It is scam-season worldwide, but Indian regulators, their well-wishers and the Finance Minister have chosen to remain in denial. First we had Deepak Parekh dismissing the gilt scam as just another fraud in a television interview. Then Mr Yashwant Sinha told the Rajya Sabha that there was no systemic failure, that the scam was a pure case of fraud and that the law would take its own course. A day later, the chief of the Securities Trading Corporation of India was on television telling viewers that there was no regulatory failure either — regulations were more than adequate, he said.
Try telling that to the seamen who saw 25 per cent of their provident fund vanish overnight. Or all other investors who put their money in Public Provident Funds on the assumption that it went into risk-free government securities and notified instruments, but are no longer sure that their money is safe. We are also told that the Reserve Bank of India is not in charge of regulating cooperative banks but only inspects them. Also, that it had warned state governments about the Nagpur Cooperative Bank and others but could do no more. Wasn’t it RBI’s job to ensure that government securities or G-Sec trading was secure? And isn’t it now plugging several holes in the system because they exist in the first place?
For instance, its recently launched Negotiated Dealing System, which combines the informal telephone market with screen-based negotiations was to comprise only of an elite segment of G-Sec investors, namely large banks. They account for the bulk of G-Sec trading, are few in number and easy to control and supervise. RBI planned on a comfortable system where these banks traded with each other without the help of brokers.
Yet, on April 13, it decided to open up the NDS to more participants by asking scheduled cooperative banks to become members of the Negotiated Dealing System by the end of May. It also announced that all settlements would only be in electronic form. A little earlier, it had directed cooperative banks in Maharashtra to route their transactions through the Maharashtra State Cooperative Bank, which would act like an apex bank. It has also tightened its fraud detection machinery by threatening tough action against those banks that fail to report fraud within seven days. Sources connected with the Clearing Corporation of India Ltd or CCIL say that smaller cooperative banks can access the NDS and CCIL either through constituent accounts with larger banks, in the same manner that retail investors access the National Share Depository through Depository Participants.
But this is certainly not a systemic solution to large regulatory gaps that remain in the gilt and bond market. In fact, all it does is to fragment the market instead of offering a comprehensive solution. A well regulated market needs RBI and the Securities and Exchange Board of India to cooperate with each other and also work with another regulator who would have a role in supervising these investments. None of them can carve out niches of authority when investors cut across multiple regulatory jurisdictions.
Today, the RBI has carved the NDS out of the pool of investors who used to report to the National Stock Exchange’s wholesale debt segment. The NDS is certainly an improvement over the telephone market, where transaction prices were reported to the NSE, without any clarity about the date, time and price of transactions. The system allowed brokers such as Home Trade to collude with banks and write transactions at prices that were completely out of line with the market. By segmenting the gilt market and leaving out a large pool of investors the RBI is showing an appalling lack of concern for the development of the debt market as a whole and could end up damaging the price discovery mechanism in the long run.
It also disregards the avowed objective of enlarging the market. The Economic Survey says “The CCIL, in conjunction with the NDS, is expected to facilitate extension of the repo market to non-government securities and enlargement of market participants”. Encouraging retail investment in G-Secs was part of this expansion. What then is the gameplan to meet these objectives? When asked, sources at the NSE, whose debt segment had been logging in turnovers in excess of Rs 4,000 crore until recently, admit that they are clueless.
But let us look at some numbers. In Maharashtra alone there are around 700 cooperative banks (including the regional rural banks); there are several hundred more in Gujarat, Andhra Pradesh, West Bengal and other states. Even if one assumes that all these banks will access the NDS through apex banks or constituent accounts, it would take some time to put in place an appropriate mechanism for their participation with a clear assessment of the counter-party risks involved. Moreover, this still leaves out an equally large segment of the market comprising provident funds and trusts.
There are around 800 trusts that invest in G-Secs and public sector bonds in Maharashtra. According to industry sources there are over 5,000 PFs in the exempt category, which are independently managed and are probably under different ministries. When asked about the supervision of these entities and their trading practices, insiders say that the answer is to create a separate regulator for pension funds. Funnily enough, this is an issue on which the FM also shrugs (as he did in the Rajya Sabha) and points to his esteemed colleague — the labour minister as the person responsible for regulating provident funds. Which brings us to the recommendations of the Oasis report on pension reforms (set up by the ministry of social welfare).
This report has more or less been mothballed because it suggested that pension funds should be allowed to invest in risky equities and corporate debt. Given the mess at Unit Trust of India, ordinary investors naturally shrink from the idea that their lifetime savings could vanish into thin air. But Oasis also has several good suggestions too which should be accepted and implemented.It has proposed an Independent Pensions Regulator to clean up, reform and regulate the pension sector and ensure transparency and centralised record keeping. It also proposes an enforcement machinery which would punish errant economic agents. Instead of a separate IPA there is an obvious case for the Insurance Regulatory and Development Authority to regulate pension funds also. Whatever the decision, the time for action has arrived. But for this, the FM has to get out of denial mode, admit that there is a systemic problem and implement some quick and obvious solutions. -- Sucheta Dalal