FINANCE AND INVESTMENT CLUB
Article of the Month
The Curious Case of Bank Recapitalisation
VOL-2 ISSUE NO. 2
Editor’s Note We are pleased to publish the thirteenth issue of ‘Arbitrage’ – Finance and Investment Club’s monthly magazine. Arbitrage aims to cover a diverse range of topics under the wide domain of Finance and Economics. Our goal is to ensure that we provide significant value to the readers through informative articles and articles on current affairs. We would like to thank all the authors for contributing their articles for Arbitrage. In the Article of the Month – ‘The Curious Case of Bank Recapitalisation’, the authors Mr. Sathya Siva Chandan and Ms. Seemanthini Swamy from T.A. Pai Management Institute, have done a good analysis on recapitalization on Indian banks. We hope for the continuous support of our authors and readers to make this magazine a success. -Finance and Investment Club, IIM Rohtak
FINANCE AND INVESTMENT CLUB IIM Rohtak 2018-19 Parag Nawani
Siddhesh S Salkar
Bibekjyoti Roy Nandi
Naveen Kumar Aditi Patil
Financial Modelling Workshop Φ - Finance and Investment Club, IIM Rohtak in association with The Wall Street School conducted Financial Modelling Workshop. The workshop was taken by Mr. Suresh Varma, an alumnus of IIM Rohtak. The two-day workshop was attended by about 50 finance enthusiasts.
Starting from a basic business model of a fruit vendor’s business, students dived into the subject. The students developed financial model for a complex business model of a 25 years’ project for Wind power generation. The workshop covered assumptions used in forecasting - revenue & cost drivers, company’s capex plan, working capital policy, choice of financing structure –debt/equity etc. Mr. Suresh also shared his experience as an investment banker. The workshop has built strong foundation for students to further work in valuation and investment analysis.
1. The Curious Case of Bank Recapitalisation
2. Long Term Capital Gain
3. Rising Consumer Confidence
4. Indiaâ€™s Forex Reserves
5. Bitcoin as a currency
6. Insolvency and Bankruptcy Code: Changing Paradigm
The Curious Case of Bank Recapitalisation
ARTICLE OF THE MONTH
Sathya Siva Chandan, Seemanthini Swamy T.A. Pai Management Institute Introduction The process of injecting fresh funds in banking system is called recapitalisation and the aim of this paper is to study the current impact of Recapitalisation push. It analyses the need and the reasons behind this move by the Government. During 2000s and 2008 Indian economy was in a boom phase, during this period most PSBs (public sector banks) lent extensively to the corporates. Lending being the primary business of the banks, provisions were created in case of the defaults. Since the corporate lending happens in huge amounts the collateral or the guarantee given against it is not sufficient to cover the entire amount lent. For banks, loans are its assets and they are classified based on its recovery. Provisions were to be created like substandard provision in case of NPAs. The global slowdown in the economy affected the ability of corporates to pay back the loans and has been the most prominent reason behind the increase in NPAs and bad loans of public sector banks. Major companies that defaulted on the loans are as follows:
The main operating income for the banks is through the interest receipts on the amount lent. By default, when banks do not receive interest payment for 90 days on the assets, they declare such assets as NonPerforming assets (NPAs) and the income on the NPAs later stops. Due to which, the net operating income for the bank decreases and to compensate for the same, provisions are created. As and when the loans are given, a part of it say 15% is added to the equity capital of the bank in case if the loan defaults. Losses may occur and the exact nature of these losses may not be not known. Due to these reasons PSBs would be unable to lend further as their capital ratios will be compromised if they lend beyond limits. The net impact here is the risk weighted assets increase, the capital held by the banks decrease due to NPAs which brings down the capital adequacy ratio and hence banks become unable to lend further if the minimum requirement of capital adequacy is compromised further. This has impacted the GDP and also the credit growth of our country.
By 2019 it is anticipated that the Indian Government will implement Basel III norms according to which the minimum capital adequacy ratio is to be maintained at 11.5%. This minimum ratio would in turn promote the efficiency and stability of the financial system thereby reducing the likelihood of banks becoming insolvent. Hence such a move by the Government is mostly justified which is not meant just for the NPAs. This has been a time-tested mechanism adopted by the Government of India to save the ailing Public-Sector Banks (PSBs) and to implement various norms in our country. One key financial instrument used in this mechanism is the recapitalisation bonds which are a form of loans. Data collected from Bloomberg clearly shows the increase in the Tier-1 capital (equity) of most of the publicsector banks. After Global Financial crisis (2007-08), to strengthen banks and have more regulations government has been in a constant effort to infuse capital and strengthen the banks. However, time and again due to various reasons banks crisis appears. To make the banking system more effective government is going for recapitalisation.
Bank Recapitalisation in other countries Bank Recapitalisation has been implemented in other countries apart from India most notably in Nigeria in the year 2005. There have been several reasons behind the recapitalisation move by the Central Bank of Nigeria (CBN). One major reason is the poor management of the banks and the proliferation of corruption into the financial services industry especially the banks in the country. CBN’s audits of the Nigerian Banks exposed the inefficiency among the banks in the country. There has been excessive lending among the 5 big banks holding 30% of Nigeria’s deposits. These banks have often been reckless and brought the banking system to the brink of collapse. Further investigation revealed that banks have been crippled with low holdings and a credit crunch. Liquidity constraints further aggravated the problem. Thus, CBN decided to infuse over N600 billion naira ($3.96) into the Nigerian banks to revitalize them with N400 billion being used to bail out the 5 big banks. Soon 4 more banks were infused with N200 billion naira. This has resulted in additional capital for the banks easing them of the capital crunch and thereby improving the banking industry in Nigeria. This mechanism has been adopted even by Greece to protect its economy after the crippling Government Debt Crisis of 2008-13. In the year 2010, a special body called Hellenic Financial Stability Fund (HFSF) was constituted to help the Greek financial institutions to recover from the crisis and promote stability in them. HFSF gives capital support in compliance with both the rules and regulations of Greece and that of the EU. Four of the biggest banks in Greece -National Bank of Greece (NBG), Alpha, Euro bank, and Piraeus received a stimulus of €48.2 billion. This resulted in an increase in debt-to-GDP ratio of Greece by 24.8 points but later the Government received equity
shares in these banks. Phase 2 of the recapitalisation was done in 2014 when €8.3 billion was injected into the banks. This time even private investors participated in the process. After some time HFSF liquidated its assets in these banks and the amount recovered was returned to Greek Government to reduce its debt. As mentioned above, the recapitalisation process was exercised frequently in many other countries over the years and each time it served its purpose. Thus, bank recapitalisation has proved to be an effective tool of improving the health of the banking system in the respective economies.
Process of Recapitalisation According to Basel II implemented by RBI in 2006 the minimum Capital Risk Adequacy Ratio (CRAR) should be 8%. RBI being prudent has mandated 9% to be maintained by the Indian banks. It is the measure of the amount of bank’s capital expressed as a percentage of risk weighted credit exposures. Exposure is defined as any fund based or non-fund based outstanding amount by the bank. This ratio is used by the regulators to rank a bank’s capital adequacy. The recapitalisation will infuse the tier 1 capital for the banks so that they are able to absorb losses without ceasing their business operations. The basic idea behind recapitalisation is that the banks should have minimum capital to cover the potential losses from its assets. Hence the intention here is to improve the capital for the banks so that the losses occurred due to the NPAs will be covered and minimum CRAR for the banks can also be achieved according to Basel III which is 11.5%. An additional capital conservation buffer of 2.5% will be added along with 9% to the CRAR.
4|Page Now the question is how the government will infuse capital. The answer to this is financial engineering. The Government issues recapitalisation bonds which are bought by the banks. The government then buys the equity shares in the banks by the money received from the sale of the bonds. The bank will receive coupon payments for the purchase of the bonds from the government. This coupon payment (interest) will be a part of the fiscal deficit
of the government. The bank converts the money thus collected through sale of these bonds into equity shares in these banks. Banks in turn receive interest payment for these bonds. Later, banks were made eligible to receive their initial principal as well. Thus, the main investors of recapitalisation bonds would be the PSBs themselves, hence the government in a way is making them finance their own bail-out.
Table 2: Tier 1 Capital Ratios (%) across various PSBs in India Tier 1 Ratio (%)
Bank of Baroda
Bank of India
Indian Overseas Bank
State Bank of India
Union Bank of India
Source: Bloomberg Table 3: Risk Weighted Assets: Equity ratios (%) across various PSBs in India Risk Weighted Assets: Equity x
Bank of Baroda
Bank of India
State Bank of India
Union Bank of India
Indian Overseas Bank
Current phase of Recapitalisation In October 2017, the Government of India announced a whopping 2.11 lakh crore of additional stimulus to the PSBs. This news was cheered by economists, banks and the industry alike for taking the necessary steps to rescue the PSBs. The plan is not out by the government yet. It is anticipated that recapitalisation will happen in three phases. First phase of recapitalisation involves issuing of recapitalisation bonds worth 1.35 lakh crore to the PSBs by the GOI. PSBs will purchase the bonds with the liquidity available in the form of deposits by the banks. As demonetisation has left the banks with excess liquidity. Apart from this the recent introduction of FRDI bill the government states somewhat the same. Second being Indradhanush scheme which involves infusion of Rs. 70,000 crore by GOI. Out of which Rs. 50000 crores has already been given to the banks. Additional Rs. 18,000 crore are expected to be released by the current allocations. Banks are also expected to raise over Rs. 58,000 crore through sale of their equity shares in the market. However, the 2.11 lakh crores seem to be very minimal amount when it comes to the equity capital requirement as per Basel III for public sector banks.
Impact of Recapitalisation Under Basel III norms when RBI eased the norms of tier I capital last year, and allowed the banks to revalue their assets, many public sector banks were unable to do it. This move of recapitalisation will not only boost the capital but will also make banks more efficient for lending. More effective and stricter norms under Basel III will make banks ry.
functioning smooth and productive. An appropriate portion of recapitalisation will be towards writing off of the bad loans and rest would be for CRAR. Since banks will be more effective in lending, that will effectively impact economy and would also make a substantial impact over GDP of the country. Talking about Fiscal deficit, the interest payments to the banks by government for issuing bonds will be a part of fiscal deficit. The equity capital could also be raised by making follow up offer by banks to the public. However, government currently is quite wary about this when it comes to give away a certain portion of ownership to the people of the country i.e. it would not be accepted by the public in a positive way. By 2019, mostly anticipated BJP government will be the ruling power and it would exercise its entire power in infusing the required capital to public sector banks. However, doing so currently would affect the public sentiments about government’s action on public sector banks. The Government of India also announced the ambitious road infrastructure project “Bharatmala” along with the recapitalization of banks. On closer look, the recapitalization can be a greater boost to the capital-intensive infrastructure sector. The Bharatmala project requires over 5.35 trillion INR of capital and aims to connect all parts of the country with an extensive network of highways. By choosing to recapitalize the banks, the construction industry invariably is getting a much-needed boost in terms of financing their projects. Also the project is set to generate over 14.2 crore man days of employment to the Indian job seekers. Thus the bank recapitalization has been a game changing move by the Government to simultaneously address the challenges of recovery of NPAs, easing out liquidity woes of banks, finance massive public infrastructure projects and generate employment in the count
Long Term Capital Gain Kalyani Upadhye DOM, BITS Pilani
(iv) Conversion of a capital asset into a stock.
Let us break the topic into parts and
(v) The maturity of a zero coupon bond;
understand the meaning of different words. Capital Gain: The profits or gains arising out of the sale or transfer of a capital asset are called capital gains. Transfer includes the following points: (i) To sale, exchange or relinquish an asset.
So what is a capital asset? - Any kind of asset held by a person whether or not connected with the business or profession of the person. Examples: Home, Car, Stocks, Bonds etc.
(ii) Removal of any rights in relation to a
Types of capital assets:
A. Short Term capital asset:
(iii) Compulsory acquisition of an asset.
Capital asset held for less than 36 months
Capital asset held for more than 36 or 12
prior to the date of transfer is called as short
months are classified as long term capital
term capital asset. However, the following
assets held up to 12 months are classified as short term assets: a) Preferred Equity in a company which are
In case of unlisted shares of a company, the holding period of 24 months will be considered instead of 24 months.
listed in any recognized stock exchange in
The assets are classified into short term and
long term assets as the tax amounts rising out
b) Other listed securities;
of the gain for both the assets are different.
c) Units of UTI(Unit Trust of India); d) Zero Coupon Bonds. B. Long Term capital asset:
Long term Capital Gains on the assets are calculated as below:
Indexation is used to determine the true value
Index (CII) which is found on Income tax
of the asset with the inflation calculations.
This is done with the help of Cost Inflation
Consider example of sale of a debt mutual
= Rs.4, 50,400
fund (A debt mutual fund invests in fixed
Long term capital gain = Sale value –
income securities like Bonds)
Indexed purchase value Therefore, in our example
Purchase value: Rs.2, 00,000/Year of purchase: 2004 Sale value: Rs.500, 000 Year of sale: 2014 Long term capital gain: Rs.300, 000/-
LTCG = Rs.5, 00,000 – Rs.4, 50,400 = Rs.49, 600 Hence, tax would be now 20% of Rs.49, 600 i.e. Rs.9, 920 which is much less than Rs.60, 000 without indexation.
Without indexation, a tax of 20% on the capital gains of Rs.3, 00,000/- i.e. Rs.60, 000/-. Considering indexation, the tax would be: CII in the year of purchase (2004): 480 CII in the year of sale (2016): 1081 Indexed purchase value = Purchase value * (CII for year of sale/ CII for year of purchase) So – Indexed purchase value = Rs.2, 00,000 * (1081/480)
The Government in its annual budget of 2018 has announced the re-introduction of LTCG( Long Term Capital Gains) Tax of 10% arising out of stocks/equities held for more than a year and on the gains being greater than 1 lakh.There is grandfathering i.e exemption from tax for the investments made till January 31. This news led to a stock market tumble by around 700 points on the day. Let us see how the gains will be taxed.
Source: The Economic Times
(a) The stock was purchased on Jan 31st 2017
(d) As the stocks are sold in less than a year,
and will mature on Jan 31st 2018. As the
the rules of short term capital gains apply.
LTCG rule comes into effect from April 1st
Hence, a total of 15% tax will be levied on
2018, this stock though earning capital gains
the gains of 1.5 lakhs.
will not be charged any tax.
(e) The stock here has lasted for more than a
(b) 10% taxes on the amount over 1lakh
year and hence the tax will be on (1, 20,000-
gained between Jan 31,2018 and April
1, 00,000) =20,000. Thus, the tax amount
3,2018.The gains earned till Jan 31, 2018 are
will be 20% of 20,000 i.e. 4000
grandfathered. (c) The stock though completed one year of maturity between Jun 25th 2017 and June 30th 2018, will not be taxed as the gains are below 1 lakh.
Measures to reduce the impact of this taxation? According to me, invest in a long holding period to reduce the taxes. This can be done by investing in mutual funds instead of equity stocks where the buying and selling period is longer.
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RISING CONSUMER CONFIDENCE Gaurav Gambhir Dept of Financial Studies, University of Delhi A recent RBI consumer confidence survey revealed a rise in confidence of consumers in Dec-17 after a four year low in Nov-17
There would be a sigh of relief for PM Modi after the RBI monthly consumer confidence survey shows positive consumer sentiments of householdsâ€™ perceptions and expectations on the general economic situation. Although the employment scenario and overall price situation remains a major concern for households. The survey was conducted in six metropolitan cities - Bengaluru; Chennai; Hyderabad; Kolkata; Mumbai; and New
Delhi - and obtained 5,035 responses on householdsâ€™ perceptions and expectations on the general economic situation, the employment scenario, the overall price situation and their own income and spending.
Consumer Confidence Index (CCI) Consumer confidence is a key driver of economic growth and is widely considered a leading economic indicator of household spending on consumption. The main
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variables of the index are â€“ Economic Situation, Income, Spending, Employment, and Price Level.
In the Dec-17 round, CCI surged from 91.1 in Nov-17 to 96.9. In the Nov-17 round CCI fell to a 4-year low. The last time it had been so low was in Sept-13 during the currency crises.
The index captures the consumer sentiments for current situation as well as future expectation via the current situation index (CSI) and the future expectation index (FEI).
General Economic Perception Householdsâ€™ current perceptions on the general economic situation improved & moved towards the neutral level after five quarters of pessimism. Their one year ahead outlook improved further within positive terrain.
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Income Sentiments on income also improved and entered into positive terrain after six months of gloominess. One year ahead expectation remains strong might be because of hope of large government spending in the last full year of Modi Government. Outlook reflects the sentiments on employment. Spending Spending sentiments remain strong despite slight decrease in proportion from the last round. Outlook also decreased marginally. One of the reasons might be the increase in the price level. In line with overall spending, the net response for both essential and nonessential spending declined slightly for the current period as well as the future.
Significance of Consumer Confidence Index In economies such as India and the US, where personal consumption accounts for more than 60% and 70% of GDP respectively, consumer confidence has a particularly significant impact on the economy. Consumers tend to increase consumption when they feel confident about the current and future economic situation of the country and their own financial conditions. Measuring it can provide critical insight into the economy's growth prospects. Consumer sentiment indices are essential tools used by global investors and will be an immense aid to individual and institutional investors in India.
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Future Sentiments Future sentiments of consumers depend largely upon how the actions of government and RBI take place. Government target of maintaining fiscal deficit 3.3% of GDP (as
per Budget) will change the consumer sentiment if private investment does not revive in this fiscal. We also have to look forward to RBI MPC policy in April which will decide direction future consumer sentiments.
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INDIAâ€™S FOREX RESERVES Nakerikanti Harish IMI, Kolkata
Indiaâ€™s Foreign Exchange reserves recently crossed US$ 400 billion for the first time in its history, in November 2017. India's foreign exchange reserves includes foreign currency assets like US $, EUâ€™s euro, the British sterling pound, and the Japanese yen, SDRs, Gold and reserve tranche position (RTP). Forex reserves refers to money and the other assets like gold, RTP.etc., held by a central bank/Monetary authority of that country, such as the currency issued by the central bank, as well as the various bank reserves deposited with the central bank by the government and other financial institutions. Foreign exchange reserves play an important role in the component of balance of payments and a crucial element in the analysis of an economy's external position.
Worldwide, more than 100 countries maintain forex reserves and provide data to IMF on weekly, monthly, quarterly or yearly basis depending on the country. China is in the top position with US$ 3.1 trillion in its forex reserves as on 31st March 2017, followed by Japan and Switzerland in 2nd and 3rd place with reserves of US$ 1.23 trillion and US$ 730.4 billion respectively. India ranks 10th with forex reserves of US$ 369.95 billion as on 31st March 2017. As per figure.1 there are 24 nations worldwide which have forex reserves of more than US$ 100 billion.
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Figure-1 In our India, the Reserve Bank of India Act set the legal provisions, necessary for governing the foreign exchange reserves. RBI accumulates/disperses forex reserves by purchasing/selling from the authorized dealers whenever required from the open market operations. In India, RBI releases reserves information every Friday. As per data release by RBI on 18th Feb 2018, Indiaâ€™s Foreign exchange reserves peaked at US$ 420 billion on 9th February 2018, of which US$ 394.6 billion was in the form of foreign currency assets, US$ 21.5 billion in the form of gold, US$ 1.5 billion in SDRâ€™s and US$ 2 billion in reserve tranche position (RTP) in the IMF. Gold as a proportion of our reserves is relatively small with just 5%. After foreign currency assets, in our reserves gold is the ultimate currency in India. Gold had a significant role in paying for the imports during the 1991 crisis. The increase in forex reserves in India in the last few years demonstrates the underlying strength of its balance of payments with
FOREX RESERVE ASSETS AS ON 31ST MAR 2017 (US $ MILLIONS)
Source: data.imf.org increase in FDI, FII and NRI investments, particularly from 2014. Reserves are always needed to ensure that a country meets its external obligations. These include international payment obligations, including sovereign and commercial debts. Imports in India during the Jan 2018 stood at US$ 40.60 billion. With the current level of forex reserves it can cover 10 months of imports easily. In comparison with BRICS nations, India is at 4th place out of the 5 nations. Please refer Table-1 for more details.
Country Name China Russia Brazil India South Africa Table - 1
Forex Reserve As on 31st Mar 2017 (US $ Millions) 3,102,764 397,907 370,111 369,955 46,588 Source: data.imf.org
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The Two important aspects of holding the high forex reserves are: 1) Benefits of holding high forex reserves 2) Forgoing the Opportunity cost by holding high forex reserves Benefits of holding high forex reserves One of the major benefits of holding high amount of forex reserves is it acts as a buffer during the forex market pressures and thereby it also helps to prevent the external crisis. In the global community for the emerging economies like India, Russia, Brazil, ETC, holding higher levels of forex reserves provide assurance to them that, the external liability incurred by the particular nations will be repaid within time and also it helps in balancing the exchange rate when required. In 1991, when India had faced its worst ever balance of payment crisis, we pledged 67 tons of gold to The Bank of England and the Union Bank of Switzerland and raised US $605 million to shore up its dwindling forex reserves, which were then barely enough to buy just two weeks of essential imports. India’s foreign exchange reserves were at US $1.2 billion in January 1991 which hardly equals to just 3 weeks of essential imports.
Since 2001, India has been maintaining a large amount of Forex reserves. As per figure 2, In 2001 Indian forex reserves stood at US$ 42 billion and currently it is US$ 420 billion, which indicates that it has increased roughly by 10 times over the course of 17 years. On the contrary, there is a major fall from 2008 to 2009, due to the 2008 global crisis. During the 2008 crisis, India’s forex reserves fallen to US$ 247.7 billion at the end of November 2008. Fallout of the global crisis has been responsible for the decline of India’s forex reserves. The value of rupee against US $ 1 declined to Rs 48.66 in Oct 2008 from Rs 40.00 in April 2008. The India rupee came under sharp pressure after the collapse of the Lehman Brothers in September 2008. The RBI has taken necessary steps in Sthe domestic foreign o exchange market aimed at reducing undue u volatility of Indian rupee. Thereafter rupee r c has attained a measure of stability. The e exchange rate was Rs. 51.2 per US dollar in March 2009. India’s: high amount of forex reserves played a key l role in balancing the exchange rate of Indian i rupee v e
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India's Forex Resrves ( In US $ Millions) 450,000 400,000 350,000 300,000 250,000 200,000 150,000 100,000 50,000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Gold
Figure – 2 *In 2018 forex reserves are as on 9th Feb 2018 (as on 31st March from 2001 – 2017) Forgoing the Opportunity cost by holding high forex reserves Our Ex RBI governor, Dr. Raghuram Rajan once said that reserves cannot buy a country immunity from volatility in global currency markets and at best will prevent second round impacts of that volatility. He was quoted saying, “Reserves are useful to have but they come at a cost”. By maintaining huge Forex reserves, India loses
Source: rbi.org.in & data.gov.in the opportunity cost. India’s foreign exchange reserves are parked in US treasury bonds, which earn just one percent annual interest i.e., US$ 4 billion on US$ 400 billion reserves. But India has a total debt of US$ 1.20 trillion (RS. 75 Lac crore) including both internal debt and external debt. The annual interest outgo on this debt is US$ 87 billion (Rs. 5.23 lac crore) as per the 2017-18 Union budget. This means India is paying around 6.5 - 7.5 % interest on its debts. So, by this we can say that India is paying more rate of interest on its debts than what its getting on its reserves.
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Bitcoin as a currency Venkat Samala and Onkar Habbu IIM Bangalore Anatomy of a Currency:
Bitcoin – in a nutshell:
Throughout the history, any form of currency which has been accepted universally broadly performs three major functions:
Now that the premise for currency is set up, let’s look at how Bitcoin positions itself in this space. Bitcoin is a form of digital currency which was developed as an open software in the year 2009 by Satoshi Nakamoto. It employs encryption and blockchain technology for peer-to-peer electronic transfer. One of the biggest advantages which work in its favour is the decentralised nature, meaning it has the same value at any point of time across the globe and there are no transfer or exchange expenses that we associate with the existing form of currency.
Serves as a medium of exchange:
As a medium of exchange, money should be able to make payments for goods and services in the country. So, as a means of facilitating transactions, the unit of currency should possess the quality of general acceptability amongst the masses. 2. Unit of value: It must form a common denomination across the landscape of economy to compare all goods and services available. With recognition as fiat currency, it should hold an intrinsic value which could be guaranteed by the Central bank. 3. Stability in its value: Currency should have stability in two ways – Time series and cross section i.e. the value of the currency shouldn’t be too volatile and at the same time be liquid for conversion to other accepted currencies at stable rates, governed by dynamics of demand and supply. As a store of value, it should be able to transfer purchasing power across time horizon allowing users to either defer or prepone their transactions with the help of financial institutions.
Bitcoin as a form of currency: Bitcoin is a sort of disruption which challenges our rudimentary understanding of currency and attempts to bring about a paradigm shift in the way the currency is perceived and forces us to think about how the currency could evolve to keep up with changes in technological domain. Though it has been accepted as a medium of payment, such instances have been very few, meaning it still has a cover a long ground to meet general acceptance, especially given its scepticism among the masses. As far as stability goes, although it has cross-sectional stability, its fluctuation across time is huge rendering it futile as a medium of exchange.
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Image Source : convoyinvestments.com
Market forces in a bitcoin economy: As an alternative monetary system, the biggest issues with the currency would be its fixed supply and lack of any central governing authority. Taking a time horizon of at least 50-60 year, letâ€™s look at how economy shall pan out if its accepted. Given the limited supply of the bitcoins, deflation would be a given in such a world. With the growing needs of people and advent of technology, the demand shall increase meaning the worldâ€™s output shall increase. However, money supply being constant, the finite money shall have to be spent on these goods and services. Hence, the prices are
bound to go down. If this price deflation manifests itself in the economy, there shall soon be a time when consumers shall start postponing or defer their purchases and discretionary spending in the hope of cheaper products soon. Meanwhile, the producers will also resort to reduction in output and trim down expenses on innovations to cut down on their losses. In a world where there have been innumerable innovations to cater to ever-growing consumer needs, such a fixedsupply monetary system is difficult to surmise and is grossly regressive in nature.
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Absence of a watchdog: Not only will the bitcoin render the power authority of central banker useless, it shall also make the current financial system obsolete. It would be indeed comforting to presume that bitcoin promotes free-market economy by letting market forces dynamics determine its worth. However, by placing an upper limit on its supply, it violates this very principle. In the current system, the central banker plays the role of a guardian, who only monitors the money supply and its environment only to nudge periodically to ensure its stability. Lack of such a regulatory framework such as central bank, will only magnify the already discussed deflation into a vicious circle which could even lead to volatility in everyday pricing of commodities.
A recipe for inequality: By adoption of such a monetary convention, the rich and middle class may postpone their purchasing decisions, thereby hoarding money with them hoping its future value will be higher than the present. It spells chaos to workers who shall be laid off by industry because lower outputs. Result â€“ rich keep growing richer and poor shall find it hard to survive. Meanwhile, the government, in the absence of central bank, will not have access to its fiscal engineering
tools to finance its social welfare schemes for these people. Gold Vs Bitcoins: Bitcoins are often compared with Gold as both tend to have difficulty in estimating intrinsic value. Both cannot be valued based on the future cash flows. They are primarily used to store value. This comparison subtly hints at Bitcoin moving towards a trading asset than an acceptable currency. But, Gold wins hands down here as it has a very stable price history throughout the history and it was even used to back the real currency at some point of time. Bitcoin, on the other hand, fails to gain even the value storage credibility owing to its price volatility and limited supply. Cost of mining per transaction: Bitcoins require the heavy computing infrastructure for its functioning. The underlying Blockchain requires machines with high processing power as well as the time of miners who are busy solving complex mathematical puzzles. This makes the bitcoin transactions expensive currently. Though, it is predicted that the scale of the Bitcoin transactions in future would reduce such costs, such network effects introduce a tinge of uncertainty.
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Rumours surrounding Bitcoins: There are lot of negative rumours surrounding bitcoins regarding their use for the illegal activities like terrorism and deep dark web funding etc. Such rumours can accrue over time and it can cause the governments around the world to be cautious about Bitcoins. Many countries could even ban Bitcoins by law if they see they are losing the control over their economy. This threat will always loom over bitcoins.
Conclusion: All the above factors reflect that Bitcoins are still not ready to be globally accepted as the currency. The price volatility and absence of
any backing make us question its credibility. Though bitcoins disrupted our financial doctrines with introduction of decentralisation of money market, it has a long way to go to meet the requirements of the transactional currency. What worries most of the finance professionals is that the current price rally bitcoin is enjoying. There are speculations of various unknown dark and illegal activities that are fueling this rally as there is nothing drastic that is happening in the public domain which will explain the more valuation and demand for the bitcoins. As every tradable asset has faced in the history at some point of time, this can sure the be Bubble of Bitcoin, which appears to burst sooner than later.
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Insolvency and Bankruptcy Code: Changing Paradigm Sristi Nanda NMIMS, Mumbai As truly said, “Insolvency and Bankruptcy laws are the poor-laws of the middle classes that unless the insolvency laws be reformed, the vices of idleness, extravagance, and dishonesty encouraged by them, will destroy the middle classes.” And so did the birth of the Insolvency and Bankruptcy Code (IBC) happen in India on 5th May'16 to deal with the illicit deposit taking schemes and to improve corporate governance in the country.
Several progressive and constructive initiatives such as the Joint Lenders Forum, Strategic Debt Restructuring (SDR) etc have been put in the job of reducing the menace of the NPA’s but sadly in many cases, the companies have failed to make profits and have defaulted even after their loans were restructured. So to counter rising NPAs,
resolve issues pertaing to the quick winding up of the insolvent companies and to redeploy capital effectively, the government has enacted the IBC in order to deliver a comprehensive resolution mechanism for India’s economy. Basically, commercial morality and respect for the rule of law may be said to constitute the very bedrock upon which the law of bankruptcy is founded. The main idea was to create a strong legal and institutional machinery in the country in line with global standards, to deal with debt default has not been Simply speaking, insolvency is a financial state of being that is reached when you are unable to pay off your debts on time. On that premise, Bankruptcy is a legal process that serves the purpose of resolving the issue of insolvency. The IBC aims to consolidate and amend the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals for maximization of value of assets of such people in order to foster entrepreneurship, availability of credit and countercheck the interests of all the stakeholders including alteration in the order of priority of payment of Government dues.
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A game changer in corporate circles, the IBC is a comprehensive, systemic and speedy reform that has reposed faith in the judiciary. The unscrupulous debtors and the chronically stressed assets would all come under the purview of this transparency rule based regime.
possession’ to a ‘Creditor in control’ regime with financial creditors exercising control through IPs in the event of a single default in repayment of any loan or interest. Thus, IBC is a quick fix solution to deal with the present deteriorating condition of banking sector in the long run.
Under IBC, once the insolvency petition is filed by the lender, borrower or any other aggrieved party is accepted by the National Company Law Tribunal (NCLT), the ‘insolvency professionals’ (IPs) take over. The IPs try to revive the company over the next 180 days (a single extension of 90 days may be given in certain cases). If an agreeable resolution is not reached by the deadline, the company is deemed insolvent “automatically,” thus starting the liquidation. In case of stressed corporates if there is a possibility of a potential default that can trigger IBC, an effective turnaround plan should be devised and communicated to all stakeholders in advance which should include aspects of financial restructuring, operational improvement and sale of assets which can be monetised. Replacing a plethora of legislation, the IBC provides a single-window, time-bound process designed to revive a company failing which the corporate (borrower) would go into liquidation, a situation both lenders and borrowers are keen on avoiding. Based on equity, asset maximization and promotion of entrepreneurship, the IBC aims to balance the interests of all stakeholders. It proposes a paradigm shift from the existing ‘Debtor in
Despite the perceived clarity, IBC throws up a range of challenges from infrastructure gaps to lawyers exploiting loopholes. Also, the need to find buyers for the stressed assets, assessing the viability of debtors, safeguarding the rights of the company before handing it over to the IP’s etc all need to be addressed in order to ensure smooth functioning of the IBC and achieve optimal output. The crux lies with the NCLT functioning efficiently and promptly, and the courts creating the right jurisprudence to allow IBC to be successful. A major challenge for the Insolvency and Bankruptcy Code could be the tidal flow of cases to NCLT courts despite the continuance of earlier
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laws, albeit with minor changes. If an IBC application has been enlisted by the NCLT, proceedings under other laws will be stayed until the IBC led insolvency resolution is concluded. Since IBC ensures time-bound resolution, several thousand cases could hit NCLT courts over the next couple of years. NCLT will have to resolve 25,000 pending bankruptcy and insolvency cases besides other corporate cases. These may include 4,000 pending cases under the Company Law Board, 700 BIFR cases, 5,200 winding-up cases in various high courts and around 15,000 DRT cases. Lastly though the Insolvency and Bankruptcy Code points to finality in the recovery process there is no guarantee about complete recovery of dues. The lack of qualified judges could be the biggest challenge for NCLT. Besides judges, the Insolvency and Bankruptcy Code would need highly qualified insolvency professionals to
mediate the resolution process, manage debtor assets and carry out liquidation. There is no doubt that the code will reduce the time taken to resolve insolvency, develop investor confidence, and will significantly improve India’s ease-of-doingbusiness ranking. It will also provide genuine business failures a second chance and make the lenders aware of their rights. It reinstates the fact that no matter how big a company is, one has to always look at business basic. While this has been a resplendent start, the real success would depend on the viability of resolution plans and how much haircut the financial creditors will have to take while working on the resolution process of the NPA’s. So time will tell and as aptly stated by David A. Skeel,” It’s important not to overstate the effect of bankruptcy on GDP growth, but an effective bankruptcy system can make a significant difference,”
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CALL FOR ARTICLES Finance and Investment Club of IIM Rohtak invites articles from all Business Schools across India. The article should be original and should be related to finance and economics. All the reference should be cited and sources of images should be mentioned clearly. The winner of the article of the month will get Rs.300/- with an ecertificate. All the other selected articles will be published in our magazine ARBITRAGE Instructions: 1. Please send your articles before 25th March, 2018 on www.dare2compete.com 2. Do mention your NAME, INSTITUTE and BATCH with your article 3. Font: - Times New Roman, Size: - 12 in word .doc/.docx 4. Please DO NOT send PDF files and kindly stick to the format 5. Number of authors 2 at max 6. Maximum Word Limit: 1500 words, Minimum Word Limit: 500 words 7. Naming Convention: Name1_Name2_CollegeName.doc 8. Any Image without the source or label will not be accepted IMPORTANT: The article should be original and should not have been/should not be published elsewhere. You will be disqualified if you violate the same.
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Finance and Investment Club Indian Institute of Management Rohtak
Disclaimer: The views and opinions expressed in this magazine are those of the authors and do not necessarily reflect the opinion of the stakeholders of IIM Rohtak.
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Published on Mar 8, 2018
Published on Mar 8, 2018
We are pleased to publish the thirteenth issue of ‘Arbitrage’ – Finance and Investment Club’s monthly magazine. Arbitrage aims to cover a di...