India has taken a big leap in protecting depositors by increasing the limit of insurance cover on deposits to `5 lakh from `1 lakh in case banks go bust. Insurance is the only financial safety net for small savers. It has become significant on account of the recent parade of failures that has seen toxic loans sinking so many small banks.
The Deposit Insurance and Credit Guarantee Corporation (DICGC), which is a wholly-owned subsidiary of the RBI, has been providing deposit insurance since 1962. Barring primary cooperative societies, all commercial banks, including the branches of foreign banks functioning in India, local area banks, regional rural banks, co-operative banks, small finance banks and payment banks are covered under the Deposit Insurance Scheme. The insurance cover was last increased to `1 lakh in 1993 from `30,000 earlier and has remained unchanged for the last 26 years.
Financial consumer protection has now become an increasingly mainstream priority for policymakers. A strong consumer protection regime is key to ensuring that expanded access to financial services serves the interests of customers, enabling them to make well-informed decisions on the choice of financial products and services, building trust in the formal financial sector, and contributing to healthy and competitive financial markets. Despite legal teeth that are periodically made to grind, scammers have always intelligently adapted, promoting alternative financial products to sidestep regulation.
Today, both financial and non-financial markets are flooded with agents hawking a bewildering array of products with a highly aggressive sales pitch. These are not backed by cutting edge consumer protection systems. Innovators are highly impatient with regulation and oversight but they must understand that lessons of the past cannot be ignored. Far too many lives have been ruined in the name of innovation and entrepreneurism.
Financial education and awareness is the most powerful antidote against risky investment traps. People need to understand that the price of financial illiteracy is very high. We need to innovate and create tools to spread awareness to the public at large. While visuals and innovative methods will help create a “buy-in”, we need to focus on training in groups by business correspondents at the village level.
Financial literacy is essential for enabling people to make the right financial choices as well as to promote greater use of digital financial services among those who do have an account. In view of the lack of proper awareness, people buy insurance policies without adequate planning and give up midway because they don’t have money to pay the premium. Aggressive pushing of products by insurance providers without adequately assessing the consistency in income streams of the buyers for servicing their policies can mean more harm to the poor. There’s a popular term to describe it; it is popularly called mis-selling. We have an esoteric world of complex financial products on which elders who depend for their retirement plans do not understand the costs of these plans and what the alternatives may be.
Financial ignorance carries significant costs. Consumers who fail to understand the concept of interest compounding spend more on transaction fees, run up bigger debts and incur higher interest rates on loans. They also end up borrowing more and saving less money. Meanwhile, the potential benefits of financial literacy are manifold. People with strong financial skills do better job planning and savings for financially savvy investors are more likely to diversify risk by spreading funds across several ventures.
Mis-selling of financial products needs to be tackled by overhauling the regulatory framework so as to stop the hawking of substandard investment products. Disclosure requirements for insurance and pension products need to be strengthened to make it easier for consumers to understand them. Financial literacy could be the best way to ensure that customers understand the financial risks they face.
While we should make a case for strong regulations to protect consumers against unscrupulous firms, we must remember that good financial literacy among citizens is the most effective antidote against these moral abuses. To blunt the potential for risk, it’s more important than ever to arm customers with the skills they need to responsibly borrow to get a business idea off the ground or to acquire an asset like a house, save and insure to stay resilient through the life’s worst moments without being pushed deeper into debt. They can then keep a distance from unscrupulous and dubious investment schemes that have lacerated the financial lives of multitudes. Stories commonly abound of people having been stripped of every rupee they earned by the time they realised that they’d been conned. Financial advisers and counsellors must be able to spot early, and sometimes subtle, signals.
Robust consumer protection rules are critical to safeguard people from fraud and abuse and the pervasive menace of illegal money pooling by companies. This is especially important for women and low-income people, who are most likely to be financially inexperienced. This also underscores the importance of targeted financial literacy and capability training and embracing opportunities to use new technologies to expand access to formal financial services. Finance can be good, bad or ugly. They can insulate customers from harmful business practices and in countries like Malaysia there is the distinctive component of the customer protection framework which ensures that financial institutions are responsible to assess the suitability of a product for a potential user.
We need to practice what is being promoted as responsible finance which has transparency and accountability and empathy as its foundational triad. Transparency implies objective communication about products’ procedures, documentation and other necessary formalities required for making a financial transaction. Providers must take care to address historical mistrust of financial institutions and give potential clients the information they need to feel empowered to make the right choice for their financial lives. Transparent processes result in greater trust and confidence in the financial system. It is important to ensure that overzealousness does not result in over-indebtedness. We must be mindful of the fact that these individuals have entered the formal financial system after a lot of pushing and prodding and it would be difficult to bring them back into the formal financial sector if they leave feeling cheated or dejected.
Disclosure is the cornerstone of the modern approach to consumer protection, focusing on empowering customers. At least in theory, informed consumers should be able to compare offers, make sound financial decisions, and demand recourse when wronged. Thus far, though, empirical evidence suggests that disclosure requirements improve transparency in credit markets more than the financial decisions of borrowers.
At the same time, there are indications that disclosure is most effective when financial literacy is high and consumers can understand what is being disclosed — for example, how the interest rates are calculated. Good practices start from the perspective that the financial sector should provide consumers with:
Transparency: by providing full, plain, adequate and comparable information about the prices, terms and conditions (and inherent risks) of financial products and services.
Choice: by ensuring fair, non-coercive and reasonable practices in the selling and advertising of financial products and services, and collection of payments.
Redress: by providing inexpensive and speedy mechanisms to address complaints and resolve disputes.
Privacy: by ensuring control over access to personal financial information.
We need an overhaul of the customer protection regime. The new regime must be one that can hold all entities to a common standard of institutional conduct in how they deal with the individual customer, including how they sell products. A misalignment of incentives between the provider and the customer leaves the customer worse-off. Therefore, we need to enforce a system that keeps the customer’s interests above everything else. Consumers should receive accurate, simple, comparable information of a financial service or product, before and after buying it. They should also have access to expedient, inexpensive and efficient mechanisms for dispute resolution with financial institutions.
The good news is that there are now several channels of information and resources to help the public build financial stability. To safeguard the hard-earned money of investors and curb the pervasive menace of illegal money pooling by companies, the Reserve Bank of India has set up a portal — sachet.rbi.org.in — to enable the public to obtain information about registered entities who accept deposits, get information regarding illegal acceptance of deposits and lodge complaints. The portal also facilitates filing and tracking of complaints.
The foundation for financial inclusion stands on three pillars — access, trust and comfort. But this foundation cannot be built through an actor. Instead, it will entail a range of partnerships across technology, banking, the civil society, regulators and government departments.
The writer is a well known development professional