IMCO study: Consumer Protection Aspects of Financial Services

28 February 2014

In the EU, mis-selling of financial products has resulted in significant consumer harm. The overarching recommendation of this study is that consumer protection in financial markets should be strengthened and consumers' financial capabilities should be raised.

Key Findings

• The inappropriate sales or mis-selling of certain mortgage products in the USA and some EU Member States in the 2007/2008 financial crisis were a major contributing factor. This was also the case in the Nordic banking crisis of the early nineties.

• The other financial products discussed in the present report can at times be seriously harmful to some consumers but do not appear to contribute significantly to financial instability.

• Some of the products identified by stakeholders as being potentially harmful to consumers were also noted by other stakeholders as being potentially positive for consumers provided they are well regulated and not mis-sold.

• The last 15 years has seen the emergence of a substantial body of academic literature pointing out that a) financial literacy and capability is relatively weak among consumers, even in industrialised countries and b) biases and cognitive limitations may be particularly important in financial markets.

• Overall, the consumer experience from 2000 to 2007 can be characterised as a period of financial innovation and liberalisation during which consumers were offered a growing range of financial products (of increasing complexity in some cases). Yet paradoxically, many consumers were not well-equipped to make proper choices and fell prey to mis-selling or inappropriate selling.

• While improved financial literacy will benefit consumers, the study also highlights that, on their own, policies aimed at raising financial literacy are not enough.

• Even in the absence of mis-selling and inappropriate selling, the purchase of many types of financial products or services will continue to be challenging for consumers because a) consumers only infrequently purchase such products and services and do not have a good knowledge of them, especially of newer products and services, b) the products and services may be very complex, opaque and their risks may be difficult to assess, especially in the case of long duration products and services and c) consumers have no or little bargaining power in retail financial markets.

• Therefore, the overarching recommendation of the present study is that consumer protection in financial markets should be strengthened and consumers’ financial capabilities should be raised. This is particularly important, since European consumers have very limited access to financial services in other Member States, where these services could be more beneficial and offer more protection (according to recent Eurobarometer survey, 94 per cent of respondents in the EU27 have never purchased a financial product in an EU Member State outside their home country. Nine detailed recommendations to achieve these twin overall objectives are set out below:

• The first three recommendations aim to reduce the information asymmetry between consumers and financial service providers. A good understanding by consumers of the financial transactions they enter into enhances the efficiency of that transaction and more generally the efficiency of the market.

Consumers should always receive from the seller accurate, simple, comparable information of a financial product or service before and after buying it. The information provided to consumers can be improved by presenting the average consumer experience, using a “descriptive norms” approach and providing illustrative worst and best case scenarios.

Consideration should be given to implementing systems whereby consumers would be encouraged by lenders to seek independent financial advice from a third party provider for more complex products which have the potential to result in significant harm to consumers. The list of such products could be established by the regulator.

• The fourth recommendation aims to better equip consumers to deal with financial matters. In light of the poor results shown by the OECD financial literacy and capability survey, and the importance of financial education to empower consumers to make the right choices, considerably more efforts and resources should be devoted by governments, the financial sector and civil society to strengthening financial literacy and capability. As well, greater efforts should be made to learn from the various programs already implemented in various countries, especially with regard to the effectiveness and efficiency of such programmes.

• The next three recommendations aim to better protect consumers by encouraging regulators to adopt a much more pro-active, preventative approach to retail financial markets, more robustly and vigorously deter financial service providers from harming consumers and sanction more forcefully mis-behaviour.

Financial sector regulators and institutions responsible for consumer protection in financial markets should adopt a much more pro-active approach to ensure that financial markets work well rather than respond to consumer complaints and pursue mis-behaviour re-actively. This could involve the prohibition of the sale of certain products or explicit action to address high transactions costs for certain products.

Financial sector regulators should also ensure that consumers do not face excessively high charges and fees which do not reflect actual costs when buying, holding or liquidating a product. In addition, the sanction (financial penalties, prohibition to undertake certain activities for a certain period, etc.) of mis-behaviour by sellers (financial institutions as well as officials of financial institutions) of consumer financial products should be made more exacting so as to increase the deterrence effect and incentivise financial firms to treat their customers fairly. Financial institutions should also be systematically liable for adequately compensating consumers who suffered detriment as a result of mis-selling or inappropriately selling of financial products or services.

• The eighth recommendation aims to ensure that, in case or problems, consumers can easily obtain redress. Consumers should always have access to an independent, fast, efficient and inexpensive dispute resolution mechanism to address any unresolved disputes with financial institutions.

• The last recommendation is that consideration should be given to develop better mechanisms and processes for dealing with excessive personal debt burdens.

Full study

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