Banking & Research - III

Dr. Bimal Jalan, Governor of the Reserve Bank of India, in his address at a recently held banking summit in Mumbai prescribed a five-point strategy to further strengthen   the Indian banking and financial system. One among them is the need to put in place a regulatory system that matches international practices with respect to capital adequacy norms, income recognition, prudential norms and provisioning requirements. He opined that adoption of these norms would ensure accountability among the bank managements, besides enhancing their credibility. 

As at the end of March 2002, 30 out of 97 scheduled commercial banks in India had a recorded Capital to Risk-weighted Asset Ratio (CRAR) in excess of 15%; 53 banks had it between 10-15%; nine banks had between 9-10%; two banks had 0-9% and three banks had a negative CRAR.  This is an impressive record for a developing country. However, this needs constant up-gradation for an ever-expanding balance sheet that demands simultaneous increase in regulatory capital.  In the normal course, banks are expected to generate sufficient business to enable them to plough back retained earnings into the capital. But this does not always hold good, warranting fresh infusion of capital from external resources. There are several ways to inject capital most of which increase in paid-up equity is perhaps the common form. Alternately, banks might issue subordinated, long-term debt and thereby allow acquisition of new earning assets. 

As against these concerns of the banking industry, the Indian capital market remained subdued for almost three years, reflecting the general depression in economy as also the co-movement of domestic stock markets with that of international stock exchanges. Raising funds through public offering in such a scenario obviously is an arduous task for banks. It therefore calls for innovative hybrid financial products to raise additional capital at will and with ease. It is in this context that the article “Bank Capital Structure, Regulatory Capital, and Securities’ Innovations” throws light on how American banks had overcome the hurdles associated with the raising of regulatory capital through hybrid products such as trust preferred securities etc. The findings of the article may pave the way for Indian banks to innovate newer forms of issuing securities.

As a sequel to the 1991 balance of payments crisis, a substantial liberalization of banking and financial sector started in India. The overall approach to the economy-wide liberalization was to open up the economy, give the market a greater role in price setting and increase the private sector role in development. This has led to the gradual freeing up of interest rates. Another important outcome of the liberalization process was the continued fall in the average interest margin of all banks by 1996-97. The year 2001-02 witnessed one of the sharpest declines in interest rates: The yield on 10-year government securities declined by as much as 287 basis points and the bank rate, the repo rate and the overnight call money rates also eased significantly. The Indian banking system has thus transformed from a regulated interest rate regime to a market-determined interest rates. In the process, interest rate risk has assumed greater significance calling for ingenuity in its management.

Against this backdrop the article “Yield Curve as a Predictor of the Behavior of the Economy: An Empirical Evidence from the Indian Economy” discusses the impact of macroeconomic fundamentals such as  interest rates, short and long-term nominal and real interest rates, inflation, investment pattern, growth in GDP etc., on the behavior of economy, the scope of using yield curve as a predictor of the future economic behavior and how a practising banker can intuitively make use of yield curve in managing his asset liabilities to ensure a healthy net interest margin.

In a falling interest rate scenario and mounting competition, corporates have become highly conscious of capital cost and its impact on the ultimate price of the product.  In their drive to stay competitive in a globalized market, many companies have been preferring prepayment of borrowed funds. In this context the article “Modeling the Prepayment Risk of a Fixed Rate MBS Portfolio” explains why prepayment risk makes the portfolio less attractive and proposes three different models for pricing this risk.

In the recent past it has been observed that call rates were moving in tandem with repo rates. Making use of the repo/reverse repo rates, the Reserve Bank of India has been managing liquidity risk by influencing call money rates. It is also attempting to arrest arbitrage between call money market and foreign exchange market by adjusting the liquidity in the economy. Thus, the complexities of the relationship between the repo rates, call rates and forward premium have assumed greater significance and the same has been discussed in the article “A Cointegration Causality Test Among Call Money Rates, Forward Premia and Repos/Reverse Repos Rates”.

With the introduction of euro, every Indian exporter having a sizeable trade with the European countries, thought that the exchange risk that one is exposed to by virtue of invoicing in a dozen European currencies stands reduced substantially. Similarly, it was expected that there would be a steep fall in transaction costs. The article “Global Economic Integration: A Case Study of Euro and its Implications for India” discusses issues such as invoicing, pricing, hedging etc., and the new skills the Indian companies have to build up in the areas of accounting, information technology, tax, treasury, legal and financial systems so as to effectively transact in euro.  Information Technology (IT) has made great inroads into banking all over the globe. The Indian financial system is spending a lot of capital on acquisition of hardware and software raising the share of IT spending up from 10 to 15% in 2001. Spending on IT in the Indian banking system is however still confined to transaction recording process rather than using it as a decision-support system.  In the wake of increasing competition from all quarters, the Indian banking system is however trying to enhance its reach to the customers, their personal profile and brand image by adopting IT across the board. The article “Perceived Benefits and Inhibitors of IT Adoption and Resulting Satisfaction” discusses about the IT adoption patterns among the Indian financial firms, operating systems and database usage, networking status and e-security measures being adopted. Based on the survey carried out during March-June 2002, the article also discusses about the perceived benefits from IT adoption and hindrances, if any. The findings of the article are likely to help not only legislators, policy-makers and technology providers in understanding the IT-adoption criteria among Indian financial firms but also the management of banks in identifying the essential influencing factors for IT-adoption and leverage over them.

(IJBM Vol.2 No. 2 May 2003)