Crowd funding: Why its dangers outweigh the potential benefits in India

The Reserve Bank of India (RBI) seems to be more convinced about the need for P2P (peer to peer) crowd sourcing borrowings model unlike market regulator, Sebi, which seems to have reservations about the model. At least, that’s the impression one gets going by the clarity with which, the RBI, has spoken on the issue in its recent discussion paper.

The 2014 Sebi discussion paper on crowd sourcing of equity discusses the pros and cons of the model, between the need for an additional source of finance and the possible misuse of this platform by money launderers.

Image courtesy: Ibnlive

Image courtesy: News 18

The Sebi’s reservations on the equity part of crowd funding is understandable. The country, has before it, the examples of two yoga guru Baba Ramdev and spiritual leader, Sri Sri Ravishanker. As Somasekar Sundaresan puts it in this Business Standard edit piece  these Gurus first won the mind share of their followers before winning market share.

Indeed if you win the confidence of your followers, the rest-including the crowd sourcing of your fund requirements—becomes easy. But the catch lies precisely here. Are the beholden if not benighted followers aware whether the financial contributions made by them to Patanjali and Sri Sri Ayurved are debts or equity?

The Sebi paper highlights a problem in this regard---there is a limit of 200 subscribers to private placements. One wonders if the two ayurved chains would breach this limit in case what they have sourced is equity. The point is while angel investors, private equity and venture finance are all well regulated, crowd sourcing remains in the realm of the unknown as far as India is concerned.

There is an additional danger in this Indian context----the trust and confidence commanded by spiritual leaders can be misused by others. For example, there is an apprehension that the Sumeru group controlled by Sri Sri Ravishanker’s nephew is making the maximum by riding piggyback on the guru’s popularity by just about supplying everything ranging from products to software for Sri Sri Ayurved in what could be viewed as a case of conflict of interest.

The market share seems to be a good idea but it could also amount to browbeating the followers into financing willy-nilly. And apart from this, the danger of money laundering also lurks given the fact that a shark may become a part of the crowd and escape scrutiny. This danger is there for both debt (RBI) and equity (SEBI) forms of crowd.

The P2P model contemplated by the RBI sets store by the marketplace template, the one the Industries and Commerce Ministry endorsed a month ago for e-commerce. Portals bringing lenders and borrowers together are currently estimated to be between 20 and 30. RBI wants these and other wannbe facilitators to have a minimum net worth of Rs 2 crore besides meeting the ‘fit and proper’ person criteria.

Since the facilitators are not permitting to accept deposits and lend but only act as online brokers for fees, they have been spared of the burden of provisioning, capital adequacy etc, and rightly so. Yet, warning bells are sounding which can be ignored only at our own peril. Ezubao, a Chinese portal became insolvent running what turned out to be a Ponzi scheme in an unregulated environment.

The point is crowd sourcing is not what the doctor has ordered for a financial system that is entirely mainstream but considerably interwoven with black money seeking laundering. Both the RBI (lending) and the SEBI (equity in the anvil) will have to contend with this danger.

While China and South Korea might pay a price for turning a blind eye, Israel and Japan have sternly put their foot down to crowd funding (mis)adventure. Probably, the interest of the lenders weighed with these two countries more. In India, apart from the money laundering concerns, the other concern is will our online lenders who simply have to go by the intermediary role of the facilitator’s portal in terms of appraisal of the borrower, his credit worthiness and collection be hurt?

The RBI must join the SEBI in putting off crowd funding till India is ready for the model. The RBI seems to feel the country is ready and in fact badly needs a P2P lending model because the banking, NBFC and microfinance sectors all put together are unable to meet the gargantuan (in aggregate) financial requirements of the SME sector. In other words, according to it, there is a void which P2P online aggregators can fulfill. But it seems to have ignored the two concerns highlighted in this article.

Meanwhile those who have mobilized equity through crowd sourcing must be asked to keep the funds as unsecured loans unless they are donations. Private placement norms must be strictly asked to be adhered to; else money returned.

Updated Date: May 02, 2016 17:47 PM

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