Friday 30 September 2011

BANKS AND ‘COLLATERAL’ DAMAGES TO ENTRE-PRENEURSHIP IN INDIA

Ask any entrepreneur what was the biggest hurdle that they had to face in the process of making their dream venture a reality – and more often than not, you will hear: getting the project financed. This is more so, when the entrepreneur has no assets to offer as collateral to obtain funding. The practice of collateral based funding, widely used by Indian banks, has been a great deterrent for entrepreneurs in this country. Owing to family-owned business structures and underdeveloped capital markets (lack of any primary market platform to support MSMEs like AIM, the London Stock Exchange’s international market for smaller growing companies), banking finance has been a preferred choice for Indian entrepreneurs not only as seed capital, but also as growth capital. But stringent collateral requirements including personal guarantees and short lending periods, have always restricted entrepreneurs either from obtaining the desired amount of capital or, at times, from getting any capital whatsoever.

No doubt, some wise men in the country’s banking system attempted to experiment in the late 1960s to move away from the “security based lending” practices to “purpose based lending”. The purpose underneath, as described by K. C. Chakraborty, Deputy Governor, RBI recently, was that credit and finance were instruments of empowerment. By unfettering credit from security, those who were able and willing, creative and talented would not be constrained by lack of funds. The security for the funds lent would not be physical assets but the discounted value of cash flows that the enterprise would generate. This marked a decisive shift in methods of lending – it reoriented lending from a static to a dynamic concept. But the real problem came thereafter. The experiment was a success, but it was never pursued the way it should have been. There is also the biggest fear that the massive corruption and rampant criminality existing within the financial industry’s rank and file would ensure that loans are blindly handed out to ‘purposes’ that are either fraudulent or impractical at the best. Still, till a way is found, entrepreneurs with great ideas but with no money or collateral, will keep suffering.

But this is not to say that there is no way. Some sparkling exceptions are already taking place. Take for example the case of SMEs. This is one segment which accounts for close to 40% of the country’s manufacturing output and over 33% of the exports. And most importantly, this is where most entrepreneurs first step into. The segment suffered for long in the hands of the banks to obtain funds, and finally the RBI came to their rescue in 2008 when it passed guidelines that asked banks not to insist on collateral security from SMEs for advances up to Rs.500,000, but only take into account the viability of their projects. However, as Usha Thorat, Deputy Governor, RBI in 2008, pointed out in a seminar, that despite banks not being supposed to ask for collateral security in SME requests, a few banks are still insisting on the same. Moreover, banks which did not ask for immovable collateral securities, required even tougher guarantee norms to be fulfilled, charged higher rates of interest and even the loan period was shortened. All this defeats the very purpose of equitable growth, where it has been proven way and beyond that a nation can spread economic gains equitably only when it promotes the SME sector – which results in massive increase in employment rates. 65% of Europe’s GDP comes from SMEs; 45% of US GDP too comes from SMEs.

Entry of an increased number of private equity players, both domestic and foreign, over the past decade has helped entrepreneurs to obtain finance on the basis of the merit of their projects. But a lack of a platform to facilitate the same and insufficient awareness is still playing spoilsport. And bank financing still remains to be the major source of funding.

To achieve and continue with a dream double-digit growth, India today needs a lot more entrepreneurs who can add to the GDP by creating employment. But for that, their basic necessity of finance must be taken care of in a good manner. And considering that India will still take some time before entrepreneurs look forward to PE players and not banks for getting their projects financed, it’s high time that RBI comes forward to facilitate the process, not just by bringing out some radical guidelines, but also by ensuring that the banks follow them religiously.

Friday 2 September 2011

THE MYTH ABOUT THE BIG FOUR AUDIT FIRMS IN INDIA

While the existing Indian Companies Act needs an overhauling on many accounts, one big area of concern is its provisions related to auditors of the companies. While auditors should be used more efficiently and diligently to put a check on the companies, due to the lack of adequate legal barriers, especially on the penalty and punishment front, over the past few years auditors have constantly failed to act as the real whistle blowers.

Going by market share, the Big Four global audit firms – Ernst & Young (E&Y), PricewaterhouseCoopers, KPMG and Deloitte – have grown tremendously in India in recent times. Reason, India Inc. feels that their association with one of the Big Four will provide them a clear image in front of the investors. So much so that many a time I have noticed companies changing their auditor and getting one of the Big Four on the board right before public issues. But the question remains, does hiring these ‘foreign branded’ firms actually help in image building? More importantly, do they really bring out all facts better than the Indian audit firms, or is this a utopian urban legend? Well, going by their track record globally, raised eyebrows are obvious; more so after their startling admissions in front of the House of Lords economic affairs committee in November last year. The irresponsibility was spot on when one of the Big Four clarified that they assumed it to be perfectly alright to portray a better picture in front of investors about their banking clients’ solvency after the government entered into discussions on possibility of a bailout. If that was not enough, a report by COSO (the US body that revolutionised the understanding of corporate reporting) points out that 79% of companies found to be engaged in frauds were being audited by the Big Four between 1998-2007. The same COSO report also indicates that 26% of the companies engaged in fraud had changed auditors during the period, as compared to just 12% of those who were not into fraud.

Cut to the Indian scenario, they have not fared anything extraordinary to keep their image better. While PwC was nearly banned for its lapses in the case of Satyam (had the PwC ban happened, it would have been the third for PwC after being banned in Russia and Japan; it’s the third mess up for the firm after DSQ Software and Global Trust Bank), very few had actually noticed that the biggest of Big Four in India, E&Y, was the auditor of Ramalinga Raju’s family firms, Maytas Properties and Maytas Infrastructure. Not that mere association with a questionable company should throw an audit firm in poor light. But if the questionable company’s financial skullduggery could have been caught much earlier by the audit firm – and it visibly chose not to – that is what is pulling the image of these firms down. For that matter, there have been instances in both global and domestic arenas, which vouch for the fact that hiring the Big Four firms does not necessarily work in favour of the regulatory bodies. In fact, in the post SOX era, while CFOs are forcing audit firms to do more for less fees, audit firms – and not just the Big Four – are focussing more on their consulting businesses rather than concentrating on diligent audit work.

However, the most surprising fact about their operations in India is that two of the Big Four (E&Y and KPMG) are not even registered with the Institute of Chartered Accountants of India. This simply means, technically they are not eligible to conduct audit of Indian companies. But still, they are here and operate through tie-ups with Indian firms. While E&Y has a tie up with S. R. Batliboi & Associates for audit works, KPMG has tied up with Bharat S. Routh & Associates to manage the show. For that matter, how many have enquired about the connection between PricewaterhouseCoopers and Coopers & Lybrand Pvt Ltd? I ask, is one company marketing its services but the cheques being cut in the other company’s name to avoid scrutiny? The fault does not lie primarily with these firms, but with the government or even, I should say, with ICAI. If the ICAI or the government plans to ensure that Andersen-like Enron cases are not encouraged, then the first step would be to ensure that audit firms do not indulge into consulting and other paid research based activities, whether directly or indirectly. And that there is no overlap of marketing functions and project functions – where a foreign name is peddled to get the audit contract and the cheque is cut in the name of the local partner by the client. For whatever it’s worth, at least a consulting firm like McKinsey & Co. sticks to what it claims and does not concurrently take up auditing activities.

Thus, before the Big Four take things for granted in India, apart from stricter norms for auditors in the newCompanies Bill, regulators must also see to the fact that the audit firms must be registered in India (and not operate by tie ups with Indian audit firms) at the very first instance, abided by Indian rules and not take up additional work. Till that time, they must be forced to disclose their various business arrangements through public notices. If the Big Four are here, they should act like watchdogs, not just voluntary puppets in the hands of the companies.