Goldman Sachs under fire

Goldman Sachs has been, at some point at least, a much admired firm. But it has come under heavy fire in recent months, as reputations in banking and investment banking have tumbled following the sub-prime crisis. The firm's stellar second quarter performance has done nothing to diminish the criticism. If anything, talk of record bonuses has infuriated people even more- the talk is that average pay at Goldman this year could touch a million dollars.

I wrote about this phenomenon in my ET column, Goldmine Sachs is an illusion. On the face of it, Goldman's performance looks impressive. It has increased return on equity while reducing its leverage by half and reducing its dependence on proprietary trading. But, then, Goldman today is a bank fully backed by the Fed. Its borrowing costs are surely lower than what they would be if it did not have an implicit central bank guarantee.

In return for the guarantee, the central bank is entitled to lay down capital requirements and other regulations for Goldman. Goldman's tier I ratio of around 13% is way above the Fed's requirement of 6%. But that is only because the regulatory requirements are far too low and are yet to be revised upwards. Capital requirements for banks will rise, even more so for banks with trading operations and for systemically important banks such as Goldman. The key question is what sort of return on equity Goldman can show after higher regulatory requirements kick in.

I argue that abnormal returns on equity such as the one Goldman showed this quarter (23%) arise not just from inadequate capital requirements but also from other market imperfections. There are others who argue that Goldman was close to imploding like Lehman and was saved only by its alumni ensconced in the corridors of power in the US. They cite the bail-out of AIG and the form it took- cash payments to counter-parties of AIG- as proof.

There's been a huge outpouring of venom towards Goldman. The most recent one is in New York magazine. The earlier celebrated diatribe appeared in Rolling Stone magazine.

Meanwhile, FT reports that Goldman's reputation has been tarnished by recent events.

In a survey of 17,000 Americans, Brand Asset Consulting found that Goldman’s stature – as measured by several gauges of brand strength – had suffered in 2008 and 2009.

“Goldman Sachs still has that Gordon Gekko look to it among the general public,” said Anne Rivers, who oversaw the survey, referring to the villain of the 1987 film Wall Street.

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.

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.

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.

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

<>

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.

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.

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?

Of awards and encomiums

Trying to work out which banks are the world's best is a bit like awarding the prize for the prettiest war-torn village. It is a title that carries little kudos. It is also likey to prompt further shelling. Winners of industry awards in the past three years include Ken Lewis, the chief executive of Bank of America for banker of the year (2008); Societe Generale for its risk management; and Angelo Mozilo of Countrywide, a failed mortage lender, for a "life-time of achievement"

- The Economist (May 23)

I am reminded of a terrific quote from Martin Wolf, FT''s economic pundit, "Those whom the gods wish to destroy, they first put on the covers of business magazines".

But why blame business chambers and the media alone for idolising the wrong guys? Remember the best-selling book by McKinsey gurus, Peters and Waterman, In search of Excellence, that identified companies that had got it all right? Within a few years of the book's coming out, many of the famous names in the book that had been held up as role models were in trouble.

Alan Greenspan was hailed as the ultimate central banker and was the subject of more than one gushing biography. Today, he's among those held primarily responsible for the global crisis.

Moral: Be careful whom you lavish praise on, be it a company or an individual.

Slavery- fresh links

Rothschild, the British investment bank, and Freshfields, a top law firm in the UK, are the latest prominent names to be linked to slavery through archival research, FT reports.

Determining Britain's links to slavery is important because it's not entirely true that innovation and the industrial revolution drove British and western growth and caused them to surge ahead of the rest of the world, including China and India. Slavery, with all its underlying brutality, was a factor although how much of a factor it was is contentious.

FT quotes a Britsh academic as saying, "“We need to fill the gaps between those who deny slavery’s role and those who believe Britain was built entirely on the blood of slaves. "

A book based on updated research is required methinks.

Conflicts of interest in academia

I wrote earlier about b-schools and their alleged role in the crisis. One complaint about b-schools is that they don't inculcate the right values in their wards- I have made it clear this is not something I take seriously. Another is that the ideas that came out b-schools are flawed- the glamourisation of financial innovation, the myth of market efficiency and so on. But these ideas didn't emanate from b-schools alone, you might fault the economics profession at large, including the famous Chicago school.

Devesh Kapur, writing in FT, has a more interesting view. He says that academics have developed a vested interest in pushing certain ideas- and suppressing others- because they stand to gain financially in the process. In other words, academic research is susceptible to considerations of pecuniary gain, just as doctors' prescriptions in the US and elsewhere are driven by gifts of various kinds, including stock options in pharma companies.

Many academics, particularly those from institutions that enjoy high prestige and reputation, now have serious business interests and an array of financial ties to the very institutions that their studies address. These interests range from lucrative speaking fees, advisory roles at financial institutions, managerial roles and stakes in private equity and hedge funds to corporate non-executive directorships.

.....There would be little chance of being invited to give a lucrative talk at Citicorp if one were in favour of sovereign debt forgiveness in the 1980s, against capital account liberalisation in the 1990s or against stock options in the 2000s..

...In recent years, the biological sciences have moved considerably to ensure greater transparency where there are potential conflicts of interest between research and financial remuneration, providing mechanisms for whistle-blowers to report conflicts of interest. Regrettably, these requirements are extremely weak in the social sciences and business schools.

There is something to what Kapur is saying. I am not sure, though, that industry and other links influence academic research in economics and business but they certainly seem to influence academics' positions on various issues of public policy, especially in so far as they impact on business.

For instance, there has been much comment about the huge fees earned from financial institutions by Larry Summers, an influential figure in the present Obama administration, and whether these are impacting on the administration's approach to solving the crisis. Academics who take positions that threaten the interests of corporates certainly stand to lose out on consulting and other sources of income and may even be denied visibility in TV and other media.

There is a more serious problem with academics sitting on boards and this has to do with governance more than research. As we saw in the Satyam episode, academics are not above using their board positions to earn consulting fees. There are other instances where academics sitting on boards have wheedled training programs out of the companies. This introduces serious conflicts of interest. Sebi must impose a ban on independent board members earning any kind of consulting income from companies with which they are associated.

Addressing the too big to fail problem

In my last post, I highlighted that central banks and regulators have begun to focus on this issue with renewed interest.

In its Financial Stability Report, the Swiss National Bank suggests three ways in which this problem can be addressed:

There are three basic strategies for resolving, or at least alleviating, the ‘too big to fail’ problem. First, one can impose very strict capital and liquidity regulations on systemically important financial institutions. This can reduce both the likelihood of government assistance being required and the cost of such an intervention. Moreover, strict capital requirements reduce moral hazard, by forcing banks to themselves bear more of the risk of losses, and also reduce the banks’ incentive to inflate their balance sheets. ...

Second, one can adapt the legal framework and the financial market infrastructure to simplify, or make possible,an orderly wind-down of large financial institutions during periods of severe crisis.
......
Third, one can directly tackle the cause of the ‘toobig to fail’ problem by limiting the size of financial institutions. One could consider direct size restrictions, forinstance by imposing a maximum market share or balancesheet-to-GDP ratio, or indirect incentives – as mentioned
above – such as increasingly strict capital requirements for big banks.

Banks- too big to manage?

Governments the world over have rescued banks that are too big to fail- Citibank and Bank of America in the US, RBS and Lloyd's in UK. One fall out is that regulators and central banks are actively contemplating measures to prevent banks from growing beyond a certain size, FT reports.

This is what the incoming head of the Swiss National Bank has to say:

“A size restriction would of course be a major intervention in an institution’s corporate strategy,” Hildebrand, the central bank’s current vice-chairman, observed with masterful understatement. “Naturally the SNB is aware that there are advantages to size. [But] in the case of the large international banks, the empirical evidence would seem to suggest that these institutions have long exceeded the size needed to make full use of these advantages.”

But what would be that size? How do you operrationalise this concept? I haven't seen any concrete ideas on this. I guess one parameter could be the recapitalisation cost as a percentage of GDP in the event the bank fails. But this only leads on to another question: what percentage of GDP? There cannot be an absolute limit across all countries. Much would depend on an economy's fiscal situation. An economy where the fiscal situation is good could afford a failure that costs, say, 15% of GDP. Another- like India's- may not be able to afford even 5% of GDP.

But this creates a piquant situation. Larger economies can afford bigger banks. So can well managed economies. In other words, the size of the economy and the fiscal situation become determinants of competitive advantage based on size.

Should we worry? I don't think so. Because beyond a point, size ceases to confer any big advantage and, in fact, becomes a problem. In India, I would say that any bank with a balance sheet of around Rs 150-200,000 crore has the requisite size to take on competition. For the regulator, the problem is: too big to fail. For bank managers, the focus should be: too big to manage.

That's why I am not enthused by talk of SBI merging with all its associate banks. Is SBI getting the most out of its current size? Does it have the necessary depth and breadth of management at its current size? If not, HRD and systems should be focus, not simply getting bigger.

B schools and the global crisis

This may seem a bit surprising but B-schools have emerged, in popular perception, as among the culprits in the present economic crisis. People think managers are to blame. Some of the high-profile managers in the crisis- Hank Paulson, former US Treasury Secretary, Christopher Cox, former Chairman of the SEC, John Thain and Stan O'Neal- are all HBS products. The conclusion drawn is that B-schools bear some responsibility for the crisis. Whether this is true and what needs to be done is the subject of my ET column, Crisis:are B-schools to blame?

Surprisingly, this view finds acceptance among b-school academics themselves. FT is running a debate on the subject and so is the Harvard Business Review. I must confess I find much of the discussion lacking in substance.

Let us grant that irresponsible managers have had a role to play in the crisis. Partly, this was a matter of bad judgement; partly, it was greed or lack of regard for the stakeholders in a business. Where do B-schools come in? You could say B-school research failed to pick up the warning signs of the crisis. But so did economic research outside B-schools. As for the greed factor, it is not confined to managers but is rampant in every walk of life- law, medicine, accounting, etc. Amongst greedy or corrupt managers, managers with MBAs are a tiny subset.

So, what can B-schools do in terms of revising their curricula? Well, there is a huge debate going on about the relative roles of state and market and, no doubt, B-school research will focus on this and weave findings from this research into revamped curricula. This is fine. The thing that disturbs me is the suggestion that B-schools also have a role in inculcating superior attitudes or ethical values in their students. HBS's contribution is to get their graduating MBAs to take a pledge or oath of ethics!

B-schools have responded to talk of their role in the present economic crisis with courses on ethics and leadership. No problem with that. But, one has to be sceptical about what to expect. To those who wish to create the New Man, I wish luck. I doubt that B-schools can contribute much. There are primary and secondary schools that were set up by saintly figures and began with similar, lofty goals but whose products are indistinguishable from those produced by ordinary schools.

Don't get me wrong.There is a hell of lot that B-schools need to do by way of updating their curricula and make it more relevant. But improving the ethics of their wards is not something that falls within B-schools' core competence. At the risk of offending people, I would suggest that there is a certain presumptousness involved in setting such goals. I mean, who's going to impart ethics to B-school faculty?

TN medical college expose

A TV channel catches the Deputy Registrar of a medical college in Tamil Nadu asking for capitation fee on camera. The HRD ministry, duly outraged, sets up an enquiry. The UGC also jumps in with its own probe. The minister, who is said to be chairman of the board of trustees of the college, dissociates himself from the medical college.

I don't know how one is supposed to react. It's good to have this sort of thing exposed but is it news to anybody? Two facts have been public knowledge for quite some time- and thousands of families who have paid through their nose can testify to these.

i. Hundreds of private engineering and medical colleges in TN, Karnataka, Maharashtra and other places offer admission on the basis of large capitation fees.
ii. Many of these institutions have been promoted by politicians.

I recall a secretary at our Institute telling me how her husband had to fly down to Chennai with around Rs 3 lakh in a suitcase in order to secure admission for her child in an engineering college there. I wondered how the suitcase had passed scrutiny at the airport- didn't the security people ask about such a large amount of currency being transported around?

Capitation fee flourishes despite the Supreme Court ban on it. The government and the quasi-regulatory bodies in education have been mute spectators thus far. (It was interesting to read in the papers that a court actually described the Medical Council of India as "den of thieves". Former minister Anbumani Ramadoss confessed that he had failed to clean up the MCI inspite of trying).
The new UPA government has education reforms high on its agenda. Tackling the menace of capitation fee and donations in various forms must be a priority in education. They render education inaccessible, of course, but they also breed corruption, with doctors and engineers coming out of these places focused on getting the quickest return on the huge investment they have made.

Downgrade in Indo US relations

President Obama's unequivocal endorsement of the two-state solution of the Palestinian problem and his criticism of continued Israeli settlements in the occupied region were undoubtedly high points of his speech and they have rightly attracted attention. For us in India, another point is equally compelling: his suggestion that Israel must be drawn into the NPT before long. If the US is unwilling to make an exception in the case of its staunchest ally, we must wonder where that leaves the Indo-US nuclear deal and the special dispensation it creates for India.

Expect Obama to focus on the NPT as well as the fissile material cut-off treaty. The signs are clear enough: the Obama administration does not attach quite the same importance to India as a 'strategic partner' as President Bush did. Chances are we will be pushed back into sub-continental status with a possible re-hyphenation with Pakistan. Earlier, Hilary Clinton's visit to China signalled that the US sees China as its principal partner in the conduct of international affairs, a view that appears to be getting reinforced with Treasury secretary Tim Geithner's recent visit to China.

The signals coming out from US moves in Pakistan reinforce this view. Relative silence on the release of Saeez Hafeez; a massive aid package for Pakistan in order to reinforce its war against the Taliban; Pakistan upping the ante on Kashmir. The unkindest cut of all: the US state department advisory to American nationals against travelling to India.

In his election speeches, Obama had made references to Kashmir that were not exactly music to our ears. It does appear that he sees the resolution of the Kashmir issue as an important item in his agenda, next only to the Palestinian problem, although he chose to omit any reference to Kashmir in his Cairo speech. The signs are that the US is willing to allow Pakistan to bring Kashmir to the top of the table in return on Pakistani cooperation on Afghanistan and the Taliban.

This must inevitably mean more firing across the LOC and greater infiltration into Kashmir and into India generally in the coming months. This may sound terribly grim but the US advisory does seem to point to an increase in terrorist activity in India in the months ahead. We have been patting ourselves on the back on the improved domestic outlook with the installation of the a stable government at the centre. Not to spoil the party, but it appears the domestic pluses may come to be outweighed by the minuses on the external front.

Anniversary of Tiananmen

The twentieth anniversary of the Tiananmen massacre- and massacre it was, of that there is little doubt- has been marked by ritual on both the western and Chinese sides. Western commentators want Beijing to allow more democracy and they also want the communist regime to come clean on what happened. China has responded with a clampdown- on BBC yesterday, I saw their Beijing correspondent being politely but firmly being shooed away from the Square by Chinese cops.

What has been the outcome of Tiananmen? China is incomparably stronger and more powerful today than it was 20 years ago. But has the communist party maintained its brutal ways and refused to learn? Not really, suggests the newly started Banyan column in the Economist (which is devoted to matters Asian). It responded to the movement in appropriate ways:

It is a commonplace that the party’s legitimacy is built on economic growth. Yet China’s leaders have long considered that to be merely the (simplistic) half of it. After the massacre, the Communist Party set about transforming itself. It launched a vast historical investigation into how political parties fall, and how they stay in power. Everyone was scrutinised, from Saddam Hussein to Scandinavian social democrats. The conclusion: adapt or die.

The outcome is a wholesale reinvention of the party, a process accelerated after Mr Hu stepped up as paramount leader in 2004. Shortcomings that were identified included corruption (a chief complaint of the Tiananmen students), lack of accountability in decision-making, no convincing ideology, and an ossified structure.

..Bright technocrats and entrepreneurs have been recruited. Retirement rules have been revamped (the Soviet Union’s gerontocracy was noted). Party members have gone back to school: three weeks a year and three months for every three years of mid-career training. More appointments are open to peer scrutiny before they are filled. The Communist Party is vastly more able to govern

......This is little comfort to Westerners projecting their hopes for democratic change on to China. Nor is there any sign that Chinese intellectuals identify with the myriad grievances of their poor countrymen, as they did during the Tiananmen protests. And the growing middle class appears more fearful of the great unwashed than of the depredations of a party that once was at war with the bourgeoisie.

FT's China expert, James Kynge provides a slightly different perspective. He questions the very characterisation of the Tiananmen protests as being "pro-democracy". The reality, as always, was more nuanced, more complicated, he suggests:

Almost everything fell within its (the movement's) scope: campaigns against corruption, nepotism, inflation, police brutality, bureaucracy, official privilege, media censorship, human rights abuses, cramped student dormitories and the smothering of democratic urges. But to say the demonstrations were to “demand democracy” is an oversimplification.

The truth is that the students in the square had only the haziest understanding of western-style democracy. To the extent that the protests were directed at abuses of an existing system by an emerging elite, they were motivated more by outrage at the betrayal of socialist ideals than by aspirations for a new system.

In other words, the protesters were asking for reform, better governance, an improvement in the quality of their lives. They were not necessarily asking for more democracy. It appears from the Economist's interpretation that the communist party got the message and responded appropriately.

When the western world pushes for democracy, what it means is the right to vote in a multi-party system. But, if a monolithic party can make itself responsive to people's needs, it can contain disaffection. It appears the communist party has managed this. The world's understanding of Tiananmen and what followed, its continued focus on "human rights" in China and prognostications about the inevitable collapse of communism there, may thus be badly flawed

Agony of Afghanistan

Khaled Hosseini's novel, A thousand splendid suns, richly deserves the accolades it has received. Hosseini is an Afghan, now settled in the US. He gives us a glimpse of the grim struggle for existence that is the stuff of daily life in Afghanistan - or was at the time when the mujahideen were trying to drive out the Russians, when the mujahideen fought amonst themselves for control and, later, when the country came under the control of the Taliban.

The novel' s special contribution is its focus on the plight of women. It deals with the lives of two women, Miriam and Laila, thrown together by reason of having got married to an ageing (in Miriam's case) and aged (in Laila's case) tailor, Rasheed. Miriam is the illegitimate child of a wealthy businessman in the city of Herat. Her father keeps her mother, a cook, and Miriam at a distance. When Miriam's mother dies, her stepmothers get her married off to Rasheed who is from Kabul. Miriam is in her teens and Rasheed in his forties.

Laila's misfortune is even worse. Her family is killed in the shelling of Kabul and she's badly wounded herself. She's nursed back to health by Rasheed and Miriam until Miriam understands the motivation behind Rasheed's concern- he wants to acquire Laila as a second wife. Rasheed is in his sixties then and Laila in her teens.

The novel deals with the humdrum existence of the trio and the two children they have (one is Laila's through her teenaged lover before her life fell apart). It's a grim struggle for existence, unrelieved by anything joyful (except the two children). There is nothing the two women can expect by way of caring from Rasheed. The only reason they have to stay with him- and endure his taunts and his endless beatings- is that there is no way they can survive otherwise. What awaits them outside Rasheed's humble house is even worse. It is a tribute to Hosseini's craftsmanship that he's able to sustain the reader's interest in this colourless existence.

As you read through the novel, you begin to wonder whether there is anything left but despair and wretchedness, whether there is any salvation at all for these two helpless, yet cheerful women, whether such a life is worth living at all. Finally, salvation arrives in the only way it possibly could......the reader is left at once happy and saddened at the outcomes.

Hosseini gives us an idea of what life under the Taliban is like- no music, no TV, no education or jobs for women, women can't even go out unescorted, nothing to life other than what purports to be the pure Islamic way of life. Taliban rule is a return to some barbaric past, except that even in that past, one would like to believe, things were not as bad.

You may have your reservations about America's posture towards Islam in general, its attitude towards Palestinians and Iran, about the so-called clash of civilisations. But, when it comes to the Taliban, there is no room for doubt as to the rationale for the US and its allies waging war against them. A Taliban take over of Pakistan is the ultimate nightmare for that unfortunate country, for India and for the rest of the world.

Indian bashing in Australia

Is the Indian media overdoing the incidence of racial attacks in Australia? There is something about the sheer power of repetition on TV, the same visuals being played by different channels throughout the day and for days together. I tell you, the effect can be inflammatory.

I have no means of knowing what the situation on the ground is. Most cities, including New York and London, have their share of lumpen elements who will bash up or rob anybody who looks vulnerable. Indians must appear as soft targets because of their build but that doesn't quite explain why the Chinese are not similar targets. Colour must be a factor.

The question is how big is the racial issue in Australia. I was there in 2007, visiting Sydney and Canberra. I came back and declared that if there was one white country that was not hostile to brownies, it was Australia. It was friendliness all the way. Of course, these fleeting impressions can be deceptive and it's only when you live somewhere that you get a feel for the place.

But, I have found that the acid test is the immigration counter. There you can sense the hostility or the lack of it. For the first time in my visit to a white country, I encountered a very warm welcome. Very different from what you would experience in, say, New York where, at immigration, every South Asian is presumed to be a terrorist unless proved otherwise.

Another test is the country's airlines. Both on Quantas and the domestic airlines, I experienced a total lack of hostility. Again, these could be misleading. Or it may be well be that the changed economic environment has caused a certain souring of moods.

Budget and reforms

Another budget will be upon us in a month or so. One of my secret fantasies is to flee town and head for some place that lacks TV around budget day. Then, I will be spared the cacophony that erupts at budget time.

Budget time is big money for the media. They create the hoopla around the budget and profit immensely from it. Live budgetary analysis is not terribly educative. You can't react to any of the numbers put out by the FM until you have had a chance to put them on a spread sheet and compare like with like in the previous year. But before people have had a chance to do that, instant wisdom will have been delivered on TV. So heavy is the overkill that informed analysis that comes a few days later in newspapers or journals is lost on the public.

Well, anyway, now that another budget is on its way, the clamour for "reforms" has begun. The argument is that the government could not push ahead with "reforms" the last time thanks to the benighted Left but now there are "no more excuses". Sorry to play spoilsport, but it appears those who clamour thus haven't read the Congress manifesto. It is reformist to my mind but the reforms it talks about are not the ones that pro-market enthusiasts have in mind- cuts in subsidies, labour market reforms, privatisation, financial sector reforms, FDI etc.

The Congress appears to have learnt from the defeat of the BJP and the lesson will have been reinforced by its own performance this time- "reforms" that the media and the business community clamour for are not vote-catching propositions. My guess is that those who are talking up the stock markets in anticipation of "big bang" reforms are in for a disappointment.

More on this in my last column, Redefining the reform agenda.

Winds of change in US board rooms

Whatever else governance reform may mean, I have always been clear about one thing it should mean: independent directors cannot be selected by management; to begin with, at least some independent directors on the board must be chosen by institutional shareholders.

I am not aware of any country where this happens. It certainly does not happen in the cradle of the governance movement, the US. In the US, the majority of companies have provisions that allow shareholders only to vote for directors proposed by management or withhold their vote. This has created a situation where directors get elected even when they do not command a majority of shareholder votes.

As the head of governance Calpers, the California pension fund, notes in a recent FT article, this is set to change. Legislation has just been introduced in the US Congress that allows shareholders to say 'no' to a director proposed by management and to propose their own directors subject to certain clauses intended to keep out frivolous proposals. The legislation also seeks to separate the chairman and CEO rules, another reform I have myself long urged. The SEC, under its new head, is introducing proposals of its own that are consistent with such legislation.

Governance reform is on the agenda of Sebi as well. This is the time for Sebi as well as the government to take the lead to usher in governance reform along these lines in India as well. After the Satyam and Nimesh Kampani affairs, there is concern about the need to protect independent directors from legal actions in matters for which they can hardly been held responsible. Two independent directors are said to have quit every day since Satyam erupted- resignations to date total over 400.

A certain measure of protection for independent directors is fine. But this must go hand in hand with measures to strengthen the mechanism of independent directors. Independent directors who collect huge fees in return for nodding their heads to whatever management wants done is clearly not on.

UK's financial sector

UK has long prided itself on its competitive financial sector and its comparative advantage in that sector. How did this advantage come about? Because of light regulation. In other words, the UK benefited from regulatory arbitrage. To put it more accurately in light of the ongoing crisis, UK bankers benefited from such arbitrage. So, what's to be done about it?

Martin Wolf reviews an astonishing report prepared by a committee that included UK's chancellor of the exchequer, Alistair Darling. The report recommends “ the financial sector be allowed to recalibrate its activities according to the sentiments and demands of the market”. They must be nuts to recommend this after seeing how the market has worked.

Wolf makes a set of eminently sensible suggestions:

First, the UK needs to make global regulation work. It should discourage regulatory arbitrage even if it expects to gain in the short run.

Second, it must, in particular, help ensure that owners and managers of financial institutions internalise most of the costs of their actions.

Third, it must reject egregious special pleading from the industry. The sector argues that moving derivatives trading on to exchangesmight damage innovation. So what? Maximising innovation is a crazy objective. As in pharmaceuticals, a trade-off exists between innovation and safety. If institutions threaten to take trading activities offshore, banking licences should be revoked.

Fourth, while trying to create a stable and favourable environment for business activities, the UK should try to diversify the economy away from finance, not reinforce its overly strong comparative advantage within it.

Fifth, UK authorities need to ensure that the risks run by institutions they guarantee fall within the financial and regulatory capacity of the British state. They should not let the country be exposed to the risks created by inadequately supported and under-regulated foreign institutions. At the very least, they should not undermine other governments’ efforts to regulate their own institutions.

Since "reforms" are the flavour of the day in India today, let me add that some of the above principles should guide banking sector policy in India as well.

A cohesive and stable government?

Those amongst the chatteratti who were euphoric about the mandate for the UPA government must be having to think again, seeing the birth pangs of the new government. The DMK leadership has retreated to Chennai and into a big sulk. Even if compromise is reached on the number of berths, it appears unlikely that the Congress can dictate who the DMK's ministers should or should not be: I doubt that any self-respecting party can concede the point that two of their earlier nominees were inefficient and corrupt.

As for the markets' relief over a patchwork of parties from the Third or Fourth Fronts forming the government and the Left being kept out, it's worth remembering that, in Mamata Banerjee, the Congress has to contend with somebody who was to the left of the ruling coalition in West Bengal. Banking reforms, labour reforms, SEZs- it won't be easy to breeze past Mamata on these issues.

Lastly, I do hope good sense prevails in the Congress and the finance portfolio stays with a politician and doesn't go to a technochrat. It wasn't the pro-reform brigade that helped the Congress do well in the 2009 elections, it was the solid political instincts of the Gandhi family, much of which goes against the spirit of "reforms".

Understanding the results of the 2009 elections

I don't know in which case instant wisdom is worse: the Union budget or the elections. In both instances, it is the idiot box that plays havoc with sober judgement. Even as the news is happening, pundits are ready to shoot their mouths. Whereas in both cases, a careful dissection of data is required in order to arrive at an informed judgement.

Let us consider some of the conclusions that abound in post-election punditry:

1. Regional parties have been shown their place, national parties have regained their dominance: We need always to distinguish between number of seats won and share of the vote. It is possible for a ruling party to become unpopular and see its share of the vote fall. Still, it may win more seats because the opposition vote happened to be more splintered.

In the present election, Yogesh Yadav estimates that the combined vote share of the Congress and the BJP climbed from 48.7% in 2004 to 48.9% in 2009- hardly any change. This translated into a disproportionate increase in total seats of the two parties from 283 to 321, with the Congress gaining 61 seats and the BJP losing 23 seats.

So, the regional parties have retained their importance. It is just that the relative shares of the Congress and the BJP in the national party pie changed so as to place one party in a stronger position than before.

2. The results are a vote for stability and good governance: This implies that regional parties are an unstable factor and the national parties alone can provide stability and good governance. The figure for the vote share of regional parties has hardly changed. Besides, the BJP, which has provided stability and good governance in Gujarat, is a big loser. The Congress benefited from the electoral arithmetic in many ways: for instance, it made big gains in AP because the Chiranjivi factor ate into the votes of the TDP and in Maharasthra, the MNS ate into the votes of the Sena-BJP. A slight change in the electoral arithmetic could once again create instability at the centre.

3. The results are a vote for "reforms" and the Congress-led UPA should, therefore, fast forward "reforms": The Congress benefited from a rise in rural incomes and prosperity driven by growth in agriculture, an area that is least touched by reforms. It also benefited from measures that "reformers" relentlessly fought: NREGA, the farm debt waiver, the Sixth Pay Commission award, an increase in subsidies and OBC quotas.

The one formation that lost heavily from its attempt to push through "reforms" was the Left in West Bengal which tried to usurp farm land in order to push ahead with industrialisation. (SEZs are an important item on the "reforms" agenda). It is fair to say that the UPA benefited from measures associated with the Left while the Left lost because of measures associated with the "reformers'!

4. The nation has rejected the "communalist" BJP: It is said that it was the BJP's attempts to project Narendra Modi as a future national leader and the vitriolic outbursts of Varun Gandhi that cost the BJP dearly. Really? Then, how come Varun himself won handsomely in Pilibhit and the BJP did well in Karnataka which is considered progressive and was out of the BJP orbit until recently?

I'm afraid none of the explanations put forward, such as the ones above, are free from infirmity. There are only three things one can say we can with a degree of certitude. One, regional parties remain a force. Two, the electoral arithmetic can cause the outcome in terms of seats won to diverge significantly from the outcome in terms of vote shares. Three, the only way to combat the anti-incumbency factor is to focus on measures that have a pro-poor and rural orientation.

The rise and rise of regional parties

The great game of searching for alliance partners is on and regional parties are being wooed arduously by the Congress and BJP alike. I hear much tut-tutting over the rise of regional parties. Somehow, there is a perception that regional parties' support or dominance leads to instability and weak governance and only the two national parties, Congress and BJP, can provide stability and good governance. So, take your pick- the secular guy or the commual guy.

Alas, life is much too complex and messy to conform to the preconceptions of the Indian elite. There is no stopping the rise of regional parties, as I note in my ET column, Fear not the regional parties, and, more importantly, there is no reason to get jittery over this phenomenon.

Regional parties have shown themselves more responsive to caste and regional aspirations and this has inevitably eaten into the vote share of the national parties. This will continue until a more homogenised and prosperous nation emerges with the middle-class being truly middle, meaning accounting for, say, more than 5% of the population, as is the case today (depending on what income level you want to take as a cut-off).

As political scientist, CP Bhambhri, writes in a companion piece in ET, regional parties have found it necessary to capture power at the centre in order to better cater even to regional aspirations because, in the Indian federation, the centre still calls the shots. In the process, regional parties are compelled to develop a national perspective. That is the beauty of democracy: it causes political actors to modify their behaviour in ways that generate wider support and hence leads to more acceptable behaviour.

There is much condescension when it comes to regional leaders- they are not as savvy or well dressed as their national counterparts and so the inference drawn is that they may not have the skills to run the nation. Nonsense. If you have run UP or Tamil Nadu and done so more than once, believe me, you have what it takes to run the nation. I quote a distinguished bureaucrat in my column as saying nice things about Deve Gowda. TSR Subramaniam, former cabinet secretary, expresses the same sentiments about Gowda. Outlook editor Vinod Mehta wrote recently that the most impressive performer from the Indian delegation at a Davos conference he attended was Gowda, not one of our high-profile businessmen.

So, let us not deride regional parties and regional leaders. Instead, let us welcome gracefully the changes being ushered in by our marvellous democracy.

Gujarat a star in agriculture

Gujarat has always been a star in industrial performance. It was news to me that Gujarat is a star i in agriculture. Gulati and Shreedhar analyse the phenomenon in an ET article. Agriculture has grown in Gujarat at an astonishing 9.6% in 2000-01, more than the thrice the all-India figure.

One key driver has been the Sardar Sarovar project and the increased availability of water in a state in which irrigation cover is only 36%. One can understand why the project arouses strong emotions in the state. Another driver is technology, especially new varieties of cotton with the private sector taking the lead. Then, good roads, better regulation of electricity for agricultural use and a thrust on extension services have helped.

The authors conclude, "Strong political commitment to promote rural development, a long term vision, and the capacity to implement this are perhaps the key ingredients of Gujarat’s success story".

That must explain Modi's success- there's a lot more to development in Gujarat than the Nano project.

Indian firms in world's 'most reputed' list

Rediff has a story on a list of the world's most reputed firms listed by the Reputation Institute of the US. (I must confess I have no clue who they are). The following are some of the Indian firms that figure (world rank in brackets):

1. Tata group (11)
2.SBI (29)
3. Infosys (39)
4.L&T (47)
5. Maruti (49)
6.HLL (69)
7. ITC (95)
8. Canara Bank (102)
9. Hindustan Petroleum (111)
10. Indian Oil (112)

Interesting omissions are the Ambanis and the Birlas. It's also interesting that Infosys, which has invested so much in building an international brand and HLL, which is a well known brand, rank below Tata and SBI. The top 10 includes four public sector firms.

Shantaram

I finally finished reading Shantaram. I say 'finally' because I am a slow reader and the novel runs into over 900 pages.

Shantaram, which came out in 2004, is penned by Gregory David Roberts, an Australian who was serving a jail sentence for armed robbery in his country. He escaped from jail, landed in Mumbai, spent several years there as part of the local underworld, was recaptured in Germany and, after serving the remaining sentence, got his novel published. He needed to write it thrice because his captors destroyed the first two versions when they found out. Roberts has since made Mumbai his home.

The novel is an epic, along the lines of,say, Gone With the Wind. And it's more than a novel, it's a soul-stirring experience. To think that a man could go through all that, retain his humanity and find the reserves to write a splendid novel! Roberts' mother taught him to appreciate literature and he spent his time in the Australian jail devouring first-rate fiction. It shows in his own writing.

It's impossible to capture the splendours of the novel in one short post. Roberts has said in interviews that the events are real, only the narrative is fictional. There is a charming account of Roberts' six month stay in a village in Maharashtra's interior where he is given his Indian name, Shantaram; a moving description of life in the slum near Cuffe Parade where the locals adopted him as one of their own; great encounters with Abdel Kader Khan, the underworld don, who combines a fine command of the English language with a fondness for philosophical speculation (every week, he and his comarades meet for lofty discussions); Roberts' embroilment in the war in Afghanistan when he accompanies Khan and others on a journey through Pakistan to arm the Taliban in their war against the Russians; and Roberts' falling in love with Karla Saaranen, a mysterious, beautiful and thoughtful American lady of European extraction... (you have to read the novel to know what the mystery is about).

Some of the scenes in the novel will stay with me for a lifetime. On one occasion, Roberts and a small boy (Khan's nephew entrusted to Roberts in order to experience slum life) find themselves attacked by a whole horde of dogs in the slum at night time. They try to fend off the pack with bamboo sticks but it's a losing battle. Then, Kader Khan's bodyguard materialises out nowhere, iron rod in hand. He's a trained martial arts specialist. He leaps into the air in true martial art fashion, swirls and strikes. Two dogs have their brains shattered. The entire pack, stunned at somebody taking the attack to them where Roberts was merely defending, flees.... Roberts is saved.

Then, there is the Colaba police station where Roberts is held for a few weeks. The lucky ones are those behind bars. The others are herded into a small corner leading to a toilet where shit is overflowing.... the weakest have to stand for days in a heap of shit until they drop dead....

One day, the detainees are led out and taken to Arthur Road jail (home to Sanjay Dutt for a while). Roberts is motioned to a corridor. There, the convict warders are waiting with lathis.... Roberts has to run the gauntlet but choses to walk in a gesture of defiance as the blows rain on him. He lands in his cell bloodied. The jail itself is hell with the warders showering blows on inmates at will. It makes your blood boil to think this is what the Indian system has been reduced to. One gets a sense of the daily brutality visited on the weak and the defenceless by the Indian law enforcement system.

What, one wonders, is the IPS brass doing? The only thing you could say in extenuation is that things are not much better in jails elsewhere. In his jail in Melbourne, Roberts was subject to the same kinds of senseless beating and cruelty. Recently, during the G-20 meet, the cops in UK, considered to be more civilised than the rest, were flailing their batons at harmless protesters. I guess it goes with the uniform, the sense of power it gives you. The power to ill-treat and also the power to extort huge sums of money.

The Afghan expedition is a story in itself. It takes weeks of trekking through the mountains to get there, with a maniac as escort. This man has only one mission in life and that is to catch hold of Russian soldiers and torture the life out of them. The return journey is a horror, with Roberts and a few survivors holed up in a snowy cave with no food or water for several days. Roberts makes it to a hospital in Pakistan and then finds his way back to Mumbai. With his heroic role in the Afghan expedition, he becomes a privileged member of the gang, specialising in counterfeit passports. He makes good money out of it.....

I won't narrate more. I will leave you to find out for yourself. Shantaram is being made into a film by Mara Nair. I can't wait to see it (I understand work on the film has stalled because of some problems in Hollywood). Let me just say that the book leaves you shaken and stirrred, to use a famous James Bond line.

I had a post some time back on another book on Mumbai, Suketu Mehta's Maximum City. That is also about the seamy side of Mumbai. But the philosophical approaches of the two books are very different. Mehta is appalled and outraged at the violence and corruption that lie beneath the surface in Mumbai.

Roberts writes with empathy and affection for those on the seamy side. There is understanding and love, an underlying humanity that comes from having experienced the worst of it. Roberts is now off smoking, drinks and drugs and leads the life of a celebrity in Mumbai. I doff my hat in humble salute to the man.

Unconvincing "stress" tests

The much awaited results of the "stress" tests on top US banks is out- the idea is to see how much extra capital these banks would need under fairly realistic economic scenarios over the next couple of years. The estimate: $75 bn in order to be well capitalised by the end of 2010. The biggest requirement is at BofA: $34 bn.Total losses at the banks are estimated at $600 bn. Of this, $363 bn would be recouped through earnings.

What do we make of these figures? Two points. One, these losses come after the accounting standards were tweaked on mark-to-market losses of toxic assets. Two, the IMF had estimated US bank losses at $1.6 trillion over the next couple of years and estimated the extra requirement of capital at around $500 bn. The market is, therefore, likely to perceived the US Treasury as under-estimating capital requirements in order to hide the gravity of the problems at banks. That, in turn, means the chances of raising additional capital from the market would be zero.

Even otherwise, chances of banks raising additional capital are bleak. FT estimates total capital requirements at $55 bn, assuming some banks want to repay capital given by the US government and also some asset sales. This amount is three times total US equity raisings in the last six months. There you are.

Since banks can't raise capital from the market and the US government is unwilling or unable to pump in more, Richardson and Roubini, writing in the FT, say that insolvent banks should be closed down, with creditors taking some of the hit (depositors alone should be fully protected). What about the Lehman effect? The authors argue that market discipline would force banks to change their behaviour in ways that would instil confidence in the market, so credit would become available.

Well, well. For this process to work out would probably take years. So implementing this solution would require some nerve. Academics have the license to prescribe theoretically neat solutions but the global crisis requires a solution here and now because there is real suffering all round. I doubt that there will be any takers for the Richardon-Roubini solution where large banks are concerned.

How real is the Taliban threat in Pakistan ?

I have been following with interest the scare stories about the Taliban being 60 kms from Islamabad and the dire prophesies about Pakistan's nuclear weapons falling into the hands of terrorists. Are things really as bad as that? I came across an article in Asia Times, which made a lot of sense to me:

Pakistan is not an ungovernable Somalia. The numbers tell the story. At least 55% of Pakistan's 170 million-strong population are Punjabis. There's no evidence they are about to embrace Talibanistan; they are essentially Shi'ites, Sufis or a mix of both. Around 50 million are Sindhis - faithful followers of the late Benazir Bhutto and her husband, now President Asif Ali Zardari's centrist and overwhelmingly secular Pakistan People's Party. Talibanistan fanatics in these two provinces - amounting to 85% of Pakistan's population, with a heavy concentration of the urban middle class - are an infinitesimal minority.

The Pakistan-based Taliban - subdivided in roughly three major groups, amounting to less than 10,000 fighters with no air force, no Predator drones, no tanks and no heavily weaponized vehicles - are concentrated in the Pashtun tribal areas, in some districts of North-West Frontier Province (NWFP), and some very localized, small parts of Punjab.

To believe this rag-tag band could rout the well-equipped, very professional 550,000-strong Pakistani army, the sixth-largest military in the world, which has already met the Indian colossus in battle, is a ludicrous proposition.

So, what's behind the hysteria being drummed up in Washington?

To start with, what Washington - now under Obama's "Af-Pak" strategy - simply cannot stomach is real democracy and a true civilian government in Islamabad; these would be much more than a threat to "US interests" than the Taliban, whom the Bill Clinton administration was happily wining and dining in the late 1990s. What Washington may certainly relish is yet another military coup - and sources tell Asia Times Online that former dictator General Pervez Musharraf (Busharraf as he was derisively referred to) is active behind the hysteria scene.

.........Moreover, there are canyons of the Pakistani military/security bureaucracy who would love nothing better than to extract even more US dollars from Washington to fight the Pashtun neo-Taliban that they are simultaneously arming to fight the Americans and NATO. It works. Washington is now under a counter-insurgency craze, with the Pentagon eager to teach such tactics to every Pakistani officer in sight.

There are wheels within twisted wheels. The only thing unexplained above is in what ways concretely the US stands to gain from a military regime in Pakistan. What are the larger designs of the US to which a civilian regime would be an obstacle? And, more importantly, where does India figure in the US plan for Af-Pak?

Global recovery will be slow

A quick economic recovery? Perish the thought. Recovery is going to be slow. The IMF thinks so. So does the RBI.

As the IMF's latest World Economic Outlook makes clear, there are recessions and recessions. The worst are the ones created by a financial crisis, especially a crisis rooted in the banking sector. When recession is globally synchronised, that makes things even more difficult because no country can export its way out of trouble (as the East Asian economies could in 1998). Today, we have a combination of a financial crisis and a globally synchronised recession. So, expect recovery to be a slow affair. Not until 2010, says the IMF, and even then it will be long drawn out.

When you have a crisis rooted in the banking sector, the way out is to fix the banking sector. Sadly, the US administration has been dragging its feet over this for more than a year now. Fixing the banking sector in the US, given the scale of losses, means nationalisation. There is just no other alternative. But nationalisation would wipe out shareholders and too many rich people, including those in the US administration, don't want that. They would like to look for alternatives that preserve shareholder wealth. But every one of these alternatives entails a slow and painful economic recovery.

It won't be a Great Depression for reasons I spell out in my ET column, Don't bank on an early recovery. But it won't be a mild and short recession either.

I wrote my ET piece and sent it off last week as I was due to travel. On my return, I was gratified to note that my assessment accords with that of both Martin Wolf of the FT and the Economist. Wolf writes:

For better or worse, the authorities have decided to bail out their financial systems with taxpayer money. Almost all the affected countries should be able to afford to do this, at least on the IMF’s numbers. So now, having made the fundamental decision to prevent bankruptcy, they must return their financial systems to health as swiftly as they possibly can.

Even so, that will prove to be a necessary, not a sufficient, condition for a return to robust economic health. The overhang of debt makes deleveraging inevitable. But it has hardly begun. Those who hope for a swift return to what they thought normal two years ago are deluded.

Says the Economist:

The worst is over only in the narrowest sense that the pace of global decline has peaked. Thanks to massive—and unsustainable—fiscal and monetary transfusions, output will eventually stabilise. But in many ways, darker days lie ahead. Despite the scale of the slump, no conventional recovery is in sight. Growth, when it comes, will be too feeble to stop unemployment rising and idle capacity swelling. And for years most of the world’s economies will depend on their governments.

Axis Bank theatrics

The curtain has finally been rung down on the succession issue at Axis Bank. P J Nayak staged an undignified walk-out after a stormy board meeting, paving the way for Shikha Sharma from the ICICI group to take over as CEO with board member Prithviraj taking over as interim chairman.

Nayak, going by reports, was completely isolated on the succession issue, with even those close to him for long deserting him in the final moments. Nayak wanted Kaul, an executive director, to succeed him. He has argued in an interview with BS that an organisation should bring in an outsider only if it is weak. Not true. It may need to bring in an outsider also if the insiders are weak (which can happen in an organisation that is strong but has been a one-man show).

Nayak had earlier successfully resisted the RBI's efforts to bifurcate the positions of chairman and MD, saying he needed time to groom a successor. It turns out that he failed to do so even when given adequate time. This is not uncommon- BS had an edit yesterday mentioning the cases of L&T and ITC where the present chairmen seem to think themselves immortal.

The right thing has happened at Axis Bank and this is, in large measure, due to the role played by the nominees of SUUTI who presented a united front on the issue and made the process of finding a successor rigorous. It appears that even in a private bank, it is the government that has to be around to ensure the right outcome. This will not come as a surprise in the present times where the same phenomenon is being seen on a bigger scale in the US banking system and elsewhere.

One last point. Nayak's quitting as chairman in a huff was inappropriate. One could have understood if some legal or ethical issue had been involved. There wasn't any. Nayak left in a fit of pique only because he couldn't have his way.

This isn't done. Banks run on confidence and for an executive chairman to walk away without ensuring a smooth hand over can be potentially harmful. It's a different matter that the Indian banking system is in good shape and that we need not fear such an outcome in the present instance.

Incidentally, I was told that AT Paneerselvam, board member at Axis and former chairman of IBA, collapsed in his car and passed away while on his way to the airport from the seven hour board meeting. Strange that no paper has reported this.

Return of good times for US banks?

Several top US banks including Citigroup and Goldman Sachs have reported impressive results in the first quarter. Some have interpreted this as a sign that the banks are finding their way back to good health and they also see this as good news for the world economy.

Sorry, it ain't all that great. Even if banks start making profits, it only reduces accumulated losses - or helps banks write off bad assets. it does not help increase the quantity of loans- and more credit is what is required to get the wheels of the economy going. The balance sheets of US banks will shrink this way until banks are restored to health. This slow process of recovery helps shareholders who would otherwise be wiped out at one stroke if the US government were to nationalise them- which is why the government, run by ex-bankers and investment bankers, doesn't want to take that step.

Moreover, US bank profits have been helped by regulatory forbearance in several ways as an article in the FT points out:

First was the decision by the Federal Accounting Standards Board on April 2 to modify what many bankers considered the FASB’s onerous mark-to-market rules forc­ing securities firms to write down the value of their assets as they lost value in the in­creasingly illiquid market. (Seems like a reasonable idea to value assets at what they are really worth, no?) The FASB had been reviewing this change and received much commentary from the financial community “that asserted that fair value is not as relevant when financial markets are inactive or ­distressed”.

.....The Federal Reserve has also been listening carefully to the banks’ pleas. It has lowered the cost of money it charges banks – and since all the big Wall Street securities firms are either gone or have become banks, this means virtually everyone – to close to zero.

Then there is the sleight of hand, at least in the case of Goldman Sachs, which, when it converted from a securities firm to a bank holding company last autumn, changed its fiscal year-end to December 31 from November 30. Its first-quarter numbers, for the three months ended March 31 2009, did not include its horrific December results – into which Goldman threw everything but the kitchen sink – of a loss of more than $1bn. During the past seven months – including December (there was Christmas, right?) – Goldman in fact lost $1.5bn.

So much for the good news from the US.

Will banking become boring?

What world of banking can we expect to see once the dust settles down in the present crisis? Regulations will be more stringent and three elements will be central to the new world of banking- higher capital, constraints on financial innovation, restrictions on bankers' incentives. Higher capital requirement in itself spell lower returns and hence lesser rewards in banking. In other words, banks and "shadow banks" will have a presence in the economy that is more consistent with the requirements of the real economy instead of becoming a world unto itself.

This is greatly welcome when you consider the atrocious waste implied by the disproportionate flight of high quality talent towards finance in recent years. Finance and IT are two sectors that have completely distorted the labour market in India- and we should welcome the fact that both are being put in their places.

More on this in my ET article.

Academics in government

There has been much criticism about how the "dream team" of Manmohan Singh, Montek Ahluwallia and P Chidambaram did little or nothing on economic reforms. It's interesting that two of the three members have strong academic credentials. An article in FT echoes the criticism:

The whole reform programme relies on the prime minister himself. Mr Rao and A.B. Vajpayee proved their mettle, despite heavy political constraints. Mr Singh has failed; he should bear much of the blame. The Congress party does not deserve to be re-elected and the dream team does not deserve to continue in office.

It also has some strong things to say about academics in positions of authority:

........Mr Singh has proved a hopeless decision-maker as prime minister. Sadly, he proves the rule that academics should generally be “on tap” but not “on top”.

Lincoln and leadership

Leadership, as I have noted earlier, is, perhaps, the most written about topic in the Harvard Business Review - it's covered even more than that other perennial favourite of management gurus, strategy. I am inclined to believe that if all the literature on leadership has simply led on to more literature, then leadership must be pretty difficult to teach or learn- either you have it or you don't and the only real teacher can be life itself.

This feeling was reinforced by an interview in the latest HBR on Abraham Lincoln and leadership. The interview is with historian Doris Goodwin, whose book, Team of Rivals, is the one book that President Obama said he would take to the White House, apart from the Bible. Goodwin says of Lincoln's secret of leadership:

Lincoln surrounded himself with people, including his rivals, who had strong egos and high ambitions; who felt free to question his authority; and who were unafraid to argue with him.
.....Obama is obviously trying to do the same thing by choosing his chief rival, Hillary Clinton, to be secretary of state; by picking rival Joe Biden as his vice president; and by including powerful Republicans in his cabinet like Robert Gates and Ray LaHood.

But you have to remember, the idea is not just to put your rivals in power—the point is that you must choose the best and most able people in the country, for the good of the country. Lincoln came to power when the nation was in peril, and he had the intelligence, and the self-confidence, to know that he needed the best people by his side, people who were leaders in their own right and who were very aware of their own strengths. That’s an important insight whether you’re the leader of a country or the CEO of a company.

Hmm.... Let me see.... I have worked for several organisations, corporate and academic, served as consultant to and board member on quite a few. How many places can I think of where the person at the top did what Lincoln did- put strong people, including rivals, in key positions and let them fight it out with him? Only one !- and this was my immediate boss, not the CEO.

This was one boss who did not feel insecure about having people superior to him working for him, indeed he openly declared that he was inferior. Did he make it to the top? No way- he didn't last long in the corporate world and ended up as a small farmer in his village.

It may be well be that you need Lincoln's ability to surround yourself with strong people in order to be a super-achiever. But this ability, I am afraid, is rare and I can't see that it is something that people can be taught. That is why Lincoln is Lincoln, one of the towering figures of all time while many corporate and other leaders have ended in the dust-bin of history.

Satyam sale

The sale of Satyam to Tech Mahindra is a morale booster, never mind the ifs and buts as to whether the buyer can make a success of the acquisition. For once, the print and visual media were willing to acknowledge the role played by the government in preventing a debacle and arranging a rescue.

It's an amazing end when you think of how things would have ended in, say, the US. The moment the fraud came to light, the company would have gone into bankruptcy proceedings and it would have been embroiled in litigation. In a software company, value comes from intangible assets- the people and the brand- so there's little that investors can claim from liquidation and litigation.

The only hope is to turn the company around under new management and wait for the stock prices to revive. Those who filed class action suits in the US may well find that they may be better off waiting for the stock price to rise instead of trying to claim a settlement from the new management.

In making the decision that Satyam was too important to go under and that it could and should be revived, the Indian government was spot on. It also acted swiftly in putting in place a new board and the regulatory authorities helped by creating a fresh set of rules for takeovers in such exceptional cases. (This was wrongly derided by some as being anti-investor, overlooking the fact that we are talking of a company that was on the brink of a collapse that would have washed out investors altogether).

What can we learn from this episode? One is that government may need to intervene in the case of any systemically important institution, not just those in the financial sector. The second lesson- driven home already by the financial crisis- is that 'leave it to the market' can be sheer nonsense in such situations.

US gunmanship in Somalia

The US showed what it means to be a superpower when it effected a terrfic rescue of the captain of a ship, a US citizen, held hostage by pirates in the high seas off the coast of Somalia. The only detailed report of the rescue operation I came across was filed by Chidananda Rajghatta in TOI ( in the print edition, I can't trace it on the web, so I'm going to describe it in my own words).

The captain had been seized and held by four pirates after a failed piracy attempt in which the pirates were repelled by the ship's crew. They managed to escape on a motorised lifeboat with the ship's captain and were adrift for five full days. The US navy sent its warships into the area to hem them in and then ensured that other pirate vessels attempting to enter the area were shooed off.

The US navy then engaged the pirates in negotiations even as the pirates' rations and fuel ran out. One ship offered to tow the lifeboat away from choppy waters into calmer ones- this brought the lifeboat within firing range of the snipers on board the US ship. One pirate was taken aboard the US ship to help with the negotiations. President Obama, who was kept in the loop througout, gave the US navy the command to go ahead and shoot if the captain' s life was judged to be in imminent danger.

When the negotiations did not progress and the pirates came within the snipers' cross-hairs, all three pirates on the lifeboat were taken out with one bullet each. The pirate on board is in US custody and the captain is flying home.

The successful end saved President Obama an early security embarassment- Americans don't take kindly to botched military missions or the deaths of US citizens- but the head of the pirates has accused the Americans of treachery saying his colleagues had been ready to given up the captain without ranson when they were shot. Unfortunately, some 200 seamen from other nations and from various ships are being held hostage by various groups of pirates. The pirate chief has also warned of revenge against Americans seen in the waters again.