Why is bad behaviour in FIs widespread?

A spate of corporate scandals and cases of poor governance have been hitting the headlines regularly for the past few months: The tottering behemoth Infrastructure Leasing & Financial Services, the sinking Dewan Housing Finance Ltd, alleged improprieties by the former managing director of ICICI Bank, the shock and horror show unleashed by the Zee promoters, unknown issues in YES Bank and Axis Bank, whose chiefs have been shown the door, and, of course, the continuing self-serving behaviour of some promoters like that of Sterlite/Vedanta, and so on.

Each of these events has led to a sudden and massive erosion in shareholder value. DHFL is the most egregious of all, whose stock has fallen from just under Rs 700 to about Rs 110 now, a crash of 85 per cent since early September 2018. The shares of YES Bank have more than halved. IL&FS is an unlisted company but its impact has reverberated across the financial sector with liquidity drying up and risk aversion rising. 

Coming in quick succession, these events have once again showed how little shareholders can possibly know about what is going on inside a publicly listed company. This applies as much to institutional shareholders as to retail shareholders. Can something be done to avoid situations like these? At one extreme, each time an “accident” happens, some will call for stricter regulation. At another extreme, some tend to shrug and say, “You can’t regulate bad behaviour,” meaning accidents will always happen and regulation cannot stop them. Is it possible to have a more meaningful perspective other than these two extremes, and, if so, a more effective solution to the problem of bad corporate behaviour? 

We can reduce accidents only if we look deeper and isolate what is by far the biggest component of the issue of bad corporate behaviour. Notice one thing common among the names IL&FS, DHFL, ICICI Bank, YES Bank, Axis Bank…? They are all financial firms. Also remember, India’s economic growth has been severely held back by the massive loot of the largest segment of the organised financial sector — public sector banks (PSBs) — by netas, babus, bankers and businessmen. Between them, PSBs and rogue financial firms have inflicted the maximum damage to savers at the micro level and to the economy at the macro level. 

If there is a systemic crisis, if there are fears of a contagion, if the money of retail savers is at risk, you can bet that one or more financial firms would have caused it. The financial crisis that started in the US and spread like wildfire from Iceland to India was entirely caused by lenders with the help of stockbrokers and institutional investors — the key players in the financial sector. 

It isn’t that non-financial firms cannot be blamed for large-scale wealth destruction through financial frauds. But such instances are rare. And over the years, regulation and disclosure in securities markets have ensured that sensible investors can avoid accidents by staying away from promoters with a poor record of governance. Supervising financial firms, however, is another matter. Financial firms need stricter rules of operations. If they are publicly listed, they have to be supervised by two regulators at least — the securities market regulator, the Securities and Exchange Board of India, and the financial markets regulator like the Reserve Bank of India. Housing finance firms are additionally supervised by the National Housing Bank. If financial firms are the cause of repeated crises, could it be that the regulators are not doing their job properly? Try to answer these questions:

• PSBs have needed repeated bailouts over the last 20 years with public money. How many people have been held accountable for it? 

• That a lender must have enforceable collaterals throughout the term of a loan is something even a school student would understand. Who has been held responsible and punished for the Rs 10 trillion which went bad at PSBs and may not be recovered because they don’t have any enforceable collateral?

• Why has the ministry of finance been funnelling public money into PSBs for three decades without doing something fundamental — bringing in a system of positive and negative incentives?

• If Dewan Housing Finance collapses, would the National Housing Bank be questioned?

• How could IL&FS, supervised by the RBI, be allowed to run by a small cabal of professionals like their private fief for almost three decades? Or allowed to create a web of almost 350 companies that borrowed more than Rs 1 trillion? 

• Didn’t the RBI brass fail to act on multiple letters from an IL&FS whistleblower and its own inspection report? If so, shouldn’t someone be punished? 

This is just a small sample of lawlessness that is rampant in the financial sector, which needs stricter, not more relaxed, regulation, one that must be followed in practice and not remain on paper. What we have, instead, is regulatory capture by crooked players due a combination of corruption and incompetence among regulators. Hence, the way to avoid systemic risks is to make regulators, especially those directly in charge of financial firms, accountable for every major slip. The question is: Who can supervise the regulators? It is the ministry of finance and the prime minister’s office since they function like a strong command and control centre. But over five years of maximum governance, neither of these offices has made financial regulators accountable. 

The writer is the editor of www.moneylife.in , Twitter: @Moneylifers