At the heart of the complex web of bits and bytes that is the modern financial system is the ability to exchange and transfer capital (money) between various participants in an economy. Borrowers, lenders, investors and entrepreneurs form the four corners of this very busy square. Traffic flow and participants can either be controlled and owned by the government as it was in India till 1991, or it can be regulated by a set of independent regulators appointed by the government, as it is today in 2021.
When we see the hectic activity in the Indian financial system today, we tend to forget what it was like just 30 years ago — in terms of scale, products, efficiency, cost and service. The sole job of a financial system is to trundle money around to find its optimal use in terms of returns at a low-cost and safety of transactions. But the centrally planned Indian economy used the state-owned financial institutions such as banks and insurance companies to gather household savings for its own use, hard coding this into the reserve ratios in banks and investment guidelines in insurance firms.
Mis-selling by banks has been flagged, caught and proven multiple times in the past decade, but nothing other than half-hearted circulars have emerged from the Reserve Bank of India (RBI). For a regulator, that is also the central bank for a $3 trillion economy, busy with large issues like monetary policy and government debt, the consumer protection department is where staff is sent to be sidelined.
When the Yes Bank AT1 Bonds were extinguished, retail investors who had been sold these as FDs with a higher rate of interest, had thought that the RBI will do something about it and protect their interest. RBI, according to news reports, took the view that the risks were explained and there was no mis-selling. Investors wrote to Sebi as well and some of them have gone to court over being mis-sold. Curiously, it is the capital market regulator that has come to the aid of retail investors. Sebi took the complaints seriously, did a full investigation and found Yes Bank and three of its officials guilty of mis-selling in a 12 April 2021 order. It has fined Yes Bank Rs 25 crore, and Vivek Kanwar (managing director of the private wealth management team) Rs 1 crore. His team members Ashish Nasa and Jasjit Singh Banga have been fined Rs 50 lakh each. The case against Rana Kapoor will be taken on a parallel track since he is already in jail and unable to join the investigation fully.
Sebi found the following:
Yes Bank showcased the bond as a ‘Super FD’ and ‘as safe as FD’
The term sheet was not shared with all the investors
No sign off was taken from investors on their understanding of the features and risks of the product
Risk profiling of customers was not done, specially those who were more than 70/80/90 years of age
In the ‘verbal pitch’ shared by the private wealth management team with the Relationship Managers, the AT1 bonds were compared with fixed deposits on rate differential only, but omitted the risk differentials
There was a push from the MD & CEO of Yes Bank to down sell the AT1 bonds which led the private wealth management team to recklessly sell the bonds to individual investors
97% of the 1,311 individual investors who were sold these bonds were existing customers of Yes Bank
277 of these closed their FDs prematurely to invest in these bonds
Yes Bank and its officials had a fiduciary responsibility towards their customers and that was broken by selling them high risk bonds without explaining the full risk
Yes Bank did not have a system in place to ensure that a term sheet would be shared with retail investors nor was there any provision for taking a confirmation from investors with respect to their understanding of the risks
Policymakers, regulators and others working the space of consumer protection along with financialisation of Indian household savings must read the entire 61-page order carefully to see how an investigation must be done when dealing with disaggregated retail investors who do not have the ability to fight large corporations. In fact, I wrote a paper along with the team at Dvara Research that found retail investors were wary of buying AT1 bonds if the risk factors were clearly marked out. It seems that even this basic hygiene of just writing down the risk in the same manner that the returns were marked, was missing in the Yes Bank case.
Sebi has used RBI’s own regulations to find that Yes Bank was guilty of mis-selling. The order says that while initially RBI only allowed AT1 bonds to be sold to institutions, in a September 2014 order, it allowed them to be sold to retail as well, but with disclosures on the risks that such bonds carry. A specific sign off was required from retail investors saying that they understood the risks. RBI rules mandate that “all the publicity material, application form and other communication with the investor should clearly state in bold letters (with font size 14) how a subordinated bond is different from fixed deposit, highlighting that it is not covered by deposit insurance.” In addition, Sebi has used its own powers under the Sebi Act and under the Prevention of Fraudulent and Unfair Trade Practices Regulations and the fact that Sebi has oversight of listed bonds to carry out the investigation and pass this order.
The Sebi order has several non-linear take-aways. One, the naming of specific wealth managers and finding them guilty, rather than penalizing the lower staff should worry bank boards and managements that the long hand of Sebi can now reach them under the various regulations in place. I have always maintained that catching one junior bank employee will not solve the systemic problem of bank mis-selling in India. This has to be a board driven initiative.
Two, for Yes Bank this is an opportunity to transform the way banks in India treat their customers. Post the Rana Kapoor regime, the management has now been taken over by a bank consortium and there is a professional board in place. This crisis is a great opportunity for the bank to set a standard in customer protection by putting in place protocols that reinforce the fiduciary responsibility of a bank towards its customers.
Three, this may not end well for Sebi if the past is any indication of future events. Steps taken in earlier years with a view to protect retail investors have usually ended badly for those taking bold steps. In 2009 CB Bhave, the then chairman of Sebi did two big things in investor interest. One, he removed the front load in a mutual fund. Two, he went to court against the insurance regulator (IRDAI) saying that the Ulip was actually a mutual fund masquerading as an insurance since 90% of the premium was in a mutual fund like product. The government in 2010 issued an ordinance to rule that IRDAI controls the Ulips. Bhave was then moved out soon after. I fear that the investor-first team lead by Sebi chairman Ajay Tyagi is at risk in a similar fashion.
In fact, the recent Ministry of Finance intervention over the valuation of AT1 bonds that Sebi was putting in place in retail investor interest points to the road ahead. Bank lobbying derailed the move to provide safe spaces for pure retail investors to put their money to work.
Finance Minister Nirmala Sitharaman must look at the story from the point of view of retail investors and not from the lobbying by firms, other regulators and bureaucrats who have caused an open loot of retail money through regulated entities like banks and insurance companies over the years.
Monika Halan is India’s trusted personal finance writer, speaker and author who helps families get their money decisions right.
Retail investors are the last to know when things go wrong with their money. This is especially true of difficult-to-value-and-trade (in India) financial products such as bonds. The story gets even more complicated on how to treat bonds that behave like (or worse than) equity – for example AT1 bonds. AT1 bonds are issued by banks to shore up core capital base to meet BASEL III norms. These are unsecured, perpetual, high-risk bonds. Banks can skip paying interest on these bonds if their capital ratios fall below certain threshold level. These bonds are junior to equity and get extinguished in case of a bank failing. In English this means that these bonds need not pay interest and need not return capital if the bank finances are under stress. Retail investors into Yes Bank AT1 bonds lost their entire savings when they bought these bonds when they were told by the bank managers that these were FDs with a higher interest.
Mutual funds also have AT1 bonds in their debt funds, introducing risk worse than equity into products that retail investors consider safe. These risks were marked out in this story in 2016. One estimate says that there were 25 schemes by end June 2020 with between 15% to 60% of their assets in these risky bonds. That’s a lot of very high-risk bonds in a debt portfolio!
A March 10, 2021 circular issued by Sebi lays out the rules of the game so that worse than equity risk is not introduced into debt funds. The circular says:
No mutual fund will own more than 10% of these bonds issued by a single issuer across all its schemes.
Not more than 10% of a scheme to be invested in these bonds.
And not more than 5% of a scheme in the bonds of a single issuer.
If a scheme and fund house already have investments that are higher than these limits, these will be grandfathered – the fund need not sell them, but not buy more.
For retail investors this is important because Sebi is putting limits on how much of these very risky bonds a fund house can buy. And for funds that are already holding more bonds than now allowed, Sebi is giving a leeway of ‘grandfathering’ their holdings. They are not being forced to sell, but cannot buy more till they fall below the new regulatory thresholds.
A second part of the circular says that:
The tenor of the bonds will be considered as 100 years since they are, well, perpetual.
Closed end schemes will not invest in perpetual bonds, because they will not have a tenor of a 100 years
Sebi’s goal seems to be to protect investors into debt funds from finding too much risk in their portfolios. Some debt funds were found to be treating these long-term bonds as short term by taking the put and call dates as the tenor of the bond. Put and call dates are those dates on which the bank can call back these bonds and pay investors back or investors can sell these bonds back on a ‘put option’ date. See this from an investor point of view, you buy a short-term debt fund to have certainty of money and a return that is slightly higher than a bank deposit. But to include highly risky, long-tenure bonds in the portfolio of short term bonds, as Franklin Templeton did, makes investors open to risks they did not want to take. Also valuing a perpetual bond on the call/put date is a real sleight of hand and a very sharp practice by the fund houses doing this.
This action by Sebi is in continuation to its October 2020 circular that put in place rules so that retail investors cannot buy these bonds directly. A minimum ticket size of Rs 1 crore, a minimum lot size of Rs 1 crore and restricting sales to only institutional buyers were all aimed to preventing a Yes Bank like mis-selling episode. Surprisingly, action was taken by the capital market regulator to what is a banking regulator problem. RBI took the view that retail investors were disclosed the risk of these bonds by Yes Bank and were not mis-sold. This paper (I am one of the authors) marks out how better disclosure would have prevented most of these sharp sales by Yes Bank officials.
But things unraveled on 12 March 2021 when the Department of Financial Services, Ministry of Finance overruled Sebi and in a memorandum as reported in the newspapers, told Sebi to withdraw the valuation rule as it would lead to market disruption. Next, the industry body Association of Mutual Funds in India (Amfi) made a press statement standing with Sebi! Amfi, actually has no option but to do this since these issues have been debated and discussed for months before the circular was issued two days back. The issue of AT1 bonds in mutual fund portfolios and how to value them has been a subject of much discussion within Sebi and with the mutual fund advisory committee (I am a member on this committee) over the past few months.
The Ministry of Finance has done two things wrong. One, it has not seen the retail investor interest in the action of Sebi and seems to be responding to the banking lobby. Two, by undermining the regulator in this manner it is setting a precedent for others to follow by messaging Delhi directly rather than work with sector regulators. It would have been better semantics had the government resolved the issue rather than take it public in this manner. Very unfortunate for retail mutual fund investors in particular and regulatory autonomy in India in general. The finance minister Nirmala Sitharaman needs to set this right.
The Reserve Bank of India (RBI) working paper by Harendra Kumar Behera and RBI deputy governor Michael Debabrata Patra on inflation targeting has waded right into one of the world’s most vibrant policy debates, one between inflation hawks and dis-inflationists. The former believe that easy-money policies pursued after the West’s financial crisis of 2008-09 that have given way to printing money as a path out of the covid crunch will eventually lead to much higher rates of inflation than experienced by the developed world in the last three decades. On the other side are dis-inflationists who believe that the world has undergone a structural change—thanks to demography, technology and globalization—that has caused the ‘Phillips Curve’ to flatten in some economies. By this, they mean that a long-observed trade-off between growth and inflation, under which an accelerative economy would overheat after a ‘speed limit’, has lost its disruptive power. The US Federal Reserve has recently loosened its rules a bit on fighting inflation, but there is no reason for RBI to follow suit.
In their paper, Patra and Behera set out to identify an appropriate inflation target for India, and find that it is still 4%, the central aim of an explicit policy adopted by RBI in 2016 that is due for a review in March. “If it ain’t broke,” they argue, “don’t fix it.” Yes. Take the pre-pandemic record. Retail inflation was in the range of 4.2% from 2014 to 2019, less than half the average over 2007-14. If India’s steady decline in inflation is consistent with a flattening of the Phillips Curve, the paper asks, what must be the right target at this point in time? A target set lower than the trend rate will result in an ‘overkill’ of tighter money that would hurt the economy, say the authors, while a higher aim will expose it to inflationary shocks. It would be best then to target 4%, as before, with elbow room of plus or minus 2 percentage points to give policymakers some flexibility.
2 min read. Updated: 22 Dec 2020, 08:35 PM ISTLivemint
The recent suicide of a Hyderabad-based techie who was humiliated when a lender went about calling people on his contact list, the consent for which he had given while taking that loan through an app, has brought into sharp focus the risks of instant app-based lending in India. The country has long been starved of credit, and despite efforts to drive up the efficiency levels of banks, our formal lending structure remains too clunky, time-consuming and costly to satisfy the vast demand in evidence for small unsecured instant loans. Online ventures spotted a big opportunity in this space and have gone all out to reach underserved customers. But this growth has been largely haphazard, while Indian regulators and lawmakers have tended to take only knee-jerk notice of creeping market failures that could end up destroying markets, choice and innovation. The unseemly tactics being used by lenders to recover their dues exemplify a failure that can no longer be ignored. We need much sharper regulation of all such practices.
In July 2020, the Reserve Bank of India (RBI) did put out rules designed to curb the opacity and violation of existing lending norms by digital lenders, but these have done little to improve matters on the ground, where lenders often ask for and get the digital records of borrowers that they have no right to. Clearly, RBI’s stated intent of viewing violations “seriously” has not been taken seriously enough by the market. This is not just India’s problem. Other countries are also taking steps to put rules in place for digital lending. In 2017, China’s regulators had to impose restrictions after a scandal arose of personal pictures being used to humiliate borrowers into repaying loans they could not afford to. In Kenya, its central bank has clamped down hard on predatory rates and recovery practices. India is in need of a policy solution that would neither kill this nascent market—which fulfils a very real need for quick and painless loans to tide people over for short periods—nor deaden the buzz of innovation in the country’s fintech sector, but is able to institute personal data and privacy protections that prevent predatory recovery practices.
The Reserve Bank of India (RBI) working paper which recommends that manufacturing groups and business houses be allowed bank licences , while mapping global norms against this and disclosing that all but one of the experts consulted were against this, has generated plenty of heat. Like almost everything else right now in India, views on the issue largely depend on which side of the political spectrum you swing on policy matters. Considering the content, disclosures and manner of this idea’s presentation, it looks to me as if this is a kite flown to see what reactions emerge. The Narendra Modi government is unlikely to spend political capital on such a big change if there are enough signals that it would be a vote loser. But since the kite is in the sky, we should use the opportunity to think through the issue of letting manufacturers own banks while trying to keep politics out of it. I will outline three areas to look at this question from different windows.
But first, why do we need manufacturing groups in banking? Because India is capital starved and needs money to grow. Public sector banks (PSBs) have eroded their capital through a mix of poor lending decisions and politically-nudged free money to business cronies for the past many decades. The playbook of funding cronies with the public money of PSBs, then recapitalizing these banks using taxpayers’ money (and by borrowing), and then inflating away the debt, has destroyed the balance sheets and morale of PSBs. Private banks find retail lending more profitable and less risky than corporate lending. The flow of capital that India needs for its next stage of growth is missing. Therefore, the need for letting firms with the deep pockets required into the banking sector at this juncture. But this is a contentious issue, globally. So, how should we look at it?
The reason that globally rules on who can set up a bank and what regulatory hoops they need to constantly jump through are much tougher than for a biscuit or a car company or even a telecom service provider has to do with the nature of banking itself. If a non-bank fails, the problem is only for the employees, the shareholders, the raw material and parts sellers and for those who liked the biscuit or car and now can’t have it. But when a bank fails, it takes down the savings and deposits of average households who trusted the bank. Worse, a too-big-to-fail entity can take down the whole system.
The report released by the Reserve Bank of India’s (RBI) Internal Working Group last week has generated a flood of opinions on why manufacturing firms should not be given a bank licence. But the issue is deeper than just that. There is a premise that expanding the number of banks and a supply of credit will fix India’s problem of being credit starved. But banks have turned risk-averse and even the existing flow of liquidity from RBI is deposited right back through the reverse repo window rather than being lent out to the non-triple-A-plus rated entities. Just expanding the supply of banks is not going to improve the flow of credit to the corporates, including the small and medium scale firms.
Indian households looking for a safe space to put their money have been going from crisis to crisis in the past few years. Banks have failed, debt funds saw deep losses, and in March 2020, we saw six debt funds frozen. Even people who trusted nobody and kept cash under the mattress lost it during demonetization.
The latest story that is spooking bank depositors is the moratorium on their money in Lakshmi Vilas Bank (LVB), ahead of its amalgamation with DBS Bank. LVB is a small bank and the impact on overall banking will be marginal, but the loss of confidence in banking escalates with every crisis. And banking is all about the trust that your money will be there when you need it. Households must understand the difference between their avatars as depositors and shareholders. RBI has moved fast to announce that no depositor will lose money, that it will be available post the moratorium. The fixed deposits will be safe—the rates may change as DBS as the new owner will decide this. The losses will go to the shareholders. The share values are slated to go to zero.
There is no contagion to other banks. This is a crisis well-managed, like the earlier Yes Bank one. Shaken savers need to only look at the history of banking to understand that depositor money in scheduled commercial banks has not been lost. Your bank is safe as a custodian of your deposits. So, ignore WhatsApp forwards that tell you to exit banks. However, investors in shares of banks, and into bonds, need to understand the risk. A bank share and a bank deposit are different instruments. Don’t get mauled by the risk if you don’t understand it.
Indian households, looking for a safe space to put their money in, have been hurtling from crisis-to-crisis past few years. Banks have failed, debt funds saw uncharacteristically deep losses and in March 2020, we saw six debt funds frozen. People who trusted nobody and kept cash under the mattress, lost it during demonetisation.
The latest story that is spooking bank depositors is the moratorium on their money in Lakshmi Vilas Bank (LVB), ahead of its amalgamation with DBS Bank. LVB is a small bank and the impact on overall banking will be marginal, but the loss of confidence in banking escalates with every crisis. And banking is all about the trust that your money will be there when you need it.
As much as $2.8 trillion, or money almost equal to the GDP of India, was available to buy shares of Alibaba Jack Ma’s Ant Group last week, making the $34.4 billion IPO, which has now run into trouble with the Chinese regulators, hugely oversubscribed. Ant is a Chinese company that began life as an escrow account to facilitate transactions on Alipay in 2004. Sixteen years later it has morphed into a gigantic multi-tentacled entity that leverages its wallet information to make loans, sell mutual funds, insurance and wealth management products, serving over a billion people. It partners with over 100 banks and over 170 asset managers, and reported an operating margin of 34% in the first half of 2020. It is mostly as much a platform as Uber or AirBnB are, but it does have proprietary offerings across credit and insurance. As the name suggests, Ant’s business philosophy rests on no client or need being small enough to be ignored. This is as bottom of the pyramid as it gets. And the treasure is equal to the GDP of the fifth-largest country in the world.
The success of Ant in serving more than a billion Chinese people and then harvesting that value on the stock market raises the question—but what about India? Why do we not have similar entities that serve a very similar demographic that regular banking has ignored for decades? It is a market where small businesses are cash starved, where the central bank has to huff and puff for transmission of credit to go beyond the best-rated largest firms. The answer has to do partly with the Chinese state looking the other way while Ant sometimes walked the grey areas of regulation and partly to do with the “if we stay in the cave, we won’t get wet” attitude of the Reserve Bank of India (RBI).
Two reasons prevent an Ant-like entity that will stitch together the entire financial life of a person onto a screen from payments, cash flow, savings, investments, insurance to wealth management. One, KYC (know-your-client) is not a one-time, portable process. It is not portable across regulators, worse it must be repeated every time one opens a new bank account with another bank. The Securities and Exchange Board of India (Sebi) has solved this problem and KYC where one part of the securities system is valid for operating in another part of the market. RBI hides behind an archaic privacy law that prevents one bank from sharing KYC information with other banks or with other regulators when they want to check the details. Of course, the same rule does not prevent rampant cross-selling of third-party products sharing bank account details to the last rupee with sharp shooter salesmen. The CKYC (Central KYC, the brain child of an UPA- 2 FM), which hoped to do the job, is useless since it just brainlessly uploads data without verifying it. This is “garbage in and garbage out” as one regulator puts it.
Two, the various regulators have their own unique ways of looking at the market and this prevents a common interface where a person can look at her entire financial life and transact on one screen. Even PayTM, where Alibaba and Ant have a large stake, is unable to give the one-screen solution due to the regulatory mess that India finds itself in, where regulators fight on turf and mostly have ignored individual needs.
But the outlook is not fully bleak if we start connecting some of the dots that are riding on the existing public goods of Aadhaar and the national payments system. Two pieces that are work in progress could change the current logjam. One, four financial sector regulators have come together to put in place an entity called “account aggregator” which is essentially a “switch” that allows data to flow between the users of and the providers of data, after getting consent from the owner of data. Read herefor more on account aggregators. This will potentially allow the owners of data to leverage their digital exhaust for their own use. The onboarding of the GSTN data will possibly solve the credit flow to small enterprises. Two, a single repository of all financial assets is underway where mutual funds, stocks, copies of bank FD originals, insurance policies, National Pension System units, bonds will all sit. A user will be able to open one screen to look at her entire financial life. A small tweak in nomenclature from “depository” to “repository”, it seems, got the buy-in from some reluctant regulators.
All this is work in progress, but if this works, India will have built a public infrastructure on which firms can build value-adds—just as we have done with Aadhaar and payments. The power of an individual losing his financial identity rests with one firm in China. But in keeping with the democratic traditions, this power will not rest with one or two large firms in India, but will be the remit of a public institution. If things go according to plan, and mistakes will be made, in two to three years, India should have not just one Ant-like firm, but several. The success of Aadhaar and payments in creating digital public utilities give me hope that the next stage of digital utilities will indeed happen.
Monika Halan is consulting editor at Mint and writes on household finance, policy and regulation
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