Winding down a financial institution while not creating panic is among the most difficult tasks any regulator can face. Given how leveraged such institutions are, any action by a regulator can easily trigger a run and compound the very problem — safety of depositors’ money — that is sought to be tackled. Even so, the RBI action with regard to Sahara India Financial Corporation merits scrutiny. Sahara, India’s largest residuary non-banking company, is owned or controlled by Subrata Roy, once very close to the Samajwadi Party (SP) that has become very important in New Delhi’s power politics. Sahara has been under RBI scrutiny for a long period, and some years ago it was told to fund its non-finance businesses through shareholders’ funds, and not with money taken from the public. This resulted in Sahara doing quite a few sell-offs (like its aviation business). Then, on June 4, the RBI barred Sahara from accepting any more deposits, while it would have to continue repaying depositors as and when their deposits matured. Sahara went to court and got a stay order.
The RBI appealed, and the Supreme Court directed the RBI to give a hearing to Sahara before deciding on the matter.
The RBI eventually gave Sahara a reprieve, allowing it to accept fresh deposits but with a maximum maturity of three years, subject to half its directors being RBI nominees and the group appointing statutory auditors from the RBI’s list of auditors. Under the plan agreed between the two, Sahara is to wind down its deposit-taking activities by June 30, 2015. If this turnaround wasn’t explained, what happened a month later was even more curious — Sahara came out with a series of advertisements claiming it had invested all its deposits in accordance with RBI guidelines and, indeed, its capital adequacy was much higher than what the RBI mandates.
The RBI has not responded to Sahara’s advertisement; perhaps it does not need to, since it has put in place a mechanism to ensure an orderly wind-down for Sahara, and the presence of independent directors will ensure that everything goes according to plan. But if the past is anything to go by, ensuring that the plan works will require effort. Take almost any company that has been accused of misusing funds in the past and most of them would have had statutory auditors of repute and independent directors nominated by the banks and financial institutions that had lent them money. While little can be said for why statutory auditors have not caught blatant fraud in the past, the failure of independent directors is easier to explain. As the experience in the US sub-prime crisis shows, even countries which have and old and fine traditions of vigilant boards find that a company’s management has many ways in which to keep boards in the dark — Enron, for instance, created off-balance sheet subsidiaries.
In any case, independent directors who don’t have a stake in the company whose board they adorn, are not the most active of watchdogs. Board meetings are often brief and need not be more than once a quarter, the issues that have to be statutorily brought before a board are easily dealt with, and that leaves company managements a great deal of leeway to do with the business as they please. In short, if it is the RBI’s belief that the Sahara management is into dodgy business practices and that it should not therefore be taking money from the public, then the insistence that half of Sahara’s board of directors comprises individuals acceptable to the RBI may lull it into a false sense of complacence.