Wednesday, July 29, 2009

ICICI plan for credit card defaulters

ICICI Bank is never far from controversy, is it? A couple of weeks ago, it made waves when it sent a legal notice to the HR head of rival HDFC Bank for allegedly saying in an interview that she didn't want the ICICI culture to seep into her bank.

Now, ET carries a story about ICICI Bank's plans to recover dues from credit card defaulters by getting employers to deduct specified sums from employees' salaries and remit these to the bank. Apparently, ICICI Bank is inserting a clause into its agreements with credit holders permitting such deductions.

As you can see from the ET website, the move has provoked a storm of outrage and even some downright abusive comments. As one reader has pointed out, such a clause may not be legally enforceable and would certainly require a tripartite agreement involving the employer. Moroever, it's doubtful that the regulator and government will permit such a clause. The move has the potential to create embarassment similar to that caused by ICICI Bank's strong arm tactics to recover housing loans.

For bankers, caution in lending has to be the watchword. Toughness in recovery won't work in this country- it will only create hostility all round. Sympathies are always tilted towards the borrower as they are towards the tenant.

Wednesday, July 22, 2009

Capital requirements for banks

How much additional capital do banks need? The Economist reports on the results of some stress tests:
Based on the estimates used in the American government’s stress tests, the 19 firms involved collectively need to hold minimum core capital of $313 billion. Between the start of the crisis in mid-2007 and the end of 2010, these firms are expected to eat up about $317 billion of capital (with gross losses of almost a trillion dollars offset by core earnings). On this basis, they would need to have entered the crisis with $630 billion to have avoided breaching the floor. That is equivalent to 8.1% of their current risk-weighted assets. The American and European systems actually had a core-capital ratio of nearer 6% at the end of 2007, according to the Bank of England. The Basel rules allowed core-capital ratios to go as low as 2%.

If anything this calculation is generous. Using Bloomberg’s higher estimates of the losses recorded so far, a peak core-capital ratio of nearer 10% would have been needed for the big American banks. And of course losses are not evenly distributed across the system. Citigroup would have needed a starting core-capital ratio in the mid-teens. Using a similar methodology, Switzerland’s UBS would have needed a pre-crisis ratio of about 12% to have avoided hitting the floor of 4% .
If we accept 8% as the core capital requirement and posit an equivalent requirement of tier II capital,we end up a minimum capital requirement of 16%. There will be further additions based on the size of the trading book and for large banks. One thing appears reasonably clear: in about two years from now, we can expect banks to be operating at a capital level of 15-20%. The current capital adequacy in the Indian banking system is 12-13%. Topping up capital to meet the new requirements will be quite a challenge considering that the government is committed to retaining 51% equity ownership.

Tuesday, July 21, 2009

Quotas and quality

Everytime, the subject of quotas for disadvantaged in education comes up, the refrain is that this will undermine 'quality' or 'excellence' in education. We will end up with engineers who can't design bridges properly and doctors who are no better than quacks. This argument was heard during the OBC quota debate.

I argued at the time that the cut-offs for OBCs- of, say, 98 percentile at the IIMs- would still mean that OBC students who got admission were in the top 2% of an applicant pool of over 200,000. This was very high quality considering that your chances of getting into a top B-school in the US are high if you are in the top 10-15% in an applicant pool of 10,000!

Well, we have the benefit now of having had a chance to see how OBC candidates have done. Outlook reports that they have done pretty well in several places:

Outlook accessed records from a few premier institutes—IIT Kanpur, IIM Ahmedabad and two Delhi-based colleges, Hindu and Lady Shri Ram—to gauge the performance of students. admitted through the OBC quota. And the good news is that all these students have fared rather well—a fact confirmed by teachers in
these institutions.

As with other institutes, IIT Kanpur too had implemented the nine per cent quota in the first phase in 2008. Of the total of 564 students admitted through the joint entrance examination, 63 were from the OBC reserved category. And if the average marks (on a grade point average) for first-year students in the general category in a coveted course like B Tech (Computer Sciences) was 7.92/10, the OBC students were not far behind at 7.2/10.......Things are equally encouraging at IIM Ahmedabad, which admitted 17 OBC students in the reserved category out of a total of 297 candidates . All have moved to the second year, and with mostly ‘A’s and ‘B’s.

So much for the concern about undermining quality through quotas. Let me add: if anything undermines quality, it is the capitation fee racket. And what is the neo-liberal answer to that? Let us have market-determined fees so that what happens underhand is legitimised. The argument is eerily similar to that made for legalising drugs. And the consequences of such legitimisation could be as malign.

One problem with legalising drugs is that it renders drug use respectable and that could stimulate demand further. With market-determined fees, your render the politics of exclusion legitimate. There is no pretence of being apologetic about cutting out a large chunk of the population from higher education.

Governance issues at Delhi Metro

Delhi Metro has had more than one big failure. Since its CEO, E Sreedharan, is something of a folk hero, the general response has been to shrug it off as a failure on the part of people down the hierarchy. I had a post on this subject the last time. Again, putting on my B-school prof hat, I would argue that management failures that occur repeatedly or are significant point to governance failures. Sunil Jain elaborates on this point very well in his column in BS in which he also asks for Sreedharan to step down:

... it (the CAG audit of Delhi Metro) points to the novel 50:50 management structure to mean that neither of the governments is in charge, so the company is pretty much run by the management, namely Sreedharan. The company’s board doesn’t even have the token independent director. There appears no standard proocedure for evaluating contracts and several changes have taken place in contracts after they have been won. The CAG talks of testing standards being watered down to meet deadline, of tests being conducted in non-accredited laboratories, of these being done without DMRC staffers being present, and so on. To top it all, DMRC hasn’t kept any records of test reports since it ‘would involve additional expenditure’!

This is a danger we need to be alive to all the time, namely, that an individual can become bigger than the system - and no individual is infallible. It is the system that must loom larger and the individual must always be subordinated to the system. That, after all, is the principle of democracy. Unfortunately, despite enormous evidence to the contrary, there continues to be a strong preference for the dictatorship model in a corporate setting on the ground that it delivers results. It is forgotten that the results are always in the short-term and they arise from storing up huge problems for the future.

Saturday, July 18, 2009

CAG Audit of Delhi Metro

Delhi Metro's iconic CEO, E Sreedharan, tendered and withdrew his resignation in quick time following the recent collapse of a Delhi metro bridge. The CAG Audit of the Metro, tabled a year after it was submitted, is damning in its contents. Although the Audit was of Phase I and not the ongoing Phase II, the report suggests that some of the problems that have arisen at the Metro are the result of flaws in procedures.

A comptroller and Auditor General (CAG) audit report has found that the Delhi Metro Rail Corporation scaled down testing requirements in four contracts as these were falling behind schedule. ...

The report also says DMRC has not been put under direct control of any administrative ministry. “This model,” the report points out, “presents ambiguity relating to coordination and control by the executive government and the proper forum for legislative accountability.”

The bidding process was also found to have flaws: out of 13 “design and construct” contracts reviewed in seven cases, the estimates were revised or approved after the opening of financial bids, the CAG report says.

So, what does the Delhi government propose to do now? I am in no position to comment on the way the Metro is proceeding. But, as a B-school prof, I will say one thing: there is something terribly wrong with a situation where a 77-year old engineer is considered indispensable.

Privatising education

Two phrases to beware of in discussions on HRD policy are 'skill development' and 'public-private partnership'.

To understand why, just take a look at Latha Jishnu's article in BS. 'Skill development' can easily become a substitute for a proper education, going all the way up to a university degree and, worse, it can mean creation of skills with limited earning potential. As for 'public private partnership' or even 'private initiative' in education, it could well mean that the government abdicates its role in education in favour of profit-seeking ventures in education that will, by definition, be non-inclusive in character.

On 'skill development', Jishnu chronicles a recent Delhi initiative:

To ensure that such a lacuna should not reflect on its image as the capital of an economic superpower in the making, it launched the programme for skill development of domestic workers, a programme to turn out trained housemaids for the rich and the burgeoning middle class. And in this endeavour, it had impressive sponsors: the International Labour Organisation (ILO) no less, the Union Ministry of Labour and Employment and the Delhi government, all under the umbrella of the high-sounding National Skill Development Programme.

For the most part, domestic workers are poorly schooled or illiterate and their skill development consists of nothing more than a basic course in how to stay clean and speak well and learn to operate household gadgets. Part of the package is learning how to prepare an ‘urban meal’, serving food in a formal environment and handling domestic pets. All this would help in their ‘career progression’, we are told.

According to figures given by the government the demand for domestic servants is scheduled to grow six-fold to 600,000 in the next five years. That clearly is an underestimation. Even today, the average middle class home in the capital employs an average of 2.5 maids, apart from drivers and gardeners, according to another calculation. In coming years, the socialist republic of India would need, perhaps, two or three times that number of domestic helpers to serve its burgeoning middle class.
The focus on 'skill development' coincides perfectly with the state truncating its obligation to provide quality school education.

There clearly is a vested interest in keeping the system thus. The debate on reforming the system, too, is skewed and dishonest. Those who advocate market-based solutions to the lack of schooling in India refuse to acknowledge that the common school system prevalent in the US, UK and other developed Western countries was vital in nation-building and building egalitarian societies.

All the solutions that are being suggested now, such as education vouchers that would allow the poor to send their children to a private school of their choice — one wonders at the choice that exists between non-functional government schools and profit-making private institutions that are just a notch above them — and the 25 per cent reservation in private schools for the poor are nothing but a deflection from the need to overhaul the grossly divisive and unequal system.

...In the intervening 45 years the gulf has only deepened. But if all of India went to the same kind of schools how would one get the endless flow of domestic helpers

Friday, July 10, 2009

How do we reform Indian banking?

Pranab Mukherjee's budget disappointed reformists and it would have been particularly crushing for advocates of banking sector reform. Not even a token reference to the Raghuram Rajan committee report; on the contrary, Mukherjee jangled the nerves of commentators by hailing Indira Gandhi's nationalisation of banks.

Here again, reformers were being foolish if they expected 'big bang' moves- greater entry for foreign banks or dilution of government shareholding in public sector banks (PSBs) below 50%. No policy maker would like to stick his neck out on foreign banks in the wake of the financial crisis in which the biggest banks have been badly hit. And after Sonia Gandhi's stout defence of bank nationalisation a few months ago, no FM could even think of diluting social control of PSBs.

But, it's not as if banking sector reform only means things like the above. We need to find creative ways of encourage more domestic players without undermining domestic stability. Letting industrial houses into banking may not be advisable but we could tinker with private bank ownership norms so that lesser entrepreneurs can get in.

But, also, as I argue in my ET column, In banking, do what is doable, we have focus on improving governance and management at PSBs. Makes sense because the global economic reality and the domestic political reality together imply that PSBs will continue to dominate the Indian banking landscape in the foreseeable future.

Tuesday, July 07, 2009

Pranab Mukherjee's budget

The market tanked yesterday. I wasn't surprised at all and had forecast a correction in my ET column a fortnight ago, Market rally may prove deceptive.

I based my assessment on two things. One, the $ 5 bn plus FII inflows in the present financial year represented something of a correction to the huge outflow of $11 bn last year. We could not expect this sort of inflow to continue. Secondly, I, for one, have never bought the notion that the Congress or the present UPA is hugely reformist is orientation and that all that it needed to get into reform mode was shake off the Left. Sonia Gandhi retains the leftward leanings of the family and this is duly reflected in the Congress today.

So, I had a few quiet laughs when I saw the commentators and businessmen on TV shake their heads in sadness at the many missing items- fiscal consolidation or even a medium term plan for one, disinvestment, petroleum deregulation, impetus to FDI, labour market reforms, financial sector reform (the Raghuram Rajan report was not even mentioned in passing).

I must mention one distinguished exception to the nay-sayers: Surjit Bhalla, whom one would regard as ultra-reformist. I did a double take reading his piece in BS today. He hails this as the second most reformist budget ever presented after Yashwant Sinha's 1999 budget. I read his piece again thinking this was being said tongue- in- cheek. No, Bhalla is serious. Well, leaving aside the critics on TV, I doubt that that is a claim that even the FM or the Congress would make!

What do I make of the budget? Well, I am yet to put the numbers on a spread sheet and pore over them (which is what I do once the media frenzy dies down). I have just a couple of thoughts for now. One, the budget is true to the Congress manifesto and the broad indications given in the President's speech.

Two, the focus is on providing the maximum fiscal stimulus. This probably reflects the government's view that the 'green shoots' hypothesis is premature, that the global economy will take its own time recovering and that, therefore, the Indian economy's growth momentum is best sustained through as big a stimulus as possible. People fear that this will push up interest rates and crowd out private investment. But private demand for credit is weak, which is why there is huge liquidity out there in the markets, so this fear may prove misplaced.

Three, my guess is that the FM has left the possibility for greater disinvestment proceeds than budgeted and spectrum auction for later in the year. To do this now would detract from the stimulus. So, give the maximum stimulus now and once there are signs that growth is of the order of 7%, push ahead with disinvestment. If this hypothesis turns out to be right, the FM may well surprise us with the fiscal deficit number in his next budget- it could prove lower than 6.8%.

Now, this is not how economists and market analysts view matters. They would have liked some fiscal consolidation here and now and they probably reckon that economic recovery is happening anyway. Unlike most of the intelligentsia (which is not necessarily very intelligent), I have great respect for the instincts of politicians, so I would go along with the FM. If the FM's calculations prove right, it would be quite an achievement.

Wednesday, July 01, 2009

Ram Guha in Nehru Memorial controversy

Historian Ramachandra Guha finds himself in the midst of a controversy at the Nehru Memorial Museum and Library. I haven't seen this reported anywhere and got to know about it only through a debate in ET last week. In the debate, Ram Guha and scholars on his side and Madhu Kishwar and several others on the opposite side aired their views.

I reproduce portions of the two versions below. The question I have is: in matters such as this, is it possible at all establish the truth? How does one do it? You can't have a judicial probe into every single matter- and even then the findings will be questioned. I don't pretend to have solution. If anybody does, please let me know.

Kishwar and company write:
The Petitions Committee of the Lok Sabha had found serious irregularities in the fellowship selections process conducted in NMML in 2004-05 (one year before Prof Mukherjee joined). Mr Ramachandra Guha was a member of the fellowship selection committee and of the sub-committee which did the shortlisting.

Their role has been questioned by the Petitions Committee and by the fact-finding inquiry set up by Dr Karan Singh, the NMML Executive Council chairman. The standing committee of Parliament for the ministry of culture and the Central Vigilance Commission have also asked NMML to take action in the matter. It is following this that Dr Karan Singh suspended the deputy director, N Balakrishnan, pending an enquiry, on 1 May 2009.

It appears that Ramachandra Guha and some others involved as selectors or beneficiaries want to remove Prof Mukherjee to subvert the process of a fair inquiry because they are afraid of being implicated by it. To this end they even launched a campaign in early May 2009 to get Balakrishnan’s suspension revoked.
Guha and others write:
The ET report vilified a senior scholar while disregarding the wider issues raised by 57 signatories to the memorandum to the prime minister, who include such widely respected intellectuals as Rajmohan Gandhi, Sunil Khilnani, Sanjay Subrahmanyam, Sumit Sarkar, Nandini Sundar, Krishna Kumar, and Mushirul Hasan.

These scholars list four objective indicators of the decline of the NMML: (1) The once excellent publication programme has been discontinued; (2) The acquisition of rare manuscripts and oral histories is virtually at a standstill; (3) The once dedicated staff is totally demoralised; (4) The NMML has abandoned its principled non-partisanship by opening its doors to political use and misuse.

The fourth charge is perhaps the most grave. In past times, the NMML was open to all ideological currents. Its vast collections include the papers of Jawaharlal Nehru and Indira Gandhi, but also of such longstanding opponents of the Congress as Dr S P Mookerjee and E M S Namboodiripad.

Will more capital harm banks?

Regulators are determined to impose higher capital requirements for banks in the wake of the present crisis. The rationale to is to make sure that banks are less vulnerable in future than they have proved this time.

Takafumi Sato, commissioner of Japan's Financial Services Agency, questions this approach in an article in the FT:

Suppose stronger regulations make banks issue more equity. Then the capital market will expect greater profits in return, and bank management may be tempted to meet such profit pressure by taking more risks. Was this, however, not the cause of the catastrophe?

Also, bigger capital requirements may induce complex risk-taking. If bankers add simple risks, regulators will notice and request more capital. In order to satisfy both regulators’ demand for a high capital-to-risk ratio and investors’ demand for return on equity, bankers may want to take risks in a sophisticated manner, inventing exotic products and creating a darker shadow banking system.

So, Sato thinks there is moral hazard attaching to more bank capital rather than less. Sato's argument is flawed on several counts:
  • With lower bank capital, equity holders today have less incentive to monitor managers.With higher capital, they will need to be more alert.
  • Also, managers have greater incentive to take risks- payoffs to risky gambles are higher with lower capital and more debt.
  • It's not as if investors' return expectations from banks are cast in stone and they will demand the same returns from banks as they have in the past even when bank capital goes up. Investors in banks will have reconcile themselves to lower returns, treating bank stock on the same par as, say, utilities. As they say, banking will become a more boring sector but a safer one.
Sato is on firmer ground when he writes:
Capital adequacy regulations are a cornerstone in our efforts towards financial stability. They, however, should be complemented by reliable valuation, good risk measurement and proper incentives.
On this, I agree. Higher capital should be accompanied by closer supervision and regulation. Isn't that what all the talk of regulatory reform is all about?