Dear Ms.Warren,

What an important challenge you face in bringing the new Consumer Financial Protection Bureau into being! Although you’re reputed to be a woman not easily daunted, it might still be comforting to know that you are not alone. At the recent Alliance for Financial Inclusion meeting of banking authorities from more than 60 developing countries, I had the opportunity to talk with regulators from countries as diverse as Peru, Malaysia and South Africa struggling with some of the same choices that confront you. All around the globe, bank regulators are acknowledging the importance of ensuring that financial services providers treat the less powerful members of society well. They are even recognizing that protecting consumers is a prerequisite to a stable financial system. But the tools and resources regulators wield just can’t compare to the vast number of client-provider interactions taking place every minute of every day. Regulators can never sit in on every transaction (nor would anyone want them to), so they have to act strategically. One sometimes undervalued way to be strategic is to encourage the industry to, as you say, fix itself.

Listening to regulators give their takes on client protection, I found them preoccupied with three different groups, each requiring different regulatory tools. Let’s call them the good girls and boys, the opportunists and the bad apples. The good girls and boys are providers that actively seek to employ good client protection practices. They may be motivated by reputation, by social aims, or by the business case in favor of treating clients right. I am hopeful that across the world most of the microfinance institutions I deal with are good girls and boys, and am convinced that in the United States there are mainstream banks, community banks and especially credit unions in this category. The great thing about such institutions is that they and the regulators are basically on the same side. A regulator from the banking superintendency of Peru stated, “In our consumer protection efforts, the banks are out greatest partners.” Wow. A statement like that would be jeered in most places in the U.S. In fact, an American consumer advocate I spoke with recently said, “What we’ve learned is that banks are the enemy.” How sad, and what a missed opportunity.

In the microfinance sector, the Smart Campaign for client protection acts on the premise that most providers either are or would like to be good players, and we have been rewarded by hundreds of microfinance institutions signing up to join the Campaign. For the good players, the strategic regulatory approach is to encourage and assist the industry to create norms and standards, to educate their members about those standards, and to build their capacity to implement them. Since reputation is a strong motivator for maintaining client protection, good providers can be rewarded with recognition, and threatened with public shaming.

The next category of providers is where much of the damage happens. The opportunists are the vast number of institutions that want to be seen as good players, but that cut corners when no one is looking. Perhaps they started as good boys and girls, but competitive pressure pushed them in the wrong direction. This category is the home of a multitude of bad practices that start small and spread virally, from excessive fees to deliberately impenetrable explanations, to terms and conditions that change without warning. Here’s where regulatory vigilance comes in, as a regulator from Malaysia told me. The Malaysian authorities – much like those in the U.S. – are engaged in continual Tom and Jerry skirmishes. They board up the latest mouse hole only to find that the providers have already created a new one. A big regulatory challenge I heard from the Malaysian regulator is to avoid bogging down in the myriad unsavory, annoying but not terribly harmful practices that can dissipate supervisory energy, reserving resources to respond to those that can cause significant harm.

Finally, the bad apples are unscrupulous providers out to get away with as much as they can, including deliberate scams. The South African National Credit Regulator, one of the best client protection enforcement organizations in the world, has a lot of experience with players like these. Most recently, a rash of providers there have refinanced mortgages at low home valuations for clients in debt trouble with the express intent of acquiring houses at below-market prices through foreclosure. Action against practices like this must be swift and severe, requiring a strong response team – with dry powder.

As I think about these three different groups, what strikes me most is that the boundary between good players and opportunists is porous. Good players become opportunists if conditions push them that way. And as this happens, a downward spiral pulls in more players and creates increasingly bad practices. Cynics may say that this is just the way the world works: competitive pressure are an inevitable and irresistible force. I agree that competitive pressure is strong, but, as the regulators from Peru recognize, it is not the only force. Behavioral norms and business ethics matter, too, if they receive the kind of backing that allows them to become stronger. It is in the public interest to enlarge the space for good players. Among other things, it frees regulators to focus on the worst abuses. Regulators should seek to pull as many players into the good behavior group as possible by making that space more attractive for providers. They can best do this as the Peruvian authorities have, by engaging in partnerships with industry. This doesn’t have to mean being soft. Rather, it means actively recruiting major portions of the provider community to the client protection cause, and enlisting them to be proponents of strong norms among their peers.

Unfortunately, this avenue for improving behavior has been neglected or is simply discounted as na