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101 Questions & Answers for Bank Interview-VRK100-05Oct2011

2011-10-06T12:06:00.002+05:30

101 Questions & Answers

for Bank Interview


Rama Krishna Vadlamudi, HYDERABAD 05 October 2011
www.ramakrishnavadlamudi.blogspot.com

Dear Friend,

The 2010 Edition of ‘101 Questions & Answers for Bank Promotion’ prepared by me for bank interviews proved to be very popular and received good response from several quarters. Now, the time has come for the 2011 Edition of 101 Q & A.

I’d already sent the ‘101 Questions-2011 Edition’ to you on 03 October 2011. Now, the answers are ready. You can access them at:

http://ramakrishnavadlamudi.blogspot.com/2011/10/101-questions-answers-for-bank.html

I wholeheartedly wish you all the best in your interview.

With regards,

Rama Krishna Vadlamudi

...please wait the answers will be uploaded in a single file here, on or before 8 October 2011...

Defining Provisioning Coverage Ratio-VRK100-05Oct2011

2011-10-05T04:16:00.000+05:30

What is Provisioning coverage ratio (PCR)?

In December 2009, RBI advised banks to achieve a provisioning coverage ratio (PCR) of 70 per cent. Prior to that, different banks were having different coverage ratios. The 70-per cent PCR was introduced by RBI to have some sort of uniformity across banks. The coverage ratio was intended to achieve a counter-cyclical objective by ensuring that banks build up a good cushion of provisions to protect them from any adverse shocks if the economy goes in to a downturn.

As per RBI norms, banks were supposed to achieve PCR of 70 per cent by 30 September 2010. But, some banks are yet to achieve this ratio even as lately as of 30 June 2011. RBI allowed them more time on a case-by-case basis.

PCR is calculated as a ratio of total provisions to gross non-performing assets of a bank and is indicative of the extent of funds a bank keeps aside to cover loan losses. The higher the PCR, the stronger the bank’s balance sheet.

In April 2011, RBI advised banks to segregate the surplus of provisions under the PCR vis-a-vis as required as per prudential norms as on 30 September 2010, into an account styled as “counter-cyclical provisioning buffer.”

As per RBI norms (May 2011), the provisioning coverage ratio of 70 per cent is with reference to the gross NPA position in banks as on September 30, 2010; the surplus of the provision under PCR vis-a-vis as required as per prudential norms, should be segregated into an account styled as “countercyclical provisioning buffer”; and banks will be allowed to use this buffer for making specific provisions for NPAs during periods of system wide downturn, with the RBI’s prior approval.

What is CERSAI?-VRK100-05Oct2011

2011-10-05T04:09:00.001+05:30

What is CERSAI?

Ø Central Registry of Securitisation Asset Reconstruction and Security Interest of India is a Government company

Ø It maintains and operates a registration system for the purpose of registration of securitization transactions as per SARFAESI Act

Ø Properties mortgaged to banks and other financial institutions will have to be compulsorily registered on CERSAI platform

Ø Such registration system prevents frauds and double financing

Ø Any one can also see and inspect the records on CERSAI platform

Ø It was started in March 2011

Basics of Inflation-Indexed Bonds-VRK-05Oct2011

2011-10-05T04:07:00.001+05:30

Basics of Inflation-Indexed Bonds

Inflation-indexed bonds are bonds issued by the government and their returns are based on inflation. If the inflation rate goes up, the bonds offer higher returns and vice versa. They offer a hedge against inflation risk. They are real safe assets for long-term investors.

Inflation-indexed bonds were first issued by the UK Government in the early 1980s and the US Government issued them in 1997. In the

, they are called as Treasury Inflation Protected Securities or TIPS. In TIPS, the principal amount changes in relation to inflation index. In other countries, like, Canada, New Zealand and South Africa, they are very popular.

International experience suggests that inflation-indexed bond prices have tended to move opposite stock prices indicative negative relationship. As such, these bonds are used by investors as a hedge against equity risk for diversification.

On behalf of the Indian government, Reserve Bank of India issued 5-year capital-indexed bonds (a form of inflation-indexed bonds) in December 1997 for the first time and collected Rs 705 crore from that issue. The inflation adjustment for the bonds was based on wholesale price index or WPI. After that, RBI never issued any further capital-indexed bonds due to lack enthusiastic response from market participants as the bonds offered inflation hedging only for the principal but not for the coupons.

A few days back, RBI Governor, D.Subbarao, said that the central bank was planning to reintroduce inflation-indexed bonds. This is an interesting development for investors when price rise is becoming unbearable.

What is Shadow Banking?-VRK100-05Oct2011

2011-10-05T03:57:00.001+05:30

What is Shadow Banking?

Traditional banks seek deposits from savers and lend money to borrowers. Deposits in traditional banks up to a certain limit are protected by the government (like deposit insurance provided by DICGC in

India

). In the US, Federal Deposit Insurance Insurance Corporation or FDIC provides deposit insurance of up to USD 250,000 per depositor, per insured bank. Traditional banks are regulated and they get funding from central banks if a need arises.

On the other hand, shadow banks are financial intermediaries who take a lot of risk and are not regulated. Shadow banking system includes investment banks, hedge funds, structured investments, real estate investment trusts, money market mutual funds, collateralized debit obligations (CDOs) and others.

Shadow banks get their funding mainly from reverse repo and asset-backed commercial paper. Deposit insurance and central bank funding are not available to them.

Shadow banking system played a major role before the global financial crisis of 2007/2008. Due to the collapse of a few shadow banks, like, Bear Stearns and Lehman Brothers in 2008, shadow banking system suffered a major blow.

Understanding Warehouse Receipts-VRK100-05Oct2011

2011-10-05T03:55:00.000+05:30

What is a warehouse receipt?

A warehouse receipt is a document issued by a warehouse to depositors against the goods/commodities deposited in the warehouse. Warehouse receipts can be either negotiable or non-negotiable. It is a document of title to goods. A warehouse receipt can be negotiable or non-negotiable and it can be in writing or in electronic form.

A negotiable warehouse receipt means a warehouse receipt under which the goods represented therein are deliverable to the depositor and the depositor holds a good title and he/she can transfer the goods by endorsement.

A typical warehouse receipt contains the following details:

Ø Receipt number and date

Ø Warehouse address, registration number and date up to which it is valid

Ø Person who deposited the goods

Ø Description of goods and their market value

Ø Storage and handling charges

Ø Whether it negotiable or non-negotiable

Ø Others

The Warehousing Development and Regulatory Authority (WDRA) was set up by the Central Government in October 2010 as per the Warehousing Development and Regulation Act. WDRA works for the development and regulation of warehouses. As per the Act, all warehouses in the country have to be registered with WDRA.

Around 150 warehouses have already been registered under WDRA. Warehousing business involves maintaining storage of goods and issuing negotiable warehouse receipts.

NCMSL became the first private sector company to issue a Negotiable Warehouse Receipt (NWR) in the country on 02 October 2011. The first NWR has been issued at Kaithal, Haryana, for Paddy. NWR can be issued only by the warehouses that are registered with WDRA.

NWR is very useful to farmers as they can store their produce in the registered warehouses, avail bank finance against the NWR and wait for a better price. With this NWR, banks in India are in a better position to offer pledge loans against warehouse receipts, increasing the credit flow to rural areas.

Highlights of Draft Mining Bill-VRK100-05Oct2011

2011-10-05T03:49:00.002+05:30

Highlights of the Draft Mining Bill:

Ø As per the proposed draft Mining Bill, coal companies will have to share 26 per cent of their net profits with the project-affected people

Ø Mining companies of iron ore and other minerals have to set aside an amount equal to the royalty paid to the states

Ø An amount of Rs 10,000 crore may accrue annually from the above

Ø This money will be spent for the welfare of tribal people in project areas

Ø The proposed bill has adversely impacted the share prices of mining companies, like, Coal India, Sesa Goa, NMDC, etc.

Liberalised Remittance Scheme-RBI-VRK100-05Oct2011

2011-10-05T03:45:00.000+05:30

Liberalised Remittance Scheme - RBI

How much can be invested by a resident Indian abroad?

All resident individuals are allowed to freely remit up to $ 200,000 per financial year (April – March) for any permissible current or capital account transaction or a combination of both. This is as per Reserve Bank of India’s Liberalised Remittance Scheme introduced in February 2004.

Under the Scheme, resident individuals can acquire and hold immovable property or shares or mutual funds or debt instruments or any other assets outside India, without prior approval of the RBI. Individuals can also open, maintain and hold foreign currency accounts with banks outside India for carrying out transactions permitted under the Scheme subject to conditions.

The facility under the Scheme is in addition to those already available for private travel, business travel, studies, medical treatment, etc. The Scheme can also be used for these purposes.

What is Marginal Standing Facility or MSF-VRK100-05Oct2011

2011-10-05T03:41:00.000+05:30

What is Marginal Standing Facility (MSF)?

The Marginal Standing Facility was started by the Reserve Bank of India during the Annual Policy announced by it on 03 May 2011. Banks can now borrow overnight from the RBI’s MSF window up to one per cent of their respective net demand and time liabilities or NDTL.

This is an additional window and the interest rate is more expensive compared to repo rate under liquidity adjustment facility (LAF). The rate of interest on amounts accessed from this facility will be 100 basis points (or one per cent) above the repo rate. At present, the MSF rate is 9.25 per cent.

Banks will look for the MSF window to borrow money from RBI once they exhausted all other avenues (like, call money market, LAF-repo window, CBLO, market repo, etc.) for overnight money. Under exceptional circumstances, banks will borrow money through MSF window.

What are Currency Options?-VRK100-05Oct2011

2011-10-05T03:38:00.001+05:30

What are currency options?

In July 2010, Reserve Bank of India has permitted stock exchanges to introduce exchange-traded currency options. Persons resident in India are permitted to participate in the currency options market, subject to RBI norms.

At present, currency options are allowed in US dollar-Indian rupee currency pair.

A currency option is a contract where the purchaser of the option has the right but not the obligation to either purchase or sell an agreed amount of a specified currency at a price agreed in advance and denominated in another currency during a specified period of time. This financial derivative is used as a hedging instrument.

Eurozone and Sovereign Debt Crisis-VRK100-05Oct2011

2011-10-05T03:32:00.002+05:30

Eurozone and Sovereign Debt Crisis

What is Eurozone?:

Those European Union (EU) member states that have adopted the euro as their single currency are part of the euro area. A single monetary policy for the euro area is conducted by the European Central Bank (ECB) under the responsibility of the Governing Council of the ECB. Euro area is informally known as eurozone. The euro was launched on 01 January 1999 on foreign exchange markets, and euro currencies replaced national currencies on 01 January 2002.

There are now 17 European countries in the eurozone, with a common currency, the euro, and a single interest rate set by the ECB. Estonia is the seventeenth country to adopt euro as its currency with effect from 01 January 2011.

The full list of eurozone countries is as follows: Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia and Spain.

The European Union (EU) was established on 01 November 1993 after the ratification of the Maastricht Treaty by the member states. It was previously known as the European Economic Community (EEC). It is a political and economic union of the member states, mainly consisting of European nations. It aims to provide a single market for the member states. Its important institutions include the European Commission, the European Parliament, the European Court of Justice and the European Central Bank.

The EU is an amalgam of 27 Member States. It consists of:

Ø 17 eurozone nations (given above); and

Ø 10 other nations – Bulgaria, the Czech Republic, Denmark, Hungary, Latvia, Lithuania, Poland, Romania, Sweden and the United Kingdom – which have not adopted euro and continue to use their own national currencies.

Sovereign Debt Crisis in eurozone:

Ø The Governments in the eurozone, like, Greece, Italy and Spain, are facing the problems of sovereign debt crisis caused by huge government debt

Ø These governments are unable to meet their debt obligations

Ø Some analysts are afraid that some countries (Greece, Portugal or Spain) may default on their debt obligations

Ø Several European banks require massive capital funds

Ø Growth in the eurozone is very low fuelling fears of recession

Ø Unemployment is generally very high in the eurozone

Ø There are fears of a break-up of eurozone

Ø Some countries in the eurozone are living beyond their means for a decade or so

Land Acquisition Bill-VRK100-05Oct2011

2011-10-05T03:26:00.000+05:30

Highlights of Land Acquisition Bill

Government of India has come out with a draft Land Acquisition Bill which aims to provide better market values to land owners and to safeguard the livelihoods of the project-affected people. The salient features of the Bill are:

Ø Government will not acquire land for private companies

Ø In urban areas, land owners will get a minimum compensation of twice the market value

Ø In rural areas, land owners will get a minimum compensation of four times the market value

Ø A comprehensive rehabilitation package for land owners and the landless people affected by the project

Ø The Bill will enjoy primacy over specialized legislations

Indian Economy-Strengths and Weaknesses-VRK100-05Oct2011

2011-10-05T03:24:00.000+05:30

Indian Economy-Strengths and Weaknesses

The Strengths are:

ü Indian economy is driven by domestic consumption of late and is less dependent on exports as compared to other Asian nations

ü Savings rate is very high at around 35 per cent (of course, the high savings rate is mainly due to the fact that common people have no social security)

India

’s population is very young providing good demographic benefits in the form of higher productivity and higher consumption of goods and services

ü The level of entrepreneurship has gone up substantially after liberalization

ü Indian banking system is very strong providing financial stability despite concerns about quality of assets of late

India

has vast natural resources

India

’s skills in export sectors – like, software services, engineering goods, gems & jewellery and garments – are well recognized across the world

India

has become a world manufacturing hub for automobiles

ü Indian companies, in general, are in good health carrying huge cash balances and lower debt levels on their balance sheets

ü If implemented properly, Goods and Services Tax will boost tax revenues

The weaknesses are:

Ø Inflation remains persistent at around 8 to 10 per cent for about four years

Ø Large price rise in food articles is affecting the poor people very adversely

Ø Corruption is entrenched in the entire social fabric

India

’s national income growth has slowed down due to rising interest rates, decline in investment cycle and gloomy global outlook

Ø Fiscal deficit is getting out of control as the government is unable to control expenditure and resorting to higher market borrowings

Ø Current account deficit is manageable now, but it may go out of hand in future if not handled properly

Ø New project clearances are delayed due to environmental concerns and problems related with land acquisition leading to social unrest stemming from improper resettlement and rehabilitation

Ø Despite huge population, there is massive skills deficit across industries

Ø There is a perception that the government is unable to push economic reforms due to a spate of corruption scandals that surfaced recently

Ø The micro challenges for

India

are healthcare, malnutrition, hunger, poverty and illiteracy

Ø Hard infrastructure (roads, ports, power, broadband, etc) is very weak and energy security is poor

Ø Low agricultural productivity – we need a second green revolution

Indian Stock Markets Are Down-VRK100-05Oct2011

2011-10-05T03:20:00.000+05:30

Reasons for the recent weakness in Indian stock markets:

India

’s GDP growth rate is slowing down

Ø The sovereign debt crisis in eurozone and the US are making investors nervous about India’s exports and GDP growth

Ø The recent rupee depreciation against US dollar is also stoking fears that some Indian companies may record losses due to foreign exchange losses in their profit and loss accounts

Ø Foreign Institutional Investors (FIIs) are net sellers this year

Ø Bank deposits are giving assured annual returns of 9 per cent to 11 per cent. As such, investors find deposits more attractive compared to stocks.

Ø Several stocks in the real estate, construction and infrastructure are hit by scandals and bribery charges

Ø Banking stocks too are losing heavily due to rising interest rates and concerns about quality of assets and compounded by Moody’s downgrade of State Bank of

India

’s credit rating

Ø Market participants believe that policymakers are not doing enough to push for economic reforms

Ø Investment cycle is down and project clearances are affected due to environmental factors and land acquisition problems

The US Dollar Gains-VRK100-05Oct2011

2011-10-05T03:13:00.000+05:30

The US Dollar Gains - Why?

Credit rating agency, Standard & Poor’s, downgraded

credit rating in the first week of August 2011. Following the downgrade, it was expected that the dollar would weaken against other currencies. Against this background, it is difficult to provide a logical explanation to dollar’s relative strength after the S&P downgrade.

However, let me try to make some sense out of this counter-intuitive behaviour of investors. The US dollar is still regarded as a global reserve currency and its usage is very widespread across the globe for trade and other purposes. Immediately after the S&P downgrade of the US, global investors started moving their money to gold, other commodities, Swiss franc and Japanese yen.

During the first week of September 2011, Swiss National Bank (SNB) announced it had pegged its currency Swiss franc (CHF) to euro (EUR) shocking the currency markets. Concerned that the massive overvaluation its franc would hurt Swiss exporters and may jeopardize their economy, the SNB said that it would not tolerate a EUR-CHF exchange rate below the minimum rate of CHF 1.20.

At around this time, sovereign debt crisis in the eurozone has deepened. Global financial markets have started worrying about the prospect of Greece defaulting on its sovereign debt and a possible break-up of eurozone.

So, investors have no choice but to rush to the safety of US dollars. They started moving away from euro and Swiss franc to dollar. Even Japanese government too intervened to stop the yen appreciating against the dollar. Japan is highly dependent on exports and yen appreciation affects them adversely.

During the first half of this calendar year, the US dollar had weakened against major currencies. The US dollar index (the indexed value of the US dollar against six major currencies, like, euro, pound sterling, Japanese yen and so on) went down to a level of 72.5 in July 2011. But, after two months, the dollar gained substantially and the US dollar index is now hovering around 79.5 showing the dollar has appreciated by nearly 10 per cent in the last two months.

Currencies in the emerging markets too have lost by about five to 15 per cent against the US dollar in the last one month. The Indian rupee has lost around 10 per cent against the dollar in the last two months.

Indian Rupee falls against US dollar-VRK100-05Oct2011

2011-10-05T03:09:00.000+05:30

Reasons for Indian Rupee's recent fall against US dollar:

Ø The dollar-rupee exchange rate depends on the supply and demand

Ø There is shortage of US dollars after the dollar has strengthened against other major currencies, like, euro and pound sterling in the past one or two months. The dollar shortage has spread to India also.

Ø Foreign Institutional Investors (FIIs) have been selling in the Indian stock markets pushing up the demand for dollars

Ø Sudden rupee depreciation has forced corporates to go for covering their imports and this has pushed up the demand for dollars to some extent. Typically, exporters try to postpone bringing their dollars to India thinking that dollar will appreciate further against the rupee causing temporary shortage of dollars in the market.

Ø However, theoretically speaking, rupee should be gaining strength against dollar as Indian economy is expected to do much better compared to the

. Even interest rates are much higher in India than those in the US. The short-term aberration will continue for some time. And the rupee is expected to appreciate against the dollar in the medium to long term.

Gold Price Declines-VRK100-05Oct2011

2011-10-05T03:04:00.002+05:30

Gold Price Declines

Due to concerns about paper currencies across the world, investors are flocking to assets, like, gold, silver and other commodities. The US dollar’s weakness has helped the commodities’ prices to rise faster. However, in the last few months, the US dollar is gaining strength against other major currencies, like, euro, pound sterling and others.

With dollar strengthening, global investors have started moving money to dollar assets and started selling other currencies, gold other commodities. After touching a peak of $ 1,930 per ounce, the world gold price has come down by 15 per cent to the current $ 1,640 per ounce. Accordingly, gold prices in India too should have come down from a peak of Rs 28,000 to Rs 24,000 per 10 gm. But the rupee value against dollar has weakened by 10 per cent in the past two months limiting the gold price decline to around Rs 26,000 per 10 gm in India.

Gold price in

India

is driven mainly by two factors – one is international gold price expressed in US dollars and the dollar-rupee exchange rate.

Gold price had gone up very fast in the last one year. As such, some investors may be booking profits on their investments by selling gold.

101 Questions for Bank Interview-2011 Edition-VRK100-03Oct2011

2011-10-03T23:45:00.005+05:30

101 Questions for Bank Interview

2011 Edition


Rama Krishna Vadlamudi, HYDERABAD 03 October 2011
www.ramakrishnavadlamudi.blogspot.com

Dear Friend,

The 2010 Edition of ‘101 Questions & Answers for Bank Promotion’ proved very popular and received good response from various quarters. Many questions that appeared in the previous edition are still relevant and I think most of them will be useful this year also. If you want to read the 2010 Edition, you can just click:

http://ramakrishnavadlamudi.blogspot.com/2010/11/answers-jumpled-to-101-interview.html

Now, the time has come for the 2011 Edition of ‘101 Questions.’ The questions are ready but not the answers. Now, I’m trying to find answers for the questions. The answers will be uploaded on www.ramakrishnavadlamudi.blogspot.com in the next few days, but not later than 08 October 2011.

I wholeheartedly wish you all the best in your interview.

With regards,

Rama Krishna Vadlamudi

Just Click the following link to download the 2011 Edition in PDF format:

http://www.scribd.com/doc/67325993/101-Questions-for-Bank-Interview-2011-Edition-VRK100-03Oct2011

101 Questions – 2011 Edition

1. What is the interest rate on banks’ savings bank deposit account?

2. Gold price has gone up several times recently. But why is it coming down now?

3. What are the reasons behind Indian rupee’s recent fall against US dollar?

4. Why is the US dollar gaining strength against other major currencies of late?

5. How may credit information companies are allowed to operate in India by RBI?

6. What is

India

’s GDP for 2010-11?

7. What are the present rates of CRR, SLR, Repo, Reverse Repo and others?

8. RBI had recently fined several banks for violation of foreign exchange derivatives norms. Which are the major banks?

9. What is India’s current account deficit?

10. What are the reasons for weakness in Indian stock markets since November 2010?

11. What are the strengths and weakness of Indian Economy as of now?

12. What are CDS?

13. What is the capital adequacy ratio of our Bank?

14. What is SBI’s BPLR?

15. What is our Bank’s quarterly profit in June 2011 quarter and why our net profit has come down?

16. What is SBI’s Base Rate?

17. What is the Land Acquisition Bill and what are the important provisions?

18. What is our Bank’s net NPA percentage as at the end of June 2011?

19. What are the reasons for the economic and financial crises in the US and eurozone?

20. What is eurozone?

21. How is RBI controlling inflation in India?

22. Why are interest rates going up in India in the last two years or so?

23. What are India’s foreign exchange (forex) reserves?

24. What are the concerns being faced by banking industry in India?

25. What is an infrastructure debt fund (IDF)?

26. Which bank has been awarded the Best Bank award by ‘Business India’ magazine for 2011?

27. What are the provisions of the proposed National Food Security Bill?

28. What are currency options?

29. What are interest rate futures (IRFs)?

30. Whether nomination facility can be extended to deposits held by a bank in the name of a sole proprietary concern?

31. What is Marginal Standing Facility (MSF)?

32. What is the single operating monetary policy rate of the RBI?

33. Why is the Government of India borrowing an extra Rs 53,000 crore from the market during the second half of 2011-12?

34. The Standard & Poor’s has downgraded the credit rating of the US from AAA to AA+. Why?

35. What is a credit rating agency?

36. Why has the demand for unit-linked insurance policies (ULIPs) come down of late?

37. Are insurance companies permitted to sell policies online?

38. Who is

India

’s Comptroller and Auditor General?

39. Who is India’s Finance Secretary?

40. How much can be invested by a resident Indian abroad?

41. Can banks charge pre-payment penalty charges for housing loans?

42. What is the share of agriculture in India’s GDP?

43. Since the beginning of this upward interest rate cycle that started in March 2010, how many times RBI has increased its Repo rate under LAF?

44. What are the salient features of the RBI’s draft guidelines issued on 29 August 2011 for issue of new bank licenses in India?

45. How much can banks invest in liquid schemes of mutual funds?

46. Swiss National Bank has recently pegged its currency the Swiss Franc to a major currency. Which is the currency?

47. Who is the managing director of International Monetary Fund?

48. What is the name of associate which was merged with State Bank of India in July 2011?

49. What are the highlights of the draft Mining Bill?

50. Why did RBI penalize Citibank recently?

51. With which country India faced problems relating to oil payments?

52. What is a self-help group (SHG)?

53. What is National Financial Switch?

54. How do you define a high net worth individual (HNI)?

55. What is solvency margin?

56. What is a warehouse receipt?

57. Why is it important to monitor end of funds after loan disbursals?

58. What is shadow banking?

59. What is an inflation-indexed bond?

60. Why did IRDA impose a penalty on SBI Life?

61. What are currency futures?

62. What is the minimum limit for sending remittance through RTGS facility?

63. What is FDI?

64. What is the objective of KYC guidelines?

65. What are semi-closed prepaid instruments?

66. Why is the Government of India increasing fuel prices?

67. What is CERSAI?

68. What is NIM?

69. Why did RBI raise interest rate on SB deposits in May 2011?

70. Which Chinese bank has opened its first branch in

India

recently?

71. How much money can resident India transfer money as a gift out of India?

72. What is a green channel counter?

73. What is the loan to value (LTV) ratio for housing loans?

74. How do you define a ‘small account’?

75. Does RBI collect any service charges from banks for RTGS transactions?

76. What is credit risk?

77. What is a payment in due course?

78. What is the maximum percentage of voting rights in a private sector bank?

79. What are ‘Gilt edged’ securities?

80. What factors determine interest rates?

81. What do you mean by ‘buffer stocks’?

82. What is a Floating-rate Bond?

83. What is LAF?

84. What is Secondary Market?

85. What is Yield to maturity (YTM)?

86. What is Mezzanine Finance?

87. What is a dear money policy?

88. What is working capital?

89. What is a capital account?

90. Can an NRI be a joint accountholder in a resident’s SB account?

91. Can banks issue prepaid instruments to corporates?

92. What is time limit set by RBI for resolution of failed ATM transactions?

93. What is the limit for housing loan under priority sector?

94. What is the revised provision for sub-standard assets?

95. What is provisioning coverage ratio (PCR)?

96. Is it necessary that all nominations and cancellation/variation of nominations are required to be witnessed?

97. Can an exporter liquidate the post-shipment rupee export credit from rupee resources?

98. What is CAFRAL?

99. What are the mobile banking services offered by banks?

100. What is Swavalamban Scheme?

101. Whether ‘Aadhaar’ letter issued by the UIDAI is valid under KYC Norms?

Note on author: The author in an investment analyst and writes copiously on financial markets – equities, bonds, currencies, taxes, Indian economy, etc. He has written more than 130 articles running into 800 pages of original content – mostly pertaining to financial markets. You can read these articles on:

www.ramakrishnavadlamudi.blogspot.com

Credit Default Swaps & Their Basics-VRK100-01Oct2011

2011-10-01T09:41:00.003+05:30

Basics of Credit Default Swaps

A New Financial Product in India


*Rama Krishna Vadlamudi, HYDERABAD 01 October 2011*
*www.ramakrishnavadlamudi.blogspot.com*

Credit Default Swaps are being introduced in India. Reserve Bank of India’s final guidelines on credit default swaps (CDS) for corporate bonds are effective from 24 October 2011. CDS are a new financial product being introduced in India for the first time.

1. What is the background to the introduction of CDS?

Originally, RBI intended to introduce this new financial product in 2003 and 2007, but could not introduce it at that time. Subsequently, RBI had set up a working group for introduction of CDS in 2010. Based on the recommendations of the working group and the feedback received on draft guidelines, Reserve Bank of

India

issued the final guidelines on 23 May 2011 for effective implementation of CDS from 24 October 2011.

2. What is the rationale behind the introduction of CDS in India?

With the introduction of the final guidelines, RBI wants to further deepen and widen the corporate bond market in

India

. It is expected that banks and other financial institutions in

India

will be able to transfer and manage the credit risk in a better manner with the help of CDS. Credit default swaps earned bad name during the global financial crisis of 2007/2008 as the

and European banks took higher risks and suffered heavy losses on account of their huge exposure in the CDS market.

Despite the global financial crisis of 2007/2008 and the latest sovereign debt crisis that is sweeping the world right now, Reserve Bank of India has been bold enough to introduce new financial products in India as part of financial sector liberalization in

India

. In the last three years, RBI has introduced a slew of products ranging from currency futures, currency options to interest rate futures and now CDS market is at our doorstep.

3. What are CDS or Credit Default Swaps?

CDS are conceptually similar to an insurance policy. Like in an insurance policy, in CDS there is a protection buyer who purchases protection (for a premium) or cover against credit risk of a specific asset. If the protection buyer suffers any loss on the asset, the protection seller will make payment to the protection buyer.

It is like buying an insurance product in the sense that CDS are a form of insurance against credit risk. It is a tool to transfer and manage credit risk in an effective manner through redistribution of risk.

Simply speaking, CDS are:

Ø similar to an insurance policy for credit enhancement

Ø a risk management tool for credit protection (buying protection against credit risk)

Ø considered as a cover basically against default by debtors

A credit default swap is a contract between two parties in which one party named protection buyer makes a series of payments to another party named protection seller and in exchange the protection buyer will receive payment if a credit event on a reference obligation occurs as specified in the contract and within the stipulated time.

The cost of buying protection against credit risk is called premium, which is expressed in basis points per annum (one per cent is equal to 100 basis points).

4. What are the benefits of CDS?

Banks and other financial institutions in

India

are big lenders to companies, firms and others. As such, the credit risk for banks goes up if the borrowers do not repay their debts in time or there is a risk of default. Now, the introduction of CDS will provide an additional avenue for lenders to manage their credit risk and help free up capital.

Banks and financial institutions are bound by RBI’s prudential norms on lending to large companies and large group of companies. Several times, banks exceed the RBI’s lending ceilings to large companies. In such cases, banks can use CDS to bring down their credit exposure to such companies.

Mutual funds and insurance companies may also participate in CDS market as a means to diversify their portfolio and broaden their asset base.

5. Who can participate in the CDS market?

Basically, there are two types of participants in the CDS market. They are market makers and users:

Market makers: These are entities permitted to quote both buy and/or sell CDS spreads. They would be permitted to buy credit protection without having the underlying bond.

Users: These are entities permitted to buy credit protection (buy CDS contracts) only to hedge their underlying credit risk on corporate bonds.

6. Which are the entities eligible to become market makers & users?

As of now, RBI has permitted the following participants in the CDS market:

Market makers		Users
Commercial banks		Commercial banks
Stand-alone primary dealers		Primary dealers
Non-Banking Financial Companies (NBFCs)		Non-Banking Financial Companies (NBFCs)
		Mutual Funds
		Insurance companies
		Housing Finance companies
		Provident funds
		Listed corporates
		Foreign Institutional Investors

Note: Insurance Companies and Mutual Funds would be allowed to act as market-makers subject to the approval of their respective regulators.

7. What are the salient features of the CDS final guidelines?

Ø The final guidelines issued by RBI are for Plain Vanilla Over-The-Counter Single-name CDS for corporate bonds in India

Ø All CDS trades shall have an RBI regulated entity at least on one side of the transaction

Ø Reference entities: CDS will be allowed only on listed corporate bonds as reference obligations. The reference entities shall be single legal resident entities.

Ø The users (except FIIs) and market makers shall be resident entities

Ø The reference asset/obligation and the deliverable asset/obligation shall be to a resident and denominated in Indian Rupees

Ø The CDS contract shall be denominated and settled in Indian Rupees

Ø The CDS contract shall be irrevocable

Ø CDS shall not be written on securities with original maturity of up to one year, for example, Commercial Papers (CPs), Certificate of Deposits (CDs) and Non-Convertible Debentures (NCDs) with original maturity up to one year

Ø Standardised CDS contracts: The CDS contracts shall be standardised.

Ø Settlement Methods: For transactions involving users, physical settlement is mandatory. For other transactions, market makers can opt for any of the three settlement methods (physical, cash or auction settlement), provided the CDS documentation envisages such settlement.

Ø Eligible credit events: Bankruptcy, Failure to pay, Repudiation/moratorium, Obligation acceleration, Obligation default, Restructuring approved under Board for Industrial and Financial Reconstruction (BIFR) and Corporate Debt Restructuring (CDR) mechanism and corporate bond restructuring are the eligible credit events for CDS.

8. What are the risks pertaining to CDS?

CDS are an off-balance sheet exposure to both credit and market risk. The sale of CDS amounts to assuming credit risk. A CDS contract creates two types of exposures for the parties concerned, namely, counterparty credit exposure and market risk exposure.

RBI’s approach to the introduction of CDS is very cautious due to the role played by CDS in the collapse of Lehman Brothers in 2008 and the subsequent global financial crisis. RBI’s final guidelines are extremely elaborate and they are allowing only plain vanilla single-name CDS and that too for only corporate bonds that are listed on exchanges.

9. Conclusion

Currency futures as a financial product are a big success in

India

with the high-volume trades being done on NSE, MCX-SX and USE. However, the interest rate futures market is still in its infancy even after two years of launch. For any market to be successful, liquidity is very crucial and so is number of players from various sections. The Indian corporate bond market is not very active. It remains to be seen whether CDS market in

India

will repeat the success of currency futures market.

- - -

References: RBI

Disclaimer: The author’s views are personal. He has a vested interest in the stock markets. His views should not be construed as investment recommendation. There is a risk of loss in investments in financial products. Investors need to consult their certified financial adviser before making any investment decisions.

www.ramakrishnavadlamudi.blogspot.com

Best Tax-Saving Mutual Funds-VRK100-30Sep2011

2011-10-01T00:12:00.001+05:30

Best Tax-Saving Mutual Funds

How to Get Good Returns While Saving Tax


*Rama Krishna Vadlamudi, HYDERABAD 30 September 2011*
*www.ramakrishnavadlamudi.blogspot.com*

Tax-saving mutual funds in India are well known as equity-linked savings schemes (ELSS) because investors can avail of income tax benefit. The current financial year ends in six months time. So, it is better to do tax planning right now and to start investing in ELSS funds rather than postponing till the last minute.

If your objective is to invest for the long term of three to five years, you can ignore the short-term movements in the stock market and allocate money in a systematic and regular way. ELSS funds offer the additional benefit of income tax saving for individual investors depending on their tax bracket; provided they can withstand the ups and downs of returns inherent to the equity mutual funds.

Essential features of ELSS funds

ü ELSS funds entail a lock-in period of three years from the date of investing

ü Due to the three-year lock-in period, you cannot sell your investments for three years and they remain illiquid for the first three years

ü Income Tax benefit is available for the principal investment of up to Rs one lakh in a financial year under Section 80C of the IT Act for any one or more of the ELSS funds

ü Under the proposed Direct Taxes Code Bill, it has been proposed to withdraw tax exemption for ELSS funds from April 1, 2012. But under the present circumstances, whether this proposal will become a law before the next budget is doubtful. For investments made up to 31 March 2012, you’ll get tax exemption without doubt.

In this article, I present a brief list of tax-saving funds that are worth considering for investors who can avail of the tax benefit offered under Section 80C of the Income Tax Act.


	The Fab Five!

	Best Tax-Saving Equity Mutual Funds
1	Canara Robeco Equity Tax Saver
2	Fidelity Tax Advantage
3	Franklin India Taxshield
4	Religare Tax Plan
5	Sahara Tax Gain

	NAV	AAUM	Return %
	Rs	Rs crore	2007	2008	2009	2010	2011
Canara Robeco Equity Tax Saver	24.3	290	65.2	-46.9	89.4	24.9	-10.8
Fidelity Tax Advantage	20.2	1 240	58.7	-50.1	86.7	29.2	-14.2
Franklin India Taxshield	201.9	827	56.0	-49.2	78.8	23.5	-8.3
Religare Tax Plan	16.6	108	-	-49.5	83.5	22.1	-10.6
Sahara Tax Gain	34.1	11	64.7	-49.6	90.6	20.4	-14.3
Nifty (NSE) return	-	-	54.8	-51.8	75.8	17.9	-19.4

Notes: NAV – net asset value as on 30Sep2011 for growth options

AAUM – average assets under management as on 30Jun2011

2011 return is up to 30Sep2011

Important Highlights:

ü If you had invested Rs 10,000 in Canara Robeco Equity Tax Saver fund on 10 January 2008 at the Sensex peak of 21,000, your total investment would have been Rs 13,465 as on 30 September 2011 when Sensex is at 16,450. It means the fund has given an absolute return of 35 per cent while Sensex has gone down by more than 20 per cent in the last 45 months!

ü All the above are open-ended tax-saving equity funds holding mainly large-cap stocks; with a good long-term track record of more than four years

ü They hold 25% to 45% in mid-cap stocks, except Sahara Tax Gain fund, which holds 51% of its assets in mid-cap stocks

ü The lowest expense ratio of 2% per annum is charged by Fidelity Tax Adv.

ü All the above funds have no entry load or exit load

ü All the fund managers are having good experience of 10 to 15 years

ü These funds have provided superior & consistent returns in the past 4 years

ü Sahara Tax Gain’s total assets are Rs 11 crore as on 30Jun2011

Investment Principles

ü It is always better for investors to invest in equity funds in a systematic and phased manner – growth options are advisable

ü Equity funds perform well in periods of five years or more

ü Investors should track the performance of funds at least every three months

ü Never borrow to invest in equities or equity mutual funds unless you are a professional investor and can track the markets on a regular basis

ü Equity mutual funds carry higher risk and their returns are very volatile

Data Source: ValueResearchOnline

Disclaimer: The author is an investment analyst & writer. His views are personal and should not be construed as an investment recommendation. Please consult your certified financial adviser before making any equity investments. There is risk of loss in ELSS schemes. The author is an equity investor and he has a vested interest in the stock market movements. It is safe to assume that he has investments in a few of the above mutual fund schemes. His articles on financial markets can be accessed at www.ramakrishnavadlamudi.blogspot.com

Best Equity Mutual Funds-VRK100-21Sep2011

2011-09-21T17:31:00.002+05:30

Best Equity Mutual Funds

Equity mutual funds are in existence in India for almost two decades. The overall performance record of them is mixed. But, there are some equity schemes which have provided superior returns to investors. Selecting the best equity mutual fund schemes from a large number of schemes is a challenge. Here is the list:

	All-season Equity Mutual Funds
1	Birla Sunlife Frontline Equity
2	Canara Robeco Equity Diversified
3	Fidelity Equity
4	Franklin India Bluechip
5	HDFC Top200
6	Quantum Long-term Equity
7	UTI Opportunities

Schemes	NAV	AAUM	Return %
	Rs	Rs crore	2007	2008	2009	2010	2011
Birla Sunlife Frontline Equity	81.3	2 909	62.3	-48.5	90.5	18.7	-14.2
Canara Robeco Equity Diversified	53.1	427	63.4	-50.8	93.0	20.7	-7.4
Fidelity Equity	33.6	3 302	55.3	-50.3	86.1	26.9	-11.5
Franklin India Bluechip	204.0	3 841	47.4	-48.1	84.5	23.0	-10.6
HDFC Top200	194.0	10 507	54.5	-45.4	94.5	25.1	-14.0
Quantum Long-term Equity	20.7	77	45.9	-47.0	103.0	28.8	-13.4
UTI Opportunities	26.9	1 576	71.3	-49.0	97.6	19.4	-6.5
*Nifty (NSE) return*	-	-	*54.8*	*-51.8*	*75.8*	*17.9*	*-16.2*

Notes: NAV – net asset value as on 20Sep2011 for growth options

AAUM – average assets under management as on 30Jun2011

2011 return is up to 20Sep2011

Important Highlights:

ü All the above are open-ended diversified equity funds holding mainly large-cap stocks; with a good long-term track record of more than five years

ü They hold 10% to 20% in mid-cap stocks, except Quantum LT Equity and UTI Opportunities funds, which hold 34% and 26% respectively in mid-caps

ü The lowest expense ratio of 1.5% per annum is charged by Quantum LTE

ü In the past four months, new fund managers have joined Canara Robeco Equity Diversified and UTI Opportunities schemes

ü All the fund managers are having good experience of 10 to 15 years

ü These funds protect the investors’ interest during downward market trends

ü These funds have provided superior and consistent returns in the past

ü As can be seen from the above table, they have outperformed the Nifty index as well as their benchmark indices

Investment Principles

ü It is always better for investors to invest in equity funds in a systematic and phased manner – growth options are advisable

ü Equity funds perform well in periods of five years or more

ü Investors should track the performance of funds at least every three months

ü Never borrow to invest in equities or equity mutual funds

ü Equity mutual funds carry higher risk and their returns are very volatile

ü If you are a long-term investor, please ignore the short-term trends

“FINALLY, HAPPY INVESTING!”

Note: Other Mutual Fund schemes worth considering are: BNP Paribas Dividend Yield, DSP BlackRock Top100 Equity, Franklin India Prima Plus, HDFC Equity, ICICI Prudential Dynamic, IDFC Premier Equity Plan A, Reliance Equity Opportunities, etc.

Data Source: ValueResearchOnline

Disclaimer: The author is an investment analyst & writer. His views are personal. Please consult your certified financial adviser before making any equity investments. The author is an equity investor and he has a vested interest in the stock market movements. It is safe to assume that he has investments in a few of the above mutual fund schemes. His articles on financial markets can be accessed at www.ramakrishnavadlamudi.blogspot.com

Rising Government Debt and Fiscal Deficit-VRK100-20Sep2011

2011-09-20T23:48:00.000+05:30

Rising Government Debt and Fiscal Deficit

There are heightened concerns about the financial position of the Government of India due to rising internal debt and fiscal deficit. Doubts have been expressed about the ability of the government to control the expenditure and keep the central government’s gross fiscal deficit within the budgeted target of 4.6 per cent ( as a % of GDP).

Big rise in Government Borrowings

In the last four years between 2008-09 and 2011-12, the central government’s market borrowings – which are raised from the banks, insurance companies and others – have been rising at an alarming rate. The yearly average net market borrowings of the central government for the last four years are at Rs 3,29,000 crore, which is 3.6 times the yearly average of Rs 91,000 crore between 2004-05 and 2007-08.

This clearly shows the central government’s increasing dependence on market borrowings to meet the gaps in its finances.

Fiscal Deficit is Becoming Uncontrollable

As the government is unable to control its expenditure on petroleum and fertilizer subsidies, the fiscal deficit is getting out of control. The budgeted gross fiscal deficit of the central government is Rs 4,12,817 crore for 2011-12 and the figure for states stands at Rs 1,98,539 crore for 2010-11. The budgeted fiscal deficit is 4.6 per cent of GDP for 2011-12 and the revenue deficit is 3.42 per cent of GDP for the central government.

As per FRBM revenue deficit is supposed to be at or below one per cent – this goal was achieved only once in 2007-08. If GDP growth rate were to decline in the next few years, the fiscal and revenue deficit ratios will deteriorate, because fiscal deficit will be growing at much faster than the GDP growth rate. The government is unable to sell its stake in public sector companies as part of its disinvestment programme.

One Positive Factor

One noteworthy feature of the central government’s finances is the internal debt ratio as a percentage of GDP, which has declined from 56.73 per cent in 2006-07 to 48.04 per cent in 2010-11. Under difficult conditions for GDP growth, it may not be possible to show further improvement in this ratio.

Interest Payments Increasing Sharply

The interest payments of the central government amount to Rs 2,67,986 crore for 2011-12, which is putting pressure on revenue deficit. Interest payments are 2.98 per cent of GDP for 2011-12 as per budget estimates.

Government’s Growing Internal Debt: ‘The Dirty Picture’

The total outstanding debt is at Rs 23.48 lakh crore as on 19 September 2011 as per the RBI data on outstanding Government of India securities. It is shocking to note that fifty-six per cent of this outstanding debt is raised in the last four years between 2008-09 and 2011-12! Interestingly, nearly half of this debt has to be paid in the next seven years beginning from 2012-13. This means the government has to resort to more market borrowings to fill the future deficits and the outstanding debt will go on increasing. These figures do not include the numbers of the 28 state governments. If included, it will indicate a worse scenario.

Outlook for Bond Market Is Bleak

The deteriorating fiscal picture has not been factored in fully in the prices of government securities in the last three to four years. The central government is able to borrow at very lesser rates in the past four years.

For example, the weighted average cost of the central government’s bonds (excluding treasury bills) is ranged from 7.23 to 8.12 per cent between 2006-07 and 2010-11. So is the case with the state governments. Going forward, will the government be able to raise money at such low rates?

FIIs are permitted to invest in government securities up to an amount of $ 10 billion comprising of $ 5 billion for bonds with the residual maturity of five years and $ 5 billion for bonds without any residual maturity restrictions.

Lately, Indian rupee has been declining against the US dollar due to a variety of reasons. Is it possible that the same negative feeling too will develop in the government bond market? I have an eerie feeling that government bond prices are in for higher volatility if there is heavy selling of government securities by FIIs.

However, the percentage of holding of FIIs in the government bonds is very low and RBI may not encourage any volatility in the bond markets.

FII – Foreign Institutional Investor, FRBM – Fiscal Responsibility and Budget Management Act, and GDP – Gross Domestic Product or national income.

Data source: RBI

Note on author: Author is an investment analyst and writer. The views are personal and this is written only for information purpose. Readers are advised to consult their certified financial adviser before taking any investment decisions.

Author’s articles on financial articles can be accessed at:

www.ramakrishnavadlamudi.blogspot.com

Market Outlook-No Signs of Interest Rates Peaking-VRK100-20Sep2011

2011-09-20T14:15:00.001+05:30


	*Market Outlook*

Rama Krishna Vadlamudi, Hyderabad 20 September 2011

In the last two or three weeks, Indian stock market is stuck in a tight range. The benchmark Sensex is moving between 16,000 and 17,500 and Nifty between 4,800 and 5,200. This is a reflection of various negative global factors impacting the sentiment of positive long term growth prospects in India and reasonable stock valuations. The sovereign debt crisis in the eurozone and the US is yet to unfold completely and nobody is having any clear idea what kind of surprises will be tossed up in the next few quarters. One thing is sure we are going to experience further uncertainty regarding the prospect of Greece defaulting on its government debt or Italy facing more trouble.

No signs of interest rates peaking

The primary ‘dharma’ of RBI is price stability. As part of its resolve to control inflation, RBI has expressed its desire to continue with its dear money policy. However, of late, there is a perception in the markets, that the interest rates in India are peaking or near peak. This view appears to be a bit misplaced when: 1) there is pressure on fiscal deficit, and 2) there is no sign of inflation getting under control in near future. Moreover, the Government has recently increased petrol prices by Rs 3.14 per litre, which will feed in to inflation in the next few months. It is not clear whether international crude prices will come down.

During the previous interest rate up-cycle from October 2005 to October 2008, RBI raised repo rate from 6 per cent to 9 per cent – the previous up-cycle lasted for three years. After a peak of 9 per cent, RBI started reducing interest rates dramatically between October 2008 and April 2009 in view of the Lehman Brothers collapse and the concomitant global financial crisis – the immediate past interest down-cycle lasted for barely 18 months in view of the extraordinary circumstances then.

In financial markets, it is a fashion to look for patterns. Based on the past experience, many market experts are of the view that the interest rates are peaking in India. But, it is not always advisable to look for such past patterns playing out in a similar manner in the future also. The current interest rate up-cycle started from March 2010, with RBI increasing repo rate from 4.75 per cent to 8.25 per cent till now. The previous peak rate is 9 per cent which existed between July 2008 and October 2008. The current situation is different from the previous interest rate down-cycle, when RBI reduced interest rates dramatically from 9 per cent to 4.75 per cent in a matter of just six months.

However, Kaushik Basu, Chief Economic Advisor, differs with RBI in respect of interest rate hikes and he argues that there is a need to cut interest rates to give fillip to growth.

India

’s Macro Picture

Last week, Reserve Bank of

India

raised interest rates by another 25 basis points (0.25 per cent) which is broadly in line with market expectations. GDP growth rate is declining, so is industrial production represented by index of industrial production (IIP). Due to concerns of global slowdown, there are some doubts about exports growth, which are quite robust as of now. Despite RBI raising interest rates by 350 per cent (3.5 per cent) in the last 18 months, the inflation refuses to show any reasonable signs of relenting.

For some time, RBI has been expressing its anxiety about fiscal deficit going out of hand which will put pressure on the growth rate. RBI is of the view that there is a need for fiscal consolidation in view of the deceleration in tax collections and higher expenses on account of fertilizer and oil subsidies. The Indian rupee has weakened to 48.20 against the US dollar from a level of 44.75 on 5 August this year. A weaker rupee increases India’s oil import bill, putting intense pressure on fiscal deficit.

Government raising fuel prices, three times this year, amidst opposition from the people and opposition political parties is a good sign that the central government is serious about curtailing fiscal deficit and bringing some transparency in fuel pricing policy.

To know about the RBI continuous raise of interest rates, just click:

http://ramakrishnavadlamudi.blogspot.com/2011/09/rbi-raises-interest-rates-vrk100.html

Outlook

Overall, the outlook for the stock markets and bond markets in India is not very optimistic considering the pressure on the growth rate – which is impacted negatively by the stubborn inflation and negative global cues. There is no reason to believe at this point of time that the RBI will stop raising interest rates and start decreasing interest rates very soon, unless some serious cooling off happens on the inflation front or some actual debt defaults happening in Greece or some other countries in the eurozone. However, several good quality stocks are available at reasonable prices while the Sensex is hovering is around 17,000 and Nifty at 5,100 for investors who have the patience and risk appetite to hold stocks or equity mutual funds for a period of more than three years.

Disclaimer: The author’s views are personal. He has a vested interest in the stock markets and his views should be taken with a pinch of salt. He may change his views very fast without any notice depending on the market and economic conditions. His views should not be construed as investment recommendation. There is a risk of loss in equity investments. Investors need to consult their certified financial adviser before making any investment decisions.

For author’s articles on financial markets, just click:

www.scribd.com/vrk100

or,

www.ramakrishnavadlamudi.blogspot.com

Rogue Traders and Wild Hearts-VRK100-17Sep2011

2011-09-17T07:37:00.002+05:30

Rogue Traders and Wild Hearts

Rama Krishna Vadlamudi, Hyderabad. 17 September 2011.

www.ramakrishnavadlamudi.blogspot.com

We humans have a speculative-cum-creative urge in our minds and hearts. The wild streak constantly encourages us to explore new worlds and unfamiliar territories. Great discoveries have been made for centuries as a result of our innovative thinking. But when greed overtakes our emotions, it makes us overconfident and in the end we stumble flat on our face many a time. Imagination knows no bounds in financial markets.

Derivates are famously described as ‘financial weapons of mass destruction’ by Warren Buffett, the legendary

investor (his company Berkshire Hathaway too trades heavily in the derivatives market is a different issue). Everybody knows what role they played in bringing down the financial world to a near collapse in 2007/2008. As the saying goes, “Guns don’t kill people, people kill people.” It’s the slipshod supervision and regulation that is responsible for the massive losses caused by derivatives traders.

On 15 September 2011, UBS had reported that unauthorized trades by its trader caused losses to the Investment Bank amounting to $ 2 billion. UBS is a Swiss-based bank. Now, we have come to know the name of the trader is Kweku Adoboli and the 31-year old has since been arrested by London Police and charged with fraud and false accounting.

Nick Leeson, who is nicknamed as Rogue Trader, was responsible for the collapse of the 233-year old Barings Bank in 1995. As a derivatives trader for the bank in Singapore Exchange, he speculated and lost a cool $ 1.3 billion for the bank. He put his bets on Nikkei, the Japanese stock market index, which crashed after the Kobe earthquake. The money was so huge that the bank had no choice but to close down permanently.

Jerome Kerviel was working as a trader for Societe Generale’s derivatives desk in Paris. He too had tried to make huge bets on financial markets. In the process, he lost $ 7.2 billion of depositors’ money in 2008.

Yasuo Hamanaka was well known as ‘Mr Five Per Cent’ or ‘Mr Copper.’ He was working as a copper trader for Sumitomo Corporation,

Japan

. He was doing copper trades for his company on the London Metal Exchange and had bought huge positions by keeping the physical copper ingots in US warehouses. He wanted to corner the entire copper market of the world. But in the end he stumbled and the total losses for his company were about $ 2.6 billion in 1996.

What is the Common Thread?

Amusingly, in all these cases the banks/companies claim they were kept in the dark by these erratic traders and their trades were unauthorized. Yasuo Hamanaka had been speculating in the copper market for 10 years. One fails to understand how Sumitomo Corporation could claim the trades were unauthorized. It’s very clear that banks’ and companies’ risk management and supervisory practices were very poor, to say the least.

We claim we have built up massive communications systems that are very fast and modern so that we can communicate with one another in split second. If one looks at these cases, there is clearly a big communication failure.

Regulators also cannot escape their share of blame. Take the case of Sumitomo Corporation. The company is headquartered in Japan, the trades were done on London Metal Exchange and the copper warehouses were located in the US. It is very curious to know that Hamanaka’s trades had escaped the attention of all the regulators in Japan, London and the US – that too for ten long years.

The familiar pattern is that we are confident of our predictive power. Everyday we predict that market will go this way or that way. We start with small bets. Initially we make profits over a period of time and we come to the conclusion that we have found a creative and unique formula for success in the financial markets. We suddenly become greedy and increase our stakes and we would be helped in the process by bull markets. More profits are made. We are acclaimed and rewarded with hefty pay packets by our pay masters. One day the music stops and the markets move violently against our bets.

Initially, we get the impression, the downside is temporary and we are tempted to increase our positions. To cover up our mistakes, we try to average down and the process goes on for some time. Suddenly one day we realize that the game cannot be continued further into infinity as there are big holes which cannot be filled or covered up. And we blame the markets for our speculative orgies. Finally, the disastrous story is out.

Once the story is out, the regulators will make some noises and make pledges to tighten the regulation, supervision and risk management. After the initial excitement dies down, boredom sets in. This continues until the next scandal breaks out of the blue. Till that time let us hope that our money with these banks and companies is safe and we will get back our principal and interest.

Interestingly, all these losses are usually revealed during bear markets. If it is our own money, the pain is restricted to our immediate family. But, if we are resorting to these speculative urges with public money, then the ache is ‘diversified’ into lot of depositors and investors.

The recent violent moves in Indian rupee against the US dollar may expose some chinks in the balance sheets of several Indian companies when they declare their quarterly results next October. During 2007 and 2008, India Inc has lost more than Rs 20,000 crore by purchasing wrong hedging instruments from banks’ derivatives desks.

Where is the end to such superhuman activities? In the last three or four centuries, fortunes have been made and evaporated by market men in futures markets. I suspect that we continue to hear such stories as long as mankind exists.

I suppose all the banks’ derivatives trading desks should be moved to the large casinos in Las Vegas, so that people who deal with them will come to know of the dangers of derivatives before they place their bets.

As you know, we go to casinos to lose our hard-earned money!

RBI Raises Interest Rates-VRK100-16Sep2011

2011-09-16T12:35:00.001+05:30

RBI Raises Interest Rates

Mid-Quarter Monetary Policy of September 2011

As expected by the markets, the Reserve Bank of India has raised interest rates by another 25 basis points (0.25 per cent). The policy rate, that is Repo rate under RBI’s Liquidity Adjustment Facility, is increased to 8.25 per cent. Since March 2010, RBI has hiked interest rates by 350 basis points and that too twelve times in succession. However, markets had expected that RBI would tone down its stance on dear money policy. In its latest review, RBI has continued with its hawkish stance.

Despite several rate hikes, the inflation rate – close to 10 per cent now – has continued to be stubborn even though GDP growth and industrial production growth are slowing down. What is complicating matters for RBI is yesterday’s decision by the Government of India to hike retail petrol prices by Rs 3.14 per litre – this is the third hike in retail fuel prices in this calendar year. The question on everyone’s mind is whether RBI will stop raising interest rates further. The RBI will be watching the macro economic indicators and global developments closely before making further moves on policy rates.

RBI Policy Decision

The Repo rate (under its Liquidity Adjustment Facility or LAF) is the benchmark policy interest rate for the RBI. The RBI has raised its Repo rate by 25 basis points (0.25 per cent) to 8.25 per cent when it announced the mid-quarter monetary policy on 16 September 2011. The new rate is with immediate effect. The Reverse Repo rate under LAF and the interest rate under Marginal Standing Facility are linked to Repo rate. As such, both the Reverse Repo rate and Marginal Standing Facility rate stand increased to 7.25 per cent (one per cent below Repo rate) and 9.25 per cent (one per cent above Repo rate) respectively with immediate effect.

Twelfth Rate Hike Continuously

Since March 2010, RBI has been increasing the interest rates continuously and the latest increase is twelfth in the series. The RBI’s Repo rate hikes started from 4.75 per cent and the rate is now at 8.25 per cent, an increase of 350 basis points. In the last decade, the highest Repo rate was 9 per cent that existed from the end of July 2008 till September 2008 when Lehman Brothers collapsed.

*Date*	20-Mar-2010	20-Apr-2010	3-Jul-2010	27-Jul-2010	17-Sep-2010	2-Nov-2010
Rate %	5.00	5.25	5.50	5.75	6.00	6.25

*Date*	25-Jan-2011	17-Mar-2011	3-May-2011	16-Jun-2011	26-Jul-2011	16-Sep-2011
Rate %	6.50	6.75	7.25	7.50	8.00	8.25

Source: RBI

Rationale for Rate Hikes

What is the rationale behind RBI’s latest increase in rates?

v Inflation rate of 9.8 per cent (for the month of August 2011 based on wholesale price index-WPI) remains at highly elevated levels for the past 11 months due mainly to high commodity prices and supply chain bottlenecks

v This calendar year, fuel prices have been increased by Government of India three times. Retail petrol prices have been increased by Rs 8 per litre in the last four months. The impact of the fuel price hike is yet to play out fully in the economy.

v Non-food manufactured goods prices too are rising

Impact

The present rate hike from RBI is on the expected lines. However, it was expected by the markets that the RBI would change its policy stance. Contrary to expectations, there is no change in RBI’s hawkish monetary policy. The stock markets were one per cent up seconds before the RBI’s rate hike. As soon as the RBI hiked the repo rate, the markets had suddenly collapsed and went into negative for a few minutes. But, later they recovered from their low levels and at the time of writing, the Sensex is at 16,990 and the Nifty is at 5,100.

The bond market too reacted negatively, though in a mild manger, to the RBI rate hike. Seconds after the RBI rate hike, the yield on the benchmark 7.80 per cent 10-year Government of India security maturing in 2021 is quoting at around 8.36 per cent from the old level of 8.32 per cent. Overall, the outlook for bond market is negative.

Banks will wait for some time to raise either deposit or lending rates – though one cannot rule out the possibility of some private banks raising interest rates immediately. Depending on liquidity conditions and various other factors, Banks will wait for some more time before taking the plunge. The overall impact of relentless increase in interest rates will be negative for the stock market as well the bond market.

Outlook on Further Rate Hikes

The macro economic indicators are presenting a mixed picture as of now. The first quarter GDP (April-June 2011) growth is at 7.7 per cent, showing a continuous decrease for the last six quarters. The Index of Industrial Production for July 2011 indicates that the overall industrial production has recorded a growth of 3.3 per cent, which is the lowest in 21 months. The investment cycle too has slowed down. The GDP estimates and IIP figures are clearly indicating that the growth rate in India is slowing down.

On the contrary, the inflation rate remains at elevated levels. Food inflation too is not under control. The Government of India has raised fuel prices three times in the current calendar year. The higher fuel prices are feeding into inflation figures. The inference is that RBI wants to keep its primary focus on inflation control despite signs of GDP growth slowing down. RBI continues with its current hawkish stance.

However, the apprehensions regarding the effectiveness of monetary policy in containing growth-induced inflation remain unanswered at this point of time. But, RBI claims that its rate hikes are having some impact on inflation, though not up to their expectations. Inflation seems to have been caused more by supply chain bottlenecks, substantial increases in personal wealth and huge Government spending in the last three to four years.

The subsidy burden of diesel, LPG and kerosene is too heavy for the Government and to keep the fiscal deficit under control, it is raising fuel prices as India imports 82 per cent of its crude oil needs. It will take some more time for the fuel price to fully reflect in inflation figures. There is no significant cut in Brent crude oil prices in the last three months and the outlook for crude oil prices remains hazy. The Government’s disinvestment programme is in a limbo as it is not able to raise any money through selling of small stakes in government companies. Due to weak market conditions and doubts about getting attractive issue price, the Government has now postponed the stake sale in ONGC, the public sector oil company.

The monsoon is good till now and is expected to be normal this year. However, what needs to be emphasized is that RBI will be keenly watching the important data, like, inflation, GDP growth, IIP numbers, fiscal deficit, crude oil & other commodity prices, global cues especially from the crisis-ridden euro zone and others before making further moves on its fight against inflation monster.

Important Terms Explained

Repo rate: The overnight rate at which banks borrow money from RBI by pledging Government securities with RBI

Reverse Repo rate: The overnight rate given by RBI to banks when the latter keep their surplus funds with RBI (one per cent below Repo rate)

Marginal Standing Facility (MSF): Banks can borrow overnight from the RBI’s MSF up to one per cent of their respective net demand and time liabilities or NDTL. The rate of interest on amounts accessed from this facility will be

100 basis points (one per cent) above the repo rate.

LAF – RBI’s Liquidity Adjustment Facility

RBI – Reserve Bank of India

GDP – Gross Domestic Product or national income

IIP – Index of Industrial Production

Note on author: The author in an investment analyst and writes copiously on financial markets – equities, bonds, currencies, taxes, Indian economy, etc. You can read these articles on:

www.ramakrishnavadlamudi.blogspot.com

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