A few weeks ago, Saradha, a money chain scheme, went bust in West Bengal. The fallout was a flurry of ignorant statements by policy makers and politicians - matched by an equally ignorant media - about possible regulatory changes. Some have breezily and cruelly concluded that unless there is "financial literacy" among savers, such scams will recur. This logic helps two sets of people: sellers of financial services and regulators. The first set, of course, would then have no obligation to sell something safe, while putting the onus of eliminating harmful products on the buyers. A parallel would be car manufacturers not having to adhere to any safety norms and car buyers having to turn themselves into auto experts to ensure that the car they are buying is safe. But why is it so hard for policy makers to understand that if safer products are allowed into the marketplace, we would have fewer scams, just as safer automobiles lead to fewer accidents?
There are three reasons for this. One, regulations are not made with savers in mind. Regulators don't even meet savers on any platform. Two, we have fragmented and inadequate regulations. Three, regulators lack financial and regulatory literacy, blasphemous though this may sound. This is clear from the fact that regulators are unwilling to incorporate conclusive proof from neuro-economics that we are hard-wired not to understand financial products; that we will make the same mistakes; and that more choices do not lead to better outcomes. As a result, we have a mess of products and regulations designed to make the saver trip up again and again. Look at two kinds of examples:
Deposit taking: Saradha, like many other money chain schemes, was allowed to freely accept deposits from the public. This was of no urgent concern to any of the following authorities: the Reserve Bank of India (RBI), which regulates deposit taking; the Securities and Exchange Board of India (Sebi), which regulates collective investment schemes; various state governments; and the Centre, which can take action under the Prize Chits and Money Circulation Schemes (Banning) Act, 1978. Saradha turned out to be a Ponzi scheme, but India permits any company of a certain size to raise money from the public at large. Non-banking finance companies, residuary NBFCs, chit funds, jewellers, manufacturing or service companies of all kinds are allowed to directly raise money from the public. In the 1990s, the public lost crores of rupees in deposits given to leasing companies, then to plantation companies and manufacturing companies - but this goes on unabated.
How does this freedom to indiscriminately convert the financially vulnerable public into unsecured lenders make any sense? This is how savers are asked to pay the price of poor regulations. Also, how does such unsecured deposit taking square with the fact that policy makers' thrust is to expand organised and highly regulated banking operations across the country? If 10 different kinds of legal entities can raise money without the RBI's permission and minimal disclosure, it makes a mockery of all discussion about prudential banking norms.
Co-operative banks: Savers have routinely lost money even in entities directly regulated by the RBI - co-operative banks, which have been at the heart of several scams over the past two decades. Mercantile Co-operative and Bank of Karad were involved in the 1992 securities scam and had to be closed down. In the scam of 2000, Ketan Parekh was found to have used Madhavpura Mercantile Co-operative Bank to divert Rs 800 crore to support his speculative positions. The bank collapsed, which caused thousands of depositors to lose money. Co-operative banks were at the centre of the Home Trade scam in 2001, when Rs 600 crore was found to have been swindled from more than 25 co-operative banks. Savers will continue to pay the price of depositing money in co-operative banks - not because they are financially illiterate. They are paying the price of the system of dual regulation, under which both the Registrar of Co-operative Societies (RoCS) and the RBI are supposed to be regulating co-operative banks. RoCS officials say the RBI does not regulate these banks, while the RBI says it waits for government recommendations to act. Most co-operative banks are set up and controlled by powerful politicians.
What is common between these two areas I have highlighted? Regulations cover products and entities instead of the broader definition of service offered to the savers. Regulators have stuck to the narrowest possible definition of their role, instead of focusing on what really helps savers. Savers pay the price for both.
Finally, there is the issue of punishment as deterrent. As someone quipped recently, if you rob a bank, you go to jail; if the bank robs you, the banker gets a bonus. Indeed, there is a debate raging around the world as to why misselling does not amount to misrepresentation and fraud, leading to criminal action.
So, the real lesson from the Saradha scam is not just that laws were weak or that regulators were sleeping. The real lesson is that the laws governing financial products do not automatically mean that the same laws amount to consumer finance protection - which is what we need, coupled with exemplary punishment. We don't have them now because regulators have no empathy for savers. Until that happens, sellers of financial products can easily sell harmful products by taking cover under the principle of "buyer beware" - condemning savers as financially illiterate.
The writer is the editor of www.moneylife.in
editor@moneylife.in
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