52798 Improving Protection in Financial Services for Russian Consumers Sue Rutledge1 Over the last decade, consumer credit in the Russian Federation has expanded from almost nothing to 9.2 Key Messages percent of Gross Domestic Product in 2008. This is an average increase of 84 percent a year for five years. · Consumer protection in financial services is critical to ensure confidence in the Across Europe, this was one of the most rapid rises in consumer lending--only Romania was higher at 100 financial system. percent annual increases. In just four years (from 2003 to 2007) in Russia, consumer borrowings--excluding · A 2008 World Bank Survey found that mortgages--skyrocketed from a minimal level of US$ Russian consumers had low levels of 100 per person to over US$ 1,200 per capita. financial literacy and did not know their rights as financial consumers. Yet, the increases have been uneven throughout the Russian population. Even now, more than 40 percent of the population lacks access to any form of financial · The World Bank has just released its services. Only 16 percent have bank accounts and less Diagnostic Review of Consumer than one percent of the population invests in securities, Protection in Financial Services in the investment funds or insurance. Russian Federation. The review proposes six recommendations: Recent developments in financial markets have highlighted the need for consumer protection and (i) A stronger institutional framework financial literacy for the long-term health of the financial sector. The rapid growth of household lending has been (ii) Clearer information disclosure accompanied by an increase in the number of households that have difficulty in understanding the risks and (iii) The prohibition of unfair practices obligations that they assume­or the full range of choices (iv) Stronger dispute resolution available. In the US mortgage markets for instance, mechanisms complex financial contracts were sold to borrowers, some of whom had weak credit histories. The (v) Financial education programs consequences were disastrous, and highlight the importance of consumer protection and financial (vi) Regular financial literacy surveys education to prevent other similar events. 1 The author would like to thank Caroline Cerruti for her valuable contribution in preparation of the Knowledge Brief. Thanks also to all the members of the Consumer Protection and Financial Literacy team who prepared the Diagnostic Review on Consumer Protection in Financial Services for the Russian Federation. ECA Knowledge Brief Why is Consumer Protection in Financial · Privacy--by ensuring control over access to Services Important? personal information. There are at least three reasons why consumer protection Consumer protection and financial literacy are part of in financial services and financial literacy are the Russian Government's long-term plan for financial paramount. sector development adopted in December 2008. The Russian Government also highlighted the importance of First, they increase consumer confidence in the financial financial literacy as a global issue in 2006 within the G8 system, which in turn reduces risks to financial stability. forum, and allocated US$ 15 million to a trust fund Both consumer protection and financial literacy are administered by the World Bank to support research and needed to build trust in the financial system and, thus, to disseminate best practices on this issue. broaden and diversify the deposit base of banks. This in turn reduces the liquidity risk of the banking sector. The Evidence in Russia Better informed consumers also help foster financial stability by protecting themselves from incurring large In June 2008, the World Bank conducted a financial exposure to market risks. This increases the transparency literacy survey of over 1,600 households in 40 regions of of credit risk assumed by the financial system and the Russian Federation. The results showed that the lowers the monitoring costs for financial supervisors. Russian population had low level of financial literacy and lacked awareness of their rights as financial Second, they address the imbalance of power, consumers. Half the respondents considered their level information and resources between consumers and their of financial literacy as unsatisfactory. Over 80 percent financial services providers. This is a typical market were unable to correctly answer five out of six basic failure. Financial institutions know their services well financial questions, such as: Does compound interest but individual consumers may find it difficult or costly increase savings more or less rapidly than simple to obtain information on the financial products they interest? In addition, more than one in ten people purchase. In addition, complex financial products may believed that the Government should bail them out of be difficult to assess even when all the information is bad investment decisions. Over 15 percent thought that disclosed. the Government should compensate them if they lost money investing, even in residential real estate. Third, they promote efficiency and transparency of retail Respondents also had little faith that financial financial markets. Consumers who are empowered with institutions would solve any problems that arose with information and basic rights are an important source of financial transactions. Over three-quarters gave a 50:50 market discipline. This encourages financial institutions chance (or worse) that disputes with financial to compete by offering better products and services, institutions would be resolved quickly and fairly. rather than by taking advantage of poorly informed consumers. The survey also showed that Russian consumers are interested in learning how to protect their financial A financial consumer protection framework should future. Three-quarters of the survey's respondents said provide consumers with: they would like to receive financial education in order to · Transparency--by providing full, plain, protect themselves financially and plan for the future. adequate, and comparable information about They wanted to learn how to protect themselves when the prices, terms and conditions, and dealing with financial institutions and how to identify inherent risks of financial products and (and avoid) pyramids2 and other financial frauds. Almost services; a third wanted to know about the laws that protect them and the procedures that should be followed in case of a · Choice--by ensuring fair, non-coercive and dispute with a financial institution. One quarter wanted reasonable practices in the selling of to understand how the pension schemes work and almost financial products and collection of as many wanted information on how to avoid being payments; · Redress--by providing inexpensive and 2 A `pyramid scheme' is a business model that involves the exchange speedy mechanisms to resolve complaints of money for enrolling other people into the scheme, often without delivering any service. New money (brought by new investors into and disputes; and the scheme) is the source of the payoff for existing participants. Pyramid schemes require an exponential increase in the number of participants to sustain them. ECA Knowledge Brief overburdened by credits. However, consumers also and be subject to business conduct supervision by a showed some distrust of private financial sector financial supervisory agency. institutions--not only commercial banks but also insurance companies and other providers of financial Second, financial institutions should make their services. consumer disclosure easy to read but still accurate and complete. Basic information regarding financial Six Recommendations services should be presented in a simple format, such as a Key Facts Statement like the one used in Australia and The World Bank recently released its Diagnostic Review elsewhere. Basic provisions of consumer contracts could on Consumer Protection in Financial Services in the be standardized. Both the Key Facts Statement and the Russian Federation3. The review is the sixth report of a standard contract provisions could be set by the relevant World Bank-sponsored pilot program to assess consumer professional associations, with the suggestion that all protection in financial services in emerging markets4. member financial institutions follow the formats. In The Diagnostic Review was prepared at the request of addition, there should be specific disclosure the Russian authorities and is intended to support the requirements for non-state pension funds, insurance Government's program on financial literacy and companies, consumer credit providers, credit reporting consumer protection. institutions, and non-credit payment service providers. The report finds that the basic legal framework for Third, unfair business practices should be prohibited. consumer protection in financial services is largely in Debt collectors should not be able to call delinquent place. It recommends that six measures be taken. These borrowers at any time of the day or night. Cooling-off measures are based on international experiences, mostly periods, when consumers can change their mind for a from Europe, United States, Australia, and Canada. few days after signing a contract, also make sense for long-term financial contracts (such as residential First, the authorities should simplify and strengthen mortgages or insurance contracts with long-term savings the regulatory and supervisory institutional structure components). Legislation on personal bankruptcy is also responsible for financial consumer protection. The needed. current framework is complex and not comprehensive. The Russian Consumer Protection Service Fourth, the dispute resolution mechanisms should be (Rospotrebnadzor or CPS) has responsibility for strengthened. Currently, there is no centralized enforcing the Law on Protection of Consumer Rights. mechanism that deals with customer complaints on Most banking credit services come under the Law but financial services. Financial consumers can complain to the latter does not cover securities, investment funds or six different institutions (the financial institution, the pension funds. Neither is it clear if the Law covers financial supervisor, the professional association, the insurance. The securities and insurance supervisors have CPS, the office of the Presidential administration, and an explicit mandate to protect investors and the Prosecutor General) but only the CPS can act as an policyholders; however the banking supervisor (the advocate of the consumer in court. Each financial Central Bank) has not. While the financial supervisors institution should be obliged to designate a department have skills in financial issues, the CPS lacks sufficient (or an individual) responsible for receiving customer expertise and institutional capability to adequately complaints--and that contact point should be identified monitor consumer protection in financial services. Three to the consumer at the time that the financial service is options are presented but the review recommends that purchased. Consumer complaints about financial the best approach would be to strengthen the capability services should be collected in one central location, of the CPS as well as its transparency and accountability. which should publish statistics on the number and status At the same time, all financial intermediaries (and of complaints and analyze the trends in the different particularly debt collection agencies) should be licensed types of complaints. Over the long-term, consideration should be given to establishing a form of consumer 3 financial ombudsman--an institution with specialized World Bank, Russian Federation: Diagnostic Review of Consumer Protection in Financial Services, Revised Draft, July 2009 (available staff to whom consumers could send their complaints at http://www.worldbank.org/ru and when the financial institutions do not seem to listen. http://www.worldbank.org/eca/consumerprotection) 4 Other reports were prepared for Azerbaijan, Bulgaria, Croatia, Fifth, one of the most effective forms of consumer Czech Republic, Latvia, Lithuania, Romania, and Slovakia. The World Bank has also prepared Good Practices for Consumer protection in the long run is ensuring high level of Protection and Financial Literacy in Europe and Central Asia: A financial literacy. Consumers should have easy access Diagnostic Tool (http://www.worldbank.org/eca/consumerprotection) to financial education so that they can learn about their ECA Knowledge Brief financial services--not just the terms of service but also · Amendments to the bankruptcy legislation have the risks and rewards of different personal financial been drafted, introducing provisions on strategies. The number of financial education initiatives bankruptcy procedures for individual consumer from private institutions and NGOs is growing in Russia, debtors. They would allow individual debtors to but it is mostly focused on investment advice and targets the most affluent segments of the population. The public file for bankruptcy. Currently, if individuals sector should be involved to ensure that middle- and default on their loans, the banks often restructure low-income people are not left behind. Topics such as the loans but the terms may vary widely. The budget planning, managing personal debt and pension draft Law would allow debtors--who have planning and insurance should be covered. It is accumulated more than Rub 50,000 in debt and recommended that financial education be provided to have not been able to make payments for the consumers at `teachable moments', when they are past six months--to ask an arbitration court to searching for information about financial services and financial planning. For this, a national strategy to declare them bankrupt. Lenders could also develop financial education should be in place. initiate the bankruptcy procedure. · The Association of Regional Banks of Russia Sixth, regular surveys of financial consumers should be conducted to evaluate the impact of policy has asked for World Bank assistance to lay the interventions and the financial education programs. ground for a banking sector ombudsman. The The surveys should cover consumer spending habits and approval of the charter establishing the banking financial well-being, as well as levels of financial ombudsman is expected by mid-2010. literacy and understanding. · The Russian Ministry of Finance, along with Where Are We Now? several Government bodies, is preparing a national strategy on financial education, Several measures have already been taken: financial literacy and consumer protection. · Five high-level dissemination workshops were · The World Bank is working with the Russian held during `Consumer Protection Week' in late authorities to prepare a Financial Literacy and September 2009. Deputy Chairman of the Financial Education Project to support the Federal Financial Markets Service of Russia, Government's program. Sergey Kharlamov, helped kick-off the opening workshop. There is still some way to go. The six measures · In July 2009, the Law `About Credit mentioned above are not easy to put in place but all are important. Taken together, they will establish the Cooperation' was passed. This Law improves foundations needed to ensure that Russian households the legal framework for the activities of can make even difficult financial decisions with consumer credit cooperatives acting in the confidence--whether it is to buy new homes, pay for car sphere of non-bank financing. Credit repairs or just find ways to save a little between pay cooperatives are non-commercial organizations checks. The program requires an active role, not just by established for providing financial aid to their the Russian Government authorities but also by the members who are individuals and/or legal financial institutions, their professional associations and members of civil society. The result will be empowered entities. The new Law regulates their financial consumers--and a stronger society. establishment, reorganization, liquidation, membership, and their management and assets. About the Author Sue Rutledge is Senior Private Sector Development Specialist in ECSPF in the ECA Region. "ECA Knowledge Brief" is a regular series of notes highlighting recent analyses, good practices and lessons learned from the development work program of the World Bank's Europe and Central Asia Region http://www.worldbank.org/eca