Niveshak

THE INVESTOR VOLUME 3 ISSUE 12 December 2010

Will
Quantitative Easing
solve the biggest problem
of this passing decade?

Mergers and Acquisitions in should NBFCs be converted

Indian Banking Industry pg.8 into banks PG. 18
FROM EDITOR’S DESK
Dear Niveshaks
Niveshak As we all get ready to take a leap into the next decade, I find myself
Volume III jotting down my thoughts for the last time in editorial. Our team’s journey
is finally coming to an end and it is the time when we need to pass on
ISSUE XII the legacy to the next team. It is indeed a déjà vu feeling of last December
December 2010 when our team had got the opportunity to work for this illustrious maga-
zine. The time since then has passed in a flash. Let us have a quick recap of
our eventful journey. We started with the footsteps to 2010 where we saw
Faculty Mentor how this world of finance was going to shape up, followed by auditing
Prof. N. Sivasankaran what is called as the balance sheet and income statement of our India Inc –
Union budget 2010. Later we had a sneak peek of some of the most impor-
tant events in the world of finance like Greece Debt crisis, Goldman Sachs
fraud case, and currency war between nations which did affect the whole
THE TEAM globe. We also took you through some of the milestones of the last century
in our anniversary edition which was highly appreciated and acclaimed by
Editor our readers including those from corporate world. In the meanwhile, we
Bhavit Sharma constantly tried to make this magazine a platform to facilitate interaction by
introducing interesting sections like Nivesh – A portfolio game and Cross-
Sub-Editors word apart from the Fin Quiz section.
Durgesh Nandini Mohanty When we took charge of this magazine, the responsibility and expec-
Hitesh Gulati tations were high as the magazine had already achieved a lot in its one year
Sumit Kedia of existence. We started the magazine with the dream of making it even
Tanvi Arora bigger in the field of finance and we firmly believe that we have achieved
Upasna Agarwal the same to a great extent. Now Niveshak has become the most coveted
platform to facilitate knowledge sharing among the finance enthusiasts of
India. This would not have been possible without your support and encour-
New Team
agement. We improved with every issue solely because of the feedback
Alok Agrawal and compliments received from your side which really motivated us and
Deep Mehta boosted our morale. We take this opportunity to thank the entire B-School
Jayant Kejriwal fraternity of the country, and especially to those participants who sent nu-
Mrityunjay Choudhary merous appreciation mails, articles, fin-Q and crossword entries. They are
Rajat Sethia the ones who are undeniably the reason behind Niveshak’s success. I would
Sawan Singamsetty also like to acknowledge the guidance and support of our mentors – Prof
Shashank Jain Sarkar and Prof Sivasankaran who inspired and motivated us throughout
Tejas Vijay Pradhan our journey. I must congratulate and also thank the entire team of Nive-
shak comprising of Bhavya, Durgesh, Hitesh, Sumit, Swarnabha, Tanvi and
Upasna for completing this journey successfully. They were phenomenal
Creative Team
during the whole journey. Here I would like to make a special mention
Bhavya Aggarwal of Bhavya and Swarnabha whose creative intelligence and perseverance
Swarnabha Mukherjee have been instrumental behind Niveshak’s grand success. Last but not the
Vishal Goel least, I would like to congratulate Biswadeep for creating this masterpiece.
Vivek Priyadarshi Just as after every sunset, the sun rises again with all the new hopes
and enthusiasm, I am confident that the new team Niveshak, with their en-
thusiasm and motivation, will take Niveshak to greater heights and achieve
All images, design and artwork those feats which our team couldn’t even think of. I just wish the new team
are copyright of gets the same love and support from you which we got in the last 1 year.
IIM Shillong Finance Club Although this is my last editorial, I won’t bid adieu as Niveshak is some-
thing to which I shall remain attached forever. Bbye for now.
©Finance Club Stay Invested.
Indian Institute of Management
Shillong
Bhavit Sharma
www.iims-niveshak.com
(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
finsight
8 M & A in Indian Banking
Industry

Cover Story
14 QE2 - Easing the Crisis

CLASSROOM
23 PE Firms

Article of the month

21 Global Imbalance

PERSPECTIVE
11 Microfinance Public Private
Partnership
FINLOUNGE
18 Should NBFCs be converted 24 Crossword
into Banks
 www.iims-niveshak.com

The Niveshak Times

REFORMING THE U.S. MORTGAGE MARKET IS THE BIGGEST SINGLE ELEMENT
MISSING FROM FINANCIAL REGULATORY REFORM: PAUL VOLCKER

TEAM NIVESHAK
IIM, Shillong

DOMESTIC BUSINESS
Splits Ville for Hero Honda
One of the
country’s most
successful JVs,
Hero Honda is all set to come to an end as its found-
ing partners, India’s Munjal family and Japanese
vehicle maker Honda decided to go separate ways.
This decision has been borne out of their conflicts
on a number of issues ranging from Japanese firm’s
reluctance towards full and free technology share
agreement ,Munjal family was also not keen on
paying high royalty payouts to Honda, Hero Honda’ s
refusal to merge its spare parts business with Honda
Motors India, a fully owned subsidiary of Honda. The
split will be carried out through a two tier deal the
The Month That Was
pain relief ointment and Crack, a cracked heal treat-
ment to RB’s portfolio and will fast track the com-
pany’s growth chart.
JSW acquires 41% stake in Ispat Industries
Sajjan Jindal led
JSW Steel has bought
a 41% stake in Mittal
brothers, Pramod and
Vinod owned Ispat In-
dustries for Rs. 2157
crore. The deal will give
rise to a new entity named JSW Ispat Steel that will
issue 108.66 crore equity shares on a preferential
basis of Rs 19.85 per share. JSW will have to make
an extra spending of around Rs. 1200 crore as a part
of its open offer of additional 20% to minority share-
holders of Ispat at a marginal premium of Rs. 20.54

first of which will see the Munjal family led by Bri-

jmohan Lal Munjal group acquire the 26% stake of as required by the market regulator SEBI. The deal
Honda Motors in Hero Honda through a Special Pur- will help the beleaguered Ispat Industries to refi-
pose Vehicle (SPV) by raising bridge loans . The pur- nance its debt of Rs.7500 crore and will also pro-
chase is likely to be made at a discount in range of vide Rs. 3100 crore to meet its long term investment
30 to 50% of the current value of Honda’s stake with needs. The deal will make JSW the biggest private
the total value amounting to around $1 billion. Next Indian steel maker with a combined capacity of 11
the 60-70% of this SPV will be divested to private mtpa (million tones per annum) that is expected to
equity firms for loan repay purpose. Top PE firms like increase up to 14.3 mtpa by March, 2011 making it
Carlyle, Kohlberg Kravis & Roberts (KKR), TPG, Bain the top Indian steel maker.
Capital and Warburg Pincus are in the race to be a RBI keeps key rates unchanged for December
part of this SPV. RBI came up with a Rs. 48,000 crore infusion
Paras Pharmaceuticals bought out for Rs. plan through sovereign security purchase for the
3260 crore month of December to deal with the cash crunch
UK based consumer goods firm, Reckitt Benck- as it kept the month’s repo and reverse repo rate
iser has come up with an Rs.3260 crore buyout of- unchanged at 6.25 and 5.25% respectively. The CRR
fer for Paras Pharmaceuticals Ltd valuing the Indian also remained unchanged at 6% while the SLR was
pharmacy company at around 8 times its annualized brought down by 1 percentage point to 24%. Infla-
revenue of Rs. 400 crore. The buyout offer scored tion for the month of November was 7.48%, an 11
over a higher value offer of around Rs. 3400 crore month low indicating partial success of exchequer’s
from Indian FMCG firm Emami Ltd as the former policies.
came with a no conditions clause. As a part of the 2G Spectrum Scam exposed
deal Reckitt will acquire 63% and 30% Rs. 170,000 Cr. (Rs. 1.7 trillion) scam surround-
of stake from UK PE firm Actis Capi- ing 2G spectrum allocation to telecom companies in
tal and Patel family, the original pro- India is considered to be one the largest in recent
moter of Paras respectively. The deal times. The purported culprit in this fiddle is Mr. A.K
will add some of the fastest growing Raja, the telecomm minister in 2008 under whose
brands in the OTC market like Moov, leadership the 2G licenses were allotted to new en-

4 NIVESHAK VOLUME 3 ISSUE 12 DECember 2010

 www.iims-niveshak.com
The Niveshak Times
ISPAT-JSW DEAL IS A HISTORIC TRANSACTION AS THIS IS THE FIRST TIME THAT
TWO FAMILY-RUN STEEL COMPANIES HAVE COME TOGETHER: SAJJAN JINDAL
trants in telecomm industry on
a “First Come First Serve” basis
rather than through the process
of auction as required by the
national telecom policy 1999.
The ministry had also brought
forward the cut off time by 6 six days from Octo-
ber 1, 2007, to September 25, 2007 without seeking
consultation of and informing other related minis-
tries, even though when it is mandatory to get an
approval from the cabinet committee (economic
affairs) in such important decisions. Moreover the
shortening of the cut off time was communicated
only to the supposedly telecomm ministry favored
companies. These newbies who received their share
of 2G spectrums at 2001 price level instead of the
required 2008 one went on to make profit by selling
their stake to the experienced players at high prices.
Further discrepancies in allotment process were ex-
posed with 85 out of the 122 new receivers turning
out to be ineligible and some of them even did not
have any telecom infrastructure, network, subscrib-
ers, knowledge or proven track record in the telecom
business.
Realty Sector to feel the pinch of Home Loan
Scam
Another major scam was exposed in the banking
sector as officials of major banking institutions were
found guilty of doling out loans to real estate compa-
nies for bribes. Current lending rules and regulations
allow banks to issue loans to realty firms for housing
construction projects only and prevent them from
providing any funding for land acquisitions. With the
realty sector in wane outside the metros, a number
of reality firms are still experiencing a fund short-
age and are still greatly dependent upon banks for
funding. This will force some of these firms to sell
their existing projects to meet their liquidity require-
ments. Deepak Parekh, chairman of HDFC Ltd pre-
dicts that the situation is likely to result in a price
correction in reality sector as many firms will be
forced to slash their prices and sell excess inven-
tories. Parekh, however, maintains that the present
scam is not an indication of any systemic failure but
a grave case of corruption that will initiate a string of
loan strengthening measures by the lenders.
© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG
INTERNATIONAL BUSINESS
The Wikileaks Saga
Wikileaks founder Julian Assange
handed himself over to the British po-
lice on 7th December. He was arrested
under a European Arrest Warrant on the
allegations of rape, sexual molestation
and unlawful coercion. He received bail
on 17th December after paying £200,000
and under stringent conditions.
The Wikileaks website, a nonprofit
organization which published classified information
of governments and private organizations, is at the
center of a row over the release of secret U.S. diplo-
matic cables on the Afghanistan and Iraq wars. Fol-
The Month That Was
lowing this many companies like EveryDNS, Amazon.
com, Paypal, Mastercard etc. have severed ties with
Wikileaks. In retaliation for this, a group of support-
ers of Wikileaks called “Anonymous”, under the
name of “Operation Avenge Assange” have started
attacking the websites of these companies.
Yahoo to lay off more than 600 employees
Internet major Yahoo Inc. announced that
it would be reducing the size of its workforce by
4%. This translates to approximately 600 out of the
company’s 14000 employees. All the said employees
would be mostly in the company’s product group.
The layoff comes in the wake of increased competi-
tion to Yahoo from Google and Facebook.
Oracle Seeks Additional $211 million from
SAP
Oracle Corp is
seeking another $211
million from SAP in addition to the $1.3 billion it
won in settlement for copyright infringement from
SAP last month. Oracle wants the additional amount
as a “prejudgement interest”, which is used to com-
pensate for the loss of use of funds and inflation
effects. SAP has agreed to pay Oracle $120 million
in attorney’s fees, but was unwilling to pay the pre-
judgement interest. “We don’t believe that Oracle is
entitled to any additional compensation beyond the
final judgment in this case,” SAP said in a statement.
5
 www.iims-niveshak.com

Market Snapshot
AoM Perspective
Month That Was

MARKET CAP (IN RS. CR)

BSE Mkt. Cap 71,27,903.58 BSE
Index Full Mkt. Cap 30,29,930.25
TheFinGyaan

Index Open Close % change

Index Free Float Mkt. Cap 15,96,521.35 Sensex 19,521.25 20,060.32 2.76
MIDCAP 7612.49 7618.12 0.07
Smallcap 9744.71 9308.91 -4.47
CURRENCY RATES AUTO 10117.88 10168.38 0.50
INR / 1 USD 45.26 BANKEX          13660.74 13077.65 -4.27
INR / 1 Euro 59.61 Consumer Durables 6434.44 6093.92 -5.29
INR / 100 Jap. YEN 54.08 Capital Goods 15068.03 15320.99 1.68
FinSight

INR / 1 Pound Sterling 70.38 FMCG 3584.84 3546.31 -1.07

Healthcare 6594.78 6481.82 -1.71
IT 6069.36 6679.20 10.05
METAL 15631.81 17097.05 9.37
OIL&GAS 10068.69 10731.50 6.58
POWER 2891.16 2914.37 0.80
PSU 10199.39 9647.79 -5.41
REALTY 2918.39 2768.00 -5.15
TECk 3707.28 3922.62 5.81

6 NIVESHAK VOLUME 3 ISSUE 12 DECEMBER 2010

 www.iims-niveshak.com

Market Snapshot
RESERVE RATIOS
CRR 6%
SLR 24%

AoM
LENDING / DEPOSIT RATES POLICY RATES
Base rate 7.6% - 8% Bank Rate 6%
Savings Bank rate 3.50% Repo rate 6.25%
Deposit rate 7% - 8% Reverse Repo rate 5.25%

Perspective
Month The
FinGyaan
That Was
FinSight

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG 7

 Need for Consolidation
Vishnuram L & Rajesh Beriwal
IIFT, Delhi
Need for Consolidation of
In today’s era of
Banks
increased competi-
The developments over the last
tion, size is a ma- fifteen years have transformed the
jor determinant Indian banking industry from being
of competitiveness highly protected and regulated to
and survival pros- one that is highly competitive and
deregulated. Moreover, with the
pects of a bank. banks moving into newer areas, they
Inorganic growth are competing directly with other fi-
nancial institutions like insurers and
through M&As
advisory firms. In the face of such
have emerged as heightened competition it is impera-
the most preferred tive for banks to stay highly com-
tool to increase the petitive. In an era of such increased
size of balance sheet competition it becomes necessary
for banks to increase its Balance
and gain market Sheet Size and Market share to re-
share for banks to main in the race. Other factors which
remain competitive. induce consolidation are technology
It has also helped in and specialisation. Inorganic growth
through Mergers and other similar
achieving consolida- tools have emerged as the most pre-
tion in the banking ferred tool in achieving the consoli-
space dation. It is a matter of time before
global banks will be allowed doing
business in India and the sheer
size of these banks could queer the
pitch against the Indian Banks. As
per most surveys, no Indian Bank
features in the Top 50 Banks as per
market capitalisation. The organic
route, though ideal, may be time
consuming and arduous.
FinSight
Size is the major determinant
of competitiveness and survival
prospects of a bank. This explains
the lagging global position of small
sized Indian banks in terns of mo-
bilization of funds, credit disbursal,
investments and rendering of finan-
cial services. A comparison between
SBI with assets of $230 bil-
lion caters to a population size
which is three times than
that serviced by BOA which
has assets of more than $1.7
trillion
8 NIVESHAK VOLUME 3 ISSUE 12 DECEMBER 2010
the State bank of India and Bank of
America would put things in per-
spective. SBI caters to a population
size which is three times than that
serviced by Bank of America (BoA).
But looking at the assets of both the
banks, BoA has more than 1.7 trillion
dollar of assets as against SBI’s asset
size of $230 billion (@Rs 46/$). This
gives BoA a muscle to cut costs and
amplify earnings.
Advantages of Consolidation
1. Advantages of scale: In the
face of increased competition a big-
ger organisation is best suited to
function profitably in both size and
area of coverage. The increased
scale of operation would aid in cost
reduction and even survival during
lean periods.
2. Efficient performance of
Complementary services: Banks with
complementary expertise in diverse
fields can pool their expertise to
create a highly efficient behemoth.
Example: Some banks have a huge
presence in the traditional banking
sector, while others are experts at
Investment advisory. The combined
strength of the two entities would
unleash a synergy resulting in sub-
stantial profits.
3. Greater Geographical Spread:
A merger of banks with strongholds
in different parts of India would re-
sult in a pan-India banking giant.
This would also result in creating a
shield from geography related risks
which a bank operating only in a
particular region might face.
4. Elimination of duplicity: The
merging banks may have similar lines of business
and a significant coverage area overlap. A lot of
this duplication may be done away with to yield a
merged entity with optimum utilisation of resources,
e.g. many banks have ATMs and branches located in
the same area, post a merger, the, merged entity will
have the luxury of doing away with such ATMs and
branches.
5. Diversification: It is easier for a big organisa-
tion to diversify into related fields. Today banks all
over the world over provide, in addition to the tradi-
tional banking services, a host of financial services.
A larger organisation may be able to better provide
all financial services a customer would require.
6. Transparency: Merger of unlisted banks with
listed counterparts could bring its books of accounts,
process and other practises to public scrutiny; these
would lead to greater transparency and consequent-
ly better performance.
7. Tax Benefits: Especially in the case where a
profit making bank merges with a loss making one.
The advantages, howsoever sweet they might
seem, need to be taken with a few pinches of salt,
for consolidation has its own limitations, hurdles
and risks and mere consolidation would not auto-
matically translate into results. At best, it can be
viewed as an efficient mean to achieve an end .
Risks of Merger
The following are a few risks which might
emerge as a result of a merger:
1. Too big to handle and too big to Fail: A behe-
moth could be too difficult and unwieldy to handle,
an extraordinarily large bank might become the ti-
tanic of banking. The term “too big to fail’ was often
seen used in newspaper reports, during the financial
crisis of 2007, in the event of its failure, the govern-
ment, as recently witnessed in the US, would be left
with a devil’s alternative of not allowing it to fail
and using the tax payers money to protect what is a
private venture.
2. Coordination: A merger is in essence a mar-
riage, there could be compatibility issues, which are
not visible on the surface, and this is true of any
merger. Issues like employee dissatisfaction could
occur in cases of banks with diverse cultures.
3. Merging of structures and procedures: This
can be an issue, especially in case of an alliance
Expansion of banks is neces-
sary to meet the expected rise
in account demands as the
working force rises with the
booming economy
© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG
between a private sector and a public sector bank.
4. Operational Difficulties: Lack of efficient co-
ordination may result in operational difficulties.
5. The valuation question: The right price might
be elusive and banks could end up paying more or
less than the correct amount which might lead to
loss in investor wealth and confidence.
6. Emergence of a Monopoly: A merger might
give birth to a monopoly which is a nightmare to the
general public.
7. Marginalisation of small customers: A large
bank may, though justified by operating expedien-
cies, might not service very small accounts as it
might entail, cost much higher than the revenue po-
tential .
Consolidation in the Indian Banking Indus-
try
Despite the recent hike in number of branches
and amount of advances and deposits, the total ac-
count holding still stands at one fourth of total pop-
ulation indicative of the long service gap the bank-
ing industry still has to plug. The situation becomes
even graver if one were to exclude multiple accounts
held by single person as is often the case in urban
areas. However some optimism may be derived from
the fact that the growth rate of domestic banking
industry is 10 to 15 times that of European counter-
parts, now withstanding the preferred investment by
commercial banks in zero risk government securi-
ties.
Moreover expansion of banks is necessary to
meet the expected rise in account demands as the
working force rises with the booming economy. Glo-
balization entails increase in size of Indian banks to
enable their foray into international markets while
maintaining a strong foothold in domestic market.
In spite of having one of the highest average
returns on capital, Indian banks lag far behind the
FinSight
other Asian banks when it comes to asset size. The
small number of Indian banks in the top 1000 or top
500 banks in the world by asset size throws light
upon the need for an increased focus on scale.
Optimists pointing to substantial fall in net NPA
for banks over past few years turn a blind eye to its
driving factor of excess provisioning which may land
the banks in trouble in the event of rising interest
rates. The ensuing plunging bottom lines will con-
9
 strain them from further provisioning to bring down
the net NPAs and expose their vulnerability to the
rising interest rate situation. This justifies the need
for merger of some weaker banks with more com- CROSSWORD SOLUTIONS
petitive ones so as to avoid the situation where the
hard earned taxpayer’s money is not used to prop
up the banks in crisis . NOVEMBER 2010
Legal Aspects
1. Companies Act: Sections 390 – 407, deal with Across
the provisions related to mergers, which require
among other things, a provision in the memoran-
dum of association to this effect, agreement by 75% 4. Kaushik Basu
of shareholders and creditors, attending and voting
in meetings held for this purpose and sanction by 6. Pension
the High court of the scheme of arrangement.
2. Competition Act: Provisions have been made
to ensure that no business combination, through an
7. Credit Limit
amalgamation or merger results in an adverse im-
pact on competition. 9. Standard Deviation
3. SEBI Takeover code and Listing Require-
ments: Various provisions have been made to ensure 10. Nikkei
that a takeover is not detrimental to the interest of
the minority shareholders. The recent amendment,
has proposed that in cases where the acquiring
company makes a purchase of more than 25% of the
paid up capital, it is bound to make an offer for the
remaining 75% of the shares. Down
Banking Regulation Act requires the interested
banking companies to secure the approval of the 1. Corporate Governance
Reserve Bank of India for merger. The government
and the Reserve Bank which has hitherto played a
relatively passive role in merger process should now
2. Enam Securities
look to provide an enabling environment through an
appropriate fiscal, regulatory and supervisory frame- 3. Option Valuation
work for the consolidation and convergence of fi-
nancial institutions, while preventing the creation of
an oligopolistic structure in banking sector. Mergers 5. Efficient Set
should be based on the need to attain a meaningful
balance sheet size and market share in the face of 8. Goodwill
heightened competition and be driven by synergies,
FinSight

location and business-specific complementarities.

In spite of having one of the

highest average returns on cap-
ital, Indian banks lag far
behind the other Asian banks
when it comes to asset size

10 NIVESHAK VOLUME 3 ISSUE 12 DECEMBER 2010

 Microfinance
Public Private
Partnership
Introduction
More than subsidies, poor
need access to credit. Absence of
formal employment makes them
‘non- bankable’ and this forces them
to borrow money from local money-
lenders at exorbitant interest rates.
Many innovative institutional mech-
anisms have been developed across
the world to enhance credit to poor
even in the absence of formal mort-
gage.
In India, during the year 1992,
NABARD launched a programme,
Self Help Group- Bank Linking Pro-
gramme (SHG-BLP), linking Self Help
Groups (SHG) to banks. This pro-
gramme has expanded over the last
eighteen years to cover millions of
rural families.
Meanwhile, following the suc-
cess of Grameen Bank’s Model in
Bangladesh, the Micro Finance Insti-
tution (MFI) model has gained signif-
icant momentum in India in the re-
cent years and has grown as a viable
alternative to SHG model. In contrast
to a SHG, a MFI is a separate legal
organization that provides financial
services directly to borrowers. As of
March 2009, MFIs have reached 22
million borrowers (Source: CRISIL).
Though both SHG and MFI mod-
el have expanded over the years, but
their reach has been limited with a
penetration of less than 15% (Source:
Intellecap). Most of the growth has
been contributed by already heav-
ily penetrated southern states. The
three southern states of Andhra
Pradesh, Karnataka and Tamil Nadu
© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG
Mohammad Taufiq, Aditya Gupta & Dhiraj Motwani
MDI Gurgaon
contributed 54% of new MFI clients
in India during 2009 (Figure 1) The increasing com-
mercialization of
MFIs and their domi-
nation over the SHG-
BLP program has led
to lack of transpar-
ency in the whole
system. The initial
Fig.1: Penetration and Growth of MF
‘not-for-profit’ model
across states has now turned into
(Source: microfinancefocus.com) ‘for-profit’ model
Perspective
SHG Model: Merits and Demer- where the poor can
its
rarely avail loans at
With more than 47 lakh SHG
linked with banks, SHG-BLP has made lower interest rates.
spectacular expansion. Though in A new framework
absolute terms the number of SHGs has to be in place to
may seem overwhelming, but when
seen in terms of number of house-
tackle this issue.
holds touched, it is clear that SHG-
BLP has not achieved the desired
level of penetration. Further, a large
portion of the rise in SHG has been
witnessed in southern states with
very little growth in northern states
of the country (Figure 2).
In a paper published by Intell-
cap in October 2010, the following
critical flaw in the SHG linked credit
programmes was identified: “There
are no clear margins built into the
program to take care of the cost of
building, managing, and scaling the
program, except through grants,
subsidies and other provisions made
by government”
Though it is evident from the
figures that SHG-BLP cannot en-
Though both SHG and MFI
model have expanded over the
years, but their reach has been
limited with a penetration of
less than 15%
11
 Fig.2: Regional disparity in SHG-BLP (Source: NABARD)
sure full financial inclusion, but the merits of SHG
linked credits over MFI credit cannot be ignored. Be-
ing strongly membership-based, small and homog-
enous, SHGs are primarily controlled by members.
Perspective
Borrowers play a key role in the development of
SHGs. They contribute small savings, regularly attend
the meetings and participate in making the rules
related to loans, interest rates, repayment schedules
and mechanisms. These groups are thus character-
ized by self-management and self-reliance.
MFI Model: Merits and Demerits
Most MFIs started with a ‘not-for-profit’ model,
as did Nobel Prize winner Mohammed Yunus’ Gra-
meen Bank. But ‘not-for-profit’ model just like the
SHG Model has limited reach, being dependent on
donor finance or government subsidies. So, many
switched to a ‘for-profit model’, which enabled them
to raise money for expansion from private equity in-
vestors and banks. Such MFIs have expanded huge-
ly, reaching not just thousands but millions.
But this expansion resulted into many prob-
lems. MFIs have been accused of lack of transpar-
ency, both in its internal operations and charging
interest rates. In order to provide significant gains
to the investors, MFIs have been charging exorbitant
interest rates making loans very costly. Recently,
industry harbinger Vikram Akula’s SKS Microfinance
raised an IPO signifying extreme commercialization
of the sector and bringing about criticism from all
corners. Some MFIs have expanded at over 100% per
year, thus affecting quality. In some areas, multiple
MFIs have given multiple loans to the same borrow-
er, leading to excessive debts. MFI’s recovery agents
have also been accused of using force to recover
loans.
SHG and MFI at loggerheads
The exponential growth of the MFIs in India is
definitely affecting the SHG movement in the coun-
12 NIVESHAK VOLUME 3 ISSUE 12 DECEMBER 2010
try, in spite of the SHG federations coming up. The
following points describe the impact of MFIs in the
SHG movement:
• Most MFIs lend to women if they are mem-
bers of a SHG and split the SHG to form the Joint
Liability Groups.
• The high cost of MFI based loans as well as
pressure put by MFIs on women to repay their loans
is resulting in some of these women defaulting to
the SHGs.
• Women able to access a loan in less than
one month from an MFI do not wish to engage in the
long processes related to SHGs and SHG federations.
• Over the past few years, banks seem to be
more interested in lending to the MFIs rather than
SHGs.
At the same time attempts by various govern-
ment institutions, for instance, Andhra Pradesh Mi-
crofinance Ordinance, to completely shut down MFIs
have only resulted in lack of availability of credit to
millions of needy borrowers.
New Paradigm
Social activists, government officials, econo-
mists and various columnists have called for a need
for a regulator to overlook the operations of MFIs in
order to protect interests of the poor and also save
the microfinance industry. The Malegam Committee
set up by the RBI will come out with its recommen-
dations on regulating the sector next year. Presence
of a regulator will certainly ensure transparency in
the operations of MFIs. However, this is not the only
solution to the entire problem. In order to achieve
the objective of poverty alleviation and financial in-
clusion for the poor, both SHGs and MFIs need to
increase their reach. This critical hour requires both
public and private players to form a partnership for
harmonizing each others’ efforts and exploring syn-
ergies.
 In a Microfinance PPP (MF-PPP) Model, the gov- help in achieving this objective of capacity building.
ernment, through agencies like NABARD and other The model also proposes to have an indepen-
interest subsidies apart from commercial banks, dent MFI rating agency to facilitate capital forma-
would be funding MFIs which will then disburse the tion of MFI by banks. It will also ensure that MFIs
same to the borrowers through SHGs. SHGs would have healthy competition among them, thus ensur-
be formed under NABARD’S SHG-BLP and would be ing that they continuously improve their operational
linked to MFIs instead of banks. NGOs would be at- efficiencies.
tached to SHGs, though their association won’t be
Conclusion
a necessary criterion for formation of SHGs. NGOs,
with the help of their continuity, commitment, local The following ‘3 Cs’ are required for this Public
knowledge and training inputs can guide SHG mem- Private Partnership to be successful:
bers efficiently. 1. Clarity: The microfinance sector needs to
PPP model clearly articulate its
would ensure easy objectives.
accessibility to funds 2. C o m m i t -
for the borrowers, ment: The willing-
which all the SHGs are ness and desire of
not availing right now every stakeholder
because banks usual- to pursue efforts
ly prefer to fund MFIs. in delivering the
At the same time, this agreed purpose.

Perspective
model will ensure 3. Capability:
that the sector is not Educate and im-
commercialized and prove the skills of
MFIs are sufficiently all the stakehold-
funded so that they ers, most impor-
need not approach tantly of the bor-
private investors for rowers so that they
funds. understand what
In such a PPP they are doing and
model, the role of the what they are being
regulator would be of offered.
utmost importance. Both SHG
Fig. 3: MF-PPP Model
Regulator would en- Model and MFI
sure that there is transparency in interest rates as Model have the same mission of poverty alleviation.
well as the internal operations of MFIs. Regulator A public private partnership in the microfinance sec-
would also ensure that MFIs’ objective should not be tor would help in exploring the synergies of both the
exorbitant profit-making but making loans available models and would help in achieving the objective of
at cheap cost while making profits that are enough ensuring financial inclusion of the poor. A PPP model
for expansion and for being commercially viable. would ensure operational efficiencies enjoyed by the
Regulator’s job would also involve setting benchmark private MFIs due to large scale of their operations.
interest rates for the loans. Regional Loan Guarantee It will also help in bringing down costs of loans, as
agency under such a regulator would ensure that financing through SHGs reduces transaction costs,
MFIs receive funds from government agencies and leading to low defaults by the borrowers. Presence
that these are disbursed among SHGs. of the regulator will ensure that there is no mul-
Entrepreneurship promoting agency would tiplicity of loans and the sector is not excessively
also form a part of the model whose prime objective commercialized.
would be to promote formation of micro enterprises
by SHG members. NGOs linked to SHGs would also

MFIs have been accused of

lack of transparency, both in
its internal operations and
charging interest rates

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG 13

Cover Story
Upasana Agarwal & Rajat Sethia
Team Niveshak
Nov 3, 2010 Press Release by
The US Federal Re- Federal Reserve Bank: FOMC state-
serve unleashed its ment
effort to kick-start “To promote a stronger pace of
the US economy by economic recovery and to help en-
embarking on a sec- sure that inflation, over time, is at
levels consistent with its mandate,
ond round of mon- the Committee decided today to ex-
etary stimulus with pand its holdings of securities. The
USD 600 million in Committee will maintain its existing
policy of reinvesting principal pay-
what is termed as ments from its securities holdings.
quantitative easing In addition, the Committee intends
2 (QE2). The policy to purchase a further $600 billion
of longer-term Treasury securities
move is an attempt by the end of the second quarter of
to bring down the 2011, a pace of about $75 billion per
high unemployment month…
and come out of low The Committee will maintain
inflation. the target range for the federal funds
rate at 0 to 1/4 percent and con-
tinues to anticipate that economic
conditions, including low rates of
resource utilization, subdued infla-
It remains to be seen whether
the Quantitative Easing will
actually stimulate the US
economy or be a repeat of the
Japan Fiasco.
14 NIVESHAK VOLUME 3 ISSUE 12 DECEMBER 2010
tion trends, and stable inflation ex-
pectations, are likely to warrant ex-
ceptionally low levels for the federal
funds rate for an extended period.”
From 2007 Ben Bernanke has
faced probably the most difficult
times of his life. He was the best
candidate to serve as the Fed Chair-
man given his strong background in
academics and his speciality in busi-
ness cycles, nevertheless the critical-
ity of his decisions raised doubts of
his potential in foraying the world’s
largest economy out of the crisis.
The first round of such expan-
sionary policy was well warranted
according to the Kenysian principle
of the need of Government interven-
tion in the face of a crisis. The Fed
has been maintaining the near zero
rate since the past two years, and
has pledged to continue it till the
economy recovers.
The point of contention how-
ever is, “Is the expansionary policy really effective were paying 0.1% while Treasury bonds being long
given that the American economy is in something term were paying about 3%. The rationale behind

that of a liquidity trap?” Before going ahead on what
the plausible consequences of such a policy decision
may be, let us see what really Quantitative Easing
implies.
What is Quantitative Easing?
When a Central Bank purchases long term
securities such as Treasuries, mortgages and com-
mercial loans from banks and credit their account
with reserves by way of payments, it is called Quan-
titative Easing (QE). QE is a form of expansionary
monetary policy used by central banks to stimulate
the economy. Since the banks don’t earn much on
reserves, the central bank hopes that they will lend
out to businesses and households to make higher
returns, which in turn increases the liquidity as a
whole. The increased liquidity and inflation expec-
tation helps to spur spending that in turn fosters
economic growth. With interest rates in US close to
zero, the QE is perhaps the only simulative tool left
in the hands of the the Federal Reserve.
What is really happening out there?
Since the short term rates in US are almost
zero there is practically no difference between hold-
ing money or holding short term bonds. That is pre-
cisely the reason that Fed is instead buying back
long term debt instead of short term debt, as buying
back short term debt and replacing it with money
will make no difference in the present era of zero Liquidity Trap
interest rates.
In more precise terms, in month of November,
Treasury bills, that are more short term in nature, it impossible for monetary policymakers to expand
Fig. 1: A Liquidity Trap Condition shown by IS-LM curve
Cover Story
Feds move is that by purchasing these bonds the
available quantity in the market will decrease thus
leading to higher price ( i.e. law of supply and de-
mand in action) essentially leading to lower yields.
This reduction in long term yields may stimulate ag-
gregate demand.
Thus all that will be achieved through this pro-
gramme is to change the structure of maturity of US
government debt in the hands of private players.
Exit strategy
Expansionary monetary policy will invariably
lead to higher prices in the long run. Therefore, it
becomes imperative to have a clear exit strategy
so as to ensure that the economy doesn’t face the
worst case situation of being stuck in state of stag-
flation. The conventional wisdom suggests that the
exit strategy should involve contactionary open mar-
ket operations however that might lead to a slower
economic growth. The Fed is of the view by rais-
ing interest rates on reserves they might be able
to decrease monetary supply without impacting the
growth machinery as such but most of the com-
mentators hold reservations against this fact. For
example, if rates on Treasury bills rise to 2%, the Fed
could pay around 2% on reserves to induce institu-
tions to maintain the excess reserves of $1 trillion
held at the Fed.
A liquidity trap is a situation in which the
nominal interest rate is very close to zero, making
the economy through further reductions in interest
rate. Nominal interest rates cannot go below zero,
because no one will lend at a negative nominal in-
terest rate (it is always possible to hold cash, which
pays a zero nominal return, instead). Because mon-
etary policy stimulates the economy by lowering in-
terest rates, it becomes ineffective in a liquidity trap
conditions.
In Fig. 1, a liquidity trap has been shown using
the IS-LM curve. The Output at point O, the inter-
section of IS and LM is below potential, but inter-
est rates are zero preventing further stimulus from
monetary policy. The LM curve is flat at a zero in-
terest rate, which shows the fact that increases in

The bottom line is that, so far,

QE2 isn’t working

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG 15

 money supply are powerless to lower the interest tion.”
rate, once it has reached zero. He argues that in a liquidity trap, the extra bor-
The term Liquidity Trap was coined by Keynes rowing is unlikely to cause a rise in interest rates,
Cover Story

during the Great Depression and he argued that ex- but, would help stimulate economic growth and en-
pansive monetary policy could stimulate the econ- able improved finances over the long term. Despite
omy even in a liquidity trap condition via the direct the experience of Greece, Krugman makes the point,
effects of increased money stocks on aggregate de- that rising government borrowing has not caused a
mand.
Arguments For
America’s recovery from the recession, if there
has been any to speak of, hasn’t been flattering.
Savings have increased as consumers do not wish
to spend as they previously used to. Krugman states
that this has resulted in excess capacity. With con-
sumer spending being low businesses are not willing
to produce let alone invest more leading to histori-
cally high unemployment rate. The increase in jobs
is barely able to keep up with the rising population
let alone bring it down from the current unemploy-
ment rate of 9.6%.
On the other had deflation has become a ris-
ing concern. Consumer price index has risen by only
0.8% in this year to September and it might fall in
the coming few months. This is much below Fed’s
Target of 2% inflation that it seeks to maintain. Greg-
ory Mankiw, the noted economist says in his blog
Fig. 3: US Inflation and FOMC projections
rise in bond yields. But, bond yields have actually
fallen - showing that critics of stimulus have exag-
gerated the fear of rising bond yields”
An important consideration is the possible im-
pact that such a move will have on asset prices.
From the time of initial announcement in August,
trade weighted dollar has fallen by 4%. A weaker
dollar will also help stimulate the economy.
Arguments Against
Besides the potential risk of a higher inflation
in the near future due to such expansionary poli-
cy, the economists are worried about other aspects
also. More importantly it is the balance of the port-
folio. In future, if the circumstances are such that
the interest rate rises, Fed will make losses on its
Fig. 2: US unemployment rates (%) and FOMC projections
portfolio of longer duration bonds. It will have to pay
that QE2 is a modestly good idea of stimulating ag- a higher interest.
gregate demand by lowering interest rate as he is Some economist however doubt the efficacy
“more worried at the moment about Japanese-style of the method adopted. What this entire exercise
deflation and stagnation than about excessive infla- will eventually result in is excess liquidity within

QE2 risks accelerating the

demise of the dollar-based cur-
rency system

16 NIVESHAK VOLUME 3 ISSUE 12 DECEMBER 2010

the system. However, liquidity was never an issue. therefore selling the bonds causing the yields to
Banks are awash with money already. They are not rise. But all measures of inflation including the CPI

Cover Story
lending it because there aren’t any borrowers. Un- numbers of US point to the fact that the inflation is
less the consumers start spending more than saving actually coming down. The bond yields rising in re-
the problem with the credit cycle is sure to persist. sponse to QE2, hence is a little bit of mystery (given
The credit cycle is not being completed and hence the Irish concerns and weak US equity markets, the
increasing liquidity may not solve the problem in the bond yields should have fallen because of flight of
given circumstances. capital to safe havens such as US Treasuries) and
Japan’s Experiment with QE experts believe that the trend may reverse shortly.
But the bottom line is that the bond yields, so far,
The Bank of Japan embarked upon QE in the
have been rising and QE2 isn’t working.
early 2000s to fight domestic deflation and liquid-
ity trap. The Bank of Japan had maintained short- Exchange rate trouble
term interest rates close to zero in the early 2000s. The US Fed views the QE2 as a tool that would
With QE, it flooded commercial banks with excess help stimulate the US economy, but the emerging
liquidity to promote private lending, leaving them countries, especially China view the policy as an at-
with large stocks of excess reserves and therefore tempt to drive down the dollar. The lower exchange
little risk of a liquidity shortage. QE helped Japan in rate will help the US to expand its exports and de-
curbing the deflationary forces and the average GDP crease in imports. The decrease in imports will hurt
growth in the period 2001-06 was about 0.5% above countries like China and they may resort to their
the growth in the 1990s. However, the aim of robust own QE or other techniques that will prevent the
growth with which Japan had launched the QE was exchange rate from going down, thus intensifying
not achieved and most experts around the world re- the currency war. The noted economist and Noble
gard Japans experiment with QE as a failure. Hence, laureate Joseph Stiglitz pointed out that while the
the US government certainly intention of QE2 was to spur
doesn’t have a good prec- banks to finance more do-
edent on QEs success but mestic loans and refinance
Japans failure with QE might mortgages, the banks are
have been because of struc- instead investing the mon-
tural problems in the Japa- ey in the more profitable
nese economy and an ageing emerging markets and for-
population. Also, the efficacy eign currencies which will
of Japan’s QE policy was re- defeat the real purpose of
duced by its implementation QE2 and lead to currency
that began well over a de- wars. However, with unem-
cade after the markets col- ployment rising and con-
lapsed in the 1990s. This lag allowed deflationary sistently low inflation num-
pressures to sink much deeper into their economy bers, US Federal Reserve doesn’t seem to have any
than now exists in the US. The US economy is far alternative to revive the staggering US economy.
better suited to QE than Japan’s. Serious deflation-
ary forces have yet to take hold, while inflationary
expectations have been held well in check.
Impact on bond rates
One of the aims of the QE2 announced in No-
vember was to bring down yields on bonds. But the
bond yields have gone significantly higher ever since
the QE2 has been announced. One plausible argu-
ment could be that the investors are worried that
all this money printing will create inflation and are

“All this liquidity that they’re

creating is not going back to
grow the American economy
and is going to Asia and other
emerging market” -
Joseph Stiglitz

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG 17

 Should N BFCs be converted into Banks
Ankit Bansal
SJMSoM, IIT Bombay
The proposition of
NBFCs being pro-
vided with banking
licenses has been
doing the rounds
since the union
budget 2010. While
it might be a good
idea considering
that we have only
around 22 private
sector banks but the
Perspective
ability of NBFCs to
function efficiently
as independent pri-
vate sector banks is
a matter of concern.
18 NIVESHAK VOLUME 3 ISSUE 12 DECEMBER 2010
Why is there a need for new
banks?
It is generally accepted that
greater financial system depth, sta-
bility and soundness contribute to
economic growth. But beyond that,
for growth to be truly inclusive re-
quires broadening and deepening
the reach of banking that helps both
consumers and producers raise their
welfare and productivity and build
savings, make investments, avail
credit, and more important, insure
themselves against income shocks
and emergencies. Though the Indian
financial system has made impres-
sive strides in resource mobilization,
geographical and functional reach,
financial viability, profitability and
competitiveness, vast segments of
the population, especially the un-
derprivileged sections of the soci-
ety, have still no access to formal
banking services. A larger number
of banks would foster greater com-
petition, and thereby reduce costs,
and improve the quality of service.
More importantly, it would promote
financial inclusion, and ultimately
support inclusive economic growth,
which is a key focus of public policy.
What are NBFCs?
NBFCs are financial institutions
that provide banking services with-
out meeting the legal definition of
a bank, i.e. one that does not hold
a banking license. Operations are,
regardless of this, still exercised un-
der bank regulation. NBFCs provide
financial services that are partly fee
based like portfolio management, is-
sue management, loan syndication,
NBFCs have experience, reach,
resources and expertise due to
which it should enjoy preference
over new private entrants in al-
location of banking licences
merger and acquisition, credit rat-
ing etc. and partly fund based like
venture capital financing, housing fi-
nance, equipment leasing, hire pur-
chase financing factoring etc.
NBFCs are doing functions simi-
lar to that of banks; however there
are a few differences like they can-
not accept demand deposits, can-
not issue cheques drawn on itself,
deposit insurance facility and Credit
Guarantee Corporation is not avail-
able to them and they are not sub-
ject to certain regulatory prescrip-
tions applicable to banks like CRR.
NBFCs can be classified into
two broad categories, viz., NBFCs ac-
cepting public deposit (NBFCs-D) &
NBFCs not accepting/holding public
deposit (NBFCs-ND).
Why NBFCs should be convert-
ed into Banks
• NBFC model particularly
those in lending activities has been
successful in expanding the reach of
financial system and thus by con-
verting to banks, this model could
be scaled up to better leverage the
benefits and achieve the objective of
financial inclusion. As at the end of
financial year 2009-10, the total as-
sets of NBFCs were at Rs.1, 09,324

crore and Public deposits were at Rs.17, 247 crore.
• Some of the sectoral credit issues, such as
infrastructure and microfinance, could be better ad-
dressed if NBFCs specializing in the specified sectors
can better leverage their competence by converting
to banks and having access to low-cost funds.
• Most of the NBFCs are regulated by RBI, NHB
or SEBI and have traceable track record in terms of
management and financial performance, risk man-
agement and statutory guidelines. Thus, addition-
al requirements of statutory ratios, priority sector
lending etc. can be met with ease as compared to
a private player who doesn’t have exposure to the
financial sector.
• The expertise of the NBFC in the financial
sector could flow into the bank if NBFCs are allowed
to promote banks. The NBFCs could retain their
niche space and yet contribute to the financial sec-
tor through the bank they would set up. Below graph
shows that NBFCs have been producing better re-
turns on assets as compared to banks.
• Currently NBFCs lose out on the front of effi-
cient fund raising which can only be done by entities
that have institutional backing like Banks. Once they
are converted into banks it will help in making them
all the more competitive.
Issues in conversion of an NBFC into a Bank
• Banking Regulation Act expressly bars any
business other than that permitted by the Act [Sec
6 (1)]. But for domestic NBFCs, there is no bar on
non-financial business, except that on crossing of a
© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG
certain barrier (50% of income or assets), conversion
of NBFCs into bank would require withdrawal from
many segments of such businesses, folding up of
large number of branches as well as disinvestment
from subsidiaries/affiliates not engaged in business-
es permitted to banks.
• The initial capital requirement for NBFCs is
a miniscule Rs. 2 crore but if it wants to turn into a
bank it has to maintain at least Rs 300 crores. Even
if it raises this capital, it may not have the finan-
cial strength or parentage to support bank’s capi-
tal needs particularly in periods of stress. The main
source of funding for Banks is low cost Retail de-
posits (at around 55%) but for NBFCs it is wholesale
funds which get reprised at a much faster rate. Thus,
in situations of tight liquidity NBFCs are likely to face
greater crunch in funds as compared to banks.
• RBI places restrictions on commercial banks
in their lending operations. Out of Rs 100 taken in
as deposits, approximately Rs 58 has to be set apart
Perspective
as statutory requirements towards CRR and SLR and
priority sector lending. Whereas for an NBFC there is
only 15% requirement for SLR and no requirement
of CRR and priority sector lending which leaves it
with Rs 85 as compared to Rs 42 for a bank. Many
NBFCs would definitely find these regulations very
restrictive.
• Due to the maturity differences of the assets
and liabilities of the NBFCs and banks, there may be
possibilities of the bank funds being utilized to meet
the NBFC liabilities and also of indulgence in regula-
tory arbitrage.
• The NBFCs generally operates on the model
of lending to riskier projects with interest rates high-
er than offered by the banking institutions. The con-
centrated loan-books which now allow some NBFCs
to focus on lucrative niches and earn exceptional
spreads may no longer be possible. The maturity mix
of the asset portfolio is also skewed towards long
term and the asset mix may not be compatible to
the banking liabilities. If NBFCs are converted into
banks they may take a long time to align themselves
19
 Cost of Funds - Banks vs NBFCs
to banking. competition for low-cost deposits. In 2008-09, NBFCs
• Promoter holding maintains capital stability accounted for 9 per cent of the total financial system
which is important especially in initial years of op- assets, while commercial banks held a dominant 70
eration for a financial services company. However, per cent of the assets. Therefore NBFCs are currently
for a bank this could risk concentration of business not of a scale to threaten existing banks.
decisions in the hands of a few, tilting them towards Conclusion
Perspective

sponsor interests rather than financial inclusion. As NBFCs play an important role in broadening of
per current discussion the cap on promoter holding financial services to unbanked segment, enhancing
is going to be 5-20%.This means that there could be competition and bringing diversification in the fi-
significant dilution of promoter holding. nancial sector. With their experienced management,
NBFC % knowledge of buyer behaviour, risk and NPA man-
Chola Invest. 75.0 agement and adherence to regulatory requirements
FCH 70.1
and traceable track record, as banks they could be
helpful in better leveraging the benefits and achiev-
MMFSL 61.0
ing the objective of financial inclusion. But there are
REL 57.1 some hindrances in their way like stringent regula-
Rcap 54.0 tory requirements of maintaining CRR, SLR etc., shut-
BAFL 50.5 ting down of their non-financial businesses, jump
Aditya Bir. Nuv. 46.1 in initial capital requirement to a minimum of Rs
STFC 41.4 300 crores, Asset-Liability mismatch will need to be
Sundaram Fin. 41.4 balanced and Lending will be required to be more
broad based. Additionally restrictions like priority
Manap. Gen. 40.7
sector lending along with competition from existing
Indiabulls 32.4
banks for low cost deposits would severely dampen
SREI Infra. 30.0 the enthusiasm of NBFCs eyeing banking licences.
Source: Company,LKP Research
In nutshell, NBFCs have experience, reach, re-
Promoter Shareholding (June 2010) sources and expertise due to which it should enjoy
• Access to low-cost deposits would depend preference over new private entrants in allocation
on the branch network and currently branch licenc- of banking licences but the path from an NBFC to a
es are scarce in metro and urban areas and expan- full-fledged bank is not going to be smooth.
sion very expensive. Banks, with their first mover
advantage, have already charted out huge branch
expansion programmes which would increase the

The initial capital requirement

for NBFCs is a miniscule Rs.
2 crore but if it wants to turn
into a bank it has to maintain
at least Rs 300 crores

20 NIVESHAK VOLUME 3 ISSUE 12 DECEMBER 2010

Gl bal
In the last decade, Asian econ-
omies have relied heavily on exports
to the US and Europe to deliver high
growth. The US has served a dual
role, one as the largest market for
goods manufactured in Asia, and
second, as home to the world’s re-
serve currency. After the Currency
crisis of 1997-98, the tiger econo-
mies of Asia began accumulating
large current account surpluses.
These current account surpluses not
only protected their currencies from
speculative attacks, but also enabled
the governments to manage the cur-
rency to maintain the
competitiveness of
their exports.
A substantial propor-
tion of the foreign cur-
rency reserves were
invested into dollar de-
nominated assets (such
as US treasury bills) and
also through sovereign
wealth funds into
corporate as-
sets. This led to large capital inflows
to the US, which along with the Feds
liberal policies, succeeded in keep-
ing interest rates low across the
world. The capital inflow from Asia
into the US maintained the dollars’
worth and suppressed the Asian cur-
rencies, ensuring their competitive-
ness while simultaneously expand-
ing the US’s current account deficit.
Put simply, the American con-
sumers received cheap credit which
was financed by Asian countries, so
While the G20 leaders expressed a commitment towards reducing the imbalances, their open refusal
to toe the US line highlighted the indebted Washington government’s waning international influence.
© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG
Urvi Ved
IIM Indore
that they continue consuming more
and more of their products. The US, The article illustrates
with a population of around 300 the reasons for the
million people, less than 5% of the existence of imbal-
world’s population, was consuming
ances within global
AoM
more than 20% of the world’s out-
put. This arrangement satisfied the economies and also
Americans, who reveled in voracious attempts to answer
consumption, as well as Asian Gov-
ernments who were able to grow and
the very critical ques-
provide jobs to the teeming masses. tion on which the
The post financial crisis sce- future of the world
nario is very different from the one economy rests -
described above. The US economy
Balancing the imbal-
and the Euro zone went into depres-
sion, and consump- ance and sustaining
tion has dropped it
sharply compared
to pre-2008 levels.
More and more
households are saving part
of their income, as sen-
timent remains negative
and unemployment, high.
The Euro crisis has dented con-
fidence to such an extent
that aggregate
demand is expected to remain low
in the future. Given such a situation,
it is no longer practical for the Asian
economies, led by China, to pursue
the strategy of export-based growth.
The financial crisis has pro-
vided an opportunity for the global
economy to correct the imbalances
it has sustained this far. The US ex-
ternal imbalance in particular (from
$706 billion in 2008 to $420 billion
in 2009) has narrowed dramatically.
As the world economy moves into
21
 recovery, a question arises. Will we return to the im-
balances of the mid 2000’s or will a more sustainable
path emerge? What must governments do to guide
their economies towards this path?
The answer to this undoubtedly lies in increas-
ing domestic consumption. At a recent conference
held in Seoul, IMF Managing Di-
rector Dominique Strauss-Kahn
stressed the need to nurture
Asia’s domestic demand. He chal-
lenged the Asian people to loos-
en their purse strings and pick
up the slack created by softening
G7 demand, also reiterating the
AoM
0.8%, though no massive appreciation is expected
in the short term. During the recent G20 meet, G20
leaders refused to support the US campaign to get
China to let its currency rise today, by printing mon-
ey to weaken the dollar in a bid to give US exports
an advantage on the world market. While the G20
leaders expressed a commitment
towards reducing the imbalanc-
es, their open refusal to toe the
US line highlighted the indebted
Washington government’s waning
international influence.
Even if all these policies are
implemented to the fullest (which

government’s role in pursuing in itself is highly unlikely), the

policies that drive domestic con- consumption of Asian tigers is not
sumption. going to be able to replace that
A high savings rate among Asians is often of the US, overnight. China’s consumption today is
credited for low domestic demand. The reason for only 12% of the US’s consumption. With reforms, it
this is the lack of social safety nets enjoyed by their may go up to 40%, but it is unlikely to become large
western counterparts. By building social safety nets enough to serve the role of global locomotive. We
such as unemployment insurance, social security, have lived in a unipolar world for close to two de-
and retirement pensions, the need for Asians to salt cades now, but the financial crisis has set the stage
money away can reduce. Increased spending on ed- for profound changes to take place in the way the
ucation and healthcare will also reduce the need for world economy functions. China will have its say on
precautionary savings such as a college fund. the world stage with the rest of the emerging giants,
with global power balances tilting towards China and
High levels of corporate savings too have con-
India. Systemic reforms will however set us on the
tributed to the savings glut, as corporations underin-
right track. The road will be bumpy, but it will even-
vested to boost short term profits and returns. These
tually lead us to a balanced and sustainable global
savings need to be channeled back to households
economic system.
in the form of dividends. A possible solution can in-
clude a tax on retained earnings that have not been
reinvested for a period. In addition, financial sector
reforms need to be undertaken so that banks are
more willing to lend to individuals and households,
reducing the reliance on self-generated funds. Once
the efficiency and diversity of financial instruments
available to people is increased, less savings will
be required to earn meet the financial goals of the
Asian investor.
Perhaps the most important policy will in-
volve allowing currencies to move freely and open-
ing up the capital account. An appreciating currency
will raise incomes and wealth and lower the desire
to save. The first step in this direction was taken
when China, under pressure from the US, removed
the 23 month old Yuan peg to the dollar. In the
six weeks since then, the Yuan has appreciated by

The financial crisis has pro-

vided an opportunity for the
global economy to correct the
imbalances it has sustained
this far

22 NIVESHAK VOLUME 3 ISSUE 12 DECEMBER 2010

 CLASSROOM
FinFunda P.E. Firms
of the
Month
The Kings of Capitalism

DEEP MEHTA
Team Niveshak

The recent $5.3 billion acquisition of Del Monte
Foods by private equity firm KKR (Kohlberg Kravis
Roberts) and news of KKR, Carlyle, TPG, Bain in race
to buyout Honda’s stake in Hero group has suddenly
brought PE firms in the news. But who are they?
What do they do? How? Team Niveshak explains it to
you in its own style. Listen to our professor who will
clear all your doubts…
Some call them mischief makers,
some call them “the Kings of Capitalism”,
but Private equity, as the name suggests,
do their business privately. This is be-
cause it gives them more flexibility and
Size of PE is huge as compared to VC, or an angel
investor. Also, angel investors are usually wealthy
individuals; VCs are entities which pool money from
institutional and individual investors; PE firms use
the technique of leveraged buyouts (LBOs) for mak-
ing big acquisitions.
That’s it?! Only size matters? What
do they invest in?
VCs are concentrated in technology,
clean tech and bio tech, while PE firms buy
companies across all industries. While an-

Classroom
gel investors focus on early stage of busi-

FinGyaan
less of regulator interference.
ness, VCs on high growth companies, PE firms like
KKR, Carlyle, Bain Capital, Blackstone group help in
What do they do privately? Are they streamlining operations, strategy and look to exit by
barbarians? Do they have sinister mo- floating the companies through IPOs and as a result
tives? earning handsome returns!

NO, no! Not at all. They invest in What about risk professor?
unlisted companies and make money by Shouldn’t they diversify?
exiting, selling their investments. Unlist-
ed because it does not require making
That would never work for a PE firm.
many disclosures, no need to publish its
They concentrate on small number of in-
quarterly results. Another plus is that the unlisted
vestments with huge size. Yes, in case
firm is not subjected to market fluctuations and so
of VC’s that should be the way ahead as
value of business entirely depends on its long term
he expects only few of his ventures to
goals. They also bring technical expertise, capital
succeed.
and management to turn around businesses!

One final question. How do they

Now this is confusing me, what
decide where to invest?
then is difference between PE firms, VC
and angel investing??
They do spend a lot of time on their
excel sheets! Due diligence, looking at fi-
I should tell you that you have
nancial statements. I would say, as you
caught me this time. Haha..let me ex-
move from VC to PE, nature of work shifts
plain. Actually speaking, VC is subset
from relationship driven to quants!
of PE. Angel investing is subset of VC.

© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG 23

 CROSSWORD
Down
1. Who Said “Emerging-market
stock valuations are a “long
way” from bubble levels and
the shares will outperform de-
veloped markets amid faster
economic growth”?

2. Who told this “Before you

can really start setting financial
goals, you need to determine
where you stand financially”?

5. He holds a Bachelor’s de-

gree in Commerce from Punjab
University and is an associ-
ate member of the Institute of
Chartered Accountants of India.
He has been the Managing Di-
rector of the HDFC Bank since
September 1994.Identify the
person.

7. Which law said that for each

percentage increase in cyclical
FinLounge

unemployment, output will fall

by 2 %?

(Note: All the clues given refer to Financial terms and not personalities 8. A large scale withdrawals of
unless explicitly mentioned) deposit from a bank, caused by
the depositor’s fear that bank
may go bankrupt is called

Across
3. In a business cycle, the time when economic activity stops falling and begin rising is called as

4. A Situation in which nominal interest rate is very close to Zero, making it impossible for moneymaker to
expand the economy through further reduction of interest rate.

6. What is the difference of net assets and liabilities called in Economics?

9. First Document released by an underwriter of a new issue to a prospective investor is called

10. Common stock trading unit of 100 shares or multiples of 100 shares is called

All entries should be mailed at niveshak.iims@gmail.com by 10th January, 2011 23:59 hrs
One lucky winner will receive cash prize of Rs. 500/-

24 NIVESHAK VOLUME 3 ISSUE 12 DECEMBER 2010

ANNOUNCEMENTS
ARTICLE OF THE MONTH
The Article of the Month winner for December 2010 is
Urvi Ved
of IIM Indore
She receives a cash prize of Rs.1000/-

Crossword Winner
The Crossword Winner for the month November 2010 is
Sachin Gayakwad
of JBIMS, Mumbai
He receives a cash prize of Rs.500/-
CONGRATULATIONS!!

ALL ARE INVITED

Team Niveshak invite articles from B-Schools all across India. We are looking
for original articles related to finance & economics. Students can also contrib-
ute puzzles and jokes related to finance & economics. References should be
cited wherever necessary. The best article will be featured as the “Article of the
Month” and would be awarded cash prize of Rs.1000/-

Instructions
»» Please email your article with the file name and the subject as <Title of the
Article>_<Institute Name>_<Author’s name/Group’s name> by 12 January 2011.
»» 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 a wordcount between 1200 - 1500
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 e-mail id/ blog if you want the readers to contact you for further
discussion
»» Also 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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