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Fraud and financial literacy

Financial literacy as defined and delivered in India, can do precious little if someone targets your money

Fraud and financial literacy

"Mastermind of Rs 400 crore Citibank scam arrested again," were the headlines last week. While the headlines appeared to imply that this was someone who had defrauded Citibank of Rs 400 crore, the truth was the opposite. This was a Citibank employee who had defrauded the bank's customers of that amount. I had actually written about this case in this column when it had come to light almost a decade ago. You can Google the details by searching for 'Shivraj Puri Citibank' if you are curious but there was actually nothing surprising about what had happened. It was the kind of fraud that was just waiting to happen.

This was what I had written at the time. Following the Citibank scam, India's wealth management business is under siege. The financial industry's grapevine is buzzing with talk of customers redeeming their investments, insisting on recordings of conversations, pulling out blank signed documents they had handed over, and generally acting as if their trust level has dropped to zero. And so it should. Even though there's no shortage of people trying hard to spin Shivraj Puri's actions as an isolated case of fraud, it's clear that this was something that was waiting to happen. The modus operandi of the service is heavily dependent on the individual being trustworthy. Far too big a role is played by word of mouth and by pre-signed blank cheques and documents. This is not a critique of wealth management itself (which is a separate story by itself), but of its general method of operation.

Even though a decade has gone past, the broad contours of the problem remain the same. People who consider themselves knowledgeable and sophisticated investors get sweet-talked into supposedly lucrative investment avenues. Why does this happen, again and again? The conventional answer is a lack of financial literacy. A lack of knowledge about what works and what does not. According to this view, people need to learn what to do.

However, the answer is possibly a little more complicated. In fact, the truth could be exactly opposite. It would be far more useful for people to instead learn what not to do with their money, and this education is not available anywhere.

Everything that passes for financial literacy involves teaching how the investment world works, what the different types of investments are, who they are useful for, how to fit them into your financial needs and so on and so forth. This is all good stuff and investors mostly know it, but it's not where people go seriously wrong. Where they go wrong is that when someone tries to hawk bad financial products dressed up as good ones they can't recognise what's happening. And if you are in the market for financial products, then sooner rather than later, someone does exactly that.

This doesn't just apply to outright frauds like the recent Citibank case, but also to products that fall within the borderline of legality. For example, let's say that you invest in stocks and prefer to choose fundamentally sound companies and stay with them for the long term. If you do this then it won't be long before your broker will try and guide you into some highly leveraged high-risk action in index derivatives. His pitch will basically amount to telling you that you are a complete fool for ignoring the massive returns that are to be had for asking if you follow his advice, except that he won't mention the risk part till it's too late. Unlike what the Citibank guy did, this is completely legal too.

The problem is that existing channels of financial education are committed to not being critical of anything. They'd like to be polite and not step on any toes, especially commercially powerful ones. This actually makes them pretty much useless. For the saver, not doing the wrong things should actually be learnt before doing the right things. Unfortunately, this is something that is often learnt the hard way.