Developments in Cooperative Banking

Wednesday, February 13th, 2019

The RBI recently released its Report on Trend and Progress of Banking in India 2017-18. In the report they have a whole section dedicated to developments in cooperative banking. Cooperative banks play a significant role in boosting financial inclusion because they provide credit to the unbanked segments of society. I found some of the data and analysis quite enlightening especially because there is not much coverage about these institutions in the financial media. Here are some of the key charts and takeaways.

Growth of cooperative institutions has been lower than the overall banking sector. According to the report, cooperative institutions accounted for only 11 per cent of the total assets of scheduled commercial banks (SCBs) in 2017 compared to 19 per cent in 2004-05. Stringent measures by the RBI have led to consolidation in the Urban Cooperative banks (UCBs). From the report:

The Reserve Bank pursued an active licensing policy for UCBs during 1993-2004, which led to a sharp increase in their numbers. Subsequently, as signs of incipient financial fragilities in the sector became evident, the Reserve Bank enunciated appropriate regulatory and supervisory policies in its Vision Document (2005) involving inter alia merger/amalgamation of weak but viable UCBs and closure of unviable ones. As a result, the number of UCBs declined (Chart V.2). Maharashtra, which has the highest number of UCBs, accounted for the largest number of mergers, followed by Gujarat (Chart V.3).

But even though the number of UCBs have come down, the ones that were left have seen a large increase in their asset base which speaks to their stronger financial position.

Traditionally UCBs have had higher level of NPAs than Scheduled Commercial Banks (SCBs). Since 2015-16, however, the position has reversed, with NPAs of SCBs increasing sharply after the asset quality review (Chart V.12).

These are very encouraging trends and the RBI has even created a scheme for voluntary transition of UCBs to small finance banks in 2018. This would enable a graduation pathway for cooperative banks to become small finance banks and possible to become full fledged banks, allowing them to have a pan-India presence and the ability to carry out a wider variety of activities. This is critical in light of the fact that UCBs are increasingly facing competition from new players like payments banks, SFBs and NBFCs. If they are able to upgrade themselves and compete with such institutions, we would have a much stronger and more inclusive financial system.


Humanity and AI

Monday, February 11th, 2019

Another great talk from the a16z Summit by Frank Chen who is a partner at Andreessen Horrowitz. A lot of the discussion about AI is around the disruption it creates to jobs, both in high skill and low skill professions. Tech-optimists on the other hand talk about how technology eventually creates new jobs that we unthinkable before that would balance out the job losses.

In this talk, the presenter helps us to see that the discussion is not about humans versus AI. The key is to have AI take over the more routine tasks while allowing humans to handle more non-routine creative tasks. This helps productivity improve even more than either humans or machines can do individually. The video has lots of cool examples of how this is currently being implemented across industries in the present time and is well worth a watch.


Monthly Market Summary: January 2019

Monday, February 4th, 2019

We look at returns of various asset classes such as equity, debt, gold, crude oil and the Indian rupee in our latest monthly market summary.

We use data for these charts from Investing.com

Global Equities

The Sensex was flat for the month but has underperformed its peers in both emerging and developed markets. Broader markets rallied sharply in January whilst the Sensex remained flat. However, barring the Sensex, most equity markets have given negative returns in the last one year. Longer term return have been positive across the board

Fixed Income

Indian bond yields gradually moved back up to 7.6 in January, reversing the previous correction in December.

Gold

Gold moved higher, continuing its rally over the last few months. If the commodity moves strongly away from 1200-1400 dollars per barrel, it would give a better indication of the long term trend.

Oil

Oil rallied in January, closing near the 60 dollars per barrel mark. This is still much lower than the value of 86 seen in October which is a positive development for the Indian economy because of our large dependance on oil imports. It is important to keep an eye on this figure as it can have a destabilising effect on our macros.

Indian Rupee

The Rupee depreciated broadly against most currencies, but especially against the pound. This is probably a reflection of Brexit related issues as well as foreign investor concerns on fiscal slippage on the part of the Indian government in the run up to elections this year.


Linkfest – 99

Friday, February 1st, 2019

Some articles from across the web in the last few weeks:

Are Market Moves Happening Faster? – A Wealth Of Common Sense

Blockchain Can Wrest the Internet From Corporations’ Grasp – Wired

Macro overview of the Indian economy over the last 5 year – Livemint

Stress and Investing – Safal Niveshak

The past, present and future of farm loan waivers in India – CNBC TV18

How Japan is overcoming the demographic challenge – Urbanomics

Every choice has an opportunity cost – Seth’s Blog

Real estate under pressure – Youtube


Narrative vs. Data

Wednesday, January 30th, 2019

I came across this interesting post by Barry Ritholtz which talks about portfolio construction and how it has evolved in the US markets over the years.

To paraphrase; earlier portfolios were built based on narratives. Fund managers regularly used stories to identify good companies. For example: “The firm is gaining market share at the expense of the competition” or “The quality of the company’s management is top notch”.

These story-driven portfolios were then marketed via data: rankings of fund performance, ratings from companies like Morningstar and net return data.

I found this to be very amusing because it is how the Indian fund management operates TODAY. We also have funds that are constructed based on stories of quality of management or longevity of the business or based on themes such as infrastructure or consumption. It is very common for fund managers, in private, to talk up narratives of the companies they invest in. We also have numerous publications from ValueResearch and others that rank mutual funds and tell you, based on past performance, what you should buy this year.

Barry mentions how this style of investing would appear “quaint” to his younger readers. In the US today, portfolios are cheaply constructed using computer driven mathematics and are marketed with narratives such as indexing, factor based investing, ESG, smart beta etc.

For me the question isn’t about “if” this story will play out in the Indian financial markets, but more about “when”. There are a number of misaligned incentives the perpetuate the current system, but we are already seeing the start of change driven both the competition and by regulation. Today active fund managers in the large cap space already find it difficult to beat the index and we have already started seeing a number of fund houses launch smart beta ETFs. This story took about two or three decades to play out in the US. I would bet that things would change much faster here in India.


Quarterly Equity Valuations: January 2019

Monday, January 28th, 2019

We take a look at equity valuations and find that they have moved into even more expensive territory.

We use data from the NSE website starting from when it is available in January 1999 to look at the P/E Ratio, P/B ratio and the dividend yield of the index and compare it to past history.

 

Price to Earnings (P/E)

Equity Valuations

 

In the chart above, the red areas highlight when the PE ratio is significantly higher than normal implying that markets are expensive and future returns are likely to be lower than in the past. On the other hand, green areas show when the PE ratio is significantly lower than normal implying that markets are cheap and returns from equities should be higher than average.

On 25th January 2019, the Nifty PE Ratio was at 26.1 which is more than one standard deviation from the historical average of approximately 19. Market valuations have corrected from the value of 28.1 seen in August, but continue to remain expensive territory from an earnings point of view.

 

Price to Book (P/B)

Similar to the PE chart above, red areas in the PB chart denote times when markets are expensive whereas green areas show when markets are cheap relative to history.

The price to book ratio of the Nifty has stayed 3.3 and is just below the long term average of 3.5. On the basis of book value, markets are trading in the normal range. The difference between valuation indicators in the PE and PB could be due to cyclically suppressed earnings. Part of this could be due to low capacity utilisation and part of this could be attributed to structural NPA issues with public sector banks that are depressing earnings. Therefore, even though the price is expensive on the basis of current earnings, it could be that an increase in utilisation levels or a normalisation of the NPA situation could give a bump to earnings in the future and normalise the PE.

 

Dividend Yield

 

The dividend yield chart denotes value in a manner that is opposite to the PE and PB charts above. When the dividend yield is higher than normal, it means that markets are cheap. Similarly when the dividend yield is lower than normal, it is a sign that markets are expensive. The dividend yield is around the same levels in the last quarter, at 1.3 per cent. This is still close to the long term average of 1.5 per cent.


Linkfest – 98

Friday, January 11th, 2019

Some articles from across the web in the last few weeks:

E-commerce: The battle for India’s giant retail market – Economic Times

New investments in India plunge – Livemint

Cronyism in financial policy – Debashis Basu

E-Commerce FDI Policy: Bored Game – Bloomberg Quint

10 Things Investors Can Expect in 2019 – A Wealth of Common Sense

A bond market update – Aswath Damodaran

Seven Big Ideas from Fooled by Randomness – Safal Niveshak

The Bull Case for commodities – Visual Capitalist


Aswath Damodaran – Laws of Valuation

Wednesday, January 9th, 2019

Great talk by Aswath Damodaran on the corporate life cycle and how companies evolve over time. Here is the video and some key takeaways:


Key Takeaways:

  • Companies don’t like to get old: fighting it can be one of the most dangerous things a business can do
  • Most value is destroyed by companies not acting their age
  • What makes for a great CEO of a company changes over the course of the life cycle
  • The progression of a company through this life-cycle:
  • The life cycle of a company is getting compressed: a 20-year old tech company is an old company
  • There are three main ways to make corporate finance decisions that maximise the value of a business:
    • The investment decision: Invest to earn a return greater than a hurdle rate
    • The financing decision: ensure the optimal mix of debt to minimise the hurdle rate
    • The dividend decision: if you cannot find investments that meet the minimum hurdle rate, then return cash back to shareholders
  • These decisions are heavily influenced by the life cycle: a start up would mainly be taking equity because it doesn’t have predictable cash flows, mature companies should think about financing mix as the cash balance start to build up and declining companies should be focusing on returning cash to shareholders
  • On Amazon as a disruption platform: it is unclear if Amazon will ever make money on any new business it enters but it is guaranteed that the existing players will lose money. 
  • Valuation is never just about the numbers; there is always a story that drives the numerical projections, especially for young companies. for mature companies, the numbers would drive the valuation more because you are at chapter 34 of a 35 chapter book and cash flows are predictable


a16z Annual Summit

Tuesday, January 8th, 2019

Andreessen Horowitz recently put up a number of talks from their a16z annual summit which cover many areas related to the ongoing disruption across various industries due to technology. Here are few of the videos that I found particularly interesting:

Moving Beyond Advertising only business models

The Evolution of Brands

How the US government used Crypto to catch fraud

The software disruption coming to real estate


Monthly Market Summary: December 2018

Monday, January 7th, 2019

We look at returns of various asset classes such as equity, debt, gold, crude oil and the Indian rupee in our latest monthly market summary.

We use data for these charts from Investing.com

Global Equities

The Sensex was flat for the month and has outperformed its peers in both emerging and developed markets. Broader markets fell sharply led by the fall in the S&P500 of around nine per cent. Barring the Sensex, most equity markets have given negative returns in the last year.

Fixed Income

Indian bond yields continued to correct in December, falling from 7.65 to 7.43. The collapse in crude oil prices and an easing of the liquidity situation has led to some relief in the bond markets.

Gold

Gold moved higher, but still was within range during the month. If the commodity moves strongly away from 1200-1400 dollars per barrel, it would give a better indication of the long term trend.

Oil

Oil continued to fall in December. From a value of 86 in early October, it closed at just above 54 dollars per barrel at the end of last month. This is a very sharp correction and is a positive development for the Indian economy because of our large dependance on oil imports. It is important to keep an eye on this figure as it can have a destabilising effect on our macros.

Indian Rupee

The Rupee was range bound in December, reflecting global currency movements.


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