The European financial services industry should be pleased that the European Parliament finally passed the Consumer Lending Directive earlier this year, after more than six years of mulling, negotiating, and digestion.
Or should it? Does the directive really bring about a single market for consumer lending, and level the playing field for consumers and credit institutions alike?
The directive’s objective is to harmonize the consumer credit market for non-mortgage loans between €200 and €75.000, a market worth at least €900 billion annually, according to the European Credit Research Institute in Brussels. It touches the daily lives of two out of three Europeans – more than 330 million people – who have subscribed to such loans to pay for furniture, buy a new car, or replace that leaking washing machine.
The revised directive aims at making it easier for millions of European consumers to solicit loans from lenders across Europe, facilitating the comparison of loan costs through a uniform way of calculating the annual percentage rate of charge (APR), providing standards for contractual information to be provided to the borrowers, and specifying (almost!) homogenous conditions for early loan repayment, among others.
Undoubtedly, the directive is a step in the right direction to strengthen consumer rights. Face value, it should also stimulate competition among credit institutions, with all it brings in terms of increased offer, more efficient markets, and better rates to consumers. All in all not negligible advantages these days, with financial markets in turmoil and consumers facing a serious credit crunch.
So banks looking to expand to new markets and tap into the €900 billion opportunity should joyfully be jumping up and down as a consequence, then? No entirely so. Important barriers are still forcefully in place, making the European market for consumer lending far from a level playing field. A look at just a few of these obstacles should display the magnitude of the issues outstanding.
No Pan-European Central Registry for Credit Information
In this information-intensive, computerized age, no central registry for consumer credit information exists in the EU. Registries are mostly national, and the information contained in these databases varies widely in terms of information collected about the borrowers and their credit worthiness, and the formats in which such information is stored. It is not uncommon, even within national borders, to find such information scattered across several databases or registries. If such registries exist at all. In certain markets, consumer credit information is only available in paper format, even today…
The lack of information sharing among credit institutions concerning customers credit history, delinquency rates, and other risk mitigating information – be it for legal or competitive reasons – further contributes to a less than perfect market for new market entrants. Data protection laws, which are largely governed by national laws and institutions, also represent a severe entry barrier for financial institutions in terms getting cross-border access to consumer credit information.
No Possibility to Provide a Fully Electronic Lending Process
Another constraints facing European credit institutions is the lack of infrastructure to provide a fully electronic lending process. If there is a striking lack of national infrastructure across the EU for verifying a person’s digital identity and providing citizens with a tool to digitally sign documents in cyberspace, the gap becomes glaring at a pan-European level. Although the directive for digital certificates was adopted in 2001, we still seem to be years away from a common, European-wide infrastructure for using digital certificates.
The result is a process which still relies on traditional mail (yes, we are talking “snail mail”) to provide the potential borrower with a contract, to be signed and returned, please. Needless to say, this process is less instant and more costly – not only the postage, but also in terms of follow-up and customer defection – than a fully electronic process.
The effects of the above constraints are tangible for consumer credit providers. Entry barriers for providing loans cross-border are still significant, both from a risk and a cost perspective. The lack of reliable information about customers’ credit history forces lenders wishing to enter new markets to accept higher risks and loss provisions, which may be reflected in higher interest rates on consumer loans.
More likely, however, is a scenario where new entrants, in order to remain competitive, will align their interest rates with local players by reducing their margins, thus making the business case for cross-border lending less attractive. Additionally, credit based marketing tools and automated assessment tools will have to be adapted to individual market needs, resulting in additional cost and complexity. Not to mention the cost and hassle of paper based processes…
The European consumer lending landscape depicted above certainly distorts competition, at the expense of a more efficient consumer lending market, and more favorable interest rates to consumers in need of credit. It also leads me to believe that the picture is not likely to change rapidly. The European Central Bank logged significant spreads in average rates charged for consumer credit in the Euro area in 2007, from a low 6% in the cheapest country (Finland) to 12%+ in Portugal, the country with the highest interest rate.
Although there are obvious benefits of harmonizing the market and allowing consumers to subscribe to loans at more favorable rates from lenders abroad, my guess is that there will be a significant inertia in the market. If the EU really wants to accelerate cross-border lending, which today stands at a meager 1% of total consumer lending, it would need to stimulate the construction of pan-European infrastructures for exchanging consumer credit information and using digital certificates.