Opinion | In search of a better way to balance divergent interests

The scales tilt from one side to the other, depending on who has greater bargaining power

The current crisis in the financial services sector has once again focused on an elusive policy objective: How to balance the public good with benefits to smaller private interests.

Recently, HDFC Asset Management Co Ltd (HDFC-AMC) decided to buy out bonds worth 500 crore from its fixed maturity plan (FMP) schemes; this one-of-a-kind transaction is designed to help the schemes repay investors on maturity of their FMPs. The schemes had invested in debt papers of two Essel Group companies, with the company promoter’s shares pledged as security. In April, after negotiations, the Essel Group promoters entered into a “standstill arrangement" with fund houses, including HDFC-AMC, under which the fund houses promised not to sell the shares till September 2019. FMP investors were repaid part of their investment, with the promise to get the balance in September, when the Essel Group borrowers repaid their outstanding dues.

HDFC-AMC’s announcement to buy the Essel bonds from the plan schemes up to a maximum of 500 crore has stirred up a hornet’s nest. The ensuing debate has pitched the AMC shareholders (HDFC-AMC had its initial public offering in July 2018) against FMP investors. Shareholders are particularly angry because the bail-out funds have come from the company’s profits for 2018-19, and this has an impact on its share price. But, that is not all.

Shareholders argued that investing in mutual fund schemes is fraught with market risks and, if the FMPs are unable to repay, then investors must grin and bear that risk. All fund offerings come with the standard caveat: “Mutual fund investments are subject to market risks, read all scheme related documents carefully." Secondly, with the asset management company deciding to bail out one class of investors, it not only creates moral hazard problems (fund managers expecting parent AMC to bail out their suspect investment decisions each time), but creates undesirable expectations among all mutual fund subscribers who invest in debt schemes.

Those batting for FMP investors argue that the fund house’s rescue act has restored confidence in the system. Confidence in the financial system is currently in short supply with loan defaults, write-downs and sticky credit flows. The fund house’s helping hand perhaps doesn’t quite restore faith, but does not let it erode further. Its trump card is its caveat emptor defence. Item 17 under Risk Factors in the AMC’s IPO prospectus clearly states: “We are required to prioritize the interests of our customers, which could conflict with the interests of our shareholders. In terms of the SEBI Mutual Fund Regulations, we are required to avoid conflicts of interest in managing the affairs of our mutual fund schemes and keep the interest of our customers paramount in all matters…Further, we may endeavor to safeguard the interests of our customers by acquiring certain non-performing/downgraded investments held by the schemes and by bearing the interest costs arising out of borrowings that may be availed of by our schemes to meet its redemption requirements." If shareholders feel that fund subscribers should be cognisant of market risks, even stock investors are expected to read risk factors before investing in shares.

The last word on this has not been spoken yet. The regulatory challenge worldwide has been to balance customer interest with investor interest. The scales frequently tilt from one side to the other, depending on which side has the superior political bargaining power, and can influence the regulator’s belief system.

This is currently playing out in yet another part of the financial system: non-banking financial companies, or NBFCs. Termed as shadow banks by global financial regulators, NBFCs have traditionally provided the last-mile linkages in the Indian financial system. With commercial banks weighed down by excessive regulatory costs and systemic financial repression, NBFCs have gone where banks were unable to venture.

Ironically, though, NBFCs have also been found to suffer from the typical Indian business malady: A disregard for risk and a virulent allergy to regulation. With systemic liquidity being easy over the past few years, NBFCs have feasted on easy credit to the point of indigestion. This included bingeing on short-term loans to finance long-term assets. This could be sustained as long there was easy liquidity in the system.

With the Reserve Bank of India making inflation-targeting the centre-piece of its monetary policy actions, liquidity became the collateral damage. NBFCs found themselves stranded and unable to roll over their loans. They have now started petitioning RBI and the government to provide some sort of a bail-out, including a liquidity window, which will allow them to borrow and repay their bond-holders. The RBI has refused to relent so far; action has shifted to the government’s pre-budget consultations.

This raises the equilibrium question once again: If resources are to be earmarked for NBFCs, it means lesser resources for some other class of beneficiaries. The contours of the ensuing debate are predictable: Why should public funds bail out private transgressions, versus, restoring confidence via NBFCs is beneficial for overall economic growth. The optimum solution actually might be to recapitalise public sector banks, which can then re-start lending to all eligible borrowers, including credit-worthy NBFC.

Rajrishi Singhal is consulting editor of Mint. His Twitter handle is @rajrishisinghal

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