NIVESHAK

THE INVESTOR VOLUME 3 ISSUE 3 March 2010

FIN-Q PG.29 The Paradigm of Temperance Pg.11

FROM EDITOR’S DESK
Dear Niveshaks
Our Indian markets have been looking upbeat since the day they gave
Niveshak a thumbs-up to the budget which was presented by our warhorse Mr Pranab
Mukherjee last month. BSE and NSE are hovering at their respective peaks and
Volume III have come a long way since the time they went into a tailspin in 2008. A slight
ISSUE 3 plunge in the sensex after the railway budget by Didi failed to meet the market
March 2010 expectation of government’s doubling its this year’s order for railway wagon, later,
paved the way for resurrection when sensex rose by 400 points reflecting the ec-
static sentiment and relief that the finance minister has rolled back only part of the
Faculty Mentor fiscal stimulus in the union budget. The positive sentiments among us, the common
Prof. S.S Sarkar Indian middle class, by this union budget were preceded by the populist stand
taken by Mamta Banerjee when she ignored planning commission’s advice to raise
passenger fares and left it unchanged. But I have my grave concerns about this,
EDITORIAL TEAM given the rot in finances as indicated by the fall in revenue and operating margin
of Indian railways in the last one year.
We have finally got the answers to the questions posed in the last month’s
Editor issue when Mr Mukherjee picked the cards of prudence and caution to sustain
Bhavit Sharma growth as well as to rein in fiscal deficit through his 6th (5 full-scale budgets and 1
interim) budget 2010-11. It was indeed a please-all budget. Through broadening
income tax slabs, he has endeavoured to make some 25 million income tax payers,
Sub-Editors including you and me, happy. We can expect that this move, which is primarily be-
Durgesh Nandini Mohanty ing done to boost consumption, will pull tax to GDP ratio to as high as 11 percent.
Hitesh Gulati However, in order to consolidate the fiscal deficit boundary, the policy planners
Sumit Kedia have gone all out to increase custom duty on crude import and excise duty which,
Tanvi Arora I suppose, will have a deep impact on inflation especially on wholesale price index.
The hue and cry from oil firms is expected to continue as the decision of freeing
Upasna Agarwal
oil prices will be taken up by minister of petroleum in due course. So taking all this
into consideration, the long term effect of this budget, its salient features, and its
expected and imminent repercussions on various sectors along with its comparison
Designers with expectations and growth parameters have been discussed in detail as the
Bhavya Aggarwal cover story of this issue.
Swarnabha Mukherjee
I, on behalf of the whole team Niveshak, welcome Mr. Manas J Sharma, AVP
Abu Dhabi commercial Bank (UAE) as the guest of this issue of Niveshak. In a spe-
cial session with him, he has talked about the recent challenges faced by SME sec-
tor in UAE and implications of global downturn on UAE’s SME. The interview also
revolves around the role of SME sector in any economy and the ways with which
SMEs are coping with the recession in the UAE.
In the current issue, we have few articles that go around our cover story and
All images, design and artwork supplement it. A different perspective on the rollback of stimulus has been present-
are copyright of ed in an article by students of NITIE. The growth path followed by India has been
IIM Shillong Finance Club criticized a lot as it fails to pass on the benefits to the rural parts of the country. So
an article on financial inclusion throws some light on this as well. I hope this issue
continues the tradition of Niveshak of bringing the latest insights of finance world
©Finance Club closer to you.
Indian Institute of Management
Stay invested for the good times ahead.
Shillong
Happy New Financial Year 2010-11.
www.iims-niveshak.com Bhavit Sharma
(Editor-Niveshak)

Disclaimer: The views presented are the opinion/work of the individual author and The Finance Club of IIM Shillong bears
no responsibility whatsoever.
CONTENTS
Niveshak Times
04 The Month That Was
He Speaketh
22 Mr. Manas J Sharma

Cover Story Finsight

06 Can we detect real estate
15 BUDGET 2010: bubble?
A Perfect Balancing Act

Fingyaan
11 The Paradigm of Temper-
ance : Changing Foundations
of Financial Risk Management?

Article of the month

19 Rollback of Stimulus : A
Risk or A Need?
PERSPECTIVE
25 Financial Inclusion
finlounge
28 FinToon
29 Fin-Q
 Niveshak Times
The Month That Was
Upasna Agarwal
Team Niveshak
Market Watch
In the month that went by, one of the most
significant incidents of the financial year, the Union
Budget has been announced by Finance Minister. To
the sheer glee of many Sensex cheered the arrival
of the budget. The benchmark Sensex saluted the
Union Budget 2010 when it was unveiled and rallied
over 400 points during the day. Experts opined that
it was an effect of short covering and positive reac-
tion to budget. The Nifty closed above the 4900 mark
but the sell-off and profit booking in ITC on hike
in excise, BHEL, Tata Power, TCS, Infosys and ABB
erased more than 50% gains from day’s high. Even
heavyweights came off their day’s high on profit
booking at higher levels. It seemed that the markets
discounted the budget.
Pranab Mukherjee in his second budget an-
nounced some positives like gradual reduction in
fiscal deficit, cut in surcharge, more allocation for
infrastructure development, increase in FY11 divest-
ment target, increase in personal tax slab to Rs 8
lakh etc, which all these pushed the Nifty above
4950 level during the day. However, there were some
negatives like hike in excise duties etc.
Post Budget there have been some more sig-
nificant incidents that have affected the stock indi-
ces. The BSE Sensex snapped a 3-day winning streak
on on March 4, as weak global markets prompted
investors to take profits, while a firmer rupee and
an expected increase in wages hit export-focused
outsourcers. The 30-share BSE index closed down 0.2 Railway Budget
percent, or 28.31 points, at 16,971.70, with half of its
components declining, after rallying 4.6 percent over
three sessions.
On March 8, there was a significant rise in the highlights of Union Minister Mamata Banerjee’s Rail-
BSE Sensex from 16,994 to 17,147 owing to Unit- way Budget for 2010-11.
linked insurance plans (ULIPs) investing 80-100 per
cent of their assets in equity. A compilation of 62
such schemes had shown that only 20 schemes had
managed to outpace the narrow benchmark, the BSE
Sensex, with a return of 83 per cent and hence the
brilliant response.
Upward and downward trends continued in the
4 NIVESHAK VOLUME 3 ISSUE 3 March 2010
www.iims-niveshak.com
days that followed with noticeable stability creeping
in towards the middle of the month.
General Budget:
Rollback of stimulus of $38million, measures to
curb inflation and lead the country to path of pros-
perous growth yet again were the major expecta-
tions from the general budget. There has been huge
increase in investments in all infrastructure domains
and projects, as high as 46% of total outlay, to help
the economy cross the 10% GDP growth barrier. But
on the other hand the growth on the petrol, diesel
duty has pegged back the overall scenario for infra-
structure. Tax slabs were revised by expanding the
slab for lower tax brackets and extending the limit
on the investment under sec 80C primarily aimed
at increasing the disposable income and to the tax
customer base, although some of luxury goods have
got more dearer including gold and silver. The much
awaited GST and DTC will be delayed by another year
by giving the authorities and state governments
some more time to get ready for it also the tax rate
has been kept at 10%. Projection of fiscal deficit to
5.5% seems to be very optimistic but transparent by
focusing on curtailing the debt and as a response the
stock markets zoomed up. A good focus on financial
inclusion has been given and more new generation
banks will be set up. As for the corporate perspec-
tive, the budget should be well received but the ma-
jor point of concern will be the MAT increase to 18%.
Overall, the budget has played on similar lines as
expected and most promising takeaway should be
control on fiscal deficit and tax slab revision.
The railway budget released lay emphasis on
security, passenger amenities, expansion of rail net-
work, and slew of concessions. Following are some
• 113 new trains; no hike in fares
• Service charge cut to Rs 10 for sleeper & Rs 20
for AC
• Rs 100/wagon cut in freight rates for foodgrain
and kerosene to help moderate prices
• No forcible acquisition of land
• No increase in freight charges
 Niveshak Times www.iims-niveshak.com

The Month That Was

• Pay more and get a rake through tatkal scheme wards an outcome-based approach where customer
outcomes can be quantitatively measured and regu-
• Special task force to clear investment propos-
als in 100 days latory response be formulated accordingly.
• 1,000 km of new lines against average of 219 Bharti set to realize its dream of becoming
km in last 5 yrs an emerging market’s MNC?
• Rly Budget is a survey budget: Lalu Its bid for acquiring Kuwait based Zain Tele-
The operating ratio (operating expenses as a com’s assets in all of Africa (except those in Sudan
percentage of revenue) is expected to improve mar- and Morocco) for 49,700 crore was reportedly ac-
ginally to 92.3% in 2010-11 from the current year’s cepted by Zain’s board.
94.7%. That depends on gross traffic receipts rising The acceptance of the offer clears the way for
7.3% — with passenger earnings growing 8.6% and Bharti to carry out a due diligence of the business
freight by a conservative 6.4% during the year — and before a final deal. If the deal fructifies, the acquisi-
limiting the expenditure increase to 4.4%. The bud- tion will give Bharti a firm foothold in a relatively
get should be commended for seeking to partner the untapped market and pit it in direct competition
private sector for new lines, railway stations, manu- with MTN, with which it has tried and failed twice
facturing units of rolling stock, multi–modal logistic to merge. The African operations in the 15 countries
parks, high speed train corridors, port connectivity that Bharti is seeking to buy are grouped under an
and multi-level parking. entity called Zain International. If it buys Zain’s Afri-
Not just Toyota and Honda, it is now Maru- can operations, Bharti will be catapulted past China
ti’s turn to recall vehicles Unicom, Sweden’s TeliaSonera, and Germany’s T-Mo-
bile to become the world’s seventh-largest mobile
Maruti said it is recalling one lakh AStar small
phone company by subscribers.
cars to fix a problem with a faulty fuel tank part.A
Maruti representative said the problem — which has The FDI reform measures that were unveiled
the potential to lead to fuel leakage — was discov- by Government
ered in November last year and the company started The government has decided that the Cabinet
contacting customers from December. Maruti will Committee on Economic Affairs (CCEA) would need
share the cost of the recall, estimated at Rs 40-50 to vet and approve only proposals involving total
crore, with its vendor Banco Products. Customers foreign equity inflow of over Rs 1,200 crore, rather
will get replacement gaskets and O-rings at no extra than proposals with a total project cost of Rs 600
cost. In a previous major recall in 2001, Maruti called crore, as per the rule in force since 1996. Assuming
in over 75,000 of its Omnis to rectify defective rout- reasonable debt-equity ratios, the new rule means
ing of a fuel hose. In 1997, the company recalled that FDI proposals with project cost adding up to Rs
50,000 Maruti 800s to fix a problem with a faulty 4,800 crore, or just over $1 billion, no longer need
pinion in the steering systems. Cabinet-level vetting.Another significant reform ef-
Banks may have to pay dearly for poor cus- fectuated has been to dispense with the obligation
tomer service on a foreign entity to obtain a no-objection certifi-
cate from its Indian partner for going it alone or
Banks with poor customer service standards
tying up with other partners in the same area of
may have to set aside more capital, according to
business. The government has also brought in some
a Reserve Bank of India (RBI) report. The regulator
procedural easing. Further approval will not be re-
has also reportedly asked banks not to discriminate
quired if, after initial vetting, the activity is placed
in lending rates between old and new customers, if
under the automatic route or where sectoral caps
they fall in the same risk category.
have been removed or increased.
The move to charge higher capital would be in
line with the ultimate aim of regulation, to move to-

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG 5

 Can We Detect Real Estate Bubble
Firoz R V, PrashanT Shukla & Sourav K. Gupta
NMIMS, Mumbai
The irony with asset bubbles
Real estate bubble
is that you only know they were
needs to be checked bubbles once they pop. But luckily,
and detected at an warning signs do exist.
early stage to pre- Real estate being closely linked
vent any such future to every sector in an economy plays
a very crucial role in determining the
happenings. The var- future of the country. Recent global
ious macroeconomic financial crisis has proven beyond
indicators and their doubt that any shock in real estate
effect is analysed can lead to shockwaves which are
felt all over the world.
here. A speculative
Though the world is right now
model is discussed into a mode of global economic re-
which helps in pre- covery, yet equally important is to
diction of the bubble discuss how to prevent the next dev-
astating financial crisis - specifically,
formation. In addi- how to spot and prick asset bubbles
tion to these, the as they are inflating. This article tries
role played by banks to look at various indicators and Ear-
in the entire setup is ly Warning Systems (EWS) which can
predict bubble creation.
highlighted. An EWS
It is widely believed that a bub-
needs to be setup ble creation starts when property
which will help in price movement moves away from
drafting all policies fundamentals. In the first section of
our article we discuss a homogenous
and taking preven-
property market where uniform im-
tive measures. pact of external macro-economic fac-
tor is assumed and hence they are
ignored. How a speculative model
can help in predicting the creation of
a boom in the market is understood
FinSight
in this section. Following that in
the next section we develop certain
macroeconomic indicators which can
be used in a EWS and predict periods
of boom.
Speculation Model
The biggest challenge, a prop-
erty market poses, is the measure-
ment of fundamental value of assets.
The uniqueness of each property,
the intricacy of local demand and
supply conditions and regulatory
environment and the lack of long
and high quality time series housing
data add to the challenge of identify-
ing a housing bubble.
6 NIVESHAK VOLUME 3 ISSUE 3 March 2010
?
Still large increase in trans-
actions and large price variation
among comparable property market
are hard to ignore.
In this section we propose a
speculation model given by Scheink-
man & Xiong 2003 to test non-funda-
mental price movement. The model
provides a unified framework in
which speculative trading arise due
to presence of overconfident inves-
tors.
This model can be successfully
applied on a geographically small
but active market, thus assuming
uniform impact of external macro-
economic factor on market player
and hence ignoring them. Also, since
a single city market is considered,
issue related to comparability be-
tween markets doesn’t arise. Cities
like Hong Kong, Dubai, Tokyo, Mum-
bai, New York city etc. provide av-
enues for perfect application of this
kind of model.
Assumptions of the specula-
tion model (both of which apply to
housing market) are:
• Short sale constraints
• Dominance of inexperienced
participants
Application of this model has
been tested on Hong Kong residen-
tial market which experienced a real
price increase of 50% from 1995 to
97 and a subsequent fall of 57% from
1997 to 2002.
Application of Speculation
Model to Hong Kong Market:
• Comparing housing prices to
different fundamentals.
• Cross-sectional variation in
size of price increase for which mac-
roeconomic justification is not con-
vincing.
• Finding correlation between
speculative price component and
turnover volume controlling for con-
founding factors such as liquidity trading key indicators which provide early warning signals
Results: towards the creation of a boom.
• During the period of rising housing price both The primary problem which has been highlight-
demand and supply side fundamental where found ed during the recent global financial crisis which led
to be very stable. to first recession since 1930 is the enormous burden
of debt. Although the role played by US mortgage
• A strong Price-Turnover correlation was found
lending and financial sector leverage has been the
during the bubble build up period (1995-97) while no
scapegoat for the blame of originating crisis, this
such correlation was available prior to this period.
issue needs to be traced to a broader reason. This
From these results one can conclude that non- reason is the enabling of globalization of banking
fundamental component explaining the property which lead to availability of huge reserves of funds.
price rise exists in the economy and can be used to Also unusually low interest rate and risk spreads led
predict whether the housing market is experiencing to rapid growth of debt in most matured economies
a “bubble” or not. after the year 2000 as seen in Figure 1. Taking granu-
Thus the appeal of this speculation model is lar view of leverage within sectors, it was found that
manifold. Not only it relates transaction volume household increase their borrowings substantially,
and price movements explicitly but also explains particularly through home mortgages. The rise of
cross-sectional variation in the size of the specula-housing prices was able to mislead the commonly
tion component. Another advantage of this model is used metric ratio of household debt to asset, making
its directly testable implications. As the name sug- it constant. But the household debt to disposable
gests, this model provides speculation as a result income increased tremendously, and this should
of overconfidence and a framework of continuous- have been the basis of raising red flag before crisis
time equilibrium where a non-zero speculative, or hit.
non-fundamental, price component results from the Thus an economy having debt beyond its ca-
heterogeneity in beliefs. pacity to service it raises a flag for a country which
indicates a bubble building situation.
Global Early Warning System
After identifying household debt to dispos-
After analysing a homogenous property market
able income as an indicator for warning signal, next
where global macroeconomic factors effects were ig-
we look at certain other indicators which provide a
nored, in this section we aspire to identify various

FinSight

Figure 1. Debt growth in most countries after year 2000

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG 7

 deeper understanding of bubble creation and pro-
vide clearer signals of boom creation. These indi-
cators can also lead to currency or banking crisis
because real estate and banking sector are closely
linked to each other. We will discuss the inter-re-
lationship and how banking and real estate sector
support each other in creating a boom and bust cy-
cle later in the article.
We would like to introduce a note of caution
here that the indicators which would be discussed
now are strictly applicable to instances of bubble
preceded by credit and real-estate expansion.
In recent past, from 2000 to 2008 it was seen
that several central, eastern and south-eastern
countries and particularly Baltic experienced strong
growth in credit relative to GDP and residential price
increase. The question arises here is whether these
increases were due to financial development or were
they signs for a looming crisis ahead. Figure 2 shows
the evolution of credit-to-GDP and house prices
growth in CEECs and the Baltic.
The final step was to use a Fixed Effect logistic mod-
el to find probability of a peak in indicators leading
to a market crisis. This study was conducted by Irina
Bunda and Michele Ca’Zorzi who concluded that this
approach helps in predicting financial crisis.
Choice of economical indicators for identifying
credit boom
Upon considering a range of indicators pro-
posed, following set of indicators were identified as
having statistical significance (for identifying credit
boom) in logistical regression.
• credit to GDP growth
• current account balance-to-GDP ratio
• change in the real effective exchange rate
• public debt-to-GDP ratio.
Amongst the above mentioned indicators, large
current account deficit and public debt-to-GDP ratio
have highest correlation with occurrence of banking
crisis during a credit bust period.
Using the above indicators, a “fitted probabil-
ity” was extracted for occurrence of a financial crisis
during a credit bubble (Figure 3).
Threshold Signals Good Signals False Alarms
10 162 28 134
% Well signalled boom crises 90%
False signals % total signals 83%
Total boom crises analyzed 20
Well signalled boom crises 18

Figure 2 Evolution of credit-to-GDP and house prices Threshold Signals Good Signals False Alarms
growth rates in CEECs and the Baltic 20 112 21 91
Here we focus on two main indicators lending % Well signalled boom crises 80%
excess and house prices. A study was done using False signals % total signals 81%
these indicators to determine their predictive power. Total boom crises analyzed 20
The methodology followed in that study was to iden- Well signalled boom crises 16
tify boom and bust episodes for each of the indica- Figure 3 Predictive performance of the model -crisis oc-
tors using a Bry-Boschan algorithm and date them curring within two years from the moment a signal
corresponding to periods of financial crisis incidents.
FinSight

is issued. Credit-to-GDP data

Choice of economical indicators for identifying
housing boom
Based on logistical regression, economical vari-
able which are statistically significant in identifying
Housing boom are:
• house prices growth
• appreciations in real effective exchange

“Though the world is right now into a mode of global economic recovery, yet equally important
is to discuss how to prevent the next devastating financial crisis - specifically, how to spot and
prick asset bubbles as they are inflating.”

8 NIVESHAK VOLUME 3 ISSUE 3 March 2010

rates ized into produc-
• current account-to-GDP ratio tive uses (through
financial deepen-
• real growth (although with low correlation)
ing)
Using the above indicators, a “fitted probabil-
OR
ity” was extracted for occurrence of a financial crisis
during a Housing bubble (Figure 4). • The capi-
tal may fuel un-
Threshold Signals Good Signals False Alarms productive use
10 117 37 80 and excessive
% Well signalled boom crises 81% consumption.
False signals % total signals 68% In either
Total boom crises analyzed 26 case, there would be increased credit creation and
Well signalled boom crises 22 asset price increase. The trick is to distinguish the
reason for the same and act accordingly.
Threshold Signals Good Signals False Alarms
In this section we also illustrate the role of
20 67 22 45 banks in creating asset bubble. Real estate price in-
% Well signalled boom crises 62% crease serves dual purpose for a bank; it increases
False signals % total signals 67% the economic value of bank’s capital and reduces the
Total boom crises analyzed 26 probability of bankruptcy because of the increase in
Well signalled boom crises 16 the market value of collaterals on outstanding real
estate loans. Enhanced profitability coupled with
Figure 4 Predictive performance of the model - crisis
occurring within two years from the moment a signal is the above gains encourages banks to increase their
issued. House prices data exposure to real estate. These gains are so entic-
The interpretations of these results are men- ing that banks relax their lending norms in order to
tioned below: gain maximum from this situation. But this move
can lead to their demise as proven in the current
At 10% threshold
financial crisis. How banks play role of catalyst in
• When boom in credit is considered, the accelerating the real estate collapse is shown in a
model catches 90% of ensuing financial crisis, how- flowchart (Figure 5).
ever number of false signals were also high at 83%.
• When boom in housing market is consid-
ered, the model catches 81% of ensuing financial
crisis, however number of false signals were also
high at 68%.
It can also be argued that the recent global
financial crisis and other crisis like Latin America in
the 1980s, Scandinavian countries in 1992, Mexico
in 1994, and South-East Asia in 1997-98 were associ-
ated with countries with weak regulatory frame. In FinSight
all the above instances, crisis was preceded huge
credit creation in economy due to strong capital in- Figure 5 Banks exacerbating collapse of Real
flow and subsequent stop of inflow. These excess estate sector
credit leads to funding of unproductive activities, ex- Thus in this section we looked that size of debt
cessive consumption and finally leads to asset price and its sustainability, certain indicators like credit-
boom (like real estate bubble). The situation here to-GDP, current account balance-to-GDP, public debt-
becomes tricky for policy makers. The problem en- to-GDP, changes in real exchange rate, house prices
countered by them is: growth and regulatory framework governing econo-
• inflow in a country may be getting channel- my provides valuable inputs for the EWS to predict

“It is widely understood that

real estate connects one and
all.”

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG 9

 the creation of a bubble

Conclusion FIN-Q Solutions

Financial crises never seem to repeat them- February 2010
selves twice in the same way, as the world keeps
finding new ways to generate them (Krugman,
1999). At the same time financial crises are so dis-
1. Kari Kairamo of Nokia Corpo-
ruptive that continuous efforts are made to identify ration
commonalities among different episodes of financial
turmoil. The ultimate aim is to draw lessons and 2. Antwerp Bourse 1460 & Lyons
design the appropriate policy responses to prevent
new crises from erupting. Bourse 1506
It is widely understood that real estate con-
nects one and all. Thus it is very much imperative 3. LaCrosse Footwear
for governments and policy makers to develop EWS
with the indicators mentioned in this article. EWS lit-
erature believes that from a forecasting perspective
4. Consolidated Edison Com-
a large number of false signals must be incurred to pany of New York Inc
anticipate booms. But this does not undermine the
importance of the variables identified in this article. 5. Former Reserve Bank of India
The deterioration of these variables might increase
the chance of a boom phase ending in financial cri- governor Bimal Jalan
sis.
In the end we would also like to highlight the 6. Group Z
importance of regulatory framework as the key play-
er in preventing the crisis. An Early Warning System
based on these indicators can help policy makers 7. Reverse repo window
to formulate proper regulations and mechanisms in
order to prevent a crisis. 8. The eurozone, officially the
euro area.

9. Feroz Gandhi , Ram Kishan

Dalmia, owner of the Times of
India newspaper

10. The Fair Isaac Corporation,

known as FICO
FinSight

Apology: We apologize for the mistake in

the February issue’s FinQ. Those questions
have not been considered while deciding
the winner.

“The biggest challenge, a

property market poses, is the
measurement of fundamental
value of assets.”

10 NIVESHAK VOLUME 3 ISSUE 3 March 2010

 The Paradigm of Temperance
“The
revolutionary
idea defining the chasm be-
tween modern times and the past is
the mastery of risk: the notion that
the future is more than a whim of
gods and men and women are not
passive before nature,” so wrote Pe-
ter Bernstein in his seminal history of
risk ‘Against the Gods’. To the careful
observer the history of human rea-
soning is fraught with a persistent
tension between those who assert
that the best decisions are based
on quantification and numbers and
those who base their belief on more
subjective foundations of the future.
A remarkable instance of this con-
flict can be found in the realms of
financial risk management.
The idea of perfecting risk has
always been the Holy Grail of fi-
nance with analysts and speculators
striving for that ‘killer’ model which
would dissect and quantify risk to
its minutest details and make hedg-
ing strategies infallible. What the
world witnessed after the 90s was a
plethora of such models which pro-
claimed the demise of financial risk.
Suddenly it seemed possible for any
risk to be broken to five places of
decimal and expected returns ad-
justed accordingly. Finance enjoyed
a golden run with low interest rates,
low volatility and high returns. The
belief took over that, even as prof-
its were being boosted by more and
more leveraged balance sheets risk
was being capped by a technologi-
cal shift. The more the risk could be
calibrated, the greater the opportu-
nities to slice debt into securities
© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG
Chang ng Foundations of
Financial Management
RIDDHIMAN KUNDU
IIM CALCUTTA
that can be sold with lower
capital charges. This came to
The definition of risk
be known as ‘systematic mod- has changed over
eration’ in risk management the years and so has
paradigm.
the risk manage-
However, recent market tur- ment techniques.
moil and financial disruption have
exposed many a vulnerability in our Lately, the compa-
nies had been wary
perfect world of risk management.
The extreme events that swept about the control
through the global markets seemed
the risk division of
to have stirred a hornet’s nest with
risk management practices coming an institution has
under intense fire. A long-ignored over the central capi-
tension in finance has resurfaced- tal markets business.
how much control over the central
capital markets business should the
Companies like JP
Morgan successfully
risk division of an institution hold?
To understand the conflict we endured the recent
FinGyaan
will take a look into some of the storm by a simple
most important tenets of risk man- mantra. There seems
agement and understand their limi-
tations. to be a need that
companies be cau-
• Value-at-risk (VAR) analysis:
VAR measures the minimum loss tious of their internal
expected from a portfolio under risks.
evaluation assuming relatively nor-
mal market conditions. It is typically
calculated at 99 percent confidence
level using scenarios generated by
Monte Carlo simulation or general-
ized covariance approaches. Pro-
pounded by JP Morgan in the 80s
VAR has become increasingly popu-
lar owing to its ability to distil the
range of potential daily profits into
a single dollar figure. However, it
works only for liquid securities in
normal markets and does not cover
catastrophic situations. The actual
losses can go far deeper than the
minimum and these are buried deep
in the tail of the profile. Finance is
prone to a wild randomness and rare
big changes can be more significant
11
 than the sum of
smaller changes.
By ignoring the
unsuspecting tail
risks VAR becomes
highly suscepti-
ble to big market
swings.
• H i s t o r i c a l
Scenario Analy-
sis: It allows for
the assessment
of extreme events
on the current portfolio composition. Unfortunately,
factor correlations are consistent with the period of
event occurrence and are unlikely to have relevance
to the current environment. The danger with such
analysis is that it may give risk managers undue
comfort regarding extreme events.
• Sensitivity analysis: This method involves small that risk is inherent in the asset and not the way it
bumps to risk factor values to evaluate such move- is financed.
ments on the value of instruments and portfolios. A second danger looming large is the prolif-
But it offers very little to the risk team in terms eration of increasingly complex investment vehicles.
of understanding the broad risk profile. For, many Take the instance of credit derivatives like collater-
instruments have built in break clauses, optionality, alized debt obligations (CDOs). Traditional products
variable FX rates that remove the concept of linearity such as corporate debt are rated employing basic
and limit the predictive power of sensitivity mea- credit analysis. But CDOs are so complex that they
sures. need to be assessed by specially designed models
Let us now look at some of the fallibilities from which invariably have some fault of their own. Each
the market side. Cheap money can lead to a whole- CDO is a unique mix of assets but the assumptions
sale under pricing of risk. Many firms rely on exces- about future defaults and mortgage rates are not
FinGyaan

sive leverage and short term wholesale financing of closely tailored to that risk nor do they factor in
long term illiquid assets stemming from a combina- the tendencies of assets moving together in a cri-
tion of low risk governance and low interest rates. sis. Moreover, there is a misalignment of incentives.
Banks are founded on this maturity mismatch of Credit risk depart-
long and short term debts but they have deposit ments think of
insurance to reduce the likelihood of a run. However CDOs as market
much of the mismatched borrowing takes place in risks as they sit
the uninsured shadow banking nature of investment in trading books.
banks, structured investment vehicles (SIV) and the Market risk teams
likes. When markets freeze banks have to absorb see them as cred-
the losses. At the peak of its madness the median it instruments as
large bank had borrowings of 37 times its equity. It the underlying
depended heavily on wholesale funding and fickle assets are loans.
non-core deposits brought from brokers meaning it The buck passing
could be wiped out by a loss of just 2-3% of its as- has proven par-
sets. The US financial crisis is littered with instances ticularly costly at
of financial institutions that sank owing to the belief UBS which report-

“The idea of perfecting risk has always been the Holy Grail of finance with analysts and
speculators striving for that ‘killer’ model which would dissect and quantify risk to its minutest
details and make hedging strategies infallible.”

12 NIVESHAK VOLUME 3 ISSUE 3 March 2010

edly lost $34 billion in CDOs in 2008. Moreover, heavy
use of models may have changed the markets they
are supposed to map. This phenomenon known as
counter-performativity is supposed to have aggra-
vated CDO risk by lowering the quality of underlying
securities.
A related problem is the similarity of risk mod-
els. Banks thought they were diversified only to see
many others holding comparable positions as evi-
dent in the financial crisis. Everyone was trying to
unwind at the same time in the scamper that en-
sued. There are also issues of poor risk aggregation
with many large banks not having adequate systems
to present latest pictures of their firm wide links
to borrowers and trading partners. Those with the
most dysfunctional legacy systems like Citi contin-
ued to pile mortgage backed securities even as oth-
ers pulled back.
Banks have also grown increasingly interdepen-
dent through boom in derivatives and cross owner-
ship. Financial firms hold big dollops of each other’s
common and hybrid equity. In such a tightly coupled
network one firm’s trouble can have an exaggerat-
ed effect on the perceived riskiness of its trading
partner. For example, when Lehmann’s credit de-
fault spreads rose to distressed levels AIG’s jumped
by twice of what would have been expected of its
own. At the same time financial firms have build
up a host of liquidity obligations not all of which
they fully understand. Banks are expected to
its collapse in 2008 causing widespread panic.
Extra-ordinary situations warrant extra-ordi-
nary measures. It is without a doubt that the finan-
cial world’s pro-
pensity for risk
has overtaken its
ability to manage
it. What this calls
for is a fall back
on the time-test-
ed paradigm of
temperance and
a more integrat-
ed approach for
mitigating risk.
We will see how.
One of the
few institutions to have successfully weathered the
financial storm is JP Morgan. It stuck by two basic
principles while others were proliferating risk expo-
sures- don’t hold too much of anything and only
keep what you are sure will generate decent risk ad-
justed returns. The bank jettisoned around $60 bil-
lion of CDO related risks and closed down 60 credit
lines for SIVs and corporate clients when it realised
these could be simultaneously drawn down if the
bank’s credit rating was cut. Hedging through bond
insurers was calculated twice- once assuming that
the hedge would hold and again assuming it worth-
less. Goldman Sachs’s risk management stood out

FinGyaan
support off-balance-sheet entities if clients too with the firm’s traders reducing exposure to
wanted out; Citigroup had to take back $58 mortgage backed securities months before the
billion of short-term securities from structured subprime crisis. More willing than rivals to take risks
vehicles it sponsored. AIG did not allow for Goldman was quicker to hedge them. By contrast,
the risk that the insurer would have UBS’s trading desks would estimate the
to post more collateral against maximum possible loss on risky as-
credit-default swaps if these fell sets, hedge it and then record the
in value or its rat- net risk as minimal, inadvertent-
ing was cut. ly concealing huge
Asymmetries tail risks in the
wrecked hav- gross exposure.
oc on the vast What it suggests
OTC derivatives market i s it is the risk practices more
too. Losses on contacts than financial instruments
linked to Lehman turned that need changing.
out to be modest b u t There is a clear
nobody knew need to move to more
this at the time of holistic forms of active

“Credit risk departments think

of CDOs as market risks
as they sit in trading books.
Market risk teams see them
as credit instruments as the
underlying assets are loans.”

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG 13

 risk management. vocated two ratios- a ‘coverage’ ratio to ensure that
An integrated ap- banks have a big pool of liquid assets to weather an
proach calls for ad- acute stress scenario and a ‘net stable funding’ ratio
ditional risk scenar- for promoting long term financing. It has also called
ios accompanying upon the board of directors of large banks to play a
the main predictive more critical role in defining the parameters of risk
scenario. These oversight.
could be consid- An overarching worry of risk managers today is
ered as the paths the complex intertwining of global financial markets.
against which port- The old supervisory framework assumes that if the
folios should be 100 largest banks were individually safe the system
positioned while is infallible. But the crisis has shown that even well-
the downsides of
going wrong are
evaluated against
the firm’s conser-
vatism. This approach will reset base case risk in
accordance with internal market expectations and
engender game changing effects- transparency in
risk numbers/limits and decreased incentive to take
large intraday risks. This would create a level playing
field between risk and profit players in the firm and
align their often conflicting objectives.
Just as it is imperative from the firm’s perspec-
tives to adopt new risk management paradigms,
the market side too needs better regulation and en-
forcement. Some of the worst abuses in securitiza-
tion stemmed from credit ratings. Rating agencies
systematically underestimated default risk on vast
amounts of debt, resulting in puffed-up prices and
a surfeit of issuance. An even bigger problem is the managed firms acting prudently in a downturn can
FinGyaan

favourable tax treatment of debt relative to equity.
Phasing this out would entail aligning pay structures
to long term strategies than returns linked to lever-
aged betas. But the idea has little political traction.
Regulators are now moving towards a more
systemic approach to risk. The Volcker plan calls for
deposit-takers to be banned from proprietary trad-
ing in capital markets and investing in hedge funds
and private equity. Regulators are encouraging banks
to issue a different type of convertible capital- con-
tingent bonds that automatically turn into common
shares in times of stress. In a big philosophical shift
the new measures will lean against ‘pyrocyclicality’
or tendency of rules to exaggerate both the good
and bad. Banks will be required to accumulate extra
capital in fat years that can be drawn upon in lean
ones. The Basel Committee of Central Banks has ad-
undermine the strength of all. And these downturns
do not occur as sparingly as our predictive models
foretell. It turns out that in financial markets ‘black
swans’ or extreme events occur much more often
than probability models suggest. If markets followed
the normal curve in which meltdowns are exceed-
ingly rare the stock market crash of 1987, the inter-
est rate turmoil of 1992 and the 2008 crash would be
expected only once in the lifetime of the universe.
This is changing the perception of financial risk and
firms are turning to risks from within the system
and how they can become amplified in combina-
tion. Systemic moderation is steadily giving way to a
bottom-up approach of contingency planning based
on temperance and introspection. A paradigm shift
in risk management is well and truly underway.

“Regulators are encouraging

banks to issue a different type
of convertible capital- contin-
gent bonds that automatically
turn into common shares in
times of stress.”

14 NIVESHAK VOLUME 3 ISSUE 3 March 2010

 Cover Story
Bhavit Sharma & SWarnabha Mukherjee
Team Niveshak

The financial risks and uncertainty witnessed economy and throw light on the implementation of
by India in the last one year has kept policy plan- GST, IFRS et al.
ners including our honourable finance minster Mr However, Mr. Pranab Mukherjee’s budget did
Pranab Mukherjee on toes. The heat and the atmo- not show any clear direction that was to be taken
sphere of the parliament during the budget presen- considering the economic and other challenges that
tation gets so intensified that Mr Mukherjee had to were identified. On one hand he reduced surcharge,
keep chocolates in his pocket to guard against sud- (which brought down the tax rate by 0.7725%) while
den low blood pressure. The heat and the mounting increasing the MAT rate from 15% to 18%. Also, un-
pressure can be gauged by the fact that he preferred listed companies now need to pay tax on shares
to have glucose water instead of normal water in the which are given as gifts, thus preventing tax eva-
Lok Sabha. sion.
This year would have certainly been a difficult However, the budget brought along with it
time for any finance minister. The main dilemma fac- some breathers. With the increase in the period to
ing Mr Mukherjee was to decide for how long to have five years, within which real estate projects can be
this fiscal expansion. Had it been withdrawn early, it completed to claim a deduction, Mr. Mukherjee has
would not have given the momentum, and perhaps provided cushion to the real estate sector to help
it would have been premature. The continuation of come out of what has been a disastrous year. Also, to
it for a prolonged period would have made it un- support expansion of in-house Research & Develop-
sustainable. There was a lot of insecurity in the first ment expenditure, thereby promoting competitive-
part of the year which was intensified by an indif- ness, weighted deduction on it has been increased.
ferent monsoon. The latter half saw strong recovery, Simultaneously, to facilitate small companies to con-
which was visible in the second-quarter GDP growth vert to limited liability partnerships, transfer of as-
of 7.9 percent. These two contrasting figures have sets due to such conversion is not subject to capital
added to the dilemma about the stimulus package. gains tax.
However, finance minister thought that the time is
Moving out of corporate India, one of the major
pertinent for a partial rollback.
impacts of this budget is the widening of the tax
Direct Tax slabs, thus reducing the burden on the individual
The India Inc. was looking forward to a budget tax payers.
eagerly as it would have set the orientation about Mr. Mukherjee indicated that the Direct Taxes
how the government plans to aid the recovery of the Code will be operational from 1 April 2011. Also im-

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG 15

 plementation of Goods and Services Tax (GST) is be-
ing planned to be introduced from April 2011.
Indirect tax
Cover Story
With the increase in indirect taxes and expan-
sion in the coverage of service tax, the net addi-
tional tax revenue earning for next year will be only
Rs 20,500 crores. Some of the important changes in
the indirect taxes and the subsequent impacts are
as follows:
• Rate reduction in Central Excise duties to be
partially rolled back (the standard rate on all non-
petroleum products enhanced from 8 per cent to
10 per cent).
• Central Excise duty on petrol and diesel
enhanced by Re.1 per litre each. This
will have direct impact on infla-
tion.
• Rate of tax on services re-
tained at 10 percent.
• Certain services, up till
now untaxed, to be brought
within the purview of the
service tax levy.
• Outright exemption
from special additional duty
provided to goods import-
ed in a pre-packaged
form for retail sale.
This would also cover
mobile phones, watches
and ready-made garments
even when they are not imported in pre-
packaged form.
• Full exemption from import duty
available to specified inputs or raw ma-
terials required for the manufacture of sports
goods expanded to cover a few more items.
• Basic customs duty on gold ore and concen-
trates reduced from 2 per cent ad valorem to a spe-
cific duty of Rs.140 per 10 grams of gold content with
full exemption from special additional duty. Further,
the excise duty on refined gold made from such ore
or concentrate reduced from 8 per cent to a specific
duty of Rs.280 per 10 grams.
• Full exemption currently available to medical
equipment and devices such as assistive devices,
rehabilitation aids etc. retained. The concession
available to Government hospitals or hospitals set
up under a statute also retained.
• To allow resale of specified machinery for road
construction projects on payment of import duty at
16 NIVESHAK VOLUME 3 ISSUE 3 March 2010
depreciated value.
• To encourage the domestic manufacture of mo-
bile phones accessories, exemptions from basic, CVD
and special additional duties are now being extend-
ed to parts of battery chargers and hands-free head-
phones. The validity of the exemption from special
additional duty is being extended till March 31, 2011.
• Central Excise duty on LED lights reduced from
8 per cent to 4 per cent at par with Compact Fluo-
rescent Lamps.
• To ease the cash flow position for small-scale
manufacturers, they would be permitted to take
full credit of Central Excise duty paid on capital
goods in a single instalment in the year of their
receipt. Secondly, they would be per-
mitted to pay Central Excise duty on
a quarterly, rather than monthly, basis.
Inclusive Growth
The spending on social
sector has been increased to
37% of the total plan outlay of
the current year. Another 25 per-
cent is allocated for rural develop-
ment.
As said earlier, this bud-
get puts in an emphasis on Ru-
ral Development, with an allocation
of Rs. 66,100 crore, with Mahatma Gandhi Nation-
al Rural Employment Guarantee Scheme being
provided with Rs. 40,100 crore in 2010-11. Also, an
amount of Rs. 48000 crore is allocated for de-
velopments of rural infrastructure under
the Bharat Nirman Programme as well as
considerable amount of funds have been
allocated to other projects. On the urban
front, allocation has been increased from Rs.
3060 crores last year to Rs. 5400 crores this year – a
whooping increase of 75%. .
Allocation in the education sector has been in-
creased by 16% to Rs. 31,036 this year with Rs. 3675
crores for elementary education to be used by the
state governments under the 13th Finance Commis-
sion Grants for 2010-11.
In the area of Health, an annual health sur-
vey is to be conducted in 2010-11 to help prepare a
District Health Profile of all districts. The allocation
for Ministry of Health and Family Welfare has been
increased by around 14% to Rs. 22,300 crore for the
year.
The funds allocated for SMEs and Micro en-
terprises is Rs. 2400 crore, which is a substantial
increase from last year’s Rs. 1794 crore, along with Impacts on Various
doubling of the corpus for Micro-finance Develop- Sectors

Cover Story
ment and Equity fund to Rs. 400 crore. The couple of fac-
The budget outlines that appropriate banking tors which affect the
facilities are to be provided to habitations having cross section of the In-
a population of 2000 or more by March, 2012 while dian Inc. are the hike in
insurance and other services are to be provided by MAT and the reduction
Business Correspondence Model, in order to cover in surcharge from 10%
the proposed 60000 habitats. to 7.5%. The first one
will be definitely nega-
Market reaction tive for companies in
“Stock markets are governed not only by fun- the MAT bracket, while
damentals but also by sentiments” – This statement, the latter has created positive sentiments across the
however clichéd, holds true for every stock market. market.
Prior to the announcement of union budget, mar- In the Oil and Gas Sector, with the increase in
ket experienced a jerk when railway minister Ms import duty for petro-products, revenue inflow for
Mamata Banerjee’s railway budget failed to fulfil ONGC and OIL is bound to increase, while things will
market expectations of government doubling its or- remain the same for standalone refineries as refin-
der for railway wagons this year to around 40000 ing protection remains the same. OMCs will be fac-
from last year’s 18000. However, the announcement ing problem as under-recovery will increase.
of union budget 2010-11 by Mr Mukherjee brought
The Banking and Financial Services sector had
a turnaround in the sentiments of the people and
a positive support from the budget, be it in the
the stock markets responded positively to it. His
extension of prepayment period of Agricultural Debt
decision to widen the income tax slabs for middle
waiver and debt relief scheme or the capital infu-
income earners and keeping the service tax rates
sion for PSU Banks to maintain Tier I ratio. More-
unchanged provided a big boost to the sentiments,
over, some pleasing announcements for NBFC and
with the sensex rising over 400 points. Market play-
private players were made, in matters like provision
ers were undivided with the feeling that this bud-
of banking license to them.
get would boost growth and corporate earnings.
The other reasons behind this sharp rise were the The biggest blow to the construction sector
positive signals from his promise to rein in the fis- was the hike in MAT. Other than that, the budget did
cal deficit and the relief among the people that he not have much in store for them. Smaller road con-
has not rolled back the fiscal stimulus completely tractors may find a hint of positivity from the bud-
all of a sudden. Share prices of the companies like get as allocation for road development projects were
Hero Honda and Tata motors also went up despite increased by 13% (to Rs. 199 billion from last year’s
increase in the excise duties. This is attributed to the 176 billion). Simultaneously, cement manufacturers
estimation that income tax reliefs, which will lead will also be happy with the increase in allocation
to higher disposable incomes for individuals, would for rural and infrastructure related programmes, and
offset duty increases. The BSE Auto index raised the also as increase in excise duty from 8% to 10% will
most at 4.7 per cent. allow them to increase the prices.

Sensex, after rising by over 400 points, cor- The Information Technology Sector, will find it
rected later on concerns over inflation, owing to positive (mainly the top notch firms) given the Fi-
the excise increases on petroleum products. On nance Minister’s greater emphasis on e-governance
26th of February, the date budget was announced, projects. However hike in MAT will be a matter of
the Sensex closed with a gain of 1.08 per cent at concern for them.
16,429.55 points, while the NSE’s Nifty index was up The Auto Industry will be affected negatively by
1.29 per cent at 4,922.30 points. The banking stocks the hike in excise duty. Companies like Tata Motors,
also, including SBI and ICICI, experienced a sharp Ashok Leyland, M&M etc., who invest in R&D will be
rise. The decision of raising Rs 40,000 crores from happy with the increase in weighted deduction for
disinvestment also caused the share prices of some R&D.
potential disinvestment candidates like Engineers With higher emphasis on social sector and
India and SAIL, rise. greater allocation for it (as given under the Inclusive

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG 17

 Growth above) things may turn out to be positive focused schemes in education, health, protection
for the FMCG sector, given that there will be more and development.
money in the hands of the rural consumers. This will
Conclusion
also be facilitated by the widening of the tax slab as
Cover Story

it would leave people in urban setup also with more This budget, as outlined above, can be thus
disposable income. A similar situation is also faced regarded as quite successful in its aims given the
by the retail industry which also depends a lot on target was to bring the economy back to the path of
the disposable income of the consumers. However, development in a more inclusive manner as well as
for the cigarette manufacturers, hike in excise duty to return to the high GDP growth path. The consid-
will definitely effect a reduction in the volumes. erable increase in allocation for inclusive develop-
ment speaks for itself, which will help in fostering
On a note that sounded similar across various
the economy.
industries, the budget was welcomed by all, although
there were not much positive elements for several Increasing of tax slabs will not only help the
sectors. However, given its progressive nature and people to save more, but also help fuelling con-
Mr. Mukherjee’s efforts to provide a strong impetus sumption due to presence of more disposable in-
towards social and infrastructural development, the come. On the other hand, hike in MAT is probably
budget faced positive sentiments from the market. the only crucial factor that hurts the sentiments of
the Industry. Other than that, even the industry is
Impacts on Aam Aadmi welcomed this budget, keeping in mind the progres-
The union budget is going to have both posi- sive and growth oriented nature of the budget. Thus
tive as well as negative impacts on the Aam Aadmi to conclude, Mr. Pranab Mukherjee has performed
in terms of higher disposable income due to wid- a very efficient balancing between partial roll back
ened tax slabs and higher inflation. of the stimulus packages and simultaneously keep
The salaried class received some relief, with the industry and the common man happy, so as to
the upper limit for the lowest income tax slab of 10 ensure a sustainable economic development.
per cent raised to Rs 5 lakh from Rs 3 lakh earlier
which will make around 25 million happy.
On the crucial matter of implementing oil pric-
ing reforms, as suggested by the Kirit Parikh Com-
mittee report, Mukherjee has put the ball in his col-
league Murli Deora’s court, saying that petroleum
minister would take an appropriate decision in due
course.
Finance Minister’s Budget 2010-11 does not in-
clude children, who form 42 per cent of the popula-
tion. Out of every rupee spent in the budget, he has
allotted only 4.63 paise to children.
More importantly, the budget measures will
lead to an all-round price rise, adding to the infla-
tion ruling at over 7 per cent now. Worse, it has no
concrete measure to counter the seriously high food
inflation, at 20 per cent now, with severe implica-
tions for the nutrition of small children and new and
would-be mothers.
Even the small increase in the share of the
budget for children will reduce once the actual es-
timates come in, as has been the trend in the past
five years.

The gap between the funds allocated and

the funds actually released on the ground is never
sharper in any other area than in the case of child-

18 NIVESHAK VOLUME 3 ISSUE 3 March 2010

 A Risk or A Need?
“The good
news is that we
may be at the end of a
free fall. The rate of economic de-
cline has slowed. The bottom may
be near – perhaps by the end of the
year. But that does not mean that
the global economy is set for a ro-
bust recovery any time soon. Hitting
bottom is no reason to abandon the
strong measures that have been tak-
en to revive the global economy”.-
Joseph Stiglitz (in “Stimulate or Die”
dated 8 Dec 2009)
Economics defines business
cycles as economy-wide fluctuations
in production or economic activity
over several months or years. It in-
cludes periods of rapid growth and
those of relative stagnation as well.
The world economy is on a revival
path from the huge contraction that
it suffered due to the subprime cri-
sis. As the credit crunch gripped the
entire financial system, the central
banks moved in unison to avert fur-
ther deepening of the recession by
injecting liquidity into the system.
These stimulus packages have pro-
vided crutches to the crippled world
economy. But these crutches come
with a caveat , the longer that you
hold on to these crutches the more
you get used to them and the lesser
become your chances of standing up
on your own. This analogy applies
© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG
Himanshu Mehra & Amitabh Vatsya
NITIE, Mumbai
to the stimu-
lus packages Even with the re-
as well. duction in systemic
The gov- risks there still are
ernment
needs to re-
significant risks due
turn to a path of to global liquid-
AoM
fiscal consolidation to ity levels combined
avert dire circumstances with the absorptive
like hyperinflation which
have the potential to ruin a per-
capacities of the
fectly healthy economy. economy. A phased
rollback of the stimu-
Stimulus Packages across na-
tions lus is essential to
The size of stimulus has var- maintain a balance
ied significantly across nations. In- between delivering
cluding the measures undertaken in sustainable growth
2008, the U.S. stimulus is largest (a
and stabilizing the
cumulative 4.8 percent of GDP during
2008–10), while Italy and India are economy. The article
at the lower end of the spectrum. deals with the risks
Two sets of factors help explain the
that are currently
relative size of stimulus packages:
(i) differences across countries in
present and should
the need for stimulus; and (ii) differ- not be overlooked.
ences in fiscal space
Countries in which the auto-
matic stabilizers are larger need
smaller discretionary stimulus. Gov-
ernment size is a proxy for the im-
pact of automatic stabilizers and
is smaller in China, India, the U.S.,
Canada, and Japan, and it is nega-
tively related to the fiscal stimulus.
Growth impacts and needs
Stimulus efforts, together with
the impact of the automatic stabiliz-
19
 by high levels of global liquidity
• Emerging market economies which are gener-
ally recovering faster than advanced economies, are
likely to face increased inflationary pressures
• Uncertainty about the pace and shape of the
global recovery
• The surge in oil prices, if global recovery is
stronger than expected
• Sharp increase in capital flows, above the ab-
sorptive capacity of the economy, which may com-
plicate exchange rate and monetary management
• Large fiscal deficits command a bigger risk
to both short-term and to medium-term economic
AoM

ers, provide an important boost to growth and help prospects

forestall a negative downward spiral. According to
Global Scenario
IMF Preliminary staff estimate, fiscal policy may have
contributed 2–2½ % points to PPP-weighted growth Last five year the world has seen a dra-
of the nine countries in 2008 and may provide 2–2¼ matic downside in term of negative growth in
% points in 2009 and ¼–½ % points in 2010.The their domestic products. All the major econo-
decreasing impact of fiscal stimulus is indication for mies except China and India have undergone con-
the rollback of stimulus worldwide. traction varying from -2.5% (France) to -10.2 %
(Brazil) during 2009, as evident from the chart.
A rollback of stimulus is necessary to bring the
economy back to its natural growth path. This arti-
ficial growth is not sustainable in the long run and
needs to be dealt with on priority. The global mar-
kets are upbeat on the magical carpet of the stimu-
lus packages, but the real test for these economies
would be when they would be left all alone ,high and
dry, in mid air. The action plan should now involve
a gradual and judicious withdrawal of the stimulus
package as any sort of misconceived notion of a V
shaped recovery will be disastrous to say the least.
The central banks need to work on their strategies
to maneuver themselves on this tight rope with the
help of an effective monetary policy.
1 France 2 Germany 3 Japan
Risk Analysis 4 UK 5 US 6 India
7 China 8 Brazil 9 Russia
The systemic risks have been substantially re-
duced following unprecedented policy actions and Chart: GDP Growth rate of major economies in last 5
nascent signs of improvement in the economy. Even years
with the momentum significant risks remain. These The IMF says that, led by China, the world
are as follows: economy is bouncing back strongly from its 2009
• The recovery is driven largely by government decline. US growth is projected to reach 2.7% this
spending in many economies year, a nice rebound from last year’s 2.5% decline.
• Commodity and asset prices have risen aided The IMF, in its latest financial stability report, says
there is an urgent need for more regulation of

“The longer that you hold on

to these crutches the more you
get used to them and the lesser
become your chances of stand-
ing up on your own.”

20 NIVESHAK VOLUME 3 ISSUE 3 March 2010

financial institutions. dustry or the banks are not lending easily.
This entire fiscal stimulus comes at the price of Industrial Growth has been high at 6.3% but
greatly expanded debt. The Congressional Budget Of- according to a recent study of 1752 manufacturing
fice this week said the US deficit will for the second firms, done by RBI, financial performance of these
straight year exceed $1 trillion, an amount equal to firms has declined by -1.6% while net profit were up
about 10% of GDP. This explosive volume of debt will by 9.6%.This happened mainly due to sharp cut of
at some point have to be halted and rolled back. 9.3 % in raw material cost.
But, says the IMF, not yet. The exit from stimulus
towards fiscal balance should come only when there
is a tangible pickup in consumption, investment and
exports. Unfortunately none of these elements are
yet present.

AoM
The import of capital goods and raw material
usually increases during industrial growth but this
is yet not visible and it has been negative for No-
vember. The fourth indicator of state of industry is
the movement in price. Growths of manufacturing
industry prices are still low at 5%.

Source: Global Financial Stability Report Oct 2009, IMF
Indian Scenario
The economy is steadily gaining momentum,
though public expenditure continues to play a
dominant role, and performance across sectors is
uneven, suggesting that recovery is yet to become
sufficiently broad-based. The baseline projection for
GDP growth for 2009-10 is now raised to 7.5 per cent.
The Industrial Growth in India has been signifi-
cant with 7.6% growth rate up to 3rd Q and 11.7%
in November but the closest indicator of Industrial
growth, bank credit has not exhibited a parallel pic-
ture. Growth in Bank credit is sluggish at 8.8% for
the first 3 Q of year as against 12.5% last year. This
can be due to either low demand of funds from in-
Conclusion
There is a need for a prudently planned exit
from the fiscal stimulus. A phased rollback of the
stimulus is essential to maintain a balance between
delivering sustainable growth and stabilizing the
economy. A hastily worked out stimulus could end
up being disastrous and counter-productive for the
industry. There also needs to be greater coordination
between fiscal and monetary exits to avoid conflict-
ing results between them. We need to understand
that we are not out of the woods yet and that the
darkness might prevail for a longer time than antici-
pated.

“ Countries in which the au-

tomatic stabilizers are larger
need smaller discretionary
stimulus.”

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG 21

 Speaketh
Story

Manas J Sharma
Assistant VP, Head SME Liabilities Product, Abu Dhabi Commercial Bank
Cover

Manas J Sharma is the Assistant Vice President and the Head of SME Liabilities Product in
Abu Dhabi Commercial Bank. He has worked with esteemed organizations like ICICI Bank
He

Ltd. as Product Manager and with Godrej Pacific Technology Ltd as Business Manager.

Manas J Sharma in He is an alumnus of National Institute of Technology, Hamirpur, Himachal Pradesh Uni-
versity and Tezpur University.
this interview with
Team Niveshak
AoM

talks about SME seg- Niveshak: How do you define an Medium

ment of the econo- SME in the UAE?
SME Defini- Trading Manufac- Service
tion turing
my in every detail, Mr. Sharma: SME segment is defined
in many ways in different countries. No of Em- 75 250 250
starting from its size ployees
The common factor all across is the
to its importance in broad categories of SME -- Micro, Turn Over 250 250 150
Perspective

(Dh) Million
the economy. SMEs Small & Medium. The classifications
in the UAE have mostly centred around the Number In India two definitions are preva-
of employees, The Annual Turn Over, lent, one from RBI that divides en-
been given a special Balance Sheet size, Investments, Typeterprises by the investments made
focus, the effect of of Activities, so on & so forth. An en-
in the business & the other by the
Recession on them terprise categorized as Micro in one Ministry of MSM based on the type
country could be bigger than a me- & investments. For banks, SMEs are
and reasons for a dium category SME in another. like the Middle class, sandwiched
flourishing SME between the Retail & the corporate
The categorization most commonly segment. Most of the banks in the
segment have also
FinGyaan

used around the world is the one de- UAE treat a business client as SME if
been discussed. The fined by the European Commission: the annual turnover is less than AED
banking services 100 Mn.
Enter- Head- Turn- or Balance
requirements of an prise count over sheet total
category (<=) (<=) Niveshak: What is the role of SME
SME have also been Medium < 250 ¤50
¤ m ¤43
¤ m segment in the Economy?
dealt with in the Small < 50 ¤10
¤ m ¤10
¤ m
Mr. Sharma: In fast most of the top
interview. Micro < 10 ¤2
¤ m ¤2
¤ m
ten companies you can count on
Very recently an arm of Dubai govt your finger tips would have been
FinSight

has classified the SMEs as follows: SMEs couple of years back. It’s only
a matter of guess how many years
Micro is that “Couple of Years”. This is a
SME Defini- Trading Manufac- Service
natural progression as most of the
tion turing companies start small initially &
No of Em- 10 20 20 grow year on year. You may as well
ployees remember that the USD 100 billion
Turn Over 9 10 3 Hewlett-Packard started in a garage
(Dh) Million (now a museum) with an initial in-
vestment of USD 538.
Small
Globally SMEs control over 99% of
SME Defini- Trading Manufac- Service
tion turing
the business sectors worldwide, ac-
counts for 50% of the global GDP &
No of Em- 35 100 100
ployees employs 85% of the labour force.
To acknowledge the crucial role the
Turn Over 50 100 25
(Dh) Million SMEs play in the economy Govern-

22 NIVESHAK VOLUME 3 ISSUE 3 March 2010

ments in many countries have special ministries & to it. However, most of the SMEs are highly adaptive
organisations for the segment & ensure that there is & flexible & they can easily adjust to the changing

He Speaketh
a smooth flow of credit & adequate tax concessions market conditions. They usually have shorter cash
to the sector. cycle which is vital during the downturn as working
capital is hard to come by. Moreover, they don’t have
The SME segment in the UAE comprises of around huge capital appetite & don’t need to access the
800,000 entities that contribute to 80% of non-oil stock market or venture capitalists for that. Reces-
GDP. The entities mainly engaged in Wholesale/Re- sion could be an opportunity to cut various costs as
tail trading, Manufacturing or services are growing some of the sizeable overheads could be negotiated.
at around 30-35% & hence the contribution to the For example the rental value for the same business
economy is really significant. Some of the SMEs also premise could be available at half the cost as com-
play the critical role as the suppliers of some of the pared to two years back & with a long term lease
finished goods or manufactured goods to large com- agreement, the business unit can reap the benefits
panies & hence contribute to the overall economy. for the years to come when the market would turn
around.
Niveshak: How is the SME segment growing so
fast in the UAE? It has been seen that in many countries SME seg-
ment overall did well during the last year as com-
Mr. Sharma: There are many factors why SMEs are
pared to the previous year even though the growth
growing fast in the UAE:
rate is lower. For example in the UK, as per Federa-
• Excellent infrastructure in the country in the form tion of Small Business Survey found that 60% small
of Ports, Roads, Airport, Power, Telecom etc. business performed either better or same as in the
• UAE is strategically located between Asia, Europe previous year. Dubai Economic Department issued
& Africa & Other Middle Eastern countries for Inter- 11,635 licenses for various businesses during 2009
national trade & commerce. & majority of these were issued to the commercial
• Low entry & exit barriers for businesses; it’s one sector recording a 76% increase.
of the top-tier countries in the region on the Ease of Niveshak: ADCB’s SME Banking division offers
Doing business. financial products under the brand of “Busi-
• Favourable monetary policies like Nil taxation & nessEdge”. How does ADCB’s “BusinessEdge”
capital account convert abilities etc help the SME grow and nurture?
• The numerous free zones within UAE offer tre- Mr. Sharma: We understand the needs of SME busi-
mendous flexibilities to operate business for expa- ness very well & that’s why we have launched many
triate businessmen & foreign entities which allow tailor-made products & services that meet the grow-
100% business ownerships. ing demands of the sector. These products & ser-
• The local government & govt arms lend excellent vices under the BusinessEdge umbrella are backed
support for the growth of the sector with positive by the bank’s investment in the latest technologies,
regulatory policies & required finances & trainings. in-depth local knowledge, an extensive network & a
For example Sheikh Khalifa Funds floated in June dedicated team of advisors & managers.
2007 to expand & diversify the SME segment has SMEs can select the kind of package that suits their
so far supported 205 projects for AED 340 Mn so requirement the most & ensure that the cost of do-
far, mainly start ups. Another prominent organisa- ing business is minimized with the help of conve-
tion called Mohammed Bin Rashid Establishment for nient channels. There are many asset & trade prod-
Young Business Leaders seeks to encourage and fa- ucts that can help an enterprise to expand business
cilitate development of business entrepreneurship & maintain smooth flow of trade related activities.
in UAE. Moreover the timely finance is the key for this seg-
ment to address most of the business opportunities.
Niveshak: How are SMEs coping with the reces-
sion in the UAE? The other option for the clients is to go for Islamic
Banking products which are Sharia-compliant prod-
Mr. Sharma: Like all other business segments SMEs ucts & offer clients a unique proposition as per their
are also affected by recession, they can’t be immune value system. There are many innovative ways how

“In fast most of the top ten

companies you can count on
your finger tips would have
been SMEs couple of years
back.”

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG 23

 the Islamic products are structured so as to maxi- role.
mise the benefits to the customers. SMERA dedicated to SME is going a great job which
Niveshak: What were the repercussions of the is win-win both for the banks & the SMEs. There
He Speaketh

recent downturns particularly on the SME
products range offered by the banks?
Mr. Sharma: Downturn or otherwise, banks need to
continuously innovate on the products range & the
services offering so as to offer the very best to the
customers. During a downturn any bank would be
cautious regarding the asset quality & hence would
tighten the policies to some extent. However, this is
also a time to offer products to existing customers
based on the relationship they maintain. A relation-
ship based pricing is a win-win situation both for the
bank & its customers.
Niveshak: What, in your opinion, are the impli-
cations of the global downturn on the UAE’s
SME sector?
Mr. Sharma: As I have mentioned earlier, global down-
turn helps some of the SME businesses to cut on
the costs & reduce the cost of raw material & other
overheads. This could also be an opportunity to get
manpower at a cheaper cost. This could also be a
time explore related business interests & diversify.
However, some SMEs would go through some kind
of financial issues as the payments may get delayed
or the goods may take longer time to move from the
inventories. Some businesses also merge & consoli-
date into a single entity to get better pricing on their
loans & access to new market segments.
Niveshak: SME Rating Agency of India Ltd
(SMERA) - the first and only dedicated rating
agency for SME sector, was born just over a
year ago in India. What is the importance and
relevance of rating for facilitating higher credit
in the SME sector?
Mr. Sharma: Most SMEs globally find themselves in
a catch 22 situation. SMEs being small in size may
not have robust financial or audited reports which
are the fundamental documents before any credit
facilities are offered by the banks. Most of the banks
offer “Collateral based lending” which is a secured
lending that may not work out always particularly
to those who don’t have accumulated much assets.
Moreover, SMEs need to keep the cost of financing
as low as possible to cut down on the cost. That’s
where the credit rating plays the most important
are other rating agencies like CRISIL, ONICRA etc who
undertake SME ratings in India. This helps the SMEs
to get financial facilities faster & at a rate much bet-
ter as compared to an unrated SME on similar foot-
ings. Even the banks are comfortable to deal with
an organisation rated by an independent third party.
Some of the SMEs who would not qualify otherwise
to get any bank finance due to reasons like business
vintage etc, can get finance with reduced collateral
once they have got a satisfactory rating. Some of the
SMEs with a rating even can even get more credibil-
ity with buyers & suppliers.
Niveshak: What are the common problems faced
by the SME sectors?
Mr. Sharma: As mentioned earlier the biggest issue
facing SMEs today is getting timely unsecured credit
at competitive rates. Even if credit is available at
a very high cost, it might affect the profit margins
thereby reducing the competitiveness. The factor be-
hind this could be like the chicken & egg story. SMEs
usually don’t have the requisite financial statements
let alone any audited statements. Many banks offer
unsecured credit based on the strength of the bank
statements, however this credit comes at a cost.
Many of the entrepreneurs need the help of venture
funding which is also hard to come by in many parts
of the world except in the US.
Many of the SMEs are unwilling to invest in sys-
tems & processes due to the cost factor & just adopt
whatever is bare minimum to run their businesses.
They would also use the old software as the upgrad-
ed version would cost more. That puts them couple
of years behind as compared to the peers in the
corporate world.
SMEs in most parts of the world find it difficult to
attract & retail the top talent. Sometimes the key
personnel are poached by large corporate or MNCs
at a much higher salary. There is a general lack of
awareness on IPRs & legal issues which is very criti-
cal due to globalisations. But against all odds SMEs
come up the ladder & one day becomes a corporate.

“We understand the needs

of SME business very well &
that’s why we have launched
many tailor-made products &
services that meet the growing
demands of the sector.”

24 NIVESHAK VOLUME 3 ISSUE 3 March 2010

 FINANCIAL INCLUSION
With over a billion denizens,
thousands of acres of land amassed,
burgeoning middle class and a resil-
ient yet growing economy despite
the tumultuous aftermaths of reces-
sion, India is resurging to be the next
world order. All major economies are
starting to take her seriously, so to
speak. Today whenever she speaks
on any global concern, the world
hushes and listens. Yet, to scale up
the ladder to assume superpower
status, India still has a long way
to go. One of the key deliverables
to address is to achieve empower-
ment and upliftment of all sections
of society. One effective pragmatic
approach would be to provide basic
banking facilities to all, especially
the unprivileged, deprived and so-
cially disintegrated destitute. Even
today, 63 long hardship years after
the nation got free from the clutches
of the tyranny of the colonial Brit-
ish, India remains a conglomerate
of nuclear hubs, some of which are
thriving on economic prosperity,
while others are still thwarted from
the mainstream channels of essen-
tial services that provide them with
accessibility to sovereign amenities,
one of which is banking. Access to
banking services by the poor and
vulnerable is imperative to reducing
social disparities and establishing a
true welfare state. Today, promot-
ing inclusive growth is an agenda
which tops the charts of every mon-
etary and fiscal policy. By financial
inclusion, we mean efficient deliv-
ery of financial services at an af-
fordable cost to the vast sections of
the unprivileged, downtrodden and
low-income groups. The various fi-
nancial services include credit, sav-
ings, insurance and payments and
remittance facilities. The objective
of financial inclusion is to include
the entire population of the country
© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG
SAPTARSHI DAS
NIBM, Pune
within the ambit of the banking sys-
tem. Through organized credit, the This article talks
attempt targets at lifting the poor about the impor-
from the desolate levels of poverty. tance of Financial
Extent of Present Financial Inclusion in the
Exclusion process of economic
According to National Statis- and social develop-
tics Organization, around 46 million ment of the coun-
farmer households in the country,
out of a total of 90 million house-
try. It discusses the
holds do not access credit, either various root causes
from institutional or non-institution- of Financial Exclu-
al sources, forming a lion’s share. sion and considers
Perspective
Further, despite the vast network
of bank branches, only 27% of total the various initia-
farm households utilize the formal tives taken by the
sources. Informal sources like mon- government in this
ey lenders still form a major chunk
regard. Concepts
of their credit exposure. Farm house-
holds not accessing credit from for- of Regional Rural
mal sources as a proportion to total Banks, NFBCs, Micro-
farm households is at enormously Insurance, Agent
high levels, at 95.91%, 81.26% and
77.59% in the North Eastern, Eastern
Banking and Mobile
and Central Regions respectively. Banking have been
Thus, we can comprehensively sur- dealt with in detail.
mise that not only is exclusion on a
massive scale, it has engulfed mass-
es across regions and social groups
and asset holdings. The poorer the
group is, greater is the seclusion.
Reasons for financial exclu-
sion
The prime factors which can
be attributed to the prevalence of fi-
nancial exclusion can be mentioned
as under:
• Absence of Technology
• Absence of reach and coverage
• No proper delivery mechanism
• Not having a Business model
• Rich have no compassion for
poor
Today, there is enormous scope
of realization of financial inclusion.
Banks have become more respon-
25
 sible to this cause, the Reserve Bank of India has led
the way forward, and with its various programs, and
technologies it has come of age to link the jigsaw
pieces together.
The scope of financial inclusion can be two-
fold:-
(a) by way of statutory enactments ( for in-
stance the US example, the Community Reinvest-
ment Act and making it a statutory right to have
bank account in France).
(b) through voluntary effort by the banking
community itself for evolv-
ing various strategies to bring
within the ambit of the bank-
ing sector the large strata of
society.
A National Mission on
Financial Inclusion has been
set up by the Government in-
cluding representatives from
all sectors to achieve the stu-
Perspective
needs to be leveraged. Instead of customers coming
up to branches, technology needs to be developed
to make it the other way round. And therein comes
the Business Correspondent model to fit in the role.
The BC model rides on advanced technology to de-
liver the outreach, and thus forms a core strategy
of implementing financial inclusion. The ambitious
touch point of BC would be to reach the 6,00,000 vil-
lages of the country.
Procedural Changes
Procedural Changes like simplifying mortgage
requirements, exemption from
Stamp Duty for loans to small
and marginal farmers and pro-
viding agricultural / business
development services in the
farm and non-farm sectors re-
spectively will help in extend-
ing financial inclusion.
Regional Rural Banks

pendous target in a stipulated Post merger RRBs have a

time. The stakeholders vary
across all domains of public,
private as well as the NGO sec-
tor.
Source of funding
A project on such a mas-
sive exercise calls for substan-
tial outlay of funds, at least in
the initial phase. Later, as the
movement gains momentum, the costs impending
might come down. For this, NABARD has come up
with two funds-the Financial Inclusion Promotion &
Development Fund and the Financial Inclusion Tech-
nology Fund with an initial corpus of Rs. 500 crore
each to be contributed in equal proportion by GoI
/ RBI / NABARD. This recommendation has already
been accepted by Government of India.
Few possible key elements in Financial Inclu-
sion:-
Business Correspondent Model.
It can be well understood that to ensure access
to everyone, extending outreach has to be beyond
branch networks. For this to happen, technology
come up a long way, to rep-
resent a powerful channel of
financial inclusion. Their expo-
sure vis-à-vis scheduled com-
mercial banks, especially in ru-
ral areas has been impressive.
RRBs account for 37% of total
rural offices of all scheduled
commercial banks and 91% of
their workforce is posted in
rural and semi-urban areas. They account for 31%
of deposit accounts and 37% of loan accounts in
rural areas. RRB’s have a large presence in regions
marked by financial exclusion of a high orde.How-
ever, there needs to be a reinforcement of their rural
presence, with a clear mandate on financial inclu-
sion.
Micro Finance Institutions – NBFCs
Micro-finance Institutions are uniquely posi-
tioned to reach the rural sector, and hence could
significantly contribute to the mission at hand. Many
of them operate in a limited geographical area, have
a greater understanding of the issues specific to the
rural public, enjoy greater acceptability amongst
them and are flexible in operations, much to the

“Access to banking services

by the poor and vulnerable is
imperative to reducing social
disparities and establishing a
true welfare state.”

26 NIVESHAK VOLUME 3 ISSUE 3 March 2010

comfort of their clientele. Such MFI-NBFCs could pro- Many poor people lack personal identity (such
vide credit, micro-insurance, remittances and other as birth record) or financial identity (such as credit
financial services up to a specified amount to the or transaction history) these act as constraints to ac-
poor in rural, semi-urban and urban areas. They cessing formal financial services. Hence the regula-
may also be recognized as Business Correspondents tors should develop a unique way by which they can
of banks for providing savings and remittance ser- be uniquely identified and proper services can be
vices and also act as micro insurance agents. provided to them. Initially rural people were given
unique PIN but since most of the people were illiter-
Micro-insurance ate they tended to write the PIN on the card itself.
When providing micro-finance to the needy, This leads to unfair practices. Hence to overcome
providing micro-insurance almost becomes inevi- this issue the banks need to have biometric authen-
table. The poor is always more risk-prone than the tication using finger prints which is more reliable
well-off owing to their lower income levels, limited and easy since most of the rural folk is illiterate.
banking knowledge and liquidity crisis most of the
time. Micro-finance without micro-insurance would Proper amenities
be self-defeating. Proper facilities should be provided by the
bank to its staff to encourage their participation
Agent Banking in going to rural areas and serving there. Proper
In places where banks branches have not been schooling and medical facilities should be provided
developed, there bank can build partnerships with in this essence. Lucrative career opportunities and
certain nonbank agents like the post offices which variable salary can also encourage them to serve for

are present in all parts of rural India, and through the rural folk.
them the bank can provide financial services to the
rural population at lower costs and with greater con- tion with the RBI, till date includes:
venience.
Mobile Banking
Close collaborations between the banking and
telecom sector can further ease the process of fi-
nancial inclusion. With the increasing usage rate of
mobile phones amongst the rural population and
lower income groups various banking operations like
depositing, withdrawing, peer to peer money trans-
fer, payments for goods etc and other conventional
banking services can be done. This can be fa-
cilitated through SMS, GPRS/
CDMA etc.
Financial Iden-
tification
Perspective
Efforts put in by the Government, in collabora-
• Providing No-Frill basic savings account to vil-
lage dwellers.
• Overdraft in Saving Bank Accounts
• BC Model
• Liberalized branch expansion
• Liberalized policy for ATM
• Introducing technology products and services
• Pre-Paid cards, Mobile Banking etc.
• Allowing RRBs’ / Co-operative banks to sell In-
surance and Financial Products
• Financial Literacy Program
• Creation of Special Funds for Financial Inclu-
sion, like the NFMI mentioned above
Yet, the journey has just only begun and hit
several roadblocks and bumpy rides. Various sur-
veys reveal that still about 50% loans are disbursed
to meet emergency needs, rather than business
needs. And even the rich are included. Many a time,
they have to approach non-institutional sources. The
problems faced to beat down the foe of exclusion
are manifold. At present, the scale of banking activi-
ties is very low, with a lot of untapped potential. The

“A National Mission on Fi-

nancial Inclusion has been set
up by the Govt/ including rep-
resentatives from all sectors to
achieve the stupendous target
in a stipulated time.”

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG 27

 transactions costs involved are too high. There is yet
an efficient business model to be developed. The
Business Correspondent model, used to deliver the
outreach of branch network, is restrictive at best.
Even the cash delivery points are limited. One of
the biggest concerns is the lack of involvement of
the big technology players in supporting the event.
Also, simply having a current account / savings ac-
count cannot be regarded as an accurate indicator
of financial inclusion. Financial inclusion and exclu-
sion can be observable at two extremes of the likert
scale of financial accessibility. At one extreme, it is
possible to identify the ‘super-included’, i.e., those
customers who are actively and persistently courted
by the financial services industry, and who have at
their disposal a wide range of financial services and
products. At the other extreme, we may have the
financially excluded, who are denied access to even
the most basic of financial products. In between are
those who use the banking services only for basic
purposes like deposits and withdrawals of money.
But they may have only restricted access to the fi-
Perspective
solutions to expand the outreach of their services
in order to promote financial inclusion. One more
mindset that needs to be changed is the feeling that
aggressive marketing on part of banks and financial
inclusion are mutually exclusive.I personally feels
that if done together, it would bring a win-win situ-
ation for both banks as well as the public. It may
appear at first that undertaking banking strains to
the sections constituting “the bottom of the pyra-
mid” may not be profitable but it might be consid-
ered that even the relatively low margins on high
volumes can be a very profitable proposition. It has
been consistently observed that the non-performing
assets(NPA) on the rural side has been much lower
compared to their urban counterparts, contrary to
the belief that the rural poor are the most risky bor-
rowers. Financial inclusion can emerge as a viable
and commercial proposition. Only the banks and the
Government should be prepared to think outside the
box!

nancial system, and may not enjoy the flexibility of

access offered to more affluent customers, meaning
the discounts, waivers and attractive rates offered.

The Way Forward

It is apparent that banks addressing financial
exclusion will require a holistic approach on the part
of the banks in creating awareness about financial
products, education, and advice on money manage-
ment, debt counseling, savings and affordable cred-
it. The banks would have to excogitate innovative

28 NIVESHAK VOLUME 3 ISSUE 3 March 2010

 FIN-Q
1. When the Dow Jones Industrial Average started, it had only 12 stocks. Today it
is an average of 30 stocks. Which is the only company of the original 12 still in the
index?
2. In which year did US Treasury first print paper money?
3. ABC is a US based corporation that wishes to set up a plant in the UK. For this
purpose it requires 2 billion pounds upfront. To hedge its risk, ABC has decided to
enter into a derivative agreement with a UK based bank. Which type of derivative
contract would be most suitable for ABC?
a) Futures
b) Forwards
c) Option
d) Swap
4. The sudden overnight appreciation of a stock’s price after it has been
recommended by the host on this famous CNBC show “X” is called “Y”. Identify the
name of the CNBC show “X” and the name of the phenomenon “Y”?
5. What is the process of shifting assets from one asset class to another in order to
maintain the original asset allocation called?
6. A NASDAQ system was introduced in 1984 under which market makers must
honor their bids for automatic execution up to 1000 shares. This system became
compulsory after 1987 crash. What is this system called?
7. A foreign insurance company P has decided to start its operations in India FinLounge
again after 29 years through a joint venture with an Indian company Q. Identify the
companies P and Q?
8. A’s strategy was to buy investments when they were at their lowest point. He/
she built a major part of today’s Franklin Resources. He/she is famously known as the
“Dean of global investing”. Identify A.

All entries should be mailed at niveshak.iims@gmail.com by 10th April, 2010 23:59 hours
One lucky winner will receive cash prize of Rs. 500/--

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG 29

ANNOUNCEMENTS
ARTICLE OF THE MONTH
The article of the month winners for March 2010 are
Himanshu Mehra and Amitabh Vatsya
of NITIE, Mumbai
They receive a cash prize of Rs.1000/-

FINQ WINNER
The FinQ Winner for the month February 2010 is
Pritish Jana
of IMT Ghaziabad
He receives a cash prize of Rs.500/-
CONGRATULATIONS!!

ALL ARE INVITED

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for original articles related to finance & economics. Students can also contrib-
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the Article>_<Institute Name>_<Author’s name/Group’s name> by 10 April 2010.
»» Article must be sent in Microsoft Word Document (doc/docx), Font: Times New
Roman, Font Size: 12, Line spacing: 1.5
»» Please ensure that the entire document has 1500-2000 words
»» The cover page of the article should only contain the Title of the Article, the
Author’s Name and the Institute’s Name
»» Mention your email id/ blog if you want the readers to contact you for further
discussion
»» Also, if certain entries which could not make the cut to the Niveshak will get
figured on our Blog in the ‘Specials’ section

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