May 27, 2007
India's Wonder Years
It appears to me that we are possibly living through what economic historians of future will refer to as India’s wonder years. Indeed, the Indian economy of the present is on the fast track. High GDP growth, rising industrial productivity, increase in per capita income – the growth process is opening up huge opportunities for its billion plus population. Remarkably, a 9 per cent growth is happening in an environment of moderate inflation of about 5 -6 per cent, lower fiscal deficit influenced by tax buoyancy accompanied by fiscal restraint. Key strengths at this point are the unleashing of the growth momentum, conducive policy perspective, educated skilled workforce and the growing investor interest in India. But the most fundamental difference that makes India special is perhaps the fact that all this is taking place in the midst of remarkable financial stability. Capital adequacy of banks are higher that 12 per cent, way above the mandated 9 per cent, the non-performing assets of the financial sector will make any advanced country proud and the regulatory bodies have proactively addressed the vulnerability concerns stemming from high interest rates and rising inflation.
Wonder years, alas, do not last forever. Some danger is always present just round the corner and history is witness to the fact that due to lack of adequate precaution and foresight ; many nations have messed up golden opportunities and much like the Indian cricket team, successfully snatched defeat from the jaws of victory. Despite all the great news, the economy is not free from risks and lack of caution can at any point of time throw the economy out of gear.
Role of Risk Management
The precise role of risk management is to identify and manage these risks that we encounter throughout the journey. While risks were managed one way or the other by individuals, companies and nations, the scientific study of risk management is still in its infancy , a few tiny decades in the long voyage of nation states. In India, risk management in its independent identity is not even in its teens.
Let us look at the risks facing what could possibly turn out to be the wonder years for India and visualize what we need to do to manage the lurking threats.
Key Risks
The biggest risk at the macro level is the economic imbalance that afflicts the economy right now and threatens to tear apart the democratic fabric of the country. While India has come a pretty long way in reducing poverty, every fifth person on the street may not be having enough to eat, let alone take care of her other basic needs. It is not that these basic needs cannot be fulfilled by the State, but the welfare state so far has done a shoddy job of meeting the basic needs of the masses. Poor delivery system, corruption at all third class democracy with a first class Constitution) all contribute to the income and wealth imbalance. The result is in the poor human development ranking of India in a global setting. The risk: social unrest can lead to political instability and can destabilize the growth process. While one hopes that Government initiatives towards inclusive growth will lead to an improved income distribution, it is high time that corporates pitch in and demonstrate social responsibility in the interest of their own survival, because ultimately business is not independent of society .
The second lurking threat is the source of India’s strength, the capital flows into the country. For the central bank, buying foreign exchange and sterilizing the market can be expensive while non-involvement could threaten the balance of trade by making exports uncompetitive. Sudden reversals in capital flows can have a potentially disastrous impact on the economy. Sustaining investor interest and keeping the growth story intact, therefore, assumes great significance.
A third challenge arises in the services sector , the ‘engine’ behind India’s growth story. The services sector is about to open up to the world as the WTO negotiation on services progresses. The services sector is about to open up to the world as the WTO negotiations on services progresses. In some sectors such as banking, India is globalizing faster than mandated by the WTO. The services sector will face competition from outside world, and it may not be easy to fight giants even on the home turf. Strategy, innovation and a keen eye on risks are the mantras for survival in tough times.
Finally, like a typical growing economy, the real estate sector is seen hectic activity and upward spirals in prices and the asset price bubble in the stock market calls for a close watch.
Better Risk Management Practices
In such a milieu, solid risk management practices make immense business sense. It not only enhances images of companies and attracts investors, it also insulates organizations from internal and external threats. No longer risk management is part of regulatory compliance, it is more about enterprise risk management. Risk management thus is likely to become a necessity of the future, not an imposed burden. A good risk management system will build trust within the organization promoting efficiency and externally, enhance investor confidence. In this context, elevating the visibility of risks and introduction of a risk perspective will assume special significance. The Chief Risk officer will find his feet and shall even be dictating terms. The complexities of the marketplace will demand the best risk practices. Companies of tomorrow will be differentiated by the risk management practices they adopt. The quality of risk management practices will be the ultimate insurance to save yourself and India’s wonder years.
Posted by sunandoroy at 07:41 PM
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May 24, 2007
Financial Sector in India - Efficiency Gains in the midst of Financial Stability
The reform in the Indian financial sector is about one and a half decades old. Prior to that, the Indian financial system essentially catered to the needs of planned development in a mixed-economy framework where the Government sector had a predominant role in economic activity. The financial sector prior to the 1990s was characterised by, (a) segmented and underdeveloped financial markets coupled with paucity of instruments. (b) complex structure of interest rates arising from economic and social concerns , (c) regulation of both deposit and lending rates, (d) a rising burden of non-performing assets. Thus, the government played a large role in deciding who gave and received credit and at what price. The phase was, nevertheless, characterised by significant branch expansion and increased flow of bank credit to important sectors like agriculture, small-scale industries, and exports.
Salient Features of the Financial Sector Reforms in India
The first phase of current reform of the Indian financial sector was initiated in 1992, based on the recommendations of Committee on Financial System (Narasimham Committee). The process has been marked by ‘gradualism’ within a consultative framework.
The main objectives of financial sector reform process in India initiated in the early 1990s have been to: (a) getting rid of the complexities created by excessive regulation with a view to create an atmosphere conducive to the emergence of an efficient, productive and profitable financial sector ; (b) enabling the growth of financial markets that would enable price discovery, in particular, determination of interest rates by the market; (c) providing operational and functional autonomy to the financial system; (d) promoting measures of financial stability, which emerged as an additional objective of monetary policy along with price stability and economic growth; and (e) opening up the external sector in a calibrated fashion so that the domestic sector could withstand the challenges posed by the global financial system.
To the attainment of these objectives, the approach of the Reserve Bank of India towards financial sector reform in India could be summarised by five key aspects :
(a) cautious and proper sequencing of various measures ,
(b) introduction of mutually reinforcing measures, enabling but non-disruptive to the system,
(c) ensuring synergies between reforms in banking sector and changes in fiscal, external and monetary policies,
(d) developing financial infrastructure in terms of supervisory body, audit standards, technology and legal framework; and
(e) taking initiatives to nurture, develop and integrate money, debt and forex markets .
Aspects of Financial Sector Liberalisation in India
Unshackling the financial system from excessive controls constituted an important element of financial liberalisation in India. Removal of these constraints meant a planned reduction in statutory pre-emption and a gradual deregulation of interest rate prescriptions. Accordingly, the complex Structure of administered interest rates has been almost totally dismantled. Prescriptions of rates on all term deposits, including conditions of premature withdrawal, and offering uniform rate irrespective of size of deposits have been dispensed with. Lending rates have been gradually abolished but transparency is insisted upon.
Secondly, reflecting the development of financial markets and the opening up of the economy, the use of broad money as an intermediate target has been de-emphasised, and a multiple indicator approach was adopted in 1998-99, wherein interest rates or rates of return in different markets (money, capital and government securities markets) along with such data as on currency, credit extended by banks and financial institutions, fiscal position, trade, capital flows, inflation rate, exchange rate, refinancing and transactions in foreign exchange available on high frequency basis were juxtaposed with output data for drawing policy perspectives.
Thirdly, there has been a sea change in the functioning of financial markets in India since the onset of financial liberalization. Since the onset of reforms, architectural policy efforts has been initiated in organized financial market spectrum cover the money market, the credit market, the capital market, the Government securities market and the foreign exchange market.
Fourthly, along with the steps taken to improve the functioning of these markets, there has been a concomitant strengthening of the regulatory framework. Regulatory initiatives include consolidation of domestic banking sector; restructuring of Development Finance Institutions; and appropriate timing for the significant entry of foreign banks so as to be co-terminus with the transition to greater capital account convertibility while being consistent with our continuing obligation under the WTO commitments.
Fifthly, the financial sector in India is increasingly being integrated to the rest of the world.
Finally, several efforts at improving the payment system in India has been considerably strengthened with the introduction of Real time Gross Settlement System (RTGS), the Special Electronics Funds Transfer System and the Online Tax Accounting System. Liquidity in the Government Securities Market was enhanced by the introduction of Delivery versus Payment mode.
Performance
Adducing to the success of banking sector reforms, the profitability of banks has shown significant improvement, especially, during the last five years. This may be attributed to improvement in asset quality, better loan recovery, rising non-interest income, and containment of expenditure. Banks have made substantial progress in cleaning off non-performing assets (NPAs) from their balance sheet adducing to various institutional measures pertaining to one-time settlement, debt recovery, asset reconstruction and securitisation, lok adalats, and corporate debt restructuring.
A comparison of India’s financial sector with financial sector performance in other countries reveal that since the initiation of reforms, the Indian financial sector has improved considerably in terms of global benchmarks.
First, due to phased deregulation of interest rates, India has migrated from a country with high interest rates to a country with moderate interest rate.
Second, with the sharp decline in reserve requirements, India has transformed into a country with moderate reserve requirement.
Third, there has also been substantial deepening of financial markets under the economic reform process. Since the early 1980s, globally the number of listed companies in India remained second only to the US.
Fourth, in the 1990s, market capitalisation in India as a proportion of GDP , though lower than the global average, improved significantly.
The Road ahead
In the immediate future, certain issues are going to be important for the financial sector reforms in India. In the Banking Sector, there is felt need for further consolidation to remain globally competitive. At the same time, efforts should be directed towards cost containment is a key to sustainability of bank profits as well as their long-term viability. Diversification into fee-based activities coupled with prudent risk management hold the key to future profitability. International convergence in risk management practices under the aegis of Basel II is likely to lead to an even closer focus on risk measurement and risk management at the institutional level. Over the past few years, the Reserve Bank of India has initiated several steps to promote adequate risk management systems across market participants.
Another crucial issue relates to improving the credit delivery system. The persistence of divergence between the informal and formal sector interest rates in effect has meant that, with deregulation, the formal credit mechanisms have not been able to pierce the informal system. Recent policies have placed explicit emphasis on streamlining credit delivery through a gamut of measures, including, among others, widening the scope of infrastructure lending, revamping the rural credit delivery system by envisaged restructuring of the rural banking segment and widening the scope of priority sector lending.
Finally, the quality of corporate governance becomes critical as competition intensifies, ownership is diversified and banks strive to retain their client base. The RBI has, on its part, made significant efforts to improve governance practices in banks, drawing upon international best practices.
In retrospect, the financial sector reforms in India represent a cautious approach towards increasing efficiency within the framework of overall financial stability.
Posted by sunandoroy at 06:21 AM
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May 21, 2007
India : RBI introduces Credit Default Swaps
In a significant move that can mark a critical shift in india's booming credit market, on 16th May, 2007, the Reserve Bank of India (RBI) issued draft Guidelines on Credit Default Swaps. The draft guidelines follow the RBI's announcement in its Annual Policy Statement 2007-2008 that it would permit single-name credit default swaps (CDS) in India, as part of the gradual process of financial sector liberalisation in India.The RBI said the move to allow the trading of CDS’ followed an increase in the sophistication of the domestic banking sector.
“The risk management architecture of banks has strengthened and banks are on the way to becoming Basel II compliant, providing adequate comfort level for the introduction of such products,” the RBI said in its annual policy statement for 2007-2008.
But it said that because of the complexities involved in the valuation, accounting and risk management aspects of credit derivatives and the “evolutionary skills” of eligible participants, it would limit the range of CDS allowed for now to instruments where the reference entity is a single entity. The contracts traded are also required to be denominated and settled in Indian rupees.
The draft guidelines regulate credit derivative transactions by Indian resident commercial banks and primary dealers. The guidelines only allow parties to enter into 'plain vanilla' credit default swaps, which have the following key features:
Single reference entity only,
which must be an Indian resident;
The protection buyer must be in a position to identify a specific credit exposure which it is hedging, and this exposure may have to be referenced in the CDS;
and The reference obligation and, if different, the deliverable obligation must be rated and denominated in Indian Rupees.
It must be a tradable financial security, a 'fund-based credit exposure' (which should include a loan) or exposure under another CDS or, for inter-dealer trades, a corporate debt security.
Further points to note from the draft guidelines are:
Both cash and physical settlement are permitted;
The 1992 or 2002 ISDA Master Agreement and the 2003 Credit Derivative Definitions (as supplemented) are recommended to document the transactions;
A party may not buy or sell protection in respect of itself or any of its related parties; and
The CDS must be denominated and settled in Indian Rupees.
Any credit derivative transactions will also be subject to the Comprehensive Guidelines on Derivatives published by the RBI in April, 2007. The Comprehensive Guidelines impose obligations on market-makers with regard to the suitability of derivative transactions, which extend to the disclosure of pricing and valuation models, due diligence on the counterparty's authority to enter into the derivative and a statement as to the appropriateness of the derivative for the counterparty.
Links:
- The RBI's announcement in respect of the draft guidelines
http://www.rbi.org.in/scripts/NotificationUser.aspx?Id=3521&Mode=0
- The draft guidelines
http://rbidocs.rbi.org.in/rdocs/content/PDFs/77380.pdf
Posted by sunandoroy at 12:57 PM
May 14, 2007
Banking with the Dabbawalas in Mumbai
The famed Mumbai dabbawallas, who ferry food tiffins to nearly 2,00,000 consumers daily in the city, are increasingly getting into promotion of products belonging to some of the most reputed banks and corporate houses in the country.Sometime back, telecom service provider Airtel had tied up with these dabbawallas to promote their pre-paid cards, new connections and bundled handsets. Now Microsoft India had also tied up with them to offer what has been termed as ‘Asliwala PC Offer’ to promote the benefits of having genuine Windows software.
Mumbai's famed dabbawallas will now offer financial services with hot and fresh meals. The dabbawallas will act as business facilitators for distributing mailers and will also collect the filled-up application forms for opening new deposit accounts.
There are around 5,000 dabbawallas in Mumbai feeding a client base of around 1.25 lakh office goers and 50,000 students every day. These dabbawallas will now not only deliver food, but also essential banking services. Their huge client base has made them attractive as delivery points of financial services.The remuneration to the dabbawallas will be based on a flat-fee structure. They will get Rs 2 per form for distribution and Rs 5 per form for collection of the completed application forms. There will be designated dabbawalla officials who will attest the feedback reports before passing them on to the marketing team of the bank.
Posted by sunandoroy at 12:34 PM
