Over the last two decades, financial institutions have been bridging the gap between idle savings and investment through a plethora of financial products ranging from simple bank deposits to ones as complex as cryptos. Though investors have multiple investment options, yet they are not fully aware of the risks associated with these myriad financial products. A lack of understanding about risk of the financial product in proportion to the risk-taking capacity, results in an investor losing hard-earned money.
Around a decade ago, Securities and Exchange Board of India (Sebi) had introduced colour coding technique for mutual funds. It reflected the probability of risk in losing invested ‘Principal’ amount. Blue colour represented low risk, yellow showcased medium risk; while brown signalled high level of risk. The above coding scheme further evolved into riskometer depicting the riskiness of MF schemes. This was the smartest way to caution even the most naïve and uninformed investor. These colour codes helped investors select schemes as per their risk aptitude.
There was no rocket science behind this thinking but perhaps just a clue from the traffic light system which is understood by any person. Perhaps it’s time for financial regulators to emulate this colour coding for products under their regulatory ambit.
Market-linked debentures (equity -linked bonds, index-linked bonds), AT1 bonds, fixed deposit of NBFCs / companies, unit linked insurance plans (ULIPs) carry market risk / credit risk, which many investors are hardly aware of. Many investors buy financial products without understanding their risk. For e.g. investors subscribing to NBFC deposits for higher interest may not be aware that these are uninsured deposits unlike deposits of scheduled commercial banks insured to the tune of ₹5 lakh, via Deposit Insurance and Credit Guarantee Corporation (DICGC).
View Full Image
In the recent debacle of Credit Suisse AT1 bonds; the Swiss banking regulator ordered to write down $17 billion AT1 bonds issued by Credit Suisse. Typically, it’s shareholders that bear losses before bond holders and same principle was applied to AT1 bondholders of Credit Suisse.
This episode in fact triggered memories of Yes Bank saga wherein Yes Bank had written-off AT1 bonds worth ₹8,000 crore as a part of its bail-out package. Being bonds, the investors took for granted the that they are ‘lenders’ to the company and would be given priority during payment and liquidation. In short, investors lacked the understanding of risk associated with AT1 Bonds.
Financial sector regulators can liaise and come up with colour coding for products based on perceived risk. Regulators may also publicize and warn investors about risk associated with unregulated products. A table summary of various financial products and associated probability of risk has been given above (see graphic).
Risk appetite differs for investors based on age, income, existing financial conditions, gender, etc. It is time that sales personnel of financial institutions act responsibly and not mis-represent products to garner commission or meet sales target. Perhaps, the colour coding system can enable investors to ask relevant questions based on the risk color assigned to financial product.
Kuldeep Thareja, Mitu Bhardwaj & Rasmeet Kohli are working with National Institute of Securities Markets (NISM).
Download The Mint News App to get Daily Market Updates.
Updated: 05 Jun 2023, 12:28 AM IST