A tale of two RNBCs
Tamal Bandhyopadhyay's 'Sahara-The Untold Story', published by Jaico, 2014 (Rs 450) has received significant attention. At the outset it must be mentioned that there was litigation between the author and Sahara, which has been settled with a disclaimer by Sahara which is carried at the start of the book.
Furthermore, Sahara is caught up in litigation with the regulators. Tamal, with his renowned skills of research and writing has made the obscure subject of finance into a thriller as he presents the saga of two Residuary Non-Banking Companies (RNBCs) viz. Peerless and Sahara.
The genesis of RNBCs
Way back in the 1950s, there were hundreds of commercial banks and after legislative amendments, most of these banks were put through a process of moratorium, amalgamation and mergers by the Reserve Bank of India (RBI) and the total number of scheduled commercial banks was reduced to a total of 70-odd banks. While this operation was successful, there was a proliferation of non-bank deposit taking companies.
In 1963, the RBI Act was amended to empower it to give directions to three types of non-banking companies viz. financial companies, non-financial companies and in 1973, directions were issued to miscellaneous non-banking companies. The Prize Chits and Money Circulation Schemes (Banning) Act, 1978 was enacted by Parliament. Following this, the West Bengal State Government in 1979 banned Peerless from undertaking further business.
This resulted in a long battle of attrition that lasted till 1996. In 1979 Peerless approached the Calcutta High Court that the 1978 Act did not apply to it. The court ruled in favour of Peerless. Years later, in 1987, the Supreme Court concurred with the Calcutta High Court, but indicated that the RBI could regulate these companies differently than the Non-Bank Finance Companies (NBFCs); the application of the NBFC Directions to these companies would result in a closure of these companies; to avoid such an eventuality, the Supreme Court urged the RBI to issue separate directions which would safeguard depositors and also enable the companies to live.
Thus came into being the Residuary Non-Banking Companies (RNBC), Directions 1987. Since liability control was not possible following the Supreme Court ruling, the RBI had to turn to asset side control-investments to be in specified instruments and only 20 per cent or ten times the net owned funds were permitted in other investments.
`These companies accepted long maturity instalment deposits with a forfeiture clause for not maintaining regular payment of subsequent instalments. These companies engaged a large number of agents and their commission structure favoured largely the first year and second year instalments and agents were encouraged not to go for collecting subsequent instalments which then brought into effect the forfeiture clause. Furthermore, these companies took deposits into their income account which enabled them to cover the balance sheet hole. Since these practices were prohibited by the RBI, it resulted in a prolonged battle in the courts between Peerless and other RNBCs. The RNBCs filed a writ petition in the Calcutta High Court, which, in its judgement in 1990, directed the RBI to make its Directions more reasonable.
The RBI had to perforce approach the Supreme Court and in 1992, the Supreme Court ruled in favour of RBI. Peerless once again filed a writ in the Calcutta High Court, which, in May 1995, upheld the RBI action. Peerless then approached the Supreme Court and in January 1996 the Supreme Court ruled in favour of the RBI. Tamal's graphic but meticulous presentation of the long litigation gives a readable account of an otherwise abstruse subject. The restructuring of Peerless under a new team led by the inveterate D N Ghosh brought an end to the whole battle between Peerless and the RBI.
The Sahara episode
While Peerless was in a 20-year-battle with the RBI in the courts, the tiny Sahara became a gigantic company. Tamal covers the Sahara episode with a chronology of events. Unlike Peerless, Sahara followed an entirely different tack. The funds raised by Sahara as an RNBC were passed on to a partnership firm, which then claimed not to be covered by the RNBC regulations. Moreover, under the then prevailing regulatory framework, no inspection was undertaken for the first 12 months, and while a new unit would be set up, the earlier unit went dormant. This was tracked down by the regulator as far back as 1995.
In contrast with Peerless, Sahara initially avoided the regulator and then turned to a lengthy dialogue with the regulator, which Tamal sets out in gripping detail. Ultimately, it took all the way till 2008 that the deposit-taking episode was brought to an end. The switch to raising funds through debentures raised yet another battle with SEBI and this issue is now before the courts.
Implication of the 1987 SC judgement
While those companies which were covered by the NBFC regulation were subject to a more exacting regulatory regime, those which could not meet the regulatory framework could take shelter under the milder RNBC regulation.
The upshot of this was that the large RNBCs grew rapidly, while the NBFCs, which were subject to a more stringent regime, grew at a slower pace. In that sense, the 1987 Supreme Court judgement has been crucial to the course of development of the non-bank sector.
Tamal's significant contribution
Tamal's meticulously researched book will be a reference document for any serious study of the evolution of RNBCs. Hence, it should be mandatory reading for policymakers, opinion makers, participants in the financial sector and the discerning public.
Please Note: This article was first published in The Freepress Journal on August 25, 2014. Syndicated.
This column, Common Voice is authored by Savak Sohrab Tarapore. Mr. Tarapore, is an economist and he runs his own Multi-Language Syndicated Column. Mr. Tarapore's other column, which appears in The Hindu Business Line, is titled Maverick View.
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