**The theme of this Working Paper is that a consumer protection regime should meet three objectives.** First, consumers should receive accurate information in simple, plain and comparable language before they buy a financial service or product—as well as during the life of the product. Second, consumers should have access to a fast, inexpensive and efficient mechanism for resolving disputes with financial institutions. Third, consumers should be able to obtain financial education when they want it and in the form that they want it. The focus of this Working Paper is thus on **_results,_** that is, measurable improvements in the provision of financial services to households. As a consequence, this Working Paper looks at what institutional structures are needed to achieve improvement in provision of financial services for consumers, but does not focus on issues of institutional design or capacity building. To help policymakers achieve the three objectives, this Working Paper points out areas where the interests of financial service providers and those of consumers overlap—and identifies areas of the greatest risk of misalignment between the interests of financial firms and those of their retail customers.

**The country Diagnostic Reviews provide valuable insight into the kinds of problems faced by financial consumers in emerging markets.** The Diagnostic Reviews for the EU new member states provide the opportunity to see how the European Commission’s strategy on consumer protection in financial services has been applied in several former transition economies. Among those countries is Latvia, whose review was conducted in June 2009—in the midst of the worst financial crisis in the country’s history. Croatia provides the perspective of a country managing a complex legal and institutional agenda for future accession to the European Union. Russia gives an insight into the largest country in the world in terms of area, spanning 11 time zones. Azerbaijan provides the view of an oil-rich country that was formerly a low-income economy. Taken together, the nine country Diagnostic Reviews provide a useful overview of the key issues emerging from systematic assessments of consumer protection and financial literacy in a number of middle-income countries. Examples of the types of financial consumer weaknesses found in the country studies are given in Box 1.<sup>9</sup>

# **Background**

**At its heart, the need for consumer protection arises from** **_an imbalance of power, information and resources_ between consumers and their financial service providers, placing consumers at a disadvantage.** Consumer protection aims to address this market failure, commonly referenced as “asymmetric information”.<sup>10</sup> Financial institutions know their products well but individual retail consumers may find it difficult or costly to obtain sufficient information regarding their financial purchases. In addition, complex financial products can be difficult to assess, even when all relevant information is disclosed. Imbalances are also present in cases where:

- _Transactions are idiosyncratic or rare_ (for example, when providing a mortgage on a personal residence);

- _Entry or exit costs are low_ (such as for financial intermediaries), thus allowing disreputable firms to emerge; or

> 9 Note that the data in this Working Paper reflects information that was accurate at the time the Diagnostic Reviews were conducted. Several countries have since improved their financial consumer protection frameworks.

> 10 Technically speaking, asymmetric information raises two main problems: adverse selection and moral hazard. Adverse selection is also referred as the “lemon problem”. The academic literature notes that, with imperfect information on the part of lenders or prospective car buyers, borrowers with weak repayment prospects or sellers of low-quality cars ("lemons") crowd out everyone else from the market. See George A. Akerlof, "The Market for ‘Lemons': Quality Uncertainty and the Market Mechanism", _Quarterly Journal of Economics_ , Volume 84, No. 3, August 1970. This is a different issue from that of borrowers lacking sufficient information to make well-informed financial decisions. However in common parlance, asymmetric information refers to the imbalance between financial service providers and consumers.

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