BULGARIA. Diagnostic Review of Consumer Protection and Financial Capability. Key Findings and Recommendations. Volume I. May 2009

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1 BULGARIA Diagnostic Review of Consumer Protection and Financial Capability Volume I Key Findings and Recommendations May 2009 Private and Financial Sector Development Department Europe and Central Asia Region Washington, DC

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3 BULGARIA Diagnostic Review of Consumer Protection and Financial Capability Volume I Key Findings and Recommendations May 2009 THE WORLD BANK Private and Financial Sector Development Department Europe and Central Asia Region Washington, DC ii

4 This Diagnostic Review is a product of the staff of the International Bank for Reconstruction and Development/The World Bank. The findings, interpretations, and conclusions expressed herein do not necessarily reflect the views of the Executive Directors of the World Bank or the governments they represent. iii

5 BULGARIA Diagnostic Review of Consumer Protection and Financial Capability Volume I Key Findings and Recommendations Contents Abbreviations & Acronyms... iv Foreword... v Acknowledgments... vi Executive Summary... 1 Introduction... 7 Importance of Consumer Protection & Financial Capability... 8 Bulgarian Policy for Consumer Protection in Financial Services in the EU Context.. 11 Background on Bulgarian Household Finances Key Findings & Recommendations Institutional Structure...19 Consumer Disclosure...24 Business Practices...28 Inquiries, Complaints & Disputes...31 Financial Education...37 References Tables Table 1: Household Currency Exposures Table 2: Household Use of Financial Services by Table 3: Number of Complaints Received by European Complaint Services in Figures Figure 1: Household Loans by Purpose and Maturity Figure 2: Shares of Foreign Currency Loans in Household Loan Portfolios Figure 3: Shares of Bad and Restructured Loans in Household Loan Portfolios iii

6 Abbreviations & Acronyms ABB ABI ADR AMC APR BAAMC BAL BALIP BASPSC BGN BNB BSE-Sofia CEE CIU COE CPC DOLCETA DG SANCO EC EU EU-15 FSC FX GDP IMF IT KYC LIBOR MFI Act MiFID MOU MTPL NBCI NGO NMS OECD SIC SOFIBOR UCITS UK USA USAID USD Association of Banks in Bulgaria Association of Bulgarian Insurers Alternative dispute resolution Asset management company Annual Percentage Rate of Charge Bulgarian Association of Asset Management Companies Bulgarian Association of Leasing Bulgarian Association of Licensed Investment Brokers Bulgarian Association of Supplementary Pension Security Companies Bulgarian Lev (local currency) Bulgarian National Bank Bulgarian Stock Exchange-Sofia Central and Eastern Europe Collective investment undertaking Council of Europe Consumer Protection Commission Development of On-Line Consumer Education Tools for Adults Directorate-General for Health and Consumers (of the EC) European Commission European Union Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, Sweden and United Kingdom Financial Supervision Commission Foreign Exchange Gross domestic product International Monetary Fund Information technology Know your customer London Interbank Offered Rate Market in Financial Instruments Act Directive on Markets in Financial Instruments Memoranda of Understanding Motor third party liability Non-bank credit institution Non-governmental organization EU New Member State Organisation for Economic Co-operation and Development Social Insurance Code Sofia Interbank Offered Rate Undertakings for Collective Investment in Transferable Securities United Kingdom United States of America United States Agency for International Development United States Dollar n.a. Not Available $1 = 1.48 BGN (April 2009) iv

7 Foreword Consumer protection in financial services lies at the heart of any financial sector that is efficient, competitive and fair. Three areas are important. Customers of financial institutions should have the right to receive information that is clear, complete, accurate and comprehensible before they decide to borrow or to invest. They should have access to recourse mechanisms that are efficient and cost-effective. They should also be able to obtain sufficient financial education to understand the terms and conditions and other information provided to them as financial consumers. We are pleased to provide this pilot Diagnostic Review of Consumer Protection and Financial Capability in Bulgaria and thank the Bulgarian authorities for their valuable cooperation and collaboration in its preparation. The Review not only looks at financial services in Bulgaria but also refines a set of good practices or benchmarks for use in reviewing consumer protection in financial services in any jurisdiction. It is expected that this work will prove helpful to the international community and those in emerging markets who seek to establish common ground for minimum good practices in consumer protection in financial services. v

8 Acknowledgments This review was prepared by a team led by Sue Rutledge, Regional Corporate Governance/ Consumer Protection Coordinator and Senior Private Sector Development Specialist, World Bank. The project team consisted of Brett Coleman (Senior Financial Sector Specialist), Evgeni Evgeniev (Private Sector Development Specialist), Martin Melecky (Financial Economist), Rodolfo Wehrhahn (Senior Insurance Specialist), Richard Symonds (former Senior Counsel), Juan Carlos Izaguirre Araujo (Consultant) and Bujana Perolli (Consultant). All are of the World Bank. The Bulgarian version of this report was made possible thanks to the translation of Simeon Enchev. The report was prepared under the general guidance of Orsalia Kalantzopoulos (Country Director for Bulgaria) and Fernando Montes-Negret (Director of the Finance and Private Sector Development Department of the European and Central Asia Region). Florian Fichtl (Country Manager for Bulgaria) provided detailed comments and strategic guidance to the team. Peer review comments were received from Tomáš Prouza, former Deputy Finance Minister of the Czech Republic, and Antony Randle, Consultant of the World Bank. Helpful comments and advice were also provided by the Ministry of Finance, Ministry of Economy and Energy, Bulgarian National Bank, Financial Supervision Commission and the Consumer Protection Commission. The authors of this report are grateful to all for their contributions. vi

9 Executive Summary The global financial crisis has highlighted the importance of consumer protection and financial capability as medium-term measures supporting financial sector development. In addition to short term measures to mitigate economic impacts, policymakers are taking steps to build better foundations for future development of the financial systems through improved regulatory reforms. These medium-term measures involve enhanced financial prudential regulation and oversight, financial sector governance (including governance of financial regulators and supervisors), business conduct regulation and supervision, and financial consumer protection. The latter receives an increasing emphasis not only in developed countries but also in emerging market economies, as most of the risk exposures associated with the latest credit boom period were assumed primarily by households. Financial consumer protection improves efficiency of financial intermediation and indirectly reduces risks to financial stability. At its heart, consumer protection addresses power, information, and resource imbalances which place consumers at a disadvantage vis-à-vis financial institutions. Financial institutions are very familiar with the terms and conditions of their financial products and their risk characteristics. Retail consumers may find it difficult or costly to obtain sufficient information on their financial purchases or understand complex financial products even when relevant information is disclosed. Consumers who are empowered with information and basic rights and who are aware of their responsibilities provide an important source of market discipline to the financial sector, encouraging financial institutions to compete on the basis of useful products and services. In addition, financial consumer protection builds trust in financial systems and helps broaden and diversify the depositors base. Such public confidence indirectly reduces the liquidity risk of the banking sector. Consumer protection is gaining increasing importance at both the EU and Bulgarian level. The EU Consumer Policy strategy of sets three objectives to: (i) empower consumers by ensuring that they have real choices, accurate information, market transparency, and the confidence that comes from effective protection and solid rights; (ii) enhance consumers' welfare regarding price, choice, quality, diversity, affordability and safety of products; and (iii) protect consumers as a group from the serious risks and threats that cannot be withstood on an individual basis. An October 2008 report of the European Parliament also identified measures to be taken to improve financial education throughout the EU. Consumer protection legislation and institutions have been put in place in Bulgaria. Consumer protection is firmly based in Bulgarian law in both the Constitution and the Consumer Protection Act. The Act establishes the Consumer Protection Commission (CPC) within the Ministry of Economy and Energy. In addition, the National Consumer Protection Council, involving representatives of the government and consumer protection associations, was set up to advise the Minister of Economy and Energy on policy strategy concerning consumer protection. The Consumer Policy Strategy for set three goals: (i) establishment of a high level of consumer protection, (ii) effective enforcement 1

10 of the legislation and (iii) promotion of the activity of consumer protection associations. The Consumer Policy Strategy for is under preparation. Bulgarian legislation has transposed the key EU Directives related to consumer protection in financial services and more revisions are being implemented. The 2007 revisions to the Consumer Protection Act transposed EU Directives related to financial consumer protection. The Directives on Consumer Credit, Distance Selling and Unfair Commercial Practices have also been transposed into Bulgarian law. At the same time, changes to the securities legislation incorporated the Directive on Markets in Financial Instruments (MiFID) while revisions to insurance legislation transposed the Directives on Life Insurance and Insurance Mediation. The Payment Service Directive was transposed into Bulgarian law. Revisions to the Law on Credit Institutions bring leasing and consumer finance companies under supervision of the Bulgarian National Bank (BNB). The Central Credit Register, held by the BNB and consisting of outstanding consumer and mortgage loans by banks, has been expanded to include reporting from all credit providers. Use of consumer financial services has been increasing in Bulgaria. Between 2003 and 2007, household borrowings increased from 7 to 24 percent of GDP. In addition, a survey conducted in September 2008 by the market research institute, GfK Bulgaria, found that one-third of Bulgarian consumers hold a debit card while about 9 percent have credit cards. The use of bank cards has significantly increased relative to January 2005, when GfK Bulgaria showed that only 20 percent held debit cards and 2 percent used credit cards. Saving products appear to be less widespread than bank cards since only 12 percent own a saving product of one form or another. At the same time, consumers complain about the practices of financial institutions. About 1,200 complaints and disputes were presented to the authorities in The Financial Supervision Commission (FSC) reported 791 complaints related to insurance products. For banking services about 100 complaints were submitted to the BNB and another 80 to the CPC. Detail is not provided on the nature of the complaints. However, some anecdotal information is provided by the financial guide Moite Pari ( which indicates that consumers have complained that: (1) financial institutions can change their lending or deposit rates without notice to customers and without clear explanation of the changes; (2) important details of the terms and conditions of financial products are contained in contracts that are difficult for consumers to understand; (3) personnel of financial institutions are unable to explain to customers their financial products; (4) consumers have difficulty obtaining information in a format that allows them to compare offers by different institutions; (5) consumers do not receive monthly statements from financial institutions; and (6) in case of disputes over entries in credit register, consumers have difficulty obtaining correction of errors. In addition, the October 2008 Eurobarometer survey of consumer protection in 27 EU Member States indicated that Bulgarian consumers need a strengthened consumer protection framework for all sectors, including financial services. Twothirds (64 percent) of Bulgarian consumers disagreed that they were adequately protected 2

11 by existing measures to protect consumers, while among the EU just over one-third (39 percent) were similarly critical. When trying to decide what to do when a complaint was not satisfactorily resolved, 22 percent of Bulgarian consumers (but only 14 percent in the EU) went to a consumer association or consumer help desk for assistance. However more than three-quarters gave up. 78 percent of dissatisfied consumers in Bulgaria took no further action (vs. only 51 percent among the EU). Clearer and more transparent rules with effective enforcement mechanisms are needed to further strengthen Bulgarian financial consumer protection framework and practices. Clear rules not only help ensure that financial institutions maintain high standards in their treatment of retail customers, but also help consumers understand their legal rights and responsibilities as purchasers of financial services and products. Financial education will help consumers understand their legal rights, but such rights must first be clearly articulated in laws, regulations and codes of conduct. While much improvement has been made in Bulgaria s legal and regulatory framework for financial consumer protection, there are still some gaps that create loopholes and undermine the effectiveness of supervisory agencies in improving consumer protection. For example, whereas the rules on consumer disclosure for consumer credits are extensive, those for residential mortgages remain minimal. Measures to improve consumer protection and financial capability should be pragmatic and effective and empower consumers. The Review recommends five main measures: A) Strengthen the institutional structure supporting financial consumer protection, B) Improve the rules related to quality and user-friendliness of consumer disclosure, C) Strengthen the rules that govern the business practices of financial institutions vis-à-vis consumers, D) Improve the mechanisms to address consumer complaints and disputes, and E) Expand the access of consumers to useful and timely financial education. A) Institutional Structure A clear structure for consumer protection in financial services is needed. Under the current structure, several agencies are responsible for addressing problems for financial consumers. For consumer credit and retail payments, consumers must approach the CPC for help, but for insurance, securities, investment funds and pensions, consumers should go to the FSC. However problems with credit registers should be presented to the Commission for Personal Data Protection. In cases where the law does not explicitly mention a competent authority, such as residential mortgages or personal leases (which are not considered to be consumer credits), CPC is the responsible authority for consumer protection. The institutional structure for financial consumer protection should be improved. The current framework provides for clear responsibilities for the agencies responsible for developing consumer policy and preparing consumer protection legislation. However less 3

12 clear are the responsibilities for enforcing financial consumer protection legislation and for helping to resolve disputes with consumers on individual cases. To ensure effective consumer protection in financial services, six functions are needed. They are to: (1) resolve financial consumers inquiries and complaints; (2) reconcile disputes; (3) gather, publish and analyze data on consumer complaints; (4) submit consolidated reports of consumer complaints and disputes to financial supervisors; (5) recommend measures to improve consumer protection; (6) initiate and conduct other activities contributing to effective and efficient financial consumer protection. All require both clear rules and effective enforcement mechanisms. Responsibility for the six areas can be divided in various ways. For Bulgaria, three approaches for the institutional structure might be considered: a) The CPC would be responsible for supervision of compliance with consumer protection legislation for all financial services, not just consumer credits and payments but also mortgages as well as leasing, insurance, securities investments, private pension plans, and credit reporting. This would require substantial capacity building within the CPC and establishment of a specialized department for financial services with additional resources. Under this option, conciliation committees should be established as permanent standing committees for each type of financial service (along the lines of the Conciliation Committee for Payment Disputes) and their operations should be improved. In the medium-to long-term, the financial services department should be detached from the CPC as a separate financial ombudsman office. b) The financial supervisory agencies would be responsible for supervision of compliance with consumer protection legislation for financial services. In this case, the CPC would be responsible for resolving consumer disputes for no financial services. Financial supervision would be provided by either the BNB or FSC and extended to cover all institutions relevant for financial consumer protection. This would require that the legal mandate of the BNB be revised to include the additional responsibility of financial consumer protection. This is not without difficulties. Combining prudential supervision with consumer protection creates conflicts for supervisory agencies but may also provide useful insights into financial stability issues arising from insufficient consumer protection. c) A financial ombudsman would be established to handle all disputes, complaints and inquiries related to consumer financial services, eventually replacing the role of the conciliation committees. The financial ombudsman could be responsible for consumer protection covering all six areas noted above. Alternatively, the financial ombudsman could be limited to providing an alternative dispute resolution mechanism outside the courts, as is currently done by the conciliation committees. The approaches are not mutually exclusive. For example, a financial ombudsman could complement the work of either the CPC or the financial supervisory agencies. 4

13 The Diagnostic Review recommends the first option that the CPC cover consumer protection legislation for all financial services as an interim solution, but with consideration of a financial ombudsman as a long-term solution. Whatever solution is chosen, substantial effort and resources will be needed to implement an effective institutional structure. If the option of creating a financial ombudsman is selected, an intermediate approach would be to start by establishing a financial ombudsman office within the CPC and later considering spinning-off the office as a separate agency. Consideration should also be given to whether the ombudsman should be under the professional associations or set up as an independent authority established by law. Again the issue is complex. The work of an ombudsman set up under a professional association is facilitated by a voluntary agreement among the association members to abide by the ombudsman's decisions, generally up to small awards. Such small amounts are not generally large enough to be of concern to financial institutions and the ombudsman can carefully review each case on its merits in order to ensure that consumers feel that they have been treated fairly. International experience, for example in Germany, suggests that a banking association ombudsman is an effective and efficient approach to resolving consumer concerns over treatment by financial institutions. On the other hand, an ombudsman set up by a banking association would not be able to cover insurance or other financial services and more ombudsmen one for each professional association in the financial sector would be needed. Also in some countries there is concern that an ombudsman set up and funded by a professional association would be beholden to the financial institutions that are members of the association or would be seen as such by the public. The Diagnostic Review recommends that careful consideration of the advantages and disadvantages of each type of ombudsman be conducted. Consumer associations should play a strong role in consumer protection in Bulgaria. Whatever option is selected, consumer associations should become strong advocates of financial consumers through their greater participation in policy-making concerning consumer protection. While increased financing support from the state budget is recommended, consumer associations should also increase their transparency, improve their accountability frameworks, and establish strong reporting links to policy makers. B) Consumer Disclosure Consumer information should be improved. Where consumers can obtain clear and comparable information, they can make informed choices and ensure that the financial products that they purchase are suitable for their needs and objectives. Clear laws and regulations and effective enforcement mechanism are needed to ensure meaningful disclosure of consumer financial products. The Bulgarian legislation on consumer credit requires clear simple information on key terms and conditions in consumer credit contracts. However a Key Facts Statement for each type of standard retail financial product would further help consumers understand the key terms and conditions of their contracts, particularly for insurance and pensions, and compare the conditions of products among different financial entities. It is recommended that the professional associations 5

14 develop standardized formats for a Key Facts Statement for each type of standard retail product. The disclosure requirements for consumer credits should also be applied to residential mortgages. Consumers should be able to obtain a copy of the full terms and conditions of retail financial products before applying for a product. Investment returns should be presented on a risk-adjusted basis with an indication of basic risk parameters. Advertising for financial services should be closely monitored to ensure that it is not misleading. Tariff surveys showing comparison pricing of financial products would be helpful. C) Business Practices Business practices need to be strengthened. The codes of ethics (conduct) prepared by the professional associations should be widely disseminated and their implementation regularly monitored by the CPC. All providers of consumer financial services should be obliged to be registered and their business conduct should be subject to,monitoring by a financial supervisory agency. The insurance and pension companies should be liable for the actions of their agents. Consideration should be given to the training and certification of all sellers of financial services. Procedures for account handling should be improved. It may be useful to apply "cooling-off" periods to longer-term financial products. Consumers should be allowed to choose the provider of any product required for another financial product. Use of a "mystery shopper" may also provide useful insights on existing sales practices. D) Inquiries, Complaints and Disputes Treatment of consumer complaints and disputes lies at the heart of financial consumer protection. All financial institutions should be obliged to establish a clear process for dealing with customer complaints and their timely resolution. In Bulgaria, about 1,200 complaints and disputes about financial services were presented to the state authorities in 2008 but this may understate the actual number of complaints. The statistics on the number and types of consumer complaints regarding financial services should be consolidated, published and analyzed. Conciliation committees help in finding an amicable solution for customer disputes. However the structure of conciliation committees should be improved, using the Conciliation Commission for Payment Disputes as a useful model. Consideration should be given to various mechanisms of making the decisions of the conciliation committees binding on financial institutions for small amounts of money. Bulgarian legislation allows for class-action lawsuits by consumers and consumer associations, but their effectiveness in providing collective redress should be monitored. It is recommended that Bulgaria joins FIN-NET, the network of national out-of-court complaint schemes in the European Economic Area countries that are responsible for handling disputes between consumers and financial services providers. 6

15 E) Financial Education Bulgaria includes financial education as part of the consumer protection legislation but consumer awareness remains extremely low. Some programs in Bulgaria are underway but much more is needed. Preparing effective financial education programs is not an easy task. A distinction should be made among three different types of programs financial education vs. information vs. advice. Financial education programs should be carefully designed and rigorously evaluated and viewed as a long-term investment. A baseline survey of financial capability should be used to identify vulnerable parts of the Bulgarian population and design targeted financial education programs. Follow-up surveys should be conducted every three to five years to evaluate the effectiveness of the programs of financial education and consumer awareness. 7

16 Introduction The Diagnostic Review of Consumer Protection and Financial Capability in Bulgaria is the eighth report in a World Bank-sponsored pilot program to assess consumer protection in financial services in developing and middle-income countries. 1 The objectives of this Review are three-fold to: (1) conduct a review of the existing rules and practices in Bulgaria compared to international good practices on consumer protection in financial services; (2) provide recommendations on ways to improve consumer protection in financial services in Bulgaria; and (3) refine a set of good practices prepared by the World Bank for assessing consumer protection in financial services, including financial capability. The Diagnostic Review was prepared at the request of Ministry of Finance with the valuable input of the Bulgarian National Bank, the Financial Supervision Commission, the Ministry of Economy and Energy, the Consumer Protection Commission and the Commission for the Protection of Competition, other public entities, the Association of Banks in Bulgaria, consumer associations and experts from the financial and legal community. The good practices used in the Review were developed based on international approaches in both developed and developing countries to effective and efficient consumer protection in financial services. 2 A set of good practices was initially assembled for the Slovakia Review and was subsequently revised for the Romania, Croatia, Russia and Azerbaijan Reviews. The good practices incorporate the provisions of the EU Directives related to consumer protection and the reports of European financial regulatory and supervisory agencies as well as the laws, regulations and business practice codes in the United States, Australia, Canada and other countries worldwide. The Organization for Economic Cooperation and Development (OECD) has also released sets of good practices for financial education and awareness on pensions and insurance 3, and a set of draft good practices for credit products, supplementing the recommendations presented in its 2005 global review of financial education programs. 4 While the good practices are based on different countries international experience in financial consumer protection, the good practices have not yet been tested as a set of benchmarks during a global financial crisis. It is likely that the ongoing financial crisis will provide useful insights to stimulate further revisions of the good practices. In the interim, the good practices provide a useful tool for conducting systematic assessments of a country s legal and regulatory framework for financial consumer protection. 1 In chronological order, other reports on consumer protection in financial services have been prepared for the Czech Republic, Slovakia, Azerbaijan, Romania, Croatia, Russia and Lithuania. The set of published final reports on financial consumer protection can be downloaded at 2 The World Bank has released the document Good Practices for Consumer Protection and Financial Literacy in Europe and Central Asia: A Diagnostic Tool as a Consultative Draft. A copy can be downloaded at 3 See OECD, Improving Financial Education and Awareness on Insurance and Private Pensions (2008) available at 4 See OECD, Improving Financial Literacy: Analysis of Issues and Policies (2005), available at 7

17 The publication of the Diagnostic Review for Bulgaria aims to enhance development of financial consumer protection both in Bulgaria and worldwide. In particular, it is anticipated that application of the good practices in middle-income countries, such as Bulgaria, will contribute to international policy dialogue on the key components of financial consumer protection and assist in the development of benchmarks that are widely accepted as generally applicable to consumer protection in financial services in any jurisdiction. The Review is presented in two volumes. Volume I notes the importance of consumer protection in financial services, provides statistics on the size and growth of the retail financial sector in Bulgaria, describes the Government's policy strategy for financial consumer protection, and sets out the key findings and recommendations of the Review. Volume II provides an assessment of the Bulgarian consumer protection framework and practices against the benchmark of good practices for five segments of the financial sector banking, non-banking credit institutions, securities, insurance and private pensions. In addition, analysis of consumer protection and financial capability issues for the credit reporting system is provided. Annex 1 to Volume II provides a list of the key laws and institutions for consumer protection in Bulgaria. Importance of Consumer Protection & Financial Capability The global financial crisis has highlighted the importance of consumer protection and financial capability as medium-term measures supporting financial sector development. In addition to short term measures to mitigate economic impacts, policymakers are taking steps to build better foundations for future development of the financial systems through improved regulatory reforms. These medium-term measures involve enhanced financial prudential regulation and oversight, financial sector governance (including governance of financial regulators and supervisors), business conduct regulation and supervision, and financial consumer protection. The latter receives an increasing emphasis not only in developed countries but also in emerging market economies, as most of the risk exposures associated with the latest credit boom period were assumed primarily by households. Each year the global economy adds an estimated 150 million new consumers in financial services. Most are in developing countries, where consumer protection and financial literacy are still in their infancy. Particularly in the countries that have moved from state planning to market economies, protecting the interests of consumers has become an important component of sound and competitive financial markets. Weak consumer protection and financial capability 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 their technology and infrastructure, has resulted in highly complex financial products sold to the public. However, the public in many emerging markets (particularly the post-transition countries of Europe and Central Asia) lacks a history of using sophisticated financial products. Even in well-developed markets, 8

18 weak consumer protection and financial literacy can render households vulnerable to unfair and abusive practices by financial institutions as well as financial frauds and scams. 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. Financial institutions know their products well but individual retail consumers may find it difficult or costly to obtain sufficient information on their financial purchases. Personal insurance, such as auto or life insurance, are often cited as examples of the imbalances. The complex contracts prepared by insurers and the risk allocation between the consumer and the financial institution are often beyond the capacity of most consumers to understand. A well-designed consumer protection framework can help reduce the imbalances of power and information between consumers and financial institutions. Consumer protection and financial capability promote efficiency and transparency of retail financial markets. Consumer protection attempts to redress the imbalances between retail consumers and financial service providers, giving individuals clear and complete information on which to make informed decisions and by prohibiting financial institutions from engaging in unfair or deceptive practices. Consumers who are empowered with information and basic rights and who are aware of their responsibilities provide an important source of market discipline to the financial sector, encouraging financial institutions to compete by offering better products and services rather than by taking advantage of poorly informed consumers. Financial capability helps consumers understand the information and make risk/return choices that optimize their financial wealth. Consumer protection also improves governance of financial institutions. By strengthening transparency in the delivery of financial services and accountability, consumer protection also helps promote good governance in the financial sector. Strong consumer protection can also have an indirect impact in reducing financial risks, contributing to financial stability. Both consumer protection and financial capability are needed to build trust in financial systems and thus broaden and diversify the deposit base. This, in turn, reduces liquidity risk of the banking sector. Empowered consumers also help foster financial stability by protecting themselves from incurring large exposures to market risks. This increases transparency of the credit risk assumed by the financial system and lowers the related monitoring costs for outsiders, including financial supervisors. In addition, consumer protection helps financial firms in facing the specific risks that arise in dealing with retail customers. In its April 2008 report, the Joint Forum of the Basel Committee on Banking Supervision, the International Organization of Securities Commission and the International Association of Insurance Supervisors identifies three key risks related to possible "mis-selling" financial products to retail 9

19 customers. 5 They are: (1) legal risk, if successful lawsuits from collective action by customers or enforcement actions by supervisory agencies result in obligations to pay financial compensation or fines; (2) short-term liquidity risk and long-term solvency risk, if retail customers are treated unfairly and thus shun the financial institution and withdraw their business; and (3) contagion risk, if the problems of one financial institution (or type of financial product) spread across the financial sector. Effective consumer protection can help ensure that the actions of financial firms do not make them subject to criticisms of mis-selling. Consumer protection could also shield the financial sector from the risk of political over-reaction in periods of financial turmoil. The political response to collapses of parts of the financial sector may be to over-compensate with heavy regulation. The impact of too little consumer protection became evident, for example, during the insurance and superannuation scandals in the United Kingdom and Australia. The result of the scandals was seen in extensive studies on recommendations for wide-ranging regulatory reform. Financial consumer protection has two modes of delivery: (1) regulation, and (2) financial education. Some substitution is possible. For example, in developed markets with informed consumers, financial education can empower consumers to demand clear and comparable information and seek redress over disputes. However in most markets, financial education alone is not sufficient and some regulation is needed. The reasons are three-fold: (1) financial education will always lag behind the development of financial markets, (2) the direct (immediate) costs of implementing financial education programs are relatively high compared to regulation, and (3) the existing governance structure (incentives) of financial markets does not support adequate market discipline. However regulation also imposes a cost on the financial sector. Regulation can impair both competition and innovation in the financial sector, thus raise consumer costs and obstruct development of adequate market discipline that would hold risk-taking in check. Clear priorities need to be set. Regulation should be subject to cost-benefit analysis and consumer protection regulations should be assessed to determine their impact on sound consumer finance. 6 An effective and efficient consumer protection framework 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; 5 Joint Forum of the Basel Committee on Banking Supervision, the International Organization of Securities Commission and the International Association of Insurance Supervisors, Customer suitability in the retail sale of financial products and services, April Bulgarian legislation on consumer protection issues is mainly driven by the application of EU Directives. The recent Directives have maximum harmonization character, which means that Member States are obliged to establish the level of protection set out in the Directive and they are not allowed to go further than that level. 10

20 Choice by ensuring fair, non-coercive and reasonable practices in the selling 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 access to personal financial information. Access to financial education that enables consumers develop the financial capability required to understand the risks/return (cost) trade-offs, and their rights and obligations regarding the financial products and services that they buy. 7 Bulgarian Policy for Consumer Protection in Financial Services in the EU Context The EU Consumer Policy strategy aims to strengthen consumer protection and financial literacy. 8 The strategy has three objectives to: (1) empower consumers by ensuring that they have real choices, accurate information, market transparency, and the confidence that comes from effective protection and solid rights; (2) enhance consumers' welfare regarding price, choice, quality, diversity, affordability and safety of products; and (3) protect consumers as a group from the serious risks and threats that cannot be withstood on an individual basis. Key steps for the implementation of the strategy involve development of benchmarks for national consumer policies, including a consumer protection policy for the financial sector, and collection of service quality data and complaint statistics. The EU takes the approach that an effective regime of financial consumer protection covers three areas. Consumers should have access to: (1) sufficient information to make informed decisions in the purchase of financial services, (2) cost-effective recourse mechanisms to redress violations of the financial service contract, and (3) programs of financial education. Financial education is being emphasized in the program under development in the EU. In November 2007, the European Commission (EC) released its survey of over 150 financial education programs conducted in the 27 Member States. An October 2008 report of the European Parliament identified six measures to be taken to improve financial education throughout the EU. 9 They are: 1) A basic program in financial education should be developed at the EU level to set common rules and principles to be applied in Member States; 2) The Commission should recommend that Member States include financial education in their national school curricula; 3) Special targeted approaches should be developed for school children, college students, adults, low-income households and pensioners; 7 Financial education is also needed to help households in making long-term financial decisions, such as savings for retirement or sending children to college. However such "life-cycle" planning is beyond the direct scope of consumer protection in financial services. 8 EU Consumer Policy Strategy COM (2007) 99 final. overview/cons_policy/en%2099.pdf. 9 European Parliament Report on protecting the consumer: improving consumer education and awareness of credit and finance (2007/2288(INI)) 11

21 4) Member States should develop networks of financial education, with participation of government and non-government agencies, as well as specially trained tutors; 5) The Commission should encourage Member States to establish special programs for pensioners and consumers at the end of their professional careers; and 6) The Commission should create a budget for financial education programs at the EU level, covering media campaigns to increase consumer awareness of the problems created by low financial literacy. In its Communication on Financial Education the Commission noted it would conduct a comprehensive review in 2010 to evaluate the effectiveness of existing programs of financial education among Member States. 10 In Bulgaria, consumer protection is also firmly based in the law. Consumer protection is firmly enshrined in the Constitution of the Republic of Bulgaria. Article 19 of the Constitution adopted on July 12, 1991 says that the state shall establish and guarantee equal legal conditions for economic activity to all citizens and corporate entities by preventing any abuse of a monopoly status and unfair competition and by protecting the consumer. In addition, the Consumer Protection Act specifies eight consumer rights. They are the right to: Be informed about products and services; Be protected against products and services that are hazardous to consumers' life, health or property; Protection of economic interests with regard to unfair commercial practices and methods of sale, unfair contractual terms, and provision of guarantees associated with consumer goods; Obtain redress for damage caused by defective products; Access judicial and out-of-court procedures for the resolution of consumer disputes; Education on issues related to consumer protection; Association for the purposes of protecting consumers' interests; and Be represented before State bodies making decisions on issues affecting consumers. The initial legislation created consumer protection institutions. The initial consumer protection legislation was approved as early as 1999 and it established the Consumer Protection Commission as a legal entity within the Ministry of Economy. At the same time, the National Consumer Protection Council was set up to advise the Minister of Economy on strategic policies on consumer protection. The Consumer Policy Strategy for identified six priorities for strengthening of consumer protection in Bulgaria. They were to: (1) complete the process of harmonizing the consumer protection legislation, including consumer protection in crossfrontier payments, e-commerce and financial services; (2) create conditions for the effective implementation and enforcement of legislation and to provide support to lawenforcement bodies; (3) improve the institutional structure for consumer protection and 10 European Commission, Communication from the Commission: Financial Education, COM (2007) 808 final 12

22 its effectiveness; (4) provide assistance to non-government associations for consumer protection, in order to involve them more actively in the process of setting up policy and its implementation; (5) ensure a stronger representation of consumer associations in collective decision-making bodies; and (6) improve consumer access to justice. In 2007 and 2008 new legislations related to financial consumer protection were enacted. However, in 2008 the Ministry of Economy and Energy s Consumer Protection Directorate was inactive in terms of policy initiation in the field of consumer protection. In addition, the National Consumer Protection Council did not meet even once in the past year, although its Statute (in force since June 10, 2006) requires a meeting every four months. In 2009, the Ministry of Economy and Energy is expected to develop the Consumer Policy Strategy for The October 2008 Eurobarometer survey of the 27 EU Member States suggests that Bulgarian consumers need a strengthened consumer protection framework for all sectors, including financial services. 11 The Eurobarometer survey was requested by DG SANCO to look at consumer protection in all sectors (including financial services). Among the EU, more consumers in Bulgaria felt that they were inadequately protected on consumer protection than in any other Member State. Two-thirds (64 percent) of Bulgarian consumers disagreed that they were adequately protected by existing measures to protect consumers, while among the EU just over one-third (39 percent) were similarly critical. Moreover, Bulgarian consumers were reluctant to rely on either government or non-government organizations (NGOs) to protect their interests. Only 27 percent in Bulgaria trust public authorities to protect their interests (vs. 54 percent average among the EU.) Still fewer would rely on consumer associations to help them. Only 22 percent of Bulgarians trust independent consumer organizations to protect their consumer rights (vs. 64 percent among the EU). Furthermore, the conciliation committees have not yet become an effective method of recourse for Bulgarian consumers. Only 12 percent thought that it was easy to resolve disputes using arbitration, mediation or conciliation bodies (vs. 39 percent among the EU.) When trying to decide what to do when a complaint was not satisfactorily resolved, 22 percent of Bulgarian consumers (but only 14 percent in the EU) went to a consumer association or consumer help desk for assistance. However more than three-quarters gave up. 78 percent of dissatisfied consumers in Bulgaria took no further action (vs. only 51 percent among the EU). Regarding general consumer protection in goods and services, Bulgarian consumers are primarily interested in having strong laws to protect their interests. When asked how best to protect consumers, the Eurobarometer survey found that the largest number of Bulgarian consumers (45 percent) preferred the legal right to terminate a contract or asking for a price reduction or repair of the goods. Tied for the second best ways (for 43 percent of Bulgarians) were the legal obligations of providers to ensure safe goods and services and not to mislead or deceive consumers. Only one-third chose disclosure as their favorite form of consumer protection. Just 34 percent thought that clear written information about the goods or services and the sales contract was the best way to protect consumers. 11 European Commission, Special Eurobarometer No. 298, Consumer protection in the internal market, October

23 While the Eurobarometer survey provides useful insights, a survey focused on consumer protection in financial services is needed. Due to their specialized nature, financial services constitute a unique set of issues related to consumer protection. A specialized survey on consumer behavior and attitudes regarding financial services would be helpful in designing targeted policy measures to strengthen financial consumer protection. Such a survey could be part of a survey on financial capability, as proposed below. Background on Bulgarian Household Finances The financial indebtedness of Bulgarian households and the maturity of household loans 12 rose from 2003 to Consumer debt increased almost six-fold from 2003 to 2007 as household borrowings rose from 7 percent of GDP in 2003 to 24 percent in Loans for house purchases gained an increased share in the portfolio of loans to households and non-profit institutions serving households (henceforth household loans), thereby increasing the maturity of the portfolio. Since ember 2003, the percentage of loans with maturities of between one and five years has been decreasing (from 65 percent of total household loans to 11 percent by end-2008) while loans with maturity above five years have been increasing proportionately and stood at 74 percent by the end of 2008 (see Figure 1). Figure 1: Household Loans by Purpose and Maturity Shares of Household Loans by Purpose Shares of Household Loans by Maturity 80% 80% 70% 70% 60% 60% 50% 50% 40% 40% 30% 30% 20% 20% 10% 10% 0% Overdraft Source: BNB. 04 Loans for house purchase Consumer loans Other loans 08 0% Loans with maturity up to 1 year Loans with maturity over 1 up to 5 years Loans with maturity over 5 years 08 Households have increasingly borrowed in foreign exchange, although almost entirely in Euros. Household loans in foreign currencies (primarily Euros) rose from 7 percent at the end of 2002 to 29 percent by end-2008 (see Figure 2). Lower borrowing interest rates in Euros relative to Levs, in combination with Bulgaria s currency board regime (foreign exchange rate of Lev pegged to the Euro) has encouraged Bulgarian consumers to borrow in Euros rather than borrow in the local currency. 12 The data on household loans used in this section correspond to the statistics on loans to households and non-profit institutions serving households granted by other monetary financial institutions as published in the English version of the Bulgarian National Bank s Monetary Statistics of ember