Learnings of the Week-3. (1/2)

Asset Liability Management (ALM)

  • Term ALM is in focus from the DHFL fiasco
  • Loans given to customers are assets for the bank and deposits, FDs, and raised money through NCD and bonds are liabilities for the bank
  • Banks put assets and liabilities according to the time slot (maturities), and if both are not matching in their particular time slot, it is called asset liability mismatching

  • Here are the techniques for asset liability management employed by banks
    • Gap analysis
      • This is to asses liquidity risk and interest rate risk on the rate sensitive assets (RSA) and rate sensitive liabilities (RSL) – this are basically floating rate loans and deposits with premature withdrawal option
      • If gap is positive (RSA>RSL), bank can deploy it in money market or create new assets (disburse loans), and if it is negative (RSA<RSL), banks have to finance it
    • Duration analysis
      • Long duration can make trouble due to interest rate changes when it is floating rate asset or liability and when it is callable debt and so (fixed rate asset and liability are safe)
      • Long duration become more sensitive for interest rate changes
    • Scenario analysis
      • Here, banks put some scenarios, like rise and fall in interest rates, which can affect ALM in future
  • ALM is important tool for bank’s risk management and banks with strong ALCO (Asset Liability Committee) can manage their risk better and can instil confidence in their shareholders

Article link:
https://twitter.com/FinsenseG/status/1259705804661256193?s=19

Should the RBI print money to revive the economy? It’s not as simple as it sounds

  • Condition of small-scale industry eagerly appealing RBI to print money
  • Due to COVID, production of non-essentials become tiny, hence govt’s tax collection avenue of excise duty and GST is collapsed; with no foreign trade, govt can’t have inflow from custom duty side also (high excise duty on petrol and diesel can give some relief)
  • There is no real estate transaction and no much alcohol sale, govt’s tax collection is becoming weaker
  • Now with all this, govt need to spend money to get economy going again, but how it can spend as it is not earning?
  • Govt borrows, by issuing bonds to insurance companies, banks etc, higher borrowing by govt will lead to less available funds in the market and banks have to borrow at higher rate
  • In this scenario, suggestions are there for RBI to print money (like US can do it so why we can’t)
  • Here, RBI is expected to buy govt bond by printing money, which will credit govt’s account and it can spend it on economy for keep it going
  • Generally, in times of crisis, three things hear; banks need to cut interest rates, govt need to spend money, and if this two don’t work, then it is like central bank need to print money
  • Let’s now see the nounce pointwise
  • From past 4000 years, government deems what can be used as money that day and citizens have to use that for their transactions; today we are using money – a piece of paper (backed by nothing) because govt told us to do it
  • Money is fiat and hence it can be created by central bank from thin air, therefore a govt can’t be insolvent in its own currency
  • With all these keep in mind, the govt need to be a spender of the last resort – that means govt need to be an employer of the last resort, it can print money and hire employees and can create economy again; this is what suggested by economists
  • These all is here because we want to transact in currency because govt told us to do so; We accept currency because other will accept it – ‘A’ want currency because he know ‘B’ will only accept it; govt has right to charge taxes, and that also to be paid in currency
  • In developed nations, the population is willing to accept more domestic currency than what is needed for tax payments, as all sales is done it their domestic currency
    • So there govt can print money and create employment and so forth, and there is nothing which can’t purchase by domestic currency
    • But in developing nation, paying tax honesty is not in practice
    • Here, population want domestic currency to pay tax liabilities, but it become limited by tax avoidance and evasion
    • This will limit the government’s ability to purchase output by making payments in its own currency
    • This is what happens with India that this informal part of economy forms a large part of economy, which doesn’t allow govt to purchase everything by printing their own currency
    • This is what advisors don’t think
    • If Indian economy want to be able to print money how other nation do, it have to reduce or nullify or formalize tax avoidance (part of informal economy), which will ensure more demand of rupee and thus will make govt to print money, when required
  • But printing money will lead to higher inflation as more money will chase same amount of goods
    • But in today’s scenario, there was huge demand destruction in past couple of months, hence printing money will not be like more money will chase the same amount of goods and services
    • Another point is according to RBI research, utilization of manufacturing companies was only 68.6%, i.e. companies’ one third part of their capacity is not utilized due to low demand
    • So, money printing will increase demand and allow them to manufacture and utilize their 100% capacity without increase in price
    • Hence, this is one point in favour of money printing i.e. it will not create inflation
  • Let’s go in more details, RBI will print money and give in Gov’t accounts
    • Let’s say govt will give it in citizen’s account and they will be started spending (as the demand is already destructed, inflation generally don’t ger flight)
    • Due to spending, money will go to businesses and in this environment, they will put them in their bank accounts
    • Now banks have more funds so they will lend it to RBI again (by reverse repo)
    • RBI’s printed money comes back to it again
    • RBI have to pay interest on it!
    • Hence, there is no free lunch, even though the RBI is printing money and creating it out of thin air
  • In normal scenarios, govt issue bond to banks to finance its deficit, and banks earn near 6% return from that bonds, but in money printing case, both private and public sector banks have to put their money in reverse repo with 3.75%; that means govt’s income again is becoming lower (as govt is owner of public sector bank)
  • If the government spends too much, this might set off pressure to depreciate currency, and in this time, govt don’t want this to happen
  • If RBI print money and buy govt bond, it will not change fiscal scenario of govt on which credit rating agencies have their eyes; but if credit rating agencies feel govt is having a big amount of debt, they will downgrade India’s rating, and so foreign investors will leave India and govt will create their own set of problems
  • Continuing on above point, US dollar have perpetual demand in the whole world and countries take it as a safe heaven, hence US central bank is able to print money without be worried about exchange rate implications; but unlike US, India may have problems as stated earlier if it does so
  • MMT works at developed market where govt forms a substantial part of economy, and it don’t work at developing market where govt have limited part in economy; just because something sounds simple and straightforward, like money printing does, doesn’t mean it is
  • Now, all these are in hands of politicians running the government need to decide whether they want to print money or not, main thing here is whether they understand all these nuance

Article link:
https://www.newslaundry.com/amp/story/2020%2F05%2F08%2Fshould-the-rbi-print-money-to-revive-the-economy-its-not-as-simple-as-it-sounds?__twitter_impression=true

Published by Aakash and Meet

I am Aakash Raotole I am currently doing Bcom from Dr. Patel and Rb Patel commerce college I am currently studying at finnacle investment academy Recently done distance internship with windrose capital, Pune - for a period of 14 weeks I am Meet Bhatt Completed HSC in commerce Now studying finbridge program at finnacle investment academy and Bcom externals I had completed CFA institute's investment foundation course and distance internship with Windrose capital, Pune - for a period of 14 weeks

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