Despite hundreds of mutual fund schemes, equity shares, insurance products and bank products, Indians are wary of financial products for reasons I have explained in my previous piece (“Signs of premature ageing?”, January 2) — companies sell harmful or irrelevant products and regulators do too little. But even assuming that Indian regulators did their job, would it have meant a lot of more (informed) buying of financial products? Possibly not.
Consider the opening sentence of a recent story in Financial Times: “Investors cannot be counted on to make rational choices so regulators need to ‘step into their footprints’ and limit or ban the sale of potentially harmful products, the head of the UK’s new consumer protection watchdog said.” In short, you don’t know what is good for you. Apart from watching companies and intermediaries, the regulator has to watch you, and be ready to pounce to save you.
This is sacrilege. For three decades after the Berlin Wall fell, the world has been in the grip of hands-off regulation. We have believed that, along with technological innovation and freer movement of goods and people, “financial innovation” and lower regulation have been good for the world — more financial products, more options, reduced costs, better lives.... And now, the circle has turned fully. Innovation, choice and global practices are not what they are supposed to be. A respected and conscientious regulator tells us that we cannot be trusted to do it all by ourselves. Martin Wheatley told Financial Times that the 2008 financial crisis had fundamentally reshaped regulators’ assumptions about the people they protected. “You have to assume that you don’t have rational consumers. Faced with complex decisions or too much information, they default ... They hide behind credit rating agencies or behind the promises that are given to them by the salesperson,” said Mr Wheatley.
Do Indian regulators have any clue as to what Mr Wheatley is saying? You cannot blame them, because even Robert Rubin (treasury secretary under Bill Clinton), Alan Greenspan (chairman of the Federal Reserve) and Larry Summers (deputy treasury secretary) did not know any of this between 1999 and 2008 when they were directly and indirectly responsible for a stock market and housing bubble in the US. Even now, US politicians and regulators remain staunch believers in the “invisible hand” playing the same role in financial markets as it does elsewhere.
But what UK regulators have realised is something so fundamental that it will alter basic regulatory philosophy. It will be unfortunate if Indian regulators don’t pay attention to it and change accordingly. The realisation draws from research into behavioural economics, which has been around for 30 years. It is the discovery that the rational economic man does not exist.
The fact is that investors are hard-wired to be irrational when confronted with financial choices — the precise reason this column has the slug it has. They cannot calculate the impact of inflation, cannot understand risk, have irrational fears, cannot deal with volatility and simply won’t do any hard work themselves. After reading dozens of books on the 2008 financial crisis, on behavioural finance and on investment processes, I came to a conclusion as to why that happens: investors move from the physical to the financial world without realising the fundamental differences between the two — and make gross mistakes. This was the subject of my column in December (“Why there’s no Apple in retail finance”, December 5).
But neither do the regulators! While the savers have been grappling with the problems of understanding (intangible) financial products and are unable to harness their true benefits as they traverse a minefield of deceit, the regulators have always behaved as if this was not their problem. The Securities and Exchange Board of India (Sebi) , born just after the Berlin Wall fell, had adopted what is called a “disclosure-based” regime. The idea: as long as all facts of a product were disclosed, the regulator had done its job. Savers were expected to read and act rationally. This was a welcome philosophy then, because we were desperate to escape the heavy hand of the state that had stifled growth throughout the post-Independence period.
Yet, the pitfalls of the disclosure-based regime were immediately visible in the public issue mania of 1994 and in the long list of harmful products which periodically duped investors. But for decades, we have blamed everything on the poor rational savers. You are condemned to lose money if you don’t read the fine print and ask the right questions. No longer. Now the assumption is investors are always irrational.
If so, this is momentous. What should be the job of regulators? Rather than ensuring that consumers are provided with enough information, the UK regulator will make sure that the right kinds of products are sold to the right kinds of people. Will Sebi, which quotes UK regulations when convenient, follow the UK example? An activist Sebi? You can’t even dream of it.
Frankly, the Reserve Bank, Sebi, the insurance regulator and quasi-regulators would not even debate this sensible regulatory approach. It demands too much independent thinking and attracts too much of responsibility. But policy makers, consumer associations and academics must push for regulation of the UK kind if they genuinely are on the (irrational) savers’ side.
The writer is the editor and publisher of www.moneylife.in editor@moneylife.in
