Will banks sharpen up?

DRAFT BILL: PROTECTS CONSUMERS FROM BEING HOODWINKED

The legislation can mean the way interest rates are advertised will be under scrutiny.

In the last few months two banks have been criticised for the way they’ve marketed fixed-term products: Absa’s 13% offer on a five-year fixed deposit, and Finbond’s 15.5% on a “fixed-term interest bearing note”.

These banks were both advertising an “effective rate” – a problematic measure.

Reverse engineering

The primary issue is that these effective rates are backward looking. They’re calculated by taking the total that would be earned by the end of an investment, then working backwards to express it as a percentage of growth on the initial capital.

Interest isn’t retrospective, which is why this “effective rate” is criticised as not being a recognised measure of return. As this “effective rate” isn’t a standard measure, it makes comparisons with other products difficult.

Credibility

A bank offering a fixed-term interest rate can calculate an end total in advance because it’s possible to determine the outcome from the beginning.

Certain structured products have also fallen into the same trap if they guarantee a certain percentage return. This isn’t possible with other investments. They must be evaluated on the actual return received. Their annual return is therefore expressed on an annualised, compounded basis. For example, the Allan Gray Equity Fund has a 41.82% fiveyear total return and a 7.24% annualised return (Morningstar figures). The 7.24% multiplied by five does not give you 41.82%, because this return has been compounded. Allan Gray could not credibly claim it had delivered an “effective return” of 8.36% per year (the total return divided by five). So why are banks allowed to do this? Banks have been regulated separately from the rest of financial services. This will change.

CoFI Bill

The draft Conduct of Financial Institutions (CoFI) Bill released for comment by National Treasury is, as one industry insider put it, an “early Christmas present” for consumers. Banks will be subject to the same conduct requirements as everyone else now.

The bill has an entire section dedicated to product marketing:

A financial institution must ensure that products and services are promoted and marketed to financial customers in a way that is clear, fair, unambiguous and not misleading; and

A specific provision is that: “promotional and marketing material must take into account the needs and reasonably assumed level of knowledge of the retail customers to whom it is targeted.”

It could be argued banks advertising “effective rates” fail to meet these requirements. First, using two different rates to promote the same product is ambiguous.

Second, most consumers don’t fully appreciate the difference. You cannot assume the ordinary person’s level of knowledge qualifies them to understand what these rates actually represent.

In the era of treating customers fairly, the Financial Sector Conduct Authority will be expected to ensure these provisions are adhered to.

Banks will be subject to the same conduct as everyone else