Global Finance in the 21st Century: A Practitioner s Perspective

1. Global Finance in the 21st Century:A Practitioner�s Perspective BITS EMBRYO Suhail Kassim The World Bank Group February 2011

2. Why are you here today? Finance = Quick Cash? �Greed is good� (Wall Street) �Show me the money!� (Jerry Maguire) �Lehman offers $340k to IIMC grad!� (Media reports) Finance = Art Meets Science? Mutual learning Theory versus experience You will live through the next 5 crises! Will you cause them or resolve them? � Suhail Kassim 2011

3. Part AAn overview of the financial world � Suhail Kassim 2011

4. Question: What are the components of a financial system? � Suhail Kassim 2011

5. Key components include� � Suhail Kassim 2011

6. India�s financial architecture landscape � Suhail Kassim 2011

7. Part BBefore and Beyond the Crisis � Suhail Kassim 2011

8. One Crisis After Another � � Suhail Kassim 2011

9. � With Worrisome Consequences � Suhail Kassim 2011

10. The �moral gradient� of the financial world The White? Commercial banks Private Equity Venture Capital Microfinance institutions Development banks The Grey? Shadow banking I-Banks Hedge Funds Sovereign Wealth Funds Products and Practices Derivatives Corporate Governance The Black? Offshore tax havens Practices Chinese walls Black market economics Money laundering Ponzi schemes � Suhail Kassim 2011

11. Investment Banking and Alternative Investments Glass Steagall Act (1933) split the world of banking into Commercial and Investment banks. In 1999, the Act was repealed. Investment banking created parallel banking system (shadow banking) � huge wealth, taxes. Greenspan � �Self regulation� Motto: �Privatization of profits and socialization of risks� IBs invested in: Securities (listed stocks, unlisted stocks, bonds) Commodities (oil, sugar, gold, metals, orange juice) Currency Real estate Innovation (science and technology, IP, start-ups) Asset pools (mix of the above) IBs raised money from funders like: Borrowings/ bonds Funders Private equity firms Venture capital Pension funds Hedge funds (to minimise risk) Mutual funds (to maximise results) Sovereign wealth funds Funders get money from HNIs, governments, pensions, institutional investors and petrodollars. � Suhail Kassim 2011

12. Understanding Financial Innovation Class assignment: Develop a product which can beat regulation and maximise profits (5 min). How about this approach? Risky assets of different risk profiles Pooled in different ways (not necessarily to minimise risk) Split in different ways (Principal vs interest, by currency, by country, by maturity) The interest itself can be packaged and resold as products Such products then sold to different investors These split up and bundled products are a standard example of �derivative securities� E.g. Mortgage-backed securities (MBS); Collateralised Debt Obligations (CAO); Collateralised Mortgage Obligations (CMO); Credit Default Swaps (CDS) Nexus between product, sales, research � �Chinese Wall�? IBs� leverage rose to 25-50%; CRAR fell to 1-2%; NPAs rose to 30% Government and regulators cannot keep track of it Also Wall Street is darling of government because of its record profits and taxes Compounded by failure of credit rating agencies and market analysts � Suhail Kassim 2011 To minimise risk, investors diversify their investment in various baskets, so the IB breaks up the investment into small units and sells it to investors as a package. In the bargain, the investor sometimes has no clue of where the money has been invested in (notable exceptions being the case of defined funds e.g. real estate funds).To minimise risk, investors diversify their investment in various baskets, so the IB breaks up the investment into small units and sells it to investors as a package. In the bargain, the investor sometimes has no clue of where the money has been invested in (notable exceptions being the case of defined funds e.g. real estate funds).

13. Wall Street brings down the world ! Investment Banks ran out of cash and trust �The interbank lending market died with Lehman Bankruptcy� Bank run and bank-to-bank run Fall of the Big Five on Wall Street: Bear Sterns � sold to Bank of America; first to go down Lehman Brothers � Government allowed it to go down Merrill Lynch � sold to Bank of America Goldman Sachs � converted into commercial bank Morgan Stanley � converted into commercial bank Global contagion � Western EU banks ran out on Eastern European banks and into Iceland (insured, high interest rate) Result: Debt burden 10x GDP ? Three largest banks collapsed in October 2008 Wall Street hits main street : Credit freeze, exports hit Africa � The forgotten continent Compounded by food and fuel crisis Government stimulus packages up to $5 trillion have been given out (IMF) Five Indias put together! � Suhail Kassim 2011

14. Role of Hedge Funds �Finance is a zero sum game� (??) � Suhail Kassim 2011 Wealth = Book +/- Notional +/- Future Wealth = Book +/- Notional +/- Future

15. Commercial Banks � �Not Guilty� ? 2001 dotcom crash and 9/11 � interest rates fell as a stimulus measure. By 2007, gigantic exposure to potentially toxic/ sub prime assets at Sub PLR ? High pool of bad debts and defaults on repayment ? Contagion effect and systemic breakdown Banks in Catch 22 situation: Debtors defaulted because they didn�t want to pay interest on a $80 asset bought for $100 The bank took over the asset but couldn�t sell it because of valuation and demand problems Why was India not affected as much (in case of the housing sector crash)? Banks loan only up to 80 per cent of asset value � Suhail Kassim 2011

16. Flight to �Tax Havens� Very low regulation Very low taxes Very low disclosures � Suhail Kassim 2011

17. What next? Wall Street still has large investment divisions Risky market behaviour is picking up The buzzwords are capital and risk �The crisis was a lost opportunity for long-term reform� Krugman � �The next crisis will be worse than this one� (nations not banks) Roubini � �We are planting the seeds of the next crisis� Doomsday careerists or real prophets? Wait and watch... � Suhail Kassim 2011

18. Part CSome other topics in finance � Suhail Kassim 2010

19. Development Finance and IFIs Bretton Woods Institutions Other Multilateral Development Banks Bilateral Donors Foundations, Funds and Trusts Concept of ODA � Suhail Kassim 2011

20. Home Assignments Case Study 1: Launch a new microfinance program in Iraq. Case Study 2: Structure a grassroots venture capital fund-of-funds in India. Case Study 3: You are the Finance Minister of a newly formed small country. Develop a new currency, 5-year economic development plan, and fiscal budget. Interested students may submit their assignments to suhailkassim@gmail.com � Suhail Kassim 2011

21. Suggested Further Study Movies: Wall Street (1987) Wall Street: Money Never Sleeps (forthcoming 2010) Enron � The smartest guys in the room: http://www.youtube.com/watch?v=o5clNtt7PgM Walmart � Good for America? http://www.youtube.com/watch?v=wTDY1MrXJPY Rogue Trader: http://www.youtube.com/results?search_query=rogue+trader&aq=f GFC documentary 1: http://www.youtube.com/watch?v=w2kihFVXW-w GFC documentary 2: http://www.youtube.com/watch?v=sZd2qKYQd1s Readings: Liar's Poker by Michael Lewis The New Power Brokers by McKinsey: http://www.mckinsey.com/mgi/publications/The_New_Power_Brokers Masters of Illusion: The World Bank and the Poverty of Nations (1996) � Suhail Kassim 2011

22. Thank You !Questions?Reach me at suhailkassim@gmail.com � Suhail Kassim 2011