RBI as a “bystander”
Yes Bank’s AT-1 bonds were actively sold to individuals even though the regulatory framework treated them as sophisticated, high-risk securities. This was not merely a case of investors buying something risky and subsequently complaining when the risk materialised. In April 2021, the Securities and Exchange Board of India (Sebi), not the RBI, completed its investigation into Yes Bank’s gross mis-selling of AT-1 bonds. The findings were devastating. Customers were told that the bonds were effectively “Super FDs”, offering a 9 per cent-plus return with the appearance of fixed-deposit (FD) safety. In several cases, the term sheet was not supplied, and customers were not given adequate confirmation that they understood the product’s features and risks. Sebi said some customers were persuaded to shift money from fixed deposits to these risky securities.
The Supreme Court has called the conduct of Yes Bank, the RBI, and the administrator “questionable”, and said that putting investors at the receiving end of administrative lapses would be “highly unfair”. It specifically said that tighter scrutiny should have been exercised before individual investors were lured into these securities. The court described the RBI as a “mere bystander” in the whole saga. The data placed before the Supreme Court identified 1,346 retail investors with around ₹679 crore invested in Yes Bank’s AT1 bonds. Of these, 1,311 were the bank’s existing customers, with nearly ₹663 crore invested. Sebi found that Yes Bank had failed to ensure that investors understood the risks. It penalised Yes Bank and its executives for the mis-selling, including a ₹25 crore penalty on the bank and a ₹2 crore penalty on then chief executive officer Rana Kapoor. Despite these startling facts, the RBI continued to defend the writeoff.
Disclosure-based regulation
There is an even bigger issue here. When India liberalised its financial sector, it embraced what is called “disclosure-based regulation”. The philosophy is that the regulator will frame the rules, including disclosure requirements; the seller will provide them along with the product; and investors, acting intelligently and rationally, will decide for themselves what is good for them.
This concept owes something to the old principle of caveat emptor, or “buyer beware”, which was common in an unregulated world of commercial transactions. If an investor buys a risky product after being told about the risks, the consequences are supposedly the investor’s responsibility. This sounds reasonable until one looks at how financial regulation actually works. Regulators do not merely ask financial institutions to disclose information. They make extraordinarily detailed rules about products, capital, eligibility, distribution, advertising, risk profiling, suitability, documentation, sales practices, compensation, and reporting. They specify what banks and financial intermediaries can and cannot do. They issue circulars, master directions, frequently asked questions (FAQs), clarifications, and enforcement orders. The regulatory state is anything but laissez-faire, the environment in which caveat emptor made sense.
The regulator is sufficiently interventionist to write detailed rules, but then retreats into a hands-off posture to say that investors must bear the consequences when those rules fail to protect them. This creates an extraordinarily convenient arrangement for private interests. The gains from selling complex financial products are privatised; the consequences of bad sales practices are pushed on to investors; and regulatory failure is discovered only after the damage has been done. Like Yes Bank’s AT-1 bonds, AAA-rated bonds of Infrastructure Leasing & Financial Services Ltd (IL&FS) had been wrongly sold, while mis-selling life insurance to senior citizens is an everyday affair.
If AT-1 bonds were so complex and risky that the regulatory framework specified the categories of investors to whom they could be offered, why should disclosure to an inappropriate investor cure the problem? There is a fundamental information and power asymmetry between a financial-services company and an ordinary customer. The former employs lawyers, accountants, investment bankers, risk managers, and compliance officers. It designs the product, determines the sales pitch, trains its employees, and controls the information presented to the customer. The individual investor does none of these things. To pretend that the two parties become equal merely because a disclosure document has been handed over is to confuse formal consent with informed consent.
It is time to confront the hypocrisy of “disclosure-based regulation” and move towards outcome-based regulation. This would mean asking whether the product is suitable for the customer; whether the seller has an incentive to mis-sell it; whether the customer has the capacity to understand it; whether the institution is complying with the rules; and whether the regulator is actually watching. Today, the answer to all five questions is effectively: The investor was warned. This should change.
The writer is cofounder of www.moneylife.in and a trustee of the Moneylife Foundation; @Moneylifers
 "YES BANK")