Vault matters: Why the business of banning businesses by RBI is justified

RBI business ban

The scene when Rancho’s drone finds Joy Lobo hanging by the ceiling fan in his hostel room and the conversation that follows between him, the protagonist played by Aamir Khan and the famous Virus or Dr. Viru Sahastrabuddhe, played by Boman Irani was, by and large, the most emotional moment in 2009’s super hit flick 3 Idiots. At the funeral, Rancho blames Virus for Joy’s suicide. He tells Virus that Joy didn’t commit suicide but was murdered by Virus. Without battling an eyelid, Virus bluntly asks Rancho whether he should go to every student’s ears and whisper: congratulations, you passed, so sorry you failed.

That is one of the few times in the movie when Rancho didn’t have a comeback.

What the Reserve Bank of India did with four non-banks last week – namely, Asirvad Micro Finance, Arohan Financial Services, DMI Finance and Navi Finserv, is something similar. It called them out in a list and said, “Sorry you cannot do business till you get your house in order”. In the banking fraternity, RBI’s action has caused a lot of unease. It was also the fourteenth instance since 2020 when RBI resorted to pulling the plug on a business. There has been a lot of commentary on how this may virtually lead to shutting shop for the business if the ban placed on these lenders runs for too long. A few sections also question whether investors would even have faith in India’s financial services landscape any longer. But be that as it may, the question is how else should a mistake be rectified?

According to sources aware of the matter, the regulator first warned the four entities that received the cease and desist order in June last year. Warnings were repeated in December 2023 and subsequently around June – July this year. A person with direct knowledge of the matter said, the four companies were at the highest layer of interest rate charged to microfinance customers. A few of them had issues on operational and procedural fronts as well, with two out of them named in the circular having highest concerns on operational aspects. If repeated warnings were not adhered, the regulator’s action to ask these entities to stop business till they mend their ways is logically the right thing to do. But given that each of the four entities had different observations, apart from that of pricing, probably RBI could have come out with different circulars for each of the NBFCs. By bunching them into one, irrespective of the degree of deviations, they have been painted with the same brush. While the punishment itself may not have sent a wrong message to the investor community, the manner in which the punishment has been delivered has certainly sent wrong signals. What also makes RBI’s action last week noteworthy is that it was possibly the first time that the regulator took objection to pricing, which is a business decision of a lender. Prior to that,, actions have always been directed at compliance lapses.

Is it in the remit of RBI to niggle with pricing?

When a car maker tries to pass on its operational inefficiencies to the customer, the market forces come into act. It’s true with soaps, shampoos and even restaurants. The business of lending is different. While a loan product, like any goods or service, works on the caveat emptor policy, the price for the availing a loan is paid over the tenure of the product and not at the time of buying it.

This basic difference makes pricing a sensitive issue for loans as against other products.

People avail loan due to necessity and the rate of interest depends on various factors including the repayment ability of the borrower. Those at the bottom of pyramid are considered riskier because many may not be formally employed or earnings. Yet, it doesn’t give the right for the lender to pass on its operational inefficiencies through interest rates.

This is what the RBI is trying to curb and it may not have been possible if lenders charging high interest do not vacate the system to course correct. In the process, should there be a second order impact on their ability to stay afloat, they perhaps their business models were built on a wrong premise. Should they have a right to exist? So what if they were built on private equity capital? The bottom layer of borrowers do not have the option to be price sensitive as their access debt is limited. Nonetheless, they are the politically vulnerable section.

Right now, we do not have another Andhra Pradesh crisis brewing in the personal loans space. But, if people start missing their loan repayments because the loans getting too expensive for them, 2010 crisis may knock the door soon. RBI intervention last week was hence required. But considering that their scale of operations is not to their favour, it would be interesting is to see if all the four NBFCs survive the ban and come back thriving once it is lifted.