FROM EDITOR’S DESK Dear Niveshak
Niveshak Volume IX ISSUE X October 2016 Faculty Chairman
Prof. P. Saravanan
THE TEAM Aaron Keith Rego Abhishek Jaiswal Aditya Kumar Jain Akshay Kaushal Anand Mittal Anisha Khurana Ankit Singhal Ankur Kumar Anoop Prakash Arjun Bhargava Devansh Sheth Dhruvika Chawalla Girraj Goyal Pratibha Sapra Sankeerth Bondugula Saurabh Gupta Shreyans Jain Vinay Gundecha All images, design and artwork are copyright of IIM Shillong Finance Club ©Finance Club Indian Institute of Management Shillong www.iims-niveshak.com
This month was mainly abuzz by the news of removal of Cyrus Mistry from Tata Sons, people’s speculations of who his successor might be; how all of it is going to affect the markets and specifically, the Tata group’s future. The hovering uncertainty did reflect on the benchmark Sensex index as well, which closed at 27,930.21, growing by only about 0.23% during the month. The security breach that resulted in the compromise of information of over 32 lakh debit cards because of a malware installed in some of the ATMs was another hot topic of the month. Majority of these cards belonged to the banking giant State Bank of India, and its officials have said that they would be reissuing over 6 lakh debit cards. Customers across different banks were suggested to change their PINs. The breach did cause some unrest among lakhs of people who use this facility on a daily basis. Subsequently, the National Payments Council of India had to intervene and call for a forensic audit to look into the issue. The incident shows that we still have to go a long way in strengthening the security in our banking system. Campaigns by the US Presidential candidates – Donald Trump and Hilary Clinton, and the uncertainty revolving around the possible outcome seemed to affect the market sentiments as well, as both of them have drastically opposite views on their foreign policies. The elections are scheduled to be held in the second week of November. Amidst all these uncertainties, China surprisingly brought some positivity in the global outlook, showing signs of recovery in its industrial output with better than expected growth in the Purchasing Managers Index. On the magazine front, the Article of the Month talks about the China Housing Bubble. The author has given some really interesting insights about the topic, and has succeeded in drawing striking similarities between the current scenario in China and the conditions that had caused a crisis in some other Economies in the past. Our cover story is about the ouster of Cyrus Mistry from Tata Sons. The article talks in detail about the hunt for the potential successors, and also discusses how certain other organizations have previously gone through a leadership crisis. In the FinGyaan section, the author talks about FRTB and its impact on Risk Management, the need for banks to redesign their trading desks, and how FRTB intends to standardize market risk treatments across various sectors. FinSight talks about the buzz word these days – Financial Inclusion. The author dwells into discussions about the background of the term, has analyzed the issues in the current banking system, and given a fair evaluation measuring the successes of initiatives taken by the government so far. In place of FinRewind, we have introduced a new section called ‘FinaFame’ under which, each month we would be bringing to light a famous personality who has had a great impact in the financial world. This month’s article talks about the ex-RBI Governor and perhaps one of the most respected men in the Indian Economy – Mr. Raghuram Rajan. The Classroom section explains the concept of ‘Swaptions’, or Swap Options. It is an interesting capital market instrument which is essentially an option to enter into an interest rate swap or some other type of swap. Finally, we would like to thank our readers for their immense support and encouragement. You remain our prime motivating factor that keeps our spirits high and gives us the vigour and vitality to keep working hard. We hope you had a great month and wish you the best for the new one. With all your blessings Stay Invested! Team Niveshak
Disclaimer: The views presented are the opinion/work of the individual author and the Finance Club of IIM Shillong bears no responsibility whatsoever.
CONTENTS Niveshak Times
04 The Month That Was
Cover Story
Equity Research
10 Page Industries Ltd.
Article of the month
12 The
Greatest Mortgage Bubble ever: A lesson from History to China’s Inflating Property Market
FinGyaan
16
TATA VS TATA
Personal Finance
32 Why financial results of a firm Fundamental Review of Trad- are key to investing decisions ing Book and its impact on Risk Management Classroom 20
FinaFame
24 Raghuram G. Rajan - A banker on the move!
FinSight
28 Financial Inclusion - an engine for Indian economy growth
34 Swaptions
The Month That Was
4
NIVESHAK
www.iims-niveshak.com
The Niveshak Times Team NIVESHAK
IIM Shillong Tata Sons ousting of Cyrus Mistry from the Chairman post
well. Amazon is estimated to be spending three times more than the local market leader Flipkart.
October 24th 2016 marks a significant day in the history of one of the biggest conglomerates in the world. Tata Sons board has decided to replace its Chairman Cirus Mistry with its former chairman Ratan Tata as its interim chairman. Cirus Mistry spearheaded the group from December 19, 2012 to October 24, 2016. He happens to be the 6th chairman of the group and replaced Ratan Tata upon the latter’s retirement.
Amazon recently ramped up investments in India, launching many international products like its annual subscription service Prime, signing deals with large Indian movie studios like Karan johar’s Dharma Productions, Mukesh Bhatt’s Vishesh Films and Chhota Bheem maker Green Gold Animation for the launch of its video service. It also picked up a tender for digital rights for the IPL indicating its plans to invest more in a market where the online retail is expected to grow to $80 - $100 Billion.
The exact reason for the decision is not yet revealed, but it is speculated that the removal was a result of persisting differences between the board’s decisions and his decisions. The latest trigger was Tata Power’s acquisition of Welspun Renewables’ solar and power assets — the deal went through without consultation with the Tata Sons board, according to a source. In fact, the process of consultation and getting approvals from a Tata Trusts committee for issues related to the group resulted in tension on several occasions. The 11 board members who took this decision also disbanded the executive council of Tata Sons with immediate effect. The board has a task of finding a new Chairman for the group and Industry insiders are betting on half a dozen senior personalities to fill in for the post. To name a few, Indra Nooyi of Pepsi, Arun Sarin, former Vodafone CEO, Noel Tata of Tata International, N Chandrasekaran, TCS CEO and Ishaat Hussain from Tata Group are few of them being considered. Amazon’s battle with Flipkart and Snapdeal left it in huge losses Amazon Inc reported significant losses in the international business for the quarter ended in September due largely in the Indian online retail market. The company has undergone losses to the tune of $541 million in the 3rd quarter as compared with$208 million loss during the same period last year. The fierce battle between Amazon and its competitors in the most competitive online retail markets is set to continue in the next quarter as
OCTOBER 2016
China shows recovery in manufacturing and services growth The Ciaxin manufacturing PMI (Purchasing Managers’ Index) rose to 51.2 in October, the fastest pace of improvement since March 2011. A rebound in new order growth amid stronger demand helped the gauge. Any figure above 50 suggests expansionary activity while sub 50 levels indicate contraction. Manufacturing’s contribution to overall growth has been slipping over the years as Beijing transitions its economy from industry to consumption, accounting for around 40 percent of gross domestic product. Services, on the other hand, now makes up more than half of the economy and the sector which includes real estate, restaurants, and e commerce has been on a steady upwards climb. But the recovery itself is cause for concern as it was driven primarily by significant credit expansion, especially within property and infrastructure. China experienced rapid growth in property prices this year, due to the measures introduced by the government to boost home sales and to reduce developers large inventories. Fears of housing bubble prompted the regulators to announce a flurry of cooling measures in more than 20 cities. Banks cut lending rates Top lenders of the country including ICICI Bank and State Bank of India, cut their lending rates under a new system of computation. ICICI was the first bank to announce a 0.10% cut in its marginal
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NIVESHAK
cost of funds based lending rate (MCLR), which was followed by a similar move by SBI, but of a larger measure of 0.15%. Following the trend, a few state-owned lenders also announced cuts in MCLR recently. While Punjab National Bank cut its MCLR by 5 bps across tenures, Dena Bank trimmed overnight rates as well as rates on one-month and one-year loans. A rate cut of 10 bps was done by Union Bank of India and State Bank of Bikaner and Jaipur across tenures. The revised rates have been effective from November 1. Since January 2015, the central bank has reduced repo rate by 175 bps, including the recent rate cut, but banks have only reduced their base rates by 60 bps. Rosneft buys 49% stake in Essar Oil Russia’s oil giant Rosneft took over India’s second largest private oil firm Essar Oil this October, in a deal valued close to USD 12.9 billion – USD 10.9 billion for a 20 million tons/year refinery in Gujarat and 2,700+ petrol pumps and another USD 2 billion for Vadinar port (Gujarat). Rosneft bought 49% stake in Essar Oil’s refinery, port and petrol pumps, while Netherlands-based Trafigura Group Pte & Russian investment fund United Capital Partners split another 49% equity equally. The remaining 2% stake will be held by minority shareholders after delisting of the company. The cash received from selling the stake in its oil unit will help Essar reduce a substantial part of the company’s debt, making this deal the largest debt reduction exercise by an Indian business. The deal 32 Lakh Debit Cards Compromised
State Bank of willthe re-issue over 6ofLakh is expected to India close in first quarter 2017.debit cards. This security breach is not at in the banks systems but at the ATMs, is what the banks claim. The data is said to be compromised when the cards were used on the infected machines. The magstripe cards are more vulnerable to this malware than the EMV chip cards. NCPI (National Payments Council of India) has initiated a forensic audit on bank servers to investigate further into this issue. India called for banning China goods during the Diwali Season In the light of calls for boycotting Chinese goods during the Diwali season, China said such a move will negatively impact India-bound investments from Chinese enterprises and also the bilateral cooperation between the two countries. Any such boycott would not have much impact on Chinese exports, but “the biggest losers… will be Indian traders and consumers”. The Chinese embassy said China is the world’s largest trading nation in goods, with its exports in 2015 amounted to USD 2276.5 billion. “The exports to India accounted for only 2 per cent of China’s total exports and India’s boycott of Chinese goods will not have much impact on China’s exports. China is more concerned that the boycott will negatively affect Chinese enterprises to invest in India and the bilateral cooperation,” it said. The call to boycott Chinese goods was being made to protest against China’s support to Pakistan, Amid the tension in Indo-Pak ties.
Over 32 lakh debit cards information has been compromised due to a security breach exposing PIN numbers to a malware installed in the ATMs. Majority of these debit cards belong to State Bank of India, HDFC Bank, Yes Bank and ICICI Bank. This malware would let unauthorized persons to access the data on debit cards. These cards use Mastercard, RuPay and Visa platforms. Some banks have volunteered to replace the compromised cards and at the same time have urged the customers to change the debit card PINs (Personal Identification Number). © FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG
The Month That Was
The Niveshak Times
5
6
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NIVESHAK
28,400.00
BSE
DII
1,500
FII
1,000
28,000.00
500
27,800.00
0
27,600.00
-500
27,400.00
-1,000
27,200.00
-1,500
27,000.00
-2,000
BSE
28,200.00
30-10-2016
28-10-2016
27-10-2016
26-10-2016
2.50%
66.72 74.05 64.62 83.14 48.16 JPY/1 USD
25-10-2016
3.00%
GBP/1 USD
24-10-2016
3.50%
Euro/1 USD
21-10-2016
CURRENCY RATES
INR/1 USD
20-10-2016
Source: www.bseindia.com
4.00%
19-10-2016
1,11,42,243
INR / 1 USD INR / 1 Euro INR / 100 Jap. YEN INR / 1 Pound Sterling INR / 1 SGD
18-10-2016
17-10-2016
14-10-2016
13-10-2016
10-10-2016
07-10-2016
06-10-2016
05-10-2016
04-10-2016
03-10-2016
Source: www.bseindia.com
MARKET CAP (IN RS. CR) BSE Mkt. Cap
SGD/1 USD
LENDING / DEPOSIT RATES Base rate Deposit rate
9.30%-9.65% 7.00% - 7.30%
RESERVE RATIOS CRR SLR
4.00% 20.75%
POLICY RATES Bank Rate Repo rate Reverse Repo rate
6.75% 6.25% 5.75%
2.00% 1.50%
Source: www.bseindia.com 1.00% 0.50% 0.00%
OCTOBER 2016
FII, DII Net turnover (in Rs. Crores)
Market CoverSnapshot Story
Market Snapshot
Date as on October 31st
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NIVESHAK
BSE Index % change Open Close Sensex 0.23% 27865.96 27930 AUTO 0.85% 22043 22232 BANKEX 1.46% 22046 22368 CG 2.33% 14582 14921 CD 3.02% 12549 12927 FMCG 0.59% 8461 8511 Healthcare 1.80% 16181 16472 IT -1.92% 10229 10033 METAL 5.67% 9764 10318 OIL&GAS 8.26% 11378 12317 POWER 0.83% 1990 2006 REALTY 2.91% 1512 1556 TECK -1.88% 5631 5525 Smallcap 6.28% 12781 13583 MIDCAP 2.33% 13167 13473 PSU 6.34% 7462 7936
% Change TECK, -1.88% Smallcap, 6.28% REALTY, 2.91% PSU, 6.34% POWER, 0.83% OIL&GAS, 8.26% MIDCAP, 2.33% IT, -1.92%
METAL, 5.67%
1 Healthcare, 1.80% FMCG, 0.59% CD, 3.02% CG, 2.33% BANKEX, 1.46% AUTO, 0.85% Sensex, 0.23%
© FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG
Market CoverSnapshot Story
Market Snapshot
7
Niveshak Investment Fund
Done on 30/6/14
Information Technology(10.68%) HCL Tech.
Infosys
TCS
Wg: 3.72% Gain : 6.21%
Wg: 3.22% Gain: 19.64%
Wg: 3.73% Gain : -5.43%
FMCG(21.80%) Colgate HUL
Britannia
Wg: 7.19% Gain: 227.95%
Wg: 5.68% Gain : 28.65%
Wg: 4.17% Gain: 20.41%
Amara Raja Wg: 4.79% Gain: 40.23%
Godrej Consm. Wg: 7.99% Gain: 74.14%
Pharmaceuticals (10.16%) Dr Reddy’s Labs Wg: 4.13% Gain: 6.65%
Lupin Wg: 6.02% Gain : 23.08%
Midcap Stocks (12.26%) Bharat Forge Wg: 3.85% Gain: -9.55%
Kalpataru Power Wg: 3.89% Gain: --6.93%
HDFC Bank Wg: 7.05% Gain: 34.91%
ITC
Wg: 4.75% Gain: 8.71%
Misc. (12.14%)
Auto (10.09%) Tata Motors Wg: 5.30% Gain: 14.24%
Bank (7.05%)
Natco Pharma Wg: 4.53% Gain: 9.98%
Titan Company Wg: 4.15% Gain: -1.61%
Chemicals (8.69%) Asian Paints Wg: 8.69% Gain: 65.87%
Textile (7.14%) Page Indus. Wg: 7.14% Gain : 50.31%
Performance Evaluation
As on 31st Oct 2016
Oct Performance of Nivehshak Investment Fund 101
185
Performance of Niveshak Investment Fund since Inception
175 100
165
99
155
NIF
145
98
135
97
125 115
96 95
Sensex
105 3/10
6/10
95 9/10 12/10 15/10 18/10 21/10 24/10 27/10 30/10 30-01-2014 18-08-2014 27-02-2015 03-09-2015 16-03-2016 28-10-2016 Scaled Sensex
Scaled NIF
Opening Portfolio Value : 10,00,000 Current Portfolio Value : 16,66,794 Change in Portfolio Value : 66.68% Change in Sensex : 31.72%
Value Scaled to 100
Risk Measures: Standard Deviation : 19.41 (Sensex 9.90) Sharpe Ratio : 3.23 (Sensex : 3.26) Cash Remaining: 58,000
Comments on NIF’s Performance & Way Ahead: The market stayed flat during the Diwali month, with the Information Technology stocks - which are one of the major drivers of the index - underperforming. Ironically, the markets dropped 0.04% even on the special trading session that was held to mark the beginning of the new Hindu Year-Samvat2073. The stagnancy was mainly driven by uncertainties arising because of the ouster of Cyrus Mistry from Tata Sons and the speculations revolving around the US Presidential Elections.In the coming month, the markets should likely be seeing more positive sentiments from the investors, counting on the better than expected industrial growth in China. The fixing of rates by the GST council would have a major impact on the markets, as it is something that is going to affect industries across all the sectors. It would also be interesting to see how the Tata group fiasco evolves as the investors would be drawing cues from any developments that might happen. The top performers during the month in the NIF were Dr. Reddy Lab and Page Industries which saw a gain of 5% and 6% respectively whereas the laggards were Asian Paints and Titan which fell by nearly 10% and 6% respectively.
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Equity CoverResearch Story
Equity Research report: Page Industries Ltd. EQUITY RESEARCH REPORT – Page Industries Limited Date: 31st October Rating Matrix Rating Target Current Market price
Hold Rs. 16453 Rs. 17581
Ticker (BSE)
532827
Ticker (NSE)
PAGEIND
M- Cap
₹ 17585.25 Cr.
Page Industries Limited is a Banglore based company in India with an exclusive license for manufacturing, distributing and marketing of products of JOCKEY® brand in India, Sri Lanka, Bangladesh, Nepal and UAE. It also has license of Speedo International Ltd., a manufacturer and distributor of swimwear and swim related accessories based in Nottingham, UK. The license with Speedo international Ltd. started on January 2012. Speedo since its inception in India has achieved the sales growth with a CAGR of 16.5% over the 4 years from 2012 to 2016. The annual turnover of Speedo has increased to INR 295 million in 2016 from INR 160 million in 2012. Page Industry established the premium segment and introduced high quality products in innerwear category. The company has achieved an annual turnover of Rs.17,896.67 million in FY 2015-16. Page Industries products under the Jockey India Brand include innerwear, sports & leisure wear, thermals and socks for both men and women. Speedo products include Swimwear, Equipment, Water Shorts, Apparel and footwear. The primary sources of revenue for Page Industries are Innerwear and Leisurewear with approximately INR 17.2 billion sales out of a total of Rs.17.5 billion. The products are sold by company through Exclusive Brand Outlets (EBOs), Large Format Stores (LFSs), Multi Brand Outlets (MBOs), Traditional hosiery stores and Multi-purpose stores spread across India. There are approximately 30,000 retail stores, and the company has opened 277 EBOs across India. The Board of Directors of company consist of 5 Independent directors, 2 Executive directors and 3 Non-executive directors. The remuneration to be paid to the Directors & Senior Management Personnel is determined by a designated Committee and is recommended to the Board for approval, and is in accordance with the provisions under the Companies Act, 2013. The remuneration policy also says that the independent directors shall not be entitled to any stock options of the company. Company in current year was not able to spend prescribed amount in CSR activities in current year and thus planning to increase CSR spending in coming year.
Growth Drivers
Company Background
Other Apparels & Accessories
Business Description
Sector
Corporate Governance
Potential Upside (Annualized) 6.85%
Basic Information
Shareholding Pattern (%) (As per BSE)
Sep 16’
June – Mar – 16’ 16’
Promoter
49.01
49.01
49.01
Public
50.99
50.99
50.99
Others
0.00
0.00
0.00
Total
100.00 100.00 100.00
The industry has been poised with a strong growth of nearly 9% CAGR. Currently, the Indian innerwear is worth INR 19,960 crore which is estimated to increase to INR 68,270 crore by 2024. The main growth drivers for in future for Page industries are consumer trends in the form of rising discretionary spend, growing number of middle income families that will prefer branded products offered by companies like Page Industries, and massive urbanization in India. Page Industries also looking for capturing more Indian innerwear women market that is expected to grow at the rate of 15% CAGR. The growing number of working women and the increased share of western wear in their wardrobe have propelled this growth. Largely unorganized, the women’s innerwear market is at present dominated by many local brands. More organized retail market with an improved retail experience offering by company can be a positive growth factor. The other potential area for the company is brand Speedo. The company is betting high on the Speedo and looking to further expand its business. The contributing factors to the growth in business is swimming is adopted by kids, high rise apartments that provides access to swimming pools to their residents, Beach/resort becoming preferred destination for holidays
OCTOBER 2016
NIVESHAK
Date: 31st October
FY12
FY13
FY14
FY15
FY16
80 60 40 20 0
FY12
FY13
Maxwell Industries
FY14
FY15
FY16
Rupa and Company
Comparable Valuation
We have calculated the stock’s intrinsic value based on a weighted average of DCF and Residual Income based valuation. Starting FY17, growth in revenues have been estimated at a gradually declining rate from 25% to 10%, averaging 21% for the first 5-yr and 11% for the next 5. Due to the non-cyclical nature of business, the sensitivity of Page Industries stock is below 1, indicating a defensive nature with a WACC of 11.44%. The fundamental value stands at INR 17581 and given a CMP of INR 16453 as on 31st Oct, ’16, the stock is undervalued. Company’s profitability has remained stable, leading to low beta. We have assumed a higher beta in coming years given the chance of instability in the future earnings. Company’s profitability might be threatened by new competitors, like Lovable Lingerie. However Page Industries commands a high brand loyalty and a market leader position.
Rating Def.
BUY: If stock is expected to deliver more than 10% annualized returns over holding period NEUTRAL: If stock is expected to deliver (-)10% 10% annualized returns over holding period SELL: If stock is expected to deliver less than (-)10% annualized returns over holding period
Technical Analysis
Page Industries Ltd
The technical analysis reflects stock retracement from recent 52 week high. It can find support at the levels of INR 15200 and INR 14800 respectively using Fibonacci retracements. Oscillators such as the MACD, RSI, and stochastics also indicate that the stock may experience a short phase of downward movement following which the stock is expected to regain its upwards momentum.
Industry Competition
30 25 20 15 10 5 0 -5 -10
ROE
Industry Figure
ROA
Comparison of Competitors
Industry Rivalry – High
•
Market growth rate is high inviting large competition and high fragmentation in market
• •
Large and diverse client base Buyers can easily switch to other brands
•
Contracts with plenty of suppliers and they are locally available Switching costs are moderate Threat of forward integration by them is low
• •
Buyer power – High
Supplier Power – Low
Threat of Substitutes – Moderate
• Innerwear segment is discretionary and down trading is possible during adverse condition. • Brand loyalty could partially control down trading
Threat of New Entry – Medium
• Entry barriers are high. The business is scalabl e with high market growth and high brand loyalty. • Power of distribution network is high.
Valuation Summary Value/Share Weight Fair Value 19072 0.5 17581 Residual Income Valuation 16088 0.5 Method Discounted Cash Flows
© FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG
Equity CoverResearch Story
EQUITY RESEARCH REPORT – Page Industries Limited
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Article of the Month Cover Story
12
The Greatest Mortgage Bubble Ever: A lesson from History to China’s Inflating Property Market Rushi Vyas “What we know about the global financial crisis is that we don’t know very much.” - Paul Samuelson Prior to the 2008 global financial crisis house mortgages were considered to be one of the safest debts in the world. The ideology that the house mortgage market can never fail was wiped out in a storm that costed the world trillions of dollars. The bursting of the ‘dot com bubble’ in 2001 urged Alan Greenspan (US Fed Chairman 1987-2006) to drop interest rates to 1% which triggered heavy borrowing of money due to its inexpensiveness. Eventually
OCTOBER 2016
IIM Rohtak
the land and real estate demand and prices peaked resulting in large scale credit defaults from owners when the market correction kicked in. It wasn’t the first time though that the housing market caused an economic downturn. In 1992 Japan’s real estate bubble collapsed which resulted in what is popularly known as ‘The Lost Decade’. From 1986 to 1991 an aggressive fiscal policy was adopted by the Bank of Japan in order to attract capital investment. Such a policy triggered a rapid acceleration of asset demand and asset prices, much of it fuelled by credit, which later resulted in large scale accumulation of non-performing loans. History is important because it teaches
NIVESHAK even higher than US’ did during the subprime crisis. This is a cause of concern because it indicates that the country does not produce enough to bear all the debts it has. and banks on sanctioning housing and real estate loans. Even though in China the lending rate is more than 25%, people have not refrained from buying houses and property on credit. This has been accelerated by the fall of the Chinese stock market in 2015, leaving investors no other options to invest in. Many of them may have resorted to the real estate markets. Here is a comparison of the amount of loans secured by mortgages and real estate in Japan, US and China: Mortgage and Real-Estate Loans During both the Japan and the US mortgage
China Japan US
(Source: Bloomberg)
(Source: Bloomberg) The graph suggests that the credit to GDP ratio for Japan peaked during the real estate bubble burst which caused the crisis in first half of the 90s. Same held true for the US, with the credit to GDP ratio peaking in 2007-08 i.e. during the crisis. China’s credit to GDP ratio has been increasing without stops and it has peaked
crisis, the amount of loans secured by mortgages and real estate were very high. This was due to the relaxed norms by governments and banks on sanctioning housing and real estate loans. Even though in China the lending rate is more than 25%, people have not refrained from buying houses and property on credit. This has been accelerated by the fall
© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG
Article of the Month Cover Story
us invaluable lessons, but perhaps China thinks otherwise. Let us see how. Credit to GDP Ratio Credit to GDP Ratio is the ratio of total debts of a country to its nominal GDP. According to Bank for International Settlements (BIS) data, the government, corporate, and household sectors in China collectively had $ 26.6 trillion in outstanding debt as of 2015. According to the IMF, a high level credit-to-GDP ratio sustained over a long period can be a prelude to a banking crisis. Kaminsky & Reinhart (2009) carried out an extensive research and found that Credit to GDP Ratio is a powerful indicator of an upcoming crisis. Based on the research, I’ve looked at the credit to GDP ratio of Japan and US over the years and found this:
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Article of the Month Cover Story
14
NIVESHAK of the Chinese stock market in 2015, leaving investors no other options to invest in. Many of them may have resorted to the real estate markets. Here is a comparison of the amount of loans secured by mortgages and real estate in Japan, US and China:
Housing and Real-Estate Prices Before the 2008 subprime crisis the housing and real-estate prices were very high and were later found to be overpriced when the markets corrected. The story was similar for Japan where the prices remained very high during the followup to the 1990 bubble burst as shown:
(Source: Bloomberg)
(Source: doctorhousingbubble.com) The number of substandard loans in case of Japan was significantly high in the 90s and the early 2000s as shown in the graph. In the US the count began rising significantly in 2006 and peaked in 2009-10 when the global crisis brought the system to reality. The substandard loans for China have risen meteorically over the past 5 years, almost identical increase to the rise in US from 2006 to 2009. This is a major cause of concern because a high amount of non-performing loans never bodes well.
OCTOBER 2016
China has been treading over the same waters recently. The prices in big cities like Beijing and Shanghai are shooting up and the government has realised that they need to control this burst. During the subprime crisis of US the house prices peaked 2 years before the crisis initiated. It is a probable pre-indicator of a looming crisis. Here is the graph indicating change in real estate prices over the years for Japan, US and China:
NIVESHAK
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Article of the Month Cover Story
(Source: Bloomberg) Hence the comparison of China’s current housing bubble to two of the most devastating financial crisis of the world shows that we may be standing on the cusp of another crisis. The similarities are alarming, rather frightening I believe. Stringent steps are required in China if it is to escape this looming disaster. During the past two crisis the central banks were too late to react to the impending problem. However China seems to realise now that it needs to curb this inflating bubble quickly. The down payment rates for house mortgag
es have been increased in big cities of China, but the question is whether it should have been done much earlier. Moreover the GDP growth of China has slowed down over the past few years. Chinese exports have fallen by 10% and the Yuan is depreciating. This housing bubble burst has the potential to turn an economic slowdown into a recession. Lastly, a crisis of this magnitude may once again threaten the stability of not only China, but of the entire global economy. For once I hope I am wrong and I don’t have to say ‘I told you so’! Amen.
© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG
NIVESHAK
Cover Story
16
TATA VS TATA Vinay KishoreGundecha
IIM Shillong
CEO Succession battles Disney, Walmart, Microsoft, Ford, Apple are some classic examples of CEO Succession. Even in the Indian context, famous examples like Infosys, L&T and ITC provide diverse cases for study. Tata fiasco is one of many such lessons in corporate governance. It’s all about how a conglomerate handles the disappearance of “charismatic leaders.” only 1/3 family businesses last till the second generation of ownership, 12% to a third and just 3% to a fourth. Tata Group is moving away from family business model to a conglomerate operated by a board
OCTOBER 2016
of directors. They have few choices for working style. But there are perils in every course. Disney got in trouble for adhering too close to founder’s vision. Wal-Mart is faulted now for steering too far from its founder’s strategy. Sony Corp’s market leadership in electronics was lost after charismatic founder Akio Morita stepped down as chairman in 1994. By differentiation, some of Honda Motor Co’s. most prominent market victories—came after Soichiro Honda resigned in 1973.
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Current Situation at Tatas
Mr. Cyrus Mistry has been on the board of the Tata Sons since 2006. He was formally selected as chairman of Tata Sons on December 28, 2012. In the wake of removing Mistry as the chairman on October 24, the group brought his antecedent, Ratan Tata, back from break as an administrator for a time of four months, in which time a board of trustees will designate another official chairman. About Cyrus Mistry and impact of removal: Mr. Cyrus and his family firm ‘Shapoorji Pallonji and Sons’ own 18.4 % stake in Tata Sons. This Stake with current market prices is worth around $16 billion. His family has one seat in 9 member Tata Sons Board. Also, his family appeared to have the Right of First refusal on Tata Business. But this share gives no authority to nominate board members in Tata Sons Board. Though Mistry was removed from Tata Sons chairman post, he remains the chairman of many important companies of Tata Group. Board
Tata group has lost Rs. 55000 crores in market valuation since 25th Oct 2016. Ratan Tata interim chairman for 4 months has told CEOs to focus on business and not to worry about current happenings. But this order of events has created a serious internal buzz. Moral of employees and upcoming chairman’s spirit may not be in positive tone. Shareholders are in the complete dark. Many institutional and international investors have requested clarification on current happenings. If Tatas continue to bleed at current pace, then Indian market will witness a new low. House of Tata needs to clear the air before it steers ahead. If Mr. Cyrus is continuing as chairman of many big companies, then his future role in these enterprises need to be clear for investors to have a clear picture. The battle between Mistry and Tatas is a perfect example for regulators to learn and devise a strategy to avoid such corporate fiascos. Investors should not be left at the mercy of time. Any such lax handling of corporate governance should be avoided. Leader Hunt for Tatas: Why a worldwide organization like Tatas need an excessive time of 14 months to locate the chairman. Is it accurate to say that Tatas, a group, and brand with global stature couldn’t discover one individual to possess all the necessary qualities? On the other hand is it that the group needs just a Parsi and somebody they know about to wear the mantle? This ought to be a
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Cyrus Mistry and the Tata Group, locked horns and started a battle of words last week. Tata Sons – the holding entity of the salt-to-software conglomerate – and trustees of the beneficent trusts that possess a greater part shareholding in the Tata group removed Mr. Cyrus Mistry from chairman’s post in last week. This is a big surprise for shareholders of Tata companies and the market has reacted sharply. Cyrus accused Tata companies of lax corporate administration standards in a letter to Tata Sons. He also accused group for not giving him freedom to execute his policies. Reacting to a secret letter composed by Mistry on October 25, the board of Tata Sons named later as “noxious” and claims as “unconfirmed.”
of Tata Sons is expecting Mistry to quit and they don’t want to force him to go. This tricky position is becoming complicated with each passing day and will take the great level of diplomacy to resolve. And Diplomacy was one of the things that were missing in this entire episode at Tata Sons.
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lesson for every single corporate in India Inc that they ought to practice professional methodology while picking a nominee and not offer into any individual reasons or inclinations. The organizations ought to set up a framework to prepare for future successions. Why House of Tatas is not using TAS (Tata Administrative Services) to groom next group head? Going forward with the current method of succession after the current generation of Tatas go away will be very unrealistic. Tata group is yet to decide whether they want a chairperson who will bring new air in the group or one who will continue the legacy. Each time a committee can’t guarantee overall interest of shareholders. So for successful operations of giant conglomerates need a professional leader grooming and a bench full of future leaders. Few current options being considered for top job at Tata are as following:
when most of the Tata group companies are witnessing challenging times due to rising debt and weak business prospects, TCS has performed extraordinarily in such troubled times. Chandrasekaran’s leadership, TCS has grown in a giant with over 3,50,000 consultants and revenues of $16.5 billion. TCS is with a market capitalization of over $70 billion is the most valuable company in India. Chandrasekaran enjoys strong backing of the group and has been part of the Tata group for almost three decades now. In spite of a turbulent business environment, TCS still contribute for more than 60 percent of the Tata’s joined market capitalization of $116 billion. It additionally right now contributes 70 percent to Tata Sons’ income, which originates from profits of its recorded firms. Chandra additionally has a risk taking ability, which can be seen by his choice to set up an all-women BPO center in Saudi Arabia, a preservationist Islamic land.
Natarajan Chandrasekaran: The present CEO and managing director of the nation’s biggest software organization Tata Consultancy Services (TCS) could be one of the leading contenders to land the top position at the Tatas. A comrade of Ratan Tata, Chandrasekaran was one of the two authorities to be named as an additional director on the Tata Sons board. At a time
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Ralf Speth: Ralf Dieter Speth, the present CEO of Jaguar Land Rover, is additionally one whom the group could consider after
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The turnaround of JLR can be ascribed to Speth’s reliable administration. Under him, the organization’s free income grew to 3.9 billion pounds, after Tata acquired the brands in 2008. JLR is the crown jewel of Tata Motors. Speth has a striking profession in the worldwide car industry, having worked with BMW for a long time and later with Ford Motor Company before moving to Tatas.
Voltas. Conclusion: Any corporate house struggle can be handled and avoided if planned in advanced. Examples of Infosys, Reliance Industries, Birla, and Tata can lay a foundation for such planning. These scenarios are like the gold rush for speculators and are the death sentence for averagel investors. Bearish market speculators will churn high returns on Tata stocks while rest are losing continuously. A professional, well-structured program is necessary for any family business to survive in next generation. A bench of future leaders needs to be groomed and retained in the organization. Leaders are not born they need to be groomed. Organizational structures can’t be abrupt, and no one should feel entitled to any job. Tata fiasco is the great example for management disciples to learn corporate governance and organization building. Market followers can test their strategies and prepare for these kinds of shock. Leadership students must develop a vision for any such situation that can occur and must learn to delegate conflicts in the calmer manner. Succession talks for Tata group will last for a couple of months. Till then let’s grab a piece of pie and keep learning.
Noel Tata: For the second time, Noel Tata’s name has risen as a successor for the chairman’s job. Noel Tata, being a part of the Tata family, was a solid contender to succeed Ratan Tata in 2012 but Cyrus Mistry was picked. He is as of now the Chairman of Trent Ltd and Managing Director of Tata International. Trent works through Westside stores, a profitable offshoot of Tata group. In 2003, he became the chief of Titan Industries and © FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG
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his great work at the Tata’s automotive companies. Since 2010 he is CEO of JLR and non-executive director at Tata Motors. Alongside Chandrasekaran, Speth was delegated as an Additional Director of the Tata Sons. Other than TCS, the Tata Group has depended intensely on Tata Motors, whose record-breaking benefits in the course of recent years has been driven by strong sales figures of JLR.
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Fundamental Review of the Trading Book and its impact on risk management Ankita Thakur
As the deadline for BASEL-III approached near, on January 14th 2016 BCBS published the revised capital requirements to model in the market risk into existing Framework. The final standard is known as Fundamental Review of Trading Book (FRTB) which changes the way banks model risk. FRTB is intended to standardize market risk treatments across sector. The Capital requirements are expected to increase as stricter regulation on book keeping as well as treatment of assets is taken into consideration. The FRTB aims to model risk at granular level , tried to ensure more accurate prediction of risk .The 2008 crisis have questioned the current framework for risk modeling , requiring revision o model to incorporate risk factor which were previously not included in the model . These changes have raise the capital management pressure on banks as more capital requirement will
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reduce the amount available for business .Though the approach tried to provide appropriately informed risk to reward ratio , which will enable banks for wiser use of capital .This will ensure risk associated with tail-risk are taken into account. The Banks need to re-design their trading desk, while methodologies should be synced from desk-level itself. Greater investment into infrastructure as well as technology is expected to model increased data modeling. Introduction : In 1988, Basel Committee on Banking Supervision (BCBS) introduced the first Basel Capital Accord – Basel-I aimed to assess the credit risk and asset classification. As the financial markets evolved, the
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Financial institutes rely heavily on VaR to get an estimate of potential losses, which used 99%, 10-day VaR to model risk which was sufficient considering the volatility and risk in the instrument were sufficiently captured. But the recent financial crisis has pointed out that the potential losses in the 1% portion can significantly affect Bank’s capital. Thus there was scope to improve the market risk capital framework and reduce the risk across the system. What is FRTB? In May 2012, committee first presented a consultative paper to address the shortcoming in
During the 2008 financial crisis, many bank’s core capital proved to be insufficient to cover impairment arising from both loan and security portfolios. Consequently several banks needed to strengthen their capital base and reduce exposure. Basel III package was set by regulators in order to enhance the resilience of banking sector and reduce risk using stringent capital requirements. Banks operate above minimum capital ratios with an additional capital buffer which together with regulatory capital forms Bank’s internal target capital ratio. Basel III is the international framework for liquidity, risk measurement and monitoring proposed in 2011. The focus is majorly on 1. Increased capital requirements for derivatives ,Repo’s Securities financing 2. Leverage ratio and liquidity requirements 3. More sophisticated treatment of Credit risk and market risk 4. Incentive to move OTC derivatives to be cleared centrally –USING CENTRAL CLEARING PARTY(CCP)
current framework using fundamental review of trading books. The committee quoted that “the crisis exposed the weakness in the overall design of framework for capitalizing trading activities “ There are fundamental components to be expected from FRTB are • Expected Shortfall Vs VaR • VaR is replaced by Expected shortfall(ES) • Liquidity Horizons • Integration of Market Liquidity risk • Increase liquidity horizon from 10d to 250d • The computation is complex and can increase basis risk • Methodology • Trading/Banking book boundary changes based on risk factors and positions • Comparable capital across Internal Model approach and standardized approach • Focus on P&L attribution and back testing ,Desk-level model approach
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complexity of market and risk increased. Basel III tried to learn from the financial crisis of 2008 and increased regulatory requirements that aim at making banks more shock-resistant. This took into account that banks in developed economies were under-capitalized, over-leveraged and had greater reliance on short-term funding. Though Basel III is expected to be implemented by 2019, there have been further studies done to improve current methodologies. The first consultative paper for this was published in May 2012 and various responses on the paper lead to the concept of “Fundamental Review of Trading book” approach being proposed by regulators.
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Section1: Market Risk Framework
Banks faced a liquidity crunch when the assets held were affected by sudden impairment of liquidity of the market. Thus market liquidity risk in incorporated in the framework using varying liquidity horizons .Though this will make the hedging against market prices difficult for the banks. Section2: Standardized approach to Market Risk The earlier standardized approached did not incorporate risk sensitivities, risks associated with complex instruments and limited recognition of hedging benefits. These shortcoming were overcome in revised version where decision to use ‘Partial risk factor approach’ was taken as full risk factor approach was too complex for some banks to implement. The sensitivity inclusion for asset classed enabled more accurate risk capture on instruments. Thus risk can be better tackled and quantified .The diversification has been limited within an asset class, with newer risk definitions created. These changes require extensive risk association and data application up to trade level as calculated on entity level earlier. The capture and analysis poses infrastructural and implementation challenges for the bank. As greater amount of calculations will be required for new method, invest into technology as well as processes must be made. Banks will see an increase in cost of capital due to new changes in Standardized approach. Section 3: Internal Model-based approach The approach focused more on use of IMA to focus on tail risk .The reduction in ES liquidity horizon along with increase in base multiplier for capital
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Exhibit 1: FRTB expectations Source: BCBS265
Trading Book –Banking Book Arbitrage: The traditional regulatory boundary between trading book and banking book has been a source of weakness. The intent to trade by banks is primary source of the conflict. Trading book is ideally used to hold the assets which are for trading purpose (For example derivative instruments for hedging purpose) against the banking books which record assets held to maturity (e.g. Corporate Loans).The Trading book requires assets to be valued at market value while 10day 99% VaR is used to calculate risk while banking books value assets at book value and 1yr, 99% VaR is sufficient capital requirement for risk calculations. Lack of clear classification of assets allowed banks to shift assets from Trading book to BANKING BOOK ( prior to crisis ) while reverse them post crisis. FRTB proposed more clear distinction on instruments that can be included in different books and advices further supervision of them to avoid risk of arbitrage .The capital requirements for both books are changed to discourage the arbitrage opportunities. Risk measurement has changed from Value-at-Risk to Expected Shortfall (ES): VaR method inherits the tail-risk where unexpected losses wipe out large capital from the system. Expected shortfall captured the riskiness of position by sixe and likelihood of losses above a certain confidence level. This tail measure gives further insights into possible losses allowing banks
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NIVESHAK Conclusion: Financial markets have evolved into a very complex inter-twined system where the risk is inherent. The models and regulations have been trying to keep up their pace with the rate of change and risk growth. The BCBS has evolved with each requirement, where BASEL III focused on liquidity if the banks, FRTB take an approach to model maximum market risk into framework. The changes proposed by regulators in FRTB will allow banks to have standardized approach where RWA can be compared across the industry while taking a granular approach to model in the risk instead of a blanket one. Efforts to model more and more inputs to capture maximum possible risk are taken while trying to keep the model as simple as possible. These changes will increase the weighted average capital requirements by 40% as compared to BASEL 2.5. The technological and methodological restructuring required by banks is huge as greater amount of data will be modeled as analysis moves to granular level, though there are complications in implementation.
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charge by 0.5. The change in IMA tries to capture non-modellable risk factors .As various banks utilize various internal models tailored for their firm, the risks captured by them on same asset may vary .Thus the risk data cannot be laterally compared with the counterparts without taking into consideration the difference in approaches. The regulators intend on making the comparison more linear and hence propose common treatment of common risk. The implementation of such requirement will need restructuring of trade desks. The in-scope trading desk shall require model approval on three criteria’s: 1. P&L Attribution 2. Back testing 3. Model Independent assessment tool This approach will capture more tail risk as ES replaces VaR and SVaR but at the cost of increased efforts. The capital charge for incremental risk is replaced with Default risk charge (DRC) which avoids double counting of credit risk and migration risk modeling will no longer be required. Liquidity approach used more granular approach for risk calculation, allowing banks to capture risk and mitigate using right instruments/methods.
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Raghuram G. Rajan: A banker on the move! Akshay Kaushal IIM Shillong Little did anyone know that a young boy studying in Delhi Public School, RK Puram will become the 23rd governor of Reserve Bank of India. Coming from a middle-class family, Raghuram Rajan saw many ups and downs in his life. His father Mr. R Govindarajan, being an Intelligence officer, had to travel a lot. Because of which, Rajan’s initial years of schooling were done in different countries. His family finally returned to India in 1974. At that time, the financial condition of the family was not very sound. It took quite an effort for his parents to get him admitted to school then. During Rajan’s visit to his alma mater, he mentioned, “I have to say I did not own one [blazer] in school then, I made through high school with a sweater, partly because at that time my parents could not afford a blazer.” But all those hardships
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could not mildew his ambitions in any way. He studied electrical engineering at Indian Institute of Technology Delhi and then went to Indian Institute of Management Ahmedabad, winning Gold Medals at both the institutes. Rajan has always been ambitious in his endeavors. He had expressed his desire to be the governor of RBI decades ago, while he was studying in IIMA. During an event organized by IIMA in Mumbai in 2014, he said, “I was asked at Ahmedabad, if you think about a career choice, what will you become? I have a confession to make here. I said I want to be the governor of RBI’. A few decades later, there is little he did not achieve. Also called a ‘Financial Prophet’, he has become a global icon. Due to his outstanding work and long-term vision, his name was included in Time Magazine 100
NIVESHAK have been done. The crisis played a key role in the failure of giant business corporations, reducing consumer wealth by trillions of US dollars, and leading the downturn in economic activities between 2008-12, which eventually contributed to European Sovereign-Debt Crisis. In Jan 2009, Wall Street Journal reported in an article titled ‘Mr. Rajan Was Unpopular (But Prescient) at Greenspan Party’ that Rajan was an unlikely dissident.
At IMF as the Director of Research, he pushed his staff to concentrate on financial sector issues, and continued to sound alarmed about the looming financial market risks. Hence,
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Most Influential People 2016. His journey as an economist started way back in 1991, when he received his Ph.D. from Sloan School of Management, Massachusetts Institute of Technology for his thesis titled ‘Essays on Banking’. Shortly after that he joined Booth School of Business, University of Chicago and went on to become a Distinguished Service Professor of Finance there. Due to his exceptional contributions to the theory and practice of finance, he was awarded Inaugural Fisher Black Prize award in 2003. Thereafter, he joined International Monetary Fund as the youngest Chief Economist in 2003. He is claimed to be the one of the few who correctly predicted the Financial Crisis 20072008 well in advance. In his book, ‘Fault Lines – How Hidden Fractures Still Threaten the World Economy’, he goes on explaining how he was criticized for his presentation at the Jackson Hole Conference in 2005 on the topic ‘Has the Financial Development Made the World Riskier?’. In his presentation, he argued that incentives in the financial sector were horribly skewed. But at that time, when the world economy was booming and everyone was busy making bucks out of it, people berated him with all their might. In his book, he mentions, “I exaggerate only a bit when I say I felt like an early Christian who had wandered into a convention of half-starved lions.” Many renowned personalities including the former U.S. Treasury Secretary, Lawrence Summers remarked the warnings as ‘misguided’ and called Rajan a ‘Luddite’. However, two years later, when the crisis materialized, little could
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NIVESHAK Rajan’s foresightedness and conviction to take action, when most of the economist shy away, brought him into limelight in the postrecession era. Rajan returned to India first time in 2007. However, he had never opted for American passport because he wanted to come back to India and contribute to public policy reforms. So even when he was making a difference in the world, his heart was always set on returning to his motherland and working for it. In India, Rajan was first appointed as the
who speaks his mind and that too with such conviction and confidence that it outdoes his dominion. Rajan never cringed from calling a spade a spade. Be it suggesting ‘Make for India’ instead of ‘Make in India’ or telling the room full of journalists that ‘RBI is not a cheerleader’, he speaks straight and to the point. When Rajan assumed his position as RBI governor, the Consumer Price Index (CPI) inflation was spiraling at 9.84% whereas rupee against dollar had soared from ₹54.24 to ₹66.64 in just a four-month span. So biggest
Chairman of the High-Level Committee on Financial Sector Reforms, India (2007-08). This decision was taken by then Prime Minister Dr. Manmohan Singh because, unlike the US, India had failed to bring the bright academics into the public policy. The first task Rajan was entrusted with was to prepare a report titled ‘100 Small Steps’ on financial sector reforms. “He worked very hard. He would finish his class in Chicago and take the flight out to India. He would head straight to meetings and once done head to the airport and make it back in time for the Monday class,” says a bureaucrat who worked closely with Rajan then. Thereafter, working as External Advisor to PM for some time and Chief Economic Advisor for a year, Rajan was appointed as RBI governor in September 2013. RBI saw many governors with high intellect and integrity, but none was as popular as him – not only in India but globally. And perhaps none,
challenge in front of him was to curb inflation and stabilize rupee against dollar, which he did indeed in due course of time. On the very first day as governor, he introduced Swap Window to attract FCNR (Foreign Currency NonResidents) Term Deposits. Within three months the scheme was able to bring $34 billion of foreign assets in India and hence was heralded as a masterstroke by the RBI governor. Henceforth, he appointed a committee, headed by then deputy governor Urjit Patel, to re-examine the monetary policy framework. Based on the committee’s recommendations, he made the CPI-based inflation the nominal benchmark for monetary policies. In February 2015, the government and RBI signed a new monetary policy framework and made inflation targeting as their agenda. Eventually due to Rajan’s endeavors, they were successful in bringing down the inflation to 3.69% in July
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NIVESHAK Rajan’s proactiveness played a significant role in making India the fastest growing economy in the world. But as he said, “Indian economy is like a ‘One-Eyed’ king in the land of blind,” – India has a long way to go in terms of inclusive growth and financial inclusion. In his last stretch as RBI governor, he reaffirmed that fight against inflation should be continued as there would be several payoffs ahead for India if it stayed the course, even though the adjustment might be painful in the short run. Hence, it will be very interesting to see, on what basis the monetary policies will be planned and executed in India in the near future.
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2015, the lowest since 1990s. Another great achievement of Rajan as RBI governor was the cleaning up of the banks’ balance sheet. With the Asset Quality Review (AQR), RBI forced banks to classify their visibly stressed assets as Non-Performing Assets (NPAs). It also provided the bankers with a number of tools to tackle these bad loans. For instance, it issued guidelines to help banks identify the opportunities and convert up to half of their bad loans into equity, provided the indebted companies meet certain criteria. Apart from that, the strategic debt structuring also allowed the lenders to turn over the management of the indebted company if need be. Though the whole exercise has been cited
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DiptiAggarwal IIM Indore Mumbai Campus Financial inclusion is the buzz word these days. It has not only drawn the attention of many academicians, researchers, and economists but has also brought together the central banks and policymakers from around the world to different forums for discussions on “Financial Inclusion” and the need to take care of it for economic growth. Background An economist named Walter Bagehot said that the financial system of an economy is most important for economic growth. He argued that when the loans are encouraged and allocated to the investors, it boosts the investments in infrastructure, technology etc. leading to high production levels. Hence, the stable financial system drives the economic growth. Also, in 2008, Sarma M and Paise J. through a research conducted on banking services provided by 49 countries, found that high financial inclusion can lead to human development. Further, high income leads to high level of inclusion.
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They said that when people have access to financial services, they park their money with the institutions resulting in high growth due to multiplier effects. These two studies clearly highlight the importance of financial system and the inclusion of society for the growth in the economy. And there are many other studies as well giving the same conclusion. But sadly, in India, money lenders still dominate the rural credit markets. And it was not until 2005, when Y.V Reddy first used the term “Financial Inclusion”. He defined the term as “the process of ensuring access to financial services and timely and adequate credit where needed by vulnerable groups such as weaker sections and low income groups at an affordable cost”. But do not confuse yourself with the words as it does not mean that all those who does not borrow from the organized financial system are excluded but all those who need credit and who want it are in the ambit of financial system or not is the question. To answer this, C Rangarajan committee was
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Why was it not achieved till now? decrease in oil prices. While the banking sector in the last two decades has shown tremendous growth in terms of profit and volume, barring the 2008 financial crisis and its aftermath, the banking services have not reached to a vast segment of the population. This Financial exclusion is primarily not because of the barriers from the supply side but also, the reluctance from the demand side as well. 1. Financial Exclusion: Although there was a demand for these services, these were not provided due to infrastructural issues, credit risk etc. Subsequently, there was no option for them but to rely on informal sector for availing finance who lend at very high rates leading to a vicious circle of poverty. The poor people earnings went to the money lenders as interest payments leaving very less earnings in their hands. 2. Regulations: The various requirements like identity proof, income proof etc. to avail the services discouraged the people from accessing it. Instead, they find it relatively easy to approach the money lender and get credit as and when required. 3. High Risks: This segment is not seen as an attractive market by the financial institutions because of the high lending risks and less income for deposits. 4. Not a good Value Proposition: The challenges to reach this segment in rural areas are many that make this business idea unviable. 5. High Cost: The services offered even if accessible, were not economically priced such that it could be availed by the low income people. Hence, it further deters the people from taking benefit of it. The above list is not an exhaustive list and there can be various other reasons that led to financial exclusion. Why was the need of it felt? If there were so many reasons for this sector remaining unserved, merely the use of a term by an esteemed personality cannot
lead to the formation of a committee and the attention of so many . There has to be a need identification that will demand of it. After careful study, I believe following are the reasons why the need of financial inclusion was felt by the policymakers1. Economic Objectives – The economists of our country are concerned about the huge gap between the rich and poor, the difference in the income levels. But if this is achieved, there would be an equitable distribution of income and the poverty will reduce. 2. Social Objectives – This will help in extending the loans to weaker sections of the society which will enable to start businesses or will help create employment opportunities for them. For example the present government initiatives like Pradhan Mantri Jan Dhan Jan Yojana, Payment banks, Relaxation in KYC norms etc. under the aegis of Mr. Narendra Modi, are steps toward achieving the financial inclusion objectives. 3. Financial Objectives – The access of banking services to lower income groups will increase the national savings through increase in bank deposits and will ultimately lead to the growth in banking sector. 4. Saturation in the existing marketOne of the reasons could also be the saturation in the existing market being served by the financial institutions. The services offered are more or less availed by all in the respective areas and there was a need to expand the reach and increase the customer base. 5. Technology Advancement and Infrastructural Changes- With the advent of technology like internet, mobile data, smartphone apps, online banking etc. it became easy to provide access to the services without incurring any huge investments unlike the case before when the business had no value proposition. All the above mentioned reasons combined to provide a favorable environment and the long held concept of financial inclusion finally took off. Major initiatives since 2005 till today The United Nations defines the goals of
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formed in 2008 to identify the hurdles preventing the vulnerable groups from access to banking services and ways to achieve financial inclusion.
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financial inclusions as follows: • access at a reasonable cost for all households to a full range of financial services, including savings or deposit services, payment and transfer services, credit and insurance; • sound and safe institutions governed by clear regulation and industry performance standards; • financial and institutional sustainability, to ensure continuity and certainty of investment; and • competition to ensure choice and affordability for clients Considering these goals in mind, the Indian government introduced various measures like:
1. No frill Account: Bank account opening that requires zero or low balance and charges making it accessible to all the segments of society. 2. Relaxation of KYC Norm: KYC requirements needed for opening of bank accounts were relaxed like the acceptance of ID and address proofs as provided, the photographs required etc. 3. Pradhan Mantri Jan Dhan Yojana: Launched in 2014, this campaign has resulted in the opening of 219 million account with a deposit of $5.7 Billion. Also, it has entered the Guinness World Records as “The most bank accounts opened in one week under financial inclusion campaign by banks of India is over 22 crores from 23 to 29 Aug 2014”. 4. MUDRA: It provides loans at low interest rates to microfinance institutions
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and NBFCs so that they can further lend it to MSMEs. It is classified into 3 categories: Shishu, Kishore and Tarun to enable the businesses to receive credit at each phase of growth. 5. Payment Banks: These banks with licenses mainly with the telecom providers and fintech companies like Paytm, Airtel, Vodafone etc. will allow the customers to pay their utility bills, manage their daily or monthly transactions and more. 6. Direct Benefit Transfer: The access of bank accounts through Jan Dhan Yojana scheme and the need created by this scheme to open accounts to receive subsidies has led to the inclusion of a
large population. The termination of the pilferage in the process and transparency in the distribution of the funds is likely to
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subsidies has led to the inclusion of a large population. The termination of the pilferage in the process and transparency in the distribution of the funds is likely to improve the living of concerned. 7. Other Regulations: The banks have to lend 40% of their total lending to priority sectors. Also, the branch authorizations norms were simplified to enable the commercial banks to open branches in areas with population less than 50000. Similarly, various other initiatives have been taken to achieve the target of financial inclusion. All the initiatives mentioned above reinforce India’s vow to achieve financial inclusion. Measuring the success of initiatives Finance has travelled a long journey from the time when it was not recognized as a factor for growth to this time when it is regarded as a brain of the financial system and every economy thrives to make their financial system more efficient. Hence, it became imperative to adopt a tool to measure the success of initiatives taken to achieve this goal. On 25 June 2015, CRISIL launched India’s first financial inclusion index named Inclusix to measure the status of India’s financial inclusion. It includes three parameters for evaluation – branch penetration, credit penetration and deposit penetration. The index has improved from 35.4 in 2009 to 40.1 today. Puducherry, Chandigarh, and Kerala scored the highest level of achievement in financial inclusion.
Otherwise as well if we see the graphs above, there has been an increase in the number of branches in the unbanked
villages from 2010 to 2013 and also, the number of KCCs has increased significantly. These observations clearly highlight the success so far but there is also much more to achieve. Road Ahead Though it took long for India to understand and appreciate the need and importance of “Finclusion”, India is moving at a fast pace to achieve its objective. Not only the financial institutions are contributing to its success but the major innovations are coming from those who are not even a part of this industry (Payment Bank licenses to Telcos). Extrapolating this statement, I mean to say that there is a need for lots of people to work together, raise awareness and to come up with the ideas that can help create better financial solutions. The mobile operators and banking system integration along with the relaxation in norms provided by Central Bank has changed the landscape to bring Banking as a Platform into existence (BaaP). Moreover, technology has proved to be an icing on the cake. Better data collection and analytics tools at the disposal have enabled the institutions to take more informed decisions. The need now is to provide a conducive environment to all these companies making efforts and taste the fruit. Last, Financial Inclusion might seem as two words but it is such a big concept that it might take billions of pages to pen down and still remain uncaptured. I have just tried to provide a snapshot of it- nothing more and nothing less.
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Prof. P. Saravanan Associate Professor, IIM Shillong Published in Financial Express As per clause 41 of the listing agreement, it is mandatory for listed companies to submit an audited or unaudited quarterly financial statement to bourses where their stocks are listed. The financial statement needs to be submitted within 45 days of the end of each quarter. The company must also publish the result in at least one English daily newspaper and in one newspaper of the region where the company is registered. Relevance of report The earnings statement is an important document through which the company communicates with the outside world. It is important not only for the current but also for the prospective shareholders. Many investors are not able to effectively understand the quarterly reports. Though these reports are prepared by companies on a prescribed format, it is the responsibility of the investors to understand the information. To understand the report, investors must read between the lines for
OCTOBER 2016
an informed decision making. Format of the report The format consists of detailed information of the quarter, the preceding quarter, corresponding quarter last year, year-todate figures, comparative figures for the last year and numbers for the previous year. The company will report the consolidated results (if it has any subsidiaries) as well standalone results. As per accounting standard (AS) 17, if a company is dealing in more than one geography or segment-wise information. Though the structure is similar for all companies, there might be a small variation between manufacturing and service companies. Banking and insurance companies are governed by different acts and their formats vary to a greater extent with that of manufacturing and servicing companies. What to look at in quarterly reports Quarterly earnings can be interpreted and
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reviewed in different ways. Some would focus on the current performance and some would look at the business and financial risks that the company is exposed to. Some prefer to compare the current quarter with that of the previous quarter. It is essential to review methodically to understand what the company is trying to communicate. One must try to get answers for these questions on the financial performance of the company: How has the company performed in the current quarter compared
Focus on the risk factors Once you have a reasonable understanding of the company’s financials, you would need to check the risks that the company is facing at present or likely to face in the coming quarters. Just check whether the company has any contingent liabilities, pending lawsuits. Generally, it is difficult to assess the monetary impact of these items, just make a rough computation of potential financial impact on the value of the company. These items are important especially for pharma companies in India. Obtaining required information and understanding the financial health of the company is not rocket science. Assess the company in which you have invested or proposed to invest and try to obtain answers for the questions raised above. But the caveat is that quarterly results need to be reviewed keeping in mind other fundamentals of the company.
Š FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG
Personal Finance Cover Story
with the previous quarter? Whether topline has improved or deteriorated? Whether cost of sales is increasing or decreasing? Whether EPS is improving quarter-onquarter? Also check for the profit retained, generally this is the amount which will be used for the future growth of the company.
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Classroom Cover Story
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CLASSROOM FinFunda of the Month
Sir, what is swaption? Is it related to interest rate swap or options derivatives or both? Swaption is a capital market instrument which is combination of both forward swaps and options. The swaption gives the purchaser of the option, the right but not the obligation to enter into an interest rate swap agreement to pay the fixed rate and receive floating rate or other way around for a term at a specified future date. In other terms, interest rate swaption is simply option to enter into an interest rate swap. Sir, like options, do we have to pay premium for purchase of swaptions also? Yes, An upfront fees (Premium) is paid by buyer of the swaptions to the seller. Purchaser and seller of swaption both agree on the strike rate (the rate at which interest rate swap agreement is triggered), the floating rate index (Prime, LIBOR), length of the option period (which generally ends on the date on which swaption is exercised), tenor, notional amount and frequency of settlement. These terms of agreement are key factors in determining amount of swaption premium charged by the seller. The owner of the swaption also make choice among European, American and Bermudan swaptions. Is it the geographical location in which swaption is purchased? No, these are three standard categories of swaption which determines the exercise right of the buyer. European Swaptions give the buyer the right to exercise only on the maturity date of the Option, whereas American Swaptions, give the buyer the right to exercise at any time during the option period. Bermudan
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Swaptions Girraj Goyal IIM Shillong
Swaptions give the buyer the right to exercise on specific dates during the option period. Sir, like exercise right, do the buyer has option to decide on fixed leg and floating leg of swaptions? Yes. There are two types of swaptions contract available in the market. A payer swaption allows the holder to enter into a swap as the fixed-rate payer and floating-rate receiver. Another one is receiver swaption allows the holder to enter into a swap as the fixed-rate receiver and floating-rate payer. Sir, how can one use swaption to its advantage? Swaptions are designed to provide benefit to buyer when market interest rates are volatile. Swaptions are used by parties who anticipate the need for a swap at a later date but would like to establish the fixed rate, while providing the flexibility to not engage in the swap later when the swap at a less favourable rate in the market. Swaptions can also be used by parties entering into a swap to give them the flexibility to terminate the swap.
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