Paying the bill

It is the tax payers, including the small investors whose savings have been wiped out, who end up bailing out failed institutions

By Mohan Sule

From a humble beginning as money collectors, the Sahara and the Saradha groups have transformed into conglomerates dabbling into media and property development among other diverse activities. Their large-scale across-the-board flouting of the basic stipulation of getting details of the depositors and promising returns above industry standards lead to two conclusions. One, for deposit-taking outfits or chit funds, maintaining digital records is a liability for it leads to paper trail of the subscribers to whom they have to deliver the promised returns. The second is by following the commission- or the target-based business model, the promoters cleverly spread the responsibility of survival of the organisation on agents, whose campaign focuses on quantity rather than the quality of deposits and results in misselling of products. Most have long maturity and are embedded with high marketing expenses. Suck out the incentive, and the industry faces seizure as was evident when Sebi banned mutual fund entry load,which was parceled out to distributors. The other side of the sordid drama is the hunger of both urban and rural investors for instruments that secure the principal as well as guarantee high returns. The fuss about proof of presence puts migrants at a disadvantage and so also the minimum balance requirement of banks for those working in the unorganised sector. It is this space that unregulated chit funds and deposit-taking firms occupy.

During the evolutionary phase of mutual funds in India, small investors had to be wooed with promise of fixed returns till some public sector bank-floated mutual funds sunk into red. The bankruptcy of UTI predating that of Lehman Brothers and following that of hedge fund Long Term Capital Management in the US stemmed from this very problem, with its flagship scheme, US-64, coming to symbolise government-backed cash-flow spigot. Another conclusion is that small investors are an important component of the financial system. The Sahara and the Saradha groups’ scale of expansion and diversification on the foundation of small savings should clear any doubt on this score. These firms saw the opportunity and deployed an army of collectors, something the organised financial services sector neglected. Insisting on adherence to KYC norms and auditing of records, to start with, and asking the deposit takers to explain how they plan to invest their corpus to keep their guaranteed-return promise are obvious steps to rein in the unruly sector. However, these measures could prove counterproductive unless public sector banks are ready to fill the gap that may be created by the crackdown. One of the justifications bandied for the emergence of shady money-collection schemes is the clogging of the capital pipeline to those who may be short of collateral but long on ambitions. Running chit funds is never their ultimate objective. Rather it is the means to an end — to build an industrial empire spanning airlines, hotels, townships, TV channels. These capital-guzzling ventures need a steady source of funds.

From another angle, keeping out elements with plenty of daring but shortage of ethics could be viewed as the soundness of the banking story in post nationalization India. Yet the mounting bad loans of public sector banks is a reminder of the bane of crony capitalism that keeps away those whose only asset is their dreams. Lack of access to liquidity prompts many of them to seek avenues that are lightly regulated to raise resources. No wonder the first thing that these promoters do on achieving critical mass is to venture into media to buy respectability and influence policy makers so as to ease the path to future projects. The other crucial issue that has to be confronted even as regulators grapple with the disciplinary aspects to prevent such occurrences in future is what to do with the thousands of depositors who have lost their savings. West Bengal chief minister Mamta Banerjee has been criticized for levying a tax on cigarettes to compensate the victims of Saradha. This is surprising considering tax payers aided in the rescue of UTI. Eventually, though, the surge in equity markets helped the mutual fund to repay the government just as large investment banks in the US returned the capital infused by the government during the 2008 credit crisis. Closer in time, large depositors in Cyprus will find their corpus reduced as the government dips into their holdings to finance the bailouts of large banks. So whenever an important link in the value chain of the financial ecosystem collapses, it is the universe of taxpayers, including the small depositors whose savings have been wiped out due to the collapse of the institution, who pays the penalty. This is an important lesson that should not be forgotten.