Impact of Trump Presidency in India

On January 20th, 2017 defeating all the opposition, Donald Trump emerged as the 45th president of the U.S.A. Trump’s 15-point agenda which he had elucidated in the run-up to the elections could impact the Indian government, business sector and people in various ways. Continue reading “Impact of Trump Presidency in India”

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Impact of US Fed Rate Hike on India

IMPACT on INDIA (Expert opinions)

Indranil Sengupta, India chief economist, Bank of America Merrill Lynch

“We hold the contrarian view that Fed tightening is a long-run positive, although EMs could well see one round of sell off in the coming months. We expect softer oil prices and sufficient forex reserves to keep Fragile Five fears at bay for India in the event of a sell-off, although India’s BoP indicators still trail other BRICs. Fed tapering is also pulling down oil prices below US$100/bbl from US$118/bbl when INR crossed Rs68/USD last year,”

Dipan Mehta, Member, BSE and NSE

FII flows are driven by interest rates movement in the US and other developed economies. Also, asset price movements in those economies also impact global flows.

No doubt, to that extent India is vulnerable and if there is a selloff in global equities or emerging markets, then we will not be spared. “However, the decline may be less than other markets. Nonetheless, there will be a negative effect. India cannot escape a ‘risk off’ trade. Since the new government formation, international events are having a less of an impact as investors focus on government steps to revive the economy and the RBI moves based on macro data such as inflation, GDP growth rates, IIP etc.,” he added.

How would India benefit?

Sutapa Roy, Research Analyst-Economy at Microsec Capital Ltd.

“Now for India, the economic situation is much better than it was 2-3 quarters ago. India has taken some of the major steps compared to its EM peers to control currency movement and increase foreign exchange reserves. Only in recent past the Indian market hit an all-time high. So corrections will definitely be there, but not as much as we saw in 2013 as fundamentals are better now,”

Roy is of the view that India has already outperformed the other markets in the recent past and after corrections, it will definitely attract some fresh capital. Although it will take the US Fed some time to shift from its zero interest rate policy, but if they do that, there may be a kneejerk reaction wherein some hot money may try to get out.

Vikram Kotak, CEO & MD, Asset & Wealth Management, Fortune Financial Services

“On a totality basis, India is possibly the only market in the emerging market basket, where a 15 per cent to 20 per cent earnings growth is reasonable to expect and the economy recovery looks robust with GDP move from 5 per cent to 7.5 per cent in three to five years’ time being almost a surety. There are a lot of positives for India right now than the negatives. However, you might see some healthy corrections coming in when the markets start consolidating again,”

The overall trend of the market looks quite positive and given the fact that the markets have run up in the last three to four months, a correction is indeed healthy as it will give opportunity for fresh investments.

Hemang Jani, Senior Vice President, Sharekhan

 “The US FOMC meet could provide the much-needed correction and about 5 per cent to 10 per cent correction at the index level in any market is part of the bull market story. I am not really perturbed by this. In fact, this would be a great opportunity for a large number of retail investors who have not been able to participate to the extent they would have wished. So it is a great welcome sign for the investors.”

Deutsche Bank Crisis

Deutsche Bank Historical stock prices in EUR (€)

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Deutsche Bank’s stock price has nearly halved since the beginning of 2015. The stock was trading at €12.30 on Nov 4, 2016. The company also posted a negative EPS of (€ 5.06) for the year 2015. The company’s S&P’s rating downgraded to ‘BBB+’ in 2015 from ‘A’ in 2014 and Fitch ratings downgraded from ‘A+’ to ‘A-‘. The bank was forced to suspend dividend payouts in 2015 to allow it to build up its cash reserves.

Problems with Deutsche Bank:

Negative interest rates:

Deutsche and other European banks have been struggling with negative interest rates, which are squeezing profits. Eurozone credit growth is still limp despite the ECB’s negative interest rate policy.

Huge exposure to the derivatives market:

Deutsche has the world’s largest so-called derivatives book, its portfolio of financial contracts based on the value of other assets in the world. It peaked at over $75 trillion, about 20 times German GDP, but had shrunk to around $46 trillion by the end of 2015. That’s around 12% of the total notional value of derivatives outstanding worldwide ($384 trillion), according to the Bank for International Settlements. Those hedges can fail, especially when, as was the case back in 2008, the likes of Lehman and AIG either failed or looked like they would.

Net loss of €6 billion for Q3 2015:

The company posted a huge loss of €6 billion for Q3 2015 which was mainly driven by billions of dollars in write-downs of the value of investment-banking and other assets. The company had announced plans to lay off 35,000 people shortly after announcing the quarterly loss and also announced plans to reduce its number of branches worldwide.

Fine of $14 Billion imposed by US regulators:

As a punishment for its role in the 2008 crisis, the Obama administration has sought a series of stiff fines against banks that allegedly sold bundles of low-quality mortgages without fully informing customers of the associated risk. Deutsche Bank faces one of the biggest fines and is expected to negotiate with the US regulators to settle the fine to $5.4 billion. In November 2015, the bank agreed to pay a $258 million fine for violating US sanctions laws.

Failed the US regulatory “Stress Tests”:

European and American regulators have performed a series of “stress tests” to try to predict how banks will fare in the event of another economic downturn. If banks fail these tests, they’re required to beef up their reserves. The US fed failed Deutsche in this year’s stress tests, for the second year in a row, saying it had “substantial” weaknesses in its capital planning. Deutsche Bank has been one of the worst performers in these tests, and last year it was forced to suspend dividend payouts to shareholders to allow it to build up its cash reserves.

Problems to the International Economy:

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The International Monetary Fund warned in a late June report that since the bank is heavily intertwined with the rest of the global financial system it appears to be “the most important net contributor to systemic risks” among Global Systemically Important Banks (GSIBs), followed by HSBC Holdings Plc and Credit Suisse Group AG. Since Deutsche bank does business with many Banks, NBFCs, Mutual funds and Insurance companies around the world a bankruptcy of such a large bank would definitely trigger a financial crisis as many people would lose their jobs and their hard earned savings.

Regulatory updates:

No bail-out this time, but a bail-in is possible:

Ever since the 2008 financial crisis, policymakers in both the US and Europe have been trying to change the rules to make another bailout unlikely. European rules prohibit national governments from providing a no-strings-attached bailout. They can allow for a “bail-in” where the creditors and depositors take a loss on their holdings to rescue the financial institution instead of the government using the taxpayers’ money to save the bank. Angela Merkel has vowed not to use German taxpayer money to rescue Deutsche Bank.

Is Deutsche Bank on a verge of a crisis?

A positive Q3 2016 for Deutsche Bank:

Third-quarter net income was €278 million, beating analysts’ average expectations for a net loss of around €610 million. The bank’s restructuring and litigation costs for the third quarter were lower than analysts had expected, in part because employee compensation dropped. Revenue from trading, especially in credit and interest-rate products, was stronger than a year earlier, offsetting weakness in equities trading within the lender’s important global markets business.

The German lender earmarked an additional €501 million in the third quarter for litigation costs (costs for legal expenses). Deutsche Bank’s common equity Tier 1 capital ratio, a measure of financial strength, increased to 11.1% from 10.8% in the second quarter. The lender is working to boost that ratio to at least 12.5% by 2018. Deutsche Bank ended the third quarter with €200 billion of liquidity reserves. Analysts say that the liquidity position is still strong, and not a central concern.

The lender has ramped up cost-cutting plans, and is still planning to dispose of its burdensome German retail-banking unit called Postbank. It also agreed to sell its U.K. insurance unit Abbey Life Assurance Co., a move which will boost the bank’s Tier 1 capital ratio by about 10 basis points.

2015 marked the start of a multiyear cost-cutting and turnaround plan under then-new CEO Mr. John Cryan (Effective Jul 1, 2015). The group has undergone restructuring of its business divisions.

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Sources:

https://www.fdic.gov/about/learn/board/hoenig/capitalizationratio2q16.pdf
http://www.bloomberg.com/news/articles/2016-09-28/why-people-have-been-worrying-about-deutsche-bank-in-12-charts
http://www.vox.com/new-money/2016/10/4/13124402/deutsche-bank-problems-explained
http://fortune.com/2016/09/27/deutsche-bank/
http://www.wsj.com/articles/deutsche-bank-swings-to-profit-1477546211

IMPACT OF TRUMP PRESIDENCY ON INDIA

Donald Trump’s improbable victory in the U.S. presidential election provoked global shock and angst on Wednesday over the implications for everything from trade to human rights and climate change. The bombastic billionaire defeated Hillary Clinton in a result that few predicted, as millions of American voters shrugged off concerns over his temperament, lack of experience, and accusations of sexist and racist behaviour.

The India-US “defining partnership” opened a new chapter with the stunning victory of Donald Trump. The element of unpredictability that has just been introduced could go either way, but an initial sweep of Trump’s probable foreign policy gives India an opportunity to up its game with the United States.

In India, Donald Trump’s victory could cause short-term economic panic, but may have long-term foreign policy benefits, argues Neelam Deo, the director of foreign policy think tank Gateway House. Close ties between the US and India under the Obama administration could also take a turn for the worse.

Trump’s view towards India

Trump has indicated that he would work towards a stronger relationship with India, saying he would be “best friends” with India, and broadcasting a message in Hindi saying “ab ki baar Trump sarkar,” referring to Modi’s campaign slogan in 2014 elections. It is unclear if those statements would translate to foreign policy benefits for India as they are designed to woo a small contingent of American Indians.

During the campaign, Trump referred to India in several ways: As a country that was growing fast, as a country that was stealing American jobs, and as a target for terrorists. Early on in his campaign, he declared he was “looking forward to working with Narendra Modi”.

Policy on Government spending and taxation

Trump said that he would leave Social Security as is, trumprepeal and replace Obamacare, and make  government spending more efficient and effective though here he has not been specific.

Trump is proposing lower tax rates for individuals and US companies. The US currently has a federal corporate tax rate of 35%, the highest in the OECD. Trump is calling for it to be lowered to a below-average 15%, with firstyear business investments to be deductible in full.

 

Policy on Immigration

trump2Immigration is one aspect of Trump’s policy that has been heavily covered by the media. The country’s economic potential would be harmed by the greater economic isolation proposed by Trump, particularly his plan to deport over 11 million illegal immigrants and increase trade barriers with Mexico and China, countries he accuses of taking advantage of their relations with the US.

 

Fears over Mr Trump’s anti-trade rhetoric were reflected in the falling shares of major Asian exporters – from car makers to cargo firms to shipping companies. He has promised to bring jobs back to America. Trump has promised to punish firms that send their jobs to Asia which could hurt economies like the Philippines and India that have massive outsourcing industries.

 

Trade Policy

Trump has also promised to ramp up US military presence in the South China Sea (SCS). In the recent past, India has quietly despaired that US’ “rebalance” may remain on paper. Increased US presence in the SCS would be welcomed in both New Delhi and Tokyo.

trump3While Trump has promised to take China to task on unfair trade practices, India would be on the mat as  well because its own trade policies are regressive.

India has benefited from globalisation, but Trump has been elected on a
platform that might make the US more inward-looking. That might cause some amount of crossed wires between India and the US. It’s safe to say that Trump will not move forward with the Trans Pacific Partnership (TPP). For India, which does not qualify for the TPP yet, it might be an opportunity to play a better trade game.

Sources:

https://www.project-syndicate.org/commentary/clinton-trump-economic-policies-by-michael-boskin-2016-09

https://www.theguardian.com/world/2016/nov/10/an-epochal-change-what-a-trump-presidency-means-for-the-asia-pacificregion http://www.bbc.com/news/business-37933376

http://timesofindia.indiatimes.com/united-states-elections-2016-us-elections-news-results-polls/India-seeks-ally-against-PakChina-axis/articleshow/55344108.cms

The Basel Accord: A Primer

What is Basel?

According to BIS, “Basel III is a comprehensive set of reform measures, developed by the Basel Committee on Banking Supervision, to strengthen the regulation, supervision and risk management of the banking sector. These measures aim to:

  • improve the banking sector’s ability to absorb shocks arising from financial and economic stress, whatever the source
  • improve risk management and governance
  • strengthen banks’ transparency and disclosures.

The reforms target:

  • bank-level, or microprudential, regulation, which will help raise the resilience of individual banking institutions to periods of stress.
  • macroprudential, system wide risks that can build up across the banking sector as well as the procyclical amplification of these risks over time.”

 

A Brief Timeline:

1973: The Bretton Woods System collapses, causing chaos in BFSI sector.

1974: Herstatt debacle: In exchange of dollars to be delivered to New York, a number of banks released Deutsche Marks to Bankhaus Herstatt in Germany. In between the timing of this payment, owing to timezone differences, Herstatt ceased operations as German regulators forced it into liquidation. The NY banks never received their dollar payment. It exposed default/counter party risk in the sector.

1974-75: Central bankers of G-10 countries forms (Basel Committee on Banking Supervision- Basel Committee) under the patronage of the Bank for International Settlements (BIS), in Basel, Switzerland.

G-10 Countries: Belgium, Canada, France, Germany, Italy, Japan, The Netherlands, Sweden, Switzerland, United Kingdom and USA

The goal of BCBS,  is to “…extend regulatory coverage, promote adequate banking supervision, and ensure that no foreign banking establishment can escape supervision”. Currently there are 27 member countries in the Committee, represented by the central bank and the authority for the prudential supervision of banking business.

1988: Basel-1 Accord issued

1990s: Banking Crisis

2004: Basel-2 Accord set up to prevent misuse of Basel-1

2008: Post 2008 crisis, Basel-3 is introduced, to be implemented in 2019

2013: RBI started implementation of Basel -3. Period allotted is 6 years.

 

Basel – 1  Accord:

Basel-1 Primarily dealt with credit risk (default risk). Capital requirement and structure of risk weights for banks were defined. the idea is to ensure that banks  “hold capital and reserves sufficient to support the risks that arise in their business”.

Capital Requirement:

Bank Assets (Loans)= External liabilities (Deposits)+ Capital

Since a banks deposits are certain, Capital requirement should be stipulated to control default risk.

The Pillars of Basel-1 Accord:

A. Tier-1 and Tier-2 Capital:

Tier-1: Equity capital+ retained earnings

Tier-2: Debts (bonds), hybrid instruments such as “optionally fully convertible debentures”. This capital is further classified into Upper T2 and lower T2.

B. Risk Weighting:

Assets are categorized into 5 with different risk weights assigned to them, namely: Cash and Government bonds of OECD member countries (0%), Claims on domestic public sector entities (10%), Inter-bank loans to bank headquartered in OECD member countries (20%), Home mortgages (50%) Other loans (100%)

C. Target Standard Ratio

Basel Capital adequacy requirement (CAR)= 8% of RWA (Risk weighted assets); of which at least 4% is in tier-1 capital. 

D. Transitional and Implementing Arrangement

A phased manner of implementation to be completed by 1992

Basel-2 Accord

Revised framework , changes to pillars:

A. Pillar I – Minimum Capital Requirements:

Credit Risk:To prevent bank transferring risk to subsidiaries, scope of regulation was widened.

Three methodologies for risk rating: Standardised (external credit rating agencies ratings), Foundation Internal Ratings Based Approach, Advanced internal ratings based approach (IRB approaches).

Operational Risk: Basic Indicator Approach, Standardized Approach and Advanced Measurement Approach

Market Risk: Categorised into asset based and principal income based

Total Capital Adequacy: 

Reserves = 0.08 * Risk-Weighted Assets + Operational Risk Reserves + Market Risk Reserves

B. Pillar 2 – Regulator-Bank Interaction

Regulators may supervise internal risk evaluation mechanisms outlined in Pillar I. Regulator  can create buffer capital requirements over and above minimum capital requirements.

C. Pillar 3– Banking Sector Discipline

Disclosures of the bank’s capital and risk profiles which were shared solely with regulators were made public.

The Shortcomings of Basel II

The financial crisis highlighted a series of shortcomings in the Basel II accords:

• The capital requirement ratio of 4% was inadequate to withstand the huge losses that were incurred.

• Responsibility for the assessment of counterparty risk (essential to the risk weighting of banks’ assets and therefore in assessing the capital requirement) is assigned to the ratings agencies, which proved to be vulnerable to potential conflicts of interest.

• The capital requirement is ‘pro-cyclical:’ if the global economy expands and asset prices rise, the country and counterparty risks associated with a borrower tend to decrease and thus the capital requirement is lower; however, in the event of a recession, the reverse is also true, thus raising the capital requirement for banks and further restraining lending.

• Basel II incentivizes the process of ‘securitization’, as financial institutions that repackage their loans into asset-backed securities are then able to move them off their balance sheets and thus reduce the assets’ risk-weighting. As a result, this process enabled many banks to reduce their capital requirement, take on growing risks and increase their leverage.

 

Basel-3 Accord

Basel II did not have any regulation on the debt that banks could take on their books. The focus was on individual financial institutions. Two sets of compliance were introduced:

1. Capital                       2. Liquidity

Liquidity Standards:

Liquidity Coverage Ratio (LCR): Sustain financial stress  upto 30 days

𝐿𝐶𝑅 = 𝑆𝑡𝑜𝑐𝑘 𝑜𝑓 ℎ𝑖𝑔ℎ 𝑞𝑢𝑎𝑙𝑖𝑡𝑦 𝑙𝑖𝑞𝑢𝑖𝑑 𝑎𝑠𝑠𝑒𝑡𝑠 𝑇𝑜𝑡𝑎𝑙 𝑛𝑒𝑡 𝑐𝑎𝑠ℎ 𝑜𝑢𝑡𝑓𝑙𝑜𝑤𝑠 𝑜𝑣𝑒𝑟 𝑡ℎ𝑒 𝑛𝑒𝑥𝑡 30 𝑐𝑎𝑙𝑒𝑛𝑑𝑎𝑟 𝑑𝑎𝑦𝑠 ≥ 100𝑝𝑒𝑟𝑐𝑒𝑛𝑡

Net Stable Funding Ratio (NSFR): obtain finances through stable sources; discourage shrt term funding during favorable times.

𝑁𝑆𝐹𝑅 = 𝐴𝑚𝑜𝑢𝑛𝑡 𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑜𝑓 𝑠𝑡𝑎𝑏𝑙𝑒 𝑓𝑢𝑛𝑑𝑖𝑛𝑔 𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑠𝑡𝑎𝑏𝑙𝑒 𝑓𝑢𝑛𝑑𝑖𝑛𝑔 > 100𝑝𝑒𝑟𝑐𝑒𝑛�

Capital:

Enhanced risk coverage through  introduction of capital conservation buffer and countercyclical buffer.

Leverage Ratio introduced to have a non-risk based metric in addition to the risk based capital requirements in place. (deter excessive leverage)

Countercyclical Capital Buffer (CCCB): build up a buffer of capital for achieving the broader macro prudential goal by restricting the banking sector’s wide range of lending in the excess credit growth period.

Impact on India

framework for revitalizing distressed assets:

Why Basel-3 for India?

Regulatory deviation from global market perspective can be detrimental for India. Hence conforming to global standards makes the country competent enough.

RBI prescribes a minimum Capital to Risk Weighted Asset Ratio (CRAR) at 9 percent, higher than 8 percent prescription of Basel III accord.

According to the CARE’s estimate, the total equity capital requirement for Indian banks till March 2019 (when Basel III would be fully implemented) is likely to be in the range of Rs.1.5-1.8 trillion assuming that the average GDP growth will be 6 percent and the average credit growth will be in the range of 15 percent to 16 percent over the next five years .

At the outset, estimates of capital infusion requirements are to the tune of USD 50 billion (Fitch) and USD 80 billion (ICRA).

The Reserve Bank of India’s (RBI) increased capital requirements under Basel III are likely to put nearly half of Indian banks in danger of breaching capital triggers, international rating agency Fitch Ratings said in a report: “Our analysis of 27 Indian banks with outstanding hybrid capital instruments indicates that at end-June 2016 the total capital adequacy ratio (CAR) for 11 banks was at or lower than the minimum of 11.5% required by end-March 2019 (FYE19),” Fitch said in its report.

RBI has eased rules to increase banks’ core capital base. Real estate assets, foreign currency assets and deferred tax assets to be counted while calculating Tier-1 capital; but only the discounted value can be taken into account. This would unlock capital of up to Rs 35,000 crore for PSBs and Rs 5,000 crore for private banks, according to RBI sources. The recent demonetization drive is estimated to provide a gain worth 2.5 lakh Cr. INR to the Indian government, which can be infused to the economy.

Challenges to implementing basel-3:

1. Capital requirement – 12000 Cr. Rs to be infused in PSBs, and private banks to raise capital from the markets. PNB and few other private players have raised capital through bonds.

2.Liquidity crunch – Liquid assets do not  have handsome returns, reducing operating profit margin. Growth may be affected as private funding will face backlash.

 

Sources:

http://www.asmgroup.edu.in/incon/publication/incon13-fin-010.pdf

https://www.iimb.ernet.in/research/sites/default/files/WP%20No.%20470_0.pdf

http://www.bloombergquint.com/global-economics/2016/07/12/reserve-bank-of-india-braces-for-basel-battle-on-sovereign-bonds

http://www.livemint.com/Industry/kTlQtgbGJ5gJt4rU52jSxI/Increased-capital-requirements-under-Basel-III-to-add-to-ris.html

https://www.linkedin.com/pulse/can-basel-norms-solve-npa-problem-indian-psbs-vivek-yadav