Archive for November 28th, 2018

Flight-to-safety and the Credit Crunch: A new history of the banking crisis in France during the Great Depression

November 28, 2018

Nice research by Patrice Baubeau , Eric Monnet, Angelo Riva  and Stefano  Ungaro.

They look at archival records of banks in France during Great Depression. They find that the impact was much severe than imagined:

Previous research has downplayed the role of banking panics and financial factors in the French Great Depression of the 1930s. Although scholars acknowledged that some banking failures occurred in France during the period 1930-1932, the common view of the absence of significant economic consequences has persisted. It results from the lack of statistics able to provide a comprehensive picture of the magnitude of banking panics, in the absence of banking regulation in France prior to 1941. The usual method to compute series of bank credit and deposits relied on the balance sheet of the four largest commercial banks – whose data were easily available – and to assume that those banks represented half of the banking sector. These large banks did not experience difficulties and their deposits did not decrease in 1930 and 1931.

Based on extensive archival research we have found the balance sheets of more than 400 hundred banks in interwar France. This finding gives a completely different view of the 1930-1931 banking crises. Whereas the four large commercial banks escaped the crisis, the remainder of the banking system experienced two dramatic waves of panic (end of 1930 and end of 1931), such that its deposits decreased by 40% between 1929 and 1931. The decrease in credit was even stronger (-44%). Banking panics were concentrated in 1930-1931. The decrease of banking activity that followed starting 1932 is fully explained by deflation.

Banking theory explains the mechanisms of bank runs, but it is silent on where deposits go when they are withdrawn from the banking system. Traditional monetary interpretations point to a drop in the money multiplier and in the money base, either because cash is hoarded or because deposits remain frozen in bankrupt banks. Our estimation of hoarded cash and frozen deposits show that they cannot account for the bulk of deposits that fled the banking system in 1930 and 1931.

Instead, most of these deposits went to savings institutions (Caisses d’Epargne) which collected deposits at a regulated interest rate and invested their assets in Treasury bonds. We characterize this phenomenon as a flight-to-safety. Because of capital inflows and the flight-to-safety from banks to non-banks, the total amount of deposits slightly increased in France from 1930 to 1932.

How can a country experience deflation and a decline of about 1/3 in real activity, whereas at the same time the money supply increases? The answer to this question lies in the dramatic decrease of credit. A credit crunch occurred because the institutions that received deposits during the banking panic – namely the saving institutions and the central bank – did not lend to the economy. New cash deposited with the savings institutions (Caisses d’épargne) was used directly to repay marketable public debt, which decreased between 1928 and 1933. 

The large banks which were not affected by the crisis deposited 25% of their assets with the central bank. The central bank increased very modestly its lending to the economy (both banks and non-banks) but it was dwarfed by the dramatic increase in gold reserves, the ultimate safe asset. Gold reserves doubled between 1929 and 1932. No financial institution replaced the banking system as a lender to the economy.

The highlighted bit suggests deposits lead to loans. But this has been disputed off late by several experts. Instead we now say loans lead to deposits.

Given this, a better way to say is there were limited business opportunities to lend to. So whether it is commercial banks or savings institutions, they either did not find lending opportunities or loan-seekers were not coming to these financial institutions….

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Thinking about regulating shadow banks and renaming shadow banks as non-banks…

November 28, 2018

Luigi Federico Signorini in this speech talks about the need for regulation of non-banks.

He also points how Financial Stability Board has changed the nomenclature of shadow banks:

With the completion of Basel 3, the post-crisis overhaul of banking regulation is essentially over; with a limited number of exceptions, the only issues remaining for the next few years will be the implementation of reforms and the evaluation of their effects, intended or otherwise, over time. Banks, however, do not comprise the entire financial sector.

Arguably, non-bank financial intermediation has taken on an increasing role in the global financial system and poses new challenges to regulators. The attention of international co-ordinating bodies such as the FSB is therefore now mainly, and rightly, directed towards what used to be known by the vaguely derogatory name of ‘shadow banking’ but is now more neutrally termed ‘non-bank financial intermediation’. The aim of this speech will be to explore the emerging risks from non-banks, to describe the (not insignificant, but still inchoate) regulatory response so far, and to speculate about a possible agenda for
the medium-term future.

Global non-bank finance concerns everybody, even countries where banks continue to play a dominant role in the internal financial system, like Tunisia – or Italy, for that  matter. In a globally interconnected financial system, no country stands alone; none can remain isolated from market shocks and turbulence whose ultimate source may be in faraway parts of the globe. This is a key point for emerging market and developing economies.

Witness the recent experience of the ‘taper tantrum’, when a number of emerging economies faced external financial conditions that had tightened abruptly and higher generalised risk premia in reaction to a policy decision taken by the US authorities. On that occasion the countries affected found that the negative repercussions on their economy stemming from the generalised repricing of assets could not be mitigated through policy actions (either by relying on floating exchange rates or through capital  flow management measures). It has also become apparent that a low degree of financial deepening may actually increase the sensitivity of emerging asset markets to external shocks.

The issue with non-bank finance, it will be argued, is not the stability of individual intermediaries—micro-prudential risk. As the risk connected to managed assets is borne almost entirely by the ultimate investor, rather than by the manager itself, it is not, or not mainly, the possible default of the manager that should concern regulators.

On the other hand, the actions of asset managers may affect the financial system and the  general economy through their systemic consequences on market developments. The key questions are then whether, to what extent and under what conditions non-bank intermediation can amplify market movements and determine instability. It is, therefore, essentially a macro-prudential question. Understanding and measuring such risks will require data, research and careful reflection; tackling them is likely to require new or reinforced supervisory tools and, quite possibly, a broader mandate for supervisory authorities.

Hmm

We are again seeing some concerns from non-banking financial sector. Here is another recent speech from Luis de Guindos, Vice-President of the ECB.

Jammu and Kashmir Bank becomes a public sector unit…(A turn in fascinating history of the bank)

November 28, 2018

Lots of things going on in Jammu and Kashmir.

One news which caught my attention was the Governor Satya Pal Malik deciding to convert J&K Bank into a State Public Sector Undertaking (read this as well):

A day after Governor Satya Pal Malik dissolved the Jammu and Kashmir assembly, the State Administrative Council chaired by him decided to turn the J&K Bank Ltd into a public-sector bank, taking its autonomy away and making it accountable to the state legislature. Further, it will also be brought under the ambit of the J&K RTI Act and the Central Vigilance Commission.

Until now, J&K Bank was classified as an ‘old private sector bank’ and supervised by the Reserve Bank of India. Besides, it is also subject to oversight by the Comptroller and Auditor General (CAG). Omar Abdullah of National Conference called it a “disturbing development” and said the Governor, who is a “caretaker administrator did not have the people’s mandate to take such major decisions with far-reaching implications”.

PDP’s Mehbooba Mufti described it as a “disturbing step to snatch every bit of autonomy that our institutions have”. Sajad Lone of People’s Conference said his party’s economic philosophy is decentralisation and total liberalisation. “We believe in smaller government, not more government control. The best thing the government of the day can do is to get out of the way. Any remedies (regarding J&K Bank) should have been institution-specific, rather than invading it with overarching government control. The track record of J&K government PSUs is extremely bad,” he said.

The J&K state holds a majority or 59.3 per cent stake in the bank. In a statement Thursday, J&K Director, Press and Information, said, “As the state is a major shareholder in J&K Bank Ltd, a need was felt that it should have a character of a PSU which is subject to general supervision and access for enhanced transparency in the transaction of its business to promote trust.” “The purpose is not to question the day-to-day activities of the bank management but a step towards strengthening better corporate governance,” the statement said.

Here is an interview of Haseeb Drabu, the former finance minister of the State and former chairperson of the bank:

Q: What do you make of the decision to declare J&K Bank as a PSU?

A: J&K Bank is a publicly listed bank where the government of J&K has a majority shareholding. It is a government company. It is a very unique institution as no other state government owns a bank. Banking is a central subject so all government-owned banks are owned by the Union government. J&K Bank is an exception. Technically, it is an old generation private sector bank. Now it has been downgraded and put at par with any other state public sector undertaking like the J&K SRTC or J&K SFC or J&K TDC.

 Q: What does it mean for the bank and the state?

A: It is a thoughtless decision which is very regressive. It will have a very negative impact on the bank and its functioning.  There is no way that the state will be benefit from it. The state government will increase its control and that may be a positive for the Governor or his team. But it will be an unqualified disaster. The institutional autonomy of decision making will be impaired and all commercial decisions can be questioned for one reason or the other. It will also open up the bank to too many masters. Already it is supervised by the RBI, annually inspected by them, then the CAG audits it, it has its own internal auditors. Now, it will have the legislature and all the bodies of government interfering in its decision making.

 Q The government today said that classifying the bank as PSU is “stating the obvious” as the state government is the owner?

A: This is not correct. It is not a PSU. It cannot be. The basic tenet of corporate governance is the separation of ownership and management. Owners are managers in PSUs. Their chairman and MDs are appointed by the government. The chairman and chief executive of J&K bank is appointed by the Reserve Bank of India, on recommendation of the board of directors.     

Q: But bringing it under the ambit of RTI is seen as a good move to increase transparency in its functioning. Will it not?

A: Bringing it under RTI is a separate matter. It can be done without putting the bank under the PSU framework. I am all for transparency but it should not jeopardise commercial functioning of the bank. Central Information Commission has ruled out disclosure of information relating to bank accounts under the RTI Act saying that the agreements entered into by banks with its customers are matters of commercial confidence. Please understand that the bank holds such information concerning private persons in a relationship of trust. On administrative matters of the bank, bringing it under the ambit of RTI is not an issue. A case in point is the recent controversy about appointments in the J&K Bank. The reason why RTI is an issue is that it makes J&K bank as State. It is a legal conundrum. This means by implication it is an intrinsic part of the state government. Once it becomes a part of Government, every decision can be questioned and it is open to political interference and misuse. It is easy to say that if I am against RTI, I am against transparency and that I am scared of skeletons tumbling out. I wish it was so simple. I have run the bank for six years. Every commercial decision, on say a loan being sanctioned and its pricing, the rate of interest, will be questioned. Competitors and even political adversaries will file RTI queries and that will be the end of business of the bank. It is the thin edge of the wedge. There will be no end to it.

 Q: What about other banks across India?

A: They are but in a limited sense. As I said, the commercial part is not. But they don’t have the complication of being State. J&K bank has. There have been many legal cases on this issue of J&K bank being State. What has made the decision adverse in the case of J&K Bank is that it has now been made accountable to the legislature. Not so long ago, when I was the finance minister, a veteran legislator was trying to raise the case of an NPA account settlement. The bank will have to submit its Annual Report to the legislature like all state PSUs. Commercial Banks, owned by the Government of India, don’t have to submit their Annual Reports to Parliament! Where is this coming from?  What makes it unacceptable is that it is done by an administration that is neither elected by the people nor accountable to them. If tomorrow, the state legislature discusses the matter and decides to bring it under its own control, there can be a debate there. At the end a view will be taken. Here, it is a set of administrators in the SAC who take a view that has serious implications. That is also an issue. Such an issue is best decided by an elected and accountable government.

Hmm..

Going back into history. The bank was established in 1938 by then Maharaja Hari Singh. So the bank is in its 80th year now.

Post Independence, RBI while looking at Princely State Banks , looked at J&K Bank: case closely. It said the following:

With the extension of the Reserve Bank of India Act to the whole of India, the question of the Bank undertaking banking business for the Jammu and
Kashmir state government came up for consideration. When the question of entering into an agreement with the state government under section 21A of
the Bank Act was considered in 1959, the Bank and the Government of India concluded that ‘it would be unwise’ to entrust currency chests to the state
government and place ‘banking arrangements with the state on par with those of other states’ until its administration ‘particularly the treasury and accounting
side … settled down’. Besides, in the Bank’s view, agreements with other states were not working ‘quite satisfactorily’, and state governments were using the Bank for ‘unregulated overdrafts’. Hence the Bank felt it was ‘not desirable to place this temptation in the way of the Jammu and Kashmir State’.

The Jammu and Kashmir Bank was the banker to the state government. A non-scheduled bank incorporated in 1938, nearly two-thirds of its paid-up capital was contributed by the Jammu and Kashmir government. The latter had three nominees on the bank’s Board, one of whom was its Chairman. A
government company under the Companies Act, 1956, the bank had entrusted to it the state government’s treasury work at Srinagar and eight other
places in the state. The government and institutions associated with or controlled by it also held substantial deposits with the bank and borrowed funds from it on a large scale. Successive inspections by the Bank’s officers revealed that the financial position of the Jammu and Kashmir Bank
was extremely unsatisfactory.

In 1959 the Bank found that the Jammu and Kashmir Bank’s paid-up capital and reserves (including undistributed profits) amounting to nearly Rs 15 lakhs had been wiped out, and that its deposits had been affected to the tune of Rs 6.72 lakhs. The inspection also revealed major defects in the bank’s investment and advances portfolio, earning capacity, and head office supervision and control over its branches. Apart from issuing directions, the Bank also deputed an officer to the Jammu and Kashmir Bank to study the latter’s working and recommend ways of placing the institution’s administration on a sounder footing. Little came of this, however, as the bank took ‘no concrete steps … to implement’ the officer’s recommendations. The Bank’s subsequent inspections revealed no improvement in the affairs of the Jammu and Kashmir Bank, and the latter was then judged ineligible for a licence under the Banking Companies Act.

The situation in Jammu and Kashmir was thus quite anomalous. However its affairs were conducted, the Jammu and Kashmir Bank was in almost every
sense of the term a ‘state-associated’ banking institution. But not only had this institution not benefited from the organizational and operational reforms
carried out of the other major state-associated banks, the State Bank of India which did conduct the central government’s treasury business to a limited
extent in Jammu and Kashmir, was a relatively negligible presence in the state.

Thus, the financial position has barely changed all these years. The RBI then debated on whether to make J&K Bank also a subsidiary of the State Bank of India like other Princely State Banks.

The possibility of the State Bank of India taking over the Jammu and Kashmir Bank was raised by the state government with the State Bank Chairman, P.C. Bhattacharyya, in October 1961.

In deliberating upon this suggestion, the Reserve Bank concluded that in principle two distinct questions had to be tackled: firstly, whether it should agree to become banker to the state government, and secondly whether it should appoint the Jammu and Kashmir Bank as its own agent in the State. 

The two issues were interconnected. If the RBI decided to become banker to State, then it would have to do away with how it allowed other Princely State banks to be bankers to State. But if it allowed J&K Bank to work like other Princely State banks and be made a subsidiary of SBI, then currency chests would remain with J&K Bank and  funds freely available to the States. By now, RBI was already dealing with problems of the States bleeding the currency chests held by the Princely State Banks. Hence, it was a dillemma of sorts for RBI.

Thus, it was decided to maintain status quo on J&K Bank.

This coincided with views of J&K Government as well. A Committee by the Government did not favor J&K Bank becoming a part of SBI (but obviously). They said a local bank should finance commerce and trade of the State. It also said the bank should continue to be banker to the State,

Thus, we had J&K Bank positioning itself as a very different bank. It was a Princely State Bank but was kept in the Old Private Sector Bank category. The history of Indian banking is quite fascinating with so many different types of banks.

Coming to present. the majority of the ownership – 59.23%- is still held by the J&K State with public owning 40%. Hence, it is a special case in every which way.  Now, it has become a Public Sector Undertaking of the State. In terms of ownership not much changes. But in case of governance, as Drabu argues it could mean a lot.  The Government on the other hand argues that this will lead to more accountability.

We have to wait for more news on this.

Given this case, one should also read this post about State Bank of Sikkim. It is a central cum commercial bank of the State which is not regulated by RBI..


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