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Saturday, July 2, 2011

The rationale behind certain banking rules/regulations

Even the best brains at times, get baffled by the intent behind certain banking rules. Given that this is the only industry which uses money as a raw material to create more money out of no where, there are restrictions imposed on it. And some of them are explained in the post below. You are encouraged to read the original texts(wherever linked), but then if you could maybe this post is not for you! Without much ado, I proceed.

  1. Why are intangible assets, deferred revenue etc excluded from regulatory capital calculations? Regulatory capital intends to capture the readily available cash in a crisis to take the loss. So the calculation tends to favour tangible assets over intangible assets(even valuable IPR!)
  2. Why are investments in other similar companies(banks/NBFCs) excluded, or given a haircut? In times of stress, systemic risk will probably hit all companies in the same sector. Given this, regulators frown upon cross holdings in companies doing the same business, because there is less diversification then. Also, unscrupulous companies may use this as a way to 'round trip' deposits and prop up the balance sheet position. For that reason, exclusion is justified. 
  3. Why exclude investments in group companies? Any non arms length deal(actual or presumably so) is frowned upon, because in case of a crisis, it may not be realized to the fullest value.
  4. Balance sheet is 'end of year' but some notes disclose averages, min/max position during the year. Why? End of year numbers may be window-dressed using repo deals(Lehmann 105), sale and lease back, short term loans etc. The other numbers(mean/min/max) portray a realistic picture and act as a signal towards companies which cook their books. 
  5. When transfers outside 'Held To Maturity' portfolio exceeds a certain percentage(5% or so) of the total portfolio value, then why do the reporting/accounting rules tighten? Held to maturity securities can be recorded at book value, and thus can be used to cover up losses. If companies decide to sell some of HTM securities early to monetize unrealized profits, they should be willing to record unrealized losses also, because then the 'intent' is in doubt. This tainting position applies in IAS 39(till it is revised atleast) under IFRS, and the RBI mandates disclosing HTM market value, if the 5% ceiling is crossed.
  6. If just one loan facility has defaulted/been restructured, why do ALL borrower accounts need to classed at NPAs? Legally, the borrower may have a legitimate dispute with the bank or may have ringfenced the remaining assets from the defaulting loan. But still, this may be an early warning signal for those other facilities, and also signify the intent of the borrower. That is why this clause exists
  7. Why do regulators insist for not doing insurance departmentally? SPV ensures that risks involved in insurance business do not get transferred to the NBFC and that the NBFC business does not get contaminated by any risks which may arise from insurance business. This would imply not giving guarantees, capital infusion schedules etc. This also holds true in a milder version for infrastructure. 
  8. Why should the RBI regulate 'non deposit' taking NBFCs, where no public money is involved like in other NBFCs? In 2006, in view of the systemic risk arising from access to public funds such as bank borrowings, CPs, etc, by NBFCs, and their interconnectedness with the financial system, the focus of regulatory concern widened to include non deposit taking NBFCs also. Hence, certain large NBFCs are also covered under this ambit(http://rbidocs.rbi.org.in/rdocs/content/PDFs/31CANN020711.pdf
  9. Why are tax concessions and bank loans for land/property contingent on purchase/contingent within 3 yrs? It is a public policy thing. Govt wishes to give tax breaks/bank loans only for augmenting the supply of serviced land and constructed units, and not for merely sitting on acquired land banks. Also, 3yrs period ensures quick re-cycling of bank funds for optimum results
  10.  Why does RBI restrict loans to non corporate Govt bodies? To ensure that Govt does not use bank loans as an off balance sheet way to finance projects which had not got budgetary approval. The rationale being that corporates(typically) even if Govt owned, are not under the Union Budget.           Banks should satisfy themselves that the project is run on commercial lines and that bank finance is not in lieu of or to substitute budgetary resources envisaged for the project
  11. The FDI policy(http://dipp.nic.in/Fdi_Circular/FDI_Circular_012011_31March2011.pdf) mandates unlisted cos issuing ADR/GDR to list simultaneously/earlier in domestic market. Why? This is to avoid regulatory arbitrage, and also that companies prohibited from raising funds in India, should not be allowed to list abroad indirectly. 
I'll update this post whenever I see any such interesting points.

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