Consumer
Protection in Financial services –Some
aspects
Recent move by the Reserve Bank
of India, putting a stop to the so called “Zero Interest schemes by Banks was a
very welcome move. Just as one was feeling happy reading this, clearly a step
towards greater transparency and a good progressive measure towards increased consumer protection,
came the dampener a few days later, that RBI’s announcement could possible apply only to Banks and not to NBFC s( Non-Banking Financial
Companies) meaning that all the Finance Companies can continue to offer Zero
Interest rates.
Why Zero Interest schemes are
really not Zero Interest? Most of the lenders charge a significant amount as
“processing charges”. Actual processing effort may be insignificant and
charging a large processing fee on the “buyer/borrower” is nothing but an
upfront interest collection. Such Zero Interest schemes are generally operated
in respect of “Durables” and run for a period of just about a year (12 Equated
Monthly Installments ) or in some cases could be a bit longer period. On a
Consumer durable of Rs. 25,000, processing fee of Rs. 4,000 is 16% PA and the
entire processing fee is collected upfront. Calling interest as “processing
fees” does not change the fact that there is an underlying financial cost.
There is need for transparency. Precisely
for this, that is, for protection of all types of consumers, that the
Government had progressively brought in various measures like the compulsory
need to have an all-inclusive MRP (Maximum Retail price), the need to clearly mention
the weight of contents on the label etc. Old timers may recall a period when
the packages used to carry “Price…..Rs…” plus local taxes. This used to give
ample scope for misuse.
Government also had enacted a
Consumer protection Act, 1986 providing protection to consumers on various aspects,
like price, quantity and quality.
A complicated law or a law which
draws oblique references or a law which gives rise to varying interpretations
or even a law which is not laid out in simple and clear terms become just laws
in the books and do not really contribute to ensure what it was enacted to
achieve.
People availing of Banking and
financial services are in fact covered by the Consumer Protection Act, 1986. The
Act does talk of shortfall in services and misleading statements, which can be a
cause for “complaint”, but let us look at some aspects in the Financial
services Industry which are misleading without appearing to be so. The players
in financial services Industry, at least many of them if not all of them,
mislead borrowers /lenders in very subtle ways. Let us examine some aspects.
Companies quoting Simple interest rates-termed as Yields
Companies which take in “deposits”
from the public talk of Annualized yields. What is this yield? A, Rs. 1,000,
5 years cumulative deposit on which, a 12% PA interest is payable, would be Rs.
1762 at the end of 5 years. Companies quote it as yield of 15.24% per annum. People
who have some basic understanding of finance and interest methodologies know
that this is nothing but “simple
interest”. Compare this with an honest Company which has very similar terms
but announces that they pay on a 5 year cumulative deposit an annualized
interest rate of 12% at yearly rests. There is absolutely no difference at all in the terms but the consumers would
gravitate towards the 15.24% interest
after all a 15.24% interest is better than a 12% interest, never
understanding the simple Interest Vs.
Compound interest aspects.
Interest accumulations at monthly Vs. Quarterly vs. Annual rests-Compounded
We all know that Interest at monthly
or quarterly or yearly rests make a difference to the overall returns. A 12%
coupon rate at monthly rests is 12.68% on an annualized basis, the same at quarterly
rests is 12.55% and at annual rests is 12%.
When a retail depositor compares,
he has to be given a logical comparison. The attempt is always to give out a
comparison computed on different assumptions. To evade the long arm of the
regulatory authorities, the Companies which come out with advertisements always
have a footnote or fine print where so much information is loaded that one
finds it difficult to make the critical ones from the non-critical ones, the
result is nothing gets read by the depositor.
Flat rate Vs. Reduced balance method
Just as Companies beef up the
rates of interest when they borrow to make it seem attractive to the
depositors, they take exactly the opposite tack when it comes to lending.
Obviously when lending, the Financial services Companies have to communicate
how attractive their lending rates are Vis a Vis the Competitors. Lower the
interest rate, real or illusory, better for the finance companies to attract
borrowers. A very common method is the bold, headline grabbing interest rates,
which come with a footnote or qualification, “flat rate”. “Flat rate” is
nothing but charge of interest on the original amount borrowed, ignoring the EMIs
(Equated monthly installments) paid on a monthly basis. The normal and the
correct method is “reducing balance method” would obviously be much higher.
Such lending is resorted to on “Cars” and “vehicles”. To illustrate the
disparity, a so called flat rate of 7% for a loan taken for 5 years on which
repayments are made on a monthly basis would be a little over 11% under the
“reducing balance method”. When Companies advertise “Flat rates”, what
incentive would be there for other Companies/competitors to be transparent and
honest, after all, it would cost them business.
In some of the countries like
United States of America, there is a requirement to quote the rate only in APP
or Annual Percentage points or APR (Annual percentage rate), which is nothing
but expressing the rate of interest at annual rests basis. The idea is to make
it really comparable.
Consumer protection in the
financial services does not require a great enactment; all it requires is
making standardization a compulsion. Standard terms and methodologies can be
defined to make the financial services company express their cost as an
equivalent of MRP (Maximum Retail Price), or in this case we can evolve
something called a Maximum Interest Cost Percentage-MICP.
We all know that even stalwarts
and seasoned finance professionals got hoodwinked a few years back on so called
“esoteric” derivatives by top class and reputed Banks in the Country. The unknowing
and sometime gullible public definitely requires protection and transparency
and standardization can be starting points towards that.
Submitted to CA Club
