Wednesday, May 07, 2008

Indian Overseas Bank Tries its Hand in The Alchemy of Finance

I was amused today while reading a story in the Business Standard titled, "Indian Overseas Bank cashes in on Realty."

The paper reports that the Bank plans to "sell" some of its real estate to a "special purpose vehicle (SPV)."

The sale, at current market price, will produce a "profit" for the bank because the real estate is valued in its books at cost which is much below its current market value. This "profit" will increase the bank's capital adequacy ratio. Moreover, the bank will then lease the real estate back from the special purpose vehicle!

There is no mention of the SPV paying cash to the Bank for the acquisition of the real estate assets.

In other words, without actually selling the real estate (in economic, not legal terms), the bank will magically increase its capital adequacy!


A simple revaluation of real estate wouldn't have worked. So, we now have this new attempt at financial alchemy. Reminds me of John Galbraith's words:

"The world of finance hails the invention of wheel over and over again, often in a slightly more unstable version. All financial innovation involves, in one form or another, the creation of debt, secured in greater or lesser adequacy by real assets."


Ashish Pandey said...

Hello sir,

Nice article about "creating virtual profits". Even I have read in annual reports of many companies that they get involve in financial innovation to create false networth and profits. If we look into the annual report of Sakthi sugar, we come to know that few years ago, due to consecutive losses, their networth went close to zero. Then they got auditor "revalue" their plants and machinery and increase the networth by 300 crore!!!. Now they reduce this 300 crore every year by some amount and "manage" their profit/loss.

If I remember correctly, in Asian Electronics' report I read that they incurred some loss and to reduce the loss shown on income statement, they reduced their networth by some amount and reduced their losses on income statement by same amount. This could have been missed by me but this blatant show of financial jugglery was pointed out in bold faced letters by their auditor in the same annual report!!!.

I think as investors we should dig deep about companies and only then take investment decisions.


Anand Gadiyar said...

Padmanabhan, reader of Deepak Shenoy's blog, raises an interesting point there - look at Comment 3 in the link below