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DECO, the Portuguese consumer protection association, welcomes the opportunity to respond to this consultation paper.
These guidelines (GLs) may have an important impact in disciplining the lending market in the EU. The shockwaves of the economic crisis of 2007-2014 are still evident. One of such effects is the accumulation of non-performing loans (NPLs) in the EU, with a more significant impact in some Member States (MSs), one of which is Portugal. Although the amount of NPLs is reducing since 2014, the existing balance is still relevant in a sub-set of MSs, including Portugal.
DECO welcomes the approach taken by the EBA in combining prudential and consumer protection focus when developing the GLs. A sound set of creditworthiness assessment policies will have a positive impact in credit risk as the potential for NPLs should be reduced. This is a key combination that makes the application of these GLs extremely relevant.
The extension of the GLs on creditworthiness assessment under MCD to other loans is also well received.
DECO’s response will focus on the consumer protection aspects as that is its remit.
DECO considers that the GLs should apply to ALL credit providers. The current drafting makes no distinction between credits proposed by banks or by non-banks, which is a very important element. Therefore, it would be important to make sure that the scope includes potential newcomers which may enter the credit market, making sure that the GLs apply to them in respect to creditworthiness assessment processes.
issue not applicable to DECO
A “future proof” approach requires an understanding if the problems faced by consumers. In this respect, the number of defaulted clients, per type of products, the size of the debt and the duration of the arrears are key indicators that should allow regulators to keep an informed view on the credit market quality in the perspective of consumers.
The draft GLs need to have a further adaptation to address challenges brought in by technology enabled innovation. New solutions and tools are introduced in the loan assessment and design of products. One such example is the use of artificial intelligence which still needs to be better assessed in terms of application and whether outcomes are more beneficial than harmful. As a result, it would be better to limit this type of usage to basic algorithms examining objective and neutral data which carries no or little risk of discrimination. Adding any other criteria may lead to discrimination over race, gender, etc. An algorithm which is trained and programmed to find correlations between likelihood of default and a set of data that it has access to will find any and all supposed links" between default rates and a certain piece of data such as sex, age, race etc."
DECO notes that the CP does not clarify the difference between credit risk and creditworthiness assessment. According to the BIS: “Credit risk is defined as the risk that a counterparty will fail to perform fully its financial obligations, and can arise from multiple activities across sectors. For example, credit risk could arise from the risk of default on a loan or bond obligation, or from the risk of a guarantor, credit enhancement provider or derivative counterparty failing to meet its obligations”. Credit worthiness assessment is defined in the MCD as “the evaluation of the prospect for the debt obligation resulting from the credit agreement to be met.”
Credit risk assessments are linked to the prudential side of regulation, making sure a bank does not go bankrupt, while creditworthiness assessment is linked to the borrowers’ situation. For consumers, this assessment should be used for example to prevent their over-indebtedness. Creditworthiness assessment should lead to an objective diagnosis of the financial capacity to repay the credit together with the other expenditures.
A sound set of creditworthiness assessment policies will have a positive impact in credit risk as the potential for NPLs should be reduced. This is a key combination that makes the application of these GLs extremely relevant.
In case of a negative decision, creditors should provide a comprehensive explanation of the decision to the client.
Overall, the above requirements are very much focused on credit risk and not so much on consumers and protecting their best interest (protecting them against loan sharks, payday lenders, debt collectors etc). More focus should be put on creditworthiness and what should be done to mitigate negative consequences of defaults and NPLs from the point of view of consumers.
These GL could be drafted with a view to incorporate the concept of responsible lending. This should follow a consumer-focused approach and be composed of 4 key elements:
• Credit products are designed in a responsible way;
• The duty to assess the consumer’s creditworthiness;
• The duty to assess the suitability of a credit or related product to the consumer; and
• Fair treatment of borrowers in difficulty.
The data collection by creditors should be carried in a way that is compliant with GDPR and non-discrimination regulation.
In par. 35.b - and to be added in Annex 1: credit granting criteria should guarantee a sufficient remaining income to allow, beside credit and contract reimbursement, to allow a decent life standard for the household. As such a key information to become compulsory in data collection should be the household composition.
In par. 41, data should be drawn from quality proof information sources, avoiding data available on internet and social media.
On par. 59, there is a reference to include geographic location of the borrower in decision making. For consumer borrowing, it is arguable to have this. This needs to be clarified as it may result in discrimination of people based on where they live.
Regarding par. 76.f, it requires a more clear definition for creditworthiness and credit risk, to ensure that the difference is clearly stated. In addition to this requirement, the following should be added: Ensure that creditworthiness and credit risk assessments do not lead to contradictory lending decisions".
Par. 76.g also needs more clarity. What is the definition of "independent"?
At the end of paragraph 76, we would recommend to add:
“Put in place preventive mechanisms for early detection of financial problems and set up a specific unit to explore solutions with customers in difficulty such as putting a loan reimbursement on hold, helping the customer with legal and administrative proceedings (obtaining social benefits, any benefits they may be entitled to given their difficult financial situation, such as unemployment benefits etc), liaising and cooperating with not for profit or independent, recognized, high quality debt counselling and debt advice services.”"
Again, these requirements are very much focused on credit risk and not so on credit worthiness assessment.
Par. 81 and 82 are missing a ban of quantitative targets as in art. 7 (4) of the MCD.
For par. 82.a, how would this work in practice? What is considered as high quality"? This is too vague. First, given staff turn-over, it may not be possible to remunerate staff based on long-term criteria. Second, does "quality" refer to complying with prudential requirements or does it refer to a specific number of non-performing contracts or defaults from borrowers? For instance, in pay day lending institutions, while their default rates are high, they still comply with prudential requirements.
The same question can be raised for point b, how is “credit quality” defined in that context?
In point c, what is the “best interest” of the consumer?"
Section 5.1.1. should include a more precise definition of creditworthiness, as this should refer to household budget (incomes, contracts, liabilities, incompressible expenditures, remaining income for a decent level of life). There should be a statement that the main objective of creditworthiness assessment is to guarantee a remaining income for a decent life considering the household composition.
Par. 91 should include:
- that employment should be understood more broadly as all type of professional activities. The current trend of moving away from traditional labour contracts (no end date) to temporary contracts should be taken into account as creditors may consider that temporary contracts are more “risky” then other labour contracts, which would significantly impair many workers from accessing credit at decent conditions;
- household composition;
- budget remaining amount (after incompressible expenditures such as contracts (rent - energy/water,...,+ financial commitments, liabilities) for decent life (food, health, education, mobility…)
Par. 91.f is too vague and should be removed as it is open ended.
The list set out in Annex 2 is very important and mostly adequate. It is important to ensure that the collection of data for assessment is carried out without any cost for consumers.
Throughout section 5.2 there are references to “reasonable enquiries” and “reasonable steps”. From a consumers’ creditworthiness assessment point of view, it would be expected to have a clear and transparent definition of the enquiries and steps required and acceptable in this assessment. The current wording using “reasonable” leaves room for misuse of the enquiries and potential for abusive requests.
On par. 98, the definition of “disposable income” should be very clear in the GL. It should not only refer to borrower’s income, but more appropriately, to borrower’s budget.
In this respect, par. 99 should also mention a ratio related to “remaining income for decent life” per person in the borrower’s household. This is aligned with the content of par, 109 which mentions “appropriate substantiation and consideration of the living expenses.
It should be mandatory to provide, without any cost, the outcome of the creditworthiness assessment carried out. Consumers’ have the right to be informed of the outcome, whether it is acceptance or refusal. In particular, a refusal should be transparent ensuring the consumer is made aware of the criteria that lead to the negative result.
There needs to be a clarification in the credit decision making process between acceptance and refusal thresholds, linked to default rates. Taken from the creditworthiness perspective, it is important to define how much of the current borrowers' savings capacity can be taken up by the reimbursement of a credit without creating a substantial risk for the consumer, especially in the case of a financial shock (loss of employment, health problem, divorce etc). This needs to be set out in the GL, for instance in par. 182.
Also on p. 182, it is important to factor in the constraints set out in macroprudential policy, where this is the case. Several EU MS have put forward macroprudential policy tools , some more binding than others, which restrict loan granting by setting limits on maturity and on ratios such as debt-to-service and loan-to-value. These Guidelines should reflect that credit decision is also bound by macroprudential measures (in those jurisdictions where such measures are in place).
On p. 183, the information on the key features of a loan being offered to the borrower should include APR as this indicator is deemed to reflect the actual cost of a loan and is fundamental to compare different proposals (as referred to both in the CCD and the MCD).
Pricing of consumer credit should be carried out in a way to eliminate any risk of discrimination.
Costs associated to credit granting should be transparent and proportionate. In particular, any fees or charges related to the product must be evidently associated to a service performed by the creditor. The Portuguese creditors have shifted their business model in recent years to rely heavily on charges and fees to ensure profitability. One of such fees is unacceptable: creditors charge a fee for collecting the monthly repayment of loans from a consumer’s account. There is no service actually provided to the consumer as this is a debit from the account as contracted. The fees are on average more than €2,00 per month. These GLs could be used to prevent such abusive practices.
Par 187.b mentions that creditors should take into account behavioural assumptions in determining cost of funding. This needs more clarification.
Par. 187.d - the idea to define cost for “different homogenous risk groups” may constitute a step towards discrimination. This should be rectified in the GL.
On par. 204 the reference should be to par. 200 (not 2000).
In general, in this section there was no mention of prevention measures, such as identifying consumers in financial difficulty before they default on their existing financial commitments.
In addition, credit rearrangements should also include the write off of part or all of the debt.
These GLs should also consider the application of measures to address consumers in arrears in foreclosure, thus reflecting the spirit of Article 28 of Directive 2014/17/ЕU (Mortgage Credit Directive) and Article 28 of Directive 2014/17/EU, e.g., setting out that lenders should exercise reasonable forbearance and try to prevent credit contacts from becoming non-performing.