Shyamal Banerjee/Mint
Shyamal Banerjee/Mint

Regulators need to be more Captain Kirk than Mr Spock

Personal experiences of regulators will go a long way in them solving the problems of consumers

Over the past one year, I’ve spoken to various groups of people in the policymaking and regulatory space on consumer protection in the financial sector. Some have been the staff of regulators, other groups comprised bureaucrats in departments that engage with the regulators. Last week, it was a large group of banking ombudsmen, bank customer relations officials and banking regulator’s customer-facing staff at the Reserve Bank of India (RBI). My attempt in these conversations is to move from finger pointing and name calling using individual experiences of consumer distress to a larger perspective where we try and solve some core issues.

I make four points in the first part of my hour long talk. One, consumers of financial products need protection more than consumers of a car or bread or even a mobile phone service because financial products are invisible and the moment of truth of the product is in the future. They are created in the mind of the consumer when they are described, either by the product manufacturer or the seller. A pension product’s moment of truth will be 30-40 years in the distance. Two, the regulatory cost of being present in the millions of conversations between the consumer and the seller is infinite. It is not possible for regulators to police each consumer interaction. Three, regulators will have to deal with this issue when India moves from a buyer beware to a seller beware market once the Indian Financial Code becomes law in the not-so-distant future. Four, regulatory time and cost can reduce if the regulators work on two basic issues—get product structures right and align incentives.

Clean product structures in a financial product mean that costs and benefits sit in easily spotted places and are such that they allow for comparison across product categories. For example, while it is easy to compare mutual funds in India due to their clean product structure, the same cannot be said about investment-embedded insurance plans that have several heads under which costs are counted.

Incentives are aligned when the compensation from making and selling the product rises as investors’ financial well-being increases. Typically, a trail commission model that rewards long stay in a corpus-building product (without the market aberration of using the trail as an upfront commission) works for all three parties—producer, seller and consumer—while upfront commissions encourage churn and sharp sales.

The second part of the argument is about getting regulators, policymakers and other consumer-facing people and entities to rethink conventional economics which looked at people as rational economic agents who took utility maximizing decisions. It is this world view of a consumer that has resulted in the financial literacy plus disclosure model of regulatory intervention on consumer protection. If you make enough disclosures and make the consumer financially literate, then she will take the optimal decision. This approach totally misses the real world experience of consumers who are unable to plough through legalese in 100-page disclosure documents and then compare it with other 50 similar products with their own 100-page disclosure documents.

I draw upon the work of behavioural economists such as Richard Thaler, Daniel Kahneman and Dan Ariely to show how we are inherently emotional and irrational about our economic decisions. When is the last time you threw away leftover food right after the meal and did not stick it at the back of the fridge shelf? Then we discuss real examples where using choice architecture has resulted in big behavioural changes for the better in countries. The most famous example is of Belgium having organ donation rates of 98% compared with the Netherlands with 28%, not because of any extra social responsibility in Belgians compared with the Dutch, but because Belgium has an opt out and the Netherlands has an opt in on the organ donation form. Financial sector regulators and policymakers need to move from thinking about ticking boxes to look at compliance to understanding that people are irrational and that emotions drive most money decisions.

One learning from interacting with these groups has been the absence of their own participation in financial markets. They remain fixed deposit, gold and land investors in their personal capacities. Unless they venture out into the world of finance that they make policies about and regulate, as consumers, their efficacy will remain largely on paper. The first wave of financial literacy needs to be within these bodies where staff are encouraged to learn the basics of cash flow management and then asked to buy into financial products like life and medical insurance and mutual funds. Personal experiences of policymakers and regulators will go a long way in them solving the problems of consumer in a much more effective way. In the words of Martin Wheatley, chief executive officer of UK’s Financial Conduct Authority: “Regulators need to be more Captain Kirk than Mr Spock."

Monika Halan works in the area of financial literacy and financial intermediation policy and is a certified financial planner. She is editor, Mint Money, Yale World Fellow 2011 and on the board of FPSB India. She can be reached at expenseaccount@livemint.com

Close