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Mis-selling of Products and Risky Financial Management in Indian Banking

Cofounder , Goalchi Capital
Jan 6, 2018 1:53 AM 6 min read

Editor’s comment: In a renewed attempt to separate the role of a financial advisor from that of a distributor, the Securities and Exchange Board of India (SEBI), India’s market regulator has recommended that if an agent advices on a product, he shall not be allowed to sell the product. Conversely, if an agent sells a product, he shall not be allowed to recommend it. This is to check the prevalent malpractice of mis-selling in the industry, wherein a financial agent suggests/sells a product not as per the requirement or risk appetite of the consumer, but instead to enhance his direct or indirect incentive from the sale.




Financial markets in India offer a varied range of products, catering to the diverse requirements of consumers. Investors can choose from a wide variety of fixed deposits, shares, bonds, mutual funds, insurance policies etc. either by themselves or through intermediaries (banks, insurance agents, mutual fund distributors and Financial Advisors like CFP). These myriad agents, even though serving as a key distribution channel to increase penetration are also in most cases responsible for the biggest menace threatening the industry i.e. mis-selling of financial products.


What is Mis-selling?

The act of misrepresenting facts and/or giving deceptive and ambiguous information about the product or service, just to complete a sale is considered as mis-selling. The salesperson may falsely represent a product and push for its immediate necessity, even though that is not really the case, or ask the customer to buy product or service that is unsuitable for him, especially in terms of one’s risk profile.


For instance, selling life insurance to a person with no dependents is a quintessential case of mis-selling.


Mis-selling by Banks

Banks in India are one of the largest and most “trusted” financial intermediaries, but are also guilty of a major share of mis-selling cases - especially mis-selling of insurance policies in India and other such third-party products like mutual funds. For such products the banks themselves do not underwrite any risk but simply make a commission on sale, similar to a broker.


Customers visiting branches for their banking needs are often ‘misled’ to invest in these intermediated products which are either unsuitable or not required by them. Many a times bank employees aggressively pitch these to customers, even as they themselves are not familiar with the product structure or its risk profile. Think of bank tellers pushing for share trading accounts or investing in a high risk growth fund, when all you came to do was deposit a cheque. Most of the customer-facing staff is not even licensed to advise nor do they in general understand the products they are pushing.

Some conclusions of a recent study regarding sales processes in banks (both public and private) are fascinating:


Most bank managers don’t take into consideration the requirements of their clients.


The product recommendation is solely a function of incentives. Thus, private sector banks majorly recommend the ‘highest commission product’ (insurance, 75% of the time) while public sector banks (PSBs) recommend the default product (fixed deposits, 72% of the time). This is because while private sector banks incentivize employees for selling high commission products, PSBs focus on deposit mobilization.


According to the same study, amongst those who went to buy Equity Linked Savings Schemes (ELSS) via a bank, 30% were discouraged, 14% were encouraged while 55% got a neutral response. In many cases, managers were unaware of the product itself.


The disclosures made by the salespersons were, in most cases, found to be false or inadequate in a large number of cases.


The following chart represents how banks recommends its products.


New Regulation

It is often challenging to hold the bank responsible if such products are mis-sold by their representatives. However, the practice has come to RBI’s attention following which the sale of mutual funds, insurance policies, and other third party-products has been brought under the purview of the Banking Ombudsman Scheme 2006.


Banking Ombudsman is a quasi-judicial authority set up under the Banking Ombudsman Scheme 2006, which looks into the complaints of customers for banking services, including third-party products such as insurance and mutual funds. The Scheme offers consumers provision to file a complaint in case of non-adherence to RBI guidelines regarding sale of third-party financial products, transparency in sale, non-disclosure of grievance redressal mechanism and delay or refusal to facilitate after-sales service by banks.


Agents and Distributors

Insurance agents and mutual fund distributors are other important intermediaries in a financial market. Most are not recognized or licensed, and have poor knowledge of the product they sell. They usually push products which will earn them more commission, regardless of its need or suitability.


Let’s begin by debunking some of the usual tricks used by agents or distributors to persuade investors into buying their financial products:


Myths and Facts

MYTH 1: Lower Net Asset Value (NAV) mutual funds have better growth prospects


FACT: This is false because growth depends on a multitude of factors such as the portfolio of the fund, the investment style, and overall market conditions. The growth in percentage terms is a better way to look at as it is independent of NAV price


MYTH 2: Invest in a fund because it has returned around 50% last year


FACT: This may be true for certain funds, but it is always better to look at medium and long-term returns as well as the objective of the fund before investing. Moreover, it should fit your portfolio and your risk appetite


MYTH 3: Unit linked insurance plans (ULIPS) offer guaranteed returns


FACT: Like any other financial product, ULIPS don’t always guarantee a return. Much like other products, their returns are linked to market movements


MYTH 4: The fund gives or is about to give huge dividends


FACT: Dividends form part of the NAV and lowers it whenever they are paid out. It is always advisable to opt for long-term growths if you don’t need periodic cash flows.


MYTH 5: These products will double your money in two years


FACT: There is no such product in the market currently that will double your money within two years with absolute certainity


The above list is in no way exhaustive. The financial market is a dynamic space with newer and improved structures evolving every day.


The Need for Financial Planning

Financial planning includes comprehensive optimisation of one’s current and future wealth. Such planning is often centered around tax liability reduction, with a traditional approach focused on investing in government-backed securities or insurance policies.


Investors are often wary of taking professional advice from a certified financial advisor, assisting them with a disciplined and structured investment plan. Instead, they prefer seeking advice from their local bank or a broker. This makes them easy victims of mis-selling.


Financial Advisors

A financial advisor is a professional who specializes in the financial planning of individuals or firms. Financial planners or advisors in India are registered under SEBI and/or have an international certification like CFP. The number of people seeking professional help in managing their portfolios is steadily rising in India. Therefore, it is important to consult an expert advisor before making any investment decision, in case one is not well informed about the diverse facets of the financial markets. A good financial advisor has a better understanding of the dynamics of the market, and has greater resources at his disposal in order to make a sound financial decision on behalf of their client.


Even as SEBI has taken a step in the right direction by mandating the separation of a financial advisor and distributor, it remains to be seen how the regulator shall ensure that an adviser is not incentivized by a distributor and vice versa. In order to cleanse the market of the malpractice these mechanisms need to be set in place, and this still remains an open question.


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