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Niveshak November 2009
Niveshak November 2009
Niveshak November 2009
GREEN SHOOTS IN INDIAN ECONOMY PG.09 SYSTEMATIC RISK FINANCIAL REGULATION pg. 17
FROM EDITOR’S DESK Dear Niveshaks,
As the Sensex kisses the 17,000 mark and the DJIA fiddles with the
Niveshak 10,000 level, it may seem that the Bull which almost seemed to be resting in
peace for the past six quarters, has returned. Economists and Analysts have
Volume II started to have a short look back at the reason of the crisis, a deep look at
ISSUE 10 the extent of its effect on the world economy and a long look at the road to
recovery ahead. But in this discussion, did we notice one thing – Recovery
November 2009 is taken for granted. Can we afford to take this as granted? Let me throw a
word of Caution.
Faculty Mentor Huge bailout packages, lowering of interest rates and opening of mul-
Prof. S.S Sarkar tiple liquidity windows to flush out the menacing bear from the markets has
created a huge problem. Firstly, this has pushed most of the countries into
a severe fiscal deficit, in the 8-10% range which may take governments a
couple of years to bring them down to 2-3% range. This can have fatal im-
THE TEAM pacts leading to lesser government spending in the next few years leading
to lower growth rate. The value of major currencies with the dollar has been
Editor very volatile over the past few months. Problems with huge inflow and out-
flow of money, heavy volatility in currency values, fiscal deficit prevailing in
Biswadeep Parida most of the countries may lead them to taking drastic measures on capital
account convertibility. So the possibility of a Currency bubble also may not
Sub-Editors be ruled out.
Amit Choudhary The billions of dollars bailout packages rolled out in the west found
Nilesh Bhaiya greener pastures in the emerging economies. As a result, these economies
defied earnings positions of companies & negative market forces and con-
Sareet Mishra tinued to rise up since March’09. The BSE Sensex for instance was trading at
Sujal Kumar 8-10 times P/E during the recession is now trading at 21 times P/E. This can
be attributed to the formation of an asset bubble in the emerging econo-
mies. When liquidity starts to dry out, investors will be seen running for cover
New Team pulling down the market.
Bhavit Sharma In its last quarterly review, Reserve Bank of India, the regulator, marked
Durgesh Nandini Mohanty an end to the easy money era which was continuing since the recessionary
Hitesh Gulati times. Now credit would not be as easy as it was until now. This so-called
Sumit Kedia start of liquidity squeeze may have an impact on the expansionary plans of
corporate India. This month credit growth recorded single digits for the first
Tanvi Arora time in last fifteen years. This is not just the case in India, many economies
Upasna Agarwal of the world have tried to control fiscal deficit and overheating of economy
due to drastic recovery steps by marking an end to the easy money regime.
Now this may stop the economy from recovering at the rate at which it was
Design Team earlier expected.
Bhavya Aggarwal Earlier we have mentioned that the Chinese have set out on a misad-
Sarvesh Chowdhury venture of going on a buying spree and have been stock piling inventory
Swarnabha Mukherjee which was then available at a very low price. Now this led to rise in com-
Tripurari Prasad modity prices all over the world. Indicators like the Baltic Dry Index pointed
that there in heavy shipping of commodities across the world. No one was
wrong. But the reason was deceptive. There was not much increase in con-
sumption in China, rather it was stock piling for future use. After a few days,
the largest buyer in the commodity market will be on leave and consume
from its stockpile.
All images, design and artwork
Now as the dust settles and the smokes clears, we join the dotted lines
are copyright of and one thing will become clear - The recovery in was not for real. We may
IIM Shillong Finance Club fall back again but not as much as we fell last time but after that the recovery
will be real. Let us wait for the best times to come back soon and in the mean
time let us go through some really insightful articles that our friends from
across all B-Schools have penned down. Hope you find this an interesting
©Finance Club read.
Indian Institute of Management
Shillong Happy Investing!
Biswadeep Parida
www.iims-niveshak.com (Editor-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
finsight
Cover Story
15 The Great Run fingyaan
is it a bubble again? 11 Derivative Instruments
in the Indian energy market
finlounge
14 Fin-Q
PERSPECTIVE
06 Agro Futures: Is it really
helping the farmers?
The cash strapped government has decided to The new monthly index launched on 14th No-
dilute a part of their equity in public sector compa- vember, declared a 0.50% increase in the WPI-based
inflation to reach 1.34% in October. Though fruits 30, 2009, GVK Power and Infrastructure Ltd (GVKPIL)
and vegetables became cheaper by 11%, the height- headed to acquire 12.2% stake in Bangalore Interna-
ened prices of a few commodities like wheat and tional Airport Ltd (BIAL). Flughafen Zurich (Unique),
rice highly affected the index. An increase of 0.1% Zurich airport operators sold 12.2% of their shares at
was also seen in the fuel and power category during Rs 485 crores to GVK Airport Developers Pvt. Ltd, a
October, majorly because of the increase in prices of fully-owned subsidiary of GVKPIL. Unique still holds
furnace oil by 3% and bitumen by 1%. a 5% stake as an operator whereas GVK would center
their attention on the management aspect. GVK is
L&T strengthens Power sector, reduces
the largest shareholder of Mumbai Airport and works
stake in Satyam
for its modernization. Acquiring stake in BIAL is a
The last two weeks saw 2 major acquisitions strategic move by GVK to be a part of one of the big-
by L&T, driving company’s growth in thermal and gest airports in the country. They also intend to look
nuclear power sector. Immediately after bagging the out for any further stake sales by other shareholders
Rs 6897 crore order from Mahgenco- Maharashtra of BIAL, namely L&T and Seimens.
for 3 super critical Boiler – Steam Turbine Genera-
tor Package of 660 MW capacity, L&T entered into Essar arm issues bonds to raise funds
another deal with the Madhya Pradesh Power Gen- Essar Group’s holding company for telecom
eration Co. Ltd. (MPPGCL) on turnkey basis. This Rs services, ETHL Communications Holdings Ltd (ECHL)
1635.30 crore Balance of Plant (BoP) contract was issued zero-coupon bonds to raise Rs 4280 crore. The
signed for two Coal fired plants of 600 MW each. L&T amount would be spent to finance the group’s steel
faced tough competition from domestic BoP bidders and refinery businesses. Non-convertible debentures
for the project. were launched in two series of Rs 2,250 crore each
On the other hand, L&T is also planning to with one maturing in July 2011 at 9.15% and anoth-
sell one-third of its 6.9% stake in Mahindra Satyam er one in December 2011 yielding 9.25%. Vodafone
which would fetch around Rs 304 crores. It is being group has backed these debentures by a put option.
seen as a strategic move to book profits as the mar- RBI diversifies
kets recover.
The Reserve Bank of India has followed the
States speak about GST footsteps of the Central Banks of China, Russia, Phil-
The much awaited discussion paper on GST ippines and Mexico and increased its gold reserves
was released on November 10 communicating the and diversified its holdings. The RBI would soon buy
proposed framework in India. The paper discusses 200 tonnes of gold for Rs 31,490 crores from the IMF.
about the administrative and threshold aspects. This pronouncement by the RBI resulted in an im-
There was broad consensus among various states pulsive rise in gold prices to reach a record high of
on GST. The two-tier structure was proposed to en- $1,093.10 per ounce.
joy concessional rates for some goods by the states,
though it would raise the GST rate. The final law
however, would be passed by the central govern-
ment.
Perspective
Development (UNCTAD) has concluded that futures
• Urad
trading in commodities does affect spot prices of
the underlying. This study, however, was carried out Wheat
at a global level and is not India specific. The study The details about the data under consider-
reveals concerns that speculators do tend to take up ations are given below:
extremely large positions compared to the size of
the market which have the power to move spot pric- Commodity – Wheat
es despite the prevalent demand supply forces. The Duration- 1st July 2009 to 5th Sept2009
study has thus highlighted the importance of a com- Contract- 18th September 2009 expiry futures con-
prehensive regulatory framework to keep a check on tract of wheat traded on MCX.
the speculative activity in the futures markets.
Regression of Spot against Future prices
Is Futures trading really benefitting the Due to moderate coefficient of determination (R2)
farmers? value (69%) and low probability –value (0.0000), in-
The big question thus remains – is futures trad- fluence of future prices on the spot prices of Wheat
ing just being used by speculators and large corpo- is significant and can’t be denied. This suggests
rations with no benefits to the farmers? The par- Spot prices are getting driven by Futures prices to
ticipation of farmers in futures trading in India is an extent but not very much. There could be also
abysmally low – primarily because of the complex be some other factor responsible for inflation. The
nature of the commodity markets and the lack of sample chart showing the regression results is given
awareness amongst the farmer community about below: (Table 1)
them. Moreover, the high lot sizes of futures con-
Coefficient Std. Error t-Statistic Prob.
tracts also discourages the small farmers to directly
C(1) -755.3289 166.3 -4.541118 0.0000
participate in these markets. The membership fees
are also exorbitantly high considering the small C(2) 1.617043 0.143 11.24145 0.0000
farmers and also the daily margining requirements
R-squared 0.696753 Mean depen- 1114.2
act as further roadblocks for those few farmers who dent var
are really interested in hedging their price risks via Adjusted R- 0.691239 S.D. dependent 34.891
futures markets. squared var
Perspective
ments in USA and other developed
Also, foreign inflows have balancing approach
countries the economies across the
started to comeback to India in
world have shown signs of improve-
steady and sustained manner as has been used to as-
ments. India along with China and sess the green shoots
India has been identified as a clear
Brazil has been at the forefront of
growth in this scenario. But experts
growth destination in this recession in Indian economy
scenario. There has been substan-
and economists are still sceptic and put forward op-
tial FDI inflow in 2009H1 in India as
about the scenario. They have called
multinationals realized the potential timistic views about
these as ‘green-shoots’.
of investing in this country. Portfo- future.
Industrial output for the month lio investors have been quite sceptic
of July was 7.2% higher than July about investing in Indian securities.
2008 and in the month of August it In spite of that, they have pumped
was 10.4% higher than last year. The in $10 billion. Sensex has gained
passenger vehicle segment grew by more than 100% to reach a level of
more than 20% in both July and Au- almost 17400.
gust after contracting double digit in
In addition to all this, compa-
2008 Q4.
nies have started hiring again in the
Imports and export levels have midst of this kind of activities after
shown pronounced sign of improve- freezing hiring process for more than
ments in spite of the fact that they one year.
are still below the level of previ-
All these have raised hopes
ous year. The reason for this better
about growth, investments, employ-
growth has been due to huge fiscal
ment and overall prosperity of the
deficits and sharp tax cuts that In-
Indian economy. But at the same
dian government implemented to
time economic news is not unam-
minimise the effect of slowdown. In
biguously well.
fiscal year 2009-10 also Indian gov-
ernment has projected its fiscal defi- There has been below average
rainfall this year. Till mid of august
FinGyaan
out of ‘License Raj’ regime, demol- power exchanges, Nordpool. While
ishing the ‘Single Buyer’ model and IEX takes care of the financial aspect
opening access to national grid. of the transactions, Regional Load
However, a lot of restructuring is yet Dispatch Centers (RLDCs)/ State Load
to be done in this regard. If India Dispatch Centers (SLDCs) ensure the
were to grow at a rate of 9% during electricity supplies and withdrawals
the next five year plan (2009-2014) correspond to the contracts entered
the country’s demand for power on the Exchange. As of September
would grow at a slightly greater rate 2009, Discoms (37), generators (37),
of about 10% i.e., from the present Trading licensees (14), CPPs (48),
120 GW (2008) to about 210 GW by IPPs, cogeneration plants and wind
2014. The installed capacity needs to generators from 23 states & 3 union
grow from the present 145 GW to 256 territories have converged on the IEX
GW in 2014. The growth in demand platform for better management of
would be fuelled by growth in the their energy portfolio.
residential consumption, continued
The key features of this ex-
growth in the services sector and
change are:
greater penetration of electricity into
the hinterlands of India. 1. Transparency for trading
FinGyaan
Power quality and demand side management
Swing options were widely used in the regu- issues under electricity trading would be a challenge
lated Scandinavian market to address the problems in Indian electricity markets. A pool-based electricity
created by the non-storability of electricity. The vari- market coordinated by a system regulator provides
ations in the demand and generation of electricity a strong foundation for building a wholesale market
tend to smoothen out over time. An electricity mar- with open access and tradable transmission prop-
ket swing option gives the buyer the right to use erty rights as mentioned in the paper.
energy up to a certain limit at a fixed price during a In designing an efficient electricity market,
fixed time interval. It may include the obligation to electricity derivatives play an important role in es-
use at least a certain amount of energy during the tablishing price signals, enabling price discovery,
same interval. India being a very large country the facilitating risk management, leading to greater
marginal utility of electricity in different parts of the investments in generation and transmission. This
country given scarcity of supply in different seasons would lead to electricity demand fulfillment at af-
is bound to differ. Buying these options would en- fordable rates to the Indian consumer. Custom de-
sure businesses to secure their requirements at a sign of electricity financial instruments as per the
critical portion of the year when they expect supply needs of the Indian market can provide energy price
to be unstable. certainty, hedge volumetric risk and synthesize gen-
Spark spread options eration and transmission capacity.
Spark spreads are cross-commodity options
paying out the difference between the price of elec-
tricity sold by generators and the price of the fuels
used to generate it. The holder of a spark spread
call option written on a fuel at a fixed heat rate has
the right, but not the obligation, to pay at the op-
tion’s maturity an amount equal to heat rate times
the fuel price at maturity time and receive the price
2. I was appointed as the Secretary of the Treasury in a leap year and resigned in the very
same year of my appointment. I share my name with a city. Who am I?
3. Identify him
4. What minimum percentage of stake does the UPA government plan to hold in the PSUs
after its disinvestment venture?
5. I was the first discount broker of the US. Not one bank failed during my tenure as the
Superintendent of Banks of New York, despite nationwide failures. However this is not what I
FinLounge
6. What is the single largest stake-holder of the Tata Group nicknamed as?
All entries should be mailed at niveshak.iims@gmail.com by 5th December 2009 23:59 hours
One lucky winner will receive cash prize of Rs. 500/--
Cover Story
MANAV JAIN
IIM Shillong
Stock markets are unique in their own way. the bull after that. The Sensex has risen more than
They love playing the game of hit-and-run. They tick- 100% and is hovering around 17000 lately. What is
le you with hope and lend dreams, and to catch you it that is fuelling such a sharp rise? Is the market
early, run unabated till you become a blind-follower. basing itself on fundamentals or just going with the
For a Sensex, which took approximately 28 years to flow? Is the path to recovery so robust or is the path
touch 12,000 and only one more year thereafter to not even visible in the mist of rise?
climb to a historical statistic of 21K, the fizz never It’s surely not the fundamentals. The balance
fizzles out! sheets and profit statements haven’t been as inspir-
The crises, so to say was culminating. And it ing to register such a booster confidence in the mar-
surfaced in full form once the spark came up in one ket system and the economy. The sentiment, despite
end of the globe. Financial crises, or global melt- all this, has been quite optimistic. Some analysts
down, or sub-prime crises were just mere terms; the say that a super bubble is being created and the
gravity of the situation was enormous. The era of reasons for them calling it so have to be observed.
praise for securitization landed into a dark reality, A Business Line editorial dated September 09, 2009
with one of the greatest innovation of the finance captures the picture right.
field turning ugly. Investment banks, known for their “In a mere six months, the mood in the stock
financial engineering, were at the receiving end, market has swung from unrelenting gloom to sun-
with most of them sinking. The crises couldn’t have ny optimism. When the stock market rally began in
shaped up the way it did, had it been restricted March, it was a case of prices ‘reverting to mean’
to such banks only. It spread, and spread fast. The from extreme pessimism. The initial leg of the rally
chain of institutions involved was too long to sus- did have strong moorings in fundamentals, backed
tain. Commercial banks, credit rating agencies, in- by resilient domestic macro-indicators and the im-
surance sector, central banks and the government, proving corporate earnings picture. However, six
all became major stakeholders of the same and the months down the line, with the Sensex almost dou-
world experienced what is now referred to as the bling, the worry is if investors are overtaken by ex-
‘bubble burst’. cessive optimism.”
Monetary policies were implemented but to no One important evidence of this bubble forma-
true discourse. Short-term relief did not extend for- tion is the Price-Earnings Ratio in the current capital
ward for too long. The creators of such meltdown market, which is over 21 for most stocks. A P/E ratio
became the victims themselves and had to be sup- of 21 is not well-supported by economy fundamen-
ported by governments and bailed out. Fiscal stimu- tals and such a drastic rise in this ratio indicates
lus became the word of the day and financial insti- that earnings have not grown proportionately with
tutions turned beggars. But what about India? With the market, which is feeding in air into itself each
a more restricted economy and not much financial passing day. Stock prices are highly inflated, as so
re-engineering in this part, the impact of such crises is the market in general. The earnings do not justify
was presumed to be less. It was, indeed, less but the rise, and factors that are leading to a situation
the globalization impact made sure the economy did like this are purely technical and propagated by op-
not go scot-free. The Sensex crashed 1408 points on timism that is so very untrue.
January 21, 2008 despite good Q3 earnings. The fi-
Indian markets still seem attractive to inves-
nancial meltdown had reached India.
tors among large stock markets all over the world.
A few days later, the Sensex gained 1139 points Though the Indian market is currently trading at a
(January 26, 2008), thus proving how volatile it can premium with respect to markets of other develop-
get. The sentiment was low until March 2009, which ing economies, the future outlook is positive. The
saw a low at 8160 points. But there was no stopping economy is expected to grow at more than 5%. Also,
is the fact that only 3.5% of the savings are invested market indices. The lower liquidity has the impact of
in the stock market. However, given the large popu- raising up valuations every time new equity enters
lation and subsequently the large amount of sav- into the system. Also, since India does not have a
ings, a small percentage increase in this rate would well-developed vast bond market, people generally
mean huge investment in the stock market. A half look forward for equity market for investment, and
percent rise in this rate would imply an increase in therefore the scope of valuations inflating rises even
domestic capital investment of $15 billion, equiva- further.
lent to about $10 billion foreign investment. Such However, there are several reasons to make be-
an investment from the savings side would create a lieve the fact that this bubble would not enlarge and
valuation bubble in the Indian economy. come down to its mean figure. First and foremast is
The Real Estate Sector is another area of con- the issue of credit availability. The revival of credit
cern that has contributed highly to the current bub- has mostly been to the corporates, and large cap
ble. Housing prices in India are reaching new highs companies, the middle and small cap companies be-
and this is reminiscent of the US housing scenario ing left out. For a sustained recovery to take place,
before the first bubble burst. And such high pric- there should be even recovery in all sectors and all
es are a fancy for speculators who engage in this companies. The biased nature of credit availability
market and inflate stock valuations, thereby raising can be sustained by this new bubble only for a short
prices further. Ground period of time, and ulti-
reality suggests that mately it would bring it
the demand for hous- back to its normal shape.
ing is not as high to Another major point
rightly explain the price of concern is the recovery
rise; neither has sup- in the developed world.
ply been inconsistent. Emerging markets might
What led to the melt- be doing well, but if the
down in America is be- developed economies
ing manifested here in dampen the recovery
India now, and if this path, even developing na-
continues, suspicions tions will be hard hit. Re-
being put up now shall covery in the west is not
take actual form in a expected to be too fast
few months from now. and therefore, emerging markets might have to suf-
The fiscal packages and the stimulus provided fer corrections every now and then. With new capital
by the government also impact the valuations of the issues for qualified institutional buyers on the rise,
stock markets. Currently, most of the growth be- the stock markets are facing a situation where there
ing experienced in the country is due to the huge is a flurry of QIPs. Companies coming out with plans
government spending through stimulus packages. to raise money through this medium enjoy a rise in
The government lends out hefty sums of money their stock prices, which further raises the index.
to needy institutions and for other sectors as part
of fiscal policy measures. What’s important is the Where do we stand?
questions as to the source where from the money is In brief, we’re at a juncture wherein the mar-
provided. The money lent as stimulus is firstly bor- kets are showing excessive volatility and valuations
rowed by the Government from its various sources do not suggest the intrinsic values that ought to be.
within the nation and/or abroad. There would come Stocks and indices are overpriced and the sentiment
a point where the government would cease to pro- is highly optimistic and positive. The bubble has all
vide further stimulus. And when such an incident the ingredients to grow further; but it has all the
happens, growth of the Indian economy would slow more reasons to burst and impact the economy in
down to a trickle. a hard way. The path to recovery is charted, but
Liquidity also plays an important role in ana- the path doesn’t allow us to run. Emerging markets
lyzing any market. Markets which are more liquid can jog, developed nations will follow, and the world
are generally more stable as compared to those would be a happier place quite soon.
which are not. Illiquidity, as the term is called affects
valuations in a magnified manner. The low free float
AoM
exposed weaknesses in the current Finally, in the last section, the potent tool for elimi-
regulatory and supervisory frame- learnings from the previous sections nating systemic risk
works. Even as governments con- are applied in Indian context and
tinue to fight probably the biggest and supervising the
need and the structure of systemic
financial meltdown ever, the focus risk regulatory agency in India are SIFI’s. The structure
has already started shifting towards discussed. of SRR prior to imple-
deciding the face of new financial
Need for a Systemic Risk Regu- mentation needs to
regulation framework which can cre-
ate a safer and sounder financial lator be thought upon.
system for the future. The current financial regula- SRR holds significant
The financial meltdown, which tory structure is institution specific. importance in Indian
brought the world down to its knees, So, we have independent regulatory
context as well for
has escalated the need for funda- bodies for institutions like banks
mental rethinking on the regulatory and large insurers while some other putting all regulato-
policies pertaining to financial sec- like hedge funds and private equity ry measures in place.
tor. A need has been felt for setting funds go unregulated. In fact a whole
up a systemic risk regulator man- gamut of these bank-like institutions
dated with broad responsibility for such as investment banks, hedge
the whole financial system, charged funds, mortgage brokers, venture
with spotting regulatory gaps and capital firms etc. grew outside the
market pressures that might desta- regulatory framework of banks. Such
bilize the system. It is believed that unregulated financial entities consti-
regulators failed to head off the re- tuted the shadow banking system
cent crisis because no one was ex- and their growth, which was largely
plicitly charged with spotting risks outside anyone’s control, was a ma-
that could lead to system failure. jor source of the current crisis. This
Such regulator gaps and overlaps system became far more important
need to be eliminated. EU has al- source of credit than the more heav-
ready formed one such agency while ily regulated banking system. High-
U.S. is still debating on the structure ly leveraged firms supplied large
of the agency they want to bring in. amounts of capital without having to
This article opens with a dis- expose their activities. These entities
cussion on why there is a need for created opportunities for regulatory
systemic risk regulator and what are arbitrage as banks shifted risk to
the gaps in the regulatory system balance sheets of affiliated entities
that they might help to fill. The next in the shadow system and evaded
section argues upon what should be capital requirements.
the ideal shape and structure of such The existing regulations ad-
an agency. While some believe that opted a micro prudential view and
the central bank is the right candi- focussed on systemically important
date to become the super regulator, individual institutions, not recogniz-
many others feel that by taking on ing that systemic stability could be
supervision and regulation, central threatened even if individual insti-
the risk that simultaneous failure of one or more key crisis like situations from deepening. However, the
financial institutions destabilizes the overall finan- SRR must be confined only to point of provid-
cial system. The havoc caused by crisis has ing regulations. Resolution of failed/distressed
brought to fore the need of a Systemic institutions should be left for other appropri-
Risk Regulator. The mandate of this ate agencies.
agency would be to constantly search 6. Enforce minimum early in-
for gaps, weak links and perverse in- tervention by “early closure and loss
centives serious enough to threaten the sharing plan” for SIFIs so that timely
system. It has become necessary that the actions are taken to prevent bank-
Systemically Important Financial Institutions ruptcies.
(SIFI) —banks, insurance firms, investment
Structure of an SRR
firms, and hedge funds—should be subjected to
consolidated supervision by a single agency. We propose 4 structures for an SRR and sub-
sequently discuss their merits and demerits: (1) A
A Systemic Risk Regulator (SRR) is needed be-
new consolidated financial solvency regulator (2)
cause it is not possible to eliminate systemic risk.
Broadening the scope of Central Bank to include the
Besides, even if systemic risk is curbed for the cur-
financial regulation as its responsibility (3) A new
rent scenario, history proves that with the advent
SRR agency (4) Simultaneous working of the current
of new technologies, new bubbles are created; new
set of financial regulators
financial innovations come into force, which bring
together a whole new dimension of systemic risk. A new consolidated financial solvency
The financial industry is so dynamic that 80% of the regulator
products sold today did not exist even 2 years ago. A good way to consolidate current multiple reg-
The housing price bubble was aggravated (and some ulatory agencies is to club them in two heads, one
may argue it was caused) by the financial stupidi- for solvency and another for consumer protection.
ties: injudicious mortgage lending, excessive high The consumer protection regulator would include
leverages and short sighted insurances. With an ef- bodies like SEC in U.S. and SEBI in India but would
fectively working SRR, we believe these kind of fool- fall outside the purview of this article. The financial
ishness would be reported and curbed much before solvency regulator would be assigned with the re-
they cause any significant damages. sponsibility of reducing systemic risk as much as
At this point, it would be prudent to define the possible. It would oversee and regulate all the finan-
exact responsibilities of an SRR (what form can this cial institutions with special focus on SIFIs. Though
SRR take is discussed in the next section): the SRR would be headed by the Central Bank, it
1. Reduce systemic risk to the extent possible would be the SRR which would have the final say.
AoM
ing before crises and finger pointing after the crises, about India’s financial stability. As India further inte-
the responsibilities must be defined in a non-ambig- grates with the rest of the world, it will get exposed
uous and explicit way so that the only authority over to forces of globalization. If financial stability any-
solvency and associated reporting requirements is where in the world is jeopardized, India’s financial
the Central Bank. In spite of all these precautions, stability will become vulnerable too. Thus India also
the idea is fraught with many dangers: needs to consider setting up a systemic risk regula-
• Asking Central Bank to regulate would compro- tory authority.
mise its focus on monetary policy While RBI could have been handed over the
• The Central Bank needs complete indepen- reins of being a systemic risk regulator given that it
dence in order to carry an effective monetary policy. is equipped to deal with financial stability because
Assigning explicit systemic risk responsibility to it of its macroeconomic perspective which enables it
would make it responsible to the Government and to conduct macro prudential regulation, we believe
thus take away its independence that forming a council of regulators would be an
ideal structure in Indian context. The role of sys-
• Significant political risks underlie the prem-
temic risk regulator might make it difficult for RBI to
ise and the Central Bank might be inappropriately
remain independent in order to conduct monetary
forced to loosen or tighten the regulatory stance to
policy. Also, the central bank may lack the expertise
favour some political gains
to engage in supervision, where micro-knowledge,
• The Central Bank might be extremely risk such as on accounting and legal issues, is required.
averse and in the process it might curb some pos-
India already has an informal setup in form
sible innovations
of a High Level Coordination Committee on Finan-
• Finally, with the current capacity Central Banks cial Markets (HLCC-FM) comprising all the regulators
across the world are very ill-equipped to handle the from financial sector - RBI, SEBI, IRDA and PFRDA and
regulatory work. While they have huge command the Finance Secretary. It serves as a forum to deal
over the monetary issues, the same cannot be said with inter-regulatory issues arising in the financial
about their accounting and taxation prowess. Also, and capital markets. The authorities should con-
infrastructure and staffing issues need to be taken sider upgrading the HLCC-FM to a formal structure.
care of
Also, in India there are no specific regulations
On account of so many issues, it is probably for the financial conglomerates which pose bigger
better to have a consolidated financial solvency risks to the system than single product service pro-
regulator as compared to assigning risk authority to viders. Setting up of a council of regulators would
the Central Bank. We out rightly reject the last two make it easy to get regulatory measures for them in
options as they do not have any merit. Creation of place as well.
a new SRR agency without consolidation would just
add one more player to the already over-crowded
Fin-Q Winner
The Fin-Q Winner for the month of October 2009 is
Ankur Singla
of FORE School Of Management
He receives a cash prize of Rs.500/-
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