The NSEL fiasco is part of a wider problem: poor financial market regulations across capital market, insurance and banking. The government is apparently considering a new regulation for commodity markets. Why wasn’t this a given higher priority than arming a corrupt and inefficient SEBI bureaucracy with draconian powers?
A massive Silver Jubilee celebration has been followed by a quick ordinance, with minimal public discussion, to give the Securities and Exchange Board of India (SEBI) sweeping new powers. Of these, the only area where some action was urgently required is on the clarity to regulate collective investment schemes (CIS). The ordinance does that and much more. It allows SEBI to decide what is a CIS, especially if it is a money pool of Rs100 crore or more.
It is now empowered to call for information (retrospectively from March 1998) as well as search and seizure, criminal prosecution, attachment of assets and disgorgement of wrongful gains. The ordinance also validates SEBI’s ‘Consent Order’ regime, which is a matter of litigation.
Was the regulator really hobbled by an absence of these powers? Will its extensive new mandate benefit stakeholders or merely create a larger bureaucracy to harass legitimate businesses? Time will tell how SEBI wields its new powers, but a look at how it had acquitted itself so far, only causes concern and discomfort.
Stock market regulation, registration of intermediaries as well as the automation of trading with settlement guarantees was seen as such a big deal that every regulator after 1992, was modelled on SEBI. But wouldn’t you think that a government as beleaguered as the United Progressive Alliance (UPA-2) would call for clear, unambiguous assessment of SEBI’s achievements before rushing ahead with an ordinance that grants it sweeping powers?
In fact, the current action seems just over a year old—starting from the time Pranab Mukherjee went over to the Rashtrapati Bhavan. Until then, the thinking was different. In March 2011, the Financial Sector Legislative Reforms Commission (FSLRC) was set up to review legal and institutional structures of the financial sector. According to Wikipedia, this was because “piecemeal amendments have generated unintended outcomes including regulatory gaps, overlaps, inconsistencies and regulatory arbitrage.”
FSLRC submitted its report in March 2013 and one of its key recommendations was the setting up of a Unified Financial Authority (UFA). However, it turns out that FSLRC itself may have been an exercise in futility and a waste of taxpayers’ money. Each of its key members—YH Malegam (well-known chartered accountant and director on the Reserve Bank of India board for over 19 years), Kishori J Udeshi (ex-RBI deputy governor), PJ Nayak (ex-bureaucrat and former chief of Axis Bank and JR Varma (academic)—voiced formal dissent against its core recommendations. FSLRC itself made no attempt to engage with core stakeholders—the consumers of financial services—who have been getting a raw deal under every financial regulator. Consider these issues.
• After 25 years of its existence, the number of retail investors has shrunk from 20 million to 8 million (D Swarup Committee report) and this includes mutual fund investors;
• RBI has not been able to make any headway in reaching over 300 million unbanked Indians. In fact, it has to share the responsibility for viewing the microfinance sector through rose-tinted glasses even as their aggressive sales and usurious interest rates pushed people to suicide and bankruptcy, nearly killing this business segment.
• The creation of an insurance regulator only encouraged rampant mis-selling of equity-linked mutual fund products; the regulator did nothing, until three years ago. RBI and the Insurance Regulation and Development Authority (IRDA) are yet to initiate action against misleading advertisements and rampant mis-selling of insurance by banks. Result: India remains one of the most under-insured countries in the world.
• The pension regulator has made no headway because of its foolish decision not to compensate distributors, because the pension Bill has yet to be passed and there is no clarity on its regulatory powers.
The FSLRC report didn’t even touch on these issues. Since the government chose the ordinance route to make SEBI more powerful, one assumes that the FSLRC report has been dumped. Otherwise, the ordinance should have been preceded by a transparent assessment of whether SEBI was even using its existing powers of regulation and supervision effectively. In our experience, SEBI’s performance is especially lacking in the area of grievance redress and is the single biggest reason for retail investors’ exit.
Let’s turn to regulatory and statutory changes that were probably more urgent than the ordinance to empower SEBI. The consequence of regulatory confusion was evident in the blind panic in connection with the National Spot Exchange Ltd (NSEL), which was asked to suspend all its contracts (except e-contracts). NSEL must be hauled up for wrongdoing, if any, but nobody seems to realise that the buck, in this case, should stop right at the top—with the ministry of consumer affairs (M-Con), which allowed a commodity spot exchange to be set up with just a government notification.
The M-Con, with no experience of regulating a market (or consumer issues for that matter), triggered chaos with an order that virtually shut down an exchange overnight. This, after it sat on concerns about NSEL’s ready-forward trades (conducted openly and transparently by the bourse), for more than a year. When NSEL suspended all contracts other than e-series, and decided to merge settlements, it triggered a panic. The shares of Financial Technologies, NSEL’s promoter, crashed over 60% and those of the Multi Commodity Exchange (MCX) dropped 20%.
Will someone tell us who at M-Con took the decision to permit and regulate a spot exchange in commodities? Was there any attempt to create a framework or infrastructure to regulate the bourse? Why weren’t spot exchanges started under the Forward Markets Commission, which regulates commodity trading? According to media reports, the government is now considering a new regulation for commodity markets—if this is true, why wasn’t this a given higher priority than the SEBI ordinance?
Then there is the Companies Bill 2012, which has been cleared by the Lok Sabha seven months ago, but remains in suspended animation because the Rajya Sabha has yet to clear it. Has the government forgotten the Bill? Or is the young minister of corporate affairs (M-Corp), Sachin Pilot, unable to make his voice heard? Sources say that it is deliberately, and repeatedly, sidelined, but it is not clear why.
Could it be that SEBI is considered a better regulator because M-Corp failed to check the rampant fund-raising by Sahara, Saradha and a host of other collective investment and chain-money schemes? If yes, then there is still no clarity about whether the new SEBI ordinance will also cover chain marketing or multi-level marketing (MLM) companies (MMM, floated by a Russian citizen, QNet by a Malaysian, Pearls or PACL and hundreds of others), which fall between the Prize, Chits & Money Circulation Act, 1978 and the Companies Act.
As we said before, the SEBI ordinance is extensive in its scope but there is little clarity about what this means for ordinary people who are victims of various scams and mis-selling. The effectiveness of a statute depends on how well it is implemented.
Unfortunately, neither SEBI nor any of the other independent regulators modelled on it have really delivered. SEBI is seen as a slothful, non-transparent, arrogant and corrupt bureaucracy, packed with officials on deputation, looking for their next sinecure. Now, it will only be bigger and more powerful. Its senior appointees are on a career extension and have little interest in making a mark or fulfilling their primary mandate of protecting investors and developing markets. They rarely interact with public stakeholders, probably afraid of exposing their sketchy knowledge about markets, financial products and investors’ issues. They get away because there is almost no accountability to the finance ministry, parliament or the people. Very few MPs have either the domain knowledge or an interest in the slowly diminishing tribe of investors; they are more interested in companies and powerful market intermediaries which hardly makes for a healthy capital market.
Sucheta Dalal is the managing editor of Moneylife. She was awarded the Padma Shri in 2006 for her outstanding contribution to journalism. She can be reached at [email protected]
Bharti AXA Life policies worth Rs3.8 lakh were sold to a senior citizen allegedly with the bait of installing mobile tower of Airtel that would give him monthly rent. HDFC Life, Reliance Life products were also mis-sold, but they gave refunds after finding out the truth. Why is Bharti AXA Life silent?
Con artists have taken their game to sell insurance to a new level with offers such as installation of Airtel tower to get monthly rent and even sending a fake engineer to check the soil for getting clearance certificate. That is how senior citizen, Om Raj Singh (name changed) from Karnal Haryana, was taken for a ride of Rs3.8 lakh investment in six Bharti AXA Life policies.
The story of Mr Singh is bizarre as it involves multiple insurance company polices and repeated defrauding with the fake promise to make good the prior investment.
Promising to set up Airtel towers is certainly an innovative way to push dud life insurance products with an inducement of lucrative monthly rent of Rs50,000 in this case. Mr Singh even deposited Rs45,000 in a bank account of an individual as fee for clearance certificate for the soil check from the engineer, which tells about his foolishness too.
Mr Singh has given phone numbers of several people who were involved in sales and follow-up on complaints. HDFC Life and Reliance Life products were also mis-sold, but they gave refund immediately after finding out the truth from Mr Singh. Moneylife had written to Bharti AXA Life couple of times for getting their side of the story on this peculiar case, but there has been no response which tells us that they may have something to hide. After Moneylife intervention, Mr Singh got mail from Bharti AXA Life declining his request for cancellation by saying that they sold the right product. But, is it correct to use deceitful ways to sell the “right” product? Did they do any investigation to contradict Mr Singh’s allegations?
According to Mr Singh, “For the Airtel tower setup, the fraud gang sent an engineer to my place for measurement of land and soil check. He came and took samples of soil from different parts of my land and measures as per their norms. I was told that my land is not compatible for placing the tower and asked me to cancel my investment or to provide some other land. They were asking me to invest the same amount in Reliance Life insurance company’s policy and promised me that my amount invested in Bharti AXA Life would be refunded as and when this process got completed. As I wanted this tower project eagerly, I again invested Rs4 lakh in Reliance Life policies from Sep 2010 to Dec 2010 with a view of getting refunded from Bharti AXA Life policies.”
Calls were made to him with crooks posing as deputy director of Insurance Regulatory and Development Authority (IRDA) with the promise to look at his complaints. The third phase of scam was the imposters calling as IRDA Chairman. According to Mr Singh, “He assured me that if I put Rs1 lakh as a token amount for the cancellation process then all my money would be refunded and this is the judgement of my complaint lodged in IRDA against these swindlers.” Mr Singh believed that the “IRDA” call was based on his complaint to the regulator.
Clearly, the cheats wanted to get Mr Singh to put another one lakh in for a repeat of fiasco. The gang of fraud sellers lured him into purchasing two HDFC Life policies worth Rs50,000 and Rs37,000 respectively, but the insurer has immediately refunded the money to Mr Singh after they came to know about his case. Similar action was taken by Reliance Life. But, why is IRDA silent and not questioning Bharti AXA about the policies? Mr Singh has IRDA Token Number: 05-13-030775. Will IRDA really investigate, considering the gravity of deceptive selling? A tough message is needed to counter this rampant brazen scam.
Mr Singh, says, “When these people stopped picking my call, I understood that this was a racket of some people who as a gang counterfeited and ensnared innocent people like me. All my signatures were forged on the application to illustrations and the details about my profession and my wife were also wrongly mentioned. I am a retired scientist and the education qualification of my wife is class twelfth, whereas her profession was mentioned as an accountant in the forged forms. Reliance and HDFC Life have cancelled my all policies and gave my money back after their investigation. But, Bharti AXA Life personnel are only hiding the facts and gave unjustified reasons for not able to cancel these policies.”
There has been a steep rise in fraudulent calls to surrender your existing policy and buy a new one with numerous reasons like product is discontinued or fund performance not doing well, etc. It is mis-selling all over again done by bank personnel, agents or dubious callers. Call from “IRDA” is another trick used by con-artists who push their own agenda for earning commissions. Offering unclaimed bonus if you buy a policy is another deceit. We certainly hope that IRDA gets it act together to curb this menace.
The failure to resolve the issues relating to non-performing assets-NPAs goes directly back to the central banks' largesse. They provided the time to allow these issues to be ignored. Now, it is both worse and too late
Last week, I read a rather disturbing story in the financial news. According to the article, Moody’s, the rating agency, downgraded Singapore’s banking sector to ‘negative’ from ‘stable’. Singapore? Last September, I wrote about problems with banks in several emerging markets, but Singapore was not on the list. It has not received a downgrade since the financial crisis. Its four banks are rated ‘Aa1’, some of the highest rated banks in the world. My first thought was how did this happen and what does it indicate for other emerging markets?
Singapore banks, like every other private bank, want to increase their profits. Like many other international banks this meant increasing loans to higher risk emerging markets. Singapore’s banks lent mostly to borrowers in Southeast Asia. They were successful in doubling their profits, but also their exposure. The region now represents the source of about 40% of those profits. But the region also represents a disproportionate amount of the risk. Last year borrowers outside Singapore were the source of 77% of Singapore banks’ nonperforming loans. What is more disconcerting is that the banking systems in other Southeast Asian countries, like Thailand or Indonesia, seem healthy. It might be time to change that assessment.
What may not be so healthy is the South Korean economy. Korea is caught in a very bad place. It is very difficult for an economy heavily based on exports to grow if its main market, China, is slowing, while its main competitor, Japan, has depreciated its currency. The result is predictable. Whole swaths of its economy including shipping, ship building, construction and real estate are having major issues. The bond market has already experienced a number of bankruptcies and its nonperforming loans have been rising.
Like China the rate of growth for the Indian economy has been declining since 2010. The predictable effect is a rise in nonperforming loans, up to 3.5% at the end of 2012. India is also like many other countries in another way. The published nonperforming loan number masks the real problem. Rather than push a borrower into default, it looks much better on a bank’s balance sheet if the loan is restructured. Theoretically, a restructured loan is supposed to be good for the overall economy by providing a bit of patience for companies going through a rough patch. Many don’t make it through.
The Reserve Bank of India (RBI) estimates that 15% of restructured loans eventually fail. In the US in certain categories the failure rate of modified loans is as high as 57%. Presently, the number of restructured loans held by Indian banks is roughly 6%. According Fitch, the rating agency the combination of restructured loans and bad loans will reach just under 12% in about 8 months, a level that has doubled in two years.
Brazil is not that different from its other BRIC colleagues. Its state owned banks are the worst offenders for making bad loans. The giant state development bank BNDES, the world’s largest, and the Caixa Economica Federal, the state run mortgage company, have both been downgraded by Moody’s two notches from A3 to Baa3, the lowest level of investment grade. The reason for BNDES is that it has targeted lending to a few favoured customers. It has lent more than four times the value of its tier one capital to its top ten customers. A particularly egregious example is loan to the mining conglomerate EBX. Alone, it amounts to 5.8% of BNDES’s regulatory capital. Grupo EBX is the energy and mining conglomerate owned by Eike Batista. Mr. Batista was once estimated to be the second wealthiest man in the world with assets worth $39 billon. Allegedly, he has lost 99.5% of his wealth and is now down to a mere $200 million.
The problems of the peripheral countries of the Eurozone are well known. What is not widely publicized is the issue of the countries of Central and Eastern Europe. Bad loans among all of these countries stood at 8.2% at the end of 2012. Some are far worse than others. The three worst offenders are Ukraine, where the NPLs level is more than 30%; Albania with more than 20%, and Romania, a member of the EU, whose banks are burdened with NPLs of close to 20%. The bad loans in Southeastern Europe have risen from 14.5% in 2011 to 17% in 2012.
Perhaps, the poster child for problem banks is Vietnam. Vietnam’s 50 banks made excessive loans to inefficient state owned companies and speculative property investments. A story repeated time and time across the world’s emerging markets. The banks’ nonperforming loans account for approximately 6% of outstanding loans, with a strong emphasis on the word approximately. While this has supposedly declined from last year, a recapitalization of the banking system will cost anywhere from 7% to 20% of GDP.
But the size of emerging market bad loans is not the real problem. The real problem is simple: bankruptcy. Countries have to take the crucial step of recognizing that these loans are not going to be paid back. They must do what is necessary to restructure their financial systems. They must take the losses and reallocate capital to more efficient businesses. They must privatize state owned banks whose loan portfolios reflect more political patronage than risk assessment. They must create efficient regulations that are strictly and fairly enforced. But the odds of this occurring are small. Recognition of the size of the problem could result in both a political and financial meltdown. So there are few incentives for doing so. It has simply been easier to accept the free money from central banks.
Without meaningful reform, the emerging market growth story is now past. With these burdens it is unlikely that it will revive anytime soon. Growth rates have been dropping for the past three years and will continue to do so until the inevitable collapse will occur. Time is not on their side. Ignoring these issues will simply make them worse. Reform is the only option, but don’t depend on it.
(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first-hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages.)