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Business News/ Money / Personal Finance/  Opinion | Common conduct rules can help align financial services with customers
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Opinion | Common conduct rules can help align financial services with customers

It must apply on all who act on behalf of the provider and engage the retail customer

An increase in trust in the formal system will translate to more uptake and use of financial services that households are in dire need of.Premium
An increase in trust in the formal system will translate to more uptake and use of financial services that households are in dire need of.

Individuals and households need access to reliable financial services like a safe and accessible place to save and affordable credit. They need adequate insurance to protect themselves from financial shocks and reliable investment options to meet their long-term financial goals. But it would be difficult to expect them to be experts in personal financial planning. It would certainly be too much to expect them to understand the capital asset pricing model. It is, however, reasonable to expect our financial services provider to have adequate knowledge about such things and to look out for our interests, else, can we trust it with our hard-earned money? This brings us to the regulatory architecture of the supply side of Indian financial services.

Financial products are sold by manufacturers and intermediaries such as agents and brokers through branches, at your home, on the internet, and through new interfaces enabled by fintech. Unfortunately, customer interests are rarely the focus of these interactions. The seller is free to make statements that influence customers in their purchase decisions. In other words, they provide free incidental advice that they have no accountability for but for which they receive volume-based incentives for sales. This is problematic if these touchpoints engage in misleading, wrong, or harmful advice to maximize sales.

Regulators are not blind to this contradiction and have taken steps to reduce mis-selling. For one, they have separated sale and advice into distinct licences. This has not worked well because “independent" financial advisers are employed by banks in their investment and wealth management departments to drive volume-based sales. The Securities and Exchange Board of India’s (Sebi) three consultation papers between 2016 and 2018 acknowledge this and proposed some steps that are yet to fructify. Two, a set of fragmented binding and non-binding rules across products and licensing types have been put in place. For instance, the BCSBI Code of Banks’ Commitment to Customers places an obligation of suitability applicable on banks’ sale of third-party products, and not on own products. “Avoiding over-indebtedness" is a requirement applicable only on NBFC-MFIs, not on banks and other NBFCs serving the same customers. Three, product-specific micro-prudential regulations have been applied. For instance, in microinsurance or microfinance, there’s a limit on the exposure of customers to a specific product type in order to “protect" them. This makes it difficult to overcome cost and risk considerations and innovate beyond traditional business models in serving low-income and difficult-to-reach customers.

The level of ex-post supervision by regulators and through industry bodies, SROs and ombudsmen does not provide much comfort. There are currently no abilities to detect the quantum of conduct violations across a specific function (say, retail unsecured credit) or at a point in the entire customer engagement life-cycle (say, misleading advertisements). Indeed, many committees such as the Bose Committee (2015) and the Ramadorai Committee (2017) have emphasized the concerns on mis-selling.

One solution is to collapse the artificial separation of sale and advice and to regulate instead, the quality of interactions between providers and consumers, as articulated in our paper . For this, we need a universal set of conduct obligations applicable on all providers serving retail customers. The responsibility for interpreting and adhering to these obligations is to be left to the provider to demonstrate, and for the supervisor to monitor through a conduct lens. We need a definition for the retail customer like the one UK uses. It includes everyone, individuals, corporate and non-corporate establishments below a certain threshold. All financial institutions and institutional investors are kept out of this definition.

The obligations must apply on all employees, individuals and companies who act on behalf of the provider and engage the retail customer. All communications and all decisions, whether face-to-face or through digital or other modes with the customer, are to be brought under these obligations. These obligations will include well-established requirements such as to act with professional diligence, to disclose relevant information in a meaningful manner, but also newer ones like incentive design that does not compromise the provider’s ability to act in the interests of the customer. It will also include an obligation to ensure that the provider deals only in activities that are not unsuitable for the customer, considering the customer’s needs, objectives and financial situation. Only under exceptional cases can this obligation be switched off. Providers’ boards must approve internal policies against which the supervisor can check for operations that demonstrate compliance. The efforts of the provider to comply are to be proportionate to the nature, scale and complexity of business, as well as to risks to the customer.

This framework calls for coordinated action by all financial sector regulators to obtain outcomes that are important for the Indian customer. An increase in trust in the formal system will translate to more uptake and use of financial services that households are in dire need of.

Deepti George is head of policy at Dvara Research. Amulya Neelan, a research associate at the institute, contributed to the column

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Published: 16 Sep 2019, 11:30 PM IST
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