In mid-2009, a little over a year since we had started Pudhuaaru Kshetriya Gramin Financial Services (Pudhuaaru KGFS), a rural financial institution in Thanjavur district of Tamil Nadu, we were confronted with a situation that re-defined our approach to financial services delivery. A customer of ours had died in a road accident on her way to the paddy field where she worked as a daily wage labourer. It turned out that she was the sole breadwinner for a family of five, including two young children. A few months previously, she had borrowed about Rs.50,000 from us against gold as collateral for some household expenses. While the Pudhuaaru KGFS branch had spoken to her about availing term life and personal accident insurance, neither she nor they followed up rigorously on this. The family, therefore, lost not only the future earnings of the breadwinner but also a significant asset that got accumulated through past savings. They were very likely about to experience severe financial distress.
We reflected at length on our role and accountability in this entire case. Were we wrong in providing her a loan for household expenses? That did not seem the case because if she had a genuine need and she had the ability to pay, the loan was an important service to smooth consumption. Moreover, if we had refused the loan, she would have taken it from an informal provider at a higher cost. Should we have automatically bundled an insurance policy with every loan? Again, this was not obvious because there would be several borrowers in different circumstances who would not need insurance and the bundling would have created potential for mis-sell. The real failure seemed to be that despite knowing the unique vulnerability of this household, we went ahead and provided the loan without ensuring that this particular customer had adequate insurance—either pre-existing or purchased from us or through another institution. In doing so, we exacerbated the risk of this household.
Our internal investigation concluded that we were guilty of having made an unsuitable sale to this household and that we should compensate the family accordingly.
This whole experience made us realize the extreme importance of developing scalable processes that would ensure that such an incident does not happen again. Our branch process was re-designed to have three components. An enrolment component where there would be comprehensive information captured about the customer and her household, including details such as age and occupation of family members, household balance sheet, including all assets (physical and financial) and liabilities (formal and informal), household income and expenditure statement and goals for the household, including retirement. While this information would never be perfect, it would provide a starting point to establish the nature of the customer we were dealing with. The second component was generating a financial well-being report for each customer. This report is the result of running a set of rules on the information captured during enrolment to arrive at a set of specific actionables. The report is organized into four sections: plan, grow, protect and diversify. This would contain specific recommendations on how much should the customer save? Can she borrow? If so, how much? Should she or other members of the household buy insurance? If so, how much? Is the household asset allocation adequately diversified? If not, how much should she invest and in what assets? Importantly, this report is not designed for the customer per se. The user of the report is our employee, the wealth manager, who is a trained individual with a high school education. The wealth manager is required to follow the guidance of the financial well-being report and to sell products accordingly. Any sale that is contrary to the recommendations, such as sale of life insurance when it is not recommended or sanctioning a loan amount that is higher than the debt service capability would have to be justified by the wealth manager. This then feeds into the audit process.
Suitability is not a new idea. In India, it has been applied to the sale of derivatives by banks to corporate customers. In Australia, it has widespread application, including in retail financial services. The recent Financial Sector Legislative Reforms Committee recommended that the customer’s right to suitable advice be enshrined as a right. World over, providers resist this notion of suitability and have been more comfortable with vague commitments to disclose and educate customers. There is a concern that a suitability regime will create opportunistic customers who will be quick to lay the blame on the provider during tough times. This is where it is important to reinforce that suitability lies in not guaranteeing outcomes to customers but in laying down a selling process that takes into account the circumstances of the customer and the likely interactions between that and the nature of the product being sold. What gets audited is the process adherence. The most important shift that suitability brings about is from “buyer beware” to “seller make sure”. If it can be done in remote rural India, it can definitely be done in more high-resource settings.
Bindu Ananth is president, IFMR Trust.