The Reserve Bank of India’s decision to gradually close down the operations of Sahara India Financial Corp. is a sensible one.
One of the accusations against Sahara Financial is that it has treated its depositors unfairly. Almost three out of every four of them earn a ridiculous 1% on their money, because of penalties imposed by the finance company on those who fail to meet deposit commitments.
(Illustration by: Malay Karmakar / Mint)
There are larger systemic worries as well. Sahara Financial has collected around Rs20,000 crore from 42 million depositors. It is like a medium-sized bank on these parameters. Yet, standards of governance and accounting are poor. Problems in a deposit-taking institution of this size could pose risks to the financial system. A banking regulator has every reason to be worried.
That said, the central bank should also be asking itself why an organization like Sahara Financial exists and prospers. It is the same question that needs to be asked about village moneylenders. Why do 42 million of mostly poor people entrust their money to Sahara Financial? Why do impoverished farmers pay stiff interest rates to borrow from village moneylenders? Why aren’t these people going to the official banking system?
Unless one believes that the poor are irrational fools to do business with informal and semi-formal financial intermediaries, it is clear banks are not catering to their needs. There is a market gap that is being filled by non-bank financiers with a low-cost and high-risk business model. Shutting them down could shut the poor out, unless the formal banking system steps in or alternatives such as microfinance groups expand rapidly.
Sahara Financial and Peerless General Finance and Investment Co.—the two are described as residuary non-banking companies—have been asked since August 2007 to park all the money they raise in government securities, thus making them less risky beasts. They now resemble mutual funds that buy safe government securities on behalf of investors.
The other parallel is with narrow banks. Banking regulators around the world have every now and then clipped the wings of banks on the verge of collapse by asking them to withdraw from commercial lending and automatically shovel money into safe bonds where there is little chance of default.
That is what Sahara Financial will be in its last years— part gilt fund and part narrow bank.
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