## Saturday, February 13, 2016

Robbing Peter to pay banks by T. N. Ninan in the Business Standard, 13 Feb.

Meet the Robin Hood of Science by Simon Oxenham on bigthink, 12 Feb.

The diplomat and the killer by Raymond Bonner in The Atlantic, 11 Feb.

Fixing enterprise plumbing by Manish Sabharwal in the Indian Express, 10 Feb.

Debt deja vu by Susan Thomas in the Indian Express, 10 Feb.

NPS is a good product that lives in a bad market by Monika Halan in Mint, 10 Feb. Also see this video with Ashish Aggarwal from 1 February, from the NIFPMF channel.

A discussion on net neutrality, featuring Pavan Duggal, T.V. Ramachandran, Raman Jit Singh Chima, Smriti Parsheera, on the Big Picture' show on Rajya Sabha TV.

The chips are down for Moore's Law by M. Mitchell Waldrop, in Nature, 9 Feb.

Is Modi Turning Policy Clock Back to Pre-1991 State Control Era? by Abheek Barman in thequint.com, 9 Feb.

## Wednesday, February 10, 2016

### TRAI's move on net neutrality

by Iravati Damle, Mayank Mishra, Smriti Parsheera, Sumant Prashant, Ajay Shah.

On Monday, the Telecom Regulatory Authority of India (TRAI) released a regulation and associated explanatory memorandum prohibiting discriminatory tariff for data services. This has elicited interest and responses from all over the world. We watched the Facebook stock price curiously over that period:

 Facebook stock price vs. the Nasdaq index
On 4th and 5th (Thursday and Friday), there were rumours in the Indian press about what TRAI was about to do. After that, when the US market opened, they may have had some impact. On Monday, the US market opened after the TRAI regulation had been released. Overall, in this period, the Nasdaq index dropped by 6% while Facebook dropped by 12%. Perhaps some of this was caused by the TRAI action.

The TRAI regulation was preceded by an extensive consultation process initiated by TRAI in December 2015, where it posed the following question: Should telecommunication service providers (TSPs) be permitted to charge consumers for data based on the content that they access?

One group, led mainly by TSPs, favoured differential pricing on the grounds that it would increase Internet penetration, encourage investments in infrastructure and allow for the development of innovative products. The supporters of net neutrality disagreed. They argued that content-based discrimination would vitiate the basic principles of the Internet, lead to discriminatory practices and hamper competition and innovation among content providers. TRAI ultimately chose to answer its question in the negative, supporting its regulations with an explanatory note that shows the process and rationale for its decision.

### Placing it in context

The topic of network neutrality has captured the Indian public discourse for the past several months. Network neutrality is the principle of equal treatment of data packets moving across the Internet. This touches on three core aspects of how TSPs should conduct their business:

Speed: No throttling or increasing speeds to access particular content.
Pricing: No paid prioritisation. No content-based pricing.

The current regulations speak only to the third issue of price related discrimination, putting an effective end to the following types of practices:

• Zero rating - Access to specific content without counting it towards a user's data charges (e.g. Free Basics)
• Sponsored data - Content provider bears the cost of access (e.g. Airtel Zero)
• Content-specific packs - User pays for data but based on type of content (e.g. Special Facebook and WhatsApp packs)

The larger issue of how India will deal with the other core components of net neutrality still remains open.

### A summary of the regulations

The regulation prohibits TSPs providing both wired and wireless services from (i) offering differential pricing to consumers, based on the type of content being accessed; and (ii) entering into agreements that have a similar effect. TRAI's rationale for moving in this direction rests on a detailed explanation of the basic architecture of the Internet, which is grounded in the idea of openness. Besides this, the explanatory memorandum also speaks about the market failures of information asymmetry and negative externalities, which created a need for regulatory intervention.

The prohibitions are subject to two sets of exclusions. First, TSPs are permitted to have differential pricing in closed communication networks - where the data is not transmitted over the Internet. This could include local intranet services and products like Internet Protocol Television (IPTV). The law however guards against potential misuse of this provision by saying that TRAI will keep a watch on practices that use the exception to evade the discriminatory pricing prohibition. Second, a reduced tariff can be charged in case of emergency services, subject to reporting to TRAI within seven days. For instance, the Chennai floods saw the instant mobilisation of applications targeted specifically for relief and rescue work. Such initiatives would not be hampered by the regulation.

The restrictions also do not cover differential pricing that may be charged independent of the content being accessed. To take an example, Aircel offers a limited period of free capped data on purchase of certain mobile devices. Within those limits, the user can access any available content on the Internet. This is not a violation of discriminatory pricing, as defined by TRAI.

### Impact on the Internet and its stakeholders

The heart of the new regulations lies in what TRAI has labelled as "the need to preserve the unique architecture of the Internet". This is in line with TRAI's mandate to promote the orderly growth of the sector (i.e. Internet services). Our analysis of the impact on key stakeholders is as follows.

Internet users: The regulations uphold the user's right to choose from among multiple sources of information on the Internet, free from the white noise of discounted offerings. This means that users will have to continue paying for the data that they use while retaining the full freedom to choose the websites and applications that they access.

Some may argue that the regulations potentially harm consumers by slowing down the process of digital inclusion and denying users access to free services. As highlighted above, the restrictions pertain specifically to the use of price discrimination to create "walled gardens" within the Internet. Other schemes that may provide free access to the Internet as a whole will continue to be allowed.

TSPs: TSPs will have to terminate existing arrangements that allow them or their content partners to subsidise access to specific content. They will also have to discontinue schemes that offer content-specific discounted rates. Another important impact will be felt in cases where a TSP is also a content provider - it will not be allowed to leverage its position as a TSP to promote its own content for free.

It is important to recognise that the value of the Internet will grow as more and more people become part of it, a process that is already taking place even without discriminatory pricing. This will continue to translate into economic benefits for TSPs. Their grouse may however be on the denial of the windfall profits that could result through discriminatory practices.

TSPs will have to then compete in the tough commoditised game of producing bandwidth at ever lower prices.

Content providers: The regulations ensure that the Internet will continue to offer a level playing field for all content providers. There will be no entry barriers for small content creators. This will foster greater innovation and competition.

Those that had already entered into private arrangements with TSPs will of course have to alter their plans to bring them in line with TRAI's regulations. Paying the TSP will not be an element of business strategy.

### Conclusion

Many people from the world of business are used to unlimited complexity in business contracts. Hindustan Lever has all kinds of innovative contracts with distributors, retailers, etc. By analogy, the world of telecom should be similarly unencumbered. However, the revolutionary achievements of Unix and the Internet, from the late 1960s onwards, are rooted in a particular philosophy and design strategy, of openness. We must recognise the value of this philosophy as a universal multilateral disarmament treaty, which ensures cooperation in some respects, and channels competition in others. Gentleman's agreements which have given hygiene in the past, but the commercial pressures of today's technology world do not give adequate guarantees about the future. Net neutrality law uses the coercive power of the State to push in favour of this design philosophy.

TRAI's differential pricing regulations place India alongside countries like Chile, Netherlands and Slovenia that have also taken a clear stand against differential pricing (or zero-rating in particular). The interesting difference however is the fact that those countries did so within the framework of their net neutrality laws. Others like United States and the new regulations in the European Union have also taken a stand on net neutrality but have decided to consider zero-rating on a case-by-case basis. By ruling on the issue of differential pricing without waiting for a broader net neutrality law, TRAI has in effect won the last battle first, within powers under the TRAI Act, 1997.

The policy analysis will now turn to practices like blocking and throttling. It would make sense to think of deeper amendments to Parliamentary law which address net neutrality in a more complete way.

## Monday, February 08, 2016

### Transforming the operational efficiency of tribunals and courts

by Pratik Datta.

Almost two decades ago in L. Chandra Kumar v. Union of India (1997), the Supreme Court had lamented that Indian tribunals function inefficiently since there is no authority in charge of supervising and fulfilling their administrative requirements. The Court had gone on to suggest that until a wholly independent agency for administration of all such tribunals is set up, it is desirable that all such tribunals should be under a single nodal Ministry. Finally, on January 18, 2016, a Constitution Bench of the Supreme Court in Madras Bar Association v. Union of India reportedly directed the Central Government to consider setting up a nodal body or agency for managing all tribunals across all Ministries.

In spite of pending tribunal reforms, Indian policy makers are heavily relying on tribunals to achieve the policy objective. For instance, the Insolvency and Bankruptcy Code, 2015 (IBC) recently introduced in the Lok Sabha envisages an efficient Adjudicating Authority which must dispose of matters within hard deadlines. The entire IBC is subject to this condition precedent. However, given the dismal performance of Indian tribunals, there are legitimate doubts as to how the DRTs and NCLTs will be able to achieve the ambition set out in IBC.

India needs to urgently reform its tribunal system. The Supreme Court's recent direction is a good starting point. This post explains the institutional reforms that would be needed to rachet up the performance of Indian tribunals.

### Back-end institutions

Institutions are crucial to the development of a nation. Backward nations have poorer institutions. They may try to develop and yet consistently fail to improve their institutions. One usual reason for this is that these countries often try to adopt forms of other functional states and organizations which camouflages a persistent lack of function. This is the case with Indian judicial institutions. There is a general agreement in India on the desirable front-end features needed for tribunals (independence, efficiency, accessability, transparency, user-friendliness). These are visible features of any Western judicial institution and have been co-opted into the Indian context through legal transplant (by statute and case-laws). However, the back-end institutional systems supporting these front-end features in the West are neither readily visible to an outsider nor always possible to adopt by legal transplant (especially by case-laws). Therefore, there is an acute lack of awareness in India of what back-end institutional support systems are actually necessary to sustain these front-end features.

### The key idea

Every judicial institution has judicial as well as administrative functions. In most advanced common law jurisdictions, the administrative functions are hived off into a separate agency with a corporate structure. This agency can take advantage of economies of scale and provide standardised administrative support services across courts and tribunals. Additionally, judges are freed from administrative burden and can fully focus on core judicial work. This simple yet critical institutional reform has enabled these countries to enhance the performance of their judiciary.

### International best practice

UK has HMCTS which provides administrative support to its courts and tribunals. Canada has a similar agency set up under the Court Administration Service Act 2002; Australia has a similar agency set up under the Court Services Victoria Act 2014; US has a similar agency set up under the Administrative Office Act of 1939.

### What are we doing in India?

In contrast, India does not have a similar agency for managing its courts and tribunals. Each tribunal has its own registry. They are administered by their respective sponsoring Ministries. Consequently, there is no standarisation of services across tribunals of different Ministries. Economies of scale are completely lost. In this overall flawed institutional design, blindly setting up more "fast-track" tribunals will not improve justice delivery. Instead, India should adopt the international best practice and set up a Tribunal Services Agency (TSA) to properly manage all the existing tribunals across different Ministries.

This idea is however not completely new in India. It has been discussed in rudimentary forms by the Law Commission in 1988 which suggested setting up of a National Judicial Centre. In 1997, the Supreme Court in L. Chandra Kumar (1997) suggested that until a wholly independent agency for administration of all such tribunals is set up, it is desirable that all such tribunals should be under a single nodal Ministry. Again in 2015, the FSAT Task Force led by Justice N.K. Sodhi (Chairman) and Mr. Darius Khambata (Vice-Chairman) also suggested incorporating a company to provide administrative services to tribunals in financial sector. And finally, on January 18, 2016, a Constitution Bench of the Supreme Court in Madras Bar Association v. Union of India reportedly directed the Central Government to consider the possibilities of setting up a nodal body or agency for managing all tribunals across all Ministries.

Recently, the Law Minister himself recognised concerns that tribunals are not working satisfatorily. However, the Central Government is yet to come up with a concrete plan on tribunal reforms.

### Conclusion

In a recent Working Paper released by IGIDR, I argue that Indian policymakers should seriously consider setting up a TSA to support Indian tribunals including the ones under IBC. The detailed organisation design is also discussed along with board structure and financial arrangements.

The author is a researcher at the National Institute for Public Finance and Policy.

### Acknowledgement

The author thanks Mehtab Hans and Mayank Mishra for useful discussions.

Areas of weakness in the thinking of financial traders by Ajay Shah, Business Standard, 8 February.

As China's economy unravels, Beijing's attempts at damage control are growing increasingly desperate by Heather Timmons, qz.com, 4 February.

Stealing White: How a corporate spy swiped plans for DuPont’s billion-dollar color formula by Del Quentin Wilber in Bloomberg Businessweek, 4 February.

Is $3T in reserves enough? by Christopher Balding on Bloomberg. Let the rupee slide by Ila Patnaik, Indian Express, 3 February. How India Pierced Facebook's Free Internet Program by Lauren Smily, backchannel.com, 1 February. ## Saturday, February 06, 2016 ### Lecture series on the Public Economics of Health Policy in Developing Countries Jeff Hammer will deliver five lectures at NIPFP in the coming week. All are welcome. ### Recessions uncover what auditors do not On 14 December 2008, I was nervously looking around at the world and wrote a blog post Goodbye great moderation, hello financial fraud? Almost on cue, we got the Satyam scandal: 21 December, 24 December, and then 7 January. We also got a few other problems in India which (I think) surfaced owing to the Great Recession : NSEL, a rash of ponzi schemes, Sahara, Saradha. In China, unprecedented times are bringing forth revelations on an unprecedented scale [link, link]. Some of the rackets that are described in China appear quite familiar to us in India, but the magnitudes seen there are astonishingly large. We had such problems in developed markets also -- Madoff and MF Global. #### Institutional reform: Consumer protection One part of addressing this problem is the familiar machinery of the Indian Financial Code (IFC) version 1.1. As an example, see this analysis of ponzi schemes. As an IFC quality law is not found in either China or India, we have a rash of such problems in both countries. #### Institutional reform: Criminal justice system An important subset of financial crime is about plain criminal law. While the main track of financial policy has been along the Indian Financial Code, we need to develop a work program on improvements of the criminal justice system also. Put together, these will create an enforcement machinery that will generate deterrence against big financial scandals. #### Procyclicality of trust? Watching China unfold in recent weeks, I wonder if there's a general proposition of the following nature. Recessions will uncover what auditors could not, but under conditions of low institutional quality, this will happen on a bigger scale. Conversely, when institutional quality is low, business and finance will be hampered at all times by low trust. But in good times, when it's easier for the crooks to keep things under wraps, fewer scandals will burst into the public consciousness, and trust will go up. Procyclicality of trust may be heightened in places with low institutional quality. ## Monday, February 01, 2016 ### Interesting readings The EU is on the verge of collapse' -- An interview with George Soros by Gregor Peter Schmitz in the New York Review of Books, 11 February. "This Is Much Larger Than Subprime" - Here Are The Legendary Hedge Funds Fighting The Chinese Central Bank by Tyler Durden on ZeroHedge, 31 January 2016. To really counter terrorism by Manvendra Singh in the Indian Express, 30 January. Narendra Modi is losing India's market liberals by Sadanand Dhume in the Wall Street Journal, 28 January. Pains of a young republic by Somasekhar Sundaresan in the Mumbai Mirror, 28 January. Christopher Balding on proposals for capital controls in China, 28 January. What a normal startup actually needs by Sumanth Raghavendra, Qz.com, 27 January. The market's troubling message by Ashoka Mody, Bloomberg, 27 January. Also see a video of his talk of 25 January. China: Surviving the camps by Zha Jianying, the New York Review of Books, 26 January. How will China influence us? by Ajay Shah, Business Standard, 25 January. PBoC in a quandary over capital controls by Tom Mitchell, Financial Times, 25 January. `My personal vendetta': An interview with Hong Kong publisher Bao Pu by Ian Johnson in the New York Review of Books, 22 January. Highway for tigers by Padmaparna Ghosh, Mint, 19 January. Be tight-fisted by Ila Patnaik, Indian Express, 18 January. Cory Doctorow in the Guardian on India's net neutrality question, 15 January. The dragnet by Russell Brandom, on TheVerge, 13 January. How Ukraine weaned itself off Russian gas by Leonid Bershidsky on the Bloomberg, 12 January. The mother of all currency defences by Ajay Shah, Business Standard, 11 January. A better bankruptcy regulator by Pratik Datta and Rajeswari Sengupta, Business Standard, 9 January. Wilderness and economics by Thomas Power and George Wuerthner, Counterpunch, 8 January. Hiring without signals, David Henderson, EconLog, 7 January. The amazing maize by Surinder Sud, Business Standard, 4 January. The big sleep by Julia Medew, the Sydney Morning Herald. ## Sunday, January 31, 2016 ### Occam's razor of public policy Occam's razor is the idea that when two rival theories explain a phenomenon, the simpler theory is to be preferred. Aristotle's epicycles fit the data as well as Kepler's ellipses, and a pure empiricist could have been agnostic between the two. Occam's razor guides us in preferring Kepler's ellipses on the grounds that this is a simpler explanation. In the world of public policy, a useful principle is: When two alternative tools yield the same outcome, we should prefer the one which uses the least coercion. ### Example: Punishment When we want to drive the incidence of a certain crime to the desired rate, we want to find out the lowest possible punishment that gets the job done. You can reduce theft to desired levels by promising to cut off the hand of the thief. We would much rather achieve the objective using a reduced use of the coercive power of the State, with mere imprisonment. The purpose of punishment is deterrence, not vengeance. And, in the class of deterrents, we seek to find the smallest possible use of the coercive power of the State that gets the job done. Suppose 4 years of imprisonment and 2 years of imprisonment are equally able to get the incidence of a particular crime down to the desired level. Suppose a person says: I am not a liberal; I am not squeamish about using the coercive power of the State; I hate the people who commit such crimes; I don't care whether they get 2 years or 4 years in jail. But an$\alpha$fraction of all convictions are in error. In these cases, we are inflicting the punishment upon an innocent. The harm is minimised when we have deployed the lowest possible punishment. ### Example: Spending on government programs All government spending is grounded in taxation, present or future. All taxation is grounded in the coercive power of the State. If there are two different spending programs that get the job done, we should favour the one which spends less. ### Example: Infrastructure bonds When the market for infrastructure bonds in India does not work, too often, solutions are proposed which use extreme force. Some people propose tax breaks. Some people propose harsh interventions such as forcing every bank to buy infrastructure bonds or forcing every bidder to NHAI to issue infrastructure bonds. As an example, we in India force insurance companies to buy infrastructure bonds. If, on the other hand, we trace the failures of financial sector policy which have held back the market for infrastructure bonds, this would show how to get the job done while actually reducing State coercion (i.e. getting the State out of inappropiate coercion). ### Example: The journey to cashless Cash is an abomination and we should have a thousand flowers of electronic payments blossoming. India is one of the most backward places in the world in the domination of cash. Tax breaks for electronic payments or high taxes for cash transaction or outright bans of cash transactions: these are all ways that get the job done using a lot of force. If, instead, we understand the failures of financial sector policy which have hobbled the sophistication of payments in India, we will get the job done while actually reducing the use of the coercive power of the State. We would have less cash in India if RBI did not use the coercive power of the State to block the clever Uber cashless transaction. ### Example: Family welfare A government which runs counselling services on family welfare is using less coercion when compared with forcible sterilisation or a one-child policy. ### How to reduce the use of coercion: go to the root cause of a market failure Market failures can be addressed in many ways. When we go to the source, with well understood causal claims about the source of the market failure, we will find ways to address the market failure using the smallest use of the coercive power of the State. If we don't have a deep understanding of the sources of the market failure, we may often endup hitting a symptom rather than the disease. Getting the job done may then require the use of a lot of coercion. As an example, for some market failures that are rooted in information asymmetry, if an intervention can be found which rearranges the structure of information, this can get the job done using the least coercion. ### Why are big punishments often favoured in India? A person who thinks of violating a law to obtain an ill gotten gain$G$faces a probability$p$of being caught and the fine imposed upon him will be$F$. Standard economic arguments suggest that we must set$F = G(1-p)/p$. In this case, the expected gain from violating the law is 0, and a risk averse person will favour the certainty of compliance over the lottery of breaking the law. In India, too often, the executive works poorly and$p$is quite low. This creates a bias in favour of driving up$F$. This is giving us very large penalties. This induces its own problems. We are inflicting terrible harm on the$\alpha$fraction of innocents who are wrongly convicted. We are giving great power to front-line investigators and judges at a time when institutional capacity is low. If we are able to build institutional capacity for enforcement, and$p$goes up, we will then be able to come back to lower punishments that generate adequate deterrence. ### Why does Occam's Razor of Public Policy make sense? 1. It is consistent with the liberal philosophy that desires that humans should be free to pursue their own life with the minimum interference. 2. At best, governments work badly. The information available to policy makers is limited, many wrong decisions are taken, many decisions are poorly implemented. Governments do not know the preferences of citizens. Politicians and officials are self-interested actors and work for themselves. The Lucas critique comes in the way: rational actors change their behaviour when policy changes take place in ways that confound the original policy analysis. Many government actions fail to achieve the desired outcome, but they always have unintended consequences. It's good to be humble, and swing the smallest stick that would get the job done. ### Limitations All this, of course, presupposes that all use of coercive power of the State is a purposive activity aimed towards achieving a certain well specified objective. This is not always the case. As an example, the objectives of exchange rate policy or capital controls are hard to decipher. Before we get to discussion of more coercion vs. less coercion, it would be a great step forward if all government intervention were fully articulated in terms of market failure, objective of the intervention, demonstration of the causal impact of the intervention upon the objective, and cost-benefit analysis. The examples above have featured comparisons where more versus less coercion is easy to identify. Amputation of the hand$>$imprisonment for 4 years$>\$ imprisonment for 2 years. Forcing banks to give out 40% of their loans into priority sector lending is more coercion than information interventions which make the credit market work for poor people. Opening up to private and foreign telecom companies is a way to get phones to everyone with less use of State coercion when compared with forcing banks to open accounts for everyone.

In many situations, however, it is not easy to identify which of two alternative policy pathways involves more coercion. A government program which educated parents that their kids should get immunised seems to involve lower coercion when compared with a forced immunisation program, but this is perhaps not the case when we envision an education program that must generate eradication of polio. A government program to educate young people about saving for old age involves less coercion than forcible participation in the NPS.

### Conclusion

The State has a monopoly on violence and is the only actor who can coerce citizens to do things against their will. All public policy initiatives involve the use of the coercive power of the State. In the field of public policy, we should be humble about our lack of knowledge, respectful of the freedom of others, and use this power as little as possible.

### Acknowledgements

I am grateful to Jeff Hammer, Shubho Roy and Renuka Sane for useful conversations.

### Land market reform is an important enabler of bankruptcy reform

By K.P. Krishnan, Venkatesh Panchapagesan and Madalasa Venkataraman

In India, it seems easy to lend money, but it is difficult to get it back. Just ask our banks. New law, and associated institutional infrastructure, for bankruptcy is in the pipeline, with the draft Insolvency and Bankruptcy Code by the T. K. Vishwanathan Committee. Will it work? What can the impediments be that could limit its effectiveness?

One of the key weapons in a lender's armoury is the collateral (or security) from the borrower. The quality of the collateral - how easy it is to collect, store, value and dispose of - determines the type and extent of credit that a lender is willing to provide. Land and associated real estate constitute a large part of collateral in India. More than 50 percent of corporate loans and 60 percent of retail loans have land and real estate as collateral. It is hence important to understand the complex nature of land markets to determine whether they would facilitate or undermine the effectiveness of these new laws. We examine this issue in a recent paper titled Distortions in Land Markets and Their Implications to Credit Generation in India.

The land market in India is not a homogenous national market but a heterogeneous collection of various State markets with variation in laws and regulations. This is because land related issues fall under the State and Concurrent List under our Constitution. This poses the first big problem: it is not easy to provide credit across state boundaries unless lenders have local presence or partners to count on. Even when land is accepted as collateral, several factors exist that could raise costs and risks for lenders. Let's run through the list of challenges faced by the lender.

### Challenge 1: Does the land belong to the borrower?

It is hard to say because titles are not guaranteed by the State (like the Torrens system used in countries like Australia). Hence, all evidence of title is merely presumptive and can be challenged at any point by a person claiming to have better title to the land.

To mitigate the risk of future challenges to title, lenders spend considerable resources, including legal help, to conduct title searches, to protect themselves. A title search can be a fairly complex and expensive exercise in the Indian setting. This is because:

1. Indian law does not mandate the registration of every single transaction that affects rights in or the enjoyment of, property. Hence, records of some transactions that affect title or enjoyment of property will not be found in any public office.

2. Land records in India are spread across three offices - the Sub-Registrar's office, the revenue offices and the offices of the survey department. Time lags between these offices in updation of land records, often lead to inconsistencies in information obtained from these three offices.

3. Title related disputes in courts require a search process in the courts, as the status of the dispute may not be reflected in the records in the Sub-Registrar's office or the revenue offices.

4. A title search is necessarily a local exercise, as land records are maintained in local offices in local languages. The contents of land records across States are not standardised. Several State laws have restrictions on the transferability of land, depending on the land classification. For instance, in most States, agricultural land cannot be transferred to a non-agriculturist. The localisation of the title investigation process adds to transaction costs.

Lenders do not have recourse to a private title insurance industry in India. Interestingly, even in countries that follow Torrens system of state guaranteed titles, there is an increasing trend for lenders to seek private title insurance (Zasloff, 2011). Hence, lenders in India have to rely on title searches conducted by independent title investigators. This raises transactions costs and particularly hampers small loans.

### Challenge 2: Has the land been already pledged with other lenders?

There is no single point of information on all the processes and transactions that can encumber land. Again, some transactions which create encumbrances on land (such as the mortgage by deposit of title deeds) are not required to be registered. Consequently, the records of such mortgages cannot be found in any public office.

The Central Registry of Securitisation Asset Reconstruction and Security Interest of India, or CERSAI, was set up to consolidate information about mortgages against property. However, its scope is limited: it does not include reconstruction loans outside the purview of the SARFAESI Act or loans given out by entities other than banks. Nor does it have information about all loans issued prior to 2011 when CERSAI was set up. Further, since the registry requires identification of land clearly, the importance of accurately mapping land boundaries becomes critical for its success. Accurate mapping of land boundaries has its own set of problems as described next.

### Challenge 3: Is the land properly identifiable in classified records?

Land parcel identification is a challenge since cadastral maps are outdated and rarely reflect the reality on the ground. As mentioned above, record-keeping of various related aspects of land - titles and registrations, encumbrances, geographic information sources, revenue and taxation - is done in silos by various departments, often leading to conflicting information on the same land parcel. The problem is more acute in rural areas, where use of technology is still limited. The use of different units (acres, hectares etc.), terms (like Khata in Karnataka and Patta in Tamil Nadu) and bookkeeping standards across states present their own set of difficulties in identifying land across States, thus hampering the economies of scale of running a nationwide lending business.

### Challenge 4: Do the constructions/settlements on the land adhere to local laws, and have all dues been properly paid?

Important attributes such as flood plain, seismic zone, lake encroachments, easements and rights of way etc. also cannot be conclusively established given the siloed nature of record keeping. If not properly accounted for through pricing, these attributes could pose significant risk to lenders. The recent announcement in Bengaluru that several lake beds have been encroached by entities including the Bangalore Development Authority - the agency obligated to protect lake beds - shows the extent of risk to lenders who have financed development activity on such land.

The problem is exacerbated where the collateral is built-up property. In the case of built-up collateral, the lender is also required to verify whether the building complies with city-level zoning regulations and has the requisite building permissions. This is to avoid the possibility of the future demolition of the collateralised property which is not compliant with the local laws. The value of the collateral may also change depending on issues such as the area on the land, if any, earmarked for municipal road widening, changes in town planning norms, etc. This requires searches in the local municipal offices.

### Challenge 5: Is the value of land sufficient enough to cover the loan in case of distress?

Land valuation is done by lenders at the time of loan origination, and after the borrower has exhibited distress. Empanelled valuers use a combination of recent transactions and government estimates (called guidance values or circle rates) to derive land values that are used by lenders. Given the significant presence of black money in land transactions, getting true market values is more an art than science. Issues such as defective land title and illegal developments, mentioned above, impede land values but are hard to account for at the time of origination of the loan.

### Challenge 6: If there is default, can the land be sold to recover dues owed easily?

The battle to recover the collateral really begins after default. The SARFAESI Act has shortened the recovery process for banks and financial institutions. However, it leaves out creditors who are not banks and financial institutions such as creditors of firms which have borrowed through secured bond issuances. For such creditors, a mortgage foreclosure suit will, under current law, have to go through the delays associated with civil courts. Moreover, the implementation and interpretation of the SARFAESI Act has not been free of problems. For instance, proceedings under the SARFAESI Act are often delayed through writ petitions or simultaneous proceedings which are pending in other fora (Ravi, 2015). Similarly, the SARFAESI Act does not resolve the problems of already encumbered collateral or collateral with no marketable title. For example, a bank or a financial institution cannot evict tenants of collateralised property under SARFAESI. This proposition was recently upheld by the Supreme Court in Vishal Kalsaria v. Bank of India and Others, January 2016.

### Conclusion

Bankruptcy reform is important and valuable in and of itself. Land market reform is important and valuable in and of itself. Given the prominence of land as collateral in the working of the Indian credit market, improved working of the land market is an important enabler of a better functioning credit market and improved working of the bankruptcy code. Parallel and simultaneous progress on both fronts will yield a magnified impact upon the economy.

While the Bankruptcy Code is expected to improve recovery proceedings, it will not help where the title to the collateral itself is challenged at the time of recovery. Unlike movable collateral, the ability of a creditor to monetise immovable collateral quickly is fettered. Indian lenders have, so far, rationally responded to these issues by protecting themselves through credit rationing and through solutions like personal guarantees. Also, due to the difficult process of establishing title and related encumbrances, urban lands - where recovery time and cost are high - are subject to higher loan to value ratios.

One part of the reforms agenda is structural, and involves significant fiscal outlays, for cleaning up land titles, improving the quality of land registry through digitisation, overhauling the land litigation system and creating efficient stamp duty and registration processes. In addition, in the paper, we propose many modest, feasible and less expensive reforms. To begin with, we must standardise land-related data capture across states and create a repository of valuers' data that can be shared across lenders. Similarly, States need to focus their energies on building capacity in land record offices to enable smooth and efficient updation of land records. While creating conclusive titles with state guarantees is a laudable and ultimate goal, there are numerous opportunities for front-loading gains by streamlining existing land records using modern technology, and facilitating private title insurance to mitigate risk from lending against land.

Most of the challenges described above relate to the structure of information. Modern technology -- computers, telecom networks, GPS, Aadhaar, ubiquitous digital cameras -- has created a new opportunity to build improved institutional infrastructure for creating, storing and disseminating information that would transform the land market.

### References

Aparna Ravi, The Indian insolvency regime in practice -- an analysis of insolvency and debt recovery proceedings, Economic and Political Weekly, 2015.

J. Zasloff, India's Land Title Crisis: The Unanswered Questions, Jindal Global Law Review, 2011.

K. P. Krishnan is at the Department of Land Resources, Government of India. Venkatesh Panchapagesan and Madalasa Venkataraman are researchers at the Indian Institute of Management, Bangalore.

## Saturday, January 30, 2016

### Draft IRDAI regulations on insurance commissions: Going back to the beginning

by Ashish Aggarwal and Renuka Sane

On 13 January 2016, the Insurance Regulatory and Development Authority of India (IRDAI) released the draft (Payment of commission or remuneration to insurance agents and insurance intermediaries) Regulations, 2016 and invited public comments. The regulations propose a substantial increase in commissions for life insurance distributors starting April 2016.

In their present form, the proposals will be detrimental to consumer interest, increase the regulatory arbitrage in favour of products regulated by the IRDAI and undermine the recent attempts by the government towards curbing mis-selling and rationalisation of incentives for financial product distribution.

The regulations are intended to govern payments by an insurance company to individual agents or intermediaries (which include corporate agents, insurance brokers, web aggregators, insurance marketing firms, and any other entity as may be recognised by the IRDAI) for soliciting and procuring an insurance policy. Payments may be in the form of a commission (paid to agents), remuneration (paid to intermediaries) or a reward (any direct or indirect benefit over and above the commission). The Bill proposes that the Board of every insurance company will approve the commissions and reward policy. The draft Regulations propose two big changes.

### Big change 1: Raise the overall commission rates

For bundled products, such as ULIPs and traditional plans, with a tenure of twelve years or more, an insurance company would be able to pay intermediaries 49% of the first year premium as commission and reward. This cap is proposed at 42% for insurance agents (See Table). The commissions for subsequent years has been increased to 7.5% of premium for year 2 to 6. Earlier, the cap from year 4 onwards was 5%. The 5% cap is now applicable from year 6 onwards.

Pure risk cover, or term plans, will have a maximum first year commission rate of 50% for policies of tenure 12 years or more. For those between 5 and 11 years, commission will be capped at 40%. Subsequent year commissions will be capped at 10%. The addition of rewards to these implies that the maximum cost cap for term policies of duration 5 to 11 years will become 48% for agents and 56% for intermediaries. For policies more than 12 years, the caps will be 60% for agents and 70% for intermediaries.

First Year Life Insurance Commissions and Rewards
Category Proposed Existing
of 5-11 year:
ULIP/ Traditional - 42% for intermediary and 36% for agent

Term - 56% for intermediary and 48% for agent [Note 1]
15% to 33% based on premium
paying tenure of the policy [Note
2]
Policies with premium paying term of 12 years and
more:
ULIP/ Traditional - 49% for intermediary and 42% for agent
Term - 70% for intermediary and 60% for agent [Note 3]
35%
Note 1: Commission:- 30% of premium (ULIP/Traditional), 40% of premium (Term), Reward - 20% of Commission for agent and 40% for intermediary.
Note 2: Tenure and Commission:- 5 year - 15%, 6 years - 18%, 7 years - 21%, 8 years - 24%, 9 years - 27%, 10 years - 30% and 11 years 33%.
Note 3: Commission:- 35% of premium (ULIP/Traditional), 50% of premium (Term), Reward - (20% of Commission for agent and 40% for intermediary).

### Big change 2: Bring in hereditary commissions

These are being reintroduced. Section 54 of the The Insurance Laws (Amendment Act), 2015 had removed section 44, according to which, if an insurance agent had served for more than 5 years, the commissions had to be paid to the heirs of the agent, even if the agent was no longer servicing the policy.

### Problems with the draft regulations

Ignores all evidence on the perverse impact of high commissions
Research has shown that the incentive structure of agents has played a large part in the mis-sale of financial products. When agents get remunerated by the product provider, the incentive comes not from higher sales driven by customer satisfaction, but from commissions paid by the product provider. The product that pays the higher commission is the product that gets sold. This is not always in the interest of the customer. The world over, the response of regulators has been to ban conflicted remuneration structures, and/or impose requirements on ensuring the suitability of the product to the customer. Against such a background, the IRDAIs proposal to increase commissions, and also not impose any suitability requirements seems misplaced. This is particularly relevant as metrics of performance such as persistency and lapsation of policies have been steadily worsening.
Increases regulatory arbitrage
The same insurance distributor is likely to be selling other products like mutual funds and New Pension System which at their core are long term investment products. The commission structure for mutual funds is based on asset based trail fee. This results in relatively much lower commissions in initial years which could grow into substantial sums after say, 10-15 years, provided the customer stays into the scheme and invests regularly. The commission structure for NPS distributor provides for a nominal flat transaction fee and a 0.25% fee on amounts invested. A distributor is naturally incentivised to push insurance plans irrespective of suitability for the consumer. A consumer would be more likely sold a traditional insurance plan than a basket of NPS, mutual fund and term insurance. This makes selling difficult for the mutual funds and NPS. The proposed regulations are likely to further skew the markets.
Does not realign the pure term and bundled insurance products
It would be misleading to assume that the regulations incentivise sale of term insurance products by providing for higher commission rate as compared to ULIPs and traditional investment oriented plans. A term plan of Rs.1 crore for a 35 year old would cost Rs.13,000. At 70% of premium, Rs.9,100 should be a very attractive first year commission given that these products are apparently more difficult to sell as compared to investments. However, even if the initial commission rates on ULIPs and traditional plans were much lower, say 10%, these could still be more attractive for distributors to sell than term plans. For example, premium for ULIP/ traditional plan with a similar insurance cover would be about Rs 100,000 and even a 10% commission would fetch Rs.10,000. Of course, these are basically investment products with only a small portion of the premium going into insurance component. The raising of commissions on pure term along with that of bundled products does not alter the skew against the sale of pure term products.
Poor process
The draft regulations provide an approach which has gone into the formulation of the regulations. They do not, however, provide a rationale. How would these regulations benefit the consumers? In less than one year of the Insurance Laws (Amendment) Act omitting hereditary commissions, it is not evident why these are now proposed to be brought back through regulations? Regulators such as RBI, SEBI, have shown a poor track record in following regulation making processes. Regulations on fund management, and regulations on aggregators of the NPS, by the PFRDA have also raised similar concerns. The IRDAI draft regulations are yet another example of the failure of the attempts by the Government to encourage regulators to frame regulations as laid down in the Handbook on adoption of governance enhancing and non-legislative elements of the draft Indian Financial Code.

### Another recent committee's recommendations on commissions

It would be useful to look at the recommendations on similar issues of another recent committee setup by the Government of India and headed by Sumit Bose, Former Union Finance Secretary. The report has recommended doing away with the practice of front loaded commissions. It noted that these created perverse incentives for distributors to push products with higher upfront/ first year commissions, increased regulatory arbitrage and proved expensive for the consumers. The committee's recommendations provided that:

1. There should be no up-fronts for the investment part of the premium. The investment part should attract only AUM based trail commissions. The trail commission treatment should be decided with consultations with the lead regulator in the market-linked investment space. These should be level or declining.

2. Upfront commissions should be allowed only on the mortality part of the premium.

3. Distributors should not be paid advance commissions by dipping into future expenses, their own profit or capital.

4. The illegal practice of rebating should be punished harshly by the regulator as it distorts the market.

In its present form, the IRDAI draft regulations ignore all the recommendations of the Bose Committee report.

### Way forward

The disjointed approach as apparent in the draft IRDAI commission regulations is not in consumer interest. A useful approach would be to:
1. Fix the commission structure for the distributors based on the  recommendations of the Bose Committee.

2. Improve the regulation making process. Inviting public comments on draft regulations is a great step but mere existence of a public consultation process does not mean that the public will spend time and resources to comment and participate in the exercise. When the final regulations get released, the IRDAI should take care that these are accompanied with a proper explanation of (i) what exactly is being changed; (ii) evidence that has been relied upon to propose the changes and (iii) expected impact of the regulations on key stakeholders like consumers and sellers.

Ashish Aggarwal is a researcher at the National Institute for Public Finance. Renuka Sane is a researcher at the Indian Statistical Institute.