Tough to separate sales from advisory

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Nearly three years ago, the Reserve Bank of India (RBI) recognised the need to separate two banking functions—giving advice on financial products, and simply selling a financial product. Usually, selling a product is called distribution, and here the bank relationship manager (RM) represents the investment company or the insurance firm. In contrast, if the RM is trying to find which product suits a client based on her needs, it’s called advisory. Till then, there was no distinction made between a seller and an adviser.

The RBI guidelines that came out in May 2013 proposed putting the advisory function—which includes wealth management services offered by banks, insurance referral, investment advisory services and portfolio management services—into a separately identifiable department or division (SIDD). This separate division is required to be registered with the Securities and Exchange Board of India (Sebi), the capital market regulator, and comply with its regulations on the matter.

Furthermore, last week, RBI released another set of guidelines for banks saying if they want to give advice (as opposed to simply selling) on financial planning and products, they need to set up a separate subsidiary. These subsidiaries will be registered with Sebi and regulated under the Sebi (Investment Advisers) Regulations, 2013.

This new set of guidelines means banks that presently offer investment advice (or intend to) through a SIDD or even through subsidiaries will have to re-organise their operations within three years.

But what does it mean for the banking customer? Does it mean that if you want to buy a mutual fund or an insurance policy when you go to a bank, you will have to instead visit its subsidiary? Will your bank RM not be able to offer you investment products and advice thereof?

Difference between paid and unpaid advisory

The new guidelines will have an effect on you if you go to the bank for investment advice and are a fee-paying advisory customer.

Advisory in the banking system can come through two platforms: paid advisory, where you opt for fee-based financial advice, and unpaid advisory. The guideline distinguishes between the two and only requires the fee-paying investment advisory business to become a separate subsidiary.

“RBI is recognising that the advisory business needs to be registered as a separate subsidiary. The reporting and compliance requirements can be carried out better,” said Ashvin Parekh, managing partner, Ashvin Parekh Advisory Services LLP, a firm that advises boards and chief executive officers of financial services companies. “The payment of fees is what distinguishes advisory from just selling,” he said.

This means that unpaid advisory—in other words, distribution—continues as is from bank branches. But buying a product over the counter doesn’t mean it won’t come with advice.

Gautam Mehra, leader-tax and regulatory services, PwC India, said, “There can be some overlap in advisory and distribution, but the defining line is who is paying. If you are an advisory client, fees and interaction needn’t always result in a transaction.”

Moreover, experts suggest that in the post-Lehman era, risk in banking businesses is sought to be defined better. There is a thought that core banking should be kept separate. “Globally, banks are being asked to focus on their core business and keep the other parts separate so that the liability is clearly defined,” said Mehra.

Not interested: M. Shyamlal (left) and Archana Veerabahu have received unwanted investment advisory pitches from their banks. Photos by S.Kumar and Aniruddha Chowdhury/Mint

Not interested: M. Shyamlal (left) and Archana Veerabahu have received unwanted investment advisory pitches from their banks. Photos by S.Kumar and Aniruddha Chowdhury/Mint

Advice in distribution

Let’s dig deeper to see if distribution of financial products could also contain some advice.

M. Shyamlal, 26, works in the sales department of ICM Plastics Pvt. Ltd in Mumbai. He has had multiple experiences of an advisory pitch from his banks even though he hasn’t subscribed to investment advisory services. For example, a few days ago, when a bank RM tried to sell him a mutual fund product, the conversation extended to why he must buy this fund.

“This happens often when I walk in to the bank branch. Recently, I went to my bank branch in Vashi with my sister for a gold loan. In between the banking activity, one guy approached me and started selling a mutual fund product. He explained the product, the kind of returns I will get and why I must invest in it,” said Shyamlal, adding that he faces such interference from bank personnel every time he walks into a branch, especially for insurance and mutual fund products.

Initially, the conversation starts with introducing the product followed by explaining the returns, benefits and way of investing. The conversation in the branch is often followed up by calls, said Shyamlal.

In such cases, when a product pitch is being made, the bank RM is acting as an agent of the insurance company or the fund house.

The initial pitch about returns can be considered as incidental to the product.

However, when the conversation veers to benefits and why a customer like Shyamlal needs to invest, is it still advice that is incidental to the product or something wider that needs to consider the customer’s risk profile and financial state, among other things?

Shyamlal’s case isn’t isolated. Archana Veerabahu, a digital marketing manager at a startup firm Weddingz.in, too, has experienced sales pitches and investment advice from her bank.

“When I was applying for my education loan, the bank tried to sell me an insurance policy. They claimed it was mandatory with the education loan. I refused, but some of my friends got trapped. Sometimes, the policy is just a small check box in the form, which the clerk instructs you to put a tick mark on. You don’t even realise that you have taken the policy. My bank has also tried to advise me on some insurance and investment products during regular banking activities,” said Veerabahu.

Saying it is mandatory to buy a product when it’s not is clearly an instance of mis-selling and here is where the line between selling and advice gets blurred. The bank RM might advise that getting insurance is beneficial, but how can she reach this conclusion without knowing the client’s background?

Who am I speaking to?

If you are looking for investment advice, ask your bank RM for representation from the investment advisory subsidiary or the department. Thanks to the new guideline, an investment adviser can’t be confused with a bank RM.

At least five banks have registered under Sebi (Investor Adviser) Regulations, 2013. However, industry sources point out that business done through the investment advisory department is negligible.

There are many factors to consider. Regulatory and compliance reporting requirements are more than for the distribution business.

Operationally, netting fees against commissions is not simple, and getting qualified advisers, too, can be a hurdle. Three senior executives in different private financial services companies confirmed that at present there is close to no business coming from the investment advisory desk. (They did not want to be quoted for this story.)

This means that the commission that banks earn from mutual fund and insurance sales comes from them acting as an agent for these companies, rather than from acting in your (the bank customer’s) interest. Six of the top 10 distributors who earned commissions from mutual fund sales in 2014-15, are banks, according to data from Association of Mutual Funds of India (http://bit.ly/1rBr2jC).

Moreover, data from Irdai’s annual report for 2014-15 shows that around 35% of the life insurance new business premium for that year for private insurers came from banks.

At the least, the RBI guidelines remove the ambiguity in who you are dealing with when you enter the bank branch.

Unlike a Sebi registered investment adviser, who has a fiduciary responsibility to act on behalf of the customer, a third-party agent or your regular bank RM selling you a policy or a fund is working on behalf of the product manufacturer.

In about three years from now, things might change. You would not have to deal with an investment adviser inside a bank branch, as they are required to be in a separate subsidiary.

But you may still be sold products that carry ‘incidental’ advice.

What the RBI guidelines fail to address is the blurred line between the distribution business and advice (beyond product-only) that emanates from it. Moreover, while Sebi registration is mandatory for advisers, there is no mention of insurance advisers being regulated by Irdai.

Those bank customers who aren’t aware of the new guidelines will still not be able to distinguish between an agent who is selling a product and an adviser whose priority is the client’s needs.

Given that distribution is where the revenue is, and hence, most customers are serviced by agents and not advisers, making a separate subsidiary changes nothing at the moment.