Commercial banks borrowing the shoes of Investment banks to walk a mile in the Financial Market.

Yechuri Naga Sumangali Pune, India. Capitalism is by nature a form or method of economic change and not only never is but never can be stationary. Joseph Shumpeter

1.1.

Introduction:

In todays market place; the world of corporate is dependent on the project financing alone. The world is advancing and changing every second. The major role players, in the todays market is the emerging demography of the banking sector from traditional commercial/retail banking to multifunctional banking regime. The companies while hunting for a financier is turning to the last place to find liquid capital for the financing of projects. That place is an investment bank. But a thought needs to be given that: Why would the investment bank be interested to invest? Why should they invest in the project without knowing who and what is the project about? The investment banks will not invest directly in the project. In order to seek finance one has to go through the traditional method of borrowing from the commercial/retail banks. Than where is the investment bank and where does the commercial banks find monies to lend loans to these projects. Are the commercial banks able to raise so much of deposits as to grant huge loans continuously? What about the loans that are not repaid back? How in spite of all these the banks go on granting loans? At this point, the investment bank steps in and the investment bank invests into the projects through these commercial/retain banks. This is only one facet of the investment. The other is through, the Securitisation route by bailout of the financial assets of the banks created through the loans lent out. The banks sell the loans to the Securitisation and Reconstruction Company which in turn forms Special Purpose Vehicles (SPV) and sell that debt (loans) in the form of bonds, debentures etc. which again are nothing

but debt. Thus, the debt is being sold for more debt and the debt is paying the debt. Thus this vicious cycle of circulation of debt doesnt stop. The outcome of such cycle of debt is what has already been witnessed by the world through the crash of Wall Street in 2009. The commercial/ retail banks in order to sustain in the market have started utilizing the loop holes in Banking Regulation Act, 1949, that has already been mutated so much as to become in effective in its operation and regulation. The biggest lacuna is Banking Regulation Act is that it only regulates the Nationalised and commercial banks alone, not subsidiaries and completely private bank. Hence, to sustain in the markets the banks are moving forward to finance the projects of the existing customer companies.

1.2.

Economic Transgression:

The capital market in India has seen the biggest transformation after the license raj ended. Ever since the financial sector reforms were introduced in early 90s the banking sector saw the emergence of new generation of private sector banks. These banks gained at most popularity as they have technology edge and better business models when compared to public sector banks and the most important thing is they are able to attract more volumes simply because they meet their customers requirements under one roof. If the newer players can do that then why cant the bigger players like the Financial Institutions (FIs) try their hands on it? There the concept of Universal banking in India has thus started coming up. Traditionally, the commercial banks in India were largely into the core banking business of accepting deposits and providing working capital funds to agriculture and allied, trade and industry sectors. In early 90s the financial sector in India was crying out for reforms. Things started changing ever since the process of liberalization hit the Indian shores; the banking sector saw the emergence of new generation private sector banks. Public sector banks which played a useful role earlier on are now facing deterioration in their performance. For very long, the banks in India were not allowed to have access to stock markets. So their dealing in other securities was minimal. But the financial sector reforms changed it all, Indian banks started to deal on the stock market but their bitter experience with scams, they became averse to deal in equities and debentures. Off late, commercial banks in India have been permitted to undertake a range

of in-house financial services. Some banks have even setup their own subsidiaries for their investment activities. Subsidiaries include in the area of merchant banking, factoring, credit cards, housing finance etc. At present, Indian banks are engaged in credit, consumer finance, savings, money and capital, advisory services and recently insurance market. Therefore, the Indian banks are already moving in the direction of Universal banking, undertaking all the financial services under one cover. The process of nationalisation of banking sector, liberalisation that made the banking sector also open to the foreign companies without any regulations till 2000, when by the way of amendment the Companies Act, 1956 was amended to include financial activity not being non banking activity into its regime. But RBI guideline to control all the economy related activities have not been put in as another body i.e. SEBI exists in the economy to regulate. The last bubble burst of Satyam Scam which brought into question the liquidity of the one of the leading bank ICICI Bank bring it to the concern as to the regime of 1999-2009 of U.S. the period after the repeal of the Glass-Steagall Act, 1933. The Glass-Steagall Act introduced the separation of the bank types according to their business (commercial and investment banking), and it founded the Federal Deposit Insurance Corporation (FDIC) for insuring bank deposits. In India, the IRDA exists to regulate the insurance sector. According to a summary by the Congressional Research Service of the Library of Congress:

In the nineteenth and early twentieth centuries, bankers and brokers were sometimes indistinguishable. Then, in the Great Depression after 1929, Congress examined the mixing of the commercial and investment banking industries that occurred in the 1920s. Hearings revealed conflicts of interest and fraud in some banking institutions securities activities. A formidable barrier to the mixing of these activities was then set up by the GlassSteagall Act.1

Although the GSA was repealed in 1999 after the banking industry had been seeking the repeal of the 1933 GlassSteagall Act since the 1980s, if not earlier. In 1987 the
1

William D. Jackson, GLASS-S TEAGALL ACT: COMMERCIAL VS. INVESTMENT BANKING, Dated June 29, 1987 http://digital.library.unt.edu/govdocs/crs/permalink/meta-crs-9065:1, last accessed on September 20th, 2011.

Congressional Research Service prepared a report that explored the cases for and against preserving the GlassSteagall act. The argument for preserving GlassSteagall (as written in 1987):2 1. Conflicts of interest characterize the granting of credit (that is to say, lending) and the use of credit (that is to say, investing) by the same entity, which led to abuses that originally produced the Act. 2. Depository institutions possess enormous financial power, by virtue of their control of other peoples money; its extent must be limited to ensure soundness and competition in the market for funds, whether loans or investments. 3. Securities activities can be risky, leading to enormous losses. Such losses could threaten the integrity of deposits. In turn, the Government insures deposits and could be required to pay large sums if depository institutions were to collapse as the result of securities losses. 4. Depository institutions are supposed to be managed to limit risk. Their managers thus may not be conditioned to operate prudently in more speculative securities businesses. An example is the crash of real estate investment trusts sponsored by bank holding companies (in the 1970s and 1980s). The argument against preserving the Act (as written in 1987): 1. Depository institutions will now operate in deregulated financial markets in which distinctions between loans, securities, and deposits are not well drawn. They are losing market shares to securities firms that are not so strictly regulated, and to foreign financial institutions operating without much restriction from the Act. 2. Conflicts of interest can be prevented by enforcing legislation against them, and by separating the lending and credit functions through forming distinctly separate subsidiaries of financial firms. 3. The securities activities that depository institutions are seeking are both low-risk by their very nature, and would reduce the total risk of organizations offering them by diversification.

Supra Note 1

4. In much of the rest of the world, depository institutions operate simultaneously and successfully in both banking and securities markets. Lessons learned from their experience can be applied to our national financial structure and regulation. After the collapse of 2009 of the Wall Street, in mid December 2009, it was proposed to reimpose the separation of commercial and investment banking that had been in effect from the original Act in 1933, to the time of its initial repeal in 1999. On January 21, 2010, President Barack Obama proposed bank regulations similar to some parts of GlassSteagall in limiting certain of banks' trading and investment capabilities. The proposal was dubbed "The Volcker Rule", for Paul Volcker3, who has been an outspoken advocate for the reimplementation of some aspects of GlassSteagall and who appeared with Obama at the press conference in support of the proposed regulations. The emergence of new dimensions of Banks is mixing of banking sector and making it as Commercial Banks = Investment Banks and vice-versa. With the advent of time and need of one corporate entity where in banks both the giant units in State Bank of India and sister concerns and Nationalised Banks and the whole Private banking sector has become a CONGLOMERATE with its separate subsidiaries that have hived off the business of Investment Banking into Commercial Banking. Thus, Commercial banks are transgressing into Investment banks to sustain in the Financial Market.

1.3.

Objective:

The main objective of this study is to assess the impact of the Commercial Banks, diversification into the Investment Banking sector, i.e. on the economy. Currently, Indian economy has not yet been touched by any kind of breakdown due to the Wall Street fall or the like events in the world. Whereas, the Commercial Banks transgress into Investment Bank could be a warning call of a coming crash. There has been few step of the RBI that indicates toward RBI sooner releasing a circular allowing the Universalization of the banking sector. This is a threat toward the economic
Paul Adolph Volcker, Jr., Chairperson of the President's Economic Recovery Advisory Board, In office from February 6, 2009 February 23, 2011, of President Barack Obama.
3

breakdown as has been experiences by US after 1999-2009 as an after effect of repealing the Glass-Steagall Act. The main objective will be met by studying the similarity in the post 1999 era of US and the present scenario of India. Numerous changes have been perceived from combination of the banking sector in the west i.e. U.S from 1999-2009. The aim is to find the outcome as to whether Indian economy is safe or is under a treat of economic meltdown. The reason being regulatory as well as market oriented could be seen. In the end, this research will analyse the market viability with respect to the regulatory frame work that will help in protecting the Indian economy from a possible break down.

1.4.

Methodology:

The methodology for the research of this would be analytical. A critical analysis of the GlassSteagall Act pre and post impacts shall help in understanding better the implications of such an Act to be introduced in Indian Market regulation regime. As there is nothing much written on the topic chosen; the methodology adopted for this research will be mainly Empirical research. As it is a new market adaptation yet to be evaluated in Indian context the study will be mainly looking through into the Primary resources collected through interviewing the Bank authorities, various Investment Bankers, Company Secretary practitioners who would be able to understand the changing impact of the transgress of the banking sector and persons who will actually get affected by the implementation of the like act as that of Glass-Steagall Act. It will also be looking into the Secondary resources like articles and discussion papers released time to time in books and articles.

1.5.

Hypothesis:

 Banking companies are becoming multifunctional bodies; this transformation will pave a pathway for their success in the Competitive Market. Whereas, the Conglomerate of Banks that will be formed would result in Financial Crises in the country as a outburst of friction that will be created in the Competitive Market.

 The Regulations that are needed and are in place, for this transgression in the economy arent sufficient to bailout the causes of market distress and prevent such market distress from being final outcome.  The possible effect of all these changes in the economy of the country will bring an Economic Tsunami, which will make the dream of economic golden era becoming a myth.

1.6.

Nature and Scope:

In this research, the analysis as to how, why and what will happen if the commercial banks keep entering in to the investment bank regime has been looked into. The RBI i.e. Central Bank is not able to put a check on this transgression. The economic, commercial and public interest aspects will be looked upon. This research would help to understand as to the reason why India needs a similar legislation as that of Glass-Steagall Act, 1933. The effect of economic and policy framework changes that has taken place in the other parts of the world affecting the Indian markets. The analysis of the legislation, that should have been in place which, has been recommended by committees that has not been looked into by the government till now. This research is focused only on Indian Origin Bank i.e. both private and public sector banks. This topic being new for analysis with legal perspective will surely be a big contribution to become a spark to think if we are a stable economy as far as legislation is concerned. The research will also try to give an estimate as to how viable is the Indian economy for the depression or the bubble burst that is being predicted sooner. Finally, the research will try to answer if commercial banks should be allowed to transgress into investment bank regime or not.

1.7.

Limitation:

The limitation to this research is primarily the time as the research has to be done within the academic year. The resources available for the research are limited. As the topic chosen is an

analysis of a new evolving phenomenon there is hardly any literature available and the time period of 6 months shall fall short for collecting elaborate empirical data and it shall be possible to only collect limited number of samples.

1.8.

Scheme of Study:

This research is a comparative analysis of India economy with that of the US economy which is considered to be 20 years ahead of the Indian economic development. The economists suggest that the development of India will out beet US in coming 5years. Considering, the above two statement the research has been opted to study the legal and economic framework that existed in US 20 years back and even before that till that of what is the present structure of the economy, development and legal framework only with regards to the Financial Markets. The two player of this market are Commercial Bank and Investment Bank which keep the economy running and the monies circulating. Thus, this research has been taken after understanding the significance of banking in the economy of the country. Chapter I. Introduction:

This chapter will briefly introduce the topic of study. It will also provide background for this study as well as object behind selecting this topic for study. This chapter will further explain the basic concepts relating to this study and will provide brief idea about goals which this study seeks to achieve.

Chapter II.

Origin of banking sector in India:

This chapter will deal with the history, background and the financial structuring of the countrys economy with regards to the operations of banking sector in the country. The types and roles that the banking industry has played in the development of the economy post independence and pre liberalisation. The differ regulation that had been introduced in that era and had changed the banking industry.

Change in the banking post liberalisation:

This part will be the understanding and the base as to how the banking sector in India started changing. The effect of foreign banks that had entered in the country and the regulatory framework formulated, to control and regulate the same. Further, this chapter will study the impact due to transformation of closed economy into liberal economy and the evolution of new banking era.

Chapter III.

Glass-Steagall Act: Introduction and Repeal:

This chapter will study the pre and post Great Depression period in US. Banking sectors failure which leading to the collapse of the US economy in 1929 and the preventive steps taken by the Congress to prevent the future happening of the similar events. Further, the chapter will critically study the effects of introduction of GSA in 1933 and the reason for repeal in 1999. y Post Glass-Steagall Act Repeal and Re-imposition:

This part of the chapter will lay its emphasis on period after the repeal of GSA and the introduction of the new act that was in force till the second Depression took place i.e. the Wall Street fall in 2009. The most spoken reason being the sub-prime mortgages in which ways this had broken the world financial castle mainly affecting US and the European markets. The study would also evaluate as to how India was left untouched by the recession and the depression that had hamper the world economy.

Chapter IV.

Banking Transgress: Universalization of banking:

This chapter will analyse the present banking set up that has been very close to the bank set up of US from 1999-2009. The reason why the economies are in support of the banking sector becoming universal and how this universal banking will impact the Indian economy. The chapter

will further critically study the pro and cons of Universalisation of Banking in India as a beam light into the future of banking.

Lax of policies, regulations and supervision:

The second part of the chapter will deal with the policy and regulatory framework that is in existence today and that is needed to exiting to meet the requirement of the future. The drastic change that polices has to undergo as the existing policies and regulations are handicapped due to excessive mutation that has resulted in the loss of the essence. The evolving new definition of banking as the change is redefining it has to be regularised and supervised. The changes that are need for a new regulation and policy to incorporate would also be looked upon.

Chapter V.

Impact of excessive Securitisation:

This chapter will only be introduction as to how Securitisation could become a threat to the economic meltdown as has been witnessed by the western countries. The securitisation is nothing but the movement of debt from one to another as an asset and resulting in benefiting no one and the owner of the property is in the end in debt. This chapter will analysis the cycle of debt in brief.

Chapter VI.

Pathway of depression: Market collapse or not:

This chapter will deal with the critical review of all the earlier chapters and would be a trail to predict the market viability and the possibility of depression which is becoming a hot topic of discussion in the US market. The study if there is another collapse in the world where will it be and how far will it impact India. There is a proximate estimate that Indian market is too viable to risk. These all preposition will be studies and attempts would be made to answer the same.

Reason for crisis to occur:

This half of the chapter will be an analysis to the prediction made in the earlier chapter. The reason for financial crisis that may occur and if not, what could be the reason that a crisis are likely to occur in the present day.

1.9.

Expected Conclusion:

The research has been taken after understanding the significance of banking in the economy of the country. Banks are an important source of funding in economies all around the world, making it vital to understand how banks directly and indirectly affect funding through capital markets4. The major activities of the commercial and investment banks today have become no inseparable to bifurcate and understand. The banks through their subsidiaries are hiving off into all the possible sectors of banking i.e. the HDFC, which is into commercial banking and insurance joint venture with Standard Assurance, ICICI that is into commercial banking, SBI investment banking division etc., have already started diversifying from their traditional activities through setting up subsidiaries and joint ventures. In a recent move, the Life Insurance Corporation (LIC) increased its stakes in Corporation Bank and is planning to sell insurance to the customers of the Bank. Corporation Bank itself has been planning to set up an insurance subsidiary since a long time. Even finance companies such as Sundaram Finance use the goodwill associated with their brand, and the years of information and insight, to offer a number of services under an umbrella brand. Few specialized Financial Institutions, like IDBI, IIBI, are now talking of turning into a universal bank. Also, Kotak Mahindra Finance, one of the largest NBFC in India, also converted itself from an NBFC into a bank, after acquiring a license to undertake banking business from RBI.5

This research will be analysing the propose Universal Bank scheme which is not yet taken any formal form. The researcher opinions that from the US market analysis that this transgression if sanctioned by the statutory authorities will lead to a contribution towards the third depression that is being predicted by the financial and economic forecasters. Thus, it is believed that a proper regulation similar to that of GSA and later legislations of US and
4

ECKBO B. ESPEN, HANDBOOK OF CORPORATE F INANCE: EMPIRICAL CORPORATE FINANCE, NEHTERLANDS, NORTH HOLLAND 2007, Pg: 191. 5 Chaitanya, Krishna V, Universal Banking. The Indian Perspective, Regional and Sectoral Economic Studies. AEEADE, Vol. 5-1 (2005) 5

proper economic theories could minimise the risk that is involved and is evolving like a bubble. The research proposes a new Banking Regulation Act, SEBI issuing guidelines in accordance with the Central Bank (RBI) for a safer economic transgression.