Tag Archives: Financial Planning

Thursday Trivia ~ Who is a Wealth Manager?

A few years back when I started my career in Wealth Management, it was extremely difficult to convey what I actually did. Things haven’t much improved even as we are in the mid of 2020. The problem in India is due to lack of financial literacy, alternate careers in managing wealth haven’t picked up. And as every optimist would hope for a better tomorrow, we hope too that people realize the importance of hiring an expert to create or manage their wealth.

A major trouble that we encounter is trust deficit towards wealth managers or financial advisors. 

Traditionally, brokers were thought of as experts who will help a person create wealth. Even today, after tonnes of research / studies showing how holding an investment for a long term creates significant wealth, affection towards making a quick buck doesn’t seem to go away.

Hence, to understand who is a wealth manager, we should first look at who is not a wealth manager. 

  • Broker

A broker earns his bread and butter through commissions. And these commissions are a result of constant ‘buy / sell’ transactions of securities. Hence, the alignment of interest for a broker is to over-trade on an investment account.

It’s not that a broker tends to have bad intentions towards managing money. But he isn’t getting money for simply buying a share that doubles in price, unless he sells that share too. And who knows, that share might just triple from there too. All of us have a few regrets of not holding on to a share that just went right up after we sold.

  • Chartered Accountant

A chartered accountant is specialized in audit and tax. Hence, his perspective towards investment is to help save taxes. The problem is that a person can’t get super rich by saving taxes. It’s a false assumption. A chartered accountant is never pro-active with their client’s life. They usually enter at a post mortem stage. As a professional, their role doesn’t allow them to create a financial plan for their clients and see whether the goals will be achieved in timely manner. They can merely suggest which investment product is safe.

If you invest in a 7% RBI Bond and lock your money for the next 10 years, then truly you haven’t beaten your own lifestyle inflation. At 7% (assuming cumulative interest and not simple interest), your money will double. At simple interest, interest amount will be paid out to you and only principle will return. But in that time, a Toyota Innova that you wish to buy will more than double in price and come with unbeatable features. And yet, the money parked in RBI Bonds will not be enough.

Due to this narrow perspective, they don’t usually help in achieving a long term goal of children’s education or marriage.

  • Life Insurance Agent

Life Insurance Agents are still the first people who get approached while thinking about investments. For most people it makes sense because they come once a year, take the premium and promise to double the money in next 20-25 years (depending on the policy). And they provide insurance too, so if something happened to you, money is coming back.

Their interest is merely selling an insurance product. They are biased towards the company that they represent. And don’t offer complete wealth management solutions to their clients. 

It was a great choice during the 1990s and early 2000s when wealth management as a profession wasn’t evolved. For a risk averse generation of the 70s and 80s, they’ve created a good deal of wealth by offering them insurance, post office investment products, fixed deposits, etc. 

Back in those days, interest rates were high too. Which have now started to come down significantly. Double digit interest rates on investments are now a distant dream. As a result of increased sophistication in financial services, an Life Insurance Agent is not as effective. He may help you save taxes, but wealth creation simply doesn’t happen.

  • Relative / Friend

If you read business newspapers regularly, then you are well aware of so many scams that happen every now and then. Other newspapers too cover some internal fights in the family or between brothers that have resulted a massive wealth destruction for shareholders.

In such times, we naturally bend towards our friend or relative that has made some money by investing in stock markets. We go to them for gaining some information on which stock to buy that will double or triple. In some risk averse people, they invest in safe companies they consider won’t be shut down. YES BANK was one example that most people thought was safe. What happened after that is a story that needs a separate article.

The problem here is that our friend and relative don’t have a complete access to the way we are looking after our money. Despite their best intentions, we tend to put only around 1-2% of our investment amount. Even if that particular stock triples in value, our overall portfolio doesn’t change a bit. Hence, we still are on the starting point.

  • Mutual Fund Distributor

A mutual fund distributor is like a broker. His interest is in selling mutual funds that offer him highest commissions. It’s not tailor made to suit a person’s risk taking appetite. Investors too get lured into higher returns offered without understanding its impact on wealth creation or destruction in some cases.

Hence, in all the above examples, we understand that it’s not that these professional has a bad intention. They are just limited to their own knowledge and perspectives. It’s like your local grocery store who has good intentions but has limited band-with of products and services. The local grocery store won’t have a sophisticated infrastructure like Amazon, D-Mart, etc. Hence, as a customer, your choices will be limited to his capacity.

Same is the case in financial services. I’m sure, your mind will now be running a question that who really is a wealth manager then? And what does he bring to the table that is so different from the ones listed above? Also, how does he make money and the biggest one – can I trust him?

So who is a Wealth Manager?

Wealth Managers have specialized understanding about the unique financial challenges and decisions faced by high net worth clients. If you’re a high net worth family or individual, you want a wealth manager. You have unique needs when it comes to money. You will face complex questions that most people do not face. You will need help with things other people don’t even have to think about. 

These areas of specialisation generally include:

  • Strategic Goal planning
  • Tax accounting 
  • Retirement planning
  • Legal planning
  • Estate planning
  • Risk management
  • Trust services
  • Banking services
  • Philanthropic planning

In our case, we do not consider these additional services optional. For most of our high net worth clients, these do become essential services at some point in their life, and the process of navigating the issues that arise in each of these categories is complex that needs a special attention.

Wealth managers wear multiple hats. On any given day, they might be an investment planner, a consultant, an advisor giving counsel about a big decision, a data-cruncher, a retirement planner, a fixer of someone else’s costly mistakes, a locator of resources and specialized expertise, or a financial trouble-shooter who looks at the client’s financial situation and finds ways to refine and improve it.

In other words, the wealth manager reduces the complexity of life that their clients would otherwise have to grapple with on their own. The wealth manager helps you not have to worry.

Investment Management

It’s a subset of wealth management. Yet highly misunderstood. As most people think it’s searching the next best investment product or which mutual fund is good. But it’s not so. Investment management involves a lot of work that starts from selecting the right securities in the portfolio to exiting them.

  • Security selection or portfolio creation

The first part is to create a portfolio of securities that include mutual funds, bonds, equity through a portfolio management service provider, etc. The portfolio so created is unique to the financial goals and risk appetite of the investor. 

  • Monitoring of security

Creating a portfolio isn’t enough. A lot of time is invested in constantly monitoring the securities. Since, a lot of events happen around the world may or may not have a direct impact to the securities in the portfolio. When China devalued its currency in 2016, Indian markets started falling, IL&FS and DHFL showed signs of troubles – our equity markets went through a very tough time, most recent event is coronavirus and lockdown.

In such times, a wealth manager tends to take proactive calls with the portfolio that result in protecting the portfolio and eventual wealth creation.

  • Rebalancing the portfolio 

There are some events in an investor’s life, where his finances get altered. It can range from a huge bonus or promotion to some additional unforeseen expenditure or job loss. In such cases, an investor’s profile changes and the portfolio needs to be rebalanced to suit the right risk appetite.

  • Exit

Buy and Hold is a good strategy to have. Also, it makes equal sense to exit a security in the portfolio when it’s useful life is over. A wealth manager is never married to the security he adds to the client’s portfolio. For him, it’s a tool for wealth creation.

How does a Wealth Manager make money?

Wealth managers tend to charge fees directly to their clients. The general ballpark figure for most wealth managers’ fees is about 1% of their client’s invested assets. The idea here is to have a complete alignment of interest with their clients.

So when they charge fees or in other words earn their income from their clients then they would like to work for them. If they would be dependent on commissions like a broker, life insurance agent or a mutual fund distributor is, then they would simply look to offer an investment product with high commissions. Even if it doesn’t result in any wealth creation.

And lastly, how do you TRUST your Wealth Manager?

It’s difficult to trust a person who sells you services that can’t be valued immediately. It’s not like buying a new software or an app. Managing wealth is an intangible thing. Value and returns are parked in the future. It’s difficult to estimate whether you’re overpaying or under-paying!

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The simplest way out is to look for whether your wealth manager simply talks or he walks the walk too. So if your wealth manager starts a conversation about an investment product in your portfolio rather than your life, then he surely shouldn’t be trusted. A wealth manager is more interested in your life than any investment product.

Thumb rule here is to have a look at his own financial plan, retirement plan, statements of financial investments, etc. If he is consuming the same financial product which he intends to put in your portfolio, then you can be rest assured that he too has skin in the game. And he won’t take any foolish decision which might hamper his portfolio and reputation at the same time.

Other aspects to look out for are his professional education, experience in the industry, expertise and most importantly alignment of interest. Once you have all these elements in place, then just enjoy the ride because your retirement destination is closer than it appears currently. 

– Jinay Savla

Thursday Trivia ~ Are you Financially Free?

 

Rahul, Divya and Mahesh are childhood friends. Everyone likes to call them  – 3 Musketeers! Right from staying in Mumbai’s suburbs during their school and colleges days to now living in posh locality of South Mumbai, their journey is not less than anything inspirational. Those sleepless nights before exams, traveling in local trains, chai-samosa parties, etc. are some of the unforgettable memories that they relive whenever they meet.

Rahul rose through the ranks of corporate ladder after completing his professional education. Divya became a doctor, she is a visiting doctor to many hospitals in Mumbai. Mahesh established a business while he was in college and has now established into a global company.

As Rahul turns 40 today, he stands on the balcony of his penthouse with Divya and Mahesh next to him reliving those days when they were hustling through life.

‘Life has blessed us with so many fond memories. We used to study till 4 am and write exams the very next day. Not to forget the chaiwalah who used to come at 1 am in the morning and ask us about our preparations for tomorrow. Remember how Mahesh used to confidently say, that we will crack the papers wide open!’ remarked Rahul.

‘Oh yes and we would be worried about whether we will be able to write the paper tomorrow or not,’ laughed Divya.

‘And we did crack the papers every single time. Didn’t we?’ smiled Mahesh.

‘Most definitely we did.’ Divya winked.

‘Seriously, I had to climb the hard corporate ladder and work around my loans for my house and Mercedes while Mahesh has been able to buy three houses and 2 BMWs by now. He seems to have some magic wand.’ Rahul said.

‘I never buy anything on loan. We have a saying in our family, a person works for 12 hours while his interest on loan works for 24 hours. The only loan we take is for business expansion and new product offerings.’ Mahesh replied with ease.

‘WHAT!! You have never taken a personal loan. Then you’re surely missing out on great things of life buddy. See this phone of mine, it’s worth Rs. 1.25 lakhs. I couldn’t afford paying straight away so I got an easy EMI option on it. I just bought my first Audi too and have my bank’s relationship manager working on a house that we are planning to buy in next 6 months. It really improves my image as a doctor, you see.’ Divya anxiously replied as she couldn’t believe Mahesh never ever took a loan.

Mahesh sensed Divya’s anxiousness. He replied, ‘That’s wonderful Divya. I am glad to see you so happy. You are a wonderful doctor but very bad at managing your money.Since you were so busy studying those big books, you never got the time to understand the power of compounding.’

‘I agree with Mahesh. Understanding money and power of compounding is a must, Divya. It’s the 8th  wonder of the World.’ Rahul interrupted.

‘I don’t believe Mahesh at all. Even Rahul took a loan for your house and Mercedes. So what’s wrong with me taking one?’ Divya was getting a little irritated now while Mahesh maintained his composure.

‘Yes, Divya. But then look at what I had to go through. Most of my money was being spent on servicing the EMIs on loans. Though I don’t have any loan on my head right now, I also don’t have any money sitting in my bank right now that will help me retire. If my daughter gets hospitalized tomorrow, I will have to take loan from you and Mahesh to help me out. Next option is credit card.

Technically, I am still a slave to the system. I can’t escape my job. I am still working for money, I just disguise it saying that it’s my passion. But it’s far from truth and you know that.’ Rahul choked while speaking.

‘Divya, don’t get me wrong. But the loans that you are enjoying today are just financial burdens of tomorrow. You still aren’t able to take your personal time off from work. It’s creating a pressure for you when in reality. You want to start a charity for underprivileged since a long time but you aren’t able to because you don’t have time. You are chasing money while dreams are slipping away.’ Mahesh chose his words carefully this time as Divya went into deep personal enquiry.

Silence for 5 mins.

Finally Divya started talking. ‘You guys are right. I have achieved so much as a doctor but there is no freedom in my personal life. I still cannot take 1 week off from work and spend time with my children. Home loans, car loans and now a loan for phone too. There is no money sitting in bank account that can be used if some emergency in family comes up. Retirement is completely out of picture, at least you have even thought about it Rahul, for me it’s a distant reality.’

Rahul got up to get a juice for Divya. On coming back he asked, ‘Mahesh how the hell did you do it? I mean, how did you become financial independent with so much stress from business every single day?’

To which Mahesh replied, ‘I never really took a loan to fulfil any of my desires. Whatever money we made, we continuously invested back in our business all the time. Plus since last 10 years, we have been investing mutual funds as well.

When you own a business, you own a piece of growth. It starts small and slowly compounds over time. Remember the days when you bought your first car and I was still traveling by public transport. I had the option of taking a loan but didn’t want to burden myself. While Divya was enjoying Europe, I was enjoying Kerala. The idea was to let money work for me.

And it took off. In last 12 years, we saw immense growth in our business. Then even our holdings in mutual funds grew and suddenly we were having more money than we had ever imagined. My business makes enough money for me to not work for a few years. My investments have earned me financial retirement. I am happy with my phone which serves the purpose of emails, chats and calls. There is no financial pressure, what more could I have asked for in life?’

Divya was listening with great interest when Rahul interrupted.

Owning a piece of business is so important. I had ESOPs of my company but I sold it off for down payment of my home. Those shares are worth 5x more today. I realize now that I made such a big blunder.’ Rahul almost stopped drinking his juice.

‘That’s in past Mahesh. Now what shall we do?’ Divya looked highly concerned now.

‘Don’t worry. We will crack this paper of your financial life wide open too, just how we did during exams’ winked Mahesh.

‘That’s the spirit boys!’ yelled Rahul with excitement.

Mahesh said, ‘listen to me very carefully now, just don’t interrupt. First and foremost, repay every loan you have. Especially your loan for Audi, Divya. If you don’t need that car then don’t buy. You are not impressing anyone. Just putting too much financial stress on yourself. And for that second home you are buying with loan, cancel that too. Find a nice broker and sell that house. You don’t need an extra house right now too.’

Divya politiely asked, ‘My dearest Mahesh, how do I repay my loans and start investing? I will need someone to guide me through the process. I am not born with mastery in numbers, like you!’

Rahul laughed while Mahesh was gathering his voice.

Mahesh replied, ‘Yes Divya, as always you are right. You need a Financial Advisor to help you through this. Just the way you take care of your patient’s health, your advisor will take care of your financial health. An advisor will see to it that you don’t overspend your income, invest the balance and see to it that you don’t take up unnecessary loans. This will secure your retirement and you will be able to work without having to worry about money any single day.’

‘Wow Mahesh. Do you have anyone in mind?’ enquired Divya with great excitement.

‘We have a financial advisor who will help you out with the process.’ Rahul intervened.

‘What!! Both of you already have one and never told me about it!’ yelled Divya.

‘That’s because you never want to discuss about investments ever with us.’ Mahesh replied.

Rahul replied, ‘Yes. I invest some portion of my salary every month into mutual funds. Also have an emergency fund set up, if I am unable to work for 3-6 months. Since I paid my complete home loan last year, I will be able to gain complete financial independence in the next 5 years. My advisor keeps a very good track of it.’

Mahesh looked at Divya and said, ‘Sit with the financial advisor for a few hours and plan a life of complete financial freedom. Just don’t let your fear or greed get in the way. It’s okay to get rich slowly because ultimately you will get rich. Getting rich fast, never really happens!’

‘Wow. What a speech, can’t get enough of it!. But for now, we are hungry and need food. Right now, we wish to focus on independence from hunger!’ Rahul smiled and thanked Mahesh.

 

Today’s Thursday Trivia has taken its inspiration from the tweet of Mr. Steve Burns. 

The most satisfying personal finance achievements:

  • No credit card debt
  • No car payments
  • Home can be paid off
  • No debt
  • Emergency fund
  • Big retirement account
  • Big trading account
  • Cash flowing assets
  • No financial pressure
  • Financial independence from a job

 

– Jinay Savla

 

Thursday Trivia ~ Easy Steps To Get Your Lost Aadhar Card Online

‘What a pain is this? Everyday someone is shouting over an SMS – Please link Aadhar. It’s frustrating’ Manish said while checking his messages.

‘It’s frustrating only because you have misplaced your Aadhar card. Don’t spill your laziness on everyone.’ Neha said in a mocking tone.

‘Alright. Let me speak to our financial advisor, I am sure he will help me out rather than passing comments’ Manish said while placing a call to his financial advisor.

‘That’s easy Manish. Don’t worry, just a few simple steps and it will be done. I will email you in five minutes’ financial advisor said.

‘That’s great. Email me.’ Manish looked excited.

Manish’s phone popped up with an email notification. A few steps were mentioned, ‘government work usually takes a long time, but thankfully this is not so!’ he thought to himself.

Instructions were as follows :

Go to website – www.resident.uidai.gov.in and select ‘Retrieve Lost EID / UID’

Upon selection, fill in your personal details and request for One Time Password ‘OTP’

Enter that OTP received on your phone. Your Aadhar number will be sent on your mobile.

Upon entering OTP, a new window will open up where you will be able to ‘Download Aadhar’

The link will take you to a new page – https://eaadhaar.uidai.gov.in where you can select ‘Aadhar’ and put in the number received on your phone. 

A couple more details need to be mentioned. Request for one more OTP for the last time.

After you put in your OTP. Your Aadhar Card will be automatically downloaded. Password to open is first four alphabets of your name in upper case and year of birth.

‘That just worked perfect. Thanks buddy.’ Manish excitedly called up his financial advisor. Neha was pleased to see this and both sat for lunch together.

– Jinay Savla

Thursday Trivia ~ New PPF and NSC Rules for NRIs

Who is a Non Resident Indian (NRI)?

Income Tax doesn’t directly define NRI. Section 6 contains criteria to consider Resident in India and provides that anyone who doesn’t fulfil this criteria is considered Non-Resident.

Simply speaking, the status of a person as a resident or non-resident depends on his period of stay in India. The period of stay is counted in number of days for each financial year beginning from 1st April to 31st March.

Who is a Resident of India?

An individual will be treated as a Resident in India in any previous year if he/she is in India for:

  1. Atleast 182 days in that year, OR
  2. Atleast 365 days during 4 years preceding that year AND atleast 60 days in that year.

An individual who does not satisfy both the conditions as mentioned above will be treated as “non-resident” in that previous year.

Old rule for Personal Provident Fund (PPF)

As per the provisions, NRIs are restricted to open a new PPF account in India. However, if they were residents while opening the account and subsequently became NRIs, they were allowed to make contributions into their said PPF account.

New Rule for Personal Provident Fund 

On 3rd October, 2017 Government came up with a notification namely Public Provident Fund (Amendment) Scheme, 2017

“Provided that if a resident who opened an account under this scheme, subsequently becomes a non Resident during the currency of the maturity period, the account shall be deemed to be closed with effect from the day he becomes a non-resident and interest with effect from that date shall be paid at the rate applicable to the Post Office Saving Account up to the last day of the month preceding the month in which the account is actually closed”.

As per this notification

  • When your residency status is changed to NRI, PPF account will be deemed to be closed, hence no further contribution would be allowed.
  • Interest on PPF would be now applicable to Post Office Saving Account which is 4% rather than prevailing interest rate of 7.8% until you close the account itself.

Old Rule for National Savings Certificate (NSC)

Similar to PPF, NRI cannot directly invest in NSC. However, if an NRI is allowed to continue existing investments till maturity date considering the account has been opened while being a resident.

New Rule for National Savings Certificate

When an individual becomes an NRI, his / her NSC account is deemed to be closed. Till the time an NRI actually enchases, the accumulated money in NSC certificate will earn an interest of Post Office Savings Account which is 4%.

It’s important to note that these rules are prospective in nature.

Suppose Mr. Ajay became an NRI citizen in 2014, he would have continued to enjoy the benefits till October 2017. Now after the amendment, Mr. Ajay would not be able to contribute to PPF Account or NSC certificate and his interest income would drop down to 4%.

In cases where, family of an individual also moves to a different country for employment purpose. If they fall into the definition of NRI, then similar rules would be applied for PPF and NSC.

How to withdraw money from PPF Account?

An NRI’s request to close PPF account can be processed by bank or post office only his / her signature is attested by an authority. The attestation can be done by a Gazette officer or PSU Bank officer.

An NRI should send a PPF account closing form to their relatives, friends, parents or financial advisor in India where they have NRE/NRO account. An authority letter must be attached allowing them to do withdrawal process by closing PPF account on behalf of an NRI.

Authorised person after getting attestation of the authority letter either from a Gazette officer or a PSU bank officer should proceed to the bank where PPF account is held. On verifying the authenticity of documents, bank will close the account.

– Jinay Savla

Thursday Trivia ~ What is Recapitalisation and How it impacts you!

What would you do if your child is unhealthy? You will take him / her to a doctor. Medicines will be prescribed. Yet, child continues to remain unhealthy. Now, there will be complete body scan. Upon reports when doctors realise medicines are not enough, they would prescribe surgery. Yes, surgery.

Similarly, banks in India have been unhealthy for quite some time now. So what can government do? In 2008, after Global Financial Crisis banks in USA were bailed out by taxpayers money. However, in India the crisis is not so severe. Hence, government has resorted to Bank Recapitalisation through a transparent financial engineering process.

Need for Recapitalisation

As per the banking norms, for every loan a bank makes it needs to have 10% of it as capital. So if a bank wants to lend Rs. 10,000 to someone, it needs to have a capital of Rs. 1,000 with it. Now, if the loan defaults by even Rs. 200 then it directly affects the capital requirement. Capital reduces (1,000-200) to Rs. 800 as a result of such a default. As a result, for Rs. 9,800 worth of lending, bank now only has a capital base of Rs. 800 which is 8.15% of the capital. Doesn’t fit the capital adequacy requirement of 10%.

At this point, either the bank can call in the existing loan which isn’t possible so they stop lending more. This stops credit take off from it’s very source – banks. Hence, the need for recapitalisation.

Structure of Bank Recapitalisation 

  • Bank Recapitalisation Bonds – Government will issue bonds worth of Rs. 1.35 lakh crores to Public Sector Banks. The banks in turn, will buy these bonds from government. The same money would be utilised by the government to buy shares of public sector banks.
  • Through budgetary allocation (taxpayers money), government will buy Rs. 18 thousand crore worth shares of Public Sector Banks.
  • Lastly, Public Sector Banks will then need to raise Rs. 58 thousand crores from market.

This adds upto a staggering Rs. 2.11 lakh crores. Indeed our public sectors banks are unhealthy.

Impacts on different stakeholders of Recapitalisation

Public Sector Banks

Banks which have already made appropriations for Non Performing Assets (NPA) will now be forced to recognise them as losses. Which in turn would result in erosion of capital. This erosion would be compensated by government by infusing capital by buying shares through bank recapitalisation process. Net effect, banks will be able to erase off their non performing loans while keeping their capital requirements intact. This would make banks healthier in process and would be able to make fresh loans.

Only caveat here is as banks will purchase these recapitalisation bonds, government will have to pay an interest on the same. This will add to fiscal deficit. Experts argue that interest amount of Rs. 10,800 crores a year considering 8% interest rate is won’t affect India’s fiscal health. However, every drop counts.

PSU Bank Shareholders

Shareholders of PSU banks will see a drop in book value of shares they hold.

How?

Let’s look at this example. Mr. A invested Rs. 200 in a PSU bank. Issued capital of the bank is Rs. 10,000. Hence safe to say that Mr. A holds 2% in the bank. Now, government infuses Rs. 30,000 to recapitalise the bank. As a result, Issued capital of the bank becomes Rs. 40,000. However, Mr A continues to hold Rs. 100 worth of shares in the bank. As a part of restructuring, Mr A will now hold 0.8% of the shares of bank. Hence, shares held by PSU Bank shareholders will get diluted.

However, it’s important to note that price of the shares have not been reduced. On the contrary, after the announcement of this scheme, PSU Banking sector index has seen a rise of 33% till date. Which means, shareholders need not worry on this issue.

Depositors

For depositors nothing changes. Apart from the fact that they can now place more confidence on solvency of the bank.

So if you had your fixed deposit in any public sector bank and were worried for a while. Then government will tell you to relax, the invisible hand is there to support you.

Taxpayers

Some of our investors raised an important question pertaining to bank recapitalisation. Central theme of their question was ‘Why should we ‘taxpayers’ bail out immoral and wilful defaulters?’ This definitely is a very important question in this context.

However, it’s important to note that in last year’s budget Finance Minister had made an allocation of Rs. 18 thousand crores for banks from the government for which the provision has already been made. Even with this announcement, no fresh allocation of taxpayers money is allocated. As a result, there is nothing to worry for taxpayers.

Investors

Bank recapitalisation will help to accelerating structural reforms in Indian economy. Infrastructure reforms such as roads, railways, power etc., transport sector will also get immense benefit on the back of proper roads being built plus Goods and Services Tax has already brought down gestation period of tucks at inter-state toll booths, manufacturing companies will be able to not only provide for consumption in India’s economy adding exports will help to put India firmly on global map.

By fixing the credit supply in the system, bank recapitalisation will prove to be a win-win for all stakeholders.

Can consolidation of PSU Banks happen?

The constitution of Alternative Mechanism is a step ahead in their direction. In August, Union Cabinet had decided to consolidate existing PSU banks under this mechanism to create stronger banks. Committee for Alternative Mechanism will be headed by Finance Minister Arun Jaitely.

One question that always strikes our heart is ‘How did situation become so bad in the first place?’ We were such a strong economy on the path to become a superpower but all fell apart.

What happened in the context of Public Sector Banks?

Flashback 2014, then Reserve Bank of India Governor Raghuram Rajan, brought to light the unhealthy state of banks. He pushed for an asset quality review. Till that time, most of us thought ‘all is well’ and then looking at bad assets amassed we were informed that ‘all is really not well’. The numbers  of ‘Non Performing Assets (NPA) ’ (loans given by bank which cannot be recovered) we saw were spectacularly high.

Due to this, banks were not only able to lend more money which is it’s primary source of income but even staying solvent was becoming a challenge. If money is stuck in the system and doesn’t come back to banks, then overall economic growth takes a backseat.

Why did this happen?

FY 2008-2013 was an era of stalled projects, immeasurable scams (2G scam, CWG scam, coal scam) and needless delays in executing projects which resulted into a standstill. Yet, the world was changing. Economic environment had become far more dynamic for India to be standstill. In other words, India did miss out.

So how is it connected to banks?

Companies take loans from banks to execute projects. If these projects get stalled for no reason (Tata Nano, Singur) or Government doesn’t allocate projects (2G spectrum scam) or there are unnecessary delays in obtaining licences to execute project (unease of doing business) then money gets locked. Also, this gives rise to morally incompetent people who float companies just to obtain loan and run away somewhere far in London, England while having their favourite drink. The whole eco system starts to breed unethical, fraudulent and immoral behaviour.

Banks which have lent money has a hard time to recover those loans. Safe to say, unhealthy. As a result, banks cannot make fresh loans to deserving projects or those projects that need of the hour. As there is lack of credit in the system, entrepreneurs are discouraged to take up more projects. As a result, no improvement takes place. Infrastructure and transport remain the same, worse off on a global scale a country tends to regress. Confidence in the system is lost.

This gives rise to a vicious circle.

In such a scenario, banks first need to recognise assets that have gone bad. Which determines the extent of fresh money required by them to start the process again. Now, banks start to look at government (one and only saviour). But, government makes money out of tax collections from citizens. Infusing honest tax payers money to cover incompetent businessmen’s bad loans brings about a negative mood to honest tax payers, especially salaried class.

This has given birth to a new challenge for the government.

If they borrow money from outside, fiscal deficit (revenue less expenses) widens as they have to pay back compulsorily regardless of bank being stable or not. If they use taxpayers money, sentiments are hurt and their chances of being re-elected become grim. So what to do?

Because of unhealthy lending structures, Public Sector Banks have suffered a lot more than Private Sector Banks. Hence, this recapitalisation is for Public Sector Banks only.

Dear readers, if you have any further query on Recapitalisation please feel free to write in the comment section below and we will resolve the same.

– Jinay Savla