Banker’s Musings

I have been working on the lending side of a bank’s business for over a decade now. And, it’s been a really mentally invigorating and hugely satisfying experience for me. The real life cases added a new dimension to the knowledge I had gained from the studies for my professional qualification.

I plan to jot down a few instances of financial shenanigans of business units that I had come across in the course of my work. At the outset, I would like to clarify that these cases were not illegal / fraudulent acts per se, but ones that were somewhat uncomfortable/non-prudent from a banker’s point of view. And, for the sake of privacy, I will not take any names either. The objective of this exercise is to bring these acts to the notice of others like me, so that everyone can be alert to such things.

Case 1: Purchase of land from promoter-director

ABC Finance Limited is an NBFC and is closely held. Its source of funds for onward lending include capital & reserves, bank finance in the form of working capital limits and funds raised from issue of debentures which are listed on the BSE. For the sake of simplicity, let’s assume that bulk of source was the debentures, followed by bank finance and then by capital & reserves.

Now, the promoters had to comply with the regulatory norms regarding capital adequacy, necessitating infusion of capital. What did they do? They adopted a rather roundabout way for this.

The company decided to buy a large tract of agricultural land from the promoter-director, valued at ~Rs.12 cr! The funds to finance this purchase came from the proceeds of the debenture issue, the terms of which, rather conveniently, included ‘Any other corporate purposes’. I don’t recall whether the Memorandum of Association was amended just prior to this, but the ‘Objectives’ clause empowered the company to engage in agricultural activities too! The company then issued new equity shares on fully paid-up basis for the same amount to the promoter-director who was also the CMD of the company. 

To summarize, the capital base of the company got enhanced using the funds given by the investors in debentures for on-lending, without any ‘real’ fund infusion by the shareholders. No effective cash flow happened.

Though there is nothing illegal in this whole matter, from the perspective of corporate governance, there were serious lapses/shortcomings. I still wonder how the independent directors could remain silent regarding this Related Party Transaction (RPT) and ‘sham’ issue of shares.  The debenture investors were short-changed, in my opinion.

As a banker, of course, there isn’t much one can do on this, but a case like this reminds us that monitoring of RPTs should go beyond sales to /purchase from associated entities. The Credit rating system should have some mechanism to penalize the company for such weaknesses in its systems. The covenants for lending should be made stronger.

I’ll return with another case shortly.

Margin Call – The Film

Happened to watch the movie ‘Margin Call‘ the other day. I have to say this – it’s one well-made film on the financial crisis of 2008.

The film is set on the trading floor of a fictional (?) investment bank on the Wall Street. The events unfold over a timeframe of a little more than 24 hours or so.

What attracted me to click on the ‘Play’ button for this one? The actors’ names of course – Kevin Spacey, Paul Bettany (familiar to me through the ‘Avengers’ franchise) and Stanley Tucci (I’d liked him in one of the ‘Transformers’ movies).

A few things that I think the film got it right:

  • Not dumbing down the jargon and the use of natural conversation style among the bankers – e.g., the bit about actuals exceeding the threshold shown by VaR models.
  • A rocket scientist works as a trader.
  • The top management is shown to be almost clueless about the actual business model followed by their firm and their ignorance of operational nitty-gritties appeared very real! The head of the firm seeks to know the issue thus: “Maybe you could tell me what is going on. And please, speak as you might to a young child. Or a golden retriever. It wasn’t brains that brought me here; I assure you that.” (Emphasis mine)
  • Clueless though they are, the top guys very well know how to get out of a sticky situation by hook or crook – here, they decide that a fire sale is the best option, hence set up incentives for traders to achieve this; at the end of the day, many are retrenched too.
  • The way the retrenched employee played by Tucci is cajoled (or in a way, threatened) to return to and stay in office till the fire sale is over. And just how is he threatened? He’s told that his severance package and health cover – which he’d been promised less than 24 hrs earlier – will be withheld and also he’d be put through litigation, if he doesn’t oblige; on the other hand, he’d be paid by the hour, if he agrees to come over!
  • A scapegoat in the form of the Risk Officer, a lady, is also found really fast so that the management can easily hide their incompetence and move on. This is despite the fact that she had alerted about the build-up of risks earlier but was not taken seriously by the management. The misogyny is hard to miss!

In India, there is no active bond market unlike in the US. Instead, it’s the banks which fund the working capital and capex of businesses. And, at least from 2015, the growth in NPAs of banks has been a matter of concern in the economy. I recalled a few real life parallels i.e., some I have seen/experienced in my career, for some of the conversations / events shown in the movie.

At one point, the character played by Bettany says this:

“The funny thing is, tomorrow if all of this goes tits up they’re gonna crucify us for being too reckless but if we’re wrong, and everything gets back on track? Well then, the same people are gonna laugh till they piss their pants cause we’re gonna all look like the biggest pussies God ever let through the door”

More often than not, it is the frontline officials who are able to identify stress in an account – both in the case of existing relationships and new ones. However, again more often than not, they are unable to take proactive action to prevent slippages in asset quality or prevent extending finance to weak ones. Why, you may wonder. I’d say it is due to the fact that it’s more beneficial to the bank and the borrower to not recognise an NPA at the earliest – the bank doesn’t have to make provisions and take a hit on the bottomline and the borrower doesn’t get to worry about increased finance costs.

In the case of onboarding of new borrowers, if the appraising officials detect something wrong while carrying out due diligence, top management tended to ignore the warnings for the sake of business figures – if the dire warnings come true on a later date, they’d blame the dealing officials for not doing enough and correctly earlier, and if they don’t, they’d haul them over the coals for lost business! I recall how I’d fought (unsucessfully, though) to not onboard a particular business entity, and it turned NPA just after two years.

Another parallel is the way a sacrificial lamb is identified and given up when some loan goes wrong, instead of rectifying the underlying systemic gaps that lead to the issues. In the public sector banking space, in case of bad loans, the dealing officials are often caught up in the disciplinary proceedings of the employer and are also in the crosshairs of institutions like the CBI, CVC & CAG as well as the judiciary. All efforts are directed at ‘nailing’ someone at the earliest, instead of trying to identify whether the processes were faulty. It needs to be remembered that the sector is ever evolving and the borrowers are often a step ahead – the banks’ internal SOPs often fail to keep pace. The information asymmetry in a bank-borrower relationship also works in the borrowers’ favor.

I’d say, Conservatism and a healthy Scepticism are the best friends for a Banker on the lending side of the business.

Coming back to the movie, it is important to note that the movie does not set up anyone as the purely evil antagonist with mala fide intentions to game the system all along. The characters do what they do, as the system itself is so set up and they have to act in the best interests of the firm. It’s very well summarized in this dialogue:

“It’s just money; it’s made up. Pieces of paper with pictures on it so we don’t have to kill each other just to get something to eat. It’s not wrong. And it’s certainly no different today than its ever been. 1637, 1797, 1819, 37, 57, 84, 1901, 07, 29, 1937, 1974, 1987…..92, 97, 2000 and whatever we want to call this. It’s all just the same thing over and over; we can’t help ourselves. And you and I can’t control it, or stop it, or even slow it. Or even ever-so-slightly alter it. We just react. And we make a lot money if we get it right. And we get left by the side of the side of the road if we get it wrong. And there have always been and there always will be the same percentage of winners and losers” (Emphasis mine).

But, is there no way to remedy the ills? In my view, at least a part of the problems can be solved by altering the incentive structure in the system – by this, I do not mean the remuneration pattern, but incentives to nudge behavior of the participants in a certain manner. Noted financial sector analyst Vivek Kaul talks about this in his book “Bad Money: Inside the NPA Mess and How It Threatens the Indian Banking System“.

Looking forward to 2014

And thus 2013 has turned from ‘is’ to ‘was’….
Cherish the joys, however small, you had in 2013…..
Forget the failures, pains, disappointments 2013 gave you……learn and grow strong from them…….

In 2014,

Read more, at least one book every month
Learn something new
Work hard
Spend money wisely
Listen to music
Travel and see new lands
Pray, pray, pray….

May God keep you healthy…….!!!

Wish all my friends a wonderful New Year 2014….

 
And, being an Indian Public Sector banker, my additional wish-points are:
 
May the NPA woes ease out
May my Bank’s market capitalization jump & it become the numero uno Bank by value in India
May our salaries get a raise! [wink, wink!!]

Companies Act 2013 & Bankers – 1


Ministry of Corporate Affairs has notified the implementation of 98 sections of the Companies Act 2013 vide a notification dated Sept 12, 2013. The corresponding sections of Companies Act 1956 have since been repealed too.

The new Act is set to usher in a new regime of transparency and rule-based governance in the country.

A few sections of the Act have enormous implications for lending institutions in credit administration.

I thought I’d jot down a few of the features in a series of entries in this blog and think aloud on the implications for Banks. Hope it’ll be useful to all.

Sec 2(57) says that “’Net worth’ means the aggregate value of the paid-up share capital and all reserves created out of the profits and securities premium account, after deducting the aggregate value of the accumulated losses, deferred expenditure and miscellaneous expenditure not written off, as per the audited balance sheet, but does not include reserves created out of revaluation of assets, write-back of depreciation and amalgamation.”

Issue: Credit Balance in P&L Account has been left out. The “Highlights of the Companies Act 2013” brought out by the Institute of Chartered Accountants of India also points this out. Should Credit Balance in P&L Account be left out by Banks while computing the Net Worth of companies henceforth? If so, the leverage ratio will move up.

The new Companies Act has withdrawn many of the privileges and exemptions that were available to Private Limited Companies – e.g. Special Resolution is necessary for borrowings “exceeding aggregate of its paid-up share capital and free reserves” u/s 180; under section 293 of the erstwhile Act, this limit was applicable in a different manner and that too for public limited companies only.


Issue: Special Resolution would now need to be obtained in case of Private Limited Companies too, who form a large part of the borrower universe of banks, failing which the borrowing would be rendered unenforceable unless bona fides is proven! And, Indian judiciary often do not take a kind view on lapses from banks.

20 years of a new sound….20 years of A R Rahman

Today [Aug 15, 2012], it’s 20 years since the release of the Tamil Movie ‘Roja‘ which marked the debut of A R Rahman who has gone on to win 2 Academy Awards (Oscars) apart from a multitude of other awards…..well, reams of papers and Giga bytes of data have already stated the kind of impact he has had on the music scene, and on a music lover, and I do not intend to add to those. Instead, I’m trying to recount the effect he and his music had on me…

I do not recall when it was exactly that I found the connection between the name ‘A R Rahman’ and the kind of music I used to like, but I think it was in my Class 8, after listening to ‘Ooh La La La’ from ‘Minsara Kanavu’ that I decided that I have indeed become a ‘fan’ of this man’s music. Till then, through 1992-1995, though I had been finding songs from ‘Roja’, ‘Gentleman’, ‘Duet’, ‘Kadhalan’, ‘Bombay’ and ‘Rangeela’ (I had not heard tracks from films like ‘Puthiya Mugham’, ‘Thiruda Thiruda’, etc till much later) likeable, the attention I used to pay to his music (and later, his persona and the values he stands by) grew thereafter only.

Grew it did, and how!

It cannot be easily expressed in words – but everyone aged 4-15 in 1992 will be able to relate to it; let me make an attempt, though.

The period from 1996 is what I’d call as the ‘golden age of my fanboy-ship’ – replete with instances like the following:

  • Incessantly arguing with my friends about how AR’s music is better than anybody else’s: This tempered down after I watched AR on Simi Garewal’s show wherein he mentioned “Appreciate good music”; and I stopped arguing after he won Oscars – one, coz by now almost everyone I’d meet had at least one AR song among their favourites and two, I began to appreciate the fact there’s absolutely no use in trying to convince anyone about that, coz I can spend that time in listening to his songs.
  • Spending time on listening to whatever his I could lay my hands on: This ‘laying my hands on’ meant the (original) cassettes my parents would occasionally buy for me from my Class 10 onwards, those I would (sometimes, beg and) borrow from like-minded friends, etc. This sort-of ‘graduated’ to mp3s after I got a PC, (back to Original) CDs after getting a job, and now, legal mp3s from ‘Flyte’ at flipkart.com
  • Rote-learning the details in the inlay cards of cassettes and thus have all details of his tracks at my finger-tips: The important, positive fall-out of this is that I learnt the names of a variety of musical instruments and this would make me try to locate the instrument in the songs I’d listen to; this further made me realise the intricate layering AR adorns his songs with. Later, I also learnt a lot about the music-making process in vogue today – to the extent I once used to say that ‘Neve 88R’ is my fav mixing console, though to this day I have never been to a recording studio!
  • Reading all his interviews wherever they’d appear: initially it was in print, and now it’s all digital. Interestingly, from the time I developed a keen interest on AR’s works, it now seems that that the universe conspired to further that interest of mine – without much effort on my part, these would reach me! In the early part of the last decade, I came across the AR Fans’ group on Yahoo! and since then, collecting the trivia on him and his works has become a breeze.
  • I fell in love with Flute, Veena, Piano, Cello – well, all those instruments AR used in his songs.
  • Liking and adoring all those singers who sang for AR and being bowled over by how they used to be at their versatile best when with AR.
  • Developing a keen ear for the background score of movies and revel that AR’s BGM scores are the best.
  • Trying to figure out which all ads of late 80s had AR’s music; plus, trying to identify all those non-AR songs [in the 4 South Indian languages] of late 80s and early 90s that had the un-mistakeable AR touch in them (coz AR as Dileep had worked as keyboard programmer for all the leading composers then). It turns out that many songs I had so noted as having the AR touch in fact had his involvement – this gets revealed in the interviews / talks given by people associated with those films and I feel proud that my instincts were indeed right!
  • Occasionally feeling that AR’s position is under threat when some new composers came along – fed by some stupid write-ups, of course. But, AR kept surprising me through his songs; the said other composers surprised too, by their very short stints and shelf-lives, repetition, arrogance, lack of versatility, etc. I grew out of this insecurity after his Oscar wins. Well, no composer in India now is that versatile, as AR is.
  • Looking forward to every new soundtrack release of AR and being a part of whatever little hype is there for it (most of AR’s films are notorious for low profile marketing).

So, what were the other impacts on me? Let me recall a few.

The more I read about AR, the more I liked his personality traits – the important ones being Humility, Hard-work, Spirituality, Patriotism, Tolerance, Courage to tread the path not taken (Risk-taking), Loving one’s family and Treating one’s job like worship. These traits, I believe, everyone needs to incorporate into their lives.

Learn to accept variety and heterogeneity – not just in music, but also in everyday lives. There is the need to be open-minded and also keep our expectations low.

Being ‘open’ means, I now listen to other composers’ works too and also develop a liking to a few of them – but, after every such bout of ‘Other Composers’, ultimately I return to AR’s fold;  like they say about having food from hotel once in a while, but being too fond of that cooked by our moms!

There’s no end to it if I were to start writing / speaking about AR, but time constraints prevent me from going the whole hog now.

So, on this special occasion, let me thank you AR – for bringing tonnes of joy to millions of people thru your music. May God shower his blessings on you and your family and continue to inspire you to compose soulful tunes.

Like every AR fan knows, it’s difficult, nay next to impossible, to name just one fav AR track – still, if you were to ask me to name just one song of AR that gives ultimate peace of mind, I’d recommend ‘Silent Invocation A’ from ‘Connections‘, a non-film album of his. But, do listen to ‘Himalayas’ from the same album too….!! Yes, it’s difficult to name just one!

As a closing note, let me also add that, AR featured in one of my job interviews also – towards the end of one, one member of the panel sought to know what my hobbies are and I blurted out, “Listening to AR songs”; the next question was “What’s so special in his music?” and that was his mistake! I talked on end for the next 10 min or so on this!! The panel rounded off the interaction saying, “Pucca Rahman fan!” Yeah, they haven’t met the others!

Short takes – The Coal India Ltd’s dilemma

Last week, by a Presidential directive, the Govt of India advised (or arm-twisted, depending on the way one views it) Coal India Ltd [CIL], a GoI-owned listed company to enter into long-term Fuel Supply Agreements with Power Producers – to supply at least 80 percent of the requirements of these power producers – who have been troubled by the prospect of having to cope with sudden price spikes and even non-availability of coal. The decision has been in the line of fire from a number of quarters, starting with the CIL’s own Independent Directors and other investors, prominent among them The Children’s Investment Fund, Coal India’s largest foreign share holder, which recently initiated legal action against the government to protect its investment in Coal India.

The decision has been sought to be justified ostensibly with the public interest angle brought in, saying guaranteed coal supplies to power producers is vital to ensure the latter’s viability given the unexpected spike in coal prices in international markets. Coal prices are currently ruling above the levels they had projected while bidding for the Mega projects. The FSAs effectively will ensure that the power producers are insulated from price changes of coal, but CIL will have to supply coal to them at the agreed price (at a deep discount to market price), either from its own production or by buying from the market. The latter scenario now appears highly probable, as CIL has not been able to add to its capacities due, again, to governmental restrictions on mining. Thus, we now have a situation where a company has been forced – through a government diktat – to supply its produce at below-market prices to a group of predominantly private sector players (NTPC is a beneficiary too), who had engaged in competitive under-pricing at the auction stage. The price risk has thus been willy-nilly transferred to CIL, whereas ideally this price risk ought to have been factored in by the power producers while bidding, either through hedging or through appropriate pass-through clauses in the Power Purchase Agreements they signed with the Power Distribution utilities. The audacity with which a few players threatened to stall work at their sites lest assurance on fuel supply came through was to be seen to be believed!

Only time will tell the impact of these FSAs on CIL’s bottomline, if it is not able to augment its capacities soon.

Budget Wishlist 2009

My wishlist regarding the Budget proposals:
  • The budget should bring forth clarity about the taxation aspects of Limited Liability Partnerships [LLPs]. This will help foster their growth, especially since it is a better and less expensive form of constituting a business.
  • The New Pension Scheme, introduced recently, has not caught on, more so since it's on EET model. The FM needs to seriously consider the suggestions to bring parity between NPS and other savings schemes like PF etc. Otherwise, this very efficient and people-friendly scheme will be left without many takers.
  • Another aspect which needs the FM's serious attention is the issue of pricing of petroleum products. The prevailing method is quite messy and lacks transparency. The earlier this is resolved and fine-tuned, the better for the fisc.
  • This brings us to the topic of fiscal discipline. Even as there is the need for the state to step up its own spending, it needs to be seen that fiscal deficit does not turn out of control. Towards this end, stake sale of profitable PSUs is advisable. At the same time, to put more money into the consumers' pockets, tax breaks like raising the exemption level and/or restoring Standard Deduction are necessary. To raise revenue, dividends above a certain threshold limit can be brought under the tax net.
  • The Govt needs to move forward on the path of introducing Uniform GST. For this, FM should present a road map towards adoption of GST and abolition of CST.
  • Development of our creaking infrastructure is critical to ensure sustained growth. To raise revenues for these long-gestation projects, a vibrant bond market is vital. The FM should introduce the necessary reforms for the development of our bond markets.

The Mithya of Satyam; aka the Satya(m) of a Mithya!!!

Mithya –> Illusion

Satyam –> Truth (also, the name of the now infamous IT company)

It was with great disbelief that I heard the story of Ramalinga Raju’s confession. In fact, till I read it, on the web, I didn’t really grasp the enormity of the fraud. Now, his confession has showed us the ‘Satyam‘ behind a number of ‘Mithyas’. What are they?

Till recently, almost all write-ups on the economy and business environment had repeatedly pointed out that we have great / impregnable systems and checks in place and the absence of any major scandal after Ketan Parekh’s proved that. Who could have guessed that a gigantic one was taking place right in front of us, without anybody knowing about it? It’s next to impossible that the auditors and key finance personnel in the company could not find this out. Just the CEO & CFO managed to pull it off and that too for a number of years? No way, I’d say.

The fiasco showed us, again, that auditors, if not all of them, are hand-in-gloves with the perpetrators of frauds. However tight the auditing guidelines & accounting standards, if one is creative enough, fudging is incredibly easy. To find gaps, given the current technological advances in book-keeping & complex business processes, auditing professionals need to be highly skilled; we have a long way to go in this respect. Revenue recognition norms, especially for those firms in service industry, need a relook.

With Enron went Arthur Anderson; will Satyam episode lead to black-listing of PwC, given that it was already under the scanner for its role in the failure of GT Bank? No chance, if one were to look at the utterances from ICAI functionaries; they say action will be taken only against the partners and not the firm. Yours truly once had a great deal of admiration towards this firm; no longer it remains. A valuable lesson is that, being big is not a guarantee against failure; in fact, as you grow in size, stronger measures to manage operational risks are to be put in place.

Independence of independent directors is to be ensured through new means. One feels that, for companies which fulfil certain criteria in respect of their assets / market cap, SEBI should be the body which appoints independent auditors, so that, the independence is fully ensured.

Listed companies carry an aura of transparency with them, and subsequently, lower risk premia are attached to them. It is assumed that fear of a market backlash will prod them along the path of self-regulation. Raju’s confession tells us that it was his fear of such a backlash and takeover attempts that made him cook up the figures! That is a direct barb at the short-termism of market participants. In fact, one is tempted to say that we are living from quarter to quarter. The behaviour of markets soon after the announcement of quarterly results is too wild nowadays; the stock is battered, even in case of growth, if the growth is not as per analysts’ predictions and no thought is given to the long-term prospects of the company. Such an obsession with the Qn figures needs to be restrained.

One’s heart goes out to those investors who bought into the Satyam stocks on Jan 7, before the story broke. Who will compensate them [that is, the ones who have not yet exited], as well as others who invested in shares of other companies and suffered losses from the market meltdown that followed?

What needs to be done now?

  • Speedy investigation, trial & justice
  • Tighter regulation
  • Revamp of audit practice – it’s time competition is brought into the auditing profession; the ICAI’s monopoly over the same is not good for the profession and the country in the long-term [yes, I’m an interested party here; but that does not dilute the logic of this line of thought].