BOSNIA AND HERZEGOVINA Diagnostic Review of Consumer Protection and Financial Literacy in Banking Services ‫ٻ‬ Volume I Key Findings and Recommendations [April 2011] Commissioned by the Ministry of Finance and Treasury of Bosnia and Herzegovina ii BOSNIA AND HERZEGOVINA Diagnostic Review of Consumer Protection and Financial Literacy in Banking Services Volume I Key Findings and Recommendations Contents Abbreviations & Acronyms ............................................................................................. iii Foreword......................................................................................................................... iv Executive Summary ......................................................................................................... 1 Introduction ...................................................................................................................... 7 Importance of Consumer Protection & Financial Capability .......................................... 8 BiH Policy for Banking Consumer Protection in the EU Context................................... 9 Background on Household Finances in BiH .................................................................. 11 Key Findings & Recommendations ............................................................................... 13 Legal Reform and Institutional Structures ................................................................ 14 Consumer Disclosure ................................................................................................ 18 Business Practices ..................................................................................................... 21 Dispute Resolution .................................................................................................... 24 Financial Education & Financial Capability ............................................................. 27 Tables Table 1: List of Recommendations ...............................................................................................5 Table 2: Financial Sector Credit to Households..........................................................................11 Table 3: Banking Sector Credit to Households by Currency and Maturity ................................11 Table 4: Household Debt with Non-regular Payment .................................................................12 Table 5: Consumer Complaints regarding Financial Services in BiH ........................................25 Table 6: Consumer Complaints Received by European Complaint Services in 2007 ................26 Figures Figure 1: Number of Non-Performing Household Loans ...........................................................12 Figure 2: Real Estate Prices and Household Long-Term Loans .................................................13 Boxes Box 1: Main Findings of Survey to Low-Income Households in Tuzla .....................................29 Annexes Annex I: Key EU Directives on Financial Consumer Protection and Applicable Laws in Bosnia and Herzegovina..........................................................................................................................31 Annex II: List of Meetings conducted in Bosnia and Herzegovina ............................................32 iii Abbreviations & Acronyms ACA Association of Credit and Collection Professionals ADR Alternative dispute resolution APR Annual Percentage Rate of Charge B2C Business-to-Consumer B2B Business-to-Business BiH Bosnia and Herzegovina CBBiH Central Bank of Bosnia and Herzegovina CPC Consumer Protection Council of BiH District Brčko District DG SANCO Directorate-General for Health and Consumers (of the EC) DFID Department for International Development DSI Data State Inspectorate EC European Commission EFSE European Fund for Southeast Europe Entities FBiH and RS Entity Either FBiH or RS ESIS European Standardized Information Sheet EU European Union EURIBOR Euro Interbank Offered Rate FBiH Federation of Bosnia and Herzegovina, an Entity of the State of BiH FCCPO Competition and Consumer Protection Office in FBiH FX Foreign Exchange GDP Gross Domestic Product IFC International Finance Corporation KM BiH Convertible Mark KonfOP Interrepublican Confederation of Consumer Societies (of Russia) KYC Know your customer LIBOR London Interbank Offered Rate LTV Loan-to-Value MOU Memoranda of Understanding NBCI Non-bank credit institution NGO Non-governmental organization OECD Organisation for Economic Co-operation and Development PARE Partnership for Advancing Reforms in the Economy PHRD Policy and Human Resources Development Fund RS Republika Srpska, an Entity of the State of BiH RSCCPO Competition and Consumer Protection Office in RS State State of BiH UK United Kingdom US United States of America USAID United States Agency for International Development USD United States Dollar n.a. Not Available USD 1 = KM 1.32 (April 2011) 1 Euro = KM 1.9558 (pegged) iv v Foreword Consumer protection and financial literacy lies at the heart of any banking sector that is efficient, competitive and fair. Three areas are important. Customers of banks need to receive information that is clear, complete, accurate and comprehensible before they decide to deposit funds or to borrow. They must have access to recourse mechanisms that are efficient and cost-effective. They need also to obtain sufficient financial education to understand the terms and conditions and other information provided to them as financial consumers. The authors are pleased to provide the Diagnostic Review of Consumer Protection and Financial Literacy in Banking Services for Bosnia and Herzegovina (BiH). They thank the authorities in BiH at State and both Entity levels, as well as other interlocutors in the private sector and civil society, for their valuable cooperation and collaboration in its preparation. This Review not only looks at banking services in BiH, but also refines a set of Good Practices or benchmarks for use in reviewing consumer protection in banking services in any jurisdiction. It is expected that this work will prove helpful to the international community and those in emerging markets who seek to establish common ground for minimum Good Practices in consumer protection and financial literacy in banking services. This Review takes into consideration the relevant laws of BiH and both Entities, well as pertinent practices and directives of relevant State and Entity institutions, as of April, 2011. vi Acknowledgments This Review was prepared by a team consisting of Eric Haythorne, former Lead Counsel, Finance, Private Sector and Infrastructure Development, World Bank, and Juan Carlos Izaguirre Araujo, Consultant. Although Messrs. Haythorne and Izaguirre Araujo are also consultants to 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. Special thanks go to Sue Rutledge (Regional Corporate Governance/ Consumer Protection Coordinator and Senior Private Sector Development Specialist, World Bank), Irina Astrakhan (Lead Private Sector Development Specialist, World Bank) and Haris Mesinović (Private Sector Development Specialist, World Bank). Peer review comments were received from Deepa Chakrapani (Senior Financial Sector Specialist, World Bank) and Ros Grady (Consultant). Helpful comments and advice were also provided by Xiaofeng Hua (Senior 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. During their 11-day mission to BiH in November 2009, the authors were fortunate to have met with numerous representatives of ministries, government agencies, commercial banks 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. Further comments and advice were provided during the Roundtable on Consumer Protection in the Banking Sector in June 2010, when the first draft of this Review was distributed for comments. This Review, however, does not attribute statements or recommendations to any interlocutor. In addition, the authors thank the Government of Japan for funding this Diagnostic Review through a Policy and Human Resource Development (PHRD) Grant to BiH. vii Executive Summary The global financial crisis has highlighted the importance of consumer protection and financial capability as medium-term measures supporting financial sector development. In addition to short-term measures to mitigate economic impacts, policymakers are taking steps to build better foundations for financial sector development through medium-term regulatory reforms. These measures involve not only enhanced prudential regulation and oversight, but also corporate governance, business conduct regulation and supervision, and financial consumer protection. The latter receives an increasing emphasis in developed and developing countries, as most of the risk exposures associated with the latest credit boom were assumed primarily by households. At its heart, consumer protection addresses power, information, and resource imbalances which place consumers at a disadvantage vis-à-vis financial institutions. Financial institutions are very familiar with the terms and conditions of their financial products and their risk characteristics. Retail consumers may find it difficult or costly to obtain sufficient information about their financial purchases or understand complex financial products even when relevant information is disclosed. Consumers who are empowered with information and basic rights—and who are aware of their responsibilities—provide an important source of market discipline to the financial sector, encouraging financial institutions to compete. In addition, financial consumer protection builds trust in financial systems and helps broaden and diversify the base of depositors. The years 2003 to 2008 saw rapid increases in levels of household credit in Bosnia and Herzegovina. Credit granted to households by financial institutions more than tripled from 2003 to 2008. As of December 2008, household credit represented 26 percent of GDP, double the percentage by December 2003. This increase was driven by credits granted with maturity over one year, which represented 23 percent by end-2009. In addition, households’ exposure to foreign currency banking loans has remained around 10 percent of GDP. The majority of foreign currency loans are in Euros and with maturity between one and 10 years. Official statistics show growth in the number of non-performing loans relative to the total number of household loans since 2007. This Diagnostic Review for BiH exclusively covers consumer protection and financial literacy issues in the banking sector. It is highly recommended that similar diagnosis be conducted in other relevant financial segments. The Diagnostic Review of Consumer Protection and Financial Literacy in Banking Services for BiH recommends measures in five key areas: (1) legislative and institutional reform, (2) consumer disclosure, (3) business practices of banks, (4) dispute resolution mechanisms, and (5) financial education. While BiH has adopted some relevant EU Directives, the legal framework for consumer protection in banking services needs to be strengthened. The Consumer Protection Act of 2005 at State level transposed several EU Directives into BiH law. However, the Act lacks clarity on key matters and defines “consumer credits” extremely broadly. Also, contrary to the terms of the Act, efforts to legislate in the field of consumer protection have not yet occurred in the Federation of BiH and have only relatively recently been under consideration in the Republika Srpska. The Act requires both Entities to harmonize their legislation with it. While there is apparently no on-going legislative drafting in this field in the Federation, a Republika Srpska consumer protection bill has been drafted but not yet circulated for comments from institutions that are legally required to issue their opinion prior to enactment. It is hoped that wide circulation of the draft will soon take place and the enacted version will be in harmony with the State Act. Otherwise, consumers and financial institutions will inevitably face unfortunate, but wholly avoidable, conflicts in the application of relevant law. In addition, the new EU Consumer Credit Directive should be adopted in BiH. 1 An array of uncoordinated institutional structures at State and Entity level has had difficulty addressing issues related to consumer protection in the banking sector. Of central concern is the fact that there is no single enforcement agency for consumer protection in banking services. The State-level Ombudsman Institution for Consumer Protection in BiH (“Consumer Ombudsman”) is modestly financed and has a staff of four, none of whom is a financial or banking sector expert. The State-level Consumer Protection Council has no staff and meets only a few times each year in order to produce an annual National Consumer Protection Program, which gives little consideration banking services to matters. The Banking Agencies at Entity level license and carry out prudential supervision of commercial banks, but both agencies are starting to take on additional responsibilities in respect of consumer protection and business conduct of commercial banks. At the Entity level, there are also inspectorate offices that, among other things, respond to consumer complaints regarding alleged breaches in the law by any institutions, including commercial banks. The legal decision is still pending, however, as to whether these Entity-level inspectorate offices have jurisdiction to enforce the Consumer Protection Act, since it is a State law.1 Institutions in civil society are also weak, particularly the Banks’ Association and consumer organizations involved in banking services. Although the legislation provides for an active role for consumer associations in representing and protecting consumers, lack of funding and staff capability limit their possibilities to assist consumers adequately, particularly in respect of banking sector issues. The Review suggests four options to strengthen the institutional framework for developing policies and enforcing laws and regulations regarding banking consumer protection. The advantages and disadvantages of each option should be carefully considered. The first option, expanding the supervisory role of the Banking Agencies in terms of consumer protection (not including settlement of consumer disputes), would require the Banking Agencies to provide not only prudential but also business conduct supervision over banks. Although conflicts of interest would inevitably arise, banking supervisory agencies elsewhere have found that putting both roles together provides valuable information and early warning for the purpose of banking supervision. The second option, setting up a special banking services unit within the Consumer Ombudsman (or at a minimum hiring specialized staff), would require additional budget to expand the existing premises and staff and provide necessary training.2 The third option, creating a separate financial consumer protection agency, would be the most difficult to achieve, but it has already been adopted in Canada. The fourth option would build on the high reputation of the Central Bank of BiH and would require it to set up an office to collect complaints about banking services, forward them to institutions responsible to handle them, analyze complaints looking for potentially systemic issues, and advise the Banking Agencies on common problems that arise from complaints3. The starting point to improve the institutional framework for banking consumer protection should be for the Banking Agencies to expand their roles to include consumer protection. This 1 The dispute arises from differing interpretations of items e) and i) of Article 98 of the State’s Consumer Protection Law. By items e) and i), “competent Entity authorities” and “Inspection … bodies as required by law” are made responsible for consumer protection. 2 In addition, concern is raised by the Government of the Republika Srpska that the formation of such a single specialized common institution for consumer protection in the financial sector would be unconstitutional since Article 53 of the Republika Srpska’s Constitution requires the Republika Srpska to ensure consumer protection. 3 While the Central Bank, strictly speaking, is not competent for consumer protection in BiH, it is vitally concerned about matters of financial stability in the banking sector. Above proposals in these respects are only very modest additions to its on-going responsibilities. 2 expansion has already been implemented by the Banking Agency of the Republika Srpska4. It would also be important to establish a coordinating mechanism between both Banking Agencies, the Banks’ Association, the Consumer Ombudsman and consumer associations, to ensure proper exchange of information, mutual education and greater dissemination of information to consumers. Consumers of banking products and services should be able to receive information that is clear, comprehensible and comparable. For all banking products and services, consumers should be able to obtain information from their banks in a simple and easy-to-understand format that allows them to “comparison shop” among providers. Full implementation of the EU Consumer Credit Directive in BiH would help improve consumer disclosure. For any banking service and product, consumers should receive a one- or two-page Key Facts Statement. While not replacing any contract, the Key Facts Statement would provide an easy-to-read summary of all key terms and conditions for the product in question, helping consumers better understand their purchases. Also important for BiH consumers would be the adoption of standard contracts or at least standard contractual provisions for basic banking services. In the context of discussions regarding adjustment of floating interest rates for consumer loans, banks and consumers would welcome better guidance from the authorities. The Banking Agencies should go further than their recent Decisions which only require banks to “clearly define conditions” for the adjustment of floating interest rates. It is recommended that technical discussions on this matter be led by the Central Bank and include representatives of all stakeholders in order to arrive at language which is elastic enough to permit the continuation of strong competition in the BiH banking system, but tight enough to give assurance to any consumer on the extent of his or her risks in entering into a floating rate loan. A suitable BiH reference point for purposes of commercial bank lending should be established by technical experts as a matter of priority. And once this is done, the Banking Agencies may require all banks to state in their floating rate loan agreements: (a) their own caps (upward and downward) on each adjustment to the rate; (b) the basis on which the rate can be adjusted, as linked directly to the BiH reference point; (c) the minimum interval between any adjustments; and (d) the maximum cap (upward and downward) that the interest rate can go during the life of the loan. All banks must be free to choose the parameters of adjustment for its floating rates, but such parameters would be known by the consumer. Annex to Volume II of this Review serves as a model for discussion purposes. Business practices for banks should also be improved through a significantly expanded and publicized code of conduct. While the Banks’ Association has developed a voluntary code of conduct for its member banks, this code is incomplete and largely unknown to bankers and consumers. There is no obligation for any Association-member bank to publicize the fact of its adherence to the code or to post a copy of the code in the lobby of all its branch offices. A more complete consumer protection code could be developed by the Banks’ Association for the banking sector. That code should then be required to be placed in bank branches and on every bank’s website. Consumers should be advised that if a bank fails to follow the code, a complaint can be submitted to the bank, the Banks’ Association and the relevant Banking Agency. Other measures would also strengthen the commercial practices of banks. Cooling-off periods of 14 days should be required for all long-term banking products (such as residential mortgages) and for financial services and products sold by telephone or over the internet, given that they are subject to high-pressure sales tactics. Consideration should be given to the Banks’ Association 4 Draft Federation Banking Agency Law, Law on Banks and Law on Microcredit Organisations follow the RS provisions. To be submitted to FBH Parliament during their sessions on December 21 and December 22, 2011. 3 providing training and certification for employees of commercial banks who work with retail customers. A pilot debt counseling center is to be established in Tuzla and it will be important to learn from its experiences before other centers are established elsewhere. Dispute resolution mechanisms should be improved, starting with the banks themselves. All banks should designate a department to receive customer complaints and the contact information for the complaints department should be communicated to consumers. At the same time, there should be a legal provision that establishes a reasonable maximum number of days (say, 30 days) for the bank to respond in writing to any customer’s complaint. In the medium term, establishing a banking ombudsman may be useful to handle consumer complaints that are not resolved satisfactorily by the banks, given the current challenges in the court system. 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. Mediation services have found favor in the construction industry as an out-of-court dispute resolution mechanism, but there has been no effort to date to introduce these services in the banking sector. There is no banking ombudsman empowered to make binding orders or non- binding recommendations to the parties to a dispute. A specialized ombudsman, as found in the United Kingdom, Ireland and Armenia, can play a powerful role in dealing with complaints, while building public confidence in the provision of banking services. To be effective and independent of banks, however, a banking ombudsman should be set up by a special law. Such a reform measure would inevitably, though, be for the long term and its costs and benefits would need special review. Financial education needs significant development. Primary schools in BiH provide no financial education for students. Such programs are, however, crucial in helping children understand that financial health is as important as physical health. In addition, education and training is needed for adults. Such training can be provided through professional associations and financial institutions and it should help consumers understand the terms and conditions of the financial contracts they sign. Training for adults should be focused on “teachable moments”, such as the time when a consumer becomes a first-time long-term borrower. It may also be helpful to conduct “mystery shopping” to see the issues that arise for consumers as they try to buy banking products and services and learn about the risks and rewards of different products. Consumer associations may be able to play a role in this area, by obtaining external funding to hire “mystery shoppers” whose experiences may be reported and published on the associations’ websites. A nationwide financial literacy survey would provide a baseline assessment of the current levels of financial capability and serve as an essential means for measuring the impact of consumer protection and financial education programs. Several countries, including the United Kingdom, Ireland, Australia, Canada and Russia, have conducted nation-wide surveys of households assessing not only their levels of financial literacy, but also their values and behaviors (taken together called “financial capability”). The survey should be segmented by age, gender, levels of formal education, and geographic area, as well as by rural versus urban areas. Segmentation will provide policy-makers with insight into the key issues for consumers of banking products and services as they look for ways to meet their debts and plan their financial futures. Such a survey should then be repeated in three to five years, to see if the consumer protection and financial education programs have had the impact that was anticipated—and if, and to what extent, the programs should be modified. Improvements in legal and institutional frameworks, consumer disclosure, business practices, dispute settlement mechanisms and financial education would substantially strengthen the levels of consumer protection and financial capability in BiH’s banking sector. Following 4 discussion of the recommendations of this Review and agreement on the way forward as a result, a detailed action plan should be developed and published that focuses on all that has been agreed and how, when and by whom each aspect will be implemented. A listing of the Review’s key recommendations is provided in Table 1 below. Table 1: List of Recommendations Action Type of Action Responsible Party Amend the State Consumer Protection Act, either improving Revision to Ministries of Trade, provisions related to financial services or carving out such Consumer Central Bank, provisions and allowing for Entities to legislate in financial sector Protection Act Banking Agencies issues Prepare Entity legislation in the field of consumer protection, Enactment of Ministries of including provisions on consumer credit, ensuring that legislation Entities’ Consumer Finance, Banking is in harmony with the State Act Protection Acts Agencies Draft a revised and updated Code of Ethics for formal Banks’ Association Banks’ Association endorsement by all banks recommendation Establish a principles-based, statutory code of conduct for banks Regulations of Banking Agencies Banking Agencies Require banks to gather, file and record sufficient information Regulations of Banking Agencies from the consumer in order to ensure that its recommended Banking Agencies product or service is appropriate to that consumer Enact and enforce suitability rules Regulations of Banking Agencies Banking Agencies Draft and issue guidelines on how, when and why floating interest Regulations of Central Bank, rates may be legitimately adjusted Banking Agencies Banking Agencies Establish a cooling-off period for all consumer loans Regulations of Banking Agencies Banking Agencies Regulate the cases where bundling is permissible, and require full Regulations of Banking Agencies disclosure in the event that any accompanying service is offered Banking Agencies to a consumer in the context a consumer credit Require banks to provide a consumer, before opening an account, Regulations of Banking Agencies with a written copy of general and specific terms and conditions Banking Agencies Produce a standard set of easily understandable scenarios Banks’ Association Banks’ Association reflecting variation of conditions of a credit agreement, to be recommendation given to consumers prior to signing a credit agreement Require banks to provide the consumer with a Key Facts Regulations of Banking Agencies Statement for each product or service offered Banking Agencies Establish and administer minimum competency requirements for Regulations of Banks’ Association, staff who deal with consumers, prepare key facts statements or Banking Agencies Banking Agencies advertisement materials, or market bank’s services and products Develop legislation on debt collection practices Law on Debt Banking Agencies, Collections Central Bank, Regulate sharing of personal information with government Regulations of Banking Agencies authorities Banking Agencies Regulate the operation of the public credit registry as well as all private credit bureaus Require banks to establish an internal procedure to handle Regulations of Banking Agencies consumer complaints Banking Agencies Establish a dispute resolution mechanism either at State or Entity Entities’ Banking Central Bank, level with jurisdiction over all types of consumer disputes related Laws Banking Agencies to banking services. Develop a national program on financial education, including Policy Decision Banking Agencies, initiatives for adult consumers and young children Banks’ Association, Ministries of Finance Develop consumer awareness campaigns on financial issues with Policy Decision Banking Agencies, 5 participation of government authorities and consumer NGOs Consumer NGOs Strengthen consumer associations, providing larger and stable Policy Decision Banking Agencies, sources of funding and promoting institutional capacity building Ministries of Finance A national financial literacy survey should be conducted as a first Policy Decision Central Bank step in the development of the financial education program Require Banking Agencies and Competition Council to consult Laws on Banking Banking Agencies, regularly with one another so as to ensure implementation and Agencies, Competition Council enforcement of consistent policies Competition Law 6 Introduction The Diagnostic Review of Consumer Protection and Financial Literacy in Banking Services for Bosnia and Herzegovina is the tenth report in a program to assess consumer protection in financial services in developing and middle-income countries.5 The objectives of the BiH Diagnostic Review have been three-fold, namely: (1) to conduct a review of the existing rules and practices in BiH compared to international good practices regarding consumer protection in banking services; (2) to provide recommendations on ways to improve consumer protection in banking services and financial capability in BiH; and (3) to refine a set of good practices prepared by the World Bank for assessing consumer protection in banking services, including financial capability. The Diagnostic Review was conducted at the request of the Ministry of Finance and Treasury of Bosnia and Herzegovina as part of the initial stage of a Project under preparation by BiH and the World Bank aimed at Enhancing Small and Medium Enterprises’ Access to Finance. 6 To support the design of this Project, the Government of Japan provided BiH a Policy and Human Resource Development (PHRD) Grant which, in turn, funded this Diagnostic Review. In June 2010 the Central Bank of BiH and the World Bank organized a Roundtable on Consumer Protection in the Banking Sector, where this Diagnostic Review was presented as a consultative draft. The Good Practices used in the Review are based on international approaches to effective and efficient consumer protection in banking services in both developed and developing countries. A set of Good Practices was initially assembled for the Slovakia Review and these Practices have been subsequently revised in the course of further reviews as part of a World Bank pilot program. The Good Practices have been released by the World Bank in the form of a Consultative Draft in order to receive feedback and comment from international regulators, supervisors and other stakeholders7. The Good Practices incorporate the provisions of the EU Directives related to consumer protection and the reports of European financial regulatory and supervisory agencies, as well as laws, regulations and business practice codes in the United States, Australia, Canada and other countries. The United Nations Guidelines for Consumer Protection have also been useful references regarding general consumer protection8. The Organization for Economic Cooperation and Development (OECD) has also released sets of good practices to enhance education and awareness on risk and insurance, pensions, and credit products9, supplementing the recommendations presented in its 2005 global review of financial education programs10. This Diagnostic Review for BiH affords the second opportunity to test the Good Practices in a country in the midst of financial crisis. 5 In chronological order, other Reviews on consumer protection in financial services have been prepared for the Czech Republic, Slovakia, Azerbaijan, Romania, Croatia, Russia, Lithuania, Bulgaria and Latvia. The published final Reviews can be downloaded at http://www.worldbank.org/eca/consumerprotection 6 The subject of this Review, however, is the protection of individual consumers not that of small and medium enterprises. 7 See World Bank, Finance and Private Sector Department of the Europe and Central Asia Region, Good Practices for Consumer Protection and Financial Literacy in Europe and Central Asia: A Diagnostic Tool, September 2009, available at: http://www.worldbank.org/eca/consumerprotection 8 United Nations, Department of Economic and Social Affairs, United Nations Guidelines for Consumer Protection (as expanded in 1999), 1999 9 Organisation for Economic Co-operation and Development, Improving Financial Education and Awareness on Insurance and Private Pensions, 2008, and Financial Literacy and Consumer Protection: Overlooked Aspects of the Crisis, OECD Recommendation on Good Practices on Financial Education and Awareness relating to Credit, 2009 10 Organisation for Economic Co-operation and Development, Improving Financial Literacy: Analysis of Issues and Policies, November 2005 7 The publication of the Diagnostic Review for BiH aims to enhance development of banking consumer protection both in BiH and beyond. In particular, it is anticipated that application of the Good Practices in middle-income countries, such as BiH, will contribute to international policy dialogue regarding the key components of banking consumer protection and will assist in the development of benchmarks that are widely accepted as generally applicable to consumer protection in banking services in any jurisdiction. This Diagnostic Review for BiH exclusively covers consumer protection and financial literacy issues in the banking sector. It is highly recommended that a broad financial sector Diagnostic Review of Consumer Protection in Financial Services be conducted in BiH in the future. The broader Diagnostic Review would cover the remaining segments of the financial sector: insurance, securities, pensions and non-bank credit institutions. The Review is presented in two volumes. Volume I notes the importance of consumer protection in banking services, describes Government policy for banking consumer protection, provides statistics on the size and growth of the retail banking sector in BiH, and sets out the key findings and recommendations of the Review. Annex I to Volume I provides a list of the key EU Directives dealing with consumer protection in banking services and applicable laws in BiH. Annex II to Volume I lists the meetings conducted in BiH during the November 2009 mission. Volume II provides an assessment of the BiH consumer protection institutional and legal framework and practices against the benchmark of Good Practices for the banking sector. Importance of Consumer Protection & Financial Capability At its heart, the need for consumer protection arises from an imbalance of power, information and resources between consumers and their financial service providers, placing consumers at a disadvantage. Consumer protection aims to address this market failure. Banks know their services well, but individual retail consumers may find it difficult and costly to obtain sufficient information about their financial purchases. Complex loan agreements prepared by banks, as well as the risk allocation between the consumer and the bank, are often beyond the capacity of most consumers to understand. Particularly in the post-transition countries of Europe and Central Asia, the public lacks a history of using sophisticated banking services. Even highly literate and well- educated consumers often have no experience among their friends and extended family of negotiating a loan product, such as a mortgage for the purchase of a house or apartment. Strong consumer protection in banking products and services helps build public trust in the banking system. The trust of consumers in their banks is critical for the long-term development of the financial sector. To build that trust, an effective and efficient consumer protection framework should provide consumers with: x Transparency by providing full, plain, adequate and comparable information about the prices, terms and conditions (and inherent risks) of banking products and services; x Choice by ensuring fair, non-coercive and reasonable practices in the selling of banking products and services and collection of payments; x Redress by providing inexpensive and speedy mechanisms to address complaints and resolve disputes; xPrivacy by ensuring control over access to personal financial information; and x Access to financial education that enables consumers to develop the financial capability required in order to understand the risk/return (cost/benefit) trade-offs, and their rights and 8 obligations regarding the banking products and services that they buy. Education and training in financial issues should also empower consumers to make well informed decisions about their finances, to manage their financial assets and liabilities and to plan their financial needs over a lifetime. Nonetheless, financial education cannot substitute for adequate financial regulation. Regulation, however, also imposes a cost on the banking sector. Regulation can impair both competition and innovation in the banking sector, thus raising consumer costs and obstructing the development of adequate market discipline that would otherwise hold risk-taking in check. Clear priorities need to be set. Regulation should be subject to cost-benefit analysis and consumer protection regulations should be assessed to determine their impact on sound consumer finance. The global financial crisis has highlighted weaknesses in consumer protection and financial capability—and their impact on financial institutions. In its April 2008 report, the Joint Forum of the Basel Committee on Banking Supervision, the International Organization of Securities Commission and the International Association of Insurance Supervisors identified three key risks related to possible "mis-selling" of financial products to retail customers.11 These were: (1) legal risk, if successful lawsuits from collective (i.e. class) action by customers or enforcement actions by supervisory agencies result in obligations to pay financial compensation or fines; (2) short-term liquidity risk and long-term solvency risk, if retail customers are treated unfairly and thus shun financial institutions and withdraw their business; and (3) contagion risk, if the problems of one financial institution (or type of financial product) spread across the financial sector. Effective consumer protection can help ensure that the actions of financial firms do not make them subject to criticisms of mis-selling. Consumer protection could also shield the banking sector from the risk of political over- reaction in periods of financial turmoil. The political response to collapses of parts of the financial sector may be to over-compensate with heavy regulation. The impact of too little consumer protection became evident, for example, during the insurance and superannuation scandals in the United Kingdom and Australia. As a result of the scandals, extensive studies were conducted recommending wide-ranging regulatory reforms. In addition, some countries have resorted to across-the-board fixed interest rate caps that have had a questionable impact, especially on the development of the credit market. BiH Policy for Banking Consumer Protection in the EU Context The EU Consumer Policy strategy 2007-2013 aims to strengthen consumer protection and financial capability12. The strategy has three objectives, namely: (1) to empower consumers by ensuring that they have real choices, accurate information, market transparency, and the confidence that comes from effective protection and solid rights; (2) to enhance consumers' welfare regarding price, choice, quality, diversity, affordability and safety of products; and (3) to protect consumers as a group from the serious risks and threats that cannot be withstood on an individual basis. Key steps for the implementation of the strategy involve the development of benchmarks for national consumer policies, including a consumer protection policy for the financial sector (including its 11 Joint Forum of Basel Committee on Banking Supervision, International Organization of Securities Commission and International Association of Insurance Supervisors, Customer suitability in the retail sale of financial products and services, April 2008 12 European Commission, EU Consumer Policy Strategy 2007-2013 COM (2007) 99 final, available at http://ec.europa.eu/consumers/overview/cons_policy/EN%2099.pdf 9 banking segment), and the collection of service quality data and complaint statistics. The EU takes the approach that an effective regime of financial consumer protection covers three areas. Consumers should have access to: (1) sufficient information to make informed decisions in the purchase of financial services, (2) cost-effective recourse mechanisms to redress violations of financial service contracts, and (3) programs of financial education. In addition, the EU is engaged in an extensive program to further strengthen consumer protection in financial services. Annex 1 of this Volume provides a listing of the key EU Directives related to consumer protection in banking services and their transposition into BiH and Entity law. In 2008, the European Parliament approved the revised Consumer Credit Directive, which requires a substantially increased level of disclosure of the terms and conditions of consumer credits. (Transposition of the Directive is required before 2010 within the EU. The amendments to the RS Law on Banks incorporate provisions of the EU Consumer Credit Directive13.) However, as the European Commission (EC) has pointed out, most consumer protection directives require only “minimum harmonization.” As a result, EU Member States have often expanded their laws and regulations related to consumer protection. To provide a common framework, the Commission has proposed a new Consumer Rights Directive that would supersede existing Directives on Unfair Contract Terms, Distance Selling, and Doorstep Selling. (A Directive on the Sale of Consumer Goods and Guarantees would also be included, but this does not relate to financial services.) Financial education is also being emphasized in the program under development in the EU. In November 2007, the EC released its survey of over 150 financial education programs conducted in the 27 EU Member States14. An October 2008 report of the European Parliament identified measures to be taken to improve financial education throughout the EU. In its Communication on Financial Education, the EC noted it would conduct a comprehensive review in 2010 to evaluate the effectiveness of existing programs of financial education among EU Member States. 15 The BiH National Consumer Protection Program only vaguely follows the EU approach. The Annual National Program for 2009 has some 100 measures to be conducted throughout the year, but there is little or nothing in this program which deals with the financial sector generally or its banking segment in particular. One measure refers to the harmonization of regulations regarding consumer protection in line with rules, regulations and Directives in the EU, which indirectly could have an impact on consumer protection in banking services. Two specific tasks within this measure are somewhat related to banking consumer protection, namely: the need for equalization and standardization of information on financial services; and the need to raise the level of awareness and education pertaining to financial services An attempt to devise a State-level plan for consumer protection for the years 2010 to 2013 was rejected by Parliament and this proposed multi-year plan was shelved. However, some limited progress had been made in the area of financial consumer protection, especially in the RS. This include the adoption of the RS draft Law on Consumer Protection by the RS National Assembly; and the amendments to the RS laws on the RS Banking Agency, on Banks and on Other Financial Organizations, supported by the Coordination Committee for Supervision of the RS Financial Sector, which included provisions dealing with financial consumer protection16. 13 The same is incorporated in draft Law on Banks Federation BiH. 14 European Commission, Survey of Financial Literacy Schemes in the EU27, November 2007. 15 European Commission, Communication from the Commission: Financial Education , COM (2007) 808 final, available at http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:52007DC0808:EN:NOT 16 Same set of changes incorporated in draft Federation laws on banking agency, banks and microcredit organizations. 10 There is need to ensure higher levels of consumer protection in the BiH banking sector. For this purpose, enhanced consumer protection should be incorporated into laws, regulations and government policies regarding banking services, and civil society should be more fully engaged in financial consumer protection issues. The goal of the strategy should be to ensure consumer protection throughout all economic sectors, including financial and banking services. Background on Household Finances in BiH Households have become increasingly indebted, mostly with long-term obligations. Credit granted to households by financial institutions has more than tripled over the last six years. As of December 2010, household credit represented 26 percent of GDP, almost double the percentage by December 2003. Household credit granted with a maturity over one year increased from 13 percent of GDP by end-2003 to 24.5 percent by end-2008, and slightly decreased to 22.5 percent by end- 2010. Short-term loans (less than one year of maturity) represented about 11 percent of the total credit granted to households on average between 2003 and 2010 (see Table 1). Table 2: Financial Sector Credit to Households (balances in KM millions) Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Total credit to households 1,996 2,628 3,453 4,374 5,686 6,696 6,304 6,315 as % of GDP 13.56 16.64 20.40 22.69 26.11 27.09 26.26 25.79 Short-term credit 154 270 396 485 586 653 715 796 as % of GDP 1.06 1.71 2.34 2.52 2.69 2.64 2.98 3.25 Medium- and long-term credit 1,812 2,357 3,057 3,888 5,100 6,043 5,589 5,519 as % of GDP 12.50 14.93 18.06 20.18 23.42 24.45 23.28 22.50 Source: CBBiH Households also increased their exposure to foreign currency loans by 2008, not only in Euros but also in Swiss Francs, although such exposure decreased by 2010. Households’ exposure to foreign currency banking loans increased from 10.2 percent of GDP in 2007 to 11.1 percent in 2008. Since then, such exposure has decreased to 10.8 in 2009 and 8.4 percent in 2010 (see Table 2). About 80 percent of the exposure to foreign currency risk resulted from loans in Euros, with the remaining from loans in Swiss Francs (CHF). Foreign currency risk of household loans in Euros is mitigated by the existing currency board regime17. However, the strengthening of the CHF exchange rate has already caused problems to households with debt in this currency. According to the Central Bank, as of end-2010, one-fifth of CHF loans were classified as nonperforming. Table 3: Banking Sector Credit to Households by Currency and Maturity (as percentage of GDP) Maturity Dec-07 Dec-08 Dec-09 Dec-10 KM Euros CHF KM Euros CHF KM Euros CHF KM Euros CHF Short-term (<1 year) 0.36 0.05 0.00 0.28 0.03 0.00 0.19 0.03 0.00 0.20 0.03 0.01 17 Bosnia and Herzegovina’s currency board arrangement was determined as a part of the Dayton peace accords. BiH Convertible Marka was initially tied to the German mark and is now pegged to the Euro at a fixed exchange rate. Moreover, the Central Bank is obliged to maintain full backing in net foreign exchange reserves for aggregate monetary liabilities. 11 Medium term (1-10 years) 10.23 5.44 0.29 9.95 5.74 0.29 8.91 5.32 0.22 9.78 3.51 0.17 Long-term (>10 years) 2.99 2.81 1.57 3.52 3.32 1.68 3.77 3.63 1.60 4.45 3.11 1.61 Total 13.58 8.31 1.87 13.76 9.09 1.98 12.88 8.98 1.82 14.43 6.64 1.79 Source: CBBiH The result has been highly indebted households. According to estimates of the Central Bank, a person with an average income and a long-term housing loan spent around 47 percent of his or her income in 2008 and 2009 on the repayment of that loan. It is also important to keep in mind the level of indebtedness arising from debit and credit cards. The average debt per debit card in December 2009 amounted to KM 448 (57 percent of average net wages, which was an increase by 9.85 percentage points compared to 2008), whereas the average debt per credit card in December 2009 was KM 1,318, which represented about 67 percent of the average net wages. Publicly available statistics already show difficulties of households to pay their debts on time. The number of household loans reclassified as nonperforming loans significantly grew from 2007 to early 2010 (see Figure 1). Since then, the number of loans reclassified as nonperforming continued growing (especially loans in foreign currency), but at a lower rate. The value of non- performing household loans stood at KM 455 million at the end of 2010, and accounted for 7.2 per cent of total household loans. General purpose loans to households accounted for the greatest share (54 per cent) of non-performing loans. A 2009 Central Bank survey of the 7 largest banks showed that 25 percent of loans were for housing purposes, 5 percent for private entrepreneurship and 70 percent for no specific purpose, which could also be used for housing-related purposes. Figure 1: Number of Household Loans Reclassified as Nonperforming (as percentage of total household loans) Source: CBBiH, Financial Stability Report, 2010 The Central Credit Registry has also shown relevant delays in debt payments by households. In 2010, 22.5 percent of bank loans to households recorded a delay in payment (including a delay of merely one-day), a decrease of 5.5 percentage points from 2009. For credit cards, the percentage of delays increased from 18 to 21 percent in the same period of time (after being 44 percent in 2007). Delays in payment of loans from microfinance organizations continued growing and reached 52 percent in 2010 (see Table 3). Table 4: Household Debt with Non-regular Payment (as percentage of total debt in each category) 12 Category 2007 2008 2009 2010 Classical loans 29.6 25.4 28.0 22.5 Credit cards 44.2 19.5 18.3 21.3 Cards with deferred payment 27.4 4.7 13.4 3.9 Debit cards 17.3 8.0 17.5 10.3 Commission business loans 14.3 16.3 13.3 17.5 Loans from microfinance entities n.a. 20.5 43.1 51.9 Source: CBBiH, Financial Stability Report, 2007, 2008, 2009 There is also a potential risk for consumers who took on mortgages in 2006 and 2007, associated with the downward trend in real estate prices. According to the data submitted by the City of Sarajevo, the City of Mostar and the Municipality of Zenica, the purchase price per square meter of residential real estate doubled from 2005 to mid-2008. With such data from these and other communities, the real estate price index created by the Central Bank (Fisher Index) significantly increased in the same period. According to the statistics, the growth of long-term household loans preceded the growth of real estate prices. However, a decrease in the demand for real estate in the second half of 2008 resulted in the decline of new housing loans and at the same time a decline in the Fisher Index. The index price of residential real estate fell considerably from 208 by September 2008 to 189 by December 2009 (see Figure 2).This scenario provides a warning sign in terms of possible repayment problems in housing loans, if the declining trend in housing market prices continues. To the extent that the value of mortgage loans exceeds the underlying values of their corresponding residential properties, the banking sector would be destabilized by reason of borrowers’ unwillingness to repay their mortgages. Figure 2: Real Estate Prices and Household Long-Term Loans Source: CBBiH, Financial Stability Report, 2009, p. 37 Key Findings & Recommendations While BiH has adopted at least some relevant EU Directives, the prevailing legal framework for consumer protection in banking services is weak, as are the existing institutional structures and the little, if any, coordination that prevails among them. Therefore, there have been difficulties in addressing the issues facing consumers of banking products and services. 13 Throughout the new EU Member States, finding ways to build the necessary institutional structures within government and civil society has been a challenge. The new institutions require not only clear legal authority, but also adequate resources and staff to fulfill their mandates as provided by law or government policy. The Review recommends consideration of five key areas of reform. They are: 1) Strengthening the laws dealing with banking consumer protection, as well as the institutions responsible for banking consumer protection; 2) Improving consumer disclosure for all banking products and services; 3) Improving the business practices of banks when dealing with their retail customers; 4) Re-visiting the question of what dispute resolution mechanisms are appropriate for consumers of banking products and services; and 5) Expanding programs of financial education for adults and schoolchildren. Legal Reform and Institutional Structures While some progress has been made of late, the explicit BiH State legal framework for consumer protection in banking services is weak, unclear and inadequate. Unfortunately, the law does not provide clear consumer protection rules regarding any banking product or service, and the existing institutional arrangements do not ensure the thorough, objective, timely and fair implementation and enforcement of the rules that exist. The Consumer Protection Act of 2005 at State level ostensibly covers protection in respect of all manner of consumer products and services in BiH, including those provided by commercial banks. Following at least some essential elements of the term “consumer” as defined in the EU, a “consumer” is “any natural person who buys, acquires or uses products or services for his or her personal needs or for the needs of his or her household”. A “trader” is “any person who directly or acting as intermediary of other persons supplies products or services to the consumer”. Chapter 11 attempted to transpose the EU Directive on Consumer Credit 1987/102/CEE. However, there is wide consensus that the definition of “consumer credit” is too broad and unclear. Many also believe that there should be a ceiling on the principal amount for any consumer credit and the definition should be restricted to loans solely for the purpose of buying an identified or identifiable product. The provisions of Chapter 11 are particularly weak, unclear and inadequate when viewed in the context of the EU Consumer Credit Directive dated 7 April 2008. Thus, the State Consumer Protection Act should be amended so that either the provisions dealing with financial services are improved following the EU Consumer Credit Directive, or such provisions are carved out and specific financial consumer protection legislation is left to the authorities at the Entity level. Given that the Entities, so far at least, have not harmonized their legislation or regulations with the Consumer Protection Act, consumer protection legislation, per se, only exists at State level. Although the Consumer Protection Act required the Entities to “harmonize their laws and regulations” with it within 6 months of its taking effect (i.e. by August 2006), neither Entity has, to date, taken any formal steps regarding consumer protection generally or regarding banking services in particular. The Republika Srpska (RS) is, however, now in the process of enacting 14 consumer protection legislation.18 In addition, provisions on consumer credit based on the EU Consumer Credit Directive, have been included in the draft amendments to the RS Law on Banks19. Regrettably, there is no institution with a clear legal mandate and the required institutional capacity to deal with consumer protection issues in banking. There is neither a single general consumer agency nor any specialized agency at any level of Government that is responsible for: (i) implementing, overseeing and enforcing consumer protection, whether generally or with respect to banking services, as such; and (ii) collecting and analyzing data on consumer communications (including complaints, disputes and inquiries) regarding banking services. A Consumer Protection Council is established under the Consumer Protection Act. This Council is chaired by the Deputy Minister of Foreign Trade and is made up of representatives of various institutions at State, Entity and District levels, including the BiH Competition Council, the Ministry of Trade of the Federation of Bosnia and Herzegovina (FBiH) and the Ministry of Trade and Tourism of RS, as well as two representatives of the Union of the Bosnia-Herzegovina Consumer Associations. Although required by the Act to meet at least four times per year, the Consumer Protection Council has consistently failed to do so. The Council has no staff and little budget. Still, it has managed to carry out its primary obligation, namely the production of the National Annual Consumer Protection Program for adoption by the BiH Council of Ministers, even though this Program has no direct bearing on matters of consumer protection in the financial system, including the commercial banking sector. In addition, the Council defines the volume of consumer protection activities to be financed or co-financed from the budget of the State. The Consumer Protection Act also established the State-level Consumer Ombudsman. Its purpose is “to promote good and effective implementation of consumer protection policy in BiH”. With a full-time staff of four, a total annual budget of KM 400,000 and responsibilities in respect of all aspects of consumer protection, it is remarkable that this institution has managed to devote any of its energies to matters of banking. In particular, in April 2009, the Consumer Ombudsman issued 16 Guidelines and Recommendations in the Sector of Consumer Loans following a media campaign regarding the so-called “loan-sharking” activities of BiH commercial banks, which unilaterally raised their interest rates on floating-rate loans when EURIBOR was decreasing. At both Entity levels, there is a Banking Agency that reports to the Central Bank of the BiH and has responsibility, inter alia, for licensing and supervising all commercial banking activity within the geographical territory of the Entity. Reacting to the media campaign early in 2009, as well as the ensuing lawsuits, both Banking Agencies issued Decisions which, among other things, now require commercial banks to “clearly define conditions” in their floating-rate loan agreements regarding the potential adjustment of the interest rate. No one is satisfied, including the Banking Agencies themselves, however, that such language provides an adequate level of guidance for commercial banks and consumers alike. Also, in March 2011 the RS’ National Assembly amended their Law on the Banking Agency of the Republika Srpska and established an Ombudsman within the Banking Agency as an independent organizational unit with the role of promoting and protecting the rights and interests of consumers of financial services.20 18 In October 2011 the RS Government adopted the draft Law on Consumer Protection in Republika Srpska, prepared by the RS Ministry of Trade and Tourism. There is no reference to the State Consumer Protection Act in the RS draft Law. The draft Law includes a specific chapter on electronic payment instruments, and other articles that explicitly refer to financial services, products and institutions. 19 The same principle followed in draft Federation BiH laws. 20 Also, in September 2011 the RS Government adopted a draft amendment to the Law on Banks of RS, 15 Inspectorate Offices also exist in both Entities. These offices are empowered to respond to any complaint from a citizen regarding the lack of application of any law. They do so by first carrying out inspections of the institution or institutions allegedly at fault and then resolving whether the allegations are well-founded. If such a finding is made, these offices levy fines under legislation at Entity level or, at least until the power to do so is resolved by the courts, at State level or both. The Inspectorates in both Entities have recently conducted investigations pursuant to the terms of the Consumer Protection Act (as well as the Law of Obligations in the case of FBiH) on the basis of non-compliance by banks as a result of the exercise of their unilateral contractual power to increase interest rates on floating-rate loans if, as and when they want21. Since in many cases in both Entities a finding of fault has ensued, the Inspectorates in both instances have imposed fines on the commercial banks in question, as well as on the individuals responsible for the transgressions inside the banks, whether under provisions of the State-level Consumer Protection Act or the Entity-level Law on Misdemeanors or both. Whether an Entity-level institution has constitutional jurisdiction to take any action to enforce a State-level law is, however, disputed and the matter is still pursued in second-instance courts. The Review suggests four options to strengthen the institutional framework for enforcing laws and regulations regarding banking consumer protection and for developing consumer protection policies. The four options are: (1) the Banking Agencies play a far greater role in consumer protection in banking services; (2) the Consumer Ombudsman sets up a specialized unit, or at a minimum, hires specialized staff with expertise in banking services; (3) a specialized banking (or financial) consumer protection agency is established; (4) the Central Bank sets up a special office for consumer protection issues. Each option has its advantages and disadvantages. The first option, namely expanding the supervisory role of the Banking Agencies in terms of consumer protection (not including settlement of consumer disputes), would require the Banking Agencies to conduct not only prudential but also in-depth business conduct supervision over banks. Many financial supervisory agencies in Europe, such as in the United Kingdom, Ireland, and the Czech Republic, have chosen this option as the most efficient. Although conflicts of interest between prudential and business conduct supervision inevitably arise, banking supervisory agencies elsewhere have found that putting the two roles together provides valuable information and early warning for the purpose of banking services supervision. This measure has already been implemented by the RS Banking Agency, following up on the March 2011 amendment to the Law on the Banking Agency of RS, which added as mandate the “adoption of secondary legislation and taking of measures for the purpose of ensuring protection of consumer rights, i.e. natural persons using the financial services of the banking system, supervision of the implementation of regulations in this field and taking of other steps and relevant measures within its competence”. The second option, namely setting up a special banking services unit within the Consumer Ombudsman, would require additional budget to expand the existing premises and staff and provide necessary training. For this, technical assistance from EU Member States may be helpful. The third option, namely a separate financial consumer protection agency, would be the most difficult to achieve, but it has already been adopted in Canada and by the Obama administration for the United States. The fourth option would build on the reputation of the Central Bank as a highly respected institution and would require it to set up an office to collect complaints about banking services, forward them to institutions responsible to handle them (such 21 The FBiH and RS Inspectorates alleged that these clauses were unfair by creating significant imbalance between the rights and obligations of contracting parties to the detriment of the consumer. It was maintained, therefore, that violations of Articles 94 and 95 of the Consumer Protection Act had taken place. The FBiH Inspectorate also argued that those terms in loan agreements did not meet the test of “equality of the parties” as required by Article 11 of the Law on Obligations. 16 as an ombudsman, mediator or consumer protection agency), analyze complaints looking for potentially systemic issues, and advise the Banking Agencies on common problems that arise from complaints. The starting point could be expanding the roles of both Banking Agencies to include consumer protection in addition to prudential supervision. The Review recommends that emphasis be given to the first option—expanding the mandates of the Banking Agencies to include consumer protection. This is particularly relevant in the current context where the RS Banking Agency has already expanded its mandate to cover consumer protection.. In this scenario, the Banking Agencies should face intense accountability for how they balance their work in order to make sure that they deal with both functions properly. It is also important that both Banking Agencies coordinate the implementation of consistent regulatory and supervisory measures to minimize regulatory arbitrage. In any case, a proper coordinating mechanism between the Banking Agencies, the Banks’ Association, the Consumer Ombudsman and involved consumer associations should be put in place to ensure proper exchange of information, mutual education, as well as expanded and effective dissemination of information to consumers. The Banking Agencies should focus on improving the understanding of the banking sector by the Consumer Ombudsman staff, while the Consumer Ombudsman should focus on explaining the importance of consumer protection alongside prudential supervision to secure a well-functioning and stable banking sector. The legislation provides for an active role for consumer associations. The Consumer Protection Act allows consumer associations as non-profit NGOs to play an active role in representing and protecting consumers, independently of traders and service providers. Each consumer association is to: (1) ensure protection of individual and collective consumer interests; (2) provide consulting services and other types of assistance for the purpose of exercising consumer rights; (3) inform consumers about prices, quality, control and safety of products and services on the market or to be on the market; and (4) cooperate with all competent bodies, inspections, other consumer associations and other subjects in BiH in charge of consumer protection. In practice, however, consumer associations operate on a voluntary basis with meager funding from State and Entity budgets. Given the existing constraints, consumer associations are not able to assist consumers adequately and, in respect of banking products and services, they have played a very limited role (although still important to orient and advise financial consumers). Nevertheless, consumer associations should be strengthened. Once BiH’s current budget crises are over, the Ministry of Foreign Trade at State level and the Ministries of Trade at Entity level may wish to consider providing some project funding for consumer associations to help consumers of banking products and services. 22 This is the approach taken by Slovakia, for example, which has been providing a total of 2 million Euros annually for consumer associations. Another approach would be to allow consumer associations to generate their own funds. In Russia, for example, where the confederation of consumer associations (KonfOP) litigates cases on behalf of consumers, KonfOP is permitted to retain one-half of court-awarded damages or compensation. A similar approach might be effective in BiH. 22 The draft RS Consumer Protection Law indicates that funds from the RS budget may be planned to support and promote the work of consumer associations that are registered under the RS Ministry of Trade and Tourism. Funds would be awarded based on a public tender and following on criteria stipulated by the Ministry. Fundable areas include operation costs of consumer associations, consumer protection projects and dissemination initiatives (e.g. workshops, brochures, educational materials). 17 Consumer Disclosure At the foundation of effective consumer protection in banking products and services is consumer disclosure. Banks 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. 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. They can also compare other products from different banks so as to find the best one to meet their needs. Clear laws and regulations, which are effectively applied and enforced, are needed to ensure meaningful disclosure of consumer banking products and services. 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. The Consumer Protection Act provides some requirements on disclosure and the calculation of the total cost of a consumer credit, but this is not sufficient. Prior to entering into a contract, the consumer must receive written information about the terms and conditions of the contract, including in respect of credit agreements: the net amount of the credit; the total cost of the credit; the terms and conditions for early credit repayment; the terms and conditions for the termination of the contract, including in case of default by the consumer; the interest rate for the credit in annual terms; the terms and conditions, if any, regarding changes to the annual interest rate; insurance costs for the outstanding debt or any other insurance concluded pursuant to the credit agreement; and the assets or promises to pay to be provided by way of collateral or guarantee. The total cost of the credit to the consumer includes “all charges, interest and other expenses to be paid”. However, the Act does not require calculation (or publication) of the Annual Percentage Rate of Charge (APR) that allows consumers to provide an effective comparison of effective interest rates among lenders. Transposition of the 2008 EU Directive on Consumer Credit into BiH law would require disclosure of the APR and other key terms for borrowers of consumer credits.23 A standardized Key Facts Statement for each type of standard retail financial service would help consumers understand the essential conditions of their contracts. For all commercial bank products and services, consumers need a short, standardized, description written in plain language that is comparable across products provided by different banks. A Key Facts Statement for each type of retail service would provide such standardized information for consumers. The format for key facts disclosure should allow consumers to identify easily and quickly the key terms and conditions of bank products and services. Requiring that all banks prepare their offers for commonly-used retail products and services in a standardized format would further facilitate the ability of consumers to compare offers from various banks. And this would ultimately increase transparency and competition in the banking system.24 23 The draft amendments to RS Law on Banks incorporates provisions of the EU Consumer Credit Directive, including requirements to disclose key information prior to entering into a contract, such as the effective interest rate (Article 98d lists 19 items and allows the Agency to add more). Also, Article 98j states that the effective interest rate shall include all costs of the financial service, be expressed as a percentage of the total annual amount of the service, be specified in compliance with the methodology prescribed by the Agency – which has not been included in the draft Law—and be made available to the public in a standard manner. 24 The draft amendments to RS Law on Banks requires banks to inform consumers on terms, conditions and key characteristics of their financial service via a “standard information leaflet” in a hard or electronic copy (Article 98d). The draft indicates a list of items that the leaflet should include, and requires that all items be written with the same font size and equally readable. No specific format has been developed though. 18 For consumer credits, ten different areas should be covered. The Key Facts Statement should summarize in no more than a page or two all key terms and conditions of the specific product or service being provided. This would include (1) the 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 particularly 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; (9) if any additional insurance (such as personal mortgage 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; 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 in question. If the credit is being provided by a retailer to finance a consumer product, such as a television or washing machine, the consumer should also be advised of the cash price of the product without financing charges. Special attention should be paid to credit card disclosures, where consumers need to be clearly informed of the financial impact on them of paying only the minimum amount due. 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 bank should be obliged to ensure that its Key Facts Statements include no incorrect or materially misleading information. Special risks should also be disclosed to consumers. For any credit secured by real property (such as a house or apartment), the mandatory disclosure should note that in the case of default, the lender could ultimately seize and sell the property. In addition, for any loan denominated in a foreign currency (such as Euros or Swiss Francs), the mandatory key facts disclosure should contain a warning that changes in exchange rates could increase the total amount of debt. The Key Facts Statement should also note that, for variable interest-rate loans, the interest rate could vary, depending on the level of the underlying base rate. 25 It is recommended that the standard formats for Key Facts Statements be developed by the Banks’ Association. 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 should develop a standard format that would allow banks to prepare Key Facts Statements efficiently and which would be reviewed by the Banking Agencies. For house purchase loans, the Banks’ Association should adopt the ESIS. 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 should formally adopt the format of Key Facts Statements and encourage its member banks to use this Key Facts format. In addition, at the time of onsite supervision, the Banking Agencies should review the pre-contractual information provided by banks to their retail customers, including these Statements. 25 The draft amendments to RS Law on Banks states that the standard information leaflet shall include a warning about the consequences in case of failure to meet liabilities as well as information on the agreed variable nominal interest rate (e.g. reference, value, periods in which it could change and manner of change). The draft law also requires a bank to bring the consumer’s attention to foreign currency and other risks assumed in foreign currency transactions and, at the request of a consumer, to explain the specific risks that a financial service may have on his/her economic position (Article 98đ) 19 Tariff surveys showing comparison pricing of banking services would also be helpful. Surveys of offered prices for standardized services could be conducted by the Banks’ Association, consumer associations or some public institution. It would be best, however, if such surveys were independent and not influenced by sponsorship and conducted regularly (so that a long-term database would be built). Alternatively, the Banks’ Association or the Banking Agencies could set a format for disclosure and commercial banks could then be required to provide the data to the public. Currently, the Banking Agency of Republika Srpska publishes comparison tables of costs of financial products offered by banks and microcredit organizations. Standard contracts, or at least standard clauses in contracts for consumer financial services, could be developed by the Banks’ Association in consultation with the Banking Agencies. Although concerns have been expressed elsewhere that standard contracts are prima facie unfair because they typically are not discussed, clause by clause, by a bank with a consumer before being signed, for the consumer, the only choice is to accept the terms of the contract without modification or to forego the loan being sought. Standard clauses could, therefore, protect the bank while being fair to the consumer. If the phrasing is developed by the Banks’ Association and approved by the Banking Agencies, the standard clauses should presumably meet the test needed to satisfy banks as well as consumers. Still, standard contract clauses should also be tested in order to ensure that the average consumer understands them correctly.26 Standard clauses may also protect banks from the risk of legislative changes. In response to public outcry, the Banking Agencies rendered Decisions in 2009 regarding the need for clarity on the part of banks in defining conditions for interest rate adjustments in respect of floating interest rate loans. Even though no guidance has been given on what “clarity” must consist of 27, the attempted revision of what amounts to consumer protection regulations in this way could likely have been preempted had banks consistently used standard clauses that already had the combined approval of the Banks’ Association and the Banking Agencies. In the current context of discussions regarding adjustment of floating interest rates for consumer loans, banks and consumers would welcome better guidance from the authorities. It is recommended that technical discussions on this matter be led by the Central Bank and include representatives of all stakeholders in order to arrive at language which is elastic enough to permit the continuation of strong competition in the BiH banking system, but tight enough to give assurance to any consumer on the extent of his or her risks in entering into a floating rate loan. A suitable reference point for purposes of commercial bank lending in BiH should be established by technical experts as a matter of priority. And once this is done, it is suggested that consideration be given by the Banking Agencies to requiring all banks to state in their floating rate loan agreements: (a) their own caps (upward and downward) on each adjustment to the rate; (b) the basis on which the rate can be adjusted, as linked directly to the appropriate BiH reference point referred to above; (c) the minimum interval between any adjustments; and (d) the maximum cap (upward and downward) that the interest rate can go during the life of the loan.28 26 A step towards standard contract forms was made in the draft RS Law on Banks, which established minimum contents for several types of contracts. 27 However, the draft amendments to RS Law on Banks indicates that the variable elements of floating interest rates shall be officially published (reference interest rate, consumer price index, etc.) and “may not be influenced by the unilateral will of any of the contracting parties” and that the bank shall publically disclose data on the trends of values of such agreed variable elements (Article 98j). 28 The draft amendments to RS Law on Banks requires banks to include in their variable rate loan contracts the variable elements on which the rate is calculated, their amount at the moment of entry into the contract, periods in which it will be changed and the fixed element (Article 98z). The draft law also states that a bank 20 Business Practices A greatly expanded code of conduct, or consumer protection code, could also help to improve the practices of commercial banks vis-à-vis their retail customers. While a code of conduct has already been developed by the Banks’ Association, this code is not well -known, even to the members of the Association. The value of any code of conduct is, of course, its widespread distribution so that consumers know that, in principle, banks have themselves agreed to provide minimum levels of service and to respond to individual consumer’s complaints and disputes. The code of conduct should be placed in all bank branches and on the websites of all commercial banks. Consumers should be advised that if a bank fails to comply with the code, a complaint can be submitted to the bank, the Banks’ Association and the relevant Banking Agency. There should be a strong mechanism to investigate breaches of the code of conduct, including the possibility that these breaches will, at the very least, be publicized and that the Banking Agency in question will use these breaches as warning signals for further issues to look at in carrying out its supervision of commercial banking activities.29 The application of a policy of “comply or explain” could be useful to strengthen the enforcement of the code of conduct. Under this policy, the bank would be assumed to be complying with the code of conduct. Otherwise, the bank would have to explain its reasons for non-compliance. Non-compliance and non-explanation would be considered a misleading business practice and be subject to sanctions as such. The same policy could be applied to standard contracts, where the need to deviate from a standard contract provision on, say, the basis for interest rate adjustments, would have to be explained. It would be advisable to place a 14-day cooling off period on the purchase of all financial services subject to high-pressure sales tactics and with a long-term savings component. The EU Directive on Distance Marketing requires that contracts in respect of all financial services sold by telephone or over the internet in the EU have provisions for a 14-day cooling-off period to allow the consumer to change his or her mind and cancel the service without penalty. Similarly, the EU Consumer Credit Directive, approved in 2008, includes a 14-day cooling-off period. Neither of these Directives has been yet, however, transposed into law in BiH30. They should be for the simple reason that cooling-off periods are an important mechanism for protecting consumers from high pressure sales tactics. They should be established for all banking products and services which include a long-term savings component (and thus large commissions for sellers of the products or services in question). However, one caveat is in order. Some financial services involve market risk, for example, on a mortgage where the lender locks in a fixed funding cost and must unwind the contract if the service is later cancelled. For contracts with such types of market risk, consumers shall not change the variable rate in dates different than those agreed, and shall adjust the rate based on the value of the reference rate specified in the contract, as published on the agreed date for the rate adjustment. 29 The draft amendment to RS Law on Banks requires each bank to elaborate “general business conditions”, specifying the standard business conditions that the bank applies to consumers, the process of communication between bank and users, as well as conditions for transactions such as loan approval, receipt of money deposits, handling of accounts, issue and use of payment cards. These conditions should be published in one of the RS official languages in the media, on the bank’s website or in the business premises, 30 The draft amendment to RS Law on Banks and draft RS Law on Consumer Protection cover several provisions from the EU Directives on Consumer Credit and Distance Marketing, respectively, although the cooling-off period for contracts concluded outside of business premises is . 21 who cancel their contracts during the cooling-off period should be required to compensate the financial institution for any out-of-pocket losses. The Banking Agencies should strengthen the requirements for administrative procedures regarding account handling and maintenance, as well as requirements of due diligence when offering a product or service to a consumer. Across the banking sector, detailed administrative procedures need to be fixed for such matters as the distribution of customer account statements by mail. 31 There should also be clear rules requiring banks to gather, file and record sufficient information from consumers and ensure that any product, service or recommendation that is being offered by a bank to a consumer is appropriate to that consumer. There should be a requirement for any loan officer to verify the creditworthiness of a consumer before a loan is made to that consumer.32 The credit registry of the Central Bank and the LRC credit bureau are valuable tools for lenders, and when employed appropriately they could prevent the over-indebtedness of consumers. The law should explicitly indicate the cases where bundling of a product or service is permissible, and require full disclosure in the event that any accompanying service is offered to a consumer in the context a consumer credit. Emphasis should also be placed on strengthening the training and certification of those who interface with the retail public. Officers who work in banks are generally respected by the public, and consumers of banking products and services tend to rely on the advice provided by officers of commercial banks. In BiH, each bank is responsible for the training and certification of its own staff who work with retail customers and no other training or certification is required by the Banks’ Association or either of the two Banking Agencies. In their disputes, however, consumers typically complain that the responsible officers of a bank were unable to adequately explain the services being sold. One way of eliminating abusive practices would be to set a two-tiered level of training for the staff of commercial banks. For those who sell only simple services, training by the bank would be sufficient. However, staff members who sell complex financial products to retail clients, would be required to attend training provided by the Banks’ Association, with a curriculum approved by the applicable Banking Agency. Banking Agencies should issue and monitor regulations on advertising practices, requiring banks to be responsible for any statements made in their advertisements and providing basic guidance on format and content of advertisements. Commercial advertising, including that of banks, is regulated by the Consumer Protection Act, but the Act does not clearly designate the competent authority to enforce the provisions on advertising. The Banking Agencies should issue regulations covering advertising practices and, at least from time-to-time, review banks’ compliance with such guidelines. Banks should be responsible for offers they make in their advertising, whether by means of newspaper, radio, television or otherwise. Banks should also bear responsibility for actions their agents make when advising or offering a product or service to consumers. It may also be helpful to require that all banks state in their advertising that they are regulated by one or both Banking Agencies. Requirements on minimum font size should also be issued. In many countries, credit institutions place large-font advertisements claiming zero percent borrowing rates and hide the APR in small font, fine print; or they disclose key information in small print in an advertisement that moves quickly at the bottom of a television screen.33 31 The draft amendment to RS Law on Banks only requires monthly statements for overdraft accounts, whereas for other products statements are only required to be submitted once a year free of charge. 32 Article 98l of the draft amendment to RS Law on Banks requires banks to assess the creditworthiness of the consumer (and the guarantor) prior to the entry into a loan contract. 33 The draft amendments to RS Law on Banks requires banks not to use inaccurate, deceptive or misleading information in advertisements, or information that would damage competitors (Article 98g). The Agency 22 The credit reporting system should be further strengthened. The Central Registry of Credits maintained by the Central Bank was established in 2006 with access limited solely to banks. Currently, the registry provides information from and to commercial banks, micro-credit organizations and savings-credit organizations, as well as those leasing organizations, insurance organizations and other entities that request to be included in the registry. However the level of coverage is estimated at approximately only 25 percent of the adult population. In addition, LRC is a private credit bureau that gathers information from banks, micro-credit organizations, insurance companies, leasing companies, public utilities, and private companies selling goods on credit. The data in LRC is not consolidated with that of the credit register, and not all financial institutions have contracts with LRC. However, there is no specific legal or regulatory framework for the operation of credit bureaus in BiH. Improved regulation and supervision of the credit reporting system is needed. The Personal Data Protection Agency was recently established as an autonomous institution, and is currently evaluating the requirements needed by the Central Bank to operate the credit registry legally under the Law on the Protection of Personal Data. The Agency has also started to conduct inspections on the data processing systems of credit institutions. There is no legal framework that specifically governs the credit reporting system and no specific procedure to deal with consumer complaints related to the accuracy of information contained in credit histories. Improved regulation is also needed for debt collection agencies. Throughout central and eastern Europe, the rise of consumer finance has also resulted in an increase in the number of companies collecting bad debts on behalf of creditors. While few banks in BiH apparently employ the services of debt collectors (preferring to keep this work “in-house”), debt collectors may in future play a valuable role, providing a way in which lenders can sell non-performing loans and thus increase liquidity in the financial system. Similar to all financial institutions, however, debt collectors should be subject to a minimum level of business conduct supervision. In BiH, debt collection agencies are not required to be licensed or even registered with any financial supervisory agency. At a minimum, the leading debt collection agencies should establish an industry association that lists the companies that are association members. An association of debt collection agencies should also adopt a code of conduct in order to establish minimum acceptable rules of conduct for debt collection agents following the Code of Ethics and Code of Operations of ACA International, the Association of Credit and Collection Professionals. It may be helpful to build on the establishment of the pilot debt counseling center in Tuzla. Like many central and eastern European countries, BiH has yet to enact legislation on personal bankruptcy. Such a law is required in order to provide an important option for heavily indebted consumers. However, prior to applying for any possible future bankruptcy protection, a heavily indebted consumer should have access to a counseling center that can provide advice before he or she applies to the court for bankruptcy protection from his or her creditors. In the United States, the 2005 revisions to the Bankruptcy Code34 require that before applying for bankruptcy, consumers must attend counseling sessions on various legal alternatives available to them. Such mandated counseling often has little impact on the behavior of US consumers. In countries that lack a long tradition of consumer finance, however, such mandatory training has proven to be helpful for consumers in reviewing their financial options. may sanction non-compliant banks and prohibit banks from entering into a contract with a consumer if advertisements did not include the standard information leaflet or the general business conditions. 34 The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Public Law No. 109-8, was enacted on April 20, 2005 and revised Title 11 Bankruptcy Code of the United States Code. 23 Dispute Resolution Finding effective and fair ways of resolving disputes between banks and their retail customers lies at the heart of effective consumer protection in banking services. For most retail customers of banks, the amounts involved in a dispute are relatively small (generally under Euros 500 equivalent). The failure to resolve disputes quickly, efficiently, transparently and professionally, however, undermines public confidence in banks and reduces the trust that is needed by banks if the financial sector is to be stable and resilient. Most banks in BiH do not have specific procedures, let alone specific departments, to deal with consumer complaints. Most banks still do not have a designated office, such as a public relations division in the retail department, which is responsible for receiving complaints from retail customers. And even in those instances where such offices exist, the contact information for the department is typically not well publicized. All BiH banks should be obliged to maintain, and to publicize the existence of, a consumer complaints department. All banks should be required to designate a department (or at least an officer) who is officially responsible for receiving and addressing consumer complaints, as well as the contact information with telephone number, fax number and email address provided in writing to consumers when they open any bank account or apply for a loan. In addition, as part of its work on prudential supervision, the Banking Agencies should request from all banks quarterly statistics on the number of consumer 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 to the complainant by the bank.35 When the response of a bank to consumer complaints is not satisfactory, banking 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. Banking customers submit complaints to any (or all) of several institutions: (1) the Banking Agency at the Entity level, (2) the Central Bank of BiH, (3) the Inspectorate at the Entity level, (4) the Consumer Ombudsman, (5) a consumer organization, and/or (6) the Banks’ Association. In none of these cases, however, can the institution in question provide any remedy for an individual consumer. The Inspectorate, for example, may carry out an inspection of a bank to verify whether the bank has complied with relevant legislation, and may even seek to impose fines on the bank and its “responsible officers”, but the Inspectorate’s efforts cannot directly bring relief to any customer, as such. Rather, in pursuit of a remedy to compensate individual consumers, these institutions themselves must have recourse to expensive, time consuming and less than predictable procedures in the courts which act as a major disincentive to a consumer taking any formal steps in the event that informal settlement discussions with his or her bank have proven fruitless. Statistics on complaints submitted to government agencies should be analyzed and published. Complaints represent an “early warning signal” for potential issues throughout the banking system. While the lack of a standard complaints procedure means that claims are submitted to any of several agencies, it appears that the Banking Agencies receive the bulk of individual complaints. When these complaints are presented to the Banking Agencies, however, they are more or less automatically transferred to the office of the Inspectorate in the relevant Entity for the simple 35 The draft amendment to RS Law on Banks addresses some of these issues by requiring banks to adopt written complaint handling procedures and processes, to submit a response to the complainant no later than 30 days after the complaint, to keep up-to-date records, and to report on this to the Agency (Art. 98č). 24 reason that the Banking Agencies, themselves, are in no position to commence any formal proceedings on behalf of any one or more consumers. Statistics, however, are not consolidated. Nor are they analyzed in a systematic way by any agency at State or Entity level in order to determine the common sources of complaints. Table 4 provides the number of complaints submitted to various institutions at State level and in the two Entities from January 1 to June 30, 2009, July 1 to December 31, 2009, and January 1 to June 30, 2010. Table 5: Consumer Complaints regarding Financial Services in BiH Source Number of Complaints 2009 2010 State of BiH Consumer Ombudsman 10736 110 Federation of BiH Banking Agency 630 690 Inspectorate 312 Major consumer NGO 50 Republika Srpska Banking Agency 20 103 Inspectorate 61 100 Major consumer NGO 25 Sources: Meetings with institutions Consumers need a central body, where they can submit their inquiries, complaints and disputes and can promptly receive an answer, advice or just additional information. As an initial step, the Banking Agencies should maintain a log of all telephone calls, as well as telephone, letter and fax complaints and analyze the nature of these complaints. Based on this analysis, the Banking Agencies should set up programs that address the common features of these concerns, by providing additional consumer education and working with local government administrations to provide advice to consumers in local centers. Another option would be for the Central Bank to set up a consumer office to handle, forward and analyze complaints, and to advise the Banking Agencies on the main problems arising from complaints. Official bodies should then take measures to help consumers become aware of their legal rights in case of complaints with banks. Consumers should be clearly informed of their rights to complain to a bank or to the applicable Banking Agency (or Central Bank) in case they are not satisfied with the response offered by their bank. In the RS, one of the tasks of the recently created Banking Agency’s Ombudsman is the “provision of information on the rights and obligations of users and providers of financial services” (Article 4b (a)). One approach would be to create brochures that describe consumers’ legal rights in simple and plain language and provide information on how to contact the relevant agency. The Banking Agencies (or Central Bank) may wish also to establish a toll-free hotline, available anywhere in their territorial jurisdiction, where consumers can call and obtain basic information about their legal rights. The Banking Agencies (or Central Bank) 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. 36 In 2009, the Consumer Ombudsman received some 1200 inquiries and requests for information concerning the banking sector, 107 complaints indicated here all pertained to allegations of unfair treatment of consumers by their banks and this sum was the total for all of 2009. All but nine of these cases were resolved in 2009. In addition, in 2009 the Consumer Ombudsman’s office referred 65 banking sector complaints to the relevant Entity’s Inspection Department. 25 A key issue for the relevant agency handling consumer complaints should be to record and separate different types of complaints. Complaints may take several forms. In most countries, the bulk of complaints turn out, in fact, merely to be inquiries, where, for example, a consumer wants to know why his or her bank has refused to extend the credit requested. Or, a consumer may want to know about his or her legal rights in case of being laid-off a salaried job, with the potential need to seek a few months of grace until a new job is found. Other complaints are based on issues of fairness: a consumer may believe that his or her bank is behaving inappropriately, say, by charging too much for a consumer credit. Yet still other complaints amount to a clear legal dispute, where the consumer has a different interpretation of a loan agreement than does his or her bank. 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. One option would be to encourage the use of mediators in banking services. The institution of mediation has recently been developed in BiH, especially after the enactment of the Law on Mediation Procedure in June 2004, and the establishment of the Association of Mediators in 2005. Over time, consideration should be given to establishing an independent ombudsman for retail banking to address increasing number of consumer complaints. While an Ombudsman exists in respect of the insurance industry, no such office exists for the banking system despite its far greater significance to the BiH financial sector. There is a proposal of a statutory banking ombudsman drafted by the banking association, to be taken into consideration. Such an Office should be completely independent of commercial banks and their customers and established by law so as to render binding decisions on banks at least when the amount in dispute is below a certain level. The recently amended RS Law on the Banking Agency created an Ombudsman within the Agency as a functionally independent unit with the objective of ensuring fair and fast resolution of complaints and disputes between banks and consumers “through agreement, mediation or another amicable manner” (Article 4a). In this process, the Ombudsman shall apply regulations on mediation procedures, and may hire specialists or mediators if needed. The written settlement agreement reached by the parties in dispute has the legal force of an executive act (Article 4v). The question of establishing an independent statutory banking services ombudsman needs careful consideration, however, with a complete review of the costs and benefits. Assuming costs do not outweigh the benefits, a clear system should be established for the sustainable funding of such an office. In countries where institutions have been established to address complaints regarding retail banking services, the number of complaints generally increases significantly, as has been seen, for example, in the years after the establishment of the UK's Financial Ombudsman Service (Table 5). Table 6: Consumer Complaints Received by European Complaint Services in 2007 Complaint Service Number of Complaints United Kingdom Financial Ombudsman Service 116,600 Italian Banking Ombudsman 4,000 French Insurance Mediator 4,000 Belgian Insurance Ombudsman 3,400 Hellenic Ombudsman for Banking–Investment Services 1,500 Consumer Complaints Scheme of the German Association of 650 26 Private Building Societies Finnish Securities Complaint Board 250 Consumer Complaints Manager of the Malta Financial Services Authority 250 Source: European Commission, Alternative Dispute Resolution in the Area of Financial Services, Consultation Document, MARKT/H3/JS D(2008). Media coverage of consumer mistreatment could also play an effective role in disseminating and developing good practices, by “naming and shaming” banks that mistreat consumers , but media should first be properly trained in financial services. Journalists need to be educated to understand banking services and thus be able to cover the stories properly. Many are rightly concerned that this was clearly not the case in respect of those journalists who were determined in 2009 to carry out a smear campaign against all banks as irresponsible “loan sharks” which sought to maximize profits at the expense of consumers. Financial Education & Financial Capability In the long-run, one of the most effective forms of consumer protection is ensuring high levels of financial education and financial capability. A well-educated consumer will have a high level of financial literacy and, as a result, will be able to understand financial disclosures better and to weigh the risks and rewards of each type of financial service that is available. However, strengthening financial capability requires a long-term, coordinated effort among different actors. Financial education is needed throughout the country, not just in the major cities but also in rural areas where the range of available financial services may be limited. The number of financial education initiatives in BiH is limited. There are some isolated measures undertaken by government agencies and consumer organizations, as well as certain financial and private institutions. However, there is no coordination of activities, let alone a plan to develop a national strategy, on financial education. Some government agencies are starting to take into account the importance of financial education in the development of the financial sector, but more is needed. The Banking Agency of Republika Srpska has developed relevant informational resources available for consumers on its website. Information ranges from basic explanations of key financial terms to comparison tables of main products offered by each bank in RS. The Central Bank of BiH recently acknowledged the importance of developing financial education initiatives. In March 2009, on the occasion of the launch of ProCredit’s campaign “Days of Transparency”, the Governor of the Central Bank of BiH stated that the Central Bank supported the development of financial education throughout the population. In his words: “Financial education is an important segment of any bank’s business operations, and, hence, special attention needs to be devoted to it, so that the requirements referring to financial services use are more comprehensible, and clients protected and satisfied”. However, there are apparently no discussions yet at either the FBiH or RS Entity level regarding any aspect of a potential financial education program. Although a minimal component of consumer education and awareness related to financial services has been included as part of a European Commission project in BiH on Single Economic Space, no progress has yet been made. Some financial institutions have undertaken initiatives to improve consumer awareness of financial issues. One of the most active institutions is ProCredit Bank. In March 2009, ProCredit launched a campaign entitled “Days of Transparency”, with a leaflet entitled “How to talk to a bank” being distributed to make “banking business understandable to citizens and businessmen in the country”. The leaflet has been distributed to 45 business units of the bank across the country, 27 has been distributed with a daily newspaper, and is available for downloading from the bank’s website. The leaflet has four parts: (i) advice on how a consumer should select a bank that best suits his or her needs; (ii) basic information on credit products, such as available types of loans, costs related to a loan, collateral, the loan application process, and advice on how to act in case of a repayment problem; (iii) basic information on savings products; and (iv) basic information on current accounts and credit cards; as well as an annex with questions that banks consider relevant to be answered by a consumer before offering a product to that consumer. The project was funded by the European Fund for South East Europe (EFSE). Micro-credit organizations have started a project to establish a debt counseling center for consumers which will also provide financial education and financial advice for consumers. This Center for Financial Credit and Counseling (CFKS) is being developed as a pilot in Tuzla, with a view to its eventual replication in Sarajevo, Banja Luka, Mostar and Zenica. The initial stage of the project has been supported by IFC, EFSE and DFID in response to the initiative of six micro- credit organizations. However, the project aims to have the support not only of the micro-credit sector, but also of the banking sector and of government agencies. Consumer organizations are starting to play a role in educating consumers regarding financial issues. Last year, Putokaz, a consumer NGO in the Federation of BiH, was granted funds to print a small leaflet summarizing the main rights of consumers, based on the Consumer Protection Law. Plava Sfera, the largest consumer NGO in Republika Srpska, has printed leaflets with the full text of the Consumer Protection Law. These leaflets are available in the premises of the NGO to any consumer who asks for advice related to consumer protection. Plava Sfera was in the process of establishing a consumer research and information center in Banja Luka. As part of this project, Plava Sfera plans to produce additional leaflets on issues regarding credit cards and on how to read a banking product contract. In addition, CFKS is seeking to become a recognizable institution in the area of financial literacy throughout all of BiH. The aim is to ensure that each organizational unit of CFKS has a financial education department staffed with personnel capable of presenting material of practical benefit to consumers. Consumer organizations have also played a role in advising consumers who have complaints against banks. During last year’s wave of complaints against banks, Plava Sfera not only distributed its Consumer Protection Law leaflets to concerned consumers, it also assisted consumers in respect of their specific complaints by seeking settlements with the banks in question, and, when this proved futile, by redirecting complaints to the Inspectorate in RS. Plava Sfera apparently redirected some 25 complaints to the Inspectorate this past year. This past year in the Federation of BiH, Putokaz was contacted by approximately 50 consumers with concerns related to specific banking products and it helped at least some of these consumers draft written complaints against their banks. Consumer organizations should be strengthened and their role increased in consumer protection in banking and financial services. Consumer organizations have problems of stable sources of funding for the development of their daily activities and building of professional expertise. There are two umbrella organizations for consumer associations in each Entity, but these four do not have good coordination among them. Still, the work of Plava Sfera shows that consumer associations can play an important role in financial consumer protection. For example, with donor funding, consumer organizations could hire “mystery shoppers” who would write up their experiences when visiting a bank to ask for a credit or to open an account. These experiences could then be published on the consumer organization’s website so that consumers could compare experiences from different institutions. This would then be another mechanism to encourage banks 28 to treat all of their customers fairly, considering the risk of a bad reputation if one or more negative experiences were published online. Financial education in schools needs development. Primary schools in BiH provide no financial education for students. Such programs would help children understand at an early age that financial health is as important as physical health. In addition, education and training is also needed for adults. Provided through professional associations and financial institutions, such training should help consumers understand the terms and conditions of the financial contracts they sign. Training for adults should be focused on “teachable moments”, such as the time when a consumer becomes a first-time, long-term borrower. The commencement of planning for retirement is another useful “moment”. It may also be helpful to conduct “mystery shopping” to ascertain the issues that arise for consumers as they try to buy banking products and services and learn about the risks and rewards of different products. There is need to develop a national program of financial education. The National Annual Program on Consumer Protection does not include measures for financial education among its 100 lines of action. In its April 2009 meeting, the EU Expert Group on Financial Education suggested that the European Commission recommend that all New Member States of the European Union develop national strategies for financial education. BiH should take into account this recommendation and start to develop its own national strategy in these respects. Some limited surveys on access to finance of micro-credit clients and low-income households have been conducted in BiH in the past decade. The most recent effort was conducted in October 2008, with a study funded by EFSE and developed by the Microfinance Centre for Central and Eastern Europe and the NIS (MFC). The study included: (i) a quantitative survey conducted in the Tuzla Canton (in FBiH), applied to a random sample of 100 low-income households who had been using credit; and (ii) a qualitative study based on eight focus groups of low-income households conducted in Tuzla and in Foca (in RS). The study included questions in 3 key areas: access to financial services, customer protection and over-indebtedness. Questions touched upon household composition, availability of financial products, use of credit, transparency of information disclosed to consumers, adequacy of complaint resolution mechanisms, and the extent of indebtedness. The study provided information on the level of knowledge of certain financial concepts, complaints procedures, information provided to the credit institution, the level of trust in financial institutions, attitudes towards savings per household, among other matters. It therefore constituted a useful step in understanding the level of knowledge, attitudes and challenges of consumers of financial services, particularly in Tuzla (see Box 1). Surveys on a larger scale and with broader scope would be useful for purposes of understanding the situation of financial consumers across BiH. A national survey of financial literacy should be conducted as a first step in the development of a national program on financial education. A rigorous survey is needed as a starting point for developing a national education program. Several countries, including the United Kingdom, Ireland, Australia, Canada and Russia, have conducted nation-wide surveys of households assessing not only their levels of financial literacy, but also their values and behaviors (taken together called “financial capability”). Box 1: Main Findings of Survey to Low-Income Households in Tuzla Regarding access to and use of financial services, the survey showed that only 46 percent of households with any type of credit also had a bank account: 25 percent used debit card, 21 29 percent had credit card, 17 percent used SMS service and 16 percent paid bills via bank transfer). Most respondents neither used credit cards (79 percent) nor saved any money for future expenses (83 percent). Only 6 percent saved their money in the banking system, whereas 16 percent used to have a bank deposit account but not anymore. The main reasons for not saving money in a bank account were: not enough money to save (88 percent), need to have permanent access to money (18 percent), not having thought about it (18 percent). The most common reason why people did not use financial services of formal institutions was that they did not meet the eligibility criteria. In terms of consumer protection issues, the survey showed that households were satisfied with the disclosure of information on conditions of financial products and with the explanations and advice provided by the staff of financial institutions. However, the level of financial knowledge of respondents seemed low. The survey showed that 22 percent of credit users were not able to remember the nominal interest rate of the loan they were repaying. At the same time, respondents did not know how to calculate the effective interest rate when given the value of monthly repayments. Regarding complaints, two-thirds of respondents said they would know how to make a complaint against a credit institution, but the majority (87 percent) of respondents had never made one. The focus groups provided insightful information on business practices of specific credit institutions. In the opinion of the focus groups’ participants, most financial institutions do not warn clients the consequences of non-repayment of delayed payment. However, participants also recognized that most borrowers sign contracts before reading them. Regarding complaints, participants said that in practice credit institutions do not inform clients on complaints procedures. Only a few had complained to credit institutions, and the most frequent reasons were transactional mistakes and delayed disbursement of loans. In the area of indebtedness, according to the survey, the average amount of monthly debt repayment represented 28 percent of the monthly household income. For almost a third of households with housing loan, their monthly debt repayment exceeded 50 percent of their monthly income. 4 percent of respondents considered themselves as over-indebted (their monthly installments were higher than what they perceived as manageable), whereas 16 percent were close to reaching their self-assessed level of over-indebtedness. Source: EFSE, Microfinance Centre for Central and Eastern Europe and the NIS, Access of Low-Income Households to Financial Services in Bosnia & Herzegovina, April 2009. A nationwide financial literacy survey would provide a baseline assessment of the current levels of financial capability and serve as an essential means for measuring the impact of consumer protection and financial education programs. The survey should be broken down by geographic area, socio-economic levels, years of formal education, gender, age and other standard variables for sociological studies. Segmentation will provide policy-makers with insight into key issues regarding banking products and services as consumers look for ways to meet their debts and plan their financial futures. Follow-up surveys of financial literacy should be conducted every three to five years. The follow-up surveys will help identify whether programs of financial education and consumer protection are working and, if they are not effective, what needs to be done. 30 Annex I: Key EU Directives on Financial Consumer Protection and Applicable Laws in Bosnia and Herzegovina CELEX EU Directive Supervisory BiH Law Reference Agency 3 1987 L 0102 Directive on Consumer Credit, Unclear Consumer Protection Act, 1987/102/CEE, as amended partially 3 2008 L 0048 Directive on Consumer Credit, 2008/48/EC, -- Not transposed repealing Directive 87/102/EEC 3 1993 L 0013 Directive on Unfair Terms in Consumer Unclear Consumer Protection Act, Contracts, 1993/13/EEC partially 3 2005 L 0029 Directive concerning Unfair Business-to- Consumer Commercial Practices in the Internal Market, 2005/29/EC 3 1998 L 0027 Directive on Injunctions for the Protection Unclear Consumer Protection Act of Consumer Interests, 1998/27/EC 3 1985 L 0577 Directive on Doorstep Selling, Unclear Consumer Protection Act 1985/577/EEC 3 2000 L 0046 E-Money Directive, 2000/46/EC 3 1997 L 0007 Directive on Protection of Consumers in Unclear Consumer Protection Act Respect of Distance Contracts, 1997/7/EEC 3 2002 L 0065 Directive on the Distance Marketing of Unclear Consumer Protection Act Financial Services, 2002/65/EC 3 2006 L 0114 Directive on Misleading and Comparative Unclear Advertising, 2006/114/EEC 3 1994 L 0019 Directive on Deposit Guarantee Schemes, Deposit Law on Deposit Insurance 1994/19/ EC Insurance Agency 3 2004 L 0109 Directive on Transparency, 2004/109/EC 3 2002 L 0058 Directive Concerning Processing Personal Data and Protection of Privacy in the Electronic Communication Sector, 2002/58/EC 3 1995 L 0046 Directive on the Protection of Individuals Personal Data Law on the Protection of with regard to the Processing of Personal Protection Personal Data Data, 1995/46/EC Agency 31 Annex II: List of Meetings conducted in Bosnia and Herzegovina in November 2009 I. Meetings in Sarajevo, Federation of Bosnia and Herzegovina Name Position Organization Mr. Miroljub Krunić Assistant Minister Ministry of Finance and Treasury of BiH Mrs. Biljana Tabaković Procurement Coordinator Ministry of Finance and Treasury of BiH Mr. Vilim Primorac Deputy Minister, Ministry of Foreign Trade and Economic Relations and Chairman of the State Consumer Protection Council Mr. Mijo Mišić Executive Secretary Banks’ Association of BiH Mr. Samir Lačević Manager of Banking Operations, Education Banks’ Association of BiH and Training Mr. Sinisa Macan Director General Agency for Identification Documents Registers and Data Exchange of BiH Dr. Stjepo Pranjić Chairman Council of Competition Mr. Branko Marić Attorney at Law Maric Law Office Mr. Samir Bakić Acting Assistant Minister Federal Ministry of Finance Mr. Djordje Racković Head of Payment Systems Division Central Bank of BiH Ms. Jasenka Žigić, Central Bank of BiH Ms. Renata Barić Head of International and European Relations Central Bank of BiH Division Mr. Peter Nicholl Adviser to the Governor of the Central Bank Central Bank of BiH of BiH, Member of the Governing Board of the Central Bank of BiH and former Governor of the Central Bank of BiH Mr. Marco Mantovanelli Country Manager for BiH The World Bank Mr. Miroslav Krezić Assistant Director Banking Agency of FBiH Ms. Jadranka Bičakčić Head of the Department of Regulations Banking Agency of FBiH Ms. Mirsada Burić Senior Expert Associate Office for Development, Banking Agency of FBiH Mr. Slaviša Raković Economic Specialist Partnership for Advancing Reforms in the Economy (PARE – USAID initiative) Mr. Dario Vinš Team Leader Partnership for Advancing Reforms in the Economy (PARE – USAID initiative) Mr. Ibrahim Tirak Director Federal Administration for Inspection Issues Mr. Džemo Čar Assistant to the Director Federal Administration for Inspection Issues Ms. Selma Rasavac Associate Operations Officer, Advisory International Finance Corporation Services Southern Europe Ms. Ivana Ćuk ISTR Consultant, Advisory Services Southern International Finance Corporation Europe Ms. Senada Hrenovica Director General LRC Credit Bureau Mr. Nedžad Gušić Intesa Sanpaolo Bank Ms. Jadranka Krajina Deputy Head of Retail Division Intesa Sanpaolo Bank Hon. Clifford Bond Former US Ambassador to BiH (2001-2004) US Government Mr. Josip Nevjestić Director Deposit Insurance Agency of BiH 32 Mr. Frieder Wohrmann Director ProCredit Bank, Sarajevo Mr. Meho Mujatić Manager Putokaz Ms. Samira Čampara Assistant director for sector of inspection Personal Data Protection Agency supervision, complaints/claims and main register Mr. Bajro Avdić Senior expert associate for complaints/claims Personal Data Protection Agency II. Meetings in Banja Luka, Republika Srpska Name Position Organization Mrs. Dragana Aleksić Assistant Minister Ministry of Finance of Republika Srpska Mr. Ivan Vidović Executive Director Investment Development Bank of RS Mr. Momčilo Svraka Legal Counsel Investment Development Bank of RS Mr. Mile Tamamović Director of Banking Supervision Banking Agency of Republika Srpska Mr. Dragomir Dražić Director of the Legal Department and Banking Agency of Republika General Administration Srpska Mr. Damir Miljević Executive Director Sinergija plus Ms. Nadežda Galić Senior Associate for Consumer Protection RS Ministry of Trade and Tourism Ms. Ljiljana Ćulum Senior Associate for Consumer Protection RS Ministry of Trade and Tourism Mr. Slavko Subotić General Director Republic Administration for Inspection Activities - Inspectorate Mr. Igor Milunović Deputy General Director Republic Administration for Inspection Activities - Inspectorate Mr. Borka Surtov Assistant Director and Chief of RS Market Republic Administration for Inspection Inspection Activities - Inspectorate Mr. Ljubo Janjić Director Plava Sfera Ms. Snježana Čolić Deputy Head of Retail Department Hypo Alpe Adria Bank Mr. Boris Šikanić Head of the SME Management Sub- Hypo Alpe Adria Bank Department, Retail Department Mrs. Irena Mojović Notary Law Firm III. Meetings in Mostar, Federation of Bosnia and Herzegovina Name Position Organization Ms. Amra Vučijak Head of Office for Consumers’ Protection Federal Ministry of Trade Mr. Dragan Doko Consumer Ombudsman Ombudsman Institution for Consumer Protection in BiH Ms. Ljubica Coković Assistant Consumer Ombudsman Ombudsman Institution for Consumer Protection in BiH Ms. Mediha Bakalović Assistant Consumer Ombudsman Ombudsman Institution for Consumer Protection in BiH Mr. Ivan Vlaho Executive Director Retail Division Unicredit Bank Mr. Vencel Matijević Director Legal Affairs Unicredit Bank 33