In the last few months the Reserve Bank of India (RBI), the country’s central bank, has made headlines several times for pulling up non-banking finance institutions. Recently it increased risk weightage for fintech companies that give credit in the form of unsecured loans, credit cards or consumer loans from 100% to 125%. This means that companies in the non-banking financial companies or NBFCs would need to set aside more capital to give out loans.
The move was to curb the growth of unsecured lending in the country and rein in fintechs. However, RBI data shows that despite this unsecured lending has continued to grow.
“The amount of capital that we have layered onto these entities, there’s no prudential reason they need to have so much capital.” Nachiket Mor, who has served on the central board of the RBI and been the head of Bill and Melinda Gates Foundation in India, told The Core.
But how then, do we make banking systems safer? “I think that if we are to expand the banking system, we have to do it on the back of a sound, safe banking system; which to me means good amount of capital; to me it means strong partnerships with the non-bank community and a very favourable regulatory treatment to the non-bank finance companies, treating them like any other corporate,” Mor said.
India’s banks face other challenges as well. With investors moving towards investments that get them more returns, the current accounts and savings accounts (CASA) deposit ratio has been declining.
Mor said, “My particular pet peeve about deposits is that we are underpaying depositors well below what the market should be paying them. Globally, the difference between the deposit rate and the risk free rate tends to be 0.04-.03%. In India it’s 4%.”
In this week’s The Core Report: Weekend Edition, journalist Govindraj Ethiraj spoke to Mor about the trust factor in banking, governance issues in the fintech sector and how to make the banking system safer.
Edited Excerpts:
As someone who’s been in banking for a long time and has worked on the periphery of banking as well as with the regulator, albeit as a director on the board of the Reserve Bank of India, how do you see the concept of trust in general and in specific?
So, you know, one perspective I certainly think is important, and particularly given my more recent experience as a board member of Reserve Bank is that — and in a way this was at the root of the crisis you saw in 2008 — are we able to trust financial institutions to do and report and say what they are actually doing, or are we going to have to police them, assuming that they are fundamentally not telling us everything that needs to be said?
The key question there is not so much that of the management of the institution, but that of the board. Is the board sufficiently in charge? Of course, the board itself will say the same thing to you and say, can I trust the management? Because if I start with the presumption that there is no trust, then the entire system breaks down because even the auditors will audit on a sample basis… There is a foundation of trust on the basis of which the entire financial system operates. And as we get bigger, this foundation starts to become much more and more important.
I remember interviewing Alan Greenspan post the crisis, and one of the comments he made, which struck me quite a bit, he said, you know, you expect the AIG board to do what it said it would do. How do you run a financial system in which the boards of large financial institutions later on put their hands up and say, I’m sorry we didn’t quite say everything, or that I’m sorry, we didn’t know what we were doing? He said, well, that’s the basis on which we run these financial systems. So I think that’s a key issue.
And of course, the second issue of trust is as we move away from paper, pencil, branch visit — I know you, you know me for 20 years — to talking to a chatbot or to a machine and transacting electronically. Now I need to move my trust from that branch manager, from that single conversation that I had, through a much larger structure. And again, you know, today, if I look at, if I look at my old experience of banking in, say, in corporate banking or retail banking, a lot of it was relationships… We would spend a lot of time getting to know people. Now it’s a lot more impersonal. Credit scores, bureaus, that kind of stuff. So now is there a real opportunity to build a new financial system in which both sides have confidence in the broader system and trust the broader system to be sending signals in an appropriate manner?
When I’m transacting with my bank, for example, I am assuming my bank knows what it’s doing with its cybersecurity, this, that and the other, because I don’t know. I’m transacting as if all of what is going on behind me is highly secure. Perhaps this was less important in the world in which I went with my passbook to a bank branch and I got them to update it, and then I had confidence in my passbook. Now that whole idea is gone. So I would say on both sides, kind of regulator to bank and bank to individual, you know, there is a need for a different type of trust. I’m not suggesting we didn’t need trust earlier, but it’s a different way of doing things.
Nachiket, if I were to now pick up, let’s say, the last seven, eight years, where we’ve seen the massive kind of growth and proliferation of fintech, to use a very broad term, but we could get into some specifics as we go deeper. Why would you say, or how would you say trust has either evolved or devolved?
If I look at the growth of, say, electronic payment transactions, you know, people’s willingness to go, whether you are the local service provider of laundry services or you are a small business or you are a large utility, your willingness to work in an electronic mechanism, it’s a big shift. One would argue to you several years ago, not just in India, but elsewhere in the world, and maybe that’s still true elsewhere in the world… without a chequebook, without all of the other paraphernalia, you couldn’t quite do most of the transactions. Now, cheque utilisation has collapsed. This was not the case and is still not the case in many countries around the world. So clearly, there is a lot more evolution.
If I look at the lending business, the whole core infrastructure of credit bureaus, all that kind of information has become important and stable. It is possible now to transact in fairly large volumes electronically, assuming that all of that infrastructure that’s informing me about your credit is becoming live. And in fact, I have now heard stories down from microfinance, down from self help groups where women are aware of CIBIL score, for example. They know what that means. They know defaulting to it. Now it’s no longer a matter of just me and the bank or me and the NBFC, but it’s me and the larger system. I think there clearly has been a lot more of that evolution.
I worry, though, that it’s possible that that has meant that we are losing, we have lost some of the growth conversations, the project finance, the long-term relationship conversations that we had earlier. Now it’s all about what is your rating, what’s your score? What’s this? What’s that? And that tends to breed a lot more in the short term. Now, we might say that’s a good thing, because those were conversations equity holders need to have, not lenders. Now, in an economy like ours that needs a lot of growth ahead of us, I think that might not be enough. And that older trust that was there where people like me who were in the infrastructure finance business, for example, and we were in a sense responsible for financing when there were really no cash flows. It was very much the dream of that entrepreneur. We spent a lot of time both putting good rigorous structures in, but also trusting people to do many things that they claimed they would. I worry that that might have gotten lost a little bit.
In the context of fintech, and I’m going to stick to that for a moment, let me pose a question from two sides. From one side, the consumer obviously is in some ways trusting something that he or she doesn’t actually feel know and so on because of the efficiency. And that’s the efficiency benefit that we’ve seen now in the last few years. But on the other side, if I look at what, let’s say a company like Paytm said, according to them, governance was something that they compromised on in pursuit of growth.
So I would sort of go further and interpret governance as saying that basically, they did not care whether their systems or structures or fiduciary responsibilities were being met because technology and growth was really what was driving it. And that in some ways was fintech for you or for all of us… Considering that we are already seeing some self correction happening here, do you feel that we are rechecking or revisiting the concept of trust? Or is it something that the few knocks that we had to take was part of life in any case?
No, I think we have to, you know, think it through much more because, you know, earlier one could argue that you could be a board member and you could be chairman of a board or chairman of audit committee and take your role somewhat, perhaps lightly because, you know, you relied on auditors, you relied on management, you relied on this, that and the other. In any case, the business was growing at 15-20% per year, so it didn’t matter so much. Life roughly today was like life. It was last year and that was like it was two years ago.
In these extremely fast environments where things can move in a few years from A to B, I think the governance by the board becomes absolutely critical, and I don’t think we have fully understood that as yet. I mean, it’s good that we are getting some signals from some of the players, but I would say, and it’s not a problem that was not there earlier. We’ve had a significant banking crisis virtually every decade. NPAs (non-performing assets) have gotten built up, banks have misreported their NPA numbers, and every so often it has had to clean up this, that and the other. So in all of them, I would say boards had to wake up and figure out what their role is. What are they supposed to be doing? And I think that journey is not over yet, particularly in the fintech era, where you’re able to accelerate very quickly. Small errors in your AI (artificial intelligence), or ML (machine learning) model, for example, can swing your portfolio from one to the other. I think boards have to become much more engaged in these conversations and much clearer how they are going to govern. What is the role they’re going to play in making sure these institutions are run as they should be run?
Okay, if you’re a lender, you might argue you don’t have the same issues because ultimately a client is borrowing from you and they are not giving you the money. But at the end of the day, you are responsible for people who lend money to you. You are responsible for the shareholders that gave you money. And also, if you are presenting yourself as a systemic player, as a player, that will change and solve a certain set of problems, in a way, customers become dependent on you because they expect you to be part of that spectrum. And if you fail tomorrow, or if you are seen tomorrow to be less than who you claimed you were, I think that has its own impact. So I think there is still quite a bit of journey ahead of us.
When you look at companies or banks, let’s say, the breakdown of trust in an earlier era, which was of course, not too long ago, was when there was some kind of, maybe a fraud, or lending without the right systems in place, or some kind of crony capitalism and so on… Today in this world, the problem is getting spread out in a much, much larger way, because obviously, instead of a few, you’re talking about millions, though the numbers, the value may still be roughly the same. How do you then govern and ensure that trust remains in this kind of environment? In this new environment?
The good thing about technologies is that while they offer you new challenges, they also offer you new opportunities for measurement and control. You can track businesses and the health of businesses in a near real time manner, in ways you couldn’t do maybe a decade ago. You’d have to wait till the end of the year, maybe sometimes over several years, in order to figure out what you did. And did it produce the outcomes that you wanted or not, because you just didn’t have the machinery that is needed.
I think the challenge is, while management is interested in growth and pushing forward, and as they should be, I am not going to fault management for saying that we wish to grow. There’s a market opportunity there and it’s a winner-takes-all. You already start to see on the payment side, one or two players that these are natural infrastructural businesses. In the long run, you don’t expect more than two or three payment players to survive, because there’s really an economy of scale that comes in and you’re starting to see some of that, which means anybody trying to enter the market knows that either they get 50% market share or they will go to zero.
But I would really go back to the board and say, what questions are you asking? Are you familiar with these tools? Have you built the right competency in the board to ask the management to deploy the tools? It’s not enough to tell the management, slow down, you’re going too fast. You could still be running a bad business slowly. The fact that you’re moving fast or slow doesn’t necessarily mean that the problems are not there. In a fast business, the cracks become more visible much more quickly. When you are moving slowly, it’s harder to sometimes tell what’s going on.
I think there are new tools that are available that you can ask questions, you can respond to the nature of the business, and not every board member will have that capacity, but there are enough people out there that you could turn to. I would definitely say that the answer here is board chairs, senior board members to look around their boards and say, do I have the right set of people around the board that can help me govern the structure? I’m putting my reputation on the line by joining this board. Am I sure that I’ve got the right people to help me do this?
Do you feel that boards are empowered enough, have the liberty or the freedom, or even the desire for that matter to actually act when it comes to time for action?
I think reputation costs are quite high. Boards have the power legally. There is no debate about that. An audit committee chair refusing to sign the accounts, however powerful the management, however powerful the investor, if the audit committee chair says, I’m not going to do it, it’s not going to happen. If tomorrow board members resign, people like you, anybody in the market wants to know, why did this person resign? So I wouldn’t say they have no power.
You might ask, do they have the desire to exercise their power? Because even competency, they don’t themselves need to do it. They can bring other people on board, but every so often, and I think this is the message that comes out loud and clear whenever you see some of these issues play out in the market. The reputational impact on a board member of having been seen to be asleep at the job can be quite severe. Sometimes legal liabilities may emerge from it, criminal liabilities may emerge from it… it can have a real impact on your career. Particularly if as a board member, you expect to be, you know, playing an important role. So I think there is real pressure on the board. I have not met too many board members that are any longer of the view that I’m just here to have the coffee and the cake.
And the director sitting fees, which have grown quite substantially in recent years. If you were to look at the kind of instances when there was a breakdown of trust, let’s say, from your time in the Reserve Bank (of India), how would you broadly classify them?
I saw two kinds of issues from what I remember, it was a while ago now. One, there’s clear evidence that there was no application of mind, even though there was competency. Even though there were explicit powers that were available to these individuals, they were sitting on bank boards, NBFC boards, wherever they were sitting— you are not seeing the kind of application of mind. And I think the biggest examples were where the chair of the board was disengaged because they were there, but they didn’t quite sense the gravitas of their responsibility, the size of their responsibility. They saw themselves as one of many and informed by the management.
And the second issue is, you know, a poorly constructed board where either deliberately or by accident, management has built boards more to help with fundraising and to this, that and the other hasn’t really paid attention to: Do I have the right competency in the board? Because you mentioned, for example, crony capitalism, this, that, and the other as some of the drivers. I mean no question those are important issues. But even how do you construct your portfolio? Why is it that in hindsight you realised that 30% of your portfolio is exposed to a single business group? There might have been nothing corrupt about it, but there is a level of incompetence that shows in running a bank that I find astounding.
I used to run a training programme for bank directors and bank senior teams, and often many of the bank board members couldn’t tell me what is the role of capital. What exactly does capital do here? Their assumption is capital is required only because the regulator insisted. But let’s assume there was no regulator. Would you run your institution with no capital? I worry that that base level of competency, particularly for a financial institution director, I saw missing in many cases. So one was a sense of not being sufficiently engaged, even though perhaps competency was not the problem. Second was, maybe it’s a link, both because if you were engaged, you would either learn or you would make sure you got other people in that learned this stuff.
Do you think that some of these issues are consistent issues, that one way or the other, they will always be there, or they will be there for much longer?
It will be there but I think that, you know, because somehow in India, we tend to look at this problem as corrupt people, dishonest people, and in some ways we make the problem worse by saying that because now a board member looks himself in the mirror and says, I’m not corrupt, therefore I’m okay.
My argument is, yes, that’s a low bar. Corruption, etcetera, is a low bar. I think the bigger problem is you don’t know what you’re doing, what your organisation is doing. You don’t have the competency to run and to be a board member of a large, complex, or even simple fintech-type organisation. Then you put the whole technology piece to it. You know, I would say these are problems that can be solved. I am not of the view that they should continue on this because you do want this economy… the reality of India, as you know better than I, is that we are still a puny financial system. Our credit-to-GDP ratio remains one of the lowest in the world. It is one of our single largest impediments to growth. Our cash-to-GDP continues to be large, even though we have done what we can… so there’s really a big journey ahead of us and we need to, we don’t have hundreds of years to figure it out. We have to move quickly to solve it.
If we don’t fix these issues, then we’ll start building balloons, which will be very unstable. Suddenly you’ll have big institutions starting to collapse on you, which would be a tragedy because it will set us back many years in our attempt to try and build a stronger financial system, a stable financial system, because financial system instability has an enormous impact on a much larger community of people.
For credit to grow and credit-to-GDP to increase the banking system which will play a role has to become bigger. It has to firstly pull in more deposits. It has to lend. And all the stuff that banks have been doing for centuries. Do you feel what is holding us back today or what holds us back today from then achieving that growth?
There are a number of issues. My pet issue has a little bit been that the advice that we had received from Mr (M) Narasimhan (former RBI governor) in 1991, in which we had argued that the non-bank sector was the sector that will open up the economy and we will allow it to fail, we will allow it to grow and die as needed. I think that is something that my sense is, again, I am an outsider now, but my sense is we are actively hindering that mechanism.
The amount of capital that we have layered onto these entities, there’s no prudential reason they need to have so much capital. They are aggregators of loans. For example, if you take a client that borrowed money directly from the State Bank of India versus borrowed money from a non-bank finance company that borrowed from the State Bank of India. There should be no difference between the two if the system is working well. But that’s not true. The loan, as it goes, via a non-bank finance company which is cheaper, more efficient, more technologically enabled, is not cheaper but significantly more expensive… Because you’ve layered capital onto these entities without a full understanding or without full clarity on what exactly is the purpose of that capital; because we have a lot of intolerance; because just as we worry about governance issues, we are very intolerant of any type of failure.
Whereas what you want is a structure in which banks don’t fail. So you don’t make banks riskier by forcing them to lend money in remote areas and doing all kinds of difficult things, because that increases the bank’s risk of failure, which you don’t want. What you want is this outer layer that really becomes high-risk taking and therefore prone to failure to grow quite a bit more and to be allowed to grow. But what we have done is made that safer than even a bank by layering so much capital on top of it that we have cut growth capability. Because now if Bihar is showing a credit-to-GDP ratio of I don’t know what the number is, but say 20-25% when it needs to be 250%, I don’t expect a bank to go out there and do this. And I don’t necessarily think deposits are our problem.
My particular pet peeve about deposits is that we are underpaying depositors well below what the market should be paying them. Globally, the difference between the deposit rate and the risk free rate tends to be 0.04-.03%. In India it’s 4%.
Driven by historical legacy and the large public sector institutions maintaining a low deposit rate on current accounts and savings accounts in order to shore up their profitability at the cost of what they are paying depositors.
I think both on the credit side and on the deposit side, there is need for, I wouldn’t say a fundamental transformation, but a tweaking so that these structures become turbocharged. Then of course, you come back to the trust issue because as you get these structures to get bigger, both banks, I wouldn’t say that the trust problem and the governance problem is only that with the fintechs and the non bank finance company, it’s across the financial system, within banks as well as outside banks.
Are the boards, are the board chairs, are the audit committee chairs well equipped to do the task that they have been asked to do? Because if they are not, the regulator will be hamstrung. Because the regulator depends on a well running institution. Audit is like a refereeing process. You know, it can look at some things, but it can’t go into every single detail. And that’s what the board is supposed to do. And then the board in turn works with management to set up the right culture and to set up the right mechanisms by which this happens.
When you mentioned two aspects, I mean you talked about banks and non-bank finance companies. And the reason I’m assuming banks can get away with giving much lower returns to depositors is because they enjoy trust and depositors in turn feel safe giving the money and they put safety above everything else.
Yeah, but I would say 4% below the rate at which the Government of India borrows is too much of a premium for it. Typically, what you want to see is what we call in banking ‘risk ordinality’. A bank is riskier than the Government of India. So therefore when a bank raises money, it must pay the depositor more than the Government of India pays. It’s an unusual situation, an exploitation of monopoly power that you’re seeing rent extraction well below what the…Yes, I can understand co-operative banks may need to pay 2% more than the government or 3% more than the government. A large commercial bank, highly trusted, may pay only half a percent more than the government, but they will all pay more than the government. It’s an unusual situation that you are paying people 4% less than what you are doing in the government. I don’t know if you heard this famous phrase at one point that was spoken about for lazy banking.
Correctly, one of the bank CEOs had said that the most profitable business model for me is to continue to exploit the fact that I can raise deposits from people at well below market rates, not partly because people trust me, but partly because we have created a little bit of a situation of a semi monopoly in which there’s no choice… because where will you go? Everybody’s paying me 4% less and then just lend to the Government of India. That itself gives me a 4% spread with zero default and no priority sector requirement. It’s a terrific business model and I would submit to you it’s not just a trust issue. I think it’s in a sense trust gone too far, in which I’m taking trust, but now I’m excessively benefiting from it.
How does this situation change? Or, I mean, what happens? Is there a way out of this, or will there be a way out of this or what could trigger it?
I mean, there are two or three pathways. One pathway is what happened elsewhere in the world, in which the securities markets, particularly the T-bill, overnight funds, and money market mutual funds, became so seamlessly accessible to depositors that you could move your money smoothly into those monies.
There was at one point, a 30% to 40% flight of deposits from the banking system into money market mutual funds that forced banks to raise deposit rates because otherwise customers said, what’s wrong with you? Now in India, that arbitrage exists, but there’s enormous friction that has been imposed on customers because they can’t move this money from here to there. And that, I think, is more a decision by these regulators to sit down if they wish to fix this problem. Currently, it’s possible that they want banks to continue to improve their CASA (Current Account Saving Account), so that they can continue to get these free income boosts and not solve this problem, because they don’t see it as a problem. They don’t see the fact that depositors are getting massively underpaid as a problem.
The other is, as the market in banking becomes more and more multipolar, today it is the public sector as a single large pole, then a few older or somewhat older large private banks, and then a mass of new banks. If the public sector pole becomes that much smaller and it becomes truly a competitive market, where even a State Bank of India is forced to revise its deposit rates, I see the second pathway to be much harder and much longer, because the banking system will have to fundamentally reform and will have to be pushed by the regulator to increase deposit rates in the way that NBFCs have been pushed to reduce lending rates. That push is not there today.
On the contrary, the opposite is the push. Make sure that you have your deposit rates low and keep the maximum amount of deposits in these low yielding accounts, because that’s what is good for your profitability. So I would say, the first route is where I’m much more enthusiastic, where gradually, as UPI… because the good thing is cheques have gone right and only banks can issue checkbooks. Now you start UPI, you start instantaneous settlements. There was once a proposal that we had put out as a committee that the clearing houses should be given wholesale payment banking licenses, so that this is what Euroclear… all of these are banks because then they don’t need to clear with commercial banks. They can clear directly with the Reserve Bank of India. That allows them to instantaneously move money and securities, which means the credit guarantee funds, they no longer are required in the securities market, which then allows you to drop transaction numbers, and transaction values. So there is a pathway here that the pathway it will take depends on the regulator, depends on what they are thinking. But I think this is a pathway that could really seriously improve the yield and reduce the de-facto tax we are all paying by keeping money in banks. It’s a large tax. If I look at the aggregate CASA balances that SMEs and small depositors hold with banks, and multiply that by 3% or 4%, whatever the difference today is between the T-bill rate and this rate, that’s a big number that we are all paying to the banking system for no reason.
You talked about non-bank finance companies. So non-bank finance companies are obviously conceptually a way to spread banking via institutions, as you said, however, that they are layered. So I’ll come to sort of asking you about the solution to that. But how do you see the role of non-bank finance companies, and by extension, let’s say the other more recent enablers, which is the fintech universe in a) enabling the banking and spread of banking, and 2) continuing to sort of carry the circle of trust along if it does, or if it were to do so?
I personally think that we have to make banks much safer. We can’t afford large crises as the banks are becoming larger. Each time we have a crisis in the banking system, it has a bigger and bigger cost associated with it. So I think that if we are to expand the banking system, we have to do it on the back of a sound, safe banking system; which to me means good amount of capital; to me it means strong partnerships with the non-bank community and a very favourable regulatory treatment to the non-bank finance companies, treating them like any other corporate.
There is nothing specific about a finance company that is different from a corporate borrower of a bank. On the contrary, the non-bank finance company constructs portfolios. A corporate borrower is a single borrower. But, you know, and therefore, the regulatory treatment, the capital treatment, has to reflect that they’re not money creators, they don’t take deposits. So they don’t have any of the systemic risk until they get to a size of, say, 100,000 crores plus, in which case their sheer size is so large. But this is true of large corporates. A large corporate borrower, their failure can hurt the entire financial system and therefore they become systemically important like any other large bank or a large finance company. But let’s assume we stay within a certain size of these entities. I think they can be urged to go and discover and open up newer and newer aspects of the financial system. Searching for opportunities, searching for growth, searching for making positive RoE (return on equity).
To me, that keeps the banking system safe because I’m now going out there. It also leverages somebody else’s local knowledge and local understanding in ways that a large financial institution that is national may not have. And I think it gives us a nice opportunity. Instead of creating regional banks or creating regional institutions, which are riskier for that very, very reason, because they’re regional. A non-bank finance company can be regional and can be high risk. And you say, yeah, I will tolerate failure. I don’t care. If they fail, that’s between them and their lender. That’s between them and their depositor. So long as the lender knows what they are doing and has constructed a good portfolio which is national… if a particular corporate borrower or a particular non-bank finance company defaults, it doesn’t matter.
To my mind, fintech plays that role and starts to open up pieces of the puzzle that it’s harder for a large complex bank to be able to… They take on more risk as a result and increase likelihood of failure. But that’s what we want, because unless we go out there and do this, we’re not going to get the answer.
But all of this is going to happen only if there is an underlying fabric of trust. If there is constantly the anxiety that nobody can be trusted, the banks can’t be trusted, they don’t have the competency to assess risks, the fintechs, the NBFCs can’t be trusted because they are really saying that they want to lend money to these poor people in Bihar. But what they are really doing is taking that money and speculating on real estate and stock markets. And we’ll have another Harshad Mehta scam on our hands. Then all of what I described to you becomes simply a figment of my imagination.
So that trust has to be there. Confidence that banks know what they are doing. Confidence that the bank boards are able to govern them in such a way that they construct good portfolios and that they are not going to be misled by another Harshad Mehta or something else. But also the sense that I don’t need to regulate and micromanage all these non-bank finance companies and fintechs. I don’t need to layer hundreds of crores of capital on them, because I think that a general fabric of trust is there, that they are well governed institutions. We have put in place guidelines on how they should build their boards, what kind of capability they should have, and that should be enough for us to assume that if failure does happen, it was quote unquote genuine failure rather than failure because of, you know, them trying actively to destabilise markets.
We started by talking about what does trust even mean in the context of banking and transactions, financial services and onto fintech. As you look ahead, I’m still trying to figure out whether the picture you painted is a grim one or an optimistic one or something which is in between. Could you sum it up for us? I mean, how are you seeing this as you look ahead? And do you feel, for example, in this new combined world of banking, which includes a very technology-driven architecture, which also includes, let’s say, tighter regulation, lessons from the past, all of which, is this leading to something better?
I definitely think so. I am enthusiastic about the direction that we are going. I think what we need is to sit down carefully and understand what are the minimal safeguards that we need. Zero failure is not a safeguard. That’s not what you want to do. You don’t want deposit taking institutions to be playing fast and lose. You need them to be dull, boring, really high quality. And if they are found to be less than so, a very strong action needs to be whether they are a bank or a fintech or whoever it is that they are. But I think we know what to do about these things. We have sophisticated regulators, they know how to regulate. I think they need to resist the urge to shut down sectors or to layer so much capital onto it that the sector just can’t move because it needs to deliver returns that are just crazy.
I mean, somebody had done the math for me. I don’t know what the current number is, but I’m told almost 70% of the lending rate of the lending spread of an MFI comes from regulatory requirements of capital. Why is that?
What is an MFI?
A non-bank finance company that lends to low income communities as a microfinance institution, they require to maintain so much capital that in order to make reasonable return on it, they have to charge a fairly high number.
But is that because they were always, was it always like this, or because of some excesses that happened and therefore the layering increased ?
I would say non-bank finance companies have always experienced a somewhat… I don’t think the picture that the role of the banking system is to expand credit, keep banks safe and expanded through the non-banks has been fully shared by everybody. I think they are viewed as competitors, they are viewed as …not as partners. And therefore, there is a sense that banks are the entities that need to be favoured. Everybody else is the competitor of these entities. So layer a lot of capital on them so that they can’t compete, rather than them seeing, because the default rates, even at the worst of times, have not been anything that even the banking system has shown. If anything, if I look to like comparisons, the non-bank sector looks extremely rosy relative to what is going on in the banks. So I don’t think there are bad eggs.
I’m not going to suggest to you that everybody is doing, there’s a lot of challenges there, but I think they can be fixed through governance, through better board structures, through better, clearer guidance as to what is going on and really, you know, strong measures against boards, against audit committees if there is found to be a failure. Because then I think it sends a signal to the market that there is a role that they need to perform. I think it’s fixable. I think it’s doable.
Many other sectors have grown quite rapidly. We have terrific telecom companies, steel companies, paper companies, cement companies. There’s no reason why we can’t build equally outstanding banks and financial institutions and fintechs. It is the reason we have a unique global opportunity to do this jump. You know, Dr Mashelkar likes to use the word pole vault, not leapfrog. We have that opportunity and I think that would be a shame that we are not using it because we are too worried that, oh my God, these people will, you know, play fast and lose. I think we will lose the opportunity. We need growth. We urgently need growth. Absence of credit is the number one barrier to growth of a Bihar or UP or Arunachal Pradesh or a northeastern state.
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