On Board with Corporate Governance

Amitabha Guha

Non-Executive Chairman

The South Indian Bank Limited

Amitabha Guha has been the Non-Executive Chairman of The South Indian Bank Ltd. since November 2, 2010. Earlier he served as the Managing Director of State Bank of Hyderabad Ltd and the Deputy Managing Director of State Bank of India. With vast expertise in finance and banking spanning 4 decades, he has held directorships at Xpro India Ltd, BSCPL Infrastructure Ltd, Andhra Pradesh State Financial Corporation, Gangavaram Port Limited, Vijayasri Organics Limited and The Oudh Sugar Mills. He is a Member of the Indian Banks Association (IBA Finance) and is on the Advisory board of ICFAI Business School, Hyderabad Management Association and the School of Management Studies, University of Hyderabad. Sri Guha holds a Master Degree in Science from University of Calcutta.

I was introduced to the domain of Corporate Governance (CG), in early 1994, by an article on the ‘Cadbury Committee Report’. Internationally, it was then an emerging concept. As a mid-level officer of State Bank Group, frankly I neither comprehended the criticality and importance of the subject then nor did I visualize the catalytic role it would be playing in the sphere of governance. The report was generated by a committee set up essentially as a response to certain serious developments in the market. It was not a proactive action aimed at enunciating some guidelines.

The committee was constituted in May’ 1991 by the Financial Reporting Council of the London Stock Exchange and the Accounting Profession. The trigger was the failure of Maxwell Communications and the Mirror Group of Companies. It was widely perceived that the failure was attributable to diversion of pension funds; a diversion pegged at 440 Million Pound Sterling. At the same time, Bank of Credit and Commerce (BCCI) also went bust losing billions of dollars belonging to customers, employees and other stakeholders. Responding to public outcry the committee was constituted with a fact finding mandate. Chaired by Mr. Andrian Cadbury it submitted the draft report in May‘ 1992 and the final report in Dec’1992. It was followed up by issuance of a set of guidelines, in U.K., bringing listed companies under its ambit and made effective with effect from 30.06.93. The chain of events attracted global attention and various economies and countries realized the need for good governance. They then took it forward with varied time lags, factoring local ethos, culture and legal frame works. India was no exception and joined this group of countries.

At this juncture it would be relevant to devote some time on the definition of CG. There are multiple definitions but broadly the core theme is ''CG deals with law, procedure, processes, practices and the implicit rules that determine the ability of a company to take informed managerial decisions vis-a- vis its claimants - in particular its shareholders, customers, employees and the State”. Though there was universal consensus on what is good CG, at the implementation level, we encountered various models. However a common thread of preserving the core objective cut across all of them.

During April 1998, the Confederation of Indian Industry (CII) articulated and introduced a set of CG codes. In 1999 the Securities and Exchange Board of India (SEBI) constituted the Kumar Mangalam Birla Committee. It was instrumental in articulating clause 49 to the listing agreements with the Stock Exchange; a quantum leap in the evolution of CG in India. Subsequent Committees such as the Naresh Chandra Committee of 2002 and N.R. Narayanmurthy of 2003 added significant values to the CG model in India. These recommendations set new and higher benchmarks, comparable to global standards.

While such developments were taking place at home, advanced economies and their collective forum widened the scope of CG. The U.S.A legislated the Sarbanes-Oxley Act in 2002 and in 2004 OECD framed guidelines outlining the important features of CG, which inter-alia include ensuring right and equitable treatment of shareholders, Protection of non-shareholding stakeholders, employees, customers, creditors, local communities and policy maker’s ethical trade practices, code of conduct for the Directors and Executives, disclosures and transparent mode of communications to the shareholders ensuring accessibility to all material information. Thus the scope of the Board as envisaged by OECD broadly related to:

• To act as a think tank to assist the management in articulating strategies
• To oversee performance against the goals so as to maintain the financial health of the company, covering the dimension of risk management architecture involving an adequate and sound system of internal control
• Selection of the CEO and other key executives and fixation of compensation
• To ensure integrity and transparency in the accounting and financial reporting system aided by an independent auditing mechanism. Thus also addressing the issue of disclosures and communications to the shareholders.

It seemed to be a big list and an enormous responsibility. If a culture of compliance is created within the organization with ownership at various managerial levels, I trust that the momentum thus created will take care of sustenance. It is obvious that the Board has to play a pivotal role and in a sense, if I am permitted to say so, it is the "Nucleus" of CG. To highlight the role of the Board Mr. John G. Smale, Chairman of the Board of Directors, General Motors, observed, “The Board is responsible for the successful perpetuation of the corporation. This responsibility cannot be relegated to the Management". Now the question arises, if that is expectation of the board, what type of people would qualify to be its members? While skill and experience is very important, the value orientation in terms of ownership and commitment has to be of an absolute nature. Is there a deficit in the Indian context? Is compliance ritualistic in nature, betraying a tendency of “tending to satisfy the letter” more than the spirit, when it should be both? If CG is to be beneficial for all stakeholders, promoters included, we need to raise the bar of selection of the Board Members to realize the true long term reward arising out of CG.

I have been associated with the Indian Banking system for more than 40 years of which more than 10 years have been at the Board level. So I am tempted to share some of my thoughts and experiences about CG in banking in general and the Public Sector domain in particular.

We have witnessed progressively successful adoption of CG, in India, in the non-banking entities. But the degree of implementation in Banking has not been at par with non-banking companies. I am afraid that the observation might be construed as misleading unless the issue is discussed in its entirety.

a. Banking business is unique because of its deposit taking activities along with working as a financial intermediary. The relationship with depositors is fiduciary and this has a flavor of trusteeship; a core element in CG.
b. Major ownership of the banks rest with the State! Such ownership demands socially oriented commitments on the part of the banks.
c. Appointment of key executives and the members of the Board are responsibilities of RBI and the GOI.
d. Regulatory architecture of RBI and expectations of the owner (the State) are the drivers of Banks' operations.

Therefore the principle of "Maximization of Wealth" for shareholders/stakeholders perhaps does not fit in here as it does in the case of non-banking entities. In India Public Sector Banks collectively account for: 75+% of total bank deposits,76% of the total loan book, 90% of the branch network and 78.4% of the personnel employed by the industry. Residual business is principally contributed by Foreign and Private Sector Banks - both old and new generation. Further, various provisions of legislations of the GOI and regulatory guidelines of RBI as detailed below govern various dimensions of a Bank’s functioning:

• Banking regulation Act, 1949
• State Bank of India Act, 1955
• State Bank of India (Subsidiary Banks Act) 1959.
• Subsequently these banks are called Associate Banks
• Banking companies, Acquisition and Transfers of Undertakings Act, 1970/1980. Amendment in the said Acts was carried out in 2006. RBI in the meanwhile, introduced “Fit and Proper” criterion for elected directors contained in section 9 (3) (i).
• Reserve Bank of India Act,1934.

Subsequently the scope was enlarged to the State Bank Group. The applicability of Clause 49 of the Listing Agreement was already operative as done in case of Non-Banking companies. In addition there are nominee directors of RBI and GOI in the Boards of the PSBs. Regulatory framework of RBI stipulates - offsite surveillance, onsite examination – at macro and granular levels, independent in-house audit mechanisms overseen by a committee (ACB) of the Board. Structures and provisions detailed above are expected to take care of healthy system and procedures, risk management and sustained profitable performance of the bank safeguarding the interest of the shareholders/stakeholders. In a realistic sense, the compliance of elements of CG is well overseen.

I must qualify here that I am neither advocating the non-application of the principles of CG in banks nor undermining the role of the board and its director in the pursuit of excellent governance through the platform of CG. The limited point I wish to make is the model of CG for banks needn’t be a mirror image of the model articulated for non-banking companies.

If the board has to deliver effectively and as expected, the selection of directors assumes paramount importance. There is scope for refinement of the process to get the right mix of skills and values. Skill or values as standalone elements are inadequate.

If the board has to deliver effectively and as expected, the selection of directors assumes paramount importance. There is scope for refinement of the process to get the right mix of skills and values. Skill or values as standalone elements are inadequate.

We have experienced the unfortunate episode of Satyam Computers where the best of experts, were members of the board. It was fairly obvious that commitment and ownership of responsibilities are as essential as the skills to qualify to be a director. I believe that the creation of a pool of such experts and their utilization would be of great use. A related example from the financial sector is that of the Global trust Bank Ltd.

The quantum of fees paid to the directors of PSBs need to be made attractive to attract the best of talent. Implementation of the revised provisions of the Companies Act, may perhaps addresses the issue adequately.

Before I conclude, I would like to state that my observations should not be generalized to include the entire population of Directors of PSBs. Further, the opinions expressed are my personal views. I have referred to the book- Corporate Governance in Banks edited by Prof. R.K Mishra et al. My sincere thanks to the editors and also to the authors who have contributed articles to the book.

Evaluation of Core Insurance Solutions

By Phani Tangirala
Practice Head - Insurance, Treasury & Capital Markets
Thinksoft Global Services

It could be said that eighty percent of global IT transformation projects in insurance companies are not successful. No exaggeration if ‘Success’ is not just a question of going LIVE. Though projects start with the objective of aligning technology with corporate growth enroute there is such turmoil that just going LIVE is often viewed as an objective in itself. Needlessly such situations do upset business users. Let’s examine some very common concerns that persist after going LIVE.

Business Users

• System is very slow
• Transactions now involve more steps compared to legacy systems
• Reports are missing
• With the new system financial books are in mess
• Too many change requests are now being received for enhancing the software
• It worked in UAT but not in production
• The vendor fixed one problem which then reopened an older one
• Documentation/User manual is not good enough
• This is a basic requirement, yet the vendor says it’s a change request
• Introducing new products is difficult and needs code change

Common complaints from software developers

 • Users do not specify their requirements in total, we always receive one line requirements
• Our application is working fine, it’s the data from legacy which is giving problems
• They agreed to use canned reports, but now they want reports in their own format.
• Users never read documentation.
• Users never spend quality time for testing, they are always pulled way by operational needs.
• Users want everything free of cost.

Most of the above concerns are generally addressed within six months of going LIVE that is during the stabilization period. It could however be a matter of concern if these issues are not resolved even a year of going LIVE with new core system; a clear symptom of flaws at strategic level than at tactical level. This necessitates a meticulous approach towards analyzing, assessing and resolving the issues, and to also put in place mechanisms preventing reoccurrence of the same issues.

Critical Success Factors

We should also examine the critical factors that drive projects towards success.

It is important to determine if one or more of the factors have contributed to the project not meeting its original objectives. This exercise should be seen more as an activity intended to find the “Right Way Forward” than looking at as “Fault Finding” task.

Case I

Needless to say, the involvement of the top management in the implementation of core insurance solutions is extremely important. Our experience in the recent past is depicted in the following chart. It is evident that projects where the top management involvement was not adequate in the early stages are forced to consume more time during the crucial latter phases.

Focus Areas

Some key areas that are to need to be critically examined to identify the source of issues discussed are: -.

While the above table gives an indication of the focus areas that needs to be covered as a part of the evaluation process, it is not exhaustive. Depending on the outcome after initial process of evaluation there could be several other areas that should be focused as a part of the evaluation process.

Evaluation Process

While the section above indicates the areas that need thorough evaluation the following section covers the steps that are typically involved in evaluating each of the above mentioned focus areas.

Requirements

In order to conduct a thorough evaluation, it is very important that the evaluators have complete access to information. Some key requirements are listed below:

Solution
The entire objective of the evaluation process is to derive at root-cause of the issues that are hampering a smooth functioning of core insurance solutions. While the issues could be several and the root causes can be even more, a generic classification of all issues generally can be limited around 3 major areas.

While there are solutions available for each of the issues categorized in the above three groups, picking up a right solution will be a herculean tasks at times. A team well balanced in its composition with adequate representation from all quarters of stakeholders need to be constituted that would ponder on each of these issues and asses its solutions based on A holistic approach needs to be designed by taking all individual solutions with responsibilities and KRAs defined. Each of the solution and the mitigation plan needs to be documented and tracked as a project by itself.

Case II

A leading life insurance organization in South East Asia has embarked into an ambitious transformation project with a view to replace their legacy policy admin systems with a solution built with contemporary technologies. Though the solution procured has been thoroughly evaluated for its fitment, the project has gone into serious troubles during the User Acceptance Testing (UAT) Phase. A planned UAT of 3 months got extended beyond 14 months with still no visibility of light at the end of the tunnel.

Key concerns being
a) many business requirements not available in the new core insurance platform
b) business users have low confidence on the solution
c) too many defects during testing
An objective evaluation of this situation has helped the organization to discover the root causes that have brought them to this situation

• Stakeholder Buy-in: Evaluation of core insurance system done without adequate involvement of business team
• Drive from the top: Top management not involved until later stages
• UAT Management: Test Management process is virtually inexistent
• Quality Gates: Poor management of quality gates in SDLC

Analytics in Banking and Insurance; Prospects and Challenges

By Prof Premchander

Professor Premchander Fellow IIMA: A visiting Professor at IIMA in the Finance and Accounting Area since 2009, he was a faculty of Finance and Control at IIMB from 1988 to 1997. Before and in between the above academic positions he has spent an equal amount of time in industry across SBI, Reliance, Accel Frontline, IL&FS, IL&FS Educational Service Ltd and lastly Mu Sigma Limited, a fast growing analytics company, as Vice President Operations. He has offered courses in management control systems, valuation, mergers and acquisitions and continues to have deep interest in the latter, financing large projects and venture capital. Prem Is also associated with a couple of schools where he volunteers his time at their management committees. In addition he is an independent Director at Yuken India Limited an engineering company.

As I walk into the ATM of any Bank and withdraw a sum of money I would have generated volumes of data for the bank. By identifying the location it is possible to map my travel pattern. By identifying the times of the day and my withdrawals it is possible to read patterns into my banking activities and spending habits. At another level the flow of customers through the ATM can in turn determine usage, waiting time and help make capacity decisions and also refilling decisions so that the ATM is never out of money and are efficiently located.

 Banking generates large volumes of data at a high velocity and in various often unrelated locations. A lot has been written about the potential for Big Data Analytics (BDA) in Banking. Already high fixed costs businesses, recent regulatory changes have pushed the fixed costs even higher making it all the more important to seek out profitable customers – that use the banks services and pay for it. In this search for customer’s banks no longer enjoy the luxury of traditional marketing paradigms of developing a product and searching for customers. The race is often to proactively assess what a customer wants and offer the service desired within the framework of the banks objectives, policies and the regulatory environment obtaining in that segment.

Driving revenue is not only about acquiring new customers but also about identifying new needs and crafting products to meet them. More often than not the customer is unable to articulate that need. A 360 degree view of the customer, personalized service, improved segmentation and targeting could be some of the benefits of BDA.. When a bank’s internal data is supported by third party data the potential could expand many fold.

Risk management has become far more critical in recent times. The events of the last decade have placed both regulatory and business pressures on comprehensive risk management policies. Risk modelling, predicting loan default, predicting fraud and identifying exposure to various segments are but a few of the areas where risk management could be critical. At a conceptual level all of them could use BDA to estimate and manage risk effectively. Banks are currently just taking baby steps in this area and the potential is huge. 

Research and strategy are yet another possible application that can grow out of BDA. At the level of individual customers analysis of data both internal and external could help identify high value assets and drive products towards them. 360 degree analysis and judicious use of external data could help reduce risk. (It could be possible to understand payment behaviour by buying data from telecom and utility companies). Such external data could embellish internal data.

 Banks with the storehouse of data that they possess would be well placed to provide a range of data based services for their clients. This could involve customer information, supply chain information and risk profiling of suppliers and customers on behalf of their clients.

With large opportunities, huge amount of data and pressure to manage risk and improve profitability one would expect greater penetration of BDA in the banking sector. Surveys show that while basic reporting tools are in place, in a majority of the banks, analytic tools are rudimentary and the application of predictive analytics is limited. In a recent survey a third of the bankers indicated that their organization did not even use analytics. 

It has to be recognised that in many situations there is often no one to one correspondence between the use of analytics and increase in revenue or reduction in costs. In addition with very tight operating budgets banks have little incentive to explore new operational technologies. Further, banking is a secretive business with much higher levels of security and reluctance to outsource.

 Banks may have to take the following steps to get the best out of BDA.

• Integrate the data being collected in various locations and coming in at high speed.
• Build internal resources in analytics to help interpret requirements from internal clients to external analytics service providers
• Look for small wins quickly to create a demonstration effect through an internal team.
  

The insurance sector, another financial sector, is in a slightly different stage of adoption and development. Traditionally, the insurance sector has used statistical tools to help in rate setting and risk profiling. Some of us were pleasantly surprised to read that hypertension and diabetes do not any more attract higher charges for health insurance. Such a measure could well also be arrived at from BDA. 

 

This sector has been slow in adopting predictive analytics, mainly because of the absence of integration in the large databases. As the level of adoption of data warehousing one should be looking to see even mid-size-insurance companies using more analytics in policy risk scoring, fraud detection, referral scoring etc. I am looking forward to an era when Indian insurance companies insure the driver rather than the vehicle. Of course that may need regulatory changes but careful drivers can hope to benefit.

 In the final analysis the financial services sector with high volumes of data and with data flying around at high velocity like banks and insurance companies are eminently positioned to benefit from the use of Big Data Analytics. The coming years, one can look forward to greater innovation in the use of Big Data Analytics in particular its integration with unstructured behavioural data and third party data, to get a 360 degree view of the business and customer.

A Commission Less World

By Richard Leeson

Richard Leeson has held senior positions at AEGON UK, Prudential International and most recently was Sales & Marketing Director for AXA International. He has been a thought leader in the industry on the strategic impact of RDR. He has authored many articles for trade publications on how RDR is affecting adviser based financial advice in the UK. Richard is also CEO of Adviser Advocate.

At the beginning of 2013, the quality of IT-Delivery of financial services companies became their biggest strength or their biggest weakness. The importance of this change has yet to be felt at the highest levels of executive management. In January 2013 the Retail Distribution Review (RDR) promulgated by the Financial Services Authority (FSA) of UK took effect and had several fundamental impacts on the financial services sector, most of which have yet to materialise.

RDR banned the payment of commission to financial advisers on investment products and required those advisers to adopt new fee charging structures known as “adviser charging”. Financial services companies largely treated this change as a problem requiring a “work around” solution from their IT departments. Having successfully made the necessary changes to remove commission payments from their products by January this year, these companies are endeavouring to return to a world of business as usual.

Business is not as usual. Many companies are reporting falls in new business volumes of substantial levels, Prudential confirmed a 17% fall in bond business and Zurich Life reported a loss of nearly a third of its new bond business in the first half of the year. Success stories seem to exist only where commission is still payable on products like annuities and protection business. Advisers are less inclined to promote products in the post-RDR world and have had to rethink their entire business models. The new mantra for advisers is “time is money” as they consider hourly fee-charging and project fees. This in turn is focusing their minds on where they spend most of their time when not sitting face to face with clients. Administration is a key focus area.

Poor service, requiring advisers to sort out client problems cannot be billed easily to the client. Advisers either have to accept this as part of their service or seek compensation for loss of earnings from the providers responsible. In my own experience in the last twenty years of dealing with fee-based advisers, they will invariably seek compensation.

Increasing compensation claims have focused the minds of the providers I have worked with as they seek to control spiralling costs. This has led in turn to a focused view of the impact of administration excellence on the bottom line. For some providers the use of service level agreements including stated compensation amounts have been a means of reassuring advisers of their administration offering. All of them have increasingly become aware of the impact of IT systems on their service delivery.

Excellence of IT delivery has been key to underpinning excellence of service delivery to both adviser and the end customer. The days of manual workarounds are long gone. In today’s financial services industry and especially so in the post RDR environment, companies need to ensure their proposition are supported by robust systems. To achieve this requires full and early engagement of the IT team in strategic and tactical planning. By ensuring early engagement from the IT team it is possible to resolve development priority conflicts swiftly and efficiently.

Banking on Insurance for all

By TCA Srinivasa Raghavan
Editorial Adviser to the CEO
The Hindu Group

The Insurance Regulatory and Development Authority (IRDA)

recently allowed commercial banks to sell insurance policies of several insurance companies, instead of just one as is now the case. In short, they need no longer be ‘sole stockists’.

Banks that opt for this will not have to start a separate entity to apply for a broking licence. Instead, they will need to put aside a deposit of Rs 50 lakh. It is not compulsory for them to become a seller of insurance, at least not yet. In due course, the public sector banks could be forced to do so because it is the finance ministry which has been pushing this idea.

Basically, in the short term, the new policy is intended to lower the cost of sales to insurance companies by passing these costs on to banks in return for a commission. The idea is also to promote long term savings.

If more people buy insurance, especially life insurance, the pool of long term savings goes up and this will speed up the growth of the long term bond market. At present this market is underdeveloped because enough long term funds are not available. A thriving market for long term bonds is a must for the development of infrastructure finance.

It does not seem likely, however, that the banks will immediately see a very useful business opportunity here. The degree of responsibility and costs associated with the sale of insurance products will almost certainly not to be their liking. Besides, banks may prefer to remain on the agency model, which is still allowed. Nor is the Reserve Bank of India likely to be well disposed towards the idea. Its approval is needed for a bank to enter the insurance broking business. It also regards banks in insurance as a threat to financial stability.

ICICI Bank, HDFC Bank, SBI, IDBI Bank, Bank of Baroda, Canara Bank, Bank of India, and Punjab National Bank have their own insurance companies, and the potential for conflict of interest is always there. It should be noted though that to limit the damage from such potential conflicts not more than 25 per cent of all insurance business can be placed with a bank’s own insurance company. IRDA Chairman TS Vijayan, has been quoted as saying as follows:

“There have been informal discussions with RBI. People have reservations with the word broker’. Broker regulations are more in tune with larger risks like reinsurance. But we are not expecting banks to sell huge risk. It is a personal line of business for them. This idea will get acceptance widely, among both companies and banks. Today, a bank is the corporate agent of one insurance company (Life and General). While an agent represents the company, a broker represents the customer. As such, banks utilise own customer base and hence represent the customer.”

That said it is important to understand the legal difference between an agent and a broker. Thus, whereas an agent represents the interests of the seller, namely, the insurance company, a broker represents the interests of the client, namely, the buyer of the insurance. This subtle change alters the redressal options for aggrieved customers and could lay banks open to a host of court cases.

In the end, though, whether an idea is good or not must be judged by seeing what it means for the common man. On balance, when everything has been considered, it does seem as if the ordinary people will benefit, because of two reasons: better access to insurance products and the altered relationship between buyer and seller.

This alone is a powerful reason for persuading banks to add the sale of multiple insurance products to their portfolios.

The Risk Based Capital framework in the Indian context

Mr. J. Hari Narayan (JHN) the immediate past chairman of the Insurance Regulatory & Development Authority of India (IRDA) in conversation with Abraham Kuruvilla (AK) on issues relating to adoption of a ‘risk based capital’ framework by the Indian insurance industry.

AK : Hello Mr Hari Narayan, how important is it for

the Indian Insurance industry to adopt a risk-based capital framework and are they ready for it?

JHN: There is a risk-based capital concept in India, but it is not within the terms of what is understood in international parlance. And particularly after the Solvency-II directive has come out! That’s the first thing we must understand. Now, within the risk-based solvency framework that they are talking about, companies are expected to assess their own risk, and create an internal model as they call it, to assess the risk which they have on their liabilities side, as well as their assets side.

Now they are entitled to use their own model and calculate their risk based upon that particular model. The model however is subject to oversight by the regulator. In the event a company doesn’t choose to develop its own model, or if the model developed is inadequate, then the regulator may prescribe a model, which the company is bound to follow. So fundamentally, that is the pattern they follow – or rather what they have adopted within the terms of Solvency–II. Now in India, we have a different concept of solvency and we believe that our system is far more robust

AK :: Related to the problems that Europe is

having with Solvency–II, what do you foresee as some of the problems that India would have in adopting the framework?

JHN: See, merely because it is adopted in Europe, that doesn’t mean it’s the best model to go by. Having said that, the need for solvency is a cornerstone of the financial structure of an insurance company, and it is so across the entire world. Briefly, what it says is that at any point of time, the insurance company must have assets which are sufficient to meet its liabilities. That law applies not just in Europe, it applies all over the world and in India too, and it is always applied in India. The question now is, how are you going to measure your assets, and how do you measure your liabilities. And how are you ensuring that one equals the other. That’s the question!

So when they are talking about risk and risk-based assessments, they’re really talking about the accuracy of estimates. For an insurance company, whether it be liabilities or assets, both are only estimates. No doubt competent estimates, professionally executed estimates, but estimates nevertheless. Take for example the question of estimating liabilities; typically, insurance companies look at these liabilities based largely on the past data and past track record, and project the liabilities in the future. Now, this might work well, but I think you know about the ‘Black Swan’ event don’t you?

AK : Yes, I’ve some idea!

It is a term which has become very popular after the 2008 financial crisis –fundamentally, the question is: how are you going to, based on past experience project, for instance, a disaster like a Fukushima, or the Christchurch earthquake, or even the Kedarnath landslide and floods and all that? Disasters of this dimension are very difficult to predict. That’s why the estimate of liabilities is always shaky. It is founded, no doubt, on statistical mathematics, but fundamentally, since it’s based upon the past, is that a very reliable indicator to the future or not, is a debate that is going on at a very esoteric level in the world of mathematics.

But having said that, essentially when you’re saying ‘risk-based’, what you’re saying is: a) we need to assess what might be our liabilities at a point of time, and b) the same thing holds with regard to assets – what is the value of assets which an insurance company holds. If you take insurance companies in India, for instance – and that’s largely true across the world, the pattern is not very dissimilar – in India, for instance, insurance companies hold about 15% of their assets in equities. And the other 85%, bulk of it – about 55% to 60% - is held in government securities, and the balance 25% to 30% is held in corporate debt. So you’ve got government debt, corporate debt and equities. As far as equities are concerned, there is no problem, because on the date when you are going to assess, the value of a given asset, there is a market value because there is discovery in most of these shares. That is why in India, for instance, we do not allow insurance companies to invest in the equities of non-listed companies. The reason is, there is not sufficient discovery of price in such instruments. But that in any case amounts to only 15% of the portfolio, generally. So the question is: how are you going to assess the debt? What is the value of the debt which one has? And that is the issue, as far as India is concerned.

AK : Could you elaborate?

JHN: There is a myth that all government securities are risk-free. Now we have seen in the 2008 crisis that that may or may not be a valid proposition. There are several government debts, for example, which certainly were not risk-free. So the question is whether it is wise to look at Indian government debt as risk-free. And even government debt in India is of two kinds; one is, you’ve got the central government debt, there are also state government debts, and there is also the debt, or the bonds issued by state government instrumentalities, like for example Power Finance Corporation and other corporations and so on. So what is the value of this debt? Is it risk-free, truly?

And then there is the question of corporate debt, and where exactly the corporate debt is. If you look at the banks now, banks have lent money to very big corporates, and several of them are in distress, because of various reasons, the repayment of the loans taken by the corporates is not as per schedule, which is why they’ve got a problem of the asset quality, and they have to make provisions for asset quality. So when we’re looking at the portfolio of an insurance company’s assets, the question is: what provisions do we need to make for different classes of debt? That is the question. And we don’t have a sufficiently robust and deep statistical basis on which one can assess that the risk in a given instrument is so much. The banks have done it.

AK : So, Sir how do we do it?

JHN: The system we follow in India is, that the liabilities side can be fairly well-assessed, because as far as life insurance companies are concerned, there’s little problem in estimating liabilities, because the statistical basis of life and life probabilities and events and so on is very well-charted, and you can do it very accurately. The same doesn’t hold good for non-life companies, that’s general insurance companies, which deals with miscellaneous types of perils, like for example, as I mentioned, the Uttarkashi issue, or the Bombay flooding and things like this. But in India, fortunately, those secular kinds of perils are not very widely insured. The bulk of our insurance is in motor car insurance and in health insurance, and these are very well tracked. So there’s not much of a problem. The problem comes only when you’ve really got vast property holdings, and then the issue of assessment of risk is of far greater importance.

So coming back, in India, what we do – we require insurance companies at all times to maintain one and a half times the assets over the liabilities as solvencies. In other words, it is not equal to, but it is one and a half times greater than. And that’s how I believe it’s a very robust thing. But on the downside, because we haven’t got well developed markers to assess what might be the quality inherent in, let us say, corporate debt, or even in a government debt, we’ve hiked up the percentage, partly to meet the inaccuracy in estimating the risk on that factor, and secondly it’s also the question of time.

Supposing we find that a company’s assets are eroding, or their liabilities are increasing over their assets, it takes some time before that can be recognized. Their system of accounting has to come up from that, it has to be recognized, it has to be reported, and so on. And having recognized it, we will again require time – of both the management and the regulator – to take sufficient steps to restore the equilibrium of the company. That also takes time. And in order to allow for this time, as also allowing for a certain uncertainty in the quality of the debt, we’ve insisted on a margin of a 150%. So that gives us enough time – partly because they have not really estimated the value of the debt, meaning what is the risk associated with a different class of debt. Let us say, if you’ve got 100 crores of bonds which are say rated at BB and let us say it is an 8% bond – what are the chances of a default on that? Is it more, or is it less than if you had 8% on let us say an AAA bond. Is it more or is it less? How much more or how much less? This kind of arithmetic and details for it are not there. And that is why we believe that our system has met our needs; there have been no failures of insurance companies unlike in the west – in the west, every year, about half a dozen insurance companies collapse, and therefore it’s a far greater concern for them.

AK : They say technology could be a crucial driver in sort of balancing this risk. Now, what would be needed to business assure these technologies? Would you like to add something on that?

JHN: I don’t think it is much of a technology issue. It’s a data issue, a question of data reliability. The calculation of a risk is no big deal. If you’ve got the statistics, it’s just a fifteen minute job. So it’s not really a technology issue. It’s an issue of whether we have the quality and depth of the data we require, and have we captured all transactions accurately at a point of time. And do it systematically, you know, quarter by quarter, month by month, or even daily for that matter!

To some extent, the Reserve Bank of India does it, and therefore what they have done for different classes of assets held by banks, they have calculated what should be the risk weights associated with different classes. So the IRDA had considered that, and based upon the expertise of the RBI on such matters, they had calculated and sent an exposure draft, saying that we could recalibrate our estimates based upon the risk weights as calculated by the Reserve Bank, and then require companies to make provisions accordingly. The question really is this: Companies are trying to balance between the need for security of an investment portfolio – rather, of an insurance portfolio, at the same time, to minimize the capital required to do so. Capital is expensive. So in countries such as in Europe, what they found as a result of the 2008 issue was it’s always in the shareholders’ interest to keep the capital as low as possible. So they used to keep it very low. They were skating on thin ice. And that is what they are trying to redress. So one of the concerns which Europe and European insurance companies have, is that they believe the Solvency–II requirement might require companies to recapitalize quite substantially, and that poses a problem for shareholders, for the economy at large, and that is the question which they are facing.

AK : Thank you Sir, have a nice day!

Thinksoft @ 18th Handelsblatt Annual Conference, Frankfurt

Thinksoft joined leading European Bankers, CEO’s, Regulators and Journalists at the “18th Handelsblatt Annual conference” held in Frankfurt, Germany. The theme of the conference was “Banks in Transition” to discuss the future of Banking and what’s in store for the public with the innovations expected Banking.

We had Anshu Jain CEO of Deutsche Bank speaking about the big merger /consolidation wave which is expected in the Banking space, thus ending the artificial equilibrium. He expects a lot of structural changes to happen which will lead to simplification of business models. He laid stress on the “Fracture of Trust” between the Banks and the customers, a key point which needs to be seriously addressed after the financial crisis triggered by Lehman brothers 5 year back.

Mr. Jain expects the following three business models for the merged bank in the coming years: 1.Regional Banks, 2. Asset Managers/ Investments Banks and 3.Global Universal Banks. Global universal banks have the unique advantage ofto their vast presence and the opportunities they have compared to others. He also expects it to be watched closely by regulators.

He also talked about the future where “Banking will happen without Banks”, where it will be done online with big internet giants and traditional data Provides coming into play in the banking and trading space.

There were other CEO’s from across Europe who expressed their views onthe changes expected in the coming years in the banking arena. These are mostly around Increase in capital, requirement for a competent yet resilient banking system and the requirement for a global regulation for all financial sectors (Banks, Insurance, Capital markets, Trading etc) which ties all the threadstogether and will create a fool proof system for all of us.

For Thinksoft this will be an ideal platform to grow along with the global banks due to our global presence and the experience which we can take and share withdifferent business regions. The expected increase in digitization and virtual banking will require sharp focus on quality and “first time right” roll-out of online features and services to ensure uninterrupted customer experience.