Sucheta Dalal :Underrated (MONEY LIFE Issue 20 Nov 08)
Sucheta Dalal

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Underrated (MONEY LIFE, Issue 20 Nov 08)  

November 4, 2008

Exclusive news, the stories behind the headlines and the truth between the lines Edited by - Sucheta Dalal



That there are only two defaults on CRISIL’s long-term credit ratings (both manufacturing entities) in the first six months of 2008-09 probably paints too optimistic a picture. The finance minister admitted that forex derivative losses were a massive Rs27,300 crore but pose no systemic risk. But is this the full extent of losses or are companies still hiding their loans to promoters’ private entities which went into speculation and losses? A very high-profile business group has reportedly run up losses running into hundreds of million dollars in international forex derivatives trading based on such borrowing. Two European banks are chasing it for additional collateral, which the group is unable to cough up. Meanwhile, realty and finance companies remain in deep trouble and seem set to face payment difficulties when their borrowings stop being rolled over by the lenders and come up for repayment starting a few weeks from now. So far, there is no indication about how the government will deal with defaults, especially if they threaten to snowball into a systemic issue. Meanwhile, many finance companies are raising money through fixed deposits for working capital needs.


ICICI's Dilemma


ICICI Bank’s recent dilemma should provide food for thought to every bank or institution that adopts an aggressive growth strategy. Clearly, the Bank had done a lot that is right to power its way to become the second largest bank in the country. It has also spawned several institutions, which have gained critical mass in areas such as insurance, stock broking and venture finance. Yet, the battering that its stock price suffered and the recent run on deposits exposes a serious vulnerability that needs to be addressed urgently. Why is ICICI Bank more susceptible to vicious rumours than others? The Bank is paying a price for ignoring consumer perception while chasing an extremely aggressive retail growth and market share strategy. In the rush to meet business targets, its telemarketing irritated people. Its Direct Selling Agents promised more than they could deliver creating disgruntled customers. It took a long time to build a complaint redressal mechanism in line with its growth. The media coverage of its recovery tactics probably did the worst damage. All this led to the perception of a bank that is over-aggressive and willing to cut corners so long as it generates fresh business. That made it an easy target for those who wanted to beat down its stock price through innuendos. Unfortunately the mischief threatened to bring down the Bank itself by causing a run on its deposits. The tragedy is that smug market pundits and talking heads on television cannot see the difference. They point out that the Bank didn’t complain when bullish speculators were driving up its stock price. Can’t they see a difference between a depressed share price and innocent depositors losing their savings if the Bank fails? We are fortunate that the RBI acted quickly to control the damage. Left to the media and stock experts, a good bank would have sunk because television shapes perceptions!


Too Futuristic


The rush for currency bourses is taking a ridiculous turn. Three bourses were launched in a month and three more are in the pipeline – the National Multi Commodity Exchange (controlled by Anil Ambani), the Bangalore Stock Exchange and a consortium of banks, led by Federal Bank.


P Ravikumar, former CEO of the National Commodity Derivatives Exchange, now a director at Federal Bank, is putting together a consortium including Canara Bank, Bank of India, Bank of Baroda, Andhra Bank, Indian Bank and the Oriental Bank of Commerce and a tie-up with the Chicago Mercantile Exchange (CME). However, CME sources say that it is talking to every one of the existing and proposed bourses and has yet to make up its mind. Will the consortium work without CME? Doubtful. But will the regulator recognise all new bourses without assessing their chances of survival? We already have 23 stock exchanges of which 21 are defunct but are not allowed to shut down. Can we afford a similar proliferation of currency and commodity bourses?


Is the Insurance Regulator  Watching?


If you have been wondering how the Sensex pulled back at least 500 points or more (intra-day) on at least two occasions recently, then look no further than Life Insurance Corporation (LIC). The government-controlled insurance behemoth is single-handedly playing the role that Unit Trust of India used to play before its two debacles and the subsequent split.

We learn that LIC has been making daily purchases of over Rs2,000 crore and may have invested over Rs40,000 crore in equities in the recent past. With several index stocks quoting at absurd lows, this may turn out to be a bonanza in the long term. But, in the short term, it is not clear if the insurance regulator is even aware of such large market operations and their impact on LIC’s finances.


Meanwhile, trouble erupted from another quarter, namely, LIC’s custodian, the Stock Holding Corporation of India Limited (SHCIL). Or rather, questions have been raised by Corporation Bank’s Risk Management Division, over the “funds pool account” that it maintains for SHCIL. SHCIL is India’s largest custodial agency and its clients include most leading banks and institutions. Essentially, SHCIL’s Corporation Bank account receives money from its many institutional clients (in line with their payment obligations) through normal RTGS banking channel clearing or intra-bank funds transfer for pay-in on their behalf. The money is then transferred to a stock exchange clearing bank for the pay-in. However, LIC’s payment comes in a day later. Corporation Bank covers this through an ‘intra-day bridge’ overdraft to SHCIL to meet immediate payment needs.


Corporation Bank’s risk management cell has panicked on noticing the growing size of this intra-day bridge overdraft which was often well beyond SHCIL’s basic net worth of Rs300 crore. Even if one values the National Stock Exchange stake (7% equity valued at around Rs1,100 crore) that it holds, its net worth would not cross Rs1,400 crore. In comparison, LIC’s transactions alone are in excess of Rs2,000 crore. Bankers say that this situation arose because LIC did not want to leave large overnight float funds with SHCIL with the result that the risk was pushed on to Corporation Bank.


The Bank is worried about falling foul of RBI policy if the overdraft has ever to be carried overnight (even unavoidably) and worse occurs on a reporting Friday. SEBI, as the capital market regulator, again seems to have failed to oversee SHCIL’s operations even though it remains under investigation by the Serious Fraud Office of the Ministry of Corporate Affairs. We learn that SHCIL is now trying to rope in its promoter, IDBI Bank to become a clearing bank for stock exchanges and take on this responsibility.


Financing the pay-in is clearly an issue that needs a systemic solution like better oversight of SHCIL and a possible conversion into a limited purpose bank for securities market operations. However, there must be a proper clean up at SHCIL first. Instead, there is a clear attempt to bury the episode (see MoneyLIFE Cover Story 5 July 2007) and SHCIL now has Rs6 lakh crore of assets under custody and is the sole custodian for the new pension scheme under the new pension regulatory authority, as well as Central Record keeping agency for e-stamping transactions, which are in the process of being rolled out in a few states.


-- Sucheta Dalal