Artha March-2021
Artha March-2021
Artha March-2021
ch ,Vol
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Editor
Dr. Sudhir S Jaiswall
Faculty Member (Finance & Control Group)
Coordinator (Financial Research & Trading Laboratory)
Editorial Office
Ms. Priyanka Dasgupta
Assistant Manager (Financial Research & Trading Laboratory)
Email: [email protected]
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Contents
1 Editorial
Sudhir S. Jaiswall
__________________________________________________________________________________________________
2 Herding and Financial Markets: The case of REDDIT daytraders versus Hedge funds
Arvind Ashta
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Balachandran R
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16 Corporate Governance in India: Understanding the History and Peeking into the
Future (Part II)
Asish K. Bhattacharya
__________________________________________________________________________________________________
Yash Sharma
________________________________________________________________________________
Teerna Chatterjee
________________________________________________________________________________
Note: The views expressed by the authors in their article published in this issue of Artha are personal and do not necessarily represent
the views of their employer, or that of Artha, FRTL and IIM Calcutta. Authors are responsible for any permission needed for copyrighted
material used in their article.
Editorial
Welcome to the March 2021 issue, the fourth and final issue of A₹tha in the current fiscal year.
I am delighted to share with you, what a remarkable year 2020-21 was for A₹tha. We published 26 interesting
articles contributed by our stakeholders from India, Europe, and the USA: 6 articles by current & former IIMC
faculty members, 4 by current IIMC students, 11 by IIMC alumni, and 5 by non-IIMC contributors.
The current issue carries five articles. In the first article, the author uses a contemporary event, the REDDIT action
on GameStop, to lucidly explain various concepts related to financial, trading, security price determination, and
valuation. The second piece discusses the tools RBI uses to intervene in the foreign exchange market and their
intended and unintended consequences on domestic liquidity. The author concludes that open market operation
purchases of government securities may be the only option for RBI in the current context. The third article is the
second part of an extended essay (part I was published in December 2020 issue of A₹tha) tracing the historical
development of corporate governance in India and offering a perspective on the future of governance practices.
In the second part, the author outlines the governance practices in India after economic liberalization in 1991. The
fourth piece is on data breaches, which has affected numerous individuals, companies, and government agencies.
The author probes various issues related to breaches of sensitive data, provides examples of some of the significant
data breaches in recent years, and suggests what individuals and organizations can do to safeguard themselves.
The last piece provides a theoretical perspective on peer-to-peer lending and its potential impact on the Micro,
Small, and Medium Enterprises (MSME) sector.
I hope that you will enjoy reading it and continue to send your feedback, suggestions, and contributions to us at
[email protected].
Sudhir S. Jaiswall
Editor
Arvind Ashta
Dr. Arvind Ashta is an alumnus of IIM Calcutta (1980-82). He is now professor of Finance at the
Burgundy School of Business, Université Bourgogne Franche-Comté in Dijon, France, and is
member of its research center CEREN, EA 7477. His main research area is micro-finance, but he
sometimes writes on macro issues. He has over sixty publications in international journals. His
most recent book is “A Realistic Theory of Social Entrepreneurship: A Life Cycle Analysis of
Micro-Finance” (Palgrave MacMillan, 2020). He is a member of a club of micro-investors.
Introduction
The whole world was shocked. On January 28, 2021, the Financial Times reported that a group of small investors
beat the hedge funds (Wigglesworth, 2021). These investors made 300% returns in one day, and about 1500% in
2 weeks, while the hedge fund Melvin Capital lost more than $4.5 billion in January (Schroeder, 2021). The
question is, what happened?
It may be good to provide a small introduction for a non-financial audience as a background to the case. As you
know, the stock market trades in shares that represent ownership in a company. After obtaining shares from a
company, investors buy and sell these shares in the secondary market. They pay a commission to the broker who
gets the shares for them. Supply and demand establish the price as shown in the top panel of Figure 1. If demand
increases, the price goes up; if supply increases, the price goes down; and there is some equilibrium price. As
seen in the bottom panel of figure 1, investors can make profits by buying low and later selling high, hoping that
price will go up from P0 to P1 in the figure. But one could also sell high and later buy low. Hedge funds backed
by high net worth investors do this, hoping the price would go down from P0 to P2.
One problem with the system is that the commission per share charged to big investors is much smaller. If a
broker is given a deal of €1 million, he could ask for a commission of €1000, which is 0.1%. But if a small investor
wants to make a deal of €1000, the broker may ask for at least €10, which is 1%. The point is that the commission
percentage is higher for small investors, and the game is biased in favor of the rich. To compete effectively, small
investors get together in mutual funds. Once their collective trades are larger, they get the advantage of smaller
fees, but they have to pay fund management fees. Besides reducing the commission costs, investors in mutual
funds also have lower risk since they can diversify into many stocks.
Figure 1: The first panel is a reminder of microeconomics, the lower panel is a reminder of financial economics.
To get higher returns, you need to take high risk, and for this, big investors group into hedge funds. Hedge funds
may be managed aggressively or make use of derivatives and leverage to generate higher returns. Hedge fund
strategies include long-short equity. For some shares, they sell them before buying.
How do people decide whether the stock price is expected to go up or down? For this, some people do technical
analysis. They look at how the stock price has been behaving. They make fancy curves, and based on these, they
decide the expected trend. If the price is over this trend curve, they would like to sell. Others do fundamental
analysis where they look at the industry, the economic conditions, the past performance of the company itself,
and then they try to project future cash flows and decide what should be the expected fair value.
But not everybody is a long-term investor. The stock market has many participants who are speculating, and these
speculators realize the role of sentiments. If the market sentiment is optimistic, everybody wants to buy; when it
is pessimistic, everybody wants to sell. Speculators try to buy before others when they feel the market will be
optimistic and will sell later. Today, market sentiment is gauged by big data analyzed with artificial intelligence
tools.
We now have the tools to study the case of GameStop, which has been the center of attention. GameStop is a
video game, consumer electronics, and gaming merchandise retailer based in Texas. It was founded 37 years ago
in 1984 and is the world’s largest video game retailer. It has about 5500 retail stores. This company’s history
shows that it was growing very fast, but it started declining in 2010 due to the shift of video game sales to online
channels. It experimented with diversification in selling smartphones, but it didn’t work out. However, with the
advent of the pandemic, all the tech stocks started booming, people were buying more and more games, which
ushered in hope. But no extraordinary change in 2020 justified a dynamic price increase (Badkar, 2021).
From the technical analysis, you can see in figure 2 that prices followed an almost a flat line from February 1,
2016 till recently. Actually, the price was going down to about till January 2020, remaining at this level till July,
and then in the last few months of 2020, it started going up till December. There was certainly no reason for it to
suddenly boom to €300. Technical analysis cannot explain this increase.
What about the fundamentals? As we mentioned before, there is no significant change in strategy. As shown by
the income statement (Figure 3), the business was down. It picked up a little bit in 2020 compared to 2019, but
total revenue and profits remained below previous years. Therefore, fundamentals can explain a slight price rise
but not a significant shift.
Would sentiments and irrational exuberance have provided such a big boost? We can see that the whole market
has been optimistic during the pandemic. This optimism is owing to several factors. First, interest rates are low,
which means your discount rate of future cash flows is low, so the firm value goes up. More consumer interest in
technology leads to high expected growth, and again the expected value of future cashflows goes up. Public
money is pouring in, and so people’s income constraint is disappearing. You know there are many new trading
platforms like Robinhood that are charging zero commission. So, there’s no friction to buying and selling of
shares. All these reasons explain the market optimism (Fletcher, 2021; Mackenzie, 2021).
While this is true about technology stocks, what about Gamestop? Should the price go up further? To understand
the analysis of the hedge funds, you can look at the monthly and weekly data presented in Figure 4. From the
beginning of February 2020 till July, there was almost no change, and the price was close to $4. Then the price
goes up reasonably fast and by January 2021, you can see that it increased by 300% to $18. This is a huge increase.
So hedge funds at this time said no, they should sell. Since they were confident of their analysis, this time they
started placing puts expecting that the price would indeed go down.
But everything changed this week (11-01-2021). Instead of price going down, it doubled, and then it doubled
again, and then it went up five times before coming down. So, hedge funds like Melvin Capital and Citron capital
lost money (Aliaj & Platt, 2021).
What can explain this reversal of fortune? It is attributed to social media (Stafford, Kantor, & Lewis, 2021). One
of these social media is REDDIT, which is a social networking website with many forums for discussion. One of
these forums is a community called WallStreetBets. There were about 7.5 million people in the community (as
on January 31, 2020). These members include individual investors, ex-bankers, and traders who exchange their
experiences. Together, they decided to do the inverse of what bankers and hedge funds were doing. No small
trader could have succeeded in what they did, but with a million small traders buying the same share, their power
becomes as much as that of the hedge funds. When hedge funds thought they would make money by selling and
then buying later at a low price, the WallStreetbets investors decided to purchase shares or calls options and the
price went up, instead of going down. Some of these small investors made extraordinary profits. One person
bought and turned $50,000 of GameStop call options into nearly $23 million (Wigglesworth, 2021). Another
bought shares worth $4,000, and these were worth $124,000 before he cashed $20,000 out (Platt, Smith,
Darbyshire, Kantor, & Wigglesworth, 2021).
This situation is called a gamma squeeze. An investor buys a call, in effect building pressure that the underlying
stock price will move higher, which happens because call option sellers must buy the stock to hedge their risk.
Furthermore, the bank or other firms that have sold the shares have to deliver the shares. This need for delivery
means they need to buy, which raises the demand for shares even more, and the price goes up even more. The
short sellers lose their money (Smith & Wigglesworth, 2021). As a result, Melvin Capital lost 53% of its value
(Aliaj & Platt, 2021).
There’s another angle to this story, which is on margin rules. The margin account is used when an investor buys
from a broker on credit, hoping to gain a leveraged effect. However, if there is a loss, then there is a leveraged
negative effect, and the broker may be worried that the investor will not pay up. The margin rules protect the
Stock Exchange from liquidity problems of an investor so that if they think that you’re going to make a loss, they
will take your margin and buy or sell shares to make sure that they have enough liquidity. The investors who are
losing money would need to sell their positions to ensure their commitments. A clearinghouse keeps this margin
money. Each day, members of the clearinghouse must put in the margin as insurance for their trades. The killing
bit is the limited time to make any shortfall. For example, a clearinghouse ordered one US Bank to find $10 billion
of margin within an hour! In our case, hedge funds had to liquidate all their stocks at market prices because their
margin had been eaten. Even platforms, such as Robinhood, feared that they would be disbarred from being a
broker, and they halted trading in an attempt to curtail the price increase (Stafford & Rennison, 2021).
A third complication is that people who are not just buying shares and selling shares, they’re buying options
(Wigglesworth, 2021). Options are like leveraged stock. For example, you can buy an option for $1.00 on a share
priced at $100. Instead of buying ten shares of $100, with the same budget, you can buy a thousand options of
$1.00. And if the price goes up, you buy the shares for the price you had agreed on, called the exercise price.
What we’ve seen is that when the markets are going up, people start taking risks. Figure 5 shows that the number
of people buying call options is going up for all the shares, but not necessarily for GameStop.
Alternative Issues
These news stories open the way for broader questions. The first question is a kind of political debate: can the
small investors win against the rich hedge funds and usher in greater equality? People on one side of the discussion
are invoking the Occupy Wall Street movement, indicating that the group of small investors is seeking economic
justice (FT, 2021b). The other side replies that such a fight is useless because the rich platforms, banks, and traders
make money every time they buy and sell through the trading commissions. Moreover, only a few small investors
make money: those who are smart enough to sell once the price goes up (Webb, 2021). Many small investors
even lose money because they would have bought the shares at a high price, and the price will eventually fall to
its fair market value. A quick “back of the envelope” kind of calculation by the FT (2021a), based on prospective
future earnings of $100 million and a price-earnings ratio of 20, values the share at $28.
The second issue is about smart money versus dumb money. Smart money is people who invest in research and
development before they buy or sell. Hedge funds have colossal research and analysis departments, and they act
in an informed way. Retail investors do not have access to such research and follow the smart. But a study of the
blogs on Reddit shows that there are intellectual analysis and discussion taking place before the action by the
group of small investors. The smart guys are now joining these websites to learn from the dumb. They’re using
AI and big data collection techniques and then analyzing them (Wigglesworth, 2021).
A third is whether speculation is legal. Certainly, we have the freedom to lose and win our money, but can we
manipulate others? Can we induce others to buy and sell? Certainly, you cannot tell lies. But what if you don’t
lie and you say “I am doing this” or “Lets do this”? When is it called manipulation? The reason the State may
want to control speculation is that if it seems that the Stock Exchange is only a gambling den, then maybe
companies won’t be able to finance their investments. Therefore, the State wants to show that the stock exchange
is a fair long-term investment platform and that returns are based on a company’s fundamental value. Watchdogs
like the SEC in the USA are examining whether this herding was manipulative (Armstrong, 2021; Martin & Platt,
2021).
A fourth issue is whether platforms like Robinhood have the right to close down and keep retail speculators from
making money. In examining this issue, one has to keep in mind that the margin money requirement also extends
to platforms that have chosen to net the margins of all their members. The trading platforms would have gone
bankrupt if they had not stopped trading (Armstrong, 2021; Martin & Platt, 2021).
Concluding Remarks
We could make a few concluding remarks. In retrospect, with the benefit of hindsight, it is clear that the prices
would fall back towards their fundamentals, as we can see in figure 6, and the best strategy is to be a short-seller
or buy puts when prices rise so high.
Figure 6: Gamestop prices fall back. Source: Yahoo finance, downloaded on February 11, 2021
We can see that the press has made a lot of noise about a few small investors making a lot of money. This noise
makes people think that they have a chance to win the lottery, and that encourages speculation. As a result, many
new people start joining the market. And that boosts the market further, already pumped with the helicopter money
that the governments are throwing in to boost the economy.
References
Aliaj, O., & Platt, E. (2021, February 1). Melvin assets drop 53% in January after Reddit assault. Financial
Times (Europe), p. 6.
Armstrong, R. (2021, January 30). Redditors throw down challenge to watchdogs. Financial Times (Europe), p.
12.
Badkar, M. (2021, January 29). Retail chain dragged into amateur traders’ war games on Wall Street: Co-
ordinated effort by army of lay investors pushes GameStop to a 28bn market capitalisation. Financial
Times (Europe), p. 8.
Fletcher, L. (2021, January 29). Tech rally pits old-school investors against followers of digital dream.
Financial Times (Europe), p. 9.
FT. (2021a, February 13). Lex: GameStop: eye of the beholder. Financial Times (Europe), p. 20.
FT. (2021b, January 30). The wave of populism shaking Wall Street: Retail investors are using social media to
take on the short sellers. Financial Times (Europe), p. 6.
Mackenzie, M. (2021, January 30). Army of small traders rages at the short-sellers. Financial Times (Europe),
p. 18.
Martin, K., & Platt, E. (2021, January 29). Overheated Online brokers slam the brakes on extraordinary Reddit-
fuelled stock rally. Financial Times (Europe), p. 1.
Platt, E., Smith, C., Darbyshire, M., Kantor, A., & Wigglesworth, R. (2021, January 30). Reddit traders take on
Wall Street’s elite: WallStreetBets trade tipping forum rocks investment establishment with dizzying
rise in GameStop stock. Financial Times (Europe), p. 10.
Schroeder, S. (2021, Feb 1). Hedge fund Melvin Capital is down $4.5 billion after epic squeeze by Reddit
traders, report says. Mashable.com.
Smith, I., & Wigglesworth, R. (2021, January 30). Day traders learn to ‘weaponise’ dynamics. Financial Times
(Europe).
Stafford, P., Kantor, A., & Lewis, L. (2021, January 29). Reddit battle drives trading volumes past 2008 peak.
Financial Times (Europe), p. 9.
Stafford, P., & Rennison, J. (2021, January 30). Betting mania puts clearing houses in the spotlight. Financial
Times (Europe), p. 11.
Webb, M. S. (2021, January 30). Reddit investors’ real power is over WallStreet’s future behaviour. Financial
Times (Europe), p. 7.
Wigglesworth, R. (2021, January 28). ‘Weaponised’ options trading turbocharges equity rally: Unloved shares
are being propelled to record highs, raising fears of wider impact. Financial Times (Europe), p. 10.
*********
Balachandran R
Balachandran R is an alumnus of IIM Calcutta (1987-89) with extensive experience in corporate banking,
investment banking and product management.
The Indian economy saw a surge in capital inflows in 2020, despite the Covid-19 pandemic, through foreign
direct investment (for example, in Jio Telecom) and foreign portfolio investment (in the secondary markets).
Despite this, the Rupee was reportedly the worst-performing Asian currency in 2020. Blame it on the RBI!
Why would the Reserve Bank of India keep the exchange rate low, risking the United States' wrath by potentially
being labeled a currency manipulator? A Dollar deluge puts upward pressure on the Rupee. Imports become
cheaper while exports can become uncompetitive. India, with the rare exception of the current financial year
2020-21 (till date i.e. February 2021), has been running a perennial current account deficit; in other words, our
exports of goods and services and NRI remittances are not sufficient to meet our import bill. Exports are critical
to managing the current account. RBI, therefore, needs to step in to curb excessive Rupee appreciation (which
can make exports uncompetitive) in the face of capital inflows.
RBI’s exchange rate policy is termed managed float. Unlike the developed market currencies (the US Dollar,
Euro, Japanese Yen, Pound Sterling, Swiss Franc, etc.), which float freely with market conditions, RBI intervenes
in the Foreign Exchange (FX) markets to curb volatility and speculative activity. In the scenario of excessive
capital inflows, RBI purchases Dollars and sells Rupees.
RBI’s intervention in the FX markets leads to unintended consequences. In buying foreign currency assets (US
Dollars), RBI unleashes an equivalent amount of Rupee liquidity into the system; when purchasing Dollars, RBI
credits banks with Rupees, increasing the money supply. Where does RBI get the Rupees? It’s from thin air!
Central banks not only print fiat currency, but they also create electronic currency when paying for the purchase
of foreign currency assets and domestic assets (e.g., open market purchase operations of government securities).
The former Chairman of the US Federal Reserve Ben Bernanke acquired the nickname of “Helicopter Ben” for
his allusion to the central bank dropping money from a Helicopter!
Sterilization Operations
The Rupees infused into the system through RBI’s FX market intervention can be potentially inflationary and
cause short-term rates to fall below the policy repo rate. RBI has monetary policy tools for neutralizing or
“sterilizing” the excess domestic liquidity. It can conduct open market sale operations of government securities.
Such securities are purchased by banks and paid out of their “excess reserves.” Here the purchase consideration
is debited to their current account maintained with RBI, and the Rupees in the accounts of banks vanishes into
thin air. It moves out of the system, thereby negating the rupee liquidity injected through RBI’s intervention in
the FX market.
Such sterilization can impact the central bank’s surplus (profits). For example, RBI replaces higher yield domestic
government securities (about 6.20% now for 10-year Indian government security) with a lower yield foreign
currency asset (about 1.6% now for a 10-year US government Treasury bill).
Table 1 depicts the effect of RBI’s FX market intervention, both for purchase and sale of FX.
MSS scheme
RBI has built up a war chest of about USD 600 billion of foreign currency assets through such interventions in
the FX market. Continuous open market sale operations of domestic government securities to sterilize the
consequent impact on Rupee liquidity can deplete RBI’s stock of such securities. Therefore, the Market
Stabilisation Scheme (MSS) was envisaged by which the Central Government would provide RBI with adequate
stock of government securities to undertake sterilization activity. In paying for its subscription to the securities,
RBI credits a separate cash account of the Government held with RBI. The original idea was that the funds would
be sequestered and not form part of the Consolidated Fund of India. In other words, the money is not for the
Government’s use but for subsequent redemption of the securities issued under the MSS scheme. RBI can use
the securities under MSS (on its balance sheet) to mop up the excessive domestic liquidity (arising from its FX
market intervention) from banks. It is noteworthy that RBI does not appear to have conducted sterilization
operations in the Covid-19 era, perhaps to keep domestic liquidity in surplus and mitigate the pandemic's impact
on the economy.
Demonetization
RBI was not using MSS as a tool for a while, until demonetization. When Rs 500 and Rs 1000 currency notes
were demonetized in November 2016, customers deposited the old notes into their savings accounts with banks.
Next, banks deposited the demonetized currency with RBI, reducing the currency in circulation by a whopping
amount of nearly Rs 9 lakh crores. When retail customers deposit currency notes into their savings account, their
bank balance goes up accordingly. Subsequently, if banks deposit these currency notes with RBI their balances
in their current accounts with RBI go up (in this case the balances went up by nearly Rs 9 lakh crores).
Demonetization led to a strange situation: the economy was starved of physical cash, while the banking system
was awash with an unprecedented amount of liquidity. The excess liquidity in the system could potentially cause
the rates in the interbank call money market to fall to the lower end of the interest rate corridor (the reverse repo
rate). This sharp decline would negate the objective of RBI’s day-to-day liquidity management operations to keep
the weighted average call money rate around the repo rate.
RBI initially used its monetary policy tool, reverse repo, to absorb the excess liquidity. In this operation, RBI
sells government securities to banks, with an agreement to repurchase them within a short tenor (usually
overnight). In the first leg of the transaction, banks pay for their purchase from their current account with RBI.
Thus, funds will move out from the banking system, thereby meeting RBI’s objective of absorbing the excess
liquidity created through demonetization. Open market sale operations are not the appropriate tool here since they
result in long-term draining of banking system liquidity; the need was to absorb temporary surplus liquidity
conditions until “remonetization” happens.
Reverse repo operations too are constrained on account of the finite availability of stock of government securities
on RBI’s balance sheet. RBI could absorb only about Rs 5 lakh crores through reverse repo auctions out of the
Rs 9 lakh crores excess liquidity in the system due to demonetization. Therefore, RBI used the ultimate weapon
in its armory: an incremental cash reserve ratio (ICRR) of 100 percent on the increase in net demand and time
liabilities (NDTL) of banks between September 16 and November 11, 2016, was applied. This drained the balance
excess liquidity of Rs 4 lakh crores. Along with the reverse repo operation, the 100% incremental CRR thus led
to the absorption of the entire excess liquidity of Rs 9 lakh crores created in the banking system on account of
demonetization.
However, the use of 100% incremental CRR led to fresh issues. CRR balances maintained by banks with RBI are
not remunerated. On the one hand, banks were paying interest on the savings account balances that had surged
due to demonetization. On the other hand, banks were not to allowed to lend or invest this amount, to the extent
of the incremental CRR. As a result, banks’ income was being hit for no fault of theirs. RBI was forced to roll
back its 100% incremental CRR mandate, leading back to excess banking system liquidity, to the extent not
absorbed by reverse repo operations.
Subsequently, in an unprecedented move, RBI deployed the MSS tool, which was originally conceived for a
different purpose: sterilizing banking system liquidity on account of intervention in the FX market. The
Government provided about Rs 6 lakh crores of securities under MSS to RBI. Armed with this, RBI sold the
securities to banks and absorbed the surplus liquidity. As “remonetization” in the economy happened over the
next few months, the securities issued under MSS were redeemed, and normalcy returned to RBI’s balance sheet.
In today’s context of surging liquidity on account of RBI’s intervention in the FX markets, talk of MSS is again
doing the rounds, with a notable mention in the latest “Report on Currency and Finance” published on RBI’s
website.1 However, neither RBI has endorsed the report as its official point of view, nor the Government has
made any statement on an agreement with RBI to provide securities under the MSS scheme.
1
https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=51187
Except for CRR, the other monetary policy tools of RBI for absorbing the excess liquidity in the banking system
depend on the availability of government securities, as RBI cannot “borrow” unsecured from banks. Therefore,
the Standing Deposit Facility (SDF) was announced in the Union Budget 2018-29, through which RBI can absorb
liquidity from banks without selling an equivalent amount of government securities.
Conclusion
With a sharp upswing in the yields on government securities post the February 2021 budget and an inadequate
market appetite to finance the massive government borrowing plans, open market operation purchases of
government securities may be the only option for RBI. The resultant surplus liquidity can be absorbed by the
Standing Deposit Facility. However, RBI is yet to activate this monetary policy tool, though the Governor alluded
to its use in a recent speech.
*********
Asish K Bhattacharyya
Asish K Bhattacharyya is Distinguished Professor at Shiv Nadar University and Founder of Nonlinear
Insights. He was a Professor at the Indian Institute of Management Calcutta and Indian Institute of
Corporate Affairs. Also, he was Director of the Institute of Management Technology Ghaziabad and the
Head of the School of Corporate Governance, Indian Institute of Corporate Affairs. Dr. Bhattacharya
started the Centre for Corporate Governance at IIM Calcutta. He was a regular columnist for Business
Standard from 2008 to 2020.
(This article is Part II of the essay. Part I dealt with corporate governance practices in India from the colonial
period until the command capitalism – 1950 to 1990 – period; it was published in the previous issue of Artha.
Part III will be published in the next issue.)
With Economic liberalisation in 1991 India ushered into the market economy from a command economy. Indian
economy got integrated with the world economy. It opened up new opportunities and transformed the sellers’
market to buyers’ market with easy availability of foreign consumer products. The government dismantled the
license raj, opened up most sectors (including the infrastructure sector) for the private sector enterprises, and
liberalized foreign investment in Indian companies through foreign direct investment (FDI) and foreign portfolio
investment. All those policy changes opened up new avenues for Indian business and a vast Indian market for
foreign multinationals. Although the government adopted the policy of privatisation of or disinvestment in public
sector enterprises (PSE), existing PSEs continue to occupy dominating position and securities some of the large
well-run PSEs have been listed in stock exchanges.
During this period, business groups diversified into sectors that were earlier reserved for state-owned enterprises
and new business groups emerged. For example, the growth of Reliance Industries Limited (RIL), which was
established by ambitious Dhirubhai Ambani in 1973, accelerated only after 1991. Adani group, which was
established in 1988, is a name to recon in the infrastructure sector. Another example is the Bharti group, which
was incorporated in 1976. It established Bharti Airtel in 1995, which is now among the top three
telecommunication companies in India. During this period, multinational companies either established their
subsidiaries or collaborated (such as through joint ventures) with Indian companies to enter the market. In 1992
the government allowed FPI in Indian companies and FDI norms are being relaxed gradually. Figure 1 shows that
the inflow of FDI has increased sharply starting from 2004.
5E+10
Net FDI inflows (current $)
4E+10
3E+10
2E+10
1E+10
0
2010
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2012
2014
2016
-1E+10 2018
The opening up of the economy also increased competition in the product market and managerial labour market.
This resulted in the reversal of the trend of unrelated diversification (demerger and disinvestment) and started the
merger and consolidation of related businesses.
Securities and Exchange Board of India (SEBI), which was established in 1988 as a non-statutory body, became
an autonomous body on 12 April 1992. It was accorded statutory powers with the passing of the SEBI Act 1992
for protecting the interests of investors in securities and promoting the development of the securities market and
regulating the same. Capital Issue Control Act was repealed, and the control over volume and pricing of capital
issues was abolished. SEBI initiated several reforms after the mega security scam in 1992 perpetrated by Harshad
Mehta, a stockbroker. SEBI’s regulations are comparable with those in advanced economies.
National Stock Exchange (NSE), the digital stock exchange, was incorporated in 1992 and was recognised as a
stock exchange by SEBI in April 1993. In 1995, the Bombay Stock Exchange (BSE) switched from an open cry
floor trading system to an electronic trading system. The Indian capital market, particularly the equity market
(cash segment) has grown significantly after the liberalisation (Acharya, 2019). Acharya (2019) reported that
“segments of the Indian capital market are comparable with counterparts in many of the advanced economies in
terms of efficiency (price discovery), tradability (low impact cost), resilience (co-movement of rates across
product classes and yield curves), and stability.”
Only in 1976, the term corporate governance, the concept of monitoring Board and audit committee surfaced in
the U.S.A. (Cheffins, 2013). Earlier the Board of directors in the U.S.A. was a management board. Top executives
strongly influenced the selection of directors, and the Board was expected to be collegial and supportive to the
management. It acted only in a situation of outright crisis. The concept of corporate governance and monitoring
board caught the imagination of the government and stock market regulators of countries – other than the U.S.A.
and the U.K.– after the Cadbury Committee in the U.K. submitted its report in 1992. The Committee incorporated
its recommendation in the Code of Best Practices, which became the model for developing a code of corporate
governance in different countries. India was no different. SEBI, for the first time, issued the code of corporate
governance in 2000. Stock exchanges, under the direction of SEBI, incorporated the Code of corporate
governance in the Listening Agreement (Clause 49). This is the first time that the listed companies were required
to induct independent directors on their board and the boards to form an audit committee. Earlier, boards in India
were similar to the boards the U.S.A. had prior to 1976. The Code of corporate governance failed to improve the
functioning of the boards and corporate governance did not improve. Boards got transformed into ornamental
boards with big names, who used to lend their names. Promoting families invest money, time and emotions in the
company. They do not like outsiders to interfere in the management of the company. Therefore, they select
independent directors known and r sympathetic to the promoter family and the senior management. Most
companies take the ‘tick-the-box’ approach to comply with the corporate governance regulation.
Clause 49 was revised many times, and in 2015, it was replaced by the SEBI (Listing Obligation and Disclosure)
Regulation 2015. This too was revised on many occasions to incorporate emerging global best practices. Every
board is now required to constitute the Nomination and Remuneration Committee, but it does not function
independently of the controlling shareholder. The question, ‘how independent are independent directors’
continues, although the Companies Act 2013, which came into force on April 1, 2014, includes several provisions
for strengthening the institution of independent directors. It also introduced audit reforms like the rotation of
auditors in order to protect the interest of the company and minority shareholders.
The National Stock Exchange (NSE) is ranked as the third largest stock exchange globally in terms of the number
of equity trades, as per the World Federation of Exchange (WFE) Report - 2019. NSE has over 1900 securities
listed on NSE with a market capitalisation of over Rs 154.32 lakh Crores (U.S. $ 2.10 trillion), as of Dec 2019.
The NIFTY 200 Index represents about 86.7% of the free-float market capitalization of the stocks listed on NSE
as of March 29, 2019.
I have analysed the shareholding pattern of companies in the NIFTY 200 index for understanding the
composition of the types of firms included in the index and getting insights into the shareholding pattern of those
companies. There are various definitions of family business (Diaz et al., 2019). Researchers use various
characteristics to define family business, and most use the ownership of ordinary shares and membership in the
board of directors. International studies on corporate ownership typically establish some minimum control
threshold such as 5%, 10%, or 20% (Villalonga, 2010). La porta et al. (1999) define a controlling shareholder as
having more than 20 percent voting rights. Using the 20 percent threshold, I have classified a company as family-
controlled if the promoter holding is 20 percent or more. I have used the term professionally managed companies
for other companies (i.e., companies with promoters holding less than 20 percent of shares). I have also treated
the subsidiaries of professionally managed companies as professionally managed companies.
The Nifty 200 index has 114 family-controlled companies (57%), 23 subsidiaries of multinationals (11.5%), 28
professionally managed companies (14%) and 35 state-owned enterprises (17.5%). If we go by the narrow
definition, which uses an additional parameter in defining family business – the business should continue in the
second generation, a few companies cannot be classified as family-controlled companies as they are controlled
by the first-generation entrepreneur.
Figure 3 shows that the promoters are tightening their grip on the companies controlled by them. However, some
promoters are selling their shares to multinationals, venture capitalists and asset management companies. For
example, ACC and Ambuja Cement were acquired by Lafarge Holcim 1n 2017. In 2016, New-York based
Blackstone, an Alternate Asset Management company, acquired a 60.5% stake in IT service firm Mphasis Limited
and subsequently sold 8 percent. Again in March 2020, it acquired 4.01 percent shares of the company. At present,
it holds 56.21 percent shares of Mphasis. Another example is Crompton Greaves Consumer Electricals Limited.
This company was born in 2016 when Crompton Greaves Limited (a Karan Thapar Group company) demerged
the consumer goods business from power and industrial systems segment. Its September 30, 2020, shareholding
report shows three foreign body corporates (promoters) are holding 26.19 percent voting rights.
Startups
As per Hurun Research Institute’s 2020 Report, India has 21 unicorns with an average age of seven years (two
are less than four years old) and a total valuation of $73.2 billion. As per the report, almost all promoters
of these 21 unicorns are IIT and/or IIM graduates and some have completed their education in universities
abroad.
Usually, the promoters enjoy the venture's growth and share only a small portion of the enormous wealth
they create. A case in point is Housing and Development Finance Corporation Limited (HDFC). At the age
of 65 years, H.T. Parekh set up HDFC in October 1977, when the concept of housing loan was unknown
in India. ICICI promoted the company. Deepak Parekh, the nephew of H.T. Parekh, nurtured HDFC and
retired as its chairman in 2009 holds just 0.7 percent of the voting rights (Times of India, 2020). At present,
HDFC has no promoter. The company and its three subsidiaries are included in Nifty 200.
Institutional investments
The interest of foreign portfolio investors (FPI) in the Indian market is increasing. It is evident by the
number of FII registered with SEBI. It was 997 at the end of 2006-2007 and increased to 9,136 at the end
of 2017-2018. The research concludes that foreign portfolio investment improves corporate governance
(Aggarwal et. 2011; Gillan and Starks, 2003). I have examined the percentage of foreign portfolio
investment in different types of companies. Table 1 below provides a summary of the shareholding pattern
of Nifty 200 companies.
Table 1 clearly indicates that the average FII shareholding in family-controlled companies (18.40 percent)
is non-trivial and total institutional holding at 31.40 percent is significant. Ther efore, intuitional
shareholders together can influence the corporate governance practices in family-controlled companies.
However, FPI holding was less than 15% in around one-half of all family-controlled entities included in
the Nifty 200 index percent(see figure 4).
100
80
60
40
20
0
0 10 20 30 40 50 60 70
FII holding (%)
100
80
60
40
20
0
-5 0 5 10 15 20 25 30
Mutual Fund holding (%)
Average FPI holding in professionally managed companies is significant (26.40 percent), average total
institutional holding is very substantial (46.40 percent). However, around 35 percent of the professionally
managed companies have less than 15 percent of FPI investment (see figure 6).
100
80
60
40
20
0
0.0 5.0 10.0 15.0 20.0 25.0 30.0
Mutual Fund holding (%)
Indian corporate governance code (CG Code) embedded in the SEBI (Listing Obligation and Disclosure)
Regulations 2015 is a hard law (comply or else), whereas, in the U.K. and some other countries, it is a soft law
(comply or explain). SEBI tracks the emerging global best practices and incorporates them in the CG Code
without delay. CG Code was last revised in 2019.
In September 2017, the government amended the Companies Act 2013 to restrict step-down subsidiaries to two.
In counting the number of subsidiaries, one 100 percent subsidiary will be excluded. A company may have as
many direct subsidiaries as it desires. The new rule is applied prospectively. Therefore, companies are not required
to close down existing step-down subsidiaries. Although the primary aim of this rule is to plug the loophole for
money laundering through shell companies, it will stop the use of the pyramid structure for controlling companies
with low cash flow rights.
The government created the National Financial Reporting Authority (NFRA) in October 2018 with a broad
authority to oversee the auditing profession and punish the auditor found guilty of negligence. NAFRA has
already taken penal actions against partners of one of the Big 4 firms. Effective from April 1, 2018, all listed
companies must apply Indian Accounting Standards (Ind AS), which is a clone of International Financial
Reporting Standards (IFRS). Indian Standards of Auditing are aligned with the international standards of auditing.
Those initiatives have improved the quality of financial reporting and audit quality leading to improved corporate
governance.
In India, Stewardship Code has been implemented effective from July 1, 2020. Under the code, institutional
investors need to monitor investee companies and intervene in their governance through meetings with the
management. Also, they need to have a policy on voting and disclose the voting behaviour.
SEBI mandated responsibility reporting by top 100 listed companies from 2012, top 500 listed companies from
the financial year 2015-2016, and top 1,000 listed companies from the year 2019-2020. In 2017, SEBI
recommended Top 500 companies to use of the Integrated Reporting <IR> Framework for annual reporting.
Awareness has been created about the benefits of good corporate governance. Some companies have good
governance practices. Still, many companies have adopted the ‘tick-the-box’ approach in implementing the code
of corporate governance. The institution of independent directors has remained weak and demand for
management-sympathetic independent directors continues. Most boards are somewhere between ‘rubber stamp
board’ and advisory board. The Satyam scam (2009), Kingfisher airlines failure (2012) and IL&FS scam (2018)
brought to the surface the poor corporate governance practices in companies in which big names were board
members. It is not that the board members colluded with the management. They did not fulfill their
responsibilities of applying due diligence while approving financial statements or strategies proposed by the
controlling shareholder. The auditing profession is adjusting to the new reality that they can no more act as a
friend, philosopher, and guide of the management. Shareholders, regulators and society expect the auditor to be
their friend and demonstrate a very high level of independence. Family-controlled companies are yet to come out
of the hangover of the managing agency system fully. However, the change is visible. India is at the cusp of
transformational changes in corporate governance.
In a nutshell
In 1991, India transited from the command economy to the market economy: Licensing raj was dismantled; the
capital market has been reformed to make it comparable with the capital markets in advanced countries in terms
of efficiency. FDI and FPI are encouraged; and the sellers’ market has been transformed into the buyers’ market.
A corporate governance code with the best corporate governance practices has been implemented. The
government has taken initiatives to improve the accounting and audit quality. A new corporate law (Companies
Act 2013) has been enacted and the government and regulators have taken steps to strengthen the institution of
independent directors. Moreover, the companies are now operating in a competitive environment and FPI
investment in Indian companies has increased.
All these measures have improved the corporate governance practices in only some of the companies. In general,
the family-controlled companies are yet to implement the corporate governance code in spirit. They have taken
the tick-the-box approach and look for management-friendly independent directors. In most companies, the audit
committee may be working at less than the desired level and the Nomination and Remuneration Committee may
be the most underrated committee. Still, a change towards the better is visible, and India is at the cusp of a
transformation in corporate governance.
References
Acharya, Viral V. Development of viable capital markets – the Indian experience. RBI Bulletin July 2019.
Aggarwal, Reena, Isil Erel, Miguel Ferreira, and Pedro Matos. "Does governance travel around the world?
Evidence from institutional investors." Journal of Financial Economics 100, no. 1 (2011): 154-181
Cheffins, Brian R. ‘The history of corporate governance’ in Oxford Handbook of Corporate Governance. Oxford
University Press (2013). Pp 47 (Kindle edition)
Gillan, Stuart, and Laura T. Starks. "Corporate governance, corporate ownership, and the role of institutional
investors: A global perspective." Journal of Applied Finance 13, no. 2 (2003).
La Porta, R., Lopez‐ de‐ Silanes, F. and Shleifer, A., 1999. Corporate ownership around the world. The Journal
of Finance, 54(2), pp.471-517.
Times of India (January 29, 2020)Deepak Parekh holds just 0.7% in HDFC that helped build. Available at:
https://timesofindia.indiatimes.com/business/india-business/deepak-parekh-holds-just-0-07-in-hdfc-that-he-
helped-build/articleshow/73717399.cms; Extracted on November 23, 2020
Villalonga, Belén, and Raphael Amit. "Family control of firms and industries." Financial Management 39, no. 3
(2010): 863-904
********
Yash Sharma
Yash Sharma is a Chartered accountant by profession, currently working with Swiggy. He cleared his CA in
2018 and is interested in the world of startups and ecommerce. Outside work, he likes badminton &
swimming.
Introduction
Instead of starting with a cliché statement, I will start with a fact. In the year 2020, the estimated loss to the global
economy due to data breaches is pegged at around $945 billion, or about 1% of global GDP. This is up about 80%
from two years ago and in addition to about $145 billion spent on cybersecurity in 2020. 2
$523
$475
$300
In this article, we understand what data and sensitive data mean, what incentivizes data breaches, and what does
it cost everyone, financially and otherwise. Besides, we look at some of the biggest data breaches in the past few
years and understand what is changing to prevent them in the future.
To understand why breaches (both intentional and unintentional) happen and why it sounds so serious, we need
to understand what data and its variants mean.
2
‘The Hidden Costs of Cybercrime’ – report by McAfee
In simplest of terms, any activity which takes place -- from the level of a little ant nest to a gigantic planetary-
scale -- generates data. In that sense, data is simply bits of information. Even our existence gives rise to many
data like age, gender, residence, and the list is practically endless. But not every data piece is economically
attractive.
Personal data, on the other hand, means any detail through which one can identify, with some accuracy, a living
person. However, every bit of personal information cannot be termed as personal data. For example, only by the
name Yash Sharma you cannot identify me. There can be many others by the same name. If you however have
the address and a phone number coupled with it, the name becomes a part of personal data.
And finally, the last piece of the puzzle, sensitive personal data. If any person’s ethnic origin, political opinion,
or similar detail can be identified by any information, it will be considered sensitive personal data. This data
requires the highest level of scrutiny and security because it can bias judgment and opinion towards another
person. To understand the importance of data privacy & security, imagining what could happen if someone with
malicious intent or opportunistic mindset gets hold of your sensitive personal information.
Access to sensitive data always yielded power. If someone knew any personal detail about you, he could have
always used it for his gain or your loss. So, why the debates on the security of data now? Earlier, the data used to
be collected and stored on paper and its summarization and use was a time-consuming process. As we entered the
digital world, everything went paperless and you started getting notifications from shopping websites as soon as
you googled any product.
In that context, a plethora of data can be summarized in minutes and can be turned into tangible profits with a
specific area of focus. The sheer volume and speed of availability of data are what makes data privacy and security
more important today.
Data privacy can be explained as policies and steps taken to ensure proper collection and usage of data. It is
concerned with ensuring that the data is obtained with the user’s consent and is accessible only to people and for
the purpose consented by the owner of data.
Data security, on the other hand, is the method to ensure data privacy. These can include both physical controls,
like locking the data servers in a cabin, as well as logical controls, like restricting access to limited authorized
users.
Suppose an organization collected my name and age through an online form. The bottom of the form described
how the data would be used and who could use the data, and the organization asked for my consent for the same.
This would be part of the data privacy policy. Once the data got stored on the organization’s servers, the data was
encrypted, the servers were put into a locked room and access to my data was protected by a password available
to certain people only. This would be data security to ensure what the organization told me under the data privacy
policy is upheld.
The collection and usage of data are taking the center stage while policy formulations of any function in almost
all organizations. Hence, having robust data privacy and security policy becomes of paramount importance. Yet,
as visible from Figure 2, only a small proportion of organizations have a plan to both prevent and respond to IT
threats.
We have a plan for both We have a plan to prevent We have a plan to respond We have a plan for neither Don't know
Figure 2
Source: 'The Hidden Costs of Cybercrime' - report by McAfee
In such a situation, there is a good chance of the occurrence of a data breach. Simply put, a data breach occurs
when sensitive information is accessed by someone who was not authorized to have it. Such breach can even be
unintentional. For example, at the beginning of 2018, the Defense Travel System (DTS) of the US Department
of Defense (DOD) accidentally sent out an unencrypted mail with an attachment to a wrong distribution list. The
mailer exposed personal details of about 21,500 U.S. marines, sailors & civilians; the details also included their
bank account numbers, truncated Social Security numbers and emergency contact info.3,4
There is an even more significant threat of intentional data breach, referred to as ‘hacking’. Traditionally, the
people who wanted to hack into a piece of code had to be the people who had the ability and knowledge. And
3
https://www.venafi.com/blog/7-data-breaches-caused-human-error-did-encryption-play-role
4
https://www.marinecorpstimes.com/news/your-marine-corps/2018/02/28/major-data-breach-at-marine-forces-reserve-impacts-
thousands/
then there were problems of doing the research, arranging the infrastructure, and selling the spoils after a
successful attack, which not every hacker wanted to do.
Enter outsourcing and e-marketplaces. Any common person, with no knowledge of coding but only an intent, can
now outsource all the services: from research to infrastructure to the entire attack. Outsourcing provides
convenience to both sellers and buyers. Some of the variants for services include:5
i. Research as a service, which covers finding vulnerabilities in a system and tools to exploit them
ii. Crimeware as a service, where code development and malware are provided
iii. Cybercrime infrastructure as a service, which covers spamming services and botnets, and lastly
iv. Hacking as a service, which covers cracking passwords and launching distributed denial-of-service (DDoS)
attacks.
All the foregoing arguments beg the question, why do data breaches, at least intentional ones, take place? The
answer: it is a profitable undertaking. To understand this, let us briefly look at the value of various data pieces in
the market and the cost to acquire them.
When it comes to the dark web, everything is a fair game. You can find bulk Instagram account, credit card
details, bank account details, citizenship & identity details and even the tools used to obtain all the above. From
a value perspective, Figure 3 depicts their price in the black market.Figure 4 outlines the costs to organize different
5
‘Cybercrime exposed: Cybercrime-as-a-service’ – report by McAfee
forms of data breaches. A banking trojan, for example, costs an average of $3,500. The number of total accounts
affected globally (only a limited set of Kaspersky protection users) was around 900,000. 6 Assume a trojan
campaign sends spam to only 500 US accounts. Even if we consider a 70% click rate of spam and assuming the
hacker can get bank info of about 50% of the people who clicked the spam mail, it makes 175 accounts.7 The
median savings bank balance in America $4,500.8 So, on average, the campaign can yield about $750,000.
As is visible from Figure 3 and 4, a data breach can be quite profitable. The high profitability, the ease of access
to the dark web, and the availability of ‘hacking as a service’ have led to an increase in breach incidents.
A N N UA L D ATA B R E A C H E S A N D N O O F
ACCOUNTS AFFECTED
2500 3500
3000
2000
2500
1500 2000
1000 1500
1000
500
500
0 0
2013 2014 2015 2016 2017
No of data breaches Accounts breached (in millions)
6
https://www.kaspersky.com/about/press-releases/2019_number-of-users-attacked-by-banking-trojans-grew
7
500*70%*50% = 175
8
https://www.thebalance.com/what-is-the-average-bank-account-balance-4171574
India ranked fifth in the world in terms of the number of attacks initiated during 2013-2017 (the US ranked first).9
In 2020, the average total cost of a breach in India was $2 million while the world average $3.86 million. However,
the time taken to identify and contain a data breach in India is 318 days while the world took 280 days on
average.10 Apart from the detection and remedial costs, data breaches also result in loss of business, disruption of
operations, loss of reputation and loss of employee confidence. Let us look at some examples of large data
breaches of the past and what did they cost.
i. LinkedIn
In 2012 and again in 2016, around 107 million LinkedIn user accounts (6.5 million & 100 million
respectively) were hacked and posted online for sale.11 12 LinkedIn has become a trusted forum for
professional interaction, and a breach of this size can hamper this trust. LinkedIn sent change password
emails to the affected accounts. For the 2012 breach, the company incurred more than $1 million towards
forensic investigation and recovery cost alone.. An additional $2 - 3 million was spent on strengthening
security. If we extrapolate the same cost for the 2016 fiasco, we get around $50 million in additional
expenditure.
ii. Equifax
In 2017, Equifax, one of the largest credit bureaus in the US, disclosed that an application vulnerability in
one of their websites exposed the personal data of about 163 million customers. The information included
Social security number, date of birth, address, and driver’s license number.13 Such information leak can
cause serious issues like identity theft for the owner. The company reached a settlement of $425 million
with the FTC in January last year.14
9
https://www.apcela.com/blog/data-breach-statistics/
10
https://www.ibm.com/security/digital-assets/cost-data-breach-report/#/
11
https://www.computerweekly.com/news/2240160962/LinkedIn-data-breach-costs-more-than-1m
12
https://blog.linkedin.com/2016/05/18/protecting-our-members
13
https://en.m.wikipedia.org/wiki/2017_Equifax_data_breach
14
https://www.ftc.gov/enforcement/cases-proceedings/refunds/equifax-data-breach-settlement
15
https://www.orfonline.org/expert-speak/data-privacy-pandemic-india-just-had-the-biggest-medical-records-breach-ever/
Healthcare remains the favorite target of hackers worldwide and even in each country. The average cost of a
data breach is also higher: $7.13 million in healthcare.16 One reason could be the price that a complete medical
profile may be worth. While identification numbers and credit card info can fetch a few dollars, a complete
medical information dossier can get prices anywhere between $300-$1000.17, 18
One might ask a question that given the importance of data and its protection, why do organizations fail to protect
it? The answer lies in the form of specific challenges that data protection presents.
There are standards for data protection both in India and elsewhere.
i. In Indian context:
a) Personal Data Protection Bill, 2019 – Still under consideration, one of the bill's highlights is the right to
be forgotten, which provides for removing private information about a person from internet directories
under certain circumstances. Critics, however, argue that this may result in the government taking control
of people’s data in the name of public welfare.19
16
https://www.ibm.com/security/digital-assets/cost-data-breach-report/#/
17
https://resources.infosecinstitute.com/topic/hackers-selling-healthcare-data-in-the-black-market/
18
https://www.forbes.com/sites/mariyayao/2017/04/14/your-electronic-medical-records-can-be-worth-1000-to-hackers/amp/
19
https://en.wikipedia.org/wiki/Personal_Data_Protection_Bill,_2019
b) Relevant sections of IT Act – Section 43A provides compensation to anyone who has suffered a loss due
to improper handling of their data by a body corporate. Section 72A, on the other hand, has provisions for
the imprisonment of any person who inappropriately utilizes information gained during a work
engagement.20
c) Digital Information Security in Healthcare Act (DISHA) – Still in the plans, DISHA makes the
individuals the owners of their own healthcare data and lays down the purposes for which digital
healthcare data can be collected and used by any entity.21
a) General Data Protection Regulation (GDPR): GDPR was one of the first legislations to focus on general
personal data security in the European Union and gives individuals control over their personal data. It
provides six lawful bases under which any personal data may be processed and a fine of up to € 20 million
for violation.22
Best Practices
Your data is your property, and no one has the right to access or use it without your consent. Yet, just like in the
case of your other properties, there would always be parties with mala-fide intentions wanting to gain at your
expense. Still, there are certain things that both individuals and organizations could do to prevent such things
from happening.
20
https://www.lexology.com/library/detail.aspx?g=08197ebe-aeb4-41d6-a855-ce57a313ea6d
21
https://www.lexology.com/library/detail.aspx?g=08197ebe-aeb4-41d6-a855-ce57a313ea6d
22
https://en.m.wikipedia.org/wiki/General_Data_Protection_Regulation
23
https://en.m.wikipedia.org/wiki/Payment_Card_Industry_Data_Security_Standard
Train your employees on how to identify Do not click on suspicious links or open email
suspicious activity attachments from unknown senders
Find, classify, and protect your most
sensitive data, particularly data covered
Use anti-malware software
under compliance regulations such as PCI-
DSS
Deploy patches as promptly as possible to Update your software regularly for security
shorten the vulnerability window patches
Be cautious accessing online banking sites,
Employ data encryption to protect sensitive
email, or other sensitive sites, especially when
data in transit and at rest
using public connections
Monitor cloud usage, manage access to Do not use the same password for multiple
cloud services, and secure any websites or services and allow a single
data/applications during migration compromised account to turn into many
Utilize security technologies such as anti-
malware software and intrusion detection Consider using credit monitoring services to
systems to build a shield around your detect suspicious activity
environment
Conclusion
We have seen that not even the largest organizations are entirely safe against the threat of data breaches, no matter
how tight the security. While locks may deter the public from entering your house, they do not deter thieves. The
financial incentives for data breaches (like every other major crime) are just too large. Still organizations must
follow the given standards and adopt best practices so that the instances can be timely identified and even reduced
to a greater extent.
*********
Teerna Chatterjee
Teerna Chatterjee is currently working as a credit manager at the Indian Bank (formerly Allahabad
Bank). She has close to ten years of work experience in the banking sector, working in the
agricultural credit as well as in the general credit departments. She did her Masters in Agriculture
from Bidhan Chandra Krishi Viswavidyalaya (BCKV), West Bengal.
1. Introduction
Over the years, we have witnessed the emergence of several e-commerce business models in the financial domain.
One such business model is Peer-to-Peer (P2P) lending, a form of crowdfunding through which money is raised
for the disbursement of credit and then gets repaid with interest (Dhawan, 2018). Crowdfunding is a method of
funding through money raised from a large group of individuals, usually with the help of a platform, including
online platforms that act as intermediaries (RBI, 2016). Thus, P2P Lending is "the use of an online platform that
matches lenders with borrowers in order to provide loans that are typically unsecured" according to Dhawan
(2018). This article explains Peer-to-Peer (P2P) lending and discusses its benefit and challenges for the MSME
(Micro, Small, and Medium Enterprises) sector.
A P2P lending platform is a marketplace, matching a set of borrowers directly with the group of investors (or
lenders). The platform, in turn, charges a transaction fee for every transaction encountered through it. Individuals
register themselves on the P2P platform by providing key information like personal details, professional details,
and financial details. The platform then performs due diligence by verifying the information itself for assessing
the creditworthiness of the individuals. Thereafter, the platform lists all approved borrowers and lenders who can
participate in lending or borrowing on its portal.
On P2P lending platforms, lenders can observe borrower loan listings, borrower's personal, professional, and
financial information, loan purpose, and a brief description as to why lenders should make the loan offers to them.
These details help lenders make an informed decision about making a loan to a borrower. The borrowers receive
offers from numerous lenders, and likewise, lenders can also propose lending offers to multiple borrowers, thereby
diversifying the default risk (Thanawala, 2020a). When the funding for a loan becomes 100%, the loan can be
ready for disbursement, subject to the borrower’s acceptance. Disbursal occurs only after signing of the agreement
of loan between borrower and lender. After that, the money is transferred to the borrower's account from the
lender for the loan amount, and EMI begins to transfer from the borrower to the lender.
According to the RBI, India had 21 P2P Lending companies as of 2018 (RBI, 2018). Some of them are involved
in businesses directed at microfinance activities. The main aim of the P2P lending firms is to create a social
influence and provide easier access to credit to small entrepreneurs and MSME. Thus, "P2P Lending platforms
are largely tech companies registered under the Companies Act and acting as an aggregator for lenders and
borrowers thereby, helping create a match between them" (Roy and Lele, 2016).
The words "finance" and "technology" can together be abbreviated as FinTech. FinTech is defined as " any
technology that’s used to augment, streamline, digitize or disrupt traditional financial services " (Walden, 2020).
Peer-to-Peer (P2P) lending platforms are one of the most commonly used FinTech products across the industry.
Apart from P2P lending, FinTech also encompasses intermediaries like crowdfunding, Blockchain technology,
cryptocurrency, and payment gateways (RBI, 2018). Further, these advanced technologies facilitate the efficient
functioning of the credit process and access to credit by drastically reducing the transaction time. Initially, P2P
lending involved one-to-one matching, but now it has evolved into a marketplace for institutional and individual
investors to lend to borrowers through a portal. Sometimes the P2P lending firms also follow a reverse auction
mechanism where both the lender and the borrower enjoy complete liberty to accept or reject the borrower and
the lender's bid for the borrower's loan proposal (Lee and Lee, 2012) respectively.
In this section, we will explain the P2P lending process through five theoretical lenses.
According to Coleman (1994), social capital is "the structure of relations between actors and among actors." The
theory of social capital entails the necessity of social bonds and social norms forming an indispensable part of our
livelihoods' sustainability (Pretty & Ward, 2001). P2P lending platforms use some unique features, for instance,
a) assessing risks on soft information and b) employing social collateral for loan screening (Liu et al., 2020).
Thus, both soft information and social collateral act as the most crucial considerations while screening the
unsecured loans. P2P lending differs from the traditional lending market because the loan is not guaranteed against
tangible collaterals (Ba, 2001). The rationale, as suggested by Egli et al. (2006), is that the entrepreneurs seeking
credit are likely to maintain a good reputation as they require credit repeatedly in the future, which could also
help them to lower the cost of financing. Such accumulated reputation forms social capital, which can serve as
social collateral, and hence enables the lenders to participate in the credit process.
When it is challenging to access tangible information, lenders can leverage soft information such as the wisdom
of the crowd, which may be qualitative or quantitative. They may use soft information to assess the risks and
increase the loan availability for the borrower. Thus, soft information loosens the constraints for the borrowers
by reducing the collateral requirements. Further, compared to a credit score-based risk evaluation, a risk
assessment based on soft information reduces loan default likelihood (Iyer et al., 2016).
P2P lending platforms operate entirely in online mode, have fewer regulatory compliance requirements, and have
lower overheads. As a result, they can provide services at a cheaper rate than comparable brick and mortar
financial institutions. Furthermore, they directly connect lenders with borrowers (without a need for another
intermediary). It also removes the intermediaries' margin (Economic Times, 2019), which results in a lower
interest rate for the borrowers, while the lenders can expect to lend at higher interest rates than the traditional
financial institutions like banks owing to the additional risks. Thus, P2P platforms lower transactional costs.
Personal loans form the bulk of transactions executed through the P2P lending platforms and are mostly
unsecured. Recently, due to their fast and convenient loan disbursement processes, P2P platforms are also
attracting budding entrepreneurs (interested in loans for their startups) and small businesses. The post-ILFS crisis
credit crunch and the repo rate increase have resulted in P2P lending gathering momentum in India (Gandhi,
2019).
Information asymmetry occurs if one entity during any transaction possesses more or better quality information
than the other entity. The existence of information asymmetry between the borrower and the lender creates a
significant challenge in P2P lending. As a result, both lenders and platforms have lower trust in borrowers (Lin
et al., 2017). Further, given this information asymmetry, P2P lending platforms attracted more borrowers with
poor credit ratings. This problem was also seen in second-hand cars as studied in the classic "Market for Lemons"
by Akerlof (1978). A study made by LenDen Club, a P2P platform, found that 80% of the borrowers are under
35 years of age and 71% of the borrowers have a monthly income of less than ₹30,000 (Thanawala, 2020b). This
finding indicates that an average borrower on the P2P platform has a weak credit profile, meager income, and
limited discipline of saving for emergencies. Leading P2P lending firms, such as Prosper, work with credit rating
agencies to mitigate the information asymmetry (Lee and Lee, 2012).
As the P2P lending platform offers a higher return, it attracts those investors who are ready to take higher risks.
We can define financial risk as the deviation of actual financial outcomes from the expected financial returns.
Risk can both be upside or downside. It is apparent from the idea of the security market line that if two investments
offer the same returns, investors prefer investing in the one with lower risk. From the above three theories, it is
evident that the risk of default of the assets created through P2P platforms is higher. Therefore, only lenders with
high risk tolerance should lend on this platform.
P2P platforms act like a two-sided market where their success depends upon the network effects. According to
Rochet and Tirole (2006), a two-sided market is defined as "a platform enabling interactions between end-users
and charging a fee from either side." Thus, in the presence of the network effect, the value of any product or
service increases with the number of others using it. It is also worthwhile to note that the network effects become
significant only when a critical mass – a minimum number of individuals – subscribe to the product or the service.
At that critical point, customers derive higher value from the product or the service than the cost incurred by them
to subscribe for the service or purchase of the good. Since the user base determines the overall value of the good
or the service, additional users will subscribe to the service or purchase the good only when the critical mass of
users has crossed. It is also to be noted that in the absence of perfect information, individuals show a tendency to
herd (Bikhchandani and Sharma, 2000).
The MSME sector contributes immensely to generating employment, promoting innovation, adding to exports,
and thereby enhancing the Indian economy's inclusive growth in a significant way. Given its immense potential,
MSME can even contribute further in the presence of proper support systems. For instance, in the last decade, its
growth is quite impressive in terms of production volume, employment generation, and exports. Its contribution
to overall employment generation is approximately 120 million, and 30% to India's GDP recently (Mehta, 2019).
Further, it has been contributing towards entrepreneurial development through business innovations. For instance,
in the manufacturing sector alone, MSMEs account for a wide range of products encompassing both traditional
as well as high-tech products (Annual Report of the Ministry of MSME, 2018).
MSMEs require reassurance and funding to support India’s inclusive economic growth. However, the informal
nature of MSMEs and a lack of audited financial statements for such enterprises make the assessment of their
creditworthiness is extremely difficult for banks and other financial institutions. As a result, an MSME finds it
difficult to fulfil a bank’s standards for extending credit. It aggravates the information asymmetry with respect
to the financial parameters of the business, and hence the access to credit becomes limited. This is evident from
the fact that the estimated credit demand by the MSMEs is ₹69.3 trillion, whereas the formal banking sector can
cater to only 16% of the overall credit requirements, and the remaining happens through informal sources,
including moneylenders, who charge exorbitant interest rates (International Finance Corporation, 2018).
Furthermore, the access to equity and venture capital financing is limited to a few MSMEs (Singh and Wasdani,
2016).
Given that 84% of the MSME credit requirement is still untapped through formal financing and the addressable
credit gap has soared to ₹25 trillion (International Finance Corporation, 2018), there lies the immense potential
of P2P lending platforms to create an alternative supply of credit for the MSMEs. It will immensely benefit the
borrowers who can also be separated from the informal institutional creditors like moneylenders and chit funds
and become a part of the formal economy, thereby accessing cheaper and faster credit. With internet penetration
in India stands at 504 million active users, covering 40% of the individuals with age greater than five years, the
P2P acceleration is also becoming more plausible (Mishra and Chanchani, 2020).
A major issue with the P2P platforms is the lack of repeat business with the borrowers. For instance, at the P2P
platform LenDen Club, new borrowers constitute 63% of the total number of borrowers (Lenden Club, 2020).
The potential reasons could be borrowers being attracted to borrowing from the P2P platform primarily for
emergency and aspirational needs, and the recurrence of such events might be intermittent. Another underlying
reason could be that owing to the absence of any physical collateral, and it is increasingly attracting some
borrowers having the ill intention of defaulting.
5. Conclusion
P2P lending has witnessed rapid growth in the recent past globally. However, the penetration is limited beyond
the USA, the UK, and China. Though P2P lending in India is in the preliminary stage, its potential benefits to
various stakeholders (like borrowers, lenders, agencies, etc.) despite its associated risks are promising
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