Saturday, September 13, 2014

Grade inflation in Ivy League colleges

Grades and grade point averages at Ivy League colleges mean less than they did before, the Economist reports :

In 1950, Mr Rojstaczer estimates, Harvard’s average grade was a C-plus. An article from 2013 in the Harvard Crimson, a student newspaper, revealed that the median grade had soared to A-minus: the most commonly awarded grade is an A........Universities pump up grades because many students like it. Administrators claim that tough grading leads to rivalry and stress for students. But if that is true, why have grades at all? Brilliant students complain that, thanks to grade inflation, little distinguishes them from their so-so classmates. Employers agree. When so many students get As, it is hard to figure out who is clever and who is not.
An earlier piece in the journal takes a rigorous look at whether grade inflation is 'inflation' at all:

.... “inflation” in grades ought to mean that work of a given standard would be awarded an ever higher grade, year by year. The highest permissible grade would therefore have to keep rising: A this year, A-star the next, A-double-star and so forth thereafter, in a ceaseless procession of non-improvement. Because in reality the top grade is fixed, the process is not so much grade inflation as grade compression. This is worse: a distortion in relative prices is more confusing than a uniform upward drift. Grade compression squeezes information out of the system. At the limit, when all Harvard's students get As all the time, the university's grades will yield no information whatsoever. 

Faculty settle for higher grades for students because it makes their job easier, it flatters students and students may return the flattery by giving faculty good grades in their feedback. But grade inflation does interfere the 'signalling' that university education is supposed to be provide employers. One answer could be that employers will find their own ways to distinguish amongst students by using group discussions, case analyses, interviews - and recommendation letters from professors. But the last, as the Economist points out, could mean more work for profs. Better that they devote more energy to having a suitable distribution of grades.

Wednesday, September 10, 2014

Outsourcing whistle blowers- and boards?

Sebi's modified Clause 49 of the listing agreement, which takes effect from October 1, provides for the creation of a whistle-blower mechanism in companies. There are many issues that employees face in blowing the whistle unethical actions or violations of the law. Is it safe to report such things? If the MD is involved, whom do they report to? Will the complaint be acted upon?

A report in BS mentions the possibility of outsourcing whistle-blowing services. Then, perhaps, employees will face safer. Maybe. But who will the third party report to? The Compliance Officer, the MD or the Board? And who hires the third party? If the MD is unhappy with a hyper-active third party, what prevents him from terminating or not renewing the contract?

We are assuming here that all violations take place without the knowledge or consent of the MD. This may not be true in all cases. And if the MD himself is reported about or even a board member, should the third party not be bringing such cases to the attention of the regulator? In short, outsourcing of whistle-blowing needs to be carefully thought through with specifications of which matter should be taken to which authority.

In the Economist, Schumpeter raises the possibility of outsourcing the board itself.  The company would hire a professional services firm to provide board services. The professional firm would find the best directors. This eliminates the problem of self-dealing in companies, namely, management selecting board members convenient to itself. Competition among service providers of this kind would ensure that companies get the best service at competitive rates.

Sounds attractive but I can see several problems. Who will evaluate the performance of the board? The management, I guess. If management finds the board too inconvenient, it will simply not renew the contract. Secondly, if an outside firm is to provide such services, it may prove expensive relative to a company finding its own board members (although the fee should still be affordable for large companies). Thirdly, conflicts of interest could arise where an outside firm is providing boards to several companies.

If the idea is to distance board selection from the management, it would be simpler to just increase those involved in nominating members. Give large institutional investors, lenders, small investors and employees all the right to nominate one or two members each. Don't leave the selection entirely to management.

Incidentally, for public sector companies, such outsourcing already happens in a way. Board members are selected by the Bureau of Public Enterprises with inputs from the concerned ministries. Management at PSUs does not select board members. But here, it is the government as owner that is using its own agency to select the board. The job is outsourced so far as management is concerned but it is not outsourced where the principal investor is concerned. And the question of paying a commercial fee for board services does not arise.

Tuesday, September 02, 2014

What to do with failed banks?

Governments in the US and Europe have set their faces against bailouts of failed banks following the crisis of 2007- the Dodd FranK Act in the US prohibits such bailouts hereafter. Yet, as an article in the FT asks: what alternatives do we have?

A time tested-alternative, the author points out, was to merge a failed bank with a strong bank. Banks are now finding out that this can be costly for one reason or another. The huge fine that BofA has had to cough up has to do with the problems at Merrill Lynch and Country which it acquired in 2008 and these problems happened before the merger. This is going to deter future acquisitions and mergers because the amount of due diligence will take too long and will be too costly.

The other alternative, getting banks to prepare living wills  that will document an orderly winding up of a bank when it fails, is proving unworkable so far- in the US, the regulators have rejected living wills prepared by US and European banks. It's no use asking for banks to have contingent capital- this will be very costly and it may not suffice.

So, governments will have no recourse against bank failure other than bailouts. The only answer, which I have urged repeatedly, is to ensure that the problem is manageable when it happens and that is to limit bank size as a proportion of GDP. No policy maker or regulator is willing to touch this political hot potato.

Pradhan Mantri Jan Dhan Yojana

The government's financial inclusion has the mighty backing of the PM. The early success in getting  in 1.5 crore accounts on the first day is no small measure to the PM writing directly to bank heads and (I believe) to lakhs of bank officers.

It is also better thought through than some of the earlier schemes. It's not just about creating deposit accounts- that doesn't attract people or make money for the bank. There is a loan product (overdraft of Rs 5000), an accident insurance policy for Rs 1 lakh and a life insurance policy of Rs 30,000, all of which are revenue generating. The public sector system is also better geared up today thanks to the experience it has had with banking correspondents and mobile technology.

There are problems on the ground. An important problem is multiple accounts being created with different banks. This has to be sorted out. Then, there are problems of communication. Many poor have queued up because they have been told that they stand to be paid Rs 1.05 lakh!

My analysis of the potential benefits of the scheme in an article in the Hindu, A big bang reform that may be spot on.

Friday, August 29, 2014

Modi's Great Leap Forward

It's a big bang reform alright but not quite what the reforms brigade has been clamouring for. The government's Jan Dhan Yojana, an ambitious plan for financial inclusion, has the potential to be a game-changer for the banking sector and the economy. It calls to mind Indira Gandhi's much-maligned bank nationalisation move which helped transform India's economic prospects over the decade of the seventies.

Bank nationalisation helped sweep small savings into the financial system and push up the savings rate from 10 per cent at the end of the seventies to over 20 per cent by the beginning of the eighties. That, in turn, caused the investment rate to double and helped lift India's trend rate of economic growth from 3.5 per cent to 5.5 per cent in the eighties. Bank nationalisation had its problems. The achievement on the lending side has not been as impressive as that on the liabilities side: small and marginal farmers and also small firms do not get the credit they need. The expansion of branches and balance sheets undermined viability in the banking system. But these problems could be dealt with over time as the basis for economic growth had been laid.

Jan Dhan Yojana holds out the promise of carrying forward the unfinished agenda of bank nationalisation. Sceptics again say it will add to the existing stresses in the banking system. The banking system will have crores of accounts that are inoperative.The overdraft of Rs5000 per accoun promised, if extended to the 10 crore accounts targeted, will create NPAs of Rs 50,000 crore.Banks may garner deposits but lending will remain an issue.And so on.

Yes, in the short run, there will be issues. Over the long run, however, the potential for transformation is enormous. The new accounts will not be idle for long. Large amounts of cash will flow in through the Direct Benefits Transfer. These could lead to large amounts of floats in the public sector (which is bearing the brunt of the initiative). Overdrafts will not be given overnight to all. Banks will watch the accounts for six months before doing so. Even if we assume that half the accounts get the overdraft and half of the overdrafts turn into NPAs, we are talking of  losses of Rs 12,500 crore over two or three years. That is bearable.

Once large numbers of people are brought into the financial system, banks will find opportunities and ways to lend. What has been the province of micro-finance institutions and Regional Rural Banks will move in a large way into the commercial banks. Banks already have made some headway with banking correspondents. Alliances with mobile operators should enable to them to leverage mobile banking as well. It is conceivable that Jan Dhan Yojana could just the shot in the arm that the public sector banks needed. Let me qualify this by saying that much depends on whether the moves under way in the finance ministry to strengthen both boards and management in the public sector bear fruit.

The goverrnment's initiative does undercut the RBI's attempts to pursue inclusion through new players such as payments banks and small banks. The RBI had taken the view that not much could be expected of the public sector and that private entrepreneurs were needed to infuse life into inclusion.The Modi government clearly has a different view. In a way, the entire locus of financial inclusion as well as bank governance has shifted from the RBI to the finance ministry. That could well be a comment on the present state of relations between the ministry and the RBI.

Above all, by unveiling an initiative that is quite different from what economists have pressed for urgently, Modi has shown his capacity for out-of-the box thinking- and his willingness to be guided by his grassroots understanding of what is required rather than the wisdom of experts.

Tuesday, August 26, 2014

US, ISIS and the "war on terror"

The gruesome killing of US journalist James Foley by ISIS, the Islamic group which has gained control of big swathes of Iraq and Syria, has given impetus to a rethink of what the US should be doing about the outfit. The US has already bombed ISIS targets in Iraq and has commenced surveillance of Isis positions in Syria. Both US and British special forces are said to have commenced the hunt for the killer of Foley, now believed to be a Briton. The US government has commenced a steady drumbeat of propaganda on the threats posed by ISIS, which is now touted as 'beyond anything we have seen so far', with the US media following suit.

This is beginning to seem like a horrible re-run of America's dealings with the Taliban. The US funded the Taliban and various Islamic forces in its proxy war against Soviet occupation of Afghanistan. After 9/11, the US turned on the Taliban and its ally, Al Qaeda. The US has since been fighting the Taliban (both the Afghan and Pak varieties) in Afghanistan as well as the Afghan-Pak border.

So it is with ISIS. The US, at the very least, turned a blind eye to ISIS which first gained importance in the battle to overthrow President Assad of Syria. Other American allies, such as Saudi Arabia, Turkey and Qatar are known to be active supporters and funders of ISIS. Once ISIS crossed into Iraq and threatened the government of Iraq, the US seems to have had a change of heart. However, while attacking the ISIS in Iraq, it has been reluctant to attack it in Syria because that would mean strengthening Assad. (The Syrian government itself is open to support from any country, including the US, in its bitter war against ISIS).

This is changing fast as ISIS looms begin to larger in Iraq and begins to pose a threat to Kurds. The US, which has portrayed the "war on terror" as primarily one against, Al Qaeda, is now well on its way to creating a new demon to take its place, ISIS. A new front is to be opened on the "war on terror". One head of the hydra has been replaced by another. How has this come about?

Patrick Cockburn offers a compelling explanation:
The "war on terror" has failed because it did not target the jihadi movement as a whole and, above all, was not aimed at Saudi Arabia and Pakistan, the two countries that fostered jihadism as a creed and a movement. The US did not do so because these countries were important American allies whom it did not want to offend.

Saudi Arabia is an enormous market for American arms, and the Saudis have cultivated, and on occasion purchased, influential members of the American political establishment. Pakistan is a nuclear power with a population of 180 million and a military with close links to the Pentagon.

Tuesday, August 19, 2014

RBI's restructuring plan

I was on Bloomberg TV India this morning for a discussion on the RBI's restructuring plan, including the proposal to create an office of COO with the rank of Deputy Governor.

The restructuring plan is facing resistance from employee unions. It is the COO proposal, however, that has attracted the most flak in the media and drawn a frosty response from the government of India. Media reports indicate that the proposal was put up to the board of directors of RBI around the time of the budget. The board of directors of RBI does not have the same monitoring authority as a corporate board; the key entity, when it comes to monitoring, is the finance ministry. It is strange that the RBI did not take the ministry into confidence in the matter before listing the item at the board meeting.

At the board meeting, the finance ministry asked that the matter be deferred since their representatives would not be able to attend. At the next board meeting, the finance ministry made it clear that an appointment of the rank of Deputy Governor would require an amendment to the RBI Act and that somebody of that rank could not be appointed by the RBI governor; the appointment would have to go to the Cabinet Committee on Appointments.

That is not the only problem with the COO post. As media reports have pointed out, it signals that the person occupying the post is no 2 in the hierarchy, so that you have on Deputy Governor who is superior in rank to the others. That is not the tradition  at RBI. Moreover, the perception has gained ground that the post is being created into order to accommodate one particular individual. The perception may not be well-founded. But the very fact that it has gained currency is damaging to the RBI.

There is also controversy over the proposal to facilitate lateral entry into RBI. Nothing wrong with lateral entry. But the case must first be made as to what specialist skills are required and at what level. The RBI spends lavishly on training so that people are ready to take up positions that require special skills. If this is not adequate, there would be room for a specialist from outside. But, as I said, this has to be justified.

The RBI has acquired a certain stature and reputation over the years, in part because it is seen to be a meritocratic organisation. It has steered clear of the sort of controversies over appointments that have bedevilled other public institutions. The RBI must be careful to safeguard this hard-won reputation.

Saturday, August 16, 2014

Raghuram Rajan's father was a spy

I have heard RBI governor Raghuram Rajan's father being described as a 'diplomat' and I have found it rather intriguing because it has never been said that his father was an IFS officer or ambassador. Well, the mystery, at least for me, is now cleared up with Rajan confirming, in an interview with FT,  that his father was an officer in India's intelligence service. ( It appears to be RAW). Rajan is quick to clarify that his father was no James Bond:
It is a topic Rajan discusses rarely, so I decide to be blunt. While growing up, did he know that his father was a spy? He didn’t, he replies, finding out only later. “He used to tell me that John le CarrĂ© got it largely right,” he says of his father’s profession. “You’re just like another bureaucrat, except you’re doing things that other people would find very, very interesting. But it’s not that you’re walking around with a Walther PPK and lovely women . . .  My mother would not have appreciated that.
For the record, Rajan denied any ambition to occupy political office, saying that he plans to get back to academics and focus on India-related research:
My intent has been, and is, to go back to academia,” he says, sketching out a future research agenda on the interplay of markets and democracy, with a particular focus on India itself. The question of what type of country India will become interests him in particular, especially given its socialist heritage and often-ambivalent relationship to the free market. “In India, we say one thing, and we do something else,” he says as we finish our coffee, and place our napkins to one side. “So what are we trying to do as a country? Figuring that out, I think, would also be fun.”