Thursday, March 25, 2010

Is SBI's foray into general Insurance wise?

A few days back, I criticised LIC's intention to get into banking.

Now comes a report that, to top its foray into Life Insurance, SBI intends to enter General Insurance business before end of April, 2010. They have already been recruiting managers for this venture for the last 10 months, and are almost ready to launch.

The same logic and criticism applies to SBI's joint venture with Insurance Australia Group too. It is bad enough that they have ventured into Life Insurance. This makes it worse, in my view. Why?

Banking and Insurance are the two most risky businesses worldwide, and involve two completely different challenges. Insurance companies have to deal wisely with a surfeit of liquidity (usually) and banks have to constantly manage threat of liquidity shortfalls. Combining both reduces the strength of the combination to overcome threats and severe demands on liquidity that affect both industries. The recent global recession is an example of a threat to both industries simultaneously. Enough financial pundits (Nouriel Roubini, Nassim Taleb, et al) have predicted that this could happen again, and in our lifetimes.

We in India escaped the impact of the global crash because of three major factors: 
  1. Our financial institutions were just not allowed to invest in derivative securities and there was consequently hardly any significant secondary market trading in debt securities;
  2. Our banks had a very significant liquidity padding (SLR/CRR) that was nearly absent in the first world; and 
  3. Our banks were not major players in any part of the banking business, and our insurance players were similarly almost absent in the banking sector.
Now the situation is set to change -- in the name of development and liberalisation. 

Banks are getting into insurance, and insurance companies are getting into banking. This in my view magnifies the riskiness of both businesses, and does not diminish it. I am not even talking of conflict of interest here, which can also rise considerably.

There is constant clamour for reduction in SLR/CRR, which, in my view is nothing but an operating profit cushion against the banking industry's inability to extract risk-adjusted returns on their lending and assurance intermediation (L/Cs, Bank Guarantees, etc) businesses, which the RBI has, in its wisdom, resolutely resisted, and I really hope they continue to do so..

In addition, our stock exchange margining system and transaction settlement system worked even better than in the US in containing huge negative exposures of individual players, mainly because algorithmic trading (which can very rapidly put through transactions involving mind-boggling amounts) was not permitted in India. Now algorithmic trading is permitted, and probably accounts for about 20% of all trades today. This percentage is set to zoom, giving traders with access to this technology a huge edge, and reducing retail investors to mere peripheral price takers. Given that our markets still do not have depth comparable to the first world exchanges, a runaway rogue trading program has the potential of putting almost the entire exchange settlement and margining system at risk, leading to a possible rapid stock market crash or boom. 

I hope I am wrong.  

1 comment:

  1. Excellent post. India was affected by recession because lot many Indians work for MNC's, and this had a cascading effect.I would also say that the limited credit card penetration in India turned like a blessing in disguise. SBI should do what it is best at-banking. I am all for it if they get aggressive on SBI Capital Markets and compete with the likes of Macquarie/Daiwa/UBS in India, but insurance is a no-no.

    The Govt should also stop using LIC as its proxy vehicle for investing in IPO's. No doubt LIC has a very huge pile of cash, but the Govt. has no business to instruct LIC to invest in divestment issues, when the subscription levels turn out to be abysmal. Look at NTPC/NMDC FPO's. If the Govt wanted LIC/SBI to subscribe, it could have done a private stake sale, rather than taking the IPO route. A clear case of reckless planning.