Though the regulators have not thought of it, consumer financial protection should stand on five pillars: financial education/literacy; competent and unbiased advice; regulation of products and firms; disclosure before transactions; and grievance redress when something goes wrong. Twenty years ago, when the Indian retail financial sector was not liberalised, none of these mattered. Apart from banks, there were only two main retail finance institutions. The Life Insurance Corporation (LIC) channelled retail savers' money primarily into government debt and some into equity market under the garb of offering insurance. The Unit Trust of India channelled retail savers' money primarily into equity market and some into corporate debt under the garb of managing small savings. Then came private sector mutual funds, insurance companies and broking firms.
Moreover, two new regulators came into existence: to oversee the securities market and insurance. The changes were impactful. The financial sector in India, as in the US, came to be a big incremental job creator. Private equity firms funded brokers and strategic investors funded mutual funds as well as insurance companies - in the hope that Indian savers would use these services. But did the changes serve consumers, whose money is the reason businesses and regulators exist?
Consider this. Two decades later, mutual funds are witnessing a torrent of outflows even as the market inches towards previous highs. The insurance business has shrunk in an economy where everything is expanding. When money first started draining out of mutual funds, a lot of people blamed it on subdued markets. When the insurance business fell off its steep upward curve, it was seen as temporary. When brokers wailed about the lack of retail investor interest in the stock market, it was blamed on the temporary market decline after 2008. Well, these have turned out to be permanent problems. No doubt poor consumer interest is what we are dealing with. So it's time to visit the five-point checklist of consumer financial protection.
Financial education: Currently, financial literacy efforts focus on describing products and markets, which is boring. Case studies about how we actually behave as financial consumers are interesting, but are not taught. Regulators treat literacy as a ritual rather than as a pillar of consumer financial protection. Forced to spread financial literacy, mutual funds slyly convert it into a marketing opportunity. Insurers and banks are not under any kind of obligation. In any case, since most financial firms are usually in conflict with consumers' interests, financial literacy efforts should come from a source other than regulators and financial firms. This is not happening much, except through the media. My rating: 3/10.
Competent and unbiased advice: This could have been the biggest pillar because consumers who are unclear about concepts are easily persuaded by self-styled "experts". All these years, advice was combined with sales as a free service, and was therefore hugely compromised. The Securities and Exchange Board of India (Sebi) has just announced an inane set of rules for advisors covering mutual funds. There are no rules when it comes to incentivising competent advice for insurance and other products. Banks, the most important source of sales for mutual funds and insurance, can continue to abuse their customers' trust. There are a few excellent advisors, but the tide is too strongly against them. My rating: 1/10.
Regulation of products and firms: This is the biggest focus for the regulators: it accounts for almost 70 per cent of Sebi's budget. I am not concerned about business-related rule making such as certification and registration. The source of all consumer issues is usually a product with wrong features, or one that is priced wrongly or is sold with false promises. These do not attract either a quick rap on the knuckles or exemplary punishment. Indeed, the only bright spot in the last decade in consumer-centric decisions was when the insurance regulator pruned charges imposed by unit-linked insurance plans - after millions of people were cheated. My rating of consumer-centric regulation: 3/10.
Disclosure before transactions: We have imported wholesale from the US what is called disclosure-based regulatory regime. The free market believer's touchstone for a well-functioning market is the well-informed consumer. When something blows up, the idea is to quietly shift the blame to consumers for not reading the entire 300-page public issue prospectus or a 150-page mutual fund prospectus. Financial players know that consumers cannot read the dense legalese; the regulators know that too but do nothing to stop the farce. My rating for this is 2/10 because, while we have a high degree of disclosure, the disclosure-based regime is so flawed that it needs to be replaced.
Grievance redress: So, consumers are not exactly literate, unbiased advice is not yet popular, regulation is not exactly consumer-centric, and the disclosure-based regime has worked more for financial firms and less for consumers everywhere in the world. The least the regulators should have done is to crack down quickly and heavily when a consumer grievance is genuine or widespread about certain issues. But the Reserve Bank is amazingly nonchalant about mis-selling by banks. Also, dealing with individual complaints is anathema to the insurance regulator because there is an ombudsman (funded partly by LIC) to deal with them. My rating on this score is 3/10, across all regulators.
The finance minister, policy makers and regulators can and should stop agonising over poor retail participation in financial products and markets. Instead, they should start addressing these five issues.