Financial innovations and emerging markets

Financial innovations and emerging markets

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  Financial innovations andemerging markets A recent case of recapitalization scheme of state own banks in India Evidence from India By Muhammad Bilal 2017
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  Introduction Financial innovations (theact of creating and the popularizing new financial instrument technology institutions and markets) are always considered the risky way of economic growth, we look at the reasons for global financing crisis one of the main reason was financial innovation like (derivatives in finance, a derivative is a contract that derives its value from the performance of an underlying entity. This underlying entity can be an asset, index, or interest rate, and is often simply called the "underlying"). Although during the crisis the most suffered countries were developed, however, the aim of the study is to review what is impact of financial innovations on the emerging markets (country that have some characteristics of developed country but does not meet the standards for the developed countries) what are innovation’s in the state own lenders they are often considered the political stunts that are done by Politician to gain political fame some of them are subsidize lending, loans are given without proper credit appraisal. Since the beginning of the 21 century, the Indian financial industry started financial innovation’s many new financial institutions were developed to energize the economy at the same time state own banks were encouraged to do the same and the beginning 21century marked the start of innovation’s in-state own banks of India which would, later on, become the biggest economic hurdle for the government of India. Background On the 24 October, Indian finances minister announced one of the biggest recapitalization schemes of human history 2.11trillion which will be generated in two-way process 1.37 trillion in recapitalization bonds and the rest will be generated through budgetary allocations and fundraising through market, however this scheme was announced for the state own lenders weighed down by bad debt seeking to energize the economy through private investment. The reason behind the deal was decaling growth rate which was 5.6 for the quarter ended June the lowest in three years. Considering the fact that India is emerging market and wants to achieve economic growth but why do we recapitalize what is the need for recapitalization following are the questions that need to be answered banks have some constraints which can stop them from lending the that is the capital ratio for every loan that’s a bank make it have to keep 10%as capital so if the banks have the 100 rupees it can lend 1000.Now consider if bank loss 50 rupees’ in loan that was given to someone who defaulted now banks have only 50 rupees as capital so it can make loan of 500 rupees, this
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  was the problemwith Indian state own banks the bad debts caused the bank capital ratio to fall and its ability to lend to the investor especially to small firms was limited, this was actually a bailout package to rescue the declining growth rate which the Indian government wants to achieve but the question is at what at cost there are two parts to this deal one increasing the capital ratio by recapitalization of the banks and second is budgetary allocations, and fund raising through markets how will this be done by Indian government which is already facing the current budget deficit of 500,000 crores for the fiscal year 2017 this will worsen the situation for the government. Following are the few innovate scheme that were offered by state-own lenders in India from last fifteen years working capital loan offered to people for their day to day business operations corporate terms loans terms loans many other loans were offered by the state own lenders but the credit appraisal system and rules were relaxed and the outcome was disastrous for both the banks and government. There are many aspects of this problem, one financial innovation in emerging markets often proves to be the disastrous for the economy, because emerging markets economies are very different than the developed economy, where if there is any financial innovation fails in developed economy government can support that without having too much impact on the fiscal budget.Second, the attitude of the population in emerging market towards economic growth quite different than population attitude in a developed economy.third, government policy towards economic development, in this case, it proofed disastrous.Every policy made by the government in emerging markets doesn’t also mean to achieve economic growth some are meant to achieve political interest. There are reference cases of recapitalizations from past, for example, Algeria government issued recapitalization bonds in 1992-92 reason “purchasing bad assets”, similarly 1996 “purchasing bad assets, Korea 1998” purchase bad assets “Malaysia “to finance the purchase of bad assets” Mexico 1995 “purchasing bad assets” Poland 1993 “to cover the bank loses” and the list goes on and we find that most of the countries that have used recapitalizations are developing/emerging. The above mention fact gives us an evidence that, whenever government tries to innovate in financial sector through its different loan schemes, financial product will tend to have disastrous effect on the economy
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  Solutions What is thesolution to this problem? Recapitalization its self is considered a solution to this problem. A retrospective of the recapitalization scheme gives inside to the story that this is considered to be the solution for funding “bad assets purchase by government”. There two consequential aspects of recapitalization short and long-term in this case if look at long-term consequential aspect which the Indian government have to bear on fiscal deficit, so what is the solution then, as mention above political decision in developing/emerging markets are often based on how to gain political fame rather, then economic goals based on economic aspect so this needs to be changed. Second population attitude towards economic growth in developing/emerging markets needs to be changed through awareness. Third privatization of state owns lenders the retrospective of privatization gives us the positive relationship between the performance of state own banks that were privatized, for example, subrata& Rudra (2010) in their study found that partial privatization of state own lender in India improved the financial performance. according to Sana &samreen (2015), that privatization has a positive impact on the bank's performances in Pakistan. Fourth credit appraisal methods for the innovative scheme should be revised and improved. Mention above are some of the solutions to the problem. Conclusion The aim of the study was to examine that how financial innovation in the emerging market impact the economic growth. Financial innovation can lead to economic growth, but it is for the short time, however in long term it can have disastrous effect on the economy of the country. Recapitalization is often uses as solution to finance bad assets or purchase bad assets. So based on the above mentioned examples we conclude that in developing economy/emerging markets privatization of state own lenders or any other state own enterprises tend to improve the financial performance, because under the public proprietorship there are many obstacles that imped these enterprises from performance. So we conclude that financial innovation in the emerging markets also fail, and the economy have to bear consequential effect. So we suggest from our results that emerging markets should avoid financial innovation, because their economies are very fragile.
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  References Micheal Andrew (2004)Issuing Government Bonds to Finance Bank Recapitalization and Restructuring design factor that affect banks financial performance IMF policy discussion paper Subrata Sarkar, Rudra Sensarma, (2010) "Partial privatization and bank performance: evidence from India", Journal of Financial Economic Policy, Vol. 2 Issue: 4, pp.276-306, Sana Siddiqui and Samreen Lodhi(2015) Impact of Privatization on Firm’s Performance: A Case of Banking Sector of Pakistan ISSN: 2321-3124