Protecting consumers, the heart of finance

Competitive markets in financial services are the best bulwark against consumer fraud in the long run. In the medium term, omnibus and dedicated legislation could be the answer

In her Budget speech this year, Nirmala Sitharaman announced several initiatives with a view to develop and deepen the country’s financial markets. This included the announcement of a unified securities market code that consolidates provisions of various laws on the subject. An investor charter has also been proposed — this charter would assimilate the rights of investors across all financial services. One year ago, a National Strategy for Financial Education (2020-2025) prepared by the financial sector regulators was released by the Reserve Bank of India (RBI). This strategy document thinks deeply about consumer protection and education. On August 17, the RBI introduced a financial inclusion index. A unique feature of the index is the weight attached to a parameter that captures the quality aspect of financial inclusion as reflected by financial literacy, consumer protection, and inequalities and deficiencies in services.

India does not have an omnibus legislation governing consumer protection for financial services. The protections offered under the Consumer Protection Act, 2019 (COPA) are an improvement over the erstwhile 1986 legislation. A full understanding of the legal effects of COPA in the context of extant financial law has not yet been achieved. But it is fundamentally oriented towards consumers of non-financial goods and services.

Alongside this, there are concerns about how consumers are treated. A respected financial newspaper ran a four-part series on the Indian investor in December 2019, which was provocatively titled “How Indian regulators have cost you money”. The series argued that it was the Indian investor “who has always paid for lax regulations, misuse, fraud, mis-selling and poor corporate governance of the financial sector”. The tagline of the first piece in the series said “household savings have been wiped off from under the nose of financial regulators”. Such feedback from the ground raises concerns about the state of affairs.

What is the root cause of these problems? The present financial laws do not establish a precise legal framework for consumer protection in finance. The sectoral organisation of regulations has created regulators that tend to identify with the objectives of “their” industries. The working of the existing regulators on quasi-legislative and quasi-executive functions has shortcomings, which feeds through into their work on consumer protection also. Invisible infrastructure on problems such as privacy is lacking. A consumer-friendly redress mechanism is lacking. Finally, the present inter-connected systems of financial repression and debt management generate financing for public debt in ways that are unfair to the users of formal finance in India.

Illustration: Binay Sinha

It is interesting to go back to a decisive moment in the history of Indian financial economic policy— 2010. In the two-three years preceding, there was widespread concern about mis-selling of ULIPs by insurance companies. Pranab Mukherjee, as finance minister, supported Irdai (against Sebi) in this conflict. But at the same time, he was a canny politician, with his ear to the ground. He understood that there were fundamental failures in Indian finance, which had created conditions for mis-selling of ULIPs by insurance companies. The mere fact that there was a regulator (Irdai) or that there was a public sector insurance company (LIC) in the fray had not sufficed in addressing the problem. This helped rule out the standard simplistic solutions that tend to be offered in India: “The private sector cannot be trusted” (but LIC was equally active in the mis-selling) and “We need a regulator” (Irdai was fully supportive of the mis-selling).

No laws had been violated when vast resources were unfairly extracted from consumers (https://bit.ly/3gxvU58). When the enormity of this sank in, Pranab Mukherjee understood that the present laws are fundamentally incompatible with a financial system that is fair to consumers. This led him to announce the creation of the Financial Sector Legislative Reforms Commission (FSLRC) in the 2010 budget. The order of the Ministry of Finance dated 24/03/11 constituting the FSLRC in clause 2 (viii) explicitly mandated an examination of issues of data privacy and protection of consumer financial services in the Indian context. 

The FSLRC drafted the “Indian Financial Code version 1.1”. In this, there is a strategy for consumer protection through prevention and cure. The prevention is done by solving the problems of financial regulatory architecture, the working of regulators, and setting regulators into motion for the pursuit of a clear set of principles defining consumer protection. By and large, this is expected to address many aspects of consumer protection. On top of this, there will always be situations with aggrieved consumers where some transactions have gone wrong. For this, it proposed a unified and independent Financial Redress Agency (FRA) — a one-stop forum for complaint settlement for all financial consumers. This does away with the multiplicity of redress forums (internal forum of the FSP, sectoral ombudsman, consumer dispute redressal forums, civil courts) and allied costs. 

The work of FSLRC ended in 2015. In many respects, when we look at the various forms of consumer abuse in Indian finance, and the root cause analysis of where these problems are coming from, we are able to see that the institutional reforms proposed by the FSLRC would have delivered better outcomes. But alongside that, we also need to note the role of sheer economic growth and private sector sophistication in protecting consumers.

It is said that the efficient market protects the sheep from the wolves. A deep and liquid market is the best protection for ordinary consumers, better than the protection of interventionist regulators. We should not lose sight of the foundations of a dynamic, innovative and competitive market economy as the greatest source of good for consumers. Too often in India, we are veering towards a more socialistic and centrally-planned system, in the name of protecting consumers. To the extent that this reduces gross domestic product growth and perpetuates poverty, this is the greatest form of consumer abuse. Our biggest task in consumer protection should be to break away from the cosy stasis of regulators and industries who enjoy their peace of mind in a low growth economy that benefits incumbents at the expense of the citizenry.

The writer is professor NCAER and member of a few for profit and not for profit boards and former civil servant