To check CRB-like scams, the government now suggests a host of measures. But are they viable?
It's a grim scenario, post-CRB. Thousands of investors defrauded of their hard-earned savings run from pillar to post in the hope of recovering at least some of it. The cheats, Chain Roop Bhansali and his coterie of relatives and friends, have fled and remain untraced. The regulators and monitors, be it SEBI, RBI, the finance ministry, auditors or credit-rating agencies, are baying for one another's blood. They need not waste their energies.
Because across the country, it's business as usual for many non-bank finance companies (NBFCS). On June 4, a national daily carried a prominent advertisement by a company called Elixier Green Shield inviting investors to join hands with them and earn 32 per cent in addition to a gold coin. In Patna, even as the CRB scandal was unfolding nationally, the police was busy locking up the branch office of PLS Technicals and freezing its bank accounts after the company's cheques began bouncing. Company chairman R. Kumar and director Arun Kumar Chaudhary are both absconding.
Down south, the situation may be worse. At the Chennai-based office of Vasudha Agrotch, investors wanting their money back are directed towards the notice board that informs them the owner is unwell but has every intention of returning public money in three months. Nobody knows the whereabouts of the owner, not even the peon. There are 10-15 companies that have collapsed in the last six months alone.
All that the CRB scam has achieved so far is to turn us into a nation of finger-pointers and busybodies. The BJP has found in CRB the perfect handle to beat the finance ministry with, the finance ministry is blaming the SEBI, SEBI the RBI and the RBI wants to deflect the blame to auditors and the auditors to credit raters. "To me it seems that more than the investors, it's the regulators who are panicking in an effort to be seen as saviours of the small investors. It will only lead to strangulation instead of streamlining, regimentation instead of regulation," says Jayant Dang, MD, Escorts Finance.
Result: a slew of hastily-conceived policy proposals. "In the flurry of activity, there is a danger that generic causes of financial failure, like inadequate understanding of nuances, inherent risks of the financial business and weak regulations, are ignored," warns ex-chairman of ICICI N.J. Jhaveri. Consider some of the measures being proposed to prevent CRB-like scandals:
Registration drive: According to the ordinance issued on January 9, all NBFCS irrespective of size have to apply for registration with the RBI. For new NBFCS, the minimum net worth prescribed in Rs 25 lakh. Existing NBFCS would be given three years to achieve this level. Estimates indicate that three are more than 4,000 NBFCS with a net world of Rs 25 lakh and above. The question being asked in financial circles is whether it's possible for RBI to supervise 4,000 companies. "Where is the staff and wherewithal with the RBI to undertake this supervision? I suspect that even the 800-odd registered NBFCS present quite a challenge to the bank. Why then create a false sense of security in the minds of the small investor that comes with the registered status," asks Dang.
Advance business plans:The RBI has now mandated that companies applying for registration must submit a detailed three-year business plan outlining its income and investment projections, market segment it will operate in, management practices and so on. Two questions come to mind. First, are we moving to market economics or back to the restrictive order of yesteryears? Second, in an era of volatile interest rates, what relevance does a pre-packaged programme have? Further, who is to decide on how far the company can deviate from plans? "The RBI should not lose its sense of proportion in a crisis," says Dhruv Prakash, president, DCM Financial. "The idea is to stick to the spirit of law rather than the letter. Market forces should be allowed to throw up rules of the game," says Atul Dhawan, partner, S.B. Billimoria &Co.
Insurance for FDs: The finance ministry is mooting a proposal for insurance cover for FDs to protect small investors. "The notion is conceptually flawed because FDs by their very nature are unsecured instruments. Providing insurance will alter the very character of the instrument," points out Prakash. Besides, it will only add to the cost for the investor. "A better idea would be to educate investors to evaluate risk," says Prakash.
Role of auditors: The RBI has taken a serious view of the failure of CRB auditors D.P Bhaiya & Co (according to latest reports, the owners are related to Bhansali) and sought to rectify the lacunae by appointing auditors themselves for top NBFCS. But the question is whether the auditors' responsibility extends to verifying the adequacy of security. " Our job is to assess whether the accounts are a true and fair reflection of the company's health and whether adequate control systems exist. Auditors can't be policemen," points out Satyavati Berera, partner, Price Waterhouse. In any case, if appointment of auditors by the government helped, then things would not be so bad in public sector banks. "Where does this government control fit into the country's commitment to liberalisation of the financial sector?" asks Ajay Raina, assistant vice-president, Apple Industries. Perhaps punitive action is the only realistic option. "Abroad auditors would be sued for millions of dollars for lax audits. Here all you get is a resting period, after which it's business as usual," points out Dhawan.
Role of credit rating agencies: The RBI has rightly diagnosed that rating agencies play an important role in guiding investors but the proposal under consideration that every FD scheme has to be rated by two agencies is absurd. The trouble with rating agencies is that companies can choose not to accept the verdict of one and go to another. "Surveillance is most certainly needed is this area because CRBS happen not because there are different ratings but because the rating is not downgraded in time and there is no adequate monitoring," says Dang. Again, punitive action can help in making agencies more responsible.
Tighter credit monitoring system: The huge loan exposure taken on CRB by SBI and the cooperative banks of Gujarat has sent the RBI into a tizzy over tightening the credit delivery system. The danger: a hurtling back to the era of nervous bankers. The finance ministry has been spearheading a drive to loosen up loan deliveries. A change of tack now would only unsettle the gains. "There is no foolproof loan disbursal just as there is no burglar-proof cash vault," says Dhawan. The conventional yardsticks used are interest cover, quality of security and business prospects of borrower but in a recessionary market even a good borrower could fail, agrees S. Venkitaramanan, former RBI governor. The RBI could end up choking the financial system.
Merchant banking restrictions: SEBI has declared its intention to ban merchant bankers from fund-raising activities. The logic: these clash with the issue underwriting function. This is strange. If the merchant banker is not allowed to raise funds, how will it gain the financial strength to underwrite issues? And the move to separate various financial functions into independent entities can only lead to a fragmentation of the financial services industry.
Is regulation then meaningless? Definitely not. But more than new regulations, what the industry needs is stricter supervision, agree most financial experts. And the investor himself has to understand changing market dynamics. For instance, in the last two years, with the returns on debt at 21 to 22 per cent almost equalling the average return on equity at 24, the accompanying risk cover has changed. That's reality, disputing conventional financial theory that equity is riskier and provides more return that debt.
Besides, market forces will automatically weed out the weaker NBFCS. The trend has already begun in the south. Unworthy NBFCS are going under, and the region is witnessing a consolidation. Three companies of the M.A. Chidambaram group have merged into one entity called MCC Finance. Premier Housing and Financial Exchange, and India Cements, Aruna Sugar Finance. The point is that the Indian investor can't have his cake and eat it too: he can't have increased market competition driving interest rates up nicely for him, while he is also insulated against competition closing some companies down.
Most importantly, the Indian investor has to understand that every investment comes with a risk attached. When someone puts his life's savings into a company, the least he can do is to keep track of its doings. The gradual deregulation of the financial sector will throw up new equations and permutations. The investors' best bet is not paranoid regulation, but informed judgement.