Shyamal Banerjee/Mint
Shyamal Banerjee/Mint

Expense account | Banks vs retail investors

There is enough smoke to signal that banks need to rethink what they do with their depositors' trust

The Hongkong and Shanghai Banking Corp. Ltd (HSBC) has been in the news in the past week for all the wrong reasons. Globally, the bank has been under pressure not just for mis-selling in the UK but also for allegedly violating the US anti-money laundering laws. Its third quarter results have a provisioning of another $800 million to account for the over $1.5 billion hit the bank may take for the alleged money laundering. The bank has already provisioned another $353 million, taking the total in penalties and compensation to about $1.8 billion on account of mis-selling the payment protection insurance (PPI) in the UK. The mis-selling issue has now chased the bank to India and recent newspaper reports say that the bank has been instructed by the London headquarters to stop selling mutual funds (MFs) and insurance products till it revamps its sales practices. The story said that a “culture audit" found instances of mis-selling. The bank denied the report to say that the revamp of wealth management was work-in-progress and no sales have been suspended.

Unhappily for the bank, the controversy over mis-selling refuses to go away. It was in the news in April this year when actor Suchitra Krishnamoorthy sent HSBC a legal notice (the case is not yet filed it seems, but you can read the legal notice to the bank) over “negligence, misconduct, lack of diligence, prudence, care and breach of fiduciary duty" in managing her corpus of 3.6 crore. Let’s look at specific charges. One charge made by Krishnamoorthy in her legal notice is that the bank indulged in excessive sales and purchase of MFs, earning a 2% commission on each purchase and these trades were not in her interest. The cost to her was 29.34 lakh. Let’s just stay with this number. A commission of 29.34 lakh at a 2% charge will accrue to the bank if it sells funds worth 14.67 crore (2% of 14.67 crore is 29.34 lakh). Krishnamoorthy’s total corpus under management with the bank, according to the legal notice, is 3.6 crore. This would mean a portfolio churn of four. This looks very high for a retail portfolio. Conventional financial planning and wealth management wisdom frowns upon a full portfolio churn—we don’t sell all our funds in a year and buy new ones—let alone a four times churn. Long-term investor wealth is created by identifying strong MF performers and then staying the course over the long term. Not churning. Churning, in fact, is the base level classic sign of mis-selling.

The issue of banks and mis-selling is bigger than HSBC in India. Banks have both access and trust of their depositors and have used this to cross-sell financial products, specially MFs and insurance. While data on commissions on insurance by distributor remains elusive, we have a much better grip on the MF data due to superior disclosure norms. We know, for instance, that banks earn the most commission among all MF distributors—there are seven banks in the list of the top 10 distributors when ranked by commissions earned in 2011-12. We know that banks (serviced by CAMS that has about 70% of the industry business) see high levels of churn. For 2011-12, banks saw an inflow of just over 11,500 crore and lost just over 11,700 crore, leading to a net outflow of almost 175 crore. Over the same year, independent financial advisers (IFAs) brought in a net of over 1,600 crore. We also know that banks’ commissions grew in an industry that saw a contraction in 2011-12. If we look at the top five companies by average assets under management, we see that HSBC’s commissions from funds rose by almost 30% over the year, Citibank’s by 47% and HDFC Bank Ltd’s by 13%. Remember this is a year in which the MF industry contracted 1%.

There is enough smoke to signal that banks need to rethink what they do with their depositors’ trust. Unfortunately, the banking regulator has taken a see-no-evil approach. I met a now-retired Reserve Bank of India (RBI) deputy governor last week and it seems that the RBI view remains the same: not our problem. It is a cynical short-term view and it should be no surprise to the government that households’ financial assets have fallen and the share of real estate and gold has gone up. Senior bankers themselves have a solution they give offline: slap large punitive penalties on banks found mis-selling, make the top management responsible for mis-selling and introduce clawback of bonuses.

Though I don’t have too much hope of hard measures from RBI that actually hurt banks and protect investors, I may still want to pull out my cobwebby Pollyanna hat. If HSBC does indeed put in best practices (we’ll review if they are indeed “best" for the consumer) and introduces a model that can be replicated by other banks, this may be a crack in the door that gets banks off short-term profit booking to building a long-term retail-focused business and gets bank customers served and not cheated.

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

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