23
Jun

Stress Testing Methodology – Brief Comparison Across Regulators

By Nishanth K & Madhu Srinivas, IFMR Finance Foundation

The below table summarises, along some key dimensions, the stress testing methodologies adopted by the central banks in India, US, UK and EU to assess the stability of their banking system. It is to be noted here that the stress tests that individual banks conduct by themselves, as part of their Internal Capital Adequacy and Assessment Process (ICAAP), do not figure in our comparison. Also the below analysis is based on the stability/stress test reports of the respective regulators for the year 2016.

All data for the above comparison was taken from the following references:

Click here for PDF of the infographic.

7
Jun

Aadhaar’s Potential for Financial Inclusion

By Bindu Ananth & Malavika Raghavan, IFMR Finance Foundation

We should care deeply that millions of Indians are still turning to expensive informal financial services in the face of seasonal and volatile incomes, despite years of trying to improve access to basic financial services. Any innovation with a promise to provide disruptive solutions deserves careful attention and a concerted effort to ensure success. It is in this spirit that we approach the Aadhaar debate.

Test and learn—but then evolve

For years, our country’s financial inclusion strategy tried to expand access by opening more bank branches. One reason this has not scaled is because providers face high operating costs for “low-value” services, driven in part by physical “know your customer” (KYC) procedures and paper-based verification of transactions. Previous work by our colleagues Anand Sahasranaman and Deepti George showed that the cost of delivering a rural loan of Rs10,000 through a branch could be Rs4,153 (41.53%) for a public sector bank and Rs3,207 (32.07%) for a private sector bank.

Aadhaar and IndiaStack have held out the promise of overcoming these costs using technology—through e-KYC for users, remote verification of transactions and lowering transaction costs of payments. Taken with other inclusion efforts, we are within striking distance of every Indian having access to a bank account and being able to easily send and receive payments. Not a panacea by any means but a definite milestone for inclusive development.

However, we have also arrived at an inflexion point for the unique identifier (UID) system. If the first part of the task for this system was about technology implementation, now it faces an important next step—creating trust and confidence in that technology and the institutions that administer and oversee Aadhaar. We must have the openness and the humility to leverage the potential of Aadhaar to deliver access to basic services while continuing to work on gaps and weaknesses, some of which we will only learn as we go.

Improving protections for users

We have some specific suggestions that need immediate attention with respect to financial service providers, the Unique Identification Authority of India (Uidai) and users, when considering Aadhaar and its use in digital financial services.

We must make providers liable to put customers back “in the money” for failed/unauthorized transactions: it is important that the users of Aadhaar-linked accounts and Aadhaar-enabled payment processes do not bear the costs of failures in this system as the volume of digital payments increases. The Reserve Bank of India (RBI) has taken the right steps by releasing a draft circular on limiting liability of customers in unauthorized electronic banking transactions. We need to move this into live regulation and extend it appropriately for non-bank providers and third parties.

Over 1.15 billion Aadhaar numbers are now in existence. Such a massive public database containing citizen information needs clear audit and accountability procedures.

We should support an independent observatory to monitor Aadhaar-based transactions: more hard data about the successes and failures of Aadhaar-based transactions will help drive an informed discussion about the system’s efficacy. An independent body monitoring Aadhaar transaction failures and user experiences, and publishing this data periodically, could be a strong accountability mechanism and improve Aadhaar.

We need a “living will” for Uidai: in large-scale projects of this nature, it is helpful to think about worst-case scenarios. In the banking world, “living wills” have been an interesting policy tool to force systemically important institutions to lay down their game plan in the event of bank failure. Similarly, no matter how improbable it might seem today, it would be useful for Uidai to lay out a plan to deal with a severe security breach.

We also need to reform the Aadhaar redress mechanism: currently, we have an opaque redress and complaints system at Uidai, especially a concern since the Aadhaar Act empowers only Uidai or its officers to initiate proceedings for disclosure or misuse of users’ information. Renuka Sane and Vrinda Bhandari’s writing addresses these lacunae clearly. We need a new framework and investment to set out accountability, reporting and performance expectations of Uidai on the Aadhaar grievance process.

We need market conduct oversight for data use by firms across the financial sector: in addition to stronger data protection laws, we need active oversight for firms using personal data. This applies more widely to the financial sector, but we highlight it in this discussion since Aadhaar-seeding of bank accounts is rising, requiring enhanced monitoring to prevent risks, and as more financial firms use IndiaStack as authorized user agencies. We must actively supervise how these firms and government use the Aadhaar system in conjunction with other customer data they hold.

We need to protect the privacy of all residents of India across all platforms, including Aadhaar: the idea that poorer people are less entitled to privacy should be dispelled. Compromising financial privacy could set back wider financial inclusion efforts, if improper disclosure of data leads to denial of credit or reputational harm. This issue goes well beyond Aadhaar, but the ubiquitous use of the Aadhaar number, including for finance, makes this more pressing.

To conclude, a project such as Aadhaar with implications for transforming service delivery must be strengthened in specific ways discussed here so that confidence and trust in the system grows.

This article first appeared in Livemint.

26
Apr

Comments on the RBI Draft Master Directions on Issuance and Operation of Prepaid Payment Instruments in India

By Bhusan Jatania, IFMR Finance Foundation

The Reserve Bank of India (RBI) released the Master Directions on Issuance and Operation of Pre-paid Payment Instruments (PPIs) in India (Draft Circular) on 20 March 2017. The IFMR Finance Foundation’s Future of Finance Initiative has provided its response to the Draft Circular.

While the Draft Circular builds upon a series of PPI related circulars issued by the RBI, it proposes significant changes such as:

  • increasing a PPI issuer’s net-worth requirement to Rs. 25 crores (from the existing Rs. 1 crore),
  • allowing PPI issuers to access payment systems in the future (without providing details),
  • requiring comprehensive system audit of PPI issuers on an annual basis (and before granting licenses to new applicants), and
  • compulsory conversion of existing PPIs (which hold minimum information about the user) to full KYC PPIs (this has to be achieved within 60 days of the Draft Circular coming into force).

In our comments to RBI we have recommended that the Draft Circular:

  • provide a higher standard of customer data protection,
  • create a more level-playing field for bank-led and non-bank led PPI issuers, and
  • clarify customer liability for unauthorised / fraudulent transactions involving PPIs.

In our response we have also compared the Draft Circular to the recent draft rules for security of prepaid payment instruments released by the Ministry of Electronics & Information Technology on 8 March 2017 (to which we also provided a response, available here).

We believe that the proposed regulatory revamp of wallet providers is driven by the principle that emergence of dominance should lead to greater supervision. The RBI appears to have taken a view that the digital payments sector, characterised by significant user expansion, has emerging customer abuse, data security and systemic risk considerations. And while the industry has raised some concerns of regulatory extravagance around the Draft Circular, it should largely be seen as a step in the right direction.

Our response to RBI’s public consultation is available here.


About the Future of Finance Initiative:

The Future of Finance Initiative (FFI) is housed within IFMR Finance Foundation and aims to promote policy and regulatory strategies that protect citizens accessing finance given the sweeping changes that are reshaping retail financial services in India – including those driven by Indiastack, Payments Banks, mobile usage and the growing P2P market.

24
Apr

A Brief Comparison of Ombudsmen Frameworks – Part 2

By Madhu Srinivas, IFMR Finance Foundation

Following our initial post on a brief comparison of grievance redressal mechanisms existing in India for financial services, at first glance it can be seen that there is considerable variation in the process elements among the various sector ombudsmen. This is indicative of varying processes, approach and service levels of the redress mechanisms. Let us delve on some common observations we made from the comparisons.

Recognition of Misselling, or a lack thereof

The Report of the Governing Body of Insurance Council (GBIC)[1] has made the following observation in its analysis of the complaints received against Life Insurers – “In most cases of mis-selling the financial underwriting rules have been disregarded by the underwriter. So mis-selling which could have been arrested at the underwriting stage instead gets an impetus when the underwriter clears long premium paying term plans even though the proposer does not have the paying capacity to maintain the policy beyond the initial first payment.

Our cursory analysis in the previous blog post[2] reveals that there is no recognition of unsuitable sale as a separate category of complaints (beyond process-level complaints). Current supervisory mechanisms also have minimal efforts directed towards systematic detection of conduct violations on a regular manner, such as for violations of affordability assessments across all lending channels, and if such efforts exist, they are not placed proactively by the supervisor in the public domain. There is therefore a systematic under-representation of, and a lack of adequate evidence on the extent of unsuitable sale to households occurring in today’s context (products being unsuited to client needs, unfair contract terms, misleading conduct and market practices of intermediaries and so on). There is inadequate information about ‘misconduct’ practices feeding back to regulators and supervisors providing no respite for consumers even in the longer run. This would substantially underestimate the occurrence of, and the costs to customers on being mis-sold unsuitable products, and consequently reduce the impetus for regulatory action on the same.

Feedback Loops into Regulation and Supervision

The grievance redressal function can act as a powerful feedback loop to the regulator and can inform their regulatory and supervisory approaches as well as actions. We cannot definitively conclude whether regular feedback loops exist and if they do, whether regulators take these as inputs into supervisory processes, and further into updations in regulations (simply because these are not available in the public domain).

However, we looked at requirements placed in the respective Ombudsmen Schemes to see if such requirements are there on paper atleast. We found the following requirements which we think are inadequate for the purpose:

  • From the Banking Ombudsman Scheme[3]The Banking Ombudsman shall send to the Governor, Reserve Bank, a report, as on 30th June every year, containing a general review of the activities of his Office during the preceding financial year and shall furnish such other information as the Reserve Bank may direct and the Reserve Bank may, if it considers necessary in the public interest so to do, publish the report and the information received from the Banking Ombudsman in such consolidated form or otherwise as it deems fit.”
  • The Governing Body of Insurance Council (GBIC) has been established under Redressal of Public Grievances Rules 1998 (RPG), to set-up and facilitate the Institution of Insurance Ombudsman in India. From the RPG “The Ombudsman shall furnish a report every year containing a general review of the activities of the office of the Ombudsman during preceding financial year to the Central Government and such other information as may be considered necessary by it. In the Annual Report, the Ombudsman will make an annual review of the quality of services rendered by the insurer and make recommendations to improve these services.” [4]

The Report of the FRA Task Force[5] points out that “a large number of complaints on a particular issue (for example, misselling in Unit Linked Insurance Plans (ULIP) resulted in consumers losing more than a trillion rupees over the 2005-2012 period) reflect regulatory and supervisory gaps, creating a conflict of interest unless feedback from complaints flows to the regulator through an independent mechanism.” It has recommended the requirement for a research team under the proposed FRA to analyse complaints data and provide feedback to the regulator on areas for improvement in regulation or supervision[6]. We can therefore conclude that such feedback loops do not exist currently.

Powers of ombudsmen/regulators to take action against non-compliant providers

There seems to be a patchy framework around powers of ombudsmen and even the regulators to take action against financial services providers who do not comply with an award made by the Ombudsmen.

RBI / Banking Ombudsman

Section 35A(1) of Banking Regulation Act, 1949, empowers the RBI to give directions to the banking company, where it is satisfied that such directions

– are in the interests of public

– are in the interests of the banking policy

– are to prevent the affairs of any banking company being conducted in a manner detrimental to the interests of the depositors or in a manner prejudicial to the interests of the banking company;

The banking company is bound to comply with such directions.[7]

SEBI SCORES In case of non-redress of a grievance by an intermediary after having being called upon by the SEBI Board in writing to redress the grievances of investors, then such an intermediary shall be liable to a penalty which shall not be less than one lakh rupees but which may extend to one lakh rupees for each day during which such failure continues subject to a maximum of one crore rupees[8]
IRDAI / Insurance Ombudsman

The GBIC cannot penalise Insurance companies for not complying with the award given by it.

Currently, there are no penal provisions available in the RPG for the non-implementation of the award passed by Insurance Ombudsman. Section 16(2) of the RPG provides that the Ombudsman cannot award compensation for an amount exceeding twenty lakh rupees. The compensation cannot exceed the amount that covers the loss suffered by the complainant as a direct consequence of the insured peril. [9]

Unregulated, unlicensed or illegal services

The current redress mechanisms do not admit complaints arising from unregulated, unlicensed or illegal services. The only recourse left to victims in such cases is to approach the police and the courts. This is a big lacuna in the redressal mechanism and it needs addressing. One of the more recent attempts to fill this lacuna is RBI’s Sachet initiative.

To sum up, it is clear that there is significant variation among the grievance redressal mechanisms in place for the Banking, Insurance, Pensions and Capital Market sectors. There is a very strong case to be made for the creation of the Financial Redress Agency (FRA) as the single agency that can act on behalf of aggrieved customers – an idea that is not new and one that has been effectively set up and is running in many other jurisdictions.


[1] Pg 33 Consolidated Annual Report of the office of the Governing Body of Insurance Council (GBIC), 2015-16
[2] http://www.ifmr.co.in/blog/2017/04/10/a-brief-comparison-of-ombudsmen-frameworks-part-1/; https://ajayshahblog.blogspot.in/2017/01/establishing-financial-redress-agency.html
[3] https://rbidocs.rbi.org.in/rdocs/Content/PDFs/67933.pdf
[4] http://www.gbic.co.in/notification/Redressal%20of%20Public%20Grievances%20Rules,%201998%20-%20copy.pdf
[5] Pg 10, Report of the Task Force on Financial Redress Agency, Government of India, June 2016
[6] Pg 15, Report of the Task Force on Financial Redress Agency, Government of India June 2016
[7] Pg 142 Report of the Task Force on Financial Redress Agency, Government of India June 2016
[8] See Section 15C of Securities and Exchange Board of India Act, 1992
[9] See Page 32 of the GBIC, Consolidated Annual Report of the Governing Body of Insurance Council & Offices of the Insurance Ombudsmen for the year 2014-15. Also, See Pg 143, Report of the Task Force on Financial Redress Agency, Government of India, June 2016

10
Apr

A Brief Comparison of Ombudsmen Frameworks – Part 1

By Madhu Srinivas, IFMR Finance Foundation

This is the first of a two-part blog series on the state of Grievance Redress in the Indian Financial System.

An independent grievance redress function that financial services consumers have access to, in the event of less than satisfactory resolution of one’s grievances by the internal grievance redressal processes of financial services providers, is an important piece of the larger customer protection frameworks in place for India (albeit one that is limited to being ex post in nature). Such an external grievance redressal mechanism has an important role to play in market conduct supervision. The redress function can potentially serve two important purposes:

  1. Misconduct by firms imposes costs on society and may damage the confidence in the financial system. This could fuel a retreat of users of financial services from the formal system. An effective and quick redress mechanism would mitigate this problem to a large extent[1]
  2. The analysis of complaints received through the redress mechanism, in particular, for their impact on institutional and systemic stability, could inform future regulation/regulatory action on micro-prudential and market conduct aspects.

While much has been written about prudential regulations and systemic stability, especially in today’s scenario of stressed banking balance sheets, regulations for ensuring market conduct have received relatively little attention, with a significant part of the focus being limited to the possible creation of a Financial Redress Agency (FRA), as envisaged by the Financial Sector Legislative Reform Commission (FSLRC). More recently, in June 2016, the Task Force set up by the Government of India for establishing the FRA submitted its report that covered an implementation plan to operationalise such a statutory FRA (the report was made available for public comment in December 2016).

Taking a step back, in this post, we carry out a short comparative assessment of the nature of redress systems in the Indian financial sector, along specific metrics, to give a more nuanced sense of differences in approach and effectiveness (without necessarily concluding whether one system is more successful than the other). For the sake of simplicity we take into account only the external grievance redress mechanism in the Banking, Insurance, Pensions[2] and Capital Markets sectors and contrast these with the Financial Ombudsman Service of Australia as a benchmark for comparison[3]. The below table[4] summarises, along certain metrics, the existence or otherwise of certain elements of the redress mechanisms, and a more detailed analysis follows it. It is to be noted that large categories of institutions remain left out of current systems – a case in point is a complaint against an non-banking financial company (NBFC) or a non-bank Prepaid Payment Instrument Provider (PPI). There are also jurisdictional uncertainties such as for annuities and pension products provided by insurance companies for instance.

Financial Ombudsman Service, Australia RBI Banking Ombudsman SEBI SCORES Insurance Ombudsman[5]
Channel for Complaint Submission
Online lodging, toll-free calling lines, E-mail, letter, fax and in person Offices in 18 locations in India, online lodging Online lodging, toll-free calling lines Offices in 17 locations in India, online lodging, toll-free calling lines
Classification of disputes
Disputes are classified under various dimensions such as – complexity of dispute, demographic characteristics of disputants, nature of financial service, issue involved and so on. Disputes are classified under various dimensions such as – product type, demographic characteristics of disputants, legal status of the disputant, FSP against which the dispute has been raised, nature of dispute. Disputes are classified under two main dimensions –

1. Entity against which dispute has been raised and

2. Nature of dispute raised.

However, the second dimension did not have any further categorisation.

Disputes are first separated as being related to either Life Insurance or General Insurance and then further classified by – Geographical origin of dispute, FSP against which the dispute has been raised, Nature of dispute. The categories under Nature of dispute are along operational lines, for instance partial or total repudiation of claim, delay in settlement of claims.
Whether ‘mis-selling’ is captured as a separate category
‘Mis-selling’ is not an explicit category under which disputes are classified, but disputes are classified under categories that have further broken down mis-selling, such as – Failure to act in client’s best interest, Inappropriate advice, Incorrect advice and so on. No such categorisation. However, there is a section on mis-selling of third party products (insurance and pension) in rural areas in Annual Report 2015-16 – it is therefore not capturing misselling of pure banking products such as loans, FDs. No recognition of mis-selling, either implicitly or explicitly. Though there is no explicit or implicit mention of mis-selling, there is a separate classification of complaints against (only) life insurers, which includes a category “Unfair Business Practice”[6].
Classification based on the Financial Services Provider (FSP) against whom grievance has been raised
No. The Terms of Reference of the FOS mandate it to keep confidential all information pertaining to a dispute, subject to certain conditions. However, the FOS is required to report information about the disputes to the Australian Securities and Investments Commission (ASIC). Yes Yes Yes
Classification based on the complexity/ severity
Yes, complaints are categorised into Fast-track, Standard and Complex – along increasing complexity and increasing time spent to close. No No No
Satisfaction level of the complainants
Yes, a yearly survey is conducted by FOS to ascertain the satisfaction level of the complainants There is no systematic process of doing surveys to ascertain the satisfaction level of the complainants. However a sample survey was conducted last year, in the New Delhi Region, to ascertain the reason for the high spurt in complaints in that region. This survey also included questions on the satisfaction level of the complainant with the Ombudsman[7] Yes, SEBI is currently conducting an independent survey to gauge the efficacy of the redressal mechanism. It is unclear if this will be a regular feature or a one-off occurrence. No
Disclosure of names of erring financial institutions, agents
No. The Annual Review Report 2015-16 contains no names of any FSP or its agents. Yes. The annual report, 2015-16, has a table which lists the number and type of dispute raised against each bank. For instance State Bank of India had 1172 complaints raised against it pertaining to deposit accounts in the year 2015-16. It should also be noted that the annual report carries sample case studies of exemplary complaints received by the banking ombudsman. Though these case studies are anonymised and the name of the bank is not revealed. Yes. The SCORES website has entity wise numbers on Pending complaints against them. This information is updated regularly. Yes . The Annual Report 2015-16 of the Governing Body of Insurance Council (GBIC) has various tables which list the number of complaints, nature of complaints, time taken to dispose the complaint for each entity against which complaints were received.[8]
Feedback loops to regulators
As mentioned in their 2015-16 report, the FOS is required, as per the ASIC regulatory guide 139, to report on systemic issues and notify Australian Securities and Investment Commission (ASIC) of cases of serious misconduct. In connection with this, FOS reported 58 cases of definite systemic issue in 2015-16 There is no explicit mention of any feedback being given to the regulator. However, the latest annual report of the banking ombudsman mentions as one of its goals – “To provide policy feedback/suggestions to Reserve Bank of India towards framing appropriate and timely guidelines for banks to improve the level of customer service and to strengthen their internal grievance redress systems” No such mention anywhere. The annual report of the GBIC gives a brief analysis of the complaints received and makes certain suggestions based on this analysis. However, it is unclear if the audience is only the regulator or if it includes insurers and other market participants.
The Body or Authority to make appeal to
The Australian courts are the appellate authority The Deputy Governor-in-Charge of the department of RBI administering the Banking Ombudsman Scheme (Consumer Education and Protection Department) is the designated Appellate Authority Securities Appellate Tribunal (SAT) Consumer/High courts of India
Details about number of cases that went to appeal
Not Given 34 awards went to appeal for the year 2015-16 Not Given Not Given
Disclosure of Total Disputes Received, Total Closed
Yes Yes Yes Yes
Disclosure of average number of days to close a dispute
Yes, 62 days No Yes, 36 days No
Age Profile of closed disputes
Yes No but the age profile of open disputes is given Yes[9]. It is given as the number of disputes closed in buckets of – 0-30 days; 31-160 days; 61-90 days and so on till More than 360 days. Yes. It is given as the number of disputes closed in three buckets – Less than 3 months; 3 months to 1 year; Greater than 1 year.

The colour coding is provided to indicate a rudimentary comparative picture, moving from green through yellow to amber, to indicate good (existence of adequate practice for a metric) to bad (no evidence for existence of any practice for the metric).

Overall, we see that there exists a set of external grievance redress forums available today, albeit ones that are varied in completeness and effectiveness and provide a fragmented set of protections for aggrieved consumers. In the next post we take a deeper look at the observations made above and briefly analyse them.

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In case you have difficultly in viewing the table please click here.


[1] https://www.esrb.europa.eu/pub/pdf/other/150625_report_misconduct_risk.en.pdf

[2] We have excluded the grievance redressal mechanism of the Pension Fund Regulatory and Development Authority of India as they currently regulate only 2 products and also score adversely on almost all the metrics.

[3] The colour coding is provided to indicate a rudimentary comparative picture, moving from green through yellow to amber, to indicate good (existence of adequate practice for a metric) to bad (no evidence for existence of any practice for the metric).

[4] All the data used to populate the below table came from the following sources –
Report of the Task Force on Financial Redress Agency, Government of India June 2016
The Banking Ombudsman Scheme 2006, Reserve Bank of India(RBI), Annual Report 2015-16
Securities and Exchange Board of India(SEBI) Annual Report 2015-16
SEBI Complaints Redress System website – http://scores.gov.in/Reports.aspx?Tab=0
Consolidated Annual Report of the office of the Governing Body of Insurance Council (GBIC), 2015-16
Pension Fund Regulatory and Development Authority(PFRDA) Annual report, 2013-14
Insurance Regulatory and Development Authority of India (IRDAI) , Annual report 2015-16
Financial Ombudsman Service, Australia. Annual review 2015-16
[5] The Insurance Ombudsman is provided with a Secretarial Staff by the Governing Body of Insurance Council and such staff is drawn from Insurance Companies. http://www.policyholder.gov.in/FAQ_on_Ombudsman_Scheme.aspx
[6] http://www.policyholder.gov.in/uploads/CEDocuments/Classification%20of%20Complaint%20Life%2015-16.png
[7] The Banking Ombudsman Scheme 2006, Reserve Bank of India(RBI), Annual Report 2015-16
[8] http://www.policyholder.gov.in/Life_Grievances_Analysis.aspx
[9] This information is not available publicly, and/or periodically. It was obtained from the Report of the Task Force to set up Financial Redress Agency (FRA), 2016