Development Bank Research Bulletin

Will India collapse in balance sheet crisis? a worse scenario analysis

Special note: this analysis is more a stress-test/worse-scenario type of exercise and "thought experiment". I don’t think a crisis is imminent for India, neither do I think it is a large-probability event. An external debt crisis is in particular impossible. The analysis however, by dissecting the problem, helps you identify the weakest links of the system and hopefully may help inform policy-makers in addressing the problem ealier than later.

Will India collapse in balance sheet crisis?

My evaluation is that: India’s national balance sheet is unsustainable in the long term, but financeable  in the short term. Nouriel Roubini has the same opinion in his article “A balance sheet crisis in India” (PDF file)

First, let me tell you why it is unsustainable in the long term. When evaluating a country’s vulnerability to crisis, we need to examine the overall balance sheet of the country, which include not only the corporate and banking sector, but also the government sector.  This is particularly true in India and China, where the liability can be easily moved between balance sheets of the banking sector and the government as a result of strong state intervention in the economy.

In both India and China, governments are heavily involved in loss-making projects. But the losses are recorded differently.

In China, government forces state-owned banks to extend so-called “soft loans” to industries and enterprises favored by the government’s fiscal goals, and thus the huge losses are recorded in the banking sector as non-performing loans.

In India, the government directly involves in subsidizing these “white elephant” projects,  and then finance the expenditure through issuing government bonds to captive state-owned banks. Indian government thus accumulates huge public debts, which amount to more than 400% of its annual revenue.

We have to understand that, although the losses are recorded differently in India and China, if we examine the balance sheet of the country as a whole, they are not better than each other. If Chinese government increases its public debt to the level of India, she can use the revenue to write off the bad loans of the banking sector for many times. Similarly, if Indian government is to default or restructure on its debts, or there are doubts among depositors about the government’s repayment capacity, Indian banking sector will be broke over night as more than 35% of Indian banking sector’s total assets are in the form of government securities. Currently, government papers are treated as very safe and capital and loss reserve is not allocated to safeguarding against potential future losses, which results in misleading capital adequacy ratios.

In a worse scenario, such structure can cost you dearly. According to Professor Roubini, anything that can go wrong tend to go wrong together:

“Note also that if a bank run were to eventually occur—when and if depositors become concerned about the quality of the bank assets and the sustainability of government  debt—the ability of the Indian government to stem the run via explicit guarantees of deposits may be limited. A solvent government running a low deficit and with little debt may credibly guarantee deposits since it has resources to finance a bailout of the financial system. But an insolvent government cannot credibly backstop the banking system and promise to protect deposits given that the cause of the run is, in the first place, concerns about the solvency of the sovereign. Thus the risks of a bank run and the necessity of a deposit freeze become more severe when the government is effectively insolvent or semi-insolvent.”

Will Indian government default on its debt? India’s public debt to GDP ratio is some 85% and the government is still running large fiscal deficits every year, and even if India can maintain its 7%-8% economic growth rates and the interest rates do not go up, the debt ratio is heading toward 90% by the end of this decade, maybe even faster with the coalition government that will certainly spend more. However, high debt ratio alone will not trigger crisis. India’s public debts have long maturity terms (which however also means that banking sector will experiences large losses when short-term interest rates hike), and are mostly denominated in local currencies (which make India relatively free from crisis in external sector).

Nevertheless, everything that can go wrong will go wrong. When the balance sheet is unsustainable in the long run, it becomes very fragile in the short term too, as participants in the economy are forward-looking. Nothing will happen if India can maintain high growth and low interest rates, and (2) No large scandals happen in state-owned enterprises and banks. But if any one of these factors (growth, interest rate, confidence in public sector) goes wrong, investors will start to reevaluate the situation, and some of them may start to think: hey, the whole system is unsustainable in the long run, someone will eventually have to pay the bill, and I don’t want to be the last one to liquidate my position! 

One may point out that European countries also accumulate huge public debt, and why don’t you worry about them. Well, since when has India become a developed country?

Emerging markets are fragile in nature. Let’s review some famous Murphy’s laws:
(1) Anything that can go wrong will go wrong.
(2) If there is a possibility of several things going wrong, the one that will cause the most damage will be the one to go wrong. Corollary: If there is a worse time for something to go wrong, it will happen then.
(3) If anything simply cannot go wrong, it will anyway.
(4) If you perceive that there are four possible ways in which a procedure can go wrong, and circumvent these, then a fifth way, unprepared for, will promptly develop.
(5) Left to themselves, things tend to go from bad to worse.
(6) If everything seems to be going well, you have obviously overlooked something.
(7)It is impossible to make anything foolproof because fools are so ingenious.
(8) Whenever you set out to do something, something else must be done first.
(9) Every solution breeds new problems
I more and more feel that Mr. Edward A. Murphy is such a damn-good economist! World-class!

Recommended Readings:

Deutsche Bank Research: India’s public finances: do they matter? (PDF file)

Also two of my previous articles on India's banking sector:

Why is India’s financial system less solvent than China’s

Fix Mexico’s banks, not China’s

McKinsey says financial sector reform could raise Chinese GDP by 17% a year

A study recently published in May by the McKinsey Global Institute, titled "Putting China's Capital to Work: The Value of Financial System Reform", has found that financial sector reforms in China, if properly executed, would raise gross domestic product by an astounding 17 per cent, or $321bn.

According to the report: better capital allocation would raise GDP by $259bn, while improving the efficiency of the banking system, switching from paper-based to electronic payments, and diversifying the mix of funding vehicles for corporations would raise GDP by $62bn annually.

Another report by McKinsey points out that Chinese domestic banks are more fragile then we thought, when facing foreign competition likely incoming in 2007.

We usually think that foreign banks cannot compete with Chinese local banks in retail banking, because it is prohibitively expensive for any foreign banks to attempt to replicate a nationwide branch network.  McKinsey report however identify an opportunity: just 2 per cent of local banks’ customers account for half of total household deposits and the bulk of banking profits in retail banking. 

This means that it is actually not that difficult for foreign banks to poach away these small number of "high net-worth individuals"  without setting up a huge branch network. These wealthy customers are more likely to have private transport vehicles and shouldn’t care that much about the location of the bank branches, so long as they are located in the posh financial districts.

Bad news for gigantic Chinese local banks though. The report warns that "If even a small number of customers from this group shift to the foreign competitors, existing banks could face a liquidity crisis"

Hat tip: Financial Time: Ready to compete in global markets

Inefficient banking sector in China is actually an optimal way of taxation

It is well perceived that China's state-monopoly banking sector (with the help of capital control) is a powerful tool in channelling private sector wealth into loss-making state-owned enterprises and numerous white-elephants public infrastructure projects.

A paper written by several Chinese economists however argues that such a mechanism is actually optimal. The idea is as follows.

In developing countries, it is usually very difficult for the government to collect taxes (everyone hides their income), and official taxation is usually very inefficient (it creates a lot of distortion in the economy and a disproportionate burden on hard-working and smart people). Formal taxation thus becomes very costly and creates a lot of dead-weight costs.

But the government needs money and by whatever means the government will try to extract revenue from the private sector. Conditional on the "grabbing hand" nature of the government, an “implicit taxation” by channeling private sector wealth into low-return public projects, through the monopoly banking sector, becomes an optimal and efficient solution:  it is efficient because (1) the cost of “tax “collection is low (you can avoid it only if you completely go underground) (2) the “taxation” is relatively fair and less distorting (it is proportionate to your existing wealth).

Certainly it is even better if the government does not try to extort the private sector in the first place. But if the government does do it, it is better that it does it through the banking sector. At least you don’t need to pay the robber to rob you, and at least hard-working people don’t have higher chance of being robbed.

When a gun is pointed at you, it makes no sense to fight. Take my money but don't hurt me.

Financial Repression and Optimal Taxation (pdf file)

Chong-en Bai, David D. Li, Yingyi Qian, Yijiang Wang

Financial repression entails an implicit taxation on savings. When effective income-tax rates are very uneven, as common in developing countries, raising some government revenue through mild financial repression can be more efficient than collecting income tax only.

William Seidman (former FDIC chairman)’s banking jokes

L.William Sediman was chairman of Federal Deposit Insurance Corporation (FDIC). He has produced numerous banking jokes. Below I put together some of them.

On Russian banking problem:
“Ivan asked his mother – mother, why have I got the biggest feet in the third grade? Is it because my dad was communist? She says, no son, it’s because you’re 19”

On Russian lending problem:
“I went into one small bank and there were three or four of the tougher looking Russians sitting around with AK47s and I said, I know that crime is awful around here, but do you need to have a real army here to defend this small of a bank? They said, well, they are not here to defend the bank, those are the people who collect our loans.”

On Japan banking problem:
“A doctor calls up his patient and says, I have bad news for you and worse news for you. You have only 24 hours to live. The patient says, oh, that’s terrible. What could be worse news? The doctor says, I’ve been trying to get you since yesterday”

On World Bank’s blank check aids
“I was there for the World Bank and we had $2 billion to spend, and if you want to really be treated royally, just wander through Russian with $2 billion that you can provide  them I got so full of caviar that I couldn’t look at a fish egg again.”

On Japan’s stagnation:
“They’ve been in a non-growth economy for many years now... if something like that was going on this country, there would be a revolution. The fact of the matter is in Japan, the average Japanese citizen may be better off than he was seven years ago... since they  have experienced deflation in effect, the average person in Japan is living as well or better than he did in the past. As a matter of fact, the crash in real estate prices ahs allowed lots of Japanese to now live somewhere closer to their work than a two-hour commute by train to Tokyo”

Finance professors rush to China

2006 seems to be a Year of China for economics and finance professors. Although many professors already realized the importance of China very early on, it is in this year that people start to think that the next research frontier has to be China, and you better start working on some China-related topics before others publish them. Professors are no different from multinational corporations that rush to China to seek for profits.

A keystone is that the Financial Intermediation Research Society, a prestigious association of U.S. and European finance professors, headed by Wharton Professor Franklin Allen, decided to host its biennial conference in Shanghai, China.

Here I recommend two papers by Franklin Allen that I think can help you better understand the past, present and future of China’s financial system. They are not very technical papers, so you shouldn’t need any academic background to understand them.

China's Financial System: Past, Present, and Future  (pdf file) (by Franklin Allen, Jun "QJ" Qian, and Meijun Qian)

Abstract:  We examine and compare the role of China's financial system in supporting the growth of firms and the economy with that in other countries, and explore directions of future development. First, we find that the current financial system is dominated by a large but inefficient banking sector, and reducing the amount of non-performing loans among the major banks to normal levels is the most important objective for reforming the financial system in the short run. Second, despite the fast growth of the stock market, its role of resource allocation in the economy has been both limited and ineffective. Further development of China's financial markets is the most important long-term objective. Third, we find that the most successful part of the financial system, in terms of supporting the growth of the overall economy, is a non-standard sector that consists of alternative financing channels, governance mechanisms, coalitions, and institutions. This sector should co-exist with banking and markets in the future in order to continue to support the growth of the Hybrid Sector (non-state, non-listed firms). Finally, in order to sustain stable economic growth, China should aim to prevent and halt damaging financial crises, including a banking sector crisis, a real estate or stock market crash, and a "twin crisis" in the currency market and banking sector.

Law, Finance, and Economic Growth in China  (pdf file)

Abstract:      China is an important counterexample to the findings in the law, institutions, finance, and growth literature: neither its legal nor financial system is well developed by existing standards, yet it has one of the fastest growing economies. We examine 3 sectors of the economy: the State Sector (state-owned firms), the Listed Sector (publicly listed firms), and the Private Sector (all other firms with various types of private and local government ownership). The law-finance-growth nexus established by existing literature applies to the State and Listed Sectors: with poor legal protections of minority and outside investors, external markets are weak, and the growth of these firms is slow or negative. However, with arguably poorer applicable legal and financial mechanisms, the Private Sector grows much faster than the State and Listed Sectors, and provides most of the economy’s growth. This suggests that there exist effective alternative financing channels and governance mechanisms, such as those based on reputation and relationships, to support this growth.

A disturbing inside peek at China's financial mania

Christopher Whalen has some great insights into Chinese banking sector in his article “The Next Great Pyramid Game: a disturbing inside peek at China’s financial mania” . Investors, read it before buying into Chinese banks!

“China’s leaders do not recognize or even understand what it means to operate private banks with private borrowers and private property in a market economy where corruption is not the dominant factor in everyday life.”

“China’s economy is like the old burlesque comedian with a loose string that when pulled disintegrates his suit.”

He however does have some hope on the ongoing baking reforms in China.

“If American manufacturers think they are having a tough time competing against Chinese manufacturers now, just wait until the day Chinese manufacturers have access to capital at market rates!”

Why financial deregulation was bad for OECD countries but will be good for China?

There is a theory that financial deregulation may be bad for China.  The idea is that when liquidity constraints on households are removed, people may save less, and if high saving/investment  rate is important for rapidly growing countries such as China, China may lose steam as a result of financial sector deregulation.

This is true in the history. Empirical results suggest that financial deregulation in the 1980s has contributed to the decline in national saving and growth rates in the OECD countries.

China however is a different case. She already saves too much, and now everyone agrees that domestic demand/consumption  needs to be jump started. Chinese financial sector is also terribly inefficient, and deregulation of financial sector will improve it mostly in asset allocation front instead of consumer lending front.  For cultural reasons, it is also hard to convince Chinese consumers to take out loans from banks to increase spending.

Currently consumer lending has very small share in Chinese banks’ loan portfolio. This is increasing over time because banks are seeing it as a more profitable and safer business, and foreign banks (e.g. Citibank) are particularly interested in developing products for high net-worth consumers and the rapidly emerging middle class.

Anyway, I can see no reason why cost of financial deregulation (in reducing saving rates) will outweigh its benefit (in increasing consumption and transform China’s economic growth  into a demand-driven model)

Saving, Growth, and Liquidity Constraints
By Tullio Jappelli and Marco Pagano (published in the Quarterly Journal of Economics)
Abstract : In the context of an overlapping-generations model, the authors show that liquidity constraints on households (1) raise the saving rate, (2) strengthen the effect of growth on saving, (3) increase the growth rate if productivity growth is endogenous, and (4) may increase welfare. The first three positions are supported by cross-country regressions of saving and growth rates on indicators of liquidity constraints on households. The results suggest that financial deregulation in the 1980s has contributed to the decline in national saving and growth rates in the OECD countries.

China bad loans may reach total of $900 billion; IMF urges China to restrain lending

(1) “China’s total liabilities for non-performing loans may be as high as $900bn, dwarfing official estimates and outstripping the country’s massive foreign exchange reserves, according to a study of Beijing’s bad debt problem. The study, part of Ernst & Young’s annual global survey of NPLs, says China’s big four state banks alone have bad loans worth $358bn, or more than twice official estimates.” – Financial Times

Update (05/15/06): Ernst & Young withdrew the report admiting that the report contains errors and did not go through normal internal approval procedure. But it is not clear whether they do it because of government pressure and/or concerns for losing lucrative clients among Chinese state-owned companies.

(2) “The International Monetary Fund urged China on Tuesday to tighten access to credit, saying that last week's modest interest rate increase was insufficient to stave off economic overheating. China's M2 measure of money supply, which includes all cash and bank deposits, rose 18.8 percent in March from a year earlier to 31.1 trillion yuan, or $3.88 trillion. The value of new lending in China rose more than 60 percent in the first three months from a year earlier.” --- International Herald Tribune

How could one of the most successful bank regulatory systems fail so easily? The case of 2001 Argentina

Found an old working paper written by Charles Calomiris (Professor in Columbia University) and Andrew Powell (then Chief Economsit of Central Bank of Argentina) back in 2000, in which they portrayed Argentine banking regulatory system as one of the two or three most successful in emerging economies and a role model for every one to follow.

Browsing through the paper, I am deeply impressed by the quality of Argentine system at that time. The Central bank even had an online database of debtors (I don’t know whether they still supply this service) where general public can enter a company name and know the name of the bank extending the credit, the amount of the credit, the quality category of the loan, and the details of any guarantees extended. Bank depositors, shareholders, and researchers thus were able to monitor banks’ credit exposure at real time. Absolute disclosure as a tool for market discipline! This is what any economists would theoretically advise and seldom expect to be realized in the real world. The Central Bank of Argentina however managed to make it happen. If I read this paper in 2000, I would have invested all my money in these wonderful Argentine banks.

Within a year, however, as everyone has known, Argentine banking system failed. Not the bankers' fault; not the bank regulator's fault. The government screwed up in macro policies and brought down the banking system -- something that Calomiris and Powell thought wouldn't happen, not again!

Several lessons for observers:
(1) It is always more risky to praise a country than criticize it. When you criticize a country, you can never be falsified because you can always argue that the arrival of crisis is just a matter of time. When you praise a county, however, the natural law of mean-reversion will always prove you wrong. Things can only get worse.
(2) As a banker, however smart, honest and hard-working you are, the state is always trying to screw you up by some irresponsible fiscal and exchange rate polices. Don’t under-estimate the evilness of government. In the wake of every crisis, Argentines think: “the government won’t do it (freeze the deposit)  again.”. The government won’t change.
(3) When everything looks so wonderful, something must be wrong! If you cannot find it after doing extensive research, something very big must be wrong.

Can Emerging Market Bank Regulators Establish Credible Discipline? The Case of Argentina, 1992-1999 By Charles W. Calomiris, Andrew Powell
Abstract: In the early 1990s, after decades of high inflation and financial repression, Argentina embarked on a course of macroeconomic and bank regulatory reform. Bank regulatory policy promoted privatization, financial liberalization, and free entry, limited safety net support, and established a novel mix of regulatory and market discipline to ensure stable growth of the banking system during the liberalization process. Argentina suffered some fallout from the Mexican tequila crisis of 1995, but its response to that crisis (allowing weak banks to close) and the redoubling of regulatory efforts to promote market discipline after the crisis made Argentina’s banking system quite resilient during the Asian, Russian, and Brazilian crises. Argentina’s bank regulatory system now is widely regarded as one of the two or three most successful among emerging market economies. This paper traces the evolution of the regulatory policy changes of the 1990s and shows that the reliance on market discipline has played an important role in prudential regulation by encouraging proper risk management by banks. There is substantial heterogeneity among banks in the interest rates they pay for debt and the rate of growth of their deposits, and that heterogeneity is traceable to fundamental attributes of banks that affect the riskiness of deposits (i.e. asset risk and leverage). Moreover, market perceptions of default risk are mean-reverting, indicating that market discipline encourages banks to respond to increases in default risk by limiting asset risk or lowering leverage.

What do Brazilian firms get for contributing money to politicians? More money.

Businessmen are not running charity organizations; They are pragmatic and calculating;  They wont’ give you money for free. For every dollar they give you, they will at least recover the costs. Last time I covered an academic paper about Thai elections, which shows that businessmen-cum-politicians reap huge benefits after they get into power. This is true for Brazil too. Let me show you a recent study.

Stijn Claessens and  Luc Laeven (World Bank) and Erik Feijen (University of Amsterdam) examine political campaign finance in 1998 Brazilian elections and find that elected politicians might  be  able to feed back to their financial supporters by directing more banks credits (presumably from state-owned banks) to them.

Every investor in Brazil (I would say it is more the case in Italy where everything is about politics) understand such game; As a matter of fact, we find that stock prices of those listed firms that contributed to politicians rose sharply over  election days.

A further question I would like to ask is: if the rule of the “game” is so clear, why do some firms contribute while the others do not?  Well, certainly I don’t believe that those who don’t contribute are cleaner in their conducts. But why don’t they contribute?

In many developing countries, those who contribute to politicians are actually the least connected. Politicians in Brazil routinely request kick-backs or "monthly-payment" from the business community. A tape revealed that Waldomiro Diniz (an advisor to the Minister Jose Dirceu) was extorting the gambling mafia of Rio de Janeiro to gain funds for Worker's Party political campaigns. These mafias are just underdogs. Those who are truely connected sit on corporate boards.

Those tycoons who really hold de facto power don’t give a shit to these politicians: In January 2002, Celso Daniel, who had already been appointed coordinator of Lula's campaign for the October elections was murdered. Unless there emerges a strongman military dictator, it is more likely that the tail (business tycoons) will wag the dog (politicians)!

Does Campaign Finance Imply Political Favors? The Case of the 1998 Brazilian Elections

Abstract: This paper provides empirical evidence that campaign contributions are strongly associated with market expectations of future firm-specific political favors, including preferential access to external financing. Using a novel dataset, we find that firms in Brazil providing contributions in the 1998 campaign to (elected) federal deputies experienced higher stock returns following the election, even after controlling for industry-specific effects. This suggests that federal deputies were expected to shape policy to benefit these firms in particular. Consistent with such political favors, we find that these firms relative to a control group substantially increased their financial leverage in the four years following election, suggesting that contributions gained firms preferential access to finance.

For a review on campaign finance's role in Brazilian politics, please read Professor David Samuels' article: Money, elections, and democracy in Brazil

It is more profitable to lend to “priority sector” in India?

According to a report in Indian Times, Chennai-headquartered Indian Bank is making very good profits in so-called “priority sector”(agriculture, backward areas, women-owned businesses, etc), to which other banks are willing to lend only when forced to by the government.  According to another report in Hindu Business Line,  many banks actually have to buy loans from public sector banks in order to meet the government-set target of priority sector lending.

Thus the news sounds too good for me to believe ( I checked my calendar and today is not April the First). The report doesn’t give details on how they manage to do it, but I think we definitely need to learn from them if it is true.

“At a time when most banks are fighting for market share in corporate/SME business, Chennai-headquartered Indian Bank is betting big on priority sector lending.  Against the mandated 40%, this bank’s priority sector portfolio accounts for 51% of its advances. “Our experience of lending to priority sector has been good. Non-performing assets (NPAs) in agriculture, for instance, account for less than 2% of that portfolio. The average net interest margin (NIM) is around 4% which is much higher than what we would get by lending to corporates,” says KC Chakrabarty, the bank’s CMD.”

How do they do it? If any readers know about articles about the experience of Indian Bank's lending to priority sector, please let me know. I'd like to look into it.

Indian state-owned banks introduce performance-linked incentive packages for employees: the true story

According to a report in today’s Business Standard, India’s finance ministry decided on a reform plan to improve efficiency in state-owned banking sector. In the plan, not only the chairmen and executive directors but also ordinary employees are entitled to  performance-linked incentive packages.

“Heads of 29 public sector banks are set to get a performance-linked annual incentive package. Besides, all of them will get a lumpsum ex-gratia payment on retirement, depending on the number of years they put in as directors on bank boards.  Down the line, close to 800,000 employees in the public sector banking industry, too, will get incentives, based on their performance in five key areas.”

Five parameters are considered to determine the size of annual bonus,  which includes “credit growth, deposit mobilization, quality of assets, and recovery of non-performing assets.” (The report mentions only four parameters though).

I don’t think such design can help achieve the efficiency goal.

First of all, credit growth and deposit mobilization has nothing to do with efficiency; to the contrary, for India, faster credit growth and deposit mobilization  in state-owned banks actually reduce financial stability and crowd out efficient investment (as state-owned banks typically use the deposits to purchase government bonds instead of to invest in good projects).

Secondly, the “incentive” package is not linked to individuals’ performance but the performance of the whole bank. No employees will work hard to improve quality of assets or to recover non-performing loans, because (1) if he works hard, his colleagues in all branches across India can free-ride on the results as well (2) if he doesn’t work hard, he can still receive bonus pay so long as his colleagues work hard (3) knowing this, no one work hard.

There are restrictions on the total size of the incentive package: “The maximum amount a bank can pay to employees through this route will be capped at 1 per cent of a bank’s profit after tax (PAT).”  Nevertheless, no details are given regarding what fractions of this 1 per cent will be allocated to ordinary employees. Theoretically, all of them may be allocated to the CEO, which did happen in many corrupted countries when they introduced so-called “employee” incentive package. As a matter of fact, I also notice that: “Financial incentives given to chairmen and executive directors will be outside the cap (1 per cent of PAT) applicable to bank employees.”  Ha, I caught you!

I speculate that the plan is drawn up simply for the purpose of legally tunneling money from the state treasury to chairmen and executive directors of state-owned banks.

China’s non-performing loan ratio down to 8.9 pct?

China's major commercial banks NPL ratio 8.9 pct at end-2005
SHANGHAI (AFX) - China's banking regulatory agency said the non-performing loan (NPL) ratio of major commercial banks fell to 8.9 pct as of the end of 2005, or 4.3 percentage points lower than at the beginning of the year.

I don’t believe in this number at all; there is no way that the non-performing loan ratio is so low. But I trust that the non-performing loan ratio is indeed going down, as a result of transfer of bad loans to asset management companies, huge cash injections by the government, large retained profits, and current economic boom.

Raghuram Rajan on Chinese financial sector reform

Related to IMF China mission chief's remarks on Chinese reform priorities, Raghuram Rajan also made similar statements one week earlier (Jan 8, 2006) at the American Economic Association (AEA) meetings.

The title of the speech is "Financial system reform and global current account imbalances". The title is not about China, but the whole speech is centered on China's financial sector reform. As a matter of fact, AEA later invited Dr.Rajan to, based on his speech, co-write a policy article with former IMF China mission chief Eswar Prasad, titled "Modernizing China's growth paradigm", to be published in May issued of American Economic Review. Looking forward to reading it.

Some background reading:
(1) Raghuram Rajan: "China's Financial-Sector Challenge", at Financial Times (May 10, 2005)
(2) Eswar Prasad: "Next Step for China: Why financial sector reform is a crucial element of a long-term growth strategy", Finance & Development (September 2005 issue)

By the way, Dr.Rajan was invited by Chinese National Development and Reform Commission (a government agency in charge of economic reforms) to make the same speech to Chinese officials in July 2005. Chinese are keen in hearing different opinions, however harsh they may be.

I am not that lucky. Since some time ago I have not been able to post any comments on an Indian economy blog. Maybe I shouldn't have criticized India for her mounting government debt. I am still reading their blog though, because I find a lot useful information in it. Why reject information?

Was there a corporate governance failure in Asian financial crisis?

Till these days, I am still not very sure whether the largest problem in Asian financial crisis is corporate governance failure. If the goal of corporate governance is to maximize shareholders' profits, then I think we had very good corporate governance back then.  The losers in Asian financial crisis were creditors, depositors, and taxpayers, none of them are whom corporate governance is supposed to protect. So it was more a government failure, as it is the government's job to protect taxpayers and creditors.

Let’s not confuse between corporate governance and corporate operation. For example, below I cite some statement by ADB.  They seem to be blaming everything on “corporate governance”, but they are actually talking about financing decisions, which is about how a corporation is operated.

“The high level of nonperforming loans among banks and the over-reliance of the corporate sector on them reflect both weak governance and the lack of alternative financing sources to banks.”

Well, how could choice of capital structure be directly related to corporate governance?? We can call it a bad finance decision in hindsight, but  at that point in time, when short-term debt was cheap, it was absolutely in the interest of shareholders to choose such capital structure.  Mismatch of maturity and currency structure in borrowing was key in bringing down Asian corporations. But this is about risk management, not corporate governance.

Cronyism lending is certainly bad. But from the perspective of shareholder in the borrower firm, it is good corporate governance that the firm borrows from connected banks at favorable terms, because it maximizes the profit of shareholders in the borrower firm, although to less extent for minority shareholders.

Even shareholders in the bank benefit, given that depositors, and ultimately taxpayers (when government bails out failed banks)  bear the cost of banking failure, while shareholders may well enjoy higher return had the banks not failed.

If we establish that corporate governance is about the interest of shareholders, then Asian financial crisis is a state failure, not a market failure created by the corporate sector.  The reason why minority shareholders are willing to participate is exactly that they expect they can still extract rents from other parties even after expropriated by the majority shareholders. Thus the greatest problem is transfer of wealth from consumers, potential competitors etc to the listed companies.  And even if the corporate governance is perfect, this benefit transfer will continue, because it is to the interest of shareholders to use political connection to gain benefit for the firm. When corporate governance is weak,  majority shareholders get larger share of the pie, but minority shareholder also benefit, though to lesser extent, otherwise they wouldn’t  have participated in the first place.

If anything about corporate governance has to be done at all, it is about the corporate governance  of banks and financial institutions, not the non-financial corporate sectors. I however won’t call this corporate governance reform, because such reform is about better protection of depositors and taxpayers, who are not shareholders.

For the corporate sector, the problem is  more about the risk management technique. I am sure controlling shareholders have best incentive to adopt good risk management, if they know that corporate failure may trigger nation-wide crisis and no one (including themselves) can escape. I still have strong belief that no incumbent would try to sink their own boats even when they have their own life boats. You still lose a lot, although less than the costs incurred by minority shareholders. It is common knowledge that, when the economy is in turmoil, political powers are more likely to change hands, and no incumbent will like to see it happens, let alone creating it on purpose. The crisis was unexpected for them too.

Who lose when foreign banks enter?

It is not clear whether the entry of foreign banks will benefit local small businesses that are previously underserved by domestic banks. Foreign banks certainly will bring competition to the market which should improve allocation of credits, but as new entrants it is also easier for them to focus on small number of big and very profitable corporations, without stretching too much to reach numerous small businesses. 

But one thing is clear:  connected firms won’t benefit from foreign banks. Foreign banks don’t care whether you are nephew of Suharto!

Mariassunta Giannetti (Stockholm School of Economics) and Steven Ongena (Tilburg University) assess the credit conditions in Eastern Euroopean countries after entry of foreign banks. They find that, one the one hand, small firms benefit less than large firms, but they do benefit; on the other hand, those firms set up in the early stage of economic transitions, presumably by those most connected red barons, are absolute losers facing  the new landscape of banking sector.

Financial Integration and Entrepreneurial Activity: Evidence from Foreign Bank Entry in Emerging Markets    
An extensive empirical literature has documented the positive growth effects of equity market liberalization. However, this line of research ignores the impact of financial integration on a category of firms crucial for economic development, i.e. the small entrepreneurial firms. This paper aims to fill this void. We employ a large panel containing almost 60,000 firm–year observations on listed and unlisted companies in Eastern European economies to assess the differential impact of foreign bank lending on firm growth and financing. Foreign lending stimulates growth in firm sales, assets, and leverage, but the effect is dampened for small firms. The biggest losers from foreign bank entry however appear to be businesses that can be identified as connected to the government or domestic banks. Overall, our findings suggest that foreign banks can help mitigate connected lending problems and improve capital allocation.

Why is India’s financial system less solvent than China’s?

First, I have to make it clear that, I am NOT saying that (1) India’s financial system is insolvent, or (2) China’s financial system is solvent. I am only arguing that India’s financial system is less solvent than China’s, i.e., you should worry about India too if you think China’s financial system is in big trouble.

There is this popular view that India is blessed by a sound and efficient financial system, while China will be troubled by the huge amount of non-performing loans sooner or later.

It is however not clear whether India’s or China’s financial system has greater amount of “non-performing assets”, because financial system is consisted of both the banking sector and the government public finance system.  Chinese banks have to assume some public finance roles and fiscal functions, while India parks all bad assets in the government’s public finance balance sheet. We thus need to take into account India’s bankrupt public finance system when we compare China and India’s financial systems.

In the early stage of China’s economic reform, in order to increase the efficiency of distributing resources, part of the government’s fiscal function was transferred to commerical banks that were spinned out from the planning-era mono-bank. Before the reform, there were no commercial banks, and planning commission of the central government was in charge of disbursing all investment funds.

Certainly state-owned banks are less efficient than private-sector banks, I don’t deny. But this move was an improvement of efficiency for public finance, which is also part of the financial system.  Later empirical studies show that state-owned banks distribute resources more efficiently than government agencies, partly because there are four state-owned bank of equal size operating nationally that are competing with each other.  Most of the non-performing loans were accumulated in this transition period. Argubaly, the other option at that time was to park these liabilities direclty in the government’s public finance balance sheet. This option is choosen by India.

In India, banks are not asked to assume these fiscal functions (burdens) as Chinese banks are, and thus the banks are much healthier. But we have to understand that bad "white elephant" projects are still there. They have to be financed by someone. They are financed by the government, directly. These "non-performing" liabilities don’ disappear, they are simply moved from the balance sheet of the banking sector to the balance sheet of the government’s public finance.  When an Indian PSU wants funding, the government borrows money and the liability is in the government’s balance sheet.  I don’t think PSU sector in any time soon will return large amount of money to the government, and I thus can assume that all the investment in PSUs by Indian government can be defined as “non-performing” if we think of the government as a “bank” that pursues profits

When we evaluate the health of India’s financial system, we have to evaluate the system as a whole, not only the banking system, but also the public finance system.  India’s public debt is more than 80% of its GDP. If Chinese government leverages its public debt to this level, she will have more than sufficient funds to write off all non-performing loans in state-owned banks. And it is legitimate for the government to do for she is the lender of last resort.  This is why depositors are still pouring more money into the system.  For India, the risk is in the balance sheet of the government, and IMF is her lender of last resort.

The reasons why India’s financial system is less solvent than China’s are that (1) when public finance and bank finance is combined, India’s balance sheet is more leveraged; (2) Chinese banks, although much less efficient than Indian banks, allocate resources better than Indian government; (3) India has a bigger public sector, more aggressive and less responsible fiscal policy;  (4) It is not clear whether IMF will bail out Indian government in a prompt fashion when she declares bankruptcy, while Chinese government will certainly bail out her banks as their is concensus that the banks have suffered for the government and it is time for paying back now that the government is flooded with tax revenues that are rising +20% yearly.

Note:   I don’t deny that China’s banking system also is in big trouble. How to improve efficiency of Chinese banks is an extremely difficult task.

"China hand" Jeffrey Williams to leave Shenzhen Development Bank (China's first bank controlled by foreign investors)

Breaking News: Jeffrey Williams will leave from his position as president of Shenzhen Development Bank (SDB).  SDB became the first Chinese bank controlled by foreigners after Newbridge Capital Group, a Fort Worth-based private-equity firm, acquired 18% of its shares in 2004. After that, Newbridge replaced the whole management and appointed Jeffrey Willams as president. Jeffrey Willams is the former CEO of Standard Chartered Bank in Tawain, and twenty years ago he openned Citibank's first mainland branch in Shenzhen. He is knowned in the industry as a China hand. In 1979, when he made his first trip to China and taught in Beijing University, he earneed the equivalent of $100 a month.

It is still unclear who will be Mr. Williams' new employer. Well, Citigroup recently acquired majority control of Guangdong Development Bank (GDB)- a much bigger player troubled by similar problems. President of GDB sounds a perfect position for Jeffrey Willams.

For NewBridge Capital's involvement in Shenzhen Development Bank, a Business Week article "The Great Bank Overhaul" provides a good review.

India people should stop hoarding gold: it is unproductive!

Indian people are the world’s largest consumers of gold. They possess $200 billion of it, equal to nearly half of the country’s bank deposits. By any definition, investment in gold is unproductive.  In the meantime, the country has saving rate and investment rate that is much lower than China; While the country is thirsty of finance, Indian banks put nearly 50% of depoisits in government bonds. Very unproductive!

According to a McKinsey report, Indian government has proposed to let Indians buy virtual, or “paper,” gold in denomination as low as $2. Savers can trade in it and get the current market value of whatever quantity they had bought. The goal is to let banks make loans based on their gold deposits, as they now do with cash deposits.

Goldman Sachs acquires stake in China's largest bank

Goldman Group to Invest in Chinese Bank
SHANGHAI, Friday, Jan. 27 - An investment group that includes Goldman Sachs, Allianz of Germany and the American Express Company is expected to announce Friday that it will pay about $3.8 billion for a 10 percent stake in the Industrial & Commercial Bank of China, China’s largest government-owned bank, according to people close to the deal.

So far, among the four largest banks in China, only the Agriculture Bank hasn't recieved any foreign investment. Foreign banks typically put in $ 3 billion to acquire 10% non-controlling stake. To put the size into perspective, $ 3 billion can certainly get you full control of ICICI bank in India, which is the largest private sector bank.

Let's take a count of foreign banks' latest investments in China: 

Citigroup put $ 3 billion into Guangdong Development Bank (85% share) -- pending (exceptionally difficult) regulatory approval
Bank of America put $3 billion into China Construction Bank (non-controlling)
Royal Bank Of Scotland and Merrill Lynch put 3$ billion into Bank of China (non-controlling)
Temasek Holdings willing to put $4 billion into Bank of China (non-controlling)
..........

Finally, I recommend to you a very good review article published by USA today: Only the bravest of bankers boldly go into China

Should BB&T bank make loans to "eminent domain" projects?

BB&T won't offer eminent domain loans
JAN. 25: Regional bank BB&T Corp., one of the nation's largest financial institutions, will make no loans to developers who plan to build commercial projects on land taken from private citizens by the government through the power of eminent domain, the company said Wednesday.

Certainly it is wrong for the government to obtain private property through "eminent domain", but I think the management of BB&T Corp by taking this action violates its fiduciary duty to the shareholders. After all, whether BB&T should give up business opportunities (and profit) in such project (however immoral they are) is up to the judgment and decision of the BB&T shareholders. The management of BB&T should not put their ideological belief before the interest of shareholders, becasue they are employed to increase value for shareholders, not as political advocates.

The case for having “stupid” banks

Russians bankers are very smart, and thus they will never lend for your business investment (except in resource extraction industry, where it is easier to collateralize you revenues). They know very well that if they do they will end up with a lot of non-performing loans for sure, being aware of the unmatched skill of Russian borrowers in cheating. But is this what we really want? A stable but non-lending banking sector? Why don't you just use your own piggy bank! If they are not performing their roles, why do we care about how stable they are and how low a non-performining loan ratio they've achieved?

Banks not investing enough in economy

Bank credits only account for 7%-8% of total investment in the country and 2%-3% of that are foreign bank credits, he said at a banking conference in Yekaterinburg on Friday. "This is a very small investment in the development of the Russian economy and such a situation needs to changed at the root," he said.

MOSCOW. Jan 27 (Interfax) - Russian banks are not investing enough in the country's economy, Deputy Central Bank Chairman Gennady Melikian said.

China has a huge banking sector, with a lot of non-performing loans. I however argue that, to promote economic growth in a mid-income developing country, it is better to have a Chinese banking sector than to have a Russian one.

Let me explain why non-performing loan is NOT a problem.

When you get bad loans, it doesn’t mean that some wealth is burned away.

Let me give you an example: I have one apple, and I decide to loan it to you and you promise to return two apples to me at the end of the period. You plant the seeds (let’s assume for simplicity that you cannot eat the apple without destroying the seeds), and grow an apple tree with four apples in the tree. Then, either (1) you harvest them and run away from me (i.e. corporate governance problem) (2) Your neighbors come at night and quietly eat them all (business environment problem) . Either way, the result is that I have bad loan, because you don't return apples to me as you promised. But for the society this “project” produces four apples of benefit out of one apple. Remind you that even it the case that you neighbors steal and eat the apples, the society benefit as your neighbors are part of the society too.

However, if I decide not to loan you the apple, but eat it (with the seeds), there will be no bad loans, but no benefit for the society, either. This is what happens in Russia, India,Mexico, etc , where the banking sector doesn’t lend to any risky (but socially productive) investment projects. No one lends, and no bad loans for sure.

In China , however, government-owned banks are “stupid”. They build roads, power plants, steel plants, etc, and somehow borrowers always manage not to pay back the loans, and the banks have a lot of bad loans. But it doesn’t mean that these roads and plants just vanish. The social value of these big projects may be very positive. And as a matter of fact, most of the government-directed investments are put into infrastructure or heavy industries; the tasks are so well-defined that even inefficient SOEs can deliver the projects without wasting too much money (well, they certainly waste a lot of money)

Most private enterprises in China “steal” well-trained engineers and technicians (who bring with them the core techonology too) from SOEs, and some even “loot” the SOEs for machines, but these engineers and machines do not disappear from the economy although they are recorded as loss for the SOEs. So all of these bad loans are just something on the balance sheet, whose share will mechanically shrink as the economy grows bigger.

Finally, I have to remind you that most of China's non-performing loans are the results of policy lending, which means that the state-owned banks are taking away some fiscal burdens from the government. In India, non-performing loan ratio is low, but the government accummulates huge public debts to finance projects that if put into private banks' loan portfoilos will in all cases become "non-performing loans". If you accuse these projects to be unproductive, then they should be unproductive no matter whether they are in banks' portfolios or in government's portfolio. As a matter of fact, Chinese banks allocate resources better than their Ministry of Finance, and thus letting the state-owned banks to perform fiscal role is definitely efficiency-improving.

Smart private sector bankers will shy away once cheated, but stupid state-owned banks will just keep on lending. Sometimes a little bit stupidity accidentally leads to better results. Wright brothers were stupid; Thomas Edison was stupid too.... A smart banker should never listen to Wright brothers, and should never have lent to Delphi, Visteon, Ford, GM.... well, there were no defaults in primitive age when people only bartered...

Wal-Mart Bank

Wal-Mart is seeking to establish  a bank in Utah to process credit card, debt card and electronic check transactions from its retail locations. Anti-Wal-Mart groups are furious and argue that Wal-Mart Bank will post threat to the economic health of the nation. I fail to follow how they come to this conclusion. Whenever anything is to affect these small group of people's entrenched interests to the benefit of consumers, they warn us that it is going to hurt the whole nation.

“Federal regulators need to heed Chairman Greenspan’s warning and realize that a Wal-Mart bank would pose serious and grave threat to consumers, community banks and the economic health of this nation,” said Chris Kofinis, communications director for WakeUpWalmart.com, a group funded by the United Food and Commercial Workers union.

Among politicians, Senator Hillary Clinton is the most active opponents against the formation of a Wal-Mart Bank. She never goes shopping in Wal-Mart stores, neither does she needs a Wal-Mart credit card. She doesn't care about those who go and those who need. She even pushs the Federal Deposit Insurance Corporation (FDIC) to hold an unprecedented public hearing on the application. What the hell has Wal-Mart Bank has to do with FDIC? Wal-Mart Bank will not take deposits anyway.

China: one country, many banking systems

China is a political unity, but when it comes to financial system, it is deeply fragmented.

Genevieve Boyreau-Debray (World Bank) and Shang-Jin Wei (IMF) find that the level of financial integration (or segregation) across Chinese provinces is similar to that across OECD countries. The level of integration actually decreased over 1990s. To make things worse, the government tends to reallocate capital from more productive regions towards less productive ones.

Pitfalls of a State-Dominated Financial System: The Case of China 
Abstract:      
This Paper examines pitfalls of a state-dominated financial system in the context of China. These include possible segmentation of the internal capital market due to local government interference and misallocation of capital. First, we employ two standard tools from the international finance literature to analyze financial integration across Chinese provinces. Both tests confirm a similar (and somewhat surprising) picture: Capital mobility within China is low! Furthermore, the degree of internal financial integration appears to have decreased, rather than increased, in the 1990s relative to the preceding period. Second, we document that the government tends to reallocate capital from more productive regions towards less productive ones. In this sense, a smaller role of the government in the financial sector might increase economic efficiency and the rate of economic growth.

Fix Mexico's banks, not China's

It always puzzled and shocked me that some Latin American and Eastern European countries have private credit to GDP ratios of merely some  30%.  What can you do with so little credit? It is barely enough to sustain basic investment given some reasonable assumption of asset-to-GDP ratio.

I notice that bank in Asians' definition is quite different from what people outside Asia define banks.  In Asia,  bank lending strikes you as commercial and industrial (C&I)  lending that finance purchase of equipment and building of factories, while outside Asia banks focus on mortgage and consumer lending, and seldom go beyond working capital financing when they lend to businesses. So Asian banks are actually development or long-term credit banks in Western definition, and certainly we cannot evaluate their performance based on the same safety requirments, if we want them to promote economic growth. Development banks will certainly be more leveraged and have higher NPL ratio as they lend to risky long-term projects. In the meantime, in Asian's definition, many Latin American countries don't have a banking sector at all, if only bank lending that finance future growth is counted as banking.

Here comes the trade-off between stability and economic growth.  I assume that it is C&I lending that really matter to economic growth. If banks never finance equipment purchase or long-term investment, then they are stable, but in the meantime they are not really doing their bit to the economy.  This is why Mexican banks are in relatively good shape now in balance sheets. In China, lending has historically been 100% C&I loans, while in the United States C&I loans account for only 15% of banks' loan portfolio. Certainly NPL ratio will be higher if you do C&I, but we have to understand why we need banks in the first place when it comes to development: we first want them to do C&I so as to promote economic growth, and then come in the second requirement that we want them to stable.  Stable banks that don't do much C&I lending is no better than "narrow banks".   10% C&I loan ratio is good for the U.S., because academic studies  show that at this very mature stage of development the overwhelming sources of financing for U.S. big corporations is not external finance, but  internal cash flows (i.e., the old money). This however doesn’t  work for developing countries.

Inefficient allocation of funds is certainly one main reason why non-performing loan ratio is high, but high NPL ratio only means that the private benefit of the failed projects are negative, the social benefit could still be positive. For many developing countries, it may not be profitable to invest in roads, dams, power plants, etc, but there is no question that the society’s benefit is far higher than the cost. In China’s case, the high NPL ratio is more a result of banks sharing some fiscal burden with the cash-constraint government at the beginning of the reform. Also, after reforms, some fiscal expenditures are no longer allocated by the bureaucracy  system, but through the banking system (which I admit is certainly also heavily influences by the government.)  Research however shows that Chinese banks allocate funds more efficiently than the governments. Certainly, they are still very inefficient, but please compared it to the alternative that the government would allocate the funds, and please take into account the stable fiscal stance in China as a result of this transfer of duty to “private sector”.

What happens in many countries is that, when we emphasize stability (particularly after crises) , many banks switch completely to residential mortgage, consumer, and working capital lending, which also help reduce their risk-weighted assets defined by Basel Capital Accord. But then they are not banks anymore, in the sense that real banks should do C&I lending and finance expansion and growth of the industrial sector.  When banks are privatized they will certainly switch immediately to mortgage and consumer lending, which are same and sometimes also very profitable, and you don't have a real banking sector anymore to achieve poverty-reduction goal.

Maybe Singapore's Temaesek with DBS bank is solution struck in the middle?  Let the private sector do what they want to do (montage, consumer and working capital lending), and let the public sector do what public sector should do (long-term credit). State-owned banks can be very inefficient, but it is still more efficient than letting ministry of finance to directly allocate long-term credits.

Micro-Savings institutions in a rich country

The development community is very interested in finding measures that can increase poor and rural people’s access to bank accounts, in order for them to be able to manage their savings and smooth their consumptions. Many people believe that we have to be very innovative in achieving this goal because it is difficult to serve poor people without heavily subsidizing the system.

Not really. Japan did it perfectly well, with very traditional methods. The Postal Savings System (PSS) in Japan, for more than 100 years has been collected savings door-to-door throughout Japan, including rural villages. The postmasters collect small amount of money from households when they deliver mails. Today 85% of Japanese have an account with PSS and half of Japan’s savings are deposited in it. The money collected will be managed by a government trust, with safety as its investment goal. The operation of PSS is probably one of the most important factors driving Japan’s high savings rate and economic miracle after World War II. Every developing country has its nationwide postal service system, and there should be not much extra investment you need to make to turn it into a savings system.

Certainly the success of the system may rely on Japan’s high trust culture, but I don’t see why it will be easier for the postmasters than the bank clerks to steal money. First, postmasters are usually locals, compared to the loss of reputation and the stable job, it is not worthwhile for him to steal the small amount of savings.  Second, depositors get their bank statements every month, and housewives usually will check the statement very carefully. There are really not much opportunities for the postmasters to steal large amount of money before they are caught. So this should work in low trust society as well.

Expecting the birth of the world’s largest bank: the Japanese Post Bank

Guess which financial institution in Japan controls the largest market share in deposit savings? It is not Mizuho; it is not Mitsubishi UFJ; it is not Sumitomo either.

The No.1 position belongs to the Postal Service!  The Postal Savings System (PSS) has 230 trillion yen of deposits in their control, which makes it the largest “bank” not only in Japan, but in the world.

In order to push forward his plan to privatize the Postal Service, Japanese Prime Minister Koizumi called early election and won with land-slide margin. Now the privatizing plan is only a matter of implementation. According to the plan, the savings system will be spinned off from the mail service, and sold to the private sector.

What are the consequences of the privatization?

(1)   Well, we will have the largest bank in the world. I have to inform you though, that the privatization will take place in 2017, not now. Be patient, Koizumi has been pushing for this since 1979 when he served as a junior finance minister.

(2)   Japanese government bond yield will rise, because the profit-maximization oriented PostBank (I guess it will be called PostBank) will not put up with the low return in government bond, and they are going to dump them. Man, more than 20% of outstanding bonds are now in their hands, what will be the market impact, I don’t know.

(3)  U.S.treasury bond yield will go down, because the PostBank will certainly purchase t-bonds to rebalance their portfolio

(4)   I don’t think the PostBank will inject credit into the private sector of Japanese economy, unless they find a really ambitious foreign buyer.

(5)   What will you get if you buy and control the PostBank? Certainly you will obtain a nationwide 100% coverage network and a customer base of 85% of Japan's population. Accepting deposit is not a profitable business, but you can profit from selling other financial services. Eh, I think this is pretty close to Citigroup’s philosophy! Could Citigroup be a potential bidder for the Postal Savings System? It is too early to say, but there is always the possibility.

And who's next? China's Postal Savings System?

Macquarie Bank's interesting acquisitions

last week, they bought Global Baggage, world's largest airport baggage cart operator.See reports in Yahoo

This week, they are on the news bidding for London Stock Exchange (LSE) plc. The LSE board dismissed the bid as 'a blatant attempt to acquire the exchange on the cheap. see reports in Forbes

I wonder what kind of synergy benefit Macquarie Bank can create with a airport baggage cart operator, and with London Stock Exchange. Austrlian firms impress me as very imaginative when it comes to diversification. Last year a giant paperboard marker from Australia ambitiously entered U.S. community banking business.

I know HSBC and RBS always bid fierecly for sponsorship advertisment slots of Heathrow Airport, but they never go as far as purchasing an aiport baggage cart operator.

by the way, I saw an academic paper recently on the (negative) value of financial conglomerates:

Is There a Diversification Discount in Financial Conglomerates?
Author: Laeven, Luc and Levine, Ross

Abstract: This paper investigates whether the diversity of activities conducted by financial institutions influences their market valuations. We find that there is a diversification discount: The market values financial conglomerates that engage in multiple activities, e.g., lending and non-lending financial services, lower than if those financial conglomerates were broken into financial intermediaries that specialize in the individual activities. While difficult to identify a single causal factor, the results are consistent with theories that stress intensified agency problems in financial conglomerates that engage in multiple activities and indicate that economies of scope are not sufficiently large to produce a diversification premium.

Ranking of the world's banking centers

I love doing rankings. I did a simple ranking of world banking centers. Here I give you a sneak view of the world's top 15. Don't take the ranking too seriously. Have fun!

Ranking/ City
1 London
2 New York
3 Tokyo
4 Singapore
5 Paris
6 Frankfurt
7 Milan
8 Madrid
9 Geneva
10 Osaka
11 Zurich
12 Brussels
13 Chicago
14 Barcelona
15 Munich

How did I create them? A very important indicator of whether a city or country can play a role as a finnacial hub for its surounding region is whether she can attract foreign banks to set up branches or representative office in her jurisdiction. If Bank of America has a represenative office in Singapore but not Kula Lumpar, then she is obviously using Singapore office as a hub, and the reason she choose Singapore must be that Singapore provides better "enviroment "(e..g better acces to more liquid inter-bank markets, specialized intermediate inputs, and a highly skilled labor force with financial expertise, aggloermation of financial industry).

All of these proxy for the level of financial sector development in a country. This is probably the easiest indicator. It is not sensitive to a country's regulation, because you don't need permission to set up a representative office. The same logic applies to higher education sector. A very simple indicator of the development level of a country's higher education sector is high percetage of international students.