Constitution of India – An overview

                                   

Indian judicial system came past a long path replete with enriched experiences, before it got ensconced with a proper constitutional framework in the year 1950. As it is widely known, the architecture of the constitution is made up of several adoptions from several judicial systems around the world.

From the British social structure, the factors of Parliamentary form of government, the position of speaker of the parliament have been adopted.

 Fundamental rights, judicial independence from the executive and legislative wing, federal structure of governance are adopted from the constitution of United States.

 One of the most special parts of the constitution of India the Directive principles of state policy is adopted from the Irish constitution.

The idea of the concurrent list is adopted from the Australian constitution.

 The concept that the residuary powers not specified in any of the three lists - i.e. Union lists, State lists and Concurrent lists – rest with the central government is adopted from the Canadian constitution.

The concepts of Five year plan and Fundamental duties are adopted from the USSR.

 Thus the constitution was designed with intent of endowing to the citizens of the nation a  legislative system, which emerges as a result of a carefully done cherry picking exercise.

History of the legal system

In 1773, considering the mismanaged state of affairs of the English East India Company, the House of Commons of the United Kingdom mandated that the company shall be brought under the purview of parliament in order that its demand for loan be sanctioned. In pursuance to the decision of bringing the company under the purview of the parliament, the Regulating Act of 1773 was passed. Under the act, Lord Warren Hastings was appointed as the first Governor -General. It authorised the British crown to set up the Supreme Court at Calcutta. Lord Warren Hastings also instituted courts of appeals christened Sardar Diwani Adalat, in respect of civil matters and Sardar Nizamat Adalat and Sardar Faujidari Adalat in respect of criminal matters.

In 1800, another Supreme court was established in the Presidency of Madras. In 1823, yet another Supreme court in the Presidency of Bombay was established. In the year 1833, Privy council of India was set up. It remained as the apex body for appeals until 1950. In the year 1861, Indian High courts act was passed. It replaced the Supreme courts and the other aforesaid courts of appeal namely Sardar Nizamat Adalat and Sardar Faujidari Adalat that existed till then at the three provinces with the High courts.

In the year 1935, Government of India act was passed. It replaced the system of Dyarchy at the provincial level. Dyarchy is a system, where matters of governance are grouped into two assemblage namely reserved list and transferred list. It was introduced by virtue of Government of India act, 1919.  Subjects covered under reserved list were retained by the British government for the purpose of administration whereas subjects covered under transferred list were placed under the purview of the elected parties in general elections. The Government of India Act, 1935 did away with the Dyarchy system to give full control over the subject matters of governance to the elected parties at the Provincial level. It also provided for the institution of the Federal court of India. Federal court’s germination was warranted to resolve the conflicts that arose between the central and state legislatures.

Indian constitution

At the Lahore session of the Indian National Congress that was held in the year 1929, it was decided 26^th January 1930 would be observed as the Poorna swaraj day. It is in remembrance of that date the Constitution of India was brought into force on 26^th January.

The construction of the Constitution was done by the Constituent assembly that was set up in the year 1946. Dr. Sachindananda sinha was the first president of the Assembly. He was elected as the acting president to fill the void. Later Dr. Rajendra Prasad took over as the president and a drafting committee was set up to draft the Constitution. The Committee comprised the following members:

1.Dr. Bheemrao Ramji Ambedkar (Chairman)
2.N.Gopalswamy Aiyengar
3.K.M.Munshi
4.Syed Mohd. Saadula
5.N.Madhav Rao ( Madhav Rao took over following the resignation B.L.Mitter)
6.D.P.Khaitan (T.Krishnamaachari, after Khaitan's death in 1948) 
7.Pandit. Govind Ballabh Pant
8.Sir Alladi Krishnaswami Iyer

The Constitution  of India contains 448 articles, 21 parts and 12 schedules. Though, on the face, the number of articles of the constitution would end at 395, the new articles appended to the original articles were done through alpha numeric numbering in order that the original numbering stays intact leaving the effective number of articles to 448.

Anatomy of the constitution –A Gist

Article	Subject
1	Name and territory of the union
13	Laws which are against the fundamental rights are invalid.
Fundamental rights of a citizen of India are describe by virtue of the following articles
14 to 18	Right to Equality
19 to 22	Right to freedom.   Freedom of speech and expression is encapsulated in Article 19.
23 to 24	Right against exploitation,,
25 to 28	Right to freedom of religion
29 to 30	Cultural and Educational rights. Article 29 envisages the Protection of interest of minorities.       Article 32 provides the remedy for violation of fundamental rights of a person. In the case a citizen’s fundamental rights are violated he could take up the issue to the Supreme Court of India directly.
36 to 51	Directive principles of state policy
51A	Fundamental duties of the citizen of India
1. To abide by the Constitution and respect its ideals and institutions, the National Flag, National Anthem 2. To cherish and follow the noble ideals which inspired our national struggle for freedom 3. To uphold and protect the sovereignty, unity and integrity of India 4. To defend the country and render national service when called upon to do 5. To promote harmony and the spirit of common brotherhood amongst all the people of India and to renounce practices derogatory to the dignity of women 6. To value and preserve the rich heritage of our composite culture 7. To protect and improve the natural environments including forests, lakes, rivers and wildlife 8. To develop the scientific temper, humanism and the spirit of inquiry and reform 9. To safeguard public property and not to use violence 10. To serve towards excellence in all spheres of individual and collective activity. 11. To provide opportunities for the education of his child/ward between the age of six and fourteen years.
80	Composition of Rajya sabha
81	Composition of Lok sabha
83	Duration of houses of parliament
112	Annual financial budget
123	Ordinance making powers of the president
124	Establishment of Supreme court
141	Decision of supreme court binding on all courts
148	Comptroller and Auditor General
149	Duties and Powers of CAG
153	Governors of state
213	Ordinance making powers of the Governor
214	High courts of state
243B	Constitution of Panchayats
266	Consolidated Fund of India
267	Contingency Fund of India
326	Elections to be conducted on the basis of Adult suffrage
352	National emergency
356	State emergency
370	Special provision for Jammu and Kashmir
371A	Special provision with respect to state of Nagaland

Constitutional system forms the fundamental groundwork for the whole legal build up of the nation. A synoptic knowledge of the system is imperative for a citizen to make informed decisions and to take rational stance on the issues that happen around him daily. 

Basel Capital Accords: An Overview*

Banks are one among the major triggers in most of the economic crises. Banks are the veins of circulation of money in an economy. So the soundness of banking system is imperative to prevent the collapse of the system. The premature liberalization of the local financial markets and the failure to keep adequate checks on lending functions of the banks are the major reasons for the Asian economic crisis of 1997. Absence of effective regulation and supervision led to large capital inflows in the domestic short term debt market. Banks lent on long term basis using the foreign inflows. Later when signs of pessimism became visible foreign inflows to economies such as Philippines, Malaysia etc... started to decline. (Buckley n.d.) Similarly, in the year 2008 the reckless lending of US banks like Lehman brothers and securitization of the sub-standard loans into instruments known as CDO-s (Collateral Debt Obligations) and trading of the securities in the stock market led to the sub-prime crisis of 2008 and resultant recession in the follow-up. Thus a perfect regulation and prudential supervision of banks is tellingly important for the smooth sailing of an economy.

Basel I

Capital is the last recourse that would be available for any bank to prevent its failure. In the year 1974, after the failure of Herstatt bank in Germany the need for regulation of banking sector was felt by G-10 countries. They constituted the Basel Committee for Banking Supervisory practices (BCBS) under the aegis of Bank for International Settlements (BIS).   

Basel I was recommended for implementation by the BCBS for mainly addressing the issue of Credit risk in the year 1988. Credit risk implies the risk involved in the recovery of loans that were lent. In order to address the issue BCBS fixed a minimum capital adequacy requirement to be maintained by the banks. It pegged the Capital adequacy ratio (CAR) at 8%. (Tarullo n.d.)

    Capital Adequacy Ratio (CAR) = Tier 1 Capital + Tier 2 Capital/ Risk Weighted Assets

Tier 1 capital represents the capital that is more permanent in nature and is more reliable. Tier 1 capital or core capital of a bank includes the normal paid up share capital of the bank and other disclosed reserves as reduced by the intangible assets of the bank such as Goodwill, fictitious assets such as debit balance to the Profit and loss account, any expenditure that is not written off and the Deferred tax asset. The Tier 1 capital should form atleast 50% of the bank’s total capital base.

 Tier 2 represents the capital that is not as much reliable as the Tier 1 capital because of the lack of corroborated ownership as in the case of Tier 1 capital. Tier 2 or Supplementary capital consists of Undisclosed reserves, Cumulative non redeemable preference share capital, General provisions and loss reserves written back as surplus if the actual loss or diminution is found to be in excess of the provision or loss reserves created earlier, Revaluation reserves, Hybrid capital instruments and Subordinated debt with minimum maturity of 5 years. There are also restrictions such as subordinated debts could not exceed 50% of the core capital, general provisions and loss reserves could not exceed 1.25% of the total risk weighted assets.

‘Risk weighted assets’ is the value of the assets adjusted for the risk of the asset failing to liquidate as valued. 

Risk Weights

Under Basel I, risk weights were classified into 5 Categories namely, 0%, 0% to 50%, 20, 50%, 100%. (Tarullo n.d.)

• The weight of zero percent was assigned to assets such as loans lent to OECD states, Investment with OECD central government’s securities, loans to borrowers, who are backed by the guaranties of the OECD states or  who had given the securities of the OECD countries as collateral. Since OECD states are considered to be developed countries their securities were assigned zero credit risk. Loans to non – OECD countries and central banks too were assigned 0% risk weights, provided loans advanced to them were in their own currency i.e., in the currency of the borrowing country. This is done to eliminate the risk of exchange rate movements on the loans advanced in view of the probable depreciation of the currencies of the non-OECD countries.
• Loans or investment with domestic public sector enterprises that remain outside the ambit of central government were given risk weights ranging from 0% to 50% at the discretion of nation’s regulator , which could be 0%, 10%, 20% and 50%.
• Loans or investment with institutions such as Multilateral development banks, OECD banks, Non-OECD banks with tenor extending upto 1 year, loans guaranteed by OECD incorporated banks, short term loans guaranteed by non-OECD banks were assigned a weight of 20%.
• Loans to non-OECD banks given on a tenor of more than 1 year are assigned a weight of 50%.
• Loans or investment with private sector enterprises, Non – OECD banks with tenor more than one year, capital market instruments issued by other banks were assigned a weight of 100%.
• In order to capture the risk that resides with the off – balance sheet items such as contingent liabilities ‘Credit conversion factor’ (CCF) was deployed. For instance :
•  General guarantees against loans were assigned 0% 
•  Letter of credits against Shipments were assigned 20% 

In 1996, in response to the financial innovations, as instruments like derivatives were started to be widely used, a new factor called market risk was introduced to strengthen the standards.  Market risk is the risk of losses on account of movements in market prices with the on-balance sheet and off-balance sheet positions. (Basel Committee on Banking Supervision 2005) The way CAR would be calculated was modified to factor in Market risk and a new category of capital called as Tier 3 capital. The Tier 3 capital is composed of Short term subordinated bonds that would exclusively cover market risks. Market risk consists of interest rate risk, equity position risk, foreign exchange risk and commodities risk. For measuring market risk, BCBS proposed two approaches namely Standardized approach, where the principles of gauging the market risk were completely prescribed by the BCBS and Internal grading based approach, where a certain degree of independence was granted to banks in assessing market risk.

Basel II

As years passed by, Basel II evolved. Basel II was given approval in the year 2004. The propositions of  Basel II accord were on three fronts which are given by the three pillars viz: 

1.The minimum capital requirement; 

2.The supervisory review; 

3.The market discipline.

The level of minimum capital requirement was continued to be maintained at 8% under the new framework. A new benchmark of risk called Operational risk was introduced. Operational risk is defined as the risk of loss resulting from the failure of internal processes or from the external events. For instance, Operational risk includes employee frauds, sabotage of assets of the bank, external frauds etc… Put simply, the losses that the bank may suffer, other than, in the normal course of business.  

Pillar 1

Basel II provided three different approaches for credit risk determination. They are:

1. Standardized approach
2.  Foundation internal rating based approach (F-IRB) 
3. Advanced internal rating based approach (A-IRB).

The standardized approach provides that risk weights should be assigned based on the ratings given by the External Credit Rating Institutions (ECAI). Under the new approach risk weights may range from 0% to 150%. Unlike Basel I, where loans to OECD central banks and OECD states where assigned a lower risk weights considering their credibility, in Basel II ratings assigned by the external credit rating agencies were considered as benchmarks and loans to foreign banks were assigned risk weights based on the ratings given by them. However when a foreign bank that is operating in a country lends to the central bank of the country, where it is incorporated then a lower risk weight may be applied to such asset provided the loan is funded and denominated in the domestic currency of the foreign bank. Another prominent feature of the Basel II accord is a corporate may get rated by an ECAI and be assigned a lower risk weight based on the ratings. This stands in contrast to the Basel I accord, where all the corporates were assigned a uniform risk weight of 100%. This might cause the banks to infer that lending to SME-s (Small and Medium Scale Enterprise) may prove to be expensive. (Francis n.d.) Internal ratings based approach allows the banks to devise their own models to assess the risk. Under the other two approaches, Banks use their own model to measure the parameters like PD (Probability of default), EAD (Exposure at default), LGD(Loss given default), which are used in calculating the Risk weighted assets (RWA).

To cover operational risk of loss, Basel II prescribes three approaches namely basic indicator approach, standardized approach and advanced measurement approach. 

• Basic indicator approach and standardized approach requires an appropriation of 15%, 12% to 18% respectively of bank’s average annual gross income to the reserves in the preceding three years.
•  Under the standardized approach, bank’s activities are divided into eight business lines each possessing a different "Denoted beta" ranging from the 12% to 18%. The past three years average of the gross annual income of  each business line is multiplied with the respective beta to arrive at the capital charge.
• Under the Advanced measurement approach banks can quantify the capital to cover operational risk using their own internal model taking into account internal risk variables and profiles.

Pillar 2

Pillar 2 specifies the norms for regulatory authorities. The banks should have deployed a system for assessing the stability of the capital and preclude any fall below the standard level. The regulator should mandate the banks to operate above the minimum capital requirement and should prevent the capital of the banks from falling below the minimum level, which is specified.

Pillar 3

Under the Pillar 3, banks are required to follow a formal disclosure policy. Disclosures regarding capital adequacy, credit risk mitigation, the internal ratings systems that it follows under the IRB approach were all specified under Pillar 3.

Indian Scenario

In India, Basel I was implemented in the year 1999. Later the RBI proposed the initial guidelines for implementation of Basel II in the year 2005. It announced that initially banks would have to adopt the Standardized approach for the determining risk weights for credit risk and the Basic indicator for determining operational risk. It was mandated that the CAR has to be maintained at 9% level, a step ahead of the prescribed Basel II CAR of 8%.

In the aftermath of the global financial meltdown in 2008, the vulnerability of the global financial system was exposed. Basel III guidelines were proposed in the year 2010 by the BIS. Modified parameters such as leverage ratio, mandatory capital conservation buffers and discretionary counter cyclical buffers were introduced.

While Basel III norms are yet to be implemented in India, the need for strengthening our banking system is telling. Between March 2011 and September 2012, the ratio of gross NPA-s to gross advances in the banks surged from 2.4% to 3.59%. (R.Kannan 2013)Thus a scientific study and review of the banking laws and practices is warranted, given the lessons that history has been teaching time and again through the financial turmoils across the globe.

Works Cited

Basel Committee on Banking Supervision. "Amendment to the Capital Accord to incorporate market risks." 2005.

Buckley, Ross P. International Finance system - Policy and regulation.

Francis, Smitha. "The Revised Basel Capital Accord: The Logic, Content and Potential."

R.Kannan. "How to swat the NPA bug." Business Line, 4 5, 2013.

Tarullo, Daniel K. Banking on Basel: The Future of International Financial Regulation.

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* The article was originally published in the site Caclubindia.com on 30th June, 2014.

Evolution of Economics

The theory of economics traces back its origin to the times of Adam Smith, who is known as the Father of Economics. His book ‘The Wealth of nations’, which was written in 1776, had laid the groundwork for the theory of Economics. The crux of the book lies around his propositions such as that an economy in order to bolster its position must increase its exports and resist its imports, an economic system is self balancing and independent in nature and the state need not involve in regulating measures such as price regulation, provision of subsidies. This idea of economic thought is known as Classical school of Economics. Prominent classical school economists are Adam Smith, J.B. Say, and David Ricardo. The classical school of economic thought could even be better illustrated through Say’s law that is popularly given as ‘Supply creates its own demand’. This means that whatever an organization produces would be bought in the market. This proposition is based on the ground that the organization in the course of its production would employ its labour. The reward that they give to the labour in the form of wages would be used by them to purchase from the market whatever the organization produces.
 

The validity of the ideas of the classical school of economics was questioned in 1930-s when the capitalist economies experienced economic crisis popularly termed as Great depression. The classical school of economics was unable to provide an explanation to the widespread prevalence of unemployment during the 1930-s. Classical thought was questioned on the footing that ‘If Supply could create its own demand, why is the question of over production arises..?’ At that point emerged another theory that was propounded by the British economist John Maynard Keynes as an answer to the puzzle. Contrary to the theory of Classical economists that the system is self regulating, Keynes made his proposition that it is not the inherent characteristic of a capitalist economy to maintain the economy at full employment. Over production of output does occur and as a result unemployment problem could arise.

The understanding of the grounds of rebuttal of theory of Classical economists by Keynes demands a finer understanding of the operational dynamics of the classical thought.  Classical economists justified their stance that full employment equilibrium tends to be natural state of existence of a capitalist economy through positing that the system is self adjusting so that the labour market and the capital market would act within itself to maintain full employment. The explanation to the self adjustment is two pronged.

The income of any individual could either be spent on goods that he consumes or saved. If the income is spent entirely on consumption, as long as the demand, which is backed by the individual’s earning, is strong enough to absorb the production of an organization, there won’t be any problem about the stability of the employment level. But if the demand falls short of the supply then the equilibrium in the employment level would be lost. The classical economists formulated a theory that the prices and the real wage rate would react among themselves to restore full employment, if the potency of demand falls short failing to absorb the entire production .  

On the other hand if an individual would have saved a part of his income, an element called savings needs to be factored in to articulate the mesh. They proposed that all the money that is saved would be invested with banks or other financial intermediaries, from where, the entrepreneurs would borrow and spend their borrowings on capital investments such as machinery, land etc... This capital investment will employ its own chunk of labour force. Thus the level of employment could be increased. The question how system could ensure all the money saved will be invested was addressed by a factor called as Rate of interest. When the rate of interest is high, people will be more willing to deposit their money as deposits in banks and will be more hesitant to borrow money from the bank. On the other hand, if the rate of interest stands low, lesser amount of money would be deposited since banks offer them lesser returns on their savings whereas more money would be borrowed since the cost of such borrowings is less now. The Central bank of a country would fix the interest rate in such a way that the deposits and borrowings strike a balance i.e., No surplus or deficit of deposits or borrowings. Thus all the money saved would be made to be invested. Therefore the question of unemployment is eliminated. Thus the classical economic thought was sailing comfortably, on the hypothesis that no matter what one earns and what one saves, the inherent nature of the system will ensure that economy remains balanced with no massive turbulence in terms of unemployment until the Great depression of 1930-s. But the inability of the classical thought to provide an explanation to the depression warranted an alternative economics to develop. 

Keynesian economics offered a solution to the conundrum. His attack on classical economics was on two fronts – The so called adjusting factors namely Real wage rate, Prices and Interest rate would not always provide for the system to strike a balance. Contrary to classical economist’s proposition that all the money saved would be made to be invested by the system, Keynes said that the system may fail to plough back the savings into investments. 

In his book ‘General Theory on Employment, Interest and Money’ he states that when a sense of pessimism takes over in the minds of the people about the business expectations, no matter however much the interest rate is brought down, the investment would not surge. Apart from rate of interest, he said, people’s attitude about business expectation plays a major role in bringing savings and investment to equilibrium. On the other hand, classical thought conceived that interest rate cuts could promote business expansion in every scenario. But the Second World War (1929-35), which was on at that time, prevented the business expectations to pick up. As a way out, Keynes proposed that the government through its fiscal policy mechanism (Tax regime) should ensure that public expenditure should be increased to create increase the employment level. This mode of increased financing by the state to create employment in excess of its earning capacity is known as deficit financing. Thus Keynesian economics entrenched.

It prevailed to be the popular theory providing the basis of economic policy formulation until    1970-s. But in the early 1970-s following events such as Vietnam war, collapse of Bretton woods system  the economic scenario in USA so turned out that it started developing both high inflation and high employment. The situation paved way for other theories to emerge such as Monetarism, which is again a theory that stood aligned to classical thought in essence. Milton Friedman, the one who propounded Monetarism, argued that an effective monetary policy (Rate of Interest wielding) by a central bank could only be a cure for economic 

crisis.

Thus over the period of time economic theory has evolved taking different forms in response to the spurs of different point of times. Of late economies have started deploying unconventional tools such as Quantitative Easing (QE), modified methods of deploying monetary policy etc... to fight against economic crisis. With the emergence of new complexities the need for a wary conception and implementation of economic theories into the policies stands very imperative.