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Rajan has yet another speech in which he says much of the same but two important points:
Changes to Markets are coming
In the coming weeks, we will roll out more recommendations of the Gandhi Committee report to improve the liquidity and depth of the G-Sec market. We will then turn to money markets and corporate debt markets. We will introduce new variants of interest rate futures and products like inflation indexed certificates, and work to improve liquidity in derivative markets.
This is interesting. The Gandhi committee report is here. They are likely to
- consolidate g-secs into lesser securities – there are nearly 90 in existence, so it’s difficult to market make
- Allow trading
- Push banks to reduce their HTM holdings where they don’t have to mark the holdings to market and will reduce the liquidity in the main market itself. This has been abused by banks in the past – and even recently, when banks moved their holdings to HTM upto 24.5% of NDTL, using July 15 prices, to avoid the depreciation caused by the bonds losing major value after the yield rises.
- FIIs should be promoted by both increasing their limits and allowing them to participate directly in markets (currently they can only go through brokers).
- Let STRIPS trade in the secondary market.
- Increase retail participation by using bank/post office networks, reducing costs and fees on gilt accounts, simplifying the Gilt-to-demat route (I have been requesting this like forever)
There are more recommendations. It will be quite interesting if these come through. Imagine if you can easily buy or sell government securities including T-Bills. You are currently getting, from the government, yields of above 9% for T-Bills as less as 91 days.
You can also get a much better deal on a long term cash flow instrument, like a 30 year bond – so if you retire today, you could easily buy a 30 year bond at a yield of about 9.25%. Comparable annuities yield far lesser, and don’t allow you to cash in part of the portfolio in the interim. And you don’t get 30 year FDs to lock in yield. This could be quite interesting for the future.
Get Serious About Defaulters and Distress Signals
And last but not least, with have to deal better with distress; The natural, and worst, way for a bank management with limited tenure to deal with distress is to “extend and pretend” to evergreen the loan, hope it recovers by miracle, or that one’s successor has to deal with it. The natural incentive for a promoter to deal with distress is to hold on to equity and control despite having no real equity left, and to stand in the way of all efforts to resolve the underlying project while hoping for an ‘Act of God’ to bail him out. Not all bankers and promoters succumb to these natural incentives but too many do.
We have to ensure that the system recognises financial distress early, takes steps to resolve it, and ensures fair recovery for lenders and investors. We could wish for a more effective judicial process or a better bankruptcy system, but while we await that, we have to improve the functioning of what we have. In the next few weeks, we will announce measures to incentivise early recognition, better resolution, and fair recovery of distressed loans.
A mechanism that creates incentives to early recognition has to mean only one thing – that banks needn’t recognize losses immediately. If banks had to, their profitability and reserve ratios will be hit badly.
Or, it might mean they will adopt a carrot and stick approach. A mechanism that puts ALL loans of any issuer at par with everyone else will be interesting – if you default on any loan, then every other bank that has lent to you must classify you as an NPA. A centralized mortgage system has already been introduced so that each mortgage is registered in a common place (so borrowers can’t borrow twice against the same collateral – a common occurance in the industry).
I would recommend that banks be forced to collaborate through a central NPA recognition system, and any secondary loan made to an entity that has not paid any other loan for even 60 days should attract big fines for the bank. Plus, for resolution banks will have to work together right from the beginning, instead of doing the CDR approach – RBI can design a framework which assigns the “lead” banker on an NPA who has to do a checklist of items that will ensure ring-fencing of assets and a short timeline to either bankruptcy or an RBI sanctioned extension. And, they have to include NBFCs and stock exchanges to participate otherwise things get moved around.
Finally, a system to auction bad assets (including collateral) might be useful, and could even involve non-banks and individuals.
We should wait and see what comes out of this. I see business opportunities for technology in both the above. I also see interesting points for new banks to make their mark in, and for good recovery companies to buy and deal in distressed debt.
Note: I’m sorry if this is too much about banking and too little about real macro nowadays.
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