Consumer Protection Report by Financial Sector Legislative Reforms Commission

satisfaction-guaranteedThe report submitted by the Commission on financial sector reforms has a detailed chapter on consumer protection. It has recommended inverting the current scenario of “buyer beware” to a “seller beware” situation. Read the following report to understand the recommendations

Strategic picture

A well functioning financial system should allow individuals, households and enterprises to efficiently allocate and manage their resources and protect themselves from risk, through the use of financial products and services. This involves complex interactions between consumers and financial service providers. At a first level, these interactions require the support of law to define and protect property rights and facilitate the enforcement of contracts.

However, the complexity of financial markets and the existence of market failures in the form of information asymmetries, market externalities and differences in the bargaining powers of consumers and service providers, create the need for a higher standard of protection for financial consumers. The need for financial consumers to be treated fairly makes it appropriate to adopt a more intrusive approach to financial regulation, when compared with most other fields.

Currently, the strategy in Indian finance is focused on the doctrine of caveat emptor: let the buyer beware. Beyond protection from fraud and provisions to ensure full disclosure, consumers are generally left to their own devices. After extensive analysis and debate on these questions, the Commission believes that to the extent that consumers of financial services are more vulnerable than consumers of ordinary goods and services, higher standards of protection ensured by special efforts of the State are justified.

The vulnerability of consumers reflects a major gap in Indian financial regulation, which needs to be addressed. As such, the Commission recommends the adoption of a consolidated, non-sector-specific, consumer protection framework for the entire financial system that will empower and require regulators to pursue consumer protection for the financial activities regulated by them. In this context, the draft Code approaches the problems of consumer protection on two fronts: prevention and cure.

Prevention requires regulation-making and enforcement across the entire financial system from the viewpoint of consumer interests. For example, looking at questions of remuneration and conflicts of interest, when a sales agent sells a financial product to a household, and gets paid a fee by the producer of this financial product, is there a problem with conflicts of interest? How do we evolve a structure where the provider acts in the best interest of the consumer? Regulators should be obliged to grapple with questions such as these.

The consumer protection part of the draft Code has three components: an enumerated set of rights and protections for consumers, an enumerated set of powers in the hands of the regulator, and principles that guide what power should be used under what circumstances. The details of consumer protection would, of course, lie in the subordinated legislation to be drafted by financial regulators. Whether or not, for example, loads and other conflicted remuneration structures should be banned is a question that would need to be addressed by the regulator. The regulator will use its authority to develop subordinate legislation which will adapt over the years to reflect financial innovation, technological change, and the evolving nature of the Indian economy. Alongside this regulation-making mandate, the regulator would also have supervisory roles to ensure compliance with the law.

In India, so far, the financial regulatory structure has been defined by sector, with multiple laws and often multiple agencies covering various sectors. This has led to inconsistent treatment, and regulatory arbitrage. Regulators have sometimes been lax in developing required protections out of notions of facilitating growth in the industry. These problems would be reduced by having a single principles-based law which would cover the entire financial system. The Commission believes that an overarching principles based body of law would allow regulatory flexibility, consistent treatment of consumers across all aspects of their engagement with the financial system, fairness and ultimately a more stable financial system.

Turning from prevention to cure, the Commission proposes the creation of a unified financial redress agency. The redress agency is expected to have front-ends in every district of India, where consumers of all financial products will be able to submit complaints. Modern technology will be used to connect these front-ends into a centralized light-weight adjudication process. A well structured work-flow process will support speedy and fair handling of cases. Consumers will deal only with the redress agency when they have grievances in any financial activity: they will not have to deal with multiple agencies.

The complaints brought before the redress agency will shed light on where the problems of consumer protection are being found, and thus suggest areas for improvement in subordinated legislation. As such, a key feature of the redress agency will be the creation of a feedback loop through which the computerised case database of the redress agency will be utilised by the regulator to make better regulations on a systematic basis.

India needs a capable financial system, with sophisticated private financial firms.

However, the emergence of this financial system should not become a carte blanche for clever financial firms who achieve undue influence with their regulators, to take unfair advantage of customers. The present financial laws in India are vulnerable to such a prospect. As such, the Commission believes that it is essential to place the function of consumer protection at the heart of financial regulation (see Table 5.1).

Framework on consumer protection

The draft Code contains a consolidated non-sector-specific financial consumer protection framework. It identifies consumer protection as a key regulatory objective and contains the following preventive and curative components:

1. Preventive tools

  • Certain protections are provided to all financial consumers.
  • An additional set of protections are provided to unsophisticated or retail consumers.
  • The regulator is given a list of enumerated powers which it can use in order to implement these protections.
  •  The regulator will be guided by a list of principles that should inform the exercise of its powers.
  • The regulator has been given the power to supervise financial service providers and initiate enforcement and disciplinary actions.

2. Curative tools

  • Creation of an independent financial redress agency to redress complaints of retail consumers against all financial service providers.
  •  A research program, applied to the data emanating from the redress agency, will feed back to the regulator and thus enable improvements in its work.

The terms “consumer”’ and “retail consumer” are defined in the draft Code to mean:

1. Consumer: A person who has availed, avails, or intends to avail a financial service or has a right or interest in a financial product.

2. Retail consumer: A consumer that is an individual or an eligible enterprise, if the value of the financial product or service does not exceed the limit specified by the regulator in relation to that product or service. The regulator may specify different limits for different categories of financial products and services.

3. Eligible enterprise: An enterprise that has less than a specified level of net asset value or has less than a specified level of turnover. Each of these caps will be specified by the regulator.