RBI Action Against JM Financial, IIFL: Supervisory Speed Finally Catches Up With Regulatory Intent 

Also the RBI regulates and supervises banks, non-banking financial companies (NBFCs), amongst others. So for media speculation or ‘experts’ describing  it to be a singling out of NBFCs for action is another error. 

Over the past many months, the RBI has taken decisive actions against banks, NBFCs, fintech firms, payment entities, and credit card issuers. These measures primarily target lapses in corporate governance, instances of operations exceeding their defined scope or not meeting their defined standards, and deviations from established regulatory norms in any operating procedures. 

Historically, regulatory intent has been clear, with the RBI emphasising the importance of compliance and governance across the financial sector space it regulates. 

However, the pace of supervisory actions has often lagged behind, across all Indian financial sectors, across all financial regulators, resulting in delays in addressing non-compliance issues. The recent flurry of RBI actions signals that supervisory speed is finally catching up with regulatory intent. 

Economic Growth And Supervisory Actions

As the Indian economy continues to grow, it becomes imperative for the financial system to uphold the integrity and quality of financial actions, entities, and behaviour. With economic expansion come bigger socio-economic stakes, necessitating a robust regulatory framework to maintain stability and trust within the financial sector. 

Therefore, it is anticipated that financial regulators, beginning with the RBI, and subsequently followed by stock market regulator SEBI, will intensify their supervisory actions against regulated entities. Additionally, one hopes that the Insurance Regulatory Authority of India (IRDAI) will also bolster its supervisory capabilities and expedite regulatory actions to align with the evolving needs of the financial landscape.

Media reports indicate that the RBI has expressed concerns regarding JM Financial Products Limited (JMFPL) due to substantial irregularities, including breaches in Know Your Customer (KYC) norms and anti-money laundering (AML)  rules, as well as improper sharing and utilisation of customer data across affiliated entities.

Additionally, anonymous sources cited in these reports reveal significant deviations in the company's loan sanctioning process uncovered during regulatory reviews. These deviations include violations of KYC and AML guidelines, discrepancies in the loan sanction process, and unauthorised sharing of customer data across group entities.

This is where one has to exercise caution to be fair to comment on these. The regulators do not put out details of their supervisory findings in public domain, except the key highlights. But then one has to be a discerning student of regulatory communication to read the ‘tone’ and ‘severity’ of their comments.

Two Entities In Spotlight

On March 4, the RBI imposed an embargo on IIFL Finance's gold loan business, followed by a similar action on JM Financial Products' loan against shares & IPO financing business the next day. These measures were taken citing persistent regulatory non-compliance and governance issues identified by the authorities.

If these issues are indeed similar to the concerns raised about Paytm in the past, it suggests a level of higher severity comparable to previous regulatory actions. However, it's worth noting that the RBI had previously flagged and penalised Paytm before taking its supervisory stance of stopping Paytm payments bank from onboarding any new customer.

Contrary to false narratives propagated by certain segments, the RBI is not anti-fintechs. In a Regulated sector, the RBI's actions demonstrate its proactive approach towards regulating payment and lending technologies, for establishing consumer safeguards and to steer good behaviour of its entities.

But then, the Indian domestic debt markets still exhibit structural flaws, leading to a regulatory-moat that banks enjoy as business model edge, for now. The intensive scrutiny and consecutive penal actions by the RBI against NBFCs, amongst other banking entities is finally indicative of its supervisory focus.

Of course market speculation is fuelled by RBI officials’ speeches about their watching the unsecured lending space. It is indicative that the RBI has intervened to forestall a potential asset quality crisis in the banking sector, particularly within segments dealing with unsecured loan portfolios.

To those bemoaning the RBI's strict enforcement, consider this: they administer penalties that are both less severe and less frequent compared to global financial regulators.

Taking a closer look at the actions against JM Financial, the RBI has pinpointed three significant regulatory breaches. These include deficient underwriting standards, the company's dual role as lender and borrower, and governance lapses.

According to the regulator, JM Financial repeatedly facilitated a group of customers in bidding for various IPO and non-convertible debentures using loaned funds, with lax credit underwriting and financing against slim margins. Furthermore, JM Financial operated the subscription applications, demat accounts, and bank accounts of these customers through a Power of Attorney (POA) and a Master Agreement, effectively assuming both lender and borrower roles.

In the case of IIFL Finance, the violation concerns the quality of the credit process. The RBI's inspection revealed significant deviations in assessing and certifying the purity and net weight of gold during loan sanctioning and auctioning upon default, alongside breaches in loan-to-value ratio standards.

However, a lingering uncertainty arises: Were these process gaps present solely within the entity this year, or did the RBI only uncover them during the latest inspection? If the latter is true, and assuming these processes existed earlier, it indicates a need for enhanced regulatory capabilities and supervisory rigour.

Will SEBI Step In?

The only hope now is that these entities don't form new ‘advisory boards’ in an attempt to "upgrade" their processes or governance. That is the task left to their boards. But then, this is where JM's issues appear to be more severe than those of IIFL. The RBI has explicitly mentioned "governance" issues in JM’s case.

While some experts view RBI’s recent actions as a messaging strategy, only to NBFCs, that may amount to underestimating the regulator. This communication could be interpreted alongside a SEBI investigation into issues concerning loans against shares and IPO financing, especially targeting High Net Worth Individuals (HNIs). It's widely known in the market that wealth managers and bank counters have been charging their clients for arranging such financing, thereby earning substantial fees for their services.

In the context of media reports suggesting that the SEBI is investigating potential malpractices in primary market activities related to IPO subscription numbers, including the possibility of JM Financial coming under scrutiny once more, this alignment becomes even more apparent. Notably, in January this year, SEBI Chairperson Madhabi Puri Buch had expressed concerns about specific merchant bankers involved in IPOs engaging in wrongdoings.

If this scenario holds true, it will be intriguing to observe how the RBI and SEBI coordinate a tougher regulatory stance and actions against errant entities that have operations spanning both these regulatory systems. The possibility of joint action between these regulatory bodies would signal a broader message about the seriousness of Indian financial regulators regarding consumer protection and their stance against any shades of regulatory ambiguity.

If the IPO subscription numbers are factually incorrect, supervisory action of SEBI has to address the market manipulation and loss of investor faith in corporate disclosures. This should ideally entail severe monetary penalties, and if the regulator acts tough to send a message, could it cancel such an investment bankers’ licence to operate ? 

But then the larger challenge for SEBI is that many a times its action are overturned and set aside by its appellate tribunal -- SAT. The true test of a SEBI’s supervisory action against a regulated entity is if it can hold its stand. 

Furthermore, Indian regulators should refrain from administering light-touch penalties. A comparison with their counterparts in the US and the UK reveals that penalties imposed by Indian regulators are significantly lower in magnitude.

Without instilling a sense of fear or shame, financial penalties lose their efficacy as deterrents. Therefore, imposing penalties that carry substantial financial consequences is a must, to uphold regulatory integrity.

This presents a golden opportunity for financial regulators to scrutinise and reassess the suitability of the existing promoters of their regulated entities. This proactive approach would ensure that financial institutions operate responsibly and understand that their licenses are not indefinite or infinite privileges.

(The author is a Mumbai-based policy researcher and corporate advisor. He is also the Editor and co-author of ‘Time for Bharat’, a book on public governance. Views expressed are personal)