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SEBI, IRDA: stop fighting, start talking

The fight over regulatory turf is as old as regulation itself. But for capital markets regulator SEBI last week to issue show cause notices to insurance companies that are regulated by IRDA shows a frustration, where communication between the two regulators, so important in an increasingly complex financial landscape, has lapsed.

business Updated: Jan 24, 2010 20:47 IST
Gautam Chikermane

The fight over regulatory turf is as old as regulation itself. But for capital markets regulator Securities and Exchange Board of India (SEBI) last week to issue show cause notices to insurance companies that are regulated by Insurance Regulatory and Development Authority (IRDA) shows a frustration, where communication between the two regulators — so important in an increasingly complex financial landscape — has lapsed.

They now speak to one another through the press — off the record, both accuse each other of “regulatory capture”, a process by which regulators get dominated by those they regulate and push regulation such that it helps the regulated entities, or so goes the theory by a University of Chicago lawyer-economist Richard Posner.

In practice, we get hints of this capture in insurance. Ask how insurers are being allowed to create products whose incentive structure is designed such that it hurts consumers, and the answer is: insurance companies are bringing out perfect products. Ask insurers how IRDA gives them such leeway — allowing their agents to charge an unacceptable two-fifths of the premium in the first year, for instance — and you’re told that IRDA is the best regulator in Telangana.

Travel two hours away into Mumbai and the scene changes. Ask SEBI officials why the regulator has banned loads altogether — and made mutual fund returns even better for consumers — without giving funds and those selling them a chance to prepare for this change and the answer is: we have been speaking to them but the industry did not respond. Ask the industry and it wails: SEBI doesn’t know anything about how financial products are sold, and that this is the end of mutual funds.

The latter is partly true. You can see investors’ money being misdirected towards an inefficient mode of investment — the unit linked insurance plan (ULIP). So strong is this mis-selling that even consumers who are aware that ULIPs should be avoided and want to buy mutual funds, come back with ULIPs in their portfolios. My colleague suffered this last week and I’m very closely tracking what IRDA does to fix this.

At a branch of one of India’s largest private banks, this mis-selling has been institutionalised. In hot pursuit of targets, executives there are forging signatures — if an investor comes to put his money in a fixed deposit, he walks out with a ULIP. An RBI official I met last week told me that the regulator is aware but “what can we do?”

So, what we have is a fascinating capture of India’s regulators such that buying financial products has become akin to buying wealth destruction. I call it the Wild East and it works like this. One, insurers create products with skewed incentives. Two, distributors and agents mis-sell them rampantly. Three, some agents hide behind the extremely high credibility of banks. And consumers hold assets they don’t need.

To show just how well it all is, take a look at this one number: in 2009, 9.1 million policies worth Rs 100,000 crore lapsed. That’s the money that some people through this industry-agent-regulator nexus made last year; this will only rise. The fix: turn all insurance products no-loads (as in the case of mutual funds) and shift IRDA to the administrative capital Delhi or financial capital Mumbai.

But why did SEBI need to issue notices? Why couldn’t it speak to IRDA in the informal mechanism created for such inter-regulatory matters, the High Level Coordination Committee where the heads of RBI, SEBI, IRDA and senior officials of ministry of finance meet?

In the case of another inter-regulatory investigation into the Satyam scam, the IT department, SEBI, Ministry of Corporate Affairs and Comptroller and Auditor General got together and supported Serious Fraud Investigation Office.

For investors, a similar start was made with the Swarup Committee report. Budget 2010 would be a good time to action it.