Organisation de Coopération et de Développement Économiques
Organisation for Economic Co-operation and Development 31-Mar-2010
___________________________________________________________________________________________
_____________
DIRECTORATE FOR FINANCIAL AND ENTERPRISE AFFAIRS
COMMITTEE ON FINANCIAL MARKETS
English - Or. English
ADDRESSING FINANCIAL CONSUMER PROTECTION DEFICIENCIES IN THE POST CRISIS ERA
15-16 April 2010
For further information please contact Mr. Bruno Lévesque [Tel: +33 145 24 76 82; Email: bruno.levesque@oecd.org]
JT03281032
Document complet disponible sur OLIS dans son format d'origine
Complete document available on OLIS in its original format

DAF/CMF(2010)6
ADDRESSING FINANCIAL CONSUMER PROTECTION DEFICIENCIES IN THE POST
CRISIS ERA
Introduction
An element that has largely been under-rated in the international debate aimed at reforming financial sector regulation in light of the global financial and economic crisis is the need to improve the framework for better protecting and empowering consumers of financial products and services.
In light of the crisis, the focus of discussions in the international arena has largely been on prudential reforms…
Observers and governments have mainly put the blame for the current crisis on systemic issues such as liquidity, solvency, accounting and leverage problems. The strategic responses and recovery plans elaborated by various national authorities and regulators as well as international organizations
(including the G20 Finance Ministers, who recently agreed on further actions to reform and strengthen the global financial system), have thus very much focused on elements of a prudential (or “macro-prudential”) and corporate governance nature.
…despite the fact that the crisis finds to a significant extent its origins in consumer protection and literacy deficiencies.
Still, it should be reminded that the crisis also finds to a large extent its origins in consumer protection and awareness deficiencies; inappropriate or misinformed household decisions; and lax market conduct 1 supervision, which gave rise to a multiplication of misselling practices in the marketplace. The resulting sub-prime crisis in the US exposed the vulnerabilities of millions of households, which found themselves incapable of making payments on mortgages that were largely inappropriate given their financial situation and profile. Ensuing foreclosures translated into a massive deterioration of assets contained in various related securitized instruments, which in turn sparked a credit crunch that would evolve into a world-wide financial and economic debacle.
This has notably been acknowledged in the US, where reforms are being proposed to enhance the protection of financial consumers.
It is therefore not surprising to note that in the early days of the crisis, the
US proposed a series of possible responses based on lessons learned to prevent a recurrence, which included consumer protection measures, such as the need to establish a standalone financial consumer protection regulatory agency; to improve disclosures made to consumers; to better protect consumers against predatory lending; and to enhance financial education in order to raise consumers’ awareness of their rights and responsibilities when dealing with financial products and providers.
2
1 Unlike prudential regulation, which focuses on the safety and soundness of financial institutions, “Market conduct regulation” refers to the consumer protection regulatory framework applying to the sales and marketing, underwriting and issuance of financial products. Proper market conduct means conducting business fairly and responsibly. For the purpose of this report, “market conduct” and “consumer protection” regulation may be used interchangeably; while deposit insurance schemes are NOT considered as being part of “market conduct” or
“consumer protection” regulatory frameworks.
2 Chairman Ben S. Bernanke, Speech at the Federal Reserve Bank of Chicago’s 43rd Annual Conference on Bank
Structure and Competition, Chicago, Illinois, May 17, 2007.
2

The OECD addressed the issue of financial consumer protection in a first report in
April 2009…
DAF/CMF(2010)6
As part of its leadership in recognizing the need for better regulatory standards and international guidelines aimed at protecting and better informing financial consumers 3 , the OECD outlined in a background report tabled in April
2009 4 , some key consumer-related considerations that emerged from an early analysis of the crisis. These included the importance of transparency and disclosure; the role, responsibilities and accountability of financial institutions in consumer protection; innovation vs. product suitability; concerns arising from regulatory arbitrage; and regulatory issues related to the principles-based and rules-based models.
… and recently undertook an indepth survey comparing market conduct regulatory regimes in 35 countries.
Following up on these first observations, the OECD undertook in 2009-10 a survey with the objective of comparing the financial consumer protection regulatory regimes in various countries. Outstanding participation from 35
OECD countries and non-member economies 5 has allowed the compilation of one of the most extensive sets of comparative information ever collected in the field. The survey examines, among other things, the various financial regulatory structures in place, how these structures and financial sector legislation integrate a wide range of specific consumer protection considerations, and the extent to which they facilitate consumers’ access to redress and compensation in case of wrongdoing on the part of financial service providers.
This paper provides an analysis of selected findings from the survey, and attempts to answer 4 broad questions…
Drawing on a first analysis of this survey and on a review of recent literature, this report endeavours to address four broad questions:
1.
Why is market conduct important and how does it fit into financial sector regulatory frameworks?
2.
To what extent can disclosure-based regulation compensate for financial consumers’ insufficient financial literacy?
…and sets the ground for future
CMF work on financial consumer protection.
3.
Efficient redress for consumers in the financial sector – a myth or reality?
4.
To what extent is the retail financial sector a “caveat emptor” market?
This report does not, however, pretend to provide an extensive coverage of all related and underlying issues. Given the very broad aspect of our survey, the discussion and analysis contained in this paper addresses only partially the data that were collected. A number of additional considerations in the survey will form the basis of upcoming CMF analyses and discussions.
6
3 OECD’s commitments in that field are laid out in the OECD Strategic response to the Financial and Economic
Crisis (See C(2008)191/REV3).
4 DAF/CMF(2009)11
5 See list of participating countries in Table 1 in the addendum document DAF/CMF(2010)6/ADD1.
6 Issues for future reports and discussions include: rules-based vs. principles-based regulation; codes of conduct as substitutes or complements to regulations; market conduct as it relates to credit issues (including debt collection, credit reporting and credit counseling); the role of NGOs in the financial consumer protection framework; the need for strengthened international cooperation, etc.
3

DAF/CMF(2010)6
1. Why is market conduct important and how does it fit into financial sector regulatory frameworks?
What is market conduct regulation?
Market conduct regulation focuses on protecting individuals in their dealings with financial products and institutions. Market conduct regulation protects consumers by addressing the unequal position of financial institutions relative to their customers. The most vulnerable customers are retail clients who often lack the sophistication and information necessary to protect themselves from fraud, market abuse or ill-informed advice and must rely on financial institutions and their intermediaries to protect their interests.
7 Consequently, this information asymmetry and market power imbalance, which may give rise to market abuse, must be addressed through policy intervention and regulation.
Regulators may address these market imperfections through a variety of means, for instance by assessing the suitability of financial products before they reach the retail markets, by imposing requirements on financial institutions to disclose conflicts of interest, offer appropriate disclosures of risk, provide detailed and understandable information about financial products and services, and train their personnel to comprehend consumers’ needs in order to provide appropriate advice and assistance, etc. Importantly, market conduct regulation also often includes obligations for market players to offer a dispute resolution scheme to financial consumers who think their rights may not have been respected (the main subject of section 3 below).
Market conduct regulation/ supervision is a relatively recent phenomenon…
It is relatively recently, mainly in the 1980-90’s, that policymakers started to recognise the need for dedicated market conduct regulation and supervision.
Traditionally, financial regulation was serving two goals: to ensure the safety and soundness of the financial system and to foster the growth and development of the financial markets. In that framework, consumer protection was seen at best as a positive externality.
…that was made necessary by a number of evolutions on the retail financial markets…
This new recognition has in large part been linked with a marked shift in financial business models whereby banks became more active purveyors of complex and risk-based products 8 , particularly on the retail market, which exposed a large number of consumers’ vulnerabilities. These concerns have been transposed to a significant extent into the legislation and the financial regulatory structures of most developed and developing countries around the world.
Along with this new awareness of the importance of consumer protection and the related emergence of a new “market conduct regulatory pillar”, came a series of significant transformations, which changed the face of financial markets. Those included the increasing interactions of financial business structures as evidenced by the multiplication of financial conglomerates; the blurring of the boundaries between financial products
9
; the changing financial risk implications caused by innovation; and the internationalization of banking operations.
10
7 Pan (2009), p.4.
8 Group of Thirty report (2008), p. 23.
9 This was a shift away from the “traditionally financial markets”, which had been mainly domestically-based and compartmentalized around clear lines of business: banking, insurance and securities.
10 Taylor and Flemming (1999), "Integrated Financial Supervision: Lessons from Northern European Experience".
4

…which forced policy makers to review their traditional approach to financial regulation (focusing on safety and soundness) to integrate consumer protection considerations.
DAF/CMF(2010)6
Consequently, in a financial sector that had traditionally been largely composed of regulators focusing solely on stability and soundness of firms in a specific sector 11 , policymakers started questioning the effectiveness of financial supervision in responding to consumer protection issues. An important element of reflection has been to determine how these new consumer protection considerations should be integrated in financial sector regulatory frameworks.
No consensus emerged and, as noted by Llewellyn (2006), the resulting model in each country has been shaped by numerous factors, many of these local or specific, such as the size and structure of the financial system, legal factors, political structures, historical evolution, the size of the country, etc.
Regulatory structures reflect unique domestic features and have largely been forged by financial crises.
But above all, financial crises and market disruptions have been a key factor that has brought governments to rethink the structure of their financial regulatory and supervisory regime.
12 As shown in our survey, the current crisis is no exception, with legislative as well as supervisory and regulatory structural reforms (of varying amplitude) being planned or discussed in Australia; Canada;
Hong Kong, China; Ireland; Lebanon; Portugal; Russia; Singapore; Slovakia and the US.
There are three
prevailing models.
While the range of financial supervisory models in place across countries is rather large, analysis of our survey data allows us to classify the regimes along three conceptual models (see table 2 in Addendum 13 for a detailed breakdown): i) “Multiple regulator model”: where regulatory authority is divided by financial sector or activity (e.g., banking, insurance, securities, etc.) among a multiplicity of financial regulators 14 ; ii) “Twin Peaks model”: objectives-based approach, whereby one regulator is responsible for prudential regulation, a second regulator is responsible for market conduct regulation and sometimes a third regulator is responsible for market stability measures; iii) “Single regulator model” (also referred to as the “integrated approach”): This is the model whereby all the financial sector regulatory authority of a country is concentrated in the hands of a single regulator.
Current debates on ideal regulatory structures highlight
tensions between prudential and
Many observers note the tension between the objectives of protecting consumers and ensuring the financial health of individual financial institutions.
For instance, Levitin (2009) suggests that lending practices that extract additional value from consumers strengthen the balance sheets of lenders.
15 From that perspective some may think that efforts to clamp down on lending practices
11 I.e., each strictly dealing with either banks, insurance companies or securities firms.
12 Further discussed in Wymeersch (2007), “The Structure of Financial Supervision in Europe About Single, Twin
Peaks and Multiple Financial Supervisors” and Group of Thirty report (2008).
13 All tables referred to in this document can be found in DAF/CMF(2010)6/ADD1.
14 Some literature, notably the Group of Thirty report (2008), further breaks down this category between an institutional approach (i.e., where the regulatory oversight of a firm is determined by its legal status) and a functional approach (i.e., where oversight is determined by the type business conducted, regardless of the legal status of the institution). Our data, has not, however, allowed us to categorize countries along these approaches.
15 Adam Levitin, “Hydraulic Regulation: Regulating Credit Markets Upstream” (2009).
5

DAF/CMF(2010)6 market conduct policy objectives.
to protect consumers could adversely impact the profitability and health of financial institutions. But, as noted by others, (see for instance Gerding 2009) 16 there is little empirical evidence that consumer protection efforts have ever threatened the stability of a financial institution to a degree that increases systemic risk. In fact, the postulate we introduced in this paper is that effective consumer financial protection is not a threat to, but rather a critical tool in mitigating systemic risk and future crisis.
17
There is a call for an integration of financial consumer protection supervisory functions into standalone and specialized authorities.
In light of the various consumer protection concerns that were identified through the crisis, strong views have been expressed in favour of an integration of financial consumer supervisory functions as part of specialized standalone bodies 18 as a means of addressing, through a clear separation of functions, the inherent conflicts between the objectives of safety and soundness regulation and consumer protection and transparency.
But structural regulatory reforms should not be substitutes to efficient consumer protection and supervision.
This view was eloquently echoed by the Chairman of the US House
Financial Services Committee, Barney Frank, when he alluded to the importance of having a US supervisory model that strikes a better balance between prudential and market conduct regulatory objective along the following terms:
“
No one familiar with the track record of the bank regulatory agencies with respect to protecting consumers can deny the need for an independent agency if we are going to have effective consumer protection. Bank regulators have traditionally treated their responsibilities for consumer protection as a second priority
.” 19
In the end, the optimal institutional supervisory model may vary between countries, depending upon the unique characteristics and structure of a country's financial system. Regardless of the chosen model, recent market developments and financial crises have strengthened the importance of having supervisory bodies dealing specifically with financial consumer protection issues in an independent manner. Reforming the institutional structure of regulation should never be viewed, however, as a substitute for effective and efficient market conduct regulation and supervision financial system.
16 Erik F. Gerding, “The Subprime Crisis and the Link Between Consumer Financial Protection and Systemic Risk”
(2009).
17 As discussed in Introduction, the causal chain that links consumer defaults with systemic risk is unfortunately not just theoretical.
18 This includes views expressed by the Group of Thirty ( http://www.group30.org/pubs/GRP30_FRS_ExecSumm.pdf
) and US Treasury ( http://www.ustreas.gov/press/releases/reports/Blueprint.pdf
).
19 Chairman Frank Statement on Consumer Protection, February 9, 2010.
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DAF/CMF(2010)6
2. To what extent can disclosure-based regulation compensate for financial consumers’ insufficient financial literacy?
Financial Literacy is an absolutely essential feature of financial consumers’ protection…
As discussed at length in the OECD’s 2005 report Improving Financial
Literacy
20 , an absolutely essential feature of financial consumers’ protection relates to their ability to understand financial products and concepts, to develop the skills and confidence to appropriately handle financial risks and opportunities, to make informed choices, to know where to go for help, and to take effective actions to improve their financial well-being. In other words, it has become necessary for consumers to develop a certain level of “financial literacy” to cope with today’s increasingly complex financial marketplace.
…but financial education is a very challenging task and long-term endeavour.
Abundant worldwide evidence 21 shows, however, that most consumers are far from having the necessary skills, knowledge, behaviour and attitudes that would qualify them as “financially literate”. This has become a significant public policy concern 22, and national financial education strategies are increasingly being implemented in both developed and developing countries to address this challenge. To also cope with this, our survey shows that in some countries (10 out of 35 – see Table 3), market conduct regulators were given a “financial education” mandate in addition to their regulatory responsibilities, while in 12 other countries, even in the absence of an explicit mandate, the regulators have undertaken substantial financial education activities.
23
Even in a perfect world where financial literacy would be optimized, market regulation would still be required…
… to address market imperfections.
While there is a wide consensus that educating consumers is a long-term and challenging endeavour, it is also agreed that financial education is not a panacea. Even in an ideal world where all consumers would attain an optimal level of financial literacy, it would be an illusion to believe that it alone would be a sufficient condition to fully secure their protection.
This is mainly due to prevailing imperfections in the retail financial services markets, which are characterised by buyer-seller market power imbalances and information asymmetries between players. Transparency is thus a key market policy and regulatory objective, based on policymakers’ conviction that it has the potential to provide consumers with the power of informed choice, which permits markets to work.
Market conduct
regulation relies
A core aspect of the consumer protection framework in most countries is therefore the mandatory dissemination of certain information by financial
20 OECD (2005), Improving Financial Literacy , OECD, Paris.
21 Including an OECD review of 26 financial literacy baseline surveys conducted in 18 countries.
22 As underlined, inter alia, at the 2006 G8 Finance Ministers’ Meeting, which called for further OECD work on financial education and guidance in this field. Ministers’ statement available at: http://www.g8finance.ru/en/documents/index.php?id19=64
23 That said, it is noted that a growing number of public authorities in general (i.e., beyond regulators and supervisors) are now deeply involved in financial education initiatives. This trend is clearly reflected as part of the membership of the OECD International Network on Financial Education, which regroups over 130 governmental organizations from more than 60 countries.
7

DAF/CMF(2010)6 strongly on information transparency and disclosure requirements… institutions (referred to here as “financial disclosure” 24 ). Disclosure provisions aim at offsetting the asymmetry of information between the parties to a financial transaction. Thus, transparent and full disclosure requirements are especially important for transactions involving a financial institution on the one hand and an unsophisticated consumer on the other. It is hence not surprising to observe that legislative disclosure provisions in all countries in our survey, without exception, serve as a central regulatory tool for protecting consumers.
…to address various policy objectives, including:
What our survey also shows, however, is that regulatory authorities have tended to strongly rely upon financial education and transparent disclosure as the main
(and often unique) means in addressing a broader set of policy objectives.
Chairman Bernanke’s views, expressed in 2007 while commenting on the subprime crisis, could be seen by some as supporting this regulatory trend:
“In my judgment, effective disclosures should be the first line of defence against improper lending. If consumers are well informed, they are in a much better position to make decisions in their own best interest.” 25
This trend has been also clear in at least three policy areas covered in our survey:
Financial inclusion 1. Access to financial services: It is widely agreed that policymakers have an important role to play in creating the conditions for improved access to affordable financial products and services, which is a major determinant of individuals’ well-being. In that respect, an objective of the survey was to identify initiatives, as part of countries’ financial consumer protection regulatory frameworks that have been developed with the goal of ensuring a broad consumer access to basic financial services. Results show that only Brazil,
Canada, Finland, Germany, Ireland and Portugal have developed targeted regulations promoting broad consumer access to the mainstream financial sector.
Those include 26 “microcredit laws” fixing a compulsory proportion of banks’ deposits that must be used in microcredit initiatives; measures allowing municipalities to offer “social credit” under favourable terms; and legislations requiring banks to open accounts for any individual and to report to the government on their contribution to financial inclusion objectives, as part of their “Corporate Social Responsibility”. In some jurisdictions where no such legislation exists, regulators have reported addressing the importance of financial access through market transparency measures, simplified disclosure and financial education material and campaigns. But in most cases (24 out of 35), countries have just not addressed the issues of access as part of their financial consumer protection regulatory regime. Reasons given for this include the fact that the regulator “does not consider it prudent to relax prudential regulatory requirements that would in any way weaken or potentially destabilise the system” 27 , or that “consumers have easy access to financial services and that government initiatives in that regard would be useless”.
24 In this paper “financial disclosure” refers to mandatory information that financial firms must provide to consumers as part of their consumer protection regulatory obligations, as opposed to “corporate disclosure” obligations governing financial reporting, insider trading, etc.
25 Federal Reserve Chairman Ben S. Bernanke at the Federal Reserve Bank of Chicago’s 43rd Annual Conference on
Bank Structure and Competition, Chicago, Illinois, May 17, 2007.
26 See details in Table 4 in Addendum 1 [DAF/CMF(2010)6/ADD1].
27 While the concept of universal and unrestricted access to credit, for instance, could indeed raise legitimate prudential concerns, it may be possible for governments (as shown in some countries) to facilitate consumers’
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DAF/CMF(2010)6
Risk transfer to households
2. Transfer of financial risks to households: Over the past two decades, consumers in many countries have been burdened with a greater share of credit and pension risks. Not only have defined contribution pension plans transferred longevity and investment risks to individuals, but innovations in the credit sector have also contributed to substantially increasing the complexity of credit instruments and the risks and responsibilities born by the consumers of such products, such as mortgages with various adjustable-rate features; balloon mortgages with reset provisions; interest only loans; foreign currency loans, etc.
In that context, participating countries to the survey were asked to describe the extent to which their financial consumer protection framework is taking account of this new market reality and related concerns. In response, 15 countries reported addressing this issues mainly (or solely) through consumer disclosure and/or financial education initiatives. We note, however, that regulators in
Finland, France, Ireland, Portugal, Singapore and Turkey have elaborated distinct dedicated measures, which include 28 :

Adjustments to credit sales regulations , including for instance prohibition of marketing practices and slogans which lead to unconsidered use of credit or that present credit products as easy and quickly available for the purpose of balancing finances; requirements that credit services be limited to such times of day that do not increase unconsidered taking of credit (especially with regards to SMS loans); etc.

Elaboration of debt-relief programmes allowing households in financial difficulties to maintain their properties, under certain conditions;
 Strengthened “know-your-client” rules obliging providers to ensure that any product or service offered to a consumer is suitable; where they offer a selection of product options to the consumer, that the product options contained in the selection represent the most suitable from the range available; and where they recommend a product to a consumer, that the recommended product is the most suitable product for that consumer;

Instauration of substantive limitations, such as a transition from variable rates to “Manageable-rate loans”, which include either a cap on the interest rate, or a limit on the amount of the monthly payments;

Imposition of outright prohibitions , especially on misleading practices and high-risk products, such as “balloon payment mortgages”, “honeymoon mortgage rates”, foreign exchange loans, negative amortization, etc.
Innovation and product suitability
3. Innovations and suitability of retail financial products: Along with innovation in the financial sector 29 and the serious consumer protection gaps that have been highlighted with the subprime crisis, voices in the markets are increasingly raising a related problem: the proliferation of “lemons” 30 in the financial markets in recent years and the inability of market supervisors to safeguard consumers access to no-frill bank accounts to all consumers who can properly identify themselves, without putting financial markets’ stability at risk.
28 A detail of these country initiatives in provided in Table 5 in Addendum 1 [DAF/CMF(2010)6/ADD1].
29 For an elaborate discussion and proposed principles on financial innovations as they relate to consumer protection, please see “Consumer protection and financial innovation: a few basic propositions” [DAF/CMF(2010)7].
30 A lemon is a product or service of unexpectedly low quality. The term “lemon” is borrowed from the used car market. If quality is difficult to assess and if there are few reliable signals of product quality in the marketplace, the principles of economics predict market failure, as shown in Akerlof’s classic research (Akerlof, 1970).
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DAF/CMF(2010)6 against those unsuitable financial products.
31 Participating countries to the survey were hence invited to indicate what regulatory, supervisory and/or monitoring mechanisms they had developed to ensure that new retail products, business practices or other financial innovations entering the financial marketplace are safe and suitable for the average retail financial consumer. Once again, of the 20 countries that reported having some consumer protection measures to address this issue, 11 rely solely on disclosure and/or consumer education. Exceptions are found in Australia, Canada (Quebec), Hong Kong
China, Ireland, Lebanon, Norway, Spain and Turkey (and to a smaller extent in
Greece and Lebanon), where targeted regulatory measures are aimed at dealing with suitability. Those include 32 :

Ex ante assessment through licensing requirements , where new products, business practices or other financial innovations must be submitted to the regulator and/or the concerned self-regulatory organisation for approval before they are offered to retail consumers.
In their analysis, regulators pay great attention to each aspect of the product, practice or innovation and particularly to safety and suitability for the retail financial consumer.

Suitability statements in which financial institutions, before providing a product or service to a consumer, must set out, in a document given to the consumer, the reasons why a product or service being offered is considered suitable; the reasons why each of a selection of product options offered are considered to be suitable to that consumer; or the reasons why a recommended product is considered to be the most suitable product for that consumer.
This (too) strong reliance on disclosure may denote a lack of
“regulatory innovation” in addressing emerging challenges…
The potentially detrimental consumer protection effects of i) insufficient financial literacy levels ; and ii) a narrow disclosure-focussed regulatory approach in addressing significant financial consumer policy challenges, is compounded by iii) the limitations of financial disclosure documents in properly informing and protecting consumers.
…and may fail to reach policymakers’ objectives, in absence of consumers’ financial literacy and regulators’ knowledge of what is
“effective disclosure”.
In fact, despite the fundamental importance of disclosure in most financial consumer protection regulatory regimes (as discussed above), disclosure documents are for the most part not subject to any testing or evaluation. Our survey indeed showed (Table 7) that apart from Australia, Austria and the US, no country has a mechanism to test the efficiency of financial disclosure provided to consumers or a method to determine whether consumers demonstrate awareness and understanding of the financial product they contract.
Unfortunately the efficiency of
Moreover, where testing and evaluation have occurred, studies show that disclosure may fail to convey the desired information to many consumers,
31 For a related discussion on this issue, please see “Financial Consumer Protection (Progress Report)”
[DAF/CMF(2009)11].
32 Please see Table 6 in Addendum 1 [DAF/CMF(2010)6/ADD1] for more details on these measures.
10

consumer disclosure
remains largely untested. Where assessments have occurred, they have shown limited
impact.
DAF/CMF(2010)6 bringing more confusion than clarity, and that consequently, may not inform consumers’ decision-making and affect their behaviour the way it should.
33
Literature proposes a number of reasons for this, including: i) the information transparency model assumes that consumers will make self-interested, wellinformed, rational probabilistic financial choices using the disclosures, which is inaccurate; ii) some disclosure formats do not work (especially those in small print and dense prose, which are immediately dismissed by consumers); iii)while the benefits of “just-in-time” disclosure are widely recognized, the timing of disclosures is in practice often inappropriate; iv) the disclosures may not be presented in simple enough lay terms, leading borrowers to ignore the disclosures as incomprehensible legally mandated jargon; v) innovative product features (such as “honeymoon rates” and “rate–as-low-as” offers) may not easily fit into traditional regulatory disclosure formats, and iv) as discussed before, most people also lack the financial literacy they would need to make sense of the increasingly complex financial products and related disclosure.
The Schumer Box approach is a promising solution that has yet to be refined and generalized to all products.
Regulators in the US have increasingly undertaken to address some of these limitations by introducing the “Schumer Box” approach, requiring promotional material to prominently display a summary of the product’s terms and costs in a very specific and simple format. This approach has also attracted the attention of policymakers in a number of countries in reviewing their disclosure requirements. Canada, for instance, has announced that it will seek improvements in the form of clear and simple summary information on credit card application documents and contracts (likely in a Schumer-like format), and clear and timely advance notice of changes in rates and fees. But as outlined by former Federal Reserve Governor Kroszner in a speech in 2007 34, consumer testing in the US demonstrated that there is room for significant improvement in the Schumer Box approach itself, especially in relation to the information it contains, and the logic of its presentation. In addition, despite a broad acknowledgement of the Schumer Box as a good practice in the area of financial disclosure, its application has for the most part been limited to credit card agreements. In light of the subprime mortgage crisis in the US, there is an urgent need to test and review the effectiveness of disclosure documents in other parts of the financial sector, notably for mortgage products. Policymakers should also work towards the goal of harmonizing efficient transparency and disclosure measures, based on consumer testing, across all financial products and services retailed to consumers.
33 See notably Lee, J. and Hogarth, JM (1999), “ The price of money: Consumers' Understanding of APRs And
Contract Interest Rates, Journal of Public Policy & Marketing ; Lacko, James M. and. Pappalardo, Janis K (2007),
“Improving Consumer Mortgage Disclosures An Empirical assessment of Current and Prototype Disclosure
Forms”, Federal Trade Commission, June 2007; Warren (2008); Pacelle (2004); Colbert (1998); Furletti (2003);
Willis (2006); Block-Lieb, S. (2008), “Disclosure as an Imperfect Means for Addressing Overindebtedness: An
Empirical Assessment of Comparative Approaches”; Board of Governors of the Federal Reserve System (2008),
“Design and testing of effective Truth in Lending Disclosures: Findings from experimental study”.
34 Governor Randall S. Kroszner (2007), speech at the George Washington University School of Business, Financial
Services Research Program Policy Forum, Washington, D.C., May 23, 2007.
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DAF/CMF(2010)6
Policy Considerations

I n the absence of a sufficient level of consumers’ financial literacy, policymakers’ strong reliance on disclosure rules and information-based measures may be creating a circular problem and exacerbate financial consumers’ vulnerabilities rather than promote their protection.

Financial education and consumer protection (including disclosure) measures are not substitutes for one another. They are necessary conditions to individuals’ financial well-being and should operate in symbiosis. Governments should therefore have a dual policy focus aimed at raising financial literacy levels, as well as optimizing consumer protection through an efficient financial regulatory framework.

Although some disclosures may be sufficiently simple and straightforward that testing is not necessary, for most disclosures testing is essential. Without consumer testing it is difficult (or impossible) to know whether new or existing disclosures effectively convey the desired information in a way that can be understood and used by consumers.

Financial education and disclosure requirements are not a panacea. They can only work when conditions are right, and substantive intervention in the market may be needed to create those conditions.

Policymakers and regulators should demonstrate flexibility and innovation in elaborating regulatory and supervisory measures – beyond the traditional disclosure solutions – for dealing with new market realities and emerging consumer protection challenges.
3. Efficient redress for consumers in the financial sector – a myth or reality?
Consumers’ access to effective redress is an essential part of any financial consumer protection framework.
It is generally agreed 35 that a sound consumer protection regime should include, as a major feature, an effective procedure to enable consumers to file complaints when they believe they may have been victims of misleading or unfair treatment by financial institutions, and to obtain redress when their rights have been violated. Given the high number of financial transactions that take place every day in any given country, it is inevitable that disagreements will occur between consumers and financial service providers. The potential for misunderstanding in the financial services sector is exacerbated by the inherent complexity of the products and to a large extent by the unbalanced contractual relationship between the financial institution and the consumer. This is largely due to the fact that financial service agreements, which serve as the legal basis to the transaction, are developed by the sophisticated party (the seller) and are largely inaccessible to the average consumer (the buyer).
A common function of market conduct supervisors is to receive consumer complaints…
As discussed before, legislation in most countries is addressing this market power imbalance issue mainly through enhanced disclosure rules and other transparency measures. In that context, a key function of market conduct supervisory authorities is to monitor the compliance of financial service providers with these (as well as other) statutory obligations and to take measures in case of breach. It is clear from our survey that in an overwhelming majority
35 See notably See notably Ferran, Eilís (2002), “Dispute Resolution Mechanisms In The UK Financial Sector”; Task
Force on the Future of the Canadian Financial Services Sector (1998), “Empowering Consumers”; New Zealand
Ministry of Consumer Affairs (2006), “Review of Financial Products and Providers: Consumer Dispute
Resolution and Redress”; OECD (1992), Consumer Information About Financial Service , OECD, Paris.
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DAF/CMF(2010)6 of countries (see Table 8) market conduct supervisors receive consumer complaints and use them as a core sources of information in taking action and identifying scope or areas of focus in market surveillance and regulatory enforcement.
…which is key to their oversight of the markets.
They do not however investigate individual complaints or provide redress.
Supervisors have access to a range of tools allowing them to take action when, as a result of a consumer complaint, it is determined that a financial institution violated consumer protection laws. These tools include the powers to impose fines and monetary penalties, to require the adoption of corrective business practice measures, to request the freezing and/or sequestration of assets, to suspend or remove licenses, to publicly disclose the enforcement measure taken against an institution, etc.
However, the survey also shows that, in virtually all countries (with perhaps the exception of South Africa), market conduct supervisors’ mandates fall short of providing compensation to aggrieved consumers. The general supervisory focus is indeed on financial institutions’ systemic breaches of legislation, rather than on the provision of individual redress.
Redress is largely
delegated to ADR schemes…
…which, according to the
OECD, should possess various specific attributes.
That function is largely delegated to so-called “Alternative Dispute
Resolution” (ADR) schemes, which may be housed within each financial institution, but are most commonly organized along the “ombuds” approach (see
Table 9). Indeed, for many observers “ the ombudsman model, which grew out of market regulation from an expressly consumer perspective and has evolved into a consumer-friendly mediation and conciliation system for consumer complaints, offers the most promise for efficient and accessible consumer redress
.” 36
Previous OECD work 37 has defined the necessary attributes of ADR mechanisms from a consumer perspective. Those are: i.
Independence; ii.
Ability to draw, where necessary, on expertise in matters of banking law and practice; iii.
Well-publicised in terms of both availability and of findings, and accessible to all financial consumers; iv.
Expeditious in its handling of complaints; v.
A comprehensive coverage, in terms of institutions and services; vi.
Able to compel co-operation from those institutions; and vii.
Have powers to handle complaints in an efficient manner, i.e.: a.
Power to investigate any case brought within its terms of reference; b.
Power to call for papers and other information from participating banks and ability to request similar details from complainants; c.
Ability to promote an agreed solution, through conciliation, arbitration and other means; d.
Ultimate power to make an award which is binding against a financial institution.
36 See notably Task Force on the Future of the Canadian Financial Services Sector (2008), “Empowering
Consumers”, September 1998.
37 OECD (1989), Electronic Funds Transfer: Plastic Cards and the Consumer , OECD, Paris.
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Our study shows that very few ADR schemes possess all these attributes.
There are relatively few empirical studies and literature that evaluate the effectiveness of financial ADR. An analysis of data obtained through our survey, however, shows that very few ADR schemes seem to exhibit all above features.
As ADR schemes are for the most part industry-funded, 60% of surveyed countries have reported having developed mechanisms to ensure their independence from the regulated entities. Those include independent selection process for board members and staff, formal government charters, standards and requirements that guarantee the neutral and independent functions of the ADR scheme, public disclosure of decisions and statistics, and budgetary powers specifically assigned to independent board members. In all jurisdictions except
Austria, dispute resolution schemes publish aggregate complaint data in their annual reports, through their websites, etc. In many cases, public reporting is a mandatory legal obligation of ADR mechanisms, and a central component of their accountability to the regulators and the public. The range of reported data, which varies between (and even within) jurisdictions, may include numbers of complaints, summaries of proceedings and resolutions, a description of criteria used for resolutions and suggestions to enhance financial consumers’ protection.
A variety of measures are used to enhance consumers’ awareness of redress mechanisms. This is an especially important element, as surveys consistently highlight low consumer awareness and confusion related to complaint processes 38 . Of course, ADR schemes themselves, as well as regulators, have a major part to play in addressing that issue. They are achieving this goal mainly through financial education initiatives (website, brochures, and awareness campaigns), training (seminars, conferences and workshops), consultation
(conferences, working parties, and advisory panels), market research (consumer surveys, data collection and analysis, feedback) and collaboration with the media. In about a third of the countries, specific regulatory provisions have also been established, requiring financial institutions to provide clear information on consumers’ redress options, as part of their contracts and other disclosure documents.
Of special concern is their fragmented structure resulting in uneven consumer coverage and gaps…
Another critical element of ADR schemes’ efficiency is their accessibility to all consumers. In many countries, even those that have endeavoured to review and streamline their financial regulatory structure, ADR schemes remain largely fragmented (by sector, by geographical jurisdiction, etc) and subject to gaps in their coverage. Mexico and Singapore appear to be the only exceptions in offering a centralized dispute resolution mechanism that deals with all financial consumer complaints, regardless of the type of product or the sector from which they originate. Our survey has identified a second barrier to general access to redress, which may be significant to some individuals. This barrier relates to the imposition of fees to consumers for making use of the redress scheme.
Although this practice seems limited to a very few countries (only Denmark,
Italy and the Netherlands in our survey), we note that the level of these fees, especially in Italy 39 , can indeed be prohibitive.
38 See for instance ASIC (2008), “Australian investors: at a glance”; FCAC (2007), “General Survey on Consumers'
Financial Awareness, Attitudes and Behaviour” and New Zealand Ministry of Consumer Affairs (2006).
39 Under the Italian scheme, clients have to pay 20 Euros to file a complaint, which are reimbursed in case the intermediary is in fault. In addition, clients have to pay 30 Euros for mediation and fee for mediation experts and
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… and their inability to issue binding decision.
DAF/CMF(2010)6
Finally, as mentioned in the above OECD’s guidelines relating to ADR mechanisms, it is agreed that these schemes should have the ultimate power to make an award which is binding against a financial institution . In practice however, we note that this principle is applied in a minority of countries. In fact, from our survey, only ADR schemes in the Czech Republic, Ireland, the
Netherlands, Singapore and South Africa have the power to issue fully enforceable binding decisions against financial service providers.
40 Some ombudsmen, in Canada notably, have expressed doubts about the benefit of granting ADR schemes the power to issue binding awards, arguing that suasion
(i.e., “naming and shaming”) is a powerful and effective tool 41 ; that binding awards would move the process toward adversarial positions; and that there is a definite risk that the process would become more legalistic and process-driven.
42
We note, however, that this real or perceived “lack of teeth” of most ADR schemes, is a factor that might have contributed to relatively low proportion of
ADR cases settled to consumers’ satisfaction (which is well below 50% in many countries, as shown through partial results emanating from the survey – see
Table 10).
Those identified deficiencies may significantly affect the credibility of financial consumer protection frameworks and limit supervisors in their watch-dog functions.
Ultimately, if consumers have a perception that neither the regulator nor the
ADR mechanism in place are able to assist them in seeking redress, they may opt i) for taking their case directly to the courts 43 ; or ii) to not complain at all and not pursue their grievance further (even though they may be entitled to compensation).
44 It is clear that either case would represent a failure of the redress scheme in carrying out its consumer protection function. arbiter. The fee is proportionate to the value of the dispute and ranges between 40-10,000 Euros for mediation, and between 600-76,000 Euros in case of arbitration.
40 The financial ADR mechanisms in Australia and Spain also issue binding decisions, but those are not legally enforceable.
41 Although this has been reported as having been used in only one case in Canada.
42 Canadian Banking Ombudsman, Submission to the Task Force on the Future of the Canadian Financial Services
Sector, letter dated October 29, 1997, p. 5.
43 Although consumers have had, and should continue to have, access to the courts to assert rights based on general legal principles, this access generally seen as not sufficient for a number of reasons. Two of the most important are the following: i) there are limits on the rights and remedies available through the courts, and many consumer situations may not fit into these boundaries; and ii) the expense of litigation may be prohibitive and justified only in more serious cases or where the consumer has substantial resources to dedicate to the case.
44 New Zealand Ministry of Consumer Affairs (2006) reports “significant problems with consumers seeking redress”, which translate into very low consumer recourse to redress. Common reasons given by consumers include "did not know who to complain to", "did not think it would make a difference", and "couldn't be bothered". This shows that further work is needed to improve access to redress in order to promote consumer confidence in financial markets.
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DAF/CMF(2010)6
Policy Considerations:

From a market conduct regulatory perspective, an inability of regulators and supervisors to help aggrieved consumers obtain compensation from a faulty institution may create doubts for consumers as to the rationale of addressing their complaint with the supervisor rather than directly with a dispute resolution scheme or the courts.
45

This, in itself, may raise conceptual difficulties by depriving the supervisors of a key source of input in monitoring the markets, since market conduct supervisors depend significantly on consumers’ complaints in fulfilling their “watch dog” functions.

This also raises the importance for market conduct supervisors of developing information sharing arrangements with all alternative redress structures in the marketplace in order to capture the most data allowing them to identify emerging issues and systemic consumer protection concerns.

Our analysis of ADR schemes across many countries highlights a number of potential deficiencies in fulfilling their consumer protection functions. Most notably, the highly fragmented structure of many ADR schemes may result in gaps in their coverage; and their inability to issue binding decisions may disqualify them in the eye of many consumers as an avenue that is worth pursuing.

These findings reinforce the necessity for policymakers to recognise redress as a core component of a country’s financial consumer protection framework.

As such, it is recommended that: 1) governments reassess the substantive role that statutory supervisory agencies could and should play in financial consumer redress; and 2) where financial redress is delegated to ADR schemes, the financial regulator should ensure that these mechanisms possess all the necessary attributes to secure their efficiency.

In that respect, the OECD may consider reviewing and updating its 1989 ADR guidelines 46 and use them as an instrument against which to conduct an in-depth multi-country assessment of financial ADR schemes?
4. Summary and conclusion – The retail financial sector, a “caveat emptor 47 ” market?
We have discussed in this paper some of the features that characterize the retail financial markets in which service providers and consumers meet. They involve:
1.
Complex financial products which may be bought infrequently and which may have long duration, as well as significant monetary value (e.g., mortgage or pension savings);
2.
Complex decisions requiring an understanding of the risks involved –which may be easy to assess;
45 In fact, our survey showed that in 8 countries supervisors are even prohibited from providing information to consumers on the status of their own complain, as “complainants” are not considered as a part to the enforcement procedure.
46 OECD (1989), Electronic Funds Transfer: Plastic Cards and the Consumer , OECD, Paris.
47 Caveat emptor is the Latin expression for “let the buyer beware”. It refers to the business principle where the risk of a transaction is assumed by the buyer.
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DAF/CMF(2010)6
3.
Complex contracts and terms which may largely be inaccessible to the average consumer;
4.
Massive market power imbalance between sophisticated sellers and purchasers who are for the most part “financially illiterate”– the information asymmetry problem;
5.
Imperfect consumer protection regulation which is in many instances based only on transparency and disclosure requirements, the efficiency of which has yet to be tested; and
6.
Deficient redress mechanisms, which are largely unknown to consumers, and which have little power and authority to issue binding decisions against faulty institutions.
Unfortunately, despite these concerns, some policymakers have yet to be convinced about the necessity of strengthening financial consumer protection, and some even consider initiatives towards that goal as a threat to prudential policy objectives. A recent illustration of this was provided by John Dugan, the US comptroller of the currency, when he said “ in every case consumer protection has the edge and will trump safety and soundness and I think that is backwards
48 ”.
This type of reaction may in part explain the revived debates on the need to reform the institutional structure of financial sector regulation; and especially the call from the proponents of enhanced consumer protection for a full segregation between market conduct and prudential regulatory functions through the adoption of a new regulatory approach.
The fact of the matter is that market conduct and prudential regulation should not be seen as seeking mutually exclusive policy objectives. To the contrary, effective protection and awareness frameworks, along with a sound redress mechanism, are primary drivers in allowing for consumers’ confidence in the financial sector, which is a key condition for “market stability”, which is also the main purpose of safety and soundness regulations.
This paper also argued that an essential factor for financial consumers’ protection is their ability to assume their responsibilities and to protect themselves from market abuses, misselling and inappropriate financial decisions. Concretely this may include 49 :
 reading advertisements and other material, particularly that required by regulation, carefully and with reasonable caution, being alert to offers that seem too good to be true and being clear as to the commitment they are taking on;
 providing openly, and as accurately as they can, material facts and attitudinal information as the adviser requests;
 asking questions where they feel uncertain, including about the purpose and risks of the products and services recommended;
 reading and reflecting upon the suitability of the product being purchased based on the disclosure documents provided by the financial institution;
48 Suzanne Kapner and Tom Braithwaite (2010), “US consumer protection proposals attacked”, Financial Times , 17
March 2010.
49 These elements were notably reflected in a consensus reached in 2006 through a debate between the UK financial services practitioner and consumer panels – statutory bodies representing respectively the interests of the
Financial Services industry and those of consumers in the UK regulatory framework. See http://www.fsa.gov.uk/pages/Library/Communication/Speeches/2006/0210_cm.shtml
for more details.
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DAF/CMF(2010)6
 making the most of the protection provided by the right to cancel the purchase during any
"cooling off" period;
 reviewing their financial needs and position on a regular basis and assessing their need for further advice where there has been a material change in personal circumstances; and
 complaining and seeking redress where they believe they have not been fairly treated at any stage in the process.
In other words, financial literacy is a fundamental condition for securing consumers’ protection. But it also represents a major policy challenge as a majority of individuals lack sufficient knowledge and understanding of financial concepts. Moreover, many ignore their own vulnerabilities. Given the overall low levels of financial literacy world-wide and the complexity of the issues at stake, governments should regard financial education as an immediate priority towards achieving realistic and longer-term policy goals, in complement to a proper consumer protection regulatory regime.
In that respect, it is critical for governments is to have consumer protection regulatory frameworks that take into account emerging developments and challenges in the financial sector, and that foster realistic expectations on the part of consumers, based on findings from other consumer-related fields, including financial education, behavioral economics, etc. In some instances regulators appear to have overly relied on disclosure provisions in addressing a variety of policy objectives. The report stressed a number of disclosure limitations in properly informing consumers and in positively affecting their behavior. This is raising the importance for regulators of i) testing disclosure documents emanating from regulatory requirements to assess their efficiency in meeting their intended consumer protection/awareness objectives; and ii) assessing the different regulatory tools that are available and adopting, where appropriate, regulatory measures (including suitability requirements, substantive prohibitions, etc.) that may be more suited to the consumer protection policy objectives being sought.
Finally, this report reviewed various existing practices across a representative number of countries relating to financial consumer redress. Based on that review, we concluded that governments should reassess the substantive role that statutory supervisory agencies could and should play in financial consumer redress; and where financial redress is delegated to ADR schemes, the financial regulator should ensure that these mechanisms possess all the necessary attributes to secure their efficiency.
In the current context where consumer protection relies heavily on disclosure requirements, and where many consumers lack appropriate financial literacy to fully benefit from disclosures, many individuals will turn to an ADR scheme or the courts, as their only available credible redress option in case of disagreement or dissatisfaction with their contract terms. Unfortunately, too often consumers’ claims will be dismissed on the grounds that no violations were found. As outlined by Willis (2006): “ Borrowers who claim that they did not understand the cost and terms of their loans when they agreed to them will face a lender brandishing the disclosures as a shield from any liability… Courts and regulators have been sympathetic to the argument that borrowers who are given disclosures are responsible for their own predation .”
In such an environment, financial retail market can indeed truly be seen as one where “caveat emptor” prevails. While, indeed, consumers should assume part of the responsibility in a financial transaction, it is through innovative and effective consumer protection measures and financial education initiatives, that policymakers will need to find better balance between consumers’ “rights” vs. their “responsibilities”, and that a fairer line will be drawn between a “buyer beware” and “vendor beware” financial marketplace.
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