Archive for July 23rd, 2018

New Rs 100 banknote: first made in India note?

July 23, 2018

RBI just released a new design of Rs 100 currency note.

Came across this ToI news which said this is the first indigenous/made in India note. Its design, currency paper, ink, and security features all are made in India. It is surprising RBI press release not mentioning this achievement.



History of Mutual Funds in India: Was UTI the first?

July 23, 2018

We are celebrating 25 years of private mutual funds in India. In 1993, the Government allowed entry of private sector in mutual funds. This liberalisation of mutual fund space was part of broader economic reforms initiated in the country after the 1991 crisis. The first private mutual fund was Kothari Pioneer which interestingly was based in Chennai and not Mumbai, the centre of Indian financial markets.

This is also a good time to reflect on history of mutual funds in India.

The history of mutual funds in India is usually seen as starting from Unit Trust of India (UTI) in 1964, started by the government to help retail investors get access to capital markets in India. UTI may have been the first public sector mutual fund in India but it was hardly the first-time funds were mobilised from small investors and give them exposure to stock markets.

Dr. V.V. Bhatt in this research paper (1979) on Syndicate bank pointed how the bank started a stock market scheme in 1960.

In 1960, the bank pioneered a unique investment service through its Investors’ Agency Department. This service enabled middle-income savers to invest in shares of reputable companies. The persons joining the scheme were ensured a return of 9 to 10 percent per year on their saving; the bank, in turn, invested these sums in shares. This scheme became very popular with middle-income groups in semi-urban areas persons who were not familiar with the stock market. It was a precursor to the Unit Trust of India sponsored by the Central Bank in 1964. The following year the Syndicate’s investment service ended because the Central Bank thought it could compete with the Unit Trust of India.

One was simply taken aback reading this as just like several others, one thought UTI was the starting point for such initiatives in India. But Syndicate Bank’s IAD pioneered this earlier. Dr. VV Bhatt could figure this as he =was an independent director with Syndicate Bank in the 1960s. Otherwise, this too would be lost.

My further research revealed that Syndicate Bank’s founder Dr T.M.A. Pai wished to start a scheme to provide better returns to the bank’s depositors.  He was also looking to boost the earnings of the overall bank which was reliant on its own operations where one earned the spread between loan rate and deposit rate (adjusting for establishment expenses).  In finance parlance, the idea was to shift reliance from fund income to fee income.

Syndicate Bank had earlier also started initiatives such as insurance company, land management company and so on. This was for both purposes, increasing sources of income and offering wider bouquet of services to depositors/investors.

The Bank came across this idea of a scheme which would help achieve both the objectives.  The bank would start a scheme to help its depositors to invest in stock markets and the bank would charge a fee for these services. As the idea was new, the bank did not open a new company but opened a new department within the bank called Investor Agency Department.

The organisation of IAD was different from today’s mutual funds. The bank would research stocks and send the list to depositors. The depositors in turn would invest in the stocks based on initial advice and suggestions by the bank. The Bank also acted as a custodian of the stocks given the small investors might not handle the certificates etc properly. The bank charged a fee for the advisory and custodian services.

This is unlike the model followed by UTI and mutual funds later. First there was a separate company/trust which would pool the savings of the investors. The trust was to be managed by professional fund managers who would then invest in stocks through their research and experience. The organisation was different but the idea was similar: provide a platform for the small investors who don’t have the expertise to access stock markets.

But then as Dr Bhatt notes, the scheme was objected by the RBI. Though, I don’t think the RBI objected on competition grounds. It was more to do with the fact that RBI wanted banks to just engage in banking business. This was also the time when banks were failing in large numbers. The non-banking business of banks was a constant source of headache for RBI and it had been asking banks to close their non-bank operations. Syndicate Bank’s earlier mentioned initiatives were also hived off to another entity or closed by the central bank. The central bank might have been weary of any more initiatives by the banks.

RBI History Volume (1951-67) while discussing formation of UTI has more insights:

Tracing the evolution of ideas about investment trusts in India, the study recalled Manu Subedar’s minority report as member of the Indian Central Banking Enquiry Committee (1931) in which he urged the creation of these trusts as vehicles for financing investment in industry. Manu Subedar’s plea was not altogether wasted, as the colonial government soon decided to exempt investment companies from super-tax.

Despite this concession, there were only a handful of such companies in India; and only two of them could be regarded as investment companies in the proper sense of the term. Many investment companies were promoted ‘only to collect public money … for employment to the advantage of the management and directors in their speculative activities’.

Investments of several such companies, the study emphasized, were concentrated in the shares of a few joint-stock companies which were often either ‘private companies’ or those whose shares were ‘not quoted on the Stock Exchanges’. Many investment companies, moreover, also counted direct loans and advances among their assets. The study found that the investments of a majority of these companies were not, by and large, ‘sufficiently diversified … or strictly disinterested’.

Only two investment companies, the Industrial Investment Trust associated with the stock-broking firm of Premchand Roychand and the Investment Corporation of India (controlled by the Tatas) held reasonably large and well-diversified portfolios of securities, the former having deployed over Rs 1.25 crores in 200 different securities and the latter Rs 3.5 crores in twice as many securities. Echoing the recommendation of the Shroff Committee, the article noted the wide scope that existed for large industrial or financial houses to form unit trusts.

The State, it suggested, should encourage the process and regulate the functioning of these intermediaries from the point of view of safeguarding the interests of their investors. Unit trusts, the article concluded, would help mobilize the resources of small savers for industrial investment and democratize industrial share-ownership as envisaged in the directive principles of the Indian Constitution.

Interesting to read name of Premchand Roychand come up again given he was seen as a central figure in the 1860s cotton and banking crisis in then Bombay. The crisis also led to brokers organising themselves to form Bombay Stock Exchange in 1875 in which again Premchand played a crucial role. It seems his broking firm could regain the lost trust fairly quickly and was mobilizing money from small investors.

One is also surprised RBI history not including Syndicate Bank’s IAD in the discussion. This is especially given the fact that RBI was behind closure of IAD.  The Bombay based  investment trusts must have had moneys of even big investors but Udupi/Manipal based Syndicate Bank’s IAD catered mostly (if not all) to small depositors/investors.

We really know very little about history of financial services in India. Whatever little, is mostly on banks. Others like insurance, fund management, venture capital etc are just given a miss. The financial history scholarship in the west is widely spread with scholars interested in all aspects of financial services.

One hopes to learn much more from these anniversaries such as the recent 25th year of private sector mutual funds.  They should not be allowed to just go like that.

It is a good time for the stock market regulator SEBI, to commission a study which looks at all these historic episodes of India’s fund management industry. More than anything else, it shows how the seeds of today’s trees were planted way back then through several ideas at work.


The political origins of section 13(3) of the Federal Reserve Act..

July 23, 2018

Parinitha Sastry (formerly at NY Fed) writes a fascinating paper which is based on this old school research. She digs through several archival material and reports to tell us how section 13 (3) of the Federal Reserve Act came into being. For the uninitiated, section 13 (3) was central to Federal Reserve’s policies during the crisis. It allows the Fed to lend to non-banking firms and invited fair bit of criticism including within Fed.

Her research shows this gradual evolution of Section 13 (3):

At the height of the financial crisis of 2007-09, the Federal Reserve conducted emergency lending under authority granted to it in the third paragraph of Section 13 of the Federal Reserve Act. This article explores the political and legislative origins of the section, focusing on why Congress chose to endow the central bank with such an authority.

The author describes how in the initial passage of the act in 1913, Congress demonstrated its steadfast commitment to the “real bills” doctrine in two interrelated ways: 1) by limiting what assets the Fed could purchase, discount, and use as collateral for advances, and 2) by ensuring that any newly created government-sponsored credit enterprises were kept separate from the Federal Reserve System. During the Great Depression, however, Congress passed legislation that blurred the line between monetary and credit policy, slowly chipping away at the real bills doctrine as it sought to combat the crisis. It was in this context that Congress added Section 13(3) to the Federal Reserve Act.

In tracing this history, the author concludes that the original framers of Section 13(3) meant to sanction direct Federal Reserve lending to the real economy, rather than simply to a weakened financial sector, in emergency circumstances. This Depression-era history provides insights into the evolving role of the Federal Reserve as an emergency provider of liquidity.

I wish more such papers were written. We might not realise but legal powers are key to central bank policies. Their decisions flow from the powers given by them to the government via their Act. Most of these legal powers come not via some scientific rule etc but based on trial and error. The author shows how multiple institutions were created to fight credit problems but eventually all things came at Fed’s door,

This blog looked briefly at evolution of the Section 7 (1) in RBI Act which allows the Govt to pass instructions to the Central Bank. This was under discussion during the demonetisation.


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