In a previous article (Banks are unfair in their role as financial advisors / distributors), we described our audit study on the sale of financial products across 400 bank branches in Delhi, India (Halan and Sane, 2016). In this paper, we found three things:
- Customers are mostly sold insurance products by private sector banks, and fixed deposits by public sector banks, regardless of what they ask for. This suggests that in private sector banks that have high sales incentives, the high commission bearing product is mostly recommended. In public sector banks, where there are deposit mobilisation targets, fixed deposits are mostly recommended. In neither case is there concern about the best interests of the customer.
- Complex features of a product such as cost are rarely voluntarily disclosed. This suggests that when customers don't know what they don't know, it is likely that material information will be shrouded.
- When bank managers do answer questions on product features, most of the information is either incorrect, or incomplete. This suggests that either managers themselves do not know, or do not care, or deliberately mislead customers.
Regulators around the world, including countries such as India, have responded to problems of mis-sales in retail finance by strengthening consumer protection regulations in the form of disclosure standards, ban on commissions and volume based payments, and suitability requirements in the sale of products. Regulators might require sales staff to disclose product features, but as we show, have little control over whether they are actually disclosed, and importantly, disclosed truthfully. How can financial regulation do better?
Solution 1: Refocus financial literacy upon distributors
The qualitative study of the audit reports showed the lack of financial knowledge of the sellers of these products. For instance, public sector bank managers, whose banks have tie ups with asset management and insurance firms, did not know the basics about the products they were selling. Some others were not even familiar with some product names. Most bank officers were not clear about the costs or other complex features. We also noticed that the more complicated the product, the worse were the disclosures reflecting the lack of distributor education by manufacturing firms. The policy debate in India has always emphasised financial literacy of the customer. We think that financial literacy efforts should be made for distributors, and not just consumers.
For an analogy, before an employee of a financial firm gets a password from NSE or BSE for trading derivatives, that employee must pass an examination which establishes a certain foundation of knowledge about derivatives. The institutional mechanism for these examinations was built by NSE before derivatives trading was launched in 2000. Similar work is required by RBI, to ensure employees of banks have a minimum standard of knowledge about finance.
Solution 2: Align incentives
A front-line staff person, when selling the product that is part of his target, is doing what any rational economic agent will do: maximising his own benefit. One way to ensure that the front-line staff do the right thing by the customer is to redesign the incentives of the front-line seller. Regulations must reshape the incentives so as to align the interests of the product manufacturer, the seller and the customer.
Solution 3: Fix Board accountability
Regulators need to understand that the front line staff is simply responding to incentives embedded in the organisation. These incentives are established by the senior management who report into the CEO. The CEO gets her direction from the Board of Directors. Some large life insurance firms have changed the product mix they offer to investors and have invested heavily in technology to prevent large scale mis-selling of their products because of a push by the board of directors who were concerned about reputational damage to the overall business group, owing to mis-selling of life insurance.
Solution 4: Data in the hands of regulators
The insurance industry has come together to set up a data repository to fight fraud. It has hired Experian to create a fraud monitoring network that will identify potential fraud by screening customer applications. The industry fears a rise in fraud, due to the new regulator rules that prevent them from refusing claims after three years of the policy being alive, no matter if the fraud is proved.
There is a need to up our aspirations for knowledge and research on consumer protection by financial agencies. This requires database building. As an example, in the UK, every financial firm submits data about every retail financial product sale, to the regulator (the FCA), every day. This makes it possible for FCA to watch patterns in product sales. The FCA links up this data to an array of 3rd party databases about individuals and neighbourhoods, and has systems which raise an alarm about potential mis-selling. In India, this requires building the Financial Data Management Centre (FDMC), writing regulations that require electronic submission of this data into FDMC by all financial firms, and then creating research capabilities in financial agencies to use this data as the UK FCA does.
Solution 5: Use mystery shopping
Mystery shopping is an accepted regulatory tool to discover market failure in developed markets. For example, the UK regulator the Financial Services Authority (FSA) in 2005 responded to concerns expressed by the media, consumer bodies and other organizations about the sales process of the payment protection insurance (PPI) by commissioning a mystery shopping exercise. A mix of phone calls and face-to-face audits got shoppers to pose as customers looking for a particular financial product. 32 of the 52 shoppers felt that they received 'limited information' about the PPI product.
The results of these exercises helps feed into regulatory action. PPI mis-selling cost banks millions of pounds in return of premium and in compensation. The no-commission structure of the UK retail finance market has partly emerged out of evidence gathered through such exercises. Indian regulators need to use such exercises to prevent tick-box regulatory compliance practiced by financial services firms. Such mystery shopping projects must be done using the resourcing of the State; it should not require researchers like us to fund-raise for and manage these research projects.
Indian policy makers have long bemoaned the fixation of the Indian household with gold. They need to look at the attraction to gold and real estate as a vote of no-confidence on the financial sector because of the recurrent scams in the market and obvious regulatory failure in preventing even regulated firms in cheating households of their savings - as was seen in the ULIP scam (Halan, Sane and Thomas, 2014). A fair market place in retail finance that works for all the three participants - the manufacturer, the distributor and the buyer - will transform the Indian financial market. The savings rates of Indian households are very high, but only with better consumer protection will we get large-scale participation by households in the formal financial system. The policy proposals of this article are aimed at building this trust, while having the dynamism of the market economy. They are part of the larger project of putting consumer protection at the heart of financial regulation.
Halan, Monika, Renuka Sane and Susan Thomas (2014), The case of the missing billions: Estimating losses to customers due to mis-sold life insurance policies, Journal of Economic Policy Reform, October 2014.
Halan, Monika and Renuka Sane (2016). Misled and mis-sold: Financial misbehaviour in retail banks? NSE-IFF Working paper.
Monika Halan is a consulting editor, Mint, and a consultant at NIPFP. Renuka Sane is a researcher at the Indian Statistical Institute, Delhi, and a visiting fellow at IDFC Institute.