What happens when a regulator digs in its heels and takes advantage of its independence to become unaccountable, non-transparent and capricious in all its roles—such as licensing, regulating, inspecting and supervising banks and finance companies as well as trading in debt and foreign exchange? Things reach a breaking point.
For nearly three decades after India embarked on a massive economic liberalisation programme, the Reserve Bank of India (RBI) has repeatedly failed to detect massive scams and wrongdoing but has never been held accountable. Weak supervision (from the securities scam of 1992, to IL&FS in 2018), failure to check dubious lending; permitting bad loans to balloon to over Rs12 lakh crore by expressly permitting various schemes to disguise them, delay repayment or permit fresh borrowing… it's a long list.
The need for RBI to be independent of political machinations is recognised by all and, hence, it is treated with such deference that its shortcomings and failures in all its other roles have remained largely unquestioned. The Comptroller and Auditor General of India (CAG) does not even audit RBI, while it audits all other regulators.
Interestingly, RBI is facing at least three specific challenges today, when public anger is running high over how the corrupt and collusive nexus between politicians, bureaucrats, bankers and regulators has allowed several dubious industrialists to commit fraud or flee abroad after running up massive debts and transferring funds to tax havens.
1. Transparency Challenge: RBI is in a long battle with the central information commission (CIC) over its refusal to disclose the names of wilful defaulters. The matter went to the Supreme Court (SC) which ruled against the RBI in 11 cases (clubbed by the SC) way back in November 2015. Stunningly, RBI has continued to defy the SC. Meanwhile, bad loans of public sector banks (PSBs) soared; many required prompt corrective action; wrote off several lakh crores of rupees of irrecoverable debt; and the government has been forced to bail out PSBs through repeated capital infusion at public expense. But nobody has held the ‘independent’ RBI accountable for failure to allow matters to reach a crisis point.
Finally, in 2018, CIC issued a show-cause notice to RBI governor Urjit Patel for dishonouring SC’s orders and failing to reveal the names of defaulters. RBI has challenged this in the Bombay High Court and obtained a stay order which buys it plenty of time. But it does make one wonder why RBI is so determined to hide the names of large defaulters, when banks are permitted to humiliate smaller borrowers by publishing their names and photographs in newspapers?
2. NCLAT Intervention: The National Company Law Appellate Tribunal (NCLAT), which is hearing the bankruptcy petition against the failed Infrastructure Leasing & Financial Services (IL&FS), waded into RBI’s turf on 25 February 2019, by directing banks and financial institutions not to declare the accounts of the IL&FS group as non-performing assets (NPAs) without its permission.
RBI has asked to be impleaded in the proceedings, but it is not going to be a walkover. While admitting the petition, NCLAT reportedly told RBI not to make its decision ‘a prestige issue’. There is no doubt that the rules for recognising stressed assets and provisioning need to be uniformly implemented by a single regulator and NCLAT may have overstepped its brief causing needless confusion. On the other hand, IL&FS’s unchecked, hydra-headed growth and the complex web of 346 companies is entirely a reflection of RBI’s failed inspection and supervision leading to a huge systemic crisis.
If RBI is unable to convince NCLAT, it will have to go to the SC; but it is already facing a similar challenge before the apex court. Power, sugar and shipping companies have challenged in the SC RBI’s directive asking banks to report all defaults that remain unresolved even for a single day beyond the 180-day period. At a time when the nation’s patience is running thin over bad loans of dubious industrialists, it is anyone’s guess whether RBI’s arguments will be heard with the same deference as earlier.
3. Kotak Mahindra Bank’s (KMB) Suit: The third and on-going challenge comes from KMB, a regulated entity, which startled the financial world when it decided to sue RBI over the demand to reduce promoter holding to 20% of paid-up capital. KMB has challenged RBI’s powers under the Banking Regulation Act (BR Act) and called its demand ‘manifestly unreasonable, arbitrary, unfair, without the authority of law’ as well as ‘wholly illegal’ and ‘unconstitutional’.
RBI, which took a couple of months to respond, while agreeing to refrain from coercive action against KMB, has come back with a rather weak defence. It argued that KMB had, at various times, agreed to comply with RBI’s demand to reduce promoter shareholding in line with its multiple directions and persuaded it to stretch the compliance deadline; it was now going back on that commitment.
KMB’s petition, however, claims that it has already complied with RBI’s directions through the issue of preference capital and voting rights are already capped. RBI also mentions ‘inordinate delay’ by KMB in filing the petition. This disingenuously ignores the fact that a tightly regulated entity, especially a bank, cannot possibly drag the regulator to court (especially one that enjoys the special position that RBI does) at the first difference of opinion. Its response also does not explain the rationale behind the frequent changes in policy.
RBI starts on a weak note by saying that KMB’s plea should not be accepted because it would set an ‘unhealthy precedent’ and that the ‘the reliefs sought by the petitioner, if granted, shall result in making inroads into RBI’s autonomy’ and make the petitioners ‘regulators of their own selves’.
RBI’s second argument is that the petition is filed by KMB, whose shareholding is regulated by it and not the promoter, Uday Kotak. RBI argues that this itself (that KMB is fighting Uday Kotak’s cause) shows how private banks need to ‘more independent’ and reflect the interest of all stakeholders whose voices need to be heard, and not those of one individual or family.
This is interesting, because documents attached to the petition indicate that all directions of RBI, including the original licence, were to Kotak Mahindra, the non-banking finance company (which applied for the banking licence) and later to KMB. Had Uday Kotak filed the writ as promoter, RBI could have argued that he has no locus standi, since its directions and dealings are with KMB. This is an issue that may be decided by the court fairly early in the hearings.
RBI’s argument is also ironical because the IL&FS scandal, counters its basic premise about the importance of promoter holding as well as the efficacy of its own supervision. If anything, it is RBI’s failed inspections and supervision that have inflicted losses on pension and mutual fund investors and led to a systemic crisis.
Ravi Parthasarthy, founder of the IL&FS group, was allowed to remain at the helm and run it like a private fief for 30 years with no direct shareholding. The Employee Welfare Trust (EWT), through which he and the management cabal held some shares (individually insignificant), was shockingly manipulated and RBI was clueless.
The experience with IL&FS and even the ‘professionally’ run National Stock Exchange (NSE), make a strong case for ensuring that promoters have adequate ‘skin in the game’ to be held directly accountable, and the need for effective regulation to ensure that they always act in the interest of all stakeholders.
In KMB’s case, it could contrarily be argued that Uday Kotak, as promoter, with most of his wealth in the Bank, has both his name (reputation) and money at stake and would work to protect both. In fact, this is an argument that is being made all over the world, in the face of new evidence that management with no ‘skin in the game’ tend to be greedy and even likely to manipulate results and fake performance to extract greater rewards over a short horizon of their tenure, sacrificing the long-term health of the organisation.
The KMB matter, which will come up for hearing on 1st April, is unlikely to be decided in a hurry. Meanwhile, there is need for a dispassionate review of RBI’s powers, policy-making and supervision and transparency to stakeholders, who pay a price for its failures. None of the challenges mentioned above is likely to lead to a comprehensive review which will be good for RBI and for the country.
As an aside, one cannot fail to mention that Uday Kotak was a member of the Bimal Jalan committee on 'Review of Ownership and Governance of Market Infrastructure Institutions' of 2010, which had concluded that: “Imposing restrictions on ownership is one of the ways of exercising regulatory control over a stock exchange.” This was seen as a way to favour the NSE structure; but, as is clear from later events, it failed in the face of ‘regulatory capture’ by NSE and the Exchange was run like a private fief by the founding team of Ravi Narain and Chitra Ramakrishna.
Market regulator Securities and Exchange Board of India (SEBI) has turned down a Right to Information (RTI) request followed up by an appeal to provide information on the documents provided by a whistleblower in the Sun Pharmaceutical matter. Interestingly, the refusal is on the grounds that it will affect.
Responding to first appeal filed by an applicant, the market regulator says, "Providing copy of the complaint would reveal the identity of the whistleblower and may lead to the undesirable consequences of danger to the life or physical safety of the person."
In any case, the applicant had not asked for details about the whistleblower and had specifically mentioned that anything sensitive can be redacted.
SEBI, however, argued that, "Severing the name and personal details of the whistleblower from the complaint may not be sufficient to avoid the perceived danger, since the contents of the complaint, the language used, timing of the complaint may be sufficient to ascertain identity of the whistleblower. Similarly, the file notings in the matter may reveal identity of the dealing officials by factors similar to those mentioned above, including the handwriting, hierarchy of officials in the particular department dealing in the matter.”
“Whistleblower complaints are made with an objective that the information contained in the complaints may be used for examination of the alleged irregularities by SEBI which may result in enforcement actions. Such complaints may, therefore, be considered as a source of information and assistance given in confidence for law enforcement, which is specially exempt from disclosures under section 8(1)(g) of the RTI Act,” SEBI stated.
While denying information under the RTI Act, the market regulator accepted that "complaints from whistleblowers are vital source of information for enforcement authorities and that such complaints are relevant for SEBI in discharging its statutory obligation to regulate securities market."
"...it is further observed that complaints from whistleblowers are received and held by SEBI in a fiduciary capacity, since such complaints are made under an implicit trust that identity of the complainant would be kept confidential and that allegations mentioned in the complaint would be examined by SEBI in the interest of investors and securities market," Anand Baiwar, first appellate authority at SEBI stated in its order.
In a sensational 150-page document, a whistleblower has alleged numerous irregularities against Sun Pharma, its main promoter Dilip Shanghvi and his brother-in-law Sudhir Valia, Mr Valia’s independent financial operations, Fortune Financial and Investment Trust of India and Dharmesh Doshi, an associate of Ketan Parekh who has been convicted of wrongdoing in the stock market scam of 2001.
Moneylife has a copy of this document filed with the regulator in mid-September. Copies of this letter have been marked to the Ajay Tyagi, chairman of SEBI and whole-time directors Madhabi Puri Buch, G Mahalingam and Ananta Barua. Sun Pharma, in an official response to Moneylife in November last year had said that it has not received any query from the regulator so far.
The 150-page document has names, phone numbers, bank account statements and complex organisation charts of hundreds of companies, foreign investors and individuals that are acting in concert.
In the covering letter to the SEBI chairman and the whole-time member, the whistleblower mentions that “for me to reach to this level of detailed letter to you along with the evidences gathered over a period, has taken an extraordinary level of efforts at my end and weeks of data compilation. Further it has added lot of risk to my family, my life and my family’s future."
The whistleblower claims to be “very closely connected to the people mentioned… My association with this set of people has been for more than 23 years now and I am directly working with them for 15 years and currently as a senior executive with the group. In my career with them, I have handled their Romania, Israel, USA and Mauritius operations directly.”
He claims not to be a beneficiary of the operations described “regularly drawing salary as my primary income and has never had anything beyond that during my entire tenure. The very reason I have decided to share this is because there are some deals that have gone bad and to cover them up from difficult questions coming along, now the management is asking the professional staff to front that event which I am not ready to do. Therefore, over a period of 6 months, I have gradually gathered all relevant evidences to present my case and bring out a rightful conclusion to this episode.”
Later, the same whistleblower sent a 172-page document to SEBI "to bring out further information of wrongdoings by Sun Pharma promoters Mr Shanghvi and Mr Valia. You may kindly refer this along with my previous submission and the contents presented therein.”
Moneylife has written several articles on Sun Pharma, which are in the public domain.
When the Union government promulgated The Banning of Unregulated Deposit Schemes Ordinance, 2019 (the Ordinance) a few days ago, the immediate reaction was one of dismay.
There is no denying the fact that unscrupulous people dupe the greedy and gullible by soliciting loans and deposits promising high returns. It is also true that such dubious schemes and ponzis have cheated...