Regulations in the financial sector need to keep evolving as the market grows in depth, breadth and complexity. Think of this as the need for road rules and a traffic management system in a large metro—what worked 30 years ago cannot work today. It was possible to travel 5 km in Delhi without running into traffic lights or traffic cops 30 years ago as road traffic was thin. A malfunctioning traffic light today causes hours of traffic jams. As the traffic volume rises, cities resort to one-way traffic rules, higher parking fees and other measures to curb traffic in the city centre. Financial markets are similar; regulations need to keep moving to keep pace with the changing face of the market. Has the market changed? Yes, the size of the assets under management by the three large parts of the retail financial market—mutual funds (only retail), life insurance and the National Pension System (NPS)—crossed Rs34 trillion in FY 2017, up from Rs22 trillion just 3 years ago. Both the volume of money and the number of people on-boarding these products has risen sharply over the past few years. The share of household savings in financial products has been rising and now more than one-third of household savings find their way into financial products. In addition to the urban users of these products, a new category of investors are getting added through the Jan Dhan accounts. These are people who will be first-time users of many financial products as they move from cash, gold and real estate.
Many of us in finance have noticed the synchronicities of its issues with health. Medicines, like financial products, are used to solve a particular problem that a person suffers from. The diagnosis is a skilled job that keeps in mind many other issues that may be unrelated to the pain in the head at first glance. The relationship is based on the patient trusting the doctor for his professional skills and due diligence. The retail financial market is similar. For instance, the problem of solving just one financial issue, while ignoring the rest of the financial life, leads to bad outcomes.
Is your wealth adviser actually an adviser or just a distributor? The answer to that question is important for your long-term financial health. Don’t think it is important? Then do you think chemists should put out boards proclaiming that they are doctors? In our heads, the difference between a doctor and a chemist is very clear. A chemist sells medicines that we ask for over the counter, either on the basis of a prescription or over-the-counter drugs that are available without the need for a prescription. Who writes the prescription? The doctor. The doctor is much better qualified as compared to a chemist, and has spent years learning and then practicing the profession. When you present your medical problems to the doctor, she will ask some questions, may conduct some tests and then come up with a diagnosis that is specific to your medical condition.
I am out for a Saturday lunch with the husband and his friend. They meet regularly to argue over whether RD (Burman, not recurring deposit) was God. They almost cause a riot arguing about Bappi Lahiri (don’t even ask). Soon, sanity comes along with the food and the conversation turns to the friend’s portfolio (thank you, God). He is using some adviser who floats around in his office and seems pretty happy with him. I ask a few questions and feeling a bit like Gregory House (those who watch the TV series House will get the reference), I set out to destroy his warm, fuzzy feelings towards a guy who is obviously incompetent.
Theoretically, it makes perfect sense. Banks have the branches—all 88,562 of them—across the length and breadth of India. Insurance companies find distribution tough through individual agents. Bank customers largely trust their banks in India. Put all three in a box and shake, and you have the bancassurance model, where insurance companies tie up with banks so that banks can cross-sell insurance policies to their existing customers—that is, you and me. So why’s there a bad smell around bancassurance and why has it taken a nudge from the ministry of finance to push the banks to become brokers?
It is not often that one finds an existential question in a dry piece of financial sector regulation. But read the Securities and Exchange Board of India (Sebi) Investment Advisers Regulation 2013 (http://goo.gl/4b5RK) carefully and you find the question “who am I?” being asked of the financial intermediaries who face the retail investors. This piece of long-awaited regulation puts in place the grid that will define all future regulation in retail financial intermediation by making a strong distinction between a person who simply sells a financial product and one who advises the buyer. This is the same distinction that we make between a doctor and a chemist. We do sometimes seek the advice of a chemist on what to take for a simple headache, but we know we’re doing something wrong to take a strong course of antibiotics on the over-the-counter advice of a vendor. We know that we’ll have to pay the doctor’s fee to get an expert opinion on a medical condition. Retail-facing financial intermediaries need to decide who they are: sellers or advisers.
Because much of policymaking in India is about lobbying power, we see some strange outcomes. Take the draft bancassurance guidelines, for example, that lay down the rules of bank tie-ups for insurance companies. The weird spectrum-like allocation of banks to insurance companies is a classic example of a compromise that benefits no one and will actually harm the market. Recent events in the bancassurance space that point to some companies tripping over regulatory boundaries corroborate this. The evolution of the November 2011 bancassurance draft guidelines (you can read them here) is the story of a face-off between two evenly matched lobbies. On one side is the insurance industry, with its flagship government-owned default sovereign wealth fund, the Life Insurance Corp. of India (LIC). And on the other is the banking sector whose lobbying power kept our money earning nothing because of a rigged formula to calculate interest rates on savings deposits that were fixed at 3.5% for years. The story of how the draft bancassurance guidelines came to be have enough masala to run a full Bollywood trilogy. But as of now, the banks are ahead.
What do you expect your mutual fund to do? It is worth asking and answering this question as we carry out Mint Money’s biannual exercise of examining Mint50—the portfolio of investment-worthy funds that the Mint Money team curates. A quick word on why we do this. Indian households have a high savings rate but most of this lies in inflation-unfriendly deposits and traditional insurance plans. A gradual move up the risk scale would benefit the investors but that has not happened and fewer than 15% of Indians expose their money to equity, either directly or through funds. Similar looking products promising to do the same thing—long-term corpus building that come from three different regulators—seem to be confusing investors.
The Securities and Exchange Board of India (Sebi) has taken a welcome step to bring in a set of adviser regulations. It has released a concept paper on the regulation of investment advisers. India needs a new set of regulations to bring order to a marketplace that moves money between households and fund managers. Investors stay in inflation-unfriendly deposits and negative-real-return endowment insurance policies because they are unable to trust the intermediary who talks about putting their money in markets through mutual funds and pension products. The unit-linked insurance plan (Ulip) fiasco where investors were looted systematically by insurance companies, banks and distributors has not helped foster trust. The Ulip debacle was a case of misaligned incentives and for trust to be built we need to align the incentives of the investor with that of the intermediary, keeping in mind the fact that the bulk of the market finds it difficult to pay for services. There is still time before we come to a stage where there is a well-recognized designation such as MBBS or LLB that qualifies the person giving financial health advice to charge for services as an accepted part of the practice.
Are loads back? The distribution industry was agog when news filtered out last week that the Bajpai committee set up by the Pension Fund Regulatory and Development Authority (PFRDA) had recommended a 50 basis points (bps) charge on the National Pension System (NPS) point of sale. A quick backgrounder: The Bajpai committee was set up to find out why the low-cost NPS is not popular with the retirement corpus-targeting Indian. Less than 50,000 people have handed over about Rs 100 crore of funds to NPS in the two years it has been thrown open to the Indian public. In contrast, equity funds have gathered a net of Rs 470 crore of retail money in the past 12 months despite the absence of a load on the product.