Who’s to blame if the toaster you bought last week explodes, even as you try to crisp that square of baked flour? Did you, as the customer, make a wrong choice buying a top branded product, or is the producer of the toaster to blame?
Elizabeth Warren, Harvard professor and chair of the Congressional Oversight Panel, the commission overseeing the disbursement of bailout funds, asked the same question of a financial product—Why is it possible to “refinance a home with a mortgage that has the same one-in-five chance of putting your family out on the street..., and the mortgage won’t even carry a disclosure of that fact”?
The answer to this question has got the US a brand new regulator—the Financial Products Safety Commission— with the mandate to do what the Consumer Product Safety Commission does for physical retail goods: prevent the manufacture and sale of harmful financial products. The commission will initially work in the two areas that have proved to be disastrous for the financial health of consumers in the US—home mortgages and credit cards.
Also Read Monika Halan’s earlier columns
The onus to manufacture explode-free financial products will now be on the financial sector and not the consumer, who does not have the ability to read through 33 pages of legalese to figure out what the product really means and whether or not it has the potential to explode.
A financial product is invisible. Its impact will only be discovered sometime in the future. The long-term nature of most investment-linked financial products makes this lack of visibility, at the point of sale, potentially harmful for the customer. This makes the point of sale extremely important to the entire product chain. It is this interface with the customer that can convert a non-exploding product into one that does.
Suppose there is a wholesale factory that makes Indian sweets. It comes under the law of the land that prevents it from producing unhygienic products or those that use harmful substances. Now sugar, for a mithaiwala, is not a harmful substance and is used to prepare, let’s say, a batch of sandesh (if you don’t know what this is, get a life). This is bought in bulk by a retail chain of sweetmeats. A diabetic person visits one of these shops and asks for sugar-free sandesh. Our retailer has just run out of the stock of this kind of sandesh, but still wanting to make a sale, he sells the sugared sandesh as sugar-free. The diabetic patient finds out in the worst possible way and incurs severe health problems. Who is at fault—the product manufacturer, the regulator of the product manufacturer, the customer, or the retail seller of sugared products?
Yes, the retail point of sale “mis-sold” a product.
Now transpose the argument in the financial products industry and you get exactly the same results. The product manufacturers are the insurance companies, the mutual funds, the banks (credit cards, home loans, personal loans, debit cards) and, now, pension products. Each has its own regulator that looks closely and approves of products that can be sold.
While there is plenty of scope for improving the outcome of these regulators in terms of benchmarks, disclosure, service and costs, there is no product that is inherently unsafe. But safety is a function of the situation of the customer, apart from the nature of the product, as we saw in the sandesh example.
A product that may not in itself explode, may still detonate in the portfolio of a person who does not understand the risk, reward and cost implications of the product. Imagine a zero-risk individual who, wanting to taste equity with a tiny part of his portfolio, is sold an equity unit-linked insurance plan that soaks up all his investable surplus or a sector fund that sits at the far end of the risk-return curve. Who is at fault? The company that made the product, the person who bought it or the seller who sold it?
The person at the point of sale has the unfair advantage of having the ability to selectively showcase product features, costs and returns to the advantage of the product he wants to sell (and is there any doubt that he will maximize his economic welfare by pushing the product carrying the heaviest commission?). The need for putting in place a set of checks on the way the distribution industry (agents, banks, distribution houses, financial advisers) in India sells products is obvious.
Without adding a regulatory layer that will add to the cost of the product, there must be a way to tie the advice to the outcome and hold the seller accountable for exploding products that have been declared as safe by the product regulators.
If you have suggestions and views on how this can be done, write in to email@example.com. The work to compile suggestions to make this happen is on.
Monika Halan is a certified financial planner and is currently working as adviser, Pension Fund Regulatory and Development Authority. Your comments and personal finance queries are welcome at firstname.lastname@example.org