Saving The Small Investor

This need to bring some order into the chaos known as the deposit mobilisation business is made more urgent by the fact that retail depositors are very vociferous about their losses and are helped every time by some underemployed politicians to further their pleas from every public forum possible.

But what can really be done about the deposit-taking NBFCs? Since the quality of assets is more difficult to ascertain for rating agencies and banks alike especially given that most auditors in the country are used to turning a blind eye to balance sheet manipulations and lack aggressiveness when it comes to judging the quality of assets, the regulators and rating agencies could do worse than keep a close eye on the funding mix of the finance company. If a firm is heavily reliant on one source of funding, especially fixed deposits, then both the regulators can try and take corrective action.

 

This argument assumes that banks and FIs are more sophisticated lenders and, therefore, are able to judge risks more effectively and accurately than individuals, although the way C R Bhansali charmed banks into lending him money seems to make a mockery of this assumption.

At present, regardless of the nature of business, NBFCs have an SLR requirement of 10 per cent. Here an important distinction needs to be made between finance firms which collect deposits from the public and those which only tap institutional sources of funding, including certificates of deposits.

One way to ensure that retail money is safe is to ask firms which have big deposit bases to keep more funds in the form of SLR securities. These securities, which are by definition, liquid and safe, can then be used to repay depositors in case of premature withdrawals. And the more retail fixed deposits a firm accepts, the higher should be the SLR requirement.

Higher SLR on fixed deposits will deter finance firms from taking on disproportionate amounts of money through this route. This is because if a large chunk of the money does not earn more than 10 per cent, finance companies are not likely to find many assets which will be give a high enough return to compensate for the lower yields on SLR securities. Hence, they will start examining other forms of funding.

With the registration process about to be completed and the RBI giving banks much more flexibility in financing NBFCs, this will encourage them to look at other options of funding. Fixed deposits, inclusive of cash incentives are anyway much more expensive than institutional sources of funding.

No doubt, finance firms will say they need FDs to finance cars, trucks and bought-out deals and banks wont fund such activities. Whatever resistance there is from banks to funding these activities will diminish soon as they realise that financing cars, or rather collecting monthly repayments from a dispersed clientele is no fun. Banks like Stanchart and Citibank are already buying car portfolios from NBFCs rather than lending directly to buyers.

In any case, financing cars will slowly become the domain of car manufacturers. Finance companies will either have to tie up with car makers (a la Kotak Mahindra and Ford Motors finance arm) or become their financing arms, with selling strategies being decided by the car markers themselves.

In such a situation, only a few players with excellent distribution capabilities will survive. As for the others, there is little harm if there is a push from the regulators to make them decide that the business may not be all that is cracked up to be.

The other area where public money is at risk is in the booming private placement market. In India, private placements are more public than private and more like an issue than a placement. It has ceased to be an exercise whereby a company raised money from a few institutional investors without having to go through the rigmarole and expense of a public issue.

However, glance at any hand-out from brokers and you will see that many finance companies come out with private placements of bonds for which the minimum investment required is as low as Rs 5,000. This placement market needs to be made safe for retail investors who have probably been duped by firms like CRB but dont know it yet but without robbing the market of the flexibility that it gives borrowers and institutional investors.

As in other developed markets, this can be done by ensuring that firms which privately place debt to over 100 investors in any particular issue should be made to make adequate disclosures as in a public issue. The minimum amount that can be invested in such issues should also be raised to Rs 50,000 so that small investors by definition are kept out of the fray.

This way, companies can still make private placements in the manner it is meant to be done, but those bending the laws to take advantage of the lack of transparency in this market will not be able to do so.

But to do all this, regulators have to heed one important point: the level of regulation for those taking public funds has to be stricter and tighter than those who use institutional sources of money. Otherwise, the RBI and Sebi will find themselves landing up in court again and again.