Money & Banking
Why bank regulators fail?

Killing off some zombie banks would be good for a system where banks are hoarding capital rather than lending it, but there is little political or economic incentive to do so

Pity the poor regulator, in this case a banking regulator. The European Union has just appointed Danièle Nouy as head of the new European Central Bank (ECB) Single Supervisory Mechanism (SSM). The SSM is to provide the entire Eurozone with a central regulator. It will directly supervise the 30 or so leading Eurozone banks. It also has the power to overrule national regulators and intervene in operation of the Eurozone’s 6,000 smaller banks.


Ms Nouy has vowed to be tough. She has warned that some of the region’s lenders have no future and should be allowed to die. But she has a major problem. She is up against intense economic and political incentives to keep the real level of bad loans quiet and the banks in existence. She is also not alone. These incentives exist everywhere. Bankers don’t want to admit to a weak balance sheet. Company managers don’t want to lose their firms and jobs. Politicians want the economy to appear healthy.


Carinthia is the southernmost Austrian state or Land. It borders Italy and Slovenia. It is within the Eastern Alps. With its picturesque mountains and lakes, it could be almost perfect, except for one thing. It owes about €14 billion. Its situation can be traced to its relationship to Hypo Bank, a former subsidiary of the German Bank Bayern LB. Hypo was taken over by the Austrian government in 2009. The government decided not to let it fail, because if it did, the guarantees given by Carinthia would become due. So Hypo still has bad loans of €18 billion on its books. No doubt the SSM would love to let it fail, but the Austrian government won’t allow it.


Italy is in the same situation. It does not want to shut down any bank. It would draw attention to the rising levels of nonperforming loans and put the country’s credit rating at risk. It is a real problem because the gross nonperforming loans in Italy reached €150 billion last November and has been growing at 22% per year. Killing off some zombie banks would be good for a system where banks are hoarding capital rather than lending it, but there is little political or economic incentive to do so. With massive amounts of cheap money from the ECB, it is easier to extend and pretend. So in a way the easy money policies of one part of the ECB are making the job of its regulatory arm that much harder.


Just like its neighbours Austria and Italy, Slovenia has problems with its banks. Its banks are burdened with €7 billion in bad debts. This is a crushing debt load for a small country with a population of only 2 million. Still it insists that it does not need a bailout. To solve the problem, it will establish a “bad bank”. The bank will buy bad loans from the country’s banks in exchange for short term bonds, but there it ends. The central bank has said that it won’t hold the bad loans indefinitely. Instead it hopes to sell them when they are “interesting to the market”. You have to wonder that if they will ever be interesting to anyone.


Europe generally has far greater levels of rule of law and stronger institutions than emerging markets. Yet even there the EU federal regulators are having issues. Their colleagues in the developing world are up against much larger, but similar obstacles.


Any regulatory issues have been exacerbated by another common characteristic of emerging countries. They all have shared a colossal credit boom. Loans have been growing by double digits for many years. The loans will not all be paid back.


In both India and China, loans are made to individuals and firms whose strengths are their connections more than their balance sheets. Since state banks dominate in both countries, the best connections are to politicians, who have few incentives to help the regulators. Loans based on connections are often backed by guarantees rather than collateral. An effort to collect such loans would put not only the connected debtor out of business, but affect another prominent individual or more often a state-owned company.


A recent example occurred in China. The Credit Equals Gold No. 1 was a product created by China Credit Trust, one of the largest Chinese trust companies. These companies are part of the $1.2 trillion shadow banking industry. They are outside the normal channels of regulation. Unfortunately the money raised from investors of Credit Equals Gold was loaned money to Shanxi Zhenfu Energy Group, a coal company that went bankrupt.


Credit Equals Gold was distributed through the offices of the world’s largest bank, Industrial and Commercial Bank of China (ICBC). Investors thought that the product was backed by the bank and the trust company. It wasn’t. Although a tiny part of a huge industry, a default by an investment product could potentially have systemic and catastrophic consequences. So Credit Equals Gold was not allowed to go under. An unnamed group bailed out its investors. Regulators never had a chance.


India has similar problems. Total problem asset are estimated to be about 10%. The State Bank of India (SBI) has promised to go after reluctant borrowers, but like other Indian banks, it will have difficulty collecting. Like the Chinese banks, many loans in India are secured only with personal guarantees from the firm’s promoters. Loans were also given as the result of bribes to the loan officers or pressure from politicians. Corrupt bankers and politicians certainly do not want their dirty laundry dredged up in a messy collection process.


The real issue for regulators is as always information. How can Ms Nouy and the SSM decide which bank to shut down if no one wants to give her accurate, timely and complete information? The problem is many times worse in emerging markets. The sad part is that if the problems are identified in time, it might be possible to have an orderly liquidation and limit the damage to the worst case. In contrast nasty surprises, and there will be many, can cause a liquidity crisis. If the banking system freezes up, everything is at risk and nothing will be orderly.


(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 has spoken four languages.)




4 years ago

This is applicable to all of Bharath Sarkar and Bharath Sarkar ki Sampathi. It is the new order. The nouveau "Cursed Aristos" provoking another 1789.

SBI Q3 net profit falls 34% on higher provisions

State Bank of India’s net profit fall to Rs2,234 crore mainly on higher provisions for bad loans and increased staff expenses


State Bank of India (SBI), the country's largest lender, reported a 34% fall in its third quarter net profit mainly on higher provisions for bad loans and increase in staff expenses.


For the quarter to end-December, the state-run lender, said its net profit fell to Rs2,234 crore from Rs3,396 crore. SBI's net interest income (NII), the difference between interest earned and expended, increased 13% to Rs12,641 crore from Rs11,176 crore while other income rose 16% to Rs4,190 crore from Rs3,627 crore, same period last year.


SBI said during the quarter its bad loan provisions grew 24% to Rs3,429 crore from Rs2,766 crore, while gross non-performing assets (NPAs) increased 5.73% from 5.3%, a year ago period. Its net NPA also rose to 3.24% as against 2.59% recorded during third quarter FY2013.


The lender's staff expenses in the December quarter, including payment and contribution to employees increased 34.8% to Rs5,867 crore from Rs4,351 crore, a year ago period.


Here are the details of profit and loss account of SBI...


SBI closed Friday 1.6% down at Rs1475 on the BSE, while the 30-share Sensex ended the day marginally up at 20,326.



NBFCs’ issuance of secured NCDs in trouble as Companies Act, 2013 and draft rules’ whammy

The only options left with NBFCs are issuance of compulsorily convertible debentures with no tenure limit on the conversion or contingently convertible debentures or a third instrument that the market may innovate

The Companies Act, 2013 is turning out to be opening a pandora box for non-banking finance companies (NBFCs). So long the NBFCs were struggling to ensure that the debenture issuances did not trespass into the domain of public deposits and were beginning to understand that optionally convertible debentures market will die out slowly that the draft rules have thrown language open to interpretation.

The reading of the Section 71 of the Companies Act, 2013 read with the draft rules indicates that the debenture issuances have to be secured by specific moveable and immoveable properties. NBFCs may have a hard time in finding these specific moveable and immoveable properties for secured debenture issuances. To throw some light on the issue, it is pertinent to read the text of the section and the extract of relevant draft rules as reproduced below.

Section 71 of the Companies Act, 2013 states that –

  1. A company may issue debentures with an option to convert such debentures into shares, either wholly or partly at the time of redemption:

Provided that the issue of debentures with an option to convert such debentures into shares, wholly or partly, shall be approved by a special resolution passed at general meeting

  1. No company shall issue any debentures carrying any voting rights.
  2. Secured debentures may be issued by a company subject to such terms and conditions as may be prescribed (emphasis ours).
  3. Where debentures are issued by a company under this section, the company shall create a debenture redemption reserve account out of the profits of the company available for payment of dividend and the amount credited to such account shall not be utilised by the company except for the redemption of debentures.

The draft rules 4.16 applicable for section 71 (3) states that –


4.16. (1) For the purposes of sub-section (3) of section 71, no company shall issue secured debentures unless it complies with the following conditions:

(a) An issue of secured debentures may be made, provided the date of its redemption shall not exceed 10 years from the date of issue. 
Provided that a company engaged in the setting up of  infrastructure projects may issue secured debentures for a period exceeding ten years but not exceeding thirty years;

(b)  such an issue of debentures shall be secured by the creation of a charge, on the properties or assets of the company, having a value which is sufficient for the due repayment of the amount of debentures and interest thereon;

(c)  the company shall appoint a debenture trustee before the issue of prospectus or letter of offer for subscription of its debentures and not later than 60 days after the allotment of the debentures, execute a debenture trust deed to protect the interest of the debenture holders ; and

(d)  security for the debentures by way of a charge or mortgage shall be created in favour of the debenture trustee on-


(i) any specific movable property of the company (not being in the nature of pledge), and/or

(ii) any specific immovable property wherever situate, or any interest therein.

The whammy

As mentioned, the reading of the section and the draft rules indicate that there has to be specific moveable/ immoveable property for security creation. The term ‘specific’ property does not relate to creation of floating charge but implies that there should be a specific and identifiable asset ear-marked for the purpose of creating security.

The term charge on specific (moveable/ immoveable) property cannot be interpreted to mean floating charge as in case of floating charge the asset is not specifically identified. The charge crystallises at the time of enforcement as opposed to charge on specific property which remains ring-fenced as security and renders priority in claims.

For anyone understanding the business and functioning of NBFCs it will be a no brainer to realise that NBFCs do not have immoveable properties on their balance sheet unlike manufacturing entities which would have land/ plant & machinery etc to offer as charge. NBFCs are financial institutions into the business of lending and their asset sides would be dominated by receivables as moveable property. However, clearly the problem here is that the receivables are amortising in nature and one cannot ear-mark/ ring fence them, call them ‘specific’ to create charge on them for the purpose of issuance of secured debentures.

What’s left on platter?

While the rules have not been enforced, if we were to consider that the final rules would contain the language same as draft rules, the conclusion that can be drawn is pretty clear. In the domain of issuance of debentures by NBFCs, optionally convertible debentures will now be public deposits and there are issues of finding the collateral for issuance of secured debentures. The only options left with NBFCs are issuance of compulsorily convertible debentures with no tenure limit on the conversion or contingently convertible debentures or a third instrument that the market may innovate for as they say, necessity is the mother of inventions.

(Nidhi Bothra is executive vice president at Vinod Kothari & Company)


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