A major weak link in financial regulation in India is the lack of emphasis on consumer protection. An academic literature on this subject has been building up. The policy discourse has also shifted considerably, and the contours of the policy research and action program are now visible.
For many years, regulators were in denial about these problems. This has started changing. A committee formed by the insurance regulator on the sale of insurance products through banks has also admitted to mis-selling through banks (IRDA, 2011). More recently a circular on August 1, 2016 by IRDA (IRDAI, 2016) has warned banks and corporate agents to stop mis-selling life insurance policies.
The key questions for the research community are about obtaining objective evidence about the problems in the field of households and finance, which can then feed into the work program on financial sector policy. A key missing link in this is an understanding of how sales actually take place.
In a financial product, a critical aspect of the sale is the disclosure made at the time of sale since the product is invisible and the moment of truth of the product can be far into the future. Regulators might require sales staff to disclose product features, but have little control over whether they are actually disclosed, and importantly, disclosed truthfully. There is weak evidence about whether agents intentionally or otherwise make mistakes in the disclosures. This can have large consequences, especially in environments such as India, where financial literacy is low, and regulatory enforcement is weak.
Financial products are sold through many channels in India. Understanding the sale of financial products through the banking channel is important for three reasons:
- There has been a rise in third-party distribution through the banking channel. In 2014-15, of the top ten mutual fund distributors on the basis of commissions earned, six were banks (Barbora and Viswanathan, 2016). In the case of insurance as well, banks had the largest share of new business premium for private insurance companies, though the state owned insurer continues to be agency dependent for sales. For example, banks became the largest sales channel for private sector life insurance companies by financial year 2015. The share of first year premium from banks rose from 33.21% in 2010-11 to 47.37% in 2014-15 for the private sector insurance companies. Commissions from sale of third-party products contribute substantially to bank profitability (Balaji and Bhaskaran, 2015).
- A 2013 Gallup Poll showed that 70% of the Indians polled said they trusted banks. The answer was 13% for Greece, 27% for the UK and 37% for the USA. Depositors' trust in the basic banking function is being carried over when buying third party products through banks such as mutual funds and insurance.
- Recent financial inclusion efforts in India, such as the Jan Dhan Yojana, or the Suraksha Bima Yojana and the Jeeven Jyoti Bima Yojana are being made through the banking channel. Instead of improving access to finance, a bank led sales strategy, if it consists of mis-selling, may result in driving customers further away from it.
A new audit study
In Halan and Sane (2016), we conducted 400 audits of the sales process of retail financial products in banks in Delhi, India. This is done by sending auditors into bank branches where they claim to be walk-in customers. Neither the auditors, nor the bank managers knew the true motivation behind the study, or the choice of questions.
We investigate what financial products are being recommended by bank managers to walk-in customers. We also study the kinds and veracity of disclosures made in the process of sale. Specifically we ask:
- What products do bank based managers recommend? How does this vary when the auditor makes a specific request vs. when the auditor appears uncertain? Are auditors who make specific requests, and are more certain of their requirements able to purchase the product of their choice?
- What product features get disclosed? Do the more salient attributes of a product, such as returns, get disclosed more frequently, while complex product features such as costs, or charges on early exit get shrouded?
- Are these disclosures accurate?
- What might the drivers of product recommendations be? When remuneration is tied to sales-linked bonuses, are the most expensive products sold?
We vary our audits to include informed and uninformed customers with different amounts to invest. An informed customer in the research design requests for the Equity Linked Saving Scheme (ELSS), which is an open-ended diversified equity mutual fund with a three year lock-in. In other cases, the customer (the auditor) acts uninformed, and displays a vague sense of wanting some tax-saving product, but does not know which one. We also vary the amount available for investment. In some cases the request is for investing Rs.25,000 in either the ELSS or a tax-saving product. In other cases the amount to be invested is Rs.100,000.
In an ideal world what would we see? In the ideal world, bank managers will sell the product requested by the customer (in the case of the ELSS) either because it is a sound investment or because they are merely acting as distributors of the product and not as financial advisors. When the customer does not have a view on the product, the bank managers should make an effort to sell the more suitable product, or at the very least show all possible products so that the customer can make an informed choice. If, on the other hand, bank based advisors are not working in the interest of the customer, they will try to steer both types of customers towards the product of their choice.
Bank managers should provide correct and complete information about a product to the customer, especially because SEBI, IRDAI and RBI have regulations that require such disclosures. We, therefore, also study the kind of product features that get disclosed in the process of sale, and the veracity of these disclosures. Our focus is on the following aspects: a) Returns, b) Guarantees, c) Costs, d) Lock-in period and e) Optimal holding period.
A criticism against the ELSS as the choice of the ``sophisticated'' investor is that it is a market linked product, and it is likely that for many investors a guaranteed product such as a fixed deposit or an insurance plan is more appropriate. While there is merit in this argument, our evaluation of product recommendations does not really rely on the ELSS being the optimal product. If bank managers feel that the ELSS is not the most suitable product, then we should see this in the conversations they have with the auditors, as well as the recommendations they finally make. The focus of the experiment is not so much about which is the better product, but about the process in which a product is sold.
Our experiment shows the following:
- Bank managers don't really make an effort to understand the client. Managers in public sector banks are less proactive in understanding the client and exert less effort.
- Overall, fixed deposits were the most recommended product (51% of the cases), followed by insurance (35%) and mutual funds (8%). When auditors did not have a specific product request and asked for any tax-saving product, mutual funds were recommended 2% of the time, while fixed deposits and insurance were recommended 53% and 36% of the time respectively.
- In private sector banks, where internal incentives are around commission income, the high commission product (i.e. insurance) is recommended most of the time (almost 75%). In public sector banks, where there are deposit mobilisation targets, fixed deposits are recommended (almost 72%).
- Of those who requested an ELSS product, only 14% were encouraged to buy it. 30% were actively discouraged, and 55% were presented with a neutral response. However, in 71% of the cases where the bank manager was neutral to the ELSS product in the beginning, our auditors later noted that the manager steered the conversation to other products, resulting in a product recommendation different from the ELSS.
- This seems to be because in several cases the bank managers themselves do not know what an ELSS is.
- Managers seem to be overly concerned about our auditors having to deal with risk in their portfolio in the context of the ELSS. However, a large proportion of the recommendations were ULIPs, which are also market linked or towards participating insurance plans, that too are partially market-linked.
- Voluntary disclosures concentrated around returns and guarantees. Customers were never made aware of the costs of the product, if they did not ask a question about costs.
- A large proportion of the disclosures were incorrect, when tested against actual information in product brochures or actual past returns.
- This suggests a market with two extremes. The private sector prescribes the most expensive products, while the public sector prescribes the least effort default product. In either case, unbiased financial advice in the interest of the customer seems to be missing. This is reminiscent of the situation of health care in India - where the private sector makes more of an effort and prescribes more drugs (often to the detriment of the patient), while the public sector does less of both (Das and Hammer, 2007).
We find that in private sector banks, where staff have high sales incentives, the high commission product is recommended. In public sector banks, where there are deposit mobilisation targets, fixed deposits are recommended. We also find that the more complex features of a product, such as costs and optimal holding period, are very rarely voluntarily disclosed. When specifically requested, information provided is inaccurate or incomplete.
It is possible that bank managers themselves do not know the product features to be able to disclose them correctly, or that they perceive that customers are impatient and do not want to listen. However, if regulations require managers to make disclosures, then their own ignorance, or inability to engage with an impatient customer require regulatory attention.
Our results point to the difficulties in the use of disclosures for achieving better consumer outcomes. Even if disclosures are made mandatory on product brochures, it is unlikely that they get conveyed to the customer in the correct manner. Regulators have taken the view that since the customer has signed on the documents, the customer is responsible for the purchase. The problem is made worse due to the lack of fixing responsibility on the sales channel for mis-sold products. Unless there is a mechanism of enforcement, a disclosure policy is unlikely to help achieve better outcomes.
Households are not being treated well by Indian finance. Much more needs to be done by way of the academic research agenda and the policy research agenda.
Balaji, Kavya and Deepti Bhaskaran (2015). Why banks resort to misselling. Mint, 22 December 2015.
Barbora, Lisa Pallavi and Viviana Vishwanathan (2016). Tough to separate sales from advisory. Mint, 28 April 2016.
Das, Jishnu and Jeffrey Hammer (2007). Money for nothing: The dire straits of medical practice in Delhi, India. Journal of Development Economics 83, pp. 1-36.
Halan, Monika and Renuka Sane (2016). Misled and mis-sold: Financial misbehaviour in retail banks? NSE-IFF Working paper.
IRDA (2011). Report of the Committee on Bancassurance. Committee Report. Insurance Regulatory and Development Authority
IRDAI (2016). Complaints of Misselling /Unfair Business Practices by Banks/NBFCs, Ref:IRDA/CAGTS/CIR/MSL/152/08/2016
Monika Halan is a consulting editor, Mint, and a consultant at NIPFP. Renuka Sane is a researcher at the Indian Statistical Institute, Delhi. We thank the NSE-IFF initiative on household finance for funding.