By Darshana Rajendran, IFMR Finance Foundation

As part of our series of posts on Consumer Protection, this post looks at the ‘Treating Customers Fairly’ (TCF) initiative which is being implemented in South Africa to ensure stronger market conduct regulation.

Issues concerning the fair treatment of customers arise out of the problem of asymmetric information between the financial services providers and the consumers. The ‘Treating Customers Fairly’ programme is a regulatory initiative (first implemented by the FSA in the UK) aimed at helping customers fully understand the features, benefits, risks and costs of the financial products they buy and minimising the sale of unsuitable products by encouraging best practice before, during and after a sale.

South Africa sees the ‘Treating Customers Fairly’ initiative as a framework to ensure tougher market conduct oversight and is on route to implementing it, based on the UK version, for the financial services industry. This will apply to all financial services that fall under the regulatory ambit of the Financial Services Board (FSB), which will soon be the market conduct regulator for both banking and non-banking services in line with the proposed twin peaks regulatory model.

TCF is a regulatory approach that seeks to ensure that specific, clearly articulated fairness outcomes for financial services customers are demonstrably delivered by regulated financial institutions. The TCF fairness outcomes, positioned from the perspective of the customer, are the following:

Outcome 1: Customers are confident that they are dealing with firms where the fair treatment of customers is central to the firm culture.
Outcome 2: Products and services marketed and sold in the retail market are designed to meet the needs of identified customer groups and are targeted accordingly.
Outcome 3: Customers are given clear information and are kept appropriately informed before, during and after the time of contracting.
Outcome 4: Where customers receive advice, the advice is suitable and takes account of their circumstances.
Outcome 5: Customers are provided with products that perform as firms have led them to expect, and the associated service is both of an acceptable standard and what they have been led to expect.
Outcome 6: Customers do not face unreasonable post-sale barriers to change product, switch provider, submit a claim or make a complaint.

These outcomes are to be demonstrably delivered at every organisational level and at every stage of the product life cycle, from product design and promotion, through advice and servicing, to complaints and claims handling. The primary responsibility of firms in implementing TCF will be to demonstrate that the first outcome (fair treatment of customers is central to the firm’s culture) is achieved. The other outcomes are seen as a consequence to achieving the first outcome. The following points are recommended in order to help firms foster a good TCF culture framework:

- Right Leadership
- Right Strategies
- Right Decision Making
- Right Controls
- Right Recruitment, Training & Competence
- Right Rewards and Recognition

Firms will be required to provide evidence that they are treating customers fairly and have embedded TCF in their organisational culture. This will require Management Information (MI) mechanisms designed to monitor and measure the firm’s performance in delivering the six outcomes and the elements of the TCF culture mentioned above. This may require both quantitative as well as qualitative management information. Firms will also be required to use their MI mechanisms to assess their own success and failures in delivering the outcomes. A self-audit checklist is also available which could form part of the firms TCF MI. This checklist helps to identify gaps in the following areas:

• Staff training/awareness of TCF
• Sales and marketing material
• Product understanding
• Advice and sales process
• Fact find and flow of information to the client (including after-sales)
• Complaint handling
• Remuneration/incentives
• Risk assessment of TCF non-compliance
• Record keeping and Management Information

With regard to reporting, The FSB suggests that it would like to have both non-public reporting (e.g. regulatory returns, compliance reports) and public reporting (e.g. claims statistics, complaints volumes and investment performance against benchmarks).In terms of enforcement, The FSB would first negotiate any corrective action by engaging with the firm’s senior management. Where this fails or where the FSB considers that there is a serious risk to consumers or unacceptable conduct on behalf of the firm, it would take formal action against the firm. The FSB’s current enforcement powers include:

• Administrative fines and penalties
• Declaration of business practices to be undesirable, with associated powers to order cessation or amendment of the practices concerned
• Suspension or withdrawal of regulatory licenses
• Termination or withdrawal of the approval of certain individuals to act in certain capacities
• Damages and compensation awards (including punitive damages)
• Referral of certain matters to the High Court
• Referral to the National Prosecuting Authority for criminal prosecution of individual wrongdoers, where a statutory or common law criminal offence is committed

South Africa’s TCF policy is expected to be fully implemented by 2014 and it is hoped that the initiative will lead to more optimal outcomes from the perspective of the regulators, consumers and ultimately, firms.

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References:
Discussion paper
Roadmap

By Darshana Rajendran, IFMR Finance Foundation

As we move towards a financial market with increasing product complexity, information disclosures alone will not lead to improved customer outcomes. We believe that the core of consumer protection is the principle of ‘Suitability’ – where the onus of advice or sale of financial services lies with the provider. Continuing on our series of posts on Consumer Protection, in this post we look at how regulators in India have been thinking about client appropriateness and suitability of financial products.

IRDA – Suitability Index for recommending insurance products

IRDA has recently introduced guidelines for the development and implementation of a Suitability Index – Prospect Product Matrix by insurance companies. These guidelines are intended to help direct sales personnel, brokers and agents to recommend products based on the need and suitability of customers. These guidelines are currently applicable to all life insurance policies (Traditional, ULIPs, Pension and Health) sold as individual policies.

According to the draft guidelines, an agent will have to obtain the consumer’s suitability information before recommending a policy through the proposed ‘proposal-cum-need analysis’ form. Suitability information means information that is reasonably appropriate to determine the suitability of a recommendation, including age, Annual Income, Financial resources used for funding the purchase of the life insurance product, Intended use of the life insurance product, Financial objectives with time horizon, Existing assets including investment and life insurance holdings, Liquidity needs, Liquid net worth, Tax status, Risk tolerance etc. At present, basic information is collected after the customer has decided to buy an insurance policy. The proposed ‘Proposal-cum-Needs analysis’ form is more detailed and will need to be filled up before any policy is recommended.

Next section of the form documents the needs of the customer – Life needs (Example: Living expenses, Education) and also Insurance, savings, investment and pension needs. Based on the information collected in the form and with the aid of the Prospect-Product Matrix, the agent will recommend products and a suitable cover.

The Prospect Product Matrix will indicate the “suitable” products for a customer on the basis of Life stage (Single, Married, Married with children, Married with grown-up children or Retirement) Generic need (Protection (Life), Protection (Health), Goal based savings for wealth creation, Investment, Income) and Income segment of the customer (Mass, Mass affluent or HNI).For example: A married person with grown up children will need goal based savings products, investments and health cover more than life protection products. So the matrix will indicate 100% suitability of products intended for goal based savings, investments and health cover. The insurer will then recommend appropriate products from its portfolio for this purpose.

RBI-Suitability and Appropriateness of derivative products

The importance of suitability and appropriateness of policies for market-makers in their offering of derivate products to customers have also been emphasised by Reserve Bank of India. In August 2011, RBI issued revisions to its 2007 Comprehensive Guidelines on Derivatives to address issues of suitability and appropriateness. It encourages market-makers to offer derivative products in general and structured products in particular only to those users who understand the nature of the risk inherent in these transactions. It is imperative that the products being offered are consistent with users’ risk appetite. It requires market makers to carry out proper due diligence to check user appropriateness and suitability of products before offering derivative products.

While undertaking derivative transactions a market-maker should:

• Analyse the expected impact of the proposed derivatives transaction on the user
• Ensure that the terms of the contract are clear and assess whether the user is capable of understanding the terms of the contract and of fulfilling its obligations under the contract
• Inform the customer of its opinion, where the market-maker considers that a proposed derivatives transaction is inappropriate for a customer. If the customer nonetheless wishes to proceed, the market-maker should document its analysis and its discussions with the customer in its files
• Ensure the terms of the contract are properly documented, disclosing the inherent risks in the proposed transaction to the customer in the form of a Risk Disclosure Statement which should include a detailed scenario analysis (both positive and negative) and payouts in quantitative terms under different combination of underlying market variables such as interest rates and currency rates, etc., assumptions made for the scenario analysis and obtaining a written acknowledgement from the counterparty for having read and understood the Risk Disclosure Statement

Responsibility of ‘Customer Appropriateness and Suitability’ review is on the market-maker.

SEBI- Suitability of Mutual Funds based on risk-profiling

A SEBI circular for Mutual Funds also talks of the principle of suitability, stating that distributors of Mutual Fund schemes/funds are required to follow the principle of appropriateness of products sold to its customers.

The circular categorises customer relationship and transactions as:

a. Advisory – where a distributor represents to offer advice while distributing the product, it will be subject to the principle of ‘appropriateness’ of products to a customer.
b. Execution Only – in case of transactions that are not booked as ‘advisory’, it shall still require:

- If the distributor has information to believe that the transaction is not appropriate for the customer, a written communication must be made to the investor regarding the unsuitability of the product.

- A customer confirmation to the effect that the transaction is ‘execution only’ notwithstanding the advice of in-appropriateness from that distributor be obtained prior to the execution of the transaction.

- That on all such ‘execution only’ transactions, the customer is not required to pay the distributor anything other than the standard flat transaction charge.

Mutual Fund distributors must conduct a risk profiling of their clients and advice products that are suitable to their clients’ risk appetite. If an investor wishes to purchase a fund that is not appropriate to his declared risk appetite, the advisor must get a disclaimer signed off by the investor that he is aware that this fund is not recommended for his risk appetite but that he is buying it on his own decision.

By Deepti George, IFMR Finance Foundation

The Committee to Re-examine the Existing Classification and Suggest Revised Guidelines with regard to Priority Sector Lending Classification and related Issues chaired by Shri. M.V. Nair (the Nair Committee) recently submitted its recommendations. Our principal observation on the Report is vis-à-vis the role of non-bank intermediaries in the achievement of priority sector policy objectives. In addition to that, we make some minor observations on biases inherent in the definition and implementation of priority sector rules. The full response is attached here.

Strong Bias towards Direct Origination/Intermediation by Banks

One of the important terms of reference of the Committee was to “consider if bank lending via financial intermediaries for eligible categories of borrowers and activities could be classified under the priority sector and if so, to lay down the conditions subject to which this classification would be admissible.” The background to this is an increasing anxiety about the growth of specialised lenders like Micro Finance Institutions (MFI) and gold loan companies fuelled by access to priority sector funding from Banks. In fact, with effect from April 1, 2011, lending through intermediaries is not considered as priority sector lending.

The Committee recommends that:
“Keeping in view the role of non-bank financial intermediaries like Primary Agricultural Cooperative Societies (PACS), Cooperative Banks, NBFCs, HFCs and MFIs in extending the financial services to the last mile, bank loan sanctioned to non-bank financial intermediaries for on-lending to specified segments may be reckoned for classification under priority sector, up to a maximum of 5 per cent of Adjusted Net Bank Credit (ANBC), subject to adherence to the terms and conditions stipulated…”

Elsewhere in the report, the Committee also states that:

“The ultimate objective for banks is to create last mile connectivity through either opening branches or BCS in a defined time manner. Therefore, it is desirable to phase out in a time bound manner the intermediary channel that banks use for reaching out to diverse priority sector segments”

While the Committee’s position on intermediaries is more flexible than current norms, it reinforces the policy direction of strongly disincentivising banks from partnering with specialised originators/intermediaries such as NBFCs while nudging banks to open their own branches and originate through their own staff or agents, despite all the issues noted with this approach elsewhere in the report including sharply rising NPAs. With only 30% of the commercial bank branches being in rural areas and with only 61% of the country’s population having bank accounts despite decades of efforts by the banking sector, there is strong reason to question an exclusive reliance on bank-led approaches. In its report, The Raghuram Rajan Committee says: “The focus should be on actually increasing access to services for the poor regardless of the channel or institution that does this—large banks may or may not be the best way to reach the poor, and while the mandate may initially force them to pay for expanding access, others may be able to offer the service more efficiently”.

This is also a systemically riskier approach. For example, when a bank directly provides farm loans on its balance sheet, it is protected merely by its own capital against potential losses. On the other hand, when a bank lends to a specialised financial intermediary who then provides farm loans on its balance sheet, the bank is buffered by the capital of the intermediary to some extent. By phasing out non-bank financial intermediaries, this additional layer of capital protection for priority sector lending will disappear, thus transferring more risk directly to balance sheets of banks. This in turn will translate into higher capital infusion commitments by the Government into state-owned banks or alternately creating fiscal mechanisms such as the Credit Guarantee Fund, as envisaged by the Committee for lending to small and marginal farmers.

This has systemic consequences. We need more institutional heterogeneity in the Indian financial system and room to innovate without directly putting depositor money and fiscal resources at risk, as implied by pure bank-led approaches. This then implies the urgent need for the growth of non-deposit taking institutions that have the expertise and capitalisation to operate in specialised markets and robust partnerships between these institutions and the banking sector.

Policy must focus on outcomes and be agnostic to the different routes in which it can be achieved or the nature of institutions involved. For example, if the outcome of interest is increasing access to crop loans for small farmers, it should not matter whether this loan was provided by a bank, a non-bank or a cooperative, everything else being equal. The only criteria to determine whether an asset must qualify for priority sector is if the underlying purpose of the loan is consistent with the stated goals of priority sector policy. This implies that if the crop loan is seen as fulfilling policy objectives, there must be no distinction made between a crop loan advanced directly by a bank or a crop loan advanced by a non-bank using wholesale funding from a bank. Making this distinction admits of lack of competitive neutrality. Conversely, if a gold loan is viewed to be not welfare-enhancing, it must not be accommodated in the priority sector framework at all, irrespective of whether the gold loan is advanced by a bank or a non-bank. Current policy places too much onus on the channel, rather than the ultimate outcome.

By Jayanth Srinivasan, IFMR Mezzanine

In our series of posts on Consumer Protection, this post represents the second part in a two part series that charts out the historical evolution of the various sources of consumers’ rights in India today.

Historical Evolution

As discussed in the first part of this blog entry, it is useful to disaggregate the study of the evolution of the different sources of consumer protection laws into four timeframes:

a. pre – 1950
b. 1950 – 1986
c. 1986
d. 1986 – present

Recent developments occurring in the past twenty five years may now be considered.

1986 – present

Apart from the remedies available through the courts of law and consumer courts, consumer in India of financial products and services may also resort to mechanisms set up by product specific regulators.

Credit

The central bank, the Reserve Bank of India, is also the regulator of the banking system – and consequently oversees the consumer protection regime for credit products in India. The RBI issues guidelines from time to time covering various aspects of consumer protection.

While the RBI was set up in 1934, it has become far more active in protecting the interests of end-consumers primarily in the past two decades – reflecting, in some senses, the creation of the SEBI in 1992 and the IRDA in 1999 to protect the interests of investors and purchasers of insurance products.

The matrix of consumer protection for aggrieved consumers of credit today is as follows:

a. Information dissemination to customers mandated by the Banking Codes and Standards Bureau of India (BCSBI) / Fair Practices Code adopted by banks
b. In-house grievance redressal mechanisms set up by banks
c. Office of the Ombudsman, created by RBI in almost every state of the country, that could enquire into complaints not properly resolved by the concerned bank
Banking Ombudsman Scheme is fully funded and managed by India’s central bank – bank customers can lodge a complaint with any of the 15 offices of the Banking Ombudsman situated across the country, on 27 different grounds of “deficiency in banking services”.
d. Consumer Courts under COPRA
e. Courts of law

The roles and functions of the different institutions overlap at times. Ease of access to these bodies depends on the location and profile of the customer. Further, rules of procedure may stipulate that aggrieved consumers move or consult another forum before approaching that particular body (for ex. the Ombudsman may insist that in-house banking redressal mechanisms be pursued as the forum for first relief).

Securities

Aspects of consumer protection relating to securities in India are regulated by the Securities Exchange Board of India. Set up by an Act of Parliament in 1992, the SEBI was set up “..to protect the interests of investors in securities and to promote the development of, and to regulate, the securities market…”. The SEBI has three functions rolled into one body: quasi-legislative (ie. drafting regulations), quasi-executive (ie. enforcement of applicable rules and regulations to its constituents) and quasi-judicial (conducts hearings and passes orders on various disputes, with in-house appellate forum).

The matrix of consumer protection for aggrieved consumers of securities in order of access is as follows:

a. SCORES
SEBI Complaints Redress System – an online portal for investors to register their complaints against listed companies and intermediaries.
b. SEBI Tribunal
SEBI Tribunal has exclusive jurisdiction in matters falling under the scope of the SEBI Act to the exclusion of courts of law and by extension, consumer courts
c. Securities Appellate Tribunal (SAT)
Forum for first appeal from decisions of the SEBI Tribunal
d. Supreme Court
Second appeal lies directly to the Supreme Court but only on “questions of law”

Various details – primarily procedural but also substantive – as regards the functioning of the SEBI Tribunal as well as the Securities Appellate Tribunal are dealt with by the SEBI Act referred to earlier as well as rules framed thereunder.

Insurance

The insurance sector in India (both life insurance and general) is governed by the Insurance Regulatory and Development Authority, set up by an Act of Parliament in 1999 “…to protect the interests of the holders of insurance policies, to regulate, promote, and ensure orderly growth of the insurance industry…”.

Quasi-legislative powers, in the form of regulation and rule-making authority, are conferred upon the regulator, subject to Parliamentary oversight. The IRDA also passes regulations from time to time regulating both substantive as well as procedural aspects of the above consumer protection structure.

The matrix of consumer protection for aggrieved consumers of insurance in order of access is as follows:

a. Grievance redressal cell within each of the life and non-life companies
Mandated by IRDA (Protection of Policyholders’ Regulations), 2002.
b. IRDA Grievance Cell / Director of Public Grievances (only for public sector insurance companies)
These remain the second port of call, coming into play in practice only after the consumer has sought redress through the in-house grievance cells. The latter, the Director of Public Grievances entertains complaints against the public sector insurance companies (including LIC, GIC, United India, National, New India, Oriental) and is based within the Cabinet Secretariat of the Government of India.
c. Insurance Ombudsman
First created by Government of India notification in 1998. There are 12 such ombudsman in India. Insured is necessarily required to first approach the concerned insurer, failing which he may approach these ombudsman.
d. Consumer courts under COPRA
e. Civil courts

Pensions

The pension sub-sector of the financial products and services sector falls under the regulatory ambit of the Pension Fund Regulatory and Development Authority (PFRDA), established “to promote old age income security by establishing, developing and regulating pension funds, to protect the interests of subscribers to schemes of pension funds and for matters connected therewith or incidental thereto”.

However, from the point of view of consumer protection, uncertainty still pervades this sub-sector as even though the PFRDA was first established through an executive Government of India order dated 10th October, 2003, the PFRDA Bill providing statutory legitimacy to the same has yet to be passed by Parliament. Till date, no consumer grievance redressal mechanism in the pension sphere analogous to those existing in the insurance, credit and securities’ spheres has been set up by the PFRDA, on account of its lack of statutory legitimacy.

Future Outlook

The overall architecture as detailed above stands at a critical juncture. The government of India has recently up set up the Financial Sector Legislative Reforms Commission (FSLRC) to examine, amongst other things, the architecture of the regulatory system governing the financial sector in India. Considering that consumer protection constitutes an integral facet of the laws governing the sector, structural changes to this regime may be expected.

Lok Capital, a venture capital firm, and one of its limited partners, Proparco, the private sector investment arm of the French development agency AFD, have together invested $5 million in IFMR Rural Channels.

Lok Capital’s series A investment in IFMR Rural Channels, which will be paid out in a single tranche, will be used for building Kshetriya Gramin Financial Services (KGFS) which offers financial services in remote rural locations.

KGFS as an entity aims at delivering a complete suite of products and services to ensure financial wellbeing of households and enterprises in remote rural locations under its unique wealth management approach. At present the KGFS network has 110 branches that serve about 200,000 households in Tamil Nadu, Orissa and Uttarakhand.

Commenting on the investment, S.G. Anilkumar, CEO of IFMR Rural Channels and Services said, “Lok and Proparco’s investment in IFMR Rural Channels and Services (IRCS) indicates their alignment with our mission of delivering high quality financial services in a way that has a profound impact on rural households. This investment also validates the sustainability of the KGFS Model that believes in the core philosophy of adding value to the customer and thereby becoming valuable as a business. With this infusion, we envisage further expansion of the KGFS Model to other remote rural locations across the country in a phased manner.“

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