Being ‘Sachet’ in Curbing Illegal Money Deposits
As part of our series on consumer protection, we seek to present views of leading experts in the field. Below is a guest post by Elisabeth Rhyne, Managing Director, Center for Financial Inclusion at Accion.
A few years ago, I refinanced my home mortgage. When I arrived to sign the contract, a mortgage company staff member led me through a thick stack of documents. At one point she put her finger on the paper to cover up a number, and said, “The following number is meaningless, but I am required by law to show it to you.” Then she moved her finger and revealed the effective interest rate.
This incident demonstrates an important problem inherent in regulating consumer protection in financial services: regulators cannot be everywhere or prevent all forms of bad treatment.
In the United States, where I live, and in India, regulators favor a rule-based approach. They prohibit or mandate very specific behaviors. But the staff person who handled my mortgage followed the letter of the law on interest rate disclosure. Although her behavior was anything but transparent, no one in her institution, let alone a regulator, was watching. Thus, a rule based approach can only go so far. Moreover, while a rule-based approach may be the best way to prevent severe offenses, it tends to degenerate into a “whack-a-mole” game: as soon as one bad behavior is prohibited, another one pops up.
In the United Kingdom and Australia, regulators favor a more principle-based approach, with greater regulatory flexibility. One way this approach plays out in the U.K. is the Financial Services Authority’s Treating Customers Fairly program, which was previously mentioned in this blog in the context of its spread to South Africa. Under Treating Customers Fairly, “Firms must be able to demonstrate that they are consistently delivering fair outcomes to consumers and that senior management are taking responsibility for ensuring that the firm and staff at all levels deliver the consumer outcomes relevant to their business through establishing an appropriate culture.” This approach recognizes that tools to enable providers to take affirmative responsibility can be an important means of tackling the consumer protection challenge.
The providers-taking-responsibility approach is also embodied in the Smart Campaign, a global effort to embed a set of Client Protection Principles into the microfinance industry. Officially launched in 2009, the Campaign now has more than 3,000 endorsers, including nearly 1,000 microfinance institutions. It is housed at the Center for Financial Inclusion at Accion in Washington and governed by a multi-stakeholder, multi-region steering committee.
The Smart Campaign is premised on the concept that most providers are willing to take responsibility for good client protection practices, if they are encouraged and enabled to do so. When the Campaign began, there was a broad consensus across the global microfinance community about the general principles of client protection, but little awareness of how to apply those principles in practice. The Campaign addresses this challenge in three somewhat sequential steps. First, the Smart Campaign has made the microfinance industry far more aware of and committed to client protection than it had previously been. This awareness has taken hold among MFIs, their supporting organizations and the investors and funders who supply their capital. Second, the Campaign has developed standards of practice for the implementation of the Client Protection Principles where none existed. As a result, the Campaign now has a resource base of nearly 60 tools on its website available for financial institutions to use. Third, the Campaign will soon introduce certification, which will allow for public recognition of organizations that apply these standards. With certification will come a means to separate those MFIs that take adequate care from those that do not and to incentivize MFIs to improve their practices.
This discussion of the Smart Campaign may sound promotional, and I confess that perhaps to some degree it is, but the broader point is to urge regulators to consider approaches like the Smart Campaign and Treating Customers Fairly as part of a complete response to the challenge of client protection, alongside rulemaking, enforcement tools, ombudsmen, client education, and even self-regulation.
The Smart Campaign now represents an important body of knowledge about how client protection culture, norms and practices can be enhanced inside an institution. For example, much has been learned about how human resource polices can translate into good client protection practice. A corporate culture favorable to client protection will create attitudes among staff and management that prevents bad practices from developing and bad behavior from occurring when no one is watching. It can be developed through such obvious means as staff training and codes of conduct. Going deeper, staff recruitment can seek applicants with positive attitudes towards client protection, and possibly most important of all, evaluation systems can integrate client protection principles. For example, when Smart Campaign assessors examine institutions, they look closely at the behavioral incentives created by the structure of any monetary staff incentives (e.g., whether growth incentives are counterbalanced by portfolio quality incentives).
Incorporating client protection principles into operations is more straightforward, but it does require systematic effort, especially for operations with a direct client interface. For example, in the Campaign’s tool, Client Protection in the Credit Process, specific points of contact with clients are identified and suggestions made about how to maintain transparency to ensure clients have the information they need at the time they need it. Similarly, with informative tools, client protection principles can be integrated into the functions of marketing, audit, risk management, governance and so on.
The Campaign has also learned that regulators are not the only external leverage force to influence financial institution behavior. In the microfinance community other influencers include investors, associations, and supporting organizations such as training institutes and consultancies. Investors increasingly view poor client protection practices as a risk factor, and the microfinance-focused rating agencies are incorporating client protection into their rating protocols. Investors are quite likely to be the driving force behind the certification program the Smart Campaign is introducing at the end of 2012. Through certification, institutions that meet adequate standards of care will be publicly identified as Smart Campaign certified. In India, certification will be adjusted to accord with the Indian microfinance Code of Conduct and RBI guidelines.
National associations also have a role in supporting client protection. Associations are often seen as the potential seat of self-regulation. In India, the regulator has mandated microfinance associations M-FIN and Sa Dhan to uphold standards among their members. However, India is unique in this respect. Regulators in few, if any, other countries have given this kind of mandate to microfinance associations, and few associations have taken on self-regulation on their own, being more comfortable with – and equipped for – standard setting, awareness raising, training and capacity building. These activities may lay the groundwork for self-regulation at a later date.
Thus, in many countries there are few external entities pushing financial institutions toward better practices, Regulators can never be ubiquitous, so they should enlist the assistance of providers as much as possible. Approaches like Treating Customers Fairly and the Smart Campaign are not substitutes for regulation, but compliments. They should make regulators’ jobs easier and allow regulators to focus their scarce resources on the most serious problems. Moreover, consider that the desired outcome is not just avoidance of the worst practices (where regulation is absolutely necessary), but the promotion of good ones.
Incentives for poor consumer protection are intrinsic to financial systems, but regulators can take heart from knowing that many people inside financial institutions are eager to do the right thing. A smart regulator will find ways to empower those people within their institutions. While regulation is essential, regulators stand to benefit from promoting or connecting to activities like the Smart Campaign that focus on commitment, knowledge and capacity among providers.
Dear Ms. Rhyne, the Smart Campaign has been instrumental
in introducing market standards for consumer protection among microfinance
institutions all over the world. Below are a few comments on the Campaign per
say and we would love to hear your views on these:
The Campaign has as one of its principles, ‘prevention of
overindebtedness’, and one of the ways this is measured is by checking whether
“Credit approval policies explicitly address borrower debt thresholds and
acceptable levels of debt from other sources’. Wouldn’t this evaluation of
overindebtedness be an integral part of the provider’s business processes
itself and therefore must it fall under the concern of consumer protection? Is
it not in the interests of providers, their employees and the customers to not
end up with a bad repayment record?
Moreover in microfinance, under the group lending model, the group knows
the risks it is undertaking and the provider relies on their ability to
identify good customers.
Providers will never be able to ascertain with absolute
certainty whether a household is credit worthy or not and therefore, wouldn’t
the decision of whether a household needs to take on more debt for consumption
or not, be best left to the household? This
is particularly important in the common scenario where a household is trying to
refinance an existing high-cost loan (perhaps not captured by a credit bureau) by availing a lower-cost loan. Denial of
credit in this case could further exacerbate the household’s financial
situation, contrary to the rationale for this principle (“Borrowers should be
able to handle debt service payments without sacrificing their basic quality of
life”). While the information asymmetry associated with this particular case
would be hard for the financial institution to bridge, a major portion of it is
taken care of by group self-selection, a key feature of microfinance. The
RBI-requirement that loans must only be given for productive purposes, also
prevents clients from availing credit for not just refinancing but also for
essential consumption needs such as for health or education.
Deepti — Thanks for you comment. You suggest, as group lenders have for many years, that the assessment of ability to pay can be left to the group. My response is that microfinance has learned the hard way what lenders in many other settings have also learned: in a rapidly growing market, with heavily indebted people and much competition clients have a tendency to borrow more than they can handle, and providers have an incentive to overlend in order to gain market share. Group lending models do not adequately prevent this behavior, as they generally rely on automatic stepped loans without a look at income streams and other debt obligations. There is no perfect way to prevent overintebtedness, but clearer rules about assessment of repayment capacity and the limits of debt service are an essential part of the toolkit. This has been a challenging area for the Smart Campaign, because it was clear that a significant change in practice was needed, and that such changes might add costs to the lender. We are happy to report that a number of group lenders in India and elsewhere are starting to find ways to incorporate simple repayment capacity checks into their credit process.