No quick fix

There is obviously no quick fix to the problems facing some companies in the financial services sector triggered by the failure of the Golden Key Credit Card Company. This was very much a Ponzi-style operation with very high interest offered to attract deposits. Peter was paid with Paul’s money and as long as the interest cheques kept coming, the suckers who are born every minute, as the threadbare but nevertheless valid cliché has it, kept investing their hard or otherwise earned money. Bubbles often take a long time to burst as demonstrated in the U.S. (Madoff) and India (Satyam) among other countries. Charles Ponzi, of course, was an Italian who at the turn of 19th century made it big in the United States and was conferred authorship of an easy-to-run scheme that had been worked in a small way from the time of Charles Dickens. The scheme in essence involved interest payments to investors out of their own money or from the funds of new investors.

All kinds of figures, most often Rs. 26 billion, are being bruited as what was deposited at Golden Key. The chances are that it would have been less than that in the sense that many depositors capitalized their interest, retaining it in the company, and such interest would have built up to a sizable amount that was really not deposited in the company. But book entries would have been made crediting the depositor with his interest dues and in his own mind as well as under the law, this was money belonging to him held by the company. There was a proposal to deduct interest and refund only the capital actually deposited which, understandably, raised a howl of protest. Why should a company that paid its CEO, by his own admission, Rs. 1.5 million a month, not to mention other huge perks, be given the benefit of what businessmen call ``zero cost capital’’ on which the depositor could have earned a return – albeit smaller – if he had the sense to invest elsewhere? It was not only the CEO who was well looked after. The chairman and other directors, by all accounts, had not done badly. A lot of people were obviously having a ball on other people’s money.

There are those who argue that there has been a regulatory failure and the Central Bank must assume at least a degree of responsibility for what has happened. The bank on the other hand has repeatedly pointed out, as it has done before, that these were companies not registered to accept public deposits and their activities were not supervised by the bank. Nevertheless, as pointed out in a news story last Sunday, the Central Bank in 2003 published a list of 31 companies (Golden Key among them) which it said while not being registered nor supervised, ``may enter into other transactions for the purpose of raising funds from the public.’’ Part of this notice was a list of the regulated and supervised deposit takers. While we would say that this was a clear signal of caveat emptor or buyer beware, those interested in getting a better rate for their money would have chosen to interpret (or misinterpret) it otherwise. They have now paid a price for their lack of prudence. But a question arises why the Central Bank wanted to go public on the existence of such companies giving them a veneer of respectability? This is something that has not yet been credibly answered.

Earlier this week, the Citizens Movement for Good Governance (CIMOGG) published a statement where some very pertinent matters were raised. There was reference in that statement to the failure of Mercantile Credit Ltd., a finance company founded by no less than a former Governor of the Central Bank that was very well regarded at a point of time, which went bust. The Central Bank moved in and more than a billion rupees of public funds were invested in an effort to rescue it. That was not to be although many depositors were refunded their capital not out of the company’s resources but out of public funds. Dr. A.C. Visvalingam, the President of CIMOGG, has asked the pertinent question on whether Central Bank officials have learned the necessary lessons from previous failures and pressed succeeding governments for more effective legislation to minimize the frequency of similar occurrences. Sadly, the answer to this question is a resounding ``No.’’

This is a matter that must be urgently addressed even now. While the authorities are busy taking various measures to ensure that the effects of the failure of a major player in the financial services industry will not lead to a chain reaction that will bring the entire sector down, it is necessary that concurrent steps are taken to close existing loopholes as best as possible. There must also be constant communication with the public about what is being done and how quickly the remedial measures that must be carefully thought out will be implemented. The Central Bank has a Department of Bank Supervision as well as a Department of Non-Bank Supervision. Thus a necessary infrastructure is already in place. There is no doubt that investment, whether in land, gold, stocks and shares or fixed income instruments is a matter of risk and reward - the higher the risk, the greater the reward. As CIMOGG has pointed out, it is not only unlicensed finance companies and pyramid schemers who are involved in playing ducks and drakes with other people’s money. The state banks are as guilty.

They too have made billions of rupees of bad loans, often to political cronies, and taken very bad beatings in the past. They continue to make such loans, such as to Mihin Air, on political direction. Most of these loans were made when money values were much higher than they are today. CIMOGG says that ``senior officers of these banks and defaulting customers appear to have come to some cozy settlements’’ including write-offs. Many such settlements have been politically influenced. The losers are the people to whom the banks belong and whose money has been used to recapitalize them. The Central Bank, rightly, wants independent directors on the boards of private commercial banks and some movement in this direction has already been made. It is an open secret that a recent effort on this front was diluted as a result of the influence wielded by a big business name now in deep trouble.

The fact of the matter is that even the Central Bank is not independent, it’s Governor, however able, being a political appointee. In Parliament last week questions were raised about People’s Bank defaulters and we heard the familiar story about secrecy provisions

in the Banking Act. But curiously, some big People’s Bank defaulters’ names were mentioned. Some of them were known as the bank had gone to court. Obviously the Banking Act too needs amendment. Why should massive defaulters be allowed to swank around in posh cars and live in big bungalows without being named and shamed?

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