Like Rapunzel, corporate debt markets need to be released from the tower

The struggles of Indian debt markets over decades with a yield curve and integrated money markets are too well known to recount.

Rapunzel's popular story, as told by the Grimm Brothers, has long been a favourite of both children and adults. A poor, childless couple lives next to a large garden owned by a sorceress, which is surrounded by high walls and locked gates. The wife pines for a plant she sees growing in the garden. She refuses to eat anything else, and her health begins to deteriorate. Her husband is afraid for her life, so one night he breaks into the garden to get some for her. As he climbs the wall to return home, the sorceress apprehends him and accuses him of stealing. He begs for mercy, and she agrees to let him go if the baby is given to her when it is born. Out of desperation, he agrees.

When the wife gives birth to a daughter, the sorceress kidnaps her and names her Rapunzel. She grows up to be a lovely young lady with long golden hair. When she reaches the age of twelve, the sorceress imprisons her in a tower in the middle of the woods, with no stairs or doors and only one room and one window. In order to visit her, the sorceress stands at the bottom of the tower and calls out:

Rapunzel! Rapunzel! Let your hair down so I can climb thy golden stair."

One day, while riding through the forest, a prince hears Rapunzel singing from the tower. Captivated by her voice, he searches for her and discovers the tower, but is unable to enter it. He returns frequently to listen to her sing, and one day notices the sorceress visiting her and discovers how to gain access. When the sorceress leaves, he tells Rapunzel to let her hair down.  When she does, he climbs up and they fall in love. He eventually proposes to her marriage, and she accepts.

The story, however, becomes murky after this point. According to the Grimm Brothers' version, they lived happily ever after. In other versions, the prince is revealed to be a knave, and Rapunzel suffers as a result. Regardless of likely good intentions, none of the versions portrays the sorceress in a favourable light for her actions.

Rapunzel of Financial Markets

Non-government debt has long been referred to as the Rapunzel of Indian financial markets. Fearing for its integrity in a world rife with potential abuse and deception, its regulatory watchdog chose to confine it in a tower for 32 years. Following the trauma of a systemic failure and fraud in financial markets in 1992, the Reserve Bank of India (RBI) chose to raise the tower’s walls even higher, locking these markets away, rather than proactively addressing root issues, managing risks, and working to develop financial markets with appropriate and progressive risk mitigation mechanisms and structures. Relying instead on loans from state-controlled banks to finance industrial growth. This regulatory strategy had a number of consequences.

The first was the concentration of this risk in public sector banks, even while credit assessment and underwriting capability — evaluating, pricing, and mitigating risk as a loan or as a market instrument — across institutions and markets remained poor and underdeveloped. The tab for this and other inefficiencies, excesses and abuses (including crony ‘phone’ banking) was repeatedly picked up by the Indian public in the form of lower interest rates on deposits as well as repeated recapitalisation of public sector banks to absorb losses and lend more.

The irony of this abusive cycle was evidently missed when some in the central bank congratulated themselves on how India avoided the 2008 meltdown of overengineered and overleveraged global financial markets. A fact true enough, but on a financial evolutionary scale akin to Bushmen hunter-gatherers of the Namibian desert (no offence meant to their simpler way of life) justifying their non-engagement with the internal combustion engine by citing a high-speed Autobahn car crash in Germany as axiomatic evidence of its horrific consequences. The struggles of Indian debt markets over decades with a yield curve and integrated money markets, which are representative of the cost and availability of funds in a developed debt market, are too well known to recount.

Skewed Risk-reward Outcomes

The second was a stunted system of market intermediaries with misallocated and skewed risk-reward outcomes. A few among credit rating agencies, mutual funds, trustees and auditors even engaged in gaming the system, secure in the comfort of the paternalistic concern of the regulator shielding them from the consequences of omission or commission and continuing to remain unaccountable to market forces for risk-reward efficiencies.

It is unarguable that a conservative stance and a long-term perspective are required by regulators, particularly central banks, in meeting their fiduciary objectives. This, however, is not an excuse for non-engagement, inaction, bureaucratic red tape or an ostrich-like attempt to avoid risk rather than risk recognition and mitigation. This observation has been made repeatedly by many people who have interacted with the RBI over the years, and it was recently rearticulated by the outgoing CEO of a leading private bank. The risks that the regulator sought to avoid by building its ivory tower over the decades have manifested themselves in unexpected crises that the regulator has struggled to deal with, as well as, sadly, in still underdeveloped debt markets.

This Hamlet-stepchild approach to the development of the corporate and non-government debt markets must end. To be or not to be is not the question. It is not nobler in the mind to suffer the slings and arrows of outrageous fortune than to take arms against a sea of troubles. And by engaging, we may not end them but at least mitigate them. It took the RBI nearly 60 years since its founding to first appoint a commercial banker as a deputy governor in 1994. It should hopefully take much less time to induct relevant debt market expertise, preferably some with experience across global markets, into regulatory management teams to shape policy and the development of these markets.

Financing Economic Growth

The importance of non-government debt markets in financing India’s future economic growth trajectory cannot be overstated. The fact that the majority of this debt will have to be financed through market mechanisms and mitigation with no recourse, explicit or implicit, to the government guarantee is also not debated. The RBI and other regulators will have to demonstrate proactive engagement with financial innovation and risk mitigation structures in equal measure to meet these requirements. The creation of the corporate debt market development fund and the tri-party repo guarantee mechanism for corporate debt demonstrate that the government and regulators are well aware of these requirements and are taking long-awaited risk mitigation steps to free non-government debt markets from the tower they are presently trapped in while at all times keeping public and investor interests in mind, which are welcome developments.

The story of Rapunzel, in both forms, also suggests some salutary lessons on gender that India’s regulators, financial markets, and corporate boardrooms too need to recognise: whether it is guiding teenagers to become responsible adults or developing corporate debt markets, patriarchal biases and locking up in towers don't quite work.

Sandeep Hasurkar is an ex-investment banker and author of `Never Too Big To Fail: The Collapse of IL&FS’. Views are personal, and do not represent the stand of this publication.