Finly March-April 2014

FINly Finance Fortnightly Since 2011 March-April 2014 - Issue 35

RBI and New Banking Licenses Subroto Roy Saga

Contents

4 The Subrata Roy Saga

Unfolding of the events

5 Cover Story: Rally of Hope An observation on elections and stock markets

10 New Banking License Challenges and Opportunities

Contributors Irina Goel Arpitha Tripathi Saurabh Prasannaraj Jay Parekh

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From the Editor's

Dear Readers,

It has been a great pleasure for us to create a magazine which aims to enlighten their readers and keep them abreast of the latest happenings.

As the year ends, we bring to you the 35th issue of FINly (the last of 2014) where we analyse the effect of the current elections sentiments on the stock market and whether it's a good time to invest.

The Subrata Roy issue is making news lately and we take a peek at the unfolding events. Finally we also look at the opportunities and challenges that have come about in the new banking licenses to be issued.

Happy Reading!

FINly Editorial Team

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The Subrata Roy Saga -By

Arpita Tripathi

He is officially managing director and chairman of the US$25.94 billion Sahara Empire handling 11 lakh employees. He is popularly known as the ‘Saharasri’. His employees praise him, His investors respect him, politicians in a way admire him for running a huge empire successfully despite the legal obstructions and yet the journalists criticise him of his unlawful and non-transparent means of working.

Subrata Roy got arrested on the morning of February 28. But what was he charged with?

It all started in November 2010 when Securities and Exchange Board of India (SEBI) barred Sahara India Group chief Subrata Roy and two companies from the Sahara stable - Sahara India Real Estate Corp and Sahara Housing Investment Corp - from raising money from the public. The two companies had raised several thousand crores through optionally fully convertible debentures. The fundraising was stated ill-legal.

In May 2011 Supreme Court directed Sahara to furnish the format of the application for an optionally fully convertible debentures (OFCD) scheme and also give a list of agents raising money on its behalf. By June 2011 SEBI directed Sahara to refund the money to the investors along with an interest of 15%.

We are talking about Rs. 24000cr. Sahara group was given deadlines to refund the money in instalments. The company missed its deadline in January 2013 when it was to submit Rs.10000 cr.

As a result the Supreme Court also rejected its plea to review its case for the refund money and it gave orders to SEBI to freeze accounts and seize property of Sahara’s two companies involved. Meanwhile the Sahara chief went ahead and gave a statement to the press that he is completely confident on the way of their operations and challenged the system to find any faults with their working.

Subrata Roy stated in April 2013 that he had repaid Rs 20,000 cr. to his investors and insisted that SEBI should pay the rest of the amount already deposited with them. Supreme court however directed Sahara to present the source of the money paid to the investors and present the title deeds of its assets worth Rs.20,000 crore to SEBI as a guarantee towards the payment of investors’ money. In January 2014 Supreme denied request of the Sahara chief to travel abroad to take care of his overseas business.

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Finally on 28th February Roy was arrested before the police when he failed to appear Supreme Court as directed after the issue of a non-baillable warrant. Subrata Roy along with two of his company directors were sent to Tihar jail on 4th March 2014 and was asked to come out with a proposal to pay back investors’ money by 7th March, which came out to be around Rs. 20000 cr. Sahara group proposed to deposit Rs. 2500 cr. Within three days and the rest by July 2015 but this proposal was rejected.

The case hearing was on 11th march but got postponed due to unknown reasons. Senior counsel CA Sundaram, appearing for Roy, told the court that sending Roy judicial custody was illegal and the decision was taken without following proper law and procedures. On side the court is showing no mercy to the Sahara CEO whereas on the other hand Roy seems to be having full support from his employees.

Reports say that its employees were helping to raise Rs. 10,000 cr.

To release Roy from prison. Additionally Sahara staff can expect a delayed salary for this month.Subrata Roy may be a successful businessman but he may see some really difficult day ahead if these questions remain unanswered.

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Cover Story

Rally of Hope

T

he markets are breaching record levels and have reached dizzying heights.Sensex is currently trading at 22,386 while the Nifty is at 6704. Market players are attributing this rally to the hope of change that Narendra Modi is promising to bring about if elected to power. On the face of it, credentials seldom lie, with a commendable performance on the economic front as the chief minister of Gujarat, the hopes are not without basis. Although, the chance of a hung parliament, a la Delhi assembly elections, is an uncertainty and risk at the back of the mind of every investor.

However, how much of these parameters are relevant to the current and near short term rally? Is it just Narendra Modi, BJP, NDA, elections or mere winds of change that are driving the market? And is this a good time to invest in the stock markets? If smart investors buy low & sell high holds then wouldn’t this be a good time to sell? If efficient market hypothesis is true then hasn't the change in government already been discounted in the current price? Let us break down our analysis into two parts: Micro (political) and macro (economical & trend).

NIFTY

SENSEX

Micro: The UPA has been underperforming for quite a few years now and it has been alleged that it has destroyed a healthy economy that it inherited from the erstwhile NDA. It's socialistic policies and outlook have led to a lost opportunity for India as a nation, which the business friendly and nationalistic NDA would have grabbed by both hands.

However much of this is a case of misperception. UPA has recently okayed 92% of the projects pending due to bureaucratic reasons, it has opened up more than 13 sectors to FDI like retail, defense, telecom and power etc. All this while allowing for pro rural reforms to take place. Therefore UPA, in its economic policy at least, is not any different from a pro business NDA, the only reason then for its image bashing is the spate of multi-billion dollars corruption charges at the highest levels.

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So, NDA and UPA are on the same page on most policy issues. The difference is however in the leadership. NDA has a candidate who has proved his mettle in the state of Gujarat for more than ten years whereas UPA has mostly poor governance to show at the centre with its leadership.

This translates to a hope that the NDA PM candidate may bring in the same “magic” at the centre as he did for the state. However, most of the spending and policy reforms in infrastructure and power that the economy needs are under the state.

This means that the centre can only open up opportunities but the state has ciently and so a change at the centre will have little effect unless followed by systemic changes at the state level.

The alternative party “AAP” with its microscopic focus on ending corruption and a lack of vision on almost all other fronts is a cause for concern. Only time will tell whether it has the wherewithal and oversight to run a nation.

Macro: In seven out of the past eight elections, the two year return from the market have been good except for in the year 1999. In that year, when the National Democratic Alliance (NDA) won the elections, markets surged by 17%. As soon as NDA lost majority and fresh elections took place in October 1999, due to uncertainty, the market lost close to 16%. Post re-election when the NDA Government came to power for the second time, from November 1999 onwards markets started picking up and gained 23%. However the two year return was volatile and unreliable.

Sensex (Before & after 1999 Election)

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Around 80% of the market return of SENSEX have come in the two year period post elections, in the last 30 years. A case in point is the 2004 elections, when UPA came to power, the markets fell immediately after the election as most exit polls predicted an NDA win. Barring this anxiety attack due to uncertainty, the two year returns were splendid. Fresh faces with new promises and a tailwind of reforms inspite of Left party’s opposition drove this rally.

Sensex post-2004 election 2yr rally

Later in 2009, UPA came back to power with stable allies and the market nodded by climbing around 29%.

What we can infer from all these events is that the market participants watch and analyse the process of government formation closely. In the coalition era, any unstable coalition is given a royal thumbs down. Stability indicates the ability of the government to come forth with reforms and have the willpower and gumption to act on it as well.

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Fresh faces matter a lot, especially when economy is at dismal stage due to intrinsic or extrinsic factors or both, as they give a psychological confidence to the participants to speculate on the future, expecting winds of change.

At an economic level, there have been slew of policy reforms, diesel price hikes of around 19 months, debt to GDP level is around 40 to 50% (Japan is at 200%), Forex reserves are at USD 300 billion and the current account and fiscal deficit are under control. All of these indicate a reversal of trend and the economy may well be on a cusp of a bullish divergence.

Macro or micro, it is human psychology to assign a face to good & evil. It is in the human instinct to create heroes in times of triumph and victory and villains in the times of trouble and misery to symbolize, idolize or to get closure and emotional catharsis. Narendra Modi is one such poster boy of hope & revival for the Indian economy at present, only time will tell in retrospect if the markets got this right.

Stocks To Tryout this Election Season !

Analyst across the board are betting high on high beta stocks to ride the election rally. With voting due in 10 days it will be interesting to see how these stocks perform during and after the elections.

Moneybhai.com an associate of moneycontrol.com is a virtual trading site where investors and students can try out different strategies for trading & investment. We urge the readers to try out an election rally strategy by investing in the analyst recommended stocks below or any other high beta stock to find out how they behave in times of election. As such events happen only every five years, valuable insights can be drawn through personal experience. All the best! Happy trading!

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New Banking Licenses Challenges & Opportunities

-By

Irina Goel

on July 1, 2013 the list of 26 applicants for new banking licenses to be issued by the Reserve Bank of India (RBI) was announced. India is one of the top 10 economies of the world, with relatively low domestic credit to gross domestic product (GDP) ratio. The banking sector in India is expected to become the fifth-largest by 2020 and the third largest by 2025. Banking credit is likely to grow at a 17 per cent compound annual growth rate (CAGR) in the medium term, leading to increased credit penetration. All these factors have attracted the new applicants for banking licenses

The parliament had passed the Banking Laws (Amendment) Bill in 2012, which has changed the landscape of the banking sector. The bill allows the Reserve Bank of India (RBI) to make final guidelines on issuing new bank licenses. This could lead to a greater number of banks in the country.

Bimal Jalan Committee The Reserve Bank of India (RBI) has set up a three-member committee under former Governor Bimal Jalan to scrutinise applications for new bank licences. The members are Usha Thorat (former RBI Deputy Governor), C B Bhave (former Sebi chairman) and Nachiket Mor (financial sector expert).The panel will make its recommendations to the Governor and Deputy Governors, who will make the final proposals to the committee of the RBI central board.

There were 26 applicants from the public and private sector for bank licences, including Tata Sons, Reliance etc. Among public sector units, India Post and IFCI have submitted applications. Microfinance institutions such as Bandhan Financial Services and Janalakshmi Financial, too, have expressed their intention to set up banks. .

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New Banking Licences- Reasons The new banking licenses were issued in 1993 and 1994 due to several economic conditions prevalent at that time. One of the reasons was the economic liberalization and the growing importance of financial institutions in the country. The broad objectives of RBI for issuing new banking licenses: 1. Financial inclusion: Financial inclusion is the delivery of affordable financial services to vast sections of disadvantaged and low income groups. Financial inclusion is achieved by offering “no-frillsâ€? savÂŹings-bank accounts and easy access to credit facilities.

2. Wider reach of financial services: Position of households in India availing Banking services

The above table shows that even though the number of households availing banking services has increase over the decade, the total number of households availing the banking services is only 58.7%.

This shows that efforts for financial inclusion need to be increased. This can be done by granting more banking licenses to private companies having the resources to enter the unbanked areas.

The main aim is to make the banking services available to wider section of the population to achieve the objective of financial inclusion.

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Opportunities for the applicants 1. An underbanked population: As per the Census of 2011, only 54.4% of the rural households avail banking services and only 67.8% of the urban households avail banking services. There is a huge underbanked population available in India which creates opportunities for the banks to open new branches. The RBI has issued guidelines to the new applicants of the banking licenses to open 25% of their branches in the rural areas with a population of 9,999.

2. Access to low cost funds and existing infrastructure: Most of the 26 applicants for the banking licenss already have a presence in the financial services sector for example Bajaj Finserv Ltd, LIC Housing Finance Ltd. and Reliance Capital Ltd. Therefore, they are likely to have better access to low-cost funds in the form of current and savings deposits.

3. Dissatisfaction with existing banks: In a survey on new banking licenses conducted by FICCI, 96% of the respondents felt that there is a need of new banks in India. The existing banks are lagging behind in several areas like customer service, technological innovations etc., the guidelines for the new bank licenses have also set the requirement of using modern banking infrastructure by the new entrants. Thus, the new entrants have an opportunity to overcome these limitations and offer a better service.

4. Low credit penetration: As per Credit Information Bureau (India) Ltd. (CIBIL), Credit penetration in India has grown in the last seven years, with the share of first-time borrowers growing from 32% in 2006 to 50% in 2012. This indicates that credit penetration still has room to grow, and that new entrants can take advantage of this opportunity.

5. Low penetration of financial products and services: As per FICCI, 80% of the Indian population is without life insurance, while 90% are excluded from the non – life insurance category. The new applicants have opportunity in the financial products and services area such as mutual funds, insurance etc. due to their low penetration.

Challenges for the new applicants 1.Regulatory requirement: The new banks have to comply with several regulatory requirements and guidelines issued by the RBI. These include CRR (cash reserve ratio) and SLR (statutory liquidity ratio) requirements. They have to maintain a Capital Adequacy Ratio of 13% of their risk weighted assets 2.Capital investment: The new banks need to set up an operational branch within 18 months of the issuance of the license.

This will require investments in land, infrastructure, recruitments and training, advertisement etc. They are also required to use modern banking infrastructure and IT facilities. Also, 25% of the branches have to be set up in rural underbanked areas to enable financial inclusion. The new banks will have to bear this cost without the possibility of immediate returns.

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3.Financial inclusion and priority sector lending: As has been covered earlier, financial inclusion is one of the main reasons for issuing new bank licenses.

The parameters for measuring financial inclusion are branch penetration (number of branches per lakh of population), credit penetration (number of loan accounts per lakh of population) and deposit penetration (number of savings/deposit accounts per lakh of population). Priority sector refers to those sectors of the economy which may not get timely and adequate credit due to absence of the financial services.

4.

Competition: The new banks will be competing with established public sector, private sector, foreign banks, co-operative banks and also with financial intermediaries.

5.

IT infrastructure: The new banks have been given guidelines to use modern IT infrastructure.

This will also pose challenges for the new banks as they need to incur costs to set up the modern banking infrastructure.

6.

Regulatory reporting and compliance automation: The new banks have to set up regulatory reporting process and have to be ADF (Automated Data Flow) Compliant which automates regulatory reports as per RBI guidelines.

7.

CBS implementation: The new banks are expected to run on a CBS (Core Banking Solutions) platform from the start. In CBS, all the information relating to a client’s account is stored in a central server of the bank which is available to all the networked branches of the bank. This needs to be carried out through an advanced software by making use of specialized agencies.

Recently there has been opposition from several quarters many economists and institutions, including Nobel laureate Joseph Stiglitz and the International Monetary Fund, as they believe that that the risks of giving banking licenses to private corporate houses are more than the benefits.

Some of the business houses among the 25 applicants are the Anil Ambani’s Reliance Capital, Aditya Birla group, and the Bajaj group.

Tata Sons and the Videocon group-promoted Value Industries had withdrawn their applications, while M&M Finance, part of the Mahindra group, did not finally apply. IDFC and a couple of prominent nonbanking financial companies and microfinance institutions are most likely to get the licenses and, it is largely certain that India Post will not be considered, as it is owned by the government. The licences will be awarded only to entities in the private sector.

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