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Volume 2, Issue 4

September 16, 2011

Vinod gupta school of management, IIT KHARAGPUR RBI IS ONE STEP CLOSER TO ISSUING NEW BANK LICENSES

About Fin-o-Menal Fin-o-Menal is the Fortnightly Financial News Letter of VGSoM which is published by Finte`est, the Finance Club. Come, Take Interest in Finte`est!

Editors Rahul Ravi Sumitpal Singh

Rates As On Sept. 16th

47.18

65.08

74.59

7.38

Editors’ Note Look for a special cartoon section to commemorate the contributions made by Engineers

In line with the guidelines of 2001, that it would consider licensing more banks, RBI has come one step closer to issuing new bank licenses in private sector. RBI has come out with a set of guidelines for the same in the last week of August 2011. These guidelines have been framed, keeping under consideration, the 1993, the 2001 guidelines and also the feedback received for the discussion paper, on the same, of August, 2010. A few key points to be noted in these guidelines are: Eligible promoters – Private groups that are owned and controlled by residents can promote new banks. These groups should be diversified, should have sound credentials and also a successful track record of at least 10 years. This prevents first generation and young entities from setting up a new bank. However, RBI has prevented the groups with more than 10% of income or assets from either real estate and/or broking activities in the last 3 years from promoting banks. Corporate structure – These private groups should set up a wholly owned Non-Operating Holding Company (NOHC), which will hold the bank and any other financial companies in the private group. This NOHC should be registered with RBI as a Non-Banking Financial Corporation (NBFC). This arrangement essentially ring fences the financial services of the group and that of the bank from other activities of the group. These financial services companies of the group would be a part of NOHC and cannot hold shares in it. Minimum capital requirement – The minimum capital needed is Rs 500 crores. Out of this, the NOHC should hold at least 40% of the paid up capital for a period of 5 years. Shareholding excess of 40% should be brought down to 40% within two years of licensing, to 20% with-

in 10 years and finally to 15% within 12 years. The NOHC can raise the remaining capital from the public or through private placements. Foreign Shareholding – Aggregate non-resident shareholding (from FDIs, FIIs and NRIs) cannot exceed 49% for the first 5 years. After this period, the cap would be decided as per the extant policy. The present cap against foreign shareholding in private banks stands at 74%. Also, no non-resident shareholder can hold more than 5% of the paid up capital. Corporate governance – At least 50% of the NOHC‘s directors should be independent. The source of promoter group‘s equity should be transparent and verifiable. Other requirements – The bank should get itself listed on the stock exchange within two years. This ensures diversified shareholding. Shareholding of more than 5% of the share capital by any individual or entity or group needs to be prior approved by RBI.The bank should maintain a minimum capital adequacy ratio of 12% for at least 3 years. This value for the present banks stands at 9%.Existing NBFCs if given license can either promote a new bank or convert themselves into banks. The banks should open at least 25% of its branches in unbanked rural areas. Thus, RBI tried to ensure the stability of the system by imposing restrictions. The draft however did not talk about the merger and acquisition of corporate houses with smaller banks. RBI has sought the feedback on these guidelines to be sent by October 31, 2011. After that the final guidelines would be issued and much awaited applications for new banks would be invited. However, one more point to be noted is that RBI might not be able to issue licenses to all the eligible applicants. So, while all these conditions are necessary to apply, these are not sufficient to get a license and the decision lies with the RBI. (Contributed by Ramya Krishna P, MBA, 2nd Year)

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Fin-0-Menal

Volume 2, Issue 4

Markets This Week Index

BSE

NSE

Opening Value (Aug 1)

16933

5084

Closing Value (Sep 2)

16963

5109

Change

-0.18%

-0.49%

(As on September 16, 2011)

Commodities This Week Commodity

`

Unit

GOLD

27550

10 gm

SILVER

64373

Kg

OIL

4225

Barrel

(As on September 16, 2011)

Sectors This Week (BSE) Indices

Last close

BSE IT

5402

AUTO

7442

BANKEX

9921

BSEPSU

9931

METAL

17951

(As on September 16, 2011)

September 16, 2011

Yuan versus Dollar: A duel in the making The recent happenings in the world economy are hinting at a new development. The viewpoint that is gaining in popularity is that the stage is all set for Yuan to replace Dollar as the Global currency. Before looking out further on that possibility, let‘s dwell a little on the definition of Global Currency. The Global Currency is also referred to as the Reserve currency or the Anchor currency. It is held in significant quantities by many governments and institutions as part of their foreign exchange reserves. It also tends to be the currency of international pricing for products as well as for commodities (like oil, gold, etc) traded on the global market. Thereby, as of the scenario until now, Uncle Sam makes commodity purchases at a marginally lower rate than other nations, which ought to exchange their currencies with each purchase and also pay a transaction cost. For major currencies, the transaction cost is negligible with respect to the price of the commodity. More interestingly, USD being the Global currency, its government enjoys borrowing money at a better rate as there will always be a larger market for USD than other currencies. It also helps to infer, how the superpower could reach such a level of debt, tumultuously shaking the world all over again. Now let‘s bring into purview the million dollar question of what Yuan is up to. Great economist Avinash Persaud once remarked that, "reserve currencies come and go‖. But for this to be true, a lot needs to actually happen. The possibility of it becoming a reserve currency is certainly there. Moreover, certain steps have been taken by China to promote the greater use of Yuan (also known as Renminbi (RMB) internationally). Though all of it is still in a nascent stage, but China is surely making the right moves and there are some concrete reasons for this. Beijing holds $2 trillion in dollar assets, accumulated through years of exports

to America and massive purchases of Treasuries by the Chinese government. If Washington can't rein in its mounting budget deficit, both Treasuries and the greenback would weaken considerably—and the Chinese could end up on the losing side. Apprehensive about this real picture, China proposed the idea of replacing the dollar with a basket of currencies supervised by the International Monetary Fund. The Sceptics may beg to differ on this. They are of the view that the Chinese were merely talking. Also they argue that the USD is not only the reserve currency but also the international currency of choice with the backing of U.S.A, by far the world's largest economy. So even if the Chinese were to bring the Yuan into competition with the dollar as a medium of international trade, they would have to turn the Yuan into a convertible currency whose value would be dictated by the market (with traders, investors, governments, and companies around the world freely buying and selling it). Can we ever expect such a loss of control by the authority loving Chinese? It would mean lowering all kinds of financial trade barriers, allowing foreign access to Chinese securities markets and much more. The chances of that are pretty slim. Another is the absence of a large market for Yuan-denominated bonds. One key sign of acceptance as a reserve currency would be if the western world purchased bonds denominated in Yuan and sold them at market rates. Until now, Yuan-denominated bonds have been sold only by Chinese banks, along with multilateral banks such as the Asian Development Bank and International Finance Corporation. Furthermore, the bonds have been sold only in China. Still we as neighbours (in a very diplomatic sense of the term!) see a bright future for Yuan and expect large volumes of free bilateral trade with a freely convertible Yuan. (Contributed by Akash Krishnatry, MBA 1st Year)

TEASER LOANS: The Wrong Move Teaser Loans have been designed to tease, or attract a home loan borrower in seeking a new loan. These loans have a relatively low, fixed interest rate in the initial 2 years; say around

8 to 8.5 percent. However after the honeymoon period (initial years where they have to pay low rate of interest) the borrower needs to move to floating interest rate existing at the

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Fin-0-Menal

Volume 2, Issue 4

Did You Know? The

N.A.

after

the

name of a bank indicates it‘s a national bank, it stands for ―National Association.‖ It means that the bank is chartered by the Office of the Comptroller of the Currency.

International Markets this week

(As on September 16, 2011)

US Dow Jones

London LSE

Japan Nikkei 225

HongKong Hang Seng

11509

8864

5368

19455

Specified time. The well-to-do start In India, teaser home loans were introduced in January 2009. The initiative which was first introduced by State Bank of India (SBI) was soon followed by other banks. Initially home loan borrowers, fearing the rates to increase in the near future, found the concept of teaser loans very attractive as they would have to pay low interest in the initial phase, but they seemed to ignore the fact that after completion of the honeymoon period, when the borrowers will start repayment at the floating rate, the shift in the EMI will be huge, resulting in disruption in their financial planning. The same results in increased default payments affecting the asset quality and profitability of the banks. However teaser loans had some advantages at the first place:  With low rates of interest initially, teaser loans made home loans affordable for new borrowers.  It served as an advantage to borrowers, especially if there was likelihood for the rates to move up shortly. RBIs Concern RBI was smart enough to soon anticipate the consequences. They knew well if interest rates go up after the initial period (first one to three years where interest rate charged is much less than market rates and fixed also), higher EMIs may become a burden to the borrowers. Such situations may force borrowers to default on repayments. Large scale defaults may even lead to a ‗sub-prime' kind of crisis. Keeping the above points in context, the Reserve Bank of India has expressed its concern that in case the floating rates shoot up, bor-

September 16, 2011

owers could default in their EMI payments. Such EMI defaults are not a good sign for the borrower or for the asset books of the lending bank. Therefore, RBI has recently increased the teaser loan standard asset provisioning to 2 percent from 0.4 percent, and has capped the home loan limit at 80 percent of the value of a property. The major issues raised by RBI were: One of the major concerns of the RBI is the EMI affordability once the rates are revised. With the shift in interest rates, the resultant EMI could end up being a burden to the borrower, especially if it is much more than what was expected. With banks following aggressive practices to lure new customers, borrowers are seldom made to understand the difference in the initial years EMI versus the EMI for the rest of the loan tenure. Many lenders do not provide appropriate illustration of the interest regime, after the initial discounted period. Many banks do not follow stringent and accurate evaluation of the borrowers financial and repayment capacity. Such evaluation should be ideally done taking into account the borrowers repaying capacity at normal lending rates, at the time of initial loan appraisal. If not done properly, the borrower could end up finding the remaining EMIs a burden. Tips for the borrower opting for Teaser Loans  Ask your bank to give you the average loan rate. Though this average loan rate is based on the current base rate of the bank, it could serve as an indicative rate to understand the lenders reference rates, and do a comparative study between other lenders.  From July 1, 2010, all loans would be priced under the new Base Rate system of the bank, ( C o n t i n u e d o n p a g e 4 )

Quote Un-Quote

"The fact that the troika is returning means that Greece has started doing some things that need to be done.", Angela Merkel, Chancellor, Germany allaying the fear of Greece‘s bankruptcy. Toon of the week

Quick Quote: The only thing money gives you is the freedom of not worrying about money.

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Fin-0-Menal instead of the earlier Prime Lending Rate. This system is transparent and has no arbitrariness to borrowers. Understand your lenders base rate system, as the interest rate after 2 years would be benchmarked according to this.  Work out your Home Loan affordability by analyzing your financials before loan disbursement. EMIs are subject to prevailing market conditions after the initial years. So ensure you are able to factor in for times when the rates shoot up. Check for personal factors such as a salary rise or promotion.  Ask your lender about prepayment clauses. Check for the flexi-

Volume 2, Issue 4

September 16, 2011

bility and penal interests for prepayment and balance transfers. The main issue arising in a teaser loan versus a regular home loan is that no clarity is available to borrowers, on the subsequent interest rates after the initial fixed rate years. It is only after the initial tenure, that borrowers get the actual lenders reference rates and an understanding of the effective cost of the loan. With RBIs stringent move, we could probably hope for more transparency and prudence from lenders offering such loans. (Contributed by Partha Pratim, MBA, 1st Year)

Can we call them Credulous Rating Agencies? It can be blatantly claimed that Credit rating Agencies (CRAs) have played a vital role in assisting institutions take financial decisions, for the past couple of decades. Institutions and individuals across the globe rely on the CRAs for extensive research and guidance to take an investment decision. The reputation of the company in primary and secondary markets, the investors it attracts and the ease with which credit is available to it, largely depends on its ratings by the CRAs. Although the agencies provide critical information, the failure to predict major occurrences such as the Mexican crisis and the sub-prime crisis of 2008, has raised serious concerns and doubts. Hence it is critical that major financial institutions complement their reliance on bond rating agencies by adhering to internal assessment and research, and reviewing the ratings over the entire life of a bond. Major players on a global scale are Moody‘s, Fitch and the very famous Standard and Poor‘s. Each institute has different models to evaluate the credit worthiness of a company/country which directly affects the rate which the issuing firm will offer to purchasers of the bond. The ratings not only affect the investor but also the company by changing the cost of borrowing that the company wants to leverage. Such an action by the issuing firm raises the cost of capital and the interest expense of the company, resulting in lower profitability. Marketability of bonds, the ability to borrow and repay capital, and the ability to issue stock are some of the ingredients of the psychological aspect of how a company is looked upon. No wonder a downgrade in the ratings of a country like the U.S - the economic powerhouse of the world, has had unbearable repercussions across borders. It was an unprecedented blow that took the country to the brink of default. Let us take a closer look. ―The downgrade reflects our opinion that the fiscal consolidation plan that the Congress and the Administration recently agreed to, falls short of what, in our view, would be necessary to stabilize the government‘s medium-term debt dynamics‖, said Deven Sharma of S&P. Sources within S&P stated that the U.S. is headed for another downgrade in the coming year and the credit rating outlook is ―negative‖. "The global system must now adjust to the many implications and uncertainties of the once-unthinkable loss of America's AAA," said Mohamed El-Erian, co-chief investment officer at Pacific Investment Management Co which oversees

$1.2 trillion in assets. The political gridlock in Washington with a backdrop of the slow economic growth in U.S. resulted in the worst week for markets since the recession in 2008. The S&P stock index plunged 10.8% with bourses fearing that a double dip recession was knocking at the door. The US Treasury and the White House downplayed the allegations and in a furious assault blasted S&P‘s misleading calculations and breath taking refusal to change its mind. The Treasury Officials unearthed an erroneous calculation amounting to 2.1 trillion US dollars, which they perceived was enough to see the US retain the elusive AAA status. Warren Buffet looked who holds around USD 40 billion in US treasuries said that the downgrade ―does not make sense, it doesn‘t at hand is a perfect example attempt me to sell‖. Eventually Deven Sharma stepped down. The issue emphasising the impact ratings can have. Ratings can make or break a nation. The fact that no one questioned the rating agencies prior to the 2008 crisis is testimony to the fact that we cannot do away with them. Their methods and models are time tested and were not under scrutiny, until recently. With the amount of information today and the fluctuations of the market, the ratings have to be the first step before taking any decision, but they have to be scrutinized and the trends have to be observed. Rating agencies employ some of the brightest minds in the corporate world and have invested huge amounts of money to gain expertise in their domains. So replacing them is out of the context, the primary objective should be to ensure that they work effectively. Steps like bringing in more transparency into the process and adopting professional standards in rating a firm are the need of the hour. The CRAs should be more accountable, this can be probably done by setting up a central body which regulates and rates the functioning of these rating agencies. The ones with poor ratings should be held accountable. An additional feature, wherein each regulatory body is allowed to reduce the reliance on these ratings for the institution it regulates, can be incorporated. It is also important for the modern day investor to learn that one should not blindly follow the ratings instead review the ratings and constantly question those ratings throughout the life of the bond. After all, courage consists in not blindly overlooking danger, but in seeing it and conquering it. (Contributed by Balajee Rao, MBA, 1st Year)

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Volume 2, Issue 4

September 16, 2011

GOLD ETF : AN EMERGING TREND What is gold ETF? Gold backed Exchange Traded Funds are essentially the securities that are designed accurately to measure and track the gold price. In gold ETF, gold is the main and the only commodity that is traded. It is very different from the general practice of buying and selling gold. Gold ETF is similar to trades of other commodities and resources except that the shares "reflect" the price of gold. Gold is stored by the Gold ETF in the form of ‗400 oz‘ London Good Delivery bars. Advantages of gold ETF:  No risk of holding physical stock  Low tracking error  Affordable  High Liquidity  Lower Cost The first point can be attributed to the fact that GETFs are issued in demat form. Affordable:-GETFs are ideal for small retain investors as they can buy just a single unit from the exchange. High Liquidity because GETFs can be easily bought / sold like any other stock on the exchange during market hours at real-time prices as opposed to end of day prices. As they are listed on the exchange, costs of distribution are much lower. Further, exchange traded mechanism helps reduce minimal

collection, disbursement and other processing charges. This ensures a lower cost. Gold ETF in India : Assets of gold ETF has grown threefold in August as compared to what it did in the same period last year. We can clearly see that the gold ETF has been a safe option for the investors for the past 2 year or so. The following graph depicts the turnover of the 11 gold ETF‘s currently in India. The Gold BeeS ETF from Benchmark Funds has the lowest expense ratio of 1%. The lower the expenses – the better it is because it leaves more on the table for investors. Expenses alone are not enough for classifying because one wants one‘s investment to be liquid, and need the fund to have good volumes too. Gold ETF Volumes in India : As you can see from the image – Gold BeeS, which has the lowest expenses also has the highest volume, and by a large margin too. Conclusion: For long, gold has been synonymous with status and wealth. Nowadays people buy gold as a protection against uncertainties in government policies and protection from their own currency. With the rising gold prices globally, investors have benefited off late by investing in Gold ETF‘s. (Contributed by Kunal Verma, MBA, 1st Year)

Role of Bharat In India After the liberalization of trade restrictions, India has come a long way today for its economy to be regarded as a modern success story. India, stimulated by the power of youth, higher education and rapid globalization, today boasts of one of the highest purchasing power parities as well as the 10th largest nominal GDPs in the world. As modern India is chanting the hymn of progress, there lies a great disparity within. It is the great Indian divide, an India versus a Bharat, an urban against a rural. Bharat - that part of rural India where the impact of world trade and globalization is still awaited to be seen, where house-hold consumption is still very low, where education is just a part and not a way of life. Or, is it really so? The FMCG companies have a different story to tell. These companies are now coming up with more and more innovative marketing strategies to capture this segment. Market research shows that the consumption of soaps, shampoos, washing powder, hair-oil and biscuits in rural areas is

nearly at par with that of urban India. Higher consumption also means larger distribution channels. Big names like Marico, HUL, Parle Products, Dabur India, Coca Cola, PepsiCo, Nestle and Capital Foods are not only trying to build strong distribution networks, but they are also trying to come up with new products specifically for the Bharat-segment. Some companies are trying to tap the niche segment within the rural segment by pushing consumers to pay a premium, while, some others are pushing the consumers for a trade-up. Some other companies, on the other hand, are pushing the consumers to shift from unbranded to branded products. With such major FMCG giants trying out different tactics to gain a large market-share, it only means one thing. The divide is narrowing. And as such, we can hope that Bharat soon becomes a part of the modern Indian success story. (Contributed by Dhiru Rabha, MBA, 2nd Year)

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