There is a famous saying: you count hours and days, while the years just fly by. This looks certainly true of changes in the road rules around banking, insurance and mutual fund products in the year gone by in the world’s second fastest growing economy. It takes a sweeping look at the past 12 months to realize the magnitude of what just happened, whereas tracking each change as it happened was just one more story to be reported on. Now that the dust-up between regulators is over, at least for the time being, it’s a good time to take stock of the changes and what they mean for our money lives.
The year saw two major changes in banking as the regulator, the Reserve Bank of India (RBI), made significant changes to make our savings earn more and loans cost less. From 1 April, a new formula that calculates interest on money in the savings account has come into effect.
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The earlier formula was built like a game: if the money in the savings deposit went to zero at any point in the 20 days counted for calculating the interest, you got zero interest, even though you may have had lakhs in the account on all other days. The savings account now earns 3.5% a year on the average balance in the account calculated on a monthly basis. There are talks to free this inflation-negative interest, but possibly that will take another five years to actually carry out.
The second change looked at a fairer benchmark for bank loans. The earlier benchmark prime lending rate (PLR) system, that allowed each bank to own and control its PLR in an unknown manner, has changed from 1 July to a base rate system where the rate depends on a formula known to all, up on the RBI site and open to discussion.
In the earlier regime, not only did banks have different PLRs for different groups of investors, they had different PLRs for the same loan at different points in time. It was again built like a game: you paid more when rates went up, but did not pay less when interest rates fell. Of course, the fine print says that all those already on BPLR loans will have to talk to their banks to move them to the new system. Yes. Right.
Possibly the boldest step happened in August 2009, when capital market regulator Securities and Exchange Board of India cracked the agent-principal problem by taking away loads, or the distribution costs, embedded in the price of a mutual fund.
Investors already pay stockbrokers a transaction charge for buying and selling stocks and a higher fee for stock market related advice and services. The same model has been applied to mutual funds. Simple transactions will be charged lower, and as you go up the advisory and service ladder, you pay more, but the cost is not part of the price you pay, but is marked out separately. Since the cost has been divorced from the price of the product, you know what you are being charged, and if you dislike it, you can take your business elsewhere.
The third set of changes were carried out by India’s Insurance Regulatory and Development Authority, which went into overdrive and made regulatory changes almost every month. Pushed largely by a wave of negative public opinion and governmental nudges, the changes are mostly to change an archaic set of terribly flawed rules working against consumer interest. The big change has been around surrender charges, allocation of costs across the life of the product and cost caps such that a product will no longer be a trap and the pay-off for hit-and-run will significantly reduce.
A common thread across all these changes is transparency. While the changes are welcome and long overdue, it is a dangerous place to stop. Transparency by itself is not enough reform in the retail financial sector. We’re at the stage where the muck is out of the water, but the water is not yet potable.
Regulating financial transactions of a country of a billion plus people spread across a subcontinent needs a two-pronged approach. First, improve transparency of the products to stop the gross instances of cheating the customer. The rules have to be such that the inherent advantage of the manufacturer and seller is reduced. Transparency means improving product structure, making costs simple and comparable and constructing benchmarks that are fair. These will allow consumers to attempt some sort of basic comparison.
Secondly, put in place common rules for sellers of retail financial products. The transparency clean-up till now has been in regulatory silos though the direction finally seems to be towards the most stringent regulation. The regulation for sellers of financial products must view the world from the consumer’s point of view.
The consumer uses financial products to solve his financial problems and is unconcerned about who the manufacturer is and who the regulator may be. What the consumer wants is a good financial outcome; while he takes on market risk in products that he clearly knows are market-linked.
That work must begin now.
Monika Halan works in the area of financial literacy and financial intermediation policy and is a certified financial planner. She is editor, Mint Money.