IRRESPONSIBLE LENDING PRACTICES

Falling into over indebtedness is usually result of the combination of systemic and individual factors, but one of the key causes is irresponsible lending. Even if it is not the major cause, it can always be something that deepens the problems of borrowers. These practices often target a vulnerable group of society and lead borrowers to a trap in cycles of debt. Irresponsible lending has serious consequences for consumers and the broader entire financial system.

When lenders design their products, they do not focus on tackling consumer needs, but on generating profits (1). When sales people are selling credits or additional services such as insurance, they mostly think about their commissions, and not on consumer needs and their losses. Most of the sales people earn a minimum salary and are motivated by additional renumeration for selling credits such as commissions, bonuses, promotions, vouchers, and others. This system promotes predatory lending practices and misselling, unsolicited and unnecessary services.

In many countries across Europe, lenders avoid assessing borrowers’ creditworthiness (hereinafter referred to as “CWA”), and they prefer to sell insurance or other paid guarantee instruments to ensure payment. In some cases, lenders, on purpose, do not conduct a CWA to be able to use higher rates and commissions, or they sell multiple small amount credits, instead of a larger one. The lack of the CWA and financial literacy is leading to households taking high cost credits, such as payday loans or credit cards. Irresponsibility in selling credit cards and/or increasing limits in credit card is creating the phenomenon of persistent debts, where consumers pay for interests and fees by years but nothing from the main amount of the credit. Uncontrolled rolling over the payday loans is increasing the costs of the credit and by that is pushing in the spiral of the debts and finally into over indebtedness.

Also, in situations of difficulties in payment, lenders don’t have procedures for amicable repayment. They would rather come to the court in a regular procedure, than take a settlement with the consumer before going to the court or during the consumer bankruptcy procedure. The lack of procedures for people with financial difficulties only deepens their problems.

Benefits from debt advisory for the financial industry

The main beneficiary of the debt advisory system, just after debtors, is the financial sector. An efficient debt advisory system guarantees for the industry: reduction of defaults, lower credit risk, and healthier loan portfolios (2). These services contribute to the overall financial stability of borrowers (individuals, households, and communities) and mitigate risks associated with debt instruments. The cooperation of debt advisors and sector leads to improved relationships between creditors and debtors and higher chances of debt repayment, avoiding consumer bankruptcy. It is estimated that the benefits of the system of debt advice in every country would be between euro 1.4 – 5.3 for every euro spent (3). Debt advisory provides ways to save money for creditors, such as lowering the costs for debt collection, improving the recovery rate (4), and faster returning over-indebted clients to the banking system. Debt advisory helps bank clients regain access to financial activities to bring them back into the economic life and social inclusion.

Corporate Social Responsibility of the financial sector (CSR)

Supporting or funding debt advisory and financial literacy initiatives by the financial sector should be a part of their corporate social responsibility. Debt advisors help debtors, who often are victims of irresponsible lending practices of the financial sector.

The impact of a single consumer with financial difficulties is not limited to one’s private life; it is impacted on their family, and even on an entire community. The provision of debt advice provides several benefits, including improvement of debtors’ mental and physical health, financial well-being, family relationships, and productivity of individuals (5). Also, it is proved that debt advisory has a crucial role in avoiding homelessness (6) and poverty. Debt advisory is important for individuals and communities to prevent severe financial crisis and contribute to the overall financial stability of communities. Everyone wants stability in the financial system. Debt advisors act as a safety-valve in this system.

The Transposition of Article 36 of the new Consumer Credit Directive (hereinafter referred to as “CCD”)

Article 36 of the CCD gives Member States the obligation to ensure that independent debt advisory services are made available to consumers with limited charges. Member States are not obligated to directly provide debt advisory centers, but only to make sure that these services are provided. The transposition of the directive should create a space for discussion in national parliaments regarding the shape of debt advisory in every EU country. Debt advisors should use this moment to lobby for sustainable and stable funding of the centers. Every country must decide whether to support existing providers or prepare new solutions. The directive leaves us with an open question: who will pay for debt advisory? The ECDN recommends the system of a 0,1 % levy from each new loan to be used to participate in the funding of debt advisory. Ultimately, creditors should take responsibility by contributing to funding debt advisory. The debt advisor’s goal is to have a written national law act regulation about the funding model.

Levy funding system

The ECDN recommends for a 0,1% levy on each new loan used to fund debt advice.

Every 0,1 % of the amount of the loan should be collected by the Fund of Support for Debt Advice Services. Creditors should frequently transfer money to the Fund and then it should be distributed according to a transparent procedure. The fund should be administrated by an independent institution. The board of this institution should be composed of representatives of the financial and the public sector (Banks, retail industry, telecommunication, money collectors, consumer associations and debt advisory associations).

The details should be discussed on a national level. Every member State has a unique financial institution, a system of support debtors, and a certification process. To create legal regulations that are general and abstract to cover all types of credits and propose the percentage from the credit which might be negotiated is in the good interest of debt advisors. During the process of preparing new regulations, legislators should find a way to charge from the creditors, and not from the consumers, and how to make sure that this model does not make consumers pay for it.

Debt advisors should be prepared for a discussion with the creditors lobby about:

1. What will be this percentage?
2. What type of credits will be involved in this? Will it be only for consumers or non- consumer credits, too?
3. Who will administrate the Fund?
4. Who will be responsible for distributing the money between the organizations?

Of course, distributing money raises questions about the quality process and maybe the certification process of debt advisors or debt advisors centers. The new directive gives us the complex definition of debt advisor services.

What do we have now?
Involving the financial industry in the funding of debt advisory
In Europe, there are some examples of collaborations between debt advisory centers and the banking sector. The levy funding system should be promoted because this could be a ground-breaking idea for the future of funding debt advisory, but we should also promote any partnerships with the financial industry. This type of collaboration should be “trendy”. Cooperation helps all actors: creditors, debtors, and debt advisors. Below, are Polish and French working examples of cooperation with the financial sector.

The Association of the Promotion of Financial Education (Stowarzyszenie Krzewienia Edukacji Finansowej, SKEF) in Poland (7)
SKEF is an association promoting financial literacy and has been running financial and consumer advisory centers since 1997. SKEF used to have centers in many of the most important Polish cities. Currently, SKEF operates in two centers – Gdynia and Biała Podlaska. SKEF has concluded agreements with 16 local credit unions (SKOK- savings and credit co-operatives). The SKOKs are based on the principles of cooperativeness and member bonds. Each credit union member pays a monthly fee of PLN 1 (approximately 20 cents/Euro). In return, members have free access to debt counseling, financial education programs for kids and adults, and various SKEF initiatives. Some programs are dedicated only to members, and some to the entire society. The centers of debt counseling are open to everyone who needs it. The financial model is based on diversified sources of income:
– 80% comes from monthly fees from credit union members,
– 15% comes from projects financed by financial institutions/EU/national or local level,
– 3% comes from individual donors and foundations,
– 2% comes from the donations of 1.5% of income tax (a program of deduction from income tax on NGOs)
However, it is worth noting that this percentage may change depending on the year.

Crésus in France (8)

The NGO CRÉSUS was created in Alsace in 1992 to help French cross-border workers who lose their jobs because of the financial crisis in Germany. In 2004, the first CRÉSUS associations in the country were brought together into one national federation to improve the exchange of practices, benefit from technical support and training sessions from volunteers. By ensuring the consistency of the CRÉSUS national network, the Federation forms a group of adept and voluntary local associations entirely dedicated to welcome over- indebted households and to prevent financial, economic and social exclusion.

The association for the CRÉSUS Foundation was created in 2008. It aims to actively promote the prevention of the financial exclusion, to cooperate with other institutional actors in favor of a more inclusive society and contribute to the conduct of change in the face of the over- indebtedness’ economic and social consequences. The association is committed to offer a nationwide budgetary support platform and to innovate in the budgetary and financial education field.

The association for the CRÉSUS Foundation is financed by companies such as banks and credit establishments, which creates partnerships. These partners use a secure intranet network to address their vulnerable customers to the nationwide budgetary support platform which supports beneficiaries until the financial difficulties. Hence, they pay for an accompaniment which is completely confidential from them and free for beneficiaries.
In terms of funding :
– 33% of funding comes from sponsorship of Banks, companies and insurance
– 50 % of funding comes from service provisions (financial educations session “Dilemme”, training and accompaniments) to Banks, insurance and social services
– 17% comes from state subvention.

Conclusions

Most of Europe’s debt advisory centers are funded by the government on a local/national level. Only a few debt advisory centers collaborate with banks or credit unions. The financial industry should play a significant role in funding debt advisory services. One of the key causes for falling into over indebtedness is irresponsible lending. The main beneficiary of the debt advisory system, just after debtors, is the financial sector. An efficient debt advisory system guarantees for the industry: reduction of defaults, lower credit risk, and healthier loan portfolios. It is estimated that the benefits of the system of debt advice in every country would be between euro 1.4 – 5.3 for every euro spent. Supporting or funding debt advisory by the financial sector should be a part of their corporate social responsibility. Debt advisors should use the moment of transposition of the CCD to lobby for having a written law: a regulation on the model of funding. The ECDN recommends the system of a 0,1 % levy from each new loan to be used to fund debt advisory. Every 0,1 % of the amount of the loan should be collected to the Fund of Support for Debt Advice Services. The levy funding system should be promoted because this could be ground-breaking idea for the future of funding debt advisory, but we should also promote any partnerships with the financial industry.

Management Committee of ECDN
Palermo, April 15, 2024