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
Showing posts with label Central Banks. Show all posts
Showing posts with label Central Banks. Show all posts
Thursday, October 21, 2010
Friday, September 25, 2009
Lessons from Lehmen Brothers Failure
Lehmen Brothers is no more ….Alas, September2008 was truly a black month that grasped such iconic financial giant from scene, even more such financial crisis that only occurred in a generation finally amounts the toll of institutional banking failures up to sixty-nine until now.
Impact of current financial crisis could be judged in retrospect as the most financially devastating after the Second World War; no regulators (including IMF) could timely foresee the actuality of potential situation despite possessing the thousands of economists battalion. Crisis broke out with the continuing fall in U.S home prices that relentlessly faded the price of Mortgage Backed Securities (MBSs); it had also hit those who insured MBSs against default through Credit Default Swaps (CDSs).
Consequently unrealistic returns that equity investors have expected to earn by taking the additional risk simply failed to materialize. If we got back to the actual causes of such large-scale failure, it becomes essential to distinct it between practice related causes and the causes emerged through institutional tempering in some core regulation.
Like former Federal Reserve chief Alan Greenspan had kept interest rate too low for too long time which led to negative sentiments; in1999 the Glass-Steagall Act of1933, which had prevented commercial banks from tying up with risky bets on securities had been repealed, further it curtailed the checks from any irregular financial practices. Even more, Securities Exchange Commission in 2004 relaxed the limits on top investment banks to leverage; so policy makers grossly exhibit the oblivious attitudes towards mushrooming of complex derivatives.
In extreme sycophancy financial regulators couldn’t became able to assess risks and also the inherent interest of financial market participant towards multiple market transaction which finally leads to excess volatility and state of chaos in financial sector across the integrated economies.
During that period of volatility, some regulators resorted to a ban on short sales to alter the movement of market, at least for time being. Albeit, that idea could not succeed as subsequent events and studies shows us in later course.Unlike initial observation of 2008, our engagement with western market is quite deep, so it was unlikely that we would have been completely saved from a financial crisis of mammoth proportion.
Liquidity arises as major problems of Indian financial sector especially the Mutual funds industry that were handled efficiently by RBI and SEBI. So, matter siege to growing in worse direction, although the Indian financial sector particularly Mutual fund industry keep witnessing the sluggish response of its business until the bad developments are halted at Dalal Street.
Despite relieve from slowdown it’s imperative for us to keep eagle watch on the development in the crisis strife markets to assess its actual impact in Indian market; the second wish list could be to bring as many as viable product to exchange traded markets, so the regulations will have better say on unrestrained myopic financial roots of investment.
Those who cannot learn from history doomed to repeal it that shows their failure ness to rationalize the unduly persisting greed’s; U.S.A Banks in large fails to learn such exercise. U.S economy roughly account for quarter proportion of world economy when its population only accounts for five percent.
It would be worthwhile to note that despite having such superb statistics America remains the largest borrower even from developing countries like India that shows the rampant artificiality in U.S core strategy; so bubble had to burst, so it has burst.
Bubbles followed by crashes are actually a recurrent theme in financial history (Tulip mania 1634-37, South sea bubble1711-20, the long Depression1873-96, Great Depression& Stock Market crisis 1929-32, Asia/ Russia/ LTCM crisis 1996-98, Dotcom Burst2000-02 and current crisis 2007…?); the impact of the present crisis was exacerbated due to a vicious circle of defaults and liquidation…and indeed also through bandwagon mania.
Innovations is always desirable in financial domain only a distinction is must between innovations like technological up gradation and complex derivatives because the ability to use derivatives to speculate, create off balance sheet positions, increase leverage, arbitrage regulatory and tax rules… and manufacture exotic risk cocktails will continue to a major factor in derivative activity.
Tectonic shift that we need in financial market should come as meticulously crafted process instead through push-button methods that would require clarity on the goal of financial sector reform. For the time being, it is quite essential to reduce the unintended consequences of financial meltdown like spiraling inflation and increase in western government’s debt & budget deficits.
Escalation of top-notch officials in American financial circle is not a right step forward instead; a utility-based pay scheme should be approached in banks and other financial institutions that would lessen the hassles from exchequer. Keynes came back in fashion…so government should ensure employment first; like NREGS (India) was implemented much before the downturn of economies.
Now it would be quite blissful for nations to appropriate fine mix of socialism and capitalism as it was conceived by the India’s first Prime Minister J.L Nehru for India’s planned development.
Also essentially we should carry on the teaching of our grand mothers on practical financial behaviors, so we become able to avoid gaining $613 billion dollar debt on iconic bank like Lehmen Brothers( Whom we commemorate our adieu presently) as policy makers. Ultimately quotation of Charles Dickens, (Literary protagonist of Great depression era, from his magnum opus work” Great Expectations”); that “we have every thing before us and we have nothing before us “…it’s up to us how we visualized the things.
Atul Kumar Thakur
22nd September2009, New Delhi
atul_mdb@rediffmail.com
Impact of current financial crisis could be judged in retrospect as the most financially devastating after the Second World War; no regulators (including IMF) could timely foresee the actuality of potential situation despite possessing the thousands of economists battalion. Crisis broke out with the continuing fall in U.S home prices that relentlessly faded the price of Mortgage Backed Securities (MBSs); it had also hit those who insured MBSs against default through Credit Default Swaps (CDSs).
Consequently unrealistic returns that equity investors have expected to earn by taking the additional risk simply failed to materialize. If we got back to the actual causes of such large-scale failure, it becomes essential to distinct it between practice related causes and the causes emerged through institutional tempering in some core regulation.
Like former Federal Reserve chief Alan Greenspan had kept interest rate too low for too long time which led to negative sentiments; in1999 the Glass-Steagall Act of1933, which had prevented commercial banks from tying up with risky bets on securities had been repealed, further it curtailed the checks from any irregular financial practices. Even more, Securities Exchange Commission in 2004 relaxed the limits on top investment banks to leverage; so policy makers grossly exhibit the oblivious attitudes towards mushrooming of complex derivatives.
In extreme sycophancy financial regulators couldn’t became able to assess risks and also the inherent interest of financial market participant towards multiple market transaction which finally leads to excess volatility and state of chaos in financial sector across the integrated economies.
During that period of volatility, some regulators resorted to a ban on short sales to alter the movement of market, at least for time being. Albeit, that idea could not succeed as subsequent events and studies shows us in later course.Unlike initial observation of 2008, our engagement with western market is quite deep, so it was unlikely that we would have been completely saved from a financial crisis of mammoth proportion.
Liquidity arises as major problems of Indian financial sector especially the Mutual funds industry that were handled efficiently by RBI and SEBI. So, matter siege to growing in worse direction, although the Indian financial sector particularly Mutual fund industry keep witnessing the sluggish response of its business until the bad developments are halted at Dalal Street.
Despite relieve from slowdown it’s imperative for us to keep eagle watch on the development in the crisis strife markets to assess its actual impact in Indian market; the second wish list could be to bring as many as viable product to exchange traded markets, so the regulations will have better say on unrestrained myopic financial roots of investment.
Those who cannot learn from history doomed to repeal it that shows their failure ness to rationalize the unduly persisting greed’s; U.S.A Banks in large fails to learn such exercise. U.S economy roughly account for quarter proportion of world economy when its population only accounts for five percent.
It would be worthwhile to note that despite having such superb statistics America remains the largest borrower even from developing countries like India that shows the rampant artificiality in U.S core strategy; so bubble had to burst, so it has burst.
Bubbles followed by crashes are actually a recurrent theme in financial history (Tulip mania 1634-37, South sea bubble1711-20, the long Depression1873-96, Great Depression& Stock Market crisis 1929-32, Asia/ Russia/ LTCM crisis 1996-98, Dotcom Burst2000-02 and current crisis 2007…?); the impact of the present crisis was exacerbated due to a vicious circle of defaults and liquidation…and indeed also through bandwagon mania.
Innovations is always desirable in financial domain only a distinction is must between innovations like technological up gradation and complex derivatives because the ability to use derivatives to speculate, create off balance sheet positions, increase leverage, arbitrage regulatory and tax rules… and manufacture exotic risk cocktails will continue to a major factor in derivative activity.
Tectonic shift that we need in financial market should come as meticulously crafted process instead through push-button methods that would require clarity on the goal of financial sector reform. For the time being, it is quite essential to reduce the unintended consequences of financial meltdown like spiraling inflation and increase in western government’s debt & budget deficits.
Escalation of top-notch officials in American financial circle is not a right step forward instead; a utility-based pay scheme should be approached in banks and other financial institutions that would lessen the hassles from exchequer. Keynes came back in fashion…so government should ensure employment first; like NREGS (India) was implemented much before the downturn of economies.
Now it would be quite blissful for nations to appropriate fine mix of socialism and capitalism as it was conceived by the India’s first Prime Minister J.L Nehru for India’s planned development.
Also essentially we should carry on the teaching of our grand mothers on practical financial behaviors, so we become able to avoid gaining $613 billion dollar debt on iconic bank like Lehmen Brothers( Whom we commemorate our adieu presently) as policy makers. Ultimately quotation of Charles Dickens, (Literary protagonist of Great depression era, from his magnum opus work” Great Expectations”); that “we have every thing before us and we have nothing before us “…it’s up to us how we visualized the things.
Atul Kumar Thakur
22nd September2009, New Delhi
atul_mdb@rediffmail.com
Monday, March 23, 2009
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
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
Thursday, March 12, 2009
Myopic Routes of Finance (Sovereign Wealth Funds& Participatory Notes)
Amidst the ongoing crisis; it will be quite interesting to see and visualize the scale of losses…what we have actually lost in recent months, which have been in our possession through a considerable time. A lot of debate and writing has been stuffed about the potential causes of financial failure and diminishing market sentiments in past few months.
There could be many reasons behind the present financial chaos; among them, inflated treatment of stock markets best be attributed because the unprecedented growth till the crisis broke out largely caused by the unrestricted financial routes which don’t even canopied under the regulation of SEBI. So, no one can exactly traced the investors as their business dealt through intermediaries, even those middlemen’s never required to follow Know Your Customers (KYC) Norms.
These myopic investment roots may be considered to progenitor and nurturer of speculative finance. Two most prolific among them are: -
Sovereign Wealth Funds (SWF): -
Some SWF own by the State Governments of countries to handle with its idle assets for its maximization of value. SWF is not a fresh concept since its genesis can be traced back to 1950’s, then their size worldwide was $300billion.The current level now reached to $2 trillion to $3 trillion, the size may be cross $10trillion by 2010.
At present more than twenty countries have set up these funds. A dozen more have expressed willingness in establishing them. More than half of assets are possessed by oil exporting countries. Ranging from Norway to Trinidad, including Australia, China and Singapore. Still the holding are mostly concentrated with the top five funds, accounting for more than 70% of total assets under management.
Like hedge funds, SWF are also not governed by any single authority except the Singapore. SWF also operates through hedge funds, Private Equity for high return. So,it requires great care in fund management.SWF have a positive tendency to go long on securities that means to say, they buy and hold it invested for longer periods. This creates some establishing influence on stock markets.
But this establishing factor of SWF is highly disproportionate with its destablishing factor. Since it creates more place for irresponsible transaction. Overall SWF are immensely surrounded with chances of risk and failures, so neither it’s a meticulous route of investments nor it is good for just and equitable society.
Participatory Notes (PN): -
PN is an investment root by Foreign Institutional Investor (FII), through Offshore Derivatives Instrument (ODI); Such as Equity linked Notes and Participatory Return Notes have created storm in stock markets.
Basically FII issues PN to funds for companies whose identity is not known to the authorities. The PN is discriminatory as it promotes unethical investments; further it creates harmful effects on domestic companies. PN having very firm presence in India, as its proportion lies around 15-20% of stock of the top 1,000 companies. They have almost ruling influence on the market.PN outstanding by middle of 2007 was 3,53,484crores(51.6% of Asset under custody of all FII Sub Accounts). The value of outstanding ODI with underlying derivatives currently stands at Rs.1, 17,071crores, which is approx to 30% of total PN outstanding.
Users Of PN Route: -
1.Regular funds whose twin objectives are returns and more returns
2.Prodigal money returning
3.Foreign Governments/Entities who would like to acquire/control Indian entities by tracking them over.
PN investors channelizes their investment through the FII, but despite playing the role of intermediary, FII are not required to reveal their face. This situation further become more mysterious when regulators like SEBI simply let PN to escape from registration, which set them free from any regulation. Such allowances, promotes Indian financiers to enter in Indian Financials to enter in Indian Financial Markets.
Overall producers of PN transaction violates know Your Customers Norms, lastly, National Security Advisor cautioned against terror financing through stock market channels. Rising concerns of Indian authorities are very genuine, because unprecedented rise as well as fall are misleading the Indian growth story.
Two major constraints, which can lessen the impacts, are: -
1.A Special Purpose Vehicle (SPV), can be created which would be dollar dominated to hold these funds at attractive rates and which are countered over a period of time to minimize the followed impacts.
2.Generally these are two types of PN- Spot based and Derivatives/Future based (ODI). The latter accounts for around 32-33 percent of all PN. FII and their sub accounts shall not issue/renew ODI with underlying as derivatives with immediate effect .It should also mean that the hedge funds ,which has been fairly responsible for the steep rise in the markets, might exit the market because SEBI will never let them register as FII.
On such proposals, due consideration was given by SEBI to cope with threats of PN. Ultimately SEBI allowed 18 months to wind up outstanding PN in late 2007, now the proposed ceiling is near end, which means ends of the unauthorized PN.Decision taken by the SEBI was in very right directions. Since its timely implementation optimized and lessen many future losses. Some such more measure are imperative to check irregularities in financial markets.
Authorities have to play catalyst role in such initiatives. Investors should have also rationalize their paramounting expectations from financial markets and now must start to keep faiths in realistic rewards.
Atul Kumar Thakur
New Delhi
March12,2009
atul_mdb@rediffmail.com
There could be many reasons behind the present financial chaos; among them, inflated treatment of stock markets best be attributed because the unprecedented growth till the crisis broke out largely caused by the unrestricted financial routes which don’t even canopied under the regulation of SEBI. So, no one can exactly traced the investors as their business dealt through intermediaries, even those middlemen’s never required to follow Know Your Customers (KYC) Norms.
These myopic investment roots may be considered to progenitor and nurturer of speculative finance. Two most prolific among them are: -
Sovereign Wealth Funds (SWF): -
Some SWF own by the State Governments of countries to handle with its idle assets for its maximization of value. SWF is not a fresh concept since its genesis can be traced back to 1950’s, then their size worldwide was $300billion.The current level now reached to $2 trillion to $3 trillion, the size may be cross $10trillion by 2010.
At present more than twenty countries have set up these funds. A dozen more have expressed willingness in establishing them. More than half of assets are possessed by oil exporting countries. Ranging from Norway to Trinidad, including Australia, China and Singapore. Still the holding are mostly concentrated with the top five funds, accounting for more than 70% of total assets under management.
Like hedge funds, SWF are also not governed by any single authority except the Singapore. SWF also operates through hedge funds, Private Equity for high return. So,it requires great care in fund management.SWF have a positive tendency to go long on securities that means to say, they buy and hold it invested for longer periods. This creates some establishing influence on stock markets.
But this establishing factor of SWF is highly disproportionate with its destablishing factor. Since it creates more place for irresponsible transaction. Overall SWF are immensely surrounded with chances of risk and failures, so neither it’s a meticulous route of investments nor it is good for just and equitable society.
Participatory Notes (PN): -
PN is an investment root by Foreign Institutional Investor (FII), through Offshore Derivatives Instrument (ODI); Such as Equity linked Notes and Participatory Return Notes have created storm in stock markets.
Basically FII issues PN to funds for companies whose identity is not known to the authorities. The PN is discriminatory as it promotes unethical investments; further it creates harmful effects on domestic companies. PN having very firm presence in India, as its proportion lies around 15-20% of stock of the top 1,000 companies. They have almost ruling influence on the market.PN outstanding by middle of 2007 was 3,53,484crores(51.6% of Asset under custody of all FII Sub Accounts). The value of outstanding ODI with underlying derivatives currently stands at Rs.1, 17,071crores, which is approx to 30% of total PN outstanding.
Users Of PN Route: -
1.Regular funds whose twin objectives are returns and more returns
2.Prodigal money returning
3.Foreign Governments/Entities who would like to acquire/control Indian entities by tracking them over.
PN investors channelizes their investment through the FII, but despite playing the role of intermediary, FII are not required to reveal their face. This situation further become more mysterious when regulators like SEBI simply let PN to escape from registration, which set them free from any regulation. Such allowances, promotes Indian financiers to enter in Indian Financials to enter in Indian Financial Markets.
Overall producers of PN transaction violates know Your Customers Norms, lastly, National Security Advisor cautioned against terror financing through stock market channels. Rising concerns of Indian authorities are very genuine, because unprecedented rise as well as fall are misleading the Indian growth story.
Two major constraints, which can lessen the impacts, are: -
1.A Special Purpose Vehicle (SPV), can be created which would be dollar dominated to hold these funds at attractive rates and which are countered over a period of time to minimize the followed impacts.
2.Generally these are two types of PN- Spot based and Derivatives/Future based (ODI). The latter accounts for around 32-33 percent of all PN. FII and their sub accounts shall not issue/renew ODI with underlying as derivatives with immediate effect .It should also mean that the hedge funds ,which has been fairly responsible for the steep rise in the markets, might exit the market because SEBI will never let them register as FII.
On such proposals, due consideration was given by SEBI to cope with threats of PN. Ultimately SEBI allowed 18 months to wind up outstanding PN in late 2007, now the proposed ceiling is near end, which means ends of the unauthorized PN.Decision taken by the SEBI was in very right directions. Since its timely implementation optimized and lessen many future losses. Some such more measure are imperative to check irregularities in financial markets.
Authorities have to play catalyst role in such initiatives. Investors should have also rationalize their paramounting expectations from financial markets and now must start to keep faiths in realistic rewards.
Atul Kumar Thakur
New Delhi
March12,2009
atul_mdb@rediffmail.com
Monday, March 2, 2009
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
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
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