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Dear Readers, Welcome to a new edition of Infineeti. Welcome to the Euphoria created by Block Chain Technology. Welcome to the Big Data Era.

Prof. K. Rangarajan is an Accredited Management Teacher (AMT conferred by AIMA) and is a member of several professional bodies including AIMM (Australia). He is also amongst the Board Of Directors of The State Trading Corporation of India Limited (STC). His expertise includes Business Strategy and Strategic Planning.


I hope all of you may be witnessing the transition in financial flows. I am happy to present this Infineeti edition which is touching upon all such transitions caused by crypto currencies, digital transactions, the disruptions caused through disruptive technology in financial flows and some of the practices like recapitalization by the corporate and sanctuous Islamic banking. We have also brought before you the interesting debate on GDP versus HDI. I hope your HI (Happiness Index) will go up after reading interesting articles in this issue. Happy e-days ahead!!!

Dear Readers, The recent budget has thrown up lots of questions regarding the government’s ability to deal with the exacerbating situation of bad debt in the Indian financial system. This, coupled with the rising deficit due to government expenditure and slowing growth has put India on the precipice of a precarious position. With the disruptions from the advent of cryptocurrency on the horizon, the next decade is set to witness a paradigm shift. This edition of Infineeti aims to present to you a snapshot of these changes and how they might effect you and the business environment. To preserve the international flavour of the magazine we have also included a special write-up on Islamic banking. Keeping in mind that the majority of our readers will be taking their first steps in the corporate world, we have also incorporated an interview from an esteemed alumnus of IIFT to help ease your transition. As usual, we also have sections to tease your financial wits and informative compilations. Regards.

Hoping that our readers would be: “To our sad faults, a little blind, To our small merits, very kind! ‘


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By Shivam Joshi, IIFT Kolkata

Cryptocurrencies are here to stay The most unique feature of Bitcoin and other cryptocurrencies is that their intrinsic value depends simply upon the trust of people in them without any regulation, issuance or control in terms of supply-demand by any regulatory authority. A characteristic that makes cryptocurrencies different from any asset or currency is that they are both; they are traded and held by investors like assets or commodities due to limited availability but in their innate nature have liquidity and transactional ease like currencies. This characteristic that ensures that cryptocurrencies are not affected by negative events in the same way currencies generally do.

the country, this is known as capital flight. When capital flight of domestic currency takes place, the domestic currency is converted to foreign currency, which further hurts the exchange rate of the domestic currency and eventually leads to currency crises. Cryptocurrencies cannot be affected in the same manner as they are not backed by any asset, central bank or government. The only condition in which they will lose their value is when the people lose trust in them and those who hold them start dumping them. While this has happened in the past with a few cryptocurrencies in their early stage, with established widely held and trade currencies like Bitcoin its unlikely to happen.

A currency crisis is a situation in which the investors loses confidence in the stability of an economy and hence try to get their monetary reserves out of

Cryptocurrencies provide one of the easiest ways of money transfer, without any transactional fee by an intermediary, as the technology


and the world around it evolves more and more uses will come up. So the chance of people losing confidence in it is unlikely, especially in currencies like Bitcoin which are now being widely accepted by people around the globe. Another reason why there is no reason for sudden loss of trust, in the general circumstance is that the trust in cryptocurrencies is actually the trust of people in each other and in a fair system of record keeping where one cannot be cheated simply by hacking a system, as the ledger is visible to everyone, its decentralised and every computer on the network is a record. So micro or macroeconomic effects that affect a country or even the global system like the financial crisis of 2008 will or should not have any effect on the legitimacy of the cryptocurrency as long as the people continue to trust the

InFINeeti | February 2018 established system continues to function fairly. Another reason why widely accepted cryptocurrencies are here to say for long is that as more and more people transact and hold cryptocurrencies because of their characteristic of appreciating like an asset, due to limited availability. They will end up being stake holders in the system and any loss to the system will be a personal loss to these stakeholders. When cryptocurrencies because of their ease of use and benefits like no surcharge or transactional fee, become widely accepted in your neighbourhood grocery store or car dealership, the stake holders and global acceptance either formal (through banks, governments) or informal (unregulated) increases, there will be further less incentive to retrieve to complete dependence on fiat currency for those who actively participate in the cryptocurrency world and more incentive for others to join. Is there a bubble? Whether there is a bubble or not in terms of the valuation of Bitcoin or other cryptocurrencies is a question yet to be answered, but there surely is a bubble or one is beginning to form in terms of the number of cryptocurrencies. The real charm of cryptocurrency is the concept of a fixed supply, for example of 21 million in case of Bitcoin, there won’t be like fiat currency any extra printing into or pulling out of money from the market to help government get out of a fix, regulate policy

or affect inflation. This gives cryptocurrency the unique character of an commodity with the high liquidity and transactional ability of a currency. With a fixed supply cryptocurrencies don’t depreciate or devalue like regular commodities, with a fixed supply there will be no future sudden discoveries of unknown Bitcoin (or other cryptocurrencies) reserves beyond the 21 million which will depreciate or devalue it, like it happens to crude oil or natural reserves of other commodities. So the only harm to the ecosystem of cryptocurrencies is gluttony of too many cryptocurrencies as they will create confusion and complication in transactional ease and may also harm their value as a new found oil reserve to the oil price in international market. One potential danger to the cryptocurrency ecosystem is that of misinformation. Since the cryptocurrency market is currently unregulated there are no defined or statutory principles to be followed in cryptocurrency trading and also the Blockchain environment. Bobby Azarian (Ph.D.) explains how the FOMO(fear of missing out) and FUD(fear, uncertainty and doubt) cycles have been weaponised using misinformation to manipulate cryptocurrency prices and harm investors and the entire ecosystem. As the cryptocurrency ecosystem evolves either organically or inorganically through regulations, eventually systems can be expected to develop to safeguard investors and others

who use it for transactions against misinformation. In conclusion we can say that the entire cryptocurrency ecosystem is still in its early stages and is evolving, but the underlying concept of decentralised record keeping and unregulated currency mechanism and the benefits over fiat currency therein make them a valuable concept. In the future whether they evolve unregulated as they are now or through government intervention or regulation like happened in New York, as they continue toward being accepted widely for the intrinsic benefits that come with them, they will become more and more a part of our everyday lives. The ecosystem does suffer from some deficiencies currently, but like any other system it will evolve and improve over the time. Even if a particular few companies or cryptocurrencies in time go through booms or bursts it can be safely assumed that the concept and ecosystem of cryptocurrencies is here to stay.


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By Athukuri Gopichand & Rajvardhan Goud, SJMSOM (IIT Bombay)

Cashless: The future of money INTRODUCTION Currency means any kind of money, coins or paper money, that is used as medium of exchange. Long back, we started trade with barter system, cowry shells, punch marked coins, gold coins, silver coins, stainless steel coins and finally currency notes. In each period, people agreed for corresponding legal tender. This legal tender changed according to different socioeconomic situations that happened around the world. Now we are in digital era which characterized by technology with 4G/ 5G speed and rapid industrialization. At this juncture of time, cashless economy, which means financial transactions are not of physical which uses currency notes or coins rather digital transaction which uses technology, is inevitable. Digital transactions include those through credit and debit cards, the unified payments interface (UPI), unstructured 7

supplementary service data (USSD), prepaid payment instruments (PPIs) and internet banking.

SCOPE This article mainly focuses on cashless economy in Indian perspective because India is a developing country with huge population, varied traditions and customs. So, it’s important to understand the cashless economy in India perspective. We have a lot to learn from the Demonetisation experiment on the scope, behaviour and psyche of us Indians towards cash as going cashless was almost forced on the people overnight. This move also helped capture how equipped the people and businesses were to go cashless and only deal in the various digital modes of payments. It also helped find which sectors are dependent on cash and in the course of the essay let's examine if they are ready to go cashless or more needed to be done to

get them cashless in the first place. Online Transactions Almost all of the cash that was withdrawn because of demonetisation is now back in circulation, indicating that people did not shift from cash to electronic means of payments mainly because of the more unorganised sectors in India, lack of technology reach and digital divide. But, this trend may change in upcoming years. The recent data from RBI on mobile transactions shows that in Sept 2017, Rs. 124.69 trillion online transactions happened which 13.5% higher compared to Aug 2017- Rs.109.82 trillion transactions. This growth rate is continuously increasing every month. This is a growth of 47% percent in the number of transactions in 10 months with an average transaction amount of around Rs.15000.

InFINeeti | February 2018 According to Reserve Bank of India’s report on ‘Trends and Progress of Banking in India (2016- 2017)’, almost 89% of the non-cash retail payments in terms of volume and 63 per cent in value terms were undertaken through cards and electronic modes during 201617. “As India moves towards a less-cash economy, digital payments are estimated to grow 10 times, from $50 billion last year to $500 billion by 2020”, said Vineet Singh, Chief Business Officer, MobiKwik. The retail payment transactions across all NPCI Platforms that include NEFT, RTGS and other electronic payments have grown just 10% year on year. Typically this payment method methods covers all the expensive transactions. This data clearly shows that people have accepted mobile payments for smaller payments, but when it comes to high end purchases, still cash is dominantly used. In india, 9 out of 10 people are employed in the informal sector. People employed in this sectors typically work in MSMEs. They also include manual unskilled labourers working on daily wages in farm fields and construction sites or people having their own small businesses.

cases people themselves did not have functional bank accounts to process the payment.

Payment methods like digital wallets and UPI are tools that can be targeted to this sector of people.

The importance of this sector cannot be overstated as around 38% of the nation’s GDP, 40% of the overall exports, and 45% of the manufacturing output is contributed by this sector, making it the backbone of the economy. This is a sector of that needs huge incentives like Indian railways cancelled digital transaction charges to switch to digital payments. They generally deal in small and regular incomes thus making cash transactions easier.

But, in spite of these tools being available, the penetration is low as not all small businesses accept electronic payments. Since not many businesses have digital payments, its customers (again people with low income) would want to have cash. Therefore they would want to be paid in cash. This does not create any want for a digital mechanism of payment. The whole sector, as one should

This sector is drives the income for a majority of people and is majorly cash run. They are paid or earn in cash. This sector took a major blow after the demonetisation move. There was reporting of people losing jobs on a huge scale simply because the contractors did not want to pay in cash. In most 8

InFINeeti | February 2018 shift to digital payments for this to work. But as we have seen, that did not happen, instead the whole sector shut down. Farming is majorly an informal sector as well. The average land owned by farmers in India is 2.2 Hectares and the average farmer household income is only around Rs.6400. This shows that the sector is deeply stressed and shifting to digital payments cannot be a priority. The focus here should be to help them increase their incomes. There were huge protests across the country by farmers in the summer of 2017 as in spite of getting a good crop, since they could not sell their product in the market because of cash crunch despite a good crop harvest. It can be concluded that this sector is still cash driven. Only about 35% of our population has access to internet in India. Also, around 90% of Indians do not have digital literacy. With number still so low, there cannot be a thrust to immediately expect to pick up digital payments as an alternative to cash. Though debit cards and POS are easier to use, the fact that NPCI payments grew by only 10% shows that even they are not used. India has a good rank of 23rd among 165 countries in terms of cyber security but it has to upgrade its infrastructure to meet the increasing demand. In December and January, when the demand for digital transactions had peaked, the number of failed transactions had increased a lot on account 9

of increased load banking systems.



With the setup of Payment banks and launching multiple digital payment options, the government has adopted a good stance of trying as many options to try and make some form of digital payment work. Also the government has succeeded in making bank accounts available to almost 99% of Indian households. But challenges still remain. About 25% of Jan Dhan accounts opened are now dormant. Also, awareness among people about the use of debit card is low. The focus must now shift on its efforts on increasing digital literacy. Organising camps in local bank branches, having the youth to participate in the process can help digital literacy spread much faster.

But the culture of our country to still deal with cash will remain. 90% of the transactions are estimated to be in cash in our country. In this context, it cannot be expected for everyone to adopt digital methods of payments immediately. Add to this the high levels of corruption in our country and cash transactions become a necessity to get through day today life. Another element that reduces the scope for a cashless India is the structure of our various businesses, specially the supply chain network of them. Tex Zippers, Vice President, Mudit Tandon says, "There are hiccups in the supply-chain. For example, we could not find a specific grade of insulation and other material we needed for our products for many weeks after demonetisation in

wholesale markets. The other important aspect to consider is the importance of petty cash. As a factory, we frequently have welding, cartage, and tool repair jobs. These are small jobs that are settled in cash and we did not have enough petty cash for this. With our regular suppliers there was no issue, but for odd jobs like these, which can actually stop work at time, we had a problem. They are lifeblood of any business, thus getting rid of cash is will bring the country to a grinding halt�. Recently,cryptocurrency added in digital transactions and some restaurants started accepting bitcoins instead of legal tender or regular digital transactions. But it’s a completely different topic and it has both pros and cons. In conclusion, the structure of the current Indian economy necessaries a cash based society. Though in urban areas there is a scope for more digital payments, the rural areas economy are still inseparably tied to cash. By slowly improving income of the people employed in informal sector, agriculture and small businesses, there can be scope for digital payments. Till then the focus must be to create wealth and opportunities to people and improve their standard of living.

InFINeeti | February 2018

Recapitalization and the Indian Landscape By Shashank Singhania, IIFT Kolkata

Recapitalization is a type of revision of capital structure or corporate restructuring. This involves restructuring a company’s debt and equity mix, with the aim of making the capital structure more optimal or stable. It principally involves the exchange of one type of financing for another. Like, when a company tries to buy its shares back by issuing debt. A prominent example would be when the U.S. government recapitalised the banking sector in the United States with various forms of equity in order to keep the banks and the financial system solvent and maintain liquidity through the Troubled Asset Relief Program (TARP) in 2008. Why Recapitalization? Banking Sector: Troubled by stressed assets and an uncertain environment that has

been in existence for quite some time now, banks, focused more on the rising NPAs than on lending. The Non-Performing Assets (NPAs) in the banking sector have been rising. In Public Sector banks (PSBs), particularly, NPAs rose from 5.43% of advances in March 2015 to 13.69% as of June 2017. This high NPA has significantly constricted the capacity of banks to lend. The bank credit growth in the year 2016-17 was 5.1 %, which is the lowest ever since 1951. Data related to credit. Growth shows that inadequate demand cannot be the total explanation for the extensive credit slowdown, as the private sector banks have been growing robustly. The central problem here is that PSBs are in damage control mode, and are

limiting new engagements.


Twin Balance Sheet problem: Twin Balance sheet problem is one of the most pertinent issues in the Indian banking domain today. Its two aspects can be summed up as: a) Over indebtedness in the corporate sector, owing to improper credit assessments, which results in unwillingness or inability to borrow, which further depresses the demand for credit; b) Stressed balance sheets of banks especially public sector banks (PSBs) makes them incapable or unwilling to finance corporate or housing projects. This clogs the economy, depriving it of the demand for credit 10

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growth in Asia’s third-largest economy.

and the lubrication that oils and feeds that demand. Countries with this kind of problem witness prolonged weak growth.

Therefore, the Indian government approved a state bank recapitalization plan of 2.11 trillion rupees (S$44.2 billion), in a bid to clean banks' books and revive investment in a slowing economy.


There are three things that will happen: Through budgetary allocations, the government will buy Rs.18,000 crore worth shares of public sector banks
and then, public sector banks will need to go raise Rs. 58,000 crore from the market.
The government will issue “Bank Recapitalization Bonds” for Rs. 1,35,000 crore which will be used to buy more shares in public sector banks. This plan is nearly ten times higher than the government’s previous pledge as it seeks to reignite

However, this is not the first time the Government has come up with this kind of reform in the banking system. Recapitalization bonds were used in 1990s to inject funds in then state - owned lenders. The economy then was on its way to improvement, after the government unveiled the reforms after the 1991 balance of payments crisis. It forced banks to separate bad loans and the then Finance Minister Manmohan Singh put aside a huge corpus for recapitalization through bonds in the Budget for 1993 -1994. According to the data by Bloomberg, in the year 1994, India had sold about 48 billion rupees of 12-year recapitalisation bonds at a coupon rate of 10 %. According to Goldman Sachs, it could boost credit growth by up to 10 %. The stock markets reacted positively to the news. The day after the announcement, 25th Oct 2017, was a historic day for the markets as the SENSEX closed beyond 33,000 for the

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estimates that PSBs would need Rs1.4 - 1.7 trillion of capital by March 2019 to offset profit and loss (P&L) losses stemming from higher NPA provisioning, and to comply with Basel III capital adequacy norms.

first time ever. An index of Public Sector Banks surged 30 % on the day. Cleaner balance sheets make banks more attractive for investments, and also enables them to concentrate more on fresh lending. This move will also boost bank capital ratios, thereby giving them more leeway in expanding credit without worrying about regulatory pressures. This is significant as under Basel III norms, the minimum level of tier 1 capital has been mandated at 10.5%. Last year when RBI eased the classification norms of tier-1 capital and permission was given to banks to revaluate their assets as per new guidelines, most including the largest lender State Bank of India, could not secure the 10.5% mark. Therefore, Recapitalization is a quintessential move to bring about some rest and allow room for the growth of the Indian banking sector, which has been marred with rising NPAs, deteriorating asset quality, and historically low credit growth. Impact of recapitalisation The proposed infusion of capital should be adequate, as CRISIL

The Front - loading of capital, through recapitalisation will help PSBs accelerate provisioning for, and resolve, NPAs, and clean up their balance sheets. The problem of provisioning was hitting the banks both the numerator as increasing stressed assets required higher provisioning and in the denominator, as the percentage of stressed assets increased so did the risk weighted assets.

CRISIL estimates that the overall stressed assets in the banking system might not increase significantly over the medium term. PSBs account for the major chunk of this, due to their higher exposure to large corporate loans in vulnerable sectors such as power, construction and steel. About two-thirds of this has already been recognized as NPAs. Given the impetus of reducing asset quality pressures and adequate capital infusion, PSBs would be well advised to bite the bullet and recognise the provisioning required, especially on large corporate NPAs, this fiscal itself. This might mean aggregate losses for the banking system of approximately Rs60,000 crores this fiscal, compared with an aggregate profit of approximately Rs31,000 crores

in fiscal 2017 (after PSB losses), because they have to provide for ageing NPAs and loan write-downs (to resolve cases under the Insolvency and Bankruptcy Code). The good part is, this will mean the pressure on earnings will be significantly reduced from the next fiscal onwards. So, a window to clean up balance sheets is coming up and PSBs should utilise it. Impact of recapitalisation on debt markets Some market participants are worried about the impact of recapitalisation on fiscal deficit of India. The fiscal cost of issuing the 1.35 lakh crores recapitalisation bonds is the interest payment of about Rs 8,000-9,000 crores. Under standard international/ IMF accounting, recapitalization bonds do not increase deficit; and are categorised as “below-theline” financing. But under India’s convention, these bonds do add to the deficit. As stated by, the chief economic advisor of India, Arvind Subramaniam, the IMF convention is economically more intuitive because bonds are a capital transaction, their issuance does not directly increase the demand for goods and services and has no inflationary consequence. It is a capital transaction because on the one hand it increases the government’s liability but it also increases its assets. Therefore, the 12

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overall or net financial position of the government remains unchanged. However, there is a cost to recapitalisation consisting of the additional interest burden on the recapitalization bonds. But these costs were always there as, the government was in any case liable for the banks as owner (for the unrecoverable part of the underlying loans that were made). Issuing bonds merely makes explicit an implicit liability; or rather puts on the books what is a contingent liability. In 1990s, when recapitalisation bonds were issued, they were not included in fiscal deficit calculations. The Government had classified them as offbalance sheet items. Either way, the yearly interest payments on the bonds issued will be will be marginal when the confidence boosting impact of addressing critical economic problems, boosting credit supply, impetus to private


investment and accounted for.



Problems One of the biggest challenges of the recapitalisation plan is the chance of a rise in debt to GDP ratio, which at 69% already indicates higher levels when compared to other Emerging Market economies. Though the Economic Survey recommends bringing debt to GDP ratio to sub-60%, the current proposal makes this achievement difficult. Restructuring accounting norms as per IMF will be a possible way to save ourselves from breaching the budgeted fiscal deficit target of 3.2%. The fiscal cost can go higher in case the bond market witnesses considerable yield spikes as was seen in 2009 due to excess supply. The 10-year Indian bond yield rate which was at 6.75% on October 24

has already touched the peak rate of 6.89% in November. The idea of recapitalisation bonds has been undertaken in other economies such as USA, UK, and Indonesia in the past. Indonesia issued them after the ‘98 East Asian Crisis resulting in collapse of its financial and banking sector. Considering the low international interest rates, Indonesia revised the strategy in 2004 by issuing Dollar dominated bonds in International markets. India could consider this option as well, other than a lower interest charge, the comfortable external debt position will give us more room to increase leverage Internationally. The government also has the option to issue “Masala Bonds� (Rupee dominated bonds issued abroad) to hedge any exchange rate risks arising from this strategy.

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However, the expectation of a rate hike by US Fed might have made the government shy away from this strategy. This exercise brings the problem of moral hazard to play as any write offs gives wrong incentives to defaulters. A prime example is Essar Steel, where promoters tried to purchase back the company after receiving write-offs, ironically after filing for bankruptcy. Therefore, the banks must be vigilant to write off only genuine deserving cases instead of inadvertently assisting wilful defaulters.

Conclusion Banks at present have funds but are unable to find creditworthy borrowers. The big infrastructure projects announced would definitely aid this. There won’t be much fiscal support available but these measures will put into play the under-utilised funds lying with the financial sector, as savings are shifted from physical to financial assets. Since there is not much fiscal space, it is important that the Monetary Policy Committee supports the effort. Inflation has been below the RBI’s 4 per cent target since October 2016, real rates are very high and there is space to reduce it.

Since Indian macroeconomic scenario is now guided by stronger rules, there is no need to fear large slippages. Since the MSMEs and the informal sector were most affected by both demonetization and the imposition of GST, it is good that refinance is being targeted to increase financing of small firms by banks. This will help generate employment growth as will be targeting labourintensive sectors such as textiles. Big data and fin tech can be used to reduce lending lags to MSMEs and risk from such lending. Mandating PSUs to use TReDs will reduce delays in their payments to MSMEs.


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Islamic Banking

By Vishal Purswani, IIFT Kolkata Islam is the youngest of the major religions in the world. It is the dominant religion in the Middle Eastern region and the third world countries of Africa, while being the second largest religion in the world with over 600 million followers. Islamic philosophy gains its elements from a blend of Arabic, Jewish and Christian faiths and is one of the least complicated of the world’s religions The followers of Islam, or Muslims as we know them, believe in one god, Allah, who is the ultimate creator and sovereign ruler of our universe. In fact, the Arabic word “Allah” means submission to the will of god. First such “submitters” include Noah, Abraham, Adam and Moses; well before Islam was even a religion. The incarnation of Allah in the form of Prophet Muhammed in the early 7th century is considered to the best and final revelation of God and the point of inception of Islam. In order to “submit” to the will of God, the Muslims follow “Sharia”. The word 15

‘Shari ’a’ literally translates into “way” or “path”. Sharia is the religious law that forms the part of the Islamic tradition and life. The word ‘law’ might be a misnomer as Sharia is, in fact, not a legal system but a way of life of Islam. People understand Sharia according to the early traditions and interpretations of the same, or through the mention in the holy book of Quran. Violation of any such principles is considered to be “Haram” or “prohibited” for Muslims. Finance and banking, as a service or a product, is an inseparable element of anyone’s life. Although, such an important pillar of the economy is treated very differently in Islam than in other religions. The followers of Islam have been historically known to possess moral and ethical values in all of their dealings. Hence Islamic Banking, as it is termed, is a system that is based on Sharia and guided by Islamic economics in its practical application. It is similar to commercial banking

in all it practices, but it is governed by Sharia which makes it distinct from any other banking operation in the world. The origin of the modern Islamic Banking concept can be very well traced back to the birth of the religion, where Prophet Mohammed himself acted as an agent for his wife’s trading operations. There are certain elements that characterize Islamic banking- The concept of charging interest (or “Riba”, which means anything in excess) is banned or considered haram for Islam. According to Sharia, charging interest is a capitalist policy which aims to make undue profits from the hard work of the people, even from those who are needy and poor. An Islamic bank is not allowed to invest in avenues that are not “Sharia compliant”. Highly speculative trades and businesses involving alcohol, war, weapons, drugs etc. are

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not permitted to be invested in by Sharia principles. It is based on the principle of profitsharing. In other words, the parties are the owners of the assets/venture for which the loan is being advanced. So, how is Islamic banking economically sustainable without interest, which is the primary source of income for banking operations? Although “riba” or interest is haram for Islamic banks, it is acceptable to follow a system of reasonable profit and return from investment where the investor takes a risk that is well calculated. In case of forwarding loans to corporates and individuals, the bank gets a stake in the borrower’s company (or asset) that is being financed in turn. In case of deposits, a separate account that calculates profit and loss is made under the profit sharing principle. The bank uses deposits as capital to invest in Sharia compliant investments and generate returns, which can be further used to invest and the cycle goes on. The profits or losses are shared between the bank and the depositor. The advent of Commercial banks, about 200-250 years back, made it difficult for Muslims to transact with noncompliant banks. However, with colonialization, most of the Islamic countries were forced to transact in the commercial banking pattern. In the 1960s, Muslim thinkers began to explore ways to make commercial banking interest-

free again. This gave birth to the Modern Islamic Banking, with the first such bank-likeinstitution in Mit Ghamr, Egypt in the year 1963. In the same year, a formal Islamic bank by the name Tabung Haji was founded in Malaysia that originally came into being with the rising demand of interestfree money for pilgrimage (Hajj) as this was not possible through the conventional banking system. The success of such banks further led to the formation of Naseer Social Bank in Cairo in the year 1972. In the same year, there was a proposal for International Islamic Bank for Trade and Development, which led to the creation of Islamic Development Bank that has a vision of creating social development for the Muslim community. Since then, over 40 Islamic banks have been institutionalized; a majority of which lie in the Middle-East.

With the rise of Islamic financial institutions and banking practices, there was a need for a regulatory framework to come into picture. Hence, in the year 1991, the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) was established in Bahrain. The AAOIFI is a non -profit corporate body that is responsible to prepare accounting, auditing, ethics, governance and Shari’ a standards for the Islamic financial institutions across the globe. It aims to standardise and harmonize international Islamic financial practices and has several programs in order to enhance the industry’s human resource base and structure. Such a unique form of banking is not limited to Islamic countries but has seen vital growth signs in other nations too. In 1991, 16

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the Dow Jones Islamic Market index came into being for investors willing to invest in sharia compliant projects. Further, the United Kingdom was the first non-Islamic country to allow a completely Sharia compliant bank known as the “Islamic Bank of Britain”. UK was also the first nonIslamic country to offer Islamic bonds known as “sukuk” starting in 2014. Non Islamic countries are now opening what is termed as “Islamic windows” in conventional banks. These are separate departments within banks that offer Sharia compliant services and investments to the customers. Multiple banks in China, United Kingdom, United States, and Germany offer such windows. Such banking practices have been considered in India as well. In his report on the financial sector in the year 2008, Raghuram Rajan recommended interest- free banking techniques to operate on a large scale in India. Even eight years after the incident, the RBI was in favour of formally introducing Islamic Banking to the country. But why did RBI want Islamic Banking in India? Why have Islamic banking in non-Muslim countries? An Interest free method of extending credit usually fulfils the motive of financial inclusion. In a country like India, where 22% of the population lives below the poverty line, it becomes extremely crucial to empower such people, especially in monetary terms. In addition to 17

this, the credibility that such a system creates instils the 11% of our Muslim population to invest in avenues that they can have faith in. This mobilizes funds from a hefty chunk of the populous that would not be possible otherwise. Even after the prospective benefits the Islamic banking system could have on financial inclusion and fund mobilization, RBI decided to drop the idea of introducing this form of banking in our country this year. There were several reasons and popular criticisms that point towards the same. One reason cited by the government was the existence of alternate financial inclusion policies and other vehicles like ‘Jan Dhan Accounts’. The second argument meted that introduction of Islamic Banking would require changing laws and legislations to be enforceable. For instance, currently, the Banking and Regulation Act requires payment of interest which is against the principles of Islamic Banking. The third reason seems to be due to the fear of funding terrorism. But the major reason for not promoting the same seems to be “cloaked in a lucid sheet”, as anything related to Islam doesn’t seem to ring the ears of the right (ist ) minds. But the criticisms related to Islamic banking make us ponder whether the issue is simply motivated by political agendas. It is said by many that in today’s world, there seems to remain a thin line

between profit making and riba. A World Bank paper even goes as far to suggest no difference between conventional and Islamic banking methods. The modern Islamic banks have found ways to work around the conventional instruments and include them in Islamic banking instruments, defeating the system’s purpose. However, it would be wrong to stick to any of the extremist opinions. The Islamic Finance system is centuries old while the Modern Islamic Banking is in a nascent stage and is evolving slowly. The Islamic system has to mature with time without violating its fundamentals as per Sharia.

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How can India overcome the Twin Balance

Sheet problem? By Om Duseja, SIMSREE Twin balance sheet problem deals with two problems in Indian economy, one is with Indian companies and other is with Indian banks. Indian companies have a large portion of debt on their balance sheet or in other words they are overleveraged whereas the Indian banks are struggling with rising NPAs. So after knowing what are the two problems let us see how this problem arises. Before the US financial crisis developing and developed economies were booming as there was heavy global and domestic demand and increase in exports due to trend of

globalization. Global economy was growing at the rate of 3.54%. In that phase companies to serve the increasing demand started expanding the manufacturing base by taking debt. Everything was fine as companies were paying the interest on account of the large profits occurring from operating and financial leverage and banks were also functioning properly. But after the crisis the global demand slumped and companies started making losses on account of high debt and high unused capacity. Hence companies ended up with default on interest and principal payments and the ripple effect was seen on the

banks as well with continuously rising NPAs. The other reason was a sharp reduce in the repo rate from 7% to 4.25% providing cheap money to Indian companies to spur the supply but it didn’t solve the problem of supply and demand, instead it give rise to inflation which forced RBI to increase rates thereafter. Thus higher cost, low revenues and weak demand squeezed the corporate profits and cash flows which lead to default of companies. It is not that only India but most of the developing and developed economies are suffering from lower growth


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rates after crisis due to the trend of de globalization being spread across the world. This can even be understood from the fact that before crisis there were more than 50 countries growing at 7% whereas in year 2016 there are hardly 6 countries growing at the same pace. Twin balance sheet has affected India in various ways. As NPAs are on rise the banks are not able to lend to the new projects. Other major issue is even as RBI has reduced the repo rate from 8% in 2014 to 6% in 2017 banks are still not able to pass the full cut in repo rate, one of the reasons being the banks are suffering from bad loans. Hence even after having low inflation, all time high forex reserves the economic activity is subdued due to higher rates on home loans and other commercial loans as well. Because of this the credit growth has declined sharply in the past years and it was 5.1%, lowest in over 60 years. The banks especially the public sector banks are underperforming due to high NPA ratios. To fight with the twin balance sheet issues, RBI had came up with multiple schemes in the past few years. First they came up with Corporate Debt Restructuring (CDR) scheme, in which banks will give some moratorium period on interest payments and longer period for payment of principal. But scheme didn’t work as from the CDR of 44 firms only five firms 19

managed to exit the CDR successfully. After that RBI introduced a scheme of SDR (Strategic Debt Restructuring) in June 2015 to solve the issue in which banks can buy stake in defaulting companies by converting debt in to equity. But in this scheme as well banks were not able to find a buyer for the assets of the default company and in some cases even if the assets were sold, the obligations cannot be met to a complete extent. After SDR RBI came up with a scheme called as Scheme for Sustainable Structuring of Stressed Assets (S4A), to solve the NPA issue. In this the debt is divided into two parts: sustainable and unsustainable. The sustainable portion will continue to perform and interest payments will be recovered from that part whereas the unsustainable part is converted in to equity or equity like securities and then sold off. Again this scheme is applicable to projects which are active as some projects in sector of power are not yet started due to late approvals from governments. RBI even came up with a new Insolvency and Bankruptcy Code (IBC) to give the control to the creditors which will mostly speed up the things. RBI has announced 12 defaulters accounting for 20% of the total NPAs. In IBC, the creditors will apply for insolvency on

corporate that default on principal or interest payments. Creditors can vote as per their voting shares and if only 75% of creditors agreed for liquidation the assets will be liquidated to repay the loans. Finally a last approach of PARA (Public Sector Asset Rehabilitation Agency) has been adopted by RBI which is a centralized agency as compared to ARC (Asset reconstruction Company) which is a privately owned company. Being a centralized agency the decisions can be taken faster and swiftly and problem of coordination can even be solved. PARA has worked in other East Asian countries and has shown that centralized agency can resolve the problem. PARA will purchase loans from the banks and then work on them by converting debt into equity and selling the stake. After this the government will recapitalize banks and once the financial obligations of the indebted companies are restored they will be able to focus on their operations and can take new investment opportunities. PARA can be

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funded by transferring the government securities or they can even raise money from capital markets. Another solution at this stage can be to reduce the amount of fixed assets the companies are holding so that the unused capacity can be removed and debt can be paid off. This however can be applied only to companies which are struggling with excess unused capacity. However the solution will change from company to company. Government has to speed up the process of approving the license procedure for the companies which have not even started the project and taken huge amount of debt. Other issues can be increase in the cost and decrease in revenues because of which the profits are squeezed leading to defaulting. Increase in cost of crude oil can be seen as the major reason for transport and logistics sector declining profits. In this case companies can lock the price of the raw material by using derivatives so that increase in raw material price will not dent the profits and hence will reduce the probability of default. Another part of decrease in revenues can be due to decrease in prices like in case of steel where the excess of supply in the market slumped the prices and hence the revenues of the companies. In this case government can put a floor to support the prices so that companies in these sectors should not suffer.

The other thing to notice is the fact that the share of public sector banks in Indian economy is close to 75% which is exactly opposite of the developed and most developing economies where share is 25%. It can even be seen that the most share of NPA’s is from public sector banks, this fact itself shows that the private sector are more efficient in terms of lending. Hence government can think of privatizing the public sector banks and reverse the share to 25% public and 75% private. After the privatization as well the government can still provide the lending to sectors to which most banks are not ready to provide. The legal action should be taken on the corporate that have done malfeasance, whereas corporate which are defaulting because of weak global and domestic demand or issues in particular sector should be given some cushion so that the credit culture should not get spoiled. Final Thought If the problem of twin balance sheet is not resolved

on a priority basis the economy may suffer from weak credit and hence declining overall growth rate. The current implementation of PARA will hopefully works well for the Indian economy as it has worked for other countries. However to make sure that this problem should not repeat in future, the global demand and growth need to pick up as it was before the financial crisis. But considering the current trend of de globalization and increasing protectionist measures taken all over the world the growth may not improve immediately but after few years. Hence focus on domestic growth and demand should be increased to create the resistance from global head winds. Hence government has to improve the ease of doing business like getting quicker approvals, improving infrastructure and connectivity, speeding up the process of land approvals, etc. to get the domestic demand and growth on the required trajectory which will make sure that the economy is not suffering from volatility in global demand and conditions.


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GDP Vs HDI: An indicator of Economic Development By Deepika S, TAPMI What is economic development? How do we know if the economy is well off compared to last year if there’s no standard means to measure it? To answer these questions there must be a shared consensus about the definition of development. But the very problem lies in the fact that the definition of progress and development varies from person to person and economy to economy. Economic development is a broader concept than economic growth. It is the culmination of social and economic progress, alongside economic growth. In the olden days, overall development levels of a country used to be evaluated based on the income levels (GDP-Gross Domestic Product) because it was strongly believed that higher productivity translates into higher progress for the country and its society. As time passed by people realized that there could be a greater contrast between societal progress and economic growth. This led to never ending debate over the limitation of GDP as a measure of societal wellbeing or economic development

which resulted in the emergence of the new multidimensional indicator HDIHuman Development Index. What is Product?



Gross domestic product is used to measure the size of an economy by adding up the value of services and goods produced within the country during a particular period of time. Using the expenditure approach, GDP equals the sum of consumption, gross investment, government spending and (exports – imports) GDP = C + I + G + (X-M) This is the most commonly used measure by various economists, policymakers etc., for understanding how much a government could spend or for designing fiscal and monetary policies to keep inflation under control. Furthermore, the data needed to compute GDP is readily available for most of the

countries. What is Human Development Index? In 1990, acknowledging the growing difference between economic growth and societal progress levels, the United Nations came up with a new measure -HDI, which focuses on using people and their capabilities for economic development calculations. This measure is a geometric mean of normalized values of 3 important factors such as per capita income, health and education. The education dimension is measured by mean of years of schooling for adults aged above 25years and expected years of schooling for school entering aged children, and the health dimension is measured by life expectancy at birth.


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How good a proxy is GDP for HDI? In the recent times, both GDP and HDI have emerged as acceptable standards for measuring overall development and progress in the economy. But the revealed evidence of a positive correlation between GDP and other aggregate social economic indicators has prompted people to use GDP as HDI’s proxy for measuring overall economic development, thereby making HDI a redundant index. Before discussing further let’s verify the appropriateness of using GDP as a proxy for HDI. For empirical examination, I considered the GDP and HDI data of 137 countries for the year 2015. First, I calculated correlation coefficient to understand strength of association between the variables. Later, I checked regression statistics to understand how much variation in HDI is explained by GDP. From the above results, since significance F stands at 0.01155, considering 95% significance level, one can infer that GDP plays a significant role in explaining HDI. But R square stands at 4.5% levels, that is only 4.5% of the variation in HDI is explained by GDP. That proves that the regression line doesn’t exactly fit the data. Henceforth, it can be inferred that it’s inappropriate to use GDP as a proxy for HDI. GDP Vs HDI: Which is the better indicator? Most countries use GDP to measure standard of living and also design various economic policies based on that. Generally accepted argument for using GDP is that, since GDP is commonly calculated by many countries, comparisons will be consistent. But the 23

raising concern that GDP doesn’t convey information pertaining to distribution of income, education levels, medical facilities etc., resulted in the design of a composite Index HDI. The very contrast that GDP focuses on the expansion of income parameter, whereas Human development index embraces the societal progresseconomic, political, social and cultural which also affect income, results in a stark

difference in the ratings calculated by GDP method and HDI method. The above difference in the ranking of countries is because of various other factors such as life expectancy at birth, expected years of schooling, mean years of schooling and GNI per capita that have been included as part of HDI calculations but not in GDP calculations. In the below

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figure - HDI, GNI per capita, GDP & mean schooling years of top 10 countries by both GDP and HDI for the year 2015, the size of the bubble refers to GDP and the colour saturation refers to mean schooling years. The above figure proves that, though united states leads in terms of economic activity taking place within their boundaries, it doesn’t exactly mean that its citizens are better off than the rest of the world in terms of overall wellbeing. Another examplethough china ranks second in terms of GDP, it is the second largest emitter of carbon dioxide as per 2015 data. One more example is the consequence of cutting down forests for logging activities, a significant contributor to GDP. These instances further substantiate the limitations of GDP as an economic development indicator. That is certain activities that can have a negative impact on the people’s overall well-being can positively contribute to the

GDP. As per Human development report, 1996, five notable ways in which economic growth i.e., GDP can turn out to be problematic are:

Jobless growth, where economic growth doesn’t improve employment opportunities Voiceless growth, where economic growth is not accompanied by

empowerment or democracy Ruthless growth, where growth doesn’t benefit poor Futureless growth, where important resources have been exploited Rootless growth, which causes extinction of minorities i.e., tribal, female etc.


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From the above discussions it can be clearly inferred that, though GDP, a measure of economic growth, remains an important factor in determining the standard of living of people, but the impact of economic growth on overall well-being depends on other aspects such as environmental sustainability, social inclusion, inequality spread, medical facilities or social progress. On the other hand, HDI accounts for jobless growth and voiceless growth through literacy rate, ruthless growth through GNI per capita and rootless growth through life expectancy at birth of both females and males. HDI, however, has its own limitations such not accounting for moral and spiritual aspects of development i.e., it doesn’t penalize countries with high suicide rates, criminal rates etc. Further, it gives equal weightage to all three main components. However, if we look on a comparative basis, GDP emphasizes economic growth alone, whereas HDI considers overall societal wellbeing in an economy. Henceforth, we can conclude


that HDI is a better indicator of the economic development.

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By Shreyans Jain, IIM Lucknow

“These gale winds of disruption and innovation brought upon by technology, regulations and government action, will fundamentally alter the banking industry.” Nandan Nilekani, Former Chairman, UIDAI & Co-founder, Infosys Ltd.

in Financial Sector



innovations in digital technologies have unleashed what may be termed as the Fourth Industrial Revolution leading to transformation of consumer lifestyle and unlocking of value for businesses at an unprecedented scale. It has fuelled the emergence of business models with structural cost advantages that are offering solutions that are often simpler, cheaper, or more convenient for customers. This has led to a paradigm shift in the current phase (Exhibit 1) with the maturity peaks of Big Data analytics, Artificial Intelligence and the Internet of Things coming together to bring about a “combinatorial” effect - the capability of technologies working in tandem far exceed their capabilities when deployed separately. The term “fintech” may be defined as a combination of technology and financial services to create a highly integrated ecosystem for the development of disruptive instruments, processes, business models and compete against, enable and/or collaborate with financial institutions. In India, the ecosystem in which fintech thrives is called IndiaStack which is a collection of Application Program Interface (APIs).

Exhibit 1: Evolution of Digital Technologies


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As per NASSCOM, the global fintech software and services sector is expected to grow at a compounded annual growth rate of 7.1 per cent to USD 45 billion. In India alone, it is forecasted to touch USD 2.4 billion by 2020 from the current USD 1.2 billion with transaction value forecasted to reach USD 73 billion. It is, therefore, imperative for the concerned stakeholders to brainstorm ideas that can sustain this wave of disruption and challenge the traditional lending and payments space Fintech and the Challenge of Financial Inclusion The fintech phenomenon has the potential to vastly improve the prospects of financial inclusion in the country. The government’s Jan Dhan-Aadhar -Mobile (JAM) infrastructure makes it fertile ground for the rapid spread of fintech revolution. However, it is important here to pause and consider some examples from the pre-fintech era that provide the basis for contemporary and future developments. The Indian Railway Catering and Tourism Corporation (IRCTC), a Government of India enterprise with “Mini Ratna” Category I status, is a case in point that has facilitated access to ticketing services by people who were traditionally out of reach for the financial system. The IRCTC portal executes several thousand simultaneous logins and requests and is at par with leading e-commerce websites in terms of the volume of traffic. By integrating prepaid scratch cards and internet kiosks into its ecosystem, it has successfully brought people without any credit history into the financial mainstream and provided them ticketing services. Thus, disruptions of traditional 27

businesses is a way of looking outside-in (“what do consumers want?”), rather than inside-out, (“which parts of our operations can we digitize?”). A majority of financial institutions, however, have gone digital with the latter approach. In the process, they have essentially failed to appreciate the fact that due to low switching costs, consumers migrate to the next digital challenger, without a thought to the incumbents’ labyrinthine network of branches that they never visit. At present, the financial inclusion penetration in India is low, where 145 million households do not have access to banking services. This has opened up new avenues for fintech companies to bring the unbanked and the underbanked into the mainstream in areas like microfinance, digital payments, remittances et cetera. Next Set of Digital Disruptions in Fintech The emergence of fintech phenomenon in India is a prelude to the transformation in payments, lending and personal finance space that has manifested in significant investor interest in the recent times. Several ideas can be looked into to redefine the financial services sector in India. Exhibit 2 depicts the core banking service offerings and the corresponding technologybased alternatives.

1. Blockchain Blockchain may be defined as the process of initiating and verifying financial transactions in a distributed environment by making use of decentralized record keeping and reporting

functionalities. The emergence of permissionless platforms enabled by cryptocurrencies like Bitcoin have fostered innovation in this sphere. In other words, a new phenomenon called Internet of Money is fast replacing the traditional centralised system. For instance, over 700 alternate currencies around the world have established themselves on the model of Bitcoin. In developing countries like India, Blockchain can facilitate remittances and significantly reduce banking industry’s operational and infrastructure costs. The Reserve Bank of India, in its Financial Stability Report 2015, acknowledged the potential impact of Blockchain as a game changer. This is likely to attract accelerators and incubation programmes in near future to achieve scale sophistication and facilitate remittances, gold trading et cetera. At present, several projects in Blockchain are being piloted in India. For instance, IBM has announced the adoption of Ethereum for its IoT projects and has also launched an open source Blockchain initiative in collaboration with a number of partners such as London Stock Exchange, Cisco and Intel. 2. Next Generation Payments Healthy regulatory environment coupled with growth in e-commerce and increased tele-density has led to a major breakthrough in payments transformation. Mobile proximity payments through the use of Near Field Communication and QR code generation is expected to reach user base of 939 million by 2019 globally. In

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Exhibit 2: Core Banking Service Offerings and Technology-based Alternatives

India, the government as part of Cashless India initiative has launched the Unified Payment Interface (UPI) to enable customers to transact through a mobile application linked with their bank accounts. To further the goal of financial inclusion by leveraging the network of fintech providers in rural India, the Reserve Bank of India has granted licences to 11 Payments Bank and given inprinciple approval to 33 entities to operate as Bharat Bill Payment Operating Unit (BBPOU) and provide interoperable online-offline bill payment service. Exhibit 3(a) shows the volume and Exhibit 3 (b) shows the value of transactions using some of the contemporary financial services in India. 3. Peer-to-Peer (P2P) Lending Peer-to-peer lending (P2P) is a method of debt financing that

enables individuals to borrow and lend money - without the use of an official financial institution as an intermediary. It has provided a whole new credit solution over traditional lending models in areas like credit risk assessment, operational efficiencies, shorter disbursements cycles, customer experience and achieving low cost models. According to a Morgan Stanley research, P2P lending is estimated to increase to USD 290 billion globally by 2020 (Exhibit 4), growing at an expected CAGR of 51 per cent. The P2P lenders in India, broadly focus their portfolio under the categories of micro finance, consumer loans and commercial loans. With more than 57.7 million small businesses in the country, the market potential is huge. Some of the key players are Milaap, i2ifunding, LendenClub, Loanmeet, MicroGraam, Vote4Cash et cetera.

The loans from P2P platforms can turn out to be much cheaper compared to the debt raised from traditional banks or NBFCs. In the spirit of financial inclusion, lending in the P2P marketplace can be a potential game changer for businesses that are creditworthy but are unable to secure a loan from a bank. 4. Security and Biometrics

Banking industry is highly vulnerable to cyber-attacks and hence financial institutions are adopting cyber security solutions by deploying biometric technologies to use customer’s unique characteristics for identity authentication. By 2021, the global cyber security market is expected to reach USD 175 billion. In the Indian context, as more and more financial transactions are now 28

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conducted through electronic banking, fingerprint recognition has become the most commonly used technology for customer interactions. For instance, Kotak Mahindra Bank is promoting fintech start-ups by organising “Mobility Hackathon” to develop innovative applications in the field of cyber security. Similarly, ICICI Bank has launched ‘Smart Vault’, a fully automated locker, equipped with multi-layered security systems including biometric authentication, debit card & PIN authentication, and unique dimple keys that are difficult to replicate. The use of large amount of data generated due to digitisation in banking is a potential area that fintech companies can exploit to increase customer’s confidence in financial institutions. This requires development of a robust strategic framework and policy mechanism to strengthen cyber security of banking industry.

Exhibit 3(a): Volume of Payment Transactions (million)

Exhibit 3(b): Value of Payment Transactions (INR billion)

Conclusion A new wave of disruptions is threatening business models across the world. India is standing at the cusp of change where through convergence of finance and technology and by leveraging the Jan DhanAadhar-Mobile (JAM) infrastructure it can unlock unprecedented value for its citizens. By having the right models and architecture in place, fintech companies can quickly understand and operationalize emerging technologies without creating chaos in the system. The regulators and enforcement agencies have new paradigms to grapple with, but must be proactive so as not to stifle the growth of the fintech sector.


Exhibit 4: Global Marketplace Loan Issuance (USD Billion)

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Infineeti new year edition 2018  
Infineeti new year edition 2018