A matter of incentives

A matter of incentives

Retail financial products are push products. How many times have we heard this said to defend products pregnant with costs?

There is an inherent flaw in this argument for three reasons. One, it is unfair to the buyers because they are sold products that benefit the seller more. Two, buyers end up paying for the negative sales calls the seller makes. Out of every 10 people approached, maybe one or two finally sign the check, say product manufacturers and distributors in defence of the high cost of distribution, which means that the cost of their negative sales calls are loaded on to the person who buys. Unfair. Three, if loads worked the insurance penetration in India would be higher than 2.5% in 2010 after 54 years of selling 40% products that carried 40% loads.

What could be another way of compensating the seller without killing the buyer? The world is grappling with the problem of getting the interest of the seller aligned to that of the buyer. We think two things will help. One, a switchover to an incentive structure that nudges the seller to look after the financial well-being of the buyer. A hit-and-run approach that a front load encourages does not work. We have a working example in the mutual fund industry that has been working with zero loads for 19 months. Now that the breast-beating and hair pulling is largely over, the industry is settling down. March will be the fifth month of positive equity (that is largely retail money) inflows and the money is coming in through the retail-preferred route of systematic investment plans (SIP). Latest data from transaction processing firm Computer Age Management Services (CAMS) shows that between 150,000 to 200,000 new SIPs have been initiated each month for the last 12 months. Other signs are also good, instead of untested new funds, older funds with a track record and performance are being bought. And investors are not pulling money out in market downturns.

Two, there needs to be ex-post liability on the seller. What is your reaction if you found a doctor prescribing a sugar supplement to a diabetic patient? A similar thing is happening in the retail financial product space. India needs rules that fix liability for selling unsuitable products. With these two shifts in the way we view the retail financial market in place, the stage will be set to convert the household savings lying in short-term deposits into long-term money in a manner that makes everybody a winner.

Does India need tougher regulation to prevent mis-selling of financial products? Tell us at views@livemint.com