Below is the second part of the three part interview with Kate McKee of CGAP. The interview is part of our Consumer Protection series.
Q: Are there any specific examples in the developing world where there seems to be a nudge towards a less prescriptive principles-based approach? For instance, recently IRDA, even in a rule based system, had put out very rudimentary rules for suitability, so the insurance agent should not provide insurance without taking into account the specific requirements of the customer and analyse requirements before suggesting an insurance product. So even though not purely principles-based, it does make a shift towards that. Are there any other examples like this in other countries?
That’s a good example. I think there are some consumer protection objectives – such as transparency on price and product features – that are better pursued through articulation of specific rules and others – such as appropriateness of product features – that are better candidates for the more flexible principle-based approach. Articulating principles such as the IRDA concept of “suitability” might be a particularly good way to go in newer markets or segments where the regulator wants to encourage innovation. The concept may initially be hard to define very precisely, and the regulator also has the opportunity to engage in a genuine dialogue with industry around what is permissible. Then if market players are found to be obviously abusing this flexibility, the authority then has the option of putting more bounds around acceptable product features and practices. Many consumer protection regimes will exhibit a combination of these two tendencies. I doubt there are many pure systems of either the principle- or rules-based variety.
Let’s look at two IRDA-type cases from South Africa, where financial and economic inclusion are also urgent national priorities. One comes from insurance and the other from credit. To protect consumers against mis-selling and ensure appropriateness of policies sold to the buyer’s circumstances, the rules generally required that qualified intermediaries advise the sale of policies. Market analysis showed that the extensive requirements on insurers to recruit, train and oversee these individuals were a significant (and unintentional) barrier for micro-insurance innovation. The distribution model that resulted was simply too expensive for the types of policies that were useful to lower-income consumers. A careful and extended consultative process led to redesign of the rules, permitting more flexible distribution for certain kinds of simple products that pose fewer risks for consumers. For example, an insurer could now team up with a retail chain; the customer would buy the “starter kit” off the retailer’s shelf and activate the policy through a call centre staffed by someone trained to answer questions and ensure a good understanding of the product.
The emerging concept of “responsible lending” offers another example of a principle-based approach. South Africa’s National Credit Act specifies that lenders have an affirmative responsibility to assess the borrower’s repayment ability with adequate care. Otherwise, they risk the rule being declared unenforceable. Although the law is quite prescriptive in some areas, in this area it is not terribly detailed and rests on this principle of lender responsibility. As the practice has evolved, lenders are generally considered compliant if they at least check the borrower’s credit bureau records and can show that they have (and follow) a defensible policy and procedures for assessing repayment capacity. But the regulation has no specific rules on exactly how lenders must do this mandatory affordability assessment, leaving flexibility for different underwriting models and innovation in practices. We see the principles vs. rules choice playing out in other markets as well. In Latin America, for example, some countries have responded to concerns about over-indebtedness by articulating this “responsible lending” concept and then monitoring the market to see if it is working, while others have chosen the more rules-based approach of regulating the debt-income ratio.
A contrasting case is disclosure, where I would argue that rules make more sense than principles. In this space, some countries rely more on principles (e.g., information should be provided to consumers on a timely basis, fairly stated, in a plain-language and comprehensible fashion, etc.) while others mandate the “what,” “how,” and “when” of the information to be disclosed and prescribe definitions and formats such as a standardised Key Facts document for a class of products. The regulator’s goal is that the consumer understands exactly what she or he is getting and is able to compare offers among providers. Principles are probably not very helpful, since this leaves it up to each provider to interpret what is important information, how to make it comprehensible, and when to share it with the consumer. Even if the temptation to be selective and deceptive were not so great, the ability to comparison-shop is likely to be extremely limited with this proliferation of approaches by different providers (and the experience on the ground in jurisdictions that rely on broad principles for transparency supports this conclusion).
Overall, I wonder if it is more useful to explore the following questions: Which consumer protection issues are best addressed by principle- vs. rules-based approaches? What is the experience in moving from principles to rules, in response to developments in the market? And how should regulator capacity and insights from consumer research inform these choices?
Q: In such experiments, what has been the role of supporting institutions such as industry organisations, the regional regulatory institutions, and other oversight bodies, in taking this forward?
Industry bodies and support organisations can play a really useful role. In many markets the boundary between regulation and “self-regulation” (broadly defined) is a shifting one. (I do not mean only self-regulation in the very formal sense of Self-Regulatory Organisations with sanctions for non-compliance and so on, but also in a more affirmative sense of industry seeking to articulate and follow codes of conduct and standards of behaviour.) A healthy back-and-forth between industry and regulator is particularly constructive and needed in new areas like interpreting the concepts of “suitability” or “responsible lending” or even in making disclosure or recourse rules actually work better.
For example, in the area of complaints handling and dispute resolution, I think there is quite a lot of scope for the regulator to set broad goals and then see what kind of specific service standards industry proposes. What would industry come up with to translate a principle such as “fair treatment” into practical measures to ensure that consumers know about their rights in this area, have access to convenient mechanisms, and can expect that their complaints will be logged, tracked, and handled objectively and within a reasonable period of time? This is at least a good starting point for dialogue between the regulator and the regulated. The regulator might come back and say “well, the mechanisms you propose will not really work for BOP consumers,” in which case the industry association might propose a toll-free number and processes to orally inform low-literacy consumers about their rights and so on. When the regulator plans to require that providers report their complaints data in a standardised way, industry and supporting institutions might have good suggestions about how to do this in the least burdensome and most meaningful way. On some consumer protection issues, there is much latitude for this type of dialogue. Because industry associations are one step removed from individual providers, they may be able to take a somewhat bigger-picture and longer-term perspective than their members.
Q. You gave examples of rule-based regulators actually going out and experimenting with concepts in a principles-based space. In doing so, have these regulators actually put down a very clear view-point about the transition from one form to another, or has it been rather an ad hoc process? For instance, Australia’s Wallis enquiry for moving towards principles-based approach was not triggered by a crisis. But it was something that was more driven by political will to take a step back and look at current system and what should the vision be for the financial system. It was a very deliberate approach. What has been the sense in developing countries?
I wonder if “incremental” is a better way to describe the process, especially in developing countries where if there are any consumer protection or market conduct regulations, they are likely to be few and fragmented. In these cases, it may be hard to say whether the system is principle– or rule- based and how it is evolving. Many jurisdictions then start by trying to fill in the highest-priority gaps in their rather sparse consumer protection landscape. Other countries have opted for a big push strategy, by creating a more comprehensive framework for market conduct regulation over and above prudential oversight. One example is Malawi, mentioned earlier. Another is Armenia, which enacted a rather thorough framework through three new laws (to regulate loans and deposits as well as create a financial mediator). Brazil is now creating a larger market conduct unit with stronger powers within its Central Bank. The dominant trend in developing countries is to get additional consumer protection regulation in place, sometimes comprehensively and other times piece by piece. This has often involved a very deliberate approach and a long-term vision, but not necessarily around the merits of a rules- vs. principles-based regime per se. The links between protection and other important policy goals such as inclusion are often prominent in the debates.
In some countries, the decision to strengthen financial consumer protection grew out of recognition that the general consumer protection law and authority (or sometimes the competition law and authority) was really inadequate for financial consumers. Many have concluded that general consumer protection bodies have more life-threatening matters to deal with such as tainted baby formula or unsafe buses, and that they rarely have the requisite expertise, clout, and investigative and enforcement tools to be effective in this specialized area. In these cases, the evolution is perhaps from “let us hope that a general consumer protection framework will protect financial consumers from harm”, to “let us give this mandate to our financial regulators.”
Q: Regulatory approaches to consumer protection need to draw the line between too much regulation (that lead to the death of certain types of institutions or products) and too much flexibility (leading to consumer interests being compromised). Are there any specific examples that come to mind in this regard?
At first I should say that I think these examples are rather rare, but it is also hard to observe because if something doesn’t happen in the market, you don’t see it so who knows what innovation could have achieved without rules. My sense is that it is rare to have too many and too prescriptive rules in developing countries. That is really not the dominant scenario.
Q: but in that case, India is an exception.
In certain respects it may be, although stepping back and looking at the entire financial consumer protection framework, there are many gaps and there is quite a bit of diversity in approach. One dominant feature of this landscape is the sheer number of entities with some role in financial consumer protection, due to the multiple sector regulators and Ombuds, as well as the authority that states have or assert in certain areas. That said, access to well-designed financial services has been shown to be protective for the poor in and of itself, and the regulatory balance of protection and innovation measures has not always been optimal.
One area that has clearly been problematic is regulation of prices or margins, although it should be noted that even before the AP crisis, India had relatively low prices for products such as micro-loans in comparison with other countries. Many other jurisdictions also struggle with this politically-sensitive issue. Clearly we need to be able to make a stronger case for the combination of “smart disclosure” and consumer education to bring prices down. At the moment this is difficult, since hard evidence that disclosure can work, including for more vulnerable consumers, is scarce and current models of financial education struggle to prove their effectiveness and scalability.
In the case of the new micro-credit regulations, one wonders whether there might be scope for greater flexibility over time, including relaxation of certain rules in the face of evidence that by restricting prices and business practices so much they are actually harming the poor by reducing their access to a service they value. The evolution of the BC regulation and the experiments such as the IRDA one you mentioned might be signs of a pragmatic rebalancing of measures aimed at protection and innovation.
