Is it time to scrap commissions?

Fri, 13 Mar Pre-Open

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It wouldn't be wrong to say that the financial services industry is driven by incentives. After all that's what brings in the money! Distributors of financial products are motivated by the incentives that they receive. Usually, this is in the form of commissions. There is nothing wrong with this per se. However, this business model places a huge premium on the trust between the customer and the agent. If the agent turns out to be unethical, the client's trust is shattered. Thus, this model works only if the distributors act in the interest of their clients. From experience, we know that this is not the case most of the time.

Therefore, a different approach may be the order of the day. Countries like the U.K and Australia have banned commissions entirely. The move to a ‘fee-only' based financial industry has been successful in these nations. Even the U.S is moving in this direction. The U.S government has proposed a new rule that will close an age old loophole that had so far, allowed agents to legally act against their client's interests. So will we see something of this sort in India?

To be fair, Indian financial regulators, SEBI, RBI, IRDA and PFRDA are fully aware of the situation. They have taken steps in the right direction. The IRDA has begun to act tough on mis-selling of ULIPs. However, mis-selling of ULIPs still occurs. SEBI had banned entry loads in mutual funds from August 2009. However, mutual fund agents still make their living based on trail commissions. Despite SEBI coming out with ‘Investment Advisers' regulations, we have not seen a big shift to a fee based model in the Indian mutual fund industry.

The way forward: We believe that for the Indian financial industry to reach its full potential, the shift to a fee based model is the need of the hour. However, it will not be an easy task. Considerable effort will have to be put into creating awareness. Investors as well as distributors will have to be educated about the benefits of the move towards a fee based financial system. Also, financial products will need to be simplified and financial jargon will have to be minimized. The government will also have to chip in and simplify the tax treatment of financial products and greater tax incentives will need to be provided. All in all, these steps will bring about maturity to the industry and channelise the huge savings in India into productive activities.