Risk Evasion is not Risk Management

August 21, 2007

DNA has an article titled ‘Being behind the curve helps Banking Street‘, where it praises the RBI for being conservative, and thus ensuring that Indian banks were not exposed to the subprime contagion:

Bless the conservative Reserve Bank of India too, for its tough regulations on overseas investments have meant Indian banks’ exposure remains limited.

I think this is a wonderful insight, and should not be limited only to banking. It must be applied everywhere.

For starters, everyone should never have sex. This will ensure that nobody is exposed to AIDS.

Also, nobody should ever take the board exams. After all, some people might flunk.

And there should be a newspaper regulator which should stop DNA from hiring business writers. There’s a chance that they’ll hire idiots.

2 Comments | Divine Arguments, Finance | Permalink
Posted by Aadisht

The Theory – Practice Gap

March 31, 2007

This is an example of why libertarians get thulped for being impractical:

If betting was legal, and as a punter you could choose from a) an HDFC subsidiary offering betting facilities, b) a Taj Group company and c) some shady outlet like the ones you can choose from now, you’d obviously choose one of the more legit ones. Being public companies, and part of bigger brands, they would be far less prone to fix matches. That would reduce bookie-led match-fixing.

It will work, in theory. Also, in theory, banks and NBFCs will drive loansharks out of business. The problem is that theory requires that there are no barriers to customers. Real life will have barriers in plenty.

Let’s look at the real real world first. Suppose we do get an enlightened government which legalises betting. Even so, the Income Tax Department and the Prevention of Money Laundering Act are going to play spoilsport. The IT Department is going to monitor all transactions made with legitimate bookies. Punters will be required to submit their PAN details with every bet they make.

This is not an issue for a software sarariman who is going to put a thousand rupees down. But if you’re a big-time punter betting ten megarupees of black money then a legitimate bookie is out of bounds for you. The big money will continue to be placed with underworld bookies, and because it’s big money, the underworld will continue to fix matches.

This is where my own inner libertarian pops up and says, bah, get rid of the regulation and the problem is solved. Money being laundered is actually a good thing as it will then find its way into legitimate uses.

Unfortunately, even in an idealised real world with no regulation or monitoring, there will still be barriers to customers, especially if the bookmaker is an HDFC subsidiary that is accountable to shareholders and can’t take too many chances. Just as HDFC won’t give anybody a loan beyond a certain limit, HDFC’s bookmaking subsidiary won’t allow anybody to place a bet beyond a certain limit. The bigtime punters will still be excluded, not by regulation but by the bookmakers’ own risk appetite. And so the biggest bets will still remain underground, and the incentive for the mafia to fix matches will still remain.

Two points before I end this post:

  1. Even so, betting should still be legalised, if only for the benefit of the small ticket punters who’re betting a day’s worth of salary. And once legit bookies are successful enough with small time punters, they’ll be able to create risk management systems robust enough to deal with the big betters.
  2. I’m sure Skimpy will respond to this by saying something to the effect that hedge funds will have enough risk appetite to serve big punters and so I’m worrying needlessly. I actually hope he does.

Leave a Comment » | Finance | Permalink
Posted by Aadisht

The Risk Industry

October 7, 2006

Three months ago, I pointed out that telecom is a bad poster child for reform because it has an unfair advantage- the network effect. I wrote about how retail is a better poster child, and also sidetracked into services retailing, but left one question unanswered: is there another industry which could benefit as much from the network effect as telecom has? Well, it’s time to answer that question.

The answer is: Yes. The financial services industry (which is actually several industries together: banking, insurance, wealth management, brokerage, capital markets, consumer lending, project finance, and probably half a dozen more).

Financial services benefit from the network effect because the fundamental product that all these sectors deal with is not equity shares, or bonds, or currency. It’s not even money. It’s risk. And every person plugged into the organised finance system is a producer and a consumer of risk.

This is similar to how the telecom industry’s fundamental product isn’t phone calls or SMSs or IP packets, but information. And everybody plugged into a telecom network produces and consumes information. The important thing is that they trade it with each other, not with the phone company- which is why the network effect kicks in.

Similarly, in the financial system, the important thing is not that a particular company takes on risk. The important thing is that all customers produce some sort of risk, which they sell to some financial intermediary- whether a bank, an insurance company, or to investors directly- which then repackages or restructures it, and sells it back to other customers. The more consumers of financial products there are, the more valuable the financial system is.

Of course, there are complications which the telecom sector doesn’t face. A voice call or an SMS goes through pretty much as it is, intermediated only by machines, but risk has to be broken down into its components and repackaged by human beings before you can sell it on further. This means that there’s more intermediation, and less transparency between intermediaries. Transaction costs are higher. But the model is the same.

What all this means is that the Indian financial services industry could take off as fast as the Indian telecom industry. It would have to overcome a bunch of hurdles first: regulatory, technological, environmental, and organisational- but the potential is there.

(Disclosure: I work in the financial services industry myself, so I may not be entirely objective.)

Leave a Comment » | Business, Business and Economics, Finance, Telecom | Permalink
Posted by Aadisht

Next Entries »