SARFAESI Act, 2002 and its Interface with BIFR

(5^th September 2009)

-Surenderrao Komera

In India, Industrial sickness has been dealt with various legislations and there have been a series of changes from time to time in the legislations to efficiently deal with industrial sickness. These legislations continued to protect the debtors at the cost of the creditors by imposing the sanctions on the later. Over time such legislations caused inefficiencies in the functioning of banking and financial institutions (creditors). For instance SICA, 1985 (Sick Industrial Companies Act), by institutionalizing the Board of Industrial and Financial Reconstruction (BIFR) aimed at protecting the sick (potentially viable) industrial units by suspending all the legal and contractual proceedings against them. Given the prevailing legal framework in restructuring and liquidation of the sick units, the claims of the creditors on the sick industrial units continued to accumulate and thereby created hurdles in their efficient functioning. Particularly, these mounting non-performing assets created roadblocks in the functioning of the banking and financial institutions and undermined their competitiveness in the global financial markets.

By considering the recommendations of Narasimham Committee II and Andhyarujina Committee to address the concerns over the mounting NPAs of the financial institutions and to provide the necessary leap for the FIs to keep pace with international institutions, GoI enacted the SARFAESI act (Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest) in 2002. This act largely facilitates the asset recovery and reconstruction.

Interface with BIFR: SARFAESI act allows the banks and financial institutions to take possession of securities, sell them and reduce non performing assets without the intervention of courts, regardless of the reference of the firms to the BIFR. In a way SARFAESI act restricts the BIFR jurisdiction and allows the secured creditors to possess the corresponding assets without its discrimination. Thus SARFAESI act may be viewed as the legislative action that undermines the efficiency and relevance of BIFR in its pursuit of protecting the potentially viable industrial units. Hence, the note calls for the reexamination of the provisions of SICA in the light of changed institutional and legislative framework.

(Views expressed above are personal and comments and suggestions are encouraged)

Opening Jump and Noise Trading

Abstract:
In this paper, we provide evidence of a chronic crisis syndrome that is present in the Indian stock market, in that we find that the opening stock price contains noise on an everyday basis. That is to say, there is a ``crisis'' brewing in the market every morning, because prices have deviated from fundamentals, i.e., from where they ought to be. However, we also find that the impact of noise does get eliminated from prices at the end of the trading day, which says something remarkable about the price discovery process inherent in the trading mechanism at work in India. We show how these seemingly contradictory twin empirical results about the Indian stock market can be reconciled in the framework of the Noise Trading Model proposed by Kyle (1985). Furthermore, we show how to come up with a simple trading strategy that makes use of the noise in opening prices and demonstrate that it is indeed highly profitable.
Download full paper

Parametric tests Versus Non parametric tests

Parametric tests Versus Non parametric tests

Prepared on 24^th July 2009

“Fewer or weaker are the assumptions, the more general are the conclusions”.

In statistics, unfortunately the most powerful tests are those which have extensive and stringent assumptions. With this assertion, I will be presenting the most prominent discussion of Parametric vs. Non parametric tests very briefly. The following write up reflects my personal (with nascent knowledge) bias for non parametric tests.

Parametric tests (t test and f test) are the tests that have certain assumptions about the population from which the samples are drawn. The strength of the results of such tests depends on the validity of those stringent conditions/assumptions. The prominent among them are.

• Observations must be independent
• Observations must be drawn from normally distributed populations
• Those populations must have same variance
• Variables are measured at least in an interval scale

Non parametric tests are the tests that make no assumption about the populations, but share few relatively weak assumptions with the parametric tests. They are:

• Observations must be independent
• Variables under study have underlying continuity.

However the concept of power of efficiency (by increasing the sample size) ensures that non parametric tests achieve the same strength as parametric test. Moreover the criticism of the non parametric tests over their usage of information (some non parametric tests ignores the sign, some convert the scale into ranks) may be answered by eliciting the answers to the following questions.

Ø How important is it that the conclusions drawn from the research are applicable to the generally rather than only to the populations with normally distributions?

Ø Which tests of the parametric and non parametric tests use the information appropriately?

The potential answer to the former question is presented in itself. The answer to the later one may be viewed from the perspective of possible assumptions one makes about the potentially unknown populations one deals with. The issue of comparing the parametric and non parametric tests may be highlighted by presenting the short summary of the advantages and disadvantages of the non-parametric test.

Advantages of Non-parametric tests:

ü The probability statements obtained from the non parametric tests are the exact ones, regardless of the shape of the underlying population.

ü For the very small samples (say N=8), there is no other alternative other than non parametric tests unless the parameters of the underlying population are known exactly.

ü Non parametric tests are suitable in the case of the samples that are drawn from various populations with different variances.

ü No other alternative than non parametric tests in the case of the samples involving nominal data.

Disadvantages of the non-parametric tests

• In the case of the samples that satisfy the underlying assumptions of the parametric tests, application of non-parametric tests is of wasteful given their power of efficiency
• Unstructured availability of literature about the non parametric tests may confine the researcher to employ the parametric tests though their validity is vague.

The author has heavily benefited from the extensive and provocative discussions with his fellow doctoral student Yoonus C. A at IFMR, Chennai; and the writings of Sidney Siegel. The comments on the draft by Nandhini R. are highly commendable. Finally, the author is solely responsible for any mistakes and constructive comments are highly respected.

Obama's Take on Health Care : A Comment

The Money Masters - How International Bankers Gained Control of America

Ficher Black definition on “Liquid Market “

“The market for a stock is liquid if the following conditions hold:

(1) There are always bid and asked prices for the investor who wants to buy or sell small amounts of stocks immediately

(2) The difference between the bid and asked prices (the spread) is always small.

(3) An investor who is buying or selling a large amount of stock , in the absences of special information , can expect to do so over a long period of time at price not very different , on average , from the current market price.

(4) An investor can buy or sell a large block of stock immediately, but at a premium or discount that depends on the size of the block. The larger the block, the larger the premium or discount.

In other words, a liquid market is a continuous market, in the sense that almost any amount of stock can be bought or sold immediately, and an efficient market, in the sense that small amounts of stock can always bought and sold very near the current market price, and in the sense that large amounts can be bought or sold over long periods of time at prices that, on average , are very near the current market price.”

Arranging the stock price for event window

In an event studies we need to pick up data for the event window which can vary from company to company. If you have the time series of data where prices of all the companies are in the same format and you want the data only for a certain event window. You can use the VBA code as user defined function for getting the prices for a event window.

Go to tool > Macro > Visual basic Editor > Insert > Module . Copy the VBA code in the module and save. Select the event window, that is if you want 3 day on both side of the event , 7 column and go the user define function and select the function , “test_adj” . it will ask for four input variable. Date1 is the time series of the date where you collected the data , match is the event date , price is the stock price data for a company and eve for number days in the event. Then Ctrl + shift +enter gives you the prices for the company on the event window. The VBA code given below

Function test_adj(date1 As Variant, match, price, eve)
'Created by C A Yoonus and Surender Komera
Dim m, n, i, j, b, c As Variant, t, k, d
t = 1
m = Application.WorksheetFunction.Count(date1)
n = 1
ReDim b(n)
ReDim c(t)
'test_adj = m

For i = 1 To m

b(i) = date1(i) - match
n = n + 1
ReDim Preserve b(n)
If b(i) = 0 Then
j = i
End If

Next i


For k = j - eve To j + eve
c(t) = price(k)
t = t + 1
ReDim Preserve c(t)

Next k
d = Application.WorksheetFunction.Transpose(c)
test_adj = d
End Function

Usefull concepts I

What are M1, M2 and M3?

M1 is the sum of the physical money that is held outside banks, travelers’ checks and demand deposits. M2 is M1 in addition to all time-related deposits, savings deposits, and non-institutional money-market funds. M3 is M2 as well as all large time deposits, institutional money-market funds, short-term repurchase agreements, along with other larger liquid assets. M3 is referred to as broad money supply and is usually the number referred to when talking about money supply. M1 is generally referred to as narrow money.

What is the impact of interest rate on the economic growth?

There is a general consensus that the growth of the economy is negatively associated with the interest rates prevailing in the economy. Interest rates in an economy has twofold effect on economic growth as they act as driving force for the investment activity on one hand (supply side) and stimulate the consumption expenditure on the other hand (demand side). In specific, moderately low interest rates not only drive the increased investment activity but also encourage the individual consumption expenditure.

What Does Nonperforming Asset Mean?

A debt obligation where the borrower has not paid any previously agreed upon interest and principal repayments to the lender for an extended period of time (say, 90 days). The nonperforming asset is therefore not yielding any income to the lender in the form of principal and interest payments. Increased nonperforming assets act negatively to the growth of the economy as the scarce capital could be holdup in unviable economic activities. It is a major concern for the emerging economies as they generally face the resource crunch.

What is a fiat currency?

Fiat currency or fiat money is a type of currency whose only value is that a government made a fiat that the money is a legal method of exchange (is usually the paper currency). Unlike commodity money it is not based on any other commodity such as gold or silver and is not covered by any special reserve. It means fiat currency doesn’t have any intrinsic value and its value depends only on the confidence holders have in the economy and its government. Most currencies in the present world are fiat currencies.

What are the leading, lagging and coincidental indicators?

Usually indicators are used to predict the future outcomes, particularly future trends of the certain economic variables. Some of these indicators are published by government bodies/private organizations eg. Inflation rate, …………..and some are observed in the market place eg. Bond yields. Depending on the prediction they make, such indicators are classified into leading, lagging and coincident indicators.

Leading indicators are the pointers towards the future outcomes. Bond yields may be considered the leading indicator for the trends in the equity markets.

Lagging indicators are of useful in reinforcing or confirming the event occurring or expected to occur. Unemployment rate may be viewed as lagging indicator for the performance of the economy. Falling unemployment rates confirms the encouraging performance of the economy.

Coincident indicators reflect the situations they signify. Increased per capita consumption is the reflection of flourishing economy.

What happens to the interest rates during deflation?

Deflation refers to the fall in the general price level. It is usually caused by the fall in aggregate demand which is in turn resulted from the decline of government spending, private consumption and investment spending. Deflation can also be the result of the fall in the supply of credit and increased interest rates. But once the deflationary situation is settled in, investors mostly become the risk averse and seek for the safe heavens such as investing in treasury securities. The increased demand for the treasury securities due to deflationary conditions brings down the interest rates and some times push the interest rates into the negative territory.

How does credit crunch affect consumption?

Credit crunch refers to the reduction in general availability of credit irrespective of the rise in interest rates. It has multifold effect on the consumption expenditure, particularly on the conspicuous consumption. On the plain grounds, lack of credit availability restricts the consumption on durable goods; on the other hand credit crunch dampens the consumer confidence by causing the steep fall in asset prices, reduction in investment rates and increased unemployment rates. The recent credit crunch resulting from the US housing sector crisis brought down the consumer confidence there by consumption expenditure.

What are the important components of the budget?

Indian budget, known as Union Budget is made up of revenue account and capital account. Revenue account comprises of government revenue mainly from taxes and government administrative expenditure. Capital account comprises of receipts and payments. Receipts on capital account include the loans brought about by the government through central bank from the market as well as other government bodies and profits from the government owned enterprises. Components of payments on the capital account include government investment expenditure on assets, infrastructure etc.

What are the direct taxes?

A direct tax is a tax which is imposed directly on the tax payer. It implies that in the case of the direct taxes the immediate impact and incidence of the money burden lies on the same person. The examples of direct taxes are personal income tax, wealth tax, tax on gifts etc. Most of the modern governments earn major chunk of revenue from imposing direct taxes. In India, contribution of direct taxes to the total revenue of the union government is 53.07% in 2008-09. This reflects the significance of the direct taxes as major source of revenue for the state.

Your valuable suggestions and corrections will be encouraged!

III. Possible Lessons from the Japanease (slump) bear market

Before deriving the possible implications of Japanese prolonged bear market for the present mess in the global financial system, I would like to investigate possible factors that caused the boom and eventual burst in the Japanese economic system.  Here I will be discussing the issue from the corporate governance perspective, whether the corporate governance mechanism added the flame to these extreme events of business cycle?

 The oversimplified corporate governance mechanisms are of two kinds, one is Anglo-American Corporate Governance Mechanism (Market based system), pioneered by USA and UK; Bank based Mechanism, nurtured and followed mainly by the Japan and Germany (Germany in the later years tilted towards market based system), is the another one. Market based system gives absolute priority to the shareholders over other stake holders. It presumes that the shareholders do monitor and impose the discipline on the management through market mechanism. It is also argued to be of having short term perspective as market gauges the performance of the management on the regular basis in terms of quarterly/half yearly accounting statements. Where as Bank based system measures the performance based on the long term growth perspective. It accords the governance mechanism to the financial institutions that monitor the performance of the managements.  In a way financial institutions posses the major stake in decision making process under Bank based system. 

 Bank based system, providing the financial institutions access to internal information to assess the potential projects, ensures the low cost of capital to the firms. This came handy to the Japanese corporate world during the bull phase of 1980s, where as the firms in the rest of the world were cautious over the investments in the light of high cost of capital.  In a way Bank based system added the flame to the Japan’s Bull Run during the second half of the 1980s.  But the same system tightened the necks of the Japanese firms during the crash and the prolonged period of bear markets (till date) as the banks became overcautious given their increasing NPAs. Thus Japanese corporate governance mechanism steepened the crash in the asset markets and contributed to the ever ending bear market conditions.

 Anglo-Saxon model, according the corporate governance to shareholders (who monitor the management performance through market mechanism) makes the management obsessed with the quarterly performance appraisals. With its short term perspective, Anglo-Saxon Model encourages the management to pursue the short term goals by forgoing the long term objectives. In a way such corporate governance model practiced in USA, UK, and Europe might have forced the yester year mighty corporations into the history and eventually caused the present mess in the global economy.

II. Possible Lessons from the Japanease (slump) bear market : Supporting document

Here we can see how savings changed in Japan after the crisis. If you look at the saving rate for US, UK and Australia we can see that it is negative. That is people are going to spend more than their income, it showing burst where people didn't care about and increase the credit limit for the public which leads this crisis.

II. Possible Lessons from the Japanease (slump) bear market

As i mentioned in my previous blog, here i am expressing some of my views on Japanese prolonged bear market.

Boom and depression are the two extremes of business cycle which are generally pursued to be caused by an array of economic factors such as over production, under consumption, over capacity, price dislocation, over confidence, overinvestment, over saving, over spending and discrepancy between savings and investments. The foremost celebrity monetary economist Irwing Fisher attributed the business cycles to the over indebtedness and thereby deflation.  In his own words, depression in the economy is result of over indebtedness which leads to distressed selling of assets. He articulated (in 1930s) the chain of factors that lead to depression in the following way….

Over indebtedness leads to a) distressed selling and b) contraction of deposit currency as bank loans are paid off and to a slowing down of velocity of circulation. The contraction of deposits and of their velocity precipitated by the distress selling causes c) a fall in the level of prices and d) a still fall in the level of corporate net worth, precipitating bankruptcies and e) a like fall in profits leads to concerns to the private – profit society to make f) a reduction in output, trade and employment. These losses, bankruptcies and unemployment leads to g) pessimism and loss of confidence which in turn lead to h) increased hoardings and still more contraction in velocity of circulation. All these factors cause i) complicated disturbances in interest rates.  Here the complicated disturbances in interest rates are vowed to my previous post on counter cyclical regulation.

The above lengthy introduction serves as the basis for my arguments on the possible lessons from the Japan’s prolonged bear market.

 From the humiliating defeat of 1945 war, Japan has raised to the second largest economy by 1989. The tremendous growth has been attributed to the hard work (Popularly known as Japan kind of doing) rendered by its citizens and supply led and export oriented policies adapted by the then governments. During the second half of the 1980s, Japan experienced a sea change, there was a sudden spurt in the asset prices, real estate prices reached unimaginable hights, stock markets were experiencing thumping Bull Run. High asset prices coupled with low/negligible unemployment rates, increased productivity and positive trade deficit prompted the irrational speculating activates. Though inflationary situation forced the Bank of Japan to keep the interest rates high, the capital gains from the asset markets (stocks/real estates) encouraged the investors to go for investing with borrowed money. Banks also added to this malady by promptly sanctioning the loans to the investing activities. There is hardly anyone who has not stepped into the band wagon of making quick buck. By the end of 1989 Nikkie index touched 39,000 mark which raised three times more than the economy’s growth. 

Such a growth led by the speculation coupled with over indebtedness became unsustainable and rate of growth of the asset prices slowed down, interest rates over took the capital gains. Thus as Fisher rightly mentioned way back in 1930s, the over indebtedness and higher interest rates forced the distressed selling resulting in steep fall in asset prices. The crash in asset market and resulted mass corporate defaults increased the proportion of distressed assets in banks’ books. Non repayments, delayed repayments and deposit withdrawals caused the banks to adapt conservative measures. Steep rate cuts by the Bank of Japan could not yield the desired fruits, moreover resulted in debt trap. Hesitant banks keep carrying the distressed assets on their books, resulting many defunct businesses were continued to float. Such an uncertain environment counter acted against all the monetary measures taken by the Bank of Japan, further steep cuts of interest rates forced the economy into deep debt trap. Hence, the failure of the transmission of monetary policies, continued business uncertainty forced the prolonged disarray in the Japanese economic system….(to be continued)

 (Comments and suggestions are welcome)

The author is highly benefitted from the writings of Irwing Fisher and Graham Turner.

I. Possible Lessons from the Japanease (slump) bear market

Japanease stock index Nikkie touched 39,000 mark in late 1980s, today it is struggling around 9,000. Virtually there was zero growth for last two decades in the Asia's largest and world's second largest economy. Fiscal measures, monetary measures all failed one after another in bringing back the normalcy.  When one look into the reasons (Irrational credit expansion and reality boom) that caused the downfall of the Japnease economy, one certainly get worried about future prospects from the current juncture.  

Here i would like to initiate and encourage the debate on the possible causes for the continued slump in the Japnease economy. Particularly i invite the arguments on the following issues:

• Reasons for the failure of fiscal and monetary measures in Japan
  
• Why an average Japanease citizen save so high? (even after realising that their savings and investments have gone for a vain)
• Possible measures to be adapted to cure the Japanease truma
• Implications of prolonged Japanease slump to the current debacle of the global financial system.

I will be posting my ideas on the above issues during this weekend.....I welcome your insights (on the issues raised), suggestions and comments....

Implied exchange rate from Commodity Market

The commodities like Gold and Silver traded all over the world in Exchanges as well as in over the counter markets for 24/7.  Given that we can trade assets like Gold and Silver in demat form instead physical form we can ignore the storage cost from the cost of carry. So we have to consider the only the interest rate between the countries, where we want for see the exchange rates. Before going to convert into exchange rates we need to consider how the different exchanges quoted the contracts in their contract design. If look at Chicago , they quote the gold for troy ounce and India it is in Kg. Similarly we need to consider for the other countries before estimating respective exchange rates. Once you compare the implied exchange rates with actual exchange rates there can be seen that almost similar direction in movement. So trader can make use of the information from the commodity market for trading the exchange rates

Does the Counter Cyclical Regulation ensure the cycle free regime?

During the run up of 2004 to 2007 world economies in general and emerging economies in particular have experienced the highest levels of consumer confidence and corporate optimism. The increased purchasing power driven by increased investments and confidence among the economic agents (I mean corporate entities and individuals) has escalated the inflationary pressures around the world.  To counter such an imbalance in the system, the apex bodies around the world have resorted to counter cyclical monetary measures such as increasing the reserve capital (which may be used in the event of negative outcome). Such a counter cyclical regulated environment has forced the firms to incur more cost of capital than market requires.  In fact during the boom times, given the confidence level in the economy, the probability of default though is very remote; the cost of capital in the economy remained irrationally high. Hence such a regulatory environment prompted the firms to shift to unregulated or less regulated activities such as structured investment vehicles which in a way caused the present trough. 

 

Aftermath of the bursting of the bubble in the housing sector, almost all the apex financial institutions around the world resorted to the (traditional) counter cyclical monetary measures which are again proved to be irrational and may contribute to the potentially void results. The trouble in the housing sector has been translated into disastrous crisis in the financial sector by the so called counter cyclical regulations of the boom period. The resulted crisis has evaporated the confidence among the economic agents and drafted vague picture about the future prospects thereby steep fall in consumer demand, accumulated inventories and unimaginable job cuts. Given the present pessimistic environment, market demands a relatively higher cost of capital from the firms and financial institutions requires higher cushion in terms of higher reserve to tide over the potential uncertainty. Counter intuitive to such an end, the regulatory bodies brought down the reserve requirements of the financial institutions and virtually advocating the low cost of capital to the firms. The credibility of these measures in the event of possible corporate mass defaults is not only questionable but they may also pose the terrifying questions about the future systemic cushion…

(Comments and suggestions are hightly respected)