WEATHER DERIVATIVES – CONCEPT, CHALLENGES, AND FEASIBILITY

By  Ishan Kekre & Girish C

Introduction

A weather derivative is a tool for managing weather risk. It is a financial contract that allows a firm to hedge itself against unexpected and adverse weather. A weather derivative contract or WD derives its value from future weather conditions. Contrary to stereotypical weather insurance, the payout of this kind of derivative is based on a parametric weather index. For instance, the index could be centimeters or millimeters of rainfall. The index could also be a cumulative frequency distribution of temperatures across many locations. The underlying of WD could also be related to snowfall or hurricanes.

Origin of Weather Derivatives

The weather derivative market as compared to other financial instruments is relatively young. The first transaction in the WD market dates back to 1997. The sector developed due to the severe repercussions of El Niño. These events were forecasted correctly by the meteorological community. Firms that had their revenues linked to weather realized the importance of protecting themselves against seasonal weather risks. Many companies who were in the business of dealing with financial futures and options saw WDs as attractive tools to hedge weather risks.

The insurance sector achieved substantial financial consolidation. As a result, there was significant capital to hedge weather risks. Insurance firms started writing options with payoffs linked to weather events. This, in turn, elevated the liquidity for the development of a WD market. Thus, the WD market evolved over the years into a strong over-the-counter market.

Continue reading

EFFECTS OF DEMONETIZATION ON THE FINANCIAL SECTORs OF INDIA

By The Editorial Board of TJEF

(Anil Shankar, Gandhali Inamdar and Isha Varma)

Introduction

Demonetization has been the buzz word since November 8th 2016 when our Prime Minister made the historic announcement about the decision to discontinue the 500 and 1000 rupee notes. This historic decision has affected almost all the sectors. Some have benefited while others have suffered. This paper intends to analyze the effects of demonetization on the major financial institutions and the Indian economy in general.

Effects of Demonetization on Banking sector

Since the advent of asset quality review (AQR), there has been a rise in the number of NPAs. To get an idea, the GNPA of banks is 6 lakh crore as of June, 2016 which is 8.2% of the total loans1. These are only the NPAs as there are an equal number of restructured loans which might transform to NPAs in future.

 p1g1

Figure 1: Total NPAs as of March 2016, Source: Finance Ministry

A recent data provided by the Finance ministry, which has been depicted in Figure 1, shows that 5.3 lakh crore of the 6 lakh crore NPAs are under the public sector banks. It’s clearly visible that there has been a rise in the NPAs from October 2015. This can be attributed to the ever greening of loans which led to the creation of a distorted picture of the banks. Though the asset quality review led to the identification of such NPAs which were previously classified as standard, the problem of NPAs existed since the 2008 financial crisis but remained hidden due to the above mentioned reason.

Continue reading

Should NBFCs be regulated in the same way as Banks in India?

By Nayan Saraf

Indian banking sector has played a crucial role in developing the Indian economy, but if there is one segment, which would significantly make a big difference in coming years, it would be the Non-banking financial services sector. The total asset base for NBFC’s stood at more than Rs. 14.5 Lac Crore and the profit of Rs. 30,000 Cr. in the year 2015 with a CAGR of about 13% over last 3 years. This enormous growth of NBFC segment has resulted in more regulations from RBI which in effect have opened the debate whether NBFCs should be regulated in the same way as banks or not.

Over the years, RBI has changed its stance on NBFC from no regulations to over regulations. This over regulation has come into the picture in recent years after the global financial crisis where the fall of systematically important FI, Lehman Brother, resulted in systematic risk across the financial world. But many economists have argued that these over regulations are nothing but overly cautious measures by the RBI which are hampering the growth of the NBFC segment.

One reasonable argument that goes in the favour of lesser regulations for NBFCs is that unlike banks they don’t have any unsophisticated depositors. The bank’s depositors are unsophisticated as they can withdraw money from the bank at any time and the bank is liable for that. Even for fixed deposits, the principal is protected in the case of premature withdrawal. Hence, banks run the risk of having ‘Run on the bank’. On the other hand, NBFC’s do not have unsophisticated depositors as they raise money by issuing bonds and promoter’s contribution. Hence, NBFCs do not run the risk of having ‘Run on the bank’.

Second argument that goes in favour of lesser regulations for NBFCs is the low risk of asset liability mismatch. Since, NBFCs lend money which was raised through bonds and promoter’s contribution rather than depositors’ money (as they cannot accept deposits); there’s a very little chance of having asset liability mismatch. In their balance sheet, the liability would be due only on maturity. Hence they can easily manage the asset liability mismatch. On the other hand, banks that lend depositors’ money, run a higher risk of asset liability mismatch as in their balance sheet the liability can be due at any time.

These two arguments question the importance of stringent regulations on NBFCs by RBI. When NBFCs are different from banks, then why should they have the same stringent regulations? NBFCs should be more risk seeking in nature for the growth of Indian economy.

Have the GOI and RBI efficiently managed the current cash crunch problem considering the withdrawal of more than 80% of currency from the economy?