Archive for the ‘Financial Markets/ Finance’ Category

NSE RH Patil Memorial Lecture 2018: Robert Merton

October 16, 2018

NSE organised RH Patil Memorial lecture yesterday and the video of the lecture is here.

Prof Merton has been talking about the need to design a bond for retirement needs which is becoming a huge issue for advanced countries today and for developing world later. He calls these bonds as Selfies: Standard of-Living Indexed, Forward-starting, Income-only Securities. These bonds will only give you payment on your retirement year like the pensions. This will help those who are not covered under pension markets.

Slides of earlier lecture on the same topic are here.

The lecture is followed by a firechat with Prof Jayant Varma of IIMA which is equally interesting.


Economic growth is not an entitlement…

October 16, 2018

Anantha in this piece says it is assumed that we are entitled to higher and higher economic growth (via his blog). It is a mistake to think so and lower economic growth though a bitter pill will do us some good:

What is the good news about the World Economic Outlook (October 2018) that the International Monetary Fund (IMF) had released this past week? The good news is that it has lowered the forecast for global economic growth from 3.9% to 3.7% this year and the next. Why is it good news? Unsustainable economic growth in the years leading up to 2008 was one of the causes of the crisis. It was sustained by fickle and debt-based capital flows into the developing world. That is one of the reasons why developing countries had not been able to shake off the effects of the crisis until now. Indeed, India and China are no longer the same economies they were before 2008. They will continue to suffer from its after-effects for quite some time to come. They are yet to figure out and admit that their growth was simply too fast for their own good.


The same goes for India. The debate over whether the rupee’s recent weakness is good or bad for the country misses the point. It is neither good nor bad. It is inevitable. India’s dependence on foreign capital flows and its higher inflation rate (despite the recent low outturn) make the medium-term case for a weaker rupee. Advocates and proponents of a strong rupee should note that the Federal Reserve could make the dollar stronger in the early 1980s with sky-high interest rates, but at the cost of inducing a recession.

India cannot replicate that. Other strong currencies around the world earned their spurs over a long time and the ingredients included not just low and stable inflation but also economic, financial and political stability and soundness. India needs an adult-like conversation on the economy. However, it lacks a quorum.

In 2012, a chart in The Economist showed that the global economy had packed so much economic growth in the decade up to 2010 (we now know how) that a prolonged period of mean reversion was not only overdue but also desirable. Only a prolonged period of low and stagnant economic growth—unfortunately with all its costs—will get us back to the table to discuss our goals and methods for the world economy and society. The World Economic Outlook (October 2018) growth downgrade marks a rather tentative beginning of a return to such a discussion. The world needs another Bretton Woods like conference, not just on exchange rate regimes but on economic growth regimes.

Keep the engine going even at the cost of total break down and stagnation thereafter….



The role of culture and values in finance and how it shows up during financial crises…

October 16, 2018

My recent article in Moneycontrol.

Finance has risen from being a controversial field and even hated field of work to being one of the most sought after careers. The early philosophers had long warned about how finance is this immoral activity one should not get into. Religions such as Christianity and Islam not just considered lending against usury as a sin but even looked down on those who dealt with money matters. They understood compared to other economic activity, it is in finance where one can make more money over other’s misery.

Yet, no one can deny that finance has been crucial to human progress. Any new idea or invention needs finance to back it and access of finance is seen as a vital ingredient to progress. How does one figure this dilemma?

In the piece, I show how we have not really figured this dilemma. In earlier times, we were concerned more with morality and traded off progress. Now we care much about progress and not much about morality.

This is important as one clear concern which emerged post global financial crisis is how lack of culture and ethics has become so central to financial sector. There have been inquiries about financial sector conduct in US, UK, Ireland, Australia etc and all show how financial market participants have been cheating  customers, manipulating their own markets as seen in Libor, high bonuses and so on. Even worse is how all this was being done with so much panache.

In India, we were patting our backs that first we avoided the crisis and the financial excesses were not seen here. But what was a global trend, was bound to happen here too given our integration with the world. Integration is not just about liberalisation and globalisation of goods and services but cultural exchange too! Eventually we are seeing all this coming out in mess in private banks and non-banks such as IL&FS. We are seeing similar stories of overpaid executives, compromised credit ratings and equity analysts’ scorecard, sleeping independent high-profile directors and so on. Travelling to Mumbai and seeing the glitzy offices of financial-sector companies, one is obviously asking “Where are the customer’s yachts”? So far, our responses to these problems have been usual. We need to probe deeper like other economies and try figure the “missing culture” in Indian finance as well.

Why Corporate Finance is a misnomer and how behavioral corporate finance can help…

October 15, 2018

Interesting paper by Prof Ulrike Malmendier of UC Berkeley.

She starts the paper with this emphatic statement:

The field of Corporate Finance might well be the area of economic research with the most misleading name (followed by Behavioral Economics as a close second). Many of the research papers identified as “Corporate Finance” deal neither with corporations nor with financing decisions. In this chapter
of the Handbook, I first conceptualize the breadth and boundaries of Corporate Finance research, and then present the advances that have resulted from applying insights from psychology. I illustrate how the behavioral toolbox has allowed for progress on long-standing puzzles regarding corporate
investment, mergers and acquisitions, and corporate financing choices.

She says much of corporate finance is too narrow and fails to include topics which are relevant today:


How banks boomed during World War I and then busted due to agricultural price shock post World War I

October 15, 2018

Matthew S. Jaremski and David C. Wheelock in this paper show evidence of American banks boom and bust:

Bank lending booms and asset price booms are often intertwined. Although possibly triggered by a fundamental shock, rising asset prices can stimulate lending that pushes asset prices higher, leading to more lending, and so on. Such a dynamic seems to have characterized the agricultural
land boom surrounding World War I.

This paper examines i) how banks responded to the boom and were affected by the bust; ii) how various banking regulations and policies influenced those
effects; and iii) how bank closures contributed to falling land prices in the bust.

We find that rising crop prices encouraged bank entry and balance sheet expansion in agricultural counties (with new banks accounting disproportionately for growth in lending and banking system risk). State deposit insurance systems amplified the impact of rising crop prices on bank portfolios, while higher minimum capital requirements dampened the effects.

When farmland prices collapsed, banks that had responded most aggressively to the asset boom had a higher probability of closing, and counties with more bank closures experienced larger declines in land prices.

Just replace the  farmland with real estate, infrastructure and so on. One will get a similar picture of most banking crises….Yet we are surprised each time…

Mobile money transfers in Somalia and how it differs from other African countries..

October 12, 2018

Nice piece. Apparently, mobile transfers have taken off in Somalia in a big way.

Mobile money initially started as a simple exchange of airtime credit between users. Over ten years ago, mobile network operators formalised this by offering mobile money services. It was quickly perceived as a convenient and safe way of making transactions and storing money.

Unlike Kenya’s famous Mpesa mobile money transfer services, Somalia’s transfers are mainly available in US dollars. Though the companies offering mobile money services are mobile network operators, as in Kenya, they are increasingly forming part of large conglomerates that also offer banking and money transfer services.

When looking at the total value of transactions, Mpesa’s are about $ 10 million a month while all mobile transactions in Kenya come to $ 3.17 billion a month. In Somalia transactions are worth about $ 2.7 billion a month.

Several factors have encouraged the impressive uptake of mobile money:

Many Somalis own mobile phones – about nine out of ten Somalis, above the age of 16 own one.

Nearly 60% of Somalia’s population is nomadic, or semi-nomadic, and move around a great deal, to find adequate grazing and water for their livestock. So mobile money suits their lifestyle and is also used to facilitate trade.

Concerns over the high prevalence of fake money, absence of monetary regulation, capacity, and limited access to traditional banking services also make mobile money an effective substitute for cash.

Today, mobile money also facilitates vast remittance flows which are critical to most Somali households due to a lack of opportunities in the Somali labour market. Taking advantage of this trend, remittance companies are increasingly partnering with mobile operators to transfer funds directly to recipients’ mobile money accounts.

What is the difference with other African countries?


Confessions of an equity analyst

October 8, 2018

Vikas Vardhan of Valueresearch in this piece gives investment advice why confessions:

  • Confession: The investible universe is very small as compared to the total listed stocks
  • Confession: There are dozens of investment rationales but the most compelling ideas are built on just a few.
  • Confession: We are no expert at running businesses. Analysts are often given the status of ‘demigods’. In reality, they are simply numbers experts. Managements, on the other hand, take years to master their businesses. An analyst covering multiple sectors and companies can never know the business the way an entrepreneur does.
  • Confession: We like it when markets behave irrationally as that creates opportunities.
  • Confession: We do not know where the market is headed in the short term.


Some Central bankers continue to believe that first banks receive deposits and then create loans…

October 5, 2018

Reflecting on the recent speech by official of RBA where he criticised the long held view of banking: that banks receive deposits and then create loans.

Came across this recent speech by Salvatore Rossi, Dep Governor  of Bank of Italy:

As President Pellicanò has already said, this is an important day. We are celebrating the fiftieth anniversary of Credit Day, an annual occasion for taking
stock together of the world of credit and the role it plays in Italy. Italy has changed greatly over the last half century, at least in some respects. In 1968 Italy was emerging from the economic miracle that had turned it into a modern country and was heading for stormy years of social and political turbulence.

Today, it is still one of the leading advanced economies, though it is threatened by decline. Fifty years ago the credit system was almost entirely public and now it is almost all private.

Yet banks continue to do essentially what they have always done: they collect deposits from a vast array of savers and use these resources to make loans to a smaller group, consisting mainly of firms. Italy’s banks find themselves at a crossroads today, as loans may no longer be their fundamental prerogative.



The gamma of banana: Beware of complex financial terminology used in finance..

October 3, 2018

Dhirendra Kumar of Valuresearch in this piece warns investors to stay away from fancy finance talk.

The moment a finance person uses Greek terminology to sell financial products/ideas, they are simply trying to impress that this bit is complex and beyond simple investors. So don’t ask questions, just shut up and pay:


Culture matters in saving behaviour

October 1, 2018

Joan Costa-i-Font, Paola Giuliano and Berkay Ozcan in this research show culture matters for savings:

Previous research (Carroll et al. 1994) could not find evidence of a cultural saving motive. They used data from the Canadian Surveys of Family Expenditures to study the saving behaviour of first-generation immigrants in Canada, and test whether saving rates varied systematically by place of origin. But the sample was small, the authors knew only broad geographical regions rather than country of origin, and did not control for wealth.  

In our recent work (Costa-Font et al. 2018) we have re-examined the cultural saving motive by looking at the saving behaviour of three generations of immigrants in the UK. The UK is one of the largest immigrant-receiving countries, with immigrants from many countries of origin. 

This strategy mitigates (though it does not totally eliminate) problems of selection and disruption due to immigration. We could control for wealth, and had access to detailed information on both actual and self-reported savings. We use a measure of saving rate over GDP, calculated from 1990 until 2010, as a proxy for culture. We attribute the association found in our data between the behaviour of immigrants and the saving rate in the country of origin to differences in cultural beliefs across immigrant groups. 

Although migrants leave the economic and institutional conditions that determined their saving behaviour behind, they bring their cultural beliefs with them. If savings/GDP at the aggregate level in the home country explains the variation in saving outcomes in the host country, even after controlling for their individual economic attributes, only the cultural component of this variable can be responsible for this correlation. 

This is because immigrants from different countries now have the same economic and institutional environment in the UK. We can attribute the correlation of saving behaviour for different generations with saving outcomes in the country of origin to intergenerational cultural transmission. 

Suddenly, culture has become one of the most fancied words to explain/figure everything in finance. One wonders though why and how culture is ruled out at the first place? Culture is central to most economic behavior and much more in financial behavior….

History of macro models (and computing) at the Federal Reserve

September 26, 2018

Nice bit of history by David Price.

It starts with this fab story on how a physicist Frank Adelman got into macro modelling:

One evening in the fall of 1956, Frank Adelman, a physicist at the Berkeley Radiation Laboratory — now the Lawrence Livermore National Laboratory — came home from work with a question for his wife, Irma, a Berkeley economist. He wanted to try writing a program for the lab’s new IBM 650 vacuum-tube computer, but he had found that all of the physics problems he considered interesting were too complex. He asked Irma whether she thought there was an economic model that he could use instead.

“A few days later,” she remembered, “I presented him with a copy of the book by Laurie [Lawrence] Klein and Art Goldberger, An Econometric Model of the United States 1929-1952.”

Frank obtained approval from his boss for one free hour of central processor time, with the stipulation that they would have to reimburse the lab for any additional time at an hourly rate of $600, several times her monthly salary. The couple then set to work together on writing code for Klein and Goldberger’s 25-equation model of the U.S. economy. Their new side project was a journey into uncharted territory: Before then, the results of such models had been worked out by human assistants — known as “computers” or “computors” — wielding slide rules or mechanical calculators.

Working in the lab’s computer room at night, loading the code and data via punched IBM cards, the Adelmans had an initial version ready to present at an economics conference a little more than a year later. Frank’s boss, impressed, allowed them a second free hour, which they used to create a more elaborate version, the results of which appeared in 1959 in the journal Econometrica.

🙂 I wish econometrics classes started with such stories for motivation.

Then the note takes us through the development of macro modelling at Fed…

From this modest start, the science — and, some would say, the art — of computer modeling of the economy has become indispensable to policymakers and businesses seeking to forecast economic variables such as GDP and employment or to analyze the likely effects of policy changes. The Fed’s main computer model since the mid-1990s, known as FRB/USOffsite (commonly pronounced “ferbus”), has about 380 equations covering the behavior of households, firms, inflation, relative prices, numerous interest rates, and government taxes and spending (at the federal, state, and local levels), among other phenomena.

Yet even as large-scale macroeconomic models such as FRB/US have attained a role probably undreamed of by Irma and Frank Adelman, their usefulness is debated within economics circles — a reflection of a rift, starting in the 1970s, between many research economists in academia and their counterparts in policymaking institutions and businesses.


How the Great Telegraph Breakthrough of 1866 shaped global markets and economies…

September 25, 2018

Superb short review by Helen Fessenden of Richmond Fed.

The article looks at how advent of telegraph technology in 1866 between US and UK shaped their markets and economies:

Economists have been increasingly studying the role of technology, in particular, as a way to break down information frictions and make markets more transparent. This field of inquiry applies not just to trade but to any kind of economic activity, especially when real-time information is critical but difficult to find. For example, economists have looked at the effect of Internet shopping on life insurance markets — cheaper on net for consumers, according to Jeffrey Brown of the University of Illinois at Urbana-Champaign and Austan Goolsbee of the University of Chicago. As these and other studies suggest, the speed and ease of online shopping can reduce these frictions for consumers.

To anyone who surfs websites to shop, these insights are intuitive. But as the case of the transatlantic telegraph cable shows, history is rich with examples of how earlier breakthroughs had similar effects. In a stroke, the cable helped reshape many U.S. industries, including one of the biggest exports, raw cotton, ultimately growing U.S. exports through increased efficiency.

This story has special resonance in the Fed’s Fifth District, especially in the Carolinas, where the cotton industry recovered with surprising speed in the years following the Civil War. Even though cotton production and exports sharply fell during the war, both rebounded to prewar levels by 1870. In particular, the communication revolution that the telegraph ushered in helped turn splintered local markets into a national network, leading to the 1871 founding of the New York Cotton Exchange.

Superb bit.


Why friends give but do not want to receive money

September 24, 2018

Laura Straeter and Jessica Exton get down to absolute origins of financial intermediation/banking:

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:


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…

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:


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.


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…


Will IL&FS be India’s mini Lehman?

September 13, 2018

The ever alert and hard hitting Andy Mukherjee in his new piece looks at the woes of IL&FS which is the new trouble for India’s financial markets.

India is marking the 10th anniversary of the 2008 global financial crisis with its own mini-Lehman moment.

True to script, ratings companies have belatedly realized that the IL&FS Group — Infrastructure Leasing & Financial Services Ltd. and its associates — is woefully short of liquidity, with about $500 million in repayments coming due in the second half of its fiscal year through March and only about $27 million available. The group, which missed a payment in the commercial-paper market last month, is now late in servicing an inter-corporate deposit.

Shocks are starting to reverberate amid an avalanche of ratings downgrades. That’s only to be expected: On the hook for the group’s $12.5 billion debt are banks and mutual funds. (IL&FS itself is a motley collection of shadow lenders that don’t take deposits.)

Meanwhile, the group’s assets include financial claims on everything from roads and tunnels to water treatment plants and power stations. This is the stuff that IL&FS has been financing for 30 years; none of it can be liquidated to make lenders and debt-fund investors whole.  

But then, infrastructure — when taxpayers don’t fund it — is always about rolling over liquid, short-term debt to create solid long-term assets. Trouble starts when power plants get stranded for lack of fuel or purchase contracts, and roads clear environmental hurdles only to crash into low tolls, poor usage and payment disputes with the highway authority. The economics collapses backward. 

He compares the IL&FS chief who resigned this year to Richard Fuld as well!

All the talk that India is different from the west as we did not allow sub-prime markets and other financial innovations, is being questioned now. The human greed and this ability to create finance from nowhere will eventually deflate all of us. We have exclusions and inequality of all kinds but in finance this goes to a different level. How sovereigns and firms are able to raise trillions of dollars of debt on one hand and completely waste it. And on other hand we talk about lack of financial access and basic livelihood for so many others. There is something fundamentally wrong with how we humans have devised and designed these mechanisms….

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