RBI, financial stability and central bank independence

 Viral Acharya, the distinguished academic who served as Deputy Governor of RBI from December 2016 to June 2019,  has been vocal on the subject of financial stability over the past several weeks.  

In several interviews and webinars following the publication of his book, Quest for financial stability in India, Acharya has said that lack of concern for financial stability on the part of successive governments has led to recurring problems in the banking system. This, in turn, has resulted to growth getting stalled time and again. 

The book is a collection of speeches Acharya made as Deputy Governor. The highlight is a lengthy introduction that Acharya has written in which he expatiates on the importance of financial stability. Acharya says that during Urjit Patel's tenure as Governor, the RBI made a valiant attempt to defend financial stability but, ultimately, could not stem pressures in favour of faster credit growth at the expense of stability. He suggests that both Patel and he had to quit as they could not reconcile their stand on financial stability with that of the government.

Acharya contends that the root cause of financial stability is what he calls 'fiscal dominance', that is, the imperative of governments having to spend in order to boost growth, no matter what the implications for the fiscal deficit. After a point this becomes untenable.Governments then lean on the central bank to facilitate faster growth through credit expansion. 

This invariably involves sacrificing financial stability in a number of ways- by not recognising bad loans and the associated losses, not recapitalising public sector banks as required, manipulating the yield curve to keep interest rates low so that governments can borrow cheaply, etc. Compromises on financial stability result in banking crises and weak growth down the road. 

The answer, Acharya suggests, is first to ensure that fiscal discipline is practised. Secondly, to ensure that the RBI enjoys greater independence, preferably conferred by law, so that it can resist pressures to compromise financial stability.

There are problems with the thesis. First, it is not true that credit booms and financial crises result exclusively or mainly from fiscal dominance. The global financial crisis of 2007 as well as multiple bank crises in numerous economies in the past several decades did not flow from fiscal dominance.

Secondly, financial stability can result from excessive concern with financial stability at the expense of growth. If you are too focused on inflation and allow growth to weaken, that itself can cause financial stability. If you are not willing to relax regulations in unusual times, such as the pandemic, and insist that defaults should automatically result in loans being categorised as non-performing assets, you are going to create a major banking crisis here and now- in the cause of financial stability. Find me one banker who thinks that the loan restructuring scheme announced recently by RBI is not desirable and that we should accept Urjit Patel's contention that a restructured standard asset is an oxymoron.

Thirdly, conferring independence on the RBI by law is a bad idea. Matters of monetary policy and regulation cannot be decided by technocrats alone. It is the elected government that is accountable to the people for its decisions that must have the final say. This is because monetary policy and regulation involve choices about trade-offs between growth and stability and they have distributional implications. These choices cannot be made by technocrats sitting in Mint Street. If central bankers are not to accountable to the government, how will make them accountable? We need a vibrant media, swift judicial redress and a culture of peer pressure that will ensure accountability once central banks are given independence by law. Those conditions are not satisfied in India today.

Fourthly, it's extremely naive to think that governments make "political" choices while technocrats are utterly apolitical or detached in their approach to questions of public policy. All public policy choices are overtly or implicitly political in nature and central bankers are political animals in their own ways. We know central bankers are not unworldly in their outlook: many have the happy gift on landing juicy positions with private banks after they have demitted office. 

We have to accept that those elected to office have the right to decide matters of public policy. If they make mistakes, the electorate has the choice of voting them out the next time. Pitting the saintly technocrat against the diabolical politician can only undermine democracy and pave the way for the technocracy known as dictatorship. 

More in my column in BS, Technocrats versus politicians

World’s top banks grapple with CEO succession

There is much speculation about who will succeed Aditya Puri as CEO of HDFC Bank. the search for a successor has commenced just about eight months before Puri is due to leave. If it’s any consolation, it’s not the only leading bank that’s trying to ensure a smooth succession. Some of the world’s top banks are grappling with the same problem- and the circumstances at those places are far more challenging.

The CEO of UK’s Barclays Bank, Jes Staley, announced last month that he would step down in about a year’s time. Staley had to quit after financial regulators announced a probe into his links with Jeffrey Epstein, the billionaire who died in jail while facing charges of paedophilia.

Two years, Staley had faced a storm when it was disclosed that he had tried to uncover the identity of a whistle blower who had written to the board of Barclays with complaints about him. The board let Staley keep his job but he had to pay a fine of £640,000 levied by the regulators. 

Staley has been CEO for five years. The board has said it will look outside for a CEO. That says something about succession planning at UK’s second largest bank. If nobody inside measures up, the board should have made the assessment long back. It would then have had time to induct an outsider and groom him or her for the top job.

Things are not much better at HSBC. Its CEO, John Flint, had to step down last August on grounds of under-performance after just 18 months into his job. The board has opted to name an interim CEO which meant that it was keeping its options wide open in respect of the appointment. If that wasn’t bad enough, last month the interim CEO chose to announce a restructuring that would involve shedding 35,000 jobs over the next three years.  What CEO want to own a radical restructuring initiated by somebody else? 

At Swiss giant Credit Suisse, the CEO, Tidjane Thiam, the first black chief of a top European bank, was somewhat abruptly shown the door last month following unsavoury revelations. Last September, a detective from a private agency was caught tailing a former senior executive of Credit Suisse. It turned out that agency had been hired by the Chief Operating Officer of Credit Suisse.

The COO was fired and the board sought to distance Thiam from the affair. However, the plot thickened. Credit Suisse, it was revealed, had also spied on its former head of human resources! To its credit, the board has been quick to name an insider and bank veteran as CEO.   But the perception that the bank’s culture is flawed will not go away quickly

At J P Morgan Chase, Jamie Dimon reigns supreme after more than 14 years as CEO. Last January, Dimon declared blithely that he had not set a retirement date for himself. There is no obvious successor in sight. Naturally. Several potential successors have left to take up CEO positions elsewhere. J P Morgan Chase is a star performer. However, performance does not exempt an organisation from the requirement of succession planning.  

Boards must have a set of two or three potential successors at any given point, with the choice narrowing to one over time. Goldman Sachs is a good example. More than a year before Lloyd Blankfein stepped down as CEO, the bank named two co-chief operating officers. A year later, one of them got the job. At GE under the late Jack Welch, three insiders were marked for succession several years before Welch’s retirement. Jeff Immelt got the job. 

A G Lafley, a former CEO of Proctor & Gamble, has written about how he started work on succession planning virtually from day one.  “Many CEOs,” he wrote in an article in the Harvard Business Review, “don’t push their boards to discuss what might happen when they leave because they don’t want to think about it…”  This was said in 2011. It seems not much has changed since. The upheavals caused by the global financial crisis of 2007 have evidently done little to change governance and culture at private banks. 

Can SBI's rescue attempt save Yes Bank?

Well, it's a long shot. First, the capital infusion may prove inadequate and the non-SBI investors may not have the appetite for investing more. Secondly, a bank cannot be run for too long with deposits from public sector banks (the amount of deposits being talked about is Rs 30,000 crore). A public-private partnership to save a private bank is a first of sorts. The outcome will be awaited with interest.

In 1998, a consortium of banks and brokerages rescued Long Term Capital Management (LTCM) by infusing capital on which they later made a modest profit. But LTCM was a hedge fund,  not  a bank. Here SBI and some private banks will be rescuing a bank that has been a competitor and will remain one if turned around. That's a big difference.

Questions have been raised about regulation and supervision, following the Yes Bank failure. I have not come across any specific lapse that people have ascribed to RBI. They simply presume that if a bank fails, there must be a failure on the part of the regulator. To my mind, the failure happened in September 2018 when IL&FS was allowed to fail. The shocks created then are continuing to take a toll on the financial sector and the economy. In a way, the Yes Bank collapse is the result of the worsening conditions in the economy and in the financial sector consequent to the failure of IL&FS.

More in my article in BS, Question Marks Remain about Yes Bank Rescue.  I also joined the Hindu Parley on the subject with Prof Ananth Narayan of SPJIMR

Yes Bank collapse should prompt rethink of bank privatisation

So SBI has been tasked with rescuing Yes Bank. It's a tall order. We don't yet the details of the plan. SBI, it's reported, will submit a plan to RBI, which, in turn, will put it up to the cabinet. That should be a couple of weeks at the least. In the meantime, will the cap on withdrawals of deposits of Rs 50,000 at Yes Bank be lifted? It would be risky, to say the least.

Giving Yes bank to SBI is, I'm afraid, a wrong move. It won't be enough to share up depositor confidence. The government should have nationalised Yes Bank. Then, perhaps, SBI and others to put in some equity and turn it around (although I have reservations even on that count).

Yes Bank was a star performer until 2017 or so. The performance of new private banks has been contrasted with that of public sector banks. There are several issues with some comparisons. They do not cover long enough periods. They ignore rescues of private banks by PSBs. They overlook the larger obligations that PSBs are saddled with and for which they are not compensated (demonetisation, Jan Dhan Yojana, financial inclusion, etc). They do not take into account the fact that PSBs were asked to finance infrastructure projects in the2004-09 boom while private banks focused on retail finance.

Once you make all these adjustments, you will get a different picture. One or two things are fairly certain. All private banks will feel the impact of the Yes Bank collapse. (The Maharashtra government's decision to withdraw funds from all private banks, if imitated by other state governments, is sure to have private banks reeling.). Two, given the shock to the banking system, any privatisation or even a fall in government ownership below 50 per cent is off the table for now.

More in my article for Bloomberg Quin, Yes Bank Revival is a Formidable Challenge.

How intelligence agencies use businesses as a cover

America suspects that Huawei, the Chinese telecom firm, could be used for espionage. It has good reason to do so, given that it has a long history of using businesses as a cover for its operations.

Schumpeter has a piece on the links between intelligence agencies and the world of business. The classic example he gives is of a CIA-owned company that produced cipher machines. Governments bought the machines not knowing that their secret communications would be read by America's spying agencies:

By the 1990s it was apparent that the firm (Crypto AG)was in bed with the National Security Agency (NSA), America’s eavesdroppers. The truth, it turns out, was even more remarkable. From 1970 to the 2000s, at least, Crypto AG was wholly owned by the CIA and, until 1993, the BND, Germany’s spy agency, according to the Washington Post. “It was the intelligence coup of the century,” crowed a CIA report. “Foreign governments were paying good money…for the privilege of having their most secret communications read.”

 Schumpeter cites other instances:

In the 1970s, at the height of the Troubles, the British Army established a brothel and launderette in Belfast. Not only could soldiers use laundry vans to move around discreetly, but IRA suspects’ clothes could be tested for explosive residue (both operations were eventually exposed and shot up). MI6 similarly operated a bogus travel agency that would lure republicans to Spain with free holidays, where they could be recruited as double agents. In the 1980s Mossad, Israel’s spy agency, ran a Sudanese beach resort that was used to smuggle out thousands of Jews from neighbouring Ethiopia.

The intelligence agencies also work closely with genuine businesses, often planting their people as employees.  This enables spies to travel freely as corporate executives instead of having to produce fake covers. Schumpeter makes the astonishing disclosure that Soviet double agent Kim Philby worked as a correspondent for the Economist in the Middle East shortly before his defection.

Businesses get paid for cooperating with the intelligence agencies. Schumpeter notes that America's telecom firms have been paid hundreds of millions of dollars for cooperating with the government. Intelligence agencies also provide useful information to companies for their help, information that could given them an edge over competition.

The links between intelligence agencies and the media have been well documented.Government departments are, of course, penetrated. One wonders now about their links with academia.

Storm over Trump nominee for Fed Governor, Judy Shelton

Shelton the charlatan, wrote economist Bradford de Long. Shel-no, commented the Economist. This is no way to run a central bank, pontificated the New York Times.

When the establishment gangs up against somebody as solidly as it has done in the case of Judy Shelton, one of two individuals nominated for Fed Governor by President Trump, you begin to suspect there must be something faintly right about her.

Shelton is not an economist. She has a doctorate in business administration. She was appointed Executive Director to the EBRD by President Trump. She was written extensively on economic matters- and quite well, I might add.

What do Shelton's critics have against her? They say she has in the past favoured a return to the gold standard- this makes her seem archaic. They argue that she has changed her views on the Fed's policies several times. She was against monetary loosening a few years ago. Today she favours loosening. She was opposed to the Fed supporting stock prices a few years ago. Now she wants the Fed to do just that.

Well, it's been pointed out that Ben Bernanke himself has spoken favourably about the gold standard at one point. Policy prescriptions can change as economic conditions change. It's not clear that these are sufficiently strong arguments against a nominee for the Fed.

No, the reason that many in the establishment are up in arms against Shelton is that she has challenged a key tenet of the establishment, namely, central bank independence. Shelton has said:

How can a dozen, slightly less than a dozen, people meeting eight times a year, decide what the cost of capital should be versus some kind of organically, market supply determined rate?. We might as well resurrect Gosplan ( the agency of the Soviet government that ran its economy.). 

You can see what gets the goat of the technocratic elite that runs our financial system.

Central bank independence, at the very least, means that monetary policy is set by technocrats insulated from political interference. The idea is that politicians are driven by short-term considerations, such as winning elections, whereas technocrats can afford to take the long view.

Well, maybe, maybe not. Technocrats do have political leanings and loyalties and may want to tailor monetary policy to favour a particular party at election time. Leaving aside voting preferences, central bankers do have views that are politically important. They may favour low interest rates and how stock prices because they have had links with financial firms (or want to hop on to cushy posts in financial firms after they retire). There is nothing apolitical about decisions on money supply.

Money is a public good. And banks, because they enjoy the public safety net, have a public dimension to themselves. The supply of money and the stability of banking are matters that involve the larger public good. Is there any reason why these matters should not be subject to political direction when most other matters in the public realm are? In other words, has the time not come to democratize central banking especially when the track record of central bankers before and after the global financial crisis has not exactly been exemplary?

Many are asking these questions. Shelton's problem is that she asks these questions and wants to get on to the board of Fed.

World Bank chief economist departure

I guess I picked this up a little late... the World Bank's chief economist Penny Goldberg, who's from Yale, is quitting.

While the departure was reported to be over the Bank's decision not to publish a paper produced by its research department, the precise details were not know. The FT today  enlightens us on the subject.

The paper, authored by a World Bank staffer and two academics, was about how aid given by the Bank to countries was creamed off by the elite. This is hardly a secret. But for the Bank to substantiate the point with research is clearly to too hot for the Bank's top brass and its principal shareholders.

The link I have provided gives the details of the research paper. The authors looked at aid flows to 22 most aid-dependent countries, flows from those countries to tax havens and also flows from those countries to non-tax havens. They found that periods of large aid flows to a country also saw large flows from the country to a tax haven. At the same time, there was no such surge in flows to non-tax havens.

This is not conclusive proof of the aid being creamed off but it's also not evidence that you can shrug off. The study estimates that 7.5 per cent of the aid leaks out. That may not take away the case for aid to the country- there's still a large portion that could benefit the people there. But it's clearly embarrassing for the Bank to accept that it is abetting corruption in aid-receiving countries. Also, there could be political reasons for the Bank's principal donors to keep the dominant elites in some countries happy.

Goldberg's departure follows the departure in2018 of David Romer following a quarrel over the use of some statistical methods. One should not be surprised if this causes top economists to think twice about spending time at the Bank.

Goldman Sachs woes

Goldman Sachs, prima donna among investment banks and once the darling of investors, is today a laggard in stock performance, the Economist says.  A dollar invested in Goldman in 2010 would today be worth just $1.60; the same dollar invested in the S& 500 would be worth $3.60.

Investment banks produced higher returns in the past than commercial banks. Today, J P Morgan Chase earns a return on equity of 19 per cent whereas Goldman earns only 11 per cent.

Well, one should not get carried away by the example of J P Morgan; banks in Europe and many in the US produce a return on equity of less than 10 per cent. Goldman's performance is still good but it's not the star it used to be.

One reason, as the Economist points out, is that trading, which typically produced the lion's share of profit for investment banks, today requires far more capital than before, thanks to tighter regulations. It isn't just that. One imagines Goldman would be subject to restrictions on proprietary trading under the Dodd Frank Act. Proprietary trading is where Goldman used to make enormous profit. Moreover, a bank with a strong retail franchise, such as JP Morgan Chase, would have greater access to lower cost funding the form of retail deposits than Goldman.

Goldman is trying to boost returns by trying to expand its consumer finance arm with the help of technology. This is useful but it has its limits: you need a solid branch network to reach out to retail customers, digital alone won't be enough. Another response could be to reduce dependence on trading profit and to try to boost fee income through more debt and equity placements, advisory services, etc.

A fundamental problem for firms such as Goldman is the culture of high pay and bonuses. Despite falling returns, investment banks have been loath to cut back on pay. Until this changes, it may be difficult for them to boost shareholder returns significantly.

LIC disinvestment is not a great idea

The FM's announcement in the budget about LIC going in for an IPO was roundly cheered by market analysts. Apart from the fact that it is intended to fetch Rs 90,000 crore in revenues to a cash-strapped government, analysts lauded the move saying it would lead to greater transparency and improved governance.

Now, 'transparency' and 'better governance' are things it's hard to argue with. However, it's worth remembering that these are not ends in themselves. In the context of a commercial institution, they are meant to result in better performance and outcomes.

The case for an IPO at LIC must, therefore, be that it's under-performing at the moment and that an IPO would result in better performance. This is simply not true. LIC is an outstanding performer, judged by any criteria one would like to apply to an insurance company. The entry of private companies into insurance, far from undermining LIC, has led to a surge in sales volumes. LIC still commands 70 per cent of the market for insurance premiums. It offers returns on annuities that hardly anybody in the market can match. And it is financially sound.

LIC has achieved these outcomes while performing a larger social role. It intervenes to support the markets where required. It is a big investor in public sector banks and is now the majority shareholder in IDBI Bank. It has a terrific reach in the yet under-served rural areas. LIC's social role has not   come in the way of commercial performance.

There's no case, therefore, for LIC being listed on the exchanges at this point- you can't seriously say that listing is necessary in order to improve outcomes. What listing would do is call into question the larger social role that LIC performs. We still need an institution that can support the market given the fickleness of foreign investors. Until a measure of stability returns to the banking system, it would not be wise to list LIC as retail and institutional shareholders could challenge its socially-driven actions as inimical to shareholder interest.

The only reason for listing LIC is that it will fetch enormous revenues for the government. That's not a good enough reason for an institution as vital and vibrant as LIC.

The good news is that listing LIC would require parliament to amend the LIC Act. LIC unions are opposing the move. Valuation of LIC and other steps required for listing would take a couple of years, so it's unlikely that the listing will happen in FY 2020-21.

Frontline carries a good article on the subject.

The bombing of Dresden

On February 13, 1945, as war against Germany was nearing its end, 800 Allied bombers mounted a raid on the Germany city of Dresden at around 10 pm.The next wave came at mid-night. The third one came the next morning. Three raids in the space of fourteen hours. The city was reduced to rubble. A firestorm swept through the city.

The casualties are a matter of dispute. The controversial British historian David Irving  claimed that as many as 200,000 could have died. Official estimates are closer to 25,000. It was hard to estimate casualties because the city had had an enormous influx of refugees who were fleeing the Soviet  army advance to the East.

Dresden was thought to have little importance as a military or industrial centre. Its claim to fame was more as a cultural centre. Many writers have contended that the intention was to terrorise the German population and force a surrender on the Hitler regime that was still putting up a tenacious fight. Some have called it a war crime. Others say that there was military objective, which was to disrupt communications in the region and prevent the flow of troops to the Eastern front.

Dresden was not unique in the savage treatment it had received. Berlin, Hamburg, Tokyo and other cities were severely bombed.  Then, we have the nuclear bombs dropped on Hiroshima and Nagasaki. Nevertheless, the bombing of Dresden will be forever remembered as a symbol of the savagery of World War II. Here is one appraisal of the event and here is another.

Fiscal deficit target is now a mirage

The fiscal deficit target of 3 per cent of gdp was supposed to be met by March 2008. It won't be met by March 2023!

Several amendments and an 'escape clause' built into the FRBM Act in recent years has made it possible for successive governments to avoid meeting the target.

Is there an answer? I'm afraid not. We will keep muddling along until a global recovery helps improve the chances of meeting the target.

More in my BS article, Missing fiscal deficit target is in Budget DNA.

Clayton Christensen

Clayton Christensen, the Harvard professor who popularised the idea of 'disruptive innovation', passed away recently. Schumpeter pays him a in tribute in the Economist.

Schumpeter explains Christensen's contribution:

In a nutshell, Mr Christensen’s insight was that it is not stupidity that prevents great firms from foreseeing disruption but rather their supreme rationality. They do “the right thing”, focusing on better products for their best and most profitable clients, often to the point of over-engineering (how many Mach and Fusion blades does a chin need?). But that is “the wrong thing” if it blinds them to the threat from poorly capitalised upstarts offering cheaper stuff in markets too obscure to worry about. Such threats can swiftly turn existential if the rivals move upmarket and go for the jugular.

I am not sure that great firms focus merely on "better products for their best and most profitable clients". They are also trying to grab market share by reducing costs and the prices of their products. Take banks, for instance. When they manage to increase the proportion of low cost deposits in their liabilities, banks compete for the best companies and retail borrowers on price.

Secondly, the idea that companies are trying to improve their products without seeing challenges emerging from altogether new ways of satisfying the customer is not all new. Peter Drucker spoke about it long ago and Theodore Levitt elaborated on the same theme in his paper on 'Marketing Myopia'.

It may well be that, in the era of the Internet, Christensen's idea caught the imagination of large companies in a way that Drucker and Levitt had not. So, as Schumpeter points out, big firms have moved to buy up challengers as Google did with YouTube and Facebook with WhatsApp. But the idea that, in a market economy, upstarts are forever dislodging entrenched giants is an old one. As Schumpeter points out, disruptive innovation merely builds on Joseph Schumpeter's idea of 'creative destruction'.

Budget 2020-21

The positive in the budget is that government capital expenditure will be 1.8 per cent of gdp, higher than the average of 1.6 per cent we have seen in recent years.

The fiscal deficit target of 3.5 per cent of gdp is unlikely to be met. Disinvestment and telecom revenues are likely to fall short. No provision has been made for bank recapitalisation, my guess is some amount will be required. Expect fiscal deficit to end up at around 3.7 per cent of gdp.

None of the structural reforms mentioned in the Economic Survey have been addressed. There's no overhaul of governance in public sector banks, no mention of a Temaske-like entity for PSUs. ( I happen to think the latter is unrealistic in our situation). Status quo on land acquistion, labour laws.

There's more focus on specific projects in mission modes. That's where the PM excels, a prime example being Swaccha Bharat. Better to focus on projects that can make an impact on the ground instead of expecting a miracle on the macroeconomic front.

My detailed analysis in the Hindu of Feb 2.

Why we need dissent

There is much talk about 'intolerance'. It is said that we must tolerate dissent. We need to go further. We need to actively welcome dissent. And we must express dissent ourselves.

Many will agree. And yet, go to any meeting- in the corporate world, in government or anywhere else- and what do you see? People sitting through the meeting in silence, often looking for cues from the person in the chair. I have often got the feeling I am in the midst of audio-vocally challenged people.

Writing in FT, economics commentator Tim Harford says dissent is valuable because it often brings information that others overlook or provides a different perspective, which improves the solution to a problem vastly.
Harford gives a telling example:

A few days after Christmas in 1978, United Airlines Flight 173 ran into trouble on its descent into Portland, Oregon. The landing gear should have descended smoothly and an indicator light blinked on to indicate all was secure. Instead, there was a loud bang and no light. While the crew tried to figure out whether the landing gear was in position or not, the plane circled and circled. The engineer mentioned that fuel was running low, but didn’t manage to muster enough forcefulness to convey the urgency to the captain, who was focused on the landing gear. Finally, when the first officer said “we’re going to lose an engine, buddy”, the captain asked, “why?” The plane crashed shortly afterwards. Ten people died. The lesson: sometimes we can’t bring ourselves to speak up, even when lives are at stake.

But the value of dissent is seldom recognised. Leaders and groups want people who mouth the same views and agree on everything.

The challenge for any organisation to not just to tolerate dissenters but to encourage them. How do we do this? Perhaps we should begin at school- by teaching people not to conform. How about not telling children: Put a finger to your lips?

It's the financial sector, stupid

Any strategy for recovery must focus resolutely on the financial sector. It's the NBFC crisis on top of a banking crisis that explains the state of the economy.

Negotiating one's way out of a financial crisis is a tall order. It cannot happen with a snap of the fingers. And, sorry, it has  little to do with "structural reforms". Deleveraging of corporates and resolution of NPAs takes its own time even in economies with private banking systems and well developed markets for stressed assets. In a public sector dominated system in which asset reconstruction companies haven't taken off and resolution of bankruptcy is still in its early stages,  recovery will take longer. Perhaps 2021-22 is when we expect growth to return to 7 per cent.

In the meantime, there are some positive signs in the financial sector. The resolution of Essar Steel has finally happened and bankers are due to get back around Rs 42,000 crore. And bank-led resolution has received a boost with banks taking a hair-cut of 52 per cent and SBI leading an effort to provide fresh loans to the company.

More in my article, Green Shoots in the Financial Sector?

Letting IL&FS fail was a policy blunder

(I return to my blog after more than 18 months. Several preoccupations, both personal and professional, kept me away from it. I hope to be regular hereafter. -TTR)

In September 2018, IL&FS failed. The consequences for the economy have been serious. It's not quite a Lehman moment in that we have not had a recession . But it's Lehman-like in the blow it has dealt to growth. The deceleration in growth - from 7 per cent prior to IL&FS failing to below 5 per cent in the last quarter- coincides exactly with the collapse. I am convinced that the IL&FS failure is the primary factor in the deceleration- never mind the babble about the lack of "structural reforms" holding up growth.

As in the case of Lehman, I believe policy-makers did not quite grasp the enormity of the impact the failure of IL&FS could have. Also, as with Lehman, they were wary of bailing out an allegedly tainted private entity at the cost of the tax payer.

There's a problem that is rather peculiar to our polity.Wherever there is a failure or loss, the media promptly raises the war-cry of 'scam'. That sends the government into a deep freeze. We saw this played out in the case of IL&FS. Whether there was a scam at IL&FS needs to be investigated by due process. But the perception that had been a scam should not have come in the way of a rescue- that was a decision to have been taken solely on the basis of the potential costs to the economy of a collapse.

It does appear that the failure on the part of IL&FS shareholders to infuse capital to deal with liquidity issues that had arisen contributed to the failure of the firm. Whatever the mismanagement at IL&FS, timely infusion of liquidity may well have averted the collapse

More in my BS column, IL&FS was  a Lehman-like moment.

Banks have a fundamental cultural problem

Not a week passes by without some bank in being embroiled in some violation or scam. This happens in many economies and it happens to well-known banks as well as obscure banks. Banks seem prone to mischief. Their mischief often creates huge problems for the economy at large. How we do address banks' propensity to land in trouble. See my article today Banking's toxic culture.

Are simultaneous polls for centre and the states a good idea?

Don't miss the terrific two part article on the subject by former RBI Governor Y V Reddy (for once wielding his pen on a political subject). The first part's here and the second part here.

What are some of the arguments made for simultaneous polls. Here's a partial list:

i. The model code of conduct comes in the way of government enacting policies at election time and results in policy paralysis

ii. It's costly to have separate polls

iii. Economic growth suffers because of frequent elections


Reddy demolishes every one of these. If the model code of conduct is a problem, let's modify it suitably. Let governments go ahead and announce polls at election time but let the EC have a panel of independent experts pronounce on these for the benefit of the public.

Costly? Reddy shows that the government expenditure on elections is trivial..

Economic growth has had little to do with frequency of elections or rule by a government by a majority or a coalition government.

So why are the major political parties pushing for it? Data indicates simultaneous polls may work to the advantage of national parties and to the detriment of regional parties.

Simultaneous elections seems intuitively appealing. They provide stability for five years. But this could well come at the cost of greater accountability. It's not enough if the electorate expresses itself once in five years. Periodic voting in states provides valuable feedback to the government at the centre. Reddy quotes B R Ambedkar as saying that responsibility must be preferred to stability. He thinks simultaneous elections could spell the opposte: stability prevailing over responsibility.

Reddy points out that our greatest achievement is making the federal system work. The present proposal could undermine that achievement.

Quote of the day

US defense secretary James Mattis greets newly appointed National Security Advisor John Bolton with the words, "“I’ve heard that you’re actually the devil incarnate and I wanted to meet you.”

Bolton is a hawk on security matters- he favours a strike on North Korea and regime change in Iran. Mattis (known during his days in the army as "Mad dog Mattis") has been a sober influence in the Trump regime.  How Trump will manage two remains a mystery.

RBI direction to Axis Bank?

The ET report that the RBI has advised the board of Axis Bank to reconsider the three-year appointment it had given to its MD Shikha Sharma has created quite a buzz.The report suggests that the RBI would like the board to limit her re-appointment to one year during which period the board could look for a successor.

It's not unusual for the RBI to give directions to private bank boards but this typically happens where the banks are in deep trouble or there is grave misdemeanour. Axis Bank has had its share of NPA woes but it cannot, at this point, be said to fall in either category- unless the RBI has information that is not yet in the  public domain.

Axis Bank's performance has come in for scathing criticism. For instance, Bloomberg columnist Andy Mukherjee wrote in October 2017:

Sharma, who came to the bank as CEO in 2009, has overseen shareholder returns of 252%, less than the country’s Bankex index at 270%. On her watch, $250 million of bad loans has swelled to more than $4 billion, even as total assets merely tripled. Now, after the September quarter, annualized credit costs have ballooned to 3.16%. That includes a 1.42 percentage point bump due to the $250 million provision management had to make after the central bank caught its lie. As for that full-year credit-cost guidance, which the CFO was planning to lower in July, it’s now been raised to between 2.2% and 2.6%.

In 2017, when her term was renewed for a further three years from 2018 onwards (when it was due to expire), Sharma had already served as MD for eight years. Extending her term until 2021 would have meant that she would serve as MD for 12 years. That's too long for the CEO of a bank and it must happen only in the rarest cases. You need extraordinary performance to justify something like that. Otherwise, a ten-year term is the most one can think for a CEO in banking (or, perhaps, a CEO in any sector).

Sharma's performance, as we have seen, was quite ordinary. The RBI must, in its annual financial inspection, ask the Axis Bank board to explain what criteria it used for Sharma's appointment for yet another term. Was it the absence of an obvious successor? If so, it represents a failure on the part of the Board. It does not help matters that rumours have been swirling around that the Deputy MD of Axis Bank and the head of its Corporate Banking have tendered their resignations. If true, Sharma will have to leave in a year's time (going by the ET report) and there's no successor in sight.

So much for governance in private sector banks.

Paralysis in banking?

The political backlash to the PNB scam is taking its toll on public sector banks (PSBs). The resolution framework proposed by RBI is likely to make matters worse- most default cases will head almost by, well, default, to the NCLT. PSBs are being denied the capital they need and they are likely to be in a state of limbo while private sector banks steal market share from them.

This is happening because policy makers want this outcome. They want to shrink the role of PSBs and increase that of private sector banks. If the present government is returned to power in 2019, it will move to amend the Banking Regulation Act so that the government's share in PSBs can fall below 51%, thus paving the way for privatisation of at least some PSBs. Until then, however, the Indian economy will pay a price for PSBs being frozen where they are.

More in my BS column, The spectre of banking paralysis.

  

Hysteria over PNB fraud

The Rs 11,300 crore fraud has create something hysteria over conditions at PSBs. Make no mistake, the sum involved is large and we should be legitimately concerned. However, to use the fraud to make the point that all PSBs are rotten is quite a leap. It's hard to resist the feeling that the fraud is being used to create a case for eventual privatisation of some PSBs and for shrinking the market share of PSBs.

When it comes to frauds, ownership cannot be said to be the crucial factor- think of the colossal frauds that have felled or battered some of the best known banks in the world. And fraud is just one form of violation of regulations and laws. International banks  have been involved in numerous other violations in recent years- LIBOR rigging, exchange rate manipulation, mis-selling of retail products, etc. Public memory may be short-lived but those with long enough memories will recall that some of the principal players in the securities scam of 1992 in India were foreign banks.

More in my article in The Wire, Public sector banks don't have a monopoly over fraud.

RBI's Resolution Framework for Stressed Assets has serious issues

The RBI's revised framework for stressed asset resolution, released on February 12, has serious issues. The intention is to minimise negotiations between lenders and borrowers and to push most cases to the NCLT. This is, in my view, not the best course to  pursue. A negotiated settlement between lenders and borrowers is the best way to salvage valuable assets. Banks face a lethal combination of higher provisions and low recoveries as a result of the RBI's new framework.

My full article in BS:

Resolution framework will crimp growth

T T Ram Mohan


Enough of crony capitalism — that seems to be the tough message of the Reserve Bank of India’s (RBI’s) Revised Framework for Resolution of Stressed Assets released on February 12.

The RBI has scrapped the various schemes introduced over the years, such as Corporate Debt Restructuring, 5/25 Refinancing of Infrastructure, Strategic Debt Restructuring, and S4A. These were all ways of “kicking the can down the road”, that is, giving more time to promoters to make their companies or projects viable while keeping provisioning costs low for banks. The RBI seems to have concluded that these have not delivered — they only enabled promoters to retain control over assets while imposing heavier costs for banks at a later point.

Under the revised framework, bad loans are to be more quickly recognised and provided for. From March 1, for all loans above ~20 billion, resolution must commence within 180 days of default. Where banks and borrowers cannot agree on a plan within 180 days, resolution will happen under the aegis of the National Company Law Tribunal (NCLT). The defaulting promoters will stripped of ownership and control. Their assets will be sold to the highest bidder or simply liquidated.

The RBI is administering strong medicine to rid the banking system of the non-performing assets (NPAs) problem at one go. This is a laudable objective. However, the RBI must ensure that the medicine does not kill the patient. Resolution is best effected when economic growth is buoyant. Borrowers then have a better chance of returning to health and repaying loans. Lenders are better placed to absorb losses. The revised framework runs the risk of undermining the ongoing economic recovery and hence worsening the NPA problem in the very process of resolving it.

Why so? First, NPAs and provisioning in the banking system are bound to rise as more stringent norms kick in. Most of the ~1.53 trillion that public sector banks (PSBs) will get from the government over two years under the recapitalisation plan could end up being absorbed by provisions — and more may be required. There will be no capital to support credit growth.

Secondly, 180 days is too short a period for achieving resolution. The RBI could argue that banks have had enough time over the past two or three years to achieve resolution. But, then, banks lacked the capital to take the hair cuts on loans required to restore viability to projects. The present bank recapitalisation plan should have happened three years ago. Delayed resolution is largely the result of delayed recapitalisation. After providing capital belatedly, expecting bankers to arrive at resolution in 180 days’ time is a bit thick.

Thirdly, the requirement that all bankers should agree on resolution is unrealistic. The RBI must modify the stipulation to state that banks that account for, say, 75 per cent of the exposure must agree. Else, very little resolution may happen at the bankers’ end.

Fourthly, while banks are now free to do whatever it takes to achieve resolution, the old problem remains. Which public sector banker will take large write-offs of loans and risk investigation after retirement? The framework requires resolution proposals to get at least an investment grade rating from rating agencies. How does a banker decide whether he should get a minimum acceptable rating with a low write-off or a better rating with a high write-off?

The cumulative result of factors two, three, and four above will be that the vast majority of bad loans will head for the NCLT. This is bound to clog up the NCLT system. Besides, the NCLT process is yet to be tested. For the sale of assets to be worthwhile for banks, we need a large number of bidders. That is not the experience we have had in the assets so far put up for sale. There are reports of waning interest amongst foreign bidders.

As more and more assets come up for sale, there is every prospect that bidders will dry up. If there are no bidders, assets would have to be liquidated. This would be a disaster for banks — liquidation will fetch them very little. It would also be a tragedy for the economy — huge infrastructure assets that are stalled will amount to nothing.

Growth is the best elixir for an NPA problem. In the early 2000s, India had an NPA problem that was just as bad. We resolved it by growing our way out of it. Large projects that have been stalled for want of funds are an important factor constraining growth in recent years. So is inadequate growth in credit to the MSME sector.

Bank recapitalisation was supposed to be the key to reviving credit growth. In his Budget speech, Finance Minister Arun Jaitley claimed that the recapitalisation bonds of ~800 billion issued in 2017-18 would lead to additional credit of ~5 trillion. The markets cheered because they thought PSBs would grow credit and profits.

What’s happening on the ground is quite different. Eleven PSBs have come under Prompt Corrective Action (PCA). The finance ministry has given some of the PCA banks targets for <i>shrinking<p> their balance sheets in the next couple of years. The stronger PSBs, including State Bank of India, have already been hit by rising provisions. The RBI’s revised framework spells even higher provisions and poor recovery for banks. Credit growth cannot possibly revive under these conditions.

Over the past two years, demonetisation and the introduction of the goods and services tax created short-term disruption while promising long-term gain. Another policy-induced disruption is the last thing we need in 2018-19. The RBI must re-examine its revised framework. The government must plan for higher capital infusion into PSBs and rethink its idea of shrinking some PSBs.

EPW reviews my book on banking crises

EPW carries a review of my latest book, Towards a safer world of banking: bank regulation after the sub-prime crisis, by Sabri Oncu, a well-known scholar and financial economist.

Stalingrad anniversary

February 2 marked the 75th anniversary of the fall of Stalingrad. This was a big event in Russia, of course, with President Putin flying over to Volgograd (as the city is now named) to commemorate the event. But we heard nothing of this epochal event in India, partly, I guess, on account of the media's preoccupation with trivia.

Stalingrad was, perhaps, the decisive turning point of World War II. It showed that the Wehrmacht, the Germany army, was not invincible and that Hitler's opening an Eastern front could pave the way for his defeat. Following Stalingrad, the Wehrmacht lost the initiative and was mostly on the defensive on the Soviet front.

In Stalingrad, the elite Sixth Army of the Wehrmacht came to be decimated. Of around 300,000 soldiers in the city, 100,000 were captured and only around 9,000 made it back after the end of the war, the majority perishing as prisoners of war.

Much has been written about Hitler's conduct of operations in Stalingrad, whether he was right to take the city in the first place, whether the Sixth Army should have hung on after it was encircled by Soviet troops and so on.

Well, Hitler's plan was to seize the oil riches of the Caucus south of Stalingrad. The city was a key junction and supply point and hence needed to be held in order to safeguard the armies that had ventured south.

Hitler's strategy was right but it came unstuck because he had underestimated the strength of the Soviet Union. Hitler thought that once his armies tore into the Soviet Union, the government and its army would simply collapse. This did not happen. Stalin was able to throw endless numbers of troops at the Germans and Soviet industrial capacity was far greater than German intelligence had supposed.
These fundamentals could not be altered and were bound to assert themselves no matter what particular tactics Hitler followed in respect of operations in Stalingrad. The whole controversy about Hitler's ignoring the advice of his professional generals and allowing the Sixth Army to perish is  secondary to the fundamentals.

Russia Today has an interesting article on the subject.

Robert Parry, peerless journalist

Robert Parry, an outstanding American reporter, who fearlessly exposed the wrongdoings of those in authority, passed away recently. Our media is quite insular, so his passing went largely unreported in the Indian media.

Parry worked for the Associated Press and Newsweek among others. He was the man who uncovered the Iran-Contra affair in Reagan's time. This involved Israel selling arms to Iran in exchange for the release of hostages. Some of the proceeds of the sales would be diverted to the rebels fighting the Nicaraguan government. The US could not sell arms directly to arm as there was an arms embargo on Iran at the time.

Parry also exposed how Nixon had struck a deal with the Vietnamese to prolong the fighting so that Humphrey would not win the Presidential elections against him and how the Reagan administration colluded with drag traffickers (of all people). In recent times, he tenaciously questioned the Russiagate affair seeking to implicate Russia in the last US Presidential polls that saw Trump being elected as President.

Parry found himself marginalised in the mainstream US media, which, as everybody knows, works closely with the US establishment and the intelligence agencies to promote the establishment agenda. He had to start his own website in order to carry on with his work.

Here is one tribute to him and here is another.

One journalist paid him this tribute:

I would suggest that it is [an] underlying devotion to the plight of mankind which allowed Robert Parry to become Robert Parry. It wasn’t his connections, his political opinions, his ideas, or even his raw talent; it was the fact that he cared so much. The fact that he couldn’t dissociate himself from the horrors of this world, the evil things humans are doing to one another and the omnicidal trajectory we appear to be headed along. He saw it all, he felt it all, and he let it move him.

This is not typically what you hear about a journalist- from fellow journalists. 

Budget for 2018-19

The budget represents a setback to the fiscal consolidation process, something in which the NDA government has invested a lot. It isn't the revenue side that is a problem although non-tax revenue (dividends from PSUs, transfer of surplus from RBI) has disappointed. The main problem is on the revenue side. RE expenditure is 2.6% of GDP for 2017-18, higher than the projected 1.9%. Government establishment expenditure (such as pensions) is higher than expected. The compensation to states for GST loss is also imposing a large cost and this is to continue for a five year period.

At the end of the day, we are looking at a combination of  around 7% growth and a fiscal deficit of 3.5% of GDP for a three year period starting 2017-18. Not the happiest of situations to be in for the economy especially given that the world economy is buoyant. The situation could get worse if global economic growth is adversely impacted by a fall in asset markets.

So, what's the way out? Well, the budget papers provide a clue. The tax/GDP ratio of 11.6% in 2017-18 after having stagnated at around 10% of GDP since 2008. It is projected to rise to 12% and above in the coming years. Greater tax revenues provide a hope for a a turnaround in the economy- we can spend more while containing the deficit. And increased tax revenues will come not so much from growth as from tax buoyancy- better compliance, more people coming into the direct and indirect tax net, thanks to demonetisation and GST.

If this is how things play out, Modi will have been proved right in respect of both demonetisation and GST- the long-term benefits of these will have outweighed the short-term costs.

More in my article in the Hindu, Goodbye to fiscal consolidation.

Gujarat polls: BJP win quite remarkable

Yes, the contest has been closer than in 2012. Nevertheless, the BJP's win in Gujarat is remarkable. It comes after 22 years of BJP rule and it happened inspite of the BJP's willingness to steer clear of  assured vote-catchers such as farm loan waiver and quotas for particular groups, both of which the Congress resorted to.

There were reasons for the electorate in Gujarat to be unhappy- farmers, MSMEs, youth and others are unhappy with economic conditions. Nevertheless, they did not think it necessary to disturb the status quo. Gujarat has seen economic progress and the absence of caste and communal strife for over 15 years now, and voters seem to have judged that it's not wise to disturb this state of affairs.

More in my BS column: Gujarat and BJP: why discontent did not spell defeat