The "R" in reform - The Honest Truth By Ajit Dayal
Investing in India - Honest Truth by Ajit Dayal
The "R" in reform A  A  A
18 AUGUST 2008

In the mornings, I glance at the book of inspirations in my father’s room.

It is strategically placed above the TV set from where the chants of stock market movements are pelted out.
The thought for August 17th reads: "Reality is always open to revision - My choice plays a key role in whether I accept the world as it is or alter it to suit my desires."

Accepting, I guess, means not going against what is given. If there is corruption all around us, accept it. Better still, say some, be part of it and profit from it. Even better, say the most forward looking sages, import the corruption from anywhere in the world - duty free - and implement it here. "Corruption", observed the astute Mrs. Indira Gandhi "is a global phenomenon."
Accept it.
If there are bad practices in the US, import them into India. After all, we live in a globalised world.

Testing reforms.
And so the Reserve Bank of India’s review of the banking policy in April, 2009 is now seen as a litmus test for "reforms". As is the supposed review of the foreign ownership limits in the insurance sector. The easing of foreign ownership rules, say the enthusiastic followers of "acceptance", is what will propel the Indian economy to a new level.
It may.
Most likely, it will propel much of the Indian banking system to a new level of bad practices.

The people we wish to bring into India as large shareholders in the Indian banks are not saints.
That is a fact.
And while they may have not yet been convicted as sinners, they have certainly been proved to be proponents of greed.

Banks are supposed to be institutions that are devoid of greed. They are supposed to measure risk and take risk away from the system. Greed - and rewarding greed - is a very un-banking thing to do.

Table 1: Coming to a corner location near you... (source: Reuters)
(billions of dollars)
Merrill Lynch46.80
UBS 36.70
HSBC 18.70
AIG 16.77
RBS 16.50
Bank of America 15.31
IKB 14.73
Fannie Mae 12.74
Morgan Stanley 11.70
Wachovia 11.58
Deutsche Bank11.40
Ambac 10.30
MBIA Inc 9.43
Barclays 9.20
JPMorgan 8.70
Credit Suisse8.13
Washington Mutual 8.10
HBOS 7.50
Lehman Brothers 7.03
Bayerische Landesbank 6.75
Freddie Mac 6.70
Societe Generale 6.40
Mizuho Financial Group 6.24
Dresdner Bank5.00
Bear Stearns 3.40
Fortis 3.10
WestLB 3.10
BNP Paribas 2.70
UniCredit 2.70
Lloyds TSB 2.60
Nomura Holdings 2.46
DZ Bank 2.00
Natixis 2.00
Swiss Re 1.85
HSH Nordbank 1.70
LBBW 1.70
Commerzbank 1.24
Mitsubishi UFJ 1.19
Sumitomo 1.19
AXA 1.14
Total 403.97
But the world is now faced with economic uncertainty partly because banks forgot their religion and worshipped market share.
Much of the developed world has a bill of USD 400 billion to pay because the banks - and the employees they nurtured and promoted - forgot their duty.
And there is an estimated additional USD 600 billion of write-downs and losses from bad loans on its way

For some reason, the India-watchers are hoping that the RBI will allow the foreign banks to buy more shares in the Indian banks. Such a move, they claim, will show that we are serious on reform.

Why would we celebrate the arrival of banks and financial institutions that failed in their basic business of assessing and pricing risks?

I can see why the poor property developers sitting on millions of unsold square feet of office space and residential projects are keen on seeing some new spurt in vanished demand. Maybe all their press-plants of how strong the property market will finally hold true. A new banking ownership law will lead to some extra demand.

And I can understand why a few thousand individuals who are unlikely to see any huge bonuses this year - or any doubling of salaries - would like to see a new source of talent hunt. This will trigger a round of wage inflation that will make the awards of the Pay Commission look pale in comparison.

But, on a serious note, what is the benefit for India in allowing people who have yet to prove that they can be "bankers" to own and control banks in India?

Will they teach their banks the own in India how not to be bankers? How to lose sight of risk and focus only on return? How to lose billions?

True, the Indian banking system is not perfect. There are some really large banks that have raced to become large focused on market share. They have acted in a manner that is at a risk to the definition to the word "banking". Rather than letting the aggressive banks move into India, maybe these banks - and their management teams - should be sent to the US, UK, and Europe where they will fit in with the prevalent definition of "banking".

Insure your commission
Allowing global insurance companies to own a large stake in Indian insurance companies is another big banner of the reform flag. For general insurance - the business of insuring oil rigs, pipelines, power plants, and factories - one can see the merits of spreading an India risk in a global basket.

And I am not sure why this is a good thing for the life insurance side of the business. The policies are sold to local Indians. The liability is to local Indians. The currency of use is the Indian Rupee. Actuaries have based their calculations on the lifespan and health factors for local Indians. The money that is collected is invested in local rupee assets to be paid out to the local Indians when they retire. How does a foreign insurance tie-up with a majority equity stake - or any equity stake - help?

Oh, yes: they will improve the reach and they will being new marketing skills.

That is why the insurance industry is facing the largest amount of churn on record. The marketing geniuses are mis-selling products to gullible investors.

Up to 40% of the premium earned in the first year on many products is paid out to agents. One of out six policies sold by the more aggressive agents "lapses". The poor policy holder probably can no longer afford the product or realises they were sold something they did not want. If you buy those cocktails - spiked to give your portfolio a high - called ULIPs, then one out of five "lapse". All this with a 26% ownership equity level by the foreign insurance companies. What could happen when insurance companies are 51% owned by foreign entities?

There is nothing sacred about these large foreign insurance companies, they are mortal. They have made mistakes. They have committed practices that their home regulators have frowned upon. In 2001, many of these biggies were in trouble: they lost control over how they had invested their portfolios. Some of them have already announced problem investments in this current mortgage crisis.

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On the health insurance side, studies in the US have shown that patients are spending about USD 130 billion a year on tests that are deemed unnecessary. A function of a doctor-pharma-insurance world that works in a "defensive medical" environment. No one wishes to get sued so everyone is happy making the patient spend more - it all gets recovered from higher health insurance premiums. That means, from you! And India is "reforming" its way to this model.
Higher medical health insurance premiums are here to stay.

As for reach: they are reaching deeper into your wallet for sure. The real reach of covering more Indians is still being done by the likes of Life Insurance Corporation.

There is nothing wrong in allowing foreign banks, insurance companies, and institutions to own and operate companies in India. But we should know what we are importing. To think of an increase in foreign ownership as a plus for "reform" is stretching it. The reality of such a reform is that it will import not-so-good practices and India will pay a price for it. Then we will be truly global. And our desires will have been fulfilled.

Suggested allocation in Quantum Mutual Funds
Quantum Long Term Equity Fund Quantum Gold Fund
Quantum Liquid Fund
Why you should own it: An investment for the future and an opportunity to profit from the long term economic growth in India A hedge against a global financial crisis and an "insurance" for your portfolio Cash in hand for any emergency uses but should get better returns than a savings account in a bank
Suggested allocation 80% 15% 5%

Disclaimer: Past performance may or may not be sustained in the future. Mutual Fund investments are subject to market risks, fluctuation in NAV's and uncertainty of dividend distributions. Please read offer documents of the relevant schemes carefully before making any investments. Click here for the detailed risk factors and statutory information"

Note: Ajit Dayal, the author is a Director in Quantum Information Services Private Limited and Quantum Asset Management Company Private Limited. Views expressed in this article are entirely those of the author and may not be regarded as views of the Quantum Mutual Fund or Quantum Asset Management Company Private Limited or Quantum Information Services Private Limited.

Mutual Fund Investments are subject to market risks. Please read the offer documents of the respective schemes before making any investments.

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