Reckoning OECD Reports!

More than the fear of cyclical recession and failure of financial institutions, the biggest worry for the global economy in the twenty-first century is that all OECD economies, which shaped, dominated and furthered the growth of global trade in twentieth century appears to have lost their edge and steam for the first time in modern period. The three major economies zones-US, EU and Japan are expected to entwine with a long-term low growth trap with additional risk of periodic recessions. The OECD reports of 2011 simply acknowledges the impending grim prospects in its constituent economies and projecting the emerging economies, especially India, China and Brazil as new engines of growth in twenty-first century. It’s indeed an unprecedented privilege for India to respond these new international trade fundamentals which can make advance it prospects at many levels.

Report on Economic Policy Reforms: Going for Growth, underlines it more resolutely as “India continues to achieve one of the highest rates of GDP per capita growth in the world. Nevertheless, the income gap with OECD countries remains large, primarily reflecting low levels of labour productivity, calling for further reforms to support rapid and inclusive growth". Incremental reforms of administrative regulation introduced by governments at all levels have led to some improvement in the operating environment for business. However, more fundamental reforms are needed in specific sectors. Obviously recommendations have referring for more liberalisation with lesser regulatory intervention. That simply forward a “dichotomous scenario” with the kind of “reforms”, India has been carrying in last two decades. This particular report is unable to broaden the distinct choices of economic reforms, which emerging economies can pursue in the days ahead. So with concentrating on better prospects, India should rely on its own model of reform instead following the bandwagon of saturated economies!

OECD Economic Outlook {No.89, May2011} presents the overall picture of global economy with special coverage of ongoing slowdown. It wrongly articulates that the global recovery is becoming self-sustained and more broad based but then why unemployment remain high across most of the OECD countries? Rather as policy recommendations, stress should have strongly oriented towards structural reforms which could play a key role while taking into account of country-specific needs and institutional features. In emerging economies too, structural reforms could make growth more sustainable and inclusive while contributing to global rebalancing and enhancing long-term capital flows. Ofcourse inflation will be remain a cause of concern in the emerging economies which will be remain a cause of concern in the emerging economies which will need judicious monetary policies for addressal, not for blindly making action on what OECD reports suggests! It will be also wrong to follow that fiscal consolidation and prudence shall be alone confined with the advanced economies; rather it should be equally concern the nations aspiring to be significantly slotted in world trade. Apprehension of this report is now very much in action as downside risks are on the verge of interaction in US/EU, and their cumulative impacts could weaken the recovery substantially, it may also lead to stagflationary developments in some of the advanced economies. Moreover, it will be a blunder to believe that higher inflation could address debt sustainability. Even it could perilously flirt with inflationary expectations, with the outcome that interest rates would soon increase more than inflation. This knowledge paper is somehow closer to the ground realities but not without missing and confusing some of the major challenges of sustainable growth.

OECD Economic Surveys: India {June, 2011}, highlights the risk of inflation and volatile capital flows, which are indeed the most formidable challenges for India’s uninterrupted growth story. Report acknowledges well that fiscal consolidation has resumed and new frameworks may help. It’s true, prior to 2008, nice progress had been made in reducing large fiscal deficits at the central and state levels under targets set out in the Fiscal Responsibility and Budget Management Act {FRBMA, 2003}. In the mean years, government finance had sharply down yet few quintessential welfare subsidies on oil, debt writes off, enhanced salaries provisions, tax cuts etc, in the response to slowdown are tolling pressure on fiscal discipline. Here, is a need of new policy measures that can balance the chord of welfare expanses and fiscal discipline.

Chapter-1{Sustaining growth and improving living standards}, emphasizes that expansionary macroeconomic policies cushioned the downturn and domestic demand led the recovery. It’s also true, private investment which benefitted from ongoing liberalisation and high private saving was a vital source of growth. But not to forget also the pre-crisis period was also characterised by a high degree of macroeconomic stability, reflecting benign economic conditions in advanced economies. Comparatively, India weathered the global downturn well like other emerging economies. India also suffered as liquidity constrained firms and banks in advanced economies reduced foreign asset holding to shore up their balance sheets which witnessed sharp capital outflow…that’s still an ongoing concern of international market. On the contra side, another fearsome possibility is that strong capital inflows could put upward pressure on the rupee, raising the prospect of worsening competitiveness and a further widening in the Current Account Deficit {CAD}, which is already high by historical standards. Since mid 2010, the nominal effective exchange rate has gradually depreciated but with relatively high inflation, albeit the real effective exchange rate has been relatively stable. The exchange rate policy has evolved and the capital account has continued to open up gradually, even though progress has been uneven and it remains relatively closed. Post Asian crisis in 1997, the rupee was linked closely to the dollar which influenced the further course. Though RBI has been promoting counter-cyclical macro prudential policies but it needs be more active and practical now to show the intent and commitments of finance ministry into the action. At this juncture, financial sector reforms needs a speedy push, especially licensing of the new banks in private sector. This report stressed that, the rapid economic growth has reduced the incidence of poverty, it’s to an extant agreeable but not without the serious persisting flaws in growth agenda. As a solution, welfare measures have to be reachable and accessible to the all targeted beneficiaries. Despite citing administrative and other bottlenecks, this part of report suggests that the India is continuing to catch up its goal.

Chapter2/ Fiscal Prospects and Reforms, considers India’s fiscal consolidation programme a partial success, which is true. The period of fiscal restraint lasted in 2008 for domestic compulsions and overwhelming world growth that fuelled up energy and commodity prices, the government raised public expenditure markedly. In the current policy debate, a new framework for fiscal policy is the need of hour. FRBMA has already expired years back. So, the central government’s goal to reduce Gross Fiscal Deficit to 4.1%of GDP by 2012and 3.5% the year after, urgently requires a proper policy maneuvering. In this direction, the Finance Commission {2009} report on fiscal relations between the central and state governments appears rational. It recommended that the Central government should go further and reduce its fiscal deficit to 3%of GDP by 2014. The Commission also recommended 2.4%deficit for the states, bringing a combined deficit at both levels of government to 5.4%.; down from its 2010 level of 7.2%of GDP. On taxation, OECD recommendations are completely stereotypical with having single aim to promote the greed’s of corporate world by ignoring the progressive fundamentals. Here needs a careful approach in pacifying its extreme policy recommendations.

Chapter3/ Phasing out Energy Subsidies, presents contentious and dubious viewpoints on India’s energy management. Report mandates that “India’s petroleum subsidies are economically and environmentally damaging”, which is an overt escaping of realities that is persisting over the world. It’s partially right on Coal market reform but again slips while recognising Public Distribution System {PDS}/Oil subsidies and electricity subsidies as impediments before the development of oil and energy sector. This shows the denial of distinct political characteristics of Indian economy which has its own set of working model and couldn’t solely rely in any cases on the western model of development.

Chapter4/Financial Sector Reform in India: Time for a second Wave? ,it’s intriguing reviewing the last Union Budget and reading this report, it seems that finance ministry is subscribing almost all OECD recommendations on financial reform! Reports suggests the speedy implementations for the institutions like, National Treasury Management Agency {NTMA}, Pension Fund Regulatory and Development Authority {PFRDA}, Financial Sector and Development Council {FSDC}and Financial Sector Law Reforms Commission {FSLRC}. Surprisingly, in the lieu of giving greater freedom/competency to banking operations, reports suggests some incomprehensible measures, like setting out a plan for ending Priority Sector Lending {PSL}, rapid liberalisation of interest rates on deposits, gradual reduction of the proportion of government bonds to be hold by the banks, widening of the scope of trading through Credit Default Swaps {CDS}, introduction of standard terms for Corporate Bonds, reducing of KYC requirements and transaction taxes etc. OECD should clarify, if do they have only a uniform model of financial reform that has already shattered the world’s most exotic and exciting financial market of US/EU. India either must ignore the stereotypical prophecy or simply turn down any reckless model of financial liberalisation without having touch of the commitments for its policy. Moreover, it shocks to read that the RBI should sell its electronic government bond market and the clearing house to the private sector and NABARD should be sold to the government that means RBI should cease to have its stake in NABARAD…both are unworthy suggestions and points out on the dubious intent of OECD’s reporting on India’s economic growth. Only solace is, report acknowledges well the financial health of India’s banks and found them competent enough for complying with the BASEL-III norms. But even this not without of suspicion and citing privatization in PSBs, instead of showing a different course for private banking and making them core competent with the Public Sector Banks/ Regional Rural Banks/Co-operative Banks.

Chapter5/ Building on Progress in Education, report recommends of maximum withdrawal of regulatory intervention and maximum allowance of private capital in higher education. Besides “Improving incentives for stronger performance by making funding less input based. Tie funding to accreditation and assessment outcomes and increase share of project based funding for research”. In less technical terms, reports enters with its recommendation as it handles a plain capitalist market, and not the world’s most vibrant democracy where policy can’t be altered from the maximum welfare of peoples. This section is even more disappointing as it fails to even canvass, what’s the real hindrances of the education sector that hammering its growth and the potential policy formulations?

There will be no denying the fact that, India’s growth momentum is the outcome of its judicious experiment with the mix of regulation and reform in its economy. Since the1991, India has improved its overall fundamentals in economy, also successfully crossed the very troubling recession. Despite these positive scenarios, India’s growth is less than its potential and needs better governance and regulatory control to end the frills of free and fair businesses. And ofcourse, without making its Public Sector less competent and less happening. OECD reports are reminder of the concern that India must follow its own path, based on intrinsic compulsions and welfare the peoples instead of Corporations. Only then, RBI Governor will be remain smarter and cheerful than the other Central bankers from across the world and even our Mint Street will be less greedy than the re-doubtful Wall Street…alas, where “greed is still good “and its evangelists are incorrigible with Ivy Leagues business degrees!
Atul Kumar Thakur
October 16, 2011, Friday, New Delhi
Email: summertickets@gmail.com

Reckoning Basel-III Norms!

Following the recent financial meltdown, the leaders of the group of G-20economies asked the Basel Committee on Banking Supervision{BCBS} to reach the new rules needed to prevent another financial crisis in future. The aim was to mitigate the greed ridden financial crisis instead to block the real factors behind it; real notion of Basel-III norms could be sensed out with the statement of Hant Wellink, head of Basel Committee on Banking Supervision-“Partly banks will have to retain profit for years which they can not use to pay shareholders or bonuses.
For another part, this will vary from bank to bank; they will have to get it from the capital market. I think it will make a new crisis less likely. Chances are much smaller, we have made calculations on this but we can’t rule it out completely”. Last Para reflect the genuine apprehension ahead in financial market…so; life even after the Basel-III norms wouldn’t remain indifferent from regulatory considerations.

Basel-III norms, with its underlying proposition of insulating banks from adverse shocks by adequately enhancing the amount of its own capital holding compared to overall deposits and other borrowing can be regarded as an improved and standard set of rules over the existing Basel-II norms. Rule of Basel-III norms written by the Bank of International Settlement’s Committee on Banking Supervision {BCBS} with lucid mandates to define the reform agenda for the banking sector across the world. The new rule comprehensively entails how to asses risks and capital management anticipating theirs risk bearing.
On September20,2010 {Sunday}, agreement finally taken place on Basel-III at a meeting of Central bank Governors and top Supervisors from 27 countries chaired by ECB President, Jean Clande Trichet. They reached to the consensus with focusing on prevention of any further International Credit Crisis with provisioning more than triple of top quality capital as reserve for addressing any meltdown sort of occurrences.

Predominant component of capital is common equity and retained earnings-new rules restrict inclusion of items such as deferred tax assets, mortgage-servicing rights and investments in financial institutions to no more than 15%of the common equity component. Here strong bank would avail an edge as now they can put excess cash to better use though with ample transition period for raising funds to compliance shouldn’t be any big issue for even smaller banks. The new norms are centered around the renewed focus of Central bankers on Macro-prudential stability. The global financial meltdown following the crisis in U.S Sub-prime market has shaped the entire propositions. Earlier guidelines, popularly known as Basel-II was focused on Macro prudential regulation, those features being carried out in Basel-III norms as well with added advanced support. That systemizes the changed motives of regulators now-they have eagle eyes on financial stability of the system in totality rather than Micro regulation of any individual bank.
Under the Basel-III norms, Key Capital Ratio has been raised to 7%of risky assets-Tier-I capital that includes common equity and perpetual preferred stock will be raised from 2 to 4.5% starting in phases from January2013 to be accomplished by January2015. Moreover, banks will have to set aside another2.5%as a contingency for future stress, taking the overall capital ratio or Capital Conservation Buffer to 7%. Banks that would fail to comply after the stipulated timeline would be unable to pay dividends, though they will not be forced to raise cash.

A further counter-cyclical buffer in average of 0%-2.5%of common equity is to be imposed depending on specific circumstances of an economy to protect the banking sector from periods of excess aggregate credit growth. In addition, a liquidity buffer, much like our Statutory Liquidity Ratio {SLR} is to be made mandatory by January2018 to check the risk based measures and higher capital norms for systemically important bank. On paper, Basel-III will triple the quantum of capital, banks will need to maintain but whether it will risk-proof the banking sector is doubtful. So, regulation would decide whether Basel-III norms is light touch set of rule or indeed an effective panacea for hassle free and ethical functioning of banking system.

Impact on Indian banks: - RBI Governor, D.Subbarao is stoutly confident that Indian banks not likely to be adversely impacted by the new capital rules. At the end of June30, 2010; the aggregate capital to risk –weighted assets ratio of the Indian banking system stood at 13.4% of which Tier-I capital constituted 9.3%. So, it wouldn’t leave any pressure on Indian banks in near future albeit there may be some negative impact arising from shifting some deductions from Tier-I and Tier-II capital to common equity.
Despite strong fundamentals, RBI should ensure even more capital than essentially stipulated limit under the Basel-III norms; besides stress must be given on long term capital inflow rather on risky short term investments. Besides, innovative credit policies, RBI should also stringently ensure the well capitalized subsidiary structure for foreign banks and financial institutions operating in India, since the stability of Indian banking system have lot to with it.

Young Committee that recommended for the establishment of Bank of International Settlements {BIS} in1930 had enough sense for volatility in International financial market and greed’s of bankers. Actual effects of even best designed rules are of no value if lacked by the competent, proactive and fearless supervision. Strengthening the global banking system should be and must be the aim of every new financial rules but it’s equally imperative to stop the adverse lobbying that makes regulation nothing more than a print order. We can easily assume this from recently enacted Dodd Frank Act {Wall Street and Consumer Protection Act} in U.S.A which loosing its effects under the stern pressure from affluent lobbyist.
Regulation couldn’t have any parallel while enforcing a law; our regulatory strength has recently tested during the world wide financial meltdown-Indian banking relatively emerged unscratched comparing the western counterparts. More attention is needed from developed world for compliance of rules envisaged under the Basel-III norms-make or break of this rule would be decided by the both Individual as well collective performances of economies. Co-operation at international level would be the real bone of contention for an ambitious rule like Basel-III…meanwhile let’s watch the movements around the financial circle!
Atul Kumar Thakur
October20, 2010, Wednesday, New Delhi
atul_mdb@rediffmail.com

Paradoxes of Banking Consolidation

Heading through the cutting edge of modern finances, sometimes policy makers tends for noble experiments with its existing businesses to break the inertia or status quo.
In recent quarters, banking industry and even the overall financial sector has witnessed upright positional shifts with unpleasant repercussions; reasons are many and it’s an open secret now but such eventuality couldn’t be easily surpassed through only following the cunning tactics instead to enlighten the knowledge of history and maximum avoidance of willy-nilly practices would be somehow more healing.

Banking consolidation in Indian context very much seems paradoxical, because Indian banking is too diverse to accommodate in single policy frame.
These banks are possessing numbers of inheritances in their own set of condition; for Regional Rural Banks (RRBs) consolidation has enhanced its efficiency but same can’t be true for other banks because of their distinct compositions.so, the foremost task should be to assess the overall nature of their structural and operational pattern and then strive for next innovations. India’s public sector banks (PSBs) including of RRBs were emerged through a very cautious deliberation to imparting banking facilities for larger masses under the vigilant regulation of Reserve Bank of India.

To a certain extant Indian banks have done commendable job in last four decades to penetrate through the requirements of institutional credit and remaining banking facilities in both urban and rural areas; despite this India is still a shabbily under banked country.
Banks are still lending less than half of as proportion to Gross Domestic Product, what a strong economy without exposing to hyper inflation should have; Indian banking here need to follow the basics, the same way in which it succeeded during recent downturns. On the operational side bank must choose to focus on rural segments where the maladies of private lending are still persisting; by appropriating a hassle free day to day banking practices and more rationalization of service charges from less empowered and under banked population.

Private sector lenders must also endeavor in similar way since the rural areas are still unexplored and they may be heaven of business in coming years; of course their expertise in local conditions rather than their size going to determine the pace of their success.
Today ensuring swift financial inclusion should be the top task before the government to keep the wolf from the door (Avoiding hunger); indeed that would need more meticulous exploitation of our own expertise rather than borrowing the abandoned outdated western ideas of banking consolidation.

United States President Mr.Barack Obama has recently reiterating his fear for unnecessarily big size of banks which creates hurdles in operational efficiency; in same manner top western economists including Joseph Stiglitz, who is known for his fair speaking, preaching the cautions to escape the loopholes of banks giant size.
Stiglitz has firm view that” banks too large to fall may also be too difficult to handle…crux of his opinion is to move in the direction of rationalization of policies as per the local conditions and requirements instead to lost in the unrealistic myopia of universal model to consolidate the banking business to its last extant.

Indeed, up gradation of services instead of size that going to help the banking industry at large…we have account of sixty nine bank failures in ongoing financial meltdown and countless bankruptcies of both institutions and common men’s through unrealistic experiments.
Failure of giant Lehmen Brothers that was many fold bigger in its size to India’s largest bank State Bank of India(SBI) shows us that true competency does not necessarily lies in its size…Indian banks are not crooks, so our brooks certainly
not spoil them.
Atul Kumar Thakur
Octobers8th2009, New Delhi

Basel II Norms – A Revised Framework

Basel II framework, refers to a set of document named “International Convergence of Capital Measurement and Capital Standard: A Revised Framework” released by the Basel Committee on Banking Supervision (BCBS) on June 26th 2004 and added more in November 2005.No doubt, the Basel I framework played a key role in raising capital levels across the banking system over the late 1980’s and 1990’s. But in the wake of present crisis,Dr Nant Wellink (President of Netherlands central bank and chairmen, BCBS) emphasized on its failure to deliver on the four objectives: -

I. To develop a more meaningful link between bank’s on and off balance sheet risk exposures and the capital supporting them.
II. To beef up the links between sound regulatory capital and risk based supervision, as a way to foster strong risk management practices at banks.
III. To enhance market disciplines through better information about banks risk profiles, risk management techniques and capital.
IV. The Basel committee endeavored to develop framework that was adaptive to rapid financial innovations.

Further he laid out how the implementation of the Basel II framework would provide an opportunity for banks and supervisors to strengthen the banking system against financial and economic shock.
Key Areas Of Importance: -
I. Basel II delivers great risk differentiation. Banks that move from prime to sub prime mortgage lending or that move from traditional or corporate lending to leveraged lending would see a hike in their capital, commensurate with the changing business strategy and risk profile. Under Basel I all such exposures receive the same charge.
II. Off balance sheet contractual exposures to structural investment vehicle (SIV) and conduits would be brought into the field and subject to regulatory capital, whatever the accounting treatment.
III. There will be much more risk sensitive treatment for secrutisation exposures.
IV. Banks will have to develop more rigorous approaches to measures and manage their operational risk exposures and whole commensurate capital.
V. Banks will have to develop more rigorous methodologies for capturing counter party credit exposures including a wrong way risk. It capitalizes on the modern means of risk management and efforts to establish and improve risk-responsive linkage between the banks operation and their capital requirements.

In modern banking sector where the transactions are increasingly becoming complex and techno specific,so,improving regulatory mechanism is an utmost need especially to deal with international banking. Basel II norms posses all the qualities that a modern global banking system needs to share. Some desirable approaches of Basel II norms are –
I. Create attention to data planning for insures meeting of evolving compliance requirements
II. It is an evolution and there is more to come
III. Pr pressure continues to propel activities
IV. Built in flexibility is mandatory for future proofing compliance initiatives of banks
V. Transparency will be the norm
VI. Modular yet integrated in an enterprise – wide approach is the only long term solution
VII. More investment will be made

It has based on the pertinent pillars which overt its aim more closely: -

I. Pillars Ist : - Deals with the maintenance of regulatory capital circulated for the major components of risk. Risk weights were linked to the external ratings by accrediated rating agencies of some of these assets. Finally, banks were allowed to develop their own internal rating of different asset and risk weight them based on these ratings.
II. Pilllar II nd : -Concerned with supervision by national regulators for ensuring comprehensive assessment of the risks and capital adequacy for their banking institutions. It provides a framework for dealing with all the other risk a bank may such as systematic risk, liquidity risk, pension risk, concentration risk, strategic risk, legal risk, reputation risk etc which are represented under the tune of residual risk. It gives bank a power to review their management system.
III. Pillar III rd: - Provides norms for disclosure by banks of key information regarding their risk exposure and capital positions and aims to improving market discipline. This designed to allow the market to have a better picture of the overall risk position of the bank and to allow the counter parties of the bank to price and deal appropriately.

Effects Of Implementation

I. Basel II allows national regulators to specify risk weights different from the internationally recommended ones for retail exposures.
II. Varying risk weights assigned by the agencies like Fitch, moody, ICRA etc.
III. In the case of retail exposures, the RBI has gone with the lower 75% risk weight prescribed under Basel II norms, as against the currently applicable risk weight125% and 100% for personal/credit card lone and other retail loans respectively. The Indian banks can get enormous benefit to deal with its un-rated high risk loans and other investments like Commercial Papers presenrly carrying 100% risk weight.
IV. The RBI’s draft capital adequacy guidelines provide for lower risk heights for short term exposures, if these are rated.
V. Its enabled Indian banks to significantly reduce their credit risk weight and their required regulatory capital. If they suitably adjust their portfolio by lending to rated strong corporate, will increase their retail lending and provide mortgage loans under high margins.

But the same is not applicable on operational risk. The Basic Indicator Approaches (BIA) specifies that banks should hold capital charge for operational risk equal to the average of the 15% of annual positive gross income over the past three years. Excluding one year when the gross income was negative. Gross income is summed as net interest and non interest income.
Basel II and India’s Banking Structure: -
In their column MACROSCAN (Business Line 2007), Jayati Ghosh and C.P. Chandrashekhar visualized some potential change in the Indian Banking System after its adaptation with Basel II norms. Some key points of their observations are: -

I. Developed countries are at a completely different level of development of their economies and of the extent of deepening financial intimidation as compared to the developing countries.
II. In principles the adoption of the core principles for effective bank supervision issued by the Basel Committee on Banking Supervision (BCBS) is voluntary. India like many other emerging countries adopted the Basel-I guidelines and has now decided to implement Basel II. India has adopted Basel-I guidelines in 1999. Subsequently, based on the recommendations of a steering committee established in Feb 2005 for the purpose the RBI has issued draft guidelines for implementing a new Capital Adequacy Framework (CAF) in line of Basel-II.
III. Regulatory capital is defined in terms “tiers of capital” that are characterized by different degrees of liquidity and capacity to absorb losses. The highest tier I, consists principally of the equity and recorded reserves of the bank assets to be risk weighted.
IV. Initially set for march 31,2007 deadline later extended for foreign operation of banks to March 31,2008 (overall Indian Overseas Banking) while all other Schedule commercial banks (SCB) will have to adhere to the guidelines by March 31,2009.

RBI had taken a view that only Indian Banks that get 20% of their business from abroad need to follow the Basel Norms. In 2003,SBI’s international operations contributed just about 6% of its business.
Difficult Aspects of Basel-II: -

I. Differing cultures, varying structural models, complexities of public policy and existing regulation.
II. Foreign pressure impacts adversely on priority sector lending. A match up attitude on profit may grow further.
III. Following the reforms; the credit-deposit ratio of commercial banks as a whole declined substantially from 60.4% in 1990-91 to 55.9% in 2003-04.
IV. Deregulation, which takes the form of both easing the entry of domestic and foreign players as well as the disinvestments of equity in Public Sector Banks (PSB) forces a change in banking practices.
V. Even the earlier implementation of Basel-I was not proven positive for credit delivery. This would worsen after Basel-II. The preferences of banks for government securities and the increased risk aversion of banks following the adoption of Basel-II would adversely affect credit allocation to priority sector.
VI. Priority sector lending as a proportion of net bank credit after reaching the target of 40% in 1991 had been keep falling short of target till 1996. It has subsequently been in excess of the target and stood at 44% in 2004, because having inclusion of funds provided to RRB by their sponsoring banks that were eligible to be treated as priority sector advances.
VII. Small Scale Industries (SSI) finance is a major problem; which fall from 17.3% of the net banking credit from PSB in 1999-2000 to 7% in 2003-04.
VIII. Basel II norms would introduce pro-cyclical elements in developing economies.


So, the Basel-II norms will effect dubiously on Indian banking system, but that does not mean its disqualification on policy matters, because its consists some very effective tools for Indian banking. Banking sector has a lot to gain in near future from Basel-II norms implementation...

Atul Kumar Thakur
New Delhi
March 23rd 2009
atul_mdb@rediffmail.com

From Wall Street to Main Street(On Financial Meltdown)

The year 2008 must be remembered as watershed year in the financial history as it shattered the confident tone of financial management which has generated through the
recent successes especially from the credit bubble of post 2003-04.Since the year 1987 crash, there have been many financial upsets –the 1997 –98 Asian financial crises, failure of the hedge funds long term capital management in 1998,the puffing Of the stock bubble in 2000,and now the sub prime ‘Mortgage debacle ‘.None has turned into a full-fledged panic, So all three mishappening formed a temptation that we have got mastership over these occurring problems .
Unfortunately situation this time is much grave than initial speculation…gravity of problems recognized very late which deepens the fear of loss and insecurity among both the participant and regulators. The main reasons for the financial mess seem to be the allocation of large funds with U.S Banks and the structural products developed to pass on the risk to investors.

Through January the United State saw on average the loss of over 800 jobs every hour, or 17000 every day since the meltdown began in September ; Off course here in India, too things are shipping but the lessons remain unlearnt .Even in such gloomious atmosphere ,corporate kleptocracy kept very profoundly as Citi group spent $50million on a corporate jet. Now the disgraced CEO of Merrill Lynch, John Thain, spent $1.22million on redecorating his office in early 2008,All that was happening when he prepared to cut thousands of jobs. The amount included purchase of an antique “Commode on legs”.
Even more top bankers from wall street didn’t felt even a bit of reluctance to acquire the hefty amount of perks and bonuses until the U.S President curb such extravagant practices in present troubled phase ,he also barred the maximum compensation to $50,000.No such initiative made from the top notch professional circle except the Citi group chief Mr. Vikram Pandit who voluntary abandoned any fees for his service till the recovery of reputation of his banks .No doubt ,it is suffice to acknowledge the lacking of corporate ethics, among the professional especially who possessed top notch authority.


DID IVY LEAGUE KILL WALL STREET?

When wall street was run by individuals without exotic degrees from Ivy Leagues, they had proper skepticism towards fancy models and managed their risk with a great deal of humility and caution.Indeed they create conducive atmosphere for the practice of “Charuvaka Economics (From the epic MAHABHARATA)”, Which expected from people to borrow, spend and live happily without bothering of repayment of debt and not feel guilty if unable to pay it back .
In same manner, the US financial system consciously pushed sub-prime loans to put cash in the hands of gullible and not creditworthy borrowers and make them splurge at shopping malls, so that wealth shifted from Individuals to corporates; And when things fall apart it was also at the cost of the global community.All credit crises having the same origins. They are spotted in buoyant economic growth that promotes over-optimism, excessive risk taking and extreme demands on liquidity. Some of the typical cases are:-

#.1907:BANKERS PANIC-Run on U.S banks and trust companies what J P Morgan did in 1907?At quarter five on a November morning, Mr Morgan presented assembled bankers a documents telling them what they showed through the kitty to restore confidence. The bankers meekly signed, and the crises was over.

#.1909:WALL STREET CRASH-Stock prices plummet for there years following rampant speculation taking almost twenty five years – Until 1954 to regain pre 1929 value.

#.1973: OIL CRISES-Oil embargo and international withdrawal from Breton Woods agreement trigger stock crash.

#.1987:BLACK MONDAY-Panic leads to 22%drop in single day.

#.2000:DOTCOM CRASH-Teach stock bubble bursts.

#.2008:CREDIT CRUNCH-Defaulters on Sub prime mortgage leads to liquidity problems for financial institution worldwide.

ANATOMY OF A MELTDOWN-

#.Collateral Debt Obligations (CDO)-Late1970’s:-Mortgage were packaged together and sold to investors as CDO’s.

#.Mortgaged-Backed Security (MBS): -1983;Larry fink pioneers MBS market while leading bond department at first Boston Corporation .MBS divides package at Mortgages into different tranches of risk. Softest investment grade bonds receive interest rate while riskiest tier-so called toxic dept-is paid 2-3%higher. Investor is now induced for accepting risk, not for lending money.

#.Sub-Prime Mortgages:-In 1990’s demands for MBS results in lenders lowering interest rates and offering 100% Sub prime Mortgage to individuals with questionable ability to pay. Rising house prices protect these borrowers from defaulting.

#.Credit Default Swaps (1997):-Invented by Blythe Masters at Investment Bank J.P Morgan Chase. CD’S or credit swaps are Insurance like contracts intended to remove risk from companies balance sheets. Presently International Swap and Derivative Association regulate Swaps.

#.Shadow Banking System (Late1990’s):-Swaps now used to package everything from Mortgages ,business card, credit card debt, and even education loans are brought by unregulated speculators and hedge funds on behalf of insurance companies and pension funds worldwide value for global CDs market rose from $1trillion in 2001 to $62.1trillion in 2007 and lastly fall to $28trillion in January 2009.

#.Credit Crunch(2006):-Interest rate rises to 5.25%;Housing market begins to confront defaulter –one in five U.S borrowers falls behind on mortgage payments.

#.2007-08:-Banks worldwide suffer huge losses and stop lending despite massive bailouts by taxpayers.

BAD ASSETS:-

Even before the Bernard Madoff’s scam may other Ponzi scam –In August 2007;the process of price discovery began a long time back when Bear Sterns declares that investment in one of its hedge funds set up to invest in mortgage tracked securities had lost all its value and there is a second such fund were valued at nine cents for every dollar of original investments. Being an interconnected institution holding assets valued at $395.4 billion dollar in November 2007 on an equity base of just $11.8billion,despite having such portfolio, its came under the severe pressure which concluded only with the life support from J.P Morgan Chase at huge loss of share prices.
Normally banking sector considered as the core of financial sector; The equity base of more banks are relatively small even when they follow Basel norms with regard to capital adequacy. Despite such allocation of trenches Banks having considerable derivative exposure.

Citi Group and Bank of New York Mellon estimated to have an exposure to the institution (Derivatives) that was placed at upward of staggering $155billion.In same manner fourth largest bank of Wall street Lehman Brothers came under the severe losses through the Derivative exposure and bad lending, ultimately came to the table with request for support, but it was refused the same. The refusal of the state sends out a strong message.
In a surprise move Bank Of America that was being spoken to as a potential buyer of Lehman Brothers was persuaded to acquire Merrill Lynch instead. But even that deal was not taken place properly and before any move from Bank of America, Black Rock acquired major arms of Merrill Lynch, consequently bringing down two of the iconic and major independent investment bank on Wall street.

In its update to the Financial Stability Report for 2008,issued on January 28,2009,the IMF has estimated the losses incurred by U.S and European Banks from bad assets that originated in the U.S at $2.2trillion.Barely two months back it had placed the figure at $1.4 trillion. So scale of severity can be easily measured since the late 1940s.U.S. has suffered to recessions, joblessness, 6.1% in September, would have to rise spectacularly to match post second world war highs .
The great depression, that followed the stock market collapse in october1929 was a different beast. By the low point in July 1932,Stock was dropped almost 90% from their peak .The accompanying devastation. Bankruptcies, foreclosures, breadlessness lasted a decade. Even in 1940s unemployment was almost 15%,it was the onset of second world war that boosted spending and bailed out the economy.

The deregulation of Banking was crucial for this transaction that was made possible by the process of deregulation that began in the 1980s and culminated in the Gramm-Leach-Billey Financial Modernization Act of 1999,which completely dismantled the regulation structure and the restriction on cross-sector activity put in place by Glass-Steagall in the 1930s.It is noteworthy that Glass-Steagalll’s own conception that there is less profitability In regulatory regime itself bounded with a deep inner contradiction in the system which set up pressure for deregulation .
Those pressure gained strength during the inflationary years in the 1970s when right monetary policies pushed up interest rates elsewhere but not in the banks .But such any claim deregulation is not justifiable in present circumstances, even the policy maker’s like Allan Greenspan who even facing a staunch liberalist, stressed on need for temporary regulation .This is need of hour, even U.S newly president elect Barack Obama ,not stop to saying that U.S should have the privately held banking system regulated by government.
Bank of Ireland and Allied Irish Banks and in the U.K whose Royal Bank of Scotland and Lloyds group are now under dominant public control, and others are expected to follow. The U.S and the U.K now have what India called the social control of banks. While in India bankers and policy makers are not stopping to encourage riskier loans by banks, In the U.S and U.K, the objectives are exactly opposite .In present circumstances India and rest economy of the world can learn a lot of tracts from Latin America where the first time in a century ,Latin America has managed to atleast partially “cushioned” itself from the seismic waves of economic turmoil in the U.S and Europe.
Even this partial success comes through the balanced monetary policies which undertaken to boost peoples development instead of fascinating merely towards numerical growth.
According to Hayek ,if monetary tightening is undertaken after the upper turning point of inflationary cycle is passed ,the downturn is accelerated. This useful concept is however anathema to Indian policy makers, who’s main focus now is on spurring higher growth. But such measures will add to the suffering of the poor. Now it is quite imperative to think about the falling purchasing capacity at mass level while prices at staple goods are reached at record high up 50%,in the last six months ,global food stocks are reached to historic lows. So, the poor can’t afford the food in present mechanism.
In present circumstances, if there is one enduring idea from Friedman, that central bankers in China and India would be well advised to heed, it is the” Monetarist Paradox” that almost every rate cut leads one time to a higher interest rate. And tightening moves such as raising the CRR do not necessarily ensure that policy has tightened, Reading Friedman tends to be a revelation .

It may interesting to note that popular rhetoric exaggerates damage done by recessions; but recessions have often overlooked benefits too. They moderate inflationary tendencies and punish reckless financial speculation and poor corporate practices like bad instruments, irresponsible lending etc. These effects contribute to an economy’s long term strength .
So, it is imperative to take some very impeccable measures to heed from ongoing downward movement of financial world, International Monetary Fund (IMF)s Global Financial Stability Report (April2008),suggested some very vital policy options to sub-prime crises:-
#IN SHORT TERM:-
1.Disclosure
2.Bank balance sheet repair
3. Management of compensation structure
4. Consistency of treatment
5.More intense supervision
6.Early action to resolved institutional maladies
7. Public plans for impaired assets.

#IN THE MEDIUM TERM:-

1.Standardization of some components of structured finance products.
2.Transparency at origination & subsequently.
3.Reform of rating system.
4.Transparency & disclosure.
5.Paying greater attention to applying fair value accounting results.
6.Reexamining incentives to set up Special Investment Vehicles{SIV} and its conducts.
7.Tightening oversight of mortgage originators.

Some of these recommendation are really very close to the solution, its judicious formulation may heed the problem to an extent. Apart from this, countries must understand what was lost in 1944 (Bretton Woods Conference) one of the reasons for financial crises is the imbalance of trade between nations. Countries accumulate debt partly as a result of sustaining a trade deficit.
They can easily destined to trapped in vicious circle; the bigger their debt, the harder it is to generate a trade surplus. International debt wracks peoples development, trashes the environment and threatens the global system with periodic crises. There have been more than a dozen financial crises since the beginning of 20th century. The aftermath of each was transitory, and markets rebounded rather quickly.

The current may be different, it will usher in profound and lasting structural behaviour and regulatory changes .In present troubled time a fresh approach is needed on overall policy matters and its implementation to curb occurring such mishappening. For restoration of confidence in financial markets a new look on corporate governance is quite imperative, this is the measure area where a lot of work have to be done in near future, personally I think governance is a biggest determinant in shaping of an administrative order, whatever we have seen in back times may be termed as failure of governance ðical work style.
It would be quite nice to see a new financial world free from such wrong practices, but before this, indeed we have to pass through a long wait…. like the Samuel Backetts Waiting For Godot….
Atul Kr Thakur
New Delhi,March 2,2009
atul_mdb@rediffmail.com