Moneycontrol Pro Panorama | The road to stability is paved with penalties

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The Panorama newsletter is sent to Moneycontrol Pro subscribers on market days. It offers easy access to stories published on Moneycontrol Pro and gives a little extra by setting out a context or an event or trend that investors should keep track of. 

Over the past weeks, India’s regulators have kicked into serious action to snuff out potential fires in the financial markets. The Reserve Bank of India’s clean-up that began with hiking risk weights on unsecured lending last year continued with the banking regulator now asking card issuers to give customers the choice to pick networks. It also increased oversight on co-branded credit cards and media reports state that the RBI is increasingly antsy on how such cards operate. The RBI is also said to be looking at the peer to peer lending space, which has grown by leaps and bounds.

On the other side of the financial pond, the Securities and Exchange Board of India (SEBI) has sent out warnings to investors standing to lose money because of froth in the smallcap space. SEBI asked mutual funds to moderate flows into small and midcap funds and rebalance their portfolios. SEBI Chief Madhabi Puri Buch said, “We see signs of manipulation in the SME segment.” Buch is worried about increasing fraudulent activities that inflate stock prices and, in some cases, even subscriptions into initial public offers. For the past year, SEBI has been tightening the screws over the equity markets, dousing potential fires that could, if unchecked, level even big portfolios.

While the two regulators have separately done their jobs, together too the RBI and SEBI have worked on bringing to light misconduct and misdemeanours in markets. The RBI has cracked down on several lenders, levying monetary penalties and at times even restricting business operations. Investment banking group JM Financial bore the brunt of both the regulators. The RBI banned JM Financial Products, a non-bank lending firm of the group, from lending against shares and bonds, including for the purpose of IPO bidding. SEBI, on its part, barred the company from acting as a lead manager of any public issue of debt securities.

Investors know that there is more coming from regulators and the market is understandably nervous. The small-cap index has already nosedived, and fund houses have begun to act on the regulator’s orders. ICICI Prudential Mutual Fund has suspended lump-sum investments into its small and midcap funds.

Why have the regulators increased their vigilance and what is with the increasingly harsh penalties?

It is obvious that regulators do not want a mess on their hands if a series of events lead to eventual financial instability. Furthermore, much of the money flow is in some ways household savings and endangering them is what regulators cannot abide. The RBI is right in protecting depositors’ interest from malpractices, shoddy governance and even fraud. It does this by protecting and policing the entities it regulates.

Household savings have been increasingly flowing into capital markets, a trend reflected in the ever rising demat accounts and systematic investment plan (SIP) flows of fund houses. SEBI’s move to protect the retail investor requires it to place a higher surveillance on institutional investors and market makers who have an unfair advantage over retail.

There is no easy way to ensure financial stability than to punish those that act against it. Even small transgressions when unchecked can lead to catastrophic losses, given that institutions, investors, and even market makers are intrinsically linked through transactions. That said, it would be naïve to conclude that harsh regulatory punishments will straitjacket the capital markets.

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