well-informed financial and corporate institutions are not subject to many of the problems that can potentially harm retail consumers. This Working Paper uses the definition of the retail market as those economic transactions made between economic operators and final consumers, sometimes called the business-to-consumer (or “B2C”) market. This market does not include businesses—however small—in their role as purchasers of financial services.<sup>18</sup> Thus this Working Paper relates only to the direct relationship between retail customers and financial institutions (or their agents and intermediaries), although one of the Diagnostic Reviews (for Azerbaijan) also looked at consumer protection issues for the microfinance sector, in light of the importance of microfinance as part of the Azeri financial system. This Working Paper does not cover areas such as personal insolvency or collateral registries. Such areas are important parts of the financial sector infrastructure but they are not directly involved in relations between consumers and financial institutions.

**Design of consumer protection and financial literacy measures should take into account recent research in behavioral economics.** Psychological biases may influence consumers to make choices that are neither rational nor optimal. These biases include mistaken beliefs where consumers assume that interest rate charges or penalties will not apply to them: they are over-optimistic about their financial future and thus unable to forecast their future financial status accurately.<sup>19</sup> Individuals often over-estimate their financial capabilities, including their understanding of the concept of the time value of money and the impact of compound interest over time.<sup>20</sup> Other consumers fall victim to projection bias, that is, the prediction of personal preferences into the future.<sup>21</sup> Other related effects are hyperbolic discounting (where consumers apply a very high discount rate to future income and thus reduce the present value of savings to very low levels), impulse purchasing and weaknesses in self-control. The research points to the need for surveys of financial literacy and consumer spending habits as essential background for designing not only programs of financial education but also measures for improving policies of consumer information and awareness.

**This Working Paper starts from the perspective that a financial sector should provide consumers with:**

- **_Transparency_** by providing full, plain, adequate and comparable information about the prices, terms and conditions (and inherent risks) of financial products and services;

- **_Choice_** by ensuing fair, non-coercive and reasonable practices in the selling and advertising of financial products and services, and collection of payments;

- **_Redress_** by providing inexpensive and speedy mechanisms to address complaints and resolve disputes; and

- **_Privacy_** by ensuring control over collection and access to personal financial information.

In addition, consumers should have access to programs of financial education that enable them to develop the financial capability required to understand financial products and services and exercise their rights (and responsibilities) as financial consumers. Training in financial issues should also empower consumers to make well informed decisions about their finances—and to plan their financial needs over a lifetime. Financial education cannot, however, substitute for adequate financial regulation.

> 18 However recent evidence suggests that businesses in the form of sole proprietorships (as are many microcredit borrowers) suffer the same kind of consumer protection issues as do retail consumers.

> 19 S. Brown, G. Garino, K. Taylor and S.W. Price, _Debt and financial expectations: An individual and household level analysis_ , Working Paper, University of Leicester, 2003. See also N. Weinstein, "Unrealistic Optimism About Future Life Events", _Journal of Personality and Social Psychology_ 39(5): 806-820, 1980

> 20 Lewis Mandell, _Personal Finance Survey of High School Seniors_ , The Jumpstart Coalition for Personal Financial Literacy, Washington, DC, 2004. Also see ANZ Banking Group, _ANZ Survey of Adult Financial Literacy in Australia_ , Melbourne, 2003

> 21 G. Loewenstein, T. O’Donoghue and M. Rabin, "Projection Bias in Predicting Future Utility," _Quarterly Journal of Economics_ 118 (4): 1209-1248, 2003

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