Financial health in emerging markets: Considerations for public policy and regulation
Last reviewed: September 2022. This resource is section of the UNCDF white paper Delivering Financial Health Globally: A collection of insights, approaches and recommendations, available for download (PDF) in English, French, Spanish and Chinese.
Financial health can be defined in many ways. Most broadly, it encompasses important aspects of an individual’s financial life: security, control and freedom.
Governments can help create an environment where people can effectively manage their day-to-day economic needs and invest in the future. This benefits individuals, communities, and society as a whole.
+ 1. At a glance
Financial health encompasses important aspects of an individual’s financial life: security, control and freedom.
Governments can bring together supply-side data, demand-side data and the voices of consumers to drive financial health.
+ 2. Why financial health matters
Role of goverment
Governments understand that the financial health of individuals impacts their capacity to be productive citizens. The pursuit of economic stability and growth requires that governments create the type of environment where people can effectively manage their day-to-day economic needs and invest in the future. Weathering financial shocks means fewer small businesses close, fewer children are pulled out of school, and fewer people suffer from preventable health concerns. Planning for the future means more businesses can invest in expansion, more children move from school to jobs, and more people live healthy, productive lives. These reasons, among many others, are why governments have an interest in public policy that promotes financial health.
Defining financial health
The concept of financial health can be defined in many ways. Most broadly, it encompasses important aspects of an individual’s financial life: security, control and freedom. The following broad definition of financial health captures these three dimensions:
The ability to meet one’s ongoing commitments now, in the future, and under adverse circumstances;
A feeling of control of one’s finances; and
The ability to meet one’s financial goals and enjoy things one values.
Connection to public policy
Despite the societal, and thus public policy, benefits of these dimensions, the practice of creating policies that align with financial health is still nascent. Most policymakers and regulators focus broadly on financial sector stability and consumer protection. Stability and protection are necessary, but insufficient, preconditions for financial health. Infrastructure, technology, business models, cultural norms, behavior, and many other factors also influence the financial health of individuals.
The impact of COVID-19
The COVID-19 pandemic has provided a clear case for the importance of financial health. The shock of lockdowns, collapse of entire industries, and prolonged nature of the pandemic have tested individual and societal resilience. With limited ability to generate income and significant uncertainty in future employment prospects, the pandemic has demonstrated that there are systemic barriers to financial health that extend beyond an individual’s propensity to save or plan. Policymakers and regulators now face an imperative to adapt their mandate, experience, and tools to promote financial health as a critical public policy priority.
Growing awareness of the importance of financial health
Financial health is a relatively modern public policy paradigm, with a growing awareness of its importance. Rightfully prudential risk management remains critical to manage systemic stability and market integrity. This inherent focus impacts institutional structures and resources allocated to research, policy, and regulation. Officials who are willing to champion financial health still face the challenge of adapting the organizational architecture that impedes the integration of financial health into policy and regulatory systems.
Financial health and the financial sector
Research, policy development, supervision, and industry engagement are examples of the systems that make up the architecture of financial system management. Within each is human resources, processes, budgets, and legacy systems that define how governments pursue financial sector public policy objectives. The rest of this brief discusses how policymakers and regulators can adapt, augment, and repurpose these systems, so financial health policy complements the existing focus on managing prudential and conduct of business risks. There should not be a trade-off between these priorities. We strongly believe there is a synergy between a financially healthy society and financial sector stability. The highest order public policy objective should be to seek out this synergy.
+ 3. The role of measurement in defining the problem
Start with a good framework and a baseline survey
Measurement becomes a central attribute of the enabling environment for financial health. Policymakers and regulators can manage the nuances defining and monitoring financial health by investing in research and data collection systems. A baseline survey is a necessary and logical starting point. The Center for Financial Regulation and Inclusion proposes a framework for measurement comprised of financial health indexes, resilience focused inquiry, and diagnostic customer research using detailed surveys. Governments would do well to apply this framework as a starting point for their own financial health agenda.
Compile supply-side data
Supply-side data from compliance reporting from financial institutions can be a foundational component of a baseline dataset. Compliance data is often focused on prudential risk and should be adapted to measure specific attributes of financial health. For example, more granular credit data can determine client exposures, particularly when cross-referenced with baseline data from local credit registries. Better data also includes disaggregating data by sex / age / location, reducing double counting of accounts and refining complaints data. However, supply-side data alone is insufficient.
Integrate demand-side data
Measuring financial health for better policy and regulations requires the complete integration of demand-side data into existing systems. Many regulators currently focus extensively on supply indicators (particularly for measuring financial inclusion) and rely on external actors to provide relevant demand-side data. Fully embracing financial health as a priority requires policymakers and regulators to invest in collecting demand-side data while also improving the quality of supply-side data.
Conduct impact assessments
Impact assessments are an essential component of the measurement systems for financial health. The OECD has extensive research on impact of policies and regulation and notes that an impact assessment “provides crucial information to decision-makers on whether and how to regulate to achieve public policy goals”. Thus impact assessment systems can help shape policy outcomes and determine if the regulations have been effective. They should be integrated into the oversight process, rather than seen as a separate exercise. The impact of policy on financial health may not always be direct. For example, the role of social capital should be accounted for as a determinant of financial resilience, particularly in markets where public welfare systems are prevalent. Systematic impact analysis, using supply and demand-side data, can give policymakers and regulators the confidence that their interventions are working. Or inform how to improve those that are not.
Influence on strategic planning, priority-setting, and research
It is expected that data derived from supply and demand side measurement will influence strategic planning and supervisory priority-setting. However, it can also define research priorities which feed into policymaking. For governments, data can also play an important role in facilitating financial health outcomes by empowering many critical non-policy or regulatory domains. Data made publicly accessible can supply sorely needed data to consumer advocacy groups, educational institutions, civil society, and academia. All of whom can integrate the insights into their own respective programs or development of market segment-specific resources. Government-sponsored financial health data can also inform public campaigns on emergent financial behaviors, risks, or activities. Lastly, it can guide the approach used to foster more responsible innovation, helping service providers to develop better, higher quality services.
+ 4. Policies to drive financial health
Creating an “enabling” environment
In addition to measurement, policymakers and regulators require other tools to implement an enabling environment for financial health. Policy objectives must be clearly defined, evidence-based, and measurable. Regulations must enforce fair and accessible markets. Supervisors need to hold financial institutions accountable to standards that serve financial health outcomes.
There are three broad areas of policy to consider:
The measurement processes should track outcomes that can translate to industry level or national targets. Targets may, initially, be imperfect in an emerging practice like financial health. At a minimum, targets are necessary to guide regulatory implementation and measure policy impact. More transformative is the role that targets play in driving dialogue with the private sector and other government agencies. They help each player to understand their role in the ecosystem and the degree to which public policy can hold them accountable.
Secondly, policies should be designed to create the right incentive structures for financial institutions to pursue financial health outcomes. Incentives can be regressive, for example, by expanding enforcement capacity in cases of irresponsible practice. They can also be progressive, like tax breaks for enhanced services that promote financial health. These might include call centres that provide financial literacy guidance or training programs for staff to improve client capability.
The third area of policy focus should be the innovation environment. There is already growing global practice among financial sector policymakers to embrace technology and its capacity to scale high-quality services. Sandbox frameworks are found as far as the Pacific Region, an indicator that regulators have already interpreted innovation as a public policy priority. For financial health, innovation may need to look different. Government policies have an opportunity to define expectations from the innovation community. This may include creating space for new entrants to easily access markets with new ideas or sharing data publicly so innovators can invest more in solutions.
Understanding trade-offs and synergies
Public policies for financial health will rely on strong measurement capacity and clarity of vision. However, policymakers cannot rely on these alone to lead the business of finance towards more financially healthy clients. The process of defining the policy objectives will need to account for potential trade-offs. For example, interest rate caps on microloans is a public policy paradoxv: they may reduce the cost of borrowing but also will increase the cost of lending. Many legislators have found it difficult to accept that small loans to poor people generally cost more than normal commercial bank rates. Though meant to protect consumers, interest rate ceilings almost always hurt the poor.
Conversely, there are likely strong synergies between financial health outcomes and systemic stability. For example, a client's ability to weather shocks more readily can dampen the negative impact of emergencies. It has been established that the guiding principles of financial inclusion are synergistic with systemic stability, integrity, and consumer protection. CGAP, a think tank in the World Bank Group, has noted that “under the right circumstances, financial inclusion, stability, integrity, and consumer protection (collectively referred to as I-SIP) can be positively related, and the failure to consider any one of these objectives can lead to problems.” Policies and regulations for financial health should seek to identify similar synergies. It may be fair to assume that a public policy framework built on these synergies will be more resilient.
Regulating financial health
Laws and regulations are not neutral. They can empower or discriminate. Therefore, their intent matters.
For financial health, the intent of regulation should be to engender trust in the financial system and enable more choice. When people trust a system, it implies that it meets at least their basic needs. Feeling like you have suitable choice empowers people to make decisions that match their expectations and available resources. Regulations can drive trust in the financial services by ensuring that assets are protected, services are fair, and institutions treat clients with dignity. Choice can be enabled by reducing the dominance of a few players, lowering barriers to entry (for customers and innovators), and providing equitable access to essential payment infrastructure.
It is still too early to conclusively determine what the enabling regulatory environment for financial health should be. For the moment we believe that they distinct from policies that promote financial health outcomes. We would encourage governments to be intentional about the impact of their existing regulations on financial health. For example, using appropriate measurement frameworks to assess how regulations contribute to meaningfully financial health.
Emergent domains: Protection, privacy, competition, and infrastructure
There are several regulatory domains that contribute meaningfully to higher quality financial inclusion, but their contribution to financial health is less clear. For example, consumer protection rules have emerged as a logical starting point to explore the direction the relationship between regulations and financial health outcomes. Particularly regarding defined standards of practice for customer redress, disclosure requirements, and service transparency.
Privacy, competition, and payment infrastructure are other examples of regulatory domains where governments should observe their potential impact on the enabling environment for financial health. Privacy rules, such as those proposed in the EU’s GDPR, are critically important as services are more technology driven and erosion of customer confidence risks driving low-income customers back to informal systems. Market dominance by incumbent service providers in maturing markets risk excluding new entrants who may bring innovative ideas that promote financial health. Payment infrastructure that is accessible and affordable contributes to more inclusive services, especially when it is interoperable and, in the case of mobile money, mobile numbers are portable.
Abuse of digital lending: An emerging threat to financial health
A digital reimagining of microcredit
A less clear regulatory space is the governance of digital lending, whose rapid growth has had a measurable negative impact on financial health. Millions of Kenyans are at the forefront of the digital reimagining of microcredit. According to research from Financial Sector Deepening, more than half of the loans issued in Kenya are digital. As of 2018, over two million digital loans below USD 10 are non-performing (a key indicator of a mismatch between product and customer). Until new regulations in Kenya are passed, these numbers are likely to increase further.
Low value / high volume digital credit
Digital credit products vary by market but often share basic characteristics. Most are managed by non-bank service providers who offer low-value loans at high-interest rates. Nearly all are enabled by algorithm-powered alternative data (such as location, social media, mobile phone activity, etc). The Center for Financial Inclusion notably reflected that "[digital credit] algorithms are optimized to predict repayment accurately, but don't factor debt stress into the model ex-ante." This is a bellwether for policymakers monitoring this evolution of digital finance.
Regulatory environment
Yet the regulatory environment for this form of low value/high volume digital credit is still unclear. There are clear benefits readily available to manage short-term economic shocks, such as job loss or medical emergency. There also must be measures in place to protect customers from abuse. Licensing of non-bank providers, which govern many digital lenders in emerging markets, has provided a gateway for better payment services, particularly those that use mobile phones. But those licensing frameworks were not designed to also bear the weight of digital lending in its evolving form. Non-banks should be held to the same standard as traditional providers in terms of protecting a customer's interests and conduct of business. Oversight of data use is another critical area where regulatory reforms are needed to better manage digital lending. Nearly all large-scale digital credit products utilize alternative data sources. Most customers do not realize their data is being used to this extent or, if they do, are not aware of their rights. This can result in violations of their privacy or unauthorized sharing of personal information. Regulators can play a role to ensure providers use data responsibly and are held accountable for doing so.
Improving the capacity of borrowers and re-imagining the role of the credit bureau are other ways in which policymakers and regulators can oversee digital lending. Growth in digital lending is trending upwards, as indicated by the high demand, despite the risks. Regulating it from the perspective of financial health will help to balance its harmful-if-unchecked algorithmic nature with the clear benefit to people when used (and offered) responsibly.
Inspect what you expect: Oversight and supervision
Systems for accountability
Regulators can hold financial institutions accountable to standards of practice that enable financial health outcomes. Systems for accountability typically include the supervision of financial institutions and oversight of critical infrastructure. These systems are most effective when used in tandem with industry dialogue and openness to innovation. However, regulatory influence derives from the enforcement mandate that underpins supervision and oversight.
Measurement, enforcement, and “on-the-ground” knowledge
Improving data collection and analysis by supervisors is critical to identify areas of non-compliance and justify enforcement action, if necessary. Hence the crucial role of measurement of financial health by policymakers and regulators. Supervisors should invest in understanding the importance of financial health and the policy intent that regulations are responsible for delivering. Supervisors benefit from frequent engagement with providers and are keenly aware of the strengths and weaknesses of financial institutions. Often better than their policymaker counterparts, who are further removed from day-to-day operations. This “on-the-ground” knowledge puts supervisors in a vital position to identify when financial institutions deviate from (or towards) good practices.
Audits, field visit, and internal accountability
Supervisors also have the unique capacity to conduct onsite audits and field visits to assess compliance. This is a unique opportunity to focus on financial health-related operations and customer engagement. Supervisors should not be confused with field researchers. They are already understaffed and under-resourced. However, they should be empowered to pay special attention to regulatory domains that impact financial health, such as compliance with customer protection or data privacy rules. Equally, supervisors should ensure that corporate governance puts the financial health of customers as a metric of institutional performance. This would likely require a mix of encouraging standards for internal KPIs as well as requiring compliance reporting. The UK's Financial Conduct Authority' Treating Customers Fairly' strategy demonstrates how regulators can hold the sector accountable.
Game changer: Empowering consumer groups
The most significant way policymakers and regulators can promote financial health is to engage directly with consumers. The prevailing model is limited to dialogue between the regulators and the regulated. This model must adapt if policymakers and regulators want to reap the systemic and individual benefits of a financially healthy society. Consumer groups have already demonstrated the capacity to advocate for their needs and ensure service providers act responsibly. Institutions like Consumers International champion many of the process and approaches needed to ensure governments can effectively consult the needs of consumers in policy design.
Financial health is also experienced differently by different segments of the population. Women, youth, small businesses, farmers, all have different needs and are all critical to a functioning economy. Local consumer groups representing these segments should be sought out by policymakers and regulators. National financial inclusion strategies and economic development plans often make specific reference to these segments. This is an essential first step to give regulators and policymakers the resources needed to engage priority consumer segments.
Active engagement with consumer groups will allow policymakers to triangulate supply-side data, demand-side data and consumers' voices. Policymakers and regulators will invariably have to make hard choices and accept the trade-offs. Not all segments can be served equally, and not all service providers will enjoy competitive advantages. However, when public policy prioritizes financial health, invests in its measurement, and defines a shared vision, the trade-offs may be offset by clear synergies. More work is needed to identify such synergies and inform the nascent financial health policy and regulatory best practices.
+ 5. Conclusion
Keeping pace with change
Financial health is not an end in itself. It is an enabler that allows people, societies, and markets to be resilient and innovative. It is therefore a compelling public policy objective. Governments play an important role in establishing the vision and pathway to achieve broad financial health, at the individual and systemic levels. Policymakers define the objectives and public good that each market actor is expected to contribute to. Regulators set the standards of practice and rules that govern how financial institutions deploy and grow services that promote financial health outcomes.
Working together
The importance of defining and measuring financial health is apparent when it becomes clear that achieving it is a ‘team sport’. No single government agency or private sector actor can alone achieve systemic or individual financial health. Without clear definitions, high quality oversight and supervision is impossible, leaving customers unprotected and regulated institutions unchecked. Equally, engaging with consumers directly helps governments understand their needs and then measure the attributes of financial health that matter.
Looking ahead
We expect best practices for financial health to emerge over the coming years. In that time, we hope to continue to build the evidence about what policies and regulations are most effective and how digital technologies can accelerate change.
