Sunday, January 4, 2015

Shadow Banking System (SBS)

Note: The article also got published in WE School's (Welingkar) magazine


What is seen is often far off from reality. In the physical manifestation what is perceived is mostly in accordance with what is seen; in economics it is not so. So while an institution appears like a bank, lends like a bank & works like a bank, it is often not a bank. It is a shadow bank.
According to Financial Stability Board (FSB), a framework with representatives from the major economies of the world designed to guard against impending future crises, shadow banking is one of the most vital issues posing dangers to the global economy. Though the global size of the shadow banking market is disputed, most big shot reporting firms, including Bloomberg, peg it to be over $70 trillion! Financial Stability Board also reported this number to be $71 trillion in 2012. This is unfathomable considering that a decade ago the picture was very different. The graph below highlights the growth of shadow banking market in absolute terms over the last decade.

Source: Financial Stability Board
What is shadow banking?
Shadow banking is defined as the process of lending credit by institutions other than the regulated scheduled banks in the country. These institutions serve as intermediaries between short-term investors and long-term borrowers thus making profits from either the fees or the arbitrage in interest rates or both. Shadow banking surely has the characteristics to play a party-pooper for economies across the world. Given the vulnerabilities that this system is exposed to and the astonishing growth path it has witnessed in the last decade it has become imperative to safeguard economies against its ill-effects.

How are shadow banks different from formal banks?
Unlike a conventional bank which depends on taxpayers and savings account depositors for their sources of funds, shadow banking system relies on short term investors in the money market. Prima facie this might seem to be a perfectly dependable option to source funds, but it is not because of its dependencies on the outside market and investor’s whims and fancies.Every lending institution engages in the process of maturity transformation to lend money in the market. For example, when banks use the depositor’s short term funds to finance long term loans they engage in maturity transformation. Non-banking entities, which form the shadow banking system, do the same exercise but with a slightly different mechanism. They buy assets, say mortgages, and then bundle them into a pool to finally split and create securities out of it. These securities are then sold to the investors. This forms the major chunk of funds sourced by SB entities. The value of the security is backed by the value of the mortgage asset and the earnings on the MBS are paid from the regular interest and principal payment by the homeowners on their mortgage loans. Shadow banks have been in the fore of late especially because of their ability to securitize mortgages. 

Why is shadow banking a concern around the world? 
Shadow banking is touted as one of the biggest threats to the global economy. But isn’t it good enough if banking ancillary services are offered by institutions outside the banking industry? Doesn’t it create more competition among the banks and improves the quality of services as a whole?
Actually the potential point of concern here is not provision of banking facilities alone but provision of credit. If a non-banking entity, say Amazon, tomorrow comes up and helps people to manage their funds and assets, it would be welcomed rather than being questioned. The problem with shadow banking is the lending exercise they engage in. This is primarily because lending institutions are inherently fragile and play around maturity transformation to maximize profits. In this effort they tend to create enormous “maturity mismatches” and if at all there is a run on the institution they fall short of liquidity. Having said that, here is where the problem starts – traditional banking system is highly regulated by the central bank which is a watchdog to keep the banks within their safe lending limits. So, the capital adequacy of a bank is upheld. In addition to this, conventional banks are also backed by the government which acts as a safety net in case the banking system collapses. Both of the above mentioned points that help the traditional banks gain stability and credibility are elusive to the shadow banking system which is largely unregulated and not backed by any sovereign fund. This makes the SBS a trifle times more vulnerable and prone to market sentiments. SBS also got itself into bad light due to its engagement in lending using financial instruments that are called Off Balance Sheet (OBS) vehicles in financial parlance. These loans have no mention in the books of the institution which makes them very difficult to track and assess. OBS vehicles are typically considered to be separate from the banks but in practice are dependent on them.

 How did the Shadow Banking System achieve its present size and avatar?
The birth of Shadow Banking system can primarily be attributed to the wariness of the scheduled commercial banks to lend money to small and medium scale businesses. The banks, beaten and battered, still coping with the bruises of the financial crisis are on the back foot and tend to retrench their expenses. Post crisis the banks have also been, rightly so, forced upon by more regulations which makes granting loans a lot more regulated activity now.
A typical supporting example is that of Republic of China. In China unlike other countries where market parameters play a vital role in setting the interest rate, it is the government that pins the interest rates for commercial lending. The government also imposes limits on loans and deposits that the banks can offer. The objective behind these regulative norms is to guarantee risk free profits for the banks. But, this leaves no incentive for the banks to remain competitive in the market by offering attractive lending rates to the customers. The result is focussed lending only to the state owned enterprises, which have near zero chances of default and are always backed by the government. Small and medium scale enterprises are thus left out of the official financial system and have no scope of borrowing money from the banks that are part of this farce system. As a result, SMEs look up to non-bank entities for credit which spawns the growth of institutions that engage in credit lending at high interest rate and take advantage of the situation. This constitutes the web of non-bank entities that make up the SBS. The Diplomat reports that China has grown to be the epicentre of ‘covert banking’ in recent times and shadow banking in China has grown by a startling 40% last year. Apparently, China is one country where shadow banking operations have grown at a rate more than formal banking operations have! JP Morgan pegs the size of the Chinese shadow banking operations to close to 46-50 trillion Yuan or $7.5-8 trillion which is about 30% of their total bank assets. 

The authorities around the world are concerned about the shadow banking activities that have seen a manifold increase in the recent past - so much so, that shadow banking operations have affected the traditional financial sector and also the economy in general. Economists are examining more and more data closely to find the hidden vulnerabilities in this system and devise a solution for it. The most important step being taken by the authorities is to bring the area of operation of shadow banks under their purview so that the sector can be regulated and overseen thoroughly. One thing is for sure, shutting down shadow bank operations abruptly is out of question now; the way out lies in exercising greater control and expanding the scope of regulation in the financial market across all domains and sectors.

Pseudonym : h!v

Thursday, May 22, 2014

Why Is The Indian Economy Still Promising?

“What !”   “Did I read the heading wrong?”
Actually no, you didn't. A lot has been said in the past few years about India and its economy. In fact, ours was the most talked about economy in the past decade. We were raring to go, speeding away in terms of growth rate, giving complex to even the biggest economies of the world; we were the most promising nation in the world teasing our 'Dragon' neighbors. But lately, India has slowed down. As a matter of fact we are snailing now.
So has India lost its sheen? Is the growth saga complete, done, finished and a thing of the past now! No, not at all. India is still one of the most promising economies of the world.
To understand better , we must delve deeper into India's status right now, it's demographics, market potential and future prospects.
Prima facie it might look like India and China, the two most talked about countries of the world and  rightly touted as the world leaders in the next generation, are among the fastest growing economies of the world. Unfortunately, that's not true. Neither India nor China figure in the list of world's top ten fastest growing economies. In fact, India ranks around 35th (2012)  in terms of economic growth rate globally with a country like Mongolia topping the list. So why is it that investors worldwide still show their confidence in India? It is important to note here that it's the base effect that's important. India is a huge economy of close to 2 tn $ annual GDP. That being said, it is really humongous addition to the economy if a nation grows at 8-9 % annually on a base value of 1.5 to 2 tn $. Nigeria is a minuscule economy so while they outpace India and China in terms of growth rate (in % terms), the absolute addition to the economy is still very small. This is the prime reason why India was considered a forerunner in the race of nations-to-be. But have we lost that edge now? No, ours is a relatively huge economy and hence a growth rate of 5% might not be good enough but it's not too bad either. India is still running the race and is going fairly good if not great.
Second is the India's self-sufficiency. We have a huge population (Thanks to male nymphomaniacs like Lalu ji) which makes India a huge market in itself. Unlike China, we are not an export driven economy relying heavily on export bills to boost the economic growth. We have a huge market within our country that makes it possible for Indian production to be consumed within India itself. This was one prime reason that India remained largely unimpacted by the 2008 recession. China, on the contrary, is highly dependent on its exports especially with US. Major chunk of Chinese exports are 'dumped' into US. This Chinese love affair with US goes to such an extent that if one fine day US economy nears death, China will have no choice but to succumb to death along with like a true loyal lover. Some might also argue here that exports form an important aspect of any country's economy because it helps boost your forex and balances your import bills thus slashing CAD. Yes, it is important but as they say there is no full-proof theory when it comes to macro-economy. There always has to be a fair balance between various parameters. No one theory can completely define a country's economics. India should definitely aim to increase its exports, but at the same time it should be checked that these exports do not come at the cost of the domestic market Also, the economy should not get over-reliant on exports only.
Third is the huge unexplored potential of the Indian markets lying at the 'Bottom of the Pyramid' (BOP). This is one sector that has almost been left out of the development process. When this market starts to pick up India's market size would almost double. Again, this would make India more self-sufficient which is desirable. This is one reason why foreign behemoths still look forward to invest money in India and will continue to do so in the coming few years. India has immense potential to grow in future which makes it a great business destination (lest we talk about the rigamaroles of Indian red tapism!).
Fourth and probably the most important is our huge labor force which apparently includes me and you. We are about 120 bn people with close to half of them being at the peak of their careers. The next 20 years are the golden age for India because we will have the biggest working force in the world. We Indians, by nature, are hard-working and street-smart which further adds on to this. India's mettle has been acknowledged by economists and business houses across the world.
Hopefully, the IT outsourcing boom was just one of many more such booms to come. The world knows the power of India today. India is raring to go, wild yet calm, strong yet feeble. So India is still one of the most promising economies of the world with a potential to transform the world in the years to come.

Pseudonym : h!v

Tuesday, May 20, 2014

4 Things That India Expects From The Modi Government (MoGo)

BJP has come to power this elections after a gap of nearly 10 years. Surely, anti-incumbency was one factor that played a vital role in their victory, but it can't be denied that the people of the country have a lot of hopes with this Modi Government. Let's do an exercise, let's analyze the top four things that the citizens of India expect from the new government.
Here we go!

Better Governance
Okay! I know this is the easiest of points to make, you always expect good governance from the elected government that we as naive, stupid but yet powerful citizens bring to power. The point is, one of the most important aspects of good governance is managing international affairs well enough. We expect Modi to make India shine in the international spectra and make true the much awaited, yet failed, objectives of ‘India Shining’. This government is expected to make its word in the world, be friendly with the super-powers and super-powers-to-be and still not succumb to their pressure and pander to their requirements. This government needs to take a strong stand in the international affairs and do away with its policy of deliberate silence (hopefully Modi speaks a lot more than Mr Singh!), only then can we think of realizing the dream of India superpower 2020. The bitter fact is India has been touted as the next big thing in the world for a bit too long without making any justice to this status internationally. At this juncture, India can at best be qualified as a regional power. For India to be an international superpower it will have to be more participative in the matters of international concern. This is the best opportunity for the BJP to bounce back into mainline Indian politics, do well and finally wipe off Congress (which is always known to come back strong).

Better Handling of issues pertaining to the cultural minorities
BJP has been under a lot of fire in the past to be a pro-Hindutva party. It's high time they did away with these orthodox idiosyncrasies. It is imperative for the BJP to restore its faith among the people of the country as a secular party whose ideologies are not motivated by caste, creed, color, religion and other such baseless crap. MoGo is expected to deal with all these issues with genuinity and fidelity without being biased to any particular section of the people. Modi's public image of being a religious hardliner needs to be over-hauled and should be rebuild on terms of pure secularism. Only if the BJP government is able to make these minority groups feel involved in the development process, Mr Modi can afford an image makeover and can wash-off the sins of 2002 that haunt him till date.

Complete check on terrorism
Cross-border militancy has always been one of the most important issues for India ever since her independence in 1947. Modi with his audacious and tit-for-tat attitude is expected to curb Indian of this menace that has been a roadblock for the country's peace perennially for years now. But whether or not Modi's hard stand be fruitful is yet to be witnessed. Nevertheless, one thing is clear, BJP has been quite clear in its agendas put forward during its campaign and has taken no restraint in portraying Congress's poor governance and mild international stand as one of the reasons for cross-border terrorism. BJP, now in power, would have to do something great to cure India of this disease that has plagued our country for eternity. Considering, MoGo is unable to do so there will be a lot of criticism and thrash talking by the opponents. MoGo just cannot afford it, for they are in a very tight spot. Only results can rescue them and prove it to the opponents that this Modi win was not just a fluke.


Now this has, by far, been BJP's USP this poll season and now that they are at the helm, they will have to do justice to it. MoGo will have a lot of pressure owing to the super-high expectations the people have from Mr. Modi. Modi has left no stone unturned to convey that he believes in development politics. But the question that comes to the fore is whether or not the Gujarat model prove to be a panacea for the nation. His theory of 'one-size-fits-all' can be under strain when implemented at the pan India level. There is no doubt to the fact that Modi has been the protagonist of the Gujarat story but there is a lot of difference between a state and a country, for the sheer magnitude of money, opportunities, people and risks involved make it a really tough task to pull off with the same ease with which it was done in Gujarat. This is a golden phase for India - we have all the ingredients that it takes to fast forward the economic growth. This is the time when India has the highest percentage of Working Age Population (WAP) in the world and this number is only to increase in the next 10 years. The ratio of WAP to dependents is highest which is just perfect. The government at this point of time should try its level best to accrue as much demographic dividend as possible and not let this opportunity slide away. If we are able to channelize our youth into productive work by creating more jobs, better self-employment opportunities and better education, there is no stopping India then.

If MoGo takes care of all of these things with precision, there are definitely good days ('ache din') to come for both India and the BJP. If not, then unfortunately in spite of having everything we would still be counted amongst the backward nations of the world.
Pseudonym : h!v

Sunday, November 17, 2013

Sachin's Farewell Speech At Wankhede

It just can't get better than this. This guy is perfect at everything. No wonder he is called 'GOD'
This is the heart moving speech that the great man delivered at the Wankhede on 16th Nov, 2013 when he decided to call it a day after 24 years of devoted service not only to Cricket but also to the Nation. Enjoy it!!!
This one's a masterpiece by the Little Master himself.

Pseudonym : h!v