An Emphasis on Product Suitability

Our earlier post covered the second approach to consumer protection that was discussed in the IFMR Financial Systems Design Conference 2012. This post carries details of the third session that discussed a framework for consumer protection based on the principle of ‘Suitability’.

Suitability is defined as the degree to which the product or service offered by the intermediary matches the retail client’s financial situation, investment objectives, level of risk tolerance, financial need, knowledge and experience .

This approach believes that that mandating increases in information disclosures alone will not lead to improved consumer outcomes in light of innovation in the financial sector and growing product complexity. In such an environment, imbalances in information, expertise and power between the buyer and seller will only increase with time. This approach believes that the most appropriate way to protect the welfare of the consumer would be to put the onus of consumer protection on the seller. The seller must be held accountable for the service provided to the buyer, by ascertaining that the products sold or the advice given is suitable for the buyer considering her needs (as determined by the buyer using its expert judgment).

Anand Sahasranaman of the IFMR Finance Foundation provided insights on the scope and rationale for Suitability; Suitability in the Indian context; the Australian experience of implementing suitability; and supervisory and enforcement options.

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Monika Halan, Editor of Mint Money provided insights from the market. Her presentation covered international experiences in different approaches to investor protection and emphasised on the need for introducing Suitability in India. She discussed the market structure required to clean up the system as preparation for Suitability. Two case studies (ULIPs and Mutual Funds) were discussed in detail as recent examples of how poor product structures and skewed incentives caused huge losses to Indian investors.

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An Emphasis on Eliminating Conflict of Interest

Our earlier post covered the first of the three approaches to consumer protection that were discussed in the IFMR Financial Systems Design Conference 2012. This post carries details of the session that discussed a framework for consumer protection based on eliminating conflicts of interest.

This approach believes that the root of mis-sale of products and services is the conflict of interest between the manufacturer and distributor of financial services. It attempts to align incentives within a financial service provider or across providers involved in developing and delivering a service.

Conflicted remuneration1 means any benefit, whether monetary or non-monetary, given to a financial service licensee, or a representative of a financial services licensee, who provides financial product advice to persons as retail clients that, because of the nature of the benefit or the circumstances in which it is given:

• might influence the choice of financial product recommended by the licensee or representative to retail clients; or
• might otherwise influence the financial product advice given to retail clients by the licensee or representative

Susan Thomas, Professor at Indira Gandhi Institute for Development Research (IGIDR) provided research based insights on the topic. Her presentation covered the problems of incentive alignment, costs of incentive misalignment and regulatory approaches to contain conflicts of interest. The presentation also discussed the various proposals that have been made to eliminate conflicts of interest. One approach that was discussed was based on the paper ‘A Regulatory approach to financial product advice and distribution’ to separate out advice from the sale, such that the advisor is independent of the manufacturer. This paper calls for an industry body which recognizes financial advisors as professionals and regulates them. Some implementation approaches -a series of business models to implement in the current framework and implementing guidelines were also discussed.

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1 – Section 963A, Corporations Amendment (Further Future of Financial Advice Measures) Bill 2011 available at http://www.comlaw.gov.au/Details/C2011B00265


An Emphasis on Disclosure

Subsequent to our earlier post that briefly laid out the three approaches to consumer protection that were discussed in the IFMR Financial Systems Design Conference 2012, upcoming posts in this series will take you through these sessions in detail.

The first session discussed a framework for consumer protection based on information disclosure.

“Disclosure” refers to any requirement that the firm disclose information to the retail client that could be material to the investment decision . Consumers of financial services have less information and sophistication about the financial system and financial services than the financial services providers. The imbalance of information leads to consumers being vulnerable to abusive practices. Disclosure is seen as a way to handle this information gap between the providers and the customers by providing as much information as possible in an understandable way to the customer. Information disclosure pertains to product terms including pricing, risk factors, and provider conflicts of interest. Plugging these information gaps is viewed as being critical to promote good consumer choices.

Recent research has pointed out the limitations of a disclosure based approach and also addressed the issue of more effective disclosure mechanisms. This approach believes that well-designed disclosures complemented by effective financial literacy programs enable consumers to make better decisions and improve their financial outcomes.

The first speaker for the session, Kate McKee, Senior Advisor at the Consultative Group to Assist the Poor (CGAP) provided research based insights on information disclosures in finance. Her presentation covered the scope, components and the importance of information disclosures, international trends in disclosure regime, limitations of the disclosure regime and policy considerations in implementing this regime.

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The next speaker Veena Mankar, Managing Director of Swadhaar FinServe provided a real world experience-based perspective on the use of information disclosures. Her presentation covered practical experience of implementing this regime in low income segments, concepts of customer profiling and matching disclosures, financial literacy as a component of disclosure and a view for the future of disclosure in India.

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IFMR Financial Systems Design Conference 2012

The second chapter of the IFMR Financial Systems Design Conference Series was held at our office on August 31-September 1, 2012. This year, we identified ‘Envisioning the Future of Financial Consumer Protection in India’ as the theme for the Conference. The objective of the conference was to stimulate discussion and debate on the possible frameworks for consumer protection in finance for India and arrive at an understanding of the most appropriate framework for India’s financial system.

In the introductory session, Dr. Nachiket Mor shared his thoughts on the future of finance in India and set the context for a discussion on appropriate frameworks for financial consumer protection in India.

Video Below:

The full transcript of the keynote address is available here.

The conference identified three stylised approaches for financial consumer protection:

  • An “information disclosure and financial literacy” based approach that argues that consumer welfare is best enhanced by providing more information to consumers while working in parallel on improving consumer financial knowledge.
  • An “eliminating conflicts of interest” based approach where the belief is that the core problem in financial services delivery is the conflict of interest between the manufacturer and the distributor or advisor.
  • A “suitability” based approach that argues that the onus of consumer protection must shift decisively from the consumer to the financial services provider, and that the provider must be legally liable for advice given or product sold to the consumer.

The two day event saw active participation and debate on consumer protection issues in India and the way forward. In the following weeks, we will share detailed outcomes of the discussions of the sessions.


FICCI Workshop on Strengthening Microfinance Institutions (MFIs)

By Jayshree Venkatesan, IFMR Mezzanine

FICCI had organised a panel discussion followed by a workshop on “Strengthening Microfinance Institutions (MFIs): Good governance and Strategic People Practices” on April 23, 2012 in Mumbai. The objective of the workshop was to examine contemporary debates in governance, with a specific focus on the unique context of Microfinance Institutions. The day-long event began with a key note address by Mr. Anand Sinha, Deputy Governor, Reserve Bank of India, who spoke about the need for microfinance institutions to focus on ways in which they could handle their concentration risk, reduce operational costs and manage corporate governance.

At the panel discussion, from left: Vishwanath Prasad (Director, Caspian Advisors), C.S. Ghosh (CEO and Founder, Bandhan Financial Services Pvt. Ltd.), Mathew Titus (Executive, Director, Sa-Dhan), Anand Sinha (Deputy Governor, Reserve Bank of India), M.V. Tanksale (Chairman and Managing Director, Central Bank of India), Shivakumar (Senior Group Vice President, ICRA Ltd), and Jayshree Venkatesan (CEO, IFMR Mezzanine Finance Private Limited).

The key discussions centred on the unique context of the microfinance sector, the resultant need for governance and what governance means in this context. The key points were as follows:

1) Customer protection: Given that the beneficiary of a microfinance institution’s services is a client belonging to a low income household, customer protection can be manifested through:

a. Greater transparency: Disclosure of effective interest rates to the customer
b. Recovery practices: Ensuring recovery practices and delinquency management practices are clearly defined
c. Good control mechanisms: Internal audit systems with regular contact points with randomly selected customers; establishing a feedback loop to strengthen processes. It is important to make sure that a senior person within the organisation is responsible for ensuring client protection is maintained

2) Evolving the overall strategy:

a. Short term vs. long term: Ensure that the board represents all the stakeholders’ interests and that short term decisions are not taken, which may be sub-optimal in the long run
b. Ensure an organisational culture to ensure that long term performance is incentivised
c. Business plan: Revisit the business plan in the current context of changing regulation to make sure that adequate diversification is factored in

3) Board composition and role of the board:

a. Striking a balance between investor directors and independent directors
b. Importance of having an independent director and the role of an independent director: how does one overcome the current shortage of independent directors in the sector
c. Board connect: Ensure that the board of directors visits various field centres at least once a quarter

To sum up, what governance does is to determine what is measured and how it is rewarded, which has an overall impact on the strategy followed by the organisation as it grows. Incorrect measurement can result in decisions that are sub-optimal in the long run, making it necessary to have board members who can balance the short and long term.