by Dhirendra Swarup.
The Ministry of Finance has recently invited comments on the report of the Task Force to establish the Financial Redress Agency (FRA). The FRA is planned as a one stop forum for speedy and convenient settlement to complaints of retail financial consumers. In this article, I tell some of the back story, highlight the shortcomings of the current regime, and present the design principles of the FRA.
Consumer protection involves prevention and cure. Prevention requires laws that set financial regulators on the objective of obtaining fairplay by financial firms. Cure requires effective complaint handling mechanisms. The current financial regulatory regime is lacking on both counts.
Gaps in prevention have resulted in unfair sales practices (e.g. see problems in bank led distribution) and poor product design (see problems in insurance). Such gaps have contributed to numerous crises involving abuse of consumers in recent years.
For the cure, we have consumer courts and ad-hoc arrangements by regulators. The consumer courts are over-burdened. They lack human and other resources to deal with financial products. Their interface with financial firms and financial regulators is inadequate. The arrangements put in place by regulators consist of multiple forums. These are SEBI, RBI, the banking ombudsman, the insurance ombudsman, IRDAI, and PFRDA. Consumers need to figure out which is the right one, depending on the situation they are placed in. For some products, like chit funds, one needs to approach the relevant forum in the concerned State. This framework has many weaknesses:-
Consumers are given the runaround. There are many locations in India through which the existing redress forums operate: 16 locations for the banking ombudsman, 17 for the insurance ombudsman and one by PFRDA. SEBI and PFRDA primarily rely on online systems. The consumers are burdened with identifying the right channel and bearing the travel and other related costs.
Lack of uniformity. Consumers and financial service providers (FSPs) have to deal with variations in approach, processes, capacity, service levels and powers across these forums. SEBI runs a facilitation system and is not empowered to award compensation. Therefore, it cannot do much if FSPs deny wrongdoing. PFRDA's system is quite similar to SEBI's. However, last month it appointed a part time ombudsman who can award compensation. The banking and insurance ombudsmen do award compensation. However, the approaches vary significantly. The banking ombudsman awarded compensation in 18 cases in 2015-16, out of over one lakh complaints. In contrast, the insurance ombudsman awarded compensation in nearly 25 percent of the 30,000 cases.
In addition to variations in the redress systems, there is a lack of uniformity in legal frameworks and supervisory capacity of regulators. This leads to regulatory arbitrage. FSPs try to push expensive and opaque products where they spot regulatory gaps or sub-optimal redress mechanisms.
Lack of specialisation. Cross functional teams are required for effective redress in forums like ombudsmen, which aim to resolve matters mainly though mediation. These teams bring together skill and experience in mediation and adjudication, domain expertise, industry experience and appreciation of consumer protection issues across consumer markets. The current system does not offer such possibilities.
Gaps in sectoral redress. Financial markets are converging. As a result, most intermediaries sell a variety of products. For example, banks are also the leading mutual fund and insurance distributors. An unhappy consumer may struggle to identify the party at fault and the relevant redress forum. Problems of this nature have been highlighted in the past. An IRDAI committee on bancassurance had emphasised making banks accountable to the banking ombudsman for insurance policy servicing complaints.
Conflicts between regulators handling individual complaints. Conflicts may arise if a regulator has an ability to deny or delay admitting to systemic problems. A redress forum dependent on the regulator would suffer from this flaw. A weak formal feedback loop between redress and regulatory functions leaves the system vulnerable. For example, the mis-selling in ULIP products may have flourished for an extended period owing to this. Moreover, levying fines on FSPs and awarding compensation to consumers is populist, but can mask prolonged existence of deeper failures of regulation. For instance, FSPs may be under pressure to comply even when they believe they are not in the wrong. This can be due to the fear of regulatory retaliation in some manner, in a non rule of law environment.
When uninformed consumers are asked to navigate this landscape, they are often hesitant and likely to avoid the formal financial system. This will give a sustained bias in the portfolio allocations of households, which is bad for the economy.
The shortcomings in the current consumer protection regime should no longer be ignored. The push for financial inclusion has gained significant momentum. First time consumers account for 260 million bank accounts, 130 million insurance policies and 8 million pension accounts. The push towards cashless payments has similarly brought millions of new consumers to financial payment providers. These new consumers have limited resources, low literacy and even lower financial literacy. There is an urgent need to build the financial regulatory machinery that will protect consumers better.
The journey to consumer protection in Indian finance
In 2009, the Raghuram Rajan committee on financial sector reforms highlighted the regulatory gaps, overlaps, inconsistencies and regulatory arbitrage in the financial sector due to the many laws and agencies. It recommended that regulators work through a collective process to protect consumers and raise financial literacy levels.
In the same year, the Committee on investor awareness and protection, led by me, documented the widespread mis-selling that retail consumers face. It built a case for common minimum regulatory standards for retail financial advisers.
In 2011, the Financial Sector Legislative Reforms Commission (FSLRC), chaired by Justice B. N. Srikrishna, began its work to review the laws governing financial sector. It cemented the understanding that consumer protection was the essence of why we do financial regulation. In 2013, it conceptualised a framework for consumer protection and the FRA. The accompanying draft Indian Financial Code, a model financial sector draft law, placed consumer protection at the centre of financial law.
In 2015, the finance minister, in his budget speech, announced the setting up of a Task Force to establish a sector-neutral financial redress agency. Later that year, the Sumit Bose committee to recommend measures for curbing mis-selling further strengthened the case for a unified FRA. It identified regulatory arbitrage; mis-aligned distribution incentives; poor product design; and disclosure norms as key reasons for mis-selling. In 2016, the Task Force submitted its report to the finance minister. This report has now been released for public comment by the Ministry of Finance.
Foundations of consumer protection
The Task Force, chaired by me, has recommended that a financial consumer protection and redress law be enacted. This should provide for the following basic protections to be uniformly implemented across the entire Indian financial system:
- FSPs must act with professional diligence;
- Protection against unfair terms;
- Protection against unfair conduct;
- Protection of personal information;
- Requirement of fair disclosure; and
- Redress of complaints by FSPs.
Enacting this law would reduce the extent to which consumers seek redress. On the FRA, the blueprint focuses on four attributes:-
Easy access. Consumers of all financial products would go the unified FRA. They would not need to know which regulator is involved. Consumers would be able to access FRA in a user friendly manner in multiple languages through letters; telephone; missed call service; email; mobile apps; text messages; and video. In addition, local facilitation centres would be available to handhold consumers. Consumers would receive regular status updates on their complaint.
Timely redress. FRA's processes, quality and capacity of teams, use of technology, quality of regulations and regulatory supervision: all these would be optimised to deliver timely redress. There would be a fast-track mechanism for simple complaints.
In each case, FRA would first ask the financial firm to offer a solution. Then, the FRA would form a preliminary view and discuss this with the consumer. The complaint would be resolved if a consumer is satisfied at this stage, or through mediation on conference calls. If mediation does not work, FRA would make a decision through adjudication based on facts. It would avoid court like processes.
Regulatory feedback loop. FRA would be independent of regulators, and have no incentive to cover up problems. It would create valuable databases about complaints, and give feedback to regulators to help improve regulations and supervision.
Accountability. FRA's accountability would be ensured through disclosure requirements and performance reviews. The FRA Board would be appointed by the regulators. It would have an Independent Assessment Office to consider complaints against its standard of service. In addition, orders by FRA would be appealable at the Securities Appellate Tribunal.
Building State capacity in FRA
In Indian public policy, there are many good policy proposals, but the implementation capacity is often weak. It is difficult to construct State capacity in the various agencies of the government. The report has worked out the detailed project planning for the construction of FRA.
The Ministry of Finance has setup many new financial agencies in the past. These include SEBI, IRDAI, PFRDA, SAT, FIU, etc. In my knowledge, most of these projects had suffered from lack of adequate preparatory work with consequential delay in implementation. The project planning for FRA has avoided these pitfalls and provides a comprehensive blueprint for establishing this agency.
Consumer protection is the reason why we do financial regulation. The existing financial regulatory system requires major reforms in order to reorient it towards the objective of consumer protection. This will be a long journey. Implementing the FRA Task Force report would be an important step in that journey.
The author was formerly Secretary (Expenditure & Budget), Ministry of Finance; Chairman, PFRDA; Member-Convener, Financial Sector Legislative Reforms Commission and Chairman, Public Debt Management Agency.