Risk Management - The Indian Way

In the aftermath of the global financial crisis triggered mainly by the US housing market crash and collapse of the structured products market linked to it, the one term that has assumed importance of gigantic proportion is “Risk Management”. It has become the focal point in most of the board meetings and business luncheons.

Financial Risk Management (FiRM) in India is still in its infancy. Blame it on the underdeveloped financial markets or the policy bandwagon that focuses more on the financial services industry (and greatly ignoring non-financial corporates that are equally vulnerable to the peril of a financial crisis)* or the management philosophy that risk management is just another tool to increase their bottom-line (rather than protecting it). We would like to focus on the last aspect as the other two are beyond the control of an organization.

The philosophy of profiting from risk management function can be attributed to the typical Indian mentality of making the most out of everything. There is nothing wrong with the concept of making profits out of risk management except that – a) profit is most of the time measured in terms of absolute income generated rather than restriction of probable losses (the classical paradox of hedging vs. speculating) and b) undermining of risk associated with various methodologies of risk management (absolutely absurd expectation of risk vs. return).

Analyze the cases of forex losses incurred by many Indian companies in the past couple of years and these are the two main factors that would pop up as culprits. Yes, the financial institution are to be blamed for so called miss-selling of products to certain extent; but majority of blame should lie with companies that entered in to such transactions in the first place. Most of them entered in to such contracts because they were: greedy of so called risk less profits (look around you and you will find many such examples in stock market) and the financial institutions heavily downplaying the riskiness of such instruments (I wonder if RBI would ever come out with any rigorous stress testing requirements for such complex products).

India Inc has a long way to go before maturing enough to understand the true perspective of risk management (and we bet they will never exhibit this unless it is forced upon them by way of some strict regulation and supervision). Today, the board of directors is given the responsibility to review the risk management of a company and we doubt whether they are capable enough to do so (the doubt lies more in their capability to understand the discipline of risk management rather than questioning their credentials). The concept of CRO (Chief Risk Officer) is still alien, the reporting structure of the risk manager is such that most important information gets filtered before it even reaches the board of directors (most of the time either CFO or the owner has some vested interest in not exposing themselves to fiery question from the board on undue risk taking, remember the Satyam saga) and foremost it appears that people just do not want to accept the new norms of risk management, after all Gordon Gekko said in the movie Wall Street that ‘Greed is Good’.

The need of the hour is educating people right from the board of directors to the chairman, MD, CFO, treasury managers and the entire gamut of people involved in managing either forex or interest rate or operations or credit or counterparty or commodities risk, about the true identity of risk management and hopefully avoid any Enron, WorldCom or Lehman ‘Made in India’.

good old days ....

year 1972:
dadar-churchgate (II class) ticket: 0.30Rs
coolie:Rupee 1
folding umbrella: 35 Rs.
coconut :Rupee 1
bombay -ahmedabad (II class) ticket:Rs 28 (one full one half)
LPG gas cylinder: 15.85 Rs. (35Rs. in 1978)
toothbrush: 0.75 Rs.
toothpaste: 4.20 Rs

year 1974
LPG gas cylinder: Rs.18.85
100 gram coffee powder:Rs.1.30
3 dry cells: Rs.4.50

year 1976
40 watt light bulb:Rs.3.60
LPG gas cylinder:Rs. 26.30
1 kg standard Tea: 5.25 Rs.

Year 1978
LPG gas cylinder: 35 Rs.
1 kg Rice: Rs. 4.20
1 loaf of bread: Rupee 1
bombay-ahmedabad(ii class ticket) :Rs. 60 (two full one half)

India interest rates-confusing signals !!

The government has sold 2.82 trillion rupees ($58 billion) of bonds so far this fiscal year from the 2.99 trillion rupees targeted in the first half ending sept.30. It plans to raise a record 4.51 trillion in 09-10. A global slowdown and then the worst dry spell in nearly 40 years have raised concerns that the govt. may overshoot its 10 trillion rupees ($206 billion) spending plan for 2009/10.

Banks have signaled the bottoming of interest rates in media .—10 year bond yields have risen by 159 bp to 7.5% so far this year But actual deposit and lending rates are unmoved from their lower levels. Interesting fact -- the central bank mentions that rising bond yields are not a cause of concern & interest rates would not come down until banks lowered their rates.

Ideally the rapid rise in long term 10 yr yields should have had some impact on the non-sovereign side of business as well in terms of deposit and lending rates. Now, just as when banks have woken up to the fact of higher yield curve and ready to re-align with the market conditions, the central bank has given an exactly opposite coment which would actually signal banks to hold their rates.

An year ago, the linkages with sovereign yields were very good. 1 year g-sec yielded 9.37% in july`08 . 1 year bank FD`s were offering anywhere between 9.5 to 11%. -though the incremental rate on 3yr or 5yr was lesser -it was still aligned to g-sec. Thereafter the g-sec yields collapsed and so did the deposit rates (not so much in terms of PLR`s). From Jan`09 the 5yr and 3yr g-secs have recovered almost 50% in terms of yield ........It remains to be seen as to how soon can the commercial banks raise their rates .

that`s the point..............

a few days back we gave market view. Most of you get it day in and day out that too from multiple sources. Its not uncommon to get carried away by them, that too when there is inherent position generated in your business through buying or selling (expressed in foreign currency). For a moment people get transfixed on a view and actions cease to follow. What follows later is a market reaction -- as if it knew your side well in advance !!. We need not narrate what happens next..........

They say earthquake cannot be predicted . It happens maybe once in a lifetime. Statistically 2 or 3 out of 100 times. But when it happens it destroys more than three quarters of the affected part. Tsunamis are worst -- they travel coast to coast -- atlantic to pacific.

Financial markets had such events right from 70`s and as recent as 2008. Oil shock of 70`s, Pound`s exit of ERM, First gulf war, etc etc. The only survivors were those who fixed their objective, took right & timely steps and evaluated objectively. Those who hoped for dream angel`s predictions to come true -- have sometimes gained bountiful only to lose everything (including existence) on next occasion.