Jayachandran/Mint
Jayachandran/Mint

Hurdles to new financial code

The draft Indian Financial Code puts consumer protection at the heart of the financial system.

I must admit I’m a bit surprised by the kind of debate that the Financial Sector Legislative Reforms Commission (FSLRC) Report (http://finmin.nic.in/fslrc/fslrc_report_vol1.pdf) has generated. The 439-page report has made recommendations to re-haul the Indian financial system to facilitate the journey of the $2 trillion Indian economy to becoming a $15 trillion one by 2026. The Justice Srikrishna Commission did not stop at recommendations, but went ahead and drafted law that that will make this happen. The draft Indian Financial Code (http://finmin.nic.in/fslrc/fslrc_report_vol2.pdf) has in it the blueprint of a principles-based, goals-oriented, democratic set of rules that, for the first time, have given consumers their place in the sun. Some of the debate trashes the entire report and calls for a total rethink. I believe this is based on either reading just the dissent notes or a very thin reading of the executive summary. But the conclusions these views come to are quite sweeping. While there may be merit in the argument against some parts of the report or draft law, it does seem a bit odd that instead of trying to correct what is wrong, some would rather throw it all out.

But maybe I should not have been surprised by the adverse views. Anything that seeks to uproot a system will get a fightback from all those that are invested in that system. Anything that seeks to clearly define goals and objectives in a systematic manner will face resistance from those that leech on the rents chaos begets. Anything that seeks to move us from a smoke and mirror system that benefits the few that operate from behind it will face tough resistance. So what does the FSLRC Report say that is so upsetting and why is it upsetting to so many people? In its essence, the report says that the regulatory structure for the Indian financial system is old, based as it is on some laws which are more than 140 years old. Old itself is not the problem; the issue is a piece-meal approach to financial sector regulation that has resulted in a ground-level mess with multiple regulators and large regulatory cracks. On the ground, this has resulted in very large-scale defrauding of retail investors by companies that have used the regulatory mess to appropriate profits from the pockets of people who could hardly afford to lose that money. The story of Indian investors who lost at least 1.5 trillion in the unit-linked insurance plan mis-selling scam is the story of the mess in the laws around Indian finance. This is a story of lax regulators given a sinecure after retiring from the bureaucracy, an industry-first approach that puts the burden of responsibility on the consumer through a caveat emptor (buyer beware) principle, regulatory turf issues that get regulators to act as industry associations and the lack of legal recourse to consumers since their rights are not fully understood by the current legal system.

The draft Indian Financial Code puts consumer protection at the heart of the financial system. A large part of the burden of consumer protection is put on the firms. Consumers will have the right to six basic protections, including the protection against unfair terms (home loan companies with reams of fine print, watch out) and unfair conduct (double your money schemes, watch out). Unsophisticated investors, or those who invest below a certain amount, will have three additional protections, including the right to get suitable advice (selling life cover to a 60-year-old? Watch out.) and protection against conflicted advice (banks churning retail portfolios, watch out.) Anything that is so consumer-friendly will upset a lot of people. So let’s see who won’t like it. The babus won’t like it because it puts regulatory sinecures out of reach by fixing the retirement date in a manner to preclude that. Read Section 38(2) of the Indian Financial Code that deals with the age at which the members of the board of the Financial Agency (all the financial sector regulators) retire. It says: “The age of retirement for executive members and nominee members will be the same as that for a Secretary to the Central Government." The law hopes to nudge career regulators into the system rather than make it a resting place for those seeking a continuation of government benefits. The firms will lobby hard because it moves from a system of caveat emptor to making the manufacturer and seller responsible for what they produce and sell. The existing regulatory regime with all its linkages and incumbencies will push back – specially those who have extra-consitutional influences on regulators or those who profit hugely from operating through regulatory cracks. The politicians will frown because it makes phone-call directions to regulators difficult to implement (regulatory change will now be a process that is open to public debate and can be contested in court). They won’t like it because the authority over their biggest war chest (funded by retail money) will get out of reach as the LIC and SBI Acts are repealed and the Life Insurance Corp. of India and State Bank of India turn into corporate entities, two more of the many for the regulators to oversee. Pushback will come from almost everybody except the final consumers, who anyway have no voice. If they did, there would be a groundswell of support for the Indian Financial Code becoming law.

Disclosure: The writer was adviser to the Swarup committee in 2009 and has peer reviewed the consumer protection chapter in the FSLRC Report.

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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