BOSNIA AND HERZEGOVINA Diagnostic Review of Consumer Protection in the Microfinance Sector June 2012 THE WORLD BANK Financial and Private Sector Development Network Washington, D.C. The findings, interpretations, and conclusions expressed herein do not necessarily reflect the views of the Executive Directors of the World Bank or the governments they represent. BOSNIA AND HERZEGOVINA Diagnostic Review of Consumer Protection in the Microfinance Sector EXECUTIVE SUMMARY ......................................................................................................................5 OVERVIEW OF THE BIH MICROFINANCE SECTOR ..............................................................................7 THE DIAGNOSTIC REVIEW: STRUCTURE AND SOURCES......................................................................9 INSTITUTIONAL ARRANGEMENTS ....................................................................................................10 CONSUMER DISCLOSURE ................................................................................................................12 BUSINESS PRACTICES ......................................................................................................................13 DISPUTE RESOLUTION .....................................................................................................................15 FINANCIAL EDUCATION ..................................................................................................................16 KEY RECOMMENDATIONS OF THE DIAGNOSTIC REVIEW .................................................................17 ANNEX 1: LIST OF RELEVANT LAWS AND REGULATIONS ...............................................................18 ANNEX 2: SUMMARY OF INSTITUTIONAL ARRANGEMENTS ...........................................................19 ANNEX 3: ASSESSMENT AGAINST GOOD PRACTICES FOR MICROFINANCE INSTITUTIONS ...............23 ANNEX 4: EXAMPLE OF UNIFORM LOAN DISCLOSURE ...................................................................53 ANNEX 5: SCHUMER BOX...............................................................................................................54 ANNEX 6: EXAMPLES OF KEY FACTS STATEMENTS .........................................................................55 1) Key Facts Statement from South Africa ............................................................................... 55 2) Key Facts Statement from Ghana ......................................................................................... 57 3) Key Facts Statement from Philippines ................................................................................. 59 ANNEX 7: EXAMPLE OF A PROPOSED MORTGAGE DISCLOSURE FORM (USA) ................................61 2 ACKNOWLEDGMENTS This Review was prepared by Monnie M. Biety (World Bank Consultant) and Sue Rutledge (Senior Private Sector Development Specialist, World Bank). The Review was updated by Andrej Popovic (Financial Sector Specialist, World Bank) and Ruvejda Aliefendic (Private Sector Development Specialist, World Bank). The World Bank, the findings, interpretations, and conclusions expressed herein do not necessarily reflect the views of the Executive Directors of the World Bank or the governments they represent. Research assistance and interpretation services were provided by Jasmin Vajzović, with special thanks to Arabela Aprahamian (Senior Operations Officer, World Bank) and Juan Carlos Izaguirre (Consultant, World Bank). Peer review comments were received from Mehnaz Safavian (Senior Economist, World Bank) and Gunhild Berg (Financial Sector Specialist, World Bank). The authors are grateful to the authorities of Bosnia and Herzegovina, Federation of Bosnia and Herzegovina and Republika Srpska for their cooperation during the preparation of this Review. The authors were fortunate to have met with numerous representatives of ministries, government agencies, microcredit organizations, and other private institutions, non-government organizations and professional firms. The authors are grateful to these individuals, each of whom generously contributed to the preparation of this Review by giving fulsome descriptions, comments and advice. This Review, however, does not attribute statements or recommendations to any interlocutor. In addition, authors thank FIRST for funding this Diagnostic Review as part of the Financial Consumer Protection Grant to BiH. 3 CURRENCY EQUIVALENTS Exchange Rate Effective March 2012 Currency Unit = Bosnian Convertible Marka (KM) KM 1 = $ .67 US ACRONYMS AND ABBREVIATIONS AMCO Association of Microfinance Organizations BiH Bosnia and Herzegovina CCR Central Credit Registry CFKS Center for Financial and Credit Counseling DAC Debt Advisory Center ECA Europe and Central Asia EIR Effective Interest Rate FBA Federation Banking Agency FBiH Federation of Bosnia and Herzegovina, MCC Microcredit Company MCF Microcredit Foundation MCO Microcredit Organization PAR Portfolio at Risk RS Republika Srpska RSBA Republika Srpska Banking Agency SME Small and Medium Enterprises 4 EXECUTIVE SUMMARY 1. Bosnia and Herzegovina was the largest microfinance market in Europe and Central Asia until the advent of the global crisis in 2008, when it started to experience rapid contraction. By 2010, the microfinance sector fell to just 2.5 percent of GDP compared to 5.5 percent in 2009. For the first time since the sector was established in BIH, a majority of MCOs registered negative returns. Weakening loan portfolios, due to highly indebted borrowers amid a global crisis, resulted in net losses for the sector in 2009 and a contraction in the number of microfinance organizations. The decrease in portfolio was followed by more restrictive credit policies, and the access to credit for the most vulnerable population of BiH was reduced. Even though the sector continued to decease in 2011 as well, some larger MCOs have managed to reduce loan delinquencies and improve portfolio quality. Finally, the authorities have put emphasis on improving consumer protection for microfinance borrowers, and have introduced new regulatory provisions to this end. 2. The Diagnostic Review of Consumer Protection in Microfinance Sector1 complements an earlier review for the banking sector and presents findings in the following five areas: 1) Strengthening the institutional arrangements for consumer protection in the MCO sector; 2) Improving consumer disclosure by MCOs; 3) Improving the business practices of MCOs; 4) Strengthening dispute resolution mechanisms with MCOs; and 5) Expanding financial education for MCO borrowers. 3. Institutional arrangements and regulatory framework for consumer protection have been strengthened, though there is still room for improvement. Both Republika Srpska (RS) and Federation BiH (FBH) have already amended their Laws on Banking Agency to place primary responsibility for banking and microcredit sector consumer protection issues and establish Banking Ombudsman with their respective Banking Agencies. Banking Ombudsman2 has been appointed in the RS in July 2011 as an independent office within the Banking Agency, while a similar appointment has yet to be made in FBH. RS has also adopted other necessary legislative changes as well. Specifically, amendments to the Law on Banking Agency, Law on Banks, Law on MCOs, and Law on Leasing companies, introducing consumer protection provisions were adopted and published officially. While FBH government proposed similar reforms, some of them still need to be approved by FBH Parliament. 4. To improve the quality of information available to consumers, additional regulatory provisions should be introduced to mandate higher level of disclosure. For example, development of a standardized Key Facts Statement would help MCO borrowers understand the basic terms and conditions of the borrowing process and would allow them to compare different proposals and find the product that best suits their needs. Further, of particular concern in BIH are loans personally guaranteed by a third party. These loans represent about five percent of MCO loans in the RS and over eight percent in the Federation BiH. To address this issue, the disclosure requirements should enable the guarantors to receive sufficient information to ensure that they fully understand the risks assumed by co-signing a loan. In addition, the standard disclosures should be tested with MCO borrowers so that the information provided is clear and easily understood. Finally, the consumers should also have a legal right to obtain a free annual copy of their credit report. 1 A mission was conducted to Sarajevo and Banja Luka by Monnie Biety (World Bank Consultant) from June 28, to July 7, 2011. The mission met with the Ministry of Finance of BiH, the Central Bank of BiH, the Banking Agencies of RS and the Federation, IFC, IFAD, the Association of Credit Guarantors, consumer associations Plava Sfera and Putokaz, and microfinance foundations and companies. 2 Includes banks, microcredit organizations, savings-credit organizations and other financial organizations as per Law Banking on Agency of Republika Srpska. 5 5. Business practices of MCOs could be improved with new regulatory requirements as well as with development and implementation of industry standards and good practices. One of the main regulatory recommendations relates to implementation of the “cooling off” period of fourteen days during which the borrowers would be allowed to cancel already signed loan agreement. This would allow consumers more time to make careful decisions regarding financial products and services. While this recommendation has already been introduced in RS, it has yet to be implemented in FBH. In addition, MCO debt collection practices should be regulated by law to ensure that they are not abusive. Further, borrowers should be able to have a choice about the guarantee they are asked to provide to secure their loan. Finally, they should receive their account statements from MCOs at least annually. In regards to industry standards and good practices, minimum standards of consumer protection could be developed and enforced by industry associations. In addition, MCOs could design and provide adequate training for the staff dealing directly with borrowers to ensure that they clearly understand the products they sell, as well as the needs of the consumers. 6. Dispute resolution mechanism should be improved with the establishment of banking Ombudsman in FBH, additional strengthening of RS Ombudsman, and systematic analysis and publication of complaints statistics. In addition to capacity building and institutional development of Ombudsman function, attention should be paid to compiling and analyzing consumer complaints as a part of the dispute resolution process. Consumer complaints provide valuable insight into the ways in which consumers are treated by financial institutions. Statistics should be compiled, analyzed, and published focusing not only on the number of complaint, but amongst other also the types of complaints, processing times, and the outcomes of the disputes. The Banking Agencies are encouraged to analyze trends in complaints in order to develop proposals on ways for improving consumer protection practices by MCOs. 7. Finally, financial education programs would be beneficial for improving financial knowledge of the consumers. According to the World Bank funded 2011 BIH Financial Literacy Survey, the level of financial education amongst the citizens of BIH was low. At the same time, the respondents recognized the need and expressed interest in financial education programs. The goal of financial education programs would be ensure consumer understanding of the risks and rewards of using financial services and products, their legal rights, as well as obligations. 6 OVERVIEW OF THE BIH MICROFINANCE SECTOR 8. The MCO sector in BIH contracted in 2008-09 after a period of rapid growth in the previous five years. Starting in late 2008, the MCO sector experienced abrupt contraction in the loan portfolio which fell from KM 809 million to KM 626.8 million, as well as deterioration of loan quality. In 2009, credit disbursements decreased by 40 percent, and MCOs ended the year with a total net loss of KM 37 million. Further, portfolio at risk (PAR) in excess of 30 days increased from 2 percent to 6.6 percent of total loans. The negative trends were attributed to borrowers’ readiness to accept loans that exceeded their ability to repay, refinancing of old loans with new borrowings, and the absence of a central credit bureau that included MCO loans. As of 2010, however, MCOs were required to start reporting to Central Credit Registry (CCR). Weak MCO governance was additional concern, with irregularities in loan approval procedures and policies and under-staffed and under-trained credit departments. 9. MCO sector in RS continued to decline in 2011. As of end September 2011, total assets and credit portfolio fell by 8% and 15% respectively. Total capital stood at KM 54.8 million, recording a 3% decline compared to end 2010. Finally, a loss of almost KM 1.5 million was reported at the end of September 2011, while employment within MCOs decreased by 8%. 10. Similar trend of declining gross portfolio was observed in FBH in 2011 as well, though larger MCOs recorded visible improvement of active loan portfolio quality compared to 2010. The reason for the decline in portfolio included more restrictive lending policies that MCOs introduced since 2008 in response to increased credit risk resulting from uncontrolled expansion of lending in previous period. As of end September 2011, the improvement of the active portfolio quality of larger MCOs is illustrated with the decline of loan loss provisioning from 7.17% to 3.75%. Further, past due loans over one day declined from 14% to 7.52%. The risk portfolio (over 30 days delinquent) declined from 7.78% to 3.86%. As a result, sector performance related to portfolio risk achieved the standard prescribed by the Banking Agency3. 11. The number of institutions providing microloans has also decreased. As of end September 2011, there were 15 microcredit foundations (MCF) and one microcredit company in the FBiH. In RS there were 4 MCFs and 3 MCCs, and the MCFs are in the process of being converted to MCCs.4 3 As reported by the Federation Banking Agency for end September 2011. 4 A MCF is required have at least KM 50,000 in equity and is limited to a maximum loan size of KM 10,000. A MCC must have at least KM 500,000 in equity and the maximum loan size is KM 50,000. 7 Table 1: Summary Data for Microfinance Sector Information for MCOs 31 August 2010 31 January 2011 Comments Number of Clients 247,446 235,563 Decrease of 5 % due to stricter lending policies and loan write offs. Number of Credits 311,386 292,490 Decrease of 6 % Amount of Approved Loans 1,259,617,444 1,146,670,940 Decrease of 9 % (KM) Arrears (number of loans) “A” – Current - < 15 days 241,743 273,193 13 % increase most likely delinquent due to improved classification of refinanced loans. “B” – 16-30 days delinquent 5,904 5,623 5 % decrease “C” – 31-60 days delinquent 4,096 3,869 5.5 % decrease “D” – 61-90 days delinquent 7,517 6,379 15 % decrease “E” - 91-180 days delinquent 3,631 3,015 17 % decrease *“X” – unidentified 48,495 411 Many refinanced loans were previously in this category. Number of Written Off Loans 28,148 44,801 KM 65.2 million is estimated as written off in the 5 months from August to January 2011. Number of Guarantors 250,652 234,056 Decrease of 6.6 % Number of Loans Guaranteed 538,727 482,548 Decrease of 10 % Source: CCR Notes: Data was submitted by MCOs that was not properly categorized. The decrease is due to MCOs reporting all data using the A-E categories. MCOs are currently not obliged by the Banking Agencies to report using the categories, but the sector has chosen to do so. 12. Over-indebtedness and multiple borrowing are seen as significant client problems in BiH. A recent survey5 of MFO clients in BIH found that 58% of clients had more than one active credit contract, and more than 32% of clients had three or more active credit contracts. According to the survey, 41% of respondents were identified as problem clients, either facing repayment issues or being over-indebted. 13. In both the Federation BiH and RS, guarantors repay a substantial portion of MCO loans and represent a major source of complaints. In 2010 guarantors repaid 5 percent of total loans made in RS and about 8.4 percent of loans in the Federation. At the same time, out of 71 complaints against MCCs in the RS, 31 or 43% were submitted by guarantors. 14. Eight MCOs in BIH have recently signed up to Smart Campaign assessment, thus launching a voluntary certification program which will identify MCOs that meet minimum standards of client protection. This is an encouraging development as it demonstrates that the MCO industry is recognizing the importance of client protection. 5 Indebtedness of Microcredit Clients in Bosnia and Herzegovina, Results from a Comprehensive Study, Klaus Maurer and Justyna Pytkowska, European Fund for Southeast Europe Development Facility, 2011. Available at http://www.microfinancegateway.org/gm/document- 1.9.53356/Indebtedness%20of%20Microcredit.pdf 8 THE DIAGNOSTIC REVIEW: STRUCTURE AND SOURCES 15. This Diagnostic Review analyses five areas of consumer protection in MCO sector: i) existing institutional arrangements, ii) consumer disclosure; iii) business practices; iv) dispute resolution mechanisms; v) and financial education programs. The institutional arrangements section covers the agencies responsible for implementing consumer protection, as well as industry and consumer associations. The section on consumer disclosure focuses on standard formats for price and product comparison, disclosure provisions, and basic rights of consumers. The section on business practices covers unfair or abusive practices, standard consumer contract provisions, and industry Code of Conduct. The section on dispute resolution focuses on internal complaints mechanisms in financial institutions and out-of-court mechanisms. The section on financial education focuses on measures aimed at increasing consumer financial literacy and awareness. 16. The Diagnostic Review for Microfinance in Bosnia and Herzegovina is based on international practice for consumer protection and financial literacy worldwide, and it uses the World Bank’s Good Practices for Financial Consumer Protection as an assessment tool. The Good Practices incorporate provisions of directives, laws, regulations and codes of business practices from the EU, United States, Australia, Canada, France, Ireland, Malaysia, Mexico, New Zealand, Peru and South Africa. They also support the recently adopted G20 Principles for Innovative Financial Inclusion. Further, the Diagnostic Review also includes the consumer protection elements of the 2011 European Code of Good Conduct for Microfinance Provision6. While the Good Practices are based on successful experiences primarily of middle- and high-income countries, the basic ideas are of universal application and should be part of financial consumer protection strategies for countries worldwide. Finally, the Diagnostic Review complements and earlier similar review for the banking sector for BIH which was also based on the cited Good Practices. 17. The Diagnostic Review is based on the analysis of the existing legal regulatory framework and interviews with market participants and the regulators. 18. The Review also takes note of consumer complaints identified by BiH Ombudsman and Association of Credit Guarantors. While these complaints were primarily related to banking sector, they are also relevant to MCOs. Specifically, they include: 1) the consumers were unable to make comparisons of written credit offers from different banks; 2) the credit contract for loans with floating interest rates did not prescribe the index against which the interest rate is changed; 3) the effective interest rate (EIR) included hidden costs and was generally 2-3 percent higher than the nominal interest rate; 4) banks did not provide an option for consumers to choose the type of guarantee offered; 5) consumers could not obtain written information of the contractual provisions prior to signing the contract; 6) while the credit contract stipulated the creditor’s rights, the consumers received only the provisions that defined their obligations; 7) banks used contracts to impose liability on the consumer to pay for potential court expenses which was in violation of the Law on Executive Procedure; 8) banks required signing of a blank promissory note as a “guarantee” for credit repayment, even if the applicant has provided other collateral; 9) banks requested personal data beyond those needed for the requested service; 10) the credit applicant and guarantor had to provide a-priori agreement allowing the bank access and oversight over all data, including those protected by the Law on Personal Data Protection; 11) as part of the credit application, banks required repeated authentication of documents, thus increasing the costs for the consumer; 12) banks retained copies of the borrower’s personal identification card that contained the borrower’s unique personal identification number; 13) the borrowers’ ability to repay was not properly assessed; 14) 6 EU Regional Policy. Enterprise and Industry. “European Code of Good Conduct for Microcredit Provision“ v.01. http://ec.europa.eu/regional_policy/index_en.htm November 2011. 9 contracts included fine print which the guarantors failed to read thoroughly; 15) financial institutions sought guarantors employed in the public sector and/or those retires as they could easily obtain an administrative ban (garnishment); 16) guarantors followed the cultural habit (from the former Yugoslavia) of guaranteeing the loans of friends and family members; 17) profit was put ahead of sound loan underwriting; and 18) officers of financial institutions engaged in fraud or collusion with borrowers. 19. The next five sections provide detailed diagnostics and recommendations for each area. INSTITUTIONAL ARRANGEMENTS 20. The Banking Agencies in both the Federation BiH and RS are responsible for licensing and supervising of MCOs. Under the Law on MCOs, the Federation Banking Agency (FBA) performs both off and on-site supervision; on-site supervision commenced in 2010. The FBA has issued ten Decisions for MCOs and five Instructions for MCO Business Operations. The RS Banking Agency (RSBA) has similarly issued 13 Decisions related to MCOs. The Central Bank of BiH coordinates the activities of the Entity Banking Agencies. 21. The amendments to the Laws on Banking Agency in both RS and FBH placed the responsibility for the regulation and supervision of consumer protection in banking and microfinance sectors to respective Banking Agencies. Given that they act as regulators of banking and MCO sector, Banking Agencies are also best placed to regulate and enforce financial consumer protection agenda. 22. In addition, amendments to Laws on Banking Agency in both Entities have introduced provisions for setting up the office of Banking Ombudsman as an independent office located under the umbrella of the two respective Banking Agencies. RS Banking Agency has already appointed Ombudsman in July 2011, while the appointment has yet to be made in the FBH. The RS Ombudsman is fully funded by the RSBA, and the service is provided at no charge to the consumers. A written settlement agreement mediated by the Ombudsman has the status of formally enforceable document. This novel institution will require further strengthening and capacity and institution building, and is overall a step in the right direction. 23. The RS Ombudsman received 56 complaints in the period from August to December 2011 and 15 have already been resolved. The Ombudsman is currently in various stages of addressing the remaining complaints. Majority if the complaints (52) were related to the banks, and only four were related to MCOs. At this stage it is not possible to conclude whether the low level of MCO complaints was related to the lack of MCO client knowledge about the establishment of the Ombudsman’s office, or if the complaints had been addressed at the MCO level (it was indicated that MCOs received 31 complaints). 24. In 2010, the Banking Agencies commenced on-site inspections which included limited market conduct reviews to assess compliance with existing regulations. In order to ensure proper market conduct supervision, the Banking Agencies should also review and supervise: 1) MCO consumer protection policies and procedures; 2) Analysis performed by loan officers to determine the borrower’s ability to repay and cash flow; 3) Standard consumer disclosures; 4) Use of the CCR and methods of analysis of credit reports; and 5) Handling of consumer complaint files. 10 The Agencies should also consider other supervisory tools which have been found effective. This includes the use of “mystery shopping” and analysis of complaints data, based on which supervisors can focus on institutions with higher incidence of complaints or those that seriously violate existing laws and regulations. 25. The State level Ombudsman for Consumer Protection in BiH covers financial services as established by the Consumer Protection Law. According to the Law, the Ombudsman is empowered to: a) publish instructions for ceasing activities that are in violation of the law and submit these instructions to the court; b) initiate a court procedure; and c) initiate procedure with courts responsible for compensation in cases of damages made in a collective interest of consumers. In April 2009, the Ombudsman issued 16 Guidelines and Recommendations in the Sector of Consumer Loans. In June 2011, the Ombudsman issued a report on consumer protection in the banking sector. The report noted that the status of consumer rights had not significantly improved since the 2009 report. However, the office is modestly financed and has a small staff with limited technical capacity, as none of the staff possess financial sector expertise, and no mechanisms to enforce relevant provisions of Consumer Protection Law. 26. Association of Microcredit Organizations (AMCO) is the primary microfinance network operating in BiH. It was formally established in 2003 includes 13 members which account for 98 percent of MCO loans in BiH. AMCO has one staff member, a board of directors that meets twice a year and a supervisory board. It was formally registered in 2003 in line with the Law on Associations and Foundations. In 2005, AMCO has developed a Code of Conduct which includes some general market conduct provisions and which is mandatory for all members. 27. Consumer advocacy organizations in both the Federation and RS have limited capacity. In the Federation, association of consumers Putokaz is financed by the Ministry of Trade. However, the officials are volunteers, except for the sole employee who was previously a professor of philosophy and has no professional experience in working with financial services. In 2010, Putokaz received approximately five to six complaints a month concerning banks (but not MCOs). The most common complaints were that banks had: (1) changed the interest rate on the loan or (2) pursued a guarantor to pay off the debts of a borrower. In RS, Plava Sfera is financed by the Ministry of Trade as well as grants from international organization. Plava Sfera has 3,000 members who make voluntary contributions and two full-time paid employees. In 2010, 10 percent of their complaints concerned the financial sector. Similar to the Federation, the primary complaint was related to how banks change loan interest rates. Both Putokaz and Plava Sfera act as mediators between financial institutions and consumers, lobby state authorities on behalf of consumers, and provide advice consumers who wish to take their case to court. Currently, there is still low capacity within consumer associations to act as effective voices of the interests of financial consumers in BiH. 28. The Center for Financial Credit and Counseling (CFKS) in Tuzla was started by several MCOs in December 2009 to provide debt counseling for consumers as well as financial education and financial advice. The Center is supported by a number of international donors such as International Finance Corporation, European Fund for Southeast Europe, and microfinance investors and lenders, Oikocredit and BlueOrchard. The Center also receives support from the Central Bank, the Banking Agencies, the banking associations, AMCO, and local banks and MCOs. CFKS currently employs four staff while additional six are being trained to provide financial education in high schools. In terms of achievements, the Center has developed a workout plan for 14 percent of its clients, agreeable to both the financial institution and the borrower. 11 CONSUMER DISCLOSURE 29. Disclosure requirements in the Consumer Credit Articles of the Consumer Protection Act should be amended. The Act should be revised to include requirements for both open and closed end credit, credit cards, periodic statements, grace periods if applicable, balance computation methods for credit cards, any subsequent disclosure requirements, and advertising requirements (for electronic and print media and marketing materials). It should also be aligned to consumer protection provisions in Entity laws and include provisions of EU Credit Directive. 30. Working with AMCO, the Banking Agencies should develop a standard disclosure format for loans to MCO borrowers. The need for disclosure rules is especially important where market monitoring reveals poor customer understanding of product terms and conditions, aggressive competition, large numbers of clients with loans from multiple lenders, or unsustainable household debts as the case in BiH. For credit products, a diverse array of evidence suggests that transparent disclosure of loan terms can contribute to reducing borrowing costs. Annex 4 of this review includes an example of a uniform disclosure format. Mandated disclosure requirements in visual format, such as that in Annex 7, can help clients better compare credit terms and conditions from one bank or MCO to another. Loan fees and costs should be disclosed both verbally and in writing, and they should be disclosed both as an amount and as a percentage of the loan. Another (longer) version of a loan disclosure form can be seen in Annex 6. Additionally it has been found helpful to separate information on rates from information on fees. This has been done in the “Schumer Box” (Annex 5) as used in the USA, which can improve consumer understanding and their ability to use disclosures in the financial decision making process. 31. A standardized Key Facts Statement for each type of credit offered should be developed to help consumers understand the essential conditions of their contracts. For all credit products, consumers need a short, standardized description written in plain language that is comparable across all credit products. The format of key facts statements should allow consumers to quickly and easily identify the key terms and conditions. These materials should be distributed when the borrowers are shopping around, and not when they are about to sign the loan agreement (See Annex 6 for examples of Key Facts Statements). 32. It is recommended that the standard formats for Key Facts Statements be developed together by the Banks’ Association and AMCO. The Banking Agencies should also review and comment on the formats to ensure that they provide material information that would not mislead consumers. The Banks’ Associations and AMCO should formally adopt the format of Key Facts Statements and encourage its members to use them. Loan disclosures and the Key Facts Statement should be tested with users. This will ensure that the Statement is understandable and useful for the average consumer. 33. Disclosure should include a clear and easy-to-understand statement on what can happen to a guarantor if the borrower does not repay. Currently, there is no disclosure to the guarantor explaining to them what can happen if the borrower does not repay. When a loan is granted, the borrower receives a copy of the loan contract, the amortization schedule and blank promissory notes to be signed by the borrower and the guarantor. MCOs should ensure that the guarantors understand the extent of their legal obligations as well as potential ramifications of their role. The guarantor should also receive a copy of the contract and the amortization schedule. The guarantors should also be informed in writing if he/she is a solitary or a subsidiary guarantor as defined in the Law of Obligations. 34. The CCR should allow each borrower to access a copy of their credit report annually. This will allow borrowers to better understand the effect on their credit when they do not repay their obligations on time. In addition, in case of an error on the report the borrower can alert the CCR so that corrections are made. 12 BUSINESS PRACTICES 35. Credit should only be extended to MCO borrowers that have demonstrated an adequate ability to repay. Over-indebtedness is an important issue for MCO borrowers worldwide. Banking Agencies should not allow financial institutions to provide credit to its customers unless the customer explicitly accepts it, and credit lines should not be automatically increased. Market participants note that it is a common practice in BiH banks to grant an overdraft line of credit for two times the salary of a customer without the customer requesting such a line. MCOs should ensure that their loans do not put borrowers at significant risk of over-indebtedness. Working with AMCO, the Banking Agencies should develop guidelines to ensure the following: 1) Each MCO should have a lending methodology in place to assess the borrower’s ability to repay. The methodology should be systematically applied and monitored--and it should be conservative. The methodology should be based on cash flow analysis rather than the borrower’s assets.7 2) MCOs should offer flexible products to fit the borrower needs and cash flow. The loan officers should consider the use of the loan, the borrower’s ability to repay, its cash flow, and the borrower’s business cycle. 3) All MCOs should use the Central Credit Registry reports and look for “signs of warning”. Such signs include debts from multiple financial institutions, failure to disclose all debts on credit applications, debts rated below “A”, and guarantors with multiple guarantees. 4) MCOs should use internal audits to check that loan officers follow loan procedures put in place to reduce borrower over-indebtedness. MCOs should periodically review a sample of current loans and delinquent loans for each branch and loan officer. 36. AMCO could also take an increased role in strengthening consumer protection practices by MCOs. For example, it could utilize its Code of Conduct as a tool to improve business practices. The Code could be updated with more specific business practices and industry standards which should be agreed and observed by all members. The mechanisms to investigate breaches of the code of conduct could be agreed as well. The Code should be placed in all branches and on the websites of all MCOs, and consumers should be advised that if an MCO fails to comply with the code, a complaint could be submitted to the MCO and AMCO. The Smart Campaign could be used to inform about the development/improvement of individual and industry-wide codes of conduct, as well as their implementation and effectiveness. In addition, AMCO could also organize trainings for member MCO’s loan officers to build their capacity and understanding about financial products and services, industry Code of Conduct, consumer protection requirements, client interaction, and so forth. 37. MCOs should be legally responsible for any statements made in their advertising, and the content of the advertising should be monitored by the Banking Agencies. MCOs should be responsible for offers they make in their advertising through any type of media. They should be required to state that their advertising is regulated by the Banking Agencies. As part of off-site supervision, the Banking Agencies should, from time-to-time, review MCOs’ advertisements to ensure that they are not deceiving or intentionally confusing consumers. 38. It is recommended to introduce cooling-off periods for MCO loans. Cooling-off periods allow consumers to take time to rethink their purchases of financial products and services and cancel the 7 It may be helpful to establish a general guideline for maximum net debt ratio (all expenses including household expenditures, existing credit commitments and the new payment/net income after taxes and other government deductions). This can be done by analyzing the credit applications received and determining the average debt ratio for those borrowers that are able to repay their loan without a problem. A net debt ratio of 50 percent may be a useful target. 13 contracts without penalty during a defined time period. The maximum period for cooling off should be fourteen business days. This provision has already been introduced in RS. 39. The MCOs should be encouraged to conduct self-assessments of their consumer protection practices by using the Smart Campaign8 Assessment Tool. Self-assessments should be regularly conducted and shared with the investors and lenders supporting each MCO. Alternatively, the assessments could be conducted by AMCO or a third party. The assessment should include an action plan with recommendations, the responsible party to complete the action, and the time frames in which the action or corrections should be made. Follow-up should be performed periodically to ensure that the MCO is following the action plan and that consumer protection has improved. It is noted that 8 MCOs in BiH have signed up to the Smart Campaign Assessment tool in early 2012, supported by the IFC. 40. Debt collection practices should be regulated by law. Currently there is no law regulating debt collectors. Further, there is no requirement for debt collectors to be registered with the Banking Agencies. The law regulating debt collection should prohibit abusive collection practices and harassment, or deceptive practices. 41. A country’s credit registry plays a pivotal role in preventing over-indebtedness by MCO borrowers. The registry assists lenders in assessing borrowers’ existing debt and repayment capacity. The registry can limit consumers from taking on too much debt while helping them build credit records. The registry also helps policy makers track debt trends, in the market and for particular segments. The broader the coverage (i.e. the more categories of providers reporting data, positive as well as negative data) the more useful the credit information system will become. 42. Starting in 2010, MCOs have had access to the CCR administered and maintained by the Central Bank of BiH. The CCR was established only in 2009 and is used by banks, MCOs and leasing companies. Financial institutions submit client data on a monthly basis. This allows checking of credit histories, number of loans outstanding, as well as the total amount of debt as of the end of previous month. Information in the CCR is not available in “real time”, but immediate access is expected to be put in place by 2012. However, the CCR only record debts of financial institutions. For all other debt – related to electrical, water, mobile phone bills - the MCOs have to rely on a private credit registry - LRC. However, reporting to LCR is not mandatory. As a result, MCOs have difficulty gaining a complete understanding of a borrower’s financial obligations. 43. Consideration could also be given to developing out-of-court mechanisms for debt relief for over-indebted borrowers. BiH has no law on personal insolvency, but the experience of other countries should be reviewed based on which an appropriate proposal tailored to the needs of BiH could be developed. It is worth considering developing a pilot and testing it before suggesting a full scale rollout. As an illustrative example only, the experience of United Kingdom on debt relief orders may be helpful. For consumers on low incomes, the UK legislation provides for two types of relief: 1) Individual voluntary arrangements (IVAs) where an individual comes to an agreement through an Insolvency Practitioner to pay less than the full amount owed to creditors in full and final settlement. There are fewer restrictions than apply with bankruptcy and some assets such as the family home may be protected. 2) Debt Relief Orders (DROs) are used to release individuals from overwhelming levels of debt. DRO's can be implemented where the level of debt is below £15,000, where there are less than £300.00 of assets and insufficient income to pay more than £50.00 a month towards debt repayment. In a DRO all debts are considered settled after a period of one year. This legislation is aimed at supporting consumers who get into excessive debt where there is little hope of 8 The Smart Campaign is housed at ACCION International’s Center for Financial Inclusion in Washington, D.C. 14 repayment without the penalties involved in bankruptcy on the one hand, and at reducing the burden on the other hand. For both IVAs and DROs, the repayment period is limited to three to five years, although the borrower’s credit rating is affected for six years. DISPUTE RESOLUTION 44. Finding effective and fair ways of resolving disputes between MCOs and their customers lies at the heart of effective financial consumer protection. With the average loan at about KM 2,500, for most MCO customers the amounts involved in a dispute are relatively small. The failure to resolve disputes quickly, efficiently, transparently, and professionally, undermines public confidence in MCOs and reduces the trust and confidence in the sector as a whole. Because most MCO borrowers are low- income consumers, they need a simple plain-language processes, trustworthy recourse providers, and accessible points of contact, such as free call centers and walk-in complaints desks. 45. MCOs should be required to publicize the procedures for lodging complaints. This information should be easily accessible and include written contact information with telephone number, fax number, and email address. This information should be available in all branches, on the MCO web site, and also provided to consumers when they apply for a loan. 46. Data on consumer complaints from MCO borrowers should be collected, analyzed, and published. Complaints data can be a valuable (and relatively inexpensive) policy tool to inform regulators’ decisions. It can help them discern patterns of abuse, monitor problematic products and practices that are emerging in the market, and spot “rogue” providers that are habitual offenders. Mandatory reporting of standardized complaints and resolution statistics can improve accountability of MCOs. In BiH, MCOs are obliged to report quarterly to the Banking Agencies the number of customer complaints. The RS Banking Agency publishes some statistics, including the nature of complaints and if they were addressed. In 2011, 71 complaints were made against MCOs. However, the Federation Banking Agency does not even publish aggregate complaint statistics. Both Agencies and/or Banking Ombudsmen should compile, analyze, and publish data on consumer complaints, including their number, nature of complaints, the average time spent to resolve the disputes presented by consumers, and the type of resolution offered. In addition, Banking Agencies/Banking Ombudsmen should exercise caution in how these are interpreted and put more emphasis on the substance and content of complaints, as well as how/if they were resolved. Also, the consumer advocacy organizations should analyze the complaints data and make suggestions on ways of addressing the outstanding weaknesses by MCOs. 47. An alternative out-of-court dispute settlement mechanism should be considered in BiH. In all countries, litigation can be slow, unpredictable and expensive, especially as compared to the sums which are typically the subject of consumers’ complaints. Consumers need efficient, inexpensive and speedy out-of-court dispute resolution mechanisms. The most effective solution would be to have effective banking system ombudsman, which has already been established in the RS and is expected in the Federation shortly. Another alternative would be to encourage the use of mediation. However, in other countries in Europe and Central Asia, the mediation process is generally more effective in resolving disputes between financial institutions rather than disputes between consumers and financial institutions. 48. Official bodies should take measures to help consumers become aware of their legal rights in case of complaints about MCOs. Consumers should be clearly informed of their rights to complain to a MCO, or to the applicable Banking Agency/Ombudsman in case they are not satisfied with a response 15 offered by their MCO. One approach would be to create brochures that describe such legal rights in simple and plain language and provide information on how to contact the Banking Agency/Ombudsman. The Banking Agencies/Ombudsman could also consider establishing a toll-free hotline, available anywhere in their territorial jurisdiction, where consumers can obtain basic information about their legal rights. The Banking Agencies/Ombudsman should also actively present important complaints and their resolution in the media to educate the public about the effectiveness of the process. FINANCIAL EDUCATION 49. Financial education programs should be tailored to meet the consumers’ needs. Consumers need to be able to understand two key issues: (1) the risks and rewards in using financial products and services; and (2) the consumer’s legal rights and obligations in using such products and services. 50. Some financial institutions have produced pamphlets to improve consumer awareness of financial issues. More such initiatives should be encouraged. A brochure published by Partner MCO addresses relevant consumer issues in lessons. It covers topics such as credit history and CCR, the difference between good and bad creditworthiness, how to avoid the pitfalls of hidden loan costs, whether to take an ear-marked or non-earmarked loan, what consumers should know about interest rates and personal data protection, what it means to guarantee a loan, and what is financial discipline. The pamphlet is available at the MCO offices. The Association of Consumer Guarantors also published a pamphlet dedicated to guarantors. The pamphlet was printed in association with a local civic group and provides information on the legal framework with respect to guarantors and their rights and obligations. 51. Development and implementation of financial education strategy/program is recommended. The World Bank funded a Financial Literacy Survey in mid-2011, based on a random, nation-wide sample of citizens of BiH aged 18 or older. The Survey showed that in general financial knowledge of BiH citizens was low, as indicated by the average score of about 5.5 correct answers out of 13. Self- assessment of financial knowledge corresponded to the results of the financial quiz. In this sense, citizens recognized the need for a comprehensive financial education, and expressed high interest in financial education, with issues related to financial planning and customer rights topping the list of potential topics. At the same time, the number of financial education initiatives in BiH remains limited. There are some isolated measures undertaken by government agencies and consumer organizations, as well as certain financial and private institutions. 52. Financial education programs should also be provided to teens. Such programs are crucial in helping them understand financial transactions and prepare for adult life. This type of education and exposure is essential to develop young adults and into financially savvy citizens that can make educated and informed financial decisions. While CFKS is currently providing financial education programs to teens, a more systemic approach is required. 16 KEY RECOMMENDATIONS OF THE DIAGNOSTIC REVIEW 53. Based on the conducted Diagnostic Review a list of prioritized recommendations and responsible institutions is presented below. This list includes only the key recommendation presented in the previous sections: Table 2: List of Key Recommendations Action Responsible Party Priority Consumer Disclosure Develop and test with consumers standardized Key Facts AMCO, Banking Short Term Statement for all credit products so that consumers can compare Agencies offers prior to signing a loan contract. Require that full disclosure is provided to guarantors clarifying Banking Agencies Short Term their specific obligations in case the borrower does not repay the loan they guaranteed. Require that guarantors are provided a copy of the loan contract, amortization schedule, guarantor disclosure and all other pertinent loan documents. Give consumers the right to obtain free copies of their credit Central Bank Short Term reports annually. Business Practices Establish a “cooling off” period for borrowers in FBH to cancel Ministries of Short Term loan agreements without penalty during a defined period of 14 Finance and days. Banking Agencies Require that financial institutions provide an option for Banking Agencies Short Term consumers to choose the type of guarantee offered. MCOs should be required to provide periodic account Banking Agencies Short Term information no less than annually through account statements, receipts, or balance inquiries. Develop legislation to regulate debt collection practices. Ministry of Medium Term Finance, Central Bank, Banking Agencies Dispute Resolution Establish banking ombudsman in Federation BiH and ensure Federation Short Term necessary capacity building support, and strengthen the existing Banking Agency ombudsman in RS. RS Banking Agency Require MCOs to publicize the procedures for lodging consumer Banking Agencies Short Term complaints. Collect, analyze, and publish the number of consumer Banking Agencies Medium Term complaints received and processed, the nature of complaints, the average time spent to resolve the disputes presented by consumers and the type of resolution offered. Financial Education Develop and implement a strategy/program on financial Ministries of Medium Term education. Finance, Banking Agencies, Central Bank 17 ANNEX 1: LIST OF RELEVANT LAWS AND REGULATIONS 54. While a general law on consumer protection exists at State-level, no such law exists in either Entity; however, recent amendments to Entity Laws on Banking Agency placing primary responsibility for the consumer protection in the banking and microcredit industries issues with their respective Banking Agencies. 55. At the same time, Laws regulating MCOs exist at Entity-level. The main laws and regulations providing directly or indirectly for consumer protection in the MCO sector are as follows. 56. State-level: x Consumer Protection Act x Law on the Protection of Personal Data x Law on Obligations x Law on Mediation Procedure x Decision on Central Registry of Credits of Legal and Physical entities in BiH, effective July 1, 2009; published in “Official Gazette BH”, 12/09 from 10.02.2009, “Official Gazette FBH”, 12/09 from 25.02.2009, “Official Gazette RS”, 13/09 from 24.02.2009, “Official Gazette of Brcko District BH”, 4/09 from 09.02.2009 57. Federation of Bosnia and Herzegovina Entity-level: x Law on MCOs x Law on Banking Agency (as provisions in this law relate directly to MCOs) x FBiH Banking Agency’s Regulations, Decisions and Instructions, most notably: o Decision and Instruction for Calculating Effective Interest Rates, o Decision on Manner of MCOs’ Action taken upon a Customer’s Complaint, o Decision on Supervision of MCOs’ and o Decision on Other Business Operations. x Law on Obligations 58. Republika Srpska Entity-level: x Law on MCOs x Relevant provisions on consumer protection in the Law on Banks x Law on Banking Agency (as provisions in this law relate directly to MCOs) x RS Banking Agency’s Regulations, Decisions and Instructions, most notably: o Decision on Method of Acting of MCO upon client complaint, o Decision for MCO Business Operations, o Decision on Examination and Supervision of MCOs, o Decision on Standards for Documenting MCO Loan Activities, and o Decision on Method of Calculating and Presenting Effective Loan Interest Rate. x Law on Obligations 59. EU Regional Policy. Enterprise and Industry. “European Code of Good Conduct for Microcredit Provision“. November 2011. 18 ANNEX 2: SUMMARY OF INSTITUTIONAL ARRANGEMENTS 9 60. Although there is no single government agency responsible for developing and enforcing consumer protection in banking or financial services, most recently the Entity Banking Agencies were tasked with this responsibility. In addition, the establishment of Banking Ombudsman in RS, and expected appointment of Banking Ombudsman in FBH should improve the status of users of financial services. Further, various other agencies at State and Entity level also deal with consumer protection issues, though with a limited mandate in financial sector. These agencies are summarized below. 61. The Consumer Protection Council (the Consumer Council) is an administration organ established at State level by the Consumer Protection Act of 2005. The Consumer Council consists of 15 individuals representing the following institutions: 1) Ministry of Foreign Trade and Economic Relations, chairman; 2) Competition Council of BiH; 3) Veterinary Office of BiH; 4) Office for Phyto-Sanitary Protection of BiH; 5) Statistics Agency of BiH; 6) Institute for Standards of BiH; 7) Institute for Measurements of BiH; 8) Institute for Intellectual Property of BiH; 9) Ministry of Trade of the FBiH; 10) Ministry of Trade and Tourism of the RS; 11) Competent body of Brčko District; 12) A FBiH consumers’ organization; 13) A RS consumers’ organization; and 14) Union of BiH Consumer Associations (2 representatives).10 62. The Consumer Council has limited institutional capacity to focus on financial sector issues. By the terms of the Consumer Protection Act, the Consumer Council is required to meet at least four times a year.11 The Council operates without any permanent staff and it does not focus on issues of financial consumer protection. The Council’s purpose is to: (i) prepare an Annual Consumer Protection Program for adoption by the State’s Council of Ministers; (ii) monitor the implementation of these annual Programs; (iii) determine the basics of consumer protection policies; and (iv) define activities to be financed or co-financed from the State budget.12 63. The Ombudsman Institution for Consumer Protection in BiH (Consumer Ombudsman) is an independent institution established by Article 100 of the Consumer Protection Act. The Consumer Ombudsman is appointed for a five-year term (renewable once) by the State-level Council of Ministers on the recommendation of the State Ministry of Foreign Trade and Economic Relations. The Ombudsman is located in Mostar and is financed exclusively by the State budget13. While it employs four full-time staff, including the Ombudsman and two assistant ombudsmen.14 However, none of the staff possesses financial sector expertise. Formally, the purpose of the Ombudsman is as follows: 9 This Review, likewise, does not deal with any Brčko District institution that may be concerned with any aspect of consumer protection in that District. 10 See Article 106 (1) of the Consumer Protection Act. 11 Ibid, Article 106 (2). The Council met four times in 2007 and three times in 2008. As of November 20, 2009, it had met only twice in 2009. 12 Ibid, Article 107. 13 The annual budget for 2009 amounts to KM 400,000. 14 The Ombudsman and the two assistant ombudsmen come from the three distinct ethnicities in BiH and operate by consensus. 19 x to disseminate information on consumer rights and obligations and to support consumer associations in performing such activities; x to review practices and proposed practices regarding business-to-consumer relationships; x to investigate market practices aimed at consumers either at its own initiative or based on consumer complaints and coordinate with Entity and Brčko District Market Inspectorates; x to take appropriate action in cases of consumer complaints or business malpractices; x to issue guidelines or recommendations about particular unfair standard terms or practices used in specific sectors or by specific economic operators; x to recommend the use of particular contractual terms; x to negotiate with representatives of concerned trade associations model contracts applicable to specific sectors of activity; x to propose and initiate the settlement of consumer disputes through alternative dispute resolution mechanisms; x to liaise with the Human Rights Ombudsman Institution on common concerns; x to advise the Consumer Protection Council and the State Level Council of Ministers on necessary improvements in consumer law and the effectiveness of Government policy in the area of consumer protection; and x to assess the impact of other governmental initiatives in the area of consumer protection. 15 64. The Competition Council is an independent State-level council established by the Law on Competition of 2005. This law is modeled on European Union (EU) competition laws and addresses non-competitive conditions in BiH. The law defines monopolistic conditions and prohibits abuse of “dominant positions”. It also contributes to general consumer protection in BiH by establishing a mechanism for the redress of individuals’ grievances against monopolies and by levying appropriate penalties. It does not, however, specifically address consumer protection issues in microfinance. 65. The State-level Market Surveillance Agency16 coordinates overall activities of market surveillance in BiH. The entity-level Inspection Authorities in RS and the FBiH (“Inspectorates”) carry out direct inspection controls, including on-site inspections. 66. The Central Bank of Bosnia and Herzegovina (CBBiH) was established in June 1997, with the goal of achieving and maintaining monetary stability.17 In addition, basic tasks of the Central Bank include coordinating the activities of the Banking Agencies at Entity-level, including monthly meetings with the heads of the Banking Agencies and receiving of monthly reports from the Banking Agencies on their activities and on developments at the financial institutions under their jurisdiction.18 While the Central Bank is one of the most respected institutions in BiH and has convening power related to banking system issues, it exercises only minimal control over each entity-level Banking Agency and does not supervise operations of commercial banks. 67. The Central Bank set up the Central Credit Registry of Legal and Physical Entities in 2006 to collect and access credit information. Initially only legal entities were covered while individuals were added later. The scope of information collected and accessed through the Central Credit Registry has been constantly evolving. In January 2009, the Central Bank issued a Decision that established access to the Registry for commercial banks, micro-credit organizations and savings-credit organizations, as well as to any leasing company, insurance organization or other entity that seeks to be included in the Registry. 15 See Article 101 of the Consumer Protection Act. 16 Established by the Law on Market Surveillance (Official Gazette of BiH No. 45/2004). 17 See Article 2, Section 1 of the Law on the Central Bank of BiH (Official Gazette of BiH, No. 1, 1997), as amended. 18 Ibid., Article 2, Section 3. e 20 68. The Personal Data Protection Agency was set up in 2009 as an independent authority in charge of implementing the Law on the Protection of Personal Data, both at State and Entity level. The Agency replaced the Committee on Personal Data Protection which was operational since 2001. The institutional change responded to the need for increased autonomy in this field and for compliance with EU standards. The Agency is planning to conduct monitoring of all institutions handling personal data, including banks and other financial institutions. The Agency has already started reviewing the data systems of banks that have requested the Agency’s opinion. 69. In both Entities, Banking Agencies license MCOs, banks and other financial institutions, and are in charge of the prudential supervision of their activities. The Banking Agencies have the authority to impose penalties upon commercial banks and their officials if regulatory requirements are violated. Most recently, their mandate was expanded to financial consumer protection. Further, regulatory provisions for establishment of Ombudsman as an independent office within each Banking Agency were introduced. As a result, RS has already appointed Ombudsman, while the appointment in FBH has yet to be made. 70. Also in both Entities, Ministries of Trade19 have set up Consumer Protection Offices. These offices provide budgetary resources to non-governmental consumer organizations or consumer associations. 71. The Association of Microfinance Institutions in Bosnia and Herzegovina (AMCO) is the primary microfinance network operating in BiH. Its 13 members account for 98 percent of microfinance assets and loan portfolio in BiH. AMCO's mission is to: 1) Reduce poverty and unemployment through economic development; 2) Build capacity of the private sector in BiH; 3) Improve the abilities of MCOs, their management and staff to respond to challenges in the sector and continue to sustain the economic development of their clients; 4) Participate actively in the national and regional microfinance industry; and 5) Promote the active role of their member MCOs in the economic development of Bosnia and Southeast Europe. AMCO has one staff member, a board of directors that meets twice a year and a supervisory board. The tasks performed by the employee and officials include: collecting MCO financial statements and providing monthly performance reports to donors, creditors and other interested parties; liaising with regulatory and local authorities and working to improve the regulatory framework; liaising with donors; organizing seminars; and communicating with stakeholders. The association is funded by their members (75%) and donors (25%). In 2005, AMCO implemented a code of business ethics. MCOs adopting this code must display it publicly and clearly communicate it to all clients. The provisions of the code are enforced by AMCO which levies penalties on non-compliant institutions. AMCO has an arbitration body that resolves disputes among AMCO member institutions. 72. There are various consumer organizations at the State and Entity levels. Many of these receive modest sums from Government budgets to assist them in helping consumers understand their rights and acting on behalf of consumers when disputes arise. There is an Association of Consumer Organizations in each Entity and a Union of Consumer Associations in BiH. These entities invariably fail to assist consumers adequately and in respect of financial services, and play little or no role at all in consumer protection for microfinance services. Putokaz is an association of consumers that is financed by the Ministry of Trade and located in FBiH. In the RS, Plava Sfera is financed by the RS Ministry of Trade as well as by international donations. Association of Credit Guarantors was founded as a reaction to the 19 In RS, the relevant Ministry is the Ministry of Trade and Tourism. 21 number of guarantors currently paying debts of others. The main objectives of the association are to protect the rights and interests of guarantors and their property during the loan collection process, educate guarantors, and improve financial literacy. The Center for Financial Credit and Counseling (CFKS) in Tuzla was started by several MCOs in December 2009 with the aim of establishing a debt counseling center for consumers. It also provided financial education and financial advice for consumers. The Center is supported by a number of international donors such as IFC, EFSE, Oikocredit, and BlueOrchard. The Center also receives non-financial support from the Central Bank, the Banking Agencies, banking and MCO associations and local banks and MCOs. 22 ANNEX 3: ASSESSMENT AGAINST GOOD PRACTICES FOR MICROFINANCE INSTITUTIONS SECTION A CONSUMER PROTECTION INSTITUTIONS Good Practice A.1 Consumer Protection Regime The law should provide clear consumer protection rules in the area of non- bank credit institutions, and there should be adequate institutional arrangements to ensure the thorough, objective, timely and fair implementation and enforcement of all such rules, as well as of sanctions that effectively deter violations of these rules. a. There should be specific statutory provisions, which create an effective regime for the protection of consumers of non-bank credit institutions. b. There should be a government authority responsible for implementing, overseeing and enforcing consumer protection in the area of non-bank credit institutions. c. The supervisory authority for non-bank credit institutions should have a register which lists the names of non-bank credit institutions. d. There should be coordination and cooperation among the various institutions mandated to implement, oversee and enforce consumer protection and financial sector regulation and supervision. e. The law should provide for, or at least not prohibit, a role for the private sector, including voluntary consumer associations and self- regulatory organizations, in respect of consumer protection in the area of non-bank credit institutions. Description There are two laws that deal with general consumer protection issues, the Consumer Protection Act and the Law on Obligations. A legal framework for consumer protection of credit clients exists in Bosnia. The Consumer Protection Act within articles 52 – 67 governs the information that must be provided in writing in a consumer loan contract between lender and client: the expenses that the lender can charge, criteria for the setting of interest rates, the conditions for termination of the contract, and the right of the consumer to settle his obligations before the expiration of the contract and provision for extension of the repayment period subject to agreement with the lender. The law also provides for mediation by a credit mediator to provide advice to the consumer prior to entering into a credit contract, and to provide information that will assist the consumer in making decisions. The law also makes provision for a credit mediator to advise the client for a fee at the point of securing a loan. This law does not discuss guarantors and their rights. The Law on Obligations is essentially the same as the Law on Obligations that prevailed throughout the former Yugoslavia and it was taken over both by FBiH and RS. There are numerous provisions of the Law on Obligations which have a direct bearing on matters of consumer protection in the financial sector. One such relevant chapter of this law is Chapter 29 entitled “Warranty”. It provides the legal basis for guarantors and establishes the relevant principles and provisions. (For additional comments on these laws, please see the Banking Diagnostic Review – Volume II, Good Practice A.1.) 23 Both Entities have their own MCO laws. Although not explicitly addressing the over-arching issue of consumer protection, the entity-level MCO laws in Bosnia include provisions that address transparency (of pricing and borrowing conditions) and other issues of interest from a consumer protection perspective. More specifically, both entities’ MCO laws state that MCOs must: x clearly publish the conditions for micro-lending, including specific provisions on the method of securing microcredits, i.e. liens over the property or rights of beneficiaries of microcredits; and x disclose the effective interest rate on microcredits. x Associated by-laws in each entity specify the appropriate methods of calculation and disclosure of the effective interest rate. At both Entity levels, there is a Banking Agency that reports to the Central Bank of the BiH and has responsibility for licensing, regulating and supervising all MCO activity. They are responsible for prudential regulation or ensuring that the financial institution is financial healthy and solvent. Most recently, with the amendments to the Laws on Banking Agency in both Entities, respective Banking Agencies in RS and FBH were also tasked with responsibility for overseeing financial consumer protection. Further, regulatory provisions for establishment of independent Banking Ombudsman were introduced in both Entities, while RS has already appointed Ombudsman and initiated implementation. The Law on MCOs in both Entities states the Banking Agencies keep the registry of microcredit organizations with the headquarters in each Entity and the registry of organizational parts in each Entity of microcredit organizations with the headquarters in the other Entity, the Brcko District and organizational parts of foreign organizations. The data from the registry of microcredit organizations are public. With the objective of regulating MCOs, the FBA has written 10 decisions, 2 of which directly address consumer protection - Decision on Standardized Calculation and Stating of the Effective Interest Rate on Loans and Deposits and Decision on Requirements and Measures to Be Taken by Microcredit Organizations upon Complaints Lodged by Clients. The Agency has also issued Instructions for MCO Business Operations. There are 5 in total, 2 of which apply directly to consumer protection. They are Instruction for the Application of the Decision on Standardized Calculation and Stating of the Effective Interest Rate on Loans and Instruction for Calculating Weighted Nominal and Effective Interest Rate. The FBA recently issued a recommendation related to the procedure of debt collection from co-debtors (solidarity debtor) or guarantor. RSBA has issued 13 decisions, 2 of which directly address consumer protection. They are Method of Calculating and Presenting EIR on Loans and More Detailed Conditions and Method of Acting of MCO upon Client’s Complaint. Prior to 2010, the Banking Agencies only performed off-site supervision. In 2010, they started making on-site contacts. Consumer compliance is reviewed 24 during the on-site contact. The review is limited to a loan file review for compliance with law, decisions and applicable instructions issued by the Banking Agencies. MCOs may be fined if they have violations. Reacting to negative stories in the media, the Banking Agencies issued decisions that pertain to consumer protection on: how to calculate the effective interest rate, all interest rates must be quoted on an annual basis only and the procedure that must be in place in MCOs to handle member complaints. This is a start; however, as described further on in this report, more is needed especially with regards to client over-indebtedness and guarantor disclosures. While there is no single institution with a clear legal mandate and the required institutional capacity to deal with consumer protection issues, the roles of the Banking Agencies in both Entities have been expanded to cover consumer protection in financial services. It is expected that as they take up their new role, and once the independent Ombudsmen are fully operational in both Entities that they will ensure enforcement of market conduct rules in banking and microfinance sectors and collection and analysis of relevant consumer communications, including complaints, disputes and inquiries, regarding financial services. At the same time, given that other institutions are also responsible for covering consumer protection issues (please see Summary of Institutional Arrangements) clarifying jurisdiction for consumer protection matters and effective coordination are challenging. Although making no reference to the private sector, as such, nor to any self- regulatory organization, the Consumer Protection Act does provide a role for voluntary consumer associations regarding consumer protection at least in general, if not to financial products and services in particular. Recommendation (Please see the Banking Diagnostic Review – Volume II, Good Practice A.1 for recommendations on how to revise and amend the Consumer Protection Act.) Additionally, the Consumer Credit Articles of the Consumer Protection Act as far as disclosure requirements are lacking and should be amended. The Act should address requirements for both open and closed end credit, periodic statements, grace periods if applicable, any subsequent disclosure requirements, and advertising requirements (for electronic and print media and marketing materials). In order to improve the institutional framework for consumer protection within MCOs: x Strengthen the capacity of Banking Agencies to ensure effective oversight of business conduct in the provision of financial services to consumers and enforce established consumer protection standards. x Support institution- and capacity building of Banking Ombudsmen in RS and FBH (once appointed) with adequate staff and resources to ensure efficient handling and resolution of inquiries, complaints, and disputes. The Banking Agencies’ role has recently been expanded to include consumer protection function. While housed in the same body, the consumer protection function should be separated from the prudential one, with its own specialized staffing, resources, etc., so each can perform its distinct responsibilities. 25 In the short-term to improve oversight of consumer protection, the on-site supervision performed by the Banking Agencies should be expanded to look at: x MCO consumer protection policies and procedures; x the analysis performed by loan officers to determine the borrower’s ability to repay and to reduce borrower over-indebtedness; x disclosures to determine if they are easily readable and understandable; x the use of the CCR and analysis of the credit report; and x the client compliant process in place. The Agencies might also want to consider some low cost tools which have been found effective such as “mystery shopping” and analysis of complaint data to target institutions with more complaints and complaints that seriously violate existing laws and regulations. In the longer-term, the consumer protection division within the Banking Agencies should take on: enforcing the consumer credit laws, regulations and instructions; plan and implement public education campaigns for consumers regarding their rights and responsibilities as consumers of financial products using print, broadcast, and electronic media; protect consumers from deceptive or unsubstantiated advertising of financial products; collect and analyze data in order to target those MCOs with more consumer protection violations and measure the impact of activities related to the agency’s consumer protection mission; and assess appropriate fines and penalties and/or take other actions against MCOs that are in violation of applicable law and regulations. Additionally, in order to improve communication between the Banking Agencies and MCOs, when the Banking Agencies put forth new regulations they should provide a comment period in which the entities that will be affected by the new regulation have the chance to comment on the proposed regulation. All proposed regulations should be put out for comment for a period of 60 days so that MCOs can comment on the regulation. Based on the comments received, the Agencies may make revisions and put the proposed regulation out for final comment for a period of 30 days before making the regulation final. Good Practice A.2 Code of Conduct for Non-Bank Credit Institutions a. There should be a principles-based code of conduct for non-bank credit institutions that is devised in consultation with the non-bank credit industry and with relevant consumer associations, and that is monitored by a statutory agency or an effective self-regulatory agency. b. If a principles-based code of conduct exists, it should be publicized and disseminated to the general public. c. The principles-based code should be augmented by voluntary codes on matters specific to the industry (credit unions, credit cooperatives, other non-bank credit institutions). d. Every such voluntary code should likewise be publicized and disseminated. Description There is no statutory code of conduct for BiH MCOs. Nor is there any regulation at State- or Entity-level providing that in order to promote the protection of consumer rights and the observance of the law, MCOs and AMCO have to 26 develop and implement a Code of Conduct. AMCO has a Code of Business Ethics for MCOs. However, it does not appear to be particularly well-known throughout the sector. The purpose of the Code is to establish standards of good conduct and open communication towards clients and other MCOs, promote the idea of responsibility, transparency and professionalism and to enhance the reputation of the sector. This code is obligatory for all members of AMCO. With membership the MCOs endorse the Code. Their acceptance and application represents one of the basic pre-conditions for AMCO membership. Key provisions of the Code include: x MCOs must apply clear, unambiguous terminology with a generally accepted meaning to facilitate clients’ ability to compare similar products or services offered by different MCOs; x no personal information about clients may be revealed, except in cases clearly defined by law or with the client’s explicit approval; x MCOs must implement and clearly communicate to their clients a transparent procedure for lodging complaints and redressing grievances related to the products or services provided by the MCOs; x all information regarding pricing and terms of services (including interest rates, maturity periods and commissions) must be available at all the offices of a given MCO and submitted to the AMCO secretariat; x MCOs must not engage in unfair competition, which includes: unreasonably low prices and remuneration for an institution’s services; unethical collecting of information about competitors; spreading any type of information on competitor institutions, especially misinformation on them or recruiting employees from other institutions in an unfair manner; however; x there was no mention of over-indebtedness. The value of any code of conduct is, of course, its widespread distribution so that consumers know that, in principle, MCOs have themselves agreed to provide minimum levels of service and to respond to individual consumer’s complaints and disputes. The Code is not well publicized, except on the AMCO website. Thus, the dissemination of the Code is limited to those consumers who have access to the internet and seek out the Code on the website. AMCO has an ethics committee. There is little to no review of Code compliance aside from the ethics committee. To date there have been no punishments or penalties rendered due to non-compliance. Some of the MCOs visited during the mission had their own Codes of Conduct; as such this is not a regulatory requirement. Recommendation AMCO should focus on “getting the word out” concerning their Code of Conduct as should MCOs. The code of conduct should be placed in all branches and on the websites of all MCOs. It should be a part of all employee handbooks and periodic review of the Code should be a part of on-going employee training. Part of MCO employee appraisals should be their compliance or non-compliance with the Code. Violations of the Code should be grounds for terminations. Consumers should be advised that if a MCO fails to comply with the codes, a complaint can be submitted to the MCO and/or AMCO. Mechanisms should be agreed to investigate breaches of the code of conduct, including the possibility that these breaches will, at the very least, be publicized. 27 Good Practice A.3 Other Institutional Arrangements a. Whether non-bank credit institutions are supervised by a financial supervisory agency, the allocation of resources between financial supervision and consumer protection should be adequate to enable their effective implementation. b. The judicial system should ensure that the ultimate resolution of any dispute regarding a consumer protection matter with a non-bank credit institution is affordable, timely and professionally delivered. c. The supervisory authority for non-bank credit institutions should encourage media and consumer associations to play an active role in promoting consumer protection regarding non-bank credit institutions. Description As stated above in Good Practice A.1, the MCOs are supervised and regulated with regards to prudential regulation by the Banking Agencies within each Entity. Most recently, the Agencies have been also made responsible for prescribing and enforcing consumer protection rules. Even prior to this new mandate it appears that they have been slowly taking on this regulation as noted in their decisions on: calculating effective interest rates, disclosure requirements that allow for the use of annual percentage rates only, measures to be taken by MCOs upon complaints lodged by clients and the FBA recently issued a recommendation related to the procedure of debt collection from co-debtors (solidarity debtor) or guarantor. The Banking Agencies have not encouraged media and consumer associations to play an active role in promoting consumer protection. The media coverage and consumer associations have been more “grass roots” in their organization. The Association for Guarantors is a good example of an organization that was formed based on an outcry from consumers. The media coverage of the situation of guarantors who have to repay loans for the primary borrowers has been extensive. Depending on the jurisdiction of a court, litigation can be slow, unpredictable and expensive, especially as compared to the small sums which are typically involved with MCO credits. The court process has slowed due to the number of suits in the courts. One MCO currently has 6000 clients in court. The court process can take as long as 2 years. There are numerous reasons for the large number of suits involving consumer credits such as consumer over-indebtedness, the global financial crisis and the Banking Agency regulation that states a loan must be written off when it is 180 days delinquent and the MCO must file suit. Recommendation Since the Banking Agencies are now going to provide non-prudential regulation and oversight it should be ensured that they have adequate staffing to cover non- prudential regulation. While housed in the same body, the consumer protection function should be separated from the prudential one, with its own specialized staffing, resources, etc., so each can perform its distinct responsibilities. Non- prudential supervision should include both off and on-site supervision to determine compliance with laws and regulation. Off-site supervision would concentrate on issues such as: reviewing and responding to consumer complaints, reviewing current MCO policy and procedures for each area of consumer protection, reviewing advertisements of financial products in all media to determine the disclosures include no misleading information and on-site 28 supervision would focus on testing and determining an MCO’s actual compliance. There is a need to establish an alternative out-of-court dispute settlement mechanism in BiH as the courts are overwhelmed. Consumers need efficient, inexpensive and speedy out-of-court dispute resolution mechanisms. The chosen option in BIH is the establishment of an independent ombudsman office in FBiH as has been done in RS for the financial sector, while a similar appointment is expected in FBH. Such an office should be completely independent of MCOs, banks and their customers and established by law so as to render binding decisions on financial institutions. It seems as though it would be impossible for the Ombudsman to work with all consumer complaints, perhaps the Office could work with complaints of a certain type, amount, or from institutions that appear to have more violations. The Ombudsman could also provide useful input on policy measures. Overall, establishment of banking ombudsmen is a step in the right direction. Another option would be to encourage the use of mediators. Mediation has rarely been used by MCOs and their clients in the past, as it was thought to be too costly for MCO clients. MCO management and staff members might want to rethink the use of mediators, as it is a less costly and time consuming alternative to the court system. Mediation can: x Foster economic development by resolving business disputes in a timely fashion; x Lower the high direct and indirect costs of resolving disputes; x Provide better solutions than the formal court system; and x Reduce the burden on the court system by reducing the number of court cases, some of which may linger for many years. Once a mediation decision is reached by the two parties and the agreement is formally written up and signed, it becomes legally binding on registration at the court. The option of mediation could provide a far quicker and more effective route for the resolution of disputes for microfinance clients (whether private citizens or businesses) than the lengthy legal procedures currently being pursued. CFKS is another organization that may be able to help settle disputes between clients and MCOs in the future. Good Practice A.4 Registration of Non-Bank Credit Institutions All financial institutions that extend any type of credit to households should be registered with a financial supervisory authority. Description All MCOs are licensed, regulated and supervised by the Banking Agencies in each Entity. Recommendation None SECTION B DISCLOSURE AND SALES PRACTICES Good Practice B.1 Information on Customers a. When making a recommendation to a consumer, a non-bank credit institution should gather, file and record sufficient information from the consumer to enable the institution to render an appropriate product or service to that consumer. b. The extent of information the non-bank credit institution gathers regarding a consumer should: 29 (i) be commensurate with the nature and complexity of the product or service either being proposed to or sought by the consumer; and (ii) enable the institution to provide a professional service to the consumer in accordance with that consumer’s capacity. Description The Banking Agency in RS issued a decision on September 10, 2010 entitled “Minimum Standard for Documenting Loan Activities”. Although the purpose of this decision is for prudential regulation reasons and was not drafted with the intent to allow the MCO to render an appropriate product, it does outline the information that should be collected for each borrower and retained in the loan file. The decision states that, at least, the following information should be in writing and in the loan file for each loan: x loan application; x applicant’s foundation documents; x latest financial information for borrower; x original loan agreement; x latest financial information for borrower; x documentation related to the examination and assessment of the borrower’s financial condition and their ability to repay; x MCO decision on loan approval; x documentation on loan purpose and the collateral used to secure the loan; x insurance documentation; x follow-up records and documentation of loan repayment; x documentation on financial condition of guarantor; x documentation on any loan modifications; x records showing measures taken to collect non-performing loans; and x any correspondence between the MCO and the borrower. Per the decision, the information required to be collected is the same for every loan, it is not commensurate with the nature and complexity of the loan. MCOs have credit policies and procedures which state the information that should be collected and retained. Per the Law on Client Data Privacy, MCOs are required to retain the loan file documentation for 10 years. However, the MCOs do not have internal rules requiring the application of these practices. There are no statutory requirements in these respects. Recommendation When making a recommendation to a consumer, any MCO should be required, by law or regulation, to gather, file and record sufficient information from the consumer in order to ensure that its recommended product or service is appropriate to that consumer. The extent of information the MCO gathers should be appropriate to the nature and complexity of the product or service being proposed to, or sought by, the consumer and enable the MCO to provide a professional service to the consumer. This is now regulated by the changes and additions to the Law on MCO in RS. Good Practice B.2 Affordability a. When a non-bank credit institution makes a recommendation regarding a product or service to a consumer, the product or service it offers to that consumer should be in line with the need of the consumer. b. Sufficient information on the product or service should be provided 30 to the consumer to enable him or her to select the most suitable and affordable product or service. c. When a non-bank credit institution offers a new credit product or service that significantly increases the amount of debt assumed by the consumer, the consumer’s credit worthiness should be properly assessed. Description Changes to the Law on MCO in RS now regulated the level of information on the product for the customer. The AMCO Code of Business Ethics states “MCOs will ensure that its employees are familiar enough with all the products, services, and possibilities offered by the MCOs as well as that they are capable of proposing a product or service which suits best the concrete need of the particular client and will give its clients accurate and useful information on the characteristics of their products and services offered as well as the terms, remunerations and decisions which are applied.” The borrower’s inability to afford the loan(s) they were granted has been the number one problem in Bosnia’s MCOs since 2008. Poor product recommendation by loan officers along with other macroeconomic problems have resulted in serious client over-indebtedness. This problem is evident in the data provided in the table below. As of 2011, it is apparent based on the indicators in Table 4 that the MCOs are still working on solving the client over-indebtedness problem as delinquency has increased from 31/12/2010 and the amount of rescheduled loans remains high. Table 4 – Portfolio Indicators Dec. 31/10 May 31/11 PAR > 30 days 5.75% 6.82% Ratio Amount of 43 million 36 million Rescheduled KM KM Loans Amount of Loans 66 million 18 million Written Off (over KM KM 180 days) There are numerous reasons at the sector and institutional levels for this level of indebtedness. Until 2008 there was strong competition and tremendous credit growth in the BiH microfinance sector. In 2007 the average growth of the number of loans was 46 percent and the loan portfolio increased by 75 percent. In 2008 growth slowed, but it still was robust as compared to international standards. The number of loans grew by 32 percent and the loan portfolio grew by 44 percent. Strong growth can frequently mask underlying problems. As long as the amount of the credit portfolio increases faster than delinquent loans, a delinquency problem may not be apparent in the indicators. If funding for lending falls and the growth of the portfolio declines and there are portfolio quality issues, problems normally emerge. Pressure from donors to make loans in BiH created vigorous competition and pushed MCOs into practices that did not coincide with pro-consumer protection practices. Because of the competition, borrowers were easily able to borrow from more than one MCO or bank. There was strong evidence of significant client 31 overlap (20-40 percent) with customers having more than one loan at a MCO and borrowing from 2 to 3 MCOs/banks at the same time. Unlike many other countries, microfinance clients in Bosnia have access to both banks and MCOs. At the institutional level, over-indebtedness is frequently the result of automatic loan size increases, stiff pre-payment penalties, loan officers recommending loans that are unaffordable or not well suited to the client’s needs, and frequently loans officers receive incentives based on the size of their loan portfolio. Initially, the quality of the portfolio was not a consideration. So loan officers were incentivized to recommend loan products to clients whether it was good for the clients or not. This type of incentive appears to have stopped based on the MCOs that were visited during the mission. Additionally, loan officers were not adequately trained on how to analyze the borrower’s cash flow and their ability to repay the debt. Loans were frequently granted to borrowers that provided a “good” guarantor; one that had public sector employment and/or a pension. If the borrower was unable to repay then an administrative ban could be placed on the guarantor’s salary or pension payment. The borrower’s ability to “afford” the loan was not one of the major considerations. MCOs were not required to report loans and loan payments to the CCR until 2010. Thus, loan officers were making loan decisions without having all the pertinent information. Many borrowers cannot be depended on to provide accurate information on the loan application as frequently their want the loan “no matter what they have to do”. Recommendation All stakeholders in the MCO sector must ensure that credit will be extended only if borrowers can afford it, have demonstrated an adequate ability to repay and loans will not put the borrowers at significant risk of over-indebtedness. In order to do this government entities such as the Central Bank and Banking Agencies should institute the following changes. x The Central Bank could continue to expand the debts reported on the credit report. Currently only financial institution’s debts are recorded. The role that CCR plays is pivotal in preventing over-indebtedness by helping providers assess borrowers’ existing debt and repayment capacity. The CCR can limit consumers from taking on too much debt while helping them build credit records. CCR can help policy makers track debt trends, in the overall market and for particular segments. The broader the coverage (i.e., the more categories of providers reporting data, positive as well as negative data), the more useful the credit information system will become. x The Central Bank could expand the credit report to show the inquiries made by financial institutions and the date the inquiry was made. x The Central Bank should ensure that “real time” reporting is available for the CCR as soon as possible. x Banking Agencies should not allow financial institutions to offer credit to its customers under the assumption that the credit is deemed accepted unless the customer explicitly refuses it, and credit lines should not be automatically increased. It is a common practice in BiH banks to grant an overdraft line of credit for 2 times the salary of a customer without the customer requesting such a line. x Legal avenues for dealing with over-indebtedness—such as bankruptcy and insolvency processes—are only rarely accessible to or workable for low- 32 income clients, however they should be pursued. There is no bankruptcy provision in BiH for citizens who are unable to pay their debts. Under current law, the borrower is never released from their obligation to repay the loan; thus, the financial institution can pursue the borrower “to the end of time”. The development of legislation that provides for bankruptcy and other remedies is needed. x Now that the responsibility for consumer protection in banking and microfinance sectors has been entrusted to specialized Banking Ombudsman (already appointed in RS and expected appointment in FBH) both housed as independent offices within Banking Agencies, it should be ensured that the customer concerns are properly addressed. x The banking agencies should consider publishing guidelines for assessing the borrower’s capacity to repay debt. Changes should be made throughout the microfinance industry from the regulator to the individual MCO. AMCO and the Banking Agencies should promote the following suggestions to the industry. The MCOs visited during the mission had put many of these suggestions in place. x Each MCO should have a lending methodology in place to assess the borrower’s ability to repay that can be systematically applied and monitored, and is always conservative. Also critical is that the MCO makes lending decisions based on cash flow analysis and does not rely on assets that may inflate the balance sheet and allow for more debt than prudent cash analysis would allow. x Loan officers should be trained to perform an analysis of the borrower’s cash flow throughout the year and their ability to repay the debt. This involves income verification and an in-depth analysis of the stability of the income and the amount and frequency of expenses (including all household expenditures, existing credit commitments and the new loan payment). o Per one of the MCOs visited during the mission, in order to obtain a good analysis of the borrower’s ability to repay, it is imperative that the loan officer has a good relationship with the borrowers. As borrowers may have up to 3 sets of books depending on who the end user is – government authorities such as the tax collector. x Loan officer performance should be based on the quality of the loan portfolio (PAR > 30 days of 5 percent or less) and the amount of loans written off (3 percent or less – FBA standard). x The industry should attempt to establish a “rule of thumb” net debt ratio ( all expenses including household expenditures, existing credit commitments and the new payment / net income after taxes and other government deductions) that can be used as a guideline as a maximum amount of debt that borrowers can handle without having problems. This can be done at the MCO level by analyzing the credit applications received and determining the average debt ratio for those borrowers that are able to repay their loan without a problem. An estimate could be made from household surveys if available, although the information is probably less reliable than what the MCOs would collect. Those individuals interviewed during the mission believed that a net debt ratio of 50 percent was probable a good ratio with which to start. x Reward borrowers with good repayment history and those that do business with only one MCO not by granting them additional larger credits, but by 33 refunding interest on existing loans or by discounting interest on future loans. x MCOs should offer flexible products to fit borrower needs and cash flow. Subsequent loans offered to clients should not be “just larger than the last loan” but rather, loan officers must take into consideration the use of the loan, the borrower’s ability to repay, their cash flow, and where the client is in the business cycle. x All MCOs should use the CCR reports and look for “signs of warning” such as borrowers: that have debts from multiple financial institutions, that do not disclose all of the debts on their credit applications, with debts that are rated below “A”, or those that are guarantors for other borrowers (they might be required to pay loans back for which they guaranteed). x MCOs should work to improve their clients understanding on how to responsibly use credit. This in an on-going task and can be performed by the loan officer and CFKS by providing: credit counseling; more formal training seminars on: business development, how much credit is too much, understanding credit contracts, what it means to be a guarantor, consumer rights or household budgeting; and relevant informational brochures. x Use internal audits to check that loan procedures are being followed by loan officers that were put in place to reduce borrower over-indebtedness. A sample of current loans and delinquent loans for branches and loans officers should be reviewed periodically. Good Practice B.3 Cooling-off Period a. Unless explicitly waived by the consumer in writing, a non-bank credit institutions should provide the consumer a cooling-off period of a reasonable number of days immediately following the signing of an agreement between the institution and the consumer. b. On his or her written notice to the non-bank credit institution during the cooling- off period, the consumer should be permitted to cancel or treat the agreement as null and void without penalty to the consumer of any kind. Description Please see the Banking Diagnostic Review, Good Practice, B.4 for comments pertaining to the Law of Obligations concerning a cooling off period immediately following the signing of an agreement between the MCO and the client. In Article 60 of the Consumer Protection Act it states “the consumer is entitled to cancel the credit agreement, provided that he notifies the creditor thereof in writing within a period of 15 working days as of the date of conclusion of the contract.” This idea of a cooling off period is not a practice at the institutional level. Recommendation Borrowers should be granted a 14 day cooling off period to withdraw from a signed loan agreements without penalty which is in line with EU Consumer Credit Directive approved in 2008. This provision has already been introduced in RS. The same provision is supported by FBH government but has yet to be approved in the FBH Parliament. Good Practice B.4 Bundling and Tying Clauses a. As much as possible, non-bank credit institutions should avoid the use of tying clauses in contracts that restrict the choice of consumers. b. In particular, whenever a borrower is required by a non-bank credit institution to purchase any product, including an insurance policy, as a pre-condition for receiving a loan, the borrower should be free to choose the provider of the product and this information should be made known to the borrower. 34 c. Also, whenever a non-bank credit institution contracts with a merchant as a distribution channel for its credit contracts, no exclusionary dealings should be permitted. Description Bundling and tying clauses are not a practice in Bosnian MCOs. There are no products such as insurance that are required to be purchased. The loan terms, in addition to the loan proceeds, include fees only. Recommendation None Good Practice B.5 Key Facts Statement a. Non-bank credit institutions should have a Key Facts Statement for each type of account, loan or other products or services. b. The Key Facts Statement should be written in plain language, summarizing in a page or two the key terms and conditions of the specific financial product or service, and allowing consumers the possibility of easily comparing products offered by different institutions. Description The changes and additions to the Law on MCO in RS now regulate and identify facts that need to be presented to client. Article 54 of the Consumer Protection Act states: “Prior to entering the contract, the consumer must receive information in a written form about the terms and conditions of the contract. This information will include the following for credit agreements generally: x net amount of credit; x total cost of credit; x terms and conditions for early credit repayment, x terms and conditions for the termination of the contract, including in case of default by the consumer; x annual interest rate for credit in annual terms; x terms and conditions of changes to the annual interest rate; x insurance costs for the outstanding debt or any other insurance concluded further to the credit agreements; and x securities to be given.” The AMCO Code of Business Ethics does not recommend this practice either. Some of the MCOs visited had a one page explanation about the loan process and general product information. This, however, is no substitute for Key Facts Statements which invariably helps consumers in comparison shopping with and between financial institutions, thereby permitting consumers to choose products and services wisely that meet their requirements on terms they can properly accept. Recommendation A regulation should be developed that requires MCOs to provide the consumer with a Key Facts Statement for each loan product in Federation BiH. And, prior to a consumer signing any loan agreement with a MCO, the consumer should sign a statement and it should be retained by the MCO to the effect that he/she has received a copy of the relevant Key Facts Statement from the MCO. A standardized Key Facts Statement for each type of credit offered would help consumers understand the essential conditions of their contracts and should be required. For all credit products, consumers need a short, standardized, description written in plain language that is comparable across credit products 35 provided within the financial sector. The format for key facts disclosure should allow consumers to identify easily and quickly the key terms and conditions. It would be helpful to test the disclosures with users to ensure the disclosures are understandable. For consumer credits, ten different areas should be covered in the Key Facts Statement. The Statement should summarize in no more than a page all key terms and conditions of the specific product being provided. This would include (1) the EIR or Annual Percentage Rate (APR); (2) the total amount of the credit; (3) the amounts of monthly payments; (4) the final maturity of the credit; (5) the total amount of payments to be made; (6) all fees, including prepayment and overdue penalty fees, and any other charges that could be incurred; (7) any required deposits or advance payments; (8) if the interest rate is variable, the base rate on which the calculation of the applicable rate of interest is made and a published source (such as a newspaper) where the consumer can readily verify the base rate and it should be noted that for variable rate loans, the interest rate could vary depending on the level of the underlying base rate; (9) if any additional insurance is required to maintain the credit and, if so, the nature and extent of necessary coverage, and, if insurance is required or is recommended to be obtained from any named insurance company, the relationship between the insurance company and the bank or MCO; and (10) the name of the department (with telephone number, fax number and email address) where inquiries, complaints and disputes can be submitted to the bank or MCO in question. For the credit reporting system, a brochure could explain to consumers the procedures for correcting inaccurate information in any credit register. Key Facts Statements would obviously not replace the contract for legal purposes, but each financial institution should be obliged to ensure that its Key Facts Statements include no incorrect or materially misleading information.20 Please see Annex 6 for examples of a Key Facts Statements. It is recommended that the standard formats for Key Facts Statements be developed together by the Banks’ Association and AMCO. The Banking Agencies should also review and comment on the formats (for example, to ensure that they provide material information that would not mislead consumers). Thus, for consumer credits, the Banks’ Association and AMCO should develop a standard format that would allow banks and MCOs to prepare Key Facts Statements efficiently and which would be reviewed by the Banking Agencies. Key Facts Statements should also be tested in order to ensure that the average consumer understands their content and can use the information to make relevant comparisons and decisions. The Banks’ Association and AMCO should formally adopt the format of Key Facts Statements and encourage its members to use this Key Facts format. Good Practice B.6 Advertising and Sales Materials a. Non-bank credit institutions should ensure that their advertising and sales materials and procedures do not mislead customers. b. All advertising and sales materials should be easily readable and understandable by the general public. 20 From Diagnostic Review of Consumer Protection and Financial Literacy in Banking Services in Bosnia and Herzegovina, draft of February 2011. 36 c. Non-bank credit institutions should be legally responsible for all statements made in advertising and sales materials (i.e. be subject to the penalties under the law for making any false or misleading statements). Description The changes and additions to the Law on MCO (and relevant provisions of the Law on Banks, applicable also to MCO) – “General Business conditions of Banks” define this. The Consumer Protection Act addresses advertising in Chapter 7. This chapter discusses advertising in general; it is not specific to advertising within the financial sector. Provisions in the chapter include the following which would be applicable to financial institutions: x Advertisements may not contain any statement or visible presentation which would directly or indirectly mislead the consumer by omission, uncertainty or overstatement, in particular with regard to: o properties of goods or service such as: nature, composition, process and date of production, possibility of efficiency and effects, quantity, quality of commercial or geographical origin or effect on environment, o value of goods or service and the total price to be actually paid, o terms and conditions of guarantee, o certificate of compliance (homologation) and official recognition, medals, prizes, awards and achievements for humanitarian and charity purposes. x Advertising of goods and services may not be improper, fraudulent or ambiguous. Good business practices are to be respected in all advertising. x Fraudulent advertising of goods and services abuses or may abuse lack of experience and knowledge or distracts the consumer’s attention span from important parts of the offer for the purpose of profit-making; it includes unclear, ambiguous and false statements, as well as over-statements and under-statements and other mechanisms which mislead or might mislead the consumer. x Any advertisement must contain name or company name and address of the advertiser. x The advertiser and the advertising agency shall be liable for their misleading advertisements, unlawful comparative advertisements or unfair advertisements. x Competent bodies (unfortunately there was no definition of a competent body in the Law) may render a decision aimed at the cessation of a misleading advertising, unlawful comparative advertising or unfair advertising. They can order the prohibition of misleading advertising, unlawful comparative advertising or unfair advertising that has not yet been published even without proof of actual loss or damage or of intention or negligence on the part of the advertiser.21 The Law on MCOs in both entities states that “a microcredit organization is obliged to stipulate and make available to the public the conditions for extending microcredits that may include provisions on the method of securing microcredits, 21 Law on Consumer Protection of Bosnia and Herzegovina, March 15, 2005 37 i.e. liens over the property or rights of beneficiaries of microcredits and a microcredit organization is obliged to disclose the effective interest rate on microcredits.” A microcredit organization shall commit a misdemeanor and be penalized with a cash fine in the amount between KM 1,500 and KM 15,000 for failing to disclose the effective interest rate on microcredits and failing to prescribe and make available to the public the conditions for extending microcredit. The AMCO Code of Conduct also addresses advertising. The relevant provisions in the Code state that “ every MCO will clearly identify itself in public and in the market. The list of services offered needs to be precise and true in describing their characteristics. All information on terms and remunerations and other marketing activities by MCOs must be clear, unambiguous and true. MCOs must not delude the public, disturb good business traditions, or harm others.” Recommendation Advertising procedures are addressed in the amendments to the Law on Banks in RS. These also refer to the MCOs. “The bank shall not use inaccurate and untruthful data in advertisements, or data that might mislead the average user, or use information that may create a wrong impression about the conditions of use of a service and lead the user to make a decision that he/she would not have made under different circumstances, and to use data that cause damage or that are sure to cause damage to a competitor. The bank shall not use in advertisements expressions through which the service is labeled as free of charge or other similar expressions, if the approval of the use of such a service is subject to entry into another contract or if it is subject to anything that represents a cost or creates another obligation for the user” Good Practice B.7 General Practices Specific rules on disclosure and sales practices should be included in the non-bank credit institutions’ code of conduct and monitored by the relevant supervisory authority. Description The AMCO Code of Business Conduct only generally addresses this issue. The Code states: x All MCOs need to apply unique, unambiguous terminology with a generally accepted meaning, in order to make it possible for a client to compare the same or similar types of products or services offered by different MCOs, and x MCO will give its clients accurate and useful information on the characteristics of its products and services, as well as on the terms, remunerations, and decisions which are applied. All the documents treating business policy, forms, and contracts with clients cannot contain any unclear provisions, which would impose upon clients non-specific obligations and would put clients into an insecure position in the sense of execution of rights and obligations towards each other. Because there are no laws or regulations that address sales practices or disclosure (with the exception of the regulation on using, displaying and calculating the effective interest rate) there is no monitoring of these elements by the Banking Agencies. The Decision on Effective Interest Rates contains the following that addresses disclosure: x MCO is obliged to calculate effective interest rates and make it available to the public and clients. x MCO shall make the effective interest rate clearly and easily seen in the 38 MCO offices, advertisements, and published in public information media. x Also, MCO shall present in the same way the foreign currency used for loan indexing or other criteria for loan revaluation and indexing. x Effective interest rate shall not be less visible than other data, and MCO shall make it sure that the term “effective interest rate” is used as well as the acronym “EIR”. x MCO shall make its clients aware of the effective interest rate before accepting their applications for loan approval, as well as before making loan agreements. x A loan agreement shall include appropriate provision clearly stating that the client has been made aware of terms of the loan and the effective interest rate, and the loan repayment schedule has been handed over to the client. x When creating a loan based relationship with a client, MCO is obliged to hand over to the client the loan repayment schedule with effective interest rate clearly stated. Lending disclosures in BiH have been less than transparent as evidenced by the serious problem with guarantors. Recently there has been a considerable amount of media coverage concerning the large number of guarantors that have been required to repay the loans of primary borrowers. When a loan is granted the typical MCO documentation includes a loan contract, amortization schedule and blank promissory note for the borrower and one for the guarantor. There is no disclosure to the guarantor explaining to them what can happen if the borrower does not repay. Recommendation At the foundation of effective consumer protection in MCO products and services is consumer disclosure. MCOs should be obliged to present their products and services in a clear and comparable format, which is easy for consumers to understand and allows consumers to compare offers from different banks and MCOs. Where consumers can obtain clear and comparable information, they can make informed choices and ensure that the products and services they purchase are suitable for their needs and objectives. Clear laws and regulations, which are effectively applied and enforced, are needed to ensure meaningful disclosure of consumer credit products. For all regulations regarding consumer disclosure, the authorities should make sure that the public clearly understands the disclosed information and knows how to use it to make informed decisions. Consumer testing of proposed disclosure rules or formats would be helpful. Prices of financial products are not always conveyed in a way that enables consumers to best understand the total cost and terms. Specifically, there is strong evidence that consumers have difficulty with percentage-based terms like APRs and interest rates and were much more likely to focus on the weekly payment rates and the total loan amount, instead of the interest rate or total annual cost of the loan. Regulators and other government entities should consider the following to improve consumer disclosures. The Consumer Credit Articles of the Consumer Protection Act as far as disclosure requirements are lacking and should be amended to include requirements for both open and closed end credit, credit cards, periodic statements, grace periods if applicable, balance computation methods for credit cards, any subsequent disclosure requirements, and advertising 39 requirements (for electronic and print media and marketing materials). To improve disclosure to clients so that they can compare credit products at different financial institutions, the Banking Agencies should require that the disclosures are displayed in the same manner throughout the financial sector. Annex 4 provides an example of a uniform disclosure format. Mandated disclosure requirements for a visual format such as that in Annex 7 will help clients better compare credit terms and conditions from one bank or MCO to another. MCOs should disclose both orally and in writing all fees and costs associated with the loan such as the loan processing fee and early repayment fee. It should be disclosed as an amount and as a percentage of the loan. Additionally it has been found helpful to separate information on rates from information on fees. This has been done in the “Schumer Box” (see Annex 5) used in the USA and it has improved consumer understanding and their ability to use disclosures in the financial decision making process. Banking Agencies should require that a disclosure be made to all guarantors that explain to them their rights, obligations and liabilities in a clear and easily understandable format. In addition to the Guarantor disclosure, the guarantor should get a copy of the contract and the amortization schedule and should be informed if they are a solidarity or subsidiary guarantor as defined in the Law of Obligations. There should be a full credit analysis of the guarantor’s ability to repay the loan. The analysis for the guarantor should be the same and as in-depth as it is for the borrower. The MCO must be confident that the guarantor is capable of repaying the loan should the primary borrower be unable to. Good Practice B.8 Disclosure of Financial Situation a. The relevant supervisory authority should publish annual public reports on the development, health, strength and penetration of the non-bank credit institutions, either as a special report or as part of the disclosure and accountability requirements under the law that governs these. b. Non-bank credit institutions should be required to disclose their financial information to enable the general public to form an opinion regarding the financial viability of the institution. Description Both Banking Agencies require the MCOs to file quarterly financial information that includes: x Balance Sheet; x Report on amount and method of establishing reserves for coverage of loan loss; x Breakdown of loans to MCO’s related persons; x Sector and Maturity Structure of Loans; x List of largest shareholders; x List of largest sources of funds; x Income Statement; and x Quarterly Report on number and qualification structure of employees. The Banking Agencies then produce a report on the sector quarterly that addresses: MCO staffing, balance sheet and income statement analysis, capital adequacy and make-up, loan portfolio quality and interest rate analysis and comparison to bank interest rates. The report can be found on the Agencies websites. 40 Recommendation None SECTION C CUSTOMER ACCOUNT HANDLING AND MAINTENANCE Good Practice C.1 Statements a. Unless a non-bank credit institution receives a customer’s prior signed authorization to the contrary, the non-bank credit institution should issue, and provide the customer with, a monthly statement regarding every account the non-bank credit institution operates for the customer. b. Each such statement should: (i) set out all transactions concerning the account during the period covered by the statement; and (ii) provide details of the interest rate(s) applied to the account during the period covered by the statement. c. Each credit card statement should set out the minimum payment required and the total interest cost that will accrue, if the cardholder makes only the required minimum payment. d. Each mortgage or other loan account statement should clearly indicate the amount paid during the period covered by the statement, the total outstanding amount still owing, the allocation of payment to the principal and interest and, if applicable, the up-to-date accrual of taxes paid. e. A non-bank credit institution should notify a customer of long periods of inactivity of any account of the customer and provide reasonable final notice in writing to the customer if the funds are to be transferred to the government. f. When a customer signs up for paperless statements, such statements should be in an easy-to-read and readily understandable format. Description Practitioners state that at their request the clients can get a statement that details all of the required loan information. The MCOs do not offer savings or deposit accounts or credit card accounts, only consumer loans. Recommendation MCOs should be required to provide periodic account information no less than annually through account statements, receipts, or balance inquiries. Good Practice C.2 Notification of Changes in Interest Rates and Non-Interest Charges a. A customer of a non-bank credit institution should be notified in writing by the non-bank credit institution of any change in: (i) the interest rate to be paid or charged on any account of the customer as soon as possible; and (ii) a non-interest charge on any account of the customer a reasonable period in advance of the effective date of the change. b. If the revised terms are not acceptable to the customer, he or she should have the right to exit the contract without penalty, provided such right is exercised within a reasonable period. c. The non-bank credit institution should inform the customer of the foregoing right whenever a notice of change under paragraph a. is made by the institution. Description The Decision on Calculating Effective Interest Rates issued by both Banking Agencies states that “if the effective interest rate is changed due to a change in 41 elements based on which it is calculated, MCO shall inform the client in writing on such a changed effective rate, while the basis for change of conditions must be clearly stated in the loan agreement.” Currently, all MCOs charge fixed interest rates on all loan products. All loans are denominated in KM and indexed to the Euro. The indexing is controlled by the currency board. There has never been a change in loan terms due to a change in the indexing. The fees charged are an application fee and there is generally a prepayment fee. Fees are paid up front. Recommendation None Good Practice C.3 Customer Records a. A non-bank credit institution should maintain up-to-date records in respect of each customer of the non-bank credit institution that contain the following: (i) a copy of all documents required to identify the customer and provide the customer’s profile; (ii) the customer’s address, telephone number and all other customer contact details; (iii) any information or document in connection with the customer that has been prepared in compliance with any statute, regulation or code of conduct; (iv) details of all products and services provided by the non-bank credit institution to the customer; (v) a copy of all correspondence from the customer to the non-bank credit institution and vice-versa and details of any other information provided to the customer in relation to any product or service offered or provided to the customer; (vi) all documents and applications of the non-bank credit institution completed, signed and submitted to the non-bank credit institution by the customer; (vii) a copy of all original documents submitted by the customer in support of an application by the customer for the provision of a product or service by the non-bank credit institution; and (viii) any other relevant information concerning the customer. b. A law or regulation should provide the minimum permissible period for retaining all such records and, throughout this period, the customer should be provided ready free access to all such records. Description The Banking Agency in RS issued a decision on September 10, 2010 entitled “Minimum Standard for Documenting Loan Activities”. Please see above - Good Practice B.1 for additional information. The Decision also states in Article 2 that the “MCO” is obliged to open a loan file for each loan approved on the date of its approval, and to maintain this file as long as the loan is not repaid or liquidated (regulated) in other manner. Keeping and maintaining loan files is the responsibility of an officer in charge, whose obligation is to assure full and reliable records in loan file. The FBA has not written a similar decision. Per the Law on Client Data Privacy, the loan documentation must be retained for 10 years. Recommendation The FBA should have a similar decision as in RS on loan documentation. 42 Good Practice C.4 Credit Cards a. There should be clear rules on the issuance of credit cards and related customer disclosure requirements. b. Non-bank credit institutions, as credit card issuers, should ensure that personalized disclosure requirements are made in all credit card offers, including fees and charges (including finance charges), credit limit, penalty interest rates and method of calculating the minimum monthly payment. c. Non-bank credit institutions should not be permitted to impose charges or fees on pre-approved credit cards that have not been accepted by the customer. d. Consumers should be given personalized minimum payment warnings on each monthly statement and the total interest costs that will accrue if the cardholder makes only the requested minimum payment. e. Among other things, the rules should also: (i) restrict or impose conditions on the issuance and marketing of credit cards to young adults (below age of 21) who have no independent means of income; (ii) require reasonable notice of changes in fees and interest rates increase; (iii)prevent the application of new higher penalty interest rates to the entire existing balance, including past purchases made at a lower interest rate; (iv) limit fees that can be imposed, such as those charged when consumers exceed their credit limits; (v) prohibit a practice called ―double-cycle billingǁ by which card issuers charge interest over two billing cycles rather than one; (vi) prevent credit card issuers from allocating monthly payments in ways that maximize interest charges to consumers; and (vii) limit up-front fees charged on sub-prime credit cards issued to individuals with bad credit. f. There should be clear rules on error resolution, reporting of unauthorized transactions and of stolen cards, with the ensuing liability of the customer being made clear to the customer prior to his or her acceptance of the credit card. g. Non-bank credit institutions and issuers should conduct consumer awareness programs on the misuse of credit cards, credit card over-indebtedness and prevention of fraud. Description Credit Cards are not offered by MCOs. Recommendation None Good Practice C.5 Debt Recovery a. All non-bank credit institutions, agents of a non-bank credit institutions and third parties should be prohibited from employing any abusive debt collection practice against any customer of the non-bank credit institution, including the use 43 of any false statement, any unfair practice or the giving of false credit information to others. b. The type of debt that can be collected on behalf of a non-bank credit institution, the person who can collect any such debt and the manner in which that debt can be collected should be indicated to the customer of the non-bank credit institution when the credit agreement giving rise to the debt is entered into between the non-bank credit institution and the customer. c. A debt collector should not contact any third party about a non-bank credit institution customer’s debt without informing that party of the debt collector’s right to do so; and (ii) the type of information that the debt collector is seeking. d. Where sale or transfer of debt without borrower consent is allowed by law, the borrower should be: (i) notified of the sale or transfer within a reasonable number of days; (ii) informed that the borrower remains obligated on the debt; and (iii)provided with information as to where to make payment, as well as the purchaser’s or transferee’s contact information. Description The Banking Agencies do not regulate Collections Practices. The vast majority of debt collection is done by the MCOs, the use of outside collectors is not a practice in MCOs. The Banking Agencies prohibit the MCOs from selling their written off loan portfolio to any 3rd party. The collection process used by most MCOs is described below. When a loan payment is not made, the following is the typical procedure used by the MCOs visited during the mission. Days 1 – 3, Contact by phone to ask for payment and to assess reason for non-payment. Days 3 – 14, Personal visit(s) with client, if payment has not been received. Day 14 – Official MCO letter to client. Days 14 – 30, The guarantor is contacted during this period if there has been no payment. Days 14 – 60, The branch manager gets involved in the process. This may involve meetings in the branch office and additional letters sent to the borrower, guarantor and to the guarantor’s place of employment requesting that payments are deducted from the guarantor’s salary. The branch manager attempts to find a solution such as loan rescheduling or prolongation. Days 60 – 90, The loan file is sent to the MCO legal department if there has been no repayment. The legal process begins. Day 180 – The loan is written off. Because of the number of complaints from guarantors, the FBiH issued a recommendation on 19 May 2010 related to the procedure of debt collection from guarantors. This, however, is not a requirement ONLY a recommendation. The recommendations states that “Before the co-debtor or guarantor signs any document, they must be informed on overall indebtedness of the primary debtor by the banks and MCOs. The procedure 44 on forced debt collection from guarantors shall not to be executed before initiation of the court procedure against the primary debtor. The bank or MCO is obliged to inform co-debtor or guarantor in writing on their rights, regulations, and internal bank and MCO acts related to debt collections before they ask from co-debtor or guarantor to service their contractual obligations.” There have been a few complaints at CFKS concerning the process and manner of late payment collections by financial institutions. Guarantors have complained, not so much as to the manner of collections but for the fact that they have to pay a debt they did not receive. Guarantors have tended to complain more about the court actions than the collection actions. Recommendation There should be a law or regulations that dictate the collection practices that can be used. The purpose of such a law or regulation is to eliminate abusive debt collection practices by debt collectors, to ensure that those debt collectors who refrain from using abusive practices are not competitively disadvantaged and to protect consumers against debt collection abuses. The law should prohibit harassment, oppression, or abuse in connection with the collection of a debt. SECTION D PRIVACY AND DATA PROTECTION Good Practice D.1 Confidentiality and Security of Customers’ Information a. The financial transactions of any customer of a non-bank credit institution should be kept confidential by the institution. b. The law should require non-bank credit institutions to ensure that they protect the confidentiality and security of personal data of their customers against any anticipated threats or hazards to the security or integrity of such information, and against unauthorized access. Description The privacy of client data should be respected in accordance with the laws and regulations and such data should not be used for other purposes specified at the time the information was collected or as permitted by law (i.e. money laundering) unless otherwise agreed with the client. Based on discussions during the mission, this really does not seem to be an area with a large number of complaints or general concern. The AMCO Code of Business Conduct addresses the confidentiality of client data as should the individual MCO codes of conduct. Also please see the Banking Diagnostic Review, Good Practice, D.1. Recommendation Banking Agencies should determine during their on-site supervision that MCOs get a customer’s consent in writing to access their credit report, or to provide any information to another individual or entity. AMCO should promote to their member MCOs that their staff members receive on-going training to protect the confidentiality, security, accuracy and integrity of a customer’s personal and financial information. Good Practice D.2 Credit Reporting a. Credit reporting should be subject to appropriate oversight, with sufficient enforcement authority. 45 b. The credit reporting system should have accurate, timely and sufficient data. The system should also maintain rigorous standards of security and reliability. c. The overall legal and regulatory framework for the credit reporting system should be: (i) clear, predictable, non- discriminatory, proportionate and supportive of consumer rights; and (ii) supported by effective judicial or extrajudicial dispute resolution mechanisms. d. Proportionate and supportive consumer rights should include the right of the consumer (i) to consent to information-sharing based upon the knowledge of the institution’s information-sharing practices; (ii) to access his or her credit report free of charge (at least once a year), subject to proper identification; (iii) to know about adverse action in credit decisions or less- than-optimal conditions/prices due to credit report information; (iv) to be informed about all inquiries within a period of time, such as six months; (v) to correct factually incorrect information or to have it deleted and to mark (flag) information that is in dispute; (vi) to reasonable retention periods of credit history; and (vii) to have information kept confidential and with sufficient security measures in place to prevent unauthorized access, misuse of data, or loss or destruction of data. e. The credit registers, regulator and associations of non-bank credit institutions should undertake campaigns to inform and educate the public on the rights of consumers in the above respects, as well as the consequences of a negative personal credit history. Description Please see the description provided in the Diagnostic Banking Review, Good Practice D.4. One of the tasks of the Central Bank of BiH is to administer and maintain the Central Credit Registry. The CCR is currently used by banks, MCOs and leasing companies. Their access to individual’s data is subject to prior written consent of the individual. All activity of the CCR is recorded in a log (including the access point and the file what has been accessed) which can be used if the Central Bank needs to establish whether there was a misuse of data. The Central Bank also has access to the data; this however is strictly for analytical purposes. The CCR was established in 2008. MCOs have only been required to report to the CCR since 2010. Thus, loan officers were making loan decisions without having all the pertinent information. There is another credit registry, LRC. LRC is a private company and financial institutions are not required to report to LRC, while they have to report to CCR. The advantage 46 of LRC is that it includes all types of debts such as electrical, water, mobile phone, etc. as well as financial institution debt. The disadvantage is that reporting is not mandatory; so it is difficult for any lender to assess the borrower’s ability to repay because the data is most likely incomplete. Currently it appears that CCR is the dominant credit bureau. The CCR does operate in real time. Financial institutions submit client data on a monthly basis. This allows checking of credit histories and the number of loans outstanding from MCOs and banks as well as the total amount of debt as of the end of previous month.. Recommendation Please see the description provided in the Diagnostic Banking Review, Good Practice D.4. The CCR should allow each borrower a copy of their credit report annually as this is currently not a practice, although it is allowed by law. This way the borrowers’ understanding of the report would improve, as well as their understanding of the effect on their credit when they do not repay their obligations on time. Also, if there is an error on the report the borrower could alert the CCR so that corrections are made. SECTION E DISPUTE RESOLUTION MECHANISM Good Practice E.1 Internal Complaints Procedure Complaint resolution procedures should be included in the non-bank credit institutions’ code of conduct and monitored by the supervisory authority. Description In 2010 both Banking Agencies adopted Decisions addressing how MCOs shall handle customer complaints. The decisions are well thought out, similar and state that a customer should submit their complaint in writing, the MCO shall have written procedures on how to handle complaints and appoint 1 employee or a separate department to handle the complaints. The MCO must make their response in writing and shall do so within 30 days from the date the complaint was received. If the customer does not accept the MCO’s response, the customer may send written correspondence to the Banking Agencies within 15 days from receipt of the MCO’s response. The Banking Agencies shall require the MCO to present its opinion in writing concerning the customer’s complaint within 8 days. The Banking Agencies are obliged to inform the customer of the MCO’s opinion. The Banking Agencies do not make a decision on the complaint, but act more as a facilitator between 2 parties. MCOs are obliged to report to the Banking Agencies on a quarterly basis about the customer complaints. In 2011, in RS there were 71 complaints made against MCOs. The FBiH Banking Agency did not report their results. The AMCO Code of Business Conduct only briefly addresses internal complaint resolution. It states “when a client discovers a fault in his/her business with the given MCO or when a client considers that he/she has been done injustice and informs the give MCO of this, the MCO has the 47 obligation of verifying the allegations in a reasonable time period and eliminating, that is, correcting the fault without undue delay.” CFKS has created a brochure on how to lodge a complaint. The CFKS will help clients through the process. The brochure needs to be updated as it does not mention the Banking Agency procedure described above. Recommendation Official bodies such as the Banking Agencies and AMCO should take measures to help consumers become aware of their legal rights in case of complaints with MCOs. Consumers should be clearly informed of their rights to complain to a MCO or to the applicable Banking Agency in case they are not satisfied with the response offered by their MCO. One approach would be to create brochures that describe such legal rights in simple and plain language and provide information on how to contact the Banking Agency. The Banking Agencies may wish also to establish a toll- free hotline, available anywhere in their territorial jurisdiction, where consumers can call the Banking Agency and obtain basic information about their legal rights. The Banking Agencies should also actively present important complaints and their resolution in the media to educate the public and show that it is possible to achieve a solution when a consumer actively fights for his or her rights. The Decision should go further and state that a summary of all complaints should be provided monthly to the MCO Board of Directors or Supervisory Board and indicate the MCO body or department that is responsible for ensuring effective complaint resolution. It appears that the reporting of complaints by financial institutions could improve, to include not only the number of consumer complaints received and processed, but the nature of complaints, the average time spent to resolve the disputes presented by consumers and the type of resolution offered to the complainant by the MCO. Complaints data can be a valuable (and relatively inexpensive) policy tool to inform regulators’ decisions. It can help them discern patterns of abuse, monitor problematic products and practices that are emerging in the market, and spot “rogue” providers that are habitual offenders. Mandatory reporting of standardized complaints and resolution statistics can improve accountability. Sometimes regulators publish this information. Additionally, MCOs should be required to publicize the procedures for lodging complaints and the employee or department where the complaint process is initiated. This information should be easily accessible; written contact information with telephone number, fax number and email address should be available in all branches, on the web site and provided to consumers when they apply for a loan. The process should be accessible to and understood by the customer. Good Practice E.2 Formal Dispute Settlement Mechanisms a. A system should be in place that allows consumers to seek affordable and efficient third-party recourse, such as an 48 ombudsman, in the event the complaint with the non-bank credit institution is not resolved to the consumer’s satisfaction in accordance with internal procedures. b. The role of an ombudsman or equivalent institution in dealing with consumer disputes should be made known to the public. c. The ombudsman or equivalent institution should be impartial and act independently from the appointing authority, the industry and the parties to the dispute. d. The decisions of the ombudsman or equivalent institution should be binding upon non-bank credit institutions. The mechanisms to ensure the enforcement of these decisions should be established and publicized. Description For most MCO customers, the amounts involved in a dispute are relatively small (the average loan is about KM 2500). The failure to resolve disputes quickly, efficiently, transparently and professionally, however, undermines public confidence in MCOs and reduces the trust and undermines the MCO and sector as a whole. When the response of a MCO to consumer complaints is not satisfactory, customers in BiH currently seek recourse to several types of institutions, without being aware that none may be allowed to provide them with personal redress. Customers submit complaints to any (or all) of several institutions: (1) the Banking Agency at the Entity level (Banking System Ombudsman), (2) the Central Bank of BiH, (3) the Consumer Ombudsman, (4) a consumer organization, and/or (5) AMCO. In none of these cases, however, can the institution in question provide any remedy for an individual consumer. The court is the only entity that can provide redress, however, this can be costly, time consuming and the decisions less than consistent. The RSBA has recently added an ombudsman whose principal responsibility is to address consumer protection issues within the financial sector. The position is 100 percent funded by the RSBA. There will be no cost to the consumer to use the ombudsman service and their decisions will be binding upon the agreement of both parties, unlike when a mediator is used. FBH has also introduced regulatory provisions for establishing banking ombudsman, but the appointment has yet to be made. Recommendation There is need to establish an alternative out-of-court dispute settlement mechanism in BiH. Depending on the jurisdiction of a court, litigation can be slow, unpredictable and expensive, especially as compared to the sums which are typically the subject of consumers’ complaints. Consumers need efficient, inexpensive and speedy out-of-court dispute resolution mechanisms. An independent ombudsman should be established in FBiH as has been done in RS for the financial sector. Such an Office should be completely independent of MCOs, banks and their customers and established by law so as to render binding decisions on financial institutions. 49 SECTION F CONSUMER EMPOWERMENT Good Practice F.1 Broadly based Financial Capability Program a. A broadly based program of financial education and information should be developed to increase the financial capability of the population. b. A range of organizations–including government, state agencies and non-governmental organizations–should be involved in developing and implementing the financial capability program. c. The government should appoint an institution such as the central bank or a financial regulator to lead and coordinate the development and implementation of the national financial capability program. Description There is no national type program of financial education and information to increase financial capacity and awareness. The only entity with this focus and mission is CFKS. CFKS currently is working primarily in Tuzla and with MCO clients. It performs numerous functions such as financial education through brochures, counseling and other uses of multi-media. CFKS performs workshops to improve financial capacity, drafts loan workout plans and works with borrowers to rehabilitate over-indebted borrowers. Its goal is to expand to cover the entire country and to work with banks and MCOs. Without the support of the sector as a whole, CFKS will not meet its goal and its success will be limited. Its role is like no other institution in the country, it is an independent entity seeking a low cost, timely solution for both the borrowers and the financial institutions. Recommendation There is need to develop a program on financial education. Good Practice F.2 Using a Range of Initiatives and Channels, including the Mass Media a. A range of initiatives should be undertaken by the relevant authority to improve the financial capability of the population, and especially from low-income communities. b. The mass media should be encouraged by the relevant authority to provide financial education, information and guidance to the public, including on non-bank credit institutions and the products and services they offer. c. The government should provide appropriate incentives and encourage collaboration between governmental agencies, the supervisory authority for non-bank credit institutions, the associations of non-bank credit institutions and consumer associations in the provision of financial education, information and guidance to consumers. Description As stated in Good Practice F.2 there is no broad based financial education initiative supported by any of the stakeholders, including the government. The media has become more involved because of the serious problems with the loan guarantors. This involvement is due to a grass roots push from the consumers and guarantors it did not come from the government. There is, however, no program or plan to use the mass media to provide financial 50 education, information and guidance to the public. The only entity attempting to do this is CFKS and their operations are only in the initial stages. Recommendation As evidenced by the serious borrower over-indebtedness in the sector, it is important for the future of the sector and the financial well being of their clients that there are initiatives offered to improve their financial capacity. Information should be given more frequently by regulators and AMCO to the media and from the media to the public. There should be a program to provide financial education or training to journalists covering financial sector issues. Good Practice F.3 Unbiased Information for Consumers a. Consumers, especially the most vulnerable, should have access to sufficient resources to enable them to understand financial products and services available to them. b. Supervisory authorities and consumer associations should provide, via the internet and printed publications, independent information on the key features, benefits and risks – and, where practicable, the costs – of the main types of financial products and services, including those offered by non-bank credit institutions. c. The relevant authority should adopt policies that encourage non-government organizations to provide consumer awareness programs to the public regarding financial products and services, including those offered by non-bank credit institutions. Description Government policies do not discourage non-government organizations to provide consumer awareness programs. To date, there has been very little emphasis place on offering such programs. A few entities such as the Association of Consumer Guarantors, Partner MCO and CFKS have put together printed publications, discussing key features of credit and associated benefits and risks. More specifically, these brochures amongst other discussed the following: Partner MCO pamphlets – credit history and CCR, differences between good and poor creditworthiness, avoiding the pitfalls of hidden loan costs, understanding about interest rates; ear marked vs. non-earmarked loans; personal data protection; loan guarantees, financial discipline, consumer protection and loan documentation. CFKS pamphlets – budgeting, advice on relations with the court, how to make a complaint and what to know when taking out a loan, etc. Association of Consumer Guarantors – obligations and rights of guarantors, and guarantors and the legal framework. Recommendation The breadth and depth of these and alike programs should expand to serve the population beyond those living in or near Tuzla where CFKS is located, clients of Partner MCO, and guarantors that belong to the association or have been forced to pay a debt for a primary borrower. 51 Government authorities could provide more information in plain language on financial products and services to improve consumer awareness. Good Practice F.4 Consulting Consumers and the Financial Services Industry The relevant authority should consult consumer associations and associations of non-bank credit institutions to help the authority develop financial capability programs that meet the needs and expectations of financial consumers, especially those served by non- bank credit institutions. Description The Banking Agencies do not consult any of the associations in order to aid the Agencies in developing financial capability programs. All the entities work independent of each other with little to no coordination. As a result, their capacity to conduct any, let alone effective, consumer advocacy, especially in respect of financial sector issues, is adversely affected. The associations have problems of stable sources of funding for the development of their daily activities, as well as a lack of professional expertise. Recommendation Consumer associations should play a key role in financial consumer protection since they are generally the first place consumers go for advice and information, especially in remote areas of the country. Consumer associations should be allies of the State and the Entities in the task of protecting consumer rights. But, in order to provide an effective service to consumers, as well as advocacy for financial consumers in the policy- making process, consumer associations need adequate and stable sources of funding, as well as significantly greater institutional capacity. Good Practice F.5 Using a Range of Initiatives and Channels, including the Mass Media a. Policymakers, industry and consumer advocates should understand the financial capability of various market segments, particularly those most vulnerable to abuse. b. The financial capability of consumers should be measured, amongst other things, by broadly based household surveys that are repeated from time to time. c. The effectiveness of key financial capability initiatives should be evaluated by the relevant authority from time to time. Description Please see the Banking Diagnostic Review- Description, Good Practice, G.5. Recommendation Please see the Banking Diagnostic Review- Recommendations, Good Practice, G.5. 52 ANNEX 4: EXAMPLE OF UNIFORM LOAN DISCLOSURE22 22 Taken from Regulation Z – Truth in Lending, USA. 53 ANNEX 5: SCHUMER BOX23 23 Taken from Regulation Z – Truth in Lending, USA. 54 ANNEX 6: EXAMPLES OF KEY FACTS STATEMENTS 1) Key Facts Statement from South Africa English PRE-AGREEMENT STATEMENT & QUOTATION FOR SMALL CREDIT AGREEMENTS in terms of section 92 of the National Credit Act 34 of 2005 -page 1- NCR number: FORM 20 Name of credit provider: Name of consumer: Physical address: Physical address: Contact number of credit provider: Contact number of consumer: Date: Id No/CIPRO/registration number: SUMMARY Installment, including interest, fees & Credit advanced / value of goods or R required insurance, excluding R services provided on credit optional insurance Deposit to be paid & deducted R Number of installments Installments payable R Total all installments including interest, R specify: monthly/weekly/other fees & required insurance, excluding optional insurance Initiation fee, charged up front R Annual Interest rate percent Monthly service fee, included in Required insurance included in R R installment installment ADDITIONAL INFORMATION PART A: Additional charges, per section 102 (b) – (f) Total of additional charges which will be included in the account, and have been included in the R calculation of the installment: Additional charges per section 102 (b) to (f) R R R R R R PART B: Optional items OPTIONAL ITEMS WHICH WILL BE ADDED TO OTHER OPTIONAL ITEMS INSTALMENT Additional monthly premium for R 55 optional insurance Description of optional insurance: PART C: Security provided PART D: Repayment arrangements {Information regarding payment, including method of {Description of security required & of conditions under payment, date of the first payment and date of last which possession would occur} payment} PART E: Further information on rights and obligations Further information on significant rights or obligations imposed on the consumer Signature: Credit Provider Representative Consumer [THIS QUOTE IS BINDING FOR 5 DAYS] 56 2) Key Facts Statement from Ghana 57 58 3) Key Facts Statement from Philippines 59 60 ANNEX 7: EXAMPLE OF A PROPOSED MORTGAGE DISCLOSURE FORM (USA)24 24 Taken from the internet article “How Design Thinking Can Help Prevent Another Mortgage Bubble”, www.fastcodesign.com. 61