Monday, March 26, 2018
Wednesday, March 7, 2018
Banks need a new social contract, not a debate around ownership
This article was published in the Economic Times on 5th Mar 2018
The PNB scam has ratcheted up the decibel levels of the debate around public sector banks (PSBs) in India. Unfortunately, the debate has been primarily focused around the ownership structure of the banks – publicly owned. It’s somewhat Kafka-esque – obsessing about black coffee after being beaten senseless by a couple of goons (Amerika, Franz Kafka’s first novel)! When the debate should be, as has been the case in the West for some time, about the role of banks per se.
In simple terms, are banks meant to be turbo-charged return on equity (ROE) machines, driving innovation, risk-taking and high returns for shareholders? Or should they be public utilities meant to provide low-risk plumbing for the real economy, not blowing up, and if they do, not presenting catastrophic outcomes for society? The question has always been around banking, but the question has become centre-of-plate since the financial crisis in 2008. At the core is the realisation that banking losses, irrespective of the nature of ownership, is a public liability.
Higher capital requirements under Basel III, higher compliance requirements, stripping off risky parts of banking from universal banks – there has been a global attempt towards making banks closer to utilities than ever before. In short, convert TBTF to “Too Boring To Fail” from “Too Big To Fail”. In many ways, the impact is visible – with ROEs of banks globally more resembling utilities (5-9%) than banking in the previous decade (15-20%).
Unfortunately, the debate in India gives this a near-complete miss. In some ways, the so-called “reforms” are looking to reverse the better characteristics of Indian banking.
To start with, the assumption of big being better. For many years now, the government has postulated that most PSBs are too small, and need to be merged into larger, “global sized” banks. While progress on this front has been slow, SBI did a mega merger of all its associate banks last year as part of the same strategy. It’s a strange hypothesis – smaller the bank, smaller would be its organic and systemic impact of failure. India is uniquely blessed in this regard – barring SBI and ICICI, most banks have single-digit market shares. It makes the system more resistant to systemic failures. But proposed “reforms” are looking to create a more vulnerable banking system by creating larger banks.
Second, while there is a welcome new process/law for bad loan resolution, there is still little work on addressing the core issues. Banking loans fall essentially under three categories – corporate finance, corporate and commercial loans and retail loans. In India, bulk of NPA issues have arisen on account of large project finance loans extended by PSBs. Earlier, the failure of Global Trust Bank was on account of large exposure to capital markets. There is a fundamental mismatch – between the riskappetite and tenor of the liability (deposits) and asset (loans) sides of the banks’ balance sheets here. Unfortunately, even as RBI (and the government) have tightened operational rules around lending, credit appraisal etc, there has not been any serious discussion around why commercial banks, funded by short-term retail deposits, should be giving out long-term project loans, or write guarantees secured by capital market exposures.
Third, India has gone slow on capital buffers. Even as GOI embarks on a massive recapitalisation plan for PSBs, amounting to over ₹2 lakh crore, there is little conversation on how and why Indian banks would continue to have weaker equity capital buffers compared to the rest of the world.
Corporate finance activities should be done from an entity outside of a commercial bank. They should not be allowed to be funded by retail deposits. Two, banks that raise bulk of their deposits from retail customers should be restricted to writing retail and selective corporate & commercial loans. Balance corporate/commercial loans should be funded out of deposits raised from wholesale (corporations, institutions etc) customers. Three, capital requirements on banks should be set high, so high that they simply cannot fail. Once done, there would be little probability of taxpayer bailouts, irrespective of ownership.
The debate on ownership, especially privatisation, is sexier than a debate around the social contract of banking. As it was for Karl Rossman in Amerika, it was more interesting to discuss the role of black coffee in his station in life, rather than the tragedy of his journey from Europe to New York. But banking might require a touch more attention than Kafka!
Tuesday, February 27, 2018
NSE/BSE refusing to share data with SGX - tilting at windmills, but not end of the world
This was published on the 24th of Feb, 2018 in DNA
Earlier this month, the three largest stock exchanges in the country — National Stock Exchange (NSE), Bombay Stock Exchange (BSE) and the new Metropolitan Stock Exchange (MSE) — agreed to stop sharing data with overseas stock exchanges that offer derivative contracts linked to popular Indian indices and stocks. As soon as the news hit the wires, the predictable responses came out like the proverbial ants out of the woodworks — it’s anti-competitive, a policy self-goal, protectionist. MSCI, the popular global index-provider, even darkly hinted at a possible cut in India’s weightage in its global benchmark indices.
The fact though is, from the perspective of the Indian stock exchanges, this was a perfectly sensible competitive move. It made so much sense that two intensely competitive companies — NSE and BSE fight a bruising battle for market share and market access — came together on this issue. This move is simply a way for Indian bourses to protect their own market share from a steady haemorrhage. The rationale is pretty simple.
NSE, BSE today share, with a range of offshore stock exchanges, price feeds and index brands for stocks and popular benchmark indices listed on their platforms. These offshore bourses — primarily in Singapore, Dubai and Hong Kong — in turn use the price feeds and brands to float their own India products — SGX Nifty for example. Over the last few years, a significant amount of incremental trading on Indian indices have moved to these offshore platforms. Reasons are manifold, lower taxes for one — Singapore/Hong Kong/Dubai do not have taxes on capital gains made out of derivative contracts, unlike India. Severe restrictions in India on Participatory Notes (P-Notes), a popular instrument used by a variety of foreign investors to take equity exposures are a second. Above all, there is also the ease of regulatory environment, where many of these offshore markets are considered better than India. The proverbial last straw in the camel’s back was the launch of 50 Indian single stock futures by SGX earlier this month.
NSE and BSE came together to essentially use the nuclear option, ie, access to price feeds. Sans access to price feeds (as also brand rights to the popular indices, though that is a smaller issue), the ability of traders on the SGX (or any other offshore exchange) platform to efficiently price Indian underlying products is severely impaired. It also required both BSE and NSE to cooperate on the issue, as restriction by only one of the two would keep the window of price feeds open from the other, and defeat the purpose altogether. In other words, it’s a question of pure self-interest in a competitive market, where offshore exchanges like SGX were actively competing with BSE/NSE for market share. Nothing “protectionist” about it at all. The fact that SGX’s own share price fell 9 per cent on the day the announcement by BSE/NSE came partially reflects the competitive impact of this move.
How does this play out now for markets and its shape? In the short run, there’s unlikely to be any great impact. India hasn’t put physical controls over foreign access to Indian stock markets. India’s attractiveness as an investment destination too doesn’t change, one way or another, by the decision of local exchanges to either share or not share price feeds with their overseas counterparts. If investors and investment themes do not materially change, chances of index providers cutting India weightages are extremely remote too.
In the slightly longer run though, this would likely be a case of delaying the inevitable. The case of currency trading is illustrative in this respect. USDINR, the most popular currency pair traded on India, are traded both in India as well as offshore (in what is called the NDF — Non Deliverable Forward — market). Volumes in the NDF market are over twice the volumes traded onshore in India. This, despite the fact that the NDF market has structural limitations in the form of inability to “physically settle” trades, given that INR is not a convertible currency. Reasons are all familiar, and similar to the ones described for stocks above. Now, currency markets are largely OTC (Over The Counter — bilateral deals struck on the phone/computer network by two traders), and not exchange-traded, and hence do not require proprietary price feeds from an exchange, unlike equities. As a result, offshore traders cannot replicate the same model easily for equities.
There is also the additional factor of India’s own IFSC (International Financial Services Centre), in GIFT City, Gujarat. There’s been a huge amount of regulatory nudge to shift offshore trades there from overseas exchanges.
However, financial innovation typically tends to trump physical barriers. While its more difficult to price offshore-listed Indian derivatives sans data from NSE/BSE, its not impossible. There would be smart structures/traders/algorithm-writers at work to develop new models to obviate the issue. Given the experience worldwide, especially on USDINR case, it is a problem that doesn’t seem immune to being cracked. On IFSC, while taxes are somewhat lower compared to onshore exchanges, the issues around acceptability, ecosystem and market depth are still open questions for foreign investors to move serious volumes, yet.
Net-net, while the popular narrative around protectionism is widely misplaced, and this buys some time for India’s local exchanges, this is likely to look a bit more of Don Quixote than Napoleon in the longer run!
Thursday, February 15, 2018
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