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Finance and Investment Cell, SRCC interviewed Mr. Prakash Singh, Professor of Banking at IIM Lucknow since 2006 and the Faculty Convener at SCIFI, an IIM, Lucknow – SIDBI/ DFID sponsored Incubation centre promoting Start-ups in the space of Fintech, wherein he shared his opinions on Capital Markets and the Economy.

1. How has the Pandemic affected the risk management practices in the Corporates? The way the pandemic has affected everyone depends on which industry we are talking about. So there are some industries where the impact is more visible and there are some in which the impact will be visible after some time. If we take an example of automobiles and the steel industry; there, the disruptions have taken place in the supply chain which have resulted in poor deliveries. The other very significant impact which is largely silent and which will show up in times to come is on the financial sector, the banking sector predominantly. This is because firstly, this sector does not have the habit of connecting to the media so much since they are very conservative but it is evident that many of their lending portfolios will get seriously impacted because of the Covid as they have lent to those sectors which we have just discussed about and the way these sectors will perform will have a direct impact on the banking sector’s performance. Although the impact is not visible right now, it may start getting visible, probably from the next Quarter on.

It needs to be understood that the banks always create provisions for situations that they can foresee but this is not a situation that they have foreseen. This is an unexpected situation, so this would immediately translate into higher provisioning going forward and the moment we mention about the higher provisioning, it means poor results and poor guidance for the future also, therefore banking sector is going to see more pain in going forward, particularly because of the exposure to these very sensitive sectors. Thus, the entire impact can be divided into two dimensions :

  • The industries which are more real, where the disruptions happening are clearly visible.

  • And the second set of industries would be those like the banking and IT sector because even the IT sector will be witnessing a lot of cuts in the spending of major Corporates. The impact might not be very visible right now but it will have its own time period to be visible.

2. In the past year, the no. of hedge funds participating in private investments have nearly doubled, so why do you think the hedge funds are increasingly participating in the venture capitalist territory? It is a very different ballgame when the discussion is about the hedge funds and the VC industry. Being a part of the incubation centre at IIM, Lucknow, I have witnessed that the investor community is not really very disturbed by the pandemic, actually, it is more excited about the whole thing and is readily putting in more money. It can be noticed from the kind of companies that are able to raise money; companies that have not even made ₹ 1 of profit are being valued at ₹ 1 lakh crore, which was the case with Zomato. And recently, an Indian company was listed on NYSE.

So this is the kind of money which is completely different from the real economy and this has to be understood, because a lot of people ask that if the real economy is not doing good how come to the markets are so galloping these days and that there is a lot of money which is coming from the private and the hedge fund space. This should not be seen as cause and effect, they should not be seen together, rather seen separately, because this is the sector that has a higher risk appetite which means it is ready to face the downside risk and even if 9 out of 10 investments go bad in the VC industry or the stock market, they are fine with it. So that is an economy that is running on a very different narrative and objective, the participants there, are very different and therefore will continue to be chasing such technologies and startups in the Indian ecosystem because they know that there’s a lot of potential there but their investment or excitement is not really a reflection of the overall performance of the economy because they are often dovetailed together.

This is a very difficult question to answer because on one hand it is said that they are not dovetailed and then it is asked whether they are completely disjointed. No, they are not completely disjointed but the triggers or the factors which pull these two markets are very different because the players and participants are very different, they are okay with that model where they have a larger risk appetite and are looking at downside risk also, but wherein in the real economy things are not really very good as of now. There is an uptick which has started and so definitely things will improve from here because this is the lowest which we could have had in the real economy. The other day, people were saying that the only way the growth will go is positive and will improve from here and therefore the only discussion point is how soon this growth would be or what would be the shape of the recovery. There is absolute clarity or unanimity that the growth will definitely come from here. How fast it will happen, what would be the exact shape, which industry will rebound first and which will rebound later, these are the discussion points but the economy is going to do better from here.

Thus it is not proper to compare the real economy with a very private club called VE or VC or hedge funds because they have a very different ballgame.

3. So in today’s time what are the most important challenges that are being faced by the banking sector and how do you propose the sector could cope up with these challenges? One of the biggest challenges of the banking industry is the quality of their loan book. That is something which is very disturbing. The World Bank’s definition of a banking crisis is that whenever in any banking system the Gross NPA crosses 10% of the total loan book, we say that the bank is facing a crisis and today as we speak, many of the banks in India have a Gross NPA of more than 10%.

So we are actually staring at a crisis whether we accept it or not, things are not really looking very good for the banking sector. We had our own methods of correction which were Mergers and Consolidations along with Recapitalisation funds being pumped in but all this will help only if the economy bounces back because banking is an industry that is not dependent on its own performance rather its performance is dependent on the performance of other sectors.

So if the real sectors like the steel, cement and infra industry bounce back, banks will also see an improvement in the quality of loans, so the biggest challenge for the banking industry is what do they do with these bad loans which they are saddled with because even though they want to look ahead and start fresh, they are being reminded of the baggage which they have been carrying and if there is somebody who can take care of this baggage only then they can do something fresh, i.e. start from a completely blank slate and do something which is good but the barrier to this progess is that baggage.

History comes back to haunt them about their very high NPAs and that probably is the biggest challenge that I can see for the Indian banking sector. Thanks to Mr. Raghuram Rajan for initiating IBC and bringing more clarity on what would be the shape of a bad bank. Although it got shelved for a while, but now as we are hearing it back again, more clarity on these things and the IBC Resolution Process will come up.

IBC is a new thing, it came up in 2016, so we cannot really expect them to do miracles over just 5 or 6 years, they need some more time but yes with more clarity on the challenges which IBC faces on the dissolution of the last decade bad loans, the bad bank concept and clarity on these things going forward should therefore improve the concern about the existing NPAs, which has been a major trouble for most of the bankers from past so many years.

4. What are your thoughts on the impact of automation of the banking sector on people in general and the country in particular? As we were discussing the challenges faced by the banking sector, one of the most talked about challenges is the technology integration or what is being coined as the Fintech Revolution.

There are two things which need to be understood in a particular way, one is should the bank itself develop the technology, move forward and integrate better technology platforms to gradually move up the learning curve or should they focus on their core activities, which is deposits and loans and let someone else do this job, someone from IIT or NIT, who understands the algorithm of it really well. Let them develop that and meanwhile the banks can just focus on their core activities and then combine to do something which will be a win-win situation for both.

Now in academia, this is a wonderful opportunity for banks to talk to technology companies but practically there are challenges. For instance, I have been talking to a lot of these Fintech startups and they always say that banks are very hesitant to talk to them.

So the problem with banks in terms of technology upgradation is that they want to do it on their own. The previous generation of large banks are not willing to discuss anything with the startup people because they don’t take them seriously. It might be the result of the cultural conflict.

But that doesn’t solve the problem because if the banks are not talking to them, then they must develop their own in-house technology; which they don’t have because they are not able to attract the talent. This is because an IITian won’t be excited to work with SBI, rather they would be excited to work with tech giants like Microsoft or Google, who can then partner with SBI and develop technology applications for them.

So there is no doubt that technology is required because the future is in the banking companies collaborating with technology companies to work closely in order to move forward. It is not happening in a big way in this country because of the cultural divide. The large public sector banks are not very convinced with these technology giants as they feel that their banking activity is very pure and they cannot really allow people to intervene in this but I am very hopeful that these kinds of undesirable gates or barriers which the banking industry has created will fall tomorrow or later and technology would definitely be the game changer for the banking industry as well. It’s just a matter of time and it’s already happening in the developed markets like Singapore where large banks have their own in-house technology incubation centres where they invite people from engineering schools to develop solutions that will then be adopted by the banks. So there are ways, there are methods, it’s only a matter of time. People in the banking industry will listen to people in the technology industry.

5. How was the microfinance sector affected during COVID-19, and what are some of the measures the government can take to ensure its growth? Microfinance is the sector that has suffered the most during the pandemic. I am on the board, an independent director of two NBFCs. These NBFCs have a very large exposure to the microfinance sector. The other day, there was a board meeting where the numbers were being presented, and it was in such a sad state as the microfinance sector lends to the bottom of the pyramid, where the people are very vulnerable and any disruption in their supply of income would result in defaults. For example, take your typical street vendor who earns say Rs.10000 a month and gives the microfinance company Rs. 2000 as an instalment. If for some reason, this inflow of Rs. 10000 stops, the first casualty is the loan repayment. In this MFI industry, there are no collaterals or security which the company can attach. It has always worked on group chemistry, where people would normally repay in time. But, in these difficult times, there has been a serious slippage in loan quality. Portfolio at risk, which is a measure of how serious the problem of loan quality is, used to be around 2-3%, but has now gone up to 25-30%. This indicates how serious the problem is. The moment the portfolio at risk is this high, companies will have to make huge provisions in their balance sheet which will result in the company reporting losses. When I saw the statements of a very large NBFC recently, the first thing that struck me was that the reserves were negative and when I checked the Statement of Profit and Loss, the loss that was reported was majorly due to the creation of provisions.

What can the government do? When you talk to a person in this field about why people aren’t paying, since MFIs do not work like a typical loan the answer isn’t very direct. The relationship is built with a young local boy who collects the funds from the borrowers, who are primarily women. But, why are these women borrowers not repaying? The message that comes out is, which is not very clear, as the women don’t want to speak on record is that when you see that the finance company isn’t making any fresh loans, then you start believing that they will not ask for the previous loans. Borrowers at the village level believe that since no fresh loans are extended, the company will close down and that they will not have to repay their loans. Here, the microfinance companies need to communicate to the villagers that they are still there, that is the company is still lending to the people around, like their neighbours who are repaying their loans, the company is only not lending fresh loans to the villagers not repaying their loans. This message needs to be communicated by the microfinance company to the villagers. At this point, the villagers cannot be blamed because when there isn’t much activity happening around, it is a natural tendency to believe that the company is sinking, and hence the villagers do not need to repay their loans. Therefore, the microfinance company needs to keep pumping funds.

Now, the question arises, where do these funds come from? This is where the government plays a crucial role.​​ The government has to ensure that MFIs, not all, can be filtered out on various criteria including SOPs, clean track record, corporate governance, board structure, quality of auditors, etc. are provided with an emergency line of credit. Though this is being done, it is not accessible by all, many a times the transmission mechanism is so weak that what is announced in Delhi will reach a remote village in Patna only after 3 months, by which time the MFI has lost its town, people don’t believe that it will survive and it will be very difficult for the enterprise to recover from there. So, more liquidity is what is required. The government has to ensure that good microfinance companies with good track records get an immediate supply of credit so that they continue to flow the credit in the villages and the village borrowers, therefore believe that this company is going to be around and they have to repay their loans. This is the only thing that can be done, and that the not so good MFIs, with shady records who have very poor practices, should be allowed to die. Those that have behaved properly by maintaining ethical standards and weren’t diluted over the pandemic should be given funds as quickly as possible, after due diligence. This sector is built on confidence and the confidence has to come from the state, if the state displays this confidence in the sector, this sector will again bounce back and continue its noble gesture. However, if the government sends a signal that it is not going to do anything major to save this industry, it will be really sad for this industry. So, the state has to send a message, it is not about how much, but the message has to be sent from the Central Bank and the government that they are very concerned about this sector and that they are opening the floodgates for funding this sector, which will be provided with the money as soon as possible.

Q6 What is the impact of the official announcement of the end date of LIBOR, and what is its impact?

The inter-bank offered rate is basically a consensus rate in which the participating banks decide on what the LIBOR is going to be, like MIBOR in India. These rates are very critical for settlement in the derivatives market because the derivative industry thrives on interest rate movements. So all interest rate derivatives, whether swaps or simple futures or even complex options, always have a settlement date, and on this date, the benchmark rate used for closing the transaction is always going to be a LIBOR based rate. If this rate is being controlled, one way or the other, that is not allowing the market forces to decide, this is going to be a dampener for the derivatives industry, because this industry does not want any control over the price movement (let the market decide). If interventions are brought in that is a check is brought in on volatility, it is good for the system but it is a dampener for the derivatives industry since it thrives on volatility. This is not very important for the state or Central Bank as they want to keep a check on volatility, if they allow volatility, it will be at a set range, and beyond that, they will not be able to allow that. Coming from pure market play, it is not a very good practice to interfere in the determination of asset prices.

The interview was conducted over video conferencing platform.


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