RISKS TO FINANCIAL STABILITY RISING

When the markets expand both nationally and internationally in terms of business, products and services, complications will arise and risks to stability are inevitable.

July 15, 2012:

The Financial Stability Report of the Reserve Bank released in June 2012 observes that the financial system remains robust though risks to stability have worsened due to global and domestic macroeconomic conditions.

Globally, the areas of concern include possibility of sovereign default and the need for substantial bank recapitalisation in the Euro Zone with escalated fears of contagion and recession. And, domestically, slowing growth, elevated inflation and rising fiscal and current account deficits are major concerns.

When the real sector is in trouble because of low savings, investment and growth, it is natural that it gets reflected in the financial sector. The report indicates that both investment and savings declined in 2010-11.

The country’s gross domestic savings rate declined from 33.8 per cent in 2009-10 to 32.3 per cent in 2010-11. While growth in gross capital formation rate declined from 36.6 per cent to 35.1 percent. GDP growth declined sharply from 8.4 per cent in 2010-11 to 6.5 per cent in 2011-12.

The high inflation, poor GDP growth, persistent fiscal deficit, thanks to food, fertiliser and fuel subsidies, sharp decline in the value of rupee (more than 20 per cent since August 2011), policy paralysis in crucial areas such as infrastructure development, FDI, and so on, resulted in international rating agencies downgrading the economy.

The general reluctance of banks and companies to reduce their profit margin despite the deteriorating economic situation have added to the risks to the financial system.

For banks, the deposit growth rate has fallen to around 14 per cent — the lowest in the last decade. Deregulation of savings bank (SB) rates has not made any impact in the mobilisation of deposits. Barring a few, banks have not effected any change in the SB account rates.

Of late, banks prefer to go in more for borrowed funds and wholesale short-term deposits. Their dependence on borrowed funds, including from the Reserve Bank, as a matter of routine has been on the increase. This shift in banks’ approach to business, perhaps due to operational convenience, if not curbed in time could lead to liquidity risks and asset-liability mismatches.

The increase in non-performing assets (NPAs) is another risk factor affecting banking stability. The quantum of restructured accounts has also increased sharply outpacing the growth of both credit and gross NPAs. Unless banks introduce an inbuilt mechanism to discipline borrowers, say, by professional rating and penalising errant borrowers, the problem of NPAs cannot be tackled. Good borrowers and other stakeholders will continue to bear the brunt and subsidise the bad borrowers.

Interconnectedness arises as banks find easy source of funds from insurance companies and mutual funds compared to raising of deposits. The insurance business is fast developing and they find banks as a safe investment avenue.

Interconnectedness brings depth to the market but adds risks which the regulators need to understand and mitigate. The SEBI, the IRDA and the RBI have a greater role to play by mutual co-operation and co-ordination, and not confrontation.

The risk to financial stability is a fact and the concern of the RBI is real. The volatility in various markets is only a reflection of the failure of the economy which is not in the hands of the RBI alone.

The fall in deposit rates, increase in non-performing loans, and the contagion risk due to interconnectedness between banks and other institutions have to be seen in the context of the weakening fundamentals of the economy.

A close observation of the financial system gives one the impression that the RBI is gradually losing its grip on the financial system, excluding, to some extent, on the banking system. Insurance companies, mutual funds, and joint stock companies which carry out various types of monetary transactions have implications on the capital, money and forex markets.

The interference of the Government in banking affairs has been on the increase, affecting the discipline among banks. Serving two masters at a time is difficult. The RBI has explicitly expressed its displeasure, and the central bank Governor has asked the Finance Ministry not to micro manage banks.

Financial stability is in the interest of the healthy growth of the economy and all the regulators have an equal responsibility in ensuring that the stability is not at risk at any point of time.

As and when the markets expand both nationally and internationally in terms of business, products and services, complications will arise and risks to stability are inevitable.

While a proactive approach of the regulators and the support of the Government can help to minimise the risk and attain the desired level of stability, growth of the real sector is the only solution to bring financial stability on an sustained basis.

(The author is a Mumbai-based consultant.)

(This article appeared in Hindu BusinessLine dated 16/07/12).

(Keywords: Financial Stability Report, Reserve Bank, financial system, global, domestic, macroeconomic conditions

Corruption in China a comparison with India

The article is a good exposure of China's corruption, but it should not be taken as a consolation for all dirty things that take place in India under the influence of politicians and bureaucrats. We should emulate only good examples and if India has achieved what Chinese has in the field of infrastructure and economy,a little bit of corruption here and there would be tolarable. We have only corruption and more of poverty and miserable living conditions for vast majority of people. SA Iyer should have highlighted these aspects also when he compared China's corruption with that of India.
(This is in response to the Article China Beats India,this time in Corruption appeared in Times of India dated 15/07/12)

NPA menace but nobody wants to try a practical solution

The npa menace continues haunt the banking system and it is becoming a threat to the Financial System's Stability. The NPAs disclosed, undisclosed (umpteen ways to camoflage NPAS)  and with those already under CDR mechanism and those in the pipeline estimated at Rs 2,68000 crores is a huge sum which neither the economy nor the banking system can bear and should bear. The loss direct and indirect to the exchequer,the banks,stake holders of banks other than bad borrowers, public ie the common man who bears the brunt ultimately the costs of NPAs through budgetary provisions to capitalise the loss making banks is something astronomical and none including the rating agencies has bothered to assess. This is something strange and questionable. When there is a direct solution to prevent formation of NPAs and to cover up the losses of NPAs available within the banks themselves involving the borrowers and banks, the need to make bear the losses by everybody other than the bad borrowers is something undigestable and not tolerable. The banks can rate the borrowers


professionately by adhering to some standards of monitoring and supervision and levy a penalty from  borrowers who happen to be performing below the prescribed standards. This approach will ensure the borrowers to be more vigilant and make perform better. The relatioship between banks and borrowers will improve and the responsibility of keeping the loan accounts healthy will augment automatically. This rating acn be a tool to  evaluate borrowers even by the SEBI and those who have dealings with bank customers in different ways. The Government can use these ratings for offering tax and other incentives. IPos of Corporates can be priced based on these ratings. Over a period, the banks will have huge fund mobilised from borrowers to cover NPAs and at the sametime the formation of NPAs will have come down considerably. Sibsidising bad borrowers by other stakeholders and general public who include the Common Man is not justifiable and does not sound reasonable.Will the authorities care to seriously consider the solution which has been approved, evaluated and recommended for a trial by veteran academicians. The solution is statistically researched and found to be worth attempting with excellent results. The Balance sheets of banks will get stronger over a period.

This comment is in response to an article appeared in Business World dated 13/07/2012) 

The problem of NPAs has been basically due to poor monitoring of accounts by bankers is a fact which unfortunately does notget the attention it deserves.The internal rating of loan accounts right from the sanction of loans to the closure of loan accounts has not been scientifically carried out by the bankers giving rise to their deterioration and turning into npas over a period. The contacts with borrowers are not very regular and the bad conduct of accounts gets noticed only when payments do not come as per the NPA classification norms. Borrowers also know the shortcomings of banks and they have their own tricks to satisfy the banks although they know very well that they have problems in business. In the case of borrowers having multiple accounts the borrowers and banks join hands to ensure that the accounts do not get classified as NPAs although there are symptoms of sickness. In the case of large accounts, the identification of problems is easy but banks seldom want to dissatisfy the borrower.


 Dr.T.V.Gopalakrishnan

(This comment appeared in Business Line dated 9/7/12) in response to an article appeared in Business Line dated 8/7/12)

Convert Gold into a productive asset

Itis time now to take a serious view on converting gold into financial assets and save the economy from the present crisis.The gold hoardings in India run into thousands of tonnes and part of these if converted into financial assets can rescue the economy and put it back into growth trajectory. The easiest way is to go in for a Gold Bank and mobilise the gold hoardings against issue of bonds carrying reasonable rate of interest.The author's suggestion to allow the banks to keep the CRR balances in gold is good and can be easily tried which will help release some funds for expansion of credit.There are umpteen ways to make use of the gold lying idle in the economy and it is for the Reserve Bank and the Govt to take steps for the productive use of gold.Imports can be fully banned for a temporary period and the gold available in the economy should be brought into the market.Issue of gold coins by banks by importing gold can be replaced by issue of gold coins by using domestic gold.

from: Dr.T.V.Gopalakrishnan

(This was published in response to an article Gold Management a Policy challenge appeared in Business line dated 6/07/12).

Posted on: Jul 6, 2012 at 08:42 IST

Coordination between the Central government and the Reserve Bank is the need of the hour

July 1, 2012:

The preamble of the Reserve Bank of India Act 1934 says ‘Whereas it is expedient to constitute a Reserve Bank of India to regulate the issue of bank notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage.’

This gives an impression that the Reserve Bank has complete grip on the economy and the financial system where the Central Government, State governments, various markets, financial and other institutions and varieties of instruments and people interact and carry out transactions involving transformation of information and high technology. But, it has its own limitations and unless and until the Central Government gives full support and functional autonomy in letter and spirit, implementation of the preamble is practically rendered difficult.

Dominating influence

Further, the Reserve Bank alone cannot bring in the desired impact on the economy when the Central Government, which owns and controls the Reserve Bank by virtue of its owning the entire capital and having the powers to appoint its own well chosen officials on the Board of the Reserve Bank as Directors, has a dominating influence and can dictate its own terms and conditions not necessarily through force but giving signals through indications and expectations conveyed directly or indirectly.

The Bank has no choice but to act. Developing the economy is basically the responsibility of the Government and the Reserve Bank being the central bank of the country having the monopoly of issue of currency note has a joint responsibility with the Government to ensure that the value of the medium of exchange is stable both domestically and internationally and money is available in adequate quantity to develop the economy. This, in economic parlance, is called monetary stability, which if maintained well brings economic growth, price stability and financial stability.

Ups and downs

The growth of the economy and stability of the rupee have seen several ups and downs but all along the Government and the Reserve Bank have maintained perfect understanding and cooperation in strengthening the economy though differences of opinion have cropped up off and on.

But, of late, seeing the present state of affairs in the economy, one is not sure whether the relationship between the Reserve Bank and the Government continues to be cordial and the policies pursued by them in containing the problems of the economy are in tune with the thinking of each other.

The Government set up a Financial Stability Development Council with the Finance Minister as Chairman to oversee the financial regulators and counsel them to ensure financial stability despite the Reserve Bank’s reservations against such an arrangement. Then, the Government appointed an additional Director (for the first time in the history of the Reserve Bank) on the Board of Directors again perhaps to ensure that Government’s thinking gets prevailed and RBI yields to the pressures of the Government.

Over and above that the Finance Minister and the Chief Economic Advisor of the Government makes announcements as to what they expect from RBI just before the Reserve Bank gets ready to decide its monetary policy so that the Bank acts to their line of thinking.

The Finance Ministry also gives directions to banks as to what they should do with interest rates and credit expansion etc; although the banking system is regulated by the Reserve Bank and giving policy directives particularly on aspects of credit is the exclusive prerogative and privilege of the Reserve Bank.

Effectiveness of fiscal policy

The success of monetary policy is fully dependent on the effectiveness of fiscal policy pursued by the Central Government. The fiscal deficit, the economy is facing (at 5.1 per cent 2011-12), has been due to the inadequacies of the fiscal policy to contain food, fuel and fertilizer subsidies.

Further, the Government has failed to develop infrastructure, particularly in generating power, among other things that the economy demands to boost growth, make taxation policies to attract investment both from domestic and international markets, remove the supply constraints by concentrating in the agricultural production, storage and transportation, etc.

The result is continued persistence of inflation (at 7.7 per cent in 2011-12) without responding favourably to monetary policies. The import and export policies have their own short comings. While oil imports which are inevitable continue to rise, the gold imports do not fall drastically despite measures initiated to contain the same.

The increase in the consumption of both oil and gold the demand for which is inelastic to prices has widened the trade deficit. With the fall in inflows of foreign exchange, particularly under FDI and FII categories, the current account deficit is widening and is in the range of 4.1 per cent. Corruption and black money add miseries and the ease of doing business has been fast disappearing.

These are the areas where the Reserve Bank’s monetary policy cannot be of any help. Monetary policy can be said to be effective only if Reserve Bank gets the operational freedom to frame policies in the best interests of the economy which again depends upon the soundness of fiscal and other policies of the Central Government.

It is time for the Central Government to introspect and come out with policies in consultation with the Reserve Bank which has established itself as a very efficient central bank getting recognition for maintaining sound monetary and financial stability without yielding to the temptations or pressures of both domestic and international economic scenario.

It is to the credit of the Central Government that it does consult and coordinate with the Reserve Bank to frame and implement its fiscal policies.

(The author is a consultant. Views are personal)

Keywords: RBI, Central Govt, coordination, economic policy, Monetary policy
(This article appeared in Business Line Dated 2/7/2012)