Perverse incentive structures in banks under RBI scanner

RBI has warned banks that it is taking a closer look at the ‘perverse incentive structures’ that are leading to ‘widespread mis-selling’ of third party products such as insurance to account holders

Intense competition and perverse incentive structures have frequently led to widespread mis-selling of products and misdirection of clients to inappropriate and risky investments by financial service providers, says the Reserve Bank of India’s (RBI) financial stability report released on 27 June 2013.

Para 3.50 of the Financial stability report states that “There seems to be an urgent need to revisit the marketing and sales strategies used by the banks in pushing insurance products, especially since insurance is among the more complex of financial products for the common man to fully comprehend”.

Regarding insurance as a third party product para 3.52 states that “Banks have been advised to disclose to the customers, details of all the commissions / other fees (in any form) received, if any, from the various companies for marketing / referring their products, even in cases where the bank is marketing/ distributing/ referring products of only one company”


Regarding mis-selling in wealth management and other related activities para 3.55 states that “The recently notified SEBI (Investment Advisers) Regulations, 2013, contain detailed norms for risk profiling and suitability, creation of a Separately Identifiable Department or Division (SIDD) for IAS, detailed disclosure to the clients including any conflicts of interest, redressal of investor grievances, etc. Such norms are expected to address mis-selling risks to a certain extent”. Read RBI reviewing guidelines on mis-selling by banks in wealth management services

Earlier, the focus of the Open House session organised by Moneylife Foundation with the RBI deputy governor Dr KC Chakrabarty was on various aspects of banking services, including mis-selling of third party products, grievance redressal system and technology glitches in banks.

While accepting that mis-selling should not happen in banks, Dr Chakrabarty had said, “Mis-selling is same across banks and brokers and we need to first identify what is mis-selling. For example, insurance penetration in our country is just 5-6%. However, even the highly educated people fall for ‘higher returns’, rather than the insurance cover and sign papers blankly”.

Moneylife Foundation placed before the deputy governor, a few submissions regarding third party products.

Selling process: If they continue to sell these products, a specific sign off by the customer on all clauses denoting risk factors and disclosure is a must. The BCSBI along with consumer bodies can be asked to work on these in a time bound manner but not more than three months.

Onus on banks: The onus of selling products appropriate to customers must be on the banks. Otherwise, they will keep selling a five-year locked in mutual fund to a 79-year old man. Or sell ULIP to a 60+ retiree, which requires hefty premium payments to be made for five years before it starts making any returns at all.

Paper trail: Banks must be made responsible to create proof and trail mail/hard copy when relationship managers/tellers accost customers at home or at the banks. A clear email spelling out specific terms and pros and cons must be sent to the consumer.

Compensation: RBI must codify compensation to victims of mis-selling. Since the onus of proving appropriateness of products must be on the bankers, there must be detailed specified penalties when mis-selling is established.

Moneylife had even written a memorandum to the RBI in context to mis-selling, it can be found here.

Regarding Technology issues para 3.60 of the report states that “While leveraging on technology has resulted in many benefits, especially, in extending the reach of the financial services, these developments pose challenges in the form of regulatory, legal and operational risks”. Moneylife has come up with certain suggestions for the same: There must be an annual IT audit to verify the robustness of banks systems and their calculation of tax deductions, interest and equated monthly instalments. Mistakes, such as SBI’s 40% deduction, must be reported to RBI along with corrective action.

Regarding KYC para 3.56 of the report mentions that “All financial sector entities need to comply with the extant KYC, which are meant for safeguarding the financial system against the possibility of its use for money laundering” which Moneylife has been advocating since a long time.

RBI has clearly listened to what we have said with some seriousness. However, flagging these issues in the financial stability report is only the first step; consumers may have to wait for a real change in rules that ensures an end to mis-selling.

You may also want to read

Mis-selling Is Inherent to Life Insurance, Cartelisation, not competition, decides banking service charges, Customer service in banking is not negotiable, asserts Dr Chakrabarty.

You can watch the

Open House session with the Deputy Governor Dr KC Chakrabarty here.


IRDA bancassurance guidelines put on hold: Will the core issues be addressed?
IRDA guidelines on bancassurance were expected to be released in August 2013, but are now on hold after the Department of Financial Services questioned the rationale of insurers tying up with banks on a geographical basis and asking for wider consultation with stakeholders  
The Insurance Regulatory and Development Authority’s (IRDA) guidelines on bancassurance, which were expected to be out by next month have hit a hurdle. The department of financial services (DFS), which works under the finance ministry, has questioned the rationale of insurance companies tying up with banks on a geographical basis. DFS also wants to have a wider consultation with stakeholders. DFS directive has asked for IRDA’s bancassurance guidelines to be put on hold.
Bancassurance guidelines specify the rules for insurance companies to appoint banks as their corporate agents to sell policies. Currently, a bank is allowed to sell the products of only one life and non-life insurance company as a corporate agent. The proposed draft divides the country into three zones comprising of 40 regions. A bank could tie up with only one insurer for a minimum of 10 regions and a maximum of 20. It means that banks can tie-up with a minimum of two insurance companies while the maximum can be four. 
DFS feels that IRDA’s proposal to have a zone-wise tie-up with banks will be complicated. Several banks and insurance companies have raised concerns about logistical problems if the zone-wise tie-up is implemented. But, banks and insurers have their own reasons for either wanting open architecture or to remain with the existing exclusive one life and non-life insurer tie-up. 
The insurance companies who are looking for open architecture are the ones who are not promoted by banks and hence have limited bancassurance alliance. Conversely, bank promoted insurance companies would like to have an exclusive tie-up with their parent bank to keep competitors at bay. What is the incentive to be their exclusive corporate agents, considering that banks get a big premium from insurance companies? Insurance companies would rather keep monopoly of exclusive tie-up with their promoter bank and hope that other banks take up a broking license to sell products of multiple insurance companies.   
Moneylife is of the opinion that making banks are not accountable to consumers, and going for an open architecture can further complicate the matter. We have highlighted numerous cases of mis-selling of life insurance policies to bank customers? Even senior citizens are not spared; in-fact they are an easy target and are conned by false promises that insurance products will offer better returns than their existing fixed deposits. Young couples fall for expensive schemes that promise to secure their child’s future and buy the products without understanding different charges that decimate the corpus. It is time the DFS addressed these issues rather than restricting themselves to the logistics of bancassurance alliances for multiple insurers.
Currently, bancassurance partners do not own the responsibility of mis-selling as they are mere corporate agents and not brokers. An insurance broker represents customers unlike an agent who represents an insurance company. The Reserve Bank of India (RBI) may not be in favour of allowing banks to set up broking arms as their performance will affect the balance sheet of the bank itself, which will not be in the interest of depositors. RBI had said that banks assuming the role of insurance brokers could lead to a conflict of interests where the bank was also the promoter of an insurance company. 
RBI's financial stability report’s Chapter III - Financial Sector Regulation and Infrastructure raises several crucial questions on bancassurance model’s use of unfair and restrictive practices. 
Here are some important points raised in the report – 
Under the ‘bancassurance’ model, banks in India have been permitted to undertake insurance business as agents of insurance companies subject to certain conditions and without any risk participation since August 2000. As announced in the Union Budget 2013-14, it is proposed to permit banks to act as insurance brokers so that the entire network of bank branches will be utilised to increase the penetration of insurance services in the country. As insurance brokers the banks will be able to sell insurance products of any company, as against the restriction of only one company applicable under the agent-principal model. 
While banks are well suited to distribute insurance products because of their wide network, several issues have arisen regarding their conduct in the process, generally pertaining to mis-selling and certain restrictive / unfair practices (such as linking provision of locker facilities to purchase of insurance products, selling of unsuitable and/or multiple policies etc). 
It was observed that in some cases, banks did not have clear segregation of duties of marketing personnel from other branch functions and bank employees were directly receiving incentives from third parties such as insurance companies, mutual funds and other entities for selling their products. In some cases direct incentives to the bank staff have created distortions in the sales structure. 
According to IRDA’s Annual Report 2011-12 the maximum complaints in life insurance related to mis-selling. They also mainly pertained to the private sector, though LIC leads the business with over 70% share. The type of complaints were mainly in the nature of unfair trade practices and mis-selling of products (e.g. malpractices, actual product sold being different from what was proposed, single premium policy being issued as annual premium policy, surrender value being different from projected, free look refund not paid, misappropriation of premiums etc). 
As a significant portion of private life insurance companies use banks as their corporate agents, there seems to be an urgent need to revisit the marketing and sales strategies used by the banks in pushing insurance products, especially since insurance is among the more complex of financial products for the common man to fully comprehend. The limits on commission structure and the operating expenses of insurance companies are laid down in the Insurance Act, 1938 and the Rules framed there under. The compliance with these limits is being monitored by IRDA on an annual basis, and instances of breach are dealt with through penal action. In the recent past, there have been instances of both insurance companies as also the corporate agents (banks) being penalised.


RBI restricts banks from F&O trading in currency

According to the Reserve Bank, any transaction by banks in currency markets will have to be necessarily on behalf of their clients

The Reserve Bank of India (RBI) has imposed restriction on banks with regard to trading in currency futures and options (F&O) with immediate effect, in order to arrest the decline of rupee against the US dollar.


In a notification, the central bank said, "On a review of the evolving market conditions, it has been decided that banks should not carry out any proprietary trading in the currency futures/ exchange traded currency options markets."


Under the new norms, the banks have been barred from trading in currency futures and exchange traded currency options market on their own. They will, however, be allowed to trade on behalf of their clients.


The move is apparently aimed at stemming the declining value of rupee which touched its life-time low of 61.21 to a dollar yesterday.


On Monday, market regulator Securities and Exchange Board of India (SEBI) tightened the exposure norms for currency derivatives to check large scale speculations in the market.


In a circular, SEBI said that it is reducing the exposure that brokers and their clients can take on currency derivatives and also doubled their margins on dollar-rupee contracts.


Currency derivative trading allows investors to take forward views on various currency pairs, including rupee- dollar, and it was being felt that large-scale speculations on their future movements might be adding to the downward pressure on the Indian currency.


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