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Business News/ Opinion / Regulation after Saradha
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Regulation after Saradha

Increased regulation could mean a warning for local financial institutions that serve needs of borrowers neglected by regular financial institutions

Illustration: Jayachandran/MintPremium
Illustration: Jayachandran/Mint

Last week, the Saradha group in West Bengal defaulted on repayments causing a furore among depositors. West Bengal chief minister Mamata Banerjee, who initially washed her hands off saying the depositors would have to deal with the crisis on their own, later backtracked to announce a relief fund financed by an increase in taxes on tobacco products.

In the aftermath of the announced relief fund, the most pressing question should have been if the government should bail out depositors who voluntarily decide to risk their money on risky investment schemes. Given that investors in other risky investments, such as junk bonds for instance, do not have the government to share their misery, it is obviously unfair to have a different yardstick applied to the investors now being bailed out.

In fact, any bailout should be unwelcome, as it not only incentivizes risk-taking behaviour through moral hazard, but by eroding the differential returns between prudent and frivolous investing it also serves as a disincentive to prudent investors. The larger debate, however, has been over the issue of regulation of such dubious funds, and other similar informal financial institutions.

It is worth noting that the best that regulators could do with regards to risky investment schemes is to outlaw them, or severely restrict their operations. But this could often come at the expense of genuine financial inclusion brought about by informal financial institutions in general.

If the track record of microfinance (MFI) regulation in the state of Andhra Pradesh is anything to go by, there is very little reason to be upbeat about the idea of regulating informal financial institutions. In 2010, with the aim of protecting rural borrowers from the clutches of lenders charging high interest, the government of Andhra Pradesh enacted an extremely restrictive legislation that effectively meant MFIs had to shut doors.

What followed was the complete demise of financial inclusion brought about by MFIs, and resurgence of local moneylenders who had their business interests served by the government’s legislation. Quite clearly the regulatory powers of the government were captured by local moneylenders with influential political connections to serve their personal ends.

With a number of reports linking politicians from Banerjee’s own party with the Saradha fund bust having already surfaced, there is reason to fear West Bengal could be a repeat of the kind of regulatory capture seen in Andhra Pradesh. Increased regulation could well mean a warning for local financial institutions that serve the needs of borrowers who have been neglected by regular financial institutions.

How should informal financial institutions be regulated? Tell us at views@livemint.com

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Published: 29 Apr 2013, 05:07 PM IST
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