Tuesday, December 16, 2008

Quis custodiet ipsos custodes?

The Latin phrase above (saw it in an Alan Moore comic) means "Who will guard the guardians?". While this debate is timeless, over the years we have started to question less and less the powers of those that serve us. Politicians are one such breed; banks are another.

Before the recent collapse, it was blasphemous to even talk of an ICICI or a Citibank engaging in ethically and economically dubious practices. The bankers' greed is now well-documented in the rubble of Wall Street collapse. All of them have proven to be no better than an exploitative money-lender in the village.

Regulators and watchdogs (like the financial press) have failed us as much as the banks, by creating an exploitative and misleading banking environment for the uneducated, unorganized credit-seeker. Much has been written about their complex products causing global turmoil in 2008. I bring attention to their simpler products; they cause small but significant turmoil in the monthly budget of a common man.

My views on two such products that require immediate fixing:

1. Credit Cards
The onus of proving that one did not use a card lies with the user. Whether the card is stolen or someone uses the card details for online payments, the bank has no liability till the time user asks for the card to be blocked. The very fact that such a potent instrument comes with few, if any, safeguards is a slap in the face of consumer-rights.

The credit card business survives on default. The 36% interest per annum is such an enticing deal for banks that customers paying on-time are treated as liability. The system implicitly promotes insecure use of cards in collusion with merchant establishments. Merchants pretend to be doddering fools, as long as they are paid by the bank and end-user is held liable for payments on a stolen/lost card. What else can explain their immunity from prosecution as accessory to theft, even if they completely ignore security protocol while honoring explicitly "fake" cards (viz, the signature is obviously mismatch, the photo is different, sometimes the name does not match the gender of user, etc).

If the regulators place onus of proof on merchants and banks, it will automatically spur banks to spend on more robust, logical and convenient security mechanisms. Merchants will also become more careful before casually honoring cards they suspect may be stolen. It may even bring down instances of credit-card theft itself!

At the bank end, they can deploy further level of security, like in other instruments:

  • Make photo mandatory on credit-cards, like in all other important documents
  • For online payments, replace the 3 digit CVV joke with a PIN, not printed on card
  • Additionally, explore use of cards with at least one more proof of identity, and so on
Read more about this on Baba Jain's intelligent blog

2. Home Loans
It is no surprise that the recent collapse was triggered by faulty home loans. The fine print in home loans have become the latest "free money" mantra for banks.

Typical home loans are for 20 years or so. All the bank needs to do is offer a low enough rate, so that monthly EMI looks affordable to an undecided new user. Once the loan is given, the debtor has few options. On some pretext or another, rates will rise after 12-18 months. Loss on interest for 12-18 months is petty cash compared to the inflated sum he will be repaying for next 20 years!

Many recent examples expose the regulators snoring while the bankers brazenly feast.

Take the drop in home loan rates. Every time a drop is announced, it applies to new users only. On the other hand, an increase in rates applies immediately to existing users. This is equivalent to "offers" made by FMCG companies to increase sales in slow season. The difference being the commitment is for life in case of a home loan.

Similarly, banks promote the misnomer "fixed" and "floating" interest rates. Despite the fact that fixed rates are subject to upward revision as much as floating rates, this incorrect term is deliberately applied to entice undecided new users. In absence of highly-educated customers, such fine print allows bankers to laugh all the way to and from their banks.

The so-called interest free loans in US by Countrywide were just a more serious manifestation of the same scam. Looking at the poor savings profile of potential customers, Countrywide and others offered loans at next to nothing EMI during initial years. After a few years, once the user is hooked, the monthly repayment obligation zoomed to stratospheric levels (to pay for the "free" period). The stunned customers had no choice but to forgo the loans, lose their houses and destroy their credit rankings. At a macroeconomic level, it caused the housing collapse and opened a rotting Pandora's box.


The recent downturn resulted in a unique paradox where Governments of all nations are racing to offer billions and trillions of dollars to Banks, hoping this will save us from a bigger mess. The paradox, of course, is that it is these Banks that are responsible for the very mess we find ourselves in. This parallels the paradox in the title of this post, especially after reading about the aptly named Madoff. As ex-chief of NASDAQ and an adviser to SEC, Bernie Madoff commanded the trust and influence to run a swindle over many years. It was not until global institutions and trusting investors lost over $50 Billion and counting, that he even showed up on the radar.

It is no surprise when regulators, cops and politicians are "suspected" of using the system for personal gains in India; in fact, many of them are elected or nominated for this very quality (latest example being Mr.Raja's reliance on circular logic). However, when it happens in mighty USA, it is a wake-up call for those who believe that everything that has worked in America must unquestioningly be implemented here.

This recession and financial crisis is an opportunity for India to develop an indigenous regulatory mechanism. India's prescription for beating the downturn must include calling upon our own experience with village moneylenders to anticipate the greed and cunning of Big Money. Under the fading influence of large banks and multinational interests, India must build regulatory firewalls and people-friendly financial instruments to spur growth and protect the common man's interest (without vote-bank gimmicks like loan waiver). New mechanisms must be developed to regulate new instruments like credit cards, online banking and microfinance before they blow up in our face.

India's experience with Microfinance is a start, a great beginning. A billion other such innovations lie latent within the billion dreams. It is not long before the Indian consumer will realize his own strength. On guard!


Anonymous said...

Hear hear. Are you creating a portfolio for a future MBA effort? ;) Yeah the way credit cards are handled in this country sucks... I suffer them every month! (Actually the way I handle Credit Cards sucks even more... jesus, keep em away from me!) About Microfinance...check out this company SKS Microfinance. Based in Hyderabad...they are really creating impact.

Toonfactory said...

The title just caught my attention and I had to come to your blog even before checking my mails...wonderful read...quiet an eyeopener for me I really need to understand this complicated world of finance and commerce, Baba Jain's blog is an awesome place to gain some insight and thanks a lot to you too for putting in these complicated concepts in such a way that a person like me can read and gain some knowledge on the matter.

Thanks a ton sir!

Indian Home Maker said...

Hey this was useful information. I am always vary of the way a credit card can be misused so easily. Yes they should have a pin number at least. And photograph also.

About home loans I would say one thing, since the value of money also comes down, chances are the the borrower with whatever interest rates, still stands to gain. The value of property (most of the time) goes up and the value of money comes down... just a layman's point of view : )

Faiyaz said...

Ref: Change is Sweet

When ever I read your posts regarding these social issues, I wondered if this will ever have an impact. Once I even quipped that you are becoming a ‘Rajani’ of a sort referring to the Tele-serial of the olden days. Now I am forced to take back my words. As Abha rightly stated, the power of writing has started delivering results. Kudos to you and your blog – Keep up the good work.

Faiyaz said...

Ref: Credit Cards

Your suggestions for the Credit Card Companies are well thought off and very practical indeed. The CC Companies need to adopt these type of measures on war footing.

Itchingtowrite said...

yes we the home loan sufferers can understand well enuf how the increase affects us immdtly

Monika said...

dont even talk abt the home loans... the heart bleeds... we the sufferer... i have been paying my home loan for the past 4.5 yrs (that is 54 installments) and currently the no of installments left are 254 and guess what we started with 240... gosh god only knows where have those 54 gone

Vidooshak said...

@Monika - Yep, the same thing provoked this post. In our case as well, the original loan letter said 204 installments and the balance today is 204, after feeding their tummies for past 2 years. Doesn't it look like Bankers use their technical wizardry to fleece mere mortals even more than lawyers and charlatans? Wish I'd paid more attention in Accounts lecture...


Monika said...

happy new year... i have something for u at my blog... please come over