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Tuesday, June 20, 2017

Interesting readings

How genetics is settling the Aryan migration debate by Tony Joseph in The Hindu, June 19, 2017.

The botanists' last stand: The daring work of saving the last samples of dying species by Zoe Schlanger in Quartz, June 17, 2017.

45 years of Watergate: Why the journalism of the Washington Post-NYT holds lessons for today's media by Saikat Datta in Scroll, June 17, 2017.

Dangerous nonsense: Once we put the Indian military above criticism we become Pakistan by Kanti Bajpai in The Times of India, June 17, 2017. Also see: How will your armed forces perform? by Ajay Shah in Ajay Shah's Blog, October 12, 2016.

Eyes in the forest by Aakash Lamba in Mint, June 17, 2017.

Where are India's TV comedy shows? by Mitali Saran in Business Standard, June 16, 2017.

Lessons from the US in Business Standard, June 15, 2017.

Modi's Message to the Media by Sadanand Dhume in The Wall Street Journal, June 15, 2017.

Keep official abuse of governance in check by Somasekhar Sundaresan in Business Standard, June 15, 2017.

The power paradox by Pratap Bhanu Mehta in The Indian Express, June 14, 2017.

Jeff Sessions and the Trail of Unanswered Questions by Amy Davidson in The New Yorker, June 14, 2017.

Want More Time? Get Rid of The Easiest Way to Spend It by David in Raptitude, June 13, 2017. Why did social media work badly? Perhaps an adverse selection process is afoot: a vicious cycle of low quality giving selective exit giving lowered quality.

Is Trump's definition of 'the rule of law' the same as the US Constitution's? by David Mednicoff in The Conversation, June 13, 2017.

Trump and the True Meaning of 'Idiot' by Eric Anthamatten in The New York Times, June 12, 2017.

Pirate Bay founder: We've lost the internet, it's all about damage control now by Már Másson Maack in Nextweb, June 10, 2017.

Donald Trump Is the Worst Boss in Washington by Britt Peterson in The New York Times, June 9, 2017.

The forking of the Indian rupee by J P Koning on Moneyness, June 9, 2017.

Blood from the Sky: Zipline's Ambitious Medical Drone Delivery in Africa by Jonathan W. Rosen in MIT Technology Review, June 8, 2017.

Bengal and business by Ashok K Lahiri in Business Standard, June 6, 2017.

Monday, June 19, 2017

Movement on the law for the Resolution Corporation

by Suyash Rai.

Capitalism without bankruptcy is like Christianity without hell.
- Frank Borman

On June 14th, the Union Cabinet approved the proposal to introduce a Financial Resolution and Deposit Insurance Bill, 2017 ("the FRDI Bill"). This is an important step forward for a critical component of the overall strategy of India's financial sector reforms. Shaji Vikraman has insight on this in the Indian Express. In this article, I look deeper into the concept of the resolution corporation, why it matters, how we got to this milestone, and what comes next.

The slow unfolding of the banking crisis reminds us of the fragility of our financial system. The financial system, especially the banking system, is generally disaster-prone. On one hand, financial firms can make mistakes and experience losses. In addition, there is a link between problems of the economy and hardship in financial firms. When an economic downturn happens, the value of business activities declines, and this induces losses upon financial positions. We need to build a financial regulatory apparatus which will reduce financial fragility. This involves three main elements of machinery : micro-prudential regulation (which aims to push the failure probability of each financial firm to a desired value), systemic risk regulation (which aims to reduce the probability of a disruption in the overall financial system, and have tools to respond to such a disruption when it does arise) and resolution (a specialised bankruptcy process for most financial firms). At present, in India, we have weaknesses on all three elements.

Consequences of a weak resolution system

When micro-prudential regulation works well, the failure probability of financial firms is at a low level chosen by the relevant financial agency. The failure probability is not zero. Failure of inefficient firms is essential for `creative destruction'. The process of failure of inefficient firms, and the shift of capital and labour to efficient firms, is essential for productivity growth. The question is: How can we make the failure of financial firms orderly?

The failure of financial firms can often be quite disorderly. Unlike real sector firms, many financial firms manage a large amount money belonging to households and businesses, with only a small amount of capital brought in by their owners. Banks in India typically have leverage of 18$\times$ to 20$\times$, which means that their balance sheet size is 18 to 20 times the amount of equity capital. Such leverage is never seen with real sector firms. When the firm gets into trouble, there is clamour by the creditors who want to see a fair and efficient process through which they get some of their money back. Matters are more challenging with some financial firms which are so large and complex that their failure could induce instability in the financial system.

An orderly failure is one where a) the consumers either get their money back quickly or continue to get services without any significant inconvencience, and b) the stability of the financial system is not threatened. If we are not able to obtain orderly failures in the financial system, this has many adverse consequences:

  • Consumers of failed financial firms suffer. As an example, in India, many cooperative banks fail every year. In spite of high entry barriers, larger institutions also fail (e.g. Global Trust Bank in 2004). Consumers lose money in these failures. These bad experiences make consumers wary of engagement with the financial system, and increase the share of gold and real estate in their portfolios.
  • Financial stability is threatened, because even if one systemically important financial firm fails, the entire system could be destabilised by a messy, long-drawn bankruptcy process. This forces government to bail out such financial firms. So, a financial crisis ends up having a fiscal consequence.
  • When faced with the possibility of harm to consumers, and threats to financial stability, governments get cold feet in situations of firm distress. They are then prone to bail out financial firms using taxpayers' money. We in India are familiar with this story. Public sector banks are routinely recapitalised with public funds to ensure they do not fail. This is almost never a good use of public money.
  • Regulators sometimes respond to these problems by setting up entry barriers, which harm competition and economic dynamism. They justify the every day harm to competition on the grounds that this averts harm to consumers, risks to financial stability and the fiscal cost of bailouts.
  • Financial firms suffer from moral hazard, and take greater risks. At its worst, financial firms obtain supernormal profit from these two interlinked channels: the certainty of being bailed out and the lack of competition.

A system that ensures quick and orderly resolution of failed financial firms can help avoid these outcomes. The system should be such that government, financial firms and consumers believe that the failures will be orderly. The present system of resolution in India is inadequate.

First, it mostly empowers the respective regulators (eg. RBI for banks) to do the resolution. Since regulators give the licenses and are supposed to ensure safety and soundness of the firms they license, they tend to be tardy in acknowledging their mistakes. This regulatory forbearance leads to delays in recognition of failure, which increases the costs of resolution, and may lead to losses for consumers and increases risk to stability of the financial system. There is a conflict of interest between micro-prudential regulation (achieving a target failure probability for a financial firm) and resolution (gracefully closing down financial firms which are nearing failure).

Second, the present system gives very limited powers of resolution. The powers that are given are: forced mergers/amalgamation, and winding up. Some of the other powers, such as bail-in (discussed later), are not available.

Third, even these limited powers are not enjoyed over many of the financial firms. For example, regulators do not have resolution powers over public sector scheduled commercial banks and regional rural banks.

Fourth, the way the system is structured, a bankruptcy resolution can take years, sometimes even longer than a decade. This is partly because the regulators do not have powers to take timely resolution action.

The Financial Resolution and Deposit Insurance Bill

Indian policy thinking on this began in the RBI Advisory group on reforms of deposit insurance, 1999, chaired by Jagdish Capoor.

This slumbered until we got to the Financial Sector Legislative Reforms Commission, chaired by Justice BN Srikrishna, which worked from 2011 to 2013. In its full design of Indian financial regulation, it recommended a Resolution Corporation.

In 2014, a Working Group of Ministry of Finance and Reserve Bank of India, co-chaired by Shri Arvind Mayaram and Shri Anand Sinha, also recommended a resolution capability for financial firms.

In 2014, the Ministry of Finance constitued a Task Force for the Establishment of the Resolution Corporation, under the chairmanship of Shri M. Damodaran, to work out the plan for establishing the Resolution Corporation. This was part of the two-part creation of task forces for building the new institutions required in the FSLRC architecture, which came about as four task forces followed by one more.

The budget speeches of 2015-16 and 2017-18 announced a plan to draft and table a Bill on resolution of financial firms. In September, 2016, a draft of the Bill was placed in public domain for comments.

On June 14th, the Cabinet approved the proposal to introduce a Financial Resolution and Deposit Insurance Bill, 2017 ("the FRDI Bill") in Parliament. The FRDI Bill, when enacted, will create a framework to ensure that failure of financial firms is orderly. It will establish an independent Resolution Corporation tasked with resolving failed financial firms. The Corporation will also subsume the deposit insurance function presently performed by the Deposit Insurance and Credit Guarantee Corporation.

This Bill stands at the intersection of two long-term reform projects: 1) financial sector reforms, of which bankruptcy resolution of financial firms is an integral part; 2) bankruptcy reforms, of which financial firm resolution is an integral part. So, this Bill moves both these projects forward, and is an important building block for an efficient system of capital allocation in India.

FSLRC had envisioned a separation between the resolution corporation, which would apply for most financial firms, and the bankruptcy code, which would apply for the remaining financial firms and for all non-financial firms. The Bankruptcy Legislative Reforms Commission (BLRC), which drafted the Insolvency and Bankruptcy Code (IBC), worked with this scheme. IBC does not cover financial firms, unless the Central Government notifies certain financial firms to be covered under that law. Many types of financial firms, especially firms handling consumer funds and firms that are critical for financial stability, require a specialised resolution mechanism. For firms handling consumer funds (eg. banks, insurance companies), the process under IBC is not suitable, as a large number of small value consumers will find it difficult to invoke that process. The processes of IBC are designed for creditors who are firms, not individuals. For systemically important financial firms (eg. central counterparties, larger banks), a creditor-led resolution process under IBC is not suitable, because what is at stake is not just the interest of creditors but the stability and resilience of the financial system. Hence, for such financial firms a specialised resolution regime is required. The FRDI Bill will create such a specialised resolution regime.

What is resolution?

In the world of financial firms, resolution complements regulation. Regulators and the Corporation are expected to work in tandem, with the regulators focused on maintaining financial health and, when a firm gets into trouble, pushing for its recovery. The Resolution Corporation will take over and resolve a firm after recovery efforts have failed. Although the version of the Bill approved by the Cabinet is not yet in public domain, based on the version that was released for public consultations last year, the framework is divided into four stages.

First, when the financial firm is healthy, the respective regulators will monitor the firm and work to ensure it continues to stay healthy. At this stage, the Resolution Corporation will only get information indirectly through the regulators. Substantive powers to monitor the firm or to take any other action with respect to the firm will not be available to the Corporation.

Second, once the financial firm starts deteriorating, the respective regulator will attempt recovery. At this stage also, only the regulators will continue to have substantial powers over the firm.

Third, if the recovery efforts fail, and as the financial firm get close to failure, the Corporation will get substantial powers to instruct the firm to improve its resolvability and prevent actions that may erode the values of assets available for resolution. At this stage, the role of regulators is restricted.

Finally, when the firm fails, the Corporation will take charge and resolve it. Resolution typically means selling the failed financial firm, as a whole or in parts, to another financial firm via a competitive bidding process. However, resolution could also involve other instruments. For example, the firm could be "bailed-in", which means that the rights of and obligations to creditors may be written down to recapitalise the firm from within. Bail-in typically includes converting some junior debt into equity, but may also include writing down other types of claims. This is the opposite of a bail-out, wherein outside investors rescue a borrower by injecting money to help service a debt. Finally, liquidation may be a tool used for resolution.

There is a certain degree of tension and potential conflict between the Regulators and the Resolution Corporation. This is a healthy check-and-balance. Resolution works as a check on regulatory incompetence and forbearance. Both sides will need to be mature, respect the role of the other, and coordinate.

The idea of a specialised resolution regime for financial firms is well-accepted globally. The US has had a resolution system for banks for more than 80 years. The scope of this system was extended after the financial crisis of 2008. There have been more than 600 bank failures in US since the crisis. In this time, there has been not been even one bank run in the US, because depositors trust the resolution system to work. Why the crisis happened in the first place is another matter, which is beyond the scope of resolution. Resolution comes into play only after regulation fails, and the occurrence of crisis resulted from regulatory failure, among other factors.

Many other countries have put in place comprehensive resolution systems. These include: all European Union member states, Switzerland, Australia, Canada, Japan, Korea, Mexico, and Singapore. Many jurisdictions have ongoing or planned reforms to resolution regimes. These include: Australia, Brazil, Canada, China, Hong Kong, Indonesia, Korea, Russia, Saudi Arabia, Singapore, South Africa, Turkey.

Next steps

We are still a few years away from having a full-fledged resolution regime. Now that the Bill is going to the legislative branch, it remains to be seen what version of the Bill eventually gets enacted. If the essential features of a good resolution regime are diluted in the final version, the chances of success will be low.

Even after the Bill gets enacted, it would still take some time to build an independent and competent Resolution Corporation. Since this capability currently does not exist in the system, it will have to be cobbled together, and then strengthened over a period of time. Consider the example of human resource strategy. There are many models out there. While the Canadian authority works with fewer than 100 employees, the US authority has more than 10,000 employees. The Corporation could choose to run a tight ship, and rely on contractual work to scale up capacity in times of crisis, or it could choose to build a large organisation that is able to, on its own, deal with a crisis. Similarly, given the skill sets required to do this job, the Corporation will have to think innovatively about attracting top talent within the constraints of a government agency.

The Task Force on Establishment of the Resolution Corporation, led by M. Damodaran, has done considerable work that lays the groundwork for constructing the agency. The implementation of their project planning needs to commence immediately, so that the delay between enacting the law and enforcing it can be minimised.

It will also take our governance system some time to get used to this kind of a system of taking over and resolving a failed financial firm in a decisive and quick manner, as opposed to the present approach of allowing things to linger on. If things do go right, there are many potential benefits of this reform.

 

The author is a researcher at NIPFP.

Wednesday, June 14, 2017

Announcements

Positions at DAKSH

DAKSH is a Bangalore based organisation working on judicial reforms using quantitative and legal-empirical methods. We focus on judicial process, procedures, management, administration and capacity building. Visit www.dakshindia.org for more details.

We have an opening for the position of Research Associate at Bangalore.

Essential requirements

We are looking for graduates in law or public policy with 2-5 years post qualification experience.

Desirable requirements

Candidates with experience or interest in inter-disciplinary legal research. Experience with litigation or consulting / advisory experience would be an added advantage.

Candidate will work in a collaborative, non-hierarchical and open environment on a unique project with a judicial body.

Salaries will be competitive and commensurate with experience, as per social sector standards.

Contact us

Interested candidates may please send their resumes to surya@dakshindia.org


Monday, June 12, 2017

Interesting readings

Firms are fearful as uncertainty has gone up by Ajay Shah in the Business Standard, June 12, 2017.

Time for reflection, fellow doctors by Vikram Patel in The Indian Express, June 10, 2017. There is a similar problem with lawyers.

Comey Drama A Reminder Presidential Disaster Often Hits In Times Of High Confidence by Ron Elving in NPR, June 9, 2017.

How to Write Like James Comey by Beth Skwarecki in Lifehacker, June 8, 2017. The Comey statement.

The Bounty Hunter of Wall Street by Jesse Barron in The New York Times, June 8, 2017. We need to careful to ensure that IFC market abuse, and laws about freedom of speech, do not interfere with such activities, which the richest 1000 families of India dislike.

Presstitute chronicles by Pratap Bhanu Mehta in The Indian Express, June 7, 2017.

Conspicuous consumption is over. It's all about intangibles now by Elizabeth Currid-Halkett in Aeon, June 7, 2017.

Smart policing and safer streets start with better data; this is not the norm in India by Neha Sinha, Avanti Durani, and Rithika Kumar in Hindustan Times, June 7, 2017.

Aadhaar's potential for financial inclusion by Bindu Ananth and Malavika Raghavan in Mint, June 7, 2017.

The crisis of expertise by Tom Nichols in Aeon, June 6, 2017.

Policing by consent: The reassuring face of the British police in trying times by Prasun Sonwalkar in Hindustan Times, June 6, 2017.

Where schools struggle, students seek out English themselves by Aman Sethi, Heena Kausar and Saumya Khandelwal in Hindustan Times, June 5, 2017.

Britain's Secret Weapon Against the Nazis? Refugees by Simon Worrall in National Geographic, June 4, 2017.

What Winston Churchill and George Orwell had in common by John Gray in NewStatesman, June 4, 2017.

Indian Council of Social Science Research: Past, present and a troubled future by Ramachandra Guha in Hindustan Times, May 28, 2017.

Loan Waivers Are Duds: India Needs An Exit Policy For Unviable Farming by R Jagannathan in Swarajya, March 20, 2017.

Tuesday, June 06, 2017

Interesting readings

Grey market for IPOs: A case for regulation? by Suranjali Tandon in NIPFP Blogpost, June 2, 2017.

Downgraded China Doth Protest Too Much by Benn Steil and Emma Smith in Council on Foreign Relations, May 31, 2017.

Masha Gessen in the New York Times: 'incompetence and autocracy are not in opposition: They are two sides of a coin'.

Why India's growing religiosity is an economic challenge by Pramit Bhattacharya in Mint, May 31, 2017.


The Politics of Clan: The Adventures of Jared Kushner by David Brooks in The New York Times, May 30, 2017.

The Loneliness of Donald Trump by Rebecca Solnit in Literary Hub, May 30, 2017.

The severity of the NPA crisis by Harsh Vardhan and Rajeswari Sengupta in Mint, May 30, 2017.

Dealing with protests in Kashmir: The army chief has spoken. Why is the prime minister silent? by Saikat Datta in Scroll, May 30, 2017.

The Aadhaar legal framework is broken by Vrinda Bhandari and Renuka Sane in Mint, May 30, 2017.

Czeslaw Milosz's Battle for Truth by Adam Kirsch in The New Yorker, May 29, 2017.

Minerals as a shared inheritance: Implications for public finance by Rahul Basu in NIPFP YouTube Channel, May 29, 2017.

Wall Street's Endangered Species: The College Jock by Justin Baer in The Wall Street Journal, May 25, 2017.

The Virus Hunters by Jeffrey Marlow in Undark, May 25, 2017.

How the Nazis Made Art Fascist by Ian Beacock in New Republic, May 23, 2017.

There has been no Aadhaar 'data leak' by Ram Sewak Sharma in The Economic Times, May 9, 2017.

Why Arendt Matters: Revisiting "The Origins of Totalitarianism" by Roger Berkowitz in Los Angeles Review of Books, March 18, 2017.

What It's Like to Live in the World's Most Polluted City by Melody Rowell in National Geographic, April 26, 2016.

The Spread of Dengue in an Endemic Urban Milieu: –The Case of Delhi, India by Olivier Telle, Alain Vaguet, N. K. Yadav, B. Lefebvre, Eric Daudé, Richard E. Paul, A. Cebeillac and B. N. Nagpal in PLoS ONE, January 25, 2016.

You Can't Trust What You Read About Nutrition by Christie Aschwanden in FiveThirtyEight, January 6, 2016. We in Economics would do much better if we understood how much these problems afflict us also.

Professor Who Learns From Peasants by Jennifer Schuessler in The New York Times, December 4, 2012.