Microfinance Horizon

Author(s): Mark Flaming, Alexander Owino, Katharine McKee, Nicola Jentzsch, Simone di Castri, Bilha Maina, Moses Ochieng, Daryl Collins and Brendan Ahern.

(N.B. – This report was commissioned by FSD Kenya. The findings, interpretations and conclusions are those of the authors and do not necessarily represent those of FSD Kenya, its Trustees and partner development agencies.)

Executive Summary:

The Kenyan population uses financial services from a broad array of providers. The financial sector regulators provide some, but incomplete and sometimes inconsistent consumer protection to the clients of regulated institutions. In the absence of a market-wide consumer protection law or authority, users of informal financial service providers lack protection entirely. As a result, Kenya falls short in providing comprehensive financial consumer protection and recourse, in policy and practice. The new Constitution commits the nation to protecting consumers and Vision 2030 proposes policy initiatives. An incremental approach offers the best way to build effective financial consumer protection.

Mass market financial services are growing at an impressive rate, generating significant benefits for consumers. Yet a growing body of evidence from on-the-ground research suggests that consumer welfare is compromised by lack of effective disclosure of prices and key terms, inadequate dispute resolution mechanisms, and abusive practices. For example, 25% of bank depositors in a 2010 FSD/CGAP survey expressed “surprise” at charges they did not know about. This is not surprising, given that a 2007 CBK survey found 53 different classes of charges that various banks levy on current accounts.

The best strategy for strengthening financial consumer protection in Kenya, as in any country, will be grounded in pragmatic solutions to problems that affect large numbers of consumers. The 2010 FSD/CGAP Consumer Protection Diagnostic analyzes key consumer protection issues and concludes that the financial sector regulators responsible for oversight of mass-market services – particularly the Central Bank of Kenya, the Insurance Regulatory Authority, SASRA and the Ministry of Finance — have adequate authority to improve financial consumer protection through incremental improvements in regulation. This can be achieved by a coordinated approach to issuing and enforcing consistent rules governing disclosure, recourse and fair treatment.

The lack of comprehensive consumer protection legislation might seem to lend urgency to finalizing some combination of the draft Competition and Consumer Protection bills. The related Constitutional provisions make this outcome still more likely. Indeed, the diagnostic noted the advantages of such legislation, both in strengthening protection for users of regulated providers and offering protections to users of unregulated providers. However, any new agency would take time to set up and delaying consumer protection action until such a time risks undermining public confidence. Evidence compiled for the diagnostic suggests that current consumer protection problems merit attention. Gradual but continual progress is a more prudent strategy than relying on future legislation and the capacity of a brand-new regulator.

From this perspective, the diagnostic recommends an incremental course that builds on the practice of the financial sector regulators, and is eventually reinforced by a comprehensive consumer protection law and a market-wide regulator. These regulators currently have the strongest legal and indeed moral authority, combined with technical capacity, to introduce consistent basic directives for providers in their respective sectors. Harmonization of these rules across the sectors will foster clear expectations from both consumers and providers, establish credibility for the mandate, and create precedents that then can be extended to the entire financial market through an agency with a broad remit.

The regulators are positioned to launch this strategy by establishing a basic protection regime covering 40% of the adult population, i.e., clients of banks, foreign exchange bureaus, deposit-taking microfinance institutions, mobile financial services, insurance companies, pension plans, investment brokers and advisors, and larger SACCOs.1 Each sector regulator already has similar legal mandates to safeguard consumer interests. It is noteworthy that some regulators have put in place rules that can be adapted by their counterparts to create a harmonized protective regime related to the following core areas:

Minimum disclosure requirements for pricing and plain language in contracts. The CBK is well advanced in reviewing credit price disclosure guide-lines, and the IRA is engaged with the insurance industry in the development of standardized, plain language policy wording for various insurance products.

Minimum requirements for provider-level dispute resolution mechanisms and independent third-party recourse. The Credit Reference Bureau regulations, for example, establish clear guidelines for providers. The IRA and CMA are mandated to, and in practice provide recourse to consumers unable to resolve grievances through provider dispute channels. The other regulators may – with good reason – choose to delegate this function to a future entity with a market-wide recourse mandate.

Regulations that clarify provider liability and responsibility for oversight of third-party agents who play a role in service delivery. The recent Agent Banking Guidelines serve as a model for other sectors in this respect. Ensuring clear provider liability for agents is particularly important in the insurance sector and with the mobile financial service providers. Where liability is limited for practical reasons, it is important that consumers are aware of that limitation.

Public reporting of provider performance in basic areas. The regulators should ensure public disclosure including:

• A list of providers that are subject to prudential and consumer protection regulations;
• A description of the regulations including, specifically, the obligations of the providers; and,
• Periodic reporting on individual provider performance against the transparency and internal dispute mechanism rules to which they are subject.

Mobile financial services deserve particular attention, since users number over ten million Kenyans or 54% of the adult population. The number of users and service providers, and the range of services are expanding rapidly. The CBK has guided the sector well in its early phase. Formalizing regulation of these providers is now timely and prudent, to control risks to consumers while ensuring a solid foundation for the industry.

Enhanced consumer awareness and financial education are required for the incremental approach to succeed, since improvements in regulation and industry practices otherwise will not have their intended effect. For now, the 27% of the population that use unregulated providers must rely mainly on their own financial capability to assess providers and products and protect themselves against abusive or unfair practices. Extrapolating from the national survey conducted as part of the diagnostic, for example, just under 1 million adults lost roughly Kshs 31 billion in pyramid schemes (see section 12.3). Informed choice and knowledge of one’s rights and responsibilities is also important for users of regulated providers.

Building the nation’s financial capabilities is a formidable challenge. The Financial Education and Consumer Protection Partnership (FEPP) already convenes most key public and private sector players and provides a strong vehicle for implementing a credible strategy. Promising pilots are underway. The sector regulators created the Joint Regulators’ Task Force with a memorandum of understanding for collective action on awareness and education. The diagnostic identifies a number of key short-term awareness and education priorities directly related to the proposed transparency, fair treatment and effective recourse measures. Although this will be a long-term process, successful pilot approaches can be scaled up rapidly to support core protection issues in the short to medium term.

These first-phase incremental efforts will cultivate the critical mass of political will and practical experience needed to drive development of a comprehensive financial consumer protection legal framework and a dedicated enforcement authority. A new authority of this type would complement the financial sector efforts in three important ways:

• An enforcement agency with a market-wide protection mandate could enforce consumer protection regulation across the entire financial market and thereby cover the clients of otherwise unregulated providers.

• It could address specific practices and products in ways that the more risk-based, prudential regulators typically do not.

• And finally, it could establish a recourse mechanism to function as a check and balance on providers’ internal dispute resolution. The authority could also cooperate with the financial sector regulators for consistent market monitoring.

As for implementation, this proposal for incremental improvements leverages the existing capacity of established financial-sector regulatory entities, in advance of creating a new cross-market authority. It mitigates the high risk of regulatory dysfunction when a new regulatory agency is set up to enforce a new law. The sector regulators can lend capacity and credibility to the early stages of this incremental process. And their early success can create impetus for an eventual comprehensive consumer protection regime.

This strategy contemplates a pivotal role for the Ministry of Finance, which is best positioned to engage the financial sector regulators, monitor progress, and guide the policy dialogue. The Ministry is also uniquely positioned to secure the public sector resources required to sustain this effort over time.

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