Is RLLR the long lost saviour?

Before we get into the topic lets know what repo rate is. It is the rate at which the central bank of a country (RBI) lends money to the commercial banks in event of any shortfall of funds.

Now people are excited about the new repo linked lending rate (RLLR) which has come into the market but let’s just roll back a few months back to December 2018. RBI in its fifth bi-monthly monetary policy review on December 5th made a big announcement (by N.S. Vishwanathan – Deputy Governor) that many bank customers were waiting for and that retailed loans will be linked to external benchmarks instead of various internal benchmarks produced by banks.RBI had instructed the banks to start the process the linking the new repo rates from 1st April 2019.

By adopting a single benchmark, the home loans for example which are linked to the marginal cost of funds will now be linked to the repo rates. This makes the banks bound to revise the rates of the home loans instantly as and when there is a change in the RBI repo rate. These changes are welcomed by the customers because it has been long sought out as RBI reduced the repo rates to control the inflation but the benefit never reaches the consumers but now because of this, the consumers will get the benefit of at least some lower interest rate to be paid. The benefit of Repo-rate linked home loan scheme is that it is transparent compared to existing loans linked to marginal-cost-of-fund based lending rate (MCLR). The interest rates on loans will change upwards or downwards in line with the movement of the repo rate announced by RBI.

The RBI had stated that banks should benchmark the rates to either the RBI policy repo rate or Government of India’s 91 or 182 days Treasury bill yields as developed by the Financial Benchmarks India Private Ltd (FBIL) or any other external benchmark developed by the FBIL but still several banks opposed the decision of linking lending rates to an external benchmark, indicating that their cost of funds was not linked to those external benchmarks and delayed the implementation indefinitely.

By March 2019 the only bank to realize this directive was SBI, the largest public sector bank but it too took some time and made it effective from July 2019. Following the same footsteps, Bank of Baroda too introduced RLLR home loan scheme from 12th August 2019 and Syndicate Bank. Allahabad Bank, Canara Bank & Union Bank of India and other banks will announce their plans to launch RLLR soon.

To be eligible for the SBI repo rate linked home loan scheme, the borrower should have a minimum annual income of Rs 6 lakhs and tenure of the loan is up to 33 years. In the case of under-construction projects, the maximum moratorium period up to two years is offered over and above maximum loan tenor of 33 years. So, in such cases, the total loan tenure cannot exceed 35 years.

In this home loan scheme, the borrower needs to repay a minimum of 3 per cent of the principal loan amount every year in equated monthly instalments. If you take a home loan of Rs 50 lakhs, you need to repay a minimum of Rs 1.50 lakhs as principal plus the interest cost every year.

The interest rates in this scheme are not directly linked with the repo rate figure announced by the RBI. The interest on the loan is 2.25% points more than the repo rate. On July 1, the repo rate was 5.75 per cent, so the repo-linked lending rate is 8 per cent. But, the repo-linked lending rate may change effectively from September 1 as we had a repo rate cut of 35 basis points (bps) announced by the RBI in August.

Currently, RLLR is at 8 per cent. Banks will maintain a spread over and above RLLR of 40 to 55 bps. So, the effective rate for home loans up to Rs. 75 lakhs range from 8.4 per cent to 8.55 per cent. For home loans above Rs 75 lakhs, the effective rate is 8.95 per cent to 9.10 per cent (i.e. spread of 95 to 110 bps on RLLR of 8 per cent). With effect from 10th August, the home loan rates linked to MCLR would be 8.6 per cent to 8.85 per cent at SBI, which is more than RLLR.

Similarly, for Bank of Baroda MCLR linked home loan rate starts at 8.45 per cent, while the repo-linked rate starts at 8.35 per cent. At present its 5 bps cheaper than SBI’s repo-linked home loan scheme. Repo rate linked home loan scheme will be beneficial to borrowers with immediate savings when the interest rate goes down.” For instance, with a further 50 bps rate cut as expected in the next year, there will be further savings for borrowers on interest.

Let aside the interest rates alone, if you choose to switch for an RLLR home loan there are more added costs to be noticed, for instance, SBI levy’s transfer and processing charges of 0.35% on the amount of loan plus GST. The minimum fees shall be Rs 2,000 and the maximum can go up to Rs 10,000 plus GST. These charges may vary from bank to bank

One should wait a bit longer as other banks are also coming up with this scheme so one can choose a home loan from the bank of his choice and preference but also take into consideration the charges and extra paperwork, hassle and time to keep a tab on both accounts one home loan and other accounts (savings, joint etc). One has to take into consideration the fact that if you choose another bank apart from your savings bank look at the spread (margin) the bank is charging over and above RLLR. Check the impact of the spread between RLLR and the final rate of interest offered. Stick to the ones which offer the least spread as it reflects RBI’s repo rate policy correctly.

It’s also to be noted that the RLLR is effective from the following month after RBI monetary policy announcement. But, the borrowers also need to be aware and prepared that RBI can increase the repo rate due to the economic factors.

As far as the private banks are concerned; from Axis Bank, Mr Rajiv Anand, executive director for corporate lending said, “It’s not necessary to use only external benchmarks; there are multiple avenues to meet the requirement that the RBI wants us to do… What RBI is essentially looking at is that the rates are being cut and there should be better transmission”. More details on this weren’t revealed whether Axis bank is planning to offer RLLR but he did mention “Axis Bank’s asset-liability committee will take a call on the same.”

Hence, this scheme is to target customers & borrowers who reside in Tier 1 or Tier 2 cities and having an annual steady income of Rs.6 lakh. So before switching your home loan take note of the above points as to charges, the spread between RLLR and final interest rate and also if the central bank may increase the repo rate due to economic scenario.

Author
Rishi Khanna
Team Member- Equity Research & Valuation
(MSc Finance, NMIMS Mumbai. Batch 2019-21)

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EFFECTIVE EXCHANGE RATES

EFFECTIVE EXCHANGE RATE (EER)

The EFFECTIVE EXCHANGE RATE (EER) is an Index which describes the strength of a currency relative to a basket of other currencies. This rate measures the value of domestic currency against the weighted value of a basket of foreign currencies. The weights used to derive the rates, reflect the foreign countries’ share in the trade of the domestic country. Thus the EER is used to compare the domestic country’s performance against its most important trading partners. The Effective Exchange Rates are always derived as an Index i.e. out of 100.

The EER is used as an indicator to comprehend the domestic currency’s international competitiveness in terms of a group of foreign exchange rates which cannot be understood by just examining the individual exchange rates of the domestic currency and other foreign currencies.

EER is used in studies in economics as well as policy analysis for international trade. Foreign Exchange Traders who engage in currency arbitrage make use of EERs. It is used to measure the equilibrium value of the domestic country’s currency, to identify the underlying factors of the domestic country’s trade flow and analysing the impact of factors such as competition and technological changes on the country and also the trade weighted index.

NOMINAL EFFECTIVE EXCHANGE RATE (NEER):

The Nominal Effective Exchange Rate (NEER) is calculated as an unadjusted weighted average rate at which the domestic country’s currency exchanges for a multiple foreign currency basket. The NEER is an indicator of domestic country’s international competitiveness in terms of the Foreign Exchange Market.

REAL EFFECTIVE EXCHANGE RATE (REER):

The Real Effective Exchange Rate (REER) is the NEER which is adjusted to relative movements in any national price or cost indicator of the domestic country and the foreign countries. REER relates to the Purchasing Power Parity (PPP) Hypothesis.

While the fluctuation in NEER accounts only for the variation in the nominal exchange rate of the domestic currency against basket of foreign currencies, the REER also accounts for the variations in the inflation differential in relation to the foreign countries.

CALCULATION OF THE EFFECTIVE EXCHANGE RATES BY THE RESERVE BANK OF INDIA (RBI)

The Reserve Bank of India (RBI)    derives the Effective Exchange Rates (EER) in Nominal and Real Terms. These rates are calculated by the institution on a monthly and annual basis. The RBI calculates two Indices – Broad and Narrow.

  1. Narrow Index – The Narrow Index is calculated taking 6 major Trading Partner countries of India into consideration. The countries are USA, UK, China, Japan, Hong Kong, and EURO Area. The EURO Zone comprised of 12 countries in 2004-05 which further increased to inclusion of 19 countries. These 6 currencies together accounted for around 40% of India’s International Bilateral Trade in the year 2004-05. China and Hong Kong together accounted for 9% in 2004-05.

  2. Broad Index – The Broad Index is calculated taking 36 Trading Partners of India into consideration. They are Argentina, Australia, Bangladesh, Brazil, Canada, Taiwan, Egypt, Indonesia, Iran, Israel, Kenya, Korea, Kuwait, Malaysia, Mexico, Vietnam, Nigeria, Pakistan, Philippines, Qatar, Russia, Saudi Arabia, Singapore, South Africa, Sri Lanka, Sweden, Switzerland, Thailand, Turkey, UAE, China, Hong Kong, Euro, Japan, UK, USA. The Euro Zone comprised of 5 countries which further increased to inclusion of 12 countries. These 36 regions accounted for nearly 61% of India’s Foreign Trade and 67% of India’s Exports in the base year i.e. 2004-05.

FORMULA

  • Nominal Effective Exchange Rate (NEER)
  • Real Effective Exchange Rate (REER)

TERMS OF THE FORMULA

e

Exchange rate of Indian rupee against a numeraire

ei

Exchange rate of Foreign Currency ‘i’ against the numeraire

(e/ei)

Exchange rates

Numeraire

IMF’s Special Drawing Rights (SDRs) in indexed form.

P

Price index of India (CPI is used as proxy prices)

Pi 

Price index for trade partner country ‘i’ (CPI is used as proxy prices)

(P/Pi)

Relative prices (Or called as Deflator)

n

Number of countries covered in the Index other than Home country

wi

Normalised, Geometric average of India’s Bilateral Trade (Exports + Imports) of preceding 3 years

CERTAIN MAJOR DEVELOPMENTS WHICH HAVE TAKEN PLACE IN NEER AND REER BY RBI

  • With effect from January 1, 2002, common currency EURO replaced the existing national currencies of the EUROZONE. This is due to the introduction of EURO – Notes and Coins.
  • The European Commission (Eurostat) introduced the Harmonised Consumer Price index (i.e. HICP) which is now used in place of the individual consumer price indices.
  • There was a significant shift in Trade Relations of India across different countries. Thus, a change was also made in the currency basket and trade weights. These changes were mainly because of the developing and emerging economies.
  • During the year 2002, the Base Year for the Wholesale Price Index (WPI) used for the calculations was changed to 1993-94. This brought a change in the Base Year for the 36 Currency Basket Index.
  • With effect from November 2005, the 6 Currency Index replaced the 5 Currency Index.
  • With the launch of the new Consumer Price Index (CPI), REER based on CPI has been calculated. The base year for the index is chosen to be 2004-05, this is to make the CPI based REER consistent to the WPI based REER.
  • Although from January 2011, the New CPI-C (i.e. Consumer Price Index – Combined) whose Base Year is 2010, is available, a back casted index CPI-IW (Consumer Price Index- Industrial Workers), since January 2001, is used for calculations.

CENTRAL BANKS AND INSTITUTIONS WHICH DERIVE THE EFFECTIVE EXCHANGE RATES

  • Central Bank of each Country derives the Effective Exchange Rates for their respective Domestic Currencies.
  • Here are some Central Banks and Institutions which calculate the Effective Exchange Rates (EER).

Institution

Reserve Bank of India (RBI)

Bank for International Settlements (BIS)

Organisation for Economic Co-operation and Development (OECD)

European Central Bank (ECB)

International Monetary Fund (IMF)

Federal Reserve Board

Bank of England (BOE)

World Bank

Currencies

Indian Rupee

52 Currencies

43 Currencies

Mainly EURO and certain other currencies

184 Currencies

United States Dollar

Sterling and 10 Non-Sterling Countries

94 Currencies

 

Calculate Indian Rupee Effective Exchange Rates

Do not calculate Indian Rupee Effective Exchange Rates

Base Year / Reference Year

2004-05

2010

2015

1999

2010

2006

1990

2010

Basket Size

Narrow- 6 Currencies; Broad- 36 Currencies

Narrow- 27 Currencies; Broad- 52 Currencies

46 Currency Basket

EER-18, EER-19 and EER-38

184 Currency Basket

Advanced Foreign Economies – 7 Currencies; Emerging Market Economies- 19; Broad- 26 Currencies

Narrow- 15 Currencies; Broad- 24 Currencies

 

Trade Weights

Bilateral (i.e. Import + Export)

Double Weighting

Double Weighting

Double Weighting

Double Weighting

Bilateral (i.e. Import + Export)

Double Weighting

Double Weighting

Base Period for Weights

2004-05

Updated every 3 years & Chain-Linked

Updated Annually & Chain-Linked

Updated Discretely & Fixed

Updated Discretely & Fixed

Updated Annually & Chain-Linked

Updated Annually & Chain-Linked

Updated Discretely & Fixed

Deflator

Consumer Price Index

Consumer Price Index

Consumer Price Index

Consumer Price Index, Producer Price Index, Unit Labour Cost in manufacturing (ULCM), Unit Labour Cost in total economy (ULCT) and GDP deflator

Consumer Prices is the deflator used for most of the countries. For certain countries even Unit Labour Cost and Normalised Unit Labour Costs

Consumer Price Index

Consumer Price Index

Unit Labour Cost in manufacturing

  • The above Graph shows a comparison of the Real Effective Exchange Rate for the Indian Rupee calculated by the different Institutions RBI, BIS, OECD and ECB on a monthly basis.
  • The indices are calculated by shifting the base year to April 2010 using the splicing technique to make the indices of the different institutions comparable.
  • From the graph it can be observed that the movement of all the indices is in the same direction.

REVISIONS TO THE EFFECTIVE EXCHANGE RATES

The following revisions have been proposed for the Narrow Index i.e. 6 Currency Basket Effective Exchange Rate which is calculated by RBI.

NARROW INDEX

 

Existing

Revised

Index

6 Currency

8 Currency – Advanced Countries

8 Currency – Important Trading Partners

Notation

6C

8CA

8TP

View

 

Similar to the Advanced Foreign Economy Basket of Federal Reserve Board.

Incorporation of the Major Trading Partners of India of the past 10 years

Basket Size

6 Currencies

8 Currencies

8 Currencies

Countries Included

USA, UK, China, Japan, Hong Kong, Euro Area

USA, Australia, Canada, Hong Kong, Sweden, Switzerland, UK, Euro Area

USA, UK, United Arab Emirates, China, Hong Kong, Saudi Arabia, Singapore, Euro Area

Total Trade Weights of the Basket for the year 2010-11

39%

20%

49%

Base Year

2004-05

2010-11

2010-11

Deflator

Consumer Price Index (2004-05)

Consumer Price Index (2010)

Consumer Price Index (2010)

Methodology

Fixed Base

Chain-Linked

Chain-Linked

  • The above graph shows a comparison of the Narrow Basket REERs with the USD/INR Exchange Rate.
  • The Effective Exchange Rates for 6 Currency Basket, 8 Currency Basket for Advanced Countries and 8 Currency Basket for Important Trading Partner Countries are plotted on the primary axis with Base Year 2010, while the USD/INR Exchange Rate is plotted on the secondary axis.
  • The existing 6 Currency Basket REERs with 2004-05 as original Base Year have the Base Year shifted to 2010 using splicing method in order to make the indices comparable with the revised indices.
  • From the graph it can be observed that the existing and revised REERs are having a similar trend and are moving in the same direction.
  • The Effective Exchange Rates and the Exchange Rates share an Inverse Relationship.
  • This means that when REER appreciates (increases in value), the Indian Rupee strengthens i.e. it appreciates. [ (Foreign Currency / Indian Rupee) drops in value]
  • On the other hand when REER depreciates (decreases in value), the Indian Rupee weakens i.e. it depreciates. [ (Foreign Currency / Indian Rupee) increases in value]
Author
Vhabiz Lala
Volunteer – Equity Research & Valuation (M.Sc. Finance, NMIMS – Mumbai. Batch 2018-20)

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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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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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