The new consumer credit directive: a feasible attempt to harmonisation?

The new consumer credit directive: a feasible attempt to harmonisation?

The European Commission has recently presented (11/09/2002) a proposal for a directive on the harmonisation of the laws, regulations and administrative provisions concerning credit for consumers. Such directive intends to “… pave the way for a more transparent market, a more effective market and to offer such a degree of protection to consumers that the free movement of offers of credit can occur under the best possible conditions both for those who offer credit and those who require it”.

The previous directive (87/102/EEC) was targeted to the two most common products at that time, namely “hire-purchase” agreements and “instalment credit”, in the context of a cash based society. Today’s credit industry resembles little retail credit in the 1980s. Existing directives were judged to offer insufficient consumer protection by governments, which added new provisions, in practice setting in place a minefield for consumers in search of credit in other member states and distorting competition between creditors in the internal market. Therefore, the case for a new directive is well argued and all parties involved agree on the need to update the existing legislation.

The scope of the new directive is extended to all credit and surety agreements including guarantors, with a few exceptions: housing credit for the purchase or transformation of property and credit and advance granted occasionally by an employer to his or her staff. The directive establishes a new framework to redress the sharing of responsibilities between consumers and lenders, including intermediaries. Such harmonisation of laws is likely to benefit consumers by covering all aspects of credit and the enhancement of the information to be provided, but also lenders by facilitating the marketing of their products cross-border in the same conditions than in their home country.

The proposal, however, seems not to have fully pleased none of the parties involved. Financial institutions regard the proposal on its present terms as a threat to the development and expansion of their business, along with an important interference in the way they operate. Consumers on their side have welcomed the proposal but remain sceptical about the effect on the level of consumer protection that will achieve.

The text spells out a comprehensive set of provisions that will impact the way the industry and the market functions. In the following we will comment on three essential aspects such as the novel concept of responsible lending, the inclusion of joint and several liability between distributors and creditors, and certain issues concerning the maximal harmonisation approach of this directive.

The proposal introduces the principle of responsible lending, based on requiring financial institutions to act as “good creditors” (Art 9). This rather philosophical concept is aimed at ensuring that the creditor does not grant further credit to consumers that might be in a difficult position to repay new debt contracted. In practice it represents an obligation to consult centralised credit databases and to examine responses provided by the consumer and the guarantor, as well as data supplied by intermediaries. However, the proposal does not include any elaboration on the consumer’s responsibility regarding the application for, and management of credit in case of breaching his responsibility to provide truthful information. Acting as good creditors also means to offer the best possible form of credit to the borrower, while the consumer very often has preference over one form of credit. This requirement leaves the field open to all kind of legal disputes between lender and borrower arising when default occurs.

From a cross-border perspective, conflicts might arise due to the different reporting scenarios within the EU. The provisions en forcing the exchange of information between national reporting agencies, or credit bureaus, is certainly well received by the industry as a key element to promote the single market. However, what will happen in case of lenders from a negative reporting country (where registries only record information on payment defaults) lend on a positive reporting country (all credit outstanding is recorded by the registry), but in the light of reciprocity exchanges only receive negative information? Will these foreign lenders be considered to neglect their credit assessment responsibilities?

Furthermore, since the burden of proof rests on lenders, the proposal creates uncertainty about how responsibilities can be cleared if lenders are obliged to destroy any records obtained from the credit registry immediately after the conclusion of the agreement (Art 7). Would credit registries be forced to keep records that offer a static picture of individuals’ finances at given point in time to assist in a litigation that might take place years after the credit is agreed? This will force credit bureaus to keep copies of all the consultations resulted in credit, might be several for a person and kept for a non-defined period of time, which will require additional resources and associated costs. It has to be kept in mind that in the US, more than 2 million credit reports are sold everyday. This requirement also raises data protection concerns, since outstanding liabilities have to be erased from the file once paid and negative records have also to be erased after a period.

Although welcomed by consumers as a tool to reduce overindebtedness, in practice, responsible lending provisions are far from solving such problem since they do not reflect the reality of the causes of overindebtedness. As an ECRI study has recently illustrated, overindebtedness is in most of the cases caused by the occurrence of economic and personal events (unemployment or divorce) that reflect on the financial health of the individual or household altering the capacity to face debts contracted, and not by the simple accumulation of credit. It is therefore difficult to prevent by consulting information available at the time of granting the credit. Moreover, the weight of consumer credit in the indebtedness of households varies importantly across EU member states. Consumer credit represents on average 15 percent of household indebtedness, the rest is mainly mortgage credit. For instance in Austria, housing credit and consumer credit represent respectively 43.7 % and 41.3 % of households’ debts, whereas it is 88 % and 4.7 % respectively in the Netherlands.

The proposal will exacerbate differences between US and EU credit markets in this area. In the US there is a combination of flexible lending practices that have contributed to the expansion of credit to less favoured social sectors, and a legislation that provides a soft approach to individuals’ bankruptcy. The EU proposal will introduce elements that would result in a restriction of credit granting without offering any counterbalance to creditors, since the responsibilities of borrowers remain unchanged. In the US overindebtedness and default are considered part of the economic cycle and its consequences are mainly borne by lenders.

Another key novelty of the proposal is the introduction of joint and several liability. The existing directive provides for subsidiary responsibility, by which the consumer is able to claim reimbursement from the creditor if his complaint against the vendor is justified and the latter refuses. This is certainly an advance for consumers, forcing lenders to monitor the good business practices of the retailers they cooperate with. It is already in place to a certain extent in Europe, with the most consumer friendly case of the UK, where credit card issuers are liable for all damages related to the purchase of the good. The Commission has adopted this model in the proposal.

A long-standing discussion conce rns maximal and minimum harmonisation. Traditionally, regulation close to the field of consumer protection has followed the minimum harmonisation principle, leaving to member states the prerogative of establishing more restrictive provisions that ensure the existing level of consumer protection in a country. However, given the few advances in the completion of the single market in these areas, the Commission seems, at present, to favour maximal harmonisation, such as the distance marketing of consumer financial services directive, whereby member states may not adopt provisions other than those laid down in the directive for the harmonised fields.

Banks have long sought maximal harmonisation that allows them to market financial products cross-border without further adaptation to the legal environments. However, they might be underestimating the risk of adopting the highest level of protection in every country that the maximal harmonisation approach entails. Contrarily, consumers are afraid of losing the high degree of protection existing in some countries for the purpose of maximal harmonisation. The search of common standards in consumer protection can bring the adoption of the lowest common denominator, and member states will not be able to establish additional provisions. The concept of “optimal protection” often mentioned as the best approach has not been yet developed into a practical set of recommendations.

The outcome is uncertain to foresee, since credit to consumers and consumer protection is a highly sensitive political issue and all elements of the proposal are bound to be extensively discussed. For instance, it is very unlikely the UK consumers and policy makers will renounce to the pure joint liability system for credit cards, whereas lenders in most of the Member States are radically opposed. The outcome might therefore be important areas are left outside the harmonised field, hampering the establishment of an effective single market for credit to consumers.

Surprisingly, the proposal fails to clear the way for the development of on-line financial services. It demands the signature of the contract in paper or other durable medium, diverging from the e-commerce directive, which recognises electronic signatures as valid, but which does not apply to financial contracts.

However, the proposal brings elements that will enhance transparency and benefits to consumers such as further provisions of advertising and harmonisation of the APR (Annual Percentage Rate), information to be provided prior to the agreement, right of withdrawal and clear assertion of the right to early repayment.

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