RBI Checks on Mis-Selling Will Likely Fail Their Purpose, Why the New Regulations Don’t Go Far Enough
The stink around the mis-selling of insurance products by banks has finally reached the corridors of power. The central bank announced the Draft Reserve Bank of India (Commercial Banks – Responsible Business Conduct) Amendment Directions, 2026. The aim is to prevent mis-selling of financial products by banks.
This, the Reserve Bank of India intends to do through suitability assessments, explicit consent requirements, prohibition of compulsory bundling and dark patterns, customer feedback mechanisms, and compensation frameworks. The expectation is that banks put customer interest over sales targets.
This is a good half-step, but unless RBI defines suitability and ensures the robustness of the customer-feedback mechanism, it will remain ineffective in stopping the haemorrhage of money.
The Long History of Mis-Selling
First, some background. The anecdotal experience of bank customers feeling like chickens in front of hungry wolves has been backed by hard evidence for more than a decade. A paper published in the Journal of Comparative Economics in 2016, based on findings from mystery-shopped banks using a third-party market research firm, found that banks were giving wrong information across costs, returns, lock-in periods, and exit costs.
In life insurance, the “lying” was at 100% on cost disclosures and at 99% on returns disclosures. In fact, after the presentation, two vigilance officers told the author that what the paper documented was just the tip of the iceberg; it was much worse on the ground. RBI knew it. It did nothing for years.
In a half-hearted first step in June 2017, RBI “allowed” customers to complain to the banking ombudsman for sale of unsuitable third-party products. Bear in mind, we were “allowed to complain.” Of course, it had zero impact.
Over time, the public outcry got so loud that the Economic Survey has flagged the problem twice in the past few years. A documentary and a research paper from a finance magazine had very hard-hitting stories. Yet the problem persists.
Three Things That Need Fixing
There are three things that need to be fixed, or the 2026 regulation will go the way of the 2017 one—that is, it will be ineffective and perpetuate the status quo.
First, suitability has not been defined. While a lot of ink has been used to describe dark patterns or digital user interfaces that manipulate or deceive users into taking actions they did not intend, what might be a “suitable” product or service is left for the banks to decide. Should the fox decide the thickness of the doors of the chicken coop?
Regulation needs to be deeply prescriptive in retail finance. Leaving it to each bank to decide what is suitable is not going to be effective. While the guidelines specify factors to consider such as age, income, risk tolerance, and financial literacy, they do not flesh these out. What constitutes “suitable” for a particular customer profile will depend on each bank. Effectively, therefore, every customer will have to search across all commercial banks to discover the various interpretations of “suitable.”
RBI needs to do the work in defining a suitability framework that all banks will follow. For example, selling a life insurance policy to a 60-year-old is an unsuitable sale, unless he has a loan that he is protecting. Steering a fixed-deposit-seeking investor into an insurance policy is an unsuitable sale. Selling a small-cap mutual fund to a low-risk investor is an unsuitable sale.
RBI needs to look at best practices globally and then examine the Indian market. We have a large first-generation-banked population. Expecting them to understand the nuances of costs, exit clauses, and market returns and then take a considered decision is simply foolish. The onus must be on the seller to make a suitable sale that does no harm at the base level and then builds financial security.
Second, RBI needs a feedback loop independent of the banks. The interests of banks lie in hiding mis-selling. RBI has a very large investor education and protection budget. It could use a part of that to go beyond conducting camps and improving financial literacy and helping celebrity endorsers, and instead carry out regular mystery shopping exercises using third-party institutions that have no skin in the game.
Relying on the banking association or their staff may not be able to fully hear the voice of the real banking customers. There is a way to hear what people are saying, provided RBI really wants to hear it.
Third, unless the insurance regulator works to remove the big fat “ladoo” embedded in the first-year payments made by an insurance buyer towards a life insurance policy, these regulations will do nothing to move the needle. The phrase “ladoo” is used by bankers to describe front commissions; “bakra” or goat is used to describe the customers.
Banks can harvest up to 100% of the first-year premium as commissions. This creates a perverse incentive. The salesperson who pushes an unsuitable policy doesn’t care if the customer lapses after a year; they already got their commission. The customer, meanwhile, has lost money and gained nothing.
India needs to link commissions to persistence of the policy rather than put incentives in the wrong place and introduce commission clawbacks for policies that don’t stay the course.
Banks as Partners, Not Predators
This is not an argument to stop banks from selling insurance. To the contrary, banks are the best placed to be partners in the journey of financialisation of the country. They are still trusted, though that trust is fast eroding, one anecdote at a time.
On the ground, the front-line staff too are deeply conflicted; they see the destruction of the finances of individuals as they are forced to sell terrible products to meet targets. They are not villains; they are victims of a system that rewards bad behaviour.
A possible solution could be AI-based, full-service financial planning offered by banks, which will give them an annuity income that grows as Indian per capita income rises. Instead of chasing commissions on individual products, banks could charge a fee for comprehensive financial advice. Households will become partners, and not victims of finance as they are today.
Conclusion: The Onus Must Be on the Seller
The 2026 regulations are a step in the right direction, but they are not enough. Without a clear definition of suitability, an independent feedback mechanism, and fundamental reform of commission structures, they will fail to address the root causes of mis-selling.
The onus must be on the seller to make a suitable sale that does no harm at the base level and then builds financial security. Until that principle is embedded in regulation and enforced with vigour, Indian bank customers will continue to feel like chickens in front of hungry wolves.
Q&A: Unpacking the RBI’s Mis-Selling Regulations
Q1: What evidence exists of widespread mis-selling by banks?
A 2016 study published in the Journal of Comparative Economics, based on mystery-shopping of banks using a third-party research firm, found banks gave wrong information across costs, returns, lock-in periods, and exit costs. In life insurance, “lying” was at 100% on cost disclosures and 99% on returns disclosures. Vigilance officers confirmed this was just the tip of the iceberg. Despite RBI’s knowledge, nothing effective was done for years.
Q2: What are the three key deficiencies in the 2026 draft regulations?
First, “suitability” is not defined—leaving it to banks to decide what is suitable is like letting the fox design the chicken coop. Second, there is no independent feedback loop; RBI relies on banks themselves to report mis-selling. Third, the regulations don’t address the fundamental incentive problem: banks can harvest up to 100% of first-year premiums as commissions, creating perverse incentives to mis-sell.
Q3: Why is defining “suitability” so important?
Without a clear definition, every bank will interpret suitability differently. A 60-year-old being sold life insurance is unsuitable unless protecting a loan. Steering fixed-deposit investors into insurance is unsuitable. Selling small-cap funds to low-risk investors is unsuitable. First-generation banking customers cannot be expected to navigate these nuances. The onus must be on the seller, defined in clear, prescriptive rules.
Q4: How do current commission structures incentivise mis-selling?
Banks can receive up to 100% of the first-year premium as commissions. This means salespeople don’t care if policies lapse after a year—they already got their commission. Commissions should be linked to policy persistence, with clawbacks for policies that don’t stay the course. Until this fundamental incentive is fixed, regulations will fail to move the needle.
Q5: What positive alternative do banks have to commission-based selling?
Banks could offer AI-based, full-service financial planning for a fee, creating annuity income that grows with Indian per capita income. Instead of chasing commissions on individual products, they could charge for comprehensive advice. This would make households partners rather than victims, aligning bank interests with customer welfare and rebuilding eroded trust.
