What is HAWALA???

Hawala, a word that has been making headlines across the globe for many years. Names like Naresh Jain, Madhu Koda, Hasan Ali Khan etc have been associated with Hawala in India and have gained popularity albeit in the wrong sense. Many of us may have heard this term in news channels or from friends but not many of us know what it is or how it works. The purpose of this article is to help you understand what it is...

Before we begin - Disclaimer: I am not suggesting that you try or use Hawala for your money transfer needs. It is illegal in most countries and you can face stiff penalties as well as jail time if you indulge in it. This article is purely for educational purposes only...

So, What is Hawala?

The word "Hawala" means trust. Its is an alternative or parallel remittance system, which works outside the circle of banks and financial systems established by countries worldwide. Hawala is an ancient system of money transfer which originated in South Asia and is now being used across the globe.

Where did Hawala come from?

Yes, you guessed it right. WE INDIANS CREATED IT!!!

This system was mainly developed in India, before the introduction of western banking practices. It is also sometimes referred to as "Underground Banking" by western countries.

Definition of 'Hawala' - Source Investopedia - http://www.investopedia.com/terms/h/hawala.asp

An alternative remittance channel that exists outside of traditional banking systems. Hawala is a method of transferring money without any actual movement. One definition from Interpol is that Hawala is "money transfer without money movement." Transactions between Hawala brokers are done without promissory notes because the system is heavily based on trust.

Is Hawala Legal?

Though it is being used across the world to remit funds, it is not a legal system. It works on the basis of many middle men called the hawaldars or the hawala dealers or the hawala brokers. It is illegal because money is transferred without paying the actual legal fee's and charges before moving money from one country to another. It is also illegal because Hawala moneybrokers have been known to facilitate terrorist financing.


If it is illegal, why is it used then?

The reason, why Hawala is extensively used inspite of the fact that it is illegal, is the inseparable element of trust and extensive use of family or regional affiliations. Some of the reasons why people still use Hawala are:

1. To Launder/Move black money - If you go via the proper channels you need show source of income
2. Does not require any ID or Address proof
3. You get better exchange rates (Because Hawala brokers dont need to pay any fee or charges for moving funds from one country to another)
4. You need not pay any taxes
5. To fund terrorist activity because Hawala is the only possible mechanism for them. Any other legal channel would outright refuse to do business with such individuals and expose them to the law enforcement authorities

How does Hawala work?

Have you seen the Rajnikanth Starrer directed by Shankar - Shivaji (The Boss)?

If you have seen the movie then you already know how Hawala works. Remember how Thalaivar (this is how we address Rajnikanth in Tamil Nadu) looted the black money from corrupt politicians and businessmen and then Vivek contacted an old man and delivered crores of money in pizza delivery bikes? Thalaivar handed over a 1000 rupee note to a guy in New York and voila, he got millions of dollars - USD. This is Hawala.

Hawala works by transferring money without actually moving it. In a hawala transaction , no physical movement of cash is there. Hawala system works with a network of operators called Hawaldars or Hawala Dealers.

Step 1: A person willing to transfer money, contacts a Hawala operator at the source location (Vivek in Chennai).
Step 2: The hawala operator at that end collects the money from that person who wishes to make a transfer.
Step 3: An authentication mechanism is agreed upon (The 1000 rupee note that Thalaivar carries with him to New York)
Step 4: He then calls upon his counterpart or the other Hawala operator at the destination place/country was the transfer has to be made. (The old man from Chennai calling up his compatriot in USA)
Step 5: Now the hawala operator at the tranferee’s end, hands over the cash to the intended recipient after verifying the authentication code & deducting a certain amount of commission. (Rajinikanth receives USD after the American sees the 1000 rupee note)

In this manner, money never actually moves. The positions held by the hawala operator’s in each others books gets squared off.

Hope this article helped you get a high level idea of what Hawala is. If you have any questions, feel free to leave a comment and I will get back to you...

Before we wrap up - Let me repeat the Disclaimer: I am not suggesting that you try or use Hawala for your money transfer needs. It is illegal in most countries and you can face stiff penalties as well as jail time if you indulge in it. This article is purely for educational purposes only...

Has the Gold Bug Bitten You?

The past one year has been really hard for gold investors. They have witnessed carnage in gold prices and have seen the value of their investments go down, day after day. In one of our older articles titled Why is Gold Price Falling? we had taken a detailed look at why the gold price is falling in the recent past. However, that is not the purpose of this article.

As collateral damage due to this fall in gold prices, individuals who had pledged their gold jewelry to make some quick cash to meet their funding demands have been caught unaware. The purpose of this article is to understand what problem these individuals are facing and how to handle the situation.

Before we begin: As you all may be aware, companies that grant loan against gold have been coming up in hundreds over the past year or so. Last year in June, I had written an article in this blog titled Tough Times Ahead for Gold Loan Companies where I had elaborated on these companies and the problems they face. It was just a matter of time before they ran into trouble and the inevitable has just happened in the past few weeks.

Who did this Gold Bug Bite?

The gold bug bit anyone and everyone who had recently pledged their gold jewelry at a bank or a gold loan company to get money.

Why is this Gold Bug Biting people?

The reason is simple – The Gold Loan Company Wants to Minimize its Losses.

Read this example from a banks perspective to understand the situation – before I actually explain what this bug bite is:

Let us say you run ABC Gold Loan Co, and I turn up at your branch to pledge 100 grams of Gold on 1st January 2013. Let us say, on that date, one gram of gold is being sold in the market at Rs. 3000/- and you are happy to give me a loan for 90% of the price value of the gold I am ready to pledge. Which means, you give me a loan of Rs. 2,70,000/- for the 100 grams of gold that I pledge with you. The difference of Rs. 30,000/- will be your cushion in case I default.

Sounds straightforward isn’t it?

Here comes the kicker…

Let us say, today 28th May 2013, the price of gold is only Rs. 2200/- per gram and I have just made interest payments in the past 6 months. So, the loan amount outstanding against my name is Rs. 2.7 lacs while the value of the 100 grams of gold I pledge with you is only Rs. 2.2 lacs.

Common sense would tell me that, it would be cheaper for me to let the loan default rather than pay 2.7 lacs for gold that is worth only 2.2 lacs. Isn’t it?

Gold Loan customers these days are doing this exact calculation outlined above and are willing to default on their loans instead of repaying their loan obligation.

What is this Gold Bug Bite?

Banks and Gold Loan companies are sending out letters to their loan customers to make either a part or full repayment of their loans to redeem their gold jewelry.

Can the Bank or Gold Loan Lender ask for this kind of repayment?

Yes, they can. If you read the loan terms & conditions carefully, there will be a clause which would say that the bank or the lender at his/her discretion can ask for part or full repayment of the loan at any time they want.

This, at their discretion means – they can ask for part or full repayment if they feel the value of the collateral held isn’t enough to meet the loan.

Go back to the above example, you as the owner of ABC gold loan co, will be sending me a letter stating that the value of the gold I have pledged isn’t enough to offset the loan outstanding. So, I should make a part or full repayment of my loan money. If I do not have surplus funds to meet your repayment needs, I may have to let the loan go into default…

What are my options – As the Loan Customer?

Option 1: The first option would be to minimize losses from my side and let the loan default because, I will actually be paying more money than what my gold is worth.

Limitations: None. You can do it anytime you want

Problem Due to Option 1: If I default on my loan, my credit history will go for a toss and no one will be willing to give me a loan in future. Banks and lenders these days are giving more and more importance to our credit history before actually giving us loans.

So, Option 1 is a REALLY BAD IDEA…

Option 2: Make a part or full repayment of the loan and redeem your gold if you have surplus cash available.

This is the best or easiest option because the bank or lender will be more than happy to close the loan or accept part repayments to keep their margins safe.

Limitations: You cannot do this if you do not have surplus cash

Problem Due to Option 2: None

Option 3: Pledge more Gold
If you do not have surplus funds to make a part or full repayment, you may consider pledging more gold as collateral to cover your loan. Most lenders will be happy to accept more collateral to cover the loan they have granted you.

Limitations: You cannot do this if you do not have surplus Gold

Problem Due to Option 3: None

From a borrowers perspective, these are our only options. Though we can let the loan default, we will end up making more damage to our credit history than the small profit we may make. So, try to liquidate your savings or borrow money from friends and family to do a part repayment as per Option 2.

Remember: The bank or lender cannot force you to do a full repayment immediately. They can only ask for part repayment or additional collateral to cover the loan amount. They may try to intimidate you into submission but the fact is, as a customer you have rights. It is a collateralized loan and the maximum liability from your side is – forfeiting the item you pledged as collateral if you default. They cannot bully or intimidate you any further. You can tell them that the best you can do is make a part repayment or pledge additional gold to cover their margin and that is all. If they push too much you will let the loan default and they can sell your gold to cover their losses.

Chances are that the bank or the lender will come down on their demand and let you do a part repayment or pledge more gold.

Best Wishes!!!

Debentures DeMystified

The Term Debentures is used very frequently in the Indian Markets and not many of us are aware of what they are or how they work. The idea of this article is to help us learn more about these debt instruments.

What is a Debenture?

Debentures function more or less like bonds. One can also term debentures as a variant of bonds. Debentures are issued by a company which offers to pay interest in lieu of the money borrowed for a pre-specified period. In essence, it represents a loan taken by the issuer who pays an agreed rate of interest throughout the life of the instrument and repays the principal normally, unless otherwise agreed, on maturity. Bonds on the other hand are more secured than debenture. As a debenture holder, you provide unsecured loan (most of the times debentures are unsecured in nature) to the company. Debentures carry a higher rate of interest as the company does not offer any collateral to you for your money. For this reason bond holders receive a lower rate of interest but are more secure in nature.

Some debentures also offer put and call window, where the issuer can call for repayment or the debenture holder can put for redemption after a certain period but before the maturity date. Debentures are further categorised based on their security and convertibility to equity shares. i.e. the debenture holder has the privilege to convert his status from a lender to an owner in the company.

Based on convertibility, you have the following options to choose from:

Non-Convertible Debentures (NCD): These instruments retain the debt character and cannot be converted into equity shares.

Partly Convertible Debentures (PCD): A part of these instruments are converted into equity shares in the future at notice of the issuer. The issuer decides the ratio for conversion, which is normally decided at the time of offer.

Fully convertible Debentures (FCD): These are fully convertible into equity shares at the issuer's notice. The ratio of conversion is decided by the issuer. Upon conversion the investors enjoy the same status as equity (i.e. ordinary) shareholders of the company.

Optionally Convertible Debentures (OCD): The investor has the option to either convert these debentures into shares at a price decided by the issuer/agreed upon at the time of the offer.

Based on the security offered by the debenture, they are also classified into the following types:

Secured Debentures: These instruments are secured by a charge on the fixed assets of the issuer company. So if the issuer fails on repayment of the principal or interest amount, then the assets of the issuer can be sold to repay the liability towards its lender. However the secured nature of the debenture does not guarantee your principal, but it only gives you the right at par with the other lenders of the company to have a claim on the assets of the
company.

Unsecured Debentures: These debentures unlike the ones mentioned above, aren’t secured against the assets of the company. Thus if an issuer defaults on payment of the interest and (or) the principal amount, then you, as a lender, do not have a claim against the assets of the company, and are exposed to very high risk.

Now, that you are aware of the various types of debentures let us move ahead and understand as to who regulates debt market in India, which will be the topic of our next post!!!

A Comparison between ICICI Bank and HDFC Bank

ICICI Bank is the Largest Private Sector Bank in India and HDFC Bank is a close second. If you talk to a random stranger on the road, there is a 50-50 chance that he/she has an account with either of these two private sector behemoths. Both ICICI and HDFC Bank are part of the National Stock Indices and are some of the most active stocks in the country. The purpose of this article is to compare these two banks on all possible aspects.

About the Company's:

ICICI Bank is the Second Largest Bank in India and the Largest Private Sector Bank in the country. The bank has a network of 2800+ branches, 10000+ ATMs and has presence in 19 countries. It was founded in the year 1954 and is headed by Ms. Chanda Kochhar (MD & CEO). It offers a variety of financial services like Consumer Banking, Credit Cards, Corporate Banking, Investment Banking, Private Banking, Wealth Management etc. It is one of the members in the 30 stock Sensex and 50 stock Nifty.

HDFC Bank is the Second Largest Private Sector Bank in India and one of the top 5 banks in the country. The bank has a network of 2700+ branches and 10000+ ATMs across India. It also has numerous branches across the globe. It was founded in the year 1994 and is headed by Mr. Aditya Puri (MD). It offers a variety of financial services like Consumer Banking, Credit Cards, Corporate Banking, Investment Banking, Private Banking, Wealth Management etc. It is one of the members in the 30 stock Sensex and 50 stock Nifty.

Shareholding Pattern:

The following table illustrates the % holding of shares of these two companies by the different categories of investors.

Criteria	ICICI Bank	HDFC Bank
Indian Promoters Holding (%)	0	23.2
Indian Institutions/Mutual Funds (%)	26.6	10.5
Foreign Institutional Investors (FIIs) (%)	35.9	30.7
ADR & GDR (%)	26.9	17.3
Free Float (Public Holding) (%)	10.6	18.4
Approx No. of shareholders	7 lakh+	4.5 lakh+

Key Financial Data:

The following table illustrates the key financial data/numbers for both the banks. As you can see below, both these banks are high profitable and have solid assets and customer base.

Criteria	ICICI Bank	HDFC Bank
P/E	16	24.6
P/BV	2.2	5.5
Average Divident Yield (%)	1.9	0.9
Earnings Per Share (EPS)	Rs. 66.3	Rs. 22.4
Income Per Share	Rs. 329.6	Rs. 117.6
Book Value Per Share	Rs. 531.6	Rs. 128.6
Outstanding Shares	1153 million	2347 million
Average Market Capitalization (Approx)	Rs. 1.02 Lakh Crores	Rs. 1.13 Lakh Crores
Number of Employees (Approx)	58000	66000
Profits Before Tax	Rs. 10,866 Crores	Rs. 7,624 Crores
Profits After Tax	Rs. 7,643 Crores	Rs. 5,247 Crores
Net Profit Margin (%)	20.1	19
Advances/Loans (Approx)	2.92 Lakh Crores	Rs. 1.98 Lakh Crores
Deposits (Approx)	2.81 Lakh Crores	2.46 Lakh Crores
Credit/Deposit Ratio (%)	103.6	80.7
Net Fixed Assets (Approx)	Rs. 5,432 Crores	Rs. 2,378 Crores
Total Assets (Approx)	Rs. 6 lakh Crores	Rs. 3.4 lakh Crores
Debt/Equity Ratio	7.2	9
Net NPA's (%)	0.007	0.002

Terms Used in this Article That you may not remember immediately:

ADR – American Depository Receipts
GDR – Global Depository Receipts
ADR & GDR are used by private organizations to raise funds from foreign investors.

P/E – Price to Earnings Ratio
P/BV – Price to Book Value
EPS – Earnings Per Share
P/E, P/BV, EPS etc are all Market Ratios that are used to gauge the financial health of a company. They were covered in one of our earlier article titled “Market Ratios”. You can revisit the article and learn more about them by Clicking Here

NPA – Non Performing Asset. This is the % of loan money the bank has disbursed but isn’t being repaid by the borrowers. Simply put – this refers to Bad or Defaulted Loans.

Hope you found this article useful. If you wanna see more comparisons, leave a comment in this article or in our facebook page and I will try to do the comparisons…

Disclaimer: All the details above were taken from the respective company websites and other financial websites in the Internet. I have just collated the requisite info in one place and cannot guarantee on the accuracy of the same.

Do I Need Debt Instruments in my Portfolio?

In the past couple of articles, we took a look at the Debt Markets in India as well as the different types of Debt Instruments that are available for us to invest in. However, the biggest question we all will have right now is "Do I Need Debt Instruments in my portfolio?"

The purpose of this article is to, try to answer this question...

If I were to answer this question in one word, the answer would be - YES.

Yes, we need Debt Instruments in our portfolio. The reasons are as follows:

1. Portfolio Diversification

Portfolio Diversification is a term used by investment experts to suggest that we must invest in different types of instruments and should not stick to just one asset class. By investing in various asset classes like Equities, Gold, Debt, Real Estate etc., we can cushion our portfolio against adverse effects of downfall in any of the aforementioned categories. For ex: If all your investments are in the Stock Market and the market takes a plunge, what would happen? You will end up losing a lot of money. Whereas, if you had diversified your portfolio and included other asset classes like Debt, Gold etc., your losses could've been minimized...

2. Capital Preservation

One of the main reasons why people especially elders prefer Debt Instruments is "Capital Preservation". The profits I make out of my investments may be low, but my principal amount invested will never be in question. In case of other asset classes like Gold or Equities or Real Estate, there is a chance that the value of my asset goes down below the price I paid for it. In case of Debt Instruments, that will never happen. So, owning a certain portion of your assets in debt instruments shields your capital from the volatility of the other asset classes.

3. Generate Regular Income

Debt Instruments are excellent at capital preservation. They are also very good at generating regular income. A big portion of the senior citizen population in this country depend on Interest Income for their sustenance. Usually when people retire, they get a lump sum amount from EPF, Gratuity etc. They usually deposit that money in a bank fixed deposit in monthly or quarterly interest paying options and then use the interest income for their sustenance. A few months ago, there was an article titled "Have You Thought About or Planned for Income After Retirement?" where I had shared some ideas to generate regular income after retirement. Debt instruments were the top 3 suggestions in that article.

4. Liquidity

Yet another strong point for Debt Instruments is their liquidity. Debt Instruments are highly liquid. Based on the timeframe for your investment you can choose the type of debt instrument that suits your needs perfectly. Durations as low as a few days to as long as 10 years or more are available. In almost all cases, options of premature withdrawal too exist which makes them the best asset class in terms of Liquidity.

Trivia:

Liquidity is a term used to signify, how easy it is to sell an asset and convert it to cash.

As you can see, Debt Instruments have their strong points which suggest that, even the Most Aggressive type of investor must have around 20-25% of his/her investments in Debt Instruments.

On the flip side, Debt Instruments do not give the extravagant rate of returns like Equities which makes them less favorable. However, I personally feel that everyone must have a healthy exposure to debt instruments for the four reasons mentioned above...

Components of the Indian Debt Market

As we saw in the previous article the Debt Market in India is growing at a rapid pace and is becoming increasingly interesting for Investors worldwide. Any market has a number of components or should I say participants. The Components of the Indian Debt Market include:

1. Investors - You and Me
2. Regulators
3. Debt Market Segments

The purpose of this article is to understand more about the Regulators of the Indian Debt Market and the broad classifications of the Instruments available in the Debt Market.

The Indian debt market can be broadly classified into four Segments. They are:

1. Money Market
2. Bank and Corporate Deposits Market
3. Government Securities Market
4. Corporate & PSU Bond Market

Let us now look at them one by one...

Money Market:

Money market refers to the market where the requirement or arrangement of funds is for a short-term. Short-term refers to a period of less than one year. As such money market instruments have a maturity of less than one year. The most active part of the money market is the market for inter-bank overnight (i.e. less than a day) call and term money between banks and institutions and repo transactions (banks' borrowing window from the RBI).

Some of the commonly used Money Market Instruments include:

1. Certificate of Deposits (CDs)
2. Commercial Papers (CPs)
3. Inter-Bank Participation Certificates
4. Inter Bank Term Money
5. Treasury Bills
6. Bill Rediscounting, Call / Notice / Term Money
etc.

Money market instruments are mainly used by Banks and other institutions to meet their short term cash requirements.

Bank and Corporate Deposits

Bank fixed deposits (FDs) are very common amongst the investors as a traditional investment avenue for decades. The tenure of bank fixed deposits range from 7 days to 10 years. Corporate deposits are nothing but fixed deposits where the issuer is a company or an institution other than a bank. Over here the interest rates vary depending upon the credit quality of the issuer.

Stories of Deposit Co.’s cheating investors by promising high returns have headlined numerous newspapers in India but still the Investor population of this country still continue to fall prey to false promises and greed. Any Debt Instrument that offers more than 10% returns has a high probability of going bust and you must never and I mean never trust them. Even if you are slightly tempted to try these out, limit your exposure to a few thousand rupees. Do not invest in lakhs and then feel for it in future!!!

Independent rating agencies assess the credit quality of the company and assign the rating indicative of the risk involved in the investment. Thus, higher the credit rating lower is the interest rate offered and vice-a-versa. However, sometimes companies raise money without securing a credit rating from independent rating agencies. In such cases companies often pay higher interest to attract investors. In such cases, Investors must be cautious and not invest too much money in a single company.

Government Securities Market

G-Secs or Government Securities are debt papers issued by the Government with a face value of a fixed denomination. In India, G-secs are issued by Government of India at face value of Rupees One Hundred in lieu of their borrowings from the market. These can be referred to as certificates issued by Government of India through the RBI acknowledging receipt of money in the form of debt, bearing a fixed coupon or interest rate (or otherwise) with interests payable semi-annually or otherwise and principal as per schedule, normally on due date of redemption.

Government Securities includes all Bonds, T-bills and instruments issued by the Central Government and State Government. These securities are normally referred to, as ‘gilt-edged’ as repayments of principal as well as interest are totally secured by sovereign guarantee and are 100% safe.

Corporate & PSU Bond Market

Corporate Bonds are issued by Public Sector Undertakings (PSUs) and private corporations in India. These bonds are issued for a wide range of tenors. The normal tenors range from 1 year to 15 years. As compared to Government Securities which are free of default risk; corporate bonds may turn out to be risky. This riskiness depends on the issuing company’s credit rating, the business into which the
company is in, the sector in which the company operates and the prevailing market conditions. As with corporate deposits, each issue comes with a Credit Rating which is assigned by a credit rating agency. This rating determines the risk involved and as always, higher the risk, higher will be the interest offered.

Regulators of the Indian Debt Market

Like any other market which needs to be regulated for its smooth and efficient functioning, the debt market in India is regulated by Reserve Bank of India (RBI) along with the Securities and Exchange Board of India (SEBI). Of the four major segments outlined just above, some are regulated by SEBI and some by RBI.

Reserve Bank of India

The RBI has the Money market and the G-Secs market under its purview. Apart from its regulatory role it also performs several other important functions such as managing the borrowing program of the Government of India, controlling inflation (by managing policy/interest rates in the country), ensuring adequate credit at reasonable costs to various sectors of the economy, managing the foreign exchange reserves of the country and ensuring a stable currency environment.

Moreover, the RBI controls the issuance of new banking licenses to banks. RBI also controls the manner in which various scheduled banks raise money from depositors. Further, it controls the deployment of money through its policy measures on Cash Reserve Ratio (CRR), Statutory Liquidity Ratio (SLR), priority sector lending, export refinancing, guidelines on investment assets etc.

Securities and Exchanges Board of India

The SEBI acts as the regulator for the corporate debt market and the bond market wherein the entities raise money from the investors through a public issue. The regulation comprises of manner in which the money is raised and tries to ensure a fair play for the retail investors. It forces the issuer to make the retail investor aware of the risks inherent in the investment, through its disclosure norms. SEBI also regulates the Mutual Funds and the instruments in which these mutual funds can invest. Investment from Foreign Institutional Investors (FIIs) also falls under the SEBI’s scanner.

Other Regulators in the Indian Debt Market:

Apart from RBI and SEBI, there are several other regulators which are specific for different classes of investors such as the Central Provident Fund Commissioner and the Ministry of Labor to regulate the Provident Funds. Also, Religious and Charitable trusts are regulated by the respective Government of the state in which these trusts are located.