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Does finance benefit society? The answer is: It depends. The answer depends on who is asking the question. Ask the average person in a living room in India and the answer will be a resounding no. Households prefer real assets such as gold and real estate to financial products. They have good reason to distrust finance due to fraud and episodes of institutional cheating of household savings—either through rules that work for the companies or due to financial repression that sees purchasing power melt away because of inflation. Another reason why individuals distrust the financial sector is due to the mismatch between what the priests of high finance do and what they earn. Just for trundling money around and then losing a lot of it for us, why should these guys be paid millions is a question that’s often asked. Of course, it does not prevent the same individual from encouraging his kid to join high finance. After all, the money and the good life is there.

Ask a roomful of finance academics and the answer you get from a bunch of tenured guys with little risk to their financial future is a resounding academic yes. Finance manages risk, gives price signals, curbs agency problems, removes information asymmetries and fosters growth. I’ve removed the citations that give evidence to each of these functions of finance. So you have a clear division in what the society at large believes—that finance is self-serving, and that it provides value. Italian-American academician Luigi Zingales asked the same question in a working paper for the National Bureau of Economic Research in January 2015. (You can read the paper here: http://bit.ly/18x3XUL). For Indians the name Zingales rings a bell because he co-authored the well-known book by the current Reserve Bank of India (RBI) governor Raghuram Rajan titled Saving Capitalism from the Capitalists (http://press.princeton.edu/titles/7822.html) in 2003, well before the financial crisis.

Zingales writes that the “academics’ view of the benefits of finance vastly exceeds societal perceptions". And to dismiss this public opinion as uneducated because “we are the priests of an esoteric religion, only we understand the academic scriptures…" will be a huge mistake because there could be truth in these criticisms. An industry does not pay $139 billion in fines in just two years if there is nothing wrong, writes Zingales. Why should it matter if the public thinks bad thoughts about finance? Zingales says that when people hate finance the only way that firms can operate is through protection from the government. This comes to those who are best able to lobby with the government and buy regulators. And those are the very entities that earn high rents that come from crony capitalism, including writing rules that benefit the lobbyists. Public support is needed for the best form of finance—the competitive, democratic and inclusive finance that works on rule of law and not a relationship-based model.

How to break out of this relationship-based model of finance that is prevalent across most of the world and give finance a good name? Laissez faire or a total hands-off approach, says Zingales, will lead to a jungle and not a well-functioning market (market fundamentalists and libertarians, please note). How to intervene, then, becomes the key question to ask. Indian regulators will benefit from the answer, which is: in designing rules we “need to think about how these rules will be adapted and enforced under heavy lobbying pressure", writes Zingales. He recommends rules that modify incentives ex-ante rather than repress behaviour ex-post. In the Indian context, this will mean removing the incentives to mis-sell financial products rather than trying to oversee millions of transactions across a billion people.

How do you do that? This is now not Zingales but me: first, remove opacity from product structures. Example: the traditional life insurance plan does not show the split between costs and benefits, nor does it show returns as an average annual number. It shows returns as a function of a third number in a deliberate way to obfuscate and overstate benefits. Second, align incentives so that producers and sellers benefit when investors do well. Moving from an embedded front commission in a financial product to a level trail model is an obvious solution. Three, move to a seller-beware world where the onus is on the seller to prove that he sold a suitable product to the individual. The average person cannot look under the bonnet any more than an average driver can certify the safety of his own car.

End note: I’d urge the RBI governor to read his erstwhile co-author’s paper and take a re-look at how the central bank deals with consumer complaints. There is enough evidence on the ground that the average private sector and foreign bank branch is indulging in what can only be called crime.

If National Spot Exchange of India Ltd (NSEL) brokers can be arrested on charges of having made “false assurances" to investors of NSEL along with “wrong and misleading statements" to entice the investors to trade on the spot exchange (http://bit.ly/1KPc3dp), then RBI should be worried about large scale arrests in banking on the same charges. A simple mystery shopping exercise—not a difficult exercise for an academic to organize—should tell the governor if there is indeed merit in what this column has been saying for years. Why not just do it and see for yourself? And do read the Zingales paper.

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

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