that comes into the country when the banking sector is distressed and a flood of assets are sold to ARCs, is particularly valuable, and foreign investors, not domestic financial institutions, are most likely to be flush with capital at those times.

There are venture capital firms such as Bain Capital that specialize in leveraged buyouts of debt ridden sick companies and turn them around, selling them subsequently for a good profit. Asset Reconstruction Companies should follow a similar business model and there could be potential for growth here.

Proposal 34: Encourage the entry of more well-capitalized ARCs, including ones with foreign backing.

This could lead to better results since a new management model might be what is needed to turn around some these companies and NPAs.

Proposal 35: The Committee outlines a number of desirable attributes of a bankruptcy code in the Indian context, many of which are aligned with the recommendations of the Irani Committee. It suggests an expedited move to legislate the needed amendments to company law.

There is a need for a consolidated bankruptcy law in India, in line with the Chapter 11 in USA. The National Company Law Tribunal has laid certain conditions on bankruptcy proceedings for sick companies. 

The Board for Industrial and Financial Reconstruction established under the Sick Industrial Companies Act also assists in reviving sick companies.

Link to previous blog post in this series: A Hundred Small Steps: Part 5

Next blog post in this series: A Hundred Small Steps: Part 7

A Hundred Small Steps (contd. Part 5)

This blog post is in continuation of the previous blog posts on Raghuram Rajan's report titled "A Hundred Small Steps" written in 2008 whilst he was with the Planning Commission of India.

The second section of the report focuses on "Creating A Growth Friendly Regulatory Environment."

Proposal 20: "Rewrite financial sector regulation, with only clear objectives and regulatory principles outlined. However, such legislation would have to be drafted carefully, as Indian courts are

not likely to look upon excessive delegation favourably (the Supreme Court of India has held that the ‘essential legislative function’ cannot be delegated and a statutory delegate cannot be given an unguided or un-canalized power). What should be left to the regulator is the ancillary function of providing the details."

--There have been a lot of developments in this field since the Financial Crisis of 2008. USA implemented the Dodd-Frank Regulations wherein banks were forbidden from trading with their own money to reduce systemic risks. This has led to reduced economic activity in the financial space but considering the impact of the crisis, this might be the right way to go.

Another important regulation in this area is the Glass-Steagall Act in USA from 1992. This made a clear demarcation (fire wall) between retail banking and investment banking and did not allow the two to mix. This restriction was lifted in an amendment in 1999, just before the dot com bubble burst.

The Canadian banking regulations are also noteworthy since not a single Canadian Bank failed during this crisis and there was no government intervention needed.

Even the Indian banks were pretty resilient at the time of the crisis and the banking system received significant recognition for its resilience.

Proposal 21: Parliament, through the Finance Ministry, and based on expert opinion as well as the principles enshrined in legislation, should set a specific remit for each regulator every five years. Every year, each regulator should report to a standing committee (possibly the Standing Committee on Finance), explaining in its annual report the progress it has made on meeting the remit. The interactions should be made public. In addition, to ensure there are more direct checks on the regulator in a system that is less rule-bound, the Committee recommends Proposal 22.

--This would be like oversight of the regulators. I don't think such a body exists in most countries. At the highest level, regulatory authorities are accountable to the Prime Minister (President) of the country and serve at his / her discretion. They should be allowed to be independent.

Proposal 22: Regulatory actions should be subject to appeal to the Financial Sector Appellate Tribunal, which will be set up along the lines of, and subsume, the Securities Appellate Tribunal.

I don't think the top regulators in USA are accountable to any one other than the President, be it the Consumer Financial Protection Bureau or the FDIC. No doubt, they are subject to Parliamentary investigations and probes if their actions are found to conflict with the interests of the businesses to an unacceptable level.

Proposal 23: Supervision of all deposit taking institutions must come under the RBI. Situations where responsibility is shared, such as with the State Registrar of Cooperative Societies, should gradually cease. The RBI will have to increase supervisory capacity to take on this task. The Committee recognizes this involves constitutional issues but nevertheless recommends a thorough overhaul of the system of shared responsibility.

I think the regulation of financial institutions should be left to the watchdogs like the Securities and Exchange Board of  India. I don't see a reason why this power should fall with the RBI.

Proposal 24: The Ministry of Corporate Affairs (MCA) should review accounts of unlisted companies, while SEBI should review accounts of listed companies.

Whilst the publicly listed companies are under the review of SEBI at present, the unlisted companies are not regulated or supervised. It might be a good idea to have unlisted public companies to be under review of a regulatory agency, but their identification would be very difficult since they are unlisted.

Proposal 25: A Financial Sector Oversight Agency (FSOA) should be set up by statute. The FSOA’s focus will be both macro-prudential as well as supervisory; the FSOA will develop periodic assessments of macroeconomic risks, risk concentrations, as well as risk exposures in the economy; it will monitor the functioning of large, systemically important, financial conglomerates; anticipating potential risks, it will initiate balanced supervisory action by the concerned regulators to address those risks; it will address and defuse inter-regulatory conflicts.

This would be a role more suited for the RBI rather than the that of a watchdog or regulator.

Proposal 26: The Committee recommends setting up a Working Group on Financial Sector Reforms with the Finance Minister as the Chairman. The main focus of this working group would be to shepherd financial sector reforms.

Special Focus Groups are a good means to deal with complex legislative issues and there should be such groups for almost all sectors. They should comprise of a eminent industrialists, academics and a few elected politicians from the Lok Sabha and Rajya Sabha.

Proposal 27: Set up an Office of the Financial Ombudsman (OFO), incorporating all such offices in existing regulators, to serve as an interface between the household and industry.

The subject of ombudsman has been raised by a lot of parties in recent times, prominent amongst them being AAP. This would be a good idea as it would set up a feedback channel from the industry participants to the focus groups and other legislative agencies.

Proposal 28: The Committee recommends strengthening the capacity of the Deposit Insurance and Credit Guarantee Corporation (DICGC) to both monitor risk and resolve a failing bank, instilling a more explicit system of prompt corrective action (see Proposal 3), and making deposit insurance premia more risk-based.

The FDIC insures all deposits of constituent banks and imposes a certain set of regulations in return. We could try a similar model. Also, bankruptcy laws are in the process of being consolidated with the Madras Court Tribunal (MCLT) and other central bankruptcy regulations having overlapping authorities. A consolidated bankruptcy law such as the Chapter 11 in USA is needed in India.

In the next post, I will discuss the next section on "Creating Robust Infrastructure for Credit" from the same report.

Link to previous blog post in this series: A Hundred Small Steps: Part 4

Next blog post in this series: A Hundred Small Steps: Part 6

A Hundred Small Steps (contd. Part 4)

This blog post is in continuation of the previous blog posts on Raghuram Rajan's report titled "A Hundred Small Steps" written in 2008 whilst he was with the Planning Commission of India.

Proposal 16: "Create the concept of one consolidated membership of an exchange for qualified investors (instead of the current need to obtain memberships for each product traded). Consolidated membership should confer the right to trade all the exchange’s products on a unified trading screen with consolidated margining." -This should make it easier for small businesses to register and trade with the exchanges. Fees always act to reduce economic activity for the activity the fee is charged for. Lower fees and consolidation of fees would lead to more economic activity in the space.

Proposal 17: "Encourage the setting up of ‘professional’ markets and exchanges with a higher order size, that are restricted to sophisticated investors (based on net worth and financial knowledge), where more sophisticated products can be traded." -This would lead to creation of niche markets with lack of access for the entire business community. This would not create equal opportunities for all sizes of investors. So it would be difficult to support such a proposal. Such structures are usually seen in dark pools of high speed trading and they have come for considerable criticism from regulatory agencies.

Proposal 18: "Create a more innovation friendly environment, speeding up the process by which products are approved by focusing primarily on concerns of systemic risk, fraud, contract enforcement, transparency and inappropriate sales practices. The threshold for allowing products on professional exchanges (see Proposal 16) or Over the Counter markets should be lower, so that experimentation
can take place." There should not be barriers to entry for new investment products that reduce systemic risk. Trading of collateralized debt obligations (CDOs) or rated covered bonds on home loans as seen in Europe and USA is absent in India. They act as means to finance home and infrastructure loans. Probably such products could be introduced through this mechanism.

Proposal 19: "Allow greater participation of foreign investors in domestic markets as in Proposal 2. Increase participation of domestic investors by reducing the extent to which regulators restrict an institutional investor’s choice of investments. Move gradually instead to a ‘prudent man’ principle where the institutional investor is allowed to exercise judgement based on what a prudent man
might deem to be appropriate investments. Emphasize providing access to suitable equity linked products to the broader population as part of the inclusion agenda." More access for mom and pop investors could conflict the proposal 17 above. I do not support proposal 17 any way.

Next post will be on "Creating a Growth Friendly Regulatory Environment" as has been covered in the report.

Link to previous blog post in this series: A Hundred Small Steps: Part 3

Next blog post in this series: A Hundred Small Steps: Part 5

A Hundred Small Steps (contd. Part 3)

This blog post is in continuation of the previous blog posts on Raghuram Rajan's report titled "A Hundred Small Steps" written in 2008 whilst he was with the Planning Commission of India.

Proposal 11: Free banks to set up branches and ATMs anywhere. "Domestic banks have not had the freedom to set up branches anywhere thus far, and will not have anticipated such liberalization (which was not an element of the RBI roadmap). Given that foreign banks have deeper pockets, experience, and skills relative to domestic banks in rolling out a branching strategy in the newly liberalized environment, the Committee believes it necessary to allow a period of say two years from the announcement of the policy till the liberal licensing policy applies to domestically incorporated subsidiaries of foreign banks." -- I cannot see a reason why banks should not be allowed to open new ATM branches at their will.

Proposal 12: "Allow holding company structures, with a parent holding company owning regulated subsidiaries. The holding company should be supervised by the Financial Sector Oversight Agency (see later), with each regulated subsidiary supervised by the appropriate regulator. The holding company should be well diversified if it owns a bank." -- This was allowed in India till a recent government regulation made it mandatory for holding companies to get a banking license and L&T Holdings was not able to get a banking license. List of holding companies looking for a banking license right now: 23 holding companies looking for a banking license

Proposal 13: "Bring all regulation of trading under the Securities and Exchange Board of India (SEBI). In areas where multiple regulators share concerns about a market (for example, RBI has a legitimate interest in the government bond market), regulators will have to cooperate even after the supervision of trading moves to SEBI." - A single regulator would definitely make regulations clearer and remove any ambiguity from overlapping authorities.

Proposal 14: "Encourage the introduction of markets that are currently missing such as exchange traded interest rate and exchange rate derivatives." This would help exporters and importers hedge their currency risks significantly.

Proposal 15: "Stop creating investor uncertainty by banning markets. If market manipulation is the worry, take direct action against those suspected of manipulation." -- There should be transparency and oversight of market operations to ensure manipulation does not happen. Strict fines could help contain such activities.

Link to previous blog post in this series: A Hundred Small Steps: Part 2

Next blog post in this series: A Hundred Small Steps: Part 4

A Hundred Small Steps (contd.)

This is in continuation of the previous blog post on a Hundred Small Steps where I analyze the 2008 Planning Commission Report prepared by RBI Governor Raghuram Rajan.

Proposal 6: Liberalize the interest rate that institutions can charge, ensuring credit reaches the poor, but require (i) full transparency on the actual effective annualized interest cost of a loan to the borrower, (ii) periodic public disclosure of maximum and average interest rates charged by the lender to the priority sector, (iii) only loans that stay within a margin of local estimated costs of
lending to the poor be eligible for PSLCs.

"The Committee believes that through a combination of transparency, incentives, and eventually competition, liberalized interest rates to the poor can be kept within reasonable limits, and liberalization would enhance, and improve the sources of, credit to the poor."

--I think this has been pretty much incorporated into the system barring the clause that banks borrowing money from the RBI's credit line for lending purposes, have to charge a rate mandated by RBI.

Proposal 7: Sell small under performing public sector banks, possibly to another bank or to a strategic investor, to gain experience with the process and gauge outcomes.
--Disinvestment has been an ongoing theme with the present government as it was with the previous. However, under performing PSUs have not met attractive stock valuations and this would be a concern. The merger of these under performing PSU banks with some of the larger PSU banks could potentially give the government a better chance at getting attractive valuations in public offerings of these PSU banks. The merger could be in the form of a majority / controlling stock holding by a larger PSU bank.

Proposal 8: Create stronger boards for large public sector banks, with more power to outside shareholders (including possibly a private sector strategic investor), devolving the power to appoint and compensate top executives to the board.
--Considering that these boards are majority governed by the members of the public services (such as IAS),  this would be very contentious proposal. Whilst the board has to be share holder appointed, the public sector companies in India are unique in the sense that they are built by and run by the government and not private enterprise. Hence the implementation of this proposal could face significant opposition from the stakeholders.

Proposal 9:  After starting the process of strengthening boards, delink the banks from additional government oversight, including by the Central Vigilance Commission and Parliament, with the justification that with government-controlled boards governing the banks, a second layer of oversight is not needed.
--This would lead to a full fledged privatization of the PSU banks and would not confer any benefits to the PSU banks on the face of it. At present, government is able to infuse large amounts of cash into these PSU banks for priority sector lending and this option would not be available once the banks are fully privatized. These cash infusions are announced during the annual budget speeches.

Proposal 10: Be more liberal in allowing takeovers and mergers, including by domestically incorporated subsidiaries of foreign banks.
--Foreign ownership in the banking sector has been limited to 49% as per the latest budget speech. The overall trend here is in the direction of more liberalization of policy. Full liberalization of FDI regime might take significant more time going by present trends.

Link to previous blog post in this series: A Hundred Small Steps: Part 1

Next blog post in this series: A Hundred Small Steps: Part 3

Right time for a hundred small steps?

"100 Small Steps" is the title of the report prepared by the present RBI Governor Raghuram Rajan in 2008 when he was working with the Planning Commission of India. Link to the report: 100 Small Steps

The report highlights 100 changes that could be made to the present economic system in India to make it more competitive. These changes have been broken down into various categories such as macro economy, leveling the playing field, creating more efficient and liquid markets, creating a growth friendly regulatory environment,  creating robust infrastructure for credit and broadening access to finance.

As this article from NDTV highlights, the recommendations from this report were far from being implemented up to 2013 Report on the progress on implementation of the Planning Commission report "100 Small Steps" 

The businesses are looking for opportunity and the country that can seize this moment and capitalize on the opportunity, will get the next decade of growth and investments coming its way.

In light of this, I think this is the right time for the implementation of the 100 small steps highlighted by Raghuram Rajan in this Planning Commission report  A HUNDRED SMALL STEPS  and shatter the fetters of the Indian economy that has been holding us back for so long.

I will be discussing this report and various points highlighted in this report in my upcoming blog posts.

Proposal 1: The RBI should formally have a single objective, to stay close to a low inflation number, or within a range, in the medium term, and move steadily to a single instrument, the short-term interest rate (and reverse repo) to achieve it.
--On this proposal, I would say that growth should be a concern of the RBI and not just inflation. In a country such as India, where a bulk of oil, coal and gas are imported, there are significant chances of hyperinflation (cost of goods rising due to weak Rupee and expensive imports) and hyper inflation does not reflect upon true growth of the economy.

Proposal 2: Steadily open up investment in the rupee corporate and government bond markets to foreign investors after a clear monetary policy framework is in place.
--On this front, Indian businesses are now allowed to borrow in Rupees under the External Commercial Borrowing route, but we don't have a domestic corporate bond market open to foreign investors as has been suggested here. That would attract significant capital into the country since a large majority of Indian corporation have very sound credit ratings.

Proposal 3: Allow more entry to private well-governed deposit-taking small finance banks offsetting their higher risk from being geographically focused by requiring higher capital adequacy norms, a strict prohibition on related party transactions, and lower allowable concentration norms (loans as a share of capital that can be made to one party).
--I think this has been implemented in a large part with increasing number of new bank licenses being given out.

Proposal 4: Liberalize the banking correspondent regulation so that a wide range of local agents can serve to extend financial services. Use technology both to reduce costs and to limit fraud and misrepresentation.
--This is where Information Technology could play a significant role where secure Information Systems services and infrastructure could go a long way in improving the accessibility to banking services.

Proposal 5: Offer priority sector loan certificates (PSLC) to all entities that lend to eligible categories in the priority sector. Allow banks that undershoot their priority sector obligations to buy the PSLC and submit it towards fulfilment of their target.
--This would lead to more inclusive growth I think.

I will highlight more aspects of this report in my upcoming blog posts.

Next blog post in this series: A Hundred Small Steps: Part 2

End Game in Greece?

The Greek Crisis is looming over the head of the World Economy and speculations are rife about what the Greeks plan to do now.

The $1.1 billion payment that is looming ahead for Greece by the end of this month is going to be the last nail in the coffin that Greece is in right now. By all measures it seems that Greece does not have the means to make this payment. Link to Bloomberg story on this

The Greek situation is akin to the End Game Effect in Competitive Strategy where in, if a game with finite repetitions is in the last stage of repetitions, the participants are incentivised to actually misbehave knowing that there is no other repetition of the game. As an example you can think of football, where you are allowed 3 yellow cards before a red card. There are more yellow cards in the final minutes of play then in the earlier minutes.

Greece is at the end of its game. If it defaults, it goes out of the Euro and gets a separate currency. The currency would probably crash given the state of the Greek economy and you would see an economic crisis worse than the present austerity in Greece. If Greece decides to make the payments, the level of austerity required is unacceptable to the present government. However, considering the finite chance that the devalued currency would aid the Greek tourism industry, Greece would be incentivized to default (End Game Effect).

Such a situation could be avoided if Greece were to undergo a GM style debt restructuring from 2008. When GM was on the verge of bankruptcy and asked for debt restructuring, the government bought a controlling stake in GM. The US Government sold off its stake for a handsome profit after GM was back in the black a few years later.

Greece could ask for a similar debt restructuring from EU to extend its 30 year loans to 50 year loans and reduce the debt payments. In return, EU could get a controlling stake in Greece through a majority vote in Greek Parliament. This could avoid the End Game Effect that has produced the stale mate in present debt negotiations.