Financial literacy and financial consumer protection- A literature review and some recommendations for vietnam

Nội dung text: Financial literacy and financial consumer protection- A literature review and some recommendations for vietnam

1. FINANCIAL LITERACY AND FINANCIAL CONSUMER PROTECTION- A LITERATURE REVIEW AND SOME RECOMMENDATIONS FOR VIETNAM Nguyen Dang Tue, PhD. 6- School of Economics and Management, Hanoi University of Science and Technology Abstract As being the critical part in the triple of financial stability, financial consumer protection gains mounting attention of both academia and practitioners in recent years owing to the rising complexity of financial market and the growing gap between financial institutions and consumers puts consumers at disadvantage. This paper aims to dissect the problem from different angles ranging from policy makers to financial institutions and consumers. First, the concept of financial consumer protection is defined, in which four sub-categories are identified and analysed including information asymmetry, financial fraud, recourse mechanism, and personal privacy. In the following section, financial consumer vulnerability is identified as a direct consequence deriving from the problem of financial consumer protection. To alleviate financial consumer vulnerability, it should be approached from both objective and subjective sides. Specifically, it necessitates the enhancement in consumer financial literacy, and the collaboration of financial organisations. By improving level of financial literacy among consumers via financial education, it is expected that the repercussions of the four problems of financial consumer protection can be mitigated. Keywords: consumer protection, consumer vulnerability, financial fraud, personal privacy, financial literacy, financial education. 1. Financial consumer protection background Financial consumer protection gains mounting attention of both academia and practitioners in recent years. Every year, there was about 150 million new financial consumers. Most of them are from developing countries, where the importance of consumer protection is not prominent. (Rutledge, 2010). At the same time, financial innovation presented financial consumer with a large set of financial products accompanied by a huge amount of information offered by numerous financial institutions giving them more choices (Ryan et al., 2010). This greater consumer autonomy accompanied with more serious financial decisions to be made poses special concerns that consumers do not always make the rational choice (Kozup & Hogarth, 2008). Indeed, Campbell et al. (2011) found that consumers may lack the cognitive ability to optimize their financial situation if presented with all the available information that in principle is required to do so. The global financial crisis has highlighted the importance of consumer protection as strong financial consumer protection is needed for public confidence in the financial system worldwide. 6 E-mail: tue.nguyendang@hust.edu.vn, nguyendangtue@gmail.com Tel.: 0787193535 - 0869281244 77
2. Weaknesses in consumer protection and financial literacy affect developing countries like Vietnam. The country has seen rapid development of financial sectors over the last two decades and rapid income growth has provided consumers with more resources to invest. Increased competition among financial firms, combined with improvements in financial techniques and information technology, resulted in highly complex financial products and services offered to the public. Financial service contracts are difficult to comprehend and impossible to compare among service providers. Vietnam consumer lacks a history of using sophisticated financial products. For many first-time financial consumers, most of the time they would be the first of their extended families to enter a long-term financial contract such as a home mortgage loan. The low level of financial literacy widen the gap between the complexity of financial products and consumers' ability to understand what they are buying. In this paper, the role of financial literacy and financial education in equipping consumers with necessary information to avoid being disadvantaged when participating in financial market was analysed using literature review method. The issue was clustered into concepts and dimensions of financial consumer protection and the relation between financial literacy improvement and financial consumer protection. Based on analysis findings, some recommendations were proposed for Vietnam. 2. Financial consumer protection concepts and dimensions There are several definitions of financial consumer protection. For example, Bank of Uganda (2011) defines financial consumer protection as the fair treatment of financial services providers to their current and potential customers. However, the most comprehensive definition was proposed by World Bank (2017) in which financial consumer protection was defined as the assurance that financial consumers receive information that allows them to make informed decisions to avoid unfair and deceptive practices, have access to recourse mechanisms to resolve disputes when transactions go awry, and maintain privacy of their personal information. In this interpretation, financial consumer protection requires dealing with four aspects, namely (1) mitigation of information asymmetry; (2) financial fraud avoidance; (3) affordable and speedy recourse mechanisms and (4) personal privacy protection. To protect financial consumer, financial service should provide consumers with: (1) Transparency: by providing full, plain, adequate and comparable information about the prices, terms and conditions and inherent risks of financial products and services; (2) Choice: by ensuing fair, non-coercive and reasonable practices in the selling and advertising of financial products and services, and collection of payments; (3) Redress: by providing inexpensive and speedy mechanisms to address complaints and resolve disputes; and (4) Privacy by ensuring control over collection and access to personal financial information. These conditions are illustrated in Figure 1. 78
3. Figure 1: Financial consumer protection aspects (Source: Adapted from World Bank, 2011) The need for consumer protection arises from an imbalance of power, information and resources between financial consumers and their financial service providers, placing consumers at a disadvantage. Consumer protection aims to address this market failure, commonly referenced as asymmetric information (Akerlof, 1970). At the same time, digital financial services also carry new risks for financial consumers, in both mature and emerging markets. Misuse of unfamiliar or new types of products to uninformed consumers can also result in new types of fraud, often taking advantage of consumers uncertainty in the digital environment. If financial consumers are not equipped with sufficient knowledge and experience for these kinds of financial products, they would be exposed to a high probability of being defrauded. OECD (2018) asserted that a serious matter in consumer protection takes shape of the lack of data security, privacy and confidentiality; inappropriate or excessive use of digital profiling to identify potential customers and exclude unwanted groups; rapid access to costly short-term credit or essentially speculative products and other market practices that can reinforce behavioural biases. Consumer protection emphasizes the responsibility of financial institutions in processing and handling consumers. When there is no viable out-of-court mechanism in place, consumers will generally abandon their efforts to gain a satisfactory resolution of their rightful claims. 3. Financial consumer protection from financial products and services providers perspective In many circumstances, financial consumer can be put at disadvantage due to the four aforementioned aspects which result in consumers to experience harm or to be unable to make informed decisions when participating in financial market (i.e., financial consumer vulnerability). Financial consumer vulnerability derives from both intrinsic and extrinsic causes. Four aspects in consumer protection mentioned in the previous section are extrinsic factors that influence financial consumer vulnerability which will be discussed in detail in this section. 79
4. 3.1. Information asymmetry Financial products and service providers show a more in-depth understanding of a given product and service in comparison to consumers, which leads such consumers to be in a less favourable position toward providers (Shen et al., 2016). Cartwright (2014) classified 4 reasons why information asymmetry problems for consumers in financial markets lead to financial consumer vulnerability. First, in a perfect market, rational and well-informed consumers make consistent decisions in accordance with their preferences and so exert market discipline. Where information asymmetry exists between supplier and consumer, intervention such as mandatory disclosure may play a role in correcting the issue. While many consumers suffer from information asymmetry, those for whom that asymmetry is greatest are especially vulnerable (a.k.a. informational vulnerability). Second, in the perfect market, transactions are fully voluntary. In practice, consumers may be particularly vulnerable as a result of their greater susceptibility to pressure (a.k.a. pressure vulnerability). Third, a perfect market contains numerous players, while in practice a small number of firms may be dominant (a.k.a. supply vulnerability). Next, perfect markets are underpinned by private law, which allows consumers to hold traders to account for breaches. However, the availability of such remedies may be more apparent than real, with some consumers finding it particularly difficult to obtain redress (a.k.a. redress vulnerability). Complex structure of financial products severely limits consumers’ understanding and causes an information asymmetry. In particular, the information asymmetry occurs in two aspects. One is about financial product characteristics itself and the other is about investment preference (Han & Jang, 2013). Benston (2000) argued that information asymmetry in financial sector is not necessarily worse than in other areas while consumers have access to a wide array of financial products from competing companies. However, severe information asymmetry was observed in some of the financial products, but they are traded in the market without difficulty, and that consumers should be responsible for investment risks that arise after the contract (Han & Jang, 2013). This asymmetry often leads to consumers buying unsuitable financial products or failing to buy the suitable ones. These risks also more likely to arise in markets where consumers have little experience of using financial products and services and therefore tend to be ill-equipped to make good choices (Bank of Uganda, 2011). 3.2.Financial fraud A wide variety of investment frauds all have one thing in common: they sell something – a company, product, or security – that either does not exist nor will not live up to the financial return being promised. Pump-and-dump scams occur when con men send out inaccurate information about a company’s stock they already own. Sham reports hyping the company’s profits or business prospects encourage naive investors to rush in and buy stock. When they do, the fraudster sells his shares for a large gain, depressing the price and leaving those who were defrauded with losses. Fake or dubious investment companies sell securities purportedly backed by a hot new consumer product, technology, or business opportunity. Scammers often capitalize on news events such as a natural disaster or stock market decline to create an appearance the company they are touting is real. High- 80
5. yield investment fraud is especially popular when stock- and bond-market returns and yields on certificates of deposit are low. Con men claim the securities they sell possess the impossible combination of low risk and very high returns. Advance-fee fraud refers to the situation where money is paid but the service or product is not delivered. Debt-settlement scams that purport to help struggling consumers pay off debt when fraudsters pose as mortgage experts or attorneys and offer to negotiate with the lender for an affordable payment schedule or a reduction in the debt balance but never complete the work. Insurance fraud against individuals occurs when unscrupulous insurance agents or brokers sell health, auto, home or life insurance and divert premium payments to their own bank accounts while making fictitious insurance policy documents to give victims the impression that the coverage is in effect. (Blanton, 2012). Many financial scams use the complexity of financial products to target victims. The potential information asymmetry between consumers and product providers make consumers vulnerable to misconduct on the part of service providers, conflicts of interest and even outright fraud (Lumpkin, 2010). Areas of fraud risk in complex products include the rise of hedge (Muhtaseb & Yang, 2008), promissory notes (US SEC, 2008) and structured products (Lumpkin, 2010). 3.3.Recourse mechanism Financial consumers generally had no clear idea of which agency to approach. In the absence of a viable alternative dispute resolution mechanism, consumers will become cynical and shy away from using financial services. Complaints from financial customers reveal what information consumers receive about their financial services and how and to what extent consumers understand the disclosure that is provided (World Bank, 2017). If complaints are not satisfactorily addressed, they undermine public confidence in the financial sector. It would be best if consumers could go to a single agency to obtain help related to financial services. Rather than asking financial consumers to navigate a maze of government agencies, one agency should ideally be tasked with the responsibility of receiving financial consumer complaints and ensuring that a response is provided, and action taken. A fast and inexpensive out-of-court mechanism—such as a financial ombudsman— is needed to resolve legal disputes about consumer financial services (Rutledge, 2010). 3.4.Personal privacy Issue of data privacy is relevant to the problem of consumer disclosure in terms of how effectively privacy policies governing the use, collection, sharing and storage of a consumer’s personal data are disclosed (OECD, 2018). The creation and rapidly increasing usage of digital data trails by firms providing digital financial services has raised the issue of consumer risks that are currently not well understood. This is particularly concerning in nascent markets where lower- income consumers are accessing services while consumer protection and data protection frameworks, regulation, and supervision are underdeveloped (Responsible Finance Forum, 2017). Cyber-security risks can facilitate consumer loss of privacy and inflict financial harm, such as identity theft. The use of non-traditional data and advanced data analytics to create proprietary algorithms for credit scoring can facilitate the extension of credit to previously unserved people but 81
6. can also lead to exclusion if data is inaccurate or the outcomes of the algorithms about different segments are not monitored carefully. (Responsible Finance Forum, 2017). According to a survey, over 80 per cent of mobile Internet users worldwide had concerns about sharing their personal information when accessing mobile applications and services (GSMA, 2014). However, World Bank (2018) stated that while most consumers are concerned about sharing their data, a smaller proportion will check what information is required to be shared and related policies and procedures before installing an application. World Bank (2017) proposed a framework and key recommendations for good practices for financial consumer protection that includes the enhancement and reformation in five fields including institutional structures, consumer disclosure, business practices, complaints and disputes resolution and financial literacy and education. From this perspective, a good practice for consumer protection entails the involvement of both policy makers and financial institutions in creating a transparent, fair, responsive, and secure financial environment. 4. Financial consumer protection from financial consumer perspective – the role of financial literacy As previously mentioned, to effectively protect financial consumer, it should be approached from both side of consumers and other parties involved. Financial consumers should learn to protect themselves and become less vulnerable against financial frauds, overcome information asymmetry, use recourse mechanism, and protect their own personal financial privacy. 4.1.Financial literacy and consumption behaviour Generally, making sensible decisions about financial products often requires considerable information on terms and conditions, not just prices. This is especially true for financial decisions that are undertaken only infrequently. But in many cases, consumers cannot efficiently generate information on their own, and the joint production of such information with other consumers, with its public good characteristics, is not easily coordinated. Some financial products are complex and difficult to grasp, particularly for financially unsophisticated investors. Klapper et al. (2013) also found that people with a higher financial literacy are more equipped to deal with negative macroeconomic effects. Lusardi et al., (2017) found that financial literacy affects financial decisions, particularly in relation to wealth management, retirement planning, credit management, and stock market participation. Bernheim & Garrett (2003) found that high school students with financial curriculum mandates and employers with financial education in the workplace enjoy higher savings. Financial literacy has also been found to have a significantly positive correlation with financial behaviours such as cash-flow management, credit management, saving, and investment (Hilgert & Hogarth, 2002). Data from Chile revealed that financial literacy and household wealth accumulation has a significantly positive relationship (Behrmanet al., 2012). Research conducted by Jappelli & Padula (2013) also confirmed the positive correlation between financial literacy and savings. Financial literacy is a necessary condition for responsible borrowing as financially literate consumers are more able to understand and assess their financial situation and the credit products on 82
7. offer by different providers. Financial literacy helps consumers understand the information and make optimal risk/return choices. The difficulty of processing complex information may hamper financial decision making and that the latter can be improved by providing decision makers with better quality information (Altman, 2012). Financial consumers rarely understood disclosure of complex terms and conditions of credit cards, such as the application of double-cycle billing and universal default (Drew, 2013). Financially literate respondents holding a more efficient and diversified portfolio may contribute to explain the positive effect of financial knowledge on financial assets (Fort et al., 2016). In the field of credit management, Scheriner (2004) proved that experience in and knowledge about lending could reduce the risk of bad loans. McHugh et al., (2011) discovered that people generally misunderstand the relationship between annual percentage rate and total cost of the loan. People with a lower financial literacy tend to borrow from costly payday loans (Agarwal et al., 2010), have higher cost consumer credit portfolios (Disney & Gathergood, 2013), more frequently pay monthly credit card balances when sufficient funds become available (Scholnick et al., 2013) or use high-cost borrowing and excessive debt (Lusardi & Tufano, 2009). 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 by offering better products and services rather than by taking advantage of poorly informed consumers. In addition, consumer protection and financial literacy help promote financial inclusion, attracting first-time consumers to access financial services and building consumers’ trust in financial institutions to increase the use of retail financial services (Rutledge, 2010). Financial literacy works to ensure that retail investors have the requisite information and skill to make informed financial decisions about the purchase of investment products and services and the engagement of financial intermediaries (US Securities and Exchange Commission, 2012). Together consumer protection and financial literacy set clear rules of engagement between financial firms and their retail customers— and help narrow the knowledge gap between consumers and their financial institutions (World Bank, 2017). 4.2.Financial literacy and financial fraud In the context of fraud victimization, financial knowledge can improve individuals’ attentiveness to fraudulent practices and empower them to deter fraud. For instance, Andreou & Philip (2018) found that financially knowledgeable students have a significantly higher propensity of declining an offer to engage in a Ponzi scheme than their peers, after being solicited. Engels et al., (2019) found that the more financially knowledgeable the respondents, the more fraud they detect in their accounts. Financial knowledge enhances the financial capability of individuals by being more aware of, and better at recognizing, fraud when it transpires. 4.3.Financial literacy and financial disputes 83
8. Shen et al., (2016) examined the relationship between the level of financial dispute and how consumer handle financial disputes and found that people with a higher financial literacy were inclined to aggressively handle financial disputes, even if it may not have been the optimal method of solving the dispute. Moreover, when the level of basic advanced financial literacy increased by one unit, the probability of the level of aggression in handling financial disputes increased by 58.5%. Campbell et al. (2011) showed that the lack of cognitive understanding and financial literacy constrain consumers’ decisions and their awareness of consumer protection. Those who are ill- equipped cannot properly make their claim in a financial dispute and tend to avoid financial dispute or proceed in an aggressive way. 5.Implications for financial education Financial education can potentially be an effective form of consumer protection. A well- educated consumer will be able to understand consumer disclosures that are provided and make informed decisions. Financial education cannot substitute for regulation but can complement an effective legal and regulatory framework for financial consumer protection. 5.1.The relevance in time and place of financial education Experience in developed countries suggests that financial education should be focused on teachable moments. To be successful, financial education needs to provide information to the right people at the right time (Drew, 2013), just in time and just enough and at the time when people are most receptive to it (Alderman, 2012). Studies in the US have found that consumers are very receptive to financial education at certain points in their lives, for example, when they first provide a mortgage for a house or apartment. Financial education is also effective for children under the age of 12 years when they need to learn about financial well-being, as well as the fact that financial health is as important as physical health. 5.2.The content of financial education The goal of financial literacy needs to go beyond improving basic financial knowledge and skills (Huston, 2010). It should empower investors to confidently apply this knowledge and skill to their personal financial decisions and make informed choices that positively impact their financial well-being (Huston (2010), ASIC (2011)). In other words, financial consumers also need to know how to use and manage these products (Kozup & Hogarth, 2008). Curriculum of financial education therefore should go beyond the field of traditional financial literacy that places the importance on product identification. In the curriculum of financial education for financial consumer protection, learners should be equipped with more knowledge and skills to cope with various financial situations rather than know financial products. Additionally, design of consumer protection and financial literacy measures should consider recent research findings in behavioural economics. Psychological biases may influence consumers to make choices that are neither rational nor optimal. These biases include mistaken beliefs where consumers assume that interest rate charges or penalties will not apply to them: they are over optimistic about their financial future and thus unable to forecast their future financial status accurately (Brown et al., 2003). 84
9. Individuals often over-estimate their financial capabilities, including their understanding of the concept of the time value of money and the impact of compound interest over time (Lewis, 2004). Other consumers fall victim to projection bias, that is, the prediction of personal preferences into the future (Loewenstein et al., 2003). 5.3.The coordination between different stakeholders It is important to consider such partnerships within a resource allocation decision framework. As highlighted earlier, improving financial literacy involves numerous stakeholders and necessitates the formation of partnerships. These include partnerships between government, schools, financial institutions, unions, businesses, charities, and community groups (ASIC, 2011). These groups work across issues of financial literacy, setting strategic agendas and operationalizing financial literacy through education and training programmes to strengthen the financial literacy approach by widening reach and impact, efficiently sharing resources, and reinforcing messages and improving effectiveness by adopting a common approach. The efficiency of resource allocation decisions that correctly identifies the right people who require particular resources at a particular time can be significantly undermined by the potential wastage of resources by multiple stakeholders engaging in unnecessary replication of activities (Drew, 2013). 6. Conclusion and recommendations From the results of this literature review, several recommendations can be drawn for Vietnam. To tackle the problem of financial consumer protection, four aspects must be considered including information asymmetry, financial fraud, recourse mechanism, and personal privacy. Information asymmetry occurs when the providers have more access to valuable information than their consumers. Four types of financial fraud include investment fraud, advance-fee fraud, insurance fraud, and tax fraud result in an ill-informed consumer being ripped off. The third dimension in financial consumer protection concerns the mechanism for consumer claim where consumer do not know who is responsible for their claims owing to the unstructured and inconsistent of dispute mechanism. As the result, consumers tend to avoid financial disputes with their providers or claim it improperly. In the last subcategory, the lack of rules or standards about data collection, usage, storage, accuracy, and sharing can create or exacerbate personal privacy risks. Furthermore, unsophisticated consumers, namely those who are lack of financial literacy, are frequently financially victimised by investment fraud. Also, their lack of privacy awareness puts them at risk when sharing their personal data. As a recommendation for the practice of enhancing financial consumer protection, in this paper, the role of financial literacy and financial education as a self-protection mechanism was emphasized. Financial literacy gives consumers the skills to understand and evaluate the information they receive. To promote financial literacy among consumers, financial education plays a critical role. There are three key points that is integral for a good practice of financial education. First, to be successful, financial education needs to be delivered to consumers who most require it and at the time when people are most receptive to it. Second, it is necessary to come to a curriculum to help consumers gain sufficient information to make sound decisions, identify and avoid financial frauds, properly 85
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