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Consumer Protection for Financial Technology in Emerging Markets

CONSUMER PROTECTION FOR FINANCIAL TECHNOLOGY IN EMERGING MARKETS

Risks faced by unbanked and underbanked consumers in digital credit and the technological and regulatory approaches to mitigate risk.

Abstract

Digital credit is an evolving industry, particularly in emerging markets with tremendous income and business potential. The growth of this industry leaves low income and financially inexperienced consumers vulnerable to a range of risks. Our project aims to identify the existing and anticipated risks consumers face in accessing digital credit; analyze the intricacies of causes that drive risk; and assess risk alleviation approaches to determine their effectiveness in stemming risk, ability to propel financial inclusion and welfare contributions. Our research is comprehensive in mapping this digital credit ecosystem.

Understanding the landscape of digital credit will allow stakeholders to more effectively intervene and provide solutions to protect unbanked and underbanked consumers in emerging markets. For the Center for Effective Global Action, our project will contribute analysis to their work on digital credit, from the consumer protection and welfare perspective. We provide recommendations for future research based on identified gaps and assess the effectiveness of tested practices to allay consumer risk. This will help CEGA design their financial inclusion programming. For implementers and CEGA affiliates including digital credit providers, governments, NGOs, and researchers, our report will provide a big picture of consumer protection in this space to inform their activities.

Context, Goal and Project Objective

Context

The rapid expansion of digital credit, defined as small loans provided instantly and remotely over digital channels, has created new, unique risks for consumers that do not exist in traditional credit markets. Three features of digital credit make these risks unique: Digital credit platforms are designed to reach households and merchants with little experience in formal finance; Digital credit is delivered online; Digital credit is largely deployed in emerging economies.

The central issue today is that actions to allay consumer risk have not kept up with this new technology. Risk mitigation approaches have either not been implemented by providers and/or regulators or remain untested. There is a dearth of evidence based analysis on the short- and/or long-run impacts of digital credit, specifically consumer vulnerabilities. While there exists a body of research and evaluations on the effectiveness of approaches that have been implemented, their reach and scope have been  limited. As a result, stakeholders including lenders, consumers, and policy-makers are making important decisions without full knowledge and critical assessment of consumers’ interaction with digital credit.

Goal and Project Objective
Protecting consumers in the digital credit marketplace is the ultimate goal. Risk mitigation means that digital credit providers and regulators understand potential consumer risks and needs and implement proven practices to stem these risks without diminishing access to credit.

The project objective is to assess, in a comprehensive manner, the risks that consumers face in digital credit. The assessment is meant to fill the gaps in stakeholder knowledge, providing a whole picture of threats and means to address these threats. The objective facilitates the ultimate goal of protecting consumers because with complete information resource deployment in the forms of intervention and further research will be deployed more effectively.

Methodology

Methods

Our methods of aggregating research and assessing consumer risk were conducted through:

  • Literature review and background research to synthesize trends in digital credit pertaining to consumer protection. Relevant research included reports, studies, and academic articles which provided perspectives from consumers, digital credit providers, NGOs and government regulators.
  • Interviews with relevant stakeholders and experts to codify results and analysis.
  • Systems mapping to synthesize the digital credit ecosystem relevant to consumer risk.
  • Analysis of relevant quantitative and qualitative data and research to identify the most salient features of risk mitigation for potential interventions and needed research. The analysis will inform decisions to invest in study, action, and innovation.

Landscape Map of Consumer Protection in Digital Credit
Mapping the consumer risk landscape includes the following topics that together provide an overview of consumer risk and risk mitigation strategies:

  • Primary risks consumers face in the fintech space
  • Causes that drive consumer risks
  • Mitigation approaches that allay consumer risks and causes
  • Examples of mitigation strategies that have been implemented

Ecosystem of Consumer Risk, Causes, and Approaches to Mitigate Risk

Consumer Risk 1:  Credit traps and Overindebtedness

Predatory lenders and lending practices take advantage of consumers. Predatory lenders target people that have trouble borrowing from legitimate, formal lenders. These borrowers are often low-literacy and low-income, have bad credit and are unfamiliar with the credit apparatus. While people with a good credit scores and stable incomes have more options when borrowing money, targets of predatory lending tend to have fewer choices. As a result, they are susceptible predatory lenders who intentionally set high interest rates, additional fees, and rigid repayment terms. Borrowers are trapped in vicious credit cycles, with increasing debt and inability to make payments in line with the aggressive lending terms.

Cause 1.1: Lenders set higher interest rates than traditional banking.[1]

Low income borrowers often take loans to pay off immediate expenses and to fulfill short term financial needs. Banks almost always turn down low-income applicants, leaving them with few options. Borrowers turn to private or informal money lenders. Lenders prey on borrowers’ low income status and lack of security to exploit borrowers through offering loans at high rates and quick and rigid repayment terms.  The instant influx of cash from informal lenders solves the borrower’s immediate problem but triggers a cycle of inability to repay and contributes to mounting debt. Poor financial capacity and the burden of high interest rates accumulating over time, trap borrowers and drives overindebtedness. Borrowers are tethered to the expensive financial product which diminishes their economic prospects.

Mitigation Approach 1.1.1: Setting interest rate caps through regulation (Implementor: Regulator)

Interest rate caps have are a key component of many countries’ credit policies. Governments use interest rate ceilings to address consequences of high costs of borrowing and predatory lending. Governments also use interest rate caps as a form of subsidy to economically vulnerable groups.

Example 1.1.1: Financial Services Law (Bolivia)[2] 

Bolivia adopted a new FSL in August 2013. The law includes several good provisions and implements a number of core Basel II and III (international regulatory framework for banks) principles. These measures include regulations on deposit and lending rates. They also regulate economic practices that pose risks to financial stability.

Mitigation Approach 1.1.2: Providing innovative and incentive driven structures for interest rates and loan terms.[3] (Implementor: Service Provider)

Loan terms and payment structures can exploit low income populations. Interest rate and loan terms can ease the financial burden of those households and merchants’ with volatile income streams. Measures to incentivize manageable interest rates and loan terms include:

  • Cash back incentive: A monetary award to the consumer for paying back all of their loan installments on time.[4]
  • Future interest rate reduction: A model that decreases the interest rates on future credit offerings for borrowers with proven repayment habits. Traditionally, lenders treat all their customers the same. Repeat borrowers with perfect repayment records are charged the same interest and fees as unproven first-time borrowers, which disincentivizes borrowers from improving their payment habits, as they perceive no benefit in doing so. Borrowers will repay loans on time, saving themselves from credit burden if there are obvious rewards for doing so.
  • Customization: A system that identifies a target group, analyzes its characteristics and needs, and designs services and products accordingly. Customization can help reach a broader customer base by offering more relevant and useful services to unserved and underserved markets, which provides a better user experience.[5]
  • Basic, “no-frills” accounts and/or services: Simplified products that are easy to use and understand. Basic accounts can help meet essential financial service needs at low cost and serve as an entry point to more sophisticated services.[6]
Example 1.1.2: LendUp (California),[7] KAITE with EcoCash (Zimbabwe), Agribusiness Systems International and GADCO with TigoCash(Ghana), SmartMoney (Tanzania), and Zoona (Zambia)
With the aim to counter the payday lending system, LendUp, a California based startup is built around a framework called the LendUp Ladder. This provides an actionable path for customers to access more money at a lower cost. A point based reward, education and gamification structure allows the user to move up the ladder to access more diverse and effective credit products. It also enables financial education, making users more responsible and improving their credit risk profiles. Gamification, where the users collect points over time and use those points to access other features and rewards helps them understand the products better. By encouraging the borrower to improve their financial habits, rewarding them for prompt repayment, providing tools for financial education, and enabling easy understanding, LendUp helps borrowers improve their financial health. 

Various financial service providers in Africa have partnered with large produce buyers to help them make payments to farmers using mobile money. These services have enabled farmers to repay microloans with mobile money, thus reducing both the need for cash and lengthy travel times previously required to make cash repayments. The produce buyers KAITE in Zimbabwe, as well as Agribusiness Systems International and GADCO in Ghana, have initiated pilots to pay farmers with EcoCash and Tigo Cash, respectively. SmartMoney in Tanzania and Zoona in Zambia have also facilitated mobile payments between suppliers and farmers, resulting in lower payment costs and improved security. Zoona, which works mainly in the agricultural sector in Zambia and Malawi, offers farmers a choice between receiving mobile money in their mobile wallet (if they have one) or receiving an electronic voucher.

 

Mitigation Approach 1.1.3: Sending SMS with summary product information and ensuring customers understand lending terms. (Implementor: Service Provider)

Consumers’ familiarity with the SMS channel for communication opens up opportunities to engage them after loan origination to facilitate user understanding of features like repayment requirements. SMS reminders is an almost costless mechanism that can address financial literacy as well as financial health of borrowers. Borrowers who make late payments because they cannot track their payment schedule are able to keep up with payments when simple reminders are sent in coordination with payment due dates.[8]

Example 1.1.3: M-Shwari (Kenya)[9] 

M-Shwari sends simple, timely SMS messages describing key terms and conditions that customers can store and access in the future. M-Shwari also calls and sends SMS messages to borrowers to remind them of impending due dates. The messages are easy to understand, short and aligned with payment schedules.

Cause 1.2:  Informal moneylending industry operates outside of formal financial services regulations.

Moneylenders, in most cases, lie outside the range of formal financial institutions, which includes banks and microfinance institutions. However, moneylenders are an important source of credit for low-income households and small and medium sized enterprises. These systems pose a number of regulatory issues. As a predominantly unregulated industry, they are free to set rigid and exploitative terms drive by profit making goals. These practices harm consumers.

Mitigation Approach 1.2.1: Developing fair and competitive markets through coordinated market regulations (Implementor: Government/ Regulator)

In the recent years,  there has been a development of a variety of institutions and technological products in the financial markets with different business models and financial products. Against that background, the fundamental question of which type of financial sector structure works best in catering to the needs of  a broad set of individuals and firms, arises. Additionally, the difference between financial systems based on banks compare with those based on financial markets becomes critical[10]? Formal financial regulations do not always cover financial technology.  Studies consistently find that what matters for economic growth is the overall development of the financial system, rather than the relative shares of banks and financial markets Therefore, a credit sector with a combination of traditional banks and nonbanking financial institutions can be effective. Such nationally and internationally competitive markets provide consumers with greater choice amongst financial services. More options creates pressure for providers to offer competitive products, drive innovation and maintain high service quality.[11]
However, difference in treatment of banks and other non banking financial institutions along regulatory lines, also increases the compliance and operational burdens and make entities  less competitive in the same financial markets. Regulations that impose differential treatment include KYC requirements, interest rate caps, and priority lending requirements. A level playing field among providers is a critical regulatory tool that drives harmonious market conditions.[12]

Example 1.2.1:Association of Banks (Peru), Banking and Finance Services Act (Zambia) 

In Peru, the Association of Banks, along with other partners, has established a mobile payments platform that all financial institutions, mobile phone operators, and electronic money issuers in the country can use. The “Peru Model” is a streamlined mobile platform that coordinates financial intermediaries and provides a shared infrastructure to consumers.

Zambia has amended its Banking and Finance Services Act to include specific provisions on consumer protection, market conduct and competition in the financial sector

Mitigation Approach 1.2.2: Harmonizing market conduct rules and oversight for all comparable credit offerings for all providers and channels (Implementor: Government/ Regulator)

While freer markets and competition are essential to sustain an effective financial industry, unhindered competition can create an environment for financial exclusion. High prices and high interest rates exclude a large part of the population. Policy measures to harmonize market conduct include:

  • Requiring banks to offer basic or low-fee accounts
  • Granting exemptions from onerous documentation requirements for consumers
  • Allowing correspondent banking (where one financial institution provides services on behalf of another
  • Providing government benefits via electronic payments
Example 1.2.2: Bank Negara Malaysia’s Consumer and Market Conduct Framework (Malaysia) 

In Malaysia, consumer empowerment and protection are pursued through a comprehensive framework that includes market conduct regulation and supervision, avenues for redress, consumer literacy and public awareness initiatives. This framework has been built progressively over time through collaborations with other departments in Bank Negara Malaysia, consumer associations, and the financial technology industry. The Bank’s Consumer and Market Conduct Department (CMC) has played a key role in developing the framework.

Cause 1.3: Credit scoring algorithms are flawed.

Credit scoring algorithms may not accurately predict ability to repay, unfairly profile or discriminate, or lack adequate informed consent by the consumer for data collection and usage. Lenders may also overestimate the capacity to repay if there is no adequate credit information system to check information on the borrower’s existing debts or reliable means to verify credit worthiness[13].

Mitigation Approach 1.3.1: Designing alternative credit scoring methods (Implementor: Service Providers)

Lenders are increasingly credit scoring by using nontraditional sources of data, many of them not directly related to money. To augment their traditional underwriting mechanism, providers are accessing consumer mobile data and using advanced analytics to assess the creditworthiness of unbanked and underbanked customers. Transaction-based lending models, especially peer-to-peer lending, allow good applicants to demonstrate their quality in nontraditional ways.[14] Alternative credit scoring methods offer opportunities for financial institutions to grow their lending portfolios while managing risk. The appropriateness of alternative credit scoring as the standalone means of credit underwriting varies.

Example 1.3.1: Vodacom (Tanzania) 

Vodacom, a mobile service provider in Tanzania, has partnered with First Access, a for-profit social business focused on data analytics using prepaid mobile data to predict credit risk for consumers who have never had a bank account or a credit score. First Access offers an instant risk scoring tool for low-income customers by leveraging demographic, geographic, financial and social network data from a subscriber’s mobile records. The scores are authorised by subscribers via text message and delivered to participating financial institutions in real time, along with a recommendation on the loan size in the local currency and eligibility for instant disbursal

Cause 1.4: Providers use price manipulation where they have hidden fee structures or “teaser” rates

Mitigation Approach 1.4.1: Establishing a licensing process for digital credit lenders and setting strict penalties for manipulation (Implementor: Regulator)

Monitoring market conduct is essential to curb price manipulation and fraud among providers and protect consumers from associated risks.[15] With the introduction of different kinds of providers ranging from telecoms to mobile money startups, entry and operation of credit providers is the first and one of the most important aspects of market conduct. Creating a new licensing framework for specialized operators corresponding to the functions they perform monitors and regulates providers’ scope and actions. This formulates a proportionate but lighter regulatory regime than the one that oversees commercial banks or other public deposit intermediaries.[16]

Formal licensing standards require regulators to assess providers’ understanding of their target market and relevant operational and security risks. Licensing would require providers to establish and maintain adequate policies, procedures, controls, audit programs, information systems, governance and reporting lines. It would also dictate hiring standards, including background checks for agents and employees.[17]

Example 1.4.1: Reserve Bank (India),[18] Draft Framework on Branchless Banking (Zambia)[19] 

Reserve Bank of India approved a new stripped-down type of bank, which are expected to reach customers mainly through their mobile phones rather than through bank branches. The objective of setting up payments banks with a structured licensing process is to provide small savings accounts and payments/remittance services to migrant labour workforce, low income households, small businesses, other unorganised users.

Under Zambia’s Framework on Branchless Banking, non-bank digital financial service providers are not allowed to extend credit but can partner with an institution that is already licensed to provide credit. In such cases, the licensed institution will be responsible for the management and extension of credit while the digital financial services provider offers the delivery channel.

Consumer Risk 2:  Unnecessary burden of credit that fails to meet consumer needs, due to misuse or poor usage of credit products.

Without access to user feedback, many providers do not fully understand consumer needs. Because target consumers are inexperienced with financial services, they do not understand their own needs either. Lack of knowledge creates a disconnect between user needs and the financial products that they access. Consumers, then, fail to manage their finances effectively and do not use the tools that would most benefit their individual circumstances.

Cause 2.1: Providers lack know your customer processes that help them  assess user needs and challenges.

Credit providers do not always understand customer credit needs and situations. Providers are unable to adequately track transactions made by consumers in their daily lives. Improper customer identification leads to improper customer compliance and unsound monitoring of credit accounts, leaving both provider and customer at risk. Providers mismanage their product offerings and consumers underutilize or misuse those products.

Mitigation Approach 2.1.1: Establishing Know Your Customer norms (Implementor: Regulator)

Know Your Customer is a type of banking regulation which requires financial institutions and companies operating in the sector to identify, document, and validate the authenticity of a customer before they engage those customers. By first verifying customers’ identities and intentions and then understanding their  transaction patterns, banks are able to more accurately pinpoint suspicious activities.

The objective is to know customers by verifying identities, confirming they’re not on any prohibited lists, and assessing their risk factors.This system is designed to prevent money laundering, terrorism financing, and more run-of-the-mill fraud schemes. Providers make transactions safer in this way. While KYC practices should not penalize innocent consumers or burden providers with limited resources.

Example 2.1.1: National Biometric Platform (India) 

In India, Aadhaar is a national biometric platform that functions as a basic validation service. The platform inputs biometric identity numbers and validates a match. The system verifies an individual’s identity and address using electronic biometric authentication.

Mitigation Approach 2.1.2: Obtaining user feedback on product and service (Implementor: Service Provider)

Continual testing and refining content can help identify best practices for disclosure of terms and conditions via digital channels. Testing is aimed at typical consumers with generalizable needs. Users are able to help shape credit products based on their lifestyle and routines which are incorporated into their feedback. Feedback mechanisms may include text-based surveys or phone calls.

Example 2.1.2: M-Shwari (Kenya), Solidaridad (Dominican Republic) 

In Kenya, M-Shwari and M-Pawa rely on user feedback, sending instant SMS’s. This system provides important product details to consumers and offers mechanism through through which users can register their comments. M-Shwari’s model has also inspired similar mobile based, small value, short term loan products in Tanzania (M-Pawa), Senegal, and the Philippines.

In the Dominican Republic, Solidaridad accurately assesses willingness and capacity of beneficiaries to repay by conducting an in-person survey. The survey is a way to measure informal income and savings in Solidaridad’s risk calculations.

Cause 2.2: Users make poor decisions based on misinformation and misaligned incentives between provider and consumer.

Users, particularly poor and low incomes individuals, lack awareness of both digital systems and financial products. They are not financially literate and are not always required to read terms of service agreements. Providers often fail to disclose information before providing services. As a result, users do not fully understand the product and its accompanying terms and regulations, leading them to make poor financial decisions or withdraw from the market completely.

Mitigation Approach 2.2.1: Conducting financial literacy trainings on how to navigate digital financial services (Implementor: Service Provider)

Providers, NGOs and regulators can offer financial literacy trainings. Trainings compile the basics of formal finance in order to educate consumers on how to make financial decisions and how to use financial products. Financial literacy notifies the consumer of what product terms mean, the information contained within the terms and the importance of reading and understanding the terms. Financial literacy also informs consumers of their roles and responsibilities in their transactions. The goal of financial education is to enable consumers to better understand financial consequences and requirements.

Example 2.2.1: The Indian Government (India), Rule-of-thumb based training (India and the Philippines)
The Government of India Guidelines strengthens the role of banking regulators and officials handling customer complaints. The guidelines encourage using customer complaints as a teaching method. Serving customers needs is a way to engage with customers and educate customers about the product and ways to protect themselves. 

Programs in India and the Philippines provide rule-of-thumb-based training. These trainings focus on delivering simple financial heuristics instead of in-depth information about financial concepts. The idea is that simple trainings may be more effective at improving financial behaviors and business outcomes.
Voice-based mobile phone messages deliver easy-to-remember and easy-to-adopt rules of thumb. While the more engaged participants who listened to a high share of the messages, reported improved business practices and sales, overall listenership was low. These results suggest that voice messages could have an impact on business practices if the messages are heard. Therefore, Rule-of-Thumb initiatives may still be useful if implementation of these initiatives ensured higher rates of user participation in whatever measures are implemented.

Consumer Risk 3:  Misinformed consumers due to lack of transparency.

Without transparency on the part of credit providers, consumers miss relevant information that they use to make financial decisions. Compounding this, consumers often have limited resources and knowledge about financial terminology which prohibits them from understanding often complex financial products and services. As a result, consumers, unable to understand or gain correct, clear, and/or comprehensive information about credit products. Consumers, then, make poor or suboptimal choices.

Cause 3.1: Providers fail to communicate product terms clearly, and poor customer decisions follow.

Providers fail to communicate lending terms, product features, and legal or contractual commitments. Communication is either missing or unclear. Even when product information is provided, consumers many not be required to read the terms before accessing the loan.

Mitigation Approach 3.1.1: Establishing transparency standards through regulation and private sector practices (Implementer: Regulator)
Countries follow different approaches in the regulation of nonbank credit institutions; some may fall under the supervision of the central bank or a supervisory agency while others may fall under a general consumer protection agency, economic development ministry or local government authorities. Non-bank credit institutions conduct consumer lending (in most cases) without taking cash deposits from the public and thus fall outside of the scope of prudential regulation. The range of legal forms of the non-bank credit institution varies but typically encompasses microfinance, leasing firms, credit card companies, consumer finance, and credit cooperatives.

A number of undesirable industry practices can be avoided by strengthening consumer rights, including predatory lending, discriminatory pricing, poor disclosure of costs of products, and misleading advertising. Tying and bundling practices can also limit a consumer’s choice and mobility.

Regulators can wholistically and systematically drive transparency practices. Possible regulators who can generate and implement transparency policies are:

  • Consumer Protection Regime: The law provides clear consumer protection rules and there provides adequate institutional arrangements to ensure fair implementation.
  • Code of Conduct for non-bank credit institutions: Principles based code of conduct
  • Dispute resolution mechanism: Judicial systems that ensure fair dispute resolution between consumers and providers.
  • Licensing non-bank financial institutions: Licensing requirements by a financial supervisory authority for all all financial institutions that extend any type of credit

Provider transparency practices should include the following:

  • Disclosure of use of customer information: Providers are clear about what customer information they gather and their information storage practices.
  • Affordability: recommendations of services should be in line with the need of the consumer
  • Cooling off periods: for services with a long term savings component, institutions should provide a cooling off period of a reasonable number of days
  • Bundling and tying clauses: bundling and tying of clauses in contracts should be avoided as much as possible so as not to restrict consumer choice
  • Statements on key product faces: Providers clearly explain each product offering.
  • Honest advertising and sales materials: Product are advertised without miselading consumers about what they will receive.

Legislation regarding non-bank credit institutions is especially developed in Europe and the US. Implementation in developing countries or countries outside of the West may need to adjust legislation differently. It is also important to note that many of these recommended practices may only work in a highly functioning, efficient government structure. Many of the countries in which emerging markets are growing most rapidly do not have sound political and financial regulating institutions that can implement or enforce such practices.

Example 3.1.1: National Financial Inclusion Strategy (Paraguay)[20] 

In Paraguay, the Secretary for Consumer Protection (SEDECO) is an umbrella consumer protection regulator whose remit covers all sectors including the financial sector. Under the national strategy, SEDECO issues market conduct rules including transparency standards for all regulated firms.

Mitigation Approach 3.1.2: Establishing standard definitions for the cost of digital credit and all bundled services (Implementor: Regulator)

Digital credit generates and at times redefines financial terminology. Establishing definitions for financial terms means clearly defining interest rates, credit-related fees, and fees for bundled products. Implementers can disclose in a clear, conspicuous and understandable way, the cost of the product, inclusive of interest rates and fees. Cost disclosure also explains monetary and non-monetary consequences of early, partial, late or non-repayment of the loan. Information can be sent electronically via mobile device.

Example 3.1.2: TechnoServe, Vodacom, CGAP and Arifu (Kenya) 

TechnoServe, in partnership with Vodacom, CGAP and Arifu in Kenya, developed an SMS-based program for farmers. The program disseminated new or confusing product information to these farmers about their credit terms. The program disclosed this information in order to prevent confusion and help farmers improve their business practices through proper use of their credit products.

Mitigation Approach 3.1.3:. Providing user education at sign-up about the product and how to calculate a loan limit (Implementor: Service Provider)

Borrowers may not know the cost or conditions of the product before they accept the conditions and become obligated to pay.[21] The consequences of this can be seen in the limited ability of consumers to manage their finances effectively and avoid unnecessary penalties and payments.

Example 3.1.3: M-Shwari (Kenya) 

User surveys from M-Shwari in Kenya showed that user experiences could be improved increasing user education at sign up stages. Detailed information about services, especially methods of calculating loan limits, will help users clearly understand how an institution works, while reducing their trial limit and increase confidence in the service. Provider transparency is critical for users to trust a service. If users trust a service, they will use it more frequently and for a wider range of transactions.

Risk 4: Lack of timely access to required funds.

These users often work with a small amount of income, used mainly for day-today expenditures. Without significant savings, they often resort to credit to meet some immediate or unanticipated needs. Loan disbursement delays hinder consumers from borrowing money to meet those needs. Without the necessary funds, consumers may not be able to cope with the emergency. Alternatively, borrowers may seek out other, more predatory loan providers.

Cause 4.1: Delays in loan disbursement due to fund availability.

A critical aspect of financial management for low income users is the timely availability of funds. Because many emerging markets are cash economies, funds are distributed electronically, then consumers get draw cash from agents, usually retailers. Retailers, however, do not always have reliable supply of cash on hand to disburse the loan amount. This problem is especially persistent in semi-urban and rural areas where the funding channels are limited.

Mitigation Approach 4.1.1: Improving agents’ liquidity management (Implementer: Service Provider)

Agents manage their cash distribution better by securing enough funding for lending at all times. Some measures than can improve agent liquidity are:

  • Funding delivery mechanism: Improved funding delivery mechanism for agents
  • Financial monitoring system: Digital credit provides are more aware of the real time financial situations of their agents.
  • Agent approval processes: Providers set criteria to determine the financial health and liquidity of retailers in order to determine retailers who serve as reliable agents.
Example 4.1.1: Agents and runners (Bangladesh),[22] EasyPaisa (Pakistan) 

In Bangladesh, agent aggregators designate “runners,” employees who deliver cash to agents regularly. The practice provides frequent opportunities for retailers to rebalance their cash supply.

Prior to designating a retailer as an agent, Pakistan’s EasyPaisa examines data on airtime sales in order to assess the business’s financial robustness and liquidity.[23]

 

Cause 4.2: Delays in loan disbursement due to weak transaction mechanisms.

Even if funds are sufficient, poor infrastructure and insufficient facilities to undertake disbursements may cause delays. Agents, bank branches, or other withdrawal mechanisms process disbursement requests slowly or transfer the funds inefficiently. Such delays leave the user vulnerable in emergency situations.

Mitigation Approach 4.2.1: Enabling account to account interoperability between financial and mobile providers (Implementer: Regulator)

The goal of interoperability is to use collective funds more effectively and respond to consumer demands with greater speed. Interoperability facilitates account-to-account transfers in real time. Mobile money customers are able to source money directly from a variety of platforms and applications.[24] Transactions across different mobile money systems and between systems are simplified.[25] Interoperability establishes a well connected system to move money around quickly and easily.

Example 4.2.1: Airtel, Tigo, M-Pesa and Vodacom (Tanzania) 

Since 2012, Vodacom Tanzania and M-Pesa have been involved in interoperable practices. GSMA reports that Vodacom has realized real-time account-to- account transfers to and from 36 banks, which accounts for the majority of Tanzania’s banking sector.

International interoperability has also been realized by money transfer partnerships like that of Safaricom, MoneyGram and Western Union. The knowledge and experience gained through these initiatives has enabled domestic account-to-account interoperability with Tigo and Airtel, which has similar integration capabilities and business processes (such as secure, real-time transaction processing; managing pre-funded settlement and reconciliation; implementing robust, aligned compliance policies and procedures)[26]

Consumer Risk 5:  Consumer security and privacy breaches

Consumer data and information leakages leave individuals vulnerable to unwanted use of their data by hackers and third party purveyors. Consumer’s financial and personal data may be used for identity theft, tax fraud or other criminal activities.

Cause 5.1: Systems vulnerabilities lead to attacks on user data and sensitive information.
Consumer data includes both data used by creditors to determine credit-worthiness and transaction data. In order for providers to distribute credit, they rely on personal information provided by consumers. All of this is transmitted digitally. Transaction details and amounts are also transmitted in this way, leaving consumer data vulnerable to attacks.

Data vulnerabilities are confirmed in Mo(bile) Money, Mo(bile) Problems, which finds that “all but one application [analyzed] (Zuum) presents at least one major vulnerability that harmed the confidentiality of user financial information or the integrity of transactions, and most applications have difficulty with the proper use of cryptography in some form.” Personal information, financial information and financial transactions are all exposed due to weak security systems operated by the digital credit provider.

Mitigation Approach 5.1.1: Establishing regulations on standard minimum security practices in handling consumer data to ensure privacy (Implementer: Regulator)

In the digital credit markets, where consumer data and other information is being increasingly used and shared in the lending and borrowing process, a standard minimum security practices in handling consumer data to ensure privacy is essential. Data security is difficult to define and regulations may not be able to keep up with emerging data encryption methods or data attacks. Regulations may include:

  • Requirement that provider implements a standard practice to notify consumers of security breaches;
  • Liability for data misuse and consequences of misuse is on the provider and stated in the terms and conditions;
  • Protocol for destruction of consumer data, including how and when to destroy user data; and
  • Secure interoperability of data across providers at the discretion of the consumer

Regulators may use the following tools to develop a regulatory ecosystem that holistically protects consumers from data breaches:

  • Pass new legislation;
  • Implement new rules and regulations; and
  • Utilize existing laws and expand their interpretation to include digital finance;

In designing a regulatory framework, the regulators must first consult with stakeholders and determine 1) the way data is being used and 2) the way that data is being protected via provider policies and practices. Thereby, they can track the main data risks and gaps in provider policies and practices to stem these risks.

Example 5.1.1: Banking Act (Tanzania), Central Bank (Kenya), Data Protection Laws (Ghana), Data Protection Laws (Uganda), Reserve Bank (India) 

• Tanzania’s Banking Act prohibits unauthorized disclosure of transaction information
• Kenya’s Central Bank credit reference bureau regulations require that credit bureaus protect the confidentiality of customer data.
• Ghana is adopting comprehensive data protection laws and establishing commissions to implement them.
• Uganda is considering comprehensive data protection laws

• Example of failure: India’s Reserve Bank (RBI) issued guidelines for mobile payment systems. Guidelines include currencies allowed, KYC/AML policies, inter- bank settlement policies, corporate governance approval, legal jurisdiction, consumer protection, and technology and security standards for a myriad of delivery channels. Because the security standards allow providers leeway about specific security practices, Mo(bile) Money, Mo(bile) Problems found that MoneyOnMobile, an Indian provider, had the most security issues among analyzed apps, despite it’s RBI authentication.

Mitigation Approach 5.1.2: Establishing industry standards on provider use of consumer data (Implementer: Regulator)

Developers and security experts can collaborate on best practices for data retrieval and use. This system will avoid gaps in product delivery and data use. Regulators can provide training and authentication to providers who abide by secure data use practices, but the system will be implemented by the industry itself rather than a regulatory body. Consumers will face the same data standards across platforms.

Example 5.1.2: Security Standards Council (United States) 

United States’s PCI Security Standards Council released a Data Security Standard, which governs the security requirements for entities that handle cardholder data

Bankers and Insurance Associations (Zambia)[27]

The Bankers Association of Zambia (BAZ) developed a voluntary code of conduct aimed to set harmonized standards that the association’s members should follow when dealing with customers. The Insurers Association of Zambia (IAZ) also issued a principles-based code of conduct, which deals with consumer protection and awareness issues, and provides for the expulsion of a company from the association for breaches.

Cause 5.2: Providers fail to communicate how they use consumer data.

Because many consumers do not have traditional credit histories, providers rely on consumer data to identify credit-worthiness, inclusive of loan limits and credit risk. Data used by providers includes phone records, mobile transactions, phone bills, and social networks. This data may be used in lieu or in addition to conventional credit assessment information depending on availability of other information. Data use in this way is important for reaching unbanked and underbanked consumers at scale.

Consumers, however, are often uninformed about the data providers are using and how they are using this data to determine credit-worthiness. Lack of financial literacy and desperation for a loan and inaccessibility of terms (often terms appear in text form or on small screens), compound the problem, undermining informed consent. Information is difficult for consumers to acquire because they do not know the right questions to ask or lack the opportunities to ask questions, and because the information that is provided is on a small screen, usually via SMS.

Mitigation Approach 5.2.1: Regulating standards for handling security breaches (Implementer: Regulator)

Customers are unable to secure their own data. Research shows that breaches can happen even when customers protect their PINs and other sensitive information. However, the customer is the party held responsible for the outcomes of data attacks. Regulators should require providers to standardize the use of data and their response to security attacks. Providers should adequately secure customer data but, in the event of a breach, have standard practices to react and protect customers. Providers should standardize practices of customer notification and liability. In cases where data is mishandled by the provider, providers should be responsible and liable for the outcomes.

Example 5.2.1: eIDAS Regulations (European Union)[28] 

In the new eIDAS Regulation, the EU gives individuals the right to compensation for damage caused by poor security and to impose additional security obligations on service providers. Given that the current EU e-Privacy Directives already impose security and security breach notification obligations on telecoms companies, and given that the European Commission is planning to extend these obligations to other sectors, and introduce a Cyber Security Directive, these regulations emphasize upon the importance of adopting a consistent and uniform approach and ensure alignment of legal instruments.

Mitigation Approach 5.2.2: Obtaining consumer consent for use of their data (Implementer: Regulator)
Providers should provide an opportunity for consumers to understand how their data is being used. Consumers will be able to give or deny consent for the use of specific data, its use, its disclosure to outside entities (private, public or legal), and its retention and destruction. Consumers should be allowed to provide separate consent for each different type of data that providers are accessing. Providers should also give an opportunity for consumer recourse in the case of data misuse. Providers should also inform consumers of the provider’s policies, especially in regard to selling consumer data.

Example 5.2.2: Credit reporting laws (Kenya) and Mobile Privacy Principles (GSMA)
Kenya’s credit-reporting laws give consumers the right to access their information, dispute it if incorrect or incomplete, and have it corrected. 

GSMA has developed a set of mobile privacy principles that address transparency, use restrictions, choice, retention and security. Under the Mobile Privacy Principles: Promoting Consumer Privacy in the Mobile Ecosystem,‘These principles were developed in 2011 and describe the way in which mobile consumers’ privacy should be respected and protected when consumers use mobile applications and services that access, use or collect their personal information. The key overarching objective of these principles is to foster business practices and standards that deliver meaningful transparency, notice, choice and control for mobile users with regards to their personal information and the safeguarding of their privacy. The principles also provide the basis for which the GSMA and its members develop further guidance in specific areas or context. For example, they laid the foundation for the Privacy Design Guidelines for Mobile Application Development (2012), which articulate the Mobile Privacy Principles in more functional terms and are intended to help drive a more consistent approach to protecting user privacy across mobile platforms, applications and devices’[29]

 

Risk 6: Fraud liability
In additional to fraudulent activity in the financial markets, fraud is a significant issue in the digital markets. Fraud appears in various forms, at various stages in the lending and borrowing chain, impacting providers and consumers in critical ways. According to the CGAP study, fraud forms can include the following[30]:

  • SIM swaps, which happen when a fraudster has a customer’s phone number moved (or swapped) to a different SIM, changes or steals the PIN associated with that user’s mobile money account, and withdraws the balance.
  • Social engineering scams, such as fraudulent SMS messages or calls (e.g., phishing) requesting or aiming to obtain a customer’s PIN or other information, or a money transfer. Claims of erroneous transfers and promotion or job application scams are other examples
  • Caller ID spoofing, which shows a false phone number on the caller ID and requests information or scams the customers
  • Counterfeit ATMs that read and copy card numbers, false facades, hidden surveillance cameras that record PINs, skimming, and the presence of fraudsters at machines to support  customers who experience difficulties[31].
  • Unauthorized account access by employees, which can be gained through one’s position in the FSP (financial services provider) or poor internal security that can cause lost funds or unauthorized access to customer confidential information. Internal fraud is much more common than hacking by external fraudsters.

Cause 6.1: Consumers are held responsible for fraudulent account activity.

Terms of service place the responsibility for most forms of fraudulent activity solely on the consumer[32].
For instance, Airtel Money, GCash, mCoin, Oxigen Wallet, MoneyOnMobile, and Zuum have terms that hold the customer solely responsible for most forms of fraudulent activity.

Mitigation Approach 6.1.1: Setting regulation to clarify liability in case of fraud and procedures for claims[33]. (Implementer: Regulator)

Governments must enforce laws to protect customers from fraud, and clarify the mechanisms to clearly identify and impose liability on the provider or consumer. For example, they can enforce laws stipulating that customers are not held liable for fraudulent transactions beyond a certain amount.

Example 6.1.1: The Indian Government (India) 

Indian Government guidelines to create necessary assurance mechanisms in case of a fraudulent transaction, where the money will be credited back to customers’ account and blocked and subsequently released after the investigation is complete[34].

Fraud liability model  (United States of America)

According to the study conducted by University of Florida, in the United States, the consumer is not held liable for fraudulent transactions beyond a small amount. This model is based on the assumption that users are vulnerable to fraud that they are powerless to prevent, combat, or detect prior to incurring losses[35].

 

 

 

Cause 6.2: Providers mishandle fraudulent activity.

Upon identifying fraudulent activity, providers often lack concrete processes and the machinery to take up the cases and address these issues. Particularly, in the case of emerging markets where small providers often dominate the markets, these systems are weak.

Mitigation Approach 6.2.1: Establishing Fraud and Risk Management Service (Implementer: Service Provider)

FRMS, which is a collaborative fraud control system, will require participating digital financial services providers to contribute data about their fraudulent and non-fraudulent accounts and transactions. These data will help create an FRMS database that will underpin a series of services, including fraud detection algorithms and scoring. The FRMS will also help participants manage compliance for anti-fraud regulations.[36]

Example 6.2.1: Level One Project FRMS (The Bill and Melinda Gates Foundation) 

FRMS is one of the two shared core layer of the Gates-Foundation-led Level One Projects, a model for a country-level digital financial services (DFS) system designed to dramatically reduce the cost of transactions, adjusting the economics to encourage aggressive attempts to bring the poor into the formal economy. The fraud control system is an integral part of this effort, creating a level playing field for everyone by building one digital financial system in every country around the world. [37]

Cause 6.3: Consumers are unable to deal with fraud due to lack of information or awareness on the subject.

Mitigation Approach 6.3.1: Improving customer awareness of fraud schemes[38]. (Implementer: Service Provider)

As the CGAP study shows, financial services providers can mandate agents and sales officers to provide customers with security product tips and security advice. In addition, alerts through SMS, radio announcements, newspaper ads, and social networking sites can be utilized.  It is effective in the short run and can be introduced by any single financial services provider. Various kinds of alerts can be flexibly introduced depending on available budget.  However, complementary actions from regulations may be needed in order to enforce all providers to take sufficient mitigation approach.

This would also contributing to financial inclusion of, in particular, those who do not have sufficient financial literacy and are vulnerable to fraud risk. Since this approach can be introduced by any provider depending on budget and expertise, this is relatively less burdensome for providers to implement.

Example 6.3.1: Banco WWB (Colombia) and M-PESA (Kenya) 

According to CGAP, Banco WWB in Colombia made a rule that agents and sales officers provide product security tips to customers when consumers open an account or register for mobile money.[39]

CGAP found that Safaricom’s M-PESA utilizes various measures to improve customer awareness, such as SMS alerts, radio announcements in local dialects, and newspaper ads.

 

Cause 6.4: Consumers are unable to deal with fraud due to lack of redressal mechanisms

While there are more general mechanisms and forums to address consumer disputes, various emerging markets lack resources and entry points for consumers to take issues of fraud for redressal. While there are general dispute resolution forums for consumer disputes in general, given the financial and technological nature of the digital credit market, unique risks arise. Specific mechanisms that address these unique challenges, must be designed.

Mitigation Approach 6.4.1: Establishing redressal mechanisms to address fraud disputes and setting minimum standards for recourse and staff qualifications. (Implementer: Regulator)

Recourse mechanisms are less developed and less visible than in traditional financial services. For this reason, consumers often do not know where or how to seek recourse when they have an issue with their financial product. There should be clear points of access for consumers to reach customer service agents and/or report claims and issues that they encounter with the product.

It is effective to reduce the fraud risk in the short run and can be introduced by a single financial services provider. This would also contributing to financial inclusion of, in particular, those who do not have sufficient financial literacy and vulnerable to fraud risk. However, it may be costly for digital credit providers to introduce new mechanism and/or hire qualified staff. Complementary actions from regulations may also be needed in order to incentivise or enforce digital financial services providers to apply the mitigation approach.

Example 6.4.1: ABSA (South Africa) and F-Road (China) 

According to CGAP, ABSA in South Africa places a temporary hold on a customer account when a SIM swap occurs. The customer has 36 hours to authenticate and advise ABSA if the SIM swap was valid. [40]

CGAP reported that F-Road in China utilize a SIM overlay card tied to financial activity (while phone activity is tied to the regular SIM), in which data are encrypted and only the financial service provider has access to the data.[41]

Assessment and Comparative Analysis of Mitigation Approaches

Stage One: Research Gaps

The mitigation approaches are divided into two categories for assessment: those that have been studied and tested and those that remain untested. Untested mitigation approaches illustrate where research gaps exist. Further research on identified yet unstudied approaches will help determine each approach’s potential to protect consumers, limitations, ability to scale across economies, and limitations.

Stage Two: Assessment of Risk Mitigation Approach

Available research and evaluations provided an opportunity to assess the mitigation approaches. Extrapolating from evaluations, the assessment considers how each mitigation approach impacts the overall focus areas and goals of CEGA’s fintech priorities. The specific criteria for assessment include:

Minimizing consumer risk: Team team evaluated the efficacy of the approach based on its ability to minimize or eliminate the identified consumer risk.

Facilitating financial inclusion: The team evaluated the saliency of each approach’s contribution to supply side and demand side financial inclusion indicators. Concerning the supply side (providers or regulators who implement the mitigation approach), financial inclusion relies on limiting costs for implementers such that they are not deterred from providing financial services or developing the market for fintech. Concerning the demand side (consumers who interact with the mitigation approaches), financial inclusion relies on limiting the burden that the mitigation approach poses on consumers such that they are not driven away from the market.

Maximizing welfare: The team evaluated the value that each mitigation approach added to the lives and economic opportunities of communities served. Analysis determined mitigation approaches’ ability to generate material and social well-being by creating a secure environment to access digital financial products.

Analysis of Mitigation Approaches

  1. Mitigation Approach 1.1.1: Setting interest rate cap through regulation.

Interest rate caps have been in the past in developing countries, and currently in emerging markets, relied upon as a policy mechanism that curb predatory credit practices and keep ‘loan sharks’ at bay. Evaluated in the present socio-economic and financial contexts of various developing countries, this approach can be evaluated in following ways:

Minimizing consumer risk: In order to minimize financial risk to consumers, interest rate calculated according to market. The cap should be set at a reasonable level, which means high enough to allow lenders to make a profit but low enough to eliminate excess profit due to a lack of competition. If set well below the market rate, this can limit access to credit, reduce transparency, and decrease product diversity and competition, thereby adversely affect financial inclusion. To meet the interest rate ceiling, financial institutions often increase loan size and shift their commercial operations from rural areas, which often face higher operational costs, to urban areas, thereby reducing services to rural and small borrowers.

A mechanism that monitors market players’ responding to the interest rate caps, and that is setup to modify the limits depending on market conditions, is essential to strike a balance between interest rate caps and competition among lenders. Without the ability to properly calculate the interest rate as per market conditions, this approach will not be effective.

Facilitating financial inclusion: Interest rate caps limit the tendency of financial service providers to increase their interest yields, especially in markets with a combination of low transparency, limited disclosure requirements and low levels of financial literacy.[42] However, they can also potentially hurt low-income populations by limiting their access to finance and reducing price transparency. If the caps are set too low, financial service providers will find it difficult to recover costs and are likely to grow more slowly, reduce service delivery in rural areas and other more costly markets, become less transparent, or even exit the market entirely.

Maximizing welfare: The existence of informal money lenders particularly in rural areas, in many ways acts barrier to the welfare of low income consumers. Moneylenders lie outside the network of formal financial institutions, which includes banks and microfinance institutions. However, they still are an important source of credit for low-income households, and small and medium enterprises, and pose a number of regulatory issues. Currently, while a number of countries impose interest rate caps, they do not cover this side of the credit sector. Therefore, it is important that the system that while protecting the consumers in the formal credit markets, must also enable a competitive digital market that minimizes and eventually eliminates informal credit streams. This is a crucial aspect of creating welfare in emerging markets not only at the economic level but also at community and society levels.

II. Mitigation Approach 1.3.1: Designing alternative credit scoring methods.

With increasing access to consumer data and advancements in technology, alternative credit scoring models hold tremendous potential.

Minimizing consumer risk: For alternative credit scoring models to minimize the risk faced by consumers, the following aspects must be considered:

  • Regulatory compliance: The data source must comply with all regulations governing consumer credit evaluation. The potential transaction costs associated with compliance of financial regulations would act as a burden on development of viable and sustainable enterprises that design and implement these models.
  • Predictive power:  Different sources of data have varying levels of predictability, a fact which must be considered while evaluating which type of data should be used. It is crucial that the data be able to provide futuristic insights into customer behaviour, particularly in relation to likelihood of repayment. Misinterpretation and misuse of data can leave consumers vulnerable and expose them to greater financial risk.
  • Integration with traditional sources of data:Financial institutions must realise that the alternate sources of data constitute only one part of the credit scoring process and must assess the compatibility of various sources of alternate data with their existing credit underwriting mechanisms. This will help them develop a more complete picture of their customers’ creditworthiness, thus reducing the default rate.

Facilitating financial inclusion: Alternative credit scoring models demonstrate the ability to reach a diverse and widespread audience. In emerging markets such as India and Kenya, digital footprints are limited to a fairly small size of the overall population. Where access to  physical and technological infrastructure is a hindrance, there will be limitations to the meaningful information that can be drawn from these areas. Therefore, alternate data must be selected keeping in mind its applicability to the predominant semi-urban/rural sections of developing societies that lack formal credit systems.

Maximizing welfare: These alternative models include consumers who are traditionally excluded from the formal credit systems due to the lack of credit history and worthiness. By using different kinds of consumer data and creating systems to meet specific needs and cultural contexts, these models contribute to greater financial inclusion, and better overall welfare in economies.

III. Mitigation Approach 1.1.3: Sending SMS with summary product information and ensuring customers understand lending terms.

Minimizing consumer risk:Due to the lack of disclosures, borrowers may not know the cost or conditions of their product before they accept these conditions and become obligated to pay. The consequences of this can be seen in the limited ability of consumers to explain what will happen (or has happened) when they do not repay the loan on time; many noted that there is increased interest assessed but were not able to state the penalty amount.
Summary product information can offer simple, easy to understand disclosures at the point of purchase. These information disclosures can be built into the product as “check-points” before a consumer is able to use the product and may vary in engagement required by the user. For example, a product may have click-through checkpoints that users must go through in order to use the product. Additionally, information disclosures may self-update, similar to terms of service agreements, where users will be made aware of the most up-to-date service or summary information before using a product. Consumers’ familiarity with the SMS channel for communication also opens up opportunities to engage consumers after loan origination to further their understanding on features like repayment requirements.

Facilitating financial inclusion: With continuing drop in phone service prices and the access to cellphones in emerging markets, SMS based solutions impose minimum cost and maximum reach for the credit providers. By establishing a clear and constant mode of communication with consumers, this establishes a healthy business relationship, helps improve consumer trust, and develops into strong financial markets.

Maximizing welfare: A healthy and transparent financial market is the cornerstone for a well functioning and equitable economy. Particularly in developing markets with a majority of low income users, these user-friendly markets will open significant economic opportunity and achieve social well-being.

Mitigation Approach 2.1.1: Establishing Know Your Customer norms.

Different countries in the emerging world are at different stages of Know Your Customer frameworks.

Minimizing consumer risk: KYC norms that forming an integral part of financial regulatory systems, will effectively protect consumers when take into account the following factors to minimize consumer risk:

  • KYC methods: Because many KYC regulations were instituted before much of today’s technology existed, the means of collecting information about customers is generally outdated. Moving loan applications online reduces risk by automating the entire process, making it reliable and perfectly repeatable. An automated process can easily be updated to keep up with changing regulations, and it’s quicker and easier for both loan officer and borrower.
  • Efficiencies of Online Systems:Most emerging markets have moved to a predominantly online system. In the digital credit markets, this system has the potential to achieve cost and process efficiencies:
  • Customization of requirements: Online verification systems can be customized to suit any individual bank’s needs. This streamlines the process, reducing the cost of loan origination, and the process is quicker and easier for both customer and provider. Flexibility to banks to tailor their requirements (within the bounds of regulation), can achieve significant gains by minimizing transaction costs both to the provider and the consumer.
  • Constant updating: it can be updated any time regulations change or new databases become available. Online systems can be updated quickly and painlessly any time new regulations or modifications of existing rules are made. This can be a cost effective, transparent, and timely system that meets the needs of consumers.
  • Consistent process: Because the verification system is automated, it happens the same way each time. This eliminates the possibility of human error in database checks or any other steps in the process.
  • Enhanced, real-time verifications: Online loan applications can check additional data-sources for up-to-the-minute verifications, giving lenders a more complete borrower profile. Online reviews, shipping trend data, social media buzz, Google Analytics activity – all of these metrics provide salient evidence of a business’ health (or lack thereof). It’s not practical to add extra verifications like these to manual loan application process, which is already too time-consuming and slow.

Facilitating financial inclusion: KYC norms that enable a quick, cost effective and transparent process will enable more consumers to access digital credit in developing markets. For instance, relaxing KYC norms to open digital bank accounts is the first step in the stage of financial inclusion. Once this is achieved, the second step will be to ensure these accounts remain active and made productive by using other basic and advanced financial services.[43]

Maximizing  Welfare: A well functioning financial system is impacted by the strength and effectiveness of the KYC norms that it is governed by. Therefore, to achieve a financially inclusive market and provide enhanced economic opportunities to all classes of citizens, KYC regulations and their implementation are critical.

VI. Mitigation Approach 2.1.2: Obtaining user feedback on product and service.

Minimizing consumer risk:CGAP tested consumer outcomes who accesses M-Shwari’s complaints and user feedback mechanism via Safaricom’s call center. This mechanism “has been credited within Safaricom for reducing non-performing loans through proactive support to and consultation with delinquent borrowers.”[44] Granting users an easy way to provide and receive feedback encourages the consumer to use the credit product more effectively, thereby reducing credit burden born by product misuse.

Facilitating financial inclusion: While more consumers may enter the market if information about the financial product is accessible, the supply side of the market may suffer. CGAP notes that in order for M-Shwari to generate the connection between consumers and agents, it relies on Safaricom’s impressive call center.”[45] The costs to providers of this service may be burdensome, however, it behooves providers for consumers to use their product better. Financial inclusion relies on providers making the product and service available, so financial inclusion would not be improved if providers viewed the costs of obtaining user feedback as too high.

Maximizing welfare: CGAP found that consumers were unaware of each of the companies involved in their financial product. Because multiple organizations including a credit provider, a cash transfer provider, a bank and a mobile company are usually all involved in the product offering, consumers were confused about who to contact to provide feedback or seek more information. Even with the existence of communication centers, however, consumers still did not always understand who to seek information from due to lack of coordination across implementers. While consumers know and trust certain providers, like M-PESA and M-Shwari, they are less familiar with other parts of the ecosystem handling their credit product.**neutral

VII. Mitigation Approach 2.2.1: Conducting financial literacy trainings on how to navigate digital financial services.
Minimizing consumer risk:Financial literacy programs have been implemented as a solution to protect consumers without much financial experience from overindebtedness. While many financial literacy programs have been found to have no significant impact on customers, simple programs appear to work. A study of rule of thumb training proved to improve financial practices. Another study by IPA, however, found that phone trainings for micro-entrepreneurs did not improve business practices or profitability. For this reason, mitigating consumer risk through financial literacy varies greatly with the complexity or simplicity of the program.

Facilitating financial inclusion: Financial literacy programs are costly to both consumers and providers. Programs, no matter the structure, take time to complete or participate in. J-PAL tested a program that called participants to share financial literacy information, and only 48% of participants who picked up the phone call actually listened to the whole message. The burden of the program appears to outweigh the benefits for the participants. Providers also incur costs to set up financial literacy trainings which may deter them from participating.

Maximizing welfare: As previously stated, financial literacy is proven effective only when provided in a certain, simplified manner. However, if effective, the results improve economic well being. J-PAL’s evaluation of LISTA, a tablet based financial literacy program, found that LISTA… had significant impacts on financial knowledge, attitudes toward formal financial services, adoption of financial practices, and financial outcomes. They also reported more trust in banks and other community members and professed more optimism. Importantly, LISTA participants demonstrated a greater ability to put their knowledge into practice than those in the comparison group. They were more likely to set savings goals and felt more capable of teaching others how to use ATMs. These women also reported saving more, both formally (immediately following tablet use) and informally (immediately following tablet use and one year after the program was initiated).”[46] This positive economic improvement in the lives of the target population is tempered by failures in program design and delivery. **neutral

VIII. Mitigation Approach 4.1.1: Improving agents’ liquidity management.

Minimizing consumer risk: Insufficient  agent  liquidity  deprives  users  of  access  to  their  own  money.  It  can  also  result  in  “split  transactions,”  a  practice  in  which  a  customer  must  perform multiple transactions, costing the customer through higher total transaction fees (in a tiered fee system).  According to the  FII (Financial  Inclusion  Insights) surveys  report by InterMedia,  this is the  second  most  common  problem  among  DFS  users  in  many  countries, following network downtime[47] and this approach would hugely contribute to solving the disbursement delay risk.

On the other hand, agents report challenges in liquidity management, citing  “fluctuations  in  client  demand”  as  one  of  the greatest difficulties in maintaining appropriate cash  and  float[48], which may be beyond control of agents .

Facilitating financial inclusion: This approach improving financial inclusion effectively by preventing disbursement from delaying in rural area and for low-income communities as well. This approach is generally scalable and the cost for provider is not significantly high.

Maximizing welfare: This approach is effective to prevent consumers from losing any economic opportunities due to delays of disbursement. This contributes to maximizing welfare of a wide range of consumers.

IIX. Mitigation Approach 4.2.1: Enabling account to account interoperability between financial and mobile providers.

Minimizing consumer risk:According to the GSMA study, interoperability has the potential to increase the efficiency of payment systems. It contributes to digitization of cash in the ecosystem, making payments more efficient, and advancing financial inclusion by bridging the gap between banked and unbanked consumers[49]. Account-to-account, as a form of domestic interoperability, has become more relevant because the financial industry has developed and the number of accounts has increased.[50] The GSMA study found some key conditions of successful launch interoperability that help minimize consumer risk such as:

  • Solid operational foundationsStrong and secure mobile money operational foundations build trust of customer and partners. Interoperability requires providers to integrate and expose their system. A successful partnership depends on the mutual trust that both providers have robust and reliable systems and foundations.[51]
  • Risk mitigation and management: Interoperability is complex and  to identify and mitigate associated risks is critical. Providers must have the capacity to develop and agree upon multilateral  rules  to confirm  that  risks  are  being  mitigated,  customers  are  protected,  and settlement is managed properly, among others.
  • Delivering a customer-centric experience: Customer usability is critical for interoperability to be scalable. If the customer interface is too complex, customers will keep finding alternative solutions for transactions—such as reverting to cash or a multi-SIM solution.[52]

Facilitating financial inclusion: Although interoperability seeks to conceptually address the issue of lack of timely access to funds, there could be other contributing social and economic factors in various country contexts that are beyond the scope of this approach, which will act as hindrances to financial inclusion. Therefore, in terms of solving the lack of timely access to required fund, the effectiveness is not clear because account-to-account transfer may not be the main reason of delay of fund transfer. Following are some key conditions:

  • Appropriate  time  to launch: Implementing  interoperability  is both  commercially  and technically complicated,  and  also  requires  resources  and  investments. Hence, providers  should  consider  when  the  most  appropriate  time  would  be  to  launch  interoperability services. The market readiness for the implementation must be closely examined.[53] Implemented well in this context, access to a range of consumers can be enhanced.
  • Competitive landscape and choice for the industry: The financial industry needs to promote a competitive landscape of financial services providers to achieve efficient and low-value transactions. Mobile money interoperability can be realized through different models and the digital credit industry should have various options as to which to use.[54]

Maximizing welfare: Interoperability may contribute to maximizing welfare by increasing transaction speed and opportunities and thereby making new business opportunities.

IX. Mitigation Approach 5.2.2: Obtaining consumer consent for use of their data.

Minimizing consumer risk: CGAP and FirstAccess study determined that consumers were very interested in how their data was used; however, “concluded… that consumers’ desperation for a loan overruled consumers desire to protect their data.”[55] Consumers would not be willing to turn down a loan in order to protect their data. Because consumers will consent to any data settings, this approach is unlikely to protect consumer data.

Facilitating financial inclusion: Low financial literacy and limited space to explain data usage can be overcome by simple messages. CGAP research shows that simple and informal SMS messages and brochures are effective at conveying necessary security and data usage information to consumers. Providers can continue testing which messages are most salient to provide consumers with relevant information. The simple nature of this system supports financial inclusion because neither party is burdened by the supply of these messages and both can benefit.

Maximizing welfare: With increasing scope and potential for abuse, it’s necessary to protect the security and privacy of individuals’ data whilst still encouraging the free flow of information and the sharing and use of data for innovation and social benefits.[56] Obtain consumer consent for use of data contributes to welfare by providing users with dominion over their information.

X. Mitigation Approach 6.1.1: Setting regulation to clarify liability in case of fraud and procedures for claims.

Minimizing consumer risk: This is effective to protect consumers from any fraud. However, setting the regulation may take long processes and may involve a large number of stakeholders. It may be difficult to set certain a amount beyond which customers are not held liable in case of fraud.

Facilitating financial inclusion: This would also contributing to financial inclusion of, in particular, those who do not have sufficient financial literacy and vulnerable to fraud risk. It may require a huge amount of coordination to set the new regulation but once it is established the approach is scalable and would not be burdensome for implementers.

Maximizing welfare: This contributes to maximizing welfare because low-income communities which lack financial access and financial literacy are benefited more by this approach.

Recommendations

Research

Tracking consumer risk enabled us to identify the tools available to stem risk. We recommend resources are allocated to studies that fill the below research gaps. Providers and regulators are implementing these approaches as illustrated by the examples, so there is ample opportunity to study the salience of these methods. Researchers could seek out the specific implementers cited in the examples in order to examine the associated approach.

1.1.2: Providing innovative and incentive driven structures for interest rates and loan terms.

1.1.3: Sending SMS with summary product information and ensuring customers understand lending terms.

1.2.1: Developing fair and competitive markets through coordinated market regulations.

1.2.2: Harmonizing market conduct rules and oversight for all comparable credit offerings for all providers and channels.

1.4.1: Establishing a licensing process for digital credit lenders and setting strict penalties for manipulation.

3.1.1: Establishing transparency standards through regulation and private sector practices.
3.1.2: Establishing standard definitions for the cost of digital credit and all bundled services.

3.1.3: Providing user education at sign-up about the product and how to calculate a loan limit.

5.1.1: Establishing regulations on standard minimum security practices in handling consumer data to ensure privacy.
5.1.2: Establishing industry standards on provider use of consumer data.

5.2.1: Regulating standards for handling security breaches.
6.2.1: Establishing Fraud and Risk Management Service.

6.3.1: Improving customer awareness of fraud schemes.

6.4.1: Establishing redressal mechanisms to address fraud disputes and setting minimum standards for recourse and staff qualifications.

Risk Mitigation Priorities

Based on the evaluations and studies of each approach, we scored them against our criteria. The three point scale (1= Negative; 2= Neutral; 3= Positive) measures how well each approach fulfills each criteria. The rank shows the strength of the approaches in each area. The scale can be used to match priorities to risk mitigation. For example, ‘Setting regulation to clarify liability in case of fraud and procedures for claims’ maximizes welfare but does not facilitate financial inclusion. If interests are primarily welfare, this approach meets those interests.

Mitigation Approach Study Minimizing consumer risk Facilitating financial inclusion Maximizing welfare
1.1.1: Setting interest rate cap through regulation. International Monetary Fund 1 3 2
1.3.1: Designing alternative credit scoring methods. World BankPWC 3 3 3
2.1.1 Establishing Know Your Customer norms Next Billion 2 3 1
2.1.2: Obtaining user feedback on product and service. CGAP 3 2 2
2.2.1: Conducting financial literacy trainings on how to navigate digital financial services. J-Pal and Innovations for Poverty ActionIPADrexler et al 2 1 2
4.1.1: Improving agents’ liquidity management. CGAP 3 3 3
4.2.1: Enabling account to account interoperability between financial and mobile providers. GSMA 2 3 2
5.2.2 Obtaining consumer consent for use of data. CGAP 1 3 3
6.1.1: Setting regulation to clarify liability in case of fraud and procedures for claims. Mo(bile) Money Mo(bile) Problem: Analysis of Branchless Banking Applications in the Developing Worlds 3 1 3

Appendices

Consumer Risk and Mitigation Approach Map

[Map]

Project and Research Proposal Assessment/Evaluation Tool

[Need to create this]


[1]Dyna Heng, Impact of the New Financial Services Law in Bolivia on Financial Stability and Inclusion, IMF Working Paper, available at https://www.imf.org/external/pubs/ft/wp/2015/wp15267.pdf

[2] Dyna Heng, Impact of the New Financial ServicesLaw in Bolivia on Financial Stability and Inclusion, IMF Working Paper, available at https://www.imf.org/external/pubs/ft/wp/2015/wp15267.pdf

[3] Ximena Cadena & Antoinette Schoar, Remembering to Pay? Reminders vs. Financial Incentives for Loan Payments, idea42 and MIT, available at http://aschoar.scripts.mit.edu/aschoar2016/wp-content/uploads/2016/07/Remembering-to-Pay-Cadena-Schoar-April2011.pdf

[4] Ximena Cadena & Antoinette Schoar, Remembering to Pay? Reminders vs. Financial Incentives for Loan Payments, idea42 and MIT, available at http://aschoar.scripts.mit.edu/aschoar2016/wp-content/uploads/2016/07/Remembering-to-Pay-Cadena-Schoar-April2011.pdf

[5] The World Bank Group’s Payment System Development Group, Innovative Digital payment Mechanisms Supporting Financial Inclusion Stocktaking Report, available at http://www.afi-global.org/sites/default/files/publications/stocktaking-of-innovative-digital-payment-mechanisms-supporting.pdf

[6] The World Bank Group’s Payment System Development Group, Innovative Digital payment Mechanisms Supporting Financial Inclusion Stocktaking Report, available at http://www.afi-global.org/sites/default/files/publications/stocktaking-of-innovative-digital-payment-mechanisms-supporting.pdf

[7] The World Bank Group’s Payment System Development Group, Innovative Digital payment Mechanisms Supporting Financial Inclusion Stocktaking Report, available at http://www.afi-global.org/sites/default/files/publications/stocktaking-of-innovative-digital-payment-mechanisms-supporting.pdf

[8] Ximena Cadena & Antoinette Schoar, Remembering to Pay? Reminders vs. Financial Incentives for Loan Payments, idea42 and MIT, available at http://aschoar.scripts.mit.edu/aschoar2016/wp-content/uploads/2016/07/Remembering-to-Pay-Cadena-Schoar-April2011.pdf

[9] Tamara Cook & Claudia McKay, How M-Shwari Works: The Story So Far, April 2015, available at https://www.cgap.org/sites/default/files/Forum-How-M-Shwari-Works-Apr-2015.pdf

[10] Global Financial Development Report: Financial Inclusion, 2014, available at http://siteresources.worldbank.org/EXTGLOBALFINREPORT/Resources/8816096-1361888425203/9062080-1364927957721/GFDR-2014_Complete_Report.pdf

[11] G20 High-Level Principles on Financial Consumer Protection, Organization for Economic Co-operation and Development (OECD), October 2011, available at https://www.oecd.org/g20/topics/financial-sector-reform/48892010.pdf

[12] Consumer Empowerment and Market Conduct (CEMC) Working Group, Digitally Delivered Credit – Policy Guidance Note and Results from Regulatory Survey, Alliance for Financial Inclusion, September 2015, available at http://www.afi-global.org/sites/default/files/publications/guidelinenote-17_cemc_digitally_delivered.pdf

[13] Global Survey on Consumer Protection and Financial Literacy: Oversight Frameworks and Practices in 144 Economies, The World Bank, 2014, available at http://documents.worldbank.org/curated/en/775401468171251449/pdf/887730WP0v20P10port0CPFL0Box385258B.pdf

[14] Non-Banking Finance Companies: The Changing Landscape, ASSOCHAM India & PWC, available at https://www.pwc.in/assets/pdfs/publications/2016/non-banking-finance-companies-the-changing-landscape.pdf

[15] Global Financial Development Report: Financial Inclusion, 2014, available at http://siteresources.worldbank.org/EXTGLOBALFINREPORT/Resources/8816096-1361888425203/9062080-1364927957721/GFDR-2014_Complete_Report.pdf

[16] Regulatory Approaches to Mobile Financial Services in Latin America, Alliance for Financial Inclusion, August 2014, available at http://www.afi-global.org/sites/default/files/publications/afi_lac_special_report_en_annex_low_res.pdf

[17] International Telecommunications Union, ITU Focus Group on Digital Financial Services: Main Recommendations, March 2017, available at https://www.itu.int/en/ITU-T/focusgroups/dfs/Documents/201703/ITU_FGDFS_Main-Recommendations.pdf

[18] Reserve Bank of India, RBI Releases Guidelines for Licensing of Payment Banks, November 27, 2014, available at https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=32615

[19] The World Bank, Republic of Zambia: Diagnostic Review of Consumer Protection and Financial Literacy, October 2012, available at http://documents.worldbank.org/curated/en/189281483674576175/pdf/111725-WP-P123485-PUBLIC-v1-ASBTRACT-SENT-ZambiaCPFLVolI.pdf

[20] Paraguay National Financial Inclusion Strategy (2014-2018), December 2014, available at http://www.afi-global.org/sites/default/files/publications/paraguay-2014-2018-national-financial-inclusion-strategy.pdf

[21] Digital Credit: Consumer Protection for M-Shwari and M-Pawa Users, CGAP, April 21, 2015, available at http://www.cgap.org/blog/digital-credit-consumer-protection-m-shwari-and-m-pawa-users

[22] “Doing Digital Finance Right: The Case for Stronger Mitigation of Customer Risks”, June 2015, CGAP, (http://www.cgap.org/sites/default/files/Focus-Note-Doing-Digital-Finance-Right-Jun-2015.pdf)

[23] ditto

[24] “Mobile Money Choosing a technical model for A2A interoperability: Lessons from Tanzania and Pakistan”, December 2015, GSMA (http://www.gsma.com/mobilefordevelopment/wp-content/uploads/2016/01/2015_GSMA_Choosing-a-technical-model-for-A2A-interoperability_Lessons-from-Tanzania-and-Pakistan.pdf)

[25] ditto

[26] “The Impact of Mobile Money Interoperability in Tanzania: Early Data and Market Perspectives on Account-to-Account Interoperability”, GSMA, September 2016 (http://www.gsma.com/mobilefordevelopment/programme/mobile-money/the-impact-of-mobile-money-interoperability-in-tanzania-early-data-and-market-perspectives )

[27] The World Bank, Republic of Zambia: Diagnostic Review of Consumer Protection and Financial Literacy, October 2012, available at http://documents.worldbank.org/curated/en/189281483674576175/pdf/111725-WP-P123485-PUBLIC-v1-ASBTRACT-SENT-ZambiaCPFLVolI.pdf

[28] Mobile Identity: A Regulatory Overview, GSMA, January 2015, available at http://www.gsma.com/personaldata/wp-content/uploads/2015/01/Personal-Data-Regulatory-Overview-2014.pdf

[29] Mobile Privacy Principles: Promoting Consumer Privacy in the Mobile Ecosystem, GSMA, 2016, available at http://www.gsma.com/publicpolicy/wp-content/uploads/2016/10/GSMA-Privacy-Principles.pdf

[30] “Doing Digital Finance Right: The Case for Stronger Mitigation of Customer Risks”, June 2015, CGAP, (http://www.cgap.org/sites/default/files/Focus-Note-Doing-Digital-Finance-Right-Jun-2015.pdf)

[31] “5 ATM Scams That Can Break the Bank.” Oakland: Investopedia,  2008, Lubitz, Lenny

(http://www. investopedia.com/articles/pf/08/avoid-atm-scams- atm-fraud.asp)

[32] “Mo(bile) Money, Mo(bile) Problems: Analysis of Branchless Banking Applications in the Developing World”, August 2015, University of Florida

(https://www.usenix.org/node/190885)

[33] “Promotion of Payments through Cards and Digital Means”, February, March 2016, Government of India Ministry of Finance Department of Economic Affairs Currency & Coinage Division

(http://dea.gov.in/sites/default/files/Promo_PaymentsMeans_Card_Digital_0.pdf)

[34] Ditto, February, March 2016, Government of India Ministry of Finance Department of Economic Affairs Currency & Coinage Division

[35] Ditto, August 2015, University of Florida

[36] “It’s the Ecosystem, Stupid – Exploring the ‘Digital Poverty Stack,’ Part 1”, August 2016, NextBillion (http://nextbillion.net/nexthought-monday-its-the-ecosystem-stupid-exploring-the-digital-poverty-stack-part-1/)

[38] “Five Ways Providers Can Do Digital Finance Better” , June 2015, Cunsultative Group to Assist the Poor (CGAP), (http://www.cgap.org/blog/five-ways-providers-can-do-digital-finance-better)

[39] Ditto, June 2015, CGAP

[40] “Doing Digital Finance Right: The Case for Stronger Mitigation of Customer Risks”, June 2015, CGAP

[41] “Doing Digital Finance Right: The Case for Stronger Mitigation of Customer Risks”, June 2015, CGAP

[42] The Worrying Trend of Interest Rate Caps in Africa, CGAP, November 11, 2013, available at http://www.cgap.org/blog/worrying-trend-interest-rate-caps-africa

[43] Relaxation in KYC Norms a Big Boost for Financial Inclusion, Business Standard, June 13, 2014, available at http://www.business-standard.com/article/finance/relaxation-in-kyc-norms-a-big-boost-for-financial-inclusion-114061201052_1.html

[44] http://www.cgap.org/blog/digital-credit-consumer-protection-m-shwari-and-m-pawa-users

[45] http://www.cgap.org/blog/digital-credit-consumer-protection-m-shwari-and-m-pawa-users

[47] “Doing Digital Finance Right: The Case for Stronger Mitigation of Customer Risks”, June 2015, CGAP, (http://www.cgap.org/sites/default/files/Focus-Note-Doing-Digital-Finance-Right-Jun-2015.pdf)

[48] ditto

[49]  “The impact of mobile money interoperability in Tanzania: Early data and market perspectives on account-to-account interoperability”, GSMA, September 2016 (http://www.gsma.com/mobilefordevelopment/programme/mobile-money/the-impact-of-mobile-money-interoperability-in-tanzania-early-data-and-market-perspectives )

[50] ditto

[51] ditto

[52] Bindo, R. (2015). Operational Guidelines for Interoperability: A Customer-Centric Approach, GSMA. available at http://www.gsma.com/mobilefordevelopment/wp-content/uploads/2015/09/2015_GSMA_Operational-guidelines-for-interoperability-A-customer-centric-approach.pdf

[53] ditto

[54] ditto

[55] http://www.cgap.org/blog/simple-messages-help-consumers-understand-big-data

[56] Abenaa Addai & Kate Rinehart, A Balancing Act: Using Innovation to Enhance Financial Inclusion while Orotecting Personal Data, October 11, 2016, available at http://www.afi-global.org/blog/2016/10/innovation-enhance-financial-inclusion-and-protect-personal-data



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