Money With Monika | RBI must signal danger: Lessons from Yes Bank AT1 Bonds
The writing down of Yes Bank’s AT1 bonds worth over Rs 8,400 crore in the aftermath of the scandal earlier this year had caused some alarm. But what seems to have heightened investor anxiety is the Reserve Bank of India’s stance to complaints filed against the write-off.
The central bank is treating the episode as investment gone bad, signalling to investors that they must pay closer attention to the product documents, and be ready to face the risk if they are opting for higher returns. While this may be justified in the case of high net worth individuals and corporates, is it fair to the retail investor?
I suggest some measures which the central bank can adopt to make investment contracts easier to understand for the retail investor, so that they don’t lose their hard-earned money due to advisors chasing targets.
The retail investors in India lurch from crisis to crisis, made worse by the pandemic. The reason that the same problem recurs has to do with broken market places and redress system than anything to do with investors behaving ‘wrongly’.
Yes Bank, Yes Bank AT1 bonds, Yes Bank AT1 bondholders, mis-selling, Yes Bank crisis, Financial firms, money management, yes bank investors, banking
The Instagram memers had predicted it and 2020 is making it come true—this is the year in which the world goes from crisis to crisis. The world war fears in January happily did not manifest but the Chinese virus quickly became a global pandemic, putting at risk not just those with the virus but the global economies that make incomes and livelihoods possible as well. In the middle of these two global events, India had its own banking crisis when Yes Bank went under. To understand a banking crisis and why it happens in India, read this.
The rumblings of discomfort had been building up for far longer than we think. When the government and the Reserve Bank of India (RBI) finally pulled the plug on Yes Bank last week, it was to stop the deposit haemorrhage that had been building up over the past few months. That the bank played on the edge of regulation plenty of people in the system knew. That RBI was “uncomfortable” with the bank has also been clear for years. A mix of flamboyance, networking with politicians and bureaucrats across the years was used by the bank, which was also known known to “massage” asset quality at points in time when the disclosures on asset quality were due.
The failure in the Yes Bank story again points to a tardy RBI and the historic lack of effective regulation to contain what has been the biggest open secret in Indian banking—the political use of depositors’ money to result in rich promoters, bankrupt companies and periodic bouts of inflation to “inflate away the debt”. Let me unpack this story. Since the nationalization of banks by Indira Gandhi, a bulk of scheduled commercial banking has been owned by the government (this is now about 60% of the deposits). Politicians quickly realized that this was the cheapest, most painless way of using taxpayers’ money to benefit businesses that were political donors. It was a hop skip and jump for the political donors to be replaced by personal wealth creation with the entire chain dipping its beak into the flow of money.
The success of the Bharat Bond issue where PSU bonds were sold through an exchange-traded fund (ETFs are mutual funds that mimic an index and list on the stock exchange) and the use of ETFs earlier for equity disinvestment of public sector firms has rung alarm bells in the plush offices of the life insurance industry. To see how they are connected, we will have to use a wide-angle lens and watch from 30,000 feet. The story is about who gets to be the pipe that connects savings to investments, and shaves off a few basis points to a few percentage points of costs, as it does so. Households and firms generate savings, which becomes the raw material for firms for their investments, that they use to start a new business or expand an existing one. Firms will either borrow or sell their equity to get the funds. Banks, insurance firms, mutual funds and pension funds are the pipes that connect savers to users (both borrowers and equity sellers).
Banks don’t mis-sell financial products in India. That is the conclusion we can draw from the annual report of the Banking Ombudsman (BO) for the year July 2017 to June 2018, where a tiny 0.4% of the total complaints made to the Ombudsman were related to mis-selling. This means that 654 banking customers in India complained that they were mis-sold by their bank. Overall too, very few Indians have a complaint about their banks—of the 700 million plus Indians with bank accounts, just 0.02% complained at all. Remove the inactive and dormant accounts, but still the percentage of people complaining at all is under 1%. But did you know that India was probably the only country where there were no complaints against mis-selling before 2017-18. The Banking Ombudsman only entertains complaints that it has defined in the categories or grounds of complaints; so if there is no category, there is no complaint. In an inter-regulator meeting in 2016, Reserve Bank of India (RBI) officials proudly said that banks did not mis-sell—see no complaints. If you don’t admit such complaints, it does not mean there are none. The attitude of not wanting to find the problem defines the RBI and the BO approach to consumer complaints in general and mis-selling in particular.
eading the Irdai (Insurance Regulatory Development Authority of India) draft on updating regulations for unit-linked insurance plans and traditional policies, you get the impression that somebody gave an aspirin when what was needed was a heart surgery. Product structures in finance are taking on a new importance globally because mis-selling and unsuitable sales can be reduced by taking the tricks and traps out of these products. This simply means that the costs and benefits are better defined and marked so that investors are able to understand the features of the products properly. Product structure rules also deal with early exits and their costs so that investors are not trapped in products they buy.
Closed-end funds have been in the news recently and not in a good way. One newspaper story has predicted the doom of these funds as the capital market regulator clamps down on mis-selling through this route. Closed-end funds have had a bad history in India and have been repeatedly used by the industry to mis-sell. My introduction to these funds happened more than a decade ago. In 2006, armed with an upgrade in the knowledge of using excel sheets and the workings of mutual funds, I did a series of stories in The Indian Express on the big mutual fund churn where mutual funds and agents were harvesting the high upfront commissions. You can read one of the stories here, the others seem to be lost online. You are being churned if your adviser or agent makes you sell a financial product only to buy something else, with an aim to earn commission on a new sale. The agent wins at your cost. It’s the oldest trick in retail finance. Churning is an industry practice that global regulators frown upon because it hurts investors.
I don’t think there will be many people in urban India who do not have a bank mis-selling story to share. The systemic use of bank branches to mis-sell life insurance products and to churn mutual fund portfolios is now part of the urban Indian discourse. The problem is not new. I remember first raising the issue of banks mis-selling insurance and mutual fund products in 2007 with one deputy governor of the Reserve Bank of India (RBI). I was treated to lunch and anecdotes from those in the room of how people close to them were ripped off by banks. In fact, subsequently, in every committee I served on—Swarup Committee 2009 (bit.ly/2tLat6F) and Bose Committee 2015 (bit.ly/2rS3xmK)—the offline conversations included stories of bank branches turning into dens of tricks and traps. I’ve raised the issue of mis-selling with RBI, and with the ministry of finance, and so have others who work in this space, most notably Moneylife magazine (bit.ly/2t7r5HJ and bit.ly/2sHtN6b), which has raised it on multiple occasions. But the messaging that came down from the towers of oblivion on Mint Street was always the same: not our problem; let the sector regulators deal with this.
I wrote about the removal of key consumer rights by the insurance regulator in my previous column. You can read it here: bit.ly/2njjAI1. Insurance Regulatory and Development Authority (Irdai) responded with a letter. In the interest of fairness, I’m using key arguments of the letter here and putting the rest online at: bit.ly/2nAhs2H. I will also respond to Irdai’s letter.