IIFT InFINeeti Annual Issue 2012

ANNUAL ISSUE SHOULD BANKS BE GIVEN MORE AUTONOMY?

ENHANCING LIQUIDITY IN THE INDIAN DEBT MARKET - A PANACEA

MIST vS BRICS INDIAN TAX REFORMS

Analysis - Impact of Basel 3 norms

SEPTEMBER 2012THE FINANCE MAGAZINE OF I IFT

MEE T THE TEAM INFO

I n F I N e e t i A n n u a l I s s u e | S e p t e m b e r 2 0 1 2

2

P I Y U S H M A R WA H A i s a s o f t -

ware engineer with keen inter-

est in f inance. He has interned

in Trident Limited in forex divi -

sion. He regularly tracks stocks

a n d c o m m o d i t i e s m a r k e t s .

R I T E S H G U P TA i s s p e c i a l i s -

i n g i n f i e l d o f f i n a n c e . H e

h a s i n t e r n e d w i t h R e l i g a r e

E n t e r p r i s e s L i m i t e d i n t h e

c o r p o r a t e s e r v i c e s d i v i -

s i o n . H e p l a n s t o w o r k

i n B a n k i n g a n d f i n a n c e

S H I L P I G H O S H i s s p e c i a l -

i z i n g t h e f i e l d s o f m a r k e t -

i n g a n d f i n a n c e . S h e h a s

i n t e r n e d w i t h M e r c k S h a r p

& D o h m e i n t h e c r i t i c a l c a re

d i v i s i o n . S h e p l a n s t o w o r k

ROHIT KHAT TAR is special izing

i n Fi n a n c e . H e h a s i n t e r n e d

with Tata Consultancy Ser vices

in i ts Financial Solutions busi-

n e s s u n i t . Po s t g r a d u a t i o n ,

h e i n t e n d s t o w o r k i n t h e

F i n a n c i a l S e r v i c e s i n d u s t r y.

S O U R AV D U T TA i s a g r a d -

u a t e o f N I T D u r g a p u r w i t h

d i v e r s i f i e d i n t e r e s t s . H e h a s

i n t e r n e d w i t h L & T i n t h e

f i e l d o f R i s k M a n a g e m e n t .

E D I TO R - I N - C H I E F

Soumya J yot i S en

E D I TO R I A L B OA R D

Rohit K hattar

Piyush Mar waha

R itesh Gupta

Sourav Datta

ASSOCIATE EDITORS

Vedik a G aner iwala

Shi lpi Ghosh

CONTRIBUTIONS FROM

Aak anksha Hajela

Bhushan k anathe

Md. Umair Ansar i

Vaibhav G arg

D E S I G N

Team I nFINeet i

F E E D B AC K / q U E R I E S

inf ineet i@i i f t .ac. in

inf ineet i@gmai l .com

Pu b l i s h e d m o n t h l y by s t u d e n t s o f I n d i a n I n s t i t u t e o f Fo r e i g n Tr a d e , New Delhi and Kolk ata

ALL RIGHTS RESER VED

» p.3 » p.11 » p.17

5 DEBT MARKETSAn analys is of the I ndian bond

m a r k e t s a n d t h e c h a l l e n g e s

f a c e d i n t h e I n d i a n s c e n a r i o.

The ar t ic le presents a detai led

v i e w o n t h e n e e d fo r a l i q u i d

debt market and the necessar y

s t e p s t o e n h a n c e l i q u i d i t y i n

I ndian markets.

9 BANKINGBank ing reforms is one of the

m o s t i m p o r t a n t i s s u e s b e i n g

r a i s e d i n t h e g l o b a l f i n a n c i a l

m a r k e t s . W e a n a l y z e t h e

p r o s p e c t s o f b a n k i n g s e c t o r

being more regulated or more

autonomous.

13 TAxATIONT h e i n d i a n e c o n o m y h a s

s t r u g g l e d f o r t h e m o s t

p a r t o f F Y 1 3 . I t h a s l i s t i t s

a t t r a c t i v e n e s s a s a b u s i n e s s

d e s t i n a t i o n . I n d i a i s w o r k i n g

o n t w o m a j o r t a x r e f o r m s .

DTC (Direc t Tax Code) and GST

(Goods and Ser v i ces Tax) . The

ar t ic le presents a v iew on the

need of the tax reforms

17 WORLD ECONOMY Fo r ye a r s , t h e U S d o l l a r h a s

s e v e d a s t h e r e s e r v e c u r -

r e n c y f o r n a t i o n s b u t w i t h

t h e f o c u s s h i f t i n g t o t h e

d e v e l o p i n g c o u n t r i e s i n

As ia , has dol lar lost i ts wor th

a s t h e r e s e r v e c u r r e n c y ?

20 CORPORATE TALK G ain ins ights about the cor-

porate culture and economic

scenario from Barclays Limited

23 ECONOMYT h e i n d i a n g r o w t h s t o r y

h a s h i t a m a j o r r o a d b l o c k .

I s m o n e t a r y p o l i c y t h e

r e a l a n s w e r t o c o n t r o l l i n g

inf lat ion?

27 BANKING NORMSW i t h t h e i n t r o d u c t i o n o f

BASEL I I I norms, the bank ing

i n d u s t r y a c ro s s t h e g l o b e i s

trying to analyze the impact of

the new reforms. We analyze

t h e i m p a c t o f t h e B A S E L I I I

norms on the I ndian bamk ing

industr y.

29 GLOBAL ECONOMY B R I C S , o n e o f t h e m o s t

p r o m i s i n g g r o u p o f c o u n -

t r i e s i s l o s i n g i t s s h e e n .

I s t h i s t h e r i s e o f M I S T ?

32 SUMMER ExPERIENCE

Students from I IFT share their

summer internship experience

34 RISK MANAGEMENT

W i t h t h e r i s i n g i s s u e s i n

w o r l d e c o n o m y, r i s k m a n -

a g e m e n t i n b a n k i n g s e e m s

to b e t t h e n e e d o f t h e h o u r.

H o w w i l l i t b e e f f e c t i v e

i n t h e p r e s e n t l a n d s c a p e ?

REGULARS

37 MONTHLY CHRONICLES

40 FUN WITH FIN

I n t h e c o v e r s t o r y, o u r

e d i t o r i a l t e a m p r e s e n t s

the new era of regulat ion

in bank ing industr y. The

issue talks about the pros

a n d c o n s o f m o n e t a r y

p o l i c y i n I n d i a a n d t h e

w ays to e n h a n c e l i q u i d -

ity in the market. I t a lso takes a c loser look on

the tax reforms with a focus on dol lar as the

wor ld ’s reser ve currenc y.

T h e b a n k i n g i n d u s t r y a l l o v e r t h e w o r l d i s

s e t to c h a n g e fo r t h e b e t te r. I t i s i m p o r t a nt

to explore the poss ib le long-ter m ef fec t s of

t h e f a s t - m ov i n g e c o n o m i c c h a n g e s a n d t h e

host of new oppor tunit ies and r isks are being

unleashed. This i ssue t r ies to address a range

of t imely oppor tunit ies and chal lenges spe -

ci f ic to investment community but relevant to

a l l g lobal investors. With a rat ional ist ic com-

parison of MIST vs BRIC, a detai led explanation

of the need of regulat ion in bank ing industr y

has been c lear ly la id out . Fina l ly a long with

the regular columns, a c loser look at the Basel

3 norms and their impac t on I ndian banks has

been analyzed.

A s b a n k s s t r i v e t o e m e r g e f r o m t h e g l o b a l

f inancia l cr is is , they are encounter ing a new

era of bank ing. I t is one marked by continuing

regulator y uncer tainty and economic instabi l-

i t y, which is h inder ing banks’ abi l i t y to move

f o r w a r d . T h e b a n k i n g i n d u s t r y h a s b e e n

f a c i n g l o t s o f u p s a n d d ow n s ove r t h e p a s t

few years . With scandals happening a l l ove r

the world l ike LIBOR rates being r igged, inves-

tors cannot trust even the world’ s most stable

f inancial inst i tut ions. This has generated a lot

of d iscuss ion among bank ing industr y exper ts

about the prerequis i tes for the smooth func -

t ioning of the sec tor. S ome has put stress on

severe regulat ions whereas some are in favour

of automation as the need of the hour. To forge

ahead, industr y leaders say banks must inno -

vate whi le apply ing the lessons of the global

f inancial crisis. To do this, banks are encouraged

to e m p l oy “d i s c i p l i n e d i n n ov a t i o n ,” p u r s u i n g

growth through reasonable r isks. This edit ion

mainly re volves around th is i s sue keeping in

mind the several changes incorporated in the

bank ing industr y in the recent past .

Happy Reading! !

With Warm regards,

Team I nFINeet i

I n F I N e e t i A n n u a l I s s u e | S e p t e m b e r 2 0 1 2 I n F I N e e t i A n n u a l I s s u e | S e p t e m b e r 2 0 1 2

3 4CONTENTS MESSAGE FROM THE EDITOR-IN- CHIEF

S o u m y a S e n i s s p e c i a l i z i n g i n f i n a n ce a n d t ra d e. H e h a s i n te r n e d a t I C F I n t e r n a t i o n a l a n d h a s d e e p i n t e r e s t s i n c o r p o r a t e a n d t r a d e f i n a n c e . P o s t h i s M B A , h e w a n t s t o p u r s u e a c a r e e r i n b a n k i n g .

The debt markets lack of l iquid-i t y, which makes investor demand higher y ie lds on these bonds. Thus mak ing these markets uncompetit ive compared to foreign markets.

I ntroduc t ionW h e n e v e r t h e

Government announces

i ts bor rowing ca lendar,

there is havoc in market

w i t h C o r p o r a t e s b e i n g

p u s h e d o u t a n d i n t e r -

e s t r a t e s r i s i n g t h u s

mak ing pr ivate players look for e i ther expen-

sive bank f inancing or dollar/euro/yen denom-

inated ECBs (External Commercial Borrowings).

But inspite of such a huge demand for rupee

denominated markets only ver y few companies

ra ise money in these markets. The problem is

the lack of l iquidity which makes the investors

d e m a n d h i g h e r y i e l d s o n t h e s e b o n d s, t h u s

m a k i n g t h e s e m a r k e t s u n c o m p e t i t i v e c o m -

pared to foreign markets even after tak ing care

of the exchange rate hedging cost . The need

of the hour is to take steps to increase l iquid-

i t y i n t h e s e m a r k e t s by l ay i n g d ow n p ro p e r

regulat ions and a lso promoting entr y of b ig

foreign players l ike F I Is and Domest ic Players

l ike insurance companies, mutual funds etc. in

order to increase par ticipation and hence l iquid-

i t y in the I ndian rupee corporate debt markets.

Current ProblemsI n d i a’s s o v e r e i g n b o n d m a r k e t s a t i s f i e s t h e

i m m e d i a c y a n d d e p t h c o n d i t i o n s o n l y f o r

“on-the - run” government bonds ( i .e . , the most

recent ly- issued government bond of a speci f ic

matur i t y ) . O ther wise, the domest ic sovere ign

b o n d m a r k e t i s l a rg e l y i n e f f i c i e nt . E xce p t fo r

about 8-10 secur i t ies at a t ime for which t wo

way quotes are avai lable in the market , other

p a r t s o f t h e y i e l d c u r ve re p re s e n t s e c u r i t i e s

t h a t a re n o t a c t i ve l y t r a d e d. Ac t i v i t y i s c o n -

centrated in a few secur i t ies due to the market

conf idence in them and the abi l i t y to l iquidate

posit ions quick ly for these speci f ic bonds at a

fa i r va lue. I n the corporate debt market , inves-

t o r b a s e i s m o s t l y c o n f i n e d t o b a n k s , i n s u r-

a n c e c o m p a n i e s , p r o v i d e n t f u n d s , P r i m a r y

D e ale r s ( P D s ) and pe ns ion funds. O f late, the

r e t a i l i n v e s t o r s h a v e b e e n s h o w i n g i n t e r e s t

Enhancing Liquidity in the Debt market : A panacea for India

i n co r p o rate b o n d s, e s p e c i a l l y b o n d s i s s u e d

by the infrastructure companies that entai l tax

incentive. Whi le investors are not shy of debts

issued by the top rated f i rms, they are re luc-

t a n t t o s u b s c r i b e t o t h e l o we r r a t e d i n s t r u -

ments. This is an anomaly because lower rated

companies do have access to bank f inancing.

C r e d i t e n h a n c e m e n t b y b a n k s c a n p e r h a p s

m a k e s u c h i n s t r u m e n t s a t t r a c t i v e t o i nv e s -

tors. But on the f l ip s ide, credit enhancement

essent ia l ly involves t ransfer of the credit r i sk

t o b a n k s a n d t h i s w i l l n o t o n l y h a m p e r t h e

d e v e l o p m e n t o f c o r p o r a t e b o n d m a r k e t b y

stunt ing the pr ice discover y process but a lso

i n c re a s e t h e r i s k i n t h e b a n k i n g s ys te m . Th e

focus must be on de -r isk ing bank ing system,

a n d at t h e s a m e t i m e, b u i l d i n g / e n co u ra gi n g

inst i tut ions that provide credit enhancement.

Th e p ro b l e m w i t h a n i n e f f i c i e nt a n d i l l i q u i d

d e b t m a r k e t i s t h a t i t m a k e s c o m p a n i e s g o

outs ide to borrow thus increas ing the ex ter-

nal debt of the countr y ; a lso i t makes the debt

more prone to change in the exchange rates.

An ef f ic ient debt market wi l l a lso open a new

avenue for investors where they would have

a b e n e f i t o f g e t t i n g h i g h y i e l d s w i t h o u t t h e

o b l i g a t i o n o f h o l d i n g t h e b o n d to m a t u r i t y.

M a r k e t S t r u c t u r e i n D e v e l o p e d M a r k e t s

C o r p o r a t e s i n m a n y d e v e l o p e d m a r k e t s –

p r e d o m i n a n t l y i n t h e U S a n d i n c r e a s i n g l y

i n o t h e r j u r i s d i c t i o n s - h ave a m a r k e d p re f -

e r e n c e t o t a p t h e b o n d m a r k e t r a t h e r t h a n

t o s e e k b a n k l o a n s fo r m e e t i n g t h e i r e x t e r-

n a l f i n a n ce re q u i re m e nt s . I n I n d i a , h owe ve r,

companies continue to depend on the banking

system for funds because of ease of avai l ing

bank f inance, absence of credit r i sk mit igat ion

mechanisms and a host of other fac tors, such

as, absence of sound bankruptcy framework and

l a c k o f a c t i ve i nte re s t o f l o n g - te r m i nve s to r s

l i k e i n s u r a n c e c o m p a n i e s . Co r p o r a t e s p re fe r

r a i s i n g f u n d s t h ro u g h p r i v a t e p l a c e m e n t s a s

against public issuances because of operational

ease of issuance under pr ivate placements with

minimum disc losures, low cost of issuance and

the speed of raising funds. The issuance process

is also impacted by costs, such as, stamp duties,

t r a n s fe r c o s t s , e t c . w h i c h n e e d s r a t i o n a l i z a -

t ion. Preference for pr ivate placement i s a lso

d i c t a t e d by t h e p ro f i l e o f i nve s t o r s w h i c h i s

most ly inst i tut ional and a narrow base at that .

N e e d s fo r a n e f f i c i e nt l i q u i d d e b t m a r k e t in I ndia :

a ) E n s u r i n g f i n a n c i a l s y s t e m s t a b i l i t y :

A l iquid corporate bond market can play a cr i t-

ica l ro le because i t supplements the bank ing

s ys te m to m e e t t h e re q u i re m e n t s o f t h e co r-

porate sec tor for long-term capita l investment

a n d a s s e t c r e a t i o n . B a n k i n g s y s t e m s c a n n o t

b e t h e s o l e s o u r c e o f l o n g - t e r m i nv e s t m e n t

c a p i t a l w i t h o u t m a k i n g a n e co n o my v u l n e ra -

b l e t o e x t e r n a l s h o c k s . H i s t o r i c a l a n d c ro s s -

sec t ional exper ience has shown that systemic

p r o b l e m s i n t h e b a n k i n g s e c t o r c a n i n t e r -

r u p t t h e f l o w o f f u n d s f ro m s ave r s t o i nve s -

t o r s f o r a d a n g e r o u s l y l o n g p e r i o d o f t i m e .

I n d e e d , o n e o f t h e l e s s o n s f r o m t h e 1 9 9 7

A s i a n f i n a n c i a l c r i s i s h a s b e e n t h e i m p o r -

t a n c e o f h a v i n g n o n - b a n k f u n d i n g c h a n -

n e l s o p e n . I n t h e a f t e r m a t h o f t h i s c r i s i s , a

n u m b e r o f co u nt r i e s i n t h e re gi o n , i n c l u d i n g


5 6 INDIAN ECONOMY INDIAN ECONOMY

K o re a , M a l a y s i a , S i n g a p o re a n d H o n g K o n g,

h a v e m a d e p r o g r e s s i n b u i l d i n g t h e i r o w n

c o r p o r a t e d e b t m a r k e t s . S p r e a d i n g c r e d i t

r i sk f rom banks balance sheets more broadly

t h r o u g h t h e f i n a n c i a l s y s t e m w o u l d l o w e r

t h e r i s k s t o f i n a n c i a l s t a b i l i t y. B o n d f i n a n c -

i n g r e d u c e s m a c r o e c o n o m i c v u l n e r a b i l i t y

t o s h o c k s a n d s y s t e m i c r i s k t h r o u g h d i v e r -

s i f i c a t i o n o f c r e d i t a n d i n v e s t m e n t r i s k .

b ) E n a b l i n g m e a n i n g f u l cove r a g e o f re a l sec tor needs:

The f inancia l sec tor in I ndia is much too smal l

to cater to the needs of the rea l economy. A

c o m p a r i s o n o f t h e a s s e t s i z e o f t h e t o p t e n

C o r p o r a t e s a n d t h a t o f t h e t o p t e n b a n k s

( a s s h o w n i n F i g u r e 1 b e l o w ) r e v e a l s t h a t

b a n k s i n I n d i a a re u n a b l e t o m e e t t h e s c a l e

o r s o p h i s t i c a t i o n o f t h e n e e d s o f c o r p o r a t e

I ndia . Needless to say, the f inancia l system is

n o t b i g e n o u g h t o m e e t t h e n e e d s o f s m a l l

a n d m e d i u m - s i z e d e n t e r p r i s e s e i t h e r. W h i l e

these are pointers to the fac t that the bank ing

s e c t o r i n I n d i a n e e d s t o b e l a r g e r t h a n i t s

current s ize, they are a lso c lear indicators that

debt markets need to grow manifold to ensure

that the f inancia l sec tor becomes adequate for

an economy as large and as ambitious as India’s.

c ) C r e a t i n g n e w c l a s s e s o f i n v e s t o r s :

Commercial banks face asset- l iabi l i ty mismatch

i s s u e s i n p r o v i d i n g l o n g e r - m a t u r i t y c r e d i t .

D e ve l o p m e nt o f a co r p o rate d e b t m a r k e t w i l l

enable par t icipation from institutions that have

the capacity as well as aptitude for longer matu-

r i t y exposures. Financia l inst i tut ions l ike insur-

ance companies and provident funds have long-

term l iabi l i t ies and do not have access to ade -

q u ate h i g h q u a l i t y l o n g - te r m a s s e t s to m atc h

them. Creation of a deep corporate bond market

can enable them to invest in long-term corporate

debt, thus ser ving the twin goals of diversifying

co r p o rate r i s k a c ro s s t h e f i n a n c i a l s e c to r a n d

enabling these institutions to access high quality

long-term assets. Thus, access to long-term debt

o p e n s u p t h e m a r k e t to n e w c l a s s e s o f i nve s -

tors with an appetite for longer matur ity assets

and thereby helps prevent maturity mismatches.

INDIAN ECONOMY

d ) R e d u c e d c u r r e n c y m i s m a t c h e s :

T h e d e v e l o p m e n t o f l o c a l c u r r e n c y b o n d

m a r k e t s h a s b e e n s e e n a s a w a y t o a v o i d

c r i s i s , n o t o n l y by s u p p l e m e n t i n g b a n k c re d i t

b u t a l s o b e c a u s e t h e s e m a r k e t s h e l p r e d u c e

p o t e n t i a l c u r r e n c y m i s m a t c h e s i n t h e f i n a n -

c i a l s y s t e m . C u r r e n c y m i s m a t c h e s c a n b e

a v o i d e d b y i s s u i n g l o c a l c u r r e n c y b o n d s .

Thus, wel l - developed and l iquid bond markets

c a n h e l p f i r m s r e d u c e t h e i r o v e r a l l c o s t o f

c a p i t a l b y a l l o w i n g t h e m t o t a i l o r t h e i r a s s e t

a n d l i a b i l i t y p r o f i l e s t o r e d u c e t h e r i s k o f

b o t h m a t u r i t y a n d c u r r e n c y m i s m a t c h e s .

e ) T e r m s t r u c t u r e a n d e f f e c t i v e t r a n s m i s s i o n o f m o n e t a r y p o l i c y :

T h e c r e a t i o n o f l o n g - t e r m d e b t m a r k e t s w i l l

a l s o e n a b l e t h e g e n e rat i o n o f m a r k e t i nte re s t

rates at the long end of the y ie ld cur ve – thus

f a c i l i t a t i n g t h e d e v e l o p m e n t o f a m o r e c o m -

plete term struc ture of interest rates. A deeper,

more responsive interest rate market would in

turn provide the central bank with a mechanism

fo r e f fe c t i ve t ra n s m i s s i o n o f m o n e t a r y p o l i c y.

Conclus ion

T h e i m p l e m e n t a t i o n o f v a r i o u s m e a s u r e s f o r

increasing the efficiency and l iquidity of the debt

markets wi l l help to maintain f inancia l s tabi l i t y

and provide a more optimal way for Corporates to

raise and investors to invest money thereby ben-

ef i t ing the real sec tor whi le a lso improving the

transmission of monetar y policy in the economy.

R ahul Bakshi-The author is a student of I IM- I ndore

INDIAN ECONOMY


7 8

I ntroduc t ion

The recent housing boom, bust , the f inancia l

cr is is and severe recess ion that fo l lowed, con-

t inue to af fec t us . These events have shaped

t h e e c o n o m i c re c o ve r y a n d t r a n s fo r m e d t h e

regulat ion of the f inancia l system. The recent

developments raise debates about the need for

improved regulat ion of bank ac t ivity for f inan-

c ia l s tabi l i t y.

The recent histor y of regulator y reform in Bank ing

The d iminish-

i n g e f fe c t i ve -

n e s s o f t r a -

d i t i o n a l c o n -

t r o l s d u e t o

f inancial inno-

v a t i o n a n d

ra p i d te c h n o -

l o gi c a l d e ve l -

o p m e n t , t h e

d e v e l o p m e n t

o f r e g u l a t o r y

a v o i d a n c e ,

c o m p e t i t i o n

b e t w e e n i n t e r n a t i o n a l f i n a n c i a l c e n t e r s a r e

some reasons why reform was needed.

B a n k i n g i s a m o n g t h e

wor ld ’s most t ight ly regu-

lated businesses. But most

of the economic problems

i n t h e p a s t t w o h u n d r e d

years were caused by banks

and speculators . Af ter the

g r e a t d e p r e s s i o n , s o u n d b a n k i n g r e f o r m s

ensured economic stabi l i ty and prosper it y for

many years . Post sub -pr ime cr is is , the Banks

a r e r e l u c t a n t t o i m p l e m e n t t h e r e g u l a t o r y

reforms saying it inhibits innovation and raises

b a r r i e r s t o e n t r y.

C a n w e t r u s t t h e

B a n k s t o re g u l a t e

t h e m s e l v e s ? T h e

r e c e n t t i m e s

reveal many f inan-

c i a l i n s t i t u t i o n s

f a i l i n g . I n t h i s

a r t i c l e w e d e a l

w i t h t h e b e n e -

f i ts and cost asso -

c i a t e d w i t h t h e

b a n k i n g r e g u l a -

t i o n , h o w a u t o n -

o m y c a n h e l p

t h e b a n k s a n d

w h a t i s r e a l l y n e e d e d c o n s i d e r -

i n g t h e c u r r e n t f i n a n c i a l s i t u a t i o n .

S h o u l d b a n k s w o r l d w i d e b e g i v e n m o r e a u t o n o my o r re g u l a t i o n - t h e n e e d o f t h e hour?

U n t i l e a r l y 1 9 7 0 ’s t h e B a n k i n g s y s t e m c o n -

trol led the pr ices, quant i t ies of business con-

duc ted and the mar ket access . But s ince mid

1 9 7 0 ’s t h e r e i s a s i g n i f i c a n t p r o c e s s o f r e g -

u l a to r y re fo r m i n m o s t co u n t r i e s a n d a s h i f t

towards more market- or iented forms of regu-

lat ion-L ibera l ized I nterest R ate, I nvestments ,

Line -of-business, ownership l inkages and entr y

of foreign f inancial institutions. Bank branching

restr ictions were phased out and in a number of

European countries by the early 1990s.Breaking

down the barr iers imposed by the (1933) Glass-

Steagal l Ac t , the Gramm-Leach-Bl i ley Financial

S er v ice M oder nizat ion Ac t of 1999 per mitted

f inancia l holding company.

Benef i ts

Some benef i ts are :

1.Freedom to adopt the most eff icient practices

& develop new produc ts and ser v ices.

2.Competit ion-forcing the exit or consolidation

of re lat ively inef f ic ient f i rms.

3 . I m p r o v e m e n t s i n t h e q u a l i t y, v a r i e t y a n d

access to new f inancia l instruments &ser vices.

4 . I mproved wor ld a l locat ion of resources due

to the removal of the barr iers to internat ional

capita l f lows.

Regulator y reform and competit ion expanded

the reach of bank ing to the under pr iv i leged.

R e g u l a t i o n i s e s s e n t i a l b e c a u s e t h e l i q u i d i t y

of bank l iabi l i t ies i s a publ ic good. The uncer-

ta int y is an unquant i f iable r isk- a learning gap

which can never be closed.Banking regulation &

super vision suppor ts the evolution of a banking

system which produces money as an asset to

h o l d i n t i m e s o f p a r t i c u l a r u n ce r t a i n t y. Th e

s t r u c t u r e o f t h e f i n a n c i a l s y s t e m h a s b e e n

u n d e r g o i n g m a j o r c h a n g e , w h i c h c e r t a i n l y

involves a major rethink about regulat ion.

Free banker ’s cr t iques

Th e y s ay t h a t t h e u n ce r t a i n t y c a n b e e l i m i -

n a te d a n d f i n a n c i a l a s s e t s c a n b e v a l u e d i n

t h e s a m e w ay a s g o o d s , s o t h a t t h e re i s n o

reason for banks to be regulated. I nstabi l i t y

i s a r e s u l t o f u nw i s e p o r t fo l i o d e c i s i o n . I n

the absence of regulat ion, the mar ket d isc i -

pl ine banks adopting prudent por t fol ios.Free

bankers argue that the r isk of contagion does

n o t j u s t i f y t h e n e e d fo r re g u l at i o n . Th e y s ay

that deposits could simply be transferred from

banks with unsound por t fo l io to banks with

sounder por tfolios thereby having sound por t-

fol io management.

Contrar y argument : Asset values can be pre -

d i c t e d , b u t v a l u a t i o n s a r e c o n t i n g e n t o n a

r a n g e o f u n k n o w n s . I t i s d i f f i c u l t e v e n fo r

centra l bankers to determine whether a bank

has a l iquidity/ solvency problem. I f tactics l ike

d e p o s i t i n s u r a n c e a n d l e n d e r - o f - l a s t - re s o r t

BANKING


9 10 BANKING

faci l i t ies were appl ied successful ly, banks could

b e p r o t e c t e d f r o m f a i l u r e i n a f r e e b a n k i n g

system but that i s a far cr y and the f ree bank-

er ’s argument ignores the potential for systemic

instabi l i t y.

Why regulate stable, d ivers i f ied banks?

Autonomy entai ls operat ional f reedom. I t fac i l -

i t ate s p r i ce a n d f i n a n c i a l s e c to r s t a b i l i t y t h at

are impor tant for achieving sustainable growth.

M o n e t a r y p o l i c y i s s u p e r e s s e n t i a l fo r w h i c h

the bank should be given some AUTONOMOUS

p o w e r. A s o u n d a n d s t a b l e f i n a n c i a l s y s t e m

i n c l u d i n g a n e f f i c i e nt p ay m e nt s ys te m i s a l s o

impor tant for a mar ket economy to rea l ize i ts

ful l potent ia l . Accountabi l i t y, t ransparenc y and

good governance should be present .

F i t c h R a t i n g s r e c e n t l y s a i d t h a t t h e c a p i t a l

requirements as per BASEL I I I wi l l increase the

lending rate, impact the economic output thereby

ex te n d t h e c u r re nt re ce s s i o n . Fu r t h e r m o re, i n

Europe the government bonds’ y ie ld is increas-

ing, that i s , the bonds are no more att rac t ive.

This in turn wi l l squeeze the market that banks

can use to meet the new capita l requirements.

Government and tax payers are not at the r isk

for bai l ing out the depositors i f insured banks

fa i l because, they just have to make up the di f -

ference when the loss exceeds the amount accu-

mulated through premiums.

Flaw in the f inancia l regulat ion system

Some macrolevel shor tcomings were:

• N o a t te n t i o n to t h e s t a b i l i t y o f t h e f i n a n c i a l

system as a whole.

• No me as ure me nt of t he de gre e to which the

tur moi l in the f inancia l system can af fec t the

economy.

• I n a d e q u a te co n ce n t r a t i o n o n t h e s a fe t y a n d

soundness of individual depositor y inst itutions

in an age of g lobal interdependenc y.

We e x p e r i e n c e d t h e c o l l a p s e o f b a n k i n g a n d

savings-and-loan industr ies, with huge costs to

taxpayers and the economy.The fac t that th is

happened to heavily regulated industries makes

u s t h i n k w h e t h e r re g u l a t i o n d o e s m o re h a r m

than good?

The reason for moral hazard is the absence of

market disc ipl ine because of government reg-

ulator y pol ic ies . D eposi tors and shareholders

we re l u l l e d by p re v i o u s a c t i o n s o f re g u l ato r s

into bel ieving that even i f the inst itut ion fai led

they would somehow be protec ted.

Cost of bank ing regulat ion

Bank ing regulat ion curbs the abi l i ty of bank ing

houses to move out of recession and re -boot the

economy. An example of restr ic t ing and cost ly

b a n k i n g re g u l at i o n i s O b a m a’s t re n c h a nt a n d

restr ic t ive Dodd-Franck ac t .

The ‘quasi-nationalization’ of the banking sector

through a policy that combines a high degree of

regulat ion and bai louts wi l l d isrupt long-term

economic growth. Apar t f rom restr ic t ing credit

through profit loss on regulator y compliance, i t

may result in the shi f t of r i sk to general credit

t ra n s a c t i o n s . O n t h e b a c k o f t h e J . P. M o rg a n’s

b i l l i o n d o l l a r l o s s e s , t h e r e i s n o w a t e m p t a -

t ion in the EU to pass a measure s imi lar to the

Volcker rule in the U.S Dodd’s-Franck Ac t .

Wh at m a k e s u s re a l i s e t h e i m p o r t a n ce o f regulat ion?

I n 1970,the debt cr is is i l lustrated the need for

centra l bank ing func t ions that natural ly ar ise

in a deregulated environment.What most of us

didn’t k now before 2007 was exac t ly how they

made profits. But the banks over-reached them-

selves. They expanded too rapidly. I n 2007 and

2008, their schemes began to unravel. We learnt

a b o u t s u b - p r i m e m o r tg a g e s, l i a r s ’ l o a n s, a n d

der ivat ives where loans were repack aged, sold

a n d re - s o l d s o t h a t a ny co n n e c t i o n b e t we e n

borrower and the f inal lender was broken.

The recent a l legat ions were Barc lays -M ar ket

interest rate manipulation, HSBC-Mexican drug

m o n e y l a u n d e r i n g a n d S t a n d a r d C h a r t e r e d -

Iranian oil money laundering.The culture began

in 1986, when Margaret Thatcher ’s government

i n t r o d u c e d t h e “ B I G B A N G ” D E R E G U L AT I O N

that introduced the culture of r isk-tak ing, b ig

bonuses and a focus on shor t-term returns.The

f inancia l instruments are so complex i t of ten

takes months to f igure out how much was lost

and where the money went .Banks used higher

leverage to maximize prof i ts f rom D er ivat ive

produc ts. One example is the recent col lapse

of MF Global .

Dodd-Frank has tr ied to reduce the costs asso -

ciated with the regulation by focusing on inst i-

tut ions whose operat ions bear most cr i t ica l ly

o n t h e s t a b i l i t y o f t h e f i n a n c i a l s y s t e m a s a

whole. I t addressed the too -big-to -fai l problem

by a l l ow i n g t ro u b l e d s y s te m i c a l l y i m p o r t a n t

f inancia l inst i tut ions to be shuttered.

T h e b a n k i n g s e c t o r h a s u n d e r g o n e m a j o r

changes over the last few years. The regulat ion

rests on economic ro le of money anduncer-

t a i n t y. Th i s u n ce r t a i n t y i n t u r n re n d e r s f re e

bank ing unwork able.R ather than saying reg-

u l a t i o n i s u n n e c e s s a r y, t h e m o re a p p ro p r i -

ate response i s to cons ider how to improve

the regulation. Good regulator y policy should

t a k e a b r o a d v i e w o f t h e w a y r u l e s a f f e c t

e c o n o my a n d s o c i e t y, w h i l e m a i n t a i n i n g a

suitable degree of humil i t y about the abi l i t y

t o a c c u r a t e l y q u a n t i f y t h e r e l e v a n t b e n e -

f i ts and costs . The bank ing industr y should

h a v e e f f e c t i v e c h a n n e l s f o r v o i c i n g c o n -

cer ns about burden or about lack of c lar i t y

regarding regulator y standards and super vi -

s o r y e x p e c t at i o n s . A fo r w a rd - l o o k i n g m a c ro

prudent ia l approach must consider how the

f inancia l system is l ike ly to evolve over t ime.

For example, what systemic issues are ra ised

by new f inancia l produc ts, such as complex

derivatives? We want a distinct regime for sys-

temical ly impor tant inst i tut ions.

Sowrira jan S and R amanaidu D.S .T-The authors are students of Inst itue f o r F i n a n c i a l M a n a g e m e n t a n d Reseacrh,Chennai

BANKING BANKING


11 12

GOVERNMENT AND TAxES

Tax Reforms:An I ndian Perspec t ive

I n order to make i tse l f an

a t t r a c t i v e b u s i n e s s d e s t i -

nat ion and to increase tax

receipts, India is working on

two major tax reforms. DTC

(Di rec t Tax Code) and G ST

(G o o d s a n d S e r v i c e s Ta x ) .

L e t ’s l o o k a t t h e t r e n d i n c o m b i n e d

t a x r e c e i p t s f o r U n i o n a n d t h e S t a t e s .

The trend looks hear tening. I n fac t the rate of

growth has outpaced the GDP growth rate by a

huge margin. But, i f we look at this with a back-

d ro p o f t h e p i l i n g f i s c a l d e f i c i t , p l u m m e t i n g

investor confidence and widening trade deficit

we’ l l understand why the f inance minist r y i s

busy look ing for avenues to increase receipts.

The broad struc ture of the tax system and the

associated tax reforms are shown in the f igure

Direc t Tax

DTC i s s a i d t o r e p l a c e t h e e x i s t i n g I n d i a n

I ncome Tax Ac t , 1961. I t seeks to consol idate

and amend the laws under IT Ac t and fac i l i -

t a t e vo l u n t a r y c o m p l i a n c e t o h e l p i n c re a s e

the tax- GDP rat io.

Le t ’s fo c u s o n t h e t a x r e fo r m s r e l a t e d w i t h

I ncome Tax and Corporate Tax .

I ncome Tax

What percentage of over 1 .21 bi l l ion popu-

lat ion of the countr y pays income tax?

J u s t a b o u t 2 . 8 % ! Co m p a re t h i s w i t h o ve r

45% for USA. Thus there i s a need to br ing

more people under the ambit of the I ncome

Ta x . DTC i s p ro p o s e d to a c h i e ve t h i s g o a l .

Some of i ts sa l ient features are abol i t ion of

surcharge, educat ion cess and Leave Travel

A l l o w a n c e . D e d u c t i o n s u p t o 1 . 5 l a k h s ,

u n d e r ‘ S e c 8 0 C ’, t o b e a l l o w e d . N o d i f fe r -

ence in tax s labs for male and females and

many more. These changes a im to increase

t h e c o m p l i a n c e b a s e a n d t h u s i n c r e a s e

t h e Ta x r e c e i p t s . T h e c h a n g e s a r e b e i n g

i m p l e m e n t e d s t e p b y s t e p e v e r y y e a r .

Corporate Tax

I n d i a h a s e n t e r e d i n t o D o u b l e Ta x a t i o n

Av o i d a n c e A g r e e m e n t ( DTA A ) ; w i t h d i f f e r -

ent countr ies. Some mult inat ional companies

operating in India exploit the loopholes in the

DTAA by routing their investment through the

countr ies I ndia has DTAA with. Whi le there is

no wrong in having a holding company there,

i t o f t e n t u r n s o u t t o b e a s h e l l c o m p a n y.

T h u s , t o t a x s u c h t r a n s a c t i o n s , G A A R

( G e n e r a l A n t i Av o i d a n c e R u l e s ) w a s i n t r o -

d u c e d i n t h e U n i o n B u d g e t o f 2 0 1 2 - 1 3 .

B u t , i t w a s r e c e i v e d w i t h a p p r e h e n s i o n

b e c a u s e o f l a c k o f c l a r i t y a n d c e r t a i n p r o -

v i s i o n s r e l a t e d t o i t s r e t r o s p e c t i v e n a t u r e .

The investor conf idence took a dip and the FI I

inflows took a U-turn. In contrast to high invest-

ment in stock market in the Jan-Mar quar ter, FI I

inf lows were negat ive for the month of Apr i l .

The stock market saw a gradual fal l from about

1 7 5 0 0 p o i n t s i n M a r c h e n d t o a b o u t 1 6 0 0 0

points in May end. Thus to boost investor confi-

dence CBDT, in May, formed a six-member com-

mittee to draf t guidel ines for enforcing GAAR.

GOVERNMENT AND TAxES


13 14

D r a f t g u i d e l i n e s r e l e a s e d i n

J u n e e n d m a j o r l y i n c l u d e d -

1 . T h e t a x r u l e s w i l l a p p l y t o i n c o m e

a c c r u i n g o n l y o n o r a f t e r A p r i l 1 , 2 0 1 3

a n d t h a t a m o n e t a r y t h r e s h o l d i s a

m u s t f o r i n v o k i n g G A A R p r o v i s i o n s .

2 . G A A R w i l l b e i n v o k e d o n l y i f a n

F I I t a k e s t h e b e n e f i t o f a n y D TA A .

3 . G A A R p ro v i s i o n s w i l l n o t a p p l y i n c a s e s

where tax treaty agreements are not invoked.

4 . S e t t i n g u p a n a p p r o v i n g p a n e l

o f n o t l e s s t h a n t h r e e m e m b e r s .

I t a lso provided an indicat ive l i s t of deals/

t r a n s a c t i o n s / a r r a n g e m e n t w h e r e G A A R

w i l l b e i nvo k e d. Wh i l e t a x m i t i g at i o n u s i n g

a v a i l a b l e p ro v i s i o n s i n t h e l a w i s a l l o w e d ,

i t i s t a x avo i d a n ce t h at G A A R wa s to d e te r.

These new guidelines too did not go well with

a l l t h e s t a k e h o l d e r s . T h u s , P M M a n m o h a n

S ingh, in charge of the f inance por t fo l io in

June, set up a committee to begin the process

of consultations with various stakeholders in a

bid to fine-tune what had hitherto been viewed

as controvers ia l provis ions and usher in more

clar ity and transparenc y in the draft guidel ines.

The overal l sentiment s ince then has been posi-

tive and the return of confidence is evident by the

rally at the stock markets from a low about 16 thou-

sand points in May end to about 17500 in August.

I ndirec t Tax

GST (Goods & Ser vices Tax) is an ambitious prop-

osit ion to create a seamless nat ional common

market, by subsuming most of the indirect taxes

i m p o s e d b y t h e s t a t e a n d t h e g o v e r n m e n t .

Indirect taxes are a hotch-potch of Union Excise

Dut y, State Excise Dut y, Addit ional Excise Dut y,

S e r v i c e Ta x , S a l e s Ta x , C u s t o m s , A d d i t i o n a l

Customs Dut y, Specia l Addit ional Dut y, VAT etc.

Viewed through a f i scal lens, the countr y is not

one market, but 28 states, each with its own tax-

rais ing powers, which they are not afraid to use.

Compl icated laws, cascading, squabbl ing over

what constitutes a good and what is a service etc are

some major issues with the present web of taxes.

T h i s m u l t i p l e t a x r e g i m e a c r o s s s e c t o r s o f

p r o d u c t i o n a n d s t a t e s l e a d s t o d i s t o r t i o n s

i n a l l o c a t i o n o f r e s o u r c e s t h u s i n t r o d u c -

i n g i n e f f i c i e n c i e s i n d o m e s t i c p r o d u c t i o n .

O n c e G S T i s i m p l e m e n t e d a p a r t f ro m m a k i n g

l i f e e a s y f o r l o c a l i n d u s t r i e s , i t w i l l a t t r a c t

fo re i g n f u n d f l o w s. Ac c o rd i n g t o e s t i m a t e s i t

wi l l lead to an increase in GDP of 0 .7% to 1 .7%.

O n e o f t h e m a j o r c h a l l e n g e s i n i m p l e m e n t -

i n g G S T i s a r r i v i n g a t a re ve n u e n e u t r a l r a t e .

A revenue -neutra l rate is one at which a state

would not record any gain or loss af ter switch-

ing to GST. The higher a state’s revenue -neutra l

rate, the more compensation it would seek from

t h e C e n t r e . O t h e r c h a l l e n g e s i n c l u d e i m p l e -

m e n t a t i o n o f I T I n f ra s t r u c t u re , Co n s t i t u t i o n a l

A m e n d m e n t , D i s p u t e r e s o l u t i o n m e c h a -

n i s m a n d c r e d i t m e c h a n i s m b e t w e e n s t a t e s .

A committee headed by Govinda R ao has been

const i tuted to ar r ive at a revenue neutra l rate

for each state. Lately there has been some con-

s e n s u s a m o n g s t a t e s r e g a r d i n g d i s p u t e r e s -

o l u t i o n a n d c r e d i t m e c h a n i s m s . T h e s t a t e s

h a ve a g re e d t h a t p e t ro l e u m p ro d u c t s c a n b e

k e p t w i t h i n G S T a s l o n g a s t h e y a r e a l l o w e d

t o l e v y a d d i t i o n a l l e v i e s t o p r o t e c t r e v e n u e.

S er vice Tax Regime

S h a r e o f s e r v i c e s e c t o r i n c o u n t r y ’s G D P

has r isen f rom 50.4% in 2000-01 to 59.0% in

2011-12. But , share of Ser vice Tax is a l i t t le

more than 1% of the GDP. We have come a

l o n g w ay s i n c e 1 9 9 4 w h e n t h e s e r v i c e t a x

w a s i n t ro d u c e d. S i n c e t h e n a p o s i t i ve l i s t

approach. i .e. ser vices included in the l ist wil l

have to pay ser v ice tax , has been fol lowed.

T h e r e i s a n a l t e r n a t e c o n c e p t o f i n t e r -

n a t i o n a l l y f o l l o w e d n e g a t i v e l i s t a c c o r d -

i n g t o w h i c h t h e s e r v i c e s i n c l u d e d i n t h e

n e g a t i v e l i s t w i l l b e e xe m p t , r e s t a l l s e r -

v i c e s w i l l h a v e t o p a y t h e s e r v i c e t a x .

As a m ove towa rd s i m p l e m e nt i n g t h e G S T,

s e r v i c e t a x r e g i m e b a s e d o n n e g a t i v e l i s t

w a s i m p l e m e n t e d f r o m J u l y 1 s t . , 2 0 1 2

States have raised concerns to cer tain i tems,

which they say are leading to double taxa-

tion. As of now some of these items have been

added to the negative l ist and a consensus will

be reached when the GST gets implemented.

Conclus ion

T h e s e t a x r e f o r m s w o u l d d e f i n i t e l y

h e l p u s i n s u b s t a n t i a t i n g o u r s t a n c e

a n d w o u l d s t r o n g l y p o r t r a y o u r i m a g e

o f b e i n g t h e – ‘ I n c r e d i b l e I n d i a ’ .

GOVERNMENT AND TAxES GOVERNMENT AND TAxES


15 16

I s i t the end of Dol lar as Wor ld ’s reser ve Currenc y?

A Br ief H istor y of the US

Dol lar

The dollar was chosen as the

currency of United States by

the passage of the Coinage

Ac t of 1792, recommended

b y A l e x a n d e r H a m i l t o n , t h e t r e a s u r y s e c r e -

tar y then. Many theor ies exist on the or igin of

t h e s y m b o l o f t h e d o l l a r ( $ ) s u c h a s Th e Pe s o

Abbreviat ion Theor y(the most widely accepted

theor y now) , The US Abbreviat ion Theor y, The

S h i l l i n g A b b r e v i a t i o n T h e o r y, e t c . T h e Pe s o

Abbreviat ion Theor y puts for ward the fac t that

the dol lar symbol is der ived f rom the Spanish

Peso.

Dol lar izat ion

I t was in 1944 the US dol lar replaced the UK ’s

Po u n d S t e r l i n g a s t h e wo r l d ’s re fe re n c e c u r-

renc y. This was agreed af ter the Bretton Woods

Conference of 1944 ,when the exchange rates

w e r e p e g g e d a g a i n s t t h e U S D o l l a r w h i c h

c o u l d b e e x c h a n g e d f o r a f i x e d a m o u n t o f

gold thereby strengthening the posit ion of US

Dollar as the world currency. The collapse of the

U S S R re i n fo rce d t h e p re d o m i n a n ce o f d o l l a r

as a wor ld currenc y. Stabi l i t y has been a key

f a c to r fo r t h e a d o p t i o n o f U S D o l l a r a s o f f i -

cial currenc y by several countr ies. Devaluation

has never happened with the US Dol lar. The

emergence of the Japanese Yen in 1980’s posed

a s e r i o u s t h r e a t t o t h e D o l l a r a s wo r l d c u r-

renc y but thanks to the recess ion in Japan in

1990’s aver ted that threat . The ar r iva l of the

Euro had a lso posed a threat to the Dol lar as

wor ld currenc y.

Threat to the Dol lar ?

T h e s h i f t i n t h e e c o n o m i c p o w e r f r o m t h e

western hemisphere to the eastern hemisphere

i s t h e e m i n e n t d a n g e r t h a t l u r k s o v e r t h e

supremac y of the US Dollar. A study conducted

by IMF has projec ted the sh i f t in Purchas ing

Power Par i t y of the wor ld f rom the west to the

east within a t ime span of 18 years .The most

l ikely contender to substitute the Dollar would

be the Chinese Yuan. The growth tra jec tor y of

China shows that it would over take the US to be

the world’s largest economy by 2020(Economic

Times Repor t) . Some of the banks have already

star ted given a higher impor tance to the Yuan

i n co m p a r i s o n to t h e U S D o l l a r by a d o p t i n g

Yuan as the S ett lement Currenc y.

From the forecast above , the emphasis should

be la id on the emergence of 2 new economic

superpowers – China & I ndia . The role played

by the t radit ional economic powerhouses l ike

The US Abbreviation Theory states that the dollar sign has been derived from the initials of the US

Unofficial Dollarization might lead to inability of local governments to control inflation & fiscal policy

Japan & Germany along with the US wil l be side -

l ined leading to a shi f t in the economic power

balance as stated ear l ier.

The future of the present ly a i l ing US economy

w o u l d b e i n f l u e n c e d g r e a t l y b y s h o r t t e r m

g l o b a l f a c t o r s l i k e a n o i l s h o c k o r a n a t u r a l

d isaster ,etc. The sustenance of the US Dol lar

h e g e m o n y w o u l d d e p e n d u p o n t h e p e r f o r -

mance of the US Economy. A potent ia l threat

to t h e U S e co n o my co u l d b e t h e o p e n i n g u p

of another war f ront in a place l ike I ran/Syr ia .

The fai lure of a couple of Major US banks could

p l u n g e t h e U S e co n o my i nto a d e e p e r a bys s .

These are some of the major fac tors that could

affect the US economy thereby having a poten-

t ia l to inf l ic t severe damage on the status of

the US Dollar as the world’s reference currenc y.

The present economic cr is is has also led the US

Government to reduce the interest rates to the

minimum possible so as to stimulate investment

in the economy. However, th is move wi l l be a

d e t e r re n t fo r t h e O P E C n a t i o n s ( b a r r i n g I r a n

) to co n d u c t O i l Tra n s a c t i o n s i n D o l l a r s . Th i s

i s because the petrodol lar system wi l l be less

a l lur ing to them on account of the lower inter-

est rates that the US Secur i t ies would provide

them. This wi l l lead to the shi f t ing away of the

OPEC countr ies f rom the Petrodol lar system.

I n such a scenar io , petroleum being a major

c o m m o d i t y t r a n s a c t e d i n t h e wo r l d m a r k e t ,

wil l cause the breakdown of dollar as the world

reference currenc y as major i t y of the nat ions

would not purchase Petroleum from the OPEC

countr ies using Dollars but by some other cur-

renc y that gives better returns.

A Wor ld without Dol lar ?

Th i s c o u l d b e a re a l i t y w i t h i n a g e n e r a t i o n .

I f at a l l the Dol lar i s ousted as the reference

currenc y and i f there is no currenc y to occupy

that posit ion , then global inf lat ion would r ise

a s i m p o r t a n t c o m m o d i t i e s l i k e o i l , p re c i o u s

m e t a l s & a gr i c u l t u ra l g o o d s wo u l d r i s e s u b -

stantial ly to compensate for the same. This wil l

hit the emerging markets l ike China, India ,etc.

However, we should a lso analyze the subst i -

tutes avai lable, other than the Chinese Yuan

which has been discussed ear l ier. Let us look

at the some of the different possible substitues

1.Euro - I f we look at the European Union now ,

what is v is ible is that there are a large number

o f c o u n t r i e s t h a t a re f a c i n g s o ve re i g n d e b t


17 18 WORLD ECONOMY WORLD ECONOMY

c r i s i s . S o m e o f t h e m a re t r y i n g t o d i s t a n c e

t h e m s e l ve s f ro m t h e E u ro. T h i s i s p r i m a r i l y

due to the di f ferent growth rates of countr ies

that have adopted a s ingle currenc y, Euro. I t

becomes di f f icult to maintain the same inter-

est rate throughout a l l the member countr ies

b e c a u s e o f t h e va r y i n g grow t h rate s . H e n ce

t h e i n h e r e n t i n s t a b i l i t y i n t h e E u r o Z o n e

deems the Euro unf i t to replace the Dol lar as

a wor ld reference currenc y.

2 .Japanese Yen- The locat ion of Japan in “ The

R ing of Fi re” wi l l never ensure the stabi l i t y of

the Yen as the countr y wi l l be f requently h i t

by natural disasters which inturn would affect

the stock markets as wel l as the currenc y of

The Euro is adopted by top performing economies like Germany & France as well as by faltering economies like Greece & Spain.

M r. S i d d h a r t h K u m a r - A s s i t a n t V i c e P r e s i d e n t ,

I nvestment bank ing, Barc lays Capitta l

q u e s t i o n : Yo u h a v e h a d a n

e x p e r i e n c e o f wo r k i n g i n t h e

I n d i a n Ca p i t a l M a r k e t s , e s p e -

c i a l l y t h e d e b t m a r k e t , f o r a

span of 5 years. How has your

entire experience of work ing in

this par t icular market been?

Answer: The Indian Debt Capital Market is quite

ac t ive. When I jo ined, the I ndian mar ket was

not real ly in i ts formative phase; rather, i t had

developed to quite an ex tent . Speak ing of the

n at u re o f t h e m a r k e t , i t d o e s n o t h ave m u c h

s imi lar i t y with the mar kets in the developed

world. So, to an extent, a niche market is devel-

oping in I ndia .

The exper ience, as such, has been ver y enr ich-

ing, given the fac t that the scenar io of a c lass-

room is ver y different from that of a workplace.

I t feels good to be in the middle of ac t ion.

q u e s t i o n : G i ve n t h e c u r re n t co n te x t , d o yo u

see a major t rend developing in this market?

A n s w e r : C o n s i d e r i n g a t i m e f r a m e o f 1 2 - 1 8

months, the trend wil l l ikely be of more domes-

t ic ac t iv i t y in the markets. This i s mainly due

to the fac t that there is lack of fa i th of foreign

investors in the Indian capital markets, coupled

with the fac t that capr ic ious pol ic y mak ing by

the government has put barr iers for their entr y.

quest ion: A recent repor t stated that 10.6 % of

the GDP of China is funded by Corporate Bonds,

w h i l e fo r J a p a n a n d K o re a t h i s s t at i s t i c g o e s

up to 40 % and 50 % respec t ively. So, can we

conclude that there is a correlat ion bet ween a

countr y ’s economic development and the evo-

lution of its debt market? Or should we say that

i t i s just another stat ist ic?

Answer : As the economies develop, the evolu-

t ion of capi ta l mar kets i s a natura l outcome,

r e g a r d l e s s o f w h e t h e r t h e m a r k e t i s d o m i -

n a t e d b y d e b t i n s t r u m e n t s o r e q u i t y i n s t r u -

m e nt s . S o, o n e c a n s ay t h at t h e re i s a co r re -

l a t i o n to t h e e x te n t t h a t a s e co n o m i e s grow

and progress, borrowing and lending tend to

increase. However, one cannot conclude that

o n e p a r t i c u l a r p a r a m e t e r w i l l i n f l u e n c e t h e

other parameter.

q u e s t i o n : I s l a m i c b o n d s t o o k o f p r e t t y w e l l

in 2007. So, ta lk ing of them along with other

S h a r i a t c o m p l i a n t p r o d u c t s , d o t h e y h a v e a

future, i f launched in I ndia?

Answer : Wel l to be honest , speak ing of I s lamic

bonds and other Shar iat compla int produc ts ,

I do not see them having much of a future in

I ndia . The spir i t and or igin of I s lamic f inance

is f rom countr ies where i t i s regarded a taboo

to c h a rg e i n te re s t . S o, i n t h i s g i ve n co n te x t ,

consider ing that I ndia is essent ia l ly a democ -

rac y, i t won’t be feas ible for I s lamic bonds to

be launched in I ndia .

q u e s t i o n : We l l co m i n g to t h e l a s t te c h n i c a l

t h e co n ce r n e d co u nt r y a s we h a d s e e n s u b -

s e q u e n t t o o c c u r r e n c e s o f e a r t h q u a k e s i n

Japan. Hence the this inval idates the compe -

t i t ion posed by Yen.

3 . G o l d - T h o u g h g o l d i s o n e a m o n g t h e

o l d e s t f o r m s o f m o n e y , t h e c o s t i n v o l v e d

in us ing gold in t ransac t ions a long with the

i nte gr i t y o f t h o s e t ra n s a c t i o n s re n d e r s g o l d

a c o s t l y r e p l a c e m e n t f o r d o l l a r a s a w o r l d

currenc y.

H e n c e , w h a t i s e v i d e n t i s t h a t t h o u g h t h e

dol lar i s in a danger zone , i t would st i l l con-

tinue to be the exchange currency of the world

for at least a couple of decades.

S a n o o p S r e e d h a r -T h e a u t h o r i s a student of FMS ,Delhi


19 20 WORLD ECONOMY CORPORATE TALK

question on debt, recently the FI I l imit has been

ra ised by USD 5 Bi l l ion. Also, we are seeing a

new set of reforms tak ing place. In this scenario

what are the reforms that you think wi l l help in

developing the debt market in I ndia?

Answer : The gover nment increas ing th e l imit

by 5 b i l l i o n f ro m 2 0 b i l l i o n to 2 5 b i l l i o n i s a

reform that is not going to make a great deal of

change, because even the in the current quote,

a lot of headroom is available which is not used.

q u e s t i o n : S o w h a t re fo r m s d o yo u t h i n k w i l l

actual ly help in changing the cl imate of capital

markets in I ndia?

Answer : Wel l , as such the government is begin-

ning to take steps. For instance, the tax on off -

shore borrowing has been reduced from 20% to

5%. But instruments l ike credit default swaps

have not real ly taken of f. I n a l l , the one s imple

thing that the government can do is to be more

consistent with their pol ic y mak ing. The pol i -

c ies should not be such that the gover nment

can c law back money that the investors have

made on their investment.

O ther than that , I ndia coming up with sov-

ereign bonds could draw more attention to the

countr y. This may enable investors from Europe

and United States to become more open about

enter ing the I ndian market .

quest ion: Given the current economic outlook ,

do you think i t i s ac tual ly correc t for I ndia to

come up with sovereign bonds?

Answer : Wel l , in the coming year or so, i f the

government is able to show some progress with

respec t to pol ic y a long with reforms l ike FDI

i n v a r i o u s s e c to r s s u c h a s re t a i l a n d i n s u r -

a n c e . T h e r e a r e m a n y s u c h w h i c h s h o u l d

have been done long back . S imi lar ly, the RBI

h a s a c a p o n h o w m u c h I n d i a n c o m p a n i e s

a re p e r m i t t e d i n t h e fo r m o f E C B f ro m o f f -

shore mar kets , mak ing i t a lmost imposs ible

for I ndian companies to tap capita l f rom the

of fshore markets. Hence, increas ing the cap

put on the I ndian companies would a lso be

benef ic ia l . So, possibly these are some of the

things one could look at .

q u e s t i o n : N o w we wo u l d l i k e t o a s k yo u a

fe w q u e s t i o n s p e r t a i n i n g to t h e co l l e g e, a s

to h ow t h e v a r i o u s e x p e r i e n ce s yo u h a d i n

your 2 years of MBA. How has an MBA f rom

I IFT helped you in your career?

Answer : Wel l , I IFT is the place where I had my

f i rst exposure to Finance as a domain. I had

a g o o d i n t e r n s h i p w i t h Ad i t y a B i r l a G ro u p,

so my interest in f inance star ted f rom there.

I n the 2nd year, we had some ver y good pro -

fessors, who helped in nur tur ing my interest

in f inance. Also, the batch that I was a par t

of had a set of common interests , which we

s h a re d a m o n g s t o u r s e l ve s . H e n c e, t h e t wo

years of MBA gave me a hol ist ic development

f rom al l aspec ts.

q u e s t i o n : We a r e p l e a s e d t o t e l l y o u t h a t

t h i s i n t e r v i e w wo u l d b e p u b l i s h e d b o t h i n

the f inance magazine as wel l as in the alumni

magazine. What according to you should the

col lege a long with the a lumni committee do

to better engage more and more a lumni?

A n s w e r : T h e c o l l e g e s h o u l d l o o k t o b e i n g

more proac t ive in reaching out to the a lumni ,

basical ly having an ‘in your face approach’. I feel

t h at e ve r y a l u m n u s o f t h e co l l e g e d o e s h ave

some feeling of aff i l iation to his alma mater and

wa nt s to co nt r i b u te to t h e co l l e g e. H owe ve r,

due to var ious reasons, they are not able to do

so. The basic fac t is that you have to be in their

face. They may ignore you, but they won’t turn

yo u d ow n . S o, yo u h ave to k e e p o n t r y i n g to

engage with the alumnus, because he/she won’t

give you t ime half-hear tedly. One has to real ize

that they do have a desi re to be in touch with

the var ious ac t iv i t ies in the col lege, i t i s only

about inf luencing that des i re.

M r. S i d d h a r t h K u m a r i s t h e A s s i s t a n t Vi c e Pres ident of the I nvestment Bank ing div i -s i o n a t t B a rc l ays Ca p i t a l . Pr i o r to j o i n i n g Barclays Capital , he worked as the manager o f t h e g l o b a l i n v e t m e n t b a n k i n g d i v i -s i o n a t I C I C I b a n k . H e h a s a to t a l e x p e r i -ence of more than 5 years in the bank ing a n d f i n a n ce i n d u s t r y. H i s a re a o f i nte re s t inc ludes Struc tured Finance, Debt Capita l M arkets, Syndicated Loans, S ecur i t izat ion


21 22 CORPORATE TALK CORPORATE TALK

was par t ia l ly a result of the

m o n e t a r y a u t h o r i t y i r r e -

sponsibly borrowing money

to pay a l l i ts expenses and

funding quasi - f iscal ac t iv i -

t ies (which are normally left

t o C e n t r a l G o v e r n m e n t ) .

F e w o f t h e p r o m i n e n t

e f f e c t s o f i n f l a t i o n c a n b e j o t t e d d o w n a s -

( i ) E ro d e s t h e b u y i n g p o we r o f t h e c u r re n c y.

( i i ) Decrease in real wage rate. ( i i i ) Decrease in

real rate of return for debt holders. ( iv ) I nstead

o f s a v i n g , c o n s u m e r s m a y s t a r t b o r r o w i n g .

Consumers tend to borrow more and spend even

m o r e . ( v ) I n f l a t i o n c a u s e s u n c e r t a i n t y w h i c h

increases r isk . Higher r isk means businesses are

less l ikely to invest. (vi ) Input pr ices (raw mate -

r ials, wages and supplies) r ise so business costs

r ise. Wages are of ten the largest business cost ,

and there could be a danger of a ‘wage -pr ice’

spiral where r is ing costs leads to higher pr ices,

workers ask for a pay r ise in compensat ion, so

co s t s r i s e a g a i n , s o p r i ce s r i s e a g a i n , a n d s o

on. (v i i ) Divers ion of resources f rom more pro -

d u c t i ve u s e s to co n t ro l l i n g i n f l a t i o n h o l d e r s

To g e t t o t h e c r u x o f i t , w e n e e d t o u n d e r -

s t a n d t h e b a s i c s o f i n f l a t i o n a n d f a c t o r s

giving r ise to i t . There is no s ingle cause which

i s a g re e d u p o n b y a l l , b u t t h e re a re a t l e a s t

t w o t h e o r i e s w h i c h a r e g e n e r a l l y a c c e p t e d :

D o e s t h i s h o l d t r u e

i n t o d a y ’s s c e n a r i o ? C a n

this be sa id for the coun-

t r i e s i r re s p e c t i ve o f t h e i r

e c o n o m i c s t r u c t u r e ?

I n f l a t i o n i s a g e n e r a l

increase in the overal l pr ice level of the goods

a n d s e r v i c e s i n t h e e c o n o my. I n f l a t i o n r a t e

r e fe r s t o a g e n e r a l r i s e i n p r i c e s m e a s u r e d

against a standard level of purchasing power.

T h e m o s t we l l k n o w n m e a s u re s o f I n f l a t i o n

are the CPI which measures consumer pr ices,

and the GDP def lator, which measures inf la-

t i o n i n t h e w h o l e o f t h e d o m e s t i c e co n o my.

Inflation today has become a major concern for

many countr ies across the globe. Developing

c o u n t r i e s s p e c i a l l y h a v e b e e n g r a p p l i n g t o

t a m e i n f l at i o n i n re ce nt ye a r s . I n d i a f a ce d a

high of 14.97% (CPI) inf lat ion rate in FY09; RBI

was par t ia l ly able to control the inf lat ion rate

and has brought i t down to 6 .87% in July ’12.

China ra ised interest rates for the four th t ime

s ince the end of the global f inancia l cr is is to

re s t r a i n i n f l a t i o n a n d l i m i t t h e r i s k o f a s s e t

bubbles in the fastest-growing major economy.

I n f l at i o n a f fe c t s t h e d i f fe re nt s e c to r s o f t h e

economy and i f kept unchecked can shake the

economic stabi l i t y of a nat ion. For instance,

Zimbabwe’s hyper-Inflation of 24,000% in 2009

I s Monetar y Pol ic y the best answer we have for I nf lat ion?“I nf lat ion is a lways and ever y where a monetar y phenomenon.”-M i l ton Fr iedman

D e m a n d - P u l l I n f l a t i o n T h e o r y

& C o s t - P u s h I n f l a t i o n T h e o r y .

These can be expla ined in terms of intersec-

t ion of shor t run aggregate supply (SRAS) and

a g g r e g a t e d e m a n d c u r v e s a s s h o w n i n t h e

f igure. I n a shor t t ime span Long run aggre -

g a t e s u p p l y ( L R A S ) c u r v e i s a s s u m e d c o n -

stant and is the level of GDP at equi l ibr ium.

D e m a n d P u l l : I n a r a n g e w h e n S R A S

b e co m e s i n e l a s t i c a n d t h e re i s f u l l e m p l oy-

m e n t o f r e s o u r c e s , a n i n c r e a s e i n d e m a n d

l e a d s t o i n c r e a s e o f p r i c e s . F e w o f t h e

m a j o r re a s o n s fo r i n c re a s e i n d e m a n d a re : -

1 . A re d u c t i o n i n d i re c t o r i n d i re c t t a x at i o n

2 . T h e r a p i d g r o w t h o f t h e m o n e y s u p p l y

3 . A d e p r e c i a t i o n o f t h e e x c h a n g e r a t e

4 . R i s i n g c o n s u m e r c o n f i d e n c e a n d a n

increase in the rate of growth of house pr ices.

T h i s e f f e c t i s e x p l a i n e d i n t h e d i a g r a m

w h e r e i n c r e a s e i n d e m a n d h a s c a u s e d

p r i c e s o f g o o d s i n e c o n o m y t o i n c r e a s e .

C o s t P u s h I n f l a t i o n : O n t h e o t h e r h a n d ,

C o s t - P u s h I n f l a t i o n o c c u r s w h e n b u s i -

n e s s e s r e s p o n d t o r i s i n g p r o d u c t i o n

c o s t s , b y r a i s i n g p r i c e s i n o rd e r t o m a i n -

t a i n t h e i r p r o f i t m a r g i n s . T h e r e a r e

m a n y r e a s o n s w h y c o s t s m i g h t r i s e :

1 . R is ing impor ted raw mater ia ls costs

2 . R is ing labour costs

3 . H i g h e r i n d i r e c t t a x e s i m p o s e d b y t h e

government

C o s t - p u s h i n f l a t i o n c a n b e i l l u s t r a t e d b y

a n i n w a r d s h i f t o f t h e s h o r t r u n a g g r e -

g a t e s u p p l y c u r v e . T h i s i s s h o w n i n t h e

diagram below. A fa l l in SRAS causes a con-

t r a c t i o n o f r e a l n a t i o n a l o u t p u t t o g e t h e r

w i t h a r i s e i n t h e g e n e r a l l e ve l o f p r i c e s .

For years now, the most common tool

w h i c h ce nt ra l b a n k e r s h ave i n t h e i r

hand to control the inf lat ion is tem-

per ing with the money supply. Idea

b e h i n d i t b e i n g t h a t m o n e y s u p p l y

c o n t r o l s t h e g r o w t h o f d e m a n d

through an increase in interest rates

and a contrac t ion in the real money


23 24 INDIAN ECONOMY INDIAN ECONOMY

s u p p l y. Fe w o f t h e m e a s u r e s a d o p t e d a r e : -

Bank rate pol ic y : I t i s used as the main instru-

ment of monetar y control dur ing the per iod of

inf lat ion. The increase in bank rate increases

t h e c o s t o f b o r r o w i n g w h i c h r e d u c e s c o m -

m e r c i a l b a n k s b o r r o w i n g f r o m t h e c e n t r a l

b a n k . Co n s e q u e nt l y, t h e f l ow o f m o n e y f ro m

t h e c o m m e r c i a l b a n k s t o t h e p u b l i c g e t s

r e d u c e d . T h e r e f o r e , i n f l a t i o n i s c o n t r o l l e d

to the ex tent i t i s caused by the bank credit .

C a s h R e s e r v e R a t i o ( C R R ) : To c o n t r o l i n f l a -

t i o n , t h e c e n t r a l b a n k r a i s e s t h e C R R w h i c h

reduces the lending capacit y of the commer-

c ia l banks. Consequently, f low of money f rom

commercia l banks to publ ic decreases. I n the

process, i t halts the r ise in pr ices to the ex tent

i t i s c a u s e d b y b a n k s c r e d i t s t o t h e p u b l i c .

Open Market Operat ions : Open market opera-

t ions refer to sale and purchase of government

s e c u r i t i e s a n d b o n d s by t h e ce nt ra l b a n k . To

control inf lat ion, central bank sel ls the govern-

ment securities to the public through the banks.

This result in t ransfer of a par t of bank depos-

i ts to centra l bank account and reduces credit

c r e a t i o n c a p a c i t y o f t h e c o m m e r c i a l b a n k s .

I s M o n e t a r y p o l i c y b e s t

a n s w e r w e h a v e f o r I n f l a t i o n ?

But are such monetar y pol ic ies the only source

of inflation control? Or are they enough consid-

ering the current world scenario where all econ-

o m i e s a re m u c h m o re co m p l i c ate d t h a n e ve r

before? Ef fec t ive pol ic ies to control inf lat ion

need to focus on the underlying causes of infla-

t ion in the economy. For instance, i f the main

cause is excess demand for goods and ser vices,

then government pol ic y should look to reduce

t h e l e ve l o f a g g re g a te d e m a n d. I f co s t - p u s h

inflation is the root cause, production costs need

to be control led for the problem to be reduced.

To ser ve this purpose var ious methods can be

a d o p te d fo r s h o r t te r m o r l o n g te r m e f fe c t s .

Shor t-term pol ic ies

A n a p p r e c i a t i o n o f t h e e x c h a n g e r a t e

A n a p p re c i a t i o n i n t h e e xc h a n g e r a te m a k e s

expor ts more expensive and should reduce the

volume of expor ts and aggregate demand. I t

a lso provides f i rms an incent ive to keep costs

d o w n t o r e m a i n c o m p e t i t i v e i n t h e w o r l d

m a r k e t . A s t ro n g e r c u r re n c y re d u c e s i m p o r t

p r i c e s a n d t h i s m a k e s f i r m s ’ r a w m a t e r i a l s

a n d c o m p o n e n t s c h e a p e r, t h e re fo re h e l p i n g

t h e m c o n t r o l c o s t s . A r i s e i n t h e v a l u e o f

t h e e xc h a n g e r a t e m i g h t b e a c h i e ve d b y a n

increase in interest rates or through the pur-

c h a s e o f c u r r e n c y v i a C e n t r a l B a n k i n t e r -

v e n t i o n i n t h e f o r e i g n e x c h a n g e m a r k e t s .

D i r e c t w a g e c o n t r o l s - i n c o m e s p o l i c i e s

I n c o m e s p o l i c i e s ( o r d i r e c t w a g e c o n t r o l s )

s e t l i m i t s o n t h e r a t e o f g r o w t h o f w a g e s

a n d h ave t h e p o t e n t i a l t o re d u ce c o s t i n f l a -

t i o n . Th i s p o l i c y h a s n o t b e e n u s e d t h at f re -

q ue nt ly in cur re nt t ime s, but i t does s t i l l t r y

to i n f l u e n ce w a g e grow t h by re s t r i c t i n g p ay

r ises in the publ ic sec tor and by sett ing cash

l imits for the pay of publ ic sec tor employees.

I n the pr ivate sec tor the government may tr y

moral suasion to persuade f irms and employees

to exerc ise moderat ion in wage negot iat ions.

This i s rare ly suf f ic ient on i ts own. Wage inf la-

tion normally fal ls when the economy is heading

i n t o r e c e s s i o n a n d u n e m p l o y m e n t s t a r t s t o

r i s e . T h i s c a u s e s g r e a t e r j o b i n s e c u r i t y a n d

s o m e wo r k e r s m ay t ra d e o f f l owe r p ay c l a i m s

fo r s o m e d e g r e e o f e m p l o y m e n t p r o t e c t i o n .

Long-term pol ic ies

Fiscal Pol ic y

• H igher di rec t taxes (causing a fa l l in dispos -

able income)

• Lower Government spending

• A re d u c t i o n i n t h e a m o u n t t h e g ove r n m e n t

sec tor borrows each year

These f iscal pol ic ies increase the rate of leak-

a g e s f ro m t h e c i rc u l a r f l ow a n d re d u ce i n j e c -

t i o n s i n t o t h e c i r c u l a r f l o w o f i n c o m e a n d

w i l l r e d u c e d e m a n d p u l l i n f l a t i o n a t t h e

c o s t o f s l o w e r g r o w t h a n d u n e m p l o y m e n t .

Labour market reforms

T h e w e a k e n i n g o f t r a d e u n i o n p o w e r, t h e

g r o w t h o f p a r t - t i m e a n d t e m p o r a r y w o r k i n g

a l o n g w i t h t h e e x p a n s i o n o f f l ex i b l e wo r k i n g

h o u r s a re a l l m ove s t h at h ave i n c re a s e d f l ex -

i b i l i t y i n t h e l a b o u r m a r k e t . I f t h i s d o e s

a l l o w f i r m s t o c o n t r o l t h e i r l a b o u r c o s t s i t

m a y r e d u c e c o s t p u s h i n f l a t i o n a r y p r e s s u r e .

I n re c e n t ye a r s t h e U K a n d G e r m a n e c o n o my

h a s n o t s e e n t h e a c c e l e r a t i o n i n w a g e i n f l a -

t ion normal ly associated with several years of

INDIAN ECONOMY INDIAN ECONOMY

susta ined economic growth and fa l l ing inf la-

t ion. This can be attr ibuted to shif t ing of power

a w a y f r o m e m p l o y e e s t o w a r d s e m p l o y e r s .

Supply s ide reforms

The equi l ibr ium level of real nat ional income

increases and the average price level remains rel-

atively constant. A classic example is of Turkey ’s

centra l bank reducing interest rates to shie ld

the economy from the impac t of the European

d e b t c r i s i s a n d s l o w i n g g r o w t h i n t h e U. S .

Supply s ide reforms seek to increase the pro -

d u c t i ve c a p a c i t y o f t h e e co n o my i n t h e l o n g

r u n a n d r a i s e t h e t r e n d r a t e o f g r o w t h o f

labour and capita l produc t iv i t y. A number of

s u p p l y - s i d e p o l i c i e s h a v e b e e n i n t r o d u c e d

i n t o t h e B r i t i s h e c o n o m y i n r e c e n t y e a r s .

P r o d u c t i v i t y g a i n s h e l p t o c o n t r o l u n i t

l a b o u r c o s t s ( a n i m p o r t a n t c a u s e o f

c o s t - p u s h i n f l a t i o n ) a n d p u t l e s s p r e s -

s u r e o n p r o d u c e r s t o r a i s e t h e i r p r i c e s .

C l e a r l y i t c a n b e s e e n t h a t i n f l a t i o n c u r b i n g

today needs much more than just monetar y pol -

ic ies and the key to control l ing inf lat ion in the

long run is for the author i t ies to keep control

of aggregate demand (through f iscal and mon-

e t a r y p o l i c y ) a n d a t t h e s a m e t i m e s e e k t o

achieve improvements to the supply side of the

economy. The credibility of inflation control pol-

ic ies can also be enhanced by the introduc tion

of inf lat ion targets which should be met with .

H i m a n s h u K u n d o o a n d P a l n i k a H e m n a n i -T h e a u t h o r s a re s t u d e n t s of I IFT


25 26

BANKING

Impact of BASEL I I I norms on Indian Banking

“ W h a t e ve r w a s o n t h e

l e f t - h a n d s i d e ( l i a b i l i t i e s )

w a s n o t r i g h t a n d w h a t -

ever was on the r ight-hand

s i d e ( a s s e t s ) w a s n o t l e f t ” -

T h i s q u o t e c h a r a c t e r i z e d

the wor ld ’s bank ing system

dur ing ear ly 2008 and ushered in the global

f inancia l cr is is that sent t remors across econ-

o m i e s t h e w o r l d o v e r. T h i s w a s i n s p i t e o f

t h e p r o t e c t i v e s a f e g u a r d s o f t h e B A S E L I I

n o r m s a n d h a s l e d t h e B a s e l Co m m i t t e e o n

B a n k i n g S u p e r v i s i o n ( B C B S ) t o c o m e o u t

with the BASEL I I I nor ms providing a broad-

ened f ramework of t ighter regulat ions a imed

a t s t re n g t h e n i n g b o t h s i d e s o f t h e b a l a n c e

sheet for banks around the wor ld. The Basel

I I I g u i d e l i n e s e n v i s a g e i n c r e a s e i n c a p i t a l

a n d l i q u i d i t y r e q u i r e m e n t s w o r l d w i d e .

I n e a r l y M a y 2 0 1 2 , R B I a n n o u n c e d n e w

n o r m s f o r t h e I n d i a n b a n k i n g s e c t o r w i t h

s t r i c t e r r e g u l a t i o n s t h a n t h e B A S E L I I I t o

b e e f fe c t e d i n a p h a s e d m a n n e r w i t h i n f i ve

f i s c a l y e a r s s t a r t i n g f r o m J a n u a r y , 2 0 1 3 .

L e t u s l o o k a t t h e s e n o r m s a n d t h e i r

p r o b a b l e i m p a c t o n t h e I n d i a n B a n k s .

The rules can be broadly c lass i f ied as bel low :-

•The capital requirements for the implementa-

tion of Basel III guidelines may be lower during the

initial periods and higher during the later years.

•The guidel ines require banks to maintain a

m i n i m u m t o t a l c a p i t a l o f 9

per cent against 8 per cent

p r e s c r i b e d b y t h e B a s e l

c o m m i t t e e o f t o t a l

r i s k w e i g h t e d a s s e t s .

• C o m m o n E q u i t y T i e r 1

( C E T 1 ) c a p i t a l m u s t b e a t

least 5.5 per cent of RWA’s. (Risk Weighted Assets)

U n d e r t h e s e n o r m s b a n k s w i l l h a v e t o m a i n -

t a i n t h e i r t o t a l c a p i t a l r a t i o a t 9 % , h i g h e r

t h a n t h e m i n i m u m r e c o m m e n d e d r e q u i r e -

m e n t o f 8 % u n d e r t h e B a s e l I I I n o r m s . T h e

n o r m s a l s o r e q u i r e b a n k s t o m a i n t a i n T i e r

I c a p i t a l a t 7 % o f r i s k w e i g h t e d a s s e t s .

F o l l o w i n g i s t h e s u m m a r y o f t h e r u l e s

p e r t a i n i n g t o t h e I n d i a n s c e n a r i o : -

2 0 1 3 M i n i m u m c a p i t a l r e q u i r e m e n t s :

S t a r t o f t h e g r a d u a l p h a s i n g - i n o f t h e

h i g h e r m i n i m u m c a p i t a l r e q u i r e m e n t s .

2 0 1 5 M i n i m u m c a p i t a l r e q u i r e m e n t s :

H i g h e r m i n i m u m c a p i t a l r e q u i r e -

m e n t s t o b e f u l l y i m p l e m e n t e d .

2 0 1 6 C o n s e r v a t i o n b u f f e r : I n i t i a t i o n o f t h e

gradual phasing- in of the conser vat ion buffer.

2 0 1 9 Cy c l i c a l C o n s e r v a t i o n b u f f e r : T h e c o n -

s e r v a t i o n b u f f e r t o b e f u l l y i m p l e m e n t e d .

2 0 1 1 S u p e r v i s o r y m o n i t o r i n g : D e v e l o p i n g

t e m p l a t e s t o t r a c k t h e l e v e r a g e r a t i o

a n d t h e u n d e r l y i n g c o m p o n e n t s .

2 0 1 3 Pa r a l l e l r u n I : T h e l e v e r a g e r a t i o a n d

i ts components to be t racked by super visors

w h i c h a re n e i t h e r d i s c l o s e d n o r m a n d a to r y.

2 0 1 5 P a r a l l e l r u n I I : T h e l e v e r a g e r a t i o

a n d i t s c o m p o n e n t s t o b e t r a c k e d w h i c h

a r e n e i t h e r d i s c l o s e d n o r m a n d a t o r y .

2017 Final adjustments : Based on the results

o f t h e p a r a l l e l r u n p e r i o d, a ny f i n a l a d j u s t-

m e n t s t o t h e l e v e r a g e r a t i o t o b e m a d e .

2 0 1 8 M a n d a t o r y r e q u i r e m e n t : T h e

l e v e r a g e r a t i o t o b e c o m e a m a n d a -

t o r y p a r t o f B a s e l I I I r e q u i r e m e n t s .

T h e I n d i a n r e g u l a t o r h a s b e e n m o r e s t r i n -

g e n t . F o r I n d i a n b a n k s , c o m m o n e q u i t y

s h o u l d b e a t l e a s t 5 . 5 % o f t h e a s s e t b a s e ,

w h e r e a s t h e i n t e r n a t i o n a l n o r m s u g g e s t s

4 . 5 % . Ti e r I c a p i t a l , o r co re c a p i t a l , i n c l u d e s

a b a n k ’s e q u i t y c a p i t a l a n d d i s c l o s e d

re s e r ve s . C a p i t a l r a t i o i s t h e p e rc e n t a g e o f

a b a n k ’s c a p i t a l t o i t s r i s k- we i g h t e d a s s e t s .

I mpac t

Given that the regulations set by RBI on capital

a d e q u a c y a r e a l r e a d y s t r i n g e n t t h e I n d i a n

banks should f ind it relatively easier to adhere

to the capita l requirement norms as most of

the Indian banks have maintained their capital

we l l a b ove t h e m i n i m u m re q u i re m e n t s . Th e

only concern is the requirement of capital ade -

quac y may create pressure on PSUs who are in

a credit crunch s i tuat ion due to the increas-

ing of NPAs. The str ic ter norm of Tier 1 capital

would l ikely result in an increase in the cost

of lending result ing in loans becoming more

expensive. I t would a lso lead to a lower ing of

t h e re t u r n o n e q u i t y. T h e c a p i t a l c o n s e r v a -

t ion and counter c ycl ical buffers look to put a

check on the di f ferent ia l amounts of lending

a t t i m e s o f u p s a n d d o w n s i n t h e b u s i n e s s

c yc l e s , t h u s h e l p i n g t o k e e p t h e r i s k b u i l d -

u p o f b a n k s a t s t a b l e l e ve l s t h ro u g h o u t a l l

business c ycles. However look ing at the fac t

t h a t I n d i a h a s u n d e r g o n e m o d e r a t e c yc l e s ,

t h i s n o r m co u l d b e a d a m p e n e r re s u l t i n g i n

r e d u c e d l e n d i n g a n d l e s s e r p e r c e n t a g e o f

sanctions than in normal condit ions. The rules

would make systems more robust and central -

ized and given the chal lenge faced by banks

o f g e t t i n g t i m e l y a n d a c c u r a t e d a t a f ro m a

myriad of systems, it would prove to be a great

co n t r i b u to r tow a rd s a m o re ro b u s t b a n k i n g

system. One of the most impor tant needs of

standardizat ion of repor t ing struc ture across

braches would also be ser ved by these norms.

Therefore i t can be concluded that BASEL I I I

would usher in a whol ly new era of bank ing

regulat ion with centra l ized and standardized

repor t ing systems which i s an imperat ive to

withstand st ress events in an ever changing

wor ld economy. However the capita l require -

m e n t s s e e m d i f f i c u l t to m a i n t a i n a n d co u l d

have an impac t on the growth of the I ndian

e c o n o m y w h i c h n e e d s b a n k i n g s u p p o r t t o

b o o s t i t s g row t h . H e n c e, t h e re i s a n e e d t o

b a l a n ce b e t we e n f i n a n c i a l s t a b i l i t y a n d t h e

r e a l i t y t h a t f i n a n c i a l s e r v i c e s a r e e s s e n -

t i a l f o r e c o n o m i c g r o w t h . W h e t h e r I n d i a

e n d s u p w i t h t h e fo r m e r, t h e l a t te r o r b o t h

i s a q u e s t i o n t h a t o n l y t i m e c a n a n s w e r ! ! !

S o u mya S e n a n d S o u rav D u t t a -Th e authors are students of I IFT

BANKING


27 28

MIST or BRICS-Who wi l l win the growth

batt le?

J im O ’Nei l l , chairman of

G o l d m a n S a c h s u s h e re d

in a decade - long invest-

ment boom in 2001 when

he coined the ter m BRIC

for the largest emerging

m a r k e t s . I n 2 0 1 0 , S o u t h

A f r i c a b e g a n e f f o r t s t o

j o i n t h e B R I C g ro u p i n g. T h i s ye a r, a l e s s e r -

known acronym that the Goldman Sachs chair-

man has coined is catching fast. The term MIST

has been coined to descr ibe the nex t t ier of

large emerging economies - Mexico, Indonesia,

S o u t h K o r e a a n d Tu r k e y. T h e y a r e t h e n e w

o p p o r t u n i t i e s . A l l f o u r h a v e i n c o m m o n a

number of factors:

a large population

and market , a b ig

economy at about

1% of g lobal GDP

e a c h , a n d a l l

a r e m e m b e r s o f

t h e G 2 0 . T h e y a r e

t e r m e d a s n e w

o p p o r t u n i t i e s a s

g r o w t h i n B R I C S

c o u n t r i e s h a s

s l o w e d r e c e n t l y .

L e t u s c o m p a r e

t h e s e t wo gro u p s

on var ious param-

eters to better understand the potent ia l .

Compar ing MIST against BRICS

1.Economic potent ia l

The MIST economies more than doubled in s ize

in the past decade. I n M exico, Lat in Amer ica’s

second-biggest economy, record auto expor ts

a r e h e l p i n g g r o w t h o u t p a c e B r a z i l ’s f o r a

s e c o n d y e a r a m i d w a n i n g C h i n e s e d e m a n d

for the S outh Amer ican nat ion’s commodit ies.

Indonesia’s domestic spending and investment

helped the nat ion’s economic growth acceler-

ate to 6 .37 per cent in the second quar ter, sur -

pr is ing economists who forecast a s lowdown.

For most poor countries, South Korea is a model

of growth, a better exemplar than China, which

is too vast to copy, and better, too, than Taiwan,

S i n g a p o r e o r

Hong Kong. Al l

three are r icher

t h a n K o re a b u t

a l l a r e , i n d i f -

f e r e n t w a y s ,

e x c e p t i o n s :

S i n g a p o r e a n d

H o n g K o n g

a re c i t y s t a t e s ,

w h i l e Ta i w a n ' s

d i s p u t e d s o v -

ereignt y makes

i t s u i g e n e r i s .

A c c o r d i n g t o

the World Bank ,

Turkey ’s rate of 11% economic growth led the

world in 2011. GDP per capita is $12,300, below

European levels , but ahead of most emerging

markets, including the BRICs (excluding Russia) .

But BRICS countr ies represent 3 bi l l ion people

w i t h co m b i n e d G D P o f 1 3 . 7 $ t r i l l i o n a n d h a s

higher average

G D P grow t h o f

5 .8% compared

w i t h M I S T

a v e r a g e o f

5 . 6 % i n 2 0 1 1 .

So, st i l l there is

m u c h t o c o ve r

fo r M I S T co u n -

t r i e s t o t a k e -

over BRICS.

2 . Credit rat ings

BRICS credit rat ings are going southwards

due to global s i tuat ion whi le MIST cont inues

to remain stable dest inat ion for rat ing agen-

c ies. That i s the reason for the upbeat fore -

cast by Goldman Sachs.

3 . Balance of Payments

Comparing the Balance of payment data for last

4 months gives better p ic ture for MIST coun-

tr ies as BRICS deficit is widening. India’s current

account def ic i t has shot up to21.2$ bn due to

r i s e i n i m p o r t b i l l . Cu r re nt a cco u nt d e f i c i t o f

Brazi l is l 5 .4$ bn which has widened from 3.59$

bi l l ion last year.

R u s s i a o n t h e

o t h e r h a n d h a s

s u r p l u s o f 4 2 $

b n w h i c h h a s

a l s o d e c r e a s e d .

C h i n a’s S u r p l u s

i s 5 9 $ b n a

decrease of 14%

f r o m l a s t y e a r.

S o u t h A f r i c a

r e c o r d e d h u g e

def ic i t of 152.6$ bn .Mexico’s current account

def ic i t i s 3 .5$ bn which is a decrease f rom last

year 5.7$ bn. Indonesia’s current account deficit

of 1 .8$ bn highest in recent years. South Korea

recorded cur rent account sur plus of 5 .84$ bn

u p f r o m 3 . 5 7 $ b n l a s t y e a r. Tu r k e y ’s c u r r e n t

account def ic i t narrows to 5$ bn f rom 7.7$ bn

last year.

4 . Foreign Reser ves

T h e c o m b i n e f o r e i g n r e s e r v e s

o f B R I C S s t a n d a t 4 . 2 5 $ t r i l l i o n

w h i c h a c c o u n t s f o r m o r e t h a n

42% of wor ld ’s reser ves. China’s

foreign reser ves are the highest

among them at 3 .2$ t r i l l ion. The

reser ves of Braz i l s tands around

3 6 5 $ b i l l i o n , R u s s i a a t 5 1 3 $ b i l l i o n , I n d i a a t

2 8 6 $ b i l l i o n . D u e to n e g at i ve g l o b a l m a r k e t s

reser ves have decreased in inf low of funds in

BRICS countr ies


29 30 WORLD ECONOMY WORLD ECONOMY

The foreign reser ves of MIST countr ies stand at

655$ bil l ion. South Korea accounts for maximum

reser ves of 312$ bi l l ion. The reser ves of Mexico

stands around 190$ bi l l ion, Indonesia’s around

1 0 6 $ b i l l i o n a n d t u r k e y ’s a ro u n d 8 7 $ b i l l i o n .

Reserves for most MIST countries have increased

or remained stable.

5 . Pol i t ica l S cenar io

C h i n a a n d R u s s i a a re a u t h o r i t a r i a n s w h e re a s

Braz i l and I ndia are democracies. Among MIST

a l l countr ies are democrac y. Decis ion mak ing

i s f a s t i n C h i n a a n d R u s s i a a s c o m p a r e d t o

I ndia and Braz i l . A lot of cor rupt ion scandals

has af fec ted I ndian pol i t ica l image in a nega-

t ive way. Braz i l has been recent ly in news for

corruption in adver t is ing budgets and pension

funds.

M e x i c o p r ox i m i t y t o t h e U S , a n d l i n k s w i t h

Centra l and S outh Amer ican mar kets , as wel l

a s i t s H i s p a n i c c u l t u r e , u n d e r p i n s i n t e r n a -

t i o n a l i nve s t o r s ' a n d m u l t i n a t i o n a l c o r p o r a -

t ions ' choice of M exico as a s t rategic inve s t -

ment locat ion. I ndonesia , the most populous

Musl im nation in the world, is one of the r is ing

s t a r s i n t h e g l o b a l e c o n o my S o u t h K o r e a i s

n o to r i o u s l y u n p re d i c t a b l e i n p o l i t i c a l te r m s.

T h e r e a r e i s s u e s o f m i l i t a r y i n t e r v e n t i o n i n

Turkey polit ics which saw many fai led attempts

coup plots. Things have improved but there are

i s s u e s re l ate d to n e w co n s t i t u t i o n fo r m at i o n

that are st i l l need to be worked out .

6 . Future prospec ts

The BRIC countr ies – Braz i l , Russ ia , I ndian and

China – have been dar l ings of pr ivate equit y

investors for some t ime. Now another group of

emerging economies may be up and coming,

sa id placement agenc y Probitas Par tners in a

recent repor t . M exico, I ndonesia , S outh Korea

and Turkey – the MIST countr ies – are attrac t-

i n g i n c r e a s i n g a t t e n t i o n f r o m i n s t i t u t i o n a l

i nv e s t o r s , a c c o r d i n g t o t h e r e p o r t b a s e d o n

a Pro b i t a s s u r ve y i n l a t e 2 0 1 0 o f 1 8 0 g l o b a l

investors. The MIST countr ies stand out, in par t

because of their comparatively high per- capita

income. The per capita gross domestic produc t

of S outh Korea , for instance, i s forecasted to

be the second largest in the world, next to that

of the U.S . , by 2050, with M exico expec ted to

re a c h 9 t h p l a ce by t h a t t i m e, a cco rd i n g to a

Goldman Sachs forecast .

Conclus ion

To be sure, the BRICS nat ions won’t fade away

for some t ime. China , Braz i l , I ndia and S outh

Afr ica sti l l top the l ist of most attractive emerg-

ing markets, according to sur vey respondents

asked about their out look for 2011. Whi le out-

per forming them in growth this year, the MIST

nat ions don’t approach the BRICs in economic

o u t p u t o r p o p u l a t i o n . I n f l a t i o n r i s k i s a l s o a

concern for investors in MIST countr ies. Turkey

is having highest among them, at 9 .07% CPI as

per latest data . But MIST countr ies of fer newer

oppor tunit ies for investors. The MIST countr ies

a re l i k e l y t o b e t h e n e x t g ro u p o f e m e rg i n g

market targets af ter the BRICS.

Vik as Gupta-The Author is a student of I IFT

INTERNSHIP ExPERIENCE

Summer Internship at Goldman Sachs

q. W h a t s k i l l s d i d y o u

develop whi le work ing at

G o l d m a n S a c h s t h a t yo u

b e l i e ve w i l l b e u s e f u l i n

your future career?

A . D u r i n g t h e c o u r s e o f

m y s u m m e r i n t e r n s h i p

at G oldman S achs, I developed the sk i l l s of

t a k i n g a h o l i s t i c v i e w o f a ny p r o b l e m a n d

work ing in v i r tual teams. I learnt the impor-

tance of net work ing and of having a profes-

sional att itude towards work- the impor tance

& seriousness of the word "deadlines". Finding

t ime to unwind- ' Work hard, par t y harder ' i s

just not a phrase here but a way of l i fe.

question. Descr ibe a typical day for an intern

at Goldman Sachs

Answer. 10 am: Repor t ing to work

1 0 a m - 1 1 a m : C h e c k i n g e - m a i l s , c o m p l e t i n g

l a s t d a y ' s l e f t o ve r wo r k a p p ro a c h i n g d e a d -

l ines, sur f ing f inancial websites t i l l the mentor

or the work arr ives

1 1 - 1 2 n o o n : Tr a i n i n g s e s s i o n s , o c c a s i o n a l

Speaker sessions & HR sessions involving inter-

ac t ions with company heads

12-2 pm: Check ing e -mai ls , work ass igned by

your mentor, receiv ing comments on the work

done ear l ier, mak ing edits and re -work ing on

the pitch books, f inding t ime to catch lunch

2-8 pm: Check ing e -mai ls, receiving new dead-

l ines, reading repor ts, work ing on excel models

& p i t c h b o o k s r e q u i r i n g w o r k o r r e - w o r k ,

attending c l ient team- cal ls

9 p m : Fi n d i n g t i m e t o w o r k o n t h e S u m m e r -

I ntern group projec ts- S earching for re levant

repor ts, building excel models, getting freaked

out by other teams' progress


31 32 WORLD ECONOMY

12-Depending how lucky your day is : Checking

e -mails, Receiving new deadlines and heading

home f inal ly

The day might be as eventful as this or lesser

(or more) , but at the end of the day you real ise

that the learning you gained today could not

h a v e b e e n a c h i e v e d i n a n y 2 0 - h o u r c r e d i t

course of col lege.

q u e s t i o n : Wh a t c h a l l e n g e s d i d yo u e n co u n -

ter dur ing the course of the projec t? How did

you tack le them?

Answer : Being a f resher, I had no pr ior under-

standing of the 'corporate culture '. The dif fer -

ences in the theoret ica l and prac t ica l appl i -

c a t i o n o f f i n a n c i a l c o n c e p t s , d y n a m i s m o f

the industr y and maintaining the motivat ion

throughout the long work ing hours were some

of the chal lenges I faced at Goldman Sachs.

What helped along was the friendly and always-

ready-to -help att i tude of ever yone on the IBD

f loor and the br i l l iant guidance at ever y step

by my mentor and the whole TMT-EMEA team

I was associated with . Financia l & other t ra in-

ing sess ions conduc ted by Goldman Sachs in

t h e s t a r t i n g we e k o f t h e i nte r n s h i p a n d t h e

ver y dedicated HR depar tment of the company

holding bi-week ly catch-ups to address any of

our concerns helped me encounter the chal -

lenges I in i t ia l ly faced.

q u e s t i o n : Te l l u s s o m e t h i n g n e w t h a t y o u

l e a r n e d a b o u t t h e c o m p a ny w h i l e yo u we re

work ing there.

A n s we r : T h e i nve s t m e n t t h e y m a k e i n t h e i r

R ISK MANAGMENT

R isk management is at the

core of ever y f inancial insti-

t u t i o n to e n s u re i t s a b i l i t y

to conduct its ongoing busi-

n e s s a n d t a k e b e n e f i t o f

o p p o r t u n i t i e s t o e n h a n c e

i ts business. I t i s impor tant

to note that r isk management as commonly per-

ceived does not mean minimiz ing

r isk , rather it means optimizing the

r isk-reward trade -off. In today ’s sit-

uat ion where the wor ld is br idled

with the economic cr isis, banks wil l

n e e d t o m a n a g e r i s k m o r e c a r e -

ful ly, notwithstanding the fact that

they are in the business of tak ing

r isk . I t appears that the staggering

losses faced due to the cr isis would

decrease banks’ appet i tes for r isk ,

but the bai louts that have helped

to prevent fur ther meltdown could

lessen the avers ion to r isk . I n any

case, a bank ’s abi l i t y to measure,

monitor and steer r i sks in a com-

p re h e n s i ve f a s h i o n i s b e co m i n g i n c re a s i n g l y

d e c i s i v e fo r i t s s t r a t e g i c p o s i t i o n i n g. Le t u s

take a look at what l ies at the hear t of effect ive

r isk management for banks and the trends that

we a re l i k e l y to s e e i n t h e co m i n g fe w ye a r s .

The research of top global management con-

s u l t i n g f i r m s i n d i c a t e s t h a t t h e c u l p r i t s

b e h i n d t h e l o s s e s f a c e d b y b a n k s d u r i n g

t h e c r i s i s w e r e b a d g o v e r n a n c e , b a d i n c e n -

t i ve s ys te m s a n d p o o r r i s k m a n a g e m e nt . Th e

current s i tuat ion demands that the best prac-

t i ce s f ro m r i s k m a n a g e m e nt b e i m p l e m e nte d

a t t h e e a r l i e s t t o b r i n g s t a b i l i t y t o b a n k s .

The overal l responsibi l i t y of r i sk management

rests with the Board of Direc tors which needs

to understand, def ine and manage the organi-

zat ion’s r isk appet i te us ing their business and

r isk exper t ise. The pol ic ies that they formulate

set the strategic di rec t ion in which the senior

management needs to steer the organizat ion

through proper execution and implementat ion

of policies. A very important aspect of the imple -

mentat ion of the pol ic ies is ensur ing that they

are embedded in the ver y culture of the organi-

zation. Not al l r isks are quantif iable. Hence, it is

R isk Management measures in this ever changing competit ive bank ing landscape

e m p l oye e s a n d h ow t h e y t re at t h e m a s t h e i r

real assets- ref lec ted in the t ra ining sess ions,

social get-togethers, speaker sessions with the

whose -who of the company. The socia l aware -

n e s s p r o g r a m o f t h e c o m p a n y, C o m m u n i t y

Teamworks, i s a g lobal volunteer in i t iat ive of

G o l d m a n S a c h s t h a t a l l o w s i t s e m p l oye e s t o

take a day out of the of f ice volunteer ing with

local non-prof i t organizat ions. Ever y summer

intern was a lso supposed to par t ic ipate in this

i n i t i at i ve a n d l e a r n f ro m t h e c ro s s d i v i s i o n a l

team-based socia l projec ts.

q uest ion: What were the expec tat ions of the

company f rom you?

Answer: At Goldman Sachs, they expect a ‘Ready

to le ar n at t i t ude’ and at te nt ion-to - deta i l s by

t h e i r i n t e r n s . B e i n g h i g h l y m o t i v a t e d a t a l l

t imes is what helps sa i l through smoothly.

Sakshi G arg- Student of I IFT. She has done her internship at Goldman Sachs. Here she enumerates her t wo months of exper ience in the company.


33 34 R ISK MANAGMENT

Given the leve l of complex i t y faced by banks,

they wi l l have to par tner with t radit ional com-

petitors and peers and IT and change special ists

in future to manage their r i sk ef fec t ively. CROs

w i l l h ave to d e m o n s t rate t h e b e n e f i t s a n d t i e

the outcomes of r isk management projects more

direc t ly to business outcomes and tangible cost

reduc t ions. I n order to achieve th is , organiza-

tions will have to seek collaborations in new ways.

One of the most impor tant aspec ts in r isk man-

agement phi losophy is to make sure that those

who take or accept r isk on behal f of the inst i -

tut ion are not the ones who measure, monitor

a n d e v a l u a te t h e r i s k s . Th e m a n a g e r i a l s t r u c -

ture and hierarchy of r isk review func t ion may

v a r y a c ro s s b a n k s d e p e n d i n g u p o n t h e i r s i z e

and nature of the business, but the key is inde -

pendence. To be ef fec t ive, the review func t ions

should have suff ic ient author i t y, exper t ise and

corporate stature so that the ident i f icat ion and

repor t ing of their f indings can be accomplished

w i t h o u t a ny h i n d r a n c e . T h e f i n d i n g s o f t h e i r

rev iews should be repor ted to bus iness uni ts ,

senior management and if required, to the Board.

Audit teams must per form a comprehensive cr it-

ica l review of potent ia l weak nesses in addit ion

to e n s u r i n g t h a t t h e p o l i c i e s a n d p ro ce d u re s

approved by the Board are being fol lowed. They

must be empowered to enforce their f indings.

B a n k m a n a g e r s n e e d t o e s t a b l i s h a s t r o n g

r i s k m a n a g e m e n t c u l t u r e t h a t p e r v a d e s t h e

e n t i r e o r g a n i z a t i o n . A l o n g s i d e t h e d e v e l o p -

ment of the sc ient i f ic and technical aspec ts of

r i s k m a n a g e m e nt , i t i s i m p o r t a nt to e s t a b l i s h

good governance and a healthy r isk culture to

g i ve b a n k s a s t a b l e fo u n d a t i o n t o re s t u p o n .

Shi lp i Ghosh-The author is a student of I IFT

R ISK MANAGMENT

impor tant that qual i tat ive r isks can be commu-

nicated as guidel ines and can be inferred f rom

management business decisions. I t is also impor-

tant that senior management off icials are in sync

with each other to ensure smooth execut ion of

the v is ion set by the board. There is of ten a lack

of consistenc y bet ween CROs and CFOs across

processes, systems and data . Conf l ic t ing pr ior i -

t ies and messages created unintentionally by the

t wo s i d e s t a l k i n g a

d i f ferent language,

leads to chal lenges

f o r t h e o r g a n i z a -

t i o n . I t i s i m p e r a -

t i v e t h a t t h e r e i s

t i g h t e r a l i g n m e n t

a n d c o l l a b o r a t i o n

b e t w e e n t h e C R O

a n d C F O a n d t h u s ,

m o r e c o n s i s t e n c y

a c r o s s f i n a n c e a n d

r i s k . T h e C R O a n d

t h e C h i e f H u m a n

R esource O f f icer should deter mine the prope r

t r a i n i n g n e e d e d t o e n s u re t h a t a l l e m p l o ye e s

u n d e r s t a n d t h e i r ro l e i n m a n a gi n g r i s k a t t h e

o r g a n i z a t i o n . R i s k m a n a g e m e n t m u s t b e p e r-

vas ive to the organizat ion’s culture, and not be

the responsibi l i ty of just the r isk function alone.

Long-s ightedness is another key to proper r isk

m a n a g e m e n t . D i s c u s s i o n s a b o u t n e w p r o d -

u c t s , e x i s t i n g a n d n e w p o s i t i o n s a n d o t h e r

i s s u e s m u s t b e b r o a d a n d n o t l i m i t e d t o

m e e t i n g q u a r te r l y t a rg e t s o r a ny o t h e r s h o r t -

t e r m g o a l s . B o t h t h e f ro n t o f f i c e a n d t h e t o p

m a n a g e m e n t m u s t h a v e r e l i a b l e a n d c o n s i s -

tent infor mat ion with respec t to the pos i t ions

and the r isks they are tak ing. L imit sett ing and

l i m i t m o n i t o r i n g m u s t b e d o n e a n d s e g re g a -

t i o n o f d u t i e s s h o u l d b e c l e a r a n d e n fo rc e d.

A signif icant challenge facing vir tual ly al l banks

is the need to integrate and harness the tech-

n o l o gi e s i n a way w h i c h w i l l b e t te r s e r ve t h e

b u s i n e s s a n d d e l i ve r t h e o u t p u t s re q u i re d to

outpace the competit ion. O ver the years, data

v o l u m e s a l o n g w i t h r e g u l a t o r y a n d b u s i n e s s

r e q u i r e m e n t s h a v e

d r i v e n b a n k s t o

take a leading posi -

t i o n i n t e c h n o l o g y,

d e v e l o p i n g n e w

a u t o m a t e d s o l u -

t i o n s , a n d d e ve l o p -

ing more complexity

covering more coun-

t r i e s a n d b u s i n e s s

a c t i v i t i e s . H owe ve r,

t h e s e re q u i re m e n t s

h a v e p r o g r e s -

s i v e l y c o n t r i b u t e d

to a dramat ic increase in IT costs as demands

have become more complex and the result ing

systems more diverse. One impor tant techno -

l o gi c a l c h a n g e d e s i gn e d to m e e t t h e i n c re a s -

ing demands is in the way that the appl icat ion

a rc h i t e c t u re i s b u i l t . Tr a d i t i o n a l l y, t h e a p p l i -

c a t i o n l a n d s c a p e w a s b u i l t l a y e r u p o n h o r i -

zo n t a l l aye r. S o e a c h l aye r c a r r i e d a f u n c t i o n

a n d i n te r f a ce d w i t h t h e o t h e r l aye r s t h ro u g h

t ransfor mat ional ru les, lead t imes, shor t cuts ,

complex repor t ing ru les , and so on. However,

that horizontal structure is changing to become

m u c h m o r e v e r t i c a l . C o n s e q u e n t l y, i n d i v i d -

u a l p i e c e s o f i n f o r m a t i o n w i l l b e g a t h e r e d

f ro m t h e b o t t o m u p, e l e v a t i n g t h e re p o r t i n g

l i n e s a n d d a t a g o v e r n a n c e w h e r e n e c e s s a r y.


35 36 R ISK MANAGMENT

B a n k s n e e d R s 5 l a k h c r to m e e t B a s e l - I I I norms: RBI

I n d i a n b a n k s w o u l d n e e d a b o u t R s 5 l a k h

crore of addit ional capita l to meet the Basel -

I I I norms, the Reser ve Bank of India (RBI) said in

i ts annual repor t for 2011-12. State -run banks

wo u l d n e e d a m a j o r i t y o f t h e s e f u n d s — R s

1 . 4 - 1 . 5 l a k h c ro re o f co m m o n e q u i t y a n d R s

2 .65-2 .75 lak h crore of non- equit y capita l .

As major i t y shareholder in the publ ic sec tor

banks, the Centre would have to infuse a s ig-

ni f icant amount i f i t wants to reta in i ts 58 per

cent stake — the government ’s stated pol ic y.

Pr i v a te s e c to r b a n k s wo u l d n e e d R s 7 0 , 0 0 0 -

85,000 crore to meet the new capital adequacy

norms. O f this , Rs 20,000-25,000 crore would

be common equity. RBI sa id these projec t ions

were based on a conser vat ive assumption of

uni form annual growth of 20 per cent in r isk-

we i g h t e d a s s e t s fo r e a c h b a n k . Th e c e n t r a l

bank a lso fac tored in lenders’ assessment of

their internal accruals .

Co n c e r n w a s r a i s e d o n w h e t h e r t h e Ce n t re

m i g h t f i n d i t d i f f i c u l t t o c a p i t a l i s e p u b l i c

s e c t o r b a n k s , o w i n g t o t h e w i d e n i n g f i s c a l

d e f i c i t . R e ce n t l y, R B I G ove r n o r D S u b b a r a o

h a d ex p re s s e d d o u b t s o n w h e t h e r t h e g ov-

ernment could infuse this amount of capita l .

Ac c o rd i n g t o B a s e l - I I I n o r m s, I n d i a n b a n k s

have to maintain a capita l adequac y rat io of

at least nine per cent, in addit ion to a capital

conser vat ion buffer, which would be in the

fo r m o f c o m m o n e q u i t y o f 2 . 5 p e r c e n t o f

r i s k - w e i g h t e d a s s e t s . I n o t h e r w o r d s , b a n k s ’

minimum capital adequac y ratio should be 11.5

per cent. Currently, Indian banks have to main-

t a i n a c a p i t a l a d e q u a c y rat i o o f at l e a s t n i n e

per cent .

S m a l l m u t u a l f u n d s u n h a p p y o v e r S e b i ’s new rules

O ff ic ia ls of

smal ler mutual

funds have

expressed

d isappoint-

ment over

Sebi ’s deci -

s i o n l a s t w e e k

to a l low the industr y to col lec t ex tra charges

wi l l benef i t their larger peers.

Th e m a r k e t re g u l a to r, i n a p re s s re l e a s e s a i d

mutual funds can charge an extra 30 basis points

(0 .3%) above the exist ing fee of 2 .25% i f they

ra ised 30% of the inf lows f rom places outs ide

the top 15 cit ies. Pr ima facie, the step appeared

to be almost in l ine with what the industr y was

expecting, but the f ine print revealed the norms

have a windfal l in store for the larger mutual

f u n d s . Th e a d d i t i o n a l 3 0 b a s i s - p o i n t fe e w i l l

be charged on the ent i re fund, not just on new

i nve s to r s , re s u l t i n g i n e x i s t i n g i nve s to r s a n d

investors residing in top cit ies subsidis ing new

investors f rom the hinter lands.

A back- of-the - envelope calculat ion shows that

the industr y, hypothet ical ly, wi l l pocket c lose

t o R s 5 8 3 c ro re i f i t c h a r g e s 3 0 b a s i s p o i n t s

o n t h e e x i s t i n g e q u i t y a s s e t b a s e ( co m b i n e d

MONTHLY CHRONICLE

Bhar t i Ai r te l shor t-l i s t s b a n k s f o r I nfratel IPO

B h a r t i A i r t e l h a s

s h o r t l i s t e d b a n k s

i n c l u d i n g S t a n d a r d

C h a r t e r e d a n d

J PM o rg a n to m a n a g e a s h a re f l o t at i o n fo r i t s

te l e co m s towe r u n i t to ra i s e m o re t h a n $ 7 5 0

mi l l ion.

Th e b i g g e s t I n d i a n m o b i l e p h o n e c a r r i e r h a s

a lso shor t l i s ted Bank of Amer ica Merr i l l Lynch,

HSBC, UBS and Kotak M ahindra for the in i t ia l

publ ic share of fer ( IPO) . Bhar t i may f i le a pro -

spec tus for the IPO with the market regulator

SEBI nex t month.

The unit , Bhar t i I nfrate l , i s eyeing a l i s t ing in

the f i rst hal f of 2013. I t has more than 33,000

m o b i l e p h o n e m a s t s , a n d a l s o h o l d s a 4 2 %

s t a k e i n j o i nt ve nt u re I n d u s Towe r s , w h i c h i s

t h e wo r l d ’s b i g g e s t te l e co m s m a s t co m p a ny,

w i t h a b o u t 1 1 0 , 0 0 0 m a s t s . B h a r t i A i r t e l h a d

ear l ier sa id i t was consider ing a sa le of up to

10 percent of I nfratel in the IPO.

B h a r t i h a s re p o r t e d 1 0 c o n s e c u t i ve q u a r t e r s

o f p ro f i t d e c l i n e, w i t h s h a re s d ow n a b o u t 2 8

percent so far th is year, underper forming the

broader market that is up more than 16 percent.

Government to not i fy the rules for advance pr ic ing ar rangement soon

Mult inat ionals wi l l

soon be able to nego -

t iate with I ndian

tax author i t ies their

potent ia l tax l iabi l i l t y

i n r e s p e c t o f t h e i r t r a n s a c t i o n s w i t h t h e i r

local arms or the local company deal ing with

i t s p a r e n t , h e l p i n g a v o i d f r e q u e n t t r a n s f e r

pr ic ing l i t igat ion with foreign companies that

has soured investment sent iment .

I ndia wi l l not i fy the rules for Advance Pr ic ing

Agreements (APA) that s ignal a shif t away from

aggressive tax approach that resulted in trans-

fe r p r i c i n g a d j u s t m e nt s a s h i g h a s ove r R s 1

lak h crore in the last t wo f inancia l years.

“All machinery has been put in place. Guidelines

should be not i f ied soon,” sa id an income tax

depar tment of f ic ia l .

An A PA i s a n a gre e m e nt b e t we e n a t a x p aye r

and the tax author i t ies that a l lows both to set

o u t i n a d v a n c e, t h e m e t h o d o f d e t e r m i n i n g

the transfer pr icing for inter- company transac-

t ions, helping avoid post t ransac t ion disputes

a p a r t g i v i n g m u l t i n a t i o n a l s c e r t a i n t y a b o u t

their tax l iabi l i t y.


37 38 REGULARSREGULARS

AUM of equit y, balanced and ELSS funds) of Rs

1 ,94 ,320 crore. The industr y had a tota l AUM

of Rs 7 ,30,000 crore on July 30.

Out of the total Rs 583 crore, at least 80% of

t h e a d d i t i o n a l f e e w i l l b e p o c k e t e d b y t h e

top f ive fund houses inc luding HDFC M ut ual

Fund, R e l iance M utual Fund, IC IC I Prudent ia l

M u t u a l Fu n d, U T I M u t u a l Fu n d a n d B i r l a S u n

L i fe Mutual .

A n o t h e r p o i n t o f d i s c o n t e n t a m o n g s m a l l

m u t u a l f u n d s i s t h e w a y e x i t l o a d s c a n b e

charged. S ebi sa id funds wi l l have to plough

back the ent i re ex i t load - the fee i t charges

for premature investor exit - into the schemes.

Fund houses do not have any restr ic t ions on

how much they charge as ex i t load, but they

usual ly charge 2% of which 1% is pocketed by

them.

Now on, fund houses wi l l have to br ing back

the entire exit load back to the fund. However,

f u n d s h ave b e e n a l l owe d to c h a rg e a n a d d i -

t i o n a l e x p e n s e r a t i o o f 2 0 b a s i s p o i n t s f ro m

the overal l fund i r respec t ive of the total ex i t

load col lec ted.

Vedanta may up offer for HZL, Balco stakes by 25%

Vedanta Group may shel l out Rs 21,635 crore,

up to 25 per cent more than previously offered,

for buying the government ’s remaining stakes

in Hindustan Zinc and Balco as its ear l ier offers

have not been accepted so far.

Ve d a n t a h a s c a l l e d s h a r e h o l d e r s m e e t i n g

o n A u g u s t 2 8 i n L o n d o n , a l o n g s i d e i t s

a n n u a l g e n e ra l m e e t i n g, to s e e k n o d fo r t h e

s we e te n i n g i t s o f fe r s i n t h e t wo f i r m s, b u t a

company s pok e s pe r s on s a id t hat i t i s just an

“enabling provision” and no new offer has been

made yet to the government.

I f i t goes through, this deal a lone could meet

over 72 per cent of the government ’s dis invest-

ment target of Rs 30,000 crore for this year.

L o n d o n S t o c k E x c h a n g e - l i s t e d Ve d a n t a h a d

a c q u i r e d 5 1 p e r c e n t s t a k e i n B a l c o i n 2 0 0 1

and 64.9 per cent stake in H industan Zinc Ltd

(HZL) dur ing 2002-2003. I n Januar y, the group

had offered Rs 15,493 crore for buying 29.5 per

cent in HZL, and Rs 1 ,782 crore for 49 per cent

res idual holding in Balco.

A f t e r s h a r e h o l d e r s a p p r o v a l , t h e c o m p a n y

b o a r d w o u l d h a v e t h e p o w e r s t o r a i s e t h e

offer pr ice up to Rs 18,606.10 crore (USD 3.378

bi l l ion) for HZL, and up to Rs 3 ,028.78 crore ($

550 mi l l ion) for Balco.

The 15 per cent increase in the previous of fer

of $ 2 .938 bi l l ion (Rs 15,493 crore) , for which

s h a re h o l d e r s’ n o d h a s b e e n s o u g ht , a m o u nt s

to $ 3 .378 bi l l ion (about Rs 18,606 crore at the

dol lar- rupee exchange rate taken by Vedanta

on August 7) .

Contr ibuted by-Rohit K hattar

REGULARS REGULARS

1) Identify the picture below, which represents the most basic form of many f inancial instruments.

2) This indiv idual ’s idea that h is company “didn’t real ly need any assets”, heralded aggress ive

investment by this company, and led to him being declared CEO of this company, before spec-

tacular ly later that year, the company foundered. Which indiv idual are we ta lk ing about?

3) Af ter this documentar y came out , a Hong Kong based merchant banker obser ved, “For a boy

f rom Watford to br ing a grand f i rm down, I mean i t was a socia l insult as wel l .” Who is the “boy

f rom Watford”, and what is the “grand f i rm” a reference to?

4) The company which had this logo has the c la im to fame for br inging out something for the

f i rst t ime in the wor ld, which a l l companies star ted to do s ince then. Ident i fy the company.

5) This par t icular bank is rooted in the ideas of Fr iedr ich Wi lhelm R ai fe issen, a founder of the

cooperat ive movement who created the f i rst farmers’ bank in Germany in 1864. One of h is fo l -

lowers, a c lergyman by the name of Ger lacus van den E lsen, stood at the bas is of local farmers’

unions in another countr y. This bank is st i l l deeply rooted in agr iculture, and the centra l orga-

nizat ion is the daughter organizat ion of the local branches, rather than the other way round.

FUN WITH FIN


39 40

Which bank has this unique histor y and hierarchy?

6) Ident i fy this logo of a ver y famous company, a behemoth in i ts f ie ld.

7) Who was the f i rst Finance M inister of independent I ndia?

8) Connec t the fol lowing: a mathematical game of st rategy, a t ype of ser ver, and a per formance

measure for f inancia l inst i tut ions.

9) Which f inancia l instrument, k nown to be pr incipal protec ted, can be thought of as a combi-

nat ion of a zero - coupon bond and an equit y opt ion?

10) Which was the wor ld ’s f i rst commodit y futures market?

S olut ion to last edit ion’s crossword: Contr ibuted by-J R ahul

REGULARS


41 42

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IIFT InFINeeti Annual Issue 2012

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