Wednesday, October 15, 2008

Banks backed by the Big Stick

Capital injection in banks – will it make them more or less efficient? Will it open a can of worms with politics interfering in commercial lending decisions of banks. I can easily draw a parallel from what happens in India, where politics routinely interferes in the everyday functioning of banks – be it small cooperative banks facing pressure from small time local politicians, or large banks that have to appease the majority shareholder – in this case the government from time to time. There has been many a distressed lender crumbling under direct or indirect political interference. A New York Times report in 1999 warned of the interference of the Clinton administration in the affairs of Fannie Mae, that was under pressure to lend to a new category called “sub-prime loans”. But that does not really mean, we must expect the worst. Considering there was no other alternative, this will be a Damocles sword for banks going forward. How will future investors in these banks perceive the presence of the sovereign on the boards of these banks? Much has been said that the government was shortchanged in terms of the kind of equity stake that it will have in these banks.

Tailpiece: So much for capital adequacy - but what ever happened with all the stress testing that Basel norms provide? I guess the stress test was not designed to register a stroke in the credit market as it were. How closely were the capital adequacy norms being implemented. Banks were supposed to maintain a minimum of 9% as Capital Adequacy Ratio as per Basel norms. The costs of implementing these norms have been tremendous for some of the smaller banks. I guess we will see greater emphasis on capital adequacy – something that will discourage unviable leverage in future.

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