Ashima Goyal

13th Annual Neemrana Conference ICRIER-NCAER-NBER, December 16-18, 2011 Ashima Goyal I n d i r a G a n d h i I n s t i ...

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13th Annual Neemrana Conference ICRIER-NCAER-NBER, December 16-18, 2011 Ashima Goyal

I n d i r a G a n d h i I n s t i t u t e o f D e v e l o p m e n t R e s e a r c h, M u m b a i

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Structure of the Presentation  Bank risks; GFC and relative ranking 

More nuanced picture of risks in EM banks required

 Comparison: advanced and EMS  Indian banking reforms 

Structural change

 Risks and regulations Lacunae

in international regulatory reform Impact on EMs

Sources of risks for Indian banks Markets and 

macroeconomic policy

Assessment of risk

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A Relative Picture: MM and EM

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A Relative Picture  Scale 2010 UK: India; Banks no. 318:81; Assets 4 times UK output: 92% of Indian output  Advanced country leverage 25:1; Indian 10:1 

 Cross border exposures  

Short-term USD funding, FX swaps Cross currency mismatches

 Liquidity Leveraged balance sheets exceed deposit liabilities: endogenous expansion  US liquidity creation  dollar carry trade even if EM banks traditional  EM more conservative banks at receiving end 

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Figure 1: External positions of reporting banks in developed countries: Liabilities (Total- 19307.35 USDb )

Figure 2: External positions of reporting banks in emerging markets: Liabilities (Total- 2151.18 USDb)

Source: Calculated from http://www.bis.org/publ/qtrpdf/r_qa1103.pdf#page=7

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Table 1: International positions by nationality of ownership of reporting banks. Amounts outstanding (USDb) End-September 2010 Assets

Parent country of bank

Liabilities

Developed Countries Australia

421

751.3

Canada

885

749.3

Euro Area

NA

NA

France

4,443.80

4,233.70

Germany

4,552.80

3,598.40

Italy

1,025.70

1,046.70

Japan

3,637.70

2,039.80

UK

4,570.20

4,492.00

US

4,043.20

4,570.30

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Table 2: International positions by nationality of ownership of reporting banks. Amounts outstanding (USDb) (contd.) End-September 2010 Assets

Parent country of bank

Liabilities

Emerging Markets Argentina

NA

NA

Brazil

202.3

223.8

Chinese Taipei

258.5

275.9

India

142.1

168.5

Indonesia

NA

NA

Mexico

44.8

45

Russia

NA

NA

Saudi Arabia

NA

NA

South Africa

78.6

78.3

South Korea

222.2

225.1

Turkey

163.4

196.5

Source: Calculated from table 8A http://www.bis.org/publ/qtrpdf/r_qa1103.pdf#page=7

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Figure 3: Volatile constituents of capital flows

Figure 4: Banks off -balance sheet items (Rs. Crs) Public Sector Bakns

Foreign Banks

Scheduled Commercial Banks

16000000 14000000 12000000 10000000 8000000 6000000 4000000 2000000 0 2001-2002

2002-2003

2003-2004

2004-2005

2005-2006

2006-2007

2007-2008

2008-2009

2009-2010

2010-2011

Source : Report on trend and progress of banking in India, RBI (2011)

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Structural Transformation

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Table 4: Changing Indian banks 1991

2004

CRR

15

4.5

SLR

38.5

25

RoA

0.15

1.01

CRAR

1.5

12.8

Public sec. deposits

92

75

12.8*

2.4**

Gross NPA Note: * Figure for 2000; **2009-10

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Reforms  Reversing financial repression 

From controls to markets

 Banks and markets 

Money markets 



LAF and its evolution:  in volatility of interest rates;  transmission

FX markets Turnover: USD 3b in 2001; 34b in 2007; 60b in 2011  OTC swaps, futures; NDF 50% 

G-secs markets

Interest rates discovered in markets—but thin markets  Large variation in the cost of G borrowing  Term structure weak—10 year G-secs most traded  SLR 25% statutory lower limit but 29% held so scope for OMOs  HTM reduces traded volumes, hedging, OMOs  Does it hold down the cost of Govt. borrowing? G debt 60% of GDP Substantial risk free treasury income  hold at lower rates?  MTM procyclical 

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Figure 5: Bank nonperforming loans to total gross loans (%) India

United States

14 12 10 8 6 4 2 0 2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Source : Calculated from World Bank dataset

Figure 6: LAF daily: 2004-07

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Figure 7: LAF daily: 2008-10

Figure 8: Transmission of RBI repo rates 15

MIBOR_1Y

CD_1Y

WHTD_1Y

TBILL_1Y

RBI Repo

13 11 9 7 5 3 Jan-08

Apr-08

Aug-08

Nov-08

Mar-09

Jun-09

Oct-09

Jan-10

May-10

Aug-10

Dec-10

Source : RBI (2011)

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Reforms  Skills and technology 

Internal risk rating—VaR models Lacunae in data, industry benchmarks, implications of legal changes  Member of FATF; centralized KYC, UID 



Strengths of traditional risk management Capital

adequacy at Basel 111 levels already

 Change from control philosophy Prudential norms plus supervision  High growth, legal changes e.g. SARFAESI Act 

 Outcomes Improvement in most parameters; NPAs historic low  Entry: 27 public, 22 private, 32 foreign banks 

Skill differentials  Diversity and learning time 



Retail and loan based business model; short-term wholesale funding ltd

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Risks and Regulation

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Typology of Risks  Measurable uncertainty 

With some probability of loss 

Finance, volatility: expected values not realized

 Types of financial risk 

Credit risk: borrower default Poor

systems; moral hazard; G forces loans on non-commercial grounds  Slowdown 

Market risk Interest and currency risk: thin markets  Liquidity and systemic risk: GFC 

 Fundamental trade-offs: incentive v. insurance criterion Too little and too much risk both reduce innovation; rewards with risk  Who can control risk should bear it; but some transfer to risk aggregators who diversify  These aggregators to the Govt: Retain the upside, pass on the downside thru bailouts  But capital buffers  bear too much risk, reduce innovation too much; so alternative? 

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Indian Regulation  Shift from micro-intervention to macro-management 

Focus on broad patterns rather than individual transactions 



Capital adequacy but also income recognition, asset classification, provisioning

Real estate prices rose: provisioning for such loans 

 Good incentives in  broad pattern prudential norms 

LTV and countercyclical provisioning Sectoral provisioning requirements directly impact the Profit and Loss Account  Compared to risk weights 



Conservative accounting standards 



Provide for losses while ignoring gains: countercyclical

Exposure limits for sectors

 So steady market development Yet escaped GFC   preserve some  regulatory features even with modern risk management 

I n d i r a G a n d h i I n s t i t u t e o f D e v e l o p m e n t R e s e a r c h, M u m b a i

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International Reforms  US Dodd-Frank Act; Basel III; UK Vickers commision 

Too strong: capital buffers; Too weak: exemptions, delays, lags Systemic risk: spilllovers, procyclicality; councils delays  Shadow banks: exemptions 



Buffers lags: 2018, difficult to impose in bad times, reduce lending  Risk based capital  high potential leverage; arbitrage increases risk 

Euro sovereign bonds assigned zero risk weights

 Broad ratios: LTV, taxes, position limits, margin reqts. 

Automatically countercyclical  improved incentives

Simple, so can be universal, prevent competitive risky strategies  Since reduce risk-taking without forcing too much risk on risk aggregators  would improve financial stability yet protect financial innovation 

 tendency to take too much risk in good times   financial boom bust cycles—observed over centuries 

I n d i r a G a n d h i I n s t i t u t e o f D e v e l o p m e n t R e s e a r c h, M u m b a i

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International Reforms  Viewpoint from India BASEL III CRAR already satisfied but  With development, scale, credit ratios to rise to international levels, so 

Bank focused regulation burdens EM bank-based financial sector  Does not address arbitrage through shadow banks  which create risks for EMs from volatile capital flows 

SLR as source of liquidity and low risk for banks not recognized  Also continued development burdens 



Priority sectors, unbanked population 60%

Use of regulatory ratios as substitute for capital adequacy?  But this should be accepted globally, not as a special exemption  Since it would fill existing gaps in international reforms 

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Risk Assessment: Indian Banks

I n d i r a G a n d h i I n s t i t u t e o f D e v e l o p m e n t R e s e a r c h, M u m b a i

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Risk Assessment for Indian Banks  Markets developed but still thin 

Large impact of shocks 



TED spreads high and erratic but liquidity related, new LAF may help

Lending rates—wide gap Definitional change BPLR sharp fall in India-US gap  Heterogeneous borrowers: lending rates very high for some 



Risk reducing regulation



Opportune measures to improve fine tuning of liquidity

I n d i r a G a n d h i I n s t i t u t e o f D e v e l o p m e n t R e s e a r c h, M u m b a i

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jan2000 apr2000 jul2000 oct2000 jan2001 apr2001 jul2001 oct2001 jan2002 apr2002 jul2002 oct2002 jan2003 apr2003 jul2003 oct2003 jan2004 apr2004 jul2004 oct2004 jan2005 apr2005 jul2005 oct2005 jan2006 apr2006 jul2006 oct2006 jan2007 apr2007 jul2007 oct2007 jan2008 apr2008 jul2008 oct2008 jan2009 apr2009 jul2009 oct2009 jan2010 apr2010 jul2010

8-Jan-99 8-Jul-99 8-Jan-00 8-Jul-00 8-Jan-01 8-Jul-01 8-Jan-02 8-Jul-02 8-Jan-03 8-Jul-03 8-Jan-04 8-Jul-04 8-Jan-05 8-Jul-05 8-Jan-06 8-Jul-06 8-Jan-07 8-Jul-07 8-Jan-08 8-Jul-08 8-Jan-09 8-Jul-09 8-Jan-10 8-Jul-10 8-Jan-11 8-Jul-11

Figure 9: Spreads between 3 month T-Bill and inter-bank rates 6 INDIA

India

US

5

4

3

2

1

0

-1

Figure 10: Spreads between bank rate and lending rate US

9

8

7

6

5

4

3

2

1

0

Source : Calculated from RBI

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Risk Assessment for Indian Banks  Monetary policy 

But levels of interest rates higher and more variation



Pass through higher since of less competition in the banking sector



More loan based activity so higher impact of interest rate changes 



Especially on modern sector, slowdown

Market determined exchange rate, volatility, shocks from capital flows Both interest and exchange rate rise adds to current cost shocks  Creates loan quality concerns 



IMF overheating: repo 8.5 industry growth fall to 2.7 Q2 (-5 Oct.), inflation still high 

Oct. WPI 9.7%; manufacturing 7.7%

I n d i r a G a n d h i I n s t i t u t e o f D e v e l o p m e n t R e s e a r c h, M u m b a i

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Table 3: Interest rate pass-through Bank lending rate

For sectors

Agriculture

Industry

Transport

Call Rate

0.664 (0.030)**

0.733 (0.022)**

Competitiven ess

0.159 (0.012)**

Size

Observations

For bank types

Trade

Finance

0.713 (0.029)**

0.701 (0.028)**

0.771 (0.028)**

0.146 (0.009)**

0.120 (0.012)**

0.111 (0.012)**

0.314 (0.070)**

0.237 (0.033)**

0.392 (0.063)**

852

1039

894

Personal

Public sector banks

Private sector banks

Foreign banks

0.565 (0.041)**

0.560 (0.027)**

0.583 (0.033)**

0.583 (0.059)**

0.131 (0.012)**

0.114 (0.017)**

0.120 (0.011)**

0.142 (0.008)**

0.162 (0.006)**

0.154 (0.052)**

0.281 (0.054)**

-0.194 (0.075)**

0.256 (0.118)**

0.293 (0.066)**

0.266 (0.061)**

999

991

1017

392

406

406

Source: Ansari and Goyal (2011) Note: ** significance at 5%; p-values in brackets

I n d i r a G a n d h i I n s t i t u t e o f D e v e l o p m e n t R e s e a r c h, M u m b a i

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Risk Assessment for Indian Banks Structural risks reduce but cyclical rise 

Default risk Govt. ownership but no cross border exposures  Mild rise in NPAs from historic lows  Some industries stressed but portfolio of industries larger now  Average credit growth 18.6 pa: 29.6 in high growth period 



Market risk Policy tightening  Sharp rise in interest, exchange rates 

Loan 

based, thin markets, policy must smooth rates So IMF advice to raise rates sharply inconsistent: created risks

Heterogeneous impact so no systemic concerns 

Across banks and rating agencies: SBI NPAs and profits rise, ICICI both fall Growth prospects better than most other countries; diverse demand sources  Market cap of private banks  since free to raise funds 

I n d i r a G a n d h i I n s t i t u t e o f D e v e l o p m e n t R e s e a r c h, M u m b a i

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Conclusion  Sensitivity to where difference can be a strength 

Awareness among analysts; policies also more nuanced and differentiated

 Some regulatory differences if included in reforms 

Would fill international reforms gaps

 Easier CCLs and swaps:  aggregate contagion costs Since EMs at receiving end  Better regulations 

Smooth volatility of private capital  Allow further opening 

I n d i r a G a n d h i I n s t i t u t e o f D e v e l o p m e n t R e s e a r c h, M u m b a i

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