- Taking a stand on the equity risk premium in India, 17 July 2013.
- Identifying each individual in financial firms that performs customer-facing functions, 8 June 2013.
- Regulatory strategy for savings/investment schemes, that would address ponzi schemes, 30 April 2013.
- Correctly defining the scope of financial regulation so as to block ponzi schemes, 30 April 2013.
- RBI vision document on payments: An evaluation, 5 July 2012.
Sunday, 9 June 2013
Author: Suyash Rai
Posted on 18:56 by Unknown
Saturday, 8 June 2013
Identifying each individual in financial firms that performs customer-facing functions
Posted on 09:41 by Unknown
by Suyash Rai.
The growth of the Indian financial system has generated opportunities for individuals to get jobs in sales and distribution roles. It is easy for individuals to switch jobs, and with that it has become easier to indulge in abusive practices, enjoy the financial benefits that accrue, and leave the firm before the consequences become visible. There is ample anecdotal evidence about sales persons and agents who have got away scot free after doing the wrong things. These individual stories add up to the overall evidence at the level of the financial system of an upsurge of difficulty in consumer protection.
This problem is greatest with agents, who can switch between firms more than employees can. Similarly, sales persons switch easily from a field such as banking to another such as insurance.
For many in this field, the prevailing notion is that some individuals in sales and distribution are bad eggs and must be stopped. While there is some value in this perspective, it is important to not blame the entire failure of consumer protection in India upon individuals. Deeper reform of the system is required, as is envisaged in the consumer protection framework of the draft Indian Financial Code.
While we strive to build systems that generate better financial health for consumers, even in the most pro-consumer system, it will be possible for individuals to indulge in abusive practices, and leave before the consequences show up. This is because of certain inherent features of financial products and services:
- For many products (eg. pensions), the consequences take years to be realised.
- Much of the discussion between a salesperson/advisor is verbal, and, even if a written advice is insisted on, it is possible to lie or mislead an unsuspecting consumer.
- Internal control systems usually work with random checks, and do not catch everybody, but consumer abuse must be comprehensively prevented or redressed.
Logically, this potential for harm goes with the potential for doing good - outliers will be on both sides. Ex-post action on consumer abuse must involve understanding what happened, compensating consumers, and punishing those responsible. This has a deterrent effect as well. In the present system, if the individual has moved on, little can be done against him. The firm has to take responsibility, and it has no recourse to the individual.
This is a malady, and a system must be developed, at least within the financial system, to keep track of individuals. This is important not just for punishment, but also for research on how different profiles, trainings and experiences lead to different consumer outcomes.
A recent initiative pushes in this direction. Association of Mutual Funds of India (AMFI), under direction from SEBI, has now notified regulations that speak to this concern. Every individual (employee or agent) dealing with the consumer is now required to be assigned an Employee Unique Identification Number (EUIN), which will be a permanent number. EUIN can be used to keep track of the individuals even as they switch jobs. This is a good step, but, given the generic nature of the sales/advise skills, this will work well only if all sub-sectors in finance adopt this approach.
The registration requirement in the Indian Financial Code
When something needs to be done by everybody, it is a good idea to put it in the law in some form. The draft Indian Financial Code (IFC) encodes this idea of identifying the individuals who deal with consumers. Section 104 of the IFC mandates every financial service provider to ensure that any individual dealing with consumers in connection with the provision of a financial product or financial service is registered with the Regulator. The provision also empowers the regulators to specify pre-conditions for registration in respect of different financial products or financial services.
Registering individuals with regulators will be expensive. Nothing in the IFC prevents the regulators from allowing self regulatory organisations or product manufacturers to implement the process and send a batch file to the regulators, who would just supervise the integrity of the process. The draft Code does not interfere with such efficiency.
If this provision is enacted, over time, the database of registered individuals will develop. It will start showing interesting patterns, and firms and regulators will be able take preventive measures, as well as strict action against abusers. The idea is necessary and will go a long way in solving this malady.
Conclusion
SEBI and AMFI are doing an interesting thing. In the short term, it will have a limited effect as IRDA and RBI and FMC and PFRDA are not part of this initiative. In addition, we should see consumer protection as a much bigger question, of which pinning responsibility upon employees is only one component. When the Indian Financial Code is enacted as law, the capacity building that would have taken place at SEBI and AMFI in building the EUIN will be a useful building block.
Friday, 7 June 2013
Iran may have developed offensive cyberwar capabilities
Posted on 10:45 by Unknown
After Stuxnet, Iran seems to have developed offensive cyberwar capabilities, possibly with Russian help.
Catnip, organised by me in chronological order. First, the Stuxnet story:
- Israeli test on worm called crucial in Iran nuclear delay, by William J. Broad, John Markoff, David E. Sanger, in the New York Times, 15 January 2011.
- A declaration of cyber war, by Michael Joseph Gross in Vanity Fair, April 2011.
- Obama order sped up wave of cyberattacks against Iran, David E. Sanger, New York Times, 1 June 2012.
- Confront and conceal by David E. Sanger, 5 June 2012.
- Stuxnet: Leaks or lies, Steven Cherry interviewed Larry Constantine, IEEE Spectrum, 4 September 2012.
And then, the recent developments:
- Cyberattacks against US corporations are on the rise, by David E. Sanger and Nicole Perlroth in the New York Times, 12 May 2013.
- New computer attacks traced to Iran, officials say, by Nicole Perlroth and David E. Sanger, in the New York Times, 24 May 2013.
- Silent War, by Michael Joseph Gross in Vanity Fair, July 2013.
Thursday, 6 June 2013
Interesting readings
Posted on 11:01 by Unknown
Indian
historical linguistics in the Economist.
A
lecture by Lant Pritchett titled Folk and the formula -
Pathways to capable states.
Anil
Padmanabhan on Myanmar in Mint.
A great
travel story from Nagaland.
Trampling on the individual in India:
Datta in the EPW, and
IP, on the attack on a blogger by the Times of India.
I was in Los Angeles when
the Rodney King
incident took place, and I thought to myself that when video
cameras become ubiquitous in India, it will really make a difference
to the behaviour of the police. One is
seeing some
examples of this, and the exponential rise of video-capable
phones will help. In Canada, some are carrying this
further: mounting
a camera on every policeman. Also
see Tarun
Wadhwa in Forbes.
Who
will audit the RBI? by K. P. Krishnan.
N. Sundaresha
Subramanian in the Business Standard about what the
independent directors of Ranbaxy were thinking and doing in
2004.
Regulation that is attacking something that is not a market
failure: Tarun
Shukla in Mint on forced hiring of domestic pilots.
Somasekhar
Sundaresan on what SEBI should do on its 25th birthday.
Patnaik on the messy issues of defining FDI, portfolio investment
and foreign control.
Ellen
Barry in the New York Times tells the story of the
flight of a key figure in Russian
economics: Sergei
Guriev. A country that cannot keep its intellectuals safe has
no
future. Also
see.
Hanif has a great piece in the Guardian looking back at the
elections in Pakistan.
economic empire by Heriberto Araujo and Juan Pablo Cardenal in
the New York Times.
A group of musicians in Lahore have an original take
on Everybody hurts by
R.E.M. Video.
A true war
story by Simone Gorrindo.
Tuesday, 4 June 2013
The role of the board
Posted on 19:42 by Unknown
The board is a critical ingredient of well functioning public bodies. The board must:
- Have a big picture of the objectives of the organisation;
- Get pushed, through accountability mechanisms, when these objectives are not being achieved;
- Lead the top level thinking about the organisation chart and resource allocation, so that the organisation is constantly reshaped so as to fit its purpose;
- Exert direct influence on key policy choices so as to push the management team towards delivering results.
In India, we lack experience with boards that perform these functions. All too often, organisations are little dictatorships where the chief executive holds all power and jealously resists any other influences upon decision making. I have been in situations where a chief executive stoutly claims that a policy discussion is not an appropriate matter for discussion in the board.
The draft Indian Financial Code works hard on establishing high quality boards, on establishing a sound work process for the board including powers of the board, and on setting up accountability mechanisms through which failures of the organisation would feed back to the board. This kind of establishment of the board is a critical component of the governance process.
In the Indian Express yesterday, Ila Patnaik and Shubho Roy reflect on the irrelevance of the RBI board. The Cobrapost expose showed a huge supervisory failure of the RBI. The entire board meeting of the RBI should have been devoted to identifying why this failure took place, and coming out with a list of actions through which things would change in the future. Instead, the board meeting dealt with things like skills development for horticulture.
SEBI does better than RBI on the role and functioning of the board, reflecting the fact that the RBI Act is ancient and these provisions in the SEBI Act are only around 20 years old. But with SEBI also, there is a lot to be desired about the working of the board.
Monday, 3 June 2013
Bureaucrats are not stakeholders
Posted on 18:18 by Unknown
Indian democracy has become quite focused on bringing views of all stakeholders into the policy debate on any question. That is a good thing.
I have an article in the Economic Times today, where I argue that while we do this, we should be careful to not treat officials as stakeholders. When the merger of Indian Airlines and Air India is being evaluated, all viewpoints should be brought to bear on the decision but one -- the views of existing employees of Indian Airlines or Air India.
Should policy makers favour home ownership?
Posted on 09:12 by Unknown
The argument in favour of home ownership
Many people believe that more home ownership is a good thing. It is felt that people who own homes have a greater incentive to get involved in local politics as they have a stake in higher house prices. In contrast, people who rent lack this commitment device. Indeed, in a short run sense, a person who is renting benefits when the neighbourhood goes bad : his rent goes down.
From the viewpoint of the individual, renting is always better as it preserves flexibility. Owning a house imposes limitations on the locations where one could live and work, as the frictions of moving home are substantial. This biases individuals in favour of renting.
In the four-part classification scheme of market failures (monopoly power, asymmetric information, externalities, errors by consumers), this falls under the heading of externalities. If home owners become better citizens and better voters and induce better urban governance, this induces positive externalities upon all residents of cities. To the extent that this is the case, some elements of State policy should favour home ownership, so as to counteract the market failure.
This argument has limited value in India today, given that urban governance is organised in a terrible way. We have just not established the feedback loops of accountability from voters to the city mayor. Even if a voter wanted to get involved in more political action, and wanted to nudge his city administration forward, he does not have the levers to do so. If one only looked at the India of the present, we would reject this externality argument and say that there should be a pure level playing field between owning and renting.
Or, one could be an optimist and think that in the future, as the political system is reformed, these feedback loops will fall into place. One could then argue that large scale home ownership sets up interest groups today that have a stake in cities doing well in the future, as their portfolio value is bound to the quality of the city. The presence of such interest groups may help increase the probability of political system reform, when households get worried about potential damage to their portfolios as a consequence of urban mis-governance.
Today we're highly distorted in favour of owning
If one started out at a undistorted market, one could have a reasonable discussion about whether there is something intrinsically good about owning as opposed to renting, and possibly envision whether levers of policy might be applied to favour home ownership, and the scale of intervention that is justified. In India today, unfortunately, the game is highly stacked against renting:
- Tax policy favours owning in the divergent treatment of interest payments as deductible versus deductibility of rent.
- Rent control laws inhibit renting.
- High inflation disrupts rental contracts by forcing repeated renegotiation.
- House owners that are corporations have not yet emerged. It is, hence, hard to find professional contracting in this field. Search costs are high, and there are often restrictions such as owners that won't rent to single women or muslims out of social conservatism. Our failures on property as a fundamental right, and on achieving a capable judiciary, have led to the risk of expropriation when the renter is elderly, a journalist or a lawyer. This has the perverse effect of diminishing access to rented houses for such persons.
- Contracts are frequently disrupted, which induces costs of moving and frictions such as fees to brokers.
- Less than professional owners imply that many practical issues such as smoothly functioning utilities don't work out properly. Under home ownership, a person has the incentive to make sure that utilities work correctly. With renting, this falls between the cracks and the service level is often poor.
The game is thus highly stacked in favour of owning. We need to level the playing field in favour of more renting.
The problems of home ownership
From first principles, the ownership of an illiquid asset (a home) diminishes flexibility. A person who lives in a home is much less likely to move.
In India, we need to achieve massive migration flows. Large scale migration will generate better matching between the requirements of the labour market at various locations all over India, and the requirements of production. Large scale migration will break down tribal and ethnic loyalties.
A country where people easily up and move is one in which the labour market is more flexible. This is a blessing and has consequences such as milder business cycle fluctuations. That's a different kind of market failure. The State should favour renting as this gives a more flexible labour market which yields milder business cycle fluctuations, which induces gains for all. Every person who owns a house imposes a negative externality upon everyone else in the form of a more inflexible labour market.
On this theme, here is a fascinating new NBER WP by Blanchflower and Oswald. The abstract says: We explore the hypothesis that high home-ownership damages the labor market. Our results are relevant to, and may be worrying for, a range of policy-makers and researchers. We find that rises in the home- ownership rate in a U.S. state are a precursor to eventual sharp rises in unemployment in that state. The elasticity exceeds unity: a doubling of the rate of home-ownership in a U.S. state is followed in the long-run by more than a doubling of the later unemployment rate. What mechanism might explain this? We show that rises in home-ownership lead to three problems: (i) lower levels of labor mobility, (ii) greater commuting times, and (iii) fewer new businesses. Our argument is not that owners themselves are disproportionately unemployed. The evidence suggests, instead, that the housing market can produce negative ‘externalities’ upon the labor market. The time lags are long. That gradualness may explain why these important patterns are so little-known.
Turning to international finance, the objective of international risk sharing is to remove home bias. In the real estate context, what works best is for a person in Bombay to rent a flat owned by Japanese investors and for a person in Tokyo to rent a flat owned by Indian investors. This achieves risk sharing: each party avoids the risk of real estate fluctuations that are correlated with the main portfolio which includes human capital. Capital controls that interfere with such investments are an obvious mistake that need to be removed. But as in trade integration, once overt restrictions are removed, an array of institutional factors that impede cross-border interaction come to prominence.
For the risk-sharing outcome (homes in Tokyo owned by investors in Bombay and vice versa), we need real estate to be owned by professional companies that rent it out. The shares of these professional companies, or securitisation instruments that generate cashflows out of rental streams, can then be purchased by foreign investors. As long as real estate ownership is in the hands of individuals in India, we will suffer from home bias with too much of the portfolio of residents being invested in local instruments. This is another dimension of owning versus renting that we need to keep in mind; we are better off when there is less home ownership.
Conclusion
Most people assume that home ownership is a good thing, that a country is better off if more people own homes. Like most interesting questions in public policy, the story is more complex than meets the eye. There are two different externality-based market failures running in different directions.
At present, in India, the first externality (more home ownership makes people better citizens) is absent since urban governance is unresponsive to voters. The only externality at work is running in the opposite direction (more home ownership gives a less flexible labour market). In the short term, policy should work on pushing towards more renting.
In the long run, urban governance in India might improve, and then we would need to understand the magnitude of these two opposing effects, and then one could choose whether it's worth pushing in one or the other direction. If one can't quantitatively estimate these things, then a cost benefit analysis is not feasible. The best thing is then to do nothing.
In either event, the mainstream view -- that policy makers should push in favour of more home ownership -- needs to be questioned.
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