VULNERABLE PEOPLE, A MARKET FOR UNFAIR, PREDATORY LENDERS
Much consumer protection legislation is based on the notion of the average consumer, and what that average consumer might understand or how they might behave. However, consumers in vulnerable circumstances are significantly more likely to be exposed to unfair and predatory practices and suffer harm than the average consumer.
A vulnerable consumer is someone who, due to their personal circumstances, is especially susceptible to detriment, particularly when a firm is not acting with appropriate levels of care. Low income households are the most predominant category of consumers affected by the dangers associated with consumer credit, in particular the short-term loans they use to make ends meet.
The key elements identified as leading to dangerous consumer credit and over-indebtedness come from market failures:
- Exploitative / unscrupulous / irresponsible lending practices: credit features, lenders’ business models and commercial practices are significantly different from mainstream practices. Only the most vulnerable people have no alternative but to use bad credit.
- High cost credit: the costs are significantly higher than the average on the mainstream market (e.g. usurious rate, very high costs and late payment penalties).
- Complex credit contract terms and conditions: the borrowers do not understand their liabilities, the way the product should be used and reimbursed to avoid penalties and extra-costs (e.g. unclear presentation of a teaser rate during an initial short period of time).
The main disadvantage of using such loans is the cost to consumers who fail to pay off their entire balance every month and continue to accrue additional interest charges from month to month. Some loans are designed in such way that most of their users are trapped in a cycle of never-ending loan debt. This is particularly the case of many payday loans, but also of some revolving credit and unarranged overdrafts: the profit making on this client segment is much higher.
SHOULD ACCESS TO CREDIT BE A RIGHT?
How can one justify that vulnerable households are victims of irresponsible lending?
Some take the view that access to credit should be one of our fundamental rights. For instance, the Nobel Prize Laureate M. Yunus considers that credit is an effective way out of poverty and should be a human right. Is this approach also valid for consumer loans?
The argument for a right to credit is not restricted to advocates of the microfinance movement. In UK, even the payday lending sector has tried to recast itself as being on the side of vulnerable consumers arguing that to limit its activities denies consumers their ‘right’ of access to credit. Some consumer advocates are also of the view that adopting too strict rules, such as capping interest rates, could push vulnerable consumers into grey or black markets because they cannot do without loans.
It is worth noting that in some countries, the right to credit does not exist due to the principle of contractual freedom. This goes very far, maybe too far, because a lender denying a credit loan has no duty to give reasons for their decision.
As demonstrated by researchers and widely by debt advice practitioners, the question of a “right to credit” inevitably comes up against the other major credit issue: the risk of over-indebtedness.
Rather than trying to limit the damages caused by the lenders who extort money from their least well-off clients by regulating some of their practices, would it not be more useful to address the causes of financial difficulties faced by households that use short-term credit on a regular basis to supplement low pay and cope with a high cost of living? It would then be possible to implement effective measures to deal with these difficulties on one hand, and define the outline of a true “right to suitable and affordable credit” on the other hand.
WHAT SHOULD BE DONE AT EU LEVEL TO TACKLE DANGEROUS CONSUMER CREDIT?
Improving the Consumer Credit Directive
Revising the Consumer Credit Directive (CCD) adopted in 2008 is an opportunity to address loopholes in current EU borrower protection law. In particular, the directive should be amended to:
- Widen the scope of the CCD so that all credit used by consumers are regulated by the CCD without any exception regardless of their type, provider, amount, duration, interest rate;
- Introduce more stringent rules on advertising claims;
- Include the principle of usury rates or cap the annual percentage rate (APR);
- Regulate abusive fees and charges that take advantage of consumer vulnerabilities, such as rollover charges, penalties for unauthorised overdrafts;
- Ban dangerous credit in the EU. The CCD should provide objective criteria to a qualify what make a credit “dangerous”;
- Ban unsolicited and door to door selling of credit, with an updated definition that should include AI and big data innovation in marketing practices;
- Enhance creditworthiness assessments requirements that should be mainly based on the income and expenditure of the borrower, on his budget balance. This is the only way to avoid proposing the extra credit that throws out the budget, the one credit too many.
Enhancing supervision of lenders and enforcement of the law
- Bring the CCD into the remit of the European Banking Authority;
- All consumer credit activity should be subject to a licence issued by the national financial supervisor before firms (banks and non-banks) are allowed to offer loans, based on principles defined at the EBA level.
- Set up a mechanism to monitor default rates across the industry and identify statistical outliers which may indicate predatory lending practices, based on principles defined at the EBA level.
- Ensure that national competent authorities responsible for oversight and enforcement of consumer credit legislation are well-equipped, i.e. have a clear mandate, qualified staff, strong monitoring, investigation and sanctioning powers.
- Harmonise the administrative sanctions, including pecuniary penalties, for infringement of the provisions of this directive. In particular, only lenders should bear responsibility for granting a loan in case of negative creditworthiness assessment or unproper assessment. The sanctions should include the total loss of interest and fees related to the loan.
Illustration of the household debt crisis Jubilee Debt Campaign
In a new paper, Finance Watch analyses consumer credit from an historical perspective, showing how different societies have tackled the problem at different times.