Quantitative easing by any name is fine

Update: Rate hike of August 2017 corrected to rate cut.

In early November, I wrote a blog post arguing that the Reserve Bank of India (RBI) needs to consider some form of Quantitative Easing (purchase of long term bonds) to address the complete lack of monetary transmission from policy rate cuts to long term rates.

Last week, the RBI announced an open market operation (OMO) that was quickly labelled by market commentators as its version of Operation Twist:

On a review of the current liquidity and market situation and an assessment of the evolving financial conditions, the Reserve Bank has decided to conduct simultaneous purchase and sale of government securities under Open Market Operations (OMO)

The RBI offered to buy INR 100 billion of ten year bonds and sell the same amount of bonds of maturities less than one year. When this OMO was carried out on Monday, the RBI ended up buying the entire INR 100 billion of ten year bonds but it sold only INR 68 billion of short term bonds.

I think this is to be expected. In the current situation, the RBI can ill afford to allow any increase in yields even at the short end. If the RBI repeats the operation, I expect the results to be similar: full offtake of the long end purchase and much lower offtake of the short end sales. If the RBI wants to avoid the suggestion that it is doing any easing or any monetization of the fiscal deficit, we should not have any quarrel with the operation being called a Twist or a Special OMO or whatever. The important thing is get on with this in greater size or more frequently until the ten year yield drops 100-150 basis points below its August 2017 level. (While the OMO did reduce the ten year yield by about 25 basis points, this yield is still about 25 basis points higher than it was before the rate cut of early August 2017).

On the other hand, if the RBI stops with just this one operation, it would leave itself open to the insinuation that this was just a cosmetic attempt to help the banks window dress their balance sheets at the December quarter end.

New Zealand goes ahead on bank capital

A year ago, I wrote approvingly about New Zealand’s non-Basel-III approach to bank capital:

One of the dangers of international harmonization of financial sector regulation under the auspices of Basel, FSB and G20 has been the risk of a regulatory mono-culture. New Zealand located at the edge of the world and outside the Basel system is providing a good antidote to this.

Earlier this month, the Reserve Bank of New Zealand announced that it was going ahead with its proposal to raise capital requirements substantially. The only concession that it has made is in terms of allowing more instruments to count as capital. The ruthless focus on preventing banking crises is reiterated:

Banking crises cause not only harmful economic costs but also distressful social issues, such as the general decline in mental and physical health brought about by higher rates of unemployment. These effects are felt for generations.

New Zealand’s reliance on foreign banks for almost all of its banking needs is an interesting choice that many other countries could find worthy of emulation. The Global Financial Crisis highlighted one risk with this approach: bank losses elsewhere in the world could lead to a shrinking of bank credit within the country. While it might be tempting to react to this with a greater reliance on domestic banks, New Zealand is suggesting that you can simply protect your economy with higher capital requirements without worrying about the ownership structure.

I am inclined to think that steadily rising capital requirements for banks coupled with ever increasing reliance on deep financial markets may be the best way to manage the risk of financial crises.

Resolution of stock broking firms

The developments over the last week regarding Karvy highlight the urgent need for an operational framework for resolution of stock broking firms and smooth portability of positions in India. Almost two weeks back, the Securities and Exchange Board of India issued an order imposing various restrictions on Karvy Stock Broking Limited, but did not shut down the stock broker.

The order also froze the securities lying in the name of the stock broker on the ground that these securities actually belonged to the broker’s clients. Subsequently, these securities were transferred to the names of around 80,000 clients who had fully paid for the shares. Since the broker had pledged these securities with various bank and non bank lenders, these creditors appealed to the Securities Appellate Tribunal (SAT) which observed today that “a lot of water has flown under the bridge”, and it is not possible to reverse what has already been done.

In this blog post, I will however focus on the problems faced by the clients of Karvy. In its appeal to the SAT, Karvy complained that because of the SEBI restrictions it was unable to execute the instructions given by its clients (especially online clients) on the basis of the power of attorney that is normally used in these cases. On a direction from SAT, SEBI examined this matter but refused to make any concession, and stated that clients were free to issue paper transfer instructions or to fax them. Meanwhile, on Monday, the stock exchange “temporarily” suspended Karvy from its membership, and yesterday the SAT has refused to entertain an appeal against this action.

Clients are now stuck with a broker who has not been shut down or liquidated but is not functioning any more. It is not acceptable to say that the 1.2 million clients of Karvy can individually initiate the paper work to move their trading accounts to another broker. Contrast this with how the SIPC does this in the United States:

Shortly after the commencement of a liquidation proceeding, a SIPA trustee may transfer customer accounts to another solvent brokerage firm in what is called a “bulk transfer.” The bulk transfer can occur without the consent or participation of any customer, and may result in customers getting access to their property in a few days or weeks. (emphasis added)

It is also instructive to see how this process worked in the case of MF Global which is in many ways similar to the Karvy episode. The SIPC stated that in the MF Global case:

SIPC initiated the liquidation proceeding within hours of being notified by the SEC

The same day (October 31, 2011), there was a court order appointing a trustee to run MF Global:

ORDERED that … the SIPA Trustee, as appointed herein, is authorized to operate the business of MF Global Inc. to: (a) conduct business in the ordinary course until 6:00 p.m. on November 3, 2011, including without limitation, the purchase and sale of securities … and obtaining credit and incurring debt in relation thereto; (b) complete settlements of pending transactions, and to take other necessary and appropriate actions to implement the foregoing, in such accounts until 6:00 p.m. on November 7, 2011; and (c) take other action as necessary and appropriate for the orderly transfer of customer accounts and related property.

Within two days (November 2, 2011), the first set of bulk transfers covering about 50,000 accounts began.

There is an urgent need to create a statutory and regulatory structure to do all this in India, but I suspect that at a crunch, the regulators may be able to achieve some of these goals using existing statutes and by stretching the powers that they already have to protect the interests of investors. The even more urgent need in my view is to create the operational capability to implement this on the ground. It should not take more than a week to just put a brokerage firm into limbo.