We Need More Financial Institutions and To Let Indians Invest in Them


Our financial institutions have, for the most part, failed us. LIC is the biggest receiver of savings as a public insurer, and yet, it puts very little of its money into the non-government economy. As of September 2014, nearly 10 lakh crore out of the 15 lakh crore of policy holders’ money with LIC was in Government securities. (Some of this is by regulation, but a very large portion, by choice). Of the rest, much is invested in buying stakes in public sector enterprises, in equity and debt.

Further, LIC works hard to backstop public sector disinvestment. Banks are similar – they don’t even want to lend to SMEs, for the most part. Indians don’t (for the most part) invest in venture funds or private equity, at least not directly. Our EPFO doesn’t want to invest even in listed equities – and that’s a big source of pensions. And it seems our institutions also don’t bother to invest in them either.

And the RBI and the government tell us to save more.

Why should we save, if all our institutions do is increase their lending to the government? Should we not attempt to encourage investments in the private sector, instead? Isn’t that what a good savings rate is supposed to help with? At this time, there is no enthusiasm among the institutions we do save with, to encourage small enterprises either by giving them equity or through debt.

This is why foreign investors – and then, mostly institutions –  have been the biggest investors in both Indian listed equities and in Indian private unlisted shares (startup companies such as Ola and Snapdeal and Flipkart). The biggest gains when these companies grow will be the foreign institutions and in turn, the investors in those institutions (typically foreign pensions, retirement funds and equities).

Why do those investors allocate money to India? For one because India needs to be a tiny part of their portfolios. They own so much money that throwing away a few million dollars each into Indian stocks is a good strategy. And then, some of that “tiny” money amounts to billions of dollars, given to venture capital funds, who then choose India as their primary strategy. Either ways, the fact that Indians receive a lot of foreign capital is not because we are important to them, but because we’re getting scraps, and those scraps are big in comparison with our economy.

Why aren’t our institutions growing?

Because we need more institutions, not larger players.  Larger players are inefficient allocators of capital because the leadership is, by human nature, myopic. You can’t have too much on your plate, so you choose to focus on the 10 or 20 things that you can focus on. Obviously, you will choose the tried and tested path. So, max allocation to government bonds, some equity and some other lending here and there.

This means the tiny player at the fringe who could become the next big guy will never even get seen. Because it is too much at the fringe.

This argument means two things:

a) that Indian institutions should allocate capital to be managed by other people. Spread the love, and they will in turn give you access to investments that would otherwise escape you. And because certain entities will know best about specific areas. Such as seed funds (for early stage equity), sector focussed private equity funds or in private debt consortiums. This could be small allocations, but small for LIC is a sum of, say, 0.5%, which is Rs. 7,500 cr. That is probably more than many Indian sourced funds have at at the seed or angel fund level.

b) that rich Indians should invest in smaller funds. Instead of parking savings in real estate or insurance or even massive diversified equity funds, put a small amount of money in smaller cap and unlisted equity funds. Current regulations prevent people from pooling in small amounts of capital to invest in companies (both the draconian Startup Tax, and the NBFC rules, which I’ll come to later). But there is a need for smart investors to be funded by Indian money, not just foreign money that they keep looking for.

The Regulation Issue

There is no focus on letting institutions be created on tap – other than payment banks and small banks (which have stringent and big criteria for creation) you can hardly even create an institution that lends money or even invests. A SEBI registration costs lakhs of rupees, even for the most basic of funds. You can’t even create a fund that invests in companies in India with less than Rs. 20 crore (okay, 10 crore for angel funds) and a slew of registration charges and costs including that your manager needs an MBA or such random criteria.

Do you know you can just not pool money, between friends, and create an entity that invests in other companies? And do you know who doesn’t allow it? The RBI. (And the Companies Act, of course)

The Companies act decides that any such company has to be a non-banking-finance-company. That is, if you have more than 75% That needs a capital of Rs. 2 crores, and RBI registration, which isn’t easy. Why? What’s the point of even regulating investment firms that are less than 2 crores in size? Why not let them be, and only require registration when they go beyond 2 crores?

(And why 2 crores? If RBI keeps harping about the fact that the “nominal” value of things are going up with inflation, then the 2 crore limit too is nonsense. Let’s require NBFCs to register only beyond a valuation of 10 crores. Below that, go on and build the business!)

The Startup tax sucks even more. It means that you as a resident Indian can’t pay a “premium” to buy a company’s shares, unless a big name accountant justifies that premium, using old concepts like “book value”. This is utter nonsense and should be done away with completely, because it is designed to prevent a very tiny set of companies from income tax evasion, while the rest of India suffers.  (To tell you one simple mechanism – the rules don’t apply if the investment is from abroad, no matter what the valuation)

The rules shackle resident Indians from investing in smaller entities, and the rules stop Indians from creating smaller institutions that can do the fringe investing which brings great technologies to life.

In the end, all we have to do is to remove the barriers. The bad will flow with the good, but in general the good will do so much that it will overshadow the bad. If we don’t do this then all the “good” investments will be taken up only by people abroad, and Indians will just have to live with the fat bloated banks and the scamming insurance agents.

Just a Sunday rant, but it’s been bothering me for a while.


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  1. If the fiscal position on the central and state governments improves over the next couple of years, long term insurance and pension sector continue to grow at a reasonable rate, and interest rates get lower, this situation will change as the large institutional investors will be forced to move to more innovative sources of investment, whether equity, bonds, or other higher yielding investments. this is because the supply of government paper will be lesser than the availability of funds and the pressure to give returns will continue. hope this happens.

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