In the series ‘Finance Matters’, we have examined the various elements that enable the provision of high-quality financial services, particularly for the under-served segments of the population. In this column (the last in this series), we summarise this thinking and paint a vision for the future of financial service access for households.
The current financial system takes a product-menu driven approach, where different providers meet different household requirements such as savings, insurance, credit, pension and payments on a piecemeal basis. The customer takes responsibility for the ultimate outcome, which could be achieving a target annuity during retirement, building the required corpus for a child’s education, or being protected for the full value of human capital.
Today, the disaggregated delivery of financial services has put the onus of taking technically complex financial decisions on the consumer. Even for the highly educated individual, this task has become difficult, if not impossible, given the rapid innovation in the financial marketplace, coupled with limited ability to assess alternatives. Even with easy availability of information, the principal-agent problem remains, with the agent or advisor having limited liability for what she sells.
We have argued in this series that a household needs providers who can offer integrated solutions in a continuous and convenient manner. There is adequate research to show that the financial needs of households are multi-dimensional and one must look to solutions that can necessarily deliver on comprehensiveness. The starting point is a customised financial plan, based on a clear assessment of a household’s financial goals, current and expected cash-flows, appetite for risk, and so on. Specific products are a means to achieve household goals, and not ends in themselves.
This additional responsibility of computation and advice means that the provider will have to take on a more holistic approach, cutting across traditional barriers of institutions and products. Future financial services providers will be akin to general physicians, who bear great responsibility for the health of their patients.
Such a prescriptive approach would also minimise instances of unsuitable advice, such as selling illiquid assets to clients with immediate liquidity requirements, or selling loans that require repayments that do not match the household’s cash-flows.
In such a regime, incentives need to move away from standalone product sale to following a set of protocols that will subsequently enhance the financial well-being of the households served. Such well-being is the state in which a household can optimally choose patterns of consumption over time and in uncertain states of the world.
To choose these patterns of consumption, households should have the ability to grow, manage liquidity and overcome financial shocks, across different periods of time. The integrated approach will equip households with the means to achieve this.
Structural models will have to evolve to incorporate market imperfections such as irrational behaviour, which will necessitate a greater investment in the development of intelligent systems and training resources to deliver high-quality solutions.
While developing provider expertise will aid better choice, this approach also calls for extending a provider’s liability to following protocols that are consistent with financial well-being, and for this to be enforceable as a statutory obligation, rather than just a fiduciary one.
This is particularly important because, unlike physical products, financial products lack visibility and, unlike many services, they reveal their real outcomes at a point in time beyond the time of purchase. Clients thus have limited ability to assess upfront, the quality of a product.
This is clearly problematic and highlights the need for ex-post liability regimes in the context of financial service providers. One way this could be addressed is by setting ‘negligence standards’, similar to those in place for consumer products. Customer protection regulation that is currently at a very nascent stage in India will have to evolve to meet these challenges.
The evolution of this fundamentally different approach to product design and delivery stresses the need for functional regulation — that is not product- or institution-based but based on functions served by them. Regulators and policy-makers have a key role to play in aligning the incentives of agencies in the financial market place.
Business model innovation must be encouraged to discover new and integrated approaches to financial services delivery. As discussed earlier, the optimal role of Government is in creating infrastructure — connectivity, unique identity and payment backbone — that will enable all service providers to reduce their cost of operations. Moving ahead, we see no trade-off between ubiquity and quality of services in financial services delivery. Both are achievable.
In summary, a well-functioning financial system should aid transfer of resources across time and different states of the world, helping individuals and organisations manage risk, disseminate price information and align incentives. This is best achieved through the provision of integrated solutions by well-trained providers and requires reliable financial institutions that work towards maximising the financial well-being of clients. Institutional structures and product innovations will need to move together to ensure that the true transformative power of finance is realised.
This article first appeared in The Hindu Business Line