The Hindu Business Line : Let the net remain

The Reserve Bank of India's advice to banks to refrain from offering a `safety net' — a commitment to buy shares of companies going public — is wrong, based as it is on a flawed premise besides being a needless attempt at micro-managing the commercial operations of the banks. Take its argument that banks are offering such a scheme without any request from the issuing companies themselves: The issue is not whether there was such a request, rather it is one of the decision itself being justified in terms of certain larger business or commercial purpose.

If banks have taken decisions that do not stand the test of legitimate commercial/business considerations, then it is a severe indictment of their internal control systems. Indeed, the instances that have come to the RBI's notice are where individual officials or offices of a bank have acted in breach of the internal control system; the RBI's role therefore would be confined to examining through its routine on/off-site inspections of how the bank had handled such a breach. Even then there is no case for the RBI to recommend against any price-support operations.

The RBI's other contention that there is no income commensurate with the risk of loss built into these schemes is also hard to fathom. If the RBI feels that banks are collecting an `option premium' that is inadequate for the risk assumed, then it must spell out the contours of a proper pricing model. It must be borne in mind that traditional option pricing models depend on observed volatility in secondary market transactions of a scrip — a condition that yet-to-be-listed scrips cannot obviously satisfy. When banks provide price support on newly-listed scrips without charging a premium, obviously in return for an enduring business relationship with the issuer company, the test to be applied is whether there has been a proper internal evaluation of the deal and of the trade-offs that banks make between current profits and future cash flows.

The RBI's mandate is not to ensure that banks conduct their businesses in a manner that leave a reasonable return to its shareholders. Its primary responsibility lies in protecting the interests of the depositors and the stability of the banking system. Its prudential norms on banks' overall exposure to the capital market and its intermediaries already ensure this. The rest is best left to the bank managements.

More Stories on : Editorial | IPOs | Investor Protection

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Let the net remain

Why a sentence should not be disturbed?

Ensuring activism leads to action

India-EU Bacchanalian cup runneth over

Tarapore Report II — Little light on deficit, gold

Power theft short-circuiting growth

When mergers emerge by the hour

Checking corruption

Urban chaos