The top challenges facing U.K. Sinha


The top challenges facing U.K. Sinha


Now that U.K. Sinha has gotten one more year as chairman of the Securities and Exchange Board of India (Sebi), what should he do? While it is tempting to continue the trodden path—more rules, more enforcements and so on—we believe that he can do something else that will have far more impact on the future of Sebi and for India’s financial markets. It is the transformation of Sebi itself from a bureaucratic, ad-hoc and reactive regulator to an agile, research-driven and proactive regulator. Obviously, this effort cannot be completed in a year but he can at least set it in motion. At Sebi now, rule-making is often arbitrary and appears to be based upon strongly held opinions rather than an evidence-based determination arrived at after weighing competing arguments. Enforcement actions are selective and often not commensurate with the size and nature of the offence. The process seems to be reactive, not proactive. The recent financial crisis exposed the shortcomings of the reactive, piecemeal approaches of regulators worldwide and led to calls for a coordinated, data-intensive, proactive approach that seeks to isolate risks before they materialize and destabilize markets. Without the capability to understand complex new financial products and the research that makes them possible, regulators can hardly be expected to do their jobs effectively in an integrated financial marketplace. In other words, it is critical that tomorrow’s regulator be agile, flexible, data-driven, research-friendly and tech-savvy. Transforming Sebi in this manner is, in our opinion, the most important task ahead for the chairman. You are probably wondering why we do not mention specific challenges such as investor protection (from practices such as misselling of financial products or fraudulent investment schemes) or in market development (such as corporate bonds). It is because we believe that the effectiveness of everything that Sebi does, including addressing these urgent priorities, depends on the quality of its rule-making and enforcement framework. Our aim is, therefore, to highlight the need for structural reforms at Sebi and, we suspect, at other regulators as well. A reformed Sebi would make for a more successful regulator, one that is not structurally behind the entities that it regulates, one that has processes in place to address current and potential regulatory transgressions more effectively. Such a transformation must start with people. According to its recent annual report, only a quarter of its workforce has any legal training or accounting background while there are almost no economists on its payroll. In contrast, nearly half of its employees carry general purpose MBAs. Enforcement actions originating from such a workforce are more likely to lack legal basis and may not stand up i n the courts of l aw. Rules without proper enforcement promote moral hazards and increase costs of trading, and eventually cost of capital for our firms. Good policies require good data and research to guide them. While it is not unusual to see global regulators put out data and encourage academic assistance in analysing the data, Sebi has been markedly reserved in this effort. Most of its research is conducted in-house and rarely shared with the broader research community. Without transparency, it is hard to determine whether Sebi’s proposals are really rooted in sound economic rationale or are just a simple response to a complex problem that could potentially do more harm than good. The backtracking by Sebi on its safety net proposal for retail investors in an initial public offering is one such example of a proposal backed by in-house research that did not pass muster either with experts or market participants. Given that there are significant costs to be borne by market participants, it is absolutely critical for Sebi to base its decision-making on transparent, data-driven research. Regulating India’s financial markets is still a work in progress. Globally, organizations such as the Bank for International Settlements, the US Securities and Exchange Commission and the European Securities and Markets Authority routinely engage academic researchers in creating and advising on their regulatory initiatives. India’s approach has been to rely on the recommendations of expert committees with limited academic inputs. Greater provision of data could help address this shortage and catalyse data-driven policymaking. Increased participation of the research community facilitates deeper understanding of issues and allows regulators to assess the true costs and benefits of regulation, objectively using the best-of-breed scientific tools and techniques.

Lender’s responsibility towards sustainable development

The enactment of the Companies Act, 2013 and its stress on Corporate Social

Responsibility (CSR) has changed the way India Inc. once thought about philanthropy. Modern

day corporations are now expected (indeed required) to participate more and more in the State’s

drive of fostering social welfare. With increasing focus on what companies should or should not

do in terms of social and environmental impact and the larger welfare of the community in which

they operate, the role and responsibility of lenders has been rather under-emphasized.

As service organizations, banks and Financial Institutions (hereafter, FIs) are not direct

polluters of the environment. However, banks can contribute indirectly when they finance

projects that have the potential to cause environmental damage. Indian regulations require project

developers to undertake a thorough analysis of the impact of the proposed project culminating in

an Environment Impact Assessment (EIA) Report. This document is a pre-requisite for obtaining

clearance from regulatory authorities and any financing.  The EIA is a comprehensive picture of

the perceived environmental impact of the project with details regarding items such as water, air

and noise pollution, displacement of local population, soil erosion, disruption of water ecology,

loss of aquatic wildlife. The EIA must be made available to banks and FIs and is an integral part

of convincing them about the feasibility and long-term viability of the project at hand.

It appears that , despite the availability of the EIA with Indian banks and FIs, they are not

adequately discharging their ‘vetting’ function. One case that illustrates the complexity is the

Loharinag Pala hydro power project which was scrapped after three years of work. This

ambitious project (which represented the NTPC’s first foray into hydro-electricity) on the river

Bhagirati in Uttarakashi, had an expected project cost of nearly 3,000 Crores. As required, an EIA

was prepared, necessary clearances obtained and work on the Loharinag Pala began.

Interestingly, the EIA had clearly spelt out that the developer believed the environmental damage

from the project to be of a ‘permanent’ nature, more specifically, in the form of loss of

agricultural and forest land, disruption of aquatic life in the Bhagirati, resettlement of households

in the area and reduced river flows, resulting in a deterioration in river quality. However, after

three years and expenditure running in millions of rupees, social and religious activists demanded

scrapping of the project. Their argument was that the Loharinag will end up contaminating the

Bhagirati, which is of significant religious importance to Hindus in India, being a tributary of the

sacred river Ganga. After a long-drawn legal battle, the State Government finally decided in favor

of scrapping the project.

Any guesses about losses due to premature termination of the project? Nearly Rs. 600

Crores had already been spent, Rs. 1900 Crores committed and equipment worth Rs. 2,000 Crores

ordered. It must be remembered that this is just one example of how carelessness on the part of a

crucial vetting authority such as the financing bank resulted in significant waste of resources,

time and of course, effort. Needless to say, an event such as this could easily have been averted, if

few hours had been spent on assessing the long-term viability of the lucrative-looking project.

On the global front, things are not that disappointing. Most countries today have both

realized and highlighted the role and responsibility of banks and FIs in ensuring financial

sustainability. One notable example is that of the Equator Principles (EP). The EPs represents a

set of voluntary guidelines designed for assessing, categorizing and managing environmental and

social risks in project financing. These are based on the World Bank and International Finance

Corporation (IFC) policies and guidelines. First announced in 2003, 80 EP Financial institutions

(EP FIs) across 35 countries have adopted these Principles till date. This represents nearly 70

percent of international project finance lending in emerging economies. Banks and FIs who adopt

the EPs commit to the application of extensive care and due-diligence on the social and

environmental front, for project values exceeding US$ 10 million.

As on date, no Indian bank has signed the EPs. In December 2007, an RBI circular

stressed the need for banks to act more responsibly toward sustainable development and also

highlighted the existence of the Equator Principles. In 2013,  IDFC, India’s largest integrated FI

adopted the Equator Principles. However, YES Bank and Infrastructure Leasing and Financial

Services (IL&FS) are the only Indian bank and FI respectively to have signed up the UNEP FI,

which is a global partnership between the UNEP and the financial sector to spread awareness and

sensitivity on sustainability matters. Still, Indian banks seem to be gearing up to the idea of

financial sustainability, thanks to the encouraging attitude of the Reserve Bank of India. Recently

(WHEN?), the Government of India has issued guidelines to banks urging them to ‘Go Green’ by

cutting down on their use of paper, electronic payments and video conferencing, to name a few.

Indian banks, therefore, have been and continue to be the backbone of industrial

development in India. The Indian banking scenario provides a colorful diversity of public-sector

banks, private banks, foreign banks and the like. However, Indian banks have differed largely

among themselves, in terms of their economic performance and ability to deal with bad loans.

Profitability has been an important objective of Indian banks and has, over time, helped them

evolve from outdated bank practices to contemporary automated ways, from making loans under

Government-pressure to choosing their clients diligently and so on. Avoiding non-performing

assets (NPAs) in future has been, and rightly so, a key factor governing the loan decisions of

Indian banks. However, perhaps what they have failed to look at is the fact that mere disbursal of

loans to apparently credit-worthy borrowers for herculean projects is not enough. While banks

may not directly influence the environment or the country’s reservoir of natural resources,

through its lending function (which stands at the heart of its existence), its role in the latter

becomes all the more nuanced. Granting loans for projects that would eventually result in

environmental degradation in any form is not only financially detrimental to the interests of

banks, but also irresponsible behavior. Not only is recovery of credit a painful task in such cases,

banks may have a lot to lose in terms of their reputation. Being associated with projects viewed as

‘unsocial’ or ‘immoral’ serves as a detriment to the public image that banks would like to

So let’s be together in our quest for sustainable development – as individuals, banks and

corporations who have great business ideas. After all, we want to see our children perform

smarter and better than us. This they can do only if we leave some resources at their disposal.

Ever-greening of Bank Loans in India

“One can put lipstick on a pig but it doesn’t become a princess.”

Raghuram Rajan, Governor, Reserve Bank of India, on the rampant practice of ever-greening of loans by banks in India






Ever-greening of bank loans is a prevalent phenomenon in India. It represents the tendency of banks to

avoid, rather delay the recognition of loans made by them, as ‘bad’ or irrecoverable even in the presence

of information supportive of potential non-recovery. Often, instead of writing off loans as bad, fresh loans

are granted to partially repay the earlier one and thus to cover up the truth. By keeping the loan account

on the books, the bank is able to justify its decision of not recording an expense. Simply put, ever-

greening is the denial of bad news by banks, until it can no longer be concealed.

Ever-greening has the appearance of a short-run win-win situation for both contracting parties – the

banker does not have to take an earnings hit and the borrower often gets a new lease of life. Banks often

justify this behavior by arguing that fresh financing increases the likelihood of poorly-performing

borrowers bouncing back and regaining financial health. Anecdotal evidence suggests otherwise. Crippled

borrowers often go bankrupt and plead for a Corporate Debt Restructuring (CDR), thereby directing

affecting lender profitability as they now have to write off an even larger loan.

Why don’t banks ‘provide’ for potential losses arising out of non-recovery based on past expectation?

The answer is simple – banks are required to put aside a certain percentage of their profits each year

towards a reserve/ provision for bad debts, representing a portion of loans that are unlikely to be realized.

The graduated structure of provisioning requirements for Indian banks reaches its maximum at 100

percent of the book value of Non-Performing Assets (NPAs), representing loans that have remained

inactive for a fairly long time. However, since this charge must come out of a bank’s profits, managers

attempt to minimize the provisioning requirements by avoiding the recognition of loans as NPAs. Hence,

the problem. This tendency is quite clear since Indian banks have the lowest Reserve Coverage Ratios in

Asia , rendering them more prone to financial turbulence.

Another closely linked phenomenon is that of unscrupulous securitization of bad loans (NPAs) by banks

to Asset Reconstruction Companies (ARCs). ARCs have gained a lot of importance in the recent past.

Indian banks are increasingly approaching them to off-load risky and potentially-bad loans from their

balance sheets. Banks sell and ARCs purchase NPAs from banks at a price, along with all risks and

responsibilities related to recovery of these loans as they fall due. Since ARCs are often able to recover

only a portion of loans purchased, they traditionally buy bank receivables at hefty discounts (called

‘haircuts’), representing up to 95% of loan value. It is estimated that the sale of NPAs to ARCs

increased from Rs. 80 billion in 2012-13 to 270 billion within a year.

Selling receivables to the ARC’s does not solve the problem, partly because of the way the deals are

settled. ARC’s frequently pay only about 5 percent of the sale value of loans purchased in cash and the

balance in Securities Receivable (SRs). These SRs continue to remain on the books of the lender (the

original bank) until the loan is realized. This means that now the lender’s risk is not mitigated, but

‘shared’ with the ARC to whom the loans are sold. One large loan goes bad and it sweeps away the

fortunes of all three – the failed borrower, the ARC and the lender who holds worthless SRs on its books.

In the Indian context, there is no dearth of examples of bank loans that were rolled over again and again

in anticipation of borrower recovery. However, in most cases, the lenders were proven wrong. The most

notable examples here are those of Hotel Leela and ABG Shipyard. In case of the former, Indian Overseas

Bank, Syndicate Bank and the Bank of India have lent significant amounts to the company. Owing to

consistent poor profitability and liquidity, the bankers are not very keen on granting fresh loans to Leela

unless a CDR is agreed upon. Even if a CDR finally happens, it appears likely that it shall be bankers who

will have to take a hit by relaxing the interest terms and haircuts. Similarly, ABG Shipyard has loans of

Rs. 11,500 Crores involved in a potential CDR. Lenders ICICI and State Bank of India appear skeptical

about promoter Rishi Agarwal’s plans of restructuring.

Ultimately, ever-greening appears to be a not-so-healthy practice for Indian banks. The Indian financial

markets have seen it all – interest rate fluctuations, massive speculation in stock markets, booms and

crashes, to say the least. An economy-wide downward spiral is the last thing we would want to see now.

On that note, a piece of advice to Indian banks – a stitch in time saves nine!

Summary of talk by Mr. Srinivas Pulavarti at the CCMRM


Mr. Srinivas Pulavarti, Chief Investment Officer, UCLA Investment Company presented his views on portfolio management and global financial markets at the Centre for Capital Markets and Risk Management, IIM-Bangalore, on September 24, 2015.

With over 20 years’ experience in managing portfolios, Mr. Pulavarti provided important perspectives on the flux in global financial markets, quantitative easing in the U.S. and the less-talked-about reasons why phased Q.E. may not yield desired results.

For the benefit of those who could not make it to his talk the other day, some key points from his talk are below:

  1. With hundreds of global investment opportunities available, it is best to keep investment avenues for one’s portfolio, limited. In his words, “for the investment manager, the eleventh alternative is always much less understood than the tenth one.”
  2. The key functions of any investment manager, irrespective of the size of assets under management, are three: where to invest, how much to invest and what stock to invest. Particularly for longer time horizons and large portfolios, clarity of an investment process is critical.
  3. Speaking about the magnitude of endowment funds available to US universities, Mr. Pulavarti pointed to the American practice of philanthropy. Such institutions consciously create a sense of identification for American students with their alma maters. Since they feel part of the family, it becomes easier for successful Americans to contribute generously to universities and schools in which they studied. Indeed, it is preferable for them for their alma mater to benefit from these funds rather than pay huge amounts as taxes to the State. With shrinking State support for academic universities, sources of such funds, supplemented by grants from the US National Institutes of Health and the National Science Foundation, form a large portion of their operating budgets.
  4. There is however considerable variation in the dependence ratios amongst Universities. Dependence ratio is the extent to which the University depends on the annual payout (approximately 5% at all institutions) from the endowment towards its annual expenditure/budget. Dependence ratios can vary from 2% for the University of California to almost 55% at Princeton University.
  5. The success stories of countries such as China and Korea have surprised the world. Mr. Pulavarti believes that this is the outcome of the processes and internal controls they have in place, even for the most minute of activities. Longer times spent on planning saves considerable time spent on execution.
  6. Pulavarti compared the state of Gujarat in India to Korea. He believes that there exist stark similarities between Gujarati’s and Koreans, in that the people are equally industrious, hard-working and business-minded. Seeing where Korea stands now in the global markets, he asks whether Gujarat really fulfilling a similar role as an Indian state?
  7. Freedom of mind is absolutely critical to the efficiency of a fund manager and the success of his fund. It is, therefore, worthwhile to reject grants and endowments from authorities, than allow them to tell you what you must or must not do.

Overall, sitting through Mr. Pulavarti’s talk was enlightening, to say the least. To hear such views from a man who has seen it all, was an experience in itself. He was both extremely clear with his explanations and patient with questions the audience had. Encouraged by the overwhelming response from the audience, in terms of attendance and their enthusiasm throughout the talk, we at the CCMRM intend to bring many more conversations of this kind, in the days to come. Time permitting, Mr. Pulavarti has kindly offered to participate at other events at IIM-B in the future. We remain thankful for his generosity.

Whither GDP

The initial furore about drastic revisions in India’s GDP which triggered my piece in Mint earlier this year requires follow-up.  Two news items in the Western Media caught my eye recently. The first is an assessment report by the Boston Consulting Group (here) and the second an inaugural report from the newly created JPMorgan Chase Institute (here). Both these reports are amibitous in scope, reflecting the need to go beyond a headline number such as GDP in understanding the general well being of an economy and its citizens.

BCG titles its effort, Sustainable Economic Development Assessment (SEDA) and proposes three main elements: a) economics which of course measures how well policies create the economic climate for efficient resource allocation and innovation; b) investment in human capital and infrastructure;  and  c) environmental protections and inclusiveness. Standard measures currently in use largely reflect the first and somewhat the second. Even in these measures, there are glaring holes- the treatment of intellectual property, and of research and development expenses. Deemed largely as intermediate outputs, these innovative contributions are poorly captured in the “final” sales numbers that GDP is based upon. The Chase Institute takes a different tack at exploring the interconnections in economic activity. Rather than look at trends in macro-economic data which has been the approach of generations of economist, the Institute looks at finer information- namely, the proprietary transactions data of nearly 2.5 million bank account holders. From this big data analysis, they are better able to understand their income and consumption patterns. Their 3 main findings are striking: a) across all income spectrums, account holders experienced high volatility in income and even higher volatility in consumption; b) changes in income and changes in consumption do not move together, exhibiting only a small positive correlation and; c) typical account holders do not have a financial buffer to withstand the volatities reported above in both income and consumption. Again, the message is clear– looking at one headline number like the GDP does not provide a perspective on how messy and volatile financial lives actually are!

I think that in India as well, overwhelming reliance on small sample surveys and then on the law of large numbers appears increasingly to be misguided. Let big data show the way!


On India’s recently revised GDP estimates

The following piece by Prof. SG Badrinath, Visiting Faculty & Chair, CCMRM, IIM-B was featured on Monday, 15th February 2015 in the Opinions section of the Mint newspaper.

In the last week, there have been a number of pieces talking about the dramatic revision in Indian GDP estimates. On January 30, 2015, the Ministry of Statistics and Programme Implementation released details in a note which economists will be poring over in the coming months. The estimate change is substantial, a 50% increase in GDP from 4.7 % to 6.9% for 2014. The change in methodology is significant, two most notable are a) the use of market prices instead of factor costs and b) a much more comprehensive coverage of the corporate sector. The former change is consistent with global practices. As Pronab Sen, Chairman of the National Statistics Commission notes, the MCA database now used carries information for nearly 5,00,000 firms as opposed to 2500 in the earlier Annual Survey of Industries. The former change will probably increase estimate volatility while the latter has to make the data more reliable.

The media reaction both domestic and overseas is predictable, the Wall Street Journal laughs pointing to reports that even India’s central bank governor Raghuram Rajan is confused. A Financial Times headline screams: “ India: GDP growth rate up, confidence in statistics down? The Financial Express quotes India’s Chief Economic Advisor Arvind Subramanian as puzzled by the high growth rate. Out-of-power politicians are quick to point out that the revised, higher GDP growth rates should mean that economic recovery started during their term. Indian press notes that the current government is hoping to reap the benefits too. The Chinese government pooh-poohs the notion that India may actually grow faster than China in the coming decades. The obsession with growth is so pervasive that the oxymoron of “negative” growth even merits a definition in Barely heard amidst all this blather are acknowledgements of the difficulty of estimating economic activity in a population of over a billion people. Measured, thoughtful responses that this release is not consistent with other data on bank credit and corporate earnings, that the information contained in it should be studied more carefully, that even this revision may eventually be revised are all relegated to the fine print. In a country where nearly half of the domestic product comes from “informal” sources, the difficulties in measurement should be self-evident.

Let us also not forget that bashing government statistics is a time-honored pastime in most domiciles. The Wall Street Journal routinely knocks economists from the Bureau of Economic Analysis in the US for leaving out oil and food from CPI calculations. If we don’t eat and don’t drive they say, we won’t have inflation, forgetting of course that the very reason for excluding these components is the volatility of prices in their underlying markets and that monetary policy pronouncements based on such numbers would be imprudent.  Follow sites like Shadow Government Statistics ( and you will see well-reasoned complaints that the US government dramatically understates unemployment figures.  Other publications hint that if the US Government were to reveal “true” inflation estimates, then the size of their entitlement payouts would increase.

The purpose of this piece is not to get into debates about estimation methodologies, political motivations, cross-country comparisons or to point fingers at a certain kind of journalism. Indeed, some journalists have valiantly attempted to go inside the numbers in this press release while others like A.S. Panneerselvan of The Hindu more generally stress the value of “data journalism. The purpose of this piece is to draw attention to a thinly veiled, somewhat pervasive, anti-intellectual attitude towards data and statistical analysis of which the furore about GDP numbers is just one more illustration. More pernicious is the feeling that by torturing data long enough, economists can get it to confess to anything! All around us are the often-annoying manifestations of data-mined marketing drives to get consumers to buy things they don’t want and may not even need! Data sometimes does not fit into the categories that our mental accounting processes allot. Data does not frequently conform to the elegance and precision that science teachers have taught us to prize. Data may not always cooperate in the quest for clarity, for certainty in an increasingly uncertain world. Rather than belittle efforts to present better data, shouldn’t we as a society adopt a more positive mindset? Shouldn’t we support nascent efforts like the National Data Sharing and Accessibility Policy, which promotes the dissemination of government data within the constraints of national security and privacy? Otherwise, hasty inferences from one-off events such as a GDP revision will reinforce the notion among already-skeptic decision makers that data and statistics are unreliable, that data providers are suspect, that efforts to collect quality data is futile. One fallout from such perceptions will be to make information gathering and dissemination less thorough and transparent. This in turn, would hamper the quality of the prescriptions that become possible through evidence-based policy making, clearly not a desirable outcome in the big data world we now inhabit.

S.G. Badrinath, Chair, Centre for Capital Markets and Risk Management, Indian Institute of Management-Bangalore.

The views expressed in this commentary are personal.

Literacy and MSME

MSME.9.5This post provides preliminary reactions to a Consultative Paper on National MSME policy which was solicited by the Development Commissioner, MSME.  Given my expertise, it only addresses the financial aspects of MSME development in India. It is well known that micro- and small enterprises seek informal sources of financing and their organizational structure (of sole proprietorships) is such that financing tends to be much more in the form of debt rather than equity.  Whatever collateral that is provided often takes the form of pawning personal valuables and is difficult to identify, especially for the service segment of these businesses. Without adequate collateral, formal institutional finance is understandably reluctant to participate. To address this, CERSAI has begun to maintain a collateral registry.  In turn, the entrepreneurs themselves do not have the expertise in record-keeping and book-keeping, to meet institutional guidelines. Indeed, enterprise size and structure are likely to be such that the costs of compliance would make the businesses themselves unviable. Programs such as credit linked capital subsidies (CLCS) largely for the manufacturing segment and credit guarantee schemes (CGTMSE) been proposed to address these concerns. Even credit ratings are 75% subsidized, and presumably assist businesses that can continue to be viable with financing, since they wouldn’t subject themselves to outsider scrutiny otherwise. Still, only a small fraction of entrepreneurs approach and a still smaller fraction obtain institutional funds while the majority rely substantially on informal financing sources.

Government interventions are targeted at making the MSME environment more palatable to institutional finance. Corresponding efforts to support the entrepreneur in the areas of skill development, connection to end-user markets and the adoption of technology have also been proposed. One aspect that has not achieved much attention is improving entrepreneur financial literacy. Developing such financial literacy would involve: a) ) teaching entrepreneurs the value of record-keeping, financial planning, forecasting, and the revolving nature of working capital needs; b) making entrepreneurs aware of how access to formal finance might benefit the business and; c) helping entrepreneurs understand what causes financial sickness and how they can recover from such distress. One would expect entrepreneurs to have some schooling and therefore the ability to comprehend basic financial concepts. In designing literacy programs the challenge is of course to find the right local language teachers, perhaps involving their more successful peers in delivering such education. It seems that basic training of this nature would be one way to bring down the costs of complying with the requirements for accessing institutional finance.

S.G. Badrinath, Centre for Capital Markets, IIM-Bangalore,  January 13, 2015.