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Global Crisis, Financial Institutions and Reforms: An Indian Perspective

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Analytical Issues in Trade, Development and Finance

Part of the book series: India Studies in Business and Economics ((ISBE))

Abstract

The relationship between finance and economic growth has witnessed a lively controversy and sharp divisions among schools of economic thought. However, even within the broad consensus recognizing the role of financial systems for economic development, important areas of disagreement persist, viz. the type of financial system most conducive to growth, private versus public ownership of financial institutions, the degree of regulation and supervision, the role of financial innovations and the pace and extent of financial liberalization. The Latin American crises of the 1980s and 1990s, the Asian financial crisis and the current global recession have once again brought the critical role of financial institutions under the scanner and introduced some important caveats to the consensus. The present chapter aims to take stock of some of these issues in the Indian context. While it is certainly not being claimed that the Indian experience is representative of the entire South Asian region, it is nevertheless felt that some of the lessons drawn here would have some relevance transcending their immediate context.

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Notes

  1. 1.

    Several well-known tracts on development economics frequently make no reference to the financial system at all (see Meier and Seers 1984; Stern 1989; etc.).

  2. 2.

    My forthcoming paper with Shahidul Islam of the Institute of South Asian Studies (ISAS) provides a comprehensive description of the financial system in the South Asian region.

  3. 3.

    The policy was loose also in a more formal way—policy rates were consistently less than those predicted by various Taylor-type rules.

  4. 4.

    For example, securitization of non-conforming mortgages (i.e. Alt-A and sub-prime) increased from 35 % in 2000 to 70 % in 2007.

  5. 5.

    Shadow banking institutions are typically intermediaries between investors and borrowers. For example, an institutional investorlike a pension fund may be willing to lend money, while a corporation may be searching for funds to borrow. The shadow banking institution will channel funds from the investor(s) to the corporation, profiting either from fees or from the difference in interest rates between what it pays the investor(s) and what it receives from the borrower. By definition, shadow institutions do not accept deposits like a depository bank and, therefore, are not subject to the same regulations. Familiar examples of shadow institutions included Bear Stearns and Lehman Brothers. Other complex legal entities comprising the system include hedge funds, Special Investment Vehicles (SIVs), conduits, money funds, monolines, investment banks and other NBFIs.

  6. 6.

    Long before the current crisis, Warren Buffet once famously remarked, ‘I’d be a bum in the street with a tin cup if the markets were efficient.’

  7. 7.

    This is not to deny that in the immediate wake of the crisis, individual country policies tended to be insular, with countries acting in an uncoordinated manner to expand lender of last resort facilities, increase protection of creditors and depositors and recapitalize banks with public funds. This lack of coordination had some destabilizing effects, at least in the short term. Two cases, in particular, stand out, viz. the Lehman bankruptcy and the collapse of the Icelandic banking system. When Lehman fell, countries moved immediately to ring-fence assets in their own jurisdictions. The case of Iceland was similar. Although Icelandic banks had a large number of non-resident depositors, the authorities failed to coordinate with the countries in question. Some of these countries ended up seizing Icelandic bank assets to protect their own depositors.

  8. 8.

    Today, the central banks in the UK, the euro area, Switzerland and Japan all have access to unlimited swap lines across different maturities.

  9. 9.

    See the speech ‘Crisis Management and Policy Coordination: Do We Need a New Global Framework?’ by Dominique Strauss-Kahn made at Oesterreichische Nationalbank, Vienna, on May 15, 2009.

  10. 10.

    Under the PCA, the RBI will initiate certain structured as well as discretionary actions in respect of banks, which have hit certain trigger points in terms of capital adequacy ratio (CAR), net NPAs and return on assets (ROA). Thus, if a bank’s CAR falls to less than 9 %, but is equal to or more than 6 %, then the RBI will initiate the following structured actions: (1) submission and implementation of capital restoration plan by the bank, (2) bank will restrict expansion of its risk-weighted assets, (3) bank will not enter into new lines of business, (4) bank will not access/ renew costly deposits and Certificates of Deposits (CDs) and (5) bank will reduce/skip dividend payments. In addition, it could also initiate any of the following discretionary actions: (1) RBI will order recapitalisation, (2) bank will not increase its stake in subsidiaries and (3) bank will reduce its exposure to sensitive sectors like capital market, real estate or investment in non-SLR securities.

  11. 11.

    In India, there is no mandatory requirement for subordinate debt, but there is a ceiling (< 50 % of Tier I capital). Such a debt is part of Tier II capital

  12. 12.

    A proposed tripling of basic votes (number of votes every country has qua member) would increase developing country votes from 32.3 to 34.4 % (the corresponding World Bank figure is 42.6 % proposed to be raised to 43.8 %). Birdsall (2009) makes a particularly relevant suggestion in this context, viz. double majority voting on selected issues—a majority of weighted votes (as currently) plus a majority of countries. The system prevails at the Inter-American Development Bank, ADB, and African Development Bank for election of a new president/head.

  13. 13.

    The G20 Insurance Solution has several points of similarity with the Chiang Mai Initiative of the ASEAN + 3.

  14. 14.

    My own reservations about this approach have predated the crisis (see Nachane 2007).

  15. 15.

    The current total fiscal deficit—both central and state and including several contingent liabilities—at 12 % of GDP may perhaps be regarded as exceptional and likely to be moderated as the fiscal stimulus is wound down.

  16. 16.

    Countries using some form of IT currently include Australia, Brazil, Canada, Chile, Colombia, Finland, Mexico, New Zealand, Poland, Sweden, UK, etc.

  17. 17.

    For a fuller discussion of this viewpoint, kindly refer Nachane (2008).

  18. 18.

    Rajan’s strong advocacy of CAC contrasts strangely with the pragmatic (and far more nuanced) approach to capital account liberalization that he espouses (along with Prasad ES) in the Journal of Economic Perspectives (Summer 2008).

  19. 19.

    Academic thinking, in the highest circles, is also veering strongly towards the need for capital controls to cite but two opinions from a long list. First, Paul Krugman (The New York Times 12 September 2009) has this to say on capital controls ‘Back in 1998, in the midst of the Asian financial crisis, I came out in favor of temporary capital controls…At the time it was regarded as a horribly unorthodox and irresponsible suggestion…Today, that wild and crazy idea is so orthodox it’s part of standard IMF policy.’ Second, in a recent lecture De Long talks about ‘the intellectual bankruptcy of the Chicago School’ (6th Singapore Economic Review Public Lecture, 7 January 2009).

  20. 20.

    The CFSR’s preferred regulatory architecture (Proposals 23–28) is one where all depository institutions come under the supervisory purview of the RBI, with a separate agency for supervising large systematically important financial conglomerates.

  21. 21.

    See De Krivoy (2000) for the Venezuelan experience of the mid-1990s, Lindgren et al. (1999) for the East Asian experience, Hartcher (1998) for Japan, etc.

  22. 22.

    The policy measures so far adopted in India may be summed up in a single phrase—easy money and fiscal stimuli. On the monetary policy front, there has been a flurry of activity—the repo rate was reduced in a succession of steps from the level of 9 % in September 2008 to 5 % in March 2009 (with a corresponding reduction in the reverse repo rate from 6 to 3.5 %), the cash reserve ratio (CRR) was also reduced from 9 to 5 % over the same period, whereas the statutory liquidity ratio (SLR) was brought down by 1–24 %. Altogether, it has been estimated that these measures have released more than ` 4,000,000,000,000 (US$ 80 billion approximately) of liquidity into the system. There have also been three successive fiscal stimuli packages amounting to a total cost of ` 801,000,000,000 (US$ 16.3 billion) to the Exchequer. Fiscal stimulus I (7 December 2008) mainly comprised an across-the-board cut of 4 % in excise duty (estimated cost of ` 310,000,000,000). Fiscal stimulus II (2 January 2009) comprised ` 200,000,000,000 towards bank capitalization over the next 2 years, as well as providing greater market borrowing access to state governments as well as the IIFCL (India Infrastructure Financing Co. Ltd.) (estimated cost of ` 700,000,000,000). The final stimulus III (24 February 2009) provides a 2 % reduction in both the excise duty and the service tax and an extension of the previous excise duty cuts beyond 31 March 2009 (estimated cost of ` 291,000,000,000). The total burden on the Exchequer at ` 810,000,000,000 amounts to nearly 1.82 % of the 2008–2009 GDP (at current prices) or 2.57 % (at constant prices).

  23. 23.

    No systematic estimates of these lags are available in the Indian case. Some work in progress currently by the author estimates the lags in monetary policy at around 8 months and for fiscal policy around 12 months. However, these estimates have yet to be firmed up.

  24. 24.

    Under SMECARE, MSME borrowers (with fund-based limits of up to ` 100,000,000) can avail additional working capital of up to 20 % of their existing fund-based limits, whereas under SMEHELP a 5-year tenured loan is extendable for MSMEs with a liberal margin of 15 % for financing capital expenditure. Both schemes offer loans at a concessional rate of 8 % during the 1st year. These concessional schemes are mainly in the areas of pharmaceuticals, food processing and light engineering goods.

  25. 25.

    Such fair value accounting could be on the lines of the SFAS No.133 issued by the US Financial Accounting Standards Board in 1998.

  26. 26.

    The concept of middle class used here corresponds to that employed in Sengupta et al. (2008).

  27. 27.

    In direct contrast to this view, we have a substantially influential group of Indian economists who see in the crisis an opportunity for introducing capital account convertibility. Thus, Lahiri in his P. T. Memorial Lecture (16 January 2009) says, ‘The current crisis may provide an opportunity for introducing capital account convertibility. The dominant worry about introducing convertibility has been an upsurge of capital flows with large upward pressure on the exchange rate of the rupee followed by a sudden sucking out of such a capital, precipitating a crisis. Risk aversion on the part of international investors is an all-time high now, and the risk of large inflows is limited.’ Not all of us may be persuaded by this somewhat convoluted logic, though it seems to have provided considerable grist to the mill for several professional bloggers.

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  1. Indira Gandhi Institute of Development Research (IGIDR), Gen. A.K. Vaidya Marg, Goregaon East, 400065, Mumbai, India

    Dilip M. Nachane

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  1. Department of Economics, Jadavpur University, Kolkata, West Bengal, India

    Ambar Nath Ghosh

  2. Department of Economics, Jadavpur University, Kolkata, India

    Asim K. Karmakar

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Nachane, D. . (2014). Global Crisis, Financial Institutions and Reforms: An Indian Perspective. In: Ghosh, A., Karmakar, A. (eds) Analytical Issues in Trade, Development and Finance. India Studies in Business and Economics. Springer, New Delhi. https://doi.org/10.1007/978-81-322-1650-6_7

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