Editorial 2: India’s financial sector reforms need a shake-up

Context               

There should be consistent rules across different areas, support for a strong bond market, lively retirement finance options, and better control over shadow banking.

Introduction

India’s financial sector is at an important turning point. For a long time, the government and regulators have made small changes in banking, financial services, and insurance (BFSI), but problems still remain. These problems are not just minor issues — they act as barriers that stop savers, discourage investors, and slow down growth. To have a truly professional, transparent, and investor-friendly financial sector, bigger changes are needed, especially in corporate bond markets, retirement planning tools, nomination processes in BFSI, and controlling the rising problem of shadow banking.

Nomination Issues Across BFSI

• Inconsistent Rules: Across banks, mutual funds, and insurance, nomination rules vary widely.
  • One account allows a single nominee
  • Another allows multiple nominees with different rights
• Confusion for Savers: This patchwork of rules lacks legal clarity and causes confusion for ordinary savers.
  • Benefits mainly those exploiting legal loopholes
  • Leads to lengthy court cases
• Need for Harmonisation:
  • A unified nomination framework is necessary
  • Clear definition of nominee rights vs legal heir claims is overdue
  • If differences exist for valid reasons, the government should provide evidence or case studies justifying them

Underdeveloped Corporate Bond Market

• Current Status:
  • Market is shallow, illiquid, and opaque despite policy efforts
  • Affects the cost of capital, key to business success
• Potential Benefits of Reform:
  • Efficient bond markets can reduce funding costs by 2% to 3%
  • Could unlock significant gains for industry and employment
• Regulatory Failures:
  • RBI directed NSE to build a secondary bond market, but it was ignored
  • Equity markets are more profitable due to opaque trading strategies
  • NSE sued a journalist exposing malpractices, but was reprimanded by the High Court

Transparency and Ownership Disclosure Challenges

• Global Compliance: India, as part of the Financial Action Task Force (FATF), must enforce Know Your Customer (KYC)norms
  • These norms require clear identification of Ultimate Beneficial Owners (UBOs)
• Practical Issues: SEBI recently pressured two Mauritius-based foreign portfolio investors (Elara India Opportunities Fund and Vespera Fund) for detailed shareholder data
  • Both failed to fully comply, delaying regulatory oversight
• Disclosure Loopholes:
  • Current UBO thresholds:
    • 10% for companies
    • 15% for partnerships
  • Allow entities to structure investments just below thresholds, avoiding detection
• Impact:
  • Opacity weakens market integrity
  • Discourages long-term domestic and foreign investments

Unmet Retirement Planning Needs for Young Professionals

• Current Situation:
  • Most retirement planning in India relies on annuities
  • These are expensive because insurance companies take a high intermediation margin
• Better Alternative:
  • Long-dated zero-coupon government securities offer a simpler, cheaper option
  • Avoid the typical 2% intermediation fee over 30 years, which can lead to big gains for savers
• Technology and Opportunity:
  • Technology exists to “strip” principal and coupon payments to create zero-coupon bonds
  • But the government and Reserve Bank of India (RBI) have not taken strong steps to promote this
• Missed Chance:
  • India is missing an opportunity to build a vibrant, low-cost retirement system backed by sovereign credibility

Shadow banking

• Shadow banking includes NBFCs, margin lenders, repo traders, and brokers providing bank-like services without full regulatory oversight.
• This is a major risk area; global experts warn the next financial crisis could start here, similar to the 2008 US crisis caused by unregulated derivatives.
• In India:
  • Brokers lend to retail investors under the guise of margin funding.
  • Interest rates can exceed 20%, often without investors’ knowledge.
  • The broker uses the investor’s own funds as collateral, lends it back, and charges interest on the total amount—a classic shadow banking tactic.
  • It’s unclear if the Finance Ministry or RBI fully understand the size of this shadow lending.
• Global Benchmark:
  • The European Union has enacted laws requiring detailed data collection on shadow banking.
  • India needs similar transparency laws first, as data collection is essential before effective regulation can be applied.

Conclusion

India’s financial reforms must move past slogans and small changes. We need a clear, future-focused plan that unifies rules across sectors, builds a strong bond market, creates better retirement finance options, and controls shadow banking.