Corporate architecture

One of the things about post-reform India is that companies have spruced up their looks and environs. Go to the Bandra-Kurla complex in Mumbai and you get at least a faint whiff of Manhattan, with ICICI's headquarters standing out. Among campuses, Infosys must be one of the stars, each one meticulously designed and spectacularly well-maintained. But those who are more sensitive to architectural style than I am have a different view, and this is the subject of an Outlook feature, which is interesting read.

The main point is that many of our organisations seem to want grandeur in their buildings but are not very concerned about whether it is rooted in Indian sensibilities or the Indian environment. For instance, there is a readiness to go in for glass buildings regardless of whether these energy efficient or even aesthetically pleasing. ( In passing, Outlook must be among the very few in the media willing to take pot-shots at Infosys):

This September, two supposed marvels of institutional architecture were unveiled before the public. The first, in honour of the fast-approaching Commonwealth Games, was a Lutyens-style makeover—large white pillars and incongruous purple-black glass—for the Ajmeri Gate side of New Delhi railway station. The second was the spanking-new addition to the Infosys Mysore campus: the classical Greek architecture-inspired Global Education Centre-2 (GEC-2). Inaugurated by a radiant, admiring Sonia Gandhi who said she wouldn’t mind “bunking party politics” to study there, it was hyperbolically proclaimed by Infosys chief mentor Narayana Murthy to be “the largest monolith classical building of post-independent India”.

The GEC-2 might win the awe of its young executive trainees, and the New Delhi railway station the glancing attention (or dismay) of those hurrying through it, but these two buildings nevertheless throw up a few questions about the practice of institutional architecture in India. Is imitating the architecture of the past—including colonial styles intended to intimidate and subjugate us—really the way to engage a contemporary public? Why does institutional architecture in India invariably entail ransacking the past and reducing it to a bunch of carefully traced out columns and pediments? Is it possible to adapt historic references to modern uses in a responsible, low-impact manner?

Here is what one of the critics has to say about Infosys' latest wonder:

The GEC-2, to Burte, is a missed opportunity for Infosys to provide a counterpoint to the wasteful, power-guzzling, glass-faced cut-rate copies of Singaporean skyscrapers that have now become synonymous with IT sector buildings. “This overblown rhetoric is a letdown considering what we know to be Infosys’s progressive work culture, and their emphasis on a knowledge economy,” says Burte. “A low-impact, climate-sensitive, energy-efficient, sensible building; a vision of sustainable corporate living and working, would be commensurate with the image we have of them.”

Another critic concludes that our latest buildings are a comment on national character:

“Right now, we see ourselves as second-rate; our approach is just to play catch-up to other cultures—the Chinese, the Europeans, or Lutyens. It’s about time we followed our own instincts.”

Rating agencies and Indian debt

India has always received a raw deal from rating agencies. This carries a cost to the country. India's present sovereign rating of BBB implies that Indian companies will rate lower and hence pay highs spreads over the risk free rates. Taking into account outstanding ECBs and NRI deposits and assuming that they cost 2 percentage points more than they should, Jaimini Bhagwati estimates that the additional forex outflow to India on this account is $2 bn annually.

Of the rating of BBB for India, Bhagwati writes:

Is it really credible that as of November 2009, the Government of India (GoI) has a higher probability of defaulting, over a five-year horizon, on its external debt obligations as compared to Enron four days before it went bankrupt or Lehman in the second week of September 2008? Currently, the GoI’s BBB– rating is the same as that of Iceland and the UK is rated triple A while China is placed at A+. Are countries rated higher if they impose fewer controls on their capital accounts? Clearly, the answer is that CRAs do not have the answers. One way forward could be for India to push for discussions about perceived anomalies in sovereign ratings in FSB and BCBS forums. Since rating agencies serve a quasi-regulatory function, we could seek the setting up of a multilateral CRA.

More flak for Goldman

Goldman Sachs is set to pay out record bonuses. Its employees should be thrilled and not thrilled. The latter because the bonus payment is likely to comes as a climac to a period that has turned out to be a PR disaster for the once-admired financial giant.

Goldman's soaring profits are today perceived as unfair- the result of implicit taxpayer guarantees and the demise of competitors such as Lehman and Bear Stearns. They are somehow not seen as legitimate reward for success. In the US, a rash of agitations has broken out against the firm. Goldman CEO, Lloyd Blankfein, did not help matters by claiming that he and his firm were doing 'God's work. This remark added various sections of the clergy to the firm's critics.

Blankfein said his remark was meant to be a joke. This points not just to a poor sense of humour but to poor judgement- the public is in no mood today to listen to jokes from Goldman top brass. Blankfein also apologised for the firm's role in the present crisis and the firm promised a commitment of $500 mn towards financing small businesses. But these moves have done little to assuage popular anger.

FT has an article that analyses the principal reasons for the firm's success for so many years now:

Goldman’s stellar performance has been built on two main strengths: a long-standing commitment to making money as a firm rather than a collection of individuals; and a daring boldness in trading and regulatory matters.

....The theory is simple: unlike other banks, where star traders routinely overrule lowly compliance officers, at Goldman the two roles have equal status. “The risk management side is just as powerful as the risk-taking side,” says a former executive. “If a trading desk makes $35m in a week, the attitude at other firms is to let these guys do whatever they want. At Goldman it is: ‘What am I missing?’ ”.

......By cultivating trading and advisory relationships with thousands of companies and investors, Goldman gains knowledge it uses to inform its own trading.

Banks are banned from “front-running” – using specific information provided by clients to trade on their own account before they act on behalf of customers. But they can, and do, use aggregate information, “market colour” gleaned from their interactions with investors, hedge funds and companies. By virtue of being the world’s largest and best-connected trader, Goldman has turned this into an art that has raised rivals’ eyebrows but not sparked regulators’ attention.

So, what does it add up to? Good people and risk management, of course, but also superior information and networking. In the present environment, add implicit government backing and weaker competition. The short point: profits at Goldmanare not driven exclusively by superior skills. Hence the widespread public hostility.

Goldman may look invincible for now. But a basic truth can't be wished away: business cannot succeed in the face of hostility. Just one false step somewhere and the regulators, politicians, media and the social sector will come down on Goldman like a ton of bricks. The biggest challenge for the firm is softening popular anger. It's doubtful that a deep-rooted culture can change sufficiently for the purpose.

HRD panel for PSBs

This is the best news PSBs have, perhaps, had in a long time. The government has constituted a panel headed by BoB ex-CMD A K Khandelwal to look into various HRD issues at PSBs. It is a timely move because PSB unions are planning a march to parliament next month and a strike in support of various demands, including strengthening PSBs.

Apart from a status report, the committee’s mandate include preparing an action plan on how to professionalise 27 public sector banks. Besides, the government wants to work out a system of succession plan at these banks, which often have to do without a chairman for months altogether.

In addition, the committee has been asked to recommend how the banks should go about preparing their recruitment plans and whether it was desirable to follow common hiring and HR practices across all these banks, accounting for nearly 75 per cent of the business carried out in India.

I am pleased because I have made the argument for constituting an HRD panel for PSBs more than once in my ET column and I have been shouting that HRD should be the no 1 priority for PSBs, not consolidation or overseas branches or getting into new areas such as insurance. My argument is simple: until you have strengthened HRD at PSBs, don't even think of other things. What has galvanised the government into action is the prospect of nearly three fourths of senior management at PSBs retiring by 2012. I only hope this is not a case of too little, too late.

I hope the committee doesn't get sidetracked into issues like performance-linked pay. I am extremely sceptical - as many academics are- about the merits of variable pay even in the private sector. In the public sector, it could be a disaster. Those at the helm need to realise one thing: you don't compete through imitation.

Fresh bout of disinvestment

Hopefully, we should soon see a fresh bout of disinvestment, with several unlisted PSUs being brought to the market. That's very good news. Not because it will help contain the fiscal deficit, as some commentators have rushed to point out. The fiscal impact of disinvestment tends to be exaggerated. Its real value lies in its potential to bring about greater commercial discipline through listing on the stock exchange.

Disinvestment helps improve performance when combined with competition and better board room governance. Liberalisation has taken care of competition. More needs to be done on board-room governance in PSUs. Unlike in the private sector, there is scope for doing a great deal more, as I argue in my ET column, Disinvest for better governance.

Tackling asset bubbles

There is a sense that we have to do something about asset bubbles in order to prevent major financial disruption although it's not clear what is to be done and at what point. Frederic Mishkin, writing in the FT, draws a distinction between "credit bubbles", which are driven by excess bank lending, and "irrational exuberance", such as the boom in IT stocks in 2001. The former are a problem, he says, because they endanger banks. The latter are ok, some investors get burnt, that's all.

Right now, Mishkin argues, the US does not face a credit bubble although various asset prices may have shot up. Credit is, in fact, in short supply, so monetary tightening would be premature.

I am not entirely persuaded about this distinction. Take a stock market bubble. It could be driven, not by excess domestic credit growth, but by a surge in foreign inflows. Does this need to be tackled or not? A sudden withdrawal of foreign funds could cause the stock market to collapse and it may derail investment plans of companies to which banks are exposed. Domestic bank credit has not driven the stock bubble, yet banks could be imperilled.

Of course, the central danger to guard against is bank exposure to risk assets- real estate, stocks and commodities. But, it's not necessary that banks are at risk only from bubbles caused by excess credit. There could be an indirect impact on banks from the collapse of bubbles for which banks are not primarily responsible. Corporates' overseas borrowings, which find their way into the domestic market, for example.

Some bubbles may be more dangerous than others, as Mishkin points out, but all bubbles may need watching.

Rich pickings for independent directors

Naresh Chandra, former cabinet secretary, made a cool Rs 2 crore from his independent directorships last year, according to an ET story. This included Rs 75 lakh from Vedanta. Omkar Goswami, the economist, raked in Rs 1.3 crore. Deepak Satwalekar, formerly of the HDFC group, and Rama Bijapurkar, marketing consultant, are among the big earners.

Not to grudge anybody their earnings but has there been any attempt to evaluate board performance and contributions of board members? And what is an optimal level of payment for board members? When payments are too low, you can't get good people. Whey they are too high, you can't expect independence.

I don't have the answers. But I am surprised these questions aren't being pursued. I guess it suits all concerned not to be asking these questions.

Indian corporate sector's lip service toeducation

India's corporate sector bemoans the lack of investment in education and the resulting skill shortages. It talks of education a a great opportunity. Businessmen have been quick to latch on to money-making opportunities in professional courses- engineering, medicine, management. But their commitment to producing first-rate educational institutions has been zilch, as Devesh Kapur points out in TOI.

The commitment of Indian business to philanthropy in higher education was strong prior to independence and has dwindled ever since. Pre-independence, business interests not only made the transition from merchant charity to organised professional philanthropy, but did so in a significant way. They created some of India's most enduring trusts, foundations and public institutions, including the Aligarh Muslim University, Banaras Hindu University, Jamia Millia, Annamalai and Indian Institute of Science. Of the 16 largest "non-religious" trusts set up during this period, 14 were major patrons of higher education.

Today, the so-called not-for-profit educational institutions do not engage in philanthropy. Their income comes from fees rather than endowments and investments. Thus even while the number of "trusts" set up for philanthropy in higher education has been steadily rising, the total share of "endowments and other sources" in higher education funding has been consistently falling - from 17 per cent in 1950 to less than 2 per cent today. Some of this decline is to be expected, as the government has expanded its role in higher education, yet the extent is remarkable.

So, what is the implication for policy? If we accept that quality in education exists only in the non-profit model and Indian business is not interested in this model, how do we produce quality education? The answer, it would seem, is a combination of higher investment by government and foreign universities. I have my doubts about foreign universities coming in entirely on their own: their cost structure would make it difficult for them to provide mass education. Perhaps, central universities and the proposed national universities forging partnerships with foreign universities may be a solution.

Greater government investment would also require putting in place proper governance mechanisms. This does not mean leaving matters to academics or 'autonomy' as interpreted by some IIT and IIM faculty, which means boards run by professionals, with government keeping a distance. This hasn't worked and it won't work, as I have argued ad nauseam in my posts. The proposed collegium for IIMs and the pan-IIT council are the sort of mechanisms we need but much work needs to be done to make these effective.

Cash transfer versus NREGS

NREGS, the national employment scheme, drew a lot of flak when it was first introduced. It has since received some grudging credit and its critics have at least recognised the value of the fiscal stimulus it has provided.

The standard argument against NREGS, which is also the argument against subsidies, is that it is better to make transfers to a carefully targeted segment, namely, the BPL category. If you spend Rs 100 on the NREGS, Rs 20 will be siphoned off, Rs 30 will be spent on administration, Rs 20 on materials, which will be wasted because of poor quality of works, and only Rs 30 will reach the poor as wages. Far better to transfer Rs 30 to designated accounts.

Tushaar Shah addresses this argument in an article in TOI.

The NREGS launch in 2006 had created a widespread impression in many parts of rural India that it would eventually end up as a cash transfer programme. Many people believed the job card-holder household would be entitled to an annual cash transfer of Rs 10,000. This is why numerous well-off households and local bigwigs, including village sarpanchs, acquired them.

NREGS design - guaranteeing 100 days' unskilled manual work toany household, rich or poor, willing to do such work - minimises type II error. Even if the rich acquire job cards, they can benefit from NREGS only if they are ready to do unskilled manual work, which they are generally not. NREGS self-targets the needy. The BPL card, ration card and NREGS job card under cash-transfer denote entitlement, not what their holders do. That NREGS reduces type II error is evident in the fact the number of households registering for work that is much smaller than that of job card-holders. Again many NREGS projects remain unfinished and funds are returned because those who registered for work do not show up. This would hardly be the case if all job card-holders were automatically entitled to Rs 10,000 deposited in their accounts.

There you have it: cash transfers would amount to looting by the powerful in the countryside. Those who advocate it have no clue as to how things work in the countryside. Shah concedes that poor quality of works is an issue. But this needs to be addressed through better governance. Indeed, that is an argument I would make for NREGS, that by mobilising NGOs and other agents at the grassroots level, it becomes a powerful tool for improving governance.

One aspect of NREGS is that the access to information on the scheme is superior to what would be provided under the RTI Act. To make NREGS-based works worthwhile, we have to bring about greater accountability at the grassroots. It is a challenge, of course, but the effort is worth it, quite apart from the purchasing power it confers on the poor.

Novel suggestion on bank bonuses

Even that paragon of the free market, the Economist, has joined the chorus against bank bonuses. I suppose you could call that progress in thinking after the sub-prime crisis.

Banks argue that they have repaid government capital, they need to retail talent, that management pay is for shareholders to approve and that the government, the media and the public should stay out of it.

The Economist makes the point that the top ten investment banks at the start of 2008 made an average return on equity of just 8% between 1999 and 2008. Four made cumulative losses. Staff got four times as much as shareholders did in profits. So, bonuses are at the expense of shareholders.

Moreover, banks are handing out large bonuses to employees while arguing that higher capital requirements would be too onerous for them! In a free market, you could still argue that these are matters between management and shareholders and that the government and the public should stay out of it. But this is not a free market situation: the banks have been bailed out by tax payers and- more, importantly- still enjoy subsidies:

It is not just that they were saved from destruction. They got public capital (much of it now repaid), short-selling bans on their shares and rescues of counterparties, such as American International Group, which the public otherwise had no interest in saving. Today they enjoy laxer accounting, loose collateral rules at central banks, explicit debt guarantees and asset-purchasing schemes. And, critically, they can borrow cheaply because they are deemed too big to fail. All of them—from comparatively healthy Goldman to the nationalised weaklings—are being subsidised by the rest of us. As a way to keep cash flowing to the wider economy and help banks rebuild their capital, this subsidy made sense; nobody intended it to go to employees.

<>If we accept that outsized bonuses, courtesy of public subsidies, are just not on, how do we deal with them? The popular solution is to rein in bonuses. The Economist thinks this won't work and it will lead to micro-management by government. It proposes an alternative:

Assume that America’s top five investment banks would pay two percentage points more on unsecured borrowings without an implicit guarantee. On that basis the subsidy is $36 billion a year (compared with pay this year of perhaps $120 billion). Providing banks have built up adequate capital, they could face a funding “premium” in much the same way that they already pay premiums for deposit insurance......The premium would last at least until the state guarantees are withdrawn. The longer-term debate may yet move from wishy-washy living wills to breaking up banks (as the governor of the Bank of England suggested on October 20th—see article).

Management gurus

The Schumpeter column of the Economist mentions three irritating habits of management gurus (the number is a sarcastic reference to these gurus' penchant for reducing all topics to a given number of 'easy steps'):

The first is presenting stale ideas as breathtaking breakthroughs. In a recent speech in London Mr (Stephen) Covey declared capitalism to be in the middle of a “paradigm shift” from industrial management (which treats people as things) to knowledge-age management (which tries to unleash creativity)......But management gurus have been making this point for decades. William Ouchi announced it in 1981 in the guise of “Theory Z”. Elton Mayo and Mary Parker Follet had made much the same point 60 years before. It makes you long for some out-of-the-box thinker who will argue that the future belongs to companies that are unfit for human beings (which it may well do).

The second irritating habit is that of naming model firms. Mr Covey littered his speech in London with references to companies he thinks are outstandingly well managed, including, bizarrely, General Motors’ Saturn division, which is going out of business. Tom Peters launched his career with “In Search of Excellence” in 1982. ...............Five years after “In Search of Excellence” appeared, a third of its ballyhooed companies were in trouble.

The third irritating habit is the flogging of management tools off the back of numbered lists or facile principles. .............But most of these rules are nothing more than wet fingers in the wind. Gurus preach the virtues of “core competences”. But in the developing world many highly diversified companies are sweeping all before them.

Which points to the most irritating thing of all about management gurus: that their failures only serve to stoke demand for their services.

The article also points out that one of the gurus' fecundity is not confined to the literary realm:

Mr Covey is working on nine other books, including one on how to end crime. He also presides over a business empire that is even more sprawling than his ever-growing family (he had 51 grandchildren as The Economist went to press)

My own view on management gurus is that there is only one original in the business and that is Peter Drucker. He said whatever needed to be said on the subject. The rest is elaboration, refinement or just plain repetition.

New paradigm for lending rates

Banks don't seem to get their pricing of loans right- and not just banks in India. In India, the RBI has had in place norms for computation of the BPLR since 2003. But this has given risen to several distortion: sub-prime lending is rife (70% of all loans), borrowers grumble about lack of transparency and lending rates rise quickly when policy rates rise but are sticky in the downward direction.

The RBI constituted a working group on BPLR last June, of which I was a member. The group submitted its report on October 20. I have brief exposition of our approach in my ET column.

Corporate suicides

France Telecom has had a rash of suicides, the Economist reports, 24 suicides since 2008. The reason? It is making the transition from state monopoly to MNC and at least new recruits don't enjoy job security.

The Economist notes that corporate suicides are an extreme expression of a pervasive problem: unhappiness at work. It provides some reasons:

The most obvious reason for the rise in unhappiness is the recession, which is destroying jobs at a startling rate and spreading anxiety throughout the workforce. But the recession is also highlighting longer-term problems.....A second source of misery is the drive to improve productivity, which is typically accompanied by an obsession with measuring performance....A more subtle problem lies in the mixed messages that companies send about loyalty and commitment. Many firms—particularly successful ones—demand extraordinary dedication from their employees. (Microsoft, according to an old joke, offers flexitime: “You can work any 18-hour shift that you want.”)

So, what can be done? More rights for workers, better HR, better communication... well, yes. The article also suggests that Europe's demographics - falling birth rates and caps on immigration- will strengthen employees' bargaining powers.

All this is fine. But, there is a simple fact that the article seems to overlook. People are unhappy in their jobs because they are doing things they don't really like. This is true not just of managers but of lawyers, doctors and other professionals. Society trains people to survive and be successful, not to pursue one's true vocation. In the performing arts, one often finds people supremely satisfied even though people are not financially well off.

So, of course, we need to improve the work culture and HR. But, the secret of happiness in one's job lies ultimately in doing what one enjoys doing.

Regulating Goldman Sachs

John Gapper, writing in FT, makes three suggestions for regulating Goldman. One, hive off private equity and hedge fund from Goldman but allow market-making and investment banking activities to continue. Two, allow it to fail in future. Three, revert to the compensation structure Goldman had when it was a partnership- that is, 90% of all bonuses to be retained until retirement. Then, top managers cannot cash out even while placing the firm in jeopardy.

I think one and three are good suggestions although the difficulty with three is that it cannot be applied only to Goldman- you would need an industry-wide norm. It's the second that poses a problem. How do you regulate Goldman so that it is allowed to fail? I can't see any easy solution.

It's interesting, though, that Goldman today makes little money from proprietary trading- only 10% of revenues. The biggest money-spinner is market-making and, there, Goldman is not betting its own money. The basic principle that Gapper espouses is a sound one: there has to be some restriction on the scope of activities of firms that have the backing of taxpayer money in principle.

Mervyn King favours narrow banking

Bank of England Governor Mervyn King has added fuel to the debate on bank regulation by favouring the break up of banks so that deposit taking and payments are clearly separated from riskier trading and other activities, FT reports.

In doing so, King has taken a position opposite to that of the UK Treasury on the subject. One corollary of limiting the scope of banks' activities is that it will automatically make banks smaller and more manageable. My own view is that, since this approach may not be practical, it would be better to limit the size of banks.

The current thinking, especially in the US, is to focus on more stringent capital requirements for large banks so that there are disincentives for getting too big. I have argued this won't work- and King appears to be of the same view.

More Goldman bashing

One rival Wall Street executive describes Goldman (with rueful admiration) as “a bunch of clever thugs”. He means that Goldman has been tough about seizing profitable opportunities even if that involves, for example, bidding for an asset against a former client.

The above from an FT article, the latest in Goldman-bashing. Goldman thinks it's free to do what it likes because it has returned the government capital of $10 bn infused last year. Not true, as the article points out. When it got capital, Goldman was an investment bank. Today, it is a bank. Goldman today is a high-risk institution gambling with people's money. That is not an internal problem of Goldman, it is a systemic issue.

Dealing with asset bubbles

Everybody now talks of 'macroprudential surveillance', which is monitoring systemic risks in order to prevent a major crisis. Is this feasible? Is it possible for central banks to meangingfully use financial stability as a goal in addition to price stability? The IMF's World Economic Outlook (October 2009) has an analytical survey. I comment on it in ET column, How to respond to asset bubbles.

The IMF's analysis suggests that having financial stability as an additional goal is not easy to implement. But the RBI has long had it as an objective. How come? Well, if you do have financial stability as a goal, then you are liable to intervene in a high growth phase even if that means sacrificing some growth. In other words, not intervening carries the risk of financial instability but intervening could mean losing out on growth. Advanced countries will tend towards the former because they can take occasional setbacks in their stride. Not so less developed countries- they don't mind sacrificing some growth but they just cannot afford financial instabilty.

In the near future, because nobody wants another major crisis, expect policy makers to intervene even while economists struggle to refine their understanding of what constitutes an asset bubble.

Significance of Kaminey

I haven't seen Kaminey (although I have seen the other film with which it is compared, Satya) but did the next best thing, which is to read a critique of it in EPW. Reading reviews is a very sensible way of sounding knowledgeable about movies without having to take the trouble of seeing them- I practise this technique very effectively with books as well.

The author sees Kaminey as marking a new trend in Bollywood- the celebration or even glorification of criminality:

Urban criminals, until the mid-1990s, were not glamorous figures in Hindi popular cinema, and only people led astray (as in Deewar 1975) became criminals. The film that changed this was perhaps Ram Gopal Varma’s Satya (1999). Satya appeared “realistic” but had a discourse interpretable in the context of the economic liberalisation initiated by P V Narasimha Rao and Manmohan Singh in 1991-92, which also marked the end of Nehruvian socialism. Law enforcement has been treated in different ways by Hindi cinema but Satya was the first film to treat the police as though they were no different from a private agency, made stronger by their indifference to the law.

......There are key dissimilarities between Satya and Kaminey and the chief among these is that while in Satya there was still a world outside the underworld, in Kaminey the underworld is the world and it would appear that everyone is somehow implicated in criminality.

In other words, the film takes the line that not only do you get away with flouting the law, it is almost a condition for success in the world. To do otherwise is to be pretty dumb. Only a complete disregard for law and scruple can produce success. It's painful, I guess, to see this portrayed but is the reality very different?

The author highlights the fact that the movie has been more successful in urban areas than elsewhere and that it has been better received in theEnglish media than in the language press. He interprets this to mean that its values are more reflective of those of the middle and upper classes than the lower classes. He links the decline in values to the way economic reforms have been pursued:

Even if one concedes that freeing the economy from the shackles of control was a good thing, it would have been appropriate at that point to strengthen enforcement in areas where intervention was still necessary. This, unfortunately, did not happen and India today is an enforcement nightmare. But it is apparently a nightmare that allows certain classes to dream.

What gets the author's goat is the portrayal of the law enforcement agencies:

The portrayal of the law in Kaminey is unprecedented in Indian cinema. The anti-narcotics squad functions as the handmaiden of drug-runners and when the police arrive at the final exchange, the criminals due to be “arrested” announce on the street their open offers to the men in khaki – 25% of the take increasing gradually to 33% – and thereby make the police waver. This is far more extreme than even Satya because policemen in Kaminey are only acting for themselves, and not even nominally engaged in enforcing the law.

Again, just a case of cinema mirroring life, uh? To those who think Bollywood is being a trifle too cynical, I would say this: Bollywood caught up with gangster politicians and the nexus between politics and crime long before the rest of the media did. It does seem to me that Vishal Bharadwaj, the director, has his finger on the pulse of reality.

Backlash from bankers

I wrote in my ET column, cited in yesterday's post, that it would be difficult to push through regulation because of the power of banking lobbies.

Josef Ackermann, the Deutsche Bank head, has fired the first salvo, reports FT:

A deluge of financial regulations threatens to harm economic growth, one of the world’s top bankers said on Friday, in what appeared to be the start of a concerted fightback by the industry against feared regulatory overkill.

........There is a trade-off between maximising stability of banks and optimising growth of the real economy. That balance [should] not be forgotten,” Mr Ackermann told the Financial Times. He warned that the entire economy would “pay a high price” if regulation went too far.

.....He cited proposals to raise the quantity and quality of capital banks have to hold, alter the definitions of capital, add capital buffers for systemic firms, rainy-day provisions, liquidity requirements and “living wills” to apply in case of failure.

Mr Ackermann's main contention is that regulators must harmonise rules across the globe, otherwise the global financial system could fragment. True. But, national regulators cannot wait until agreement is reached on all matters. In some cases, they are bound to press ahead, depending on how pressing local needs are. We must hope that if some nations give the lead, that will force others to follow suit. Otherwise, we may have to wait forever for meangingful changes to emerge.

I am not very hopeful that there will be radical changes in regulation. As I have said before, we need a bigger crisis and wider social unrest for that to happen.

G-20 meet and proposed solutions

The G-20 has promised to get tough with banks. And the proposals are stronger than the ones talked about earlier. So far, so good. But is it good enough? No. Because higher capital, executive pay linked to risk and stiffer regulatory requirements for large banks will not stave off the next crisis, if only because the solutions that finally get implemented will not be tough enough.

We need better macroeconomic mangement. In other words, regulation must be supplemented by "macro-prudential" surveillance. More on this in my ET column, Tame the economy, not the banks

Demonising Wall Street

From the Economist:

At a hearing in February a Congressman addressed JP Morgan Chase's boss, Jamie Dimon, as "Mr Demon". Deliberate or not, it captured the mood.

I guess you could say that, on Wall Street, such CEOs come a Dimon-a-dozen.

Incidentally, Oliver Stone is planning a sequel to his movie,"Wall Street", that features an institution resembling Goldman Sachs. It is due in cinemas next spring. Hopefully, with the recovery gaining ground by then, it will run to full houses.

Reforming b-schools

The debate continues. The Schumpeter column of the Economist has some suggestions:

So what should business schools do to improve their performance? More history classes would help. Would-be business titans need to learn that economic history is punctuated with crises and disasters, that booms inevitably give way to busts, and that the business cycle, having survived many predictions of extinction, continues to prey on the modern economy.....

History courses aside, business schools need to change their tone more than their syllabuses. In particular, they should foster the twin virtues of scepticism and cynicism....

The original sin of business schools is boosterism. Professors are always inclined to puff the businesses that provide them, at the very least, with their raw materials and, if they are lucky, with lucrative consultancy work.....Business schools need to make more room for people who are willing to bite the hands that feed them: to prick business bubbles, expose management fads and generally rough up the most feted managers. Kings once employed jesters to bring them down to earth. It’s time for business schools to do likewise

What to make of these suggestions?

History lessons? You mean to say the people who ran Bear Stearns and Lehman had not heard of booms and busts? Scepticism and cynicism? You could argue that the latter has a tendency to triumph over the former. Why be sceptical about financial engineering products when you can make money at somebody else's expense? B-schools do not need to foster cynicism. Their faculty and students have this quality in abundance.

I agree with the third point, about boosterism at b-schools. Faculty writing great stories about organisations that provide them the material, consultancy, and, in some cases, chair professorships. This is a serious governance issue for the boards of b-schools, it is not a matter that concerns only faculty.

Sibal takes on the IITs

NDTV had a debate featuring the president of the IIT faculty federation, Dinesh Mohan, professor at IIT Delhi and Mohandas Pai of Infosys. I had meant to report this on my blog but Abi has pre-empted me with a detailed account.

There are just a couple of other points made by Dinesh Mohan that I would like to highlight. Mohan said he had taught in European and American universities and that the degree of autonomy he had at IIT Delhi was far more than was available in those places. So much for the talk of infringement of 'autonomy'. Yes, Sibal knocked the stuffing out of the IIT faculty's arguments with the strident declaration that the protest was not about 'autonomy' but money.

Mohan made another point that I had made myself in my post on the Yash Pal report: partly, the faculty shortage at elite institutions is the result of senior faculty not being receptive to quality talent coming in.

Let me add: both the IITs and IIMs have used the 'autonomy' argument to gain public sympathy whenever they are at the receiving end of criticism or when government has attempted to look closely into their affairs. As somebody who has been part of the IIM system, I can vouch for what Dinesh Mohan has said: you cannot have greater academic freedom than is available currently in the IIM system. At no point has government made the remotest attempt to infringe such freedom. Moreover, there is virtually no funding constraint on academic exploration, the problem that cripples research at universities.

I do believe that the IITs and IIMs offer the fullest scope possible for faculty to develop themselves as academics. Not only that, we are free to express ourselves on matters of public policy and often find ourselves taking positions contrary to those of government or public authorities and even criticising government. We must give government credit for making this possible.

My greatest fear is that it is the withdrawal of government from these institutions that will threaten academic freedom because then academics would become more subject to the control of management and the boards. Boards in which government representatives are present have never prevented us from expressing our views. But boards in which government is absent and that are run by people from the private sector well may.

Being part of government makes for true academic autonomy in other ways: you have job security; the institutions come under the writ jurisdiction of High Courts, so there is easier recourse against mala fide actions of management; and then there is the whole range of supervision and protection afforded by coverage under CAG, CVC and the RTI Act.

I come back to my old argument: putting in place a governance structure with checks and balances that will adequately substitute the benefits conferred by government presence cannot be done overnight; it has to be a slow and gradual evolution and it has be fully tested before we can contemplate government withdrawal. A governance vacuum in the IITs and IIMs caused by precipitate government withdrawal is for me the ultimate nightmare.

Bonus for IIT faculty

IIT and IIM faculty have been asking for more...... well, not quite like poor Oliver. IIT faculty have planned a hunger strike for September 24. Indian Express reports that IIT directors are seeking to head off the crisis by offering a performance-linked bonus:

Directors of the Indian Institutes of Technology (IITs) are fine-tuning a Performance Related Incentive Scheme (PRIS) which they are expected to place on the table later this week to defuse the stand-off with protesting faculty across all seven IITs.

Under this, an incentive equivalent to “two to four months of salary” could be offered annually to faculty depending on their performance which will be quantified on key indicators.

This is a terrible idea. There is a sufficiently large literature on incentives that casts doubt on the efficacy of these even in a corporate context. In academics, such schemes can play havoc with the very culture of academia.

Leave aside the measurement aspect. You produce high quality work in academics because you are driven by intellectual curiosity- not because you hope to get two months' bonus. Pecuniary rewards can come in other, more satisfying ways- sponsored reserach, consultancy, high value awards for outstanding work, royalty on books, patents, etc.

How many great academic institutions in the world have performance-linked bonuses? Top academic institutions have variable increments that are linked to performance. Your base salary itself can move up sharply based on work done- and that translates into extra pay over the rest of your career. There is nothing like extra pay for a given year- which is what bonuses are about.

The Sixth Pay Commission had suggested the cautious introduction of performance-linked incentives in government. The suggestion has not taken off because of the difficulty in implemting such schemes in government. Why should government make an exception in the case of government-run academic institutions?

I am surprised that IIT directors should have thought up such a scheme.

B-schools after the crisis- business as usual?

There was much talk in the early months of the present crisis of b-schools doing deep introspection into their goals and pedagogy and coming out with a radical revamp. What has actually happened? Not much, according to the Economist. Even as the world recovers from the crisis, b-schools, it appears, will carry on as usual, with some cosmetic changes to take into account the crisis.

Most (b-schools) have settled for modest adjustments. Columbia Business School in New York, for example, set up a faculty committee that delved into every aspect of the MBA programme. But it is introducing just two new modules—on the future of finance and the collapse of the auto industry. At Thunderbird School of Global Management in Arizona, too, there is to be no ripping up and starting afresh. Instead, students on the Global MBA course are to be brought together at the end of the programme for a final module on global citizenship.

Instead of radical change, there will now be attempts to incorporate the crisis and its lessons in various courses, as required. That is normal. The East Asian crisis is part of courses in economic development. LTCM is standard fare in courses on financial institutions and markets.

Randall Kroszner, a former governor of the Federal Reserve and an economics lecturer at Chicago University’s Booth school, agrees that his MBA students will notice a change of emphasis, if not a radical new curriculum. “If I just taught my money class as I did four years ago I wouldn’t have the same emphasis on the housing market or the inter-connections between the banking and non-banking financial systems. I touched on it, but one would be foolhardy not to put a new emphasis on it.”

Monetary policy is another example. Five years ago, the theoretical possibility of a zero lower bound on interest rates may have been mentioned in passing, but most students saw it as such a low-probability event for most developed countries that they didn’t pay it much attention. Now it is a real issue that affects business decisions.

Anthing else? Well, there is talk of greater focus on "soft skills". But this can only give those familiar with b-schools a sense of deja vu......

Bank consolidation

There is a revival of talk about bank consolidation. The chairman of SBI, Mr O P Bhatt, wants Indian banks to grow bigger. Mr Bhatt has been quoted as saying: “The size of Indian banks is not good enough, we need to consolidate....Even SBI is not large enough to serve Indian corporates”. Mr Bhatt thinks there should be at least two to three banks bigger than SBI and half a dozen banks the size of SBI in the country.

I have been sceptical about bank consolidation in India for quite some time. I reiterated my doubts in my recent ET column, Beware of bank consolidation. Earlier, my concern was about the HRD issues: did management of Indian public sector banks (PSBs) have it in them to manage mergers? Making a success of mergers has been a challenge to top management even in advanced economies where there is freedom of hire and fire. In India, where this is difficult and so is closure of branches, I would reckon that mergers would stretch top management for several years. It would prove a major distraction from other tasks that need urgent attention.

Now, after the recent financial crisis, I have an additional concern: the systemic risk posed by largeness. Better, on balance, to have a number of small banks competing with each other instead of having a few 'systemically large' institutions- except where banks are so small as to lose out on scale economies. The larger the bank, the greater the difficulty in managing it. Moreover, consolidation can work to the detriment of the customer. Lastly, you have to make out a case for merger, saying: look, I have made the most out of my present size, I need to get larger in order to sustain earnings growth.

I doubt that many PSBs can make this case. They have failed to get the most out of their existing size. As for SBI itself, it is large as it is. It doesn't have to get larger by gobbling up its subsidiaries, many of which have done better than SBI.

Incidentally, I read in one paper that SBI's proposed merger with State Bank of India has been held up by the finance ministry because of concerns about the malign effects of consolidation.

Small banks, manageable banks

I wrote earlier that we needed banks that idiots could manage and this meant that banks should not become too large or complex. The Economist carries a profile of a successful East European bank wherein the banker talks about the virtues of being small. The bank is Erste Bank,Austria's second biggest. Its CEO says banks should stay small because they can't attract the best talent, only mediocre people.

People who want to make a lot of money fast go to work in investment banks, but people who work in commercial banks are pretty average people," says Mr Treichl in an office so understated that it almost seems calculatedly so...."We should not think we can invent something brilliant. If we could we would be working somewhere else,"he says of the exotic credit derivatives that spread risk, like a contagion, through the financial system.

The banker also points to the difficulties in managing large banks, sprawled across several countries.

If you run something like Citi how the hell do you know what's going on in Poland if you only go there every three years?" he asks. "This is very much a people business. I need to touch and smell and feel what's going on."

Very true. But I would question the presumption that because investment banks attract brighter people, they can afford greater risks. If this were true, then Lehman, Bear and others would not have gone under. The problem is two fold. First, firms that are beyond the capability of even the brightest to manage because of their sheer size. Then, the problems of excess leverage, which create incentives to take excess risk that even the brightest are not immune to. Greed is not something that bright people are free from.

Should IITs and IIMs become universities?

Yes, says the recent Yash Pal committee on higher education. I say: no. The IITs and IIMs have serious work to do in their respective fields, engineering and management, and cannot afford to fritter away energies in diversifying into unrelated fields. More on this in my ET column, IITs and IIMs:Yash Pal is wrong.

The Yash Pal committee also takes too benign a view of governance at IITs and IIMs. On the hierarchy of governance, the committee places universities, IITs and IIMs in an ascending hierarchy. Now, it's true that IITs and IIMs have done a better job than universities. But that doesn't mean they have no governance issues. The IITs and IIMs have become high quality teaching institutions, thanks, in large measure, to generous financial support from government and the benefits of exclusivity in a highly uncompetitive Indian market for higher education.

I argue in my column that, to progress further, they need substantial improvements in governance and accountability. The composition and performance of their boards is one area that cries out for reform. The Bhargava committee noted that the IIM boards tended to reduce their roles to one of providing routine administrative approvals.

The most important function of a board is to lay down performance objectives for top management and to measure performance against objectives. How many IIT and IIM boards can claim to have done this? Somewhere along the line, many have forgotten that boards don't exist in order to approve canteen contracts.

I would add: there are limits to the effectiveness of board monitoring. We have seen this in the corporate world and must not expect anything different from academic board. The difference is that companies are subject to the discipline of the market place in a way in which academic institutions are not- certainly not, institutions of higher education in India.

America has a reasonably competitive market for higher education.Yet, it has state universities of high quality. In India, the government cannot afford to withdraw from public institutions until a more competitive market has evolved. For the same reason, board monitoring at the IITs and IIMs will not suffice. There must be periodic, external audits commissioned by an Appointments Committee for Higher Education that I propose.

The Bhargava committee provided an overview of the functioning of the IIMs. The government must now ask for detailed, institute-specific audits for the older IIMs and IITs. These audits must be based on extensive interactions with all stakeholders, not written documents provided by the institutions. There are private schools in the west that have subjected themselves to such an audit on their own. One b-school I know has benefited enormously from external audit is Toronto's Rotman School of Business which has moved up in the international rankings quite a bit over the years.

Do we need mega banks?

I had a post earlier on the problems posed by large banks and I proposed then that we may need to impose a regulatory cap on bank size.

I find that this proposal is being mooted by some very illustrious names and indeed is gaining some momentum- although I doubt that large banks, with their political clout, will allow the proposal to fructify. In an article in ET, Joseph Stiglitz writes:

We need to break up the too-big-to-fail banks; there is no evidence that these behemoths deliver societal benefits that are commensurate with the costs they have imposed on others. And, if we don’t break them up, then we have to severely limit what they do. They can’t be allowed to do what they did in the past — gamble at others’ expenses.

Much the same is echoed by Henry Kaufmann, a much respected figure on Wall Street. In his book reviewed in the latest Economist, Kaufmann is quoted as warning against the dangers of consolidation forced on the financial sector in the wake of the crisis and the problems posed by large banks:

Driving the weak into the arms of the strong may have been expedient, but it swelled the oligopoly of financial conglomerates deemed too big to fail.

Mr Kaufman draws a convincing link between this consolidation and greater market vulnerability. He sees two possible roads to reformation: dismantling the monsters or curbing their riskier activities to the point that they become public utilities, too safe, rather than too big, to fail.

So, if you can't limit the size of banks through regulatory fiat, then you have to limit the nature of their activities. My own view is that the former is,perhaps, the lesser evil. But, a former deputy governor of the Bank of England, John Gieve, quoted in FT, thinks the latter is preferable:

Sir John (Gieve) doubts that policymakers can set an optimum size for financial services, but suggests the industry could be subject to the sort of economic regulation applied to other utilities, such as telecommunications.

Green shoots, what green shoots?

Hopes of a quick recovery in the world economy are overblown. Emerging markets may bounce back but the advanced economies are mired in problems, especially the US. Nouriel Roubini thinks the chances of a double-dip recession are rising. He gives several reasons for this, including the damage to the US financial system and the failure to revive it. He also thinks the rise in oil prices, driven by excess liquidity, may well stymie a quick recovery.

The Obama administration has ducked the banking challenge, I argue in EPW. Not only is there no quick solution to the present crisis, I am increasingly sceptical about long-term proposals for reform after seeing the US treasury proposals. We have a serious problem of government capture by the financial system in the US. The proposals do not tackle the too big to fail problem, they do are not tough enough on bank compensation and it is unlikely that rules for bank capital will be stringent enough, as and when they emerge in the US. We probably need another serious crisis for banking reform to take place.

Meanwhile, China has circulated draft proposals for increasing bank capital to 12%. We in India should do likewise. We have a golden opportunity to create an even stronger, more competitive banking system in the near five years as the international banks struggle to get out of the present mess.

Let's put a cap on the size of banks

Large, complex financial institutions are lethal to the financial system. They can fail and when they do, they wreak havoc on the economy.That's why they have to be rescued- as we have seen in the present crisis. We also saw what happens when they are not rescued, as in the case of Lehman Brothers when confidence in the system evaporated.

I do not believe that the present two-pronged approach, which consists of a regime for winding down such institutions in the event of failure and higher capital requirements, will suffice. You have to tackle the root cause of the problem, the bigness of the bank itself. I cannot see how any CEO can manage risks in institutions with over a trillion dollars or so in assets. Ask any bank CEO with, say, $10 bn in assets and he will tell you he is fully stretched.

I elaborate on this in my ET column, Banks that can be run by idiots. I propose a ceiling a bank size- say, 5-10% of GDP. For a large economy, we should be closer to the lower end of the range; a smaller economy could be at the higher end. In addition, regulators should keep in mind some absolute size limit beyond which financial institutions become impossible to manage. In the process, we will also have less concentration and more competition.

In defence of economists

Morale in the economics profession is rather low, given the panning that economists have received in the wake of the sub-prime crisis. People have asked: how come economists did not provide warnings or don't seem to have solutions? (although some did warn and many have proposed solutions). The Economist ran a cover story in July about all that went wrong with the economics profession.

Robert Lucas responds to the criticism about why models failed to predict the depth of the downturn:

The Economist’s briefing also cited as an example of macroeconomic failure the “reassuring” simulations that Frederic Mishkin, then a governor of the Federal Reserve, presented in the summer of 2007. The charge is that the Fed’s FRB/US forecasting model failed to predict the events of September 2008. Yet the simulations were not presented as assurance that no crisis would occur, but as a forecast of what could be expected conditional on a crisis not occurring.

Until the Lehman failure the recession was pretty typical of the modest downturns of the post-war period. There was a recession under way, led by the decline in housing construction. Mr Mishkin’s forecast was a reasonable estimate of what would have followed if the housing decline had continued to be the only or the main factor involved in the economic downturn. After the Lehman bankruptcy, too, models very like the one Mr Mishkin had used, combined with new information, gave what turned out to be very accurate estimates of the private-spending reductions that ensued over the next two quarters. When Ben Bernanke, the chairman of the Fed, warned Hank Paulson, the then treasury secretary, of the economic danger facing America immediately after Lehman’s failure, he knew what he was talking about.

Lucas is right, of course. Models do incorporate policy responses. Few economists would have thought that the US government would let a big bank fail. Such a failure would not have been part of the model. The decision to let Lehman was an inexplicable blunder- and it is doubtful that the crisis would have been as severe if that had not been allowed to happen.

Lucas also points out that the policy response to the crisis, based on whatever economics has taught us about crises in the past, has been pretty effective at least ensuring that there is no repeat of the Great Depression:

The recession is now under control and no responsible forecasters see anything remotely like the 1929-33 contraction in America on the horizon. This outcome did not have to happen, but it did.

Crisis won't upset US dominance

That's the title of my last ET column. Several commentators have predicted the eclipse and decline of the US consequent to the crisis just as gloomier commentators have forecast the demise of capitalism. They are both wrong. Capitalism will reinvent itself, with fresh rules for the financial sector, and the US will retain its pre-eminent position.

One reason, as historian Niall Ferguson points out, is that when the US has a serious recession, its principal economic rivals suffer sharper setbacks to growth, so the US ends up the winner. Another is that the dollar does not have a serious competitor- does anyone seriously believe that the world's central banks will hoard their reserves in remnimbi?

America's economic dominance is to some extent derived from and supported by its military and political dominance. The US can, if it is really pushed, exert pressure on its oil producing allies to rein in oil prices. It can get economies with surpluses to park these in US treasuries. It has a major say in the creation of rules for the world economy through institutions such as the IMF, World Bank and WTO.

There are two areas in which the US is far ahead of the rest of the world: military power and higher education. Its lead in these areas will serve to ensure its pre-eminence in the world economy for as far as we can see now.

Status of IIMA

An important judgement related to IIMA is due on August 25- and it seems to have escaped the notice of much of the media. The only detailed report I have seen appeared in DNA.

The Gujarat High Court, the paper reports, will rule on "Whether the legal status of IIM-A (Indian Institute of Management, Ahmedabad) is of an autonomous institution, a State or an instrumentality of State..". If IIMA is a state institution, then article 226 of the constitution would become applicable whereby a high court can entertain a writ petition against the state or any state institution.

The issue has arisen in the context of a case filed by a dismissed IT manager of IIMA. The employee stated that "despite having performed her duties satisfactorily, she was illegally dismissed by the present director in complete violation of the principle of natural justice.".

Claims and counter-claims regarding the status of IIMA were made by the concerned counsels:

The IIM-A counsel, Nandish Chudgar, countered the argument by stating that the petition was not maintainable as the institute was an autonomous institution - it did not fall under the status of 'State' and 'an instrumentality of State' under Article 12 of the constitution, as held by a division bench of the Gujarat high court in 2002 in a case against IIM-A.

In his counter reply, Sinha argued that the decision of the division bench of the Gujarat high court, which is relied upon by the IIM-A's advocate, was mainly based upon the decision of the Supreme Court in the case of Chander Mohan Khanna vs. National Council of Educational Research and Training in 1991. However, by a subsequent judgment of a division bench of the supreme court, in the case of Pradeep Kumar Biswas vs. Indian Institute of Chemical Biology in 2002, has specifically held that the decision in Chander Mohan Khanna does not lay down the correct law.

IIMA has thus far scrupulously adhered to norms applicable to public institutions in matters such as SC/ST quotas, OBC quotas, the Pay Commission awards and the RTI Act. It is also subject to CAG audit.

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

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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.