The following post was originally published on the IFMR Trust Blog.
The Mor Committee Report offers a radical take on client protection, built around the concept of a legal right to suitability. After describing the recommendations briefly, I would like to tell IFMR’s readership why I’m excited about the approach (two big cheers), provide some thoughts on how to make it work (and how the Smart Campaign could assist), and raise a couple of questions.
Suitability is about ensuring that clients are sold financial services that are appropriate for their circumstances. A suitable product is one the client can be expected to manage with a low probability of serious hardship and a reasonable prospect that it will provide value. The concept has been present for some time in financial consumer protection regulation, most notably in the UK and Australia. The Mor Report proposes a unique approach to implementing suitability, which places responsibility on the service provider to install processes to ensure that clients are sold suitable products, e.g., client targeting and underwriting procedures that adequately assess repayment capacity. Regulation would hold the board of directors responsible for approving and overseeing the implementation of these processes, subject to external review. Hand in hand with this, the report recommends an energetic grievance redress system (which I will not address here), including both internal and external mechanisms to cope with individual problems.
The first big cheer goes to the decision to focus on suitability as the heart of client protection. This directs attention exactly where the greatest potential for harm occurs. Overindebtedness, is perhaps the greatest failure of suitability, resulting from selling loans that exceed a client’s debt threshold. This is why the Smart Campaign places Appropriate Product Design and Delivery and Prevention of Overindebtedness as Client Protection Principles #1 and #2, even ahead of Transparency. Among all the standard client protection problems, only overselling of credit has repeatedly caused sector-wide crisis and collapse, and thus if there is to be a focal point, this is the right one. (The report discusses the relative merits of suitability vs. disclosure as the core of consumer protection policy, which raises both practical and philosophical issues – an engaging topic for another day’s post.)
The second big cheer goes to the decision to place responsibility on providers in an intelligent way that appears to have good prospects for success. Regulators, no matter how empowered, have an uphill battle to identify and contain financial abuse. It is in the interests of the regulator to enlist providers on the side of good client protection practices to the greatest extent possible. This idea is, in fact, one of the tenets of the Smart Campaign, which seeks to embed good practices inside microfinance institutions. The Mor Report recommendations would require processes inside every financial institution that, if well executed, would provide suitability. The potential benefits of this are, first, that it enlists the staff of all provider institutions into the client protection effort (multiplying the reach of regulators), second, it distributes action on client protection into the capillaries of the financial system, as close as possible to client-provider interactions, and third, it allows providers to innovate products and processes rather than focusing on compliance with regulator-determined ones.
Enlisting providers is, nevertheless, tricky. After all, consumer protection problems arise from the existence of incentives for providers to use poor practices, and those incentives can be strong. Self-policing alone is bound to be insufficient. The Smart Campaign regularly sees institutions give themselves greatly inflated grades on client protection in self-assessments. Thus, skeptics would rightly question whether a mandate for responsible processes would have teeth in the face of counter-incentives. The Mor Report’s solution stands or falls on the superstructure that oversees the fulfillment of the responsibility placed on providers.
The first bit of the superstructure would be a requirement for the board of each institution to approve and annually review these processes, which in turn makes them a matter for scrutiny by external auditors. Thus the apparatus of governance and audit that every financial institution must have would be pulled into the task of protecting clients through a special customer audit.
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