After years of ignoring warnings and complaints, Reserve Bank of India (RBI) has finally accepted that commercial banks are not the pillars of virtue it has believed them to be so far. In general the banking regulator concedes that banks have not kept the best interests of consumers in mind. Specifically, India’s central bank acknowledges the unholy nexus between banks and insurers and spells out the M-word.
Misselling has finally entered RBI’s lexicon. It has even stumbled upon a new expression — “perverse incentive structures” — for the misselling, a phenomenon where carrots of high bonuses induce bankers to sell wrong products to relationships (a perverse word of consumers).
“Intense competition and perverse incentive structures have frequently led to widespread misselling of products and misdirection of clients to inappropriate and risky investments by financial service providers,” the regulator says in its Financial Stability Report, released on June 27. “The instances of misselling of products have been observed across customer groups, such as faulty derivatives to corporates (for hedging their exposures) or inappropriate insurance products to individuals.”
You would think that after infinite alerts in newspapers and magazines and a recent working paper — Estimating losses to customers on account of mis-selling life insurance policies in India by Monika Halan, Renuka Sane and Susan Thomas for Indira Gandhi Institute of Development Research — the banking regulator would look at this problem from the perspective of consumers. More so, because the paper has diligently worked out the loss to consumers — Rs 1.5 trillion (or Rs 150,000 crore or $28 billion).
But no, even now RBI is interested in reputation of banks, not losses of consumers. “The reputation risk for individual institutions indulging in such activities for short term gains is high,” it says. “Against this backdrop, regulation is increasingly tilting towards strengthening the aspects of consumer protection and market conduct in the financial sector.” The regulator’s reluctance to serve consumers is mysterious.
Along with misselling, RBI has identified the problem of loading consumers with unwanted baggage, resulting in issues of unfair and restrictive practices, something that the Competition Commission of India must look into. “While banks are well suited to distribute insurance products because of their wide network, several issues have arisen regarding their conduct in the process, generally pertaining to mis-selling and certain restrictive / unfair practices (such as linking provision of locker facilities to purchase of insurance products, selling of unsuitable and/or multiple policies),” it says.
This confession ties in well with what RBI’s cousin in Hyderabad, the insurance regulator Insurance Regulatory Development Authority (IRDA) noted. “The maximum complaints in life insurance related to misselling,” RBI states, quoting IRDA’s annual report. “The type of complaints were mainly in the nature of unfair trade practices and misselling of products (e.g. malpractices, actual product sold being different from what was proposed, single premium policy being issued as annual premium policy, surrender value being different from projected, free look refund not paid, misappropriation of premiums etc).”
RBI’s new concern stems from what journalists have been writing since 2004 — that since banks do the misselling, and the “agent” lies somewhere in the regulatory gap between IRDA and RBI, the banking regulator needs to take note at its end. “As a significant portion of private life insurance companies use banks as their corporate agents, there seems to be an urgent need to revisit the marketing and sales strategies used by the banks in pushing insurance products, especially since insurance is among the more complex of financial products for the common man to fully comprehend.”
The result, unfortunately, is lacklustre. “Banks have been advised to disclose to the customers, details of all the commissions / other fees (in any form) received, if any, from the various companies for marketing / referring their products, even in cases where the bank is marketing/ distributing/ referring products of only one company,” RBI states. “As a further step in enhancing transparency, banks have also been advised to disclose details of fees / remuneration received in respect of the bancassurance business undertaken by them in the ‘Notes to Accounts’, from the year ending March 31, 2010.”
What RBI should have done was to inflict severe and profits-debilitating penalties on banks, so that its shareholders raised a stink that reached the noses of the bonus-feeding fat cats running the banks. Instead, what it has done is to inflict increased disclosures. Before you turn your nose against it, remember, disclosures are good. But they have been abused and are falling off the map as a consumer-friendly regulatory response because companies have turned the idea on its head and overloaded consumers with so much information that it serves no purpose.
RBI needed to do was four things. One, disclosures — which it has done. Two, get banks to return the Rs 1.5 trillion consumers lost back to them. Three, put a penalty on banks that looks like one and hurts like one — not the statistically-insignificant fines that it imposed on banks for breaches of know your customer (KYC) norms that allow laundering money that could be used for terror activities, a breach exposed by Cobrapost. Four, hold the top management to account — we need to see some sackings at the top, not some helpless junior executives, who are merely following the incentives set by the management.
The Financial Sector Legislative Reforms Commission (FSLRC) report has taken existing regulations forward and to fix wrong incentives, has leaned on “claw backs” to top management.
“Bank supervisors must have powers to comprehensively look at human resource policy documents of a bank and recommend changes to the extent such policies impinge upon excessive risk-taking and soundness,” the report states. “The Board of Directors (BOD) and shareholders of banks must have the power to claw back payments made to the top management in line with the global trend of curbing excessive risk taking by the top management.
“Regulators must look at compensation policy and structure and its impact upon incentives and the ability of the bank to perform adequate risk management. The focus of supervisors should be upon the incentive implications of the compensation structure. There is a case for rules that require compensation to be spread over longer horizon, with provisions for claw back of payments in certain cases. While there is some thinking on framework for compensation in private and foreign banks, the same needs to be extended to public sector banks (PSBs). The legal and regulatory framework for compensation should give the BOD and shareholders the ability to push PSBs towards more rational compensation structures, given the deep links between the problems of risk management, operational controls of PSBs, and the flaws of compensation structure.”
Claw backs go far, but not far enough. Beyond the regulatory space, there is a fifth weapon to fix the problem that will complete the circle of regulation, possibly plug every loophole and align incentives of bankers to those of consumers. But in order to pull that, we as consumers will need to reach out to lawmakers and get them to turn economic crimes into criminal offences. In other words, if a bank missells a product to consumers, there should be a jail term for top management — not any trainee, not any junior agent, not a middle-level advisor. If this sounds drastic, unviable, impossible, read what the Report of the Parliamentary Commission on Banking Standards in the UK has recommended. Released a week ago, on June 20, the report is a strong and unambiguous signal to bankers behaving like wolves.
“A more effective sanctions regime against individuals is essential for the restoration of trust in banking. The current system is failing: enforcement action against Approved Persons at senior levels has been unusual despite multiple banking failures. Regulators have rarely been able to penetrate an accountability firewall of collective responsibility in firms that prevents actions against individuals. The patchy scope of the Approved Persons Regime, which has left people, including many involved in the Libor scandal, beyond effective enforcement. The Commission envisages a new approach to sanctions and enforcement against individuals:
* all key responsibilities within a bank must be assigned to a specific, senior individual. Even when responsibilities are delegated, or subject to collective decision making, that responsibility will remain with the designated individual;
* the attribution of individual responsibility will, for the first time, provide for the full use of the range of civil powers that regulators already have to sanction individuals. These include fines, restrictions on responsibilities and a ban from the industry;
* the scope of the new licensing regime will ensure that all those who can do serious harm are subject to the full range of civil enforcement powers. This is a broader group than those to whom those powers currently extend;
* in a case of failure leading to successful enforcement action against a firm, there will be a requirement on relevant Senior Persons to demonstrate that they took all reasonable steps to prevent or mitigate the effects of a specified failing. Those unable to do so would face possible individual enforcement action, switching the burden of proof away from the regulators; and
* a criminal offence will be established applying to Senior Persons carrying out their professional responsibilities in a reckless manner, which may carry a prison sentence; following a conviction, the remuneration received by an individual during the period of reckless behaviour should be recoverable through separate civil proceedings.”
It’s time the Indian Parliament, particularly the members of the Standing Committee on Finance, picked this report and pushed for this one clause. In this clause that hits the vitals of bonus-at-any-cost banking criminals lies consumer redemption. Until then, let’s not get too hopeful — banks will continue to sell wrong products to us, hurt our financial lives, all under the benign eye and protection of its association, RBI.