A primer on leadership for Wall Street CEOs

Stan O'Neal, CEO of Merrill Lynch, has had to exit his job following huge losses on the sub-prime portfolio. It wasn't just the magnitude of the writedown- $ 8bn- that appalled the board and analysts. O'Neal was seen to have failed to provide the right guidance- the estimate only a few weeks earlier was of $4.5 bn. This was seen as a poor reflection on risk management at the firm.

O'Neal was also faulted for having approached Wachovia Bank for a possible merger without prior discussion with his board.

These are both failures, all right, but are they big enough to cost a CEO his job? Wall Street's standards, you might say, are exacting. You earn big money as the CEO of a Wall Street firm and you must expect the margin for error to be narrow.

However, as former star analyst Abigail Hoffman points out, others have got away with failures of the same order.

I find it odd and odious that Mr O’Neal has been hounded from office while other chief executives linger on. At Citi, Mr Prince has presided over third-quarter fixed-income losses and a lacklustre share price performance; Bear Stearns, under James Cayne, has stumbled badly; and Ken Lewis, Bank of America’s chief executive, had the wrong people in charge of the investment banking division, where net income fell by $1.33bn in the third quarter.

Hoffman notes that O'Neal had conspicuous success at Merrill:

Mr O’Neal changed Merrill and, in my opinion, he changed it for the better. He diversified the business away from its traditional retail broking focus and oversaw significant profit growth. Net earnings rose 47 per cent last year to a record $7.5bn.

So, why was O'Neal singled out for heavy punishment? Hoffman says the problem was not the failures he ran up recently. It is just that he antagonised people through his cost-cutting and, more critically, failed to pack the board with supporters. As a CEO, you need to perform, of course, but there are other things you need to keep in mind:

Mr O’Neal’s departure was not inevitable. Nevertheless, this squalid incident has lessons for us all. Chief executives must be careful to keep the board on side. And the maxim: “On your way up, be cautious who you step on because you may meet these people on the way down” remains true.

Service quality in London

London. Financial capital of Europe? Yes. Throbbing metropolis? Yes. Great amenities and services befitting an advanced economy? NO- says Sudeshna Sen in today's ET.

there’s nothing I can do to be politically correct about the fact that average customer service standards in London - across the spectrum from banking, hospitality, utilities, telecoms, retail, internet, IT et al - is, to put it mildly, appalling.

And yes, to make another sweeping generalisation, it’s much worse compared to what you get in urban India today — even more in higher end services like telecom or banking. It can take up to two months to set up a bank account, another three weeks to three months for an internet connection, a week to check a faulty phone line, an hour for an order to be delivered in some of the poshest restaurants.

What could be the reason for such poor quality of services? Sen has her hypotheses:

From what I’m able to make out, it has little to do with employees - more with corporate attitude. Service providers here seem to have business models that are all carved in stone, possibly invented in pre-Thatcherite times, and no real new competitors in decades to drive innovation in any segment. Another reason, I’m told, is the European obsession with employee rights has pushed customer rights completely off the map.

I don't believe this is the whole of the explanation. I think the privatization of key services has been a disaster- government monopolies have given way to quasi-monopolies in the private sector. Whereas there is a certain accountability in government, thanks to parliament and the media, the private sector is free to operate as it pleases. No amount of regulation seems to help.

I shudder to think of what we can expect when we in India too make a wholesale shift from government to the private sector in respect of education, health, telecom, banking and the rest.

No certitudes in bank regulation

In today's BS, Shankar Acharya has an article that shows how the certitudes underlying bank regulation in industrial economies have been shaken by recent events. The certitudes were:

first, a nation’s central bank should be accorded statutory independence from government; second, the central bank should be charged with the single (or primary) target of keeping inflation low; and third, all financial trading and intermediaries should be brought under a separate single regulator.

Following the collapse of Northern Rock in UK, the Bank of England could not fend off pressures from government to effect a rescue of depositors. This was after all the tough talk from Bank of England Governor Mervyn King. So much for central bank independence.

As for focusing on inflation alone, the US Fed found itself obliged to cut interest rates in order to maintain financial stability. As for having a single regulator, Acharya rightly points out that there cannot be a uniform prescription for all contexts- you have to see what will work in a given context.

Acharya has some kind words to say about the criticism that RBI has attracted for its efforts to contain rupee appreciation:

Against this background it should be easier to sympathise with the Indian authorities’ recent and somewhat untidy efforts to grapple with the unprecedented surge in foreign capital inflows and their destabilising consequences. The shrill and simplistic critiques of over-zealous “market fundamentalists” are not very helpful. Nor, of course, is blind defence of any and all public regulatory interventions.

A swipe at risk management techniques

Naseem Talib, a former trader, is something of a maverick when it comes to risk management. He has produced articles and books that question the value of many modern tools of risk management. In FT, he takes another swipe at these:

MPT (Modern Portfolio Theory) produces measures such as “sigmas”, “betas”, “Sharpe ratios”, “correlation”, “value at risk”, “optimal portfolios” and “capital asset pricing model” that are incompatible with the possibility of those consequential rare events I call “black swans” (owing to their rarity, as most swans are white). So my problem is that the prize is not just an insult to science; it has been putting the financial system at risk of blow-ups.

I was a trader and risk manager for almost 20 years (before experiencing battle fatigue). There is no way my and my colleagues’ accumulated knowledge of market risks can be passed on to the next generation. Business schools block the transmission of our practical know-how and empirical tricks and the knowledge dies with us. We learn from crisis to crisis that MPT has the empirical and scientific validity of astrology (without the aesthetics), yet the lessons are ignored in what is taught to 150,000 business school students worldwide.

.......The environment in financial economics is reminiscent of medieval medicine, which refused to incorporate the observations and experiences of the plebeian barbers and surgeons. Medicine used to kill more patients than it saved – just as financial economics endangers the system by creating, not reducing, risk

Caste discrimination in Indian industry

Indian industry claims it has no caste bias and that its hiring policies are entirely meritocratic. It uses this claim to oppose caste-based job quotas. The Economist had a feature on the subject largely supporting industry's contention and arguing that quotas would hurt industry while doing little for the underprivileged. Much of the discrimination, the feature suggests, may have to do with class rather than caste:

There is no strong evidence that companies discriminate against low-caste job applicants. Upper-class Indians, who tend also to be high-caste Hindus, can be disparaging about their low-caste compatriots. “Once a thicky, always a thicky,” is how a rich businessman describes Ms Mayawati. Yet this at least partly reflects the fact that low-caste Hindus tend also to be low class; and in India, as in many countries, class prejudice is profound.

Two academics, Paul Atwell, Professor of sociology at City University of New York and Katherine Newman, Professor of sociology at Princeton, contest these claims in a letter to the editor. Their empirical study bears out what those who favour quotas have been saying: caste discrimination may not be overt but it exists and improving the educational credentials of lower castes alone will not be enough.

Our two-year study, which we will soon present, found widespread discrimination against highly qualified low-caste individuals. We sent out 4,800 applications in response to advertisements for graduate jobs in Indian and multinational companies. These applicants bore distinctively upper-caste names, Muslim names and dalit surnames, but were otherwise identical in educational qualifications and work experience.

The odds of a dalit being invited for an interview were about two-thirds of the odds of a high-caste applicant with the same qualifications. The odds of a Muslim applicant being invited to an interview were even worse: only one-third as often as the high-caste Hindu counterpart.

The evidence is solid. Serious policies, coupled with an overhaul of India's education system, a required to overcome this pernicious form of social exclusion. Maybe then the widespread relegation to the bottom of the barrel of India's poorest castes will begin to diminish.

The difficulty I see with quotas in industry is that they will be hard to implement- bureaucrats and politicians alike will be bought off by businessmen and anybody who leans too hard on industry will find it hard to survive in politics- he or she will not be able to access the kind of funds that political surivival requires these days.

A more stable world economy

The world economy is more stable today in the past, it is growing faster than at any time except the 1960s, deep recessions have disappeared in the industrial economies and emerging markets have grown stronger since the east Asian crisis. Facts worth emphasising when there are long faces over the sub-prime crisis in the US and its possible impact on the world economy.

The IMF's World Economic Outlook makes the point that better economic management has helped in a big way- monetary management especially, based on the insights developed in monetary theory, has had huge pay-offs. The WEO does not mention the role of central bank coordination in dealing with economic crises- I believe this too has been a big factor. As a result, central banks are better placed today to deal with the fallout of crises in financial markets of the sort we are facing now and to limit their impact on the real economy.

More on this in my ET column, Good times last longer.

Craze for emerging markets

Investors have rediscovered emerging markets after being burnt in the east Asian crisis. But net inflows into emerging markets as a whole are still lower than their historical highs. That is because the rise in gross inflows has been matched by outflows from emerging markets into other economies.

That was the position until last year. Things may have changed dramatically after the sub-prime crisis. Money is flooding the emerging markets on an unbelievable scale. FT reports:

Brad Durham of EPFR Global, which tracks fund flows, says that of the $29bn (£14bn, €20bn) in net inflows to emerging markets so far this year, 82 per cent has arrived over the past seven weeks, “which is astounding”.

By contrast, during the same period, US equity funds tracked by the group saw outflows of $6.3bn, European equity funds (excluding east European funds) surrendered $6.9bn and Japanese equity funds gave up $3.9bn.

There you have it. Funds are being switched out of industrial economies and into emerging markets. As a result, the price-earnings ratio in emerging markets is at a small premium to that in industrial economies. Macroeconomic conditions in emerging markets are today seen as sounder than before- growth is strong, 50% of global growth was contributed last year by China, India and Russia and foreign exchange reserves of emerging economies exceed inflows into emerging markets, making these economies net creditors for a change.

India is particularly favoured among emerging markets and that must explain the dizzying rise in the Sensex in recent weeks.

Restrictions on capital flows- Sebi proposals

Not to sound boastful but I wasn't perturbed at all when I learnt this morning that trading had been halted after a steep fall in stock prices triggered the circuit breaker. I was awaiting "clarifications" from official sources that would calm the markets. That's exactly what happened. After the PM and the SEBI chairman came on the air, the market recovered to end the day around 400 points lower- a considerable recovery from the fall of 1700 points earlier.

The draft regulations circulated by Sebi, which will become law with or without some minor modifications by October 20, are intended to curb capital inflows into the country. It will do so by curbing the volume of Overseas Derivative Instruments (Participatory Notes), instruments through which foreign investors can invest in India even if they are not registered as Foreign Institutional Investors.

PNs constituted 51.6% of Assets under Custody (AUC) in August 2007, 30% of which had derivatives as the underlying. The RBI has long been in favour of phasing out PNs but the finance ministry was resisting because it didn't want the stock market run to stop. With the kind of rise in the Sensex we have seen in recent weeks, the ministry, no doubt, reckons that a correction is affordable.

Sebi's proposals are as follows:

1) FIIs and their sub-accounts shall not issue/renew ODIs with underlying as derivatives with immediate effect. They are required to wind up the current position over 18 months, during which period SEBI will review the position from time to time.
2) Further issuance of ODIs by the sub-accounts of FIIs will be discontinued with immediate effect. They will be required to wind up the current position over 18 months, during which period SEBI will review the position from time to time.
3) The FIIs who are currently issuing ODIs with notional value of PNs outstanding (excluding derivatives) as a percentage of their AUC in India of less than 40% shall be allowed to issue further ODIs only at the incremental rate of 5% of their AUC in India.
4) Those FIIs with notional value of PNs outstanding (excluding derivatives) as a percentage of their AUC in India of more than 40% shall issue PNs only against cancellation / redemption / closing out of the existing PNs of at least equivalent amount.

So, the idea clearly is to limit investment in the Indian market through PNs. There has always been a problem about the identity of investors holdings PNs. For that reason alone, restrictions on PNs are welcome. But will it help meet the objective of curbing capital inflows? In the short run, yes. In the long run, no, for the simple reason that the volumes waiting to enter India are enormous. Once PNs are barred, we should see an increase in those wanting to register as FIIs.

I am sure the finance ministry and Sebi recognise this. But a breather on the capital inflows is welcome- and the present proposals will provide just that. JP Morgan estimates that the ouflows on account of the unwinding of PNs with derivatives as underlying could be $4-7 bn; the unwinding on account of PNs issued by sub-accounts of FIIs will be even larger. Of course, all this will happen over a 18 month time horizon although it may not be evenly spaced out over that period.

Forex additions this year have been $50 bn- the addition considered comfortable was around $25 bn. In relation to overall capital inflows, the outflows that will be triggered by the Sebi move
will be a minor speed-breaker. International factors remaining the same, it will slow the rise in the Sensex over the next few months. But it does provide some breathing space for RBI in terms of managing the exchange rate- the way things were going, it appeared the rupee would soon touch Rs 35 to the dollar.

In macroeconomic terms, the Sebi move does not amount to much over the long term. It does little to alter the trend towards rupee appreciation. But, as I said, it gives a little time for adjustment to appreciation- and that is exactly what Indian industry needs and can expect at best. Rupee appreciation can be managed, not eliminated.

The combination of a rising stock market and rupee appreciation would have meant capital inflows on an uncontrollable scale. That would have had a severe impact on the Indian economy. The speed-breaker imposed by Sebi is good for the economy. It is also good for the stock market. I think the market will recognise this - and continue its climb.

"Overpaid" US executives

Many think US executives are overpaid but not many would expect the executives to say so. Well, in a poll carried out by the National Association of Corporate Directors, four out of six CEOs or presidents polled acknowledged this was the case, FT reports.

Four out of six chief executives or company presidents polled by the NACD in July and August said the compensation of top executives was high relative to their performance.

Only 2.2 per cent of the nearly 70 chief executives and presidents involved in the survey said compensation was too low, while a third deemed it “just right”.

Their views were backed up by outside directors, with more than 80 per cent of them saying chief executives were overpaid.

“There is an overall realisation that executive compensation is an area that boards and management are struggling with,” said Peter Gleason, chief operating officer of the NACD.

The issue is particularly sensitive because the gap between rich and poor in America has reached its widest point in more than 60 years.

Figures released last week showed the share of national income claimed by the wealthiest 1 per cent of Americans had reached 21.2 per cent – a postwar record – partly because of booming company profits.

This is not a problem that can be addressed by "restraint" among corporate executives- I can't see these guys practising self-denial. It cannot also be solved by boards of directors as they are constituted at present.

There is a fundamental problem with corporate boards- and this includes corporate boards. The "independent" directors are, in fact, chosen by CEOs and are beholden to them for the fat fee and commissions they get these days- in the US, $100,000 is pretty common. The figures I have seen in the papers for Indian boards are an average of Rs 9- 10 lakh. A CEO requests you to join the board and he pays you Rs 10 lakh - do you think many people would question the CEO or oppose the CEO in the knowledge that that would be the end of the goodies they get? Not a chance!

We will have truly "independent" directors only when institutional shareholders get to nominating directors on boards. Then, we will have directors independent of management. Today, the word "independent" is construed to mean anybody who does not have a pecuniary relationship with management. That's not enough- to be independent, a director must not owe his job to management.

A peep into IIM-C's board room

Ajit Balakrishnan, Chairman of IIMC's board, has a piece about a recent board meeting. The board was reviewing proposals for a revamp of the PGP course curriculum.

The interesting thing to me is that not the comments made at the meeting. It is that Balakrishnan has thought fit to share some of the proceedings with his readers. This is hardly typical of boards. The agenda item itself would be "secret". The proceedings would be "confidential". So much that even at supposedly "faculty-governed" academic institutions, faculty have little clue as to what is discussed in their own boards. True, there are faculty nominees on these boards but try eliciting information from them!

I concede that not all matters discussed in the board of an IIM can be shared with a wider audience. But many matters can. And matters related to the strategic direction of the Institute certainly should be shared.

Changes in MBA curricula are a matter of intense discussion worldwide. What IIMC board members and what IIMC faculty have to say on the subject is certainly a matter of public interest. Balakrishnan has rendered a valuable service by giving us a peep into IIMC's board room. Congrats, Balakrishnan- and more power to those who favour greater disclosure rather than less.

Lack of Ph Ds threat to IT industry

Microsoft MD Ravi Venkatesan thinks the shortage of computer science Ph Ds threatens the future of the IT industry, FT reports. I was taken aback at the figure mentioned in the report- just 35 Phds in a year in India compared to 1000 in the US !

“It’s an incredibly urgent and important issue,” Ravi Venkatesan told the Financial Times. “It affects the pipeline of future talent because the teaching institutions aren’t getting enough qualified faculty and, of course, if you really want to do cutting edge innovation in computer science, you’re restricted by the pool of talent out there.”

While Indian companies have until now relied on the difference between Indian wages and those in developed markets to attract business, the strategy is not sustainable, Mr Venkatesan said.

“It’s inevitably a matter of time before these wage disparities disappear and the only thing that’s going to matter is the quality of ideas coming out of an employee,” Mr Venkatesan said.

Fashions in bank regulation

Until the other day, the ruling wisdom was that it makes sense to separate the conduct of monetary policy from bank supervision. Combining the two roles, as the RBI does, is folly, we were told - among other things, there could be lack of focus and conflict of interest in doing so. The British separation of the Financial Services Authority from the Bank of England was held up a role model and the RBI was portrayed as being cussed in resisting any separation of roles.

That wisdowm is being turned on its head in the wake of the collapse of the British bank, Northern Rock. Now, we are told that the collapse could have been averted but for the fact that three players were involved- the UK Treasury, the BoE and the FSA- and none of them regarded as its primarily responsibility to avert disaster. Here is a sample from a comment in FT

It is, incidentally, worth noting that compared with the problems of mounting and co-ordinating a last resort lending operation to a big multinational bank, a Northern Rock bail-out should have been child’s play. But the tripartite division of responsibility between the Treasury, the Bank of England and the FSA has become the Bermuda triangle of the British financial system.

Evidently, fashions in bank regulation keep changing as they do elsewhere.

Lean times for Indian economy gurus

Swaminathan Aiyar has a piece in today's ET on how the mystery underlying the growth of the Indian economy. He says it is not clear why India should be growing at an average rate of 8.6% in recent years when there are still so many negatives in the scenario.

A different way of putting this would be to say-as I have been saying for long- that economic pundits have simply been wrong about the Indian economy. They warned us that there was no way the Indian economy could grow at 8% plus without "reforms". Many of these reforms have not been implemented or implemented in full. But that has not kept the economy from growing.

Aiyar mentions several hypotheses that attempt to explain the Indian economy's performance- "tipping point" or the cumulative effect of past reforms, steady improvement concealed by external shocks such as the east Asian crisis or the IT bus, the revival of manufacturing, the global boom. He is not sure they adequately explain the outcome. In particular, governance remains weak and the fiscal deficit is disconcertingly high.

I have never bought the governance thesis- that shifting coalitions or even political instability can be a growth inhibiting factor. Look around and you will find countries wracked by insurgencies doing quite well in terms of economic growth- Sri Lanka is a striking example. The fiscal deficit may be high in absolute terms but the trend towards improvement is unmistakeable.

I happen to think that the biggest factor in the improved performance of the Indian economy is the increase in savings and investment rates. The savings rate has risen by nearly 10 percentage points over the past decade. Fiscal improvement has been an important factor underlying the increase in the savings rate. Fiscal improvement, in turn, has been made possible by falling interest rates. And lower interest rates are the result of huge foreign inflows.

Why have foreign inflows risen so fast? Remittances have risen sharply after the exchange rate became market determined and hence it made sense to remit money through official channels and not through the havala route. FII flows have shot up as the stock market was modernised and foreigners realised that here was an economy that had grown at over 6% for two decades and would grow even faster. FDI has risen for the same reason. Falling interest rates have also boosted corporate profitability and corporate savings.

When an economy of India's size shows sustained growth, it becomes a magnet for global savings. Once the savings start pouring it, domestic savings rise because of the impact on the fisc and corporates of falling interest rates. The momentum imparted to the economy is sufficiently strong that it does not require "second generation" reforms. That's bad for economic pundits- they are left with little to preach. But it's just fine for the economy.

Would we have been even better off with a further dose of reforms? No- and here I think the political class got it right in preferring to move gradually. More reforms would have been socially disruptive- vocal segments would have been alienated and that would have created serious governance issues. The trick was to recognise the trend towards improvement and let the economy be. In this the politicians were right, the pundits wrong.

I have said this before: the performance of the Indian economy is ultimately a tribute to the democractic process and a warning against setting too much store by experets.

Why can't the media get its facts right?

Today's Indian Express carries an interview with outgoing IIMA director Bakul Dholakia. The report carries the following item in a box:

No three-month extension for Bakul

IIM-A directors have always been given three-month extension after the expiry of their term. This was done to facilitate the handing over of the charge process to the next director, as the selection process for the same is a time-taking affair. For Prof Bakul Dholakia, however, October 9 is the last day of his term as also his last day in office. Sources in IIM-A said the chairman of the governing body of IIM-A, DrVijaypat Singhaniya, had written to Union HRD Ministry seeking an extension of Bakul's term until the next director is appointed.

It has been learnt that an "explicit" communiqué has been issued to Dholakia to hand over the charges on the last day of his term

The report is factually incorrect. In 2002, the then outgoing director too was asked to hand over charge the day his term expired. If the suggestion is that Prof Dholakia is being single out for special treatment by the MHRD, that is completely erroneous.

In previous rounds, yes, there were occasions when the director's term had got extended until the appointment of his successor but not all the time.

Leaving aside the historical record for the moment, isn't it a good idea to have fixed terms for such positions? Is it not a healthy practice for the director to step down when his term expires and for somebody else to hold temporary charge till the new director takes over? IIMA and its governing council should have instituted this practice on their own in the interests of good governance- that is the least one expects of the nation's top business school, many of whose faculty have made careers out of preaching governance to the rest of the world.

If they failed to do so and if the MHRD has now instituted an altogether healthy practice- of adhering strictly to the a director's term limit- then the ministry surely deserves bouquets, not brickbats.

Illusory surge in FDI

I remember an interview with P Chidambaram sometime ago- as I recall, he was being interviewed by an Indian business channel and the interview was in London. He was asked whether the opposition to reforms was not coming in the way of greater foreign direct investment (FDI) into sectors such as insurance. Chidambaram said he wasn't too worried because largely flows of FDI were happening anyway. If lack of progress on reforms made it difficult for foreign investors to enter some sectors, "so be it".

There is a certain smugness, I notice, about FDI since the official figures place FDI at $16 bn. As a proportion of GDP, FDI in India would today not compare unfavourably with China's. I have been taking a close look at the numbers and I find that nearly $ 8bn of FDI is private equity. Now, private equity is not the same as firm- or MNC- related FDI. It is in the nature of secondary market investment, with no immediate addition to capital stock or jobs.

Now, it's true that FDI from MNCs is also mostly of the secondary market variety, as it happens through mergers and acquisitions. But there is always the prospect of additions to capacity down the road, infusion of technology and export linkages with the parent. With private equity, you have a ruthless focus on efficiency- and this often takes the form of asset-stripping and paring of jobs- but the other benefits that arise from MNC FDI are not there. Much of the private equity flowing into India has gone into the services sector,including real estate. It is more akin to stock market investment with the prospect of additional gains from an appreciating rupee.

Take away the private equity component and changes in accounting practices in relation to FDI and the figure of FDI in 2006-07 falls to $5 bn. It does seem that the hype over FDI in India is misplaced. More on this in my latest ET column, Are FDI flows into India for real?

Investment banking losses

Banks and investment banks are unlikely to go under in the present market crisis but their earnings are bound to take a hit.

Deutsche Bank and Merrill Lynch are the latest additions to a growing list of investment banks hit by losses in fallout of the sub-prime crisis. Earlier, Citigroup, UBS and Credit Suisse all had issued profit warnings. Lehman is among the few banks to have weathered the storm better than expected. The losses are in billions of dollars and heads are rolling merrily.

The sources of loss in banking are the following:

• Direct losses from exposure to sub-prime securities
• Loans for takeovers that have ended up on the books of banks- this will require higher allocation of capital and the terms on which these were negotiated are unfavourable in the changed context in which interest rates have shot up
• Fee income from structured products will decline
• Private equity income will be hit
• Interbank financing costs are higher, this will impact margins

How to ride out the storm? Having a large retail base helps. Also, equities have risen and this may compensate for weaker fixed income markets. Banks will also look to boost income from emerging markets- this may well explain the surge in flows into markets such as India and the boom in the Sensex in recent weeks.

Celebrity woes!

I read this with some disbelief and I hope the report I saw is correct. Newly crowned Vishwanathan Anand was quoted ( sorry, I forget which paper or website) as saying that he wanted to see what sort of crowds he would attract when he returned home. He said he had heard about the rapturous welcome accorded to the Indian cricket team after their T20 win and he wanted to see how he would be received. (Reader Guru has since provided the link to TOI- http://timesofindia.indiatimes.com/articleshow/msid-2416546,prtpage-1.cms)

I am sympathetic to the hockey players being deprived of cash rewards after their Asia Cup win but I thought Anand's remarks were rich! Anand takes home $400,000 as prize money, so he isn't exactly financially deprived. As for the crowds any winner draws, doesn't that have to do with the popularity of a sport? Like so many Indians, I rejoice in Anand's win but, sorry, I am not going to be able to show up at the airport when he arrrives.

In defence of Northern Rock

I commented earlier on the Northern Rock debacle (the UK bank that went under recently)- I mentioned how the reliance on capital markets for funds had proved the bank's undoing.

In the latest Economist, its chairman offers a spirited defence. He argues that the conventional wisdom has been that as long as a bank's loan portfolio is good, funding is always available. Northern Rock maintained a high quality of loans. So there was good reason for either the wholesale markets or retail depositors to desert it. For no apparent reason, the capital markets decide one day that they are not in a mood to take risk. Boom!- there go the institutions that had accessed funds from capital markets.

Northern Rock's strategy was at all time transparent to the market and to the regulator. Our lending was and is prudent. We have half the industry average of arrears and no subprime loans. To manage liquidity risk, our funding is deliberately diversified, both geographically and between four funding streams—retail, wholesale, securitisation and covered bonds. Of the non-retail funding, less than 20% has a shorter term than the average three-year duration of a mortgage on our balance sheet.

We were repeatedly advised that liquidity in wholesale markets depended on lending quality: good loan books would continue to attract funding when bad loan books began to default. Instead, from August 9th, liquidity has dried up across all wholesale markets, making no distinction between loans of different quality, for much longer than even the most extreme forecast. In America and Germany, where many subprime loans have ended up on banks' balance sheets, the liquidity crisis has been managed smoothly, whereas in Britain, with low arrears, a bank with a high-quality loan book nonetheless found itself in a situation where its retail depositors temporarily felt threatened.

Northern Rock's Chairman has a point. But his bank's debacle only highlights a shortcoming in the present way of managing risk. Capital in a bank is viewed as a cushion against as a defence against loan deterioration, most of the focus is on managing credit risk or market risk. But banks have not been adequately mindful of liquidity risk. You really cannot have capital to take care of liquidity risk, you will need lines of credit for contingencies of the sort that Northern Rock faced. The management of liquidity risk is an area that will preoccupy regulators and banks alike in the near future.

Some reciprocity, please

US banks are itching to get into India. Senior US officials make it a point to lecture India on the virtues of opening up the Indian banking sector even more to foreign banks. The RBI has plans to liberalise entry further post 2009.

There is a vexatious issue involved here that can't be wished away. Most industrial economies are reluctant to allow Indian banks into their turf for one reason or another. They do not believe in reciprocity in this area. The soundness and management of Indian banks was an issue for long. Now that Indian banks have proved their mettle, the issue is money laundering and terrorist funding. As Indian Express reports, the Indian security establishment's warnings that Indian financial institutions are vulnerable to terrorist groups has now provided a convenient handle to the US treasury.

There are some who advocate unilateral opening up of the Indian banking sector- they contend that we benefit from unilateral liberalisation. They have a point but how far do we go?

Finance minister P Chidambaram had to do some tough talking in the US on this subject recently.

Chidambaram told the US team that India would have to review its policy if ndian banks aren’t allowed to open branches in the US. While there are 52 branches of US banks in India, including 19 opened in the past four years — four branches of US banks have been approved in Tier II cities this year — Indian banks have just around a dozen branches in the US.

........Chidambaram emphasized that Indian Banks were Basel II (international standard to safeguard solvency and market risks) compliant and the Money Laundering Act was in place to guard against any questionable transfers.