How RBI could tighten its draft guidelines against the mis-selling of financial packages by banks
Traditionally, a bank served only two types of customers: depositors, who were primarily individuals, and borrowers that were usually corporate entities. The bank courted both categories because it needed deposits for lending (after making allowances for statutory reserves and other risk mitigation measures) and the loans advanced allowed banks to make profits.
Over time, banks added other sources of income, such as treasury income earned by trading bonds or foreign exchange. Revenue streams were progressively diversified by including new services (issuing letters of credit, for example) and the sale of products from inhouse subsidiaries and even third-party providers. This helped hedge slowing credit demand during economic downturns.
It has now reached such a stage that banks in India, especially in the private sector, have found that hawking financial products requires less work than core credit functions (such as credit appraisal, execution and monitoring); all it takes is the deployment of sales and marketing skills.
An apparent desperation to maximize this revenue has found its way into a perverse incentive structure. Front-line bank staffers are typically rewarded for selling packages regardless of whether a particular product actually meets customer needs.
The Reserve Bank of India (RBI) has rightly been frowning on that practice for a while. Not only is it unethical, it also violates customer trust, the glue that holds the financial sector together. This week, RBI issued draft guidelines that spell out detailed regulations on the advertising, marketing and sales of financial products and services.
Broadly, these guidelines aim to inhibit the institutional mis-selling of products, bar banks from bundling sales of third-party products with its own, dissuade the exploitation of “dark patterns” to delude customers, enjoin banks to compensate customers fully in case mis-selling is established and upend incentive structures that embolden unfair practices. RBI has also, for the first time, defined ‘mis-selling’ to minimize ambiguity and discourage forum shopping.
The financial sector is expected to make some noise about these guidelines, since they are bound to depress bottom-lines for some time. On the bright side, though, it might push banks and non-bank financial companies to expend greater energy on increasing credit sanctions and disbursals, especially to medium- and small-scale industries.
These guidelines are both timely and appropriate, but have three grey areas that demand RBI’s attention.
The first is their lack of an explicit penalty clause that could truly act as a deterrent. The guidelines specify that for a complaint within a specified time-frame, banks should refund the entire amount paid by a customer. However, most customers are unlikely to complain and bank officials might be willing to refund a few disparate customers if it lets them continue with their egregious practices.
The second concerns the proliferation among banks of cumbersome grievance redressal systems, including customer-unfriendly user interfaces that discourage customers from lodging complaints or going through with the process.
The third gap in the guidelines relates to their ominous silence on fintech companies, which have not only emerged as key dispensers of financial products and services, but are known to have indulged in unethical practices to shore up their top-lines. The financial sector’s next crisis could arise from here.
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