As part of our series of posts on Consumer Protection, in this post Deepti George of IFMR Finance Foundation interviews Denise Dias of CGAP. Denise specializes in prudential banking and microfinance regulation and supervision, and shares valuable insights with us in this interview.
What broad trends can you draw from your experience with developing countries in terms of the extent of regulator-led, quasi-regulatory and industry-led supervisory approaches? Are there any specific interesting cases that come to mind?
In most developing countries I know the financial supervisor is taking the lead in financial consumer protection supervision, even in those cases where it does not have a clear legal mandate to do so. In an upcoming CGAP publication on the topic we highlight this trend, that financial supervisors, even in low-income countries, are starting or improving their frameworks for financial consumer protection supervision . It is a major finding that financial supervisors, whose core mandate is ensuring systemic stability (in many cases also currency stability, when the supervisor is also the central bank), are engaging with consumer protection supervision1. At some point there were many who argued that the two objectives were conficting, but now a very visible trend is that these two objectives are increasingly and strongly in some cases, considered complementary and reinforcing, regardless of which government entity is charged with consumer protection supervision.
Most have based their actions on the reality that at least in the short term the national financial supervision institutional structure and regulatory framework will not change. They adopt pragmatic steps to make the best out of the current conditions and framework, working within the powers, the institutions and the resources available, and defining a strategy that fits their unique position in the supervisory landscape of the country.
While the industry bodies have a role to play (arguably more in consumer protection than in prudential supervision), self-regulation has not shown to be able to substitute supervision by a government body. What you refer to as quasi-regulatory approach would be self-regulation that is enforceable. This is ideal, as most countries I know where the industry body does not have enforcement powers it becomes a very weak body in terms of setting standards for market conduct. Supervisors can leverage on industry bodies to shape industry codes of conduct and enforce compliance to these codes. Some of them, such as Philippines, try to leverage industry bodies to implement consumer protection in unregulated markets (e.g. NGO MFIs), which is very positive. The Banco Sentral has engaged with the microfinance association to encourage this unregulated industry to adopt transparency standards (more specifically, the key facts statement for loan operations) that are imposed to regulated entities such as banks.
Developing countries have seen the need for and the development of many models of financial intermediation in order to meet the needs of the financially excluded (such as MFIs, m-banking). What have been the typical regulatory responses to this? Have regulators responded favourably or have they been exceedingly conservative and cautious thus preventing the development of new models? How have countries managed this crucial and delicate balance?
Most regulators in developing countries have responded positively to innovations such as e-money and branchless banking, in addition to more traditional models of microfinance, to accelerate financial inclusion. However, not always do their reactions have positive consequences. For instance, many have passed regulations in order to allow for such innovations, but their approach to regulation was many a times based on existing understanding of how businesses are done in the banking sector, which most often will not permit innovative models to happen in practice, or at least not sustainably and profitably. Many regulations impose too many restrictions, with the intent of protecting consumers, the integrity of the system, or financial stability, and end up making innovation very difficult. For instance, regulators tend to be very wary of allowing account opening at retail agents who work on behalf of regulated financial institutions, but this is a key feature of innovation that would allow a greater number of people to have access to accounts provided by regulated entities. Another error is imposing too many restrictions on the minimum characteristics of agents, which reduce the options for financial service providers to choose the best agent in each new place to which it wants to extend outreach.
Regulations only reach a balance when they have a very clear view of the risk of tending too much to one or the other side. They make themselves aware of this risk and can examine their own approach when they purposedly try to learn from international experience (by reading, by talking to peers and participating in events), when they consult the local market and other local stakeholders (while being aware of vested interests that can shape different opinions), and by setting regulatory and policy objectives that can be measured with time (regulatory impact evaluation). Those supervisors and regulators that seek to be more clear, open and transparent about their own objectives, by communicating with others, usually have been more successful in reaching a balance between enabling and protecting.
In some countries, such as Australia, the regulatory regime has moved towards shifting the onus of consumer protection to financial service providers by making them liable for advice they give. What are your views on this?
I think that shifting the onus is a valid proposition in many situations, particularly for low-income consumers, who usually have low-value transactions and accounts, and have more difficulty in solving problems with financial services providers. I think it is dangerous to make a blank statement saying that shifting the onus totally is always a good option, one would need to list and examine the impact of such a measure in all potential situations. In general, this is a good measure, particularly for areas where the regulator opted for giving more flexiblity to the industry that would in practice leave the consumer less protected.
One example is in Mexico, where the regulator has imposed banks to shift to chip (smart) cards, which offer a much higher level of protection to consumers. However, these cards are much more expensive for the provider, and hence this shift could make debit cards too expensive for banks to offer to low-income persons. The decision was to allow banks to continue using magnetic stripe cards, but in cases of frauds or stolen funds, or any other problem faced by the consumer, the bank has the obligation to pay the value to the customer, without right to recourse or any conflict resolution to try to blame the customer. This approach is actually very realistic. A bank in Brazil, for instance, has stated that the cost of shifting all its debit cards on low-value accounts to chip card was equivalent to 60 years of frauds in such accounts, taking into consideration the level of frauds the bank sees today.
Financial services intermediaries getting paid a volume-based commission (among other incentives), has been a prevalent feature in many developing nations since the beginning of formal financial intermediation. What supervising measures have you come across, that have been successful in preventing and managing ‘conflicts of interest’ among financial services providers?
The question of commissions to intermediaries such as credit sales persons is indeed a concern for many supervisors and regulators. I have seen some instances where both regulatory and supervisory measures are taken to try to correct bad practices. One regulatory measure in Brazil, for instance, to correct bad practices in the consumer credit market, was to prohibit up-front commissions and impose the obligations for these commissions to be amortized through the life of the loan. This may not be a good measure everywhere as it was taken to address specific abuses in the Brazilian market such as subsequent resales of the loan to other providers.
Supervisory measures include monitoring media reports about abuses in the market, reports from consumer protecton and advocacy bodies, and analysis of complaints statistics. These information sources will help the supervisor define on which issues and institutions it needs to focus. Based on these and other complementary information, supervisors do inspections to check how the management is implementing its policies, and how the internal controls reduces the risk of misbehavior by intermediaries. As the evidence shows today, only a few developing countries have advanced supervisory systems for consumer protection or market conduct issues such as this one. Some countries that can be mentioned as specifically focusing on these topics are Peru, Malaysia, South Africa, and Brazil.
The problem is not in the fact that the commission is paid by volume. It’s in the overall incentive structure for misbehavior. If there is only a commission that is based in volume and no other incentive for the intermediaries, it is very likely they will misbehave. Commissions may be tagged to performance of loans, may be amortized with time, or other different structures. The role of the supervisor is to evaluate how good or not the financial institution is in creating this incentive structure and how it monitors the effectiveness of its own policy. Complaints statistics are simply a key to help the supervisor do its work.
1 – Countries differentiate consumer protection from market conduct supervision, but in this interview we are referring to both areas broadly as “consumer protection”.