Daily Bulletin


The Conversation

  • Written by Kevin Davis, Professor of Finance, University of Melbourne
Requiring firms to only sell financial products we can use is good, but not enough

The government’s financial system inquiry, on which I sat, reported five years ago.

It recommended that the creators of financial products be subject to a design and distribution obligation (DDO), which would mean the products they sold had to not only make money for them, but also meet the needs of the people buying them.

An insurance policy that couldn’t be claimed on would fail the test, as would a product that charged fees for advice that wasn’t given, as would any number of products later detailed in the 2018 report of the financial services royal commission.

It’s the first half of 2020, and the Australian Securities and Investments Commission is seeking input into how the obligation will work. It has asked for comments by March 11.

Requiring products to be useful is good…

There ought to be nothing controversial about the idea. It reflects the fundamental premise upon which the free market economy is founded – that transactions should provide gains to both the seller and buyer.

Reputable financial institutions, seeking to meet community expectations, ought to already meet such obligations, although they are likely to incur some (hopefully minor) administrative costs.

However, as history and the royal commission have reminded us, even reputable institutions’ procedures can go awry and lead to badly designed products that exploit consumers.

Read more: CommInsure proves the need for a banking royal commission

Less reputable firms exploit consumers anyway, leading to a race to the bottom in terms of product quality.

…but not enough

Unfortunately, even if a financial product meets the DDO requirements, which means it is suitable for its intended consumers, it can be a bad purchase for consumers who aren’t aware of its true worth. Retail customers who overpay for a “suitable” product can lose just as much (if not more) as those being sold one that’s unsuitable.

Many financial products (actually, most financial products) have characteristics that make them hard to value accurately. When product outcomes depend on future events – as do insurance products – accurate valuations can be almost impossible even for customers who are financially literate.

For example a consumer might assume that there is a 10% chance of an event happening, when the true probability is less than 1%. Not only would they overpay on insurance (perhaps repeatedly), they would be unlikely to ever know about it.

It’s hard to tell when prices are bad

Suppose a producer can supply a financial product profitably for any price over $6. Suppose that buying it for any price under $8 would would benefit the consumer, but that the consumer is unable to tell what it is really worth.

Since the supplier’s profits increase as the selling price increases, what is there to stop the supplier increasing the price to more than $8 and harming consumers, in part because some would never get the product?

Standard answers talk about competition, disclosure, financial advice and financial education.

But if consumers don’t have the information they need (or the time they need) to do the calculations, what’s likely to happen instead is that competition will cut the worth of the products in ways that are not obvious to consumers.

As important as disclosure, advice and education are, they haven’t been able to stop this happening in the past.

What we are seeing are first steps

Plans by the Australian Prudential Regulation Authority to make banks and other deposit-taking institutions designate an accountable executive as responsible for the “end-to-end” creation and delivery of each product under a Bank Executive Accountability Regime (BEAR) would be an important step.

The government has announced plans to extend it to all financial institutions, making it a FAR (Financial Accountability Regime).

But there is nothing in either the BEAR or FAR rules that that would require the executives to price their products fairly.

Read more: HILDA Survey reveals striking gender and age divide in financial literacy. Test yourself with this quiz

DDO’s, together with the Securities and Investments Commission’s new temporary banning powers, should help to rid the financial sector of the most egregious types of consumer abuse. But will they do nothing to prevent profit seeking institutions setting prices for “suitable” products that cause poorly informed consumers harm.

It is not clear what could, short of instilling a sense of “fairness” into corporate cultures. While welcome, DDO’s are only the start.

Authors: Kevin Davis, Professor of Finance, University of Melbourne

Read more https://theconversation.com/requiring-firms-to-only-sell-financial-products-we-can-use-is-good-but-not-enough-131887

Writers Wanted

Australia's states have been forced to go it alone on renewable energy, but it's a risky strategy

arrow_forward

The missing middle: puberty is a critical time at school, so why aren’t we investing in it more?

arrow_forward

A Beginner’s Guide To Caring For Your Lawn

arrow_forward

The Conversation
INTERWEBS DIGITAL AGENCY

Politics

Prime Minister Interview with Ben Fordham, 2GB

BEN FORDHAM: Scott Morrison, good morning to you.    PRIME MINISTER: Good morning, Ben. How are you?    FORDHAM: Good. How many days have you got to go?   PRIME MINISTER: I've got another we...

Scott Morrison - avatar Scott Morrison

Prime Minister Interview with Kieran Gilbert, Sky News

KIERAN GILBERT: Kieran Gilbert here with you and the Prime Minister joins me. Prime Minister, thanks so much for your time.  PRIME MINISTER: G'day Kieran.  GILBERT: An assumption a vaccine is ...

Daily Bulletin - avatar Daily Bulletin

Did BLM Really Change the US Police Work?

The Black Lives Matter (BLM) movement has proven that the power of the state rests in the hands of the people it governs. Following the death of 46-year-old black American George Floyd in a case of ...

a Guest Writer - avatar a Guest Writer

Business News

Nisbets’ Collab with The Lobby is Showing the Sexy Side of Hospitality Supply

Hospitality supply services might not immediately make you think ‘sexy’. But when a barkeep in a moodily lit bar holds up the perfectly formed juniper gin balloon or catches the light in the edg...

The Atticism - avatar The Atticism

Buy Instagram Followers And Likes Now

Do you like to buy followers on Instagram? Just give a simple Google search on the internet, and there will be an abounding of seeking outcomes full of businesses offering such services. But, th...

News Co - avatar News Co

Cybersecurity data means nothing to business leaders without context

Top business leaders are starting to realise the widespread impact a cyberattack can have on a business. Unfortunately, according to a study by Forrester Consulting commissioned by Tenable, some...

Scott McKinnel, ANZ Country Manager, Tenable - avatar Scott McKinnel, ANZ Country Manager, Tenable



News Co Media Group

Content & Technology Connecting Global Audiences

More Information - Less Opinion