And now, willy nilly, towards a bubble economy

R K Roy

The Reserve Bank of India (RBI) has tightened the ceiling on bank advances against shares, including bank loans to share brokers and bank guarantees on behalf of the latter. Bank chairmen (CEOs) will be responsible now for keeping a close watch on such advances; CEOs will not be parties to decisions on share-related advances, which will be the domain of investment committees of the respective banks.

It may seem uncharitable to say that the RBI is seeking to lock the stable after the horse has bolted. But the bank scam in the KP (Ketan Parekh) speculation took place in the overly permissive regime put in place by the RBI’s circular of November 2000 (noted in “Speculation in shares is RBI’s new priority sector”, FE, April 13). The question now is, how secure can the stable be (even after the RBI finalises its directions on May 3)?

The new arithmetical ceiling and sub-ceilings (adding up to over Rs 32,000 crore), it is assumed, will be sufficient to keep the banks on the straight and narrow. However, share prices are volatile, extremely so, in India. Fewer than a dozen market players can ramp up prices or push them into a tail-spin. To engage in share-related business, banks must have a nose for goings-on behind the market facade.

Insider trading is rampant. (Managers of mutual funds, with depleted net asset values, are in clover). The KP bull run was fuelled by at least four corporates, including a bank. The Unit Trust of India has denied it had invested in shares of a company to which it lent funds. How will a bank get to know of the corporate tie-ups (including the nexus via benami firms as also NBFCs) with brokers and speculators?

The issue is not one of expertise (which in any case banks do not possess) but of access to tightly-held information. This puts the banks at sea. Net of margin money, advances against shares are in the nature of clean loans. (Incidentally, does this not call for a hike in the capital adequacy ratio of banks from the current 10 per cent?)

Share markets are the weakest point of capitalism in India. Is it fair to push banks into the share markets? Banks normally fund the working capital requirements of corporates. If they also finance shares of these corporates, bank-client objectives will converge. Now bring in banks’ asset management companies, which will directly invest in shares. The emerging scenario is one in which the banks, unable to fight the speculators, will join them—to create a bubble. (The consequence of such an unholy alliance is seen in Japan).

This may seem an extreme view. Share market reforms are being accelerated. New rules are in the offing, including rolling settlement. The trouble is, for every rule violated, new ones are brought in place by Sebi and the RBI. Previous violations are swept under the carpet. Has any violator been punished so far?

Powerful business men are behind speculators. (No wonder, rumours—threats, really—surface that the RBI governor is on his way out or the Sebi chairman is to be retired). The Central Bureau of Investigation’s dossiers on Foreign Exchange Regulation Act violations are a who’s who of big business in India. Their political leverage puts them beyond the pale of the law.

The Reserve Bank can bring in new rules; in vain. The milieu requires the RBI to watch its step.