Can Self-Regulation Work to Protect Clients?

The SEEP Network recently released a new study, “Codes of Conduct and the Role of Microfinance Associations in Client Protection” that explores the potential for codes of conduct to improve industry practices in client protection through three case studies: the Pakistan Microfinance Network, the Microfinance Institutions Network in India, and ProDesarrollo in Mexico.

The publication uses these case studies to demonstrate how industry actors are addressing some of the core consumer protection issues—transparency and disclosure, dispute resolution and complaints channels, responsible lending, and fair treatment—as well as some country-specific issues—such as a “staff bureau” in Pakistan that tracks past and current employees of PMN members who have committed fraud at work to warn others against hiring them.

But what does this movement towards codes of conduct amongst microfinance associations mean from the policy perspective? Policymakers (and the rest of us) cannot count on the microfinance industry to handle client protection all on its own, not least of which because it is only one niche amongst the broader range of financial services used at the base of the pyramid. So what then is the right balance between regulation and self-regulation in consumer protection?

To answer this question it is useful to analyze the comparative advantage of regulators and retail providers on an issue-by-issue basis. Some consumer protection goals and principles are more amenable to self-regulation and others less so. And there are a few areas where both providers and regulators can collaborate for better outcomes. Here are a few examples of what I mean:

Less amenable to self-regulation:
Pricing transparency and disclosure. All three cases in the SEEP study described how difficult it can be for associations to achieve consensus amongst their members on pricing and disclosure rules. In some cases it is even profitable in the short-term for a provider to obfuscate terms and collect high interest, fees, or penalties even if the loans provided are not sustainable in the long-run. Even if consensus is achieved by an industry association, it will likely not cover a large segment of the market, leaving some actors capable of continuing to gain market share and competitive advantage through price obfuscation. For example, in Mexico, the ProDesarrollo network includes 85 financial institutions, including many leading MFIs, but does not cover most of the hundreds of the consumer credit institutions common in the Mexican market.

Regulatory rules on pricing transparency can achieve broader market coverage than most association-driven efforts. For example, in 2001 the National Bank of Cambodia prohibited the use of flat interest rate calculations amongst MFIs, which recent analysis by MFTransparency shows helped increase pricing transparency and reduce borrowing costs across the entire sector, something that may be beyond the reach of even the most powerful national MFI
Association.

Finally, since transparency and disclosure are fairly rules-based issues where unambiguous guidance and definitions can be established for all to follow, they lend themselves well to a legal and regulatory approach to develop market standards that can be applied broadly and effectively enforced.

Amenable to self-regulation:
Collections practices. Experience suggests that while regulators have a role in pointing out practices that are unacceptable, providers are better at developing operational solutions to the problems. Collection practices probably fall into this category. While regulators might want and need to set some basic rules (for example, around abusive behavior, property seizures, or handling of collateral), it is unlikely that they can determine the best way to implement those rules. Regulators’ impact on the market is likely to be limited without providers taking the lead in translating ideas into specific rules regarding collections staff and agents, training and internal controls to ensure compliance. Furthermore, given the reputational risk and politicians’ sensitivity to any whiff of abusive behavior, the industry has a strong self-interest to fix this particular problem.

May depend on the market context:
Responsible lending. Private sector efforts to improve lending practices through a code of conduct can include measures concerning affordability assessments, appropriateness of product design, or flexible payment terms. However, these topics are fairly subjective and hard to properly define and monitor. This means that the success of such measures will likely depend in great part on the level of influence and market share coverage of a particular industry association. Similarly, the theory that increased competition in a market will punish bad actors and reward responsible lenders with new customers does not always hold true in the short-term, and so there may be a need for policymakers to intervene and stem a growing credit bubble or widespread improper practices before they impact the entire market.

Opportunities for public/private collaboration:
Recourse and dispute resolution. Effective recourse systems generally involve both internal and external complaints and dispute resolution mechanisms, which ideally are coordinated. Many complaints made by consumers are actually questions or inquiries for further information, and can be handled quickly and efficiently at the provider level. In general it is important that complaints be addressed and resolved as close to the customer and transaction as possible and that they be filtered from minor to more severe so that the government body responsible for recourse is not overwhelmed by handling hundreds or thousands of lower-level complaints, and can focus its time on the more significant or egregious cases. Sharing of consumer complaints data between public and private complaints mechanisms is also an important component of a public/private approach to recourse, and can help both sides monitor and detect client protection “hot-spots” as they arise.

Financial capability and customer education. Increased government interest in financial capability and consumer education programs is occurring simultaneously with interesting findings that point to the benefits of using actual consumer experiences to design more salient and “sticky” financial education programs. There is an opportunity here for providers and governments to partner and develop joint financial education initiatives that are based on products consumers use, but achieve national scale in their outreach (just such a campaign was recently launched in Colombia.)

What do you think? Are there other client protection issues that you feel are particularly “private,” “public,” or “both?” Are there other success stories you have seen of coordinated regulation/self-regulation efforts to improve financial consumer protection? How can we make effective business cases for these client protection measures that help industry associations convince their members to adopt these codes of conduct?