What is the connection?

The FT has a long article on the demands bankers are making of regulators.

Let us see the demands in one place:

(1) “One executive said banks were pushing for an extension of the implementation of Basel IV — which is due to come into full effect by 2027 — to prevent banks having to build up capital levels by 2021.  

(2) “Lenders in the UK have written to the Bank of England to demand that the transition to the new accounting rules — which are due to come into full effect by 2023 — is extended, said several people who have seen the letter. ” 

(3) “Several executives said the industry was also asking supervisors to take a “best efforts” approach to money laundering and market abuse, whereby banks would avoid punishment as long as they had tried to do the right thing — even if they had technically breached rules.” 

(4) “Executives have also asked that the transition from the discredited Libor rate to new interest benchmarks be delayed from its current hard deadline of 2022 to free up employees to work on more pressing matters.” 

(5) In the UK, banks are also pushing for the BoE to delay climate change stress tests. “Steps on the whole green debate have put an additional onus on banks,” said the executive. “We’ve got to be pragmatic.” 

FT can hold a contest among its readers to guess the most egregious demand of the five listed above. Personally, my vote is for no. (3).

Regulations that are to come into effect at least two years from now are being asked to be suspended for banks to lend now!

What is their record on lending for productive purposes, to small and medium businesses and to low income households?

How much of their earnings they derive from these relative to the monies they make from lending to capital market participants and from proprietary trading?

Articles galore on how much humans are going to change for the better on account of the crisis – sustainable living, respect for climate change, respect for the environment, cooperation over conflicts, etc. 

Most of us know, from past evidence, that such behaviour tend to be fleeting. They occurred during the previous WW II (see this: https://www.collaborativefund.com/blog/common-enemies/). That is why they are called fleeting social utopia. But, at least, they instil some hope and make for good reading.

Stories such as these bring us down to earth and keep us grounded in a way. We must be grateful to the bankers for reminding us of the inherently self-destructive nature of Sapiens.

Preliminary thoughts on the evolving situation surrounding YES Bank

This was inevitable. Andy Mukherjee of Bloomberg had suggested on 13th January that the Government of India (GoI) and the Reserve Bank of India (RBI) must bite the bullet but budget time-table came in the way, I guess. Even then another month had elapsed.

Hence, some are concerned that there could still be a big contagion like it happened in the case of the collapse of IL&FS in October 2018. Possible. One can never say never to things in fluid and rapidly evolving local and global situations.

However, there is an important difference between October 2018 and now. Then, RBI leadership took a rigid, uncompromising and doctrinaire approach to both liquidity provision and inflation targeting. Monetary policy was restrictive and liquidity provision was inadequate. Indeed, RBI had an important role to play in precipitating India’s economic slowdown in 2018.

The current RBI leadership is more pragmatic and less academic. Hence, the hope is that the repeat of the ripple effects of the collapse of IL&FS would be avoided now.

What follows are my (current) take-aways and the situation could evolve differently. I am aware.

(1) Since the financial system was already largely impaired and credit to non-financial industry was growing at below 5%, there cannot be a big incremental damage.

(2) Lenders to YES Bank and investors in YES Bank would take a hit. Mutual funds list is there. But, most of them have already marked down their exposure to zero value (see https://www.bloombergquint.com/business/heres-how-much-mutual-funds-are-exposed-to-yes-bank-debt)

(3) State Bank of India (SBI) has assets ten time (10.3x) the size of YES Bank (Ref: https://www.bloombergquint.com/global-economics/india-must-end-yes-bank-s-theater-of-the-absurd). Together, the Life Insurance Corporation of India (LIC) and SBI can absorb this. 

Pl. read the excellent article by Aarati Krishnan of ‘BusinessLine’ on the portfolio of LIC and how secure it is.

(4) Some market commentators point to potential contagion effects. At this stage, the analysis is largely speculative. Withdrawal limit of Rupees 50,000.00 is reasonable for retail depositors and, in any case, and curbs on depositors’ withdrawals will likely go well before April 3.

As for loans to small and medium enterprises, as noted earlier, loans have already dried up and, hence, the incremental impact will be negligible, if at all.

Settlement of derivatives positions has to be clarified. I have no doubt that, before too long, RBI will issue necessary clarifications.

As for the impact on stock markets, they were unsettled even before this development, by global developments. One should not be worried by potential action in stock markets and further declines. Stock prices will become cheaper for long-term investors.

The real issue is how the clients of YES Bank would fund themselves going forward. While most of them would have made or attempted to make alternative arrangements in the last few months, this space has to be watched. Incremental credit crunch needs to be avoided.

(5) There is also a view circulating that meaningful reforms would happen in India only with personnel and leadership change in the Ministry of Finance. That is mischievous.

There have been corporate and personal income tax cuts; consolidation of public sector banks; government’s intent to get out of IDBI has been announced; the Finance Minister has followed through on de-criminalising many of the violations of the provisions of the Companies Act; the budget has improved transparency of the fiscal arithmetic, etc.

India’s economic growth slowdown is due to the financial sector crisis and history has it that all economies experience a deep and prolonged slowdown when the slowdown is set off by banking and financial sector crises. India is not experiencing uniquely severe slowdown. 

Yes, this is an opportunity for meaningful reforms. Yes, it is an opportunity to redefine the balance between government-owned and privately owned commercial banks. But, the solution to all problems is not privatisation and privately-owned banks in advanced economies nearly collapsed the world economy in 2008 and might do so again. Indeed, the collapse of the YES Bank is a cautionary tale of the so-called superiority of the model of private ownership in financial institutions.

That said, the opportunity to improve the resilience of India’s financial system as much as possible remains to be grasped.

Availability of liquidity for Small and Medium Enterprises (SME) is largely a working capital issue and that is as much a failure of banks to make risk-based lending as it is that of large buyers of MSME supplies not paying on time – both government and non-government buyers. That is a systemic change and change in MoF leadership will not solve the issue.

(6) Covid-19, as of now, has had limited impact on India’s health system and the number of infections is exceedingly low, for a large country. India escaped SARS because, by February, India turns warm. It is no exception this time. I expect India to be less affected than most countries.

Covid-19 might also end up contributing to an improvement in India’s bilateral trade deficit with China. See the positive Cummins India story, for example. It could be repeated in other cases.

Overall balance of payments would be less affected as reduced investment flows would be offset by improved trade balance and I don’t see the current account deficit worsening, because of still-weak economic growth impulses and further likely delays in the recovery of investment demand. Further, crude oil prices will remain depressed for the year, helping keep India’s import bill under check. Recent rupee weakness is not a cause for worry and perhaps is, on balance, a good thing.

There will be supply chain disruptions to some industries. Some analysts wonder whether the impact of Covid-19 would be inflationary or deflationary in India. I think it would be mostly deflationary rather than inflationary and hence, allowing RBI room to continue to ease policy conventionally and unconventionally.

India’s economic growth rate for 2020-21 could be 5.5% (my personal central case) with downside risk all the way to 5%. That is the current estimated growth rate for 2019-20.

By the time the dust settles on Covid-19, it might turn out to have done a good deed for India for some of the migration of global supply chain out of China would not be easily reversed. For example, see this riveting story on how the incidence of swine flu conitnues to be suppressed in China. By now, it is common knowledge that the outbreak of Covid 19 had happened a month before the world came to know of it.

It is significant that a cross-party group of twenty senators has urged the UK government to reconsider granting Huawei a role in the country’s 5G telephone network.

(7) Finally, visible leadership from the very top and communication are essential. Such communication too should be non-defensive and non-reactive. They should merely aim to reassure and soothe rather than refute genuine or exaggerated criticisms. 

Being a commentator in these times is far easier than to be a decision-maker. Arm-chair wisdom is relatively intellectually undemanding and most of it is with the benefit of hindsight too. In the rush to get their story out, commentators make big errors. Imagine how difficult it must be to make decisions in real-time under uncertainty often with imperfect and inadequate information?!

Decision-makers should ignore commentators and simply focus on communicating and taking decisions with only one consideration:

Help, if and only if possible, in the short-term, without sacrificing the medium to long-term growth prospects.

Overall, it is possible for India to end the year with a stronger and better base for faster growth with some reasonable steps combined with a calming and reassuring communication. Noise can and should be ignored.

Unintended side effects of stress tests on American banks

Unintended side effects: stress tests, entrepreneurship, and innovation
BIS Working Papers  |  No 823  |  22 November 2019
by  Sebastian Doerr

Regulators have introduced stress tests for the largest banks with the aim of ensuring that they hold enough capital to withstand another crisis. Stress tests have effectively reduced systemic risk and improved risk management and capital planning at individual institutions. However, policymakers and academics worry about the potential negative effects on credit and the real economy. This paper investigates how regulatory stress tests may have affected entrepreneurship in the United States.

Contributing to the literature that highlights some negative consequences of stress tests on credit supply to small businesses, this paper presents new evidence on the real effects of financial regulation. Regulatory stress tests for the largest banks might have an unintended side effect by curtailing credit to young businesses, which are especially dependent on external financing. The contraction in lending has the potential to stymie entrepreneurship and innovation. This novel channel, through which stress tests dampen economic dynamism, could help to explain the persistent decline in entrepreneurship since the crisis.

Stress-tested banks have sharply reduced home equity loans to small businesses, an important source of financing for entrepreneurs. The resulting contraction in loan supply has affected the real economy. By exploiting geographical variation in county exposure to stress-tested banks, the paper shows that counties with a higher exposure have experienced a relative decline in employment at young firms during the recovery, especially in industries that rely more on home equity financing.

Additional findings also suggest that counties with a higher exposure to stress-tested banks have seen a decline in patent applications by young firms, as well as a fall in labour productivity. The latter finding reflects the disproportionate contribution of young firms to innovation and growth. While the results do not imply that stress tests have reduced overall welfare, they highlight a possible trade-off between financial stability and economic dynamism.

Post-crisis stress tests have helped to enhance financial stability and to reduce banks’ risk-taking. In order to quantify their overall impact, regulators have turned to evaluating the effects of stress tests on financing and the real economy. Using the U.S. as a laboratory, this paper shows that stress tests have had potentially unintended side effects on entrepreneurship and innovation at young firms. Banks subject to stress tests have strongly cut small business loans secured by home equity, an important source of financing for entrepreneurs. Lower credit supply has led to a relative decline in entrepreneurship during the recovery in counties with higher exposure to stress tested banks. The decline has been steeper in sectors with a higher share of young firms using home equity financing, i.e. where the reduction in credit hit hardest. Counties with higher exposure have also seen a decline in patent applications by young firms. I provide suggestive evidence that the decline in credit has negatively affected labor productivity, reflecting young firms’ disproportionate contribution to growth. My results do not imply that stress tests reduce welfare, but highlight a possible trade-off between financial stability and economic dynamism. The effects of stress tests on entrepreneurship should be taken into account when evaluating their effectiveness. [Link]

Be sure of what you want. You may get it.

Based on the current repo rate of 5.4 per cent, the impact on SBI’s profitability is compressed to 10 basis points (bps). Home loans offered by the bank now start at 8.1 per cent. However, we are in a declining repo trajectory.

Therefore, if the central bank announces another rate cut anywhere between 25 and 40 bps — in October or later — profitability or net interest margin (NIM) may take a huge knock. At 3 per cent in the June quarter, numbers have just about started firming up and looking better.”

Source: “Linking loans to external benchmark may delay SBI’s profit revival – Profitability may take further hit on policy rate cut of 25-40 bps [Link]

The Chinese proverb I have used in the header is a very profound one.

A template on how to merge

Tamal Bandyopadhyay not only writes interestingly but he also writes about good stuff being done. This piece is an example. He had written on how the Bank of Baroda went about merging Dena Bank and Vijaya Bank into itself. A good read.

It comes across as a good template for other PSU CEOs to follow. May be worthwhile to ask P.S. Jayakumar and the CEOs of the other two banks to hold workshops (half-a-day seminars?) for the entities being merged now (announced in late-August by the Finance Minister) on what they did and how they did it.

Just so that we know

The most popular Mudra loans, given to micro and small units, have three segments — Shishu (up to Rs 50,000), Kishore (between Rs 50,001 and Rs 5 lakh) and Tarun (beyond Rs 5 lakh and up to Rs 10 lakh).

As on March 2019, 16.2 per cent of the Shishu loans have turned bad (for Bank of Maharashtra, it’s 48 per cent and for BoI and Punjab National Bank and a couple of others, at least 25 per cent); the bad loans in the Kishore scheme are 13.22 per cent (four banks, including SBI, have more than 20 per cent bad loans) and Tarun scheme, 9.61 per cent.

We are yet to know the state of affairs at the 59-minute loans (Rs 1 lakh to Rs 5 crore), as loans disbursed on the fast lane are not a year old as yet. [Link]

Incentivising malpractice

The mind-bending complexities of the new financial technology combined with the modern practice of incentive payments that reward employees for particular deals practically invites malpractice, whatever the pious institutional statements about the priority placed on client relationships and an ethical culture. In fact, rewards for successful proprietary transactions, inherently speculative and often in conflict with client interests, will tend eventually to color the overall atmosphere and the reward systems in banks, even beyond the trading rooms.

Volcker, Paul. Keeping At It: The Quest for Sound Money and Good Government (p. 216). Public Affairs. Kindle Edition.

The emphasis was mine and that is the key part of that comment.

Wake up, gentlemen. I can only say that your response is inadequate. I wish that somebody would give me some shred of neutral evidence about the relationship between financial innovation recently and the growth of the economy, just one shred of information.”

Volcker, Paul. Keeping At It: The Quest for Sound Money and Good Government (pp. 216-217). Public Affairs. Kindle Edition.

… concerns about regulatory complexity are common and not limited to financial regulation. Pictures of the thousands and thousands of pages of federal regulation are grist for election campaign mills. I cringe, like others. But then I also cringe a bit when I receive, each year, the eighty or so pages explaining precisely my rights and the policy limitations in my “simple” household insurance policy.

Volcker, Paul. Keeping At It: The Quest for Sound Money and Good Government (p. 218). Public Affairs. Kindle Edition.