Changing Dynamics of Finance

Changing Dynamics of Finance

www.excelpublish.com


Editors Prof. Mrunal Joshi

Prof. Svetlana Tatuskar

Indian Education Society’s

Management College and Research Centre Mumbai—400050, India

EXCEL INDIA PUBLISHERS

New Delhi

First Impression: 2011

© Management College and Research Centre, Mumbai


ISBN: 978-93-80697-47-5

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Preface

It is a pleasure to bring out a volume on select papers presented at the 4th International Finance Conference at IES Management College and Research Centre, Mumbai, India on “Changing Dynamics of Management through Innovation and Creativity—The Finance Perspective”.

Around the world, the experiences and lessons emerging from the global financial-market crisis have created awareness among leaders – and indeed academicians – that crisis prevention requires several things. We need to engage in a fundamental reform of the regulatory framework for financial markets, we need a change in the behaviour of financial market participants and we need to undertake a critical review of some financial instruments. Therefore innovations and creativity have become the centrestone in the financial sector in order to avoid a repitition of the financial apocalypse. Innovation and creativity is seen as the possible solution to overcome any challenge in the corporate business environment.

Prevailing business scenario compels managers to be creative themselves and bring creative structural changes in business organization, market segmentation, product specification, as well as tangible and intangible service extensions. Re-examining own processes from different angles opens up doors of innovation and creativity that are ultimately desirable from the view point of cost reduction and cost optimization as an effective tool for corporate sustenance and growth. Instead of cost driven pricing businessmen are compelled to redesign the structure for price driven costing and new credit theories for better financial results and positions.

In the light of the above discussion, the edited book provides research concepts by Academicians; Research Scholars and Corporate Delegates that stimulate further thinking and innovative ideas to deal with challenges faced by contemporary practitioners in finance and related fields of management. The research views included in this edited volume encompass a variety of topics in finance like Banking and Insurance, Mergers and Acquisitions, Corporate Governance, Corporate Finance, Money and Capital Markets and many other multidisciplinary topics in finance with sharp focus on creativity and innovation.

We hope that this volume fuels your knowledge and creates new directions of research for each of you. We invite your comments and views to improvise the future editions and make this book more user-friendly. You may write to us at [email protected] or [email protected].

Acknowledgements

The Editors wish to thank Indian Education Society’s, Management College and Research Centre, Mumbai, India for having extended their support to organize the academic initiative of the International Finance Conference-2011 and edit this volume of IESMCRC-IFC-2011 research papers.

We sincerely thank and acknowledge the inspiration and direction provided by Dr. Dinesh D. Harsolekar, Director, Indian Education Society, Management College and Research Centre, Mumbai, and our Dean, Prof. Parag Mahulikar for their continuous support and encouragement at various stages of conceptualizing and planning the conference.

This edited volume of research papers has been possible only due to the enthusiastic response by the authors. Our sincere thanks and regards to the authors who have submitted their research papers for the conference. An overwhelming response from eminent faculty, practicing managers, research scholars, colleagues and students of Management towards the call for papers has been instrumental towards the success of the conference and this edited volume.

A large number of colleagues from academia and corporate came forward to accept the task of reviewing the papers received for the conference and offering their suggestions towards modification and alteration of the papers received. It is their critical review process that has added value to the quality of publication and has made it thought provoking and meaningful. We are grateful for their effort.

We would like to thank the Finance Conference Committee members comprising Faculty and Students who worked hard round the clock to complete this journey.

We would particularly like to thank Mr. N.K. Varun for providing enormous administrative support.

We would like to thank all our sponsors for their invaluable support. Last but not the least; we would like to thank Excel India Publishers, New Delhi for their support and cooperation in making the book available in time.

Contents

Preface v Acknowledgements vii

TRACK 1: BANKING AND INSURANCE

1. Financial Inclusion through Mobile Banking Gauri Prabhu 3

2. Rural Infrastructure Development Fund (RIDF)—An Initiative towards Inclusive Growth

Dr. Gopal K. Kalkoti 13

3. Effects of Macroeconomic Dynamics on BSE—A Case of Banking Stock Dr. Nageshwar Maruti Rao 22 4. Role of Financial Innovation in Making Banking an Organized

Competitive Sector Ragini Singh 34 5. Profitability Performance of Indian Scheduled Commercial Banks:

An Empirical Analysis A.N. Shukla and R.K. Bhardwaj 47 6. A.C.A.M.E.L. Model Assessment of Old Private Sector Banks in India Shweta Mehta and Dr. Nirvesh Mehta 53 7. A Study on Approach and Status of Financial Inclusion

in Indian Subcontinent Dr. Smita Shukla and Dr. Anjali Gokhru 68 8. Case Study on Documentary Credit Mechanism Sonali Dharmadhikari and Dr. H.G. Abhyankar 79 9. Banking on the Mobile—A Study of Mobile Banking in India Dr. Suresh Chandra Bihari 86

10. Changing Dimensions of Banking Sector in India Dr. T. Aswatha Narayana and Shankar Reddy P. 107

TRACK 2: CORPORATE FINANCE

11. Impact of Financial Leverage on Firm’s Value: An Empirical Analysis of FMCG Sector

Anshu Bhardwaj and Dr. Vikas Choudhary 117

12. Analysis of Dividend Payout Policy of Indian Companies and Multinational Companies

Dr. Archana Singh, Abha Tulsian and Bhawna 130

x Contents

13. Dividend Policy of Indian Multinationals Dr. Manisha Panwala 161

TRACK 3: CORPORATE GOVERNANCE

14. Tax Avoidance and Evasion: Issues within Corporate Governance Ashutosh Singh and Pankaj Shah 169

15. The Malfunction of Corporate Governance in India Dr. T. Satyanarayana Chary and P. Sagar 178

16. Corporate Governance Research in India: A Selected Annotated Guide to the Free Web and Empirical Work

R. Vishal Kumar and Dr. M.V. Subha 186

TRACK 4: ECONOMY AND INFLATION

17. Public Private Partnership is an Instrument of Faster Economic Growth of India: Perspective on Policies and Practices in Education Sector

Madhavi I. Dhole 199

18. Review of Changes in Monetary Policy and it’s Impact on Indian GDP & WPI

Dr. Mrinalini Kohojkar 209

19. The Great Inflation and a Recovering Economy Rashmi and C.A. Rishi Ahuja 219

20. Microfinance as A Panacea for Developing Economies Myth or Realty

Dr. Veena Tewari Nandi, S. Das and Dr. V.V.R. Raman 232

21. Leveraging Innovations for Successful Entrepreneurship Vivekanand Pawar 245

22. Social Entrepreneurship: Changing Face of India Dr. Gulnar Sharma and Mithisha Amin 258

TRACK 5: FINANCIAL CRISIS

23. Financial Crisis and its Impact on India Rashmi Gairola 273 24. Financial Crisis S. V. Pradeep Krishnan 298

25. Financial Innovations: Engine of Growth or Source of Financial Crisis Dr. Varsha Ainapure 307

Contents xi

26. Global Meltdown and Indian Financial Market: Some Issues Dr. Anil G. Suryavanshi 313

TRACK 6: INFRASTRUCTURE FINANCE

27. Infrastructure Finance Contrivance for Economic Ripeness Dr. Navneet Joshi and Khushboo Gupta 325

TRACK 7: MERGERS AND ACQUISITIONS

28. SEBI Takeover Code 2010: Assessment and Emerging Issues C.S. Balasubramaniam 337 29. Changing Dynamics of Management in Mergers and Acquisitions

through Innovation and Creativity Mohammad Murtuja 346 30. Mergers and Acquisitions in Indian Corporate Companies—

A Special Reference to Telecom Sector F.B.A. Hanfy and S. Ramesh 357

31. Analysis of Trends of Mergers and Acquisitions in India and Growth of GDP

Dr. Sanjay Namdev Aswale 370

TRACK 8: MONEY AND CAPITAL MARKET

32. Economic Value Addition to Shareholders Wealth Arvind A. Dhond 379 33. Fundamental Analysis of Indian Telecom Sector Dr. Keyur M. Nayak 388 34. Market Anomalies in the Indian Stock Market Girija Nandini and Dr. Bishnupriya Mishra 396 35. Recent Trends in Indian Capital Market Poonam Dhawale, Indrabhan Thube and Shivanand Fulari 406 36. Accounting Numbers as a Predictor of Stock Returns:

A Case Study of BSE Sensex Dr. Navindra Kumar Totala, Dr. Ira Bapna, Vishal Sood

and Harmender Singh Saluja 421

37. Investigating the Role of Prior Investment and Gender on the Investment Decision of a Casual Investor

Dr. Sumeet Gupta, Meenakshee Sharma and Mahendra Kumar Iktar 431

xii Contents

38. The Study on the Impact of Corporate Action Events on Stock Prices and Volume Behavior

Preeti Sharma and Mithilesh Kumar 440

39. Comparative Study on the Performance of Mutual Fund Industry of India in Past Five Years

Vidya Shivaji Shinde 453

TRACK 9: RISK ASSESSMENT AND RISK MANAGEMENT

40. Creative Multi Manifestations and Scope of Operational Risk Management in the Indian Banking SectorAftermaths of Basel II Implications

Dr. Deepak Tandon, Saurabh Agarwal and Shibumi Kalita 461

41. Measuring Interest Rate Risk Associated in Bonds with the Help of Portfolio Duration—A Study

Dr. Rekhakala. A.M. and Sahil Kapoor 484

42. Factors Affecting Exchange Rate of India— A Study of Major Determinants

Dr. Munira Habibullah 495

43. Strategic Risk Management J. A. Kagal 501

TRACK 10: SECURITIZATION AND RECONSTRUCTION OF FINANCIAL ASSETS

44. Mortgage Backed SecuritiesHow Far Secure Akinchan Buddhodev Sinha 509

45. Securitization and Reconstruction of Financial Assets— An Axe for NPAs

Dr. Ratna Sinha 520

AUTHOR INDEX 528

Track 1 Banking and Insurance

Financial Inclusion through Mobile Banking

Gauri Prabhu*

Abstract—According to McKinsey Report, March 2010, more than 65% of population of India does not have a bank account. However 80% of population owns a mobile phone. Thus, banking over the mobile phone will play a major role in financial inclusion.

With rapid urbanization, when people from rural areas start to adapt to city life, they create demand for goods such as television, refrigerators, and mobile phones. They emerge potential mobile banking customers, a fact that banks have been quick to spot. Mobile banking enables customers to transact on their own confidently and reliably without the need to visit a bank.

The aim of the study is to find out whether mobile banking will aid in financial inclusion. This paper uses primary data and secondary data to analyse financial inclusion through mobile banking.

Methodology/Approach used is examination of the demographic, attitudinal and behavioural characteristics of the mobile bank users.

Keywords: Mobile banking, Financial Inclusion, Aid, Demographic and Attitudinal Characteristics.

INTRODUCTION

We see the popularity of the mobile phone all around us and Mobile Phone has become an order of the day. A comparison between banking and mobile phone penetration in emerging markets is an eye-opener. According to McKinsey report in March 2010, in India, more than 65% of the population has limited or no access to a bank however, one out of two persons owns a mobile The banking penetration remains modest and this can be attributed to some crucial factors. However the integration between banking and telecom technologies will give birth to mass mobile banking.

In order to ensure a level playing field and considering that the technology is relatively new, the Government of India has taken the right initiative to set Industry standards for Electronic and Mobile payments to bring about desired effectiveness. The Reserve Bank has brought out a set of operating guidelines for adoption by banks for the Mobile Banking transactions in India.

There are in effect guide lines viz. Mobile Banking Guide lines, Prepaid Instruments Guidelines and the Mobile banking for the financial Institutions Mobile phones as a delivery channel for extending banking services have off-late been attaining greater significance. The rapid growth in users and wider coverage of mobile phone networks have made this channel an important platform for extending financial services to customers. With the rapid growth in the number of mobile phone subscribers in Indian, banks have been exploring the feasibility of using mobile phones as an alternative channel of delivery of banking services. Some banks *AISSMS Institute of Management (MBA), Pune

4 Changing Dynamics of Finance

have started offering information based services like balance enquiry, stop payment instruction of cheques, transactions enquiry, and location of the nearest ATM/branch etc. Acceptance of transfer of funds instruction for credit to beneficiaries of same/or another bank in favor of pre-registered beneficiaries have also commenced in a few banks. For the purpose of these Guidelines, “mobile banking transactions” is undertaking banking transactions using mobile phones by bank customers that involve credit/debit to their accounts. It also covers accessing the bank accounts by customers for non-monetary transactions like balance enquiry etc.

MOBILE BANKING

Mobile banking also known as M-Banking, SMS Banking etc. is a term used for performing balance checks, account transactions, payments, credit applications etc. via a mobile device such as a mobile phone or Personal Digital Assistant (PDA). The earliest mobile banking services were offered via SMS. With the introduction of the first primitive smart phones with WAP support enabling the use of the mobile web in 1999, the first European banks started to offer mobile banking on this platform to their customers.

Mobile banking has until recently, most often been performed via SMS or the Mobile Web. Apple's initial success with iPhone and the rapid growth of phones based on Google's Android (operating system) has led to increasing use of special client programs, called apps, downloaded to the mobile device.

Mobile Banking offers services which include facilities to conduct bank and stock market transactions, to administer accounts and to access customized information. Over the last few years, the mobile and wireless market has been one of the fastest growing markets in the world and it is still growing at a rapid pace. With mobile technology, banks can offer services to their customers anytime anywhere, receiving online updates of stock price or even performing stock trading while being stuck in traffic.

A wide spectrum of Mobile/branchless banking models is evolving. However, no matter what business model, if mobile banking is being used to attract low-income populations in often rural locations, the business model will depend on banking agents, i.e., retail or postal outlets that process financial transactions on behalf mobile service providers or banks. The banking agent is an important part of the mobile banking business model since customer care, service quality, and cash management will depend on them. Many service providers will work through their local airtime resellers. However, banks in Colombia, Brazil, Peru, and other markets use pharmacies, bakeries, etc.

India’s mobile phones will reach more than the targeted half billion people by the end of 2010 or 60 per cent of the tele-density, going by the country’s telecom ministry estimates. According to a report, approximately 43 million urban Indians used their mobile phones to access banking services during quarter ending August, 2009, a reach of 15% among urban Indian mobile phone user.

Reserve Bank of India (RBI) has taken progressive steps to accelerate the rollout and adoption of mobile banking services. Based on the requests received from the banks, the

Financial Inclusion through Mobile Banking 5

Reserve Bank of India has now hiked the daily ceiling for mobile banking transactions to Rs 50,000 per customer for both funds transfer and transactions involving purchase of goods and services.

Thirty-two banks have been given approval to provide mobile banking services in India. Of this, 21 banks have already started providing these services to their customers. ICICI Bank now has eight million customers registered for mobile banking services. It is closely followed by HDFC Bank & State Bank of India.

In RBI's Vision for Payment Systems in India- 2009-12, Mobile payments settlement network is one of the major projects intended to be pursued by banks. Technology will play a major role in these initiatives and will provide vendors new business opportunities in India.

While internet penetration and use in India is relatively low, mobile phone penetration is much higher and growing rapidly. There are over 200 million mobile phone subscribers in India and the number continues to explode. Financial services companies are now working with mobile payment players like mChek to offer innovative mobile phone solutions to urban and rural Indian population. Reserve Bank of India has restrictions on non-bank involvement in money transfer. Therefore, development of mobile financial services application is being sponsored by banks in India.

Mobile Banking Services

Mobile banking can offer services such as the following:

• Account Information • Mini-statements and checking of account history • Monitoring of term deposits • Access to loan statements • Access to card statements • Mutual funds / equity statements • Insurance policy management • Pension plan management • Status on cheque, stop payment on cheque • Ordering cheque books • Balance checking in the account and Recent transactions • Payments, Deposits, Withdrawals, and Transfers • Domestic and international fund transfers • Mobile recharging

Challenges for Mobile Banking Services

Key challenges in developing a sophisticated mobile banking application are:

Handset operability

There are a large number of different mobile phone devices and it is a big challenge for banks to offer mobile banking solution on any type of device. Some of these devices support Java


ME and others support SIM Application Toolkit, a WAP browser or only SMS. Initial interoperability issues however have been localized with countries like India using portals like R-World to enable the limitations of low end java based phones.

Security

Security of financial transactions, being executed from some remote location and transmission of financial information over the air, are the most complicated challenges that need to be addressed jointly by mobile application developers, wireless network service providers and the banks' IT departments.

Security of any thick-client application running on the device

In case the device is stolen, the hacker should require at least an ID/Password to access the application and authentication of the device with service provider before initiating a transaction. This would ensure that unauthorized devices are not connected to perform financial transactions. User ID / Password authentication of bank’s customer, encryption of the data being transmitted over the air, encryption of the data that will be stored in device for later / off-line analysis by the customer, one-time password (OTPs) are the latest tool used by financial and banking service providers in the fight against cyber fraud. Instead of relying on traditional memorized passwords, OTPs are requested by consumers each time they want to perform transactions using the online or mobile banking interface.

Scalability & Reliability

It would be expected from the mobile application to support personalization such as:

• Preferred Language • Date / Time format • Amount format • Default transactions • Standard Beneficiary list • Alerts

Application Distribution & Settings

Operator settings are not really meant for critical operations since most of the settings are used for entertainment based activities. For Mobile Banking it is another area where some Banks are facing challenges. While some forward looking Banks are overhauling their gateways and reducing their reliance on Mobile Operators settings to enable customer's phones, Some Banks are actually asking that Customers come with regular Operator settings which in many instances might not be correct configurations settings. Banks that are looking at competing at this sector must look beyond operator’s settings which might not be correct, delayed in arrival, may not come at all and not regularly updated. Some Mobile operators do update like every three months while some do not at all. For wap and Gprs based Mobile Banking applications, mobile network coverage will also be an issue.


FINANCIAL INCLUSIONS

Definition

Financial Inclusions means delivery of financial services at an affordable cost to vast sections of disadvantaged and low income groups Financial Inclusion may also be defined as the process of ensuring access to financial services and timely & adequate credit where needed by vulnerable groups such as weaker sections & low income groups at affordable cost. It mainly includes Savings, Credit, Insurance and Remittance facilities etc.

The Reserve Bank of India (RBI) says that financial inclusion is not restricted merely to opening of bank accounts and should imply provision of all financial services like credit, remittance and overdraft facilities for the rural poor. The accounts must be operational to provide benefits beyond deposit of money like availability of credit, remittance facility and overdraft among others.

Statistic

The one billion number that today represents mobile phone owners in emerging markets without a bank account will grow to 1.7 billion by 2012. Similarly, un-banked users of mobile money will grow almost tenfold to 360 million from 45 million today. There’s an annual business worth $8 billion for the taking: $5 billion to be earned through direct fees for financial services rendered whenever someone uses the mobile phone to make a purchase or P2P payment, and another $3 billion in indirect revenues arising from the usage of voice, network and other services over mobile.

With 85% of mobile subscribers being prepaid and a monthly spend over $2 bn, it is the low hanging watermelon. Mobile banking, which is catching up fast in the cities and hinterland, is not only helping the government to take a step forward towards fulfilling its aim of having one bank account for every household, but also saving it crores of rupees by way of reduced transaction costs. While the government incurs a transaction cost of Rs 12-13 for every Rs 100 it shells out, mobile banking helps it reduce the cost to a mere Rs 2. RBI estimates that around 40 per cent of Indians lack access to formal financial services and are largely 'unbanked'

Financial Inclusions through Rural M‐ Banking

Mr. Sam Pitroda, advisor to Prime Minister on public information, the person who brought in the Telecom revolution in India, has said in a seminar on financial inclusion, that over 250,000 panchayats will soon be connected with broadband connections. He is planning to bring fibre cable to majority of them. According to him, financial inclusion cannot be achieved without inclusive growth and every initiative should be directed at the rural poor. He said mobile banking is the next big challenge for government and it will change the nature of banking in India. If merchants, bank and operator can come together, they can develop a platform for mobile banking. Mr. Pitroda said he is trying to set up new platforms for the new generation. For the first time we are a country of 600 million connected people.


Thousands of people from rural areas across 12 states are likely to get their social security pension and wages paid under the National Rural Employment Guarantee Act (NREGA) scheme with the help of mobiles over the coming few months. In Andhra Pradesh alone, for instance, 250,000 people have registered for mobile banking services. The state government is rolling out a programme to enroll three million people by the end of 2008. Mobile banking pilots and full-scale operations has been conducted across 12 states, and the entire ecosystem is being managed by the government with the help of the Reserve Bank of India, banks, leading telecom operators and technology implementation partners.

A Little World (ALW), a technology implementation partner, has collaborated with NXP Semiconductors to design a mobile for the AP government that encloses an RFID card, and works with ALW's micro-banking platform ZERO. The mobile acts as a branch of the bank by storing a database of customers. It also has a smartcard, which biometrically stores the identity of the customer such as name, address, photograph, fingerprint templates and relevant details of the savings or loan accounts held by the issuing bank. Customers get a secure electronic identity via phone or smartcard, while agents take deposits and dispense cash. ALW works with the banks on a revenue-sharing basis.

Anurag Gupta, founder director & CEO of ALW, says: "We have carried out pilot projects with SBI in villages located in some of the most inaccessible and difficult terrains of the country such as Pithoragarh in Uttarakhand, Mizoram, Meghalaya, and remote villages in Andhra Pradesh." Lokanath Panda, director, ALW, also pointed out that SBI had tied up with the Indian Post to extend banking services especially in unbanked/under-banked areas. "Select post offices will make available to the public SBI's deposit and loan products, and ALW is the technology partner." ALW is also conducting a pilot programme with SKS Microfinance and the Bank of India to provide a mobile banking service that works on BSNL SIM cards.

Airtel has already partnered with the Indian Farmers' Fertilizer Cooperative Limited (IFFCO) to set up IFFCO Kisan Sanchar Limited in Rajasthan. Under this initiative, the cooperative department will provide mobile handsets to farmers at marginal price through its outlets in the rural areas. These handsets would be loaded with green SIM cards, which will flash daily updates on agricultural practices and weather forecast free of cost.

While he did not provide details, Kapoor hinted that the partnership deal would be extended to mobile banking services too. Kapoor reasons that with 55 per cent of the mobiles being internet-enabled, mobile banking would help bridge the digital divide.

ICICI Bank account holders with Reliance handsets (even the low-end Rs 1,000 ones - with or without Internet connectivity) to make intra-bank (to ICICI account holders) money transfers. It has already tied up with HDFC to offer Reliance mPay - a virtual credit card.

Other M‐Banking Business

Mobile Commerce: The Next Wave in Electronic Payments.

Not only is the humble mobile a communication device pervasive across all wage earners, but also a Point of Sale (PoS) for the merchant boss. With prohibitive upfront costs and recurring expenses taken care of, the mobile becomes an ànytime, anywhere' device or a wireless PoS.


Clearly, India seems to be one step ahead of Europe and North America in this- more by default perhaps than by design. The second low hanging fruit lies at the other end of the SEC scale-domestic money transfer. Clearly, while all wage earners carry mobiles, not all wage earners will have a bank account or even want to step sideways through the portals of a bank. This informal economy abounds in 80% of India and will continue to do so.

NRE Transfers through MBS

Corporation Bank and Tata Teleservices have launched the first pan-India mobile-based financial inclusion service called `Green'. Initially, it is for mobile money transfer between migrant workers working in metros and tier-1 cities sending money back to their families in Karnataka and Kerala. This is a simple model where both the sender and the beneficiary open `no frills' accounts at PCOs, and then are able to remit money. The service is powered and the brand is owned by PayMate. The next step will be, only one of the parties needs to have a `no frills' account. And in due course, for the service to be viable and popular, perhaps it will need to evolve into a cash-in and cash-out service at either end, with no need for a mandatory bank account. And in time, perhaps, a UID linked to a job card. This is where NREGA marries with the UID project.

Retail Markets in India

But all this will come to naught if the `merchant boarding' for a mobile payment is not mature enough to handle these transactions. The retail market is in a constant state of flux. E-Commerce broke the stranglehold that brick-and-mortar retail held for over 50 years. Today, e-commerce is well-established and popular for most of our daily needs and aspirations, whether they be ticketing, e-shopping, gifting, entertainment, utility bills, etc. An online retail merchant ecosystem is critical for e-commerce, which has flourished into a $3 bn industry today.

Retail in India is a $320 Mn market. Merchant establishments are key to the growth of organized retail and electronic payments. In that respect, we are frightfully low down the chain when it comes to the number of retail outlets, which are electronically enabled even 20 years after the emergence of the credit card and PoS. The conclusion: a penetration of less than 3%. Clearly, that is both a lacuna, yet opportunity. The traditional model is that the EDC has an initial cost, a recurring expense, and a cost to merchant (merchant discount rate), etc. The adoption perhaps has been a problem not only because of these very factors, but the fact is that the local store funds your credit for 30-45 days, depending on your relationship.

This huge base of unorganized SME merchants is what has hitherto been untapped and for whom the current model of merchant discount rate, PoS/EDC infrastructure may never seem worthwhile. That is, until the mobile PoS device came along and changed the economics of the industry, or in Internet parlance, dis-intermediated the existing stakeholders. Not only is the humble mobile a communication device pervasive across all wage earners, but also a Point of sale (PoS) for the merchant boss. With prohibitive upfront costs and recurring expenses taken care of, the mobile becomes an ànytime, anywhere' device or a wireless PoS.


OBJECTIVES OF RESEARCH

• To study the awareness of mobile banking. • To find out whether financial inclusion is possible through mobile banking

RESEARCH METHODOLOGY

The research method used was the structured survey research. A questionnaire was prepared and addressed to the residents of Pune‘s elite area i.e. Deccan Gymkhana which represents the urban population of Pune and the villagers of Khanapur and Donje, Mulshi area which represents the rural population. The sample size selected was 200 people from urban and 150 people from rural areas of Pune.

FINDINGS & ANALYSIS

• Out of the total urban population 56% were male respondents and 44% were female respondents. Out of the rural population 77% were male respondents and 33% were female respondents.

Fig. 1: Percentage of Respondents

• Out of the total respondents 95% owned mobile. Rest 5% used their relatives or friends mobile.

MOBILE OWNERSHIP

OwnersNon-Owners

Fig. 2: Mobile Owners


• Out of the total urban population 82% had bank account while only 26% of rural population had a bank account. This shows that most of them have a mobile phone but don’t have a bank account.

• It was observed that 42% of people used GPRS facility on their mobile. The rest used mobile only for communicating.

• Out of the total respondents only 12% were aware that banking service can be availed over the mobile.

• 40% of the respondents expressed their willingness to use mobile for banking purpose.

WILLINGNESS

% Willing% Non - willing

Fig. 3: Willingness of Mobile Users to Use Mobile Banking

• Majority of the above would like to use mobile service for Account balance enquiry, last five transactions statement, Status of cheque clearance.

• Younger population showed keen interest to use mobile phone for money transfer, bill payments and stock market trading.

• 17% of respondents were apprehensive to use mobile banking for security purposes. They preferred the traditional methods of banking.

• People in the income group 3 lakhs and above were more interested in using mobile banking than wasting their time going to the bank or using the computer for account balance enquiry, deposits and payments.

The survey indicates that financial institutions still need to do more to educate consumers about the security of conducting financial activities on their cell phones and other mobile devices. A majority of respondents cited fear of transaction security as a key reason that would prevent them from using mobile banking. Due to lot of bank closures due to bankcruptcy or scams, consumers are monitoring their finances especially bank statements on a regular basis. Thus mobile banking has a greater scope. Nearly two-thirds of the consumers surveyed reported contacting their financial institution once a month or more. Among owners of smart phones and other high-end devices, consumer interest and usage of mobile banking


services was significantly higher than among users of basic cell phones The top three reasons for phone or other high-end device indicating a desire to do more than just talk. The rapid adoption of high-end mobile devices over the next couple of years suggests mobile banking may have a bright future.

CONCLUSION

The Financial inclusion is emerging as a global hot topic. The G-20 has launched an expert group to look into the matter. Mobile banking has come in handy in many parts of the world with little or no Infrastructure development, especially in remote and rural areas. This part of the mobile commerce is also very popular in countries where most of their population is un-banked. In most of these places banks can only be found in big cities and customers have to travel hundreds of miles to the nearest bank.

Mobile banking is also seen as the most promising front end technology for broadening the access of banking in the country. Immense potential of mobile banking in the process of financial inclusion and financial growth is now well acknowledged.

It’s time for banking offerings to make the same evolutionary progress that automobiles, entertainment devices or mobile phones have made. This means offering choice, becoming smarter, better packaged, cheaper and easier to use. Through alliances with the right partners from the device, telecom, network, applications and retail space, Indian banks can turn this vision into reality.

With the expectation that the number of deposit account holders will double from its current 400 million to 800 million by 2019, banks need to find innovative ways of on-boarding new customers and servicing existing ones. Clearly, there is no shortage of challenges or opportunities. The emergence of mobile telephony and its hi-tech variants such as 3G and BWA, kiosks, ATMs and Internet will ensure that banks get to ride the growth wave like other industries. Parallel to the Internet bank concept, we envisage the rise of the mobile-only bank, where every banking activity from origination and transaction to fulfillment and settlement can be completed using a mobile phone.

With the extensive Rural Mobile banking coverage planed by the Govt of India with the RBI & the banking sector, the true financial inclusion will be achieved in near future.

REFERENCES [1] The Indian Journal of Commerce, Vol 63, April-June 2010. [2] “Financial Inclusion”, Sameer Kochhar, Eastern Book Corporation, 2009. [3] “Promoting Financial Inclusion Through Innovative Policies”, John D. Conroy, Julius Caesar Parrenas,

Worapot Manupipatpong, 2010 [4] The Hindu Business line, 7 Aug 2010 [5] Financial Inclusion, M/s Taxmann Publications Pvt. Ltd., 2006.

Rural Infrastructure Development Fund (RIDF)—An Initiative towards

Inclusive Growth

* Dr. Gopal K. Kalkoti

Abstract—In order to encourage quicker completion of the rural infrastructure projects, the Union Finance Minister had indicated setting up of “Rural Infrastructure Development Fund” (RIDF) in NABARD from April 1995, with an initial amount of Rs.2000 cr. Made up of contributions by way of deposits from scheduled commercial banks operating in India. Since then, the scheme has been continued and as on date total corpus of RIDF has grown to Rs.86000 crore.

RIDF was setup by NABARD for providing loan assistance to the State Government and State owned Corporations for completion of ongoing projects and taking up new projects related to medium and minor irrigation, rural roads, bridges etc. In the Union Budget Speech 1995-96, Hon'ble Finance Minister announced that- "Inadequacy of public investment in agriculture is today a matter of general concern. This is an area, which is the responsibility of States. But many States have neglected investment in infrastructure for agriculture. There are many rural infrastructure projects, which have been started but are lying incomplete for want of resources. They represent a major loss of potential income and employment to rural population." RIDF-I was launched in 1995-96 with an initial corpus of Rs.2000 crore through contributions both from public and private sector having shortfall in the agricultural lending. Since 1996-97 i.e. RIDF-II, source of deposits from commercial banks has been broad-based by including shortfall in lending to agriculture and/or shortfall in priority sector lending. As a result in 2008-09 the corpus has increased to Rs.14000 crore.

This paper will study and suggest ways to improve the RIDF reach and effectiveness, which is essential for the growth of Indian Economy to benefit the weaker sections of the society.

Keywords: Infrastructure, potential income, broad-based, effectiveness

In order to encourage quicker completion of the rural infrastructure projects, the Union Finance Minister had indicated setting up of “Rural Infrastructure Development Fund” (RIDF) in NABARD from April 1995, with an initial amount of Rs.2000 cr. Made up of contributions by way of deposits from scheduled commercial banks operating in India. Since then, the scheme has been continued and as on date total corpus of RIDF has grown to Rs.86000 crore.

RIDF was setup by NABARD for providing loan assistance to the State Government and State owned Corporations for completion of ongoing projects and taking up new projects related to medium and minor irrigation, rural roads, bridges etc. In the Union Budget Speech 1995-96, Hon'ble Finance Minister announced that- "Inadequacy of public investment in

*Nagindas Khandwala College, Mumbai


agriculture is today a matter of general concern. This is an area, which is the responsibility of States. But many States have neglected investment in infrastructure for agriculture. There are many rural infrastructure projects, which have been started but are lying incomplete for want of resources. They represent a major loss of potential income and employment to rural population."

RIDF-I was launched in 1995-96 with an initial corpus of Rs.2000 crore through contributions both from public and private sector having shortfall in the agricultural lending. Since 1996-97 i.e. RIDF-II, source of deposits from commercial banks has been broad-based by including shortfall in lending to agriculture and/or shortfall in priority sector lending. As a result in 2008-09 the corpus has increased to Rs.14000 crores

The tranche-wise size of corpus has been as under: TABLE 1: TRANCHE‐WISE CORPUS

RIDF TRANCHE/ YEAR YEAR CORPUS (RS CRORE) PERCENTAGE INCREASE OVER PREVIOUS YEAR RIDF I 1995-1996 2000 RIDF II 1996-1997 2500 25% RIDF III 1997-1998 2500 - RIDF IV 1998-1999 3000 20% RIDF V 1999-2000 3500 17% RIDF VI 2000-2001 4500 29% RIDF VII 2001-2002 5000 11% RIDF VIII 2002-2003 5500 10% RIDF IX 2003-2004 5500 - RIDF X 2004-2005 8000 64% RIDF XI 2005-2006 8000 - RIDF XII 2006-2007 10000 25% RIDF XIII 2007-2008 12000 20% RIDF XIV 2008-2009 14000 17% TOTAL 86000

The projects pertaining to eligible sectors under each RIDF tranche are submitted by the State Governments through their Finance department to NABARD’s Regional Offices. The project proposals are scrutinized and appraised by the Regional Office with the help of Consultants by conducting desk and field appraisal. Appraisal reports submitted by the ROs are then scrutinised by State Projects Department at HO before placing the same to Sanctioning Committee (SC) for consideration of sanction

The SC is a committee of the Board of Directors with following Members: • Chairman of NABARD; • Managing Director of NABARD; • Secretary (Banking), MoF, GoI, on the Board of NABARD; • Secretary, Ministry of Rural Development, GoI, on the • Board of NABARD; • Secretary, Ministry of Agriculture, GoI, on the Board of • NABARD; • Deputy Governor, RBI, on the Board of NABARD;

Rural Infrastructure Development Fund (RIDF)-An Initiative towards Inclusive Growth 15

• One Nominee from RBI Board of Directors: and • Two State Government Representatives from the Board of NABARD.

NEED FOR ESTABLISHMENT OF RIDF

After independence the government was on the lookout on which areas need to be funded and developed to reach the development to all the people. With this aim they evaluated the infrastructure capacities of the country and found that there was dire need for developing the infrastructure if India was to develop. The table below shows the path which finalized the institution of RIDF

TABLE 2: ALL INDIA EXPANDED STOCK OF INFRASTRUCTURE [1950‐51 TO 1995‐96]

Year Irrigated Area

[million hectares]

Fertilizer production [lakh tons]

Number of Regulated Wholesale markets

Power Generation

[billion kwh]

Road length [‘000 kms]

Number of commercial

Vehicles [lakh]

1950-51 22.56 0.5 206 5.1 400 1.16 1960-61 27.98 1.5 715 16.9 524 2.25 1970-71 38.19 10.50 1777 55.8 918 4.37 1980-81 49.73 30.08 4158 110.8 1491 7.01 1990-91 62.47 90.45 6250 264.3 2037 17.44 1995-96 70.25 117.03 6836 380.0 2884 22.21

Chart 2a


Chart 2b

Chart 2c

Chart 2d


Chart 2e

Chart 2f

• The Charts 2a to Chart 2f which show how there is steady increase in the need for infrastructure. As all sectors expenses are increasing, specially the increase is significant in 1995-96. This clearly indicate how the economy was rearing to move into progress by the year 1995-96. Recognizing this need of a growing economy and the urgent requirements of funds to furnish development of infrastructure RIDF was set up by the Union Finance Minister.

• The Union Finance Minister also announced that certain other funds will be set up with NABARD/SIDBI/NHB during 2008-09 from the contribution to be made by scheduled commercial banks which failed to achieve their priority sector lending targets. These funds were set up in June 2008 and the corpus allocations were revised in August 2008. The revised allocations were Rs.10,000 crore for RIDF-XIV and Rs.5,000 crore for Short-Term Cooperative Rural Credit [STCRC] [refinance] Fund with NABARD; Rs.1,600 crore for Micro, Small and Medium Enterprises [MSE][refinance] Fund and Rs.1,000 crore for MSE[risk capital] Fund with SIDBI


and Rs.1,000 crore for Rural Housing Fund with NHB. The corpus allocation under the separate window of RIDF-XIV for rural roads component during 2008-09 remains unchanged.

• During 2008-09, 12 State Governments were sanctioned loans aggregating Rs.2,572 crore under RIDF-XIV which included Rs.277 crore sanctioned to the distressed districts of two States-viz, Andhra Pradesh and Maharashtra identified in the Prime Minister’s Relief Package for mitigation of distress farmers.

• The disbursements under RIDF-XIV during 2008-09 amounted to Rs.58 crore.

ANALYSIS OF SECTOR-WISE PROJECTS

It is important to know the sectors in which the RIDF focus was more in the years it has been in existence so that planners can decide the utility these funds have created and the need for any changes that may be incorporated to make RIDF more effective.

TABLE 3: SECTOR‐WISE PROJECTS AND AMOUNT SANCTIONED UNDER RIDF AS ON 31ST MARCH’08 [RS. CRORE]

Sector RIDF-XII - No RIDF-XII - Amt RIDF I to XI -No RIDF I to XI –Amt Irrigation 13189 [35.7%] 4730.86 [37%] 118890 [48.9%] 20278.24[33.1%] Rural Bridge 717 [1.9%] 796.23 [6.2%] 10664 [4.4%] 6235.92 [10.2%] Rural Roads 6424 [17.4%] 3876.06 [30.3%] 54961 [22.6%] 20720.94[33.8%] Social Sector* 12222 [33.1%] 1605.08 [12.5%] 38637 [15.9%] 6987.11 [11.4%] Power Sector** 10 148.37 [1.2%] 721 [0.3%] 1502.70 [2.4%] Others *** 4402 [11.9%] 1638.41 [12.8%] 19390 [7.9%] 5553.49 [9.1%] Total 36964 [100%] 12795.01[100%] 243263[100%] 61278.40 [100%]

*includes rural drinking water supply, primary/secondary schools, public health institutions, pay and use toilets and Anganwadi centers **includes system improvement and mini/small hydel projects ***includes soil conservation, watershed development, rainwater harvesting, flood protection, CADA, drainage, cold storage, fishing harbor/jetties, riverine fisheries, animalhusbandry, forest development,inlandwaterways, rubber plantation,seed/agri/horti farms, citizen information centers,food park, rural libraries, rural market/market yard/rural godown, meat processing, rural knowledge centers etc.

RIDF XII Number of Projects

Chart 3a


RIDF I to XII Number of Projects

Chart 3b

Figures in Brackets indicate Percentage of that Item to the Total

• The charts 3a and 3b show that in RIDF XII and RIDF I to XII all over India the focus on sanctions is on irrigation projects and the social sector sanction.

AMOUNT SANCTIONED AND DISBURSED UNDER RIDF

Projects are approved and sanctioned by the government, how much money has been actually disbursed will indicate the power of the infrastructure plans that has percolated to the rural areas of the country.

TABLE 4: SANCTIONS AND DISBURSEMENTS UNDER RIDF AS ON 31ST MARCH’08 [RS. CRORE]

Sector Sanctioned amount Amount phased Amount disbursed Irrigation 25009.10 20993.31 15621.13 [74.4%] Rural roads & Bridges 31629.15 27861.11 21166.36 [75.9%] Social sector 8592.19 6932.48 4412.30 [63.6%] Power 1651.07 1514.16 1124.80 [74.3%] Others 7191.41 5556.74 3270.26 [58.8%] Total 74073.41 62857.80 45594.85 [72.5%]

Figures in brackets indicate % of amount disbursed to amount phased.

As the above table shows the overall disbursed amount is high in the irrigation, rural roads and bridges, power sectors. In the social sector and other sector it is not very good. However when sanctioned amount is compared to the disbursed amounts the diversion is more, this is because the phased amount is much lesser than the sanctioned amounts. This means that the projects are not completed as stipulated by the loans when they are sanctioned, time and cost overruns are the main reasons for non fulfillment of this criterion.

CUMULATIVE SANCTIONS AND DISBURSEMENTS UNDER RIDF

The picture of the cumulative projects and amounts disbursed is shown below.


TABLE 5: CUMULATIVE SANCTIONS AND DISBURSEMENTS UNDER RIDF AS ON 31ST MARCH’08 [RS. CRORE]

Trench Corpus [Deposits] No. of Projects Sanctioned amount Amount disbursed I 2000 [1586.56] 4168 1906.21 1760.8 [92.4] II 2500 [2225.00] 8193 2636.08 2397.95 [91.0] III 2500 [2308.02] 14345 2732.69 2453.50 [89.8] IV 3000 [1412.53] 6171 2902.55 2482.00 [85.5] V 3500 [3051.88] 12106* 3434.52 3054.96 [88.9] VI 4500 [4073.45] 43168 4488.51 4072.14 [90.7] VII 5000 [4065.77] 24598 4582.32 4038.16 [88.1] VIII 5500 [5031.61] 20964 5996.97 4975.47 [83.0] IX 5500 [4490.24] 19579 5649.09 4513.74 [79.9] X 8000 [5710.05] 17368** 8077.21 5635.52 [69.8] XI 8000 [4302.04] 30305 8412.07 4395.22 [52.2] XII 10000[3171.73] 42299 10460.18 [7959.30]# 3466.62 [43.6] XIII 12000[1656.91] 36964 12795.01[4080.28]# 2348.70 [57.6] Total 72000 280227 74073.41[62857.80]# 45594.85 [72.5] *one lakh STWs sanctioned for Assam treated as single project **42616 construction of primary school structures sanctioned to Madhya Pradesh converted to 213 projects. # Amount phased; figures in parentheses indicate % disbursement to sanctioned/phased amount under XII &XIII Rs.3855.57 crore & Rs.528.85 crore deposits under Bharat Nirman Program

The table 5 shows that in the RIDF I, II and VI there is a very good % disbursement to sanctioned/phased amount (92.4%, 91% and 90.7%). As the RIDF plans are advancing further the disbursed percentages are reducing reaching the lowest in RIDF XII (43%.6), it is also low in the RIDF XI and XIII (52.2% and 57.6%). This may be because the number of projects under RIDF and its purview increased due to which the amounts disbursed reduced in percentage. Form RIDF X to XI the number of projects increased by 12937 projects from 17368 to 30305from RIDF XII to XIII it increased by 11994 projects from 30305 to 42299. The functionaries may not have been able to handle the sudden increase in the projects.

CONCLUSION

The studies to examine the relationship between infrastructure and agricultural output showed that Punjab, which has the highest index of infrastructure also has the highest yield of food grains and value of agricultural production per hectare. Tamil Nadu and Haryana, which have the second and third highest index of infrastructure have third and second highest yield per hectare of food grains. Rajasthan and Madhya Pradesh, which have a very low index of infrastructure also have low yield of food grains and total value of agricultural production per hectare [Bhatia, 1999]

Fan et al [1999,2000] studied the relationship between government expenditures on agricultural research and development, irrigation, roads, education, power, soil and water conservation, rural development spending on agricultural growth and rural poverty. The study concludes that improved rural infrastructure and technology have all contributed to agricultural growth, but their impacts have varied by settings. Government expenditures on road and R&D have by far the largest impact on poverty reduction and growth in agricultural productivity.

The linkages between infrastructure development and sustained output growth have been significantly confirmed by empirical researches.

Cross-country analyses have also confirmed strong linkages between infrastructure and agricultural output growth.


Antle in 1983, using cross-sectional data for 47 less developed countries including India, established a strong and positive relationship between infrastructure development and aggregate agricultural productivity.

These views have been substantiated by several studies from Asian countries and more importantly Antle [1984] documented evidence of positive linkages between various types of infrastructure and agricultural output growth specifically from studies under Indian settings.

Thus it is imperative that policy makers and politicians realize that the only way to success of any country, state, district town or village is heavily dependent on infrastructure available to the common inhabitants of the said locality.

REFERENCES [1] Gyan Chandra Kar & Mamata Swain, Farmer And Local Participation In Management Commonwealth

Publishers, New Delhi, 2005 [2] K.K. Singh, Farmers in the Management of Irrigation System Sterling Publishers Ltd. L-10, Green Park

Extension New Delhi.-2006 [3] Dr. M.V.K. Sivamohan, K.B. Satyanarayana, INDIA: Irrigation Management Partnerships, Book links

Corporation Narayanaguda, Hyderabad – 500 029–2007 [4] Norman Uphoff with Priti Ramamurthy and Roy Steiner, Managing Irrigation Analysing and improving the

performance of bureaucracies, Sage Publications India Pvt Ltd. -2008 [5] Singh Rudrapratap, NABARD, Deep & Deep Publications, New Delhi, 2004

Effects of Macroeconomic Dynamics on BSE— A Case of Banking Stock

Dr. Nageshwar Maruti Rao* Abstract—The relationship between stock prices and macroeconomic dynamics is well documented for the United States and other major economies. It was found that Indian stock market also reacts according to changing macroeconomic dynamics. The risk associated with the stock market is always cause of worry for retail investors. With severe volatility in the stock market due to changing macroeconomic dynamics there is fair degree of inconsistency in returns on investment. However, few studies were conducted to find out what is the relationship between bank stock prices and macroeconomic dynamics in emerging economies like India?. The goal of this study is to investigate the relationship between banking stock prices and the macroeconomic dynamics such as FIIs, crude oil prices, inflation, GDP and gold prices correlation technique. There was a significant relationship was found between macroeconomic dynamics on the bankex and individual stocks, suggesting the bankex exhibit the strong -form of market efficiency.

Keywords: Bankex, Gross Domestic Product, Inflation, Crude Oil prices, Foreign Institutional Investment, gold prices.

INTRODUCTION

The relationship between stock prices and macroeconomic dynamics is well documented for the United States and other major economies. It was found that Indian stock market also reacts according to changing macroeconomic dynamics. The risk associated with the stock market is always cause of worry for retail investors. With severe volatility in the stock market due to changing macroeconomic dynamics there is fair degree of inconsistency in returns on investment. However, few studies were conducted to find out what is the relationship between bank stock prices and macroeconomic dynamics in emerging economies like India?. The study has thrown light on correlation between macroeconomic dynamics such as inflation, FII, GDP, FER, gold prices and crude oil prices. The study has taken into effect of aforesaid dynamics on Bankex. Abbreviation

FER: Foreign Exchange Rate GDP: Gross Domestic Products FII: Foreign Institutional Investment

OBJECTIVES

The present study was undertaken with the following objectives:

• To find out the effect of macroeconomic dynamics on bank stocks

*Kousali Institute of Management Studies, Karnataka

Effects of Macroeconomic Dynamics on BSE— A Case of Banking Stock 23

• To find out the correlation between selected macroeconomic dynamics and Bankex. • To study the beta of bank stocks.

REVIEW OF LITERATURE

Esen E & Umit O conducted a study on effects of macroeconomic dynamics on Turkish stock market and found that there was varying effect of different macroeconomic variables. Nil Günsel & Sadõk Çukur had conducted investigated the performance of the Arbitrage Pricing Theory (APT) in London Stock Exchange for the period of 1980-1993. The study develops seven pre-specified macroeconomic variables such as Interest rate, risk premium, exchange rate, money supply and unanticipated inflation and industry specific variables such as sectoral dividend yield and sectoral unexpected production. They have demonstrated that there are some big differences among industries. Robert D. Gay has investigated the time-series relationship between stock market index prices and the macroeconomic variables of exchange rate and oil price for Brazil, Russia, India, and China (BRIC) using the Box-Jenkins ARIMA model. He found that there is no significant relationship between respective exchange rate and oil price on the stock market index prices of either BRIC country. As noted by Suresh Srivastava (2001), the relationship between bank stock return and interest rates found to be positively correlated. No empirical study was conducted to find out correlation between macroeconomic dynamics such as GDP, Inflation, FER, etc. and their effect on banking stock. This has motivated researchers to take up present study. METHODOLOGY

For the purpose of the study, five macroeconomic dynamics were selected - inflation, FII, GDP, gold prices and crude oil prices. The data for the study was collected from various secondary sources such as web-site of Finance Ministry, OPEC, RBI, BSE and Business dailies etc. The selection of the macroeconomic dynamics was made based on their impact on stock market in major economics such as USA. The analysis of the data collected was carried out with the help correlation. The study was descriptive and causal in nature. The period of study has been confined to April 2001 to March 2010.

Meaning of Key Words used

Inflation Rate: It refers to annual change in Wholesale Price Index or Consumer Price Index.

Systematic Risk: Risk which affects all securities can not be diversified or controlled. These risks have to be assumed by investors while entering into the market.

ANALYSIS

The table-1 reveals that there was a strong positive correlation between inflation and bankex as it can be seen from value of correlation which is 0.72. So, increase in inflation has resulted in increase in return on bankex.


TABLE 1

YEAR INFLATION (%) BANKEX X Y XY X*X Y*Y

2001-02 3.6 1178.51 4242.636 12.96 1388885.82 2002-03 3.4 1369.42 4656.028 11.56 1875311.14 2003-04 5.5 2992.9 16460.95 30.25 8957450.41 2004-05 6.5 3847.96 25011.74 42.25 14806796.2 2005-06 4.4 5265.24 23167.056 19.36 27722752.3 2006-07 5.4 6542.01 35326.854 29.16 42797894.8 2007-08 4.7 7717.61 36272.767 22.09 59561504.1 2008-09 8.4 4490.97 37724.148 70.56 20168811.5 2009-10 14.2 10652.31 151262.8 201.64 113471708

SUMMATION 56.1 44056.93 334124.98 439.83 290751115 R 0.723290202

Correlation(r) = NΣXY - (ΣX)(ΣY) / Sqrt([NΣX2 - (ΣX)2][NΣY2 - (ΣY)2])

TABLE 2

Year GDP % Bankex X Y XY X*X Y*Y

2001-02 5.8 1178.51 6835.36 33.64 1388885.82 2002-03 3.8 1369.42 5203.8 14.44 1875311.14 2003-04 8.5 2992.9 25439.7 72.25 8957450.41 2004-05 7.5 3847.96 28859.7 56.25 14806796.2 2005-06 9.5 5265.24 50019.8 90.25 27722752.3 2006-07 9.7 6542.01 63457.5 94.09 42797894.8 2007-08 9 7717.61 69458.5 81 59561504.1 2008-09 6.2 4490.97 27844 38.44 20168811.5 2009-10 6.7 10652.31 71370.5 44.89 113471708

SUMMATION 66.7 44056.9 348489 525.25 290751115 R 0.45607304

The table-2 displays that GDP and bankex has moderate positive correlation as it equals to 0.46. So, the increase in GDP has resulted in increase in Bankex.

TABLE 3

Year FII (Rs.crores) Bankex X Y XY X*X Y*Y

2001-02 1178.51 1178.51 1388885.8 1388885.82 1388885.8 2002-03 1369.42 1369.42 1875311.1 1875311.136 1875311.1 2003-04 2992.9 2992.9 8957450.4 8957450.41 8957450.4 2004-05 3847.96 3847.96 14806796 14806796.16 14806796 2005-06 5265.24 5265.24 27722752 27722752.26 27722752 2006-07 6542.01 6542.01 42797895 42797894.84 42797895 2007-08 7717.61 7717.61 59561504 59561504.11 59561504 2008-09 4490.97 4490.97 20168812 20168811.54 20168812 2009-10 10652.31 10652.31 113471708 113471708.3 113471708

SUMMATION 44056.93 44056.9 290751115 290751114.6 290751115 R 1

The table-3 exhibits that the value of correlation is equal to 1.


TABLE 4

Year Crude Oil Price Bankex X Y XY X*X Y*Y

2001-02 1116.7421 1178.51 1316091.7 1247113 1388885.8 2002-03 1150.7013 1369.42 1575793.4 1324113 1875311.1 2003-04 1367.534 2992.9 4092892.5 1870149 8957450.4 2004-05 2126.475 3847.96 8182590.7 4521896 14806796 2005-06 2518.9024 5265.24 13262626 6344869 27722752 2006-07 2490.318 6542.01 16291685 6201684 42797895 2007-08 3974.7864 7717.61 30675851 1.6E+07 59561504 2008-09 2548.587 4490.97 11445628 6495296 20168812 2009-10 2022.3009 10652.31 21542176 4089701 113471708

SUMMATION 19316.3471 44056.93 108385334 4.8E+07 290751115 R 0.629036774

The table-4 displays that crude oil price and bankex has moderate positive correlation as it equals to 0.63. So, the increase in crude oil price has resulted in increase in Bankex.

TABLE 5

Year Gold/Ounce Bankex X Y XY X*X Y*Y

2001-02 15124.12 1178.51 17823926.7 228739005.8 1388885.8 2002-03 17271.45 1369.42 23651869.1 298302985.1 1875311.1 2003-04 17781.85 2992.9 53219298.9 316194189.4 8957450.4 2004-05 19399.56 3847.96 74648730.9 376342928.2 14806796 2005-06 26841.01 5265.24 141324359 720439817.8 27722752 2006-07 29971.31 6542.01 196072610 898279423.1 42797895 2007-08 34895.84 7717.61 269312484 1217719649 59561504 2008-09 49463.44 4490.97 222138825 2446631897 20168812 2009-10 50441.5 10652.3 537318495 2544344922 113471708

SUMMATION 261190.08 44057 1535510598 9046994818 290751115 R 0.7741632

We can note from the table-5 that there was strong positive correlation between gold price and bankex.

TABLE 6

Year Inflation (%) SBI X Y xy x*x y*y

2001-02 3.6 278.65 1003.14 12.96 77645.823 2002-03 3.4 642.25 2183.65 11.56 412485.06 2003-04 5.5 584.85 3216.675 30.25 342049.52 2004-05 6.5 891.35 5793.775 42.25 794504.82 2005-06 4.4 1101.9 4848.36 19.36 1214183.6 2006-07 5.4 1781 9617.4 29.16 3171961 2007-08 4.7 1291.15 6068.405 22.09 1667068.3 2008-09 8.4 1700.4 14283.36 70.56 2891360.2 2009-10 14.2 2300 32660 201.64 5290000

Summation 56.1 10571.6 79674.77 439.83 15861258 R 0.7820536

The chart-1 exhibits that there was a strong positive correlation between inflation and stock prices of SBI.


It is worthy to note from chart-2 that there was a strong positive correlation between foreign institutional investment and stock price of SBI.

Chart-1: Inflation v/s SBI

02468

10121416

0 500 1000 1500 2000 2500

Stock Price

Infla

tion

Rat

e (%

)

Series1

TABLE 7

Year FII (Rs. Crores) SBI X Y xy x*x y*y

2001-02 1178.51 278.65 328391.81 1388885.8 77645.8225 2002-03 1369.42 642.25 879510 1875311.1 412485.063 2003-04 2992.9 584.85 1750397.6 8957450.4 342049.523 2004-05 3847.96 891.35 3429879.1 14806796 794504.823 2005-06 5265.24 1101.9 5801768 27722752 1214183.61 2006-07 6542.01 1781 11651320 42797895 3171961 2007-08 7717.61 1291.15 9964592.2 59561504 1667068.32 2008-09 4490.97 1700.4 7636445.4 20168812 2891360.16 2009-10 10652.31 2300 24500313 113471708 5290000

Summation 44056.93 10571.55 65942617 290751115 15861258.3 R 0.882625375

Chart-2:FII v/s SBI Bank

0

2000

4000

6000

8000

10000

12000

0 500 1000 1500 2000 2500

Stock Price

FII (

cror

es)

Series1

TABLE 8


Year GDP % SBI X Y XY x*x y*y

2001-02 5.8 278.65 1616.17 33.64 77645.8225 2002-03 3.8 642.25 2440.55 14.44 412485.063 2003-04 8.5 584.85 4971.225 72.25 342049.523 2004-05 7.5 891.35 6685.125 56.25 794504.823 2005-06 9.5 1101.9 10468.05 90.25 1214183.61 2006-07 9.7 1781 17275.7 94.09 3171961 2007-08 9 1291.15 11620.35 81 1667068.32 2008-09 6.2 1700.4 10542.48 38.44 2891360.16 2009-10 6.7 2300 15410 44.89 5290000

Summation 66.7 10571.55 81029.65 525.25 15861258.3 R 2.943885135

Chart-3: GDP v/s SIB Bank

0

2

4

6

8

10

12

0 500 1000 1500 2000 2500

stock price

GD

P (%

)

Series1

The chart-3 depicts that the GDP and SBI stock price have very strong positive correlation.

The chart-4 exhibits that there was a strong positive correlation between gold price and stock prices of SBI.

TABLE 9

YEAR GOLD/OUNCE SBI X Y XY X*X Y*Y

2001-02 15124.12 278.65 4214336 228739006 77645.823 2002-03 17271.45 642.25 11092589 298302985 412485.06 2003-04 17781.85 584.85 10399715 316194189 342049.52 2004-05 19399.56 891.35 17291798 376342928 794504.82 2005-06 26841.01 1101.9 29576109 720439818 1214183.6 2006-07 29971.31 1781 53378903 898279423 3171961 2007-08 34895.84 1291.15 45055764 1217719649 1667068.3 2008-09 49463.44 1700.4 84107633 2446631897 2891360.2 2009-10 50441.5 2300 116015450 2544344922 5290000

SUMMATION 261190.08 10571.55 371132297 9046994818 15861258 R 0.905140237


Chart-4: Gold Price V/s SBI Bnak

0

10000

2000030000

40000

50000

60000

0 500 1000 1500 2000 2500

Stock price

Gol

d Pr

ice/

Oun

ce

Series1

TABLE 10

Year Crude Oil Price SBI x Y Xy x*x y*y

2001-02 1116.7421 278.65 311180.2 1247113 77645.823 2002-03 1150.7013 642.25 739037.9 1324113 412485.06 2003-04 1367.534 584.85 799802.3 1870149 342049.52 2004-05 2126.475 891.35 1895433 4521896 794504.82 2005-06 2518.9024 1101.9 2775579 6344869 1214183.6 2006-07 2490.318 1781 4435256 6201684 3171961 2007-08 3974.7864 1291.15 5132045 15798927 1667068.3 2008-09 2548.587 1700.4 4333617 6495296 2891360.2 2009-10 2022.3009 2300 4651292 4089701 5290000

Summation 19316.3471 10571.6 25073244 47893748 15861258 R 0.506381661

Chart-5: Crude Oil Price V/s SBI Bnak

0

1000

2000

3000

4000

5000

0 500 1000 1500 2000 2500

Stock Price

Cru

de O

il Pr

ice

Series1

The chart-5 shows that the crude oil price and stock price of SBI have moderate positive correlation.


TABLE 11

Year Bankex SBI x Y x*x x*y

2001-02 1178.51 278.65 1388885.82 328391.81 2002-03 1369.42 642.25 1875311.14 879510 2003-04 2992.9 584.85 8957450.41 1750397.6 2004-05 3847.96 891.35 14806796.2 3429879.1 2005-06 5265.24 1101.9 27722752.3 5801768 2006-07 6542.01 1781 42797894.8 11651320 2007-08 7717.61 1291.15 59561504.1 9964592.2 2008-09 4490.97 1700.4 20168811.5 7636445.4 2009-10 10652.31 2300 113471708 24500313

Summation 44056.93 10571.6 290751115 65942617 Beta 1.56750036

The table-11 exhibits that the SBI stock is riskier as its beta is 1.57. This stock is meant for those investors who are ready to assume more risk. However, it also signals that the return on SBI stock is more than the Bankex.

TABLE 12

Year Inflation (%) ICICI x y xy x*x y*y

2001-02 3.6 140.55 505.98 12.96 19754.303 2002-03 3.4 295.7 1005.38 11.56 87438.49 2003-04 5.5 370.7 2038.85 30.25 137418.49 2004-05 6.5 584.7 3800.55 42.25 341874.09 2005-06 4.4 890.4 3917.76 19.36 792812.16 2006-07 5.4 1232.4 6654.96 29.16 1518809.8 2007-08 4.7 448.35 2107.245 22.09 201017.72 2008-09 8.4 875.7 7355.88 70.56 766850.49 2009-10 14.2 921.35 13083.17 201.64 848885.82

Summation 56.1 5759.85 40469.78 439.83 4714861.3 r 0.4742531

The chart-6 exhibits that there was a moderate positive correlation between inflation and stock price of ICICI bank. The increase in inflation will boost the ICICI Bank’s stock price.

Chart-6: Inflation v/s ICICI Bank

0

2

4

6

8

10

12

14

16

0 2 4 6 8 10 12 stock prices

Inflation rate (%)

Series1


TABLE 13

Year FII (Rs. crores) ICICI X y xy x*x Y*y

2001-02 1178.51 140.55 165639.58 1388885.8 19754.3025 2002-03 1369.42 295.7 404937.49 1875311.1 87438.49 2003-04 2992.9 370.7 1109468 8957450.4 137418.49 2004-05 3847.96 584.7 2249902.2 14806796 341874.09 2005-06 5265.24 890.4 4688169.7 27722752 792812.16 2006-07 6542.01 1232.4 8062373.1 42797895 1518809.76 2007-08 7717.61 448.35 3460190.4 59561504 201017.723 2008-09 4490.97 875.7 3932742.4 20168812 766850.49 2009-10 10652.31 921.35 9814505.8 113471708 848885.823

Summation 44056.93 5759.85 33887929 290751115 4714861.33 R 0.647704584

The chart-7 display that there is moderate positive correlation exists between foreign institutional investment and stock price of ICICI Bank.

TABLE 14

Year GDP % ICICI X Y xy x*x y*y

2001-02 5.8 140.55 815.19 33.64 19754.3025 2002-03 3.8 295.7 1123.66 14.44 87438.49 2003-04 8.5 370.7 3150.95 72.25 137418.49 2004-05 7.5 584.7 4385.25 56.25 341874.09 2005-06 9.5 890.4 8458.8 90.25 792812.16 2006-07 9.7 1232.4 11954.28 94.09 1518809.76 2007-08 9 448.35 4035.15 81 201017.723 2008-09 6.2 875.7 5429.34 38.44 766850.49 2009-10 6.7 921.35 6173.045 44.89 848885.823

Summation 66.7 5759.9 45525.665 525.25 4714861.33 R 0.503285653

Chart-7: FII v/s stock Price

0

2000

4000

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0 500 1000 1500

ICICI Bank's stock price

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Series1


The chart-8 shows that the GDP and ICICI bank have positive correlation. TABLE 15

Year Gold/Ounce Bankex x y xy x*x y*y

2001-02 15124.12 140.55 2125695.1 228739006 19754.303 2002-03 17271.45 295.7 5107167.8 298302985 87438.49 2003-04 17781.85 370.7 6591731.8 316194189 137418.49 2004-05 19399.56 584.7 11342923 376342928 341874.09 2005-06 26841.01 890.4 23899235 720439818 792812.16 2006-07 29971.31 1232.4 36936642 898279423 1518809.8 2007-08 34895.84 448.35 15645550 1217719649 201017.72 2008-09 49463.44 875.7 43315134 2446631897 766850.49 2009-10 50441.5 921.35 46474276 2544344922 848885.82

Summation 261190.08 5759.85 191438355 9046994818 4714861.3 R 0.625061903

Chart -9: Gold Price v/s ICICI Bank

0100002000030000400005000060000

0 200 400 600 800 1000 1200 1400Stock Price

Gold Price/Ounce

Series1

Chart-8 GDP v/s ICICI Bnak

0 2 4 6 8

1012

0 500 1000 1500stock price

GDP (%)

Series1


The chart-9 reveals that the increase in gold price will lead to increase in stock price of ICICI bank.

TABLE 16

Year Crude Oil Price ICICI x Y xy x*x y*y

2001-02 1116.7421 140.55 156958.1 1247113 19754.303 2002-03 1150.7013 295.7 340262.4 1324113 87438.49 2003-04 1367.534 370.7 506944.9 1870149 137418.49 2004-05 2126.475 584.7 1243350 4521896 341874.09 2005-06 2518.9024 890.4 2242831 6344869 792812.16 2006-07 2490.318 1232.4 3069068 6201684 1518809.8 2007-08 3974.7864 448.35 1782095 15798927 201017.72 2008-09 2548.587 875.7 2231798 6495296 766850.49 2009-10 2022.3009 921.35 1863247 4089701 848885.82

Summation 19316.3471 5759.85 13436554 47893748 4714861.3 R 0.41757525

The chart-10 shows that there was a weak positive correlation between crude oil price and stock price of ICICI bank

Chart-10: Crude Oil Price v/s ICICI Bank

0500

10001500200025003000350040004500

0 200 400 600 800 1000 1200 1400Stock Price

Crude Oil Price

Series1


TABLE 17

Year Bankex ICICI x y x*x x*y

2001-02 1178.51 140.55 1388885.82 165639.58 2002-03 1369.42 295.7 1875311.14 404937.49 2003-04 2992.9 370.7 8957450.41 1109468 2004-05 3847.96 584.7 14806796.2 2249902.2 2005-06 5265.24 890.4 27722752.3 4688169.7 2006-07 6542.01 1232.4 42797894.8 8062373.1 2007-08 7717.61 448.35 59561504.1 3460190.4 2008-09 4490.97 875.7 20168811.5 3932742.4 2009-10 10652.31 921.35 113471708 9814505.8

Summation 44056.93 5759.85 290751115 33887929 Beta 0.82686672

The table-17 reveals that it is safer to invest your money in ICICI Bank as its beta is equal to 0.83.

CONCLUSION

Among the five macroeconomic dynamics used for the purpose of the study it was found that change in inflation rate, gold prices and crude oil prices have very strong impact on bankex. In other words, the increase in these macroeconomic dynamics will results into increase in return as well as risk on bankex. Further, all the five macroeconomic dynamics have very strong correlation with stock price of SBI signaling that SBI stock is very sensitive to macroeconomic dynamics. The study also reveals that all the five macroeconomic dynamics used for the study have a moderate correlation with stock price of ICICI Bank.

To conclude the macroeconomic dynamics have affected bankex as well as the individual stocks in bankex. There was a significant relationship was found between macroeconomic dynamics on the bankex and individual stocks, suggesting the bankex exhibit the strong -form of market efficiency.

REFERENCES [1] Ajay R A and Mougue M, “On the dynamic relation between stock price and exchange rate”, Journal

Financial Research, 1996. [2] Donald E Fisher and Ronald J J, “Security analysis and portfolio management”, Prentice Hall India, 2004. [3] John Ammer, “Inflation, inflation risk and stock returns”, International Financial Discussion Paper, No.464,

1994, Board of Governors of Federal Reserve System. [4] Ma C K and Kao G M, “On exchange rate changes and stock price reactions”, Journal of Business Finance

and accounting, 17(3), 1990. [5] Suresh C Srivastava, “Interest rate sensitivity of bank stock returns: re-examination since Basel Accords”.

University of Alaska Anchorage. [6] Business line Newspaper, Various Issues.

Websites

[7] Finance Ministry [8] OPEC [9] RBI Website [10] www.yafinance.com [11] India stats [12] World gold organization [13] www.bseindia.com

Role of Financial Innovation in Making Banking an Organized Competitive Sector

Ragini Singh* Abstract—Innovation is an indispensable part of growth. As financial sector has undergone a complete re-engineering, financial innovation has a major role to play.

Financial innovation is a term used to describe new and creative approaches to different financial circumstances. Financial innovation is all about offering an idea or financial instrument that is different from what has gone before, and has the potential to be desirable in long run.

A number of innovative financial strategies and instruments have come into being since the decade of the 1980s. One example is the creation of interest rate swaps in the early years of that decade, innovation that allowed many companies and investors to take advantage of the dramatic increase in interest rates that was taking place. In recent years, the development of the credit default swap also allowed businesses to more effectively manage the increasing number of defaults on loans, mortgages, and other forms of credit that took place as the world economy The commercial banking has changed dramatically over 25 years. Commercial banks embedded as part of various innovations like ECS, RTGS, EFT, NEFT, ATM, Retail Banking, Debit & Credit cards, fund transfers, internet banking, mobile banking, selling insurance products, travel cheques and many more value added services.

The paper studies how technological change and financial innovation has helped to transform banking from a Government undertaking to competitive corporate institution. We then survey the literature relating to several specific financial innovations, which we define as new products or services, production processes, or organizational forms.

Keywords: Financial innovation, Interest rate swaps, Credit default swaps, Retail banking, RTGS, NEFT etc.

OBJECTIVES

• This paper discusses the technological changes and financial innovations that commercial banking has experienced during the past twenty-five years.

• The paper aims to study the various new financial products introduced in the banking sector post liberalization.

• The level of acceptance of these services by the common customers. • Analysis and impact of these innovations on the growth and development of Banking

sector in India.

LITERATURE REVIEW

In early study, western scholars searched the original motive of financial innovation through different ways. In earlier time, Greenbaum and Haywood (1973) reviewed the history of

*Tirpude Institute of Management Education, Nagpur

Role of Financial Innovation in Making Banking an Organized Competitive Sector 35

American financial market and argued that the growth of wealth is the determinant of demand of financial innovation. In other words, the fast development of economy caused financial innovation to develop at a high speed. Besides, there are four famous theories of the innovation motive, including constraint-induced financial innovation theory of W.L.Silber, transaction cost innovation theory of Hicks and Niehans, regulation innovation theory of Davies and Silla, and circumvention innovation theory of Kane.American economist Silber (1983)]advanced constraint-induced financial innovation theory. This theory pointed out that the purpose of profit maximization of financial institution is the key reason of financial innovation. Constraint-induced innovation theory discussed the financial innovation from microeconomics, so it is originated and representative. But it emphasized “innovation in adversity” excessively. So it can’t express the phenomenon of financial innovation increasing in the trend of liberal finance commendably.

Financial institutions deal with the status such as the reduction of profit and the failure of management induced by government regulations in order to reduce the potential loss to the minimum. Therefore, financial innovation is mostly induced by the purpose of earning profit and circumventing government regulations. It comes true through the game between government and microcosmic economic unity. Kane’s theory is different from the reality. The regulation innovation he assumed is always towards the direction of reinforcing regulation, however, the regulation innovation in reality is always towards the direction of liberal markets innovation, the result of the game is release of financial regulation and market become more liberal. But his theory is better than constraint-induced financial innovation theory. It not only considered the origin of innovation in the market but also researched the process of regulation innovation and their dynamic relation. Regulation innovation theory was put forward by Scylla etc. in 1982. They argued researching financial innovation from the perspective of economy development history. And they thought financial innovation connects with social regulation closely, and it is a regulation transformation which has mutual influence and is mutual causality with economic regulation. They thought that it is very difficult to have space of financial innovation in the planned economy with strict control and in the pure free-market economy, so any change leaded by regulation reform in financial system can be regarded as financial innovation. The Omni-directional finance innovative activities can only appear in the market economy controlled by government. When government's intervention and the management have hindered the finance activities, there will be many kinds of financial innovation which intend to circumvent or get rid of government controls. The game between the market and government finally form the spiral development process, namely, “control-innovate controls again-innovates again”.

The transaction cost innovation theory’s main pioneers are Hicks and Niehans (1983). They thought that the dominant factor of financial innovation is the reduction of transaction cost, and in fact, financial innovation is the response of the advance in technology which caused the transaction cost to reduce. The reduction of transaction cost can stimulate financial innovation and improvement financial service. This theory studied the financial innovation from the perspective of microscopic economic structure change. It thought that the motive of financial innovation is to reduce the transaction cost. And the theory explained from another


perspective that the radical motive of financial innovation is the financial institutes’ purpose of earning benefits. Since the late 80s, foreign scholars mainly researched the financial innovation theory in the designing of securities and the direction of general equilibrium, and carried on analyzing the application of financial innovation and the process of diffusion. These theories and viewpoints discussed the motive and the process of financial innovation from different sides.

According to the Location Theory, they advanced the financial innovation microscopic economic model. Desai and Low (1987) utilized this theory to confirm and measure the gap in the scope of acquirable product in financial market, which indicates the potential opportunity of the new products’ innovation and promotion. Chen (1995) built the financial intermediacy model in which new security secured by old security is created. In the period of decomposing the old securities and opening new market, innovators play an influential economical role. For example, investors can obtain the consumption at lower cost; investors can realize a better share of risks. His research indicated that even when introducing the surplus securities which are not distributed yet, the innovators can also play these roles. In other words, although these innovations have not changed the scope of acquirable financial tools, it makes investor’s trade at lower expected cost. The main focus is on security designing in incomplete financial market. Rahi (1995) used a simple parametric framework for comparing alternative incomplete asset structures in a productive economy, focusing on the role of assets in allocating risk and transmitting private information.

Based on an empirical study in the financial services sector, Patrick (2003) first describes how financial companies organize their innovative processes and what barriers to innovation can be identified in banks and insurance companies. The author pointed out that large firms often do have more difficulties with the development of new products than smaller firms. The most important changes that are needed for these organizations to become more innovative are concerned with the organizational structure, the underlying values, beliefs and information technology. Michael and Arnold (2004) studied the Hong Kong banking industry to examine the role of information complementarily and market competition in governing the diffusion of off-balance-sheet (OBS) financial innovations. A simultaneous equation model is devised to estimate the impacts of information complementarily, market competition, and a number of other factors on the diffusion of OBS financial innovations.

Therefore, it is very necessary for us to develop our financial innovation. And the research about financial innovation in commercial banks has gradually increased.

INTRODUCTION TO BANKING SYSTEM

Without a sound and effective banking system in India it cannot have a healthy economy. The banking system of India should not only be hassle free but it should be able to meet new challenges posed by the technology and any other external and internal factors.

For the past three decades India's banking system has several outstanding achievements to its credit. The most striking is its extensive reach. It is no longer confined to only metropolitans or cosmopolitans in India. In fact, Indian banking system has reached even to the remote corners of the country. This is one of the main reason of India's growth process.


The government's regular policy for Indian bank since 1969 has paid rich dividends with the nationalization of 14 major private banks of India.

Not long ago, an account holder had to wait for hours at the bank counters for getting a draft or for withdrawing his own money. Today, he has a choice. Gone are days when the most efficient bank transferred money from one branch to other in two days. Now it is simple as instant messaging or dial a pizza. Money have become the order of the day.

The first bank in India, though conservative, was established in 1786. From 1786 till today, the journey of Indian Banking System can be segregated into three distinct phases. They are as mentioned below:

• Early phase from 1786 to 1969 of Indian Banks • Nationalization of Indian Banks and up to 1991 prior to Indian banking sector

Reforms. • New phase of Indian Banking System with the advent of Indian Financial & Banking

Sector Reforms after 1991.

PHASE

The General Bank of India was set up in the year 1786. Next came Bank of Hindustan and Bengal Bank. The East India Company established Bank of Bengal (1809), Bank of Bombay (1840) and Bank of Madras (1843) as independent units and called it Presidency Banks. These three banks were amalgamated in 1920 and Imperial Bank of India was established which started as private shareholders banks, mostly Europeans shareholders.

In 1865 Allahabad Bank was established and first time exclusively by Indians, Punjab National Bank Ltd. was set up in 1894 with headquarters at Lahore. Between 1906 and 1913, Bank of India, Central Bank of India, Bank of Baroda, Canara Bank, Indian Bank, and Bank of Mysore were set up. Reserve Bank of India came in 1935.

During the first phase the growth was very slow and banks also experienced periodic failures between 1913 and 1948. There were approximately 1100 banks, mostly small. To streamline the functioning and activities of commercial banks, the Government of India came up with The Banking Companies Act, 1949 which was later changed to Banking Regulation Act 1949 as per amending Act of 1965 (Act No. 23 of 1965). Reserve Bank of India was vested with extensive powers for the supervision of banking in India as the Central Banking Authority.

During those days public has lesser confidence in the banks. As an aftermath deposit mobilization was slow. Abreast of it the savings bank facility provided by the Postal department was comparatively safer. Moreover, funds were largely given to traders.

PHASE

Government took major steps in this Indian Banking Sector Reform after independence. In 1955, it nationalized Imperial Bank of India with extensive banking facilities on a large scale especially in rural and semi-urban areas. It formed State Bank of India to act as the principal


agent of RBI and to handle banking transactions of the Union and State Governments all over the country.

Seven banks forming subsidiary of State Bank of India was nationalized in 1960 on 19th July, 1969, major process of nationalization was carried out. It was the effort of the then Prime Minister of India, Mrs. Indira Gandhi. 14 major commercial banks in the country was nationalized. Second phase of nationalization Indian Banking Sector Reform was carried out in 1980 with seven more banks. This step brought 80% of the banking segment in India under Government ownership. The following are the steps taken by the Government of India to Regulate Banking Institutions in the Country:

• 1949: Enactment of Banking Regulation Act. • 1955: Nationalization of State Bank of India. • 1959: Nationalization of SBI subsidiaries. • 1961: Insurance cover extended to deposits. • 1969: Nationalization of 14 major banks. • 1971: Creation of credit guarantee corporation. • 1975: Creation of regional rural banks. • 1980: Nationalization of seven banks with deposits over 200 crore.

After the nationalization of banks, the branches of the public sector bank India rose to approximately 800% in deposits and advances took a huge jump by 11,000%. Banking in the sunshine of Government ownership gave the public implicit faith and immense confidence about the sustainability of these institutions.

PHASE

This phase has introduced many more products and facilities in the banking sector in its reforms measure. In 1991, under the chairmanship of M Narasimham, a committee was set up by his name which worked for the liberalization of banking practices.

The country is flooded with foreign banks and their ATM stations. Efforts are being put to give a satisfactory service to customers. Phone banking and net banking is introduced. The entire system became more convenient and swift. Time is given more importance than money.

The financial system of India has shown a great deal of resilience. It is sheltered from any crisis triggered by any external macroeconomics shock as other East Asian Countries suffered. This is all due to a flexible exchange rate regime, the foreign reserves are high, the capital account is not yet fully convertible, and banks and their customers have limited foreign exchange exposure.

THE ROLE OF FINANCE AND FINANCIAL INNOVATION

“Innovate” is defined in Webster’s Collegiate Dictionary as “to introduce as or as if new,”3 with the root of the word deriving from the Latin word “Novus” or new.


Economists use the word “innovation” in an expansive fashion to describe shocks to the economy (e.g., “monetary policy innovations”) as well as the responses to these shocks (e.g., Euro deposits). Broadly speaking, financial innovation is the act of creating and then popularizing new financial instruments as well as new financial technologies, institutions and markets. The “innovations” are sometimes divided into product or process innovation. The primary function of a any banking system is to facilitate the allocation and deployment of funds. History shows that financial innovation has been a critical and persistent part of the economic landscape over the past few centuries In the years since Miller’s 1986piece, financial markets have continued to produce a multitude of new products, including many new forms of derivatives, alternative risk transfer products, exchange traded funds, and variants of tax-deductible equity. A longer view suggests that financial innovation is an ongoing process whereby private parties experiment to try to differentiate their products and services, responding to both sudden and gradual changes in the economy.

The banks have come a long way as far as development and contribution to the economy is concerned. A major factor that has brought banking to such a stage is “FINNCIAL INNOVATION”. The various innovations in banking and financial sector are ECS, RTGS, EFT, NEFT, ATM, Retail Banking, Debit & Credit cards, free advisory services, core banking services, implementation of standing instructions of customers, payments of utility bills, fund transfers, internet banking, telephone banking, mobile banking, selling insurance products, issue of free cheque books, travel cheques and many more value added services.

Some of the popular financial innovative products are as follows:

Products

Mortgage loans: are one suite of products that have experienced a great deal of change over the past 25 years in the United States. In 1980, long-term fully amortizing fixed-rate mortgages were the norm and this product was offered primarily by thrift institutions. Moreover, these loans required substantial down payments and a good credit history and the accumulated equity was relatively illiquid.

These characteristics have markedly evolved. The first big change occurred in the early 1980s with the widespread introduction of various types of adjustable-rate mortgages (ARMs), which had previously been banned by federal regulators. The Tax Reform Act of 1986, which ended federal income tax deductions for non-mortgage consumer debt, spurred substantial growth in home equity lending. One mortgage innovation more directly tied to technological change is subprime lending, which was originally predicated on the use of statistics for better risk measurement and risk-based pricing to compensate for these higher risks. However, the subprime mortgage crisis has uncovered significant shortcomings in the underlying statistical models.

Subprime Mortgages: Subprime mortgage lending, broadly defined, and relates to borrowers with poor credit histories or high leverage as measured by either debt/income or loan-to-value. This market grew rapidly in the U.S during the first decade of the twenty-first century – averaging about 20% of residential mortgage originations between 2004 and 2006.


At the end of 2007, subprime mortgages outstanding stood at $940 billion; down from over $1.2 trillion outstanding the previous year (Inside Mortgage Finance 2008).

Since the onset of the subprime mortgage crisis, research has attempted to identify various sources of the problem. Mayer, Pence and Sherlund (forthcoming) provide an overview of the attributes of subprime mortgages outstanding during this time and investigate why delinquencies and defaults increases so substantially. These authors, as will as Gerarbi, Lehnert, Sherlund, and Willen (forthcoming), point to significant increase in borrower leverage during the mid-2000s, as measured by combined loan-to-value (CLTV) ratios, which was soon followed by falling house prices.

Services

Recent service innovations primarily relate to enhanced account access and new methods of payment-each of which better meets consumer demands for convenience and ease.

• Automated Teller Machines (ATMs), which were introduced in the early 1970s and diffused rapidly through the 1980s, significantly enhanced retail bank account access and value by providing customers with around the clock access to funds. ATM cards were then largely replaced through the 1980s and 1990s by debit cards, which bundle ATM access with the ability to make payment from a bank account at the point of sale. Over the past decade, remote access has migrated from the telephone to the personal computer. Online banking, which allows customers to monitor accounts and originate payments using "electronic bill payment," is now widely used. Stored-value, or prepaid, cards have also become ubiquitous.

• Debit Cards: Debit cards are essentially "pay-now" instruments linked to a checking account whereby transactions can happen either instantaneously using online (PIN based) methods or in the near future The primary line of research relating to online banking has been aimed at understanding the determinants of bank adoption and how the technology has affected bank performance. In terms of online adoption. Furst, Lang, and Nolle (2002) find that U.S. national banks (by the end of the third quarter of 1999) were more likely to offer transactional websites if they were: larger, younger, affiliated with a holding company, located in an urban area, and had higher fixed expenses and non-interested income. Turning to online bank performance, De Young, Lang, and Nolle (2007) report that internet adoption improved U.S. community bank profitability – primarily through deposit-related charges. In a related study, Hernando and Nieto (2007) find that, over time, online banking was associated with lower costs and higher profitability for a sample of Spanish banks.

• Prepaid Cards: As the name implies, prepaid cards are instruments whereby cardholders "pay early" and set aside funds in advance for future purchases of goods and services. (By contrast, debit cards are "pay-now", and credit cards are "pay later"). The monetary value of the prepaid card resides either of the card or at a remote database. According to Mercator Advisory Group, prepaid cards accounted for over $180 billion in transaction volume in 2006.


Prepaid cards can be generally delineated as either "closes" systems (e.g., a retailer-specific gift card, like Macy's or Best Buy) or "open" systems (e.g., a payment-network branded card, like Visa or MasterCard). Closed-system prepaid cards have been effective as a cash substitute on university campuses, as well as for mass transit systems and retailers.

PRODUCTION PROCESSES

The past 25 years have witnessed important changes in banks production processes. The use of electronic transmission of bank-to-bank retail payments, which had modest beginnings in the 1970s, has exploded owing to greater retail acceptance, online banking and check conversion. In terms of intermediation, there has been a steady movement toward a reliance on statistical models. For example, credit scoring has been increasingly used to substitute for manual underwriting – and has been extended even into relationship-oriented products like small business loans. Similar credit risk measurement models are also used when creating structured financial products through "securitization". Statistical modeling has also become central in the overall risk management processes at banks through portfolio stress testing and value-at-risk models – each of which is geared primarily to evaluating portfolio value in the face of significant changes in financial asset returns.

• Asset Securitization: Asset securitization refers to the process by which non traded assets are transformed into the U.S., securitization is widely used by large originators of retail credit – specifically mortgages, credit cards and automobile loans. As of year-end 2007, federally sponsored mortgage pools and privately arranged ABS issues (including private-label mortgage-backed securities) totalled almost $9.0 trillion in U.S. credit market debt outstanding.

By contrast, as of year-end 1990, these figures were $1.3 trillion, respectively. One recent innovation in the structured finance/securitization area is the introduction of collateralized debt obligations (CDOs). According to Long staff and Rajan (2006) these instruments, which were first introduced in the mid-1990s, are now in excess of $1.5 trillion. Like ABS, CDOs are also liabilities issued by financial-institution-sponsored trusts, which essentially pool and restructure the priority of cash flows associated with other types of risky financial assets, including senior and mezzanine ABS, high-yield corporate bonds and bank loans.

• Risk Management: Advances in information technology (both hardware and software) and financial theory spurred a revolution in bank risk management over the past two decades. Two popular approaches to measuring and managing financial risks are stress-testing and value-at-risk (VaR). In either case, the idea is to identify the level of capital required for the bank to remain solvent in the face of unlikely adverse environments.

• Organizational Forms: New bank organizational forms have emerged in the United States over the past few decades. Securities affiliates (so-called "section 20" subsidiaries or the creation of "financial holding companies") for very large banks and Subchapter S status for very small banks, were the by product of regulatory/legal evolution. Indeed, only one new organizational form, the internet-only bank, arose


from technological change. These institutions, which quickly emerged and disappeared, may represent an interesting laboratory for the study of "failed" financial innovations. We believe that understanding such experimental failures may hold important insights for understanding the keys to successful innovations.

RESEARCH

Research Problem

The paper aims to study the various financial innovations that took in the banking sector in last decade. It will study the level of awareness and the level of acceptance of these innovations among common man. Last but not the least a brief study on the contribution of these innovations on the economic growth.

Research Methodology

The research has been done based on both, the primary data as well as the secondary data.

Primary Data: A sample of 100 customers was taken randomly to collect the required data for conducting the research. Some data was collected by way of interviewing the bank managers of five banks:

• State Bank of Indie, Dharampeth, Nagpur • ICICI, Ramdespeth , Nagpur • Canara Bank, Gandhinagar, Nagpur • HDFC, Shankarnagar, Nagpur • Axis Bank, Laxminagar, Nagpur

Secondary Data: This data is basically and only used for analyzing the contribution of banking innovations on its growth and revenue towards the country. This data is collected from the internet.

DATA ANALYSIS AND INTERPRETATION

Has banking system become easy to access and has made life easier and simpler?

The entire 100 sample agreed to the fact that banking system has become much easier to access. The system has become less complex and completely transparent especially after the LPG (Liberalization, Privatization and Globalization) policy.

Level of awareness about Core Banking facilities.


Level of awareness about RTGS (Real Time Grass Settlement)

No. of people using core banking and RTGS facilities

Awareness levels of debit and credit cards


Awareness levels and the number of people availing the services of internet banking

Credit and loan facilities: formalities, procedures, mortgages have become simple and

easier.

Inference drawn from interviewing the bank employees of the sample banks.


• The awareness levels of people have risen to a considerable extent and also the number of people approaching banks for loans and advances has also risen by 65% as compared to the last decade.

• The number of customers using internet banking has also improved from 5% to 15% in last five years.

• Core banking and RTGS though not much popular among individual customers (12%) but is well accepted and exercised by the corporate houses and the employees (68%)

Role of Banking Innovations towards Economic Growth and National Income

The last decade has seen many positive developments in the Indian banking sector. The policy makers, which comprise the Reserve Bank of India (RBI), Ministry of Finance and related government and financial sector regulatory entities, have made several notable efforts to improve regulation in the sector. A few banks have established an outstanding track record of innovation, growth and value creation. This is reflected in their market valuation. However, improved regulations, innovation, growth and value creation in the sector remain limited to a small part of it.

Summarized data of the adjusted PAT (profit after tax) ( in crores) mar'10 mar'09 mar'08 mar'07 mar'06

ICICI bank Adjusted PAT 3,890.47 3,740.62 4,092.12 2,995.00 2,532.95 HDFC bank Adjusted PAT 2,944.68 2,240.75 1,589.48 1,142.50 870.51

SBI Adjusted PAT 9,176.51 9,124.18 6,718.08 4,529.18 4,404.73 Axis bank Adjusted PAT 3,909.62 2,893.07 1,890.54 1,102.46 865.05

Canara bank Adjusted PAT 3,018.65 2,071.59 1,563.92 1,420.32 1,342.83

(Source: money control.com)

From the above we can comprehend that there has been a constant and consistent growth in the profit of the sample banks. A major reason for this success is the increase in the amount and the variety of products offered by the banks. There has been a considerable rise in the turnover of the cash in-flows and the cash out flows.

As the services have increased, the earnings have also increased in the form of commissions and the brokerage and other value-added services. As the individual profits have risen, this has also contributed and added to the economic growth and revenue of the nation.

CONCLUSION

• Post LPG policy, as the private players entered the Indian economy, the level of competition led to a lot of customization of the services in the banking services.

• Debit cards, credit cards, core banking, RTGS, interest rate swaps etc. though have been implemented by the banks, yet it is not very popular among common set of customers.

• From the above we can also conclude that the there is still a lot of unexplored area will is still left to be popularized among India.


• Another conclusion that can be drawn from this study is that the corporate houses have benefitted more from the financial innovations in the form of interest rate swaps, credit rate swaps, asset securitization, and mortgage loans as compared to the individual customers.

• The contribution of service industry has risen from 42% to 54% towards India’s GDP in last five years.

• The banking index has grown at a compounded annual rate of over 51 per cent since April 2001 as compared to a 27 per cent growth in the market index for the same period.

REFERENCES [1] Mohd. Arif Pasha, "Financial Markets and Intermediaries", Kalyani Publishers, New Delhi, 2009 [2] Mohan, Rakesh. 2004 a. "Finance for Industrial Growth." RBI Bulletin, March. 2004b. "Ownership and

Governance in Private Sector Banks in India." RBI Bulletin, October. [3] 2006. "Financial Sector Reforms and Monetary Policy: The Indian Experience." RBI Bulletin, July. [4] 2007. "India's Financial Sector Reforms: Fostering Growth while Containing Risk [5] Allen, F. and D. Gale (1994), Financial Innovation and Risk Sharing (MIT Press, Cambridge, MA). [6] National income report on Rediff research .com

Profitability Performance of Indian Scheduled Commercial Banks:

An Empirical Analysis

A.N. Shukla* and R.K. Bhardwaj*

Abstract—Growth of an Industry essentially depends upon its economic viability. This in turn, depends upon the ability to generate adequate surplus from its operations for sustaining steady growth. Commercial banking is no exception to this rule as its growth rests on the capacity to generate surplus from its working. The dwindling profitability of commercial banks has been a cause for anxiety and concern among the banking circles. This paper examined the profitability of Scheduled Commercial Banks in terms of the total income, expenses and earning to expenses ratio and their relationship from the period 1971-72 to 2005-06.

Keywords: profitability performance, scheduled banks, commercial banks

INTRODUCTION

During the two decades 1971-91 the formal agricultural credit system comprising the National Bank for Agriculture and Rural Development (NABARD) rural and semi urban branches of Scheduled Commercial Banks (SCBs), Co-operatives and Regional Rural Banks (RRBs), has expanded sizably in quantitative terms in response to the increasing need for effective credit support to farmers for the meeting working capital as well as investment needs. However, the benefits of this green revolution have been largely limited to areas having irrigation potential. For the dry land, watershed development programmes have achieved success in some locations but its benefits remain modest as compared to that of green revolution. White revolution, based upon genetic improvement of cow and buffalo, has been relatively better widespread but is perhaps restricted to certain section of farm community. With growing pressures for commercialization and diversification of agriculture in response to growing demands for market and trades need for efficient and effective institutional credit support has accentuated, in addition to other kinds of support such as policy and infrastructure.

Credit has been considered not only as one of the critical inputs in agriculture, but also an effective means of economic transformation. A large number of agencies, including cooperatives, regional rural banks, commercial banks, non-banking financial institutions, self-help groups and a well spread informal credit outlets together represent Indian rural credit delivery system. These networks apart from working as financial intermediaries also play a key developmental role in the economy.

The process of globalization and deregulation of financial institutions have thrown open new challenges and opportunities. The financial institutions need to meet the expanding credit needs of agriculture sector. In an emerging situation agriculture sector in order to enable it to *G.B. Pant University of Agriculture & Technology, Uttarakhand


high value addition and export orientation requires higher credit to strengthen primary production base like land and water, support investment in farm machinery and current inputs. Thus, qualitative dimensions of the credit delivery channel are equally important. The capability of the institutional credit delivery channel will be severely tested in funding farmers at the extremes of the spectrum; small and marginal holdings with more than a third of the production base, and the large and enterprising farmers. As the credit requirements of different sections of producers have specific characteristics of content, scale, timing, mode of payment and back-up services, the quality of credit delivery by various institutions will determine their competitiveness in a deregulated financial regime. The objective of the study is to examine the pattern of profitability of banks and its relationship with rural coverage of banks, share of agricultural credit in total bank credit, and rural credit deposit ratio.


The study is based exclusively on secondary data obtained from various sources. Relevant time series data on profitability of banks, rural coverage of banks, share of agricultural credit in total bank credit, and rural-credit deposit ratio were collected from various publications such as Reserve Bank of India Bulletins, Report on Currency and Finance, Statistical Tables Relating to Banks in India, Economic survey of India, Govt. of India, Economic and Political Weekly Research Foundation etc.

Growing participation of commercial banks in financing agriculture sprung up many issues in relation to its functioning and viability functions. Profitability of commercial banks is one such important issue. To examine the issue whether expansion in agricultural financing by banks has resulted in erosion of banks profitability, net profit and earning to expenses ratio were regressed separately upon share of agricultural credit in total bank credit and share of rural offices in total offices of banks. Before taking up regression analysis, zero-order correlation matrix for the above variables was constructed to look for the problem of multicollinearity. The regression equations that was undertaken given below:

(i) Linear: Y= a + b1x1 + b2x2 + b3x3

Two different sets of equations was used wherein the dependent variable’y’ in one set represents the net profit of banks in lakh rupees and in other represents the earning to expenses ratio.

The independent variables xi, which are common for both the sets of equations, are as under:

x1 = Proportion of agricultural credit in total bank credit (%) x2 = Proportion of rural branches in total bank branches (%) x3 = Rural credit – deposit ratio a = Constant b1, b2, b3 are regression coefficient for x1, x2, x3 respectively.

Profitability Performance of Indian Scheduled Commercial Banks: An Empirical Analysis 49

RESULTS AND DISCUSSION

The data in table 1 shows that the total income, total expenses and income to expenses ratio of SCBs increased in both the pre and post-liberalization period.

TABLE 1: TOTAL INCOME, TOTAL EXPENSES AND INCOME TO EXPENSES RATIO OF SCHEDULED COMMERCIAL BANKS. (RS CRORE)

Year Total Income Total Expenses Income to Expenses Ratio PRE-LIBERALIZATION PERIOD

1971-72 685 628 1.09 1975-76 2098 1855 1.13 1980-81 5323 5259 1.01 1985-86 12447 12224 1.01 1990-91 30404 29661 1.02

POST-LIBERALIZATION PERIOD 1995-96 65112 64199 1.01 2000-01 132078 125654 1.05 2005-06 220756 196174 1.12

Source: Report on Trend and Progress of Banking in India,Various Issues

Total income, by and large, continued to increase from Rs. 685 crore in 1971-72 to Rs. 220756 crore in 2005-06, except few dips here and there. Similarly, total expenses also continued to rise from Rs. 628 crore in 1971-72 to Rs. 196174 crore in 2005-06.

In pre-liberalization period it is seen that income to expenses ratio stagnated around 1.1. In post-liberalization period, the ratio showed signs of improvement after mid-nineties. In first two years of post-liberalization period, the ratio worsened perhaps because of adjustments required to implement measures of banking sector reforms.

TABLE 2: RURAL COVERAGE OF BANKS, SHARE OF AGRICULTURE CREDIT IN TOTAL CREDIT AND RURAL CREDIT‐DEPOSIT (C‐D) RATIO

Year Rural Coverage of Banks (%)

Share of Agricultural Credit in Total Bank Credit (%)

Rural C-D Ratio

Pre-liberalization Period 1971-72 36.0 7.18 47.7 1975-76 36.6 9.2 56.5 1980-81 51.2 14.2 60.6 1985-86 55.7 18.49 65.3 1990-91 56.9 14.22 60.0

Post-liberalization Period 1995-96 51.2 10.82 47.3 2000-01 48.3 11.01 39.0 2005-06 44.48 12.68 56.3

Relationship between Profit of Banks, Rural Coverage of Banks, Share of Agriculture Credit in Total Credit and Rural C‐D Ratio

Increasing financial assistance by Scheduled Commercial Banks to agriculture and rural branch expansion area undertaken in a massive scale after nationalization has resulted in eroding profitability of banks, as is held out in many circles. To examine this issue three sets of regression analysis was done. Income to expenses ratio (Y1), Income (Y2) and expenses (Y3) were separately regressed upon share of rural offices in total bank offices (X1) and rural C-D ratio (X3) for pre-liberalization period, post-liberalization period and the pooled two


periods separately using linear regression models. Before taking up the regression analysis zero order correlation matrices were constructed. The correlation results showed that share of agriculture credit (X2) has high association with share of rural offices (X1) (0.79) and also with rural C-D ratio (X3) (0.71). Therefore, X2 variable was dropped from regression analysis to avoid the problem of multi-collinearty. Thus, income to expenses ratio was regressed upon the two variables X1 and X3 to examine the empirical relationship.

TABLE 3: SIMPLE CORRELATION RESULTS, 1971‐72 TO 2005‐06

Rural Coverage of Banks (X1)

Share of Agricultural

Credit in total credit (X2)

Rural C-D ratio (X3)

Total Income (Y2)

Total Expenses (Y3)

Earning to Expenses ratio (Y1)

Rural Coverage of Banks (X1)

1 .787** .317 .073 .094 -.456**

Share of Agricultural Credit in total credit (X2)

1 .709** -.202 -.200 -.322

Rural C-D ratio (X3) 1 -.567** -.575** -.248 Total Income (Y2) 1 .998** .214 Total Expenses (Y3) 1 .156 Earning to Expenses ratio (Y1)

1

**Significant at 10 per cent level

The regression results showed that in pre-liberalization period (i.e. 1971-72 to 1990-91), the share of rural offices (X1) and rural C-D ratio (X3) turned out to be non-significant variables in explaining the declining earning to expenses ratio (Y1) of banks. In other words, the share of rural offices in total bank offices and rural C-D ratio (X3) have nothing to do with the falling earning to expenses ratio of banks, the ratio which could be taken as a measure of profitability (ability to make profit) of banks. This kind of result is very obvious when one observes the statistics given in table, which clearly indicates that income to expenses ratio began to fall before the pre-liberalization period.

In post-liberalization period (i.e. 1991-92 to 2005-06) the linear regression results show that the share of rural offices (X1) and rural C-D ratio (X3) turned out to be significant variables explaining the increasing income to expense ratio (Y1) of banks. In other words, the share of rural offices in total bank offices and rural C-D ratio explains significantly and positively the increasing income to expenses ratio of banks.

However, the overall results for the pooled period 1971-72 to 2005-06 do indicate rural coverage of banks having a significant negative effect on profitability (Y1), but not on total income (Y2) and total expenses (Y3). However, rural C-D ratio is found to have significant negative effect on income-expenses ratio, total income and total expenses. Yet, the total variation explained together by the two variables X1 and X3 in profitability is only 26 per cent, but some what higher at 40 per cent and 42 per cent in total income and total expenses respectively.

The table 4 results refute the view (through with weak relationship) that increasing involvement of banks in agriculture sector by way of massive branch expansion in rural areas

Profitability Performance of Indian Scheduled Commercial Banks: An Empirical Analysis 51

has been responsible for erosion in profitability of banks. Commercial banks are involved not only in financing agriculture but in many other sectors of the economy such as small, medium and large industries, services, export sector etc. Therefore, there will be so many determinants of banks’ profitability.

TABLE 4: LINEAR REGRESSION RESULTS ON DETERMINANTS OF PROFIT OF SCHEDULED COMMERCIAL BANKS

Independent/ Variables Dependent variables

Dependent Variables Earning to Expenses Ratio (Y1) Total Income (Y2) Total Expenses (Y3)

1971-72 to 2005-06 (Pooled) Constant (A) 1.52 263830.6 224440.4 Rural Coverage of banks (X1) -.008***

(.003) 872.6

(2498.5) 1247.2

(2216.2) Rural C-D ratio (X3) -.003*****

(.0024) -6083.2** (1845.6)

-5433.8** (1637.1)

Coefficient of multiple determination (R²) 0.26 0.40 0.42 1971-72 to 1990-91 (Pre-liberalization Period) Constant (A) 1.20 -46158.8 -44413.0 Rural Coverage of banks (X1) -.0009

(.0031) 2573.3* (589.1)

2397.6* (520.7)

Rural C-D ratio (X3) -.0008 (.0041)

-431.0 (774.6)

-376.0 (684.7)

Coefficient of multiple determination (R²) 0.37 0.68 0.71 1991-92 to 2005-06 (Post-liberalization Period) Constant (A) 2.02 740065.3 629418.5 Rural Coverage of banks (X1) -.023***

(.0078) -15508.4* (2858.8)

-12753.9* (2892.7)

Rural C-D ratio (X3) -.0026 (.0064)

2902.3 (2358.7)

2496.6 (2386.7)

Coefficient of multiple determination (R²) 0.51 0.79 0.72 Figures in parentheses indicate standard errors of regression coefficients *Significant at 0.01 per cent **Significant at 0.5 per cent, ***Significant at 2.5 per cent, ****Significant at 5 per cent *****Significant at 10 per cent

These determinants could not be included in the present regression model. However, such excluded determinants might affect the banks’ profit adversely. That is why the combined variation explained by the two factors together in profitability was found to be only in the range of 26 per cent in profitability and 40 to 42 per cent in total income and total expenses. Therefore, the profitability of bank is adversely affected by increasing share of agricultural credit in total bank credit, increasing rural coverage of banks and increasing rural credit-deposit ratio is accepted but these variables account for small (less than 50 percent) variation in the profitability. This indicates that there are non-agricultural factors also adversely affecting the profitability of banks.

Commercial banks have been experiencing high volume of non-performing assets (NPAs) in non-agricultural sector also. Their exclusion, and a relatively less number of observations in the time series period, however, makes the results only indicative and not conclusive in the present study.


CONCLUSION AND POLICY IMPLICATIONS

The profitability of banks is depend on their operational efficiency, customer orientation, creation of large volume of performing assets, attainment of optimum levels of productivity. Harnessing technology to improve productivity, to ensure required standard of customer service and internal efficiency, continual product innovation and strengthening of competitive edge on an ongoing basis to mass business in the competitive environment, while adhering to prudential norms and maintaining prescribed levels of capital adequacy on risk assets simultaneously will impact banking sector in days to come. Continuous quest for skill upgradation at all levels, development of vision, mission and commitment are some of the aspects, which require urgent attention by the banking industry in future to ensure optimum staff productivity. Banks, which are pro-active, respond quickly to the changing needs of the customer, and give adequate attention to the changing scenario, alone can survive successfully, perform well and prosper. Despite the relatively moderate profitability of Indian commercial banks, the fact that is in their favour is their core business on a rising trend. This means that they are able to better leverage the growth opportunity that currently exists and are enhancing their earning capacity.

REFERENCES [1] Shukla, A.N. and P.P. Dubey (2008), “Performance of Commercial Bank credit to Agriculture in India: An

Empirical Analysis”. Ph.D., Thesis, Submitted to C.S.J.M University Kanpur, U.P. [2] Reserve Bank of India. Report on Trend and Progress of Banking in India, Various Issues from 1971–72 to

2006-07. [3] Tewari, S.K. (2007),’Rapporteur’s Report on Trends in Rural Finance’ Indian Journal of Agricultural

Economics, 62 (3), July-Sep., pp.551–561.

A.C.A.M.E.L. Model Assessment of Old Private Sector Banks in India

Shweta Mehta* and Dr. Nirvesh Mehta* Abstract—This study investigates performance and financial health of old sector private scheduled banks of India in the context of new regulations and stiff competition. Performance of 13 banks has been analyzed with reference to CAMEL variables (Capital Adequacy, Asset Quality, Management Efficiency, Earnings Quality and Liquidity Management) for a period of ten years from 1996-97 to 2005-06. Paper analyzes and compares each bank's performance; banks are ranked accordingly. The findings of the study reveal that i) The performance of old generation banking industry is not satisfactory; ii) banks should aim for better performance to cope up the changes and competition. Aggregate performance of Federal bank is the best among all the banks, followed by Karur Vysya bank and South Indian bank. This evaluation of Indian banks performance based on internationally accepted model will be useful to investors, customers, bankers, policy makers and the economy in general.

INTRODUCTION

The financial reforms, initiated in India in the beginning of 1990's, have drastically changed the banking scenario of Indian economy. During the pre-liberalization period, the industry was merely focusing on deposit mobilization and branch expansion. The Narasimhan Committee, appointed by Reserve Bank of India (RBI), recommended efficient, productive and competitive financial system in the country. Governments, irrespective of their political affiliations, adopted these recommendations and reduced reserve requirements, deregulated interest rates and gave more autonomy to banks (Roji 2007). To have global standards. India also joined the Basel accord and urged the banks to adhere to the norms by March 2007. Subsequently, this deadline was extended due to the difficulty of banks to implement the recommendations. The regulator, RBI in its guidelines issued in January 2004, liberalized foreign investment in banking sector by allowing foreign direct investment up to 74%. By the end of 2009, foreign banks will get a free hand to grow and acquire other banks in India on an equal footing with banks incorporated in India. Government in favor of any type of merging either a strong bank with another strong bank, or a week bank with a strong bank etc. The banking sector reforms have improved the profitability, productivity, and efficiency of banks; but in the days ahead, banks will have to prepare themselves to face new challenges and more competition.

Old Sector Banks are the scheduled banks, which have been operating in the country for long and are considered as traditional banks. By definition, they are banks, which started before the liberalization initiatives in India. These banks are concentrated in a particular geographical area with limited branch network. Their functions were limited mainly

*S.K. Patel Institute of Management and Computer Studies, Gujarat


to lending activities. Typical examples are Federal Bank of Kerala and Jammu & Kashmir, Bank of Jammu & Kashmir, which have been concentrating mainly on their home states for longtime. The changed face of Indian banking compelled these banks to become technologically upgraded, customer oriented and cost effective banks with wider geographical coverage.

NEED OF THE STUDY

As a policy decision on banks' health and performance, RBI directed the old private scheduled banks to have a minimum capital base of rupees three hundred crore on par with their counterparts in the private sector. Joshy (2005) commented that old private sector banks have a slender capital base, and for most of them attaining the proposed capital base is a Himalayan task. So an option can be an enhancement of profit margin and retaining the profit so that banks can show improved tier 1 capital. But the crux of the problem is how to increase the profit? Roji (2006) commented that merger is inevitable in Indian banking. Foreign banks, which will be in India in large number may prefer taking over the small capital based banks instead of their own organic growth. Apart from the above, these banks may face other important regulatory problems, since adhering to the 9% Capital Adequacy R'1tio (CAR) may not be possible for these banks. Avinesh (2005) estimated that CAR of scheduled commercial banks may fall down by 1.14% points by 2008.

In this context, this study focuses on the evaluation of the financial health and performance of old scheduled banks. It is expected that such a study will be useful to investors of these banks, borrowers, customers, regulators and the economy, since the performance of these banks will have multifaceted impact on production, employment, corporate performance in Indian economy. Table 1 provides an insignt into the performance of Indian banks, classified into groups. It can be inferred from the table that the performance of old sector banks is very much comparable with their counterparts despite their small size disadvantage.

TABLE 1: GROUP‐WISE AND PERCENTAGE WISE MAJOR COMPONENTS BALANCE SHEETS OF SCHEDULEDCOMMERCIAL BANKS

Bank Group, Parameters & Year

No. of Branches

Assets Deposits Advances Investment 2005 2006 2005 2006 2005 2006 2005 2006

l.PSB 48,016 75.3 72.4 78.2 74.9 74.3 73.0 78.9 73.0 NB 34,185 48.7 47.6 50.7 49.8 49.6 48.5 48.9 47.1 SBI 13,831 26.6 24.8 27.5 25.1 24.7 24.5 30.0 25.9 2. Pvt S B 6,516 18.2 20.4 17.1 19.8 19.2 20.6 16.2 20.8 O. Pvt S B 4,566 5.7 5.4 6.4 6.0 5.9 5.5 5.1 5.2 N. Pvt S B 1,950 12.5 15.1 10.8 13.8 13.3 15.2 11.0 15.6 3. F. Banks 259 6.5 7.2 4.7 5.3 6.5 6.4 4.9 6.2 Total 54,791 100 100 100 100 100 100 100 100

Abbeviations: PSB: Public Sector Banks, NB: Nationalised Banks other than SBI group of banks, SBI: State Bank of India and other state banks, Pvt. S.B: Private Sector Banks, O. Pvt S B: Old Private Sector Banks, N. Pvt S B: New private Sector Banks, F. Banks: Foreign Banks.

A.C.A.M.E.L. Model Assessment of Old Private Sector Banks in India 55

This paper is organized as follows: Section 2 portrays a conceptual explanation of CAMEL model. Section 3 reviews the previous studies, conducted abroad and in India, and section 4 describes the method of analysis. Findings of the study are explained in section 5 and section 7 concludes this study by giving suggestions for improvement.

C.A.M.E.L. MODEL

Over the past decade, bank regulators introduced a number of measures to link the regulation of commercial banks to the level of risk and financial viability of these banks. Risk-based capital requirements and risk based deposit insurance premia are two prominent examples. Right from the beginning of BASEL accord 1 in 1988, economists discussed warning models, which can predict bank failures. Most recently, the regulators have augmented bank exam CAMEL rating model (early warning, off-site surveillance model) to include explicit examiner's assessment of the bank’s ability to manage its performance. Due to the nature of banking, the important role that banks play in the economy (i.e. capital formation), banks should be more closely regulated than any other type of economic unit in the economy. In this context, the early warning off-site surveillance CAMEL model reflects the likelihood of both financial distress and regulatory intervention.

Bank supervisors use both on-site examination and off-site surveillance to analyze and identify the financial viability of banks. The most useful tool for identifying problem banks is on-site examination, in which the examiners travel to a bank to review all aspects of its safety and soundness. On-site examination is, however, both costly and burdensome: Costly to supervisors because of the intrusion in their day today operations. Consequently, supervisors monitor banks' conditions off-site. Another disadvantage is that, the power can be exercised only by regulatory authorities, who are legally not supported by researches, or investors and even lenders and borrowers. Off-site surveillance also provides banks with incentives to maintain safety and security norms between on-site visits. Now CAMEL is accepted as an internationally recognized tool for measuring bank performance and its financial health, since it covers all functional activates related with banking operations.

Padmanabhan Working Group (1995), in its report on on-site supervision, recommended for supervisory interventions and introduction of a rating methodology for banks on the lines of CAMEL model with appropriate modification to suit Indian conditions. The Working Group has recommended six rating factors-Capital Adequacy, Assets Quality, Management, Earnings, Liquidity, Systems and Controls (ie., CAMELS). For Foreign Banks, four rating factors, are Capital Adequacy, Assets Quality, Compliance, Systems and Controls (i.e. CACS). Narasimhan Committee (1998) made several important recommendations like introduction of internationally accepted prudential norms, relating to income recognition, assets classification, provisioning and capital adequacy. Accordingly, a framework for the evaluation of the current strength of the system and of the operations and performance of banks has been provided by Reserve Bank's measuring rod' of "CAMELS", which stands for Capital Adequacy, Assets Quality, Management, Earnings, Liquidity and Internal Control Systems.


The main endeavor of CAMEL system is to detect problems before they manifest themselves. The RBI has instituted this mechanism for critical analysis of the balance sheet of banks by themselves and presentation of such analysis before their boards to provide an internal assessment of the health of the bank. The analysis, which is made available to the RBI, forms a supplement to the system of off-site follow up. The entire cycle of inspection and· follow-up action are now completed within a maximum period of 12 months. Monitorable action plan for rectification of irregularities deficiencies, noticed during the inspection within a time frame is drawn up and progress in implementation pursued with the bank concerned.

Thus, the present supervisory system in banking sector is a substantial improvement over the earlier system in terms of frequency, coverage and focus as also the tools employed. Nearly one-half of the Basle Core Principles for Effective Banking Supervision has already been adhered to and the remaining is at a stage of implementation. Two Supervisory Rating Models, based on CAMELS and CACS factors for rating of Indian commercial banks and foreign banks operating in India respectively, have been worked out on the lines recommended by the Padmanabhan Working Group (1995). These ratings would enable the Reserve Bank to identify the banks whose condition warrants special supervisory attention. CAMEL VARIABLES

Capital Adequacy

Capital adequacy signifies the level and quality of capital. It is the overall financial condition of the institutions. Regulators view a higher level of equity as a cushion against future losses. This helps to protect the individual depositors (customers of banks) from incurring any loss and also reduces potential bail out costs to the taxpayers. Again, higher capital adequacy of a bank implies higher alignment of the owner's interest with the success of the banks, thus reducing moral hazard.

Asset Quality

Asset Quality reflects the quantity of existing and potential credit risk, associated with the loan and investment portfolio, other real estate owned assets, as well as off-balance sheet transactions. It a1so reflects the ability of management to identify, measure, monitor and control credit risk. Management Efficiency

The ratio in this segment measures the efficiency and effectiveness of management, which is the most important ingredient that ensures the sound functioning of banks. With increased competition in the Indian banking sector, efficiency and effectiveness have become the rule as banks constantly strive to improve the productivity of their employees.


Earning Quality

Earnings reflect the capacity to grow and the financial health of the bank. High earnings signify high growth prospects and low risk exposure and smooth operations. A high value indicates higher profitability and quality of earnings.

Liquidity Management

Liquidity implies the cash position of the banks and the ability of the banks to meet customers day-to-day cash needs and to respond to sudden cash withdrawals. Liquidity can be stored or purchased. Stored liquidity like loan or deposit ratio is highly correlated with the capital adequacy ratio. It appears redundant. However, purchased liquidity problem will be forced to purchase funds at higher interest rates.


Status Outside India

Operating and financial ratios have long been used as tools for determining the condition and performance of the firm. Altman's (1967) seminal work on identifying distressed firms radically changed a well-established tradition by introducing discrimination analysis. Modern early warning models for financial institutions gained popularity, when Sinkey (1975) used discriminant analysis for identifying and distinguishing problem banks from the sound banks, and Altman examined the savings and loan industry. Since then, there have been numerous studies of early warning systems that focus on the development of models to identify problem banks and or to predict bank failure. Most of these studies have used a dichotomous approach (variable approach) by defining the dependent variable as a problem (non problem) or failure (non-failure) bank for CAMEL Variables.

Researchers have tested the effectiveness of CAMEL ratings information for indicating the changes in the condition of banks. Using United States call report data, Sinkey (1975) and Espahbodi (1991) developed models to identify factors that distinguish problem banks or failed banks from sound banks. A number of researchers have combined call report data with regulator's examination data to explore the efficacy of CAMEL ratings. Most of these studies concluded that the CAMEL ratings generally reflect the soundness of the financial institutions. Internal factors have been identified as the most important cause of troubled banks. Most recent study has been by Hanc (1998). Sinkey (1975) points out that the internal factors, causing bank failures, are decisions over which the managers and the directors of the bank have direct control.

Berger and Davies (1994) answered the query whether supervisors might benefit by disclosing CAMEL ratings to public. Such disclosure could benefit the supervisor by improving the pricing of bank securities and increasing the efficiency of the market discipline. As argued by Flannery (1998), market assessment of bank conditions compare favorably with supervisory information. He suggests further research and debate on the question whether supervisory information be made public.


Robert D Young, Joseph P Hughes and Choon Ceol (1998) stated that, due to the nature of banking (banks have opaque asset quality and a substantial portion of their debt is demandable) and the important part that banks play in the economy (the payment system), banks should be more closely regulated than other types of firms. Such a regulatory process is one, on the basis of which the regulators write debt contracts and covenants on behalf of the bank's demandable debt holders, monitor bank's compliance to safety and soundness regulations, and if necessary, enforce these cost! y covenants (e.g. higher deposit premia, more frequent and rigorous examinations, restrictions on investment activities etc), when banks experience financial distress. In this framework, CAMEL rating reflects the likelihood of both financial distress and regulatory intervention.

Reducing the regulatory oversight may adversely affect the market's ability to price bank securities effectively. The bank examination process contributes significantly to the market's understanding of financial problems of the banks (John 1999). Confidential supervisory information, garnered through bank examination, can potentially improve the forecasts of key macroeconomic variables, including bank stock performance in the capital market. De Young, Flannery, Lang, and Sorescu (1998) and Berger, Davies and Flannery (2000) found strong evidence to support that a large portion of information contained in CAMEL ratings remains confidential. Hence, the predictable component of CAMEL should be incorporated in the CDP forecasts, leaving CAMEL to serve as a proxy only for that part of the change in bank's health that is unobservable by the public for publicly traded banks.

According to Robert De Young (2001), bank supervisors pay closer attention to newly charted banks than to similarly situated established banks. Federal Reserve supervisors conduct full scope examination for safety and soundness of a newly charted bank at six-monthly intervals (established banks are examined every 12-19 months) and will continue to schedule exams at this frequency until the bank receives a strong composite CAMEL rating of 1 or 2 in two consecutive exams.

Indian Studies

Rao and Datta (1998) attempted to derive rating based on CAMEL. In their study, based on these five groups (C-A-M-E-L), parameters were developed. After deriving separate rating for each parameter, a combined rating was derived for all the nationalized banks (19) for the 1998. The study found that Corporation Bank has the best rating, followed by Oriental Bank of Commerce, Bank of Baroda, Dena Bank, Punjab National Bank, etc. The worst rating was found for Indian Bank, preceded by UCO Bank, United Bank of India, Syndicate Bank and Vijaya Bank. Parsuna (2004) analyzed performance of Indian banks by adopting the CAMEL Model. The performance of 65 banks was studied for the period 2003-04 and the author concluded that the competition was tough and consumers benefited from it. Better service quality, innovative products and better bargains are all greeting the Indian customers. The coming years will prove to be a transition phase for banks, as they will have to align their strategic focus to increasing interest rates, according to the author of this study.


Veni (2004) studied the capital adequacy requirement of banks and the measures adopted by them to strengthen their capital ratios. The author highlighted that the rating agencies give prominence to Capital Adequacy Ratios of banks, while rating the bank's certificate of deposits, fixed deposits, and bonds. They normally adopt CAMEL Model for rating banks. Thus, Capital Adequacy is considered as the key element of bank rating. Satish, Sharath and Surender (2005) adopted CAMEL model to assess the performance of Indian banks. They analyzed the performance of 55 banks for 2004-05, using CAMEL Model. Study concluded that the Indian banking system looks sound and information technology will help the banking system grow in strength in future.

The review of the studies, it is clear that the CAMEL Model has been used extensively for ranking/rating of the banks. Researchers have generated various variables that significantly relate to CAMEL components and their rating. All the financial ratios taken in this study are quantitative and adequately represent the CAMEL component.

METHOD OF ANALYSIS

Objectives and Hypothesis

The objective of this study is to access the overall financial performance of old generation private sector banks. An attempt is made to compare the banks on the basis of CAMEL parameters - Capital adequacy, Asset Quality, Management Quality, Earnings Quality and Liquidity Management-. This study formulated the following null hypotheses for validation.

H01: There is no significant difference in capital adequacy performance between the old generation private sector banks;

H02: There is no significant difference in asset quality performance between the old generation private sector banks;

H03: There is no significant difference in management efficiency performance between the old generation private sector banks;

H04: There is no significant difference in earnings quality performance between the old generation private sector banks; and

H05: There is no significant difference in liquidity management performance between the old generation private sector banks with reference to the stipulated norms.

Data Source

The study is based on secondary data. The main sources of data are Capitaline database of Capital Market Publishers (P) Ltd and database of Reserve Bank of India. The study has also made use of data from the annual reports of the banks and websites of respective banks.

This study is based on secondary data. The information are collected from annual report of the bank, capital line database and websites.

The present study analyzed for a period of 10 years from 1996-1997 to 2005-2006.


Population and Sample

Population of this study consists of twenty two banks, which are considered and accepted as old generation banks by RBI during various periods. Study analyses the performance for a period of ten years from the accounting year 1996-1997 to 2005-2006. Bharat Overseas Bank, Global Trust bank, Lord Krishna Bank and United Western Bank are excluded due to their merger with other old sector or nationalized banks. Five banks - Sangli Bank, Nainital Bank, Tamilnadu Merchantile Bank, SBI Commercial and International Bank and Ganesh Bank of Kurundwad, due to non availability of sufficient data are also not included. This study uses data of thirteen banks, which we consider sufficient for making a general conclusion about old generation private banking Industry.

Variables

Variablesl used for measuring CAMEL are illustrated in table 2. It is expected that, by increasing the number of variables, the extreme as well as non-significant values can be avoided and quality of study can be improved.

TABLE 2: CAMLE VARIABLES AND SUB VARIABLES

Sr. No Camel Variable Sub variables Ratio 1 Capital

Adequacy Capital Adequacy Ratio, Debt Equity Ratio, Advances to Assets Ratio and Government Securities to Total Investment Ratio.

2 Asset Quality Gross NPAs to Net Advances, Gross NPAs to Total assets, Net NPAs to Net Advances, Net NPAs to Total Assets, Total Investments to Total Assets

3 Management Efficiency Total advances to Total Deposits, Business per Employee, Profit per Employee. 4 Earning Quality Operating Profit To Average Working Funds, Percentage Growth in Net Profit,

Spread, Net Profit to Total Assets, Interest Income to Total Income, Non-Interest Income to Total Income

5 liquidity Management liquid Assets to Total Assets, Government Securities to Total Assets, liquid Assets to Demand Deposits, liquid Assets to Total Deposits, Approved Securities to Total Assets

Note: In asset quality, variables considered are non performing assets and so higher the rate, lower the performance and in all other cases it is reverse.

Analysis

The first part of the study finds value of each variable, which is basically a ratio. Once, these ratios are computed for every bank for all the years, the overall value of each variable (C/A/M/E/L) is found, by giving a weight equal to the value for the particular variable. Based on these values, performance of banks is compared and conclusions are made.

Analytical Results

The objective of this study is to analyze the performance of the banks and to assess the old public sector banks in general. First part of this section describes the performance of the banks individually and second part deals with the overall performance.


BANK WISE PERFORMANCE

Dhanalakshmi Bank Ltd. (DBL)

Capital adequacy figures show that capital adequacy position of OBL is consistent with mean of 7.47 and standard deviation (SO) of 0.03, but compound annual growth rate (CAGR) is not satisfactory. Asset quality variable fluctuates widely with a mean of 0.12 and SD of 0.04 and the level of asset quality is not satisfactory. In management efficiency, performance is improving with a CAGR of 16.96%. In earnings quality, performance is very poor and the growth rate is negative. The liquidity variable also shows that the performance of the bank is poor with a negative growth rate. So it is concluded that, performance of OBL is not satisfactory.

BANK OF RAJASTHAN LTD. (BOR)

Bank is in the top list in capital adequacy figure with a CAGR of 7.83% which fluctuates widely with a mean of 19.75 and SD of 35.48. Asset quality variable fluctuates widely with a mean of 0.12 and SO of 0.04 but the level of asset quality is quite satisfactory for some years and it is improving since CAGR is positive. Management performance of the bank is very poor with negative CAGR. In earnings quality, CAGR is satisfactory with a growth rate of 2.72%. The performance is not consistent with the mean value of 0.15 and SO of 0.71. The liquidity variable shows that the growth rate is negative. Overall, the performance of the Bank of Rajasthan is moderate.

Catholic Syrian Bank Ltd. (CSB)

During the beginning of period of analysis, CSB showed an excellent performance in Capital adequacy variable. But it deteriorated with a negative CAGR. Analysis of asset quality variable fluctuates widely with a mean of 0.14 and SD of 0.03. But the quality is increasing. Efficiency of management is found satisfactory, which shows growth rate of 11.46% even though the bank shows a slight fluctuation wi.th the mean of 0.48 and SD of 0.17. In earnings quality, the performance is very poor and the growth rate is negative. The liquidity management shows a slight growth rate of 1.78%. So, it is concluded that performance of the Catholic Syrian Bank is not satisfactory.

City Union Bank Ltd. (CUB)

The capital adequacy figures show that performance is not consistent with a mean of 6.61 and SO of 1.12 (CAGR is 1.70%). Asset quality is not satisfactory and it fluctuates slightly with the mean of 0.11 and SD of 0.03. Management Efficiency has an excellent growth rate of 43.37%. The earnings quality shows a slight fluctuation with the mean of 0.63 and SD of 0.19. It is found that the performance is improving and CAGR is 10.36%. The liquidity variable also shows that the performance of the bank is poor, since the growth rate is negative. It is concluded that performance of the CUB is moderate.


Development Credit Bank Ltd. (DCB)

Capital adequacy ratio of the bank is quite satisfactory with little fluctuations (mean of 7.41 and SD of 0.93) and CAGR of 1.11 %. Asset quality of the bank is not satisfactory and it fluctuates slightly with the mean of 0.10 and SD of 0.02. The efficiency of management improves with a CAGR of 24.91 % and it is almost consistent during the study period. In earnings quality, the performance is very poor and the growth rate is negative. The liquidity variable also shows that the performance of the bank is poor. It is concluded that performance of the DCB is not satisfactory.

Federal Bank Ltd. (FBL)

The capital adequacy position of the FBL is satisfactory (mean of 7.62 and SO of 1.32) and it is growing at 6.91 %. The asset quality is not satisfactory and it fluctuates widely with the mean of 0.11 and SD of 0.03. The management efficiency of the bank shows a slight fluctuation with the mean of 3.83 and SD of 2.77, it shows high growth rate of 11.20%. It is found that earnings quality performance is improving and compound annual growth rate is 18.11%, even though it fluctuates (Mean of 0.85 and SD of 0.92). The liquidity management shows that the performance of bank is good with a growth rate of 3.32%. So it is concluded that performance of the Federal Bank is satisfactory.

ING VYSYA Bank Ltd. (ING)

The capital adequacy position of the bank is not satisfactory and inconsistent with the mean of 7.2.5, SD of 0.53 and a very low CAG rate of 0.52%. Asset quality is found satisfactory; it is improving too with a negative CAGR. Management efficiency factor reveals that the performance of the bank is very poor with negative CAGR. In earnings quality, the performance is very poor and the growth rate is negative. The liquidity variable shows that the performance of the bank is not satisfactory. The performance of the bank is not satisfactory.

Jammu and Kashmir Bank Ltd. (JKB)

Capital adequacy figures of the bank show that the performance of the bank is poor with negative CAGR. Asset quality of the bank is satisfactory, even though it shows a slight fluctuation with mean of 0.09 and SD of 0.01. Bank performed efficiently in management efficiency factor, with an impressing growth rate of 67.92%. The earnings quality shows position of the bank was consistent with the mean of 0.64 and SD of 0.20. Performance is improving with CAGR of 4.04%. The liquidity variable shows that the performance of the bank is poor and growth rate is also negative. So overall performance of the Jammu and Kashmir Bank is moderate.

Karnataka Bank Ltd. (KBL)

Capital adequacy factor of the bank improves by 5.77% with the value mean of 6.81 and SO of 1.14. Compared to other banks, its quality of assets is not satisfactory and it is deteriorating too (mean of 0.11 and SD ofO.03). The efficiency of the management improved with a CAGR of 44.56% (mean of 2.11 and SD of 1.37). The earnings quality shows some fluctuation with


the mean of 0.61 and standard deviation of 0.19, but it has a growth rate of 8.81 %. The liquidity management of the bank is good (growth rate is 6.26%). Even though KBL does not fall in the list of best five banks, yet its improving performance shows that performance of the Karnataka Bank is satisfactory.

Karur Vysya Bank Ltd. (KVB)

Capital adequacy ratio of the bank shows that the performance is comparatively good, but compound annual growth rate is negative. Asset quality of the bank is satisfactory; comparing it with its counterparts it is not improving (mean of 0.09 and SO of 0.02). Management efficiency is considered good with compound growth rate of the 12.51 % and with mean of 6.53 and SO of 4.01. In earnings quality, the performance is poor and the growth rate is negative. The liquidity variable also shows that the performance of the bank is poor. So the performance of KYB is rated as moderate.

Lakshmi Vilas Bank Ltd. (LVB)

Capital adequacy position of the bank is not satisfactory and CAGR is very low having rate of 0.01 % (mean of 6.95 and SO of 0.23). Asset quality is satisfactory and it is improving (mean of 0.10 and SO of 0.02). In management efficiency, the bank shows growth rate of 10.49% even though fluctuation is high (mean of 2.50 and SO of 1.34). The earnings quality also shows some fluctuation with the Mean of 0.60 and SO of 0.30. The performance is improving as compound annual growth rate is 22.24%. The liquidity variable shows that the performance of the bank is poor and growth rate is negative. So it is concluded that performance of the LVB is moderate.

Ratnakar Bank LTD. (RBL)

Capital adequacy performance of the bank is poor with a negative CAGR. Analysis of asset quality variable fluctuates slightly with the mean of 0.08 and standard deviation of 0.01. Further the asset quality is not satisfactory. In management efficiency, it shows growth rate of 20.85% with mean of 0.24 and SO of 0.26. Earnings quality shows a slight fluctuation with mean of 0.20 and SO of 0.08. It is found that the performance is improving with compound annual growth rate of 2.05%. The liquidity variable shows that the performance of the bank is poor and growth rate is negative. So it is concluded that performance of the Ratnakar Bank is not satisfactory.

South Indian Bank Ltd. (SIB)

Capital adequacy of the bank is quite satisfactory, even though the growth is negative. Analysis of asset quality variable fluctuates widely with the mean of 0.11 and standard deviation of 0.03. Further the asset quality is satisfactory and it is improving. Efficiency of the bank is very good and it is improving with a CAGR of 39.33%. Similarly, the earnings quality is improving and CAGR is 19.58%. The liquidity variable shows that the performance is satisfactory. It is concluded that performance of the SIB is moderate.


INDUSTRY ANALYSIS

Capital Adequacy

Table 3 names the best performing banks in ' different time periods. It shows the capital adequacy values of various banks for the period of ten years and rank of each bank in different years. On an average, banks show a consistent capital adequacy level during the ten year of analysis. Leading bank is Catholic Syrian Bank, followed by Bank of Rajasthan, South Indian Bank and Jammu & Kashmir Bank and FBI. No other bank showed a superior performance than the average. Analysis of individual bank shows that, out of four leading banks, Catholic Syrian bank, Bank of Rajasthan and South Indian Bank show a consistent Performance, whereas performance of Jammu & Kashmir Bank has been deteriorating. Another player, Kerala based Federal Bank, has shown good performance except in first two years of analysis. The analysis also gives almost similar results, which supports the ranking done based on averaging. Test of hypothesis by ANOVA, conducted for analyzing the significance of difference between banks reveals that there is no difference between the capital adequacy levels of different banks. This finding is not consistent with the rank ordering and its continuous change between the years.

Asset Quality

Asset Quality measures the efficiency of banks in their management of assets to make maximum return. Table 4 depicts the asset quality values of banks for the given period with the ranks of the banks. The average asset quality has been coming down from 1996-97 to 2001-02 (in quantitative terms it is increasing), and thereafter the performance is rising.

TABLE 3: CAPITAL ADEQUACY VALUE: BEST PERFORMING BANKS

The Karur Vysya is the topmost bank, followed by Ratnakar Bank and ING Vysya Bank.

Rank Considering last 10 years 5 years 3 Years 1 CSB CSB BOR

11 BOR BOR CSB 111 SIB FBL DCB IV JKB SIB FBL V FBL DCB SIB

Apart from these, Jammu and Kashmir bank and Federal bank showed a consistent performance. ANOV A suggests the rejection of the null hypothesis. It shows that there is a significant difference in performance in asset quality of banks.

TABLE 4: ASSET QUALITY: BEST PERFORMING BANKS

Rank Considering last 10 years 5 years 3 Years 1 KVB ING ING

11 RBL RBL KVB 111 ING JKB FBL IV JKB KVB JKB V DCB FBL RBL


Management Efficiency

Management efficiency of banks has shown inconsistent performance during the period. In 1997" 98, the value was 1.32, the lowest in ten years, it rose to 5.04 in 2003-04. But it again came down to 4.4 in 2005-06. Banks like Karur Vysya Bank, Jammu and Kashmir Bank, lNG Vysya Bank, Federal Bank and Lakshmi Vilas bank have a very consistent and superior performance, while the performance of the banks like Catholic Syrian bank, Rathnakar Bank and Development and Credit Bank is very dismal. The statistical test shows that there is a significant difference in the performance of management efficiency between the old generation private sector banks.

TABLE 5: MANAGEMENT EFFICIENCY: BEST PERFORMING BANKS

Rank Considering last 10 years 5 years 3 years 1 KVB JKB KVB

11 ING KVB JKB 111 JKB ING ING IV FBL FBL FBL V LVB KBL LVB

Earning Quality

Like management efficiency, earning quality of banks is also not consistent during the period of the study. The best performance was in 1999-2000, with earnings quality being 0.82. The worst performance was in 2004-05 with value of 0.18. The performance of the best banks is also like that except for Karur Vysya Bank. Statistically there is a significance difference between the performances of old generation banks. It is found that, Federal Bank is the best performing bank in all the years followed by Karur Vysya Bank and South India Bank.

TABLE 6: EARNINGS QUALITY: BEST PERFORMING BANKS

Rank Considering last 10 years 5 years 3 YEARS

1 FBL FBL FBL 11 KVB KVB SIB

111 CSB SIB KVB IV SIB KBL CUB V JKB CUB LVB

Liquidity Management TABLE 7: LIQUIDITY MANAGEMENT: BEST PERFORMING BANKS

Rank Considering last 10 years S years 3 years

1 SIB CSB CSB 11 RBL SIB SIB

111 DBL RBL FBL IV KBL PEL RBL V FBL KBL CUB

The following graph shows the fluctuating nature of performance in all the fields.

In case of Liquidity, it is found that the banks have enough liquidity and performance is almost consistent during the last seven years of analysis; but the performance in three years is


better than the remaining period. The leading banks are South Indian Bank, Catholic Syrian Bank and Rathnakar liquidity management, it is found that there is a significance difference between the performances of old generation banks.

CONCLUSION

The study analyzed the overall financial performance of 13 old private sector banks. It assessed the performance on the basis of Capital adequacy, Asset quality, Management efficiency, Earnings quality and Liquidity management of these banks for a period of ten years from 19961997 to 2005-2006. Various ratios have been used to find the position of banks. The result of overall ranks of the selected banks indicate that Federal bank is the best bank, followed by Karur Vysya Bank, South Indian bank, Jammu & Kashmir bank and ING Vysya bank in order.

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Handbook of Banking Strategy, John Wiley & Sons, 1985, pp.473–510.

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Economics Discussion Series, no. 9420, Federal Reserve System, July. [4] Berger, Allen N., Sally M. Davies, and Mark J. Flannery (2000) "Comparing Market and Supervisory

Assessments of Bank Performance: Who Knows What When?" Journal of Money, Credit and Banking, 32, August.

[5] Bodla, B.S. and Verma Richa (2006) "Evaluating Performance of Banks through CAMEL Model: A Case Study of SBI and ICICI", The lCFAl Journal of Bank Management, Vol. V 3, pp. 49–63.

[6] Das, M.R. (2002) "An Objective Method for Ranking Nationalized Banks", Prajnan, Vol.31, 2, pp.111–136. [7] Das M.R. (2002) "Risk and Productivity Change of Public Sector Banks", EPW, Vol.37, 5, pp.437–448. [8] De, Young, Robert, Mark J. Flannery, William Lang, and $orin, Sorescu (1998) "Could Publication of Bank

CAMELS Ratings Improve Market Discipline? Office of the Comptroller of the Currency, November. [9] Economic Times, (2007) "Banking Sector to see more M & As: Moody's" , Chennai, July 13, 2007, p.1 [10] Flannery, Mark J. (1998) Using market information in prudential bank supervision: a review of the U.S.

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Economic Review, 39–53.

[12] Joshy, P. N .(2005) "A National Banking Policy" EPW, July 9, pp 2996–98 [13] Leeladhar (2005) "Contemporary and future Issues in Indian Banking", BlS Review, 17/2005. [14] Padmanabhan Working Group, Report, from RBI web site, www.rbi.org.in [15] Parsuna (2004) in Bodla B. S. and Richa Verma (2006) [16] Rao and Datta (1998) in Bodla B. S. and Richa Verma (2006) [17] Reserye Bank of India (1991 and 1998) "Report of the Committee on Financial Sector Reforms -1 & II ",

Bombay (Chairman - M. Narasimham) [18] Young, Robert D. (2001) in Bodla B. S. and Richa Verma (2006) [19] Roji George (2006) "Consolidation: An inevitable Opportunity for Kerala based Private Banks" National

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Research, Vol. 1, 2 July, pp. 1–12.


ANNEXURE HYPOTHESIS TEST RESULT – ANALYSIS OF VARIANCE (ANOVA)

Sum of Squares

df Mean Square Square

F Sig.

Capital Adequacy Between GropuGroups 1535.617 12 127.968 1.307 .224 Within Groups 11454.705 117 97.903 Total 12990.321 129 Asset Quality Between Groups 3.190E-Q2 12 2.658E-Q3 3.190 .001 Within Groups 9.749E-Q2 117 8.332E-Q4 Total .129 129 Management Between Groups 490.445 12 40.870 7.944 .000 Efficiency Within Groups 601.966 117 5.145 Total 1092.411 129 Earnings Quality Between Groups 5.943 12 .495 2.500 .006 Within Groups 23.177 117 .198 Total 29.120 129 Liquidity Anagement Between Groups .193 12 1.608E-Q2 3916 .000

Within Groups .480 117 4.107E-Q3 Total .673 129

ANNEXURE CAPITAL ADEQUACY RATIO OF SAMPLE BANKS

Year/ Banks

1996- 97

1997- 98

1998- 99

1999- 00

2000- 01

2001- 02

2002- 03

2003- 04

2004- - 05

2005- 06

DBL 9.75 11.39 10.06 10.02 9.69 11.23 10.45 13.56 10.16 9.75 BOR NA NA 0.83 5.73 10.57 12.07 11.29 11.18 12.75 10.6 CSB NA NA 2.51 NA 6.08 9.57 10.58 11.23 11.35 11.26 CUB 0 11.6 0 13.33 13.59 13.97 13.95 13.36 12.18 12.33 DeB 23.47 19.79 16.9 11.34 11.28 11.49 10.08 14.26 9.88 9.66 FBL NA 9.43 10.32 11.33 10.29 10.63 11.23 11.48 11.27 13.75 ING 14.21 12.48 10.63 12.24 12.05 11.57 9.81 11.05 9.09 10.67 JKB 15.88 20.48 24.48 18.82 17.44 15.46 16.48 16.88 15.15 12.14 KBL NA 13.23 10.85 11.04 11.37 12.96 13.44 13.03 14.16 11.78 KVB 12.76 14.47 14.53 15.16 15.56 16.9 17.01 17.11 16.07 14.79 LVB 10.64 10.35 9.64 10.45 10.21 11.54 11.35 13.79 r 11.32 10.79 RBL NA NA NA NA NA NA NA NA 12.03 10.77 SIB 8.28 9.4 10.4 10.41 11.17 11.2 10.75 11.32 9.89 13.02

A Study on Approach and Status of Financial Inclusion in Indian Subcontinent

Dr. Smita Shukla* and Dr. Anjali Gokhru**

Abstract—Financial inclusion of the section of population that does not have access to organized sources of finance is the biggest challenge in front of developing economies in the Indian subcontinent.

This paper focuses on current status, practices and approach for financial inclusion in the Indian subcontinent i.e; in countries like Sri Lanka, Pakistan, India etc. The paper also discusses what further changes are required in the current practices to enhance the process of financial inclusion

Keywords: Financial Inclusion, Banking, funds, microfinance

INTRODUCTION

Financial Inclusion refers to delivery of Financial Services and Credit at an affordable cost to the vast sections of disadvantaged and low income groups. Various financial services include savings, loans, insurance, payments, remittance facilities and financial counseling / advisory services by formal financial system. According to the Committee for Financial Inclusion in India headed by Dr. C Rangrajan (Former Governor, Reserve Bank of India) financial inclusion may be defined as the process of ensuring access to financial services and timely and adequate credit where needed by vulnerable groups such as weaker sections and low income groups at an affordable cost The basic objectives of Financial Inclusion process is to extend the scope of activities of organized financial system in order to include within its ambit people with low incomes through graduated credit. The basic purpose of Financial Inclusion exercise should be to attempt to lift the poor from one level to another so that they come out of poverty.

However financial inclusion scenario worldwide is not very encouraging. According to CGAP Research Report titled “Financial Access 2009” (A report based on Survey of financial regulators of 139 countries following result has emerged: Survey indicates that about 70% of adults in developing countries still are excluded from the regulated financial system, despite years of growth in financial sector. The CGAP (Consultative Group to Assist the Poor) is a consortium of 33 public and private development agencies working together to expand access to financial services for the poor in developing countries. CGAP was created in 1995 by these aid agencies and industry leaders to help create permanent financial services for the poor on a large scale (often referred to as microfinance).

Reserve Bank of India is actively pushing for the cause of financial inclusion with following aims: To connect people with banking system. The focus is not just on credit

*Alkesh Dinesh Modi Institute, Mumbai **K.S. School of Business Management, Gujarat

A Study on Approach and Status of Financial Inclusion in Indian Subcontinent 69

dispensation but on long term relation building with the formal banking system. RBI also is aiming at portraying financial inclusion as a viable business model and opportunity while ensuring access to basic banking facilities. The above aims are difficult to achieve in country like India on account of large population spread, social and cultural factors, illiteracy etc. According to NSSO Survey (59th Round), only 27% of total farmer households access formal sources of credit. One third of these groups also borrow from non-formal sources. Overall, 73% of farmer households have no access to formal sources of credit. 51.4 % of farmer households are financially excluded from both formal / informal sources (45.9 million out of 89.3 million). Farm households not accessing credit from formal sources is high in North Eastern ( 96 % ) , Eastern ( 81 % ) and Central Regions ( 78 % ). Exclusion in general is large; it also varies widely across regions, social groups and asset holdings. Poorer the group, the greater is the exclusion. Some idea regarding financial exclusion can also be gathered from basic statistical reports on development and progress of Banking as prepared by Reserve Bank of India. According to RBI reports the population per branch in rural and urban branches in India has changed as following over the years:

POPULATION PER BRANCH (FIGURES IN THOUSAND)

Year Rural Urban 1969 82 33 1981 20 17 1991 14 16 2001 16 15 2007 17 13 2009 17 13

Source: Reserve Bank of India

According to various reports of RBI on Banking and Finance, by the year 2009 only 48.9 savings bank accounts exist per 100 adults on an all India basis. The coverage in rural areas is only 38.8 accounts per 100 adults. Coverage in urban areas is 75.2 accounts per 100 adults. Coverage in North Eastern (21.2) and Eastern regions (23.3) savings accounts per 100 persons is very low. Here, Eastern includes Bihar, West Bengal, Orissa, Jharkhand, Sikkim & A/N Islands North-Eastern states include Assam, Arunachal Pradesh, Manipur, Meghalaya, Mizoram, Nagaland & Tripura Central states are Madhya Pradesh, Chhattisgarh, UP & Uttaranchal Northern States include Haryana, HP, Punjab, Rajasthan, J&K, Delhi & Chhattisgarh. Southern states includes Andhra Pradesh, Karnataka, Kerala, TN, Pondicherry& Lakshadweep, and Western states include Gujarat, Goa, Maharashtra, D& NH,& D& . FINANCIAL INCLUSION EXPERIENCE IN INDIA

At the time of independence the network of not varied banks operating in India was not impressive. Thus it was felt that some alternative institution should be available to provide the basic banking facilities to those who were otherwise beyond the baking reach. Thus India Post was facilitated to act as an alternative medium to provide the basic banking facilities. According to the book of information for India Post (year 2007-08) following are the details of Savings accounts with India Post across various states of India:


POST OFFICE SAVINGS BANK ACCOUNTS (2007‐08)

Circles Closing Balance of Accounts (Numbers) Closing Balance (Amount in Crores) 80.53 Andhra Pradesh 6758916 316.22 Assam 1060231 1379.72 Bihar (including Jharkhand) 6016094 241.62 Chhatisgarh 568157 806.03 Delhi 901259 1198.21 Gujarat 1881936 491.13 Haryana 1589198 397.85 Himachal Pradesh 769235 212.71 Jammu & Kashmir 584051 2201.34 Karnataka 2980925 212.31 Kerala 2054454 939.88 Madhya Pradesh 3505423 903.39 Maharashtra 3354364 494.00 North Eastern 510054 1531.11 Orissa 2609996 282.14 Punjab 1489937 611.83 Rajasthan 2735252 1106.27 Tamil Nadu 8183028 792.09 Uttar Pradesh 14656722 1408.90 Uttarankhand 1043789 101.39 West Bengal 5628344 3066.12

Source: India Post

The Government has also taken several other initiatives to strengthen the institutional rural credit system. The rural branch network of commercial banks has been expanded and certain policy prescriptions imposed in order to ensure greater flow of credit to agriculture and other preferred sectors. The commercial banks are required to ensure that 40% of total credit is provided to the priority sectors out of which 18% in the form of direct finance to agriculture and 25% to priority sector in favour of weaker sections besides maintaining a credit deposit ratio of 60% in rural and semi-urban branches. Further the IRDP introduced in 1979 ensures supply of credit and subsidies to weaker section beneficiaries. Although these measures have helped in widening the access of rural households to institutional credit, vast majority of the rural poor have still not been covered. Also, such lending done under the poverty alleviation schemes suffered high repayment defaults and left little sustainable impact on the economic condition of the beneficiaries. However in spite of above along with financial inclusion activities of India Post it is being felt that financial exclusion in India is still very high. Thus Reserve Bank of India and government have tried to propose and implement various other formats to provide/ increase the financial inclusion in India. Some of these formats are Banking Correspondent Scheme and development of Micro Finance Institutions in India.

BANKING CORRESPONDENT SCHEME

As per RBI guideline released in 2006, the banks have been permitted to appoint Business Correspondents and Business facilitators for expanding the bank reach in remote areas or places where bank branch is not functioning. Business correspondents are entities (either individuals or organizations) which offer the banking facilities like opening of accounts, cash withdrawal, cash deposit and even credit facility beyond the boundaries of bank’s branch. The


services offered by banking correspondents is enhanced by technology tools like point of sale (POS) devices, mobile phones etc. Such technology devices facilitated by technology vendors help in connecting customer, business correspondent and banks.

The Business correspondent and business facilitator scheme is slowly becoming a cost effective medium for financial inclusion during the last few years. However it will also be fair to state that BC and BF scheme has not been able to match the expectation of Reserve Bank of India for furthering the cause of financial inclusion. Nevertheless, the scheme still has been an alternative good medium for achieving following goals: Increasing the outreach of banks, facilitating banks services at lower costs, and bringing even such individuals under the bank net who otherwise would have remained financially excluded.

The public sector banks in India that have actively used the business correspondent model are – State Bank of India, Indian Bank, Canara Bank, Union Bank of India, Corporation Bank, Oriental Bank of Commerce, Andhra Bank and Punjab National Bank. Among the private sector banks the banks leading in use of business correspondent model have been – ICICI Bank, HDFC Bank, and Axis Bank. These banks are generally using non governmental organizations and micro finance institutions as their business correspondents. Business correspondent model is being used by banks to open no frill accounts, to channel payments for programmes like NREGP (National Rural Employment Guarantee Programme) and expanding the microcredit. Some active business correspondent companies/NGO in India are: Eko Aspire Foundation, Fintech Foundation, Zero mass, Basix, Zero Microfinance and saving Support Foundation, Drishtee, Swadhaar Finance ce. The related technology vendors are – Eko Financial Services limited, FINO and Little World. India Post has tied up with State Bank of India to act as their banking correspondent. As per data provided by CGAP and RBI – HDFC had enrolled 203 banking correspondents and was operating in 13 Indian States and had client reach of over 6, 50, 000 by the end of the year 2008. State Bank of India was using 33 banking correspondents and was operating on all India basis and had reached more than 27, 00, 000 clients by the end of year 2008, ICICI Bank was using 48 banking correspondents and was operating in 13 states in India and had reached over 5, 00, 000 clients by the end of year 2008.

The issues and challenges that have emerged under the banking correspondent model are:

• Problem of dormant accounts – according to reports of banking correspondents, more than 80% of the accounts opened by the clients stay inactive because the clients are not financially literate and are not aware of the advantages of banking services.

• Viability Issues: Under the banking correspondent model the BC cannot charge fees from the client for the services. They are only entitled to commission and service charges paid by the banks. Many banking correspondents are not finding the model viable enough as the current revenue format is not enough to cover their expenses like staff salaries, technology costs etc.

• Frauds: The banking correspondent staff operates on individual basis with the clients who are illiterate and not familiar with technology. Their have been reports of frauds by banking correspondent staff in handling of cash, incorrect accounting, falsification of records etc.


• Shortage of qualified Banking Correspondents – It is feeling of the banks that enough qualified vendors are not available that have well trained field agents, are conversant with use of technology and possess management skills of offering financial services.

MICROFINANCE IN INDIA

Indian model of micro-credit is driven by partnership between mainstream credit institutions and indigenous SHG’s through intermediaries called micro finance institutions. According to RBI annual report 2005-06, the cumulative number of SHG’s linked to banks stood at 2.2 million with total bank credit to theses SHG’s at Rs. 11, 398 crores. The Nodal agency for funding the SHG’s is NABARD. Today the public and private sector banks such as SBI, ICICI, UTI, ABN Amro etc have also developed impressive micro-finance projects. However activity in micro-finance area is still too little to match the national requirements. Along with above, few of the NGOs engaged in activities related to community mobilisation for their socio-economic development have initiated savings and credit programmes for their target groups. These community based financial systems (CBFS) can broadly be categorised into two models: Group Based Financial Intermediary and the NGO Linked Financial Intermediary. Most of the NGOs like SHARAN in Delhi, Federation of Thrift and Credit Association (FTCA) in Hyderabad or SPARC in Bombay have adopted the first model where they initiate the groups and provide the necessary management support. Others like SEWA in Ahmedabad or BARODA CITIZEN's COUNCIL in Baroda pertain to the second model.

Four largest Microfinance Institutions operating in India are – SKS Microfinance, Spandana Spoorthy Financials Limited, Share Microfinance Limited, AsmithaMicrofin Limited. As per the data of these above mentioned organizations, they cover more than 8, 00, 000 clients, have loan portfolio of over USD 100 million and asset size of more than USD 170 million by the end of the year 2009.

The numbers offered by the microfinance institutions operating in India may seem to be impressive but the real microfinance format under operation in India does not seem to be very satisfactory. The microfinance institutions in India are charging very high rates of interest. This has in recent times, resulted in spate of suicides by individuals on account of their inability to repay MFI loans and interest due on such loans on time and subsequent harassment by collection agents of microfinance institution. In an article published in ‘The Week’, (Lalita Iyer, “Death by Interest”), Vijay Mahajan, founder Chairman of Basix, the first MFI in India, justified high interest rates by saying “The basic fact is that providing credit is expensive, difficult and risky. If MFI’s have to be sustainable, society will have to get accustomed to the interest rates”. Further, unregulated microfinance activity has resulted in multiple financing to same individuals. This has resulted in building up of debt pressure on small borrowers leading to extremes step of suicide by some of them. Microfinance Institutions in India are converting themselves from non profit organizations to profit making entities operating in commercial format. Controversial example of SKS Microfinance is now known to all.

A fact finding study conducted by RBI and select banks in 2008 found following:


• Some of the microfinance institutions (MFIs) financed by banks or acting as their intermediaries/partners appear to be focusing on relatively better banked areas, including areas covered by the SHG-Bank linkage programme. Competing MFIs were operating in the same area, and trying to reach out to the same set of poor, resulting in multiple lending and overburdening of rural households.

• Many MFIs supported by banks were not engaging themselves in capacity building and empowerment of the groups to the desired extent. The MFIs were disbursing loans to the newly formed groups within 10-15 days of their formation, in contrast to the practice obtaining in the SHG - Bank linkage programme which takes about 6-7 months for group formation / nurturing / handholding. As a result, cohesiveness and a sense of purpose were not being built up in the groups formed by these MFIs.

• Banks, as principal financiers of MFIs, do not appear to be engaging them with regard to their systems, practices and lending policies with a view to ensuring better transparency and adherence to best practices. In many cases, no review of MFI operations was undertaken after sanctioning the credit facility.

FINANCIAL INCLUSION EXPERIENCE IN BANGLADESH

The Grameen Bank’s establishment in Bangladesh was the first and revolutionary step towards financial inclusion in Bnagladesh. The bank began as a research project by Yunus and the Rural Economics Project at Bangladesh's University of Chittagong to test his method for providing credit and banking services to the rural poor. The Bank today continues to expand across the nation and still provides small loans to the rural poor. Grameen Bank methodology is almost the reverse of the conventional banking methodology. Conventional banking is based on the principle that the more you have, the more you can get. In other words, if you have little or nothing, you get nothing. As a result, more than half the population of the world is deprived of the financial services of the conventional banks. On the other hand Grameen Bank starts with the belief that credit should be accepted as a human right, and builds a system where one who does not possess anything gets the highest priority in getting a loan. Grameen Bank’s methodology is not based on assessing the material possession of a person; it is based on the potential of a person. Grameen Bank believes that all human beings, including the poorest, are endowed with endless potential. Conventional banks look at what has already been acquired by a person. Grameen looks at the potential that is waiting to be unleashed in a person. Conventional banks are owned by the rich, generally men while the Grameen Bank is owned by poor wome. The basic objective of the conventional banks is to maximize profit while Grameen Bank's objective is to bring financial services to the poor, particularly women and the poorest to help them fight poverty, stay profitable and financially sound. It is a composite objective, coming out of social and economic visions. Conventional banks focus on men, Grameen Bank has given high priority to women. 97 per cent of Grameen Bank's borrowers are women. Grameen Bank works to raise the status of poor women in their families by giving them ownership of assets. It makes sure that the ownership of the houses built with Grameen Bank loans remain with the borrowers, i.e., the women.


Grameen Bank’s branches are located in the rural areas, unlike the branches of conventional banks which try to locate themselves as close as possible to the business districts and urban centers. First principle of Grameen banking is that the clients should not go to the bank, it is the bank which should go to the people instead. Grameen Bank's 21,676 staff meets 7.01 million borrowers at their door-step in 75,950 villages spread out all over Bangladesh, every week, and deliver bank's service. Repayment of Grameen loans is also made very easy by splitting the loan amount in tiny weekly installments. Doing business this way means a lot of work for the bank, but it is a lot convenient for the borrowers. There is no legal instrument between the lender and the borrower in the Grameen methodology. There is no stipulation that a client will be taken to the court of law to recover the loan, unlike in the conventional system. There is no provision in the methodology to enforce a contract by any external intervention.

Conventional banks go into 'punishment' mode when a borrower is taking more time in repaying the loan than it was agreed upon. They call these borrowers "defaulters". Grameen methodology allows such borrowers to reschedule their loans without making them feel that they have done anything wrong (indeed, they have not done anything wrong.)When a client gets into difficulty, conventional banks get worried about their money, and make all efforts to recover the money, including taking over the collateral. Grameen system, in such cases, works extra hard to assist the borrower in difficulty, and makes all efforts to help her regain her strength and overcome her difficulties.

In conventional banks charging interest does not stop unless specific exception is made to a particular defaulted loan. Interest charged on a loan can be multiple of the principal, depending on the length of the loan period. In Grameen Bank, under no circumstances total interest on a loan can exceed the amount of the loan, no matter how long the loan remains un-repaid. No interest is charged after the interest amount equals the principal.

Conventional banks do not pay attention to what happens to the borrowers' families as results of taking loans from the banks. Grameen system pays a lot of attention to monitoring the education of the children (Grameen Bank routinely gives them scholarships and student loans), housing, sanitation, access to clean drinking water, and their coping capacity for meeting disasters and emergency situations. Grameen system helps the borrowers to build their own pension funds, and other types of savings. Interest on conventional bank loans are generally compounded quarterly, while all interests are simple interests in Grameen Bank. There are four interest rates for loans from Grameen Bank: 20% (declining basis) for income generating loans, 8% for housing loans, 5% for student loans, and 0% (interest-free) loans for Struggling Members (beggars). All interests are simple interest, calculated on declining balance method. This means, if a borrower takes an income-generating loan of say, Tk 1,000, and pays back the entire amount within a year in weekly installments, she'll pay a total amount of Tk 1,100, i.e. Tk 1,000 as principal, plus Tk 100 as interest for the year, equivalent to 10% flat rate.In case of death of a borrower, Grameen system does not require the family of the deceased to pay back the loan. There is a built-in insurance programme, which pays off the entire outstanding amount with interest. No liability is transferred to the family.


Grammen bank thus has contributed in a major way in the process of financial inclusion in Bangladesh. Besides Grameen Bank, other institutions that are very active in process of implementation of Financial Inclusion are: Bangladesh Rural Development Board that had 4.7 million active borrowers by the end of the year 2007 and Bangladesh Krishi Bank that had another 521,000 active borrowers by the end of 2007.

As per data published in paper titled “Financial Inclusion as a tool for Combating Poverty – The Bangladesh Approach” by Dr. Atiur Rehman, Governor, Bangladesh Bank, the status of financial inclusion in Bangladesh is as follows:

Year Adult# Population in Millions

Number of Bank Deposit Accounts

(in Million)

Number of members in MFI

(in millions)

Number of members on Co-

operatives (in Million)

Financial Inclusion as % of Adult

Population

1999 73.16 27.30 - - - 2000 75.16 28.40 - - - 2001 77.18 30.10 - 7.65 - 2002 79.59 30.90 - 7.67 - 2003 80.80 31.30 14.63 7.57 66.21 2004 82.25 31.60 14.40 7.76 65.36 2005 83.80 33.10 18.82 7.92 71.41 2006 84.60 34.50 22.89 8.03 77.33 2007 84.95 35.70 20.83 8.22 76.22 2008 85.78 37.60 20.90 8.44 78.04

# Adult Population here refers to age 15 years and above Source: Bangladesh Bank, 2010

FINANCIAL INCLUSION EXPERIENCE IN SRI LANKA

Performance of Sri Lanka’s performance in financial inclusion has been remarkable. A GTZ-led national household survey (2006-2007) on use of financial services found the following: 82.5% household in Sri Lanka have used financial institutions (FIs) for loans and/or savings. 75% of house holds have saved in financial institutions. 17.3% households have 3 or more savers in financial institutions. More than 60% house holds have used microfinance institutions. 9.7% of households have used both formal and informal credit while a mere 8.6% have used only informal credit. 31% of households have some form of insurance

Mr. W.M. Karunaratne, Assistant Governor, Central Bank of Sri Lanka in a Microfinance Leadership Summit held at Colombo stated that the Sri Lankan microfinance institutions are well ahead and in the process to promote microfinance. Self help groups and technology to reach the masses have been developed well. This has helped banks in Sri Lanka to reach more people at low cost. The government of Sri Lanka has taken steps to regulate the microfinance system. The central bank of Sri Lanka has tried to reach to the low income people by promoting linkages between banks and microfinance institutions through the process Bank of Ceylon and other prominent banks through microfinance institutions for have reached 100 thousand households for financial inclusion. To enhance the poor’s income model, microfinance institutions have tried to maintain good relationships with the groups. Through microfinance, Central Bank of Sri Lanka has tried to promote more income opportunities and has helped in reducing income disparities.


FINANCIAL INCLUSION EXPERIENCE IN PAKISTAN

As per Pakistan’s A2F Household Survey 2008, in Pakistan only 14% households use formal sector of banking. Formal sector savings were applicable to only 8.2% households. Households borrowing from the formal sector were 2.5%. Microfinance users were 2.2% of the total households. Insurance user households were 1.9%. The above indicated that status of financial inclusion in Pakistan is not good. Like India, Pakistan post also has contributed to financial inclusion in Pakistan. Pakistan post has 13, 000 branches and covers 20 million households. Pakistan post, under Banking-Agent model is being used by First bank of Pakistan. Since 2008, First Bank of Pakistan has been able to add above 4, 00, 000 new clients [1]

State Bank of Pakistan has implemented a flexible prudential regulatory regime for Microfinance Banks (MFBs) which allows innovation and organic growth without abandoning prudential objectives. NGOs have been encouraged to restructure themselves into legally established companies, preferably licensed by central bank, so that they can operate under effective and transparent ownership with adequate capital base. Microfinance institutions are encouraged to have alliances with commercial financial institutions in order to meet funding needs of the sector. [2]

Smart subsidies through donor based programs for providing infrastructure and capacity building support to the sector are being provided under the Financial Inclusion Program. Under the program, funds have been established government which provides subsidies on matching grant basis. However Pakistan has a long way to go to be called a success in the financial inclusion process. ISSUES AND CHALLENGES IN FINANCIAL INCLUSION

The biggest challenge in front of the micro finance industry has been to reach the poorest of the poor. In words of Professor Muhummad Yunus “……If you lend to the poor, do it without concern for profit, so that they can have the maximum help in climbing out of poverty. Once they’ve completed the climb, then treat them like every other customer—but not till then.” However this is not what is happening worldwide.

As per a data of “Microfinance India: State of the Sector Report 2008”, it emerges that 49% of the SHG members are non-poor. National Council of Applied Economic Research (NCAER) 2007 study indicated that SHG created had majority non-poor members. In such Self Help Groups the percentage of non poor members in Uttar Pradesh was 63%. In Andhra Pradesh 43% , in Maharashtra 34% etc. As per SIDBI-funded Poverty Audit study indicated that in five MFIs out of eight, the proportion of non-poor clients were more than the poor. Banks and MFIs tend to cherry-pick their clients. Products and processes by design or default exclude the more vulnerable of the poor.

Another challenge is that the rates charged by the microfinance institutions have been very high and poor find it difficult to afford such high interest rates. Recent spate of suicide in Andhra Pradesh in India indicates the same. As per claims made by state government in


Andhra Pradesh the interest rate charged by microfinance institutions after adding up the hidden charges has been ranging from 25% to 70-75%. The government of Andhra Pradesh promulgated an ordinance recently. This ordinance among other things states and implements the following: [4]

MFIs will now have to specify the area of their operations, the rate of interest and their system of operation and recovery while registering with the Registering Authority.The Registering Authority may, at any time, either suo moto or upon receipt of complaints by Self-Help Groups (SHGs) or the general public can cancel the registration of the MFI after assigning sufficient reasons. The MFIs cannot seek collateral from a borrower by way of pawning or any other security and they will now be required to display the rates of interest rates charged by them in prominent places at their offices. MFI’s cannot charge any other amount from the borrower except the charge prescribed in the Rules for submission of an application for grant of a loan.The ordinance also states that the amount of interest should not be in excess of the principal amount. MFI’s cannot extend a second loan unless the first loan has been fully paid off.

An issue which has become very debatable during recent period has been that microfinance institutions are emerging as profit making bodies. In a public discourse at USA in May 2010, Muhammad Yunus stated that “I get very worried when investment funds come to microfinance,” said the founder of Bangladesh’s Grameen Bank, which pioneered the industry by giving small loans to rural women to start their own businesses. “I don’t want to excite businessmen that there is profit to be made here,” he stated. He appealed that microfinance institutions should not profit from the poor. [5]

Further in the zest of financial inclusion it should not happen that bank accounts are created and they then onwards become dormant. Similarly multiple loans should not go to same individual in the microfinance scheme as it increases the debt burden on the poor individuals who are not in position to repay the same.

CONCLUSION

The biggest challenge in front of microfinance industry in India and worldwide is to ensure that microfinance and financial inclusion takes place without exploitation of poor in the process. Secondly as microfinance institutions are increasingly looking for profits, it should not happen that they forget that their purpose of existence is financial inclusion at affordable rates. They should not act as loan sharks exploiting the borrower in the process. At the same time the microfinance institutions should be self sustainable in nature. However, this does not mean that they should be able to justify themselves in charging very high interest rates. Instead a cost plus approach is a better approach and basic tenant of this approach should be social objective/service but not charity. Further in the Indian subcontinent, Pakistan and India need to do much more for reduction of financial exclusion.


REFERENCES [1] D Collins, J Morduch, S Rutherford and O Ruthven (2009). Portfolios of the poor: How the world's poorlive

on $2/day (Princeton: Princeton University Press). [2] Rutherford, S (2001). The Poor and their Money (New Delhi: Oxford India Paperbacks). [3] A Chaia, A 3. Dalal, T Goland, MJ González, J Morduch and R Schiff (2009). Half the World is Unbanked. [4] T Beck, A Demirguc-Kunt, P Honohan (2007). Finance for All? Policies and Pitfalls in Expanding Access [5] A de la Torre, JC Gozzi and S Schmukler (2007). Innovative Experiences in Access to Finance: Market [6] I Mas (2009). The Economics of Branchless Banking. Innovations, Volume 4, Issue 2 (Boston, MA:

MIT Press). [7] T Lyman, D Porteous, and M Pickens (2008). Regulating Transformational Branchless Banking: Mobile

Phones and Other Technology to Increase Access to Finance. CGAP Focus Note 43 (Washington, D.C.: CGAP).

Websites

[8] http://www.microfinancefocus.com/news/2010/05/19/state-bank-of-pakistan-devising-strategic-framework-for-microfinance/

[9] http://www.sbp.org.pk/MFD/FIP/index.htm [10] http://www.ibtimes.com/articles/72593/20101016/geographic-exclusion-overseas-foreign-workers-from-the-

philippines-achieving-financial-inclusion-pan [11] http://indiamicrofinance.com/andhra-pradesh-mfi-ordinance-2010.html [12] http://www.muhammadyunus.org/In-the-Media/dont-profit-from-the-poor-says-grameen-banks-yunus/ [13] http://www.cgap.org/p/site/c/ [14] www.nabard.org/pdf/report_financial/Chap_II.pdfwww.nabard.org/pdf/report_financial/Chap_II.pd [15] www.grameen-info.org

Case Study on Documentary Credit Mechanism

Sonali Dharmadhikari* and Dr. H.G. Abhyankar*

Abstract—The buzz word today is “Globalization”. Due to globalization, volume of cross border trade transactions has considerably increased in the recent past. However, rise in this volume is certainly not without issues related towards settlement of the trade transactions. It is observed that complexities about the trade settlement get accentuated in cross border trading as compared to domestic trading due to various factors differentiating cross border trade from domestic trade. In view of this, there are more than one methods for early settlement like Advance payment, Open Account, Documentary Collection and Documentary Credit etc. of which Documentary Credit also known as Letter of Credit is the most popular and acceptable method being used in international trade settlement.

Even though it is considered that Documentary Credit is the most popular and acceptable method assuring payment to the exporter and performance to the importer, errors are likely to creep in the very mechanism of Letter of Credit in case parties to the letter of credit failed in sticking to ICC provisions and guidelines resulting either in non payment or non performance thereby raising doubts about reliability of L/C mechanism itself.

Against this background, the hypothetical case based on Documentary Credit method is prepared and presented.

The whole case is developed in such a manner that how Exporter may get deprived of payment even though it is assured under L/C and raises a doubt in the mind whether L/C can be treated as a foolproof method amongst all other trade settlement methods. The case progresses by pointing out avoidable errors committed by parties to the L/C while complying UCP provisions and identifies and highlights embarrassing positions to the beneficiaries to the L/C. The case also gives alternative solutions to the problems faced by parties particularly Beneficiary in realizing proceeds of the bill and presents an excellent opportunity to learn principles and practices followed in International Trade Settlements.

INTRODUCTION

In India, the process of globalization started after 1991. Due to globalization, volume of cross border trade transactions has considerably increased in the recent past. However, rise in this volume is certainly not without issues related towards settlement of the trade transactions. It is observed that complexities about the trade settlement get accentuated in cross border trading as compared to domestic trading due to various factors differentiating cross border trade from domestic trade. In view of this, there are more than one methods for early settlement like Advance payment, Open Account, Documentary Collection and Documentary Credit etc. amongst which Documentary Credit also known as Letter of Credit is the most popular and acceptable method being used in international trade settlement. The statistics show that more

*Bharati Vidyapeeth Deemed University’s, Institute of Management and Entrepreneurship Development, Pune


than 85% trade settlement is through Documentary Credit method and hence, it has become an integral part of international trade mainly due to its specific advantages to parties to the letter of credit.

The advantages of the Letter of Credit to the Exporter are as follows:

• Exporter is assured of payment. • Exporter gets the facility of discounting his bill i.e. can avail of export finance due to

backing of L/C. as compared to bills drawn under collection basis. • Exporters do not have to worry about the consignment getting confiscated at the port

of destination as L/C opening bank has already verified the relevant provisions of Exchange Control regulations prevalent in the importer’s country at the time of opening of the L/C.

The advantages of the Letter of Credit to the Importer are as follows:

• Importer is assured of performance. • Importer’s creditworthiness in the market is established when L/C is opened by the

importer’s banker. • Importer is entitled to get finance even though for the short period from the date of

payment to the beneficiary till drawing on account of importer.

Due to all above advantages L/C is considered as the most popular and acceptable method assuring payment to the exporter and performance to the importer. In spite of this, the errors are likely to creep in the very mechanism of Letter of Credit resulting either in non payment or non performance thereby raising doubts about reliability of L/C mechanism itself.

OBJECTIVES

• To acquaint the reader with statutory basis of cross border trading under documentary credits.

• To critically analyze ICC provisions pertaining to duties and responsibilities of parties to the letter of credit.

• To understand the procedure followed in case of amendments and discrepant documents

• To explore the ways for trade settlement in case L/C mechanism is ineffective. • To discuss about efficacy of Documentary Credit.

ORGANIZATION OF THE CASE

The case initially highlights upon roles expected to be performed by parties to L/C and later bring to the fore the consequences arising in the form of non payment to the beneficiary due to non adherence to the relevant provisions of UCP.

The case comprises of a plot depicting typical cross border trade transactions and related issues pertaining to non payment to the exporter in spite of firm commitment by opening banker to the beneficiary exporter and in the process throws light on learning principles

Case Study on Documentary Credit Mechanism 81

involved in the case against the backdrop of selected articles of Uniform Customs and Practices for Documentary Credit ICC- 600.

The case takes an interesting turn when exporter is really in a fix and dilemma about realizing proceeds of the bill when commitment by the banker becomes ineffective due to avoidable lapses committed by parties to the letter of credit.

Before comprehending the case situation, problem, definition and alternative solutions etc. it is necessary to have a conceptual framework of “Documentary Credit” as a method of international trade settlement. CONCEPTUAL FRAMEWORK

The mechanism of Documentary Credit popularly called as Letter of Credit is governed as per the provisions of The Uniform Customs and Practice for Documentary Credits, 2007 Revision, ICC Publication No. 600 (UCP) however, in order to have more conceptual clarity, the researcher has referred to Clause 2 of earlier version i.e. UCP 500 for the definition part and text of the case, the problem identified and alternate solutions are based on latest version i.e. UCP 600 with reference to Article 16.

In the further part, above referred articles are reproduced so as to provide statutory basis. The actual presentation of the case is done later followed by problem identification and alternative solutions.

The case concludes with learning principles and gives reader an opportunity to study intricacies involved in cross border trade.

Clause ‐ 2 (UCP 500)

“Any arrangement however named or described, whereby banker acting at the request of and as per instructions of its own customer or on its own behalf is to make payment to or to the order of third party or authorizes another bank to effect such payment and or to accept and pay such bill of exchanges or authorizes another bank to negotiate provided terms and conditions of the credit are strictly complied with.”

Article 16 (UCP 600)

Discrepant Documents, Waiver and Notice

• When a nominated bank acting on its own nomination, a confirming bank, if any, or the issuing bank determines that a presentation does not comply, it may refuse to honor or negotiate.

• When an issuing bank determines that a presentation does not comply, it may in its sole judgment approach the applicant for a waiver of the discrepancies. This does not, however, extend the period mentioned in sub-article 14(b).

• When a nominated bank acting on its nomination, a confirming bank, if any; or the issuing bank decides to refuse to honor or negotiate, it must give a single notice to that effect to the presenter.


The notice must state:

• That the bank is refusing to honor or negotiate; and • Each discrepancy in respect of which the bank refuses to honor or negotiate; and • that the bank is holding the documents pending further instructions from the

presenter; or • that the issuing bank is holding the documents until it receives a waiver from the

applicant and agrees to accept it, or receives further instructions from the presenter prior to agreeing to accept a waiver ; or

• that the bank is returning the documents; or • that the bank is acting in accordance with instructions previously received from the

presenter.

o The notice required in sub-article 16(c) must be given by telecommunication or, if that is not possible, by other expeditious means no later than the close of the fifth banking day following the day of presentation.

o A nominated acting on its nomination, a confirming bank, if any, or the issuing bank may after providing notice required by sub article 16(c) (iii) (a) or (b), return the documents to the presenter at any time.

o If an issuing bank or confirming bank fails to act in accordance with the provisions of this article, it shall be precluded from claiming that the documents do not constitute a complying presentation.

o When an issuing bank refuses to honor or a confirming bank refuses to honor or negotiate and has given notice to that effect in accordance with this article, it shall then

CASE

Swastik Co. Ltd., India approached to Bank BK 1 to open a Letter of Credit in favor of Macmilan Co. Ltd. New York. A credit was opened by Bank BK1 for USD 5,30,000/- in favor beneficiary BB. The credit was advised through BK2 who was requested to conform the credit. BK2 accordingly advised the credit and also added its confirmation. The credit was valid up to 31st August 2010.

This credit was amended on 23rd May 2010 to increase the value to USD 5,50,000/- On 27th August the beneficiary BB submitted documents for USD 5,50,000 to BK2 and asked BK2 bank to make payment.

BK2 refused to make payment stating that its confirmation was only for USD 5,30,000 and the documents tendered were for USD 5,50,000/- BK2 bank offered to forward the documents to the issuing bank BK1.

On receipt of documents at the counters of BK1, the issuing bank was unable to effect payment as it was under liquidation and a receiver was appointed.


ANALYSIS OF THE CASE

In the Case presented above, the parties to the Letter of Credit are as follows:

• Opener (Importer) --- Swastik Co. Ltd., India • L/C Opening Bank --BK 1 • Amount of L/C ----- USD 5,30,000 • Advising Bank ----- BK 2 • Beneficiary (Exporter)---Macmilan Co. Ltd. New York • Confirming Bank---- BK 2

As described in the case, The Swastik Co. Ltd., India approached BK 1 to open L/C in favor of Macmilan Co. New York for USD 5,30,000. The L/C is advised to the beneficiary through an Advising Bank BK 2 which also is a Confirming Bank.

It is pointed out that as per Article 8 of UCP 600, the confirming Bank steps into the shoes of L/C Opening Bank and is also irrevocably committed to pay to the Beneficiary the stipulated amount in the L/C provided documents are strictly in compliance to the terms and conditions of Credit.

The case further states that the above, on 23rd May, L/C was amended for value USD 5,50,000 and Beneficiary submitted documents for enhanced value.

It is pointed out here that as per Article 10 of UCP 600, the credit being irrevocable in nature any amendment has to be subject to the consent of all parties to the L/C and as per Article 10 b, Confirming Bank may extend conformation and will be irrevocably bound as of the time it advises the amendment. A Confirming Bank may however choose to advise an amendment without its confirmation and if so it must inform the Issuing Bank without delay and inform Beneficiary in its advice.

From the description of the Case, it is observed that BK 2, Confirming Bank has neither accepted nor rejected amendment; rather the Case is silent on this issue.

The case further states that Beneficiary Macmilan Co. Ltd. presented documents for enhanced value and BK 2 refused to pay stating discrepancy that documents under L/C are overdrawn and simply forwarded documents to Issuing Bank for payment who could not pay due to insolvency.

The result was Beneficiary, Macmilan Co. Ltd. though secured his payment through L/C mechanism could neither get payment from Confirming Bank nor from Issuing Bank and goods of enhanced value had already reached to the port of destination.

Under the circumstances, when it comes to the fixation of the responsibility and accountability, following points emerged:

As per Article 16, it is very clear and states that “If an issuing bank or confirming bank fails to act in accordance with the provisions of this article, it shall be precluded from claiming that the documents do not constitute a complying presentation.” which clearly means that since the Confirming Bank has failed to follow the discrepant documents


procedure and therefore precluded from refusing payment to the Beneficiary. (It is felt here that in a way, Confirming Bank’s mistake should have really benefitted the Exporter even though the documents are of enhanced value.)

Interestingly, even if it is presumed that BK 2 has adhered to Article 16 f, then Beneficiary would have been required to draw invoice for less amount where goods are of higher value which by all means is impracticable.

Hence, it can be said that whether Confirming Bank BK 2 has failed or otherwise, it hardly matters because if discrepancy procedure is followed drawing documents of less amount is impractical and if not followed, the only way out was holding payment and forwarding documents to Issuing Bank as has been done exactly by Confirming Bank. In either case, Exporter is deprived of payment.

The fact now remains to be seen that in this typical situation and under the given circumstances, what are the options left so that Exporter would get the payment irrespective of non adherence to the clauses by the parties to the L/C and responsibility and accountability involved in the Case under consideration.

ALTERNATIVE SOLUTIONS / OPTIONS

• Even though Issuing Bank is under liquidation, the Importer’s creditworthiness is assumed and therefore the Issuing Bank would simply ask Importer to make payment for the enhanced bill amount.

• If Importer declined to pay, then Issuing Bank can always exercise an option to explore alternate buyer and effect the payment.

• If any of the above option does not work, the rarely exercised option is that of re- importing goods.

OBSERVATIONS

The researcher is of the view that as per Article 16 d, Five days are given for the scrutiny of the documents and therefore failure on the part of the Confirming Bank is of remote possibility and more possibility is that BK 2 i.e. Confirming Bank will abide by the provisions of Article and may not effect the payment and as described in the case, send the documents to the Issuing Bank and go by options stated above. It is really not understood how Exporter remained unaware of the fact that Confirming Bank has not confirmed the amendment of enhanced value, as such doubt, might have led Exporter to approach the Confirming Bank and all the above problems could easily avoided. In a way, Exporter is also at a fault.

LEARNING PRINCIPLES

The in-depth analysis of the case enables the reader to learn following aspects in cross border trade settlement:

• The detailed working mechanism of the Documentary Credit operations • The roles and responsibilities of parties involved in the Letter of Credit


• The procedure to be followed in the event of discrepant documents • Irrespective of compliance to relevant UCP provisions, it is ultimately trust between

the parties that secured payment and performance in the event of default by either party.

• The case gave an excellent opportunity to the reader to understand and correctly interpret The Uniform Customs and Practice for Documentary Credits, 2007 Revision, ICC Publication No. 600 (UCP) provisions that are being in use from July 2007 superseding earlier ICC 500 version.

SUMMARY AND CONCLUSION

To summarize, the researcher comprehended a typical cross border trade transaction where method of trade settlement used was Documentary Credit. It can be said that if all parties to the Letter of Credit remain alert and vigilant in their roles, the Letter of Credit is the only best method of Trade Settlement.

The whole case is developed in such a manner that how Exporter may get deprived of payment even though it is assured under L/C and raises a doubt in the mind whether L/C can be treated as a foolproof method amongst all other trade settlement method. The case progresses by pointing out avoidable errors committed by parties to the L/C while complying UCP provisions and identifies and highlights embarrassing positions to the beneficiaries to the L/C. The case also gives alternative solutions to the problems faced by parties particularly Beneficiary in realizing proceeds of the bill and presents an excellent opportunity to learn principles and practices followed in International Trade Settlements.

To conclude, the case is a lesson to learn that when it comes to Documentary Credit method, if all parties remain alert and vigilant in performing their role, the Documentary Credit is only the best method to secure payment and performance in cross border trade settlement.

REFERENCES [1] The Uniform Customs and Practice for Documentary Credits, 2007 Revision, ICC Publication No. 600

(UCP)UCP 600 [2] The Uniform Customs and Practice for Documentary Credits, ICC Publication No. 500 (UCP)UCP500 [3] Foreign Exchange Dealers Association of India Booklets [4] Cases in International Trade.

Banking on the Mobile— A Study of Mobile Banking in India

Dr. Suresh Chandra Bihari*

Abstract—Mobile banking is a subset of electronic banking which emphasizes on the banking business as well as the special services of mobile commerce. Electronic banking – the execution of financial services via the Internet – changed the business of retail banks significantly, at the same time reducing costs and increasing convenience for the customer. The widening spread of Internet-enabled phones and personal digital assistants (PDA) has made the transformation of banking applications to mobile devices as a logical development of electronic banking. This has created a new subset of electronic banking, that is, mobile banking.

Mobile banking as that type of execution of financial services in which, within an electronic procedure - the customer uses mobile communication techniques in conjunction with mobile devices. Most relevant is GSM/GPRS, also typical are comparable 2G standards (e.g. IS-136, IS-95) and soon will be evolving 3G-technologies (EDGE, CDMA-2000, and UMTS).

While technologies such as e-commerce and payments are limited to computer users with Internet connection and bank account, mobile payments can use technologies as simple as SMS and interactive voice response (IVR) among other things. With mobile penetration of 10 times that of computer and expected to become 1 billion by 2014 (the overall cards market is growing at a 30 per cent compound annual growth rate), it won’t be long before India becomes a very large player in the mobile-commerce space.

Keywords: Mobile banking, mobile commerce, financial services, mobile payments

INTRODUCTION

Mobile banking is the next frontier in the banking industry, and is expected to dethrone the debit/credit card industry in the future. Electronic banking – the execution of financial services via the Internet – changed the business of retail banks significantly, at the same time reducing costs and increasing convenience for the customer. The widening spread of Internet-enabled phones and personal digital assistants (PDA) has made the transformation of banking applications to mobile devices as a logical development of electronic banking. This has created a new subset of electronic banking, that is, mobile banking.

Mobile Banking refers to provision and availment of banking- and financial services with the help of mobile telecommunication devices. The scope of offered services may include facilities to conduct bank and stock market transactions, to administer accounts and to access customized information. As mobile networks are upgraded with WAP, GPRS and UMTS to deliver next-generation multimedia services, the banks are getting ready to unleash services on mobile phones. Customers will be able to view their account statement, transfer funds between accounts, be notified of large payments or get notified of transactions above a pre-defined threshold, and will have immediate and full control over their finances.

*IBS, Hyderabad

Banking on the Mobile—A Study of Mobile Banking in India 87

Mobile banking as that type of execution of financial services in which, within an electronic procedure - the customer uses mobile communication techniques in conjunction with mobile devices. Most relevant is GSM/GPRS, also typical are comparable 2G standards (e.g. IS-136, IS-95) and soon will be evolving 3G-technologies (EDGE, CDMA-2000, and UMTS).

Mobile banking is divided into two main areas: mobile brokerage which covers securities transactions via mobile devices, especially stock trading, and - mobile banking (in the narrower sense) which covers the account management via mobile devices.

BACKGROUND

Over the last few years, the mobile and wireless market has been one of the fastest growing markets in the world and it is still growing at a rapid pace. Mobile phones have become an essential communication tool for almost every individual. Advent of mCommerce has managed to take mobile VAS to next level, adding tremendous value to telecommunication industry. Mobile banking which is an integral part of mCommerce has become very popular among mobile users ever since its existence in 2007. It creates new, convenient communication and fast financial transactional channel for mobile users which is accessible from anywhere, anytime.

Checking account information, balance available, credit/debit card information, cheque status, setting alerts, payment reminders, locating ATMs and bank branches, accessing mini statement, accessing loan and equity statements, insurance policy management, placing orders for cheque books etc via mobile phones are some of the services offered in mobile banking. With multiple access channels such as SMS, downloadable client, mobile Internet (WAP) mobile banking is encouraging mobile users more to explore the service

TOTAL MOBILE SUBSCRIBER BASE IN MAY 2010

Indian Telecom Statistics Total telephone subscriber base 653.92 Tele-density 55.38% Wireless user base (GSM + CDMA + WLL(F)) 617.53 Monthly additions (Wire line + Wireless) 15.86 Monthly additions (Wireless) 16.30 Broadband subscribers 9.24

MOBILE BANKING-2009

Mobile banking (also known as M-Banking, mbanking, SMS Banking etc.) is a term used for performing balance checks, account transactions, payments etc. via a mobile device such as a mobile phone, pagers etc. To avail this service banks provide with mandatory registration. The registration can be done through visiting the branch, ATM, internet banking sites or through phone call or even SMS in most cases through a JAVA enabled mobile phone.

Mobile banking report: “Most popular services and income profile” (Two month ended March 2009, Urban Indian Mobile Phone Users).


Fig. 1: Statistics on Most Popular Mobile Banking Services

Filtering the data further to understand which income groups in urban India use mobile banking more. As depicted in the chart below, mobile banking is most used by subscribers falling in Rs. 1 Lakh to Rs. 2.99 Lakhs income bracket followed by less than Rs 1 Lakh income bracket. Therefore it is observed, mobile banking is more popular among low income group of mobile users than higher income group of mobile users.

Fig. 2: Mobile Banking users – Income Profile

CONCEPT OF MOBILE BANKING

Many believe that mobile users have just started to fully utilize data capabilities in their mobile phones. Service providers are every day coming up with new services, providing methods to make the solution more easy to use, implementing techniques to improve security, launch of 3G is providing higher data transfer rate and invention of new phones more frequently is driving mobile users towards subscribing to mobile banking services. In India, where mobile subscribers far exceed fixed line subscribers because of better mobile infrastructure in comparison to fixed line infrastructure has made mobile banking much more


appealing in India today. Various players involved in providing mobile banking services (banks, financial institutions, service providers, operators etc) are therefore expecting a potential growth in mobile banking industry in India.

There are generally two ways to classify mobile banking services. The first method classifies the banking services as 'Push' or 'Pull', depending on the originator of a service session. If the bank sends information as per the already agreed rules, then it is categorized as 'Push'. An example of 'Push' is a minimum balance alert, when the balance goes below a particular amount. On the other hand, when the bank sends information as a response to the request sent by the customers, it is termed as 'Pull'. The second classification of mobile banking services depends on the nature of transactions. So, if a request is send to the bank to for a bank statement, then it is a inquiry-based service, while a request for fund transfer is a transaction-based service.

Mobile banking services are not only beneficial for the customers but for the banking institutions as well. These services can significantly lower the operating cost of banking institutions by reducing the dependence on costly call centers. They can also lower the frequency of errors that are usually committed in paper based payments. As mobile banking is a cost effective innovation, it can considerably reduce the financial risk associated with starting a new business initiative. It can also enable banking institutions to closely monitor their new campaigns. Besides this, it can provide a new avenue for selling their products like insurance packages and other banking services.

On the other hand, mobile banking helps customers by ensuring the fast processing of their banking transactions. As any kind of financial transaction is immediately reported to the customers, they can easily monitor and detect any error in transactions, or any unauthorized transactions.

Today, the mobile and wireless market is one of the fastest growing markets. However, a lack of trust and general awareness has been observed among the people when it comes to mobile banking services. Therefore, it is essential to address issues like security of the banking transactions that are executed from a distant place and transmitted over the air. Besides this, it is also important to ensure the security of financial transactions, if the device is stolen by hackers. If these concerns are properly addressed, then it would help increase the popularity of mobile banking by instilling a sense of trust among the customers. ISSUES IN MOBILE BANKING

The advent of the Internet has enabled new ways to conduct banking business, resulting in the creation of new institutions, such as online banks, online brokers and wealth managers. Such institutions still account for a tiny percentage of the industry.


Over the last few years, the mobile and wireless market has been one of the fastest growing markets in the world and it is still growing at a rapid pace. According to the GSM (mobile based technology) Association and the United Nations the number of mobile subscribers is 4.6 billion in 2010.The mobile technology being improving day by day, banks can offer services to their customers such as doing funds transfer while travelling, receiving online updates of stock price or even performing stock trading while being stuck in traffic. Smart phones and 3G connectivity (now 4G) the advanced technologies in latest mobile phones provide more capabilities, which older text message-phones do not possess.

In India however the mobile banking based service is in its budding stages and is mainly based on SMS (Short Message Service)based service, where the customer get details regarding their transactions through SMSes. Other services through mobile internet are evolving but at a faster rate.

There are a number of banking models which revolve around the relationship with the end customer.

They have been divided into 3 categories:

• Bank Focused • Bank-Led • Non Bank-Led.

Bank‐Focused Model

This can be considered an extension of traditional banking which is branch based. A bank will use low costing new channels to provide banking services such as ATM or internet banking etc to customers. However, the services are largely limited.

Bank‐Led Model

This model gives a very different alternative to conventional banking because the customer can conduct financial transactions with the help of a range of retail agents. This helps the banks to significantly increase the penetration of financial services by using a different delivery channel, a more experienced trade partner etc which can result in significant cost savings for the bank.

Non Bank‐Led Model

This is a model where the bank does not play any part except maybe as a keeper of excess funds and the non-bank has the onus of performing all the functions. Technologies Used In Mobile Banking

Currently, Mobile Banking uses one of the following to provide mobile applications:

• IVR (Interactive Voice Response) • SMS (Short Messaging Service)


• WAP (Wireless Access Protocol) • Standalone Mobile Application Clients

IVR – Interactive Voice Response

In this, banks have to allot a specific number which customers call to reach an electronic message stored in advance. Customers reach a menu and can choose the options by pressing a number on the keypad and this provides the necessary information. However, this can only be used for enquiry and is relatively more expensive as it involves voice calls. Keeping this in mid, banks should opt for technology based services as ‘one button banking’ could very well be the future.

SMS – Short Messaging Service

This is by far the most popular standard to implement mobile banking. The customer can send a SMS to a pre-specified number with the query and the banks can reply with the relevant information. For example the customer can send a SMS regarding the balance available in his account to which the bank generates the appropriate information. However, one of the prime disadvantages is security. Unless password enabled or encrypted, this type of sensitive information should be refrained from sharing as SMS facility and SMS gateway is available on all mobile phones.

WAP – Wireless Access Protocol

Banks can maintain WAP sites which are accessible using a WAP compatible browser on the customer’s mobile phones. Thus WAP sites can provide significant security which further enables customers to access or carry out transactions, information, trade etc.

A WAP based service pre-requires a WAP gateway. Customers use the bank's site through the WAP gateway to carry out transactions, receive information etc.

Standalone Mobile Application Clients

These are the most promising of the lot as they can be customized to suit the needs of complex banking activities and is secure and reliable.

However, this customization can become a major disadvantage of as the applications needs to be customized for each mobile phone.

In India, Reliance Infocomm which is the largest CDMA player in the market has 7 million users who have handsets which support J2ME.

MOBILE BANKING IN INDIA

The Reserve Bank of India came out with its mobile banking guidelines in October 2008, and after that, more than 32 banks have been given clearance for some form of mobile banking/payment service or the other to be offered to their customers. The annual value of transactions using the mobile banking channel is to the tune of Rs 150 crore for about 2-3 million transactions.


While technologies such as e-commerce and payments are limited to computer users with Internet connection and bank account, mobile payments can use technologies as simple as SMS and interactive voice response (IVR) among other things. With mobile penetration of 10 times that of computer and expected to become 1 billion by 2014 (the overall cards market is growing at a 30 per cent compound annual growth rate), it won’t be long before India becomes a very large player in the mobile-commerce space.

Generally the Mobile banking can offer services such as the following:

Account Information

• Mini-statements and checking of account history • Alerts on account activity or passing of set thresholds • Monitoring of term deposits • Access to loan statements • Access to card statements • Mutual funds / equity statements • Insurance policy management • Pension plan management • Status on cheque, stop payment on cheque

Payments, Deposits, Withdrawals, and Transfers

• Domestic and international fund transfers • Micro-payment handling • Mobile recharging • Commercial payment processing • Bill payment processing • Peer to Peer payments • Withdrawal at banking agent • Deposit at banking agent

Support

• Status of requests for credit, including mortgage approval, and insurance coverage • Check (cheque) book and card requests • Exchange of data messages and email, including complaint submission and tracking • ATM Location

Content Services

• General information such as weather updates, news • Loyalty-related offers • Location-based services


Based on data gathered in April 2009 for Feb/March mobile banking urban Indian customers checking account balance is the most frequently cited reason for using mobile banking. 40 million Urban Indians used their mobile phones to check their bank account balances followed by viewing last three transactions. ICICI bank continues to maintain its leadership extending in mobile space, 42% of all mobile banking users bank with ICICI, followed by HDFC (25.3%).

Filtering the data further to understand which income groups in urban India use mobile banking more. As depicted in the chart below, mobile banking is most used by subscribers falling in Rs. 1 Lakh to Rs. 2.99 Lakhs income bracket followed by less than Rs 1 Lakh income bracket. Therefore it is observed, mobile banking is more popular among low income group of mobile users than higher income group of mobile users.

RBI Guidelines†

INTRODUCTION

1.1 Mobile phones as a delivery channel for extending banking services have off-late been attaining greater significance. The rapid growth in users and wider coverage of mobile phone networks have made this channel an important platform for extending banking services to customers. With the rapid growth in the number of mobile phone subscribers in India (about 261 million as at the end of March 2008 and growing at about 8 million a month), banks have been exploring the feasibility of using mobile phones as an alternative channel of delivery of banking services. Some banks have started offering information based services like balance enquiry, stop payment instruction of cheques, transactions enquiry, and location of the nearest ATM/branch etc. Acceptance of transfer of funds instruction for credit to beneficiaries of same/or another bank in favor of pre-registered beneficiaries have also commenced in a few banks. In order to ensure a level playing field and considering that the technology is relatively new, Reserve Bank has brought out a set of operating guidelines for adoption by banks. 1.2 For the purpose of these Guidelines, “mobile banking transactions” is undertaking banking transactions using mobile phones by bank customers that involve credit/debit to their accounts. It also covers accessing the bank accounts by customers for non-monetary transactions like balance enquiry etc.

†http://www.rbi.org.in/Scripts/bs_viewcontent.aspx?Id=1660


Regulatory & Supervisory Issues

• Only banks which are licensed and supervised in India and have a physical presence in India will be permitted to offer mobile banking services.

• The services shall be restricted only to customers of banks and holders of debit/credit cards issued as per the extant Reserve Bank of India guidelines.

• Only Indian Rupee based domestic services shall be provided. Use of mobile banking services for cross border transfers is strictly prohibited.

• Banks may also use the services of Business Correspondent appointed in compliance with RBI guidelines, for extending this facility to their customers.

• The guidelines issued by the Reserve Bank on ‘Risks and Controls in Computers and Telecommunications’ vide circular DBS.CO.ITC.BC. 10/ 31.09.001/ 97-98 dated 4th February 1998 will apply mutatis mutandis to mobile banking.

• The guidelines issued by Reserve Bank on “Know Your Customer (KYC)”, “Anti Money Laundering (AML)” and combating the Financing of Terrorism (CFT) from time to time would be applicable to mobile based banking services also.

• Only banks who have implemented core banking solutions would be permitted to provide mobile banking services.

• Banks shall file Suspected Transaction Report (STR) to Financial Intelligence Unit – India (FID-IND) for mobile banking transactions as in the case of normal banking transactions.

Registration of Customers for Mobile Service

• Banks shall put in place a system of document based registration with mandatory physical presence of their customers, before commencing mobile banking service.

• On registration of the customer, the full details of the Terms and Conditions of the service offered shall be communicated to the customer.

TECHNOLOGY AND SECURITY STANDARDS

Information Security is most critical to the business of mobile banking services and its underlying operations. Therefore, technology used for mobile banking must be secure and should ensure confidentiality, integrity, authenticity and non-repudiability. An illustrative, but not exhaustive framework is given at Annex-I below.

Inter‐Operability

• Banks offering mobile banking service must ensure that customers having mobile phones of any network operator is in a position to avail of the service. Restriction, if any, to the customers of particular mobile operator(s) is permissible only during the initial stages of offering the service, up to a maximum period of six months subject to review.

• The long term goal of mobile banking framework in India would be to enable funds transfer from account in one bank to any other account in the same or any other bank


on a real time basis irrespective of the mobile network a customer has subscribed to. This would require inter-operability between mobile banking service providers and banks and development of a host of message formats. To ensure inter-operability between banks, and between their mobile banking service providers, banks shall adopt the message formats like ISO 8583, with suitable modification to address specific needs.

Clearing and Settlement for Inter‐Bank Funds Transfer Transactions

To meet the objective of a nation-wide mobile banking framework, facilitating inter-bank settlement, a robust clearing and settlement infrastructure operating on a 24x7 basis would be necessary. Pending creation of such a national infrastructure, banks may enter into bilateral or multilateral arrangement for inter-bank settlements, with express permission from Reserve Bank of India, wherever necessary.

Customer Complaints and Grievance Redressal Mechanism

The customer /consumer protection issues assume a special significance in view of the fact that the delivery of banking services through mobile phones is relatively new. Some of the key issues in this regard are given at Annex-II below.

Transaction Limit

• 8.1 A per transaction limit of Rs. 2500/- shall be imposed on all Mobile Banking transactions. Subject to an overall cap of Rs. 5000/- per day, per customer.

• 8.2 Banks may also put in place monthly transaction limit depending on the bank’s own risk perception of the customer.

Board Approval

9.1 Approval of the Board of Directors (Local Board in case of foreign banks) for the product as also the related security policies must be obtained before launching the scheme.

Approval of Reserve Bank of India

10.1 Banks wishing to provide mobile banking services shall seek prior one time approval of the Reserve Bank of India, by furnishing full details of the proposal.

SWOT Analysis of Mobile Banking

Strengths

• End-users benefit from greater control of their personal finances, as well as time saved by not having to access account details via other channels (Internet, phone, ATM, among others). Bankers are of the opinion that mobile banking gives the banks an opportunity to expand their customer base without incurring additional infrastructure costs. It would also help in financial inclusion as it would provide a large number of unbanked people access to banking services.


• Yet another strength is the anywhere/anytime characteristics of mobile services. A mobile is almost always with the customer. As such it can be used over a vast geographical area. The customer does not have to visit the bank ATM or a branch to avail of the bank’s services. Research indicates that the number of footfalls at a bank’s branch has fallen down drastically after the installation of ATMs. As such with mobile services, a bank will need to hire even less employees as people will no longer need to visit bank branches apart from certain occasions.

• Banks would save a huge amount of money on card issuance and merchant acquiring with zero point of sale cost. Mobile banking could be used to make remittances from person to person, banking purposes and to make payments for purchases or services provided.

• Mobile operators benefit from increased customer stickiness, data usage and, potentially, customer experimentation with other forms of mobile content.

Weaknesses

• Perception problem. • User experience with the Internet on mobile not ideal -- screen size, keypad and slow

network speeds. • Why not regular HTML browsers like the Safari on the Apple iPhone? • Wireless carriers not innovating at faster pace. • Lack of standards across platforms and carriers. • Many mobile marketing service providers not sophisticated in marketing outreach --

don't tell, won't sell. • Lack of Trust amongst the users on the new technology

Opportunities

• Mobile is the future -- no, the present -- of database marketing. Marketers must have mobile loyalty program to complement online and offline.

• Benefit from marketing dollars pulled from television, print and radio toward more measurable, ROI-driven media, a.k.a., the Internet and mobile.

• Untapped market potential in “ The Easy Way Of Marketing” • Mobile advertising subsidizes content and services for consumers who understand the

tradeoff . • More SMS text marketing for marketers and retailers targeting offers and alerts to

opted-in consumers in database. Make the short code common. • More quality content on mobile as publishers launch mobile editions.

Threats

• Handset Operability: There are a large number of different mobile phone devices and it is a big challenge for banks to offer mobile banking solution on any type of device. Some of these devices support Java Me and others support SIM Application toolkit a


WAP browser, or only SMS. Initial interoperability issues however have been localized, with countries like India using portals like R-World to enable the limitations of low end java based phones. The desire for interoperability is largely dependent on the banks themselves, where installed applications (Java based or native) provide better security, are easier to use and allow development of more complex capabilities similar to those of internet banking while SMS can provide the basics but becomes difficult to operate with more complex transactions. There is a myth that there is a challenge of interoperability between mobile banking applications due to perceived lack of common technology standards for mobile banking. In practice it is too early in the service lifecycle for interoperability to be addressed within an individual country, as very few countries have more than one mobile banking service provider. In practice, banking interfaces are well defined and money movements between banks follow the IS0-8583 standard. As mobile banking matures, money movements between service providers will naturally adopt the same standards as in the banking world.

• Security: Security of financial transactions, being executed from some remote location and transmission of financial information over the air, are the most complicated challenges that need to be addressed jointly by mobile application developers, wireless network service providers and the banks' IT departments.

• Scalability & Reliability: Another challenge for the CIOs and CTOs of the banks is to scale-up the mobile banking infrastructure to handle exponential growth of the customer base. With mobile banking, the customer may be sitting in any part of the world (true anytime, anywhere banking) and hence banks need to ensure that the systems are up and running in a true 24 x 7 fashion. As customers will find mobile banking more and more useful, their expectations from the solution will increase. Banks unable to meet the performance and reliability expectations may lose customer confidence. There are systems such as Mobile transaction platform which allow quick and secure mobile enabling of various banking services. Recently in India there has been a phenomenal growth in the use of Mobile Banking applications, with leading banks adopting Mobile Transaction Platform and the Central Bank publishing guidelines for mobile banking operations.

• Application distribution: Due to the nature of the connectivity between bank and its customers, it would be impractical to expect customers to regularly visit banks or connect to a web site for regular upgrade of their mobile banking application. It will be expected that the mobile application itself check the upgrades and updates and download necessary patches (so called "Over The Air" updates). However, there could be many issues to implement this approach such as upgrade / synchronization of other dependent components.

• Personalization: It would be expected from the mobile application to support personalization such as :

o Preferred Language o Date / Time format


o Amount format o Default transactions o Standard Beneficiary list o Alerts

ADVANTAGES OF MOBILE BANKING

Probably the biggest advantage to banks that mobile banking offers is the reduction in costs to provide service to customers. The cost associated with electronic transactions is as low as $0.10. Further, it opens up the opportunity for banks to cross sell their products and financial services like credit cards etc.

Even for service providers, mobile banking offers a win-win situation. In saturated markets in the developed world like Korea, mobile penetration is not so attractive. Mobile banking can now help increase revenues. To provide better service to customers, service providers can now share information to customers regarding the time and value of purchase on their mobile phones. This will also help reduce credit card fraud. Along the same lines, banks can set reminders for customers regarding their upcoming loan repayments or send copies of bills. The customer would simply authorize payment through their mobile phones.

The customers can also request for specific information like stop cheque or to view deposit details etc using his mobile phone.

Thus mobile banking helps banks not only to reduce costs, but provide services to customers at lower costs. This will help in customer profiling.

Further convenience becomes very important as a mobile is carried by the customer most of the time and frequent visits to the bank or ATM are not required. Footfalls will reduce thus leading to less operational costs in terms of employee costs. Phone based credit systems can soon be a reality in the near future thus widening the benefits received due to mobile banking.

.Automation thus helps banks to personalize their services. For example, if the customer requires his account balance after completing a transaction, an automated reply can be sent.

Hence it’s important to analyze the business benefits of mobile banking.

BUSINESS BENEFITS

Robust Inclusivity Framework

Mobile Banking has tremendous scope for financial inclusion. It can enable banks to include its diverse customer segments from corporate to high net worth individuals, from unbanked groups to its high valued customers. It helps overcome the problems associated with diversity of location, differentiated mobile phones, far flung branches etc.

Maximize Innovation

Rapid innovation helps to configure various services from any channel to a mobile. There will be instant delivery of financial services to customers on mobile phones with the new


improved features. Therefore, innovation is the backbone for a mobile banking interface. Growing competition can be tackled by constant up-gradation and innovation.

Robust Security

Mobile Banking will require good security with proper encryption and a good referral system in place. This will enable banks to offer complex financial services with a robust security network. A two factor or multi factor encryption with authentication ensures a safe security net enabling banks to protect its customers from the security threats and attacks in mobile transactions.

Cost Savings

There is significant cost savings attached for the banks as already discussed. The mobile banking business model is independent of the service provider of the customer, thus reducing the necessity to opt for a revenue sharing model with them. Thus, it’s attractive for banks to opt for mobile banking.

Customer Delight

Mobile banking offers convenience and ease of banking to customers using various technologies. Customer convenience has assumed prime importance as it enables customers to make queries regarding account balances, impending loan repayments etc anytime anywhere. Banks can share and disseminate information in a secure framework

Increase Market Penetration

Mobile banking goes a long way in reducing costs and helps increase penetration of services especially in rural areas. Mobiles can now be used as cash and credit cards and enable merchants for faster and safer transactions. It reduces the need to carry plastic money or cash. It also reduces the need to physically access a service point of a bank.

Sell More Services to Existing Customers

Mobile Banking helps understand and address the latent demand among customers. The mobile could then be used as a new functionality or as a different way to interact through the use of technology.

Retention of Most Valuable Customers

It helps retain the most profitable customers who bring in the most business. This will ensure that they do business with the banks and reduce the chances of them moving to a different bank. Banks can make technology and innovation their core competency as it would be inimitable and difficult for competitors to copy. Banks can thus extend the concept of ease of banking and convenience to all its products through mobile banking technology.


DISADVANTAGES OF MOBILE BANKING

Insecurity

Mobile banking is considered to be safer than online banking as it s protected from viruses and Trojans. However, mobile banking has its own threats most significant among them being ‘smishing’. A customer receives a fake SMS asking for the details of his account number etc. seemingly from a bank. Many such cases have been reported and money from accounts has been stolen due to this.

The security of confidential information and safety of transactions conducted needs to be addressed most urgently by mobile phone companies, service providers and banks. It is very important to check:

• That the mobile phone is in secure hands • The requirement of ID/Password in the event of theft or loss of the mobile device. • Proper Authentication of the customer/user before any transaction or inquiry. • Encryption of data. • Encryption of data stored in banks and in the mobile device. • Usage of One time Password to prevent fraud.

Compatibility

Mobile Banking is not supported in any handset and in India one requires a smart phone or a RIM Blackberry to avail of these services. Some of the handsets have no option of mobile banking at all. Banking application services are available only on RIM and Apple I Phones. Further, the advanced facets of mobile banking are only available on high end sophisticated phones.

Cost

Network service charges are expensive. The costs associated to mobile banking may not be substantial in the presence of an existing compatible device, but charges for data and text messaging are quite high. Some financial institutions charge a premium fee for mobile banking service and for the software. These costs can be very high if there is frequent usage of mobile banking services.

Handset Operability

A variety of mobile handsets makes it difficult to offer mobile banking services of uniform nature on these devices. They support different application like JAVA ME, SMS or WAP. CONCLUSION

As far as mobile banking is concerned, it’s a new type of service offered by the banks to the customers. So it’s very important for the banks to give due priority to it for its successful implementation. As far as the future scope is considered, it can provide great opportunities for micro financing in the developing countries. Also many technological innovations and researches are required to make the service more effective.


The advantages greatly outnumber the disadvantages and would prove profitable for the banks given the willingness to pay premium by the customers. Banks should invest in up gradation of technology and infrastructure to provide adequate security and ease of transactions etc. With mobile phones becoming a necessity and increasing penetration, banks can tie up with service and handset providers as well.

There are lots of people who are aware about the mobile banking but are still rigid to prefer internet banking over mobile banking maybe because of lack of promotional strategies and adequate enthusiasm from the bankers. The customers prefer internet banking over mobile banking and still consider it safer than the mobile banking. There is lack of proper awareness among the customers. They have a wrong risk perception about the mobile banking and consider it insecure and not as reliable as internet and direct banking. They just know that mobile banking exist but are not aware about the services provided. There is a need of deeper penetration for the mobile banking not only in urban areas but also in the rural areas.

The banks like Yes bank are moving forward to tap the rural sector by starting its services commercially along with Nokia and Obopay in Chandigarh. Named as ‘Mobile money services by YES Bank, powered by Nokia,’ it would augment financial inclusion amongst the unbanked and under-banked consumer segments by bringing financial services to the consumer mobile device. This is the first of its kind, providing customers the ability to initiate mobile payments through multiple channels i.e. SMS, IVR, WAP, JAVA and FIRE. This service would eliminate dependence on the physical presence of a branch or availability of internet banking services and will successfully ride on the deep penetration of mobile services in the region.

There are about 600 million subscribers in India and 46 per cent of the mobile users don’t have any bank account. The bankers must first initiate these people to have bank accounts and then move to the other services like mobile banking and internet banking. The findings also conclude that people are more interested with private sector bank for the mobile banking as they find it more technologically advanced and secure than that of the public sector bank. In a comparative study it can be seen that while private sector bank like HDFC make the mobile banking easy to use and is compatible with any platform while public sector banks like SBI provides a differentiated services depending on the platforms used. So the reputation of the bank also plays an important role. The trust that the customer has with the bank is a key for the expansion of mobile banking. Customers are not much happy about the limit on the transactions as mentioned by RBI.

Thus to expand the customer base, the bank can count on mobile banking by targeting a large base of 600 million mobile subscribers and making banking easier and accessible for them. The bankers should create awareness about the various services provided through mobile banking which don’t only include account information but also services like stop payment of cheque and enquiries regarding equities. There is a need of building trust among customers and changing their perception towards reliability and riskiness of mobile banking. The bankers must tap on the existing customers and then expand via them.

Mobile banking is poised to become the KING of all technologies present in the Banking arena. However, banks going mobile the first time need to tread the path cautiously. The


biggest decision that banks need to make is the set of services that they will allow to prosper to bank upon. Mobile banking through an SMS based service would require the lowest amount of effort, in terms of cost and time, but will not be able to support the full breath of transaction-based services. But, in markets like India, where a bulk of the mobile population users' phones can only support SMS based services, this might be the only option left.

Mobile banking has the potential to do to the mobile phone what E-mail did to the Internet. Mobile Application based banking is poised to be a big m-commerce feature. Mobile banking could well be the driving factor to increase sales of high-end mobile phones. Moreover, Bank's need to take a hard and deep look into the mobile usage patterns among their target customers and enable their mobile services on a technology which reaches out to the majority of their customers.

Last, but not the least, in a hugely populated country like India, where concepts like Microfinance, SMEs, Self Help Groups etc. are picking up the pace, Mobile Banking can play a fantastic role in bringing about Financial Inclusion in various nations including India by reaching the masses and allowing them to BANK – ANYWHERE ANYTIME.

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ANNEX- I

Technology and Security Standards

• The security controls/guidelines mentioned in this document are only indicative. However, it must be recognised, the technology deployed is fundamental to safety and soundness of any payment system. Therefore, banks are required to follow the Security Standards appropriate to the complexity of services offered, subject to following the minimum standards set out in this document. The guidelines should be applied in a way that is appropriate to the risk associated with services provided by the bank and the system which supports these services.

• Banks are required to put in place appropriate risk mitigation measures like transaction limit (per transaction, daily, weekly, monthly), transaction velocity limit, fraud checks, AML checks etc. depending on the bank’s own risk perception, unless otherwise mandated by the Reserve Bank.

Authentication

Banks providing mobile banking services shall comply with the following security principles and practices for the authentication of mobile banking transactions:

• All mobile banking shall be permitted only by validation through a two factor authentication.

• One of the factors of authentication shall be mPIN or any higher standard. • Where mPIN is used, end to end encryption of the mPIN shall be ensured, i.e.

mPIN shall not be in clear text anywhere in the network. • The mPIN shall be stored in a secure environment.

Proper level of encryption and security shall be implemented at all stages of the transaction processing. The endeavor shall be to ensure end-to-end encryption of the mobile banking transaction. Adequate safe guards would also be put in place to guard against the use of mobile banking in money laundering, frauds etc. The following guidelines with respect to network and system security shall be adhered to:

• Implement application level encryption over network and transport layer encryption wherever possible.

• Establish proper firewalls, intruder detection systems (IDS), data file and system integrity checking, surveillance and incident response procedures and containment procedures.

• Conduct periodic risk management analysis, security vulnerability assessment of the application and network etc at least once in a year.

• Maintain proper and full documentation of security practices, guidelines, methods and procedures used in mobile banking and payment systems and keep them up to date based on the periodic risk management, analysis and vulnerability assessment carried out.


• Implement appropriate physical security measures to protect the system gateways, network equipments, servers, host computers, and other hardware/software used from unauthorized access and tampering. The Data Centre of the Bank and Service Providers should have proper wired and wireless data network protection mechanisms.

The dependence of banks on mobile banking service providers may place knowledge of bank systems and customers in a public domain. Mobile banking system may also make the banks dependent on small firms (i.e mobile banking service providers) with high employee turnover. It is therefore imperative that sensitive customer data, and security and integrity of transactions are protected. It is necessary that the mobile banking servers at the bank’s end or at the mobile banking service provider’s end, if any, should be certified by an, accredited external agency. In addition, banks should conduct regular information security audits on the mobile banking systems to ensure complete security.

For channels which do not contain the phone number as identity, a separate login ID and password shall be provided to ensure proper authentication. Internet Banking login IDs and Passwords shall not be allowed to be used for mobile banking.

ANNEX-II

Customer Protection Issues

• Any security procedure adopted by banks for authenticating users needs to be recognized by law as a substitute for signature. In India, the Information Technology Act, 2000, provides for a particular technology as a means of authenticating electronic record. Any other method used by banks for authentication is a source of legal risk. Customers must be made aware of the said legal risk prior to sign up.

• Banks are required to maintain secrecy and confidentiality of customers' accounts. In the mobile banking scenario, the risk of banks not meeting the above obligation is high. Banks may be exposed to enhanced risk of liability to customers on account of breach of secrecy, denial of service etc., on account of hacking/ other technological failures. The banks should, therefore, institute adequate risk control measures to manage such risks.

• As in an Internet banking scenario, in the mobile banking scenario too, there is very limited or no stop-payment privileges for mobile banking transactions since it becomes impossible for the banks to stop payment in spite of receipt of stop payment instruction as the transactions are completely instantaneous and are incapable of being reversed. Hence, banks offering mobile banking should notify the customers the timeframe and the circumstances in which any stop-payment instructions could be accepted.

• The Consumer Protection Act, 1986 defines the rights of consumers in India and is applicable to banking services as well. Currently, the rights and liabilities of customers availing of mobile banking services are being determined by bilateral agreements between the banks and customers. Taking into account the risks arising


out of unauthorized transfer through hacking, denial of service on account of technological failure etc. banks providing mobile banking would need to assess the liabilities arising out of such events and take appropriate counter measures like insuring themselves against such risks, as in the case with internet banking.

• Bilateral contracts drawn up between the payee and payee’s bank, the participating banks and service provider should clearly define the rights and obligations of each party.

• Banks are required to make mandatory disclosures of risks, responsibilities and liabilities of the customers on their websites and/or through printed material.

• The existing mechanism for handling customer complaints / grievances may be used for mobile banking transactions as well. However, in view of the fact that the technology is relatively new, banks should set up a help desk and disclose the details of the help desk and escalation procedure for lodging the complaints, on their websites. Such details should also be made available to the customer at the time of sign up.

• In cases where the customer files a complaint with the bank disputing a transaction, it would be the responsibility of the service providing bank, to expeditiously redress the complaint. Banks may put in place procedures for addressing such customer grievances. The grievance handling procedure including the compensation policy should be disclosed.

• Customers complaints / grievances arising out of mobile banking facility would be covered under the Banking Ombudsman Scheme 2006 (as amended up to May 2007).

• The jurisdiction of legal settlement would be within India.

Changing Dimensions of Banking Sector in India

Dr. T. Aswatha Narayana* and Shankar Reddy P.* Abstract—The Indian Banking sector has been the fastest growing in the post liberalization period. The banking industry is undergoing a paradigm shift in scope, content, structure, functions and governance. The information and communication technology revolution were radically and perceptibly changing the operational environment of the banks. But along with this change the banking sector is prone to multiple and concurrent challenges. Increased competition, rising customers' expectations and diminishing customers' loyalty. In such an environment Indian banking sector will have to equip itself to meet the challenges of competition from within the country as well as from abroad. While they more to meet these challenges, they have to ensure that their foundation remains sound and their attention is not distracted from principles of prudent banking. In this background, some of the major challenges and trends which are likely to emerge in future and the strategies to be adopted to combat with these challenges were being covered in this paper. This sort of development, no doubt, would strengthen the banking sector base in particular and Indian economy in general. In view of this, the paper makes an attempt to highlight the changing dimensions of banking sector in India, along with an emphasis on the challenges that the banking sector prone to face, to offer certain strategies for the growth and development of banking sector in India in future.

INTRODUCTION

The service sector has been the fastest growing sector in the post liberatization Period. With the intensification of the pace of ongoing economic and financial sector reference for more liberalization and Globalization of the Indian economy, the Indian Banking industry is undergoing a paradigm shift in scope, content, structure, functions and governance. Their very character, composition, contour and chemistry is changing. The information and communication technology revolution is radically and perceptibly changing the operational environment of the banks. Banking sector is faced with multiple and concurrent challenges, increased competition, rising customer expectations and diminishing customer loyalty. In the complex and fast changing scenario, the only sustainable competitive advantage is to give the customers and optimum blend of technology and personalized service. Banks are in true with each other far introducing sophisticated e-banking facilities to give the customer extra reach and convenience. Banking is the key sector of any economy. Its energy and vitality indicate the health and prosperity of any nation.

OBJECTIVE

The present paper makes an attempt to highlight the changing dimensions of banking sector, to focus on the state of banking sector in the post liberalization period, to make an emphasis on the challenges the sector is facing in India and offer to adopt certain strategies for the growth and development of banking sector in future. *Govt R.C. College of Commerce and Management, Bangalore


State of Banking Sector in the Post‐Liberalization Period

After liberalization the Indian banking industry was operating in a highly regulated and protected region. In the changing scenario of liberalization, it was realized that the banking sector would have to play a key role in the economic reforms process. Thus, the Narsimhan Committee was formed to recommend reforms in the banking sector with the objective of granting autonomy and flexibility to the banking industry and improving its efficiency and profitability.

The important reform measures recommended by the Narsimhan committee were;

• Reduction in Statutory Liquidity Ratio (SLR) • Reduction in CRR • Reduction in priority sector lending • Freeing of Interest rates on Deposits and Advances to promote competition in the

financial sector. • Capital Adequacy Norm. • Access to capital markets. • Prudential Accounting Norms. • Competition through permission to private sector banks.

Most of the measures suggested by the committee have been accepted by the Government. Interest rates have been deregulated over a period of time, branch, licensing procedures have been liberalized and statutory liquidity ratio (SLR) and cash reserve ratio (CRR) have been reduced. The entry barriers for foreign banks and new private sector banks have been rationalized as part of the medium terms strategy to improve the financial and operational health of the banking system by introducing on element of competition into it. In 1994, SEBI for the first time notified regulations to bankers pertaining to public issue. Public sector banks are now allowed to access the capital market to raise funds, leading to a dilution in the shareholding of the govt. Another important dimension of the banking sector reforms was reduction of the non-performing assets. With introduction of securitization Act, 2002, a long felt need has been realized.

Challenges before the Indian Banking Sector

Major challenges which Indian banking sector are facing today and which are likely to be more poignant in the ensuring years in view of the irreversible process of the reforms and resultant verisimilitude of many players entering the banking sector are discussed.

Problem of Pressure on Profitability The greatest challenge which Indian banking sector are facing in recent years arises out of pressure on their profitability. With continuous expansion in number of branches and manpower, thrust on social and rural banking, directed sectors lending maintenance of higher research ratios, waiver of loans under ARDR type concessions, repayment default by large industrial corporates and other borrowers, etc, had their telling impact on the profitability of the banks.

Changing Dimensions of Banking Sector in India 109

Problem of Low Productivity Another ferocious challenges which Indian banking sector are confronting is low productivity. The low productivity has been due to huge surplus manpower, absence of good work culture and absence of employees commitment to the organisation.

Problem of Non-Performing Assets (NPA):

A Serious threat to the survival and success of Indian banking system is uncomfortably high level of non-performing assets. In its Report on Trend and progress of Banking of India, 1997-98, the RBI reported that gross NPAs as percentage of advances of PSBs was 16 percent as on March 31, 2000 with a colossal amount of about Rs. 52,000 crore being locked up. This might have recently recorded further increase due to default in repayment by the industrial units affected by the two-year old recession. This is much higher than the international level of below 5%

Problems from Customers

In view of competitive forces, fast changing life style and values of customers who are now better informed, have a wide choice to choose from various banking and non banking intermediaries, become more demanding and their expectation in terms of products, delivery and price are increasing, the PSBs lacking in customers orientation are finding it difficult to even retain their highly valued customers what to talk of attracting the new client particularly when the foreign banks as also the new breed of private sector banks have embarked upon aggressive marketing programmes aiming at niche markets.

Competition from Private Banks

The commercial banks in India which enjoyed monopoly position until recently are facing perilous challenges particularly on quality, cost and flexibility fronts from the newly emerging players who by dint of their invigorating ambience and work culture supported by pragmatic leadership committed, courteous, affable and friend staff and modern ultra gadgets are offering excellent customer services and marking in roads in the business centers.

Competition from Mncs

Globalization and integration of Indian financial market with world and the consequent entry of foreign players in domestic market has infused, in its wake, brutal competitive pressure on the Indian commercial banks. Foreign players endowed with robust capital adequacy, high quality assets, world-wide connectivity benefits of economies of scale and stupendous risk management sills are posing serious threats to the existing business of the Indian banks .

Problem of Managing Dual of Ownership

Managing duality of ownership is a peculiar problem which the PSBs have to encounter because of participation of private shareholders in their share capital. A public sector bank to survive and grow successfully is expected to operate according to the expectations of one of its principal shareholders. In the changed scenario, there would be two major groups of


shareholders, viz., the Government of India and RBI on the one hand and the private shareholders, on the other.Since the expectations of these two categories of owners are not necessarily identical, the bankers will have to manage conflicting interests.

Problem of Managing Customers' Diverse Strata

Another very important challenge which PSBs are faced with is managing two ends of spectrum of banking services. PSBs, unlike their counterparts in the private sector as also the foreign banks have two faces; a commercial side and non-commercial side, each having various strata. In a country like India with wide disparities in needs, standards and ways of living of the people in various regions, the bankers are expected to manage these different starts in its total expanse equally well without ignoring any of the or even performing one at the expense of the other.

Challenge of Qualitative Changes in Banking Paradigm

The greatest challenge which Indian banks are facing is to bring about change in the mindsets and attitude of the employees and inculcate. Bank employees in India as noted earlier, are highly cynical and less motivated with decreasing loyalty towards their work life. They are not very much concerned with their productivity and lack cost consciousness. Strong and militant trade unions resisting any organizational change and archaic approach of managing have also been the barriers to bank development.

Evolving of Strategies for the Growth and Development of Banking Sector in Future

Visualizing the scenario in the years ahead, success would crucially depend on strategically effective and intelligent management of marketing and customer relationships.

Intensely Competitive Market

The market has changed drastically and has become largely customer centric. The key to success in this changed competitive environment will be one's ability to reach the client at his door step and meet his requirements of product and services in a customized manner. This development is indeed welcome as it has immense potential for growth of banking business in future but it has its own draw back as there could be adverse selection of customers.

Need-Based Technology Technology is increasingly finding its use in banking by way of conveience in product delivery and access, managing productivity and performance, product design adapting to market and customer needs and access to customer market. For the Indian Banking Sector, these development are of significant interest in the future. The ability to access and share information will contribute in improving efficiency and value additing, moreover; focus on e-banking will open new business potential and opportunities for banking sector.

Consolidation through Mergers Globalization has brought severs competitive pressures to bear on Indian banks, from international banks. In order to compete with these entities effectively, Indian commercial


banks need to posses matching financial strength, as fair competition is possible only among equals. Size, therefore assumes criticality even in these days of virtual banking. Mergers and acquisition, route provides a quick step forward in this direction offering opportunities to share synergies and reduce the cost of product development and delivery.

Customer Relationship Management

The process of relationship banking which has been ushered in on the Indian banking scenario would become sharper and widespread. The competencies required from a banker in the future include expertise in information technology and functional knowledge. This would warrant that the banks have to be careful in selection of personnel as regards to their skills, as the requirement of job would be to take decisions based on risk-reward paradigm rather than process – based administration. The training and skills upgradation system is also required to be aligned to desired competencies.

Delivering Customer Delight It is a method which can pro-actively monitor customer satisfaction, identifies the areas where most beneficial improvements can be implemented and suggest the uses of web to market measurable improvements to a wider audience. It is a revolutionary and cost effective approach to link customer satisfaction with internal improvements, performance and increased business. Delight results from exceeding the expectations of satisfied, customers. Meeting only current needs’locks a firm into the present' but to move beyond the threshold of satisfaction, one must tap into the unmet or even to the domain of unimagined needs of the customer. Hence, the only key that can unlock the door to delight is new ways of thinking and working

Imparting Good Governance The road ahead for the banking industry will be entirely different from the track traversed hitherto. Banks will be compelled to concentrate more on how to improve performance with regard to capital adequacy, asset quality, management performance, earnings capacity, liquidity, and systems and controls, while capital adequacy, asset quality and profitability can be ascertained from balance sheet management, systems and controls will involve subjective evaluation.

Corporate Social Responsibility

Corporate Social Responsibility is the continuing commitment by business to achieve commercial success in ways that honour ethical values, address legal issues and contribute to economic development will improving the quality of experience of the workforce and their families as well as the local community and society at large.

Efficient Customer Service

In the future competitive pressures will become more intensified in the banking environment in India and the markets will get changed drastically, with the focus on being customer centric. The key to success in the changed environment will be the banks ability to reach the


client at his door step and meet his requirements of product and services in a customized manner leading to customer delight and customer ecstasy.

Appropriate HR Policies It has become imperative that for meeting the challenges and opportunities in future, there will be great need for changes in mindset in the human resource available within the Bank. Training and Development in updating the skills is essential to face the emerging challenges. In a service industry like banking, human resources will occupy the pivotal part for making the bank services enduring. With the entry of new private banks and foreign banks, the system of hire – and – fire will become unavailable. Security and age old practices of conducting traditional banking will undergo revolutionary changes.

Management of NPAs

In future, the non performing assets will become the major causes of banks concern. Imbibing the credit management skills will become all the more important for improving the bottom line of the banking sector. It becomes essential to master the expertise for monitoring exposure levels, industry scenarios and timely action in respect of troubled industries. Skills of NPA management, which include working out negotiated settlements. Companies, constituting active settlement advisory committees, compromise, constituting active settlement advisory committees. Restructuring and rehabilitation, effective recourse to suitable legal remedies, etc., are to be supplemented with most suitable legal reforms by the banks to recover dues well in time so that the financial soundness of the banking sector will not be undermined.

Product Re-Engineering Strategy The growth in disposable incomes, changing lifestyles, global changes and their impact on the economy will result in ever changing and diversified needs of the customers. Banks in future will have to understand the dynamic needs of a changing society through detailed market survey and structure innovative products so as to channelize the savings of the community and also to satisfy the credit requirements of various sectors of the economy.

CONCLUSION

For a successful banking business management and analysis of large data and information play key roles in devising new strategies, products and services, with the cost of technology falling and their capacities increasing day-to-day, datawarehousing has become affordable. Banks should set up their own intranet and extranet, which will be boon to both employees and customers, spread over wide geographic locations. We are in an era where technology is all-pervasive. However, in service like banking due care has to be taken while embracing technology and transforming traditional touch points to electronic ones, so that human touch with customers is not lost.

In the end, it can be rightly evolved that productivity and efficiency will be the watch words in the banking industry in the years ahead. Strategizing organizational effectiveness


and operational efficiency will govern the survival and growth of profits changes in the mindset of the employees is imperative with the changing times. Continuous quest for skill upgradation at all levels, development of vision and mission and commitment are some of the aspects which required urgent attention by the banking sector in future. REFERENCES [1] Singh, Ranbir (2003), Profitability management in Banks under deregulated environment, published in IBA

Bulletin. July. [2] Upinder Dhar, Santosh Dhar, (2005) Strategies of Winning organisation. [3] Dr. Anju Singla, Dr. R.S. Arora (2005) financial performance of public sector banks. Published in Punjab

Journal of Business Studies, Vol-I, No.1, September. [4] M. Subramanya Sharma, P. Amaraveni, (2005) CRM in Banks- An analytical approach, published in sedme,

Vol. 32, No.3 September. [5] Dr. K.K. Agrawal (2005) Indian Banking Today: Impact of Reforms, Published in Vanijyam Souvenier 58th

All India Commerce Conference at Varanasi. [6] www.google.co.in

Track 2 Corporate Finance

Impact of Financial Leverage on Firm’s Value: An Empirical Analysis of FMCG Sector

Anshu Bhardwaj* and Dr. Vikas Choudhary**

Abstract—In the analytical and empirical literature on the subject of finance and growth, there is a consensus among economists that development of the financial system contributes to economic growth. The Indian economy is showing resilience and is in the forefront of a worldwide recovery. The key to sustain India’s growth momentum is possible by changing dynamics of management through innovation and creativity. After breezing through the slowdown that cut such a wide swathe across the Indian economy in the past but now manufacturers of FMCG (Fast Moving Consumers Goods) are now up against fresh challenges to their growth. The firms operating in this sector are quite cautious in the choice of sources of funds and thus forming their capital structure to be known as optimal capital structure. De Angelo and Masulis (1980) demonstrated that with the presence of corporate tax shield substitutes for debt, each firm will have a “unique interior optimum leverage decisions with or without leverage costs.” The firms have realized that attaining overall competitiveness would entail reducing the overall cost of their operations including financial costs. It has compelled the firm’s to rethink and redesign their financial strategies focusing on global integration and competitiveness. The present study is an attempt to examine the capital structure of the various firms under study and to find out its impact on the firms value.

Keywords: Indian economy, financial leverage, firm’s value, capital structure, competitiveness.

INTRODUCTION

Capital structure is one of the most prolific domains of research in corporate finance. Capital structure has attracted intense debate and scholarly attention in the financial management arena over the last few decades. The capital structure debate has been live for decades, with the key point of contention for many researchers being whether capital structure positively or negatively impacts firm’s value. Much of the literature on this question takes its departure from the seminal writings of Modigliani and Miller (1958) and their Theorem of Irrelevance. Research is spinning around a few theoretical models of capital structure since over more than fifty years but could not be able to provide the conclusive assistance to managers and practitioners for choosing between debt and equity in financial decisions. Many researchers have subsequently argued their case for and against the optimal value capital structure.Franco Modigliani and Metron Miller’s (M&M) theory (1958) is considered as fundamental corporate structure model in the modern corporate finance. The theory ascertained the irrelevance of capital structure to firm’s value in perfect markets, without taxes and transaction costs. MM irrelevance theory was generally accepted and subsequent research focused on relaxing some of its assumptions to develop a more realistic approach. In this sense, MM published another paper considering some of the criticisms or deficiencies of their *BPS Mahila Vishwavidayalaya, Sonipat **National Institute of Technology, Haryana


theory and relaxed the assumption that there were no corporate taxes (Modigliani and Miller, 1963).Thus, one of the central issues in both the theory and practice of financial management is the problem of determining the optimal capital structure of the firm. Given capital market conditions and the array of investment opportunities, is there some optimal composition of liabilities and equity at which the value of the firm will be maximized? The purpose of this research is to evaluate whether in an Indian context an increase in financial leverage positively or negatively impacts firms value in case of FMCG (Fast Moving Consumer Goods).

Following the seminal work of Franco Modigliani and Merton Miller (1958, 1963), a substantial amount of effort has been put forward in corporate finance theory to determine the factors that influences a firm’s choice of capital structure. Many empirical studies have tried to explain the factors that affect on capital structure choice. One of the most renowned initial empirical studies is made by Rajan and Zingales (1995) and they explain the various institutional factors of firm’s capital structure in the leading industrial countries. Existing empirical research on capital structure has been largely confined to the United States and a few other advanced countries.

Myers (1984) holds that the various capital structure theories do not explain actual financing behavior and it is therefore presumptuous to advise firms on optimal capital structure. However various researchers have found evidence in support of a positive relationship between optimal capital structure and a maximized firm value: Ward and Price (2006) indicate that an increased debt/equity ratio in a profitable business increases shareholders returns, but also increases risk. Sharma (2006) concludes that there is a direct correlation between leverage and firm value. Lasher (2003) asserts that increased levels of debt finance can result in increased earnings per share (EPS) and return on Equity (ROE). De Wet (2006) proves that a significant increase in value can be achieved in moving closer to the optimal level of gearing and Fama and French (2002) conclude that there should be a positive relation between debt ratio and firm’s profitability. Contrary to this, Rajan and Zingales (1995) find a negative relationship between debt and profitability.

The purpose of this study is to empirically evaluate the impact of financial leverage on firm’s value. An optimal debt/equity ratio is achieved when the value of a firm is maximized while the cost of capital is minimized Firer et al.(2004) and Erhardt and Brigham (2003). The literature suggests that leverage is value reducing for high growth firms and value enhancing for low growth firms (Mc Connell & Servaes,1995).These value effects of leverage are related to the ability of debt to mitigate the effects of under and over investment related to manager-shareholder agency costs. However, other studies suggest that there is no such leverage-value relationship(Agrawal&Knoeber,1996).The present study seems to resolve the leverage-value relationship puzzle and may at least partially explain the puzzling phenomenon of debt conservatism documented by Graham(2000). Validity of the pecking order and trade-off theories for the sample companies is also tested. In this paper multiple data regression model i.e., OLS regression for 22 companies listed in index constituent of BSE for the period from 2001 to 2009.The results of the present study reveal that Interest Cover Ratio(ICR) and profitability are negatively correlated with financial leverage. On the

Impact of Financial Leverage on Firm’s Value: An Empirical Analysis of FMCG Sector 119

other hand, Return on Net worth (RONW), Return on Capital Employed (ROCE), Non debt tax shield(NDTS), Profitability(PROF), Collatralizable value of assets or Tangibility(TANG), Size (SIZE) Growth (GROWTH) are positively correlated with financial leverage.

This research is grounded in the well-known Theory of Capital structure irrelevance proposition introduced by Modigliani and Miller (1958) which states that in a perfect market, capital structure has no impact on firm value.The modern theory of capital structure is said to have begun with a seminal paper by Franco Modigliani and Merton Miller (1958). Since then, several theories have been proposed to explain the variation in debt ratios across firms. The prior research on the corporate capital structure is based on irrelevancy propositions. The capital structure theory suggests that firms determine what is often referred to as a target debt ratio, which is based on various trade -offs between the costs and benefits of debt versus equity. Assuming perfect and complete capital market structure, Modigliani and Miller (1958) postulate that the leverage of a firm is independent to, and, therefore, uncorrelated with, its market value.

Most researchers on capital structure take as their point of departure from the seminal work of Modigliani and Miller (1958), which derived the Leverage Irrelevance Theorem, concluding that capital structure does not impact firm value in an ideal environment. Their assumption of an ideal financial environment excludes the impact of tax, inflation and transaction costs. This theory, known as MM-I received criticism from peers who question the validity of their theory given the fact that the no firm actually operates in an environment without the impact of tax, inflation and transaction costs.

This prompted Modigliani and Miller (1963) to issue a correction, which is referred to as MM-II Proposition. They still argue that a change in the debt/equity ratio does not impact on firm value, however when taxes and other transaction costs are considered two factors need to be acknowledged:

First, a firm’s weighted average cost of capital (WACC) decreases as it increases its debt. Second, a firm’s cost of equity increases as it increases its debt since shareholders bear higher business risk due to the increased possibility of bankruptcy. Given the great debate on capital structure, and adding to the aforementioned Modigliani and Miller models (1958,1963), a number of theories have provided further contributions.

Pecking Order Theory

Myers and Majluf (1984) propose that the “pecking order framework” is based on asymmetric information since managers have inside information on the future prospect of the firm and act in the favour of existing shareholders. According to Pecking Order theory firms prefer internal finance (retained earnings) to external finance. And when external finance is required, firms prefer debt before equity. Myers (1984) modifies the strict pecking order hypothesis and suggests that firms with many investment opportunities may decide to issue equity before it is absolutely necessary.

The outcome of empirical tests on pecking order theory is mixed. Shyam Sunder and Myers (1999) find support for the pecking order hypothesis utilising data from the New York


Stock Exchange for various sectors, over the period 1971-1989. Frank and Goyal(2003) observed little support for pecking order hypothesis also using American publicly traded firms for the period 1971-1998and argued instead that net equity issues are more closely correlated with financing deficit than are net debt issues. The pecking order hypothesis seems to be more applicable to data prior to 1990 then post 1990.Fama and French (2005) examine the financing decisions of many individual firms and observe that these decisions are in conflict with the pecking order hypothesis. They also find that while equity is supposed to be the last financing alternative, most firms issue some sort of equity every year.

Seifert and Gonenc(2008) in their study titled, the international evidence on pecking order hypothesis, find little support for pecking order behaviour in the US,UK and Germany for the period 1980-2004. They indicate that this is largely attributed to the information asymmetry due to widespread ownership of stock where insiders know more than outside investors. They find evidence to support pecking order behaviour in Japan during the 1980’s and 1990’s. Ni and Yu (2008), also find little support for pecking order theory amongst Chinese listed firm’s in2004.They indicate that this is largely attributed to the information asymmetry due to widespread ownership of stock where insiders know more than outside investors. They find evidence to support pecking order behaviour in Japan during the 1980’s and 1990’s. Ni and Yu (2008), also find little support for pecking order theory amongst Chinese listed firms in 2004.They conclude that in China, large companies follow the pecking order hypothesis while small and medium companies do not. Trade off Theory

Myers (2001) postulates that debt offers firms a tax shield, and firms therefore pursue higher levels of debt in order to gain the maximum tax benefit and ultimately enhance profitability. However, high levels of debt increase the possibility of bankruptcy.

The advantage of this approach include the possibility of deducting interest payments from company tax(Modigliani and Miller, 1963).Kim (1978),states that the disadvantage of debt is the potential cost of financial distress. Jensen and Meckling(1976) add that an additional disadvantage is the agency costs for equity holders and debt holders.To further substantiate this argument DeAngelo and Masulis(1980) predict an inverse relationship between leverage and investment tax shield, while the association between the corporate tax rate and the debt level is expected to be positive. However Nagesh(2002), in his investigation into sixty four JSE listed firms, finds a negative relation between between the tax rate variable and the extent of leverage. He also concludes that the trade –off between investment related tax shields and debt –related tax shield is unobserved.

Myers (1984) asserts that the trade –off approach implies that a firm’s leverage reverts to a target or optimal level. Nagesh(2002) states that Frank and Goyal(2005) break Myers notion of trade off into two parts The first part describes the static trade –off theory, where a firm’s leverage is determined by a single period trade-off. The second part consists of Target adjustment behaviour, where the firm’s leverage gradually reverts to the target over time. More recently authors have developed a dynamic trade –off model in an attempt not only to verify the prediction that leverage reverts to an optimal level, but also to understand how quickly this adjustment is made Hennessy and Whitehead (2005).


Agency Cost Theory

Capital structure is influenced by firm management, which has a long term impact on the firm’s capital structure. However, management might be tempted to pursue personal incentives instead of maximising shareholders value Myers (2001).

Research in this area was initiated by Jensen and Meckling (1976), building on earlier work by Fama and Miller (1972). They identified two types of conflicts: those between shareholders and managers, and those between debt holders and equity holders. They postulate that conflicts between shareholders and mangers occur since managers hold less than one hundred percent of the residual claim. Managers do not capture the entire gain from these activities, but they do bear the entire cost of these activities by foregoing expenditures that would benefit them personally.

Harris and Raviv (1990) share a common concern regarding manager-shareholder conflicts. They postulate that mangers and shareholders may disagree over the firm’s operating decisions. Managers tend to prefer to continue the firm’s operations even if liquidation of the firm is preferred by shareholders. Stulz (1990) support the manager-shareholder conflict argument from a different angle, stating that managers look to invest all available funds even if paying out cash is more suitable for shareholders.

All of the aforementioned offer mitigation to manager –shareholder conflict by recommending the issuance of debt. Jensen and Meckling (1976) find that this conflict is reduced and even mitigated relative to the percentage of equity the manager holds in the firm. If the manager’s equity stake in the firm is held constant while the level of debt increases, this result is an increase in the manager’s share of equity, thereby mitigating the loss from conflict between the manager and shareholder. Jensen (1986) and Stulz(1990) add to the discussion on the mitigation of manager –shareholder conflict by stating that since debt commits the firm to pay out cash it reduces the amount of cash available for management to engage in personal pursuits. Therefore, the mitigation of conflicts between managers and equity holders constitutes one benefit of debt financing. Harris and Raviv (1990) assert that debt gives debt holders, who are also investors in the firm, the option of forcing liquidation if cash flows are poor. Grossman and Hart (1982) offer a further benefit of debt financing, stating that bankruptcy is costly for managers who are concerned with losing control and they should therefore focus on efficient utilisation of firm resources to reduce the probability of bankruptcy. Short term debt maturity has the additional benefit of reducing agency costs since in this instance management is more frequently monitored by underwriters and debt holders.

Stulz(2000) support this notion and Rajan and Winton (1995)concur that short term debt facilitates effective monitoring with minimum effort. Capital Structure is determined by trading off the benefits of debt against the costs of debt Harris and Raviv (1991). Harris and Raviv(1990) also indicate that investor control through bankruptcy requires additional costs in order to produce information useful in the liquidation decision. Stulz(1990) asserts that debt payments reduce free cash flow, thereby reducing funds available for investment in profitable opportunities.


Several authors have pointed out that agency problems can be reduced by utilising managerial incentive schemes, financial securities or stock ownership. Datta, Iskandar –Data and Raman (2005) also prove that managerial stock ownership improves the relationship between credit quality and debt maturity and between growth opportunities and debt maturity. Their findings support Stulz’s (2000) findings relating to the use of short term debt as a monitoring tool and are also consistent with Johnson’s(2003) finding where that managers with high equity ownership choose a higher proportion of short term debt.

The second type of conflict identified by Jensen and Meckling(1976) was the conflict between debt holders and equity holders. They postulate that the debt contracts give equity holders an incentive to invest sub-optimally. If firms are successful and yield a large return above the cost of debt, the equity holders enjoy most of the benefit, however if the firm fails, the debt holders bear most of the loss due to limited liability. Denis and Milov (2002) contend that a firm’s decision to borrow funds implies that it will be monitored by the debtholder and this constitutes a control mechanism discretionally chosen by the firm.

Information Asymmetry Theory

The information asymmetry theory of capital structure is credited to the work of Ross (1977).He poists that firm managers possess more information about the future prospects of the firm than the market. Therefore management’s choice of capital structure may provide the market with signals of a firm’s future prospects. Therefore, an increase in leverage would increase the value of the firm since investors would deem this to be a positive signal of the size and stability of future cash flows.

Fama and French (1988) disagreed with this notion, arguing that more profitable firms tend to have lower levels of debt. In this case increasing debt would signal poor future prospects for the firm, since future earnings will be impacted negatively due to cash flow being used to service debt, reducing the amount or money available to fund future development. Raju and Roy(2000) establish that the value of available information contributing to firm profitability is higher for larger companies and is higher for larger companies and is higher for industry sectors where there is intense competition. Therefore the release of credible information by managers affects the performance of a firm and has an impact on the perceptions held by the external market about a firm.

Finally, Liu(2006) asserts that there is an increase in monitoring of a firm as the size of external financing increases. This serves as a mitigating factor against the challenges of information asymmetry and agency costs as mentioned earlier. Stulz(2000) and Rajan and Winton(1995) also support this notion. Implicitly, this lends support to pecking order theory, where managers prefer internal funds before looking outside of the firm to raise funds in capital markets.

Literature Summary The literature reviews above provides a summary of the various views and theories held with regard to capital structure. The theories considered here are as follows:


• Pecking order theory proposes that firms follow a hierarchy in their capital structure choice especially with regard to debt.

• Trade off theory states that firms endeavor to maximize returns by balancing the benefits of the tax shield that debt can affords the firm against the possibility of bankruptcy brought upon by increased debt.

• Agency cost theory asserts that the capital structure of a firm is influenced by management personnel who are conflicted by their pursuit of personal enrichment before the maximization of shareholder value.

• Information asymmetry theory states that since managers have more information on the future of the firm, their decisions on capital structure could provide signals to the market on the firm’s value.

OBJECTIVES AND HYPOTHESIS Objectives

The aim of this study is to analyze the relation between Capital structure and firm’s value in context of Fast Moving Consumer Goods(FMCG) as well as to evaluate the impact of financial leverage on firm’s value. Thus, an attempt is being made to establish whether capital structure positively or negatively impacts the firm value. There have been similar studies in this regard. Sharma (2006) suggests that there is a direct correlation between financial leverage and firm’s value in the manufacturing industry in India.

Hypothesis

The null hypothesis states that an increase in leverage (D/E ratio) for a firm decreases firm value. The alternative hypothesis states that a change in leverage (D/E ratio) for a firm increases firm value.

METHODOLOGY

The research methodology utilized was casual research. The present study is an attempt to be made to identify cause and effect relationships existing between financial leverage and firm’s value. The research method employed is quantitative analysis of secondary data. Albright (2006) suggested that the sample selected from the total population was stratified by industry sector in order to better understand the characteristics of the homogeneous subsets. Therefore, the FMCG sector firms are considered for the study. The total numbers of 22 companies are included in the sample. The next part of the selection required that all firms in the sample are to be listed on the Bombay Stock Exchange (BSE) for the period 2001-2009. The information relating to the FMCG sector firms financial performance and capital structure provided in the company’s annual financial statements to be sourced from the Capitaline Database. The research analysis to be confined to the FMCG sector of manufacturing firms listed on Bombay Stock Exchange (BSE). The study involves impact of financial leverage on firm’s value and to examine the capital structure of FMCG sector listed on BSE Index.

The study also involves determinants of capital structure of FMCG sector from manufacturing sector using pooled data regression analysis. Based on earlier work of (Remmers et al., 1974; Al-Najjar and Taylor, 2007; Mallikarjunappa & Goveas, 2007, Shah


and Hizari, 2004; Buferna et al., 2005; Kakani, 1999; Gropp and Heider, 2008; Sayılgan et al., 2008) the dependent variable used in the study is leverage (LEV) which is described as total debt divided by total assets of the firm. The explanatory variables include, Return on Net worth (RONW),Return on Capital Employed (ROCE), Interest Cover Ratio (ICR), Non debt tax shield(NDTS), Profitability(PROF), Collatralizable value of assets or Tangibility(TANG), Size (SIZE) Growth (GROWTH). The variables used in this study are based on book value as per the argument proposed by Myers (1984) that book values are proxies for the value of assets in place. Since variables differ in scales in which their value lies, so data is normalized before conducting statistical analysis. The complete OLS model after incorporating all variables used in our study is:

LEVi,t =β0 + β1 RONW + β2 ROCE + β3 ICR + β4 NDTS + β5 PROF + β6 TANG it+ β7 SIZEi,t + β8 NDTSi,t + εit (1)

Where: LEVit , ratio of total debt to total assets for firm i in period t; PROFit, ratio of earnings before interest and tax to total assets of firm i in period t; TANGit, ratio of fixed assets to total assets for firm i in period t SIZEit, log of net sales for firm i in period t; NDTSit, ratio of fixed assets to total assets for firm i in period t.

EMPIRICAL RESULTS

Correlation Analysis

The table I exhibits the correlation matrix of Financial Leverage and explanatory variables. Positive correlations coefficient values can be observed of financial leverage (LEV) with Return on Net worth (RONW), Return on Capital Employed (ROCE), Non debt tax shield (NDTS), Profitability(PROF), Collatralizable value of assets or Tangibility(TANG), Size (SIZE) Growth (GROWTH). On the other hand Interest Cover Ratio (ICR) and profitability are negatively correlated with financial leverage. Highest correlation of financial leverage can be found with CVA and the same is also statistically significant. Overall highest value of correlation coefficient can be observed between ROCE and NDTS (i.e. .860) and is also statistically significant at .01 level of significance.

TABLE I: CORRELATIONS MATRIX

FL RONW ROCE ICR NDTS PROF CVA SIZE GROWTH FL 1

RONW .096 1 ROCE .021 .549** 1

ICR -.010 .041 .261 1 NDTS .132 .367 .860** .243 1 PROF -.091 .347 .534* .179 .510* 1 1 CVA .670** .455* .603** .108 .735** .194 SIZE .147 -.028 .349 -.018 .388 .573** .207 1

GROWTH .122 -.231 -.263 -.107 -.251 -.660** -.091 -.468* 1 FL= Financial Leverage, RONW= Return on Net worth, ROCE= Return on capital employed, ICR= Interest Coverage Ratio, NDTS= Non debt tax shields, PROF= Profitability, CVA= Collatalrized Value of Assets, Size= Firm size, as used natural logarithm of sales, Growth= Year on year growth in investment opportunities. Note: **. Correlation is significant at the 0.01 level (2-tailed). *. Correlation is significant at the 0.05 level (2-tailed).


Regression Analysis

Before analyzing the coefficients, we examine the diagnostics of regression. For detecting the presence of autocorrelation in data, Durbin Watson (D-W) statistics is analyzed. D-W statistics shows the serial correlation of residuals (first order) and ranges in value from 0 to 4 with an ideal value of 2 indicating that errors are not correlated. Analysis of D-W statistics about pooled data reveals that our value (1.903) which is well in range indicating no possible autocorrelation. The table also exhibits R value which is the square root of R-Squared and is the correlation between the observed and predicted values of dependent variable (financial leverage). The present study on FMCG sector concludes that the correlation between dependent variables and predictor is .91 which is considered as a high value. The high value tells that they are positively and significantly correlated with each other. R- Square tell us how much variation is explained by all the independent variables or predictors. This is an overall measure of the strength of association and does not reflect the extent to which any particular independent variable is associated with the dependent variable. Any High value is better. In present study 83.5% variation in financial leverage (dependent variable) is explained by the GROWTH, CVA, ICR, RONW, SIZE, ROCE, PROF, NDTS taken together. The high value shows that the model is constructed well for the study. Adjusted R- Square may be defined as an adjustment of the R-squared that penalizes the addition of extraneous predictors to the model. This is generally used in research for reporting the proportion of variation explained in the dependent by the Independent or predictors. In the present study of FMCG sector 73.4 (.734) percent of variation is explained by all independent variables together. Besides, Durbin Watson (D-W) statistics test the first degree serial correlation among variables and our value is less than the critical range of 2.25. so it is acceptable and concludes that there is no presence of first order serial correlation.

TABLE II: OLS REGRESSION

Variables Entered/Removedb Model Variables Entered Variables Removed Method 1 GROWTH, CVA, ICR, RONW, SIZE, ROCE, PROF, NDTSa . Enter a. All requested variables entered. b. Dependent Variable: FL ( Financial Leverage)

Model Summaryb Model R R Square Adjusted R Square Std. Error of the Estimate Durbin-Watson

1 .914a .835 .734 .1019761 1.903 a. Predictors: (Constant), GROWTH, CVA, ICR, RONW, SIZE, ROCE, PROF, NDTS b. Dependent Variable: FL( Financial Leverage)

ANOVA

The table III shows the analysis of variance related to financial leverage as dependent variable and predictors are GROWTH, CVA, ICR, RONW, SIZE, ROCE, PROF, NDTS.In the table,F value is calculated which shows that whether the constructed model is significant or not. If sign value is less than 0.05 then (generally less than .010 is also accepted) it is assumed that the model is significant. The present study on FMCG sector reveals that the F value is 8.236 which are associated with p-value of .001, so our model is highly significant and we can


conclude that our model is made correctly. The results of the OLS regression between leverage (dependent variables) and the eight independent variables are reported in Table III. The table reveals that our overall model is significance as F= 8.236 with p value =.001.

TABLE III: ANOVA

ANOVA Model Sum of Squares Df Mean Square F Sig.

Regression .685 8 .086 8.236 .001a Residual .135 13 .010

1

Total .820 21 a. Predictors: (Constant), GROWTH, CVA, ICR, RONW, SIZE, ROCE, PROF, NDTS b. Dependent Variable: FL

COEFFICIENTS

The table IV represents the dependent variable i.e. financial leverage (constant) in the first column. And after that various independent variables are defined in the table. The second column B represents the values for the regression equation for predicting the dependent variable from the independent variable. The regression equation consisting of various dependent and independent variables are already explained and defined in the methodology section. The b0 is constant and value of b0 is -.090 in case of FMCG manufacturing sector firms. The various independent variables are explained as follows:b1(RONW) the coefficient of RONW is -.141. So for every unit decrease (as it is negative value) in Return on net worth there is a 0.14 unit decrease in financial leverage is predicted, holding all other variables constant, b2(ROCE) the coefficient of RONW is -.085. So for every unit decrease (as its is negative value) in Return on capital employed there is a 0.18 unit decrease in financial leverage is predicted, holding all other variables constant ,b3(ICR) the coefficient of ICR is .074. So for every unit increase (as it is positive value) in interest coverage ratio there is a 0.074 unit increase in financial leverage is predicted, holding all other variables constant,b4(NDTS) the coefficient of NDTS is -.740. So for every unit decrease (as it is negative value) in Non debt tax shield there is a .74 unit decrease in financial leverage is predicted, holding all other variables constant,b5(PROF) the coefficient of Profitability is .223. So for every unit increase (as it is positive value) in profitability there is a .22 unit increase in financial leverage is predicted, holding all other variables constant, b6 (CVA) the coefficient of collateralized value of assets is 1.547. So for every unit increase (as it is positive value) in CVA there is a 1.547 unit increase in financial leverage is predicted, holding all other variables constant,b7 (Size) the coefficient of size is .179. So for every unit increase (as it is positive value) in Size there is a .179 unit increase in financial leverage is predicted, holding all other variables constant and b8 (Growth) the coefficient of growth in investment opportunities is . 151. So for every unit increase (as it is positive value) in growth there is a .151 unit increase in financial leverage is predicted, holding all other variables constant. The next column shows the standard error associated with the coefficients and Beta is also shown as standardized coefficients. It can be concluded from the table that larger betas are associated with the larger t-values and lower p-values. Further, t and Sig. are shown in the table and are the t-statistics and these are associated with 2-tailed p-values used in testing whether a given coefficient is significantly different from zero, using an alpha of (0.01,


0.05 and 0.010).The findings of the study are, the coefficient for RONW is not significantly different from 0 because its p-value is definitely larger than 0.05,the coefficient for ROCE is not significantly different from 0 because its p-value is definitely larger than 0.05,the coefficient for ICR is significantly different from 0 because its p-value is definitely smaller than 0.010,the coefficient for NDTS is significantly different from 0 because its p-value is definitely smaller than 0.010,the coefficient for PROF is not significantly different from 0 because its p-value is definitely larger than 0.010,the coefficient for CVA is significantly different from 0 because its p-value(.000) is definitely smaller than 0.005,the coefficient for SIZE is significantly different from 0 because its p-value(.068) is definitely smaller than 0.010,the coefficient for GROWTH is significantly different from 0 because its p-value(.070) is definitely smaller than 0.010.

For detecting the multicolinearity in OLS regression analysis, variance inflation factor (VIF statistics) is used and analysed. Highest value of VIF statistics obtained among all variables was 5.802 whereas a commonly given rule of thumb is that VIF's of 10 or higher may be a cause of concern (Chatterjee & Price, 1977; Gujrati & Sangeetha, 2008).Thus, results indicate no presence of autocorrelation and multicollinearity in the data used.

TABLE IV: COEFFICIENTS

Coefficientsa Unstandardized Coefficients Standardized Coefficients Collinearity Statistics Model

B Std. Error Beta t Sig.

Tolerance VIF (Constant) .090 .195 .463 .651

RONW -.141 .142 -.172 -.990 .340 .421 2.376 ROCE -.085 .197 -.118 -.434 .671 .172 5.802

ICR .074 .111 .081 2.660 .072 .860 1.163 NDTS -.740 .255 -.889 -2.908 .052 .136 7.370 PROF .223 .211 .211 1.056 .310 .316 3.160 CVA 1.547 .220 1.396 7.026 .000 .321 3.115 SIZE .179 .132 .215 2.357 .068 .503 1.987

1

Growth .151 .115 .205 2.319 .070 .525 1.906 a. Dependent Variable: FL

CONCLUSION

Debt and equity are the principal source of funding for a business. The proportional distribution of these two sources of funding depends on how a firm decides to divide its cash flow between two broad categories: a fixed component which is utilized for obligations toward debt capital and a residual component which belongs to equity shareholders. Therefore a firm’s financial leverage affects the firm value, Sharma (2006). The above information could lead to the assumption that all firms should ensure that their capital structure is greatly weighted towards a higher level of debt. However there is a limit to the amount of debt a firm should take on De Wet (2004). In India corporate firms play a significant role in contributing to economic growth. In order to attain their objectives, firms need to efficiently manage their funds. To respond to global competition firms need to make massive capital investment in modern technologies, infrastructure, product development and product promotion and so on. Such investments may promote productivity and efficiency. There are several sources of


financing those investments. Financial leverage is one of them. In its simplest form, financial leverage is the amount of debt used to finance a firm's assets and projects. It is good to note that during the great depression and throughout the 1930s and 1940s, financial leverage was predominantly viewed as a clear evil. It was perceived that huge amount of debt leads to financial distress. However, such a view point is no more universal. Nowadays, financial leverage is seen as important resource for the production of goods and services as well as for their distribution. Financial leverage is an important component in capital structure along with equity and retained earnings. One of the main debates in Corporate Finance is the impact of financial leverage on a firm’s value. Among the various sources of corporate financing, financial leverage is perceived to have both positive and negative attributes as a debt financing instrument. The issuance of debt commits a firm to pay cash as interest and principal. A firm with significantly more debt than equity is considered to be highly leveraged. Modigliani and Miller (1958) stated that we should not “waste our limited worrying capacity on the second-order and largely self-correcting problems like financial leveraging.” However, a lot of theoretical and empirical literatures have challenged this point, arguing that financing considerations considerably complicate the investment relation. Myers (1977), for instance, explained how highly levered firms are less likely to exploit valuable growth opportunities as compared to firms with low leverage levels.

It is well perceived fact that financial leverage has become the important factors in determining the capital structure decisions of a firm. One of the major issues encountered by fund managers today is not just procurement of funds but also their meaningful deployment to generate maximum returns. Sources of funds are generally the same across all businesses but then why is it that some businesses are able to do better than the rest. If the logic of outstanding performance is a viable business idea, then why is it that some companies still fail to achieve success even with ample funds and the right business idea? The above discussion clearly implies that there is something beyond financial success of business besides great ideas and good geographic presence. Capital structure is one of the important determinants of a firm's success. The research aims to analyze the capital structure of FMCG sector of manufacturing sector industries in India and how this has had an impact on their overall value of the firm. In order to test our hypotheses, we used financial leverage (LEV) as dependent variable and independent variables include Return on Net worth (RONW), Return on Capital Employed (ROCE), Interest Cover Ratio (ICR), Non debt tax shield (NDTS), Profitability (PROF), Collatralizable value of assets or Tangibility(TANG), Size (SIZE) Growth (GROWTH) that are well established and widely used by the researchers in various international studies. There are various theories in corporate finance that propounded the relationship between capital structure and valuation of firm. Validity of the pecking order theory and trade-off theory are also empirically tested using OLS regression model. The various propositions related to optimal capital structure focus more on the theoretical aspect, this study has gathered financial information of selected firms of FMCG sector and attempted to establish a relationship between financial leverage and firm’s value and its impact on the capital structure.


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Analysis of Dividend Payout Policy of Indian Companies and Multinational Companies

Dr. Archana Singh*, Abha Tulsian* and Bhawna*

Abstract—This paper aims at analyzing the dividend payout policy prevailing in various Indian companies and evaluating them alongside multinational firms, keeping in view certain underlying factors. A sample set of 44 companies which are listed on Bombay Stock Exchange, 29 Indian and 15 multinational companies have been taken (on the basis of the data availability). The past 9 year annual reports have been utilized to study the dividend payout policy.

We have examined the determinants of dividend payout for firms and the consequential impact of these factors on dividend payout by performing regression analysis. The result shows that firm's dividend policy will depend upon its past growth rate, future growth rate, systematic risk, profitability, liquidity and size of business. The result of the study indicates that dividend policies of Indian companies were highly influenced by profitability of the firm while the dividend policies of multinational Companies were majorly influenced by growth rate.

The result of this study will contribute in assisting other firms to develop a dividend policy which divides the net earnings into dividends and retained earnings in an optimum way so as to achieve the objective of wealth maximization of shareholders.

Keywords: Dividend payout, Capital Market, Wealth maximization of shareholders, Earning per share, Dividend yield

INTRODUCTION

Dividend payout policy has been the primary riddle in the economics of corporate finance. Several rationales for a corporate dividend policy have been proposed in the literature, but there is no unanimity among researchers. Dividend policy is the payout policy that managers follow in deciding the size and pattern of cash distribution to shareholders over time. The decision is an important one for the firm as it may influence its capital structure and stock price. The dividend policy of the company should aim at achieving the objective of the company to maximize shareholder’s wealth.

Keeping in view the relationship between dividend policy and the value of the firm, different theories have surfaced. They have been majorly categorized into two categories. The first group consists of theories which consider dividend decisions to be irrelevant. According to Modigliani and Miller’s Hypothesis (1961), under a perfect market situation, the dividend policy of a firm is irrelevant to the firm’s value. They argued that the value of the firm depends on the firm’s earnings which result from its investment policy. The shareholders do not necessarily depend on dividends for obtaining cash. The second group consists of the theories which consider dividend decisions to be an active variable influencing the value of

*Delhi School of Management, Delhi Technological University, Delhi

Analysis of Dividend Payout Policy of Indian Companies and Multinational Companies 131

the firm, supported by Walter’s Model (1963) proposed by Professor James E. Walter which clearly shows the importance of the relationship between the firm’s rate of return, its cost of capital in determining the dividend policy. Myron Gordon also developed Gordon’s Model (1962) which explicitly related the market value of the firm to dividend policy. Gradually, theorists identified a number of factors which play a significant role in making dividend decisions. John Lintner in 1956 conducted his classis study on American companies and stated that dividend policy has two parameters: the target payout ratio and the speed at which current dividends adjust to the target. The extent to which it affects the firm also depends upon other internal and external environment. Extensive studies have been conducted to recognize these factors.

The undertaken study captures the different dimensions influencing the dividend policy decisions in BSE listed Indian companies and evaluating them alongside International firms on the same parameters. The independent factors includes profitability, growth rate, liquidity, size of business, systematic risk, and percentage of common stocks held by insiders. Depending upon these factors, the dividend payout ratio has been estimated. The determinants of dividend payout for firms are analyzed and the consequential impact of these factors on dividend payout is studied by performing regression analysis. The study differs from the past survey research. It reveals some interesting results by comprehensively analyzing how Indian firms make dividend decisions. On the other hand, this paper uses several financial variables to explain the possible differences in the dividend policy of both Indian and foreign firms listed in Bombay Stock Exchange.

This paper now proceeds as follows: Section-2 provides a brief review of the relevant literature. Section-3 presents the description of the data and the empirical methods used. Section-4 contains the findings, and Section V concludes the paper with a conclusion and summary.

OBJECTIVE OF THE STUDY

• The primary objectives of the study are as under: • To recognize the factors influencing the dividend payout policies of the Indian firms. • To recognize the factors which determine the dividend payout policies of the

multinational firms. • Comparison of the two results

LITERATURE REVIEW

A substantial theoretical literature is accessible on dividend payout behaviour of the firms. Researchers have proposed many different theories about the factors that influence a firm’s dividend policy. A number of factors have been identified in previous empirical studies to influence the dividend policy decisions of the firm.

Setia and Atmaja [2010] provided an explanation whether board independence influences debt and dividend policies of a sample of Australian publicly-listed firms. which have higher levels of leverage and dividend payout ratios than their non-family counterparts.


Najjar et al. [2009] examined that the number of outside directors on the board of directors is indirectly proportional to the dividend payout, applied by UK firms to control agency conflicts of interest within the firm. Pandey and Bhat [2007] suggest that the dividend pay-out ratio in the context of emerging market (India) is influenced by macro-economic policies. Abdulrahman Ali Al-Twaijry [2007] identified the variables with an expected influence on dividend policy and on payout ratio in an emerging market using 300 firms randomly selected from the Kuala Lumpur Stock Exchange.

Renneboog [2007] investigated the relationship between the dynamics of earnings payout and the voting power enjoyed by different types of shareholders. Ian D. McManus et al. [2006] has focused on the returns performance of zero dividend stocks in its research paper. It provided link between dividend payment and returns history and firms’ subsequent stock market performance. It was found that payment history is not a significant determinant of returns, while past returns play a far greater role. Gugler [2003] investigates the relationship between dividends and ownership and control structure of the firm for Austrian firms.

Collins and Wansley [1996] compared the dividend payout patterns of a sample of regulated firms with unregulated firms. They did not find that the financial regulators' role is one of agency cost reduction for equity holders.

Khigbe et al. [1993] measured the common share price response to dividend increases for both insurance firms and financial institutions relative to unregulated firms. They find that insurance firms stock prices react positively to increases in dividends over a four-day interval surrounding the announcement, but that these reactions differ depending on the insurer's primary line of business.

These studies in general tried to explain the dividend behaviour over time with the help of numerous factors. Every research paper considered a single nation and observed the effect of various factors on the dividend pay-out ratio to the stakeholders. But not much work has been done in comparing the dividend policies of Indian firms and the foreign firms. This research study analyzes the dividend payout policy prevailing in various Indian companies and evaluated them alongside International firms keeping in view certain underlying factors like profitability, growth rate, liquidity, size of business, systematic risk, and percentage of common stocks held by insiders. The paper examines the determinants of dividend payout for firms and the consequential impact of these factors on dividend payout by performing regression analysis. An attempt has also been made to calculate estimated dividend payout based on the results. There is a wide gap in literature to address the comparison between Indian and foreign firms on the same platform. This paper expansively tries to fill this gap.

METHODOLOGY OF THE STUDY

In the undertaken study, in order to examine the dividend payout policy of Indian companies and Multinational Companies, we firstly concentrate our attention on Indian corporate sector. The Indian Corporate Sector has large number of corporate firms, providing itself to large sample statistical analysis.


There is a blend of private and public sector companies in Indian Corporate Sector (which are again a mix-up of firms owned by business houses, privately owned multi-nationals and standalone firms), still it has not suffered from the discrimination that has dominated some of the developing economies.

Accounting system in India is very well established and it is similar to those followed in most of the advanced economies. This increases our confidence in the reliability of our data.

Sample Selection and Period of the Study

This paper studies the dividend payout practices of BSE-listed companies (Indian and foreign firms) which are significant for deciding dividend policy of the Indian corporate sector. The study is an explorative study and is based on secondary data. The firm level panel data for our study has been obtained primarily from the corporate database (PROWESS) maintained by CMIE (Center for Monitoring the Indian Economy).

The initial data set includes the universe of 200 companies of Indian Corporate Sector firms. The period of study extends from 1999-2000 to 2008-09. To construct the data sample, we start with all companies listed in Group-A of BSE. We have chosen only group A companies for our analysis, since this group consist of those companies which have the highest growth rate. We have excluded financial firms and utilities because their dividend polices are highly constrained by external forces. The analysis has been restricted to firms which have no missing data for at least 10 consecutive years. Among these remaining listed companies, 29 Indian Companies and 15 Multinational firms having the highest market cap are selected.

Tool of Data Analysis

Various ratios have been calculated and correlation analysis is used among various variables. In order to identify the factors influencing the dividend payout of Indian and multinational firms, multiple regression analysis has been carried out and based on this model, the best explorative variable influencing DPR has been identified for both of them.

The factors influencing on dividend payout policies of Indian and multinational firms have been judged based on the model as depicted below

DPR = B0 + B1ROCE +B2RONW + B3DPS + B4EPS + B5β + B6QR + B7CEPS + B8TA + B9P/E + B10 CR

Variables of the Study

This research study analyzes the dividend payout policy prevailing in various Indian companies and evaluated them alongside International firms keeping in view certain underlying factors like profitability, growth rate, liquidity, size of business and systematic risk. These six factors are then evaluated using certain ratios. Profitability is evaluated using ROCE (return on capital employed), RONW (return on net worth), EPS (earning per share) and DPS (dividend per share). Evaluation of growth rate is done using P/E ratio. Liquidity of


firm is calculated by using ratios such as Quick ratio, Cash EPS and Current Ratio( incl mgtl. Securities), Size of business is determined by total assets. Systematic risk is measured through a statistical measure called beta (β). These ratios are defined below:

Dividend Payout Ratio (DPR)

The ratio reveals that how much profits are distributed as cash dividend. It is computed as follows

DPR = DPS

X 100 EPS

Companies that have high growth rates generally have low payout ratios because they reinvest most of their net income into business.

Dividend Per Share (DPS)

This ratio shows that how much income as profit will be received by the investors. It is calculated as follows

DPS = Dividend paid to equity shareholders No. Of equity share outstanding

Earnings Per Share (EPS)

It is the net income earned on each share of common stock.

The objective of determining this ratio is to measure the profitability of firm on equity shares. It is computed as follows

EPS = Earnings available for equity share holders Number of equity shares

Return on Capital Employed (ROCE)

This ratio is an indicator of the earnings capacity on the capital employed in the business. The objective of calculating this ratio is to determine how efficiently the long term funds supplied by the creditors and shareholders have been used. It is calculated as follows

ROCE = Operating net profit before interest and tax X 100

Capital employed

Return on Net worth (RONW)

This ratio helps the company to discover the return on net worth on the basis of net profit

RONW = Net Profit Net worth


Systematic Risk (Β)

The movement of share prices in relation to movement in stock market is termed as systematic risk, which is measured through a statistical measure called beta (β)

Quick Ratio (QR)

It is a measure of company’s immediate short term liquidity without relying upon realization of stock. It is computed as follows

QR = Liquid assets

Current Liabilities

Cash EPS

It looks at the cash flow generated by a company on a per share basis.

This differs from basic EPS, which looks at the net income of the company on a per share basis. The higher a company's cash EPS, the better it is considered to have performed over the period. It is determined as follows

Cash EPS = Operating cash flow Diluted outstanding shares

Total Assets (TA)

The sum of current and long-term assets owned by a company.

Price ‐ Earning ratio (P/E ratio)

This ratio is helpful in predicting the market price of equity shares at some future date and in determining whether the share of a particular firm are undervalued/overvalued. This ratio is determined as

P/E Ratio = Market price per equity share Earning per share

FINDINGS

In this section, the multiple regression analysis between the dependent variable DPR and independent variables (Earning Per Share, Current ratio (including marketable securities), cash EPS, P/E ratio, Dividend Per Share, Beta, Quick Ratio, Total Asset, ROCE, RONW is presented to study the relationship between dividend payout policy and liquidity, profitability, systematic risk, growth rate, size of the Indian as well as multinational companies. This is done to find out single most explanatory variable of Dividend policy of the Indian and multinational companies. For this purpose, the regression is run for each year, separately on the sample companies with backward elimination method to select the best predictor. This backward elimination method begins with all independent variables in the model and at each step removes the least predictor out of all of them. Variables are removed until an established


criterion for the F-statistics and adjusted R-square no longer holds. Accordingly under this method, the remaining variable is the best predictor.

The significant value of the F indicates that the dependent and the independent variable or the set of independent variables are statistically significant and particularly the independent variables explain the dependent variable in the scientifically accepted fitted model.

This section is further divided into two parts. Part one shows the multiple regression analysis for the sample of Indian companies whereas part two depicts the multiple regression analysis for the sample of multinational companies.

The year-wise analysis for both Indian as well as multinational companies follows as under:

EMPIRICAL ANALYSIS OF INDIAN COMPANIES

Year 2000

The correlation table (Table 1.a) of the year 2000 shows that there is very low correlation between all the selected independent variables and the dependent variable (i.e. dividend payout ratio). The only ratio that shows some correlation is DPS, which shows that dividend payout moves positive with DPS of the firm.

TABLE 1.A

Correlations dividen

d payout ratio

Beta Quick ratio

Cash EPS

Current ratio (incl.

mktgl. securiti es)

Log total asset

RON W

ROC E

P/E DPS EPS

Pearson Correlatio n

Dividen d payout ratio

1 0.04 0.129 -0.03 0.172 -0.08 0.147 0.093 0.03 0.2 2 -0.01

TABLE 1.B

Model Summary Model R R Square Adjusted R

Square Std. Error of the

Estimate Change Statistics

R Square Change F Change df1 df2 1 0.49819 0.2482 -0.169471 0.298309 0.24819704 0.594244 10 18 2 0.49651 0.24652 -0.110386 0.290675 -0.0016733 0.040063 1 18 3 0.492997252 0.087689 1 19 4 0.48261 0.23292 -0.022778 0.278973 -0.0101302 0.267656 1 20 5 0.45794 0.20971 -0.005823 0.276651 -0.0232056 0.635286 1 21 6 0.428 0.18319 0.0056201 0.275072 -0.0265226 0.738332 1 22 7 0.39982 0.15986 0.0198336 0.273099 -0.0233306 0.656949 1 23 8 0.38835 0.15082 0.0489156 0.269017 -0.0090398 0.258237 1 24 9 0.34213 0.11705 0.0491318 0.268987 -0.0337666 0.994091 1 25 10 0.22061 0.04867 0.0134333 0.27399 -0.0683831 2.013661 1 26 11 2.4E-08 5.6E-16 0 0.275849 -0.0486678 1.381254 1 27

It is evident from the regression table (Table 1.b) that the adjusted R-square is going up till 9th model; this shows that DPS and Cash EPS are the best determinant of dividend policy in 2000. The Table 1.c presents the result of ANOVA analysis. The F-statistics shows that the


value of the residual is lowest in the 9thmodel and the results are supporting the earlier observation in the previous table 1.a. The overall conclusion throws light on two variables that is DPS and Cash EPS.

• Predictors: (Constant), EPS, log total asset, Beta, Quick ratio, P/E, DPS, RONW, ROCE, Current ratio (incl. mktgl. securities), Cash EPS

• Predictors: (Constant), EPS, log total asset, Beta, Quick ratio, P/E, DPS, RONW, Current ratio (incl. mktgl. securities), Cash EPS

• Predictors: (Constant), log total asset, Beta, Quick ratio, P/E, DPS, RONW, Current ratio (incl. mktgl. securities), Cash EPS

• Predictors: (Constant), log total asset, Beta, Quick ratio, P/E, DPS, Current ratio (incl. mktgl. securities), Cash EPS

• Predictors: (Constant), Beta, Quick ratio, P/E, DPS, Current ratio (incl. mktgl. securities), Cash EPS

• Predictors: (Constant), Beta, Quick ratio, P/E, DPS, Current ratio (incl. mktgl. securities), Cash EPS

• Predictors: (Constant), P/E, DPS, Current ratio (incl. mktgl. securities), Cash EPS • Predictors: (Constant), DPS, Current ratio (incl. mktgl. securities), Cash EPS • Predictors: (Constant), DPS, Cash EPS • Predictors: (Constant), DPS

TABLE 3.C

ANOVAModel Sum of Squares Df Mean Square F Sig.

9 Regression 0.24939 2 0.124694 1.72338596 0.198227 Residual 1.8812 26 0.072354 Total 2.13059 28

Year 2001

Table 2.a represents the correlation table of the year 2001. It shows that the only ratios which depict some correlation between independent variables and dividend payout ratio are RONW and DPS, which exhibits that dividend payout moves positive with DPS and RONW of the firm.

TABLE 2.A

Correlations dividend

payout ratio

Beta Quickratio

Cash EPS

Current ratio

(incl.mktgl securities)

log total

assest

RONW ROCE P/E DPS EPS

Pearson Correlation

dividend payout ratio

1 -0.04 -0.08 -0.21 0.018 -0.12 0.146 0.011 0.028 0.187 -0.21

It is obvious from the regression table (Table 2.b) that the adjusted R-square is moving up till 5th model; this shows that the parameters - Total asset, RONW, DPS, quick ratio, ROCE and Cash EPS are the best determinant of dividend policy in 2001. The Table 2.c presents the


result of ANOVA analysis. The overall conclusion highlights the variables like Total asset, RONW, DPS, Quick ratio, ROCE and Cash EPS.

TABLE 2.B

Model Summary

Model R R Square Adjusted R Square Std. Error of the Estimate

Change Statistics

R Square Change F Change df1 df2 1 0.812 0.659 0.470 0.136 0.659 3.480 10 18 2 0.812 0.659 0.498 0.132 0.000 0.003 1 18 3 0.811 0.062 1 19

4 0.809 0.655 0.540 0.126 -0.003 0.156 1 20 5 0.804 0.646 0.550 0.125 -0.009 0.552 1 21 6 0.784 0.615 0.531 0.128 -0.032 1.961 1 22

• Predictors: (Constant), EPS, log total asset, Beta, Current ratio (incl. mktgl. securities), RONW, DPS, P/E, Quick ratio, Cash EPS, ROCE

• Predictors: (Constant), EPS, log total asset, Current ratio (incl. mktgl. securities), RONW, DPS, P/E, Quick ratio, Cash EPS, ROCE

• Predictors: (Constant), EPS, log total asset, Current ratio (incl. mktgl. securities), RONW, DPS, Quick ratio, Cash EPS, ROC

• Predictors: (Constant), log total asset, Current ratio (incl. mktgl. securities), RONW, DPS, Quick ratio, Cash EPS, ROCE

• Predictors: (Constant), log total asset, RONW, DPS, Quick ratio, Cash EPS, ROCE • Predictors: (Constant), log total asset, RONW, DPS, Cash EPS, ROCE

TABLE 2.C

ANOVA Model Sum of Squares df Mean Square F Sig.


Year 2002

Table 3.a represents the correlation table of the year 2002. It depict the only ratios that show some correlation are RONW, ROCE, P/E ratio and DPS, which exhibit that dividend payout is directly related to DPS, ROCE, P/E and RONW of the firm.

TABLE 3.A

Correlations Dividend

payout ratio

Beta Quick ratio

Cash EPS

Current Ratio

(incl. mktgl. securities)

Log (total asset)


Pearson Correlation


1 -0.02 -0.10 -0.26 -0.140 0.020 0.209 0.117 0.489 0.114 -0.29

The regression table (Table 3.b) shows that the adjusted R-square is going till 5th iteration, this shows that Total asset, RONW, DPS, ROCE and P/E are the best determinant of dividend policy in 2002. The Table 3.c is presenting the ANOVA analysis results.


TABLE 3.B

Model R R Square Adjusted R Square

Std. Error of the Estimate

Change Statistics

R Square Change F Change df1 df21 0.818 0.669 0.485 0.186 0.669 3.639 10 18 2 0.817 0.668 0.510 0.182 -0.001 0.071 1 18 3 0.815 0.157 1 19 4 0.808 0.653 0.538 0.176 -0.012 0.706 1 20 5 0.802 0.643 0.545 0.175 -0.010 0.626 1 21 6 0.784 0.615 0.531 0.178 -0.028 1.731 1 22

• Predictors: (Constant), EPS, log total asset, P/E, RONW, Quick ratio, Beta, DPS, Current ratio (incl. mktgl. securities), ROCE, Cash EPS

• Predictors: (Constant), EPS, log total asset, P/E, RONW, Quick ratio, DPS, Current ratio

• (incl. mktgl. securities), ROCE, Cash EPS • Predictors: (Constant), EPS, log total asset, P/E, RONW, Quick ratio, DPS, Current

ratio • (incl. mktgl. securities), ROCE • Predictors: (Constant), EPS, log total asset, P/E, RONW, Quick ratio, DPS, ROCE • Predictors: (Constant), EPS, log total asset, P/E, RONW, DPS, ROCE • Predictors: (Constant), EPS, P/E, RONW, DPS, ROCE

TABLE 3.C



Year 2003

The correlation table (Table 4.a) of the year 2003 shows that the only parameters that shows some correlation are Total asset, RONW, ROCE, P/E ratio and DPS, which shows that dividend payout moves positive with Total asset, DPS, ROCE, P/E and RONW of the firm.

TABLE 4.A


payout ratio

Beta Quick ratio

Cash EPS

Current ratio (incl. mktgl. securities)

Log Total Asset


Pearson Correlation


1 -0.03 -0.25 -0.17 -0.213 0.136 0.293 0.168 0.133 0.164 -0.23

The regression table (Table 4.b) makes it evident that the adjusted R-square is going up till 4th model, this shows that Total asset, RONW, Quick ratio, current ratio, DPS, ROCE and cash EPS are the best determinant of dividend policy in 2003. The Table 4.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is lowest in


the 4th model and the results are supporting the earlier observation in the previous table (table 4.a).

The overall conclusion throws light on variables like Total asset, RONW, Quick ratio, current ratio, DPS, ROCE and cash EPS.

TABLE 4.B

Model Summary Model R R Square Adjusted R Square Std. Error of the


R Square Change

F Change

df1 df2

1 0.83688 0.7004 0.53391 0.12072 0.7003729 4.2075 10 18 2 0.83534 0.6978 0.55465 0.118 - 0.0025748 0.1547 1 18 3 0.826459933 0.9281 1 19 4 0.82236 0.6763 0.56836 0.11617 -0.0067628 0.4267 1 20

• Predictors: (Constant), EPS, log total asset, P/E, Current ratio (incl. mktgl. securities), RONW, Beta, DPS, Quick ratio, ROCE, Cash EPS

• Predictors: (Constant), EPS, log total asset, P/E, Current ratio (incl. mktgl. securities), RONW, DPS, Quick ratio, ROCE, Cash EPS

• Predictors: (Constant), EPS, log total asset, Current ratio (incl. mktgl. securities), RONW, DPS, Quick ratio, ROCE, Cash EPS

• Predictors: (Constant), EPS, log total asset, Current ratio (incl. mktgl. securities), RONW, DPS, Quick ratio, Cash EPS

TABLE 4.C



Year 2004

Table 5.a presents the correlation table of the year 2004 showing that there is very low correlation between beta, current ratio, total asset and the dependent variable dividend payout ratio. The parameters having some correlation are RONW, ROCE, P/E ratio, cash EPS, EPS and DPS, which shows that dividend payout ratio moves positive with DPS, ROCE,P/E and RONW of the firm out of which the highest correlation is with ROCE(.44 ),P/E(.58) and EPS(.64).

TABLE 5.A

Correlations

Dividend payout ratio

Beta Quick Ratio Cash EPS Current ratio (incl. mktgl. securities)

Log total asset


Pearson Correlation

Dividend payout ratio

1 -0.4 0.048 0.311 0.048 0.068 0.276 0.446 0.587 0.647 0.344


The adjusted R-square is going till 5th model as evident from table 5.b. This shows that RONW, Quick ratio, DPS, ROCE, P/E and EPS are the best determinant of dividend policy in 2004. The Table 5.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is lowest in the 4th model and the results are supporting the earlier observation in the previous table (table 5.a).

TABLE 5.B

Model Summary Model R R Square Adjusted R Square Std. Error of the Estimate Change Statistics R Square Change F Change df1 df2

1 0.896 0.802 0.692 0.095 0.802 7.294 10 18 2 0.895 0.800 0.706 0.093 -0.002 0.152 1 18 3 0.894 0.061 1 19 4 0.892 0.796 0.728 0.089 -0.004 0.359 1 20 5 0.887 0.787 0.729 0.089 -0.009 0.918 1 21 6 0.880 0.774 0.725 0.090 -0.013 1.382 1 22

• Predictors: (Constant), EPS, log total asset, P/E, Current ratio (incl. mktgl. securities), Beta, RONW, Quick ratio, DPS, ROCE, Cash EPS

• Predictors: (Constant), EPS, P/E, Current ratio (incl. mktgl. securities), Beta, RONW, Quick ratio, DPS, ROCE, Cash EPS

• Predictors: (Constant), EPS, P/E, Current ratio (incl. mktgl. securities), Beta, RONW, Quick ratio, DPS, ROCE

• Predictors: (Constant), EPS, P/E, Beta, RONW, Quick ratio, DPS, ROCE • Predictors: (Constant), EPS, P/E, RONW, Quick ratio, DPS, ROCE • Predictors: (Constant), EPS, RONW, Quick ratio, DPS, ROCE

TABLE 5.C

ANOVA Model Sum of Squares Df Mean Square F Sig.

4 Regression 0.649 7 0.09272 11.718 5.3E- 06 Residual 0.1662 21 0.007913 Total 0.8152 28

Year 2005

The correlation table (Table 6.a) of the year 2005 shows that the parameters that show some correlation are DPS and total asset, which shows that dividend payout moves positive with DPS and total asset.

TABLE 6.A


payout ratio

Quick ratio

Cash EPS

Beta Current ratio (incl. mktgl. securities)

RONW ROCE P/E DPS EPS Log total asset

Pearson Correlation


1 0.10 -0.15 -0.42 0.104 -0.26 -0.142 0.022 0.434 -0.17 0.19


It is evident from the regression table (table 6.b) that the adjusted R-square is going up till 6th model, this shows that Quick ratio, DPS, ROCE, beta and cash EPS are the best determinant of dividend policy in 2005. The Table 6.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is lowest in the 6th model and the results are supporting the earlier observation in the previous table (table 6.a). The overall conclusion throws light on variables like Quick ratio, DPS, ROCE, beta and cash EPS.

TABLE 6.B

Model Summary Mode

l R R

Square Adjusted R Square Std. Error of the


R Square Change F Change df1 df21 0.823 0.677 0.497 0.102 0.677 3.771 10 18 2 0.823 0.677 0.524 0.099 0.000 0.012 1 18 3 0.822 0.035 1 19 4 0.821 0.674 0.565 0.095 -0.002 0.143 1 20 5 0.820 0.672 0.582 0.093 -0.002 0.120 1 21 6 0.818 0.669 0.597 0.091 -0.003 0.225 1 22 7 0.804 0.647 0.588 0.092 -0.022 1.508 1 23 8 0.784 0.615 0.569 0.094 -0.032 2.168 1 24

• Predictors: (Constant), log total asset, RONW, Beta, Cash EPS, Current ratio (incl.

mktgl. securities), P/E, DPS, ROCE, Quick ratio, EPS • Predictors: (Constant), log total asset, RONW, Beta, Cash EPS, P/E, DPS, ROCE,

Quick ratio, EPS • Predictors: (Constant), log total asset, RONW, Beta, Cash EPS, P/E, DPS, ROCE,

Quick ratio • Predictors: (Constant), log total asset, Beta, Cash EPS, P/E, DPS, ROCE, Quick ratio • Predictors: (Constant), Beta, Cash EPS, P/E, DPS, ROCE, Quick ratio • Predictors: (Constant), Beta, Cash EPS, DPS, ROCE, Quick ratio g. Predictors:

(Constant), Beta, Cash EPS, DPS, ROCE • Predictors: (Constant), Cash EPS, DPS, ROCE

TABLE 6.C


6 Regression 0.388 5 0.078 9.279328 6E- 05 Residual 0.192 23 0.008 Total 0.58 28

Year 2006

Table 7.a represents the correlation table of the year 2006 showing that the parameter that depicts some correlation are P/E, DPS and total asset, out of which the highest correlation is with P/E (.61) which shows that dividend payout moves positive with DPS, P/E and total asset.


TABLE 7.A

Correlations dividend

payout ratio

Beta Quick ratio

Cash EPS

Current ratio

(incl. mktgl. securities)

log total asset


Pearson Correlation


1 - 0.292 -0.063 - 0.153 -0.092 0.041 -0.266 -0.106 0.615 0.156 - 0.165

Table 7.b shows the regression table .The adjusted R-square is going up till 5th model, this shows that Total Asset, Current ratio, DPS, ROCE, and RONW are the best determinant of dividend policy in 2006. The Table 7.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is lowest in the 5th model and the results are supporting the earlier observation in the previous table (table 7.a). The overall conclusion highlights Total Asset, Current ratio, DPS, ROCE, and RONW.

TABLE 7.B

Model Summary Model R R Square Adjusted

R Square Std.

Error of the EstimateChange Statistics

R Square Change F Change df1 df2 1 0.780 0.609 0.391 0.245 0.609 2.799 10 18 2 0.780 0.609 0.423 0.238 0.000 0.001 1 18 3 0.780 0.000 1 19 4 0.779 0.608 0.477 0.227 -0.001 0.054 1 20 5 0.775 0.601 0.492 0.224 -0.007 0.356 1 21 6 0.760 0.577 0.485 0.225 -0.024 1.313 1 22 7 0.746 0.557 0.483 0.225 -0.020 1.081 1 23

• Predictors: (Constant), EPS, log total asset, Beta, Current ratio (incl. mktgl. securities), ROCE, P/E, DPS, Quick ratio, RONW, Cash EPS

• Predictors: (Constant), log total asset, Beta, Current ratio (incl. mktgl. securities), ROCE, P/E, DPS, Quick ratio, RONW, Cash EPS

• Predictors: (Constant), log total asset, Beta, Current ratio (incl. mktgl. securities), ROCE, P/E, DPS, Quick ratio, RONW

• Predictors: (Constant), log total asset, Current ratio (incl. mktgl. securities), ROCE, P/E, DPS, Quick ratio, RONW

• Predictors: (Constant), log total asset, Current ratio (incl. mktgl. securities), ROCE, P/E, DPS, RONW

• Predictors: (Constant), log total asset, ROCE, P/E, DPS, RONW • Predictors: (Constant), log total asset, ROCE, P/E, RONW

TABLE 7.C




Year 2007

The correlation table (Table 8.a) shows that there is very low correlation between all the selected independent variables and the dependent variable dividend payout ratio. The parameters that show some correlation are P/E, DPS and total asset, out of which the highest correlation is with DPS (.20) which shows that dividend payout moves positive with DPS and total asset.

TABLE 8.A

Correlations divid

end payo ut ratio

Beta Quick Ratio

Cash EPS

Curre nt ratio

(incl. mktgl . securi ties)

log tota l asse t


Pearson Correlation


1.000 -0.35 -0.08 -0.19 -0.20 0.17 -0.40 -0.31 0.12 0.20 -0.22

It is evident from the regression table (Table 8.b) that the adjusted R-square is going up till 6th model, this shows that EPS, Beta, DPS, Cash EPS, and RONW are the best determinant of dividend policy in 2007. The Table 8.c presents the result of ANOVA analysis.

TABLE 8.B


R Square Std. Error of the


R Square Change F Change df1 df2 1 0.7308185 0.5340956 0.2752598 0.1468634 0.5340956 2.0634537 10 18 2 0.7308011 0.5340702 0.3133667 0.1429502 -2.538E- 05 0.0009807 1 18 3 0.729841795 0.0571385 1 19 4 0.7095482 0.5034587 0.3379449 0.1403684 - 0.0292104 1.2500945 1 20 5 0.7002242 0.490314 0.3513087 0.1389445 - 0.0131447 0.5559228 1 21 6 0.6896442 0.4756091 0.3616111 0.1378367 - 0.0147048 0.6347161 1 22 7 0.6709937 0.4502325 0.3586046 0.1381609 - 0.0253766 1.1130297 1 23 8 0.6275755 0.393851 0.3211132 0.1421415 - 0.0563815 2.4613227 1 24 9 0.5702847 0.3252246 0.2733188 0.1470599 - 0.0686264 2.8304276 1 25

• Predictors: (Constant), EPS, Beta, ROCE, log total asset, Quick ratio, P/E, DPS, Current ratio (incl. mktgl. securities), RONW, Cash EPS

• Predictors: (Constant), EPS, Beta, ROCE, Quick ratio, P/E, DPS, Current ratio (incl. mktgl. securities), RONW, Cash EPS

• Predictors: (Constant), EPS, Beta, Quick ratio, P/E, DPS, Current ratio (incl. mktgl. securities), RONW, Cash EPS

• Predictors: (Constant), EPS, Beta, Quick ratio, DPS, Current ratio (incl. mktgl. securities), RONW, Cash EPS

• Predictors: (Constant), EPS, Beta, Quick ratio, DPS, RONW, Cash EPS • Predictors: (Constant), EPS, Beta, DPS, RONW, Cash EPS • Predictors: (Constant), EPS, Beta, DPS, Cash EPS • Predictors: (Constant), EPS, Beta, DPS • Predictors: (Constant), EPS, DPS


TABLE 8.C


6 Regression 0.396 5.000 0.079 4.172 0.008 Residual 0.437 23.000 0.019 Total 0.833 28.000

Year 2008

The correlation table (Table 9.a) shows that the parameters that show some correlation are P/E, DPS and total asset, out of which the highest correlation is with DPS (.27) and with total asset it is (.18) which shows that dividend payout moves positive with DPS and total asset.

TABLE 9.A

Correlations dividen

d payout ratio

Quic k ratio

Beta CashEPS

Curren t ratio

(incl.mktgl. securit

ies)

log total asset

RON W

ROC E

P/E DP S

EPS

Pearson Correlation


1.00 `.05 `0.50 -0.17 -0.20 0.19 -0.27 -0.10 -0.19 0.27 -0.19

The regression table (Table 9.b) shows that the adjusted R-square is going up till 7th model. The Table 9.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is minimum in the 7th model and the results are supporting the earlier observation in the table 9.a. The overall conclusion throws light on variables like Beta, DPS, Cash EPS, and Quick ratio.

TABLE 9.B

Model Summary Model R R Square Adjusted R Square Std. Error of the Estimate Change Statistics

R Square Change F Change df1 df21 0.812 0.659 0.469 0.106 0.659 3.473 10 18 2 0.812 0.659 0.497 0.103 0.000 0.004 1 18 3 0.811 0.012 1 19 4 0.811 0.657 0.543 0.098 -0.001 0.062 1 20 5 0.810 0.656 0.563 0.096 -0.001 0.053 1 21 6 0.808 0.653 0.578 0.094 -0.003 0.193 1 22 7 0.799 0.639 0.578 0.094 -0.015 0.985 1 23 8 0.787 0.619 0.573 0.095 -0.020 1.319 1 24

• Predictors: (Constant), EPS, Beta, Current ratio (incl. mktgl. securities), log total asset, RONW, P/E, Quick ratio, DPS, ROCE, Cash EPS

• Predictors: (Constant), EPS, Beta, Current ratio (incl. mktgl. securities), log total asset, P/E, Quick ratio, DPS, ROCE, Cash EPS

• Prediictors: (Constant), EPS, Beta, Current ratio (incl. mktgl. securities), P/E, Quick ratio, DPS, ROCE, Cash EPS

• Predictors: (Constant), EPS, Beta, P/E, Quick ratio, DPS, ROCE, Cash EPS • Predictors: (Constant), EPS, Beta, P/E, Quick ratio, DPS, Cash EPS


• Predictors: (Constant), Beta, P/E, Quick ratio, DPS, Cash EPS • Predictors: (Constant), Beta, Quick ratio, DPS, Cash EPS • Prediictors: (Constant), Beta, DPS, Cash EPS

TABLE 9.C



Year 2009

The correlation table (Table 10.a) shows that the parameters that show low correlation are RONW, Cash EPS and EPS while the highest correlation is with DPS (0.47) followed by total asset (0.433) and P/E (0.33) which show that dividend payout moves positive with DPS, total asset and growth rate.

TABLE 10.A

Correlations divid

end payo ut ratio

Beta Quic k ratio

Cas h

EPS

Curre nt ratio

(incl. mktgl. securit ies)

Log total asset


Pearson Correlation


1.00 -0.49 - 0.10 0.18 -0.21 0.43 0.16 0.22 0.33 0.48 0.13

It is evident from the regression table (Table 10.b) that the adjusted R-square is going up till 4th model, this shows that Total asset, Beta, ROCE, RONW,DPS, and Cash EPS are the best determinant of dividend policy in 2009. The Table 10.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is lowest in the 4th model and the results are supporting the earlier observation in the table 10.a.

The overall conclusion throws light on variables like Total asset, Beta, ROCE, RONW, DPS, and Cash EPS.

TABLE 10.B


R Square Change F Change df1 df21 0.793 0.629 0.422 0.089 0.629 3.048 10 182 0.793 0.629 0.453 0.086 0.000 0.005 1 183 0.793 0.009 1 194 0.789 0.622 0.496 0.083 -0.006 0.349 1 205 0.773 0.597 0.487 0.083 -0.025 1.377 1 216 0.742 0.551 0.454 0.086 -0.046 2.504 1 227 0.711 0.505 0.423 0.089 -0.046 2.366 1 23

• Predictors: (Constant), EPS, Beta, Current ratio (incl. mktgl. securities), log total asset, P/E, ROCE, Quick ratio, DPS, RONW, Cash EPS

• Predictors: (Constant), EPS, Beta, Current ratio (incl. mktgl. securities), log total asset, ROCE, Quick ratio, DPS, RONW, Cash EPS


• Predictors: (Constant), Beta, log total asset, ROCE, Quick ratio, DPS, RONW, Cash EPS

• Predictors: (Constant), Beta, log total asset, ROCE, DPS, RONW, Cash EPS • Predictors: (Constant), Beta, log total asset, DPS, RONW, Cash EPS • Predictors: (Constant), Beta, log total asset, DPS, Cash EPS

TABLE 10.C



The table 11 summarizes the regression results for the Indian companies and provide some interesting insights regarding the payout behaviour of these firms. First, it is found that liquidity and profitability in the organization plays a significant role in determining the dividend policy of Indian firms, as indicated by the statistically significant values of ROCE, RONW, cash EPS, DPS and quick ratio. It is evident that the growth, systematic risk and size have the least impact on Indian firm’s dividend policy.

TABLE 11

EMPIRICAL ANALYSIS OF MULTINATIONAL COMPANIES

Year 2000

The correlation table (Table 12.a) shows that the parameters that show some correlation with DPR are P/E, RONW, ROCE and DPS, out of which the highest correlation is with ROCE (.306). This shows that dividend payout moves positive with P/E, RONW, ROCE and DPS.


TABLE 12.A

Correlations DPR beta EPS P/E Quick

ratio Cash EPS Current ratio (incl.

mktgl. securities) Log total

asset RONW ROCE DPS

Pearson Correlation

DPR 1.00 -0.005 -0.12 0.22 -0.11 -0.11 -0.064 0.07 0.276 0.306 0.217

It is evident from the regression table (Table 12.b) that the adjusted R-square is going up till 4th model; this shows that current ratio (incl. mktgl. securities), P/E, TA, beta, ronw and roce are the best determinants of dividend policy in 2000. The Table 12.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is lowest in the 4th model and the results are supporting the earlier observation in the previous table 12.a. The overall conclusion throws light on variables like current ratio (incl. mktgl. securities) P/E, TA, beta, ronw and roce.

TABLE 12.B


R Square Change F Change df1 df21 0.713 0.509 -0.376 302.750 0.509 0.575 9 5 2 0.713 0.508 -0.148 276.576 -0.001 0.007 1 5 3 0.712 0.017 1 6 4 0.711 0.505 0.134 240.168 -0.001 0.018 1 7 5 0.611 0.373 0.024 254.933 -0.132 2.141 1 8 6 0.515 0.265 -0.029 261.810 -0.108 1.547 1 9 7 0.436 0.190 -0.031 262.075 -0.075 1.022 1 108 0.352 0.124 -0.022 260.890 -0.066 0.892 1 119 0.306 0.094 0.024 254.986 -0.031 0.418 1 1210 0.000 0.000 0.000 258.101 -0.094 1.344 1 13

• Predictors: (Constant), dps, curr_ratio, pe, eps, TA, beta, ronw, casheps, roce b. Predictors: (Constant), dps, curr_ratio, pe, TA, beta, ronw, casheps, roce

• Predictors: (Constant), dps, curr_ratio, pe, TA, beta, ronw, roce d. Predictors: (Constant), curr_ratio, pe, TA, beta, ronw, roce

• Predictors: (Constant), curr_ratio, pe, TA, beta, roce • Predictors: (Constant), curr_ratio, TA, beta, roce g. Predictors: (Constant), curr_ratio,

beta, roce • Predictors: (Constant), beta, roce i. Predictors: (Constant), roce • Predictor: (constant)

TABLE 12.C




Year 2001

Table 13.a presents the correlation table of the year 2001. The parameters having correlation are beta, RONW, ROCE and P/E ratio which shows that dividend payout ratio moves positive with beta, RONW, ROCE and P/E of the firm out of which the highest correlation is with P/E (.317)

TABLE 13.A

Correlations DPR beta eps pe qr casheps curr_ratio TA ronw roce dps Pearson Correlation

DPR 1.000 0.176 -0.12 0.317 0.079 -0.062 0.098 0.046 0.187 0.236 0.032

It is evident from the regression table (Table 13.b) that the adjusted R-square is going up till 3th model; this shows that current ratio (incl. mktgl. securities), DPS, total asset, ronw, beta, casheps, quick ratio and roce are the best determinants of dividend policy in 2001.

The Table 13.c presents the result of ANOVA analysis. TABLE 13.B


R Square Change F Change df1 df21 0.975 0.951 0.827 20.093 0.951 7.694 10 4 2 0.975 0.950 0.860 18.084 -0.001 0.050 1 4 3 0.973 0.333 1 5

• Predictors: (Constant), dps, pe, curr_ratio, TA, ronw, beta, casheps, qr, roce, eps b. • Predictors: (Constant), dps, pe, curr_ratio, TA, ronw, beta, casheps, qr, roce • Predictors: (Constant), dps, curr_ratio, TA, ronw, beta, casheps, qr, roce

TABLE 13.C

ANOVAModel Sum of Squares df Mean Square F Sig.


Year 2002

Table 14.a represents the correlation table of the year 2002 showing that the only parameter that show some correlation is P/E (0.187) which shows that dividend payout moves positive with P/E.

TABLE 14.A

Correlations DPR beta eps pe qr Casheps Curr_ratio TA ronw roce dps Pearson Correlation

DPR 1 - -0.15 0.187 -0.09 -0.032 -0.053 -0.04 0.043 0.074 -0.02

0.005


It is evident from the regression table (Table 14.b) that the adjusted R-square is going up till 8th model; this shows that dps, casheps, eps are the best determinants of dividend policy in 2002. The Table 14.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is lowest in the 8th model and the results are supporting the earlier observation in the previous table 14.a. The overall conclusion throws light on variables like dps, casheps, eps

TABLE 14.B


R Square Std. Error of the Estimate Change Statistics

R Square Change F Change df1 df2 1 0.864054 0.746589 0.113062 30.32781 0.746589 1.178464 10 4 2 0.863882 0.746292 0.289618 27.1419 -0.0003 0.004686 1 4 3 0.822745393 1.367365 1 5 4 0.786282 0.61824 0.23648 28.13874 -0.05867 1.089542 1 6 5 0.774029 0.59912 0.298461 26.97245 -0.01912 0.350579 1 7 6 0.74057 0.548443 0.297578 26.98941 -0.05068 1.011319 1 8 7 0.726689 0.528078 0.339309 26.17542 -0.02037 0.40591 1 9 8 0.709167 0.502918 0.367351 25.61392 -0.02516 0.533123 1 10 9 0.609172 0.37109 0.266272 27.5843 -0.13183 2.917249 1 11

• Predictors: (Constant), dps, pe, ronw, curr_ratio, TA, casheps, beta, qr, eps, roce • Predictors: (Constant), dps, pe, curr_ratio, TA, casheps, beta, qr, eps, roce • Predictors: (Constant), dps, pe, curr_ratio, casheps, beta, qr, eps, roce d. Predictors:

(Constant), dps, curr_ratio, casheps, beta, qr, eps, roce • Predictors: (Constant), dps, curr_ratio, casheps, qr, eps, roce f. Predictors:

(Constant), dps, casheps, qr, eps, roce • Predictors: (Constant), dps, casheps, eps, roce h. Predictors: (Constant), dps, casheps,

eps • Predictors: (Constant), casheps, eps

TABLE 14.C

ANOVA Model Sum of

Squares df Mean

Square F Sig.

8

Regression

7301.536

3

2433.845

3.709719

0.045894

Residual 7216.799 11 656.0727 Total 14518.34 14

Year 2003

The correlation table (Table 15.a) shows that the parameters that depict some correlation are

RONW, P/E, ROCE and DPS which demonstrate that dividend payout ratio moves positive with RONW, P/E, ROCE and DPS of the firm.


TABLE 15.A

Correlations DPR beta eps pe qr casheps curr_ratio TA ronw roce dps

Pearson Correlation

DP R 1.00 -0.18 -0.11 0.79 -0.24 -0.04 -0.019 -0.13 0.24 0.27 0.167

It is evident from the regression table (Table 15.b) that the adjusted R-square is going up till 4th model; this shows that dps, TA, curr_ratio, ronw, casheps, roce, eps are the best determinants of dividend policy in 2003. The Table 15.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is lowest in the 4th model and the results are supporting the earlier observation in the previous table 15.a. The overall conclusion throws light on variables like DPS, TA, curr_ratio, ronw, cash EPS, ROCE, EPS

TABLE 15.B


R Square Std. Error

of the Estimate

Change Statistics

R Square Change

F Change df1 df2

1 0.974467 0.949587 0.823553 89.43692 0.949587 7.534404 10 4 2 0.974042 0.948757 0.85652 80.65013 -0.00083 0.065804 1 4

3 0.973279303 0.144867 4 0.968358 0.937718 0.875436 75.14621 -0.00955 1.087272 1 6 5 0.961045 0.923608 0.866314 77.84892 -0.01411 1.585806 1 7 6 0.957429 0.916671 0.870377 76.65699 -0.00694 0.726514 1 8 7 0.955975 0.913889 0.879444 73.92712 -0.00278 0.300452 1 9 8 0.948641 0.89992 0.872625 75.9891 -0.01397 1.622184 1 10

• Predictors: (Constant), dps, TA, pe, curr_ratio, ronw, beta, qr, casheps, roce, eps • Predictors: (Constant), dps, TA, curr_ratio, ronw, beta, qr, casheps, roce, eps • Predictors: (Constant), dps, TA, curr_ratio, ronw, qr, casheps, roce, eps d. Predictors:

(Constant), dps, TA, curr_ratio, ronw, casheps, roce, eps • Predictors: (Constant), dps, TA, ronw, casheps, roce, eps f. Predictors:

(Constant), dps, TA, casheps, roce, eps • Predictors: (Constant), dps, casheps, roce, eps h. Predictors: (Constant), dps, casheps,

eps TABLE 15.C

ANOVA Model Sum of

Squares df Mean

Square F Sig.

4 Regression 595141.3 7 85020.19 15.05594 0.000992 Residual 39528.67 7 5646.952 Total 634670 14

Year 2004

The correlation table (Table 16.a) shows that the parameters that show some correlation with DPR are P/E, RONW and ROCE out of which the highest correlation is with P/E (.667). This shows that dividend payout moves positive with P/E, RONW and ROCE.


TABLE 16.A

Correlations DPR beta eps pe qr casheps curr_ratio TA ronw roce dps Pearson Correlation

DPR 1 0.045 -0.08 0.667 -0.04 -0.062 -0.089 -0.14 0.174 0.20 -0.05

It is evident from the regression table (Table 16.b) that the adjusted R-square is going up till 5th model; this shows that qr, pe, beta, curr_ratio, casheps, eps are the best determinants of dividend policy in 2004. The Table 16.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is lowest in the 5th model and the results are supporting the earlier observation in the previous table 16.a. The overall conclusion throws light on variables like qr, pe, beta, curr_ratio, casheps, eps.

TABLE 16.B


R Square Std. Error

of the Estimate

Change Statistics

R Square Change

F Change df1 df2

1 0.988898 0.977918 0.922714 59.18214 0.977918 17.71453 10 4 2 0.988855 0.977834 0.937936 53.03454 -8.4E-05 0.015192 1 4 3 0.988496722 0.159852 1 5 4 0.987055 0.974277 0.948554 48.28556 -0.00285 0.747283 1 6 5 0.986364 0.972915 0.952601 46.34749 -0.00136 0.370687 1 7 6 0.98419 0.96863 0.951203 47.02594 -0.00428 1.265418 1 8 7 0.981902 0.964131 0.949784 47.70467 -0.0045 1.290745 1 9

• Predictors: (Constant), dps, qr, TA, pe, ronw, beta, curr_ratio, casheps, roce, eps • Predictors: (Constant), dps, qr, TA, pe, beta, curr_ratio, casheps, roce, eps • Prediictors: (Constant), dps, qr, pe, beta, curr_ratio, casheps, roce, eps • Predictors: (Constant), qr, pe, beta, curr_ratio, casheps, roce, eps • Predictors: (Constant), qr, pe, beta, curr_ratio, casheps, eps • Predictors: (Constant), qr, pe, beta, casheps, eps • Predictors: (Constant), qr, pe, casheps, eps

TABLE 16.C

ANOVA Model Sum of

Squares df Mean

Square F Sig.

5

Regression

617281.347

6

102880.225

47.893809

0.000007727

Residual 17184.7221 8 2148.09026 Total 634466.069 14

Year 2005

The correlation table (Table 17.b) shows that the parameters that depict some positive correlation are cash EPS, P/E, RONW and ROCE, which demonstrate that dividend payout moves positive with these profitability ratio but the correlation is weak.


TABLE 17.A

Correlations DP

R beta eps pe qr cashep

s curr_rati

o TA ronw roce dps

Pearson Correlatio n

DP R

1

- 0.01

1

- 0.23

6

0.20

8

- 0.11

2

0.047

-0.134

- 0.21

5

0.06

8

0.10

6

- 0.03

1

It is evident from the regression table (table 17.b) that the adjusted R-square is going up till 5th model, this shows that Total Asset, P/E,RONW,ROCE,EPS and cash EPS are the best determinant of dividend policy in 2005. The Table 17.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is minimum in the 5th model and the results are supporting the earlier observation in the previous table (table 17.a).The overall conclusion throws light on variables like Total Asset, P/E,RONW, EPS and cash EPS.

TABLE 17.B


R Square Std. Error

of the Estimate

Change Statistics

R Square Change

F Change df1 df2

1 0.9725122 0.9457801 0.8102303 92.741484 0.9457801 6.9773613 10 4 2 0.9724627 0.9456837 0.8479143 83.024215 -9.64E-05 0.007112 1 4 3 0.971925027 0.0962335 1 5 4 0.9714785 0.9437706 0.8875411 71.3933 -0.0008677 0.0940404 1 6 5 0.9707566 0.9423683 0.8991445 67.609903 -0.0014023 0.174567 1 7 6 0.9587344 0.9191717 0.8742672 75.489218 -0.0231966 3.2199709 1 8 7 0.9522977 0.9068709 0.8696193 76.871826 -0.0123008 1.3696607 1 9 8 0.9400051 0.8836095 0.8518666 81.938309 -0.0232614 2.497763 1 10 9 0.9269215 0.8591835 0.8357141 86.290034 -0.0244259 2.3084825 1 11

• Predictors: (Constant), dps, TA, pe, casheps, curr_ratio, beta, ronw, qr, eps, roce • Predictors: (Constant), dps, TA, pe, casheps, curr_ratio, beta, ronw, eps, roce • Predicitors: (Constant), dps, TA, pe, casheps, curr_ratio, ronw, eps, roce • Predictors: (Constant), TA, pe, casheps, curr_ratio, ronw, eps, roce • Predictors: (Constant), TA, pe, casheps, ronw, eps, roce • Predictors: (Constant), pe, casheps, ronw, eps, roce • Predictors: (Constant), pe, casheps, eps, roce • Predictors: (Constant), pe, casheps, eps • Predictors: (Constant), casheps, eps

TABLE 17.C

ANOVA Model Sum of

Squares df Mean

Square F Sig.



Year 2006

The correlation table (table 18.a) shows that the parameters that depict some positive correlation are Quick ratio, RONW and ROCE, which demonstrate that dividend payout moves positive with these profitability ratio but the correlation is weak.

TABLE 18.A

Correlations DPR beta eps pe Qr casheps curr_ratio TA ronw roce dps Pearson Correlation

DPR 1 0.044 -0.26 -0.04 0.015 -0.056 0.006 -0.23 0.070 0.094 -0.07

The regression table (table 18.b) shows that the adjusted R-square is going up till 9th model, this shows that EPS and cash EPS are the best determinant of dividend policy in 2006. The Table

18.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is minimum in the 9th model and the results are supporting the earlier observation in the previous table (table 18.a).The overall conclusion throws light on variables like EPS and cash EPS.

TABLE 18.B


R Square Std. Error

of the Estimate

Change Statistics

R Square Change

F Change df1 df2

1 0.8369929 0.7005572 0.0480498 217.96853 0.7005572 0.9358144 10 4 2 0.836015 0.698921 0.1569789 195.48888 -0.0016362 0.0218561 1 4 3 0.83205581 0.1096749 1 5 4 0.8041412 0.6466431 0.2932862 178.98828 0.0456737 0.8906646 1 6 5 0.7743067 0.5995508 0.2992139 178.23606 -0.0470923 0.932899 1 7 6 0.7518391 0.565262 0.3237409 175.08922 0.0342888 0.6850066 1 8 7 0.7239641 0.524124 0.3337736 173.78559 -0.041138 0.8516443 1 9 8 0.6942358 0.4819634 0.3406807 172.88238 0.0421606 0.8859575 1 10 9 0.6670314 0.4449309 0.3524194 171.33645 0.0370325 0.7863491 1 11

• Predictors: (Constant), dps, TA, curr_ratio, casheps, ronw, beta, qr, pe, eps, roce • Predictors: (Constant), dps, TA, curr_ratio, casheps, ronw, qr, pe, eps, roce • Predictors: (Constant), dps, TA, curr_ratio, casheps, ronw, pe, eps, roce • Predictors: (Constant), dps, curr_ratio, casheps, ronw, pe, eps, roce • Predictors: (Constant), curr_ratio, casheps, ronw, pe, eps, roce • Predictors: (Constant), casheps, ronw, pe, eps, roce • Predictors: (Constant), casheps, ronw, eps, roce h. Predictors: (Constant), casheps,

eps, roce • Predictors: (Constant), casheps, eps


TABLE 18.C



Year 2007

The correlation table (19.a) shows that the parameters that exhibit some positive correlation are Cash EPS, P/E and Quick ratio which shows that dividend payout moves positive with these profitability ratio but the correlation is weak. With other variables the correlation is negative.

TABLE 19.A


Pearson Correlation

DPR 1 0.168 -0.28 0.004 0.05 0.042 0.010 -0.23 -0.05 -0.03 -0.07

It is evident from the regression table (table 19.b) that the adjusted R-square is going up till 2nd model, this shows that besides EPS,P/E, RONW and cash EPS, DPS and Current ratio are also the best determinant of dividend policy in 2007. The Table 19.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is minimum in the 2nd model and the results are supporting the earlier observation in the previous table 19.a. The overall conclusion throws light on variables like DPS, RONW,ROCE,,p/e, EPS, beta, current ratio, total asset and cash EPS.

TABLE 19.B


R Square Std.

Error of the Estimate

Change Statistics

R Square Change

F Change

df1 df2

1 0.956618 0.915117 0.70291 126.6032 0.915117 4.312372 10 4 2 0.956445 0.914786 0.761402 113.4576 -0.00033 0.015577 1 4 3 0.941204 0.885865 0.733684 119.8668 -0.02892 1.697019 1 5 4 0.930199 0.86527 0.730541 120.5722 -0.02059 1.082632 1 6 5 0.91612 0.839276 0.718733 123.1855 -0.02599 1.35055 1 7

• Predictors: (Constant), dps, TA, ronw, pe, casheps, qr, beta, curr_ratio, eps, roce • Predictors: (Constant), dps, TA, ronw, pe, casheps, beta, curr_ratio, eps, roce • Predictors: (Constant), dps, TA, ronw, pe, casheps, curr_ratio, eps, roce • Predictors: (Constant), dps, TA, ronw, pe, casheps, eps, roce • Predictors: (Constant), dps, ronw, pe, casheps, eps, roce


TABLE 19.C



Year 2008

The correlation table 20.a shows that the only ratio that shows very high positive correlation is P/E which exhibit that dividend payout moves positive with this profitability ratio

TABLE 20.A

Correlations DPR beta eps pe qr casheps curr_ratio TA ronw roce dps arson Correlation

DPR 1 0.21 -0.23 0.36 0.00 0.04 -0.05 -0.23 0.07 0.09 0.02

It is evident from the regression table (table 20.b) that the adjusted R-square is going up till 5th model, this shows that besides EPS,P/E, ROCE and cash EPS, DPS and Current ratio are also the best determinant of dividend policy in 2008. The Table 20.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is minimum in the 5th model and the results are supporting the earlier observation in the previous table (table 20.a). The overall conclusion throws light on variables like DPS, P/E, beta, EPS,current ratio and cash EPS.

TABLE 20.B


R Square Std. Error

of the Estimate

Change Statistics

R Square Change

F Change df1 df2

1 0.9808235 0.9620147 0.8670514 131.76303 0.9620147 10.130389 10 4 2 0.9807275 0.9618264 0.893114 118.14415 -0.0001883 0.0198266 1 4 3 0.980599765 0.0328133 1 5 4 0.9804779 0.961337 0.922674 100.4881 -0.0002389 .037308 1 6 5 0.9803888 0.9611621 0.9320337 94.210319 -0.0001748 0.0316562 1 7 6 0.9725126 0.9457808 0.9156591 104.94722 0.0153813 3.1683088 1 8 7 0.969848 0.9406052 0.9168473 104.20535 -0.0051756 0.8591214 1 9 8 0.9671257 0.9353321 0.9176954 103.67254 -0.0052731 0.8877984 1 10

• Predictors: (Constant), dps, ronw, TA, pe, casheps, qr, beta, eps, roce, curr_ratio • Predictors: (Constant), dps, ronw, pe, casheps, qr, beta, eps, roce, curr_ratio • Predictors: (Constant), dps, ronw, pe, casheps, beta, eps, roce, curr_ratio • Predictors: (Constant), dps, pe, casheps, beta, eps, roce, curr_ratio • Predictors: (Constant), dps, pe, casheps, beta, eps, curr_ratio • Predictors: (Constant), dps, casheps, beta, eps, curr_ratio • Predictors: (Constant), dps, casheps, eps, curr_ratio • Predictors: (Constant), dps, casheps, eps


TABLE 20.C

ANOVA Model Sum of

Squares df Mean

Square F Sig.

5 Regression 1757228.4 6 292871.39 32.997421 0.0000320417 Residual 71004.674 8 8875.5843 Total 1828233 14

Year 2009

The correlation table (table 21.a) of the year 2009 shows that the only ratio that shows very high positive correlation is P/E which demonstrate that dividend payout moves positive with this profitability ratio. Other variables like ROCE, EPS and Quick Ratio show a very weak correlation

TABLE 21.A


Pearson Correlation

DPR 1 0.23 0.25 0.86 0.09 1.00 0.01 -0.28

0.04 0.04 0.02

It is evident from the regression table (table 21.b) that the adjusted R-square is going up till 4th model, this shows that besides EPS,P/E, ROCE and cash EPS, DPS and Total Assets are also the best determinant of dividend policy in 2008. The Table 21.c presents the result of ANOVA analysis. The F-statistics shows that the value of the residual is minimum in the 5th model and the results are supporting the earlier observation in the previous table (table 21.a).The overall conclusion throws light on variables like P/E, DPS, total asset, beta, ROCE, EPS and cash EPS.

TABLE 21.B


R Square Std. Error

of the Estimate

Change Statistics

R Square Change F Change df1 df2 1 0.9999994 0.9999988 0.9999959 0.7851509 0.9999988 340478.96 10 4 2 0.9999994 0.9999988 0.9999967 0.7076961 -1.826E-08 0.062163 1 4 3 0.9999993 0.9999987 0.9999969 0.6773823 -1.186E-07 0.4969953 1 5 4 0.9999992 0.9999983 0.9999967 0.7076432 -3.584E-07 1.6393965 1 6 5 0.999999 0.999998 0.9999965 0.7284954 -3.527E-07 1.4784185 1 7 6 0.9999988 0.9999975 0.9999962 0.7578771 -4.401E-07 1.7406172 1 8

• Predictors: (Constant), dps, casheps, curr_ratio, TA, ronw, eps, beta, pe, qr, roce • Predictors: (Constant), dps, casheps, curr_ratio, TA, eps, beta, pe, qr, roce • Predictors: (Constant), dps, casheps, curr_ratio, TA, eps, beta, pe, roce • Predictors: (Constant), dps, casheps, TA, eps, beta, pe, roce • Predictors: (Constant), dps, casheps, TA, eps, beta, roce • Predictors: (Constant), dps, casheps, eps, beta, roce


TABLE 21.C

ANOVA Model Sum of

Squares Df Mean

Square F Sig.


The table 22 summarizes the regression results for the multinational companies and provide some interesting insights regarding the payout behaviour of these firms. First, it is found that besides profitability and liquidity playing important role in the case of Indian companies, growth rate and size of business also plays a key role in Multinational companies as indicated by the statistically significant values of ROCE, cash EPS, EPS, P/E ratio, DPS and total asset. It is evident that the systematic risk has the least impact on multinational firm’s dividend policy.

TABLE 22

CONCLUSION & SUMMARY

In summary, this paper develops a model to explain dividend payout ratios of Indian and multinational firms. Several variables explaining liquidity, size, growth, systematic risk and profitability are utilized as possible determinants of dividend policy. The empirical research in this paper focused on the time period 1999-2000 to 2008-09. Based on a sample of 44 BSE A group firms listed on Bombay Stock Exchange, the empirical evidence shows that these companies have paid constant dividend throughout the study period and follows stable dividend policies. This can be confirmed from the statistical significance of DPS in most of the years covered under study.

Further, the paper investigates if any of these determinants differ between Indian and multinational firms. The usual statistical tests are carried out and the multiple regression analysis indicates that the EPS and liquidity ratios are significant. It is also found that whereas Indian firms value profitability and liquidity while deciding their Dividend payout, Multinational firms value size and growth rate as well. One thing common in both the sample


companies are that systematic risk is the least impacting factor in deciding the dividend policy of the companies as indicated by the insignificant value of beta.

The main conclusions of the paper are that a firm's dividend policy will depend upon various factors. One of which is that Profitable firms are more likely to support high dividend payments to shareholders. More importantly, however, some of the determinants of dividend policy are different for Indian and multinational firms. It shows that profitability and liquidity of the firm are highly influencing factors in determining the dividend policies of Indian companies whereas in multinational companies size and growth also play a key role in a firm's payout ratio. These can be the guiding factors for other firms framing their dividend policy. REFERENCES [1] Akhigbe, Aigbe, Stephen F. Borde, and Jeff Madura, "Dividend Policy and Signaling by Insurance

Companies", The Journal of Risk and Insurance, vol. 60, September 1993. [2] Baker, M. and J. Wurgler [2003], “Appearing and Disappearing Dividends: The Link to Catering Incentives”,

NBER Working Paper Series. [3] Bhat, R. and I. M. Pandey [1994], “Dividend decision: A Study of Managers' Perceptions”, Decision 21. [4] Collins, M. Cary, Atul K. Saxena, and James W. Wansley, "The Role of Insiders and Dividend Policy: A

Comparison of Regulated and Unregulated Firms", Journal of Financial and Strategic Decisions. [5] Fama, E. F. [1974], “The Empirical Relationship between the Dividend and Investment Decisions of Firms”,

The American Economic Review. [6] Gorden, M. J. [1959], “Dividends, Earnings, and Stock Prices”, Review of Economics and Statistics 41. [7] Gugler, K. [2003], “Corporate governance, dividend payout policy, and the interrelation between dividends,

R&D, and capital investment”, The Journal of Banking and Finance. [8] Gugler, K. and B. B. Yurtoglu [2003], “Corporate governance and dividend pay-out policy in Germany”,

European Economic Review. [9] Linter, J. [1956], “Distribution of incomes of corporations among dividends, retained earnings and taxes”,

The American Economic Review. [10] Mahapatra, R. P. and P. K. Sahu [1993], “A Note on Determinants of Corporate Dividend Behavior in India -

An Econometric Analysis”. [11] Miller, Merton, and Franco Modigliani [1961], "Dividend Policy, Growth and the aluation of Shares," Journal

of Business, vol. 34. [12] Twaijry, Abdulrahman Ali [2007], “Dividend policy and payout ratio: evidence from the Kuala Lumpur stock

exchange”, Journal of Risk Finance, vol. 8. [13] Bebczuk R. (2005)," Corporate governance and ownership: measurement and impact on corporate

performance and dividend policies in Argentina", Center for Financial Stability, Working Paper.


ANNEXURE

Sample of Indian Companies TABLE 1

Sr. No. Indian Company Name 1 Reliance Industries Ltd. 2 Oil & Natural Gas Corpn.Ltd. 3 Infosys Technologies Ltd. 4 Bharat Heavy Electricals Ltd. 5 I T C Ltd. 6 Wipro Ltd. 7 Steel Authority Of India Ltd. 8 Indian Oil Corpn. Ltd. 9 Jindal Steel & Power Ltd. 10 G A I L (India) Ltd. 11 Tata Steel Ltd. 12 Hindustan Zinc Ltd. 13 Hindustan Copper Ltd. 14 Tata Motors Ltd. 15 Sun Pharmaceutical Inds.Ltd. 16 Adani Enterprises Ltd. 17 Mahindra & Mahindra Ltd. 18 Tata Power Co. Ltd. 19 Sesa Goa Ltd. 20 Hindalco Industries Ltd. 21 National Aluminium Co.Ltd. 22 Cipla Ltd. 23 Neyveli Lignite Corpn. Ltd. 24 Reliance Infrastructure Ltd. 25 Grasim Industries Ltd. 26 Dr. Reddy'S LaboratoriesLtd. 27 Unitech Ltd. 28 Ranbaxy Laboratories Ltd. 29 Reliance Capital Ltd.

Sample of Multinational Companies TABLE 2

Sr. No. Multinational Company Name1 Hindustan Unilever Ltd. 2 Nestle India Ltd. 3 Siemens Ltd. 4 A B B Ltd. 5 Bosch Ltd. 6 Glaxosmithkline Pharmaceuticals Ltd.7 Cummins India Ltd. 8 Colgate-Palmolive (India) Ltd.9 Castrol India Ltd. 10 Glenmark Pharmaceuticals Ltd.11 Areva T & D India Ltd. 12 Glaxosmithkline Consumer Healthcare Ltd.13 Procter & Gamble Hygiene & Health CareLtd.14 Alstom Projects India Ltd.15 Rolta India Ltd.

Dividend Policy of Indian Multinationals

Dr. Manisha Panwala*

Abstract—The companies of the world follow different types of dividend structures. A company's dividends may be declared quarterly, bi-annually or annually. Companies may pay dividends in the form of checks, stocks, property, or in some other form, dependent upon the company's policy. The dividend per share to be paid by the company is determined by the amount of profit earned in that fiscal year. The paper focuses to analyze the influence of various factors on dividend policy of Indian multinational firms. The data for the study is secondary and correlation is used to analyze the data. The analysis reveals that the dividend of the companies mostly dependent on the net income of that company except Mahindra. There is no significant relation between the liquidity position and dividend payment of the company. The macro economic factor, that is, GDP also do not have any significant influence on the companies’ dividend policy.

Keywords: Multinational Companies, Dividend Policy, Net Income, Owners Fund

INTRODUCTION

When a company earns a profit, it pays a certain amount of the profit to its shareholders, in the form of dividends. The companies of the world follow different types of dividend structures. A company's dividends may be declared quarterly, bi-annually or annually. Companies may pay dividends in the form of cheques, stocks, property, or in some other form, dependent upon the company's policy.

When a company earns a profit, it has two options for implementing it. They are the following:

• Re-investment of the profit into business operations, which is also known as, retained earnings paying dividends to the shareholders of the company.

• A large number of companies keep aside a part of the profits earned by them, the remainder distributed as dividends..

Normally, public companies make the payment of dividends on a specified schedule. Nevertheless, they have the discretion to declare a dividend at any point in time, hence, the special dividend.

If a company has suffered a loss, it still has the option to pay dividends out of retained earnings made during earlier years or cancel the dividend.

SEBI Guidelines on Dividend Policy

SEBI has fine-tuned guidelines on dividend payments, bonus issue, IPOs and preferential allotment of warrants. Mandating that listed companies should declare dividend only on per-share basis. SEBI has also decided to reduce the period for completing a bonus issue to 15 days, where no shareholders’ approval is required as per Articles of Association of the *Veer Narmad South Gujarat University, Gujarat


company and to 60 days where shareholders’ approval is required. SEBI has also reduced the timeline for notice period for payment of dividend. The notice period for record date has been reduced to seven working days and for board meetings has been reduced to two working days.

Corporate Income Tax

Dividend distribution tax: Arguably the most notable fiscal measure for Belgian investors is in relation to the Indian dividend distribution tax. Dividends distributed by Indian companies to their shareholders are in principle subject to a dividend distribution tax of 16.955% (15% tax increased by the 3% education cess and 10% surcharge). The new fiscal measure allows the Indian parent company to offset dividends received from its Indian subsidiary against dividends distributed by the parent when computing the dividend distribution tax liability. This means that the 16.995% dividend distribution tax will solely be due on the difference between the dividends distributed by the parent itself and the dividends received from its subsidiary.

However, in order to benefit from the dividend distribution tax credit, there are several conditions to be met:

• The Indian parent company must hold more than 50% of the nominal value of the equity share capital of the Indian subsidiary;

• The Indian subsidiary must have paid dividend distribution tax on the dividends distributed to the Indian parent; and

• The Indian parent may not be a subsidiary of any other company (i.e. any other company may not own more than 50% of the shares of the Indian parent company).

Corporate income tax rate: Indian companies are taxable on their worldwide income at a corporate tax rate of 30% increased by 3% education cess, plus a 10% surcharge if the taxable income exceeds 10 million Indian Rupees (INR). For branches of foreign companies, the corporate tax rate is 40% increased by 3% education cess, while the surcharge is 2.5%. Effective tax rates for company with Indian company Branch of foreign company Taxable income not exceeding 10 million INR 30.9% 41.2% Taxable income exceeding 10 million INR 33.99% 42.2%

(Using an average approximate exchange rate for 1/1/2008-30/05/2008 of 61.5 INR to the euro, 10 million INR is about 162,600 EUR.)

So far, a subsidiary used to pay DDT on the dividend it distributed and on the same dividend, the parent company again paid DDT. This is because the dividend received from a subsidiary company is included in the total dividend income on which a parent firm has to pay DDT. There was no mechanism for getting credit for the DDT already paid.

Factors Affecting Dividend Policy of Indian Multinationals

The main purpose of this study is to analyze the companies’ behaviour of dividend payout as a reaction to changes in various factors for emergent markets, with a study case of Indian Multinationals.

Dividend Policy of Indian Multinationals 163

In fact, based on dividend payout, the behaviour of listed companies can be distinguished relative to consumption or to investments. Thus, a higher dividend ratio can be translated as a decision oriented to consumption. On the other hand, a lower dividend ratio can be explained by a preference for future economic growth, taking into consideration not only tangible and intangible assets, but also investments in human resources. Dividend Payout Policy remains one of the main issues in Corporate Finance.


Research Question

• What is the influence of various factors on dividend policy of Indian Multinational Firms?

Research Objectives

The purpose of the study is:

• To analyze the influence of various factors (dividend payment, net income, owners funds, fixed assets turnover ratio, total debt / equity, current ratio and GDP) on dividend policy of Indian multinational firms.

Variables for the Study

The key variables for dividend policies of the study are as follows: Variables Description Dividend payment Dividend Per Share paid by companies Net Income Reported net profit before preference dividend payment Owners funds Owners fund as % of total source Fixed assets turnover ratio

FA Turnover = Total debt/equity

TD/Equity = Current Ratio

CR = GDP GDP real growth rate (%)

Data Collection and Analysis

The data for the study is secondary and the various ratios are calculated for the study. For the analysis of the data the statistical measures like correlation is used to find out how various variables are related with dividend payment of company. The companies selected are: (1) Asian Paints Ltd. (2) Mahindra & Mahindra Ltd. (3) Infosys Technologies Ltd and (4) Videocon Industries Ltd.


Data Analysis

Asian Paints Ltd

Descriptive Statistics Mean Std. Deviation

Dividend 13.9000 3.34290 Net Income 273.9740 94.55729 Owners fund as % of total source 90.6740 2.70794 Fixed Asset turnover 3.6800 .46519 Total Debts to Equity .0980 .03421 Current Ratio 1.1280 .07981 GDP 8.4800 .96540

Correlations Dividend Net

Income Owners fund as

% of total sourceFixed Asset

turnover Total Debts

to Equity Current

Ratio GDP

Dividend Pearson Correlation

1 .947(*) .740 .947(*) -.735 -.315 -.055

Sig. (2-tailed) .014 .153 .015 .157 .606 .930 N 5 5 5 5 5 5 5

* Correlation is significant at the 0.05 level (2-tailed).

Dividend payment of Asian Paints is highly related with its net income that is positively related. With increase in net income the dividend also increases. Dividend is also positively related with owners fund and fixed asset turnover. But it is negatively related with total debts to equity, current ratio and GDP. The dividend payment for Asian paints is highly dependent on its net income.

MAHINDRA & MAHINDRA LTD.

Descriptive Statistics Mean Std. Deviation N

Dividend 11.2000 1.25499 5 NI 876.4580 235.73119 5 Owners fund as % of total source 65.8940 7.47283 5 Fixed Asset turnover 2.9060 .29569 5 Total Debts to Equity .5280 .17254 5 Current Ratio 1.1920 .12235 5 GDP 8.4800 .96540 5

Correlations Dividend NI Owners fund as %

of total source Fixed Asset

turnover Total Debts to Equity

Current Ratio

GDP


1 -.391 -.063 -.327 -.038 .200 -.378

Sig. (2-tailed) .515 .920 .591 .952 .747 .531 N 5 5 5 5 5 5 5

**Correlation is significant at the 0.01 level (2-tailed).

Dividend Policy of Indian Multinationals 165

For Mahindra the dividend is negatively related with its net income. It is also negatively related with fixed assets turnover and total debts to equity. It is partially related with current ratio.

Infosys Technologies Ltd.


Dividend 24.9500 14.44645 5 NI 3677.3580 1577.88955 5 Owners fund as % of total source 100.0000 .00000 5 Fixed Asset turnover 3.3240 .12740 5 Total Debts to Equity . . 0 Current Ratio 3.6320 .95910 5 GDP 8.4800 .96540 5

Correlations Dividend NI Owners fund as

% of total source

Fixed Asset turnover

Total Debts to Equity

Current Ratio

GDP


1 .009 .(a) -.116 .(a) -.430 .608

Sig. (2-tailed) .988 . .852 . .470 .277 N 5 5 5 5 0 5 5

*(a)Cannot be computed because at least one of the variables is constant.

There is 100% owners fund in Infosys, so the total debt to equity ratio is zero. Dividend is negatively related with fixed asset turnover but it is partially determined from GDP.

Videocon Industries Ltd.


Dividend 2.1000 1.55724 5 Net Income 505.8140 371.12338 5 Owners fund as % of total source 39.0620 21.64050 5 Fixed Asset turnover .8520 .40071 5 Total Debts to Equity .8520 .49852 5 Current Ratio 3.8240 1.50264 5 GDP 8.4800 .96540 5

Correlations Dividend Net

Income Owners fund as % of total

source

Fixed Asset turnover

Total Debts to Equity

Current Ratio

GDP


1 .491 .769 .703 .676 .316 .775

Sig. (2-tailed) .401 .129 .186 .210 .604 .124 N 5 5 5 5 5 5 5

Dividend in Videocon is affected by all the factors as it is positively related with all factors.


CONCLUSION

The analysis reveals that dividend payment of Asian Paints is highly related with its net income. With the increase in net income the dividend also increases. Dividend is also positively related with owners fund and fixed asset turnover. But it is negatively related with total debts to equity, current ratio and GDP. The dividend of the companies mostly dependents on the net income of the company except Mahindra. Dividend in Videocon is affected by all the factors as it is positively related with all the factors. There is no significant relation between the liquidity position and dividend payment of the company. The macro economic factor, that is, GDP also do not have any significant influence on the companies’ dividend policy. REFERENCES [1] http://money.rediff.com/companies/videocon-industries-ltd [2] http://money.rediff.com/companies/infosys-technologies-ltd [3] http://money.rediff.com/companies/mahindra-and-mahindra-ltd [4] http://money.rediff.com/companies/asian-paints-ltd

Track 3 Corporate Governance

Tax Avoidance and Evasion: Issues within Corporate Governance

Ashutosh Singh* and Pankaj Shah**

Abstract—Purpose: Corporate crimes are the planed activates in which some of the smartest minds around the world work to accomplish the malpractices. The intention behind this research to identify relationship among corporate governance and taxation. In corporate crimes around the world organization heads enjoyed the savings and pension funds of the investors. And at the end of the day they were behind the bars and the companies were liquidated.

Methodology: Exploratory based laboratory research observation & analysis is used as a method of research. The data is investigated from various books and research publications.

Findings: This research work concentrates on one of the burning issues of the corporate governance. Taxation is the issue which is very much ignored and it was known as the matter of technical experts with in the organization. But in the current scenario taxation is not just the matter of board room. As there are various corporate crime cases in which CG rules and regulations are violated by contravening tax regulation. This research introduces readers to role of taxation under practices of CG.

INTRODUCTION

For top managers running a business organization is like formula one car racing where some time drivers take a huge risk to come in the top ranking. In business these risks are the aggressive strategies where one wrong step becomes the question of life and death. The world corporate history is full of biographies of such drivers. Some of them lost everything and some of them become legends.

Whether it’s walking on the street or driving, we expose ourselves to risk. It depends on the personality of the person that how much risk he takes in his life time. Globalization of business has not just provided not just granted a new lot of customers, intellectual staff and global presence. Various kinds of risks in the business were also some of the uninvited guests in the party. Scholars classified the risks in various parts like financial risk, business risk, credit or default risk, country risk, interest rate risk, political risk, market risk, foreign exchange risk and many more.

Taxes are the compulsory payments for individuals and multinationals. Taxes play a vital role in the economy. Proper procurement of taxes is the foundation of good governance. It’s been a longtime people try to save the money instead of paying taxes. To avoid or evade taxes companies hire lawyers, accountants for that. Anyone can get into serious trouble for avoiding or evading taxes. This becomes a riskier situation when someone caught red-handed while evading taxes. It harms the reputation and various other problems for the accuse person or company. *Amrapali Institute, Haldwani **GRD Academy, Dehradun


Corrupt practices by the board members make the situations riskier for the investors. Tax evasion is one of the traditional malpractices. Managing or making ourselves safe from risk is there in our subconscious behavior which guides us in searching the best possible options every time (Fiscalis Risk Analysis Project Group, 2006). For sake of protecting stakeholders interest organizations across the world try hard. But when there is one rule there are 100 ways to violate it too. This research discussion about the risk of stakeholders interests from tax evasion and the corporate governance practices with in various organizations to make the work transparent.

Legal obligations are essentials for preventing corporate crimes. But this is not enough as we have seen scandals in the recent past. The punishments are not enough for corporate crimes. Self regulations in the companies should be obligatory (Prasad, 2006). The recent financial crisis and the failure of various organizations around the world made it clear the appetite of risk and getting more profit were the main causes behind it. Aggressive tax strategies have made the things worst. Taxes are one of the biggest items on the income statements of organizations. There management and planning is a critical component in terms of corporate governance. But tax risk from an organizational point of view - and the role of tax in good corporate governance - has not featured as prominently as government interventions (Oupa Magashula, September 27, 2010).

In the current age of globalization as the technology is changing the world so fast. From needle to yacht everything can be purchased by a simple mouse click and the funds can get transfer from one part of the world to another in a single minute. Tax havens emerged as a favorite destination for corporate managers to save the hard earned money no matter from what way. Tax havens have allowed multinational companies, rich individuals, corrupt leaders, criminals and terrorists to keep their wealth away from the prying eyes of national tax authorities. In the words of one tax expert, ‘I have never come across any reason for people to set up an offshore business in a tax haven other than to avoid tax (The Times, 10 July 2000).

This research work is divided in three major parts, the survey of prior research examine the basics of Tax risk, Tax evasion and avoidance, Corporate governance & Relationship between Taxation and Corporate Governance. The analysis part covers the ticks and tactics which the corporations use to avoid and evade the taxes, the tax havens and how Enron used the tax havens for evading the taxes.

OBJECTIVES OF THE STUDY

Objectives behind this study are as follows:

• To examine the relationship between taxation and corporate governance. • To make aware to the stakeholders about the corporate crimes related to tax

avoidance and evasion. • To examine the criminal activities related to tax avoidance and evasion in the past and

the rules and regulations made by various institutions in respect to avoid them in future.

Tax Avoidance and Evasion: Issues within Corporate Governance 171

SURVEY OF PRIOR RESEARCH

Tax Risk

Risks are unseen phenomenon that arises from the conditions; the possible outcomes are identifiable and even time of occurrence without being sure which will actually occur (E.J. McLaney, 2001). These are the chances of future losses that can be predicted (Jhon J. Hampton, 2001).Tax risk is an adverse fiscal incidence. It includes unexpected tax liabilities, unavailability of tax relief etc. the results of such risk can be damage of reputation at large scale (Robin Godman, March 2006). Daniel N. Erasmus II, October 2009 defined and classified tax risk as external and internal tax risks. The External Tax Risk occurs due to changes in legislative regulations. Internal Risks are transactional risks, operational risks, compliance risks, financial accounting risk, portfolio risk, management of tax risk and reputational risk. These are discussed in International KPMG Survey in tax risk management they are as follows-

Risk Type Nature General Risk Compliance Risk Technical or factual errors Miscoding of expenditures Late submission of returns Late payment of taxes Poor presentation of tax panning Planning Risk Failure to plan Technical imperfection of planning Excessively aggressive planning Failure in implementing plans Accounting Risk Incorrect recognition of tax liability Transaction Risk Technical Risk Error in technical treatments of risk Accounting Risk Tax analysis depending upon accounting treatment Change in law It affects the transactions before maturity, break even point or required rate of return. Administrative Transactions not been made, or not correct, tax return not been made Operational tax risk Performance of groups in the organization, allocation of income and expenses and

transfer pricing issues. Portfolio risk Pattern of taxes to be paid, Management risk Systematic and effective management of various tax risks Reputational tax risk When a negative image of the organization get created in the eyes of public,

shareholders, investors and analysts.

The tax risk management involves three aspects-

• Building a suitable tax risk policy and the acceptable level of risk • Current risk position. • Controlling, communication and monitoring procedures.

Tax Evasion and Avoidance

Corporate managers try to solve the problem of risk via reduction, avoidance, control and transfer of risk. An aggressive tax strategy like avoidance and evasion may lead to risks apart from penalties and other direct consequences like misallocation of corporate resources, loss of auditor’s independence, (Wolfgang Schön, April 28, 2008). For managing tax instead of


avoidance CFOs prefer evasion. It crafts jeopardy for the institutions goodwill. It is cauterized as reputation risk under tax risk is one which affects the goodwill of an organization.

Tax evasion is one of the most common economic crimes from the time when taxation has been started. It is an illegal intentional act by which a taxpayer evades the payment of his statutory dues. Firms evade there taxes by underreporting sales, income and wealth, by overstating deductions, exemptions and credits or by failing to file appropriate tax return (Jorge Martinez-Vazquez and James Alm, May 2003). Some times tax avoidance also termed as same as evasion but both of them are different, the complexity of tax laws makes it difficult to distinguish between fraudulent and aggressive tax planning (David O. Friedrichs, 2010). Avoidance is legitimate while evasion is a fraud activity by falsification in accounts (Sum Yee Loong, 2009). Evading taxes is a corporate crime and have serious consequences for the society and the citizenry because they allow the corporations to raise there profits, lesson their tax burdens and at the same time underpay there employees (Richard D. Hartley, 03/2008).

Corporate Governance (CG)

Manipulation with accounting records, hiding them from the stakeholders is a serious issue for the corporate governance. The corporate collapse in the year 1970/80 of Rolls Royce, Leyland and corporate scandals questioned the managerial excellence. The stock exchange has commissioned the Adrian Cadbury and his committee to check the financial aspects of the corporate governance. But the companies like WorldCom, Enron, Adelphia who have a well established procurers of CG but these were by passed by them to peruse there personal agenda. The common factor in all these scandals was misuse of power by executives (Adrian Davies, 2006).

The term corporate governance is a result of the problems which were arising due to ownership and control of the firm. Corporate governance separates both of them (A. C. Fernando, 2006). Corporate governance is a system by which corporations can be directed and controlled. BODs are responsible for the governance of the company and the role of shareholders is to appoint the directors and auditors and assure themselves that a suitable governance structure is in place (Adrian Cadbury, 2002). It is a system of authoritative directions (John L. Colley, Wallace Stettinius, Jacqueline L. Doyle and George Logan, 6 December, 2004)

The reasons for corporate mis-governance in India are: A closed economy, a sheltered market, limited need and access to the global business, lack of competitive sprit and an inefficient regulatory framework. There are major unethical practices in terms of tax evasion. Many large corporations hire tax consultants to get the benefits of loopholes in the tax system and to evade the taxes as much as they can (A. C. Fernando, 2006).

CG and Taxation

BOD plays a vital role in establishing and maintaining a strong CG structure. They have to manage a wide range of priorities. Due to recent economic events BODs are felling necessity of a proper tax risk management system. Various security exchanges around the world


pressurize the listed companies to consider CG principles and recommendations and a sound risk management system. On the international platform, taxation as a concern of CG has gained greater importance due to stricter accounting and financial reporting requirements for better tax governance. The tax administrators have a vital role to play in ensuring boards understand that they are ultimately responsible for their business’s tax strategies and outcomes. At the end it depends on the decisions directors whether tax remains a hidden issue within BOD, with all the barriers to identifying and mitigating risks this entails, or whether management of material tax risk is built into the foundations of your business (Michael D’Ascenzo, 16 February 2010).Tax law has an impact both on the personal level of shareholders, managers, board members and other stakeholder as well as on the company level. Transparency in the taxation strategies is an essential feature. And it has same relevance in the recording of taxation in the organization. tax rules tend to foster complexity and reduce transparency because they pro-mote in-transparent, tax driven corporate structures. With respect to accounting standards the authors generally support the connection between tax and financial statements, in the belief that the results are a more balanced and realistic picture of companies situation. However, insofar as tax rules influence financial accounts due to a reverse authoritativeness, this results in a risk of in-transparency due to unrealistic tax-driven accounting positions (Arne Friese, Simon Link, Stefan Mayer, 19 January 2006).

Tax Haven Tax havens around the world

Caribbean/West Indies Anguilla, Antigua and Barbuda, Aruba, Bahamas, Barbados, British Virgin Islands, Cayman Islands, Dominica, Grenada, Montserrat, Netherlands Antilles, St. Kitts and Nevis, St. Lucia, St. Vincent and Grenadines, Turks and Caicos, U.S. Virgin Islands

Central America Belize, Costa Rica, Panama Coast of East Asia Hong Kong, Macau, Singapore Europe/Mediterranean Andorra, Channel Islands (Guernsey and Jersey), Cyprus,

Gibralter, Isle of Man, Ireland, Liechtenstein, Luxembourg, Malta, Monaco, San Marino, Switzerland

Indian Ocean Maldives, Mauritius, Seychelles, Middle East Bahrain, Jordan, Lebanon North Atlantic Bermuda Pacific, South Pacific Cook Islands, Marshall Islands, Samoa, Nauru, Niue, Tong

Vanuatu West Africa Liberia

Source: Tax Havens: International Tax Avoidance and Evasion, Jane G. Gravelle, July 9, 2009, CRS Report for Congress. Tax havens provide the opportunities of tax avoidance and evasion. According to Organization for Economic Co-operation and Development (OECD) these are the areas where the taxes are levied at negligible rate there are no taxes, there is protection of financial information. A high level of secrecy is maintained by the authorities and there are no provisions for the exchange of information about the investment. So the transparency also ignored in the tax havens. For the economies it is easy to track the onshore systems but in the case of offshore operations it is really difficult to track the financial games. In the case of tax


havens it becomes much difficult. In tax havens MNC’s evade the taxes by channelizing the various kinds of funds through foreign entities, some individuals evade taxes illegally by not reporting these assets or income on their tax returns (Erek Barsczewski, Oct 10, 2009). Countries become tax haven to attract the business houses to establish the infrastructure on their soil. It happens because the private sector of these countries is not so much powerful to give employment opportunities and the standard of living to the citizens. In this case the foreign multinationals are the ray of hope for these countries. The list of tax havens around the world is as follows:

Analysis Tax payments by the corporate houses are the most obvious contributions to the government. But it is a social responsibility of the business to pay tax and it is an ethical topic of discussion too. Corporate governance and taxation is subject matter which is a blend of corporate ethics and corporate social responsibility.

The well-known tax consultant, Dinesh Vyas, says that JRD never entered into a debate over ‘tax avoidance’, which was permissible, and ‘tax evasion’, which was illegal; his sole motto was ‘tax compliance’. On one occasion a senior executive of a Tata company tried to save on taxes. Before putting up that case, the Chairman of the company took him to JRD. Mr. Vyas explained to JRD: “But sir, it is not illegal.” JRD asked, softly: “Not illegal, yes. But is it right?” Mr. Vyas says that during his decades of professional work no one had ever asked him that question. Mr. Vyas later wrote in an article: “JRD would have been the most devoted supporter of the view expressed by Lord Denning: ‘The avoidance of tax may be lawful, but it is not yet a virtue.’ (R.M. Lala, Friday, Jul 29, 2005). Yes it’s true that various business icons doesn’t feel bad to say that tax evasion is a malpractice.

Tax Avoidance and Evasion in Tax Havens the Enron Case Overview

Enron was the seventh-largest corporation in terms of revenue of United States of America. Its job was to buy natural gas and electrical energy from producers and re-sell those commodities to distributors and consumers. Enron was heavily in debt, but the debt was hidden in various partnerships. (Neal Boortz Friday, Jan. 11, 2002) Enron has paid no income taxes in the last five years. The tax was avoided/evaded by the help of 900 subsidiaries in tax-haven countries. The company was liable for $382 million of tax refunds (David Cay Johnston, January 17, 2002). The company has set up its network in the off-shore tax havens to avoid the taxes. Due to this set up the profit of the company was $2 billion between 1996-2000.

Tricks and Tactics of Tax Avoidance and Evasion

Tax havens were used for offshore bank account to hide assets and income with the intention unreported income. This is tax evasion. Tax evasion schemes involving tax havens are very sophisticated, and take many twists and turns. Here entities are used as part of aggressive tax strategy to hide critical parts of the transactions. These transactions under the category of aggressive tax planning create foundation of tax evasion. Aggressive tax planning involves


complex arrangement at domestic and international levels. The objective behind such acts is to get those benefits which are not possible in the normal conditions. MNCs manipulate transactions to avoid crossing the line to tax evasion.

The following are some of the arrangements involving tax havens that the CRA is reviewing:

Tax Shelters

In very general terms, a tax shelter could be a gifting arrangement or an acquisition of property for which you are told that the tax benefits and deductions arising from the arrangement or the acquisition will equal or be more than the net costs of entering into the arrangement or acquiring the property.

Offshore Investment Funds / Foreign Investment Entities

Offshore investment funds and foreign investment entities are generally located in tax havens, and are used to channel investments and delay the taxation of the income earned on them. In India such kind of investments are very popular.

Tax Havens and Developing Countries

Tax havens affect developing countries also as the taxes from the multinational organizations are one of the biggest sources of the federal earning. According to the tax justice network and global financial integrity study the developing countries are losing $98 billion to $106 billion each year. In 2006 the figure of tax evasion and avoidance was $858.6 billion – $1.6 trillion. Indian nationals hold 1.456 trillion US dollars in Swiss banks (Times of India, Aug 24, 2009) it clearly says that Indian are also not way behind in offshore investments. Switzerland is one of favorite destination for Indians because it assures investors that their assets are protected under valid and legal terms. And the most important lawsuits are only applicable within the jurisdiction of a particular country unless there is an agreement between both the countries and authority regarding execution of legal decisions. In Nigeria, the National Economic and Financial Crimes Commission (EFCC) has estimated that during the year 2005 that around $400 billion of foreign aids have been sent to the offshore financial center illegally for the investment purposes.

Initiatives for Tax Havens As the situation due to tax havens was becoming worst. Various countries and international organizations have taken measures to control the financial activities the tax havens. The FATF (Financial Action Task Force on Money Laundering) which is an intergovernmental organization founded in 1989 by G7 at that time later G8 has published a blacklist of "Non-Cooperative Countries or Territories" (NCCTs). These countries were non-cooperative in the global fight against money laundering and terrorist financing. The last list which was published on 25 February 2009 includes 5 countries including Pakistan, Iran, Turkmenistan, Uzbekistan and São Tomé and Príncipe. The number of countries is comparatively less than the first list which was including 15 countries


Bahamas, CaymanIslands, CookIslands, Dominica, Israel, Lebanon, Liechtenstein, Nauru, Niue, Panama, Philippines, Russian Federation, Saint Kitts and Nevis, Saint Vincent and the Grenadines, Marshall Islands. However the OECD maintains the black list for the tax crimes. On 22 October 2008, at an OECD meeting in Paris, 17 countries led by France and Germany decided to draw up a new blacklist of tax havens. The OECD has been asked to investigate around 40 new tax havens in the world where undeclared revenue is hidden and which host many of the non-regulated hedge funds that have come under fire during the 2008 financial crisis. Germany, France and other countries called on the OECD to specifically add Switzerland to a blacklist of countries which encourage tax frauds. The representatives of Germany were in the favor to include Switzerland in the blacklist because the country is attracting funds from all over the world. But as Switzerland have the treaties with various countries regarding the discloser of undeclared funds it was not included at the end. (http://www.euronews.net)

SUMMARY AND CONCLUSIONS

The technological change in the present world and role of media has increased the responsibility of the directors of the business organizations. A bad name of the multinationals comes in the front covers of the newspapers and the reputation of the organization which takes years to build get ruined in just few moments. The case of worlds one of the biggest bankruptcies and frauds in the field of corporate governance has proved that company’s directors and audit committees cannot close their eyes for a longer duration in the context of taxes planning. It is not easy and not relevant to say no to aggressive tax strategies (John Christensen, 14 November 2003).

As far as the corporate governance is concerned this is an issue which is inter related with the ethical practices in the business and responsibility towards the society that is corporate social responsibility. The main theme of corporate governance that is transparency and accountability comes when the practices of business will be ethical and responsible for the society. As per the reports the total investment in the Swiss banks is 2500-4000 billion Swiss Francs. In which 90% is the undeclared money or the black money. As far as ethics are concerned it tells what is good and what is bad and what can be the outcomes of the good and the bad practices. Corporate scandals in the past clearly say that violation of corporate governance codes cannot just ruin the life of share and the stake holders but top managers also. Getting tax is the right of government and a responsibility of citizens which should be followed in a proper manner.

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The Malfunction of Corporate Governance in India

Dr. T. Satyanarayana Chary* and P. Sagar**

Abstract—Ethical behavior is a necessity to gain trust. Trust will be used as an indicator variable of ethics. Basically, trust is three-dimensional, that trust in suppliers relationships, trust in employee relationships and trust in customer relationships. If the company is able to maintain this trust relationship with the internal as well as external stakeholders, then we can call the company an ethical company. Businesses should act ethically to protect their own interest (prudence) and the interests of the business community, keep their commitment to society to act ethically, meet stakeholder expectations, prevent harm to the general public, build trust with key stakeholder groups, protect themselves from abuse from unethical employees and competitors, protect their own reputations, protect their own employees, and create an environment in which workers can act in ways consistent with their values.

Indian companies face two types’ of corrupt practices: political corruption in which money is paid for favors done, and administrative corruption. A study on the ethical attitudes of Indian managers conducted by Arun monappa (1977)reported that business executives listed three major obstacles to ethical behavior, namely, company policies, unethical industry climate and corruption in government.

Corporate Governance has become prominent over the last two decades as many countries witnessed corporate succumbing to questionable corporate polices and unethical practices, setting in motion reforms through codes and standards on corporate governance. India too had had its share of corporate scams. The recent fraud in satyam has shattered the dream of various investors, shocked the government and regulators alike and led to questioning the accounting practices of statutory auditors and corporate governance norms. Unethical business conduct, cooking of books of accounts, questionable role of audit committee, flawed ownership structure and other major governance flaws were noticed in the collapse of stayam. As in USA, UK and other countries, in too needs similar kind of corporate governance reforms. Even through corporate governance mechanisms cannot prevent unethical activity by top management completely, but they can at least act as a means of detecting such activity before it is too late

The present paper is a modest attempt to discuss on the maladies of corporate governance with a comparison to its counter parts over the Asia. Also dwells on the failures of corporate governance with the help of certain case analysis. The methodology is descriptive and case analysis one.

INTRODUCTION TO CORPORATE GOVERNANCE

Corporate governance is a central and dynamic aspect of business. The term “governance” Derives from the Latin gubernare, meaning “to steer”, usually applying to the steering of a ship, which implies that corporate governance involves the function of direction rather than * Telangana University, Nizamabad **Sri Chaitanya P.G. College, Karimnagar

The Malfunction of Corporate Governance in India 179

control. Infarct, the significance of corporate governance for corporate success as well as for social welfare cannot be overstated. Recent examples of massive corporate collapse resulting from weak systems of corporate governance have highlighted the need to improve and reform corporate governance at international level. In the wake of Enron and other similar cases, countries around the world have reacted quickly by pre-empting similar events dramatically. As a speedy response to these corporate failures, USA issued the Sarbanes-OXLEY Act in July 2002(Solomon and Solomon, 2004)

ETHICS AND CORPORATE GOVERNANCE

An ethical company is one that does what it believers in, and if it does it well then shareholders will benefit. People will work better, and the company will be respected by everyone including customers and clients (Charles Handy, 1995). Ethics is easier to define than to interpret. Dictionary definitions usually refer to ethics as: ‘set of moral principles or moral values held by individuals or groups’. Something is ethical if it is in accordance with principles of conduct that are considered correct, especially those of a given profession or group’. Essentially ethics means ‘doing the right thing’. However the problem is determining what is the right thing to do, what are the principles of conduct that are considered correct in a given set of circumstances? This is because each one of us, as a result of our individual backgrounds, cultures, value and belief systems, can interpret and judge a particular action and behavior in different ways, and from differing ethical viewpoints. In business, ethics evaluates managerial decisions and actions with reference to moral standards. Ethics offers a moral framework within which to make judgment and decisions when confronted with difficult business choices and dilemmas.

BACKDROP OF CORPORATE GOVERNANCE

Policy makers, practitioners and theorists have adopted the general stance that corporate governance reform is worth pursuing, supporting such initiatives as splitting the role of chairman/chief executive, introducing non-executive directors to boards, curbing excessive executive performance-related remuneration. Improving institutional investor relations, increasing the quality and quantity of corporate disclosure, inter alia. However, is there really evidence to support these initiatives? Do they really improve the effectiveness of corporations and their accountability? There are certainly those who are opposed to the ongoing process of corporate governance reforms. Many company directors oppose the loss of individual decision making power, which comes from the presence of non-executive directors and independent directors on their boards. They refute the growing pressure to communicate their strategies and policies to their primary institutional investors.

They consider that the many initiatives aimed at “improving” corporate governance in UK have simply slowed down decision-making and added an unnecessary level of the bureaucracy and red tape(refer to summary .Richard Branson’s experiment with the stock market Appendix A,4). The Cadbury Report emphasized the importance of avoiding excessive control and recognized that no system of control can completely eliminate the risk of fraud(as in the case of Maxwell) without hindering companies’ ability to compete in a free


market .This is an important point, because human nature cannot be altered through regulation, checks and balances. Nevertheless, there is growing perception in the financial markets that good corporate governance is associated with prosperous companies. The research of Solomon j and Solomon A. Showed some evidence to support the agenda for corporate governance reform. The findings indicated that the institutional investors welcomed corporate governance reform, viewing the reform process as a “help rather than a hindrance” .Specifically, towards corporate governance reform.

COMPONENTS OF CORPORATE GOVERNANCE

Parties involved in corporate governance include the regulatory body (e.g, the Chief Executive Officer, the board of directors, management and shareholder). Other stakeholders who take part include suppliers, employees, creditors, customers and the community at large. In corporations, the shareholder delegates decision rights to the manager to act in the principal’s best interests. This separation of ownership from control implies a loss of effective control by shareholders over managerial decisions. Partly as a result of this separation between the two parties, a system of corporate governance controls are implemented to assist in aligning the incentive of managers with those of shareholders. With the significant increase in equity holdings of investors, there has been an opportunity for a reversal of the separation of ownership and control problems because ownership is not so diffuse.

A board of directors often plays a key role in corporate governance. It is their responsibility to endorse the organization’s strategy, develop directional policy, appoint, supervise and remunerate senior executives and to ensure accountability of the organization to its owners and authorities. All parties to corporate governance have an interest, whether direct or indirect, in the effective performance of the organization. Directors, workers and management receive salaries, benefits and reputation, while shareholders receive capital return. Customer receives goods and services: suppliers receive compensation for their good or services. In return these individuals provide value in the form of natural, human, social and other forms of capital. A key factor in an individual’s a decision to participate in an organization, e.g., through providing financial capital and trust that they will receive a fair share of the organizational returns. If some parties are receiving more than their fair return then participants may choose not to continue participating leading to organizational collapse.

EMERGING CORPORATE GOVERNANCE PRACTICES IN ASIAN NATIONS

India’s Corporate Governance Framework

India is now implementing important corporate governance reforms that position the country’s corporate governance framework as above average compared to other emerging market economies. However, as is the case with many other countries weaknesses remain in enforcement of rules and regulations. Edward baker, Chief Investment Officer of Global Emerging Markets. Alliance Capital Management, and published as new Indian regulations are coming into effect with the aim of significantly strengthening the system of corporate governance. The Securities and Exchange Board of India (SEBI), the independent capital


markets regulator, has made significant efforts to keep-up with changing corporate governance practices in leading equity markets around the world, namely the United Kingdom and the United States. We welcome the actions that the Indian authorities are pursuing. IIF Managing Director Charles Dallara said, it is important that Indian corporate governance standards continue to improve as the country becomes an increasingly important participant in global trade and finance. It is encouraging that, as our new report points out, companies such as Infosys Technologies, the Tata Group, ICICI Bank and the Housing Development Finance Corporation Ltd. (HDFC), are developing sound corporate governance approaches. These can serve as models for the thousands of listed Indian companies that have yet to put in place governance systems that meet the requirements set by the Indian authorities and that can enhance international investor confidence.

World bank initiative to work with the Indian government vis-a vis the private sector organization of international market is a good illustration of the efforts of the international body for improving corporate governance as a measure for attracting the badly needed foreign capital into the country. India is among the oldest stock exchanges in the emerging economies. It has nearly 7000 listed companies in the country, which is slightly higher than those in the UK. However, the flow of FDI capital was not high during 2000-2001.

The CII (confederation of Indian industries) had taken steps prior to the Asian financial crisis on its own to promote the code of best practices on corporate governance as a measure for attracting FDI. It had issued self-regulatory practices in May 1998 for the business leaders. They were, no doubt, though recommendations, even tougher than those in the UK. These recommendations implied that no director should have more than ten seats and that the board should be constituted with at least 30% external directors. The attendance records of the directors should be an open secret. In case of companies listed in foreign countries, they were required to disclose all the information to the shareholders in India which they did overseas. Seventeen companies s signed the CII code and accepted to implement.

The CII was ambitious in its efforts. It aim was not just create local code on governance but to encourage Indian companies achieve international standards in governance. It prime objective is to get the domestic companies listed on the NASDAQ, NEW YORK. Besides, the effort by the CII, the Securities and Exchange Board of India (SEBI) issued another code in draft form towards the late 1999. The code was harsher than the CII code and aimed at compliance by the companies on disclosure of information as part and parcel of the rules on listing. The GCGF was happy with effort of the CII and SEBI because these codes met the objectives of the forum to promote investments through corporate governance based on the best practices.

CORPORATE GOVERNANCE IN JAPAN

A UK research firm, Oxford Analytica, had carried out a study of the governance system in Japan. It was an in-depth research into the Japanese model of governance which developed over the years since 1945.


Theoretically, during the post-world War II period, the structure of governance in japan’s major organizations known as kabushiki kaisha (stock companies) was comparable to the US corporations. Accordingly, the boards of directors were elected by the shareholders. So, the board was answerable to the shareholders. The board defined nd implemented corporate policy, appointed company executives and was responsible for monitoring and providing direction for business operations. The board represented interest of the shareholders and to some extent interests of the society.

In practice, the board of directors of the major organizations represents the interests of the organization and its staff as a collective body and not the interests of the shareholders. There are two factors which account for this kind of practice.

The first factor: the constitution of the board: All the directors are ex-employees of the organization and are senior mangers. Around 80% of the corporations in Japan have no external or outside members on the board and 15% have up to two outsiders on the board. In 1990.

The second factor: The shareholders are not active owners: Japanese companies usually exchange a small number of stocks with business partners and lenders. This is done as a matter of showing commitment, sincerity and goodwill to the other companies. The numbers of stocks exchanged are small. But they are significant number of share keeping in view the outstanding shares. Institutional investors such as trusts and pension funds or insurance companies also have some stake in most of the major corporations in Japan. The shares held by the business partners or the institutional investors are rarely sold and they constitute 60 to 80% of the total shares. These shares represent the friendly and stable equity owners. Around 20 to 30% of the shares are in general circulation.

Relationship with the government: Japanese corporations maintain good relations with the central government. The central government enforces the legal provision through passing informal administrative guidelines. Meetings are held between the Ministry of Finance and the concerned institutions frequently. The relationship is further strengthened with the retiring government officials joining the corporations which fell under their administrative control while in service. Government’s role in Japan is that of a protector and promoter of industry. Government sponsors research projects in collaboration with industry. This is an example of state industry cooperation in national interest.

Authority of board and the management: Although, theoretically, the board of directors has to look after the interests of the shareholders, it tends to control the business management. Management of the business is answerable to the board whereas control and management are distinctly separate. In Japanese industry, control and management are part of one activity in spite of the business structure being identical to the of the US

Information or orientation of directors: In the ‘bottom up’ consumers approach in decision making, managers are fully aware of the viewpoint of the subordinate staff. Representative Directors know the internal matters through the weekly/ monthly meetings. Directors too are updated on the external environment through many meetings and


interactions. Monthly meetings with the mangers and directors of the industrial groups (keiretu), of which the company may be members, provide the valuable information on group activities in the monthly meeting with mangers and directors of keiretsu organization.

Japan also framed its own code on governance. A Japanese corporate governance forum was constituted which defined its guidelines in may 1998.the corporate governance forum consisted of lawyers, academics and executives as well as representatives of shareholders who exhorted the need for improved governance as essential for effective operation of business in the global market. The code took a holistic view of governance compared to the Western nation. In its view, organizations are made up different constituents and shareholders being the equity owners deserve a special status. It underlined the need for corporate solidarity in consonance with social harmony.

The forum made significant recommendations which involved a lot of changes in the governance system. One such recommendation was to include more external/outside directors on the board. Japan had just above 4% members outside sources. Another recommendation was to have independent committee. The forum monitors the implementation and has taken help of Tokyo Stock Exchange to include these codes in the exchange rules on listing. These recommendations were widely recognized the world over.

CORPORATE GOVERNANCE IN SOUTH KOREA

The OECD (Organization for economic cooperation and development organizations) had recommended to South Korea after its survey of the country’s economic conditions that all the companies in the country should have external directors. In 1999, the Stock exchange of Korea instituted a committee based on Cadbury model.

The Federation of Korean Industry (FKI), being the representative institution of big South Korean companies, had expressed reservations late 1998 on the country’s program on reform of governance. The body was critical of the OECD’S draft of code/principles on governance. In particular, it disagreed in principle that the OECD should have any say in matters related to international governance of the country, i.e., composition of board of directors. It rejected the international standard on accounting on the ground that it was not beneficial for Korean organizations.

CORPORATE GOVERNANCE IN HONG KONG

The Stock Exchange of Hong Kong made it obligatory that the board audit committees will overview companies’ outside audit. It is noteworthy that at the time of the reform process in Hong Kong, only 12 of 600 listed organizations had an audit committee. The Exchange wanted the best practiced structure of governance of the Western economies standards. The committee had to be chaired by an external, but it could include executives.

THE MALFUNCTION OF CORPORATE GOVERNANCE IN INDIA

Shadows of Satyam

Problems in Satyam begin when on December 16, 2008; its chairman Mr.B. Ramalinga Raju, in a surprise move announced a $1.6 billion bid for two Maytas companies’ i.e Maytas


infrastructure Ltd and Maytas Properties Ltd, saying he wanted to deploy the cash available for the benefit of investors. The thumbs down given by investor and the market forced him to retreat within 12 hours. Share prices plunges by 55% on concerns about Satyam’s corporate governance. In a surprise move on December 23, 2008, the World Bank announced that Satyam has been barred from business with World Bank for eight years for providing bank staff with “improper benefits” and charged with data theft and bribing the staff. Share prices fell another 14% to the lowest in over 4 years. The lone independent director since 1991, US academician Mangalam Srinivasan, announced resignation followed by the resignation of three other independent directors namely, Vinod K Dham (famously known as father of the pentium and an ex Intel imployee), M Rammohan Rao (Dean of Indian School of Business) and Krishna palepu (professor at Harvard Business school)”. At last, on January 7, 2009, B. Ramalinga Raju announced confession of over Rs. 7800 crore financial fraud and he resigned as chairman of satyam. He revealed in his letter that his attempt to buy maytas companies was his last attempt to “fill fictitious assets with real ones”. He admitted in his letter, “It was like riding a tiger without knowing how to get off without be being eaten.

Satyam’s promoters, two brother B. ramalinga raju and B.Rama Raju were arrested by the state police and the central government took control of the tainted company. The Raju brother’s wer booked for criminal breacdh of trust, cheating, criminal conspiracy and forgery under the Indian Penal Code. The central government” reconstituted Satyam’s board that included three-members.HDFC Chairman Deepak Parekh, EX Nasscom chairman and IT expert KiranKarnik and former SEBI member C Achuthan. The Central Government appointed three more directors to the reconstituted board i.e., CII chief mentor Tarun Das, former president of the Institute for Chartered Accountants (ICAI) TN Manoharan and LIC’s S Balakrishnan. A week after satyam founded B. Ramalinga raju’s scandalous confession, satyam’s auditiors price Waterhouse finally admitted that its audit report was wrong as it was based on wrong financial statements provided by the Satyam’s management. Senior partners s. Gopalkrishnan and Srinivas Talluri of the auditing firm pricewaterhousecoopers (PWC) were arrested for their alleged role in the satyam scandal. The state’s CID police booked them, on charges of fraud (Section 420 of the IPC) and criminal conspiracy (120B). The reconstituted satyam Board appointed former Head, Delivery and Leadership Development Department of Satyam Mr.A.S Murty as the new Chief Executive Officer (CEO) of the beleaguered company.

CONCLUSION

Corporate governance deals with laws, procedures, practices and implicit rules that determine a company’s ability to take managerial decisions vis-à-vis its claimants- in particular, its shareholders, creditors, the State and employees. To most international experts on the subject, corporate governance is interplay between companies, shareholders, creditors, capital markets, financial sector institutions and company law.

Therefore, from the information presented it is understood that accounting irregularities occurred in the reporting systems and the internal controls remained ineffective in preventing


them from further occurrence. From the cases reviewed above certain issues can be raised. For instance, issues relating to stakeholders’ theory and corporate governance, i.e., malfunctions of corporate governance Vs ethical practices of corporate governance, cases like satyam proved that unethical actions of the CEOs, CFO and auditors lead to the firms Bankruptcy and there by the most adversely hit were the employees, creditors, investors and so on. Likewise, issues like Good governance and poor performance and poor governance and good performance can be raised for the further research perusal.

Corporate Governance Research in India: A Selected Annotated Guide to the Free

Web and Empirical Work

R. Vishal Kumar* and Dr. M.V. Subha**

Abstract—Corporate governance research represents a very dynamic inter-disciplinary field of study. This area of research has moved from the general analysis of principal-agency conflicts and associated agency costs to examining the role of directors, independent directors, separation of CEO and board chairs, executive remuneration and financial reporting and the market for corporate control.

For any researcher embarking on the research journey, the free web undoubtedly provides a large and ever expanding wealth of information pertaining to the widely researched area of corporate governance. The primary aim of this paper is to introduce key sites of relevance to nouveau Indian researchers in the area of Corporate Governance. It will also prove useful to researchers who intend to build their knowledge of major topics in the area of governance.

Design/Methodology/Approach: Important and groundbreaking works in the area of corporate governance literature with specific reference to India are identified and cited in this paper to place selected web sites within the context of historical developments in the area of corporate governance and empirical work in this area spanning the period 2000 to 2010. A wide range of web-based resources and empirical work are critically evaluated in this study.

Findings: The result of this work is a significant sampling of quality web-based information sources and empirical works with evaluative annotations.

Originality/value: Given the recent surge in the area of Corporate Governance research, this paper will prove to be useful and timely to anyone interested in accessing and reading qualitative work in the corporate governance arena.

Keywords: Corporate governance, worldwide web, empirical work, annotated source, compendium

INTRODUCTION

Corporate Governance has been an important issue of enquiry for researchers. The underpinnings of this research area draws from multiple disciplines like accounting, corporate laws, economics, finance, management and sociology. Thanks to the burgeoning empirical work and literature in this area, researchers have made corporate governance highly interdisciplinary. Neophyte researchers thus need to gain an in-depth understanding of the many disciplines as they affect the arena of corporate governance.

*Happy Valley Business School, Coimbatore **Anna University of Technology, Coimbatore

Corporate Governance Research in India: A Selected Annotated Guide to the Free Web and Empirical Work 187

CORPORATE GOVERNANCE RESEARCH

Empirical work in the area of Corporate Governance can be categorised into two distinct types: quantitative and qualitative research. Quantitative researchers need access to publicly accessible quantitative information, for instance, financial reports of companies. Most researchers in this area attempt to establish/explain/predict relationships amongst corporate governance and financial performance variables.

Qualitative researchers deal with guidelines, codes, practices, procedures and the like pertaining to corporate governance while attempting to explain how adherence to such standards furthers the cause of good governance. A challenging task to such researchers however is gaining access to the ‘soft’ data on understanding the dynamics of the environment in the board room, perception of the board towards corporate governance, their skills and competencies.

While both groups of researchers add/refine previous knowledge on corporate governance, new researchers in this area face the arduous task of harnessing information concerning this interdisciplinary area. This article serves to provide value to first time researchers in understanding the direction of research in this area. Using empirical work accessible through the free world wide web and by providing references to important websites the authors attempt to provide a foundation. At the time this article was being written the authors were unaware of similar work in the Indian context and thus believes that this paper would benefit first time researchers and information professionals alike.

Corporate Governance in India: Historical Perspective1

The history of Corporate Governance in India is replete with a rich legislative history. At the time of independence, India was one of the poorest economies with its factory sector accounting for one-tenth of the national product, four stock markets with well defined rules for listing, trading and settlement, a sound banking system with prudent lending, recovery norms and public skepticism about investing in equity markets.

1. This section draws heavily from the history of Indian corporate governance in Goswami (2002)The early stages of corporate development in India were marked by the agency system. This system enabled control to be vested in British hands. The lack of indigenous capital and Indian industrial leadership gave British merchants the opportunity. Available British capital seeking investment found among these British merchants the right sort of men who could safely be entrusted with it (Lokanathan 1938).

The decade after independence marked by the Industries Development and Regulation Act (IDRA) 1951, and the Industrial Policy Resolution 1956, spelt a regime of licensing, protection and red-tapes. In the absence of a widespread equity culture the onus of corporate funding dwelt on the shoulders of the three Development Financial Institutions (DFIs) of Industrial Development Bank of India (IDBI), Industrial Credit and Investment Corporation of India (ICICI) and the Industrial Finance Corporation of India (IFCI), which were supported by the State Financial Corporations (SFCs).


As the DFIs were evaluated more in terms of quantum of credit dispersed than their quality there was no incentive for proper credit appraisal or monitoring. Nominee directors of such institutions had a nominal role to play on their respective boards. Promoters of businesses thus enjoyed managerial control with very little investments of their own. Such promoters had little incentive to repay the loans and siphoned money to other businesses they controlled. A surge in the bankruptcy caused the government to form its bankruptcy reorganisation measures.

The Sick Industrial Companies Act (SICA) and the Board for Industrial and Financial Reconstruction (BIFR) were thus born. However the legal process often took a decade or more eventually leading to the demise of SICA.

The Companies Act of 1956 has remained a major piece of legislation governing the functioning of companies registered in India. Several amendments have been made to the Act; however more needs to be done to protect the interests of minority shareholders and creditors in India.

The post liberalisation era witnessed landmark changes in the laws driving corporate governance. The establishment of the Securities Exchange Board of India (SEBI) represents a milestone in the history of Indian corporate governance reforms. The SEBI set out to regulate and monitor the stock market trading besides establishing minimum ground rules of corporate conduct in the country.

The Harshad Mehta stock scam in 1992 shook the Indian capital market and eroded investor confidence. The scam reflected a failure of the corporate governance mechanism which led to an investigation into ways to fix the corporate governance system in India. This led to the first endevour that led to the Confederation of Indian Industries (CII) Code of Desirable Corporate Governance, developed by a committee chaired by Rahul Bajaj.

TABLE 1: INDIAN CORPORATE GOVERNANCE: SPECIFIC REFORMS TIMELINE

Year Key Reforms Securities and Exchange Board of India (SEBI) Act passed by the parliament. SEBI instituted as an independent regulator.

1992

SEBI institutes four committees (in 1996, 1998, 2000 and 2002) for corporate governance reforms.

1994

Government efforts to reform the Bombay Stock Exchange (BSE) face stiff resistance. Government institutes a new stock exchange the National Stock Exchange (NSE) as a competitor to BSE establishing better practices and more standard corporate governance. This eventually leads to reforms in the BSE as well.

2000 The Institute of Chartered Accountants of India introduces two accounting standards aimed at improving accounting disclosures and transparency related to Related Party Transactions and Segmental Reporting.

2001 The Institute of Chartered Accountants of India issues a Guidance Note on Certificate on to provide guidance to members certifying corporate governance clause 49 of the Listing Agreement.

2003 SEBI made single window approver for FIIs (earlier they had to seek approval from the federal bank also).2009 CII’s Voluntary Code of Corporate Governance.

*Source: Adopted and modified by the authors from Gaur( 2007)

Two other committees were formed by SEBI. The Kumar Mangalam Birla Committee that resulted in the adoption of Clause 49 Listing Agreement and the Narayanamurthy committee with focus on improving board practices. The SEBI committee recommendations have had far reaching impact on changing the corporate governance scenario in India. The


Advisory Group on Corporate Governance of the Reserve Bank of India’s Standing Committee on International Practices and Codes submitted their recommendations in 2001. These codes and committee recommendations form the basic legislative framework of Indian corporate governance (refer Table-I for the reforms timeline).

TAKING STOCK OF CORPORATE GOVERNANCE RESEARCH IN INDIA

The scope of corporate governance research in India in all its manifestations spans a broad spectrum of topics that include studies on board practices, diversification, event studies, firm performance, governance codes, governance indexes, ownership structures and the like. The authors’ goal in writing this paper is twofold.

• To provide a selective annotated reference to major empirical work in these areas. Most of the work reviewed by the author is accessible freely on the Social Science Research Network at www.ssrn.com. This paper attempts to serve as a ready reckoner for first time researchers. We categorize corporate governance research over a decade (2000-10) into four broad areas viz., Corporate Governance Systems & Indices, Corporate Governance & Firm Performance, Corporate Boards and Shareholding & Corporate Governance.

• To provide a list of important websites in the area of Corporate Governance that provides qualitative information. The information contained in these websites would help first time researchers gain a better understanding of the discipline. By offering a short review of the websites we intend to help researchers bookmark important websites for the purposes of their research.

We attempt to provide succinct and accurate information of a representative cross-section of selected empirical work spanning a decade (2000-2010). Readers may note that the year of publication mentioned refers to the year in which the article was posted on SSRN website, which may be different from the original date of publication of the article. Where the reviewed paper is not available on SSRN, an indication as to the source is made.

The authors consolidate each category of review with a note on the scope for further research. We believe this would serve as a fair indication of the emerging themes in the area of corporate governance. First time researchers in the early stages of their research may use this to understand the direction of future research in this area.


Selected Annotated Review of Corporate Governance Research in India (2000‐2010) TABLE II: RESEARCH PAPERS ON CORPORATE GOVERNANCE SYSTEMS & INDICES

Reference Work type, Source discipline ,Data Discussion Disclosures and Corporate Governance in Developing Countries: Evidence from India. (2010) Ruchita Daga & Dr. Dimitrios. N. Koufopoulos

Examines the level of disclosures regarding corporate governance practices of 29 BSE listed companies. Authors use attributes compiled by Standard & Poor to measure corporate governance and disclosure in India.

Almost all companies disclose mandatory information. Some companies disclose additional information which is not mandatory on a voluntary basis.

Corporate Governance Convergence: Lessons from Indian Experience (2009) Afra Afsharipour

An interesting essay of whether globalization will lead to convergence of Corporate governance laws towards one model of corporate governance or whether regional characteristics will impede convergence.

Indian corporate governance reforms may be seen as a formal convergence towards Anglo-American practices or a continuing persistence of traditional weak governance reforms. The author contends that greater institutional changes would be necessary for any convergence.

Corporate Governance: Regulatory and Cultural Issues (2009) Gurbandini Kaur Richa Mishra

A narrative of the regulatory framework of corporate governance and its reforms in India.

The author argues that the focus of all reforms is through enforcement and compliance with external laws and regulations. The problems with corporate governance in India are more of execution and there are no easy answers as to what is the best solution for corporate governance.

Table II Contd… Research Papers on Corporate Governance Systems & Indices Corporate Governance : The Indian Capital Market Law and International Standards (2010) Dr.Tabrez Ahmad Satyajit Surjyakant Sen Nidhi Singh Siddharth Singh

This paper enunciates the Indian standards for corporate governance as spelt in the Clause 49 Listing Agreement and compares it with the Sarbanes Oxley of USA. International standards of corporate governance like the UK Regulations, Higgs Review and Cadbury Report is also discussed.

Corporate governance measures in US and UK are ‘outsider systems’ from where concepts like independent directors, audit committee, CEO/CFO certification and the like emerged. The transplantation of these to Indian businesses which are ‘insider systems’, may not augur well as these differences need to be factored in for effectiveness of governance.

Law Enforcement and Stock Market Development : Evidence from India (2009) Vikramaditya Khanna CDDRL Working Paper

This paper explores the enforcement of corporate and securities law as a critical feature in determining the health and growth of stock markets. The author attempts to offer explanations as to the surge in FIIs given the weak enforcement of laws in India.

Corporate governance reforms helped FIIs gain access to standardized information thus reducing their information processing costs. Governance lent credibility due to sanctions imposed for inaccurate disclosures.

Corporate Governance in India (2008) Rajesh Chakrabarti W.Meggison P.Yadav

Describes the Indian corporate governance system and examines how the system has both helped and hampered India’s ascent to the top ranks of the world economy.

The authors opine that the Indian legal system offers high levels of investor protection in the world (on paper). In reality our courts are over-burdened, share holding is relatively concentrated and evidences of pyramiding and tunneling of resources is rampant. However India ranks high compared to the other BRICs economies and the reforms mooted by the SEBI and BSE are on the right track to steer Indian companies ahead.

Firm Level Corporate Governance in Emerging Markets: A Case Study of

Provides an overview of Indian corporate governance practices based on a 2006 survey of 370 Indian public companies. The authors

The authors opine that large companies have complied with board independence requirement. However the compliance on seeking approval for


India (2008) N.Balasubramanian Bernard.S.Black Vikramaditya Khanna

explore connections between governance and firm value and aspects of overall firm governance that predict a firm’s market value.

Related Party Transactions is quite weak. The authors construct an Indian Corporate Governance Index (ICGI) and posit that a significant correlation exists between ICGI and firm value.

Divergent Corporate Governance Standards and Need for Universally Accepted Governance Practices. (2008) Syeedun Nisa Khurshid Anwar Warsi Asian Social Science Journal

Corporate governance reports of different countries are explored together with salient features of government industry models. Authors provide different country examples where governments play different roles of referees, managers and coach. Authors raise issues such as should companies follow the Anglo-American or European model of corporate governance. Is it possible to have universal corporate governance norms in a divergent world?

There appears to be no consensus on which system of corporate governance is the best one and whether legal convergence should be encouraged on a global basis.

Table II Contd… Research Papers on Corporate Governance Systems & Indices Regulatory Norms of Corporate Governance in India (2008) Dimple Grover Amulya Khurana Ravi Shankar

A qualitative research paper which presents a detailed account of corporate governance model in India from the period 1866 to 1998.

The authors present a chronological account of developments in the area of corporate governance till 2003.

Capital Market and Corporate Governance in India: An Overview of Recent Trends. (2007) P.M.Vasudev

An essay that outlines important changes in the Indian capital market and corporate law regimes since the early 1990’s.

Key developments related to governance of stock markets like Regulation of Capital Issues, Issue pricing, Repurchase of shares, Sweat equity, Inter-company loans, Options, Derivatives and Financial reporting standards are enumerated.

Corporate Governance in India: Evolution and Challenges ( 2007) Rajesh Chakrabarti

The paper is a treatise on central issues in Indian corporate governance. A wide range of issues in corporate governance are addressed.

Implementation of corporate governance at the ground level represents a formidable challenge. It can be widely observed that the influence of corporate governance reforms is restricted to the top (large) companies and much need be done toensure adequate corporate governance in the average Indian company.

Understanding the Corporate Governance Quadrilateral (2004) Malla Praveen Bhasa

This paper wades through extant corporate governance literature and identifies the existence of four different governance models in practice across the world.

The author opines that the existence of transition and emerging economy models (like India) have not been extensively discussed by researchers. An understanding of the governance quadrilateral would be a pre-requisite for understanding global corporate governance.

Scope for further research:

A closer examination of research in this area reveals that corporate governance involve a series of codes of practice, policy recommendations and legislations. Much of the corporate governance today falls within a broad ‘comply’ or ‘explain’ framework. These frameworks have done little to prevent the global financial crisis, arrest the failure of banks and prevent market collapses. In fact these events are attributed to weak corporate governance.

Recent events demonstrate that further work needs to be done in this area. Researchers could examine the possibilities of exploring the best practices in corporate governance on a case to case basis, differentiate the mandatory and voluntary disclosures and construct models based on assigning weights to voluntary disclosures made.


More than emulating standards that have worked well in different contextual scenarios (like the Anglo-American model or the European model meant for outsider oriented systems); Indian researchers could factor in regional characteristics (family controlled firms) and evolve hybrid models that are more relevant for Indian corporate governance.

The area of developing indices to measure corporate governance variables is well documented in extant literature. The GIM index, 2003 (Gompers, Ishii and Metrick) and the BCF, 2004(Bebchuk, Cohen and Ferrell) on a global level and India Corporate Governance Index (ICGI), 2008 by Balasubramanian, Black and Khanna are trend setting researches in this area.

Further research could attempt to understand how managements attempt to proactively measure and / or mitigate technology / political / economic risks. Helping companies to measure risk by developing a risk management index would benefit both management and investors alike.

TABLE III: RESEARCH PAPERS ON CORPORATE GOVERNANCE AND FIRM VALUE/PERFORMANCE

Reference Work type, source discipline ,data Discussion Corporate governance characteristics and company performance of family owned and non-family owned businesses in india. (2009) Palanisamy saravanan

Explores the impact of family control in determining the firm value together with corporate governance variables based on data from 771 firms listed on the bse for the period 2001-05.

The author observes significant differences between family controlled and non family controlled firms in corporate governance factors namely board size.

Corporate governance, product market competition and firm performance in india: an empirical enquiry (2008) Manoranjan pattanayak

This paper explores the interaction effort of product market competition and corporate governance variables on firm performance.

The author observes a complementary relationship between insider ownership and firm productivity. The relationship becomes stronger when the completion in the firms product market is intense.

Corporate governance and firm performance: evidence from large governance changes ( 2008) N.k.chidambaram Darius palia Yudan zheng

Examines the relationship between governance changes and firm performance and attempts to explore the impact of 13 large positive and negative governance changes on the future firm value while controlling for reverse causality.

The authors contend that changes in particular measures of corporate governance alone do not lead to performance improvement. The interplay between governance, observable and non observable characteristics of firm performance are complex and not amenable to a sort of single governance measure or firm characteristic.

Can corporate governance reforms increase firm market value: evidence from india (2007) Bernard.s.black Vikramaditya.s.khanna

An event study on the adoption of clause 49 listing agreement and its impact on the stock returns of large, medium and small firms over a two-day period i.e., date of announcement plus next trading day.

The authors observe an increase in returns of large firms relative to that of small firms from 4 percent over a two day window to over 10 percent over a two week window. Mid size firms exhibit an intermediate response.

Scope for further research: While most research in this area attempts to demonstrate that improvements in corporate governance adds value to companies reflecting in firm value/performance it would be interesting to ex-ante identify a sample of firms and their characteristics in which good governance leads to better performance so that the link between ‘good’ corporate governance and corporate financial performance is more forthcoming.


TABLE IV: RESEARCH PAPERS ON SHAREHOLDING AND CORPORATE GOVERNANCE

Reference Work type, source discipline ,data Discussion Role of institutional investors in corporate governance (2009) Manya srivardhan

Explores the role of institutional investors like fis, insurance companies, mutual funds, fiis, private equity funds and pension funds in furthering the cause of governance in companies through board representation.

Authors opine that the monitoring role of institutional investors is either missing or marginally visible. The presence of institutional investors is negligible in the case of smaller companies and there is no evidence of a monitoring role being played by such investors in small companies. The need for issuing regulations to facilitate institutional investor activism is addressed.

Disentangling the performance and entrenchment effect of family shareholding : a study of indian corporate governance (2008) Manoranjan pattanayak

Examines the relationship between firm performance as measured by tobin’s q and family shareholding using data of 1833 listed firms from 2001-04.

The author reports a curvilinear relationship between insider (family) shareholding and firm value. The author posits that concentrated ownership does not destroy firm value as is generally believed.

Can independent block-holding really play much of a role in indian corporate governance. (2008) George.s.geis

Explores the role of share block-holders (hedge funds and institutional investors) in guarding against abusive behaviour by monitoring a firm’s activities.

Many firms currently lack enough of an outside share holder presence to provide meaningful governance counter balance. Reform efforts in this area can create an impact.

Foreign and domestic ownership: business groups and firm performance: evidence from large emerging markets. (2008) Sytse douma Rejie george Rezaul kabir

This paper explores how property rights (ownership structure), the provision of scarce and inimitable resources by various shareholders and the associated institutional context explains differences in firm performance.

The author observes that foreign corporate ownership, foreign financial institutional ownership and domestic corporate ownership are positively associated with firm performance.

Debt and corporate governance in emerging economies: evidence from a large emerging market (2008) Jayati sarkar Subrata sarkar

This paper analyses the role of debt in corporate governance, given that debt constitutes a major source of external finance for indian companies. Authors address the question does debt discipline corporations and explore the role of institutional change in supplementing or mitigating expropriation effects of debt.

The study posits that during the early years debt did not have a disciplining effort on group/non-group firms. However debt is observed to have a disciplining effort during the later years. There is limited evidence on debt being used as an expropriating mechanism in group firms.

Equity pattern, corporate governance And performance: a case study of indian corporate sector. (2006) Murali patibandla Elsevier (science direct)

Using panel data for 11 indian industries for the period 1989-99, the author examines empirically whether large investors reduce agency costs of corporate governance by monitoring and disciplining managers (owners). This study breaks outside investors into foreign and government owned local financial institutions.

The author observes that higher the share of government financial institutions in investment, lower is the profitability (efficiency) of the firm and higher the foreign equity higher the profitability. However the author notes that this relationship between foreign equity and profitability is non-monotonic (i.e. Increases at a decreasing rate).

Ownership structure and firm value: empirical study on corporate governance Systems of indian firms (2003) Saikat sovan deb C.v. chaturvedula

The authors test the monitoring, expropriation, convergence of interests and entrenchment effect hypothesis.

The authors find support for all but the expropriation hypothesis. Firm value is observed to increase and after a certain threshold point decrease as ownership concentration increases.


Agency theory and firm value in india (2004) Jayesh kumar

An empirical examination of the effects of organization structure on firm performance from an agency perspective using panel data of more than 2000 indian firms for the period 1994-2000.

Foreign shareholding pattern does not significantly influence firm performance. Directors’ shareholding beyond a threshold level influences firm performance.

Capital structure and corporate governance Jayesh kumar (isb website: refer bibliography).

Explores the relationship between corporate firm’s ownership and capital structure in the context of an emerging market economy-india.

Debt structure is non-linearly linked to corporate governance (ownership structure). Firms with weaker corporate governance mechanisms and dispersed shareholding patterns tend to have higher debt levels. Firms with foreign ownership and low institutional ownership have lower debt levels.

Scope for further research: Researchers thus for have invariably considered the independent effect of ownership structure on firm performance. It would be interesting to explore what happens if the interaction effect between ownership structure and firm performance is considered. Such studies would present researchers with the challenging task of dissecting the independent and interaction effects of these variables and establishing how they explain firm value. Another interesting angle of research would be to seek answers for questions like what prompts equity investments in emerging markets like india with weak minority protection. Also there is not much work assessing the impact of trade / tax policy changes and its consequential impact on ownership structure if any.

TABLE V: RESEARCH PAPERS ON CORPORATE BOARD EFFECTIVENESS

Reference Work type, source discipline ,data Discussion Board structure and size: the impact of changes to clause 49 in india. (2010) Helen lange Chinmoy sahu

Examines the impact of potential country specific factors and the role of individual entrepreneurs and institutional investors in determining the board size and structure. Authors delve on issues like how regulatory changes have impacted corporate governance practices in india and what in addition to regulation has had an effect on the size and composition of boards.

Country specific factors influence the size of the board however there is little evidence for the determination of board composition.

Evolution and effectiveness of independent director in Indian corporate governance. (2010) Umakanth varottil

Explores the rationale for the emergence of the concept of independent directors by tracing their evolution in us/uk and examines the transplantation of the concept into india with a view to evaluate effectiveness of independent directors.

Diffused shareholding in the west made it conducive for controls like having independent directors on the board. In india due to concentrated ownership the concept of independent directors is a misnomer. The author addresses the question what does the future hold for independent directors in india and elaborates on measures from a normative view point.

Corporate governance in an emerging market: what does the market trust? (2010) Rajesh chakrabarti Subrata sarkar

An event study centered on the satyam scam. Authors attempt to answer the question what corporate governance variables have an effect in determining the cross-sectional variation of returns experienced in the stock market following public knowledge of the scam.

There exists a significant difference in markets perception of corporate governance indicators from those frequently listed or discussed in extant literature. More than board and audit independence it is the quality of the board/audit committee, the process of selecting the independent directors, the setting up of an effective board and the audit processes that are important for effective governance.

Independent directors and firm value: evidence from an emerging market. (2010) Rajesh chakrabarti K.v.subramanian Frederick tung

An event study that follows unique data on the cessation of independent directors across indian companies following the satyam scam. Authors examine cumulative abnormal returns in the stock market for the period succeeding the scam.

Authors observe that listed firms in which independent directors resigned in jan’09 experience negative abnormal stock returns. Such returns were found to be more negative where the independent directors have a monitoring role on the board.

Independent directors : This paper presents he preamble to The author opines that independent directors are


an indian legal perspective (2009) Dipen chatterjee

independent directors-clause 49 listing agreement. It presents a theoretical perspective of how an independent director is defined by law, the need for having independent directors and the role played by them.

not truly independent because they are handpicked by the promoters. Unlike uk in india there is no public advertisement for the post of independent directors. The author ideates that sebi could regulate the right to nominate independent directors so that there is more transparency in the process.

Scope for further research: In the area of board effectiveness studies, assessing the value of independent directors in varying legal / economic contexts such as developing economy / emerging economy perspective and offering to explain determinants of variations there in present formidable opportunities to researchers

Selected Annotated Source of Indian Corporate Governance Websites

The World Wide Web (internet) represents a powerful medium that is of use to tech savvy researchers. Some of the most significant sites on the free web offering information to those interested in researching corporate governance is listed below. The authors like to state that the nature of information found on each website would be influenced by the objectives, goals, missions etc., of the authoring body. The emphasis here is to present readers with a compendium of important websites related to corporate governance in India.

http://www.mca.gov.in:

This is a resource offered by the Ministry of Corporate Affairs in India. The website links readers to the Corporate Governance Voluntary Guideline 2009, a set of voluntary guidelines proposed for voluntary adoption by the corporate sector based on the recommendation of the task force set up by CII under the Chairmanship of Naresh Chandra in February 2009. It is expected that these guidelines will progressively converge towards a framework of best corporate governance standards and practices. The guidelines would help first time researchers/readers in the area of corporate governance acquaint themselves with various guidelines concerning board of director’s appointment, independent director attributes, remunerations for independent directors, responsibility of the board, audit and remuneration committee and mechanism for whistle blowing.

http://www.academyofcg.org/

The Academy of Corporate Governance, ACG, founded and angel funded by Yaga Consulting Private Limited, Hyderabad, India has as its objectives of being an independent think tank for corporate governance policy, advocacy or knowledge development. The link leading to codes and best practices reports corporate governance of 25 countries and the European continent. For readers interested in India centric information there are links to the CII’s Desirable Code of Corporate Governance, Clause 49 listing agreement, First Principle of Corporate Governance for PEs in India, Kumar Mangalam Committee report on Corporate Governance. This web site also supports an e- journal which features articles on corporate governance (however this feature has been disabled from the third quarter of 2005).

http://www.nfcgindia.org/home.html

The National Foundation for Corporate Governance (NFCG) has an online library of principles, codes, rules and regulations related to corporate governance. These relate to both


the Indian as well as the international context. In addition, the online library also contains few original research papers commissioned by the foundation. The library resources are freely accessible.

http://www.directorsdatabase.com

This website provides a single point access to information on the Board of Directors of listed companies with their age, experience and other directorships they hold. It contains rich data of independent directors of 2618 BSE listed companies. Information on cessation of directors is also available.

www.iodonline.com

Institute of Directors (IOD) is the association of company directors. The site is rather messy, sparse on information, and while it offers links to related sites, quite a few are broken. The Institute’s monthly newsletter is online, as well as the Centre for Corporate Governance’s quarterly journal.

http://www.corpfiling.co.in

www.corpfiling.co.in is the common filing and dissemination portal for all companies listed on the BSE & the NSE. www.corpfiling.co.in has been developed and is being maintained by IRIS Business Services (India) Pvt. Ltd. Readers interested in gaining access to the share holding patterns of BSE/NSE listed companies will find this website very useful.

http://www.corpgov.deloitte.com/site/in/

The Deloitte's Centre for Corporate Governance, aims to promote a dialogue in the critical areas of corporate governance among industry bodies, companies and their boards of directors and senior management, professional services firms, academia, government and others. This site is designed to discuss governance related issues for the Indian boards and their committees. The site contains a diverse collection of resources and thought leadership from Deloitte including third party resources.

CONCLUSION

In more recent years, the area of corporate governance has emerged as a highly relevant and prominent area of business research. The proliferation of the internet has caused a rapid increase in the quantity of information available. This paper is an attempt to provide a good foundation for first time researchers in the area of corporate governance to embark on their research journey.

As the field of corporate governance evolves information available on the free web will become more abundant and wide ranging. By attempting to categorize research in this area the authors believe that this paper will benefit new researchers in understanding the direction of research. The papers and the websites reviewed could be bookmarked by new researchers. This paper may constitute a modest, though not insignificant step in furthering the good work done by previous researchers while serving as a compendium for new entrants.

Track 4 Economy and Inflation

Public Private Partnership is an Instrument of Faster Economic Growth of India: Perspective on Policies and Practices

in Education Sector

Madhavi I. Dhole*

Abstract—Good quality infrastructure has been the main enabler of high level of economic growth in any developed as well as developing country. Despite becoming the second fastest growing and the fourth largest economy of the world, India continues to face large gaps in the demand and supply of essential social and economic infrastructure and services. India’s global competitiveness is greatly affected by the lack of infrastructure, which is critical for improving productivity across all sectors of the economy. Up gradation in transport, power and urban infrastructure is critical in sustaining India’s economic growth, along with improved quality of life, increase in employment opportunities and a step towards eradication of poverty. The importance of infrastructure for India’s growth, as well as the growing consensus on the need for PPPs. It emerges from a government-led planning and prioritization process. It symbolizes long term cooperation between the government and the private sector where the government’s role gets redefined as a facilitator and enabler, while the private partner plays the role of a financier, builder and operator of the service and facility. The current trend in the infrastructural development has highlighted the facilitating role played by the Government for increasing private participation in various sectors. Government has permitted 100% FDI under the automatic route for all road development projects.

Keywords: developing economy, PPP, infrastructural growth

INTRODUCTION

The Education system that we are following today is the same system the English framed for Indians in the 19th century. They had planned it for us from their point of view as they needed a lot of babus for their offices in India. They never wanted to give Indians the education that would make them something higher than the babu. Now, from their point of view, the system was correct and viable. However, tradegy is that even after 50 years of independence, we still continue to follow the system of education framed by the English for us. We have never bothered to study the application and utility of the education we are imparting to our children. After independence there has been a mushroom growth of schools and colleges but education remained at the level of 50% of the population. Then the moot point now is what has been the utility of these myriads of education homes that have grown in the last 50 years? The growth of these institutions has also been sporadic. Most cities and town have seen growth in the

*Sterling Institute of Management Studies, Navi Mumbai


number of schools and colleges but the rural areas which consist of 70 – 80% of India’s population could not share with this growth.

New policy on Education as approved by the Government stresses that a human being is an asset and a precious resource for the whole nation which needs to be cherished. It requires to be developed with dynamism and removal of disparities in a phased manner. For all round development of the society, it is essential to take effective measures in the direction of the implementation of our new education policy and also common school education system as recommended long back. The National system of Education envisages a common educational structure. The common core of national curricular framework has to include contents related to national integrity and identity including our freedom struggle years and constitutional obligations.

The new policy envisages promotion of values such as India’s common cultural heritage, democracy and secularism, protection and preservation of our environment, removal of any type of social barriers and follows the message of small family norms. The youth requires being motivated towards peaceful co-existence and international co-operation and making them understand education as a unique investment for present and future

The higher education system in India has grown in a remarkable way, particularly in the Post-independence period, to become one of the largest system of its kind in the world.However, the system has many issues of concern at present, like financing and management including access, equity and relevance, reorientation of programmes by laying emphasis on health consciousness, values and ethics and quality of higher education together with the assessment of institutions and their accreditation. These issues are important for the country, as it is now engaged in the use of higher education as a powerful tool to build a knowledge-based information society of the 21st Century.

EDUCATIONAL PLANNING AT LOCAL LEVELS

The provision for educational facilities, although necessary, in itself does not ensure universalization of basic education. Whether children actually attend school depends on decisions made by families and individuals. While the planning techniques and public investments were successful with regard to creating facilities, they were not suffi cient to attract children to schools, especially in deprived regions which needed educational progress the most. Many of those who remained non-enrolled were from economically backward localities and disadvantaged groups. Therefore, developments in the next stage of planning pointed to efforts more to generate demand for education at the local levels than to create supply through public Investment. Much educational planning represents an explicit or implicit attempt to regulate and control learning, regulating who may or may not teach, and authorizing who, individually or as groups, shall have access to various types and levels of schooling. This aspect of the educational process did not always receive adequate attention in the plans and planning processes. Educational planning by convention has rarely given adequate attention to curriculum development and curriculum transactions. At the university level, institutional planning has different emphases from that at the school level. The decline in public funding for higher education has required institutions of higher education to

Public Private Partnership is an Instrument of Faster Economic Growth of India 201

mobilize resources for their survival and development. At the school level, the dominant thrust of institutional planning has been improvement in operational efficiency rather than resource mobilization.

Indian universities need to be dynamic and adoptive to the changing needs and priorities of the society and should provide an arena of freedom to young innovative minds. It is disturbing that the number of students opting for undergraduate courses in basic sciences is declining. The public-private partnerships will have tremendous influence on the development of technologies and how these are managed. There is a need for high level of funding for research, including contractual research. A critical review of activities of higher educational institutions as well as their budgets needs to be conducted to phase out obsolete activities and create necessary space for new activities. The shifting from traditional incremental budgeting to a performance based one is now necessary to arrest the erosion in quality and the resource crunch. The institutes are under-financed and under-staffed. Effort can be made to harness the full potential of trained workforce. Along with the necessary and inevitable quantitative expansion of higher education, it is equally important to improve the quality of higher education. Institutions of higher education would find it difficult to meet the challenges of globalization of higher education if one fails in this front. Emphasis on quality parameters becomes all the more necessary in the light of mushrooming of private institutions with the opening up of the Indian economy.

PUBLIC PRIVATE PARTNERSHIP

The higher education system in India has grown in a remarkable way, particularly in thepost-independence period, to become one of the largest system of its kind in the world. However, the system has many issues of concern at present, like financing and management including access, equity and relevance, reorientation of programmes bylaying emphasis on health consciousness, values and ethics and quality of higher education together with the assessment of institutions and their accreditation. These issues are important for the country, as it is now engaged in the use of higher education as a powerful tool to build a knowledge-based information society of the 21st Century.

Objectives of Study

• To study the impact of PPP on education sector • To analyze the impact of PPP on different aspects of education

Limitation of Study

India as mixed economy having socialistic pattern and one of the largest democracies in the world. It is difficult to cover every sector of economy. Education sector have been covered for the research purpose.

Methodology

For the purpose of paper different research articles, journals, books magazines, news paper articles Reports are reffered. Data is collected from secondary sources.


Education and Management of Higher Education

The Indian higher education system is one of the largest such systems in the World. The new regime under WTO where competence is the cardinal principle of success in international operations has made it abundantly clear that the country should exploit its excellent potential in higher education and training facilities and prepare itself to export the Indian brand of education to foreign countries. Policy planning and evolving strategies for this task are somewhat new for the country. But, this is an opportunity which cannot be missed by India, as it offers interesting possibilities for strengthening of the nation’s talent and resourcefulness .Indian higher education system has undergone massive expansion in post-independent.

India with a national resolve to establish several Universities, Technical Institutes, Research Institutions and Professional / Non-professional Colleges all over the country to generate and disseminate knowledge coupled with the noble intention of providing easy access to higher education to the common Indian. The Public initiatives played a dominant and controlling role in this phase. Most of the Universities were Public institutions with powers to regulate academic activities on their campuses as well as in their areas of jurisdiction through the affiliating system. Even the private institutions enjoyed large-scale financial support in the form of grants from the public exchequer. Private funds as well as individuals played key roles in the cause of higher education. With the public funding being no more in a position to take-up the challenging task of expansion and diversification of the higher education system in the country to meet the continuously growing demands at present, there is little option other than bringing in private initiatives in a massive way to meet the various challenges. The deregulating mechanism of controls started with the granting of “Autonomous Status” to identified Colleges in the 1970s. Some of these Colleges have graduated further to receive the “Deemed to be University” status in later years. Now, the country is on the threshold of the establishment of Private Universities in different States.

• It is the primary responsibility of the State to provide the eligible with good quality higher education at reasonable cost. There shall be no withdrawal of the State from this responsibility. In fact, the investment in this area by the State shall be stepped-up to 3% of the GDP. This is essential for the intellectual strength of the State to address equity concerns.

• A huge dedicated fund says, National Human Resource Development Fund, to the tune of at least one- percent of the GDP, may be created to tackle the equity problems. It shall be the accepted principle that ‘no talented person shall be denied access to higher education opportunities on the grounds of economic and social backwardness’. This fund may be dedicated to offer direct financial support in the form of scholarships, partial financial assistance and educational loans to students directly, based on the criteria of talent and financial and social backwardness. A well-designed mechanism to spot talents in different disciplines of knowledge is needed for this purpose. Further, foolproof criteria to determine financial or any other social backwardness is required.


• Taxing the individuals, who had the benefit of the State resources in the past for their education, and the industries, which are likely to derive advantage from good human resources, are the options for creating such a fund. While it is difficult to arrive at an ideal solution to the equity problems, the absence of a credible and efficient method of addressing these problems will lead to lowering of the quality of human ware and large-scale discontent. The society may be the ultimate looser.

• Industries may be encouraged to be partners with educational institutions directly for the development of human resources dedicated to their interests. This could happen in the areas of creating infrastructure, faculty sharing and direct support with funds. The UGC may set-up a High Power Committee to explore these possibilities and to workout the modalities for such a partnership.

• The industries belonging to a specific discipline or related disciplines shall be encouraged to establish state of the art Research and Training centres to develop the necessary specialized man power. Automobile industry is a case point. Existing Public and Private Institutions and possible new Institutions may generate ample provisions for partnerships in this regard.

• The areas not capable of attracting private funds shall be supported sufficiently well from public funds. This, as indicated earlier, is essential for the balanced intellectual growth of the society.

• Industries and individuals may be encouraged to channel a percentage of their profits to the higher education sector, with no strings attached to such contributions. Viable incentives may be offered for attracting such investments from the private resources.

• Strong quality control measures to assure performance above an acceptable benchmark is essential for the institutions. The various rating agencies shall evolve scientific, transparent and consistent benchmarking techniques for this purpose. A regulatory system to ensure compliance to the set bench marking is needed with sufficient powers to close down non-complying institutions is a need of the hour. The Higher Education Policy needs to incorporate such features in it in the interest of the nation.

• A Total Quality Management for courses offered, monitoring the achievement of the students at all stages of the course, shall be introduced at all higher education institutions.

• An accreditation system for individuals in various disciplines may be thought of.Indeed, GATE and NET examinations with limited objectives are forerunners of such a system. The performance of students in such examinations may be made an important parameter for the accreditation of the institution.

• The idea of allowing students to do Diploma or Certificate courses side by side with their Degrees, recently put forward by the UGC, is a welcome step towards empowering the students to take-up work soon after their Degree courses. This is an area where private initiatives can come up to augment the activities of the Colleges. The Colleges can develop in-house faculty and other facilities for this purpose and make these facilities available at a reasonable cost. Such a measure will turn around many Colleges from the non-performing class to the performing class. There shall be


a mechanism to accredit these courses and facilities to ensure quality. This is an area where public/private partnership has a creative role to play.

• It is important to realize that we live in a fast changing world, dictated by the developments in technology. Quick access to information has made knowledge creation fast, and the multiplier effect has made it even explosive. It is increasingly difficult to anticipate changes and respond to them with creative purpose. Designing courses with relevance to the future and developing the necessary manpower to deliver them is a challenging task. All this calls for a team of professionals in different areas to come together to develop proactive strategies for higher education to meet the future demands. A Strategy Planning Body and an Institution to design and develop futuristic courses for transferring them to the Universities and Colleges may be created.

• Good Faculty is a must for any higher education institution aspiring for Quality. It is high time that an Indian Higher Educational Service, along the lines of the IAS, is formed. This has the advantage of quality control of the teaching faculty for higher education. A new Human Resource Development Policy shall be evolved to facilitate this. This could assure that there is continuous infusion of young blood in to the teaching cadre; which is not happening at the moment. With some restrictions on faculty appointments, the present evil of inbreeding can be eliminated. The inbreeding has destroyed many departments at Indian Universities.

• Private Universities are a reality now and, as such, strong regulatory mechanisms are to be put in place immediately to monitor and control their activities with the objective of ensuring quality and social accountability. Higher education is a Public Good and cannot be left to the market forces to control. Those who venture investment in this area shall be properly scrutinized. Those with commercial interests dominating over the interests and ethics of higher education shall be eliminated.

• The present archaic administrative practices need a thorough reform. A healthy Public/Private partnership can do much in this regard by way of exchanging good practices. A management system, lean but professional, making use of modern communication and information technologies is required to facilitate quality higher education.

Basic primary education is generally viewed as a public sector’s responsibility, which makes any shared involvement of public and private sectors a highly sensitive issue. Transfer of user fees to private sector providers is sensitive, especially in basic education. Even more sensitive is the management of public education institutions by the private sector. PPPs can be used by unions and opposition as pretext to claim that government is abandoning its core task of providing public education.


Fig. 1: PPP Formulation: Key Success Factors Obstacles

With education in many poor countries provided substantially by the private sector (e.g. 40% in Pakistan), there is often a wide pool of educational and administrative expertise upon which to draw. With regard to accessibility, quality and efficiency, state schools perform poorly for a wide range of reasons. Some of these lie outside the sphere of influence of the individual schools or local educational authorities – the effects of HIV/AIDS and violent conflict on the available teacher population; cultural realities that discriminate against educating daughters in favor of domestic work; and resource allocation decisions taken by national governments. Other weaknesses, however, may lie inside the control of the local education system. These include the quality of teaching; relevance of curriculum (e.g. to dropouts); management of buildings and equipment investments; sexual violence among student populations; teacher and student absenteeism; administrative inefficiencies; and lack of accountability. Innovations abound for involving the private education (and corporate) sector in outsourcing, in-sourcing and marketization initiatives in relation to public schools and educational authorities. Many of these examples require, at a minimum, policy reform and, in many cases, legal reform. “if we start with direct provision of services we end up working on policy and vice versa.” Further, the controversial nature of these PPP arrangements requires winning over public support, which is a function of transparency in the balance of outcomes between social benefits and private sector returns. There is perhaps a role here for development assistance agencies to work with ministries of education and finance to evaluate the available options. Most important, policy-makers and education professionals need to jointly assess the suitability of each option given the specific social, political and infrastructural circumstances of a particular country or region..

PPP Arrangements for Marketing ‘Bottom of the Pyramid’ Educational Products

A more direct form of private sector participation in basic education is the provision of text books, computers, science and vocational training equipment, and other educational and


teaching aids. There is much discussion in the world of corporate social responsibility at present on the ‘fortune at the bottom of the pyramid (BoP)’ – the notion of marketing low-cost products in high volumes to low-income end-users. Educational department procurement budgets offer one obvious potential source of revenue for companies who manufacture teaching aids for this market.

Present Status on TVET Programs in Relation to Education for Sustainable Development

Technical and Vocational Education and Training (TVET) programme run from the Ministry have been contracting public and private training institutions to prepare the youth for employment by acquiring skills. TVET system is demand driven, accessible, beneficiary financed and quality assured that meets the needs of society for stability and economic growth, the needs of Enterprise for a skilled and reliable workforce, the need of young people for decent jobs and the needs of workers for continuous mastery of new technology. TVET also prepares learners for employment and then helps them to continue their education and training on flexible mode with courses running part time and fulltime. Since TVET programs are demand driven it is targeted to cater for the labour market through various skills training programs Institution Based training and Employer Based Training are equally recognized pathways or tracks to develop a career based on skills training.

Regulatory framework for the higher education sector Regulatory body Ministry of Human Resources Development (MHRD) Profit making Must be run as ‘not-for-profit’ institutions in the form of a society or trust

Affiliation/accreditation

Higher education institutes must be affiliated to a university and are therefore accredited by the University Grants Commission (UGC) Further, each stream (medicine, management, engineering and law) is monitored by a specific body – for instance the .All India Council for Technical Education (AICTE) for engineering and management colleges – and affiliation to these is mandatory.Without affiliation in one of these categories, a higher education institute will be considered illegal unless it can be demonstrated that graduating students are successful in the job market (an example is the Indian School of Business in Hyderabad, a proven premier business school with strong industry acceptance) Curriculum As required by affiliated body Typical operating models Greenfield project Public Private Partnership Foreign investment 100% permitted through the automatic approval route Private Sector Participation and corporate social Responsibility Education presents a large opportunity to the private sector, especially corporate India, who need to look at education not just as Corporate Social Responsibility (CSR), but also as a profit venture that will also create trained manpower for their other businesses There is clearly an opportunity for private players to enter the education space. There is a large demand supply gap, which is further exaggerated due to the low quality of education and capacity constraints at the premium colleges / institutions. This opportunity exists in all three segments – schooling, higher education and vocational training, and in almost all parts of India. Some success stories are Manipal


University, Amity University and the Indian School of Business. Also, private sector participation is more likely to lead to the creation of thought leadership and centers of excellence in the country. This can then support policy development and at the same time incorporate industry demands in a market based curriculum.Schooling and higher education are ‘not for profit’ ventures due to the requirements of being registered as a Trust or Society. However, an ‘operate and manage’ model is now legally accepted and enables a ‘for profit’ model in education. In such ventures, financial returns are attractive, with EBITDA levels of 30% plus and project IRRs ranging from 20% to 30% levels.

Corporate participation is clearly required in building the education landscape of India, as such firms not only bring in project management experience and financial capability, but also the mindset to achieve the right quality. Some examples of corporates in education are:

K12 Schooling

• Dhirubhai Ambani International School, by Reliance Industries • Stonehill International School, by Embassy Group • Educomp Millennium Schools, by Knowledge Tree Infrastructure, a subsidiary of

Ansal API and Educomp’ssubsidiary, Edu Infra

Higher Education

• Proposed Vedanta University by Mr. Anil Agarwal, Chairman of Vedanta Resources Plc, spread across 6,000 acres with estimated investment of more than US$ 3 billion in Orissa

Key Findings

• The NGO is familiar with the local language, the school administration and the relevant issues

• We can also think of opening up the FDI for education. • Employment opportunities for many unemployed IT trained youth, • Computer Education at young age lays a good foundation for the students for higher

education • Computer has been used by teachers to make their job easy by avoiding the writing

hassles (result preparation, notifications etc) • Used for school management system software • Internet has enabled more GK and basic knowledge • Education due to e-content has given good impetus to students ability to retain things

for longer duration • There are many such PPP cases in Vocational education in university level but none

so far in school level as the education system in India is not as similar to US/UK where more stress is on hands on rather than textual.

• Higher Education should be developed as social economic growth of the country.


• Public-private-partnerships, academia-industry partnerships, academia-research laboratories, public- NGOs, public-community etc. will need to be the models rather than working in separate compartments

CONCLUSION

The current trend in the infrastructural development has highlighted the facilitating role played by the Government for increasing private participation in various sectors. The education sector in a state of transformation. There is a lot of money to be made in addition to really adding value and giving back to society. This development whereby a promoter of an infrastructure group takes a big stake in an education company really signals a paradigm shift. That there are difficulties in negotiating and reaching agreement is really the tip of the iceberg; the real issue is the private sector is not part of the education sector policy dialogue in developing countries for reasons on both sides. This has to change. PPPs in education will come out of a strong education policy environment. In the globalized World, the State-protected educational system cannot withstand the pressure without making itself competitive. Taking the problem of resource crunch in higher education at face value, research grants from industries, donations for admissions etc. which were found to be inadequate. It was observed that an organized structure for higher-educational fund raising and creating a culture of giving are the only possible solutions.

REFERENCES [1] A Technical and Vocational Training (TVET) system for the Briefing Paper (April, 2007) [2] Country Report (2007) [3] Interim Report, Employment Skills Training Project [4] Management of higher education journal [5] Finance and Development Journal [6] Management of higher education in India [7] What’s worth of teaching by Marion Brady 1989 [8] Aggarwal A, Rizvi IA and Popli S (2004) Global branding of business schools: an Indian perspective. [9] Report of UGC (2006) University Grants Commission. [10] Nigavekar A (2005) Ensuring quality higher education for all. Country Report: India [11] Central Advisory Board of Education Report of the CABE committee on Financing of Higher and Technical

Education [12] Report Card of India’s education Vol.1

Review of Changes in Monetary Policy and it’s Impact on Indian GDP & WPI

Dr. Mrinalini Kohojkar*

Abstract—The Liberalisation Privatisation Globalisation policy of 1991 created waves of changes in India. A decade after the implementation of the policy, Indian economy was placed on high growth trajectory. However, the global meltdown of 2008 – 09 slowed down the growth process. Benefits of globalization also underlined the risks from the same. Reserve Bank of India (RBI) as the regulatory authority in the banking sector had to adjust the liquidity in the economy to promote the growth and simultaneously had to manage the inflationary pressure. In fact the more challenging job was the withdrawal of the accommodative monetary policy and implementation of monetary tightening without disturbing the growth prospects. This paper tracks down the changes in monetary policy in terms of repo rates, reverse repo rates and CRR since September 2008 and analyses the impact of the policy on growth rates and price levels.

Keywords: Repo rates, Reverse repo rates, CRR, Growth (GDP), Inflation (WPI)

OBJECTIVE

The study aims at establishing the impact of the monetary reforms such as changes in repo rates, reverse repo rates and CRR on the major macroeconomic indicators such as GDP & WPI.

METHODOLOGY

Simple technique of matching the reforms with subsequent changes on GDP & WPI is used. The data for the comparison is mainly obtained from RBI website – www.rbi.org.in

Main Components of the Paper

• Basic challenges to emerging market economies in dealing with growth- inflation dilemma in the light of global meltdown.

• Shifts in Indian monetary policy during September 2008 to October 2010 • Impact of policy changes on Indian GDP growth rates and WPI. • Analysis of future growth prospects and risk of inflation in India.

The paper aims at a review of changing repo, reverse repo and CRR rates and the impact of the same on Indian GDP and WPI.

Basic Challenges to Emerging Market Economies in Dealing with Growth‐ Inflation Dilemma In The Light of Global Meltdown

The emerging economies have very high growth potentials but they are exposed to the risks like political, monetary and social instability. India is being looked upon as a huge emerging *Thakur Institute of Management Studies & Research, Mumbai


market because of the demographic advantage and Increasing GDP and PCI. The present task for the policy makers is to bring the economy back on the high growth track and to curb the inflationary pressures to avoid overheating of the economy.

The real GDP growth rates from 2000 to 2009 are given in Table 1.1. TABLE 1.1: REAL GDP GROWTH RATES (%)

YEAR 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Real GDP Growth rate 4.4 3.9 4.6 6.9 8.1 9.2 9.7 9.9 6.4 5.7

Source – Global finance – www.gfmag.com

The real GDP growth rate suffered a major setback in the year 2008 and 2009 due to global meltdown. The series of bank failures and collapse of financial institutions created a major economic crisis in the US and subsequently in many European nations. The shrinking global demand adversely affected Indian growth rates and hence there was a slowdown in overall economic progress.

The major concern of the Indian monetary policy one year ago was the significant slowdown in growth in the wake of the financial crisis in the advanced economies. All the policy rates and reserve ratios were tuned to generate the high growth rates. Indian GDP registered a robust recovery since second half of 2009-10 and is continued in the first quarter of 2010-11.

The recovery of GDP growth rate is mainly due to strong performance of the services sector. Manufacturing sector exhibited a robust recovery but recently has become very volatile. To achieve and maintain high growth rate of GDP, all the sectors require monetary and fiscal policy support.

Business confidence surveys conducted by NCAER and FICCI have shown remarkable improvement over the previous quarter. The forecast of the various agencies for real GDP growth rate for the year 2010-11 is in the range of 8.3 % to 9.7%. The well known measures of inflation are the Consumer Price Index (CPI) which measures consumer prices, and the Wholesale Price Index (WPI) which measures inflation in the wholesale market for the selected commodities. The basic classification of the commodities is done as primary articles, Fuel and power and manufactured products. The prevailing view in mainstream economics is that inflation is caused by the interaction of the supply of money with output and interest rates. Mainstream economist views can be broadly divided into two camps: the "monetarists" who believe that monetary effects dominate all others in setting the rate of inflation, and the "Keynesians" who believe that the interaction of money, interest and output dominate over other effects. Other theories, such as those of the Austrian school of economics, believe that an inflation of overall prices is a result from an increase in the supply of money by central banking authority.

Review of Changes in Monetary Policy and It’s Impact on Indian GDP & WPI 211

TABLE 1.2: MONTHLY CPI FOR 2006 TO SEPTEMBER 2010

YEAR JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC 2010 16.22 14.86 14.86 13.33 13.91 13.73 11.25 9.88 9.82 2009 10.45 9.63 8.03 8.70 8.63 9.29 11.89 11.72 11.64 11.49 13.51 14.97 2008 5.51 5.47 7.87 7.81 7.75 7.69 8.33 9.02 9.77 10.45 10.45 9.70 2007 6.72 7.56 6.72 6.67 6.61 5.69 6.45 7.26 6.40 5.51 5.51 5.51 2006 4.39 5.31 5.31 5.26 6.14 7.89 6.90 5.98 6.84 7.63 6.72 6.72

Source- www.tradingeconomics.com/Economics/Inflation-CPI

The inflation rate, which was briefly negative in the middle of 2009, began to accelerate rapidly later in the year. This upward momentum continued into the first half of 2010, with double-digit inflation persisting for a few months. The rapidity of the transition was surprising, given the fact that the recovery in growth was just getting under way and, importantly, the global situation was still very uncertain. The reason for the sharp increase was that all the possible drivers of inflation were simultaneously contributing. Each one by itself may not have resulted in the outcome that we saw, but all three working together resulted in a rather sharp acceleration. Food prices rose sharply because the monsoon of 2009 was deficient in most parts of the country, impacting agricultural production. However, there are longer term forces at work on food prices, which are a matter of concern. Fuel prices also rose as the prospects of a global recovery improved and, particularly, the Emerging Market Economies actually saw a sharp acceleration in growth. The most significant factor from the monetary policy perspective was the growing demand-side pressures. The manufacturing sector – overall and without the food processing component the non-food manufacturing inflation, show a tremendous acceleration.

• The basic challenge for EMEs is to retain the high growth rates, when developed nations are still struggling to regain the economic strength and employment. The dormant demand in advanced countries have adversely affected the prospects of exports and hence affect growth adversely.

• Rising prices of fuel, power and other materials add to inflationary pressure. Measures adopted to control inflation may affect growth adversely.

• The protectionist policy of developed nations may also create obstacles in the growth process.

Shifts in Indian Monetary Policy during October 2008 to Septmber2010

The focus of the study is to track the changes predominantly in repo and reverse repo rates in response to dual policy objectives i.e. growth and control over inflation. With effect from 29th October 2004 the nomenclature of repo and reverse repo was aligned as per international terminology. As per the new usage of the terms Reverse repo indicates absorption of liquidity and repo indicates injection of the liquidity.

Bank rate was almost constant during 2004 to 2008 at 6%. By August 2008 ,Reverse repo was raised from 4.5 to 6.0% , repo was raised from 6% to 9% during 2004 to 2008 and CRR was updated from 4.5% to 9%. Overall the focus was on control over inflation and India’s performance on growth front was satisfactory.


The global crisis that started in September 2008 did not have much impact on India instantly. However international instability and turmoil affected Indian growth rates subsequently and the macroeconomic growth indicators exhibited a slowdown. Industrial production index and exports were the major cause of concern. Hence there was a shift in RBI’s policy objective from control over inflation to the concern for growth. From October 2008 to 5th March 2009 reverse repo and repo rate were drastically lowered. The reverse repo was brought to 3.50 from 6 and repo rate to 5.00 from 9%. CRR was also lowered from 9% to 5%. All the measures were focusing on increasing liquidity to boost the declining growth rates.

The annual policy statement 2009-2010 on April 2009 underlined the need for Government and Reserve Bank to work in coordination and cooperation to minimize the impact of global economic crisis on India. In order to provide ample liquidity for all productive activities RBI further reduced repo rate from 5.0 to 4.75 and reverse repo from 3.5 to 3.25 on April 21st 2009. The major focus of monetary measures was towards providing growth stimulus to the apparently sluggish economy. The rates almost remained stationary during April 2009 to February 2010.

TABLE 2.1: MOVEMENTS IN KEY POLICY RATES (%)

Effective since Reverse Repo Repo Rate CRR April 26 2008 6.00 7.75 7.75(+0.25) May 10, 2008 6.00 7.75 8.00(+0.25) May 24, 2008 6.00 7.75 8.25(+0.25) June 12, 2008 6.00 8.00(+0.25) 8.25 June 25, 2008 6.00 8.50(+0.50) 8.25 July 05, 2008 6.00 8.50 8.50(+0.25) July 19, 2008 6.00 8.50 8.75(+0.25) July 30, 2008 6.00 9.00(+0.50) 8.75 Aug 30, 2008 6.00 9.00 9.00(+0.25) Oct 11, 2008 6.00 9.00 6.50(-2.50) Oct 20, 2008 6.00 8.00(-1.00) 6.50 Oct 25, 2008 6.00 8.00 6.00(-0.50) Nov 03, 2008 6.00 7.50(-0.50) 6.00 Nov 08, 2008 6.00 7.50 5.50(-0.50) Dec 08,2008 5.00 (-1) 6.50(-1.00) 5.50

January 05, 2009 4.00 (-1) 5.50(-0.50) 5.50 January 17, 2009 4.00 5.50 5.00(-0.50) March 04, 2009 3.50 (-0.50) 5.00(-0.50) 5.00 April 21, 2009 3.25 (-0.25) 4.75(-0.25) 5.00 Feb. 13, 2009 3.25 4.75 5.50(+0.50) Feb.27, 2009 3.25 4.75 5.75(+0.25)

March 19, 2009 3.50 (+0.25) 5.00(+0.25) 5.75 April 20, 2009 3.75 (+0.25) 5.25(+0.25) 5.75 April24. 2009 3.75 5.25 6.00(+0.25) July 02, 2009 4.00(+0.25) 5.50(+0.25) 6.00 July 27, 2009 4.50 (+0.50) 5.75(+0.25) 6.00

Source –Macroeconomic and Monetary Developments Second Quarter Review 2010-11 of Reserve Bank of India Mumbai)

Gradual recovery of the growth rates, especially industrial production created an energetic atmosphere on the overall growth front. The early signs of recovery of US and other European countries also created favorable expectations for the future. The baseline projection for GDP


growth was revised to 7.5%. The food prices in the domestic market started rising and global commodity prices were also soaring. The prices of crude oil and other products increased with the favorable forecast of global demand conditions. The policy stance changed once again from managing recovery to containing the inflation.

The dominant factor that shaped monetary policy for 2010-11 was high inflation. The shift in the policy was not a easy task for India. The process of exit from monetary expansion has been relatively smooth because there was no undue expansion of RBI’s balance sheet. Monetary intentions were to contain inflation and so the reverse repo rates were brought to 4.50 and repo rates were brought to 5.75 by July 2010. The CRR was raised up to 6% .The major changes in reverse repo, repo and CRR rates are provided in Table number 2.1

The recent global financial crisis triggered a spate of policy responses that differed in their magnitude and coverage.The use of central bank balance sheets, in particular, as a key instrument of monetary policy received unprecedented focus during the recent crisis. In this context, the study of the impact of policy actions taken during the crisis on the balance sheets of central banks, brings out interesting results. It also reveals the fact that the RBI’s balance sheet exhibited different trends than the ones exhibited by central banks of advanced countries.

• The assets of the Fed and the Bank of England more than doubled, that too in a matter of weeks, while that of the European Central Bank (ECB) grew by more than 30 per cent. In the Fed’s case, this reflected direct lending to banks and dealers through existing and new lending facilities; indirect lending to money market funds; purchases of commercial papers (CP) through special purpose vehicles and drawings by foreign central banks on dollar swap lines.

• Balance sheet changes with respect to the Bank of Japan ( BoJ) were mainly driven by introduction of measures to facilitate corporate financing, along with the purchase of CPs and corporate bonds.

• Several challenges emerged from significant changes in the size of central bank balance sheets, such as change to the risk profile of balance sheets with rise in credit.

• Although several emerging market economies (EMEs) resorted to various measures for expanding liquidity, both in domestic currency and in foreign currency, the size of central bank balance sheets in EMEs increased much less than their counterparts in advanced economies, due to absence of aggressive measures.

• In India, despite some pressure on financial markets after September 2008, with RBI ensuring ample rupee and forex liquidity in the system, normalcy and orderly conditions were restored in the markets. Unlike other countries, RBI’s balance sheet did not expand much as the ample liquidity was injected through CRR operations.

Impact of Policy Changes on Indian GDP Growth Rates and Inflation Scenario

The growth rates in most of the advanced countries have remained sluggish where as the EMEs have regained the robust growth rates in recent times. The prompt and timely measures that RBI has taken to deal with the exceptional global economic crisis have successfully


attained the duel goals – The economy is back on the high growth track and the inflation is well within the limits. Following table indicates growth rates of GDP at factor cost (2004-05 prices)

TABLE 3.1: GROWTH RATE OF GDP AT FACTOR COST (2004‐05 PRICES)

09-10 09-10 Q1 09-10 Q2 09-10 Q3 09-10 Q4 10-11 7.4 6.0 8.6 6.3 8.6 8.8

Source: ( CSO as mentioned in Macroeconomic and Monetary Developments Second Quarter Review 2010-11 of Reserve Bank of India Mumbai)

RBI’s measures to provide ample liquidity during December 08 to April10 have helped the economy to attain higher growth rates. Of course many more factors such as domestic demand, good monsoon worked as major drivers for the growth. The growth is inward and is happening at the time when EME are getting stronger and advanced economies are struggling to maintain growth and employment.

With growing unemployment and sluggish growth rates, the advanced economies are experiencing moderate levels of inflation. IMF has projected 1.4 rate of inflation for advanced economies. Global review indicates that EME are exposed to the dangers of inflation and IMF e projection for the price rise is 6.4 for 2011. Increasing demand from EMEs have led to fuel price hike and thus inflationary pressures. Rising domestic demands add fuel to the fire. Indian economy started feeling the heat of the inflation from March 2010 and then the stance of monetary policy shifted from growth to contain inflation. The repo, reverse repo and CRR rates were raised in from April 2010 and today the indicators reveal that the inflation is well within the control. Table no. 3.2 indicates rates of change in WPI as per the new base – i.e. 2004- 05.

TABLE 3.2: RATES OF CHANGE IN WPI AT 2004‐05 BASE

Mar08 Mar09 June09 Sept09 Dec.09 Mar 10 June10 July 10 Aug10 Sept10 7.7 1.5 -0.7 1.1 6.9 10.2 10.3 10.0 8.5 8.6 Source –Macroeconomic and Monetary Developments Second Quarter Review 2010-11 of Reserve Bank of India Mumbai

The data reveals the fact that the inflation is being brought to the acceptable levels from August 2010 . The supply side of the market has also extended the support in the fight against inflation. Good monsoon, food and nonfood manufacturing and the growth of the service sector together have prevented the WPI to go on spiral rise.

Currently Reverse repo rate is 5.5%, repo rate is 6.25% and CRR is 6% . It is an indication of the slow transition from growth orientation to inflation management.

Analysis of Future Growth Prospects and Risk of Inflation in India

The EMEs have played a strategic role in pulling the global economy out of deep economic crisis. The present position of the EMEs appears to be very promising and strong. Specifically for India, the growth prospects are very high and the inflation is also being managed efficiently without disturbing the growth. In fact, India has a great opportunity to take a leap forward.


Growth scenario - The factors that will drive the growth in the near future are–

Demographic Factors • India’s sheer size of the population makes it possible to consider ‘inward looking

growth ‘strategy. At the time when, all rich and advanced economies are going through tough times, Indian corporate sector has huge domestic market. This provides enormous opportunity to grow and prosper.

• The age structure of Indian population is rightly described as demographic dividend. With the youth power at the disposal, India can take any challenge successfully. The youth generate demand for anything and everything and hence can give a great boost to the corporate sector. The youth also present themselves as the labour force. The volume of the labour force will provide cheaper labour to the incorporations , reducing their cost of production.

Economic Factors • The need for better infrastructure will attract many big players in the market.

Currently power generation is one of the most lucrative business and many domestic and foreign players are eagerly waiting to enter the market . The growth may follow the typical path of unbalanced growth strategy.

• The economy is poised to grow with high rates of Per capita Income, savings and investment.

• The foreign capital is being invested on a very large scale and this becomes an opportunity for faster economic growth.

• India has a strong industrial and service sector base.

Political Factors

India is being led by a matured leader like Dr. Manmohan Singh. The political impact on economic policy decisions is being minimized. The decisions are based on experience and economic considerations.

Social Factors The importance of education is being understood and increasing number of children are pursuing education and higher education.

Government and Regulatory Authorities

The government and regulatory authorities design appropriate policy framework to ensure smooth and steady growth.

Challenges to Growth

• EMEs are growing at a time when advanced economies are struggling to maintain the growth rates and employment. Many advanced economies are following protective policies to ensure jobs foe the locals. These policies may hamper the growth of EMEs by reducing the opportunities of outsourced jobs.


• Weaker growth and declining job opportunities in the advanced countries may adversely affect the prospects of exports.

• Capital flows in EMEs are needed to augment their investible resources. However the large volumes of foreign capital with their volatile nature may create instability and severe fluctuations in EMEs.

• The exchange rate fluctuations, especially the appreciation of exchange rates may adversely affect the demand for the exports.

• For India in specific , current account deficit on BOP account is cause of concern. Higher growth rate may increase the gap in future. Currently, capital account is in surplus due to heavy flow of FII and FDI. However, foreign capital inflow is not the permanent solution for deficit on current account as capital inflows are volatile in nature.

Future Growth Projections In spite of the challenges India is being considered as the one of the fastest growing economy. India’s performance in terms of growth in 2011 is projected by different institutions separately as follows-

• Economic Advisory Council to PM has revised projection of 8.2 % of February 2010 to 8.5 in July 2010

• IMF has revised the projection of 9.4 of July2010 to 9.7 in October 2010 • NCAER revised projection of 8.1 July 10 to 8.4 in October 2010 • OECD revised the projection of 7.3 of November 2009 to 8.3 in May 2010. The growth rate projections for 2011 given by the four important sources have some

difference. IMF has placed a heavy confidence in India’s growth potentials. All the projections are revised with higher expectations. It is indeed very encouraging to see that Indian economy is poised to move on high growth track.

Inflation Scenario Factors affecting inflation are classified as real and monetary.

Keynesian explanation and solution for control over business cycle lies in real factors operating in the real market. Aggregate demand and supply need to be in balance to maintain price movements in comfortable limits. Monsoon plays a key role for agricultural production in India and fuel, power supply, labor, infrastructure and other raw material determine the supply side of manufacturing and services sector.

Monetary factors, specifically money supply is affected by velocity of money, foreign capital inflow, government borrowings and investment. RBI through monetary measures tries to attain balance between demand for money and supply of money. Liquidity adjustment is the major tool to regulate money supply and price fluctuations.

Projections for Inflation Looking at WPI and CPI movements from April 2010 to October 2010, there is moderate rise in price level. Considering the YOY movement of WPI , there is actually a fall in the movement.


Looking at the current scenario in India, domestic demand is going to remain high in future and challenge is to match the supply side. For augmenting the supply side, special focus should be on the sector specific requirements. The supply can flow smoothly if the financial resources are made available at reasonable cost. The cooperation from other countries in obtaining the materials and for the sell of the products is essential. The control over inflation can be obtained only if government, RBI and governments of our trading partners operate in cooperation.

Summary and Conclusion

The period from September 2008 is marked by global turmoil and financial instability. RBI had the difficult challenge to steer India through global financial crisis and thereafter to manage inflation effectively. The study was aimed at the review of the monetary policy changes in the area of repo rates, reverse repo rates and CRR and the impact of the same on GDP growth rates and inflation. The period from September 2008 to October 2010 was covered for the study.

The success of RBI’s monetary policy is beyond doubt and same has been appreciated worldwide. The changes in policy rates were precisely matched with needs and were perfectly calibrated to achieve the required results.

In the first phase December 2008 to April 2010 the focus of the monetary policy was restoration of growth. The success of the policy is visible in the upward revision of the growth projections by IMF, NCAER, OECD and economic advisory council to PM. All have projected the growth rate for 2011 well above 8%.

In the second phase- April 2010 till date, the challenge is much more complex. The global economy has not yet regained the full strength. India along with other EMEs is registering robust growth. Inflation in double digit is not acceptable. To control inflation in this scenario without hampering growth was truly a very difficult task. The withdrawal of the accommodative policy and reinforcing monetary tightening had a risk of slipping out of high growth trajectory.

We must congratulate RBI for establishing control over inflation and maintaining high growth prospects.

There are many other factor which have worked in favor of RBI policy without which this success would not have been possible. For e.g. Good monsoon of 2010 has contributed to both – growth as well as price stabilization. Even then, we all must appreciate the key role played by RBI in steering the country successfully through the rough weather of financial turmoil.

We can also conclude that reverse repo, repo and CRR are the powerful monetary tools, when used in appropriate quantity and time, will give the required results. However, the success of these measures also require support from government policies and other real factors.


The study can be made more technical and elaborate by establishing the lags between the time of introduction of reforms and the subsequent time taken by the objective variables for the necessary response.

REFERENCES [1] World development indictors2010- The World Bank

Websites

[2] www.rbi.org.in- Monetary policy statements, various reports, publications and reviews. [3] www.tradingeconomics.com/Economics/Inflation-CPI [4] www.gfmag.com [5] The paper is heavily based on facts and figures provided by RBI on the website and the information published

in Economic Times on day to day basis.

The Great Inflation and a Recovering Economy

Rashmi* and C.A. Rishi Ahuja**

Abstract—“Law of inflation: whatever goes up will go up some more” Inflation and the economy of a country are closely related. The effect on the economy of any country is not immediate. There is a cumulative effect. Inflation and the economy both influence all the major macroeconomic indicators of a country like GDP, Demography, Capital investment, Export-import, Industrial production.

Negative effects of inflation include a decrease in the real value of money and other monetary items over time, uncertainty over future inflation may discourage investment and savings. Positive effects include a mitigation of economic recessions, and debt relief by reducing the real level of debt. Inflation would make the heavy debt more manageable as wages rise but the amount owed stays the same.

The objective of this paper is two-fold: firstly, to study how the scope of inflation has widened in the form of food inflation, stock market inflation, industrial inflation, etc.and secondly to analyze and study how inflation can help as an aid to boost an ailing economy( In Indian context). Inflation and its effect on economy are enormous. In other words, all events are interlinked and the entire economic cycle gets upset.

Very often we hear the word "Inflation", every time we hear some CRR Rates, Price High, Credit Policy and more, and don't understand what exactly it is.

Keywords: Inflation, Ailing economy, Food inflation, Stock market inflation, Industrial Inflation

MEANING OF INFLATION

Inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation is also erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy.

Mismatch of Demand and Supply Leads to Inflation

Inflation is not the rise of prices, but the excess money printing and expansion of the money supply.

For example, let’s say, earlier, a product can be bought for Rs.10, but now the same product costs Rs.50. An increase of 400%, If you ask any one why this happened, the answer will be simple the cost of production has gone up so the end value. The reason is right, but the perspective is wrong, the price has not gone up but the value of the money has gone down.

*Institute of Productivity and Management, Meerut


“Inflation is a self-perpetuating and irreversible upward movement of prices caused by an excess of demand over capacity to supply.”

—Emile James

Relation between demand, supply & cost going up

People has excess of money holding with them, which forces them to spend it, by which the demand is going up for the respective product but the supply is same/constant, simple rule applies here, demand is high, supply not reaching demand, price is high.

Now, why does one spend when the rates are already high?

The answer is simple, ask your mother. She says, the prices may go even more up tomorrow, so let me buy and store the stock today itself.

Inflation is a state in the economy of a country, when there is a price rise of goods as well as services. To meet the required price rise, individuals have to shell out more than is presumed. With increase in inflation, every sector of the economy is affected. Ranging from unemployment, interest rates, exchange rates, investment, stock markets, there is an aftermath of inflation in every sector. Inflation is bound to impact all sectors, either directly or indirectly.

FACTORS LEADING TO INFLATION

There are several factors which lead to inflationary circumstances in an economy. These factors enable the demand to increase without maintaining any balance with the supply. The factors are:

• Increase in the supply of money • Price Controls • Expenditure of monetary reserves

A sustained rise in the prices of commodities that leads to a fall in the purchasing power of a nation is called inflation. Although inflation is part of the normal economic phenomena of any country, any increase in inflation above a predetermined level is a cause of concern. High levels of inflation distort economic performance, making it mandatory to identify the causing factors. Several internal and external factors, such as the printing of more money by the government, a rise in production and labor costs, high lending levels, a drop in the exchange rate, increased taxes or wars, can cause inflation.

Different schools of thought provide different views on what actually causes inflation. However, there is a general agreement amongst economists that economic inflation may be caused by either an increase in the money supply or a decrease in the quantity of goods being supplied. An increase in the quantity of money in circulation relative to the ability of the economy to supply leads to increased demand, thereby fuelling prices. The case is of too much money chasing too few goods. An increase in demand could also be a result of declining interest rates, a cut in tax rates or increased consumer confidence.

The Great Inflation and a Recovering Economy 221

Inflation occurs when the cost of producing rises and the increase is passed on to consumers. The cost of production can rise because of rising labor costs or when the producing firm is a monopoly or oligopoly and raises prices, cost of imported raw material rises due to exchange rate changes, and external factors, such as natural calamities or an increase in the economic power of a certain country.

EFFECTS OF INFLATION

Inflation affects the whole of the economy squarely including the taxes and import tariffs. The effect of inflation and economic growth is manifested in the following cases:

Investment If the prices of goods increases and people have to compensate for the increase in price, they usually make use of their savings. In the event when savings are depleted, fund for investment is no longer available. An individual tends to invest, only if savings of an individual is strong and has sufficient money to meet his daily needs.

Interest Rates

Whenever inflation reigns supreme, it is a well known fact that the value of money goes down. This leads to decline in the purchasing power. In the event, when the rate of inflation is high, the interest rates also rise. With increase in both parameters, cost of goods will not remain the same and consequently people will have to shell out more money for the same goods.

Exchange Rates

Inflation and economic growth are affected by exchange rates as well. Exchange rates denote the value of money prevailing in different countries. High rate of inflation causes severe fluctuations in exchange rates. This adversely affects trade (export and import), important business transaction across borders and value of money also changes.

Unemployment

Growth of a nation depends to a large extent on employment. If rate of inflation is high, unemployment rate is low and vice versa. This theory is propounded by economist William Philips and this gave rise to the Philips Curve.

Stocks

The returns a company offer, on investment fully depend on the performance of the company. Past performance, current positions of the company and future trends decide how much (money, in form of bonus or dividend) is to be returned to the investors. Owing to inflation, several monetary as well as fiscal policies are impacted.


INFLATION AND ECONOMIC GROWTH

Inflation is a condition, when cost of services coupled with goods rise and the entire economy seems to go haywire. Inflation has never done good to the economy. Inflation and economic growth are parallel lines and can never meet. Inflation reduces the value of money and makes it difficult for the common people. Inflation and economic growth are incompatible because the former affects all sectors as indicated by:

CPI or Consumer Price Index

A rise in the CPI indicates inflation. The CPI or the consumer price index is used as an index for salaries, wages, contracted prices, pensions. This is done to adjust with the inflation effects. It is an important economic indicator.

GDP or Gross Domestic Product

The gross domestic product is another important economic indicator and is usually inflation adjusted. This is an important tool for measuring the rate of inflation. The important segments, which are hampered include:

• Investment • Interest rates • Exchange rates • Unemployment • Stocks • Various monetary policies • Various fiscal policies

Economic Costs of Inflation

The economic costs of inflation are many. They are stated and briefly illustrated below:

• Global competitiveness: Inflation initiates competitiveness in the worldwide markets. The higher are the prices of the products of a country, the lesser are the scopes of competition, which subsequently reduces the country's exports. But, this situation may be counterbalanced if there is a fall in the exchange rate.

• Disorder and improbability: With high inflation, the inhabitants of a country become indecisive about the ways of spending their money, and what to spend their money on. It is under this circumstance that the country's commercial firms become indifferent and less willing towards investment, as they are not sure about their future profits.

• Boom and Bust economic Cycles: Generally, the high inflationary growth is followed by a collapse; as such constant situation becomes unbearable at times. It is low inflation which initiates a sustained growth in the economy of a country. It is beneficial and harmless in nature, for allowing easy and smooth price adjustments.


• Cost of decreasing inflation: High inflation is believed to be unacceptable. Hence the governments of different countries across the world feel that it is best to decrease inflation. This attempt involves high rates of interest. However, a fall in the inflation may lead to decline in the economic growth and development of a nation, and increase in unemployment problems.

• Re-allocation of income: With redistribution of income, the economic conditions of the borrowers improve and that of the lenders, deteriorate. However, this situation is more dependent on the real interest rates.

• Shoe leather costs: mean making savings on losing bank interests. As a result, the customers hold less cash amounts and frequent the banks more.

High Inflation

High Inflation is a condition in which the prices of goods and services reach an all time high. The prices of goods and services increase rapidly under such a circumstance, faster than the remuneration of people. Before one can receive his/her paycheck the prices are skyrocketing. The price level during the high inflation period shoots up very high. But the increase in prices does not assure the increase in the production of goods and services. Instead the demand of goods increase and the supply decrease. The supply of money also increases. This is measured against the standard price index.

High inflation in an economy can harm the economy by affecting it in a negative way. It casts long-tem effects. High inflation reduces the incentive within the mass to save money hence it reduces the potential for long-term capital formation. The accumulation of money is perturbed by this phenomenon as the value of money hits rock bottom and people lose the spirit of saving. The consumers cannot buy the goods since the price level shots up beyond their reach. However, the high inflation also grants a positive effect to the economy by reducing the spending capability of the mass in the long-term by making goods less affordable. In this way they might be able to save some amount of money in the long run.

High inflation is not good for an economy since it dismantles the steadiness of the economy. The rising of the prices take place at an uneven rate and that makes it even more harmful. In the present times none of the economy is free from inflation but reducing the rate of inflation is probably the greatest challenge for the countries.

Inflation Statistics

Inflation Statistics gives the record of inflation in different countries depending on the available data of the changes in the purchasing power of the mass. Inflation takes place when the general price of goods and services experience an upward movement. Inflation is measured by placing the altered price against the various price index, the most common being the CPI or the Consumer Price Index. Inflation statistics reveal the impact of inflation on the various economies by recording how much problem an economy suffers due to the hike in


price. The statistical report expresses the inflation rate in terms of figures. This numeric data divulge the situation of an economy during an inflationary period.

Contents in Inflation Statistics

The inflationary rate is measured against the CPI which takes into account the changes that take place at a daily basis in the market. The CPI again is divided into two groups. They are:

• CPI for the Urban Consumers • CPI for Urban Wage Earners and Clerical Workers • A new incorporation is the Chained Consumer Price Index which is a correspondent

of the Cost-of Living index.

The Producer Price Indexes is a group of indexes that records alterations brought about changing prices on the part of the seller who sells domicile goods. They were previously referred to as the Wholesale Price Index.

Import and Export Prices also form another index against which inflation rate is measured. In this index is recorded the changes in the price of international goods and services. This comparison is done by setting the US price level as a parameter against which the prices of all the other goods and prices of various countries are measured.

Consumer spending survey is yet another index which records the spending habits of the consumer and also includes the data on their expenditure and income.

TYPES OF INFLATION

There are three major types of inflation:

• Demand-pull inflation: is caused by increases in aggregate demand due to increased private and government spending, etc. Demand inflation is constructive to a faster rate of economic growth since the excess demand and favorable market conditions will stimulate investment and expansion.

• Cost-push inflation: also called "supply shock inflation," is caused by a drop in aggregate supply (potential output). This may be due to natural disasters, or increased prices of inputs. For example, a sudden decrease in the supply of oil, leading to increased oil prices, can cause cost-push inflation. Producers for whom oil is a part of their costs could then pass this on to consumers in the form of increased prices.

• Built-in inflation: is induced by adaptive expectations, and is often linked to the "price/wage spiral". It involves workers trying to keep their wages up with prices (above the rate of inflation), and firms passing these higher labor costs on to their customers as higher prices, leading to a 'vicious circle'. Built-in inflation reflects events in the past, and so might be seen as hangover inflation.

Some other Categories of Inflation are

Pricing Power Inflation: Pricing power inflation is more often called as administered price inflation. This type of inflation occurs when the business houses and industries decide to


increase the price of their respective goods and services to increase their profit margins. A point noteworthy is pricing power inflation does not occur at the time of financial crises and economic depression, or when there is a downturn in the economy. This type of inflation is also called as oligopolistic inflation because oligopolies have the power of pricing their goods and services.

Sectoral Inflation: This is the fourth major type of inflation. The sectoral inflation takes place when there is an increase in the price of the goods and services produced by a certain sector of industries. For instance, an increase in the cost of crude oil would directly affect all the other sectors, which are directly related to the oil industry. Thus, the ever-increasing price of fuel has become an important issue related to the economy all over the world. Take the example of aviation industry. When the price of oil increases, the ticket fares would also go up. This would lead to a widespread inflation throughout the economy, even though it had originated in one basic sector. If this situation occurs when there is a recession in the economy, there would be layoffs and it would adversely affect the work force and the economy in turn.

Fiscal Inflation: Fiscal Inflation occurs when there is excess government spending. This occurs when there is a deficit budget.

Hyperinflation: Hyperinflation is also known as runaway inflation or galloping inflation. This type of inflation occurs during or soon after a war. This can usually lead to the complete breakdown of a country’s monetary system. However, this type of inflation is short-lived.

EXPANDING SCOPE OF INFLATION IN THE GLOBAL ERA

As we have talked above, regarding the various traditional types of Inflation, now we are moving towards the major objectives of the research paper. The Scope of Inflation has widened in this new era of Globalization and has been replaced by some new aspects in the form of food inflation, stock market inflation and industrial inflation.

Food Inflation

Food inflation continues to soar as the Indian economy remains firmly on the path to recovery. The spike in food price inflation comes in the backdrop of stronger than expected GDP growth in the second quarter.

What’s Causing Global Food Price Inflation?

New research shows that India, China, and speculators are not the culprits in the food price explosion. Biofuels were a significant element in the 2005-2007 food price surges as they accounted for 60% of the growth in global consumption of cereals and vegetable oils. There cannot be any doubt that Biofuels were a significant element in the rise of food prices. Since new research also shows that Biofuels support policies are disappointingly ineffective on environmental grounds, governments should reconsider them.

Global food prices have exploded since early 2007, causing major social, political, and macroeconomic disruption in many poor countries and adding to inflationary pressure in the


richer parts of the world. Concerns about high food prices have been expressed at the highest political level, including during the recent G8 summit.

What has caused the explosion of food prices? Several culprits have been blamed.

• Newspapers have cited an internal World Bank document as having found that 75% of the price increase was due to Biofuels.

• Several governments and commentators see speculation as a major driving force. • A widely held view has it that rapidly growing food demand in the emerging

economies is pushing up global food prices.

New evidence on the causes

The OECD (Organization for Economic Co-operation and Development) has carefully looked at market developments and analyzed the implications of Biofuels support policies. The analytical framework used is a large-scale partial equilibrium model of agricultural commodity markets in all major countries at the international level, with detailed representation of the multitude of policy instruments affecting these markets, including those targeting Biofuels.

Results were published recently in the OECD-FAO Agricultural Outlook, a paper on the causes and consequences of rising food prices, and a report on the economic assessment of Biofuels support policies. The evidence is pretty clear.

No Hard Evidence that “Speculation” Boosted the Spot Price

Yet, there is no hard evidence that “speculation” has added much to the price increase on spot markets. After all, it is only when “speculators” actually buy produce on the spot market that they can drive up the price, and this would have to be reflected in growing stock levels – but stocks appear to have declined throughout the period of rising prices.

A different type of panic, though, has without doubt contributed to food price inflation – the barriers to exports that some food exporting countries have imposed in order to keep domestic food prices under control. Yet, the precise effect that this form of government panic has had on short-term price movements is very difficult to quantify.

OECD analysis clearly shows that two factors external to agriculture and food have had, and will continue to have in the years to come, a significant impact on the rise of global food prices.

• The rapid increase in crude oil prices and energy prices more generally has significantly raised the costs of producing and shipping agricultural products.

• The weak dollar has contributed to driving up dollar-denominated commodity prices in international trade.

Causes of Rising Food Prices

This rise in prices is a consequence of both demand and supply trends. On the demand side, food prices, are rising on a mix of strong consumption growth in emerging markets, which in


turn has been powered those countries’ impressive income gains. In recent years, the world’s developing countries incomes have been growing about 7 percent a year, an unusually rapid rate by historical standards. China, for example, has accounted for up to 40 per cent of the increase in global consumption of Soya-beans and meat over the past decade.

Industrial Inflation

The JOC-ECRI Industrial Price Index is the brainchild of Geoffrey Moore. Originally created in 1986, the current Index has been in use since 2000. It is designed to give an early "heads-up" to inflationary pressures. Although textiles (-4.28%) and "miscellaneous" (-3.33%) are down, the rise of petroleum (+31.46%) and metals (+27.51%) in the last year brings the Industrial inflation rate to a heart-stopping 10.58%.

Rising production costs have hit a rate that is the highest since 2004 – 28.1 percent annually. One of the reasons for it is the raw materials boom on the world market. It should not affect consumer prices in the short term, but production prices will pull consumer prices up eventually, and producers will fell keener competition with imports. According to Rosstat, the state statistics agency, the producer price index rose 4.9 percent in June for a total of 17 percent since the beginning of the year. Minerals rose in price the fastest at 10.6 percent and 18.3 percent for the half year. The main factor driving the price rise is oil prices.

The consumer price index rose 9.1 percent from January to mid-July of this year. That is about 15 percent annually. One reason that an increase in the producer price index does not automatically lead to an increase in the consumer index is that export goods are high in the producer index. Petroleum products and coking coal have increased in price by 150 percent in the last year. They are to a significant extent export goods as well.

Excluding the raw materials sector, producer prices do not looks as catastrophic. But manufacturing will be affected sooner or later because of rising costs and face lowered profitability, forcing them to raise prices. It will be easiest for producers to raise prices on goods with little import competition. In the long term, there is a threat of slowing down the growth of industrial production and the economy as a whole.

Stock Market Inflation

If there is inflation, stock markets are the worst affected.

Inflation and Stock Market- the Logistics

Prices of stocks are determined by the net earnings of a company. It depends on how much profit, the company is likely to make in the long run or the near future. If it is reckoned that a company is likely to do well in the years to come, the stock prices of the company will escalate. On the other hand, if it is observed from trends that the company may not do well in the long run, the stock prices will not be high. In other words, the prices of stocks are directly proportional to the performance of the company. In the event when inflation increases, the company earnings (worth) will also subside.


This will adversely affect the stock prices and eventually the returns. Effect of inflation on stock market is also evident from the fact that it increases the rates if interest. If the inflation rate is high, the interest rate is also high. In the wake of both (inflation and interest rates) being high, the creditor will have a tendency to compensate for the rise in interest rates. Therefore, the debtor has to avail of a loan at a higher rate. This plays a significant role in prohibiting funds from being invested in stock markets. When the government has enough funds to circulate in the market, the cost of goods, services usually go up. This leads to the decrease in the purchasing power of individuals. The value of money also decreases. In a nut shell, for the economy to flourish, inflation and stock market ought to be more conforming and predictable.

There is no one-to-one correlation between the market and inflation. Typically, most investors stay away from the stock market when inflation goes up. This is because prices of shares along with the prices of everything else go up without any corresponding increase in intrinsic value. Such a bull phase soon leads to a market correction due to many investors deciding to realize profits.

Debt Market becomes More Attractive

One step most governments take to contain inflation is to tighten money supply by raising interest rates. This is because inflation is classically defined as too much money chasing too few goods. Once the money supply is tightened, the prices of commodities come down, thereby bringing down the inflation rate. The increase in interest rates means investors will now find debt instruments such as fixed deposits more attractive than shares. This prompts investors to stay away from the stock market.

Export-oriented Companies

The tight money supply affects different industries differently. For instance, a company that manufactures automobile parts for the foreign market will be adversely affected by the price hike due to inflation as it will not be able to increase its prices in line with the rise in its costs. This will affect its bottom line and in turn impact its share price negatively.

FMCGs

However, an FMCG (Fast Moving Consumer Goods) manufacturer will see an increase in revenue growth due to the inflationary prices and, hence, it’s EPS (earnings per share) and scrip price are likely to go up. However, it must be kept in mind that once prices fall, as they are bound to once inflation is contained, such companies will end up reporting a lower EPS.

Luxury Goods Manufacturer

A manufacturer of luxury goods for the domestic market (such as the makers of high-end cars) on the other hand might find its market size reduced as its products might find themselves priced out of the market. In this scenario as well the profits of the company and hence its share price is likely to be affected adversely.


An investor should, therefore, not be averse to allocate funds in his portfolio to shares, but instead pick the right company to avoid incurring losses during an inflationary period. Investors can also consider booking profits when the market goes up and wait for the correction to set in before buying shares once again. However, those who have invested for the long term should consider staying invested. Investing solely in debt funds will lead to net erosion in the value of the corpus as the interest rates do not keep pace with inflation in the long term.

AILING ECONOMY AND INFLATION

Somewhat higher inflation could strengthen the ailing economy. Inflation would make the heavy debt a bit more manageable as wages rise but the amount owed stays the same. And it would create more incentive for businesses to invest their cash rather than sit on it, because inflation would reduce the value of hoarded money.

Some economists fear outright deflation, a destructive, self-reinforcing cycle of falling prices that can cause a long period of economic misery.

Very Important question: Is Inflation Good or Bad?

When the government is trying to decrease the inflation rate at its best means the answer is the inflation is bad.

But we say Inflation is absolutely good, why?

As we said inflation means excess of demand over supply, so if the demand is more and supply is low there will be a start of new player entry, again advantages of competitive rates, best quality, and latest methods technology comes in, most importantly the Foreign Direct Investment (FDI) goes up.

The current economic recovery could suffer if extremely low levels of inflation become the norm. With deflation, consumers and businesses respond to falling prices by sitting on cash, because it will become more valuable in the future as its buying power increases. Hoarding, in turn, weakens the economy further, putting more downward pressure on prices.

But that vicious cycle doesn't suddenly kick in only when inflation moves from slightly positive to slightly negative. For example, businesses that forecast a very low rate of inflation would be more inclined to hold onto cash than they would if inflation were higher. Yet without new investment, the jobless rate could remain high, keeping wages - and ultimately prices - from rising.

Inflation during recession may not seem like such a good thing, because a recession means money is tight for many, while inflation means higher prices. The fact is though that inflation during recession periods may benefit the economy of the country in some ways. Inflation is better than stagflation, because inflation usually occurs when the economy increases, because there is more spending going on. Right now many parts of the world do not have this problem because consumers are not spending. Instead consumers and even lending institutions are keeping their cash close, and hoarding it instead of spending it. Inflation can


actually help the economy at times, as long as it is a steady rate of inflation. It increases consumer spending, and can stimulate the economy.

Right now the economy is stagnant, with employment at an all time high and businesses closing frequently. Usually the gross domestic product and inflation go together, with an increased GDP meaning an increased rate of inflation. Increasing the gross domestic product and having inflation can mean an economy that is expanding, not retracting. Anyone who has stocks in their investment portfolio usually realizes that without an increase in the GDP, companies can not make bigger profits, which is detrimental to their stock performance. An inflation rate of two to three percent, and that is very stable, is critical for a healthy economy. One way that inflation benefits the economy during a recession is that it affects wages. Workers do not take wage cuts usually, but inflation can actually reduce wages once inflation is taken into consideration. Employers usually give raises, sometimes as a cost of living adjustment, or COLA, which takes inflation into consideration and adjusts the real wage to account for it. If a COLA or raise is two percent of a wage, but inflation is five percent, the worker is taking a three percent pay cut even though it appears they are making more money, because the value of a dollar is less.

Because of the current lack of inflation, with an interest rate in America as close to zero as it has been in a long time, the stock market is extremely volatile, and many investors have lost most or all of their investment capital. The crisis has hit across almost all sectors of the economy, but it started with the housing and sub prime markets, and spread from there. The stagnant economy and lack of inflation has hurt investors and financial institutions, and a small steady rate of inflation could stimulate the economy so that it starts to grow again, instead of shrinking. This may be one of the few options that can help revive an economy that is falling lower and lower.

CONCLUSION

In reality, low inflation rate and an upward economic growth is never possible. Nevertheless, low inflation rate means slow economic growth. Whenever, money is in excess, there is bidding by the consumers due to which the cost of goods escalates.

High inflation rates are regarded as harmful to an overall economy. They add inefficiencies in the market, and make it difficult for companies to budget or plan long-term. It discourages investment and saving. And also increases hidden tax, as it pushes taxpayers into higher income tax rates.

With high inflation, purchasing power is redistributed from those on fixed nominal incomes. This redistribution of purchasing power will also occur between international trading partners. It will become more expensive and affect the balance of trade. It also increases instability in prices.

People will stores consumer goods and products with their wealth in the absence of resources and thus causing and creating shortages of the hoarded resources. With high inflation, firms must change their prices in order to keep up with economy-wide changes. But often changing prices itself a costly activity. For Example –to print new menus, more money is required.


It is always seen that high unemployment occurs in the labor market. As, some inflation is good for the economy, as it would allow labor markets to reach equilibrium faster.

Debtors who have debts with a fixed rate of interest will see a reduction in the "real" interest rate as the inflation rate rises.

Economic Benefits of Inflation are: Controlled growth of Inflation can become part of business growth, simply because savings are often invested, because of the net loss if they are kept in a Bank. During times of controlled Inflation, people in the past tended to spend, as they feared prices could rise, saving on buying now, rather then paying more lately.

Higher Inflation eats away at the real value of a currency. This could mean that the actual value of debts decrease, benefiting indebted businesses and private individuals.

Stocks bought at an earlier value, could rise in price and sold off at a higher price bringing higher profitability.

Values of fixed assets could rise, making some Companies more financially secure. Traditionally higher Inflation often leads to higher prices; therefore fixed assets in theory should rise in value.

“The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are

the refuge of political and economic opportunists.”

—Ernest Hemingway

Microfinance as A Panacea for Developing Economies—Myth or Realty

Dr. Veena Tewari Nandi*, S. Das** and Dr. V.V.R. Raman***

“Feed a man fish and you feed him for a day, teach him to catch fish and you feed him for life”

—Chinese Proverb Abstract—Microfinance as we know it today was first started in 1976 in the Bangladeshi village of Jobra. The concept got shape in the form of Grameen Bank, the brainchild of a Professor of Economics in Chittagong, Dr. Mohammad Yunus. Today it has spawned thousands of other institutions doing similar things: World Bank statistics show that more than 7,000 microfinance institutions serve some 16 million people in developing countries with $7 billion in outstanding loans, 97 percent of which are repaid. Dr. Mohammad Yunus and the institution he founded, Grameen Bank was jointly awarded Nobel Prize in 2006 for the endeavor in this field.

The most exciting promise of microfinance is that – even without being a panacea – it can reduce poverty with a self fulfilling mechanism, once adequately ignited, without requiring continuous donations that often spoil and humiliate the poor, empting the donors’ pockets. Unsubsidized sustainability and profitability combined with deep outreach to the underserved stands as the most ambitious and difficult goal.

In this paper we have highlighted the problems, issues and opportunities of microfinance especially in the developing countries. Some small case studies have been incorporated in the paper from the developing countries.

Keywords: Micro Credit, Group Lending, Entrepreneurs, Informals, MFI

INTRODUCTION

The term microfinance as used here refers to financial services for the poor and lower-income sectors of the population. Most microfinance loans range in size from a few dollars up to several thousand dollars, with a standard loan in the $300 to $1,000 range. Loans typically are used for working capital and have maturities of below one year, although longer-term products are also sometimes available. Borrowers vary in size from the self-employed to enterprises with up to five or even 10 employees.

Microfinance sometimes generates confusion for non specialists because there are two microfinance models. The model that will be emphasized in this article is based on lending to single borrowers using principles familiar to most lenders.

* CBE, Halhale **IPM, Ghaziabad ***College of Health Sciences

Microfinance as A Panacea for Developing Economies—Myth or Realty 233

The other main microfinance model, and the one that has captured the public imagination, is the group-lending model originated by Grameen Bank of Bangladesh and its charismatic founder, Muhammad Yunus, on the basis of a $27 loan that he made to 42 basket weavers in 1976. The defining characteristic of group lending is that all group members are responsible for the timely repayment of any loan made to any single member of that group. This model therefore internalizes risk diversification and monitoring into the structure of the loan. It also mitigates the difficulties of securing adequate collateral, because the group lending structure provides the secondary source of repayment if collateral fails. One of the great legacies of this model is the fact that the poor can be very reliable borrowers. There is much debate within the microfinance field about the pros and cons of the individual-lending versus the group-lending model. In fact, the models are similar in every way except for the definition of the borrower--that is, a group or an individual.

LITERATURE REVIEW AND STUDIES

The eradication of poverty continues to be a central political issue in most developing countries. Despite serious efforts by local governments as well as bilateral and multilateral donor communities over the past few decades, many people still suffer from poverty. According to estimates by the World Bank, more than 1.2 billion people were classified as extreme poor in 1998, living on less than US$1 a day (World Bank 2000). To combat pervasive poverty, the United Nations declared as the first of its Millennium Development Goals (MDGs) to halve the proportion of people who suffer from extreme poverty by 2015 compared with the 1990 level, and called for unprecedented commitment from nations worldwide.

It is widely recognized that limited access to financial services is one of the major bottlenecks preventing poor households from improving their livelihoods. Moreover, imperfect information significantly increases default risks caused by adverse selection, moral hazard, and strategic default (e.g., Stiglitz 1990; Ghatak 1999), which make formal banks reluctant to offer services to the poor who cannot supply sufficient collateral to secure their loans. As a consequence, poor households tend to be excluded from formal financial services, not only borrowing but also savings and insurance, which in turn prevents the poor from investing in various profitable projects, smoothing consumption, and improving their ability to cope with various unexpected shocks (Okten and Osili 2004; Conning and Udry 2007).

In the absence of sufficient collateral to pledge, the poor generally have to rely on loans from informal moneylenders at high interest rates or from friends and family, whose supply of funds is generally limited (Weiss and Montgomery 2004; Conning and Udry 2007). In order to supply cheaper credit, many developing countries intensively implemented large-scale subsidized credit programs between the 1950s and 1970s. These programs were originally intended to target rural farmers with the hope that subsidized credit at below-market interest rates would not only increase their income but would also promote investment in agricultural modernization, such as in the diffusion of fertilizer and high-yielding crop varieties, thereby increasing food production and, subsequently, stimulating overall economic growth (Yaron and Benjamin 2002). Nevertheless, a growing body of evidence suggests that the subsidized


credit programs were unsuccessful in that they induced local political elites to take advantage of below-market interest rates, leading to rent-seeking activities, insufficient outreach to the rural poor farmers, very low loan repayment rates, and inefficiency in financial markets with excess demand (Adams, Graham, and Von Pischke 1984; Robinson 2001; Zeller and Meyer 2002).

As an alternative, microfinance has recently attracted growing attention as a means of overcoming such a situation (Morduch 1999). Most microfinance institutions (MFIs) provide collateral-free small loans to low-income households who have long been deemed to be unbankable. These loans are generally expected to be used for self-employment and income-generating activities. Even though many MFIs rely on financial support from the state and donors to expand their outreach, in response to the widespread failure of government programs in the past, financial self-sustainability has also been of major concern, and appropriate pricing of loans is viewed as crucial for sustainability (Zeller and Meyer 2002). Therefore, interest rates are generally set at the market level to cover operational costs, and most microfinance programs across the world have extremely high repayment rates at around 90% to 98%.

Although the provision of credit is by far the most important product of financial services, much progress has also been made by many MFIs offering a range of savings and insurance products, which has great potential for alleviating poverty and reducing vulnerability (Nourse 2001; Robinson 2001; Churchill 2002; Zeller and Meyer 2002; Armendáriz de Aghion and Morduch 2005).With enthusiasm for their ability to improve the welfare of the poor, the number of MFIs has rapidly grown, from 618 to 3,133 between 1997 and 2005, and, correspondingly, the number of clients who benefitted from microfinance increased from 13.5 million to 113.3 million over the same period (Daley-Harris 2006). Given this growth in the microfinance industry, the United Nations declared 2005 to be the “International Year of Microcredit” and attempted to link the microfinance movement with the achievement of the MDGs. Furthermore, a leading MFI, the Grameen Bank, and its founder, ProfessorYunus, received the Nobel Peace Prize in 2006 “for their efforts to create economic and social development from below.” In this way, microfinance is increasingly gaining popularity as an effective tool for poverty reduction, and its evolutionary process is often termed the “microfinance revolution.”

Yet, microfinance is not without controversy. Many studies have examined whether microfinance is as effective as originally expected. For example, although most people have agreed that microfinance is good for the poor, it should be proved in a rigorous way. The recent development of impact evaluation techniques allows us to go in the direction of asking whether microfinance is actually good for the poor. Another strong belief bolstered by the success of the Grameen Bank has been that its lending scheme, characterized by non-collateralized, jointly liable, groupbased lending, is effective in maintaining the high repayment rate. However, recent theoretical as well as empirical studies have cast doubt on this and show there are other mechanisms underlying the high repayment rates. In addition, the belief that the increase in the number of MFIs relaxes credit constraints of the poor has come under challenge. There is also a growing concern that MFIs, often operated by


nongovernmental organizations, should put more effort into becoming regulated for-profit financial institutions that work to enhance financial sustainability instead of primarily pursuing services to the poor. However, there is concern that MFIs might shift away from serving poorer clients in pursuit of commercial viability. This is referred to as “mission drift.”

WELFARE IMPACT OF MICROCREDIT

Whether microcredit truly helps to improve the welfare of the poor is a fundamental question asked by both practitioners and scholars.

Evaluating the Impact

Although anecdotal evidence of the welfare impact of microcredit is mounting in the literature, empirical evidence based on rigorous evaluation is scarce. As Karlan and Goldberg (2007, p. 1) point, the rigorous impact evaluation has to answer “How are the lives of the participants different relative to how they would have been had the program, product, service, or policy not been implemented?”

This requires the comparison of two potential outcomes, such as income, business profits, or physical and human capital investment, of the same individual, i.e., one with the treatment and the other without it. Because we can never observe both statuses for a particular individual simultaneously, the existing reports often try to compare the states before and after microcredit programs to estimate their impact on individuals (before–after comparison). However, in most cases, this does not provide reliable estimates because other factors like macroeconomic shocks also affect the post-treatment outcome. In other words, this approach fails to isolate the impact of microfinance from the time trend that affects the result. This implies that it is almost impossible to measure the impact of a program on a given individual (Duflo, Glennerster, and Kremer 2006). However, it is possible to obtain the average impact of microfinance if the counterfactual outcome of the treatment group can be constructed from the pool of the remaining population who has a similar outcome to the treatment group in the absence of the treatment. This can serve as a comparison group. Therefore, a major challenge for impact evaluation is to create a good counterfactual through the use of appropriate techniques under a set of acceptable assumptions.

A line of studies have used non-clients to approximate the counterfactual of clients without treatment (with–without comparison). In this case, the average difference in outcome of interest between clients and non-clients is regarded as the impact of microcredit. This is a good strategy as long as the outcome is independent of participation in microcredit. However, under a situation where participation is voluntary, it may well be that clients who decided to participate significantly differ from non-clients in terms of their expected gains and other relevant characteristics explaining participation and outcomes. If there are systematic differences between them, the outcome of non-clients cannot represent those of clients without treatment, and, as a result, the evaluated impact is highly likely to be biased. Even if such self-selection does not matter, nonrandom program placement by MFIs can potentially yield a similar bias. For example, MFIs might implement a program in villages where impacts are expected to be high or where poverty is more pervasive.


CHALLENGES OF MICROFINANCE INSTITUTIONS

We have discussed the mechanisms of microcredit that might contribute to high repayment rates. However, due to the expansion of MFIs and the expansion of microfinance services, these organizations now face new challenges. In this section, we focus on the rising competition among MFIs and the insurance services for the poor, micro insurance, because the theoretical framework provided in the previous section is useful for considering these two issues.

Competition among Microfinance Institutions

It is generally thought that an increase in MFIs will expand financial service opportunities for the poor, thereby contributing to the improvement of their welfare. Yet, if there are too many MFIs competing with each other in the same region, borrowers who did not complete repayments to a certain MFI might be able to obtain loans from other MFIs.

It is also possible that borrowers of a certain MFI can borrow additional loans from other MFIs in order to repay the loans or to finance everyday needs. We have argued the role of frequent installment as a commitment device to solve saving constraints. If they can obtain loans whenever they want, those who face pressure from their spouse or relatives or face the problem of self-control might decide to repay their weekly installment by borrowing money. In this way, the existence of competing MFIs who generously offer loans will actually render the effectiveness of frequent installment as a commitment device ineffective. The final result will be that some borrow an unrepayable amount of money from multiple sources and enter the multiple debt trap.

The rising competition among MFIs will also change their portfolios. Facing such competition (McIntosh and Wydick 2005), MFIs will find their profits reduced and will need to improve their portfolios. Note that clients who generate more profits are usually the non poor, because they are less likely to have repayment problems and they often apply for larger loans than the poor, which will decrease the transaction costs per dollar. Thus, the rising competition will shift the target of MFIs away from the poor and the poor’s access to financial services will end up declining.

Bond and Rai (2009) argue the possibility of “borrower runs.” Because the effectiveness of dynamic incentives depends on the expectation of future loan availability, if the bank suffers severe losses due to the competition and borrowers expect that the bank may cease to lend, then they have less incentive to repay. If the repayment rate or the market condition for the bank worsens beyond a certain level, then borrower runs occur: borrowers choose not to repay because they expect other borrowers not to repay and the bank then withdraws. Therefore, any increase in default rates or worsening of the bank balance sheet caused by the competition might increase the likelihood of borrower runs.

Microinsurance

Microinsurance is insurance for the poor. It constrains its premium at low levels so that the poor can afford to pay it by limiting the coverage of the insurance. Along with savings and transfers, many large MFIs are considering offering microinsurance services to the poor.


Although poor people insure themselves from income risk to some extent through informal insurance among community members, their consumption is still significantly affected by fluctuations in income (Townsend 1994; Grimard 1997).

In addition, this insurance strategy does not function against regional income shocks such as famine and flood, because all the community members suffer from the shocks. Credit can help people protect themselves from negative shocks, but some shocks such as serious disease or the death of cattle are persistent and can reduce income in subsequent years. Large medical expenses and the death of income earners followed by the selling off of productive assets are often the causes of falling into poverty. Given the importance of insuring the poor from negative shocks, some MFIs provide insurance for the poor at low costs.

To date, however, microinsurance has suffered from low uptake rates and, in some cases, MFIs have ceased to provide microinsurance due to huge losses incurred by the schemes. The problem with microinsurance is the lack of well designed contract schemes. Although microcredit successfully tackles the problem of asymmetric information through group lending and dynamic incentives, most microinsurance schemes have no effective measures to solve the asymmetric information problems inherent in the insurance market; namely, adverse selection and moral hazard. Below we discuss these problems in health insurance as an example; most of the argument is applicable to life insurance, cattle insurance, and crop insurance.

The successful expansion of small-scale financial services to the poor with high repayment records by many microfinance institutions in developing countries is often referred to as the “microfinance revolution.”

A review of the literature demonstrated that, although there is much anecdotal evidence emphasizing the positive effect of microfinance, the empirical results from more rigorous impact evaluations are mixed. Some researchers argue that microfinance has a positive impact on clients (Pitt and Khandker 1998), some point out that when controlling for selection biases (which are caused by such factors as self-selection and program placement), the impacts of microcredit become weaker than naïve estimates, which do not take into account selection, although positive and significant impacts still remain (Alexander-Tedeschi 2008). Others find little impact of microcredit when controlling for selection biases (Morduch 1998; Coleman 1999). Moreover, a strand of the published literature shows that near poor or non poor households tend to become the beneficiaries of microcredit.

However, in contrast to the widespread failure of subsidized credit programs in the past, many MFIs achieve remarkably high repayment rates, which is a prerequisite for financial self-sustainability. We showed how group lending, which was adopted initially by the Grameen Bank and then by others, theoretically overcomes adverse selection, moral hazard, and strategic default caused by asymmetric information.

We also discussed that group lending is not the panacea and showed how other innovative schemes, such as dynamic incentives and frequent installments, work well to increase repayment rates.


Although these new schemes have become emblematic of microcredit, most MFIs have not succeeded in creating any innovative and effective insurance schemes that solve the asymmetric information problems inherent in the insurance market. The emerging scheme of index insurance has the potential to mitigate these problems, but so far it has not significantly increased participation.

All in all, the microfinance revolution may be revolutionary with its relatively high repayment rates, which could not be achieved by past subsidized credit programs. In addition, the introduction of insurance products can be labeled as innovative, because virtually no institutions have ever tried this in developing countries. However, judging from the empirical evidence, there is still room to improve the performance of microfinance, especially in terms of impact on and outreach to the poor. With this empirical evidence in mind, we conclude that microfinance is developing in a promising direction but has yet to reach its full potential.

Around the World

It is important to differentiate at the outset between the microfinance markets in developing countries and the U.S. It would not be an exaggeration to say that microfinance has revolutionized the field of poverty alleviation in developing countries, as demonstrated by the fact that today there are over 68 million microfinance borrowers worldwide--an almost fivefold increase over the past six years. Loans outstanding are estimated to be $16 billion with an average outstanding of $400. Approximately one-third of these loans are made by commercial banks, one-third by cooperative banks and credit unions, and one-third by specialized microfinance institutions. The enormous outreach indicated by this data is a clear testament to microfinance's two great advantages as a development tool: Its resources are reusable, since they are provided in the form of loans, and microfinance offers the poor an opportunity to help themselves.

The U.S. microfinance market began its development later than the international market; one of the key dates is 1991. When the Small Business Administration (SBA) Microloan Demonstration project was legislated and the first association of American microfinance intermediaries was created. The potential market for microfinance is smaller in the U.S. and, because of the higher cost of operating a business in a mature economy, the size of microfinance loans tends to be higher--the average loan extended tinder the SBA Microloan Program is $11,670. Operating a micro business is also more complicated in the U.S.; in fact, one of the important lessons learned in microfinance domestically is that training is a significant factor in success. Microfinance in the U.S. has historically been largely the province of nonprofits; the involvement of banks is typically in the form of loans or grants to these nonprofits, often for CRA purposes.

Essentially Grameen Bank lends to very poor self employed people a majority of them being women, through Self Help Groups(SHGs).To ensure timely recovery of the loan the amount is disbursed through a SHG. In case of any default the SHG to which the defaulter belongs is held accountable. The system has worked efficiently with almost 97% recovery rates. However the responses in trying to replicate the same model in other parts of the world have been mixed. A prominent reason for Microfinance being so successful in Bangladesh is


having a viable model for delivery and recovery of the loans. The core group of borrowers being women, the socio-cultural aspects became prominent in ensuring success of the model. From Micro Credit, Micro Finance has spawned into Micro Savings and Micro Insurance.

ISSUES

A key problem in developing countries is that there are many poor people who can provide only their work and since complementary assets require outside financing (being savings not existent or not properly “stored”), the lack of finance (together with lack of education, state aid, infrastructures …) is an obstacle to the birth of entrepreneurship, with negative side effects on employment. (Ashta 2007).Yunus (1999) shows that if the poor are provided access to finance, they might start up micro enterprises, building up a virtuous cycle and transforming underemployed laborers into small entrepreneurs.

In the mind of many, microfinance and micro credit are synonymous; however, while micro credit simply deals with the provision of credit for small business development, microfinance - sometimes called “banking for the poor” - refers to a broader synergic set of financial products, including credit, savings, insurance and sometimes money transfer.

MFIs can be classified according to their organizational structure (cooperatives, solidarity groups, rural or village banks, individual contracts and linkage models …) or to their legal status (NGOs, cooperatives, registered banking institutions, government organizations and projects …) or even according to their capital adequacy standards.

Microfinance firms are different from traditional banks since they have to use innovative ways of reaching the underserved and poorest clients, not suitable to mainstream institutions, mixing unorthodox techniques such as group lending and monitoring, progressive lending (if repayment records are positive), short repayment installments, deposits or notional collateral, as it will be seen later.

Group lending is the most celebrated microfinance innovation, making it different from conventional banking, even if microfinance goes beyond it. Frequent repayments (short term installments, starting immediately after disbursement) is another smart pragmatic device, avoiding balloon payments where the principal is all reimbursed at maturity: given the financial illiteracy of many poor (which find it hard to understand that “time is money).

The several features of Microfinance which are unique in themselves and need to be addressed separately include:

• Microfinance’s attempt to deepen financial markets to serve micro enterprises and poor households;

• High unit costs of lending; • Physically taking banking services to clients who have few other options to receive

financial services; • Relatively undiversified and sometimes volatile nature of MFI credit portfolios; • Cost MFIs began as unregulated credit NGOs, with a focus on social goals rather than

financial accountability and sustainability;


• Difference in institutional orientation, with some MFIs clearly profit-oriented while others are committed to providing services to the poorer segments of the population on a non-profit basis, creating very different cost structures and funds sources;

• The fact that MFIs deal in savings and credit transactions with relatively low value in relation to the system as a whole -- and as a result are unlikely to have problems that cause broad systemic instability (Jansson 1997); and

• The market risk posed within the microfinance sector itself when MFIs (especially large ones) are not properly managed and monitored.

Microfinance Experience in Developing Countries‐A Few Cases

Ethiopia: MFIs

Microfinance, as defined by the statute and National Bank of Ethiopia (NBE) directives, consists of extending “small” credits to “rural small farmers or urban entrepreneurs.” All MFIs must be 100% Ethiopian-owned, meet minimum capital of approximately $25,000, Some 16 MFIs operate in Ethiopia, with a mixture of regional government, NGO, and individual ownership. These MFIs reach nearly half a million active clients at a given time with about $34 million in credit outstanding (cumulatively $66.8 million) and hold about $16 million in savings. Repayment rates for most MFIs are close to 100%. However, the prohibition of foreign n ownership and ministerial control on donor funding appear to have deterred involvement in the sector by foreign donors and international NGOs. (Shiferaw and Amha 2001)

Ghana: NBFIs

Ghana has several types of organizations engaged in microlending, including informals, NGOs, credit unions, thrifts (savings and loans, and building societies), and rural banks. Informals, including susus (mobile deposit collectors) and moneylenders, as well as NGOs are not regulated by the Bank of Ghana. Incorporated non-bank MFIs (including thrifts) and cooperative credit unions fall under the Financial Institutions (Non-Banking) Law of 1993, while rural banks operate under the Banking Law of 1989, which brings both of these categories of institutions under the authority of the Bank of Ghana. Micro loans backed by group guarantees have a much higher ceiling than individual micro loans ($1,400 vs. $140), but group guarantees are not reflected in the risk-weighting criteria at all – nor is moveable collateral for that matter. In each case, the loans are treated as unsecured and given a 100% risk-weighting for capital adequacy purposes.

By recent estimates, all rural banks were covered by the supervisors, but only half of those institutions were in full compliance with Bank of Ghana standards, and 8 percent were in distress. Outstanding loans in mid-1999 were approximately $8.9 million.

While informals are not included in the law or regulation, they are also not explicitly excluded. A microfinance network called GHAMFIN works with informals, NGOs, and Bank of Ghana on the development of performance standards and monitoring systems.


The first Credit Union in Africa was established in Northern Ghana in 1955 by Canadian Catholic Missionaries. Susu, which is one of the current microfinance methodologies, is thought to have originated in Nigeria and spread to Ghana in the early 1990s. Microfinance has gone through four distinct phases worldwide of which Ghana is no exception;

Phase One: The provision of subsidized credit by Governments starting in the 1950’s when it was assumed that the lack of money was the ultimate hindrance to the elimination of poverty.

Phase Two: Involved the provision of micro credit mainly through NGOs to the poor in the 1960’s and 1970’s. During this period sustainability and financial self –sufficiency were still not considered important.

Phase Three: In the 1990’s the formalization of Microfinance Institutions (MFIs) began.

Phase Four: Since the mid 1990’s the commercialization of MFIs has gained importance with the mainstreaming of microfinance and its institutions into the financial sector.

Microfinance in Peru

The microfinance sector in Peru represents about 5% of the total financial sector, but during the last ten years average annual rates of growth of the loan portfolios of MFIs has been 32.3% (SBS). While microfinance remains a small percentage of the total financial sector, the picture is altered if the focus on the number of clients rather than portfolio size, and it is estimated that MFIs have 30-40% of the borrowers in the financial system.

The majority of the approximately 55 non-bank MFIs operating in Peru are regulated. In terms of portfolio size, the vast majority of the sector is regulated as the non-regulated MFIs tend to have relatively small portfolios. MFIs vary greatly in quality and size. As one commentator remarked, the sector has “both ants and elephants”.

Most of credit provided by the MF sector is directed towards micro-enterprises as opposed to consumer credit. Mortgage lending is an increasing area of focus for many MFIs. By economic sector, most of the micro enterprises tend to operate in the retail sector in urban areas. Rural microfinance is considered both unprofitable and highly risky, as a result only 3.2% of formal MFI lending is for agricultural and livestock

Microfinance in the Philippines

In September 2004 the amount of loans through all microfinance programs in the Philippines had reached 2.5 billion pesos (US$ 50 million). The President has called for an additional 4.5 billion pesos (US$ 90 million), of government money to be distributed over the next ten years, to “develop a nationwide network of viable and sustainable microfinance institutions”. The government is also working to ensure that the Small Business Guarantee and Finance Corporation (a government financial institution) triples its lending to small and medium enterprises from the present 3 billion pesos (US$ 60 million) to 9 billion pesos (US$ 180 million) in the next 6 years.


Microfinance can be thought of as either (a) a band-aid approach to development, or (b) as a bridge toward a sustainable solution (“graduation”).The band-aid approach is a way of temporarily stemming the misery that comes with extreme poverty by addressing malnutrition, and increasing caloric intake and financial security. Second approach (graduation) takes a much longer view. It sees microfinance as a stepping stone which leads to graduation. Graduation implies moving from a dependence on informal personal relations to the more impersonal formal dealings taken for granted in developed countries. CONCLUSION

Microfinance is an enabling, empowering, and bottoms-up tool to poverty alleviation that has provided considerable economic and non-economic externalities to low-income households in developing countries. Microfinance is being hailed as a sustainable tool to combat poverty, combining a for-profit approach that is self-sustaining, and a poverty alleviation focus that empowers low-income households. Microfinance is increasingly becoming a tool to exercise developmental priorities for governments in developing countries.

But there has been a gradual realization that microfinance alone is not enough. Microfinance is not a replacement for jobs that are not there, markets that are inaccessible, or education and skills that do not exist. Particularly, the main objective of microfinance institutions - poverty alleviation - requires a holistic and in depth understanding of the interplay between economic, social, cultural extracts of the developmental process.

Microfinance has become a ‘viable option’ only because of a poorly functioning institutional environment, i.e. if the institutional environment was properly functioning; the need for microfinance would be greatly reduced;

• Microfinance is working reasonably well as a band-aid solution to poverty, i.e. it puts food on the table;

• Microfinance is not providing a bridge to sustainable development, because it fails to address the root causes of poverty. As such, microfinance borrowers fall short of graduating.

A rich pattern of substitution among the credit alternatives is confirmed, depending on household characteristics. Generally households in self-employed business prefer formal credit for ensuring stable financing sources, but access was sometimes impeded when they were located in rural areas, probably because of high transaction costs. The poorest households have relatively lower probability of exploiting new credit opportunities than middle-income households, even if credit scale was very small.

In future work, more detailed credit attributes should be incorporated so that a fuller understanding may be gained concerning the ways in which households choose credit, and how to expand credit outreach to nonparticipants in the market. This line of research will also be valuable for evaluating the effects of policies for encouraging commercial banks to extend credit to smaller business enterprises through the so-called linkage program in Indonesia (Hamada 2010).


Another concern of practical importance is whether or not small amounts of credit indeed help borrowers to improve their economic livelihood. Our companion paper focuses on this issue (Takahashi, Higashikata, and Tsukada 2010), and it reveals that the effect of microcredit is very small after the elimination of possible selection bias. This indicates a need for policy tools to enhance both the abilities and the economic opportunities of poor households, in addition to enhancing their credit access. As elaborated in the present paper, such enhancement will then increase credit demand per se.

The future success of microfinance depends on deeper institutional reforms. The path to a modern economy requires secure property rights, trusted mechanisms of enforcement and an absence, or at least a massive reduction, in corruption and predation. Simply put the government and international aid agencies would do best to invest their efforts in the reforms in Financial Policies and goals with inclusive growth as a primary objective of reforms. The lives of millions of people are improved when the right mix of reforms are advocated and enacted. Working to enhance the economic environment in which exchange takes place might not produce the almost instantaneous results many wish to see. However, it will prepare the terrain to enable a greater degree of entrepreneurial activity among the poor. REFERENCES [1] Akoten, John E.; Yasuyuki Sawada; and Keijiro Otsuka. 2006. “The Determinants of Credit Access and Its

Impact on Micro and Small Enterprises: The Case of Garment Producers in Kenya.” Economic Development and Cultural Change 54, no. 4: 927–44.

[2] Andersen, Thomas Barnebeck, and Nikolaj Malchow-Møller. 2006. “Strategic Interaction in Undeveloped Credit Markets.” Journal of Development Economics 80, no. 2: 275–98.

[3] Barslund, Mikkel, and Finn Tarp. 2008. “Formal and Informal Rural Credit in FourProvinces of Vietnam.” Journal of Development Studies 44, no. 4: 485–503.

[4] Bell, Clive, and T. N. Srinivasan; and Christpher Udry. 1997. “Rationing, Spillover and Interlinking in Credit Markets: The Case of Rural Punjab.” Oxford Economic Papers 49, no. 4: 557–85.

[5] Microfinance penetration and credit choice 123© 2010 The Authors Journal compilation © 2010 Institute of Developing Economies

[6] Berry, Steven; James Levinsohn; and Ariel Pakes. 2004. “Differentiated Products Demand Systems from a Combination of Micro and Macro Data: The New Car Market.”

[7] Journal of Political Economy 112, no. 1, part 1:68–105. [8] Bose, Pinaki. 1998. “Formal-Informal Sector Interaction in Rural Credit Markets.” Journal of Development

Economics 56, no. 2: 265–80. [9] Boucher, Steve, and Catherine Guirkinger. 2007. “Risk, Wealth, and Sectoral Choice in Rural Credit

Markets.” American Journal of Agricultural Economics 89, no. 4: 991–1004. [10] BPS Gresik. 2006. Gresik in Figures 2005/2006. Gresik: BPS Gresik. [11] Cappellari, Lorenzo, and Stephen P. Jenkins. 2003. “Multivariate Probit Regression Using Simulated

Maximum Likelihood.” Stata Journal 3, no. 3: 278–94. [12] Coleman, Brett E. 1999. “The Impact of Group Lending in Northeast Thailand.” Journal of Development

Economics 60, no. 1: 105–41. [13] Conning, Jonathan. 2001. “Mixing and Matching Loans: Complementarity and Competition amongst Lenders

in a Rural Credit Market in Chile.” [14] http://econ.hunter.cuny.edu/~conning/papers/Mixing_0801.pdf (accessed July 1, 2009). [15] Chowdhury, Prabal Roy. 2007. “Group-Lending with Sequential Financing, Contingent Renewal and Social

Capital.” Journal of Development Economics 84, no. 1: 487–506. [16] Churchill, Craig. 2002. “Trying to Understand the Demand for Microinsurance.” Journal of International

Development 14, no. 3: 381–87.


[17] Coleman, Brett E. 1999. “The Impact of Group Lending in Northeast Thailand.” Journal of Development Economics 60, no. 1: 105–41.

[18] Conning, Jonathan, and Christopher Udry. 2007. “Rural Financial Markets in Developing Countries.” In Handbook of Agricultural Economics Vol. 3, ed. Robert Evenson and Prabhu Pingali. Amsterdam: North-Holland.

[19] Copestake, James; Sonia Bhalotra; and Susan Johnson. 2001. “Assessing the Impact of Microcredit: A Zambian Case Study.” Journal of Development Studies 37, no. 4:81–100.

[20] Cull, Robert; Asli Demirguc-Kunt; and Jonathan Morduch. 2007. “Financial Performance and Outreach: A Global Analysis of Leading Microbanks.” Economic Journal 117, no.1: F107–F133.

[21] Daley-Harris, Sam. 2006. “State of the Microcredit Summit Campaign Report, 2006.” Microcredit Summit, Washington D.C.: Mimeo.

[22] Drake, Deborah, and Elisabeth Rhyne, eds. 2002. The Commercialization of Microfinance:Balancing Business and Development. Bloomfield, Conn.: Kumarian Press.

Leveraging Innovations for Successful Entrepreneurship

Prof. Vivekanand Pawar*

Abstract—Invention is act of creating or developing a new product or process. Innovation is act of creating a commercial product or process from an invention. Entrepreneurship is any new business or new venture creation - the act of creating new goods or services or serving new markets. Innovation is much more common than invention. Innovations can be classified into two types: process innovation and product innovation.

Innovation is investing resources to create wealth or investing wealth to create resources. Innovation is conscious search for opportunity. The innovation entrepreneurship link means either the entrepreneur creates new wealth producing resources or endows existing resources with enhanced potential for creating wealth.

Innovations also have two effects on existing firms; they can be either competence enhancing or competence destroying. Competence enhancing innovations help firms further extend their resources and capabilities. Competence destroying innovations undermine existing firm resources and capabilities. More radical the innovation the more competence destroying it is. Most of the new innovations fail as 80% of new products fail and most new product ideas don't even make it to commercial introduction.

Organizations today are talking about reaching the bottom of pyramid and setting the business connect between being socially responsible and business-wise innovative and meaningful. The Tata Nano is an ideal example of how empathy towards social needs and connect with the common man can change the rules of the game for a business and eventually make terrific business sense.

Big organizations are much better at incremental innovation that they are at radical innovation.

Taken together, innovative entrepreneurs rely on their ‘courage to innovate’ – an active bias against the status quo and an unflinching willingness to take risks – to transform ideas into powerful impact.

This paper attempts to highlight the role of innovation for successful entrepreneurship. It also discusses how any innovation- be it product, process or any ther type- can be converted into a sustainable competitive advantage to make a firm standing in the arena of business.

Keywords: Innovation, Entrepreneurship, Sustainable competitive advantage

INTRODUCTION

The economic basis for innovation comes from Joseph Schumpeter and the metaphor of creative destruction. Schumpeter saw industries being reconfigured by the results of invention and innovation. He speculated that only large companies would be able to profitably innovate because only they would have the resources to capture the returns from innovation. However, *PIMSR, New Panvel


Schumpeter was wrong, most innovation comes from small companies or individual entrepreneurs as people, not firms are the ones who engage in creative activity that can lead to invention and innovation. Firms can only enable creative activity by providing incentives and resources. Firms generally require employees to sign intellectual property agreements that state that everything they think up belongs to the firm and non-competing agreements that they will not compete with the firm. Hence most innovation occurs from smaller firms, including groups of people leaving a large firm to start their own.

The challenge for existing firms, especially those in a technologically driven industry, is how to encourage their employees to invent and innovate while meeting the challenges from new entrants with superior technology.

Innovation is not a technical term. It is an economic and social term. Its criterion is not science or technology, but a change in the economic or social environment, a change in the behavior of people as consumers, producers or as citizens. Innovation is investing of resources to create new wealth or investing of wealth to create new resources. It is measured by assessing its impact on environment, and therefore innovation should always be market focused.

Innovation is the responsibility of every executive, and it begins with a conscious search for opportunities. Finding those opportunities and exploiting them with focused, practical solutions requires disciplined work.

Innovation is the specific function of entrepreneurship, whether in an existing business, a public service institution, or a new venture started by a lone individual in the family. It is the means by which the entrepreneur either creates new wealth-producing resources or endows existing resources with enhanced potential for creating wealth.

There prevails a lot of confusion about the proper definition of Entrepreneurship. Some use the term to refer to all small businesses; others, to all new businesses. In practice, however, a great many well-established businesses engage in highly successful entrepreneurship. The term then refers not to an enterprise’s size or age but to a kind of activity. At the heart of that activity is Innovation: the effort to create purposeful focused change in an enterprise’s economic or social potential.


Innovations Innovation has been traditionally defined as the successful implementation of creative ideas (Stein, 1974; Woodman, Sawyer & Griffith, 1993). Contemporary economic theorists have tried to address the concept and related issues with varying success. This is despite widespread recognition of the fact that innovation is crucial to the success of an economy at both the micro and macro levels (Leavy & Jacobson, 1997).

Damanpour (1991) has viewed innovation as a continuous and cyclical process involving the stages of awareness, appraisal, adoption, diffusion and implementation. However, it is also possible to view innovation as an outcome, where an innovation is the tangible product.

Leveraging Innovations for Successful Entrepreneurship 247

For conceptual reasons, it is possible to divide this outcome view of innovation into radical and incremental innovations.

Pavitt (1991) describes radical innovations as revolutionary or discontinuous changes. On the other hand, incremental innovations are conventional or simple extensions of a line of historical improvements.

Moreover, Drucker (1986) has attempted to clarify such discussion by suggesting that innovation is not explicitly the improvement or technical modification of a product. Instead, innovation is the “creation of new value and new satisfaction for the customer."

Leavy and Jacobson (1997) note that theories of innovation (much like those concerning entrepreneurship) have tended to focus on a single level of analysis. They note the aforementioned work of Drucker (1986) as an example of this at the firm level. The three paradigms that were described above also compete against one other for prominence in research on innovation. Moreover, they even criticise themselves in this regard: Leavy (1997) has previously concerned himself with factors governing innovation at the firm level too, while Jacobson (1994) established an interest in innovation at the regional or national level. Innovation at the sectoral level (Nelson, 1992) and at the global level (Niosi & Bellon, 1996) has also been completed.

It is worth considering some basic models of innovation and related innovation paradigms. In this context, the subject of analysis is to establish an understanding on how innovations occur in general. For this purpose, analysis can start with three competing basic explanations of the innovation phenomenon, which are (Sundbo, 1995):

An Interface between Entrepreneurship & Innovation Pirich, Knuckey & Campbell DRUID Nelson & Winter Conference 2001

• The entrepreneurship paradigm; • The technology - economic paradigm; and • The strategic innovation paradigm.

The entrepreneurship paradigm (Sundbo, 1995) is frequently used to describe innovation activities that occur at the level of individual firms that have gained favourable market position due to the development of a particular innovation.

This happens without any systematic previous approach to the innovation process. Rather, there is a "market forced" effort to introduce a new product, process or service into various markets in order to retain, and possibly enlarge, the volume of activities, or to facilitate new business opportunities. The focal point of this paradigm is the entrepreneur - inventor whose individual and independent actions drive the innovation process. Here innovation per se is seen as a key to obtaining a better position in the market and generation of extra profits, and is often generated in a relatively unstructured manner.

However, in recent years, quite a few innovators – entrepreneurs have adopted a more formal and systematic view towards innovation activity and long-term business strategy. The technology - economic paradigm (Sundbo, 1995) is usually associated with innovation policies of large companies, which are users of so-called "mass-technologies".


The key feature of this paradigm is the significant involvement of engineers and technicians in the development of new technologies under a company umbrella. Engineers and technicians were not involved directly in defining the company’s business development strategies, apart from technical input, but rather were given the task to solve particular technical issues.

There are several ways these individuals approach a problem, e.g. in-house R&D, co-operation with other companies who are facing the same issue, buy-in of a solution from someone else, etc. It is important to note that these options require varying levels of internal R&D competencies for utilising, developing, exploring and absorbing new technologies.

The strategic innovation paradigm (Sundbo, 1995) is relatively new. Its emphasis is on firm strategy, market conditions and broad firm competencies. An Interface between Entrepreneurship & Innovation Pirich, Knuckey & Campbell DRUID Nelson & Winter Conference 2001 as factors that impact on the innovation process and as such significantly determine the market performance of a firm. This approach to innovation is multifunctional and represents a combination of internal competencies, long term marketing strategies, market developments, the identification of new market opportunities or new market approaches, the creation of technological alliances and partnerships, and the fostering of networks, etc. Innovation is viewed as both technological and non-technological, i.e. it can be an entirely new artefact, process, production activity, or a marketing innovation. The key feature of this paradigm is a strategic manager or management team who are able to recognise new possibilities in the market and exploit them by using internal resources together with other available elements. In this context, the strategic behaviour of enterprises contributes to the economic growth of a country.

In addition, innovation activity is often modelled in several different ways for either analysis or policy purposes, and for many years the so-called "linear model" of innovation was widely used to describe the innovation process.

Because of the dynamics in the last few decades, the traditional linear model of innovation has become less relevant (Klein & Resenberg, 1986) and, increasingly, the chain-link model of innovation is becoming a more common tool of analysis. This chain-link model suggests that the national innovation system should be examined as an integrated whole and policy developed accordingly.

These new insights have important implications for the firm. Innovation is not simply driven from formalised research and development but depends on access to information, to technologies and to the skills needed to implement them effectively. Increasing the capabilities of firms to learn and to be aware of superior technological opportunities is as important as making sure firms have the resources to innovate (Metcalfe, 1998). In this regard, a significant amount of innovation originates through design improvements, "learning by doing" and "learning by using". This process, along with R&D, results in the accumulation of knowledge and experience, i.e. the development of competencies and human capital.


ENTREPRENEURSHIP

The theories of entrepreneurship and knowledge generation have been consistently approached from either one or another perspective. Firstly, an economics perspective Cantillon (1755) described the entrepreneur as one “who assumes the risk of buying goods, or parts of goods, at one price and attempts to sell them for profit, either in their original states or as new products.”

Say (1852) saw the “entrepreneur as a person who judges, combines factors of production and survives crises.”

Knight (1921) views the entrepreneur as an “economic pioneer who initiates change or innovation by managing uncertainty and risk.”

Hayek (1948) noted that the entrepreneur never has the benefit of perfect knowledge and therefore must have the ability to adapt quickly. This concept is elaborated upon later.

• Schumpeter (1934) describes the leadership role of the entrepreneur in an economy in his belief that entrepreneurs are “continually reorganizing the economic system” via evelopment of new products, new processes and new markets etc. He is best known for describing entrepreneurship as a process of ‘creative destruction’.

• Liebenstein (1968) suggests that “successful entrepreneurs are those that are able to overcome market inefficiencies.”

• Casson’s (1982) entrepreneur is one who can co-ordinate resources without perfect knowledge.

Bolton (1971) gives several economic functions of entrepreneurs in society including market innovation, product and service variety and providing seedbeds from which large companies will grow.

• Kirzner (1973) believes that the relationship between entrepreneurship and economic growth is a function of alertness to identification and exploitation of market opportunities.

• Baumol (1993) concludes this body of work by arguing that entrepreneurship is a vital component of productivity and growth.

A review of the theories surrounding entrepreneurship and innovation reveals an immense amount of material. Researchers in economics, with varying success, have often addressed the issue of interface between entrepreneurship and innovation. Recently, there has been an increased interest in this field, due to the realisation that entrepreneurs and entrepreneurship can contribute to society in various ways, including for example, economic growth (Hayek, 1948), business creation (Gartner, 1985), national identity (Bolton, 1971), and the innovation process (Schumpeter,1934).



• The objective of the study was • To understand the strategic benefits of entrepreneurship and innovation. • To study the sources of innovation. • To highlight the role of innovation in successful entrepreneurship with respect

to sustainable competitive advantage. An in-depth desk research through secondary data was conducted to understand the

various aspects that are involved in the success of entrepreneurship through innovation. The study used was mainly ‘Exploratory’ in nature

THE STRATEGIC BENEFITS OF ENTREPRENEURSHIP AND INNOVATION

What is Innovative Strategy?

Like all business strategies, an innovative strategy starts out with the question, “What is our business and what should it be?” But its assumptions regarding the future are different from the assumption made with respect to the ongoing business.

The first objective of a strategy for an ongoing business is to optimize what already exists. However, the ruling assumption of an innovative strategy is whatever exists is aging. The assumption must be made on the premise that existing product lines and services, existing markets and distribution channels etc will sooner or later go down rather than up. The motto of a strategy for the on going business is “Better and More”, however the motto of a strategy for Innovation is “New and Different”. Innovative Strategy is planned out by systematically getting rid of the old, the dying and the obsolete, because abandoning yesterday alone will free resources for tomorrow.

The scope of Innovation s verified in terms of Relative Advantage that the Innovation will provide them with.

WHY DOES ONE NEED TO INNOVATE?

• To face competition • To stand out in a clutter • To survive recession • To solve certain problems

INNOVATIONS AND PROFITS: JOSEPH SCHUMPETER’S THEORY OF PROFITS

It has been held by Schumpeter that the main function of the entrepreneur is to introduce innovations in the economy and profits are reward for his performing this function. Innovation as used by Schumpeter has a very wide connotation. Any new measure or policy adopted by an entrepreneur to reduce the cost of production or to increase the demand for his product is an Innovation.


HENCE, INNOVATIONS CAN BE DIVIDED INTO TWO CATEGORIES

Those which reduce the cost of production i.e. which change the production functions. This first type of Innovation includes the introduction of new machinery, new and cheaper technique or process of production, exploitation of a new source of raw material, a new and better method of organizing the firm etc.

Those which increase the demand for the product i.e. which change the demand or utility function. This category includes the introduction of a new product, a new variety or design of the product, a new and superior method of advertisement, discovery of new markets etc.

ROLE OF AN INNOVATOR

Schumpeter assigns the role of an Innovator to the Entrepreneur. The Entrepreneur in not a man of ordinary managerial ability, but one who introduces something entirely new. The Entrepreneur is motivated by the desire to be the founder of a private commercial kingdom, the will to conquer and prove his superiority and the joy of creating, of netting things done or simply of exercising one’s energy and ingenuity.

To perform his economic function, the entrepreneur requires two things - the existence of technical knowledge to produce new products and the power of disposal over the factors of production in the form of finances.

ROLE OF PROFITS

An entrepreneur innovates to earn profits. Profits arise due to dynamic changes resulting from innovation. They continue to exist until the Innovation becomes general.

BREAKING OF THE CIRCULAR FLOW

Schumpeter’s model talks about the breaking of the circular flow with an innovation in the form of a new product by an entrepreneur for earning profits. Profits caused by a particular Innovation tend to be competed away as others imitate and adapt that. But if the entrepreneur comes out with another innovation at that time when the favourable effects of the former Innovation are dying out, he will make profits again. Therefore as long as Innovations exist, profits continue to arise out of them. So, according to Joseph Schumpeter, innovation is the sole cause of profit.

INSTILLING ATTITUDE FOR INNOVATION

Innovative organizations will survive and prosper. Non-innovative ones will weather away. Therefore, the top management has to start treating the innovation initiative as a critical one in which every level of employees must participate. It will be important to remove fear of risk by examples well demonstrated. The following ideas will come very handy.

Encourage Creative Conflict: Suppressing conflict is one of the cultural behaviours that inhibits innovation. Conflict should be played out under the direction of a strong and fair leader who encourages open and forceful differences.


Big Ideas come from small teams: Big organizations command resources but small groups generate camaraderie. Innovative teams within large corporations are inspired to meet stretch goals where they learn to think and act like agile, high energy elites who come out with brilliant innovative ideas.

Learning happens away from the desk: Employees with inquiring minds visit experts, see new technology in operation, observe fascinating products in use. That’s how managers find the knowledge needed for bigger ideas. In contrast, many hierarchical organizations assume their employees are only productive when they’re in office.

Understand the Product’s user: Successful innovation depends on cultivating the ability to empathize with the customer. The human side of new product introductions cannot be ignored.

Live in the future: Don’t think of the past. Construct the future at the work-place, so that the employees and clients can experience what it will be like to live and work in the next century. It is a very effective technique. The secret is to physically mimic revolutionary conceptual break-through affecting the home and office environments.

Failure sometimes produces innovation: The most valuable begins to occur when the most elegantly designed apparatus fails. The faster a project flops, the quicker it gets better. Don’t just try to reproduce past successes. Real innovation isn’t a rabbit you can pull out of the same hat over and over.

Join Prototyping to Brainstorming for Fast-Track Innovation Results: Never be scared of trial and error. Don’t be embarrassed to play with crude prototypes in round one. A multidisciplinary team will come out with new ideas when you brainstorm with the prototype.

Peter F. Drucker in his book Innovation and Entrepreneurship answers this key question. He says, Innovation can be systematically managed if one knows where and how to look.

SOURCES OF INNOVATION

Drucker Mentions the Different Sources of Innovation

Innovations can spring from a flash of genius, however, most Innovations result from a conscious, purposeful search for Innovative opportunities, which are found only in a few situations. Within a company or Industry, areas of opportunity can exist in the form of the following:

• Unexpected occurrences • Incongruities • Process needs • Industry and Market changes Outside the Company in its Social and Intellectual environment, areas of opportunity can

exist in the form of the following:


• Demographic changes • Changes in perception • New knowledge These sources are different in terms of the nature of risk, difficulty in implementation,

complexity, and potential for innovation may lie in more than one area at a time. But together, they account for the great majority of all innovation opportunities.

For the purpose of clear understanding, we shall look into these different Sources of innovation with opportunities explored by the entrepreneurs (authorized dealers) in the two wheeler industry.

UNEXPECTED OCCURRENCES

The easiest and simplest source of Innovation opportunity—the unexpected. Bajaj launched sunny for the rural and semi — urban markets to up-grade over the mopeds using modern technology (no gears) which made riding more comfortable and hassle free. But the product did not appeal to them. Here market survey revealed that men found the vehicle less macho and hence rejected it, but the vehicle was well accepted by female riders who formed a sizeable portion of riders in these areas. Bajaj smartly started advertising the product targeting females as a vehicle being the new savvy thing in the market, a product that is smart, easy and comfortable especially for the girls. Bajaj accidentally found a new market, which was huge enough, and fill now they treated it as the spillover from the primary target — male users.

The Unexpected Failure is also an Important Innovation Opportunity Source

When Hero Honda’s sales figures were reaching the sky with its 4-stroke economy bike CD100, Bajaj developed its own 4- stroke economy bike 4S, which gave more mileage than CD1 00. Bajaj was confident that its product will beat the competition, launched the bike with great hype with publicity and advertisements comparing the technical superiority against Hero Honda - but the public was not interested. They had already tried and tested the CD100 and were satisfied with its performance. They refused to acknowledge anyone who compared with it. As a result the marketing launch failed. But this was a lesson Bajaj learnt.

When they came out with their new, model Caliber (in Jan’99), they took utmost care not to repeat the same mistakes of comparing and positioned it in a very unconventional way. They carried out a soft launch. The result - Caliber grabbed 15% of share in sales within 4 months of launch.

Unexpected successes and failures are such productive sources of innovation opportunities because most businesses dismiss, disregard, and even resent them. No manufacturer thought of launching a two-wheeler for females thinking that they are not the decision makers in buying, they do not constitute a big enough market, they can use mopeds if they have to, they can not have their separate vehicle etc.. With such ideas in mind no marketer was willing to leap in this market segment. The successes of Bajaj Sunny and TVS Scooty have proved otherwise.


INCONGRUITIES & DISAGREEMENTS

An incongruity within the logic or rhythm of a process can give rise to Innovation opportunity. 70% of two-wheelers are bought on finance provided by banks or other financial institutions. The process was time consuming and tedious. Also the interest charges were high and the acceptance criteria very strict. To cut this time and process short, and make their products available at a reasonable rate, Bajaj started its auto finance company, Bajaj Auto Finance which provided finance to all their dealers. Even the interest charged was lower than the rest. (Banks charge 18-20%, whereas Bajaj charges less than that)

An Incongruity between Economic Realities can also Lead to Innovations

In the late 80’s newer vehicles with Japanese technology bombarded two-wheeler users in India. The problem was that those who already had old model vehicles would not buy a new vehicle until they found buyers for their old vehicles. Here Alibhai Premji (dealers since 1920) found a solution. They started Exchange Schemes where they would appoint an evaluator (Usually a second hand vehicle dealer) who would evaluate the old vehicle and buy it and that amount would be deducted from the price of the new vehicle. This scheme facilitated the old vehicle owners and also pushed the sales of the dealer. Many companies like Bajaj, LML, and also many dealers later adopted this scheme.

PROCESS NEEDS

We saw earlier how two-wheeler sales were promoted through exchange schemes and n-house financing. Now came a new element - time. Time to wait for the exchange scheme, then finance for the balance amount and then waiting for the bike with the colour chosen. All this took time, which an urban buyer did not have. Auto-riders came in with a new concept: Instant Loan Me/as. They would put up a stall in a convenient location in the city and advertise it. Representatives of their vehicle exchange department, sales department, technicians to aid test rides and inquiries, finance company, insurance, RTO registration agent, stores/delivery all would be present at the same time. Customers are promised that the entire process would take them one hour after which they would be riding back home on a bike of their colour choice.

INDUSTRY AND MARKET CHANGES

Industry structures can - and often do- change overnight. Such changes create tremendous opportunity for innovation. Established companies, concentrating on defending what they already have, tend not to counterattack when a newcomer challenges them. When market or industry structures change, traditional industry leaders neglect the fast growing market segments. New opportunities rarely fit the way the industry has always approached the market, defined it, or organized to serve it. Innovators therefore have a good chance of being left alone for a long time.


DEMOGRAPHIC CHANGES

Demographics are the most reliable sources of Innovation opportunity coming from outside the company. Those who watch them can reap great rewards from them. Managers have known for a long time that demographics matter, but they have always believed that population statistics change slowly. However, we have seen that in this century, it has changed very quickly. Innovation opportunities possible due to changes in the numbers of people, their age distribution, education, occupations and geographical location are one of the most rewarding and less risky of entrepreneurial pursuits.

In the 80’s, the primary target of a bike zi7 as a man, aged 25- 40 years, income Rs.5,000 p.m. and above. In the 90’s, the shift was clearly seen. Though this segment was still catered by the economy bikes segment, a new audience was formed; boy, aged 17-21 years, pocket money —Rs. 5,000 p.m. and above. The significant part of this change was that this young audience would be the decision-maker. Gemini Motors, Bandra, Mumbai caught on this segment. it launched the TVS Shogun by sponsoring college festivals like Mood Indigo I.I.T, Powai; Malhaar in St. Xaviers, etc. where this young audience was able to test ride the vehicle. So huge was the response and success, that Gemini Motors has since then sponsored many college festivals on a regular basis and launched two other models using this ready audience. All this was supported by TVS (45% financial support for expenses).

CHANGES IN PERCEPTION

The glass is half-empty’ and the glass is half-full’ are descriptions of the same phenomenon but have vastly different meanings. Changing a manager’s perception from half-full to half-empty opens big Innovation opportunities. A change in perception does not alter facts. it changes their meaning. What determines whether people see a glass as half- full or half-empty is the mood rather than fact, and a change in mood defies quantification. It has to be concrete, defined and could be tested. Then it can be exploited for innovation opportunity.

We saw earlier how Bajaj Sunny was discounted as a rural small town Scooterette and as replacement for conventional Moped. The dealer in the bigger town however, saw sales picking up by women riders and this finding was passed to the company, which smoothly positioned the vehicle as an easy riding machine and strategically placed it as the right vehicle for female riders. This strategy was then supported by the dealers who provided test rides to these users who were able to get a feel of the vehicle, its driving ease and comfort. The result -Sunny’s sales increased 300% within 3 months of the new campaign.

NEW KNOWLEDGE

These are the superstars of entrepreneurship. They earn the publicity and the money. They can be scientific, technical or social. They are what people usually mean when they talk of innovation. Knowledge-based innovations differ from all others in many ways. Like the time they take, their predictability the challenge they pose to entrepreneurs etc. They have the longest lead time of all Innovations, long time span between the emergence of new knowledge and its convergence to usable technology.


Kinetic Honda launched the first gear-less scooter in India. Indians saw this as a technological innovation. To supplement it and to support it Autoriders developed a test track at its workshop. The customers could actually experience the vehicle and also have their queries answered by the engineers at the workshop. No other automobile dealer has yet been able to copy this as they do not have the infrastructural support. Also Kinetic Honda has protected this commitment by huge territory rights to Autorider.

The Role of Innovation in Successful Entrepreneurship With Respect To Sustainable Competitive Advantage in Automobile Industry

VIP MOTORS

Any inquiry which is made by a prospective customer is recorded in the computer. All details regarding the model preferred, mode of payment, approximate date/ occasion when purchase is intended, the user’s name, address, profession and even some points the conversation are recorded. The salesman also puts in the date when he should make a follow-up call (usually 8-10 days later). The computer system is so built that on that particular date the salesman gets a print out on his table reminding him to contact that person. It also gives all details of the last conversation. In addition, in his absence, another salesperson can continue the sale.

ALIBHAI PREMJI

The oldest player in this market (since 1920) and going strong. They have a supermarket for two-wheelers where they offer all brands and surprisingly at a cheaper price than the authorized dealer of the company himself. All through these years have continuously innovated to survive the competition. Presently run high in their exchange scheme, keep in touch with the prospective customers by keeping records of their responses to test rides, etc.

SERVICE MOTORS

They have realized the importance of giving servicing and after sales service. At their showroom at Andheri, they kept their workshop walls of glass so that everyone who visits showroom can see the quality of technical service they offer.

GEMINI MOTORS

They have bought a Delivery cum Breakdown Van. The van is used to deliver bikes, which could be surprise gifts and to help distressed customers who need help at times of breakdown, A unique service offered only by them. The showroom also boasts of a guest lounge for waiting customers whose vehicles are being serviced. It has a carrom board, television etc. The proprietor promises one such Innovation every year.

FORT POINT MOTORS

Hero Honda is the bike for the economy seeking masses. Staff from factories/offices finds it difficult to take out time to visit the showrooms. Fort Point Motors have developed a


corporate sales department, which puts stalls at big companies, and offer vehicles to the employees at special price and under a loan scheme.

CONCLUSION

Purposeful, systematic Innovation begins with the analysis of the sources of new opportunities. Depending on the context, sources will have different importance at different times. However, whatever the situation, innovators must analyze all sources of opportunity. Because innovation is both, conceptual and perceptual, would-be innovators must go out and look, ask and listen. They should use both the right and the left side of their brains. They look at figures. They look at people. They work out analytically what the innovation has to be to satisfy an opportunity. Then they go out and look at potential entrepreneuirs to study their expectations, their values, and their needs. Effective innovations start small. They try to do one specific thing. Even innovations that create new entrepreneiurs and new markets should be directed towards a clear, specific and carefully designed application.

REFERENCES [1] Dr. Amir Pirich et al.An Interface between entrepreneurship and innovation,New Zealand SMEs Perspective -

Prepared for DRUID Nelson & Winter Conference 2001 ,Aalborg University, Denmark ,12 - 15 June 2001. [2] Brockhaus, R., (1982), The Psychology of the Entrepreneurs, in Kent et al, Encyclopaedia of

Entrepreneurship, Englewood, Cliffs: Prentice Hall. [3] Damanpour, F., (1991), Organizational innovation: A meta-analysis of effects of determinants and

moderators, Academy of Management Journal, 34: 555-590. [4] Dess, G., Lumpkin, G., McGee, J., (1999), Linking corporate entrepreneurship to strategy, structure, and

process: Suggested research directions, [5] Entrepreneurship theory & Practice. 23(3): 85-1-2. [6] Drucker, P.F., (1986), Innovation and Entrepreneurship: Practices and Principles. New York: Harper & Row.

Economist, (February 20th 1999), Special Report on Innovation in Industry

Social Entrepreneurship: Changing Face of India

Dr. Gulnar Sharma* and Mithisha Amin*

Abstract—Social entrepreneurship in India has successfully grown over the last decade. Every year, more and more people utilize their entrepreneurial skills in building sustainable enterprises for profit and non-profit to effect change in India. Although social entrepreneurship has been practised in India for some time now, social business is a comparatively new phenomenon in the country.

Social entrepreneurship, as a practice and a field for scholarly investigation, provides a unique opportunity to challenge, question, and rethink concepts and assumptions from different fields of management and business research. Social entrepreneurship is seen as differing from other forms of entrepreneurship in the relatively higher priority given to promoting social value and development versus capturing economic value. India still has a long way to go compared to the West where governments are funding non-profit organizations by outsourcing social sector services. Though social enterprises are definitely making an impact on Indian society with a population of 1.1 billion, it is very difficult to see that impact on a macro level.

This paper titled “Social Entrepreneurship: Changing Face Of India” tries to understand a view of social entrepreneurship as a process that catalyzes social change and addresses important social needs in India.

INTRODUCTION

Though many may consider Social Entrepreneurship as the buzz word today, the truth of the matter is that it has existed since the 1960’s. Whilst it may represent a newly coined term, it is hardly a novel concept. Innovative individuals and enterprising groups have been addressing social issues for centuries But nonetheless, Social Entrepreneurship has become a global phenomenon since and has achieved tremendous success, especially in India.

The popularity of Social Entrepreneurship is growing at a very high pace in India over the past few years. With the media having increasingly raised attention to outstanding people who received awards for their social enterprises from a growing range of recognised organisations, like the Schwab Foundation for Social entrepreneurship or Ashoka. The attention to the topic spread to a broader audience when Muhammed Yunus, founded the Grameen Bank to eradicate poverty and empower women in Bangladesh, was awarded the Nobel Peace Prize in 2006. This shed light on the growing number of successful social entrepreneurial initiatives that contribute to solving the world’s most pressing problems.

Earlier, the individuals or groups acted as catalysts challenging the status quo by identifying an apparently insoluble social problem and tackling it with tenacity and vision. Their outstanding leadership towards a social end and their ability to see opportunities where

*Janaki Devi Bajaj Institute of Management Studies, SNDT University, Mumbai

Social Entrepreneurship: Changing Face of India 259

others only saw hurdles further single out these charismatic figures. Today, the same distinguishing features are also present in a new breed of social entrepreneurs and, therefore, a direct line of descent can be discerned between these extraordinary public change-agents of the past and such modern-day social pioneers as Muhammad Yunus (Grameen Bank, Bangladesh), Fazle Abed

(Bangladesh Rural Advancement Committee or BRAC), Chief Fidela Ebuk (Women's Health and Economic Development Association, Nigeria), David Green (Project Impact, USA), Liam Black (Furniture Resource Centre, UK), and Jeroo Billimoria (Childline, India).

Social entrepreneurs recognises the parts of society having difficulties, solves the problem by changing the system, spreading the solution, and persuading societies. Social entrepreneurs drive to produce measurable impact to address social and environmental problems that are often deep-seated.

However, in comparison with the past, what is notable now is that the number and range of social actors behaving entrepreneurially is far larger than at any previous point in history (Bornstein, 2004, pp.3-6). For example, a recent survey of socially entrepreneurial activity in the UK suggested that new ‘social’ start-ups are emerging at a faster rate than more conventional, commercial ventures.

Social entrepreneurship concept gained importance in today's world where innovative-oriented entrepreneurs are welcomed not only in business world but also within the scope of social world. Thus, companies also try to solve social problems by realizing social entrepreneurship activities and have demonstrated remarkable examples. Social entrepreneurship as an important tool for social transformation have turned NGOs into vital units besides state and private sector in struggling societal matters.

WHAT IS SOCIAL ENTREPRENEURSHIP?

The meaning of social entrepreneurship is indefinite and a variety of definitions co-exist.

A social entrepreneur is someone who identifies a social problem and uses entrepreneurial principles to create, organise, and manage a venture to make social change. A social entrepreneur measures success based on the impact on the society. While social entrepreneurs are often non-profit groups, the aim is to advance the social and environmental goals. In India, a social entrepreneur can be a person, who is the founder, co-founder or a chief functionary (may be president, secretary, treasurer, chief executive officer (CEO), or chairman) of a social enterprise, which primarily is a NGO, which raises funds through some services (often fund raising events and community activities) and occasionally products. Rippan Kapur of Child Rights and You and Jyotindra Nath of Youth United, are such examples of social entrepreneurs, who are the founders of the respective organizations. Jay Vikas Sutaria of Bhookh.com is a social entrepreneur who is leveraging the power of the Internet to fight hunger in India.

Social Entrepreneurship cannot be confused with charity. While charity reflects the benefactor’s compassion for humankind and is measured in terms of the generosity of


donations to the less fortunate, social entrepreneurship reflects more than the good intentions of its practitioners, who are not merely driven by compassion, but are also compelled by a desire for social change. Oftentimes, charitable organizations survive at the mercy of their donors whose contributions vary with the economic climate. A nonprofit that practices social entrepreneurship, on the other hand, relies less heavily on donor funds because it creates social programs that are meant to be self-sustaining. Social entrepreneurs manage donor contributions in an effective manner, investing in social ventures which can then generate their own revenues to sustain themselves.

In other words, while charity uses donor funds to buy food to ease the poor’s hunger, albeit only temporarily, social entrepreneurship uses its funds to make a lasting social impact, creating instructional programs that teach the poor how to grow their own food so that they can take care of themselves in the long run. In a world of scarce resources, it is no longer enough to simply donate out of good intentions. Rather, Greg Dees emphasizes the need for people to value the social impact that their donations are actually having:

THE ROUTE OF SOCIAL ENTREPRENEURSHIP

The definitions of social entrepreneurship – the work and initiatives of social entrepreneurs – are also numerous, as they are as well derived from the many academic approaches. One group defines social entrepreneurship by its non-profit initiatives in search of alternative funding strategies to create social value, a second as the socially responsible practice of commercial business engaged in cross-sector partnerships. A third group describes it as a means to alleviate social problems and to catalyse social transformation.

Roberts and Woods and Roper and Cheney claim that social entrepreneurship is a paradigm that has place in any business, be it in the for-profit, non-for profit or public sector wherever there is a social need. Its features depend on the nature of social needs addressed, the amount of resources needed, the scope for raising capital, and the ability to capture economic value. The first tend to adapt appropriate business trends, with an orientation to planning, profit and innovation. The second have to compete for funding. And the last can be characterised by the economic applications of business and market models to the public sphere.

In general, social entrepreneurship is regarded as an innovative, social value creating in response to basic human needs that remain unsatisfied by current economic or social institutions. As a combination of commercial enterprise with social impacts, it is a multidimensional construct deeply rooted in an organisation's social vision and mission and its drive for sustainability.

The context of social entrepreneurship is shaped by environmental changes – increased globalisation, new forms of government initiatives and the increasing entry of for-profit organisations into markets traditionally served by non-profits. Social entrepreneurship therefore takes on multiple forms depending on the socioeconomic and cultural circumstances.In developed nations, for example, social entrepreneurship exists because of the decline of the welfare state, changes in the institutional environment and resulting gaps in


the social safety net. In developing and emerging economies it developed because of a distrust of the NGO community, apathy within the private sector and the impotence of governments to provide services to people.

The particular aspects of social entrepreneurship usually follow certain patterns. It begins with the identification of a specific social problem and an attractive opportunity to provide a solution with a promising social impact. Hence, the core process of social entrepreneurship is according to Drayton and the

Schwab Foundation the systematic spotting of ideas to solve the world’s most urgent problems and to change their underlying patterns by turning these ideas into transformational solutions.

Once a concept for an initiative has been found, to establish and sustain it, frequently resources generated from successful activities are used. This can involve the offering of products and services or the creation of new organisations. Sometimes, part of the income of a social enterprise comes from the beneficiaries when they have to contribute to the specific programme.

The creation of economic value is a means to the objective, the condition to ensure financial viability and to achieve sustainability and self-sufficiency. The later is usually more difficult to achieve because the customers that social entrepreneurs are serving often can not afford to pay for the services or products. Social entrepreneurship therefore relies on individuals who are exceptionally skilled at collecting and mobilising human, financial and political resources.

The effect of social entrepreneurship as a catalyst for social transformation goes beyond the mere solution of the initially identified problem. The original idea usually grows into a major initiative and spreads in regional and functional scope.

The focus of social entrepreneurship, whether for-profit or not, is social change. Hence, the evaluation process should assess the progress made in achieving specific environmental or societal improvements. Clear and well-defined goals greatly simplify measuring the impact of a program on its intended eco-system or recipients.

In addition, it seems appropriate to evaluate the leadership performance of the social entrepreneur. After all, that individual is at the heart of social entrepreneurship, acting as the proponent, champion, and steward of a driving vision to improve the environment or society. Thus, assessing the social entrepreneur’s leadership, management, and spokesperson capabilities is essential to ensure the sustainability and ultimate success of the enterprise.

Finally, as with any startup, the economic performance of the organization should be analyzed using the same methodologies applied to traditional for-profit businesses. Although profit can be a secondary or even nonexistent consideration for some social entrepreneurs, every enterprise must receive or generate sufficient funds to survive, if not thrive.


SUCCESSFUL SOCIAL ENTREPRENEURSHIP CASES SO FAR

• AMUL (Anand Milk Union Limited)

SOCIAL ENTREPRENEUR: DR. VERGHESE KURIEN

Type of Organization: Co‐operative

Website: www.amul.com

Amul has been a sterling example of a co-operative organization’s success in the long term. It is one of the best examples of co-operative achievement in the developing economy. The Amul Pattern has established itself as a uniquely appropriate model for rural development. Amul has spurred the White Revolution of India, which has made India the largest producer of milk and milk products in the world.

• Shri Mahila Griha Udyog Lijjat Papad

Type of Organization: Society

Website: www.lijjat.com

Shri Mahila Griha Udyog Lijjat Papad is a Women’s organisation manufacturing various products from Papad, Khakhra, Appalam, Masala, Vadi, Gehu Atta, Bakery Products, Chapati, SASA Detergent Powder, SASA Detergent Cake (Tikia), SASA Nilam Detergent Powder, SASA Liquid Detergent. The organisation is wide-spread, with it’s Central Office at Mumbai and it’s 67 Branches and 35 Divisions in different states all over India.

The organization started of with a paltry sum of Rs.80 and has achieved sales of over Rs.300 crores with exports itself exceeding Rs. 12 crores. Membership has also expanded from an initial number of 7 sisters from one building to over 40,000 sisters throughout India. The success of the organization stems from the efforts of it’s member sisters who have withstood several hardships with unshakable belief in ‘the strength of a woman’

• Grameen Bank

SOCIAL ENTREPRENEUR: MUHAMMAD YUNUS

Type of Organization: Body Corporate

Website: www.grameen-info.org

Grameen Bank (GB) has reversed conventional banking practice by removing the need for collateral and created a banking system based on mutual trust, accountability, participation and creativity. GB provides credit to the poorest of the poor in rural Bangladesh, without any collateral. At GB, credit is a cost effective weapon to fight poverty and it serves as a catalyst in the over all development of socio-economic conditions of the poor who have been kept outside the banking orbit on the ground that they are poor and hence not bankable. Professor Muhammad Yunus, the founder of “Grameen Bank” and its Managing Director, reasoned that if financial resources can be made available to the poor people on terms and conditions that


are appropriate and reasonable, “these millions of small people with their millions of small pursuits can add up to create the biggest development wonder.”

As of May, 2009, it has 7.86 million borrowers, 97 percent of whom are women. With 2,556 branches, GB provides services in 84,388 villages, covering more than 100 percent of the total villages in Bangladesh.

• Aravind Eye Hospital & Aurolab

SOCIAL ENTREPRENEUR: DR.GOVINDAPPA VENKATASWAMY (DR. V) & DAVID GREEN

Type of Organization: Trust

Location: Madurai, India

Website: www.aravind.org

Mission: Making medical technology and health care services accessible, affordable and financially self-sustaining

Founded in 1976 by Dr. G. Venkataswamy, Aravind Eye Care System today is the largest and most productive eye care facility in the world. From April 2007 to March 2008, about 2.4 million persons have received outpatient eye care and over 285,000 have undergone eye surgeries at the Aravind Eye Hospitals at Madurai, Theni, Tirunelveli, Coimbatore and Puducherry. Blending traditional hospitality with state-of-the-art ophthalmic care, Aravind offers comprehensive eye care in the most systematic way attracting patients from all around the world.

• SKS India

SOCIAL ENTREPRENEUR: VIKRAM AKULA

Type of Organization: For‐profit

Website: www.sksindia.com

Mission: Empowering the poor to become self-reliant through affordable loans SKS believes that access to basic financial services can significantly increase economic opportunities for poor families and in turn help improve their lives. Since inception, SKS has delivered a full portfolio of microfinance to the poor in India and we are proud of our current outreach. As a leader in technological innovation and operational excellence, SKS is excited about setting the course for the industry over the next five years and is striving to reach our goal of 15 million members by 2012.

SOCIAL IMPACT OF ECONOMIC ENTREPRENEURSHIP

India being an agile economy, backed up by solid fundamentals; is driven primarily by domestic consumption. This essentially allows India to regulate its economy, independent of the splurge/dip in other nations. While most of us rejoice at the visible parameters that are


grossly urban and portrayed in the media, the fact remains that India’s urban lifestyle has remained mostly static. It’s the rural and semi-urban classes who are spending and spending like never before. India’s meteoric rise as a telecom market is one of innumerable examples. Social Enterprises that are vying to cater to take to the semi-urban consumer have massive scopes for scalability. A major chunk of these will be social enterprises as the India demography is plagued with problems that demand a socio-entrepreneurial approach.

Social entrepreneurs and social enterprises share a commitment to furthering a social mission and improving society. Some of the basic definitional issues that remain include the choice of for-profit /non-profit structure, the necessity of earned-income strategies among nonprofits, and the degree to which social entrepreneurs/enterprises can manage the toughest social and environmental issues.

A social entrepreneur is someone who identifies a social problem and uses entrepreneurial principles to create, organise, and manage a venture to make social change. A social entrepreneur measures success based on the impact on the society. While social entrepreneurs are often non-profit groups, the aim is to advance the social and environmental goals.

Often social entrepreneurs present new ideas that are user friendly and ethical, social and environmental problems. They typically get people support to implement and make a positive impact on the society.

ROLE OF SOCIAL ENTREPRENEURS

Social entrepreneurs recognises the parts of society having difficulties, solves the problem by changing the system, spreading the solution, and persuading societies. Social entrepreneurs drive to produce measurable impact to address social and environmental problems that are often deep-seated.

• To make a positive impact on society:

Social entrepreneurs are similar to business entrepreneur in the society with a purpose for a social cause. Often, social entrepreneur need profit but emphasis is on the development of the society and in solving the problems in it. Finding the effects of social or environmental problem, finding root cause, and solving them becomes obvious to social entrepreneur.

• With focus on positive change:

Social entrepreneur focus on daunting social problems to make a positive change, further motivating common people to persuade the same. Corporate social entrepreneur can reap strategic benefits with a combination of commercial aims and social objectives.

• Rev up the social team

While social entrepreneurs often work through nonprofits and citizen groups, many work in the private and governmental sectors. Social entrepreneurs work with local groups motivate them to pursue, and develop good solutions for their local communities as well as globally.

• In innovative and effective community building:


Distinct from business entrepreneurs who seek value in the creation of new markets, social entrepreneurs aim for value in the form of transformational change that will benefit underprivileged group of people and eventually society at large.

Social entrepreneur identifies fundamental social and environmental problems in the ever-changing society. They guide society through these turbulent times, to help the society.

Like any other business venture, social entrepreneurship programmes cannot be isolated exercises. Most entrepreneurs, for instance, promote a non-profit organisation in the hope that other individuals and agencies will move in to support the cause and help multiply its benefits across larger sections of society. The extent of success of such endeavours is often based on the amount of collaboration and grassroots involvement they are able to generate.

Furthermore, and just like business ventures, social entrepreneurship projects depend on some degree of risk-taking. Only, in this case, the risk is not limited to financial security but involves social activism and passion. In this context, social entrepreneurship activities may appear to be incredibly perilous, but the risks pay off many times more in terms of their benefits to society.

Social entrepreneurship is as important for a growing society as business entrepreneurship is for a developing economy. They are both critical for sustainable development and accelerated inclusive growth.

The significance of their impact on societies can be gauged from the contributions of some eminent social entrepreneurs who are feted for positively and permanently impacting our world. In 19th Century United States, Susan B Anthony led the fight for women's suffrage and helped establish equal rights for them. In 20th Century India, Vinoba Bhave founded the Land Gift Movement that caused the redistribution of more than 700,000 acres of land to the country's poorest. Italian physician Maria Montessori (1870 - 1952) determined deficiencies in the early educational system and developed a new approach that continues to be relevant across the world today. Before her, compatriot Florence Nightingale helped establish the first school for nurses and fought to improve hospital conditions. Birth control activist Margaret Sanger encouraged family planning around the world with her Planned Parenthood Federation of America. These and other social entrepreneurs have made extraordinary contributions in shaping the modern world.

ECONOMIC IMPACT OF SOCIAL ENTREPRENEURSHIP

In recent years, ‘not-for-profit’ has been pushed to the back partly because of responsible lenders and social enterprises are being run more like businesses today. The focus is on enterprising micro groups which want to transform their own, and the community’s, circumstances but can’t access any finance.

Fast company in their March 2010 listed “top 10 by Industry”. And four of the top 10 most innovative companies in India were standalone social enterprises or have socially entrepreneurial initiatives.


In India alone social entrepreneurship space has a countless mixture of models with a one billion thinking structure. One billion thinking requires cost-effective models involving the bottom of the pyramid. The majority of these models are scalable and replicable.

Table 1: Profitability by Sector

The Profitable Sectors of Social Entrepreneurship in India

• Education: Sector with a track record of profit: The Education sector has shown a marked degree of financial stability and growth potential. There are two key elements. First, the sector represents the highest number of profit-making enterprises (38%) among others, and also has one of the lowest numbers of loss-making entities (24%). Second, the observation says that there is a good growth potential; 38% of education enterprises are breaking even — which means the number of profit-making enterprises in this sector could increase in the coming years.

• Health: Sector with large growth potential: Although the sector currently produces a very small number of profit-making entities, it has the lowest percentage (13%) of loss-making enterprises. Most importantly, at 73%, the Health sector has the largest segment of break-even businesses. If/when these enterprises begin to turn a profit, the Health sector could sustain a multitude of successful, profit-making enterprises.

• Rural Development: Sector to watch out for future growth: Despite the fact that the largest number of social enterprises are in this field, it is the biggest loss-making sector at the moment. However, Rural Development demonstrated the largest revenue increases last year, so there could be more surprises in store.

There are more enterprises that are loss-making (34%) than those earning a profit (25%). And 41% percent of enterprises are currently breaking even. If you look at the profitability by


measure of years in operation, you can clearly see that making profit through social enterprise is no easy task.

There are more enterprises that are loss-making (34%) than those earning a profit (25%). And 41% percent of enterprises are currently breaking even. If you look at the profitability by measure of years in operation, you can clearly see that making profit through social enterprise is no easy task.

It is true that the percentage of loss-making enterprises steadily goes down as the companies get older. But there is virtually no disparity in the number of profit-making entities across age categories. Many enterprises stop making losses as they grow older but do not begin to turn a profit; they merely start breaking even. Surprisingly, even after 11 years or more of operations, the percentage of profit-making enterprises is only 27%.

Social entrepreneurship in India is emerging primarily because of what the government has not been able to do. The government is very keen on promoting social entrepreneurship – not necessarily by funding it or by advising on it or enabling it. What they do, is not disable it.

For example, in Mumbai alone, non-profit organizations educate more than 250,000 children on a daily basis. The government has not told these organizations not to do it. Whereas in some countries, when someone takes it into their own hands to start a facility for education or healthcare or empowerment, the government often puts in place barriers to prevent this from happening.

Our country does not have a homogenous people or geography, so the impact largely remains regional. With the current economic climate, it is very likely that social needs will increase and, consequently, the number of people committed to addressing them will increase. Definition of social entrepreneurship has changed over time. From corporate philanthropy to non-profit and now to self-sustainability, Social Entrepreneurship has evolved and will keep evolving with time and needs of the world.


MAIN SOURCES OF FINANCING–LIMITED ACCESS TO THE COMMERCIAL

FINANCING

There is a divide between those that have access to mainstream and/or commercial funds and those that rely on personal connections and grants/donations to raise money. The ratio is about 50/50.

• Foreign grants: 8% • Domestic grants: 8% • Debt (credit loans): 11% • Government Funding: 3% • Charitable Organization: 5% • Bank Loan: 13% • Loan from Family and friends: 21% • Equity Investors: 21 % • Others: 10%

As per Beyond Profit survey, Forty-five percent of respondents obtained funds from commercial sources whereas 21% of respondents source their funds from personal connections such as family members and friends; another 21% rely on grants and donations from charitable organizations. Arranging finances for a social enterprise in India is still very difficult. And knowing in which sector to finance is even more difficult. In bar diagram mentioned below is a mention of profitable sectors and a trend which clearly states areas to divert funds.

The survey results revealed that there is a clear divide between those that have access to

mainstream and/or commercial funds and those that rely on personal connections and grants/donations to raise money. The ratio is about 50/50. Forty-five percent of respondents obtained funds from commercial sources whereas 21% of respondents source their funds from personal connections such as family members and friends; another 21% rely on grants and donations from charitable organizations.


The challenges faced in financing terms included factors like lack of like-minded investors, inappropriate business models, complex fund-raising processes, lack od fund-raising investors and so on.

THE ROAD AHEAD

The future of Social entrepreneurs definitely seems very bright, especially in India.

Funding will keep growing in a gradual, linear fashion and organizations will compete for resources by demonstrating performance. The sector will consolidate, with some efficient organizations gaining scale, some merging and then growing, and some failing to achieve either scale or efficiency and eventually shutting down.

Existing and new enterprises will apply strategies to achieve and demonstrate performance, improving efficiency and effectiveness and attracting new funding sources. More organizations will enter a reformed, competitive field of social change with new entrepreneurial models, established traditional organizations, and innovative funding strategies fuelling widespread success.

Rather than focusing exclusively on performance, funders and organizations may view their investment as an expressive civic activity. As much value is placed on participating in a cause as on employing concrete measures of impact or efficiency. Funding will flow as social entrepreneurs experiment with new models based on a range of individual priorities and relationships.

REFERENCES [1] www.wikipedia /social entrepreneurship/background.org [2] Jean-Baptiste Say, quoted in J. Gregory Dees, “The Meaning of ‘Social Entrepreneurship,’” reformatted and

revised, May 30, 2001 [3] http://www.fuqua.duke.edu/centers/case/documents/Dees_SEdef.pdf [4] Joseph A. Schumpeter, Capitalism, Socialism, and Democracy (New York: Harper,1975) [5] Peter F. Drucker, Innovation & Entrepreneurship (New York: Harper Business, 1995) [6] Israel Kirzner, quoted in William J. Baumol, “Return of the Invisible Men: The Microeconomic Value Theory

of Inventors and Entrepreneurs.” [7] http://www.aeaweb.org/annual_mtg_papers/2006/0107_1015_0301.pdf [8] Carl J. Schramm, “Entrepreneurial Capitalism and the End of Bureaucracy [9] http://www.aeaweb.org/annual_mtg_papers/2006/0107_1015_0304.pdf

Track 5 Financial Crisis

Financial Crisis and its Impact on India

Rashmi Gairola* Abstract—The Global Financial Crisis which had been brewing for some time really started to show its effects in the middle of 2007 and it is still not over. Triggered by a liquidity shortfall in the United States banking system, it has resulted in the collapse of large financial institutions, bailout of banks by national governments and downturns in stock market around the world.

It is often said that when the US sneezes the rest of the world catches a cold. On the contrary, India, unlike most other emerging market economies has not been seriously affected by the recent financial turmoil in developed economies. By and large, India has been spared the panic that followed the collapse of banking institutions such as Lehman Brothers and Merrill Lynch. The relative freedom from the contagion spreading from the global tsunami on the Indian financial system owes much to the wise and judicious policies of the central bank and Government of India.

However, the impact of the global crisis has been transmitted to Indian economy through three distinct channels, viz., the financial sector, exports and exchange rates. This can be contrasted against other countries, like Iceland that were hit very severely by the global crisis.

INTRODUCTION

A financial crisis refers to a situation in which the supply of money is outpaced by the demand for money. This mean that liquidity is quickly evaporated because available money is withdrawn from banks, forcing banks to either sell other investments to make for the shortfall or to collapse. It can be also defined as a loss of confidence in a country’s currency or other financial assets causing international investors to withdraw their funds from the country. The term financial crisis is applied broadly to variety of situations in which some financial institution or assets suddenly lose a large part of their value. The financial crisis of 2007 to the present is a crisis triggered by a liquidity shortfall in the United States banking system. It has resulted in the collapse of large financial institutions, the bailout of banks by national governments, and downturns in stock markets around the world. It contributed to the failure of key business, declines in consumer wealth estimated in the hundreds of trillions of US dollars, substantial financial commitments incurred by governments, and a significant decline in economic activity.

The Global Financial Crisis which had been brewing for some time really started to show its effects in the middle of 2007 and it is still not over. Triggered by a liquidity shortfall in the United States banking system, it has resulted in the collapse of large financial institutions, bailout of banks by national governments and downturns in stock market around the world. India is not exposed to the new and innovative financial instruments that triggered the meltdown. This is one of the main reasons as to why India has not been severely hit by the crisis, as can be seen from the following discussion.

*Pune Institute of Business Management, Pune



• Impact of global meltdown on India o Macro economic impact o Impact on common man o Impact on the Indian corporate sector o Why impact on India was limited?

• Compare with impact on Iceland. • What does Indian economy needs to do different – financial innovations?


• Scope of the study: o Macro economic indicators used in the study are GDP, Stock Exchange, Export,

Import and Foreign Exchange. o To study the impact on common man, various parameters are used such as,

Unemployment rate, Inflation rate (consumer price), Labour force and Population below poverty line.

o To study the impact on the Indian corporate sector, a random sample of 1 company, each from the following industries, viz., Banking, Aviation, FMCG; and 2 companies from IT & Outsourcing, will be selected.

• Type of Data: o Secondary data will be used.

• Data Source: o Websites and other published data.

FINDINGS

Macro‐Economic Impact

To study the effect of crisis on India, let’s take into consideration few important macro-economic indicators. (Refer to Appendix I)

Gross Domestic Product (GDP) Year GDP real growth

rate (%)

-1.002.003.004.005.006.007.008.009.00

10.00

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Year

GD

P re

al g

row

th r

ate(

%)

2002 4.3 2003 4.3 2004 8.3 2005 6.2 2006 8.4 2007 9.2 2008 9.0 2009 7.4 2010 *6.5

*2010 figures are estimated

Financial Crisis and its Impact on India 275

GDP is one of the primary indicators to gauge the health of a country’s economy. It basically indicates a country’s health. As we can see above the GDP of India over a period of time is given. In the year when financial crisis started, it increased to 9.2%. It marginally decreased in 2008 and then further in 2009.

Industrial Production Growth Rate Year Industrial

production growth rate (%)

Industrial production growth rate (%)

-1.002.003.004.005.006.007.008.009.00

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Year

Indu

stri

al p

rodu

ctio

n gr

owth

ra

te(%

)

2003 6.0 2004 6.5 2005 7.4 2006 7.9 2007 7.5 2008 8.5 2009 4.8 2010 *7.6


As can be seen from the table, the year 2007 and 2009, both showed a negative growth and it was extremely low in 2009. This can be directly related to the decline in the GDP that we described earlier. This could be considered the main indicator showing any traces of financial crisis in India.

Exports Year Exports ($)

020,000,000,00040,000,000,00060,000,000,00080,000,000,000

100,000,000,000120,000,000,000140,000,000,000160,000,000,000180,000,000,000200,000,000,000

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Year

Expo

rts(

$)

2003 44,500,000,000 2004 57,240,000,000 2005 69,189,000,000 2006 76,230,000,000 2007 112,000,000,000 2008 151,300,000,000 2009 176,400,000,000 2010 *165,000,000,000


The exports show an increasing trend in the whole crisis period.


Imports Year Imports ($)

0

50,000,000,000

100,000,000,000

150,000,000,000

200,000,000,000

250,000,000,000

300,000,000,000

350,000,000,000

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Year

Impo

rts(

$)

2003 53,800,000,000 2004 74,150,000,000 2005 89,330,000,000 2006 113,100,000,000 2007 187,900,000,000 2008 230,500,000,000 2009 305,500,000,000 2010 *253,900,000,000


Imports are also showing an increasing trend for the period taken into consideration except for the year 2010

Stock Exchange (BSE) Year BSE Sensex

0

5000

10000

15000

20000

25000

0 1 2 3 4 5 6 7 8

Year

BSE

Sen

sex

11th Feb 2000 6000 9th Dec 2005 9000 5th Dec 2006 14000 29th Oct 2007 20000 17th Oct 2008 9000 18th May 2009 12000 12th Oct 2010 20000

The stock market has been quite volatile. But the point to be noted here is that in the year 2007, it reached as high as 20000.

Exchange Rate (Indian Rupee to USD) Year Indian Rupees

to 1 USD

40.0041.0042.0043.0044.0045.0046.0047.0048.0049.0050.00

1998 2000 2002 2004 2006 2008 2010 2012

Year

Indi

an R

upee

s to

1US

D

2000 44.952 2004 45.340 2007 41.197 2008 43.814 2009 48.849 2010 *45.857

*2010 figure is 10 month average (January to October)


The above data is quite interesting. In the year 2007, the rupee appreciated with respect to dollar. This was the time when many big companies in the US were going bankrupt.

Impact on the Common Man in India

Let us consider few parameters to study the impact of the crisis on the common man in India.

Unemployment Rate Year Unemployment

rate (%)

-

2.00

4.00

6.00

8.00

10.00

12.00

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Year

Une

mpl

oym

ent r

ate

(%)

2002 8.8 2003 8.8 2004 9.5 2005 9.2 2006 8.9 2007 7.8 2008 7.2 2009 6.8 2010 *10.7


It is expressed as the percentage of labour force which is without jobs. Although the rate of unemployment has been increasing leading to substantial unemployment, but in the year 2007 when the crisis started, the rate dropped and it further dropped in the year 2008 and 2009. It should be noted that, this was the period of innumerable lay offs by several big companies in the US. There were lay offs in India also but in comparison it was less which can be confirmed by the data above.

Inflation Rate (Consumer Prices) Year Inflation rate

(%)

-

2.00

4.00

6.00

8.00

10.00

12.00

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Year

Infla

tion

rate

(%)

2002 5.4 2003 5.4 2004 3.8 2005 4.2 2006 4.2 2007 5.3 2008 6.4 2009 8.3 2010 *11.25

*July 2010.


It shows the annual percentage change in consumer prices compared with the previous year’s consumer prices

As can be seen from the table above, the rate of inflation has been rising. The rate increased by 26.19% in 2007 from 2006. But in the year 2008, it only increased by 20.75% which shows that the government of India was making all the efforts to control the prices.

Labour Force Year Labour Force

0

100,000,000

200,000,000

300,000,000

400,000,000

500,000,000

600,000,000

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Year

Labo

ur F

orce

2002 406,000,000 2003 406,000,000 2004 472,000,000 2005 482,200,000 2006 496,400,000 2007 509,300,000 2008 516,400,000 2009 523,500,000 2010 *467,000,000


It gives the amount of total labour force. India is number 2 in the world for its labour force. This shows the human capital available with India. It also has been increasing as can be seen. In the year 2007 it went beyond 500 million.

Population Below Poverty Line Year Population

below poverty line (%)

0

5

10

15

20

25

30

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Year

Pop

ulat

ion

belo

w p

over

ty li

ne(%

)

2002 25 2003 25 2004 25 2005 25 2006 25 2007 25 2008 25 2009 25 2010 *25


The above information shows that the percentage of population below poverty line in India has been quite stable and constant at 25%. This data proves that in spite of the global meltdown, the poverty in India did not increase to enormous levels, which mean the effect of crisis on the common people was not much.


Impact on the Indian Corporate Sector

The failure of Lehman Brothers in mid-September 2008 was followed in quick succession by several other large financial institutions coming under severe stress. This made financial markets around the world uncertain and unsettled. This contagion spread to emerging economies and to India too. Let us take a few sectors to study the impact of the global meltdown on the Indian corporate sector

Banking Sector

The Indian banking system has had no direct exposure to the sub prime mortgage assets or to the failed institution in the USA. It has very limited off-balance sheet activities or securitized assets. Also the Indian Central Bank relaxed some of its rules in order to help banks. RBI first cut the reserve requirements and then it declined the short-term lending rate. That was the reason the banks in India remained safe and healthy. This can be justified by looking at the financial position of ICICI. (Refer to Appendix II)

Mar ' 10 Mar ' 09 Mar ' 08 Mar ' 07 Mar ' 06 Profitability ratios Operating margin (%) 16.95 14.13 14.45 13.33 18.66 Gross profit margin (%) 15.06 12.36 12.99 11.41 15.10 Net profit margin (%) 12.17 9.74 10.51 10.81 14.12 Liquidity ratios Current ratio 1.94 0.78 0.72 0.61 0.62 Quick ratio 14.70 5.94 6.42 6.04 6.64

The profitability ratios show a consistent rate of profit (gross as well as net) earned through out the period from 2006 to 2010. Also their liquidity condition was quite good as can be seen above.

Aviation Sector

The aviation industry has been impacted by the global meltdown in the form of oil crisis and strong inflationary trends. The situation in India has been challenging for airlines in the last few years on account of the most expensive aviation turbine fuel (ATF) rates in the world. This is coupled with poor and expensive infrastructure which leads to high fuel wastage and diminished asset utilization. In 2008, late September, the most happening airline company of India, Kingfisher Airlines, decided to go for massive layoffs. Due to volatile fuel prices, they were forced to go for cost cutting measures. The following data is taken from the financial statements of the Kingfisher Airlines. (Refer to Appendix III)

Mar ' 10 Mar ' 09 Mar ' 08 Jun ' 07 Jun ' 06 Profitability ratios Operating margin (%) -18.73 -10.49 -22.32 -14.57 -8.82 Gross profit margin (%) -21.94 -13.02 -23.58 -15.55 -9.86 Net profit margin (%) -31.25 -27.43 -12.50 -22.92 -26.31 Liquidity ratios Current ratio 1.34 1.09 1.71 2.33 1.27 Quick ratio 0.57 0.52 0.87 2.20 1.14


As can be seen from the profitability ratios of the company, it has been negative all through the concerned period.

IT & Outsourcing Sector

The IT Outsourcing boom had really created a buzz in the Indian economy in every which way. More jobs, high salaries – leading to increased cost of living and so on. But because of inflation and tight monitory policies, Indian economy had slowed down and as a result IT industry took a downward slope. Due to the global economic slow down, US companies reduced IT outsourcing. As a result of reduced business, Indian outsourcing companies took to reducing the number of employees in order to balance the low demand figures.

Wipro Ltd. (Refer to Appendix IV) Mar ' 10 Mar ' 09 Mar ' 08 Mar ' 07 Mar ' 06

Profitability ratios Operating margin (%) 24.00 22.12 21.24 23.78 24.28 Gross profit margin (%) 21.47 19.64 18.63 21.15 21.42 Net profit margin (%) 20.97 13.53 17.19 20.34 19.53 Liquidity ratios Current ratio 2.39 1.83 2.54 1.68 1.46 Quick ratio 2.29 1.76 2.44 1.61 1.40

Infosys Technologies Ltd. (Refer to Appendix V) Mar ' 10 Mar ' 09 Mar ' 08 Mar ' 07 Mar ' 06


In spite of whatever has been said above, the IT and Outsourcing sector of India has not performed very badly as one could have expected. As can be seen from the data above of the two companies, Wipro and Infosys, both the companies have increasing profitability ratios and maintaining sufficient amount of liquidity. One reason can be the declining rate of Indian currency, attracting more western investors to the outsourcing sector. Another reason can be availability of cheap and abundant manpower.

FMCG Sector

Post liberalization, because of the entry of number of MNCs in India, the FMCG sales went up. But between 2000 and 2004, FMCG sector got hit, attributed to agricultural crisis and industrial slowdown. From 2005, consumers are willing to move to evolved brands (premium products), because of changing lifestyles, rising disposable income etc. In nutshell, consumers are looking for value and not MRP. Also the sales in rural sectors are growing faster. Therefore it can be said that this sector has shown strong volume growth.


(Refer to Appendix VI) Mar ' 10 Mar ' 09 Mar ' 08 Mar ' 07 Mar ' 06


As is evident form the data above, which is taken from the financial statements of Dabur India Ltd., there has been steady growth in the profitability of the company.

The performance of India during the crisis has been mixed. Although the environment has been volatile and week, there still remain pockets of opportunity. India has been in great shape during the difficult times. The Indian firms have some how tapped the situation intelligently in order to ease out the blows form the financial crisis. Therefore it can be said that the impact of the crisis on India has been limited, specifically because of;

• Its strong fundamentals • Stringent regulations by the Government • Untapped growth potential • Burgeoning consumer market • Availability of cheap workforce

Crisis in Iceland and its impact on India

In the fall of 2008, Iceland experienced wide-spread financial difficulties. In the wake of the global financial crisis, Iceland’s three largest private banks, Glintir, Landisbanki and Kaupthing, were taken into government administration due to lack of available credit to finance debts, despite substantial assets. The banks were unable to refinance their debts, which went as high as 50 Billion Euros. Iceland accomplished most of its expansion activities in the new economy by taking loans on the inter-bank lending market. External debt also played a key role in financing the expansion. The fact that household debts were about 200% of the average disposable income of the family fuelled the prices of essential commodities to rise. This resulted in inflation, which got further attested by the Central Bank of Iceland issuing loans on uncovered bonds, to bank. Most banks in Iceland refused to make fresh loans. The larger banks also found it difficult for them to roll over their loans in the inter-bank market, as their creditors asked them for repayment. In such a tough scenario, banks approach the largest bank, which they did, in approaching the Central Bank of Iceland. The problem was – the Central Bank refused to take ownership and the government of Iceland couldn’t guarantee repayments of debts, as institutionally, the Central Bank of Iceland is much larger than the Government of Iceland. All this resulted in an absolute free-fall for banks, as credit was just not readily available for banks.

Basically, the Icelandic financial crisis was a systematic malady though the ultimate reason lies in the failure of the banking sector, unlike the sub-prime crisis which was a joint


effort of real estate and finance. Comparing it with the crisis in India, the Indian banking system was relatively insulated from the factors lending to the turmoil in the global financial market. The tight liquidity in the Indian market was also qualitatively different from the global liquidity crunch. Due to these reasons, the Indian banks’ global exposure, with respect to sub-prime mortgage lending and investments in complex collateralised debt obligations, was relatively small. Also, the Indian banks had limited vulnerability towards freezing of inter-bank lending market.

Mr. Srichand P Hinduja, Chairman and CEO of Hinduja Group had said in one of his interviews, “Initially everyone will get because the US is still the leader in the financial market be it in terms of volume, size, or products, and no other country or currency can take the burden of what the US has of the world, particularly in the financial sector.…… In the long run, India has a great opportunity. It will be able to sustain as the country is not in the same kitty as others.”

In evaluating the response to the crisis, it is important to remember that although the origins of the crisis are common around the world, the crisis has impacted different economies differently. Most countries have responded to the crisis depending on their specific country circumstances.

What does the Indian Economy Need to do Different?

The world economy went through an unprecedented crisis that started in the financial sector in the US and slowly spread globally. The magnitude of the crisis was such that it affected economies of the world, including India. The question which now arises is that, what the economies can do to secure themselves from such crisis? What are the things that they need to do different?

First let’s take a look at some of the steps that can be taken and which India took, in order to minimize the impact of the crisis:

• The crisis should be converted into an opportunity to introspect and find a way within the problem. This can be achieved only if one has strong fundamentals, like India.

• The first priority should be to protect the financial system, indirectly the investor, from the possible loss of confidence.

• Banks should be well regulated and also well capitalized. Not only that, they should be well supported by the government so that there is no fear for the safety of deposits. As we saw earlier, the impact of crisis on the Indian banking sector was minimum because:

o The Indian banking system had no direct exposure to the sub prime mortgage assets or to the failed institution in the USA.

o It has very limited off-balance sheet activities or securitized assets o The Indian Central Bank relaxed some of its rules in order to help banks. o There should be enough liquidity in the system to ensure adequate flow of credit.

This step was also taken by the Indian government.


There are also some areas where India can do better to mitigate any risks of being exposed to the global economy, while still benefiting from the upside.

• The number one scourge in India today is corruption. If there was a single factor that is holding us back from becoming a super power within the global financial world then it is corruption. In the recently released Global Corruption Index, India has the dubious honour of being 87th (where 1 is the least corrupt country)

• While exports are good for the country, India should look to diversify its export base from the traditional North American and Western European focus. In addition to making political efforts to exporting more goods to China, India should look to developing nations on the African continent.

• The most critical growth need for India is in Infrastructure. The entire basis for having a strong industrial nation is the infrastructure.

• The situation should be watched on a day to day basis and corrective actions should be taken immediately as and when required.

• Required duty cuts should be announced by the government to provide relief to civil aviation sector and iron and steel industry.

• Government has to closely monitor the evolving macro-economic situation in order to sustain the growth momentum of the economy at a reasonable level.

CONCLUSION

When the financial crisis erupted in a comprehensive manner on Wall Street, it was argued that India would be relatively immune to this crisis, because of the “strong fundamentals” of the economy and the supposedly well-regulated banking system. However, with the world becoming smaller, it is not possible to insulate the Indian economy completely from what is happening in the financial systems of the world. Effectively speaking, the Indian banks and financial institutions have not experienced the kinds of losses and write downs that even venerable banks and financial institutions in the Western world have faced. Perhaps this is the first time during such crisis period when world’s big economies like US was struggling to overcome this situation when India was able to invest money for launching chandrayaan-1. When big giants in the US were going bankrupt, the companies in India were reporting and still reporting, successes. The major role of the financial crunch has been to expose political, structural and financial weaknesses of an economy. It explores efficiency in the financial market, transparency and accountability of new or reformed organizations, opportunity for creating new jobs and technologies, sufficient fund for investment in R&D innovation and education. During the financial crisis period, the extent of sufferance of an economy shows its weaknesses. One of the most important reasons that India was not affected badly is that India has been reforming very slowly, which proved to be advantageous. By ensuring that the regulatory system is proper, India dealt with the situation quite sophisticatedly. However, once the global economy begins to recover, India will turn around faster than expected because it has strong fundamentals and untapped growth potential. Meanwhile, all we need to do is keep functioning in the present environment with patience.

In the end it can be said that although India’s growth of public sector and the narrow reliance on the financial services for growth needs to change, with manufacturer and exporters


having particular attention paid to them, still it is quite evident that India is a safer place in comparison to many developed countries economy. Definitely it is going to come out a stronger India once the whole financial crunch is over.

SUMMARY

The global financial crisis has caused a considerable slowdown in most developed countries. It has accelerated the shift of economic power to emerging economies like India. Stock markets crashed, investment banks collapsed and rescue package were drawn up. In the whole turmoil, few growing economies like India have performed extremely well and are emerging sturdier due to strong fundamentals and untapped potential. The major macro economic indicators show how India has done in the past difficult years. The common man has not been severely affected as it has been in most of the developed countries. Similarly the position of the Indian companies has been far better and progressing. This can be contrasted against other countries, like Iceland that were hit very severely by the global crisis. At the same time it can not be completely ruled out that there was no effect of the global meltdown on India. With the world becoming smaller, it is not possible to insulate the Indian economy completely from what is happening in the financial systems of the world. Especially in the Indian IT and Outsourcing sector, there is huge influence of the Western countries. In order to summarise it can be said that the performance of India during the crisis has been mixed. Although the environment has been volatile and week, there still remain pockets of opportunity.

REFERENCES [1] Global Financial Crisis and Key Risks : Impact on India and Asia – Rakesh Mohan Deputy Governor, RBI [2] The US Financial Crisis : Impact on the Indian IT Sector – Manohar M Atreya [3] Global Financial Crisis : Impact on India’s Poor – Rajiv Kumar, Bibek Debroy, Jayati Ghosh, Vijay Mahajan,

K. Seeta Prabhu [4] How the global financial crisis affects India, Sep 19th 2008, Business Standard [5] Global financial crisis : reflections on its impact on India – S. Venkitaramanan, Oct 18th 2008, The Hindu [6] Crisis Will Accelerate the Power Shift to Emerging Economies, CEBR Says – Scott Hamilton [7] India – Managing the Impact of the Global Crisis1 – Duvvuri Subbarao [8] Financial Crises: A Cascading Effect on India – Madhuri Malhotra [9] http://www.aboutcorporateindia.com/aci/reports/global%20meltdown.pdf [10] http://www.rbi.org.in [11] http://www.aboutcorporateindia.com/aci/reports/global%20meltdown.pdf [12] http://www.vccircle.com/columns/the-us-financial-crisis-impact-on-the-indian-it-sector [13] http://en.wikipedia.org/wiki/2008%E2%80%932010_Icelandic_financial_crisis [14] http://www.iceland.org/info/iceland-crisis/ [15] http://www.bis.org/review/r100129a.pdf [16] http://www.rediff.com/money/2008/nov/21bcrisis-globalisation-eventually-has-a-positive-impact.htm [17] http://fmcgmarketers.blogspot.com/2008/12/impact-of-slowdown-and-inflation-and.html [18] http://www.nowpublic.com/tech-biz/indias-outsourcing-firms-hit-us-financial-crisis [19] http://www.ezilon.com/articles/articles/12001/1/Impact-Of-US-Financial-Crisis-On-Indian-Outsourcing-

Companies [20] http://www.voanews.com/english/news/a-13-2009-06-19-voa18-68802772.html [21] http://www.finance-trading-times.com/2008/09/kingfisher-lay-off-job-cut-kingfisher.html [22] http://money.rediff.com/companies/kingfisher-airlines-ltd/16600017/balance-sheet [23] http://money.rediff.com/companies/wipro-ltd/11060011/profit-and-loss [24] http://money.rediff.com/companies/infosys-technologies-ltd/13020007/balance-sheet [25] http://money.rediff.com/companies/dabur-india-ltd/12540103/balance-sheet [26] http://money.rediff.com/money/jsp/p_l.jsp?companyCode=14030056 [27] http://www.indexmundi.com/ [28] http://www.bseindia.com/


APPENDIX I

India’s Macroeconomic Indicators INDICATORS 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 GDP (at current prices, US$ bn)

837.2 947.0 1231.0 1222.0 1317.0 1529.0#

GDP Growth (at constant prices, %)

9.5 9.7 9.2 6.7 7.4e 8.5#

Agriculture & allied 5.2 3.7 4.7 1.6 0.2e 4.5# Industry 9.3 12.7 9.5 3.9 8.5e 9.7# Services 11.1 10.2 10.5 9.8 9.3e 8.9#

Sectoral Share in GDP (%) Agriculture & allied 18.1 17.2 16.4 15.7 14.6e - Industry 27.9 28.7 28.8 28.0 28.5e - Services 53.9 54.2 54.8 56.3 56.9e - Inflation rate (WPI, annual avg. %)

4.4 5.4 4.7 8.3 9.9 (Mar '10) 9.97 (Jul '10)

Gross Fiscal Deficit (% of GDP)

4.1 3.5 2.7 6.0e 6.7e -

Exchange Rate (Rs/US$, avg.)

44.3 45.3 40.2 45.9 47.4 46.81 (Aug 26)

Exchange Rate (Rs/Euro, avg.)

53.9 58.1 57.0 65.1 67.1 59.45 (Aug 26)

Exports (US$ bn) 103.1 126.4 163.1 185.3 178.7 50.8 (Apr-Jun)% change 23.4 22.6 29.0 13.6 -3.6 32.7 (Apr-Jun)Îmports (US$ bn) 149.2 185.7 251.7 303.7 286.8 83.0 (Apr-Jun)% change 33.8 24.5 35.5 20.7 -5.6 34.2 (Apr-Jun)^Trade Balance (US $ bn)

-46.1 -59.3 -88.5 -118.4 -108.2 -32.3 (Apr-Jun)

Services Exports (US$ bn)

57.7 73.8 90.3 101.7 93.8 -

Software Exports (US$ bn)

23.6 31.3 40.3 46.3 49.7 -

Services Imports (US$ bn)

34.5 44.3 51.5 52.0 59.6 -

Services Balance (US$ bn)

23.2 29.5 38.9 49.6 34.2 -

Current Account Balance (US$ bn)

-9.9 -9.6 -15.7 -28.7 -38.4 -

CAB as percentage of GDP (%)

-1.2 -1.1 -1.3 -2.4 -2.9 -

Forex Reserves (US$ bn)

151.6 199.2 309.7 252.0 277.0 282.8 (Aug 13)

External Debt (US $ bn)

139.1 172.4 224.4 224.5 261.5 -

External Debt to GDP Ratio (%)

17.3 18.2 18.1 20.5 18.9 -

Short Term Debt / Total Debt (%)

14.1 16.3 20.4 19.3 20.1 -

Total Debt Service Ratio (%)

10.1 4.7 4.8 4.6 5.5 -

Foreign Investment Inflows (US$ bn)

21.5 29.8 62.1 21.3 69.6 10.4 (Apr-Jun)

FDI (US$ bn) 9.0 22.8 34.8 35.2 37.2 5.8 (Apr-Jun) GDRs/ADRs (US$ bn)

2.6 3.8 6.6 1.2 3.3 1.0 (Apr-Jun)


FIIs (net) (US$ bn) 9.9 3.2 20.3 -15.0 29.0 3.5 (Apr-Jun)FDI Outflows (US$ bn) (Actual)

6.1 13.1 18.7 16.2 10.3 -

Memo Items: 2006 2007 2008 2009e 2010P 2011P Global GDP (% change)

5.1 5.2 3.0 -0.6 4.6 4.3

World Merch. Trade (Vol., % change)

8.8 6.5 2.4 -11.8 8.0 6.2

Source: Economic Survey, Various issues; Union Budget, RBI Monthly Bulletin, Annual Report & Weekly Statistical Supplement; Ministry of Finance; Ministry of Commerce & Industry; CSO; Institute of International Finance (IIF); EIU; NASSCOM; WEO, IMF. e estimates; - Not available; ^ Growth over corresponding period of previous year. P Projections. # PM Economic Advisory Council's projections. Note: (a) Debt-service ratio is the proportion of gross debt service payments to External Current Receipts (net of official transfers). (b) Short term debt coverage increased beginning with the quarter ended March 2005, with the inclusion of (i) suppliers' credits up to 180 days and (ii) investment by Foreign Institutional Investors (FII) in short-term debt instruments. Updated on August 26, 2010

APPENDIX II

ICICI Bank Ltd.

Profit Loss Account (Rs crore) Mar ' 10 Mar ' 09 Mar ' 08 Mar ' 07 Mar ' 06

Income Operating income 32,747.36 38,250.39 39,467.92 28,457.13 17,517.83 Expenses Material consumed - - - - - Manufacturing expenses - - - - - Personnel expenses 1,925.79 1,971.70 2,078.90 1,616.75 1,082.29 Selling expenses 236.28 669.21 1,750.60 1,741.63 840.98 Adminstrative expenses 7,440.42 7,475.63 6,447.32 4,946.69 2,727.18 Expenses capitalised - - - - - Cost of sales 9,602.49 10,116.54 10,276.82 8,305.07 4,650.45 Operating profit 5,552.30 5,407.91 5,706.85 3,793.56 3,269.94 Other recurring income 305.36 330.64 65.58 309.17 466.02 Adjusted PBDIT 5,857.66 5,738.55 5,772.43 4,102.73 3,735.96 Financial expenses 17,592.57 22,725.93 23,484.24 16,358.50 9,597.45 Depreciation 619.50 678.60 578.35 544.78 623.79 Other write offs - - - - - Adjusted PBT -12,354.42 5,059.96 5,194.08 3,557.95 3,112.17 Tax charges 1,600.78 1,830.51 1,611.73 984.25 556.53 Adjusted PAT -13,702.10 3,740.62 4,092.12 2,995.00 2,532.95 Non recurring items 134.52 17.51 65.61 115.22 7.12 Other non cash adjustments - -0.58 - - - Reported net profit -13,567.59 3,757.55 4,157.73 3,110.22 2,540.07 Earnigs before appropriation -10,757.94 6,193.87 5,156.00 3,403.66 2,728.30 Equity dividend 1,337.95 1,224.58 1,227.70 901.17 759.33 Preference dividend - - - - - Dividend tax 164.04 151.21 149.67 153.10 106.50 Retained earnings -12,259.94 4,818.07 3,778.63 2,349.39 1,862.46


Balance Sheet (Rs. crore) Mar ' 10 Mar ' 09 Mar ' 08 Mar ' 07 Mar ' 06

Sources of funds Owner's fund

Equity share capital 1,114.89 1,113.29 1,112.68 899.34 889.83 Share application money - - - - - Preference share capital - 350.00 350.00 350.00 350.00 Reserves & surplus 50,503.48 48,419.73 45,357.53 23,413.92 21,316.16

Loan funds Secured loans - - - - - Unsecured loans 2,02,016.60 2,18,347.82 2,44,431.05 2,30,510.19 1,65,083.17 Total 2,53,634.96 2,68,230.84 2,91,251.26 2,55,173.45 1,87,639.16

Uses of funds Fixed assets

Gross block 7,114.12 7,443.71 7,036.00 6,298.56 5,968.57 Less : revaluation reserve - - - - - Less : accumulated depreciation 3,901.43 3,642.09 2,927.11 2,375.14 1,987.85 Net block 3,212.69 3,801.62 4,108.90 3,923.42 3,980.71 Capital work-in-progress - - - 189.66 147.94 Investments 1,20,892.80 1,03,058.31 1,11,454.34 91,257.84 71,547.39

Net current assets Current assets, loans & advances 29,997.23 34,384.06 31,129.77 23,551.85 15,642.79 Less : current liabilities & provisions 15,501.18 43,746.43 42,895.38 38,228.64 25,227.88 Total net current assets 14,496.05 -9,362.37 -11,765.62 -14,676.78 -9,585.09 Miscellaneous expenses not written - - - - - Total 1,38,601.54 97,497.56 1,03,797.62 80,694.15 66,090.96

Notes: Book value of unquoted investments - - - - - Market value of quoted investments - - - - - Contingent liabilities 7,33,546.20 8,40,670.63 4,01,114.91 1,99,771.41 1,34,920.99 Number of equity sharesoutstanding (Lacs) 11148.45 11132.51 11126.87 8992.67 8898.24

Ratios Mar ' 10 Mar ' 09 Mar ' 08 Mar ' 07 Mar ' 06

Per share ratios Adjusted EPS (Rs) -122.91 33.60 36.78 33.30 28.47 Adjusted cash EPS (Rs) -117.35 39.70 41.97 39.36 35.48 Reported EPS (Rs) 36.10 33.76 37.37 34.59 28.55 Reported cash EPS (Rs) 41.66 39.85 42.56 40.64 35.56 Dividend per share 12.00 11.00 11.00 10.00 8.50 Operating profit per share (Rs) 49.80 48.58 51.29 42.19 36.75 Book value (excl rev res) per share (Rs) 463.01 444.94 417.64 270.37 249.55Book value (incl rev res) per share (Rs.) 463.01 444.94 417.64 270.37 249.55Net operating income per share (Rs) 293.74 343.59 354.71 316.45 196.87Free reserves per share (Rs) 356.94 351.04 346.21 199.52 193.24Profitability ratios Operating margin (%) 16.95 14.13 14.45 13.33 18.66 Gross profit margin (%) 15.06 12.36 12.99 11.41 15.10 Net profit margin (%) 12.17 9.74 10.51 10.81 14.12 Adjusted cash margin (%) -39.58 11.45 11.81 12.30 17.55 Adjusted return on net worth (%) -26.54 7.55 8.80 12.31 11.40 Reported return on net worth (%) 7.79 7.58 8.94 12.79 11.43 Return on long term funds (%) 10.63 56.72 62.34 82.46 56.24 Leverage ratios Long term debt / Equity - 0.01 0.01 0.01 0.01 Total debt/equity 3.91 4.42 5.27 9.50 7.45 Owners fund as % of total source 20.35 18.46 15.95 9.52 11.83 Fixed assets turnover ratio 4.60 5.14 5.61 4.52 2.94


Liquidity ratios Current ratio 1.94 0.78 0.72 0.61 0.62 Current ratio (inc. st loans) 0.13 0.13 0.10 0.08 0.08 Quick ratio 14.70 5.94 6.42 6.04 6.64 Inventory turnover ratio - - - - - Payout ratios Dividend payout ratio (net profit) 37.31 36.60 33.12 33.89 34.08 Dividend payout ratio (cash profit) 32.33 31.00 29.08 28.84 27.36 Earning retention ratio 110.96 63.23 66.35 64.80 65.82 Cash earnings retention ratio 66.70 68.87 70.51 70.22 72.58 Coverage ratios Adjusted cash flow time total debt 44.79 49.41 52.34 65.12 52.30 Financial charges coverage ratio 0.33 1.25 1.25 1.25 1.39 Fin. charges cov.ratio (post tax) 1.26 1.20 1.20 1.22 1.33 Component ratios Material cost component (% earnings) - - - - - Selling cost Component 0.72 1.74 4.43 6.12 4.80 Exports as percent of total sales - - - - - Import comp. in raw mat. consumed - - - - - Long term assets / total Assets 0.80 0.75 0.78 0.80 0.82 Bonus component in equity capital (%) - - - - -

APPENDIX III

Kingfisher Airlines Ltd.

Profit Loss Accoun (Rs. crore) Mar ' 10 Mar ' 09 Mar ' 08 Jun ' 07 Jun ' 06

Income Operating income 5,067.92 5,269.17 1,456.28 1,800.21 1,285.42 Expenses Material consumed 40.89 51.19 43.79 45.94 36.73 Manufacturing expenses 1,802.99 3,715.47 1,297.51 1,597.06 1,050.93 Personnel expenses 688.75 825.42 244.96 247.72 163.04 Selling expenses - 683.82 85.00 17.90 13.48 Adminstrative expenses 3,484.88 546.47 110.20 154.00 134.68 Expenses capitalised - - - - - Cost of sales 6,017.51 5,822.36 1,781.46 2,062.61 1,398.86 Operating profit -949.59 -553.19 -325.17 -262.40 -113.44 Other recurring income 203.12 594.43 48.64 29.98 8.45 Adjusted PBDIT -746.47 41.24 -276.54 -232.42 -104.98 Financial expenses 1,096.51 2,029.33 434.44 466.05 250.72 Depreciation 162.80 133.20 18.28 17.67 13.34 Other write offs 54.49 38.39 18.31 26.25 18.94 Adjusted PBT -2,060.26 -2,159.68 -747.57 -742.39 -387.99 Tax charges -770.69 -546.38 -494.45 3.40 3.75 Adjusted PAT -1,289.57 -1,613.30 -253.12 -745.79 -391.73 Non recurring items -357.65 4.47 64.98 312.12 51.19 Other non cash adjustments -97.27 - -0.97 14.09 - Reported net profit -1,744.49 -1,608.83 -189.10 -419.58 -340.55 Earnigs before appropriation -4,321.08 -2,576.59 -967.76 -778.65 -359.08 Equity dividend - - - - - Preference dividend - - - - - Dividend tax - - - - - Retained earnings -4,321.08 -2,576.59 -967.76 -778.65 -359.08


Balance Sheet (Rs. crore) Mar ' 10 Mar ' 09 Mar ' 08 Jun ' 07 Jun ' 06


Equity share capital 265.91 265.91 135.80 135.47 98.18 Share application money 7.48 8.11 10.09 - - Preference share capital 97.00 97.00 - - - Reserves & surplus -4,268.84 -2,496.36 52.99 249.23 125.95

Loan funds Secured loans 4,842.43 2,622.52 592.38 716.71 448.16 Unsecured loans 3,080.17 3,043.04 342.00 200.00 3.50 Total 4,024.15 3,540.21 1,133.26 1,301.41 675.80


Gross block 2,048.14 1,891.80 322.33 340.77 247.33 Less : revaluation reserve - - - - - Less : accumulated depreciation 493.62 316.29 43.55 33.74 16.40 Net block 1,554.51 1,575.52 278.78 307.03 230.93 Capital work-in-progress 980.61 1,630.95 346.25 357.62 286.53 Investments 0.05 0.05 - 0.41 0.41

Net current assets Current assets, loans & advances 5,298.13 4,189.37 1,188.41 1,063.68 558.83

Less : current liabilities & provisions 3,954.80 3,860.18 696.83 456.09 439.98 Total net current assets 1,343.34 329.19 491.58 607.59 118.85 Miscellaneous expenses not written 145.64 4.51 16.64 28.75 39.08 Total 4,024.15 3,540.21 1,133.26 1,301.41 675.80

Notes: Book value of unquoted investments 0.05 0.05 - 0.41 0.41 Market value of quoted investments - - - - - Contingent liabilities 23,135.77 27,468.70 6,797.11 7,485.33 8,935.97 Number of equity sharesoutstanding (Lacs) 2659.09 2659.09 1357.99 1354.70 981.82

Ratios Mar ' 10 Mar ' 09 Mar ' 08 Jun ' 07 Jun ' 06

Per share ratios Adjusted EPS (Rs) -48.50 -60.67 -18.64 -55.05 -39.90 Adjusted cash EPS (Rs) -40.33 -54.22 -15.94 -51.81 -36.61 Reported EPS (Rs) -61.95 -60.50 -13.85 -30.97 -34.69 Reported cash EPS (Rs) -53.78 -54.05 -11.16 -27.73 -31.40 Dividend per share - - - - - Operating profit per share (Rs) -35.71 -20.80 -23.95 -19.37 -11.55 Book value (excl rev res) per share (Rs) -156.01 -84.05 12.68 26.27 18.85 Book value (incl rev res) per share (Rs.) -156.01 -84.05 12.68 26.27 18.85 Net operating income per share (Rs) 190.59 198.16 107.24 132.89 130.92 Free reserves per share (Rs) -167.98 -94.05 2.68 15.46 8.08 Profitability ratios Operating margin (%) -18.73 -10.49 -22.32 -14.57 -8.82 Gross profit margin (%) -21.94 -13.02 -23.58 -15.55 -9.86 Net profit margin (%) -31.25 -27.43 -12.50 -22.92 -26.31 Adjusted cash margin (%) -20.34 -24.58 -14.38 -38.34 -27.78 Adjusted return on net worth (%) - - -147.04 -209.52 -211.67 Reported return on net worth (%) - - -109.29 -117.87 -184.01 Return on long term funds (%) -23.99 -7.90 -36.52 -36.27 -22.19 Leverage ratios Long term debt / Equity - - 3.54 0.98 1.76


Total debt/equity - - 4.95 2.38 2.02 Owners fund as % of total source -99.65 -63.14 16.80 29.56 33.16 Fixed assets turnover ratio 2.47 2.85 4.61 5.37 5.24 Liquidity ratios Current ratio 1.34 1.09 1.71 2.33 1.27 Current ratio (inc. st loans) 1.34 0.64 0.96 0.79 1.01 Quick ratio 0.57 0.52 0.87 2.20 1.14 Inventory turnover ratio 30.74 5,738.39 - 28.80 21.59 Payout ratios Dividend payout ratio (net profit) - - - - - Dividend payout ratio (cash profit) - - - - - Earning retention ratio - - - - - Cash earnings retention ratio - - - - - Coverage ratios Adjusted cash flow time total debt - - - - - Financial charges coverage ratio -0.68 0.02 -0.63 -0.49 -0.41 Fin. charges cov.ratio (post tax) -0.30 0.29 0.65 0.19 -0.22 Component ratios Material cost component (% earnings) 0.80 0.97 3.00 2.55 2.85 Selling cost Component - 12.97 5.83 0.99 1.04 Exports as percent of total sales 13.79 4.54 3.42 18.56 8.65 Import comp. in raw mat. consumed - - - - - Long term assets / total Assets 0.32 0.43 0.34 0.38 0.48 Bonus component in equity capital (%) 10.26 10.26 20.09 20.14 27.78

APPENDIX IV

Wipro Ltd

Profit Loss Account (s. crore) Mar ' 10 Mar ' 09 Mar ' 08 Mar ' 07 Mar ' 06

Income Operating income 22,922.00 21,507.30 17,492.60 13,683.90 10,227.12Expenses Material consumed 4,029.40 3,442.60 2,952.30 1,889.00 1,367.67Manufacturing expenses 2,213.20 1,841.80 299.80 120.50 1,020.70Personnel expenses 9,062.80 9,249.80 7,409.10 5,768.20 4,279.03Selling expenses 378.10 308.40 532.10 - 171.05 Adminstrative expenses 1,737.00 1,906.00 2,583.70 2,651.70 904.78 Expenses capitalised - - - - - Cost of sales 17,420.50 16,748.60 13,777.00 10,429.40 7,743.22Operating profit 5,501.50 4,758.70 3,715.60 3,254.50 2,483.90Other recurring income 434.20 468.20 326.90 288.70 113.59 Adjusted PBDIT 5,935.70 5,226.90 4,042.50 3,543.20 2,597.49Financial expenses 108.40 196.80 116.80 7.20 3.13 Depreciation 579.60 533.60 456.00 359.80 292.26 Other write offs - - - - - Adjusted PBT 5,247.70 4,496.50 3,469.70 3,176.20 2,302.10Tax charges 790.80 574.10 406.40 334.10 286.10 Adjusted PAT 4,456.90 3,922.40 3,063.30 2,842.10 2,016.00Non recurring items 441.10 -948.60 - - 38.33 Other non cash adjustments - - - - -33.85 Reported net profit 4,898.00 2,973.80 3,063.30 2,842.10 2,020.48Earnigs before appropriation 4,898.00 2,973.80 3,063.30 2,842.10 2,020.48Equity dividend 880.90 586.00 876.50 873.70 712.88 Preference dividend - - - - - Dividend tax 128.30 99.60 148.90 126.80 99.98 Retained earnings 3,888.80 2,288.20 2,037.90 1,841.60 1,207.62


Balance Shee (Rs. crore) Mar ' 10 Mar ' 09 Mar ' 08 Mar ' 07 Mar ' 06


Equity share capital 293.60 293.00 292.30 291.80 285.15 Share application money 1.80 1.50 58.00 3.50 7.49 Preference share capital - - - - - Reserves & surplus 17,396.80 12,220.50 11,260.40 9,025.10 6,135.30

Loan funds Secured loans - - 4.00 23.20 45.06 Unsecured loans 5,530.20 5,013.90 3,818.40 214.80 5.10 Total 23,222.40 17,528.90 15,433.10 9,558.40 6,478.10


Gross block 6,761.30 5,743.30 2,282.20 1,645.90 2,364.53 Less : revaluation reserve - - - - - Less : accumulated depreciation 3,105.00 2,563.70 - - 1,246.27 Net block 3,656.30 3,179.60 2,282.20 1,645.90 1,118.25 Capital work-in-progress 991.10 1,311.80 1,335.00 989.50 612.36 Investments 8,966.50 6,895.30 4,500.10 4,348.70 3,459.20

Net current assets Current assets, loans & advances 16,545.30 13,517.20 12,058.10 6,338.40 4,076.68 Less : current liabilities & provisions 6,936.80 7,375.00 4,742.30 3,764.10 2,788.39 Total net current assets 9,608.50 6,142.20 7,315.80 2,574.30 1,288.29 Miscellaneous expenses not written - - - - - Total 23,222.40 17,528.90 15,433.10 9,558.40 6,478.10

Notes: Book value of unquoted investments 5,884.90 6,884.50 - 1,234.10 514.23 Market value of quoted investments 1,855.60 - - - 2,956.87 Contingent liabilities 778.00 1,045.40 749.90 661.60 509.18 Number of equity sharesoutstanding (Lacs) 14682.11 14649.81 14615.00 14590.00 14257.54



Per share ratios Adjusted EPS (Rs) 30.36 26.77 20.96 19.48 14.14 Adjusted cash EPS (Rs) 34.30 30.42 24.08 21.95 16.19 Reported EPS (Rs) 33.36 20.30 20.96 19.48 14.17 Reported cash EPS (Rs) 37.31 23.94 24.08 21.95 16.22 Dividend per share 6.00 4.00 6.00 6.00 5.00 Operating profit per share (Rs) 37.47 32.48 25.42 22.31 17.42 Book value (excl rev res) per share (Rs) 120.49 85.42 79.05 63.86 45.03 Book value (incl rev res) per share (Rs.) 120.49 85.42 79.05 63.86 45.03 Net operating income per share (Rs) 156.12 146.81 119.69 93.79 71.73 Free reserves per share (Rs) 116.54 81.06 - - 42.65 Profitability ratios Operating margin (%) 24.00 22.12 21.24 23.78 24.28 Gross profit margin (%) 21.47 19.64 18.63 21.15 21.42 Net profit margin (%) 20.97 13.53 17.19 20.34 19.53 Adjusted cash margin (%) 21.56 20.27 19.74 22.91 22.32 Adjusted return on net worth (%) 25.19 31.34 26.51 30.50 31.39 Reported return on net worth (%) 27.68 23.76 26.51 30.50 31.46 Return on long term funds (%) 30.12 37.17 23.32 33.31 35.87 Leverage ratios Long term debt / Equity 0.01 0.01 0.33 0.02 - Total debt/equity 0.31 0.40 0.33 0.02 0.01 Owners fund as % of total source 76.18 71.39 75.13 97.50 99.22 Fixed assets turnover ratio 3.47 3.85 7.81 8.31 4.35 Liquidity ratios Current ratio 2.39 1.83 2.54 1.68 1.46 Current ratio (inc. st loans) 1.34 1.10 2.54 1.68 1.42 Quick ratio 2.29 1.76 2.44 1.61 1.40 Inventory turnover ratio 45.40 56.15 39.41 57.23 78.23 Payout ratios Dividend payout ratio (net profit) 20.60 23.05 33.47 35.20 40.23 Dividend payout ratio (cash profit) 18.42 19.54 29.13 31.24 35.14 Earning retention ratio 77.36 82.53 66.53 64.80 59.68 Cash earnings retention ratio 79.97 84.62 70.87 68.76 64.79 Coverage ratios Adjusted cash flow time total debt 1.10 1.13 1.09 0.07 0.02 Financial charges coverage ratio 54.76 26.56 34.61 492.11 829.08 Fin. charges cov.ratio (post tax) 51.53 18.82 31.13 445.71 739.19 Component ratios Material cost component (% earnings) 18.06 15.98 17.94 14.43 13.60 Selling cost Component 1.64 1.43 3.04 - 1.67 Exports as percent of total sales 73.26 77.28 73.66 80.05 69.25 Import comp. in raw mat. consumed 36.83 45.00 - - 62.12 Long term assets / total Assets 0.44 0.45 0.40 0.52 0.55 Bonus component in equity capital (%) 95.32 95.51 95.68 95.84 98.08


APPENDIX V

Infosys Technologies Ltd.

Profit & Loss Accoun (Rs. crore) Mar ' 10 Mar ' 09 Mar ' 08 Mar ' 07 Mar ' 06

Income Operating income 21,140.00 20,264.00 15,648.00 13,149.00 9,028.00 Expenses Material consumed - 20.00 18.00 22.00 16.00 Manufacturing expenses 2,317.00 1,822.00 1,549.00 1,378.00 854.00 Personnel expenses 10,356.00 9,975.00 7,771.00 6,316.00 4,274.00 Selling expenses 215.00 83.00 89.00 63.00 55.00 Adminstrative expenses 883.00 1,456.00 1,257.00 1,144.00 839.00 Expenses capitalised - - - - - Cost of sales 13,771.00 13,356.00 10,684.00 8,923.00 6,038.00 Operating profit 7,369.00 6,908.00 4,964.00 4,226.00 2,990.00 Other recurring income 910.00 874.00 678.00 333.00 221.00 Adjusted PBDIT 8,279.00 7,782.00 5,642.00 4,559.00 3,211.00 Financial expenses - 2.00 1.00 1.00 1.00 Depreciation 807.00 694.00 546.00 469.00 409.00 Other write offs - - - - - Adjusted PBT 7,472.00 7,086.00 5,095.00 4,089.00 2,801.00 Tax charges 1,717.00 895.00 630.00 352.00 303.00 Adjusted PAT 5,755.00 6,191.00 4,465.00 3,737.00 2,498.00 Non recurring items 48.00 -372.00 5.00 46.00 -77.00 Other non cash adjustments - -1.00 - -5.00 - Reported net profit 5,803.00 5,818.00 4,470.00 3,778.00 2,421.00 Earnigs before appropriation 5,803.00 12,460.00 9,314.00 5,973.00 3,849.00 Equity dividend 1,434.00 1,345.00 1,902.00 649.00 1,238.00 Preference dividend - - - - - Dividend tax 240.00 228.00 323.00 102.00 174.00 Retained earnings 4,129.00 10,887.00 7,089.00 5,222.00 2,437.00

Balance shee (Rs. crore) Mar ' 10 Mar ' 09 Mar ' 08 Mar ' 07 Mar ' 06

Sources of fundsOwner's fund

Equity share capital 287.00 286.00 286.00 286.00 138.00Share application money - - - - - Preference share capital - - - - - Reserves & surplus 21,749.00 17,523.00 13,204.00 10,876.00 6,759.00

Loan fundsSecured loans - - - - - Unsecured loans - - - - - Total 22,036.00 17,809.00 13,490.00 11,162.00 6,897.00

Uses of fundsFixed assets

Gross block 3,779.00 5,986.00 4,508.00 3,889.00 2,837.00Less : revaluation reserve - - - - - Less : accumulated depreciation - 2,187.00 1,837.00 1,739.00 1,275.00Net block 3,779.00 3,799.00 2,671.00 2,150.00 1,562.00Capital work-in-progress 409.00 615.00 1,260.00 957.00 571.00Investments 4,636.00 1,005.00 964.00 839.00 876.00

Net current assetsCurrent assets, loans & advances 17,242.00 15,732.00 12,326.00 9,040.00 6,105.00Less : current liabilities & provisions 4,030.00 3,342.00 3,731.00 1,824.00 2,217.00


Total net current assets 13,212.00 12,390.00 8,595.00 7,216.00 3,888.00Miscellaneous expenses not written - - - - - Total 22,036.00 17,809.00 13,490.00 11,162.00 6,897.00

Notes: Book value of unquoted investments 4,636.00 1,005.00 964.00 839.00 876.00Market value of quoted investments - - - - - Contingent liabilities 295.00 347.00 603.00 670.00 523.00Number of equity sharesoutstanding (Lacs) 5728.30 5728.30 5719.96 5712.10 2755.55


Per share ratios Adjusted EPS (Rs) 100.47 108.08 78.06 65.42 90.65 Adjusted cash EPS (Rs) 114.55 120.19 87.61 73.63 105.50Reported EPS (Rs) 101.30 101.58 78.15 66.23 87.86 Reported cash EPS (Rs) 115.39 113.70 87.69 74.44 102.70Dividend per share 25.00 23.50 33.25 11.50 45.00 Operating profit per share (Rs) 128.64 120.59 86.78 73.98 108.51Book value (excl rev res) per share (Rs) 384.69 310.89 235.84 195.41 26.56 Book value (incl rev res) per share (Rs.) 384.69 310.89 235.84 195.41 26.56 Net operating income per share (Rs) 369.04 353.75 273.57 230.20 327.63Free reserves per share (Rs) 378.73 305.80 230.74 190.30 245.07Profitability ratios Operating margin (%) 34.85 34.09 31.72 32.13 33.11 Gross profit margin (%) 31.04 30.66 28.23 28.57 28.58 Net profit margin (%) 26.31 27.52 27.37 28.05 26.17 Adjusted cash margin (%) 29.75 32.57 30.69 31.19 31.43 Adjusted return on net worth (%) 26.11 34.76 33.09 33.47 36.21 Reported return on net worth (%) 26.33 32.67 33.13 33.89 35.10 Return on long term funds (%) 33.90 39.80 37.77 36.64 40.62 Leverage ratios Long term debt / Equity - - - - - Total debt/equity - - - - - Owners fund as % of total source 100.00 100.00 100.00 100.00 100.00Fixed assets turnover ratio 5.59 3.39 3.47 3.38 3.18 Liquidity ratios Current ratio 4.28 4.71 3.30 4.96 2.75 Current ratio (inc. st loans) 4.28 4.71 3.30 4.96 2.75 Quick ratio 4.20 4.67 3.28 4.91 2.73 Inventory turnover ratio - - - - - Payout ratios Dividend payout ratio (net profit) 28.84 27.03 49.77 19.85 58.32 Dividend payout ratio (cash profit) 25.32 24.15 44.35 17.66 49.89 Earning retention ratio 70.92 74.60 50.17 79.91 43.48 Cash earnings retention ratio 74.49 77.16 55.60 82.15 51.43 Coverage ratios Adjusted cash flow time total debt - - - - - Financial charges coverage ratio - 3,891.00 5,642.00 4,559.00 3,211.00Fin. charges cov.ratio (post tax) - 3,257.50 5,017.00 4,253.00 2,831.00Component ratios Material cost component (% earnings) - 0.09 0.11 0.16 0.17 Selling cost Component 1.01 0.40 0.56 0.47 0.60 Exports as percent of total sales 99.69 97.88 92.59 92.44 95.86 Import comp. in raw mat. consumed - - - - - Long term assets / total Assets 0.33 0.25 0.28 0.30 0.33 Bonus component in equity capital (%) 93.26 93.58 93.58 93.58 93.65


APPENDIX VI

Dabur India Ltd

Profit & Loss Accoun (Rs. crore) Mar ' 10 Mar ' 09 Mar ' 08 Mar ' 07 Mar ' 06

Income Operating income 2,867.42 2,408.33 2,093.63 1,745.14 1,345.50 Expenses Material consumed 1,384.29 1,232.85 1,023.94 778.27 582.43 Manufacturing expenses 58.17 54.22 54.02 39.24 27.10 Personnel expenses 212.34 167.32 149.69 118.66 98.31 Selling expenses 474.79 358.75 337.69 403.42 316.46 Adminstrative expenses 187.90 153.67 138.69 100.90 80.24 Expenses capitalised - - - - - Cost of sales 2,317.49 1,966.81 1,704.03 1,440.48 1,104.55 Operating profit 549.93 441.52 389.60 304.66 240.95 Other recurring income 14.85 10.72 9.76 3.14 1.05 Adjusted PBDIT 564.78 452.24 399.36 307.80 242.01 Financial expenses 13.28 14.47 10.92 4.43 5.73 Depreciation 31.91 27.42 25.75 21.98 19.05 Other write offs 5.66 3.94 5.67 6.49 4.26 Adjusted PBT 513.93 406.41 357.01 274.90 212.97 Tax charges 93.70 51.44 48.40 32.15 25.78 Adjusted PAT 420.23 354.97 308.61 242.76 187.19 Non recurring items 13.10 18.58 8.16 9.32 1.90 Other non cash adjustments -0.19 -0.72 -0.86 -0.13 0.21 Reported net profit 433.14 372.84 315.92 251.94 189.29 Earnigs before appropriation 862.08 696.07 545.07 426.95 314.52 Equity dividend 173.60 151.39 129.60 122.13 100.32 Preference dividend - - - - - Dividend tax 29.50 25.73 22.03 17.13 14.07 Retained earnings 658.98 518.95 393.44 287.70 200.13


Balance Sheet(Rs. crore) Mar ' 10 Mar ' 09 Mar ' 08 Mar ' 07 Mar ' 06


Equity share capital 86.76 86.51 86.40 86.29 57.33 Share application money 0.14 - - - - Preference share capital - - - - - Reserves & surplus 662.48 651.69 441.92 316.90 390.54

Loan funds Secured loans 24.27 8.26 16.45 19.28 19.23 Unsecured loans 81.80 130.72 0.24 0.26 1.25 Total 855.45 877.17 545.01 422.73 468.35


Gross block 687.23 518.77 467.93 404.30 328.23 Less : revaluation reserve - - - - - Less : accumulated depreciation 236.28 210.45 189.77 168.97 142.46 Net block 450.95 308.32 278.17 235.33 185.77 Capital work-in-progress 23.31 51.71 16.26 3.71 13.07 Investments 348.51 232.05 270.37 145.35 275.08

Net current assets Current assets, loans & advances 941.77 973.42 576.82 397.78 285.68 Less : current liabilities & provisions 911.83 696.97 610.57 379.27 324.12 Total net current assets 29.94 276.45 -33.75 18.52 -38.44 Miscellaneous expenses not written 2.74 8.64 13.95 19.82 32.87 Total 855.45 877.17 545.01 422.73 468.35

Notes: Book value of unquoted investments 98.60 319.12 67.99 65.99 234.43 Market value of quoted investments 250.52 118.48 205.19 80.82 43.43 Contingent liabilities 173.48 174.15 171.24 153.25 190.02 Number of equity sharesoutstanding (Lacs) 8675.86 8650.76 8640.23 8628.84 5733.03


Per share ratios Adjusted EPS (Rs) 4.84 4.10 3.57 2.81 3.27 Adjusted cash EPS (Rs) 5.28 4.47 3.94 3.14 3.67 Reported EPS (Rs) 4.99 4.32 3.67 2.92 3.30 Reported cash EPS (Rs) 5.43 4.68 4.03 3.25 3.70 Dividend per share 2.00 1.75 1.50 1.75 2.50 Operating profit per share (Rs) 6.34 5.10 4.51 3.53 4.20 Book value (excl rev res) per share (Rs) 8.60 8.43 5.95 4.44 7.24 Book value (incl rev res) per share (Rs.) 8.60 8.43 5.95 4.44 7.24 Net operating income per share (Rs) 33.05 27.84 24.23 20.22 23.47 Free reserves per share (Rs) 7.14 6.84 4.33 2.80 5.21 Profitability ratios Operating margin (%) 19.17 18.33 18.60 17.45 17.90 Gross profit margin (%) 18.06 17.19 17.37 16.19 16.49 Net profit margin (%) 15.03 15.44 15.06 14.41 14.04 Adjusted cash margin (%) 15.88 15.97 16.16 15.51 15.63 Adjusted return on net worth (%) 56.29 48.65 59.99 63.32 45.10 Reported return on net worth (%) 58.04 51.20 61.58 65.75 45.56 Return on long term funds (%) 68.96 55.29 68.93 68.63 48.02 Leverage ratios Long term debt / Equity 0.02 0.03 0.01 0.01 0.01


Total debt/equity 0.14 0.18 0.03 0.04 0.04 Owners fund as % of total source 87.59 84.15 96.93 95.37 95.62 Fixed assets turnover ratio 4.31 4.84 4.67 4.50 4.24 Liquidity ratios Current ratio 1.03 1.40 0.94 1.05 0.88 Current ratio (inc. st loans) 0.92 1.19 0.91 0.96 0.81 Quick ratio 0.67 0.98 0.57 0.63 0.52 Inventory turnover ratio 11.31 10.94 12.52 13.44 14.44 Payout ratios Dividend payout ratio (net profit) 46.86 47.41 47.86 55.24 60.49 Dividend payout ratio (cash profit) 43.13 43.74 43.54 49.63 53.85 Earning retention ratio 51.67 50.11 50.87 42.64 38.89 Cash earnings retention ratio 55.64 54.16 55.41 48.66 45.66 Coverage ratios Adjusted cash flow time total debt 0.23 0.35 0.04 0.07 0.09 Financial charges coverage ratio 42.53 31.26 36.56 69.48 42.26 Fin. charges cov.ratio (post tax) 36.46 28.99 32.87 64.33 38.09 Component ratios Material cost component (% earnings) 48.61 52.80 49.05 45.86 42.97 Selling cost Component 16.55 14.89 16.12 23.11 23.52 Exports as percent of total sales 4.31 4.56 4.49 3.96 1.97 Import comp. in raw mat. consumed 1.22 1.06 0.97 1.22 0.72 Long term assets / total Assets 0.45 0.36 0.48 0.48 0.61 Bonus component in equity capital (%) 87.10 87.35 87.46 87.58 81.74

Financial Crisis

S. V. Pradeep Krishnan*

Abstract—The turmoil in the international financial markets of advanced economies, that started around mid-2007, has exacerbated substantially since August 2008. The financial market crisis has led to the collapse of major financial institutions and is now beginning to impact the real economy in the advanced economies. As this crisis is unfolding, credit markets appear to be drying up in the developed world. The financial sector, especially banks, is subject to prudential regulations, both in regard to capital and liquidity. In many areas, the housing market has also suffered, resulting in numerous evictions, foreclosures and prolonged vacancies. It is considered by many economists to be the worst financial crisis since the Great Depression of the 1930s. It contributed to the failure of key businesses, declines in consumer wealth estimated in the trillions of U.S. dollars, substantial financial commitments incurred by governments, and a significant decline in economic activity.

India has by-and-large been spared of global financial contagion due to the subprime turmoil for a variety of reasons. India’s growth process has been largely domestic demand driven and its reliance on foreign savings has remained around 1.5 per cent in recent period. Financial stability in India has been achieved through perseverance of prudential policies which prevent institutions from excessive risk taking, and financial markets from becoming extremely volatile and turbulent. The U.S. Federal Reserve and central banks have taken steps to expand money supplies to avoid the risk of a deflationary spiral, in which lower wages and higher unemployment lead to a self-reinforcing decline in global consumption

Keywords: exacerbated, evictions, foreclosures, prolonged vacancies, contagion.

The turmoil in the international financial markets of advanced economies that started around mid-2007 has exacerbated substantially since August 2008. The financial market crisis has led to the collapse of major financial institutions and is now beginning to impact the real economy in the advanced economies.*

The financial crisis of 2007 to the present is a crisis triggered by a liquidity shortfall in the United States banking system. It has resulted in the collapse of large financial institutions, the bailout of banks by national governments and downturns in stock markets around the world. In many areas, the housing market has also suffered, resulting in numerous evictions, foreclosures and prolonged vacancies. It is considered by many economists to be the worst financial crisis since the Great Depression of the 1930s. The collapse of a global housing bubble, which peaked in the U.S. in 2006, caused the values of securities tied to real estate pricing to plummet thereafter, damaging financial institutions globally. Questions regarding bank solvency, declines in credit availability, and damaged investor confidence had an impact on global stock markets, where securities suffered large losses during late 2008 and early 2009.

The immediate cause or trigger of the crisis was the bursting of the United States Housing bubble which peaked in approximately 2005–2006. An increase in loan packaging, marketing

*Nehru College of Engineering and Research Centre, Kerala

Financial Crisis 299

and incentives such as easy initial terms and a long-term trend of rising housing prices had encouraged borrowers to assume difficult mortgages in the belief they would be able to quickly refinance at more favorable terms. However, once interest rates began to rise and housing prices started to drop moderately in 2006–2007 in many parts of the U.S., refinancing became more difficult.

Low interest rates and large inflows of foreign funds created easy credit conditions for a number of years prior to the crisis, fueling a housing construction boom and encouraging debt-financed consumption. Loans of various types (e.g., mortgage, credit card, and auto) were easy to obtain and consumers assumed an unprecedented debt load. As part of the housing and credit booms, the number of financial agreements called mortgage-backed securities (MBS) and Collateralized debt obligation (CDO), which derived their value from mortgage payments and housing prices, greatly increased. As housing prices declined, major global financial institutions that had borrowed and invested heavily in subprime MBS reported significant losses. Falling prices also resulted in homes worth less than the mortgage loan, providing a financial incentive to enter foreclosure. While the housing and credit bubbles built, a series of factors caused the financial system to both expand and become increasingly fragile, a process called Financialization. Policymakers did not recognize the increasingly important role played by financial institutions such as investment banks and hedge funds also known as the shadow banking system. The crises culminated on Sept. 15, 2008 with Lehman Brothers filing for bankruptcy.

SUB-PRIME LENDING

The term subprime refers to the credit quality of particular borrowers, who have weakened credit histories and a greater risk of loan default than prime borrowers. The value of U.S.


subprime mortgages was estimated at $1.3 trillion as of March 2007, with over 7.5 million first-lien subprime mortgages outstanding. In addition to easy credit conditions, there is evidence that both government and competitive pressures contributed to an increase in the amount of subprime lending during the years preceding the crisis Subprime mortgages remained below 10% of all mortgage originations until 2004, when they spiked to nearly 20% and remained there through the 2005-2006 peak.

A proximate event to this increase was the April 2004 decision by the U.S. Securities and Exchange Commission (SEC) to relax the net capital rule, which permitted the largest five investment banks to dramatically increase their financial leverage and aggressively expand their issuance of mortgage-backed securities. Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people... In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn.

FINANCIAL GLOBALIZATION: THE INDIAN APPROACH

The Indian economy is now a relatively open economy, despite the capital account not being fully open. The current account, as measured by the sum of current receipts and current payments, amounted to about 53 per cent of GDP up from about 19 per cent of GDP in 1991. Similarly, on the capital account, the sum of gross capital inflows and outflows increased from 12 per cent of GDP in 1990-91 to around 64 per cent. With this degree of openness, developments in international markets are bound to affect the Indian economy and policy makers have to be vigilant in order to minimize the impact of adverse international developments on the domestic economy. The relatively limited impact of the ongoing turmoil in financial markets of the advanced economies in the Indian financial markets, and more generally the Indian economy, needs to be assessed in this context. Whereas the Indian current account has been opened fully, though gradually, over the 1990s, a more calibrated approach has been followed to the opening of the capital account and to opening up of the financial sector. This approach is consistent with the weight of the available empirical evidence with regard to the benefits that may be gained from capital account liberalisation for acceleration of economic growth, particularly in emerging market economies. The evidence suggests that the greatest gains are obtained from the opening to foreign direct investment, followed by portfolio equity investment. Accordingly, in India, while encouraging foreign investment flows, especially direct investment inflows, a more cautious, nuanced approach has been adopted in regard to debt flows. Debt flows in the form of external commercial borrowings are subject to ceilings and some end-use restrictions, which are modulated from time to time taking into account evolving macroeconomic and monetary conditions. Similarly, portfolio investment in government securities and corporate bonds are also subject to macro ceilings, which are also modulated from time to time. Thus, prudential policies have attempted to prevent excessive recourse to foreign borrowings and dollarisation of the economy. In regard to capital outflows, the policy framework has been progressively


liberalised to enable the non-financial corporate sector to invest abroad and to acquire companies in the overseas market. Resident individuals are also permitted outflows subject to reasonable limits. The financial sector, especially banks, is subject to prudential regulations, both in regard to capital and liquidity.

As the current global financial crisis has shown, liquidity risks can rise manifold during a crisis and can pose serious downside risks to macroeconomic and financial stability. The Reserve Bank had already put in place steps to mitigate liquidity risks at the very short-end, risks at the systemic level and at the institution level as well. Some of the important measures by the Reserve Bank in this regard include, first, restricting the overnight unsecured market for funds to banks and primary dealers (PD) as well as limits on the borrowing and lending operations of these entities in the overnight inter-bank call money market. Second, large reliance by banks on borrowed funds can exacerbate vulnerability to external shocks.

Accordingly, in order to encourage greater reliance on stable sources of funding, the Reserve Bank has imposed prudential limits on banks on their purchased inter-bank liabilities and these limits are linked to their net worth. Furthermore, the incremental credit deposit ratio of banks is also monitored by the Reserve Bank since this ratio indicates the extent to which banks are funding credit with borrowings from wholesale markets (now known as purchased funds). Third, asset liability management guidelines for dealing with overall asset-liability mismatches take into account both on and off balance sheet items. Finally, guidelines on securitization of standard assets have laid down a detailed policy on provision of liquidity support to Special Purpose Vehicles (SPVs). In order to further strengthen capital requirements, the credit conversion factors, risk weights and provisioning requirements for specific off-balance sheet items including derivatives have been reviewed. Furthermore, in India, complex structures like synthetic securitization have not been permitted so far. Introduction of such products, when found appropriate, would be guided by the risk management capabilities of the system.

The Reserve Bank has also issued detailed guidelines on implementation of the Basel II framework covering all the three pillars with the guidelines on Pillar II. In tune with RBI’s objective to have consistency and harmony with international standards, the Standardised Approach for credit risk and Basic Indicator Approach for operational risk have been prescribed. Minimum capital-to-risk-weighted asset ratio (CRAR) would be 9 per cent, but higher levels under Pillar II could be prescribed on the basis of risk profile and risk management systems. The banks were asked to bring Tier I CRAR to at least 6 per cent before March 31, 2010. After analyzing the global schedule for implementation, it was decided that all foreign banks operating in India and Indian banks having a presence outside India should migrate to Basel II and all other scheduled commercial banks encouraged to migrate to Basel II in alignment with them. In addition to the exercise of normal prudential requirements on banks, the Reserve Bank has also successively imposed additional prudential measures in respect of exposures to particular sectors, akin to a policy of dynamic provisioning. For example, in view of the accelerated exposure observed to the real estate sector, banks were advised to put in place a proper risk management system to contain the risks involved.


Banks were advised to formulate specific policies covering exposure limits, collaterals to be considered, margins to be kept, sanctioning authority/level and sector to be financed. In view of the rapid increase in loans to the real estate sector raising concerns about asset quality and the potential systemic risks posed by such exposure, the risk weight on banks' exposure to commercial real estate was increased from 100 per cent to 125 per cent in July 2005 and further to 150 per cent in April 2006. The risk weight on housing loans extended by banks to individuals against mortgage of housing properties and investments in mortgage backed securities (MBS) of housing finance companies (HFCs) was increased from 50 per cent to 75 per cent in December 2004, though this was later reduced to 50 per cent for lower value loans.

Similarly, in light of the strong growth of consumer credit and the volatility in the capital markets, it was felt that the quality of lending could suffer during the phase of rapid expansion. Hence, as a counter cyclical measure, the Reserve Bank increased the risk weight for consumer credit and capital market exposures from 100 per cent to 125 per cent. An additional feature of recent prudential actions by the Reserve Bank relate to the tightening of regulation and supervision of Non-banking Financial Companies (NBFCs), so that regulatory arbitrage between these companies and the banking system is minimized. The overarching principle is that banks should not use an NBFC as a delivery vehicle for seeking regulatory arbitrage opportunities or to circumvent bank regulation(s) and that the activities of NBFCs do not undermine banking regulations.

The rate of increase in foreign exchange market turnover was the highest amongst the 54 countries covered in the latest Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity conducted by the Bank for International Settlements (BIS). According to the survey, daily average turnover in India jumped almost 5-fold from US $ 7 billion in April 2004 to US $ 34 billion in April 2007; the share of India in global foreign exchange market turnover trebled from 0.3 per cent in April 2004 to 0.9 per cent in April 2007. There has been consistent development of well-functioning, relatively deep and liquid markets for government securities, currency and derivatives in India, though much further development needs to be done. However, as large segments of economic agents in India may not have adequate resilience to withstand volatility in currency and money markets, our approach has been to be increasingly vigilant and proactive to any incipient signs of volatility in financial markets. In brief, the Indian approach has focused on gradual, phased and calibrated opening of the domestic financial and external sectors, taking into cognizance reforms in the other sectors of the economy. Financial markets are contributing to efficient channelling of domestic savings into productive uses and, by financing the overwhelming part of domestic investment, are supporting domestic growth.

These characteristics of India's external and financial sector management coupled with ample forex reserves coverage and the growing underlying strength of the Indian economy reduce the susceptibility of the Indian economy to global turbulence.

IMPACT OF THE CRISIS ON INDIA

While the overall policy approach has been able to mitigate the potential impact of the turmoil on domestic financial markets and the economy, with the increasing integration of the Indian


economy and its financial markets with rest of the world, there is recognition that the country does face some downside risks from these international developments. The risks arise mainly from the potential reversal of capital flows on a sustained medium-term basis from the projected slow down of the global economy, particularly in advanced economies, and from some elements of potential financial contagion. In India, the adverse effects have so far been mainly in the equity markets because of reversal of portfolio equity flows, and the concomitant effects on the domestic forex market and liquidity conditions. The macro effects have so far been muted due to the overall strength of domestic demand, the healthy balance sheets of the Indian corporate sector, and the predominant domestic financing of investment.

As might be expected, the main impact of the global financial turmoil in India has emanated from the significant change experienced in the capital account in 2008-09. Total net capital flows fell from US$17.3 billion in April-June 2007 to US$13.2 billion in April-June 2008. Nonetheless, capital flows are expected to be more than sufficient to cover the current account deficit this year as well. While Foreign Direct Investment (FDI) inflows have continued to exhibit accelerated growth (US$ 16.7 billion during April-August 2008 as compared with US$ 8.5 billion in the corresponding period of 2007), portfolio investments by foreign institutional investors (FIIs) witnessed a net outflow of about US$ 6.4 billion in April- September 2008 as compared with a net inflow of US$ 15.5 billion in the corresponding period last year. Similarly, external commercial borrowings of the corporate sector declined from US$ 7.0 billion in April-June 2007 to US$ 1.6 billion in April-June 2008, partially in response to policy measures in the face of excess flows in 2007-08, but also due to the current turmoil in advanced economies. With the existence of a merchandise trade deficit of 7.7 per cent of GDP in 2007-08, and a current account deficit of 1.5 per cent, and change in perceptions with respect to capital flows, there has been significant pressure on the Indian exchange rate in recent months.

As on October 2008 US $ 1 was equal to Rs.48.74. The following table shows the Trends in Capital Flows for the period 2007-08 to 2008-09.

Table- Trends in Capital Flows (US $ Million)

Component Period 2007-08 2008-09 Foreign Direct Investment to India April-August 8536 16,733 FIIs (net) April – Sept 26 15,508 -6,421 External Commercial Borrowings (net) April- June 6,990 1,559 Short-term Trade Credits (net) April- June 1,804 2,173 Memo: ECB Approvals April-August 13,375 8,127 Foreign Exchange Reserves (variation) April-September 26 48,583 -17,904 Foreign Exchange Reserves (end-period) September 26, 2008 247,762 291,819

With the volatility in portfolio flows having been large during 2007 and 2008, the impact of global financial turmoil has been felt particularly in the equity market. The BSE Sensex increased significantly from a level of 13,072 as at end-March 2007 to its peak of 20,873 on January 2008 in the presence of heavy portfolio flows responding to the high growth performance of the Indian corporate sector. However, the corporate sector has, in recent years, mobilized significant resources from global financial markets for funding, both debt


and non-debt, their ambitious investment plans. The current risk aversion in the international financial markets to EMEs could, therefore, have some impact on the Indian corporate sector’s ability to raise funds from international sources and thereby impede some investment growth. Such corporates would, therefore, have to rely relatively more on domestic sources of financing, including bank credit. This could, in turn, put some upward pressure on domestic interest rates.

Moreover, domestic primary capital market issuances have suffered in the current fiscal year so far in view of the sluggish stock market conditions. The financial crisis in the advanced economies and the likely slowdown in these economies could have some impact on the IT sector. According to the latest assessment by the NASSCOM, the software trade association, the current developments with respect to the US financial markets are very eventful, and may have a direct impact on the IT industry and likely to create a downstream impact on other sectors of the US economy and worldwide markets. In summary, the combined impact of the reversal of portfolio equity flows, the reduced availability of international capital both debt and equity, the perceived increase in the price of equity with lower equity valuations, and pressure on the exchange rate, growth in the Indian corporate sector is likely to feel some impact of the global financial turmoil

In short India's financial sector is not deeply integrated with the global financial system, which spared it the first round adverse effects of the global financial crisis and left Indian banks mostly unaffected. However, as the financial crisis morphed in to a full-blown global economic downturn, India could not escape the second round effects. The global crisis has affected India through three distinct channels: financial markets, trade flows, and exchange rates. The reversal in capital inflows, which created a credit crunch in domestic markets along with a severe deterioration in export demand, contributed to the decline of gross domestic product by more than 2 percentage points in the fiscal year 2008–2009. In line with efforts taken by governments and central banks all over the world, the Government and the Reserve Bank of India took aggressive countercyclical measures, sharply relaxing monetary policy and introducing a fiscal stimulus to boost domestic demand. However, this paper argues that with very limited fiscal maneuverability and the limited traction of monetary policy, policy measures to restore the Indian gross domestic product growth back to its potential rate of 8–9% must focus on addressing the structural constraints that are holding down private investment demand.

IMPACTS ON FINANCIAL INSTITUTIONS

The International Monetary Fund estimated that large U.S. and European banks lost more than $1 trillion on toxic assets and from bad loans from January 2007 to September 2009. These losses are expected to top $2.8 trillion from 2007-10. U.S. banks losses were forecast to hit $1 trillion and European bank losses will reach $1.6 trillion. The IMF estimated that U.S. banks were about 60 percent through their losses, but British and eurozone banks only 40 percent. Initially the companies affected were those directly involved in home construction and mortgage lending such as Northern Rock and Country Financial, as they could no longer obtain financing through the credit markets. Over 100 mortgage lenders went bankrupt during


2007 and 2008. Concerns that investment bank Bear Stearns would collapse in March 2008 resulted in its fire-sale to JP Morgan Chase. The crisis hit its peak in September and October 2008. Several major institutions either failed, were acquired under duress, or were subject to government takeover. These included Lehman Brothers, Merrill Lynch, Fannie Mae, Freddie Mac, Washington Mutual, Wachovia, and AIG.

IMPACT ON THE INDIAN BANKING SYSTEM

One of the key features of the current financial turmoil has been the lack of perceived contagion being felt by banking systems in EMEs, particularly in Asia. The Indian banking system also has not experienced any contagion, similar to its peers in the rest of Asia. A detailed study undertaken by the RBI in 2007 on the impact of the subprime episode on the Indian banks had revealed that none of the Indian banks or the foreign banks, with whom the discussions had been held, had any direct exposure to the sub-prime markets in the USA or other markets. However, a few Indian banks had invested in the collateralised debt obligations (CDOs) / bonds which had a few underlying entities with sub-prime exposures. Thus, no direct impact on account of direct exposure to the sub-prime market was in evidence. However, a few of these banks did suffer some losses on account of the mark-to-market losses caused by the widening of the credit spreads arising from the sub-prime episode on term liquidity in the market, even though the overnight markets remained stable.

In the aftermath of the turmoil caused by bankruptcy, the Reserve Bank has announced a series of measures to facilitate orderly operation of financial markets and to ensure financial stability which predominantly includes extension of additional liquidity support to banks.

Measures Taken by the Reserve Bank during September‐October 2008 in Response to the Global Financial Market Developments

• CRR cut by 250 basis points to 6.5 per cent, effective fortnight beginning October 11, 2008

• Repo rate cut by 100 basis points to 8.0 per cent • As a temporary measure, banks permitted to avail of additional liquidity support

under the LAF to the extent of up to 1 per cent of their NDTL. • The mechanism of Special Market Operations (SMO) for public sector oil marketing

companies instituted in June-July 2008 taking into account the extraordinary situation then prevailing in the money and forex markets will be instituted when oil bonds become available.

• Under the Agricultural Debt Waiver and Debt Relief Scheme Government had agreed to provide to commercial banks, RRBs and co-operative credit institutions a sum of Rs.25,000 crore as the first installment. At the request of the Government, RBI agreed to provide the sum to the lending institutions immediately.

• Interest rates on FCNR (B) Deposits and NRE(R)A deposits were increased by 100 basis points each to Libor/Euribor/Swap rates plus 25 basis points and to Libor/Euribor/Swap rates plus 100 basis points, respectively.


• Banks allowed to borrow funds from their overseas branches and correspondent banks up to a limit of 50 per cent of their unimpaired Tier I capital as at the close of the previous quarter or USD 10 million, whichever is higher, as against the existing limit of 25 per cent.

• Special 14 days repo to be conducted every day up to a cumulative amount of Rs.20,000 crore with a view to enabling banks to meet the liquidity requirements of Mutual Funds.

• Purely as a temporary measure, banks allowed to avail of additional liquidity support exclusively for the purpose of meeting the liquidity requirements of mutual funds to the extent of up to 0.5 per cent of their NDTL.

• Under the existing guidelines, banks and FIs are not permitted to grant loans against certificates of deposits (CDs). Furthermore, they are also not permitted to buy-back their own CDs before maturity. It was decided to relax these restrictions for a period of 15 days effective October 14, 2008, only in respect of the CDs held by mutual funds.

• For fine-tuning the management of bank reserves on the last day of the maintenance period, a second LAF (SLAF) on reporting Fridays, was introduced with effect from August 1, 2008. It was decided to conduct the SLAF on a daily basis.

Thus we can conclude that India has by-and-large been spared of global financial contagion due to the subprime turmoil for a variety of reasons. India’s growth process has been largely domestic demand driven and its reliance on foreign savings has remained around 1.5 per cent in recent period. It also has a very comfortable level of forex reserves. The credit derivatives market is in an embryonic stage; the originate-to-distribute model in India is not comparable to the ones prevailing in advanced markets; there are restrictions on investments by residents in such products issued abroad; and regulatory guidelines on securitization do not permit immediate profit recognition. Financial stability in India has been achieved through perseverance of prudential policies which prevent institutions from excessive risk taking, and financial markets from becoming extremely volatile and turbulent.

REFERENCES [1] Daniel Cho –“Causes of Financial Crisis” [2] Williams, Mark T. (March 2010). “Uncontrolled Risk: The lessons of Financial Crisis”-Tata. Mcgraw-Hill.. [3] The Financial Times – “Global Financial Crisis”

Financial Innovations: Engine of Growth or Source of Financial Crisis

Dr. Varsha Ainapure*

Abstract—Board as a Corporate Governance Mechanism - A Comparative Study of Indian Information Technology Companies

The corporate financial scandals of the early 2000s, which brought down Bearings Bank and Enron necessitated a new emphasis on corporate and individual ethics. Corporate governance is about commitment to values and ethical business conduct. It is about how an organization is managed. The literature on corporate governance identifies the board as a prominent corporate governance mechanism. This paper concentrates on various aspects of directors and board structure. It examines the role of directors, and looks at the important areas of independence of the directors, board sub-committees and composition of the board that affect corporate governance.

Governance practices of some of the Information Technology companies have been studied for the year 2006-07. This study analyses the following Board characteristics used by the sample companies - Independent Directors' Shareholding in the Companies, Bifurcation of Chairman and CEO Posts, Composition of the Board, Director Tenures, The Presence of Lead Director, The Board Committees and Independence, Number of Directorships of Directors and Frequencies of Board and Committees’ Meeting. The study concludes by proving that majority companies are concerned about conformance and compliance to the regulatory framework rather than looking at corporate governance from a strategic perspective.

Keywords: Corporate Governance, Independent directors, Composition of the Board, Board Sub-committees, Lead Director

INTRODUCTION

For a quarter of a century before 2007 finance basked in a golden age. Financial globalisation spread capital more widely, markets evolved, businesses were able to finance new ventures and ordinary people had unprecedented access to borrowing and foreign exchange. Modern finance improved countless lives. But in 2007 something went awry. Financial services were in ruins first in America and then all over the world. Perhaps half of all hedge funds went out of business. Without government aid, so would many banks. Britain suffered its first bank-run since 1870s. The Wall Street grandees had been humbled. Hundreds of thousands of people in financial services lost their jobs; many millions of their clients lost their savings.

When the financial system fails, everyone suffers. Over the years 2007-08 the shock spread from American housing, sector by sector, economy by economy. Some markets were completely seized up; others were being pounded by volatility. Everywhere businesses were going bankrupt and jobs were being destroyed. For the first time since 1991 global average income per head was falling. Even as growth in emerging markets came to a halt, the rich economies looked set to shrink. Alan Greenspan, who as chairman of America’s Federal *Nagindas Khandwala College of Commerce, Mumbai


Reserve oversaw the boom, called the collapse “a once-in-a-half-century, probably once-in-a-century type of event”. Barry Eichengreen of the University of California at Berkeley and Michael Bordo of Rutgers University identified 139 financial crises between 1973 and 1997, compared with a total of only 38 between 1945 and 1971. Crises are twice as common as they were before 1914, the authors concluded. Financial panics have become almost commonplace; events that are meant to occur once in a millennium now seem to occur every few years.

In 2006 America’s current-account deficit peaked at 6% of its GDP. Between 2000 and 2008 the country received over $5.7 trillion from abroad to invest, equivalent to over 40% of its 2007 GDP. Over the same period Britain and Ireland absorbed around a fifth of their 2007 GDPs. The financial system had the job of recycling the money to borrowers. Inevitably, credit became cheaper and savings declined. In America savings fell from around 10% of disposable income in the 1970s to 1% after 2005. The question is why did America, home to the world’s most advanced financial system, turn foreign credit into the world’s most serious post-war bust? Probably the American know-how and talent made the disaster worse.

Thanks to financial innovations like credit default swaps, collateralized debt obligations (CDOs), and negatively amortizing mortgages the world experienced enormous explosion of indebtedness. This ultimately led to global financial meltdown.Of all the financial instruments to have failed, CDOs turned out to be the most devastating. Before studying more about causes and effects of financial crisis, some terms used in this paper are explained.

TERMS EXPLAINED

Collateralised-debt obligations (CDOs): CDOs, says Raghuram Rajan, a professor at the University of Chicago, is as a mechanism for converting mortgage securities and corporate bonds from huge, illiquid assets owned by local investors into liquid financial instruments that could be flogged across the world.

Innovation: National Knowledge Commission (2007) defines Innovation as: "Innovation is defined as a process by which varying degrees of measurable value enhancement is planned and achieved, in any commercial activity. This process may be breakthrough or incremental, and it may occur systematically in a company or sporadically; it may be achieved by:

• Introducing new or improved goods or services or • Implementing new or improved operational processes or • Implementing new or improved organizational/managerial processes in order to

improve market share, competitiveness and quality, while reducing costs."

Subprime Lending: means the practice of making loans available to borrowers who do not qualify for normal market interest rate loans due to various risk factors, such as income level, size of the down payment made, credit history and employment status.

Subprime Mortgages: are defined as housing loans which do not conform to the criteria for prime mortgages, and also have a lower probability of the full repayment of mortgages.

Financial Innovations: Engine of Growth or Source of Financial Crisis 309

According to Federal banking and thrift regulatory agencies, subprime mortgages are those made to borrowers who display among other characteristics, (i) a previous record of delinquency, foreclosure or bankruptcy, (ii) a low credit score, and/or (iii) a ratio of debt service to an income of 50% or greater (Office of the Comptroller of the Currency, et al, 2007).

Securitization: is a type of structured finance which turns mortgage loans into financial securities by taking existing loans or assets backed by their future cash flows. It involves the pooling of financial assets, particularly assets for which readymade secondary market does not exist. Securities are sold in the market, after separating them into tranches. The main advantage of securitization is that the lender or the originator of the loan gets a lump sum amount, rather than the interest and principal payments over the loan's term and period. In this way, it provides lenders an additional cushion and flexibility to re-lend the capital for new projects. Hence, it provides the capital to investors at the lowest cost, increases liquidity for lenders and helps lenders and investors better manage their financial risk.

FINANCIAL CRISIS: BACKGROUND

Subprime mortgages were mainly responsible for an increased demand in housing and home ownership rates in the US. The overall US home ownership rate increased from 64% to 70% between 1994 and 2004. This surging demand helped fuel housing price hike and consumer spending. Between 1997 and 2006, American home prices increased by 124%. This was, partly, due to the encouragement from the Federal government for the consumption economy. Subprime mortgages, which amounted to $35 bn (5% of total originations) in 1994, had increased phenomenally to $600 bn (20%) in 2006.

During the period of the housing property bubble in the US, when property price was rising, many homeowners used the increased property value to refinance their houses with lower interest rates available in the market. Such second mortgages against the increased value of home ownership were used for personal consumer spending. In 2007, the US household debt was 130% (as a percentage of income), which was considerably higher compared to 100% recorded in the last decade.

Once, the housing bubble burst and prices started dropping sharply, home loan refinancing became more and more difficult. Defaults and foreclosure activity increased steeply as Adjustable Rate Mortgages (ARM) interest rates reset higher, making it even more difficult for borrowers to repay. The US subprime crisis began after the housing bubble burst, which ultimately resulted in high default rates on higher risk borrowers, such as subprime and other ARM. Subprime borrowers were influenced by mortgage loan incentives and the trend of rising home prices to assume large mortgage loans, considering that they would be able to refinance existing mortgage loans with more favorable terms later on.

FINANCIAL CRISIS: CAUSES

The major causes of subprime crisis include: the inability of the homeowners to make their mortgage repayments; poor judgment by borrowers as well as lenders, while dealing with


property loans; excessive speculation in property prices during the strong period of economy; high-level of personal and corporate debt; lack of proper government control and regulation and innovation of structured financial products that concealed the risk of mortgage default for subprime clients.

According to a research study conducted by Federal Reserve of US, between 2001 and 2007, the average difference between subprime and prime mortgage interest rates decreased drastically from 280 to 130 basis points. It means that the risk premium considered by lenders or loan issuers to offer a subprime loan to clients, declined. Mortgage underwriting practices, such as automated loan approvals, have also been responsible for subprime crisis, as such approvals were not subjected to appropriate review and documentation. In 2007, 40% of all subprime loans resulted from automated underwriting.

The securitization process, which provides a secondary market for mortgage transactions also had a role to play in the crisis. The issuers of mortgages were no longer compelled to hold them to maturity. Pooled assets created by securitization, act as collateral for new financial assets issued by financial institutions. In this way, mortgages with a high risk of default could be derived effectively through Mortgage Backed Securities (MBS) and CDOs, by shifting inherent risks from the mortgage issuer to the investors.

The deteriorating situation was further compounded by the failure of the financial markets to recognize the fast changing mortgage scenario and suitably modify their lending and risk management practices. The credit and default risk inherent in the new mortgage structures was not fully recognized. Hence, such risks were not fully reflected in the overall credit ratings of the repackaged financial offerings such as MBS. Credit Rating Models must ensure constant credit monitoring, so that the fast changing environment of the global economy is reflected and accounted in the credit rating processes. Credit rating agencies, such as Moody's, Fitch and Standard & Poor's, gave triple-A ratings to a broad spectrum of subprime mortgage securities -- implying that they were nearly risk-free when, as it soon became clear, they were not.

CORRECTIVE MEASURE

This financial crisis laid bare fundamental weaknesses in the global economy. Confidence in the market as the main mechanism for efficiently allocating resources for economic growth has dropped dramatically, and debate now centers on what new regulations and additional restrictions are needed in the future.

As for lessons to be learned, Botín, who worked at Banco Santander beginning in 1988, directing the bank's international expansion in the 1990s with responsibility for the Latin American, corporate banking, asset management and treasury areas; cited the importance of countercyclical measures and liquidity, the risks caused by non-intrusive supervision, and the limitations of local regulators. "We need supervisors who are on top of the situation and see [trends/events] as they happen." In addition, the industry has relied on local regulators and local supervisors "with zero coordination on the global level." There is no way to avoid systemic risk without" the ability to intervene when necessary. "

Financial Innovations: Engine of Growth or Source of Financial Crisis 311

Corrado Passera, managing director and CEO of Intesa Sanpaolo in Milan, offered his view of the main causes of the financial crisis, including excessive leverage and lack of transparency in the derivatives market. Passera's three priorities for moving forward include first, focusing on limits to total leverage. "The enormous explosion of indebtedness during the last few years has been at the very root of the crisis We need to account not just for on-balance sheet liabilities but off-balance sheet liabilities... all the components of real indebtedness." Second, the new rules must make sure that liquidity management is under control. "You go bankrupt because you get in trouble with your liquidity. If you raise money short-term but lend money long-term, sooner or later you simply blow up." Third, "we need to put derivatives under control by moving towards standardization and in the direction of having these instruments only on regulated exchanges."

The U.S. government and Congress have been looking at rating agency reform in an attempt to eliminate conflicts of interest; to set requirements as to how much information ratings agencies should be required to disclose, and to determine whether the agencies should be held liable for their ratings, among other issues. The Senate bill would establish an independent board to assign ratings agencies to securities, so issuers could not shop around for the best ratings. The bill would require the agencies to register with the Securities and Exchange Commission.

The most popular reform is the move to centralize trading of derivatives, including hard-to-value mortgage-backed securities. These bills would create a centralized exchange and clearinghouse that would make prices public, and assure that each party to a trade gets what it is due -- payment or delivery of securities -- even if the other party defaults

CONCLUSION

Leave it to Wall Street to give innovation a bad name. The world prizes out-of-the-box thinking in technology and culture, but they fear it in finance—understandably, thanks to innovative disasters like credit default swaps, collateralized debt obligations. The big problem: It's hard to tell the beneficial ideas from the ones that are self-serving or dangerous. Many top economists, including former Federal Reserve Chairman Alan Greenspan, once lauded subprime mortgages as a fantastic innovation.

Many free-market economists do acknowledge that some regulation is appropriate in the wake of the crisis. But some economists go further and argue that any financial innovation is guilty until proven innocent. Former International Monetary Fund chief economist Simon Johnson and James Kwak, authors of the popular Baseline Scenario blog, wrote in the summer issue of the journal Democracy that innovation often generates unproductive or even destructive transactions.

The debate over innovation is about the Administration's proposed Consumer Financial Protection Agency, which would vet new financial products for safety. Bankers and laissez-faire economists object claiming that government is bad at picking winners and losers. Andrew W. Lo, director of the MIT Laboratory for Financial Engineering, favors letting


markets work: "Financial technology is no different from any other technology. It goes through a maturation process. Version 2.0 is going to be better than version 1.1."

In the words of John Lipsky, First Deputy Managing Director, International Monetary Fund, `Despite the unsettling and even dramatic recent global experience with “cutting edge” finance, I believe that without a renewed effort to foster financial innovation in the global economy, all countries—including emerging market economies—will underperform their potential. The principal challenge for policymakers, then, is to strike an appropriate balance between financial openness that supports growth-enhancing innovation while at the same time implementing regulations and effective supervision that limit the potential risk of financial instability.’

Looking forward from the current conjuncture, financial innovation has three principal tasks. First, it should address the challenge of missing markets, such as those for the long-term financing that is required for creating long-lived assets, or for efficient risk sharing by providing appropriate insurance and hedging products. Second, it should deepen liquidity in existing markets, for example by reducing excessive reliance on a narrow base of depositors for funding. And, third, by raising the quantity and quality of investment, it can increase efficiency in the economy as a whole.

REFERENCES [1] Knowledge@Wharton (2010), Ùshering in a 'New Financial World' While Avoiding the Excesses of the Old’

Published : July 14, 2010. [2] Knowledge@Wharton (2010),` Regulating the Unknown: Can Financial Reform Prevent Another

Crisis?’Published : June 09, 2010. [3] Reena Jana (2009), Business Week `Recession: The Mother of Innovation?’ [4] Peter Coy (2009), Business Week, ` Financial Innovation Under Fire:Can we protect consumers and still be

creative?’ [5] Saurabh Agarwal, Megha Agarwal, Pankaj Kumar Jain, (2009) Indian Journal of Economics and Business,

`Globalization, crisis and financial engineering in India.’ [6] John Lipsky, Dy. M.D. International Monetary Fund,(2010) Managing Financial Innovation in Emerging

Markets at the Reserve Bank of India First International Research Conference [7] The Economist,(Jan. 2009), A special report on the future of finance, `Greed—and fear.’ [8] The Economist (Oct.2010), A special report on the world economy The cost of repair : A battered finance

sector means slower growth [9] Panic (2008), Ed. By Michael Lewis, Penguin Books.

Global Meltdown and Indian Financial Market: Some Issues

Dr. Anil G. Suryavanshi* Abstract— The financial crisis of 2007 to the present is a crisis triggered by a liquidity shortfall in the United States banking system. It has resulted in the collapse of large financial institutions, the bailout of banks by national governments and downturns in stock markets around the world. It is been found that the sub prime crisis as the major cause for the meltdown and as far as India is concerned IT, Real estate, Banking, Insurance, Indian capital market, and infrastructure industries were adversely affected. Rarely in economic history there has been any episode like the cataclysmic global meltdown seen since the second half of 2008. Though there is an impact of global meltdown on international business, it is a need of tomorrow to in introspect Indian business with remedies.

The main focus of this research paper is to know the impact of global meltdown on Indian Financial Markets

Keywords: global meltdown, financial institutions, impact, remedies.

INTRODUCTION Meltdown or Recession is nothing but a phase of Business cycle. The term ‘Business

cycle’ in Economics refers to the wave-like fluctuations in the aggregate economics activity, particularly in employment, output and income. There are four phases of Business cycle 1) Prosperity phase 2) Recessionary phase 3) Depressionary phase 4) Revival or recovery phase. It is said that when a nation’s gross domestic product is affected negatively on account of a decline in the economic activities, the situation is described as an economic recession and when this recession continues for long, it can turn into depression. (Ruddar Datt, 2009).

According to National Bureau of Economic Research in US defines an economic recession as, “a significant decline in (the) economic activity spread across the country, lasting more than a few months, normally visible in real GDP growth, real personal income, employment (non-farm payrolls), industrial production, and wholesale-retail sales.” Though Indian economy is a developing economy and overcome on the various problems in meltdown, Global economic crisis has definitely made an impact on Indian economy but not that extent which was expected. 1

BEGINNING OF GLOBAL MELTDOWN

The basic cause of the crisis was largely an unregulated environment, mortgage lending to sub prime borrowers. Since the inefficiency and lack of capacity of borrowers to repay the borrowed amount with interest, the situation became worse. As once the housing market collapsed, the lender institutions realized their balance-sheets go into red. But Indian economy could not affected by this crisis, later it was found that the Foreign Direct Investment (FDI) *Sanjay Ghodawat Group of Institutions, Faculty of Management, Kolhapur


started drying up and this affected investment in the Indian economy. It was; therefore, felt that the Indian economy will grow at about seven per cent in 2008-09 and at six per cent in 2009-10. The lesson of this experience is that India must exercise caution while liberalizing its financial sector. It is been found that the sub prime crisis as the major cause for the meltdown and as far as India is concerned IT, Real estate, Banking, Insurance, Indian capital market, and infrastructure industries were adversely affected. Rarely in economic history there has been any episode like the cataclysmic global meltdown seen since the second half of 2008. Though there is an impact of global meltdown on international business, it is a need of tomorrow to in introspect Indian financial market with remedies.

INDIAN FINANCIAL SYSTEM

Broadly speaking, the main regulators of the Indian financial sector are particularly SEBI and RBI. In spite of the strict vigilance by the regulators, the investors find Indian market very attractive. A structural change was noticed in the Indian financial system with the establishment of a host of financial intermediaries during the second phase of evolution of the system. Financial intermediaries comprises of public financial institutions, NBFCs, mutual funds, commercial banks, housing bank etc.

Global Meltdown and Impact on Foreign Financial Market: Some Issues

Impacts on Financial Institutions

The International Monetary Fund estimated that large U.S. and European banks lost more than $1 trillion on toxic assets and from bad loans from January 2007 to September 2009. These losses are expected to top $2.8 trillion from 2007-10. U.S. banks losses were forecast to hit $1 trillion and European bank losses will reach $1.6 trillion. The IMF estimated that U.S. banks were about 60% through their losses, but British and Euro zone banks only 40%. 5

Initially the companies affected were those directly involved in home construction and mortgage lending such as Northern Rock, a medium-sized British bank and Countrywide Financial, as they could no longer obtain financing through the credit markets. Over 100 mortgage lenders went bankrupt during 2007 and 2008. The investment bank Bear Stearns was collapsed in March 2008 and resulted in sale to JP Morgan Chase. The financial institution crisis hit its peak in September and October 2008 and resulted in takeover of Lehman Brothers, Merrill Lynch, Fannie Mae, Freddie Mac, Washington Mutual, Wachovia, and AIG.

Credit Markets and the Shadow Banking System

During the crises in September 2008, the equivalent of a bank run on the money market mutual funds, which was frequently invest in commercial paper issued by corporations to fund their operations and payrolls. Withdrawals from money markets were $144.5 billion during one week, versus $7.1 billion the week prior. This interrupted the ability of corporations to rollover (replace) their short-term debt

Global Meltdown and Indian Financial Market: Some Issues 315

Wealth Effects

The New York City headquarters of Lehman Brothers

There is a direct relationship between declines in wealth, and declines in consumption and business investment, which along with government spending represent the economic engine. Between June 2007 and November 2008, Americans lost an estimated average of more than a quarter of their collective net worth. By early November 2008, a broad U.S. stock index the S&P 500, was down 45% from its 2007 high. Housing prices had dropped 20% from their 2006 peak, with futures markets signaling a 30-35% potential drop. Total home equity in the United States, which was valued at $13 trillion at its peak in 2006, had dropped to $8.8 trillion by mid-2008 and was still falling in late 2008. Total retirement assets, Americans' second-largest household asset, dropped by 22%, from $10.3 trillion in 2006 to $8 trillion in mid-2008. During the same period, savings and investment assets (apart from retirement savings) lost $1.2 trillion and pension assets lost $1.3 trillion. Taken together, these losses total a staggering $8.3 trillion. Since peaking in the second quarter of 2007, household wealth is down $14 trillion.

European Contagion

The crisis rapidly developed and spread into a global economic shock, resulting in a number of European bank failures, declines in various stock indexes, and large reductions in the market value of equities and commodities.

Global Meltdown and Impact on Indian Financial Market & Government Initiative: Some Issues

The global financial crisis, brewing for a while, really started to show its effects in the middle of 2007 and into 2008. Around the world stock markets have fallen, large financial institutions have collapsed or been bought out, and governments in even the wealthiest nations have had to come up with rescue packages to bail out their financial systems. The global meltdown has been transmitted to the Indian economy through three distinct channels, viz., the financial sector, exports and exchange rates. The financial sector including the banking sector, equity markets, external commercial borrowings and remittances has not remained safe and sound fortunately; the Indian banking sector was not overly exposed to the sub-prime crisis.

In India, there were no adverse effects found so far been mainly in the equity markets because of reversal of portfolio equity flows, and the concomitant effects on the domestic forex market and liquidity conditions. The macro effects have so far been muted due to the overall strength of domestic demand, the healthy balance sheets of the Indian corporate sector, and the predominant domestic financing of investment.

Aspects of Financial Disorder in India

Mainly the finance sector is disordered by the two important financial aspects


CAPITAL OUTFLOW

Impact on Stock and Forex Market

Capital Outflow

The main impact of the global financial turmoil in India has commenced from the significant change experienced in the capital account in 2008-09, relative to the previous year. It was observed that Total net capital flows fell from US$17.3 billion in April-June 2007 to US$13.2 billion in April-June 2008. Nonetheless, capital flows are expected to be more than sufficient to cover the current account deficit this year as well. While Foreign Direct Investment (FDI) inflows have continued to reveal accelerated growth (US$ 16.7 billion during April-August 2008 as compared with US$ 8.5 billion in the corresponding period of 2007), portfolio investments by foreign institutional investors (FIIs) witnessed a net outflow of about US$ 6.4 billion in April-September 2008 as compared with a net inflow of US$ 15.5 billion in the corresponding period last year.

Similarly, external commercial borrowings of the corporate sector declined from US$ 7.0 billion in April-June 2007 to US$ 1.6 billion in April-June 2008, partially in response to policy measures in the face of excess flows in 2007- 08, but also due to the current turmoil in advanced economies.

Impact on Stock and FOREX Market

The impact of global meltdown was observed in 2008 on equity market particularly. The withdrawals by foreign investors from Indian stock market have been affected during this period. FIIs had invested over Rs 10, 00,000 crore between January 2006 and January 2008, driving the Sensex 20,000 over the period. But from January, 2008 to January, 2009 this year, FIIs pulled out from the equity market partly as a flight to safety and partly to meet their redemption obligations at home. These withdrawals drove the Sensex down from over 20,000 to less than 9,000 in a year. It has seriously crippled the liquidity in the stock market. The stock prices have tanked to more than 70 per cent from their peaks in January 2008 and some have even lost to around 90 per cent of their value. Equity values are now at very low levels and many established companies are unable to complete their rights issues even after fixing offer prices below related market quotations at the time of announcement. Subsequently, market rates went down below issue prices and shareholders are considering purchases from the cheaper open market or deferring fresh investments. This situation naturally has upset the plans of corporate to raise resources in various forms for their ambitious projects involving heavy outlays. The withdrawals by the foreign investors has made burden on dollar demand and created problems before the domestic, corporate Indian financial system of creating the foreign fund. Because of this initially the impact of global meltdown has been limited to the stock market and the foreign exchange market, but it spreads to all sectors. Dollar purchases by FIIs and Indian corporations, to meet their obligations abroad, have also driven the rupee down to its lowest value in many years. Within the country also there has been a flight to safety. Within this period the Investors have shifted their investments from stocks and mutual


funds to bank deposits and from private to public sector banks. Even though it is observed that highly leveraged mutual funds and non-banking finance companies (NBFCs) have been affected in this situation.

Impact on the Indian Banking System

The Indian banking system is not directly exposed to the sub-prime mortgage assets. According to my opinion, the saving of Indians has made a great help in maintaining the stability in financial transactions with bank. It has very limited indirect exposure to the US mortgage market, or to the failed institutions or stressed assets. As compare to US banking sector, Indian banks as the public sector and the private sector has financially sound, well capitalized and under well regulation. The average capital to risk-weighted assets ratio (CRAR) for the Indian banking system, as at end-March 2008, was 12.6 per cent, as against the regulatory minimum of nine per cent and the Basel norm of eight per cent.

However, a few Indian banks had invested in the collateralized debt obligations (CDOs)/ Bonds which had a few underlying entities with sub-prime exposures.

Thus it is observed that no direct impact on account of direct exposure to the sub-prime market.

As compared to Indian Banking, the US has taken support of shadow banking. During the crises in September 2008, the equivalent of a bank run the money market mutual funds, which was frequently invest in commercial paper issued by corporations to fund their operations and payrolls. Withdrawals from money markets were $144.5 billion during one week, versus $7.1 billion the week prior.

Impact on Industrial Sector and Export Prospect

There is a crucial impact of meltdown over to the real world. If we consider the industrial sector, It has slowed down with industrial growth projected to decline from 8.1 per cent from last year to 4.82 per cent this year. The service sector, which contributes more than 50 per cent share in the GDP and there is slowing down, besides the transport, communication, trade and hotels & restaurants sub-sectors. The growth of manufacturing sector has also come down to 4.0 per cent in April-November, 2008 as compared to 9.8 per cent in the corresponding period last year.

The export of gems and jewellery, fabrics and leather etc. is also come down. It is observed that this declining is the first in the last seven years. Export as a percentage of GDP in India is closer to 20 per cent. Therefore, the adverse impact of the global meltdown on our export though it is marginal; we have to take it seriously. Indian exporters are under unexpected pressure as global demand is set to slump frighteningly. The export growth was turn negatively in recent months and the government has scaled down the export target for the current year to $175 billion from $200 billion. For 2009-10, the target has been set at $200 billion.


Liberlisation Impact

With the collapse of Lehman Brothers and other Wall Street icons, there was growing recession which affected the US, the European Union (EU) and Japan. This was the result of large scale defaults in the US housing market as the banks went on providing risky loans without adequate security and the repaying capacity of the borrower. The principal source of transmission of the crisis has been the real sector, generally referred to as the ‘Main Street’. This crisis engulfed the United States in the form of creeping recession and this worsened the situation. As a consequence, US demand for imports from other countries indicated a decline.

The industries most affected by weakening demand were airlines, hotels, real estate.. Industrial production and manufacturing output declined to five per cent in the last quarter of 2008-09. Consequently, a vicious cycle of weak demand and falling output developed in the Indian economy.

A weakening of demand in the US affected our IT and Business Process Outsourcing (BPO) sector and the loss of opportunities for young persons seeking employment at lucrative salaries abroad. India’s famous IT sector, which earned about $ 50 billion as annual revenue, is expected to fall by 50 per cent of its total revenues. This would reduce the cushion to set off the deficit in balance of trade and thus enlarge our balance of payments deficit. It has now been estimated that sluggish demand for exports would result in a loss of 10 million jobs in the export sector alone.

To lift the economy out of the recession the Government announced a package of Rs 35,000 crores in the first instance on December 7, 2008. The main areas to benefit were the following:

• Housing—A refinance facility of Rs 4000 crores was provided to the National Housing Bank. Following this, public sector banks announced to provide small home loans seekers loans at reduced rates to step up demand in retail housing sector.

o Loans up to Rs 5 lakhs: Maximum interest rate fixed at 8.5 per cent. o Loans from Rs 5-20 lakhs: Maximum interest rate at 9.25 per cent. o No processing charges to be levied on borrowers. o No penalty to be charged in case of pre-payment. o Free life insurance cover for the entire outstanding amount.

This means a borrower can get a loan up to 90 per cent of the value of the house. The government hopes to disburse Rs 15,000 to 20,000 crores under the new package.

The housing package is the core of the government’s new fiscal policy. It will give a fillip to other sectors such as steel, cement, brick kilns etc. Besides, the small and medium industries (SMEs) too get a boost by manufacturing all kinds of fittings and furnishings.

The success of the housing package will, however, depend on the State governments efforts to free up surplus land so that land prices come down and the cost of housing becomes reasonable.


• Textiles—Due to declining orders from the world’s largest market the United States, the textile sector has been seriously affected. An allocation of Rs 1400 crores has been made to clear the entire backlog in the Technology Upgradation Fund (TUF) scheme. The Apparel Export Promotion Council (AEPC) Chairman, however, said: “It is a disappointing package. The allocation of Rs. 1,400 crores has been pending for many years and thus, it is the payment of arrears only. There is nothing new in it. It would have been much better if more concrete measures have been taken to reverse the downturn in the exports of readymade garments and avoid further job losses in the textile sector.”

• Infrastructure—The government has been proclaiming that infrastructure is the engine of growth. To boost the infrastructure, the India Infrastructure Finance Company Ltd. (IIFCL) has been authorized to raise Rs 14,000 crores through tax-free bonds. These funds will be used to finance infrastructure, more especially highways and ports. It may be mentioned that ‘refinance’ refers to the replacement of an existing debt obligation with a debt obligation bearing better terms, meaning thereby at lower rates or a changed repayment schedule. The IIFCL will be permitted to raise further resources by the issue of such bonds so that a public-private partnership (PPP) programme of Rs 1, 00,000 crores in the highway sector is promoted.

• Exports—Exports which accounted for 22 per cent of the GDP are expected to fall by 12 per cent. The government’s fiscal package provides an interest rate subsidy of two per cent on exports for the labour–intensive sectors such as textiles, handicrafts, leather, gems and jewellery, but the Federation of Indian Export Organization (FIEO) felt the measures are not enough as they will not make the exports price-competitive and, therefore, will not boost exports. G.K. Pillai, the Commerce Secretary, has estimated a loss of 1.5 million jobs in the export sector alone during 2008-09 on account of the $15 billion decline in the expected exports.

• Small and Medium Enterprises (SMEs)—The government has announced a guarantee cover of 50 per cent for loans between Rs 50 lakhs to Rs 1 crore for SMEs. The lock in period for loans covered under the existing schemes will be reduced from 24 months to 18 months to encourage banks to cover more loans under the scheme. Besides, the government will instruct state-owned companies to ensure prompt payment of bills of SMEs so that they do not suffer on account of delay in the payment of their bills.

In short, the fiscal package is aimed at boosting growth in exports, real estate, auto, textiles and small and medium enterprises. The aim is to encourage growth and boost employment which has been threatened by the recession in the world economy, more especially in the United States.

The purpose of the new package announced on January 1, 2009 was to minimize the pain. With this end in view, the new package included the following measures:-

• To boost investment and spending to revive growth, the RBI cut the repo rate, which it charges on short-term loans to banks from 6.5 per cent to 5.5 per cent and also reduced the Cash Reserve Ratio (CRR)—the share of deposits which has to be kept with the RBI from 5.5 per cent to five per cent.


• To revive exports which has resulted in a contraction of industrial output, drawback benefits have been enhanced for some exporters. Export-Import Bank also gets Rs. 5000 crores as credit from the RBI.

• To help the realty sector, realty companies have been allowed to borrow from overseas to develop “integrated townships”.

• To boost infrastructure, the India Infrastructure Finance Company Ltd. (IIFCL) has been allowed to raise Rs 30,000 crores from tax-free bonds. Besides, Non-Banking Finance Companies (NBFCs) need no government approval to borrow from overseas for infrastructure projects. This will sustain the growth momentum on infrastructure.

• To make more funds available, ceiling on foreign institutional investments (FIIs) in corporate bonds has been increased to $ 15 billion from $ 6 billion. The purpose is to seek much bigger FII investment.

• To stimulate the Commercial Vehicles (CVs) sector, depreciation benefit on commercial vehicles has been increased form 15 per cent to 50 per cent on purchases. Besides, the States will get one-time funding from the Centre to buy buses for urban transport. In addition, public sector banks would provide finance firms funds for commercial vehicles. It is hoped that Tata Motors and Ashok Leyland’s sales would revive.

On February 24, 2009, the government announced a slashing down of excise duty from 10 per cent to eight per cent—a reduction by two per cent. Since 90 per cent of the manufactured goods attract 10 per cent excise duty, this measure is designed to reduce the prices of colour TV sets, washing machines, refrigerators, soap, detergents, colas, cars and commercial vehicles. Cement prices are likely to drop Rs 4-5 per bag of 50 kg while steel prices may cost Rs 500-600 per tonne less. In addition to this, the government decided to cut service tax form 12 per cent to 10 per cent—a reduction by two per cent. As a consequence, phone bills, airline tickets, credit card charges, tour packages etc. would cost less. A two per cent reduction in service tax will directly touch the lives of over 500 million persons by reducing monthly expenses. The entire stimulus package of Rs 30,000 crores to boost demand in the economy and thus reduce the impact of recession.

CONCLUSION

The impact of global meltdown is not only on one sector but all economic sectors, but India has not suffered far from high problems. The RBI and government of India have given very good packages to all sectors for survival in future. Finally, The Companies and Management may follow the simple suggestions to protect themselves from the Global Recession i.e. all sectors have to create their own financial stability for overcoming the economic situations. If they believe in Security, protecting, improvement, reshape with technology and sustainability, no doubt they have a bright future.


REFERENCES [1] R Ruddar Datt: Meltdown and its Impact on the Indian Economy, Mainstream Weekly, Vol XLVII, No 15,

March 28, 2009, a well-known economist, is a Visiting Professor, Institute of Human Development, New Delhi.

[2] R Report on Indian capital markets By IANS Tuesday, 29 January 2008, 09:48 RHrs, The Economics times of India.

[3] R www.nseindia.com, www.bseindia.com, www.google.co.in [4] R Payel Jain, Vinod Kothari & Company, Indian Financial Market: A quick Rintroduction,

([email protected]) [5] "Bloomberg-U.S. European Bank Writedowns & Losses-November 5, 2009". Reuters.com. November 5,

2009. [6] HM Treasury, Bank of England and Financial Services Authority (September 14, 2007). "News Release:

Liquidity Support Facility for Northern Rock plc". [7] Roger C. Altman. "Altman - The Great Crash". Foreign Affairs.

http://www.foreignaffairs.org/20090101faessay88101/roger-c-altman/the-great-crash-2008.html [8] V. Padmanabhan, July 02, 2009, article on U.S Financial Crisis and ITS Impact on Indian Markets [9] “The Global Economic Crisis: Assessing Vulnerability with a Poverty Lens”, The World Bank Policy Note,

Newsletter n. 5, February 2009 [10] Kum Kum Dasgupta, “Less on our plate”, The Hindustan Times, December 30, 2008 [11] “The Global Financial Turmoil and Challenges for the Indian Economy” Speech by Dr. D. Subbarao,

Governor, Reserve Bank of India at the Bankers' Club, Kolkata on December 10, 2008 [12] Global Economic Crisis and its Impact on India Rajya Sabha Secretariat, New Delhi, June 2009 [13] Global Financial and Economic Crisis: Impact on India and Policy Response Rajiv Kumar, Director & Chief

Executive, Indian Council for Research on International Economic Relations (ICRIER), New Delhi p.p. 9 [14] Global Meltdown and India - Issues, Concerns and Challenges, V. Basil Hans St Aloysius Evening College,

Mangalore (INDIA), April 8, 2009.

Track 6 Infrastructure Finance

Infrastructure Finance Contrivance for Economic Ripeness

Dr. Navneet Joshi* and Khushboo Gupta*

Abstract—The economic advancement of a country critically depends upon availability of adequate physical infrastructure. This includes transportation (roads, ports, railways, and airports), energy (generation and transmission), communications (cable, television, fiber, mobile and satellite) and agriculture (irrigation, processing and warehousing). India, being a fast emerging country, has been the focal destination for such infrastructure development over a decade. Considering the efforts of Indian government, the study critically evaluates the development of Indian infrastructure which says that financing such developments has been the critical factor for the success of the same. Consequently, infrastructure finance is undergoing an unprecedented boom with the sector’s stable cash flows, attracting the interests of whole range of structured financiers including both the debt and equity. The study finds that there is a dire need for large and continuing amounts of investment in almost all areas of infrastructure in India. The key issue is, while the need exists, how these projects will get financed. There are certainly issues surrounding the availability of suitable intermediaries with an adequate amount of risk capital for infrastructure financing. While Foreign Direct Investment (FDI) has the potential to provide some of the equity capital, it appears very likely that the Government itself would have to emerge as the provider of the bulk of this risk capital with banks and capital markets providing the bulk of the debt finance.

This paper attempts to address these issues: a) Increasing the supply of infrastructure finance b) Facilitating the flow of funds to infrastructure finance sector, c) Enha*ncing the role of banks as intermediaries for infrastructure finance.

Keywords: Infrastructure, Developing, Infrastructure Finance, Capital market,Risk

INTRODUCTION

Availability of viable physical infrastructure serves as the corner stone of an economy, whether being developed or developing. Although, the drivers for infrastructural development may vary from country to country, the need and demand for the same are always directed upward. For instance, on one side, developed economies of the world are aggressively indulged in upgrading their infrastructure; the emerging economies are vigorously paying attention on building new infrastructure so as to facilitate economic growth and prosperity. This is largely due to the fact that there remains strong linkage between the economic growth and infrastructure development of a country. The development of physical infrastructure including transportation (roads, ports, railways, and airports), energy (generation and transmission), communications (cable, television, fiber, mobile and satellite) and agriculture (irrigation, processing and warehousing) serves as a barometer of a country’ economic growth and prosperity.

*Jagan Institute of Management Studies, Delhi


Thus, infrastructure development is critical for sustainable growth of India. It has often been noted that the unavailability of sound infrastructure i.e. shoddy roads, irregular energy supply, lack of water and sanitation has been the major constrains restraining the overall economic growth potential of the country. A major area of concern for sustaining the real GDP growth in India has been lack of adequate infrastructure, which can support the growth process. The deplorably low levels of public investment have rendered India’s physical infrastructure incompatible with large increases in the national product and clearly, without improving the rate of infrastructure investment, the overall growth rate at best would remain modest. However, the country continues to witness growing demand for infrastructure over a period of time, mainly since the economic liberalization and industrialization, the time when major MNCs entered into the country. The country reported a GDP growth of more than 8% even during the financial crisis. But, India has not been able to meet the growing demand for infrastructure due to numerous reasons such as lack of funds, sound investment policies, regional disparities, private sector intervention, to name a few. Among all said factor, availability of investment funds has emerged as the most critical element for the successful infrastructural development in India. In this regard, the research paper discusses various aspects of infrastructure finance in India.

Defining the Infrastructure Finance Market in India

In India, Infrastructure financing has a long way to penetrate in order to sustain the uptrend in the cycle of growth. It has critical dimensions and contributes to increased investment and productivity, which is vital for an economy like India. It is thus important to know as what comprises infrastructure financing. Infrastructure projects differ in significant ways from manufacturing projects and expansion and modernization projects undertaken by various companies. To define, infrastructure financing has following characteristics:

• Infrastructure finance tends to have long term maturities, ranging from around 5 years to 40 years.

• Infrastructure projects require huge investments. For example a kilometer of road or a mega-watt of power could cost as much as several Crore rupees and consequently large amounts could be required per project.

• Since large amounts are typically invested for long periods of time, it is not surprising that the underlying risks are also quite high. The risks arise from a variety of factors including demand uncertainty, environmental transformations, technological obsolescence (in some industries such as telecommunications) and very importantly, political and policy related uncertainties.

• Infrastructure financing results in fixed and low (but positive) real returns. The annual returns here are often near zero in real terms. However, once again as in the case of demand, while real returns could be near zero, they are unlikely to be negative for extended periods of time (which need not be the case for manufactured goods).

• The infrastructure projects are characterized by non-recourse or limited recourse financing, i.e., lender can only be repaid from the revenues generated by the projects requiring to the large scale of investments.

Infrastructure Finance Contrivance for Economic Ripeness 327

The official data by the Indian government recently revealed that the investment in infrastructure in the first three years of the 11th Plan (2007-12) had already exceeded the target of Rs 9,81,119 Crore. The actual investment was Rs 10,65,828 Crore, which is 7.1% of the GDP and 109% of the targeted expenditure. Major areas for investment have been the sectors such as electricity, telecommunications, irrigation and oil and gas pipelines. Growth has certainly been driven by various measures undertaken by the Indian Government to enable greater flow of funds into the infrastructure sector such as the "takeout financing" scheme of the India Infrastructure Finance Company Ltd (IIFCL); separate classification of infrastructure non-banking finance companies (NBFCs); and, long-term infrastructure bonds with tax exemption up to Rs 20,000 for individual investors. Moreover, The Union Budget 2010-11 has provided resources amounting to Rs.1,73,552 Crore for upgrading rural and urban infrastructure.

Several initiatives have been undertaken to accelerate the pace of project implementation. The policy framework, especially for the PPPs, has been modified by streamlining PPP approvals in the central sector through Public Private Partnership Appraisal Committee (PPPAC), introducing viability gap funding facility, providing finance through India Infrastructure Finance Company Ltd. (IIFCL), standardising contracts to regulate terminologies related to risk, liabilities and performance standards, etc.

SCOPE

The scope of infrastructure financing remains bullish for an emerging economy like India as there remain significant demand supply gaps in availability of infrastructure in the country. The main variants on the demand side are high growth aspirations, burgeoning population, urbanization along with the rapidly changing consumer lifestyle, rapid technological changes and globalization. In order to sustain the economic growth, Infrastructure development serves as a key driver of inclusive growth. It is already identified as one of the serious impediments to high growth in India in the coming years. With fast pace of economic growth and urbanization, availability of adequate facilities as well as upgrading the quality of existing infrastructure would assume paramount importance. Infrastructure development in new townships is a priority to redistribute the influx of growing population. Attention is to be paid to the rural infrastructure provision such as irrigation, electrification, roads, drinking water, sanitation, housing, community IT service, etc. Financial issues are often cited as the key constraint to the availability of provisions in an emerging economy like India.

SOURCES OF INFRASTRUCTURE FINANCE

There are three principal forms of infrastructure finance:

• Public finance • Corporate finance; and • Project finance.

In industrialized countries, public finance consists of government providing equity financing (seed capital) through general budget reserves, earmarked reserves, self-raised


funds (e.g. licensing fee, and sale, rental or leasing of government assets), and intergovernmental grants and fiscal transfers. Debt financing in the public finance system is through policy loans at concessional rates, supplier credits, and fixed income securities in the form of tax-secured bonds and revenue bonds secured by project-related revenue streams. In some cases, public debt financing is guaranteed by governments either explicitly or implicitly.

Corporate finance consists of corporations providing equity financing through retained earnings and shareholders’ equity. Debt financing takes the form of commercial bank borrowing, subordinated debt (including convertible debentures and preferred stocks), privately-placed borrowing, and issuance of fixed income securities. These securities can be short-term in the form of commercial paper, or of longer durations in the form of corporate bonds. Debt is secured through collateralization of corporate assets and assignments of receivables. Much of the infrastructure-related debt incurred in recent years by State Owned Corporations in China has been through commercial bank borrowings. However, unlike in industrialised countries, much of this debt is implicitly guaranteed by governments, and is not fully collateralised from corporations’ own assets.

Project finance consists of government, corporations and Pubic Private Partnership (PPP) financing investments solely through the revenue stream of the infrastructure projects without taking recourse to government guarantees. Most project finance is made available by project-specific companies (often called the ‘project company’) with equity held by sponsors. Equity takes the form of sponsor investment in share capital of the project company. Debt is fully secured through the revenue stream of the infrastructure project; this stream is assigned to lenders through security agreements with trustees and does not appear on sponsor companies’ balance sheets. Debt financing usually takes the form of a combination of bank loans (usually syndicated for large projects), sponsor loans, subordinated loans, suppliers’ credits, and bonds of the project company. Corporate and project finance is clearly applicable only to private and club goods type of infrastructure for which there is sufficient revenue stream that can be legally collateralized to lenders.

PPP Emerging as a most Viable Source of Infrastructure Funding

A PPP refers to a contractual arrangement between a government agency and a private sector entity that allows for greater private sector participation in the delivery of public infrastructure projects through concession agreements which lay down the performance obligations to be discharged by the concessionaire. In comparison with the traditional models, the private sector in the PPP model assumes a greater role in planning, financing, design, construction, operation and maintenance of public facilities. Project risk is transferred to the party best positioned to manage the same. PPP projects have been found to be sources of various efficiencies such as resource allocation efficiency, production efficiency, and economic and social efficiency.


Potential Sources of Efficiencies from PPPs Type `Definition Examples Resource Allocation Efficiencies

Efficiencies are gained from the private sector’s ability to allocate resources more effectively.

The private sector’s motivation is on the completion of the project to a set of performance standards. Conversely, the public sector will have competing interests for operating resources, which may reduce the performance of the project over its life-cycle.

Production Efficiencies

Resources for a specific application can also be used more effectively; The ability to be more productive is developed during the private sector organization’s years of practice delivering similar projects.

The construction and operation of infrastructure may be completed in less time and/or lower overall cost by using market-tested techniques and incentives for innovation.

Economic and Social Efficiencies

Access to more capital allows more projects to be funded on a fixed capital budget; Social benefits of infrastructure accrue faster as infrastructure is built sooner.

More efficient movement of goods and people; Improved quality of life resulting from increased access to infrastructure.

Further, some of the commonly used PPP models are:

• Build-Transfer (BT): Under this model, the government contracts with a private partner to design and build a facility in accordance with the requirements set by the government. Upon completion, the government assumes responsibility for operating and maintaining the facility. This method of procurement is sometimes called Design-Build (DB).

• Build-Lease-Transfer (BLT): This model is similar to Build-Transfer, except that after the facility is completed it is leased to the public sector until the lease is fully paid, at which time the asset is transferred to the public sector at no additional cost. The public sector retains responsibility for operations during the lease period.

• Build-Transfer-Operate (BTO): Under this model, the private sector designs and builds a facility. Once the facility is completed, the title for the new facility is transferred to the public sector, while the private sector operates the facility for a specified period. This procurement model is also known as Design-Build- Operate (DBO).

• Build-Operate-Transfer (BOT): This model combines the responsibilities of Build-Transfer with those of facility operations and maintenance by a private sector partner for a specified period. At the end of the period, the public sector assumes operating responsibility. This method of procurement is also referred to as Design-Build-Operate-Maintain (DBOM).

• Build-Own-Operate-Transfer (BOOT): Here the government grants a private partner a franchise to finance, design, build and operate a facility for a specific period of time. Ownership of the facility goes back to the public sector at the end of that period.

• Build-Own-Operate (BOO): In this model, the government grants a private entity the right to finance, design, build, operate and maintain a project. This entity retains ownership of the project.

• Design-Build-Finance-Operate/Maintain (DBFO, DBFM or DBFO/M): Under this model, the private sector designs, builds, finances, operates and/or maintains a new


facility under a long-term lease. At the end of the lease term, the facility is transferred to the public sector.

Fig. 1: Public and Private Sector Responsibilities in New Projects

Source: Closing the Infrastructunre Gap: The Role of public-Private partnerships, De;potte Researc

Despite its critical role in the development process in India, most of the state and local governments in India would not be in a position to undertake such investments and resultantly our various flagship programs had to depend on central assistance. While funding is understandably a key issue, it is needless to say that much of the success in creating the provision would depend upon some related non-financial factors like project viability, realization of user costs, avoiding time and costs overrun, contract enforcement and efficient utilization of funds. Traditionally the government bore the burden of building up infrastructure in India. However, the strategy of development has been revisited with economic reforms in the 1990s. Accordingly, the infrastructure industry has been opening up to the private players in various sectors. The Electricity (Supply) Act of 1948 was amended in 1991 to promote the entry of Independent Power Producers. Similarly, the National Highways Act of 1956 was amended in June 1995 to allow and attract private investment in road development, maintenance and operation. The telecommunications sector was deregulated and the Telecom Regulatory Authority of India (TRAI) was established in 1997 to oversee the industry.

The private sector has exhibited increasing interest in infrastructure investment in India. Resultantly, the relative shares of public and private investment in total infrastructure investment during the Eleventh Plan are projected to be about 70 per cent and 30 per cent, respectively as compared with 80 per cent and 20 per cent, respectively during the Tenth Plan. It is interesting to note that private sector is anticipated to take up projects in telecommunications, ports and airports and private investment is envisaged to constitute more than 60 per cent of total investment in these sectors during the Eleventh Plan. For the power sector, the investment is expected to rise to 28 per cent and for the road sector to 34 per cent.

On strength of these arguments, the government has endeavored to create a facilitating environment for large scale involvement of private sector in development of infrastructure. The private sector category includes PPP projects as well as pure private sector projects. While the former must be based on a Model Concession Agreement (MCA) with the government such as for toll roads, ports, and airports; the latter are market-based such as in telephony and merchant power stations.


Overall, there has been some notable progress in attracting private investment in the infrastructure industries. Usually investments from private sources are high in those sectors where user cost is well defined and easily recoverable. For the remaining segment, it is primarily the public investments that have to supplement infrastructure provisions given their importance in the economy. Irrigation, water supply, electricity and gas are the specific cases in point where user charges need to be defined and contract enforcement mechanism need to be strengthened further to ensure an uninterrupted flow of investments from private sources. Overall, the financing requirement from the private sectors during Eleventh Five Year Plan is estimated to be over 30 per cent from a little less than 20 per cent during the Tenth Plan period. The flagship Bharat Nirman Programme of the Government of India focuses on the provision of key rural infrastructure like irrigation, electrification, roads, drinking water supply and sanitation, affordable housing, and connectivity via community IT service centers.

Bridging the Infrastructure Financing Gap

Considering the importance of infrastructural development in India, there has been evolved various measures and solutions to bridge the gap of ‘what is required’ and ‘what is available’ for infrastructure funding. One such measure is the inclusion of private sector funds, banks, and insurance companies in funding the infrastructure projects. Some larger funds globally are beginning to invest in infrastructure via private-equity funds, or, occasionally, even directly such as seen in Australian, Dutch and Canadian pension funds.

Further, involvement of private sector investment in infrastructure will largely depend upon the capital market in India. Also it has been found that, there is a dire need to improve the depth and liquidity of the corporate bond market to provide an additional source of funds for infrastructure companies. Industry sources reveal that a number of factors such as limited investor base, limited number of issuers and preference for bank finance over bond finance are the main barriers for development of a deep and liquid corporate bond market in the country. Further, syndication of loans would diversify the risk in infrastructure financing, given the fact that a bank would not like to take upon itself the entire financing given the risks involved and the capital and consequent exposure constraints.

One of the recent trends in financing the infrastructure has been the Public-Private Partnership (PPP) model which is being actively pursued in India to meet the gaps in the provision of basic infrastructure services. However, for such partnerships to be successful, the framework of PPP including pricing has to be transparent. The development finance model has to be characterized by good planning, strong commitment of the parties, effective monitoring, regulation and enforcement by the government. A separate Ministry for Infrastructure Development could help immensely in channelising government’s efforts. The issue of pricing is crucial in view of the political sensitivities, while also simultaneously ensuring the viability of the project.

According to the industry experts, credit enhancement to infrastructure by way of risk transfer and risk reduction could help bridge the gap in the Indian context. Lenders tend to look for credit enhancement from government like policy guarantees, refinancing and


maturity extension guarantees, grants/viability gap funding, etc. Similarly, non-government mechanisms like bond insurance, credit rating, etc. provide risk mitigation to the lenders. Providing credit enhancement by way of insuring the debt payment by insurance companies to banks for the loans extended by them towards infrastructure projects is a concept considered in the North American infrastructure

Market. Besides this, the government can also offer various incentives such as issuance of Zero Coupon Bonds for infrastructure with income tax benefits to the individuals so as to increase their participation in infrastructure financing, thus helping India in development of its overall infrastructure. Active participation from the banks can also lead to a successful infrastructure finance market in India. It would ensure ample funding, strong interest, and awareness of a project on a global scale. Managerial incentives could be more aligned with productivity, thus reducing the widespread problems of cost overruns and inefficiency.

CONCLUSION

In India, Infrastructure finance market offers vast potential for growth as the development of sound infrastructure requires huge amounts of rupees to invest in. And, there has been found a large gap between the available funds to the required funds. Till now, it has been observed that traditional forms of government (or public) funding continue to dominate the infrastructure market. However, with the growing demand for infrastructure development, the proportion of public spending on infrastructure in the developed economies has been steadily falling. Government treasuries are being squeezed as they are geared-up close to breaking point, and taxes are at high levels.

Major conclusions of the study are:

• The active participation of private sector funds, banks, and insurance companies in funding the infrastructure projects will pave the growth of the infrastructure financing market in India.

• Since the government alone cannot provide sufficient funds, the private sector has to complement the government’s efforts in financing the development of infrastructure in India.

• The study vouches for the PPP model for infrastructure financing and the success of such models would require facilitating factors, such as, bureaucratic efficiency, adequacy of returns, efficient market mechanisms, information access, to name a few.

• The government should regulate the infrastructure financing in a way so as to ensure safety and security to the retail and corporate investors.

• Banks should also actively participate in providing finance. • There should be introduced some innovative means to channelise the individual

savings into infrastructure financing, such as offering income tax rebates, etc so as to bridge the required gap of many projects.


REFERENCES [1] D. Bain, “Economics of the Financial System Blackwell Publishing”, 1992. ISBN10: 0631181970 [2] Alberto Giovannini (Ed.)” Finance and Development: Issues and Experience”Cambridge University Press,

1993. ISBN10: 0521440173 [3] Bharti V.Pathak, The Indian Financial System (markets, institutions and services), Pearson Education, 2009,

ISBN 978–81–7758-562-9 [4] Ephraim Clark, Michel Levasseur, Patrick Rousseau, “International Finance” Thomson Learning, 1993.

ISBN10: 1861523823 [5] Franklin Allen, Douglas Gale “Understanding Financial Crises (Clarendon Lectures in Finance)”Oxford

University Press, 2007. ISBN10: 019925141X [6] Ferdinand E. Banks,’’ Global Finance and Financial Markets”World Scientific, 2001. ISBN10: 9810243278 [7] Graham Bird,’’ International Finance and the Developing Economies”Palgrave Macmillan, 2004. ISBN10:

0333733975 [8] Gabrielle Demange, Guy Laroque, “The Finance and the Economics of Uncertainty”, WileyBlackwell, 2005.

ISBN10: 140512139 [9] Henry A Davis “Infrastructure Finance: Trends and Techniques” ISBN: 978 1 84374 282 1 [10] J.C. Rochet,” Why Are There So Many Banking Crises? The Politics and Policy of Bank Regulation”

Princeton University Press, 2008. ISBN10: 0691131465 [11] John R. Boatright (Ed.),’’ Ethics in Finance”Blackwell Publishers, 1999. ISBN10: 0631214275 [12] John Eatwell, Murray Milgate, Peter Newman (Eds.)” Finance”Palgrave Macmillan, 1989. ISBN10:

0333495357 [13] Keith Pilbeam,” International Finance”Palgrave Macmillan, 1998. ISBN10: 0333730976 [14] Keith Pilbeam,” Finance and Financial Markets”Palgrave Macmillan, 2005. ISBN10: 1403948356 [15] Kern Alexander, Rahul Dhumale, John Eatwell,’’Global Governance of Financial Systems: The International

Regulation of Systemic Risk (Finance and the Economy)”Oxford University Press Inc, USA, 2004. ISBN10: 0195166981

[16] L.M.Bhole, Jitendra Mahakud,”Financial Institutions and Markets” Tata McGraw-Hill Education Private Limited, New Delhi, 2009, ISBN-13987-0-07-008048-5

[17] Mohamed Ariff,’’ Liberalization and Growth in Asia: 21st Century Challenges”Edward Elgar Publishing, 2005. ISBN10: 1843767910

[18] M.Y.Khan, Indian Financial System, Tata McGraw Hill, 2009, ISBN-13–978–0–07–008049–2 [19] Mario I. Blejer, Zvi Eckstein, Zvi Hercowitz, Leonardo Leiderman (Eds.), “Financial Factors in Economic

Stabilization and Growth Cambridge University Press”, 1996. ISBN10: 0521480507 [20] P.N.Varshney, Indian Financial System, Sultan Chand & Company, 2009, ISBN 978–81–8054–625–9 [21] Pierre-Richard Agénor, Marcus Miller, David Vines, Axel Weber (Eds.),”The Asian Financial Crisis: Causes,

Contagion and Consequences (Global Economic Institutions)”Cambridge University Press, 2006. ISBN10: 0521029007

[22] Roy Bailey, “The Economics of Financial Markets”, Cambridge University Press, 2005. ISBN10: 0521612802

[23] Robert J. Shiller,’’ The New Financial Order: Risk in the 21st Century”Princeton University Press, 2004. ISBN10: 0691120110

[24] Roy E. Allen,’’ The Political Economy of Financial Crises” Edward Elgar Publishing, 2004. ISBN10: 1843761068

Track 7 Mergers and Acquisitions

SEBI Take Over Code 2010: Assessment and Emerging Issues

C. S. Balasubramaniam* Abstract— Mergers and Acquisitions promote inorganic growth of a business enterprise that can help it to grow faster than the organic route for asset creation. The New Take over Code recommended by Takeover Regulations Advisory Committee (TRAC) headed by Shri Achutan has made a paradigm shift towards international best practices are evident from a number of proposed changes . However, it is also felt that it has not fully taken account of certain ‘tropicalities’ and so may not automatically translate into a more efficient market for corporate control and greater room within the rules of fair play for all stakeholders.

Part I spells out the types of corporate takeovers and benefits of a Takeover Code to the economy. Part II brings out the need for a new takeover code and the Composition of the Takeover Advisory Reforms Committee (TRAC) headed by Shri Achutan . Part III discusses the main recommendations and the comments /suggestions arising from the TRAC Report. The new Takeover code 2010 heralds a refreshing era for the corporates for whom the main drivers of change would be in the form of “VET” – which means takeovers constantly involve scanning the business landscape by the acquirers keeping in mind Valuations, Efficiency and speed in implementation and Transparency in disclosures and information provided to the regulator SEBI and stakeholders alike. The Indian corporate legal system needs to change significantly in consonance with the pace of events in corporate takeover scenario.

INTRODUCTION

Mergers and Acquisitions promote inorganic growth of a business enterprise that can help it to grow faster than the organic route for asset creation. The New Take over Code recommended by Takeover Regulations Advisory Committee (TRAC) headed by Shri Achutan has made a paradigm shift towards international best practices are evident from a number of proposed changes . However, it is also felt that it has not fully taken account of certain ‘tropicalities’ and so may not automatically translate into a more efficient market for corporate control and greater room within the rules of fair play for all stakeholders. Here it has been attempted to assess the main revisions in the New Take over Code and bring out the emerging issues for further discussion.

The objectives of a Take over

The Take over assumes significance from corporate management as well as macro economic aspects. In a take over, the management of the acquirer may maintain the legal identity of both the companies and operate them under the direction of separate Boards of Directors (having common directors) or the management may decide that both the companies should merge or amalgamate in a new company or one may amalgamate or merge with the other so that there is only one company, either the new company or the merged or the amalgamated

*Allana Institute of Management Studies, Mumbai


company functioning under a unified command of a single Board of Directors. In either case, the object of a successful take over should be economic betterment of the shareholders, the management, staff and all other employees’ suppliers of raw materials and other consumables, personnel engaged in the marketing network, the ultimate consumer, the public at large and the Government. Besides being advantageous to the concerned companies, takeovers are also beneficial to the economy in a number of ways.

• Disciplining the capital market: Takeovers help in disciplining the market as inefficient and errant companies get taken over due to their low book value and share prices. This also helps in discovering the potential of the acquired companies.

• Consolidation of efforts & capacities: During the license era, Government authorised units to function below their minimum economic size .Such units were either incurring losses or earning marginal profits. Also, due to stringent control standards and emergence of MNCs, small units have realized the importance of conservation of resources &reduction of costs. However, due to lack of proper infrastructure and sufficient capacity they are unable to implement their schemes efficiently. Under such circumstances, takeovers can be effective mode for consolidation & efficiency

In the past, due to the restrictive licensing policies, large companies were not allowed to grow and diversify. Rigorous MRTP posed serious obstacles. Recent liberalization environment and FDI amendments have encouraged companies to concentrate on their core competencies. M&A or takeovers offer greener pastures and through these strategies, companies can rationalise their portfolios and enlarge entity value &leverages.

Having discussed the pre liberalization scenario, now it is apt to bring out the kinds and modes of takeover:

SEBI Take Over Code 2010: Assessment and Emerging Issues 339

KINDS OF TAKE OVER

• Friendly takeover: The Bidding Company approaches the directors of the other company to discuss &agree an offer before proposing it to the shareholders of that company. The bidding company will also have the right to look at their accounts &complete due diligence.

• Hostile Takeover: The acquirer makes a direct offer to shareholders of a company, without the prior consent of promoter and/mgmt.In India, hostile takeovers are very few in comparison to what one sees abroad. It is mainly because promoter shareholding in India is quite high and the likelihood of financial institutions supporting the current management is also high.

• Bailout takeover: a financially sick company by a financially rich company as per Sick Industrial Companies (Special Provisions) Act, 1985 (SICA) to bail out the former from losses.

• Reverse Takeover: When a private unlisted company buys a listed company as a means of acquiring public status without having to list itself.

• Horizontal takeover of one company by another company in the same industry. The main objective behind this takeover is achieving the economies of scale or enhancing the market share .e.g., the take over of Hutch by Vodafone.

• Vertical takeover by one company by its suppliers /customers, the former becoming a backward integration and the latter becoming a forward integration.e.g.,the take over of Sona Steerings by Maruti Udyog Ltd. is a backward take over caused by reduction in costs .

• Conglomerate Takeover of one company by another company engaged in totally different industries with the purposes of diversification, growth and improvement in profits.

MODES OF TAKEOVERS

A takeover can take place in many ways. Some important ones are:

• Staged Acquisition: Staged Acquisition occurs in several stages with foreign investor initially acquiring only an equity stake, and gradually increasing their equity stake to 100 %...Staged acquisitions allow continued involvement of previous owners where they are unwilling to sell outright, or favoured to maintain legitimacy with local consumers. The major drawbacks of this mode of takeovers are (a) shared control being a source of conflict and (b) uncertainty over conditions of eventual take over.

• Multiple Acquisitions: This mode of acquisitions involves entry by acquiring several independent businesses, and subsequently integrating them. Through multiple acquisitions global players can build a nationwide strong market position in a traditionally fragmented market.

• Indirect Acquisition: This mode of acquisition occurs outside the local market of a company that also owns an affiliate in the same emerging economy. The main objective of the indirect acquisition may be outside the country. The affiliate may be a strategic asset motivating the acquisition, but this is rare. However, locally the local affiliate may or may not with the existing local operations.


• Brownfield Acquisition: A Brownfield acquisition is one in which the foreign investor subsequently invests more resources in the operations .such that it almost resembles a Greenfield project. Brownfield acquisitions provide access to crucial local assets under control of local firms that are in many other ways not competitive. The major drawback in this form of acquisition is the post acquisition investments may exceed the price originally paid for the acquired firm.

The terms ’takeover ‘and ‘merger’ though used in common parlance as synonymous they are not the same. A merger involves the mutual decision of two companies to combine and become one entity; it can be seen as a decision made by two equals .The combined business, through structural and operational advantages secured by the merger, can result in reduction of costs and increase profits, enhancing values for both groups of shareholders. A typical merger, in other words, involves two relatively equal companies, which combine to become one legal entity with the goal of producing a company that is worth more than the sum of its parts. In a merger of two corporations, the shareholders usually have their shares in the old company exchanged for equal number of shares in the merged entity. The takeover, on the other hand, is characterized by the purchase of a smaller company by a much a larger one. This combination of “unequals” can produce the same benefits as a merger, but it does not necessarily have to be a mutual decision. A larger company can initiate a hostile takeover of a smaller firm, which essentially amounts to buying the company in the face of resistance from the smaller company’s management. Unlike in a merger, in a takeover, the acquiring firm usually offers a cash price per share to the target firm’s shareholders on the basis of a specified swap ratio.

The Changes in the Scenario and the Rationale

SEBI introduced a formal takeover code in 1997, which helped set basic rules for mergers and acquisitions in the nascent market scenario for such transactions. However, the rules left scope for interpretation leading to many disputes including Gujarat Ambuja Cements purchase of a near 15% in rival ACC. SEBI did a further review of the takeover code in 2002 when it made greater disclosures at every level of holding mandatory and exempted preferential issues from the purview of the code. The company takeover code in India are set to get egalitarian and move closer to global best practices ,if the new take over code being framed now by the Committee headed by Shri Achutan gets implemented.

The basic theme of the SEBI Takeover code 2010 is to provide fair play and transparency in acquisitions and takeovers but at the same time to ensure they are not stifled into extinction. The fair play is provided in terms of stipulation of a public offer to be made whenever there is a substantial acquisition or takeover so that the other shareholders get an equal exit route as well. The transparency is sought to be brought in through mandatory disclosures and guidelines on the conduct of the public offers. These recommendations, if implemented, will replace an archaic takeover rule that was amended 23 times in 13 years and created more confusion than clarifying the regulatory status of the law and SEBI. Average annual takeovers rose to 99 between 2006 and 2009, from an average of 69 a year between 1997 and 2005. The increasing sophistication of the takeover market in India along with rise


in the interest of foreign players /MNCs in the takeovers in India .The decade long regulatory experience and various judicial pronouncements have also made it necessary to bring in a new take over code that would create a seamless changeover from the existing takeover code to the new scenario. The reforms in the corporate debt markets and rise in the number of Private equity players have further heralded the context of the new takeover code. Other factors that have compelled the revision in the code include the changes in the threshold level, pricing norm and public offer.

The New Take over Code 2010

Now, we may discuss the Takeover Regulations Advisory Committee (TRAC) and its main recommendations. The composition of the Committee is as follows:

• Mr. C. Achuthan, Former Presiding Officer, Securities Appellate Tribunal –Chairman.

• Mr. Kumar Desai, Advocate, High Court. • Mr. Somasekhar Sundaresan, Advocate; Partner, J. Sagar Associates. • Mr. Y.M. Deosthalee, Group Chief Financial Officer, Larsen and Toubro Ltd. • Mr. Koushik Chatterjee, Group Chief Financial Officer, Tata Steel Ltd. • Mr. A.K. Narayanan, President, Tamil Nadu Investors‘Association. • Prof N. Venkiteswaran, Professor, Indian Institute of Management, Ahmedabad. • Ms. Usha Narayanan, Executive Director, Corporation Finance Department, • SEBI. • Mr. J. Ranganayakulu, Director, Legal Department, SEBI, and • Ms. Neelam Bhardwaj, General Manager, Division of Corporate Restructuring, SEBI

Main Recommendations of the TRAC are as Given as Under Along with Comments

• New threshold of 25 % suggested by the Achutan Panel wields the power to stop special resolutions and acquires negative control : The initial trigger has been raised from 15% to 25% based on two counts, (1)a factual assessment of current shareholding patterns of listed companies which reveal that ‘promoters’ are capable of exercising de facto control at 25 %and (2) a shareholder holding in excess of 25% has the ability to block special resolutions .Promoters may however be concerned by the mischief that may be caused by the ‘predators’ holding just less than 25% who may exercise significant voting rights on account of the multiplier effect caused by the absenteeism at general meetings.

• De facto control as the primary trigger has also been hardwired into the definition of control, which is referenced not just against the ‘right’ but also the ‘ability’ to control .As a result, the control trigger continues to be an elusive and subjective determination in each case. The objectivity of control as a positive determination put forth by the Securities Appellate Tribunal (SAT) in the “Shubhkam” case –currently in appeal before the Supreme Court –has sadly not found favour with the Committee. There is however no longer a concept of ‘greater control’ and ‘joint-to-sole’ control has ceased to be a trigger.


• Rise in quality of corporate governance and disclosures are considered to be in line with global best practices and would help in overall administration by SEBI over the capital market. In terms of continuous disclosures, perhaps the most significant point is the parity that it restores between a potential acquirer and the target company. A potential acquirer makes its intentions known though public announcements, but the shareholders of the target company get no information from their own Board as to the future course of action. The draft makes the Board of the target company accountable for making (and publishing) a recommendation to all stakeholders on the offer. That is, the Board should recommend either taking up the offer or dropping it, with adequate background justification. This parity is line with international best practices and will help shareholders to decide. It is hoped that independent directors will exercise jurisprudence with respect to some loose ends, such as the appointment of conflict free advisers. The Board could have taken this step further to include a mechanism for potential bidders to conduct due –diligence thereby leveling the potential information advantage with the target company’s Board.

• One item that will be debated for log time is the proposal to increase the trigger level for open offers from the current 15% to 25%. Segments of corporate (especially those with small promoters’ holdings) will no doubt baulk at the idea, as it increases the risk of hostile acquirers. But such is the reality that PE and other large investors will have to plan to hold larger stakes in companies, even if they do not have any acquisition plans. But before this clause turns into an unbridled license for incumbent promoters to poison-pill their companies, as extreme defensive action, perhaps the New Code could set indicators or markers to flag inappropriate corporate behavior which defeats the central idea of promoting good corporate governance.

• In a similar vein, the Code recommends that the offer size should be hiked from the current level of “a minimum 20 %” to all the shares of the target company, subject to the aggregate shareholding not exceeding the maximum permissible non-public shareholding. Though this raises the financing obligations of the potential acquirer and could potentially come in the way of the corporate M&As, it provides a fair mechanism for all shareholders to exit.

• At this point, the lack of a “squeeze out “provision becomes glaring. According to clause 7 (4) ,if the bidder acquires 90 % or more though the open offer ,the outstanding public investors have a put option on the bidder for one year post the open offer. But the bidder cannot squeeze out remaining shareholders. This is a somewhat unequal clause and makes capital markets route relatively unattractive for corporate transactions. Potential bidders and the target may seek off- market mechanisms, such as the sale of business operations, to the same end. However, regulatory changes to affect a squeeze out are beyond the purview of SEBI and would require changes in legislation.

• Given that SEBI and Stock exchanges places a great reliance on timely information flows to iron out arbitrage opportunities ,it seems odd why the draft recommendations of the Takeover code has not put forth a mechanism for forcing bidders/ target to make a public announcements of impending discussions ,in the event of abnormal


share price movements. In the UK, for instance, any price movement of more than 5% requires target/ bidder to voluntarily inform the regulator. The regulator then judges if the price movement is on account of normal market movements or if market participants are potentially trading on unequal information creating a “false market “.

• In the context of asset stripping in the last few years, the Code states that the acquirer shall not dispose assets of the target company within a period of 2 years, unless the intention has been stated in the offer letter. This can logically be extended to areas beyond ‘alienation of assets’. Disclosures on strategic intent should go beyond asset disposals and also cover intent in relation to strategy, employees, facilities ( owned or leased) key contracts,etc.,Basically the Code could incorporate a framework in which the shareholders of the target company should get access to the acquirer’s intenton,before they evaluate an open offer.

• A separate regime for voluntary offers –consolidation offers by controlling shareholders .In case of unsolicited /hostile offer by a new acquirer does not seem to be permissible. This is not justifiable is that an unsolicited/hostile offer by a new acquirer doesn’t hold water. Mandatory exit to all (100 %) shareholders as against the current norm of 20% is a laudable move from shareholders perspective, though not investor friendly However ,public mergers and acquisitions will become more expensive and thereby deter takeovers Mandatory open offer for 100% of outstanding shares and provision for automatic delisting is a positive step .The existing procedures which forces the acquirers to effectively make two open offers –one for control and the second for delisting was too cumbersome. A combination of Indian rules against financial assistance by the target company and limitations on acquisition financing by banks results in the creation of an unequal playing field between Indian & foreign players . Non cash payment option though available under the current code has not found favor with Indian corporate .Some stream lining here would be appropriate.

• The new Code’s definition of ‘control ‘also needs to be tightened up significantly .It defines ‘control’ as either” the ability to appoint majority of directors “or “the ability to control the management or policy decisions “. This undermines two scenarios .First is a situation of private equity investor with affirmative rights –since by the definition of the Committee such investors would be deemed to be in control. Second is the scenario where the existing management may control 25% or less –something that is true of several of India’s largest and most valuable companies .Under these circumstances, hypothetically speaking, if someone was to acquire 24% of the company’s shares, that investor would wield dominant influence on “management or policy decisions “.Yet the current recommendations would not trigger the takeover code.

• A seamless “go private “ has been made available to the new acquirers who buy out more than 90 % in an offer –a route has not been extended to promoters holding above 25 %. Promoters have to necessarily initiate delisting procedures which may become expensive due to higher price offers through reverse book building route ,requisite approvals under SEBI procedures stock exchanges and Company Law Board


The pricing norm revisions would ensure that minority shareholders of the target company would not be cheated out of the price obtained by strategic shareholders Open offer obligation – Initial trigger of an aggregate of 25 % or more voting rights in a target company would be required to make an open offer by the acquirer from the present 15%. The trigger for mandatory offer in the UK and Singapore is 30 %. To consider Creeping Acquisition trigger, an acquirer holding 25 % or more in a target company is allowed to acquire additional voting rights in the target company up to 5 % within a financial year, without making an open offer.

Indirect acquisitions – Acquisition of shares or voting rights in, or control over any entity that would enable the acquirer to exercise or direct the exercise of such percentage voting rights in, or control over the target company, as would attract the obligation to make an open offer would be regarded as an indirect acquisition, requiring the acquirer to make an open offer. If the indirectly acquired target company is a predominant part of the business entity being acquired, the Proposed Takeover Regulations would treat such indirect acquisition as a direct acquisition for all purposes.

Voluntary open offer –Shareholders holding shares entitling them to exercise 25 per cent or more of the voting rights in the target company may without breaching minimum public shareholding requirements under the listing agreement, voluntarily make an open offer to consolidate their shareholding. The impact of these recommendations would be to raise the cost of acquisitions substantially and only the serious bidders would go for the buyouts. While the proposed code regulations are aimed at creating a level playing field , the number of acquisitions would reduce ,given the buyers may have to invest at least double of what they have to with the Current regulations . Private equity firms would be placed better with the proposed code as they allow them to take a higher stake without having to make an open offer. The recommendations further raise a pointer towards the haziness in extant regulations such as the gap between the minimum public holding threshold for a listed company (75%) and the delisting threshold (90%).

• The efficiency drivers are largely dependent upon the buy-in by other regulators, in particular in relation to bank financing of take over and the treatment of shares tendered in an open offer as an ‘on-market’ transaction for tax purposes .Foreign direct investment (FDI) rules may need to be amended to include swaps under the automatic route. Speedy adoption of the new code would raise the overall efficiency levels of the implementation process for corporate takeovers and mergers. Promoters with low holdings may be forced to raise stakes to pre-empt hostile takeovers

• Minority shareholders will be able to exit fully if the Acquirer cannot acquire shares in target firm for 26 weeks following completion of open offer. This will prevent acquirers from under pricing offers and later buying shares from secondary market. Equal tax treatment on gains due to sale of shares through open offer as well as those sold in the open market would encourage more people to tender shares in open offer Acquirer to accept shares in open offer proportionately, if response exceeds maximum permissible promoter shareholding of 75%, but fails short of delisting threshold of 90%, could affect and dampen the complete acceptance of their shares in


open offer. However Indian businesses have become keen to sell their stakes cashing on the recent boom in stock market .Open offer formalities need to be completed within 57 days instead of 95 days as allowed currently will help in reducing unnecessary delays.

• The new code ensures justice to minority shareholders in the form of the mandatory offer of 100% of outstanding offer of shares has to be the same for all shareholders. Proposed changes would facilitate PE funded promoters/foreign acquirers as they have access to leveraged finance abroad/tax havens at a lower cost than that prevailing in Indian capital market . A combination of PE players or qualified institutional promoters (QIP), acting as concerted minority shareholders can now help in improving corporate governance of listed companies in India. The proposed changes in Takeover code provide a legal framework for orderly acquisition of shares and control and .provides for equitable treatment to all shareholders.

• The new Code facilitates leveraged buyouts and making the financing of takeovers easier and convenient to corporate rather than facing difficulties in implementing expansion/diversification strategies...Further the new take over code would facilitate strategic alliances and minority investments that can be equity accounted, and promote greater ownership from private equity investors. These changes will help acquisitions by making it simpler to acquire control and delist in one simple step.

• To conclude, the new Takeover code 2010 heralds a refreshing era for the corporates for whom the main drivers of change would be in the form of “VET” – which means takeovers constantly involve scanning the business landscape by the acquirers keeping in mind Valuations, Efficiency and speed in implementation and Transparency in disclosures and information provided to the regulator SEBI and stakeholders alike. The Indian corporate legal system needs to change significantly in consonance with the pace of events in corporate takeover scenario.

REFERENCES [1] Report of the Takeover Regulations Advisory Committee under the chairmanship of Mr. C.Achutan,

SEBI (2010) [2] Dr. Bhagaban Das, Dr. Debdas Rakshit & Dr. Sathyaswaroop Debashish: Mergers Acquisitions and

Corporate Restructuring, Himalaya Publishing House, 2010 [3] Dr. Kamal Ghosh Ray: Mergers and Acquisitions, PHI Learning (P) Ltd.2010 [4] Several articles, comments and editorials in Economic Times, Financial Express and other business dailies.

Changing Dynamics of Management in Mergers and Acquisitions through

Innovation and Creativity

Mohammad Murtuja* Abstract–With rapidly changing business forces over the past few years, the only way for companies or the corporate houses to survive in the long run in the intensely competitive world market is to think beyond its competitors. As a result of which they will have to differentiate themselves on the basis of innovation and creativity in their business or else in the long run they will be forced to shut down its business. One of the ways is to consolidate through Mergers and Acquisitions or to restructure and reorganize business operations.

It will focus on why the companies go for merger and acquisitions? Are the Mergers and Acquisitions able to meet their anticipated purpose? It will also focus on how the significant percentages of Mergers and Acquisitions destroy profitability and shareholder value. It will also focus on that if the people side of Mergers and Acquisitions and the integration of different cultures are ignored, the merging companies could face many difficulties, including, ultimately not meeting the anticipated purpose of the transaction.

INTRODUCTION

Growth is always essential for the survival of a business concern. A concern is bound to die if it does not try to enlarge its related activities. Mergers may prove to be beneficial depending on the strategies adopted, but it would not be right to say that all mergers have been successful. The process of mergers and acquisitions has gained substantial importance in today's corporate world. This process is extensively used for restructuring the business organizations. Mergers and acquisitions are prevalent in India right from the post independence period. But Government policies of balanced economic development and to restrain the concentration of economic power through introduction of Industrial Development and Regulation Act-1951, MRTP Act, FERA Act etc. made these actions almost impracticable and a very few mergers and acquisitions took place in India prior to 90s. But the economy liberalization in 1991 had exposed the corporate sector to severe domestic and global competition, which was further emphasized by the reversionary trends, resulted in diminishing demand, which in return result to overcapacity in some sectors of the economy. So companies started to combine themselves in areas of their core competence and strip from that business where they do not have any competitive advantage. It led to an era of corporate reformation through Mergers and Acquisitions in India.

In India, the concept of mergers and acquisitions was initiated by the government bodies. The Indian economic reform since 1991 has opened up a whole lot of challenges and

*ICFAI University, Jharkhand

Changing Dynamics of Management in Mergers and Acquisitions Through Innovation and Creativity 347

opportunities both in the domestic and international spheres. The increased competition in the global market has prompted the Indian companies to go for mergers and acquisitions as an important strategic choice. The trends of mergers and acquisitions in India have changed over the years.

Mergers and Acquisitions is very imperative tools for corporate to grow. A firm can achieve growth in several ways such as internally or externally. Internal Growth can be achieved if a firm expands its existing activities by upscaling capacities or establishing new firm with fresh investments in existing product markets. However if a firm wants to grow internally it can face certain problems like the size of the existing market may be limited or the existing product may not have enough growth potential in the near future or there may be government restriction on capacity enrichment, they may not have specialized knowledge to enter in to new product/ market and beyond all it takes a longer time to establish own units and capitulate positive return. One alternative way to achieve growth is resort to external arrangements like Mergers and Acquisitions, Takeover or Joint Ventures. External alternatives of corporate growth have convinced advantages. For example a particular company is very good at administration while some other company may be good at marketing strategies or in operations. So if the expertise of both is combined it produces synergy. A new company is shaped in the process, which has a much higher potential and superior to what the individual companies previously had. By apply pertaining the rules of synergy efficiently a merger can be made a success. Several other reasons for mergers are as follows:

• Enhancing company productivity. There is also a common tendency that the merged companies would monopolize the market, thereby expelling others.

• Cutting down expenses and increasing revenues. • When a company is not self sufficient to operate on its own the subsidiaries may

merge with the parent company for better output. Obstacle may be in the form of insufficient investment capacity, excessive competition due to which the company is not able to keep pace with other companies.

• Political factors. • Tax purposes.

Corporate mergers and acquisitions have a great impact on the industry and economy of any country. These events restructure the industry and influence the country's economy as a whole. Corporate mergers and acquisitions also increase the market competition and also work as ‘engines of growth’. Corporate mergers and acquisitions involve skill transfer and other sharing activities.

Among the various Indian sectors that have resorted to mergers and acquisitions in recent times, telecom, finance, FMCG, banking, automobile and steel industry are worth mentioning. With the increasing number of Indian companies opting, India is now one of the leading nations in the world in terms of mergers and acquisitions. Sectors like pharmaceuticals, IT, ITES, telecommunications, steel, construction, etc, have proved their worth in the international scenario and the rising participation of Indian firms in signing mergers and acquisitions deals has further triggered the acquisition activities in India.


OBJECTIVE

It has been proven theoretically that Mergers and Acquisitions used to improve the performance of the company because of Synergy effect, increased market power, operational economy, financial economy, economies of scales etc. But does it really improve the performance in short run as well as long run? Various studies have previously been done on this matter but related to European countries or US countries. I have not come across with any of such study in Indian context. So I am just trying to have an analysis why the Indian Companies goes for mergers and acquisitions and the impact of mergers and acquisitions on the performance of the companies in Indian context with reference to banking sector?

HISTORY OF MERGERS AND ACQUISTIONS

Most of the mergers and acquisitions are an outcome of the favorable economic factors like the macroeconomic setting, boom in the GDP, higher interest rates and fiscal policies. These factors not only setoff the mergers and acquisitions process but also play an active role in laying the mergers and acquisition strategies between bidding and target firms. The history of mergers and acquisitions can be traced back to the 19th century which has evolved in different phases mentioned as under:

• From 1897 – 1904: During this period merger took place between the firms which were anti-competition and enjoyed their dominance in the market according to their productivity in sectors like electricity, railways, etc. Most of the mergers during this period were horizontal in nature and occurred between the steel, metal and construction industries.

• From 1903 – 1905: Most of the mergers which took place during the first phase were proven as unsuccessful for not being capable enough of attaining the required competence. The crash was stimulated by the slowdown of the world's financial system in 1903, which was further followed by a stock market collapse in 1904. Later the apex judiciary body issued its directive on the anti-competitive mergers stating that they could be de-merged by implementing the Sherman Act.

• From 1916 – 1940: This period concentrated on mergers between oligopolies, rather between anti-competitive firms which was triggered by the financial boom as seen after the World War I. The expansion further lead to developments in the fields of science and technology and the emergence of infrastructure firms which provided services for required growth in railroads and transportation by automobiles. Financial institutions like government and private banks also played a significant part in aiding the mergers and acquisitions process. The mergers which occurred during 1916-1929 were horizontal or multinational in nature. Most of these industries were the manufacturers of metals, automobile tools, food commodities, chemicals, etc. This phase ended in 1929 with a massive decline in stock market followed by great depression. However, the tax exemptions in 1940s encouraged the conglomerates to involve themselves in mergers and acquisitions activities.


• From 1965 – 1970: Most of the mergers from 1965-70 were horizontal mergers and were triggered by elevating stock and interest rates. During this phase the bidding companies were small in size and fiscal strength than the target companies. These kinds of mergers were sponsored by equities, thereby eliminating the roles of banks which they actively played in investment activities earlier. Some of them were INCO merging with ESB, OTIS Elevator with United Technologies and Colt Industries with Garlock Industries.

• From 1981 – 1989: This phase saw the acquisition of the companies which were much bigger in size as compared to the firms in previous phases. Industries like oil and gas, pharmaceuticals, banking, aviation combined their business with their national and international counterparts. Cross border buyouts became regular with most of them being unfriendly in nature. This phase came to an end with the introduction of anti acquisition laws, restructuring of fiscal organizations and the Gulf War.

• From 1992 till present: This period was stimulated by globalization, rise in stock market boom and deregulation policies. Major mergers were seen taking place between telecom and banking giants out of which most were sponsored by equities. There was a change in the attitude of the industrialists, who opted for mergers and acquisitions for long term profitability rather than short lived benefits. Promising economic trends, investments by corporate and revised government policies provoked the participation of many company to contribute in the acquisition trend. Therefore, we can conclude that as long as business entities exist and the economic factors are encouraging the trend of mergers and acquisitions will continue.

Seven Biggest Mergers and Acquistions in India

• Tata Steel acquired 100% stake in Corus Group on January 30, 2007. It was an all cash deal which cumulatively amounted to $12.2 billion.

• Vodafone purchased administering interest of 67% owned by Hutch-Essar for a total worth of $11.1 billion on February 11, 2007.

• India Aluminium and copper giant Hindalco Industries purchased Canada-based firm Novelis Inc in February 2007. The total worth of the deal was $6-billion.

• Indian pharma industry registered its first biggest in 2008 M&A deal through the acquisition of Japanese pharmaceutical company Daiichi Sankyo by Indian major Ranbaxy for $4.5 billion.

• The Oil and Natural Gas Corp purchased Imperial Energy Plc in January 2009. The deal amounted to $2.8 billion and was considered as one of the biggest takeovers after 96.8% of London based companies' shareholders acknowledged the buyout proposal.

• In November 2008 NTT DoCoMo, the Japan based telecom firm acquired 26% stake in Tata Teleservices for USD 2.7 billion.

• India's financial industry saw the merging of two prominent banks - HDFC Bank and Centurion Bank of Punjab. The deal took place in February 2008 for $2.4 billion.


BENEFITS OF MERGERS AND ACQUISITIONS

The primary benefits from mergers and acquisitions can be listed as increased value generation, increase in cost efficiency through economies of scale and increase in market share which force the companies to enter into these deals. It can also generate tax gains, can increase revenue and can reduce the cost of capital.

The main benefits of Mergers and Acquisitions are the following:

• Mergers and Acquisitions can lead to an increased value generation for the company. It is expected that the shareholder value of a firm after mergers or acquisitions would be greater than the sum of the shareholder values of the parent companies.

• Merger & Acquisition can also lead to tax gains and can even lead to a revenue enhancement through market share gain

• Mergers and Acquisitions can prove to be really beneficial to the companies when they are weathering through the tough times. If the company which is suffering from various problems in the market and is not able to overcome the difficulties, it can go for an acquisition deal. If a company, which has a strong market presence, buys out the weak firm, then a more competitive and cost efficient company can be generated. In this case the target company benefits as it gets out of the difficult situation as a result of which they agree to be acquired by the large firms.

• When two companies come together by merger or acquisition, the joint company benefits in terms of cost efficiency. A merger or acquisition is able to create economies of scale which in result generates cost efficiency. As the two firms form a new and bigger company, the production is done on a much larger scale and when the output production increases, the cost of production per unit of output gets reduced.

IMPACT OF MERGERS AND ACQUISITIONS

As mergers and acquisitions may be fruitful in some cases, the impact of mergers and acquisitions on various division of the company may differ. Mergers and acquisitions are aimed at improving profits and productivity of a company. However, mergers and acquisitions are not always successful. At times, the main goal for which the process has taken place loses focus. The success of mergers or acquisitions is determined by a number of factors. Those mergers and acquisitions, which are opposed not only affects the entire work force in that organization but also harm the credibility of the company. In the process, in addition to deviating from the actual aim, psychological impacts are also involved. Studies have revealed that mergers and acquisitions affect the senior executives, labor force and the shareholders in the followings manner:

• Impact of Mergers and Acquisitions on workers or employees: the consequences of mergers and acquisitions impact the employees or the workers the most. It is a well known fact that whenever there is a merger or an acquisition, there are bound to be layoffs. In the event when a new resulting company is efficient business wise, it would require less number of people to perform the same task. Under such


circumstances, the company would attempt to downsize the labor force. It is usually seen that the employees those who are being laid off may not have a significant role under the new organizational set up which accounts for their removal. Even though this may not lead to drastic unemployment levels, yet the workers will have to compromise for the same. If not drastically, the mild wave shaped in the local economy cannot be ignored entirely.

• Impact of mergers and acquisitions on top level management: Impact of mergers and acquisitions on top level management may involve a "clash of the egos". There might be disparity in the cultures of the two organizations. Under the new set up the manager may be asked to implement such policies or strategies, which may not be quite accepted by him. When such a situation arises, the main focus of the organization gets diverted and executives become busy either settling matters among themselves or moving on.

• Impact of mergers and acquisitions on shareholders: We can further classify the shareholders into two parts:

o The Shareholders of the acquiring firm o The shareholders of the target firm. o Shareholders of the acquired firm: The shareholders of the acquired company

benefit the most. The reason being, it is seen in majority of the cases that the acquiring company usually pays a little excess price than what it is prevailing in the market. Buying a company at a higher price can actually prove to be beneficial for the local economy.

o Shareholders of the acquiring firm: They are most affected parties. If we measure the benefits enjoyed by the shareholders of the acquired company in degrees, the degree to which they were benefited, by the same degree, these shareholders are harmed. This can be attributed to debt load, which accompanies an acquisition.

REASONS FOR FAILURE OF MERGERS AND ACQUISITIONS

Despite the highest degree of strategy and planning and investments of hundreds of crores, the majority of the mergers and acquisitions cannot create a value and fail miserably. In 1987, the professor of Harvard, Michael Porter found that around 50% to 60% of the mergers and acquisitions ended in a failure. In 2004, McKinsey also found that only 23% acquisitions ended in a positive note on investment. Many company look mergers and acquisitions as the solution to their problems. Before an organization goes for mergers and acquisitions, it needs to consider a lot such as the parties, viz. buyer and seller need to do proper research and analysis before going for mergers and acquisitions. Following could be the reasons behind the failure of mergers and acquisitions:

• Cultural Difference: One of the major reasons behind the failure of mergers and acquisitions is the cultural difference between the two organizations. Most of the times it becomes very tough to mix the cultures of two different companies, who often have been the competitors. The mismatch of culture leads to deterring working environment, which in turn ensure the slump of the organization. When a company is


acquired, the decision is typically based on product or market synergies, but cultural differences are repeatedly ignored. It's a mistake to assume that personnel issues may be easily overcome. As the human beings are the more valuable resources for any organization so they should not be ignored. For example, employees at a target company might be habituated to easy access to top management, flexible work schedules or even a relaxed dress code which may not seem to be significant, but if new management removes them, the result can be bitterness and reduction in productivity.

• Faulty Intention: faulty intentions time and again are becoming the main reason behind the failure of mergers and acquisitions. Companies often go for mergers and acquisitions getting influenced by the booming stock market prevailing which may be risky. Sometimes, organizations also go for mergers just to imitate others. Often the ego of the executive can become the cause of unsuccessful merger. Top executives often tend to go for mergers under the influence of bankers, lawyers and other advisers who earn immense fees from the clients. Mergers can also happen due to global fear. The situation like technological advancement or change in economic scenario can make an organization to go for a change. As a result of which they may end up by going for a merger. Due to mergers, managers often need to concentrate and invest time to the deal for which they often get unfocused from their work and start neglecting their core business. The employees may also get emotionally confused in the new environment after the merger. So their work gets hampered.

• As the study from McKinsey, a global consultancy states that companies often focus too keenly on cutting costs following mergers, while revenues and profits, suffer. Merging companies focus on integration and cost-cutting so much that they neglect their day-to-day business activities, thereby prompting anxious customers to flee. This loss of revenue momentum is one of the reasons that so many mergers fail to create value for shareholders.

MERGERS AND ACQUISTIONS OF BANKING SECTOR

• Centurion Bank of Punjab merged with HDFC Bank: Banking sources said that both banks have agreed to merge as it fits into their growth prospects. For around 25 shares of Re 1 of Centurion Bank of Punjab, an investor will get one share of Rs 10 of HDFC Bank. In last two days, share price of Centurion Bank of Punjab moved from Rs 49.85 on Wednesday to Rs 56.40 on Friday. However, it seems, investors of HDFC Bank did not like the development. The share price of HDFC Bank on Thursday moved up from Rs 1,534.50 to Rs 1,543. But on Friday, it fell sharply to Rs 1,475. Total branches of the combined entity will be around 1,100 in over 400 cities and towns. A senior bank official said the merger will help HDFC Bank to penetrate rural areas. The biggest plus of the merger is the number of branches it will add to HDFC Bank. Both of them have the similar management styles are as well as they both understand consumer and retail banking. They have been on a technology platform from day one, so no data-related legacy issues. Clear-cut synergies exist, and


one can expect that change-management issues will be tackle comprehensively. This merger is on the right track.

• "The challenge could be that Centurion Bank of Punjab has a workers' union innate from Lord Krishna Bank whereas HDFC Bank has always worked in a union-free environment and Centurion Bank of Punjab is more focused on low-cost operations and distributes more low-cost products while HDFC's products are more universal and sophisticated and higher up the value chain," continues Roy. "How well the Centurion Bank of Punjab team deal with HDFC products and union could be an area of challenge."

• IDBI Bank to merge IDBI Gilts with itself: IDBI Bank officially said that IDBI Gilts is a loss making subsidiary and it is tough for standalone Primary Dealers to survive. Allowing IDBI Gilts to carry on operations will mean investing extra capital at a time when other subsidiaries like insurance venture needs equity infusion. IDBI Gilts has reported losses for last two years. For 2009-10 its net loss was Rs 18.09 crore as against Rs 19.75 crore in 2008-09. Bank will take up existing staff working at IDBI Gilts

• United Western Bank (UWB) with Industrial Development Bank of India: Apart from synergies to the participating banks, it is likely to add value to the later in the long run. The merger is likely to help IDBI expand its retail presence, though its size may not increase substantially. There will be an outflow of Rs 150 crore which may appear inexpensive. But if one has to consider the hidden costs in the form of bad loans and the likely slippages in the quality of present assets, the effective cost is likely to climb by another Rs 100 crore. Considering IDBI's size, this may still be a small sum. Post-merger, its level of net non-performing assets is likely to increase to 1.4 per cent from about 1 per cent now. As such, managing and containing the level of bad loans remain a challenge for IDBI.

CHANGE MANAGEMENT IN MERGERS AND ACQUISITIONS Cultural One of the components of failure of Mergers and Acquisitions is organisational culture. Before a transaction is concluded it is important to measure the cultural compatibility of the merging firms. But this could not be done as such formal cultural assessment is usually not possible because the negotiations leading up to the merger have to be kept secret. This creates the risk and however, that the merging firms do not discover important differences until after they have committed themselves to the new organisation (Schein p.178).

To obtain true cultural insight, need both parties to take part in each other’s cultures. This can be done by sending employees into the other organisation for some time or by creating “dialogues between members of the two cultures that allow differing assumptions to surface. Success of a cultural change can be achieved by a well-designed plan of the management for such change. It has been found that companies with strong integration plans created above-average value in their industries and effective post-merger management policies were seen to improve the odds of success by as much as 50 percent (Research was done by Mercer


Management Consulting cited in Tetenbaum, 1999: 3). Just as critical as planning for the management of cultural change is the need for effective communication, in every stage of the merger process. Employee resistance to change can be a massive blockade towards the flourishing implementation of a merger or acquisition. Resistance is a normal part of the change process as change involves going from the known to unknown. Keeping communication channels open will avert nervousness from getting out of hand and providing clarity about expectations will reduce distrust or conflict.

Without group effort the process of culture integration may be drastically hampered. In the initial phase of the merger, teaming up to create cross-company task forces and project teams will help problem solving and ensure future collaboration (Kets de Vries, 1995: 47). In addition to that, commitment and patience are very essential. Just as a marriage “demands a lot of attention and commitment of resources” so does the merger of two often divergent cultures. Mergers and Acquisitions and the resultant changes to the organisational culture often require a collective change of mind but minds cannot be changed they can only be inspired through the right style of leadership (Laurent, cited in Evans, Doz, Laurent, 1989:87). Leaders must be able to communicate the vision of the change and its impact as widely and effectively as possible.

Employment Changes in the Banking Sector

The reformation process of European and global banking has fetched substantial changes in the nature and quality of employment. In short we can say that international experience and research noticed that the important quantitative and qualitative consequences of mergers and acquisitions in employment are:

• Reduction of less specialized categories. • Imperative changes in the role of senior staff towards more complex and more

flexible duties. • A relative increase in the employment of specialized and younger staff. Companies

are relieved of less specialized or/and older excess staff through early or voluntary retirement programs.

• Serious incorporation and compatibility problems among the various management systems, industrial relations and organization of work.

• Another fresh and common technique to reduce production costs in the banking sector is outsourcing, i.e. the decision to assign duties such as maintenance, security, cleaning, movement of titles, transfer of material or money etc. to an outside firm, as well as the development of different distance banking services, like tele banking, phone banking etc. (Kanellopoulos et. al., 1998). Customer service and various sales functions are performed today by call centers, where a great number of tasks are carried out by low skilled and poorly remunerated personnel and with almost no trade union activity.


CONCLUSION

Most large mergers and acquisitions fall short of achieving the desired synergies. In January 1999, The Economist reported that the study of past merger waves has shown that two of every three deals has not worked. According to a Merrill Lynch study in 2003, not only do most Mergers fail to deliver their promised value, but large deals have tended to perform worse than smaller ones. And at least 50% of major mergers since 1990 have eroded shareholder returns. Reasons for failed mergers are diverse and complex, but most can be attributed to losing something: critical people, customers, market confidence. Uncontrolled costs, hidden losses, unrealized benefits, avoiding decisions, cultural barriers etc.

It is generally accepted that through mergers and acquisitions banks manage to better utilize their total human and operational resources, aiming at maintaining and, most of all, expanding their market share, efficiently promoting new products, achieving better customer service, improving their staff operations and achieving capital reforming and raising. Furthermore, by growing their size, banks can benefit from utilizing those synergies that are necessary to develop within modern institutions, thus eliminating all disadvantages and bureaucratic barriers of large business establishments. However, all these positive consequences are not just the result of obtaining an ideal company size; they are mostly the outcome of insightful bank management teams that can define and achieve appropriate goals, while avoiding all wrong and inappropriate choices made in the past.

Despite the high failure rate, mergers and acquisitions that succeed can pay large dividends. HSBC’s 1992 entry into Europe, when it acquired Britain’s Midland Bank, is a good example. The successful restructuring resulted in a payback period of less than four years, and operating profits soared by more than 700%. HSBC’s success has been attributed to its pre acquisition understanding of Midland and a well-conceived and executed post-acquisition integration process, reflecting many of the critical success factors common to mergers and acquisitions. The most successful acquiring firms have clearly established and well-understood acquisition processes, both for ensuring good strategic decisions before the acquisition decision is made and for integrating the acquired firm once the deal is complete.

By going through this paper one can conclude that the mergers and acquisitions have failed to contribute positively in the performance of the company. It neither provides Economies of scale nor synergy effect. But still here I would like to add one thing that there are numerous objective that motivate a company to enter in to merger activities. Some times these motives are qualitative and cannot be interpreted in to quantitative figures. Again, a merger may be efficient to deliver the immediate objective but may be failed to deliver all the theoretically defined benefits. So, it will be misleading to assume, on the basis of this paper, that overall mergers do not contribute any thing to the companies and it is an ineffective and hopeless exercise. It would not be correct to say that all mergers and acquisitions fail. There are many examples of mergers that have boosted the performance of a company and addressed the well-being of its shareholders. The primary issue to focus on is how realistic the goals of the prospective merger are.


REFERENCES [1] A Capgemini Financial Services Point of view (2006), “Retail Banking Mergers and Acquisitions: Strategic

Choices” [2] BS Reporter / Mumbai September 10, 2010, 0:55 IST, “IDBI Bank to merge IDBI Gilts with itself” [3] India Knowledge@Wharton (March 06, 2008), “Are Bank Mergers in India Entering a New Era?” [4] John Mylonakis (2006), “The Impact of Banks’ Mergers & Acquisitions on their Staff Employment

& Effectiveness”, International Research Journal of Finance and Economics Issue 3 [5] K. Ramakrishnan (2006), “Mergers & acquisitions in India, the long-term post-merger performance of firms

and the strategic factors leading to M&A success” [6] Mahesh Kumar Tambi (2006), “Impact of Mergers and Amalgamations on the Performance of Indian

Companies.” [7] Sharma and Gupta, Principles and Practices of Management Accounting, Kalyani Publisher, 2006 Edition.

Mergers and Acquisitions in Indian Corporate Companies—

A Special Reference to Telecom Sector

F.B.A. Hanfy* and S. Ramesh* Abstract— Mergers and Acquisitions are strategic tools in the hands of management to

achieve greater efficiency by exploiting synergies and growth opportunities. Mergers are motivated by desire to grow inorganically at a fast pace, quickly grab market share and achieve economies of scale. India is now one of the leading nations in the world in terms of mergers and acquisitions. Merger and Acquisitions in the Indian telecom industry have been driven by a few important factors like the inclusion of internet and the cable services in the telecom sector , new technologies like wireless fixed phone services and De-regulation in the telecom sector.

The paper explores the various mergers and Acquisitions in the Indian Telecom sector and puts forward the various reasons for merger in the Indian Telecom sector.

The paper concludes on the note that the Indian telecom space is picking up quickly because of the fact that on one hand domestic players are looking at foreign money to fund expansion plans and on the other international operators are exploring ways to move into emerging markets with their home market reaching saturation.

INTRODUCTION

Merger and acquisition are two terms already identified as one in the business world. Merger and acquisition refers to the combining of separate companies or entities. Merger and acquisitions is a form of a change in ownership and management done through buying and selling of the joining corporations, most of the time retaining the buyers name and omitting the sellers. This is done for different reasons, but mostly to expand business. A strategy of acquisitive growth is by no means a novelty in India. It has been widely practised well before the onset of market liberalization. But there is a fundamental difference between these empires building acquisitions of the past and the wave of mergers and acquisitions that have begun to reshape the structures of several Indian Industries.

Mergers and Acquisitions are strategic tools in the hands of management to achieve greater efficiency by exploiting synergies and growth opportunities. Mergers are motivated by desire to grow inorganically at a fast pace, quickly grab market share and achieve economies of scale. India has become a hotbed of telecom mergers and acquisitions in the last decade. Foreign investors and telecom majors look at India as one of the fastest growing telecom markets in the world. Sweeping reforms introduced by successive governments over the last decade have dramatically changed the face of the telecommunication industry. Mergers and * Al-ameer College of Engineering and IT, Vizag


acquisitions in the telecommunications sector have been showing a prosperous trend in the recent past and the economists are advocating that they will continue to do so. The majority of telecommunication services providers have understood that in order to grow globally, strategic alliances and mergers and acquisitions are the principal devices.

Telecommunications is among the fastest moving industries in today’s economy, with technology as a catalyst. New technologies in the way we access voice, data and video are continually evolving, such as V0IP, IPTV and WiMAX. As a result of Globalization, markets got expanded and the size of the firms also grew. As a result of deregulation, industries which earlier enjoyed monopoly position were exposed to competition from private international players. Indian companies today are buying companies abroad as strategic acquisition and proving their competitiveness. Strategically speaking, Indian companies should acquire various well established companies in overseas markets with commodity prices moving up gradually after feeling the heat of demand from emerging economies. This would give the Indian companies a platform for establishing businesses in international markets.

In the late 1990’s Merger activities were common in industries where global markets are of particular importance (e.g., automobile and pharmaceutical) and in industries where deregulation and liberalization significantly changed the intensity of competition like Telecommunications and utilities. Going by the historical evidence, in India, the increase in merger and acquisition activity can be seen as a reaction to the changing business environment.

Merger, acquisition, Joint Venture, takeover or reorganisation – these are not dangers. They are common in the way of an organisation effort to grow and survive. At a time, when companies the world over are discovering that organic growth is hard to come by, the focus is now more on acquisitive growth or inorganic growth. This is all the more true in case of big corporations. Multinational firms such as GE, Johnson and Johnson have for long relied on acquisitions to fuel their growth. Mergers and Acquisitions movement made a beginning in India during 1980’s. Wining the race to the future and the rest of the world requires a strong sense of purpose and speed. The idea of racing as a team is somehow uplifting to the human spirit.

In the Telecom Industry, since the early 1990’s there has been a spurt of mergers, mainly due to deregulation which was characterized by the dismantling of the call rates and the elimination of barriers among the telecom and the mobile operator companies , thereby reducing the entry barriers for both the domestic as well as foreign mobile companies. The other reasons for such surge of merger activities include macro economic pressures, global trends, technology advancements etc. The main motivating factors behind these mergers were cutting down the costs and indirectly benefitting the customers by reduced call rates with better service. These have not only led to domestic mergers, but also included cross border

Mergers and Acquisitions in Indian Corporate Companies—A Special Reference to Telecom Sector 359

mergers. Today, these mergers and acquisitions have reached unprecedented levels and are expected to further grow in the future as well.

Before acquisition the company should go for thorough evaluation of the buying company.

They have to take the consideration and suggestions of Merchant Bankers, Consultants, and Corporate planners and so on.

Similarly at the same time in the post- acquisition phase they need to be proactive. They should anticipate and solve the problems early.

In today’s globalized economy, competitiveness and competitive advantage have become buzz words for corporate around the world. Merger and acquisition are being increasingly used the world over, as a strategy for achieving higher size, faster growth in market share and reach, and for becoming more competitive through economies of scale. This research study has attempted to study the mergers among Indian telecom and mobile industry.

TELECOM SECTOR AND CHANGING INDIAN SOCIETY

Cell phones which even a decade ago seemed destined to remain a toy for the rich have transformed lives and livelihoods of the poor like no one imagined. The opening up of the Indian economy has not only brought forth new opportunities for a typical middle class Indian family but it also created a change in the aspirations of the consumers. A whole new world of choices has been opened for it, which has hitherto unrealized and unsought for. It has led to reassess ones priorities and telecom industry and marketers are leaving no stone unturned to capture customer attention and target to this new breed of consumers. The new class of Indian consumers are aspiring for products that would change their lifestyle and give them greater convenience.

The mobile phone has affected almost every one in the Indian society. In developing economies, consumers on the fringes do not participate in the formal economy because they need proof of some kind of bank accounts, license, and like. Mobility lets many people enter the formal economy through its sheer simplicity. Mobility will give marketers the ability to target one consumer at a time, while also targeting millions as a media vehicle. Due to all these reasons Merger and acquisitions activity took place among various companies.

MERGER AND ACQUISITION WITH REFERENCE TO INDIAN TELECOM

India is now one of the leading nations in the world in terms of mergers and acquisitions. Merger and acquisition activity in the Indian Telecom industry have been driven by a few important factors like the inclusion of internet (including broad band) and cable services in the telecom sector, new technologies like wireless fixed phone services , Deregulation in the telecom sector etc.

Merger and Acquisition in telecom industry are subject to various statutory guidelines and industry specific provisions like companies Act 1956, Income Tax Act, 1961, Competition


Act, 2002; MRTP Act; Indian Telegraph Act; FEMA Regulations; SEBI Takeover regulation; etc.

With the speed at which technology advances, telecom companies are scrambling to keep up. One of the fastest and most effective ways for companies to do this is to look into Mergers and Acquisitions. Landline and mobile operators, cable companies, Internet service providers, and even companies in the telecom infrastructure, software and hardware sectors are ripe for consolidation. With the evolution of digital technology, finding companies who use related resources allow them to converge their technologies to become more efficient and diversified. It also allows them to bundle services under one roof driving up their competitive edge. Of course, there is also the aim of grabbing a bigger market share, be it local or transnational market. s

The rate at which Mergers and Acquisitions are being transacted in the Telecom industry has also spurred the growth of an industry dedicated to facilitating it. Telecom Mergers and Acquisitions Specialists have responded to the need of both buyers and sellers in the industry. Their market, however, is not limited to telecom companies. There is a whole range of interested parties in this highly dynamic industry, including governments of developing markets who are opening their telecommunications industry to international players. Armed with telecom industry expertise, these telecom mergers and acquisitions specialists offer a wide range of services; from purely advisers, to a full range of service, from valuation, to finance sourcing, to closing the deal. Buyers and sellers can also join listings which act as a venue for networking and eventual business- matching.

The Department of Telecommunications issued guidelines on merger of licenses in February 2004. The provisions laid down that prior approval will be necessary for merger of the license from the DoT. The findings of the Department of Telecommunications would normally be given in a period of about four weeks from the date of submission of application. Merger of licences shall be restricted to the same service area. There should be minimum 3 operators in a service area for that service , consequent upon such merger. In addition to M&A guidelines, DoT has also issued guidelines on foreign equity participations and management control of telecom companies.

George Bernard Shaw had once said “Economists know the price of everything, but the value of nothing”. This saying is aptly reflected in case of telecom valuation also. The acquirer pays hefty valuation to acquire an entity and the “Business value” placed is much higher than “Accounting Value”. Merged telecom companies are striving hard to capture the potential market.

Benefits and Reasons for Merger and Acquisition in telecom and mobile Companies

• As an opportunity to attain greater market share and higher revenue growth. • Globalizing in a short span of time. • Creating new synergies through product market efficiencies and economies of scale. • Acquiring new customers and expanding the market /customer and service portfolio.


• Enhancing infrastructure base through acquisition of under valued infrastructural assets or brands or additional manufacturing capacities from weaker competitors.

• Building infrastructure for telecommunications is not easy. Moreover it consumes much time. Merger and acquisitions provide access to infrastructure much easily.

• Benefits of existing network are available much easily through Mergers and Acquisitions.

• In certain regions there may be restrictions on getting new license. In such a case Mergers and Acquisitions provide an option to run services in that region.

• Customer base • Brand value • Spectrum.

The objectives of Merger and acquisitions in between various companies can be for acquisition of licenses or geographical territory, acquisition of spectrum, acquisition of infrastructure and network, acquisition of customer base to achieve an economic base, acquisition of brand value, higher operating profit margin or a combination of above. Mergers and Acquisitions in the telecommunications industry have grown by substantial proportions in India since the mid 1990s. Economic reforms undertaken in the 1990s in India opened up the telecom sector which used to be a predominantly state controlled one. Private investment in the telecom sector in India not only facilitated the rapid expansion of telecom services in the urban, as well as rural parts of India, it also provided the opportunity for mergers and acquisitions in this sector. Acquisitions in the Indian Telecommunication industry have been driven by a few important factors-

• The inclusion of internet (including broadband) and cable services in the telecom sector.

• New technologies like wireless fixed phone services. • Deregulation in the telecom sector.

Mergers and Acquisitions emerged as one of the most effective methods of such corporate restructuring, and have therefore, become an integral part of the long- term business strategy of corporate in India. Since 1996 there was increased activity in consolidation of subsidiaries by telecom companies operating in India, followed by entry of several Multi national companies, into Indian markets, through the acquisition route with liberalized norms in place of foreign direct investments (FDI). After 2002, Indian Telecom and mobile companies started venturing abroad, and making acquisitions in developed markets, for gaining entry into international markets.

The opening up of Indian economy and financial sector , huge cash reserves following some years of great profits , and enhanced competitiveness in the global markets, have given greater confidence for Indian mobile companies to venture abroad for market expansion. Changes made in regulations made by the Finance Ministry in India pertaining to overseas investments by Indian companies have also made it easier for the companies to make international acquisitions.


RULES RELATED TO MERGERS AND ACQUISITIONS IN THE INDIAN TELECOM INDUSTRY

Certain regulatory and statutory norms pertaining to mergers and acquisitions in the Indian telecommunications sector are laid down by the Indian government and its authorized agencies. These include-

• Mergers and acquisitions require approval from the department of elecommunications (DOT).

• Mergers are allowed in the same service area. • Mergers or acquisitions in a service area should not lead to less than 3 operators in

that area. • Mergers and acquisitions should not lead to monopoly.

Along with this the acquiring companies should take into consideration regarding certain issues like the price paid for the unit and the procedure for the payment of the price. What should be the exchange ratio between the shares of the parent company and the merger company? What would be the impact on business of the parent company after the take over and the merger, impact of the share prices of the parent company, any new conditions of the financial institutions for the new proposal?

The kind of post merger problems that are likely to arise, is the parent company fully prepared to tackle them? Does the merger help both the companies or not.

Taking into consideration in regard to the Technical aspects, Commercial aspects, financial aspects, managerial aspects, Human aspects, Legal aspects etc.

IMPORTANT MERGERS AND ACQUISITIONS BY THE INDIAN

TELECOMMUNICATION INDUSTRY

The first merger and acquisition deal in the Indian telecom industry occurred in 1998 between Max group of Delhi and Hutchison Group of Hongkong. 41 percent of stakes of Orange services in Mumbai was acquired by Hutchison from Max for 560 million US dollars. In the year 2000 acquisition of command cellular services in Kolkata by Hutchison from Usha Martin. 100 percent of stakes of command cellular was acquired by Hutchson and Indian group. Again in the same year 2000 hundred percent of stakes of Modi Telestra, Kolkata has been acquired by Bharti group from B.K. Modi ane Telestra. The merger and acquisition in between Qualcomn , Sandiego, US and Reliance infocomm in 2002, is also a notable feature. Vodofone group holds 67 percent in vodofone Essar. The Essar group has an option to sell its entire stake to vodofone for $ 5 billion by May 2011.

The merger in between Sterling group, Chennai and RPG group in between Essar group and Max India, Aditya Birla group, India and Tata group, in the year 2005, in between Essar group and Max India, Vodofone and Bharti group in 2005, in between Max India and Kotak Mahindra, India, in between Hutchison group, Hongkong and Hinduja, in between Maxis, Malaysia and Sterling group in the year 2006 are remarkable aspects in the Indian Telecom industry.


MAJOR M&A DEALS IN INDIAN TELECOM SECTOR

Company/Service Name

%Stake Sold

Buyer Seller Year Deal size(US$)

Indicative Enterprise Value(US$)

Per Sub Value (US$)

Orange, Mumbai 41% Hutchison Group, HongKong

Max Group, Delhi 1998 560 Min 1.36 Bln NA

Command cellular, Kolkata

100% Hutchison &Indian Group UshaMartin& others

2000 - 138Mln

Modi Telestra, Kolkata

100% Bharti Group, India B.K.Modi &Telestra 2000 N.A 160 Mln NA

Reliance CDMA - Qualcomm,San Diego, US Reliance Infocomm 2002 - 10 Bln _

Aircel, Chennai 79.24% Sterling group,Chennai RPG Group 2003 210 Cr

Hutch Essar 3.17% EssarGroup MaxIndia 2005 146 Mln - 570

Idea Cellular 48.14% Aditya BirlaGroup TataGroup 2005 NA 2Bln 400

BhartiAirtel 10% Vodofone BhartiGroup 2005 1.5 Bln 16 Bln 1000 BPL Mobile and BPL Cellular

- Promoters 2005 1.15Bln NA

Hutch Essar, India 5.1% HutchSonGroup, HongKong

Hinduja 2006 450Mln 9Bln NA

Hutch, India 8.33% Max India Kotak ahindra, India 2006 225 Mln - NA Aircel, TN, Chennai and NE

74% Maxis,Malaysia Sterling Group 2006 750 Mln 1.07 Bln 496

Spice (Punjab and Bangalore)

49% Telekom Malaysia,Malaysia

NA 2006 178 Mln 363 Mln -

Bharti 9.3% Private Investors Warburg Pincus NA 873Mn NA 1000

In the years that followed several other mergers and acquisitions took place in the telecommunications sector in India. Important ones among them include-

• Acquisition of Command Cellular Services in Kolkata by Hutchison from Usha Martin in 2000.

• Acquisition of 79.24 percent stakes of Aircel, Chennai by Sterling group from RPG group for Rs 210 crores in 2003.

• Acquisition of 48 percent stakes in Idea cellular by Aditya Birla group from the Tata group in 2005.

• Acquisition of Hutch services in India by Vodofone in 2006. • Bharti Airtel acquisition with Zain in 2010.

The Reserve Bank has liberalised the investment norms for Indian telecom companies by allowing them to invest in international submarine cable consortia through the automatic route. In April 2010, RBI issued notification stating “As a measure of further liberalisation , it has now been decided... to allow Indian companies to participate in a consortium with other international operators to construct and maintain submarine cable systems on co- ownership basis under the automatic route.”

The notification further added “Accordingly, banks may allow remittances by Indian companies for overseas direct investment”. Africa is in the same stage of evolution where India was 5-6 years ago and hence the potential is truly huge. Telecom industry leaders such


as Bharti Airtel swear by Africa and believe the opportunity there is actually bigger than India, where the industry seems to a have passed the phase of hyper growth. While the Ruia’s promoted Essar and Bharti Airtel have been successful into cracking into this market, others such as Reliance communications, BSNL, and MTNL have not been as lucky.

In 2008, the Essar group acquired 49 percent in ECONET wireless international to make Kenya its first overseas bastion for telephony operations. In 2009 November, Essar group entered into a definitive agreement to pick up majority stake in Warid Telecom, the Dhabi Groups subsidiary in Uganda and Republic of congo for around $ 150 million (rupees 692 crores). Infact the Ruia’s were also in the race to acquire stake in Zamtel, after the Zambian government had invited bids to sell 74 percent stake in the countries only land line operator.

Essar is planning to double its investments in Kenya. The company has already invested $ 300 million in the Kenyan markets, and the extra money would go towards data and enhancing network quality. In India the Essar group has a 33 percent stake in vodofone Essar and a minority interest in Loop mobile.

BYTE Mobile : Mobile internet service provider BYTE mobile has developed recently research and development centre in the country with an investment of $10 million (about rupees 44 crore) in order to take advantage of the launch of 3G operations in India. Byte mobile has customers such as Bharti Airtel and Vodofone in India. The company is also in talks with other service providers including Tata teleservices and Reliance Communications. Byte mobile was open for acquisition or takeover for growth and ready for any kind of organic or inorganic growth opportunities.

The company deployment spans 120 operators in 58 countries, serving nearly two billion subscribers. The company is proactively addressing any potential hang-ups by exploring the possibility of new partnership to create a services alliance for the company’s global customer base, which has its operations in countries like China, US, and Greece.

FDI AND MAURITIUS CONNECTION

The scenic Mauritius has emerged as the favourite landing point for foreign investors for FDI in Indian telecom companies. Mautitius accounts for more than a third of the aggregate FDI inflows. India’s tax treaty with Mauritius provides exemption from capital gain arising out of investment in India made by a Mauritius resident company. A common strategy adopted by foreign investors is to hold the shares of Indian operating company through Mauritius based special purpose vehicle (SPV). In case of exit, these SPVs are sold to foreign investors who land in Mauritius. Board level changes are made in such SPV and nominate their representative on the Indian telecom company. In such a case, in accordance with DTAA with Mauritius, no capital gains tax is levied on the foreign investor. No transfer is needed to be


recorded in the register of transfer of Indian Telecom Company as the same Mauritius SPV continues as shareholder.

BHARTI AIRTEL ACQUISITION WITH ZAIN

Sunil Mittal led Bharti Airtel had completed the acquisition of Zain Telecoms Africa operations for $ 10.7 billion. It’s a great acquisition for Bharti Airtel as it has become the world’s fifth largest mobile operator.

The company now has 180 million subscribers in 18 Asian and African nations. The company has launched the Airtel brand in Zains operations in all the 15 nations recently.

The transaction is the largest ever cross – border deal in an emerging market and will result in combined revenues of about $ 13 billion. Bharti finally entered Africa after aborting negotiations twice for merger with MTN since 2008, now Airtel will have total control in Zains operations. Zain Africa is now 100 percent subsidiary of Bharti International. This deal has given signal for many new investments in Africa.

At present China mobile is the world’s largest mobile player with a subscriber base of 522 million, followed by Vodofone (348 million), Telefonica (206 million) and American Movil (201 million).

Bharti has acquired Zain Telecoms operations in 15 countries, excluding Sudan and Morocco. Zain has operations in 17 countries in the region and is claiming to be the 2nd largest operator after MTN. With this acquisition, Bharti had an unparalleled footprint in one of the fastest developing regions in the world. Bharti has also reached a settlement with Broad communications, the single largest share holder in Zain Nigeria.

There is no extra payment made for the settlement. The company does not see any problem with another small shareholder Econet wireless in Nigeria. (Settlement- The chief Otudeko would now head Bharti’s operations in Nigeria.) For completing the deal, Bharti paid $ 7.9 billion and the balance $ 400 million from the total upfront payment would be done in a few days on completion of certain formalities. These things can be expected to come to a shape in the beginning of the coming New Year 2011. It is really a great success that Indian companies are able to dominate and expand their markets in the foreign countries.

BHARTI AIRTEL IN BANGLADESH

Bharti Airtel , recently in the month of October 2010 made an agreement with Ericsson and Huawei to deploy a mobile network across Bangladesh. The agreement is modelled on Bharti’s highly successful managed networks model in India and Srilanka. This agreement will enable Bharti take its network deep into Bangladesh and contribute to the growth of telecom in the country with affordable services. Bharti had acquired 70 percent stake in Warid Telecom in January 2010.


Bharti’s agreement with the two companies includes network design, project management as well as material and services for the base station sites and microwave transmission.

Ericsson will expand and upgrade circuit and packet core network, energy efficient radio access network with evolved EDGE technology, intelligent network, Country wide microwave mobile backhaul and Business Support Systems (BSS).

The other network partner, Huawei will swap the existing radio network in the eastern areas of Bangladesh. This is the third deal Bharti had signed with the Chinese vendors, Huawei also manages Airtels network in SriLanka and will be rolling out the operators 3G network in three circles in India.

IMI Mobile Vs WIN mobile: The Hyderabad based company IMI mobile has possessed 100 percent of the U.K mobile content and the service provider WIN co. Win is having good business in Europe and having strong agreements with the prime mobile operators.

SUCCESS OF MERGER AND ACQUISITIONS IN TELECOM

The foreign investors continue to look at India to spread their market. Most of the GSM operators resorted to Merger and acquisition in order to achieve growth. Reliance infocomm did not go for inorganic route and instead rolled out a green field project. Merger and acquisition in Indian Telecom were successful as they have created new capabilities, by offering better value proposition and enhancing share holder’s value, benefitting the Indian economy and society at large. Foreign investors have gained immensely from investing in India.

On witnessing telecom success stories in India, some of the world’s largest telecom companies have all returned to India. The success of a merger hinges on how well the post – merged entity positions to achieve cost and profit efficiencies. New license holders will continue to look to sell their stake at a premium. New policies will seek to curb this license arbitrage. Small players with operations in only a few circles will find it difficult to compete with the nation wide players. The industry may witness more consolidations with these small operators being acquired by the larger ones. The main reason for this is to seek for economies of scale and lower startup cost by infrastructure sharing. 3G and Wimax license will spur Merger and acquisition and partner ship activity.

SUMMARY

As Robert C Higgins of University of Washington points out “careful valuation and disciplined negotiation are vital to successful acquisition, but in business as in life, it is sometimes more important to be lucky than smart”. Critics claim telecom mergers reduce competition and promote monopoly. In reality, these mergers are part of a healthy competitive process and would foster innovation and bring benefits to consumers. Finally the success of a


merger hinges on how well the post-merged entity positions itself to achieve cost and profit efficiencies.

Merger and Acquisition in the Indian telecom space picking up fastly because on the one hand domestic players are looking at foreign money and expansion plans and on the other international operators are exploring ways to move into emerging markets with their home market reaching saturation. After raising concerns over Black Berry devices and telecom network equipment the Ministry of Home affairs has asked the Department of Telecomm to look at the feasibility of making it mandatory for local manufacturer of Sim Cards used in mobile phones.

BSNL was the top operator in terms of subscriber addition with 2.3 million users. BSNL now has 72.7 million subscribers and is ranked fourth among GSM operators. Among the private players, newcomer Uninor ramped up its user base by 2.17 million beating incumbent operators such as Airtel and Vodofone. Market leader Bharti Airtell got just over 2 million new subscribers to take its total user base to 143 million. Vodofone added 1.7 million users in September 2010 against 2.3 million in August 2010. Of course, there is no standard reporting norm and for some of the operators it may be discounted 30 to 40 percent.

With profits and market share plunging, privatisation seems to be the best option before BSNL. BSNL can go in the lines of VSNL i.e., Videsh Sanchar Nigam Ltd way. VSNL, now known as Tata communications, has become a global player, acquiring even a government owned company Teleglobe of Canada. BSNL can be privatised likewise, or by a statute as in the case of a British Telecom. Statutory privatisation involves government holding a single golden share. Some shares can be given to employees at less than the market price and the rest to the public as an initial public offer (IPO).

The Indian market is highly price sensitive. Easy and cost effective last mile access to the customer is another key issue. The Asian countries especially China now compete with each other in promoting the industry. Alongside low tariffs and low handset prices what is fuelling today’s mobile growth is the innovative use of the device. The mobile market is 16 years old in India but has had a dramatic impact in every area. The Indian Telecom Market is possibly the most competitive globally, has excellent self regulation and regulation that works. The vodofone group which holds 67 percent in vodofone Essar plans to launch 3G services early next year.

The mobile portability which is going to be implemented in the coming days may encourage more mergers and acquisitions in the country. India’s Telecom industry gets strengthened with the commitment of all the companies for sustaining the industries growth and momentum. One of the key developments is that the amount of data coming into the network is very high. If we look at the US and the European markets, with launch of smart


phones, data is becoming more prominent. How to handle data is becoming a key issue. So from being a commoditised element, networks are becoming very important again.

The development and management of the quality of networks to cater to huge upsurge of data is becoming a key issue. It is not just enough to manage the network, we are moving up the value chain to say how we can manage the services and understand subscribers. Operator has a lot of data on subscribers and through the subscriber data management companies can help them create value on network than just offering dumb pipes. If operators spend $100 billion on capital expenditure annually, there is a corresponding spend of $250 billion on the network operational expenditure. Of this 70 percent is done internally by operators. Only 10 percent comes to the vendors. So there is opportunity for vendors to look at improving operator’s opex by bringing in value like energy solutions.

Even as telecom operators get busy with the 3G roll out plan, they are also evaluating various wireless broadband technologies, including those using 4G. Aircel hopes to start rolling out 3G services in the first quarter of the next year. Although the rate haven’t been decided, it will be affordable, 3G is not about network alone, it is about setting the experience for consumers. With a 5 MHz spectrum, companies have to strike a balance between the consumers and utility of the spectrum.

WI-MAX or LTE : Currently the telecom market is debating which is the best technology beyond 3G – WiMAX or LTE , akin to the GSM versus CDMA debate. While the fundamentals are similar, the main difference between the two is WI-MAX (wireless interoperability for microwave access) needs a new network to be deployed, while LTE, which uses a radio platform to transmit signals instead of micro waves is an evolution of existing 3G networks. Both promise greater data transfer and download speeds, superior audio / video quality and flexible use of spectrum as India looks to leapfrog to fourth generation networks. While 2G talks of speed upto 0.3 mbit/ second 3G in India is looking at a data rate of upto 42 Mbit/ sec speed. 4G is promising even more- 100 mbit/sec.

There is evolution of both wi-max and LTE with trials going on in the country for both technologies. Companies have to make technology affordable. LTE is transformational technology and what is happening in India is concurrent with what is available in the rest of the world. With the 3G services which enables mobile users to enjoy broadband services like video downloads, high speed data services of interest in education, health and entertainment and many other bandwidth hungry applications we can expect more changes in the telecom mergers and acquisitions. The rapid growth of the telecom industry in India was led by a joint effort by operators, regulators and customers. The same three will have to join forces again and redirect their energies to see the sector through to the next phase. A lot has been achieved by the growth of the telecom sector, the most impressive being its ability to bring economic


inclusion. With these developments in the telecom sector let us hope that it will pave path for more Mergers and Acquisitions in the coming future.

REFERENCES [1] Icfai Journals [2] www.economy watch.com

Analysis of Trends of Mergers and Acquisitions in India and Growth of GDP

Dr. Sanjay Namdev Aswale*

Abstract—As we know that economic reform has opened up new challenge, competition among various sectors of the world. These competitions compelled the Indian companies to go for mergers and acquisitions. Mergers and acquisitions are useful for consolidation of markets as well as for gaining a competitive edge in the various sectors of the economy. The immediate effects of the mergers and acquisitions have also been diverse across the various sectors of the Indian economy after 2007. In this context the researcher focuses how the mergers and acquisitions market has experienced an exponential growth. The main objective of this paper is to examine the trends of merger and acquisition in corporate sectors after and before economic reform 1991 in India in the form of mergers and acquisitions deals and also in the GDP The paper recommends that the government may take initiatives for promulgating flexible rules and regulations to avoid the difficulties in the mergers and acquisitions. The financial reforms and convenient rules and regulations have contributed to the growing trends of mergers and acquisitions in India.

Keyword–Finance - Economic Reform – Merger and acquisition – Trends – GDP Growth–Corporate Sector

Purpose-The purpose of this paper is to analyze the trends of Mergers and acquisitions in India after and before global reforms and its impact on GDP.

INTRODUCTION

Mergers and acquisition has a very long history; it has been existed at least since the 1900s.1 However, the saliency of M&A has increased considerably during the past two decades as numerous US firms have adopted M&A as a common corporate strategy to expand their organizational capabilities and to take better competitive market positions.2 This propagation continued during the 1990s, and beyond, including 7,809 M&A transactions with a total value of $1.19 trillion in the United States in 1998 alone.3 In the process of global waves of reforms there are increased competitions, new regulations and financing possibilities etc. Mergers and acquisitions (M&As) have become popular strategy since global reforms in India 1991.Merger and Acquisition is a process of restructuring the business organization. Today, India has become one of the leading nations in the world in terms of mergers and acquisitions. The estimated value of mergers and acquisitions in India for 2007 was greater than $100 billion which became greater than $700 billion in 2009-10. In this context my paper focuses on the issues of Mergers and Acquisitions in India before and after economic reforms in India. The paper also reveals the changes of the trends of mergers and acquisitions in India.

* Shri Chhatrapati Shivaji College, Osmanabad

Analysis of Trends of Mergers and Acquisitions in India and Growth of GDP 371

STATEMENT OF PROBLEM

India has accepted the economic reforms in the year 1991. This policy has opened up a lot of challenges both in the domestic and international spheres because it implies free economy and open competition of world economy. These open competitions in the world market have prompted the Indian companies to go for mergers and acquisitions as an important strategic choice. The immediate effects of the mergers and acquisitions have also been diverse across the various sectors of the Indian economy.


• Nahavandi and Malekzadeh (1993) – he has highlighted that despite the popularity of Mergers and acquisitions, the general consensus is that about 80% of M&A do not reach to their financial goals

• Sally Riad. (2007) – he concluded in his study that about 50% simply fail the Mergers and acquisitions in India

• Lodorfor (2006) - he has studied the cultural clashes between the two merging companies.

• Simpson (2000) – the research shows that the opportunity for mergers fails is greatest during the integrated process. Integration fails because of improper managing and strategy, culture differences, delays in communication and lack of clear vision.

Thus past research on M&A has focused on either the effect of various financial issues, but my paper focuses on trends of Mergers and acquisitions and global reforms

OBJECTIVES

The main objective of my paper is to analyze the trends in mergers and acquisitions before and after economic reforms

HYPOTHESIS

In view of the above objective the following hypothesis formulated and tested.

H1 – The trend of Mergers and acquisitions of Indian companies in the world markets is an indication of the participation in the overall globalization process.

METHODOLOGY

This study is based in exploratory research method. The study is mainly conducted through the analysis of the available secondary data. The secondary data is collected for the period 1985- 2010 for the purpose of analysis of GDP and mergers and acquisition deals before and after global reforms. The data taken as before global reforms is for ten years (1980-90) and the data taken as after global reforms is 18 years (1992-2010). These data are tabulated and analyzed by using simple statistical technique like averages / mean.


BUSINESS ENVIRONMENT AND M&AS

The business environmental incompatibility is the single largest cause of lack of projected performance, departure of key executives, and time consuming conflicts in the consolidation of business.4 Business environment plays a vital role in the way how employees react to the new business environment. Business environment has been coined to describe the conflict of two companies’ philosophies, styles, values, and missions. This may, in fact, be the most dangerous factors when two companies decide to combine. Even in the best circumstances, mergers can so change the nature, orientation and character of one or both of the merger partners; this means five to seven years are typically required for employees to feel truly incorporated into a merged entity.5 Due to the multitude of these changes, the post-merger period witnesses many problems adjustment.6 Most of these adjustments problems arise from employees’ fears regarding the loss of job, also financial debt regarding job loss. Moving into the realm of the unknown with a new manager and a new team is also distressing and anxiety provoking. Other fears include the loss of effective and close team members, as well as the uncertainty about the new team members and supervisors to be inherited. When forced to deal with new team members and supervisors, employees may frequently develop fears of taking risks and raising sensitive subject. This may adopt ‘us verses them’ thinking, where trust for the new team members will be minimal. Corporations facing this kind of behaviour may have to pay the high price of loss of cooperation and initiative among the employees of the new business combination. The synergies that were initially sought may be harder to achieve, conflicts and disagreement will be more difficult to resolve, if at all, and this friction occur more frequently, post-merger will be the most difficult time for the new team to move forward as a whole.7

TRENDS OF MERGERS AND ACQUISITIONS

There is growing opportunities for the players of the economy that are in position to acquisition to take advantages of competition raised due to world global reform. In the process of globalization there is need of huge fund as well as manpower and material resources. The business models are also changed. Firms or companies with exciting businesses, either in generating or distributing content, are being created right and left and can be purchased or partnered with very cheaply. Such opportunities can provide substantial value.8

With the increasing number of Indian companies opting for mergers and acquisitions, India is now one of the leading nations in the world in terms of mergers and acquisitions. The total estimated value of mergers and acquisitions in India for 2007 was greater than $100 billion. It is twice the amount of mergers and acquisitions in 2006. Today the acquisition of foreign companies by the Indian businesses has been the latest trend in the Indian corporate sector. The following are the key factors behind the changing trends of mergers and acquisitions in India

• Favorable government policies • Buoyancy in economy


• Additional liquidity in the corporate sector • Dynamic attitudes of the Indian entrepreneurs

Along with these key factors the increased participation of the Indian companies in the global corporate sector has further facilitated the merger and acquisition activities in India.

GLOBALIZATION AND MERGERS & ACQUISITION

As seen from past experience mergers and acquisitions are triggered by economic factors. The macroeconomic environment, which includes the growth in GDP, interest rates and monetary policies play a key role in designing the process of mergers or acquisitions between companies or organizations. The mergers and acquisitions were inspired by globalization. The Mergers took place mainly in the banking and telecommunications industries. They were mostly equity financed rather than debt financed. The mergers were driven long term rather than short term profit motives. Global markets are also considerably influenced by the merger and acquisition trends.

In the process of mergers and acquisitions 1270 Indian activities recorded deals worth of 50 billion USD. The number of activities have decreased by less 6 per cent and value of deals also decreased by 18 per cent in 2008 The share of Indian cross-border deals in the total value of deals has also decreased, but is still high with 66 per cent. Especially the number and value of foreign acquisitions in India has dropped. In respect to number of transactions almost all sectors have experienced a decrease with the notable exceptions of real estate retail, energy & power, and healthcare. The Indian Companies acquiring foreign businesses are more common since 2006-07. Buoyant Indian Economy, extra cash with Indian corporate, Government policies and newly found dynamism in Indian businessmen have all contributed to this new acquisition trend. This trend of Mergers and acquisitions of Indian companies in the world markets is an indication of the participation in the overall globalization process. The following table shows the Top ten Indian Companies acquired the foreign companies in the 2007-08. Out of the top Ten Indian Companies acquired the foreign companies the highest deal of mergers and acquisitions was Tata steel companies deal which is 1200 million dollar

TABLE 9.1: TOP ACQUISITIONS MADE BY INDIAN COMPANIES WORLDWIDE

Acquirer Target Company Deal value ($ ml) Tata Steel Corus Group plc, UK 12,000 Hindalco Novelis, Canada 5,982 Videocon Daewoo Electronics Corp,. Korea 729 Dr. Reddy’s Labs Betapharm , Germany 597 Suzlon Energy Hansen Group, Belgium 565 HPCL Kenya Petroleum Refinery Ltd. Kenya 500 Ranbaxy Labs Terapia SA , Romania 324 Tata Steel Natsteel , Singapore 293 Videocon Thomson SA , France 290 VSNL Teleglobe , Canada 239


TRENDS OF MERGERS AND ACQUISITIONS DEAL

The following graph clearly indicate the mergers and acquisitions deal since 2000-01

Graph 9.1: Trends of Mergers and Acquisitions Deal

It is concluded from the above graph that the mergers and acquisition deals which was very low in the year 2001-02 which increased to US$ 4.3 billion in 2005, and further crossed US$ 15 billion-mark in 2006. The total M&A deals for the period January-February 2007 have been 102 with a value of US$ 36.8 billion. Of these, the total outbound cross border deals have been 40 with a value of US$ 21 billion. There were 111 M&A deals with a total value of about US$ 6.12 billion in March and April 2007. Of these, the number of outbound cross border deals was 32 with a value of US$ 3.41 billion. There were 74 M&A deals with a total value of about US$ 4.37 billion in May 2007. Of these, the number of outbound cross border deals was 30 with a value of US$ 3.79 billion. The sectors attracting investments by Corporate India include metals, pharmaceuticals, industrial goods, automotive components beverages, cosmetics and energy in manufacturing; and mobile communications, software and financial services in services, with pharmaceuticals, IT and energy being the prominent ones among these.The total number of mergers and acquisitions deals in India was 287 with monetary transaction of US $47.37 billion from the month of January to May in 2007. Out of these 287 merger and acquisition deals, there have been 102 cross country deals with a total valuation of US $28.19 billion. Recently the Indian companies have undertaken some important acquisitions.

TRENDS AND GROWTH OF GDP BEFORE AND AFTER GLOBAL REFORMS

There are increasing trends of mergers and acquisitions after global reforms period. The immediate effects of the mergers and acquisitions have also been diverse across the various sectors of the Indian economy. India is now one of the leading nations in the world in terms of mergers and acquisitions. The following table shows the average trends and growth of GDP and average trend and growth of mergers and acquisitions deal value before and after global reforms.


The table clearly indicates that the trends and growth of GDP and also mergers and acquisitions deals since global forms (1991-92). The table also shows the average annual trend in case of GDP and deal value is high inspite of world recession.

TABLE 11.1: TRENDS AND GROWTH OF GDP BEFORE AND AFTER GLOBAL REFORMS

Year Average Annual

Growth of GDP in (%)

GDP before and after Global Reforms

Average Trend of Mergers and

Acquisitions deal in Billion Dollar

Mergers and acquisitions (deal Value)

before and after Global Reforms

1980-85 5.7 0.10

1985-90 6.0

Before Global reforms Mean GDP = 11.7/10 = 1.17 0.13

Before Global reforms Mergers and acquisitions deal Mean = 0.23/10 = 0.023

1992-97 6.8 0.21 1997-02 5.3 0.30 2002-07 6.5 0.60

2007-10 6.7

After Global reforms Mean GDP = 25.3/18 = 1.40

19.50

After Global reforms Mergers and acquisitions deal Mean = 20.61/18 = 1.45

Source: Economic Survey 2001-02, Ministry of Finance, Government of India, 2002. Growth rates for 2001-02 are projections of the Ministry of Finance based on partial information.

The above data is grouped in two period like before global reform period -1980 -1990 and after reform period of 1992- 2010. The GDP and value of the mergers and acquisition deal for that period is compared by calculating mean value. The period of before global reforms has taken as 10 years; whereas the period of after global reforms has taken as 18 years i.e. full terms since 1991 to 2010. It can be concluded by analyzing the above table that there is continuous increasing trends in the GDP and Mergers and acquisitions. The mean value of average GDP after global reforms is high (1.40 per cent as compare to 1.17 per cent ). The average tends in deal value of mergers and acquisitions is also high (1.45 billion dollars) after global reforms as compare to before reforms ( 0.023 billion dollars)

GDP Growth and trends befroe and after Global reforms

5.7 66.8

5.36.5 6.7

0

2

4

6

8

1980-85 1985-90 1992-97 1997-02 2002-07 2007-10Year

Perc

enta

ge

Graph 11.1: Trends and Growth of GDP Before and After Global Reforms

The above graph shows the trends in GDP. The annual growth of GDP rose from 5.7 per cent in the 1980 – 85 to 6 per cent in the 1985-90 and again it was increasing trend during 1992-97 i.e. 6.8 per cent making India one of the ten fastest growing countries in the world by accepting global reforms. The economy grew more open, and growing faster than GDP during the period 1997-02 as GDP is fell down as annual average rate was 5.3 per cent.


But the average annual GDP has been increasing since 2002. The mergers and acquisitions deal is also increasing since 2002 as stated in the above graph 9.1.

It can be conclude that there is global impact on Mergers and Acquisitions and GDP after reform period inspite of recession in the world.

HYPOTHESIS TESTING

The alternative hypothesis framed in this paper “The trend of Mergers and acquisitions of Indian companies in the world markets is an indication of the participation in the overall globalization process” is proved and accepted by the researcher as there is increasing trend in mergers and acquisitions as well as average annual rate in GDP RESULTS AND DISCUSSION

The number mergers of actuations and their values after economic reforms period has rapidly increased as compare to earlier period of economic reforms. Thus it can be concluded that the Mergers and Acquisitions become very common incidents in the 21st century. By analyzing various authors’ views in the literature and secondary data, the mergers and acquisitions help the corporate sectors to sustain in the global competitive economy. The government may take initiatives for promulgating flexible rules and regulations to avoid the difficulties in the mergers and acquisitions. The financial reforms and convenient rules and regulations have contributed to the growing trends of mergers and acquisitions in India.

Thus during the 1980-2000 Indian companies having acquired foreign entities was very rare. But the trend during the recent phase of global reforms Indian Companies acquiring foreign businesses are more common. The increasing engagement of the Indian companies in the world markets is not only an indication of the maturity reached by Indian Industry but also the extent of their participation in the overall globalization process.

REFERENCES [1] Gaughan, P. A. (1999). “Mergers, Acquisitions, and Corporate Restructuring.” New York: John Wiley and

Sons, Inc. [2] Buono, A.F., Bowditch, J.L.1989. “The Human side of Mergers and Acquisitions” San Francisco: Jossey-

Bass. [3] Gaughan, P. A.(1999). “Mergers, Acquisitions, and Corporate Restructuring.” New York: John Wiley and

Sons, Inc. [4] Bijilsma-Frankema, K. (2002), “On managing cultural integration and cultural change processes in mergers

and acquisitions,” Journal of European Industrial Training, Vol. 25, April, pp. 192-207 [5] Covin, T.J., Kolendo, T.A., Sighter, J.W. and Tudor, R.K. (1997), “Leadership style and Post-merger

satisfaction,” Journal of management development [6] Mirvis, P.H. and Marks, M.L. (1992), “Rebuilding after the merger: Dealing with survivor sickness,”

Organizational Dynamics, Vol. 21. No.2, pp. 18–23 [7] Appalbaum, S.H., et al (2004), “Anatomy of a merger: behaviour of organizational factors and process

throughout the pre-during-post-stages”, Management decision, Vol.38, No.2, pp.649–62 [8] Bartel Robert (2009) - Limited Director Liability in Mergers, Demergers and spin off, Mergers and

Acquisitions Report 2009 p– 44 [9] www.mergers ans acquisitions .com - Mergers and acquisitions in India, accessed on 20.09.2010

Track 8 Money and Capital Market

Economic Value Addition to Shareholders Wealth

Arvind A. Dhond* Abstract—Corporate firms exist to create wealth and maximize wealth for its shareholders. Most corporates are today geared to understand and act upon the concept of shareholders value creation in order to stay competitive in the dynamic business environment. Maximizing shareholders’ wealth has thus become the new corporate paradigm. Maximizing the shareholders’ wealth means maximizing the net worth of the company for its shareholders’. This is reflected in the market price of the shares held by them. Therefore wealth maximization means creation of maximum value for company’s shareholders’ which means maximizing the market price of the shares. Shareholders value maximization, which is the heart of economic growth, as a long-term proposition that delivers higher economic output and prosperity through productivity gains, employment growth and higher wages. Management’s most important mission is to maximize shareholders wealth. Therefore wealth creation is dependent on management’s performance. In order to measure the performance of company’s management; accountants, finance managers, investors, analysts and other users use several tools.

In the past decade sea changes has been made in the performance and measurement criteria of corporate entities, from the traditional profit based measures like, Earning Per Share (EPS), Return On Capital Employed (ROCE), Return On Net Worth (RONW), Net Operational Profit After Tax (NOPAT) and Earning Before Interest and Tax (EBIT), to the new ‘trendier’ value based performance measures, like Market Value Added (MVA), Shareholder Value Added (SVA), Cash Value Added (CVA), and Economic Value Added (EVA). Shareholders need some tools, which would enable them to assess and forecast the performance of company’s management. Shareholders expect to achieve the required return from their investments. In order to measure the performance of company’s management, various users use several tools. Major problem of the shareholders is to understand that among the various tools available in order to measure the performance of company’s management, which tool has more relationship with shareholders wealth creation. Among the modern tools, Economic Value Added (EVA) has received attention and recognition in accounting and financial areas as a vital tool to measure corporate performance. Economic Value Added (EVA) concept is a correct criterion in performance management, because it includes all the cost of capital employed

INTRODUCTION

Maximizing shareholder’s wealth has become the new corporate paradigm. Managers and researchers have traditionally recognized shareholders wealth maximization as the ultimate corporate goal. The owners of the company i.e. the shareholders are more interested in maximizing their wealth. Maximizing the shareholders wealth means maximizing the net worth of the company for its shareholders. This is reflected in the market price of the shares held by them. Therefore wealth maximization means creation of maximum value for *St. Xavier’s College, Mumbai


company’s shareholders which means maximizing the market price of the shares. Shareholders value maximization, which is the heart of economic growth, as a long-term proposition that delivers higher economic output and prosperity through productivity gains, employment growth and higher wages. Management’s most important mission is to maximize shareholders wealth. Therefore wealth creation is dependent on management’s performance. In order to measure the performance of company’s management; accountants, finance managers, investors, analysts and other users use several tools.

MEASURES AND INDICATORS

Companies are using various measures and indicators for measuring the financial performance. These indicators help in identifying the performance and its strengths and weaknesses and suggesting improvement in its future course of actions. It is thus very important for business concerns to analyze its financial performance at the end of each financial year, to know the trend and progress over the period of time along with its extent and change in it. In order to analyze the performance of the selected sectors and companies, the following measures and indicators has to be considered as the basis:

PARAMETERS FOR MEASUREMENT

In the past decade sea changes has been made in the performance and measurement criteria of corporate entities, from the traditional profit based measures like, Earning Per Share (EPS), Return On Capital Employed (ROCE), Return On Net Worth (RONW), Net Operational Profit After Tax (NOPAT) and Earning Before Interest and Tax (EBIT), to the new ‘trendier’ value based performance measures, like Market Value Added (MVA), Shareholder Value Added (SVA), Cash Value Added (CVA), and Economic Value Added (EVA). It would be very useful to measure and compare the shareholders wealth created by company on the basis of traditional and modern measurement criteria for the purpose of best corporate governance and improving credit worthiness. It is important to measure the shareholders wealth on the basis of traditional and modern methods and compare them to know relative importance of measurement.

Parameter‐I: Return on Net Worth (RONW)

Rationale: The profits earned by the firm has to be related to Net Worth, which is the actual shareholders investment made in the business.

Parameter‐II: Return on Capital Employed (ROCE)

Rationale: The earnings before interest and tax earned by the firm has to be related to the total Capital Employed in the business.

Parameter‐III: Earning Per Share (EPS)

Rationale: The total annual profits earned by the firm has to be divided by the total number of equity shares outstanding in order to determine profit per equity share.

Economic Value Addition to Shareholders Wealth 381

Parameter‐IV: Economic Value Added (EVA)

Rationale: The returns earned has to be related to the Cost of Capital Employed while taking investment decisions by the firm.

There exists a significant relationship between:

• Economic Value Added and Earning Per Share, and • Economic Value Added and Market Price of share in stock exchange/ markets.

There exists a relationship between two traditional parameters of shareholders’ wealth creation, viz. Earning Per Share and Share Price in stock exchange/ market and the modern parameter ‘Economic Value Added’.

Shareholders wealth creation is the ultimate objective of corporate financial management and problem of the shareholders is to understand that among the various tools available in order to measure the performance of company’s management, which tool has more relationship with shareholders wealth creation. There is a need to assess the extent of and change in shareholders wealth creation. Has there any change in the shareholders wealth creation and the extent of change in it, if any. Shareholders need some tools, which would enable them to assess and forecast the performance of company’s management. Shareholders expect to achieve the required return from their investments. In order to measure the performance of company’s management, various users use several tools. Major problem of the shareholders is to understand that among the various tools available in order to measure the performance of company’s management, which tool has more relationship with shareholders wealth creation. Among the modern tools, Economic Value Added (EVA) has received attention and recognition in accounting and financial literature as a vital tool to measure corporate performance. Investors, who want to buy stocks, need to know the relationship between returns on their investments and financial information. They have to know measurement tools that help them to buy the stock with higher return; and Economic Value Added (EVA) concept is a correct criterion in performance management, because it includes all the cost of capital employed. There is also a need to study and examine the relationship between Economic Value Added with two parts of shareholders’ wealth, viz. Earning Per Share and Share Price in stock exchange/ market. There is a need to understand the relationship between two traditional parameters of shareholders’ wealth creation, viz. Earning Per Share and Share Price in stock exchange/ market and the modern parameter ‘Economic Value Added’ and finally to compare the performance of the companies applying traditional parameters such as Earning Per Share and Share Price in stock exchange/ market with that of ‘Economic Value Added’ and assessing and evaluating that whether there is any significant change in the performance of the companies applying traditional parameters such as Earning Per Share and Share Price in stock exchange/ market with that of Economic Value Added. It is believed that, the companies are expected to generate higher wealth for their shareholders over a period of time since generation of higher wealth year after year for their shareholders is the ultimate goal of corporate financial management. In recent years it is believed that, measuring shareholders wealth on the basis of Economic Value Added concept is more meaningful than traditional concept. Economic Value Added being the modern


parameter for measuring shareholders wealth is termed better than traditional parameters of shareholders’ wealth creation, viz. Earning Per Share and Share Price in stock exchange/ market.

RESIDUAL INCOME OR ECONOMIC VALUE ADDED (EVA)

In the field of corporate finance, economic values added is a way to determine the value created, above the required return, for the shareholders of a company. Shareholders of the company will receive a positive value added when the return from the capital employed in the business operations is greater than the cost of that capital. The goal of all companies is to create value for the shareholder. But how is value measured? Wouldn't it be nice if there were a simple formula to figure out whether a company is creating wealth? A growing number of analysts and consultants think there is an answer - Economic Value Added (EVA). EVA is a performance metric that calculates the creation of shareholder value. It distinguishes itself from traditional financial performance metrics such as net profit and EPS. EVA is the calculation of what profits remain after the costs of a company’s capital - both debt and equity - are deducted from operating profit. The idea is simple but rigorous: true profit should account for the cost of capital. In corporate finance, Economic Value Added or EVA is an estimate of true economic profit after making corrective adjustments to accounting, including deducting the opportunity cost of equity capital. The concept of EVA is in a sense nothing more than the traditional, commonsense idea of “profit”, however, the utility of having a separate and more precisely defined term such as EVA or Residual Cash Flow is that it makes a clear separation from dubious accounting adjustments that have enabled businesses such as Enron to report profits while in fact being in the final approach to becoming insolvent. EVA can be measured as Net Operating Profit After Taxes (NOPAT) less the money cost of capital. EVA is similar to Residual Income (RI), although under some definitions there may be minor technical differences between EVA and RI (for example, adjustments that might be made to NOPAT before it is suitable for the formula). Another, much older term for economic value added is Residual Cash Flow. In all three cases, money cost of capital refers to the amount of money rather than the proportional cost (% cost of capital). The amortization of goodwill or capitalization of brand advertising and other similar adjustments are the translations that can be made to Economic Profit to make it EVA.

THE CALCULATION OF EVA

There are four steps in the calculation of EVA:

FORMULA

The formula for the calculation is EVA i.e. residual income equals to income earned minus cost of capital on investment.

Economic profit = [ROIC × Invested Capital] - [WACC × Invested Capital] For example, suppose that the cost of capital is 12 percent. Then the cost of capital for the

company is 12% on Rs.1,000 Lakhs capital invested = Rs. 120 Lakhs. It the net gain is Rs. 130 Lakhs, therefore Rs.130 Lakhs - Rs. 120 Lakhs = Rs. 10 Lakhs. This is the addition to shareholder wealth due to management’s hard work (or good luck). But if the cost of capital were 20 percent, then EVA would be negative by Rs. 70 Lakhs.


According to Stern Stewart, literally dozens of adjustments to earnings and balance sheets - in areas like R&D, inventory, costing, depreciation and amortization of goodwill - must be made before the calculation of standard accounting profit can be used to calculate EVA. To protect its trademark, Stern Stewart doesn't fully disclose the adjustments - making the job of using the metric even more difficult. Figuring out the cost of capital (WACC) is even more thorny. WACC is a complex function of the capital structure (proportion of debt and equity on the balance sheet), the stock's volatility measured by its beta, and the market risk premium. Small changes in these inputs can result in big changes in the final WACC calculation.

This method calculates a net return to shareholders. It considers the earnings after deducting a charge for the cost of capital. When firms calculate income, they start with revenues and then deduct costs, such as wages, raw material costs, overheads and taxes. But there is one cost that they do not commonly deduct i.e. the cost of capital. They even allow for depreciation of the assets financed by investors’ capital, but investors also expect a positive return on their investment. A business that achieves the break even point in terms of accounting profits is really making a loss; it is failing to cover the cost of capital. In order to judge the net contribution to value, it is necessary to deduct the cost of capital contributed to the company by its stockholders. Net income after deducting the return required by investors is called residual income or economic value added (EVA). Net return on investment and EVA are focusing on the same question. When return on investment equals the cost of capital, net return and EVA are both zero. But the net return is a percentage and ignores the scale of the company. EVA recognizes the amount of capital employed and the amount of additional wealth created. A growing number of firms now calculate EVA and tie management compensation to it. They believe that a focus on EVA can help managers concentrate on increasing shareholder wealth.

The EVA is a registered trademark (EVA™) by its developer, Stern Stewart & Company. The term EVA has been popularized by the consulting firm Stern–Stewart. But the concept of residual income has been around for some time, and many companies that are not Stern-Stewart clients use this concept to measure and reward managers’ performance. Other consulting firms have their own versions of residual income. McKinsey & Company uses Economic Profit (EP), defined as capital invested multiplied by the spread between return on investment and the cost of capital. This is another expression of the concept of residual income.

STRENGTHS AND WEAKNESSES OF ECONOMIC PROFIT

The map of metrics above helps to understand that economic profit it is one of several valid performance measures, each of which offer a different type of insight into a company. Finally the following strengths and weaknesses are reported in order to consider whether economic profit is an appropriate performance metric for the company one is evaluating:


ECONOMIC PROFIT'S STRENGTHS INCLUDE THE FOLLOWING

• If one had to rely on only one single performance number, economic profit is probably the best because it contains so much information (mathematicians would call it “elegant”): economic profit incorporates balance sheet data into an adjusted income statement metric.

• Economic profit works best for companies whose tangible assets (assets on the balance sheet) correlate with the market value of assets - as is often the case with mature industrial companies.

• Because it is a residual performance metric, it conveniently summarizes into a single statistic the value created above and beyond all financial obligations.

• By applying a capital charge, it corrects the key deficiency of earnings and earnings per share (EPS): they do not incorporate the balance sheet. Economic profit explicitly recognizes - by way of the capital charge - that capital is not free and, if growth is purchased with capital, economic profit recognizes that the growth is not free and assigns a charge for the capital used to purchase the growth.

• As an operational metric, it helps managers clarify how they create value. Generally, they do it either by investing additional capital that produces returns above WACC, by reducing capital employed in a business, by improving returns by growing revenues or reducing expenses or by reducing the cost of capital.

ECONOMIC PROFIT'S WEAKNESSES INCLUDE THE FOLLOWING

• Unless fully loaded and all cash adjustments are made, economic profit can be subject to accrual distortions. For example, because NOPAT is after depreciation and amortization, a company that does not reinvest capital to maintain its plant and equipment can improve its accrual bottom line simply by virtue of the declining depreciation and amortization line. This sort of attempt at boosting economic profit is known as harvesting the assets.

• It has the limitations of any single-period, historical metric: last year's economic profit will not necessarily give you an insight into future performance. This can be especially true if a company is in a turnaround situation or makes a large lump-sum investment, in which case, economic profit will immediately suffer (due to the higher invested capital base) but the expected future period payoff will not show up as a benefit in the calculation.

• Any value obtained by employees of the company or by product users is not included in the calculations.

• Although some proponents argue economic profit is “all you need”, it is very risky to depend on an single metric.

• The companies least suited for economic profit are high-growth, new-economy and high-technology companies, for whom assets are ‘off balance sheet’ or intangible.


UTILITY OF EVA

EVA’s most important use is in measuring and rewarding performance inside the firm. It is said, if carried out consistently, EVA should help us identify the best investments, that is, the companies that generate more wealth than their rivals. All other things being equal, firms with high EVAs should over time outperform others with lower or negative EVAs. But the actual EVA level matters less than the change in the level. According to research conducted by Stern Stewart, EVA is a critical driver of a company's stock performance. If EVA is positive but is expected to become less positive, it is not giving a very good signal. Conversely, if a company suffers negative EVA but is expected to rise into a positive territory, a good buying signal is given. Of course, Stern Stewart is hardly unbiased in its assessment. New research challenges the close relationship between rising EVA and stock price performance. Still, the growing popularity of the concept reflects the importance of EVA's basic principle: the cost of capital should not be ignored but kept at the forefront of investors' minds. Best of all, EVA gives analysts and anyone else the chance to look skeptically at EPS reports and forecasts. From a commercial standpoint, Economic Value Added (EVA) is the most successful performance metric used by companies and their consultants. Although much of its popularity is a result of able marketing and deployment by Stern Stewart, owner of the trademark, the metric is justified by financial theory and consistent with valuation principles, which are important to any investor's analysis of a company. Because it relies on invested capital, it is more suitable for analyzing asset-intensive firms (those whose value comes largely from tangible assets on the balance sheet) that exhibit somewhat predictable growth trends. The best use of economic profit tends to be in traditional and mature industries. It therefore has less relevance for firms that are valuable largely because of intangible, off-balance-sheet assets; economic profit has shown limited success in high-tech and service-oriented companies.

PROS AND CONS OF EVA

The advantages and disadvantages of EVA are as listed below:

PROS (ADVANTAGES) OF EVA

EVA, economic profit, and other residual income measures are clearly better than earnings or earnings growth for measuring performance. EVA is conceptually the same as the residual income measure long advocated by some accounting scholars (Source: R. Anthony, “Accounting for the Cost of Equity,” Harvard Business Review (1973), pp. 88–102 and “Equity Interest - Its Time Has Come,” Journal of Accountancy 154 (1982)) for its managers as well as value for shareholders. EVA may also highlight parts of the business that are not performing up to scratch. If a division is failing to earn a positive EVA, its management is likely to face some pointed questions about whether the division’s assets could be better employed elsewhere. EVA sends a message to managers: Invest if and only if the increase in earnings is enough to cover the cost of capital. For managers who are used to tracking earnings or growth in earnings, this is a relatively easy message to grasp. Therefore EVA can be used down deep in the organization as an incentive compensation system. It is a substitute


for explicit monitoring by top management. Instead of telling plant and divisional managers not to waste capital and then trying to figure out whether they are complying, EVA rewards them for careful and thoughtful investment decisions. Of course, if the junior managers’ compensation is tied to their economic value added, then they must also be given the power over those decisions that affect EVA. Thus the use of EVA implies delegated decision-making. EVA makes the cost of capital visible to operating managers. A plant manager can improve EVA by (a) increasing earnings or (b) reducing capital employed. Therefore underutilized assets tend to be flushed out and disposed of. Working capital may be reduced, or atleast not added too casually. Introduction of residual income measures often leads to surprising reductions in assets employed - not from one or two big capital disinvestment decisions, but from many small ones. EVA lets the business managers realize that even assets have a cost and hence stock won’t be lying idle. The firm will start using JIT and change the way they connect with their suppliers, and have them deliver raw materials more often.

CONS (LIMITATIONS) OF EVA

EVA does not involve forecasts of future cash flows and does not measure present value. Instead, EVA depends on the current level of earnings. It may, therefore, reward managers who take on projects with quick paybacks and penalize those who invest in projects with long gestation periods. Think of the difficulties in applying EVA to a pharmaceutical research program, where it typically takes 10 to 12 years to bring a new drug from discovery to final regulatory approval and the drug’s first revenues. That means 10 to 12 years of guaranteed losses, even if the managers in charge do everything right. Similar problems occur in startup ventures, where there may be heavy capital outlays but low or negative earnings in the first years of operation. This does not imply negative NPV, so long as operating earnings and cash flows are sufficiently high later on. But EVA would be negative in the startup years, even if the project were on track to a strong positive NPV. The problem in these cases lies not so much in EVA as in the measurement of income. The pharmaceutical R&D program may be showing accounting losses, because the accounting principles require that outlays for R&D be written off as a current expense. But from an economic point of view, the outlays are an investment, not an expense. If a proposal for a new business forecasts accounting losses during a startup period, but the proposal nevertheless shows positive NPV, then the startup losses are really an investment - cash outlays made to generate larger cash inflows when the new business hits its stride. In short, EVA and other measures of residual income depend on accurate measures of economic income and investment. Applying EVA effectively requires major changes in income statements and balance sheets.

CRITICISMS OF EVA

• EVA could be misleading as a wealth metric because it reflects momentary swings in the capital markets rather than inherent company performance.


• EVA is also shareholder-centric and hence of little relevance to the rest of the stake holders.

• EVA is identical to residual income, which was largely abandoned by companies years ago.

CONCLUSION

In the field of corporate finance, economic value added is a way to determine the value created, above the required return, for the shareholders of a company. Shareholders of the company will receive a positive value added when the return from the capital employed in the business operations is greater than the cost of that capital. On comparison of the traditional and modern parameters of measuring shareholders wealth creation it is identified that the modern parameters are superior over the traditional parameters of measuring shareholders wealth creation. There is a need for revision and reforms required in the parameters of measuring shareholders wealth creation due to the superiority of the modern parameters over the traditional parameters of measuring shareholders wealth creation. The corporates have to view shareholders not merely as a part-owner, who is a supplier of finance and share capital as merely a source of finance but have to shift their paradigm towards shareholders being the true owner of a corporate firm and to run the corporate firm with an ultimate objective of achieving shareholders wealth creation. Today EVA is not a mandatory part of financial reporting and hence it does not form a part of annual reports. Due to the increasing importance of EVA in future it should form a part of mandatory accounting information reported through annual reports.

REFERENCES [1] James L. Grant, Foundations of Economic Value Added, 2nd Edition. [2] S. David Young & Stephen F. O'Byrne, EVA and Value-Based Management: A Practical Guide to

Implementation. [3] Joel M. Stern, John S. Shiely & Irwin Ross, The EVA Challenge: Implementing Value-Added Change in an

Organization. [4] Karam Pal Singh and M.C. Garg, Deep and Deep, 2004, Economic Value Added (EVA) in Indian Corporates. [5] Arvind A. Dhond, SFIMAR Research Review, Issue 10, 2010, Shareholders Wealth Creation through

Economic Value Added (EVA). [6] Arvind A. Dhond, Economic Value Added (EVA), Special Study in Finance, Vipul Prakashan, 1st Edition,

2010. [7] Craig Savarese, Economic Value Added: The Practitioner's Guide to a Measurement and Management

Framework.

Fundamental Analysis of Indian Telecom Sector

Dr. Keyur M. Nayak* Abstract—Fundamental analysis on Indian telecom sector was done keeping in mind the fast pace of growth in this sector. This sector has achieved a lot in past few years and has a great potential to grow & flourish. Fundamental analysis tells us about the financial soundness and strong fundamental of the sector. The investment in this sector become a craze among the investors from the investor point of view it is very important to know the fundamental of the company before investing. Whether it is worth investing in company shares or not. Fundamental analysis tells when and where to invest. Intrinsic value of the shares tells us about the future potential growth of the shares. The basis of the study provides us the deep insight into the telecom sector companies.

Keywords: Fundamental Analysis, Financial Soundness, Intrinsic Value, Investing

INTRODUCTION

Indian telecom is world’s fastest growing telecom expected to grow three fold by 2012.Tremendous strides in this industry have been facilitated by the supportive and liberal policies of the Government. Especially the telecom policy of 1994 which opened the doors of the sector for private players. Rising demand for a wide range of telecom equipment has provided excellent opportunities for investors in the manufacturing sector. Provision of telecom services to the rural areas in India has been recognized as another thrust area by government which also helps for the enormous opportunities in this sector. Therefore telecom sector in India is one of the fastest growing sectors in the country and has been zooming up the growth curve at a feverish pace in the past few years. Any investor while making investment is concerned with the intrinsic value of the asset, which is determined by the future earning potential of the asset. In case of securities market, an investor has number of securities available for investment in telecom sector. But, he would like to invest in the one, which has good potential for future. In order to ensure the future earnings of any security, an individual has to conduct fundamental analysis of the company. Fundamental analysis of a company involves in-depth examination of all possible factors, which have bearing on the prospects of the company as well as its share price. Fundamental analysis is divided into 3 stages namely economic analysis, industry analysis, company analysis. Therefore fundamental analysis on Indian telecom sector was done keeping in mind the fast pace of growth in this sector.

* Laxmi Institute of Management, Sarigam

Fundamental Analysis of Indian Telecom Sector 389


Indiabulls – February 3, 2009 Research Report

Bharti Airtel Limited (Bharti) ended Q3’09 with more than 8.2 mn new customers, keeping its mobile wireless market share intact at 24.7%. The net revenue grew by a robust 6.8% q-o-q in a declining ARPU environment and amid a subdued sequential performance by the non-mobile segment. Target price reduced to Rs. 797: As new telecom operators roll out their services with the financial support of deep-pocket international players, competition is likely to intensify in the Indian telecom market. Hence, we expect a near-term contraction in Bharti’s market share. Other than this, we expect pressure on margins due to the rising network costs and advertising spend. Thus, we reduce our target price to Rs. 797. However, we maintain our positive outlook on the stock based on Bharti’s already scaled-up operations, superior execution, strong financial metrics, and brand equity and therefore maintain a Buy rating.

JP Morgan Research Report on 13 March 2009.

Our new Dec-09 PT is at Rs 600/share based on DCF (including Rs89/share for Indus stake) as opposed to an earlier PT of Rs725/share. The DCF value of Rs570/share with additional Rs89/share from Indus, makes for Rs659/share. we apply a 9% competition risk discount to get a price target of Rs600/share. Our PT implies a one-year forward P/E/EV/EBITDA of 11x/7x, below the historical average. However, Bharti’s stock is still ahead of the historical average on growth-adjusted multiples. Key upside risks to our price target are faster-than-expected subscriber growth and lower-than-expected ramp-up from new operators. Key downside risks are sharper fall in ARPMs due to competition, 3G bids rising irrationally, and regulatory policies (faster roll-out of MNP). DCF valuation (not including Indus) Our Dec-09 DCF fair value estimate is Rs570/share. The DCF estimate assumes 10- year revenue CAGR (2009-2019E) of 7%, long-term EBITDA margin of 34%, and terminal growth of 5.0%. We assume a beta of 0.94, risk-free rate of 9.0%, market risk premium of 6.0%, and cost of debt of 6.1% to arrive at a WACC of 12.53%. We believe that our revenue growth estimates are fair given the stable subscriber growth momentum in spite of increasing competition. The stock, we believe, looks more attractive on a rolling EV/EBITDA basis because growth rates have slowed sharply. Growth adjusted charts still suggest that the stock is overvalued.


Edelweiss Research Report on January 2009

Regulations Potential impact Higher spectrum charges Regulator has proposed one-time levy for over 6 2 MHz besides

• Higher spectrum charges will negatively impact EBITDA or lead to erosion of scale economies

• Negative for majority of incumbents who hold spectrum in excess of 6.2 Mhz

Proposed reduction in termination Charges

• Will impact net recipients of termination charges—primarily GSM operators because of higher proportion of incoming calls on their network

Introduction of IP telephony • Could lead to pricing pressures on LD tariffs • No significant impact on existing operators because of

low broadband penetration • Business case for ISPs not favourable given

accompanying regulatory levies and carriage charges Mobile number portability (MNP) • Increase in subscriber acquisition costs coupled with

higher churn rates • Likely to lead to increasing competitive pricing

pressures and short-term volatility in earnings and profitability

Mobile virtual network operator (MVNO) • Positive for new entrants as it will allow utilisation of spare capacity

• Neutral to mild negative for incumbents, as it could lead to further tariff pressures on the voice business


Primary Objectives

• To analyse the financial performance of the Indian telecom sector companies. • To measure the intrinsic value of shares of telecom companies • To suggest the buy or sell decision to the investors


Information Sources

Information has been sourced from namely, books, newspapers, trade journals, and white papers, industry portals, industry news and developments.

Tools of Analysis

The analysis methods includes the following Economic Analysis, Industry Analysis and Common Size financial Statement Analysis.

Key Players to be Analyzed

This section provides the overview, key facts, financial information, future plans and business strategies of prominent players in the Indian Telecom market like Reliance Communications, Bharti Airtel, Tata Teleservices and Idea cellular.


DATA ANALYSIS AND FINDINGS

Economic Analysis

Favourable and Improving Demographics

India has one of the youngest populations in the world with around 68% of the current population below 35 years of age. This factor, coupled with increasing per capita income,has been a key driver of wireless growth in India in the last two years. By 2011, 65% of the Indian population will still be below 35 years of age, compared to about 50% for China, the largest wireless market in the world today. India’s working population is estimated to overtake the total population of entire Europe in that year. We expect this young working population to drive wireless subscriber penetration and faster growth compared to the other markets in the next five years.

Rising Middle Class Will Drive Spending

Economic growth has led to a twofold increase in the number of middle-class households in India from 77m (60% of the total households) as of 1994-1995 to over 150m (74% of total households) today. This increase in the consuming class, coupled with corporate profit growth, has led to strong growth in communication spending in recent years. Yet, despite this increase, communication spending as a percentage of total private expenditure remains significantly low. As incomes rise further, we believe that such spending is only set to rise.

Six States Will Together Account For 40% of Net-Adds

We highlight below some of the states that we forecast will see stronger growth in the coming quarters. We forecast that these six states (Maharashtra, Gujarat, Andhra Pradesh, Karnataka, Uttar Pradesh - West and Uttar Pradesh -East) will account for about 40% of total net-adds in India in the next four years.

INDUSTRY ANALYSIS

Enabling Policies, Competition, Strong GDP Growth Power Subscriber Numbers

The Indian Mobile Telecom Industry has been one of the best examples of the success of the Indian Government's reforms programme. The sector has grown at a scorching pace over the past few years aided by enabling regulations, heightened competition resulting in across-the board lowering of telecom tariffs, higher disposable income due to India's strong GDP growth rates and greater coverage of India's landscape by mobile service operators. Going ahead, there exists scope for mobile companies to grow their subscriber base. Mobile tele-density stands at around 26% as of July 2008, with 291.2mn subscribers. China, on the other hand, has a mobile tele-density of over 45% and has around 600mn mobile subscribers. Even on this huge base, the country is still adding 7.5-8mn subscribers each month. Thus, there exists significant scope for further growth of the Indian Telecom Industry.


India To Have 541.3mn Mobile Subscribers By Fy2011

We estimate the Indian mobile market hit 541.3mn mobile by FY2011 (excluding BSNL and MTNL CDMA-WLL subscribers). This implies a CAGR growth of 28.3% over FY2008-11E. Thus, the industry in the medium-term is expected to continue to record good subscriber growth rates on as-yet low penetration levels, heightened competitive intensity, a continued fall in minimum subscription costs and tariffs leading to better affordability for lower-income rural users, expansion of coverage area by mobile operators and government support through schemes like the rural infrastructure roll out funded by subsidies from the USO Fund. We expect a majority of this growth to be driven by the 'A' and 'B' circle categories, which have been rapidly growing over the past few years and where tele-density is still relatively low at 21-29% levels.

Rural India, The Next Bastion of Growth

The next phase of growth will undoubtedly be led by rural India. It should be noted that a majority of the Indian population still does not have access to mobile services and has largely remained untouched by the 'mobile revolution' that has swept the country. This has led to a huge 'digital divide', which is reflected in the urban tele-density levels, which stand at over 60%, whereas rural tele-density has barely touched double digits. As many as 800mn people in the country do not own a mobile phone and connection, in spite of the rapid expansion that has been witnessed over the past many years by all mobile operators. Thus, this is clearly the next bastion of growth for mobile operators.

Fixed Line Subscriber Base‐'Triple‐Play', Value‐Added Services Provide Hope

India's fixed line subscriber base has dwindled. With mobile telephony proving to be a considerably superior technology, there has been de-growth in the fixed line base, with many people surrendering their landlines in favour of mobile phones. In July 2008, the total number of fixed line subscribers in the country stood at 38.76mn (penetration of just 3.4%). Going forward, to grow the fixed line subscriber base, it is necessary for telecom companies to introduce a greater number of value-added services such as broadband and 'triple play', that is, voice, data and video connectivity through a single line, also known as Internet Protocol Television (IPTV). This could arrest the decline in the fixed line subscriber base. The move towards fully integrated entertainment companies. Major telecom companies are taking initiatives to expand their suite of services and become 'fully integrated entertainment players' rather than remaining merely telephone companies. These companies are making investments in businesses such as DTH and IPTV with a view to tap a greater share of the entertainment spend of consumers. Ball-park calculations suggest an approximate market size of Rs27,000cr for the DTH market, assuming average cable expenditure of Rs300 per household per month and if all C&S households (75mn) were assumed to go for DTH connections. Thus, the market size and growth potential is significant.

Spectrum Remains The Biggest Concern…

Despite the strong growth prospects of the sector, the biggest concern remains that of spectrum. Spectrum is the lifeblood of the Telecom business, without which growth is likely


to get severely restricted. Even though in the short-term, the issue does seem to have been resolved, going ahead, with the Defence Forces scheduled to release more spectrum for 3G services, any delays on this front could have adverse implications for the sector. The ever-increasing competitive intensity in the sector, with licences and spectrum in several circles like Tamil Nadu (including Chennai), Orissa, Kerala and Karnataka allotted to newer operators like Loop Telecom, Swan Telecom, Datacom and Unitech Wireless, is also a concern and could lead to unrealistic pricing levels to grab subscribers.

Announcement of 3G and BWA Policies

The government in August 2008 finally announced the much-awaited 3G and Broadband Wireless Access (BWA) Policies. 3G mobile services are expected to facilitate higher speeds and data throughputs, which enable the delivery of a wide range of multimedia services, including video telephony, e-commerce and television on mobile devices like handsets, smart phones and palm tops.

COMPANY ANALYSIS

Sales Turnover

The sale turnover of Bharti Airtel is very high which shows that it is undisputed leader in the market. Increasing sales offers strong sign of strong fundamentals. Another two major players are Reliance Communication and Idea Cellular. But, even both together can not match the size of Bharti Airtel.

TABLE 1: COMMON SIZE PROFIT & LOSS ACCOUNT

Particulars Bharti Airtel

Mar '10

%

Reliance Comm

Mar '10

%

Idea Cellular Mar '10

%

Tata Comm

Mar '10

%

Net Sales 35,609.54 100.00 13,554.60 100.00 11,850.24 100.00 3,218.04 100.00 Other Income 1,118.46 3.14 2,455.17 18.11 383.83 3.23 359.95 11.18 Total Income 36,693.09 103.04 16,009.77 118.11 12,234.07 103.23 3,577.99 111.18 Total Expenses 21,608.29 60.68 11,361.17 83.81 8,606.15 72.62 2,467.43 76.67 Operating Profit 13,966.34 39.22 2,193.43 16.18 3,244.09 27.37 750.61 23.32 PBDIT 15,084.80 42.36 4,648.60 34.29 3,627.92 30.61 1,110.56 34.51 Interest 283.35 0.79 1,253.84 9.25 982.44 8.29 251.02 7.80 PBDT 14,801.45 41.56 3,394.76 25.04 2,645.48 22.32 859.54 26.71 Depreciation 3,890.08 10.92 1,511.24 11.14 1,366.61 11.53 574.73 17.85 Profit Before Tax 10,703.53 30.05 1,883.52 13.89 1,094.28 9.23 284.81 8.85 Tax 1,177.87 3.30 1,404.59 10.36 115.08 0.97 106.16 3.29 Reported Net Profit 9,426.15 26.47 478.93 3.53 1,053.66 8.89 483.18 15.01 Earning Per Share (Rs) 24.82 0.06 2.32 0.017 3.19 0.02 16.95 0.52 Equity Dividend (%) 20.00 0.05 17.00 0.12 0.00 0 0.00 0 Book Value (Rs) 96.24 0.27 244.66 1.80 34.59 0.29 255.47 7.93

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Operating Profit

As there is constant upsurge in the operating profit of the companies, which represents the profit of a company made from its actual operations and excludes certain expenses and


revenues that may not be related to its central operations and shows its effective control over costs, or those sales are increasing faster than operating costs. As it is more reliable measure of profitability since it is harder to manipulate with accounting tricks than net earnings. The operating profit margin is the highest in case of Bharti Airtel followed by Idea Cellular, while it is comparatively lower in case of Reliance Communication and TATA Communication.

Net Profit Margin

Due to the high operating profit margin of Bharti Airtel, the net profit margin is also higher as compared to other players. It is interesting to observe that Idea Cellular, Reliance Communication have very low net profit margin while TATA Communication is better than these two players. It indicates that indirect expenses are higher in case of theses two companies.

TABLE 2: COMMON SIZE BALANCE SHEET

Particulars

Bharti Airtel Mar ‘10

%

Reliance CommMar '10

%

Idea CellularMar '10

%

Tata Comm Mar '10

%

Liabilities Total Share Capital 1,898.77 4.55 1,032.01 1.38 3,299.84 18.35 285.00 2.87 Equity Share Capital 1,898.77 4.55 1,032.01 1.38 3,299.84 18.35 285.00 2.87 Share Application Money 186.09 0.45 0.00 0.00 44.45 0.25 0.00 0.00 Reserves 34,650.19 82.94 49,466.88 65.98 8,112.95 45.11 6,995.78 70.52 Revaluation Reserves 2.13 0.01 0.00 0.00 0.00 0.00 0.00 0.00 Net worth 36,737.18 87.94 50,498.89 67.35 11,457.24 63.71 7,280.78 73.40 Secured Loans 39.43 0.09 3,000.00 4.00 5,988.61 33.30 1,281.76 12.92 Unsecured Loans 4,999.49 11.97 21,478.28 28.65 537.81 2.99 1,357.15 13.68 Total Debt 5,038.92 12.06 24,478.28 32.65 6,526.42 36.29 2,638.91 26.60 Total Liabilities 41,776.10 100.00 74,977.17 100.00 17,983.66 100.00 9,919.69 100 Assets Net Block 28,024.97 67.08 30,612.48 40.83 14,927.06 83.00 4,504.80 45.41 Capital Work in Progress 1,594.74 3.817 1,683.52 2.245 462.58 2.572 386.15 3.89 Investments 15,773.32 37.76 31,898.60 42.54 2,755.13 15.32 2,501.30 25.22 Total Current Assets 2,187.11 5.235 2,118.89 2.826 605.95 3.369 736.44 7.42 Total CL & Provisions 12,842.00 30.74 9,223.37 12.3 4,451.52 24.75 2,259.34 22.78 Net Current Assets -3,616.91 -8.658 10,782.57 14.38 -161.11 -0.896 2,527.44 25.48 Total Assets 41,776.12 100.00 74,977.17 100.00 17,983.66 100.00 9,919.69 100.00


From the above table, it can be concluded that all the companies are having large accumulated reserve, which has been created on the base of less amount of equity capital. The debt equity ratio is also adequate in case of all the companies which indicate that they are able to take the advantage of leverage. However it is interesting to know that the debt portion is relatively lower in case of Bharti Airtel and higher in case of Reliance (32.65%) and Idea Cellular (36.29%) as compared to (12.06%) of Bharti Airtel. However it cab be concluded that TATA Communication has moderate debt policy. We can also conclude that Reliance Communication is having the highest net worth, but return is less on it, while Bharti Airtel has less net worth compared to Reliance, but the return is higher than Reliance. The fixed assets and total asset turnover ratio is very good in case of Bharti Airtel as compared to any other players in the market.


TABLE 3: INTRINSIC VALUE BASED ON EPS AND RISK FREE RATE OF RETURN

Name of the Company

Current EPS

Risk Free Rate of Return

Value of

Shares

ForecastedEPS

Forecasted Price

As on date

Currently Traded Price as on dated

Buy/Sell Decision

Rcomm 2.32 4% 58.00 2.55 63.8 130.00 Sell Bharti Airtel 24.82 4% 620.50 27.30 682.55 338.00 Buy Idea Cellular 3.19 4% 79.75 3.50 87.72 69.50 Buy Tata Communication

16.95 4% 423.75 18.64 466.12 258.35 Buy


There are actually a few different ways to calculate the intrinsic value but we'll just go over the most common method. To get started, we must first gather the company's EPS figures for the year ended 2010. We then take this number and divide it by the annual return of the investment we are comparing it with (discount rate). We compare it with Treasury bonds, current rate is 4.00%.we simply divide the EPS by 0.04. We get the intrinsic value of Rs. 58.00 relative to government bonds. If we are interested in finding out what the stock will theoretically be worth next year, we just substitute next year's expected EPS with the increment of 10 % in current year’s EPS. The stock is expected to 63.80 per share next year (2011), and we get intrinsic value of Rs.58.00, relative to treasury bonds.

SUGGESTION

The company shares are being traded at Rs. 130 (November, 2010) on BSE which is approximately higher to value we get through intrinsic value. Intrinsic value is lesser than current market price, which means that its investing in company shares is not advisable. It is better to sell it in the market to book the profit. In case of remaining three companies the intrinsic value is more than the traded price which means the shares are under priced and really good to invest in such companies to earn a better return in future.

CONCLUSION

Indian telecom is world’s fastest growing telecom expected grow three fold by 2012.Tremendous strides in this industry have been facilitated by the supportive and liberal policies of the Government. Especially the Telecom Policy of 1994 which opened the doors of the sector for private players. Rising demand for a wide range of telecom equipment has provided excellent opportunities for investors in the manufacturing sector. Provision of telecom services to the rural areas in India has been recognized as another thrust area by govt.which also helps for the enormous opportunities in this sector. Therefore telecom sector in India is one of the fastest growing sectors in the country and has been zooming up the growth curve at a feverish pace in the past few years. And even the Indian Wireless Market is booming which has plenty of room for growth. In FY 2010, Bharti Airtel shows strong growth, their sales turnover is very high as well as their operating profit. ROI and leverage ratio is also good for the company. Debt -equity ratio is balanced. Therefore Bharti Airtel is good picks for investment compared any other company in the Indian telecom sector.

Market Anomalies in the Indian Stock Market

Girija Nandini* and Dr. Bishnupriya Mishra** Abstract—Numerous studies have been conducted to find the stock behaviour across the world. The most commonly documented market anomalies are the January effect and the day-of-the-week effect. According to day-of-the-week phenomenon the average daily returns of the market is not equal for all days of the week. Literature available in this area suggests that there is existence of day of the week effect not only in the USA but also in U.K, Canada, Australia, Singapore, Malaysia, Hong Kong, Turkey etc. This paper attempts to investigate the presence of seasonal effects in the Indian stock market through week day effect and month of the year effect .The anomalies in the Indian stock market have been studied by the two major indices, the Bombay Stock Exchange Index and the National Stock Exchange Index. The closing price of SENSEX and NIFTY has been taken for 17 years , from 1993 to 2009.Variety of statistical techniques have been used to see if any seasonality is present in the Indian Stock market.

Keywords: Stock market, India, Seasonality, Day of the week effect, month of the year effect

INTRODUCTION

Anomalies in stock-market returns, such as weekend, day of the week, and January effects, have been of considerable interest. Engle (1993) argues that risk-averse investors should reduce their investments in assets with higher return volatilities. Therefore, the investigation of return and volatility patterns is a useful exercise. Most of these patterns are associated with the day-of-the-week (DOW) effects and month of the year effect. Broadly speaking, calendar effects occurs when the returns of financial assets display specific characteristics over specific days, weeks, months or even years. Undoubtedly, this is in contradiction to the efficient market hypothesis where returns should be random and as such, should not be associated with a specific time period. However, a number of studies have documented the presence of calendar effects on several stock markets. For instance, studies by French (1980), Gibbons and Hess (1981), Keim and Stambaugh (1984) found the existence of a Monday effect on the US market.

According to the Efficient Market hypothesis, past prices of shares should have no predictive power of future prices. In effect, prices should be random. However, numerous studies have been carried to prove that market inefficiencies do exist and that anomalies may be in terms of seasonal effects over the day of the week, the months of the year or over specific years. For instance, the months of year effect would exist if returns on a particular month are higher than other months. This will negate the notion of efficiency in markets since traders will be able to earn abnormal returns just by examining patterns monthly returns and setting trading strategies accordingly. *Regional College of Management, Bhubaneswar **Academy of Management Studies, Bhubaneshwar

Market Anomalies in the Indian Stock Market 397

Essentially, this will entail an inefficient market situation where returns are not proportionate with risk. Several studies such as Keim (1983), Ariel (1987) and Jaffe et al. (1989) have pinpointed out the existence of a monthly effect on the US and other developed markets. However, most of the studies reveal the existence of a January effect where returns on January tend to be larger than returns on other months. One must consider the fact that those anomalies may not necessarily mean that these market are inefficient. In fact, it may turn out that gains on a specific time period may be insignificant when transactions costs are taken into account. Also, one must control for risk premium which may be time varying such that high returns on a specific day may be associated with high risk on that same day. Over the last two decades, considerable attention has been paid to estimate and predicting aggregate stock market volatility. Anomaly is defined as the degree to which a market rises or falls in a short period of time .Since the 1970’s volatility in the bond and stock markets has increased globally and stock market volatility is not only detrimental to investors but also can be harmful to the stability of national and global economic system. So it needs a brief study of stock market anomaly.

A common problem in the low and slow growth of small developing economies is the swallow financial sector. Financial markets play an important role in the process of economic growth and development by facilitating savings and channeling funds from investors to company. Volatility may impair the smooth functioning of the financial system and adversely affect economic performance. Similarly, stock market volatility also has a number of negative implications. A rise in stock market volatility can be interpreted as a rise in risk of equity investment and thus a shift of funds to less risky assets. This move could lead to a rise in cost of funds to firms and thus new firms might bear this effect as investors will turn to purchase of stock in larger, well known firms. While there is a general consensus on what constitutes stock market volatility and, to a lesser extent, on how to measure it, there is far less agreement on the causes of changes in stock market volatility. Some economists see the causes of volatility in the arrival of new, unanticipated information that alters expected returns on a stock . Thus, changes in market volatility would merely reflect changes in the local or global economic environment. Others claim that volatility is caused mainly by changes in trading volume practices or patterns, which in turn are driven by factors such as modifications in macroeconomic policies, shifts in investor tolerance of risk and increased uncertainty. So the study on market anomalies in India can help forecasters and also the investors for the analysis of their investment.


The objective of the study is to examine the anomaly in the Indian stock market .More specifically the objective of the study are

• To find out the day of the week on which the stock market return is the highest and the day on which it is lowest.

• To examine the month of the year pattern for the highest and that for the lowest stock market returns.


• To study the significance of seasonality in returns across different days of the week and different months of the year.

LITERATURE REVIEW

There is undoubtedly an extensive literature on the day of the week effect. In fact, studies on such stock market anomalies started since the late 1930 where Kelly (1930) revealed the existence of a Monday effect on the US markets where the returns turned out to be negative. From thereon, researchers have documented findings in support of the low Monday returns in the US markets. Fields (1931) studied the day of the week effect and was of the opinion that the security prices declined on Saturday and this was because of the unwillingness of traders to carry their holdings over the uncertainties of a week-end which led to liquidation of long accounts. An investigation of the day of the week effect was made by Godfrey, Granger and Morgenstern (1964), who reported that Monday’s variance was about 20% greater than other daily returns. Fama (1965) had also reached the same conclusion. Cross (1973) using the standard and poor’s 500 index showed that the Monday returns were negative and the Friday returns were very high in the U.S stock market. Officer (1975) detected the presence of seasonality in Australian stocks market.French 1980 analysed the day of the week effect for the period 1953 to 1977 by taking the Standard and Poor’s Composite Portfolio index and found out that the average return for Monday was significantly negative for the entire period .

Chaudhury (1991) studied the seasonality in share returns particularly the day of the week effect in the Indian context for the period June 1988 to January 1991. He observed that return on Monday was negative. Broca (1992) also studied the day of the week patterns in the Indian stock market for the period April 1984 to December 1989 using Bombay Stock Exchange National Index of equity price and observed that Wednesday consistently earned the lowest (negative) returns where as Friday exhibited the highest returns in a week. Similarly, Dubois and Louvet (1996) documented the existence of a Monday effect on nine developed markets where as Tong (2000) reported this stock market anomaly in twenty three stock markets which include European, Asian and North American markets. Moreover, Nath and Dalvi (2004) examined the week day effect in the Indian equity market and found evidence of Monday and Friday effects before the rolling settlement in 2002. Nath & Dalvi examines empirically the day of the week effect anomaly in the Indian equity market for the period from 1999 to 2003 using both high frequency and end of day data for the benchmark Indian equity market index S&P CNX NIFTY. Using regression with dummy variables, the study finds that before introduction of rolling settlement in January 2002, Monday and Friday were significant days. Choudhary and Choudhary (2008) studied 20 stock markets of the world using parametric as well as non-parametric tests. He reported that out of twenty, eighteen markets showed significant positive return on various days other than Monday.

James and Edmister (1981) had observed that there is existence of the January effect in the stock market. Stoll and Whaley (1983) , Blume and Stambaugh (1983) had studied the month of the year effect and observed that the January effect existed with respect to small firms. Lakonishok and Smidt (1984) had also confirmed the January effect in their study . Berges, Mc Connell and Sclarbaum (1984) investigated the January effect in Canada stock


market for the period 1951-80 and had a strong evidence in favour of January effect. Lamoureux and Sanger (1989) examined the turn of the year effect, the firm size effect and relationship between these two effects for a sample of OTC stocks traded via the NASDAQ reporting system over the period 1973 to 1985. A recent study of Balaban (1995) investigated the month of the year effect on the Turkish stock exchange. His analysis showed that January, June and September had significantly higher returns than other months and among these, January had a compounded return of 22%, about four times greater than the global return if all months are considered.

STOCK MARKET IN INDIA

The stock markets in India have an important role to play in the building of a real shareholders democracy. A market, which deals in securities that have been already issued by companies, is known as the secondary market or stock Market. For the efficient growth of the market, a Sound secondary market is an essential requirement. There are currently 23 recognized stock exchange in India of which 4 are national and 19 are regional exchanges. The four national level exchanges are Bombay Stock Exchange (BSE), National Stock Exchange (NSE), Over the Counter Exchange of India (OTCEI) and Inter-connected Stock Exchange of India (ISE). All these exchanges operate with due recognition from the government under the Securities & Contracts (Regulations) Act, 1956. The overall development and regulation of the securities market was entrusted to the Securities and Exchanges Board of India (SEBI) by an act of Parliament in 1992. There are stringent regulations to ensure that directors of joint stock companies keep their shareholders fully informed of the affairs of the company.

The first stock exchange in India was started in Bombay in 1875. BSE was established in 1875 under the name of “The Native Share & Stock brokers Association”. It is the oldest Stock exchange in Asia. In March 1995,BSE has introduced screen based trading called BOLT (BSE on-line trading).The national stock exchange (NSE)was set up in Mumbai in November 1994.The main objective is to provide a fair, efficient and transparent securities market to investors using an electronic communication network. Today with the availability of the Internet and broadband communication, most of the securities trading is conducted at NSE and BSE through trading terminals available all over India .The Inter-connected Stock Exchange of India Limited (ISE) was promoted by 14 regional stock exchanges, with a view to provide trading connectivity to all members of the participating exchanges, in a cost-effective manner. This, like all other national exchanges, provides trading, clearing, settlement, risk management and surveillance support to its dealers and traders, in order to address the needs of smaller companies and retail investors in smaller towns .OTCEI was promoted in 1990 as a profit making company, along the lines of NASDAQ in the USA. Its main objective was to help enterprising promoters in raising finance for new projects in a cost effective manner and to provide investors with a transparent and efficient mode of trading. OTCEI introduced many novel concepts to the Indian capital markets. It was the first to offer screen-based nationwide trading, sponsorship of companies, market making and scripless trading. It primarily targeted technology related growth companies for listing. Notwithstanding its excellent start, the exchange did not take off in a big way over the years.


The most visible and tracked parameter of any stock market is the movement of the stock index. This is just a number that helps to measure the movement of the market against a benchmark index, taken as 100, on a base year. Most stock indices attempt to be proxies for the market they exist in. Each stock exchange has a flagship index like the Sensex of BSE or the Nifty of NSE. An index is calculated daily by tracking the share prices of its constituent member companies. For example, the Sensex is an index comprising 30 component stocks representing a sample of large, well established and leading companies while the Nifty consists of 50 company stocks. Sensex and Nifty are calculated using market capitalization weighted method. Every index is associated with a base year. For example, the base date for Sensex is 1st April 1979 and for the Nifty is 1st April 1995 .This means that the Sensex and Nifty were assumed to be 100 on these respective base dates. It may be interesting to know that Sensex actually came into existence only on 1st January, 1986, when the index was computed at 598.53. In fact, the base date does not have any significance beyond the introduction date, since for all the subsequent days the index is calculated by comparing the previous day’s value. In addition to the flagship indices, stock exchanges also maintain & publish other indices like BSE-100 Natex, BSE Dollex(BSE Sensex in US Dollar terms), BSE-200, BSE-500, S & P CNX Nifty Junior(Comprises next batch of liquid securities after S&P CNX Nifty) , S&P CNX Defty(measured in US Dollar Terms), S&P CNX Midcap, S&P CNX 500 and many other sector or industry specific indices like ET-Mindex(Comprising 30 companies media and information technology sectors and calculated by the Economic Times).

These indices are useful for certain specific purposes. For example, the BSE Dollex or S&P CNX Defty is more relevant for a US citizen investing in India than the Sensex or Nifty.

FUNCTIONS OF STOCK MARKET

The stock market occupies an important position in the financial system. It performs several economic functions and renders invaluable services to the investors, companies and to the economy as whole. They may be summarized as follows:

• It gives liquidity and marketability to the Securities • It ensures safety of funds invested because they have to function under strict rules and

regulations. • Generally securities are transferable in nature and one investor is substituted by

another, so the companies assured of long term availability of funds. • The profitability and popularity of companies are reflected in stock prices. Investors

are attracted towards securities of profitable companies and this facilitates the flow of capital into profitable channels.

• Stock market provides room for the price quotation and public exposure, by which a company is conscious of its status and motivated to improve the performance.

• It mobilizes the savings of the public and promotes investment through capital formation.

• The changing business condition in the economy is immediately reflected on the stock market. Booms and depressions can be identified through the dealings on the stock market and suitable monetary and fiscal policies can be taken by the govt.



The data for this study consists of BSE and NSE data that comprise of daily closing price of SENSEX and NIFTY for the period 1993-2009. All the data points where returns are zero have been eliminated. The tests performed are from the parametric group and the various hypothesis tested are listed below. Multiple Regression using dummy variables has been carried out and the P value is used to test the significance.

The daily returns are calculated as:

( ( ))( ) 100( 1)

Ln I tR t xt

=−

Day of the week Effect

Model: Rt =a1d1 +a2d2 +a3d3 +a4d4 + a5d5 + ut

where Rt is the return on day t, I(t) refers to index price on day t; a1 to a5 are the mean return for each day-of-the-week; d1 through d5 are day-of-the-week dummies that are either 0 or 1 (d1 = 1 for Monday and 0 otherwise and so on); ut is the random error term for day t.

Hypothesis (Ho): a1 =a2 =a3 = a4 =a5

If this hypothesis is rejected, it would imply that the mean daily returns are significantly different from each other, i.e. there is seasonality in returns across different days of the week.

Month of the year Effect

Model: Rt = b1Djan + b2Dfeb + b3Dmar + b4Dapr + b5Dmay + b6Djun + b7Djuly + b8Daug + b9Dsep+ b10Doct + b11Dnov + b12Ddec + ut

where Rt is the monthly return on month t, b1 to b12 are the mean return for each month of the year. Djan through Ddec are month of the year dummies that are either 0 or 1 (Djan = 1 for January and 0 otherwise and so on); ut is the random error term for month t.

Hypothesis (Ho): b1=b2=b3=b4=b5=b6=b7=b8=b9=b10=b11=b12

If this hypothesis is rejected, it would imply that the mean monthly returns are significantly different from each other, i.e. there is seasonality in returns across different months of the year.

ANALYSIS OF DATA AND RESULTS

The table 1 below provides summary statistics for daily Nifty returns across the days of the week for 17 years from 1993-2009.


TABLE 1: SUMMARY STATISTICS FOR DAILY NSE(50) RETURNS

Column 1 Mon Tue Wed Thus Fri Mean -0.050935 -0.03481 0.283498 0.057913 0.049642 Standard Error 0.0327766 0.052157 0.057022 0.056617 0.060441 Median 0.0109513 0.032793 0.181286 0.116295 0.083227 Standard Deviation 0.8879969 1.40726 1.545922 1.535976 1.597965 Variance 0.7885385 1.98038 2.389874 2.359221 2.553491 Kurtosis 5.4021375 5.210285 1.890467 2.224008 3.070398 Skewness -0.899074 -0.2233 0.367184 -0.03057 -0.23293 Observations 826 830 836 832 795

TABLE 2: SUMMARY STATISTICS FOR DAILY BSE(30) RETURNS

Column 1 Mon Tue Wed Thus Fri Mean 0.009 0.005 0.112 0.011 -0.009 Standard Error 0.033 0.0523 0.057 0.056 0.065 Median 0.071 0.0558 0.091 0.08 0.095 Standard Deviation 0.918 1.4651 1.596 1.581 1.792 Sample Variance 0.843 2.1465 2.546 2.501 3.21 Kurtosis 3.787 3.8186 1.599 1.777 4.161 Skewness -0.71 -0.182 0.255 -0.02 -0.476 Observations 821 835 845 836 797

Table1 & Table 2 reports the preliminary statistics (evidence) for the returns for the each day of the week. Study shows that the Wednesday returns appeared to be higher (0.112) relative to other trading days and Friday return(-0.009) is lowest in BSE. But in NSE the Wednesday returns (0.2834) is higher relative to other trading days and Monday return(-0.0509) is lowest. Additionally, the Standard Deviation (SD) is used to measure the risk return tradeoffs across the days. Essentially a high Standard Deviation (SD) can be the result of either higher return or higher risk or even both.. In BSE Wednesday has the highest SD (1.596) and Monday has the lowest (0.918) SD. But in NSE Friday has the highest(1.5979) SD and Monday has the lowest (0.887)SD. In BSE and NSE only Wednesday is positively skewed. This inconsistent pattern may suggest that returns may be random and as such, may reduce support for any strong argument in favour of a day of the week effect.

NSE TABLE 3: TESTING OF THE DAY OF WEEK EFFECTS

Monday Tuesday Wednesday Thursday Friday Coefficient 0.132 0.186 0.019 -0.081 -0.113 P-value .361 .64 .477 .312 .188

BSE TABLE 4

op Monday Tuesday Wednesday Thursday Friday Coefficient 0.152 0.112 0.143 -0.093 0.072 P-value .284 .252 .079 .245 .348

Table 3 & table 4 indicate that the variation in returns across different days of the week in both BSE & NSE is not significant at the 5% level, i.e. the null hypothesis is accepted. This suggest that no evidence in favour of the day of the week effect. The results are in sharp


contrasts with the findings of Gibbons and Hess (1981), Mills and Coutts (1995), and Arsad and Coutts (1997) where the significant day of the weeks effects were noted in the US and UK markets.

TABLE 5: SUMMARY STATISTICS FOR MONTHLY NSE(50) RETURNS

Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec Mean -0.07 2.29 -2.82 0.72 1.16 0.87 1.70 2.17 0.39 -2.73 2.79 4.65 Standard Error 2.33 1.48 2.04 1.87 2.59 1.91 1.48 1.58 1.90 2.42 2.03 1.08 Median 0.21 2.05 -2.44 -2.02 3.13 1.84 3.38 0.62 3.38 -2.37 3.75 5.29 Standard Deviation 9.32 6.09 8.39 7.73 10.68 7.87 6.10 6.50 7.82 9.96 8.38 4.47 Sample Variance 86.83 37.07 70.41 59.70 114.12 61.98 37.20 42.29 61.12 99.27 70.21 19.97 Kurtosis -0.15 0.47 -0.83 -1.16 0.60 1.39 -0.27 -0.22 -1.03 3.47 -0.24 1.78 Skewness -0.11 0.47 -0.04 0.34 0.19 -0.96 -0.83 -0.10 -0.48 -0.93 -0.18 -0.06 Observations 16 17 17 17 17 17 17 17 17 17 17 17

TABLE 6: SUMMARY STATISTICS FOR MONTHLYBSE (30) RETURNS

Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec Mean 0.41 2.02 -3.12 -3.10 0.97 1.14 1.79 2.23 0.17 -2.65 2.43 4.26 Standard Error 2.11 1.47 2.01 2.01 2.59 1.98 1.46 1.58 2.01 2.24 2.07 1.059 Median 0.39 2.38 -3.33 -3.33 2.20 2.01 4.21 1.44 2.84 -2.02 3.92 4.495 Standard Deviation 8.45 6.05 8.30 8.30 10.67 8.15 6.03 6.50 8.30 9.22 8.53 4.365 Sample Variance 71.33 36.57 68.84 68.84 113.80 66.43 36.32 42.21 68.88 85.03 72.68 19.05 Kurtosis -0.12 0.08 -0.94 -0.94 0.51 1.87 -0.38 -0.32 -1.22 2.40 -0.46 1.486 Skewness 0.11 0.31 0.08 0.08 0.44 -1.12 -0.87 -0.31 -0.35 -0.79 -0.13 0.169 Observations 16 17 17 17 17 17 17 17 17 17 17 17

Table 5 & Table 6 reports the preliminary statistics (evidence) of the returns for the month of the year. Study shows that the December return appeared to be higher relative to other months and March return is lowest in BSE as well as NSE. Standard Deviation (SD) is highest in May and lowest in December in BSE as well as NSE. On overall, the mean returns are positive for nine months except on January, March and October in NSE. But in BSE the mean returns are positive for nine months except on March, April and October. In NSE the month Feb, April and May is positively skewed but in BSE January, February, March, April and May is positively skewed.

NSE TABLE 7: TESTING OF MONTH OF THE YEAR EFFECTS

Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec Coefficient 0.15 1.14 0.16 0.74 -.91 -1.28 0.77 0.84 0.14 1.07 0.78 2.68

P-value 0.94 0.73 0.93 0.78 0.35 0.54 0.80 0.74 0.96 0.54 0.73 0.41

BSE TABLE 8

Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec Coefficient -.70 2.74 1.15 0.51 1.74 -1.46 0.20 0.66 0.62 1.08 1.09 3.19 P-value 0.77 0.46 0.59 0.86 0.46 0.52 0.95 0.79 0.82 0.57 0.66 0.35

Table 7 & table 8 indicate that the variation in returns across different month of the year in both BSE & NSE is not significant at the 5% level, i.e. the null hypothesis is accepted. This


suggest that no evidence in favour of the month of the year effect. The results, on overall, do not seem to have a strong support in the month of the year anomaly. It seems that returns are not more or less random, consistent with the efficient market hypothesis.

CONCLUSION

This paper has investigated day of the week effects on the BSE & NSE for 17years from 1993 to 2009.The results, on overall indicate no significant presence of the day of the week effect for the whole period. This paper also investigated there is no existence of the month of the year effect in BSE and NSE. The regression analysis heavily supports the predictions of Efficient Market hypothesis that the returns are not dependent on all the months of the year. These above results undoubtedly call for further research on the presence of a week day effect and month of the year effect based on individual securities.

REFERENCES [1] Agrawal, A. and Tandon, K. (1994), “Anomalies or illusions? Evidence from stock markets in eighteen

countries”, Journal of International Money and Finance, pp. 83–106. [2] Ariel, R. (1987), “A monthly effect in stock returns”, Journal of Financial Economics, Vol. 18,pp. 161–74. [3] Branch, B. (1977), “A tax-loss trading rule”, Journal of Business, Vol. 50 No. 2, pp. 198–207. [4] Brooks, R. and Kim, H. (1997), “The individual investor and the weekend effect: a re-examination with

intraday data”, Quarterly Review of Economics and Finance, Vol. 37 No. 3, pp. 725–37. [5] Asian stock markets”, Asia-Pacific Journal of Management, Vol. 13 No. 2, pp. 1–24. [6] Chatterjee, A. and Maniam, B. (1997), “Market anomalies revisited”, Journal of Applied Business Research,

Vol. 13 No. 4, pp. 47-56. [7] Chow, E., Hsiao, P. and Solt, M. (1997), “Trading returns for the weekend effect using intraday data”, Journal

of Business Finance & Accounting, Vol. 24 Nos 3/4, pp. 425–44. [8] Draper, P. and Paudyal, K. (2001), “Explaining Monday returns”, working paper, Centre for Financial

Markets, University of Edinburgh, Edinburgh. [9] Dubois, M. and Louvet, P. (1996), “The day-of-the-week effect: the international evidence”, Journal of

Banking & Finance, Vol. 20 No. 9, pp. 1463–84. [10] Dyl, E. and Maberly, E. (1988), “A possible explanation of the weekend effect”, Financial Analyst Journal,

pp. 83-4. French, K. (1980), [11] “Stock returns and the weekend effect”, Journal of Financial Economics, Vol. 8, pp. 55–69. [12] Gultekin, M. and Gultekin, N. (1983), “Stock market seasonality: international evidence”, Journal of

Financial Economics, Vol. 12, pp. 469-81. [13] Hess, P. (1981), “Day of the week effects and asset returns”, Journal of Business, Vol. 54 No. 2,pp. 579–95. [14] Johnston, K. and Cox, D. (1996), “The influence of tax-loss selling by individual investors in explaining the

January effect”, Quarterly Journal of Business & Economics, Vol. 35 No. 2, pp. 14–20. [15] Keim, D. and Stambaugh, R. (1984), “A further investigation of the weekend effect in stock market returns”,

Journal of Finance, Vol. 39 No. 3, pp. 819–35. [16] Khaksari, S. and Bubnys, E. (1992), “Risk-adjusted day-of-the-week, day-of-the-month, and month-of-the-

year effects on stock indexes and stock index futures”, Financial Review, Vol. 27, pp. 531–52. [17] Lee, I. (1992), “Stock market seasonality: some evidence from the Pacific basin countries”, Journal of

Business Finance & Accounting, Vol. 19 No. 2, pp. 199–209. [18] of Financial Research, Vol. 20 No. 1, pp. 13–32. [19] Porter, D., Powell, G. and Weaver, D. (1996), “Portfolio rebalancing, institutional ownership, and the small-

firm January effect”, Review of Financial Economics, Vol. 5 No. 1, pp. 19–29. [20] Raj, M. and Thurston, D. (1994), “January or April? Tests of the turn-of-the-year effect in the New Zealand

stock market”, Applied Economic Letters, Vol. 1, pp. 81–3.


[21] Rogalski, R. (1984), “New findings regarding day-of-the-week returns over trading and non-trading periods: a note”, Journal of Finance, December, pp. 1603–14.

[22] Star, M. (1996), “The January effect: dead or just missing in action”, Pensions and Investments, Vol. 24 No. 3, pp. 3–31.

[23] Wang, K., Li, Y. and Erickson, J. (1997), “A new look at the Monday effect”, Journal of Finance, Vol. 52 No. 5, pp. 2171–86.

[24] Ward, S. (1997), “The striking price: warm to the January effect”, Barrons, Vol. 77 No. 47, p. 17. Further reading Dyl, E. and Maberly, E. (1986), “The weekly pattern in stock index futures: a further note”,Journal of Finance, pp. 1149–52.

Recent Trends in Indian Capital Market

Poonam Dhawale*, Indrabhan Thube* and Shivanand Fulari*

Abstract—Over the last few years, SEBI has announced several far-reaching reforms to promote the capital market and protect investor interests. Reforms in the secondary market have focused on three main areas: structure and functioning of stock exchanges, automation of trading and post trade systems, and the introduction of surveillance and monitoring systems.

Capital market trends can be sub-divided into primary, secondary (short-term), and secular (long-term) trends. Secondary market trends refer to price changes within a primary trend. These price changes are not permanent. A temporary decrease in price during a bull market is a correction and opposite bear. Secular market trends are long-term. They usually remain for a period of five to twenty five years. Many primary trends sequentially arranged result in a secular market trend. *

A financial crisis arises in India during 2008 and its effect on capital market and role of SEBI during the financial crises and the role of Government during financial crises. They perform two valuable functions: liquidity and pricing securities. It has two mutually supporting and indivisible segments: the primary market and secondary market. In the primary market, companies issue new securities to raise the funds. The secondary market may also include the over-the-counter (OTC) market and the derivatives market.

Keywords: SEBI, Financial Crises, Bulls & Bears, Derivatives, liquidity and pricing securities.


The basic feature of Stock Market Trend, and its process was studied based on secondary data collected from the books, journals and related websites regarding Indian Stock Market.

Objectives

As stated above, the present paper is focused towards the identification of ups and downs in stock indices with respect to Bombay Stock Exchange and National Stock Exchange from financial crises 2008 to July 2010. To be more specific, the present study seeks to attain the following objective.

• Trends in Indian Capital market with respect to BSE and NSE. • Stock Market Trend during the recession. • Strategies to battle the recession with respect recovery of Stock Exchange. • Recessionary impact on Indian Economy.

INTRODUCTION

Between 1800 and 1970, credit crises, often caused or accompanied by real estate collapses, occurred in the united states on average once every 14 years, according to Prof. James Van Horne of Stanford University. Since 1970, the wave of financial and corporate deregulation

*SVPM’s Institute of Management, Baramati

Recent Trends in Indian Capital Market 407

that began in the 1970s and accelerated over the past 10 years. One of the biggest changes was affording financial institutions the facility to securitize their loans. Although an important innovation for aiding economic growth, it also gave bankers an incentives to generate large volumes of loan and then move the loans onto somebody else without really worrying about what happens to them after that.

Prof. James van Horne compares the recent lack of regulation to the late 1800s. That atmosphere culminated in the banker’s panic in 1907, a severe Wall Street crash that prompted the creation of the Federal Reserve and the modern system of financial regulation. The speculative bubbles that caused credit crises in the past included railroads in the late 1800s, electronics and autos in the 1920s and high-tech and internet startups in the late 1990s. At the core of each crisis was real estate.

During the panic of 1819, the real estate speculation involved farmland on the Ohio frontier. In the panic of 1837, there was a real estate bubble along the Mississippi. The panics of 1873 and 1893 involved investment in land near rail lines. The crash of 1929 was preceded by the bursting of real estate bubbles in Florida and Southern California.

HISTORY OF MAJOR WORLD RECESSION

Recession has been traced a long back in the 1930's which took place in the United States , but as recession or crisis is a part of the normal cycle of business it again came back during 2008-09 again taking its toll in the United States. Major Recession which led to the collapse of the world economy are: -

• The Great Depression (1929-1939) Stock markets crashed worldwide, and a banking collapse took place in the United States.

• The Oil Crisis and resulting recession (1973-1975) a quadrupling of oil prices by OPEC coupled with high government spending due to the Vietnam War led to stagflation in the United States.

• Recession of the early 1980s (1980-1982) the primary cause of the recession was a contraction in monetary policy by the Federal Reserve in the United States designed to control high inflation.

• Stock Market Crash (1987) and the recession of the early 1990s Stock markets around the world crashed, shedding a huge value in a very short period.

• Asian Financial Crisis (1997-1998) investors deserted emerging Asian share markets, including an overheated Hong Kong stock market. Asian economies began showing signs of recovery after two years

• Collapse of the dotcom bubble (2001-2003) the collapse of the dot-com bubble, the September 11 attacks, and accounting scandals contributed to a contraction in many western economies.

• Subprime crisis and bankruptcy of Lehman Brothers (2008-09) as follows

The response to current crises bears resemblance to past solutions. Most U.S. credit crises have been followed by expansion in credit, tightened trade restrictions, employment-boosting public works projects and, in some cases, direct aid to indebted borrowers. Until the present


crises came to the most prominent example of government intervention was Franklin Roosevelt’s new deal, which entailed massive infrastructure projects, tight regulation of the financial system and direct support to defaulting homeowners.

WORLD CRISES STORY

Attack on America 9/11

After 9/11 American people were encouraged to spend in the spirit of patriotism to help the restart the falling economy. To fuel that spending, in the extraordinary political and psychological climate of that time, U.S. policy makers actively encouraged levels of borrowing and lending that would never otherwise have been allowed. Federal Reserve was worried that the U.S. would face a severe recession and it began cutting interest rates to 1% and kept them at that level until 2004, raising them slowly only 0.25% at time thereafter. With interest rates so low, the financial services industry sensed that a lot of money could be made and went over vigorously in real estate, seemingly unaware that low interest rates could be distinguish large risks.

Commercial Banks and Investment Banks

Commercial banks and investment banks lent vast sums-trillions of dollars- for house purchases and consumer loan to borrowers not really equipped to repay. The easy lending pushed up still higher when speculators bought houses on expectation of further price increases. The prices rose significant because easier access of fund or loans as also historically low interest rates, looser lending and appraisal standards, low documentation (no income proof), speculative fever, low teaser rates, that is low mortgage rates for first year, other creative structures and homeowners seeking extra profit from buying and selling homes. Greater facilitation to the boom was provided by funding the mortgages based securities which were sold to the investment bank, pension funds, insurance companies, foreign banks and other financial institutions, and individuals.

Boom in the Housing Sector and Easy Loan

The boom in the housing sector was taking the economy to a new level. A combination of low interest rates and large inflows of foreign funds helped to create easy credit conditions where it became quite easy for people to take home loans. As more and more people took home loans, the demands for property increased and fueled the home prices further. As there was enough money to lend to potential borrowers, the loan agencies started to widen their loan disbursement reach and relaxed the loan conditions.

As a result, many people with low income and bad credit were given housing loans in disregard to all principles of financial prudence. These types of loans were known as sub-prime loans as those were are not part of prime loan market .With stock markets booming and the system flush with liquidity, many big fund investors like hedge funds and mutual funds saw subprime loan portfolios as attractive investment opportunities.


Hence, they bought such portfolios from the original lenders. Major (American and European) investment banks and institutions heavily bought these loans (known as Mortgage Backed Securities, MBS) to diversify their investment portfolios. Owing to heavy buying of Mortgage Backed Securities (MBS) of subprime loans by major American and European Banks, the problem, which was to remain within the confines of US propagated into the world’s financial markets.

Home Prices Started Declining

As the home prices started declining in the US, sub-prime borrowers found themselves in a dirty situation. Their house prices were decreasing and the loan interest on these houses was increased rapidly. As they could not manage a second mortgage on their home, it became very difficult for them to pay the higher interest rate. As a result many of them opted to default on their home loans and vacated the house. However, as the home prices were falling rapidly, the lending companies, which were hoping to sell them and recover the loan amount, found them in a situation where loan amount exceeded the total cost of the house.

Eventually, there remained no option but to write off losses on these loans. The problem got worsened as the Mortgage Backed Securities (MBS), which by that time had become parts of CDOs of giant investments banks of US & Europe, lost their value. Falling prices of CDOs bad effect on banks' investment portfolios and these losses destroyed banks' capital.

US Federal Bank & Lehman Brothers

Despite efforts by the US Federal Reserve to offer some financial assistance to the in difficulties financial sector, it has led to the collapse of Bear Sterns, one of the world's largest investment banks and securities trading firm. Bear Sterns was bought out by JP Morgan Chase with some help from the US Federal Bank. The crisis has also seen Lehman Brothers - the fourth largest investment bank in the US and the one which had survived every major upheaval for the past 158 years - file for bankruptcy. And slowly this recession started to creep into other countries like a contagious disease.

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Collapse of Lehman Brothers Collapse of Lehman brothers, ranked among the world’s top investment banks, Lehman Brothers expanded aggressively into property related investments including the sub-prime mortgages. The sub-prime crises with the decline in the value of those asset and lead to loss of about U.S. $14 billion, this further leads to Lehman’s prime customer pulling out their monies into much safer investments. The collapse of the company put ten thousands of jobs around the world at risk. The impact was also huge in other major economics considering the integration of the financial markets and the global nature of business today. Everything on Wall Street changed.

Spreading of Financial crises The U.S. financial crises first spread to other rich countries the U.K., Europe and Japan

and later to emerging economics, including china and India. The impact, of course, has varied from country to country. The Government has been responding with bail-out packages, through which more and more liquidity is being made available and interest rates are gradually brought down. Countries like Japan, China, and India have put up Bail-out packages to impact of financial crises.

Indian Stock market Trends The Indian stock market appears highly promising for the overseas investors as reflected by the inflows in the past few weeks with the high flow in investments in the country’s stocks. The growing FII investments made the BSE index not only cross 17 K points but to get closer to the 20 K points in September 2010.


TABLE 1: MONTHLY TRENDS IN STOCK MARKET INDICES (BEGINNING OF MONTH FIGURES)

Date BSE Sensex % Change S&P CNX NIFTY % Change 1.01.08 20300 4.8 6144 6.6 1.02.08 18242 -10.1 5317 -13.5 3.03.08 16677 -8.5 4953 -6.8 1.04.08 15626 -6.3 4739 -4.3 2.05.08 17600 12.6 5228 10.3 2.06.08 16063 -8.7 4739 -9.3 1.07.08 12961 -19.3 3896 -17.8 1.08.08 14656 13.1 4413 13.3 1.09.08 14498 -1.1 4447 0.8 1.10.08 13055 -9.9 3950 -11.1 3.11.08 10337 -20.8 3043 -23 1.12.08 8839 -14.5 2682 -11.9

26.12.08 9328 5.5 2857 6.5 30.01.09 9424 1 2874 0.5 02.03.09 8607 -8.7 2674 -7 31.03.09 9708 12.8 3020 12.9 29.04.09 11403 17.5 3473 15 01.06.09 14840 30.1 4529 30.4 01.07.09 14645 -1.31 4340 -4.1 03.08.09 15924 8.7 4711 8.5 01.09.09 15551 -2.3 4625 -1.8 01.10.09 17134 10.2 5083 9.9 03.11.09 15405 -10.1 4564 -10.2 01.12.09 17198 11.6 5122 12.2 04.01.10 17558 2.1 5232 2.1 01.02.10 16356 -6.8 4900 -6.4 02.03.10 16773 2.5 5017 2.4 01.04.10 17693 5.5 5291 5.5 03.05.10 17386 -1.7 5223 -1.3 01.06.10 16572 -4.7 4970 -4.8 01.07.10 17509 5.7 5251 5.7

Half Year wise Breakup of BSE Sensex First- January 2008- June 2008

Date BSE Sensex Date % Change Sensex

Date S&P CNX NIFTY

Date % Change Nifty

1.01.08 20300 1.01.08 4.8 1.01.08 6144 1.01.08 6.6 1.02.08 18242 1.02.08 -10.1 1.02.08 5317 1.02.08 -13.5 3.03.08 16677 3.03.08 -8.5 3.03.08 4953 3.03.08 -6.8 1.04.08 15626 1.04.08 -6.3 1.04.08 4739 1.04.08 -4.3 2.05.08 17600 2.05.08 12.6 2.05.08 5228 2.05.08 10.3 2.06.08 16063 2.06.08 -8.7 2.06.08 4739 2.06.08 -9.3


TABLE 3: SECOND‐ FROM JULY 2008 – DECEMBER 2008

Date BSE Sensex

Date % Change Sensex

Date S&P CNX NIFTY Date % Change Nifty

1.07.08 12961 1.07.08 -19.3 1.07.08 3896 1.07.08 -17.8 1.08.08 14656 1.08.08 13.1 1.08.08 4413 1.08.08 13.3 1.09.08 14498 1.09.08 -1.1 1.09.08 4447 1.09.08 0.8 1.10.08 13055 1.10.08 -9.9 1.10.08 3950 1.10.08 -11.1 3.11.08 10337 3.11.08 -20.8 3.11.08 3043 3.11.08 -23 1.12.08 8839 1.12.08 -14.5 1.12.08 2682 1.12.08 -11.9


.


TABLE 4: THIRD‐ DECEMBER 2008 – JULY 2009

Date BSE Sensex Date % Change Sensex Date S&P CNX NIFTY Date % Change Nifty 26.12.08 9328 26.12.08 5.5 26.12.08 2857 26.12.08 6.5 30.01.09 9424 30.01.09 1 30.01.09 2874 30.01.09 0.5 02.03.09 8607 02.03.09 -8.7 02.03.09 2674 02.03.09 -7 31.03.09 9708 31.03.09 12.8 31.03.09 3020 31.03.09 12.9 29.04.09 11403 29.04.09 17.5 29.04.09 3473 29.04.09 15 01.06.09 14840 01.06.09 30.1 01.06.09 4529 01.06.09 30.4


TABLE 5: FOURTH‐ JULY 2009 – DECEMBER 2009

Date BSE Sensex

Date % Change Sensex

Date S&P CNX NIFTY

Date % Change Nifty

01.07.09 14645 01.07.09 -1.31 01.07.09 4340 01.07.09 -4.1 03.08.09 15924 03.08.09 8.7 03.08.09 4711 03.08.09 8.5 01.09.09 15551 01.09.09 -2.3 01.09.09 4625 01.09.09 -1.8 01.10.09 17134 01.10.09 10.2 01.10.09 5083 01.10.09 9.9 03.11.09 15405 03.11.09 -10.1 03.11.09 4564 03.11.09 -10.2 01.12.09 17198 01.12.09 11.6 01.12.09 5122 01.12.09 12.2


TABLE 5: FIFTH‐ JANUARY 2010 – JULY 2010

Date BSE Sensex Date % Change Sensex Date S&P CNX NIFTY Date % Change Nifty 04.01.10 17558 04.01.10 2.1 04.01.10 5232 04.01.10 2.1 01.02.10 16356 01.02.10 -6.8 01.02.10 4900 01.02.10 -6.4 02.03.10 16773 02.03.10 2.5 02.03.10 5017 02.03.10 2.4 01.04.10 17693 01.04.10 5.5 01.04.10 5291 01.04.10 5.5 03.05.10 17386 03.05.10 -1.7 03.05.10 5223 03.05.10 -1.3 01.06.10 16572 01.06.10 -4.7 01.06.10 4970 01.06.10 -4.8 01.07.10 17509 01.07.10 5.7 01.07.10 5251 01.07.10 5.7


STRATEGIES TO BATTLE THE RECESSION

Weakening of the American economy is bad news, not just for India, but for the rest of the world. The fear of a recession looms over the United States. And as the obvious remark goes, whenever the US sneezes, the world catches a cold. This is evident from the way the Indian markets crashed taking a cue from a probable recession in the US and a global economic slowdown.

Not to Divert From Core Business

All companies should focus on their core competencies during disturbed economic times. Companies who did diversify and split focus away from their core competencies often struggled to manage their unrelated businesses whereas companies that remained focused, or


re-focused on their core created opportunities to gain market share more easily from their competitors.

Improved Process and Efficiency

A common theme among the companies is the process by which they implemented their strategy during recessions. It is logical that process efficiencies will be sought to trim costs from budgets during a recession. All the companies should have the flexibility and must be fast action oriented as these are the key to surviving and prospering during recession. Flexibility will allow the business to implement their recession strategies quicker than competitors. In some cases horizontal management structures will also directly attribute to the speed with which companies were able to integrate acquired businesses successfully.

Strategic Divestment

Most companies should divest parts of their business during recessionary periods. At face value these divestments will be a part of a strategy of cutting costs and/or generating short term liquidity, particularly where less profitable divisions were divested. For the companies, divestment is primarily used to raise cash to service debt and fund further investment. However it is important to note that most divestitures to be made must be of divisions that are not in-line with the company's long term strategic view, or differed from the company's core-business.

Contingency Planning

Companies should actively plan alternative strategies for adverse times well in advance of them occurring. This is important as it demonstrates it is never too late to act, as these companies will survive turbulent times despite having no specific plan for the recession. However, in all cases when the downturn hit, the companies quickly assembled a plan and put in place a strategy for dealing with adverse conditions.

Acquisitions and Strategic Alliances

There are several reasons why acquisition of competing or allied businesses is seen as a good strategy by some companies in a period of economic downturn. The 'entry price' is likely to be lower than at other times as businesses are sold under stress or to liquidate assets. This means that companies can purchase targets that may otherwise have been out of their reach. There may also be less competition for acquisition targets because few companies make available the resources to make acquisitions during periods of economic stress. Sometimes businesses become available for acquisition that has previously been unattainable, as they struggle to deal with a downturn.

Increased Advertising and Marketing

One of the biggest mistakes business owners make during periods of economic slowdown is to cut back on marketing and advertising, doing this could be most detrimental to their business .Advertising was used effectively by these companies to help weather downturns and


strengthen demand for their core products. Instead, the marketing needs to be more aggressive and more comprehensive than ever. One should start by contacting past clients and simply touching base. Chances are a good number of them will have projects or assignments for which the company's services may be required.

Research and Development

The companies should use Research and development to meet the increasingly diverse needs of their recessionary customers who seek greater value from their spending. Most companies should also try to increase their speed to market with new products to gain advantage over their competition. They must do this by prioritizing development of the most promising products that met the immediate needs of their customers.

Human Factor

Make sure that one has the right people for the job. As much as possible, the company should get everybody in the team to think lean. Extravagance becomes a luxury, and one can't simply splash advertisements ad infinitum like there is no tomorrow.

One should be constantly re-evaluating not just the marketing plan, but all of the business strategies including policies, pricing, and employee performance. The idea is to eventually be as efficient and effective as possible so the company runs smoothly and profitably. Companies should look closely at the competitors. Talking to business leaders will also help. Experiment Solicit feedback from the workers and customers. By doing several of these things one will accumulate a wealth of knowledge and experience crucial to the survival of your business.

CONCLUSION

• Recession affect on Indian stock market but immediately recovered after 6 months, so it was not really affect on Indian stock market.

• In the globalized market scenario, the impact of recession at one place/ industry/ sector percolate down to all the linked industry and this can be truly interpreted from the current market situation which is faced by the world.

• A global recession occurs or not, there will be people whose businesses go under simply because of the speculation about a recession.

• Recession was not affected very hard on Indian economy because of strong fiscal and monetary policies of Indian government and RBI.

• It's incredibly sad but it's a fact and it's happened all throughout history whenever the economy has faltered.

• These recession strategies won't turn the business around when used independently, but if we combine several of them, they can help to transform one's outlook for the future.


• This recession have turned down the growth process and have set the minds of many for finding out the real solution to sustain the economic growth and stability of the market which is desired for the smooth running of the economy.

REFERENCES [1] A Bank Quest, The Journal Of Indian Institute Of Banking & Finance January-March 2009 (ISSN 0019 4921)

Vol: 80 No: 1 P. 5, 6. [2] A Bank Quest, the Journal of Indian Institute of Banking & Finance January-March 2009 (ISSN 0019 4921)

Vol: 80 No: 1 P. 8. [3] A Bank Quest, the Journal of Indian Institute of Banking & Finance January-March 2009 (ISSN 0019 4921)

Vol: 80 No: 1 P. 15, 16. [4] Corporate India, The corporate Magazine for business and investment 31st October 2008 P. 48. [5] Corporate India, The corporate Magazine for business and investment 15th October 2008 P. 26, 27. [6] Corporate India, The corporate Magazine for business and investment, Mumbai April 2008 P. 54, 55.

Accounting Numbers as a Predictor of Stock Returns: A Case Study of BSE Sensex

Dr. Navindra Kumar Totala* , Dr. Ira Bapna**, Vishal Sood** and Harmender Singh Saluja**

Abstract—Capital Market is a barometer of company’s economic and financial condition. The market has witnessed its worst time with the recent global financial crisis that originated from the US sub-prime mortgage market and spread over to the entire world as a contagion. The stringent norms in India made it able to sustain the shock and are able to dictate terms to world capital market. It reflects sustainable growth, developed regulatory mechanism, growing market capitalization with market liquidity and mobilization of resources. It is necessary to know the factors affecting the capital market of the country. In the different informational environment and accounting practices from those of developed market, the research paper aims to evaluate the relevance of accounting numbers for investors in their investment decisions and predict investor’s return through company’s financial analysis. Company analysis is a way of expressing relationship between accounting numbers of the company and their trends over time that analysts use to establish values, evaluate risks and interpret company’s past and present financial health and helps in predicting its future.

In this framework, the present research is vital to study the performance of Indian capital market by way of company financial analysis. The objective of this study is to examine the value relevance of accounting information in explaining stock returns. The study uses liquidity, profitability, solvency, and leverage ratios as proxies of accounting information. The research is an attempt to analyze the year wise average stock prices of top 26 companies of BSE Sensex on consolidation basis for period of five years from 2006 to 2010 to predict impact of accounting numbers on stock returns. Regression Analysis, t- test, f- test, and Correlation were used. It was concluded that accounting numbers do not predict Stock Returns.

Keywords: BSE Senex; Ratio Analysis; Stock Returns; Accounting Numbers; Regression Analysis

INTRODUCTION

Accounting information from financial reports can describe firm’s condition. The financial reports are affected by two factors, firms’ activities and accounting system adopted by the firms (Palepu et al, 2004). Some researchers studied accounting information in predicting firms’ future financial performance, such as earnings and growth (Lev and Trigrajan, 1993), while other researchers measured the effect of accounting information on share prices (Abarbanell and Bushee, 1998). Fundamental analysis is essential for determination of market efficiency. It involves two different approaches in the search of mispriced securities. The first approach involves estimating the intrinsic value and comparing the same with the prevailing

*Institute of Management Studies, M.P. **Maharaja Ranjit Singh College of Professional Sciences, M.P.


market price to determine whether the security is underpriced, fairly priced or overpriced. The second approach involves estimating a security’s expected return, given its current price and intrinsic value and then comparing it with the appropriate return of securities with similar characteristics.

Analysis of company can be categorized into two parts, a study of financials and other factors. In company analysis, stake holders including investors assimilate several bits of information related to the company and evaluate the present and future values of the stock. Risk and return are associated with the purchase of stock in order to take better investment decisions. The present and future values of a company are affected by a number of factors like, the competitive edge, strength, earnings, capital structure, management, operating efficiency and financial statements of the company.

LITERATURE REVIEW

Favouring Effect on Stock Returns

A study conducted fifty years ago, observed that stock prices seem to wander randomly over the time, and test whether the past prices can be used to predict the future price changes (Kendall, 1953). The study expanded to indicate other predictive variables like financial variables that commonly tested to predict stock returns. These variables appear to be of particular interest in predicting asset returns, as they should be positively related to expected returns. The generally accepted statements in capital markets context are; income statements, statement of affairs i.e., Balance Sheet, Cash flow and Fund Flow, etc. in which accounting figures are aimed at providing investors with relevant information for their investment decisions (Dumoter and Raffournier, 2002). Accounting numbers are supposed to facilitate the prediction of firm’s future cash flows and help the investors to assess future securities’ risk and returns and for which many studies were carried out in the USA and Europe.

The research on effect of Financial Ratios, including Net Profit Margin, Return on Assets, Return on Equity, Debt Equity Ratio, and Earning Per Share, on stock price of companies listed on Jakarta Islamic Index in 2004 found that statistically all variables except Debt Equity Ratio are significant and have positive impact on stock price (Mais, 2005). The correlation between Financial Ratios, including Liquidity Ratio (Current Ratio), Profitability Ratio (Return on Investment), Activity Ratio (Total Assets Turnover), and Solvability Ratio (Debt to Equity), and both capital gain (loss) and dividend in 135 manufacturing companies listed on Jakarta Stock Exchange discovered that all ratios have positive correlation with capital gain (loss). However, only Current Ratio which is statistically significant (α = 5%), Furthermore, for correlation with Dividend Yield, only Total Assets Turnover that is proved significant (α = 10%) (Hamzah, 2007).

Accounting Numbers as a Predictor of Stock Returns: A Case Study of BSE Sensex 423

DISFAVOURING EFFECT ON STOCK RETURNS

A large body of accounting literature explores the relation between accounting information and stock returns and concluded that accounting information explains a surprisingly low proportion of the variation in Stock Returns (Ball and Brown, 1968). In the research, it was found that earnings can explain not more than 10% of the variation in Stock Returns and concluded that earnings are of limited usefulness to investors (Lev, 1989). The research extended to incorporate changes in expectations of future abnormal earnings and is able to explain up to 30% of the valuation in the Stock Return (Liu and Thomas, 2000). The corporate financing and investing activities are negatively related to future Stock Returns (Ritter, 2003; Titman, 2004). A study conducted on100 manufacturing firms in Bursa Efek Jakarta (BEJ) during 1999-2002, concluded that, with profit persistence as intervening variable, Cash Flow from Operating Activities does not affect Stock Price (Meythi, 2006).

The relation between Financial Ratio and Stock Returns was studied during economic crisis in Indonesia by adding firm size as variable. Using 120 manufacturing companies listed on Bursa Efek Jakarta, 2004 as sample, this study used eight financial ratios (Quick Ratio, Total Asset Turnover, Gross Profit Margin, and Return on Equity, Price to Book Value and Earning per Share) (Manao and Nur, 2001). Those companies were divided into three size categories (small, medium and big) based on total assets. The result showed that Price to Book Value and Earning per Share have significant influence on all models (Martani, et al, 2009). The effects of Return on Equity, Earning per Share, and Cash from Operations on Stock Returns of manufacturing industry in Bursa Efek Jakarta were studied using data of 32 manufacturing companies during 1999-2002. The result showed that only Return on Equity significantly influences Stock Return (α = 5%) while Earning per Share and Cash from Operations have insignificant negative effect on Stock Returns (Sparta and Februwaty, 2005).

The effect of Return on Asset, Return on Equity, Earning per Share, Profit Margin, Assets Turnover, Debtors Turnover Ratio and Debt Equity Ratio on Stock Return using samples of stocks from LQ 45 Index (La Quinta, Stock Market Index for Indonesia Stock Exchange) in Bursa Efek Jakarta during period 2001-2002 came up with the fact that Total Assts Turnover, Return on Equity, Earning per Share and Debt Equity Ratio have positive effect, while Return on Equity and Debtors Turnover Ratio have negative effect on Stock Returns (Kennedy, 2005). Research about accounting information for predicting Return on Shares conducted in Indonesia showed that Cash Flow from Investing Activities, Gross Profit, and Company Size significantly affects Expected Return on Shares. On the other hand, Cash Flow from Operating Activities does not affect Expected Return significantly (Daniati and Suhairi, 2006).

The effect of Current Ratio, Total Assts Turnover, Debt Equity Ratio, Return on Equity, Earning per Share, and Price to Book Value on Stock Price of manufacturing industry was studied with five sub-industries including Retail, Food and Beverages, Tobacco, Automotive, and Pharmacy concluded that the significant financial ratios; In Retail Industry are Return on Equity, Earning per Share, and Price to Book Value; In Food and Beverages industry are Earning per Share and Price to Book Value; In Tobacco Industry are Current Ratio, Total


Assts Turnover, Debt Equity Ratio, Earning per Share, and Price to Book Value; In Automotive Industry are Debt Equity Ratio, Return on Equity, Earning Per Share, and Price to Book Value; While in Pharmacy Industry are Current Ratio, Earning per Share, and Price to Book Value. In overall five industries, the influential financial ratios are Total Assts Turnover, Debt Equity Ratio, Earning per Share, and Price to Book Value. Furthermore, the research showed that the variety of Average Stock Prices can still be explained properly by financial ratios during 1-3 month period after the issuance of Annual Financial Report (Roswati, 2007).

The long-term association between Capital Stock Returns and Accounting Numbers i.e., association studies, values the information in financial statements against information in Stock Prices. The association studies do not presume that investors use only accounting data in their investment decisions. If accounting data are good summary measures of the events incorporated in security prices, then they are value relevant because their use might provide a value of the firm that is close to its market value (Dumontier and Raffournier, 2002). Thus, association studies revealed that Accounting Numbers provide a good summary measure of the value relevant events that have been incorporated in stock prices during the reporting period. It tests whether and how quickly accounting measures capture changes in the information set that is reflected in security returns over a given period (Kothari, 2001).

OBJECTIVES

• To analyze the significant impact of the Financial Ratios on Stock Returns. • To study the linkage between Financial Strength of individual companies and Stock

Market Returns.

RESEARCH DESIGN

Hypothesis For the present study following hypothesis were tested:

• Ho1 = There is no significant impact of Current Ratio on Stock Returns. • Ho2 = There is no significant impact of Quick Ratio on Stock Returns. • Ho3 = There is no significant impact of Gross Profit Margin Ratio on Stock Returns. • Ho4 = There is no significant impact of Net Profit Margin Ratio on Stock Returns. • Ho5 = There is no significant impact of Debt Equity Ratio on Stock Returns. • Ho6 = There is no significant impact of Return on Assets on Stock Returns. • Ho7 = There is no significant impact of Earning per Share on Stock Returns. • Ho8 = There is no significant impact of Dividend per Share on Stock Returns.

SCOPE OF THE STUDY

The present study is dependent on stock prices. With the passage of time, the stock prices will change, resultantly changing the results of the study.


• The study is based on the secondary data. • The research has considered only stock price fluctuations taking all other things as

constant. • The present study is undertaken for the limited period of time i.e., five financial years. • The study has used only basic ratios to check the objectives namely, liquidity ratios,

profitability ratios, solvency ratios and leverage ratios. • Basically the study was aimed at to take all 30 companies forming BSE Sensex but

research could be conducted only on 26 companies as the data of four companies were insufficient to carry out the research.

SOURCES AND COLLECTION OF DATA

The present study is based on secondary data. The Financial Ratios and the Stock Prices of top thirty companies of Bombay Stock Exchange were acquired from different websites, like, www.bseindia.com, www.moneycontrol.com, www.rediff.com, www.yahoofinance.com, and company websites.

SAMPLE AND SAMPLE TYPE

The present research is undertaken on the top thirty companies contributing to the Sensex of Bombay Stock Exchange to find out the impact of Financial Ratios on the Stock Returns of the companies. These companies are actively traded companies comprising of different sectors. The data are taken for the period commencing from the financial year 2005-06 to 2009-10.

The Tools for Data Analysis

• The statistical tool applied in the study are regression analysis find out the significant impact of Financial Ratios on Stock Returns using Liquidity Ratios (Current Ratio and Quick Ratio), Profitability Ratios (Gross Profit Margin Ratio and Net Profit Margin Ratio); Solvency Ratios (Debt Equity Ratio and Return on Asset) and Leverage Ratio (Earning per Share and Dividend per Share).

• To find the linkage between Financial Strength of individual companies and Stock Market Returns correlation is used.


ANALYSIS AND INTERPRETATION Year 2006 Correlation f-Value Beta

Value t- Value Significance Significant /

Insignificant Current Ratio on Stock Returns 0.113 0.312 0.113 0.558 0.582 Insignificant Quick Ratio on Stock Returns 0.113 0.312 0.113 0.558 0.582 Insignificant Gross Profit Ratio on Stock Returns

-0.12 1.65 -0.254 -1.258 0.211 Insignificant

Net Profit Ratio on Stock Returns

-0.25 0.359 -0.121 -0.599 0.555 Insignificant

Debt Equity on Stock Return -0.07 0.113 -0.069 -0.337 0.739 Insignificant Return on Assets on Stock Returns

-0.316 2.65 -0.316 -1.63 0.116 Insignificant

EPS Ratio on Stock Returns 0.27 2.17 0.288 1.47 0.154 Insignificant DPS Ratio on Stock Returns 0.4 4.58 0.4 2.14 0.043 Insignificant Year 2007 Correlation f Value Beta

Value t Value Significance Significant /


-0.14 0.52 -0.14 -0.72 0.48 Insignificant


-0.2 1.05 -0.2 -1.05 0.31 Insignificant

Debt Equity on Stock Returns 0.01 0.003 0.01 0.05 0.96 Insignificant Return on Assets on Stock Returns

-0.3 2.76 -0.32 -1.66 0.11 Insignificant

EPS Ratio on Stock Returns 0.45 6.18 0.45 2.49 0.02 Insignificant DPS Ratio on Stock Returns 0.33 3.063 0.34 1.75 0.093 Insignificant Year 2008 Correlation f-Value Beta



-0.17 0.31 -0.112 -0.55 0.58 Insignificant


-0.11 0.77 -0.176 -0.875 0.39 Insignificant

Debt Equity on Stock Returns -0.12 0.001 -0.005 -0.026 0.98 Insignificant Return on Assets on Stock Returns

-0.28 2.04 -0.28 -1.43 0.17 Insignificant

EPS Ratio on Stock Returns 0.3 2.36 0.3 1.54 0.14 Insignificant DPS Ratio on Stock Returns 0.25 1.67 0.255 1.29 0.21 Insignificant Year 2009 Correlation f-Value Beta



-0.15 1.47 -0.24 -1.21 0.23 Insignificant


-0.24 0.56 -0.15 -0.75 0.46 Insignificant

Debt Equity on Stock Returns 0.036 0.032 0.04 0.18 0.86 Insignificant Return on Assets on Stock Returns

-0.27 1.94 -0.27 -1.4 0.176 Insignificant

EPS Ratio on Stock Returns 0.47 6.85 0.47 2.62 0.015 Insignificant DPS Ratio on Stock Returns 0.32 2.76 0.32 1.66 0.12 Insignificant


Year 2010 Correlation f-Value Beta Value

t- Value Significance Significant / Insignificant

Current Ratio on Stock Returns -0.114 0.32 -0.114 -0.56 0.58 Insignificant Quick Ratio on Stock Returns -0.05 0.06 -0.05 -0.25 0.8 Insignificant Gross Profit Ratio on Stock Returns

0.07 0.62 -0.16 -0.79 0.44 Insignificant


-0.16 0.11 0.07 0.33 0.75 Insignificant

Debt Equity on Stock Returns -0.07 0.11 -0.07 -0.33 0.74 Insignificant Return on Assets on Stock Returns

-0.33 2.9 -0.33 -1.7 0.102 Insignificant

EPS Ratio on Stock Returns 0.38 4.48 0.39 2.12 0.04 Insignificant DPS Ratio on Stock Returns 0.25 1.61 0.25 1.27 0.22 Insignificant

INTERPRETATION

For the year 2006 correlation of Current Ratio and Quick ratio with Stock Returns reveals very low degree of positive correlation; EPS Ratio and DPS Ratio with Stock Returns depicts low degree of positive correlation; Gross Profit Ratio, Net Profit Ratio, Debt Equity Ratio and Return on Assets with Stock Returns are negatively correlated. This implies that there is no impact of these ratios over stock returns. The stock returns are independent of these ratios. It also implies that the ratios do not predict stock returns.

For the year 2007 correlation of Current Ratio, Quick ratio and Debt Equity Ratio with Stock Returns reveals very low degree of positive correlation; EPS Ratio and DPS Ratio with Stock Returns depicts low degree of positive correlation; Gross Profit Ratio, Net Profit Ratio and Return on Assets with Stock Returns are negatively correlated. This implies that there is no impact of these ratios over stock returns. The stock returns are independent of these ratios. It also implies that the ratios do not predict stock returns.

For the year 2008 correlation of Current Ratio, Quick Ratio and DPS Ratio with Stock Returns reveals very low degree of positive correlation; EPS Ratio with Stock Returns depicts low degree of positive correlation; Gross Profit Ratio, Net Profit Ratio, Debt Equity Ratio and Return on Assets with Stock Returns are negatively correlated. This implies that there is no impact of these ratios over stock prices. The stock returns are independent of these ratios. It also implies that the ratios do not predict stock returns.

For the year 2009 correlation of Current Ratio, Quick ratio and Debt Equity Ratio with Stock Returns reveals very low degree of positive correlation; EPS Ratio and DPS Ratio with Stock Returns depicts low degree of positive correlation; Gross Profit Ratio, Net Profit Ratio and Return on Assets with Stock Returns are negatively correlated. This implies that there is no impact of these ratios over stock prices. The stock returns are independent of these ratios. It also implies that the ratios do not predict stock returns.

For the year 2010 correlation of Gross Profit Ratio and DPS Ratio with Stock Returns reveals very low degree of positive correlation; EPS Ratio with Stock Returns depicts low degree of positive correlation; Current Ratio, Quick Ratio, Net Profit Ratio, Debt Equity Ratio and Return on Assets with Stock Returns are negatively correlated. This implies that there is no impact of these ratios over stock prices. The stock returns are independent of these ratios. It also implies that the ratios do not predict stock returns.


The Beta value for the all years is very low for all the ratios. This implies that the stock prices are low volatile for all the ratios. It reveals that the ratios do not predict volatility and risks themselves and they do not shape the prices in concern with risks.

The f value and t value are insignificant for Current Ratio, Quick Ratio, Gross Profit Ratio, Net profit Ratio, Debt Equity Ratio, Return on Assets Ratio, EPS Ratio and DPS Ratio are insignificant to determine Stock Returns.

CONCLUSION

It can be seen that all the ratios during the entire study period have insignificant relationship with the Stock Returns, i.e., there is no significant impact of the ratios on the Stock Returns predictions and determinations. In fact, different financial ratios do not predict Stock Returns. The financial ratios have no influence over Stock Returns. Financial ratios are replica of financial results whereas financial results represents accounting numbers. Thus, this is evident that accounting numbers do not predict Stock Returns.

IMPLICATIONS

The results and conclusion implies that stock market do not take account of accounting numbers, either in the form of financial results declaration or their interpretation in the form of ratio analysis. Market finds its own way ignoring financial results and accounting numbers. This affirms and confirms the Random Walk theory and all forms of Efficient Market Hypotheses. Probably investors are more aware of accounting numbers in the form of quarterly results and they do not wait to take note of it and immediate prevailing prices are the reflection of discounting of the accounting information. In fact it seems that market is driven by sentiments, monetary and fiscal environment of the country and moreover demand supply tug of war or other known and unknown dynamic variants among them accounting numbers seems to be one alone insignificant variable and the rule of impact of discounting one information if another significant information is floated in the market, seems to be playing dominant role in determining Stock Returns.

The results of BSE Sensex are independent of financial results of the company results. The BSE Sensex has its own independent and autonomous state. The findings implies that company analysis by way of accounting numbers have a limited role for speculation but has vital role to play in long term perspective as a part of fundamental analysis.

SUGGESTION

In the light of findings and implications, it is suggested that the investors should not overreact to accounting information. They should not either buy or sale investment on decision making based only on accounting numbers. Ratio analysis is multidimensional multiuser instrument which should be used very cautiously in portfolio investment decision. Other variables like, company projects, budgets, plans, market share, marketing strength, company position in the industry may be considered as variables in investment decision. Accounting numbers have their own limitations. They may predict profits or losses but they have lesser role to shape Stock Returns. So, one should use accounting numbers with greater degree of care and


caution in predicting Stock Returns. An investor will have to consider both the financial and non-financial factors so as to form an overall impression about a company. Internal and external strengths and weakness of an industry can also be evaluated.

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The Accounting Review,73(1), 19–45. [2] Ball and Brown (1969). An Empirical Evaluation of Accounting Income Numbers. The journal of Accounting

Research, 39(3), 159-178. [3] Daniati, Nina and Suhairi. (2006). Effect of Information Content: Component of Cash Flows, Gross Profit and

Size of the Company to the Return of Shares (Survey on the Textile and Automotive Industries on the BEJ). Padang: National Accounting Symposium, 9. Cited in…..

[4] Dumontier, P. and Labelle, R. (1998). Accounting Earnings and Firm Valuation: The French Case. The European Accounting Review, 7 (2), 163–183.

[5] Hamzah, (2007). Cited in Martani, Dwi; Mulyono; and Rahfiani Khairurizka (2009). The Effect of Financial Ratios, Firm Size, and Cash Flow from Operating Activities in the Interim Report to the Stock Return. Chinese Business Review, 8(6), 1537–1506.

[6] Kendall, M. (1953). The Analysis of Economic Time Series. Journal of the Royal Statistical Society, 96, 11–25.

[7] Kennedy, W.F. (2005). An Empirical Examination on Large Banks Dividend Payout Ratios. Business Economics, 21, 48–56.

[8] Kothari, S.P. (2001). Capital Markets Research in Accounting. Journal of Accounting and Economics, 31, 105–231.

[9] Lev, B. (1989). On the Usefulness of Earnings and Earning Research: Lessons and Directions from Two Decades Research. The Journal of Accounting Research, 27, 153–192.

[10] Lev, B. and Thigarajan, R. (1993). Fundamental Information Analysis. Journal of Accounting Research, 31(2), 190–215.

[11] Liu, J. and Thomas, J. (2000). Stock Returns and Accounting Numbers. The Journal of Accounting Research, 38(1), 119–138.

[12] Mais, Gusliana Rimi (2005). Effect of Major Financial Ratios of Companies to the Stock Price: A Company Registered in Jakarta Islamic Index in 2004. STEI Economic Journal, 14(3), 30.

[13] Manao, Hekinus and Nur, Deswin (2001). Association with Stock Returns of Financial Ratios: The Consideration of Company Size and Influence of the Economic Crises in Indonesia. Padang: National Accounting Symposium, IV.

[14] Martani, Dwi; Mulyono; and Rahfiani Khairurizka (2009). The Effect of Financial Ratios, Firm Size, and Cash Flow from Operating Activities in the Interim Report to the Stock Return. Chinese Business Review, 8(6), 1537-1506.

[15] Meythi, (2006). Effect of Operating Cash Flow to Share Price to Earning Persistence as an Intervening Variable. Padang: National Accounting Symposium, IV.

[16] Palepu, G. Krishna; Healy, M. Paul; and Bernart, L.Victor (2004). Business Analysis and Valuation: Using Financial Statements. Paperback Edition, USA.

[17] Ritter, J.R.; Constantinides, G.; Harris, M.; and Stutz, R. (2003). Investment and Securities Issuance. Handbook of Economics and Finance, 255–306. North-Holland, Amsterdam.

[18] Roswati,(2007). Cited in Martani, Dwi; Mulyono; and Rahfiani Khairurizka (2009). The Effect of Financial Ratios, Firm Size, and Cash Flow from Operating Activities in the Interim Report to the Stock Return. Chinese Business Review, 8(6), 1537–1506.

[19] Sparta, Februaty (2005). Effect of ROE, EPS, OCE on Manufacturing Industry to the Stock Price of the Stock Exchange Jakarta. Journal of Accounting, 9(1).

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SUMMARY

The market has witnessed its worst time with the recent global financial crisis that originated from the US sub-prime mortgage market and spread over to the entire world as a contagion. Accounting information from financial reports can describe firm’s condition. It is necessary to know the factors affecting the capital market of the country. In the different informational environment and accounting practices from those of developed market, the research paper aims to evaluate the relevance of accounting numbers for investors in their investment decisions and predict investor’s return through company’s financial analysis.

In this framework, the present research is vital to study the performance of Indian capital market by way of company financial analysis. The objective of this study is to examine the value relevance of accounting information in explaining stock returns. The study uses liquidity, profitability, solvency, and leverage ratios as proxies of accounting information. The research is an attempt to analyze the year wise average stock prices of top 26 companies of BSE Sensex on consolidation basis for period of five years from 2006 to 2010 to predict impact of accounting numbers on stock returns. Regression Analysis, t- test, f- test, and Correlation were used.

It was concluded that accounting numbers do not predict Stock Returns. It can be seen that all the ratios during the entire study period have insignificant relationship with the Stock Returns, i.e., there is no significant impact of the ratios on the Stock Returns predictions and determinations. The results and conclusion implies that stock market do not take account of accounting numbers, either in the form of financial results declaration or their interpretation in the form of ratio analysis. Market finds its own way ignoring financial results and accounting numbers. This affirms and confirms the Random Walk theory and all forms of Efficient Market Hypotheses. Probably investors are more aware of accounting numbers in the form of quarterly results and they do not wait to take note of it and immediate prevailing prices are the reflection of discounting of the accounting information. In the light of findings and implications, it is suggested that the investors should not overreact to accounting information. They should not either buy or sale investment on decision making based only on accounting numbers.

Investigating the Role of Prior Investment and Gender on the Investment Decision

of a Casual Investor

Dr. Sumeet Gupta*, Meenakshee Sharma** and Mahendra Kumar Iktar**

Abstract—A number of factors influence investment decision. One of the crucial factors among them is the prior investment. Depending upon the results of prior investments investors feel happy or regret their investment decision and thereby chart the course of their future decisions. Among other factors are gender and culture. For example, in India, women largely depend upon their husband / father for making investment decisions. A number of psychology studies also show that men are more confident than woman. Traditionally in India, male members of the family actively participate in major financial decisions of the family as compared to women. This paper attempts to empirically examine the role of prior investment and gender in the investment decision making of a casual investor. The study shows that gender has a significant impact on investment behavior but prior investment doesn’t have significant influence on the investment behavior.

Keywords: prior investment, gender, investment decision making, casual investor

INTRODUCTION Investment is not a new concept. In ancient times, empires and civilizations invested their savings in land, jewelry and animals just like Horse, Cows, and Buffaloes, which are comparatively riskless. Now-a-day’s investment instrument and investment behavior of investors have changed. Investors rarely invest their savings in animals. People often want to invest their money in risky instruments such as shares and equities in an attempt to obtain quick returns in short time. However, the dilemma of risk Vs return is always present in front of a small investor.

Normally investors want higher return with minimum risk (Thaler, 1985) but they know very well that high returns require high risk. In 2009 share market crashed from 21000 to 16000 in a day. A number of investors lost their huge savings in an attempt to gain higher return. To prevent such shocking events investors hedge their risk by investing in a portfolio of risky and riskless instruments. Since, every instrument has some risk every investor has to include low and high level risky instruments for making an efficient portfolio.

A number of portfolio theories have been proposed to develop an efficient portfolio. Prominent among them are Markowitz Portfolio Utility Theory (Markowitz 1952, 1959), Sharpe Single Index Model (Sharpe, 1963) and Capital Asset Pricing Method (Markowitz and Sharpe, 1964). Portfolio theory considers only risk and return as two major factors for developing an optimum portfolio. Identifying the risk level, management of risk and proper

*Shri Shankar Acharya College of Engg. & Technology, Bhilai **Shri Shankar Acharya Institute of Technology of Management, Bhilai


diversification of fund in different instruments is primary objective of making efficient portfolio (SLIM, 2007). High dividend payout policy, which should be associated with higher accounting rates of return and higher market to book value ratios, would be consistent with optimization theory (Stanley et al., 2005). However, a casual or a small investor hardly understands these theories and neither has the patience to learn them for identifying an investment portfolio. His investment decision is largely a result of discussion with friends and experts in the field of investment. Moreover, his prior experience with the investment significantly influences his future decisions. A failure with any investment may put him off for making future investments.

Most of the studies in investment behavior examine the role of social factors (Gupta and Sharma, 2009), income level of investors (Morgan et al., 2001), financial advisor recommendation, advertisement (Lee, 2004) and risk and return (Markowitz 1952, 1959). The primary objective of this study is to examine the role of prior investment in the investment decision of casual investor. According to Atkinson et al. (2004), men are more confident than women about their ability to make financial decision. In the ancient times major decisions were taken by male members of the family and female members played a subordinate role in making investment decisions. But time is drastically changing and these days’ women also earn and make investment decision not only in riskless instruments, but also in risky instruments. Therefore, this study also examines the role of gender in the investment decision of a casual investor.

CONCEPTUAL BACKGROUND AND HYPOTHESIS DEVELOPMENT

A Casual Investor

A number of studies (e.g., Al-Azmi, 2008; Alexander et al., 1997; Wilcox, 2003; Capon et al., 1994) have been conducted in the field of investment decision making. These studies argue that investors are different from one another and therefore cannot be treated homogeneously. It is possible that informal investors, that is, private individuals who provide risk capital directly to unlisted small firms, may play a significant role in filling the finance gap for entrepreneurial ventures (Hans Landstrom, 1995). Advertisement also influences an Investor’s investment decision. Advertisement can change the mood and attention of investors and we can say it is good to attract investors (Frank et al., 2005). Al-Azmi (2008) argues that men and women have own need requiring different market strategies to target them. According to Catherine (2004) before taking investment decision every investor takes information regarding investment from various sources. Education level of investor also influences investment decision. Morgan et al (2001) says that it is not the level of marginal tax that appears to matter nor in the aggregate is the array of sophisticated loopholes or tax havens of many consequences in influencing investor decision. Wallace et al., (1989) report that fluctuations in the stock market also influence an investor’s investment decision. The abnormal returns of a year are positively correlated with the abnormal returns of next year and vice versa. Investor’s decisions are also influenced by the overreaction of stock market. The prior investments made by an investor also influence his investment decision (Gupta and

Investigating the Role of Prior Investment And Gender on the Investment Decision of a Casual Investor 433

Sharma, 2009). If the investor feels regret in his previous investments, then he tries to change his investment strategies. Regret arise when investment instrument are not fulfill the expectation of investors. Anticipated regret also influences investment decision. Lack of proper investment strategy, confusion regarding information and uncertainty influences investor investment decision (Basu et al., 2006; Zhang, 2006).

Portfolio Management Theories

Return is the primary motivating force that encourages investment. Basically return is reward for understanding investment. If investors are able to understand different investment option and try to make better investment strategy than they can generate higher return. But we know always return comes with risk. We can’t talk about investment return without taking risk. Investment decision is nothing but it involves a tradeoff between risk and return. These two factors effect investor’s investment decision the most. A number of investment theories has been introduced by some financial expert like Markowitz portfolio model (Markowitz 1952, 1959), Arbitrage Pricing Theory (Ross, 1976), Sharpe single index model (Sharpe, 1963), Capital Asset Pricing theory (Sharpe, 1964). Capon, (1992) says that investor can take right decision on the basis of these theories and maintain the risk and return on portfolio. The problem with these theories is that takes into account only risk and return and are not very useful for evaluating multi attributes. These theories are easy to implement, more easy to understand result.

Bayesian networks have also been used for making financial forecasts (Ronald et al., 2006). This method is good when investor invests huge amount in market or invest in venture capital. Bayesian network help investors to take unbiased decision. The output of Bayesian network is probability distribution for the value of the portfolio. Network selection behavior is also a new approach for making efficient portfolio (Litman et al., 2002). It is concerned with maximizing returns whereby an investor is willing to take a minimum level of risk.

Most of the investors are unaware of even basic financial theories and hardly consider these theories or models for making optimum portfolio. Casual investors are not familiar with different financial tools based upon which they can take good investment decision. Investor’s experience and friends experience also influence investment decision. Limited liability and level of wealth affect rational investor’s investment decision. Limited liability can be one reason for minimization of risk (Rochet et al., 1997).

Role of Prior Investment in Investment Decision

Prior experience can also influence one’s investment decision. If past experience is good then the investor feels happy and in future will again try to invest in same instrument. On the contrary, if he / she feels regret (sadness) than he switches to other instruments or stops making investments. On the basis of prior investment, investors try to learn something for future course of action. Regret basically divided in to two parts; Experience and anticipated regret. Counterfactuals (expressing what has not happened but could, would, or might under differing conditions) are more frequently generated when a decision is associated with unfavorable outcomes (Bailey and Kinerson, 2005). For example, suppose an investor has


invested Rs. 100,000 in stocks and founds that after 5 years these stocks have appreciated 3 times in values. When the investor compares this with the situation whereby he would have invested the same amount in a bank (the appreciation would be say 2 times), the possibility of generating counterfactuals is less as the outcome is favorable. However, if he compares this investment with another situation whereby he could have invested in stocks which have appreciated more than 3 times in value, he might generate counterfactual thoughts.

According to Inmam (2001) repeat purchasing may cause as much or even more regret than switching. Timing and choice between brand name and price can also influence by asking consumer to imagine how would feel if they made the wrong decision (Simonson, 1992). Sometime people blame other for initial action, it can be one cause of experience regret and experience regret always affects future investment (Fuzikawa, 2009). The study found that prior experienced regret and a complete feedback on the subsequent choice (anticipatory regret) should be both present for a change in behavior in subsequent different choice (Raeva, 2009). Hence, we hypothesize:

H1: Prior investment has significant positive impact on Intention to invest

Role of Gender in Investment Decision

In the modern society both male and female both invest their savings in different avenues but risk taking capacity of investors is different because of gender. Gender influence investor behavior and risk aversion (Arano et al., 2010). Men are considered more knowledgeable and confident about their ability to make financial decision. One study (Pawlowski et al., 2008) showed that brokers were more likely to insist that women go home and discuss their financial choices with a spouse before making any final decisions. Sexual theory (Pawlowski et al., 2008) predicts that males tend to behave in a way that they are more risky than female. Single male pursue a more risky strategy than single female (Pawlowski et al., 2008).

Information processing style may account for the lower risk-taking tendencies among female investors as well as the tendency toward lower confidence level. Investment expertise, general knowledge of natural information, and adviser recommendation are also very important factors which affect investment decision of investors. Limited liability is another parameter, which affects risk taking behavior of investors. That is why rational investors take decision after calculating each and every aspect of their decision (Rochet et al., 1997). Opinion of one’s social group (family members, peers groups) is also important in determining risk taking capacity of casual investors (Niklas and Weber, 2004).

Al-Azmi (2008) argues that men and women as investors should be treated as separate market niches, each with its own needs and requiring targeted marketing strategies. Hence, we hypothesize:

H2: Gender has significant positive impact on Intention to invest

Based on the above discussion, we develop the research model as shown in figure 1.


Fig. 1: Research Model


Instrument Development

We developed the survey instrument by adopting existing validated questions wherever possible. Items for Investment intention were adapted from Gupta and Sharma (2009). The dependent variable was the choice of the investor between a risky investment, a riskless investment or a portfolio of investments. All the investors were given a choice to invest Rs. 100,000 into any of the above option. To understand the dependent variables let us consider an example. Anil who is already invested Rs. 1, 00,000 in risky instruments and now we again give a condition of investing Rs. 1, 00,000 in risky and riskless instrument, than what will be decision taken by the investor. Thus, the dependent variable is some measure of the effectiveness of the treatment. To characterize the dependent variable we developed an index from 0 to 100. A 0 index implied that the treatment had no effect (that is no change from previous investment decision) and a 100 index implied that the treatment was fully effective (complete change from previous investment decision).

We choose survey method for this study as it is most suitable and easy method for establishing generalizability. We conducted survey in Tier II cities of India, where most of the investors are less informed about financial instruments. In other words, the investors in these cities are most likely to be casual investors. To further ensure that the investors were casual, we surveyed members of middle-class families in these cities (Capon et al., 1994).

Data Collection

The empirical data for the study was collected from casual investors over a period of one month. A total of 150 valid responses were collected for the study. Table 1 shows the demographic characteristics of the respondents.


TABLE 1: DESCRIPTIVE STATISTICS OF RESPONDENT CHARACTERSTICS

Item Measure Frequency Percentage Age (years) <20 67 44.66

20-29 43 28.66 30-39 40 26.66 >=40 0 0.00

Missing 0 0 Gender Female 75 50.00

Male 75 50.00 Missing 0 0

Annual Income

<1lakh 33 22.00 1-3lakh 68 45.33 3-5lakh 39 26.00 >=5lakh 10 6.66 Missing 0 0

Net worth

<10 lakh 72 48 10-20.99 lakh 53 35.55 30-40.99 lakh 21 14

>50 lakh 4 2.66 Missing 0 0

Total 150 100%

Table 1 shows that about 75 of investors were male and 75 investor were female. They are equally distributed among investors. In India, investment decisions, particularly in middle class families are usually taken by males. Investors were fairly spread over three age groups. The annual income of most of the investors was between 1 and 3 lakh, fairly common among Indian middle class families. Most of the investors had net worth between <10 lakh. The above data fairly represents the characteristics of casual investors.

DATA ANALYSIS AND RESULTS

The data analysis was done using SPSS 18.0. We used ANOVA technique for analysis. The data was analyzed separately for prior investment (subject type: risky and riskless instruments). The variable gender is also important factor which affect investment decision of investors. The results of ANOVA analysis for the influence of gender (male and female) are shown in Table 2.

TABLE 2: TEST OF BETWEEN SUBJECT EFFECT Dependent Variable: Index

Source Type III Sum of Squares Df Mean Square F Sig. Corrected Model 28178.137a 3 9392.712 10.900 .000 Intercept 423126.454 1 423126.454 491.012 .000 Prior Investment 741.088 1 741.088 .860 .355 Gender 25779.787 1 25779.787 29.916 .000 Interaction 1663.792 1 1663.792 1.931 .166 Error 254214.438 295 861.744 Total 704776.000 299 Corrected Total 282392.575 298 a. R Squared = .100 (Adjusted R Squared = .091)


Hypothesis Testing

The results of the test are shown in Figure 2. Figure 2 shows that gender has a significant influence on intention to invest, thus supporting H2. The surprising finding is that prior investment does not have a significant influence on intention to invest, thus failing to accept H1.

Fig. 2: Results OF Hypothesis Tests (H1 AND H2)

NS=Not Significant; *: p<0.05; **: p<0.01; ***: p<0.001

DISCUSSION AND IMPLICATIONS

The results of this study show that casual investors’ investment behavior is significantly influenced by the gender (male and female), specifically when investors invest his/her saving in risky instruments. Surprisingly, the results also indicate that prior investment does not have a significant influence on an investors’ intention to investment. The collected data revealed that investors did not switch from risky to riskless in general or vice versa but they switched from one form of risky (or riskless) to another form of risky (or riskless) instrument. For getting optimum return from investment they have to make optimum portfolio. In portfolio investors have to keep both (risky and riskless) the instruments. In this time many hedging instruments are also available in the market. This implies that mutual fund companies and insurance companies and other hedging instruments might obtain a better market among casual investors. By investing in those hedging instruments, investors can get good return and hedge against risk.

CONCLUSIONS AND LIMITATIONS

In this paper we investigated the effect of prior investment experience and gender on a casual investors’ subsequent investment decision. The results of the study show that gender plays a significant role in influencing casual investors’ subsequent investment decisions. Risk taking capacity of male and female both are different male are more rational and practical as compare to female investors. Moreover, a casual investor is largely a risk averse investor and would like to take measured risk. Mutual fund firms and insurance company can take advantage of their risk-averse nature as well as their desire for higher returns.


There are several limitations in this study. First, although we sampled casual investors, the sample size could have been greater. Secondly, we did not capture the initial risk level of the investors. By capturing the initial risk level of all investors, we can measure the effect on subsequent decision more accurately. Future studies, may consider measuring the initial risk level of investors and then measuring the effect on subsequent decision. Thirdly, the investment decisions are based on one’s beliefs. Therefore, the scenarios presented may not be said to be free from response bias due to extraneous variables. Although scenarios help to some extent in understanding investment behavior, their hypothetical nature precludes one from generalizing the results. The reality may be quite different whereby an individual might have experienced both happiness and regret from investment decision.

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The Study on the Impact of Corporate Action

Events on Stock Prices and Volume Behavior

Preeti Sharma* and Mithilesh Kumar*

Abstract—The research examines the impact of major corporate action events on stock

prices & volume between 2006 -2010. Corporate Actions are instances where some action is

taken by the company as a result of which the share price will react. Common examples are

dividends, bonus, rights, stock splits, buy back, mergers and de-mergers. This study examines

the impact of right issue on the share price and volume behavior around the event. The sample

period consists of growth/boom and slowdown/recession phases of the market. Therefore this

study will also attempt to find out the relationship between the frequency of right issue and

market cycles.

Keywords: Corporate Actions, Bonus issue; growth/slowdown, Share price and volum

Summary

Corporate actions have potentially strong effects on share prices and trading activity,

although these effects depend on the type of corporate action and the particular point in the

corporate action processing cycle.

For analyzing the impact of stock split announcements on stock returns and volume

behavior, our sample consists of stock split announcements of 29 companies during the

period 2006 to 2010 with a net-worth of 1500 crore or above as on 10.10.2010.

For analyzing the impact of bonus issue announcements on stock returns and volume

behavior, our sample consists of bonus announcements of 35 companies during the period

2006 to 2010 with a net-worth of 1500 crore or above as on 10.10.2010.

Our findings are summarized as follows:

Impact of Stock Split announcements: The chart for Mean Abnormal returns shows the

Higher average market adjusted returns(at t = -1, AAR = 2%) just before the announcement

day of Stock Split and shows the low average market adjusted returns just after the

announcement day of Stock Split (at t = 4, AAR = -1%). However from t = 12 day onwards

stock returns shows the high AAR.

However the pattern of charts, for mean volume and mean no. of trades does not shows

the improvements after the announcement day. In the pre announcement period liquidity is

higher in comparison to post announcement period.

Impact of Bonus Announcements: The chart for Mean Abnormal returns shows the

Higher average market adjusted returns(at t = -2, AAR = 1.5%) just before and on the

announcement day (at t = 0, AAR = 2%) of Bonus and shows the low average market adjusted

returns just after the announcement day of Bonus (at t = 4, AAR = -0.3%). However from t =

6 day onwards stock returns shows the high AAR.

*International College of Financial Planning, New Delhi

The Study on the Impact of Corporate Action Events on Stock Prices and Volume Behavior � 441




Thus the results for the both the corporate actions shows the similar results and supports

the information content of corporate action event announcements but however reflected in

stock returns after few days of announcements in the form of high AARs. The lower returns

just after the announcement days may be attributed to the phenomenon of market adjustment

of new information.

However for both the corporate actions the results does not support the hypothesis of

increased liquidity in the stocks after the announcement.

Market Cycles and Frequency of Stick Splits

• During the period Sep 2006 to Dec 2007 total 140 stock split announcements were made

which corresponds to growth and boom period of Indian Stock Market.

• During the period Jan 2008 to March 2009 total 87 stock split announcements were made

which corresponds to slowdown period of Indian Stock Market.

• During the period April 2009 to Oct 2010 total 208 stock split announcements were made

which corresponds to Recovery and Growth period of Indian Stock Market.

With the help of above information it may be concluded that during the growth phase the

frequency of stock-split announcements increases. One of the reasons may be to bring the

increasing prices in the normal trading range.

Market Cycles and Frequency of Bonus Issue

• During the period Oct 2006 to Dec 2007 total 93 Bonus announcements were made


• During the period Jan 2008 to March 2009 total 45 Bonus announcements were

made which corresponds to slowdown period of Indian Stock Market.

• During the period April 2009 to Oct 2010 total 104 Bonus announcements were

made which corresponds to Recovery and Growth period of Indian Stock Market.


frequency of Bonus announcements increases. One of the reasons may be the willingness of

management to send positive signals supported by good performance during growth

INTRODUCTION

A Corporate action is an event initiated by an issuer that affects the securities (equity or debt)

issued by the company. These include, mergers and acquisitions, spin-offs, cash stock

mergers, forward and reverse stock splits and name changes. Some corporate actions, such as

a dividend (for equity securities) or coupon payment (for debt securities or bonds) may have a

directfinancial impact on shareholders or bondholders. Some, such as stock splits, may have

an indirect impact on shareholders, as the increased share liquidity may cause the stock price

to rise. Others, such as a name change, have no direct financial impact.

442 � Changing Dynamics of Finance

Corporate actions may have significant implications for the financial risks faced by

market participant .In particular, such actions often contain new information about the current

and expected profitability and growth prospects of firms or they can result in firms operations

and financial structure. In our study we analyzed the effects of corporate action associated

with bonus issue & Stock Split announcements using the share price returns and volume

measure.

This study analyses the impact stock split announcement on the stock returns and

liquidity on a sample of 29 companies. Further this study analyses the impact of another

corporate action event, bonus announcement on the stock returns and liquidity on a sample of

35 companies, spread over a period of year 2006 to year 2010. All the companies in the

sample have the net-worth of 1500 Crore or more as on 10.10.2010. Thus the sample

comprises of large companies.

• Announcement Date – The date on which a particular action is announced

LITERATURE REVIEW

Several studies have been conducted in advance countries to analyze the announcement

effects of corporate action events. However in India only few studies have been conducted.

Some of the studies are examined as follows:

The paper by Fama, Fisher, Jensen and Roll (FFJR, 1969) that pioneered the event study

methodology. FFJR consider the behavior of stock prices around stock splits. They ask the

following question: do stock prices behave differently around stock splits than in normal

periods? To address this issue, they compare the holding returns on the stock around the event

date (i.e. the actual date of the stock split) and the expected return if there had been no event.

The difference between the actual return in the event period and the expected returns is

referred to as the abnormal return. To study the effects of, in this case, stock splits the

observed return series of one single firm is not very informative because returns are

stochastic. Therefore, they aggregate abnormal returns over all stock splits in the sample.

Statistical tests are then invoked to test the hypothesis that on average, returns around the

event date are not different from their expected returns.

Ball, Brown & Finn (1977), This study concluded that the observed abnormal returns

were due to information concerning anticipated cash flows, and not to the increased number

of shares which resulted from the capitalization changes.

Emanuel (1977), examines that for the 148 bonus issues 109 (75%) reported excess

returns above their control portfolio in the pre announcement period and 82 (56%) reported

excess returns above their control portfolio in the post announcement period. The evidence

reported strongly supports the view that the New Zeeland stock market is efficient with

respect to bonus and right issue announcements.

Richard G. Solan (1987), examines Australian share price behavior on and around the ex-

days of bonus issues and share splits. It employs daily transaction prices for a sample of 89

screened bonus issues and splits made over the period 1974 through 1985. Results for the ex-


day itself reveal that the null hypothesis of zero abnormal returns can not be rejected.

Statistically significant positive abnormal returns are, however documented in the five day

prior period to the ex-day.

John J. Binder (1998), discusses in his paper the event study methodology, beginning

with FFJR (1969), including hypothesis testing, the use of different benchmarks for the

normal rate of return, the power of the methodology in different applications and the

modeling of abnormal returns as coefficients in a (multivariate) regression framework.

Frank de Jong (2007), in his lecture notes, provided an introduction to the methodology of

event studies. He discussed the various parametric and non-parametric tests which are popular

in the applied literature. Indeed, the statistical methods used in conducting event studies are

often complicated and confusing. Nevertheless, most extensions of the basic t-tests are

designed to deal with serious empirical problems. Neglecting problems such as cross-

sectional dependence and event-induce variance may easily lead to spurious inference.

However, there is also much to gain from a careful selection of the data and an exact

determination of the event dates.

Pavabutr, Sirodom (2008), This paper explores the impact of stock splits on stock price

and various aspects of liquidity using daily and intraday data from the Stock Exchange of

Thailand between 2002- 2004. This provides evidence that reductions in trade frictions and

increases in split-adjusted price levels are associated with the size of split factors and post-

split trading range. Stocks with high split factors have better post-split adjusted price

performance and lower trade bid-ask spreads and price impact. The empirical findings lend

support to the trading range hypothesis of stock splits.

Shirur (2008), In the case of issue of bonus shares, the first three factors, viz., rate of

growth of sales and profit as well as value of beta significantly explain the difference between

the companies issuing bonus shares and the Nifty companies. This proves that the capital

market is not inherently

a semi-strong form of EMH and that the top management has to send signals to make the

market efficient. Similarly, the last two factors, viz., stake of promoters and negative

companies also significantly explain the difference between the companies issuing bonus

shares and the Nifty companies. This shows that the market is not able to inherently depict

strong form of EMH. In the case of stock splits, only the rate of increase in share price

explains the difference between the companies resorting to stock split and the Nifty

companies. This proves that the capital market is not inherently a semi-strong form of EMH

and there is a possibility of investors overvaluing the shares of certain companies for an

unduly long time. Since the promoters’ stake in companies resorting to stock split is higher

than the Nifty promoters’ stake, it could be concluded that the promoters’ stake has a major

role to play in the top management taking decisions regarding stock splits. As a defensive

measure, promoters resort to stock split in order to restrain the price of stocks from falling.

ERaja, Sudhahar & Selvam (2009), empirically examined the informational efficiency of

Indian stock market with regards to stock split announcement released by the information


technology companies. The result of the study showed the fact that the security prices reacted

to the announcement of stock splits. The reaction took place for a very few days surrounding

day 0, remaining days it was extended up to +15. Thus one can conclude from the forgoing

discussion that the Indian stock markets in respect of IT companies in general are efficient,

but not perfectly efficient to the announcement of stock split. This can be used by investors

for making abnormal returns at any point of the announcement period.

Raja & Sudhahar (2010), this study has empirically examined the informational efficiency

of capital market with regard to bonus issue announcement released by the IT companies. The

results of the study showed that the security prices reacted to the announcement of bonus

issue. It concludes that the Indian capital market for the IT sector, in general, is efficient, but

not perfectly efficient, to the announcement of bonus issue. This informational inefficiency

can be used by the investors for making abnormal returns at any point of the announcement

period.


Sample

For analyzing the impact of stock split announcements on stock returns and volume behavior,

our sample consists of stock split announcements of 29 companies during the period 2006 to

2010 with a net-worth of 1500 crore or above as on 10.10.2010. Some of the companies are

excluded from the analysis because of unavailability of data. However during the said period

total 438 stock split announcements were made but we have analyzed the data fore only the

large companies with a net-worth of 1500 crore or more.

For analyzing the impact of bonus issue announcements on stock returns and volume

behavior, our sample consists of bonus announcements of 35 companies during the period

2006 to 2010 with a net-worth of 1500 crore or above as on 10.10.2010. Some of the

companies are excluded from the analysis because of unavailability of data. However during

the said period total 245 bonus announcements were made but we have analyzed the data fore

only the large companies with a net-worth of 1500 crore ore more.

DATA COLLECTION

The data for this research study has been collected from the Capital-line corporate database.

The data was collected for all the companies in the sample period for a period of 20days pre

announcement period to 20 days post announcement period for each day, for the following

parameters:

Closing price

Volume traded

Number of trades

BSE-Sensex closing values


However these data sets belongs to different time periods as all the event announcements

were made at different dates during the period 2006 to 2010.


We selected the corporate action announcement date as the event date. The data was collected

fore the above discussed period.

Daily Returns

Then we calculated daily returns for all the scrips in our sample for 15 days pre

announcement period to 15 days post announcement period, where vent date is characterized

as 0 day. Daily returns are calculated using t following formula:

Ri, t = [(Pt-Pt-1)/Pt-1]* 100

Where,

Ri, t = Returns on Security i on time t.

Pt = Price of the security at time t

Pt-1 = Price of the security at time t-1

The daily returns on sensex for the similar period were also calculated using the same

method.

Abnormal Returns

Abnormal Returns (AR) under market-adjusted abnormal returns are calculated using the

equation as below;

ARi,t = Ri,t – Rm,t

Where,

ARi,t = Abnormal returns on security i at time t

Ri,t = Actual returns on security i at time t

Rm,t = Actual returns on market index, which is proxied by BSE Sensex, a weighted

average index of 30 companies published by BSE, at time t.

We have proxied market returns by BSE Sensex returns because our sample consists the

large companies which matches with the chosen benchmark Thus daily actual returns over the

announcement period (31days) were adjusted against their corresponding market returns.

Analyzing abnormal returns

In analyzing abnormal returns, it is conventional to label the event date as time t = 0. Hence,

from now on ARi;0 denotes the abnormal return on the event date and, for example, ARi;t

denotes the abnormal return t periods after the event. If there is more than one event relating

to one .rm or stock price series, they are treated as if they concern separate .rms. We typically


consider an event period, running from t1 to t2. Assuming there are N firms in the sample, we

can construct a matrix of abnormal returns of the following form:

Each column of this matrix is a time series of abnormal returns for firm i, where the time index t is counted from the event date. Each row is a cross section of abnormal returns for time period t.

In order to study stock price changes around events, each firm’s return data could be analyzed separately. However, this is not very informative because a lot of stock price movements are caused by information unrelated to the event under study. The informativeness of the analysis is greatly improved by averaging the information over a number of firms. Typically, the unweighted cross-sectional average of abnormal returns in period t is considered:

Average Abnormal Returns

The Average Abnormal Returns is calculated by the equation given below

n

AARt = 1/n ∑ ARi,t

i=1

Where,

AARt = Average Abnormal Returns on day t

ARi,t = Abnormal Returns on security i at time t

n = total number of scrips in the sample

Large deviations of the average abnormal returns from zero indicate abnormal

performance. Because these abnormal returns are all centered around one particular event, the

average should reflect the effect of that particular event. All other information, unrelated to

the event, should cancel out on average.

These Average abnormal Returns for the event window are plotted on a graph and

analyzed for any significant difference in pre and post announcement pattern of returns.


Similarly Average volume and average number of trades are also plotted on the graph for

the period t=-15 to t=15 around the event day t=0 to find the liquidity impact of event

announcements.

FINDINGS AND RESULTS

Our findings for stock split announcements during the period 2006 to 2010, fore a sample of

29 scrips with a net-worth of 1500 Crore as on 10.10. 2010, are summarized as follows

Days Mean Market Adjusted Returns Mean Volume Mean No. of Trades

-15 0.46% 171,476 4,049

-14 0.70% 107,188 3,471

-13 -0.08% 184,290 3,993

-12 -0.43% 147,954 3,856

-11 0.32% 155,640 3,909

-10 -0.16% 253,168 5,649

-9 0.81% 265,918 6,443

-8 -0.03% 134,060 3,671

-7 0.46% 129,730 3,474

-6 0.27% 92,231 3,362

-5 -0.25% 102,008 3,802

-4 -0.28% 112,897 3,989

-3 1.17% 118,927 4,438

-2 1.01% 151,138 5,836

-1 1.97% 231,979 7,032

0 0.84% 227,573 6,775

1 0.27% 135,936 3,437

2 0.74% 231,768 3,743

3 0.54% 177,969 3,801

4 -0.96% 128,152 2,891

5 0.49% 157,793 3,449

6 0.87% 114,308 3,008

7 -0.10% 119,093 2,995

8 0.85% 108,755 2,498

9 -0.18% 157,725 3,108

10 0.47% 133,558 3,134

11 -0.37% 100,344 2,522

12 0.97% 115,575 2,551

13 1.68% 153,576 3,556

14 0.74% 121,631 3,420

15 1.41% 116,594 3,885

The above data sets when plotted on a graph, shows the following patterns:


Mean Market Adjusted Returns

-1.50%

-1.00%

-0.50%

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

-1

5

-1

4

-1

3

-1

2

-1

1

-1

0

-9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

DaysM

ean

Ab

no

rmal R

etu

rns

Mean Market Adjusted Returns

Fig. 1: Impact OF Stock split Announcement ON Average Abnormal Returns During THE Period T = -15 Days TO T = 15 DAYS

Mean Volume

0

50,000

100,000

150,000

200,000

250,000

300,000

-15 -14 -13 -12 -11 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Days

Mean

Vo

lum

e

Mean Volume

Fig. 2: Impact of Stock split Announcement on Mean Volume during the period t = -15 days to t = 15 days

Mean No. of Trades

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

-15 -14 -13 -12 -11 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Days

Mean N

o. of Tra

des

Mean No. of Trades

Fig. 3: Impact of Stock Split Announcement on Mean no. Of Trades During the Period t = -15 days to t = 15 days


Our findings for bonus announcements during the period 2006 to 2010, fore a sample of

35 scrips with a net-worth of 1500 Crore as on 10.10.2010, are summarized as follows:

Days Mean market adjusted returns Mean Volume Mean number of trades

-15 -0.24% 278116 5641

-14 -0.03% 262255 5298

-13 -0.16% 276966 5381

-12 -0.54% 333455 4957

-11 0.28% 353259 6289

-10 0.34% 350408 6920

-9 -0.35% 384879 6413

-8 -0.45% 321216 6101

-7 -0.74% 312491 5816

-6 -0.15% 297438 6284

-5 -0.30% 287097 6321

-4 0.28% 320035 5899

-3 0.95% 309373 6433

-2 1.45% 412535 8375

-1 0.40% 597025 11998

0 1.93% 782770 16086

1 1.05% 303988 5450

2 0.46% 194960 3598

3 -0.03% 311460 4939

4 -0.37% 242192 4223

5 -0.12% 277105 4843

6 0.84% 270711 4529

7 0.90% 372689 4805

8 0.50% 348412 5169

9 0.75% 243123 4386

10 0.28% 223115 3679

11 0.15% 215560 4109

12 0.47% 244187 4159

13 0.52% 206589 3888

14 0.30% 208607 3495

15 0.27% 255703 4245

The above data sets when plotted on a graph, shows the following patterns:

Mean market adjus ted returns

-1.00%

-0.50%

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

-1

5

-1

4

-1

3

-1

2

-1

1

-1

0

-9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Days

Me

an

Re

turn

s

Mean market adjusted

returns

Fig. 4: Impact of Bonus issue Announcement on Average Abnormal Returns During the Period t = -15 days to t = 15 days


Mean Volume

0

100000

200000

300000

400000

500000

600000

700000

800000

900000

-15 -14 -13 -12 -11 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Days

Me

an

Vo

lum

e

Mean

V olume

Fig. 5: Impact of Bonus issue Announcement on Average Volume During the Period t = -15 days to t = 15 days

Mean number of trades

0

2000

4000

6000

8000

10000

12000

14000

16000

18000

-1

5

-1

4

-1

3

-1

2

-1

1

-1

0

-9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Days

Me

an

nu

mb

er

of

tra

de

s

Mean number of

trades

Fig. 6: Impact of Bonus issue Announcement on Average Number of Trades During the Period t = -15 days to t = 15 days

CONCLUSION

Impact of Stock Split Announcements

The chart for Mean Abnormal returns shows the Higher average market adjusted returns(at t =

-1, AAR = 2%) just before the announcement day of Stock Split and shows the low average

market adjusted returns just after the announcement day of Stock Split (at t = 4, AAR = -1%).

However from t = 12 day onwards stock returns shows the high AAR.





Impact of Bonus Announcements

The chart for Mean Abnormal returns shows the Higher average market adjusted returns(at t =

-2, AAR = 1.5%) just before and on the announcement day (at t = 0, AAR = 2%) of Bonus

and shows the low average market adjusted returns just after the announcement day of Bonus

(at t = 4, AAR = -0.3%). However from t = 6 day onwards stock returns shows the high AAR.




Thus the results for the both the corporate actions shows the similar results and supports

the information content of corporate action event announcements but however reflected in

stock returns after few days of announcements in the form of high AARs. The lower returns

just after the announcement days may be attributed to the phenomenon of market adjustment

of new information.

However for both the corporate actions the results does not support the hypothesis of

increased liquidity in the stocks after the announcement.

MARKET CYCLES AND FREQUENCY OF STICK SPLITS

• During the period Sep 2006 to Dec 2007 total 140 stock split announcements were

made which corresponds to growth and boom period of Indian Stock Market.

• During the period Jan 2008 to March 2009 total 87 stock split announcements were

made which corresponds to slowdown period of Indian Stock Market.

• During the period April 2009 to Oct 2010 total 208 stock split announcements were

made which corresponds to Recovery and Growth period of Indian Stock Market.


frequency of stock-split announcements increases. One of the reasons may be to bring the

increasing prices in the normal trading range.

MARKET CYCLES AND FREQUENCY OF BONUS ISSUE

• During the period Oct 2006 to Dec 2007 total 93 Bonus announcements were made


• During the period Jan 2008 to March 2009 total 45 Bonus announcements were made

which corresponds to slowdown period of Indian Stock Market.

• During the period April 2009 to Oct 2010 total 104 Bonus announcements were made

which corresponds to Recovery and Growth period of Indian Stock Market.



frequency of Bonus announcements increases. One of the reasons may be the willingness of

management to send positive signals supported by good performance during growth phase.

SCOPE FOR THE FURTHER RESEARCH

• We have covered the data for large companies only. Further research can be

conducted to study the data for all types of companies large as well as small.

• We have covered only two corporate actions events, stock split and bonus. Further

study can be done to include more corporate actions.

REFERENCES

[1] Fama, E.F., L. Fisher, M. C. Jensen and R. Roll 1969). “The Adjustment of Stock Prices to New

Information”, International Economic Review, 10, 1–21

[2] Ball, Brown and Finn (1977). “Share Capitalization Changes, Information and the Australian Equity Market”,

Australian Journal of Management, 2, 105–26

[3] D. M. Emanuel (1977),“Capitalization Changes and Share Price Movements: New Zealand Evidence”

[4] Richard G. Sloan (1987). “Bonus Issues, Share Splits and Ex-Day Share Price Behaviour: Australian

Evidence”, Australian Journal of Management, 12, 2, December 1987

[5] John J. Binder (1998). “The Event Study Methodology Since 1969”, Review of Quantitative Finance and

Accounting, 11, 111–137

[6] Jijo Lukose P. J. & S N. Rao (2005). “Does Bonus Issue Signal Superior Profitability? A Study of the BSE

Listed Firms”, Decision, Vol. 32, No.1, January - June, 2005

[7] Frank de Jong, 2007, Tilburg University, Event Studies Methodology Lecture notes written for the course

Empirical Finance and Investment Cases.

[8] Huang, K. Liano, H. Manakyan and M.S. Pan (2008). “The Information Content of Multiple Stock Splits”,

The Financial Review, 43, 543–567

[9] P. Pavabutr, K. Sirodom (2008). “The Impact of Stock Splits on Price and Liquidity on the Stock

[10] Exchange of Thailand”, International Research Journal of Finance and Economics,

[11] ISSN 1450-2887 Issue 20 (2008)

[12] Srinivas Shirur (2008). “Dilemma of Corporate Action: Empirical Evidences of Bonus Issue

[13] vs. Stock Split”, Vikalpa • Vol. 33 , No. 3, july – september 2008

[14] M.Raja, J.C.Sudhahar, M.Selvam (2009). “Testing the Semi-Strong form Efficiency of Indian Stock Market

with Respect to Information Content of Stock Split Announcement – A study in IT Industry”, International

Research Journal of Finance and Economics, ISSN 1450-2887 Issue 25 (2009)

[15] M. Raja and J.C. Sudhahar(2010). “An Empirical Test of Indian Stock Market Efficiency in Respect of Bonus

Announcement”, Asia Pacific Journal of Finance and Banking Research, Vol. 4. No.4,2010

Comparative Study on the Performance

of Mutual Fund Industry of India

in Past Five Years

Vidya Shivaji Shinde*

Right from its existence, Banks, whether nationalize or corporate, always dominated others, in

case of public investments or retail investments. But in past few years due to various reasons

like continuously falling of interest rates, various scams etc. investors will have to look for

various other investments avenues that will give them better returns with minimization of

risks. Here Mutual Funds Industry has very important role to play in providing alternate

investment avenue to entire gamut of investors in scientific and professional manner.

Indian Mutual Fund Industry has been definitely maturing over the period. In four decades of its existence in India Mutual Funds have gone through various structural changes and gained prominent position in Financial Industry. Because of ease of investments, professional management and diversification more and more investors are gaining confidence in Mutual Funds. Even government policies like abolishment of long term capital benefit taxes added advantage to growth of Mutual Funds. This is all the way leading to pool of more and more money from retail investors into the Mutual Funds.

Date SBI Magnum Contra Fund UTI Contra Fund

2-7-06 28.990 8.380

1-9-06 33.430 9.720

3-1-2007 38.210 9.900

2-4-07 34.240 8.720

1-7-07 41.970 9.980

2-9-07 50.000 11.430

1-1-2008 40.720 13.980

1-4-08 29.680 10.270

1-7-08 21.130 8.720

2-9-08 22.310 9.100

1-1-2009 16.990 7.990

1-4-09 17.890 7.790

1-7-09 22.160 11.080

3-9-09 23.850 12.840

1-1-2010 24.650 13.720

1-4-10 25.840 12.840

2-7-10 21.180 12.750

1-9-10 21.290 13.190

A Mutual Fund is an investment tool that allows small investors access to a well-diversified portfolio of equities, bonds and other securities. Each shareholder participates in the gain or loss o Mutual funds are financial intermediaries, which collect the savings of investors and invest them in a large and well-diversified portfolio of securities such as money market instruments, corporate and government bonds and equity shares of joint stock Companies. The fund's Net Asset Value (NAV) is determined each day.

*Vidya Pratishthan’s Institute of Information Technology, Baramati


Here I have taken the NAV values of different mutual funds from year 2006 to year

2010 .I have also compared the % returns of these mutual funds, sectorwise allocation of

assets.

INTERPRETATION

Above data shows that from year 2006 to 2008 the mutual fund was in growing status. But

due to economy meltdown during year 2008 to 2009 it was found that NAV was declining.

Currently it is holding its grip in market economy.

Returns of Fund

YEAR OF RETURNS SBI MAGNUM CONTRA FUND UTI CONTRA FUND

2008 33.4% 12.4%

2009 40% 20.2%

2010 21.4% 20.3%

Comparative Study on the Performance of Mutual Fund Industry of India in Past Five Years � 455

INTERPRETATION

From the above data rate of return of SBI Magnum Contra Fund is greater than UTI Contra

Fund. UTI Contra fund was launched on 22 feb,2006 .SBI magnum contra fund have high

return as compared to UTI contra fund. So SBI is best alternative to invest for high returns.

Comparison of Sectors

Sector % of Allocation of SBI % of Allocation of UTI

Oil & gases 17.04 9.83

Banking & Finance 14.79 17.79

Engineering & Capital goods 9.67 12.14

Utilities 9.04 9.90

Cement & Construction 7.18 5.69

Telecommunication 6.27 6.39

Chemicals 4.25 1.70

Metals & Mining 3.71 1.82

Food & Beverages 3.15 0.00

Services 3.02 0.00

Pharmaceuticals 2.66 5.42

Conglomerates 2.37 0.00

Automotive 2.35 3.77

Information Technology 2.24 7.36

Tobacco 2.13 4.82

Consumer Non-durables 1.39 1.68

Miscellaneous 1.31 0.00

Media & Entertainment 1.21 1.37

Real Estate 0.94 0.00

Manufacturing 0.54 8.25

Debt 0.89 0.08

Cash/Call 3.84 1.93


INTERPRETATION

Above data shows that different sectors are allocated differently by the SBI & UTI Contra

fund.

Oil & Gases is largely allocated by SBI whereas Banking & Finance by UTI fund

Comparison of NAVS

Years SBI Magnum TAXGAIN Scheme HDFC Taxsaver

1-1-2005 15.620 62.680

2-4-2005 18.343 68.669

1-7-2005 22.301 79.211

3-10-2005 28.550 99.313

2-1-2006 30.758 110.305

1-4-2006 36.701 131.223

1-7-2006 32.351 115.193

2-10-2006 37.649 131.676

1-1-2007 44.333 149.015

1-4-2007 42.420 129.521

3-7-2007 48.780 156.535

1-10-2007 56.310 177.498

2-1-2008 69.520 205.662

1-4-2008 51.070 151.451

1-7-2008 40.820 122.538

1-10-2008 40.870 131.063

1-1-2009 31.640 100.472

1-4-2009 32.570 100.627

2-7-2009 46.360 148.269

1-10-2009 54.230 183.457

3-1-2010 57.770 197.021

2-4-2010 57.800 208.199

1-7-2010 59.470 216.660

2-9-2010 61.250 234.781

We observe, at the year 2005 there was consistency of NAV but for the year 2006-2008

NAV was booming at higher rate. For 2008-2009 it was fallen to rapid rate. Again it grown

up for some extent for the year 2009-2010.

Comparative Study on the Performance of Mutual Fund Industry of India in Past Five Years � 457

Returns of Fund

Years SBI Magnum TAXGAIN Scheme HDFC Taxsaver

2008 -54.8% -51.9%

2009 82.9% 96.1%

2010 -6.3% 16.9%

IAbove data shows that returns of SBI & HDFC in year2008 are in negative due to

economy melt down. In year 2009, returns were highly grown. HDFC leads to attract the

investors. In current year HDFC is at good return position.

Comparison of Sectors

SECTOR % allocation of SBI % allocation of HDFC

Banking & Financial Services 15.67 25.85

Engineering & Capital Goods 12.33 12.27

Pharmaceuticals 7.52 10.86

Oil & Gases 11.99 9.20

Information Technology 6.65 7.68

Media & Entertainment 2.12 5.19

Automotive 4.93 4.81

Consumer Non-durables 0.00 4.03

Telecommunication 2.62 3.58

Food & Beverages 5.13 2.96

Utilities 6.19 2.62

Services 1.24 1.83

Manufacturing 1.56 1.51

Chemicals 4.11 1.05

Cement & Construction 3.67 1.00

Consumers Durables 0.25 0.78

Conglomerates 2.92 0.15

Miscellaneous 0.00 0.04

Cash & Call 1.73 2.92

Metals & Mining 5.75 0.00

Debt 1.96 0.00

Tobacco 1.15 0.00

Others/Unlisted 0.00 1.67

Real Estate 0.52 0.00


INTERPRETATION

We observe in SBI Magnum Tax Gain Scheme Banking & Finance sector have larger

allocation of resources. Engineering & capital goods, Pharmaceuticals, oil & gases

information technology are followed accordingly.

In past few years, there have been ups & downs in the growth of Mutual industry like

growing amount of corporate investments; other is that, investors have understood the need

for asset allocation, which is why we see high net worth individuals coming to mutual funds.

There are good numbers of qualified and educated people who are trying to advice people on

how to invest. These key developments are the driving force for industry. While it also have

been through weak phase in year 2008 to 2009 due to economy meltdown which loosed many

investors but again it accelerated its grip towards the market investment.

In all, key challenges will be to reach out to much larger population. The size of market is

very large and competition is nothing compared to size of industry. As we know, compared to

other avenues, mutual funds are somewhat different. Other investment avenues are more

traditional and people are much more comfortable with them. Whereas mutual funds are

market related instruments, so one will find that the return will go up and come down and

sometimes they will be negative depends upon markets. So there is possibility of very high

degree of discomfort with uncertainty, which is major difference between mutual funds and

other investment instruments. Currently, mutual funds are very urban focused. It needs to be

able to take financial investment culture to much wider market

Track 9 Risk Assessment and Risk Management

Creative Multi Manifestations and Scope of Operational Risk Management in the Indian Banking Sector—Aftermaths

of Basel II Implications

Dr. Deepak Tandon*, Saurabh Agarwal** and Shibumi Kalita*** Abstract—In the era of uncertainty, the future of banking lies, undoubtedly, in the management of risk orientation. In the Banks, reduced concentration of the credit risk, galloping Non Performing Assets (NPAs) in the public sector banks invite greater concern for risk based supervision i.e. Operational Risk Management. Various challenges and issues surmount the banks post Basel II and invite grave concern for Basel III in the near future by the Indian Banks. Internal and external frauds, employment practices, clients and products, damages to physical assets, execution, delivery and process management all attract operational risk management in line with credit or market risks. Standardized Approach (TSA), Alternative Standardized Approach (ASA) and Advanced Management Approach (AMA) all are used to measure capital requirements for operational risk. If not controlled, as a policy method by anyone tool namely self risk assessment (quantitative metrics/scores), risk mapping, key risk indicators provide insight of banks’ risk portfolio. The authors have, through this paper, analyzed ‘continuum’ of Increase Risk Sensitivity and sophistication have highlighted the lapses of Basel II (Credit Allocation, Credit Risk Mitigation- Collateralized, Guarantees) and have suggested an urgent need of Basel III in Indian banking. Value at Risk (VaR) specific risk, stress-testing VaR risk- Stressed inputs, risk weightage to inter-bank loans, integrated management approach through AMA has been emphasized. The authors have empirically studied the operational risk management of SIDBI and Punjab National Bank (a public sector bank) and have concluded that organizational arm in the risk management structure is robust keeping in view risk profile, adequate resources, assessments, capital and loss event databases, complacency does not set in, in the case of PNB whereas the risk indicators, self assessment, capital model is to be developed in SIDBI. Further, detailed loss event classification can be done with respect to business line approach in these banks as suggested by the authors.

Keywords: TSA = Standardized Approach

• BIA = Basic Indicator Approach • AMA = Advanced Management Approach • IRMP = Integrated Risk Management Policy • GI = Gross Income • KRI = Key Risk Indicators

*Lal Bahadur Shastri Institute of Management, New Delhi **Lal Bahadur Shastri Institute of Management, New Delhi ***Lal Bahadur Shastri Institute of Management, New Delhi


INTRODUCTION

Operational Risk has been defined by the Basel Committee on Banking Supervision (BCBS) as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This definition includes legal risk, but excludes strategic and reputational risk. Legal risk includes, but not limited to, exposure to fines, penalties, punitive damages resulting from supervisory actions, as well as private settlements.

Unlike market and credit risks, which tend to be in specific areas of business, operational risk is inherent in all banking business processes. Operational risk differs from other banking risks in that it is typically not taken directly for an expected reward, and emanates from internal operational performance factors and has the potential to affect the risk profile. However, it is recognised that in some business lines with minimal credit or market risks, the decision to incur operational risk or compete based on its perceived ability to manage and effectively price this risk, is an integral part of a bank's risk /reward calculus.

Operational Risk Management is a continuous systematic process of identifying and controlling operational risks in all activities according to a set of predetermined parameters by applying appropriate management policies and procedures. This process includes detecting hazards, assessing risks, implementing & monitoring risk controls to support better-informed decision-making.

The broad Operational Risk Management objectives should encompass the following:

• To identify operational loss events and analyse their causative factors • To build up robust database for operational loss • To estimate expected and unexpected losses; allocate capital for operational risk • To set up prudential limits • To mitigate & control the factors leading to expected losses • To protect against unexpected losses • To make audit mechanism independent of operation • To minimize and eventually eliminate losses and customer dissatisfaction due to

failures in processes • To identify the flaws in products and their design that can expose the institution to

losses due to fraud and similar events

Implementaton of Operational Risk Managament

The following diagram illustrates the process of Operational Risk Management as implemented in few of the most successful and operationally efficient banks world over.

Creative Multi Manifestations and Scope of Operational Risk Management in the Indian Banking Sector 463

One of the most crucial steps to tackle and manage operational risk is through continuous scrutiny of operations for their validity, effectiveness and efficiency. To accomplish this daunting task, the senior management should check all operations for compliance with standards and laid down norms. Moreover, it also becomes quintessential for the Audit and Risk Committee needs to conduct periodic audits, the report of which should be forwarded to the Board of Directors to maintain transparency in operations and prevent excessive risk taking by bank employees.

Benefits of Operational Risk Management (ORM)

The ORM shall ensure adoption of Basel Committee’s governing principles on Sound Practices for the Management and Supervision of Operational Risk. With the implementation of a robust Operational Risk Management Framework, banks will be able to:

• Identify the internal & external causative factors leading to operational risk events, • Understand the risk drivers • Strengthen internal controls to minimize operational risk • Find out the extent of Bank’s OR exposure • Integration of OR in decision support system • Allocate capital for operational risk Following diagram indicates the board steps involved process of Risk Management,

which are explained thereafter:


Risk Identification is of paramount importance for the development of viable operational risk monitoring and control framework. Effective risk identification considers both internal factors (such as complexity of Bank’s structure, nature of activities, quality of human resources, organisational changes and employee turnover) and external factors (such as changes in the industry and technological advances) that could adversely affect the achievement of Bank’s objectives. Based on the past experience, the following operational risks have been identified at the Macro level along with their components:

• People Risk – Placement, Competency, Work Environment, Motivation, • Turnover/Rotation • Process Risk (Transaction Risk) - Transaction guidelines, Errors in execution of

transaction, Product Complexity, Competitive Disadvantage • Systems Risk (Technology Risk) - System failure, System security, Programming

error, Communications failure, MIS Risk • Legal and Regulatory Risk – Fines, Penalties or Punitive Damages resulting from

supervisory actions as well as private settlements. It can also be defined as failing to comply with laws and regulations (e.g. company, industry, environment, data protection, labour, taxation, money laundering) to protect fully organisation’s legal\rights and to observe contractual commitments.

Risk Assessment

Risk assessment allows the Bank to understand its risk profile better and most effectively target risk management resources. Risk assessment shall also identify and evaluate the internal and external factors that could adversely affect the bank’s performance, information already available and compliance by covering all risks faced by the bank and operate at all


levels within the bank. There are various approaches to the same. A few are considered and elucidated below:

Score Card Approach

The tools which are proposed to be used for assessing operational risk is Self Risk assessment wherein the operations and activities of the Bank will be assessed against a menu of potential operational risk vulnerabilities and Key Risk Indicators which provide insight into banks risk position. The self risk assessment will be carried out using the score card approach. The process for risk assessment is outlined below –

• Identify all processes, sub-processes of each product line of the Bank • List the risk events associated with people, processes, system and legal or external

factors • Identify existing controls for each risk event and suggest improvements • Classify identified risk events in various event types under business lines (as defined

by RBI) • Identify causes of the identified risk events Assess the severity of the risk events

through “Risk Severity score card" on a judgemental basis (Insignificant, Minor, Moderate, Major & Catastrophic) with the help of IAD for assessing severity of various risk events.

• Assess the risk event probability using "Frequency score card analysis” on a judgemental basis (Rare, Unlikely, Moderate, Likely and Frequent) with the help of IAD for assessing frequency of various risk events.

• Classify operational risk events in three risk categories (Insignificant, Minor, Moderate, Major & Catastrophic) based on Severity – frequency analysis matrix, identify the audit controls in place and suggest new controls.

• Finalise the events to be tracked based on the Severity – frequency analysis matrix • Fine tune events to be tracked using data on bank's historical loss experience • Set audit bench marks for high loss events in co-ordination with IAD • Develop key risk indicators for events to be tracked which may be quantitative or

qualitative with inputs from IAD • Develop a mechanism for tracking key risk indicators and risk profile of the bank

along with IAD

Risk & Control Self –Assessment Process (RCSA)

To conduct self-assessment exercise, following steps are undertaken: -

• Identification of activities for the survey, • Organizing seminars for the concerned divisions to clarify the concept of RCSA,

discuss the methodology of RCSA, • Preparation of Risk Description Chart and the questionnaire, which shall involve the

following steps: - o Identification of the processes in the activity,


o Identification of the sub- processes in the activity, o Identification of the Operational Risk Events (ORE) of the activity, o Explaining the Risk Description (possible deviations) in the activity, o Mapping the OREs to Loss Event Types, o Identification of the factors responsible for deviations and o Explaining the description of existing controls

• Conduct of the survey by the concerned activity owner, • Continuous monitoring of the implementation of RCSA surveys, • Analysis of the findings of the survey and preparation of the bar/histogram charts, • Placing the findings of the survey to the concerned authorities • Placing the action take report along-with the findings to Operational Risk

Management Committee for deliberation. • Consolidation of RCSA findings at entity level and making a central repository. • Validation of the process of conducting the survey • This process should be repeated for all the activities annually.

Risk Monitoring An effective and regular monitoring process is essential for adequately managing operational risk and offers the advantage of quickly detecting and correcting deficiencies in the policies, processes and procedures for managing operational risk. Promptly detecting and addressing these deficiencies can substantially reduce the potential frequency and/or severity of a loss event. In addition to monitoring operational loss events, banks should identify key risk indicators that provide early warning of an increased risk of future losses and could reflect potential sources of operational risk such as rapid growth, the introduction of new products, employee turnover, transaction breaks, and system downtime. Thresholds directly linked to these key risk indicators should be in place, which shall provide an effective monitoring process and help identify key material risks in a transparent manner and enable the banks to act upon these risks appropriately.

The frequency of monitoring should reflect the risks involved and the frequency and nature of changes in the operating environment and shall be decided while finalising the events to be tracked. The reports on these monitoring activities as well as the compliance reviews performed by the internal audit functions shall be included in regular reports to ORMC. The monitoring of Operational Risk should basically focus on the following three areas:

• Correctly interpreting and observing all the standards and guidelines set out in the operational risk policy and other related documents

• Monitoring operational risks in a timely manner and in the framework of the defined methods, structure, and processes

• Pursuing the measures initiated by the concerned HO division for addressing the weaknesses in processes, structures and control, and for limiting the losses.


Risk Event (Hazard) is an incident or a set of incidents that results into actual/potential or direct/indirect or a near-miss loss.

• Actual or Direct Loss: Actual operational risk losses are those losses, which have actually materialized and have the financial impact associated with the operational event in the financial statement (P&L A/c, Suspense, Protested, Provision, write off etc) and would include the following:

o Loss incurred due to: -

Write downs: Direct reduction in value of assets due to theft, fraud, unauthorized activity or market and credit losses arising as a result of operational events;

Loss of recourse: Payments or disbursements made to wrong parties and not recovered;

Restitution: Payment to clients of principal and/or interest by way of restitution, or the cost of any other form of compensation paid to clients;

Legal liability due to operational risk: Judgments, settlements and other legal costs;

Regulatory and compliance including taxation penalties: Fines or any other statutory/regulatory penalties;

Loss /damage of assets: Direct reduction in value of physical assets due to some kind of accident (e.g. neglect, accident fire, earthquake etc.)

Write off: Write-off means relinquishment of our claims recorded in our books on actual basis and have impact on P&L A/c.

o Expenditure incurred to resume normal functioning:

Safe, Fixture & Furniture/Motor Car & Cycle Expenditure incurred on repair & maintenance of SFF/MCC/Bank’s premises

damaged due to fire / flood / other calamities /disaster/ accident etc.

o Stationery /Records

Expenditure incurred to restore the damaged stationery/records/important documents like loan documents, securities and stamp papers etc. due to fire/ flood/other calamities/disaster etc.

o Currency Notes

Expenditure incurred to restore the damaged Currency Notes due to fire/flood/other calamities/ disaster etc.

o Network/Connectivity failure

Expenditure incurred towards restoration of network/connectivity. This includes payment to outsourcing agency to restore normal functioning etc.


• Potential Loss: Potential Loss Events are those events that posses characteristics to transform into actual loss events if proper corrective measures are not taken.

• Foregone Revenue: In terms of the RBI definition of the actual loss, foregone revenue and opportunity cost have been excluded from the definition of operational risk loss.

o Waiver: Since waiver means remission of our claims recorded in our books on notional basis and do not have any direct impact on P&L A/c, we will exclude waiver from the purview of operational risk loss database.

• Opportunity Cost: It is the expected return foregone by bypassing other potential options available for a given decision. In other words, where a choice between two or more options exists, any decision to choose a particular option has an opportunity cost in terms of benefits that could have been received from the other opportunities foregone. In view of the aforementioned definition and RBI guidelines, opportunity cost is excluded from the purview of operational risk losses.

• Near-Miss Events: A near miss event is an operation risk incident, which could have resulted in a loss, had it not been discovered and corrected in time. As such, a near miss event can be defined as one, where the maker & checker of a transaction have made a mistake, but subsequently detected and rectified without loss.

Operational risk management in the indian scenario

Basel Committee on Banking Supervision (BCBS) came out with guidelines on ‘International Convergence of Capital Measurement and Capital Standards (Basel –II)’ in June 2004, under which banks, now, had to set aside some capital charge for the operational risk, in addition to capital charge against credit and market risk, that they bear.

Source: Basel Committee on Banking and Supervision (BCBS), International Convergence of Capital Measurement and Capital Standards: A revised framework


In accordance with it Reserve Bank of India came out with Guidance Note on ‘Management of Operational Risk’ elaborating the elements for Operational Risk Management Framework. As per the guidelines, banks are required to establish an Operational Risk Management policy Framework, duly approved by the Board and put in place the Operational Risk Management Policy of the Bank.

Supplementing it Reserve Bank of India has distributed a circular on “Risk Management System in the Bank” which suggests the inclusion of the following as the broad parameters of the Operational Risk Management function: -

• Organisational Structure: The following diagram indicates a robust organizational structure to curb operational risks at large

• Key Responsibilities for Operational Risk Management function; • Comprehensive risk management approach; • Risk Management Policy approved by the Board, which should be consistent with the

broader business strategies, capital strength, management expertise and overall willingness to assume risk;

• Guidelines and other parameters used to govern risk taking including detailed structure of prudential limits;

• Strong MIS for reporting, monitoring and controlling risks; • Well laid out procedures, effective control and comprehensive risk reporting frame-

work; • Separate risk management frame-work independent of operational departments and

with clear delineation of levels of responsibilities for management of risks; • Periodical review and evaluation.

The Reserve Bank of India Guidance note has listed out the following seven types of operational loss events which have the potential to result in substantial losses, namely:

• Internal Fraud: Losses due to acts of a type intended to defraud, misappropriate property or circumvent regulations, the law or company policy, excluding diversity/discrimination events, which involve at least one internal party.

• External Fraud: Losses due to acts of a type intended to defraud, misappropriate property or circumvent the law, by a third party.

• Employment Practices and Workplace Safety: Losses arising from acts inconsistent with employment, health or safety laws or agreements, from payment of personal injury claims, or from diversity/discrimination events.

• Clients, Products & Business Practices: Losses arising from an unintentional or negligent failure to meet a professional obligation to specific clients (including fiduciary and suitability requirements), or from the nature or design of a product.

• Damage to Physical Assets: Losses arising from loss or damage to physical assets from natural disaster or other events.

• Business Disruption and System Failures: Losses arising from disruption of business or system failures.


• Execution, Delivery & Process Management: Losses from failed transaction processing or process management, from relations with trade counter-parties and vendors.

Capital Allocation for Operational Risk

Pillar I of the Basel II framework presents 3 methods for calculating operational risk capital charges in a continuum of increasing sophistication and risk sensitivity. These are, in the order of their increasing complexity, viz., (i) the Basic Indicator Approach (ii) the Standardised Approach and (iii) Advanced Measurement Approaches. Though the RBI proposes to allow banks to initially use the Basic Indicator Approach for computing regulatory capital for operational risk, banks are expected to move along the range toward more advanced approaches as they develop more sophisticated operational risk management systems and practices which meet the prescribed qualifying criteria. The Advanced measurement methodologies are outlined in detail in the RBI guidelines on operational risk management. The three approaches are briefly described below.

• Basic Indicator Approach: RBI has proposed that, at the minimum, all banks in India should adopt this approach in computing capital for operational risk while implementing Basel II. Under the Basic Indicator Approach, banks have to hold capital for operational risk equal to a fixed percentage (alpha) of a single indicator which has currently been proposed to be “gross income”. This approach is available for all banks irrespective of their level of sophistication. The charge is expressed as follows:

KBIA = [(GI*a)]/n,

Given,

KBIA = the capital charge under the Basic Indicator Approach

GI = annual gross income, where positive, over the previous three years

a = 15% set by the Committee, relating the industry-wide level of required capital to the industry-wide level of the indicator

n = number of the previous three years for which gross income is positive


The Basel Committee has defined gross income as net interest income and has allowed each relevant national supervisor to define gross income in accordance with the prevailing accounting practices. Accordingly, gross income will be computed for this purpose as defined by the RBI for implementation of the new capital adequacy framework. Gross income has been defined as follows by the RBI in the draft guidelines issued for implementation of the new capital adequacy framework.

“Gross Income = Net Profit (+) Provisions & Contingencies (+) Operating Expenses (-) Profit on Sale of Held to Maturity Investments (-) Income from Insurance (-) Extraordinary / Irregular Item of Income (+) Loss on Sale Of HTM Investments”

• Standardised Approach: In the standardised approach Bank’s activities are divided into 3 business lines; as outlined below:

Business Lines Level 1 Level 2 Activity Groups Trading and Sales Treasury Fixed Income, Foreign Exchanges, Funding, Own

Position Securities, Lending and Repos, Debt Retail Banking Retail Banking Retail lending and deposits Commercial Banking Commercial Banking Project Finance, Real Estate, Export Finance, Trade

Finance, Factoring, Leasing, Lends, Guarantees, Bills of Exchange. Also includes Refinance & Microfinance Scheme

Within each business line, Gross Income is taken as exposure indicator that serves as a Proxy for scale of business operations and thus the likely scale of operational risk exposure. The capital charge for each business line is calculated by multiplying gross income (gross income as defined in basic indicator approach) by a factor (denoted Beta which serves as a proxy for the industry-wide relationship between the operational risk loss experience for a given business line and the aggregate level of gross income for that business line) assigned to that business line by RBI. The summation of the gross income for the three business lines should aggregate to the gross income of the bank as computed under the Basic Indicator Approach.

The total capital charge is calculated as the three- year average of the simple summation of regulatory capital charges across each of the business lines in each year. In any given year, negative capital charges (resulting from negative gross income) in any business line may offset positive capital charges in other business lines. In order to qualify for use of the Standardised Approach, a bank must satisfy certain qualifying criteria like active involvement of board directors and senior management, existence of operational risk management function, sound operational risk management system Systematic tracking of loss data, etc.

• The Alternative Standardised Approach (ASA): At national supervisory discretion a supervisor can choose to allow a bank to use the Alternative Standardised Approach (ASA) provided the bank is able to satisfy its supervisor that this alternative approach provides an improved basis by, for example, avoiding double counting of risks. Under the ASA, the operational risk capital charge/methodology is the same as for the Standardised Approach except for two business lines – retail banking and commercial


banking. For these business lines, loans and advances (total outstanding loans and advances (non-risk weighted and gross of provisions), averaged over the past three years) – multiplied by a fixed factor ‘m’ (0.035)– replaces gross income as the exposure indicator. The betas for retail and commercial banking are unchanged from the Standardised Approach.

• For the purposes of the ASA, total loans and advances in the retail banking business line consists of the total drawn amounts in the following credit portfolios: retail, SMEs treated as retail, and purchased retail receivables. For commercial banking, total loans and advances consist of the drawn amounts in the following credit portfolios: corporate, sovereign, bank, specialised lending, SMEs treated as corporate and purchased corporate receivables. The book value of securities held in the banking book is also to be included. As under the Standardised Approach, the total capital charge for the ASA is calculated as the simple summation of the regulatory capital charges across each of the eight business lines.

• Advanced Measurement Approach (AMA): Under the Advanced Measurement Approach the regulatory capital requirement will equal the risk measure generated by the bank’s internal operational risk measurement systems using the quantitative and qualitative standards criteria. Use of Advanced Measurement Approach (AMA) is subject to supervisory approval. In addition to the qualifying criteria applicable to Standardised approach, the following criteria are to be complied with:

o Bank’s internal operational risk measurement is closely integrated into the day to day risk management process

o Review of management and measurement process by internal/external audit o Numerous quantitative standards in particular 3-5 years of historic data o Under the Advanced Measurement approach the risk mitigating impact of

insurance in the measure of operational risk will be allowed subject to compliance of stipulated criteria and threshold level of 20% of capital charge for operational risk

Internal Capital Assessment

Under the pillar 2 of the New Capital Adequacy Framework, banks are expected to have a process for assessing overall capital adequacy in relation to the risk profiles - taking into account all material risks - and a strategy for maintaining their capital levels. This requires an assessment of the potential operational risk losses that the bank could face at a reasonable sound standing. Meaningful economic capital and allocations can help in identifying which business is truly profitable and therefore increase the shareholder value. The process for arriving at the total economic capital number for operational risk at the bank-wide and business lines level should be based on reasonable and transparent assumptions that lend themselves to validity both internally and by the supervisors. A starting point for such a process is a clear definition of risk events that are considered within the operational risk framework. The operational risk measurement methodologies and economic capital assessment techniques are evolving rapidly. The major conceptual elements in such capital assessment techniques are –


• Quantitative approaches to assessing bank-wide operational risk capital • Qualitative assessment and adjustments • Validation techniques

RBI has issued final guidelines to commercial banks on the approach to be followed for calculation of minimum capital under the New Capital Adequacy Framework. As per the guidelines, commercial banks have already adopted at least the Basic Indicator Approach for operational risk effective from March 31, 2009. RBI has recently issued the proposed time schedule for implementing Advance Approaches by banks, where for the Standard Approach for operational risk the earliest date of making application by the banks to RBI is scheduled for April 01, 2010 and Advance Measurement Approach by April 01, 2012.

Proposed Basel Iii

The Basel committee is expected to finalise the Basel III guidelines by December 2010, with a stipulated six year phase-in period beginning 2013. The key elements of the proposed Basel III guidelines include the following:

• Definition of capital made more stringent, capital buffers introduced and Loss absorptive capacity of Tier 1 and Tier 2 Capital instrument of Internationally active banks proposed to be enhanced

• Forward looking provisioning prescribed • Modifications made in counterparty credit risk weights • New parameter of leverage ratio introduced • Global liquidity standard prescribed

The proposed Basel III guidelines seek to improve the ability of banks to withstand periods of economic and financial stress by prescribing more stringent capital and liquidity requirements for them. The tentative capital requirements are a positive for banks as it raises the minimum core capital stipulation, introduces counter-cyclical measures, and enhances banks’ ability to conserve core capital in the event of stress through a conservation capital buffer. The prescribed liquidity requirements, on the other hand, are aimed at bringing in uniformity in the liquidity standards followed by banks globally. This benchmark would help banks better manage pressures on liquidity in a stress scenario.

IMPLICATIONS

• Capital Requirement: The capital requirement as suggested by the proposed Basel III guidelines would necessitate Indian banks1 raising Rs. 600000 crore in external capital over next nine years, besides lowering their leveraging capacity. It is the public sector banks that would require most of this capital, given that they dominate the Indian banking sector. Further, a higher level of core capital could dilute the return on equity for banks. Nevertheless, Indian banks may still find it easier to make the transition to a stricter capital requirement regime than some of their international


counterparts since the regulatory norms on capital adequacy in India are already more stringent, and also because most Indian banks have historically maintained their core and overall capital well in excess of the regulatory minimum. The guidelines seek to enhance the minimum core capital (after stringent deductions), introduce a capital conservation buffer (with defined triggers) and prescribe a countercyclical buffer (to be built up in times of excessive credit growth at the national level).

Regulatory Capital Adequacy Levels Proposed Basel III Norms Existing RBI Norms

Common equity (after deductions) 4.5% 3.6% (9.2%) Conservation buffer 2.5% Nil Countercyclical buffer 0-2.5% Nil Common equity + Conservation buffer + Countercyclical buffer

7-9.5% 3.6% (9.2%)

Tier I(including the buffer) 8.5-11% 6% (10%) Total capital (including the buffers) 10.5-13% 9% (14.5%)

Source: Basel committee documents, RBI, Basel II disclosure of various banks; Figures in parenthesis pertain to aggregated capital adequacy of banks covering over 95% of the total banking assets as on March 31, 2010.

Overall, with the Basel III being implemented, the regulatory capital requirement for Indian banks could go up substantially in the long run. Additionally within in capital, the proportion of the more expensive core capital could also increase. Moreover, capital requirements could undergo a change in various scenarios, thereby putting restriction on bank’s ability to distribute earnings. On an aggregate basis, the capital adequacy position of Indian banks is comfortable, and being so, they may not need substantial capital to meet the new norms. However, differences do exist among various banks. While most of the private sector banks and foreign banks have core capital in excess of 9%, that is not the case with some of the public sector banks.

Deductions from Capital Proposed Basel III Guidelines Existing RBI Norms

Limit on Deductions Deductions to be made only if deductibles exceed 15% of core capital at an aggregate level, or 10% at the individual item level

All deductibles to be deducted

Deductions from Tier I or Tier II (intangible asset or losses)

All deductions from core Capital

50% of the deductions from Tier I and 50% from Tier II (except DTA and intangible assets wherein 100% deduction is done from Tier I capital )

Treatment of significant investments in common shares of unconsolidated financial institutions

Any investment exceeding 10% of issued share capital to be counted as significant and therefore deducted

For investments up to: (i) 30%: 125% risk weight or risk weight as warranted by external rating (ii) 30-50%: 50% deduction from Tier I and 50% from Tier II

Source: Basel committee documents, RBI, Basel II disclosure of various banks

While the proposal to make deductions “only if such deductibles exceed 15% of core capital” would provide some relief to Indian banks (since all such deductibles are currently reduced from the core capital), the stricter definition of “significant interest” and the suggested 100% deduction from the core capital (instead of 50% from Tier I and 50% from Tier II) could have a negative impact on the core capital of some banks.


• Liquidity: As for the liquidity requirement, the liquidity coverage ratio as suggested under the proposed Basel III guidelines does not allow for any mismatches while also introducing a uniform liquidity definition. Comparable current regulatory norms prescribed by the Reserve Bank of India (RBI), on the other hand, permit some mismatches, within the outer limit of 28 days. The net stable funding ratio (NSFR) is likely to be implemented from 2019. But implementation of the liquidity coverage ratio (LCR) from 2015 may necessitate banks to maintain additional liquidity since the LCR requirement is more stringent; also some assumptions on the rollover rates and the required liquidity for committed lines may be more stringent. However, considering the period of one month and the fact that most Indian banks have upgraded their technology platforms, the transition to LCR may not be a very difficult one


The various objectives that the Research Paper aims to cover are as follows:

• To establish the vital aspects of Operational Risk Management Policies in India • Succinctly covering the mainstays of the current Operational Risk Management

Policies in place in Punjab National Bank (PNB) and Small Industrial Development Bank of India (SIDBI)

• Comparing the above mentioned policies with reference to Operational Risk Model, Operational Risk Structure, Operational Risk Loss Data, Requisite Technology and Audit Mechanism

METHODOLOGY

The technique followed is to study operational risk models implemented (or to be implemented) in Punjab National Bank (PNB) and Small Industrial Development Bank of India (SIDBI). The exercise is specifically to recognize the lacunae in the present models and also compare the efficiency of the model vis-à-vis the costs incurred in the application of the model.

At Punjab National Bank

Organizational Structure for Effective Operational Risk Management (ORM)

For effective Operational Risk Management (ORM), it is essential that the bank identifies, assesses, monitors and mitigates these risks. In terms of RBI Guidance note on Management of Operational Risk, the following will be the Organizational Structure for effective ORM:


Fig. Profiles of Organisational Arms of Organisational Risk Management Structure

Risk Management Committee It presently comprises of the following members:

• Chairman and Managing Director • Executive Director (KR) • Executive Director (JMG) • RBI Nominee Director • GOI Nominee Director • One independent Director nominated by Board • Two External experts – Special Invitees • CGM-RMD (Convener)

Operational Risk Management Committee (ORMC)

The present composition of the ORMC is outlined below:

• Chairman & Managing Director (Chairman) • Executive Director (KR) • Executive Director (JMG) • CGM, RMD

Board of Directors


Operational Risk Management Specialists

Operational Risk Management Department (ORMD)

Business Operational Risk Mangers

Divisional Heads (GMs of Divisions)

Chief Risk Officer (CRO) ie CGM/GM-RMD

Divisional Heads (GMs of Divisions)

Risk Management Committee (RMC)


• GM, IT • GM, I&AD • GM, OPSD • GM, HRDD • GM, RBD • GM (Management Audit and Review Division) • DGM (RMD)/Chief (ORMD) - (Convener)

Chief Risk Officer

The Chief General Manager/ General Manager, Risk Management Division shall be the Chief Risk Officer.

Operational Risk Management Department (ORMD) ORMD shall be the core operational unit of the Bank dealing with Operational Risk Management and shall be functioning within the Risk Management Division (RMD), Head Office, New Delhi. The broad objectives of ORMD shall be:

• Co-ordinating implementation of Operational Risk Management (ORM) framework across the Bank.

• Building Bank’s ORM capabilities by well defined ORM policy and strategies, creating awareness about Operational Risk throughout the organisation and developing or purchasing appropriate ORM tools.

• Apprising top management with the OR status of the Bank. • Providing necessary support to Finance Division in allocating capital for CRAR

purposes for operational risk. • Identifying and sharing best practices in Operational Risk Management, providing

industry level Operational Risk overview to Bank, build and monitor an overall risk profile of the bank through the Centralized Operational Risk Loss Data (CORD), Risk & Control Self Assessment (RCSA) surveys, Key Risk Indicators (KRI), etc. to minimize Operational Risk.

The ORMD shall achieve these objectives in the following ways:

• Preparing and updating the Bank’s Operational Risk Management Policy/Manual. • Ensuring that RCSA is being conducted by the concerned Divisions on regular basis. • Maintaining the Centralized Operational Risk Loss Database (CORD) and other

related reports. • Extending necessary support to the concerned business line in evolving ‘Best Practice

Procedures’ for banking operations undertaken by the business lines. • Analysing and reporting the Bank’s Operational Risk status and developing

Operational Risk Profile for the Bank as a whole. • Extending necessary support to the concerned business lines/divisions/activity owners

in monitoring of Key Risk Indicators (KRIs). • Providing secretarial services to the ORMC.


Structure of the ORMD

The ORMD shall be headed by a Chief Manager, who shall be reporting to the Chief Risk Officer (CRO) of the Bank i.e. CGM/GM – RMD through Dy. General Manager/Assistant General Manager - RMD. As per Basel II and RBI guidelines, the internal audit department should not be directly involved in the ORM process. The audit department may provide valuable input to those responsible for Operational Risk Management but it should not have direct Operational Risk Management responsibilities. As per guidance note of RBI on Operational Risk Management, internal audit will be responsible for examination and evaluation of internal control, apart from other functions.

In Punjab National Bank the work relating to audit of Regional Offices/Zonal Offices/Head Office Divisions and Subsidiaries has been allocated to Management Audit and Review Division (MARD). As such, in the organisational structure on Operational Risk, MARD has been proposed to review the application and effectiveness of ORM procedure, periodically validate the process of Punjab National Bank’s ORM framework apart from other functions.

HO Division / Department Heads

The heads of the different Divisions of the bank are responsible for risk taking and initiating steps to control & mitigate the risk in the activities /functions undertaken by them. The specific criterion is:

• Must be the General Manager who oversees the entire operations of the activity/function.

Operational Risk Management Specialist and Business Operational Risk Managers

Each HO Division/Department of the bank shall identify at least one person to work as Operational Risk Management Specialist (from support departments) /Business Operational Risk Managers (from risk taking units).

At Small Industries Development Bank Of India (Sidbi)

As per RBI guidelines and in preparedness for Basel II Norms implementation, Bank will be estimating capital charge as per Basic Indicator Approach and will be graduating to more sophisticated approaches in due course.

To start with, Bank shall estimate capital charge under Basic Indicator Approach. With the implementation of Integrated Risk Management System (IRMS) Bank will move over from the basic indicator approach to Standardized/Advance Measurement Approach for estimation of operational risk capital charge. Estimation under standardised approach involves mapping of existing business activities of the Bank to Business Lines defined under RBI guidelines, which will be to the extent modified to meet with the business lines in SIDBI.

Though the standardised approach is easier to implement it lacks risk focus and proper incentive structure. It fails to capture the risk sensitivity and effect of bank’s management of


operational risk. Hence, it is proposed that the Bank should prepare to move towards advanced measurement approach in due course for:

• Targeted management for operational risk • To demonstrate to the regulator that the economic capital required may be less than

that measured under standardised approach Score Card Approach as outlined above, assessment of operational risk is perceived as an

attractive approach. Bank’s assessment of operational risk using the score card is a step in this direction. The Score Card Approach assimilates the following steps:

• Forward looking using subjective estimates of frequency and severity where data is limited.

• To be validated using historical data by capturing data over time. This will help in calculating Expected Loss (EL).

• Initial level of operational risk capital is determined and then modified based on underlying risk profile and risk control environment.

This method has the following advantages:

• It provides complete and accurate measure of operational risk by incorporating forward-looking risk indicators and qualitative assessments of the control environment as well as loss data.

• It gives managers much stronger incentives to reduce risks and much better tools to help them identify how to do so.

• It is much easier to implement and also easier to adapt as the requirements of the bank and the regulators evolve over time.

Going forward with the upgradation of technical and risk management capabilities the bank shall put in place in due course a framework for assessing overall capital adequacy in relation to the risk profile.

Organisation for operational risk management: roles and responsibilities

Board Responsibilities The Board of Directors, being primarily responsible for ensuring effective management of the operational risks, shall include the following:

• Approve operational risk management framework and implementation across the bank and review it annually.

• Approve policies for managing operational risk in all products, activities, processes and systems.

Risk Management Committee (RiMC)

The Subcommittee of Board of Directors for Risk Management Committee (RiMC) shall be delegated with specific operational risk management responsibilities as enlisted under:


• Shall review operational risk management framework and implementation across the bank on an annual basis to ensure that the bank is managing the operational risks arising from external market changes and other environmental factors, as well as those operational risks associated with new products, activities or systems and is concurrent with the berst practices in the industry.

• Review of profiles of operational risk throughout the organization. • Approve operational risk capital methodology and resulting attribution. • Going forward, set and approve expressions of risk appetite, within overall

parameters set by the Board. • Re-enforce the culture and awareness of operational risk management throughout the

organization.


At the operational level, the ORMC headed by the Chief General Manager with General Managers of key departments as members shall look after Operational Risk management. Its principal objective will be the mitigation of operational risk within the bank by the creation and maintenance of an explicit operational risk management process with a cross-business view. The Committee shall meet once in a quarter or more often as it determines is necessary. Key roles of the Committee shall be –

• Review and approve processes and procedures for managing operational risk in all products, activities, processes and systems.

• Review and approve the development and implementation of operational risk methodologies and tools, including assessments, reporting, capital and loss event databases.

• Receive and review reports/presentations from the business units/functional departments and other areas about their risk profile and mitigation programs.

• To discuss and recommend suitable controls/mitigations for managing operational risk.

• Review the risk profile, understand future changes and threats, and concur on areas of highest priority and related mitigation strategy.

• To analyse frauds, potential losses, non compliance, breaches and recommend corrective measures to prevent recurrences.

• To proactively review and manage potential risks which may arise from regulatory changes/or changes in economic /political environment in order to keep ahead.

• Communicate to business units/areas and staff the importance of operational risk management, and ensure adequate participation and cooperation.

• Ensure adequate resources are being assigned to mitigate risks as needed.

Senior Management Responsibilities

The Senior management will have responsibility for implementing the operational risk management framework approved by the Board of Directors. The additional responsibilities that devolve on the senior management include the following:


• To translate operational risk management framework established by the Board of Directors into specific policies, processes and procedures that can be implemented and verified within the different business units.

• To clearly assign authority, responsibility and reporting relationships to encourage and maintain this responsibility for implementation of sound risk management practice.

• To assess the appropriateness of the management oversight process in light of the risks inherent in a business unit’s policy.

• To ensure that the bank’s operational risk management policy has been clearly communicated to staff at all levels in their functional/business area.

• To ensure that there are no significant gaps or overlaps in the Bank’s overall risk management programme.

• To give particular attention to the quality of documentation, controls and transaction handling practices.

• To ensure that the Bank's HR policies are consistent with its appetite for risk and are not aligned to rewarding staff who deviate from policies.

Chief Risk Officer (CRO)

The Chief General Manager (Risk Management) shall be the Chief Risk Officer (CRO). The CRO shall have supervisory responsibilities over the

Operational Risk Management Department as well as responsibility over market risk and credit risk:

• Create Awareness • Assess interrelationships between Operational and other risk types

Operational Loss Event Category

No. Level – 1 Level – 2 Level – 3 1. Internal Fraud

Unauthorised activity Theft and Fraud

Transactions not reported(intentional), Trans type unauthorized(monetary Loss), Mismarking of position(intentional) Fraud/credit fraud/worthless deposits, Theft/extortion/embezzlement/robbery Misappropriation of assets, Malicious destruction of assets, Forgery, Check kiting, Smuggling, Account take-over/impersonation, Tax non-compliance/evasion(wilful), Bribes/kickbacks, Insider trading (not on bank’s account)

2. External Fraud Theft and Fraud Systems Security

Theft/robbery, Forgery, Cheque kiting Hacking damage, Theft of Information

3. Employment practices and workplace safety

Employee Relations Environmental Safety Diversity and Discrimination

Compensation, benefit, termination issues, organized labor activity General liability (workplace accidents slip), Employee health & safety rules events, Workers compensation All discrimination types


4. Clients, Products and business practices

Suitability, Disclosure and Fiduciary Improper business or market practices Product Flaws Selection, Sponsorship and Exposure Advisory Activities

Fiduciary breaches/guideline violations, Suitability/disclosure issues (KYC etc), Retail consumer disclosure violations, Breach of privacy, Aggressive sales, Account churning, Misuse of confidential information, Lender liability Antitrust, Improper trade/market practices, Market manipulation, Insider trading, Unlicensed activity, Money laundering Products effects(unauthorized etc), Model errors Failure to investigate client per guidelines, Exceeding client exposure limits Disputes over performance of advisory activities

5. Damage to Physical Assets

Disasters and other events

Natural disaster losses, Human losses from external sources(terror vandalism)

6. Business disruption and system failures

System Hardware, Software, Telecommunications, Utilty outage/disruptions

7. Execution, delivery and process management

Transaction capture, execution maintenance Monitoring and ReportingCustomer intake and documentation Customer Client Account Management Trade Counterparties Vendors and Suppliers

Miscommunication; Data entry, maintenance or loading error, Missed deadline or responsibility, Model/system misoperation, Accounting error/entity attribution error, Other task misperformance, Delivery failure, Collateral management failure, Reference data maintenance Failed mandatory reporting obligation, Inaccurate external report (loss incurred) Client permissions/disclaimers missing, Legal documents missing/incomplete Unapproved access given to accounts, Incorrect client records(loss incurred), Negligent loss damage of client assets Non client counterparty misperformance, Misc. non-client counterparty disputes Outsourcing, Vendor disputes

SUMMARY

Comparative Analysis of Operational Risk Structure Punjab National Bank Small Industries Development Bank of

India Operational Risk Model Basic Indicator Approach Basic Indicator Approach

Though the implementation of scorecard approach (under AMA) is underway

Operational Risk Structure Well Defined with clear designated role at every level

Clarity of responsibilities but organisational picture missing

Operational Risk Loss Data Proposal to tabulate but directions vague Loss categories well defined and put in practice. Bank activities are correspondingly classified

Requisite Technology Proactive monitoring of risks through Integrated Risk Monitor

Policy specifies the specific need to invest in appropriate processing technology. The possibility of outsourcing these activities is under consideration

Audit Mechanism The potential loss is assessed on the basis of Risk Based Internal Audit reports (RBIA)

The possible extent of loss is captured by the gist of serious irregularities in various audit reports presented half yearly by the Internal Audit Department


FINDINGS & CONCLUSIONS

Enumerated below, are the conclusions arrived upon in course of completion of the paper:-

• All banks use the Basic Indicator Approach for calculating capital for operational risk as per the Reserve Bank of India guidelines. Banks planned to move along the spectrum to the advanced approaches. The intention is to adopt a step-by-step approach to Basel II ORM framework; in the first instance The Standardised Approach and thereafter the Advanced Measurement Approach.

• While few banks have experienced no change in operational risk losses as a result of implementation of the Basel II framework, the other banks expect a reduction in operational losses as a result of implementation.

• The availability of internal operational loss data varies widely between the banks. The number of years' loss data available with banks varied widely between two years and six years.

• Better controls are listed as the most significant benefit/gain from the successful implementation of operational risk management framework by many banks. Reduction in losses, improvement in performance and reduction in regulatory capital are considered the other significant benefits. External frauds, internal frauds, and IT system failures constituted the top operational risks for banks in terms of impact on the banks business.

• The new norms are based on renewed focus of Central Bankers on macro prudential stability as global regulators are determined to ensure financial stability of the system as a whole rather than micro regulation of any individual bank.

REFERENCES [1] Elsevier (2006), “Economic Capital Allocation with Basel II”, Oxford [2] Jorion P. (2007), “Financial Risk Manager Handbook”, Wiley Finance [3] Jorion P. (2000), “Value at Risk: The New Benchmark for Managing Financial Risk”, Mcgraw Hill [4] OWC (2001), “Study on the Risk Profile and Capital Adequacy of Financial Conglomerates”, Wyman

and Company

Journals

[5] Arjun C. Marphatia and Nishant Tiwari, “Risk Management in Financial Services Industry” [6] Ribarics Pal, Oracle’s Basel II Solution [7] Banca d’ Italia, Temi di discussion del Servizio Studi (2004), “The Modelling of Operational Risk:

Experience with Analysis of the data, collected by the Basel Committee” [8] BCBS (2006), “International Convergence of Capital Measurement and Capital Standards, a Revised

Framework, Comprehensive Version”, Basel Committee on Banking Supervision, Bank for International Settlement, Basel

Measuring Interest Rate Risk Associated in Bonds with the Help of Portfolio

Duration—A Study

Dr. Rekhakala. A.M.* and Sahil Kapoor** Abstract—here is always an element of interest rate risk associated with government securities. Macaulay duration and Modified duration measures the interest rate risk associated with bonds. The mainpurpose of our study is to how to manage the interest rate risk associated with portfolio of bonds. For this purpose, we have created a hypothetical portfolio of seven government securities with different maturity dates, spread over a wide period. The portfolio is prepared in two different scenarios, both increasing yield as well as decreasing yield scenario. And after having the results of each case we analyze how the portfolio value is affected with yield to maturity moving upwards and vice-versa.

The analysis is also talks about whether long-term securities are more favourable in a decreasing or increasing yield scenario and short-term securities are more favourable in a decreasing or increasing yield scenario. To estimate the effects of parallel yield curve shifts we have used Duration approach where interest rates may change equally on all the bonds in the portfolio.

As the valuations of all the portfolios and the comparisons will be done, we will have the conclusion as what kind of portfolio is more suitable and what kind of securities would dominate in the present market scenario.

Keywords: Government securities, Interest rate risk, Portfolio, Duration, Yield.

INTRODUCTION

Fixed income securities, historically were promises to pay a stream of semiannual payments for a given number of years and then repay the loan amount at maturity date. The contract between borrower and lender can really be designed to have any payment stream that the parties agree to.

The contract that specifies all the rights and obligation of the issuer and owner of a fixed income security is called bond indenture. The indenture defines the obligations of and restrictions on the borrower. These provisions are known as covenants and there are negative as well as affirmative covenants

Negative covenants include restrictions on asset sales, negative pledge of collateral and restrictions on additional borrowings.

Affirmative covenants include maintenance of certain financial ratios and timely payment of principal and interest.

*Alliance Business School, Bangalore **Alliance Business School, Bangalore

Measuring Interest Rate Risk Associated in Bonds with the Help of Portfolio Duration—A Study 485

FEATURES OF BOND

The principal features of a bond are:

• Maturity • Coupon • Principal

In the bond markets, the terms maturity and term-to-maturity, are used quite frequently. Maturity of a bond refers to the date on which the bond matures, or the date on which the borrower has agreed to repay (redeem) the principal amount to the lender. The borrowing is extinguished with redemption, and the bond ceases to exist after that date. Term to maturity, on the other hand, refers to the number of years remaining for the bond to mature. Term to maturity of a bond changes everyday, from the date of issue of the bond until its maturity.

Coupon Rate refers to the periodic interest payments that are made by the borrower (who is also the issuer of the bond) to the lender (the subscriber of the bond) and the coupons are stated upfront either directly specifying the number (e.g.8%) or indirectly tying with a benchmark rate (e.g. MIBOR+0.5%). Coupon rate is the rate at which interest is paid, and is usually represented as a percentage of the par value of a bond.

Principal is the amount that has been borrowed, and is also called the par value or face value of the bond. The coupon is the product of the principal and the coupon rate. Typical face values in the bond market are Rs. 100 though there are bonds with face values of Rs. 1000 and Rs.100000 and above. All Government bonds have the face value of Rs.100. In many cases, the name of the bond itself conveys the key features of a bond.

For example, A government security CG2008 11.40% bond refers to a Central Government bond maturing in the year 2008, and paying a coupon of 11.40%. Since Central Government bonds have a face value of Rs.100, and normally pay coupon semi-annually, this bond will pay Rs. 5.70 as six- monthly coupon, until maturity, when the bond will be redeemed.

Returns associated with Bondsh

Bond Yields

Current Yield: It is the ratio of the annual interest payment to the bond's current price. It keeps on changing during the maturity period as price keeps on changing.

Coupon Income Current Yield= Market Price of Bond

The current yield will be greater than the coupon rate when a bond sells at a discount and vice-versa i.e., lesser that the face value.


Nominal Yield

It is the coupon rate of the security. Also it does not vary with the market price of the security.

Yield to Maturity (YTM)

It is the effective yield promised to the bondholder over the entire maturity of the bond. For this it is assumed that the bond is held till its maturity and the coupon income (not there in case of T Bills) are reinvested at the same yield. So, the YTM takes into consideration all the sources of income from a bond. It has an assumption inbuilt that the interest receipts would be reinvested. If a bond’s market price is equal to its par value then its YTM equals its coupon rate. However, if the market price is less than the par value then the bond has a YTM greater than the coupon rate. Alternately, if the market price is greater than par value, then the bond has an YTM less than the coupon rate.

BOND PRICE VOLATILITY

There are various factors which affect the change in the price of the bond which in relation to changes in the required rate of return. These are usually termed as the bond pricing theorem. The theorems are as follows:

• The percentage change in the bond’s price associated with the change in its yield will be smaller if the coupon rate is higher.

• If a bond’s market price increases, then its yield must decrease, or if a bond’s market price decreases, then its yield must increase.

• If a bond’s yield does not change during its life, then the size of its discount/premium will decrease at an increasing rate as its life gets shorter.

• If a bond’s yield does not change during its life, then the size of its discount/premium will decrease as its life gets shorter.

• A decrease in bond’s yield will raise the bond’s price by an amount that is greater in size than the corresponding fall in the bond’s price that would occur if there were an equal sized increase in the bond’s yield.

RISKS ASSOCIATED WITH BONDS

The return from fixed income securities comprises of capital gain/loss when the bond is finally disposed off, periodic interest and interest earned through reinvestment of periodic interest. However, these are affected by a number of factors, which associate the returns with major risks like:

Price/market Risk

The price of fixed income securities varies inversely with the movement in interest rates. When the interest rate raises, the market price of bond falls and when the interest rate falls, the market price of bond increases. Hence when an investor sells the security before maturity and the interest rate increases, then he will face the risk of capital loss. So, the


interest rate risk is the biggest risk faced by an investor. The most common measure of interest rate risk is duration.

Yield Curve/Maturity Risk

The yield curve demonstrates the relationship between the yield and maturity of securities with the same credit quality. The risk lies here in the form of unanticipated shift in the curve thereby reducing the value of the portfolio.

Reinvestment Risk

The intermediate cash flows received on a bond during the holding period are reinvested which can be termed as interest on interest. This additional income varies with the changes in interest rate. The risk lies here in the form of falling interest rates at the time of reinvestment.

Call Risk

Some bonds have an embedded option giving a right to the borrower call the issue before the maturing date. Here, investors face the reinvestment risk and loosing the opportunity of capital appreciation potential of the bond. But such bonds are not available in the Indian market.

Liquidity Risk

The risk is that the investors may be forced to sell the security much below its true value which is indicated by the recent transaction is called liquidity risk.

Volatility Risk

The price of a bond with an embedded option depends on the level of interest rates and factors that influence value of embedded option. So, the risk that a change in volatility will adversely affect the price of a security is called volatility risk.

Credit/Default Risk

There is always a risk that the issuer of fixed income securities will be unable to make a timely payment of the principle and interest rate on the security. This is usually the case with State government securities and corporate bonds. Most bonds are sold either at a lower price, comparable to government securities as the government securities are thought to be free of credit risk.

Inflation Risk

This is applicable for all securities except the inflation adjusted and adjustable/floating rate securities. The risk lies in unanticipated inflation causing erosion in the value of cash flows.


Interest Rate Risk

This is associated with change in value of the portfolio with respect to change in market interest rates.

A financial institution or a nonfinancial firm may face market risk due to unexpected movements in interest rates. Such market risk arises as a result of positions in fixed income securities taken by traders, portfolio managers or financial managers. This risk may arise because rates move opposite to the forecast on which an active strategy is based. For example, a hedge fund may short sell U.S. Treasuries because its traders think that rates will rise in the U.S. This position is exposed to losses should rates tumble due to a global crisis which triggers a flight into U.S. dollar assets. Alternatively, the risk may derive from a business activity of the firm which leaves it vulnerable to a shift in interest rates. For example, a firm receives cash inflows into its pension plan and invests in fixed income securities.

If rates rise after the cash is invested, the pension plan will experience a loss. In both cases, risk managers need to assess the possible loss, or value at risk, if the positions remain open. Should value at risk be unacceptably large, risk managers need to explore techniques to reduce exposure by hedging? Central to both risk assessment and hedging is duration and we turn now to discussing this key risk management tool in detail.

OBJECTIVE

The main objective of our research is to measure the interest rate sensitivity of government securities with the help of a measure called ‘Portfolio Duration’. We want to measure the effect of changing interest rates on our portfolio of government securities. After measuring the interest rates, we will try to find out positive and negative effects on the value of the portfolio and then we will be able to decide as to how much weightage should be given to short term or long term securities in the portfolio. Our main objective is to maximize the returns on our portfolio and guard it against the interest rate movements.

METHODOLOGY

For calculating the interest rate risk associated with bonds, we have created a hypothetical portfolio with 8 different securities having different yields, maturity & coupon. Then the portfolio is tested in both increasing as well as decreasing yield scenario. The affects of both of the scenarios have been calculated.

According to the result that we got from this, we have tried to make a new portfolio that can reduce the effect of adverse interest rate movements on bonds. With the help of results, we were able to decide which security should have more weightage in portfolio i.e What should be the respective weights of long term and short term securities in portfolio. All our analysis is based on the concept called ‘Portfolio Duration’. With the help of ‘Portfolio Duration’, we are able to measure the interest rate sensitivity of the portfolio of government securities. Now we will show a ‘Dummy Portfolio’ consisting of 12 securities varying in coupon, maturity & yield. Then we will show the impact of yield change on these securities. We have also prepared a short term & long term portfolio to show what type of portfolio is more suitable in either increasing or decreasing interest rate scenarios.


There are various approaches are available to measure the interest rate risk associated with bonds viz., Duration approach, full valuation approach, convexity approach etc. For the purpose of our analysis we have applied Duration approach due to it’s simplicity and effectiveness.

Duration Approach

Duration is an important measure to measure the interest rate risk associated with bonds. In a zero coupon bond the tenor of the bond is the measure of the time of the bond because there are no intermittent cash flows. But in a coupon paying bond, there are intermittent cash flows. So, we need to calculate the weighted average maturity of the bonds keeping into consideration the cash flows. The technical measure for calculating tenor of the bond is called duration. Duration is the weighted average maturity of the bond. By calculating duration, we came to know that what is the effect of cash flows on the tenor of the bond. The formulae for calculating duration is –

Maculay Duration = T x PVCFt / K x PVTCF

Where,

T- Period in which cash flow is expected to be received PVCFt -Present value of cashflows in period t discounted with YTM(yield to maturity) PVTCF - Total present value of the cash flow of the bond discounted at bond’s YTM

How to calculate Duration in Excel

Syntax

Duration (settlement, maturity, coupon, yld, frequency, basis)

Settlement is the security's settlement date. The security settlement date is the date after the issue date when the security is traded to the buyer.

Maturity is the security's maturity date. The maturity date is the date when the security expires.

Coupon is the security's annual coupon rate.

Yld is the security's annual yield.

Frequency is the number of coupon payments per year. For annual payments, frequency = 1; for semiannual, frequency = 2; for quarterly, frequency = 4.

Basis is the type of day count basis to use. Basis Day count basis

0 or omitted US (NASD) 30/360 1 Actual/actual 2 Actual/360 3 Actual/365 4 European 30/360


There is an inverse relationship between yield and duration of the bond. Higher the yield lower is the duration of the bond and vice versa. As we now that duration is the payback period of the bonds i.e., how quickly we recover our cash. With a higher yield, cash flows are reinvested at higher amount. So, cash flows are recovered quickly.

Whether one want higher or lower yield, it depends upon the objective of the person. If we want capital appreciation, then we will go for a lower yield because there is an inverse relationship between yield and the price of the bond. A trader will always be interested in a volatile yield, so that he can take the advantage of price movements.

Modified Duration

Modified duration explains the percentage change in the price of the bond given a change in yield. It helps to calculate the price risk associated with the bond.

Modified duration = Maculay duration / 1- yield

Its basic characteristics are

Higher the Macaulay’s duration, higher will be the modified duration. Higher the yield, lower would be modified duration.

Modified duration of a zero coupon bond is less than its maturity

Duration of a Portfolio

Duration of a portfolio of bonds has the same interpretation as a single bond. It is the approximate %age change in value of the portfolio with a 1% change in yield. It measures the sensitivity of portfolio’s value to the changes in interest rate. It can be cleared with the help of an example-

Bond Market value Portfolio weight Duration A $10 MILLION .10 4 B $40 MILLION .40 7 C $30 MILLION .30 6 D $20 MILLION .20 2

Duration of portfolio = 0.10*4 + 0.40 *7 + 0.30 *6 + 0.20 *2 = 5.4 This means that if yield increases by 1%, portfolio value changes by 5.4%

ANALYSIS

Portfolio – Overview & working

The portfolio prepared consists of twelve actively traded central government securities with different maturity dates, spread over a wide period. The portfolio consists of securities with different coupons and different amount invested in each. The portfolio is balanced portfolio as in context of the weights being allotted to the securities of both short term class and long term class are equally matched and supported by all the other factors like coupons, continuous returns as the maturity will also take place in a systematic manner.


The portfolio prepared is then used to prepare portfolios in different scenarios, both increasing yield as well as decreasing yield scenario. This gives us an idea how this portfolio will react when the yield will move by 5 basis points in the positive direction indicating the same upto 30 basis points. The same is also being analyzed while the yield moves negatively. And after having the results of each case we have analyzed how the portfolio value is affected with yield to maturity moving upwards and vice-versa.

After this as the valuation of the portfolios at different yields are compared and analysed, then we start of with dividing the portfolio into two parts on the basis of the maturity, as long term portfolio and short term portfolio. Now after the original portfolio was divided we analiseid both the portfolios in both scenarios, namely increasing yield scenario and decreasing yield scenario.

After all the various portfolios are ready we valued all the portfolios and analysied which kind of portfolio is favourable in which kind of scenario. As the valuations of all the portfolios and the comparisons of all the portfolios will be done, we will have the conclusion as what kind of portfolio is more suitable in kind of market scenario. On the other hand we can also take it as what kind of securities should dominate our portfolio in which scenario .All this will be dealt in the analysis.

Portfolio Composition

Composition of the original portfolio

Security Name %Value Face Value 6.57% GS 2011 8.77% 5,000,000,000.00 7.40% GS 2012 5.26% 3,000,000,000.00 7.27% GS 2013 3.51% 2,000,000,000.00 7.32% GS 2014 8.77% 5,000,000,000.00 6.49% GS 2015 8.77% 5,000,000,000.00 7.02% GS 2016 14.04% 8,000,000,000.00 6.25% GS 2018 12.28% 7,000,000,000.00 6.90% GS 2019 3.51% 2,000,000,000.00 6.35% GS 2020 10.53% 6,000,000,000.00 10.25% GS 2021 5.26% 3,000,000,000.00 7.35% GS 2024 7.02% 4,000,000,000.00 8.24% GS 2027 12.28% 7,000,000,000.00


Short – Term Portfolio

Security Name %Value Face Value 6.57% GS 2011 21.0526316 12000000000.00 7.40% GS 2012 19.2982456 11000000000.00 7.27% GS 2013 14.0350877 8000000000.00 7.32% GS 2014 14.0350877 8000000000.00 6.49% GS 2015 15.7894737 9000000000.00 7.02% GS 2016 15.7894737 9000000000.00

Long – Term Portfolio

Security Name %Value Face Value

6.25% GS 2018 21.05% 12,000,000,000.00 6.90% GS 2019 19.3% 11,000,000,000.00 6.35% GS 2020 14.04% 8,000,000,000.00 10.25% GS 2021 14.04% 8,000,000,000.00 7.35% GS 2024 15.79% 9,000,000,000.00 8.24% GS 2027 15.79% 9,000,000,000.00


OBSERVATIONS

Mentioned below is the important information taken from the prepared portfolio. The table below shows what is the change in value of original, long term and short term portfolios with the change in yields of the securities and how will be the effect of changing yield on the comparative valuations in the various scenarios. Here the movement of yield is between 5 basis points & 30 basis points.

Yield Movement (Basis points)

Change In Original Portfolio Value (In Crores)

change in Short Term PF Value( in Crores)

Change in Long Term PF value(in Crores)

30 (86.73) 99.89 (178.75) 25 (73.41) 107.96 (159.55) 20 (58.85) 125.01 (120.85) 10 (29.55) 132.3 (101.36) 5 (14.9) 140.44 (81.77) -5 (14.87) 156.8 42.30

-10 (29.81) 164.99 22.42 -20 (59.87) 181.45 17.64 -25 (75.01) 189.72 37.82 -30 (90.21) 197.9 58.10

From the above table we can observe that, in the short term portfolio when the yield get increases, the value of the portfolio will show positive change and further the value of the portfolio will increases as the yield get decreases.

In the Long term portfolio when the yield get increases, the value of the portfolio will show negative change and further the value of the portfolio will increases as the yield get decreases.

Here we can see that in the original portfolio as we move towards the negative yield scenario the depreciation becomes appreciation as due to some factors that can be concluded by taking short term and long term portfolios. Hence the affect of the changing yield on the original portfolio is majorly due to the influence or imbalance between long term and short term securities, as the securities in the portfolio are with various terms to maturity.

FINDINGS & CONCLUSION

As we have discussed that duration is the measure of interest rate sensitivity of the bonds. If we look at the portfolio duration obtained in short term as well as long term portfolio in increasing and decreasing yield scenario, we can draw out the conclusion that in an increasing yield scenario the bank should prefer short term portfolio and in a decreasing yield scenario, bank should prefer long term portfolio. This can be made more clear by referring to the following table-

A higher portfolio duration means higher interest rate sensitivity. If we look at the above table, in increasing yield scenario, portfolio duration in case of long term portfolio is higher as compared to short term portfolio. A portfolio duration of 7.30 means if the yield increases by 100 bps, portfolio value gets reduced by 7.30%. So, we can say that a long term portfolio is more sensitive to increase in interest rates. So, we can say that in an increasing yield scenario, the bank should prefer ‘short term portfolio’.


Yield Movement (Basis Points)

Portfolio duration in Short Term PF (in percentage)

Portfolio duration in Long Term PF (in percentage)

30 2.93 7.30 25 2.93 7.29 20 2.93 7.28 10 2.93 7.27 5 2.94 7.26 -5 2.94 7.32 -10 2.95 7.33 -20 2.95 7.35 -25 2.95 7.36 -30 2.95 7.37

Similar is the case in a decreasing yield scenario. In decreasing yield scenario, higher the portfolio duration, the better it is. A portfolio duration of 7.30 means if the yield decreases by 100 bps, portfolio value increases by 7.30%. So, we can say that in a decreasing yield scenario, the bank should prefer ‘long term portfolio’.

Based on the above analysis, we can conclude that “long term securities are more favorable in a decreasing yield scenario and short term securities are more favorable in an increasing yield scenario”.

REFERENCES

Text Books

[1] Frank J.Fabozzi , (Handbook of fixed income securities), Seventh edition, Tata McGraw-Hill [2] Bruce Tuckman, ( Fixed Income Securities),Second Edition, Wiley Finance [3] Moorad Choudhary, ( Advanced Fixed Income Analysis) , Elsevier Finance [4] Moorad Choudhary, ( The Bond & Money markets), Butterworth Heinemann Finance [5] Frank J.Fabozzi, ( The Handbook of Financial Instruments) , Wiley Finance [6] Hull, J., and A. White, 1990. “Pricing Interest Rate Derivative Securities.” Review of Financial Studies

Articles

[7] Bierwag. “Duration Analysis: An Historical Perspective,” working paper, Florida International University [8] Bierwag, G.G. Kaufman, R. Schweitzer and A Toevs, “The Art of Risk Management in Bond Portfolios,”

Journal of Portfolio Management [9] Hopewell, M., and G.G. Kaufman,. “Bond Price Volatility and Years to Maturity American Economic

Review [10] Fooladi, I. and G.S. Roberts, “Bond Portfolio Immunization: Canadian Tests,” Journal of Economics and

Business [11] Fooladi, I., and G. Roberts, 1989. “How Effective Are Duration-Based Bond Strategies in Canada?” Canadian

Investment Review

Websites [12] www.fisbonds.com/ [13] www.incomesecurities.com [14] ideas.repec.org/a [15] www.quantminds.com [16] www.informaworld.com/ [17] www.intaver.com/index-faq.html - [18] beginnersinvest.about.com

Factors Affecting Exchange Rate of India— A Study of Major Determinants

Dr. Munira Habibullah* Abstract—Foreign exchange rate is the price of a unit of foreign currency in terms of the domestic currency. In a floating exchange rate mechanism, foreign exchange rate is determined much in the same way as the price of any commodity in a free market economy. The paper focuses to study the factors affecting the exchange rate between Indian and US. The variables considered for the study are exchange rate, GDP, Broad money supply and foreign exchange reserve. The data for the study is secondary and the analysis of the data is done by using regression model. The analysis of the data indicates that the factors like GDP, Broad Money Supply and Foreign Exchange Reserve have impact on exchange rate by 45.83%.

Keywords: Exchange Rate, Foreign Exchange Reserve, GDP, Broad Money Supply.

INTRODUCTION

What are the major determinants of exchange rate between the US dollar and Indian rupee? This question is of utmost importance especially since the US is the single largest trading partner of India. Not only that, the US dollar is the major international currency, in spite of emergence of euro as a strong competitor. And, considering the economic strength of the US economy, it is bound to continue as a major currency during the coming few years This is essential to test the hypothesis that foreign exchange reserve in various capacities are major determinants of exchange rate between the US dollar and Indian rupee. Appreciation or depreciation of the domestic currency thus depends on the supply of foreign exchange reserves, liquidity conditions in the economy as determined by money supply, central bank’s policy intentions and differences in the interest yield on dated securities of the concerned economies.

The present article discusses validity of the hypothesis that money supply and foreign exchange reserve can prove to be significant determinant of exchange rate along with the impact of changes in liquidity, i.e., changes in broad money supply and foreign exchange reserves. A monthly time series from January 1998 to January 2009 is used for the purpose. It is observed that the monetary policy intentions depicted by the bank rate of the RBI, the short-term and long-term domestic interest differentials and interest yield differentials, and the rate of change of foreign exchange reserves have a significant impact on the monthly average of the exchange rate between Indian rupee and the US dollar and quite in line with the economic theory.

Chart shows the high range of volatility in rupee-dollar exchange rates over the last eleven years. While the rate of depreciation peaked at -9.372 per cent in January 1998, appreciation registered a high of 9.796 per cent in January 2009. Other major fluctuations in *Department of Business & Industrial Management, Veer Narmad South Gujarat University, Surat


the exchange rate are also shown in the chart. This clearly implies that there has been a significant variation of almost 18 per cent in the exchange rate.

Date Exchange Rate Persantage Jan-98 39.384 9.796793412 Jan-99 42.5061 7.927330896 Jan-00 43.55 2.455882803 Jan-01 46.5439 6.874626866 Jan-02 48.3287 3.834659322 Jan-03 47.9358 -0.812974485 Jan-04 45.4557 -5.173794951 Jan-05 43.7545 -3.742544939 Jan-06 44.397 1.468420391 Jan-07 44.3325 -0.145280086 Jan-08 46.73 5.407996391 Jan-09 42.35 -9.372993794

EXCHANGE RATE DETERMINANT VARIABLES

Foreign Exchange Reserve

Foreign exchange reserves are the foreign currency deposits held by national banks of different nations. These are assets of Governments which are held in different hard currencies such as Dollar, Sterling, Euro and Yen. These rates are important because they determine how much money a country needs to buy goods from abroad and how much money it needs to service its external debt. If a currency gets depreciated the country will need more money for its imports and debt. This will make its economic planning more difficult and its economy weak.

Broad Money Supply(M3)

In India, narrow money (M1) is measured by adding the currency in circulation, demand deposits with banks and other deposits with the Reserve Bank of India. Broad money (M3) is measured by adding M1 and term deposits with banks. We use M3 to reflect a broader constitution of money supply. Other than currency in circulation and demand deposits with banks, it also includes term deposits with banks. Unlike demand deposits, you cannot write a cheque against money lying in your term deposits. That makes term deposits less liquid than demand deposits. Nevertheless, you can still convert your term deposits into cash. That’s why term deposits are treated as part of broad money.

GDP of India

The India GDP is a combination of all the differential factors, contributing to the welfare of the India economy. The main factor that contributed to the growth of India GDP post 1990s was the opening-up of the Indian economy. The GDP of India, even after the opening up of the economy and other relaxed norms couldn't survive the aftermath of the global financial crisis. The GDP of India over the past two fiscals (2008-09 and 2009-10) experienced considerable slowdown.

Factors Affecting Exchange Rate of India—A Study of Major Determinants 497

OTHER DETERMINANTS OF EXCHANGE RATE

The following theories explain the fluctuations in FX rates in a floating exchange rate regime

International Parity Conditions

Relative Purchasing Power Parity, interest rate parity, Domestic Fisher effect, International Fisher effect. Though to some extent the above theories provide logical explanation for the fluctuations in exchange rates, yet these theories falter as they are based on challengeable assumptions [e.g., free flow of goods, services and capital] which seldom hold true in the real world.

Balance of Payments Model

This model, however, focuses largely on tradable goods and services, ignoring the increasing role of global capital flows. It failed to provide any explanation for continuous appreciation of dollar during 1980s and most part of 1990s in face of soaring US current account deficit.

Asset Market Model

The asset market model of exchange rate determination states that “the exchange rate between two currencies represents the price that just balances the relative supplies of, and demand for, assets denominated in those currencies.”

Supply and demand for any given currency, and thus its value, are not influenced by any single element, but rather by several. These elements generally fall into three categories: economic factors, political conditions and market psychology. Economic factors includes (a) economic policy, disseminated by government agencies and central banks, (b) economic conditions, generally revealed through economic reports, and other economic indicators. Internal, regional, and international political conditions and events can have a profound effect on currency markets. All exchange rates are susceptible to political instability and anticipations about the new ruling party. Political upheaval and instability can have a negative impact on a nation's economy. Market psychology and trader perceptions influence the foreign exchange market in a variety of ways like flights to quality, long term trends, buy the rumor, sell the fact, economic numbers, and technical trading considerations.

Thus, percentage variation in dollar-rupee exchange rate is defined as a function of five months lag values of exchange rate, difference between call rate and bank rate, including its lag effect for five months, interest yield differentials between 90 days T-bills of India and the US as well as 10-year government securities of India and the US, money supply in India, foreign exchange reserves and two dummy variables.


Research Objective

• To find out the factors affecting exchange rate between India and US. • To find out impact of foreign exchange reserves on exchange rate


• To find out impact of GDP on exchange rate. • To find out impact of Broad Money supply on exchange rate. • To find out to what extent these variables affect the exchange rate.

Variables under Study

• Exchange rate between India and US (Dependent Variable) • GDP of India (Independent Variable) • Broad Money Supply (Independent Variable) • Foreign Exchange Reserve (Independent Variable)

Hypothesis

H0 = Independent variables (GDP, Broad money supply and Foreign exchange reserve) do not affect the dependent variable (exchange rate).

H1 = Independent variables (GDP, Broad money supply and Foreign exchange reserve) do affect the dependent variable (exchange rate).

Data Collection and Analysis

The data is collected from the secondary source through internet. The data is taken from indiabudget.nic.in. The period of study is from January 1998 to January 2009. For the analysis of the data regression model is used.

DATA ANALYSIS

Regression model used for analysis

Y=a +bx+cy+dz Where, Y=Exchage Rate for Year A = constant g= broad money supply (M3) h = gross domestic product i= foreign reserves

COEFFICIENTS

g= co efficient of broad money supply (M3) h= co efficient of gross domestic product i= co efficient of foreign reserves

SUMMARY OUTPUT Regression Statistics

Multiple R 0.778493329 R Square 0.606051863 Adjusted R Square 0.458321311 Standard Error 1.89159464 Observations 12

Factors Affecting Exchange Rate of India—A Study of Major Determinants 499

ANOVA TABLE ANOVA Df SS MS F Significance F Regression 3 44.03691387 14.67897129 4.102413865 0.04899953 Residual 8 28.62504227 3.578130284 Total 11 72.66195614 Coefficients Standard Error t Stat P-value Intercept 57.22676833 8.421572097 6.795259563 0.000138491 Foreign exchange reserves -4.25454E-05 7.4512E-05 -0.570987106 0.583687511 GDP in Rs. In crores -2.60396E-05 1.06952E-05 -2.434691217 0.040901818 Broad money reserve 3.48161E-05 1.07247E-05 3.246360151 0.01176502

CORRELATION ANALYSIS Exchange Rate Foreign exchange reserve Exchange Rate 1 0.064615724 Foreign Exchange Reserves 0.064615724 1 Exchange rate GDP in RS in Crores Exchange rate 1 0.097504461 GDP in RS in Crores 0.097504461 1 Exchange rate broad money Exchange Rate 1 0.141565484 Broad Money Reserve 0.141565484 1

INTERPRETATION

From Regression Model

From the summary output table it can be concluded that the From summary output table we can conclude that independent factors such as broad money reserves, foreign exchange reserves and money supply affects dependent variable (exchange rate between India and US) by 45.83%. From ANOVA TABLE it can be said that significance value of GDP in crores for India is 0.0409 and for broad money supply is 0.011which is less than 0.05 so the null hypothesis is accepted so GDP and broad money supply does not affect exchange rate between India and US. Apart from that significance value for foreign exchange reserves is 0.5836 which is greater than 0.05 so the null hypothesis is rejected and accept H1 so foreign exchange reserves do have impact on foreign exchange reserves. From correlation table between exchange rate and foreign exchange reserves show that correlation between exchange rate and foreign exchange reserves is 0.06461. It means that change in foreign exchange reserve of India for 100% leads to wards 6.461% change in foreign exchange rate and vice versa. Similarly it is for the Broad Money Supply and GDP as per table.

CONCLUSION

The analysis of the data reveals that foreign exchange reserves do have significance impact on exchange rate. And all the factors like broad money supply, foreign exchange reserves and gross domestic product having the impact on exchange rate by 45.83%. Correlation table between exchange rate and foreign reserves shows positive relation between these variables,


and it indicates that increase in foreign reserve leads to a depreciation of rupee. And correlation between and exchange rate and money supply is positive, that means increase in money reserves leads to an depreciation of rupee and same for the case of GDP of India and exchange rate. The exchange rate determinations are dependent on several other variables.

REFERENCES [1] Reserve Bank of India. (2009) Handbook of Statistics on Indian Economy. [2] Yearly data for Exchange Rate is taken from

http://www.tradingeconomics.com/Economics/Currency.aspx?Symbol=INR and http://ssrn.com/abstract=1165602

[3] Data for Foreign Exchange reserves is taken from http://mospi.gov.in/national_data_bank/index.htm

[4] Data for Gross Domestic product is taken from http://indiabudget.nic.in/es2009–10/esmain.htm

[5] Data for Money Reserves is taken from http://www.rbi.org.in/scripts/BS_EntireSearch.aspx?searchString=money+reserve

Strategic Risk Management

J. A. Kagal*

INTRODUCTION

Strategic Planning is an essential exercise which is conducted by all companies who wish to succeed at the marketplace. Strategic planning involves definition of a future roadmap and the critical success factors required in the planning phase to achieve success. It also involves a forward looking exercise by the company in which the company looks at ways in which the company can achieve its stated long term objectives by carrying out strategic activities such as acquisition, expansion etc. Typically the strategic planning period covers a planning period of 3 to 5 years and its long term objectives are supposed to be reflected in the shared vision of the company. For example the vision statement of a company should be well crafted to indicate to the stakeholders its statement of intent. Tata Motors had envisaged a very dream come true vision in 1998 to make a wholly indigenous small car for the middle class population which would cost less than a lakh of Rupees. Twelve years down the line they have realized their vision of manufacturing the worlds cheapest car though at the time of writing this article owing to cost escalations which is one of the strategic risks, the cost has gone upto around 1.5 lakhs. Strategic planning encompasses a process which is called an environmental scan wherein the company has a hard look at emerging markets and the industry scenario in particular and crafts a long term strategy which decides to strengthen existing business lines by expanding or diversifying into new business lines which may be related or unrelated to the existing lines of businesses. For example engineering giant Larsen and Toubro which had tons of core competence in making switchgears and heavy engineering machinery such as turbines etc diversified into infrastructure where it succeeded and cement manufacturing and shipping services where it failed. This paper has a look at the strategic planning exercise in terms of expansions, diversifications, acquisitions etc and reviews the risks entails in each strategic exercise listed later on in the paper. Sequel to the exercise in risks involved in strategic planning it tries to understand the risks involved in achieving competitive advantage through the strategic plan deployment activities.

RISK MANAGEMENT

Risk as is understood today, is the probability that an event which could cause loss or damage. Risk as an entity covers decisions taken under uncertainty or ignorance and the probability that a stated outcome is not achieved partially or fully. Risks especially strategic risks which cover the uncertainties of impacts of long term decisions taken by the company are damaging and need to be identified and attended to effectively to ensure the attainment of long term goals as envisaged in the long term goal paragraph of the vision statement. In fact after the collapse of Enron Corporation the SEC in the US introduced SOX 409 which was a declaration of all perceived risks, in the annual report of the company. In India since 2004 *Visiting Faculty-B-Schools, Former Advisor-Mgt Consulting Division Deloitte and Touche India Pvt Ltd


SEBI has introduced Clause 49 of the listings agreement wherein every Indian listed company has to disclose its risks and the handling methodology to the shareholders in the paragraph titled Areas of Risks and Concerns which is a part of the mandatory chapter titled Management Discussions and Analysis which forms a part of the Chairman’s speech to the shareholders. However it is seen from the analysis of annual reports several leading Indian companies that although strategic plans may be cove red in brief by a few discerning companies; till now companies disclose only operational risks and that too a very few of them.None of them have ventured to disclose strategic risks in their annual report. Tata Motors highly publicized small car venture in Singur West Bengal was highly publicized in their earlier annual reports but the risk elements involved in setting up operations were never disclosed if ever considered resulting in a 1500 crore loss to the company. Hence companies need to have a very careful look at all their strategic plans in detail and identify all strategic and operational risks involved in translating strategies into action plans, The scope of this paper is limited to the understanding of strategic risks and how they can be mitigated to enable the translation of strategic goals to short term goals and then to action plans which produce the desired outcomes in the short term leading to realization of long term goals and ultimately the corporate vision.

CLASSIFICATION OF STRATEGIC RISKS

Strategic risks can be be further categorized as following

• Political • Technological obsolescence • Market • Reputational • Economic • Financial • Legislation (government policies) • Business Relationship risks

Political risks are of paramount importance in India. Take Tata Motors Singur in West Bengal. Although the government was very keen on the project and had given all the go ahead signals,the lack of government participation financially in the project created a degree of vulnerability for the project which was exploited by the opposition resulting in culling of the project and immense investment loss to Tata. Similar is the case of ADAG groups project for erecting two super capacity power plants in Uttar Pradesh. The project was initiated at t5he behest of the previous government but the company failed to assess the risks and impact if the then government was voted out of power which exactly happened putting the project in the doldrum.

Technological obsolescence is a very high strategic risk and this happens in the case of high investment long duration projects such as power plants where because of the high gestation period the fuel costs either sky rocket or fuel itself is in short supply as in the case of some naptha based power plants.

Strategic Risk Management 503

Market risks are incurred by a company which introduces products and services which customers do not want. Customer requirements keep changing dynamically and a company which wishes to succeed at the market place should understand the changing expectations of the customers and adopt differentiation as a key success factor. One of the successful strategies towards understanding the changing expectations of the customer is institution of the voice of the customer process where the customer future requirements are understood and translated into delivery of products and services.

Reputation risks arise out of either some damage inflicted by company products/services or by mis governance of the company.

Economic risks are inflicted on a company by industry slow down, economic depression, fluctuation in foreign currency values. Economic risks cause slow down of company activities resulting in sluggish sales.

Legislation risks are the risks which a company faces when it is about to effect a strategic activity such as setting up a new unit based on certain government concessions. These concessions at a later date may be revoked by a new government that comes to power through a legislation which affects the strategic planning. A typical example was of Reliance Petrochemicals being given the license to sell the produce of its refinery in Jamnagar at several petrol pumps in India. At the time of the license being awarded Reliance along with the other public sector oil companies were exempt from paying certain taxes. Later on the tax exemption was waived for non public sector oil companies resulting in Reliance terminating its petrol pump business and later selling its petrol pumps to Indian Oil. Petrol refined at the Jamnagar refinery is now being exported to African countries.

Business relationship risks are risks which arise out of a principal with which a company has a marketing agreement or a partnership closes down or sells out or is acquired leading to termination of the relationship.

STRATEGIC ACTIVITIES IN A COMPANY

After a company has enunciated its long term goals and the modus operandi for achieving its long term goals, it needs to formulate a strategy for achieving the long term goals. The strategy formulation exercise entails enunciation of how the company needs to operate in the strategic deployment areas to achieve its long term goals. The options open to a company are -Capacity expansion.

• Vertical integration upwards and downwards(Related diversification) • Horizontal integration (Unrelated diversification) • Collaborations and joint ventures • Acquisitions


CAPACITY EXPANSION

It is one of the most questioned strategic exercises undertaken by a company. Capacity expansion is measured in terms of capital involved and obsolescence of technology.

Power plants in India expand its capacity without utilizing its current capacities. Capacity expansion should be closely associated to the strategic growth figures projected and expansions should be planned in advance. While expansion planning is done an exercise related demand and supply of product/service must be done.

DIVERSIFICATION

A company should diversify into related or unrelated activities when it feels it can leverage its brand name and enter new markets which may be new or in their current line of business. It is however advisable that the company possesses core competence in the areas of intended diversification.Towards this a company wishing to enter into new markets through the diversification route may be advised to acquire a company which has core competence in that area rather than developing its own as in the case of IBM Global Services acquiring the IT arm of PWC. A company generally diversifies when it sees an opportunity to expand into areas whose technologies and products complement its existing business. For example a fast moving consumer goods company sets up a caustic soda plant and also opens retail outlets to sell its products. Diversification to maximize the value chain effectiveness is a strategy which is fast gaining currency in the industry where companies wish to reduce their supply chain costs by diversifying. Diversification can assume two routes 1.Vertical upwards and downwards (related) 2.Horizontal(unrelated). For example in the case of Reliance Industries, they started with vertical integration with petrochemicals went upwards to oil exploration; came down to erecting a refinery and then went downstream into petrol retailing (an activity since discontinued. Since then they have horizontally diversified into several businesses which include ready made garments, fresh vegetables, music etc.

Horizontal diversification may be fraught with high risks because of the lack of core competence as was in the case of Cement Division of Larsen and Toubro which incurred heavy losses and ultimately had to be sold to Birlas as Ultratech.

STRATEGIC DIVERSIFICATION AT RIL

Strategic Risk Management 505

COLLABORATIVE

Increasingly, strategic alliances are being forged by companies who wish to achieve and sustain competitive advantage by entering into strategic alliances with companies which are perceived to have core competence in the area. Collaborations are also sought to enter into new markets where the proposed collaborator has immense core competence and enjoys market leadership. Indian case studies include collaborations between Hero Cycles and Honda; Maruti Motors and Suzuki.

ACQUISITIONS

A company wishes to create core competence without actually building it can opt to acquire companies which have such competence by way of human capital. Acquisition should result in enhancement of competence as well as achievement of operational economics. For example acquisition of the IT arm of PWC by IBM Global Services and CMC by TCS has considerably improved the service value chain value of the respective companies.

RISKS IN STRATEGIC ACTIVITIES

Once a company frames its vision it needs to formulate a strategy towards achieving the long term goals. Various strategies for addressing the changing customer expectations and succeeding at the marketplace are cited above. But in all strategic planning exercises a risk assessment exercise needs to be done to identify the blind spots in the planning mechanism and through risk identification, assessment and handling methods and adequate risk mitigation policies should be designed to minimize the effects of strategic risks. Selected risks along with suggested mitigation procedures are listed below: Initiative Risks Addressal Capacity Expansions • Technological obsolescence

• Anticipated volume of business not forthcoming

• Non availability of spares Non availability of raw material

• Cost escalation of raw material • Mismatched process capability

• Upgradation of technology • Subcontract unutilized space • Backward integration • Hedging • Agreement fixed cost PO • Alignment of supply chain capabilities

Integration • Mismatched process capability • Lack of core competence • Suppliers with uncertain capability

• Alignment of supply chain capabilities • JVs with companies or acquisition of such

companies deemed to have core competence • Train supplier to enhance capability or acquire

Acquisitions • Inadequate due diligence • Over optimistic goodwill costing • Effects of hostile takeover

• Risks of intangibles assessment not correct • Fixed assets to be valued accurately • Employee involvement

Collaborations • Lack of alternative strategy in the event of breakdown of collaboration or closure of collaborator

• No active part in operations

• Need to annunci alternate strategies to be deployed in event of collapse

• MOU needs to ensure active participation of collaborator

CONCLUSION

Strategic risk management is a very critical activity which complements the strategic planning process. As of today all listed companies are obliged to disclose their risks especially the strategic risks. The inability to understand and address the strategic risks has led to the


downfall of several large companies. Since public limited companies have a large portion of the funds used by them by way of public borrowings it is suggested that (a) A full fledged enterprise risk audit be made compulsory as external financial audits are today (b)As a part of the corporate disclosures companies should be made to disclose as part of their statutory disclosures the following –their long term goals; their proposed strategic activities to achieve their long term goals (c)Detailed analysis and expected mitigation plans for all listed risks especially statutory risks.(d)Regulator should have a detailed audit of corporate governance risks.

REFERENCES [1] Managing Business Risks by Simmons Kogan Page Publication ISBN 0–7494–4921–7 [2] Competitive Strategy by Micheal Porter Free Press Publication ISBN 0–684–84148–7 [3] Managing Business Risk by Young Amacom Publication ISBN 0–8144–0461–8

Track 10 Securitization and Reconstruction

of Financial Assets

Mortgage Backed Securities— How Far Secure

Akinchan Buddhodev Sinha* Abstract–For several years after they were launched in the 1970’s mortgage-backed securities worked as they were intended, expanding the loan base for borrowers and spreading the risk of default. But during housing boom that reached an acme during 2005, the process went deeply awry, as the issuance and trading of securities based on shaky mortgages infested the financial system with assets that later produced mammoth losses. We are all aware and may not be able to forget the financial catastrophe of 2008, arising from the huge defaults in installment payments on the part of home loan borrowers and thereby badly affecting the investors who invested in this ‘Toxic Financial Asset’, i.e. Mortgage Backed Securities (MBS). After experiencing the financial tremors, mortgage backed securities have almost become nightmares for the investors.

It will not be wrong if we say that mortgage backed securities have become scary. Toxic assets are making many people shy away from mortgage-related investments as it almost destroyed the economies of the globe. Mortgage backed securities now requires more babysitting than other forms of assets. However, there is light in the tunnel, meaning that those investors who can do their due diligence and seek assistance from trustworthy investment advisers can minimize the incidence of financial loss by diversifying their portfolio.

An important point to note is that the degree of risk associated with private mortgage backed securities is higher than government mortgage backed securities. These are quite trickier investments as they stands affected due to increase in interest rates and pre-payments. Pre-payment happens when, for example, a homeowner sells his house and has to pay off the rest of his mortgage. If the pace of pre-payment slows down on these securities, investors who thought they were holding onto a 10-year security mighty actually have a 15-year investment.

The dynamics of mortgage backed securities acts as a trigger to take up its indepth study. As stated in the earlier paragraphs that its villainous role in causing the global economic turmoil have questioned its financial rectitude. Hence it becomes imperative for an investor to look into its various aspects.

Keywords: Meaning of mortgage backed securities; Safe Heavens of Investment- A Question; Proper Financial Planning; Impact of Pre-payments; Impact of increase in interest rates; Global outlook towards mortgage backed security

FULL LENGTH PAPER

The year 2008 will be remembered as the most ugliest year of the financial history. As it was in this year, that almost the whole world was gobbled up by the financial demon i.e. ‘Global Economic Turmoil’. The scenario was extremely disturbing in US, the birth place of the crisis. In 2008, US teetered on the brink of financial disaster. Unemployment moved northwards. The cause of all these were the defaults on the part of home loan borrowers.

*ICFAI University, Meghalaya


Enormous investment banks that had been in business for more than a century and had endured the Great Depression faced collapse. And all of it, every last part of this looming economic disaster, was due to a unique financial instrument called mortgage-backed security.

MEANING OF MBS

These are securities whose values are backed using mortgage loans. Those mortgage loans are bought from banks and lending institutions and linked together into pools to increase value and reduce risk. Those securities are sold to investors as bonds, which can be bought and sold any way investors want. So long as the mortgages in the pool are paid off on time, the bonds will have value. Mortgage-backed securities were popular during the housing bubble. They have lost some of that popularity since the housing market collapsed.

THE ERRONEOUS APPROACH

Prior to the first decade of the 21st century, it was customary for a US bank to exercise due diligence when considering lending money for a mortgage. The scenario changed after the launching of mortgage backed securities. Eventually, the most desirable, qualified customers dried up; they all own houses. So the next group to target were those customers, whom earlier banks ignored because they failed in the financial parameters for lending home loans, i.e. income, debt and credit rating. These new loan customers were sub-prime borrowers. In the process, the concept of no-document loan was born, a kind of loan for which the lender did not bother to ask for any requisite information and the borrower didn’t provided it. People who may have been unemployed as far as the lender knew received loans for hundreds of thousands of dollars. As with the introduction of mortgage backed securities, lenders no longer assumed the risk of a loan default. They simply granted the loan and promptly sold it to others who ultimately borne the risk if payments are not made. They fared so well that investors clamoured for more. In response, lenders flexed their restrictions for mortgage applicants and borrowed heavily to create cash flows for loans in order to generate more mortgages. The investors in MBS faced the same risk and reward system that the old lender-borrower relationship was exposed to, but on a much larger scale due to the sheer volume of mortgages bundled into a MBS.

After MBSs touched financial markets, they were reshaped into a wide form of financial instruments with different degree of risk. Interest only derivatives divided the interest payments made on a mortgage among investors. If interest rate moves up, the return is good. If rates fall and homeowners refinance, then the security loses value. Other derivatives repay investors at a fixed interest rate, so the investors incurs loss when interest rates rise since they aren’t making any money off the increase. Subprime mortage-backed securities, comprised entirely from pools of loans advanced to subprime borrowers, were riskier, but they also gave rich dividends. Subprime borrowers are saddled with higher interest rates to offset the increased risk they pose.

A substantial amount of the mortgages taken out by subprime borrowers were hybrid adjustable rate mortgages (ARMs). These loans maintain a discounted (and usually affordable) fixed interest rate for a given number of years and then adjust to a higher rate. A

Mortgage Backed Securities—How Far Secure 511

homeowner with an ARM could find the monthly payments doubling after the rates adjusted. When the slew of ARMs that had been issued in a frenzy early on began to reset, the rate of foreclosure began to increase.

In just the month of August, 2008, one out of every 416 households in the United States had a new foreclosure filed against it. When borrowers stopped making payments on their mortgages, MBSs began to perform badly, The average collateralized debt obligation (CDO) lost almost half of its value between 2006 and 2008. And since the riskiest and highest returning CDOs were comprised of subprime mortgages, they became valueless after the nation wide increase in loan defaults started.

IMPACT OF TREMORS

The onslaught was so severe that major banks of US i.e. Bank of America, Citigroup, JPM Chase and Wells Fargo lost substantial value in terms of Equity to Total Assets, which becomes clear from the Equity to Total Assets ratio. Moreover, the situation demanded for the infusion of equity capital to the tune of $11,064 million, $56,022 million, $52,636 million and $46,623 million for Bank of America, Citigroup, JPM Chase and Wells Fargo respectively. (Refer Exhibit-1).

Due to the poor performance of the mortgage backed securities, rating agencies eg; S&P and Moody’s have downgraded the credit ratings on nearly $1.9 trillion in MBS. Consequently, it exerted pressure on financial institutions holding these securities to write down their value, potentially requiring banks to procure additional capital. (Refer Exhibit-4).

As of August 2008, financial firms around the globe have written down their holdings of subprime related securities by US$501 billion. The IMF estimated that financial institutions around the globe will eventually have to write off $1.5 trillion of their holdings of subprime MBSs. About $750 billion in such losses had been recognized as of November 2008. These losses have wiped out much of the capital of the world banking system. It was mandatory for the banks headquartered in nations that have signed the Basel Accords to have so many cents of capital for every dollar of credit extended to consumers and businesses. Thus the massive reduction in bank capital described above resulted in the reduction of credit available to households and corporate.

RECTIFICATION MEASURES TOWARDS PRE-PAYMENTS/FORECLOSURES

On 18 February 2009, U.S. President Barack Obama announced a $73 billion program to help up to nine million homeowners avoid foreclosure, which was supplemented by $200 billion in additional funding for Fannie Mae and Freddie Mac to purchase and more easily refinance mortgages. The plan is funded mostly from the EESA's $700 billion financial bailout fund. It uses cost sharing and incentives to encourage lenders to reduce homeowner's monthly payments to 31 percent of their monthly income. Under the program, a lender would be responsible for reducing monthly payments to no more than 38 percent of a borrower’s income, with government sharing the cost to further cut the rate to 31 percent. The plan also involved forgiving a portion of the borrower’s mortgage balance. Companies that service mortgages will get incentives to modify loans and to help the homeowners stay current.


The US Federal Reserve recently, initiated a first step towards extending its crisis-era monetary policy regime, as it downgraded its view of the economic outlook amid rising fears of a ‘double-dip’ recession. In a recently held meeting, Fed monetary policy makers agreed to start reinvesting more than $150bn in annual proceeds from maturing mortgage backed and agency securities into Treasury debt, halting plans to allow a natural shrinkage of the $2,300bn balance sheet the US central bank built up during the recession. The move signals an important shift in thought process at Fed, which only a few months back was inclining towards tightening monetary policy to fend off inflation as the economic recovery catched steam.

CAUTIOUS APPROACH

In an eye-opener incident, pensioners and large investors in US were deceived by the banks which sold them mortgage backed securities based upon fraudulent misrepresentation. The stories goes like this that giant banks hired a company called Clayton Holdings to sample the quality of mortgages being purchased. However, instead of disclosing to the investors purchasing mortgage backed securities that several mortgages were bad, the banks preferred to restrict this information to themselves, and utilized that inside information about poor mortgage quality to negotiate a discount of the price that the banks paid when purchasing the loan portfolios from the folks who originated the loans. The incident resembles like a purchasing a used car, but having a mechanic look it over first. Once the mechanic discovered a cracked engine block, the purchaser negotiates the purchase price way down, but then turns around and sells the car for a higher price without ever disclosing that there was a cracked engine block or even that a mechanic looked it over.

A disclosure from a financial insider brings out the fact that the entire mortgage backed securities sausage-making is a scam. The whole purpose of MBSs was for different investors to have their different risk appetites satisfied with different bonds. Some bond customers desired for super-safe bonds with low returns, some others wanted riskier bonds with correspondingly higher return. As every person was conversant of the fact that the loans were bundled into REMICs (Real-Estate Mortgage Investment Conduits, a special vehicle designed to hold the loans for tax purposes), and then ‘sliced and diced’, split up and put into tranches, according to their likelihood of default, their interest rates, and other characteristics. These slicing and dicing created 'senior tranches,' where the loans would likely be paid in full, if the past history of mortgage loan statistics was to be believed. And it also created 'junior tranches,' where the loans might well default, again according to past history and statistics. "These various tranches were sold to different investors, according to their risk appetite. That's why some of the MBS bonds were rated as safe as Treasury bonds, and others were rated by the ratings agencies as risky as junk bonds.

Now such stories compels an investor to undergo thorough investigation before jumping into the decision to go for investments in MBS.

As the villainous role of mortgage backed securities have stolen the confidence of the investors, in this view, it becomes imperative to embrace the following five rules or commandments before jumping into bond investments especially mortgage backed securities.


Embrace Reality

The bull market in bonds has now become a history. For 27 years, falling yields boosted returns to levels rivaling stock returns. That was then. So if the equity market’s “lost decades” motivates you take the bond route to add wings to your returns, then it may be a wrong decision. Given current yields, annual returns on intermediate-term treasury bonds over the coming decade will likely to be about half the 8.4 percent they provided from 1982 through 2008.

Be careful what you wish for

If interest rate don’t move northwards, but remain flat, there will be no wheels to bond prices. That’s agreeable from the point view of stability. But this scenario implies that the Fed must keep rates at their current low levels to stimulate a faltering economy, which is nothing to happy about. What’s more, it wouldn’t take much of a increase in inflation before those yields enters the negative territory in real terms.

Concentrate on long‐term

Going by the market winds into and out of the asset class after another is a recipe for failure. Instead of devising your asset allocation in response to a market’s short-term moves, build a portfolio for the long-term. Stocks will provide the growth you will require to attain your financial goals; bonds will give you peace of mind when stock value falls. Once you have chosen your mix balancing your need for growth with your desire for protection, resolve to continue with it. No doubt, owning a bond fund will amount to taking a bit of haircut on the bonds in the fund when the rates rise. But the fund will also invest in new, higher-yielding bonds, which will make the blow quite comfortable.

Stay short with your bond funds

The longer a bond fund’s duration, the further it will decline in price if interest rates rise. And with rates more likely to rise than to fall in the next few years, you might consider trading a bit of current income for protection from rising rates by favoring short-term bond funds. Then, plan to shift a proportion of your short-term bond fund holdings into longer-term bond funds at fixed intervals over time.

Be careful reaching for yield‐

When rates are low, it can be tempting to goose your yield, particularly when junk bonds are sporting high yields (seven to nine percent around February, 2010). But markets are not silent spectators. Higher yielding investments are accompanied with greater degree of risks. So while investing in fixed income securities, you need to study the various financial aspects associated with the bond investments and not only restricting your analysis to yield.


GLOBAL OUTLOOK TOWARDS MBS

If we refer to Exhibit-9, we can see that the upper part of the graph disappears in 2008, as though it surgically removed. That is because in 2008, the source of funding for residential mortgage-backed securities (RMBS), commercial mortgage -backed securities(CMBS), consumer asset backed securities and home equity loans has completely dried up. In fact, all that’s left of the earlier ardent credit markets, is the agency mortgage-backed securities sold through Fannie Mae and Freddie Mac which depend exclusively on government funding. Apart from government sponsored GSEs, there is no mortgage credit. In 2009, mutual fund investors piled into bond funds like circus clowns. New cash flow into bonds totaled $375 billion in 2009, according to the Investment Company Institute, and more than two-thirds of that money came from individual investors. To put that figure in perspective, the total new bond-fund cash flow for the previous 10 years combined was $423 million. If we refer to Exhibit-10, then we can see that more money flowed into bond funds in 2009 than flowed to stock right before the tech bubble burst. But after the economic crisis triggered by MBS have shaken the confidence of the investors badly and therefore investment in bonds may not be as attractive as it used to be earlier.

CONCLUSION

When George Soros stated that the financial system had “effectively disintegrated”, it caused some minor fears. But if we think carefully, then we can see that he was not exaggerating. We need to accept the hard core fact that after the onset of global economic crisis which assumed the shape of a financial contagion, have made the financial systems across the world disintegrated substantially. What we are experiencing presently is the fallout from that event. This can be explained with the aid of an example. Imagine watching the demolition of a hundred-storey skyscraper. After the explosives detonate and the building implodes, the chunks of debris and shattered begin to fall to the ground below. That’s where we are right now. The financial super structure has already been blown to bits, but a thick shower of fragments keeps raining down on earth. Rising unemployment, falling consumer confidence level, severe contraction of the economy, growing pessimism; these are all the knock-on effects of a full-blown system collapse.

The collapse of securitization (the bundling of pools of loans into securities and sold at market) has acted like a vampire, i.e. it sucked more than $1.2 trillion from the credit markets and forced a cycle of deleveraging throughout the financial system. The idea that securities based lending was a viable option was predicated on the Radian belief that self-interested speculators could sustain the flow of credit to the system. That notion turned out be “catastrophically wrong”.


Exhibit–1

Note: The $ gap indicates the amount of common equity (capital) each bank would require to return to its average pre-crisis level.

Banks studied: Bank of America-Purple Bars, Citigroup-Yellow Bars, JPM Chase-Red Bars and Wells Fargo-Green Bars.

Exhibit–2

Source: http://en.wikipedia.org/wiki/File:Lending_%26_Borrowing_Decisions_-_10_19_08.png


Exhibit–3

Source: http://en.wikipedia.org/wiki/File:Subprime_Crisis_Diagram_-_X1.png

Exhibit–4

Source: http://en.wikipedia.org/wiki/File:MBS_Downgrades_Chart.png


EXHIBIT–5

Exhibit–6

Source: http://upload.wikimedia.org/wikipedia/en/7/70/TED_Spread_Chart_-_Data_to_9_26_08.png


Exhibit–7

Source: http://www.econoutlook.com/2009/10/mortgage-backed-securities-part-1.html

Exhibit–8

Source: http://www.econoutlook.com/2009/10/mortgage-backed-securities-part-1.html

Exhibit–9


Exhibit–10

Source: investment company institute

REFERENCES [1] How can mortgage-backed securities bring down the U.S. economy? [2] Website: http://money.howstuffworks.com/mortgage-backed-security.htm [3] Retrieved on 2nd of November, 2010 [4] Why the Mortgage-Backed Security Went the Way of the Dinosaur [5] Website: http://money.howstuffworks.com/mortgage-backed-security1.htm [6] Retrieved on 2nd of November, 2010 [7] What are Mortgage Backed Securities? [8] Website: http://www.finweb.com/investing/what-are-mortgage-backed-securities.html [9] Retrieved on 3rd of November, 2010 [10] Are All Mortgage Backed Securities a Scam? [11] Website: http://www.globalresearch.ca/index.php?context=va&aid=21480 [12] Retrieved on 3rd of November, 2010 [13] Subprime Mortgage Crisis

Website

[14] http://en.wikipedia.org/wiki/Subprime_mortgage_crisis#Bailouts_and_failures_of_financial_firms Retrieved on 4th of November, 2010

[15] Fed downgrades recovery outlook [16] Website: http://www.ft.com/cms/s/0/0567152a-a49c-11df-8c9f-00144feabdc0.html [17] Retrieved on 6th of November,2010 [18] Financial Meltdown: Haircut Time for Bondholders by Mike Whitney [19] Website: http://www.globalresearch.ca/index.php?context=va&aid=12683 [20] Retrieved on 6th of November, 2010 [21] Bond Warning: Why Your ‘Safe’ investment Isn’t so Safe [22] Website: http://moneywatch.bnet.com/investing/article/bond-funds-bubble-ahead/389341/ [23] Retrieved on 6th of November, 2010

Securitization and Reconstruction

of Financial Assets—An Axe for NPAs

Dr. Ratna Sinha*

Abstract—Global Financial Turmoil creates the stunning repercussion on Indian Banking

Sector. The total Non-Performing Assets (NPAs) in All Scheduled Commercial Banks rise

after the recent economic downturn From Rs. 54,402 crore (Sept 2008) to Rs. 67,192Crore

(Sept 2009). To tackle the NPAs stock problem, the banking sector adopted many strategies

where Securitisation (SARFAESI Act 2002) is the major mechanism to recover NPAs and

enforce security without the intervention of the courts. It is the tool of risk management as

they allow elimination of substantial risk associated with Non-Performing Assets and allows

diversification of asset portfolio. Securitisation is essential to the evolving global financial

system because it provides a number of important economic benefits - through increasing the

diversification of risk and reducing the costs of intermediation between savers and borrowers.

This paper discusses the process of Securitisation and Legal provision for Act. The

methodology adapted to analyse the comparative performance of major three legal process

DRTs, LOK ADALAT and SARFAESI applicable for Banking Industry. The conclusion has

certain loopholes of securitization process which happen due to inadequate risk management

practices and a lack of due diligence on the part of financial market participants in

securitization process. The Author has Suggested Some Corrective major for improvising the

SARFAESI Act.

BACKGROUND OF THE STUDY

Non-Performing Assets (NPAs) swelling the Indian Financial Sectors. In Financial year2008-09, NPAs could arise more from small and medium enterprises segment and the provisions for bad loans will continue to remain high for the banking sector and will reduce the overall profitability. Banking Industry was grappling with the huge amounts of NPAs touching an amount of Rs 1, 11, 000 crores as in March 2005, constituting 14% of the country's gross domestic product (GDP).

TABLE 1: GROSS NPAS OF SCHEDULED COMMERCIAL BANKS (AS AT END-MARCH 2005-2009)

Year Total Advance Gross NPAs Net NPAs

2005 11,52,682 59,373 (5.2) 21,754 (1.8)

2006 15,51,491 51,097 (3.3) 18,543 (1.1)

2007 20,12,510 50,486 (2.5) 20,101 1.0

2008 25,07,885 56,435 (2.3) 24,734 (1.0)

2009 30,38,258 68973 (2.3) 31,424 (1.1)

Sources: rbi.org.in

(Rs in crore)

*Figure in parentheses is Percentage to total Advance.

To resolution of NPAs levels the Government of India and Reserve Bank of India (RBI)

initiated different measures where Securitization and Reconstruction of Financial Assets and

*The Oxford College of Business Management, Bangalore

Securitization and Reconstruction of Financial Assets – An Axe for NPAs � 521

Enforcement of Security Interest Act (SARFAESI Act 2002)†‡ is established to acquire,

manage, and recover NPAs from lenders, and unlocking value trapped in them.


• To Study the process of Securitization in India.

• To analyze the performance of SARFAESI with Lok Adalat and DRTs.

• To Study the Loop-holes in SARFAESI Act and provide some corrective measure to

improvise the act.

NEED AND SCOPE OF THE STUDY

Securitization(SARFAESI) is the ray of hope for funding resource starved infrastructure

sectors like Power, real state, steel etc. it has enabled banks and Financial institutions(FIs) to

realise long-term assets and improve recovery by taking possession of securities, sell them

and reduce Non-Performing§ Assets (NPAs) by adopting measures for recovery or

reconstruction. This study explores the process and performance of Securitization and

Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 in India.

The scope of the study is Indian economy and few measures for recovery of NPAs.

LIMITATION OF THE STUDY

The study will be basically focusing on the analysis the performance of the Securitization

process (SARFAESI 2002Act) in Indian financial System, and how it is providing new

options to struggle with the NPAs. But restricted to the comparative study with DRTs and

Lok- Adalat.

METHODOLOGY

This Research Paper is done mainly by collecting and analyzing secondary data. The major

sources of these data are websites of Reserve Bank of India. A fair amount of information is

collected from magazines and other academic publications to obtain Knowledge working

procedure regarding in this field.

NECESSITATE FOR SARFAESI ACT

SARFAESI Act 2002, Established because of failure of Recovery of Debts Due to Banks and

Financial Institutions Act (RDDBFI act 1993). The main purpose of the RDDBFI Act was to

cut down the time consuming Procedure of civil courts and facilitates speedy recovery. While

this Act facilitated faster ascertainment of dues, but it could not achieve much in the

execution of the decree. So, rising level of Bank NPAs raised concerns and Committees like

†An asset is classified as Non-performing Asset (NPA) if due in the form of principal and interest are not paid by the borrower

for a period of 90 days. ‡Gross NPAs- Provisions in NPA Accounts + DICGC/ECGC claims received and held pending adjustment+ Part payment

received and kept in Suspense Account + Balance in Sundries Account+ Floating Provisions+ Provisions in lieu of diminution

in the fair value of restructured accounts classified as NPAs §Report on Trend and Progress of Banking in India, 2005-06, p-68.


the Narasimham Committee II**

and Andhyarujina Committee††

which were constituted for

examining banking sector reforms considered the need for changes in the legal system to

address the issue of NPAs.

These committees Taking cue from similar attempts by other countries like US, Mexico,

Sweden, Korea in both bank Restructuring and Asset Restructuring, suggested a new

legislation for securitization, and empowering banks and Financial Institutions is to take

possession of the securities and sell them without the intervention of the court and without

allowing borrowers to take shelter under provisions of BIFR‡‡

. Acting on these suggestions,

the SARFAESI Act was passed in 2002 to legalize Securitization and Reconstruction of

financial Assets and Enforcement of Security Interest 2002. The act visualize legal framework

for the formation of Asset Reconstruction Companies (ARCs)§§


There have been many research works were done on Process and performance of

securitization SARFAESI Act 2002,Rajesh Chakrabarti (2005) specified the SARFAESI

Act2002 that Banks are authorized by a special law that they can bring to auction of a

property mortgaged to them as security for a loan, even without moving the Civil Court.

Shrikant S. Kamath (2004) focuses the salient features of the Securitisation and

Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 -

exclusively discusses certain relevant definitions and the process of securitisation, advantages

of securitisation, the accounting treatment, and the tax implications.

Subhrarag Mukherjee and Vatsal Arya,(2004) scans the provisions relating to SARFAESI

Act as the measure to curb this evil, and pointes out many flaws in the Act which need to be

set right in order to make the Act function smoothly -highlights the judicial views on the said

Act including the Supreme Court's judgment in Mardia Chemicals' case - suggests that, in the

light of the criticisms made by the Supreme Court on certain provisions in the Act, the

loopholes and inequalities in the said Act may be ironed out through appropriate legislative

measures without tampering with the basic structure of the Act.

Many Literatures stressed on the Advantages of SARFAESI Act 2002 when Bank and

Financial Institutions have been financing infrastructure projects, when Formation period and

schedules for repayment in such projects are very long and hence ability of banks and

financial institutions to commit funds for such projects is limited. With the creation of the

legal framework for securitisation, Under the banks and financial institutions will be

**RBI Framed a committee chaired by M.Narasimham, former governor of RBI, to review the structure, organization, procedures

and functions of financial system in India in 1991 extended to the 1998. ††Committee on Banking Laws appointed by the Government of India in 1998 which led to the passing of the Securitisation and

Reconstruction of Financial Assets & Enforcement of Security Interest Act, 2002 ‡‡the Government of India set up in 1981, a Committee of Experts under the Chairmanship of Shri T.Tiwari to examine the

matter and recommend suitable remedies for sick companies, due to Board recommendation the Board for Industrial and

Financial Reconstruction (BIFR) was set up in January, 1987 and functional with effect from 15th May 1987 §§Asset Reconstructions companies are created to manage and recover Non Performing Assets acquired from the banking system

with effect from 21st June, 2002.


encouraged to lend to such projects without having any concern for locking up of their funds

for number of years.

Process of Securitization

Fig. 1: Graphical consequence of securitisation Process

Source: http://www.docstoc.com/docs/906179/securitization-process

The Process of Securitizations Consist of Following Steps

• The originator***

first selected the pool of assets of an obligor†††

(commercial mortgages, Lease receivables etc.) of homogeneous nature, considering the maturities, interest rate involved, frequency of repayment which is suitable to use for securitization.

• After the selection Process Special Purpose Vehicle is created and the originator sells the asset to that SPV

‡‡‡. This effectively separate the risk related to the original entity

operations from the risk associated with collections. • The SPV Issues Asset Backed Securities to investors in the capital markets in a

private placement or pursuant to the public offering.

*** The lending financial institution- financial Institutions and Banks †††The debtor of the loan ‡‡‡Merchant Banker or Investment Banker


• These securities are structured to provide maximum protection from anticipated losses using credit rating agencies and reserve account.

• These agencies rate the securities and they are ready for sale usually in the mid term

notes with a term of three and ten years.

Securitisation is a structured transaction, whereby the Originator transfers some of its

assets to SPV which breaks this asset into tradable securities of smaller values which could be

sold to the investing public. Most of the securities are issued by SPV Pass- through

Certificate-without recourse.§§§

The Securities Structured and marketed in that way that the

Public ready to purchase at large.

The following Assets securitized by financial Institutions

• Term loans to financially reputed Companies • Receivables from government Departments and Companies • Credit Card Receivables • Hire purchase loans like Vehicles • Lease Finance • Mortgage Loans etc.

TABLE 2: PROPORTIONAL PERFORMANCE OF SARFAESI ACT, (DRTS) AND LOK ADALAT 2007-08 AND 2008-09

(Rs. in crore)

Recovery

Channel

2007-08 2008-09

No. of case

referred

Amount

involved

Amount

Received

Percentage

of Amount

Received

No of

Cases

referred

Amount

Involved

Amount

Received

Percentage

of Amount

Received

Lok -Adalata 1,86,535 2,142 176 8.2 5,48,308 4,023 96 5.4

DRTs 3,728 5,819 3,020 51.9 2,004 4,130 3,348 81.1

SARFAESI Act 83,942 7,263 4,429 61.0 61,760 12,067 3,982 33.0

Sources: rbi.org.in

From the above data its clear indicated that among the various channels of recovery available to banks for dealing with bad loans, the SARFAESI Act and DRTs have been the most effective in terms of amount recovered. In 2008-09 amount received from DRTs is approx 82 percent and 33 percent but amount received in SARFAESI Act is Rs 3982 cores more than DRTs recovered Rs3348crore.The amount recovered as percentage of amount involved was the highest under the SARFAESI Act, followed by DRTs and Lok- Adalat in 2007-08. The SARFAESI Act has been largely perceived as facilitating asset recovery and reconstruction.

ISSUES RELATED TO SARFAESI ACT

Absence of Proper Guidelines

The Sarfaesi Act was enacted to allow banks and financial institutions to recover debt by

enforcing security without intervention of courts. However, defaulters often misuse the

provisions of the Act. They often file frivolous litigation before the Debt Recovery Tribunal

(DRT) to delay the process initiated by the bank against them. The problem is compounded

by the Tribunal not being able to take these matters on a priority basis.

§§§ SPV are responsible for payment of Interest and payment for securities holder if obligor failed to repay their loan amount.


Absence of Proper Accounting and Taxation

One issue is the priority of claims of government (arrears of tax) provided in certain taxation

laws that defeats the recovery efforts of banks. There have been cases where entire amount

recovered by a bank was directed to be deposited in government treasury. At present there are

no special laws governing recognition of income of various entities in a securitization

transaction. Certain trust SPV structures actually can result in double taxation and make a

transaction unviable.

Heavy Stamp Duty and Registration Fees

Securitisation process requires the transfer of various illiquid and Non-performing Assets to

central agency SPV. This transfer involves heavy stamp duties and registration fees. These

costs are so exhorbitant that people are automatically discouraged to go in for this technique

Absence of Proper Debt Market

Lack of a sophisticated debt market is always a drawback for securitization for lack of

benchmark yield curve for pricing. The desire for long ended exposures (above 10 years) is

very low in the Indian debt market requiring the Originator to subscribe to the bulk of the

long ended portion of the financial flows.

Lack of Expertise

Banks and financial institutions are ill-equipped to take over the management of business of

the borrower due to lack of expertise in business management.

Inadequate Credit Rating Facilities

The credit rating agencies are not adequately available in India to take up the stupendous task

of credit rating instruments for securitization purposes.

New Concept

Investor awareness and understanding of securitization is very low. There is much awareness

not only among the investors but also among the various Financial Institutions.

SUGGESTION

The SARFAESI Act aimed at eradicating the shortcomings of all the previous legislations for

recovery of debts and to bring the financial institutions at par with the rest of the world. It

stressed more on the recovery part rather than ascertainment part for dues. The Act accepted

the fact that the assets held as security often decline in value till the date. The lawyers play a

significant part in delaying the hearings of such applications by seeking unnecessary

adjournments. The notice period for a delinquent borrower can be shortened to 15 or 30 days

since the account has become a non performing asset and the borrower is aware of this. The

seven days provided for banks to respond to the borrower’s reply is too short and should be

suitably enhanced.


Further, when the possession of the secured asset is to be taken in areas other than cities

— where there are Chief Metropolitan Magistrates—the secured creditor has to approach the

District Magistrate—who is also the District Collector. However, the district collector is

invariably unavailable to attend to these matters due to his pre-occupation with other duties,

leading to inordinate delays. It would be appropriate to substitute the District Magistrate with

the Chief Judicial Magistrate to hasten the proceedings. The Chief Metropolitan Magistrate

should continue with the stipulation that orders to be issued within a fixed timeframe

(maximum 60 days).

The development process of Indian economy also impact of the of the Indian debt market

would naturally increase the securitization activity in India. The transfer of Property act

should be suitably amended so as to facilitate securitization process in country. Rating

agencies like CRISIL and ICRA should have to actively educate corporate investors about

securitization. Mandatory rating of all structured obligations would also give investors much

needed assurance about transactions. Once the private placement market for securitized paper

gathers momentum, public retail securitization issuances would become a possibility.

Securitization legislation should also specify in Proper class basis of quality of assets

requirements for off balance sheet treatment for securitization and regulatory capital

requirements for Originator and Investors. All these factors help to securitization process to

facilitate the transfer of NPAs into efficient assets.

CONCLUSION

The enactment of the SARFAESI Act has completely revamped the procedure of debt

recovery in the Indian financial marketplace. But SARFAESI Act is also being misused by

banks and housing finance companies. The borrower loses his job or dies; and innocent

default of 90 days occurs. In the past 8 years, it has not helped stop any willful default by big

borrowers with who the bankers are in collusion and whom they finally help out through

liberal settlements. Only middle or lower classes are thrown out of their houses. It is far from

true that the NPAs of banks have dropped significantly on account of the enactment of the

SARFAESI Act. And SARFAESI Act has not acted as a kind of deterrent to the erring

borrowers especially the willful defaulters. There needs to the new proposal to improve the in

the technique of the securitization process in respect of their borrowings and the lending

institutions.

REFERENCES

[1] Avadhani. V.A., (2009), “Financial services in India” first edition, Himalaya Publishing House- Mumbai. PP–

354.

[2] Chakraborty .Rajesh, (2005) “Banking in India – Reforms and Reorganization.” Social Science Research

Network, http://ssrn.com/abstract=649855

[3] Gordon .E, & Natarajan .K, (2009), “Financial Markets and services”, 5th revised Edition, Himalaya

Publishing House, girgaon, Mumbai. PP- 378-384.

[4] Gomez. Clifford, (2009) “Financial Markets, Institutions and Financial Services” PHI Limited New Delhi-

110001. PP-450.

[5] Khan. MY, (2010), “Indian Financial System”2010, sixth edition, Tata McGraw hill Limited, New-Delhi. PP

11.12.


[6] Mathur, K.B.L., (2006). “Public Sector Banks in India: should they be privatized?” Economic and Political

Weekly, June 8 .PP-23.

[7] Machiraju, H.R. (2007) “Indian Financial System” 3rd Edition, Vikas Publishing House Pvt Ltd. PP–67.

[8] Muniappan, G.P. (2005), “The NPA overhang-Magnitude, Solutions, Legal Reforms” CII Banking

Summit2002, Mumbai, April 2002

[9] Shekhar.K.C, Shekhar. Lekshmy 2007 “Banking Theory and practice”20th Edition, Vikas Publishing House

Pvt Ltd.PP- 347.

[10] Subhrarag Mukherjee and Vatsal Arya, (2004) "Curbing the Menance of NPAs in the Indian Banking Sector -

will the Securitisation Act be Effective", 55 SCL 39.Indian Banking Association, Navi Mumbai.

(Magazine).PP-163.

[11] Shrikant S. Kamath, "Securitisation", (2004) 49 SCL 125 Indian Banking Association, Navi Mumbai

(Magazine).PP–76.

Websites

[12] http://www.bis.org/speeches/sp080602.htm

[13] http://cab.org.in/Lists/Knowledge%20Bank/DispForm.aspx?ID=31

[14] http://www.dnb.co.in/Arcil2008/Reconstruction.asp

[15] http://www.legalserviceindia.com/articles/see2.htm.

[16] http://www.peerpower.com/et/debate/41/Time-to-strengthen-Sarfaesi-

[17] www.rbi.org.in

Author Index

Abhyankar, H.G., 79 Agarwal, Saurabh, 461 Ahuja, Rishi, 219 Ainapure, Varsha, 307 Amin, Mithisha, 258 Aswale, Sanjay Namdev, 370 Balasubramaniam, C.S., 337 Bapna, Ira, 421 Bhardwaj, Anshu, 117 Bhardwaj, R.K., 47 Bhawna, 130 Bihari, Suresh Chandra, 86 Chary, T. Satyanarayana, 178 Choudhary, Vikas, 117 Das, S., 232 Dharmadhikari, Sonali, 79 Dhawale, Poonam, 406 Dhole, Madhavi I., 199 Dhond, Arvind A., 379 Fulari, Shivanand, 406 Gairola, Rashmi, 273 Gokhru, Anjali, 68 Gupta, Khushboo, 325 Gupta, Sumeet, 431 Habibullah, Munira, 495 Hanfy, F.B.A., 357 Iktar, Mahendra Kumar, 431 Joshi, Navneet, 325 Kagal, J. A., 501 Kalita, Shibumi, 461 Kalkoti, Gopal K., 13 Kapoor, Sahil, 484 Kohojkar, Mrinalini, 209 Krishnan, S. V. Pradeep, 298 Kumar, Mithilesh, 440 Kumar, R. Vishal, 186

Mehta, Nirvesh, 53 Mehta, Shweta, 53 Mishra, Bishnupriya, 396 Murtuja, Mohammad, 346 Nandi, Veena Tewari, 232 Nandini, Girija, 396 Narayana, T. Aswatha, 107 Nayak, Keyur M., 388 Panwala, Manisha, 161 Pawar, 245 Prabhu, Gauri, 3 Raman, V.V.R., 232 Ramesh, S., 357 Rao, Nageshwar Maruti, 22 Rashmi, 219 Reddy, Shankar P., 107 Rekhakala., A.N., 484 Sagar, P., 178 Saluja, Harmender Singh, 421 Shah, Pankaj, 169 Sharma, Gulnar, 258 Sharma, Meenakshee, 421 Sharma, Preeti, 440 Shinde, Vidya Shivaji, 453 Shukla, A.N., 47 Shukla, Smita, 68 Singh, Archana, 130 Singh, Ashutosh, 169 Singh, Ragini, 34 Sinha, Akinchan Buddhodev, 509 Sinha, Ratna, 520 Sood, Vishal, 421 Subha, M.V., 186 Suryavanshi, Anil G., 313 Tandon, Deepak, 461 Thube, Indrabhan, 406 Totala, Navindra Kumar, 421 Tulsian, Abha, 130 Vivekan, 245