Of News and Other Stuff-12

• Maharashtra is trying to enact a law to ban social boycott of individuals by caste panchayats. Apparently they have previously banned superstition. I am hardly a libertarian, but how are they going to implement this law? Or is that precisely why they are passed? No headache of implementation, with all the positive press.
• Pratap Bhanu Mehta, when willing himself to be comprehensible, is brilliant (yes, I used that word). Here he defends judicial over-reach calling it the ‘jurisprudence of exasperation’. 
• Economic theory, as you know it,may soon be extinct. At least that’s what I am telling the well-meaning relatives/ family friends who insist I do a PhD.
• The problem with being a social science student (and economics at that) is that you assume the worst about people. When I heard about the Yellow Sea to the east of China, my first reaction was to assume that this was an act of racism by the British. Turns out, the sea actually looks yellow (in colour) due to its sand and silt deposition.
• I think I have regressed as a writer. I was reading an answer I wrote in college on the variance in regional experience of human development in India. If I had to describe it in one word, I would call it ‘strident’. Somehow I can never command that much feeling in anything I write now, leave alone an examination answer (not saying it was a good answer-it wasn’t).
• Krugman calls himself an SOB. Student of Bhagwati.
• Have you ever wondered why leftists refer to MNCs as ‘transnational corporations’? Bhagwati explains:

My favourite example [of the importance of the use of suitable phraseology] from economics is the business schools’ preferred use of the word “multinationals, nudging your subconscious in the direction of multilateralism and hence evoking the image of a benign institution, and the radicals’ insistence on calling these international corporations “transnationals”, strongly suggesting transgression.

• Hence Bhagwati does not refer to growth-led poverty alleviation as ‘trickle-down’ but as the strategy of ‘pulling up’ the poor.
• If you read some of Bhagwati’s older scholarly writings (and not his invective filled newspaper columns), it is remarkable how his position sounds so much like Sen’s. Before the 2014 general elections, when the two were having a public spat on the right strategy of poverty alleviation (nerds!), neutral commenters, called it a question of sequencing-i.e. what should come first-growth or redistribution. But Bhagwati is not even that radical (or conservative, depending on your world-view). He insists that growth is the principal instrument of poverty alleviation (as opposed to Sen who says it is important, but not adequate in itself), but also that there need to be institutions to ensure that growth have a pro-poor bias.
• May be I just want the two old men to get along.

Ditching the Washington Consensus?

Pulapre Balakrishnan and Ila Patnaik take opposing views on how to revive the economy. He advises revving up public investment, she says-follow easy monetary and tight fiscal policy.

Who is (more) right?

Both focus on the need to increase private investment. This is backed by the mid year economic review that shows that its contribution to GDP growth has been muted in FY 2015 and 2016 compared to the period from 2004-11.

Theoretically either method could work. If we assume the flexible accelerator model of investment, producers are looking to reach a certain 'desired capital stock'. Higher the expected GDP of the economy, higher would be the desired capital stock, because of higher likelihood of output produced being sold. Producers will typically adjust slowly to this desired level of capital. How much they add to the capital stock in a given period (that is, investment), depends on the cost of making the investment. This could be rate of interest or regulatory factors (for example, a temporary investment subsidy or tax holiday).
More public investment => producers expect higher demand for their output in the future = increase investment.
Easy monetary policy => lower rate of interest => ability to finance the investment more easily.

Other findings of the mid year economic review:

• Real consumer credit has picked up while industrial credit has slowed. Note that this slowdown is in spite of the RBI's loosening of money supply.

• The Review conjectures that stressed balance sheets have caused corporates to go slow on investment. Interest cover-i.e. the ratio of earnings to interest payments have been on the decline. Profit after tax between FY15 and FY14 also dipped slightly.

Both above facts make it difficult to understand how a (further) lower interest rate in isolation will help increase investment. This is because-
1. If the RBI already reducing rates has not helped increase investment, while consumer credit has picked up, this is possibly due to a lack of credit demand from the corporate sector.
2. If the balance sheets already stressed, reducing interest rates henceforth does not help the past issues.

[The government is planning to ask the RBI to change NPA classifying norms such that projects that have more than 2 years of delay (currently classified as NPA) not be classified as NPA if the delay is not due to the fault of the promoter. Similarly, they are asking that banks be allowed to provide additional funds to promoters to meet cost overrun on projects, even if the overrun is greater than 10% of the initial cost (10% being the current limit for such additional support, at present).]

Hence, stepping up public investment so that it boosts profit expectations more likely to help in activating 'animal spirits'.

Caveats:

• It is possible that increasing investment only props up the desired capital, and not the yearly investment which is more sorely needed.
• In that case, temporary investment incentives may be given, announcing clearly that these incentives will not be available, say three years hence. Businesses likely to want to take advantage of these incentives then.
• More public investment does mean higher rate of interest, thus dulling the ability of the private sector to invest. So Patnaik right about the undesirability of 'tight' monetary and easy fiscal policy. 
• The Mid year Review seems to suggest that the RBI should not stick to its avowals of reaching the set CPI inflation target and possibly follow easy monetary policy. But then why go to the trouble to announce inflation targeting as the goal of monetary policy and sign an RBI-government agreement  'guaranteeing the same', if you backtrack at the first hint of trouble? But then this is the classic discretion versus rule based monetary policy dilemma.
• More public investment likely to worsen the fiscal deficit and the debt to GDP ratio. Already the 10 year G sec yield exceeds the nominal GDP growth. Balakrishna says rejigging the public finance- away from unproductive subsidies to productive investment and raising more funds through disinvestment may help reconcile the two objectives of growth revival and fiscal consolidation. 
• I bet you are now smirking at how welfare subsidies are a waste while subsidies for investment are seen as incentives [hence not a waste].  
• Arun Maira takes the easy way out by plumping for institutional change and nice alliterations.
• I am now beginning to wonder whether the call for reducing non-merit or unproductive subsidies is also an easy way out...given that you can pretty much expect that the government will never follow through on that. [The reduction in the LPG subsidy has been an exception, but then that too will not affect a large part of the voter base].

Of News and Other Stuff (Links mostly)

Apparently Piketty and I agree on how much economists know about anything...almost nothing.

Also you call yourself a science? Compared to this stuff, economics is pure hokum.

And it's scary given how much economics influences policy. Like after months of study, and deliberation, the whole idea of the RBI targeting the CPI is turning out to be not that great. And that's in spite of their success in achieving the target. Essentially, while the CPI inflation turned out to near target levels, such that the returns on savings for consumers is attractive, the negative WPI has meant that the borrowing cost of investment [nominal rate of interest minus (minus WPI inflation)] is too high. Lower borrowing means lower investment which means lower real growth. So the projected tax revenues, calculated on an assumed growth rate cannot be met. More so, because the projection is based on the nominal growth rate, which a priori is expected to be higher than the real growth rate. This turns out to be wrong however, when inflation rates (that is the WPI or the GDP deflator-which in turn reflects the WPI more closely than the CPI) are low or negative.

Ila Patnaik argues  that the conversation about inflation targeting is misplaced. Whether it is the WPI or the CPI, the government should concentrate on keeping inflation low (which will more likely be missed if the fiscal deficit is high). Hence she roots for a mix of easy monetary and tight fiscal policy, where the fiscal policy, instead of the monetary policy directly attacks inflation. The reverse-where the there is a easy fiscal and tight monetary policy is not the best option because higher government spending could crowd out private investment if it raises rates of interest-in this case a tight monetary policy will aggravate things further. In India, such a policy is defended on the grounds that monetary policy transmits only weakly while government spending increases aggregate demand immediately. Patnaik argues that government expenditure is often allocated, but the spending takes place only with a lag. Moreover private companies already have stressed loans they have to repay, so it is unwise to burden them more with a tight monetary policy.

Budget 2014-15: A stronger case of cooperative federalism?

Honestly, this does not deserve a separate post-at best a comment on the Firstpost page where this article was published. But if you are a regular visitor on the website (does it say something about me that I am?), you would know how the regular commenters there are...how do I say it politely...moronic.

Anyway, the facts stated in the article are accurate enough. That is, as Jagannathan notes, there has been a  "...massive transfer of fiscal implementation power to states in just one year. In P Chidambaram’s last fiscal year (2013-14), states got Rs 1,19,039 crore out of the Rs 4,75,532 crore plan outlays; this year (2014-15), they get a huge Rs 3,38,408 crore from the total plan kitty of Rs 5,75,000 crore."

Essentially, there are two ways in which states can receive funds- Centrally sponsored schemes (CSS) and Central Assistance to State and UT plans. CSS schemes come with certain strings attached. Namely, states have to make proportionate expenditure contribution to the scheme if they are to access CSS funds. On the other hand, Central Assistance comes in two forms-Normal Assistance and Additional Assistance. Additional assistance funds are scheme-based. However, Normal Central Assistance are not tied to any specific schemes. Transfers to states depend on the Gadgil-Mukherjee formula which uses criteria like population, per capita income, fiscal discipline and special problems of the state to determine how funds are to be transferred. Once received, states can work with these funds in the manner that suits the state, on schemes that are tailored to the states’ specific needs.

However, the writer is being disingenuous when he says that,

"The one-cap-fits-all approach of the UPA years, dictated by dynastic and centralising feudal considerations, is now being whittled down by a former state chief minister who is now prime minister."

In fact, the almost three-fold jump seen in Central Assistance to State and UT plans (and a corresponding decline in allocations under CSS as reflected by the Gross Budgetary Support to States) under Jaitley's 2014-15 budget, mirrors the allocations made by Chidambaram's interim budget of 2014-15. He, of the party "dictated by dynastic and centralising feudal considerations". To be fair, the budget document itself does not claim to reversing any trend of "de-federalising a federalising trend that had begun earlier in the last decade". Rather, it maintains that it is continuing with the restructuring of CSS, as suggested by the B K Chaturvedi committee report.

Just goes to show that media coverage needs to be taken with a heavy dosage of salt.

Back to (D) School

The e-rick driver is in a good mood. He sings 'Suhana safar hai yeh mausam haseen', while facing the risk of a heat stroke.

I down two glasses of iced tea within the first thirty minutes. I come back later for a third, but the ice cubes are over. I settle for masala coke instead.

I make my job sound way cooler than it is  to people I don't like (Guess who). I am more honest with my friends.

I feel happier seeing Rawat bhaiya (who ignores me) than any of the professors at D school.

I spend inordinate amounts of time talking to professors I didn't even like in D school. But let's face it-there were very few profs I did like.

For the second time in my life, I follow every word of a speech. For the first time, someone is giving me advice I really need.

They serve vegetarian shaadi wala food. I die a little. The shaadi wala desert (ice cream with hot gulaab jamuns) saves the day.

I salivate at the description of food served at a friend's wedding. I am shocked I have a friend who has had a wedding.

I introduce a friend to my colleagues. I feel weird having colleagues.

Blog Ki Kasam

I realised that the only resolutions I manage to keep (and that too, only just) are all blog-related.

And short term.

And since I really need to rekindle my interest in economics, I will be posting economics related content for the coming two months. I am aiming for weekly updates, as of now.

Of course, that means you (dear, reader) are probably going to lose interest.

Or maybe I will be a really fun economics writer, like this guy here, the other love of my live.

Decoding the Basel III regulations on the Leverage Ratio (Because God knows it requires decoding)*

Leverage can be understood as the “magnification of the rate of return (positive or negative) on a position or investment beyond the rate obtained by a direct investment of own funds in the cash market.”** In less tedious terms, we know banks lend using resources that do not really belong to it. Leverage ends up measuring the extent to which this is true. As a formula, it is the ratio of a bank’s assets to its capital-the assets being the loans and advances (the investment) the bank makes, and capital (to put it a tad inaccurately) being its own funds. But if lending other people’s money is the bank’s primary job (it is), why is high leverage such a big deal?

It wasn’t (I think), till the global financial crisis, when banks exhibited very high leverages. This meant that they were extremely vulnerable if their investments did not pay off- so many more of their creditors would have to be paid out of their own funds (or capital). Even the perceived fear of such an eventuality would then mean de-leveraging-borne out by the credit crunch that followed.  

Were our regulators completely blind to these risks, then? Not entirely. Banks were required to maintain a certain proportion of their risk-weighted assets as capital. The more risky their assets, higher the capital they had to maintain to protect against possible losses. However, the way that banks calculated the risks attached to their assets, was left to them. It wasn’t apparent to the regulators that banks might under-estimate the risks attached. To prevent the kind of skulduggery that did happen, Basel III has now come up with its recommendations on the Leverage ratio.

For the uninitiated (which if you are reading this post, you probably are), the “leverage ratio” is not the same as leverage. It is the exact inverse (because financial concepts were not murky enough already), i.e. it is the ratio of a bank’s capital to its assets. Basel tentatively fixes this at 3% (to be reported as the average of the monthly leverage ratios maintained over a quarter), but might make further changes in case a need is felt. Paid-in common shares of the bank, retained earnings, share premium account etc. qualifies as capital. The reason the regulation needs decoding is the way that “assets” (or as Basel puts it, the exposures) are to be treated when calculating the ratio. Essentially, these may fall into four categories-non derivative balance sheet exposures, derivatives, securities financial transactions and off-balance sheet exposures.

The treatment of non-derivative balance sheet exposures - simply the loans and advances made by the bank-is simple enough. If a bank has made provisions against certain non-performing or doubtful loans, it may deduct the same from the measure of loans it reports.  A gross measure of loans has to be reported, without netting for liabilities. This means that if a bank has loans of Rs. 10,000 and deposits of Rs. 2000, then its exposures are the Rs. 10,000, not the Rs.8000 difference between loans and deposits. Liabilities cannot be counted at all. For instance, a bank may have issued a bond (which counts as its liability) at a certain rate of interest. If the market rate of interest increases thereafter, the price of the bond falls. In accounting terms, banks make a profit. Basel III disallows profit on this account to be counted as part of capital or added to the measure of exposure.

The treatment for derivatives is a little more involved. Remember that derivatives refer to financial instruments which reference an underlying asset. This asset may be a real good (in the case of a commodity forward contract) or a financial instrument (e.g. credit default swaps or interest rate swaps). Take the example of an interest rate swap. Such a contract brings together two (counter-) parties who agree to exchange interest payments on a certain principal amount, a predetermined number of times, on pre-specified dates. The principal amount has actually no role to play, except serve as the base on which the interest payment is calculated. This may be for instance Rs. 1000, and is the notional value of the interest rate swap. One party to the swap agrees to pay the other a flexible interest rate on the 1000 rupees, the other a fixed interest rate-of say 10%. If at the time when the interest payments have to be exchanged, the flexible interest rate is 12%, the flexible interest rate payer is at a loss of Rs. 20 (120 he has to pay minus the 100 he receives). If the rate is 8%, the fixed interest payer loses (100 that she has to pay minus the 80 she receives from the counterparty).

Derivatives exposures of the bank have to be treated, both for the counter-party credit risk involved (i.e. the risk of the opposite party in the contract, reneging on its obligations), and the exposure to the underlying. To calculate the exposure to counterparty risk, banks need to account for the current market value of the contract (replacement cost), if they expect to benefit from the contract (i.e. if they are the flexible interest payer when the flexible interest rate is 8%). If they are set to lose, then the replacement cost is zero. However, this would only count for current exposure. To account for potential future exposure, banks have to add an amount equal to a certain fixed percentage of the notional value of the derivative (which like I said before, is the principal amount of Rs. 1000). Where the underlying is a credit exposure, (e.g. credit default swap- the buyer of the contract makes a regular payment to the seller in exchange for the promise that he will be reimbursed in case of a default on a loan she made to a third party) the notional amount referenced by the credit derivative counts as the bank’s exposure to the underlying asset. In the example of the credit default swap, this is the loan amount that the derivative insures.

Collateral received on derivatives, is not be not subtracted from the measure of the derivatives exposure, it also has to be added in separately as an exposure. This is because banks can possibly use the collateral so obtained to leverage themselves even more. The treatment of the cash variation margin as a “form of pre-settlement payment” is more benign. The cash variation margin is essentially the payment that one party makes to the other, in response to changes in the market for the underlying. In futures trading mediated through an exchange (known as the central counterparty), participants have to be submit an “initial margin” as good faith payment. Suppose this is Rs. 10 for each futures contract, actually worth Rs. 100 in the future (i.e. the two parties have agreed to trade the underlying good at this price, at a fixed time in the future). If A and B, the two parties, respectively bought and sold 50 such futures contracts, they both would have to post an initial margin of 500 with the exchange. Suppose also that the maintenance margin on each contract is Rs. 7. This means that if the initial margin deposited by either party, falls below this threshold, the concerned party will have to reimburse the exchange till the initial margin is met again. This reimbursement has to be in cash. As you may have guessed, this is the cash variation margin. Suppose during the course of a trading day, the futures price for the contract A and B traded, turns out to be lower at Rs.96. A, the buyer consequently makes a loss of Rs. 4 on each of the 50 contracts. If the total loss of Rs. 200 is deducted from the initial margin, the remaining balance is Rs. 300, lower than the maintenance margin of Rs. 350. A has to then step in to make up for the difference between the current balance and the initial margin. The Rs. 200 paid in this case, is the cash variation margin. Banks can subtract it from the measure of the replacement cost. Banks that have paid cash variation margin can subtract it from its exposure measure if it had been counted as one, on the balance sheet.

A last word with respect to derivatives- banks may also act as clearing members, wherein they interpose themselves between the client and the central counter-party (essentially the exchange where derivatives trade). In the scenario where they guarantee the performance of the derivatives contract to a party in case of default by the opposite party (either by the central-counterparty or the client), this exposure must count as if the bank had entered into the derivatives contract for its own sake.

Next, is a discussion on the securities financing transactions that banks may enter. Examples include repo transactions, wherein the “borrower” sells securities to the “lender” with the agreement to buy the same back, at a pre-specified time and (higher) price in the future. The securities sold are essentially a collateral for the cash loan made. This is a repo transaction if described from the point of view of the borrower, a reverse repo defined from the point of view of the lender. A similar transaction involves securities lending, where as the name suggests, securities are lent. Other securities or cash, serve as the collateral.

Where the bank enters into a securities transaction for its own sake, the gross assets (cash/security lent) serve as the measure of exposure. Additionally, banks must account for the counter-party credit risk. This is simply the difference between the amount lent and the value of the collateral already received. In case this difference is negative (i.e. the bank is a net borrower), banks must count this as zero. In cases where the bank enters into a transaction as an agent for a client, its exposure must only be on account of the counter-party credit risk. That’s because, as an agent, banks also explicitly offer indemnity (or protection in case of default by the counter-party). The last interesting regulation in this case, is the calling out of “sales accounting” by banks. This is a neat little trick banks employ to understate their leverage on balance sheets. Right before they have to disclose their balance sheets, banks enter into a repo transaction. In the first leg, they sell securities and account for the proceeds as a sale (and not as borrowing as they should). This cash is then used to draw down their debt temporarily. As soon as the balance sheet submission is done with, they buy back the securities (the second leg of the repo transaction), and things return to business-as-usual. The most infamous example of this practice, which Basel III explicitly prevents, was Lehman Brothers.

The last component that the current regulation deals with, are off-balance sheet exposures. These refer to components like bankers’ acceptance-which are short-term debt instruments issued by companies and guaranteed by banks. Or commitments to lend, that haven’t materialised as yet. Basel III requires these to be converted into credit equivalents by multiplying them with pre-determined factors. So for instance, standby letters of credit are to be treated as a credit exposure of an equivalent amount (a 100% conversion factor). The very dangerous securitisation exposures are to be treated the same way. Then there are other exposures where the conversion factor is lower. For revolving underwriting facilities-where a bank stands ready to lend in case the prospective borrower fails to raise funds in the euro-currency market, the conversion factor of 50%.

Most importantly, Basel III imposes heavy disclosure requirements on the banks. They must report a comparison table between their assets for accounting purposes and for the calculation of the leverage ratio, a breakdown of the components under the leverage ratio’s purview, details of the difference between balance sheet assets and on-balance sheet exposure component of leverage ratio exposures and reasons for the changes in the leverage ratios between reporting periods.

The interesting question is, have any countries used this measure? And to any success?

Canada reportedly serves as an example of one such country-which has used a ceiling on the assets-to-capital multiple (leverage, really) for many years. Though it plans to officially move to a Basel III regime for the leverage ratio, it currently places a limit of 20 on the leverage allowed. Banks may increase this to 23, if they are able to take prior approval of the regulator. In turn, this approval is contingent on the risk-based capital ratios exceeding certain targets, the absolute level of capital being above a threshold, ratio of risk-weighted assets to un-weighted total assets, adequacy of banks’ capital management policies (where the banks can prove compliance to the leverage ceiling and the risk based capital ratio, through the period, and not just at the time of reporting), no regulatory skirmishes for four consecutive quarters, and no risk concentrations. These have to maintained at least for two years after the bank has received the permission to increase its leverage beyond 20. Failure to meet the ceiling may lead to imposition of still stricter ceilings. The measure of capital is Tier 1 equity capital (in line with Basel III). Exposures include off-balance sheet exposures like letters of credit and guarantee, transaction and trade related contingencies, and sale and repurchase agreements, all of them taken at their notional value (100% credit conversion factor).

The United States of America requires banks to maintain a minimum leverage ratio of 4%. However, the denominator is just the organisation’s average total consolidated assets less deductions to tier 1 capital. That means off-balance sheet exposures are not counted as exposures. However, banks that use their internal models to attach risks to assets, are subjected to what the regulators call a minimum “supplementary leverage ratio” of 3%. This is quite close to Basel’s leverage ratio-i.e. the denominator includes both on and off-balance sheet exposures. UK also requires its major banks to maintain a leverage ratio of 3%, again taking into account all exposures (on and off-balance sheet). Maldives imposes a leverage capital ratio of 5% f, though its denominator only includes total assets. Efforts are on to design these for other countries-even those that do not have any banks with internal models for risk measurement. The argument in favour of that is the leverage ratio’s simplicity. Will you be surprised to know that I laughed really hard at that?

* Needless to say, you are a prat of the first order if you think this post (or any post on any blog for that matter) constitutes professional advice. So don't be a prat.

** See, "Measuring Off Balance Sheet Leverage", Peter Breuer, 2000. Available at www.imf.org/external/pubs/ft/wp/2000/wp00202.pdf‎

(How seriously are bloggers meant to reference material?)

You Know You have a Masters Degree in Economics When...

• You haven’t bought a text book in three years-all three of which were spent as a student.
• You look at the contents of a textbook (the ones you bought the first time in three years), and disappointedly conclude, “Meh…undergraduate stuff”.
• You feel dissatisfied with your understanding of a concept (any concept) until you have worked out the math.
• You remember more about Keynes’ love life than his economics.
• You categorise fantasy fiction into two types- One, including the works of Tolkein and Rowling. The other, more whimsical type covering development models.
• You understand that for a lot people (not necessarily economists), “in fact” means roughly the same thing as “in my opinion”.
• You are the only person in social gatherings who does not feel outraged by how low the poverty line is. (It’s a only a measurement benchmark people, relax!)
• People who studied physics are more likely to have solutions to the country’s economic problems than you. 
• Your friend circle can be neatly classified into people who read the Hindu and those who read the Economics Times.
  
  (Secretly, you would rather just read the Times of India.) 
• You think sociologists/ political scientists/schoolteachers have glamourous jobs.

In Which I Try My Hand at Blogging About Economics

I was initially going to bitch about how  this article in the Economic Times is badly written and badly edited, and why I hate the newspaper. Then I decided that it would be a little rich coming from a person who was going to try their hand at writing an economics blogpost (without making fun of the subject) for the first time.

(By the way, this has nothing to do with my lack of real blogging ideas, promise.)

What is BASEL?
 BASEL, or more accurately the Basel Committee on Banking Supervision (BCBS) sets standards for prudential regulations in the banking sector. Member countries are not legally obliged to follow these regulations. However, since the Committee comprises representatives from the Central Banks of the various countries, who formulate and agree to these, adherence is normally expected.
BASEL III is the latest set of regulations that countries are expected to enforce.
In particular, the BASEL III document lists the various capital requirements on banks.

What is capital?
Capital refers to those components of a bank's balance sheet that do not have to be repaid, and thus can be used to cover losses (due to loans that are defaulted on, for example). Capital is categorised according to tiers. "Tier 1" capital is the strongest, and includes things like common shares (that do not have legal requirements on dividends) and are repaid only in the case of liquidation, that too after all other claimants (like bond holders) are paid first. Higher the tier number, broader are the definitions of capital that apply.

What does BASEL say about capital?
BASEL and most countries have minimum capital requirements from banks. This requirement is expressed in terms of risk-weighted assets* and hovers around 8-10 per cent. BASEL III stipulates the requirement in terms of various types of capital. So 4.5 per cent of a bank's risk weighted assets are to be maintained in the form of Common Equity Tier 1 Capital (the strongest type of capital within Tier 1 capital), 6 per cent in terms of Tier 1 capital and and 8 per cent in terms of Tier 2 capital.

Are minimum capital requirements enough?
BASEL III also imposes an additional requirement of 2.5 per cent of Common Equity Tier 1 capital as a proportion of risk weighted assets. This is over and above the minimum requirement. If a bank fails to meet it, then restrictions are imposed on the manner in which it distributes its profits in the subsequent financial year. According to the BASEL requirements then, banks have to maintain Common Equity Tier 1 Capital to the tune of 7 per cent of risk weighted assets. If a bank's actual maintenance is 5 per cent then it may distribute x per cent of its profits in a manner it deems fit. If the number is 6 per cent, then it may distribute y per cent (y>x) of its profits the way it wants to.
This buffer can be drawn down in cases where the bank faces financial stresses.

So what it the article saying?
The RBI's requirements of banks are a little more stringent than the BASEL ones. Banks have to maintain Common Equity Tier 1 Capital to the tune of 5.5 per cent, total Tier 1 Capital equaling 7 per cent and total capital equal to 9 per cent of its risk weighted assets. The capital conservation buffer is put at 2.5 per cent of Common equity Tier 1 capital, which makes the total requirement of Common Equity Tier 1 capital at 8 per cent (hence the 8 per cent you see in the article). If the capital falls below this requirement then restrictions on the way the bank distributes its profits kick in. Effectively, this has increased the capital requirements on banks. However, this is being implemented in phases and the full strength of the restrictions will only be felt by 2018.
Hence, banks are now implementing measures to augment their capital. This includes introducing BASEL III compliant instruments which entail the risk to investors of non-payment of coupon (when a bank's Common Equity Tier 1 Capital falls below the 8 per cent mark).
The United Bank of India has introduced exactly this type of instrument earlier this year.

If you are wondering what the headline to the article is about, then refer to the last two paragraphs. Which have nothing to do with capital requirements-what the columnist spends 90 per cent of the newsprint on.

Are bank level capital requirements enough?
No. In their haste to maintain minimum capital requirements, banks often end up reinforcing pro-cyclicality in lending. This may happen because of falling bank profits (which figure in the calculation of capital) or due to increasing risk weights to assets (on account of higher risk of default that an economic downturn invariably entails). Instead of taking measures to enhance capital, banks end up lending less, which in turn leads to a further downturn in economic activity. To guard against this, BASEL III moots the concept of a counter-cyclical capital buffer.

How does the Counter cyclical capital buffer work?
The buffer gets activated in 'good times' when banks can afford to jack up their capital, and this can be drawn down in 'bad times' to ensure that the additional losses during the adverse economic situations can be covered. This may lead to banks not lowering their lending just to meet their capital requirements (though they may lower it anyway, if they are very risk averse).
The signal for the good times-i.e. for the bank to start increasing its capital is based on the movement of a macro-economic indicator. For example, the aggregate credit to GDP is recommended by BASEL III. If this exceeds the long term trend value by more than a pre-decided threshold, banks have to start increasing their capital. This is why the counter-cyclical buffer is called a macro-prudential instruments, as against the micro-prudential or bank specific requirements that are made under the conservation buffer (i.e. the drawing down begins when the individual bank is in trouble). The signal for drawing down the buffer may be different from the one that signals building up.
BASEL III envisages the buffer as an additional requirement of 2.5 per cent of capital over and above the minimum and the conservation buffer requirements. If a bank fails to meet the additional requirement (during the times it is meant to), then restrictions are imposed on the manner in which it may dispose off its profits in the subsequent financial year.

There is no small print?
There are actually lots of terms and conditions for the buffer to work well.
The most important being the choice of indicator that signals to banks to start increasing their capital. For example, according to a Countercyclical Capital Buffer Guidance for India (June 2012), the credit to GDP ratio in India was low and stable (with very little variation) up until 2002-03. Using the long term trend of the ratio as benchmark would also be misleading since financial repression in the past has meant that the trend itself if very low. Any deviation from that does not necessarily imply overheating or over-leveraging. This may simply be due to desirable financial deepening, a switch from informal to formal credit sources, priority lending, and increased lending to the manufacturing sector (which the Government aims to develop) where credit intensity is higher. This is possibly true of most emerging market economies. Indeed, the BASEL guidance document itself urges regulators to exercise their discretion when asking banks to increase capital.

This also the approach recommended by UK'S Draft Policy Statement on the Financial Policy Committee and its power to direct regulators on countercyclical capital buffers and sectoral capital requirements. In particular, FPC, intends to monitor 17 indicators including credit to GDP ratio,leverage ratios (capital to unweighted assets), returns on assets before tax (as a measure of bank profitability), loans to deposit ratio (indicative of stable source of funding for banks), bank debt measures like subordinated debt spreads (decreasing spreads during recessions may signal improvement in climate),nominal credit to the private sector, net foreign assets, gross external liabilities (where debt liability may be more risky than foreign direct investment),current account (reflecting possible imbalances in borrowing), metrics reflecting volatility in equity and debt markets, global spreads in debt markets (a spread that is too low may indicate that the premium on risk is not high- hence may trigger increased CCB to build resilience, the same occurrence during a downturn may reflect improvement in conditions and lower risks) etc. The FPC also rejects an "automatic buffer" which the BASEL guidance document recommends (automatic in the sense that as soon as a certain mark on the indicator is breached, the countercyclical buffer should increase or decrease). This is supported by EU recommendations.

The decision on the threshold of the variable (crossing which would signal banks to increase capital) is another matter of concern. The threshold should be low enough, and early enough for banks to start jacking up the capital in time. This is especially relevant as the banks would get 12 months after the trigger to meet requirements under the counter cyclical capital buffer. Drawing down can begin immediately.

How the adjustment should take place-i.e. how a threshold  translates into a particular capital requirement may depend on how badly banks would be affected in terms of a crisis (this is done through a simulation). Whether the minimum capital requirement is pro-cyclical at all is also an important consideration.

Yet another criticism of the countercyclical capital buffer is its crudeness. This means that the tool requires higher capital provisioning for all classes of assets, regardless of whether these are actually contributing to increased risks. This is addressed by imposing cyclical buffers relative to loans to specific "culprit" sectors. For example, Switzerland in January 2013, asked its banks to increase capital provisioning by 1 percentage point as a proportion of mortgage positions held (in risk weighted terms).

Does India have a countercyclical capital buffer?
Not yet. BASEL allows countries to start the buffer from 2016, implementing it in phases. Completion is expected only in 2019. UK and Switzerland are early birds in this respect. End November will likely see the release of a report by a B Mahapatra led committee, set up to look into the operationalise the buffer in India.

*That implies that riskier the asset- i.e. higher the possibility of default of a loan, higher the capital provisioning that has to be made.

Everything You Really Need to Know about the Delhi School of Economics

There’s a lot to hate about the Delhi School of Economics.

Delhi School of Economics Campus

Its course content in the first year- mostly revolving around mathematics.

Teachers who appear inaccessible.

The huge class size.

The (initial) daily struggle to get good seats.

Some of the teaching assistants.

The weekends. When followed by a mid-term.

The exams themselves, especially when the professors play tricks. (Beware when the teacher announces something as ‘not important from the exam-point-of-view’. That is exactly what will be tested in the form of a question worth 35 marks).

The pressure, the lack of time to really absorb what you’re learning.

But thankfully, there’s also a lot to love.

The Good Professors- God knows that every institution, however great, has its share of mediocre faculty. This is true for D-School as well. However, the brilliance of some of them in the classroom will startle you. There are professors who can explain the most convoluted concepts with the most ridiculous examples (so imperfect capital mobility becomes akin to taking coins out of your torn pocket slowly). There are others who will revel in students questioning assumptions and explanations, will go back and think through those objections, then physically search for students in the corridors, to clarify the concepts again. A few professors will discuss things in class that appear more advanced than the (considerably difficult) texts. And then yet others who understand your life is difficult anyway, without “wasting valuable hard-disk space” memorising things.

The Very Efficient Photocopy Shop (till some kill-joys entered the fray)- Prem Bhaiya knows more than you do. Period.  Your life’s going to be much easier if you curtail the habit of arguing with him about readings. And bear with it when he incredulously asks, “Padoge kab??”, when you want to buy LADW after the math mid-sem is over. He means well.

The Ratan Tata Library-is certainly well stocked. But as with everything in DSE, it’s the people who make it as good as it is. There are catalogues of course, but don’t bother with those if you want a text-book. The two elderly gentle men at the desk have an encyclopaedic memory of every book that has passed their hands. And they will take it as a personal insult if you can’t locate a book that is less-asked for (as every non-text-book is likely to be). On the flip side, they issue books for a very short time. If you are a regular though, you only get gently chided for being late.

The Infrastructure- the Lecture Theatre is fantastic. The loos have been recently beautified (and get users from as far as Ramjas). The air-conditioning in the CDE will put an end to your constant whining about how hot/ cold it is in Delhi. The speed of the computers could be better. But the staff certainly couldn’t be (especially now that I have realised their shared dislike of a certain faculty member).

The D-school canteen- According to some students the quality of the food is unsatisfactory. Ignore them, they are stupid. The food’s fine (though unholy rumours abound about the source of the meat in the mutton dosas). The ambience is better. The service, if nothing else, is entertaining.

Ask Baba how much you need to pay. He confidently says, “Pachasi (eighty five)”

“Kaise, Baba? (How come)”, you ask.

“Arre, pachas hi (fifty only).”

JP Tea Stall and its Iced Tea- I have already waxed eloquent about it before. And I have nothing new to add. Unless you want to know I choked up just a little, while having my last glass there.

The peer group- there are 180 students in a batch. It’s very unlikely you won’t find friends here.

Though very lucky to find the friends I did-

·         A Bong who shares my enthusiasm for films and music (though her tastes are more evolved than mine will ever be). Also an authority on photography (in our group, anyway).

·         A Bong enthusiast who thinks she speaks better Bangla that I do (she most certainly does not) and whose studious look belies her chatterbox self, as well as her appreciation of Prakash Raj

·         A smartass with an enviable collection of ‘videos’ and a brain that can solve problem sets from courses she did not have

·         A freakishly quick reader, who frequently uses words like ‘syapa’ (though in her defence, D school provides for many occasions for such words to be used). Also thinks that the world is divided into good people and rapists.

·         An introvert who can be incredibly fun to be with when she opens up. Also, what notes‼

·         An eternal optimist, who maintains ‘sab ho jayega’, when I assail her with my whining. Likes JP iced tea, so didn’t take long for me to really like her.

Besides the 180 are going to include people from your college, most of whom share a similar work ethic and a passion for discussing Singham. Their reassurances of also not knowing any linear algebra, helps as well. As do other people you find (even if it’s a little late in the course to know them very well) to talk to due to courses you have in common, during lunch hours or when you are killing time at JP.

Overall, even though it's not something you ever believe yourself to be capable of feeling during the two years at DSE, you are going to miss the place only a few days into your hard-earned holidays.

“My servant hasn’t come today”, Mira mashi wailed on the phone.

“Domestic help.” I could see Asha mashi’s eyebrows twitch as she mentally corrected her sister.

“I will have to cook, clean all on my own, that too on a Sunday…”

Asha mashi rolled her eyes, then looked apologetically at me. I pretended I hadn’t seen her disinterest, getting up to drink water from the bottle kept at her bedside table.

Mashi , my mother’s first cousin, was my local guardian in Delhi. To my misfortune, she was also a senior Professor in the Department I had chosen to do my PhD. Luckily though, I had avoided her being my Supervisor as well (though I did not realise the lucky part until I spoke to Sourav, her graduate student/personal indentured labourer).

As a kid, I loved her. She had a large, pretty home, and had the fanciest delicacies served, when we visited her. That would usually be enough as a mark of character. But I also loved the way she dressed-cotton kurtas and lots of big, ethnic jewellery. Her salt and pepper hair, cut extremely short gave her gravity, as well as warmth. Also as little as I like to admit my absolute lack of depth, I loved the way she spoke English. It was fluent, but most importantly free of the embarrassingly heavy Bengali accent that saddled my parents’ diction.

What led to my grown up self not particularly liking her, was what has historically been responsible for drawing a wedge in even the most tightly knit of families: close contact.

It is difficult to avoid that, given that we spend the better part of the day in the same building. But I make sure that every visit I make to her place is punctuated by a gap of at least three months. This time it hadn’t been so bad. She had just discovered blogging. So we talked about that.

“It’s really lovely, isn’t it?, she said.

“ It really allows me to interact with people from all walks of life -other academics, enlightened journalists, social workers. No other forum provides such a democratic space for free discussions and debate. And it’s becoming quite a necessity in the increasingly censored non-virtual world, no?”

I agreed absent-mindedly as I stared at her blog counter. The number of hits she had gotten in two weeks had exceeded the number I had managed in over ten months.

Her first post had been an impassioned argument against a rabid communal leader, emerging as the Prime Ministerial candidate of a right-wing party. That had received a rousing reception from the readers. Her latest post was a chilling account of how the film industry and a best-selling author were conspiring to turn popular opinion in the leader’s favour.  The first few comments awaiting moderation, showed that there were others who agreed with the view.

“The dumbed down easy version of history that the film offered will be lapped up by the ignorant and consumerist masses of the country”, a journalist from an Eminent Newspaper wrote.

I didn’t take kindly to being called ignorant. And my stipend didn’t allow me to be consumerist. So I felt happy seeing an Indian Warrior, defending my ilk. Unfortunately, his argument, that I speed-read while Asha mashi was busy tuning her sister out, was less than convincing.

 “how can you pseudos ignore 59 innocents killed in the train…your arguments are not only dishonest, but downright treacherous. You people should just go to China. They will shoot you in the head there if you write such things and you would bloody well deserve that…”, he had written.

It never got published.

                                                                       ***

Monday morning, a mail from mashi sat in my inbox. It had her recent academic paper in the attachment. She invited everyone from the Department to give feedback. Apparently an anonymous referee had said the paper made sweeping generalisations, and that certain sections were devoid of research. The same day, Sourav had his research methodology torn apart. I deleted the mail in solidarity with him. Plus I was already being compelled to do the same kind of work for my Supervisor, Prof Abhimanyu. I was certainly not going to voluntarily do more.

Actually I don’t know what I hate more. The pointless vacillations that Mashi’s papers are, or the equally useless, complicated mathematical edifices that my professor constructs. Of course, he gets more respect in the Department, as in the profession in general. Some of the older professors practically dote on him, their star ex-student, who went on to get a PhD from Harvard, but returned after years of teaching there, to give back to his alma-mater.

“It’s an exciting time for India, isn’t it?, he said when I asked him what made him come back.

I would like him more, I think were it not for his budding friendship with Asha mashi. More sources of close contact, I rued, when I saw them having tea from the coffee-house. Apparently, they had bonded since the last Departmental meeting (which Sourav had attended by virtue of being a TA).

Some of the professors had wanted to drop Mashi’s subject. In a department dominated by Game theorists and Econometricians, it was seen as soft.  The matronly Head of the Department had offered her the chance to teach economic history instead. Mashi had been shocked. Nobel prize winning economists had been in the vanguard of her subject. Economic history was the preserve of historians, she had argued. Abhimanyu had backed her up then. He and Prof Qureshi. The three of them had been inseparable since. And not just on campus. I once spotted them at Habitat, where I had gone to meet a friend. I deduced they were there for a Sufi Music Recital. Prof Qureshi was nowhere around though.                                                                               
                                                                                           ***

In the afternoon, Prof Abhimanyu called me to his office to discuss my dissertation. I had asked for an appointment two weeks back and he could finally accommodate me. He looked busy when I entered, evidently going through the document I had sent him. He found a fault in my work, and tilted the computer screen in my direction, so that I could explain myself. My stuttering was interrupted by his intercom ringing. The HOD wanted to see him. He told me to think while I waited for him to come back. I obediently decided to google my way through the problem. Apparently the Professor was going through a blog before I had entered. The post was by an Indian Warrior. The post revealed how the mainstream media’s coverage was biased towards the ruling pseudo secular party. How it was mechanically spreading canards about the only alternative, a dynamic leader, slowly emerging as the most viable candidate to lead the country into a new, bright future. A half written, yet-unsubmitted comment by a TruePatriot47 sat in the comment form.

“You have nailed it!  The youth want development. Which he CAN deliver. And which these sickular commies refuse to acknowledge”, the message said.

My Taxonomy of Academic Writing (in Economics)

I am currently reading a paper, firmly ensconced in the intersection of B, D and E (see below). Which motivated this.

A.      Vishal Bharadwaj cinema^*- Our microeconomics professor encourages students to write short answers in exams. He cites the example of Kenneth Arrow, who was notorious for his short papers (most of which, went on to span complete branches of economics). I haven’t read much of Arrow, but I have certainly read other economists who decide to infuse meaning into every word they construct. You blink. And you miss the most important plot point. These economists enjoy sneaking in a harmless looking line in the introduction, or worse, a footnote- the one line that holds the key to all the mind numbing (unsolved) differential equations that you are so impatient to get to, in later sections.

B.      Ekta Kapoor Soaps- These authors lie on the other extreme end of the continuum. They absolutely must give us a recap of every section of the paper at the end of the section, as well as at the beginning of the subsequent section. And in the introduction. And in the recommendations. And in the concluding remarks. You get the idea. (And then almost start missing the algebra).

C.      Farhan Akhtar/ Abbas-Mustan projects- While the Vishal Bharadwajs are theoretical economists (in the vanguard of academia), empirical economists (especially if you skip the methodology bits to power on to the results and discussion) are more accessible. That’s not to deny their capability of employing stunning gadgetry on the way to the climax. When done well, the results are sublime. When not…umm I trust you have seen Race.

D.      Rohit Shetty filums- unambitious and unpretentious. But (happily) not very taxing on the brain. These benign authors decide that they must make life easy for students, and spend most of their paper presenting a simplified version of the papers written by Exhibit A and C. Just as fancy cars hurtling in the air are a regular fixture in Shetty’s films, the penultimate section of these papers too must invariably involve critiquing the papers they discuss, and sometimes an extension.

E.       The ensemble film (in the tradition of Aaja Nachle, Chak de India)- Chak de India straddled regional chauvinism, national unity, religious persecution, sexism, the pathologies of Indian sport, all in a three hour narrative. The academic equivalents may not give such gripping results, but they do manage to flog a single mathematical model into providing amenable results on a variety of points the author wishes to prove. Sometimes this is not limited to a lone paper. Several careers have often hinged upon one model, one idea. Sometimes so much so that all the loving self referencing pushes it into Yashraj Films territory (who remind us at every chance they get, that Aditya Chopra made DDLJ).

^* Yes I compare academic papers to Bollywood films and Hindi television. Sue me.