One danger in keeping the incentive structures common across all categories is that distributors will stop focusing on products that are more difficult to sell.
Executive Director, Business Advisory, KPMG Advisory Services
‘If customers are to be attracted to higher-risk products, those doing the selling need incentives - uniform commissions will kill the business’
Those clamouring for standardised commissions across all financial products would do well to keep in mind Abraham Lincoln’s statement that ‘Equality of opportunity is freedom, but equality of outcome is tyranny’. Many argue for a customer-centric model instead of a commission-centric one and claim various financial products are opaque. While the idea of standardised commissions sounds idealistic, it is highly infeasible — it’s like saying that each financial product will give exactly the same returns.
Good practices such as the need for transparency in advice or commissions on the basis of performance are good causes to pursue, but their pursuit must not be diluted by impractical ideas such as standardised commissions.
We need to keep three key underlying facts in mind: The risk-versus-returns profile of products differs not just between various categories of financial products but also within the same category. As an illustration, while the differences between the risk-versus-returns of debt and equity products are stark, the differences between different equity products or debt products are equally vast. Each product, therefore, needs to be priced according to its underlying risk and potential return and, in turn, the commission payable to the distributor must be aligned. To bring fairness to this mix, some portion of the commission could be paid at the time of buying the product, while the balance would be paid on the basis of the performance of the product over time.
Building a critical mass and ensuring deeper penetration in a developing market requires a sustainable high-volume distribution model. Basic economics tell us that this can only be built on the back of an attractive commission structure. To reach customers in the hinterland, the right financial incentives are a must for distributors to build scale. Low standardised commissions will potentially result in distributors looking for easy pickings, rather than investing in deepening the market.
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Given our conservative nature (look at our unproductively high savings rate), advisors and distributors in India have a huge challenge getting a very risk-averse population (that prefers investing in fixed deposits, small savings scheme and other low-yield instruments) to move to even slightly higher risk categories of investment. In order to be able to do this, the distribution and advisory force will have to be better educated and trained — to understand customer needs, to give appropriate advice and invest in building trusted relationships. This investment in training will not happen unless there is payback — initially, in the form of attractive commissions and, as relationships mature, in the form of a success and transparency-based advisory fee. In a balanced portfolio, low commission-based debt products or term plans will only be sold if the commissions on equity or ULIP plans compensate the advisor adequately, thus enabling them to sustain interest in nurturing the relationship.
In a relatively free-market model, as adopted wisely by India, there will always be a thin grey line between protecting investors’ interest and over-regulating the spirit of free markets. Companies that invest in product- innovation, in building long-term performance and distribution reach and enhanced customer service infrastructure must seek and be rewarded with differentiated pricing and thus be able to pay better commissions.
Standardising commission structures will do immense long-term harm by rewarding bad performers and punishing the good ones.
Robin Roy
Associate Director, Financial Services PricewaterhouseCoopers
‘Just as no-frills bank accounts encourage users, standardising commission across various financial products will attract users’
In an under-penetrated financial services market, consumers are not aware of product details and cost structures. Financial products have got commoditised and, more often then not, are sold to consumers by various distributors. In a growing market, everything sells quickly. Depending on the risk profile of the consumers, they pick a suitable product, hopefully supplemented by the distributor’s inputs.
While product brochures of various financial products have more disclosures, these are often in the fine print and may not always be seen by consumers who either lack the time or the patience to examine them in detail. The BCSBI (Banking Codes & Standards Board of India), an independent watch-dog, monitors the code adopted by participating banks, covering service tariffs, interest rates and customer rights.
A welter of service charges, covering transactions, inter-bank fees and a maze of interest calculations hide the all-inclusive cost to the consumer. The question is of how many times an average consumer even looks at such charges while agreeing to a transaction.
Given the need for financial inclusion, we need to bring in more people into the fold of the banking system through the use of no-frills accounts — the same has to be done when it comes to financial products as well. This could be done by standardising commissions on plain vanilla financial products — this will also help sustain volume growth in the financial services sector in these times when there is a lower demand for such products. Financial services’ firms can always charge high net worth individuals (HNIs) additional fees under the head of wealth management or other sophisticated products,tailored to their requirements.
Let us not forget that consumer banking or retail banking is not immediately profitable and needs to be built up over a couple of years. Banks indicate their lending rates as a percentage above or below the Prime Lending Rate — the RBI has formed a committee to look into bringing in more transparency into the cost structures of banks. This would suggest that having a welter of charges for financial products could well hamper their growth.
Would standardisation of commissions for financial products be a catalyst for future growth? All indicators would suggest we have a long way to go. Thus, our life insurance premium-to-GDP ratio is under 6 per cent, we have under 30 crore bank accounts for our 120 crore population and the Assets Under Management (AUM) of mutual funds is a very small proportion of our GDP.
It would be myopic to constrain growth in the financial services sector at the altar of commissions, service charges, discounts or fee. We should allow the market to stabilise and mature and only then look at creating a more segmented market with differential commission structures. To cite one example, the non-life insurance premium-to-GDP was just 0.6 per cent in India in 2008, as compared to 1.6 per cent in Asia as a whole and 3.1 per cent in the world. To cite another example, the life insurance premium-to-GDP in 2007-08 was below 4 per cent in India as compared to above 6 per cent in Singapore and more than 9 per cent in the UK.
So, until the penetration of financial products in India reaches levels close to either global or Asian benchmarks, it would be a good idea to standardise charges on similar and mass-marketed products — this would also go a long way in sustaining growth in this sector.