Archive for May, 2017

The curious case of NPA underreporting in India: Role of auditors…

May 25, 2017

As I have argued before, the recent NPA mess is just inexplicable given wide-scale inspection powers the regulator has on banks. But there are more players in the game whose role has to be explored.

One of them is auditors whose role in reporting any such issue has been found wanting for so many years now. It is not any different this time as well.

Hemindra Hazari of Wire reports:

Recently, Axis Bank and Yes Bank jolted the Indian banking community while releasing their annual results. Both banks disclosed a staggeringly large divergence between the banks’ audited accounts and the Reserve Bank of India’s (RBI)  findings regarding bad loans on the books of these banks for the year ended March 31, 2016.

Against this background, the role of the auditor needs a closer look.

Surprisingly, in FY’2016, both Axis Bank and Yes Bank were audited by the same person, one Viren H. Mehta (membership number 048749). Mehta is a partner at Batliboi and Co., which in turn is a member firm of Ernst & Young. Some would call it strange for the same auditor to audit competing banks in the same year. What is even more unusual is that the accounts certified of both the banks by the same, individual statutory auditor have been found misleading by the statutory regulator. 

Sigh…

It is all such a complex game of multiple stakeholders:

The new private sector banks, unlike government banks, regularly seek additional  global financial capital and prefer, for international credibility, to be audited by the ‘Big Four Audit Firms’: Deloitte, Pricewaterhouse Coopers (PWC), Ernst  and Young and KPMG. However as PWC was the auditor of scam-tainted Satyam Computers and the erstwhile Global Trust Bank, the RBI had for a period of time effectively blacklisted the firm from auditing Indian banks. Therefore, only the remaining three can audit, via rotation, the new private sector banks. The preference for the remaining ‘Big Three’ is ostensibly to provide greater international credibility to the accounts of the new private sector banks.

For an Ernst and Young member auditor to simultaneously certify not one but two of such divergent banks is quite peculiar. Despite the RBI divergence being known by December 31, 2016, the Axis Bank senior management reaffirmed their faith and permitted the same auditor to continue to audit FY’2017 accounts as well.

When this writer reached out to Axis Bank with a questionnaire, the bank replied that it had made “true, fair and full provisions on said dates in accordance with the RBI guidelines in force”.

“However, the RBI being entitled to call its charges to take such further steps as may be necessary, called Indian banks to make new disclosures as per RBI circular dated 18th April, 2017. The ‘divergence’ that you aver is the outcome of RBI’s annual assessment of all banks. For a better understanding of the matter, and to draw meaningful conclusions, may we advise you to please observe similar disclosures of rest of the banking system,” Axis Bank said in a statement.

The “similar disclosures” in other banks in the private sector, so far reveals only Yes Bank has surpassed Axis Bank in the percentage divergence in NPAs and both banks have been audited by the same auditor. The regulators – RBI, Securities and Exchange Board of India, Company Law Board and the ICAI – need to evaluate the conduct and quality of the audits of Axis Bank and Yes Bank in FY2016 by Batliboi and Co. in order to restore public confidence.

Authoring an article on December 23, 2012 , Viren H. Mehta had argued for the disclosure of risk-related measures as a means to improve corporate governance in banks and as an “obligation to stakeholders.” More than four years later, a similar disclosure by the RBI on NPA divergence has cast him in the spotlight.

 

Church of England fund becomes top world performer

May 25, 2017

Always fascinating to see connections between religion and finance.

Came across this bit of news:

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Prof. Tyler Cowen interviews Prof. Raj Chetty…

May 25, 2017

Prof Cowen does such a good job of bringing all kinds of aspects in his interviews.

His reecnt one with Raj Chetty does not disappoint:

……If we look at your papers, they’re about topics people have already thought about. The data work is completely state of the art, but I don’t think it would be said you’re doing something other people can’t do, and yet several times a year, you come out with papers of great import that make a big splash, and the results seem to hold up. So what in fact is your competitive advantage? [laughs]

CHETTY: That’s a tough question. Part of what we try to do is exactly as you said: take old questions. I think some of the most important questions in economics and social science have not yet been fully answered, and the recent availability of big data of various types allows us, for the first time, to tackle those classic questions. What our research group tries to do is bring those two things together.

COWEN: But those both sound replicable, right? What’s the non-replicable asset?

CHETTY: What hopefully our contribution and scale is, is showing how you can take those large datasets and not get lost in them, and bring out the key lessons that are relevant for thinking about these classic questions.

It’s very easy — students often have this reaction, that all I need to do is get access to this big dataset, and then I’m going to be all set for my thesis. And what you end up finding is that that is often not the case. It’s very easy to write a paper that is not that good, even with cutting-edge data and modern techniques. So one of the things that I try to do — and the easiest way to see this is if you internally, within our research group, see the iterations of the papers we’ve been working on — where we start out is often very far away from the papers that people see as the finished product. We work hard to try to write a paper that ex post seems extremely simple: “Oh, it’s obvious that that’s the set of calculations you should have done.”

The dangers that lurk beneath India’s IT layoffs

May 24, 2017

Prof Maitreesh Ghatak just nails it:

You can spin a web of statistics and say all izz well when people are hurting. You can use catchy phrases like ‘the digital economy’ and ‘Make in India’ to raise aspirations of global domination, or blame it all on past government policy. The problem, though, is that you can only do it for so long without actually delivering on job creation.
The Sensex can hit the skies, our growth figures can beat China’s, and it may keep those whose fortunes are tied to either our protected corporate sector or the bloated public sector happy and willing to wait for achche din.
However, these are not meaningful indicators of economic development unless accompanied by the creation of jobs, and rising wages and salaries enabling ordinary citizens to enjoy a better quality of life. Being laid off or struggling to find jobs while being told of wonderful times to come or that unemployment is a choice tends to make people very upset.
And even though they command a small fraction of wealth or income in our highly unequal economy, they have strength in numbers. They can vote. And at some point, may be a few years down the line, they may well choose to make some politicians and their economic advisers voluntarily unemployed.

102 years of Statistical Tables Related to Banks in India..oldest running annual database/publication in India?

May 24, 2017

I have mentioned this publication/database few times in previous posts and even said will write a post on this in future.

It is fascinating to note that Statistical Tables Related to Banks in India, an annual publication released by RBI is running into 102nd year! I would guess this would make it the oldest running publication/database of India.

The first volume was released in 1915 and was published by Department of Statistics by order of Governor General in Council. The publication was printed by Superintendent Government Printing in Calcutta.

The need to have a publication assessing banking conditions was needed due to multiple banking failures in early 20th century. The British Government finally decided to collect and publish data following large banking failures in Punjab in 2015. Between Nov-13 and Dec-14, around 57 banks had failed with 22 of them from Punjab.

Thus, we see the Government collecting data on failed banks right at the beginning. Infact that is the focus as introductory memorandum suggests:

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At proposed ‘Sholay’ park in Ramnagara, the fight is between movie memories and vulnerable vultures..

May 23, 2017

Superb piece from Archana Nathan of Scroll. One was excited to read earlier of an upcoming Sholay Park in Ramnagara, a town about 50 kms from Bangalore. This place was the iconic Ramgarh where the iconic Hindi movie Sholay was shot and made history.

However, the Park has run into difficulties with environment authorities:

Off the highway between Bengaluru and Mysuru, a patch of land surrounded by hills comes alive when Ramesh Sippy’s Sholay is mentioned. The 1975 blockbuster was shot there and curious tourists, especially from outside Karnataka, continue to visit the area to search for markers of the vendetta drama. There are none, but there soon might be. Early this year, the state government’s tourism department proposed a Sholay inspired theme park at Ramanagara, which is depicted as Ramgarh in the movie.

The theme park will include virtual reality recreations of key moments from the movie, adventure games and a crafts hub over a 120-acre stretch. The location seems perfect: packed with giant yet scaleable boulders and hills, Ramanagara is an ideal pit stop between the cities. But the proposal has been opposed by the state Forest Department, which has pointed out that it is illegal to construct a tourist hub in a reserved forest area. The parts of Sholay that fans remember – Gabbar Singh’s lair, Thakur Baldev Singh’s house, and the sequence in which Gabbar chops off Thakur’s hands – are part of the Ramadevara Betta vulture sanctuary at Ramanagara.

A case which makes for the eternal debate on growth vs environment..

Impacts of an online English learning programme among Japanese high school students

May 23, 2017

Interesting paper by Yuki Higuchi, Miyuki Sasaki, Makiko Nakamuro.

They evaluate whether Japanese students can learn English using online programmes. They show students do make progress but also procrastinate learning:

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Reserve Bank of India will be utilising Army’s services…

May 23, 2017

An interesting update on how central bank uses armed forces to guard itself:

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An interesting chronology of evolution of US Dollar

May 23, 2017

Nice bit from Visual Capitalist Blog. True to its name, it has superb pictures showing how US Dollar came into being…

Will Indian Railways charge more for lower berths?

May 23, 2017

Missed this news which came  a few days ago.

Apparently, the Indian Railways is mulling charging an extra Rs 50 for the lower berths:

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Why any modern banking system is necessarily uncompetitive?

May 23, 2017

Interesting post by Cameron Murray, a professional economist on Naked Capitalism blog.

He argues why banks are uncompetitive in today’s system.

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Empire and the Economist: Analysis of 19th century economic writings in Maharashtra

May 22, 2017

This is a brilliant paper by a brilliant economist – Prof Neeraj Hatkar of Mumbai University.  I just stumbled on the paper written in 2003 .

It reviews history of economic thought of scholars from Maharashtra region in the 19th century.

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Why India needs another statistical revolution..

May 22, 2017

Recently a trio of economists had deplored the decline in Indian statistical system.

Pramit Bhattacharya in this superb piece writes more on the issue:

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Time for passive investing in India is coming…

May 22, 2017

I have always wondered this aspect of mutual funds in India. If Indian equity markets have indeed become more efficient over the years, why is it that active mutual funds continue to do better than passive funds? Why are active funds preferred over passive funds? After all if markets are getting efficient, then information asymmetry is becoming lesser. The fund managers should be knowing as much as entire markets and no advantage can be drawn from any analysis.

Dhirendra Kumar of Valuresearch feels time for passive funds is coming in India:

So should you invest in index funds? So far, the answer has been no. However, I can see symptoms that tell us the time for passive investing is well on its way. So far, index investing has not succeeded because the market was not heavily institutionalised and large chunks of companies were not owned by professional fund management. This is now changing.

Another huge factor which points towards the impending rise of passive investing–the main one, I feel–is rising costs. Fund management costs have now gone through the roof. Actively managed funds charge up to three per cent of total assets. This is something that will now start impacting returns in a way that is noticeable to investors.

The next factor is the size of the funds. Indian equity funds have been seasonal and small. A small fund can opportunistically try many investments in midcap and smallcap companies that can yield returns that have a big impact on the portfolio. This is not possible for large funds. The Indian equity fund universe is now dominated by big funds. There are now more than fifteen funds that have more than Rs 10,000 crores. Seven-eight funds are close to Rs 20,000 crore. Such funds have no choice but to be large cap funds. They’re finding it hard to beat the index consistently. They have a compelling performance track record over a long period and they have beaten the indices by a big margin. However I visualise that going forward, because of their size, because of the expenses they charge, and because of the growing institutionalisation of the market, they won’t find it easy to outperform.

So does that mean that if you are starting an SIP for ten years, you should do so in an index fund? Well, the case is not that strong yet. Over the last five years, the top five actively managed funds would have earned you one and a half times more than a Nifty fund and that’s a big difference.

However, it’s something that an investor should keep a watch on. At some point in the coming five years, there will likely be a time when it will make sense to stop your SIP in an actively managed fund and turn to an index fund. We’re heading in that direction, slowly but surely.

Hmm..

Will be interesting to watch this space. Another interesting aticle says we need more broad based indices before passive funds can kickoff in India..

Who should create jobs in India? Government or private sector?

May 22, 2017

I am quite amazed by recent debates on 3 year anniversary of the Indian government. On one hand ,our experts want Government to get out of most economic activities. But on the other hand, they hold government responsible for every economic activity under the sun.

The Government has got a thumbs up for most such economic activities barring one: jobs. Lack of job creation is seen as a major deficiency of the current government. So much so, the experts say this one deficiency does away with whatever good work the current government has done.

This leaves one to question: How is it that Government can create jobs?

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Bundesbank joins Bank of England in saying banks are not financial intermediaries but creators of money…

May 19, 2017

We usually understand banks as financial intermediaries which first collect deposits from surplus units and then pass them as loans  towards deficit units.

In 2014, Bank of England turned this wisdom upside down with their research. They said banks first give loans and then put deposits as liabilities to balance the balance sheet. This had massive implications on the way we thought about banking, monetary transmission and so on. The most important being we need to pay more attention on quality of loans than just mobilising deposits. More on this here.

Now it seems other central banks are catching up to this view.

Bundesbank in its monthly report reviews this literature:

The accommodative non-standard monetary policy measures taken by the Eurosystem in response to the financial and sovereign debt crisis caused the reserves of (commercial) banks in the euro area to increase sharply. In spite of this, the annual growth rate of the monetary aggregate M3 has remained at a moderate level over the past two years, reigniting interest in the connection between the creation of reserves and growth in the broader monetary aggregate.

It suffices to look at the creation of (book) money as a set of straightforward accounting entries to grasp that money and credit are created as the result of complex interactions between banks, non-banks and the central bank. And a bank’s ability to grant loans and create money has nothing to do with whether it already has excess reserves or deposits at its disposal. Instead, various economic and regulatory factors constrain the process of money creation. From the perspective of banks, the creation of money is limited by the need for individual banks to lend profitably and also by micro and macroprudential regulations.

Non-banks’ demand for credit and portfolio behaviour likewise act to curtail the creation of money. The central bank influences the money and credit creation process in normal times through its interest rate policy, which affects the financing and portfolio decisions of banks and non-banks through various transmission channels. Non-standard monetary policy measures, too, have effects on the creation of money and credit. One such unconventional measure, the Eurosystem’s asset purchase programme, differs from interest rate policy in that it directly boosts the supply of reserves. Moreover, purchase programmes structured in this manner have an immediate expansionary impact (originating directly from the asset purchase) on the stock of money held by non-banks, though this effect is dampened in the euro area by the fact that the Eurosystem does not only purchase the assets from domestic non-banks.

There are also indirect effects resulting from the transmission of the purchase programme and its impact on lending and portfolio allocation. Critics point to the banking system’s capacity to create money as one of the main culprits behind destabilising financial cycles and financial crises, hence the long-standing debate about proposals to fully back deposits with central bank money, a move intended to restrict the extent to which the banking sector can create credit. It is not evident, however, that these constraints do indeed make for a financial system that is more stable overall than might in any case be achieved through targeted regulatory action. At the same time, that kind of transition to a new system would risk impairing important functions which the banking system performs for the economy and are crucial for keeping real economic growth on a steady path.

Lots of other details in the publication..

Being realisitic about cash vs digital payments debate

May 19, 2017

Interesting speech by Bank Negara Malaysia’s Deputy Governor – ncik Abdul Rasheed Ghaffour. He speaks on the burning issue of cash vs digital payments.

He says there are three aspects to this debate:

 

As a policy maker, I would think that there are three elements, or the ‘3S’, that we should consider in determining an optimal balance of paper and digital, cash and cashless.

Security
The first consideration is security. Counterfeiting is as old as money itself. However, cash has become more secure in recent years. In Malaysia, the amount of counterfeits discovered reduced by 25% in the past year. The currency industry is continuing to make good progress in enhancing security features. I am particularly pleased to note the recent efforts to make such features intuitive – so that the man on the street is likely to notice when something is amiss

The security challenge will not disappear by going cashless. The latest being the recent Ransomware attack. Cyber risk remains a real threat that must be managed. Significant efforts have been made to strengthen resilience against cyberattacks. The banking and payments systems industry has made this a key priority in recent years. However, cybersecurity is ultimately a shared responsibility between the provider and the consumer. Even the most robust systems can be breached if consumers do not exercise adequate caution or are deceived by fraudsters. In this regard, consumer education plays an important role in keeping cashless payments secure.

In addition, cash is also a choice payment instrument for illicit activities. Unlike digital transactions which almost always leave a trail to the parties, payments in cash are anonymous. In his recent book, The Curse of Cash, Kenneth Rogoff points out a very sobering reality – the amount of US Dollars in circulation outside of banks suggests that each American should have around USD4,200 in their wallet. This is not the case. According to him, most of this money is used to hide transactions.

However, this alone does not warrant moving away from cash entirely. Rogoff himself acknowledges this, and proposes the solution of eliminating large denomination notes – such as the United States’ hundred dollar bill. The logic is simple. With the next largest bill being USD50, such a move would immediately make it twice as cumbersome to hoard and pass around suitcases of cash. This is in fact a policy call which Malaysia has made, when we phased out the RM1000 and RM500 notes in 1999. At the same time, the case for removing large denominations becomes weaker as each year goes by. This is because the effect of inflation plays a similar role in making cash transactions more difficult for illegal activities.

Social cost
The second element for consideration is the social cost imposed by the form of currency chosen. On the surface, cash may appear to be costless. Consumers do not have to worry about subscription fees and exorbitant interest rates lying in wait. Retailers are not required to pay fees to accept cash, and so need not pass on any servicing charges to the consumer. There is no need for banks and merchants to invest in and maintain sophisticated software and hardware to support digital payments.

However, cash does not come cheap. Money needs to be printed and minted, and then transported, counted and guarded – several times over. Each step here poses a significant cost to various actors within the economy. Central banks have to deal with the rising cost of producing secure and durable money. Storing and moving money around under tight security can be expensive for both commercial banks and retail businesses. This does not yet account for the losses relating to under-reported taxes which is directly enabled by a cash economy – a cost borne by society as a whole. A 2005 study estimated this figure to be USD100 billion annually in the United States alone

The task of calculating the relative total cost of cash and cashless payments is a difficult one. Apart from the methodological challenges, the findings for each study are also likely to differ according to the nuances of each country. Nonetheless it is a worthwhile endeavour. Policy makers around the world have made positive progress in this area, and I believe we will see more efforts on this front in the coming years.

This leads to another dimension of the social cost consideration, which is the impact on financial inclusion. Millions of people live in rural areas globally, with little or no access to the modern infrastructures necessary to facilitate cashless solutions. The availability of cash is therefore paramount in ensuring that they continue to be seamlessly included in the financial system. At the same time, the success of mobile payments operator M-Pesa in rural Kenya has demonstrated that cashless alternatives can in fact be a means to promote financial inclusion for the unbanked. Here in Malaysia, where mobile banking transactions have tripled in the past year, there is potential to leverage the high mobile penetration rate to improve financial inclusion.

Stability
The third element is stability. The ability to make retail payments reliable is crucial for the effectiveness of the financial system. As discussed earlier, we have come a long way in developing a reliable way of transacting electronically – through solutions such as credit cards, mobile transfers and prepaid balances. Central banks are now carefully monitoring newer developments, particularly digital currencies based on the use of a distributed ledger. Digital currencies have tended to be volatile and subject to speculative hoarding. This raises the potential for runs on the digital currency, triggered for instance by a loss of confidence in the currency itself or a third party provider like an exchange. This risk is likely to be augmented where the digital currency is not backed by an issuer, and where there is no lender of last resort function. If digital currencies are widely used, such a shock could have systemic repercussions. At the same time, some of these concerns may be addressed if the digital currencies used are issued by a central bank. Many policymakers are studying this option.

In addition to facilitating payments, cash has been a powerful instrument for central banks to build trust and credibility with the public. The notes issued by central banks provide us with a direct and tangible link to the people – making it a key branding tool. Trust and confidence in the central bank are crucial for us to effectively deliver our mandate. This dynamic is augmented in jurisdictions like Malaysia, where the central bank is responsible for promoting both monetary and financial stability. If we were to go completely cashless, central banks might lose this traditional means of maintaining a strong brand.

Hmm..

Despite all the criticism, RBI Board still remains empty..

May 18, 2017

It is really puzzling. Despite much criticism on role of RBI Board in recent demonetisation, the board still remains empty.

Just to reiterate, the decision to demonetise the notes was taken by RBI Board. RBI Board comprises 21 members but just 10 were appointed on the eve of demonetisation. Out of the 10, only 8 were present to take a decision as momentous as this one. Imagine any Corporate Board taking a decision at that kind of magnitude with around 40% Board members being present.

So, on 8-Nov-2016 table looked like this:

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How the cold war led CIA to promote government financed human capital theory..

May 18, 2017

Fascinating piece by Prof. Peter Fleming of Cass Business School.

We in economics rarely figure how the guys at the top push certain ideas onto us. He says human capital is one such idea. The idea emerged as Profs. Theodore ‘Teddy’ Schultz and Milton Friedman debated how to beat USSR in the ideas battle during Cold War.

USSR announced how it will smash capitalist system by pushing state driven growth in agri and industry. The question was how should US respond?

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When silver ended as a unit of account…

May 18, 2017

Superb note by Ricardo Fernholz, Kris Mitchener, Marc Weidenmier. It is based on a bigger paper here.

They show how silver declined and ended as a unit of account. Moreover, it had sharp mpact on agricultural commodities:

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