Home / Opinion / Online-views /  Lean, clean financial products for the Indian investor

A dozen meetings that lasted more than a cumulative 60 hours over three-quarters of a year and much debate later, the Sumit Bose Committee Report was uploaded by the Ministry of Finance on 3 September (http://mintne.ws/1NeFMNj ). The committee was set up in November 2014 to recommend measures for curbing mis-selling and rationalizing distribution incentives in financial products. The report is now open for public comments. Disclosure: I was a member of this committee.

The report gives a roadmap to remove the skew in financial product regulations for products that do similar things. To solve the problem of mis-selling of financial products at its root, the removal of the current skew in the marketplace is essential. It is this skew that causes market failures, leading to a lack of trust in the financial sector, nudging savings towards real estate and gold. The key recommendation is the primacy of function over form in regulatory design—or that products that behave in a certain manner must have the same rule governing them. For example, a guaranteed-return traditional insurance plan (money-back, whole-life, endowment plans, to name a few) is akin to a bank deposit with a small crust of insurance. The rules that govern the bank deposit-like function must be set by the Reserve Bank of India. The rules around insurance (risk management) must be set by the insurance regulator. Non-guaranteed or market-linked investment products must follow rules set by the capital market regulator—no matter where they sit in the system. Pensions must be governed by one set of rules, those set by the pension regulator. Most of the other recommendations flow from this key change in the way policymakers think about regulators and their jurisdiction.

Lean, mean products for the new Indian investor who wants to move away from the fixed deposits, real estate and gold troika need policy to be rethought. Piecemeal setting up of regulators over the past two decades has resulted in the current fragmented marketplace where investors are faced with products that solve the same problem (for example: building a retirement corpus) but come under vastly different rules. It is a bit like having different safety standards in car manufacturing across different states. Those with lower standards can offer cheaper cars, and if the faults are well-hidden, the less safe cars will sell more.

The first few commentators have flagged a few issues already and there has been some social media chatter on the report as well. Some of the arguments are here: http://mintne.ws/1IVySoC and http://mintne.ws/1JQuBXs . Two things have been flagged. The first: commentators are worried that the capital market regulator will quickly put in place rules for greater investor protection, but the insurance regulator will not, increasing the skew in the marketplace. This is based on past experience as lax insurance regulations have seen the biggest value destruction of household savings. There is an urgent need for the insurance regulator to rethink its role and move from a 1970s monopoly mindset to one that is able to set regulations in a very different marketplace. Because the regulator so tightly tries to manage the marketplace—clearing each product, clearing each advertisement—it loses focus on the big picture. Worse, once it has cleared the products, it becomes an incumbent with the manufacturer and seller when the product is mis-sold. One has to only look at the lapsation and persistency numbers in the report (pages 28 and 35) to see the extent of value destruction for households. There is absolutely no reason why investors cannot be told what a product returns in terms of a percentage of amount invested other than deliberate obfuscation to hide the true nature of the product. There is absolutely no logic that allows insurance rules to book profits from lapsed policy premiums. Conversations with industry leaders in life insurance indicate that they will stop booking profits if the regulator changes the rules. Till the rules allow, they continue to appropriate profits from the traditional policies that have not completed five years.

The second issue flagged is the dependence of the government on life insurance money to soak up its bonds to fund the deficit. As on 31 March 2014, all life insurance companies held a stock of 5.18 trillion worth of central government securities. If the recommendations are implemented, it would mean the end of the traditional plan in their current opaque, value destroying avatar. There will be a few years of transition when savings move from these to transparent products (think inflation-indexed government of India bonds) bought on merit and not on obfuscation. The government will need a plan to take care of the slump in bond sales when that happens. If the economy revives, there is a hope that the buoyant tax revenues will wean the fisc off this debt.

Modern financial products will never be trusted as long as there is obfuscation and traps built into regulations. It is a choice that policymakers will have to make—do we continue with a 1970s mindset or do we move to a new paradigm?

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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