And it contributed to the near collapse of our financial system.”<sup>5</sup> Chairman of the Federal Deposit Insurance Corporation Sheila Bair went further stating, “There can no longer be any doubt about the link between protecting consumers from abusive products and practices and the safety and soundness of the financial system. Products and practices that strip individual and family wealth undermine the foundation of the economy. As the current crisis demonstrates, increasingly complex financial products combined with frequently opaque marketing and disclosure practices result in problems not just for consumers, but for institutions and investors as well.”<sup>6</sup> The US experience shows that where financial markets have developed a high level of innovation and growth in retail financial services, special attention should be paid to issues of consumer protection and financial literacy. Improved consumer protection and financial literacy cannot be a “magic bullet” to solve all problems in consumer finance but they can identify preventive measures to help avoid some of the worst financial consumer abuses.

**Weaknesses in consumer protection and financial literacy affect both developed and developing countries.** Emerging countries worldwide have seen rapid development of their financial sectors over the last ten years and rapid growth of income has provided consumers with more resources to invest. Increased competition among financial firms, combined with improvements in financial techniques and information technology, resulted in highly complex financial products being sold to the public. The public in many emerging markets, however, lacks a history of using sophisticated financial products. For many first-time financial consumers, often no member of their extended families has entered into a long-term financial contract such as a home mortgage loan. The growth of financial literacy significantly lags the growth of available investment resources (or access to credit), widening the gulf between the complexity of financial products and consumers' ability to understand what they are buying. Especially in low-income countries, technology is also changing the types of protection needed by many first-time financial consumers. Where more than half the population has no bank account, financial services delivered via cellular telephones have filled a critical need for consumers, but such services raise important issues of consumer disclosure, safety and education. Even in well-developed markets, however, weak consumer protection and financial literacy can render households vulnerable to unfair and abusive practices by financial institutions (or just inadequate disclosure of the risks involved in taking on large debts, particularly in foreign currency), as well as financial fraud and scams.

**The objective of this Working Paper is to take the lessons from nine country studies and lay out a broad framework for reviewing consumer protection and financial literacy in emerging markets.** Starting in 2005, the Europe and Central Asia Region of the World Bank initiated a pilot program in Consumer Protection and Financial Literacy. For the pilot program, nine Diagnostic Reviews were conducted, six in new member states of the European Union (Bulgaria, Czech Republic, Latvia, Lithuania, Romania, and Slovakia) plus Azerbaijan, Croatia and Russia.<sup>7</sup> This Working Paper pulls together the lessons from the nine country studies and identifies common issues across all the studies. While this Working Paper summarizes key lessons from reviews only in middle-income countries, the findings may also be useful for low-income countries.<sup>8</sup> This Working Paper thus provides a framework against which detailed studies, such as consumer protection in mobile banking or consumer protection for low-income countries, can be developed.

> 5 Written Testimony by Assistant Secretary for Financial Institutions Michael Barr before the US Senate Committee on Banking, Housing and Urban Affairs, July 14, 2009

> 6 Statement of Sheila C. Bair, Chairman of the Federal Deposit Insurance Corporation, on Modernizing Bank Supervision and Regulation before the US Senate Committee on Banking, Housing and Urban Affairs, March 19, 2009

> 7 The Diagnostic Reviews, Good Practices and materials from dissemination seminars can be found at <u>www.worldbank.org/eca/consumerprotection.</u>

> 8 The World Bank divides economies according to their Gross National Income (GNI) per capita, calculated using the World Bank Atlas method. Based on 2008 GNI, the groups are: low income $975 or less; lower middle income $976 - $3,855; upper middle income $3,856 - $11,905; and high income $11,906 or more.

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