Risks and effects of shadow or non-banks on govt funds
Governments across the world have rewarded the wealthiest individuals who were to a great extent responsible for their financial debacle at state expense. There are far better uses for scarce government funds, than to underwrite excessive risk
In February 2013, the then Federal Reserve governor Jeremy Stein gave a now famous speech. In it he outlined the factors that could lead to overheating and an eventual crash. The first was a change in regulation. A change in regulation inevitably leads to the second factor, financial innovation. When confronted by a change of regulation market players, as advised by their legal talent, adapt to the new regulation by trying to find ways around it. The reason is simple. The new regulation usually prevents or adds addition costs to activities, which are profitable for market players.
This game of regulatory cat and mouse goes on all the time in every country. The exact methods to avoid the regulations vary from clever schemes to out right avoidance either legally through jurisdiction arbitrage or illegally. This game is generally not a problem unless the third factor is present. The third factor is an economic environment that encourages large risk taking. The deluge of monetary stimulus, again from almost every government, has created such an environment around the globe.
This week The Economist featured a report on shadow banking. They used the definition of the Financial Stability Board. A shadow bank is “credit intermediation involving entities and activities outside regular banking system”. In short any entity or instrument that involves a loan, provided the entity does not raise funds from depositors.
The distinction is important because governments feel that it is vital to protect one of the largest and most vulnerable parts of the financial system: depositors. Depositors in the US alone have almost $10 trillion on deposit with US banks. Most of these deposits are insured for $250,000. If a US bank goes under, which has happened 500 times in the past seven years, the depositors are guaranteed to receive at least the insured amount. There is no such guarantee for shadow or non-banks.
The list of the activities of non-banks would be long. They would include financial firms like money-market funds, asset managers, private equity, mortgage real-estate investment trusts, mortgage servicers, middle-market lending funds and clearing houses. These days they would also include large internet firms like Alibaba in China, P2P platforms, mobile payment systems of telecom companies, PayPal and the entire Chinese shadow banking system. They also would include traditional debt instruments like bonds.
The reason why these nonbanks or shadow banks are important has to do with the post crash regulations. Since the riskier behavior of the banks was considered to be a prime cause of the recession, regulators have tried to limit their exposure. They have also been required to increase their capital cushion. The result has been a slowing of lending especially to businesses.
As former governor Stein predicted the restriction of one area of lending by banks has led to enormous growth for non-banks. They have doubled in the past ten years. They make up 50% of the lending in China.
The money cascade from central banks has increased other areas. In 2007, corporate bonds issued by US corporations made up 29% of GDP. It is now 42%. It is not just the US  corporations. Around the world, corporations have doubled the amount of bonds they issued between 2007 and 2012 to more than $1.7 trillion.
Asset management firm Black Rock has over $4 trillion under management dwarfing the world’s largest bank, the Industrial and Commercial Bank of China (ICBC) by a trillion dollars. Even internet firm, Alibaba, in China has collected $81 billion for its on line banking service Yu’e Bao (“leftover treasure”).
The rise of these shadow banks along with the mountain of debt they represent brings up an important question. By clipping the wings of banks, have the regulators been successful in making the financial systems safer? There are major benefits to banks. Unlike their competitors they are subject to stricter regulations everywhere they exist. Encouraging money to flow into less transparent areas of the financial world may not be the safest bet.
The argument in favour of the shadow or nonbanks is to spread the risk. If depositors are not at risk and governments do not have a legal obligation to bail these firms or their customers out, what difference does it make? If Paypal gets hacked and its users lose money, it might be a problem for Paypal and its customers, but is it really a threat to the financial system? Bonds have always defaulted. Determining which bonds are more likely to default is what rating agencies are for.
Removing risk from the parts of the financial system that the government has a legal obligation to support is an excellent goal for regulators. But there is one problem. Just because there is no legal duty does not mean that there is not a political imperative.
The US government did not have a legal duty to take over the insurance company AIG. AIG sold credit protection in the form of credit default swaps (CDSs) on collateralized debt obligations (CDOs). The amount insured amounted to a staggering $441 billion. Of those almost $60 billion were structured debt securities backed by subprime loans. When the loans went bad, AIG’s counterparties wanted the company to pay up. It couldn’t. By the middle of September 2008, it was bankrupt.
Even though AIG was not a bank and not part of the financial system, the US Federal Reserve stepped in and provided $182 billion of tax payer money. In time, AIG paid back a total of $205 billion. So the Fed made a profit, but was it worth the risk?
AIG wasn’t the only non-bank to be bailed out. The US government also bailed out broker-dealers, car-finance companies and money-market funds. The Irish almost bankrupted their government with an unnecessary unlimited guarantee of six banks. So far the Chinese government has bailed out almost every large company that has had a financial problem.
The bailouts also had the perverse effect of saving those who had taken the greatest risk. It rewarded the wealthiest individuals who were to a great extent responsible for the debacle at state expense.
Capitalism has the potential to create enormous wealth for all members of society, but there is a cost. Regulators, politicians and voters must understand that it will only work efficiently if its creative destruction is part of the process. They must understand that in a world awash in debt, a lot of it went to inefficient firms and will never be paid back. There are far better uses for scarce government funds, than to underwrite excessive risk.
(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first-hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and speaks four languages.)


Appointing directors at private companies becoming difficult
With the new Companies Act, the law has become more stringent for private companies than for public companies, especially while appointing directors 
Moving from the Companies Act 1956 to the Companies Act 2013 is like shifting from your old house to a new one. In the old house, where you have stayed for years, everything would have found its own place – the shoes, the clothes, umbrella, first aid, brooms, and whatever else you need in your household. Your legs can find their own way, even in pitch dark of night – they know the way to the bathroom, to the stairs, they even know where the stairs end. 
As you move into the new house, first, there is a huge process of “getting used to” – which is anyway usual for any such shifting. But the biggest issue is – we get to realise several shortcomings that we did not realise until we shifted. This might include silly things such as an electric point that we missed, or a water outlet that is not working, and so on. In case of the new house, all these are our own follies, or those of the architect – so we go ahead and get them fixed. In case of the new Act – the fixing process is the long trail of amending the law, and in the meantime, you have the 6-months-in-jail staring at you all the time! 
One such folly is the provisions of the new law relating to the appointment of directors in case of private companies. Notably, about 90% of all incorporated companies are private companies, and these companies, being incorporated proprietorships or small businesses in essence, may not be well served by competent professionals. Hence, the chances of errors and omissions are substantially high, exposing the companies to the spectre of hefty prosecutions.
Appointment of directors in case of private companies: Old law
English law, based on which the 1956 Act was drafted, was quite reasoned and seasoned, and had stood the test of over six decades. Lately, UK has gone for substantial de-regulation of private companies, realising that these companies are de facto partnerships, and there is no reason for these companies to suffer regulation at par with larger companies where public interest is significant.
The rules about appointment of directors, under the 1956 Act, were as follows:
  1. In case of private companies, there was absolute liberty as to the manner of appointment of directors. The articles could have named all directors, or the articles could have laid the manner of appointment of directors.
  2. In case of public companies, at least two third of the total number had to be those appointed by general meetings. That is, public companies had the right to self-regulate appointment of one third of the total board strength.
  3. The board could, subject to articles, appoint additional directors. These were pro-tem directors – they will lay down their office at the AGM and may be regularised there.
  4. The board could also fill up casual vacancies. 
  5. The board could also appoint alternate directors.
In essence, in case of private companies, there was absolute liberty as to the appointment of directors. Private companies could self-regulate the process by their articles. 
Appointment of directors in private companies as per new law:
The liberty given to private companies to self-regulate the appointment process has, surprisingly, been completely taken away in the new Act. This sounds completely paradoxical, in view of the fact that in case of public companies, they still have the liberty to self-regulate to the extent of one third of the board strength.
This highly anomalous and surprising implication is coming due to a combined reading of sec 152 (2) and sec 152 (6) (b).
Section 152 (2) casts a generic, unexceptional principle,  stating that except where the Act provides a carve-out, all director  of all companies will be appointed by the general meeting. This provision is applicable to private companies too.
Sec 152 (6) (b) provides liberty, but only to public companies, to appoint one third of the total board by a self-regulated process. While there was an exception to private companies in Sec. 255 (2) of the 1956 Act, that exception has been dropped while transporting the provisions into the new Act. 
It could not be the case that such was the intent of the lawmaker – there is absolutely no case for imposing more stringent regulations in case of private companies, than in case of public companies.
Even casual vacancies cannot be filled by the board:
Now, as if the anomaly above was not enough, sec 161 (4) empowering the board to fill a casual vacancy is also not applicable to a private company. This means, the board of a private company cannot act to fill up a casual vacancy even – it will have to move to call a general meeting, and get he vacancy filled up only in general meetings.
What if the section is violated?
Since the 8-lakh odd companies, sitting with more than 16-lakh directors, may not even be aware of this change of law, what is the provision gets violated? There you have section 159 to take care of – which provides for a jail up to six months, of course with/without a fine too! 
It is no one’s case that the move from the 1956 Act to the 2013 Act was to scare people away from corporatisation. In fact, the much hyped concept of one person company (OPC) was explicitly for encouraging small businesses to move to the corporate form. However, what has clearly and undenyingly happened, not due to the intent of the lawmaker, but the myriad follies of the lawmaker, is that the corporate form has become strangulatingly difficult for small companies.
It is certainly necessary to revisit these provisions and exempt private companies where exemptions are logically necessary. Private companies must be regulated with a reason, and not exempted for a reason.
(Vinod Kothari is a chartered accountant, trainer and author. He is an expert in such specialised areas of finance as securitisation, asset-based finance, credit derivatives, accounting for derivatives and financial instruments and microfinance. He has written a book titled “Securitisation, Asset Reconstruction and Enforcement of Security Interests”, published by Butterworths Lexis-Nexis Wadhwa.) 


Amethi vs Baramati

Whichever wave may come, the Sharad Pawar family manages to keep its bastion, Baramati, intact, mainly on development works carried out by them. Why can't we see such developments in either Amethi or Raebareli, the so-called bastion of Congress' first family?

After weeks of campaigns, slogans and advertizements, we finaly witnessed “Abki baar Modi Sarkar” turning into reality. The Indian National Congress has faced an embarrasing and much needed defeat. But, for a few minutes, lets make a shift from this gung ho view of the Narendra Modi wave and look at the picture from a different point of view.

Much known for his austerity drives, strolls in villages streets and one on one meetings with the 'aam aadmi', we have very often heard Congress vice president Rahul Gandhi talking his connections with Amethi that are emotional and familial rather than political. On 6th April, the day Sonia Gandhi was scheduled to file her nomination papers from Rae Bareli, he told a cheering crowd: “Amethi and Raebareli are like a family to me'' he said, adding, “I am aware of the problems faced by you here. You leave it to us for their solution.''

The Gandhi legacy in Amethi has continued since decades altogether, large sections of populations considering Rahul 'bhaiya' their own. However, the picture that was painted by the election results is unusual. Rahul bhaiya faced stiff competition from Smriti Irani, the favourite bahu of TV soaps and BJP contestant from Amethi. Cleary, something seems to have gone wrong.

Neither the strolls, nor the pretended dedication has done any good to Amethi in all these years of incessant Congress rule. The dilapidated condition of the roads and other infrastucture further concretize this observation. With the country going tech-savvy and the era of e-governance approaching, Amethi still awaits a bare minimum of uninterrupted supply of electricity. Education, health care and other public enterprises remain stagnant. And while there's no development worthy enough to showcase, the factories and other establishments of the Rajiv Gandhi tenure have closed down. The growing distrust is inevitable, but also healthy in a democracy.

A similar plunge is also visible in Maharashtra, where the Congress–Nationalist Congress Party (NCP) has been rejected. After having enjoyed massive and unchallenged power for a long time, the Pawars are now tasting the flavour of people's anger. This leads us to a curious comparison between Amethi and Baramati, dynastic strongholds of the Gandhis and Pawars respectively. However, in deep contrast to Amethi, Baramati was fortunate to have enjoyed complete attention of the Pawars. In 2006, in keeping with the then union agriculture minister's aim of making his constituency a global show piece, Baramati went live with its own WiMax network. From agriculture to irrigation to industries, the economy of Baramati runs on well developed and updated systems. Well connected with the major cities in the state, last decade has seen growth of Baramati as a Prominent Education Center with Colleges and Schools ranging from Engineering to Biotechnology to Law and soon a Medical college is going to start in MIDC area. None of the above however, saved the Pawars from sinking in the quagmire of scandals that they built for themselves.

The question now is 'what remains ahead for Amethi's Rahul bhaiya?' Apart from just the embarassment, the abysmal performance calls for some genuine and serious introspection. Far, far away from women and youth empowerment or implementation of the RTI, Amethi continues to be deprived of basic amenities.



ramchandran vishwanathan

3 years ago

Amethi & Rai barelly should have votedout the Gandhis. They have only played with the emotions of the people there. Hope they take this defeat positively & start performing their duties. Baramati has clealy rewarded Pawar's work. We the people must make the representatives perform. Its equally our responsibility to make them work.

Jayprakash Save

3 years ago

How Tathawade (part of PCMC) & some part of Pune city were included in Baramati constituency during this LS elections? Voters got confused at the polling booths for not finding BJP/Shivsena representation & might have voted for NCP (as it was the only familiar symbol) or NOTA. The progress is limited to Baramati City/Town, here many parts of PCMC/Pune the residents depend on water supplied by tankers mostly owned by NCP/Congress leaders for last few years. There is nexus between corporators, PCMC, Builder & Tanker lobby to screw life of residents.

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