Low-income Americans are penalized by the current financial system. The main problem is the lack of aligned incentives. Banks and other financial service providers make money the hard way. One need only look at the sad history of payday loans and car titles, subprime mortgages, or bank overdraft “protection” programs to find examples of financial products and practices that are profitable for providers but harmful to vulnerable populations. What is needed is a different regulatory approach that links the profit of financial service providers to the financial health of customers. In short, banks should only be successful financially if their customers are doing well financially. The good news is that financial service providers now have the data – and the methods of processing the data – to create a meaningful assessment of how their practices are improving or harming the financial health of their customers. First, this information needs to be made public so that regulators, consumers and other stakeholders can see which banks are the best and which are the worst. Ultimately, banks could be rewarded based on results.
The current American financial system is essentially broken for the many working Americans who are living on financial edge. Inadequate incentives are at the heart of the problem. One need only look at the sad history of payday loans and car titles, subprime mortgages, or bank overdraft “protection” programs to find examples of financial products and practices that are profitable for providers but harmful to vulnerable populations.
Unfortunately, the regulations haven’t done much to create win-win solutions. Respect for efficient market theory and “consumer choice” has created a regulatory system that places much of the responsibility – barring the most egregious abuses – on the individual consumer. In a new report, we argue that what is needed is a different regulatory approach that links the profit of financial service providers to the financial health of customers. In short, banks should only be successful financially if their customers are doing well financially.
Such a scheme would be similar to ongoing experiments in healthcare that compensate providers for improving the health of patients, rather than paying them just to treat patients, regardless of the outcome of the medical intervention. Of course, the healthcare delivery and consumer credit markets differ considerably – in terms of competitiveness, focus, public and professional ethics, regulatory regimes and incentive structures. But while the U.S. healthcare system is not perfect, there is a general consensus that the quality of care and patient outcomes among the insured population have benefited significantly from the investment and deployment of patient data and associated analyzes to measure and improve patient outcomes.
We desperately need similar innovations in the financial services industry. The good news is that there are many elements in place for reform. The past few decades have seen a huge expansion in both the quantity and quality of consumer financial data and data science techniques that can be used to improve credit analysis, customer authentication, management. risk and marketing. At the same time, more sophisticated measures of the “financial health” of consumers have been developed. The best known of them were created by Consumer Financial Protection Bureau and The Financial Health Network, and measuring things like if people spend less than they earn, pay their bills on time, plan their spending in advance, and have enough cash and long-term savings, long-term debt, access to affordable credit and appropriate insurance. Applying metrics like these to the wealth of financial data held by vendors using data science techniques can observe changes in an individual’s overall financial well-being over time , as well as to discern how their financial health may be affected by their use of specific financial resources. products and suppliers.
Our regulations proposal has three stages and would be implemented over time. The first step would require large providers of consumer financial services to periodically make available to regulators internal data that regulators can use to analyze and measure changes in the financial health of clients. At the same time, regulators and industry will collaborate to test, refine and standardize a set of consumer financial health measures that can be used at both the product and supplier level. These outcome measures can be standardized to avoid favoring providers who serve affluent customers, to track differences in outcomes by income, age, gender, education, race, geography, etc., and to control the impact of recessions and other macroeconomic factors. Once the initial set of consumer financial health measures are ready for use, the Regulatory Data Science team will use the compiled data from providers to analyze and measure correlations between financial product use, product characteristics, individual suppliers and supplier practices, on the one hand, and results, on the other.
To give an idea of how this type of analysis works, we looked at bank overdraft practices, which are clearly linked to one indicator of financial health: the ability of consumers to pay their bills on time with their regular income. Consumers who regularly default each month and who are therefore in short supply are, by definition, in financial difficulty. Our analysis found considerable differences between large banks both in the frequency with which individual bank customers overdraw their accounts (a four-to-one difference in overdraft intensity) and in the relative contribution of income. from overdrafts to the bank’s bottom line. Unsurprisingly, and reflecting the perverse incentives at play, there is a correlation between banks’ reliance on overdraft income and the likelihood of their mass market customers being chronic overdrafts.
These huge differences in overdraft intensity between banks probably have little to do with consumer choice. They could stem from differences in supplier practices, such as the way banks handle verification transactions or the extent to which they encourage their customers to opt for debit card overdraft coverage, or possibly differences in programs. and tools provided by banks to encourage customers to accumulate emergency savings, track balances and avoid overspending. Today, we can only guess what is really causing these large disparities in results. But that will change according to our proposal. When such information is correlated with other data by regulators, we believe that the causes of the disparity and the impact on the financial health of clients will become apparent.
In the second step, regulators would publish their analysis of financial health outcomes institution-by-institution and product-by-product and make the underlying data available to researchers, consumer advocates, lawmakers and government agencies. Such transparency – when coupled with appropriate privacy protections – will stimulate further analysis and understanding and provide feedback in the regulatory process. Consumer advocates will use benchmarking data to lobby for changes in the practices of underperforming institutions and adoption of practices employed by better performing institutions. Shopping comparison sites will integrate the data into their reviews of companies and their products, causing some consumers to switch providers. Some vendors are likely to change their products or practices in response to adverse financial performance revealed by the data and strive to improve their performance relative to their competitors.
However, we believe that public disclosure will be insufficient to realign supplier business models. Our third step would provide a regulatory counterbalance (similar in some ways to the role insurers play in health care) to the mismatched incentives prevalent in consumer credit. This would make improving the financial health of consumers a statutory goal of federal regulation and would require regulators to publish a periodic “Financial Health Assessment” (FHR) for each supplier in a manner similar to the system. Community Reinvestment Act (CRA) rating. Under the CRA, which requires banks to meet the credit needs of low- and moderate-income neighborhoods in which they operate, a bad credit rating can derail a bank’s long-term growth strategy by preventing opening of new branches and merger or acquisition operations. A negative CRA rating can also seriously damage relationships with regulators, customers, employees, and community members. For these reasons, banks are focused on achieving the best possible CRA rating. A similarly structured FHR system would impose a significant regulatory ‘price’ on underperforming providers, which should cause them to adjust their business practices to focus on providing products and services that can be shown to improve. the financial health of their clients. This approach has the additional advantage of functioning largely through market mechanisms implemented by suppliers in their own interest.
While the three steps will not immediately replace existing US consumer financial protection law, the framework will generate rich empirical information on the harms and benefits to consumers resulting from particular supplier practices or product characteristics and will inform traditional regulatory approaches. When the new framework is fully operational, many aspects of the current imperfect and contentious rules and US disclosure-based regulatory regime may be phased out. In its place, a principled, data-driven, transparent, and market-driven “learning” system to improve the financial health of consumers.