Spectacular Failure

deposits were safe, put the company on a watch only after the RBI stopped it from accepting fresh deposits.

Sebi, too, has much to answer for. It had conducted a closed-door enquiry into the groups mutual fund last year. Instead of blowing a whistle on the groups creative accounting practices, Sebi came out with such a measured response that it was interpreted as a no-objection certificate by the RBI, though the latter should have known better. To add to all this, there were the warning signals from an income-tax raid on the company last year and the firms consequential acceptance of an additional liability of Rs 7 crore.

 

At the policy level, the CRB affair exposes structural anomalies in the regulation of NBFCs. The entire safety clause of having these companies register with the RBI has proved to be riddled with holes. The RBI denied the company registration in November last year, but CRB was able to carry on with its high risk business. Indeed, the entire policy framework of regulating NBFCs has not addressed the basic fact that business undertaken by them is riskier and hence more safeguards have to be applied for them than for banks, especially since NBFCs are allowed to collect money from retail depositors. Their capital bases are low compared to the banking sector but their asset portfolios are skewed towards higher risk, a substantial part being in real estate and in the stock markets. In such circumstances, the statutory liquidity requirements of this sector should have been increased, and not progressively reduced as the RBI has been doing. Not only would this have improved asset quality, it would also have acted as

a safety net for repayments. As leasing becomes unattractive, hire purchase expensive and money from banks abundant, finance companies will have to turn to even more riskier forms of investment to earn the returns they have to have.

Thus, more such spectacular failures like the CRB can be expected. Hence it becomes all the more important for the regulators to devise a rescue plan in advance for the depositors. Otherwise, in the short term there could be a sharp shift from financial assets to the physical holding of cash as savings.