WIXLIB

4Box 3. What Can Go Wrong?Typical cross-cutting consumer protectionconcerns Product transparency. Consumers don’t understandthe service’s total cost; this can be exacerbated bydeceptive advertisements, excessive small print,complicated terms, inadequately trained staff, etc. Overcharging. Consumers are charged extrafees and commissions that are not authorized orproper. Sales practices. Consumers face aggressive salestechniques as part of door-to-door solicitations orlimited-time offers. Inadequate documentation. Consumers do notreceive copies of contracts, receipts, etc. Privacy, security, permission to share with thirdparties. Consumers cannot be sure that personaldata will be treated appropriately. Recourse. Consumers don’t know that they havethe right to complain or get errors resolved; theymay know they have this right, but don’t knowhow and where to complain; they know how andwhere to complain, but fail to receive appropriateredress.nonprudential consumer protection regulationgoverning the market conduct7 of providerstoward users of financial services. Ideally, thisshould set rules for practices and productfeatures across provider types, covering allproviders of similar products and services.Consumer protection regulation focuses mainlyon products, whereas prudential regulationseeks to maintain the financial health andsolvency of institutions and the broader financialsystem. Prudential regulation contributes toconsumer protection as well, however, by tryingto prevent losses by small, unsophisticateddepositors and promote sound providers thatcan offer reliable access to financial servicesProduct-specific concerns Deposit products. Consumers’ savings are erodedby hidden fees or deposits are lost to fraud. Credit products. Consumers don’t understandthe terms and conditions of their loan agreement,e.g., what happens in the case of delinquency ordefault; they pay a high price; they take on toomuch debt; they are exposed to loan officers thatask for a “gift” to complete the loan process, torecommend a larger loan, or to expedite loanapproval; they are subject to intimidation, abuse,or humiliation by collections staff/agents. Payments services. Consumers transfer money tothe wrong person or mobile phone and don’t knowhow to correct the error; they lose their personalidentification number or have it interceptedelectronically by a fraudster. Insurance. Consumers don’t understand, or they failto receive, policy benefits (e.g., they don’t receivethe full benefit when a family member dies); theydon’t realize that the loan price includes credit lifeinsurance, and so are paying more than expectedand failing to benefit from the insurance.over time.8, 9 Some consumer protection rulesserve both prudential and nonprudentialobjectives (e.g., reckless lending rules aimedat keeping both lenders and borrowers fromgetting into trouble). Enforcement of other lawsand regulations (e.g., those governing fraud,financial crimes, and bank secrecy) through civiland criminal penalties may also have consumerprotection dimensions, as when Ponzi schemesare detected and disrupted. Competitionoriented regulation can rein in practices such asunreasonable barriers to switching providers,which can have negative consequences for bothconsumers and competitors in the market. Asa result, in many countries responsibility for7 Market conduct (or conduct of business) refers here to the interaction between provider and consumer. While regulation also can govern otherdimensions of conduct, such as providers’ interaction with other providers or investors, this paper focuses on consumer-oriented market conduct.8 This distinction refers to the nature of consumer protection regulation rather than the locus of enforcement. Most such consumer protectionregulation is currently overseen and enforced by prudential regulators.9 Other measures such as deposit insurance also serve to protect consumers.

5financial consumer protection is shared amongmultiple financial and nonfinancial regulatorsand enforcement bodies.makers identify priority market segments, theyneed to consider how best to tailor consumerprotection measures to the segments’ specificcircumstances so that they are effective.Which consumers?Typically, consumer protection regulation seeksto protect all retail consumers.10 Special attentionmay be given to segments that are morevulnerable to abuse or unfair treatment. In manydeveloping countries, where financial inclusionis an ever more prominent policy goal, onepriority area might be consumers who are lessexperienced (e.g., those who are just beginningto use formal finance), which often correlateswith lower incomes and education levels. This isthe primary market segment considered in thisFocus Note. A central problem these consumersface is too few options for good quality, formalfinancial services to help them manage theircomplicated financial lives.11Another segment policy makers might prioritizecomprises lower level salaried workers—theaspiring middle-class segment that is growingvery rapidly in some countries. In contrast tothe poor, this group is vulnerable preciselybecause it has too many options. In countrieslike Russia, Brazil, South Africa, and India, withskyrocketing consumer credit, salaried workersare bombarded with credit offers and subjectedto high-pressure sales tactics that take advantageof their limited experience with formal finance.This market segment tends to be ill-prepared tosort through the options, make good choices,and avoid getting overextended. As policyWhat is the relationship betweenfinancial inclusion and protecting lowincome consumers?Although industry leaders, journalists, andacademics debate the available evidenceheatedly, most now accept that access toformal financial services of a variety of typescan improve the well-being of poor people. Infact, access to well-designed financial servicescan yield substantial protective benefits to poorhouseholds. Being able to tap savings or creditfrom a reliable financial institution, for example,can help the poor manage crises, such as illness,without having to sell assets.12Thus, in low-access environments, regulatorsshould take special care that the cost ofcomplying with new consumer protection rulesdoes not make serving low-income customersunattractive for responsible providers, with theunintended consequence of “protecting thepoor out of the market.” At the same time,the goal of financial inclusion need not implythat unbanked customers should receive lowerstandards of safety and quality.Regulation engenders direct and opportunitycosts for regulators, providers, and consumers.The direct costs of monitoring, compliance,and enforcement may be easier to quantify10 Some countries define the scope of retail consumers to include very-small-scale businesses whereas others limit the definition to natural persons.11 For example, Collins et al (2009) collected financial diaries from hundreds of poor families in Bangladesh, India, and South Africa and foundhouseholds used an average of 8 to 10 different financial instruments over the year, including savings mechanisms, loans, remittances, andinsurance. This work highlights a key consideration for regulation: the poor manage to derive benefit from financial instruments that may appearto be of unacceptably low quality to outsiders, such as regulators. Reducing their options should be done with considerable care.12 See, for example, Collins et al. (2009).

6than the benefits of responsible financial sectordevelopment. This can make it tempting toavoid introducing new regulation in low-accessenvironments, where regulatory capacity orthe transaction costs of serving low-incomepeople are major issues. Many valid questionsarise: Will new consumer protection rules beenforced adequately to deliver their intendedbenefits? Will compliance costs be passed onto consumers, hindering access for the poor?Will providers find the cost of complyingwith basic conduct rules—covering plainlanguage price disclosures, fair advertising andcollections, or recourse—so onerous that theyare discouraged from serving the unbanked?There is little evidence to suggest that basicconsumer protections will pose a major barrierfor responsible providers offering appropriateproducts and services.Let’s take the hot-button issue of the price ofcredit for the poor. Policy makers concernedabout high-cost providers and deceptiveadvertising, for example, can (i) imposestandard disclosure requirements on all creditproviders in the market, (ii) make consumersaware of their right to this information, and(iii) find cost-effective enforcement steps.Responsible players are likely to find the onetime, up-front compliance costs (redesigningforms and signage, training staff on the newrules, etc.) and ongoing expenses feasible. Forthose players with a business model that relieson opaque pricing and fees for its profitability,however, the new regime could make service tothis market untenable.Is this a loss from a financial inclusionperspective? Typically it is not—if the goal isresponsible finance, where market practicesand products balance the interests of providersand their clients. Consumer protection rulesin low-access environments should safeguardthe interests of consumers, promoting qualityservices and fair competition. The exit of lowerquality players that are deceptive and abusive orthat seek to maximize profits in the short termat the expense of long-term value for customersand shareholders is in fact usually a major goalof such regulation.Where to Begin? A Targeted,Incremental ApproachIn a small but growing number of developing andemerging market countries, policy makers havedeveloped innovative and effective consumerprotection regulation. They have taken anincremental, proportional approach, phasing innew rules that responded to specific consumerrisks, the country’s financial inclusion priorities,and regulatory capacity. By incremental andproportional, we mean regulatory responses thatare crafted in light of (i) the nature and extentof the most critical problems; (ii) the benefits orthe consequences of not acting—for consumers,providers, and the market as a whole; (iii) thecosts to providers of new rules, and how the rulesmight affect overall affordability and availabilityto the covered providers and products; and(iv) the supervisory capacity and political willto implement and enforce regulations.13 Policymakers in low-access environments should not13 “Proportionate” or “proportional” is used differently in different contexts, e.g., for the U.K. FSA: “The restrictions we impose on the industry mustbe proportionate to the benefits that are expected to result from those restrictions: In making judgments in this area, we take into account thecosts to firms and consumers. One of the main techniques we use is cost benefit analysis of proposed regulatory requirements.” index.shtml.

7Box 4. Getting Started: Some Key Questions Which customer segments are particularlyinexperienced or vulnerable to abuse? Which significant consumer protection problemsare present in our credit markets? Are there problems emerging around noncreditproducts, such as remittance and payment services,deposit services, and insurance? What regulation, if any, is in place? Whichtypes of consumer protection rules—disclosurerequirements, fair treatment standards, restrictionson potentially harmful products and practices,feel that they need to come up with an all ornothing approach or to do too much too fast.If regulatory capacity to monitor and enforce islimited, an overly ambitious new regime couldcreate expectations that are hard to meet.An example from Cambodia emphasizeshow taking fairly simple first steps can lay thegroundwork for fair, competitive, and efficientdelivery of financial services; extend basic rightsto consumers; and reduce instances of deceptive,unfair, or confusing financial products andpractices. Cambodian microfinance providersserve far more customers than commercialbanks. Little consumer protection regulation wasin force, so the central bank began by identifyingwhat it believed to be the greatest problemfacing microloan customers—transparentpricing—and implemented simple rules on pricecalculation and disclosure. The formula requireduse of the declining balance rather than flatformula (common in many microfinance markets)for interest calculation. The regulation wasmechanisms for recourse, etc.—are best suited tothe problems observed? What nonregulatory alternatives—such as industrystandards or consumer awareness and financialcapability measures—might complement orsubstitute for new regulation? Do certain types of providers or products accountfor a disproportionate share of problems? Which entity or entities should oversee marketconduct regulation? How can adequate capacityfor this expanded role be ensured?widely credited with bringing down the cost ofcredit at the time for consumers and increasingcompetition (CGAP 2009a and Clark 2006). Thisinitial step laid a good foundation from whichCambodia can now build with further consumerprotection rules as needed.14The reality is that overstretched policy makersoften wait until a pronounced market failure hasoccurred to devise a regulatory response. Yetfailure to anticipate risks to a financial sectormay bring its own inefficiencies and potentialdamage down the road, to the system as wellas to individual consumers. In markets withrapidly expanding access to consumer credit,for example, preventive actions may be the leastcost approach in the long run by preventingwidespread delinquency and default. Andsetting clear rules at the beginning can allowresponsible providers to achieve efficiencies byputting in place any one-time changes to theirsystems, forms, and staff training occasioned bythe new regulation.14 South Africa offers another example of incremental, proportional regulation of credit markets. In 1999, policy makers put in place an Exemption tothe Usury Act aimed at reining in problematic practices by credit providers while promoting healthy growth of credit to underserved segments. In2005 the more comprehensive National Credit Act was enacted, creating a National Credit Regulator and adding provisions to address additionalrisks and problems arising in the fast-growing market. 1

8Box 5 lays out two broad packages ofregulation, to provide general guidance fortailoring consumer protection rules to countrycontext and allocating regulatory resources.It is important to emphasize, however, thatstylized delineation of this type will not work forall contexts or products. Consumer protectionissues and regulatory capacity in a country mightbe at a very different stage for credit productsthan insurance products, for example. In manycases, countries will likely apply this frameworkseparately for different types of products andproviders. And in all cases, they will be buildingon their existing legal and regulatory framework.The packages are meant to offer a startingpoint for assessing rules to protect low-incomeconsumers that are likely to be appropriate atdifferent stages of market development andregulatory capacity.The first package includes those basic provisionsmost relevant in low-access settings. These rulesare generally less complicated and less costlyto implement, both for regulators and industry.They raise fewer risks of unintentional barriers togrowth of responsible providers and services.The second package has measures that could bephased in later, as markets develop, competitionheats up, and provider and product diversityincreases. As a rule, these measures are moreexpensive or more challenging to implementand enforce, requiring a greater degree ofregulatory capacity. They also demand a deeperunderstanding of what is happening as theindustry develops, to strike the right balancebetween access and protection in addressingemerging risks.Three Core ConsumerProtection GoalsA policy framework to protect financialconsumers in low-access environments shouldfocus first on three general goals:151. Transparency—Customers know what theyare getting.2. Fair Treatment—Customers are treatedfairly and are not sold inappropriate/harmful financial services.3. Effective Recourse—Customer complaintsare resolved fairly.TransparencyTransparency issues in low-access markets.Meaningful transparency rules provide thefoundation for the basic package. They figurehigh among the priorities of financial sectorpolicy makers in many low-access markets. Theneed for rules is especially important wheremarket monitoring reveals poor customerunderstanding of product terms and conditions,aggressive competition, or large numbers ofclients with loans from multiple lenders orunsustainable household debts.For credit products, a diverse array of evidencesuggests that transparent disclosure of loanterms can contribute to reducing borrowingcosts, which is a policy goal in many countries.Disclosure requirements offer a more marketfriendly alternative than interest rate ceilings.Microfinance interest rates declined significantly,for example, in a number of more competitivemarkets, such as Cambodia, Peru, and Ghana,15 Country-specific factors will yield important additional consumer protection goals, of course. An example is nondiscrimination in South Africa,India, and other countries.

9Box 5. Basic Consumer Protection Package forLow-Access Environments vs. Second-Generation PackageBasic package Basic registration and coverage by regulation ofall providers of a particular product or service,to the extent feasible: Ideally, registration wouldbe triggered by activity rather than institutionaltype. And consumer protection rules wouldbe extended to as many providers as possible,with loopholes minimized. As a practical matter,exemptions might need to be put in place for tinytransactions and/or providers with a very smallnumber of transactions. However, serious thoughtshould be given before completely exempting theoften informal providers low-income consumersmight depend on; even these providers couldbe required to comply with basic conduct rules,while the oversight and enforcement strategyfor individual firms might differ proportionate tothe risks observed in very small providers versuslarger providers that are already regulated and/orsupervised. Basic information: Written, easily understoodinformation provided to consumers before theypurchase the financial service; written agreementsprovided to consumers that clearly showamount borrowed/deposited/paid, obligationsof customers and providers, and penalties fornonperformance; written notification to consumerswhen prices or other conditions of financing changeover the course of the agreement. Going one stepfurther by mandating standardized disclosure (e.g.,standard wording, formats,a effective lending ratecalculation) enables better comparison shopping. Basic standards of conduct: Prohibited practices,such as physical violence, fraud, deception, misuseof personal information, discrimination. Basic consequences: Depending on the severityof the infraction, penalties (fines, withdrawingdeceptive advertisements, nonenforceability ofnoncompliant loans, jail time, or public “namingand shaming,” which has served as a deterrent insome settings). Basic recourse: Designated contact in eachprovider that will receive and respond toconsumers’ queries and complaints.b Basic consumer awareness initiatives: To makeconsumers aware of the rules and inform them oftheir rights and redress optio

8 This distinction refers to the nature of consumer protection regulation rather than the locus of enforcement. Most such consumer protection regulation is currently overseen and enforced by prudential regulators. 9 Other measures such as deposit insurance also serve to protect consumers. Box 3. What Can Go Wrong?