Philip R Lane: The role of financial regulation in protecting
consumers
Speech by Mr Philip R Lane, Governor of the Central Bank of Ireland, at the University College
Cork, Cork, 23 February 2017.
* * *
Introduction
It is pleasure to visit University College Cork and I thank the Financial Services Innovation Centre
for hosting this talk. Today, I aim to outline the Central Bank's approach to fulfilling its consumer
protection mandate. I will first discuss the underlying theoretical case for regulatory interventions
to protect consumers. Next, I will describe the institutional framework for consumer protection at
domestic and international levels. I will then explain our vision for how the Central Bank can
contribute to consumer protection and the methods by which we implement this agenda. I will
then turn to laying the current priorities in our consumer protection work. Finally, I will discuss
some developments that will influence the nature of consumer protection regulation in the
coming years.
The Case for Consumer Protection
A vast empirical literature shows that consumers tend to make poor financial choices, taking on
too much debt, misunderstanding investment risk and choosing financial products that do not
match their needs. Over recent decades, the formal economic theory to rationalise these
patterns has been developed, with insights from economics and psychology blended in the
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vibrant fields of behavioural economics and behavioural finance.
The fast pace of financial innovation has created a complex world for consumers, where the
range of available financial products is broad, and the consequences of financial choices are
significant. Coupled with this, the typical household tends to have a limited personal track record
in making financial decisions, since the purchase of financial products happens only infrequently.
This is problematic, since the demands for financial sophistication and knowledge are sizeable if
a consumer is to navigate safely through the options put forward by providers of financial
services. Financial decisions often require consumers to assess risk and uncertainty, for
example, and to consider trade-offs between the near term and the long term. A growing body of
academic literature shows that, among the general population, the level of financial knowledge,
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skills and ability to consider such complexities is low.
There is also a growing body of evidence from the field of behavioural economics that
consumers are subject to behavioural biases when making decisions. In other words, decisions
are affected by emotions and psychological experiences, by rules of thumb and accepted norms.
For example, consumers can exhibit present-biased behaviour, which leads them to over-value
payoffs today relative to payoffs in the future, a bias which can be associated with self-control
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problems. In addition, households can be overly attached to the status quo and suffer inertia
bias, taking default options in financial contracts, failing to switch product or provider even when
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there are clear benefits to switching. Retail investors also tend to follow naïve investment
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strategies rather than identifying superior options. Consumers can also exhibit loss aversion
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bias, meaning that they care more about potential losses than making equivalent gains.
The design of financial products and services can serve to ease or exacerbate these biases. In
this context, behavioural economics shows that framing matters - put simply, firms can present
the same information in different ways and this can lead to different choices by consumers. A
key insight from the recent experience with financial crisis and from the growing literature on
behavioural economics, is that consumers do not always act in their own best interest. In
addition, market forces do not always act to reduce consumer mistakes. Firms face their own
incentives when designing and framing products, and these incentives may not align with the
best interests of the consumer. For example, analysis by the Office of Fair Trading in the UK
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shows that firms can frame prices in a way that plays on consumer biases. Empirical research
also suggests that firms can choose to market the salient features of products that appeal to
consumer biases, while shrouding the less favourable aspects that could alter a consumer's
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choice to purchase that product. The interactions between misaligned incentives and
behavioural biases can adversely affect consumer welfare, and there are many examples of
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analytical work that highlight such costs.
In summary, there is abundant empirical and theoretical research to show that consumers do not
always act in their own best interest in making financial decisions and that biases can be
exacerbated by the design of financial products. In this context, financial regulation to protect
consumers can play a critical role and I would now like to talk to you about the institutional
arrangements for the protection of consumers across the globe, and the vision for consumer
protection at the Central Bank of Ireland.
Consumer Protection: Institutional Setup
Around the world, institutional arrangements in place to protect consumers vary from stand-alone
consumer protection agencies to bodies with dual regulation and consumer protection mandates
and bodies like the Central Bank of Ireland with financial stability, prudential regulation and
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consumer protection mandates. Measures applied to protect consumers range from working
to ensure financial stability, through prudential and macro prudential regulation, supervision and
enforcement to personal financial information and education. Whatever the institutional
architecture, achieving effective outcomes for the consumers of financial services requires
collaboration between all the parts of the system.
Here in Ireland, a number of agencies are charged with the protection of consumers of financial
products. Our prudential, supervision and consumer protection roles include the setting of
statutory codes of conduct for financial services firms, such as codes on how products should
be sold, the information that should be provided and how complaints should be dealt with. The
role of the Competition and Consumer Protection Commission includes the provision of personal
finance information and education, including a web helpline and comparisons of financial
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products. The Financial Services Ombudsman assesses the complaints of individual
consumers against their financial services providers and can direct redress where he finds
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against a firm. We work co-operatively for the protection of consumers. A consumer can also
take action through the courts against a financial services provider, although there is no
legislative provision in Ireland for class actions by a group of consumers.
Following the global financial crisis, there is consensus on the need for greater international and
European convergence and cooperation on how financial institutions are regulated and
supervised. Within Europe, this has resulted in the setting up of the Single Supervisory
Mechanism (SSM) for bank regulation (although it has no consumer protection mandate), as well
as regulatory initiatives such as Solvency II which has the twin goals of enhancing consumer
protection and maintaining financial stability in the insurance sector, the Capital Markets Union
project and the growth and influence of the European Supervisory Authorities (ESAs). In addition,
investor protection is being enhanced through the MIFID II Directive.
The three Supervisory Authorities, the European Banking Authority (EBA), the European
Securities and Markets Authority (ESMA) and the European Insurance and Occupational
Pensions Authority (EIOPA) are working to shape the consumer protection framework across
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Europe. EIOPA, for example, is focused on promoting transparency, simplicity and fairness in
the market for retail insurance and pension products. Its guidelines on product oversight and
governance for insurers aim to minimise the risk of consumer detriment and mis-selling of
insurance products and underpin new regulatory requirements under the Insurance Distribution
Directive which must be transposed into national law by member states by 23 February 2018.
The introduction of EU directives into national legislation plays an important role in the ongoing
strengthening of protection for consumers within the regulatory framework.
In the international arena, bodies such as the OECD, the G20 countries and FinCoNet are active
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in promoting the protection of consumers of financial services. In October 2011, a set of ten
high-level principles on Financial Consumer Protection was endorsed by the G20 Finance
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Ministers and Central Bank Governors. These non-binding principles include that: financial
consumer protection should be an integral part of the legal, regulatory and supervisory
framework; there should be oversight bodies explicitly responsible for consumer protection; all
financial consumers should be treated equitably; honestly and fairly at all stages of their
relationship with financial services providers; and financial services providers and their
authorised agents should aim to work in the best interests of their customers and be responsible
for upholding financial consumer protection. Promotion of financial education and awareness by
all relevant stakeholders as well as easily-accessible clear information on consumer protection,
rights and responsibilities and the disclosure to consumers of key information informing them of
the fundamental benefits, risks and terms are also among the high-level G20 principles.
Our Vision
At the Central Bank our mission statement is "Safeguarding Stability, Protecting
Consumers". Our vision is of a well-functioning, well-managed and well-regulated financial
services system that is underpinned by a strong culture of compliance, with firms and individuals
within firms acting in the best interests of their customers, backed up by comprehensive and
enforceable legislation, rigorous supervision, a credible threat of enforcement and powers of
redress when consumers have suffered detriment.
A fundamental protection for consumers lies in ensuring that the financial system is stable and
the firms that operate within it are financially safe and sound. This means, inter alia, that investor
assets are safe and available and that an insurer's promise to pay out in the event of an
unforeseen future loss will be honoured.
Our aims are articulated in our 5 C's framework. In order for regulated firms to act in the best
interests of all regulated firms should embed and demonstrate a positive
Consumers,
consumerfocused Culture which will allow consumers to have Confidence in the financial decisions they
are making and the firms they are dealing with. We firms where their focus is not on
Challenge
positive consumer outcomes and we take appropriate regulatory action to ensure that firms meet
their statutory Compliance standards.
As well as working to develop a positive consumer focused culture within firms, we continue to
develop and review our consumer protection framework to enhance the protections in place. In
this regard we participate actively in the European and International bodies, including the three
European Supervisory Authorities and FinCoNet, to influence the future shape of consumer
protection.
Our Methods
Let me explain our working methods. As an integrated organisation, we work to deliver
consumer protection through a continuum of functions ranging from financial stability, through
authorisation, prudential regulation, supervision and inspections to enforcement and redress.
As I said earlier, ensuring that the financial system is stable and the firms that operate within it
are financially safe and sound is a basic level of protection for consumers. A recent example is
the introduction of the macro-prudential mortgage lending rules aimed at reducing the risk of
overheating in the housing market and reducing the risk of consumers over-borrowing.
In our role of authorising financial services firms to operate in the Irish market, we act as a
gatekeeper to protect consumers. We are rigorous and challenging in our application of the
requirements and standards so that the firms we authorise can be expected to meet the best
interests of consumers. Our criteria include: the fitness and probity of individual directors and
senior management; the adequacy of firm capital; the adequacy of internal controls and risk
management systems; and the level of resources and expertise of staff. We can and do refuse
applications from financial services providers and we can and do withdraw or revoke
authorisations. We can investigate individuals performing specific functions where we suspect
an individual's fitness and probity. We can issue a suspension notice and/or a prohibition notice
potentially prohibiting the individual from performing all such functions indefinitely.
As prudential regulator, we have regular supervisory engagement with firms. During this
engagement, we may identify an issue or process that is not necessarily consistent with the best
interests of consumers. In such cases, we can seek additional information, request the firm to
perform a task, cease a practice or modify a process. In the first instance, we may require the
firm to mitigate the risk but we can also use our regulatory powers to issue a direction to the
firm.
We use the Probability Risk and Impact SysteM (PRISM) as our framework for the supervision of
regulated firms. We developed this risk-based framework so that we could prioritise our work
and target our finite resources on the highest level risks. It allows supervisors to judge the risks
a firm poses to the economy and the consumer and mitigate those risks we consider
unacceptable. To identify high- level risk issues, we build business intelligence through the
analysis of, for example, data on sales, complaints about products and services, advertising
spends, new business and product development, issues arising from queries and social media,
horizon scanning and feedback from supervisors, enforcement and authorisation officers. This
helps us to detect and understand where potential consumer detriment can arise and helps
supervisors compile conduct risk reports on which our actions to mitigate risk will be based.
We use themed inspections to focus on a specific issue, topic or product rather than on a
specific institution. We identify the themes to pursue in a number of ways, including consumer
queries, complaints, issues arising from previous inspections, market intelligence and annual
sectoral risk assessments, as well as advice from the Consumer Advisory Group on our
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consumer protection strategy and policy initiatives. Themed inspections are conducted by
survey or by a combination of survey and on-site inspections. Following a themed inspection, we
issue firm-specific letters, an industry-wide letter and a press release and publish our findings on
the Central Bank website. Where we identify a specific compliance issue in an individual firm, we
address this directly with the firm.
A credible threat of enforcement underscores our powers to protect consumers of financial
services. We take robust enforcement action aimed at promoting principled and ethical
behaviour by and within regulated entities. Transparent and strong action where entities or
individuals fall short of required standards helps to deter poor practices, achieve compliance and
encourage the behaviour we expect. We take action where firms or individuals have breached
provisions in prescribed legislation, a code, or a condition, requirement or obligation imposed by
the Central Bank. In 2013, legislation provided the Bank with formal redress powers to direct
regulated financial services firms to make appropriate redress to customers where they have
suffered or will suffer a loss as a result of widespread or regular relevant defaults by a regulated
financial services provider. Where consumers suffered detriment prior to 2013, we have used
our influence to obtain redress for consumers on a range of issues including payment protection
insurance and credit card protection insurance, as well as part of the tracker mortgage
examination.
Current Priorities
We set out what we see as the key risks now facing consumers in our Consumer Protection
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Outlook Report, which was published last week. These range from the absence of a
consumer-focused culture in financial services firms, through the ongoing problems of high
levels of indebtedness and mortgage arrears, to the implications for consumers of the significant
increases in the cost of health and motor insurance. There are risks to consumers from poor
product design and marketing especially where products are complex and terms and conditions
may be difficult to understand. There are risks, as well as advantages, for consumers from the
greater use of technology to deliver financial products and services and from the pace and scale
of technological innovation in the financial services sector. And there are potential risks for
consumers from the changing international economic and political landscape from Brexit to the
post-Trump reform of regulation in the United States.
In a recovering economy, there are also risks for consumers. We see an increase in the level of
new lending in all areas which needs to be managed by lenders to ensure that new debt is both
affordable and suitable for the borrower. Lenders are aware that they are required under our
Consumer Protection Code to assess affordability and to lend responsibly on a case by case
basis. In a low interest environment earning a return on savings or providing for retirement is
more difficult and firms need to make their customers aware of the increased risks involved in
products that offer higher rewards. Again, regulated firms know that they are required to ensure
that the products they sell to their customers are properly explained and understood and
appropriate to that customer's risk appetite.
Having identified these and other risks, what is the Central Bank doing to address these risks and
to enhance its protection of consumers? First, we continuously assess our consumer protection
regulatory framework to ensure it is fit for purpose and working for consumers. To do this we
use market intelligence, our supervisory experience, consumer research and insights into
consumer behaviour as well as feedback from key consumer protection bodies such as the
Competition and Consumer Protection Commission and the Financial Services Ombudsman.
European legislation, including new directives, as well as wider international developments
continue to shape our framework. We are active participants in the three European Supervisory
Authorities as well as in FinCoNet. Ongoing developments in the consumer protection framework
include the implementation of EU Directives in Insurance, Payments Services and Markets in
Financial Instruments and reviews of our Codes, including the Minimum Competency Code and
the Consumer Protection Code for Licensed Moneylenders.
I referred earlier to the risk to consumers from the absence of a consumer-focused culture within
financial services firms. What do I mean by such a culture? We see a positive
consumerfocused culture as one in which financial services firms communicate clearly with their
customers, help customers to understand the financial products and options available to them
and to make the financial decisions that best meet their needs. It is a culture in which
consumers can be confident that firms are acting in their best interests. It is a culture in which
boards and senior management set the tone through their commitment to achieving good
outcomes for their customers. It is a culture where a firm engages constructively with
customers who have queries or complaints and which rectifies its errors or mistakes. It is a
culture where staff are incentivised to build good customer relationships and to aim to sell
appropriate products rather than large numbers of products.
Our work to promote the development of a consumer-focused culture includes directing all
banking, insurance and investment firms to review and restructure their incentive payments for
sales staff in light of guidelines we issued to ensure that employees, individually and collectively,
act in the best interests of their customers and provide products suitable to their needs. We are
currently examining additional measures to ensure that firms remuneration structures for
intermediaries encourage responsible business conduct, fair treatment of consumers and to
avoid conflicts of interest.
There has been progress by some firms towards this type of culture but there is a long way to
go. Firms need to put internal consumer risk management frameworks in place to help make
the shift to a consumer focused culture. Recognising the fundamental importance of risk
management in achieving this cultural shift, we have enhanced our on-site Consumer Protection
Risk Assessment model (CPRA), which provides us with a robust framework to assess how
consumer risks are being identified and managed by firms. The new model equips us to assess
how firms' risk management frameworks are designed and governed, but also how effective they
are in practice at delivering fair consumer outcomes.
Following the successful pilot-testing of the model in 2016, we will conduct a series of targeted
CPRAs across the different retail sectors throughout 2017, with a particular focus on culture,
performance management, sales incentives and product governance. The CPRAs will be in
addition to and support our regular programme of consumer-focused thematic inspections,
which examine how firms are selling their products and services in practice. And we continue to
engage with the boards and senior management of regulated firms to ensure there is a very clear
focus from the top on embedding and measuring the firms cultural change programme.
Looking to the Future
In determining the appropriate scope of the Central Bank's work to protect consumers, I would
like to sound a note of caution. The Central Bank is committed to working effectively to protect
consumers of financial services but it is important we do not over-promise on the outcomes we
can achieve. The goal is to secure an appropriate degree of protection of consumers while
recognising that expectations of what can be achieved through regulatory mechanisms need to
be reasonable.
It is inevitable that consumer protection issues will arise that could not have reasonably been
foreseen or may be the result of fraud, criminal conduct or human error. What is important is
that where these issues arise, we take corrective action swiftly and work to redress the detriment
to consumers. The Central Bank played a leadership role in this area with the development of
the Consumer Protection Code and we continue to pursue a strong consumer protection agenda
through our involvement in European and international bodies.
It is important to appreciate that much of the consumer protection work undertaken by the
Central Bank is not publicly visible, such as when we take action to address potential problems
at the outset and thus avoid consumer detriment. Examples would include where we refuse to
authorise firms to offer financial services here, where we identify issues through supervision or
themed inspections and take action to mitigate before consumer detriment arises. Restitution of
over €19 million was paid to consumers in 2015 on foot of issues identified through our
supervisory activity. We have also taken strong enforcement action - since 2010 we have
concluded some 80 enforcement cases, half of which dealt with consumer issues. We have
imposed fines totalling over €46 million and have removed individuals for the management of
firms.
But this is a challenging area and sometimes our best efforts will not achieve our desired targets
or may not progress as quickly as we would wish. In tackling the issue of the fair treatment of
tracker mortgage customers, for example, we have initiated the largest and most complex
consumer protection investigation we have even undertaken. To ensure that a fair outcome is
achieved for consumers this review will some take time. We have required each lender to carry
out a thorough, comprehensive and robust review which is independently overseen. Some two
million mortgage accounts are being reviewed and lenders will have to pay redress and
compensation to affected customers and are facing enforcement action by the Central Bank.
We have fined one lender €4.5 million and directed that its customers receive appropriate
redress and compensation - by November 2016, this had amounted to €5.8 million. Two other
enforcement cases are currently ongoing.
As we strive to protect the consumers of financial services, I believe that more needs to be done
to empower consumers in their dealings with financial services firms. Improving financial literacy
is an integral part of the consumer protection agenda. International financial literacy studies
indicate that a majority of the world population do not have sufficient knowledge to understand
even basic financial products and fail to make effective decisions to manage their finances and
the risk associated with them. The OECD and G20 have advised that this needs to be
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undertaken through nationally coordinated and tailored approaches.
At the Central Bank, we know we need to deliver effective protection for consumers of financial
products and services in a rapidly evolving financial services landscape. It is our responsibility to
respond to emerging threats, to be vigilant to evolving potential threats and to be proactive in
tackling risks to consumers. Looking ahead, consumers would benefit from simpler products for
example in the areas of pensions and health insurance. In the insurance sector, work needs to
be done to attain the goal of consistent supervisory standards across Europe and to coordinate
the various national protection schemes for policyholders.
Finally, the technological innovations that bring the potential benefits of lower costs, speed,
automation and convenience for consumers also pose some challenges for regulators in relation
to consumer protection. Our focus is on ensuring that the appropriate frameworks are in place
so that firms must take the best interests of consumers into account in their design, operation
and monitoring of online distribution and automated advice channels. Furthermore, given the
scope for online distribution channels to foster cross-border trade in financial services, it is
essential that the legislative framework fosters internationalisation without compromising
consumer protection.
Acknowledgements: I thank Mary Canniffe, Yvonne McCarthy and Helena Mitchell for their
inputs into this speech.
References
Badarinza, C., Campbell, J. Y. and Ramadorai, T. (2016). International comparative household
finance, Annual Review of Economics, 8, pp. 111-144.
Benartzi, S., and Thaler, R.H. (2001). Naive Diversification Strategies in Defined Contribution
Savings Plans. American Economic Review, 91(1), 79-98.
Campbell, John Y., Howell E. Jackson, Brigitte C. Madrian and Peter Tufano (2016), "Consumer
Financial Protection," Journal of Economic Perspectives 25(1), 91-114.
Campbell, John Y. (2016), "Restoring Rational Choice: The Challenge of Consumer Financial
Regulation," American Economic Review: Papers & Proceedings 106(5), 1-30.
Choi, J.J., Laibson, D., Madrian, B. C. and Metrick, A. (2005). Optimal defaults and active
decisions. NBER Working Paper no. 11074. Cambridge, MA: National Bureau of Economic
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DellaVigna, S. and Malmendier, U. (2004). Contract Design and Self-Control: Theory and
Evidence. Quarterly Journal of Economics, 119(2), 353-402.
Gabaix, X., and Laibson, D. (2006). Shrouded Attributes, Consumer Myopia, and Information
Suppression in Competitive Markets. Quarterly Journal of Economics, 121(2), 505-40.
Heidhues, P., and Kőszegi, B. (2010). Exploiting Naïvete about Self-Control in the Credit Market.
American Economic Review, 100(5), 2279-2303.
Loewenstein, G., O'Donoghue, T., and Rabin, M. (2003). Projection Bias in Predicting Future
Utility. Quarterly Journal of Economics, 118(4), 1209-1248.
Lusardi, A. and Mitchell, O.S. (2007). Baby boomer retirement security: the roles of planning,
financial literacy and housing wealth, Journal of Monetary Economics, 54(1), pp. 205-224.
Lusardi, A., Mitchell and Curto, V. (2010). Financial literacy among the young, The Journal of
Consumer Affairs, 44(2), pp. 358-80.
Lusardi, A. and Mitchell, O.S. (2011). Financial literacy around the world: an overview, Journal of
Pension Economics and Finance, 10(4), October.
Lusardi A. and Tufano, P. (2009). Debt literacy, financial experiences and overindebtedness,
NBER Working Paper No. 14808.
Madrian, B., and Shea, D.F. (2001). The Power of Suggestion: Inertia in 401(k) Participation and
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Office of Fair Trading (2010). The Impact of Price Frames on Consumer Decision Making.
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Henderson, B.J. and Pearson, N.D. (2011). The Dark Side of Financial Innovation: A Case Study
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1
See Campbell et al. (2011), Campbell (2015), Badarinza et al. (2016) for surveys of the literature.
2
See Lusardi and Mitchell (2007, 2011), Lusardi et al. (2010) and Lusardi and Tufano (2009).
3
See Loewenstein et al. (2003), Della Vigna and Malmedier (2006) and Gabaix and Laibson (2006).
4
Madrian and Shea (2001) and Carroll et al. (2009).
5
Benartzi and Thaler (2001).
6
Heidhues and Kőszegi (2010).
7
Office of Fair Trading (2010).
8
Henderson and Pearson (2011).
9
May et al. (2014) and Lusardi and Tufano (2009).
10
Consumer Protection agencies such as the Financial Conduct Authority in the UK, the Netherlands Authority for
the Financial Markets, and the Financial Consumer Agency of Canada do not have a prudential regulation role.
Agencies with dual regulation and consumer protection mandates include the German Federal Financial
Supervisory Authority (BaFin), the Financial Supervisory Authority in Denmark and the Financial Supervisory
Authority of Norway. The Central Bank of Ireland and the Central Bank of Portugal have financial stability,
prudential regulation and consumer protection mandates.
11
ccpc.ie/.
12
www.financialombudsman.ie/ .
13
www.eba.europa.eu/ , www.esma.europa.eu/ , eiopa.europa.eu/ .
14
FinCoNet is the international organisation of financial consumer protection supervisory
authorities. www.finconet.org/
G20 High-Level Principles on Financial Consumer Protection. Published by OECD October 2011. Followed by
"Effective Approaches to Support the Implementation of the remaining G20/OECD High-Level Principles on
Financial Consumer Protection". Published by OECD September 2014.
16
The Consumer Advisory Group was set up under the Central Bank Reform Act 2010 to advise the Central Bank
on the performance of our functions and the exercise of our powers in relation to consumers of financial
services.
17
www.centralbank.ie/press-area/press-releases/Pages/CPOR2017.aspx
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Advancing National Strategies for Financial Education: OECD 2013 message from Anton Siluanov Minister of
Finance Russian Federation. P 6