Wednesday, December 27, 2017

Beneficiaries of Rs 26,000 cr grants unknown: CAG

HYDERABAD: The Comptroller and Auditor General of India (CAG) has dropped another bombshell. Two of the Union ministries released grants of over Rs 26,000 crore in three years, but the auditor found no record of the beneficiaries. In a majority of cases, no MoUs were signed, violating a practice all departments must comply with. While some grants were meant to create capital assets, the CAG, in its latest report on Union Government Finance Accounts, wondered if they met the purpose at all, while in some others, it didn’t rule out the possibility of fraud or misappropriation.
As part of its annual routine, the CAG reviewed the sanctioning and monitoring mechanism of grants, quality and effectiveness of the expenditure incurred in two ministries — the Ministry of Health and Family Welfare and the Ministry of Power.

The analysis brought to light that during FY14 and FY16, both the ministries separately released grants running into crores, but no centralised records, including names of the grantees, details and nature of assets created, amount of grants utilised, ownership of assets, were maintained. This raises two concerns. Are funds being diverted for purposes other than intended? If so, what would be the magnitude of this irregularity if the CAG reviewed the other ministries?
Grants-in-aid are payments made by the government to government, bodies, institutions or individuals for operating expenses, capital asset creation, and delivery of services. As per the General Financial Rules, 2005, for grants of above Rs 5 crore per annum, MoUs should be signed indicating output targets, programme details, and commensurate input requirements. However, the Ministry of Health blatantly violated this norm, while the Ministry of Power provided no centralised records for verification.

Monday, December 25, 2017


An unprecedented civil suit was filed last week by PBT president, Dr. Kunal Saha, in Calcutta High Court demanding Rs. 100 crore compensation from the West Bengal government for failure to take any steps against the defamatory statements made by then Justice G.C. De who, while dismissing Anuradha Saha wrongful death case and acquitting all accused doctors in 2004, made blatantly slanderous and false claim that Anuradha died due to “interference” and wrong treatment by her husband. In 2009, Supreme Court not only held all accused doctors responsible for Anuradha’s death but also severely criticized Justice De for making “irresponsible accusations” against Dr. Saha.

After moving a “criminal defamation” case against retired Justice De in 2011, Calcutta High Court directed that the proper “authority”, not any private citizen, may take action for wrongful act against any judge. Dr. Saha then approach the West Bengal Legal Authority (Legal Rememberencer) for taking appropriate action in this matter in view of the Calcutta High Court and Apex Court’s observations but despite repeated pleas, Bengal Law department remained absolutely silent. Thus, this new civil suit seeking compensation of Rs. 100 crore was filed by Dr. Saha against the state government for causing mental trauma and defamation. However, Dr. Saha has given a written undertaking in the same petition that if and when Dr. Saha wins, he will not take a single rupee from this award and the entire money will be donated for public awareness against judicial impropriety and to help victims of medical negligence in India (see news in Statesman below).

Wednesday, December 20, 2017

FRDI: Grossly at Odds with the Indian Financial System

The government’s penchant for painting all legitimate questions about its faulty policy-making as scaremongering or anti-national is getting rather irksome. Prime minister Narendra Modi (at the FICCI annual general meeting) and finance minister Arun Jaitley have both responded to fears over the implications of the Financial Resolution and Deposit Insurance Bill (FRDI Bill) , 2017, by lashing out at critics and reassuring people that the government will protect bank deposits. 

Yes, we are quite certain that the government will not confiscate bank deposits and convert them into equity to bail out bleeding public sector banks (PSBs) in the year and a half before the 2019 general elections when this government’s term ends. It is true that people have been rattled by social media messages into believing that such a move is imminent. But whose fault is that? 

The government certainly wants to enact legislation that will enable such action and public assurances by ministers will have no sanctity, especially if there is a different government or even different ministers in relevant positions. What is worse, the legislation itself is completely at odds with the structure and operation of Indian banking. 

Moneylife Foundation has sent a representation to the Joint Parliamentary Committee (JPC) which is examining this Bill. In my last column, I had also written about the ‘bail-in’ provision that would allow a bank, on the verge of bankruptcy, to convert un-insured deposits above a threshold into equity in order to recapitalise banks. But I realise that it makes no sense to present the bail-in as a last resort action, when the FRDI Bill itself is so drastically flawed that it is bound to cause a wanton destruction of PSBs. 

The main reason why the FRDI Bill must be withdrawn is this: The only part of Indian financial sector where it can be potentially applied to is wobbly PSBs which account for over 63% of Indian banking; but then it is illogical to apply it on them. If a bank goes bankrupt the owner is responsible; and, in case of PSBs, the government is the owner. You cannot have a bail-in clause where the owner pays no price but depositors are made to take the risk.

If the FRDI Bill has to be made applicable to PSBs, they must be privatised and the government holding brought below 26% in order to insulate them from political interference and behest lending. Clearly, this is impossible without resolving the massive bad loan issue; because, without a sovereign guarantee that ensures the safety of depositors’ money, deposits will instantly flee to profitable private banks with a low incidence of bad loans. This would end up destroying the Indian banking system instead of curing it of a hypothetical problem that does not apply to Indian banks in the first place. 

Dr KC Chakrabarty, former deputy governor of the Reserve Bank of India (RBI), highlights another issue. He says, “Globally, all deposit taking institutions are regulated and supervised under a single regulatory framework and same standard of regulation.” This means that cooperative banks have to be removed from the clutches of politicians and the Central and state registrars of cooperatives. 

In the past 20 years, every single payment made by the Deposit Insurance Guarantee Corporation was on account of politically-controlled cooperative banks which fail with astonishing regularity. In most cases, RBI as well as the registrar of cooperatives have ignored whistleblowers and refused to initiate strict action. Bombay Mercantile Cooperative Bank is a good example. The Bank has gone steadily downhill over the past 15 years, despite innumerable attempts by a set of whistleblowers to rein in dubious management. They were ignored and victimised. 

In a last ditch attempt, they filed a public interest litigation (PIL) alleging breach of trust by the chairman and directors; the PIL named RBI and the Central Registrar of Cooperative Societies (CRCS) as respondents. On 21st September, a bench headed by then chief justice Dr Manjula Chellur and Justice NM Jamdar, Bombay High Court directed the CRCS to consider representations made by the whistleblowers and dispose them within a month. The CRCS has not even bothered to respond to this court order. In fact, getting CRCS to bestir itself is a herculean task. The FRDI Bill excludes cooperative banks, but does not provide a separate deposit insurance scheme for them, so they may be quietly included later on. The loss-making Bank of Maharashtra’s whistleblower was similarly victimised for drawing attention to the most egregiously dubious lending decisions. 

As Dr Chakrabarty says, all deposit-taking entities, including deposit-taking non-banking finance companies and cooperative banks, must be brought under the same stringent supervision in order to ensure that money does not flow from one set of institutions to another and weaken the financial system. But regulation of deposit-taking finance companies under the RBI’s supervision has also been poor. 

A third issue, which is also a global problem, is the lack of accountability of regulators. Three former RBI governors have published self-congratulatory memoirs in 2017 that have one thing in common—silence about their failure to deal with cronyism, behest lending and burgeoning bad loans which are set to touch Rs10 lakh crore. Even in the US, which is pushing for creditors to bailout bankrupt institutions in the future, regulatory failure of 2008 went unpunished, despite a huge public outcry.

It is pertinent to note that D Subba Rao and Raghuram Rajan had ignored the All India Bank Employees Association (AIBEA) campaign since 2013 to ‘Stop the loot of PSU Banks and start recovery of funds’. The Association had gone ahead and published the list of top defaulters even while RBI has been acting coy about revealing names even in 2017. Isn’t AIBEA fully justified in demanding withdrawal of the FRDI Bill that could potentially destroy PSBs and lead to massive job losses?

A fourth issue is the ‘corporate insurance fund’ which, we are given to understand, will cover a larger chunk of deposits (as opposed to Rs1 lakh per depositor today). There is no discussion on the cost of this insurance and who will bear it. The annual insurance paid by banks to cover Rs30,509 billion deposits was Rs101 billion in 2017. If the insurance cover per depositor is raised to Rs10 lakh or Rs20 lakh per depositor, there will logically be a 10-fold increase in premium paid. The FRDI Bill intends to cover insurance as well. Neither the government nor the FRDI Bill explains where this money will come from. Won’t we, as depositors, end up paying a significant cost for deposit protection? After all, banks already extract all charges from consumers, despite enjoying a fat spread on our deposits. We need an explanation. 

A fifth issue that remains unclear is the role and authority of RBI itself. In the past few decades, RBI has ensured that no big bank has failed, by engineering mergers with strong banks. These decisions have been dictated as much by the need to cover its own lapse of supervision, as to safeguard the financial system. 

Under the FRDI Bill, this will be decided by a Financial Resolution Authority (FRA) which is only obliged to consult RBI. More importantly, without a sovereign guarantee, neither the FRA nor RBI can possibly force a merger like that of Global Trust Bank with Oriental Bank of Commerce. It is not clear whether those who wrote the FRDI Bill saw this possibility. 

Far from protecting the taxpayer and exchequer from the cost of large bankruptcies, the FRDI Bill threatens to weaken the Indian banking system when it urgently needs fixing. In a country that provides no social security to people, a legislation that can appropriate hard-earned, tax-paid, savings is bound to cause anxiety and fear. But when the Bill itself is incompatible with the structure of our banking system, it needs to be withdrawn until PSBs that have been looted for decades by dubious industrialists and politicians are restored to health. 

The above is from Sucheta Dalal's Petition

Tuesday, December 19, 2017

Government doctor caught taking bribe hangs himself

CHENNAI: More than a month after he was caught on camera demanding a bribe, K Sridhar, suspended superintendent of Government Ophthalmic HospitalEgmore, on Thursday committed suicide by hanging at a friend’s house in Ponneri.

In September, a citizen action group released a video of the doctor demanding bribe of Rs 500 from one of its volunteers, who was partially blind, to issue a disability certificate. The health department later set up a two-member committee to probe the matter.

Dr Sridhar was placed under suspension pending inquiry by Dr Geetha, additional director of medical education and Kilpauk Medical College and Hospital dean Dr P Vasanthamani.

Suspension took mental toll on Sridhar: Health official

In October, the Directorate of Vigilance and Anti-Corruption launched an inquiry. Sridhar admitted that he used to receive Rs 100 or Rs 200 from beneficiaries while issuing the certificates. DVAC sources said Sridhar was not supposed to collect money from beneficiaries and if any amount was to be collected, it was to be done by Jothi Ramalingam, an assistant in his office.

Sridhar was booked under Prevention of Corruption Act 1988 section 7, 13(2) read with section 13(1(d).

Sridhar’s family and friends advised him to stay away from the city for a while and he had been staying at his friend’s house in Mallivakkam, around 6km from Ponneri, for the last five days. Neighbours say he was rarely seen outside.

When phone calls to him went unanswered on Thursday, his family members asked a few friends nearby to check. They found his body hanging from the ceiling and alerted police who sent it to the Government Hospital in Ponneri for autopsy. A case was registered under CrPC Section 174 (unnatural death).

Senior officials in the health department said the doctor was due for retirement on November 30 when allegations of corruption came to the fore. “He had been in government service for more than two decades. The suspension took a mental toll on him,” said a senior health official, who did not wish to be named. The department said his family would still be entitled to his pension benefits, “whether guilty or not.”

Leading medical ethics body, World Medical Association appointed tainted Indian physician Ketan Desai as its president last week.

Reuters reported that Desai who has previously headed Indian Medical Association delivered his speech at the body’s annual assembly in Taiwan on Friday and is set to serve as the president for the 2016-17 period.

The appointment of Ketan Desai as the president of an ethics body is ironical, as Desai is an accused in corruption cases in India. 

Desai’s name was first proposed as a future president in 2009, but was suspended in 2010 after he was jailed as an undertrial in a corruption case. (currently being heard by the Supreme Court).

PTI reported that Kunal Saha, President of People for Better Treatment (PBT), an advocacy group, demanded an intervention following the development sent a legal notice to the MCI and the Union Health Ministry.

He had allegedly taken a bribe of Rs.2 crore from a private medical college in exchange for favours regarding accreditation from Medical Council of India.

It is alleged that Desai along with three others accepted the bribe from Gyan Sagar Medical College in Patiala in exchange of permission to admit a fresh batch of students.

His wife Alka Desai was also charge sheeted by the CBI as a co-conspirator in the case.

In the same year, CBI also alleged that he took another Rs.20 crore as bribe from a Kolkata hospital for sanctioning extension of its academic session.

Apart from these allegations of accepting bribes, he was charged with possessing disproportionate assets by the CBI.

Following Desai’s arrest, the MCI was dissolved by the then President of India Pratibha Patil.

His suspension was lifted in 2013 after the IMA told WMA that charges against Desai were dropped which a Reuters investigation deemed “incorrect”. But the body went on to appoint Desai as its president.

Friday, December 15, 2017

A Dangerous Bill on Banks:Where Depositors Are Made to Pay For Corporate Defaulters


NEW DELHI: The BJP government, it appears, cannot remain content without inflicting irreparable damage on the institutions of the Indian economy. Its latest move in this direction is the Financial Resolution and Deposit Insurance (FRDI) Bill which was introduced in Parliament on the last day of the winter session and is now with a Select Committee.

What this Bill proposes is the setting up of a Resolution Corporation, consisting largely of central government officials, which, in the case of stressed banks whose condition is considered “critical”, will use creditors’ money, including that of depositors, to overcome the default by borrowers.

Until now it was the budget of the central government, the owner of the nationalized banks, which was supposed to be used for their “bail out”; now, however, the idea is not to have a “bail out” but a “bail in”, i.e. not to have central government help for supporting distressed financial institutions but creditors’ funds, including those of depositors.

Currently all deposits up to Rs.1 lakh are insured by banks themselves, so that there is no risk of loss to these depositors in the event of a bank failure.

The Deposit Insurance and Credit Guarantee Corporation, a subsidiary of the Reserve Bank of India, which covers such depositors is proposed henceforth to be wound up; and no other institution has been suggested in its place in the Bill.

More importantly, however, it is not just the existence of this Corporation that instilled confidence among depositors about the safety of their deposits with the nationalized banks; it was the fact that the banks were government-owned, the conviction that the government would never let these banks fail.

It is this confidence which made millions of depositors, especially pensioners and senior citizens, hold their wealth in the form of bank deposits, even though such deposits offered comparatively lower rates of return than shares, mutual funds and many other assets. This confidence will now disappear.

In the old days people used to hold cash in boxes, since they had little confidence in the banking system which was controlled in their perception by a set of unknown private operators with no scruples.

Bank nationalization changed all that, and an enormous amount of deposits got mobilized across the country because of the confidence it generated among people that these banks, being owned by the government, would never let depositors down, that depositors’ money was totally safe in these banks.

While this confidence is now set to be undermined, demonetization, with Modi’s explicit promise that the experiment will be repeated from time to time, has served ironically to undermine people’s confidence in currency as well at the same time. (Though demonetization does not necessarily involve an actual monetary loss, it means standing in long queues and going through a lot of hassles, even if we ignore the inconvenience it causes by the temporary relinquishing of purchasing power).

Hence money in both its forms, currency and bank deposits, is now no longer going to be considered a safe asset to hold. Since the FRDI Bill also covers State-owned insurance and other financial companies, their liabilities too, like bank deposits, would lose their attractiveness for numerous small wealth-holders.

In an economy in which people’s confidence in money and these other financial assets is sapped, assets like gold or land or physical commodities become the favoured forms of wealth-holding, because they are considered comparatively “safe”. A shift from money to these latter assets constitutes a retrogression in economic terms; this is what the BJP government is bringing about.

To be sure, the FRDI Bill is not a brainchild of the BJP government. It is based on the recommendations of a Financial Stability Board which was set up in the wake of the 2008 global financial crisis to ensure that financial systems caught in such crises in future did not need rescuing through budgetary resources, as the U.S. financial system had done at that time. India was one of the G-20 countries that accepted the Financial Stability Board’s recommendations, and the FRDI Bill is the outcome of this acceptance.

But there is a fundamental difference between tax-payers’ money being used for rescuing a privately-owned financial system and its being used for rescuing a government-owned financial system; the former lacks legitimacy but not the latter.

In fact the government can come into the picture much earlier to prevent the banks it owns from getting saddled with “toxic” assets, so that the very question of banks needing to be rescued through tax-payers’ money should not arise at all, and certainly not on the scale of the banks in the advanced countries at that time. It is not surprising that even at that time the exposure of nationalized banks in India to the “toxic” assets was so minuscule that hardcore private-sector-enthusiasts too had to concede that bank nationalization had stood India in good stead.

Hence the very idea of adopting in India measures devised in the advanced capitalist countries, despite our having a very different financial system, whether these measures are the Basel “capital adequacy norms” (for meeting which the nationalized banks are supposed to dilute the share of government equity), or the institution of a “bail-in” programme in the place of a “bail-out”, is quite absurd.

But the BJP government, lacking any imagination of its own in economic matters and blindly pursuing whatever course the neo-liberal “pundits” hand down to it, fails to see this.

Finance Minister Arun Jaitley has assured the public that depositors’ interest will be protected; but it is not clear how. The FRDI Bill lists those to be protected, in the event of a bank being in a critical condition, in order of priority; and uninsured depositors come fifth in this list. Even in their case, no doubt, the government claims that they would not lose their deposit value; rather their deposits would be converted into equity.

In other words, bank are supposed to recapitalize themselves, when they are in a critical condition, by using depositors’ funds under this Bill, rather than by using budgetary resources as now. But this, apart from being of little consolation to depositors, provides a surreptitious route to privatization of public sector banks.

It is of little consolation to depositors, because the value of such equity will fall precisely when the bank is in such a critical state that deposits have to be converted into equity; the depositors therefore will lose much of their wealth anyway. Additionally, they are likely to sell off this equity to private corporate entities to get back at least a part of their money, and this will mean a privatization of public sector banks.

A bunch of government nominees on the Resolution Corporation in other words can so orchestrate a public sector bank’s financial credibility that it can pass into private hands, and even into private corporate hands at throwaway prices, without Parliament coming into the picture at all, and entirely at the whim of the executive.

But then, it may be asked, is it “fair” to use “tax-payers’ money” for rescuing banks?

The principled answer to this is “yes”, provided banks are playing their assigned social role.

It is not “fair” if banks are financing speculative bubbles and come to grief for that reason; but this is not what public sector banks are supposed to be doing anyway.

In other words, “tax-payers’ money” should in principle be available for rescuing public sector banks, but there must be democratic control over the activities of such banks. Being State-owned alone is not enough; they must be subject to democratic control in order to be deserving of “tax-payers’ assistance”.

Besides, this entire wedge that is sought to be driven between “tax payers” and “depositors” is a red herring being used for pushing through the FRDI Bill.

Notwithstanding all the hullaballoo over non-performing assets of the banks, these assets are no more than about 12 percent of total bank assets. Almost 90 percent of such NPAs belong to the nationalized banks; but given the large share of such banks in total banking business, the weight of the NPAs even in their case is not so large as to be alarming.

In addition, the government has just announced a Rs. 2.11 lakh crore recapitalization programme. So there is no question of such banks being in any critical condition now, or even in the foreseeable future.

To present a Bill in Parliament that is sought to be justified by a presumed conflict of interest between the “tax payer” and the “depositor” which can only arise in an eventuality that is nowhere on the horizon, and that can be prevented from arising anyway if we are careful, is not just absurd; it is actually quite mischievous.

It is ironical that the government, instead of measures whereby the corporate defaulters on bank loans, who reportedly account for 75 percent of total NPAs, are made to pay for their misappropriation of depositors’ resources, is announcing measures whereby the depositors would be made to pay for such corporate misappropriation!

Thursday, December 14, 2017

Who is Benefitting from Lower Interest Rates?

Over the last one year, bank interest rates have fallen majorly, at least in theory (it will become clear later in the column, why I say this). The question is, who is benefitting from the lower interest rates? The savers, whose fixed deposits have matured, have had to reinvest them at significantly lower interest rates. This includes retirees who have seen interest rates on their deposits, fall from nine per cent to six per cent in a short period of time. In the process, their incomes have crashed by a third. Not surprisingly, they are having a tough time.
People have suggested that senior citizens should invest with the post office where higher interest rates are on offer. Anyone who has actually invested money with the post office for generating a regular income, would never suggest anything like this. Their service levels are abysmally low. They can give a thorough run around to anyone looking to get paid regularly on the investment he has made with the post office.
In fact, I know of several retirees who have reluctantly moved their investments into mutual funds (both equity and debt), given the low after-tax returns on fixed deposits. Even if the returns on mutual funds are the same as bank fixed deposits, the different tax treatment for both these forms of investing, helps generate higher after-tax returns in case of mutual funds.
This investing strategy has worked well for retirees in the last one year, given that the stock market has rallied massively. Nevertheless, is this a sustainable strategy in the long-term for anyone who is looking to generate a regular income out of his accumulated corpus, given the volatility that comes with investing in a mutual fund?
In a country with almost no social security and a health care system which keeps getting expensive by the day, this is a fair question to ask.
Another set of savers who has lost out due to low interest rates are people saving for their future, the wedding and education of their kids, and their own retirement. These people now need to save more in order to meet their long-term investment goals. Of course, these people still have the option of discovering the power of compounding by investing in mutual funds through the systematic investment plan (SIP) route.
But given the abysmal levels of financial literacy that prevail in the country, the chances that they will be mis-sold a unit linked insurance plan(ULIP) by a private insurance company or an endowment or a money-back policy by Life Insurance Corporation of India, remain very high. These forms of investing remain the worst way you can invest your money.
Also, consumption growth and interest rates are closely linked. Conventional economic logic tells us that at lower interest rates people borrow and spend more, and this increases private consumption growth and in turn helps economic growth. QED.
While that may be true for developed countries, it doesn't quite work like that in India. In India, if interest rates fall, the retirees need to cut down on their regular expenditure because their regular income also falls. People who are saving for the long-term also need to save more in order to meet their investment goals.
Given that most household financial savings get invested in fixed deposits, a fall in interest rates makes people feel less wealthy and this has an impact on their consumption. Due to these reasons people end up cutting down on their expenditure. This is reflected to some extent in Figure 1, which plots the growth in private consumption expenditure over the last few years.
Figure 1:

As interest rates have fallen through 2017, the growth in private consumption expenditure has collapsed from 11.1 per cent to 6.5 per cent. As of December 2016, private consumption expenditure formed 59 per cent of the Indian gross domestic product. Since then, it has fallen to 54 per cent. So, much for lower interest rates.
There are two sides to interest rates, the saving side which I was talking about up until now, and the borrowing side, which I will talk about in the remaining part of this column.
The total non-food lending carried out by Indian banks has actually contracted during this financial year. But weren't lower interest rates supposed to help increase lending? Now only if economic theory and reality played out same to same, the world would be such a different place.
Banks are extremely quick to cut interest rates on their fixed deposits, as well as raising interest rates on their loans. Nevertheless, the same cannot be said about a situation where they need to pass on the benefit of lower interest rates to their borrowers.
Let's take the example of people who have taken on home loans from banks as well as housing finance companies. Over the last one year, the interest rate on a home loan has fallen from 80 to 100 basis points. One basis point is one-hundredth of a percentage.
The trouble is in many cases the banks and the housing finance companies haven't bothered to inform the borrower, about the lower interest rate. And the borrower has unknowingly continued to pay the higher EMI. This never happens when the banks and the housing finance companies need to raise interest rates on their home loans. In that case, the letter/sms/email arrives right on time.
In fact, I have heard cases where people have pointed this dichotomy out to a leading housing finance company, and they have been told that they are expected to come to the office of the housing finance company and keep checking. So much for market competition which is supposed to lower interest rates. Of course, the stock market rewards such companies with a higher price to earnings ratio, given that they can do these things, get away with it, and make more money in the process.
The media which is quick to announce lower EMIs whenever RBI cuts the repo rate, never goes back to check whether EMIs have actually fallen. This is simply because it is easier to take the theoretical way out and announce lower EMIs when RBI cuts the repo rate, whereas actual checking would involve doing some legwork and speaking to banks, housing finance companies and borrowers. And who wants to work hard? It's worth pointing out here that banks are huge advertisers in the media.
The question is when higher interest rates are passed on immediately, why is the same not true with lower home loan interest rates? What are the Reserve Bank of India (RBI) and the National Housing Bank (the RBI subsidiary which regulates housing finance companies) doing about this? Aren't the regulators also supposed to take care of the consumers? Or are they just there to bat for those who they regulate? Or is it a case of "regulatory capture" where those who are regulated (i.e. the banks and the housing finance companies) given that they are organised, manage to get their point of view to the regulator, but the borrowers, given that they are not organised, cannot do that.
Whatever it is, it is not fair. And the RBI and the National Housing Bank need to do something about it. Consumer protection is something that should be high on their agenda, even though it may be the most unglamorous of things that they are supposed to do.

Monday, December 11, 2017

Using Deposits to Rescue Banks is a Bad Idea; It Needs to Be Nipped in the Bud

The following is from Vivek Paul's Diary
I have been travelling for the past two weeks and a question that has been put to me, everywhere I have gone is: "will fixed deposits be used to rescue banks that are in trouble?"
People have been getting WhatsApp forwards essentially saying that the Modi government is planning to use their bank deposits to rescue all the banks that are in trouble. As is usually the case with WhatsApp, this is not true. The truth is a lot more nuanced.
Let's try and understand this in some detail.
Where did the idea of fixed deposits being used to rescue troubled banks come from?
The government had introduced The Financial Resolution and Deposit Insurance(FRDI) Bill, 2017, in August 2017. This Bill is currently being studied in detail by a Joint Committee of members belonging to the Lok Sabha as well as the Rajya Sabha.
The basic idea behind the FRDI Bill is essentially to set up a resolution corporation which will monitor the health of the financial firms like banks, insurance companies, mutual funds, etc., and in case of failure try and resolve them.
The Clause 52 of the FRDI Bill uses a term called "bail-in". This clause essentially empowers the Resolution Corporation "in consultation with the appropriate regulator, if it is satisfied that it necessary to bail-in a specified service provider to absorb the losses incurred, or reasonably expected to be incurred, by the specified service provider."
What does this mean in simple English? It basically means that financial firms or a bank on the verge of a failure can be rescued through a bail-in. Typically, the word bailout is used more often and refers to a situation where money is brought in from the outside to rescue a bank. In case of a bail-in, the rescue is carried out internally by restructuring the liabilities of the bank.
Given that banks pay an interest on their deposits, a deposit is a liability for any bank. The Clause 52 of FRDI essentially allows the resolution corporation to cancel a liability owed by a specified service provider or to modify or change the form of a liability owed by a specified service provider.
What does this mean in simple English? Clause 52 allows the resolution corporation to cancel the repayment of various kinds of deposits. It also allows it to convert deposits into long term bonds or equity for that matter. Haircuts can also be imposed on firms to which the bank owes money. A haircut basically refers to a situation where the borrower negotiates a fresh deal and does not payback the entire amount that it owes to the creditor.
But there are conditions to this...
The bail-in will not impact any liability owed by a specified service provider to the depositors to the extent such deposits are covered by deposit insurance. This basically means that the bail-in will impact only the amount of deposits above the insured amount. As of now, in case of bank deposits, an amount of up to Rs 1 lakh is insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC). This amount hasn't been revised since 1993.
Typically, anyone who has deposits in a bank tends to assume that they are 100 per cent guaranteed. But that is clearly not the case. Over the years, the government has prevented the depositors from taking a hit by merging any bank which is in trouble with another bigger bank.
So, to that extent the situation post FRDI Bill is passed, is not very different from the one that prevails currently. It's just that the government has come to the rescue every time a bank is in trouble and I don't see any reason for that to change, given the pressure on the government when such a situation arises and the risk of the amount of bad press it would generate, if any government allowed a bank to fail.
Over and above this, Clause 55 of the FRDI Bill essentially states that "no creditor of the specified service provider is left in a worse position as a result of application of any method of resolution, than such creditor would have been in the event of its liquidation."
This basically means that no depositors after the bail-in clause is implemented should get an amount of money which is lesser than what he would have got if the firm were to be liquidated and sold lock, stock and barrel.
While, this sounds very simple in theory, it will not be so straightforward to implement this clause.
So why is the government doing this?
In late 2008 and early 2009, governments and taxpayers all over the world bailed out a whole host of financial institutions which were deemed too big to fail. In the process, they ended up creating a huge moral hazard.
As Mohamed A El-Erian writes in The Only Game in Town: "[IT] is the inclination to take more risk because of the perceived backing of an effective and decisive insurance mechanism."
If governments and taxpayers keep rescuing banks what is the signal they are sending out to bank managers and borrowers? That it is okay to lend money irresponsibly given that governments and taxpayers will inevitably come to their rescue.
In order to correct for this moral hazard, in November 2008, the G20, of which India is a member, expanded the Financial Stability Forum and created the Financial Stability Board. The Board came up with a proposal titled "Key Attributes of Effective Resolution Regimes for Financial Institutions". This proposal suggests to "carry out bail-in within resolution as a means to achieve or help achieve continuity of essential functions". India has endorsed this proposal. Hence, unlike what WhatsApp forwards have been claiming this proposal has been in the works for a while now.
But does this really prevent moral hazard?
A bulk of the banking sector in India is controlled by the government owned public sector banks. As of September 30, 2017, these banks had a bad loans rate of 12.6 per cent (for private banks it is at 4.3 per cent).
Bad loans are essentially loans in which the repayment from a borrower has been due for 90 days or more. The bad loans rate when it comes to lending to industry is even higher. In case of some banks it is close to 40 per cent.
This is primarily because banks over the years, under pressure from politicians and bureaucrats, lent a lot of money to crony capitalists, who either siphoned off this money or overborrowed and are now not in a position to repay. This is a risk that remains unless until the banking sector continues to primarily remain government owned in India.
Also, the rate of recovery of bad loans of banks in 2015-2016, stood at 10.3 per cent.
This does not inspire much confidence. In this scenario, having a clause which allows the resolution corporation to get depositors to pay for the losses that banks incur, is really not fair. The moral hazard does not really go away. The bankers, politicians and crony capitalists, can now look at bank deposits to rescue banks. As of now, the government and the taxpayers have kept rescuing public sector banks, by infusing more and more capital into them. Now the depositors can take over, if FRDI Bill becomes an Act.
It is worth pointing out here that the other G20 countries which have supported this proposal have some sort of a social security system in place, which India lacks. Given this, deposits are the major form of savings and earnings for India's senior citizens and clearly, they don't deserve to be a part of any such risk.
While, any government will think twice before using depositor money to rescue a bank, this is not an option that should be made available to governments or bureaucrats in India. It is a bad idea. It needs to be nipped in the bud.
These are my initial thoughts on the issue. Depending on how the situation evolves, I will continue to write on it.
Vivek Kaul is the Editor of the Diary and The Vivek Kaul' Letter. He is the author of the Easy Money trilogy. The books were bestsellers on Amazon. His latest book is India's Big Government - The Intrusive State and How It is Hurting Us.

Wednesday, November 29, 2017

Bitcoin: Headed to the Stars?

BALTIMORE - Bitcoin blew by another milestone.

This morning, the world's first cryptocurrency hit a new record of $9,680.

It started off the year trading at just $997.

"I can't believe what happened," said a friend.

"I bought $1,000 worth in 2012. Bitcoin was trading at about $8 at the time. Then one of the big cryptocurrency exchanges, Mt. Gox, was hacked and almost $500 million worth of bitcoin was stolen. I got out.

"If I had just held onto my stake, it would have been worth more than $1.2 million today."

Lighter Than Air
You hear stories like that all the time now. They are bull market stories. The hero regrets having sold too early.

Later on come the bear market stories when he regrets having sold too late.

But let's enjoy the bull stories now... while we can.

The typical story has its hero... and its villain. The hero bought bitcoin when everyone told him not to. Now he's regarded as a genius. Even his father-in-law is asking his opinion on everything from politics to cocktail recipes.

Last week, the geniuses multiplied...

From what we can tell, bitcoin is headed to the moon. Or to Hell.

Weightless... frictionless... why not?

If it hit $9,000... why not $90,000... or even $900,000?

Bitcoin is a perfect "investment" for the fake-money era. Lighter than air. Not here; not there. Neither animal, vegetable, nor mineral.

Immaterial. Implausible. Imponderable. And immeasurable. There is nothing to hold it back.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

Shutting Out Chinese Products is Not Going to Create Jobs

Public rallies against imported Chinese goods are held quite regularly these days, across different parts of the country. India's dependence on Chinese goods has only grown over the years. This can be made out from Figure 1, which plots India's imports from China every quarter, for the last few years.

Figure 1 tells us very clearly that India's imports from China have grown over the years. Having said that, it doesn't make sense to look at imports in isolation given that India exports stuff to China as well. Hence, Figure 2 (on the next page) plots India's trade deficit with China (i.e. the difference between our total imports from China and our total exports to it).

Figure 1:

Figure 2 clearly shows that India's trade deficit with China has grown over the years. This means that we import much more from China than we export to it. A major reason for this lies in the fact that most of the Indian firms are small in size. Take a look at Figure 3.

Figure 2:

What does Figure 3 tell us? It tells us very clearly that close to 85 per cent of Indian manufacturing firms are small. They employ less than 50 workers. In case of China, only around 25 per cent of the manufacturing firms are small. Also, in case of China, more than 50 per cent of manufacturing firms are large i.e. they employ more than 200 workers. In the Indian case, around 10 per cent of the manufacturing firms are large. And India has very few middle-sized firms which employ anywhere between 50 to 200 workers.

Figure 3: Distribution of manufacturing workforce among small,
medium and large firms in India and China

Given this small size, Indian firms lack economy of scale, which is basically a proportionate fall in costs gained with increased production. Hence, Indian products are costlier than Chinese products. In a recent newsreport, Blooomberg quotes a small shopkeeper as saying: "India-made lights cost twice as much... Customers aren't willing to pay that."

The other factor that helps make Chinese imports cheaper is the huge fall in international shipping costs over the years. This is a point that Tim Harford makes in his new book 50 Things That Made the Modern Economy: "Goods can now be shipped reliably, swiftly and cheaply: rather than the $420 that a customer would have paid... to ship a tonne of goods across the Atlantic in 1954, you might now pay less than $50 a tonne."

This has had a major impact on the way goods are manufactured and business in general is carried out. As Harford writes: "Manufacturers are less and less interested in positioning their factories close to their customers - or even their suppliers. What matters instead is finding a location where the workforce, the regulations, the tax regime and the going wage all help make production as efficient as possible. Workers in China enjoy new opportunities; in developed countries [AND DEVELOPING COUNTRIES] they experience new threats to their jobs; and governments anywhere feel that they're competing with governments everywhere to attract business investment. On top of it all, in a sense, is the consumer, who enjoys the greatest possible range of the cheapest possible products - toys, phones, clothes, anything [EMPHASIS ADDED]."

The point is that the Chinese factories operate on a very large scale and that makes their products cheaper than the ones being made in India. The fact that transportation costs are low, helps as well.

Those against Chinese products want this dominance of Chinese products on India to end. As Arun Ojha, national convener of Swadeshi Jagran Manch recently told Bloomberg: "Our youth are losing jobs and we are becoming traders of Chinese products."

It is important to dissect Ojha's statement. What he is essentially saying is that because Indians are buying Chinese products, Indian industry is shutting down and the Indian youth are losing jobs. So, what is the way out? The way out is that we stop buying Chinese products and start buying Indian ones. Will this help?

This is where things are no longer as straightforward as they seem. The straightforward interpretation here is that, as Indians stop buying Chinese goods and start buying Indian goods, Indian industry will flourish, and Indian youth will find jobs. Now only if it was as simple as that.

Henry Hazlitt discusses a similar situation in his brilliant book Economics in One Lesson, in the context of United Kingdom of Great Britain and United States of America. As he writes: "An American manufacturer of woollen sweaters... sells his sweaters for $30 each, but English manufacturers could sell their sweaters of the same quality for $25. A duty of $5, therefore, is needed to keep him in business. He is not thinking of himself, of course, but of the thousand men and women he employs, and of the people to whom their spending in turn gives employment. Throw them out of work, and you create unemployment and a fall in purchasing power, which would spread in ever-widening circle."

An American manufacturer of sweaters can sell his sweaters for $ 30 per piece. At the same time, an English manufacturer can sell the same sweater for $25 per piece. Hence, the American manufacturer charges $5 or20 per cent more for the same product than the British one. Of course, if both the products are allowed into the American market, the consumer will buy the cheaper one. This would mean that the British manufacturer would flourish. In the process, the American manufacturer might have to shutdown and this would mean a loss of a huge number of jobs.

The American government would obviously be bothered about the American manufacturer and the American jobs. Given this, to ensure that the American manufacturer can compete, the American government needs to impose a duty of $5 on the British manufacturer. This will mean the British manufacturer will also sell sweaters for $30. In the process, the American manufacturer would be able to compete, and jobs would be saved.

This trouble with this argument, as convincing as it sounds, is that it does not take the point of view of the consumer buying the sweater into account. As Hazlitt puts it: "The fallacy comes from looking merely at this manufacturer and his employees, or merely at the American sweater industry. It comes from noticing only the results that are immediately seen, and neglecting the results that are not seen because they are prevented from coming into existence."

If the consumer ends up paying $30 per sweater, he would be paying $5 more. This basically means that he would have $5 less to spend on other things. As Hazlitt writes: "Because the American consumer had to pay $5 more for the same quality of sweater he would have just that much less left over to buy anything else. He would have to reduce his expenditures by $5 somewhere else. In order that one industry might grow or come into existence, a hundred other industries would have to shrink. In order that 50,000 persons might be employed in a woollen sweater industry, 50,000 fewer persons would be employed elsewhere."

If the British manufacturer was allowed a level playing field and sweaters continued to sell at $25 per piece, the American manufacturer would soon have to shutdown. The loss of these 50,000 jobs would be noticed. This would be the seen effect of letting the British sell in the American market.

If these jobs are to be protected, then even the British sweaters would have to sell at $30 per piece. This would leave the consumer with $5 less, which he could have spent on something else, otherwise. This lack of spending would impact other industries and jobs would be lost there. It's just that the loss of these jobs would not be so visible as was the case with the American sweater industry. This is the unseen effect.

Now replace the United States with India and the United Kingdom with China in the above example, the entire logic remains the same. If Indians move towards buying more Indian goods than Chinese, they will end up paying more for those goods. This will leave them with less money to spend elsewhere. This would impact other industries, where jobs would be lost. It's just that these job losses won't be so obvious.

This is a rather obvious point that most people miss out on while analysing this issue. There is a certain opportunity cost of money. As Dan Ariely and Jeff Kreisler write in Dollars and Sense-Money Mishaps and How to Avoid Them: "The opportunity cost of money is that when we spend money on one thing, it's money that we cannot spend on something else, neither right now nor anytime later."

Given this, shutting out Chinese products is not going to create jobs in India. The only way jobs can be created is if Indian industry can compete with China. Right now, it doesn't.

Vivek Kaul is the Editor of the Diary and The Vivek Kaul' Letter. He is the author of the Easy Money trilogy. The books were bestsellers on Amazon. His latest book is India's Big Government - The Intrusive State and How It is Hurting Us.