The 2008-09 U.S. financial crisis was huge, but it’s aftermath – still vibrant. While most countries struggled their way out of the global fall, a continent to specify, didn’t have an easy escape. The Eurozone or European Sovereign debt crisis, a multi-year debt crisis has been haunting the fates of European Union since 2009, leaving Eurozone members incapable of bailing out over-indebted financial institutions under national direction, minus intervention from major external monetary rescues. Needless to quote Sir Mervyn King it has been “the most serious financial crisis at least since the 1930s, if not ever.”
Category: Finance Page 1 of 9
Talking about mezzanine financing in the real estate industry might be a new term to begin with, along with being a tad bit confusing. Mezzanine funding enables real estate developers to close the gap between their equity and the senior debt they will receive from a lender. Usually, it’s in the form of a subordinated debt, although it may have an element of equity. Although an investor would pay a higher mezzanine financing interest rate, it will allow them to receive a higher rate of return on their investment.
Often regarded as the CEO’s dilemma, debt or equity is the one indispensable question which has enthralled extensive discussions for centuries now. Keeping aside the for and against of this celebrated discussion of the financial world, what if we tell you about the road that exists between debt and equity? Yes, a hybrid fashion of financing! Encompassing the features of both debt and equity financing, mezzanine financing allows the lender to convert its loan into equity in case of default upon repayment of senior debt i.e. the debt that takes priority over other unsecured debts or otherwise more ‘junior’ debt owed by the issuer. Commonly used to finance large amounts that are intended to repay through profits earned in the due course of business, these loans are offered as cash with portions transforming into equity after an agreed time has elapsed. To put it in a nutshell, the companies are effectively using their own equity as loan security while cashing in on the interest payments!
The sine qua non for achieving growth and inflation-the two main objectives of monetary policy formulation in a bank dominated financial economy, is a robust monetary policy transmission framework that transmits its impulses through the banking system. As signaled, effective monetary policy transmission is largely dependent upon sound health of the banks’. Healthy banks with low default risks accelerate monetary policy transmission by amplifying the effect of changes in money market interest rates (short-term policy) on lending interest rates, by changing their lending standards and their use of non-price measures while sanctioning loans. These banks are better able to pass on interest rate changes of the RBI symmetrically on its deposits and loans as compared to banks with a high level of prospective or realized non-performing assets (NPAs) who tend to push up the lending rates and their net interest margins (difference between the net income generated by banks and the amount of interest paid out to their lenders) on account of building up provisions by loading credit risk premium on its performing loans.
Regulatory forbearance; Propulsion to Asset Quality Review
The Reserve Bank of India, in the aftermath of the global financial crises of 2008, relaxed norms for restructuring assets, allowing companies to recoup from the funding imbalance and repay their debts. However, these companies classified troubled assets as standard assets rather than non-performing assets, hence eliminating the need to create provisions, those non-performing loans would attract. This allowed the banks to not set aside provisions for such loans with the expectation that once the economy turns around, the borrower’s fortunes shall improve along with improvement in the quality of the asset in the bank’s books.
RBI believed that banks were simply postponing their bad loan recognitions under the forbearance regime. Banks on the other end insisted on delaying their bad loan recognition and not calling their loans bad even after 3 years of non-payment of loan. This erratic behavior of banks caused colossal amounts of apprehensions on the investors’ part.
This regulatory forbearance regime was sought to end in 2015 when RBI pointed out that the classification of the restructured assets was not in line with the international best practices and that the total restructured assets in the economy have significantly outgrown total non-performing assets. In an attempt to ensure that banks across the nation took steps to clean their balance sheets and are adequately capitalized, RBI worked with the senior national supervisors and unfolded the Asset Quality Review (AQR).
AQR – causing stir in the banks’ balance sheets
Owing to the rising NPAs within the banking systems, often regarded as the leading financial sector problem, RBI set in motion, as a part of its routine annual financial inspection (AFI- annual inspection of banks’ books by RBI), a special inspection of sample of loans to ensure that the asset classifications are in line with the loan repayments and that the banks have made adequate provisions. This special inspection was called asset quality review. AQR is essentially an endeavor to value the asset to ascertain the credit risk associated with it; assessing the value of the asset in books of the lender, evaluating the collateral provided by the borrower and his repayment capacity in order to compute the value of the loan closest to its perceived value and determine whether a provision is to be made or it should be written off from the books.
A Bloomberg Quint study comparing the results of 42 listed banks reported in the December 2016 quarter with the results reported in the September 2015 quarter (i.e. before AQR was conducted), revealed that the bad loans nearly doubled from ₹3.4 lakh crores to ₹ 7 lakh crores., just how much the banks were hiding! According the study, the gross NPA of private sector banks increased from ₹33,634 crores in September 2015 to ₹ 80,409 crores. The bad loan pile of public sector banks which stood at ₹3.06 lakh crores in September 2015, swelled to ₹6.2 lakh crores in December 2016. Clearly, both public and private sector banks were guilty of hiding the true quality of their balance sheets!
Data source- Centre for Monitoring Indian Economy
Post RBIs clampdown on bank defaults in 2016, the share of public sector banks in overall lending decreased at a rapid pace from 71.6% in 2015 to 57.1% in December 2019, while the private sector banks took away the majority of the share that public sector banks lost. During the same period, the share of private sector banks in total outstanding loans in the economy nearly doubled from 17.4% to 35%. The profits of public sector banks were severely affected as compared to the private sector banks. Between March 2015 and March 2020, the former grew by just 4.1% per year as compared to the latter which grew by 20.1% per year.
However, the private sector banks seem to be lagging behind since December 2019. Their share in over all lending is said to have decreased by 60 basis points to 34.4% while an increase of same amount has been observed in public sector banks’ share which climbed to 51.7%. Economists believe that this stark reversal is due to recapitalization of public sector banks by the government, AQR and prompt corrective actions taken by the RBI.
But wait, what about NBFCs?
Is the Indian economy nearing its completion of bad loans’ recognition? Not at all! Almost a year ago, in august 2019, the current RBI governor Shaktikanta Das denied any plans of conducting asset quality review of non banking financial companies (NBFCs). Even after the financial pressure over several quarters due to the dramatic default by Mumbai based Infrastructure Leasing & Financial Services (IL&FS, that began the liquidity squeeze causing a downward cycle in the economy, and severe mismatch in the books of other NBFCs facing credit squeeze, RBI resorted to closely monitoring them and their interconnectedness with banks while recommending NBFCs with a size of over Rs 5,000 crores to appoint functionally independent chief risk officers with clearly specified role and responsibilities in a bid to bring in professional risk management system.
Businesses, supply chains and individual incomes have been severely affected by the nationwide lockdown to contain the spread of Coronavirus. The recent measure- extension of 90 day moratorium on recognition of impaired loans to 180 days along with severe relaxations in the bank lending limits, announced by the RBI puts the banks with already weekend balance sheets at a greater risk. According to the Fitch Ratings, a leading credit rating provider, Indian banks are looking at significant asset challenges for the next two years despite the regulatory measures.
Impaired bank loan recognition will be stretched longer. As more and more relaxation in lending norms is provided by the RBI, lower earnings along with the risk of solvency and balance sheet risks heightens for banks-specially public sector banks that have a greater share of loan books under moratorium as compared to private sector banks. Strong capital support to the banks from the state governments is critical along with gaining control over the rising cases of Coronavirus patients to reverse the currently tepid consumer demand, so as to gain momentum on India’s economic revival.
This article has been written by Neha Haldia, a 3rd year student of Bcom (H) at SRCC.
How many times you have used the phrase “I knew this would happen”? Let’s say that you are watching a match and you bet that your favorite cricket team is going to win here match. Now here two scenarios are possible- first, where your favorite team wins, you are likely going to be cheery about and it and say “I knew they would win!”; Other situation could be where your team loses, your reaction will likely be “the opposition balling was too strong, I saw this coming”, implying that you knew that this was going to happen because there were signs. Though, in reality, you did not have any control or knowledge on what was going to happen, you tell you already knew. Well, you have been tricked by your brain to only recall the memories which make you feel that you are aware of what is going to happen. This in psychology is called a “hindsight bias”.
The study of behavioural finance has proved that psychological influences and biases affect the behaviour of investors. Behavioural finance explains how investors think and the repercussions of their decisions on the market. In this article, we shall be looking into one such behaviour bias of investors- the overconfidence bias.
Overconfidence bias is exactly what it sounds like. The investor tends to hold an egoistic and sometimes even misleading sense of assessment of his/her skill set. It could be a false appeal of their skills and intellect. One of the main talents of an investor is to understand how the market is functioning and which areas are facing fluctuations. Sometimes, a few good predictions can lead to analysts thinking highly of themselves and considering themselves better than the average investor. Overconfidence bias is seen not only in investors but also in other areas of life like sports, driving, and almost everything related to being an expert on a subject.
Do you remember getting loads of cash on your birthday from relatives along with cards from your friends? The majority of us, I assume, used to rush out to the mall the very next day and spend it on an item that we wanted to purchase for a long time, but never wanted to spend so much money on that item. People may severely judge how you spend your ‘job income’, but no one bothers how you spent your one-time ‘birthday pay off’. Before diving deep into what is mental accounting, let’s study some examples.
In the above example, the reality is that this birthday money is in no way different than your regular job income, or investment returns, perhaps. If your house loan installment needs to be paid, there’s no logic in thinking that ‘why do I use my birthday money in paying it?’.
The past 20 years have witnessed a dramatic rise of corporate interest in European football. Football clubs have transformed from being community-owned organisations to full-blown capitalist entities owned by individuals or companies who have nothing to do with the game. Before explaining the 50+1 rule, the consequences of this transformation and how it fits into today’s topic, it is important to understand the historical significance of football clubs. Or to be more precise, what exactly have football clubs historically meant to common people?
In many European households that support their respective local clubs, football is almost as important as religion. If you head down the streets of any European city and visit such a household, you’ll realise that club kits and flags are treated as sacred symbols and every home fixture calls for a pilgrimage, yes that’s the word, to the local stadium.
What makes it even more special is that in most cases, this football fandom is intergenerational. Many contemporary local fans can testify to the fact that their grandfathers also supported their local clubs. Hence, the support of a club can be characterised as a tradition which must be carried forward at all costs.
For such fans, and there are many of them, trophies and winning is secondary. What matters most is having a sense of stability and familiarity in life which is provided to them by their constant, life-long support for a football club and everything associated with it. A decades-old stadium, an enduring philosophy and a distinct culture hold much more importance than a trophy which is bound to rust sooner or later.
After considering this, it is fair to state that every football club exists for, and because of, its fans. If the fans were to boycott a club, no amount of financial jockeying would be able to save it from imminent collapse since no one would watch that team play. This undisputed and supreme bond between the fans and a football club is the bedrock of Bundesliga’s 50+1 rule.
German football has always respected and valued this fan culture. The Bundesliga has one of Europe’s highest average attendances for its games primarily because of low ticket costs. In fact, Germany’s respect for football fans is so immense that up until 1998, no private investment in football clubs was allowed at all. The clubs were run as non-profit organisations by fan groups. Even though private investment was allowed after 1998, the DFB (Deutsche Fußball Bund) devised the 50+1 rule to ensure that the interests of fans don’t become subordinate to capitalist enterprises. The rule basically states that in order to be eligible to compete in Bundesliga (German domestic league system), a club must give its members a majority stake (50% shares +1 share) in its financial structure.
The average annual membership fee is around 30 to 60 Euros. This means that any middle-class person in Germany can easily become a member of the local football club and influence its decisions. One of Germany’s best clubs, Borussia Dortmund, has over 150,000 members. What purpose does this rule serve? Since the members have a majority stake in the club, all potential operational decisions need to get passed by the club membership. This usually occurs through a process of voting.
A proposed policy is put up on the agenda and all members have the right to vote on it. Only if the vote is favourable can the proposed policy be implemented. The club president is elected using the same procedure. However, there is a caveat in this rule. If a company or an individual has funded a club for more than 20 years, they can acquire a majority stake in the club. VFL Wolfsburg (owned by Volkswagen) and Bayer Leverkusen (owned by Bayer) are notable examples of clubs where the respective companies acquired a majority stake after substantially funding these clubs for 20 years.
It is clearly evident that this rule stands for democratization and respects the pivotal role of fans in European football. Despite claims that this rule harms German football by depriving clubs of potential capital worth billions, German clubs have performed reasonably well at the highest stage. In fact, just a week ago, Bayern Munich lifted the UEFA Champions League which is the ultimate achievement for all European teams. However, the revolutionary scale of the 50+1 rule can be properly understood only when we compare the financial structure of German and Non-German clubs.
Let’s start with the team which took on Bayern in this year’s Champions League final. About 10 years ago, Paris Saint Germain was languishing at 13th place in Ligue 1 (France’s domestic league). It was facing considerable financial debts, had no marquee player and no discernible international fan base. Notwithstanding, its fortunes were about to change. In 2011, Qatar Sports Investment (QSI) acquired a majority stake in the club.
What’s interesting is that QSI, being a state-owned organisation is under the direct authority of Tamim Bin Hamad Al Thani, the ruler of Qatar. Hence, it won’t be far-fetched to claim that PSG is literally a capitalist extension of the state of Qatar. This takeover may have allowed PSG to win trophies and woo players like Beckham, Ibrahimovic, Neymar and Mbappe but it also meant that the power was concentrated in the hands of only one person who lives thousands of miles away from Paris with no direct link to the club’s culture. The fans of the club have no decision making power at all.
PSG is just one of the many examples where a football club has been taken over by capitalists who have no interest in the sport. One of the most famous clubs on the planet, Manchester United, is owned by The Glazer Family which is based in the United States of America. One of the members of this family openly admitted that it took him 3 years to wrap his head around the offside rule and that he still hadn’t fully understood it.
Another interesting story outlining the absurdity of capitalist expansion in football revolves around a Manchester City fan, Colin Shindler. He is a 71 years old professor of history who has been a lifelong fan of the club. Unfortunately, for most of his lifetime, Manchester City was overshadowed by its arch-nemesis and neighbour, Manchester United. So, in 1999, Shindler penned a book called ‘Manchester United Ruined My Life’, in which he spoke about his love for Manchester City and highlighted his frustration at United’s seemingly endless phase of dominance.
However, in 2008, Manchester City was acquired by UAE-based Abu Dhabi United Group. The owner of the group, Sheik Mansour, pumped in hundreds of millions of pounds into the club and completely transformed its stadium and training facilities. Within a short span of time, Manchester City had won their first Premier League title in 46 years and had developed an international fan base. Currently, Manchester City is one of the biggest clubs in the world and consistently performs better than Manchester United. Colin must be happy, right? Wrong. Instead, he wrote another book called ‘Manchester City Ruined My life’.
While it did not achieve as much publicity as its predecessor, the book outlined his disgust at the radical changes that Sheikh Mansour had made at the club. Even though Manchester City won trophies, Colin claimed that the decades-old philosophy and structures of the club had been dismantled and he felt a sense of disenchantment with the new project.
After considering all these examples, it is easy to appreciate the ethical basis of the 50+1 rule. However, it has had its fair share of problems. For starters, a German club called RB Leipzig was able to exploit a lot of loopholes to its benefit. RB Leipzig is owned by the Austrian soft drink giant, Red Bull. In order to bypass the 50+1 rule, RB Leipzig kept the annual membership fee so high (600 euros) that no rational person wanted to become a member.
As a result, for a long time, the club only had 17 members and all of them were Red Bull employees! So, RB Leipzig was under the direct control of a capitalist enterprise which is a big no-no in the eyes of German football fans and a clear dereliction of the spirit of the 50+1 rule. On top of that, this club has risen quite rapidly in German football and, in addition to being placed third in Bundesliga, was also a semi-finalist in the UEFA Champions League this season.
These achievements are amazingly remarkable especially after considering that RB Leipzig was founded only in 2009. Many critics of the rule, such as former Hannover 96 president Martin Kind, claim that it stops German clubs from competing at the top level against the best clubs of Europe. For these critics, RB Leipzig is the perfect symbol of the potential success that German clubs can achieve if the rule is lifted.
Apart from this argument, many critics claim that scrapping this rule will pull out a lot of clubs from the quagmire of financial insecurity. Nearly 13 out of the 36 clubs making up the top two divisions of German football almost went bankrupt due to the pandemic. This prompted Herbert Hainer, Bayern Munich’s president, to claim that the rule must be lifted as strong private investors will have the capability to bail German clubs out of such sticky situations; but the fans remain adamant and firm in their protection of this rule and any attempts to tweak it is met by fierce protests.
The chief executive of DFB, Christian Seifert, has suggested establishing a task force to investigate possibilities for any future change to the rule but no further action has been taken against it. The drama is just beginning and one can expect to hear about the 50+1 rule on a regular basis from now on as the debate around it intensifies.