Fixing Mis-selling of Market-linked Products

UPSC Syllabus: Gs Paper 3- Indian economy

Introduction

The popularity of market-linked financial products has grown rapidly after the Covid-19 pandemic, but financial literacy has not kept pace. This has increased the risk of mis-selling by banks, Non-Banking Financial Companies (NBFCs) and their agents through unsuitable products, poor disclosures and aggressive cross-selling. To strengthen ethical sales practices and customer protection, the RBI has issued a comprehensive framework governing the advertising, marketing and sale of financial products by regulated entities, effective from 1 January 2027.

Why Was the New Framework Needed?

1. Expansion of Financial Product Distribution: Banks and NBFCs now sell insurance, mutual funds, pension products and other investment products along with their regular banking services. This has made financial product distribution more complex.
2. Low Financial Literacy: Many customers do not fully understand product risks, charges, lock-in periods or exit conditions. This makes them vulnerable to unsuitable financial products.
3. Commission-driven Selling: Financial institutions earn fee income by distributing third-party products. This creates an incentive to promote products that generate higher commissions rather than those suitable for customers.
4. Rise in Mis-selling Practices: Unsuitable products were sold through forced bundling, misleading information and aggressive cross-selling. Past concerns involved mis-selling of Additional Tier-1 (AT-1) bonds, currency derivatives and insurance products.
5. Need for Better Consumer Protection: Mere customer signatures or digital consent were often used to justify sales. The new framework shifts the focus from a sales-first approach to a suitability-first approach.

Key Features of RBI’s New Ethical Conduct Framework

1. Transparency in Sales: Banks using external agents must display an updated list of authorised intermediaries on their websites. Agents selling third-party products must clearly disclose their identity.
2. Explicit Customer Consent: Every product requires separate and clear consent through signed declaration, OTP or digitally recorded confirmation. Sales calls should be limited to normal business hours, while digital platforms must keep the default consent option as “No”.
3. Suitability Assessment: Banks and NBFCs must assess whether a product matches the customer’s age, income, financial knowledge, risk appetite and investment horizon before selling it.
4. Restrictions on Unfair Selling: Banks cannot bundle loans with any financial product or force customers to purchase insurance or other products while availing financial services. Third-party commissions to bank staff and loans to finance products sold by the same institution are also prohibited.
5. Digital Protection and Complaint Redressal: The framework prohibits dark patterns such as hidden consent and misleading app designs. Customers get a 30-day complaint window, and proven cases of mis-selling require a full refund, including for third-party products.

Significance of the New Framework

1. Customer-centric Selling: Financial products must now suit the customer’s needs instead of only generating commissions. This strengthens responsible financial advice.
2. Greater Transparency: Better disclosures, informed consent and clear explanations will help customers make better financial decisions and reduce confusion.
3. Better Digital Practices: Restrictions on dark patterns make digital journeys fairer and reduce manipulation during online financial transactions.
4. Higher Institutional Accountability: Banks and NBFCs must maintain proper consent records, customer feedback systems and stronger compliance processes. Sellers must prove that products were sold fairly.
5. Improved Market Confidence: Better quality sales can reduce complaints, improve customer trust and encourage long-term participation in financial markets.
6. Ethical Sales Practices: The framework regulates both the products being sold and the manner in which they are marketed, making the sales process more transparent and customer-focused.

Challenges and Remaining Concerns

1. Limited Appeal Mechanism: The framework does not clearly specify the remedy if banks or NBFCs fail to resolve customer complaints satisfactorily.
2. Pressure on Ombudsman System: The existing Banking Ombudsman already handles a large number of complaints related to core banking services. Additional cases may affect its effectiveness.
3. Compliance Burden: Institutions may have to redesign forms, digital platforms, sales processes and employee training systems to meet the new requirements.
4. Impact on Fee-based Business: Banks depending heavily on cross-selling may experience slower growth in commission and distribution income after the rules take effect.
5. Need for Public Awareness: Customers must know how to verify authorised agents and understand their rights under the new framework for the rules to work effectively.

Way Forward

1. Strengthen Grievance Redressal: A dedicated mechanism similar to SEBI’s SCORES can provide quicker resolution of mis-selling complaints beyond the banking system.
2. Ensure Strict Enforcement: High penalties for violations can discourage unethical selling practices and improve compliance with RBI directions.
3. Promote Financial Literacy: Customers should receive better awareness about financial products, risks, charges and their rights before making investment decisions.
4. Monitor Implementation: RBI should closely supervise digital sales practices, third-party agents and customer complaint trends after implementation.
5. Encourage Responsible Distribution: Banks, NBFCs and insurers should focus on long-term customer trust through transparent, suitable and well-explained product sales instead of aggressive cross-selling.

Conclusion

The RBI’s framework marks an important move towards ethical, transparent and suitability-based distribution of financial products. Its success will depend on effective enforcement, stronger grievance redressal, strict penalties and greater financial awareness. These measures can reduce mis-selling, improve customer confidence and promote a more responsible and accountable financial services ecosystem from January 2027.

Question for practice:

Examine the need for the RBI’s new ethical conduct framework to curb the mis-selling of market-linked financial products. Discuss its key features, significance, challenges and the way forward.

Source: Businessline