Fiscal Responsibility and Budget Management (FRBM) Act

The Government appointed a five-member Committee in May 2016, to review the Fiscal Responsibility and Budget Management (FRBM) Act and to examine a changed format including flexible FRBM targets. The Committee formation was announced during the 2016-17 budget by FM Arun Jaitely. The Panel was headed by the former MP and former Revenue and Expenditure Secretary NK Singh and included four other members, CEA Arvind Subramanian, former Finance Secretary Sumit Bose, the then Deputy Governor and present governor of the RBI Urjit Patel and Nathin Roy. There was a difference of opinion about the need for adopting a fixed FRBM target like fiscal deficit, and the divisive opinion lay precisely in not following through such a fixity in times when the government had to spend high to fight recession and support economic growth. The other side of the camp argued it being necessary to inculcate a feeling of fiscal discipline. During Budget speech in 2016, Mr Jaitley expressed this debate:

There is now a school of thought which believes that instead of fixed numbers as fiscal deficit targets, it may be better to have a fiscal deficit range as the target, which would give necessary policy space to the government to deal with dynamic situations. There is also a suggestion that fiscal expansion or contraction should be aligned with credit contraction or expansion, respectively, in the economy.

The need for a flexible FRBM target that allowed higher fiscal deficit during difficult/recessionary years and low targets during comfortable years, gives the government a breathing space to borrow more during tight years. In it report submitted in late January this year, the committee did advocate for a range rather than a fixed fiscal deficit target. Especially, fiscal management becomes all the more important post-demonetisation and the resultant slump in consumption expenditure. The view is that the government could be tempted to increase public spending to boost consumption. but, here is the catch: while ratings agencies do look at the fiscal discipline of a country when considering them for a ratings upgrade, they also look at the context and the growth rate of the economy, so the decision will not be a myopic one based only on the fiscal and revenue deficits.

Fiscal responsibility is an economic concept that has various definitions, depending on the economic theory held by the person or organization offering the definition. Some say being fiscally responsible is just a matter of cutting debt, while others say it’s about completely eliminating debt. Still others might argue that it’s a matter of controlling the level of debt without completely reducing it. Perhaps the most basic definition of fiscal responsibility is the act of creating, optimizing and maintaining a balanced budget.

“Fiscal” refers to money and can include personal finances, though it most often is used in reference to public money or government spending. This can involve income from taxes, revenue, investments or treasuries. In a governmental context, a pledge of fiscal responsibility is a government’s assurance that it will judiciously spend, earn and generate funds without placing undue hardship on its citizens. Fiscal responsibility includes a moral contract to maintain a financially sound government for future generations, because a First World society is difficult to maintain without a financially secure government.

But, what exactly is fiscal responsibility, fiscal management and FRBM. So, here is an attempt to demystify these.

Fiscal responsibility often starts with a balanced budget, which is one with no deficits and no surpluses. The expectations of what might be spent and what is actually spent are equal. Many forms of government have different views and expectations for maintaining a balanced budget, with some preferring to have a budget deficit during certain economic times and a budget surplus during others. Other types of government view a budget deficit as being fiscally irresponsible at any time. Fiscal irresponsibility refers to a lack of effective financial planning by a person, business or government. This can include decreasing taxes in one crucial area while drastically increasing spending in another. This type of situation can cause a budget deficit in which the outgoing expenditures exceed the cash coming in. A government is a business in its own right, and no business — or private citizen — can thrive eternally while operating with a deficit.

When a government is fiscally irresponsible, its ability to function effectively is severely limited. Emergent situations arise unexpectedly, and a government needs to have quick access to reserve funds. A fiscally irresponsible government isn’t able to sustain programs designed to provide fast relief to its citizens.

A government, business or person can take steps to become more fiscally responsible. One useful method for government is to provide some financial transparency, which can reduce waste, expose fraud and highlight areas of financial inefficiency. Not all aspects of government budgets and spending can be brought into full public view because of various risks to security, but offering an inside look at government spending can offer a nation’s citizens a sense of well-being and keep leaders honest. Similarly, a private citizen who is honest with himself about where he is spending his money is better able to determine where he might be able to make cuts that would allow him to live within his means.

Fiscal Responsibility and Budget Management (FRBM) became an Act in 2003. The objective of the Act is to ensure inter-generational equity in fiscal management, long run macroeconomic stability, better coordination between fiscal and monetary policy, and transparency in fiscal operation of the Government.

The Government notified FRBM rules in July 2004 to specify the annual reduction targets for fiscal indicators. The FRBM rule specifies reduction of fiscal deficit to 3% of the GDP by 2008-09 with annual reduction target of 0.3% of GDP per year by the Central government. Similarly, revenue deficit has to be reduced by 0.5% of the GDP per year with complete elimination to be achieved by 2008-09. It is the responsibility of the government to adhere to these targets. The Finance Minister has to explain the reasons and suggest corrective actions to be taken, in case of breach.

FRBM Act provides a legal institutional framework for fiscal consolidation. It is now mandatory for the Central government to take measures to reduce fiscal deficit, to eliminate revenue deficit and to generate revenue surplus in the subsequent years. The Act binds not only the present government but also the future Government to adhere to the path of fiscal consolidation. The Government can move away from the path of fiscal consolidation only in case of natural calamity, national security and other exceptional grounds which Central Government may specify.

Further, the Act prohibits borrowing by the government from the Reserve Bank of India, thereby, making monetary policy independent of fiscal policy. The Act bans the purchase of primary issues of the Central Government securities by the RBI after 2006, preventing monetization of government deficit. The Act also requires the government to lay before the parliament three policy statements in each financial year namely Medium Term Fiscal Policy Statement; Fiscal Policy Strategy Statement and Macroeconomic Framework Policy Statement.

To impart fiscal discipline at the state level, the Twelfth Finance Commission gave incentives to states through conditional debt restructuring and interest rate relief for introducing Fiscal Responsibility Legislations (FRLs). All the states have implemented their own FRLs.

Indian economy faced with the problem of large fiscal deficit and its monetization spilled over to external sector in the late 1980s and early 1990s. The large borrowings of the government led to such a precarious situation that government was unable to pay even for two weeks of imports resulting in economic crisis of 1991. Consequently, Economic reforms were introduced in 1991 and fiscal consolidation emerged as one of the key areas of reforms. After a good start in the early nineties, the fiscal consolidation faltered after 1997-98. The fiscal deficit started rising after 1997-98. The Government introduced FRBM Act, 2003 to check the deteriorating fiscal situation.

The implementation of FRBM Act/FRLs improved the fiscal performance of both centre and states.

The States have achieved the targets much ahead the prescribed timeline. Government of India was on the path of achieving this objective right in time. However, due to the global financial crisis, this was suspended and the fiscal consolidation as mandated in the FRBM Act was put on hold in 2007- 08.The crisis period called for increase in expenditure by the government to boost demand in the economy. As a result of fiscal stimulus, the government has moved away from the path of fiscal consolidation. However, it should be noted that strict adherence to the path of fiscal consolidation during pre crisis period created enough fiscal space for pursuing counter cyclical fiscal policy.the main provisions of the Act are:

  1. The government has to take appropriate measures to reduce the fiscal deficit and revenue deficit so as to eliminate revenue deficit by 2008-09 and thereafter, sizable revenue surplus has to be created.
  2. Setting annual targets for reduction of fiscal deficit and revenue deficit, contingent liabilities and total liabilities.
  3. The government shall end its borrowing from the RBI except for temporary advances.
  4. The RBI not to subscribe to the primary issues of the central government securities after 2006.
  5. The revenue deficit and fiscal deficit may exceed the targets specified in the rules only on grounds of national security, calamity etc.

Though the Act aims to achieve deficit reductions prima facie, an important objective is to achieve inter-generational equity in fiscal management. This is because when there are high borrowings today, it should be repaid by the future generation. But the benefit from high expenditure and debt today goes to the present generation. Achieving FRBM targets thus ensures inter-generation equity by reducing the debt burden of the future generation. Other objectives include: long run macroeconomic stability, better coordination between fiscal and monetary policy, and transparency in fiscal operation of the Government.

The Act had said that the fiscal deficit should be brought down to 3% of the gross domestic product (GDP) and revenue deficit should drop down to nil, both by March 2009. Fiscal deficit is the excess of government’s total expenditure over its total income. The government incurs revenue and capital expenses and receives income on the revenue and capital account. Further, the excess of revenue expenses over revenue income leads to a revenue deficit. The FRBM Act wants the revenue deficit to be nil as the revenue expenditure is day-to-day expenses and does not create a capital asset. Usually, the liabilities should not be carried forward, else the government ends up borrowing to repay its current liabilities.

However, these targets were not achieved because the global credit crisis hit the markets in 2008. The government had to roll out a fiscal stimulus to revive the economy and this increased the deficits.

In the 2011 budget, the finance minister said that the FRBM Act would be modified and new targets would be fixed and flexibility will be built in to have a cushion for unforeseen circumstances. According to the 13th Finance Commission, fiscal deficit will be brought down to 3.5% in 2013-14. Likewise, revenue deficit is expected to be cut to 2.1% in 2013-14.

In the 2012 Budget speech, the finance minister announced an amendment to the FRBM Act. He also announced that instead of the FRBM targeting the revenue deficit, the government will now target the effective revenue deficit. His budget speech defines effective revenue deficit as the difference between revenue deficit and grants for creation of capital assets. In other words, capital expenditure will now be removed from the revenue deficit and whatever remains (effective revenue deficit) will now be the new goalpost of the fiscal consolidation. Here’s what effective revenue deficit means.

Every year the government incurs expenditure and simultaneously earns income. Some expenses are planned (that it includes in its five-year plans) and other are non-planned. However, both planned and non-planned expenditure consists of capital and revenue expenditure. For instance, if the government sets up a power plant as part of its non-planned expenditure, then costs incurred towards maintaining it will now not be called revenue deficit because it is towards maintaining a “capital asset”. Experts say that revenue deficit could become a little distorted because by reclassifying revenue deficit, it is simplifying its target.

 

access to reserve funds. A fiscally irresponsible government isn’t able to sustain programs designed to provide fast relief to its citizens.

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Data Governance, FinTech, #Blockchain and Audits (Upcoming Bangalore Talk)

This is skeletal and I am febrile, and absolutely nowhere near being punctilious. The idea is to note if this economic/financial revolution, (could it even be called that?) could politically be an overtone window? So, let this be otiose and information disseminating, for a paper is on its way forcing down greater attention to detail and vastly different from here. 

Data Governance and Audit Trail

Data Governance specifies the framework for decision rights and accountabilities encouraging desirable behavior in data usage

Main aim of Data Governance is to ensure that data asset are overseen in a cohesive and consistent enterprise-wide manner

Why is there a need for Data governance? 

Evolving regulatory mechanisms and requirements

Could integrity of data be trusted?

Centralized versus decentralized documentation as regards use, hermeneutics and meaning of data

Multiplicity of data silos with exponentially rising data

Architecture

Information Owner: approving power towards internal + external data transfers + business plans prioritizing data integrity and data governance

Data steward: create/maintain/define data access, data mapping and data aggregation rules

Application steward: maintain application inventory, validating testing of outbound data and assist master data management

Analytics steward: maintain a solutions inventory, reduce redundant solutions, define rules for use of standard definitions and report documentation guidelines, and define data release processes and guidelines

What could an audit be?

It starts as a comprehensive and effective program encompassing people, processes, policies, controls, and technology. Additionally, it involves educating key stakeholders about the benefits and risks associated with poor data quality, integrity and security.

What should be audit invested with?

Apart from IT knowledge and operational aspects of the organization, PR skills, dealing with data-related risks and managing a push-back or a cultural drift handling skills are sine qua non. As we continue to operate in one of the toughest and most uneven economic climates in modern times, the relevance of the role of auditors in the financial markets is more important than ever before. While the profession has long recognized the impact of data analysis on enhancing the quality and relevance of the audit, mainstream use of this technique has been hampered due to a lack of efficient technology solutions, problems with data capture and concerns about privacy. However, recent technology advancements in big data and analytics are providing an opportunity to rethink the way in which an audit is executed. The transformed audit will expand beyond sample-based testing to include analysis of entire populations of audit-relevant data (transaction activity and master data from key business processes), using intelligent analytics to deliver a higher quality of audit evidence and more relevant business insights. Big data and analytics are enabling auditors to better identify financial reporting, fraud and operational business risks and tailor their approach to deliver a more relevant audit. While we are making significant progress and are beginning to see the benefits of big data and analytics in the audit, this is only part of a journey. What we really want is to have intelligent audit appliances that reside within companies’ data centers and stream the results of our proprietary analytics to audit teams. But the technology to accomplish this vision is still in its infancy and, in the interim, what is transpiring is delivering audit analytics by processing large client data sets within a set and systemic environment, integrating analytics into audit approach and getting companies comfortable with the future of audit. The transition to this future won’t happen overnight. It’s a massive leap to go from traditional audit approaches to one that fully integrates big data and analytics in a seamless manner.

Three key areas the audit committee and finance leadership should be thinking about now when it comes to big data and analytics:

External audit: develop a better understanding of how analytics is being used in the audit today. Since data capture is a key barrier, determine the scope of data currently being captured, and the steps being taken by the company’s IT function and its auditor to streamline data capture.

Compliance and risk management: understand how internal audit and compliance functions are using big data and analytics today, and management’s future plans. These techniques can have a significant impact on identifying key risks and automating the monitoring processes.

Competency development: the success of any investments in big data and analytics will be determined by the human element. Focus should not be limited to developing technical competencies, but should extend to creating the analytical mindset within the finance, risk and compliance functions to consume the analytics produced effectively.

What is the India Stack?

A paperless and cashless delivery system; a paradigm that is intended to handle massive data inflows enabling entrepreneurs, citizens and government to interact with each other transparently; an open system to verify businesses, people and services.

This is an open API policy that was conceived in 2012 to build upon Aadhaar. The word open in the policy signifies that other application could access data. It is here that the affair starts getting a bit murky, as India Stack gives the data to the concerned individual and lets him/her decide who the data can be shared with.

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So, is this a Fintech? Fintech is usually applies to the segment of technology startup scene that is disrupting sectors such as mobile payments, money transfers, loans, fundraising and even asset management. And what is the guarantee that Fintech would help prevent fraud that traditional banking couldn’t? No technology can completely eradicate fraud and human deceit, but I believe technology can make operations more transparent and systems more accountable. To illustrate this point, let’s look back at the mortgage crisis of 2008.

Traditional banks make loans the old fashioned way: they take money from people at certain rates (savings deposits) and lend it out the community at a higher rate. The margin constitutes the bank’s profit. As the bank’s assets grow, so do their loans, enabling them to grow organically.

Large investment banks bundle assets into securities that they can sell on open markets all over the world. Investors trust these securities because they are rated by third party agencies such as Moody’s and Standard & Poor’s. Buyers include pension funds, hedge funds, and many other retail investment instruments.

The ratings agencies are paid by investment banks to rate them. Unfortunately, they determine these ratings not so much by the merits of the securities themselves, but according to the stipulations of the banks. If a rating fails to meet the investment banks’ expectations, they can take their business to another rating agency. If a security does not perform as per the rating, the agency has no liability! How insane is that?

Most surprisingly, investment banks can hedge against the performance of these securities (perhaps because they know that the rating is total BS?) through a complex process that I will not get into here.

Investment banks and giant insurance firms such as AIG were the major dominoes that nearly caused the whole financial system to topple in 2008. Today we face an entirely different lending industry, thanks to FinTech. What is FinTech? FinTech refers to a financial services company (not a technology company) that uses superior technology to bring newer and better financial products to consumers. Many of today’s FinTech companies call themselves technology companies or big data companies, but I respectfully disagree. To an outsider, a company is defined by its balance sheet and a FinTech company’s balance sheet will tell you that it makes money from the fees, interest, and service charges on their assets—not by selling or licensing technology. FinTech is good news not only for the investors, borrowers and banks collectively, but also for the financial services industry as a whole because it ensures greater transparency and accountability while removing risk from the entire system. In the past four to five years a number of FinTech companies have gained notoriety for their impact on the industry. I firmly believe that this trend has just begun. FinTech companies are ushering in new digital business models such as auto-decisioning. These models are sweeping through thousands of usual and not-so-usual data sources for KYC and Credit Scoring.

But already a new market of innovative financial products has entered into mainstream finance. As their market share grows these FinTech companies will gradually “de-risk” the system by mitigating the impact of large, traditional, single points of failure. And how will the future look? A small business might take its next business loan from Lending Club, OnDeck, Kabbage, or DealStruck, instead of a traditional bank. Rather than raising funds from a venture capital firm or other traditional investor, small businesses can now look to Kickstarter or CircleUp. Sales transactions can be processed with fewer headaches by Square or Stripe. You can invest your money at Betterment or Wealthfront and not have to pay advisors who have questionable track records outperforming the market. You can even replace money with bitcoin using Coinbase, Circle, or another digital-currency option. These are the by-products of the FinTech revolution. We are surrounded by a growing ecosystem of highly efficient FinTech companies that deliver next-generation financial products in a simple, hassle-free manner. Admittedly, today’s emerging FinTech companies have not had to work through a credit cycle or contend with rising interest rates. But those FinTech companies that have technology in their DNA will learn to ‘pivot’ when the time comes and figure it all out. We have just seen the tip of this iceberg. Technically speaking, the FinTech companies aren’t bringing anything revolutionary to the table. Mostly it feels like ‘an efficiency gain’ play and a case of capitalizing on the regulatory arbitrage that non-banks enjoy. Some call themselves big data companies—but any major bank can look into its data center and make the same claim. Some say that they use 1,000 data points. Banks are doing that too, albeit manually and behind closed walls, just as they have done for centuries. FinTechs simplify financial processes, reduce administrative drag, and deliver better customer service. They bring new technology to an old and complacent industry. Is there anything on the horizon that can truly revolutionize how this industry works? Answering this question brings us back to 2008 as we try to understand what really happened. What if there was a system that did not rely on Moody’s and S&P to rate the bonds, corporations, and securities. What if technology could provide this information in an accurate and transparent manner. What if Bitcoin principles were adopted widely in this industry? What if the underlying database protocol, Blockchain, could be used to track all financial transactions all over the globe to tell you the ‘real’ rating of a security.

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Blockchain can be defined as a peer-to-peer operated public digital ledger that records all transactions executed for a particular asset (…) “The Blockchain maintains this record across a network of computers, and anyone on the network can access the ledger. Blockchain is ‘decentralised’ meaning people on the network maintain the ledger, requiring no central or third party intermediary involvement.” “Users known as ‘miners’ use specialised software to look for these time stamped ‘blocks’, verify their accuracy using a special algorithm, and add the block to the chain. The chain maintains chronological order for all blocks added because of these time-stamps.” The digitalisation of financial service opens room for new opportunity such as to propose new kind of consumer’s experience as well as the use of new technologies and improve business data analysis. The ACPR, the French banking and insurance regulatory authority, has  classified the opportunities and risks linked to the Fintech such as the new services for uses, better resilience versus the difficulty to establish effective supervision, the risks of regulation dumping and regarding clients interest protection such as data misuse and security. The French Central Bank is currently studying blockchain in cooperation with two start-ups, the “Labo Blockchain” and “Blockchain France”. In that context, blockchain is a true financial service disruption, according to Piper Alderman “Blockchain can perform the intermediating function in a cheaper and more secure way, and disrupt the role of Banks.”

Hence, leading bank wants to seize that financial service opportunity. They are currently working on blockchain project with financial innovation firm, R3 CEV. The objective is that the project delivers a “more efficient and cost-effective international settlement network and possibly eliminate the need to rely on central bank”. R3 CEV has announced that 40 peer banks, including HSBC, Citigroup, and BNP Paribas, started an initiative to test new kind of transaction through blockchain. This consortium is the most important ever organized to test this new technology.

And what of security? According to the experts “the design of the blockchain means there is the possibility of malware being injected and permanently hosted with no methods currently available to wipe this data. This could affect ‘cyber hygiene’ as well as the sharing of child sexual abuse images where the blockchain could become a safe haven for hosting such data.” Further, according to the research, “it could also enable crime scenarios in the future such as the deployment of modular malware, a reshaping of the distribution of zero-day attacks, as well as the creation of illegal underground marketplaces dealing in private keys which would allow access to this data.” The issue of cyber-security for financial institutions is very strategic. Firstly, as these institutions rely on customer confidence they are particularly vulnerable to data loss and fraud. Secondly, banks represent a key sector for national security. Thirdly they are exposed to credit crisis given their role to finance economy. Lastly, data protection is a key challenge given financial security legal requirements.

As regard cyber security risks, on of the core legal challenge will be the accountability issue. As Blockchain is grounded on anonymity the question is who would be accountable for the actions pursued? Should it be the users, the Blockchain owner, or software engineer? Regulation will address the issue of blockchain governance. According to Hubert de Vauplane, “the more the Blockchain is open and public, less the Blockchain is governed”, “while in a private Blockchain, the governance is managed by the institution” as regard “access conditions, working, security and legal approval of transactions”. Where as in the public Blockchain, there is no other rules that Blockchain, or in other words “Code is Law” to quote US legal expert Lawrence Lessing. First issue: who is the block chain user? Two situations must be addressed depending if the Blockchain is private or public. Unlike public blockchain, the private blockchain – even though grounded in a public source code – is protected by intellectual property rights in favour of the organism that manages it, but still exposed to cyber security risks. Moreover, a new contractual documentation provided by financial institutions and disclosure duty could be necessary when consumers may simply not understand the information on how their data may be used through this new technology.

‘Disruption’ has turned into a Silicon Valley cliché, something not only welcomed, but often listed as a primary goal. But disruption in the private sector can have remarkably different effects than in the political system. While capital forces may allow for relatively rapid adaptation in the market, complex political institutions can be slower to react. Moreover, while disruption in an economic market can involve the loss of some jobs and the creation of others, disruption in politics can result in political instability, armed conflict, increased refugee flows and humanitarian crises. It nevertheless is the path undertaken….

Forward Pricing in Commodity Markets. Note Quote.

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We use the Hilbert space

Hα := {f ∈ AC(R+,C) : ∫0 |f′(x)|2 eαx dx < ∞}

where AC(R+,C) denotes the space of complex-valued absolutely continuous functions on R+. We endow Hα with the scalar product ⟨f,g⟩α := f(0) g(0) + ∫0 f′(x) g(x) eαx dx, and denote the associated norm by ∥ · ∥αFilipović shows that (Hα, ∥ · ∥α) is a separable Hilbert space. This space has been used in Filipović for term structure modelling of bonds and many mathematical properties have been derived therein. We will frequently refer to Hα as the Filipović space.

We next introduce our dynamics for the term structure of forward prices in a commodity market. Denote by f (t, x) the price at time t of a forward contract where time to delivery of the underlying commodity is x ≥ 0. We treat f as a stochastic process in time with values in the Filipović space Hα. More specifically, we assume that the process {f(t)}t≥0 follows the HJM-Musiela model which we formalize next. The Heath–Jarrow–Morton (HJM) framework is a general framework to model the evolution of interest rate curve – instantaneous forward rate curve in particular (as opposed to simple forward rates). When the volatility and drift of the instantaneous forward rate are assumed to be deterministic, this is known as the Gaussian Heath–Jarrow–Morton (HJM) model of forward rates. For direct modeling of simple forward rates the Brace–Gatarek–Musiela model represents an example.

On a complete filtered probability space (Ω,{Ft}t≥0,F,P), where the filtration is assumed to be complete and right continuous, we work with an Hα-valued Lévy process {L(t)}t≥0 for the construction of Hα-valued Lévy processes). In mathematical finance, Lévy processes are becoming extremely fashionable because they can describe the observed reality of financial markets in a more accurate way than models based on Brownian motion. In the ‘real’ world, we observe that asset price processes have jumps or spikes, and risk managers have to take them into consideration. Moreover, the empirical distribution of asset returns exhibits fat tails and skewness, behavior that deviates from normality. Hence, models that accurately fit return distributions are essential for the estimation of profit and loss (P&L) distributions. Similarly, in the ‘risk-neutral’ world, we observe that implied volatilities are constant neither across strike nor across maturities as stipulated by the Black and Scholes. Therefore, traders need models that can capture the behavior of the implied volatility smiles more accurately, in order to handle the risk of trades. Lévy processes provide us with the appropriate tools to adequately and consistently describe all these observations, both in the ‘real’ and in the ‘risk-neutral’ world. We assume that L has finite variance and mean equal to zero, and denote its covariance operator by Q. Let f0 ∈ Hα and f be the solution of the stochastic partial differential equation (SPDE)

df(t) = ∂xf(t)dt + β(t)dt + Ψ(t)dL(t), t≥0,f(0)=f

where β ∈ L ((Ω × R+, P, P ⊗ λ), Hα), P being the predictable σ-field, and

Ψ ∈ L2L(Hα) := ∪T>0 L2L,T (Hα)

where the latter space is defined as in Peszat and Zabczyk. For t ≥ 0, denote by Ut the shift semigroup on Hα defined by Utf = f(t + ·) for f ∈ Hα. It is shown in Filipović that {Ut}t≥0 is a C0-semigroup on Hα, with generator ∂x. Recall, that any C0-semigroup admits the bound ∥Utop ≤ Mewt for some w, M > 0 and any t ≥ 0. Here, ∥ · ∥op denotes the operator norm. Thus s → Ut−s β(s) is Bochner-integrable (The Bochner integral, named for Salomon Bochner, extends the definition of Lebesgue integral to functions that take values in a Banach space, as the limit of integrals of simple functions). and s → Ut−s Ψ(s) is integrable with respect to L. The unique mild solution of SPDE is

f(t) = Utf0 + ∫t0 Ut−s β(s)ds+ ∫t0 Ut−s Ψ(s)dL(s)

If we model the forward price dynamics f in a risk-neutral setting, the drift coefficient β(t) will naturally be zero in order to ensure the (local) martingale property (In probability theory, a martingale is a model of a fair game where knowledge of past events never helps predict the mean of the future winnings and only the current event matters. In particular, a martingale is a sequence of random variables (i.e., a stochastic process) for which, at a particular time in the realized sequence, the expectation of the next value in the sequence is equal to the present observed value even given knowledge of all prior observed values.) of the process t → f(t, τ − t), where τ ≥ t is the time of delivery of the forward. In this case, the probability P is to be interpreted as the equivalent martingale measure (also called the pricing measure). However, with a non-zero drift, the forward model is stated under the market probability and β can be related to the risk premium in the market. In energy markets like power and gas, the forward contracts deliver over a period, and forward prices can be expressed by integral operators on the Filipović space applied on f. The dynamics of f can also be considered as a model for the forward rate in fixed-income theory. This is indeed the traditional application area and point of analysis of the SPDE. Note, however, that the original no-arbitrage condition in the HJM approach for interest rate markets is different from the no-arbitrage condition. If f is understood as the forward rate modelled in the risk-neutral setting, there is a no-arbitrage relationship between the drift β, the volatility σ and the covariance of the driving noise L.

BRICS Bloc, New Development Bank and Where the Heck is it

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Some of this post is a bit dated, as this was meant to be written as an editorial for a BRICS Journal way back towards the fag end of 2015, and a lot of water has flown under the bridge ever since, with India holding the BRICS Summit in October last year in Goa, which also saw parallel sessions being organized by Peoples’ BRICS Forum, a conglomerate of civil society organizations from BRICS member countries raising concerns over the possible funding patterns the Bloc would be undertaking at the expense of environmental degradations and human rights violations. So, let us get on with it:

The BRICS bloc, a conglomerate of five of the biggest emerging economies is home to 43% of the world’s population with a share of 22% of the global GDP. These staggering statistics make Brazil, Russia, India, China and South Africa truly a force to reckon with. The bloc’s initiative to erect a development finance institution in the form of New Development Bank (NDB), is often attributed in the West as a reaction to the institutional sclerosis of Washington-DC-dominated World Bank and the International Monetary Fund (IMF), whereas it is a catalyst complementing rather than challenging the Bretton Woods institutions or the Asian Development Bank in fighting poverty in the emerging economies. Whatever be the attributions, the logic of fighting global poverty is itself steeped in controversies ranging from applying mathematical and statistical juggleries to determine the number of poor according to standards that are a far cut from realities on ground, to economic measures built upon the plinth of models that on many occasions forgo the human capital in a relentless pursuit of development agenda, which is meaningless if only persevered in concentrating on the extreme poverty and purblind to the gap yielding inequalities.

The world is watching with keenness on the mushrooming of New Development Bank, which was officially launched in Shanghai in July, 2016. What would be the underlying rationale of this model? How and where would the finances flow? If the investments were complemented to fill a vast infrastructural gap, how would the safeguards be architected to prevent socio-economic and environmental violations on ecologies? What of the democratic set-up that underlies the formation of this bloc and subsequently of NDB getting hijacked by the political and economic clout and prowess of China? These have been some of the pressing and contentious questions that could either derail the rationale behind this initiative or leave no stone unturned in replicating the western-dominated financial institutions that find themselves increasingly in the eye of the storm for fostering irreversible violations and damages. Aside from that, China’s growing eminence in G20 is a step to rival G8’s macroeconomy, international trade and energy capitalisation lending it legitimacy for a foreign policy geared towards a north-south dialogue in addition to the south-south dialogue efficacious through BRICS and G20. Moreover, China views G20 as an economic platform with other emerging countries on board for a resolve on international affairs. G20 along with BRICS Bank is a contrivance for a financial architecture that focuses on development issues on the one hand, and internationalising its currency on the other. Clearly, it is not a case of what Deng Xiaoping called for “China keeping a low profile”. So, is it merely a speculative materialism that is the engine behind China’s true intentions?

The Asian Development Bank has calculated an infrastructural gap worth $8 trillion in the Asia Pacific needing to be filled by 2020. This is where NDB would cash-in most, and likely create a polarity between infrastructural funding and other developmental concerns. But, what is infrastructure is as hazy as the fuzzy logic of the calculated gap. It is a prerogative to continuously industrialise the BRICS, of building and upgrading ports, gateways, intelligent transportation and communication, power generational and distributional capabilities to augment developmental agenda, which incidentally sets parameters for economic prosperity, the fruits of which permeate to the hitherto-considered peripheries in a fight against poverty. However, the Articles, according to NDB President KV Kamath have a purpose sketched out for the Institution, “To mobilise resources for infrastructure and sustainable development projects in BRICS and other emerging economies, complementing the existing efforts of multilateral and regional development banks.” This is imperative of sustainability, pragmatism, innovation and speed of execution, of which the last could accelerate in a more experimental manner. The speed could pierce through bureaucratic red tapes, blunt operating procedures, and intensify delivery of massive infrastructural projects. Dang Xiaoping, in a rather philosophically pensive manner referred to reform as a process of feeling stones while crossing the river. Although, this should be the dictum NDB needs to seriously gravitate to, dangers of transgressions are lurking heavily.

The BRICS economies are undergoing economic upheavals, and China, the second largest economic power in the world with a nominal GDP more than the rest of bloc’s combined GDP is seeing NDB along with the Asian Infrastructure Investment Bank (AIIB) and Shanghai Cooperation Organisation (SCO) as cardinal tools of its foreign policy initiatives. All of the three have a vision to revive China’s economic might through One Belt One Road (OBOR) and Silk Route through regional collaboration on the one hand and transcending state boundaries for facilitating trade links on the other. How would this augur for India is as important a question as how would the Government in India prioritize its policies for the NDB to plug in? The Government has sockets in place to provide the necessary plug ins, be they in the form of new tax allocations providing more funding for the states in order to empower growth, set budgetary allocations in order to expedite transport, communication and power capacities, proposal to create National Investment in Infrastructure Fund with a base capital of $3.25 billion, to planning and implementing regulatory reforms keeping a steady eye on growing influx of private capital and associated technologies to finally expunge bottlenecks to growth-led development model as a result. This is crucial, not just for India but for the entire bloc as a whole, since NDB’s priorities will be in line with the national development banks of member countries in effectuating the removal institutional roadblocks to growth. With a stated lending of up to $34 billion every year to begin with for filling up the huge infrastructural gap, NDB will act as an additional source of funding for India where the estimated gap in infrastructure is up north of $500 billion till 2020.

For the vast number of Indians, reality is far from development modelled on growth as envisaged by the political machinery at the centre. Growth forecasts have been revised downwards fearing a significant deceleration in exports and a capital flight from the country, courtesy unfavourable investment climes and a pitiable ease of doing business standards. While the Index of Economic Freedom ranks the country at 128 on a scale that defines the economy as situated in a mostly “unfree” zone, socio-economic concerns like malnutrition, falling public health indices, extreme poverty and growing inequality continue to plague the country. NDB’s role will be put under an intense scanner in addressing such internal contradictions of a magnitude that cannot be resolved merely by an external makeover tied to a growth that belittles its own citizenry. Unless Human Development Index, which emphasises life expectancy, education and income and GINI Coefficient Index, which measures inequality representing income distribution to country’s citizens are brought to affect the rating agencies’ take on India’s investment climate, Government’s relentless pursuit of developmental ends would never reach the multitude of people caught between the scylla and charybdis of regimental vagaries.

(DATED) With the upcoming India-Africa Summit to be hosted by New Delhi in October, there is a likelihood of trade relations between the two regions getting an uplift. Not only are India-Africa relations much softer compared to China’s scrambling for the African continent, it could also signal the way NDB gets projected by India in tune with its own foreign policy and diversify trade patterns seeking inroads into natural resources rich countries to augment a new investment destination for the increasing global profile of Indian corporate sector. As the Bank’s focus is concentrated on private investments, this gears in well with India’s investment in Africa in services and manufacturing sectors, roping in a vast population of non-resident Indians on the continent in a drive to foster economic regionalism on the one hand and throw around diplomatic weight on the other in a benign manner underlying India’s unique power equations. NDB could be a strong node bringing these realities to fruition, by promoting a reform in global economic governance with far-reaching significance and consequences. What remains to be seen is how much the NDB will abide by operation guidelines and procedures to see itself as not only different from other multilateral development institutions in terms of expediency, but also hold true to safeguards that protect vulnerabilities rather than exploiting and expropriating them. The latter is still a desiderata!!

Where is it all headed now?

The bank is planning to raise funds by issuing bonds in India, denominated in the local currency, the rupee, after to issued renminbi-denominated bonds in China in 2016. “In 2017, predominantly we’ll aim at taking up more lending tools to raise another $2.5bn for projects spreading over our member countries that are sustainable and do economic good. Virtually, we will try to double the lending of 2016 this year. What we are doing here at NDB is only a fraction of the need. Beyond lending, we would like to act as a catalyst, to get more parties involved in the lending process for projects that contribute to economic growth and sustainability,” said Kamath.

Major challenges for the bank lie in the changing global economic situation, which is seeing interest rates rise in developed countries. But, developing countries’ fast economic growth will help offset the effects, said he. Kamath also called the China-led OBOR a sound initiative that would bring benefits across several countries by investing in a significant way and creating economic momentum. “The program also brings synergy, making regions come together all along the Belt and the Road,” he said. Further he called, “We see it as something that will clearly spur economic activity in the region, and we think that the program is going to succeed.” On to renewable energy, where the focus seems to be concentrated….

In October last year, a new strategic report was produced by the Institute for Energy Economics and Financial Analysis (IEEFA), reviewing how successful the NDB has been so far. The report looked both at the increased renewable capacity of all five BRICS countries, but also the economic strain of such an ambitious project, a strain that is clear from the funding gap already present.

The NDB set targets tailored to each of the BRICS countries, taking into account their plans and their existing renewable capacity. The bank is designed to offer loans quickly and flexibly to the BRICS countries to make achieving these possible. “They had financed about $911m and that they had declared intent to finance or increase their loan by about $1.2bn every year,” says IEEFA consultant and the report’s author Jai Sharda. “So [the NDB is providing] about 11% of the public capital required.”

The report uses the concept of blended finance to work out the progress made and the progress required by the BRICS countries. “The concept of blended finance is basically built on the idea that when there is public money going into a sector it draws private money into that sector,” Sharda explains. “For every one dollar of public finance – the sort of finance being provided by the New Development Bank – it is estimated that it will make four dollars more of private money. So we built our estimations on that basis.”

Developing countries are some of the biggest consumers of energy in the world, as expanding a country’s infrastructure is energy-intensive. Economic development often requires large-scale industrialisation, such as we have seen in China, which has led to a more prosperous economy but also meant that China is the largest producer of CO2 in the world. All five of the BRICS countries rank in the top 20 polluters.

As such, the NDB has set goals to reduce the BRICS environmental impact while increasing the amount of energy they produce through renewable energy sources. Brazil is arguably in the best position to do this, as in 2015, 74% of its energy came from renewable sources. According to the IEEFA’s report, “Brazil’s 2024 Energy Plan envisages an increase in total installed renewable capacity, including large hydropower, from 106.4GW in 2014 to 173.6GW in 2024.”

India, China and South Africa have all set impressive targets, and have begun work to reach them. India intends to increase its renewable energy production by 40% by 2030, as well as reducing emissions intensity by 33%-35% over 2005 levels. China’s targets are even greater, as it plans “to reduce emission intensity by 60%-65% over 2005 levels”, the IEEFA report says. “China is estimated to increase its solar capacity to 127GW by 2020 from 43GW at the end of 2015, and wind capacity from 145GW in 2015 to 250GW by 2020.” South Africa has the furthest to go of the BRICS, as at present it gets 94% of its energy from fossil fuels but has plans to install a further 17.8GW of renewable energy capacity by 2020.

Russia is slightly different to the other BRICS countries as it has technically already met its target. Russia’s target was to reduce emissions by 25%-30% over 1990 levels, and emissions are currently around 40% lower than 1990 levels. However, the country is planning a 4.5% increase in the amount of renewable energy it produces by 2020.

All five BRICS countries have made progress, although to different extents. Brazil currently produces the most renewable energy, with 74% of its energy coming from renewable sources, the vast majority coming from large hydroelectric plants.

Sharda suggests that Brazil’s current success is, in part, due to its long-standing history of renewable projects, necessitated by a lack of coal: “I think Brazil has been better off than especially China and India in implementing more renewable energy because they lacked fossil fuel alternatives.”

Despite their fast-growing economies, India and China have historically been slower to develop their renewables sectors. “India and China have massive amounts of coal deposits, similarly Russia has large amounts of oil and gas deposits, and South Africa is one of the biggest exporters of coal,” Sharda says. “All of these countries have had a traditional, natural advantage.”

But things are beginning to change for both China and India, and they are expected to see the biggest boom in renewable energy of any of the BRICS countries in the next few years. “China led the coal and thermal power boom, they didn’t have an issue with dealing with worsening environmental conditions at a national level then,” Sharda says. “But the government and policy makers have actually become very sensitive to environmental issues which are why they are focusing a lot on renewable energy now.”

There is a massive trend moving towards renewable energy sources in China so, despite the fact that 74% of its energy came from fossil fuels in 2015, the IEEFA report estimated that China would increase its solar capacity to 127GW and increase its wind capacity to 250GW by 2020. However, in January, China increased its targets and its spending on renewable energy, and now plans to invest at least $360bn by the end of 2020, solidifying its position as a global leader on clean energy. Meanwhile, India increased its renewable capacity to 225GW by August 2016, a huge leap from 97GW in 2005. This is predominantly from using hydro.

Russia and South Africa are making slower progress. South Africa still relies on fossil fuels, increasing its renewable capacity to just 2.1GW in March 2016 from 1.8GW the previous year. Russia is making small progress predominantly due to a lack of investment from the country itself, only allocating $1bn for renewable technologies in all 17 Russian states in 2014.

Despite rapid development in the BRICS countries, for Brazil, China, India and South Africa there is a long way to go for any country to meet its targets. There is a funding gap which the NDB, among others, need to fill to help stimulate the development of the renewable energy industries in each country. The IEEFA estimates that “meeting these targets would require an annual investment of around $177bn. In comparison, the investment in the renewable sector in BRICS countries in 2015 was $126bn, leaving an average shortfall of $51bn.”

It is clear, therefore, that a vast increase in investment is needed. “Brazil’s renewable capacity expansion plans would require an investment of $86bn, or 85.2% of overall electricity generation capacity investment,” the IEEFA report states. This is despite Brazil’s impressive hydroelectric infrastructure. Meanwhile Russia would require an investment of $44bn, India will require $128bn, China $254bn and South Africa $30bn.

Whilst these figures are for varying timescales and some countries, China in particular, are likely to be able to channel enough money to meet their targets, it is clear that a much greater and more sustained investment will be needed if the BRICS countries as a whole are to achieve their goals. Furthermore, these figures do not include the knock-on infrastructure upgrade costs that renewable energy generation will create. India alone will need a further $26bn over the next ten years to update its grid.

But more is going to be done, starting with an announced increase in the loans available from the NDB. “The development bank has actually declared that they were targeting to expand and increase their support of energy development this year,” Sharda says. “Their target is actually about 35% percent of the overall public capital required.” This large increase could make all the difference.

At present, despite impressive advances in renewable capacity in the BRICS countries, some look set to miss their targets. If the NDB and other multilateral development banks and financial institutions manage to increase investment, the BRICS could have a massive effect on the environmental damage currently being created by their energy systems. Their success will be evident across the next ten years and beyond, and will be keenly anticipated around the world.

India’s Banking Crisis is Made Worse by the Poor Performance of its Debt Recovery Tribunals, and What to Say About the Bankruptcy Code?

Debt recovery tribunals were set up under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 with the aim of streamlining the mechanism to recover bad debts. This process was earlier handled by civil courts before being shifted to 38 debt recovery tribunals and five debt recovery appellate tribunals across the country. Since their conception, these tribunals have been dogged by concerns about their judicial independence because the Ministry of Finance, which controls public-sector banks, has had significant influence on them.

Almost as soon as its parent statute was passed by Parliament in 1993, the Delhi High Court Bar Association challenged the constitutionality of the debt recovery tribunal on the grounds that its parent statute lacked the judicial independence that is expected of judicial bodies. In 1995, the Delhi High Court struck down the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 ruling that it was “unconstitutional as it erodes the independence of the judiciary and is irrational, discriminatory, unreasonable, arbitrary and is hit by Article 14 of the Constitution”. (Article 14 deals with equality before the law). Subsequently, the Gauhati and Karnataka High Courts also struck down the same legislation for being unconstitutional. On appeal, however, the Supreme Court in 2002 over-ruled all of the High Courts and upheld the constitutionality of the legislation.

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DRTs were created to help financial institutions recover dues speedily without being subjected to lengthy procedures of civil courts have fallen into the same trap precisely. In the words of Shaswat Sharma, partner, KPMG, India, “The functioning of DRTs needs to improve to ensure banks are able to recover their existing loans and offer fresh advances at cheaper rates…In the current scheme of things there is no mechanism in place to ensure that the tribunal disposes the case in a timely manner. There is a strong case to bring in more accountability for the DRT.” If dealing with the subject matter at hand with speed is the biggest challenge facing DRTs, any number of additional DRTs and Appellate Tribunals should address this problem convincingly as was outlined by the Finance Minister during his Budget Speech 16-17. The under performance is even keeping the RBI worried. In the words of Raghuram Rajan, Governor, RBI, “If bankers cannot get their money back, they are not going to give ou loans at cheap priceSo, making sure DRTs work better, making sure that you don’t have excess number of stays, excess number of appeals, is what needs to be focused on.”
Bankruptcy Code: Now with all the possible means exercised to constrain the rising debts, bad assets of financial institutions, the situation still seems far from under control, and its here that the proposed Bill on Bankruptcy with the vision to consolidate scattered laws relating to insolvency of companies makes a strong point. Recently, Finance Minister reiterated the commitment to introduce the Bill in the upcoming session of the Parliament. As with other mechanisms, the efficacy is still in hypothetical stage, but the Bill at least promises to accelerate the winding-up process of defaulting companies and opening up a quicker exit route for lenders. The draft of the code draws on may parallels to the US Bankruptcy Code, especially allowing companies to carry out businesses while simultaneously going through bankruptcy proceedings, while differing on management control, where, unlike in the US, the management control in India passes over to “insolvency resolution processes”. But, the question remains as to how would this Bill address the issue of NPAs? The impact felt is likely to be in,
a. The time frame of 180-day limit (an extension of a further 90 days in exceptional cases) would help lenders decide on the viability of the business, whereafter a liquidation process sets in.
b. Economic and financial viability of the debtor company is to be discussed in negotiations with the creditors facilitated by “insolvency experts” rather than courts lending the process more credibility.
c. Bill would have ample scope for early recognition of financial distress helping the process of easing out businesses under stress.
The success of the Bill would depend on how well it is implemented and whether setting up of an “insolvency regulator” would have the requisite powers to see its successful implementation. For the RBI, “an early clearance of the proposed insolvency and bankruptcy bill will play an important role in the face of mounting potential losses.”
Despite having a handful of measures to address the issues of NPAs and NPLs, few seem to be working positively, but are heavily relied upon and banked on for lack of a better alternative. What is really the need of the hour is to arm these mechanism to the teeth for results to flow out, and unless such is undertaken, the likelihood of policy paralysis would ensue.

Top-down Causation in Financial Markets. Note Quote.

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Regulators attempt to act on a financial market based on the intelligent and reasonable formulation of rules. For example, changing the market micro-structure at the lowest level in the hierarchy, can change the way that asset prices assimilate changes in information variables Zk,t or θi,m,t. Similarly, changes in accounting rules could change the meaning and behaviour of bottom-up information variables θi,m,t and changes in economic policy and policy implementation can change the meaning of top-down information variables Zk,t and influence shared risk factors rp,t.

In hierarchical analysis, theories and plans may be embodied in a symbolic system to build effective and robust models to be used for detecting deeper dependencies and emergent phenomena. Mechanisms for the transmission of information and asymmetric information information have impacts on market quality. Thus, Regulators can impact the activity and success of all the other actors, either directly or indirectly through knock-on effects. Examples include the following: Investor behaviour could change the goal selection of Traders; change in the latter could in turn impact variables coupled to Traders activity in such a way that Profiteers are able to benefit from change in liquidity or use leverage as a mean to achieve profit targets and overcome noise.

Idealistically, Regulators may aim for increasing productivity, managing inflation, reducing unemployment and eliminating malfeasance. However, the circumvention of rules, usually in the name of innovation or by claims of greater insight on optimality, is as much part of a complex system in which participants can respond to rules. Tax arbitrages are examples of actions which manipulate reporting to reduce levies paid to a profit- facilitating system. In regulatory arbitrage, rules may be followed technically, but nevertheless use relevant new information which has not been accounted for in system rules. Such activities are consistent with goals of profiteering but are not necessarily in agreement with longer term optimality of reliable and fair markets.

Rulers, i.e. agencies which control populations more generally, also impact markets and economies. Examples of top-down causation here include segregation of workers and differential assignment of economic rights to market participants, as in the evolution of local miners’ rights in the late 1800’s in South Africa and the national Native Land act of 1913 in South Africa, international agreements such as the Bretton Woods system, the Marshall plan of 1948, the lifting of the gold standard in 1973 and the regulation of capital allocations and capital flows between individual and aggregated participants. Ideas on target-based goal selection are already in circulation in the literature on applications of viability theory and stochastic control in economics. Such approaches provide alternatives to the Laplacian ideal of attaining perfect prediction by offering analysable future expectations to regulators and rulers.

Debt versus Equity Financing. Why the Difference matters?

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There is a lot of confusion between debt and equity financing, though there is a clear line of demarcation as such. Whats even more sorry as a state of affair is these jargons being used pretty platitudinously, and this post tries to recover from any such usage now bordering on the colloquial, especially on the activists’s side of the camp.

What is Debt Financing?

Debt financing is a means of raising funds to generate working capital that is used to pay for projects or endeavors that the issuer of the debt wishes to undertake. The issuer may choose to issue bonds, promissory notes or other debt instruments as a means of financing the debt associated with the project. In return for purchasing the notes or bonds, the investor is provided with some type of return above and beyond the original amount of purchase.

Debt financing is very different from equity financing. With equity financing, revenue is generated by issuing shares of stock at a public offering. The shares remain active from the point of issue and will continue to generate returns for investors as long as the shares are held. By contrast, debt financing involves the use of debt instruments that are anticipated to be repaid in full within a given time frame.

With debt financing, the investor anticipates earning a return in the form of interest for a specified period of time. At the end of the life of a bond or note, the investor receives the full face value of the bond, including any interest that may have accrued. In some cases, bonds or notes may be structured to allow for periodic interest payments to investors throughout the life of the debt instrument.

For the issuer of the bonds or notes, debt financing is a great way to raise needed capital in a short period of time. Since it does not involve the issuing of shares of stock, there is a clear start and end date in mind for the debt. It is possible to project the amount of interest that will be repaid during the life of the bond and thus have a good idea of how to meet those obligations without causing undue hardship. Selling bonds is a common way of funding special projects, and is utilized by municipalities as well as many corporations.

Investors also benefit from debt financing. Since the bonds and notes are often set up with either a fixed rate of interest or a variable rate with a guarantee of a minimum interest rate, it is possible to project the return on the investment over the life of the bond. There is relatively little risk with this type of debt financing, so the investor does not have to be concerned about losing money on the deal. While the return may be somewhat modest, it is reliable. The low risk factor makes entering into a debt financing strategy very attractive for conservative investors.

What is Equity Financing?

Also known as share capital, equity financing is the strategy of generating funds for company projects by selling a limited amount of stock to investors. The financing may involve issuing shares of common stock or preferred stock. In addition, the shares may be sold to commercial or individual investors, depending on the type of shares involved and the governmental regulations that apply in the nation where the issuer is located. Both large and small business owners make use of this strategy when undertaking new company projects.

Equity financing is a means of raising the capital needed for some sort of company activity, such as the purchase of new equipment or the expansion of company locations or manufacturing facilities. The choice of which means of financing to use will often depend on the purpose that the business is pursuing, as well as the company’s current credit rating. With the strategy of equity financing, the expectation is that the project funded with the sale of the stock will eventually begin to turn a profit. At that point, the business not only is able to provide dividends to the shareholders who purchased the stock, but also realize profits that help to increase the financial stability of the company overall. In addition, there is no outstanding debt owed to a bank or other lending institution. The end result is that the company successfully funds the project without going into debt, and without the need to divert existing resources as a means of financing the project during its infancy.

While equity financing is an option that is often ideal for funding new projects, there are situations where looking into debt financing is in the best interests of the company. Should the project be anticipated to yield a return in a very short period of time, the company may find that obtaining loans at competitive interest rates is a better choice. This is especially true if this option makes it possible to launch the project sooner rather than later, and take advantage of favorable market conditions that increase the projected profits significantly. The choice between equity financing and debt financing may also involve considering different outcomes for the project. By considering how the company would be affected if the project fails, as well as considering the fortunes of the company if the project is successful, it is often easier to determine which financing alternative will serve the interests of the business over the long-term.

In summation, equity financing is the technique for raising capital organization stock to speculators whereas debt financing is the technique of raising capital by borrowing. Equity financing is offered forms like gained capital or revenue while debt financing is available in form of loan. Equity financing involves high risk as compare to debt financing. Equity holders have security but debt holders don’t have. In equity financing, entrepreneurs don’t need to channel benefits into credit reimbursement while in debt financing, entrepreneurs’ have to channel profit into repayment of loans.