08 October 2010

Is richer better than smarter?

I have a column in today's Economic Times on whether it makes sense to impose networth criteria for all financial sector players. I think today's rules imposing them are mainly wrong in areas where networth is irrelevant as an entry barrier. Here are excerpts:
Almost all financial regulations in India favour entities with more money than less. These regulations are often wholly agnostic to whether the entities are competent beyond some minimal standards. This is a pity, given the large number of smart and self-driven people who graduate from the IITs and IIMs and who have everything going for them except a very large chequebook. The regulations provide a virtually insurmountable barrier for these youngsters in India.
While there are some areas that do require capital to run, there are many others which do not. So, while a bank or a custodian requires capital to operate with manageable risk, a portfolio adviser needs no bank balance to operate, as the adviser is as good as the advice she gives. Yet, Sebi regulations require a net worth of 2 crore for a person to be able to give advice.
There are several arguments forwarded by these net worth advocates. First, these net worth requirements act as buffer for losses and are, therefore, a means of providing redress to investors in case of some mishap or problem. This argument works for very few entities, and for most, the argument doesn’t apply at all. For yet some more, the argument is inappropriately applied. It does indeed work for entities where capital is an important part of risk management of the operations of the entity. These would include , for instance, clearing corporations, custodians and underwriters. In reality, no requirement is imposed on clearing corporations ; a fixed amount is charged on custodians — whether they manage 1X or 100X the amount of net worth — and a mere flat 20 lakh is imposed on underwriters, again irrespective of the risk they manage.
Some areas where the applicability is completely inappropriate are credit rating agencies, portfolio managers, asset managers and stock exchanges (as opposed to a clearing corporation, see my ET piece on May 12, 2010, on the subject). Having similar requirements for lawyers and accountants is as perverse as having them for these entities. One would be more comfortable taking investment advice from an IIM graduate than from a person who has 2 crore in his bank and two employees on his payroll and who can ply his trade only because of his bank balance.
Lastly, it is argued that allowing anyone to operate would open the floodgates of scamsters. This, of course, raises the question whether all rich people are honest and all not-so-rich , including middle class people with good education, are fundamentally not trustworthy. The lazy regulation of keeping money in the bank as an entry barrier needs to change, as it is built strongly on this assumption.
A committee of SEBI did look into capital requirements of securities intermediaries and has recommended an across-the-board increase of net worth numbers without addressing the fundamental question of whether net worth is relevant to a particular business activity or not. Perhaps the committee should review the requirements and ask some fundamental questions.

No comments: