Privatisation of Public Sector Banks - A really bad idea

This article was published by The Economic Times on the 16th of Feb, 2018

Credit Policy - Thank RBI for small mercies

This article was published in the Hindu Business Line on 12th Feb 2018

Issue with Defence is not allocation, but dishonesty

This article was published in the Economic Times on 9th Feb, 2018

Budget 2018 - the fault is in BJP's stars

This article was published in the DNA opinion page on 2nd Feb 2018

Bitcoin as currency - closer than we think

This article was published in the DNA op-ed page on 24th Jan, 2018

Bitcoin has assumed cult proportions, and naysayers in both financial markets (through their dire warnings of a Dutch Tulip redux) and global governments (through pre-emptive executive actions) have not really been able to fully dampen the enthusiasm of cult-followers. The real question though is if Bitcoin would be ever able to transcend its cult-status into its promised nirvana, ie, an alternative global currency. Prospects of that happening, while enormous challenges remain, are perhaps not the in “not in my lifetime” domain. Why? Let us examine the key hot buttons — demand and supply considerations of an alternative global currency. 

Starting with demand — is there a demand for an alternative global currency? This is an easy answer — it is a loud, unambiguous YES. There are multiple intellectual convincing and politically powerful support for Bitcoins as an alternate currency. 

First, the current international financial system is predicated on the status of US Dollar (USD) as the de facto reserve currency. Bulk of trade settlements, capital flows and money transfers happen in USD — giving the US government supranational powers to regulate the international financial system. Along with USD as the reserve currency, the entire global financial architecture is run by financial institutions around US rules. This gives enormous political powers to the US government — it can (and has) try to influence behaviour of people, corporations, even countries, by sanctioning their access to the global financial system. States at the receiving end of such action — Russia, Iran, Venezuela come immediately in recent memory — have enormous interest in breaking out of the straightjacket of USD. Bitcoin, where custody, transfer and trust are ensured by a disaggregated, decentralized protocol (rather than US laws), reduces the leverage of sanctions today that US government has. 

Second, the crisis of confidence in the traditional monetary regime. Under the traditional monetary policy, new money is primarily created by “fiat”, or by central banks (representing their respective sovereign governments) printing money. Post the global financial crisis in 2008, central banks around the world used this power to print very large sums of money (popularly described as Quantitative Easing), with the objective to keeping interest rates low, finance government buy-outs of toxic financial assets, and give a general “monetary boost” to a crisis-hit global economy. In some parts, it worked. But it also left in its wake a crisis of confidence with a section of thought-leaders  — as currency as an asset was seen to have been devalued by printing such large amounts, opening up possibilities of run-away inflation in the future. 

Next, what about supply? Is Bitcoin (and the whole family of cryptocurrencies at large) geared up to become an alternative form of money? Any form of money has two features — as a medium of exchange and as a store of value. At an overarching level, money also has to support business cycles in the real economy. 

As a medium of exchange, Bitcoin (and cryptocurrencies in general) shows the maximum promise — as a decentralised, public architecture — since money transfers can be done faster, cheaper and without taking credit risk on various intermediaries along the chain. A typical international wire transfer today navigates its way through multiple banks, clearing houses, custodians and transfer protocols (like SWIFT) — takes several days, with the only beneficiary being the intermediary banks making money out of the idle float. Cryptocurrencies like Litecoin can do the transfer in minutes, and cost virtually nothing.  

The real issue with Bitcoin today though, is as a store of value. Rather, as a “stable” store of value. Volatility in Bitcoins today is very high, 20-25 times the volatility of stocks. Now, no one would generally like to be paid in a form of money that can be worth 15 per cent more (or less) the day after. Part of this is growing up pangs, Bitcoins do not have the normal full suite of financial products underlying the asset — most financial assets that do not have well-traded option contracts tend to be non-ergodic (in simple terms, subject to massive blow-ups). Recently, mainstream exchanges like Chicago Board of Trade and Chicago Mercantile Exchange started offering futures contracts on Bitcoins. Its not enough, futures contracts, sans a large, liquid options market, will not bring volatility down markedly. The point though is, this is just the beginning. Moore’s Law in financial market innovation will kick-in at some stage, especially with mainstream financial market participation increasing, and newer derivative instruments would start trading off Bitcoin underlyings. However, this is the toughest condition for Bitcoin to achieve for it to become a form of money. 

Which brings us to the last issue, does Bitcoin lend itself to viable monetary policy formulation, one that can support the real economy? The first objection would be in terms of its finite quantity – Bitcoin is limited to 21 million. In times of economic downturn, it limits the ability of governments to expand the money supply to tackle the same. This isn’t as such a difficult problem, as Bitcoin is but one of many cryptocurrencies, there are many more (like Litecoin, Dash etc).  

The bigger issue, though, is around the power of the State associated with money. Fiat money today is printed by governments, it’s a sovereign obligation. How would states react to a new architecture stripping that power away? 

Philosophically, this would be the biggest supply-side question that Bitcoin has to answer. Good news (for Bitcoin fans), is that there is a modern precedent. About 500 million citizens in dozens of States, gave up their sovereignty to print money to a common shared pool — the European Monetary Union, on January 1, 1999 — giving birth to Euro. Some of the objectives of the Euro are not very dissimilar to the demand-side arguments for Bitcoin. In a nutshell, it has happened before! While the obstacles are many, so it would seem are the arguments in favour of Bitcoin. How the cookie crumbles would be an interesting story of our lifetime!

Cutting Small Savings rates - penny wise pound foolish

This article was published by the Economic Times on 11th Jan 2018

Bailing in deposits - the only alternative is to nationalise banking

This article was published by DNA on its opinion page on 13th Dec 2017

There’s never a dull moment in banking these days. The Financial Resolution and Deposit Insurance (FRDI) Bill 2017, now sent to a Parliamentary Committee, has been the latest source of much-alarmed commentary recently. At the heart of the alarm is the concept of “bail in” introduced in the bill. Typically, when in stress, banks around the world have been bailed out, ie, external funds (mostly taxpayer) have been used to rescue depositors and bond-holders. A bail-in is just the opposite, where depositor/bond-holder funds could be used to rescue a distressed bank.

In simple terms, it would mean conversion of the bailed-in deposit into equity. In the case of FRDI, the relevant bail-in clause has a provision of “cancelling a liability owed by a specified service provider” and “modifying or changing the form of a liability owed by a specified service provider”. 

The principle of bail-in has been discussed in depth since the global financial crisis of 2008 when the US and Europe alone spent upwards of $1 trillion of taxpayer funds to bail-out stricken banks. The moral hazard question — using taxpayer money to bail-out private investors/depositors — is one that had to be answered. The Bank of International Settlements (BIS, the central bank of all central banks) and G20 formed the Financial Stability Board (FSB) in 2009 to draft rules to prevent an encore of such situations. Bail-in was part of the package of sweeping reforms suggested by BIS. Since then, a number of countries have implemented country-specific banking regulations around bail-ins. European Union’s Bank Recovery and Resolution Directive set out broad guidelines for rescuing distressed European banks. 

Since then, Europe has used bail-ins a number of times to rescue banks. Starting with a small Danish bank (Amagerbanken), which went bankrupt in 2011, prompting Denmark’s Finansiel Stabilitet to force bailing in of high-value deposits and bonds. This was small compared to Cypriot banks in 2013, which saw massive bail-ins of high value ( >Euro 100,000) deposits and bonds to rescue banks reeling from Greek sovereign defaults. Even more recently, in 2016, Banco Popular, Spain’s sixth-largest bank, had certain categories of bonds bailed in en masse, even though depositors were spared. 

In a nutshell, it is an idea whose time has not just come but has been tested live many times. What explains the “oh my God” reactions to FRDI then?

Prima facie, the rationale is deceptively intuitive — small depositors put their life’s savings into bank deposits. Corralling them as equity to rescue distressed banks is unfair and illogical. Politically, this has indeed been the case globally (and in India). Outside of cooperative banks, not a single depositor has lost any money in India, even when their banks went belly-up. In the recent past, instances of Global Trust Bank (GTB) and Bank of Rajasthan are illustrative — RBI organised bail-outs in each case to protect depositors. The issue is, all bailouts involve taxpayer funding, explicit or implicit. In the case of GTB, the same was implicit, via funding required in the Oriental Bank of Commerce that took GTB over. The recent Rs. 1.3 lakh crore recapitalisation programme of Public Sector Banks (PSB) is an instance of explicit taxpayer funding of bank bailouts. Back to moral hazards!

The bigger issue is simple — private sector banks, in good times, make profits for its shareholders. But in distress, they are expected to be bailed out by the state. 

A classic case of privatisation of profits and nationalisation of losses. It is an untenable equation, precisely why bail-ins become crucial. Banks are not ordinary enterprises. Sans a bailout or a bail-in, a bankrupt bank will have massive repercussions on not just the financial system but also the larger economy. Lehman Brothers is an illustrative case — a medium-sized investment bank, its bankruptcy nearly brought the financial system to a collapse.

Above all, while Lehman did not have depositors, its senior unsecured bondholders (same seniority in capital structure as depositors) received nothing more than 10-15 cents on every dollar they had invested. Turn back to the Cypriot example, where bailed-in depositors/bondholders have retained at least 40-50 cents to every dollar they had invested. No two cases are the same, but they do provide illustrative lessons.

In a nutshell, the choice between a taxpayer-funded bailout and a depositor-funded bail-in isn’t that much of Hobson’s territory. 

If bail-ins are considered sacrilege, the default option left is to nationalize banks altogether. That way, all profits would belong to taxpayers. And then, when there is a bank in distress, taxpayers pick up the rescue tab. The Indian banking system, with PSB having 70 per cent market share, have tackled the moral hazard quite elegantly. Unfortunately, some of those who cry loudest for privatisation of banks are also those that have expressed the greatest horror at the bail-in provisions of FRDI. Unfortunately, like in everything else in life, we cant have our cake and eat it too!