Indian banking troubles: A case of activist regulators vs quiescent shareholders

September 21, 2018

Prof JR Varma of IIMA who regularly treats us with food for thought posts, has another such post.

How come the regulators have become so active but shareholders remain so passive in Indian banking cleanup:

The Indian central bank or other government agencies have been instrumental in effecting a change of management in three under-performing private sector banks (ICICI Bank, Axis Bank and Yes Bank) in recent months. While much has been written about the functioning of the boards and of the central bank, the more fascinating question is about the dog that did not bark: the quiescent shareholders of these banks. They have suffered in silence as these banks have surrendered the enviable position that they once had in India’s financial system. The void created by the wounded banking system in India is being filled by non bank finance companies. So much so that one of these non banks (Bajaj Finance) trades at a Price/Book ratio 3-4 times that of the above mentioned three banks and now boasts of a market capitalization roughly equal to the average of these three banks.

The question is why has this not attracted the attention of activist investors. One looks in vain for a Third Point, Elliott or TCI writing acerbic letters to the management seeking change. The Indian regulatory regime of voting right caps and fit and proper criteria has ensured that such players can never threaten the career of non performing incumbent management in Indian banks. The regulators have entrenched incumbent managements and so the regulators have to step in to remove them.

Incidentally, the securities regulator in India has been no better. It too has ensured that the big exchanges and other financial market infrastructure in India are immune to shareholder discipline, and over the last several years many of these too have performed far below their potential.

Indian regulators do not seem to understand that capitalism requires brutal investors and not just nice investors talking pleasantly to the management. Capitalism at its best is red in the tooth and claw.

This is so true. It does not just apply here but is a global problem. One barely sees shareholders holding the top management to be more accountable. But yes far more subdued in India.

Part of the problem is everyone is involved in keeping things pleasant for common gains. See Stock Analysis for instance. How many analysts care to write sell reports? Very few and that is a huge problem by itself….


Gradually, we are admitting that banks create money by giving loans and not accepting deposits…

September 21, 2018

After the storm created by Bank of England questioning the inter-mediation role played by banks, other central banks are also waking up. We are usually taught that banks first accept deposits and then lend this money and via the multiplier money is created. But this is wrong. Banks actually first give loans and then this money comes back to the banking system as deposit.

Chris Kent, Assistant Governor of Reserve Bank of Australia also says banks create money via credit and not deposits:

Read the rest of this entry »

Does It Pay to Study Economics in Australia?

September 21, 2018

James Bishop and Rochelle Guttmann of Reserve Bank of Australia in this Bulletin article:

The Bank has increased its efforts to encourage more students to study economics at school and university. This could improve the quality of public discourse and have benefits for society as a whole. Our analysis suggests that an economics degree also confers substantial private benefit to graduates in terms of their earnings, relative to many other degrees. This arises from the development of analytical and maths skills, which command a wage premium in the labour market. However, our analysis also reveals that the probability of finding work as an economist is low, given the small number of jobs relative to qualified graduates. Nonetheless, the wide range of disciplines in which economics graduates work suggests it is a degree that is useful beyond the narrow discipline. As Heath (2017) explained, doing an economics degree appears to give one a set of skills that are currently rewarded quite well and looks set to continue in importance in the future.


The Yes Bank episode: We clearly want more transparency…

September 20, 2018

How fortunes are changing for RBI. Suddenly, markets have picked up this idea that one lasting legacy of the current regime would be cleaning up Indian banking system. All this while RBI has been telling us all is well with Indian banking system. But now the former Governor says troubles were brewing in early 2000s. So much so far all this analysis and clean-up.

Back to the title of the post. There have been some interesting orders from the central bank where it has refused to extend the tenure of current CEO of Yes Bank. This has been taken as one major decision by the central bank as it is showing mirror to all these revered CEOs of private sector banks.

But then where is the RBI order  for this decision? It is not there on the central bank website. One actually got to know this as Yes Bank informed the Stock exchanges about the RBI decision.  Infact, if one sees the Press Release by Yes Bank, one would be confused as it says the current CEO’s tenure has been extended. It is only when you read other articles you realise that the original plan was to get an extension of 3 years but RBI has only allowed an extension of 4 months till Jan 31, 2019.

Compare this to UK’s FCA which issued this 44 page document  (HT: good friend Pratik) to explain the rationale behind penalising Canara Bank of all banks. 44 page is a bit too much but still one atleast has some idea. Compare this to the information RBI shares on penalising a bank and in Yes Bank case, we know nothing at all.

RBI does a lot of regulation and has a whole history behind it. Even if the current Governor says they do not have enough powers to regulate PSBs, the central still knows much more than us. It should now try and let people understand the rationale behind all these decisions. Analysts should be able to see how the regulation at Private Sector Banks is better than PSBs. Nothing of this sort is known.

Cleaning-up is not just about taking decisions but also telling the people why and how of the clean-up. Over a long run, “the why and how matters” much more as then this process is institutionalised.


What Keynes should have said: Central banks/government should target stock markets

September 20, 2018

Prof Roger Farmer of UCLA has this proposal:

Swedish banknotes will be printed by De La Rue of UK..

September 20, 2018

I had pointed how on one hand Swedes are moving towards digital money but on the other hand are looking for a new banknote supplier. The previous banknote supplier had closed shop in Sweden.

The new contract has gone to De La Rue of UK, the largest manufacturer of banknotes and its technology:

The Riksbank has signed an agreement with the British banknote manufacturer De La Rue on printing Swedish banknotes. The contract is valid for just over three years, with the possibility to extend it for another four years. De La Rue is one of the world’s largest manufacturers of banknotes, with many central banks as customers, including the central banks in the United Kingdom and Iceland. The Swedish banknotes will be manufactured in the United Kingdom.

“We are pleased that it was possible to arrange a new supplier so quickly,” says Ann Fridell, Head of the Analysis and Development of Payments Division. “De La Rue is a well-renowned company with considerable experience and they have been in this branch for 200 years, so it feels secure that they will be printing Swedish banknotes.”

Last spring, the Riksbank gave notice of termination of the contract with the pre-vious supplier, Crane, as the company decided to close the printing works in Tumba and move manufacture to Malta. According to the Riksbank’s require-ments, the notes must be printed in northern or central Europe.

De La Rue would be happy to add Swedish Krona to its list, which is the oldest currency in Europe.

The fate of English in the EU after Brexit: Expected and unexpected twists

September 20, 2018

Preserving national language and larger countries respecting languages is such an important part of European Union.  Victor Ginsburgh, Juan Moreno-Ternero and Shlomo Weber in this article look at fate of English post Brexit:

Need for a multi-disciplinary approach for India’s policymaking

September 20, 2018

Apurva Bamezai and M.R. Sharan in this piece argue that we need to move beyond just evidence based research in policy. So far the idea is look at the evidence and then generalise the whole thing. Instead, we should aim to be more inter-disciplinary and try and bring particulars of each intervention:

Jean Drèze’s thought-provoking piece on the complex relationship between evidence, policy, and politics has been widely shared in policy research circles recently. One of the main theses in this article is that development economists (more precisely, quantitative social scientists in development – we will use ‘development economists’ as a general umbrella term to cover all of these, à la Drèze) are no better equipped to comment on development policy design than researchers from other social science disciplines and also other stakeholders. However, development economists continue to hold sway among bureaucrats and policymakers in government as well as big donor organisations in the international development space. 

We explore the roots of development economists’ centrality in social policy design. We locate it in the coming together of two key factors: (a) the nature of the evidence they generate, and (b) the top-heavy policymaking paradigm in India. 

Policymaking, as Drèze argues, requires more than just evidence. The apparent ubiquity of the phrase ‘evidence-based policy’ must not distract us from the recentness of the phenomenon. Much of policymaking continues to be in the old mould and is not evidence-based. Political preferences, personal ideology and beliefs, anecdotes, etc. continue to play key roles in determining policy. 

However, focusing squarely on evidence alone, we make two broad points: one, that a more multidisciplinary approach, even under current constraints, can prove beneficial. Two, evidence-generation can also be a by-product of increased citizen-State interactions, a neglected aspect of policy design in India. 

Nice read..

Hindu newspaper celebrates 140th anniversary…

September 20, 2018

The paper started on Sep 20, 1878 and today is its 140th anniversary.

Here are some links:

Nice bit..

How did banks get limited liability status? Debates from 19th century Britain..

September 20, 2018

This is a superb paper and we need more such research.

It is written by Matthew Willison of Bank of England. It tracks the debates in UK in 1850s on whether banks should be given a limited liability status or not.

In 1853 a Royal Commission was set up to investigate whether laws related to limited liability in Britain needed to be modified. As part of its evidence gathering the commission issued a questionnaire that included a number of questions on whether banks should be subject to the same liability laws as other types of commercial enterprises.

This paper analyses the responses to the questions about banks to understand whether banks were seen as a special case. Support for modifying the law to make limited liability more easily available to banks was lower than for enterprises in general.

Banks were seen as a special case because of the risk of bank runs and because their creditors were not able to assess accurately the riskiness of banks. But the special nature of banks caused others to favour limited liability because it made banks’ capital levels more transparent. These arguments echo wider debates during the nineteenth century and are similar to contemporary theories for why banks are regulated.

In Britain, there was limited liability for chartered banks, unlimited liability for others.

There were arguments on both sides for limited liability for banks. Those who supported unlimited liability said that depositors and note holders are not well-informed and unlimited liability gives them comfort. Those which supported limited liability said it gave a truer picture of the bank’s financials. The shareholders may not be in a position to pay back all the debts.

In 1857, limited liability status was given to banks in UK.

In 1861, limited liability status was given to banks in India too (and may be other colonies). Before this, lack of limited liability was seen as a major reason for instability in banks. Large number of banks failed in Bengal before 1861.

This change in law along with US Civil war led to several banks coming up in Bombay catering to the demand for cotton. There was huge euphoria leading to eventual panic in 1865 as civil war ended with closure of these banks. Even Presidency Bank of Bombay had to shut shop in 1867. So clearly limited liability hardly made much impact as far as prudence in Indian banking is concerned.

But the key here is how ideas shape up. How law and finance come together and become so critical to thinking about financial organisations…

SEBI capping Mutual Fund expenses

September 19, 2018

One wonders why financial services industry needs to be pushed by regulatory bodies to act in investor’s interests.

In the Board meeting y’day, SEBI knocked off a few percentage points from the expenses charged by Mutual Funds:

Read the rest of this entry »

RIP Anna Rajam Malhotra: The first Woman IAS officer..

September 19, 2018

Another torchbearer passed away.

Anna Rajam Malhotra (wiki profile) was Independent India’s first woman IAS officer. SHe was asked to take up IFS which was seen more suited to women. Apparently there were rules which said if the woman married on being an IAS, she had to quit the job! But obviously Anna fought all these rules and biases. Better India has a more detailed profile.

She married another IAS, R.N. Malhotra who became the 17th Governor of RBI (04 February 1985 – 22 December 1990).

I just checked to figure whether there is an autobiography/biography of Ms. Anna. Could not fine one. I hope she has written something about her experiences which will help inspire the future generations…


Iceland’s crisis, its successful stabilization program, and the role of the IMF

September 19, 2018

Nice lecture (must read) by Poul M. Thomsen of IMF summing the aftermath of the Iceland crisis.

The lecture is titled as: Ragnarök: Iceland’s Crisis, its Successful Stabilization Program, and the Role of the IMF.  In Norse mythology, Ragnarök is a series of future events, including a great battle, foretold to ultimately result in the death of a number of major figures, the occurrence of various natural disasters, and the subsequent submersion of the world in water.

Upfront, some humility is needed:

To me, it seems entirely appropriate that I should mark the tenth anniversary of Lehman’s collapse with you here in Iceland, in a country that was one of the first in the path of the financial tsunami that followed.

I will not get into why Iceland had become so vulnerable—why the banking system had been allowed to explode in size relative to the Icelandic economy during a very short period, relying on a funding model of aggressive foreign borrowing. Much has already been said about this, and it is clear that there is ample blame to go around—in Iceland and abroad.

Indeed, if I was to get into this, I would have to admit that we at the IMF also have to be humble. Among several things that we in retrospect might want to have done differently, we had for a while moved Iceland from the standard 12‑month cycle for our surveillance missions to a 24‑month cycle, reflecting a benign view on vulnerabilities. The same was the case for Cyprus, another small country that would soon be engulfed in a deep crisis.

Instead, he focuses on the policies to ease the crisis:

Read the rest of this entry »

What led Gandhi to develop ideas on trusteeship? Ahmedabad’s Nagarseths and Pedhis…

September 19, 2018

Superb paper by Jaitirth Rao and Shishir Jha.

They look at the sources behind Gandhi’s idea of trusteeship. Given the total chaos in corporate governance and lack of ethics, one could revisit Gandhi’s idea of trusteeship:

Mahatma Gandhi’s views on trusteeship deserve special attention as part of the discipline of political economy. He repeatedly opposed the idea of expropriating wealth or property from the rich, yet, for him, wealth did not “belong” to the rich owner. The owner was merely the “trustee,” one who was duty-bound to take care of the wealth and use it not just for his personal welfare but for the welfare of many. Similarly, the firm too was in his opinion held “in trust” by the person in control in a tripartite partnership along with its employees and customers. The different nuances of Gandhian trusteeship are examined by tracing the influences on Gandhi that led him to his conclusions.

The literature points to three such sources:

  • Trusteeship is seen as an integral part of English Common Law. Being a lawyer trained in England, he knew about the Trusts
  • Quaker ideas
  •   Hindu Scriptures particularly Isavasya Upsanishad whose opening line says: It is a call to ­enjoy the worldly gifts given to a person while simultaneously refraining from coveting another’s wealth.

The authors point to a fourth source: Ahmedabad’s Nagarseths and Pedhis:

English law, Quaker ideas, and Hindu scriptures are three credible sources from which Gandhi must have and indeed did derive inspiration as he began developing his ideas on trusteeship. Exploring each of these sources would involve separate exercises. But, was there and is there something still missing? And, as we were grappling with this question, we came across this quote from Gandhi:

If the wealthy and the educated wish, they can change the face of Ahmedabad. The biggest Jain firm is in Ahmedabad. It is said that the firm of Anandji Kalyanji is wealthier than any other firm in the world which can be described as a religious body. (Gandhi 1999a)

This unexpected sentence sent us off in various directions and, during the ensuing journey, we managed to explore a uniquely Indian, nay Gujarati, wellspring, from where Gandhi seems to have drawn considerable inspiration. We explored the world of Gujarati pedhis and nagar­sheths and found empirical validation in the work of Dwijendra Tripathi and M J Mehta (1978). We found a theoretical position where we could locate Gandhi’s intellectual forebears in an authentically Indian setting as we explored the article titled, “The Work of Theory: Thinking across Traditions” by Prathama Banerjee, Aditya Nigam and Rakesh Pandey (2016).


The paper goes onto connect these dots…

Do the Rich Get Richer in the Stock Market? Evidence from India

September 18, 2018

John Y. Campbell, Tarun Ramadorai and Benjamin Ranish in this paper:

We use data on Indian stock portfolios to show that return heterogeneity is the primary
contributor to increasing inequality of wealth held in risky assets by Indian individual investors.

Return heterogeneity increases equity wealth inequality through two main channels, both of
which are related to the prevalence of undiversified accounts that own relatively few stocks.

First, some undiversified portfolios randomly do well, while others randomly do poorly. Second,
larger accounts diversify more effectively and thereby earn higher average log returns even
though their average simple returns are no higher than those of smaller accounts.

Our paper partially supports Pikettyís (2014) concern that the rich get richer by earning
high investment returnsó subject to the distinction, central in Finance theory, between simple
and log returns. Our results also highlight the importance for developing countries of
investment vehicles, such as mutual funds and exchange traded funds, that are already
common in developed countries and that give small investors an affordable way to diversify


How Keynes got idea about his General Theory book from Malthus…

September 18, 2018

Fascinating paper by Steven Kates.

He draws evidence showing how Keynes book General Theory drew inspiration from Malthus. More specifically Keynes drew insights about aggregate demand from the letter exchange between Malthus and Ricardo. Malthus wrote to Ricardo showing how excessive savings could lead to fall in demand to a fall in profits and to a fall in output.

It was because Keynes read Malthus’s letters to Ricardo in late 1932 that he eventually focused on effective demand in the General Theory. Because of his reading of Malthus, Keynes attacked Say’s Law and wrote the General Theory to establish variations in effective demand as the major cause of fluctuations in economic activity. If these conclusions are right, the story of how the General Theory came to be written cannot be understood in isolation from Malthus’s role nor is it possible to understand the General Theory itself without seeing it in relation to Keynes’s interpretation of Malthus. The continuing focus on aggregate demand by macro and business cycle theorists is due to the insights gained by Keynes from his reading of the Malthus side of the Malthus-Ricardo correspondence during the months of October and November, 1932.

How ideas evolve…

Women in Finance: A Case for Closing Gaps

September 18, 2018

IMF econs in this working paper write on the #metoo movement needed in finance industry:

The paper studies the large gaps between the representation of men and women in leadership positions in banks and in banking-supervision agencies worldwide. It finds that, shockingly, women accounted for less than 2 percent of financial institutions’ chief executive officers and less than 20
percent of executive board members. Contrary to common perceptions, many low- and middle income countries have a higher share of women on bank boards and banking-supervision agency boards compared with advanced economies.

Econometric analysis suggests that, controlling for relevant bank- and country-specific factors, the presence of women as well as a higher share of
women on bank boards appears associated with greater financial resilience. This study also finds that a higher share of women on boards of banking-supervision agencies is associated with greater bank stability. This evidence strengthens the case for closing the gender gaps in leadership positions
in finance.

Further research is needed on the causal links, to identify specific mechanisms through which these stability benefits are achieved, and to understand the conditions that have facilitated or hindered the entry of women into leadership roles in banks and supervision agencies.

This note underscores the need for better data to monitor gender gaps in finance. Improved measurement will help researchers better understand the drivers of these gaps and their effects on financial stability and other variables. It will also help in better designing policies to address those gaps.


RIP: Deena Khatkhate

September 18, 2018

It is quite something about 2018 as notable figures in their respective fields leave us one after the other.

Last weekend, Deena Khatkhate also passed away.

Niranjan of Cafe Economics tweeted about Mr Khatkhate:

 Sep 17

Deena Khatkhate, Anand Chandavarkar, M. Narasimham and V.V. Bhatt were the formidable quartet that built up economics research at the RBI in the 1950s and 1960s. Three of them subsequently moved to the IMF. Narasimham stayed on — and became RBI governor

 Sep 17

Khatkhate was also an elegant writer on economic issues. His EPW column of dispatches from the banks of the Potomac were consistently brilliant. And his collected essays –Ruminations of a Gadfly — is one of my favourites, especially the pen portraits of great Indian economists.

There is another tribute by Prakash Loungiani of IMF on his blog. Prakash cites three main areas of Mr Khatkhate’s work:

“Life is lived forwards but understood backwards,” wrote the philosopher Kierkegaard. This collection of a life-time’s work of the Indian economist Deena Khatkhate can be understood as an act of rebellion against much of his intellectual inheritance: socialism and central planning, Keynesian macroeconomics, and an adversarial view of North-South relationships. Instead, these essays put forward a spirited (but not uncritical) defense of capitalism and markets, espouse a macroeconomics as much Friedmanite as Keynesian, and urge a constructive approach to relationships between developing and advanced nations.

The last of these themes is illustrated in arguably the best article in the collection, which is on the brain drain—the emigration of skilled workers from developing to advanced countries. In this article, published in F&D in 1971, Khatkhate challenged the prevalent view of the brain drain as an evil, a form of aid from the poor to the rich. He showed that because most emigration occurred from developing countries with a clear excess supply of skilled workers, it was actually a social safety valve for the poor countries. And because it encouraged the “cross fertilization of ideas” between skilled workers from the poor nations and the richer nations, the brain drain could be “a desirable investment.”


Prior to joining the IMF, Khatkhate worked for over a decade—from 1955 to 1968—at the Reserve Bank of India, the country’s central bank. Not surprisingly, therefore, a second major theme of the essays is the role of macroeconomic and financial policies in promoting economic growth. In the 1950s, the Keynesian view advocated running fiscal deficits to promote growth in developing countries. The rationale was that since there were underemployed resources in these economies, heavy government spending could lead to employment of those resources without triggering inflation. However, Khatkhate writes that the negative evidence on the actual impact of government spending convinced him that “all that happened as a result of heavy resort to fiscal deficit was inflation, decline in income, saving and investment.” Khatkhate’s views on monetary policy also differed from the 1960s Keynesian view, emphasizing as they did the need for rules to guide the central bank rather than give it too much discretion.

A third theme is the rhetoric vs. the reality of socialism and central planning. Khatkhate blamed socialism for trying to deliver both growth and equity and delivering neither. The real problem in developing countries, he said, was not so much the skewed income distribution but “improving the standard of the whole mass of people, which is possible only with rapid economic growth.” These views were far from the mainstream when Khatkhate wrote them in 1978. He is not, however, an unvarying defender of capitalism and free markets. On the free mobility of capital, for instance, his views are close to that of his compatriot Jagdish Bhagwati in favoring a cautious approach, given the evidence that hasty liberalization can contribute to financial crises.

Just as in case of Prof Dwijendra Tripathi, so little is known about Dr. Khatkhate as well.

Infact, barring M. Narasimham whose name comes up in the two financial sector reforms committees he chaired in 1990s, we hardly know anything much about the other three economists mentioned by Niranjan. The works of these economists is barely taught anywhere in economics departments in Indian universities.

I had the good fortune to review some of VV Bhatt’s work during my PhD thesis work, but is hardly enough.


Arvind Subramanian pays a tribute

Will ECB issue central bank digital currency?

September 17, 2018

Mr Jonás Fernández, Member of the European Parliament recently posed the CBDC question to ECB.

ECB answered that it is studying CBDC, but currently it is not a feasible option:

There are several reasons why we do not consider issuing a central bank digital currency to be a concrete option for the near future. First, the technologies which could potentially be used to issue a central bank digital currency, such as distributed ledgers, have not yet been thoroughly tested and require substantial further development before they could be used in a central bank context. With regard to the central bank administering individual accounts for households and companies, this would imply that the central bank would enter into competition for retail deposits with the banking sector and lead to potentially substantial operational costs and risks.

In addition, current conditions do not indicate that there is a concrete need to issue a central bank digital currency in the euro area. The demand for euro banknotes continues to grow, and cash remains a popular means of payment.2 Moreover, there is an increasing range of options for digital payments which allow noncash transactions to be completed almost as immediately as cash transactions. This development will be further supported by the TARGET instant payment settlement (TIPS) service, which, as of November 2018, will allow payments to be settled in central bank money 24/7 on a pan-European basis.


It will be really useful if other central banks also adopt this communication policy of ECB. It puts up letters addressed to Parliamentarians on its website, letting people know of the kind of interactions between the two agencies.

The rise of Inequality Industry: But is it interested in making us more equal?

September 17, 2018

Superb piece by Atossa Araxia Abrahamian in Nation.

It says:

Since 2008, wonks, politicians, poets, and bankers have all started talking about inequality. But are they interested in making us more equal?

Lots to think about in this piece…


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