Tuesday, September 02, 2014

What to do with failed banks?

Governments in the US and Europe have set their faces against bailouts of failed banks following the crisis of 2007- the Dodd FranK Act in the US prohibits such bailouts hereafter. Yet, as an article in the FT asks: what alternatives do we have?

A time tested-alternative, the author points out, was to merge a failed bank with a strong bank. Banks are now finding out that this can be costly for one reason or another. The huge fine that BofA has had to cough up has to do with the problems at Merrill Lynch and Country which it acquired in 2008 and these problems happened before the merger. This is going to deter future acquisitions and mergers because the amount of due diligence will take too long and will be too costly.

The other alternative, getting banks to prepare living wills  that will document an orderly winding up of a bank when it fails, is proving unworkable so far- in the US, the regulators have rejected living wills prepared by US and European banks. It's no use asking for banks to have contingent capital- this will be very costly and it may not suffice.

So, governments will have no recourse against bank failure other than bailouts. The only answer, which I have urged repeatedly, is to ensure that the problem is manageable when it happens and that is to limit bank size as a proportion of GDP. No policy maker or regulator is willing to touch this political hot potato.


Pradhan Mantri Jan Dhan Yojana

The government's financial inclusion has the mighty backing of the PM. The early success in getting  in 1.5 crore accounts on the first day is no small measure to the PM writing directly to bank heads and (I believe) to lakhs of bank officers.

It is also better thought through than some of the earlier schemes. It's not just about creating deposit accounts- that doesn't attract people or make money for the bank. There is a loan product (overdraft of Rs 5000), an accident insurance policy for Rs 1 lakh and a life insurance policy of Rs 30,000, all of which are revenue generating. The public sector system is also better geared up today thanks to the experience it has had with banking correspondents and mobile technology.

There are problems on the ground. An important problem is multiple accounts being created with different banks. This has to be sorted out. Then, there are problems of communication. Many poor have queued up because they have been told that they stand to be paid Rs 1.05 lakh!

My analysis of the potential benefits of the scheme in an article in the Hindu, A big bang reform that may be spot on.

Friday, August 29, 2014

Modi's Great Leap Forward

It's a big bang reform alright but not quite what the reforms brigade has been clamouring for. The government's Jan Dhan Yojana, an ambitious plan for financial inclusion, has the potential to be a game-changer for the banking sector and the economy. It calls to mind Indira Gandhi's much-maligned bank nationalisation move which helped transform India's economic prospects over the decade of the seventies.

Bank nationalisation helped sweep small savings into the financial system and push up the savings rate from 10 per cent at the end of the seventies to over 20 per cent by the beginning of the eighties. That, in turn, caused the investment rate to double and helped lift India's trend rate of economic growth from 3.5 per cent to 5.5 per cent in the eighties. Bank nationalisation had its problems. The achievement on the lending side has not been as impressive as that on the liabilities side: small and marginal farmers and also small firms do not get the credit they need. The expansion of branches and balance sheets undermined viability in the banking system. But these problems could be dealt with over time as the basis for economic growth had been laid.

Jan Dhan Yojana holds out the promise of carrying forward the unfinished agenda of bank nationalisation. Sceptics again say it will add to the existing stresses in the banking system. The banking system will have crores of accounts that are inoperative.The overdraft of Rs5000 per accoun promised, if extended to the 10 crore accounts targeted, will create NPAs of Rs 50,000 crore.Banks may garner deposits but lending will remain an issue.And so on.

Yes, in the short run, there will be issues. Over the long run, however, the potential for transformation is enormous. The new accounts will not be idle for long. Large amounts of cash will flow in through the Direct Benefits Transfer. These could lead to large amounts of floats in the public sector (which is bearing the brunt of the initiative). Overdrafts will not be given overnight to all. Banks will watch the accounts for six months before doing so. Even if we assume that half the accounts get the overdraft and half of the overdrafts turn into NPAs, we are talking of  losses of Rs 12,500 crore over two or three years. That is bearable.

Once large numbers of people are brought into the financial system, banks will find opportunities and ways to lend. What has been the province of micro-finance institutions and Regional Rural Banks will move in a large way into the commercial banks. Banks already have made some headway with banking correspondents. Alliances with mobile operators should enable to them to leverage mobile banking as well. It is conceivable that Jan Dhan Yojana could just the shot in the arm that the public sector banks needed. Let me qualify this by saying that much depends on whether the moves under way in the finance ministry to strengthen both boards and management in the public sector bear fruit.

The goverrnment's initiative does undercut the RBI's attempts to pursue inclusion through new players such as payments banks and small banks. The RBI had taken the view that not much could be expected of the public sector and that private entrepreneurs were needed to infuse life into inclusion.The Modi government clearly has a different view. In a way, the entire locus of financial inclusion as well as bank governance has shifted from the RBI to the finance ministry. That could well be a comment on the present state of relations between the ministry and the RBI.

Above all, by unveiling an initiative that is quite different from what economists have pressed for urgently, Modi has shown his capacity for out-of-the box thinking- and his willingness to be guided by his grassroots understanding of what is required rather than the wisdom of experts.



Tuesday, August 26, 2014

US, ISIS and the "war on terror"

The gruesome killing of US journalist James Foley by ISIS, the Islamic group which has gained control of big swathes of Iraq and Syria, has given impetus to a rethink of what the US should be doing about the outfit. The US has already bombed ISIS targets in Iraq and has commenced surveillance of Isis positions in Syria. Both US and British special forces are said to have commenced the hunt for the killer of Foley, now believed to be a Briton. The US government has commenced a steady drumbeat of propaganda on the threats posed by ISIS, which is now touted as 'beyond anything we have seen so far', with the US media following suit.

This is beginning to seem like a horrible re-run of America's dealings with the Taliban. The US funded the Taliban and various Islamic forces in its proxy war against Soviet occupation of Afghanistan. After 9/11, the US turned on the Taliban and its ally, Al Qaeda. The US has since been fighting the Taliban (both the Afghan and Pak varieties) in Afghanistan as well as the Afghan-Pak border.

So it is with ISIS. The US, at the very least, turned a blind eye to ISIS which first gained importance in the battle to overthrow President Assad of Syria. Other American allies, such as Saudi Arabia, Turkey and Qatar are known to be active supporters and funders of ISIS. Once ISIS crossed into Iraq and threatened the government of Iraq, the US seems to have had a change of heart. However, while attacking the ISIS in Iraq, it has been reluctant to attack it in Syria because that would mean strengthening Assad. (The Syrian government itself is open to support from any country, including the US, in its bitter war against ISIS).

This is changing fast as ISIS looms begin to larger in Iraq and begins to pose a threat to Kurds. The US, which has portrayed the "war on terror" as primarily one against, Al Qaeda, is now well on its way to creating a new demon to take its place, ISIS. A new front is to be opened on the "war on terror". One head of the hydra has been replaced by another. How has this come about?

Patrick Cockburn offers a compelling explanation:
The "war on terror" has failed because it did not target the jihadi movement as a whole and, above all, was not aimed at Saudi Arabia and Pakistan, the two countries that fostered jihadism as a creed and a movement. The US did not do so because these countries were important American allies whom it did not want to offend.

Saudi Arabia is an enormous market for American arms, and the Saudis have cultivated, and on occasion purchased, influential members of the American political establishment. Pakistan is a nuclear power with a population of 180 million and a military with close links to the Pentagon.


Tuesday, August 19, 2014

RBI's restructuring plan

I was on Bloomberg TV India this morning for a discussion on the RBI's restructuring plan, including the proposal to create an office of COO with the rank of Deputy Governor.

The restructuring plan is facing resistance from employee unions. It is the COO proposal, however, that has attracted the most flak in the media and drawn a frosty response from the government of India. Media reports indicate that the proposal was put up to the board of directors of RBI around the time of the budget. The board of directors of RBI does not have the same monitoring authority as a corporate board; the key entity, when it comes to monitoring, is the finance ministry. It is strange that the RBI did not take the ministry into confidence in the matter before listing the item at the board meeting.

At the board meeting, the finance ministry asked that the matter be deferred since their representatives would not be able to attend. At the next board meeting, the finance ministry made it clear that an appointment of the rank of Deputy Governor would require an amendment to the RBI Act and that somebody of that rank could not be appointed by the RBI governor; the appointment would have to go to the Cabinet Committee on Appointments.

That is not the only problem with the COO post. As media reports have pointed out, it signals that the person occupying the post is no 2 in the hierarchy, so that you have on Deputy Governor who is superior in rank to the others. That is not the tradition  at RBI. Moreover, the perception has gained ground that the post is being created into order to accommodate one particular individual. The perception may not be well-founded. But the very fact that it has gained currency is damaging to the RBI.

There is also controversy over the proposal to facilitate lateral entry into RBI. Nothing wrong with lateral entry. But the case must first be made as to what specialist skills are required and at what level. The RBI spends lavishly on training so that people are ready to take up positions that require special skills. If this is not adequate, there would be room for a specialist from outside. But, as I said, this has to be justified.

The RBI has acquired a certain stature and reputation over the years, in part because it is seen to be a meritocratic organisation. It has steered clear of the sort of controversies over appointments that have bedevilled other public institutions. The RBI must be careful to safeguard this hard-won reputation.


Saturday, August 16, 2014

Raghuram Rajan's father was a spy

I have heard RBI governor Raghuram Rajan's father being described as a 'diplomat' and I have found it rather intriguing because it has never been said that his father was an IFS officer or ambassador. Well, the mystery, at least for me, is now cleared up with Rajan confirming, in an interview with FT,  that his father was an officer in India's intelligence service. ( It appears to be RAW). Rajan is quick to clarify that his father was no James Bond:
It is a topic Rajan discusses rarely, so I decide to be blunt. While growing up, did he know that his father was a spy? He didn’t, he replies, finding out only later. “He used to tell me that John le CarrĂ© got it largely right,” he says of his father’s profession. “You’re just like another bureaucrat, except you’re doing things that other people would find very, very interesting. But it’s not that you’re walking around with a Walther PPK and lovely women . . .  My mother would not have appreciated that.
For the record, Rajan denied any ambition to occupy political office, saying that he plans to get back to academics and focus on India-related research:
My intent has been, and is, to go back to academia,” he says, sketching out a future research agenda on the interplay of markets and democracy, with a particular focus on India itself. The question of what type of country India will become interests him in particular, especially given its socialist heritage and often-ambivalent relationship to the free market. “In India, we say one thing, and we do something else,” he says as we finish our coffee, and place our napkins to one side. “So what are we trying to do as a country? Figuring that out, I think, would also be fun.”

Friday, August 15, 2014

Raghuram Rajan on venal politicians

RBI Governor Raghuram Rajan's Lalit Doshi memorial lecture last week created a bit of a stir. Rajan chose to lash out against crony capitalism and the venal Indian politician:


Even as our democracy and our economy have become more vibrant, an important issue in the recent election was whether we had substituted the crony socialism of the past with crony capitalism, where the rich and the influential are alleged to have received land, natural resources and spectrum in return for payoffs to venal politicians. By killing transparency and competition, crony capitalism is harmful to free enterprise, opportunity, and economic growth. And by substituting special interests for the public interest, it is harmful to democratic expression. If there is some truth to these perceptions of crony capitalism, a natural question is why people tolerate it. Why do they vote for the venal politician who perpetuates it?
Rajan then proceeds to answer his question:
Our provision of public goods is unfortunately biased against access by the poor. In a number of states, ration shops do not supply what is due, even if one has a ration card – and too many amongst the poor do not have a ration card or a BPL card; Teachers do not show up at schools to teach; The police do not register crimes, or encroachments, especially if committed by the rich and powerful; Public hospitals are not adequately staffed and ostensibly free medicines are not available at the dispensary; …I can go on, but you know the all-too-familiar picture.

This is where the crooked but savvy politician fits in. While the poor do not have the money to “purchase” public services that are their right, they have a vote that the politician wants. The politician does a little bit to make life a little more tolerable for his poor constituents – a government job here, an FIR registered there, a land right honoured somewhere else. For this, he gets the gratitude of his voters, and more important, their vote.
What Rajan says is, of course, true. Go to the office of any municipal corporator, MLA and MP and you will see people queuing up for all sorts of favours. The politician dispenses these to win their goodwill. But this is not the only reason that the venal politician gets the vote. The venal politician delivers in other ways as well, by ensuring that various development measures happen in his constituency, whether new investment by the government or private sector, new schools, hospitals etc. The politician is often drawn from the oppressed classes and so the politician has a natural empathy with his constituents. Of course, he enriches himself but, in the process, he does his bit for his people as well. In other words, the venal politician is not as bad as Rajan makes him out to be.

Moreover, the politician is not the only venal character in the system. Businessmen, corporate professionals, lawyers, doctors, accountants- virtually all groups that constitute the upper classes- are venal in their own way. The voter sees the politician at least as being responsive to their needs- and that's because of the greatness of parliamentary democracy- in a way in which other groups are not. The rest can only look after themselves.

Rajan goes on to argue that the voter's dependence on the politician for favours is what keeps the politician from reforming the system, from ensuring better delivery of services: he has a vested interest in poor delivery so that he can then play saviour. That is why, Rajan argues, that direct benefit transfer linked to financial inclusion is so important.Then, the poor have the cash with which they can buy services from the private sector, they do not have to depend entirely on the public sector and the venal politician.

This is true only up to a point: there is only so much cash that the poor can get. There will still be a need to access public sector services, such as healthcare (the private provision of which cannot be bought with the cash given to the poor). It is also worth making another point: the focus on cash transfer and financial inclusion is being driven by the very venal politician on whom Rajan takes aim.

There are many ills in our polity and we need to address crony capitalism. It's a bad idea, however, to start off by condemning the political class.


Modi's independence day speech

Modi's maiden independence day speech as PM was a winner. The PM spoke without a prepared text, he was eloquent, he was passionate and he connected superbly.

The  PM started off on just the right note: he had come, not as PM, but as the prime servant of the  people. He was an outsider to the Delhi durbar. In two months, however, he had had a chance to develop an "insider's view" of Delhi. And what he had seen had given him a jolt. For, there was not one sarkar in Delhi but multiple sarkars within one sarkar. Departments were warring with each other, working at cross-purposes. It made news when he reminded public servants that they should show up on time. The spirit of public service was missing: the right question to ask was not 'what is in it for me' but 'what is in it for the nation'.

There was a lot on character building and serious shortcomings in Indian society. And there were some significant announcements: a plan for financial inclusion, the scrapping of the Planning Commission, a plan to create model villages etc.

The Republic Day is about a grand coming together of the nation. The event achieves this beautifully. The PM's Independence Day has, over the years, should be about the PM reaching out to the nation and sharing his perspective. It hasn't quite met this objective for a while now because that require oratory of a high order. It does appear that this is poised to change with PM Modi.

Wednesday, August 13, 2014

The Economist on Reliance Industries

The Economist had Mukesh Ambani on its cover in a recent issue. It carried an edit as well as a feature on the Reliance group with the edit titled, "An unloved billionaire".

The magazine is generous is handing out bouquets to the group. Reliance invests massively in India unlike other groups which have said they find the Indian environment uncongenial. It accounts for 15% of India's exports. It ventures into areas where other fear to tread and is hugely profitable.

However, the Economist thinks the group needs a major overhaul of governance. For two reasons. One, India is now exposed to MNCs with much better governance standards. Two, the country is "turning against its tycoons." The magazine has a number of suggestions:
There is plenty that Mr Ambani could do to reform his firm. He could adopt global accounting rules, reveal and simplify its ownership and appoint as directors global heavyweights with reputations to lose who can subject Reliance to scrutiny. The company’s shares—like those of many Asian firms—could be listed in America, which has the world’s toughest disclosure regime. To avoid conflicts of interest Mr Ambani could merge his private businesses into Reliance, on terms that are fair to minority shareholders. He could publish details of Reliance executives’ meetings with politicians and officials. He could sell its media assets. He would lose something in personal and political power but gain more through the opportunity to build a more global and more admired business.
One suggestion took my breath away, namely, that the company "could disclose its executives' meeting with politicians and officials." Is there any large company anywhere in the world that does this? If so, the Economist should publish a list of such companies. Also, how many other industrial groups in India have chosen to appoint global heavyweights on their boards who subject these groups to scrutiny?

I am all for improved corporate governance. However, I would like the Economist to enlighten me on which of the major companies in the world, it thinks, are models of governance.