Don't blame the financial players, educate yourself
I notice two disturbing trends in public debates about financial products and advice-sensationalism and righteousness. What are the issues that rile everyone? Banks are defrauding customers, insurance companies are bringing out dubious products, advisers are ripping off customers, mutual funds are inefficient, micro-finance is bad for the poor, and brokers are encouraging gambling. The recommendations and remedies are righteous about who should do what and how. Can we have a balanced debate instead?
Let us not assume that products on sale, including financial products, are expected to meet only basic, defined, necessary and 'good' needs. Marketing is about creating and growing demand for products and services beyond the basics. Otherwise, all of us would be holding the simplest press button mobile phone, and paying a low and affordable price. Those that produce diamond-crusted handsets would surely be sinners.
We can argue about the wasteful consumption of societies and the harmful effects of advertising, but we have come quite a distance to now return to the basics. False claims are made about what shampoos do to hair, ready-to-eat cereals to nutrition, and so on. Product choices are a reality and producers, including those offering financial products, will release into markets what they believe appeals to greed, aspiration, or status.
Consider loans. We should ideally live within our means and spend what we have and taking a loan is downright harmful. Why then do we have banks at all selling us loans? The truth is that without the benefit of borrowing, it would be a small, shrunken world of limited assets, jobs, wealth and opportunities. We may paint loans as the demon, but countless entrepreneurs and households have expanded their horizons with this product. Millions would not own homes if banks did not agree to lend against the asset they liked to own.
By the same reasoning, we can rubbish credit cards as harmful spend-inducing loans, at usurious rates; stock trading as mindless speculative activity; and derivatives as useless tools to disaster. The problem, perhaps, is not in the product, but in its misuse. We need fair and informed exchange between the buyer and seller without being righteous and patronising.
Every financial product, in its basic form, engages two different entities and their balance sheets. A microfinance loan is a useful product for a self-help group of poor women entrepreneurs trying to get a regular income. The lender likes to price it based on his balance sheet, primarily driven by his cost of funds and operations. The borrower takes the loan on her balance sheet hoping to generate income that helps repay the loan in instalments.
Regulatory and governance structures should protect this premise and ensure that the exchange happens on fair terms for both parties. The problems in this market primarily arose with lenders expanding their balance sheets at the cost of quality, and borrowers using multiple lenders to fund expenses rather than assets. Ill-informed regulatory action targeted pricing, recovery and more micro issues and killed this market. The responses to the problem came from a position of misplaced righteousness.
Responsible financial decision-making is the strategic choice that both businesses and households have to make. As consumers, we have learnt to distrust the fancy sale of pure silk garments at a 90% discount, but easily buy into 24% assured returns. It is in our interest to understand what financial products do to our finances, our own balance sheets driven by our income, risks, plans and problems.
If we are able to strategise and implement key life decisions with financial implications, such as how many children we will have and when, whether both spouses will work, and where we will live and earn, we need to make money choices with the same level of strategic seriousness. If it requires us to learn and educate ourselves, that is how it should be.
At a macro level, to create a more healthy market for financial products, we need two core ingredients. The first is the presence of long-term players, who are well capitalized, and set industry benchmarks as they grow. The regulatory environment should focus on nurturing such growth and development, and provide a competitive environment that encourages fair play. Mistaken activism has all but killed the business in at least two cases-micro finance and mutual funds One cannot legislate or integrity, a lesson lost in both these cases.
The second is the presence of a legal system that ensures prompt and punitive action for fraudsters. It is under the inefficient criminal justice system that flyby-night operators dupe investors. Misrepresentation of product features, masking risk in fine print, misleading ads are criminal activities that need to be dealt with as such. Financial product mis-selling is one manifestation of this deficient justice system.
Financial products and their sales happen in the larger context of a poorly regulated and less developed market. Passing on the blame, expecting protection, and wallowing in helplessness is not going to help anyone. Investors can begin by making the effort to see financial transactions as a deal between equals on terms both parties understand and agree upon. There is no short-cut to informed decision-making.
Source: ET
Best Regards
Prakash Nair
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