FCA Consumer Duty and Financial Inclusion: Does Artificial Intelligence Matter?
The Consumer Duty: What does it entail?
The Financial Conduct Authority (FCA) has recently issued the Consumer Duty Principle to guide financial services firms' conduct in delivering good outcomes to their retail customers. The Consumer Duty is consumer-centric and outcome-oriented with the potential to bring about major transformation in the financial services industry.
The Consumer Duty is supported by three cross‑cutting rules that require firms to:
- Act in good faith towards retail customers.
- Avoid causing foreseeable harm to retail customers.
- Enable and support retail customers to pursue their financial objectives.
The Consumer Duty is expected to help firms achieve the following outcomes:
- The first outcome relates to products and services, where products and services are designed to meet the needs of consumers.
- The second outcome relates to price and value, which inter alia focuses on ensuring that consumers receive fair value for goods and services.
- The third outcome seeks to promote consumer understanding through effective communication and information sharing. This is to ensure that consumers understand the nature and characteristics of products and services including potential risks.
- The fourth outcome relates to consumer support, where consumers are supported to derive maximum benefits from financial products and services.
What are the implications for financial inclusion?
The Consumer Duty has significant implications for financial inclusion. Financial inclusion refers to access to and usage of financial services. While access is the primary objective of financial inclusion it does not always translate into usage due to several inhibiting factors such as price, transaction costs, and service quality. Removing the bottlenecks that limit the usage of financial services is therefore indispensable in unlocking the full benefits of financial inclusion.
The Consumer Duty is expected to trigger behavioural changes among financial institutions leading to significant effects on financial inclusion. Financial institutions are compelled to comply with the Consumer Duty and the cross-cutting rules to avoid regulatory risks that may take the form of sanctions. This implies that consumers will now have access to products and services that are fit for purpose, receive fair value for goods and services purchased, have a better understanding of products and services, and receive the support needed to derive maximum benefits from financial services. In this scenario, financial wellbeing will improve leading to a reduction in poverty and income inequality.
In contrast, however, the Consumer Duty can serve as a disincentive to innovate especially when the costs of compliance far outweigh the benefits, and this has significant implications for financial inclusion. Compliance costs may come in various forms including recruitment or training of staff, updating existing software and systems, or purchasing new ones. To reduce the risks of non-compliance financial institutions will be reluctant to innovate thereby limiting consumer choice. Firms can equally avoid the provision of services in areas and to segments of the population where the risk of non-compliance is high. In this case, vulnerable groups and areas are likely to be excluded from the provision of financial services (financial exclusion). These aspects of firms’ behaviours are more likely to be unobserved and subtle making it difficult to detect.
Does Artificial Intelligence matter?
Financial institutions are likely to adopt regulatory technologies and Artificial Intelligence (AI) solutions to comply with the Consumer Duty. This is particularly true given that financial firms are in constant search for automation and AI solutions to drive down the costs of regulatory compliance. The deployment of Machine Learning (ML) and AI in Anti-Money Laundering (AML) systems is taking a front stage in the financial services industry. AI-powered AML systems hold great promise to help financial services firms to detect suspicious activities that are likely to cause significant harm to consumers in real-time.
AI can help financial firms deliver good outcomes to consumers at low costs, especially to those at risk of financial exclusion. AI and ML algorithms can equip financial firms with the capability to remotely onboard customers and conduct remote identification checks thereby reducing costs. AI-powered solutions available to financial institutions during customer onboarding include but are not limited to real-time data access using open Application Programming Interface (API), image forensic, digital signature and verification, facial recognition, and video-based KYC (Know Your Customer). Remote customer onboarding simplifies the account opening process and reduces the costs and inconveniences associated with physical travel to bank branches which can discourage financially excluded consumers from accessing financial services.
AI and Natural Language Processing (NLP) play significant roles in customer-facing roles. The use of chatbots has the prospect of enhancing customer experiences through a rapid resolution of queries. Banks, for example, are moving from simple chatbot technologies to more advanced technologies including Large Language Models and Generative AI to enhance customer service. These advanced technologies facilitate communication between financial institutions and their customers.
AI and ML technologies also support automatic investment or financial advisory services. Robo-advisors use ML algorithms to automatically offer targeted investment or financial advice that is mostly done by human financial advisors. These technologies expand the provision of advisory services to a wide range of consumers including low-income consumers in a cost-effective manner.
AI and ML technologies offer financial institutions the potential to explore alternative sources of risk scoring using both structured and unstructured consumer data to predict their creditworthiness. The use of alternative sources of risk scoring has the potential to facilitate the provision of credit to consumers with limited credit history and low income.
What are some of the challenges with AI?
Regulatory technologies such as AI hold great prospects for compliance, but the deployment of these technologies comes with potential risks that can undermine the gains of financial inclusion. AI models for example are prone to embedded bias especially when the underlying dataset discriminates against certain groups or persons leading to differentiation in pricing and service quality. Bias in credit scoring algorithms can exclude vulnerable groups or regions from accessing loans and even if they do have access such loans are likely to be offered at high interest rates owing to unfair credit scoring. Also, bias in the underlying datasets of chatbots and Robo-advisors can lead to misinformation and cause significant harm to consumers. Data privacy concerns are on the increase especially given that any leakage in the dataset used to train AI models can expose sensitive consumer information. AI and ML technologies are not immune to cyber-attacks and technical glitches which can disrupt their functionality and expose consumers to harm. These examples imply that regulatory technologies and AI models pose a non-compliance risk to the Consumer Duty especially if they inhibit the delivery of good outcomes to consumers for example through discrimination and data privacy breaches.
What is the way forward?
The Consumer Duty is an important regulatory initiative with enormous potential to deepen financial inclusion and accelerate the positive contribution of financial inclusion to development. To achieve the objective of delivering good outcomes to consumers there is a need for constant engagement between the Financial Conduct Authority and stakeholders in the financial services industry. This will help timely identification and resolution of challenges that may arise during the implementation of the Consumer Duty.
While regulatory technologies and Artificial Intelligence are likely to play central roles in complying with the Consumer Duty there is the need for financial institutions to ensure that these technologies are themselves compliant with the Consumer Duty. This can be achieved by addressing the risks inherent in regulatory technologies and AI models. Senior managers of financial institutions are expected to play leading roles in mitigating the risk of non-compliance within the firm in line with the Senior Managers & Certification Regime.
About the Author(s)
Godsway Korku Tetteh is a Research Associate at the Financial Regulation Innovation Lab, University of Strathclyde (UK). He has several years of experience in financial inclusion research including digital financial inclusion. His research focuses on the impacts of digital technologies and financial innovations (FinTech) on financial inclusion, welfare, and entrepreneurship in developing countries. His current project focuses on the application of technologies such as Artificial Intelligence to drive efficiency in regulatory compliance. Previously, he worked as a Knowledge Exchange Associate with the Financial Technology (FinTech) Cluster at the University of Strathclyde. He also worked with the Cambridge Centre for Alternative Finance at the University of Cambridge to build the capacity of FinTech entrepreneurs, regulators, and policymakers from across the globe on FinTech and Regulatory Innovation. Godsway has a Ph.D. in Economics from Maastricht University (Netherlands) and has published in reputable journals such as Small Business Economics.
Email: godsway.tetteh@strath.ac.uk
LinkedIn: https://www.linkedin.com/in/godsway-k-tetteh-ph-d-83a82048/
Photo by Tara Winstead: https://www.pexels.com/photo/an-artificial-intelligence-illustration-on-the-wall-8849295/
