Household savings have been wiped off from under the nose of financial regulators
Regulators’ development role, along with turf wars, has taken precedence over the protection role
You, the Indian investor, have been pick-pocketed, stolen from, mis-sold, cheated and defrauded in all kinds of scams perpetrated not by knife-wielding muggers but white-collar criminals who bend, twist and totally escape from regulatory norms that are meant to protect you. A mapping of the big money vanishing tricks of the past two decades points a finger at systemic regulatory failure to protect household savings.
As the Indian economy opened up, the regulators were set up to develop the market and protect the investors. However, the development role, along with turf wars, has taken precedence over its protection role and India has found its regulators repeatedly asleep at the wheel, costing the household its savings again and again (see graph). The latest season of the loot story has Karvy Stock Broking Ltd dipping its fingers into your money and using your shares to borrow money for its own use. Why have the regulators failed investors in India? The answer to this question is a mix of politics, power, capture, hubris and incompetence.
Before we even get to the regulators, it must be remembered that it took till 2016 for real estate to get a regulator. With an average household holding over 77% of its wealth in real estate, it remains the biggest investment most people make over their lifetime. Given the huge wallet and mindshare of this asset class, the fact that the sector had no regulator till 2016 tells its own story. The years before the Real Estate Regulatory Authority (Rera) saw an unprecedented loot of retail money by a nexus of builders, brokers, auditors, government officials and bankers. “The sector was highly opaque. It was extremely unregulated, fragmented and had no systems in place," said Samantak Das, chief economist and head of research, JLL India, a real estate consultancy firm.
However, just setting up a regulator does not ensure that investors get protection. Getting regulators their power has not been easy—it took capital market regulator Securities and Exchange Board of India (Sebi) several scams before it could gather the powers required for more effective oversight. The Sebi Act, for example, was amended in 2002 after the Ketan Parekh scam to give it power to call for records from any bank, authority or board. It also got powers to inspect books of any listed public company, to suspend trading of a security, and bar persons and companies from accessing markets and suspend any office bearer in a stock exchange. It was after the Satyam scam in 2008 that the responsibility of auditors and independent directors were questioned. Following this, Sebi introduced new norms for corporate governance and asked companies to disclose pledged shares and mandatorily rotate auditors.
Issues of turf have also caused investors to lose money. For example, the spat between Sebi and the Insurance Regulatory and Development Authority of India (Irdai) in 2009 when Sebi went to court over trying to regulate unit-linked insurance plans (Ulips), which it said was a mutual fund masquerading as an insurance policy. Irdai fought back to retain its control over what was then a ₹3.3 trillion market and the government, in an unprecedented ordinance, decided in favour of Irdai, a regulator that has traditionally been captured by firms and agents . “I resigned from my job in an insurance company over the issue. Ulips are investment products unlike term insurance and should’ve ideally been regulated by Sebi. Irdai has traditionally prioritized the interests of insurers over those of consumers," said Prakash Praharaj, founder, Max Secure Financial Planners. The small Indian investor lost upwards of ₹1.5 trillion over a seven-year period ending 2012 in mis-sold Ulips due to lax regulations.
Then there are regulatory cracks into which gullible investors fall. For example, builder and jewellery deposit schemes. In February 2019, the government cracked down upon high-risk deposit schemes offered by builders and jewellers by passing the Banning of Unregulated Deposit Schemes Ordinance that made all such schemes, except those with specific regulatory approval, illegal. Rajesh Khosla, spokesperson of the India Bullion and Jewellers’ Association, an all-India jeweller’s body, said: “The government mandates that jewellers can only take deposits if it’s part of their business." However, many jeweller companies are passing off deposits as advance taken.
Scams and frauds going undetected also have to do with the capacity of regulators. The Punjab and Maharashtra Co-operative Bank (PMC) scam and Punjab National Bank (PNB) fraud prove this well. The PMC scam caught the Reserve Bank of India (RBI) asleep at the wheel in its supervision of co-operative banks. The bank used over 21,000 fake accounts to conceal non-performing assets of real estate firm Housing Development and Infrastructure Ltd. It took a scam to the tune of about ₹4,355 crore for RBI to direct co-operative banks to replace the existing system of email-based reporting at bank branches to a web-based central system (central information system for banking infrastructure).
Other than auditors that each bank appoints, RBI has inspectors who regularly inspect books of the banks. But the PMC and PNB scams show negligence in this role. “In case of the PMC scam, even RBI inspectors who were auditing the books of the bank for the past 10 years failed to detect the fraud. This shows RBI lacks the right people with the right aptitude. They need people who can look beyond the transactions and have analytical skills," said Amarjit Chopra, former president, Institute of Chartered Accountants of India.
The safety valve
Regulatory gaps, arbitrage and turf wars harm the investor as retired bureaucrats, sometimes with very little understanding of the market, are given a free reign over an entire market. Indian investors need a unified regulatory environment, with roles in accordance to function and not form. This means that financial products that are similar in their function should be governed by similar regulations.
A much-needed regulatory change is a coordinated approach by all regulators towards intermediaries and advisers. The strictest rules are with Sebi on disclosures, commissions and adviser behaviour, but these are of no use when banks sell Sebi-regulated products. Investors also need far better disclosures so that another Karvy does not happen where the account statement of Karvy and NSDL showed a totally different picture to the retail investor.
When the government opened up the markets, it put in regulators to bring order and protect the investor who is now operating in the free market, but it forgot to put in a road map and rule book to hold these regulators to account.
Investors’ Loss: This is the first of a four-part series on the Indian investor who has always paid for lax regulations, misuse, fraud, mis-selling and poor corporate governance of the financial sector. The series maps why Indian investors have lost money in products they buy from the regulated part of the market and the regulatory risks they face.
An earlier version of the graphic inadvertently said, "NSEL mis-sold the commodity products to its clients and assured fixed returns". It should've read, "NSEL was allegedly involved in mis-selling of commodity products to its clients and assuring fixed returns". The graphic has been updated to reflect the change.
*The graphic has been updated
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