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Libra – Facebook’s cryptocurrency

Facebook has revealed plans for a new global digital currency, claiming it will enable billions of people around the world without a bank account to make money transfers. The digital currency is called Libra and will allow its billions of users to make financial transactions across the globe, in a move that could potentially shake up the world’s banking system.

Facebook revealed the details of its crypto currency, Libra which will let you buy things or send money to people with nearly zero fees. It released its white paper explaining Libra and the technicalities of its blockchain system before a public launch in the first half of 2020.

The effort announced with 27 partners right now ranging from Master Card to Uber and should launch sometime next year with 100 partners, as it hopes. It is a stable coin backed by a basket of actual currencies and marketable securities. Facebook will only get a single vote in its governance of the crypto currency along with its partners.

The currency will be run by the Libra association as Facebook is distancing itself from the direct management. Facebook’s involvement will be run via a new subsidiary called Calibra that handles its crypto dealings and protects users’ privacy by not mingling an individual’s payments with his/her facebook data. By this an individual’s real identity won’t be tied to his/her publically visible transactions. Calibra will also be launching a digital wallet for Libra, as a standalone IOS, android application and also as a functionality within whatsapp and messenger. Libra is the underlying technology but Calibra is likely how most people will interact with the currency. It will be the first crypto currency wallet that millions of people will have access as it takes advantage of facebook’s massive ecosystem with billions of potential users.

One of the biggest problems that the regulators will have to tackle is drug dealers and money launderers from getting their hands on Libra and using it to move money from the eyes of the law enforcement like with any crypto currency.

“The issue is that once you apply traditional regulation to tokens that are backed by money in the bank then those tokens start to look a lot like normal fiat money, after all most money we use today – credit card, apple pay, PayPal etc is just the digital representation of money that the banks promise to ultimately backup. This is the exact same thing except on a blockchain”- Techcrunch

Libra Whitepaper states that unlike previous blockchains which view the blockchain as a collection of transactions, the Libra blockchain is a single data structure that records the history of transactions and states over time. Facebook has created a whole language for writing commands on its protocol called MOVE (programming language), which is an open source prototype in anticipation of a global collaborative effort to advance this new ecosystem.  The facebook has done its homework to cherry pick the best bits and pieces of other crypto project to create Libra.

Like bitcoin there is no real identity on the blockchain; from the perspective of the block chain itself you don’t exist, only public private key pairs exist. Like hyperledger it’s permissioned (at least to start); initially the consensus structure of Libra will be dozens of organisation that will run nodes on the network, validating transactions. Like tezos it comes with on-chain governance; the only entities that can vote at the outset are founding members. Like ethereum, it makes currency programmable and in a number of ways the whitepaper defines interesting ways in which its users can interact with the core software and data structure. For example anyone can make a non-voting replica of the blockchain or run various read comments associated with objects such as smart contracts or a set of wallets defined on Libra. Crucially, Libra’s designers seem to agree with ethereum that running code should have a cause so as to all operations require payment of Libra as gas for it to run. Also like ethereum, it thinks proof of stake is the future but it is also not ready yet. Like binance’s coin it does a lot of burning. Like coda, users don’t need to hold on to the whole transaction history – states Coindesk.

Now needless to say, this is pulling a lot from the latest and greatest crypto ideas and collaborating it.

Facebook launched 2 crypto currencies, addition to Libra the project will also have a Libra investment token, which is how the stake holders (100 or so partners facebook hopes to have lined up on launch) will make money on this, as Libra itself is not supposed to fluctuate in value.

Unlike Libra a currency that will be broadly available to the public, the investment token is a security according to facebook that will be sold to a much more exclusive audience – the funding corporate members of the projects governing consortium known as the Libra association and accredited investors. While Libra will be backed by a basket of fiat currencies and government securities, interest earned on that collateral will go to holders of the investment token. As previously reported ahead of the official announcement, each of the 27 companies that facebook recruited to run validating nodes as founding members of the consortium, invested at least 10 million dollars for the privilege. The investment token is what they received as a financial reward, but that reward will only be meaningful if the network takes off – states Coindesk.

The assets in the reserve are low risk and low yield for early investors which will only materialise if the network is successful and the reserve grows to a substantial size, facebook said in one of the series of documents that supplement the Libra white paper.

This sound a lot like how an Initial Coin Offering – (ICO) has worked over the past of years, except without the expectation of price appreciation as the reward to early investors.

 We will have plenty of time and a lot of information to dig into in the coming months, but my bottom line and initial take is that the money we have today has not worked very well for all of us, furthering the gap between the rich and the poor. Libra (crypto currency) has the potential to bridge this gap but it has to bypass too many regulatory complications.

If facebook succeeds and receives cash for Libra, it and the other founding members of the Libra association could earn big dividends on the interest. If Libra gets hacked or proves unreliable lots of people around the world could lose their personal information and money. But it is clear that facebook has tried to reinvent money, we will have to wait and see if they can pull it off.

Author
Indrajith Aditya
Team Member – Equity Research and Valuation
(M.Sc. Finance, NMIMS – Mumbai 2018-20)


Connect with Indrajith on LinkedIn
finvert Economics, General Blogs

Non-Performing Assets (NPA) of India: Journey so far and the road ahead!

“The failure of a loan usually represents miscalculations on both sides of the transaction or distortions in the lending process itself.”

— Radelet, Sachs, Cooper and Bosworth (1998)


In the recent times the newspapers have been filled with some or the other news, issues, policies, regulation or resolution of NPAs. The NPA ratio has come down to 9.3% in March, 2019 from 11.5% in March,2018 according to mention by RBI Governor Shaktikanda Das. 

Source: SCB’s GNPA Ratio,Financial Stability Report, RBI

According to RBI, the definition of NPA is: ‘An asset, including a leased asset, becomes non-performing when it ceases to generate income for the bank.’

A non-­performing asset (NPA) is a loan or an advance where the payment of principal/interest is due (in default) for 90 days or above.First, when there is a default of payment, till 90 days, the accounts are subsequently classified as Special Mention Accounts (SMA): SMA 0/1/2. Then after 90 days, these accounts are classified as NPAs.Further NPAs are classified into sub­standard,doubtful and loss assets.Any income for standard assets is recognized on accrual basis, but income from NPAs is recognized only when it is actually received.

Reasons for accumulation of NPAs:

Increasing cases of wilful defaults and frauds are often considered as the primary reason behind the accumulation of bad loans in the Indian banking system.

When an economy experiences healthy GDP growth, a substantial part of it is financed by the credit supplied by the banking system. As long as the GDP keeps growing, the repayment schedule does not get substantially affected. However, when the GDP growth slows down, the bad loans tend to increase due to macroeconomic factors, primarily among them are interest rate, inflation, unemployment and change in the exchange rates.Hence, bad loans accumulate as borrowers are unable to repay due to stalling/closure of the big development projects

Bank-related micro indicators such as capital adequacy, size of the bank, the history of NPA and return on financial assets also contribute to the accumulation of bad loans. NPAs, specifically in the Public Sector Banks (PSBs), have adverse effects on credit disbursement. Increasing amounts of bad loans prompt the banks to be extra cautious. This in turn has caused drying up of the credit channel to the economy, particularly industries, making economic revival more difficult.

Need for Solution

Reviving industrial credit is crucial for the health of the overall economy, because industry (particularly manufacturing) tends to create more employment.

Mounting bad loans suggests vulnerability in the system, wherein short-term deposit-taking banks have to extend credit for long-term big development projects. And this model is visibly failing. Hence NPAs put several small depositors of the banks, particularly in the PSB, at risk.

Also an improvement in the recovery rate and reduction in timeline for resolution for insolvent companies will increase investor confidence in Indian Bond Market.

Recognition of the problem and the solution:

NPAs story is not new in India and there have been several steps taken by the GOI on legal, financial and policy level reforms. In the year 1991, Narsimham committee recommended many reforms to tackle NPAs.

SICA Act, The Debt Recovery Tribunals (DRTs) – 1993, CIBIL: Credit Information Bureau (India) Limited-2000, LokAdalats – 2001, One-time settlement or OTS- compromise settlement-2001, SARFAESI Act- 2002, Asset Reconstruction Company (ARC), Corporate Debt Restructuring – 2008, 5:25 rule – 2014, Joint Lenders Forum – 2014, Mission Indradhanush – 2015, Strategic debt restructuring (SDR) – 2015, Asset Quality Review- 2015, Sustainable structuring of stressed assets (S4A)- 2016 were some of the techniques applied to tackle the problem by government and RBI.

Every method was entangled, rules were not that clear, there were lot of cases pending in front of DRTs owing to limited infrastructure, not enough field experts and hence, it took years for creditors to recover their money. India needed a structured process; thereby Insolvency and Bankruptcy Code (IBC) -2016 came into existence.

It sets a time limit of 180 days which can be extended by another 90 days to complete the entire process. Some of the features of the code include the allocation of a new forum to carryout insolvency proceedings, setting up a dedicated regulator, creating a new class of insolvency professionals and another new class of information utility providers.

The forum where corporate insolvency proceedings can be initiated is the National Company Law Tribunal (NCLT) and appeals against its decisions can be made in the (National company Law Appellate Tribunal) NCLAT. The IBC vests the NCLT with all the powers of the DRT.

Insolvency professionals will have the task of monitoring and managing the business so that neither the creditors nor the debtor need worry about economic value being eroded by the other.On acceptance of the application by NCLT for proceeding for Corporate Insolvency Resolution Process (CIRP), Board of Directors of the company has to step down and Insolvency Professional takes the charge and the plan for revival or liquidation of the company, approved by majority of creditors is put in the action according to the IBC rules and timeframe.

It is predicted that the NCLT is focused on the legal process while the insolvency professional is focused on business matters.RBI listed out the 12 major accounts in India, which has the largest share of NPAs in the country.

Source : ICRA

Some great results have fared in: Ranking for ‘Resolving Insolvency’ But still there is a long way to go: Suggestions

As mentioned above, there is a mismatch of assets and liability for the banks. Banks’ assets are long term loans, whereas banks liabilities are short term deposits, which have landed banks in failures. Hence, it makes sense to say that commercial banks should be focusing on short term assets to match their short term liabilities. And for Long term projects, special purpose vehicles (SPV) should be created to fund a particular sector project and financial institution should be created to fund these SPVs and should be given incentives and proper regulation from the government.

Also, as recapitalization of PSBs is going on, a bank should first divide its assets into good and bad, meaning viable and unviable asset. Banks should be recapitalized according to viable assets to revive with its positive core rather than just giving out public money. By this, banks can also focus on their core business rather than managing NPAs and not contribute to slowing of the economic growth.

SICA Act in India was a ‘Debtor in Possession’ (DIP) Model just like U.S. Chapter 11. But there were flaws in the act compared to the U.S.model. There was also a problem in the assessment of viability of the company as only a few accounts were revived. ‘Another relevant fact is the definition of insolvency or ‘sickness’ under the SICA. The N.L. Mitra committee criticized the definition provided by SICA i.e. ‘at the end of any financial year, accumulated losses equal or exceed its entire net worth’ stating that this is the end rather than the initial point where the company’s problems begin.’

Time has changed, India made a comeback with ‘Creditor in Possession’ (CIP) Model of IBC inspired by U.K. owing to similarities in the judicial process and SMEs culture, but there is one problem. In SICA, debtors were made liable to take the proceeding to court if it is identified by them that company is in trouble. Under IBC there is no such amendment and hence there is a ‘problem of initiation’ which was clearly seen in the case of Jet Airways. Just because directors didn’t want to step down, they dragged the process, rejected lot of revival bids in early insolvency phase. And be it any reason, even the financial or operational creditor did not initiate the process.

Australia also followed CIP model, but faced the same problem and added the amendment to make directors liable for any default under their directorship, directors became scared to default and didn’t take any risky decision to grow the company making them stagnant. This also should not happen with India. But then Australia laid ‘Safe Harbor’ provision to ease out the rules. Hence still amendment in the IBC is required to make directors take help from outside professional for the revival of their company in the early insolvency stage itself.

On June 7,2019, RBI laid provision pertaining to rules for creditors to enter into a ‘review period’ in the first 30 days of default by the debtor account, and make a resolution plan for the concerned account and apply the plan in next 180 days to revive it. If the plan is not put into implementation, provision for this account is required to be increased more and more as days pass. This might lead the banks to initiate the CIRP of the account under IBC and may overcome the ‘Initiation Problem’ from the side of creditors. According to this new frame work for stressed assets, the above mentioned rule is now applicable to Small Finance Banks and NBFCs, as they have become an integral part of the economy and needs to be properly regulated to retain the trust of investors.

There can be a solution to mitigate the problem of NPA by forming a‘Bad bank’. But this is a very risky model as it requires extensive research and cross-country analysis as the taxpayers’ money is on table.

In India Secondary Market for Corporate Loans, particularly distressed loan is in the making, taking inspiration from U.S. and European market. But there is a problem of transfer pricing of these distressed assets. India will have to design a proper mechanism, a platform and regulation of valuation techniques using DCF method, so that there isn’t much of a gap between the bid and the ask price of the assets and so the market remains active and transparent.

India and the banking system requires a major turn around and all the financial professional will have to put in the work.

Author
Vishwa Parekh
Volunteer – Fixed Income & Risk Management
(M.Sc. Finance, NMIMS – Mumbai. Batch 2018-20)

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How Does The 2019 General Election Results Alter The Market Dynamics For India?

The stock market indices and the share price of the companies listed on these indices constantly keeps changing due to company related factors and market-related factors. The company related factors are usually its annual performance in terms of revenue generated, market size captured, innovative product/service offered, capturing various synergies that derive its value on the index, etc. The key elements that drive the market-related factors are the macro events that take place which dictates the direction in which a particular company or the whole industry tends to move towards.

The prominent macro events such as inflation, monsoon, trade policies, financial factors, trade war, oil prices, global markets etc. are a few to name. But, one of the most crucial factors is the government that is ruling the country as it’s the epicentre of all the policies, reforms, schemes and decisions made in the country which acts as an indicator of the road which is ahead to come. Hence the importance of the motto and ambition of the incoming government is so crucial. However, the market overall will tend to thrive in the long-run irrespective as to which government comes into power.

As seen in the table below are the annual returns derived by the BSE index over the tenor of the ruling government. Here, it’s clearly visible that the returns derived from the market index have more to it than the party ruling the government.  

The markets always hope for a stable government at the Centre so as to have consistency and stability in the economy as the government is the sole authority of framing the prominent economic policies of India. The foreign players generally prefer to invest in economies that have a stable government with strong policies with long-term visibility. The Indian equities have witnessed foreign inflows worth a net of $6.7 billion from January to March, which is more than the outflows of $4.4 billion in 2018. This optimism has kept foreign investors bullish on India and the market is benefitting from huge emerging market inflows.

India is set to emerge as a USD 5 trillion economy over a period of five years and as a USD 10 trillion economy eight years after that. This gives a clear indication of the growth prospects and the sectors in which the opportunities will arise on these lines. In terms of fundamentals of the country’s economy, its inflation has come down from over 10% five years ago to about 4.6%, the fiscal deficit has come down from almost 6% to 3% which are very important indicators. We have already grown in the last five years from being the 11th largest economy in the world to the sixth. This has led to ease in the monetary policy (which we already have started to witness) which in turn can boost consumption.

To attain this kind of scales, the country needs inclusive and sustainable growth. And for this, the focus needs to be on physical and social infrastructure. The government has been taking a number of initiatives to address and correct the imbalances in both the economic growth and development of the country. BJP’s election manifesto this time around was focused on infrastructural development which has already started to witness growth from the ground level during their last tenor.

The government is expected to make a capital investment of Rs 100 lakh crore by 2024 in the infrastructure sector as well as announce a new industrial policy to improve the competitiveness of manufacturing and services. This has given a more optimistic outlook going forward. Hence, companies of sectors such as Infrastructure, Power, Capital goods, Manufacturing and Construction will witness significant progress and growth over the government’s next tenure. Some sectors such as FMCG, IT, Metals. Pharma keeps growing irrespective of the election cycles.

With the progressive economic steps of implementing Goods & Service Tax, De-monetization, the government looks to roll out further steps to organize and streamline the conduct of businesses and trades. Hence it would advisable to avoid the sectors or companies which have an unorganised structure and a low sustainability business model.

The Modi government’s return to power is likely to propel the agriculture sector stocks as well. New agricultural reforms, policies, financial aids availed to the farmers and the export policies and incentives has improved the quantity and quality of the output which can be used for domestic consumption as well as for exports.  This will leave more money in the hands of farmers which will be spent on buying tractors, cars and two-wheelers in the rural market.

The power sector has also witnessed a significant improvement in energy deficit situation over the last four years of the tenure. The country’s energy deficit, which remained in the range of 8% and 10% during 2011-13, has improved in FY14 to 4-4.5%, and subsequently contracted to a mere 0.7%.

With the implementing of Housing for All, Rural Development & Electrification, Smart City Projects, development of roadway and waterway connectivity, and many such policies being already rolled on and many being in the pipeline as well, industries that have been directly linked with these schemes and policies such as construction, building materials and accessories etc. will directly benefit from the same.

Banking sector stocks are also likely to rise since sales in the auto sector, demand for housing loans and agriculture loans will lead to a rise in their loan books. The re-organisation of the increased banking NPA’s has also propelled these stocks towards profitability. Also, banking stocks have been at the forefront of almost all rallies on the benchmark indices.

The Make in India policy and Start-up incentives provided by this government is expected to increase the employment opportunities in this market. With the kind of global recognition India is gaining throughout has been reflected by the way other economies and government is viewing India as an investment destination. This has led to strengthened relations with major member nations giving the country a much greater economic, financial, technological and political horizon to look forward to.

Though many of the investors have a different philosophy and they prefer not to try and time the stock market. They prefer to stay invested for a long time and usually have a diversified portfolio which can smoothen the impact of the immediate volatility of the market. However, analysis of this event helps to not only smoothen the immediate impact of the volatility in the market but also helps to plan the portfolio reshuffling. Thus, understanding the vision and policy-making of the government over the next tenure will help to identify the sectors that will grow in the upcoming tenor and investing in the most efficient business model of the company in that particular sector can give the investors multi-beggar returns. 

Author
Dhrumil Wani
Team Leader – Equity Research & Valuation
(M.Sc. Finance, NMIMS – Mumbai. Batch 2018-20)

Connect with Dhrumil on LinkedIn



finvert Economics

Gaining the edge: Parallel banking for Indian economy

India is going to emerge as the fourth largest economy in the world by 2025 with a GDP of about $5 trillion. With that, India needs to address financial credit access to its rural population that today constitutes about 66% but having an economic contribution of 15%. To achieve a figure like this, the country needs to create 10 million jobs a year, which can be best achieved by meeting the credit needs of small businesses. Moreover, meeting the gap requirements of infrastructure investments, of over US$ 526 billion over the next 20 years is another challenge. Fact scan, check. Problem Statement, check.

Figure 1 – India’s GDP growing at a CAGR 20.83%
Source – RBI

Now let’s look at what the parallel banking sector has in store for us

A quick google check tells us that it is a term for the collection of non-bank financial intermediaries that provide services similar to traditional commercial banks but outside normal banking regulations. A simple solution. Empower NBFC’s. Check.

It is likely that the next 5-year period will be marked by corporate CAPEX cycle as well as continued Government spending in the Infrastructure sector. Assuming a steady Credit-GDP ratio of 85% and a nominal GDP CAGR of 10-11% suggests that the banking cum NBFC credit can increase by 12-13% CAGR to touch levels of US$ 2.7 trillion by 2025. The question arises, can our present banking infrastructure support this requirement or do we need more vibrant participation by NBFC’s?

Figure 2- Credit-to-GDP ratio
Source – RBI
Figure 3 – GDP Contribution
Source – DBEI

In the last few years, the ratio of Manufacturing & Industry – Credit to GDP has consistently fallen from 79% (2013-14) to 72% (2018-19). Indeed, this was the period marked with NPA’s that fettered the bank’s ability to lend to the manufacturing sector. On the other hand, the NBFC’s share of credit-GDP ratio has gone up substantially from 6.5% in FY-08 to 19.1% in FY-18. Participation of NBFC’s has been across the value chain from high-risk and un-collateralised credit to mortgage financing for salaried class.

Clearly, the approach going forward will require a massive expansion of a banking network, re-tooling the NBFC’s for expansion of credit especially to small businesses, creation of a dedicated Rural banks, specialised NBFC’s for diverse assets, and other measures that would stimulate private investment and provide mechanisms to  promote project financing and infrastructure development.

In India, we have the situation that banks finance large businesses, medium and small businesses, home mortgages, auto loans, personal loans, and credit cards, each of which have totally diverse risk management requirements. Should we not adopt the model of the developed economies where there are specialised financial institutions for different assets? While we do have housing finance companies, NABARD for Agri-credit, NBFC’s for auto loans etc, the need is to allow a larger number of NBFC’s specialised in the diverse asset class. This enables focused risk management, relevant to the nature of the asset being financed.

Presently, the NBFC’s balance sheets are pre-dominantly funded from the banking sector. NBFC’s access to public deposits is very tightly regulated by the RBI due to issues of the past.

Moreover, the rising importance and the geographic reach of the NBFC’s especially to the small businesses requires a refreshing look on the allowing the NBFC’s to tap the public deposits and making them as cost-effective competitors to the banking sector. The fear of default or misuse of public funds by NBFC’s can be managed by the deployment of technology to manage the risks on a real-time basis.

Another challenge for India is to finance its massive infrastructure requirements estimated at US$1.5tn over the next 20 years (“Around US$4.5trillion worth of investments is required by India till 2040 to develop infrastructure to improve economic growth and community wellbeing. The current trend shows that India can meet around US$ 3.9trillion infrastructure investment out of US$ 4.5trillion. The cumulative figure for India’s infrastructure investment gap would be around US$ 526bilion by 2040.” – Economic Survey 2017-18).

The key issue plaguing the financing of infrastructure is a lack of long-term debt market in India. Perhaps, the time has come to allow a relaxation of the present rating norms for the investment of 5-10% of the corpus of pension funds, insurance funds and provident funds to invest in A-rated infrastructure finance companies.

The banking sector has limited ability to provide project finance, which acts as a barrier to attract private investments in new projects. Perhaps, we need to once again revive the old concept of development financial institutions (DFI’s) that will take the lead in providing project finance. The business model could be that the DFI’s are owned by the Government and international financing institutions – investment funds. The proceeds of bank privatization could partly offset the capitalization requirement of the DFI’s from the  Government.

Let us now look at what could be done to the existing banking sector:

In the 1970s and 80’s the nationalization of the banking sector was to support and promote the socialistic economic ideology. Since 1992 India has been on a path of private capitalization and has aborted the socialistic pattern of economic development. This being so, why is our banking sector still Government-owned? We have also evidenced that Governmental control of the banking sector necessarily implies that the banks must fall in line with Government guided lending directives whether they make economic sense or not. The saga of NPA’s and loan waivers proves the above and establishes the basis of Government divestment in the commercial banks. The privatization proceeds so received by the Government should be used to capitalize the launch of rural banks. Ideally, the State Governments should join hands with the Centre – RBI for capitalization of the rural banks.

In conclusion, if in the next 11-12 years India is to emerge as a $7 trillion economy thus being the third largest in the world, and if we are to ensure an economic development percolates to the bottom of the pyramid, we will need banking reforms which lead to:

  1. Privatization of existing PSU commercial banks
  2. Expanding the participation of Small Finance Banks, as well as allowing a level playing field for the NBFC’s to raise public deposits
  3. Establishment of Rural banks with technology support
  4. Establishment of Development Financial Institution’s to provide project financing support to private and PPP projects
  5. Creation of a long-term debt market, and
  6. Commercial banks to focus on doing short to medium term loans and consumer loans.
Author
Anushka Chordia
Team Member– Alternative Investment Funds
(M.Sc. Finance, NMIMS – Mumbai. Batch 2018-20)

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finvert FIntech

Illuminating the dark side of valuation using a Vanilla LSTM Recurrent Neural Network

One of the major problems faced by investors is to try and distinguish between “Price” and “value”, This problem arises because there are several behavioral biases as well as unethical practices that play a role while doing valuation. Sometimes, the valuation company is given a figure by their client and they do a backward calculation to keep up the pretense. The root cause for there even being a “Dark Side” of valuation is that in the DCF model, we make projected cash flows; These, projected cash flows are based on assumptions made by the valuation company. Now, based on their assumptions the valuation company could grow the cash flows at 100% or 1%, it’s perfectly acceptable as long as they have a story to back them up. Due to this ambiguity in projections, the valuation company provides their client with any valuation they want.

In this article, I have solved this problem by implementing an Artificial Recurrent Neural Network (Vanilla LSTM) to predict future cash flows. This gives us an unbiased prediction and takes away the ambiguity from a valuation that caused “The Dark Side”. The Artificial Recurrent Neural Network is able to detect interrelationships between thousands of diverse market variables and therefore is the perfect analytical tool for the financial forecast. In this article, I have used the Vanilla LSTM to forecast cash flows and arrived at a valuation of Maruti Suzuki Ltd and avoided any biases that usually pay a role while valuating a company.

What is a Recurrent Neural Network?

Recurrent Neural Network is a type of Neural Network where the output of the previous step is fed as an input of the current step. Usually in neural networks (feed-forward), the outputs and inputs are independent; But, in situations where you must predict the next word of a sentence, the previous word is essential. Recurrent Neural Networks solved this issue using hidden layers. The hidden layer remembers some of the information about a sequence. A Recurrent Neural Network remembers all the information over a period. It is considered as a powerful tool because of its ability to remember previous inputs.  An RNN remembers each information through time. It is useful in time series prediction only because of the feature to remember previous inputs as well. This is called Long Short-Term Memory (LSTM). A Vanilla LSTM is an LSTM model that has only one hidden layer of LSTM units, and an output layer used to make a prediction.

  • For forecasting Time series data Via a Vanilla LSTM Recurrent Neural Network, we are taking 10 data points or historical data. These data points are nothing but Net cash flows we arrive at while doing FCFE. Therefore, we start with getting Income statement and Profit and loss from FY 2010 to FY 2019.
  • For each of these 10 years, we take the Profit after tax add the depreciation, Changes in Debt (Current year Debt – Previous years debt) and subtract the Capital expenditure and changes in working capital (Excluding cash). Using this, we arrive at Net Cash Flows of 10 years.
Source
  • These Net Cash Flows are used as Inputs for the Vanilla LSTM Recurrent Neural Network and are used to predict the future cash flows for the next 5 years. The code for this is written on Python by Dr. Jason Brownlee. Each time the neural network is used to predict the future net cash flows, it gives only one output (the net cash flow of the next year). This output is included in the input for the next year. This is how even though the neural network is capable of forecasting only 1 year, I have forecasted for the next 5 years. The Vanilla LSTM is as follows:
  • The terminal growth rate has been assumed at 10% because that is the rate at which the automobile sector is expected to grow as per Research Cosmo. However, to avoid any biases I have done a sensitivity analysis with terminal growth rates varying from 9% to 11%. To find the terminal value we increase the Net Cash flow value of the 5th year by the terminal growth rate and divide this by the difference between the Cost of Equity (Ke) and the terminal Growth rate.
  • These discounted cash flows are added to arrive at Equity Value of the company. This equity value is divided to arrive at Expected market price of the company.

Conclusion

The objective of this article was to remove the assumptions made while valuation because these assumptions create a window for ambiguity which can be used to unethically inflate the valuation of the company. In this article no assumptions were made except the terminal growth rate (taken from a Research Cosmo Report). To tackle this, I have done a sensitivity analysis with terminal growth rates varying from 9% to 11%. Using this new model, we got a valuation at 10% terminal growth rate of Rs 8,417.22. Therefore, using the method I suggested in this article, you can find the “Value” of the company and not “price”. This way you save up on the money you would have paid the valuation company and also get a unbiased valuation.

Author
Neil Jha
Team Leader – Fintech
(M.Sc. Finance, NMIMS – Mumbai. Batch 2018-20)

Connect with Neil on LinkedIn
finvert Merger and Acquisition

THREE-WAY CONSOLIDATION OF BANKS

The union government agreed with the merger on Jan 2, 2019. Union Minister Ravi Shankar Prasad says the merger will allow the combined entity under Bank of Baroda being the leading power. This means that BOB will be the transferee bank and Dena bank and Vijaya Bank will be the transferor bank. After the merger BOB will be the third largest bank in India in terms of Assets after SBI and HDFC Bank. The merger will be completed by 1st April 2019. And after the Merger BOB will be the second largest public sector bank in India.

Merged Entity

The total business will rise  from Rs. 10.3 trillion to Rs 14.8 trillion. The deposits will rise from Rs. 5.8 trillion to 8.4 trillion. The NPA will increase from 5.4% to 5.7% because as of now, the net NPAs with Dena bank is 11%.The financial of BOB will be diluted during the initial phrase of merger, mainly because of the bad loans of Dena Bank. Also, technology change, possible NPA (non-performing asset) provisions requirements etc. are likely to take a toll on near-term earnings of BoB” said Lalitabh Shrivastawa, assistant vice-president at Sharekhan. There is no retrenchment of any employee in the merged entity. But there are chances that some of the branches can be closed because of multiple presence in key locations.

Synergies

All the employees of Dena bank and Vijaya Bank will come under BOB. There will be no change in their services or working conditions. This merger will help to create a strong, global competitive bank with Economies of scale and enable realisation of wide ranging synergies. Because of enhance range of services, general public as a whole will be benefited. The government hopes that the economies of scale and wider scope would position the merged entity for “improved profitability, wider product offerings, and adoption of technology and best practices across amalgamating entities for cost efficiency and improved risk management, and financial inclusion through wider reach.”

Swap Ratio

The swap ratio has been finalised for both Dena bank and Vijaya Bank. According to the scheme of Amalgamation, the shareholder of Vijaya Bank will get 402 equity shares of BOB for every 1000 shares and in case of Dena Bank, people will get 110 shares for every 1000 shares. The swap ratio seems to be in favour of BOB. As according to the closing price as of 2nd January 2019, the ratio is 27% sharp discount for Dena Bank and for Vijaya Bank, it is at 6% discount.

Conclusion

The three banks have strengths of their own, which will help the merged entity. Dena Bank has relatively higher access to low cost current and savings accounts (CASA), Vijaya Bank is profitable and is well capitalized and BoB has extensive and global network, as well as good product offerings.

The amalgamated banks will have access to a wider talent pool and will have a large database that may be leveraged through analytics for competitive advantage in a rapidly digitalising banking context. There will be a flow of benefits because of wider reach and distribution network and there will be reduction in distribution costs for the products and services through subsidiaries.

Author
Apoorva Goenka
Team Leader- Equity Research & Valuation
(MSc Finance, NMIMS Mumbai. Batch 2018-20)

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finvert Economics

Rate Cut, Who is the Winner?

In the recent Bimonthly Quarterly statement, RBI Governor announced a rate cut of 0.25 basis points, thereby shifting the rate from 6% to 5.75%. Who is going to benefit from the same ? Let’s do Economics! Like, Share & Subscribe to Areesha Fatma on YouTube!
Areesha Fatma
(M.Sc. Economics, NMIMS – Mumbai 2018-20)

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on LinkedIn
ashishtekwani1 Equity Research & Valuation

Low Risk Anomaly: Does it work?

I remember my first introduction to finance. ‘Higher the risk, higher the rewards’ were the exact words uttered by the professor as the young minds were trying to contemplate the entirety of it. One brief explanation and all of us were satisfied with the answer. ‘If you want to move upward/earn high in life, you have to take risks’. Time and again we’ve heard versions of these words (if not the exact same thing) being thrown on us. These words then go on to shape students’ brains and most of the decisions that we take in our lives. Calculated risks are what they call it and that’s because taking unnecessary risks don’t make sense at all. Just like falling down a mountain is a way of descending but isn’t always a great choice. You may get to the destination faster but at a huge cost of life. Likewise, you can take a smooth road down the mountain which may take more time but it’ll get you there safe & sound.

Although not entirely false, sometimes it is better to not take risks. This behaviour is explained in behavioural finance by the concept of Low-risk anomaly. The concept takes the high risk/high return concept and dumps it in the garbage. Okay not so dramatically, but what it does say and in most cases, prove, is that even with low risk, one can achieve high returns or better, even generate alpha over high-risk stocks. This just undermines the whole CAPM theory. A number of studies in the field have shown that this strategy has worked in most of the developed economies and so this strategy has caught the eyes of investors everywhere.

Seeing its popularity grow in the US, NSE even launched a Nifty Low Volatility (LV) 50 index on November 19, 2012, comprising 50 of the least volatile stocks out of the top 300 companies listed on the NSE. Similarly, launched on July 08 2016 came the Nifty100 LV 30 consisting 30 of the top 100 least volatile stocks. Along with it NSE also launched the Nifty High Beta 50 index with just the opposite outlook but with the same expectations.  Since these indices have been launched recently, the 5 and the 10 year returns calculated below have been back-tested to get the annualised returns.

Source

A look at the 10-year return of both these indices and comparing them with the benchmark NIFTY 50 will give some pretty disappointing results for high-risk takers. Forget high returns, the Nifty High beta 50 didn’t even give positive returns to its investors while the Nifty LV 50 beat the benchmark with comfortable margins. Both the Nifty100 LV 30 and Nifty LV 50 have had similar returns 

Five year returns tell us the same story with the high beta index still not giving any returns at all. A quick glance at the graph will tell us how similarly both the LV indices move over a long term horizon.

The three-year returns tell us a different story wherein our LV indices haven’t able to beat the index. Some good news for the high beta 50 index but still, returns are in single digits while nifty has given fantastic returns at 20.7%. Notice how similarly the benchmark index and the LV indices move.

For the last year comparison disappointment continues for the high beta index with the most negative returns at 16.5% while the LV indices manage similar returns at around 5.5%. Benchmark still beats every index with double the returns of its nearest competitors.

It is important to note that all the constituents of Nifty100 LV 30 are overlapping with Nifty LV 50 i.e. all 30 companies in the former are a part of the later index which probably explains the similarity of returns between the two indices. NSE hasn’t cared to explain the reason for introducing LV 30 index as there isn’t much of a difference between the two apart from the number of index constituents. The only real difference to note is that the former chooses from a list of top 100 while the latter chooses from a list of 300 stocks with the highest market cap on NSE.

BSE, too, wanted a piece of the pie and launched its own S&P BSE Low Volatility Index on December 03 2015. The index comprised 30 of the least volatile stocks in the S&P BSE LargeMidCap as measured by Standard deviation. There is no high volatility index to compare it with. Keep in mind returns of both these indices are Total Returns (TR) which basically means that dividends, if any, are reinvested in the index as & when distributed by the company.

Source

Calculations for the BSE LV TR index have been back-tested as the index was launched in 2015 and so the returns are hypothetical. The low-risk strategy has worked in our favour providing comfortable margins over and above the benchmark BSE SENSEX.

Looking at the image below aligns with our previous findings of the LV indices at the NSE. Only 5Y and 10Y returns have beaten the benchmark (remember these returns are hypothetical since the index launched in Dec 2015). The LV index hasn’t actually beaten the benchmark since it launched as seen in the 3Y and the 1Y returns. 28 out of the 30 stocks in the index are the same as NSE LV 50 so there are no surprises here.

From the above findings, we observe that the LV strategy hasn’t really worked for short and medium-term returns but rather for the long term (5+ years). Most of the results are hypothetical since none of the LV indices were launched 10 years ago. Thus, it is only to be seen in the years to come whether the indices will hold up to the expectation resulted from success around the world or we’ll see another case of a gap between expectation and reality.

Disclaimer: This is not to be considered financial advice in any manner. Do your research before investing in any of the mentioned assets. Our work is limited to educating the readers regarding the same. I just wanted to check the degree to which the concept of low-risk anomaly works.

Author
Ashish Tekwani
Forerunner- Finvert
(M.Sc. Finance, NMIMS – Mumbai 2018-20)

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finvert Personal Finance, Wealth Management

Find out how much return your investment should give to retire at your desired age in just 2 mins

The other day I received an SMS saying invest Rs. 5,000 every month till the age of 60 and get Rs. 30,00,000 lump sum and Rs. 25,000 every month post the age of 60. I am sure every one of us is bombarded with these kinds of messages every other day. There are several online calculators available to check how much you should invest now to get the desired amount at the age of retirement. But what if you don’t have that much amount to invest in? Also, do you know much return your current investment should earn to generate a corpus for your retirement?  To be honest, I didn’t know so I guess we are sailing on the same boat.

So without wasting any time, let’s see how can you use our tool to know the Return on Investment (RoI) required on your current investment to generate a corpus for your retirement in just 3 steps. Download the sheet from here.

What are the objectives of this sheet? 

The whole purpose to build this sheet is to tell you how much return your investment should earn so that you can generate the desired corpus for your retirement. 

What are the questions will be answered by this sheet?

You will know how much RoI needs to be earned on your investment. You will also know the amount you require to retire with. It also calculates your per annum post-retirement expense.

For illustration purposes let us assume there’s someone called Mr. X. He is 25 years old. He wants to retire at the age of 60 and expects to live till the age of 85. His current salary is Rs. 95,000 per month.

Follow the below steps to get your questions answered:

Step 1: Enter your personal details

Here, you are required to enter your current age, age at which you want to retire and age till which you are expected to be alive. Please note, this sheet is designed for a person who is more than or equal to 25 years old and expected to live till the age of 99.

Step 2: Enter your per month income and expense

In this step, you are required to enter your current per month salary. Expected every year increment in salary and bifurcation of a monthly expense. Please note: It is required that saving as a percentage of income to be more than or equal to 15% (Otherwise person either has to increase his salary or reduce his expense)

Step 3: The easiest step among all

One only has to press submit the inputs enter by one.

The output of the sheet:

The Output indicates how much person has invested till retirement and what RoI he should target on his investment. If a person manages to get the RoI calculated by this sheet, he can achieve his corpus by the time he retires. ( Basically, in this case, Mr. X has invested Rs. 1.44 Cr. till 60 years and he has managed to get RoI of 12.44% on his investment. So at the age of 60, he has generated a corpus of Rs. 20.26 Cr. which will take care of his post-retirement expense.)

This graph indicates how generated corpus will be depleted over a period of time
This graph indicates the proportion you have invested and corpus generated by your investment with RoI calculated by the sheet

So those who are interested to know the math behind this, here we go!

Following are the few assumptions made by me while preparing the sheet. Please refer the same.

Let’s look at the Expense tab:

Expense sheet indicates how your expense will grow over a period of time. To be on the safer side I have considered 13 months as annum. I have also considered growth rates of each expense heads will remain the same for a decade and will be revised by 0.5% compounded annually (Can be edited as per your requirement). 

Salary and investment tab:

We know our annual salary and annual expense. Annual saving is just a difference between income and expense. I have kept 5% (editable input) aside as an emergency fund which will be kept aside in savings account. Available per month funds to invest is remaining funds in hand after the emergency fund is kept aside. Now, Corpus generated is a sum of funds in hand and money parked in a savings account. (Note: Funds in hand should fetch min. RoI as shown in the output box)

Corpus tab:

Corpus sheet indicates post-retirement annual expense and how that corpus will be depleted over a period of time to cover your expense. Here I have considered the generated corpus will fetch 3% post-tax return on the corpus (Pre TAX savings return is 4% -editable input).

Hope this article has helped you to understand your target RoI on current investment and required corpus to retire on desire age. Let me know topics you would like me to cover in next post in the comment section below.

Author
Kartik Tripathi
Forerunner- Finvert
(M.Sc. Finance, NMIMS – Mumbai 2018-20)

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finvert Equity Research & Valuation

NSEL Scam

National Spot Exchange Limited (NSEL), the first Electronic Commodity spot exchange of India, was incorporated in May 2005. NSEL was a subsidiary of 63 moons technologies limited, then known as Financial Technologies India Limited (FTIL) which was founded by Jignesh Shah.

The then Prime Minister’s vision to create a single market across the country for both manufactured and agricultural produce was the reason for NSEL to be conceived.

NSEL commenced its operations in October 2008. Its operations included providing an electronic platform to undertake spot trading of commodities. The then Managing Director of NSEL, Anjani Sinha announced that the NSEL had launched gold, mini gold, silver and cotton contracts, and more commodities were to launched in every following week.

The case came into light when NSEL made a payment default on the orders of the Forwards Market Commission (FMC) to stop launching any fresh contracts. This led the Exchange to abruptly shut down in July 2013.

According to the rules of FMC, the ‘SPOT’ contracts needed to be settled within 11 days. In other words, the entire transaction including delivery of the commodities as well as transfer of money should be settled in 11 days. Thereby, keeping the transaction as ‘Spot’ and not a ‘Forward Contract’.

What exactly happened?

NSEL supposed to make just T+2 contracts which were spot in nature. But NSEL did not abide by the guidelines. They designed multiple contracts such as T+25 or T+36 contracts. These contracts were forward contracts and NSEL was not authorised to make such contracts. But they did and no one stopped them.

NSEL made paired contracts and termed them as Arbitrage contracts. Investors assumed the arbitrage to be guaranteed as NSEL as an exchange stood guarantee. The brokers sold such arbitrage contracts to the customers where they could Buy the T+2 contracts and sell the T+25 contracts.

A long term contract usually has a higher price as compared to a short term contract. Thus the T+25 days contract was priced higher than the T+2 contracts. Thus the pattern of contract for the customers was that they purchased the T+2 contracts and sold the T+25 contracts. Now on the second day, they took the delivery of the commodities and stored them in the NSEL warehouse. Further on the 25th day they provided delivery of those commodities to whom they had sold the T+25 contracts. The price difference produced almost 15-18% net return to the investor after deducting storage charges, VAT, etc.

This went on for two years resulting in NSEL to generate high revenues. The number of customers to escalate to around 15000, who put in at least INR 2 lakhs, in order to earn higher returns.

Now the issue that arose was that these contracts were always executed in pairs. None of the investor was allowed to take just one side of the contract i.e. either purchase or sell. The brokers reported to have sold the pair contracts in the format of purchase on the near side while sell on the far side.

What stopped them?

Exemption was provided to spot exchanges like NSEL and NCDEX by the Forwards Market commission (FMC), for one day carry forward facility. Although, the day limit was not specified in the law, the rule stated that the contract should not surpass the 11 day trade settlement.

The Ministry of Corporate Affairs issued a show cause notice dated April 27, 2012, to NSEL for certain clarifications regarding the trades. Further on the orders on the Department of Consumer Affairs (DCA), NSEL suspended trading in all but its E-Series contracts as on 31st July 2013. NSEL would not launch any new contracts and the existing contracts were needed to be settled on the due date.

As seen earlier, there were investors who had purchased commodities on the T+2 contracts. These investors expected that after 25 days their sell contract would actuate and they would be paid back money from the sell contract.

According to Anjani Sinha, the MD, there were 40 live contracts out of the 86 contracts they launched in various commodities which had settlement period of over 11 days.

This resulted in the INR 5600 crore settlement crises in July 2013.

In August the FMC ordered Financial Technologies India Limited to appoint a reputed Forensic auditor firm to establish the creditability of the Books of accounts authenticate the commodity stock it had in the warehouses with the records. It was also in news that FTIL in a draft audit report suggested system and process improvements in some of NSEL’s departments.

Choksi and Choksi was the audit firm who was provided with the assignment of NSEL. In the audit report, they had provided a clean chit regarding the E-series contracts on NSEL. The FMC gave a No Objection Certificate for the E-Series settlement. Thus 40,000 genuine claimants of E-Series received benefit.

The audit report which came down heavily on NSEL stated that the NSEL had no mechanism to monitor the activities of the custodians in respect of quality, quantity or verification of underlying stock except for the two audit conducted in the past in December 2012 and March 2013. In many cases the collateral was just inadequate or just missing leading to the settlement crises.

In October 2013, Amit Mukherjee (Former Vice- President, Business development NSEL) was the first to be arrested by the Economic Offenses Wing (EOW) of Mumbai Police. Further arrests were of Jay Bahukhandi (Former Assistant Vice President, NSEL) and Anjani Sinha (Former Chief executive of NSEL).

Who were actually opposite the investors?

Opposite to the investors i.e. who were supposed to sell the contracts of T+2 and purchase the contracts of T+25 were revealed quite later. In reality they were just 24 who used the paired contracts pattern to raise money easily.

One of these 24 was Nilesh Patel, the Managing Director of NK Proteins Limited, supposedly the first borrower in the NSEL Scam. He was arrested by EOW in October but subsequently got out on bail.  Raised funds under the garb of the contract without depositing any collateral in the warehouses. The amount earned by NK Proteins due to the above contracts were utilised for expansion purposes and a castor oil joint venture with Adani group. It had deployed around 333 crore of the investor’s money it earned into the joint venture contract.

Some of the other defaulted borrowers who were also arrested include – Arun Sharma (Lotus Refineries), Surinder Gupta (PD Agro), Indrajit Namdhari (Namdhari Foods), Kailash Aggarwal (Ark Imports), Narayanam Nageswara Rao (NCS Sugar), B V H Prasad (Juggernaut Projects), Varun Gupta (Vimladevi Agrotech), Chandra Mohan Singhal (Vimladevi Agrotech), Ghantakameshwar Rao (Spin-cot Textiles)and Prashant Boorugu (Metcore Steel & Alloys).

What about the Brokers?

In November 2016, on the orders of the Ministry of Corporate Affairs, the Serious Fraud Investigation Office (SFIO) conducted investigations for the alleged irregularities in the NSEL Scam. SFIO is a multidisciplinary organisation which is involved in detecting white collar crimes. It recently submitted a report to the government stating that all the 148 member brokers of NSEL had earned ‘Unlawful Gains’ while their clients had to suffer ‘illegal Losses’.

SFIO wanted the Securities and exchange Board of India (SEBI) to put the commodity broker houses or their promoters or their directors through the ‘Fiat and Proper test’. SFIO also suggested the government to begin the ‘Winding Up Process’ of the 148 broker firms as they had been conducting business in a fraudulent manner.

The brokers had been accused for indulging in manipulation of client KYCs large scale modification of client codes on multiple deals as well as infusion of unaccounted money via their NBFCs. They made false representations of assured and risk free returns to clients.

Accused of the alleged role in the NSEL Scam of about INR 5600 crores, Criminal proceedings were initiated by SEBI against about 300 brokers.

Show cause notices were dispensed by SEBI to top 5 broker firms namely Anand Rathi commodities, India Infoline Commodities (IIFL), Geofin Comtrade, Motilal Oswal Commodities and Phiilip Commodities. The charges issued were mis-selling of NSEL contracts as they promised assured returns without ensuring delivery. Further they were also issued second show cause notices when SEBI was not satisfied with their explanations offered on the mis-selling allegation. SEBI said that these broker firms seemed to have a close association with the paired contracts and NSEL as they facilitated the paired transactions for their clients.

Nearly two years after it issued the show cause notices, Market regulator SEBI, Motilal Oswal and IIFL Commodities as ‘Not Fit and Proper’ and they shall cease to act as a commodity derivatives broker. In the orders uploaded by SEBI on its website, Motilal Oswal and IIFL had a close connotation with NSEL and allowed themselves to become a part of the network.

“Thus…the notice is not a fit and proper person to be granted registration to operate as a commodity derivatives broker,”

said the SEBI order.

SEBI also ordered that the clients of Motilal Oswal and IIFL Commodities need to withdraw or transfer the securities held by them with the broker within 45 days at no additional cost.

Motilal Oswal in a statement said that they too were the victim of the scam like thousands of other investors. They also claimed to have its own group investment of around INR 57.8 crores due from NSEL on the date of default. They would explore legal options as they were aggrieved by the order and also the order would not have any impact on the overall business of the company.

India Infoline Commodities Limited did not have any outstanding dues from NSEL, but would also explore legal options being aggrieved by the order.

In case of IIFL only 0.06% of its total business is in commodity trading and a 326 crore exposure to NSEL. While Motilal Oswal had a 263 crore exposure to NSEL.

Both the companies are likely to appeal the directions in the Securities Appellate Tribunal (SAT), according to the officials of the two firms.

The next to be declared as ‘Not Fit and Proper’ were Geofin Comtrade (Formerly known as Geojit Comtrade) and Anand Rathi Commodities (ARCL) by SEBI on 26th February 2019.

According to a report, Geofin Comtrade had an exposure of about INR 290 crores while ARCL had an exposure of INR 591 crores against NSEL.

Phillip Commodities India was the latest and fifth broker that SEBI declared as ‘Not Fit and Proper’.

The clients of Phillip Commodities, Geofin Comtrade and Anand rathi Commodities were given the same order to withdraw their funds or securities within 45 days. If they failed to do so the broker would transfer it within 30 days thereafter.

SEBI said that even though the broker firms were yet to be established in court, it is justified to keep a person in doubtful reputation out of the market rather than having the risk of market to get affected.

Fear looms around the other broker firms named by various investigating agencies as similar actions would be taken for their alleged involvement in   the NSEL Scam.

Author
Vhabiz Lala
Volunteer – Equity Research & Valuation (M.Sc. Finance, NMIMS – Mumbai. Batch 2018-20)

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