GROWING up in the ’70s and ’80s in urban middle India was to know what shortages were. The state strangled enterprise and everything from a scooter to a phone to butter, milk and grain was scarce. The civics and history textbooks stank of double standards as they spoke about an India that was far away from the life of the person for whom that English textbook was written. I call it the Manoj Kumar phase of India – we were losers, but brainwashed into looking back at a glorious past. A past that was distant enough in its historical dividend not to matter to people struggling to find an average ‘service class’ livelihood. Of course, ‘business class’ then did not mean an airline seat, but something totally different.

Socialism and state were dirty words for me back then. The economics classes I attended in the Delhi School were ‘market oriented’ in that we learnt that markets were good and that capitalism was the way for a country to grow. But then India began opening up its economy and embraced, though still a bit gingerly, the capitalist way. The first fruits of that breath of fresh air was indeed more goods and services, lower prices, understanding what the phrase ‘spoilt for choice’ meant and better, much better, service.

That was the low hanging fruit of competition that the consumer celebrated, but now 20 years later, I find myself questioning that very system whose coming I welcomed with such gusto. Possibly, the problem is in the version of capitalism that walks the streets today. I call it predatory capitalism where profits must be made at any cost – at the cost of the people who work to produce the goods and services for the free market, at the cost of the consumers in that free market. Theory claimed that competition would ensure that prices that did not clear the markets would fall and shoddy companies would lose to competitors.

It is visible everywhere. The financial sector and the effect of predatory capitalism has been well documented in my column in Mint titled Expense Account.¹ But look around and you see its effect in many other places as well. What we have right now are stories and anecdotes that are swapped, but these usually boil over when the fraud acquires a minimum of seven zeros behind a positive integer in the financial sector or when there is an excess of malpractice in the other areas. Take the stories coming out of the corporate hospital chains. The stories I hear, that you must hear too, are around the test and scalpel happy doctors who have revenue targets and cut open women who may deliver normally or put stents in people who’ve just had a meal they shouldn’t have had. Or the one about how hospital bills now come to the exact amount that the health insurance policy has set as a limit – no matter what the disease.

 

Then there are other stories. You must have experienced the one where electronic goods support teams are instructed to change the picture tube of a TV when all that is not working is the fuse. Incidentally, this story I have from an engineer on the team of one of the largest TV makers that sell in India. Or the story about the coffee shop that wants to drink to this kind of predatory capitalism. Ever wondered why the RO of a pan-India chain never works and you’re forced to pay for the water they are by law supposed to serve. Or why their computer suddenly begins to stop taking the cheaper combo meal deals on a high sales day like Valentine’s Day. Or the one where one of the biggest retail chains routinely raises it prices and then slashes them to offer on their tri-annual discount sale.

India does not have a strong consumer rights movement that takes up these causes in a systematic, issue and evidence based manner. Most are the breast beating mar gaye lut gaye ban the company kind of outfits. The need is for a consumer watch movement that focuses on malpractice, exposes those who perpetrate it and then suggests ways to reform (we can’t do without the TV company or the coffee shop – I don’t want to go back to watching Krishi Darshan on a grainy black and white TV whose picture came on only when somebody climbed the two floors to the roof and held the antenna the right way for about three minutes) rather than threats to shut them down. I believe that the first stage of the happy consumer is over. It is a matter of time when an intelligent consumer movement begins taking on some of these issues. The precursor to this has happened in the form of several organizations beginning to work.

 

But the financial sector is special and no amount of consumer activism will be big enough to change the behaviour of predatory firms. We just have to look at the sub-prime crisis in the US to understand why this is so. It will take a legal rewrite of financial sector laws to give consumers of financial products and services their due. This is because financial products are invisible and cannot be tasted, or otherwise experienced at the point of sale. Worse, the moment of truth of a financial product is far into the future, like that of an insurance or pension product. Financial products are sold by sellers such as agents and bankers by describing what they do. If this description is not correct, or is tweaked to suit the seller’s interest in pushing it, the principle of ‘buyer beware’ fails. It fails because once sold on selected description, the product literature describes it in reams of legalese and most often needs an advanced degree in finance and law to decode.

So we have a system that says that the buyer must beware and read disclosures before buying, but then does nothing to ensure that the product is not described poorly or that the disclosure is understandable to an average human being. This leads to large-scale market failures in retail finance. Retail consumers being disaggregated, their stories take time to filter through and by the time they do, the scam is already several zeros gone.

Take the case of the unit linked insurance product (Ulip), the market linked life insurance product that was introduced in India in 2002. The Ulip was structured like a trap – it was sold on 40% first year agent commissions, had a three year lock-in and rules that allowed insurance companies to appropriate money towards profits from policies that investors stopped funding when they realized that they were sold a wrong product. Investor losses from such policies exceed Rs 1.5 trillion over the years 2004-05 to 2011-12.²

 

When a country moves from a central command economy to a market based one, the key to the transition is a well thought out regulatory approach. India has hurtled forth pell-mell, in brief bursts of manic energy, and then years of lethargy on the road to a market economy. The on-again-off-again approach has not allowed a structured thought through regulatory system to be put in place. The damage this approach has done shows up in India’s current asset mix. Households have continued to prefer, and have increased their share of gold and real estate for conversion of savings to investment. That left their share of financial products at just 10% of gross domestic product (GDP) in 2010-11, down from almost 13% in the year before. The financial sector is the key resource allocator that moves money from savers to investment destinations. How easily and safely and at what cost it does so determines its efficacy.

India has clunky systems and a regulatory framework that is out of tune with the new needs of an integrated global financial system, where even a tiny exporter may need a hedge in several different currencies or a retail investor may use derivatives to hedge a stock portfolio. The Indian financial sector rule book is not just fragmented across overlapping turfs but is, in many cases, more than 50 years old. The Reserve Bank of India Act dates back to 1934, and the Insurance Act to 1938. Worse, it has been written separately for each subsequent regulator piecemeal, oftentimes keeping political outcomes in mind – nothing else would explain the location of a regulator in Hyderabad (where the insurance regulator is based). The result has been regulatory arbitrage and large-scale harm to consumer confidence in the financial products market.

 

In 2011, the government took notice of the fact that this was indeed a problem and set up the Financial Sector Legislative Reforms Commission (FSLRC) as the legal and institutional structures of the financial sector needed review and recast. The aim was to make the rules contemporary and construct a set of financial laws to give the Indian financial sector a strong legal foundation over the next 30 years. Headed by Justice Srikrishna, the committee submitted the report to the finance minister on 23 March 2013. The 439 page report³ recommends a rehaul of the Indian financial system to facilitate the journey of the $2 trillion Indian economy to becoming a $15 trillion one by 2026. The commission did not stop at recommendations but went ahead and drafted a law that would make this happen.

The draft Indian Financial Code (http://finmin.nic.in/fslrc/fslrc_ report_vol2.pdf) has in it the blueprint of a principle based, goal oriented, democratic set of rules that, for the first time, have given consumers their place in the sun. In its essence, the report says that the regulatory structure for the Indian financial system is old, based as it is on laws, some of which are more than 140 years old. Old itself is not the problem. The issue is a piecemeal approach to financial sector regulation that has resulted in a ground level mess with multiple regulators and large regulatory cracks. On the ground this has resulted in large-scale defrauding of retail investors by financial companies that have used the regulatory mess to appropriate profits from the pockets of people who could hardly afford to lose that money.

 

The commission uses the ‘common law’ approach that allows for a principle based approach where laws will define broad principles that will not change with technology or innovation. The commission sees individual regulators writing subordinated legislation that could be rule or principle based, depending on the regulatory aim. These laws will be across eight areas – consumer protection, micro-prudential regulation, resolution of failing financial firms, capital controls, systemic risk, development, monetary policy and debt management.

Two things that jump out at the first reading are the deep consumer focus of the commission and the plan to move to a seven agency financial sector regulatory system. First, the paper correctly lists consumer protection as the first objective of any financial regulation and looks at a two-pronged strategy that works on both prevention and cure. Prevention will put the burden of consumer protection on the provider of financial products and services, a definite improvement from the current ‘buyer beware’ model. Cure will look at setting up a Financial Redressal Agency (FRA) as a single stop for all consumer complaints in the financial sector with a consumer front in every district.

 

Two, the paper seeks to put in place the aforementioned seven agencies in the regulatory architecture – a central bank with a focus on monetary policy and one that enforces consumer protection and micro-prudential law in banking and payments; a unified financial regulatory system that enforces consumer protection law and micro-prudential law in all finance other than banking; a resolution agency; a unified appellate body; a consumer complaints agency; the Financial Redressal Agency; the Financial Stability and Development Council (FSDC); and an independent debt management office.

This would mean that the current multiple non-banking financial sector regulators will collapse into one. The capital market, insurance, pension, and forward markets regulators will all be merged into the unified financial agency, if this approach paper becomes reality.

But let’s explore the consumer-first approach of the commission. The report says: ‘The first objective of financial regulation is consumer protection’, and then goes on to define how consumers will be protected. Buyer beware – or the disclosure and financial literacy route that the US follows – has been discredited. The sub-prime crisis was a classic case of market failure with commission driven agents seeking to maximise personal gain at the cost of the consumer who was communicated selective product features and often lied to in the rush to get business. The report suggests a two step process for consumer protection that has both prevention and cure. If we know the reasons for bad consumer outcomes (badly structured products, misaligned incentives, opacity in costs) why would we first not try and sort that out rather than try to redress a million consumers?

The report proposes a unified consumer protection law that has three parts to it. First, a set of rights for consumers. Some of these would be protection against unfair terms of contract, protection against misleading and deceptive conduct, right to reasonable quality of service, right to data privacy and security. Two, the law will give regulators power to ensure these rights. For example, to ensure that consumers are protected against misleading and deceptive conduct, a regulator will be free to frame rules that use a mix of clean product structures, aligned incentives and suitability criterion at the point of sales. Three, a set of principles will guide the powers that ensure consumer rights so that innovation and competition are not killed while focusing only on consumer rights.

 

The commission has already drafted the law around this and the draft Indian Financial Code puts consumer protection at the heart of the financial system. A large part of the burden of consumer protection is put on the firms. Consumers will have the right to six basic protections, including protection against unfair terms (home loan companies with inches of fine print, watch out) unfair conduct (double your money schemes, watch out). Unsophisticated investors, or those who invest below a certain amount, will have three additional protections, including the right to get suitable advice (selling life cover to a 60 year old? watch out) and protection against conflicted advice (banks churning retail portfolios, watch out).

 

But anything that is so consumer friendly will upset a lot of people. So let’s see who won’t like it. The babus won’t like it because it puts regulatory sinecures out of reach by fixing the retirement date in a manner to preclude that. Read Section 38(2) of the Indian Financial Code that deals with the age at which members of the board of the financial agency (all the financial sector regulators) retire. It says: ‘The age of retirement for executive members and nominee members will be the same as that for a Secretary to the central government.’ The law hopes to nudge career regulators in the system rather than a resting place for those seeking a continuation of government benefits. The firms will lobby hard because it moves from a system of caveat emptor or buyer beware to making the manufacturer and seller responsible for what they produce and sell.

The existing regulatory regime with all its linkages and incumbencies will push back – specially those who have extra-constitutional influence on regulators or those who profit madly from operating through regulatory cracks. The politicians won’t like this because it makes phone call directions to regulators difficult to implement (regulator change will now be a process that is open to public debate and can be contested in court). They won’t like it because the authority over its biggest war chest (run out of retail money) will be out of reach as the LIC and SBI Acts are repealed and these become firms, one of the many for the regulators. Pushback will come from almost everybody except the final consumer, who anyway has no voice. If they did, there would be a grounds-well of support for the Indian Financial Code becoming law.

 

* This article is based on columns written by the author in Mint, India’s second largest business daily.

** Disclosure: The author was adviser to the Government of India constituted Swarup Committee in 2009 and has peer reviewed the consumer protection chapter in the FSLRC Report. Monika Halan can be reached at monika.h@livemint.com

Footnotes:

1. http://www.livemint.com/Search/Link/Keyword/expense%20account

2. http://ideas.repec.org/p/ind/igiwpp/2013-007.html

3. http://finmin.nic.in/fslrc/fslrc_report_ vol1.pdf