Comparative Perspectives of Consumer Over-Indebtedness : A View from the UK, Germany, Greece, and Italy 9789462745346, 9789462366732

Citation preview

Comparative Perspectives of Consumer Over-Indebtedness

Comparative Perspectives of Consumer Over-Indebtedness A View from the UK, Ger many, Greece, and Italy

Federico Ferretti (Ed.)

Published, sold and distributed by Eleven International Publishing P.O. Box 85576 2508 CG The Hague The Netherlands Tel.: +31 70 33 070 33 Fax: +31 70 33 070 30 e-mail: [email protected] www.elevenpub.com Sold and distributed in USA and Canada International Specialized Book Services 920 NE 58th Avenue, Suite 300 Portland, OR 97213-3786, USA Tel.: 1-800-944-6190 (toll-free) Fax: +1 503 280-8832 [email protected] www.isbs.com Eleven International Publishing is an imprint of Boom uitgevers Den Haag.

ISBN 978-94-6236-673-2 ISBN 978-94-6274-534-6 (E-book) © 2016 The authors | Eleven International Publishing This publication is protected by international copyright law. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the publisher. Printed in The Netherlands

The rich rules over the poor, and the borrower is the slave of the lender (King Solomon, Holy Bible KJV, Proverbs 22:7)

To all those who wonder whether debt may be a form of modern-day slavery

Table of Contents List of Contributors

xi

1 Introduction: Setting the Scene Federico Ferretti

1

Part I The EU Framework 2

The Over-Indebtedness of European Consumers under EU Policy and Law Federico Ferretti and Christina Livada

11

Part II The UK 3

Facts and Figures of Consumer Over-Indebtedness in the UK: Experience from Debt Advisers Joanna Elson What Explains the Low Impact of the Financial Crisis on Levels of Arrears among UK Households? Elaine Kempson

41

4

5 Britain’s Debt Crisis and Responsible Credit Damon Gibbons 6 Responsible Lending in the UK: What Role Does the State Play? Karen Rowlingson, Jodi Gardner and Lindsey Appleyard Consumer Protection Problems Created by the Structure of English Personal Insolvency Law John Tribe

61

87

105

7

125

Part III Germany 8

The Statistic of Over-Indebtedness of the Federal Statistical Office of Germany (Destatis) Walter Joachimiak

vii

151

Table of Contents

9

Consumer Over-Indebtedness in Europe and Germany: Considering Micro- and Macro Dimensions from a Lender’s Perspective Patricia Wruuck 10

Insufficient Prevention of Over-Indebtedness – Legal and Policy Failures

167

189

Peter Rott 11

An Analysis of the German Legal Framework and the (Limited) Influence of EU Law Holger Sutschet

207

Part IV Greece 12

The Dimensions of the Crisis and the Response of Greek Private Law – A General Overview Georgios Mentis (Failure to Set up an Efficient) Out-of-Court System to Deal with Debtors in Financial Distress in Greece Melina J. Mouzouraki

227

13

14 The Greek Regulatory Framework on Responsible Lending Christina Livada Key Elements of the Greek Legal Framework on Insolvency of Natural Persons Theodor G. Katsas

235

247

15

Private Insolvency Legislation and the Protection of the Principal Residence Viktoras Tsiafoutis

259

16

271

Part V Italy 17

The Dimension of Over-Indebtedness in Italy and the Characteristics of the Over-Indebted Households Luisa Anderloni and Daniela Vandone

viii

291

Table of Contents

18

The Italian Banking System, Consumer Credit and the Financial Crisis: Economic Perspectives Stefano Cosma Consumer Over-Indebtedness in Italy: The Role of Consumer Organisations to Prevent and Repair Over-Indebtedness Carlo Biasior

315

19

Consumer Over-Indebtedness and Interference with Credit Contracts: An Italian Perspective Diana Cerini

331

20

The Italian Law against Over-Indebtedness: Fresh Start, Debt Advice and Financial Education Guido Comparato

345

21

ix

371

List of Contributors Anderloni, Luisa is Professor of Corporate Finance at the Università degli Studi di Milano. She has participated in and coordinated international research groups privately or publicly funded (MIUR, CNR, European Parliament and European Commission). She has published widely, adopting a comparative approach to analysing models and experiences in Europe. Her main fields of interest are retail and corporate banking; finance; financial regulation and supervision; European integration; consumers and financial exclusion; and venture capital. She is a member of the European Association of University Teachers of Banking and Finance and of Suerf (The European Money and Financial Forum). Appleyard, Lindsey is a Research Fellow at the Centre for Business in Society (CBiS) at Coventry University. Lindsey is an economic geographer with interests in financial geographies, particularly mainstream and alternative finance. Her research is policy-focused and broadly based around the concept of financial exclusion and inclusion of consumers, as well as commercial and social enterprises. Before joining CBiS, Lindsey held research posts at the University of Birmingham and at the University of Nottingham. Biasior, Carlo is the Director of the Centro di Ricerca e Tutela dei Consumatori e degli Utenti (CRTCU), a research centre for the protection of consumers (Trento, Italy). A qualified lawyer, he has worked for several years as a Consumer Advisor and Board Member in the Italian consumer association Altroconsumo (Milan, Italy) and as a practitioner in a few law firms. He holds a Ph.D. in Comparative Private Law from the Università di Ferrara (Italy). He has experience in working on European research projects. Cerini, Diana is Professor of Comparative Law at the School of Law of Università degli Studi di Milano Bicocca, where she is in charge of the courses in Private Comparative Law and Comparative Law of BRICS and EU. She has extensive experience in international research on comparative law of financial services, and specifically in insurance and banking law. She has authored several books and papers, in particular ‘Sovraindebitamento e consumer bankuprtcy: tra punizione e perdono (2012)’. She has been a visiting scholar in several universities. Diana Cerini is also a lawyer and arbitrator. Admitted to the Bar in 2001, she has long experience in consultancy and litigation, especially in contract law, company law, financial services, surety and insurance law. Comparato, Guido is Research Associate at the European University Institute, Florence (Italy) within the “European Regulatory Private Law” research project. He holds bachelor’s

xi

List of Contributors .

and master’s degrees from the University of Ferrara (Italy), and a doctoral degree from the University of Amsterdam (the Netherlands), where he was PhD researcher at the Centre for the Study of European Contract Law. His research interests lie in the theory and politics of private law and regulation. Cosma, Stefano is an Associate Professor in Banking and Finance at the ‘Marco Biagi’ Department of Economics of the University of Modena and Reggio Emilia (Italy), where he is vice-Dean and a member of CEFIN (Center for Studies in Banking and Finance). He obtained a doctorate in Business Administration from Cà Foscari University, Venice. He is currently a member of the scientific committee of the Banking and Financial Diploma of the Italian Banking Association (ABI), and he acts as an adviser to various public institutions, consulting firms and various banks. Research topics include corporate and retail lending, consumer credit, behavioural finance and the economics of banking. Elson, Joanna, OBE Cdir, is the Chief Executive of the Money Advice Trust, whose vision is to help people across the UK tackle their debts and manage their money more wisely. The Trust helps over 1 million people a year manage their debts via National Debtline and Business Debtline, and via its training services branded Wiseradviser. Previously, Joanna was Executive Director at the British Bankers’ Association, running their policy department for personal and small business customers. Before that she was a House of Commons researcher, and prior to that a primary school teacher. In 2010, Joanna was awarded an OBE for services to people in debt. Joanna is a member of the advisory panel of the Commission for Financial Inclusion, the ABCUL/Lloyds Banking Group Grants Committee, H M Treasury’s Home Finance Forum, the Chartered Banker Professional Standards Board Advisory Panel, the British Bankers’ Association’s Consumer Panel, the Advisory Panel at Birmingham University’s Centre on Household Assets and Savings Management and the chair of the BBA’s Financial Services Vulnerability Taskforce. She is also a trustee and director of the Friends Provident Foundation and a school governor and a Chartered Director. Ferretti, Federico is Senior Lecturer in Law at Brunel University London (UK). He is a member of the Financial Services User Group (FSUG) of the European Commission, an expert group that advises the Commission in the preparation of legislation or policy initiatives that affect the users of financial services; provides insight, opinion and advice concerning the practical implementation of such policies; proactively seeks to identify key financial services issues that affect users of financial services; and liaises with and provides information to financial services user representatives and representative bodies at the European Union and national level. Federico is the Principal Investigator of a research project on European consumer over-indebtedness and personal insolvency law funded by

xii

List of Contributors

the Civil Justice Programme of the European Commission. A qualified lawyer of the high courts of Italy, he has worked as a practitioner for the financial services industry, for consumer organisations and in academia. Gardner, Jodi is a College Lecturer in Contract Law and the Law of Torts at Corpus Christi College, Oxford University. She holds an LLB/B.Int.Rels from Griffith University, an LLM from the Australian National University, a BCL/M.Phil from Magdalen College, Oxford, and is currently a Doctoral Researcher at Corpus Christi College, Oxford. Jodi started her career as a consumer advocate at the Centre for Credit and Consumer Law in Australia, before qualifying as a solicitor and working at Caxton Legal Centre as a community lawyer specialising in consumer protection. Her D.Phil topic is the regulation of small amount credit (often referred to as ‘payday loans’), exploring the role that social minimums can play in determining an appropriate approach to regulating this area of law. Gibbons, Damon is the Director of the Centre for Responsible Credit, a dedicated policy unit focused on credit regulation, over-indebtedness and financial inclusion issues within the Learning and Work Institute. Damon has more than twenty years’ experience of providing, designing and commissioning services to meet the needs of disadvantaged groups and communities, and has been involved in consumer campaigns at the national level on issues of credit, debt and financial exclusion for well over a decade. He has been heavily involved in campaigns for caps on the cost of credit and for greater responsible lending requirements, and he has worked closely with Paul Blomfield MP and Stella Creasy MP to secure regulatory changes, including the recent cap on payday lenders. His book, Britain’s personal debt crisis: how we got here and what to do about it, which reviews the reliance of the British economy on credit extension and details fifteen years of campaigning activity, was published in July 2014 Searching Finance. Joachimiak, Walter M.A. works at the Federal Statistical Office of Germany (Destatis), currently in the position of assistant head of section “Statistics of Agreed Earnings, Quarterly Earnings Survey, Labour Cost Index, Over-Indebtedness”. Since 2014 he, along with others, has been responsible for the official Statistics of Over-Indebtedness. Before working at Destatis he studied sociology and political and economic sciences at the universities of Oldenburg and Mannheim. Katsas, Theodor G. is a qualified lawyer of the High Court, and was admitted to the Athens Bar in 1990; Dr. Jur. (Humboldt University of Berlin); Mediator (Tulane Law School, New Orleans/Institut für Anwaltschaftsrecht HU, Berlin), LL.M. (Humboldt University of Berlin); Lecturer in Commercial and Business Law at the Demokritus University Law School – Greece (2009 - to date).

xiii

List of Contributors

Kempson, Elaine is Professor of Personal Finance and Social Policy Research at the University of Bristol and an acknowledged expert on personal financial services. She has nearly thirty years of experience of policy development and research into over-indebtedness. The areas of her work that are well known internationally include consumer behaviour and the provision of financial services, consumer protection, financial capability and financial inclusion. Details of her research can be found here: . Elaine has held various appointments: she was the first independent reviewer of the UK Banking Codes in 2002 and was reappointed to undertake the 2004 review; she was also the first independent assessor of the work of the UK Financial Ombudsman Service in 2005; and the independent reviewer of Insolvency Practitioner fees in 2013. She is currently a member of the Consumer Advisory Group at the Central Bank of Ireland; the Money Advice Service Financial Capability Strategy Board; the advisory board for the Secretary of State for Work and Pensions on the expansion of credit unions in the UK and the Futures and Affordability Panels of Wessex Water. Previous public appointments include non-executive directorships of the UK Financial Ombudsman Service, Pensions Client Board and the UK Banking Codes Standards Board, and membership of the Department for Trade and Industry Over-indebtedness Advisory Group; Department for Work and Pensions (Social Security Advisory Committee); UK Treasury Financial Inclusion Taskforce. In 2007, she was awarded a CBE in the Queen’s Birthday Honours List for services to the Financial Services Industry. Livada, Christina studied law at the Law School of the National and Kapodistrian University of Athens, where she obtained her degree in Law, and at the University of Paris II (Panthéon-Assas), where she obtained a Diplôme des Etudes Approfondies (D.E.A.) in Private International Law and in International Commercial Law. She was awarded her PhD on “Codes of Conduct in the Financial Sector: Legal nature and function” from the Law School of the National and Kapodistrian University of Athens with a research scholarship of the Swiss Federal Institute of Comparative Law. Since January 2011 she has been Lecturer of Commercial Law at the Law School of the National University of Athens. She has several publications on issues of banking law, capital markets law, consumer protection law and commercial law. She is a member of scientific associations of commercial and financial law. She is Special Legal Advisor at the Hellenic Bank Association. In this capacity she has participated in law-making committees for the implementation of several Directives of the financial sector in Greek law. Mentis, Georgios is Professor of Civil Law at the Law School of the University of Athens. He teaches Contract Law, Property Law, Banking Law, Consumer Law and Environmental Law. He is also attorney at law before the Supreme Court. He has been a member of the Committee of the Ministry of Development for the reform of the rules of the unfair com-

xiv

List of Contributors

petition and of the law of agency. He has written a number of articles, comments on court decisions and studies on matters pertaining to his interests (unfair terms, product liability, etc.), and he has authored the book Unfair contract terms in consumer and business contracts. His last book was on Restschuldbefreiung (Debt discharge) according to Civil Law and Insolvency Law. Mouzouraki, Melina J. studied law at the National University of Athens, and European Law in Brussels at the Institut d’ Etudes Europeennes. She has been a qualified lawyer of the Bar of Athens since 1991, and she specialises in consumer protection law in financial services and civil law. A specific area of specialisation is that of consumer over-indebtedness in Europe and Greece. She has been a member of the National Consumer Council of Greece, and of the Hellenic Competition Committee as a representative of consumers’ interests. A former legal adviser of the Hellenic Consumers’ Association E.K.PI.ZO, Melina has been representing E.K.PI.ZO on several occasions, including the European Consumer Debt Net (ECDN). Rott, Peter is Professor of Civil Law, European Private Law and Consumer Law at the University of Kassel (Germany). Before joining the University of Kassel, he held posts at the Universities of Sheffield (UK), Bremen (Germany) and Copenhagen (Denmark). He has published widely in the area of European private law with a focus on consumer law in its broadest sense, including the core areas of contract and tort law, the law of financial services and enforcement issues. Among his main interests are the access of low-income consumers to services of general interest and the prevention of over-indebtedness. Peter works in a number of international research networks such as the Ius Commune project and the International Association of Consumer Law. He is lead editor of the German consumer law journal Verbraucher und Recht and a member of the editorial boards of the Journal of Consumer Policy and the European Journal of Consumer Law. Rowlingson, Karen is Professor of Social Policy and Director of Research and Knowledge Transfer for the College of Social Sciences at the University of Birmingham. The chapter in this book is based on work supported by the Arts and Humanities Research Council (AHRC), FinCris project [grant number AH/J001252/2]. Other publications from this work focus on payday lending, the variegation of consumer credit, and responsible borrowing. Sutschet, Holger is Professor of International Commercial Law, Labour Law and Comparative Law at the University of Applied Sciences Osnabrück. He studied law in Germany and holds a doctorate from the University of Trier, Germany, where he also did his habilitation. From 2007 to 2012 Professor Sutschet worked at Brunel University London. He

xv

List of Contributors

has written extensively in the field of private law, covering German, English and international law. Tribe, John is a Senior Lecturer in Law, School of Law and Social Justice, University of Liverpool, Liverpool (UK). John’s research interests are English and Welsh personal insolvency law and bankruptcy history. He has given evidence to the Scottish Parliament on bankruptcy reform and has undertaken commissioned research for, inter alia, the Insolvency Service, Grant Thornton and Baker Tilly. John is joint editor of Muir Hunter on Personal Insolvency, a contributing editor to Tolley’s Insolvency Law and a consulting editor of the Bankruptcy and Personal Insolvency Reports. Tsiafoutis, Victor is an attorney at the Court of Appeals and, since 2007, has been working as a legal adviser at the Consumers Association “Quality of Life” – EKPIZO. He has experience in consumer protection and financial law, and has represented EKPIZO in international and European conferences, and committees of the Greek Parliament. He has also been a member of legislatorial committees, such as the committees for the transportation of EU directives 2011/83/EU and 2014/17/EU. He has published several articles and studies in law journals and in the press, and has participated as a speaker at legal conferences and workshops. He is vice president of the Panhellenic Federation of Consumer Associations “The Intervention”, and alternate member of the board of the Consumer Protection Law Association. A graduate from the Faculty of Law of the University of Athens, he is a candidate for an LL.M in Competition and Consumer Protection Law. Vandone, Daniela is Professor of Banking and Finance at Università degli Studi di Milano. Her research interests are in applied economics, with a focus on financial regulation, consumer credit, households’ over-indebtedness and financial inclusion. During her professional career she has been involved in high-profile studies, evaluations and advisory activities for the European Commission (mainly DG Justice and Consumers) and other national and international institutions. She has published widely; her research papers have appeared, among others, in the Journal of Economic Psychology, Energy Policy, Quantitative Finance, International Review of Economics and Finance, Research in Economics, Journal of Psychophysiology. Wruuck, Patricia is Senior Economist at Deutsche Bank Research, focusing on European economic policy issues. She has published in the area of banking and financial markets as well as economic policy with a particular focus on Europe. Patricia studied at the Freie Universität Berlin (DE) and at Duke University (USA). She holds a doctoral degree from the University of Mannheim (DE). Her previous positions include working at the German Federal Chancellery, the University of Mannheim and Google.

xvi

1

Introduction: Setting the Scene

Federico Ferretti* The topic of this book is the over-indebtedness of consumers in the European Union (EU) from a multidisciplinary and multi-stakeholder perspective. With the recent unprecedented turmoil in financial markets and the long-lasting effects of the ensuing most severe economic crisis in the modern history of Europe, this has become a concern for both national and EU policymakers. Yet it is not an entirely new theme, and the possible role of the EU has already been discussed in both policy and academic circles for over twenty years.1 However, materially, little has been done so far at the EU level, but in the light of the gravity of the recession on consumers, the issue seems to have turned from urgency into emergency. The latest official figures are a few years old, and they indicate that over-indebtedness is a problem that concerns one in nine people across the EU2 and that it impacts harshly on the lives of those who are affected, carrying great social and economic costs for the EU as well as challenges for the integration of its markets. Few years on, anecdotal evidence suggests that these figures have certainly not improved. On the contrary, they may be even worse as the effects of the crisis persist and many Member States are still coping with profound economic, political and social repercussions. Moreover, with the austerity measures imposed by many Member States, non-performing loans and job losses have remained high with poor prospects of improvement. All in all, the harm caused by the financial crisis has raised important issues regarding the protection of consumers, the scope, intensity and effectiveness of regulation in financial

* 1

2

Senior Lecturer, Brunel University London. For example, see the writings over twenty years ago of Huls “Towards a European Approach to Overindebtedness of Consumers”, 16 Journal of Consumer Policy (1993), 215-234 and the early academic literature and reports that followed. Examples are Reifner, Kiesilainen, Huls, Springeneer, Consumer Overindebtedness and Consumer Law in the European Union, Final Report, Contract Ref. B5-1000/02/000353 (September 2003); Huls, Reifner and Bourgoinie, Overindebtedness of Consumers in the EC Member States: Facts and Search for Solutions (Kluwer, 1994). See also Group of Specialists on Seeking Legal Solutions to Debt Problems (Cj-S-Debt), Final Activity Report of the Group of Specialists for Legal Solutions to Debt Problems (CJ-S-DEBT), CJ-S-DEBT (2006) 6 Final (Strasbourg, 18 January 2007); OCR Macro, Study of the Problem of Consumer Indebtedness: Statistical Aspects, Report submitted to the Commission of the EU DG Health and Consumer Protection, Contract n. B5-1000/00/000197 (October 2001); OEE Etudes, Towards a Common European Operational Definition of Over-Indebtedness, report prepared for the use of the European Commission, Directorate-General for Employment, Social Affairs and Equal Opportunities (February 2008). Eurostat, “Over-indebtedness and financial exclusion statistics”, data from September 2012, available at .

1

Federico Ferretti

markets as well as the need for additional safeguards to alleviate the social problems that the crisis has exacerbated.3 At the same time, the topic of this book is a traditionally difficult one to analyse, especially if taken in its European context. Consumer over-indebtedness has often been associated with financial credits, whose cultural approach, use and extension have varied significantly from one Member State to the other. Yet the integration of EU consumer and mortgage credit markets is crucial for an efficient functioning of the EU financial system, the economy and the Internal Market. The market for loans available to consumers has grown rapidly across the EU, and it has become increasingly sophisticated. The liberalisation and expansion of credit markets alongside the increased availability of credit from financial institutions have explained the relatively recent mounting levels of consumer debt across societies. If more credit is available and offered to a broader base of consumers, more consumers become indebted and, consequently, a larger number of consumers become unable to meet the contracted obligations. On the other hand, credit availability and open access to credit markets have meant widening participation and financial inclusion to allow as many consumers as possible without discrimination to participate in the credit society and the consumption model of the market economy. These observations may also suggest why excessive lending or borrowing has long been the focus of consumers becoming overcommitted and unable to repay their debts, pushing the debate over behavioural issues of creditors or debtors. Irresponsible lending and predatory practices, on the one hand, and irresponsible borrowing decisions, consumption choices and cognitive biases, on the other hand, have so far dominated the attention of scholars and policymakers alike.4 The emphasis on behavioural causes has often resulted in the attribution of defaults to a responsibility of the creditor or a personal failure of the debtor. Therefore, alongside the advancement of measures for the removal of obstacles for further integration, the promotion of responsible lending to limit over-indebtedness has gained priority in the EU agenda as the core policy to address consumer over-indebtedness. It has introduced a new concept that makes reference to the delivery of responsible and reliable markets, where consumer confidence is restored and credit products are appropriate for consumers’ needs and tailored to their ability to repay. They envisage a framework that could ensure that all lenders and intermediaries act in a fair, honest and professional manner before, during and after the lending transaction. To obtain credit, consumers must provide relevant, complete and accurate information on their finances. They are encouraged

3 4

See, e.g., European Commission, Staff Working Paper on National Measures and Practices aimed at Avoiding Foreclosure Procedures for Residential Mortgage Loans, SEC(2011) 357 final. Ramsay, “Between Neo-Liberalism and the Social Market: Approaches to Debt Adjustment and Consumer Insolvency in the EU”, 35 Journal of Consumer Policy (2012), 421-441; Micklitz, “Access to, and Exclusion of, European Consumers from Financial Markets after the Global Financial Crisis”, in Wilson (ed.) International Responses to Issues of Credit and Over-indebtedness (Ashgate, 2013), 47-77.

2

1

Introduction: Setting the Scene

to make informed and sustainable borrowing decisions.5 The resulting legal instruments focus on the advertising and marketing of credit products, the information to be provided to borrowers before granting any loans, ways to assess product suitability and borrower creditworthiness, advice standards, responsible borrowing and issues relating to the framework for credit intermediaries (disclosures, registration, licensing and supervision).6 However, in so doing, over-indebtedness has been looked at in its static dimension. All definitions, conceptualisations and measurements make reference to the time when consumers apply for credit. This has been reflected in the policy and the law, which insist on the usual paradigm of information requirements and the assessment of creditworthiness at the time the loan is being made. Such measures may capture existing or likely debt problems if further credit is taken, but they cannot address the most frequent causes of consumer over-indebtedness, such as life-time events and poor market conditions, when repayment difficulties emerge at a later stage. Certainly, behavioural factors may have a role in consumers becoming over-indebted, but market deregulation, coupled with incomplete social safety nets, is often recognised as a structural condition that leads to an environment hospitable to financial difficulty.7 This consideration should be contextualised with the findings of recent studies on the nature and causes of over-indebtedness, which reveal empirically how this is not limited to the issue of debts stemming from financial credits but includes all consumer essential outgoings, and is tied to income and other expenditures relating to taxation and cuts in social welfare. Consumers are considered over-indebted if they are having – on an ongoing basis – difficulties meeting (or falling behind with) their commitments, whether these relate to servicing secured or unsecured borrowing or to payment of rent, utility or other household bills.8 The major causes of consumer over-indebtedness, which the literature had already acknowledged,9 have been confirmed to be external lifetime events such as illness or divorce, 5

6

7 8 9

See Communication of the European Commission to the European Council of 4 March 2009 ‘Driving European Recovery’, COM (2009) 114 and the Public Consultation on Responsible Lending and Borrowing in the EU, available at: . See Directive 2008/48/EC of the European Parliament and of the Council of 23 April 2008 on credit agreements for consumers and repealing Council Directive 87/102/EEC, L 133/66; Directive 2014/17/EU of the European Parliament and of the Council of 4 February 2014 on credit agreements for consumers relating to residential immovable property and amending Directives 2008/48/EC and 2013/36/EU and Regulation (EU) No 1093/2010, L 60/34. Braucher, “Theories of Overindebtedness: Interaction of Structure and Culture”, 7 Theoretical Inquiries in Law (2006), 323-346. Civic Consulting, The Over-Indebtedness of European Households: Updated Mapping of the Situation, Nature and Causes, Effects and Initiatives for Alleviating its Impact (Brussels, 2014). For example, see Ramsay, Consumer Law and Policy (Hart, 2007), pp. 578-580; Caplovitz, The Poor Pay More: Consumer Practices of Low Income Families (Free Press, 1963); Adler and Wozniak, “The Origins and Consequences of Default – An Examination of the Impact of Diligence”, Research Report n. 6, (Scottish Law

3

Federico Ferretti

or macroeconomic factors such as unemployment, declining wages or generally low income vis-à-vis the cost of living.10 The findings reveal that people who lose their jobs and incomes have a higher probability to default and become entrapped in unsustainable debt, as do people confronted with accidents of life no one can anticipate. Behavioural factors, such as poor financial choices, mismanagement of resources or irresponsible lending practices, seem to have a limited bearing. Yet a reading of the major causes behind problem debt could be a conjuncture of external events with behavioural factors, where consumers do not effectively adjust their budgets to the external changes.11 All considered, it becomes clear that the nature of the problem is rooted in a number of national soils that are beyond the remit or control of what the law can do, and that are far broader than the credit–debt relationship – for example, issues of political economy, taxation, labour markets, salary levels and cost of living, etc. These are very sensitive national political issues, and not much can be expected at the level of EU policies and law. Clearly, responsible lending policies and the resulting law appear inadequate to address the problem comprehensively and certainly do not offer debt solutions. Yet if the law cannot do much to solve the causes of the problem, it may nevertheless intervene to alleviate it in ways similar to the recovering of the economic value of businesses facing financial hardship or collapse. When natural persons are involved, however, this issue raises moral and political questions and resistance. Still, as over-indebtedness has increased with the crisis, in the last few years many Member States have moved towards national regimes for the protection of consumers in financial distress and the treatment of the insolvency of natural persons. However, these are individual but uncoordinated regimes or initiatives in the Member States that expose the absence of common, harmonised or appropriately resourced strategies at the EU level.12

Commission, 1980); Berthoud and Kempson, Credit and Debt: The PSI Report (PSI, 1992); Hoermann (ed.), Consumer Credit and Consumer Insolvency: Perspectives for Legal Policy from Europe and the USA (ZERP, 1986); Elliott, Not Waving but Drowning: Over-Indebtedness by Misjudgment (CSFI, 2005); Balmer, Pleasence, Buck, and Walker, “Worried Sick: the Experience of Debt Problems and their Relationship with Health, Illness and Disability”, 5(1) Social Policy and Society (2006), 39-51; Dominy and Kempson, Can’t Pay or Won’t Pay? A Review of Creditor and Debtor Approaches to the Non-Payment of Bills (DCA, 2003); Niemi, “Consumer Bankruptcy in Comparison: Do We Cure a Market Failure or a Social Problem?”, 37 Osgoode Hall Law Journal (1999), 473-503. 10 Civic Consulting, supra note 8. 11 For example, see Banque de France, Étude des Parcours Menant au Surendettement (September 2014). 12 See, e.g., London Economics, Study on means to protect consumers in financial difficulty: Personal bankruptcy, datio in solutum of mortgages, and restrictions on debt collection abusive practices, Final Report prepared for the Financial Services User Group, Contract No MARKT/2011/023/B2/ST/FC, (December 2012); Gerhardt “Consumer Bankruptcy Regimes in the US and Europe. Further effects and implications of the crisis” CEPS Working Document No. 318 (July 2009).

4

1

Introduction: Setting the Scene

As far as the EU is concerned, Council Regulation (EC) 1346/2000 and its Recast Regulation13 – which have been designed for the cognate area of corporate insolvency but that can have limited application for the insolvency of natural persons – attempt not to impose a common system at the EU level, but instead to ensure that insolvency proceedings opened in one Member State are recognised in all other Member States. The Council Regulation outlines that the domestic law of the country where the case is opened is applicable as long as the individual has established a ‘centre of main interest’ (COMI) in the relevant jurisdiction. Moreover, the Council Regulation’s rules have given rise to forum shopping also by natural persons through abusive COMI-relocation, i.e. the movement of assets from one country to another so as to take advantage of a more favourable legal position. The Recast Regulation is designed to improve the coordination of insolvency proceedings within the EU, ensure the equitable treatment of creditors and minimise ‘forum shopping’. They do not provide for substantive rules on insolvency proceedings. In any case, COMI provisions and the new rules of the Recast Regulation are capable of affecting a minority of skilled or well-informed consumers/small traders, but can hardly be applicable to the majority of people in financial distress, i.e. the vulnerable consumers. It is in this context and against this background that this book took shape as part of a broader research project funded by the Civil Justice Programme of the European Commission. If EU responsible lending alone does not appear suited to deal with the complex multidimensional problem of household over-indebtedness, to what extent would an integrated but reformed EU personal insolvency regime be necessary? This is the wider research question of the research project entitled ‘Consumer Over-indebtedness, Responsible Lending, and the Insolvency of Natural Persons: the Need for a Comprehensive Reform to Protect Consumers in Financial Difficulty’, led by Dr Ferretti (Brunel University London, UK) in partnership with Prof Salomone (University of Trento, Italy), Prof Sutschet (Osnabrück University of Applied Sciences, Germany) and Mr Tsiafoutis (Consumer Association EKPIZO, Greece). The research project is related to the EU priority that aims to promote the creation of a genuine European area of justice in the area of personal insolvency. As hinted, it aims to investigate the extent to which re-conceptualised and integrated responsible lending and personal insolvency regimes at the EU level may be necessary or desirable, where irresponsible lending and borrowing behaviours are punished but objective difficulties and good faith of over-indebted consumers find protection. The hypothesis is that a desirable legal regime should comprehensively address all the stages that lead to the

13 Council Regulation (EC) No 1346/2000 of 29 May 2000 on insolvency proceedings, OJ L 160 1-18; regulation (EU) 2015/848 of the European Parliament and of the council of 20 May 2015 on Insolvency Proceedings (Recast), OJ L 141 19-72.

5

Federico Ferretti

financial difficulty of consumers from prevention to cure, and it should recognise that the financial distress of natural persons is intertwined with social, political and cultural issues. This collection of edited multidisciplinary essays from academics and a variety of stakeholders originates from expert workshops that the research team has organised in four selected Member States: the UK, Germany, Greece and Italy. They are a selection of papers emanating from a range of presentations delivered by recognised national academic and non-academic experts representing a diversity of interests involved in the issues surrounding over-indebtedness. These experts were invited to discuss national perspectives from different disciplines and interest groups, and to exchange knowledge with the research team – consumer organisations, practitioners, academics, advisors, industry representatives and local agencies. The workshops held in the UK, Germany, Greece and Italy also offered the opportunity to draw comparisons of the social, economic and regulatory frameworks of over-indebtedness; responsible lending and borrowing; and personal insolvency regimes and understand the difficulties behind a prospective EU intervention in the area and its form. These jurisdictions have been chosen to offer samples of diversity in terms of economic and legal tradition, culture, historical and current attitude towards personal debt, and the scale of pre-crisis household indebtedness.14 They also offer an interesting comparative view from the perspective of the impact of the current economic crisis and its effect on the levels of over-indebtedness, since they are at extreme ends of the spectrum. According to the latest findings, each jurisdiction belongs to a different grouping/cluster of countries classified as ‘very high’ (Greece), ‘high’ (Italy), ‘moderate’ (UK) or ‘low’ (Germany) in terms of frequency of household arrears and percentage of total population with arrears on key commitments.15 The selection of countries that are mature in their membership of the EU is intended to avoid issues of financial sectors typical of the new Member States that have been through structural changes in a relatively short period and, consequently, have common structural characteristics that may have exacerbated the effects of the financial turmoil or have impacted differently on the causes of over-indebtedness (e.g. borrowing in foreign currencies, heavy reliance on influx of foreign capital, transition to

14 On the different legal traditions and cultural issues of personal debts see, e.g., Gelpi and Julien-Labruyère, The History of Consumer Credit (Basingstoke, Macmillan Press, 2000); Graeber, Debt – The First 5,000 years (Melville House, 2011); La Porta; Lopez-de-Silanes, Shleifer, and Vishny, “Law and Finance”, 106(6) The Journal of Political Economy (1998), 1113-1155; Beck, Demirgüç-Kunt and Levine, “Law and Finance: Why Does Legal Origin Matter?”, 31(4) Journal of Comparative Economics (2003), 653-675. On the statistics on level of personal indebtedness see OECD, “Household Debt”, in OECD Factbook 2014: Economic, Environmental and Social Statistics (OECD Publishing, 2014). ; See also Eurostat, supra note 2. 15 Civic Consulting, supra note 8; See also the data in Bouyon and Boeri, ECRI Statistical Package (ECRI, 2014).

6

1

Introduction: Setting the Scene

market economy and sudden growth in house prices with ensuing severe negative equities, etc.).16 The research team is indebted to all those experts who held presentations or participated as discussants. In particular, in the UK it is grateful to Professor Peter Cartwright (University of Nottingham), Professor Elaine Kempson (University of Bristol), Professor Robin Jarvis (Brunel University London and ACCA), Dr Joseph Spooner (London School of Economics and Political Sciences), Ms Joanna Elson (Money Advice Trust), Ms Gillian Key-Vice (Arrow Global and GVK Limited), Ms Sue Lewis (Consumer Panel UK), Mr Mick McAteer (The Financial Inclusion Centre), Ms Sarah Beddows, Mr Peter Tutton (Step Change). In Germany, many thanks go to Professor Heinz Vallender (University of Cologne), Professor Peter Rott (University of Kassel), Ms Patricia Wruuck (Deutsche Bank, Research), Mr Walter Joachimiak (Statistisches Bundesamt), Mr Christoph Zerhusen (Verbraucherzentrale), Mushtaq Ahmad (Deutsche Bank, Credit Risk Management), Michael Bretz (Creditreform), Eva-Maria Trube (Diakonie); Professor Antonio Miras (University of Applied Sciences Osnabrück). In Greece, the team’s appreciation is for Professor Giorgos Mentis (University of Athens), Ms Despoina Prassa (Bank of Greece), Ms Melina Mouzouraki (Practitioner and Member of European Consumer Debt Network), Professor Christina Livada (University of Athens and Legal Advisor in Hellenic Bank Association), Ms Olympia Linardatou (Legal Advisor in EKPIZO), Professor Theodoros Katsas (Democritus University of Thrace), Ms Celia Tsekeri (Lawyer, Vice President of Panhellenic Federation of Consumer Associations ‘Paremvasi’). Finally, in Italy the expertise of the following experts is deeply valued: Professor Luisa Anderloni and Professor Daniela Vandone (State University of Milan), Professor Diana Cerini (University of Milan Bicocca), Professor Stefano Cosma (University of Modena and Reggio Emilia), Dr Guido Comparato (European University Institute), Dr Carlo Biasior (Center for Research and Protection of Consumers), Mr Alessio Bertocco and Mr Marco Pasini (UNIREC), Mr Enrico Lodi, Ms Luisa Monti, and Ms Claudia Pollio (Centrale Rischi Finanziari), and Ms Fabrizia Giacomini (Experian). The book is structured in five parts. Part I comprises a chapter on the EU dimension. It sets the scene and explores the state of the art of EU policies and law to address consumer over-indebtedness (Ferretti and Livada).

16 For example, see European Central Bank, Banking Structures in the New EU Member States (January 2005), at ; Farkas, “The Impact of the Global Economic Crisis in the Old and New Cohesion Member States of the European Union”, 57(1) Public Finance Quarterly (2012), 53-70; Koyama, “Economic Crisis in New EU Member States in Central and Eastern Europe: Focusing on Baltic States”, 5(3) Romanian Economic and Business Review (2010), 3155.

7

Federico Ferretti

It is followed by four parts, each focusing on the studied Member States and presented in the book in the chronological order of the workshops held throughout the project. Part II covers the UK, with contributions from the perspective of debt advisors (Elson), the impact of the crisis on household over-indebtedness (Kempson), the debt crisis and the function of responsible credit (Gibbons), the role of the State in responsible lending and how it has been regulated over the last decade along with evidence of irresponsible behaviour (Rowlingson, Gardner and Appleyard), and the structure of English and Welsh personal insolvency solutions and the problems that they create for consumer protection (Tribe). Part III explores consumer over-indebtedness in Germany. It includes contributions on the statistics and analysis of over-indebtedness in the country and the role played by the Federal Statistical Office (Joachimiak), followed by an economic discussion of the micro and macro dimensions of over-indebtedness from a lender’s perspective (Wruuck). An analysis of the law and policy in relation to prevention of over-indebtedness (Rott) and the German legal framework (Sutschet) provides the juridical picture. Part IV is focused on Greece. Essays range from a discussion of the dimension of crisis and a general presentation of the response of the law (Mentis) to the role of debt advice and consumer organisations in the Greek personal debt crisis (Mouzouraki), a detailed account of the regulatory framework of responsible lending as a preventive tool of overindebtedness (Livada), the recent amendments introduced in personal insolvency legislation (Katsas) and the sensitive issue in Greece of the protection of the principal residence of consumers (Tsiafoutis). Finally, Part V analyses the situation in Italy from multiple perspectives. Contributions include the dimension of over-indebtedness in Italy and the characteristics of the overindebted households (Anderloni and Vandone), the evolution of the household credit market and changes in the structure of the supply side in order to highlight the way in which these changes have improved the quality and efficiency of the credit provided (Cosma), the powers and the duties of consumer associations in Italy, including case studies and proposed solutions for preventing and repairing over-indebtedness (Biasior), an analysis of the peculiar approach taken by the Italian legal system and the interface with credit contracts (Cerini), and non-contract legal tools against over-indebtedness in the debt discharge discipline introduced by the new consumer insolvency law, addressing in the end the residual issues of debt advice and financial education (Comparato). Grant Agreement JUST/2013/JCIV/AG/4620 under the Civil Justice Programme of the European Commission.

8

Part I The EU Framework

2

The Over-Indebtedness of European Consumers under EU Policy and Law

Federico Ferretti* and Christina Livada**

2.1

Introduction and Background: EU Consumer Over-Indebtedness

For quite some time over-indebtedness has been perceived as a national problem to be addressed by the Member States. By the late 1980s there were already a number of national initiatives introducing personal bankruptcy or debt counselling services to seek solutions to household debt problems. They represented the response to the consequences of the rapid increase in the volume and variety of credit services in some Member States, especially in northern Europe. Such a variety of retail credit markets with different degrees of openness reflected a significant gap in the culture, tradition, use and pattern of consumer borrowing across the then European Community. The diversity started to narrow only with the 1993 Maastricht Treaty and the establishment of the single market, alongside the liberalisation and opening up of national credit markets for consumers.1 Contextually, EU policymakers too started to show an interest in consumer overindebtedness as a side effect of the common market. Reports commissioned by the European Commission and some literature have followed suit, recommending national actions and pointing towards the adoption of common principles for a European approach to the overindebtedness of consumers. Such scholarship is often directed towards debt restructuring or consumer insolvency regimes to capture common traits or trends towards possible convergence.2 * Senior Lecturer, Brunel University London. ** Lecturer, Law School, National and Kapodistrian University of Athens and Special Legal Advisor in the Hellenic Bank Association. 1 For example, see the early initiatives in Britain, France, Germany, Denmark and The Netherlands. See Kilborn, “Two Decades, Three Key Questions, and Evolving Answers in European Consumer Insolvency Law: Responsibility, Discretion and Sacrifice”, in Niemi, Ramsay and Whitford (eds.), Consumer Credit, Debt and Bankruptcy: Comparative and International Perspectives (Hart, 2009), 307-330; Huls, “Towards a European Approach to Overindebtedness of Consumers”, 16 Journal of Consumer Policy (1993), 215-234; Reifner, Kiesilainen, Huls and Springeneer, Consumer Overindebtedness and Consumer Law in the European Union, Final Report, Contract Ref. B5-1000/02/000353 (September 2003); Ramsay, “Between Neo-Liberalism and the Social Market: Approaches to Debt Adjustment and Consumer Insolvency in the EU”, 35 Journal of Consumer Policy (2012), 421-441. 2 For all see Kilborn, Expert Recommendations and the Evolution of European Best Practices for the Treatment of Overindebtedness, 1984-2010 (21 August 2010), available at SSRN: or .

11

Federico Ferretti and Christina Livada

According to internationally set principles, policy and legal interventions aiming at tackling over-indebtedness consist essentially of two main pillars: a. a first pillar with measures for the prevention of over-indebtedness; the legislative implementation of the broadly formulated principle of responsible lending is one of the main measures taken in this respect; and b. a second pillar with measures taken to address over-indebtedness ex post, i.e. the insolvency of the debtor/natural person and his reintegration into the economic and social life.3 However, in line with the efforts to achieve a single market in credit for consumers, the EU policy response to over-indebtedness has been aimed at preventively delivering a credit market that is ‘responsible’. The main objectives of EU measures to achieve a common market are directed towards the creation of a regime that encourages vigorous competition, innovation and choice within a trusty framework that rejects unfair and irresponsible practices. The focal drive is the economic one of enabling consumers and businesses to take full advantage of the single market.4 Even in the aftermath of the latest economic crisis the European Commission has stressed the need for Member States to introduce “measures to prevent over-indebtedness and maintain access to financial services”5 (emphasis added). But the declared goal is to deliver “responsible and reliable financial markets for the future”, announcing that “to ensure that European investors, consumers and SMEs can be confident about their savings, access to credit and their rights as concerns financial products, the Commission will come forward with (…) measures on responsible lending and borrowing”6 (emphasis added). It appears evident how the creation of trust in the market is essential and how to some extent the goal of prevention of over-indebtedness has remained blurred in the quest for the promotion of the internal market. Over-indebtedness becomes incorporated in the rhetoric of ‘responsible lending and borrowing’ as an introduction of best market practices

3

4

5 6

The World Bank, Responsible Lending – Overview of Regulatory Tools (October 2013); Consumers International, Responsible Lending: An International Landscape (November 2013); OECD, G-20, High-Level Principles on Financial Consumer Protection (October 2011); Financial Stability Board, Principles for Sound Residential Mortgage Underwriting Practices (April 2012); G20/OECD Task Force on Financial Consumer Protection, Effective Approaches to Support the Implementation of the Remaining G20/OECD High-Level Principles on Financial Consumer Protection (September 2014); FinCoNet, FinCoNet Report on Responsible Lending – Review of Supervisory Tools for Suitable Consumer Lending Practices (July 2014); International Monetary Fund, Dealing with Household Debt (World Economic Outlook, 2012). See, e.g., European Commission, Discussion Paper for the Amendment of Directive 87/102/EEC Concerning Consumer Credit (2001); see also the Recitals of the Consumer Credit Directive, infra note 17 and the Mortgage Credit Directive, infra note 18. European Commission, Communication for the Spring European Council, Driving European Recovery, COM(2009) 114 final, 4 and 7. Ibid., 7.

12

2

The Over-Indebtedness of European Consumers under EU Policy and Law

to be achieved by means of the regulatory public intervention on the behaviour of the contracting parties of credit agreements. Responsible lending refers to the delivery of responsible and reliable markets, where consumer confidence is restored and credit products are appropriate to consumers’ needs and tailored to their ability to repay their debts. It envisages a framework that should ensure that all lenders and intermediaries act in a fair, honest and professional manner before, during and after the lending transaction. Similarly, for responsible borrowing, consumers are expected to provide relevant, complete and accurate information on their finances in order to obtain credit. They are also encouraged to make informed and sustainable borrowing decisions.7 The policy documents specifically target measures to adequately assess, by all appropriate means, borrowers’ creditworthiness before granting them a loan, thus attempting to tackle over-indebtedness. The focus is on the advertising and marketing of credit products, the information to be provided to borrowers before granting any loans, ways to assess product suitability and borrower creditworthiness, advice standards, responsible borrowing and issues relating to the framework for credit intermediaries (for example, disclosures, registration, licensing and supervision).8 Intuitively, it may not be readily understood why such an obligation needs to be imposed on party autonomy for what already appears to be in their self-interest: prima facie, lenders have no self-interest in giving credit irresponsibly, i.e. lending money that will be unlikely to be repaid to them. Moreover, the economic literature has long explained that the credit industry is traditionally risk-averse.9 Likewise, with the exclusion of the disproportionally fewer cases of fraud, it may be unclear why someone would borrow money despite knowing that he or she cannot repay it, with all the harsh consequences that follow from non-payment. Yet financial markets have demonstrated distortions in such basic principles. Recent experience has shown how lenders have devised instruments to pass on the risk of default to third parties, ultimately creating dangerous financial products, discouraging the former from acting responsibly towards their original interest.10 Also, in a very competitive market 7

See Communication of the European Commission to the European Council of 4 March 2009 Driving European Recovery, COM (2009) 114 and the Public Consultation on Responsible Lending and Borrowing, available at . 8 Ibid. 9 For example, see Stiglitz and Weiss, “Credit Rationing in Markets with Imperfect Information”, 71(3) American Economic Review (1981), 393-410; Akelof, “The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism”, 28(3) Quarterly Journal of Economics (1970), 523-547; Diamond, “Monitoring and Reputation: the Choice between Bank Loans and Directly Placed Debt”, 99(4) Journal of Political Economy (1991), 689-721; Admati and Pfleiderer, “Forcing Firms to Talk: Financial Disclosure Regulation and Externalities”, 13 Review of Financial Studies (2000), 479-519. 10 See, e.g., Engel and McCoy, The Subprime Virus (OUP, 2011).

13

Federico Ferretti and Christina Livada

the costs of properly assessing the risks of default through individualised controls – coupled with the pressure to gain market share and acquire new customers through a speedy approval of credit applications – may encourage financial institutions to budget the losses of defaults in the cost of credit. Likewise, false economic assumptions of the ever rising value of collateral such as property may induce lenders to exceed limits. Again, sale structures via intermediaries who earn their fees through commissions incentivise the latter to conclude as many credit agreements as they can.11 These behaviours are driven by competition, and, in a way, fuel the debate over the extent to which competition and consumer protection in the financial marketplace are compatible. This exceeds the purpose of this chapter, but it shows how competition, alongside ‘predatory’ yet not ‘fraudulent’ business models taking advantage of indebted consumers,12 may provide market failures of ‘irresponsible’ behaviour that need correction. By the same token, behavioural economics has demonstrated that borrowers are not rational maximisers of their resources and that they may well take wrong borrowing decisions or have decisional biases even if they are provided with adequate information.13 The above are market failures that may justify the intervention of public measures of responsible credit. The restoration of a contractual balance between the parties to a credit agreement, redistributive justice and paternalism may be additional rationales. Others have identified a further justification in a broader public function of regulation to prevent citizens from falling below a minimum welfare level within a healthy free market economy, thus protecting social welfare.14 But the question remains as to how ‘responsible lending and borrowing’ are translated into law and tackle over-indebtedness. Similarly, once introduced as legal measures, the extent to which they alone are sufficient to stem the problem remains to be ascertained.

11 Europe Economics, Study on Credit Intermediaries in the Internal Market, MARKT/2007/14/H (Brussels, 15 January 2009), available at . 12 See, e.g., the sweatbox business model of credit cards or payday lending. Mann, “Bankruptcy Reform and the ‘Sweatbox’ of Credit Card Debt”, 1 University of Illinois Law Review (2007), 375-403; Pottow, “Private Liability for Reckless Consumer Lending”, 1 University of Illinois Law Review (2007), 405-465; McAteer and Beddows, Fixing a Broken Market (Report for Association of Chartered Certified Accountants, 2014). 13 Sustain, “Boundedly Rational Borrowing”, 73 University of Chicago Law Review (2006), 249-270; Ramsay, “From Truth in Lending to Responsible Lending”, in Howells, Janssen and Schulze (eds.), Information Rights and Obligations (Ashgate, 2005), 47-65; Howells, “The Potential and Limits of Consumer Empowerment by Information”, 32 Journal of Law and Society (2005), 349-370. 14 Atamer, “Duty of Responsible Lending: Should the European Union Take Action?”, in Grundmann and Atamer (eds.), Financial Services, Financial Crisis and General European Contract Law (Kluwer, 2011), 179202; Posner, “Contract Law in the Welfare State: a Defense of the Unconscionability Doctrine, Usury Laws, and Related Limitations on the Freedom to Contract”, 24 Journal of Legal Studies (1995), 283-319.

14

2

2.2

The Over-Indebtedness of European Consumers under EU Policy and Law

The Establishment of Responsible Lending in EU Law

The responsible lending principle as it currently stands in EU law consists mainly of the legislative requirement for the creditor to assess the creditworthiness of the consumer and to confirm that the latter will be able to repay his credit.15 However, laying down the exact content of this principle is quite complex, particularly at the European level, for two reasons: the first is that it is directly linked to the market characteristics and specific conditions prevailing in each Member State, which may differ substantively; the second reason is that it is very difficult to achieve consensus at a political level regarding the extent of regulatory intervention. Although the study of over-indebtedness and the examination of possible initiatives at the European level to tackle the phenomenon had started quite early,16 the establishment of the legislative requirement to assess the consumer’s creditworthiness, which is a fundamental element of the responsible lending principle, took place only recently. In particular, it was adopted for the first time with Directive 2008/48/EC on credit agreements for consumers,17 and later with Directive 2014/17/EU on credit agreements for consumers relating to residential immovable property.18

2.2.1

The Emphasis on the Responsible Creditor

The principle of responsible lending is not limited to the creditworthiness assessment requirement. It also includes – indirectly in the Consumer Credit Directive and directly in the Mortgage Credit Directive – an approach of strong intervention with regard to the conclusion of the credit agreement, focusing on the responsible creditor. In particular, the approach of the Crowther Report of 1971, on which the British legislation for consumer credit, was based seems to have been abandoned at the European level. According to this Report, “the first principle of social policy should be to treat the users of consumer credit as adults who are fully capable of managing their own financial affairs and not to restrict their freedom of access to it in order to protect the relatively small

15 The obligation to confirm the capability of the consumer to repay his credit is expressly provided for only in Directive 2014/17/EU and not in Directive 2008/48/EC on consumer credit. 16 See in detail Λιβαδά, Το νέο ευρωπαϊκό ρυθμιστικό πλαίσιο για την καταναλωτική πίστη (Νομική Βιβλιοθήκη, 2008), 319. 17 Directive 2008/48/EC of the European Parliament and of the Council of 23 April 2008 on credit agreements for consumers and repealing Council Directive 87/102/EEC, OJ L 133/66. 18 Directive 2014/17/EU of the European Parliament and of the Council of 4 February 2014 on credit agreements for consumers relating to residential immovable property and amending Directives 2008/48/EC and 2013/36/EU and Regulation (EU) No 1093/2010, OJ L 60/34.

15

Federico Ferretti and Christina Livada minority who get into difficulties.”19 Instead, the assumption made at present has the vulnerable consumer as a point of reference, who – even when he receives sufficient information – is not able to either manage efficiently the risks he takes or to calculate appropriately his economic capabilities. Thus, he is in need of increased protection.20 At the same time, it is accepted that the credit risk to which the creditor is exposed may – under normal circumstances – be manageable and controllable, owing to sufficient diversification of his portfolio or to his ability to ensure his profitability in alternative ways. Moreover, a creditor’s aggressive commercial policy or the conditions of competition prevailing in the market may result in a lack of sufficient incentive not to grant credit to persons with a high risk of over-indebtedness.21 The crucial question arising in this case is whether the creditor, even when he himself is not at risk, should not grant credit to a consumer because of the risk of over-indebtedness for the latter and, in any case, whether the creditor is obliged to take certain preventive measures in this respect, and, if so, to what extent. On the other hand, risk-management processes have proved inadequate in certain cases. For example, in mortgage credit this inadequacy may be attributed to certain credit institutions’ tendency to rely on the value of the residential immovable property, to the possibilities of credit default transfer through securitisation or factoring as well as to conflicts of interest created, especially in the past, from compensation policies encouraging the granting of credit irrespective of the bad debts created.22 In this framework, the European Commission considers that linking the creditworthiness assessment with the granting of credit, and establishing the requirement for the creditor to grant credit only if the result of the creditworthiness assessment indicates that the obligations resulting from the credit agreement are likely to be met, will contribute to

19 Fairweather, “The Development of Responsible Lending in the UK Consumer Credit Regime”, in Devenney and Kenny (eds.) Consumer Credit, Debt and Investment in Europe (CUP, 2012), 84-110, at 86. 20 Garcia Porras and Van Boom, “Information Disclosure in the EU Consumer Credit Directive: Opportunities and Limitations”, in Devenney and Kenny (eds.), supra note 19, 21-55; Fairweather, supra note 19, 89-90; Nield, “Mortgage Finance: Who’s Responsible?”, in Devenney and Kenny (eds.), supra note 19, 160-181, at 168-169. 21 Ibid. 22 See Commission Staff Working Paper, Impact Assessment, Accompanying Document to the Proposal for a Directive of the European Parliament and of the Council on Credit Agreements Relating to Residential Property (SEC 2011, 356), Vol. I, 15 and Vol. II, 203. See also Financial Services Authority, Mortgage Market Review: Responsible Lending (2010), 10/16, Annex 1, Part 1, at 1, 5-11. It is worth noting that remuneration policies were among the first fields in which ‘corrective’ measures were taken immediately after the outbreak of the crisis, both at the international and at the European level. See as a mere indication Financial Stability Board, Principles for Sound Compensation Practices (April 2009) available at and Financial Stability Board, Principles for Sound Compensation Practices. Implementation Standards, (September 2009), available at .

16

2

The Over-Indebtedness of European Consumers under EU Policy and Law

the promotion of financial stability. Thus it will be ensured that creditors shall act responsibly and make sound decisions concerning the granting of mortgage credit.23 As a result, according to the European legislation, the framework of responsible lending is creditor-centred, as it is the creditor who must assess the creditworthiness of the consumer and make use of its results in the best way possible with regard to the decision to grant credit or not.

2.2.2

The Content of the Obligation to Assess the Creditworthiness of the Consumer

The assessment of creditworthiness is to take place both before the conclusion of the credit agreement and before any significant increase in the total amount of credit after the conclusion of the credit agreement.24 The main pillars of the obligation of assessment are, in both cases, pursuant to Directive 2008/48/EC and Directive 2014/17/EU25: – sufficient information obtained from the consumer either by the creditor or by the credit intermediary, if the latter intervenes for the conclusion of the credit agreement and – consultation of the relevant database.26 However, the provisions of the above two legal acts concerning the obligation of responsible lending differ substantively; the relevant provisions of Directive 2008/48/EC are quite laconic and consequently general,27 while those of Directive 2014/17/EU are, clearly, much more detailed. In particular, Article 8 of Directive 2008/48/EC provides for the obligation of the creditor to assess the consumer’s creditworthiness before the conclusion of the credit agreement “on the basis of sufficient information, where appropriate obtained from the consumer and, where necessary, on the basis of a consultation of the relevant database”.28 However, in this provision neither the content of the information to be obtained from the

23 See Commission Staff Working Paper (2011), supra note 22, Vol. I, 21 and Vol. II, 220. 24 See Directive 2008/48/EC, Art. 8 and Directive 2014/17/EU, Art. 18 paras. 1, 6, respectively. For the difference between the assessment of creditworthiness and of affordability, see in detail Fairweather, supra note 19, 93-99. 25 See Λιβαδά, «Η εξέλιξη της αρχής «του υπεύθυνου δανεισμού» στο ενωσιακό δίκαιο με έμφαση στις ρυθμίσεις της υπό υιοθέτηση πρότασης Οδηγίας για τις συμβάσεις πίστωσης σε ακίνητα κατοικίας», 2 Χρηματοπιστωτικό Δίκαιο (2012), 205. 26 See Καραγιάννης, «Προσέγγιση μιας περίπτωσης ανεπίτρεπτης σύνδεσης δεδομένων προσωπικού χαρακτήρα με την αξιολόγηση της πιστοληπτικής ικανότητας», 3 Χρηματοπιστωτικό Δίκαιο (2010), 311. 27 See Fairweather, supra note 19, 94. 28 Directive 2008/48/EC, Art. 8 para. 1.

17

Federico Ferretti and Christina Livada

consumer in order for the creditor to be able to assess his creditworthiness nor any restrictions of the creditor for the granting of credit in case of negative assessment are determined; on the contrary, in the respective provisions of Directive 2014/17/EU the above issues are specifically addressed.29 Pursuant to Article 18 of the Directive 2014/17/EU, the creditor shall make a thorough assessment of the consumer’s creditworthiness, taking appropriate account of factors relevant to verifying the prospect of the consumer to meet his obligations under the credit agreement.30 According to the guidance given in the Directive to the creditor, Member States shall ensure that: i. the procedures and information on which the assessment is based are established, documented and maintained and ii. the assessment of creditworthiness shall not rely predominantly on the value of the residential immovable property exceeding the amount of the credit or the assumption that the residential immovable property will increase in value unless the purpose of the credit agreement is to construct or renovate the residential immovable property.31 The purpose of this provision is to ensure that the creditor does not rely solely on the value of the immovable property given as collateral for the credit, if the consumer does not possess any other means sufficient for the repayment of his loan.32 Furthermore, according to paragraph 5 of Article 18, the creditor makes the credit available to the consumer only where the result of the creditworthiness assessment indicates that the obligations resulting from the credit agreement are likely to be met in the manner 29 In particular, the question arising thereof is whether in case of negative creditworthiness assessment, the creditor should or could grant the credit or not. Both approaches have been supported by scholars. See, indicatively, Λιβαδά, supra note 16, 325 and Μεντή, Άμυνα & ελευθέρωση του υπερχρεωμένου οφειλέτη (Δίκαιοb και Οικονομία 2012), 33 in favour of the view according to which the creditor should not grant the credit in such a case, as well as Περάκη, «Ηαρχήτου «υπεύθυνου δανεισμού» και η πρόσφατη κοινοτική Οδηγία για την καταναλωτική πίστη», 3 Χρηματοπιστωτικό Δίκαιο (2009), 357-358; Τασίκα, «Η υποχρέωση του πιστωτικού φορέα για αξιολόγηση της πιστοληπτικής ικανότητας του καταναλωτή στην παροχή καταναλωτικής πίστης», Νομικό Βήμα (2011), 2293, 2299; Πελλένη-Παπαγεωργίου, Ζητήματα από τις νέες ρυθμίσεις για τις συμβάσεις καταναλωτικής πίστης (Εκδόσεις Αντ. Ν. Σάκκουλα 2012), 221-223 in favour of the view according to which the creditor remains free to provide the credit; he could warn the consumer on his low creditworthiness, but this does not mean that he should abstain from the granting of credit. 30 Directive 2014/17/EU, Art. 18 para. 1 and recital 55 according to which: “In particular, the consumer’s ability to service and fully repay the credit should include consideration of future payments or payment increases needed due to negative amortisation or deferred payments of principal or interest and should be considered in the light of other regular expenditure, debts and other financial commitments as well as income, savings and assets. Reasonable allowance should be made for future events during the term of the proposed credit agreement such as a reduction in income where the credit term lasts into retirement or, where applicable, an increase in the borrowing rate or negative change in the exchange rate.” For the initial drafting of the relevant provisions of the proposal for a directive, see Λιβαδά, supra note 25, 207 and FinCoNet, supra note 3, 60-71. 31 Directive 2014/17/EU, Art. 18 paras. 2-3. 32 Directive 2014/17/EU, recital 55. See also Fairweather, supra note 19, 91-92; Nield, supra note 20, 173.

18

2

The Over-Indebtedness of European Consumers under EU Policy and Law

required under that agreement.33 Therefore, if the outcome of the assessment is negative, indicating that the consumer is not likely to be able to repay his loan, the creditor should not – pursuant to this provision – grant the credit.34 Moreover, should the case arise, the creditor must also be able to invoke the specific indications he took into account for the assessment of the consumer’s ability to repay the loan.35 Clearly, the will of the European legislator is to impose a duty to deny credit in such a case and to intervene in the freedom of the contractual parties, who could have wished to proceed to the conclusion of the credit agreement despite the negative assessment.36 The establishment of such an obligation does not mean, on a reversed reading, that a positive creditworthiness assessment obliges the creditor to provide the credit. This is expressly provided for in the relevant recital of the Directive.37 The same conclusion would be drawn even without any relevant reference as the imposition of such an obligation, which would also constitute an intervention in the general principle of the freedom of contracts, presupposes an express legislative provision justified by reasons of superior public interest.38 Thus, it is the creditor who makes the final decision to grant credit considering, among others, his business policy, his prospects, the market and economy conditions and his overall strategy.

2.2.3

The Guidelines of the European Banking Authority

To ensure that the above-mentioned provisions of Directive 2014/17/EU on responsible lending are implemented and supervised consistently across the EU Member States, the European Banking Authority (EBA) has issued guidelines on the way in which the creditworthiness assessment should be conducted. These guidelines enter into effect in March 2016, with the exception of the information requirements, which apply from the first day following the date of publication in the official languages of the Member States.39 33 See also Directive 2014/17/EU, recital 57. 34 An obligation to deny credit already exists under the Swiss law for consumer credit since 2003 (Loi sur le crédit à la consommation), even if not directly, but by combining the relevant provisions (Arts. 28-32). Moreover, heavy sanctions are imposed in case of substantive infringement of the said obligation (see Stauder and Favre-Bule, Droit de la consommation. Loi sur les voyages à forfait, Code des obligations, articles 40a-40f CO. Loi sur le crédit à la consommation. Commentaire (Helbing Lichtenhahn, 2004), 188). 35 See also Περάκη, supra note 29, 356-357. 36 Ibid., 357. 37 Directive 2014/17/EU, recital 57. 38 For the prevailing opinion in theory that the start of negotiations does not in any way create an obligation to conclude the agreement, see Γεωργιάδη, Γενικές Αρχές (Εκδόσεις Αντ. Ν. Σάκκουλα, 1997), 378; Ρόκα and Γκόρτσου, Στοιχεία ΤραπεΦικού Δικαίου. Δημόσιο § Ιδιωτικό ΤραπεΦικό Δίκαιο (Νομική Βιβλιοθήκη, 2012), 227, 233-234. 39 European Banking Authority, Final Report. Guidelines on creditworthiness assessment (EBA/GL/2015/11). The guidelines of ΕΒΑ are governed, under Art. 16 of its founding Regulation 1093/2010 by the principle “comply or explain” for its member supervisory authorities.

19

Federico Ferretti and Christina Livada

By way of indication, according to EBA’s guidelines, the creditor – when verifying a consumer’s prospect to meet his obligations under the credit agreement as referred to in Article 18 of Directive 2014/17/EU – “should make reasonable enquiries and take reasonable steps to verify the consumer’s underlying income capacity, the consumer’s income history and any variability over time. In the case of consumers that are self-employed or have seasonal or other irregular income, the creditor should make reasonable enquiries and take reasonable steps to verify information that is related to the consumer’s ability to meet his/her obligations under the credit agreement, including profit capacity and third-party verification documenting such income”.40 However, there is no guidance, for example, as to whether the income includes only the net individual income and/or the family income, the period of time for which data should be gathered – particularly in the case of consumers with variable income depending on various parameters such as the profitability of the enterprise where they are employed or the market conditions – and what applies for the calculation of the income in the case of consumers who will retire within the duration of the credit agreement and whose income will thus be reduced.41 The precise determination of several of those elements that should be checked by the creditor is objectively quite difficult, since their configuration depends on many different factors varying per category of borrower and the market of each Member State.42 Moreover, taking into account the long average duration of home loans,43 the assessment process is quite complex and cannot but end up in assumptions and indications. This is exactly why in Article 18, paragraph 5 of the Directive, reference is made to the terms “likely to be met”, as it is impossible to have certainty, particularly in periods of financial instability or crisis.

2.2.4

Measures Aiming at the Creation of the Responsible Borrower

As already mentioned, according to the European legislation in force, responsible lending focuses on the obligations of the creditor, who carries the main responsibility to assess the creditworthiness and ensure that the borrower will be in a position to repay the credit provided to him. In this framework, Directive 2008/48/EC does not establish any obligation 40 Ibid. under 1.1-1.2, 10. 41 For example, see the guidelines of the UK Commission for Competition and Consumer Protection, Office of Fair Trading, OFT (March 2010, updated February 2011): Irresponsible Lending – OFT Guidance for Creditors, 40-45. See also Finlay, Consumer Credit Fundamentals (Palgrave Macmillan, 2009), 143-144. 42 See also FinCoNet, supra note 3, 15: “the decision-making process for how and when a consumer can, or should, enter into a credit contract can be very complex. A range of factors can influence the decision and it can have extensive ramifications for the consumer, the credit provider and, indirectly, the economy as a whole”. 43 See Finlay, supra note 41, 14-15.

20

2

The Over-Indebtedness of European Consumers under EU Policy and Law

for the borrower, while Directive 2014/17/EU is limited to urging the consumer to provide the creditor with the information needed for the assessment of his creditworthiness. However, the concept of responsible lending cannot but include the responsible borrower as well.44 More particularly, in the provisions of Directive 2008/48/EC, in which the obligation of creditworthiness assessment was adopted for the first time at the European level, there is no reference to the borrower’s obligations except from recital 26, where it is mentioned that “Consumers should also act with prudence and respect their contractual obligations”. Therefore, no obligation is established; there is only a light suggestion that the borrower should also be prudent on his part, i.e. regarding the planning of his family budget, avoiding undertaking credit that he cannot afford and being diligent concerning his obligations. The suggestion to respect his contractual obligations does not concern responsible lending but an obligation he has under the general provisions. In Directive 2014/17/EU, the European legislator focuses on the need for the consumer’s participation in the process of his creditworthiness assessment, in the sense that he should provide the creditor with the information required for this purpose. According to Article 20 paragraph 3 of the Directive, the creditor should specify in a clear and straightforward way, at the pre-contractual stage, the necessary information and independently verifiable evidence that the consumer needs to provide, and the timeframe within which the consumer needs to provide it.45 In this framework, the consumer should be aware that he needs to provide information that is correct and as complete as possible.46 Furthermore, the creditor and, where applicable, the credit intermediary or the appointed representative shall warn the consumer that where the creditor is unable to carry out an assessment of creditworthiness because the consumer chooses not to provide the information or verification necessary for this assessment, credit cannot be granted.47

44 See Ryder, Griffiths and Singh, Commercial Law. Principles and Policy (CUP, 2012), 509; FinCoNet, supra note 3, 15. 45 On the basis of the principle of good faith, it should be accepted that both parties may, at a reasonable time period, complete and/or update this information, if it was not possible for objective reasons to produce a certain document or if important changes concerning the consumer took place during this period that have an impact on the assessment of his creditworthiness. 46 Directive 2014/17/EU, Art. 20 para. 4. Furthermore, according to Art. 18 para. 1, the creditor should himself judge the need to verify the information provided by the consumer and to ask him to produce the relevant documentation, where applicable. Even if it is not expressly provided for, the creditor should not take into account elements that he knows or should know, from other sources of information to which he has access either in the framework of a contractual relationship he already has with the consumer or from databases, that they are manifestly unfounded and false. 47 Directive 2014/17/EU, Art. 20 para. 4. According to the same provision, this warning may be provided in a standardised format.

21

Federico Ferretti and Christina Livada

In case it is proven that the consumer knowingly withheld or falsified information he provided to the creditor, the latter is allowed to renounce the credit agreement.48 Thus, the creditor is responsible for determining the data and information needed from the consumer in order to assess his creditworthiness – without prejudice to Directive 95/46/EC – and the consumer is responsible for providing the creditor with correct, complete and precise information.49 Considering that the creditworthiness assessment of the consumer is carried out on the basis of information provided by the consumer and, where applicable, internal or external sources of the creditor including databases, with regard to the first part of the information the creditor depends to a great extent on the soundness of information provided by the consumer. In parallel, the consumer, in order to receive the credit he wants, often tends to be overoptimistic as to the affordability of the credit, or he is unable to understand the risks inherent in the conclusion of the credit agreement50; as a result, sometimes, he does not provide – intentionally or by negligence – the creditor with the correct information for the assessment of his creditworthiness. Therefore, the obligation of the consumer to provide correct and complete information in the process of his application for credit, the warning – as mentioned above – to the consumer concerning the consequences in case he does not collaborate with the creditor, and the right of the creditor to renounce the credit agreement if the consumer knowingly provided falsified or incorrect information contribute, without doubt, to the encouragement of his active participation in the process of his creditworthiness assessment and the demonstration of responsible behaviour on his part in this stage of the process. In other words, it is expected that the establishment of these obligations for the consumer shall contribute to him exhibiting diligence as a “responsible borrower” when he concludes a credit agreement and avoiding undertaking obligations that he knows, or should know, that he is not able to meet. At the same time, in this way the important role of both parties in the implementation of the responsible lending principle is highlighted, in the sense that

48 Directive 2014/17/EU, Art. 20 para. 4. See also Art. 18 para. 4, according to which: “Member States shall ensure that where a creditor concludes a credit agreement with a consumer the creditor shall not subsequently cancel or alter the credit agreement to the detriment of the consumer on the grounds that the assessment of creditworthiness was incorrectly conducted. This paragraph shall not apply where it is demonstrated that the consumer knowingly withheld or falsified the information within the meaning of Article 20” as well as recital 58 of the Directive: “While it would not be appropriate to apply sanctions to consumers for not being in a position to provide certain information or assessments or for deciding to discontinue the application process for getting a credit, Member States should be able to provide for sanctions where consumers knowingly provide incomplete or incorrect information in order to obtain a positive creditworthiness assessment, in particular where the complete and correct information would have resulted in a negative creditworthiness assessment and the consumer is subsequently unable to fulfil the conditions of the agreement.” 49 Directive 2014/17/EU, Arts. 18 para. 7 and 20 para. 5. 50 For example, see Financial Services Authority, supra note 22, 57-58.

22

2

The Over-Indebtedness of European Consumers under EU Policy and Law

this principle undoubtedly presupposes the contribution of both contractual parties.51 Consequently, Directive 2014/17/EU is considered quite positive, although in need of further enhancement to achieve a responsible behaviour by the consumer during the lending process.

2.2.5

Indirect Measures

Directives 2008/48/EC and 2014/17/EU establish measures to ensure that the preconditions are in place that will allow the borrower to be able – but not obliged – to show the responsibility required. In this respect, the following obligations of the creditor are mainly established: – the provision of the appropriate information to the consumer, which will potentially52 allow him to understand the credit product and make a conscious decision for the undertaking of the credit, being aware of the obligations he undertakes and the potential risks of the credit for him53; and – the provision of adequate explanations to the consumer so that he is in a position to assess whether the proposed credit agreement and any ancillary services are adapted to his needs and to his financial situation.54 Especially with respect to Directive 2014/17/EU, the establishment of the Member States’ obligation to promote measures supporting the financial education of consumers is expected to play a significant part to this end55 as well as the obligation of the creditor, in case he provides or may provide advisory services at a pre-contractual stage, to recommend suitable

51 Ibid., 57: “Clearly, firms must give suitable advice and lenders must lend responsibly. But consumers also have an important role to play in the mortgage process – for irresponsible lending goes hand-in-hand with poorly informed or irresponsible borrowing”. See also Office of Fair Trading, supra note 41, 13. 52 The use by the consumer of the information provided to him either regarding the effort to understand it or use it for a comparative assessment of the products offered is a different issue. See Λιβαδά, supra note 16, 19-22; Garcia Porres and Van Boom, supra note 20, 47. 53 The provisions on information to be given to the consumer at all the stages of the credit agreement and during the credit agreement constitute the core provisions of both Directives (see Directive 2008/48/EC, mainly Arts. 5-6, 10-12 and Directive 2014/17/EU, mainly Arts. 8, 13-15, 23, 27). See also in detail Λιβαδά, supra note 16, 165; Garcia Porres and Van Boom, supra note 20, 26 ss; FinCoNet, supra note 3, 45-51. 54 Directive 2008/48/EC, Art. 5 para. 6 and Directive 2014/17/EU, Art. 16. It is rightly mentioned that the correct and efficient fulfilment of the creditor’s obligation for the provision of adequate explanations contributes to responsible lending to the extent that the consumer is able to better understand the obligations he undertakes and whether he is able to fulfil them (see Office of Fair Trading, supra note 41, 31-34), Περάκη, supra note 29, 355; Τασίκα, «Υποχρέωση των τραπεΦών για συνδρομή και παροχή επαρκών εξηγήσεων στον αντισυμβαλλόμενο στην καταναλωτική πίστη» 10 Δίκαιο Επιχειρήσεων § Εταιριών (2011), 1019-1021. 55 Directive 2014/17/EU, Art. 6 and recital 29. In Directive 2008/48/EC, there is only one reference to financial education in recital 26.

23

Federico Ferretti and Christina Livada

credit agreements to the consumer on the basis of his personal and financial situation, his preferences and objectives.56 Financial education, for the promotion of which an express provision is established in Directive 2014/17/EU, is of decisive importance with respect to the possibility of the consumer to make informed decisions to the extent that, through financial education, the consumer becomes familiar with financial products and acquires the knowledge required for him to be able to manage his debt efficiently.57 Here it should also be mentioned that providing information to a consumer who does not possess the knowledge to comprehend this information is not adequate for the consumer to make conscious decisions; this is the reason why – especially in recent years – increasing emphasis is being laid on the promotion and encouragement of financial education. On the other hand, the obligation to propose suitable credit agreements to the consumer, under the condition of the provision of advisory services, is different from the obligation of creditworthiness assessment, since it aims to identify appropriate credit products for the consumer, independently of his ability to repay them. In other words, it may happen that a consumer may receive positive assessment with regard to his income for more than one credit product; however, one of them may not be suitable for the consumer on the basis of his educational profile or the absence of his familiarity with certain transactions.58 Moreover, taking into account the obligation of the creditor to refuse the credit in case of negative creditworthiness assessment and that one of the criteria that should be considered is the financial situation of the consumer, it is clear that products for which the consumer has a negative assessment are not suitable for him. This obligation is similar to the one established in European capital markets law concerning the conduct of appropriateness or suitability testing depending on the investment service provided each time59; however, the appropriateness or suitability test is mandatory 56 Directive 2014/17/EU, Art. 22. Advisory services may also be provided under the conditions set in Art. 22 from the credit intermediary and the appointed representative. 57 See Gortsos, “Financial Inclusion: An Overview of Its Various Dimensions and the Initiatives to Enhance Its Current Level” ECEFIL Working Paper Series No 2016/15, available at , Pearson, “Financial Literacy and the Creation of Financial Citizens, in The Future of Consumer Credit Regulation”, in Kelly-Louw, Nehf and Rott (eds.), The Future of Consumer Credit Regulation (Ashgate, 2008), 3-28; Ryder, Griffiths and Singh, supra note 44, 509; FinCoNet, supra note 3, 53-57. 58 An illustrative example is that of mortgage loans, whereby the consumer pays only interest and, at the end of the agreement’s term, he has to repay the principal in full (interest-only mortgages). If the consumer is not familiar with this type of loan and is not in a position to understand the risks it entails, this product is not appropriate for him despite the fact that his creditworthiness assessment may be positive. For the individual types of loans, see Ψυχομάνη, ΤραπεΦικό Δίκαιο. Δίκαιο ΤραπεΦικών Συμβάσεων, Τόμος ΙΙ (Εκδόσεις Σάκκουλα, 2010), 185 and especially for consumer loans 207; Commission Staff Working Paper, supra note 22, 206. 59 This is the obligation of the investment firm to conduct a suitability test when providing investment advice or portfolio management pursuant to para. 4 of Art. 19 of Directive 2004/39/EC. Through this test the investment firm shall obtain the necessary information regarding the client’s or potential client’s knowledge and experience in the investment field relevant to the specific type of product or service, his financial situation

24

2

The Over-Indebtedness of European Consumers under EU Policy and Law

before the provision of investment services and free of charge, while the provision of advisory services in the framework of the Mortgage Credit Directive takes place only upon the consumer’s request and is a paid service. In this sense, it is more similar, in terms of its content, to the investment service of investment advice,60 i.e. the provision of personalised recommendations to a customer, either upon his request or on the initiative of the investment firm, regarding one or more transactions relating to financial instruments on the basis of his personal and financial situation. Pursuant to Article 22 paragraph 5 of Directive 2014/17/EU, it is left to the discretion of the Member States to provide for an obligation for the creditor to warn the consumer when, considering his financial situation, a credit agreement may induce a specific risk for him. Therefore, if the consumer has a negative assessment of his creditworthiness, Article 18 paragraph 5 shall apply, and the creditor shall not grant the credit. On the other hand, if the consumer receives a positive assessment – and under the condition that the creditor also provides advisory services and the national legislator has made use of the above-mentioned option – the creditor should warn him about the specific risk the credit agreement may induce for him. According to the relevant provisions of capital markets law, if in the opinion of the provider of the investment services61 the product or service is not suitable for the customer, he should also warn him about this.62 One of the issues arising in this regard is the extent of the creditor’s liability in this case. The obligation and liability of the credit institution must end with the issuing of the warning, where applicable, to the consumer,63 who will be responsible for any loss he may

60 61 62

63

and his investment objectives so as to enable the firm to recommend to the client or potential client the investment services and financial instruments that are suitable for him. Respectively, the appropriateness test is provided for in para. 5 of the Directive 2004/39/EC and is conducted by the investment firm when providing investment services other than those referred to in para. 4. The purpose of this test is to ask the client or the potential client to provide information regarding his knowledge and experience in the investment field relevant to the specific type of product or service offered or demanded so as to enable the investment firm to assess whether the investment service or product envisaged is appropriate for the client. See in detail Αλεξανδρίδου, «Τα επενδυτικά προϊόντα της Lehman Brothers και η κάλυψη των Φημιών των επενδυτών, 2 Δίκαιο Επιχειρήσεων & Εταιριών (2010), 134; Ρόκα and Γκόρτσου, supra note 38, 320-322; Moloney, EC Securities Regulation (OUP 2008), 614-617; Αυγερινό, «Η παροχή των επενδυτικών υπηρεσιών στην Οδηγία MiFID», in Καλλιμόπουλος and Γκόρτσος (eds.), Το θεσμικό και κανονιστικό πλαίσιο της ενιαίας Ευρωπαϊκής Κεφαλαιαγοράς (Νομική Βιβλιοθήκη 2009), 153; Gortsos, “MiFID’s Investor Protection Regime: Best Execution of Client Orders and Related Conduct of Business Rules”, in Avgouleas (ed.) The Regulation of Investment Services in Europe under MiFID: Implementation and Practice (Tottel Publishing, 2008), 101; McMeel, “Investment Firms – Retail Sector”, in Blair, Walker and Purves (eds.), Financial Services Law (OUP, 2009), 637-680. See Λιβαδά, supra note 16, 262. The investment services of investment advice and portfolio management are excluded. Directive 2004/39/ΕC, Art. 19 para. 5, 2nd sub-paragraph. He is also obliged to warn him that he cannot proceed to this assessment if the (potential) customer does not provide the required information or if the information he produces is inadequate (Directive 2004/39/ΕC, Art. 19, para. 5, 4th subparagraph). See Ρόκα and Γκόρτσου, supra note 38, 321.

25

Federico Ferretti and Christina Livada

suffer if he chooses the offered credit product despite the warning that it was not suitable for him. Respectively, the consumer takes the risk of an unsuitable product offered to him by the credit institution because of his having provided insufficient or no information to it.

2.3

The Cure of Over-Indebtedness

Consumer defaults are the other side of the same coin, but EU law is oblivious of the negative economic and social consequences generated by the same market that it aims at integrating. To the extent that the EU focuses on the prevention of behavioural causes of overindebtedness, it overlooks the externalities that are the main causes of the problem, leaving a vacuum of market functionalism and consumer protection. Debt solutions and procedures once consumers become insolvent have been left to the competence of national legislation in a multilevel division of functions between the EU and the Member States, despite a clear interest of the EU in the matter evidenced by the many commissioned reports.64 Until now, EU policy measures or legal instruments that directly cover the financial difficulties of consumers have remained scarce. The only handful of documents that the EU has produced are a pre-financial crisis Council Recommendation,65 two Opinions of the Economic and Social Committee66 and a Recital in a Recommendation with an invitation to explore the possibility of applying recommendations designed for business insolvency also to consumers. They all point to declarations of intent or principle regarding the need for prevention, alleviation and rehabilitation with measures such as monitoring, financial education counselling, responsible credit practices, balanced debt enforcement measures and the promotion of debt adjustment procedures. Leaving aside the non-binding nature of these instruments, other scholars have noted that in reality the EU had no programmes in place relating to consumer over-indebtedness and that the matter did not even appear in the Consumer Policy strategy 2007-2013.67 Equally, all that 64 For a reference of the studies see Kilborn, supra note 2. 65 Recommendation CM/Rec(2007)8 of the Committee of Ministers to Member States on legal solutions to debt problems (20 June 2007). 66 Opinion of the Economic and Social Committee on ‘Household over-indebtedness’, (2002/c 149/01); Opinion of the Economic and Social Committee on ‘Consumer protection and appropriate treatment of over-indebtedness to prevent social exclusion’ (Exploratory opinion), INT/726 (Brussels, 29 April 2014). There is also a sketchy mention of over-indebtedness in the European Commission’s Green Paper on Mortgage Credit in the EU COM(2005) 327 final, which is limited to the observation that “there is a huge social and human dimension attached to housing and credit, including aspects such as over-indebtedness. Any policy in this area must take that dimension into proper consideration”. 67 Niemi, “Consumer Insolvency in the European Legal Context”, 35 Journal of Consumer Policy (2012), 443459; EU Consumer Policy Strategy 2007-2013: Empowering Consumers, Enhancing Their Welfare, Effectively Protecting Them, COM(2007) 99 final.

26

2

The Over-Indebtedness of European Consumers under EU Policy and Law

the new European Consumer Agenda does is make a generic reference that “households’ over-indebtedness is also worrying”, anticipating the above-analysed European Commission study,68 yet problem debt finds no mention in the EU multiannual consumer programme for the years 2014-2020.69 With the increase in over-indebtedness in the aftermath of the 2008 economic crisis, many Member States have moved towards new or renovated national regimes for the protection of consumers in financial distress and for the treatment of the insolvency of natural persons, with nearly all Member States now having a law in place.70 However, these are individual but uncoordinated legal initiatives in the Member States, which expose the complete absence of common, harmonised or appropriately resourced strategies at the EU level. Each Member State has developed its own legislation that has its own features and institutional infrastructure for the implementation of the law, but whose design has been driven by emergency and purely internal social policy considerations.71 Within such a fragmented legal framework, the EU has pursued the route of mutual recognition to ensure engagement between the Member States. The legal instruments that have emanated from the EU concern procedural aspects and jurisdictional rules applicable to cross-border insolvencies mostly in the context of the cognate – yet different – area of business insolvency.

2.3.1

Council Regulation 1346/2000

Council Regulation (EC) 1346/2000,72 though designed for business insolvency, also applies to natural persons as consumers, as long as the national proceedings are listed in its Annex A. The listed national proceedings do not include the large number of national insolvency laws, which were enacted later by the Member States. The application of Brussels I(a) Regulation 1215/201273 to these uncovered legal instruments is questionable. First, it may

68 Communication from the Commission to the European Parliament, the Council, the Economic and Social Committee and the Committee of the Regions A European Consumer Agenda – Boosting Confidence and Growth, COM(2012) 225 final. 69 Regulation (EU) No 254/2014 of the European Parliament and of the Council of 26 February 2014 on a multiannual consumer programme for the years 2014-20 and repealing Decision No 1926/2006/EC, OJ L 84/42. 70 London Economics, Study on means to protect consumers in financial difficulty: Personal bankruptcy, datio in solutum of mortgages, and restrictions on debt collection abusive practices, Final Report. MARKT/2011/023/B2/ST/FC (December 2012). 71 Liu and Rosenberg, “Dealing with Private Debt Distress in the Wake of the European Financial Crisis – A Review of the Economics and Legal Toolbox”, IMF Working Paper WP/13/44 (2013). 72 OJ L 160/1. 73 Regulation (EU) No 1215/2012 of the European Parliament and of the Council of 12 December 2012 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters (recast), OJ L 351/1.

27

Federico Ferretti and Christina Livada

apply only to some proceedings as long as these qualify to the requirement of decisions being issued by a ‘court or tribunal’, so it does not apply in those jurisdictions where insolvency proceedings are of an administrative nature. Second, it does not apply to “bankruptcy, proceedings relating to the winding-up of insolvent companies or other legal persons, judicial arrangements, compositions and analogous proceedings”,74 where the ‘analogous proceedings’ have been interpreted as including personal insolvency ones by analogy.75 A drawback of the above combination is that when a payment plan is confirmed by a Court in a Member State it is not recognised or enforceable in another Member State, with debtors remaining liable to foreign creditors, thus frustrating the aims of the proceedings.76 However, regardless of the (then) scant number of relevant national proceedings for the insolvency of natural persons in the Annex, the Regulation neither regulates substantive insolvency law nor attempts to enforce a common system at the EU level, but deals with matters of jurisdiction, recognition and enforcement, applicable law and cooperation in cross-border proceedings. The principle of mutual recognition is the central point of the Regulation. The aim is to make sure that insolvency proceedings opened in one Member State are recognised in all other Member States. The Regulation establishes that the domestic law of the country where the case is opened is applicable to the insolvency proceedings and their effects.77 In theory, as the determination of who qualifies for bankruptcy/insolvency is made under national law,78 any European consumer who meets the qualification criteria of a country that does permit consumer insolvency has the ability and right to access this, effectively making their domestic or other legislative position irrelevant.79 The Regulation further provides that the domestic law of the country where the case is opened is applicable as long as the individual has established a ‘centre of main interest’ (COMI) in the relevant jurisdiction. The concept of COMI, designed with businesses in mind, corresponds to the place where the debtor conducts the administration of his interests on a regular basis.80 Incidentally, the Regulation’s rules have given rise to 74 Art. 1(2)(b). 75 Linna, “Cross-Border Debt Adjustment – Open Questions in European Insolvency Proceedings”, 23 International Insolvency Review (2014), 20-39; Israël, European Cross-Border Insolvency Regulation (Intersentia, 2005). 76 The personal insolvency procedures in Annex A are those of Austria, Belgium, the Czech Republic, Cyprus, Germany, Latvia, Malta, The Netherlands, Poland and partly France, Slovenia and the UK. See Report from the Commission to the European Parliament, the Council and the European Economic and Social Committee on the Application of Council Regulation (EC) No 1346/2000 of 29 May 2000 on Insolvency Proceedings, COM(2012) 743 final. According to London Economics, supra note 70, many countries have moved or are moving from judicially led to administrative processes because of the high costs of the former when consumers are unable to meet such costs. 77 Art. 4. 78 Art. 4.2(a). 79 London Economics, supra note 70. 80 Recital 13.

28

2

The Over-Indebtedness of European Consumers under EU Policy and Law

forum shopping by a handful of natural persons through abusive COMI relocation. But this is an irrelevant issue for over-indebted consumers, as COMI provisions could potentially affect a minority of skilled or well-informed individuals/small traders who take advantage of regulatory arbitrage, but can hardly be applicable to the large majority of millions of people in real financial distress across the EU, i.e. the vulnerable consumers.

2.3.2

The Recast Regulation 2015/848

The Recast Regulation 2015/84881 – which comes into effect on 26 June 2017 and applies only to insolvency proceedings opened after that date82 – builds on the main shortcomings identified under Regulation 1346/2000, namely its scope of application, the exact determination of which Member State is competent to open insolvency proceedings and issues with COMI jurisdiction (forum shopping referred to above), the opening of secondary proceedings in other Member States, problems with rules on publicity of proceedings and the lodging of claims, and the absence of specific rules dealing with the insolvency of multinational enterprises.83 The Recast Regulation includes pre-insolvency proceedings for viable debtors and the many personal insolvency proceedings that were outside the scope of the prior law because of their later enactment in the Member States. The Recast goes further than the liquidation proceedings of its predecessor, extending to proceedings that provide for the restructuring of a debtor at a stage where there is only a likelihood of insolvency, proceedings that leave the debtor fully or partially in control of his assets and affairs, and proceedings providing for a debt discharge or a debt adjustment of consumers and self-employed persons. The employed technique is an addition to the pre-existing requirement of proceedings based on laws in which “a debtor is totally or partially divested of its assets and an insolvency practitioner is appointed”84 of the alternative of proceedings where “the assets and affairs of a debtor are subject to control or supervision by a court”.85 The Recitals reinforce that since consumer proceedings do not necessarily entail the appointment of an insolvency practitioner, they should be covered by the Recast Regulation only if they take place under 81 Regulation (EU) 2015/848 of the European Parliament and of the Council of 20 May 2015 on Insolvency Proceedings (Recast), OJ L 141/19. 82 Ahead of that date, Member States will be required under Art. 86 to provide a description of their national insolvency legislation and procedures. In turn, Art. 24(1) – to come into effect on 26 June 2018 – provides for the establishment of publicly available insolvency registers in each Member State, with the European Commission to establish a system for the interconnection of these registers by 26 June 2019. 83 See European Commission, Proposal for a Regulation of the European Parliament and of the Council amending Council Regulation (EC) No 1346/2000 on Insolvency Proceedings, COM (2012) 744 final – followed by the endorsement from the European Parliament’s Legal Affairs Committee (JURI) on 17 December 2013 (MEMO/13/1164). 84 Art. 1(1)(a). 85 Art. 1(1)(b).

29

Federico Ferretti and Christina Livada

the control or supervision of a Court (including situations where the Court intervenes only on appeal by a creditor or other interested parties).86 The new law also clarifies that it applies only to proceedings that are based on laws relating to insolvency, thus not only excluding proceedings based on general company law not designed exclusively for insolvency situations, but also specific proceedings in which debts of a natural person of very low income and very low asset value are written off, provided that proceedings of this type do not make provisions for payment to creditors.87 This excludes the application of proceedings in those Member States where laws have been designed to maximise creditor returns, or to preserve human dignity where access to discharge has been made easier for consumers with no or little assets88 and who constitute the majority of over-indebted consumers. The other novelties under the Recast Regulation applicable to consumers concern the improvement of the coordination of insolvency proceedings within the EU, the equitable treatment of creditors and the minimisation of ‘forum shopping’, i.e. the movement of assets from one country to another so as to take advantage of a more favourable legal position. In particular, for individuals who do not carry on an independent business or professional activity, COMI is to be presumed to be the place of the individual’s ‘habitual residence’, unless this was shifted in the preceding six months, in which case the presumption does not apply.89 As explicated in the Recitals, it should be possible to rebut the presumption, for example where the major part of the debtor’s assets is located outside the Member State of the debtor’s habitual residence or where it can be established that the principal reason for moving was to file for insolvency proceedings in the new jurisdiction and where such filing would materially impair the interests of creditors whose dealings with the debtor took place before the relocation.90 Evidence about the location needs to be put forward, as strengthened under Article 4, which requires the Court of its own motion to examine whether it has jurisdiction and to specify the grounds on which jurisdiction is based. In any event, the requirements of ‘habitual residency’ remain unclear, especially in those circumstances when an individual moves to another Member State and the continuity or stability of such a move needs to be determined.

86 Recital 10. 87 Recital 16. 88 For example, the proceedings in France, Sweden, Austria, Germany Belgium, Estonia and Denmark. See Kilborn, supra note 1. 89 Art. 3. 90 Recital 30.

30

2

2.4

The Over-Indebtedness of European Consumers under EU Policy and Law

EU Procedural Control of Unfairness: The Role of the CJEU

In the wake of the 2008 economic crisis the caselaw of the Court of Justice of the EU (CJEU) has shown a surge in litigation grounded in the dated unfair contract terms legislation (UCTD)91 applied to procedures relating to credit agreements of consumers in financial difficulty.92 The ‘Spanish mortgage saga’ takes stock of the way in which the UCTD has been used in the control over national procedural law to protect over-indebted consumers. Significantly, Spain did not have legislation in place for debt solutions or the insolvency of individual debtors. From its jurisprudence in Océano Grupo,93 Penzügyi,94 and Invitel95 the CJEU has developed a doctrine of procedural effectiveness of unfair terms, obliging national judges to undertake an investigation to assess the effective protection of consumers. In Aziz,96 Spanish procedural law was found to breach EU law by failing to provide for the assessment by a court with regard to the unfairness of standard terms in a mortgage contract to offer interim relief. Particular reference was made to the impossibility to suspend mortgage execution proceedings, as a result of which the debtor could have been evicted from his property before a court could give a judgment on the fairness of the lender’s standard mortgage terms. As a result, national law was amended to repair the legal flaws concerning the enforcement of mortgage contracts.97 Later, in Sánchez Morcillo98 it was held that the amended Spanish procedural law still fell short of the standards required under the UCTD by leaving to the discretion of the national court the assessment of the unfairness of the relevant terms. Moreover, the law did not grant consumers the same procedural defences accorded to lenders. Next, Unicaja Banco and Caixabank99 confirmed the trend of Member States having to ensure that over-indebted consumers are protected and not bound by unfair clauses in credit agreements. The Spanish courts referred the question as to whether it should declare void and not binding on the consumer unfair clauses regarding default interest rates that were higher than those set by law, or whether they should instead adjust the clause to the statutory limits. In fact, Article 6 UCTD provides that unfair terms should not be binding 91 Directive 93/13/EEC of 5 April 1993 on Unfair Terms in Consumer Contracts, OJ L 95/29. 92 Micklitz and Reich, “The Court and Sleeping Beauty: the Revival of the Unfair Contract Terms Directive (UCTD)”, 51 Common Market Law Review (2014), 771-808. 93 Case C-240/98. 94 Case C-137/08. 95 Case C-466/11. 96 Aziz v. Catalunyacaixa (Case C-415/11). 97 Lei 1/2013 amending Art. 695 of the Spanish Code of Civil Procedure. 98 Sánchez Morcillo y Abril García v Banco Bilbao Vizcaya Argentaria SA (Case C-169/14). 99 Unicaja Banco, SA v José Hidalgo Rueda and others and Caixabank SA v Manuel María Rueda Ledesma and others (Joined Cases C-482/13, C-484/13, C-485/13 and C-487/13).

31

Federico Ferretti and Christina Livada

on the consumer who remains nevertheless bound by the other terms of the contract if this is capable of remaining in existence without the excluded unfair term. At the same time, EU law does not authorise national courts to revise the content of the unfair term, as affirmed in precedent case law100 where the CJEU held that the contract containing the term “must continue in existence, in principle, without any amendment other than that resulting from the deletion of the unfair terms, in so far as, in accordance with the rules of domestic law, such continuity of the contract is legally possible”.101 However, in Kasler102 the contract was found not to remain in existence without the unfair clause and, given the negative consequences this would have had on the consumer, the CJEU held that the national court was allowed to replace the unfair term by a supplementary provision of national law. Against this legal background, the referred issue raised difficult questions because the further existence of the mortgage contract might be endangered in case lenders no longer received interest payments, which may be considered to be an essential part of the mortgage agreement.103 Nevertheless, the CJEU held that national law is compatible with EU law insofar as it does not interfere with the national courts’ duty to hold unfair terms to be not binding on the consumer, without revising the terms’ content,104 effectively offering protection to the affected consumers. Again, in BBVA SA v. Lòpez et al.105 the CJEU persisted in the reinforcement of the protection of the over-indebted consumer. With reference to cases in which enforcement proceedings were pending and no unfair terms control had been exerted under the procedural rules in place before the Aziz case, the new Spanish law granted consumers one month from its publication to bring an action based on the unfairness of a contractual term. The CJEU found that the transitional provision does not guarantee the effective exercise of the new right. The ‘Spanish saga’ is not over, with a new opinion of the Advocate General in Finanmadrid EFC SA106 heading in the same direction of protection for the over-indebted consumer. Moreover, new preliminary references have already been filed to challenge the other aspects of the Spanish procedural law on the same grounds of unfairness,107 as well

100 101 102 103 104 105 106

See Banco Español de Crédito (Case C-618/10) and Asbeek Brusse and de Man Garabito (Case C-488/11). Unicaja Banco and Caixabank, para. 28. Case C-26/13. Unicaja Banco and Caixabank, Conclusions of the Advocate General Whal (16 October 2014). Unicaja Banco and Caixabank, supra note 93. Case C-8/14. Finanmadrid EFC SA v. Jesús Vicente Albán Zambrano and others (Case C-94/14). The AG finds it against EU law national legislation not providing for the judge of the execution the possibility to declare ex officio abusive clauses void and not binding for the consumer. 107 Request for a preliminary ruling from the Audiencia Provincial de Cantabria (Spain) lodged on 7 August 2015 – Liberbank S.A. v. Rafael Piris del Campo, (Case C-431/15).

32

2

The Over-Indebtedness of European Consumers under EU Policy and Law

as the testing of its compatibility with the principle of effective judicial protection affirmed in Article 47 of the Charter of Fundamental Rights of the European Union.108 The above caselaw suggests what has been defined as the new constitutional role of the CJEU,109 where the judiciary takes over from politics and substitutes the legislator in policy and law making: where a Member State and the EU failed to put in place measures to provide for the insolvency of over-indebted consumers, the CJEU has been described as engaging in a form of social engineering that compensates for the deficiencies of the institutions pre-established by law.110

2.5

2.5.1

Concluding Remarks

Prevention and Responsible Lending/Borrowing

The current European framework of consumer and mortgage credit makes reference to responsible lending mainly in the assessment of the consumer’s creditworthiness and the direct link – concerning Directive 2014/17/EU – between the results of such an assessment and the granting or not of credit. In this sense, direct intervention into the contractual freedom of the parties is exercised, and the creditor cannot provide credit unless the consumer has a positive assessment of his creditworthiness.111 On the contrary, there is no obligation for the creditor to provide credit in case of positive assessment of the consumer if the creditor does not want to do so because, for example, of his business policy. The interventionist approach of the European legislator reflects a turn regarding the treatment of the consumer, considering that he does not always act rationally and autonomously; instead, he is vulnerable to aggressive or misleading practices, is often unable to understand the consequences of the decisions he makes and sometimes tends to act frivolously. However, even if this assumption is true for a large number of consumers, clearly it is not valid for all of them.

108 Request for a preliminary ruling from the Audiencia Provincial de Illes Balears (Spain) lodged on 16 July 2015 – Francisca Garzón Ramos and José Javier Ramos Martín v Banco de Caja España de Inversiones, Salamanca y Soria, S.A., Intercotrans, S.L., (Case C-380/15). 109 See Micklitz, “Unfair Contract Terms – Public Interest Litigation before European Courts Case – C-415/11 Mohamed Aziz”, in Terryn, Straetmans and Colaert (eds.) Landmark Cases of EU Consumer Law – In Honour of Jules Stuyck (Intersentia, 2013), 633-652; Gerstenberg, “Constitutional Reasoning in Private Law: The Role of the CJEU in Adjudicating Unfair Terms in Consumer Contracts”, 21(5) European Law Journal (2015), 599-621. 110 Micklitz, “Conclusions: Consumer Over-Indebtedness and Consumer Insolvency – from Micro to Macro”, in Micklitz and Domurath (eds.), Consumer Debt and Social Exclusion in Europe (Ashgate, 2015), 229-235; Kelman, The Transformation of Law and Regulation in the European Union (Harvard University Press, 2012). 111 See Nield, supra note 20, 178.

33

Federico Ferretti and Christina Livada

It is correctly mentioned that the point of reference of provisions of this kind are the most vulnerable consumers, to the extent that credit for them entails higher and possibly not controllable risk. However, it would be appropriate for legislation to provide more flexibility to creditors vis-à-vis consumers not demonstrating those characteristics.112 On the other hand, the adoption of such an approach in European legislation is disadvantaged by the difficulty of determining the criteria for differentiating between the various categories of consumers, and it would probably not be possible to achieve security of law in this way. In any case, under the current legal framework (Directive 2014/17/EU), the creditor is responsible for making the final decision as to whether to grant credit or not, based on the results of the assessment. However, taking into account the difficulties arising in the process of the creditworthiness assessment, it is quite possible that – except for the cases in which the result of the assessment is manifest (positive or negative) – when the results are not so clear or if both positive and negative indications exist, the creditor will tend to be reluctant and finally refuse to grant credit or reject applications that he would have accepted under different conditions. This will happen both for grey areas and for lack of adequate verifiable data. Besides, the creditor has to rely on assumptions and, in particular, on the assumptions as at the moment of the conclusion of the credit agreement, making the allowed or imposed deductions with regard to the typically long-term duration of the credit agreement. As a result, access to mortgage credit will probably be reduced for the more vulnerable and/or less privileged groups of the population (for example because of low or unstable or not easily verifiable income113); those groups may be more in need of credit, but because they will not fulfil the criteria or because they will be considered more risky, they will be deprived access to credit, at least in a legal way.114 Such a probability may lead to financial exclusion,115 i.e. exclusion from access to financial services116 of vulnerable and fragile

112 Ibid., 179. 113 According to the Financial Services Authority, “Mortgage sales could be affected by the income verification proposals via two primary drivers. Customers could be excluded from the market for their inability to prove income, or mortgage lenders might decide not to offer a mortgage due to the expense of verifying income. Oxera’s survey indicated that almost all of the expected reduction in sales volumes from income verification would be expected to arise from applicants being unable to prove income” Financial Services Authority, supra note 22, Annex 1, Part 1, paras. 80, 20. See also Λιβαδά, supra note 25, 213. 114 See Περάκη, supra note 29, 358; Brown, “European Regulation of Consumer Credit: Enhancing Consumer Confidence and Protection from a UK Perspective?”, in Devenney and Kenny (eds.), supra note 19, 56-83. 115 See Ryder, Griffiths and Singh, supra note 44, 503. 116 For financial exclusion, see indicatively Wilson, “Responsible Lending or Restricting Lending Practices? Balancing Concerns Regarding Over-Indebtedness with Addressing Financial Exclusion”, in Kelly-Louw, Nehf and Rott (eds.), supra note 57, 91-106; Gómez, “Financial Exclusion in the European Union: Addressing Difficulties in Accessing Finance within the Current Integration Framework”, 23 Journal of Contemporary European Studies (2015), 100-117; Ambarkhane, Singh and Venkataramani, “Developing a Comprehensive Financial Inclusion Index”, (August 2014), available at .

34

2

The Over-Indebtedness of European Consumers under EU Policy and Law

groups of population that may become over-indebted precisely because they are excluded from the possibility to receive credit.117 The recent Directive 2014/17/EU precludes any safe conclusions from being drawn about the way the relevant provisions will be implemented; the same applies with respect to Directive 2008/48/EC, which has been transposed to the Member States, but the practices followed have not been consolidated yet. Thus, it is not possible to know their exact impact on the consumer credit market. The difficulty of quantifying the impact of Directive 2014/17/EU is also mentioned by the European Commission in its impact assessment report in the framework of the proposal for a Directive.118 However, the Commission believes that the percentage of reduction of mortgage credit due to the establishment of those provisions will be low,119 while, on the contrary, the benefits for consumers, society and financial services providers will be more important.120 The supervisory authorities will play a crucial part in the supervision of compliance with these provisions and the imposition of sanctions in case of infringements of the national provisions. The courts will also play a very significant role since they will be called to decide, in case of litigation, whether the granting of credit was responsible or not. As it stands, the core of the principle of responsible lending at the European level is the assessment of creditworthiness of the consumer and the link between the assessment and the granting of credit. The contribution of the borrower is limited only to the provision of correct and comprehensive information to the creditor. This choice of the European legislator entails certain risks, the most important of which may be the exclusion from credit of groups of population not fulfilling the criteria of lending and their consequent over-indebtedness because of the exclusion. Such a prospect clearly runs counter to the objectives of the regulatory intervention and, if it occurs, will have to be addressed. In any case, the mechanisms of activation of the responsible borrower, who has and should have an active role in the lending process, should be enhanced. The current European legal framework, according to the above-mentioned, moves in this direction, even if reluctantly, and should be further reinforced.

2.5.2

Cure and Personal Insolvency Law

The emphasis given to COMI relocation lies far from the reality of millions of over-indebted vulnerable consumers. 117 See Ryder, Griffiths and Singh, supra note 44, 504; Brown, supra note 114; Wilson, supra note 116, 101; Περάκη (2009), supra note 29, 358. 118 See Commission Staff Working Paper, supra note 22. See also the very detailed impact assessment of the Financial Services Authority, supra note 22, 13-34. 119 Ibid. 120 Ibid.

35

Federico Ferretti and Christina Livada

Like its predecessor, the Recast Regulation does not attempt to harmonise substantive provisions and does not aim at tackling divergences and inconsistencies between individual proceedings under national law. Mutual recognition and private international law in the EU are legal tools usually employed when it is difficult for Member States to reach agreement on substantive laws. In this sense, they have been portrayed as a fallback or ancillary position where harmonisation cannot be achieved.121 As far as personal insolvency legislation is concerned, it would be difficult to negate such a stance. However, given the absence of substantive harmonisation, some Member States remain exposed to internal weak systems, and coordination may not always be straightforward. A gap in the law is the treatment of consumers with little or no assets. This is often the case with over-indebted consumers, who are in that situation precisely for want of any other means to pay off their debts. However, substantive laws of the Member States are very different, and many countries that focus on creditors’ fair treatment and satisfaction exclude these kinds of debtors from insolvency proceedings precisely because of the impossibility of making a repayment plan. Likewise, the Recast Regulation is explicit in excluding them from its scope. This exclusion may infringe the free movement of vulnerable consumers who after the economic crisis have shown a tendency to move to other EU countries to escape the lack of jobs and austerity in their home Member State. In Radziejewski122 the CJEU has already established that national insolvency procedures for natural persons may restrict the fundamental free movement rights of the EU. The case dealt with the issue of residency as a requirement for access to the national insolvency procedure and its lack of compatibility with Article 45 TFEU on the free movement of persons. The CJEU held that national provisions that preclude or deter someone from leaving his country of origin in order to exercise his right to freedom of movement constitute restrictions on that freedom, even if they apply without regard to the nationality of the workers concerned. The CJEU jurisprudence over the procedural control of fairness – though significant in providing a remedy to over-indebted consumers and plastering problematic situations emerging from a legal vacuum – has many limits, especially in the vast majority of situations where there are no unfair standard terms to be contested in a condition of over-indebtedness. This is a frequent instance where under the UCTD the assessment of fairness of a term cannot relate to the definition of the main subject matter of the contract or to the

121 Mills, The Confluence of Public and Private International Law (Cambridge University Press, 2009). See also Council of the European Union, The Hague Programme: Strengthening Freedom, Security and Justice in the European Union available at , 31. 122 Ulf Kazimierz Radziejewski v. Kronofogdemyndigheteni Stockholm (Case C-461/11).

36

2

The Over-Indebtedness of European Consumers under EU Policy and Law

adequacy of the price or remuneration.123 Such exclusion, for example, made the UCTD powerless to challenge mortgage agreements in foreign currencies that created so many problems in a number of countries. Moreover, consumer protection through procedural means is not easily attainable as it rests on the capacity and resilience of over-indebted consumers to seek enforcement of rights. All in all, the legislative choices of the EU legislator are questionable. Much can be debated over the details of the law. Overall, however, it is argued that a more cohesive and holistic approach to treating the effects of over-indebtedness would be desirable. No policy or law designed to prevent a problem can on its own solve it. Prevention alone, however designed but without ex post debt solutions, cannot be conclusive.124

123 Art. 4 of the UCTD. 124 See also Vandone, Consumer credit in Europe (Physica-Verlag, 2009).

37

Part II The UK

3

Facts and Figures of Consumer Over-Indebtedness in the UK: Experience from Debt Advisers

Joanna Elson*

3.1

Introduction

The Money Advice Trust has been helping people to tackle their debts and manage their money wisely since 1991. The Trust runs two key debt advice services for the UK public. These are National Debtline, supporting consumers who are in debt, and Business Debtline, supporting small business owners and the self-employed with their business and personal debts. The Trust also runs Wiseradviser, a service that trains debt advisers across the UK and supports them with their professional development. Both our consumer-facing services have been in operation for over twenty years, and have helped millions of people. Since the financial crash in 2007, the numbers using our helpline and online tools have increased significantly. In that time there has also been a marked shift in the profile of clients helped through our services. I will outline in this chapter the two key shifts that have changed whom we are helping and the types of debt problems they face. The first of these shifts is the change in household budgets in recent years. A gradual erosion of families’ surplus income between 2008 and 2014 in the face of rising prices has led to the emergence of a new generation of debt problems – one to which more people are vulnerable, one that is harder to resolve and one that has no definitive cause or solution. Our National Debtline advisers have reported over recent years that more callers have deficit budgets, where their income does not match their expenditure. They have also had to help people with a growing number of different debt types, from the emergence of payday loans to an increase in telephone arrears. A second significant change whose impact we are seeing is the notable shift in employment dynamics, heralded by the new and burgeoning population of the selfemployed. The UK’s self-employed headcount is now approaching 5 million, and small businesses employ one-third of the population. Despite this encouraging new chapter, not all small businesses are trading successfully, with some burdened by unmanageable debt. *

OBE CDir, Chief Executive, Money Advice Trust.

41

Joanna Elson

When someone ventures out on their own, to pursue their trade or follow their dream, they cannot always predict the bumps on the road. We know first-hand from our Business Debtline service that it is vital that small businesses can access the help and support they need both to develop the necessary skills to keep operating and to manage their finances effectively. For these people, help is a ‘light at the end of the tunnel’, enabling them to support themselves and their families, and to continue to make an invaluable contribution to the UK’s economy. We explored both of these changes and their impact on those who seek advice and the type of debts they are struggling with in two of our recent reports on Changing Household Budgets1 and The Cost of Doing Business.2 We summarise these trends and key themes from the reports, over the next few sections.

3.2

Changes in the Personal Debt Landscape

Average incomes have been increasing since the end of 2014, after years of having fallen sharply. The average UK household saw its spending power fall year on year from 2008 until late 2014. During this period, CPI inflation was stubbornly high, remaining for almost four years above the Bank of England’s 2% target rate, and significantly higher than income growth. This meant that the Institute for Fiscal Studies estimates that real income for the median household in 2013-2014 was more than 6% below the pre-crisis peak.3 While wage growth now outstrips inflation, the impact of this prolonged period of suppressed wages and rising costs has given rise to many of the debt challenges our advisers deal with today (Figure 3.1). These figures hide the different cost of living problems facing households at either end of the income spectrum, particularly the great number on low incomes. Price variations in certain elements of the CPI inflation basket, like food, rent and energy, are likely to have a disproportionate impact on lower-income households. This phenomenon was explained by the Resolution Foundation in its 2013 Squeezed Britain report:4

1 2 3 4

Money Advice Trust, Changing Household Budgets, 2013. Money Advice Trust, The Cost of Doing Business, 2014. Institute of Fiscal Studies, The Green Budget, February 2014. Resolution Foundation, Squeezed Britain, February 2013.

42

3

Facts and Figures of Consumer Over-Indebtedness in the UK: Experience from Debt Advisers

Figure 3.1 Average earnings and CPI annual growth rates

Source: Office for National Statistics.

Although household incomes for all groups have fallen in real terms since the recession, low to middle income households feel the squeeze particularly acutely because they spend a greater proportion of their income on essentials than higher income households. The costs of essentials such as food, fuel and transport have risen much faster than inflation in the overall economy in the last decade, leaving the group facing an ‘inflation premium’. This ‘inflation premium’ means their annual spending power was £280 lower in 2012 than it would have been had they faced the same inflation rate as higher income households from 2003. Problems arising from an inflation premium are compounded for low-income households by the ‘poverty premium’5 they already face, whereby they often: – Pay higher than average utility tariffs for a given amount of consumption, because of the payment method used or what is described as suboptimal deals – Pay more per unit because of being lower users – especially an issue in telecommunications – Pay more because of limited choices of how to buy things, for example not being able to use direct debit or buy online – Pay high interest on consumer credit 5

Consumer Futures and Joseph Rowntree Foundation, Addressing the Poverty Premium: Approaches to Regulation, March 2013.

43

Joanna Elson

Taken cumulatively, paying higher prices for utilities and credit can raise the costs of a minimum household budget by 10%, a situation exacerbated by not having access to enabling products like full banking facilities or the Internet.6 The gap between income-relevant inflation and earnings growth for low-income households was significant for a number of years. As a result, many households were driven into arrears on basic household bills, and the traditional model for debt problems in the UK has moved from being largely ‘change of circumstance’ focused to one that included a growing number of ‘deficit budgets’. Since the late 1990s the debt problems National Debtline advisers have dealt with have centred on financial products – most notably bank loans, overdrafts and credit cards – and there was a long-term trend of increasing numbers of people contacting National Debtline to report debts owed on these products. This reached a peak in 2007 when 69% of all callers reported a debt owed on a bank loan/overdraft and 67% reported a debt owed on a credit card. These figures underline a traditional model of debt difficulty that National Debtline advisers saw repeatedly between 2003 and 2007. This model featured a person or household managing stretched credit commitments until a major income or expenditure shock (such as relationship breakdown, illness or unemployment) meant that they could no longer maintain repayments on their credit products. In 2007, the same year that the proportion of National Debtline callers with debts owed on credit cards and bank loans/overdrafts peaked, the full extent of the financial crisis began to make itself known – with famous images of Northern Rock customers queuing to take their money out of the bank. The following two years would be characterised by a number of established financial institutions reporting severe financial problems, with governments throughout the developed world deciding to inject significant funds into the banking sector. This, in turn, led to a restriction in the credit products supplied by mainstream lenders. It may therefore not be surprising that the proportion of callers to National Debtline reporting debts owed to these products began to slowly decline. By 2015 the proportion of callers reporting debts owed on a bank loan/overdraft was 36%, and the proportion of callers reporting debts owed on a credit card was also 36%. By contrast, the number of callers reporting debts owed on other items such as water rates, gas/electricity, rent, council tax, telephone bills and catalogue purchases has increased significantly in both real and proportionate terms. This shift in debt types reported to National Debtline is demonstrated in Figure 3.2, which reflects a new model of debt problem characterised by a person/household not necessarily suffering a major change in circumstances, but struggling to make their income stretch to meet their essential expenditure.

6

Consumer Futures and Joseph Rowntree Foundation, Addressing the Poverty Premium: Approaches to Regulation. March 2013.

44

3

Facts and Figures of Consumer Over-Indebtedness in the UK: Experience from Debt Advisers

Figure 3.2 Debt types reported by National Debtline callers 2007-2014

Source: National Debtline.

In the ‘deficit budget’ model of a debt problem a person/household finds that the increased cost of essential-living items outstrips their income and that they begin to fall into arrears on some household bills such as energy, water or telephone bills. While different households respond differently to this situation, it has been well documented that many households cut expenditure significantly in an attempt to maintain a functioning budget. In 2011, the Trust undertook research with the University of Bristol7 to see how household financial management had been impacted by the economic crisis. This research found many households had made drastic moves to cut expenditure: Cutting back on essentials included cutting back on food by ‘sticking to the basics’ or buying raw ingredients instead of pre-prepared meals… one participant described taking discarded raw food home from his office canteen to supplement meals at home. Many people – from a range of household types –

7

Money Advice Trust, University of Bristol and Barclays, Understanding Financial Difficulty, October 2011.

45

Joanna Elson

described cutting back on petrol or diesel consumption by leaving the car at home more and more often, opting to cycle, use public transport, or simply not going out to ‘make a tank of petrol last’. This led some households to question the value of keeping a car (in addition to those that had already sold their cars). Other essential spending is also often being cut to ease short-term budgetary constraints, leaving households at risk of further financial costs in the medium term and even more vulnerable to income shocks. More than half of the poorest fifth of UK households do not have home contents insurance, and the number is growing. This leaves these households open to significant financial risk. Additionally, calls into National Debtline from people owing money for the TV Licence have increased in recent years from 764 calls in 2007 to 9,893 calls in 2015, yet another indicator that household finances are being squeezed and many are taking significant personal and financial risks in order to make expenditure cuts. The extent to which low- to middle-income households have seen their surplus income eroded away over years of price increases outstripping the growth in their income has led to a complete reshaping of the UK debt landscape. Companies in the mobile telephone industry, catalogue industry and the energy sector all find themselves facing the prospect of collecting debts from struggling households.

3.2.1

The Cost of Housing

The most fundamental element of most household expenditure budgets is the money spent on housing, whether through a mortgage or rent agreement. The cost of housing over recent years has split somewhat between people renting and people paying a mortgage. Those renting have faced a very different climate: with a limited stock of rented properties and growing demand, the cost of renting has increased consistently since 2007. Between September 2014 and September 2015 alone, the cost of renting privately has increased at around 2.7%.8 More and more people are struggling to maintain rent repayments. A recent Shelter survey reported that one in five renters is struggling to keep up with rent payments in January and one in ten parents is cutting back on heating costs in order to pay the rent.9 In 2015 rent arrears were the fastest growing debt problem reported to National Debtline advisers, with over 25,000 calls made about this issue, up from 19,300 the year before. That rent arrears problems are growing so sharply will be partially attributable to the increasing proportion of the population in the rental market. Another factor in the growth 8 9

Office for National Statistics (ONS), Index of Private Rented Housing Rental Prices, September 2015. .

46

3

Facts and Figures of Consumer Over-Indebtedness in the UK: Experience from Debt Advisers

in problems with rent arrears is likely to be the cuts made to welfare payments. Where the newly introduced total cap on benefits is exceeded, Housing Benefit is the payment that is cut, and some families will be facing increases in rent payments as a result of the Spare Room Subsidy cut. However, even accounting for these factors, it is clear that the increase in rent arrears problems is partially down to the impact of rent taking a greater proportion of income. As rent costs continue to outstrip earnings growth, the cost of paying the rent takes up a greater proportion of the household budget. Similarly to payment of energy bills, water bills, telephone bills, catalogue bills and council tax, paying the rent is getting harder, and more people are finding themselves unable to avoid arrears. There is evidence that people in rented accommodation are increasingly likely to be facing broader debt problems. In 2015, 63% of National Debtline callers were living in rented accommodation, compared with 43.6% in 2010. For those with a mortgage the situation since 2009 has been a little more comfortable. With arrears falling consistently over the last four years, there is a clear sign that low interest rates have helped households maintain repayments. In 2015, less than one in five callers to National Debtline had a mortgage, compared with 40% in 2010. However, the high cost of living meant many of these families were unable to take advantage of the prevailing low interest rate by saving or paying back more debt. While cost of living pressures have improved somewhat, many households remain extremely vulnerable to even a small movement in interest rates, a particular concern now that interest rate rises are looming large. Without a significant change in the status of household finances, mortgage holders will not be able to swallow a rise in mortgage repayments without falling into arrears on one or more of their household bills. Research in September 2015 from the Building Societies Association (BSA) revealed that over half (52%) of borrowers said they would struggle or fall behind with mortgage repayments when interest rates rise.10 These findings are echoed by research carried out by the Money Advice Trust on a sample of callers to National Debtline in late 2015 and early 2016. Nearly four in ten people (38%) who contacted the service were not aware that interest rates may rise in the near future. A further 76% of those aware of a potential rate rise claimed that they were concerned about the impact this would have on their finances.11 The potential for a significant growth in debt problems for mortgage holders will factor into the Bank of England’s decision making; however, advice agencies, Government and creditors should all be preparing for a sharp increase in mortgage arrears. The Trust has worked with the Building Societies

10 Building Societies Association, Over Half Say They Will Struggle When Interest Rates Rise, Media Release, September 2015. 11 Money Advice Trust, Survey of a Random Sample of 641 Callers to National Debtline between August 2015 and January 2016.

47

Joanna Elson

Association and others to raise public awareness and preparedness for rate rises, through media, financial institutions and by publishing information resources.12

3.2.2

Council Tax

One of the most frequent issues we hear about on our helplines is council tax arrears. Council tax is an annualised tax charged through local authorities with the level dependent upon the value ‘band’ of an occupier’s property. People living in more valuable properties pay more; people in less valuable properties pay less. Council tax rates vary significantly across local authorities, but have broadly not been subject to sharp increases in the last few years. In April 2013, Council Tax Benefit was abolished and replaced with a smaller fund that was devolved to local authorities to provide Council Tax Support with the proviso that householders over the age of 65 would see no cut in support. While some councils have taken steps to smooth the transition from one benefits system to another, many households are now paying council tax for the first time, and facing an unexpected new bill. Problem debt related to council tax arrears had been rising consistently before 2013, despite the lack of sharp increases in council tax bills since 2009. This can be attributed to some degree to the manner in which local authorities collect council tax arrears – in 2014 local authorities referred debts to bailiffs for collection on 2.1 million occasions13 – primarily for council tax and parking penalties. This incurs fees and charges that are added to the debt. Another issue with council tax repayments is that local authorities often require full repayment of the arrears within the twelve-month billing period. This is often unrealistic for households where large arrears have been built up and differs markedly from other creditors who are more likely to accept sustainable repayment arrangements over longer periods. Broader economic factors cannot be ignored as a further cause of the growth in council tax debt problems. Council tax bills have faced greater competition from other expenditure categories within household income. As more and more of a single budget is taken up by the cost of food, transport, energy, water and other bills, less remains for the payment of council tax. While the punishment for non-payment of council tax can be sufficiently severe to warrant this bill being a top priority for payment, many households do not prioritise council tax bills ahead of other items, and so arrears can quickly build up. One in four National Debtline callers now has arrears on their council tax compared with around one in ten in 2006, before the financial crisis. 12 Money Advice Trust and Building Societies Association, Can’t Pay Your Mortgage? Help Is at Hand, September 2014. 13 Money Advice Trust, Stop the Knock: Local Authorities and Enforcement Action, September 2015.

48

3

Facts and Figures of Consumer Over-Indebtedness in the UK: Experience from Debt Advisers

3.2.3

Energy Bills

No industry has been so closely tied to the cost of living debate as the energy industry. Successive price rises have seen the cost of gas and electricity take up a greater proportion of household budgets. As essential products for safe and healthy modern living, it is not easy for households to drastically cut their consumption of energy products. However, there is evidence that households began a process of cutting energy consumption as far back as 2005. Energy consumption in the UK has decreased to levels not seen since the early 1980s, yet trends in consumption are inversely correlated with the changing cost of energy.14 In 2005, National Debtline advisers answered a total of 2,512 calls from people with arrears owed to their energy company. That figure has increased consistently year on year, and in 2015 National Debtline advisers answered 27,970 calls from people with arrears owed to their energy company. The big six energy suppliers in the UK increased energy prices by an average of 36% between 2010 and 2013, whereas average earnings rose only 4.4% during the same period. Whatever the reason behind price increases in the energy sector (UK households tend to spend less per unit of energy than the EU average), there can be little doubt that the increased price of heating the home or turning on the kettle was one of the factors that have led to an increase in debt problems. While some companies have stabilised or reduced recently, there continue to be calls to the industry to reduce costs. Many households still face a stark choice between reducing energy consumption to unsustainable levels, building up energy bills that they cannot afford to pay and thereby voluntarily incurring problem debt, and cutting back expenditure in other areas (often referred to as the ‘heat or eat’ decision). Of course, energy bills and energy debts do not exist in isolation, but instead sit among other household expenditure competing for a slice of the same limited budget as food, water, clothing, transport and much more.

3.2.4

Water Bills

Similar to energy consumption, our ability to manage the cost of the water we consume is limited. Households cannot choose lower quality water, they cannot stop using water altogether and without moving home they cannot change supplier. Also in a similar way to energy, the cost of water in the UK has risen significantly in recent years. The number of calls answered by National Debtline advisers from people seeking help with their water debts has grown in recent years. In 2015 around four times as many people 14 Department of Energy and Climate Change (DECC), Energy Consumption in the UK, September 2013.

49

Joanna Elson

called the service for help with this debt type as was the case in 2007. The rise in water debt problems corresponds closely with the rise in water prices. As of 1999, water companies have been unable to restrict access to water supply for domestic properties in cases where a debt is owed. This means that water arrears repayments have become a non-priority debt alongside credit cards, bank loans and other unsecured credit products. It will be important for water companies to reduce debt write-offs and agree sustainable repayment plans with struggling customers. Acknowledging the increases in recent years, the water regulator, OFWAT, has announced that water bills will reduce by 5% by 2020. This represents a positive move away from the recent trend of annual price rises. There are other positive signs from the water industry: there has been a growth in the availability of water trust funds to help households in crisis. These kinds of measures can help alleviate the very worst end of household difficulties.

3.2.5

Telephone Bills

As of 2015, two thirds of UK adults owned a smartphone.15 Smartphones are becoming an essential part of modern life for people across different income brackets. For those on low incomes a smartphone is often the only source of regular and accessible Internet connectivity. The need for digital inclusion will become even more important with the roll-out of Universal Credit and other new government services, for which the application process is largely online. Additionally, where landline telephones have been disconnected, the upkeep of a mobile telephone can be essential for emergency contact. The nature of smartphone contracts is such that in many ways they resemble a loan for a small computer. The spread of smartphones across UK households has led to more and more expensive phone contract deals being sold, whereby the borrower receives a free or cut-price handset upfront and pays a monthly fee to cover the cost of calls, data and text messages as well as the cost of the handset itself. Over the same period National Debtline has seen a sharp rise in calls for help from people with telephone debts, including a rise of 11% in the last twelve months. This trend may be accelerating, but it is not new. Calls for help with telephone debts have been going up since 2007, the same year the iPhone was launched. National Debtline took 5,830 calls from people with telephone debts that year, representing 3.9% of all calls, but in 2015 that figure had ballooned to 18,077, representing 10.1% of all calls. It is easy to see how a family of four (with two teenage children) might be paying around £120 per month in mobile telephone contract bills – this is more than the average energy

15 The Office of Communications (Ofcom), The Communications Market Report, August 2015.

50

3

Facts and Figures of Consumer Over-Indebtedness in the UK: Experience from Debt Advisers

bill for a household of four in the UK. Smartphone contracts now represent a significant expense for many households, contrary to the case seven years ago. Additionally, the length of these contracts has been growing (such contracts now tend to operate over a minimum of a two-year period), making the overall cost far more expensive, and also making it harder for a borrower to maintain repayments. These contracts cannot simply be cancelled, and there have been numerous cases of monthly bills being raised mid-contract. There is very little consumer choice around contract length, and where shorter contracts are available they are more expensive (as the cost of the handset has to be absorbed into fewer monthly payments). The cost of running a mobile phone should be considered part of the fabric of the cost of living. Telephone debts have now become a major part of the UK’s debt landscape. The increase in calls to National Debtline for help with telephone debts reflects a society that is becoming more reliant on digital services. In the same ways that households are vulnerable to changes in the energy and water industries, they are also vulnerable to changes in the telecoms industry.

3.2.6

Borrowing

Different households respond in different ways to a squeezed budget. Some seek to cut back spending to balance their income and expenditure; others see bills run into arrears; and some borrow to cover the gaps in the finances. Most households will react in more than one of these ways – for example one might use credit initially to cover budget gaps in the belief it is a short-term problem, following which they may cut back spending significantly, and when they can cut no further, bills will run into arrears. Borrowing to cover a structural household budget deficit is nearly always counterproductive to getting the household back into financial health. When budgets are squeezed they have little flexibility, and it can be easy to fall behind with credit commitments. The period following the financial crises that took place between 2007 and 2009 saw a fall in total outstanding consumer credit that lasted until the end of 2013.16 While we cannot know to what extent this fall is attributable to the two causes of declining supply and declining demand, we can surmise that there was some decline in both. The decline in supply of credit can be largely linked to new capital requirements placed on organisations selling credit products. The cause of decline in demand is trickier to pin down. The fall in total unsecured credit cannot be attributed to a fall in outstanding credit card balances as these continued to grow (albeit at a slower pace). It is clear that a fall in other unsecured loans is the driving factor. It is understandable that credit card balances continued to grow despite squeezed budgets as households can more flexibly use credit 16 Bank of England, Trends in Lending, October 2013.

51

Joanna Elson

cards to cover the gaps in their finances. Other unsecured loans have been traditionally dominated by personal bank loans. It is perhaps understandable that households would be less inclined to take on these credit products, which represent a longer-term financial commitment and are more geared for funding one-off expenses, which many households would have delayed making. One contributing factor to the re-established growth in unsecured credit was the emergence of a large short-term high-cost credit market – better known as the payday loans industry. The appetite for short-term credit agreements, rather than longer-term commitments, chimes closely with budgets being less flexible and households being reluctant to make long-term financial commitments. The growth of this industry is reflected in the number of calls National Debtline has received on payday loans over the last few years. A downside of the growth in short-term, flexible lending is that it is more expensive (largely because a relatively similar overhead expenditure must be accounted for in a shorter repayment period and because of the high default rate on such loans). The inflated cost of borrowing allied to budget inflexibility means households can more easily fall into a debt spiral in cases where further credit or loan rollovers are used to meet existing credit commitments. A cap on the total cost of credit was introduced by the Financial Conduct Authority in 2015, which appears to be preventing some consumer detriment as the number of calls we receive about this debt type has declined. The prospect of an increase in interest rates should not just worry mortgage holders. The quoted average rate of a £10,000 personal loan correlates closely with demand for debt advice. Should these interest rates increase (most likely following a rise in the Bank of England Base Rate), it will be interesting to see whether debt problems remain correlated with this measure, or whether the growth of short-term, high-cost credit means that demand for debt help and the average rate of a £10,000 personal loan are now decoupled.

3.3

Case Study of National Debtline Clients: James and Emma

James and Emma live in Hertford. James works locally in a small, supermarket-branded, convenience store while Emma commutes to London where she works as an Assistant Researcher. They married in 2009 but have held off having children until their finances are on a more stable footing. In 2010 James was given a small promotion at work, which came with a 3.5% pay rise; otherwise his salary has remained unaltered since 2008. Emma’s salary has grown less than 1% in the last five years. In the last couple of years James and Emma have had to consciously cut back spending on various items – eating out only very rarely, rationing use of central heating, staying in

52

3

Facts and Figures of Consumer Over-Indebtedness in the UK: Experience from Debt Advisers

Hertford on weekends rather than travelling farther afield, and paying for items such as a TV Licence and insurance monthly – rather than taking advantage of cheaper ‘pay-in-one’ deals as they had previously done. Despite these conscious spending restrictions, they eventually found themselves unable to pay all their monthly bills. For a year they attempted the delicate balancing act of paying different bills every month and falling into limited arrears with their rent, council tax, energy, water and telephone bills. When their energy arrears grew to three months Emma was encouraged by their supplier to contact National Debtline. An adviser at National Debtline helped Emma to put together a thorough household budget, which showed they were spending about £100 more per month than they had coming in. The adviser helped Emma find a few ways to increase their income (for example by claiming Working Tax Credit) and cut their expenditure (for example by moving on to a water meter), which helped bring their budget in with a surplus that was used to make informal arrangements to pay off their debts in a sustainable way. James and Emma have been working through their repayments for six months and have to manage spending with a great deal of care. They have to respond to any price rises by consuming less. However, they are back in control and hopeful that salary increases might make things easier in the coming years.

3.4

Changes in the Business Debt Landscape

The second major change we have seen has affected our Business Debtline service and is the growth in the number of struggling small businesses. The UK’s small businesses are the heroes of our economy. Whether it is the local plumber on hand to fix a leak or the corner shop we pop into on the way home from work, we all benefit from their success. That success also has a ripple effect across the UK as small businesses help to make other businesses tick by acting as contractors or putting money into the supply chain. Recent years have been marked by a significant increase in the self-employed population. These are our tradespeople, our high-street heroes and our entrepreneurs, many of whom are attracted by the flexibility and rewards that can come from ‘being your own boss’, adding value to the economy in the process. As a result, the UK’s self-employed headcount is now approaching 5 million, and small businesses employ one third of the population. Towards the end of 2015, the number of self-employed people in the UK rose to 4.62 million.17 Across the European Union, the UK has experienced the third largest percentage rise in self-employment since 2009.

17 Office for National Statistics (ONS), UK Labour Market Statistics, September – November 2015.

53

Joanna Elson

The rise in the UK self-employed population mirrors a steady growth in small businesses, in particular non-employing businesses. Since 2000, the number of businesses in the UK has increased each year, by around 3% on average. There were a record 5.4 million private sector businesses at the start of 2015. This is an increase of 146,000 since 2014 and 1.9 million more since 2000. In 2015, there were 1.3 million employing businesses and 4.1 million non-employing businesses. 76% of businesses did not employ anyone aside from the owner.18 Many of the self-employed also set up as sole traders, where there is no legal distinction between them as an individual and the business. In 2015 the UK private sector business population comprised 3.3 million sole proprietorships (62% of the total), 1.6 million actively trading companies (30%) and 436,000 ordinary partnerships (8%) (Figure 3.3).19 Figure 3.3 Growth in the UK private sector business population 2000-2015

Source: Department of Business, Innovation and Skills.

While there is much speculation about the cause of increasing levels of self-employment, key contributing factors are changing lifestyle choices and an ageing population. The number of over-65s who are self-employed has more than doubled in the past five years to nearly half a million. The number of women in self-employment is increasing too at a faster rate than the number of men (although self-employment remains largely maledominated).20 18 Department for Business, Innovation and Skills (BIS), Business Population Estimates – 2015 Statistical Release. 19 Ibid. 20 Office for National Statistics (ONS), Self-employed Workers in the UK, August 2014.

54

3

Facts and Figures of Consumer Over-Indebtedness in the UK: Experience from Debt Advisers

However, some are driven by less desirable influences resulting from the long-term impact of the recession. Redundancies and a lack of suitable employment opportunities coupled with welfare reforms have been cited as possible causes. Some reports suggest that the drop in unemployment figures can be partly attributed to the increase in self-employment as people who are struggling to find work decide to set up on their own. The recent recovery may reverse this trend. However, at present, there are only limited signs this is happening, and indications are that permanent structural changes in the nature of the labour force are here to stay. Positively, when we carried out extended interviews with some of our Business Debtline clients last year, most said they became self-employed from personal choice. However, for a minority, redundancy and little prospect of work on the horizon had forced them down the route of setting up their own business. Many of these people said they felt trapped in this position, finding it hard to make ends meet.

3.4.1

Earning a Living

Many of the UK’s self-employed and micro-businesses are thriving as the recovery continues to gather pace. For the ‘success stories’ this translates as growth and an expectation of improved business performance. However, for some the picture is less optimistic. At Business Debtline, we witness first-hand the specific challenges faced by those who struggle to make a living from self-employment. More than one in ten Business Debtline callers we spoke to for a recent survey have a business that is trading at a loss. Despite the welcome upturn in the climate for many of the UK’s successful businesses, the divide between the incomes of those who are self-employed compared with those of employed people in the UK is widening. On average, self-employed people earn 40% less than a typical employed person, and their incomes have dropped much further than for those who are employed.21 The average income from self-employment in the UK has fallen by 22% since 2008/2009.22 Self-employed people are also not protected by the minimum wage. Perhaps unsurprisingly, many of the Business Debtline callers we surveyed take an income from their business that falls well below the level of this safety net. More than a third of the Business Debtline callers in this survey earn less than £100 a month from their business. Over two-thirds have other sources of income coming into their household, and in a significant proportion of cases these are not the sole earner in the household. Over half receive benefits, and just under half get tax credits, while a smaller number supplement their income with a parttime job. 21 Resolution Foundation, Just the Job – or a Working Compromise?, May 2014. 22 Office for National Statistics (ONS), Self-employed Workers in the UK, 2014.

55

Joanna Elson

These issues can be exacerbated by the challenges of operating a business. Our advisers report that many callers to Business Debtline need support to do a business budget and calculate their turnover and profitability. This can be for a range of reasons, including the fact that the business is a new start-up or because the work is sporadic or seasonal in nature. Factors such as the apparent complexity of doing tax returns have also made ‘sorting out the books’ seem even more overwhelming, especially for those unable to pay for the services of an accountant to help them. Our experience of helping clients shows us that there is also a significant gap in the provision of support to enable people to acquire the skills necessary to operate their business finances. This means that some people start trading without an understanding of the basic skills needed. They may also not have a grasp of what to do to prepare ahead, including some of the ‘groundwork’ they need in place to ensure that their business has the best possible chance of success. Without this, there is a risk that they will be less likely to have a grasp of their finances, and subsequently less likely to spot their financial difficulties until their situation has become more extreme.

3.4.2

Debts

The day-to-day challenges in trading that some businesses face are illustrated by the significant changes we have seen to the levels of debt Business Debtline callers are now struggling to repay. Our clients are accessing lower levels of credit, but finding that their finances are squeezed to such a degree that even these are becoming unmanageable. The challenges of operating a successful and profitable small business, coupled with the rising cost of living, have left many of those surveyed unable to meet basic costs despite cutting back on their expenses. In an attempt to keep up with their bills, some people start to use personal credit such as a credit card to pay for day-to-day essentials like food. This practice, combined with the use of personal credit to cover business expenses, such as paying for suppliers, can leave people saddled with unmanageable debt. Concerns have been expressed over an unequal playing field for small businesses compared with domestic utility customers. The ‘big six’ utility companies have promised better support for businesses by stopping the practice of automatic rollover contracts (the practice of requiring advance notice in writing to terminate a contract and avoid automatic renewal, potentially at an uncompetitive tariff). However, there is still some way to go to ensure that the self-employed are treated in the same way as domestic customers. This includes improved tariff information and pricing transparency to make price comparison and switching easier, and passing on of the benefits of energy tariff reduction to business customers and not just domestic customers.

56

3

Facts and Figures of Consumer Over-Indebtedness in the UK: Experience from Debt Advisers

Small businesses taking part in a survey showed that two thirds (65%) thought it was difficult to switch energy suppliers. Among those who attempted to switch, the biggest problems cited were unclear notice periods, complicated contract terms and the speed of the switching process.23 The level of priority business debts among Business Debtline clients is significant, including Her Majesty’s Revenue and Customs (HMRC) debt as well as business rates or council tax debts. Others owe money on business mortgages, business leases and business utility bills as well as to suppliers. These debts are particularly critical as many impact on whether the business can continue to trade. If creditors do threaten legal proceedings to secure payment, a business owner usually has two options: try to save the business while attempting to settle outstanding accounts or allow the business to fail by implementing an exit strategy that minimises the financial consequences. In Scotland, however, the Government has legislated for a new formally recognised debt support tool for businesses that allows small businesses to fulfil their obligations to creditors and continue to trade.24 The amount of money owed to their suppliers by the self-employed and micro-businesses that are in financial difficulty is only one side of the coin. Many clients are in a position where their business is owed money for the goods and/or services they have supplied to others. For small businesses in particular these debts can be crippling and create a cycle of problems relating to cash flow. Evidence suggests that this is indicative of a wider problem in the UK, with estimates that 76% of businesses are forced to wait three months or more for payment. This results in over a quarter (26%) becoming reliant on an overdraft to make ends meet.25 Research into the late payment burden shows that small and medium-sized enterprises (SMEs) were accumulating a collective £10.8 billion a year in their attempts to recover overdue payments. This represents an average of almost £11,500 each, or £955 a month. That compares with a total cost of £8.2 billion in July 2014.26 To combat suggestions that the Government and local authorities are among the worst offenders for late payment, the Government has set out measures to strengthen its Prompt Payment Code. This voluntary code currently has over 1,700 businesses signed up to it and promotes a thirty-day standard payment limit with a commitment to make all payments within sixty days. The code is intended to complement tougher reporting laws that require the UK’s largest firms to publish their payment terms. A code compliance board has the remit to use this data to check the performance of code signatories and consider ‘naming and shaming’ late payers. 23 24 25 26

Federation of Small Businesses, Small Business Survey, May 2014. This applies to legal entities, e.g. partnerships, limited partnerships, trusts and charities. BACS, Late Payments Are Forcing Businesses to Make Tough Decisions, Media Release, February 2015. BACS, UK Businesses Face a Late Payment Burden, Media Release, July 2015.

57

Joanna Elson

The causes of late payment are also complex and may stem not from an intention to delay the release of monies but instead from internal payment practice inefficiencies within organisations. While this does little to ease the burden that such problems put on the small business owner, having a better understanding of the causes of late payments may help when seeking effective solutions to tackle them. In addition, the problem can be exacerbated by the understandable focus of small businesses on securing and renewing contracts at whatever cost. This may lead some to enter into agreements without fully considering or attempting to negotiate reasonable contractual payment terms. Raising awareness of this issue among new and existing business owners, and considering the feasibility of measures such as a ‘fair contractual payment terms’ standard could help to address these problems.

3.5

Case Study of Business Debtline Clients: Leanne and Martin

Martin and Leanne are a husband and wife partnership whose business has been providing festival catering supplies since 2005. Their small business was owed over £40,000 in invoices that had yet to be paid. As a result, they were struggling with business and personal debts. Without enough money coming in, they were behind on their domestic gas and electricity bills, their council tax and their self-assessment tax and had a penalty charge notice with bailiffs threatening them. Most worryingly, they had mortgage arrears and faced a possession order. When Leanne first called Business Debtline she said she felt totally overwhelmed by their situation. With the home at risk and bailiffs threatening to seize their delivery van, she was struggling to know what to do next. They had been hoping that the monies owed to the business would be paid, and that they could clear their priority debts in full. Unfortunately, this did not happen. As it came into winter, the seasonal nature of festivals made life even more difficult. Leanne needed further emergency advice on getting the house repossession order suspended and was questioning whether they could afford to keep trading. Business Debtline took time to talk through her situation and set out a realistic budget, focusing on how the business was actually performing rather than how Martin and Leanne hoped it would. They also discussed a longer-term analysis of the business to take into account low season figures and suggested that Leanne put money to one side in good periods to offset the low season. They also gave advice on recovering the funds owed. It took over two years to get the business back on its feet, but Business Debtline worked with Leanne and Martin over that period to help them get a reduced and affordable suspended possession order on their home. They also helped them to make affordable payments to keep the van and clear the other debts.

58

3

Facts and Figures of Consumer Over-Indebtedness in the UK: Experience from Debt Advisers

Martin and Leanne are now budgeting for the low season months, and the business provides the family with an income for them to live on.

3.6

Conclusion

The landscape for people in debt and financial difficulties has changed considerably in recent years, in line with social, economic and regulatory changes. Amidst this, the provision and availability of debt advice is more crucial than ever. While we, and other agencies, ultimately strive to help people avoid problem debt, we know that there will always be some level of need for our services. We also know that our advice works – as the testimonies of a few of our clients demonstrate: …..I heard about National Debtline and called – I’m so glad I did because it’s changed my life. I was so stressed and worried about my debts and now I am so happy that after this year I can live my life with no debts. I found the advice invaluable, it saved my life, I was so desperate. I followed all the suggestions, and at last I am clear and have sold my house and paid off all my debts. Thank you. Our own research with clients also shows that getting help with debt problems not only helps people to get out of debt. It can also help people to build their financial resilience and improve their overall well-being. For example, in 2015, 79% of clients felt less likely to find themselves in a similar situation again six weeks after they contacted us, and twelve months later 70% said the actions they took after contacting us had had a positive effect on their overall well-being. However, we know that far too few people who need and would benefit from advice are taking it. We continue to work with other advice agencies in the UK, creditors, Government and regulators to improve the debt landscape, highlight the importance of free debt advice and ensure that it is provided effectively.

59

4

What Explains the Low Impact of the Financial Crisis on Levels of Arrears among UK Households?

Elaine Kempson*

4.1

Introduction

The UK economy was hit quite hard in the recent financial crisis. Yet, although UK households were undoubtedly affected by this, the levels of arrears on household commitments that they experienced were more muted than might have been expected, or were predicted. This chapter explores some possible explanations for this and takes as its starting point a framework that has been proposed to explain the differential effects of the crisis on households across European countries (Kempson, 2015). This suggests that the severity of the impact of the financial crisis on household finances can be explained by three factors. The first of these is the macroeconomic and regulatory environment when the crisis hit and the extent to which this exposed the economy to the effects of the crisis. The second factor is the state of household finances when the crisis occurred, which included high levels of borrowing, of poverty and of insecure employment, mitigated by access to savings and to support from family and friends. Finally, there are the actions that were taken by governments, regulators and others, some to deal with the consequences of the financial crisis and others to minimise its impact on household finances. This framework is used to compare the UK with two close neighbours – Ireland, where the financial crisis had a serious impact on both the economy and household finances, and Norway, where it had little impact on either. In doing so it illustrates that the consequences for UK households, in terms of arrears, were nowhere near as serious as might have been expected from either the nature of the economy or the state of household finances and that this is largely explained by the actions taken to deal with the crisis. Some of these actions will, however, be short-lived and have mitigated rather than eliminated the potential impact on households, leaving many at risk of delayed effects of the crisis.

*

Professor of Personal Finance and Social Policy Research at the University of Bristol.

61

Elaine Kempson

4.2

The Impact of the Financial Crisis on Household Finances

Comparable data from the Eurostat Survey of Income and Living Conditions (EU-SILC) shows that in 2007, before the financial crisis took hold, the proportion of households in arrears on household commitments (rent, mortgage, fuel bills or consumer credit) in the UK (8.5%) was remarkably similar to those in Norway and Ireland and below the average for the (then) twenty-seven countries of the European Union (see Figure 4.1). Figure 4.1 Proportion of households in arrears on household commitments (rent/mortgage, consumer credit commitments or fuel bills)

Source: Eurostat SILC [ilc_mdes05]. Note: 2005 and 2006 figures for the EU twenty-seven countries are estimated.

The financial crisis caused arrears among UK households to rise during 2009 and 2010, and these then fell back steeply so that in 2013 they were half the level recorded in 2007. The latest figures, however, seem to indicate a sharp increase in arrears in the UK. The changes until 2013 were very similar to those occurring in Norway, although here the decline from the peak has been less pronounced. They are, however, in stark contrast to Ireland, where arrears began to rise sooner, more steeply and over a longer period so that they almost trebled in the period between 2007 and 2012. Since then there has been only a very modest decline, and in 2013 the proportion of households in arrears with one or more of their commitments was almost six times higher than in the UK.

62

4

What Explains the Low Impact of the Financial Crisis on Levels of Arrears among UK Households?

Similar patterns can be seen for arrears on rents/mortgages and consumer credit (Figures 4.2a and 4.2b). The situation with regard to the proportion of households in arrears on fuel bills – which tend to be poverty-related – is different (Figure 4.2c). Here the UK experienced a steady increase from 2008 to 2012. This is similar to the pattern in Ireland, although the effect in the UK was less pronounced. Since then, arrears have continued to rise, albeit slowly, while those in the UK have fallen slightly. Norway, in contrast, experienced only a very modest increase up to 2011, but has seen levels of arrears on fuel bills fall since then. This suggests that the effects of the financial crisis on low-income households in the UK may be closer to expectations than the effects among better-off households. Figure 4.2a Proportion of households in arrears on mortgage or rent payments (%)

Source: Eurostat SILC [ilc_mdes06]. Note: 2005 and 2006 figures for the EU twenty-seven countries are estimated.

63

Elaine Kempson

Figure 4.2b Proportion of households in arrears on hire purchase instalments or other loan payments (%)

Source: Eurostat SILC [ilc_mdes08]. Note: 2005 and 2006 figures for the EU twenty-seven countries are estimated.

Figure 4.2c Proportion of households in arrears on fuel bills (%)

Source: Eurostat SILC [ilc_mdes07]. Note: 2005 and 2006 figures for the EU twenty-seven countries are estimated.

64

4

What Explains the Low Impact of the Financial Crisis on Levels of Arrears among UK Households?

The extent to which borrowing-related arrears in Ireland was appreciably worse than in the UK is further shown by World Bank statistics on non-performing bank loans (Figure 4.3). Between 2005 and 2007 the levels in the UK stood at around 1% and were similar to those in Norway and Ireland. By 2009, levels had begun to increase in all three countries, and in the UK reached 4% in 2010 and 2011 before beginning to decline slightly. The increase in Norway was very modest; it is the steep and sustained increase in Ireland that stands out, and by 2013 it stood at 25.7%. Figure 4.3 Total value of non-performing loans to total value of loan portfolio (%)

Source: World Bank [FB.AST.NPER.ZS].

A very similar and more detailed picture in the UK and Ireland can be seen in official statistics on mortgage arrears – the only household commitment where detailed aggregate figures on default are collected routinely. In the case of Ireland these figures are only available from 2009.1 In the UK, the proportion of owner–occupier mortgages more than ninety days in arrears peaked at 2.50% in the second quarter of 2009. It has since fallen steadily and in the second quarter of 2015 was 1.29% (Council of Mortgage Lenders). In contrast, the level of mortgage arrears on owner-occupied properties rose more steeply and over a longer period: from 3.6% in 2009 – a level similar to that in the UK – to 12.9% in the third quarter of 2013. It has fallen back since, but still stands at 9.3% in the second 1

It should be noted, however, that the figures for Ireland and the UK are not strictly comparable. Although both express the arrears outstanding as the number of days’ payments this would represent, the UK statistics relate to borrowers (however many accounts they may have), while the Irish ones are on an account basis.

65

Elaine Kempson

quarter of 2015. But the fall in Ireland has predominantly been among borrowers with lower levels of arrears, and in the second quarter of 2015, 5% of owner-occupied mortgages were more than 720 days in arrears (Central Bank of Ireland). In interpreting these figures it is important to note that households tend to prioritise mortgage payments on their residential homes over other household commitments (Ford et al., 1995), and, as such, they are a conservative indicator of overall levels of arrears among mortgagors. Indeed, as is discussed below, a much higher proportion of mortgage borrowers reported that they were facing difficulties keeping up with payments. The comparable figures for arrears on buy-to-let mortgages are even starker. Such mortgages were fairly common in both countries, but while the financial crisis took a great toll on this market in Ireland, arrears on buy-to-let mortgages in the UK have been a good deal lower. At the end of 2008, 2.31% of UK buy-to-let mortgages were more than ninety days in arrears, with the level falling steadily since. At the end of 2012 (the first year from which Irish figures are available) 1.14% of UK mortgages were over ninety days in arrears; the figure for Ireland was 18.9%, and by the end of 2013 it had reached 21.1%. Although the situation has improved slightly since then, 19% of Irish buy-to-let mortgages were more than ninety days in arrears in the second quarter of 2015, compared with just 0.65% in the UK. Indeed, the proportion that was more than 720 days in arrears was 11.1% and still rising (Central Bank of Ireland and Council of Mortgage Lenders).

4.3

Macroeconomic and Regulatory Environment

UK and Ireland are both members of the European Union, although Norway’s trading agreements with the EU mean that it transposes and complies with EU policy and regulations. But only Ireland was a member of the Eurozone, and this had a significant impact on the room for manoeuvre that the Irish government had in terms of managing the economy to mitigate the effects of the crash compared with the UK. This point is covered again below and certainly helps to explain why the impact on UK household finances was less severe than in Ireland. When the crisis hit, the UK in common with Norway and Ireland had experienced a period of sustained growth, although the growth in Ireland had outstripped that in other European countries during the so-called Celtic Tiger economic boom. There were, however, important differences in the extent to which the economies of the three countries were reliant on sectors such as financial services or construction, which were at risk in the economic downturn. All three countries’ economies were reliant on household consumption for GDP growth (Grytten and Hynnes, 2010, Norris and Winston, 2011, Office for Budget Responsibility,

66

4

What Explains the Low Impact of the Financial Crisis on Levels of Arrears among UK Households?

2015, Scanlon et al, 2011). In the words of Lord George (former Governor of the Bank of England), in his evidence to the Treasury Select Committee on Treasury in March 20072: … when we were in an environment of global economic weakness at the beginning of the decade it meant that external demand was declining. Related to that, business investment was declining. One had only two alternatives in sustaining demand and keeping the economy moving forward: one was public spending and the other was consumption. It is true that taxation and public spending can influence the demand climate and consumer spending, but confronted with what we saw we knew that we had to stimulate consumer spending. We knew that we had pushed it up to levels that could not possibly be sustained in the medium and longer term, but for the time being if we had not done that the UK economy would have gone into recession, just like the economies of the United States, Germany and other major industrial countries. That pushed up house prices and increased household debt. That problem has been a legacy to my successors; they have to sort it out, but we really did not have much of a choice about what we did unless we accepted that we would yank it back or give up stability altogether. Like many other major economies, the UK, Ireland and Norway all experienced strong and long-term growth in real house prices. Over a ten-year period to 2007, UK house price rises averaged 11.23% a year; in Norway they were 9.3%. In Ireland, they were even higher than in the UK and averaged 14.92% a year over the ten years to the peak in 2006 (European Mortgage Federation, 2007 and 2014, see also Scanlon et al, 2011). This boom in prices has been attributed to a combination of continuing income growth and benign monetary conditions (McCarthy and McQuinn, 2014). The rise in house prices led to high levels of borrowing among households in all three countries, as discussed below. There were, however, some important differences between the three economies. Both the UK and the Irish economies relied heavily on the financial services sector (Blacklock and Whittaker, 2014). This contrasts with Norway, where banks accounted for only 2% of the economy and where lessons had been learned from the previous financial crisis in 1987-1992, which hit the Nordic countries especially hard and led to several major banks being taken over by the Norwegian government. Consequently, in Norway in 2007-2008 there was more robust regulation covering the whole financial sector (Grytten and Hynnes, 2010). When the crisis hit, both the UK and Ireland had to take major banks into partial or full public ownership, and this led to a large increase in their budget deficits. In Ireland this culminated in the need to request financial assistance from the so-called Troika – the 2

.

67

Elaine Kempson

European Commission, the European Central Bank and the International Monetary Fund – and the terms of this further affected the actions that the Irish government had to take to resolve the effects of the crisis. Again we return to this below. Ireland’s economy, unlike those of the UK or Norway, was also heavily exposed to the construction industry. Over the ten years to the peak in 2006, the number of annual housing completions in Ireland rose from 38,842 to 93,419 partly because of the house price boom (McCarthy and McQuinn, 2014). Over the same period the number of completions a year in the UK rose far more gradually – from 191,075 to 219,070 – indeed, for part of this time the number declined. Norway experienced a growth in house building that was only slightly higher than that in the UK. This means that at its peak in 2006 the number of completions in Ireland was equivalent to 5.08% of the housing stock a year; comparable figures for the UK and Norway were 0.83% and 1.34%, respectively (European Mortgage Federation, 2007 and 2014). Writing in the Irish Times in December 2006, Morgan Kelly, professor of economics at University College Dublin, noted that the construction industry accounted for 18% of the Irish economy and employed about a fifth of Irish workers.3 Following the financial crisis, housebuilding in Ireland fell dramatically, and in 2013 there were just 8,301 housing completions – about 8% of the number at the peak (European Mortgage Federation, 2007 and 2014). This led to widespread job losses and increased the exposure of Irish households compared with their UK counterparts. In contrast, the Norwegian economy was dominated by the oil and gas industry, and high prices helped to sustain the economy when the crisis occurred. Hence, it was one of only a small number of developed economies to have avoided a serious impact of the financial crisis. Low oil prices in 2015, however, are adversely affecting the economy.4 Bringing this together, there can be little doubt that the UK macroeconomic and regulatory environment was not as robust as that in Norway, and this meant that the UK economy (and potentially UK household finances) was far more exposed when the financial crisis occurred. It is also clear that Ireland was even more exposed. This is reflected in the incredibly steep rise in arrears among Irish households. However, the increase in arrears that UK households experienced was far more muted than might have been expected, and the proportion of households in arrears with commitments was (and has remained) remarkably similar to that in Norway, despite the macroeconomic and regulatory environments being very much more benign.

3 4

. and .

68

4

4.4

What Explains the Low Impact of the Financial Crisis on Levels of Arrears among UK Households? State of Household Finances

In the run-up to the financial crisis, UK households were experiencing rising prosperity and low unemployment, but were borrowing ever larger sums of money – both in cash terms and also as a proportion of their income. At the same time, they were saving less. Similar trends were experienced in Ireland and Norway prior to 2007. Potentially, this put UK and Irish households at risk when the economy went into recession, incomes fell and unemployment rose. Most significantly, there were important differences across income groups with UK households on the lowest incomes experiencing much lower long-term increases in real incomes (indeed, they experienced a fall in some cases), as well as similar disparities in changes in wealth and savings ratios. Here similar trends can be found in Ireland, but both income and wealth disparities were (and remain) very much smaller in Norway. At the time of the financial crisis, UK households had experienced an extended period of rising prosperity, with rising incomes and low levels of unemployment. Disposable incomes in the UK had risen steadily, and in 2007 stood at €23,161, which was well above the EU average and on a par with those in Norway. Incomes in Ireland had also grown steadily, but were somewhat lower (Figure 4.4a). The UK also experienced increasing income disparities so that long-term income growth for the three lowest income quintiles was appreciably lower than in better-off households (Lucchino and Morelli, 2012). Levels of unemployment in the UK had been low and in the range of 5%-6% for ten years. This it also shared with Ireland and Norway, and in 2007, unemployment levels in Ireland and the UK were similar – Norway’s was half their rate, however (Figure 4.4b). Figure 4.4a Real adjusted gross disposable income of households per capita

Source: Eurostat [tec00113].

69

Elaine Kempson

Figure 4.4b Total unemployment rate (%)

Source: Eurostat [tsdec450]. Note EU 28: data not available before 2000. Norway: breaks in time series in 1995, 1997 and 2006.

The rising prosperity of households was accompanied by the removal of constraints on bank lending arising from access to the wholesale market for funding. This resulted in a sustained increase in the levels of both secured and unsecured borrowing in the UK. The total amount owed by UK households rose from just over £511 billion at the end of 1997 to over £1.35 trillion at the end of 2007. The bulk of this was in the form of mortgages, but almost £196 billion was owed in unsecured credit (Figure 4.5).

70

4

What Explains the Low Impact of the Financial Crisis on Levels of Arrears among UK Households?

Figure 4.5 Amounts outstanding in lending to UK individuals (£ billion)

Source of Data: Bank of England.

The amounts borrowed outstripped rises in incomes so that the gross borrowing-to-income ratio of UK households rose from 103.92 in 2001 to 143.09 in 2008 (Figure 4.6a). The rise in Ireland, however, was even steeper and more than doubled in this period to its peak of 207.27 in 2009. This has been attributed to the significant rises in disposable income and dramatic falls in unemployment going hand in hand with persistent increases in house prices and substantial levels of housing activity (McCarthy and McQuinn, 2014). The increase in the borrowing-to-income ratios of Norwegian households was also greater than in the UK. As might be expected, a similar picture exists for the ratios of outstanding mortgage loans to disposable income (Figure 4.6b). Figure 4.6a Gross borrowing-to-income ratio of households (%)

Source: Eurostat [tec00104]. Note: Ireland: data not available for 2001; Norway data not available for 2013.

71

Elaine Kempson

Figure 4.6b Total mortgage borrowing-to-income ratio of households (%)

Source of Data: European Mortgage Federation 2014.

This rise in the level of borrowing was accompanied by looser lending practices, especially among mortgage lenders not only in the UK but also in Ireland and Norway. These practices included an increase in self-certified and interest-only mortgages and also in loan to value (LTV) and loan to income (LTI) ratios (Blacklock and Whittaker, 2014; Ford and Wallace, 2009; Fuentes et al, 2013; Gerlach-Kristen and Lyons, 2015; Grytten and Hynnes 2010; Lydon and McCarthy, 2011; McCarthy, 2014; McCarthy and McQuinn, 2014; Norris and Winston, 2012; Wallace and Ford, 2010). As a result of falling home-ownership levels, mortgage lenders diversified away from the traditional home-ownership market towards higher risk lending. There was a notable change in the profile of borrowers, and specialist lenders providing mortgages to high-risk borrowers accounted for 7% of the UK mortgage market in 2009. Mortgages were offered to borrowers previously excluded from mainstream borrowing (Ford and Wallace, 2009; Wallace and Ford, 2010). At the same time, there was a significant growth in both equity withdrawal, not just in the UK (Ford and Wallace, 2009; Wallace and Ford, 2010) but also in Ireland (McCarthy, 2014) and Norway (Almaas et al, 2015). Buy-to-let mortgages also increased in number both in the UK and in Ireland (Ford and Wallace, 2009; Lydon and McCarthy, 2011; Wallace and Ford, 2010). As household borrowing in the UK rose, levels of saving fell. In 2008, when borrowing peaked, the savings rate was just 5.81% compared with 10.77% seven years earlier (Figure 4.7). This was half the rate in Ireland and Norway at that time.

72

4

What Explains the Low Impact of the Financial Crisis on Levels of Arrears among UK Households?

Figure 4.7 Household saving rate (%)5

Source: Eurostat [tsdec240].

Moreover, once again there are important differences across income groups in the UK. There was a mild decline in savings rates across most income groups, but the decline among the lowest income decile was especially steep (Lucchino and Morelli, 2012). Both the UK and Ireland had wide disparities of net wealth-holding (that is assets less liabilities in the form of borrowing) (Lawless et al, 2015; Office of National Statistics, 2008). At the time of the financial crisis, the poorest wealth decile in the UK had negative wealth values for both property and financial wealth, and any wealth they had was in the form of physical assets. And if pension wealth is excluded they had negative wealth overall. The second-lowest decile had just over £40,000 in assets – almost all of it in physical assets; indeed, their financial wealth was negative and property wealth only just positive. Even in the third lowest wealth decile, which had mean total assets of £85,000, most of it was in physical wealth, and only £20,000 was in the form of property wealth. Looked at in the round, disparities in income, borrowing, saving and net wealth put a sizeable minority of UK households at risk when the financial crisis hit. After the crisis hit, all this changed – at least in the UK and in Ireland. Unemployment began to rise, but not to the extent predicted in the UK. It peaked in 2011 at 8.1%. In contrast, Ireland, with its heavy reliance on the construction industry, saw unemployment 5

The gross saving rate of households (including Non-Profit Institutions Serving Households) is defined as gross saving (ESA2010 code: B8G) divided by gross disposable income (B6G), with the latter being adjusted for the change in the net equity of households in pension funds reserves (D8net). Gross saving is the part of the gross disposable income that is not spent as final consumption expenditure. Detailed data and methodology on site .

73

Elaine Kempson

rates peak at 14.7% in 2011 and 2012 (see also Fuentes et al, 2013). In contrast, Norwegian rates rose only modestly to 3.5% in 2013 and 2014 (Figure 4.4b). Real adjusted disposable incomes in the UK fell between 2007 and 2011, from €23,161 to €21,439, the level they had been in 2004 (Figure 4.4a). They fell most for the lowestincome decile households (Lucchino and Morelli, 2012). Irish households experienced a fall in incomes of a similar order of magnitude, taking them below the EU average in 2011 for the first time in over fifteen years. But while UK incomes have recovered slightly since 2012, those in Ireland have continued to fall. Norwegian households, in contrast, continued to see a rise in their prosperity, reflecting the buoyancy of their economy. Following the crisis, new lending was curtailed, and the total amounts owed by UK households, which had peaked in September 2008 at £1.39 trillion, fell back slightly for the three years to December 2011 as new lending dried up (Figure 4.5). The fall in unsecured credit was, however, more marked than that for secured lending. Between September 2008 and April 2013 the total amounts owed by UK households in unsecured credit fell from £208 billion to £156 billion as households reined in their spending and paid back outstanding balances. The amounts owed by UK households then increased once again and reached a new high of more than £1.45 trillion in September 2015 (Figure 4.5). Unsecured borrowing, however, was still some way from its previous high. And while the gross borrowingto-income ratios fell in both the UK and Ireland in response to the slowdown in lending, they have continued to rise in Norway (Figure 4.6a). The fall in unsecured borrowing by UK households was accompanied by a temporary rise in the rate of saving in 2009 and 2010, but it has since fallen to a new low of 5.40% at the end of 2014 and is way below the level found in Norway and similar to that in Ireland (Figure 4.7). The other significant change at this time was a drop in house prices, taking some households into negative equity. In the UK this amounted to a small and short-lived correction in 2008 (down 0.9%) and 2009 (down 7.8%). Norway also faced a small correction in 2008 (down 1.1%). But in Ireland the correction was both large and sustained – with prices falling by an average of 12.8% a year over five years from 2007 to 2012, before rising slightly in 2013 (European Mortgage Federation, 2007 and 2014). Moreover, about 30% of the total stock of mortgages in 2007 had been issued in the previous two years (McQuinn, 2014). This has left many Irish households with very high levels of negative equity, which research has shown is strongly linked to being in arrears (Fuentes et al, 2013; GerlachKristen and Lyons, 2015; McCarthy, 2014; McCarthy and McQuinn, 2014; McQuinn, 2014; Norris and Winston, 2015). This was particularly important in the Irish buy-to-let market, where yield (based in part on house price growth) has a significant effect on the propensity to keep up with mortgage payments. So many UK households were at considerable risk of getting into financial difficulties when the financial crisis occurred. The risks faced by Irish households were greater still,

74

4

What Explains the Low Impact of the Financial Crisis on Levels of Arrears among UK Households?

and this is reflected in the levels of arrears that ensued (see above). Of particular interest is the comparison between the UK and Norway. Households in both countries were similarly exposed, but, as we have seen, the UK economy was badly hit by the financial crisis, whereas the Norwegian economy escaped any serious effects. This meant that in the UK there was a rise in unemployment and a fall in real disposable incomes as well as a modest house price correction. In contrast, Norwegian households continued to prosper, and savings rates were appreciably higher. Taken together, one would expect the level of arrears in the UK to have risen above those in Norway and to be rather closer to those in Ireland. Instead, they have remained lower. The explanation for this almost certainly lies in the action taken to deal with the downturn in the UK economy.

4.5

Responses to the Crisis by Governments, Regulators and Others

A number of macroeconomic factors have acted to reduce the financial strain felt by UK households, including the large cut in interest rates, the modest house price correction, cutbacks in lending and borrowers paying off unsecured credit and starting to save. The UK, like Norway, has a national central bank setting monetary policy, whereas Ireland is part of the Eurosystem. This meant that the UK, unlike Ireland, could reduce the real impact of the crisis by allowing its currency to devalue and by reducing interest rates, as also happened in Norway. Although interest rates fell in Ireland, the timing and the extent of this was controlled by the European Central Bank, not the Irish government. There can be little doubt that the large cut in the base rate by the Bank of England to an historic low and its maintenance at this level for a sustained period has played a significant part in containing the level of arrears in the UK (Blacklock and Whittaker, 2014, Financial Conduct Authority, 2012; Financial Services Authority, 2011; Wallace and Ford, 2010). Ireland had a profound sovereign financial crisis necessitating financial assistance from the EU and the IMF. The terms of the financial assistance package from the Troika were such that the austerity measures that the Irish government needed to put in place were more severe in the short term than those the UK government introduced, and led to much higher levels of unemployment (Norris and Winston, 2011). This led to high levels of financial difficulty and arrears among Irish households. It is, however, likely that severe and swift austerity would have happened even if the international programme of support had not been sought. And the restrictions Ireland faced as a result of being part of the Eurosystem need to be set against the relative stability it afforded a small country like Ireland and the access that banks had to European Central Bank liquidity in a stable international currency. In contrast, the much lower levels of unemployment in the UK have helped to contain levels of arrears (Financial Conduct Authority, 2012; Financial Services Authority, 2011).

75

Elaine Kempson

Compared with Ireland, the UK also experienced a much smaller house price correction, which affected a smaller proportion of the population and for a shorter time and can almost certainly be attributed to the long-standing shortage of housing in the UK (Blacklock and Whittaker, 2014). This meant that UK households facing financial difficulty had a greater incentive to keep up with their mortgage repayments than many of their Irish counterparts. In theory they were also able to trade down or sell up in order to pay off or avoid arrears, although this was constrained by the slowdown in the housing market. The main exception to this was in Northern Ireland, which was exposed to effects in the Irish housing market and experienced similar levels of negative equity. The collapse in lending by UK banks was, as was seen above, accompanied by consumers temporarily paying back unsecured credit and increasing their level of saving (McCarthy and McQuinn, 2014). Although short-lived, this will also have helped to contain the level of arrears UK households experienced. Indeed, there is evidence that it was households with the highest levels of mortgage borrowing who cut back spending most in the years after 2007 (Bunn, 2014). Also of significance were a range of actions taken by the UK government, the financial services regulator and lenders themselves to contain levels of arrears and that led to a period of ‘managed forbearance’ (Blacklock and Whittaker, 2014; Wallace and Ford, 2010). Since the previous economic recession in the early 1990s, there have been some significant changes in lender forbearance in the UK – by both secured and unsecured lenders – allowing borrowers time to recover from economic shocks and facilitating the repayment of arrears (Aron and Muellbauer, 2010; Blacklock and Whittaker, 2014; Gall, 2009; Ford and Wallace, 2009; Wallace and Ford, 2010 p. 139ff). At its best this involved a shift to a ‘holistic end-to-end view’ of the customer experience, tailoring solutions to individual customers’ needs. It includes arrears management systems (both in-house and outsourced) that are customer-orientated and proactive, with effective engagement with borrowers at an early stage in their financial difficulties, as well as more imaginative approaches to debt recovery and the avoidance of litigation (Collard, 2011; Dominy and Kempson, 2003; Financial Conduct Authority, 2014; Ford and Wallace, 2009). This strategic shift to being more focussed on supporting arrears recovery was underpinned by Bank of England Special Liquidity Schemes and rising equity in homes after the initial correction in prices. In many cases, the use of forbearance was also driven by a realisation by lenders that there was a good business case for doing so as well as a significant cultural shift among some lenders (Ford and Wallace, 2009). However, the degree of voluntary change varied across lenders and, where lenders’ procedures were process-driven and formulaic, was enforced by regulatory action by both the Financial Conduct Authority (Blacklock and Whittaker, 2014; Financial Conduct Authority, 2014) and its predecessor, the Financial Services Authority (Gall, 2009; Wallace and Ford, 2010). It has been calculated that 28% of mortgage borrowers and 47% of unsecured borrowers in forbearance would

76

4

What Explains the Low Impact of the Financial Crisis on Levels of Arrears among UK Households?

have been in arrears but for the actions of their lender. Grossing up showed that a further 3.4% of mortgages would have been in arrears in the absence of forbearance measures (Kamath et al, 2011). And the Financial Services Authority reported that, at the end of 2009, for every residential mortgage in arrears a further two were in forbearance (Financial Services Authority, 2011). In contrast, such forbearance was largely absent among Irish lenders when the financial crisis began to take its toll. Most Irish lenders had no or inadequate processes and expertise in place to deal with arrears, and no scalable long-term sustainable solutions. In contrast to the UK, figures on forbearance from the Central Bank of Ireland show a picture that is the mirror image of the one in the UK. In December 2010 (the earliest data available) for every one mortgage account that was in forbearance another 2.5 were in arrears. Changes in how lenders handled mortgage arrears came about largely through the introduction and enforcement of the Mortgage Code by the Central Bank, and a lot of time was lost while the institutions put the required resources and arrangements in place. During this time, arrears levels soared (Andritzky, 2014). The tightening up on arrears management and recovery by the Financial Conduct Authority and Financial Services Authority was accompanied by a reining in of the loose lending practices that had contributed to the crisis (Blacklock and Whittaker, 2014). In common with regulators in Ireland and Norway, the Financial Conduct Authority put new mortgage lending rules in place to ensure the affordability of new lending. It has also begun taking action against exploitative unsecured lenders since it took over responsibility for this sector in 2014. In addition to regulators and lenders, the UK government also took swift action to stem the increase in mortgage arrears (Blacklock and Whittaker, 2014). This included substantial changes to the eligibility of home owners for Support for Mortgage Interest, which is payable to people who are out of work. Most significant of these was the reduction in the waiting period between job loss and receiving assistance from thirty-nine to thirteen weeks. This has been shown to have had a marked effect in lowering levels of mortgage arrears and possessions (Aron and Muellbauer, 2010; Wallace and Ford, 2010). The government also introduced a Pre-action Protocol for Possession Claims in England and Wales at the end of 2008 (Ford and Wallace, 2009; Long and Wilson, 2010). Although this reform was already in the pipeline, it was introduced earlier than originally planned. This covers all mortgages and secured loans and requires lenders to have taken all reasonable steps to contact the borrower to discuss their financial circumstances and the reasons for their arrears and to have exercised full forbearance before seeking possession of a home6 (Ford and Wallace, 2009). A similar scheme was also introduced in Northern Ireland, but not in Scotland. 6

.

77

Elaine Kempson

A Mortgage Rescue Scheme and a Homeowner Mortgage Support Scheme were introduced by the UK government at the beginning of 2009, although the numbers of people assisted in these ways were quite small (Long and Wilson, 2010, Wallace and Ford, 2010). Finally, there were many other factors that have undoubtedly played a part in containing the levels of arrears of all kinds being experienced by UK households. First, the UK is generally considered to be at the forefront of international practice in the provision of legal procedures relating to debt and insolvency. This contrasts with the situation in Ireland, where the system was in great need of reform and these reforms were introduced seven years after the crash occurred (Andritzky, 2014). It also contrasts with Norway, where the Debt Settlement process is designed to recover the money owed by creditors rather than rehabilitating the debtor and giving them a fresh start. It can also be accessed only once in a lifetime. The UK’s labour market was restructured some time ago, and the flexibility of both employers and employees meant that levels of unemployment were much lower than in previous recessions. Given the strong link between job loss and financial difficulties, this has undoubtedly played a significant role in keeping levels of arrears low (Financial Conduct Authority, 2012; Financial Services Authority, 2011). At the same time, while employment levels have held up, underemployment was, and remains, a problem, and there has been a sharp fall in real earnings (Blacklock and Whittaker, 2014). There is one further factor that is generally considered to have had a significant effect on household finances in the UK, and that is the incredibly high level of compensation paid to people who were mis-sold payment protection insurance policies. Official figures from the Financial Conduct Authority show that between January 2011 and August 2014 a total of £21 billion was paid out. In February 2014 the average amount paid per customer was £2,810, and most people spent the money on things they would otherwise have borrowed the money for, including major purchases such as cars or household appliances and paying bills.7 In Ireland, the regulator acted more swiftly and, before the problem escalated, required all firms that had sold payment protection insurance to carry out a back book review and to compensate customers to whom it had been mis-sold. As a consequence, its effect on household finances was much less pronounced than in the UK in terms of both the number of people affected and the sums of money they received. In total, €67 million was paid to 77,000 policyholders – an average of €870 per policyholder compared with almost four times that amount in the UK. Setting total payment protection insurance payout of £21 billion in context, it is equivalent to an 11% reduction in the amount outstanding in consumer credit in 2009.

7

.

78

4

What Explains the Low Impact of the Financial Crisis on Levels of Arrears among UK Households?

Other calculations have shown that PPI payouts have been the equivalent of 0.2% to 0.6% of total annual household expenditure, depending on the particular year.8 And, in 2012, the National Institute for Economic and Social Research calculated that, should total payouts reach £15 billion, this would boost UK GDP by 0.7%. Indeed, when the independent Office for Budget Responsibility revised its 2012 growth forecast in March 2012 from that published in the previous November, it assumed that PPI payouts would boost inflationadjusted household incomes (Office for Budget Responsibility, 2012).9

4.6

Looking to the Future

There can be little doubt that households in the UK were protected from the effects of the financial crisis and the recession that followed primarily through a range of actions that were taken to mitigate the effects, but also by some fortuitous factors. Consequently, levels of arrears never came anywhere close to those seen in Ireland and have, instead, tended to mirror those experienced by households in Norway, where the economy was relatively unaffected by the crisis and continued to grow until the large fall in oil prices in 2015. Moreover, levels of arrears among households in the UK have been falling in recent years. So does this mean that we can now put the crisis behind us? The answer to this is ‘Probably not.’ Many of the risk factors that were present in the UK at the start of the crisis are still evident, exposing households who escaped, or have recovered from, the effects of the previous downturn to a future financial shock. These risks are heightened by the fact that some of the mitigating factors discussed above are time-limited and their removal could precipitate an increase in the financial strain on households in the UK.

4.6.1

Many Households Remain under Financial Strain

Despite the upturn in the economy, many UK households have not seen a rise in their incomes and remain under financial strain. As we have already seen, real adjusted incomes are still below their level in 2007 (Figure 4.4a). Wage levels have recovered to some extent, but those of the lowest-paid workers have not recovered to the same extent as those of the better-off (Blacklock and Whittaker, 2014). Although levels of employment are high, many new jobs are part-time and more insecure. And this situation will be made worse for the poorest households by the proposed cuts to Tax Credits, which will not be offset by the increase in minimum wage and will see incomes of the poorest families fall (Elming et al, 2015).

8 9

Ibid. .

79

Elaine Kempson

At the same time, the level of consumer borrowing remains high (Figure 4.5), and as a consequence, many low- to middle-income households in the UK remain under financial strain. Figures from the Bank of England showed that more than four out of ten (44%) mortgagors reported that they were concerned about the burden of their borrowing, and 15% of tenants said that they were concerned about their level of unsecured borrowing (Anderson et al, 2014). The Money Advice Service 2015 survey of financial capability found that almost one in five households (18%) was facing financial difficulties in 2015 and that this was strongly associated with low income (Money Advice Service, 2015). This percentage was hardly changed from the figure two years previously, when it was reported that for every two UK households in arrears another one reported having levels of borrowing that were a burden (Money Advice Service, 2013). Further analysis of the 2013 data showed that there were few differences between these two groups and, for example, around seven in ten of each group thought that living in debt was inevitable for them in the current economic climate. The main difference between them related to their access to credit. Two thirds of those in arrears had been declined credit in the past twelve months, compared with one in five of those who were up-to-date with payments but reported that their level of borrowing was a burden (Whittaker, 2013). Qualitative research with low- to middle-income households that had avoided getting into arrears with commitments following the financial crisis showed that they had done so through a diverse range of strategies, not all of which were sustainable. They had deployed tighter techniques of money management, cut back spending on essentials as well as nonessentials, but were also relying on unsecured credit – and credit cards and overdrafts in particular – to meet shortfalls in their incomes (Finney and Davies, 2011). These are the very households that have experienced least growth in their incomes since the research was undertaken. The Resolution Foundation has estimated that in 2014, 13% of mortgagors (1.1 million) were spending more than 30% of their after-tax income on mortgage repayments. As might be expected, there was considerable variation by household income. Two thirds (66%) of the decile of mortgagors with the lowest household incomes were spending 30% or more of their income on their mortgage. For the second-lowest decile it was just over a quarter (27%), and for the third and fourth deciles almost one in five (18%) (Blacklock and Whittaker, 2014). Similar analysis undertaken by the Bank of England estimated that in 2014 around 4% of mortgagors (equivalent to 1% of all households) had mortgage payments that were 40% or more of their gross income and this had fallen by one percentage point since 2011 (Anderson et al, 2014). Although levels of mortgage arrears have been low, the proportion of mortgagors reporting problems meeting their monthly payments is a good deal higher – and higher than might be expected given the base rate. In September 2014, 14% of mortgagors reported

80

4

What Explains the Low Impact of the Financial Crisis on Levels of Arrears among UK Households?

that they were having problems keeping up-to-date with payments, compared with only 1.4% who were in arrears (Anderson et al, 2014). That proportion had, however, fallen substantially from 19% in the previous year. Many of these people (perhaps as many as a million) will be locked into their existing mortgage because of the tightened mortgage lending rules and, consequently, be unable to trade down to lessen the burden of their mortgage payments (Blacklock and Whittaker, 2014). It is, therefore, of some concern that, in their thematic review of mortgage lender forbearance, the Financial Conduct Authority reported that not all lenders had put in place provisions either to identify or to help customers who are showing signs of financial strain or whose circumstances put them at risk of experiencing such strain (Financial Conduct Authority, 2014). In any case, forbearance can only buy time for home owners in financial distress until their income rises or the equity in their home increases and they can trade down to get out of financial difficulty.

4.6.2

An Upturn in Consumer Spending and Borrowing, and a Downturn in Saving

There are also signs that consumers may be reversing the restraint they showed in relation to borrowing immediately after the crisis hit, quite possibly because interest rates have remained low. House prices are rising, and so, too, are levels of both secured and unsecured borrowing. At the same time, levels of non-pension saving have been falling. The Office for Budget Responsibility has expressed concern that house prices are rising, and their forecast for 2015 is 8.5% rise. Household consumption is also rising and is predicted to exceed the increase in household disposable income. Consequently, levels of borrowing for both house purchase and consumer spending are rising, and the OBR forecasts that household borrowing-to-income ratios will almost regain their previous peak by the end of 2018/19 and exceed it in 2020 (Office for Budget Responsibility, 2015). The tighter mortgage lending rules that have been introduced by the Financial Conduct Authority to ensure mortgage lending is affordable raise concerns about the extent to which unsecured lending will fill the gap. Equity withdrawal is now more difficult and, as a consequence, some borrowers can be expected to turn to higher-cost unsecured credit to consolidate debts when they face financial difficulties.

4.6.3

Some of the Mitigating Factors Are Inevitably Time-Limited

As noted above, compensation for the mis-selling of payment protection insurance has played a significant part in containing levels of financial difficulty. Most banks and the Financial Ombudsman Service reported a decline in the number of such complaints between

81

Elaine Kempson

2013-2014 and 2014-2015, and the FOS also reported a substantial decline in the proportion of complaints that they uphold. Changes made in response to the financial crisis to Support for Mortgage Interest payments will end in 2016, when borrowers will have to wait thirty-nine weeks for the first payment instead of thirteen. Moreover, the government has announced that from 2018 such payments will be made as a repayable loan. But the main area of concern is what will happen when interest rates begin to rise. The effects of this on households will clearly depend on the sequencing of rises and economic environment at the time, including house prices, levels of household borrowing, employment levels and wage inflation. Conversely, a delay in raising rates runs the risk of excessive consumer borrowing. The Bank of England survey (noted above) asked households who were concerned about their level of borrowing what was causing that concern. Well over a third (36%) cited the possibility of being unable to meet loan repayments if interest rates rose (Anderson et al., 2014). Opinions differ on the likely impact of an interest rate rise. Analysis by the Resolution Foundation shows that exposure to rate rises is concentrated mainly among low- to middleincome households (Blacklock and Whittaker, 2014) and the impact will depend on whether incomes across the households most affected have increased sufficiently to accommodate them. They also estimated in 2014 that a rise in the base rate of two or two and a half percentage points by 2018 could lead to a doubling in the number of mortgagors with a 30% mortgage loan servicing ratio from 13% to 27% (equivalent to 4.0% to 8.3% of all households) (Blacklock and Whittaker, 2014). The Bank of England has estimated that if interest rates were to rise by two percentage points, while over the same period incomes rose by 10%, the proportion of all households that have a 40% mortgage loan servicing ratio would rise from 1.3% to 1.8% (equivalent to a rise from 4.2% to 5.9% of mortgagors). However, the authors note that this remains well below previous peaks for this measure (Anderson et al., 2014). We do not know how ‘at risk’ borrowers will behave as interest rates rise. They could cut back on other spending, borrow to make ends meet or fall into arrears or any combination of these. Nor do we know whether lenders will continue to exercise forbearance when interest rates rise or how they will react when the terms for Support for Mortgage Interest change. The one thing that remains clear is that households in the UK are every bit as vulnerable now as they were when the financial crash occurred and, as a consequence, the outlook for the future is uncertain. In the words of the former chair of the Financial Services Authority:

82

4

What Explains the Low Impact of the Financial Crisis on Levels of Arrears among UK Households? While my fellow economists and I may differ on the solutions to this problem, all of us agree on one thing. If we can’t break this dependence on debt, it is only a matter of time before we face another disaster. (Adair Turner: The Debt Business, Radio 4, 30 August 2015)

References S. Almaas, L. Bystrøm, F. Carlsen and X. Su, Home Equity-Based Refinancing and Household Financial Difficulties: The Case of Norway, June 20, 2015. Available at SSRN: or ; . G. Anderson, P. Bunn, A. Pugh and A. Uluc, ‘The Potential Impact of Higher Interest Rates on the Household Sector: Evidence from the 2014 NMG Consulting Survey’, Bank of England Quarterly Bulletin, Quarter 4, 2014, pp. 419-433. J. Andritzky, Resolving Residential Mortgage Distress: Time to Modify? Working Paper 14/226, International Monetary Fund, Washington, DC, 2014. J. Aron and J. Muellbauer, Modelling and Forecasting UK Mortgage Arrears and Possessions, Department of Economics, University of Oxford, Oxford, 2010. K. Blacklock and M. Whittaker, Hangover Cure: Dealing with Household Debt Overhang as Interest Rates Rise, Resolution Foundation, London, 2014. P. Bunn, ‘Household Debt and Spending’, Bank of England Quarterly Bulletin, Quarter 4, 2014, pp. 304-314. S. Collard, Understanding Financial Difficulty: Exploring the Opportunities for Early Intervention, Barclays, London, 2011. N. Dominy and E. Kempson, Can’t Pay or Won’t Pay? A Review of Creditor and Debtor Approaches to the Non-payment of Bills, Department for Constitutional Affairs, London, 2003. W. Elming, C. Emmerson, P. Johnson and D. Phillips, An Assessment of the Potential Compensation Provided by the New ‘National Living Wage’ for the Personal Tax and Benefit

83

Elaine Kempson

Measures Announced for Implementation in the Current Parliament, Briefing Note 175, Institute for Fiscal Studies, 2015. European Mortgage Federation, Hypostat: a Review of Europe’s Mortgage and Housing Markets, European Mortgage Federation – European Covered Bond Council, Brussels, 2007 and 2014. Financial Conduct Authority, Retail Conduct Risk Outlook 2012, Financial Conduct Authority, London, 2012. Financial Conduct Authority, Mortgage lenders’ arrears management and forbearance, Thematic review TR14/3, Financial Conduct Authority, London, 2014. Financial Services Authority, Prudential Risk Outlook 2011, Financial Services Authority, London, 2011. A. Finney and S. Davies, Facing the Squeeze, Personal Finance Research Centre, Bristol and Money Advice Trust, London, 2011. J. Ford, E. Kempson and Wilson, Mortgage Arrears and Possessions: Perspectives from Borrowers, Lenders and the Courts, HMSO, London, 1995. J. Ford and A. Wallace, Uncharted Territory: Managing Mortgage Arrears and Possessions, Shelter, London, 2009. G. Fuentes, A. Etxarri, K. Dol and J. Hoekstra, ‘From Housing Bubble to Repossessions: Spain Compared to Other West European Countries’, Housing Studies, Vol. 28, No. 8, 2013, pp. 1197-1217. A. Gall, Understanding Mortgage Arrears, Building Societies Association, London, 2009. P. Gerlach-Kristen and S. Lyons, Mortgage Arrears in Europe: The Impact of Monetary and Macroprudential Policies, Swiss National Bank, Zurich, 2015. O. H. Grytten and A. Hunnes, A Chronology of Financial Crises for Norway, Discussion Paper, Norwegian School of Economics and Business Administration, Oslo, 2010.

84

4

What Explains the Low Impact of the Financial Crisis on Levels of Arrears among UK Households?

K. Kamath, K. Reinold, M. Nielsen and A. Radia, ‘The Financial Position of British Households: Evidence from the 2011 NMG Consulting Survey’, Bank of England Quarterly Bulletin, Quarter 4, 2011, pp. 304-314. E.Kempson, ‘Over-debtedness and Its Causes Across Europe’ in Consumer Debt and Social Exclusion in Europe ed H Miklitz, Ashgate Publishing, Farnham, 2015. M. Lawless, R. Lydon and T. McIndoe-Calder, ‘The Financial Position of Irish Households’, Central Bank of Ireland Quarterly Bulletin, Quarter 1, 2015, pp. 66-89. R. Long and W. Wilson, Mortgage Arrears and Repossessions: Standard Note SN/SP/4769, House of Commons Library, London, 2010. P. Lucchino and S. Morelli, Inequality, Debt and Growth, Resolution Foundation, London, 2012. R. Lydon and Y. McCarthy, What Lies Beneath? Understanding Recent Trends in Irish Mortgage Arrears. Research Technical Report 14/RT/11, Central Bank of Ireland, Dublin, 2011. Y. McCarthy, ‘Disentangling the Mortgage Arrears Crisis: the Role of Labour Market, Income Volatility and Negative Equity’, Journal of the Statistical and Social Inquiry Society of Ireland, Vol. XLIII, 2014, pp. 71-90. Y. McCarthy and K. McQuinn, Consumption and the Housing Market: An Irish Perspective, Economic and Social Research Institute, Dublin, 2014. K. McQuinn, Bubble, Bubble, Toil and Trouble? An Assessment of the Current State of the Irish Housing Market, Economic and Social Research Institute, Dublin, 2014. Money Advice Service, Indebted Lives: the Complexities of Life in Debt, Money Advice service, London, 2013. Money Advice Service, Financial Capability in the UK 2015: Initial Results from the 2015 UK Financial Capability Survey, Money Advice Service, London, 2015. M. Norris and N. Winston, ‘Transforming Irish Home Ownership through Credit Deregulation, Boom and Crunch’, International Journal of Housing Policy, Vol. 11, No.1, 2011, pp. 1-21.

85

Elaine Kempson

Office for Budget Responsibility, Economic and Fiscal Outlook March 2012, Cm 8303, Crown Copyright, London, 2012. Office for Budget Responsibility, Economic and Fiscal Outlook March 2015, Cm 9024, Crown Copyright, London, 2015. K. Scanlon, J. Lunde and C. Whitehead, ‘Responding to the Housing and Financial Crises: Mortgage Lending, Mortgage Products and Government Policies’, International Journal of Housing Policy, Vol. 11, No. 1, 2011, pp. 23-49. A. Wallace and J. Ford, ‘Limiting Possessions? Managing Mortgage Arrears in a New Era’, International Journal of Housing Policy, Vol. 10, No. 2, 2010, pp. 133-154. M. Whittaker, Crisis Averted, or Delayed Reaction? Analysis of Money Advice Service Data on the Over-Indebted Population, Resolution Foundation, London, 2013.

86

5

Britain’s Debt Crisis and Responsible Credit

Damon Gibbons*

5.1

Introduction

The extent of unsecured household debt in the UK is a major economic policy concern, but it is not receiving sufficient attention as such. Having contributed to economic crises in both the 1970s and 1980s, it was again allowed to expand rapidly from 1996 onwards. The unsustainable nature of the household debt burden was then brought into sharp focus by the onset of the financial crisis in 2007/2008. In the wake of this, the immediate political rhetoric emphasised the need for deleveraging and the restoration of a more balanced economic model. However, very little has actually been achieved in this respect. Although the UK economy has since returned to growth, this has been heavily reliant on further consumer credit expansion, and interest payments on the outstanding stock of debt are reducing aggregate demand. Further to this, the measures being taken to reduce the Government’s budget deficit (including public sector pay freezes and savage cuts to welfare) have combined with longer-term trends (including real wage stagnation and the casualisation of labour) to cause a renewed rise in the number of over-indebted households. This chapter contends that addressing the high level of household indebtedness is now an urgent economic priority, and provides new evidence of the impact of household indebtedness on economic growth to make the case for action. The chapter is structured as follows: It begins by reviewing how the deregulation of financial services in the UK has contributed to three distinct cycles of economic boom and bust since 1970, and how, when combined with an overarching economic strategy to bear down on inflation, credit expansion has provided the basis for deep cuts in public spending. Despite this, household indebtedness has ceased to be viewed in its proper economic and political context. The state’s interventions in household credit markets from the 1980s onwards have been limited to providing a neo-liberal regulatory framework: built upon the belief in the rationality of both lenders and borrowers and focused on ‘truth in lending’ requirements rather than direct controls. *

Director, Centre for Responsible Credit (UK).

87

Damon Gibbons

The chapter then examines how the rhetoric of policymakers in the immediate wake of the financial crisis, which promised the rebalancing of the economy away from debtfuelled consumption and towards an ‘export-led recovery’, has not been delivered in practice. Although the future build-up of household debt has been identified as an economic risk by both Government and the Bank of England, action to prevent this has remained limited, mainly involving the introduction of greater ‘responsible lending’ requirements. Beyond this, there have been no serious attempts to address Britain’s significant ‘debt overhang’. Finally, the chapter presents an analysis of aggregate data to estimate the extent to which interest payments on consumer credit debts are a problem for households and affecting the UK’s economic growth prospects. Considering these findings, the chapter concludes that growth will remain subdued unless a structured programme of debt writeoff is implemented and suggests a mechanism for such an intervention. It also refocuses attention on whether the current approach to responsible lending will be sufficient to prevent another crisis.

5.2

From Boom to Bust and Back Again… and Again…

Financial services deregulation, and the subsequent explosion in household indebtedness that has taken place, has had a profound and damaging impact on the UK economy over the past forty-five years. This section provides a brief history of the process of deregulation in the UK and examines its main economic effects. It is important to note how far the financial services sector has grown over the period. In 1960 there were sixteen major clearing banks, holding assets equivalent to approximately 30% of Gross Domestic Product (GDP), but by 2010, the banking sector had consolidated and had a balance sheet worth more than 500% of GDP. Three of our largest banks each individually hold assets worth more than our entire annual economic output (Davies et al., 2010, p. 322). This tremendous growth in the financial sector was facilitated by the abandonment of direct Government control over credit creation: a policy shift that was instigated by the Bank of England (‘the Bank’), and that has now resulted in three cycles of credit boom and bust. The first of these cycles lasted from 1970 until the end of 1973. In 1970, the Bank’s Executive Director for Home Finance, John Fforde, bemoaned the Treasury’s then direct control over levels of credit extension to his Governor, Leslie O’Brien, in the following terms1:

1

Cited in Gibbons, 2014, p. 32. The note was previously available from the Bank of England website but has subsequently been removed.

88

5

Britain’s Debt Crisis and Responsible Credit

…prolongation of the present system [of credit controls] is inconsistent with the…view that the shape of the banking industry…should not be notably subordinated to the requirements of monetary policy…There is a persistent temptation to convert banks into mere slaves of official policy. We have always said…that this is a temptation that must be resisted. In Fforde’s view, direct controls were inefficient and holding back economic growth. Lenders and borrowers, not Government, were best placed to decide whether or not a return could be generated in excess of the interest rate charged. When Government intervened and set limits on the amount of credit that could be extended, it was constraining the ability of the banks to do profitable business, which inevitably meant that some opportunities to spur growth were being missed. Although the Treasury was initially reluctant to abandon direct controls, poor economic growth and worsening unemployment over the following year persuaded it to do so in September 1971. In their place, the Bank of England was to control lending through the manipulation of interest rates alone. This ‘Competition and Credit Control Policy’ was accompanied by measures to allow banks to participate in wholesale financial markets and reduced the level of liquid assets that they had to hold. Banks were also allowed to make mortgages (previously the sole preserve of Building Societies), and restrictions on hire purchase lending were relaxed. The following year also saw the creation of the first credit card, the Access card, in the UK. The expansion of credit that resulted combined with increases in personal income tax allowances and public spending to rapidly stimulate economic growth. GDP grew by 5.5% between the second quarter of 1972 and the same period one year later. Unemployment fell by around 200,000. However, this boom was to be swiftly followed by a banking and economic crisis. Too much of the credit expansion had flowed into the mortgage market, leading to a doubling of the average house price in England between 1970 and 1973. Consumer credit spending led to a rapid increase in imports, a deterioration in the UK’s trade balance and fuelled inflation. The Bank sought to counter this by raising interest rates. Between June and November 1973 these increased from 7.5% to 13%. The result was a surge in mortgage repossessions and a fall in house prices. The collateral held by lenders was now worth less than the value of their loans, and the Bank had to organise a ‘lifeboat’ operation to bail out a number of ‘fringe banks’ that had emerged to enter the mortgage market. By December 1973 the policy of ‘Competition and Control’ was ended, and the Government returned to a system of direct lending controls and restrictions on consumer credit. Despite the experience of 1970 to 1973, the deregulation of financial services markets continued to be taken forward. The following year, Parliament passed the Consumer Credit Act, which removed direct controls, including, for example, the ability of Government to

89

Damon Gibbons

set maximum rates for hire purchase, in favour of ‘truth in lending’ requirements. Again, the underlying theory was that lenders and borrowers would make rational decisions, provided the terms were transparent. They should, therefore, be provided with the freedom to contract to mutual benefit without Government interference. In practice, by the late 1970’s there were very few ways in which Government could control the level of credit expansion. Although a formal system of controls (the ‘Supplementary Special Deposit Scheme’, which was commonly referred to as ‘the corset’) had been introduced following the economic crisis in 1973, banks were increasingly finding ways around this. The corset sought to limit the amount that banks could lend by restricting loans relative to the deposits held on their balance sheets. To avoid these limits, banks found ways to lend ‘off balance sheet’.2 Bills held outside the banking system increased from £232 million at the end of June 1978 to £2.6 billion just two years later (Cobham, 2002). However, the second, much longer, cycle of credit boom and bust, which took place between 1979 and 1992, was also fuelled by deliberate policy choices. Coming to power in 1979, Margaret Thatcher’s Conservative Government embarked on an ambitious programme to both deregulate financial services and create a highly individualistic consumer culture as a means of undermining the welfare state. At first sight, the deregulation of financial services markets appeared to run contrary to the stated intention of the Thatcher administration to ‘master inflation’ through the exercise of ‘proper monetary discipline’.3 This was a clear political priority, given inflation had been running at nearly 9% in the months preceding the General Election of May 1979. Combined with the then Labour Government’s attempts to impose wage restraint, the rate of inflation constituted an attack on living standards and created the conditions for widespread industrial action (‘the winter of discontent’) towards the end of 1978. This, together with high levels of unemployment, which allowed the Conservatives to campaign under the slogan ‘Labour isn’t working’, was a major factor in Thatcher’s election victory. Despite the priority to master inflation, the new Chancellor, Geoffrey Howe, was, on his very first day in office, advised, by the Bank of England Governor, Gordon Richardson, that the ‘corset’ was no longer effective as a means of limiting the expansion of credit.4 The corset was formally abandoned the following year, and the battle against inflation was

2

3 4

For example, through a process which became known as ‘bill leak’, whereby banks would guarantee commercial bills (effectively promises to repay) issued by companies seeking credit, and broker these onto investors. The bank would take a commission for this brokerage but the amount of credit would flow directly from the investors to the companies seeking credit and would not appear on the bank’s balance sheet and therefore not on its returns to the Bank of England. Conservative Party General Election Manifesto, 1979. Letter from Gordon Richardson to Geoffrey Howe, 4 May 1979, available from .

90

5

Britain’s Debt Crisis and Responsible Credit

taken up through the setting of high interest rates by the Bank of England5 and through deep cuts to public spending. As a consequence, the economy entered recession in 1981, and the unemployment rate doubled to 10.2%. By 1982 over 3 million people were out of work. Although unemployment rose sharply, the policies were successful in bringing inflation under control – this fell to 4.6% by 1984. It should be noted that this was achieved at the same time that household borrowing was expanding. The use of credit was deliberately fuelled by Government policies aimed at promoting home ownership. These included providing Council housing tenants with a ‘Right to Buy’ in 1980 and the breaking of the Building Society monopoly on mortgage lending. Between 1980 and 1984 the number of mortgages had increased by over 17%, and the average cost of a home rose from just under £18,000 to nearly £30,000. Consumer credit also expanded, supported by the widespread advertising of credit cards both as a convenient means of paying for goods and services and as a stepping stone to a ‘celebrity lifestyle’.6 Outstanding credit card balances increased from just £0.9 billion in 1979 to £5.2 billion by 1986. Reducing inflation at a time when lending to households is expanding generally requires either the raising of taxes, reductions in public spending or a combination of the two. However, the Government has been elected on a pledge to reduce income tax, and had a clear desire to ‘roll back the frontiers of the state’.7 The initial cuts to public spending were focused on housing and education.8 Net housing expenditure was reduced by approximately three-fifths between 1979 and 1984, largely due to Council house sales and increased rents – another factor that made exercising the Right to Buy more attractive. Education spending fell by 12% over the same period. Social Security also became a key target. State pension increases were linked to prices rather than earnings. Short-term benefits for the sick, unemployed and disabled were cut by 5% in real terms in 1980/1981, and the following year saw the removal of the earningsrelated supplement for the newly unemployed. Unemployment thereby became a much greater threat to living standards than it was earlier. However, owing to rising unemployment, total expenditure on social security payments actually rose. This resulted in a cycle of continuing and increased pressure for further savings, and a widespread review of social security took place in 1986. 5 6 7

8

These increased from 12% to 17% over the course of 1979. For a brief review of adverts of the period see Gibbons, 2014, pp. 48-50. See, for example, the speech given by Nigel Lawson, then Financial Secretary to the Treasury, to the Bow Group on 4 August 1980. Transcript available at: . For an assessment of both welfare state expenditure and qualitative changes in the nature of spending in the early years of the Thatcher Government see Gough, I. (1983). ‘Thatcherism and the Welfare State’ in Hall, S. & Jacques, M. (eds.). The Politics of Thatcherism (pp. 148-168). Lawrence & Wishart: London.

91

Damon Gibbons

Alongside these cuts, mass unemployment provided the foundation for the Government to push through a raft of reforms designed to weaken the bargaining power of trade unions in the Employment Acts of 1980 and 1982. These included the abolition of a statutory right for trade unions to be recognised in pay bargaining with employers, and measures to end ‘closed shop’ arrangements as well as limiting rights to picket and making it legal for employees to sack workers involved in strike action. Unions were also made liable for civil damages for secondary action, thereby deterring them from organising strikes in support of each other. These measures were to prove critical in helping the Government to win its battle with the National Union of Mineworkers concerning their plans for widespread pit closures following the year-long strike of 1984. The impact of these changes created a downward pressure on wages, although this was not evenly distributed. Lower paid workers were most affected, contributing to a significant increase in wage inequality over the period.9 Combined with a reduction in income tax for higher earners, from 83% to 60% in the first Conservative Budget, and subsequently to 40% in 1988, this contributed to rapidly widening income inequality during the Thatcher years. While the expansion of lending to households over the period to 1986 may therefore appear to have run counter to the stated aim of mastering inflation, it actually provided the basis for greater cuts in public spending than would otherwise have been required, was central to its ambitions to promote home ownership and, critically, also supported Britain’s emergence from recession. This latter point is particularly important given that growing North Sea Oil revenues over the period10 had led to an appreciation in the value of Sterling and contributed to a slump in manufacturing exports. Household consumption therefore became an increasingly important contributor to growth,11 and the Government was to embark on a radical reconfiguring of the UK’s financial services sector in order to boost this further with its ‘Big Bang’ reforms of 1986. These broke up the traditional cartels in the City of London and brought international investment banks into the heart of the UK’s financial system. The reforms afforded the opportunity for retail and investment banking operations to be brought together and, for example, resulted in the creation of new endowment mortgage

9

For further details see Machin, S. (Autumn 2008). ‘Big Ideas: Rising Wage Inequality’. Centrepiece, Centre for Economic Performance, London School of Economics: London. 10 From 1980 to 1985 Britain’s oil revenues increased year on year, and peaked at around £30 billion in today’s prices. But from 1985 onwards these started to decline rapidly, dropping by a third in just two years. 11 In 1978 Household final consumption expenditure constituted 50.2% of GDP, but by 1986 it was 54.5% (Office for National Statistics, National Accounts, using the chained volume measures, seasonally adjusted).

92

5

Britain’s Debt Crisis and Responsible Credit

products (which were also supported by Government in the form of tax breaks) and the securitisation of loans: which facilitated a dramatic expansion in credit.12 From October 1986 onwards, a huge expansion of mortgage lending took place, which was also boosted by an incremental reduction in Bank base rates over the following eighteen months. By May 1988 the cost of borrowing had been reduced by roughly 4%. House prices rose, and lenders relaxed their underwriting criteria in order to allow households – especially first time buyers – to borrow increased amounts relative to their incomes. The aspiration for home ownership was also underpinned by the Housing Act 1988, which abolished the system of rent controls and limited security of tenure for private tenants, making renting more expensive and a less attractive long-term proposition. Consumer credit was also expanded. In 1979 the total amount of unsecured lending undertaken by banks had been just £5 billion. By the end of 1990, this had ballooned to nearly £43 billion. This fuelled household consumption, with the growth in spending outpacing the increase in incomes. By the third quarter of 1987, aggregate household expenditure began to exceed total household income. It subsequently peaked at 102.5% in the third quarter of 1988 and did not return to below 100% until a year later. By 1989, the level of debt as a proportion of household income was unsustainable, and inflation was rising. Inflation rose from 3.3% in January 1988 to 7.9% the following year, and the Bank hiked interest rates to 15%, where they stayed for a further twelve months. The impacts were predictably devastating. In 1989 there were just 15,800 mortgage repossessions, but the following year the figure nearly tripled to 43,900, and in 1991 the number of homes lost soared to a record high of 75,500. Consumer credit defaults also rose, with over 3 million county court claims for default submitted by lenders in each of the years from 1990 to 1992, and with the number of people made bankrupt quadrupling over the same period. With the consumer spending boom now at an end, Britain’s economic growth collapsed, and the economy entered into recession at the start of 1991. Although growth returned towards the end of the year, it took until the beginning of 1993 for Britain to recover its lost output, by which time unemployment was, once again, heading towards 3 million. The recession led to a brake on lending for approximately three years, but was to lay the foundation for the third credit crisis of 2007. In particular, the period led to a ‘flight to quality’ by lenders, with those households most affected by the recession now excluded from mainstream credit markets due to their defaults and impaired credit scores. This created a pool of ‘sub-prime’ borrowers who would later be targeted by lenders who began to seek higher returns from the mid-1990s onwards. However, confidence in lending to

12 For an excellent assessment of how securitisation facilitates credit expansion and an analysis of the consequent placement of risk within the financial system see Shin, H.S. (2009). ‘Securitisation and Financial Stability’, The Economic Journal, 119, pp. 309-332.

93

Damon Gibbons

these borrowers had first to be built through the introduction of new technologies and processes to assess and price for risk and, once this had been done, sources of investment needed to be found to drive further credit expansion. The second of these was achieved by expanding the use of securities, including into the UK credit card market from 1998 onwards.13 The introduction of risk-based pricing and the use of securitisation, in both the housing and consumer credit markets, resulted in a rapid expansion of lending to households from 1997 onwards. Despite the horrific repossession crisis of the early 1990s, no attempt was made to rebalance Britain’s housing market – for example by embarking on a major social house building programme or by providing long-term security of tenure for private renters. The demand for home ownership therefore remains high, and because the overall stock of housing has not been significantly expanded,14 an expansion of mortgage credit leads to rising house prices. Between 1997 and 2002, the average cost of a home rose by 45%, and in the following five years (to 2007) it increased by a startling 83%. Similarly, there was an explosion in the use of consumer credit after 1997. Between 1997 and 2002, the total amount owed on credit cards increased by 164% to £41 billion. Competition between credit card providers became fierce, but this was competition for people who would fail to pay off their balances at the end of each month. Free balance transfers and time-limited zero percent offers became commonplace. But no safeguards were put in place to ensure that borrowers had closed the initial account, and so it became possible for people to multiply the number of their active accounts. By 2004, the outstanding balance on Britain’s credit card had increased to £50 billion, with balance transfers accounting for 14% of the value of all new card transactions made that year. Many people, under financial pressure, rotated their debt on a regular basis until the stress of the situation became too much and a number of debt-related suicides started to be reported by the media.15 In March 2005, by which time Britain’s credit card debt had risen to £63.1 billion, the Government intervened by requiring greater sharing of data on outstanding balances, and by introducing measures to provide borrowers with greater transparency of pricing.

13 Securitisation of credit card lending began in the US in the late 1980s. For example, Citibank began to issue securities backed by its credit revenues in 1988. By the mid-1990s US credit card issuers were beginning to operate in the UK. For example, Capital One, which specialises in offering sub-prime cards and is headquartered in the US, began its UK operations in 1996. Its first sale of securities based on UK card revenues came two years later. 14 Over the forty years from 1971 to 2011 the average annual growth rate in England’s housing stock has been just 1%. 15 In one case, reported in March 2004, a 37-year-old man was reported to have committed suicide after having acquired nineteen credit cards and run up an outstanding debt of £70,000, despite receiving an annual salary of only £22,000.

94

5

Britain’s Debt Crisis and Responsible Credit

However, it did little to address other emerging problems, including the growth of payday lending and the mis-selling of payment protection insurance. There was also no consideration of the likely long-term economic impacts of the consumer credit boom.

5.3

The Interest Payment Burden

The ability of households to meet their debt obligations is contingent on three main factors: the amount of debt that households have taken on; the cost of servicing that debt in terms of the interest rate and other fees and charges, and the resources that households have available to meet those payments (i.e. their income less the amount expended to meet other living costs). Figure 5.1, below, indicates how total interest payments (including both mortgages and consumer debts) grew to take up nearly 90% of available household resources by 2008. Figure 5.1 Total interest payment burden, 1997 to 201416

As can be seen from the above, the interest payment burden of British households had been at a similar level previously: immediately before the recession of the early 1990s. However, the journey back to such an unsustainable level of household debt in aftermath of that recession was not straightforward. In general terms, there was a ‘debt fuelled consumption boom’ from 1998 through to the end of 2005. In total, the growth in household spending over this period exceeded the growth in incomes by £40 billion. However, the interest payment burden on households did not increase evenly.

16 Calculations by the author using UK Economic Accounts data. For a detailed discussion of the methodology Gibbons & Vaid (2016) ‘Britain in the Red’, TUC, London.

95

Damon Gibbons

In particular, the interest burden reduced from 55% in 2000 to 45% by the end of 2002, which were both years in which real incomes grew. This growth in real incomes, combined with high levels of employment and low interest rates, encouraged consumer spending which then grew at a much faster rate until the end of 2004, where the net growth in spending exceeded that in incomes by more than £18 billion (see Table 5.1, below). This coincided with the explosion of credit card lending referenced previously, and, although the measures introduced to limit the excesses in that market the following year appear to have had an impact, the consumer boom continued into 2005. Table 5.1 The distribution of Britain’s consumer boom 1998-200717 Year

Net of growth in household spending less growth in income (£ billions)

1998

12.1

1999

8.2

2000

−13.5

2001

−15.0

2002

9.7

2003

10.5

2004

18.2

2005

9.8

2006

0.3

2007

2.1

Responding to the boom in the housing market, the Bank of England began raising interest rates in the summer of 2006. This was done incrementally until July 2007, and the cumulative effect was to add around £84 per month to the cost of servicing a £100,000 mortgage. Although this seems a relatively small shock to household finances, the increased leveraging of households had left them vulnerable. Indeed, in 2006, the OECD had cautioned18: Over the past decade, household debt has risen to record levels in a number of OECD countries. The large size of these debt run-ups, coupled with, in several instances, changes in the characteristics of some of the relevant instruments, are estimated to have raised the sensitivity of the household sector to changes in interest rates, asset prices and incomes. In this sense, the household sector may have become more vulnerable to adverse shifts in these variables. 17 Ibid. 18 OECD, World Economic Outlook, 2006.

96

5

Britain’s Debt Crisis and Responsible Credit

The OECD’s analysis was particularly accurate in respect of the UK. Between 2002 and 2006, households with mortgages increased their expenditure on housing costs as a proportion of their income by an average of 6% (from 23% to 29%), and the number paying out more than 30% of their disposable incomes on housing costs rose from 2.8 million in 2002/2003 to more than 4 million in 2006/2007. But it was not just people with mortgages that found times were getting tougher. Rising food and fuel prices were squeezing real incomes, which stagnated throughout 2007 and 2008, causing the interest payment burden to head further upwards to its crisis point of 90%. Mortgage repossessions and consumer credit defaults both increased sharply, with around 25,000 people entering into insolvency each quarter from 2007 onwards. By September 2007, Northern Rock was in trouble and the ‘financial crisis’ was upon us. Although the scale of mortgage repossessions did not reach that of the early 1990s the human cost of the crisis has been significant. Over 79,000 mortgage possession actions were taken out by lenders in the first half of 2008, and the total number of outright possession orders made by courts from July to September was 15,603. Back in the third quarter of 1991, the number of possession orders made peaked at just over 20,000, and it appeared that Britain was heading for a repeat. However, in September 2008 the then Labour Government, headed by Gordon Brown, intervened by introducing a series of measures designed to prevent a repossession crisis. These included the establishment of a £200 million mortgage rescue scheme; a reduction in the waiting time for unemployed households to obtain support with mortgage interest payments; and new guidance for the judiciary to ensure that lenders had considered all reasonable alternatives, such as capitalisation of arrears and the extension of mortgage contracts, before making orders for possession. Unfortunately, we have since seen the abandonment of the mortgage rescue scheme and a reduction in the the amount of mortgage interest that can be covered by social security payments.

5.4

Deleveraging or Drowning in Debt?

In the wake of the financial crisis the initial rhetoric from Government indicated a willingness to address Britain’s over-reliance on ‘debt-fuelled consumption’. On coming to power after the General Election of May 2010, the Conservative and Liberal Democrat Coalition set out a programme for Government that correctly identified that: In recent years, we have seen a massive financial meltdown due to over-lending, over-borrowing and poor regulation.

97

Damon Gibbons

The document went on to commit the Coalition to rebalancing the economy in favour of ‘export-led’ growth, promoting responsible and sustainable banking and providing greater assistance for people to manage their debts. As well as these general priorities, a number of specific promises relating to Britain’s credit markets were also made. These included giving regulators new powers to define and ban excessive rates on credit and store cards, and to end unfair bank and financial transaction charges. However, the subsequent review of ‘consumer credit and personal insolvency’, which was conducted by the Department for Business, Innovation and Skills in 2011, failed to deliver on any of these. Instead, the emphasis was placed on “…promoting more responsible corporate and consumer behaviour through greater transparency, competition, and by harnessing the insights of behavioural economics”. That said, a number of interventions have been made by the Bank and by the new conduct regulator, the Financial Conduct Authority, that attempt to ensure greater responsibility in lending. – In July 2014, the Bank’s Financial Policy Committee introduced a number of restrictions on mortgage lending, including the requirement for lenders to ‘interest rate stress test’ borrowers when determining whether or not a loan was affordable, and placing limits on the proportion of mortgages that can be offered at loan to income multiples of 4.5 or above. Writing in the Bank of England’s Quarterly Bulletin, Bunn & Rostom (2015) reported that the introduction of these measures was motivated by a recognition of the potential for household indebtedness to have ‘a large adverse impact on aggregate demand and on the banking system’. – In the same year the Financial Conduct Authority (FCA) introduced its final rules for consumer credit lending. These included a requirement for firms to take “reasonable steps to assess the customer’s ability to make repayments in a sustainable manner, without incurring financial difficulties or experiencing significant adverse consequences. For example, the customer should be able to make repayments on time, while meeting other reasonable commitments and without having to borrow further.19” Further to this, the FCA has announced in its business plan for 2015/2016 that it intends to undertake ‘wide-ranging research’ with a view to consulting on possible changes to its rules on creditworthiness in order to clarify the expectations of firms, and it is able to ensure that business models are compliant with responsible lending requirements as it proceeds with the authorisation of firms. – Following a lengthy campaign by consumer agencies and politicians, in which the author was heavily involved, the FCA also introduced new rules for the High Cost Short Term Credit sector, which includes payday lenders. This included the capping

19 ‘Understanding consumer credit – creditworthiness and affordability: common misunderstandings’, Financial Conduct Authority, 2015.

98

5

Britain’s Debt Crisis and Responsible Credit

of payday loan rates and restrictions on the number of times that loans can be refinanced or ‘rolled over’. Unfortunately, a number of policies originally introduced by the Coalition, many of which have been continued by the current Conservative majority Government elected in May 2015, have run counter to the general ambition to reduce Britain’s reliance on credit. For example: – Between July 2012 and January 2014 the Bank of England directly injected cheap ‘funding for lending’ to support new mortgages. Around £41.9 billion was drawn from the scheme by lenders until the end of 2013, with around 70% of loans going to households and 30% to small businesses.20 However, the scheme appears to have primarily fuelled the ‘buy to let’ mortgage market. According to the Council for Mortgage Lenders, there was a significant rise in the number of Buy to Let mortgages following the introduction of the Funding for Lending scheme, with 40,000 such mortgages provided between April and July 2013 alone. – The Right to Buy scheme was reinvigorated, with reductions in the qualifying period and increases in the discounts on the market prices of houses for council tenants wishing to purchase. The current Government has indicated that it will legislate to further extend the Right to Buy to Housing Association tenants. – A ‘Help to Buy’ Scheme was introduced, incorporating mortgage guarantees and Government equity loans to help people borrow 95% of the house price, and a new tax free Individual Savings Account (‘ISA’) product was launched with matched Government contributions to help people save for their deposit. The consequence has been a dramatic rise in house prices over the recent period. The average cost of a home rose by 4.8% in 2013, 8.5% in 2014 and by 9.2% last year.21 In London, the rate of house price inflation has been significantly higher, rising by 16% in each of the past two years. Government policies have also contributed to a rise in consumer credit-based overindebtedness. Chief among these have been the use of wage restraint in the public sector and cuts to housing and other benefits. Between 2010 and 2014 these combined with rising fuel, food, housing and transport costs and falling real wages22 to create a significant squeeze on living standards. The percentage of over-indebted households, defined as those spending 25% or more of their income on unsecured debt repayments, more than doubled

20 See box 14 in Bank of England, Inflation Report, May 2014. 21 Halifax House Price Index, all homes, UK basis, annual growth rate. 22 Although there has been a recent improvement in wage growth, the median real wages of full-time employees fell by over 8% between 2010 and 2014.

99

Damon Gibbons over the period (from 5% to 12% of all households holding unsecured liabilities).23 This increase in over-indebtedness has been particularly evident in households with someone in work: in 2012 only 3% of working households with some form of unsecured borrowing were over-indebted, but by the end of 2014 this had risen to 10%. Unsurprisingly, overindebtedness was higher among working households with incomes of less than £30,000 (up to 16% from 9%). However, the largest single group of over-indebted households were those containing someone with a long-term health problem or disability, with one in five of such households over-indebted by the end of 2014. The much vaunted ‘export-led recovery’ has not been forthcoming either. As at the end of 2014, Britain’s current account balance (the net value of exports in goods and services less the value of imports) was in deficit by the equivalent of 6% of nominal GDP: the highest deficit since records began in 1955. As a consequence, much of Britain’s recent economic growth has been reliant on household consumption. From the start of 2013 until the middle of 2014, the growth in household spending exceeded that of incomes, and although this position has recently reversed, the total net excess of consumption growth less income growth until the end of the third quarter in 2015 is £35.1 billion (see Figure 5.2). Figure 5.2 Real household income and spending, quarterly growth, 2013-2015 Q324

23 Gibbons, D. & Vaid, L. (2015). ‘Britain in the Red: Preliminary Report’. TUC: London. 24 Author’s own calculations, derived from ONS National Accounts, 2012 prices.

100

5

Britain’s Debt Crisis and Responsible Credit

The excess of the growth in spending over the growth in incomes is clearly apparent in the period from the start of 2013 until the end of 2014, when real incomes fell but spending rose by a total of £41.2 billion. During the same period, GDP25 grew by only £84.5 billion (5% above the level achieved in 2012). On this basis, it is clear that, had it not been for a significant increase in spending over and above that which could be met from income growth, the UK would have achieved just half of this. However, not all of the growth in consumption was a result of more borrowing. Certainly, the unsecured liabilities of households did increase considerably over the period, and have continued to do so into 2015. By the end of 2014, £31 billion had been added to the stock of household debt. It is important to note that this figure includes both student loans and consumer credit debts. Student loans for living expenses were introduced in 1990/1991, and were extended to cover tuition fees in England from 1998/1999 onwards. In 2012, the maximum amount of tuition fees that universities could charge was increased from £3,290 to £9,000. This has caused the level of student debt to rise rapidly in recent years. As at the end of 2014, student loan debt amounted to £61.4 billion in real terms (2012 prices). However, this rising level of student debt does not have as great an impact on households as their consumer debts. This is because the interest rates charged on student debt are much lower than for consumer credit agreements and borrowers do not need to make repayments if their earnings are below set thresholds. Consumer credit debts did also increase from the start of 2013 until the end of 2014, by £20 billion in real terms, but this does not fully explain the growth in consumption over the period. In particular, the period also saw an increase in the overall propensity of households to spend from their current incomes. At the start of 2013, households consumed 91% of their total incomes, but by the end of 2014 this had risen to 97.2%. Although there has been a recent increase in real incomes, the proportion of income being spent to meet the interest burden on both secured and unsecured liabilities has risen from 43% to 57% (see Figure 5.1, above), and it is notable that this increase has occurred when interest rates on mortgages have remained low. Indeed, the main cause of the increasing interest payment burden on British households today is the large consumer credit overhang from the boom in mid 2000s, which has combined with a decline in real incomes. The interest payment burden on consumer credit debts alone has now reached 22%, which is the same level as in the crisis of 2008 (see Figure 5.3, on the next page).

25 Chain Volume Measurement, Seasonally Adjusted, 2012 Prices: ONS UK Economic Accounts.

101

Damon Gibbons Figure 5.3 Consumer credit interest payment burden, 2000 to 201526

5.5

The Need for a Radical Response

The consumer credit debts of British households are now as much of a burden as they were at the height of the crisis in 2008. To address this will require either a reduction in the cost of debt; an improvement in the financial resources of households; or a reduction in the scale of debts that they hold. Concerning the cost of debt, interest rates on consumer debts have hardly changed since the crisis despite the Bank of England base rate being at the historic low of 0.5%. In particular, credit card rates on interest bearing balances remain at around 18%. Normal monetary policy therefore holds no prospect of lowering this. Neither are households likely to witness any major increase in the resources available to them from which they can meet their existing interest payments and start to pay off their debts. Increasing the ‘household surplus’, (i.e the amount left from income after other essential and desirable expenditures) requires either a significant increase in real incomes or a large reduction in non-essential spending. For example, to return to the level of indebtedness as at the end of 2002 would require households to make debt repayments totaling £160 billion, which is around 15% of total household spending. If this were attempted then this would have a significant and negative impact on economic growth.

5.6

Towards a Structured Programme of Debt Write-Off?

In the absence of reductions in consumer credit interest rates, significant reductions in household spending or a sustained rise in real incomes, there remains one option: which 26 Author’s estimates of consumer credit interest calculated from Bank of England data.

102

5

Britain’s Debt Crisis and Responsible Credit

is to reduce the scale of the debt burden held by households. Ordinarily, over-indebted households could be expected to utilise insolvency procedures in order to write-off at least a proportion of their outstanding debt. However, Government’s decision to increase the fees for bankruptcy applications in England and Wales has led to a decline in the numbers of people taking this route.27 More people are using non-court-based solutions, such as Debt Management Plans (DMPs), which do not provide for any write-off. In 2012, the number of ongoing DMPs was estimated to be between 520,000 and 645,000.28 This does not mean that no write-offs have been taking place. In fact, UK financial institutions have written off nearly £40 billion of consumer debt between the start of 2008 and the end of 2014.29 Unfortunately, debtors may still be pursued for debts ‘written off’ in this way, as there is a secondary market in debt purchase and collection. This has seen debt collection companies, often supported by private equity companies, purchase portfolios of non-performing loans from banks and credit card lenders at a fraction of their face value.30 The debt collection agencies then pursue the debtors for the full nominal value of the loans. The size of this sector is not clear, and many of the private equity companies are foreign owned, which creates a further barrier to transparency. Nevertheless, the sector has, unwittingly, provided a possible example of how Government could intervene to help reduce the household debt burden. Specifically, consideration should be given to providing debt advice agencies with access to a fund to enable them to purchase those debts that have been included within their DMPs, or otherwise identified as too onerous to repay, at a reduced rate. If debts were purchased at 10 pence in the pound, which seems to be the current ‘going rate’, then this would allow a significant proportion of the overall debt to be written off, while also allowing agencies scope to cover their own costs, and even turning a small profit for the Treasury – for example, by collecting 15% of the face value of the debt back through the DMP.

5.7

Concluding Remarks: Responsible Lending?

Given the recent increase in the unsecured liabilities of households, Government also needs to re-examine the way in which it is regulating the activities of lenders. Despite clear evidence that credit expansion has contributed to three cycles of boom and bust since the 27 Nearly 60,000 personal bankruptcies took place in England and Wales in 2010, but the number declined to around 20,000 by 2014. Insolvency Service Statistical release. 28 Estimates cited by the Financial Conduct Authority in its work on the debt management sector . 29 Bank of England data sets, series RPQTFHE & RPQTFHF. 30 A newspaper report in 2014 indicated that debt purchasers paid as little as 10p in the £. .

103

Damon Gibbons

1970s, the overarching framework for credit regulation continues to be based on the assumption that lenders and borrowers should be provided with freedom to contract, albeit with tighter rules now in place concerning how lenders should assess creditworthiness. A more radical approach would be for Government and the Bank of England to adopt a joint target for household indebtedness as part of a broader strategy to rebalance the economy and reduce its reliance on consumption. This could, for example, involve taking direct action to reduce the returns on consumer credit loans relative to those that can be obtained by lending to (non-financial) businesses. Interest rate caps on credit cards and other forms of consumer loans could have a key part to play here, as could the refocusing of elements of the Bank’s Funding for Lending scheme on small businesses or key growth sectors of the economy, such as investment in new, and greener, technologies.

References Bunn, P. & Rostom, M. (2015). Household Debt and Spending in the United Kingdom. Staff Working Paper No. 554. Bank of England: London. Cobham, D. (2002). The Making of Monetary Policy in the UK, 1975 – 2000. John Wiley & Sons: Chichester. Davies, R., Richardson, P., Katinaite, V. & Manning, M. (2010). Evolution of the UK banking system. Bank of England Quarterly Bulletin Gibbons, D. (2014). Britain’s Personal Debt Crisis: How We Got Here and What to Do About it. Searching Finance: London.

104

6

Responsible Lending in the UK: What Role Does the State Play?

Karen Rowlingson*, Jodi Gardner** and Lindsey Appleyard***

6.1

From Irresponsible Mortgage Lending to Irresponsible Unsecured Lending

The Global Financial Crisis of 2008 was one of the most serious financial crises since the Great Depression of the 1930s. The financial services sector was on the brink of collapse, and this was prevented only by the action of national governments in bailing out the sector, at huge cost to the public purse. The causes of the crisis are hotly debated, but a key part of the problem was the growth of the sub-prime mortgage market in the US, which led to a housing bubble, peaking in 2004. In some cases in the US, mortgages had been given to people with no income, no jobs or assets (NINJA mortgages) based on the idea that house prices would inevitably increase, and so the risk to the lender seemed minimal. In the UK, self-employed people were allowed to self-certify their incomes without any real checks carried out to verify this. Many multiples of income were lent to people who could get 110% mortgages. But these loans were then bundled together into complex financial products that were not fully understood, and as soon as confidence fell, this financial house of cards began to collapse. As a result of irresponsible mortgage lending (among other things), stock markets crashed, house prices fell, mortgage arrears increased, repossessions rose and unemployment shot up. A major period of economic stagnation and recession ensued. In the wake of this crisis, mortgage lending has, quite rightly, it seems, subsequently become much harder to obtain. But other forms of unsecured lending have increased quite dramatically, such as payday lending. This is because of a combination of factors linked to the financial crash including: growing income insecurity for people both in and out of work, cuts in state welfare provision, and increasing financialisation.1 This has led to calls

*

School of Social Policy, University of Birmingham, Edgbaston, Birmingham, B15 2TT (corresponding author). ** Corpus Christi College, Merton Street, Oxford, OX1 4JF. *** Centre for Business in Society, Coventry University, Priory Street, Coventry, CV1 5FB. 1 K Rowlingson, L Appleyard and J Gardner, ‘Payday Lending in the UK: the Regul(aris)ation of a Necessary Evil?’, Journal of Social Policy, published online: 3 February 2016.

105

Karen Rowlingson, Jodi Gardner and Lindsey Appleyard

of irresponsible lending, particularly in relation to the unsecured credit market, which is the focus of this chapter. To discuss ‘irresponsible lending’ we need to start by providing some kind of definition. In its essence, the lending of money occurs when one person or organisation gives money to another person or organisation on the understanding that it will be paid back at a later date. This could, for example, involve one friend lending another friend a small amount of money with no expectation about precisely when the money will be returned and no expectation that they will receive interest on the loan. Or perhaps both parties have different expectations about this, which could lead to tension between the two parties. Notions of ‘responsible lending’, however, tend to refer to formal rather than informal lending, where one party is a commercial lender, lending money as a business rather than as a friend. Whereas a friend might lend money for altruistic reasons – to help their friend out – lenders with a commercial motive will be more concerned about their own interests in the form of profit size. Commercial lenders are therefore incentivised to encourage people to borrow more than they need or even want. And they may not be overly concerned about people struggling to repay the loan, particularly if it means the payment of higher default charges. This brings us to the heart of the definition of ‘responsible lending’, which tends to be seen as involving, at a minimum, the following components: being very clear about the terms and conditions of the loan before it is taken out; not encouraging people to borrow more than they need/want; not charging an ‘extortionate’ level of interest; checking that people can afford to repay the money borrowed under the conditions of the loan; and treating people reasonably if they fall behind with payments. If these are the general principles of responsible lending, what role should the state play in creating and enforcing these obligations? Perhaps the state should play no formal role beyond normal contract law, as unsecured loans could be seen as private agreements between individuals. As long as lenders are clear and transparent when disclosing the terms and conditions of the loan, surely borrowers should take responsibility for whether or not to take the money offered on those conditions? Or perhaps the state should simply check that the lenders are generally responsible (through licensing) and then encourage the credit industry to self-regulate as an additional safeguard? This laissez-faire approach has largely dominated the UK over the past century or more, but has changed more recently with the growth of payday lending during the 2000s. Indeed, the government has recently empowered a new regulator (the Financial Conduct Authority) to set tighter rules on unsecured lending of High-Cost, Short-Term Credit (HCSTC).2 Once rules are set, the next question is how they are enforced and whether the regulator waits for individual

2

This is defined by the Financial Conduct Authority (FCA) as unsecured credit agreements for less than twelve months and with an APR over 100%; community finance organisations and doorstep lenders are exempt from both the definition of HCSTC and the cap on the total cost of credit.

106

6

Responsible Lending in the UK: What Role Does the State Play?

complaints or takes a more proactive role. Linked to this, the Financial Ombudsman adjudicates individual complaints against lenders, thus also playing a role in checking how lenders are operating in the market. This chapter now reviews changes in how responsible lending in the unsecured credit market has been regulated over the last decade, alongside evidence of irresponsible behaviour in this sector. It is clear that irresponsible lending has been, and will continue to be, a significant concern in the HCSTC market. The government has taken steps to address these issues and enacted laws designed to clamp down on the most outrageous forms of irresponsible lending. However, this is only dealing with the supply aspects of HCSTC. With the ongoing cuts to the welfare safety net, increased cost of living and stagnated wages, the demand for credit is likely to continue to increase. People in desperate situations are increasingly likely to accept credit that is lent irresponsibly. We argue, therefore, that the state must take a role in addressing the demand for, in addition to the supply of, credit. This chapter will therefore conclude by discussing a range of actions that can be taken by the government to tackle irresponsible lending by decreasing the demand for HCSTC.

6.2

Responsible Lending Protections Pre-2010

Legislation protecting borrowers from exploitation has long been a part of the legal scene.3 This regulation was, however, largely focused on registration of lenders, to ensure that only ‘responsible’ people and companies engaged in lending, and increasing disclosure to borrowers. This combination effectively placed responsibility on borrowers to ensure they read and understood credit agreements. It became clear in the 1960s that this approach provided inadequate legal protection for the increasing number of people accessing shortterm credit products. After significant research, the 1971 Consumer Credit: Report of the Committee (‘Crowther Report’) made a number of recommendations to improve standards of responsible lending, including limits on advertising of consumer credit products, provision of pre-contractual information, mandated disclosure of the cost of credit, rights of cancellation and a uniform licensing system for consumer credit.4 On the basis of these recommendations, the Consumer Credit Act 1974 was introduced to tackle ‘the failure of private law to protect indi-

3

4

The earliest known English law against moneylending was 20 Hen. II, c 5 in 1235, which stated that interest should not run against an expectant heir, between the time he inherits the property and the time he comes of age. Moneylending laws in the current era started with the 1898 House of Commons Select Committee on Money-Lending and the Moneylenders Act 1927 (UK). Sir G Crowther, Consumer Credit: Report of the Committee, Department of Trade and Industry, London, 1971, pp. 257, 266, 271, 289 and 329-334.

107

Karen Rowlingson, Jodi Gardner and Lindsey Appleyard

vidual rights or deter unscrupulous practices and the limited scope of existing licensing regimes’.5 During the 2000s, the payday lending part of the unsecured credit market in the UK grew dramatically. Payday loans can be acquired from retail stores or, more recently, through online platforms. According to Beddows and McAteer, payday loans grew from an estimated £0.33 billion lent in 2006 to £3.709 billion in 2012.6 The term ‘payday lending’ is commonly used, but often ill-defined. The original aim of a payday loan was to lend a small amount to someone in advance of their payday. Once they received their wages, the loan would be repaid. Such loans would therefore be relatively small amounts over a short period. Other forms of high-cost credit, such as instalment loans, are therefore not technically payday loans. Regardless, the term ‘payday loans’ is now often (inaccurately) used to refer to almost all forms of high-cost credit. According to the OFT Compliance Review, the average ‘payday’ loan in 2013 was between £265 and £270 and was borrowed over thirty days, typically with a single repayment made to clear the debt (a ‘bullet’ approach rather than a number of repayments). In 2013, payday loan companies reported that the average cost of borrowing £100 was around £25, but ranged from £14 to £51.7 To give an idea of the cost of this form of credit, in 2014, Wonga would lend £150 over eighteen days and charge interest of £27.99. The fixed interest rate for this loan would be 365% pa. The transmission fee would be £5.50. The total repayment would therefore be £183.49, which would equate to a representative 5,853% Annual Percentage Rate (APR).8 Payday lending (and other forms of HCSTC) is certainly far more expensive than many other forms of credit, such as personal loans, but the industry defends its high charges with reference to the high costs involved in providing small-amount loans over short periods. Another defence used is that APRs are designed to compare year-long loans and so appear particularly high when applied to shorter loans. And even though payday loans are expensive, they may be cheaper than some alternative forms of credit such as going into an (unauthorised) overdraft. Despite its high cost, payday lending is certainly filling a gap in the credit sector, as witnessed by its growth. APRs are usually displayed prominently, suggesting that customers are willing to pay extra for this service for some reason.

5 6 7 8

I Ramsay, Consumer Law and Policy, 3rd edn, Hart Publishing, Oxford, 2012, p. 386. S Beddows and M McAteer, Payday Lending: Fixing a Broken Market, Association of Chartered Certified Accountants, London, 2014. Office of Fair Trading, Payday Lending Compliance Review: Final Report, Office of Fair Trading, London, 2013. Since the enactment of the cap on the total cost of credit in January 2015, the amount of interest that can be charged has been significantly limited. Providers of credit in the UK can now charge only an initial cost of 0.8% per day, 0.8% per day default interest and fees not exceeding £15; creating an effective interest rate cap of 1,270% per annum. For more information, see J Gardner and K Rowlingson, ‘Towards a ‘Cost of Credit’ Cap in the UK: Lessons from Australia’, CHASM Briefing Paper, 2014.

108

6

Responsible Lending in the UK: What Role Does the State Play?

Some may have no alternative to this form of lending or may not understand the nature of APRs. So it is not entirely clear, on the surface, whether any harm is caused by payday lending and whether or not this form of lending is inherently ‘irresponsible’. Nevertheless, since 2008, concern grew about whether there was insufficient protection for borrowers at a time of recession and austerity. In 2010, the Office of Fair Trading (OFT) created the ‘Irresponsible Lending Guidelines’ (ILG), which set forth the steps businesses must take in order to be considered ‘responsible’ in their lending activities. Responsible lending obligations became, arguably, the most important aspect of the current legislative regime for the regulation of high-cost lenders, especially as there were no explicit responsible lending duties in the 1974 Act. Under section 25(2B) of the ILG, creditors were required to lend ‘responsibly’ as a licence condition. This means that responsible lending obligations were part of the fitness test for licensees; creditors had to engage in responsible lending in order to obtain and continue a consumer credit licence.9 There were also indications of responsible lending obligations in the duty to explain the nature and consequences of credit,10 and the duty to make a creditworthiness assessment.11 Under the ILG, lenders were also expected to conform to general principles of fair business practice. Under the guidance, lenders had to take ‘reasonable steps’ to ensure that borrowers could meet their credit repayments in a sustainable manner (i.e. credit could be repaid without undue difficulty, over the life of the specific credit agreement and without the borrower having to release any assets). The specific requirements of ‘reasonable steps’ were proportionate to, and dependent upon, a variety of factors including the type of credit product, the amount of credit provided, the borrower’s financial situation, existing and future financial commitments and the borrower’s credit history. The OFT did not lay down any guidance on the type of steps that may be required in this regard, indicating that it was left to the discretion of the lender to determine what was reasonable in the specific circumstances of the loan. Eighty pages of guidance gave more details on each of these, and other principles, providing a broad framework with which to measure the payday lending industry. In addition, the legal enforceability of the guidance is uncertain, as outlined by the text in the Foreword: The primary purpose in producing this guidance is to provide greater clarity for businesses and consumer representatives as to the business practices that the Office of Fair Trading considers may constitute irresponsible lending 9

See references to the requirement to lend responsibly in the Office of Fair Trading, Consumer Credit Licensing: General Guidance for Licensees and Applicants on Fitness and Requirements, Office of Fair Trading, London, 2010, pp. 4, 6, 8, 9 and 30. 10 Consumer Credit Act 1974 (UK), s 55A. 11 Id, s 55B.

109

Karen Rowlingson, Jodi Gardner and Lindsey Appleyard

practices…. Whilst this guidance represents the OFT’s view on irresponsible lending, it is not meant to represent an exhaustive list of behaviours and practices which might constitute irresponsible lending. The ‘guidance’, however, appeared to have been treated exactly as such, with a number of Trade Association Codes of Conduct stating that members merely need to ‘have regard to’12 the ILG when making their lending decisions.

6.3

Lending Practices and Responsible Lending Reform 2010-2014

From 2010 onwards, despite the existence of the ILG, successive investigations by government agencies and consumer groups highlighted serious problems with the payday lending industry. In 2010, Consumer Focus published a report on payday lending based on desk research and in-depth interviews with twenty customers. The study highlighted the problems that some customers had with payday loans, particularly those on the lowest incomes. The authors called for a limit on the number of loans or rollovers to a maximum of five per year. Consumer Focus argued that this could be achieved by clarifying the definition of ‘unsustainable’ lending in the OFT’s guidance on irresponsible lending. They also recommended: more thorough affordability checks; limiting the number of months that a loan could be deferred for; limiting the value of repeat loans; and sharing information to avoid people being able to take out loans from multiple lenders at the same time. Interestingly, Consumer Focus did not call for a cap on the cost of credit. They also highlighted the fact that some customers had a positive experience of payday loans and warned that banning such loans would not necessarily help people.13 Further evidence of irresponsible lending was produced in December 2011, when Citizens Advice (CA) issued a press release documenting a four-fold increase in the number of people with payday loans coming to Citizens Advice Bureau (CAB) for debt advice in the first quarter of 2011, compared with the same period in 2009.14 CAB evidence pointed to a range of problems that included: people being given unaffordable and unsuitable loans; people being offered multiple rollovers; and aggressive practices when people fall behind with repayments.

12 For example, see section 3.10, page 4 of the Consumer Finance Association’s (2012), Lending Code for Small Cash Advances. 13 M Burton (2010) ‘Keeping the Plates Spinning: Perceptions of Payday Loans in Great Britain’, Consumer Focus, . 14 G Guy (2011) ‘Citizens Advice Response to R3 Report on Payday Loans’, Citizens Advice Bureau, 7 December 2011, .

110

6

Responsible Lending in the UK: What Role Does the State Play?

In response to these reports, the four main trade associations covering payday lenders introduced a Good Practice Customer Charter to increase responsible lending in November 2012. For example, the payday lenders committed to: give clear information about how a payday loan works and an example of the price; not place undue pressure on customers to take out a loan or extend (roll over) the term of an existing loan agreement; carry out proper and appropriate affordability assessment, and credit vetting to check that customers can afford the loan; set forth clearly how repayments would be made; and freeze interest and charges if a customer is in financial difficulty and making payments under a repayment plan. To monitor whether lenders were reaching the standards of their own charter, CAB launched a survey to help people who had payday loans to check whether their payday lender was sticking to the charter. Over 4,000 people completed the survey, and one year on, Citizens Advice found that the majority of people filling in their survey reported instances where the charter was not being adhered to. Particular problems arose once borrowers were facing difficulty with repayments. Fewer than 10% of survey respondents said that lenders had advised them about the availability of free and independent debt advice, and fewer than 20% said that they had been dealt with sympathetically or had interest frozen when they had agreed a reasonable repayment plan.15 This research was followed in 2013 by in-depth analysis of 665 payday loan cases between 1 January and 30 June 2013 by CAB. The results were that three out of four payday borrowers had some ground for an official complaint to the Financial Ombudsman Service (FOS) about their treatment, including fraud (20%), problems with Continuous Payment Authorities (CPAs) (more than 33%), harassment of borrowers (12%) and unfair treatment of people in financial difficulties (10%). This led the Public Accounts Committee, in May 2013, to call the OFT a ‘timid and ineffective regulator’ of consumer credit, pointing out that it waited for complaints from consumers rather than proactively identifying bad practices. Furthermore, it had never fined any of the 72,000 firms it licensed. The Public Accounts Committee also pointed out that the OFT’s resources were limited in comparison with other regulators as it had access to only £1 for every £15,300 in its sector compared with Ofcom’s £1 for every £517 spent in the telecoms market, for example. In its defence, the OFT said that it had been set up to run a ‘licensing regime’ rather than a ‘supervisory regime.’16 CAB deals, of course, with people who have particular problems. Its evidence is extremely valuable, but does not, necessarily, give a picture of customer experience as a whole. The payday lending industry saw themselves as being unfairly criticised and pointed

15 Citizens Advice Bureau (2014) Payday Loans: Campaign Success, . 16 Public Accounts Committee, Regulating Consumer Credit, 8th Report, Houses of Parliament, London, 2013.

111

Karen Rowlingson, Jodi Gardner and Lindsey Appleyard to high levels of overall customer satisfaction from their own surveys.17 One of the main trade associations for the industry, the Consumer Finance Association, also commissioned YouGov to carry out research comparing customers’ views of the payday industry with politicians’ views.18 The research, published in April 2014, found that customers of payday lenders were generally very positive about how they had been treated and the fairness of the deal; conversely, politicians were very negative towards payday lenders.19 In total, 93% of customers said that payday lenders treat their customers with dignity and respect, whereas only 5% of policymakers thought they did so. Furthermore, 89% of customers thought payday lenders explained their charges and fees clearly, whereas only 12% of politicians believed they did. Clearly, there was a massive gulf between the views of the politicians/consumer lobby and those of the industry. An independent review of the industry was needed, and a report from this review was published by the OFT in March 2013.20 This Compliance Review involved: inspections of fifty leading payday lenders; mystery shopping with 156 online and high-street lenders; analysis of the contents of fifty lenders’ websites; questionnaire responses from 1,013 respondents from the industry, consumer groups, local authority trading standards service, etc; analysis of 686 consumer complaints; and market analysis, drawing on data from 190 firms. This thorough review found “evidence of widespread non-compliance with the Consumer Credit Act and other legislation”.21 The review also found that payday lenders were not meeting the standards set forth in the Irresponsible Lending Guidance. On the basis of their research findings, the OFT contacted all payday lending firms and conveyed their expectations for responsible lending. The regulator also required fifty lenders to take immediate steps to address issues associated with non-compliance or face losing their licence. The main outcome of the compliance review was that the government, instead of taking steps to address the issues outlined by the OFT, referred the entire industry to the Competition & Markets Authority (CMA) for yet another review. As part of this review, Europe Economics conducted detailed research on compliance costs and firm behaviour in the payday lending market. The October 2013 report outlined a number of ingrained problems, including lenders not carrying out affordability assessment, overuse of loan rollovers, exploitative and inappropriate use of CPAs, provision of unsuitable advice, unfair dealings with borrowers experiencing financial difficulties, and

17 Consumer Finance Association (2013) Facts & Research: the Payday Lending Market, . 18 300 customers of The Money Shop were surveyed online, alongside 100 MPs, 100 Peers and 100 local councillors/members of the devolved assemblies. 19 . 20 Office of Fair Trading, supra note 7. 21 Id, p. 2.

112

6

Responsible Lending in the UK: What Role Does the State Play?

aggressive debt collection practices.22 Thirdly, the Department of Business Innovation and Skills undertook in-depth consumer and business surveys, which confirmed that payday lenders were not complying with the Good Practice Charter or the relevant Codes of Practice.23 While the report highlighted a number of disturbing practices, it was particularly concerned with the unfair treatment of borrowers in financial difficulty.24 The CMA then reviewed overall levels of competition in the industry, based on an extensive analysis of data relating to 15 million payday loans taken out between 2012 and 2013 along with a survey of 1,500 customers and analysis of Credit Reference Agency records for over 3,000 payday lending customers. On the basis of this research, the CMA’s Payday Lending Investigation Group found25 that price competition between payday lenders was weak and that competition from other forms of credit was also limited. The CMA saw this as being largely due to the lack of transparency associated with these types of credit products and, as a result, price competition was exceptionally weak as borrowers generally did not ‘shop around’ before entering into a loan. The absence of price competition was, the CMA estimated, adding £5-£10 to the average cost of a payday loan.26 Given that customers took out around six loans a year on average, a typical customer would have saved between £30 and £60 per year if the market had been more competitive. The CMA therefore concluded that the market-wide impact of greater competition could be substantial. The CMA, following their analysis of the (lack of) competition in the industry, argued that, while the FCA’s price cap would mitigate some of the harm to customers currently arising from high prices, there was still scope for increased competition below the level of the cap. The CMA therefore proposed the development of a high-quality price comparison sector for payday loans. As a condition of participation in the market, payday lenders would be required to provide details of their products on accredited price comparison websites that would allow people to make quick and accurate comparisons between loans. The CMA also proposed: greater transparency on late fees and charges – which were not always clear to customers when choosing payday loans; measures to help borrowers shop around without damaging their credit record; further development of real-time data 22 Europe Economics, A New Consumer Credit Regime: Benefits, Compliance Costs and Firm Behaviour, Europe Economics, London, 2013. 23 Department of Business Innovation and Skills, Making Consumer Credit Fairer: BIS Report on Surveys of the Payday Lending Good Practice Charter and Codes of Practice, Department of Business Innovation and Skills, London, 2013. 24 Id, pp. 13-14. 25 Competition & Markets Authority (2014) Notice of Provisional Findings Made under Rule 11.3 of the Competition and Markets Authority Rules of Procedure (CMA 17), . 26 Competition & Markets Authority (2014) ‘Payday Borrowers Paying the Price for Lack of Competition’, Media Release, 11 June 2014, .

113

Karen Rowlingson, Jodi Gardner and Lindsey Appleyard

sharing systems, which would help new entrants better assess credit risks; and a requirement for lenders to provide borrowers with a summary of the charges they had paid on their most recent loan and over the previous twelve months, so that they could get a clearer picture of how much they are spending with an individual lender. Further evidence of irresponsible lending came from the CMA. It found that more than half of all loan applications were turned down by most of the major lenders in 20122013. This might, of course, suggest that lenders were, indeed, acting responsibly by checking affordability. However, the CMA also found that while 64% of loans were repaid in full by the due time, 22% of loans were only repaid in full after the originally agreed repayment date (including loans that were refinanced or ‘rolled over’) and 14% of loans issued in 2012 had still not been repaid in full by October 2013.27 This suggested that more than a third of borrowers cannot afford to repay the loan they are given according to the terms of that loan arrangement. This was in line with the findings from the 2013 OFT Compliance Review, discussed above. Indeed, one of the reasons why payday lending was considered harmful was that the business model employed by most lenders was based specifically on lending to borrowers who could not afford to repay their loans. In their detailed review of business models, Beddows and McAteer concluded: ‘Consumer detriment, in the forms of default, repeat borrowing and the taking of multiple loans from different lenders, appears to play a highly profitable role in existing business models … many payday loans serve only to increase the likelihood of future indebtedness.’ Thus: ‘Money spent on rollovers flowed out of the hands of people with a high marginal propensity to consume and into the hands of shareholders, company directors and venture capitalists, all with a much lower propensity to consume.’28 Finally, the number of new payday loan cases opened up by the Financial Ombudsman Service increased by 168% between March 2012 and March 2014. Of the complaints resolved during the year, the Ombudsman upheld 63% in favour of the consumer. The main reasons for complaint were: allegations of fraud; poor administration; the unauthorised or unexpected taking of funds; and the inability to agree a debt repayment plan with the lender.29

27 Competition & Market Authority (2014) Payday Lending Market Investigation Summary of Provisional Findings Report, London, . 28 Beddows and McAteer, supra note 6, p. 65. 29 Financial Ombudsman Service, Payday Lending: Pieces of the Picture, Financial Ombudsman Service, London, 2014.

114

6

Responsible Lending in the UK: What Role Does the State Play?

It is clear from a range of evidence that payday lending companies have behaved irresponsibly in the past, but practice varied. For example, one of the major payday lending companies, Wonga, was found, in October 2014, to have behaved particularly irresponsibly by inadequately assessing customers’ ability to meet repayments in a sustainable manner.30 The FCA came to this view on the basis of analysis of the volume of Wonga’s relending rates (i.e. lending to the same people more than once). On the basis of this finding, Wonga entered into an agreement with the regulator that approximately 330,000 customers who were currently in excess of thirty days in arrears would have the balance of their loan written off and would owe Wonga nothing. A further 45,000 customers who were between zero and twenty-nine days in arrears would be asked to repay their debt without interest or charges and would be given an option of paying off their debt over an extended period of four months. This enforcement action cost Wonga over £220 million and has had a significant impact on their reputation in the market. Wonga had also hit the headlines earlier in 2014 when the FCA found that the firm had sent letters, between 2008 and 2010, to customers in arrears from non-existent law firms, threatening legal action.31 In some instances, Wonga had also added charges to customers’ accounts to cover the administration fees associated with sending the letters. Wonga have since agreed to identify and pay redress to all affected customers, including refunding and/or reducing the outstanding balances on thousands of accounts. It is thought that up to 45,000 customers could receive, between them, a total of over £2.6 million in compensation. Given all the evidence of irresponsible lending, it is not surprising that a campaign for reforming payday lending had gathered steam from 2011 onwards. CAB joined with the Money Advice Trust, Toynbee Hall, Which?, the Centre for Responsible Credit, Church Action on Poverty and Stepchange Debt Charity to lobby for major reform. Walthamstow MP, Stella Creasey, also played a high-profile media role in calling for a cap on the cost of payday loans. In February 2011, Creasey wrote an article for the Guardian entitled: “Legal loan sharks are circling the poor.”32 In fact, this article did not focus particularly on payday lenders but on all forms of HCSTC, including home collected credit. It called for much stronger government action in this field. The campaign also worked closely with MPs from the Debt and Personal Finance All Party Parliamentary Group, including Paul Blomfield and Yvonne Fovargue. This campaign successfully applied pressure for reform, and resulted in some significant changes to the responsible lending regime in the UK. 30 Financial Conduct Authority (2014) ‘Wonga to Make Major Changes to Affordability Criteria Following Discussions with the FCA’, Press Release, 2 October 2014, . 31 Financial Conduct Authority (2014) ‘Wonga to Pay Redress for Unfair Debt Collection Practices’, Press Release, 25 June 2014, . 32 Stella Creasy (2011) ‘Legal Loan Sharks Are Circling the Poor’, The Guardian, 3 February 2011, .

115

Karen Rowlingson, Jodi Gardner and Lindsey Appleyard

6.4

Changes to the Regulation of Responsible Lending from 2014 to 2015

In the shadow of the Global Financial Crisis, caused at least in part by irresponsible (mortgage) lending and inadequate regulation of the financial services sector, the Financial Services Act 2012 ushered in major changes to the regulation of financial services. The Financial Services Authority was abolished, and its functions were transferred to two new bodies: the FCA and the Prudential Regulatory Authority. That Act transferred the regulation of consumer credit from the OFT to the FCA from 1 April 2014. The FCA is a far better resourced regulator than the OFT; it takes a different approach, with more emphasis on early intervention and greater regulatory powers. Questions, however, still remain on whether it will go far enough to tackle the deep-rooted problems associated with HCSTC. With the movement of the consumer credit jurisdiction to the FCA, the guidance on irresponsible lending has been supplemented by the FCA’s Consumer Credit Source Book (CONC 5) Responsible Lending. Lenders are expected to conform to general principles of fair business practice and must make ‘reasonable creditworthiness assessment’ to ensure that borrowers can meet their credit repayments in a sustainable manner (i.e. credit can be repaid without undue difficulty over the life of the specific credit agreement and without the borrower having to release any assets).33 The specific requirements of the assessment are proportionate to, and dependent upon, a number of factors including the type of credit product, the amount of credit provided, the borrower’s financial situation, existing and future financial commitments and the borrower’s credit history.34 The FCA does not lay down any guidance on the type of steps that may be required in this regard, indicating that it is left to the discretion of the lender to determine what is reasonable in the specific circumstances of the loan.35 In addition to the increased responsible lending requirements, the FCA also enacted a range of new rules for lenders that were designed to remove the most harmful aspects of HCSTC. These included: – requiring adequate affordability assessments, including a consideration of the borrowers’ other financial commitments; – allowing for a maximum of two rollovers of the loan amount; – allowing for a maximum of two unsuccessful attempts at continuous payment authorities (CPAs) to pay off the loan in full;

33 Financial Conduct Authority, Consumer Credit Sourcebook (CONC), Responsible Lending, 5.2.2. 34 Id, 5.2.3. 35 Id, 5.2.4.

116

6

Responsible Lending in the UK: What Role Does the State Play?

– a prohibition on the use of CPAs for part payments; – requiring a financial warning to be included in payday advertisements; and – requiring lenders to provide borrowers who roll over a loan with an information sheet including information on how to access free debt advice.36 The purpose of these reforms is twofold: first, to reduce the incentive for businesses to lend to consumers who cannot afford the loan; and second, to increase borrowers’ awareness of the costs and risks associated with irresponsible borrowing. Although this is a step in the right direction, we have yet to fully see how the new regime will work in practice, and whether it will effectively curb the irresponsible lender behaviour currently in the market. The continued focus on education and information, we would argue, is unlikely to have much of an impact.37 For education and information disclosure to be an effective form of consumer protection, borrowers have to: (a) read the material disclosed, (b) understand the information provided and (c) respond to the information in a rational way.38 Unfortunately, “humans can be short-sighted, impulsive, inert and optimistic”,39 and consumers do not necessarily undertake these steps or act in what might be seen as a rational manner.40 Despite these issues with disclosure, the FCA has continued to focus on “increas[ing] borrowers’ awareness”41 as a way of preventing exploitative lending. The recent FCA proposals include risk warnings on payday advertisements and a requirement for lenders to 36 For full details see Financial Conduct Authority (2014) Policy Statement: Detailed Rules for the FCA Regime for Consumer Credit Including Feedback on FCA QCP 13/18 and ‘Made Rules’. For more information on this issue, see J Gardner, Payday Lending in the United Kingdom: Meeting the Needs of the Modern Borrower, M.Phil Thesis, University of Oxford, 2013. 37 See further, A Sen, ‘Rational Fools: A Critique of the Behavioral Foundations of Economic Theory’, Philosophy & Public Affairs, Vol 6, 1977, pp. 317-344; H Einhorn and R Hogarth, ‘Behavioural Decision Theory: Processes of Judgment and Choice’, Journal of Accounting Research, Vol 19, 1981, pp. 1-31; L DiMatteo, R Prentice, B Morant and D Barnhizer, Visions of Contract Theory: Rationality Bargaining and Interpretation, Carolina Academic Press, Carolina, 2007, pp. 115-118, 120; W Richard, H Michael, W Ryan, C Jason, G Karen and B Susan, ‘Consumer Credit Card Use: The Roles of Creditor Disclosure and Anticipated Emotion’, Journal of Experimental Psychology, Vol 13, 2007, pp. 32-46; K Francis, ‘Rollover, Rollover: A Behavioral Law and Economics Analysis of the Payday-Loan Industry’, Texas Law Review, Vol 88, 2010, pp. 611-638; R Mann, ‘Nudging from Debt: The Role of Behavioral Economics in Regulation’, The Lydian Payments Journal, 2011, . See also the comprehensive critique of the impact of mandatory disclosure in O Ben-Shahar and CE Scheider, ‘The Failure of Mandated Disclosure’, University of Pennsylvania Law Review, Vol 159, 2011, pp. 647-729, especially 665-667. 38 G Hadfield, ‘An Expressive Theory of Contract: from Feminist Dilemmas to a Reconceptualisation of Rational Choice in Contract Law’, University of Pennsylvania Law Review, Vol 146, 1998, pp. 1235-1285, especially 1247. 39 D Evans, ‘The Behavioral Economics of Paying and Borrowing’, The Lydian Payments Journal, 2010, . 40 R Thaler, ‘Toward a Positive Theory of Consumer Choice’, Journal of Economic Behaviour and Organisation, Vol 1, 1980, pp. 39-60. 41 Financial Conduct Authority, Detailed Proposals for the FCA Regime for Consumer Credit, Financial Conduct Authority, London, 2013, p. 175.

117

Karen Rowlingson, Jodi Gardner and Lindsey Appleyard

provide borrowers with an information sheet before a loan is rolled over, both of which aim to increase borrower knowledge.42 In the light of economic and psychological evidence on the impact of bounded rationality and cognitive bias, the protective potential of consumer disclosure and the impact it has on the decision-making abilities of consumers is subject to significant and valid criticisms.43 Despite these criticisms, the new rules do also affect lending practices in more concrete ways than these (e.g. in relation to affordability assessments, limited rollovers and CPAs). These appear to be having an impact, as in the five months following their introduction, the number of loans and the amount borrowed from payday lenders dropped by 35%.44 Many consumer advocates were, however, still not satisfied and argued that these reforms were inadequate as they did not tackle what they believed was the main cause of the problems with payday lending: the unregulated level of interest being charged by lenders. Previous research had argued against a cap on the cost of credit for fear of reducing access to this form of credit. In 2011, the Department of Business, Innovation and Skills (BIS) commissioned a major report from the Personal Finance Research Centre (PFRC) to analyse the potential impact of a cap on the total cost of credit. The report argued against a cap on the cost of credit, arguing that short-term credit was necessarily high-cost because the loans are small and the risk of default is higher than for other forms of credit. They argued, further, that consumers faced six main issues in relation to this form of credit, with price issues comprising only two of the six: the total charge for credit, and default charges. The other four related to affordability assessment; financial difficulty; multiple and repeat borrowing from short-term lenders; and loan renewal.45 Despite the evidence and arguments in this report, the government made a surprise move in November 2012, and amended the Financial Services Bill to give regulators the power to put a cap on the cost of credit. This development came in response to a possible House of Lords defeat on an amendment put down by the Labour peer, Lord Mitchell, over the issue. Lord Mitchell’s amendment had also been signed by Justin Welby, the incoming Archbishop of Canterbury. The community pressure continued, and in November 2013, an amendment to the Banking Reform Bill was passed that required the FCA to implement a cap on the total cost of credit by early 2015. Key details of the planned cap were announced in November 2014 as follows:

42 Id, p. 54. 43 B Bix, ‘Contracts’ in F Miller and A Wertheimer (eds.), The Ethics of Consent: Theory and Practice, Oxford University Press, Oxford, 2009, pp. 265-266. 44 Financial Conduct Authority (2014) ‘FCA Confirms Price Cap Rules for Payday Lenders’, Press Release, 17 November 2014, . 45 Personal Finance Research Centre (2013) The Impact on Business and Consumers of a Cap on the Total Cost of Credit, University of Bristol, Bristol, .

118

6

Responsible Lending in the UK: What Role Does the State Play?

1. The initial cost of credit capped at 0.8% per day, with an annualised percentage rate of 1,270%; 2. Default fees limited to £15 and default interest not to exceed 0.8% per day; and 3. A 100% repayment cap, meaning that the borrowers will never have to repay more than double the amount they borrowed. The cap was introduced from 2 January 2015 to apply to HCSTC; however, it specifically excluded home collected credit and overdrafts. The main focus was therefore on ‘payday loans’ though some personal instalment loans were included. The FCA estimated, in November 2014, that 7% of current borrowers may not have access to payday loans – some 70,000 people – following the introduction of the price cap.46 But they argued (perhaps without adequate justification) that these people were likely to have been in a worse situation if they had been granted a loan. The FCA therefore contended that the price cap would protect them by excluding them from obtaining potentially harmful credit products.

6.5

Problems with Other Types of Lenders

As we saw earlier, various investigations have confirmed that payday lending companies have engaged in irresponsible lending behaviour. The new regulatory framework and price cap have, as outlined above, reduced the level of unsecured HCSTC lending and thereby, it is assumed, increased responsible lending. However, the reforms have done nothing to reduce the demand for this type of credit and so it is possible that some of those people who are now excluded from payday lending will turn to sources of credit which are possibly more expensive and less suitable.47 This is because the cap on the total cost of credit and other additional regulatory requirements discussed above apply only to HCSTC – defined by the FCA as credit costing more than 100% APR and lasting no more than twelve months. It is possible that lenders can avoid the cap by changing their lending models. For example, a small loan over thirteen months will not be subject to the cap. Although lower APRs are generally assumed to be better, a small loan of 99.9% APR over eleven months will fit within the cap, but may not be in the best interests of a customer when compared to a much shorter term loan with a higher APR. Furthermore, the cap specifically excludes home collected credit and overdrafts, both of which might otherwise be covered by the definition. The reason for these exclusions is not at all clear, and despite a number of Consultation Responses arguing against this limited definition, the FCA have not provided any additional justifications for their continued focus on payday lenders in particular or HCSTC, more generally. Perhaps the fact that the 46 Financial Conduct Authority, supra note 44, 11 November 2014. 47 Rowlingson, supra note 1.

119

Karen Rowlingson, Jodi Gardner and Lindsey Appleyard

Competition Commission argued against a cap on the cost of home collected credit in 2006 was considered reason to exempt it?48 And perhaps the power of the major banks to resist being treated the same as payday lenders helped them avoid the cap on overdrafts? In April 2014, the FCA released research that showed that overdrafts were not providing good value, with many consumers confused about the costs associated with this service. The FCA has therefore launched a review of overdrafts to consider ways to improve the value they provide. Similarly in November 2014, the FCA launched an investigation into credit cards, arguing that consumers do not sufficiently understand the different features of this market and so competition is undermined. The FCA’s report into the credit card industry was more positive about the level of competition in this part of the financial services industry, finding evidence that consumers shop around, switch and value the flexibility offered by credit cards. The FCA also found that consumers in default were unprofitable and firms were active in contacting consumers who missed payments and triggered forbearance at this point. However, firms did little about those who borrowed more than they really wanted to and also did little about those who made only the minimum payment each month. The FCA suggested the following possible remedies in relation to under-repayment: disclosures to encourage faster repayment; provide a wider range of pre-set repayment options. Another option would be to increase the minimum repayment across the board, but this would reduce the repayment flexibility from which many consumers benefit. For over-borrowing, the FCA have pointed out that the following measures could make the market work better for consumers: providing timely information to remind consumers to consider how much they are borrowing; giving consumers more control during the lifetime of the credit card on variations, such as an opt-in for credit limit increases. Consumers could also benefit from being able to choose the same payment due date each month, to align with the time they receive their regular income where this is not currently an option. In relation to potentially problematic debt, the FCA have suggested earlier forbearance. However, these reforms are relatively modest, and the FCA acknowledges that there are more radical approaches possible to tackling problem debt including a cap on the cost of credit cards, but the regulator does not currently intend to pursue this approach because they see it as compromising the flexibility of credit cards that people value.49 In November 2014, the CMA launched its investigation into the supply of personal current accounts and of banking services to small and medium-sized enterprises. Its interim report was published in October 2015 arguing that competition was not working well in the mainstream current account sector. Overdraft charges were complex, it argued. These 48 Competition Commission (2006) Home Credit Market Investigation: Final Report, . 49 Financial Conduct Authority (2015) Credit Card Market Authority, .

120

6

Responsible Lending in the UK: What Role Does the State Play?

should be much more transparent, but the report stopped short of calling for an end to so-called free banking services.50 There are major issues with mainstream banking services, therefore, which do not serve consumers, particularly those on lower incomes, well (if at all). Personal bank loans are typically large loans over a long period, designed to help with major purchases, home improvements, holidays and so on. Such loans are not designed to help people with shortterm needs. Nor will banks typically deal with people who have a poor credit rating. People on low incomes therefore have little choice but to borrow from alternative (and often highcost) lenders. Banks, as the core financial institutions in the UK and recipients of over £38 billion of taxpayer subsidies in 2013 alone, should have an obligation to support and assist all people with their financial needs. When mainstream banks do lend to higher-risk customers, however, some of the products offered can be a cause for concern. For example, some high-street banks have also been found to be using debt recovery tactics not too dissimilar from those of Wonga discussed above. In July 2014, an investigation found that some banks, including Royal Bank of Scotland, Lloyds Bank and HSBC, were routinely issuing legal demands from what appeared to be independent firms of solicitors, giving the impression to borrowers that their case had been escalated to a third party, and that proceedings were imminent, which was not the case. The limited definition of HCSTC means that a number of other potentially exploitative loan products are not covered by the cap or increased responsible lending requirements. Two examples of this are logbook loans and the rent-to-buy sector, both of which are of concern to the FCA. Logbook loans are secured on a vehicle where the consumer can continue using the vehicle, but ownership of the vehicle transfers to the lender. Lenders charge high rates of interest, do not make sufficient affordability checks and obtain strong rights of seizure if repayments are missed. The rent-to-buy sector allows customers to purchase and take home the product in question and repay it after the fact through instalments. These products are often sold at (sometimes significantly) higher cost than purchasing outright, and there can be obligations on customers to buy expensive insurance and other services in conjunction with the product. The overall cost can therefore be considerably higher than if the customer had obtained a small loan and purchased the product outright. Despite the numerous reports highlighting the dangerous and exploitative actions of many lenders and the potential harm of high-cost credit products (both inside and outside of the definition of HCSTC), the regulator continues to focus on choice and competition.

50 See details at Competition & Markets Authority (2015) Retail Banking Market Investigation, .

121

Karen Rowlingson, Jodi Gardner and Lindsey Appleyard

The FCA states that its amendments to the high-cost credit regime aim to ‘best secure the appropriate degree of protection while minimising the impact on firms’. So while the FCA amendments are a step in the right direction, what more could be done?

6.6

Increasing the Supply of Affordable Credit

As we have argued above, it is clear that people on low incomes or with impaired credit histories have limited credit choices, and HCSTC can sometimes be the only option available to them. This means that enhancing responsible lending obligations can result in decreased lending options and, potentially, the financial exclusion of people who were dependent on HCSTC as their only credit option. It is therefore important for the state to address responsible lending on both the supply and demand sides. Three ways in which this can occur is through a revitalised social fund system whereby the state provides nointerest loans directly to those on the lowest incomes; a new No Income Loan Scheme/Low Income Loan Scheme (NILS/LILS) following the example in Australia; and the provision of further support to the long-term growth of Credit Unions. With the devolution of the social fund to local authorities and the dwindling of resources, there seems little appetite currently to revive the social fund. One potentially alternative model could be the NILS and LILS scheme being run by the National Australia Bank and Good Shepherd Microfinance, which has assisted over 125,000 financially excluded Australian borrowers to access affordable credit in times of need.51 This programme provides no-interest loans of up to $1,200 AUD to people on low incomes for the purchase of essential household items. The NILS capital is ‘circular community credit’. The repayment of one NILS loan provides funds for another, and 97% of all NILS loans are repaid in full by borrowers. Once the NILS loan has been repaid, it is a pathway to a StepUP low-interest loan. These are loans of $3,000-$8,000 AUD that are repaid, in a similar fashion to a bank loan, over a three-year period. They are designed to provide a low-interest product for people who are excluded from affordable and appropriate mainstream credit. A 2013 review of the programme found that people who use these products are one step closer to financial inclusion and are less likely to borrow from high-cost lenders. The current mainstream banking industry already in the UK has the size and infrastructure to provide short-term loans to large numbers of individuals and, potentially, compete with the payday lenders in this regard. However, for a variety of reasons, banks generally do not provide these sorts of financial products. Nevertheless, it could be argued that banks in the UK should take measures to provide financial services to all consumers, 51 Good Shepherd Microfinance, Life Changing Loans at No Interest, Good Shepherd Microfinance, Victoria, 2014.

122

6

Responsible Lending in the UK: What Role Does the State Play?

even those that may be considered a higher risk – especially in light of the large sums of taxpayer money recently spent to keep the industry afloat. As suggested above, there are many examples of the ways that banks can rise to the occasion in this regard and assist those who are financially excluded. This includes reassessing the current fee structure, which has significant penalties for people who go overdrawn or cannot afford repayments, exacerbating the financial situation of people who are already struggling. Further transparency and disclosure from the banking industry will also help to identify any regional disparities in the provision of financial services. Another approach we might take to increase the supply of affordable credit is via Credit Unions. These are often viewed as a potential alternative source of credit to payday loans, particularly for those excluded from payday loans since the interest rate cap was introduced. Indeed, a few of the 360 UK Credit Unions have developed a ‘payday loan’ type product, albeit one that is affordable (up to 42.6% APR), quick to access and repaid over a period of months rather than in a single repayment. These Credit Unions have chosen to provide such a product to attract new customers and build savings alongside the loan (both for the benefit of the members and the sustainability of the Credit Union). Yet Credit Unions cannot serve all those that are now excluded from payday loans, owing to a range of factors, notably the following: responsible lending policies; and the level of risk that would be necessary to meet the expected level of demand that is ultimately unsustainable for the Credit Union business model. The £38 million government-funded expansion project to which over seventy Credit Unions are subscribed is designed to encourage Credit Unions to diversify and grow. Therefore, the UK government is eager for Credit Unions to both become more mainstream (by attracting financially wealthier customers) while also lending to customers at the financial margins. If credit unions can achieve both objectives they might then provide a sustainable way of reducing financial inclusion in the longer term.52 But this may not be possible without increasing interest rates, for example.53 Moreover, this policy allows for mainstream banks to continue their ‘business as usual’ without being forced by regulators to consider the fees and charges of their credit products.

6.7

Conclusions

Responsible lending has been part of the regulatory landscape since the enactment of the Consumer Credit Act in 1974. The state’s role in creating and enforcing responsible lending behaviour has been an ongoing question – with some stakeholders arguing for a

52 S Sinclair, ‘Credit Union Modernisation and the Limits of Voluntarism’, Policy & Politics, Vol 42, 2014, pp. 403-419. 53 D McKillop, AM Ward and JO Wilson, ‘Credit Unions in Great Britain: Recent Trends and Current Prospects’, Public Money & Management, Vol 31, No 1, 2011, pp. 35-42.

123

Karen Rowlingson, Jodi Gardner and Lindsey Appleyard

laissez-faire, self-regulatory model of encouraging responsible behaviour and information/education, while others have advocated a strong, paternalistic government response to the issues of irresponsible (and at times exploitative) actions from lenders operating in the high-cost credit market. This chapter has analysed the historical developments of the responsible lending protections in the United Kingdom, up to and including the recent enhancement of the requirements by the newly created Financial Conduct Authority. While the scope of responsible lending guidelines is up for (at times, very strong) debate, we argue that there are five clear messages that can be gleaned regarding the role of the state in creating and enforcing responsible lending obligations for high-cost credit providers. First, responsible lending raises issues above and beyond merely the cost of credit, and includes other factors such as affordability assessments; use of rollovers and CPAs; and adequate/suitable disclosure. Second, it is important to recognise that stringent responsible lending requirements are likely to result in a lack of access to high-cost credit for some people, often those who have no other financial options. This can be counter-productive and mean that strong consumer protection responses may actually result in some excluded people being worse off. Third, if the state really wants to address the issues associated with irresponsible lending practices in the high-cost credit market, it must tackle the supply of credit across the broadest range of mainstream and alternative lenders rather than merely reforming one part of the alternative lending sector. Fourth, other sources of affordable credit need to be provided, either through the state (social fund/local welfare assistance) or through the third sector (via Credit Unions) or a new partnership between mainstream and alternative lenders (a NILS/LILS scheme). Finally, it is vital to tackle the demand for credit that is primarily caused by insecure, low incomes. This is too large an issue for discussion here, but if the underlying problems associated with the growth in demand for high-cost credit are not addressed, borrowers will continue to be vulnerable to exploitative businesses and thus irresponsible lending practices.

124

7

Consumer Protection Problems Created by the Structure of English Personal Insolvency Law

John Tribe*

7.1

Introduction

This chapter critically examines the three main procedures that exist in English and Welsh personal insolvency law to deal with the plight of the insolvent consumer debtor. We are focusing almost exclusively on consumer debtors – not debtors whose indebtedness is a result of entrepreneurial activity.1 The procedures that are examined from the perspective of the consumer debtor are: Bankruptcy, the Debt Relief Order (DRO) and, finally, the Individual Voluntary Arrangement (IVA). The substance, policy and use of these three procedures are critically examined.2 The subject is ripe for consideration. In recent years there has been a relative explosion in the use of consumer credit and corresponding academic literature.3 Consumer credit and insolvency solutions to over-indebtedness are, of course, not new in this jurisdiction or others. As early as 1972, Ziegel was getting to grips with how personal insolvency solu-

*

1

2

3

Senior Lecturer in Law, University of Liverpool, Liverpool, UK. Email: [email protected]. I would like to thank Dr Federico Ferretti for the invitation to contribute to this collection and for his comments on the draft chapter. I would also like to thank His Honour Judge Abbas Mithani QC, Mr John Townsend, Ms Lynne Davies, Mr Toby Davies, Professor Harry Rajak and Ms Susan Morgan for their constructive comments on earlier drafts of this chapter. Responsibility for any errors or omissions rests solely with the author. The division of types of debt within a debtor’s estate can cause difficulties for a Trustee in Bankruptcy or IVA supervisor. For example, to what extent are shoes purchased using credit for work that are also a fashion item a consumer debt or a reasonably incurred work-related item? The dividing line between consumer debt expenditure and other types of indebtedness is sometimes hard to identify. Cornelius v. Casson [2008] BPIR 504 is the authority for the proposition that an IVA can compromise debts incurred by a partner in a business. On the current policy of England and Welsh personal insolvency, see: Tribe, J. The Kekhman quintessence: what is English personal insolvency law for? (2015) Nottingham Business and Insolvency Law eJournal, 3(18), pp. 331-367. On the three procedures generally, see: Keay, A & Walton, P. Insolvency Law: Corporate and Personal. 2nd Edition. Jordans Publishing, Bristol, 2012. See, for example, Niemi-Kiesilainen, J, Ramsay, I & Whitford, W. Consumer Bankruptcy in Global Perspective. Hart Publishing, Oxford, 2003. See also: Ziegel, JS. Comparative Consumer Insolvency Regimes – A Canadian Perspective. Hart Publishing, Oxford, 2003, pp. 109-126 for a discussion of English and Welsh activity. See also: Niemi, J, Ramsay, I & Whitford, WC. Consumer Credit, Debt & Bankruptcy – Comparative and International Perspectives. Hart Publishing, Oxford, 2009.

125

John Tribe tions might be communicated to debtors in the context of consumer bankruptcy in Canada.4 More recently, he has, however, observed: Before the 1980s, most countries did not perceive consumer insolvencies as a significant social, legal and economic problem, and even fewer gave it much legislative attention…all this has changed dramatically…5 Things have indeed moved on apace. The recent spike in consumer credit use means that we must consider the options that respond to how consumer credit is used, and sometimes abused. What does English and Welsh personal insolvency law have to offer currently over-indebted consumer debtors? Although this chapter is concerned with consumer debtors, and relevant personal insolvency procedures, it would be a misnomer to conclude that the procedures exist only for the use of this species of debtor. As will become clear, the DRO procedure is primarily aimed at the consumer debtor, whereas the bankruptcy and IVA regimes were formulated and have evolved to deal with entrepreneurially incurred over-indebtedness and the subsequent relief that is supposed to accompany exit from those procedures. Consumer debt can still lead to levels of indebtedness that surpass the DRO thresholds, however. This means that for rehabilitation of that consumer debtor an IVA or bankruptcy may be sought by creditors or debtors. There are a number of potentially apposite procedures that are not considered in this chapter. That is because they do not fall under the Insolvency Act 1986 or because they are informal in nature. Examples of the former include Deeds of Arrangement (DofA)6 and County Court Administration Orders (CCAO).7 Both of these procedures are largely moribund.8 Debtors can also come to informal agreements with their creditors. These settlements and compromises are also not considered in this chapter. Debt Management

4 5 6 7

8

See: Ziegel, J. Consumer bankruptcies (1972) Chitty’s Law Journal, 20(10), p. 325. Ziegel, J. The challenges of comparative consumer insolvencies (2005) Pennsylvania State International Law Review, 23, p. 639. See further: Fletcher, IF. The Law of Insolvency. 4th Edition. Sweet & Maxwell Ltd, London, 2009, at paras. 4-059. (Hereafter referred to as Fletcher Insolvency). If one or more of the debtor’s creditors has a court judgment against the debtor, and if the total debts are £5,000 or less, the county court could make an administration order. This is similar to an IVA (see Part (3) below) whereby payments are made to the court over a given period pursuant to a timetable. These payments are then made to creditors. A fee is payable for the administration order. See, for example, Fennel, S. Voluntary Arrangements (individual), In: Briggs, N (Ed). Tolley’s Insolvency Law Service (looseleaf), LexisNexis, London, Division V, 2016, at paragraph V5001, who notes that DofA “had fallen into disuse, in part because of the legal and practical difficulties in utilising the procedures…[DofA] remains in force, but is little used.” The Deregulation Bill 2014 included provisions to remove DofA from the statute book.

126

7

Consumer Protection Problems Created by the Structure of English Personal Insolvency Law

Plans and other informal non-statutory agreements fall under this species of agreement.9 The very existence of these alternative procedures could be cited as an undermining influence of the superstructure of the personal insolvency law offering. This is particularly true of the CCAO as the policy formulation for this procedure is undertaken by a different organ of state than the Insolvency Service; it falls under the remit of what is now the Ministry of Justice.10 It goes without saying that the consequence of two different sets of policymakers offering different solutions for similar purposes can lead to confusion for debtors (Figure 7.1).

Figure 7.1 Insolvency Act 1986 personal insolvency procedures – the options

This chapter is primarily concerned with examining how the structure of the English and Welsh personal insolvency regime affects the consumer debtor and their use of the available regimes.11 Does the structure itself, e.g. threshold levels of debt, entry costs to the procedure, compliance obligations, inter alia, hamper the effective use of the procedures for their stated policy aims? For example, if the DRO is meant to satisfy consumer debtors, but the upper limit is unduly low in terms of reflecting the average level of personal indebtedness, 9

For an Australian perspective on these provisions, see: Wyburn, M. Debt agreements for consumers under bankruptcy law in Australia and developing international principles and standards for personal insolvency (2014) International Insolvency Review, 23(2), pp. 101-121. 10 See further: . County Court administration orders relating to individuals are made under the County Courts Act 1984 (CCA84) sections 112-117, and the procedures are governed by the Civil Procedure Rules 1998 (CPR98) Schedule 2 CCR Order 39. 11 It is not concerned with other tangential issues that also affect the effectiveness of the English and Welsh personal insolvency provisions, i.e. how easily accessible information is regarding the use of the provisions for consumer debtors. See further: Tribe, J. Book review of: going bust? How to resist and survive bankruptcy and winding up by Professor Muir Hunter QC (2007) Tolley’s Insolvency Law and Practice, 23(3), p. 92.

127

John Tribe

does the DRO factor itself out of usage? If bankruptcy is perceived as a negative and stigmatising device because of its history,12 and not as a rehabilitative regime that is now designed to get debtors back on their feet, is it so unattractive as to put potential users off using it entirely? Are the professional costs associated with an IVA so prohibitive that they stop consumer debtors entering into these compositions with their creditors? These and other questions will be addressed in the following three case study sections: (1) Bernadette the Bankrupt, (2) Deepak the DRO user, and, finally, (3) Isabel the IVA user. Two primary arguments are advocated in this chapter. First, it is argued that historical baggage and modern perception stymie the use of both bankruptcy and the IVA procedure. The DRO has gone some way towards alleviating stigma issues, but, fundamentally, English and Welsh consumers are ill-served due to the long-held perception of indebtedness, particularly in relation to the older procedures of bankruptcy and IVAs. Second, it is argued that in England and Wales there is too much focus on technical insolvency. If we allowed ourselves to rethink bankruptcy and insolvency as occasions when restructuring and reorganisation should occur, as opposed to thinking negatively about how the debtor got into that position, we would find ourselves in a better position more generally. If we instead concentrated on what could be done to get the debtor back on the solvent road contributing to society again, we would be in a more rehabilitative environment. This argument takes forward rehabilitation and renewal to a new level as it, in essence, posits that debtors need rehabilitation procedures as part of their general dayto-day existence and that a personal insolvency law should not be seen as a statutory privilege for debtors that comes in when all else has failed and we are at the extreme negative end of an individual’s personal debt position. Of course, there should be checks and balances against reckless behaviour. Credit should not be abused.13 The Bankruptcy Restrictions Order (BRO) regime,14 which was introduced as a check and balance against the reduction in bankruptcy discharge,15 is examined in Section 7.3 of this chapter. This procedure exists to ensure that miscreant and feckless behaviour is called to account. This regime exists against a background of liberalism and general rehabilitative forgiveness that is embodied in the changes wrought by the Enterprise Act 2002.

12 For a brief exposition of this negative history, see: Tribe, J. Bankruptcy and capital punishment in the 18th and 19th centuries (2009) Insolvency Intelligence, 22(3), pp. 44-47. 13 Nor should credit be extended in a reckless and overgenerous and extravagant way. Both parties make the credit contract – there is an argument that both should bear the costs and effects of a breakdown in the credit relationship. 14 On BROs see further: Tribe, J. Parliamentarians and bankruptcy: the disqualification of MPs and peers from sitting in the Palace of Westminster (2014) King’s Law Journal, 25(1), pp. 79-101. 15 On the changing nature of discharge see: Tribe, J. Discharge in bankruptcy: an historical and comparative examination of personal insolvency relief in England and Australia (2012) Insolvency Law Journal, 20(1), pp. 240-263.

128

7

Consumer Protection Problems Created by the Structure of English Personal Insolvency Law

Before moving to an examination of the three sets of provisions it is appropriate to address three points that impinge on all three sets of provisions, namely16 (a) England and Wales’s general attractiveness as a personal insolvency jurisdiction; (b) the current and historical statistical position on how the three procedures have been used over the last thirty years; and (c) how consumer debtors might come to access the provisions.

7.1.1

England and Wales’s Attractiveness as a Personal Insolvency Jurisdiction

At this introductory point it should be said, particularly in the context of a volume that is both multidisciplinary and multi-jurisdictional, that we should not think too negatively about the solutions available for personal insolvents in England in Wales.17 Indeed, the jurisdiction has become increasingly attractive for individuals seeking to clear indebtedness and start again. The language identifying this phenomenon is sometimes pejorative. Indeed, England has sometimes been referred to as a bankruptcy brothel. This shift in perception does indicate that the jurisdiction provides a set of provisions that meets debtor need. EU member state citizens, particularly from Ireland and Germany, have for some time been seeking to change their Centre of Main Interest (COMI) to England and Wales so as to gain access to our more favourable personal insolvency regime.18

7.1.2

Statistics – Personal Insolvency Use and Credit Extension

Before we progress to a close examination of the pertinent personal insolvency procedures and how these may impact on the consumer debtor in terms of their nature, it is appropriate to consider the incidence of use of the various procedures. Figure 7.2 shows how the personal insolvency procedures have been used over time from the introduction of the Insolvency Act 1986 to the present day. 16 For a discussion of further factors affecting the development of personal insolvency provisions, see: Spooner, J. Fresh start or stalemate? European consumer insolvency law reform and the politics of household debt (2013) European Review of Private Law, 21(3), pp. 747-794. 17 Personal insolvency solutions are, of course, available in other jurisdictions! For some recent reform activity elsewhere see: Kilborn, JJ. Twenty-five years of consumer bankruptcy in continental Europe: internalizing negative externalities and humanizing justice in Denmark (2009) International Insolvency Review, 18(3), pp. 155-185. See also: Zyto, K, Sadowski, P & Opalinska, J. Consumer bankruptcy in Poland: current situation and proposed changes (2013) INSOL World, 3, pp. 38-39. See also: Boraine, A & Roestoft, M. Fresh start procedures for consumer debtors in South African bankruptcy law (2002) International Insolvency Review, 11(1), pp. 1-11. See also: Coetzee, H & Roestoft, M. Consumer debt relief in South Africa – should the insolvency system provide for NINA debtors? Lessons from New Zealand (2013) International Insolvency Review, 22(3), pp. 188-210. 18 See further: Tribe, J. Bankruptcy tourism in the European Union – myth or reality? King’s Law Journal (In Press).

129

John Tribe

Figure 7.2 Personal insolvency procedures in England and Wales: 2005-2015

Source: Insolvency Service, 2015.

Figure 7.3 Individual insolvency rate in England and Wales as against total adult population19

Source: Insolvency Service, 2015.

19 “Insolvency rate – the total number of bankruptcies, IVAs and DROs in the latest twelve month period, divided by the average estimated adult (18+) population of England and Wales. Bankruptcy, IVA and DRO rates are calculated in the same way.”

130

7

Consumer Protection Problems Created by the Structure of English Personal Insolvency Law

It is one thing to consider the various personal insolvency procedures and how these have been used. To put this use in context we also need to consider the levels of consumer credit over the same period. Figure 7.3 demonstrates how consumer credit patterns have changed over the last thirty years: Figure 7.4 Consumer credit: 2008-2014

Source: The Guardian Newspaper and Bank of England.

These statistics for personal insolvency show that there has been a sharp increase in both consumer credit and personal insolvency regime usage, particularly since 2004 (Figure 7.3).20 It is at this point that the new revised discharge period was introduced (see Section 7.2 below). Was it this discharge liberalisation that caused an increase in the use of bankruptcy demonstrated in Figure 7.2, or was it more that the increase in use was driven by the simultaneous increase in the consumer credit that is shown in Figure 7.4? Research suggests the latter.21 There is no doubt that the use of credit has changed over the period

20 On this rise in consumer credit see: Ramsay, I. Consumer Credit Society and Consumer Bankruptcy: Reflections on Credit Cards and Bankruptcy in the Informational Economy, In: Niemi-Kiesilainen, J, Ramsay, I & Whitford, W (eds.). Consumer Bankruptcy in Global Perspective. Hart Publishing, Oxford, 2003, pp. 17-40. 21 See: Tribe, J. Bankruptcy Courts Survey 2005: A Pilot Study. Final Report January 2006 (Project Report). Faculty of Business and Law, Kingston University, Kingston upon Thames, 2006, p. 222.

131

John Tribe

under discussion in this chapter. Consumer credit is much more prevalent than when the provisions under discussion were introduced in the Insolvency Act 1986.22

7.1.3

Access to the Regime

Access to the various procedures is obviously of critical importance if they are going to be used properly. If they cannot be accessed how can their qualities be properly utilised by the intended users? How to access the available advice is, of course, of considerable significance, as is the quality of advice once the consumer debtor has found the salient resources and information.23 There have been instances of advice being skewed towards the interests of those giving the advice in England and Wales and other jurisdictions.24 This is particularly true of IVAs, a process that invariably requires a fee to be paid to a professional.25 We must get both the provisions and the accompanying advice as to which procedure is appropriate if the system is to function properly. So how do consumer debtors go about finding out about the various options that are available to them? In addition to hard copy literature such as books26 and help sheet guidance from the Insolvency Service,27 the routes for consumer debtors to access information on the various procedures are through digital resources, such as the previously mentioned Insolvency Service,28 or debt advice charities, such as Money Advice Trust,29 StepChange30 and National Debtline.31 Alternatively, more traditional face-to-face methods for debt advice are the Citizens’ Advice Bureaux (CAB)32 and other charitable organisations, in addition to profes22 On the make-up of consumer debtors and over-indebtedness in the UK, see: Ramsay, I. ‘Wannabe WAGS’ and ‘Credit Binges’: the Construction of Overindebtedness in the UK, In: Niemi, J, Ramsay, I & Whitford, WC (eds.). Consumer Credit, Debt & Bankruptcy – Comparative and International Perspectives. Hart Publishing, Oxford, 2009, pp. 75-89. 23 On failed IVAs, arguably because of inappropriate advice, see: Morgan, S. Causes of Early Failures in Individual Voluntary Arrangements (31 March 2008). Available at: . 24 For an American example see: McIntyre, F, Sullivan, DM & Summers, L. Lawyers steer clients toward lucrative filings: evidence from consumer bankruptcies (2015) American Law and Economics Review, 17(1), pp. 245289. 25 See further: Tribe, J. Personal Insolvency Law in England and Wales: Debtor Advice, Debtor Education and the Credit Environment (Personal Insolvency Project – PIP) – Vol. 1 (July 2007). Kingston Business School Occasional Paper No. 61. Available at: . 26 See, for example, the following text that is written in a question-and-answer format specifically to assist debt advisers and those suffering from liquidity issues: Tribe, J, Morgan, S & Smyth, N. Personal Insolvency Law in Practice. Jordan Publishing Ltd, Bristol, 2013. 27 See, for example, their: Bankruptcy: Alternative Options for People in Debt. Insolvency Service, May 2015. Available at: . 28 See: . This is not the easiest website to navigate in the sense of quick access to the information, particularly for the non-IT savvy. 29 See: . 30 Formerly Consumer Credit Counseling Service (CCCS), see now: . 31 . 32 .

132

7

Consumer Protection Problems Created by the Structure of English Personal Insolvency Law

sional advice from qualified and regulated Insolvency Practitioners (IPs).33 Access is important for two reasons. First, the idea of e-poverty must mean that some consumer debtors cannot access the provisions as easily as they might otherwise do if they had access to appropriate computer facilities. Imagine existing in a world where you cannot access the websites cited in the footnotes of this chapter. This is a reality for far more people than one might consider at first blush. When constructing insolvency provisions and advice structures this must be borne in mind. Second, as will be shown below, the new DRO procedure now requires that Approved Intermediaries facilitate the process for gaining access to the DRO.34 Computer facilities of some sort are therefore a prerequisite. We are moving towards a position of digitisation both in debtors’ petitions in bankruptcy and also in the DRO process. This increases efficiency and lowers cost according to the policy documentation that accompanied the change in approach to both reforms. This is laudable as long as the e-poverty caveat mentioned above is borne in mind. With these three sets of factors in mind we can now move to the next part of this chapter, namely a consideration of the three main personal insolvency procedures and how these can be used to assist the consumer debtor. Three pertinent, albeit fictitious, case studies will now be examined.

7.2

7.2.1

Bernadette the Bankrupt

Bankruptcy Policy

Bankruptcy is our longest held personal insolvency procedure, other than imprisonment for debt. First introduced into English law in 1542, bankruptcy has, perhaps unsurprisingly, shifted and changed its function and purpose over its 474-year-old history. The procedure has had different outcomes and roles throughout its history. It has been used to achieve various and differing aims. An examination of different periods in bankruptcy history would reveal marked differences. A Tudor bankrupt in 1557 would certainly be a trader.

33 See, further, the personal insolvency section of the Association of Business Recovery Professionals (R3) website at: . The Insolvency Service recommends that the following professionals’ guidance is sought for those suffering from debt problems: “a solicitor, a qualified accountant, an authorised insolvency practitioner or a reputable financial advisor.” (see further: Dealing with Debt – How to petition for your own bankruptcy, The Insolvency Service, September 2015). 34 For more details on the minutiae of the DRO process, see: Tribe, J. Debt Relief Orders, In: Burrow, V (ed.). Tolley’s Insolvency Law (Looseleaf). LexisNexis, London, 2015, pp. D100-1-D100-12. (no. 100).

133

John Tribe If he was not, he would be in a debtors’ prison.35 Travel to 1730, where a bankrupt is attempting to flee the realm to Holland with his assets. He vomits on the boat and returns to England, whereupon he is promptly hanged for non-disclosure of his assets. This unfortunate debtor would have been a trader.36 A Victorian bankrupt in 1852 might be a partner of a Joint Stock Company who is waiting longingly for the introduction of limited liability so that the separate legal entity might take the burden of debt instead of him in his personal capacity.37 He would, however, still be a trader and certainly not someone using credit for purposes other than business. Move to 1967, and the bankrupt might be a disgraced peer, in which case the consequence of bankruptcy would be the loss of the right to vote as a legislator.38 At whichever time period you disembarked from a bankruptcy time machine it would be very unlikely that the bankrupt would be a consumer debtor, not until the later half of the twentieth century anyway. Credit was extended for commercial reasons and not for consumer credit purposes. The insolvency law response, therefore, was not designed to deal with this species of debtor. The aims and purposes of the bankruptcy legislation have changed over time, while the nomenclature describing the procedure has not. This has been part of our problem for the superstructure of personal insolvency legislation as is demonstrated over the following pages. In its original form the bankruptcy procedure was used from 1542 until 1869 as a mechanism for trader debtors. ‘Trader’ was a narrowly defined term of art. As a consequence, non-traders found themselves in the infamous debtors’ prisons.39 From 1869,

35 On bankruptcy in the Tudor period and before, see: Jones, WJ. The Foundations of English Bankruptcy: Statutes and Commissions in the Early Modern Period (1979) Transactions of the American Philosophical Society, 69(3), pp. 1-63. See also: Cadwallader, FJJ. In pursuit of the merchant debtor and bankrupt: 10661732. Unpublished Ph.D. thesis, University College London, University of London, June 1965. See also: Treiman, I. A History of the English Law of Bankruptcy, with Special Reference to the Origins, Continental Sources, and Early Development of the Principal Features of the Law. Unpublished D.Phil thesis, University of Oxford, 1927. See also: Cooke, RM. The Foundations of the Law of Bankruptcy. LL.M. thesis, University of Manchester, 1924. 36 On bankruptcy during the eighteenth century see: Servian, MS. Eighteenth Century Bankruptcy Law: From Crime to Process. Unpublished Ph.D. thesis, University of Kent at Canterbury, 1985. 37 On bankruptcy in the nineteenth century see: Duffy, IPH. Bankruptcy and Insolvency in London during the Industrial Revolution. Garland Publishing, Inc., New York & London, 1985. See also: Lester, VM. Victorian Insolvency. Clarendon Press, Oxford, 1995. 38 See: Tribe, J. Parliamentarians and bankruptcy: the disqualification of MPs and peers from sitting in the Palace of Westminster (2014) King’s Law Journal, 25(1), pp. 79-101. 39 On these institutions see further: Weiss, B. The Hell of the English: Bankruptcy and the Victorian Novel. Bicknell University Press, Lewisburg, 1986. See also: Haagen, P. Imprisonment for Debt in England and Wales. Princeton University Ph.D. thesis, 1985.

134

7

Consumer Protection Problems Created by the Structure of English Personal Insolvency Law

when the procedure was opened to all (save for married women),40 the jurisdiction was still biased towards entrepreneurial debt. Consumer debts only became an issue for insolvency law per se from the 1970s onwards.41 It is not until 1986, and even then not really until 2002, that we really see bankruptcy policy and enacted provisions being modified to address the plight of the consumer debtor.42 The 1986 Insolvency Act was still largely focused on entrepreneurs, particularly in regard to the rationale for the introduction of the IVA procedure. IVAs were designed with the struggling entrepreneur in mind as an alternative to bankruptcy. As outmoded as it might now seem even as recently as 1986, the personal insolvency provisions had not been formulated to address the needs of consumer debtors. Put quite simply, as in the nineteenth century and before, credit was extended prima facie for business purposes. For much of the late eighties and early nineties, entrepreneur and business debt relief provision may have been the policy; however, consumer debt increased dramatically over the period, not least with overgenerous lending practices of the banks.43 This has been demonstrated by Figures 7.2 and 7.3 above. Theory, policy and subsequent legislation no longer matched reality. Personal insolvency law was incorrectly geared towards the needs of a declining market. What was increasingly needed was a system that would rehabilitate a large and increasing body of consumer debtors who needed access to the debt relief. Relief was needed for these consumer debtor individuals if they were to be rehabilitated into fully functioning members of society. They needed a mechanism through which they could seek relief from their crippling debt obligations. Bankruptcy and IVAs (as well as Deeds of Arrangement) existed as options for such debtors, but the qualities of the regimes were ill-suited to their needs. A change was needed. This came about as a result of policy shifts starting in the late nineties that culminated in the enactment of the Enterprise Act 2002.44 This statute, inter alia, reduced the

40 See: Fletcher, IF. Law of Bankruptcy. Macdonald & Evans Ltd, Plymouth, 1978, pp. 7, 15, citing the Law Reform (Married Women and Tortfeasors) Act 1935, section 1(d). A married woman could be made bankrupt only if she was engaged in trade. 41 For an exposition of insolvency law in the 1970s, see further: Tribe, J. The Poulson affair: corruption and the role of bankruptcy law public examinations in the early 1970s (2010) King’s Law Journal, 21(3), pp. 495-528. 42 On trends around 2002 in English and Welsh bankruptcy, see: Ramsay, I. Bankruptcy in Transition: The Case of England and Wales – The Neo-Liberal Cuckoo in the European Bankruptcy Nest?, In: Niemi-Kiesilainen, J, Ramsay, I & Whitford, W (eds.). Consumer Bankruptcy in Global Perspective. Hart Publishing, Oxford, 2003, pp. 205-226. 43 On the changing nature of the credit market and insolvency regulation, see: Sealy, L. Publication reviewconsumer bankruptcy in global perspective (2004) Cambridge Law Journal, 63(2), pp. 518-520. 44 Interestingly, just as Europe was going one way in terms of bankruptcy liberalisation, the Americans, having influenced England and Wales with their approach, then went in the opposite direction and became much more strict in their provisions. See further: Ziegel, J. Facts on the ground and reconciliation of divergent consumer insolvency philosophies (2006) Theoretical Inquiries in Law, 7, pp. 299-322. See also: Ziegel, J. The philosophy and design of contemporary consumer bankruptcy systems: a Canada-United States comparison (1999) Osgoode Hall Law Journal, 37, p. 205.

135

John Tribe

bankruptcy automatic discharge period from three years – the figure at which it had been set by the Insolvency Act 1986 – to one year.45 Upon the lapse of one year, automatic discharge would happen, and the bankrupt debtor would be discharged from their bankruptcy.46 The principal policy drivers of this reform were American-influenced notions of fresh start and rehabilitation. These influences were percolating through the Insolvency Service at the same time as a massive expansion in consumer lending, and, as noted above, they came together in the reformed, repurposed bankruptcy provisions. A pressure value was needed and was provided in the shape of the rebalanced bankruptcy system.

7.2.2

Bernadette’s Bankruptcy

We need a fictitious bankrupt to test how a consumer debtor might interact with the bankruptcy system and its current aims of (1) rehabilitating the debtor and (2) distributing the value of the debtor’s assets among her creditors.47 Bernadette owes £170,000. This is made up of an unsecured loan of £10,000, and three credit cards on each of which £10,000 is owing. This consumer debt amounts to £40,000. The residue of her indebtedness derives from a mortgage on her property that she owns in her sole name. The mortgage is for £200,000. The property is currently worth that same amount. Her income as a mobile music teacher and concert pianist is £50,000 per annum. She has no other significant assets to speak of other than a collection of extensive correspondence between herself and JK Rowling, the famous author of the Harry Potter series of books. The letters dwell on, inter alia, the nature and process of writing, single parenthood and JK Rowling’s writing beyond the Potter work. Bernadette also has her 2008 Audi A4 motorcar, which is valued at approximately £4,000. Her daughter, Matilda, is currently at Mount Carmel preparatory school, where the fees are £4,000 a term. So how would the bankruptcy laws treat Bernadette?48 Table 7.1 sets out the eligibility criteria.

45 On the statute generally see: Davies, S (ed.). Insolvency and the Enterprise Act 2002. Jordans, Bristol, 2003, at Part 2. 46 Income Payments Orders (IPOs) and Bankruptcy Restrictions Orders (BROs) were also introduced as a check and balance mechanism against the more liberal discharge period. The latter is discussed below. 47 We do not necessarily need to rely on fictitious case studies. Empirical work on the experience of actual bankrupts has been undertaken. See: Tribe, supra note 21. However, for the purposes of giving a fully rounded and relatively exhaustive impression of the bankruptcy provisions, Bernadette’s case encompasses many of the qualities that are required – to fiction we must therefore resort – although in the realm of bankruptcy, on occasion the truth is stranger than fiction (in this regard see: Tribe, supra note 41). That said, Bernadette’s bankruptcy contains rather more points of interest than the usual run-of-the-mill case. 48 On bankruptcy law procedures and provisions generally, see: Fletcher Insolvency at 5-001.

136

7

Consumer Protection Problems Created by the Structure of English Personal Insolvency Law

Table 7.1 Bankruptcy values and eligibility Cost

Court fee: £180 – official receiver deposit: £525

Debt level

Minimum level of £750 (creditor’s petition) – unlimited ceiling. If debts more than £100,000 the case will be heard in the High Court in London

Income

£50,000

Domicile

England and Wales (for at least three years) or business connections

Assets

£4,000 motor car

Bars to access

Not currently in a comparable procedure

Restrictions

Ibid

Length

One year but with a potential extension

Credit record

Some evidence of an effect on credit reference agency scoring

For the sake of argument, let us presume that Bernadette satisfies the requirements for entry into bankruptcy and that she has petitioned for her own bankruptcy,49 that the relevant bankruptcy order was made and that a Trustee in Bankruptcy has been appointed to administer her estate.50 The assets have passed to the control of the Trustee in Bankruptcy, and they are now dealing with the various assets and liabilities as part of the augmentation of the available estate and subsequent distribution process. Bernadette has cooperated fully with both the Official Receiver and the Trustee in Bankruptcy in disclosing her assets and liabilities. We will start with Bernadette’s assets and potential exposures. Perhaps the most liberal element of the bankruptcy laws relates to section 283(2) of the Insolvency Act 1986. This provision provides for the exceptions to the bankrupt’s realisable estate. It provides: (2) Subsection (1) does not apply to – (a) such tools, books, vehicles and other items of equipment as are necessary to the bankrupt for use personally by him in his employment, business or vocation;

49 Filling out the petition (Insolvency Rules 1986 form 6.27) and the statement of affairs (Insolvency Rules 1986 form 6.28). 50 On the stages of the bankruptcy process see the helpful set of articles by the Chief Registrar (judge) in Bankruptcy: Baister, S. Bankruptcy basics – the hearing of the petition (2007) Insolvency Law and Practice, 23, p. 80. See also: Baister, S. Bankruptcy basics – preparing the bankruptcy petition (2006) Insolvency Law and Practice, 22, p. 210. See also: Baister, S. Bankruptcy basics – filling and issuing the petition (2007) Insolvency Law and Practice, 23, p. 5. See also: Baister, S. Bankruptcy basics – before the petition is heard (2007) Insolvency Law and Practice, 23, p. 45.

137

John Tribe

(b) such clothing, bedding, furniture, household equipment and provisions as are necessary for satisfying the basic domestic needs of the bankrupt and his family.51 As regards the letters to JK Rowling, there is an interesting case, Haig v. Aitken,52 that relates to this area. As part of his estate, Aitken had a series of letters between himself and other noteworthy individuals including parliamentary colleagues, foreign statesmen and other dignitaries. The Trustee in Bankruptcy believed that these were worth as much as £100,000 and wanted to realise them for the benefit of creditors. Aitken objected, arguing that the letters did not form part of his estate for the purposes of the Insolvency Act 1986. At first instance this argument was upheld. Mr. Justice Rattee held that a bankrupt’s personal correspondence, being of a nature peculiarly personal to him and his life as a human being, was excluded from his estate for the purposes of the statute. The term “affairs” in section 311 of the Insolvency Act 1986 was confined to the financial or other affairs relevant to the carrying out of the trustee’s duties under the Act. As a consequence, Aitken was allowed to keep the letters. As an interesting postscript, it would be interesting to know whether Aitken subsequently sold the letters post his bankruptcy discharge. Bernadette would be able to keep her correspondence with JK Rowling. In this regard, the bankruptcy laws are favouring the interests of the debtor over the creditors. The private school fees for Matilda may be payable out of exempt property as part of the reasonable expenses of family life. They were held to be in Re Rayatt (A Bankrupt).53 In the case, the question before the court was whether school fees fell within the scope of “the reasonable domestic needs of the bankrupt and his family” within s.310(2) of the Insolvency Act 1986.54 The judge in the case, Mr. Michael Hart QC, held that the bankrupt’s child would be placed at a significant disadvantage if she was removed from her school at that particular point in her education. The liberal approach to the treatment of bankrupt debtors explained in the previous two cases is to be contrasted with what can happen to the bankrupt’s home. This asset is almost invariably taken to satisfy creditors, and there is no homestead exception comparable 51 Insolvency Act 1986, s.282(2). For an example of documents as exempt property see: Church of Scientology Advanced Organisation Saint Hill Europe and South Africa v. Scott [1997] B.P.I.R. 418. Personal injury claims are also exempt property, see: Davis v. Trustee in Bankruptcy of the Estate of Davis [1998] B.P.I.R. 572. Horse boxes used for work purposes are exempt property. Although a cheaper reasonable replacement may be found with the surplus being returned for distribution to creditors: Pike v. Cork Gully [1997] B.P.I.R. 723. Certain types of machinery and tooling are not exempt property as they are not personal or necessary: Official Receiver v. Lloyd [2015] B.P.I.R. 374. 52 [2001] Ch 110, [2000] BPIR 462. 53 [1998] 2 F.L.R. 264; [1998] B.P.I.R. 495; [1998] Fam. Law 458. 54 “reasonable domestic needs” under s.310(2) IA86 have also been deemed to include hairdressing bills and savings for presents. See further: Deloitte & Touche. What are the “reasonable domestic needs” of a bankrupt? (1999) Insolvency Intelligence, 12(1), p. 6.

138

7

Consumer Protection Problems Created by the Structure of English Personal Insolvency Law

to that which exists in the United States of America.55 The bankrupt’s interest in the home forms part of their bankruptcy estate to be administered by the Trustee in Bankruptcy. Sales of the family home can, however, be postponed.56 In Martin-Sklan v. White57 a sale was postponed for seven years. This was to allow the bankrupt’s youngest child to carry on living in the family home until the child reached the age of eighteen against the backdrop of problems caused by the mother’s alcoholism that caused frequent absences from the house for drinking bouts. There was a local support network consisting of neighbours, relatives and schools that helped the children during the drinking bouts. Mr. Justice EvansLombe held that the creditors’ interests could be postponed as they would be paid in full plus generous interest. In the limited facts currently available it is likely that Bernadette’s house would be sold to meet creditor demands. Section 282 of the Insolvency Act 1986 exceptions also relate to Bernadette’s car, the Audi A4. The car is an asset and is prima facie available for the creditors. However, her car may well be deemed to be so low in value and also essential for her job as a mobile music teacher for her to retain the asset as exempt property. £1,000 is the current guideline allowance for a replacement vehicle.58 If the Audi is worth no more than that she may be allowed to retain it. By way of conclusion for Bernadette’s largely consumer debt bankruptcy, we can see that in the main her treatment is relatively liberal, straightforward and rehabilitative. It is not draconian. There is little stigma left in modern bankruptcy.59 The judges as well as the legislation have both contributed to a position whereby she has managed to keep a number of her assets, while largely maintaining her lifestyle at the same time as simultaneously shedding a very large amount of indebtedness following the process of discharge. She has lost her home, however, but the statutory contract into which she has entered can be seen to be relatively enabling towards her situation.

7.3

BROs

Now imagine a position whereby Bernadette is a chronic gambler. Five nights a week she spends the lion’s share of her salary at the gaming tables. This activity has huge increased creditors’ exposure. This is conduct that is sufficiently serious to warrant a BRO. As the

55 56 57 58

This extends to land located in other jurisdictions. See: Sanders v. Donovan [2012] B.P.I.R. 219. Pursuant to s.337(5) of the Insolvency Act 1986. [2006] EWHC 3313 (Ch); [2007] B.P.I.R. 76. See also: Avis v. Turner [2007] EWCA Civ 748; [2008] Ch. 218. See: What will happen to my motor vehicle, Insolvency Service, February 2012. Available at: . 59 But debt can still lead to difficulties with sensitive subjects for debtors, like the disclosure of a previous name, see: Bankruptcy and Transgender, Guidance for transgender bankrupts, Insolvency Service, November 2013. Available at: .

139

John Tribe

Insolvency Service makes clear, “A BRO is a court order imposing certain restrictions on a bankrupt for a set period between two and fifteen years.”60 This check and balance mechanism against the reduced discharge period ensures that miscreant behaviour by debtors does not go unchecked. In addition to the gambling, another untoward set of circumstances arises if the bankrupt Bernadette hires a piano as part of her activity as a music teacher. While the piano is in her possession it disappears and is no longer available for the owner to take back. A new debt has arisen – there is further exposure to creditors. The case of Official Receiver v. Doganci61 is apposite. The case involved a debtor who made himself bankrupt on his own petition. During the course of his bankruptcy he rented a grand piano worth over £9,000 from Bernard Morley & Co Ltd. The piano was a 1904 gate-legged, mahogany Bechstein grand piano. It had a retail price of £9,360. The piano was disposed of by the bankrupt, and he failed to account for this disposal. The bankrupt claimed that he had destroyed the piano in a fit of rage using his fists, a chainsaw and a hammer and that he had placed the destroyed piano outside his flat for the weekly domestic rubbish collection with the assistance of his partner. As a consequence of the grand piano’s disappearance and the bankrupt’s explanation as to what happened to it, the Official Receiver sought a BRO. This was because the Official Receiver was keen to stop the bankrupt and others behaving in a similar manner. Furthermore, the Official Receiver was keen to stop the bankrupt obtaining further credit in the future so that other creditors would not be affected in the same way as the piano creditor, i.e. lose over £9,000. Furthermore, the Official Receiver contended that the piano could not have been destroyed by hand without tools. The matter came before Chief Registrar Baister for consideration. He held that the bankrupt’s “explanation as to what happened to the piano left much to be desired and stretched credulity to its limits, such that there were considerable doubts about his case, [although] there was nothing that could lead to the conclusion that the bankrupt was being deliberately untruthful.”62 A BRO was not made. This is another example of a set of provisions being administered for the benefit of debtors as opposed to creditor interests.

60 Bankruptcy Restrictions Orders, The Insolvency Service, November 2014, p. 3. Available at: . 61 [2007] B.P.I.R. 87. 62 [2007] B.P.I.R. 87, at paragraph 22.

140

7

Consumer Protection Problems Created by the Structure of English Personal Insolvency Law

7.4

Deepak the DRO User

7.4.1

63

DRO Policy

As noted in the previous section, the pre-existing structure of personal insolvency law from 1986 until 2002 was geared towards the interests of business-related indebtedness, i.e. the needs of the entrepreneur. A solution was needed that looked to the interests and needs of consumer debtors. Reform proposals that sought to address this constituency were mooted as early as 2006 with the proposed introduction of a Personal Financial Protection Order (PFPO).64 This would be an entirely new regime that was not saddled with the history and negative connotations of bankruptcy. As has been explained in the previous section, post Enterprise Act 2002 bankruptcy is different. It is more liberal than what had been before, but it still had the taint of its history, particularly from the perspective of the consumer debtor. This recommendation for an alternative procedure, specifically the PFPO, was not taken up, certainly in terms of the name. But the DRO that followed is relatively close in terms of its qualities and the policy rationale that basically consists of a desire to have a procedure that had all the rehabilitative functions and nature of bankruptcy, but with none of the negative historical stigma and baggage that came with the centuries-old regime. DROs are sometimes referred to as Bankruptcy-Lite.65 This reflects the fact that they are, in essence, bankruptcy, but with lower thresholds in terms of the amount of indebtedness that the debtor can have before entering the procedure, i.e. if they owe too much they must enter bankruptcy instead. As the Insolvency Service note: DROs do not involve the courts. They are run by The Insolvency Service in partnership with skilled debt advisers, called approved intermediaries, who will help [you] apply to the Insolvency Service for a DRO.66 This paragraph neatly summarises the nature of the DRO. Much like with the recent reforms to debtor’s petitions in bankruptcy,67 the DRO is administered out of court, supposedly to save costs. It is an administrative as opposed to a judicial process. The inappropriateness of this approach to debt forgiveness, i.e. no court involvement, has been well

63 64 65 66 67

On DROs, generally see: Tribe, supra note 34. See further: Tribe, supra note 21. Tribe, Morgan & Smyth, supra note 26. See supra note 33. On this see further: Baister, S & Toube, F. All change is not growth, as all movement is not forward! (2012) Insolvency Intelligence, 25(4), pp. 49-54.

141

John Tribe argued elsewhere.68 The courts play an important function, inter alia, in ensuring fairness among all the parties and also provide an appropriate appeal and review process if new circumstances arise relating to the debtor’s affairs.69 In a positive sense, DROs do provide a low-cost, less stigmatising route out of indebtedness for a relatively large group of debtors, as Figure 7.2 (above) clearly shows. How does an insolvent debtor interact and use the DRO system? We can now consider our fictitious DRO user, Deepak.

7.4.2

Deepak’s DRO 70

The eligibility guidance for DROs is set out in Table 7.2. Fortunately, Deepak satisfies these criteria. He currently owes £14,500 on two credit cards. This expenditure was entirely on consumer goods. He has paid the £90 fee as part of the process of obtaining a DRO through the approved intermediary system. His net income from his salary as a record shop assistant satisfies the £50 after tax, national insurance and normal household expenses. Deepak had assets far in excess of £300, but nearly all of these have been sold off to try and pay back the money he owes on his credit cards. He now only has his telephone, which is valued at approximately £300. Other than clothes he has no assets to speak of. He currently rents a room in a shared house. The fictitious factual exposition detailed above shows that the sort of debtor that would use a DRO has to be very impecunious indeed to meet the criteria, in terms of both assets and income. The maximum ceiling on the debt level that is owed is also relatively low, i.e. £15,000. It could be argued that although the DRO offers a debt solution, its categories are particularly narrow. Students, younger people with no real assets and others, perhaps divorcees, who have fallen on difficult times, would squeeze into the narrow category of debtors that can use the DRO. That said, the statistics highlighted in Figure 7.2 (above) do show that the DRO has been a success. There obviously is a market for it and one that is perhaps broader than is being suggested here. Indeed, in the third quarter of 2012, DRO as a procedure outstripped bankruptcy in terms of popularity for the first time.71

68 Ibid. 69 On this supervisory function see: Tribe, J. Termination of Bankruptcy Orders Other than through Discharge, In: Burrow, V (ed.) Tolley’s Insolvency Law (Looseleaf). LexisNexis, London, 2015, pp. T20-1. 70 There have been very few reported decisions on DROs. See for example: Payne and another v. Secretary of State for Work and Pensions [2011] UKSC 60, [2011] All ER (D) 94 (Dec). See also: R (on the application of Howard) v. Official Receiver [2013] EWHC 1839 (Admin). 71 There were 7,777 DROs as opposed to 7,298 bankruptcy orders. See further: Insolvency Service statistics April to June 2015, Tables – Available at: .

142

7

Consumer Protection Problems Created by the Structure of English Personal Insolvency Law

Table 7.2 DRO thresholds and eligibility Cost

£90 Official receiver fee

Debt level

Less than £15,000

Income

Less than £50 each month after paying tax, national insurance and normal household expenses

Domicile

Lived in England and Wales in the last three years

Assets

Not worth more than £300 in total

Bars to access

Not had a DRO in the last six years, not adjudged bankrupt or in an IVA

Restrictions

Cannot borrow more than £500 without telling the lender or act as a director of a company

Length

One year

Credit record

Six years from the date the DRO was granted

Source: Insolvency Service, 2015. See: .

So how does Deepak’s DRO experience assist with our superstructure of personal insolvency examination, particularly in the context of consumer debtors? First, it shows that there is a less stigmatising, administrative process for the very low-income, no asset debtor. We might posit that this species of debtor is the classic consumer debtor. If a DRO is not appropriate because of the quantum that is at stake, i.e. the debt is over £15,000, the debtor has a larger income than the DRO parameters or has an asset of note, then there is always the bankruptcy route. As the previous section has demonstrated, ‘modern’ bankruptcy is now a liberal, effective mechanism with a substantial commitment to debtor rehabilitation.

7.5

7.5.1

Isabel the IVA User

72

IVA Policy

The IVA is a creature of the 1986 Insolvency Act.73 It is, in essence, a statutory composition between the debtor and the creditor whereby the debtor agrees to repay the creditor on a termly basis over a given period. This timetable of repayments is overseen by a supervisor, 72 On IVAs generally see: Lawson, S (ed.). Individual Voluntary Arrangements. Jordan Publishing Ltd, Bristol, 2015 (Looseleaf). 73 As is the Company Voluntary Arrangement (CVA), which, in essence, borrowed the IVA qualities in its own formulation. See further: Tribe, J. Company voluntary arrangements and rescue: a new hope and a Tudor orthodoxy (2009) Journal of Business Law, (5), pp. 454-487.

143

John Tribe

a professionally qualified insolvency practitioner (IP). As enacted, the IVA procedure was “designed to be used by small businesses and professionals.”74 It was not designed for consumer debtors. Use, however, changed with the growth in consumer credit and, in particular, with the advice given by IPs in relation to the use of an IVA (as discussed above).75 Despite the change in use, the IVAs’ underlying function remains the same, namely compromise. Rimer made this clear in Re Bradley-Hole (a Bankrupt), ex p Knight when he stated that: the essence of a voluntary arrangement is that under it each creditor compromises or releases his rights against the debtor in respect of his pre-existing debt and receives in exchange and in full satisfaction whatever payment terms are being offered by the debtor.76 The procedure has not been without its problems.77 Indeed, the whole edifice broke down in the mid-2000s, when the banks refused to sign off on a vast number of IVAs. This was primarily due to problems with the way in which IPs had front-loaded their fees into the IVA, and in some cases recommended an IVA when such a device was not actually the correct personal insolvency mechanism for the debtor to have embarked on. Bankruptcy may have been more appropriate. In effect, the IVA marketplace ground to a halt. That was until the Insolvency Service and the British Bankers’ Association began to negotiate. They produced what is known as the IVA Protocol 2008. This document sets out industry best practice on IVA use.78 The IVA Protocol 2008 highlights the changing shift of use of the IVA procedure towards the interests of consumer debtors. The document also highlights how we are in fact dealing with human beings and that, therefore, more care might be exercised.79 Clause 1.1 states:

74 See: Ramsay, supra note 42, 205. 75 On the recent use of IVAs see: Green, M. New Labour: More Debt – The Political Response, In: Niemi, J, Ramsay, I & Whitford, WC (eds.). Consumer Credit, Debt & Bankruptcy – Comparative and International Perspectives. Hart Publishing, Oxford, 2009, p. 394. 76 [1995] BCC 418, p. 437. 77 See further: Tribe, J. Personal insolvency law: Debtor education, debtor advice and the credit environment: Part 2 (2008) Insolvency Intelligence, 21(7), pp. 97-102; and Tribe, J. Personal insolvency law: Debtor education, debtor advice and the credit environment: Part 1 (2007) Insolvency Intelligence, 20(2), pp. 23-28. 78 For a case law exposition of the protocol see: Mond and another v. MBNA Europe Bank Ltd [2010] EWHC 1710 (Ch), [2011] Bus. L.R. 513. This case established that the protocol is purely guidance and not obligatory in terms of compliance. Lenders can divert from the guidance. 79 On the human interest elements in personal insolvency see: Tribe, J. The Governing Dynamics of Personal Insolvency Law: In Pursuit of Policy & Principle (In Press). See also: Baister, S. Shooting from the Hip. A chapter delivered to the INSOL Academic Forum, Istanbul 8 October 2014.

144

7

Consumer Protection Problems Created by the Structure of English Personal Insolvency Law The purpose of the protocol is to facilitate the efficient handling of straightforward consumer individual voluntary arrangements … The protocol recognises that the IVA supports a valid public policy objective by providing debt relief for individuals in financial distress. It also recognises that at the centre of this process there is a person, who needs to understand the process and the associated paperwork and the impact that the IVA will have on their lives.80

So do the guidance and the statute match up in practice? What is the debtor’s experience of the IVA in the post-protocol world? For that we can turn to the fictitious case of Isabel and examine her consumer IVA.

7.5.2

Isabel’s IVA

Isabel satisfies the entrance criteria set out in Table 7.3 for entry into an IVA. On the date of her composition she owed £36,000 to three creditors. Two of them are credit card companies to whom she owes £10,000 each. The final creditor is a bank, to which she owes the final £16,000. This indebtedness is entirely due to consumer-based activity. She is not an entrepreneur. Isabel has a fondness for fine wine and Michelin star restaurants. A Friday does not pass when she is not dispatching a glass of bubbles at Duke’s Hotel in London’s Mayfair. Isabel currently owns property. Horseshoe cottage, her first home, is worth £260,000. This property is subject to a mortgage of £180,000 with a bank. She also owns a Chesil Porsche 356 motorcar valued at £15,000. Other than clothes and some KitchenAid household appliances, there are few assets to speak of. Her annual income as a publisher is £70,000. Isabel has a child from her previous marriage. She pays maintenance for that child of £500 a month. After Isabel has paid off her student loans, child maintenance, rent, council tax and other monthly outgoings she has £2000 left over from her net monthly salary. She has proposed to her creditors that she will pay them £1,000 of this a month for a period of three years. This totals £36,000. Isabel’s IP nominee has seen this proposal that has been drafted in accordance with the statute.81 The IP agrees with the proposals, believing that

80 IVA Protocol 2008, clause 1.1. Author’s emphasis. The most recent edition of this protocol that has been promulgated by the British Bankers’ Association is the third edition, which was issued in January 2013. 81 See: Section 256(2) of IA86 (statement of affairs and document detailing the terms of the voluntary arrangement).

145

John Tribe

they are viable, and has written a report to the creditors that recommends that they accept the IVA proposal.82 The creditors have agreed to her proposal. Table 7.3 IVA values and eligibility Cost

Variable

Debt level

Less than £40,000

Income

No restrictions

Domicile

England and Wales (for at least three years) or business connections

Assets

Need to be more than £4,000

Bars to access

Not currently in an alternative procedure

Restrictions

Not been bankrupt and have not made an individual voluntary arrangement in the previous five years

Length

Approximately five years

Credit record

Some effect post completion on credit reference scores

There are a few issues with the IVA structure that should be examined, particularly when considering the procedure from the perspective of the consumer debtor. The first issue of note is the undue complication in the setting up of the process. As the Insolvency Service admits: …it is for the debtor to prepare the proposal for the intended IVA on which the nominee reports. However, due to the technical matters involved in drawing up such a proposal, the debtor will almost invariably consult an insolvency practitioner or other authorised person in the first event, who will become their intended nominee. Most proposals are thus professionally prepared.83 The complicated nature of the process, which necessitates the input of an expensive professional is not ideal, particularly in relatively low-value consumer cases. From the perspective of creditors, debtors have also been seen to use the IVA interim order as a way of postponing an inevitable bankruptcy. As Sir Richard Scott VC has observed: Judges must…be careful not to allow applications for interim orders simply to become a means of postponing the making of bankruptcy orders in circum82 This is no rubber-stamping exercise. In Re A Debtor (No 222 of 1990) [1992] BCLC 137, p. 140, where Harman, J severely critiques the nominee’s comments on the debtor’s proposals. See also Vinelott, J, In: Re A Debtor (No 2389 of 1989) [1991] 2 WLR 587G, “The proposals are little more than a fairy story…”. 83 See: , at paragraph 3. Author’s emphasis.

146

7

Consumer Protection Problems Created by the Structure of English Personal Insolvency Law stances where there is no apparent likelihood of benefit to creditors from such postponement84

The second structural issue of note is highlighted by Isabel’s child maintenance obligations within the IVA. An opposite case in this regard is Child Maintenance and Enforcement Commission (CMEC) v. Beesley.85 The case related to the CMEC’s ability to prove in the IVA as a creditor. Etherton (as he then was) held that the CMEC was not entitled to prove. In so doing he also made some interesting comments on the nature and policy of the IVA provisions. He stated: It is only possible to make sense of the provisions of IA 1986, Part VIII [IVAs], against the statutory background of the insolvency regimes of bankruptcy and debt relief orders, the discernible policy of the state in relation to the support and welfare of children which I have mentioned, the purpose of an IVA and its function as a consensual agreement of creditors (bound by the decision of the requisite majority), if the creditors entitled to participate in the IVA, and who are bound by it, are restricted to creditors with the capacity to make compromises of debts and liabilities. I consider that such a restriction is a necessary implication in the IA.86 Isabel would need to ensure that provision for her CMEC obligations was drafted into her IVA proposal so as not to fall into arrears with child maintenance. There have also been a number of reported decisions that cast a shadow over IVAs in illustrating how they can provide a procedure and structure that allows for abusive behaviour.87 Such behaviour arises in the case of consumer debtors as much as with commercial debtors. Indeed, the other types of insolvency procedure examined in this chapter are as likely to fall foul of miscreant behaviour, where the debtor is exhibiting mala fides. IVAs are not unique in this regard. Other than the stigma issues outlined in Section 7.2 above and the restrictions that come with bankruptcy, why else might a debtor elect to go down the IVA route instead of bankruptcy? As well as the perception issue, there is an element of flexibility with an IVA. As part of the composition, creditors could even agree to a postponement of repayment. Or assets that are not included within a bankruptcy could be introduced into an IVA, i.e. third party funds or income from the debtor’s continued trading or employment. Perhaps 84 85 86 87

See: Hook v. Jewson [1997] BPIR 100. [2010] EWCA (Civ) 1344, [2010] All ER (D) 309 (Nov). Ibid. See, for example, Cadbury Schweppes plc v. Somji [2001] 1 BCLC 498 and National Westminster Bank plc v. Kapoor [2011] EWCA Civ 1083, [2012] 1 All ER 1201.

147

John Tribe

most importantly, the debtor can use the procedure to avoid presenting his home as part of the available estate. As we have seen above in Isabel’s case, that is exactly why she went down the IVA route.

7.6

Conclusion

This chapter has critically examined the three main personal insolvency procedures that currently exist on the statute book in England and Wales. It has shown that there has been a gradual policy shift over the past thirty years to respond to changes in the nature of debtors. The procedures now on the statute book are geared towards the consumer debtor, as well as the long and well-served entrepreneur debtor. We have moved from trying to deal with the insolvencies of entrepreneur debtors to focusing on the plight of consumer debtors. This was led not by conscious policy choice, but by a reaction to the lending practices of banks and what that caused, namely, a massive spike in consumer debtors. Those consumer debtors, in turn, needed relief and rehabilitations from overburdensome indebtedness, and a change was needed in personal insolvency law to address that demand. The statistics cited in Figure 7.2 show that the DRO procedure has certainly replaced bankruptcy in terms of usage. Indeed, in recent years DROs have come to dominate the debt relief procedures. This tells us two things. First, that the type of debtor we are dealing with has changed. They are smaller in terms of indebtedness and income and asset levels. Second, that our laws have been appropriately amended to meet the demands of this new stakeholder. If our laws are to remain appropriate for the market in which they sit, we must ensure that policy formulation recognises what is occurring in the market and that it is not a reflection of what the policy formers think or hope is going on. It is one thing to try to enhance entrepreneurial activity by making more liberal bankruptcy laws, but if in so doing you waste legislative time because you have not catered for another section of debtors that also need relief (consumer debtors), then you are not fulfilling your wider general policy function to ensure there is a personal insolvency law structure for all. The case law88 discussed in Section 7.2 of this chapter in relation to bankruptcy has shown that not only has our legislation attempted to be more liberal, but the interpretation of the same by the judges has attempted to be more liberal and focused on the interests of debtors. This bodes well for debtors of all types, not least consumer debtors.

88 Which is admittedly potentially biased as it represents only those cases that have been reported in the law reports, as opposed to the unreported decisions.

148

Part III Germany

8

The Statistic of Over-Indebtedness of the Federal Statistical Office of Germany (Destatis)

Walter Joachimiak*

8.1

Overview

The Statistic of Over-indebtedness1 in Germany is carried out by the Federal Statistical Office (‘Destatis’) on a yearly basis. The main aims of the Statistic are to provide information on the situation of people with financial problems or who are over-indebted, identify how people get into the situation of over-indebtedness, what kinds of creditors they owe how much money to and, as an important side effect, toraise public awareness of the subject and promote the work of the advisory agencies. There are about 1,400 such advisory agencies in Germany providing counselling for over-indebted people. Their service is free of charge and includes financial guidance, negotiations with creditors and also representation at court. With the help of the agencies, over-indebted people can find a way to get their financial situation back under control or achieve, under certain conditions, a full debt discharge. In the following, the circumstances under which the Statistic of Over-indebtedness is conducted are presented, starting with the legal and administrative framework and covering also the collection, processing and dissemination of the data via multiple channels. To better understand the Statistic and what it covers, the contents of the questionnaire on which it is based are presented; in what follows, these contents are analysed with data from the latest round for the year 2014. Here general findings about the exposure to overindebtedness by several socio-demographic characteristics, the main reasons for overindebtedness and the amount of debts are presented. Attention is focused on a new indicator to assess the severity of over-indebtedness for a certain group of people at a certain point in time. The ‘Intensity of Over-indebtedness’ is a time- and location-consistent indicator that illustrates, in a hypothetical model, how many months a person would have to use all her net income to pay back all of her debts. The chapter concludes with an outline

* 1

Assistant Head of Section ‘Statistics of Agreed Earnings, Quarterly Earnings Survey, Labour Cost Index, Over-Indebtedness’ (Destatis). Or in short: the Statistic.

151

Walter Joachimiak

of some worthwhile research approaches to put the Statistic of Over-indebtedness to further use for the public and the scientific community.

8.2

Legal and Administrative Framework

The Statistic of Over-indebtedness is, as every official statistic, mandated by law. The relevant laws for this case are the Federal Statistical Law (Bundesstatistikgesetz – BstatG) and the Law for the Statistic of Over-indebtedness (Überschuldungsstatistikgesetz – ÜschuldStatG). The former regulates how, in general, the statistical offices conduct their surveys; the latter describes how and by whom the survey and the statistic are to be done. The law defines the over-indebtedness advisory agencies as the survey units that shall submit their information for the reference period until 15 February the following year. The law further defines the contents and electronic submission of the information needed for the Statistic. Destatis is the sole recipient of the micro data on the basis of which to conduct primary analyses, but researchers can access anonymized micro data to perform their own analyses via the Research Data Centres of the Federal Statistical Office and the Statistical Offices of the Bundesländer.2 In contrast to many other official statistics, the Statistic of Overindebtedness is conducted in a centralized way, i.e. all work is done by Destatis rather than by the statistical offices of the Bundesländer. The procedures and infrastructure for such a survey include maintaining a database of the basic population, collecting the data based on a questionnaire and, most importantly, running plausibility checks for the delivered data.

8.3

Conducting the Survey

Destatis has been conducting the Statistic on a yearly basis since the reference year 2006. During this period the processes have been constantly improved. The timeliness of the first data dissemination is a good example of this process; in the beginning it would often take more than a year after the reference period to publish the first results, but this has now been reduced to six months, and work is being done to improve the Statistic even further. The following outlines the current procedure to conduct the Statistic as of reference year 2014.

2

Bundesländer (sometimes abbreviated ‘Länder’) = German federal states.

152

8

8.3.1

The Statistic of Over-Indebtedness of the Federal Statistical Office of Germany (Destatis) Database

Destatis maintains a databank of all the over-indebtedness counselling agencies in Germany. They are mostly, in one way or the other, financially supported by the Ministries for Social Affairs of the Bundesländer. They supply an annually updated list of agencies. Currently, the databank holds around 1,400 entries. All of them are contacted once a year and asked to participate in the survey. This is the second striking difference from most other official statistics in Germany; it is up to the agencies to provide data or not. Since the introduction of the Statistic the rate of participation has risen over the years from 124 in 2006 to 395 in 2014. Several Länder started to link their financial support for the agencies to the condition that they participate in the survey, thus eliminating or at least reducing the effort of the Bundesländer for their own statistical monitoring.

8.3.2

Collection of the Data

The collection of the data is carried out exclusively online via Destatis’ own interface, eSTATISTIK.core; it is implemented in the software modules the agencies are already using to organize their data and daily work, thereby minimizing the work of the agencies and Destatis. The moment the data is submitted by the agency the system checks whether the variables and values are consistent with the pre-specified definitions. If not, the data cannot be transmitted. Only data with all the necessary information in the right format is forwarded to Destatis. After receiving the data, it is subjected to extensive plausibility checks to identify contradictory values, for example households completely lacking any source of income. To check whether these values are really accurate or a result of false input, the agencies are called by telephone to clarify in a personal conversation how to proceed with the case in question. If the implausibilities are extensive, a new transmission of the data may be necessary with another run of plausibility checks. Destatis thereby ensures only plausible and consistent data is used for analyses based on the Statistic of Over-indebtedness (Figure 8.1).

153

Walter Joachimiak

Figure 8.1 Technical execution of the survey

8.3.3

Dissemination

After this process, which takes a most considerable amount of time invested in each wave of the Statistic, Destatis prepares the data for statistical analyses and dissemination. A book of tables is generated regularly each year; it covers most of the variables contained in the data and gives insight into the distribution and nature of debts of over-indebted people in Germany. A book of tables representing data for Germany is published by Destatis, and on the level of the Bundesländer each Land’s Ministry for Social Affairs receives one book for the respective Land. Apart from that, as a token of appreciation for their support of the Statistic, each agency receives a CD with their respective data presented in the form of statistical tables similarly to the results for Germany. Additionally, since 2015, researchers have been able to access the micro data of the Statistic of Over-indebtedness by contacting the Research Data Centres of the Federal Statistical Office and the Statistical Offices of the Bundesländer. So the data can be analysed in new ways to answer a multitude of research questions in the fields of economic and social sciences. To further promote attention for the subject, Destatis not only puts out statistical tables, but also publishes the results via several channels3; the most important of these are regular press releases highlighting special aspects of the topic, e.g. in 2015 the over-indebtedness of working people who are also dependent on social transfers was brought into focus.

3

Other ways of publication are the Destatis website , articles in journals of Destatis and other publishers, participation in symposiums and press conferences.

154

8

8.4

The Statistic of Over-Indebtedness of the Federal Statistical Office of Germany (Destatis) Contents of the Survey

The purpose of the Statistic of Over-indebtedness is to give a thorough insight into the situation of over-indebted people and the structure of their debts as well as to gain information about the advisory agencies, which provide answers to questions such as the type of association they belong to. There are several big charitable associations, which fund the greater part of the advisory agencies in Germany, as well as municipal associations and private companies providing advisory services. The questionnaire also covers the number of people working in an agency and their profession. One can thereby visualize the multitude of different types of service provided to over-indebted people. There are social workers, social education workers, psychologists as well as economists, lawyers, tax advisors and sociologists working at the agencies. With all these different types of professionals it is possible to cater for a wide range of needs of the debtors, from financial or psychological counselling to organizing the household and negotiating with creditors or providing legal support and representation. There are three different types of consultations: regular, short-term and online. For each of them Destatis collects the total number of consultations in the reference period per agency. Online consultations and short-term consultations often consist of only a few contacts to solve immediate financial shortages. With regard to these contacts no detailed data is collected, so they do not find further entry in the deeper analyses of the Statistic. For consultations with full data coverage there is information about the date of beginning and closure of the consultation. For ongoing consultations the current status is clarified. The status of the ongoing consultation reflects the status of the negotiations with the creditors as well as the process of the possible insolvency procedure at court. If a consultation process was closed in the reference year, details are recorded concerning whether the case was settled out of court or went to court with or without insolvency procedures and whether full debt discharge was announced. The main focus of the Statistic is on the individual case, which can be subdivided into several components, the first being the socio-demographic characteristics of the debtor. These include gender, age, marital status and citizenship of the assisted person as well as education and employment status. Further, the composition of the household of the debtor is explored, e.g. by counting the number of underage children. Naturally, questions concerning the financial status of the person play an important role in the questionnaire of the Statistic. On the one hand, the income from several sources for the debtor as well as for other household members is recorded, including income from employment, social benefits or other financial assets. On the other hand are recorded selected expenditures such as rent or alimony payment. Highlighting the circumstances of over-indebtedness is the main goal of the item ‘Main reason for Over-indebtedness’, which seeks to portray how people get over-indebted in the first place. Although at first sight it might not be too

155

Walter Joachimiak

difficult to identify the main reason for over-indebtedness, it is crucial to make the right assessment here because there are few ways to correct mistakes later on. For instance, if a person’s income never suffices to cover even basic expenses, one could argue that longterm low income is the main reason, but this again can be the result of unemployment or divorce. So the real main reason should be identified as that event or process that brought the person into debt. Other reasons for the current difficulties are also documented, but no further analyses of these variables have been done yet. The Statistic also gives information about who the creditors of the over-indebted person are; normally, there are many more than just one party that money is owed to. There are different types of creditors – first, institutional financial creditors such as banks, insurances or debt collection agencies. Second, there are those creditors often associated with consumption: mail-order and other retail companies. Electricity and telecommunication companies as well as the tax authority and other public entities are also among the parties involved in cases of over-indebtedness. Severe debts can also arise from failed selfemployment or criminal acts, even though this is not often the case. The Statistic documents the parties to whom the person owes money and the magnitudes of their respective claims. Putting all this information together, the Statistic of Over-indebtedness gives an overview of the general situation of over-indebted persons as well as a detailed insight into the single cases to facilitate knowledge about how people get into financial problems as well as steps to prevent this from happening.

8.5

Results for the Year 2014

As of autumn 2015, the most recent results of the Statistic of Over-indebtedness available cover the reference year 2014. In that year information from 395 out of about 1,400 debt advisory agencies were sent to Destatis, a new all-time high. However, this still represents only about more than a third of the basic population. Based on this data the analyses of the last years could only represent those agencies and cases for which data was available. Starting with reference year 2014, Destatis introduced a method of grossing up the figures to better represent all cases of over-indebtedness counselling in Germany in the reference period. Because the above-mentioned databank precisely describes the basic population of the agencies and the supplied data gives information about the total number of consultations per submitting agency, regardless of whether the individual data of each case were delivered, it is possible to estimate the grossing-up factors for both stages of unit nonresponse. In the first a grossing-up factor is calculated to compensate for those agencies that did not send any data stage for each Bundesland. In the second stage, for those agencies with submitted data, it is compensated as not all debtors agreed to have their case data

156

8

The Statistic of Over-Indebtedness of the Federal Statistical Office of Germany (Destatis)

used for statistical purposes. The grossing-up factors for both stages are calculated in the following way: Gx = Bx/Px With Gx = grossing-up factor for stage x Px = participating units in stage x Bx = basic population in stage x x = first stage for agencies or second stage for individual debtors In this way, for the first time, now the results of the Statistic of Over-indebtedness represent all consultations done by any advisory agency in Germany. One remark has to be made at this point: it is still not possible to estimate the overall number of over-indebted people in Germany. This is because not every person seeking consultation at an advisory agency is truly over-indebted, and there could be just some minor financial shortages that need to be tackled. Those cases are not easy to identify. Also, there are an unknown number of over-indebted people who do not go to an agency at all and are therefore not covered by the Statistic. The first fact leads to an overestimation of the total number, whereas the second leads to an underestimation of it. Since there are no reliable estimates of either of these groups of people, the stated limitation remains.

8.5.1

Exposure to Over-Indebtedness

Of the roughly 460,600 people covered by the Statistic, men and women almost equally often seek assistance in an over-indebtedness advisory agency. 52% of the counselled were men, 48% were women. Apart from this, the Statistic shows over-indebted people are not a homogeneous group. In particular, one household type is at high risk of ending up in over-indebtedness. Single mothers make up 14% of the over-indebted but only 4% of the general population. Single men are also disproportionately often in severe financial difficulties, and their share of the German population, namely 18%, is clearly exceeded in the Statistic (29%). Couples without children are present in a significantly lower number than their share in the general population, making up 15% of the people seeking assistance against an overall share of 29% of the population. These findings directly reflect the fact that couples with their combined financial assets are less likely to suffer from financial problems than singles. This effect is even amplified by the presence or absence of children. Strongly associated with these findings are the exposure rates depending on marital status.

157

Walter Joachimiak

Table 8.1 Share of counselled people in 2014 Socio-demographic characteristic

Share of debtors (%)

Gender Woman

48

Man

52

Age Under 25 years

7

25-34 years

28

35-44 years

23

45-54 years

23

55-64 years

13

65 years and older

6

Household type Single woman

17

Single mother

14

Single man

29

Single father

2

Couple without children

15

Couple with children

20

Marital status Single

44

Married, civil partnership

23

Married but separated

9

Widowed

4

Divorced

20

Employment status Self-employed

1

Employed

33

Unemployed

47

Not employed

19

Education With vocational/university education

60

Currently attending education

3

Without vocational/university education

37

158

8

The Statistic of Over-Indebtedness of the Federal Statistical Office of Germany (Destatis)

With a share of 44%, singles are the largest group within the sample. This is no surprise given the above findings. This share nearly matches its counterpart in the general population. Very significantly over-represented are divorced people, who make up 20% of the over-indebted, but only 7% of the people in Germany. Quite the opposite applies to married or people in a civil partnership – 44% of the population but only 24% of the agencies’ clients. The interpretation of these findings is consistent with the above (Table 8.1). Looking at the age of people with overwhelming debts, one finds something like a problematic age between 25 and 54 years. In this cohort the share in the population of over-indebted people is partly drastically higher than in general. Especially 25- to 34-yearolds are disproportionately often over-indebted; in this subpopulation they make up 28% in contrast to only 15% in the general population. The opposite is true for persons aged 65 and older, with only 6% of the over-indebted coming from this age cohort in contrast to 24% for all people of legal age living in Germany. Nearly half of the agencies’ clients are unemployed, with a share of 47%. On the other side, self-employed make up only 1% of the respective sample. Together with the 33% of employed people, only one third of the over-indebted have some kind of job. The rest are not employed but without being registered as unemployed by the unemployment agency.4 Looking at the relevant population with the focus on education, almost 60% have completed either vocational or university education. An additional 3% are currently attending some sort of education. But still 37% have not completed any education. This makes it very hard for them to get a job that pays them enough to cope with the debts. In the year 2014 7% of the 460,600 over-indebted people seeking assistance at an agency were supplement benefit recipients. For those people the income from going to work does not suffice to maintain a certain minimum standard of living, so they are dependent on additional social transfers like the unemployed, but to a lesser degree. The share of supplement benefit recipients in the general population of Germany was significantly lower, only 3%. They are often drastically disproportionally over-indebted. This comes from the often still low level of combined income generated by employment and social benefits. Table 8.2 Average debts by employment status and unemployment benefit in 2014 Counselled people Overall Employment

4

Overall

Unemployment benefit Yes

No

34,500

25,000

41,900

Yes

45,800

38,000

47,500

No

27,300

22,700

34,500

This is mainly the case for old-age pensioners, students or housewives/husbands.

159

Walter Joachimiak

The average debts of a supplement benefit recipient amount to nearly €38,000 and are thus about €3,500 lower than the average debts of all debtors covered by the Statistic. Still employed persons without supplement benefits have even higher obligations (€47,500). Unemployed people who are completely dependent on unemployment benefits owe their respective creditors an average amount of about €22,700. But even though this is low compared with the debts pertaining to other groups, it can be assumed that their situation is very severe because of the extremely low income of unemployed people (Table 8.2).5

8.5.2

Main Reasons for Over-Indebtedness

One may assume that the main reason for financial difficulties lies in over-the-top expenditures that cannot be balanced by the income of a person. But the results of the Statistic show that uneconomical budget management led to over-indebtedness only in 11% of the cases, and that strokes of fate like illness, addiction or accidents were much more common to constitute the main cause, accounting for 12%. Equally often the consequences of separation, divorce or death of the partner are responsible for the current situation. This again reflects the protective power of a stable relationship. If the synergistic effects of the combined financial assets and income of the partners cease to exist, the foundation of a previously stable budget collapses, often beyond the ability to repair it. The same process applies to the case of sudden unemployment, which is actually the most frequent and main reason for over-indebtedness, with 19% of the cases of the year 2014 attributed to being without work (Table 8.3). Table 8.3 Main reason for over-indebtedness in 2014 Reason

Share of debtors (%)

Unemployment

19

Separation, divorce, death of partner

12

Illness, addiction, accident

12

Uneconomical budget management

11

Failed self-employment

8

Obligations from bail

2

Failed real estate financing

2

Damages from illegal activities

1

Birth of a child

2

Insufficient credit advice

2

5

See details in section ‘Intensity of Over-indebtedness’.

160

8

The Statistic of Over-Indebtedness of the Federal Statistical Office of Germany (Destatis)

Starting one’s own business can be the cornerstone of a prosperous and lifelong enterprise, but in some cases it is the first step towards overwhelming debts. To start a new business, almost regardless of the type of economic activity, substantial investments are necessary. These are often acquired via a bank loan. If the business fails to generate sufficient income to pay back the loan and to be managed in a self-sustaining way, closure becomes inevitable and oftentimes bankruptcy of the entrepreneur. On the one hand stand the debts resulting from the failed own business, and on the other hand there is no or not sufficient income. Because of the often high amount of debts the insolvency of the business often brings along the insolvency of its founder.

8.5.3

Debts and Creditors

The average debtor in the year 2014 had obligations of about €34,500. The numbers of counselled people by gender may be similar, but the amount of their debts is not – men owe on average €40,400, whereas women have significantly lower obligations (€28,200). The largest difference can be found for debts associated with alimony payment. Women with debts in this category owe on average about €4,500, whereas men have average debts of about €8,000. The facts that children often stay with the mother after separation or divorce of the parents and that men on average have higher earnings and work less, likely part time,6 can be seen in the Statistic of Over-indebtedness too. For both genders the main creditors are credit institutions such as banks, and the highest debt item, in general, is by far for deferred payment credits with an average amount of over €8,500. If one looks at the average debts of debtors with obligations in the respective category of creditor, mortgages play the main role, with an average of €113,000. Because of the large amount of money involved in mortgages, they are another great source of risk to become over-indebted if an external shock disturbs the financial planning, e.g. the loss of employment. ‘The older a debtor, the higher the debt’ is a rule directly derived from the data; young debtors under the age of 25 have average debts of lower than €8,000, and from this value onwards the amount owed steadily rises with the age of the debtor. People older than 70 years have average obligations of over €55,000. This illustrates drastically the need to seek assistance as soon as possible; because of often high interest rates, debts accumulate over the years to much higher levels than what was initially borrowed or owed. The composition of the debts also differs, depending on age. Usually the debts rise with age, but not those owed to telecommunications companies. Debtors younger than 25 years owe an average of over €1,000; in contrast, all age cohorts of 35 and older have less obligations due to telecommunication, with people 65 years and older owing on average less than €300.

6

See press release regarding Gender Pay Gap.

161

Walter Joachimiak

Money is seldom owed to one creditor alone; only 11% of the counselled had only one debt. The amount owed rises with the number of creditors on the list. People with only one creditor owed this party on average €20,000. This number grows continuously to over €54,000 for debtors with twenty or more different parties to satisfy. Most debtors (27%) owed on average €36,000 to five to nine creditors. Especially single parents are in the situation of owing money to many different parties. Here again, the presence of children amplifies the effect of earning a living alone; with more than one child in the household, the rate of people having more than twenty creditors rises.

8.5.4

‘Intensity of Over-Indebtedness’

The average debts of over-indebted persons who were counselled by an over-indebtedness advisory agency in 2014 were about €34,500, which equals roughly thirty-four times their monthly net income of marginally more than €1,000. This means that, hypothetically, if an average debtor could use all her income to serve the creditors’ demands, it would take this person nearly three years to pay back all the due obligations. This relationship of income to debts expresses the ‘Intensity of Over-indebtedness’ better than the plain amount of debts. Since income varies strongly between different groups of people, a certain amount of debt means a much heavier burden for people with lower income than for rather wealthy people. For a poor person even small debts can mean bankruptcy. The formula to calculate the new indicator for the ‘Intensity of Over-indebtedness’ is straightforward – the division of the debts of a person by her monthly net income: O = D/I With O = Intensity of Over-indebtedness D = debts I = monthly net income Of course, no one is actually able to invest all income into debt servicing, so the ‘Intensity of Over-indebtedness’ is merely a hypothetical model, but one that enables researchers to compare over-indebtedness situations of different countries with different currencies and even over long time frames without losing precision due to inflation, currency fluctuations or purchasing power differences. This new indicator can serve as a standard figure to assess the severity of over-indebtedness situations.

162

8

The Statistic of Over-Indebtedness of the Federal Statistical Office of Germany (Destatis)

In the hypothetical model, men would have to pay all their income of about €1,000 for thirty-nine months to get free from debts. For women this period would be much shorter because of their lower debt level. There is no great difference in the average net monthly income of over-indebted men and women. Women would have to pay for twenty-eight months, eleven months less than men but still more than two years. The ‘Intensity of Overindebtedness’ rises with age, just as the average debts do. People younger than 25 years have average debts ten times as high as their monthly net income, whereas persons over 65 years old are facing obligations fifty-three times their income. This is mainly in accord with the above-mentioned observation that the higher the average debts, the older the debtor is. In the same time the average monthly net income of over-indebted people just rises narrowly with age and accounts in a range from about €800 to €1,150 (Table 8.4). Table 8.4 Average debts, monthly income and Intensity of Over-indebtedness of counselled people in 2014 Socio-demographic characteristic

Debts (€)

Income (€)

Intensity of overindebtedness

34,500

1,000

34

Woman

28,200

1,000

28

Man

40,400

1,000

39

7,900

800

10

25-34 years

18,800

1,000

19

35-44 years

35,700

1,200

31

45-54 years

45,600

1,100

42

55-64 years

47,600

900

51

65 years and older

53,000

1,000

53

Single woman

24,800

900

28

Single mother

22,600

1,200

19

Single man

34,300

900

38

Single father

47,100

1,400

34

Couple without children

49,700

1,000

50

Couple with at least one child

37,500

1,200

31

Employed

45,800

1,300

35

Not employed

27,300

800

32

Overall Gender

Age Under 25 years

Household type

Employment status

163

Walter Joachimiak

The ‘Intensity of Over-indebtedness’ differs depending on the household type a person lives in. Couples without children would need more than the average length of time to pay back their debts, about fifty months. Single men and single fathers also face very high indicator values with thirty-eight and thirty-four months, respectively. Whether a debtor is employed has no strong impact on the time necessary for hypothetical debt payback. Employed persons have obligations of about €45,800, whereas unemployed just owe about €27,300. But due to a difference of over 50% in terms of average monthly net income, the indicator for both groups assumes rather similar values with thirty-five for employed and thirty-two for unemployed.

8.6

Summary and Conclusions

The Statistic of Over-indebtedness was established in 2006 to provide an overview of the situation of people seeking advice at the over-indebtedness advisory agencies in Germany. By this means the data can be collected not by individual personal interviews with affected people, who would be difficult to identify, as is often done in social research, but simply by submission of the completed data sets the agencies already maintain about their clients for the daily business. The data sets are sent online to the Federal Statistical Office of Germany (Destatis) for centralized plausibility checks, data processing and dissemination. The results are published on a yearly basis at the end of June in the form of a book of tables. Additionally, press releases accompany the new data release to generate public awareness of over-indebtedness and also to promote the work done by the advisory agencies. The questionnaire of the voluntary survey features questions about the agency itself, the state of ongoing consultations or, alternatively, the circumstances of completed or aborted consultations. The main focus of the Statistic is on the personal and financial conditions of the particular debtor and the nature and amount of debt. Additional information about the creditors completes the questionnaire. Since the Statistic is conducted as a voluntary survey, the agencies as well as the debtors can decide whether to participate or not. To compensate for this lack of data completeness, beginning with reference year 2014, the gathered information is grossed-up to facilitate results representative of all people seeking help at an over-indebtedness advisory agency. This group of people consists of nearly equal proportions of women and men. Strongly over-represented are single men and single mothers between the ages of 25 and 54 years who are divorced or separated. Unemployment is the main reason for over-indebtedness, followed by other external shocks that tend to destabilize the financial architecture of a person’s life. In situations with abruptly dropping income and no sufficient financial assets, the path into overwhelming debts is often set. Even a small amount of debt can overexert a person’s ability for timely payback when the income side is dangerously low, a fact

164

8

The Statistic of Over-Indebtedness of the Federal Statistical Office of Germany (Destatis)

described by the newly introduced indicator for the ‘Intensity of Over-indebtedness’. This indicator sets the average amount of debt in relation to the average monthly net income of a group of persons. The result is a positive number indicating the average time measured in months a person would need to pay back all debts, under the condition that she could use all her income for this one purpose. Of course, this assumption is strictly hypothetical, but it illustrates the severity of the situation. It allows comparisons of different subgroups defined by certain distinctions, e.g. their income or employment status, as well as enabling researchers to conduct analyses across currency boundaries and time frames. In general, debtors in Germany would need thirty-four months to pay off all their debts. The older the debtor, the longer this period; debtors younger than 25 years would need ten months, whereas it would take people older than 65 up to fifty-three months. The Statistic of Over-indebtedness draws an exact picture of the situation of persons counselled by over-indebtedness advisory agencies. Despite the fact that it cannot cover all people with high obligations, it gives a good insight into the topic with an intense focus on the specific characteristics of the debtor and her financial situation. The discussion in academic fields as well as in the public media lacks international comparisons. The Statistic is a feasible basis for such comparable studies, but until now no comparable data source from other countries has come to our knowledge; more efforts should be made to look for data sources and methods to do research on an international basis, and the indicator for the ‘Intensity of Over-indebtedness’ can be put to full use for such endeavours. Some characteristics covered by the Statistic of Over-indebtedness have still not been used by any researching party yet. It could be worthwhile to have a closer look at questions regarding the waiting period until a person can access the counselling procedure of an agency. Are there different waiting periods, depending on geographical location or type of debtor? Also, the additional reasons for over-indebtedness have not been looked at yet. Additionally, the data sets regarding the agencies have not been analysed yet, and questions regarding the different professionals working in the agencies could lead to new insights on the kind of knowledge that is essential to provide good assistance for people with grave financial problems.

References Destatis, ‘Statistik zur Überschuldung privater Personen – Fachserie 15 Reihe 5 – 2014’, Book of Tables, 2015, .

165

Walter Joachimiak

Destatis, ‘Virtual questionnaire for the statistic of over-indebtedness’, 2015, . Destatis, ‘Disproportionate number of supplement benefit recipients affected by overindebtedness’, Press Release, 2015, . Destatis, ‘Average debt of over-indebted people 34 times as high as their monthly income’, Press Release, 2015, . Destatis, ‘Gender pay gap in Germany remains at 22%’, Press Release, 2015, . Finke, C, ‘Überschuldung: mehr als ein gesellschaftliches Randphänomen’, STATmagazin, June 2014, .

Laws Federal Statistical Law – Gesetz über die Statistik für Bundeszwecke (Bundesstatistikgesetz – BStatG). Law for the Statistic of Over-indebtedness – Gesetz über die Statistik der Überschuldung privater Personen (Überschuldungsstatistikgesetz – ÜSchuldStatG).

166

9

Consumer Over-Indebtedness in Europe and Germany: Considering Micro- and Macro Dimensions from a Lender’s Perspective

Patricia Wruuck*

9.1

Introduction

Consumer over-indebtedness (OID) is a complex phenomenon. On the one hand, this holds true when looking at its causes. While typical triggers can be identified, often OID cases reflect a mix of individual (micro)-level and macro-level factors that contributed to a person’s financial difficulties. On the other hand, this mix of micro and macro is a challenge for designing measures to tackle OID. While measures at the individual level, such as debt counselling, need to consider case idiosyncrasies to provide support effectively, a better understanding of why individuals ended up with excessive debt requires a look beyond the individual level. Taking into account the broader environment, i.e. economic, societal and institutional factors, is particularly important to understand what policies and conditions can help to prevent excessive household debt as well as enable households to be more resilient to shocks. The financial and economic crisis in Europe has re-emphasized the need to better understand OID and develop measures to tackle it. First, the crisis and the subsequent period of recession caused an increase in the number of households being in a financially fragile situation or living in economic distress. Second, the crisis triggered an intensive discussion about the role of debt in today’s economies. While sovereign debt and ways of dealing with it remains at the heart of this debate, the issue of household debt has also been getting increasing attention. In particular, it is the micro–macro linkages that have come into focus. This includes, for instance, the question concerning to what extent (excessive) household debt has contributed to the crisis, what levels of household debt are sustainable in industrialized economies and how household debt and sovereign debt interact. Also, the question concerning the extent to which household debt and deleveraging

*

Senior Economist, Deutsche Bank Research. The author would like to thank Leonie Rhiel and Mushtaq Ahmad for valuable insights and discussion.

167

Patricia Wruuck

puts a drag on economic recovery continues to be debated against the background of subdued growth in a number of member states. Third, the experience of the crisis led to an overhaul of financial market regulation in Europe to increase resilience. This includes measures that focus on strengthening consumer protection, for instance via better product information or requirements for lenders, as well as a changed approach to banking supervision and an emphasis on careful management of risks in banks. In addition to the interaction of micro- and macro factors, what makes OID challenging to tackle at the European level is the high level of heterogeneity across member states. Germany, in particular, has proved to be an exception in recent years. While OID has become more widespread in most parts of Europe, several indicators suggest that this is not the case in Germany. Are there ‘lessons to be learnt’ from the German example? Given the need for a comprehensive approach to OID and the increased emphasis on micro- and macro linkages, this chapter deliberately starts with a broader view encompassing credit developments and aggregate measures of household indebtedness as well as household-based measures available for comparison at the European level. The assessment from a European perspective emphasizes several points. First, there remain pronounced differences in levels of aggregate household debt as well as households’ living conditions across Europe. Second, the impact of the crisis has been rather uneven, which is reflected in country developments and the different measures accordingly. From a methodological perspective, the cross-country comparison defies simple connections from micro to macro (and vice versa). Rather, the sustainability of debt or the extent to which the crisis as a macro shock translated into a deteriorating situation for households is highly contingent on individual country characteristics. Against this background, the situation in Germany is examined in greater detail. Again, it is the mix of micro- and macro factors intermediated by institutions that can best explain the ‘German exception.’ In short, lower levels but also structure of (household) debt implied relatively greater resilience when the crisis hit. Labour market regulations, in particular Kurzarbeit, i.e. the possibility to introduce short-time working without laying employees off, helped to avoid sharp rises in unemployment, which in turn limited effects to households and help to avoid a macro-driven rise in OID. Given the strong labour market performance, macro factors have in fact become less of a concern in recent years. However, this does not suggest that OID in Germany is not a problem at all or only a negligible one. Rather, it puts the micro dimension of OID back into focus. Frequently, OID is triggered by events at the personal level such as divorces, death of a partner or health issues. These can hardly be prevented by policy measures. What policy can do, however, is invest in prevention – strengthening financial literacy remains a notable case in point here. How can banks help to tackle OID and contribute to prevention? The second part of the chapter focuses on the example of Deutsche Bank (DB) explaining its processes to

168

9

Consumer Over-Indebtedness in Europe and Germany: Considering Microand Macro Dimensions from a Lender’s Perspective

address situations when customers face financial difficulties. Special units to assist customers who have problems repaying their debt have received much more attention in European banking recently. Again, this reflects the impact of the crisis, an increase in customer delinquencies and payment delays and banks’ need to (better) manage it. At the same time, it also reflects banks’ greater emphasis on risk management processes. To that extent, Risk Management and Customer Assistance units can improve management of risks by helping to avoid customer default. Also, they can contribute to strategies of OID prevention. The key task of CR units is counselling of customers who face (extended) financial difficulties. In this regard, their day-to-day work is very much focused on individual cases, i.e. the micro dimension of OID. To the extent that better management of (over-)indebted customers can also contribute to the overall health of a financial institution and eventually also the financial soundness of the financial system at large, the macro dimension also comes into play.

9.2

Trends in Household Debt and Over-Indebtedness: Germany as an Exceptional Case

9.2.1

Credit Developments and Aggregate Measures of Household Debt

In 2014, households had continued to deleverage in a majority of European countries. For fifteen member states, lending statistics show a year-on-year decrease in household credit. Latvia, Hungary and Ireland saw the biggest drops, with −7.1%, 7.5% and −10.2%, respectively. For the latter, it has been the sixth year since 2008 with reductions in household credit.1 At the other end of the spectrum are Belgium and Slovakia, which have recorded double-digit growth in 2014. Lending to households in Germany increased by 1.5% year on year. While credit cycles have different shapes across countries and volatility is obviously less pronounced in large markets, the most notable development when comparing developments in credit to households in Germany with other European member states during the past fifteen years is the high level of stability. Cyclical movements show very low amplitude and appear almost non-existent in comparison (Figures 9.1 and 9.2).

1

Only in 2012 was household credit basically stable; all other years recorded drops.

169

Patricia Wruuck

Figure 9.1 Lending to the private sector: Households

Source: ECB and Deutsche Bank Research.

Figure 9.2 Divergences in credit growth – selected European countries

Source: ECB and Deutsche Bank Research.

This clearly contrasts with trends in the rest of Europe. Credit stocks to households in the Euro area – excluding Germany – expanded from 2003 to 2011 by about €1.7 trillion. A number of member states such as Ireland, the Netherlands and Spain but also France saw periods of pronounced credit expansion following the introduction of the Euro. Notably,

170

9

Consumer Over-Indebtedness in Europe and Germany: Considering Microand Macro Dimensions from a Lender’s Perspective

mortgage financing contributed to pronounced credit growth in a number of member states. Since the start of the financial crisis many credit markets in many European member states have been undergoing a phase of stagnation or contraction. Notably, in addition to countries in Western Europe such as Ireland or Spain where property bubbles have burst, this also includes a number of central and eastern European countries with extended reductions in credit (e.g. Bulgaria, Hungary and Latvia) as well as Greece and Portugal, which did not have property bubbles but experienced particular difficulties due to the Euro and debt crisis. On balance, total Euro area credit stocks have stagnated during the past three years and still remain below their peaks. In contrast, credit stocks to households in Germany, after having remained flat for almost a decade, have started to pick up slightly since 2009. Most recently, the growth in household credit has been accelerating moderately, reflecting the exceptionally low interest rates and increased mortgage borrowing.2 What credit developments clearly show are the pronounced divergences across countries with respect to their credit cycles and the (differentiated) impact of the financial and economic crisis on lending to households in Europe. Credit developments do not measure over-indebtedness – they measure debt. Aggregate figures therefore give no indication about over-indebtedness per se. From the perspective of an individual, a lender and financial stability, it is the sustainability of debt that matters. Measures that consider household debt in relation to other factors can therefore provide further information on households’ (aggregate) financial position. From a macroeconomic perspective, debt sustainability is typically assessed in relation to GDP and to households’ disposable income. Here, Germany again stands out with respect to levels as well as recent developments. Household debt remains relatively low both in comparison with other European countries and over time. German household debt peaked in 2000 at 71.6% of GDP. In Spain it was much higher, at 88%, in 2010. The Netherlands (2010: 127.9%), Denmark (2009: 150.3%), Ireland (2009: 122.3%) and the UK (2009: 106.8%) had all experienced much higher peak debt levels. Debt levels in Portugal, Ireland or Spain have been coming down lately. In 2014, thirteen out of twenty-eight EU member states, including Germany, saw household debt ratios drop. In fact, aside from a slight increase in 2009, Germany’s debt to GDP ratios have been continuously decreasing from 2000 to 2014 (Figures 9.3-9.5).3

2

3

Total lending to households in Germany increased by 1% in 2013 and 1.5% year on year in 2014, respectively. Source: ECB. The first quarters in 2015 indicate greater borrowing activity, suggesting that the pick-up is becoming more pronounced. See Rakau and Roller (2015). See Rakau and Roller (2015) for further discussion.

171

Patricia Wruuck

Figure 9.3 German household debt: low in international and historic comparison

Source: Eurostat and Deutsche Bank Research.

Figure 9.4 Household indebtedness across Europe

Source: OECD and Deutsche Bank Research.

172

9

Consumer Over-Indebtedness in Europe and Germany: Considering Microand Macro Dimensions from a Lender’s Perspective

Figure 9.5 Stabilizing debt ratio in Germany

Source: Federal Statistical Office, Deutsche Bundesbank and Deutsche Bank Research.

Household debt-to-income ratios show similar patterns, i.e. there are considerable differences in levels as well as divergent trends. Since the start of the financial crisis, most European countries have shown increases in debt-to-income ratios. In contrast, in Germany they had already been decreasing for almost a decade and have continued their decline against the background of the economic crisis with the share of debt to disposable income falling by almost 10 percentage points from 2007 to 2012.4 Again, this reflects the heterogeneous impact of the economic crisis across European member states. While some countries saw disposable incomes drop faster than debt, leading to increases in debt ratios (e.g. Greece), others saw stagnating incomes or slower drops but quick reductions of debt, and hence declining ratios. In Germany, disposable incomes kept growing, but debt came down over time; hence the decline in ratios.

4

In 2000 the share stood at 116%.

173

Patricia Wruuck

9.2.2

Micro Measures to Assess Households’ Situation across Europe

Data from the European statistics on income and living conditions (EU SILC)5 sheds further light on financial distress and (perceived) risks of OID from a micro perspective and helps to compare households’ situations across Europe. In particular, it contains information on (i) households’ inability to face unexpected expenses – which can be interpreted as measures of perceived OID risk, (ii) the share of households in arrears including information on different types (e.g. for loans or utilities, mortgages and rent) and (iii) stated inability to make ends meet. Similar to macro measures, two main patterns can be discerned: a considerable heterogeneity when it comes to households’ situation and financial strain across Europe, and the impact of the financial and economic crisis. The latter is clearly visible when looking at most recent years. In the EU, the proportion of households unable to face unexpected financial expenses increased from 35.2% in 2007 (35.3% in 2009) to 38.5% in 2014.6 While already showing some improvements compared with 2012 (40.1%), the share remains above pre-crisis values. Similar trends can be seen for arrears as well as stated difficulties of making ends met.7 The share of households in arrears in the EU (twenty-seven) was about 10% before the financial crisis hit (2007), increased to 11.6% in 2009 and stood at 12.6% in 2014. The share of households unable to make ends meet rose from 9.1% in 2007 (10.4% in 2009) to 12.1% in 2013, decreasing slightly in 2014 (to 11.3%). Developments in Germany again stand out: The share of people stating inability to face unexpected expenses stood at 32.9% in 2014, which is 3.6 percentage points lower than in 2007. Total arrears have been significantly lower than European averages for years. With 5.6% in 2014, they remain at similar levels as 2007.8 Finally, the proportion of households that state inability to make ends meet has been fluctuating around 3% since 2007 without indicating a clear trend. While the latest value, at 2.8%, remains somewhat higher than that for 2007, which marked a ten-year low at 2%, the value remains the third lowest across the EU; only Sweden and Finland currently show lower shares (Figures 9.6-9.8).

5 6 7 8

See . Values for total population. Source: EU SILC (2015). Includes provisional values for 2014. See Eurostat, EU SILC. See Eurostat, EU SILC (2015). Total arrears in 2009 was 5.8%.

174

9

Consumer Over-Indebtedness in Europe and Germany: Considering Microand Macro Dimensions from a Lender’s Perspective

Figure 9.6 Inability to face unexpected expenses

Source: Eurostat and Deutsche Bank Research.

Figure 9.7 Share of people in arrears

175

Patricia Wruuck

Figure 9.8 Inability to make ends meet

Source: Eurostat and Deutsche Bank Research.

Again what the short review of EU-SILC data shows are pronounced differences in levels for the different measures, indicating divergent living conditions of households across Europe. Second, in terms of trends over time, on balance, the impact of the crisis also shows when looking at the household level. Yet again, effects differ across countries. On the one hand, this is due to how strongly countries have been affected by the crisis. On the other, it also reflects the extent to which macroeconomic shocks actually impact on the household level. Countries can be clustered with respect to level differences before the crisis and recent changes, indicating the extent to which household financial distress has been a longstanding (structural) issue compared with a more recent (cyclical) phenomenon. At one end of the spectrum are several eastern European countries where household measures indicate that households’ financial difficulties reflect (persistently) low incomes and poverty. At the other end of the spectrum are countries like Ireland, where households’ financial situation was not exceptionally bad pre-2007, but deteriorated with the crisis (Figure 9.9).

176

9

Consumer Over-Indebtedness in Europe and Germany: Considering Microand Macro Dimensions from a Lender’s Perspective

Figure 9.9 Households in arrears: differences in levels and recent trends

Source: Eurostat (2015) and Deutsche Bank Research.

While, for instance, both new and old member states show an increase in their levels of arrears, new member states have higher levels and have seen a more pronounced increase (in new MS9: 13.4% in 2007 to 19.7% in 2014, and in old member states from 8.2% to 11.7%, respectively). A notable outlier in this group is Poland. While in terms of levels the country remains above EU median values, it has been the only country in Central and Eastern Europe to record a decrease in the level of arrears for recent years. As for old member states, the case of Greece clearly stands out, where the proportion of households in arrears almost doubled between 2007 and 2014. Arguably, in Greece the crisis had a particularly strong impact, and cushioning the hardship for households became very difficult in view of the country’s overall economic situation.

9.2.3

Micro, Macro and Measurement (Shortages)

Macroeconomic measures of debt and indebtedness do not necessarily mirror developments at the household level that is stated in surveys. While household-based measures are necessary to learn about the prevalence of OID across the population and specific sub-groups, survey-based measures are necessarily more subjective. They can suffer from reporting biases and to some extent be influenced by different societal and cultural notions of debt.10 Also, country-specific factors such as differences in countries’ welfare state systems need to be taken into account to interpret micro- and macro measures ‘in context’. In the EU, a number of member states with high levels of household indebtedness, for example Scandinavian countries such as Denmark or Finland, are at the low end in terms of measures that assess households’ financial difficulties via surveys. The opposite holds 9 Not including Croatia. 10 Looking at mortgage debt, Georgarakos, Lojschova and Ward-Warmedinger (2010), for instance, find that households’ perceived vulnerability to debt is affected not only by their own level of indebtedness, but also by the fact that their own debt burden exceeds that of households in their reference group.

177

Patricia Wruuck

for some countries in Central and Eastern Europe, where indebtedness ratios tend to be low but the share of households indicating difficulties is often higher. In many cases the level divergences and micro–macro combinations can be explained simply by countries’ structural differences, for instance with respect to income and its distribution, but in addition, issues such as tax and social systems or the breadth and depth of financial markets can play a role and affect both micro- and macro-level measures.11 To that extent, structural heterogeneity across Europe defies straightforward mapping from macro- to micro measures and vice versa. As any indicator used provides only part of the picture, it remains important to keep in mind what selected micro- and macro indicators can (and do) measure and what not. On a stand-alone basis, measures of credit and household debt provide no indication of the extent to which debt is balanced by assets – which is important for assessing debt sustainability – at both micro- and macro levels. Also, credit-based measures naturally do not capture other sources of debt or payment difficulties. Yet a closer look at EU-SILC statistics on arrears, for instance, suggests that the structure of households’ financial difficulties in Europe also varies. Despite the growing research interest in household debt and its potential macroeconomic consequences, assessment of OID requires micro-based measures to understand its triggers as well as the characteristics of households at risk. Central banks in Europe have stepped up efforts to collect better micro data on households’ assets and liabilities (e.g. European household finance and consumption survey).12 However, these are not specifically focused on OID, its causes and (potential) consequences for households. Empirical assessment of OID in Europe also remains limited because some data sources are not easily comparable. Partly, this is due to differences in legal frameworks and processes, for instance with respect to personal insolvency. Partly, this reflects different data sources and traditions of data collection across countries. Official data on over-indebtedness in Germany,13 for instance, is based on aggregating information from a subset of debt counselling services (and counselled persons) that have agreed to share their data. While still insightful, this remains a subsample and is difficult to compare across Europe. Most information on the macroeconomic environment and credit developments are readily available in standardized formats. Data on non-performing loans (NPL) – which might be useful in combination with other factors for further research on OID – remains difficult to compare across countries due to definitions.14 In this respect, changes in the

11 For example, the level of financial inclusion and its historical development would affect households’ credit stock. Having access to credit also is a prerequisite for falling into arrears on a loan. However, it does not imply that arrears are higher where access to credit for households is more prevalent. 12 See . 13 See Destatis – Statistik zur Überschuldung privater Personen. 14 See for instance IMF (2012).

178

9

Consumer Over-Indebtedness in Europe and Germany: Considering Microand Macro Dimensions from a Lender’s Perspective

institutional framework of the European banking market, notably common banking supervision, can help to improve comparability over time. All in all, improving on measurement of OID and the factors related to it remains a challenge, particularly when OID is looked at from a European perspective. While it may not have an immediate effect in terms of improving households’ situation, it can improve understanding of the factors that lead to OID as well as those helping to prevent it.

9.3

What Factors Account for Differences in Levels and Recent Trends?

Country characteristics play a key role in explaining differences in levels across European member states. These include historical and cultural factors, market structures and regulatory incentives. These are not triggers of OID. Rather, they form part of the environment in which OID occurs or can be prevented. They also need to be considered for interpretation of macro- and micro-level data on debt and over-indebtedness. Take the example of differences in aggregate household indebtedness. First, countries in Central and Eastern Europe have a shorter history with deeper credit markets for households and therefore still relatively lower levels of debt. Second, mortgage financing accounts for a large share of households’ credit volumes. Differences in property markets across member states affect differences in levels of indebtedness accordingly. To that extent, property market developments and their structural differences including incentives for (more leveraged) property financing such as tax deductibility of interest rates can over time also contribute to differences in levels of indebtedness. Here, experiences of recent years has led to changes in tax rules in a number of member states, which have taken steps to reduce or abolish tax deductibility of mortgage rates.15 At the same time, buying property, the extent to which households are willing to take on debt and how they finance it varies across member states and also reflects sociocultural factors. This is, for instance, reflected in differences in age level of (first-time) buyers.16 At the same time, differences in age might also reflect different motives for purchases and a different income situation when taking on mortgages, thus affecting debt sustainability.17 In any case, it implies that characteristics of households, which take on debt, vary too. So do the characteristics of persons (at risk of) being over-indebted.

15 European member states use different policies to encourage home ownership including tax incentives but also subsidies. See for instance Wruuck and Zipfel (2015) for further information. 16 With an average age of about 42, buyers in Germany tend to be rather old compared with their European counterparts. See LBS (2014) and ECB (2009). 17 To the extent that, for instance, age typically affects income and accumulated wealth, a different structure of buyers can also impact on risks.

179

Patricia Wruuck

Specific policies to tackle OID cases often have to take these country factors as a given, or it would take considerable time to change them, such as income levels and distribution or attitudes towards saving and spending money. Nevertheless, from a practical perspective, these differences need to be accounted for when designing measures to address OID. Second, structural differences across Europe also suggest that (European) strategies need to start at the local level and that there is no ‘one size fits all’ approach. Considering the financial and economic crisis as a macro shock, a natural follow-up question is what factors can increase resilience to withstand crises. In Europe, this discussion has mostly been focused on changes in regulation to increase the resilience of financial markets and country-level measures to increase (macroeconomic) resilience, for example stressing the importance of fiscal discipline, better ‘early warning’ to spot imbalances, etc. What has been less in focus but arguably more important with respect to OID is how macro shocks are being transmitted to the micro level, i.e. to what extent households’ situation (immediately) deteriorates if the economy experiences a shock and enters a recession.18 While these transmission processes warrant further research, it is plausible to assume that impact depends on a mix of starting conditions – i.e. the situation households are in when the shock hits – and country-level factors that mediate shocks. This combination also explains the German case.

9.4

What Explains the German Case?

Germany stands out to the extent that the country has low levels of household indebtedness at the aggregate level as well as a limited share of households in financial difficulties compared with the case in other European countries. Also, it proves an exception with respect to recent trends as the financial and economic crisis did not lead to a deteriorating situation at the household level. What factors account for these differences? Again, the explanation involves micro- and macro-level factors. Unlike other countries, Germany had not experienced a ‘boom phase’prior to 2007. Credit to households remained relatively stable because there was no catch-up effect in terms of personal consumption – as in some of the new member states – and property markets had remained sluggish for years. While for a number of southern European countries the introduction of the Euro led to significantly lower interest rates, this effect was less pronounced in Germany. While the overall level of household debt in 2007 was at the lower end compared with that in

18 For instance, the extent to which interest rate changes affect households depends on whether financing is with variable or fixed rates. The extent to which a macro shock impacts on employment also depends on labour market structure and regulation and the impact of an eventual employment loss on, for instance, benefits for unemployed persons as well as the probability of finding alternative employment quickly.

180

9

Consumer Over-Indebtedness in Europe and Germany: Considering Microand Macro Dimensions from a Lender’s Perspective

other mature markets (see Figure 9.4 above), arguably, the debt that existed might also have been more sustainable because of its characteristics. First, it was the result of stable developments over time, rather than households adjusting to a new situation. Second, debt at an aggregate level was (more than) balanced by households’ assets. This also reflects a third factor, namely, sociocultural attitudes towards debt and savings. Savings ratios tend to be high in international comparison, and households stress security motives for saving.19 When the financial crisis hit, labour markets held up rather well. Labour market regulation that allowed employers to reduce hours and, in doing so, not have to lay off employees, helped to avoid a surge in unemployment. That labour markets held up rather well in turn helped to contain the impact of the crisis on households. Then, Germany was not at the centre stage of the evolving Euro crisis and has experienced years with moderate growth contrasting with other countries’ deep recessions. Germany’s relatively benign macro situation is also reflected with respect to OID. Business failure is a frequent trigger of OID. With good macroeconomic conditions, businesses have a better chance of succeeding, and fewer companies are founded out of necessity. The number of personal insolvencies in Germany has kept decreasing for five years in a row, and stands at its lowest value since 2005.20 In 2014, 84.443 new consumer insolvency proceedings were initiated, recording a decrease of −5.8% year on year.21 Similarly, unemployment, typically the most frequent reason, has become less of a concern in Germany during recent years. While it was identified as the main reason by 28% of indebted persons in 2008, not having a job now accounts for less than 20%.22 Hence, a relatively good macro situation also impacted on the structure of OID cases and resulted in micro-level triggers assuming more importance (Figure 9.10). Arguably, this does not make OID easier to address because triggers at the personal level are harder to predict and prepare for or to address via policy measures. Rather, they emphasize the importance of taking individual debtors’ conditions carefully into account. Based on this, measures targeted to cases can then be developed.

19 A preference for plannability in turn also has implications on financial products. For example, credit with fixed interest rates (Festzinskredite) has been by far the preferred option of households when taking on a mortgage. 20 Destatis – Statistik über beantragte Insolvenzverfahren (2015). Note that comparing figures on personal insolvencies can be difficult across countries in view of differences in insolvency procedures and traditions of data collection on the issue. Similarly, changes in legal provisions within countries can affect data collection on insolvencies. 21 Note that there have been legal changes to personal insolvency rules taking effect as of July 2014. 22 Figures refer to debtors counselled at the set of debt counselling agencies as collected by Destatis.

181

Patricia Wruuck

Figure 9.10 Main triggers of over-indebtedness in Germany

Source: Statistisches Bundesamt and Deutsche Bank Research.

Counselling debtors also requires experience and infrastructure, and many different players are involved in this in Germany, including consumer protection agencies, charity organizations, etc. What is less known is that many banks have also developed an infrastructure and processes to work with customers who face financial difficulties.

9.5

Addressing Over-Indebtedness – A Lender’s Perspective

Banks have a role to play in tackling OID by addressing individual cases, i.e. working with customers who face difficulties meeting their payment obligations, as well as by contributing to OID prevention. If a bank seeks to maintain a healthy and long-term relationship with its customers, it is in the company’s genuine interest to not see him default. From a bank’s perspective, customer default is in many ways a ‘worst case scenario’ as it implies costly handling, loss on loans and often the end of the relationship with the client. Also, individual customers’ non-payment (and potentially default) negatively impacts on a bank’s credit portfolio, adding to total non-performing loans, which require special

182

9

Consumer Over-Indebtedness in Europe and Germany: Considering Microand Macro Dimensions from a Lender’s Perspective

loss provisioning and higher capital costs accordingly. In addition, frequent customer default can entail further reputational costs, and raise questions about a bank’s lending practices as well as its risk management. Against this backdrop, addressing OID is closely intertwined with risk management for a bank. Many banks have set up special departments that focus on dealing with customers who have difficulties in meeting their debt obligations. In DB, in addition to the advisory services provided by the bank branch, specialized units have been set up to assist the customers who have problems repaying their debt. These Risk Management and Customer Assistance units focus on working with customers who face (extended) payment difficulties. While such departments have received more attention in European banking recently – reflecting the impact of the crisis – DB had already set up such centralized dedicated units in 2000. From an organizational perspective, setting up a dedicated Risk Management & Customer Assistance (RM) unit has the advantage of being able to draw on specialized expertise to better deal with customers who face financial difficulties and often a difficult lifetime situation. Also, it facilitates the development of ‘best practices’ in the bank. To that effect, it supports and complements individual branch advisors who ‘own’ a customer relationship, often having known clients for a long time, but typically have less experience in dealing with OID cases. In addition, OID management from a bank’s perspective also involves infrastructure, e.g. IT systems that track payment developments, flag cases with difficulties and facilitate monitoring. From a lender`s perspective, there is no ‘standard case’ of a customer facing financial difficulties or a ready clear-cut solution to address it. As cases are specific, solution strategies too need to be so, taking into account the nature and extent of payment difficulties and debt as well as the customer’s circumstances. However, there are typical stages in terms of working with customers who face payment difficulties at a bank. Payment difficulties are not the same as over-indebtedness, but can be forerunners to OID. They can be temporary and easily solved, or they can indicate an emerging but more severe problem. A non-payment event can be a symptom; it is not a diagnosis. Rather, it is a warning signal, and the bank has to respond. If, for instance, a customer is late on a loan payment or exceeds his overdrafts on an account, automated systems would flag a non-payment event immediately, to facilitate follow-up by the customer’s advisor and the specialized department. Typically, the bank would then contact customers through various channels including text messages, email, letter or telephone, making them aware of their obligations. At an early stage, client advisors continue to serve as the first contact point and play a role in helping to assess the customer’s situation. If payment difficulties turn out to be only temporary, e.g. a customer simply missed to balance an account before a due date but is not facing extended difficulties, the case would end at a very early stage.

183

Patricia Wruuck

If arrears persist over a longer period or the customer’s issue is more complex, the case is addressed by the RM department, which in turn works with customers for an extended period, ranging from several weeks to several months. Typically, this involves several customer contacts and counselling sessions via telephone and mail. The counselling process seeks to thoroughly analyse the reasons for the payment difficulties, an exercise that entails comprehensively assessing the client’s circumstances and payment obligations (a part of the financial literacy process). This goes beyond the debt and obligations from the specific product that ‘triggered’ the process. Counselling also needs to take into account payment obligations to other parties and the customer’s overall situation. A ‘holistic’ assessment is needed to better assess the customer’s situation and develop possible solution strategies. Typical options for easing payment difficulties include pausing payment obligations or reconsidering due dates for interest payments or debt. These can be promising strategies if customers are facing a combination of unforeseen expenses and a temporary drop in income. In total, experience has shown that more than 80% of delinquent loans can be cured at this stage by working with customers through extended counselling.23 Additional tools for customers in hardship can include partial debt waivers, depending on the individual case. From a customer’s perspective, this is only a partial solution, as customers in this phase tend to have multiple debt obligations (e.g. utilities, other banks, telecoms). By and large, however, DB’s experience suggests that the two goals, namely supporting customers in times of difficulties and protecting the bank from losses, are not incompatible. More often than not, the former actually helps with the latter while contributing to keep the customer–bank relationship on good terms. DB has had good experience with being proactive with customers at a very early delinquency stage. Contacting and working with customers can help to decrease the probability of a loan default. In fact, a large proportion of delinquent loans can be ‘cured’ through consultation and alternative debt plans. Another advantage of providing counselling services by operating a specialized unit is that it facilitates evaluation, i.e. assessing what works (best) and what does not when providing advice. This can help to focus resources on cases where default can be prevented. Also, it serves to improve efficiency and quality of counselling, for instance by evaluating response rates via different channels to improve outreach to customers with payment delays or developing ‘best practices’ for counselling customers in particular life situations. The debt counselling offered by a bank is a service that contacts customers actively and at a rather early stage. In this respect, it does not substitute the work of charities or consumer protection agencies that also offer counselling services (normally at a later stage), but it

23 Based on a multiannual period (2009-2014).

184

9

Consumer Over-Indebtedness in Europe and Germany: Considering Microand Macro Dimensions from a Lender’s Perspective

can help to complement it; for instance, by sharing experiences and best practices with other players. From a bank’s perspective, addressing OID is not limited to the counselling process. It starts before a customer gets into payment difficulties. A careful and well-informed credit decision remains a key part and also contributes to prevention. From a practical perspective,24 this involves evaluating information on a (potential) customer’s income situation and financial circumstances, employment situation, etc. as part of a check on creditworthiness. Customers provide this information when applying for credit (Selbstauskunft) and together with verification, e.g. payslips, checking account information, etc. The information provided by customers is then complemented by information from credit information bureaus such as SCHUFA in Germany. The existence and coverage of credit information agencies and the availability of this information to banks are also among the institutional factors that can contribute to sustainable development of household debt. Also, the experiences with counselling and proactive debtor management can be useful and improve advice on credit products. However, all the due diligence at the time of credit initiation cannot fully prevent OID. Primary causes of OID include unforeseeable events (e.g. loss of employment) and changes in spending behaviour, both of which are unknown at the time of credit initiation. This is why DB processes are geared towards early identification and resolution. Customers’ ability to pay is checked not only when they apply for credit but also regularly during the life cycle of a loan. Early recognition of changing circumstances can make a key contribution to prevent customers from getting into financial difficulties. Early warning signals could include a deteriorating income situation or changes in consumption behaviour. Whether and to what extent these signals give rise to action again depend on the individual case. Here, the monitoring and experience of individual advisors and their assessment of the customer’s situation also play an important role. They have to determine on an individual basis how to address the particular situation. For example, a possible measure at this stage would be setting a lower credit limit after discussion with a customer to keep him from getting into further debt. Making the customer aware of his financial situation is one of the key possible OID tools. A further step in this direction is the recent implementation of an account-based financial planning tool, which is available to every customer with a DB checking account. This tool shows graphically, and in a format that is easy to understand, the income/expense behaviour of the customer over time, allowing him to set budgets for different categories and measure against them. This helps the customer to better understand his financial flows and situation, which in turn can contribute to staving off unwanted OID.

24 Legal requirements of Kreditwürdigkeitsprüfung are laid out as part of the Kreditwesensgesetz (§18).

185

Patricia Wruuck

Banks’ lending practices and processes to deal with customers who face financial difficulties can make a contribution to tackling OID – but are merely one part of the puzzle. The institutional context they operate in as well as market structures can significantly influence the build-up and sustainability of household debt. This is also emphasized by the European comparison.

9.6

Outlook

The European perspective suggests that household debt and its sustainability as well as households’ situation remain quite heterogeneous. This is partly due to the uneven impact of the financial and economic crisis, but also due to structural differences across countries. Considering macroeconomic developments in Europe in recent years, there is limited possibility to generalize on the basis of the German case in particular. What the case of Germany emphasizes, however, is the interaction of multiple factors that have contributed to a sustainable development of household debt and a relatively lower incidence of OID. Notably, these include sociocultural factors, which affect attitudes towards taking on debt and have provided a strong motivation for savings. This works to increase households’ debt sustainability in an aggregate perspective. Further, households’ preferences for safety affect the way they take on debt, opting, for instance, for fixed-rate mortgage financing contracts with sufficient equity. From a household perspective, this can make debt more predictable and reduce the possibility of getting into excessive debt, contributing to mortgage financing being stated only rarely as one of the main reasons for OID. At the same time, households’ choices in turn also impact on reducing overall economic volatility because consumption tends to be less sensitive to interest rate changes. Ultimately, preferences for stability are also reflected in the low volatility and less pronounced cycles, for instance with respect to household credit, mortgages in particular as well as house prices.25 Against the background of the exceptionally low interest rate environment, borrowing activity in Germany has increased lately, notably to finance property. Strong growth in incomes and low levels of aggregate household debt, in international and historic comparison, limit potential worries regarding debt sustainability at an aggregate level at the moment. Fixing interest rates for a longer period and increasing redemption ratios, a tendency that has been observed in recent years, can help to better manage (mortgage) debt sustainability at the household level.26 Good conditions on the German labour market have helped to improve households’ income situation and reduced the risks of getting over-indebted due to a job loss. While 25 See Möbert, Peters and Lechler (2014). 26 See Bundesbank (2014).

186

9

Consumer Over-Indebtedness in Europe and Germany: Considering Microand Macro Dimensions from a Lender’s Perspective

labour market conditions are robust at the moment, employment developments will remain a key factor for mid-term developments of OID in Germany. Finally, in spite of the supportive macro conditions, ‘investing’ in the prevention of OID remains key. One factor easily overlooked in this regard is financial literacy. Arguably, improvements in financial literacy are but one element of a strategy to prevent OID. Nevertheless, it remains an important part of the puzzle given results from household surveys and an increasing body of research that suggests a strong connection between financial literacy and household well-being.

References Bundesbank (2014): Immobilienkredite unter Beobachtung: Ergebnisse einer Umfrage zur Vergabe von Wohnimmobilienkrediten. In Finanzstabilitätsbericht 2014. Deutsche Bundesbank, Frankfurt am Main. Dimitris Georgarakos, Adriana Lojschova and Melanie Ward-Warmedinger (2010): Mortgage Indebtedness and Household Financial Distress. ECB Working Paper Series, No. 1156, European Central Bank, Frankfurt. European Central Bank (2009): Housing Finance in the Euro Area. Structural Issues Report, European Central Bank, Frankfurt. IMF and European Banking Coordination “Vienna Initiative” (2012): Working Group on NPLs in Central Eastern and Southeastern Europe. Joint Paper Published March 2012, available at . LBS (2014): 2014 Markt für Wohnimmobilien. LBS. Jochen Möbert, Heiko Peters and Marie Lechler (2014): Deutschlands Hauspreise aus internationaler und historischer Perspektive. Wirtschaftsdienst, Vol. 94(1), pp. 76-78. Oliver Rakau and Mark Roller (2015): Private households in Germany: Low interest rates trigger increased borrowing. In Focus Germany: Strong domestic demand but no excesses. Nov.2015, Deutsche Bank Research, Frankfurt. Patricia Wruuck and Frank Zipfel (2015): Einheit in Vielfalt? Immobilienbesteuerung in Europa und Deutschland. Research Briefing, Deutsche Bank Research.

187

10

Insufficient Prevention of Over-Indebtedness – Legal and Policy Failures

Peter Rott*

10.1

Introduction

Consumer insolvency can have different causes. It can stem from the materialisation of risk factors within a contractual relationship or from external risks, in particular unemployment, whereby such external risks could, of course, be considered in contractual relationships. The law can be used to reduce risks and/or the negative consequences of adverse events. In this chapter, it is argued that German politics and German courts have not done enough to prevent over-indebtedness. Even worse, Germany has ignored a number of EU initiatives, if not acted in breach of EU law. This chapter focuses on two specific causes of consumer insolvency in Germany: irresponsible lending (10.2) and debt handling practices of energy suppliers (10.3). In addition to that, it shows how traders, debt collection service providers and lawyers interact to aggravate the situation of debtors (10.4). Finally, it shows how the focus on individual enforcement of consumer rights works against vulnerable consumers who are either overindebted or close to being over-indebted. It demonstrates how the legislature and also the judiciary have failed to introduce or to use mechanisms that could have avoided at least some of the bankruptcies that have occurred in the past. However, it also reports some promising recent developments in these areas. Germany does not publish statistics that show the causes or the absolute amounts of debts. According to the Institut für Finanzdienstleistungen (iff), in the years 2004-2013, bank credit has constituted between 38.9% (€13,304) and 55.1% (€22,346) of the debts of consumers who took consumer counselling, while debts with debt collection services amounted to between 9.1% (€3,434) and 13.6% (€4,607).1 Destatis reports that consumers who took consumer counselling had an average of €1,300 in energy debts.2 This is why this chapter focuses on these three types of debts. Moreover, it includes observations on

* 1 2

Professor of Civil Law, European Private Law and Consumer Law at the University of Kassel, Germany. See Knobloch et al., p. 26. See Destatis.

189

Peter Rott

the limited access of vulnerable consumers to justice, which aggravates their situation even when facing unlawful claims.

10.2

Irresponsible Lending

Irresponsible lending both in the mortgage credit market and in the consumer credit market has been identified as one of the causes of the crisis of the financial system. This has also been recognised in the recitals of Directive 2014/17/EU on credit agreements for consumers relating to residential immovable property3 (hereinafter Mortgage Credit Directive). Therefore, it seems highly likely that national law and policy on responsible lending has played a role in the protection of consumers against over-indebtedness. Here, German law has offered little protection in the past.

10.2.1

The Traditional Approach

10.2.1.1 Before the Implementation of Directive 2008/48/EC Traditionally, German credit law has followed the liberal approach, under which consumers are responsible for their lending decisions. Generally speaking, creditors were not required to assess the consumers’ creditworthiness before making a lending decision.4 An exception applied in relation to bank credit of nowadays more than €750,000.5 That latter exception, however, was part of prudential supervision law of the Kreditwesengesetz (Banking Act; KWG) and it was meant to protect the financial market rather than the individual consumer. Consequently, the OLG Cologne rejected a consumer’s liability claim that was based on the breach of §18 KWG.6 The traditional approach was also eminent in the debates that followed the publication of the EU Commission’s first proposal for what became the Consumer Credit Directive 2008/48/EC. Not only the credit industry7 but also the German Ministry of Justice8 and

3 4

5 6 7 8

OJ 2014, L 60/34, in particular recital (3). See Bundesgerichtshof (Federal Supreme Court, BGH), 16 March 1989, 43 Wertpapier-Mitteilungen (WM) 1989, p. 595. See also the position of the former presiding judge of the 11th senate of the BGH which is responsible for credit contract law, Nobbe (2008), pp. 78 et seq., at p. 80. §18 para. 1 KWG. Earlier versions referred to credit of more than 150,000 DM (until 1993), 100,000 DM (until 1995), 250,000 DM (until 1997), 500,000 DM (until 2002) and €250,000 (until 2005). OLG Cologne, 23 June 1999, 13 W 32/99, 20 Zeitschrift für Wirtschaftsrecht (ZIP) 1999, p. 1794. For the position of the Saving Banks Finance Group (Deutscher Sparkassen- und Giroverband), see Danco (2003), pp. 853 ff., at p. 854. See the position of the Ministry of Justice of January 2003, quoted by Rott (2003), pp. 851 et seq., at p. 852.

190

10

Insufficient Prevention of Over-Indebtedness – Legal and Policy Failures

mainstream academia9 argued against the bank’s co-responsibility for the consumer’s borrowing decision. 10.2.1.2 After the Implementation of the Consumer Credit Directive 2008/48/EC Article 8(1) of Directive 2008/48/EC requires that before the conclusion of the credit agreement the creditor must assess the consumer’s creditworthiness. This shall occur on the basis of sufficient information obtained from the consumer where appropriate and on the basis of a consultation of the relevant database where necessary. The German legislature has explicitly treated the duty to assess the consumer’s creditworthiness as a public law duty and implemented that duty in §18 paragraph 2 Kreditwesengesetz, thus, in prudential supervision law.10 Parts of academia supported that view.11 The purpose of this classification was to avoid private law remedies of consumers who might wish to claim that they suffered damage because the bank had not performed the creditworthiness assessment correctly.12 Only public law sanctions under the KWG should apply, and these public law sanctions are widely recognised to be by no means deterrent.13 To my knowledge, the competent supervisory authority, the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin), has not imposed any sanctions at all. The contrasting view has always been that the duty to perform the consumer’s creditworthiness was intended, inter alia, to protect the consumer against avoidable over-indebtedness.14 Obviously, that system was not effective.15 Effectiveness, as AG Kokott once described it in the case of Berlusconi and others, comprises the severity of a sanction and the likelihood of its imposition. Both aspects were not present in German law.16 In March 2014 the Court of Justice of the European Union (CJEU) had to decide, for the first time, on the creditor’s duty to assess the consumer’s creditworthiness. In the case of LCL Le Crédit Lyonnais,17 which the Cour d’appel d’Orléans had referred to the CJEU, the CJEU made the following remark:

9 10 11 12 13 14 15

See Rohe (2003), pp. 267 et seq. See also Ady & Paetz (2009), pp. 1061 et seq., at p. 1064. See, e.g., Herresthal (2009), pp. 1174 et seq., at p. 1176. See Rott et al., (2011), pp. 163 et seq., at pp. 166 et seq. See, in particular, Hoffmann (2010), pp. 1782 et seq., at pp. 1784 et seq. See, e.g., Rott et al. (2011). Unless one referred to the risk of retrospective interpretation of German law in the light of the Consumer Credit Directive as interpreted by the CJEU, a risk that has materialised in the past, for example, in the aftermath of the Heininger judgment of the (then) ECJ. 16 See A.G. Kokott, opinion of 14 October 2004 in joined Cases C-387/02, C-391/02 and C-403/02, Silvio Berlusconi, Sergio Adelchi, Marcello Dell’Utri and others, ECLI:EU:C:2004:624, at para. 89. 17 CJEU, judgment of 27 March 2014 in Case C-565/12, Le Crédit Lyonnais SA gegen Fesih Kalhan, ECLI:EU:C:2014:190.

191

Peter Rott

[…] the creditor’s obligation, prior to conclusion of the agreement, to assess the borrower’s creditworthiness is intended to protect consumers against the risks of over-indebtedness and bankruptcy […].18 In the aftermath of that decision, a number of authors concluded that the duty to assess the consumer’s creditworthiness is also meant to protect the individual consumer and that the consumer must therefore have a remedy available if the creditor does not comply with that duty. Under the German legal system, such a duty would form part of private law.19 In contrast, others have interpreted the judgment of the CJEU to imply that the (public law) sanctions must merely be given a more deterrent character.20 The Bundesgerichtshof (Federal Supreme Court) has not had to decide on the matter directly but continued, in the context of unfair contract terms law, to state that the creditworthiness was not performed in the interest of the consumer but only in the self-interest of the bank.21

10.2.2

Recent Developments

In February 2014, the Mortgage Credit Directive 2014/17/EU was adopted, which Member States must implement by March 2016. In the first draft for the implementing legislation of December 2014, the Ministry of Justice proposed detailed rules on the duty to assess the consumer’s creditworthiness to be introduced into the German Civil Code (Bürgerliches Gesetzbuch; BGB). However, banks that are supervised under the KWG should still be exempted and only regulated by a revised provision of the KWG.22 Interestingly, this exemption was dropped in the draft bill that the Government introduced in the Bundestag in July 2015.23 Referring to Le Crédit Lyonnais, the Government argued that it has become highly doubtful that the duty to assess the consumer’s creditworthiness can be implemented in prudential supervision law alone. Under the new rules that were adopted in February 2016, creditors that do not comply with the duty to assess the consumer’s creditworthiness will be severely sanctioned if they cannot show that they could have concluded the contract in the same way had they assessed the creditworthiness correctly. First, the interest rate will be reduced significantly to the one applying to bank 18 Ibid., at para. 42. 19 See Freitag (2014), p. 358906; Rott (2014), pp. 201 et seq., at pp. 202 et seq.; Barta & Braune (2014), pp. 324 et seq., at pp. 329 et seq. 20 See Herresthal (2014), pp. 497 et seq., at p. 500; Schürnbrand (2014), pp. 168 et seq., at p. 177; Servatius (2015), pp. 178 et seq., at p. 185; Buck-Heeb (2015), pp. 177 et seq., at p. 181. 21 See BGH, 13 May 2014, XI ZR 170/13, 29 Neue Juristische Wochenschrift – Rechtsprechungsreport (NJW-RR) 2014, p. 1133; BGH, 13 May 2014, XI ZR 405/12, 67 Neue Juristische Wochenschrift (NJW) 2014, p. 2429. 22 See Bundesministerium der Justiz und für Verbraucherschutz. 23 Regierungsentwurf eines Gesetzes zur Umsetzung der Wohnimmobilienkreditrichtlinie, BundesratsDrucksache (Printed Matter of the Federal Council; BR-Drs.) 359/15, p. 73.

192

10

Insufficient Prevention of Over-Indebtedness – Legal and Policy Failures

refinance on the capital market. Second, the creditor will lose the right to claim damages resulting, in particular, from delayed payment by the consumer stemming from his or her lack of creditworthiness. Third, the consumer will get the right to terminate the credit contract without having to pay compensation for early repayment.24

10.2.3

Conclusion

The German legislature as well as the judiciary have, over decades, avoided providing incentives for responsible lending practices. This is in sharp contrast to the protection that German consumer credit law offers once the consumer’s payments are delayed. In such a situation, the law provides for interest caps. The exact effect of that failure of prevention is unknown, as it is impossible to estimate how many consumers would not have become over-indebted. It will be interesting to see whether credit rejection rates will increase once the Mortgage Credit Directive has been implemented.

10.3

Energy Debts

Energy is expensive in Germany. Energy costs rank second highest in the EU, exceeded only by Denmark.25 Price controls were abolished with effect from 1 July 2007. Price abuse is, of course, prohibited by cartel law but is notoriously difficult to prove by cartel authorities. Energy debts, or so-called ‘energy poverty’, is a problem experienced by households that live on state welfare but also, or perhaps even more, by households with an income just above the level that would qualify them for state welfare and that are, therefore, excluded from the welfare system. Households that live on state welfare receive a monthly award for energy. That award, however, does not always meet the demand, especially since such households typically live in houses with bad insulation and that have old electrical equipment, with the result that their expenses are disproportionately high.26 In what follows, two aspects of German energy law will be highlighted: the lack of social tariffs for vulnerable customers, and the low level of protection against disconnection from 24 See new §505d BGB and the explanations of the Government, BR-Drs. 359/15, pp. 122 et seq. For more details, see Rott (2016), margin notes 80 et seq. 25 For a detailed comparison of household energy prices in the EU, see Bundesministerium für Wirtschaft (Federal Ministry of Economy; BMWi). 26 See, e.g., Luschei (2014), pp. 85 et seq., at p. 87 et seq. and 90 et seq. See also the parliamentary enquiry of the party Bündnis 90/Die Grünen, Bundestags-Drucksache (Printed Matter of the Parliament; BT-Drs.) 17/10475 of 13 August 2012. See, however, also the deviating view of the German Government, BT-Drs. 18/3395, pp. 7 et seq.

193

Peter Rott

the network that leads to follow-on costs, in particular, for the reconnection to the network or for substitutes. One interesting aspect of German politics in that area is that, although the Bundesnetzagentur (Federal Networks Agency) has published monitoring reports on the energy market since 2006, until 2011 they did not contain information on disconnections. The problems of low-income consumers could be derived only from reports of consumer organisations, debt advisors and the general press and from court cases. The first comprehensive report relates to the year 2012.27

10.3.1

The Lack of Social Tariffs

Germany has always relied on the general welfare system. Thus, the Government has until now rejected the introduction of a special regime for the energy sector.28 The Government assumes that the funds that are so made available are sufficient for regular energy consumption.29 Even after the adoption of Directive 2009/72/EC concerning common rules for the internal market in electricity,30 according to which “Member States shall take appropriate measures to protect final customers, and shall, in particular, ensure that there are adequate safeguards to protect vulnerable customers”,31 no special rules for vulnerable customers were introduced. When asked about compliance with Article 3(7) of Directive 2009/72/EC, the Government explicitly referred to the general welfare system.32 Interestingly, the Government knows very little about the electricity consumption of vulnerable customers, such as customers that receive state benefits due to unemployment.33 Neither the Government nor the regulator, the Bundesnetzagentur, collects relevant data.34 Access to cheap energy is meant to stem from price competition. Indeed, numerous electricity suppliers are nowadays active in the marketplace. Low-income customers, however, are usually limited to the supply by the supplier of last resort, which is under an obligation to contract.35 Other suppliers usually reject low-income consumers after a

27 Based on the amended §35 EnWG that introduced in §35 para. 1 no. 10 EnWG the duty to monitor the energy prices for household customers, disconnections of household customers and household customers’ complaints. The annual reports are available at . The annual reports from 2012 onwards are available in English. 28 See, e.g., BT-Drs. 17/10582, p. 2. 29 For more details, see Rott (2011), pp. 79 et seq., at pp. 86 et seq. 30 OJ 2009, L 211/55. 31 See Art. 3(7) of Directive 2009/72/EC. 32 See BT-Drs. 17/10582 of 30 August 2012, p. 3. 33 See also Mayer (2013), pp. 61 et seq.; Luschei (2014), p. 92. 34 See BT-Drs. 18/3395, p. 4. 35 See §36 Energiewirtschaftsgesetz (Energy Act; EnWG).

194

10

Insufficient Prevention of Over-Indebtedness – Legal and Policy Failures

creditworthiness check, which the Government has realised.36 The suppliers of last resort are among the most expensive suppliers in the market.37 This becomes particularly clear when one compares those parts of the price that the supplier can influence, i.e. the price excluding taxes, charges and the like. In 2013 the difference between those parts of the electricity price between suppliers of last resort and other suppliers was 31%, and the gap is widening.38 Energy suppliers, of course, try to protect themselves by asking for advance payment, which the law explicitly allows. Suppliers can claim, in advance, the price of the same amount of energy that the customer consumed in the equivalent period of the previous year.39 Moreover, the supplier can install prepaid meters if he has reason to believe, in the circumstances of the individual case, that the customer will not pay the bill in due time, or ever at all.40 The actual bill is usually prepared only once a year. Suppliers have to offer customers a monthly, quarterly or semi-annual bill, but they do not normally have to supply such a bill free of charge.41 In the past, suppliers have charged €10-€20 per bill,42 which is obviously illusory for low-income customers. Demand for such bills is therefore negligible.43 Thus, even if advance payments have been made, problems arise if the final bill is higher than the previous year’s. Bills have to be paid, and advance payments have to be made within two weeks after notification.44

10.3.2

Disconnection from the Network

In the energy supply sector, the legislature has introduced some special protection against disconnection. This includes, in a broader sense, measures to control one’s own consumption and the related costs and, in a narrower sense, protection against disconnection and termination of the contract if customers are still unable to pay their bills. An initiative of

36 See BT-Drs. 18/3395, p. 2. 37 See Bundesnetzagentur & Bundeskartellamt, pp. 149 et seq., in particular at p. 152. See also BT-Drs. 18/3395, p. 5. 38 Ibid., p. 152. 39 §13 of the Stromgrundversorgungsverordnung (Regulation concerning the general conditions for the supply with electricity of household customers; StromGVV). 40 §14 para. 3 StromGVV. 41 According to §40 para. 3 sent. 2 EnWG, the special bill is free of charge only if the electricity consumption is measured by use of a system that is integrated into a communications network so that the supplier can read the data out electronically. 42 See the comments by the German Bundesrat, BT-Drucks. 17/6248 of 22 June 2011, suppl. 3. 43 See Bundesnetzagentur & Bundeskartellamt, p. 143. 44 §17 para. 1 StromGVV.

195

Peter Rott the party Die Linke to prohibit disconnection of private households altogether45 was rejected by the other parties, with the green party Bündnis 90/Die Grünen abstaining.46 In principle, a supplier or service provider obviously has the right to stop supplying or providing his service if he is not paid. With regard to energy supply, the issue is whether the delay in payment must reach a certain quality until the service provider’s interest outweighs the customer’s interest in continuous supply. Disconnection requires, first of all, that the customer be in delay, which can only happen after payment is due (which is two weeks after receipt of the bill). Second, the supplier must announce the disconnection at least four weeks before the customer is actually disconnected. This announcement can be made together with the demand note that triggers the customer’s delay. If the customer pays within these four weeks, he or she cannot be disconnected. Third, the customer’s debts must sum up to at least €100. Fourth, the precise time of disconnection must again be announced three days before to allow the customer to ensure that he or she does not suffer damage for want of electricity.47 Of course, the customer must be reconnected once the problem is solved.48 This, however, involves disconnection and reconnection costs that a low-income household has difficulties to shoulder. For the whole process of disconnection and reconnection, a fee of €150 is not uncommon.49 Moreover, following payment problems that have led to disconnection, suppliers often ask for security for future payment obligations. There are two reasons why disconnection may still not be allowed. First, if the customer can show that there is good reason to believe that he will pay his debts, and second, ‘if the consequences of disconnection are disproportionate to the gravity of the breach of contract’, here: of the lack of payment. The first exception may, in particular, arise in cases where the customer can show that his electricity bill will be paid in the future by municipal authorities, under the welfare law regime.50 The second exception invokes Article 3(7) of Directive 2009/72/EC and would seem to cover, for example, disconnection in the midst of winter. The problem with the second exception is that it is worded very vaguely. Unlike other Member States, including France,51 Germany has not introduced a winter period in

45 46 47 48 49

BT-Drs. 17/11655 of 28 November 2012. BT-Drs. 17/12767 of 14 March 2013. §19 paras. 2 and 3 StromGVV. §19 para. 4 Strom GVV. See, e.g., the case of AG Hamburg-Harburg, 24 June 2015, 647 C 6/15, 30 Verbraucher und Recht (VuR) 2015, 476 (€144.80). In 2013, the network operators charged €48 on average for the disconnection alone, see Bundesnetzagentur & Bundeskartellamt, p. 143. 50 On follow-on problems in cases where the welfare authority does not pay the monthly bill in time, see Rott (2014), pp. 675 et seq., at p. 681. 51 See Décret no 2004-325 du 8 avril 2004 relatif à la tarification spéciale de l’électricité comme produit de première nécessité, amended by Décret no 2012-309 du 6 mars 2012 relatif à l’automatisation des procédures d’attribution des tarifs sociaux de l’électricité et du gaz naturel and by Décret no 2013-1031 du 15 novembre 2013 portant extension à de nouveaux bénéficiaires des tarifs sociaux de l’électricité et du gaz naturel.

196

10

Insufficient Prevention of Over-Indebtedness – Legal and Policy Failures

which disconnection is not allowed, although consumer organisations have often called for such a provision.52 Finally, even the supplier of last resort has the right to terminate the contract if the situation that leads to disconnection has arisen several times.53 German energy suppliers have often been rigorous in the past. The numbers of disconnections of household customers by suppliers of last resort have constantly increased over the last few years. According to a survey of Bundesnetzagentur and Bundeskartellamt (Federal Cartel Office) for 2013, almost 7 million disconnections were announced, and 344,798 disconnections were executed,54 which concerned about 800,000 people.55 It is estimated that around 60% of the households concerned are elderly people.56 The average debt of disconnected households was €105.57 Reports from debt counsellors show that suppliers not only use their legal rights uncompromisingly but also sometimes act in clear breach of the legal precautions against hasty disconnection. For example, in Berlin, the formerly state-owned gas supplier GASAG, now owned by Gaz de France and Bewag, disconnected an elderly lady from heating when temperatures were −10°C.58 In other cases, disconnection of electricity concerned a blind man who needed his electric appliances and an elderly lady with a 90% handicapped husband and a 100% handicapped son. Both had (lawfully) refused to accept a price increase.59 Moreover, suppliers act rather formal. They send the required letters in legal language but do not offer personalised advice.60 In particular, they do not create a situation in which a vulnerable person would consider approaching them directly, in order to solve problems. Prepaid meters provide a technical solution that makes sure that at least the extra costs of reminders and enforcement measures including disconnection and reconnection do not arise. They are actually quite popular with low-income customers. Some suppliers, however, refuse to install them, citing extra costs.61 While some suppliers and some municipalities are testing additional methods to support low-income households, for example, through contracting of refrigerators,62 the Government does not appear to have a strategy, or even thoughts, on this problem.

52 53 54 55 56 57 58 59 60

See, e.g., Bund der Energieverbraucher, ‘Gas- und Stromsperren im Winter verbieten’. §21 StromGVV. See Bundesnetzagentur & Bundeskartellamt, p. 142. See Bund der Energieverbraucher, ‘Wachsendes Problem Energiearmut: 4,5 Millionen Betroffene’. See Bund der Energieverbraucher, ‘Die 1.000-Watt Lösung von Köln’. See Bundesnetzagentur & Bundeskartellamt, p. 142. See Peters (2008), pp. 56 et seq., at p. 57. See Bund der Energieverbraucher, ‘Energieunrecht’. The Government has declined to introduce the duty to give customers advice before disconnection, see BTDrs. 17/10582, p. 7. 61 See also Luschei (2014), p. 95. 62 Ibid.

197

Peter Rott

10.3.3

Lack of Enforcement

Generally speaking, Germany relies on individual litigation of legal disputes.63 This favours a system of non-compliance with the law. One should remember that vulnerable customers are even more ignorant of the law than the average customer. Thus, this group of customers would usually not question the supplier’s right of disconnection if it is presented to them in a well-written letter containing legal terminology, and neither would they sue for damages in cases of unlawful disconnection.64 Typically, those customers who are unable to pay their bills would also not seek legal advice before they are disconnected. And even if they do, again under a legal aid scheme,65 they are highly unattractive clients to lawyers. Experience, again from debt counselling, demonstrates that in such cases lawyers do not tend to invest much work but at best ask their customers to negotiate instalment payment. If suppliers agree, they often charge an extra fee for that agreement. Therefore, even protective measures are bound to fail in the case of vulnerable consumers. Despite this practical enforcement gap, the law does not provide for public law sanctions against rogue suppliers, as, for example, the UK does through the licensing regime. In summary, suppliers do not risk much when they neglect the protection of vulnerable consumers.

10.3.4

Recent Developments

At the policy level, there has been no development. All attempts by the political opposition to introduce measures for the protection of vulnerable customers have been rejected by the majority that is in Government, pointing at the general welfare system. Help can be expected only from courts. In the past almost ten years, the focus of case law was on price increases, and the matter even reached the Court of Justice in two distinct cases.66 More recently, however, courts seem to turn to other issues that are of particular relevance to vulnerable households. In a judgment of June 2015, the AG Hamburg-Harburg

63 See, explicitly, BT-Drs. 16/9656, p. 2. 64 Which they could claim under §280 para. 1 BGB. 65 People with low income can obtain one appointment with a lawyer for a maximum of €15 if they apply for a voucher from the first instance court, see §8 para. 2 Beratungshilfegesetz (Act on Legal Advice and Representation for Citizens with Low Income; BerHG) with §44 and Annex 1 part 2 no. 2500 Rechtsanwaltsvergütungsgesetz (Act on Lawyers’ Fees; RVG). The lawyer can then claim his fees from the state budget, but the fees are low and do not represent adequate remuneration. 66 CJEU, judgment of 21 March 2013 in Case C-92/11, RWE Vertrieb AG v. Verbraucherzentrale NordrheinWestfalen e.V., ECLI:EU:C:2013:180; CJEU, judgment of 23 October 2014 in joined Cases C-359/11 and C-400/11, Alexandra Schulz v. Technische Werke Schussental GmbH und Co. KG and Josef Egbringhoff v. Stadtwerke Ahaus GmbH, ECLI:EU:C:2014:2317.

198

10

Insufficient Prevention of Over-Indebtedness – Legal and Policy Failures

had to deal with fees of €144.80 for the disconnection from and reconnection to the electricity network. Applying the much overlooked provision of §19 paragraph 4 StromGVV,67 the court asked the supplier to explain why disconnection and reconnection caused expenses of that amount, which the supplier failed to do. The court therefore rejected the fee altogether.

10.4

Debt Handling Practices

A crucial issue is the general step from debts to over-indebtedness. The following section argues that German law has not done enough in the past to prevent that step, but also reports some recent developments in the area. The rules of the BGB are clear-cut. If the debtor is in delay, the creditor can claim damages unless the debtor can show that he or she did not act negligently (§§280, 286, 288 para. 4 BGB). Illiquidity does not, of course, count as lack of negligence. Potential heads of damages include expenses for reminders and expenses for enforcement measures, such as efforts of debt collection services or lawyers, and, finally, expenses for litigation and execution of judgments. Typically, damages are claimed as ‘fees’ under the standard terms of the supply contract.

10.4.1

Fees for Reminders

Expenses for reminders have experienced rather stringent court control in recent years. The basic rule is that fees must reflect the actual expenses for the individual reminder or debt collection measure, in particular for material and posting, whereas suppliers, or traders in general, are prohibited from charging general expenses for IT or staff.68 On that basis, courts have declared numerous standard terms on all kinds of fees unlawful. This includes fees by airlines, telecommunications service providers, banks and also energy suppliers. For example, the consumer organisation Verbraucherzentrale Bundesverband (vzbv) succeeded in a lawsuit against an energy supplier on a fee of €5 for a reminder. The court argued that on the basis of the figures that the supplier had presented, the maximum fee for a reminder could have been below €1.50.69 The OLG Munich held that a reminder fee

67 §19 para. 4 sent. 4 StromGVV reads: “On the customer’s request, the supplier has to prove the calculation basis.” 68 See generally, OLG Hamburg, 25 June 2014, 10 U 24/13, 68 NJW 2015, pp. 85 ff. For energy supply contracts, see, e.g., BGH, 18 July 2012, VIII ZR 337/11, 66 NJW 2013, pp. 291 et seq., at pp. 294 et seq. 69 LG Frankenthal, 3 February 2015, 6 O 2281/12.

199

Peter Rott of more than €1.20 was unlawful.70 The LG Kassel confirmed that no special rules apply to suppliers of last resort that would put them in a better position than other traders.71 The AG Hamburg-Harburg went even further. Applying the above-mentioned §19 StromGVV, it required the supplier to explain the calculation of the reminder fees. As the supplier did not react, the AG Hamburg-Harburg rejected the fee.72 The AG Hamburg-Harburg also had to decide a case in which the supplier agreed to accept payment in instalments against a ‘handling fee’ of €16. Again, the supplier did not explain why he had incurred expenses of €16 to arrange for the change of payment modalities, and the AG Hamburg-Harburg rejected the fee.73

10.4.2

Debt Collection Fees

The judicial control of reminder fees led to an interesting circumvention strategy. Suppliers, or traders in general, do not send reminders themselves anymore, but hand the case over to debt collection services. The simple reason is that the fees of debt collection services do not come under the same regime as reminder fees. Some traders have even founded legally independent debt collection services, or have bought formerly independent debt collection services.74 The legislative reaction to the well-known problems with debt collection services has been modest. In 2013 the Gesetz gegen unseriöse Geschäftspraktiken75 (Act against frivolous business practices) was passed. It included certain information obligations of debt collection service providers related to their client and the claim,76 and limited the fees to the amounts that lawyers can charge for the same activity under the Rechtsanwaltsvergütungsgesetz (Lawyers’ Fees Act; RVG).77 The law also allowed the Ministry of Justice to introduce caps, in particular for the first reminder and for mass sending of more than hundred equivalent letters, but that competence has not been used until now. Interestingly, the same transparency requirements were introduced for lawyers,78 which shows that some lawyers acted just as frivolously as debt collection service providers.

70 71 72 73 74 75 76 77 78

OLG Munich, 28 July 2011, 29 U 634/11. See LG Kassel, 18 March 2010, 1 S 355/09. AG Hamburg-Harburg, 24 June 2015, 647 C 6/15, 30 VuR 2015, 476, with a case note by M. Butenob. Ibid. See Jäckle (2016), pp. 60 et seq. For example, Otto Group owns the debt collection service provider EOS CARI RECOVERIES S.L., see Otto Group, p. 129. Bundesgesetzblatt (Federal Gazette; BGBl.) 2013 I, pp. 3714 et seq. Now §11a RDG. Now §4 para. 5 Einführungsgesetz zum Rechtsdienstleistungsgesetz (Introductory Act for the Legal Services Act; RDGEG). Now §43d Bundesrechtsanwaltsordnung (Federal Lawyers’ Order; BRAO).

200

10

Insufficient Prevention of Over-Indebtedness – Legal and Policy Failures

The standard fee for a letter relating to a claim of €100-€500 is €58.5.79 Simple letters trigger a fee of €15,80 but debt collection services usually charge the standard fee.81 Thus, where courts held standard terms related to a reminder fee of €5 unlawful, debt collection services charge €58.5 for the very same letter. Consequently, even small debts can explode fast when debt collection services become involved. Finally, debt collection services are distinct from lawyers. Thus, debt collection services can pass on the file to a law firm that charges a fee of €58.5 again, and there have been reports that debt collection services and law firms work closely together to increase the fees.82 Courts can, in principle, intervene where unnecessary costs are claimed.83 In a decision of 1993, the OLG Dresden held that it was unlawful to claim both debt collection fees and lawyers’ fees.84 Among others, the OLG Dresden argued that the trader that engaged a debt collection service should not be in a better position than the trader that operated his own claims management system.85 The court also referred to the creditor’s duty to mitigate the damage.86 Some courts generally do not accept debt collection fees unless the trader can show that he had reason to believe that the consumer would pay if reminded by a debt collection service, which is not the case if the consumer cannot pay anyway.87 The AG Dortmund rejected fees of a debt collection service that was a 100% subsidiary of the creditor.88 The law is, however, not clear at all, and the attitude towards debt collection fees varies from one court to the next.89 The main problem is again that the over-indebted consumer will not challenge fees that the debt collection service or a lawyer charges. The Government has announced a review of debt collection services again in 2016.

79 §13 RVG with VV no. 2300. 80 §13 RVG with VV no. 2301. 81 The AG Essen-Borbeck only accepted a fee of €10, arguing that the procedures are standardised and automatised; see AG Essen-Borbeck, 10 April 2012, 6 C 101/11, 21 Anwaltsgebühren spezial (AGS) 2012, p. 362. 82 See Ludwig. 83 For an overview of legal instruments to that end, see Jäckle (2016). 84 OLG Dresden, 1 December 1993, 5 U 68/93, 9 NJW-RR 1994, p. 1139. 85 Ibid. See also AG Bochum, 6 October 2006, 75 C 187/06, 58 Juristisches Büro 2007, p. 91. 86 §254 BGB. See also Jäckle (1995), pp. 2767 et seq. For a similar situation of two different lawyers acting in an order of court procedure and in subsequent litigation in court, see BGH, 20 October 2005, VII ZB 53/05, 59 NJW 2006, pp. 446 et seq. 87 See, e.g., AG Dieburg, 20 July 2012, 20 C 646/12; AG Brandenburg, 27 August 2012, 31 C 266/11. 88 AG Dortmund, 8 August 2012, 425 C 6285/12, 66 Monatsschrift für deutsches Recht (MDR) 2012, p. 1220. See also Jäckle (2016), pp. 61 et seq. 89 See the references in AG Brandenburg, 27 August 2012, 31 C 266/11.

201

Peter Rott

10.5

Conclusion

This chapter demonstrates that in many areas the German legislature relies on the selfresponsibility of consumers where it is recognised that consumers are, for one reason or another, unable to protect themselves and where the EU has flagged up the problem for years. In other areas, vulnerable consumers are insufficiently protected against sliding from financial troubles into over-indebtedness. Courts have helped in certain cases, but the attitudes of courts vary greatly, and most cases never go to court because low-income consumers have limited access to the court system. One major problem even with the promising developments in case law is that they lack broader effect. To begin with, even a judgment in a collective action by a consumer organisation is binding only on the particular trader or supplier that was party to the lawsuit. Thus, consumer organisations would have to sue each supplier individually. Moreover, individual consumers do not benefit immediately from a judgment in injunction proceedings, but have to claim and probably sue for reimbursement of unlawful fees, which is highly unlikely to happen in the vast majority of cases. Finally, collective actions by consumer organisations do not bar the prescription of individual claims related to the reimbursement of fees that have been charged on the basis of an unlawful standard term. All this has been well known for a long time, and it is just another failure of the German legislature to ensure the protection of consumers, whether vulnerable or otherwise.

References Ady, J. & Paetz, E., ‘Die Umsetzung der Verbraucherkreditrichtlinie in deutsches Recht und besondere verbraucherpolitische Aspekte’, 63 Wertpapier-Mitteilungen 2009, pp. 10611070. Barta, S. & Braune, U., ‘Schadensersatz als Rechtsfolge der unzureichenden Prüfung der Kreditwürdigkeit des Verbrauchers – Konsequenzen aus der Entscheidung des EuGH in Sachen Le Crédit Lyonnais SA/Fesih Kalhan für das Verständnis des deutschen Rechts’, 14 Zeitschrift für Bank- und Kapitalmarktrecht 2014, pp. 324-330. Buck-Heeb, P., ‘Aufklärungs- und Beratungspflichten bei Kreditverträgen – Verschärfungen durch die EuGH-Rechtsprechung und die Wohnimmobilienkredit-Richtlinie’, 15 Zeitschrift für Bank- und Kapitalmarktrecht 2015, pp. 177-186. Bund der Energieverbraucher, ‘Die 1.000-Watt Lösung von Köln’, available at , 2013.

202

10

Insufficient Prevention of Over-Indebtedness – Legal and Policy Failures

Bund der Energieverbraucher, ‘Energieunrecht’, available at , 2013. Bund der Energieverbraucher, ‘Gas- und Stromsperren im Winter verbieten’, available at , 2014. Bund der Energieverbraucher, ‘Wachsendes Problem Energiearmut: 4,5 Millionen Betroffene’, available at , 2014. Bundesministrium der Justiz und für Verbraucherschutz, ‘Referentenentwurf eines Gesetzes zur Umsetzung der Wohnimmobilienkreditrichtlinie’, available at , 2014. Bundesministerium für Wirtschaft, ‘Internationaler Energiepreisvergleich für Haushalte’, available at , 2015. Bundesnetzagentur & Bundeskartellamt, Monitoring Report 2014, Bonn, 2014, available at . Butenob, M., ‘Anmerkung’, 30 Verbraucher und Recht 2015, pp. 477-478. Danco, A., ‘Die Novellierung der Verbraucherkreditrichtlinie’, 57 Wertpapier-Mitteilungen 2003, pp. 853-861. Destatis, ‘Durchschnittlich 1300 Euro Energieschulden bei überschuldeten Personen in Deutschland’, available at , 2014. Freitag, R., ‘Anmerkung’, Kommentierte BGH-Rechtsprechung Lindenmeier-Möhring 2014, p. 358906. Herresthal, C., ‘Die Verpflichtung zur Bewertung der Kreditwürdigkeit und zur angemessenen Erläuterung nach der neuen Verbraucherkreditrichtlinie 2008/48/EG’, 63 Wertpapier-Mitteilungen 2009, pp. 1174-1180.

203

Peter Rott

Herresthal, C., ‘Unionsrechtliche Vorgaben zur Sanktionierung eines Verstoßes gegen die Kreditwürdigkeitsprüfung’, 25 Europäische Zeitschrift für Wirtschaftsrecht 2014, pp. 497500. Hoffmann, C., ‘Die Pflicht zur Bewertung der Kreditwürdigkeit’, 63 Neue Juristische Wochenschrift 2010, pp. 1782-1786. Jäckle, W., ‘Erstattung der Inkassokosten’, 48 Neue Juristische Wochenschrift 1995, pp. 2767-2769. Jäckle, W., ‘Unseriöses Inkasso und kein Ende’, 31 Verbraucher und Recht 2016, pp. 6064. Knobloch, M., Laatz, W., Neuberger, D. & Flach, L., ‘iff-Schuldenreport 2014’, available at , 2014. Ludwig, K., ‘Wie Konzerne an verschuldeten Menschen verdienen’, Süddeutsche Zeitung of 15 September 2015, available at , 2015. Luschei, F., ‘Energiearmut: Wer sind die verletzlichen Verbraucher und wie viele gibt es?’ in C. Bala & K. Müller (eds.), Der verletzliche Verbraucher, Dusseldorf, Verbraucherzentrale NRW, 2014, pp. 85-98. Mayer, I., ‘Energiearmut: Der weiße Fleck in der deutschen Forschungslandschaft’, 63 Energiewirtschaftliche Tagesfragen 2013, pp. 61-98. Nobbe, G., ‘Verantwortlichkeit der Bank bei der Vergabe von Krediten und der Hereinnahme von Sicherheiten’, 20 Zeitschrift für Bankrecht und Bankwirtschaft 2008, pp. 78-82. Otto Group, Geschäftsbericht 2014/2015, , 2015. Peters, A., ‘Strom und Gas für alle’, 23 BAG-SB Informationen 2008, pp. 56-58. Rohe, M., ‘Privatautonomie im Verbraucherkreditrecht wohin?’, 3 Zeitschrift für Bankund Kapitalmarktrecht 2003, pp. 267-273.

204

10

Insufficient Prevention of Over-Indebtedness – Legal and Policy Failures

Rott, P., ‘Mitverantwortung des Kreditgebers bei der Kreditaufnahme – Warum eigentlich nicht?’, 3 Zeitschrift für Bank- und Kapitalmarktrecht 2003, pp. 851-859. Rott, P., ‘Services of General Interest, Contract Law and the Welfare State’ in J. Rutgers (ed.), European Contract Law and the Welfare State, Groningen, Europa Law Publishers, 2011, pp. 79-103. Rott, P., ‘The Low-Income Consumer in European Private Law’ in K. Purnhagen & P. Rott (eds.), Varieties in European Economic Law – Liber amicorum for Hans Micklitz, Dordrecht, Springer, 2014, pp. 675-692. Rott, P., ‘Verbraucherschutz durch Kreditwürdigkeitsprüfung’, 24 Europäisches Wirtschaftsund Steuerrecht 2014, pp. 201-204. Rott, P., ‘Verbraucherdarlehensvertrag’ in K. Tonner & M. Tamm (eds.), Verbraucherrecht, 2nd ed., Baden-Baden, Nomos, 2016, §22 D. Rott, P., Terryn, E. & Twigg-Flesner, C., ‘Kreditwürdigkeitsprüfung: Verbraucherschutzverhinderung durch Zuweisung zum Öffentlichen Recht?’, 26 Verbraucher und Recht 2011, pp. 163-169. Schürnbrand, J., ‘Die Richtlinie über Wohnimmobilienkreditverträge für Verbraucher’, 26 Zeitschrift für Bankrecht und Bankwirtschaft 2014, pp. 168-178. Servatius, W., ‘Aufklärungspflichten und verantwortungsvolle Kreditvergabe’, 19 Zeitschrift für Immobilienrecht 2015, pp. 178-189.

205

11

An Analysis of the German Legal Framework and the (Limited) Influence of EU Law

Holger Sutschet*

11.1

Introduction

Over-indebtedness is a widespread problem in Germany. Some 6.7 million people face problems in meeting their financial obligations.1 This does not mean, however, that all these people are over-indebted. There is no generally applied definition of over-indebtedness and no general standard for the methods of data collection and analysis in this field.2 Thus, it is not surprising that different institutions publish different figures on certain aspects of over-indebtedness. The recently published report of the iff3 on over-indebtedness in Germany identifies the following as the main reasons (‘big six’) for over-indebtedness: unemployment (26.8%), low income (10.5%), failed self-employment (10%), irrational consumption behaviour (8.6%), divorce or separation (9%) and illness (7.7%).4 Together, they account for 72.6% of all cases of over-indebtedness. Interestingly, the figure for low income has risen from 7.3% in 2014 to 10.5% in 2015, the very year when minimal wages were introduced in Germany for the first time.5 The report of the German National Statistical Office on over-indebtedness in the year 2014 states that the main reasons are accountable to the following extent: unemployment (19.1%); divorce or separation (12.4%); illness (12.1%); mismanagement of finances (11.2%); failed self-employment (8.1%). This institution does not include ‘low income’ as a factor in over-indebtedness in its own right. Thus, cases in which income is not high enough to

* 1 2

3 4 5

Holger Sutschet is Professor of International Commercial Law, Labour Law and Comparative Law at University of Applied Sciences Osnabrück, Germany. , retrieved on 14 December 2015. Which is a problem in itself. In an expert seminar on consumer over-indebtedness and responsible lending at the University of Applied Sciences, Osnabrück, in February 2015, the desirability of a unified system for data collection and analysis was emphasised by both advice agencies and industry representatives. IFF stands for “Institut für Finanzdienstleistungen e.V.”, Hamburg. Iff Überschuldungsreport 2014, p. 9ff. The Minimum Wages Act (Mindestlohngesetz) came into force on 1 January 2015, setting minimum wages to €8,50 per hour.

207

Holger Sutschet

cover the monthly expenses, but in which none of the five main reasons apply, would fall under ‘other’ (30.2%).6 The number of insolvency proceedings, which were initiated in 2014, has fallen from the levels in previous years to about 84,000 now. Since the introduction of debt relief in 1999, numbers had rose from 1,634 in 1999 to slightly more than 100,000 in the years 2007, 2010 and 2011, but are now trending downwards.7 Comparing the numbers of insolvency proceedings with the numbers of over-indebted people, it seems that either most overindebted people are not insolvent or that insolvency proceedings are not initiated in cases where people are insolvent, or both. Some indication might be provided by the mean debt figures: the overall debts of the 84,000 people who initiated insolvency proceedings were €4,721 million, or about €56,000 on average.8 The mean debts of people who are overindebted are about €32,500.9 This might mean that the likelihood of insolvency proceedings being initiated depends on the extent of over-indebtedness. There is, however, another possible explanation for the relatively low number of insolvency proceedings: the mere existence of debt relief increases the willingness of creditors to settle out of court. This was already anticipated by the legislature, who argued that this would happen in response to the fear that the introduction of debt relief would lead to a large number of court proceedings that would overwhelm the insolvency courts.10 The extent to which lending policies or practices of finance institutions contribute to over-indebtedness and insolvencies is unknown. However, banks are among the main creditors of over-indebted people. The percentage of debts owed to banks stood at over 50% in 2004 and 2005, but has hovered around 40% since 2009.11 Advice to people facing financial difficulties is available. Numerous institutions are offering debt advice, including charity organisations such as Caritas or Diakonie, besides governmental authorities. Together, they run about 1,400 debt advice agencies throughout Germany. The legal basis for the work of these organisations is insolvency law, on the one hand, and social security law, on the other. Under s.305 Insolvency Act (Insolvenzordnung, InsO), a ‘light version’ of insolvency proceedings leading to debt relief can be initiated if debtors, with the help of an acknowledged debt advice agency, have tried to enter into outof-court settlements with their creditors. As this provision aims to reduce the workload of insolvency courts, an attempt to negotiate an out-of-court settlement is mandatory on

6

, retrieved on 10 December 2015. 7 See supra note 4, p. 15f. 8 , retrieved on 10 December 2015. 9 Supra note 4, p. 21. 10 BR-Drucksache 1/92, p. 107. 11 Supra note 4, p. 26.

208

11

An Analysis of the German Legal Framework and the (Limited) Influence of EU Law

the debtor’s way to debt relief.12 The Social Benefits Act (SGB XII) contains a regime of advice and support to help people live without state support. A part of this advice and support is made available through debt advice agencies. The costs of such advice in some cases must, and in other cases can, be paid for by the government. Although debt advice is widely available and is certainly a good starting point for people who would like to rid themselves of their financial difficulties, the uptake of advice is comparably low. In 2014, about 460,000 people were given advice by debt advice agencies.13

11.2

The Legal Framework

11.2.1

Insolvency

11.2.1.1 The Introduction of Debt Relief Until 1999, German insolvency law did not have a regime of debt relief. If the debtor was a legal entity, this corporation would be extinguished at the end of the proceedings (unless the financial problems were cured within the proceedings). If the debtor was a natural person, he or she would remain liable for repayment of any remaining debts after the conclusion of the proceedings.14 Thus, the indebtedness of natural persons could, and in reality often did, continue for a lifetime, giving over-indebted people no incentive to initiate such proceedings. At the same time, insolvency proceedings in cases where the debtor was a natural person were not very promising for creditors either: usually debtors did not have enough money (otherwise they would have paid their debts in the first place), and their future income was not accessible to creditors using the insolvency regime because this regime dealt with only existing but not future assets. As a result of this, insolvency proceedings under the old regime (pre-1999) were not a useful route to take either for debtors or for creditors.15 In 1999 the legislature introduced the new insolvency regime, granting debt relief under certain circumstances to natural persons. The then government explained the idea in a nutshell as follows: A debtor who, despite honest efforts, fails economically gets the chance to rid himself of any remaining debts after undergoing insolvency proceedings. To prevent abuse, debt relief is linked to sharp requirements. Prior to the proceed12 Ott and Vuia, Münchener Kommentar zur Insolvenzordnung, C.H. Beck, München, 2013, §305 (idF vom 15 July 2013) at 2. 13 Statistisches Bundesamt, Fachserie 15, Reihe 5, Jahr 2014, p. 6. 14 Andres and Leithaus, Insolvenzordnung, C.H. Beck, München, 2014, §1 InsO at 4. 15 Ott and Vuia, supra note 12, §304 at 5ff.

209

Holger Sutschet

ings, the debtor must abstain from any actions which are detrimental to his creditors; during proceedings, he must collaborate constructively; and for a period of seven years after the proceedings he must use his income (as far as it exceeds a certain threshold) to satisfy his creditors.16 When debt relief for personal debt was introduced, stakeholders were of the opinion that this new act would infringe their constitutional right to property. The argument ran thus: whatever natural persons owed their creditors was part of the latter’s property and thus protected under Article 1417 of the German Constitution. The new regime of debt relief took away from the creditors this part of their property without a lawful justification. This view, however, is that of a minority. The vast majority of scholars and practitioners cannot see any infringement of constitutional rights by granting debt relief.18 Undoubtedly, creditors are deprived of their property by this instrument, but the value of what they are deprived of is almost nil in most cases. Against this background, the legitimate interest of the debtor in being granted a fresh start outweighs the creditor’s interest. Interestingly, the legislature even held that granting debt relief would work in favour of the creditors: their chances of getting at least some of what they are owed would get better if the debtor had an incentive to behave correctly, especially in respect of applying for insolvency proceedings at an early stage and in respect of collaborating duly in those proceedings.19 This view is shared by some authors.20 Despite some efforts of a specific county court,21 the German Constitutional Court did not yet have to decide the question as to whether or not debt relief infringes any constitutional rights of the creditors.22

16 Bundestags-Drucksache 12/2443, p. 3. 17 Art. 14 [Property – Inheritance – Expropriation] (1) Property and the right of inheritance shall be guaranteed. Their content and limits shall be defined by the laws. (2) Property entails obligations. Its use shall also serve the public good. (3) Expropriation shall only be permissible for the public good. It may only be ordered by or pursuant to a law that determines the nature and extent of compensation. Such compensation shall be determined by establishing an equitable balance between the public interest and the interests of those affected. In case of dispute concerning the amount of compensation, recourse may be had to the ordinary courts. 18 Wenzel, in: Kübler and Prütting (eds.), Kommentar zur Insolvenzordnung, RWS Verlag, Köln, 2002, §286 Rdnrn. 56ff.; Römermann, in: Nerlich and Römermann (eds.), Insolvenzordnung – Kommentar, C.H. Beck, München, 2002, Vorb. §286 Rdnrn. 32ff.; Forsblad, Restschuldbefreiung und Verbraucherinsolvenz im künftigen deutschen Insolvenzrecht, Peter Lang, Pieterlen, 1997, S. 275ff. 19 See supra note 16, p. 82. 20 Ganter and Lohmann, Münchener Kommentar zur Insolvenzordnung, C.H. Beck, München, 2013, §1 InsO at 101. 21 Amtsgericht München, Zeitschrift für Verbraucher- und Privat-Insolvenzrecht (ZVI) 2002, p. 330. 22 Bundesverfassungsgericht, Beschluß of 3 February 2003 – 1 BvL 11/02, 12/02, 13/02, 16/02 and 17/02, Neue Zeitschrift für Insolvenz- und Sanierungsrecht 2003, p. 162.

210

11

An Analysis of the German Legal Framework and the (Limited) Influence of EU Law

11.2.1.2 Critique of Debt Relief While most lawyers think that debt relief does not infringe the Constitution, many do think that debt relief after insolvency proceedings is not the best answer the law can give to the problem of over-indebtedness of natural persons. One major point of criticism is that in many cases no money is being paid to creditors at all during the term of the proceedings, because the debtor’s income is below the relevant threshold.23 This fact does not sit well with the function of insolvency proceedings, which is that creditors should get at least some part of what they are owed. Therefore, the legislature has been called upon to provide an alternative route to debt relief, i.e. outside of the insolvency regime.24 In reaction to this criticism the legislature planned at some point to introduce an easier way to debt relief25; this, however, came to nothing. The second major criticism is the lack of support for debtors during and after the period that leads to debt relief. If no such support is provided, debtors are likely to either fail to meet the requirements for debt relief in the first place or, if they succeed in being granted debt relief, to become over-indebted again later.26 Another problem in this respect is that debtors may not be allowed to re-enter their old profession, e.g. as a lawyer or a pub owner. 11.2.1.3 Development of the Debt Relief Regime Since 1999 the debt relief regime has been amended on a number of occasions. Under the original regime, proceedings for personal insolvency could be opened (and debt relief at the end of proceedings granted) only if the debtor had the means to pay for the costs of the proceedings. As it turned out, in many cases this requirement was not met, leaving the debtors in a position where no redress could be hoped for. This was criticised by some authors: while debtors who had just enough money to pay for the insolvency proceedings were granted debt relief, this benefit was not available to those debtors who did not even have enough money to pay the costs of the proceedings, and who therefore most urgently needed debt relief.27

23 The limits are laid down in ss.850 ff. Civil Procedure Act (Zivilprozeßordnung – ZPO). Under s.850c ZPO, the limits are dependent on how many people the debtor needs to pay maintenance for (mainly, spouse and children). In terms of gross salary, a single person with no dependants can – depending on a number of circumstances – earn around €1,420 before going beyond the limit; a person with one dependant can earn €1,810, with two dependants €2,135, with three dependants €2,490, with four dependants €2,870 and with five dependants €3,245. 24 Aufruf deutscher Insolvenzrichter und -Rechtspfleger zur Wiederherstellung der Funktionsfähigkeit der Insolvenzgerichte und der Insolvenzordnung, Zeitschrift für das gesamte Insolvenzrecht (ZInsO) 2002, p. 949. 25 Bundestags-Drucksache 16/7416. 26 Scholz, ‘Stellungnahme zu den §§225-242 des Entwurfs des Bundesministers der Justiz zur Reform des Insolvenzrechts’, Zeitschrift für Wirtschaftsrecht (ZIP) 1988, p. 1157. 27 Pape, ‘Muß es eine Restschuldbefreiung im Insolvenzverfahren geben?’, Zeitschrift für Rechtspolitik (ZRP) 1993, p. 285.

211

Holger Sutschet

Others, however, argued that the ‘social’ argument should be used with great care, considering that he who with the greatest efforts manages to escape insolvency does not get the benefit of debt discharge, whereas it is bestowed on him who recklessly slithers into insolvency. They add that it was not inappropriate to deprive of the benefit of debt discharge a debtor who initiates insolvency proceedings at such a late stage where he has even consumed any money that otherwise might have covered the costs of the proceedings. Finally, they claim that debt discharge is legitimate only where it works in the interest of not only the debtor but also his creditors, thus limiting debt discharge to cases where creditors get at least some of their money.28 This view, however, is based on the assumption that insolvency has the main aim of looking after the interests of the creditors and that, when granting debt discharge the insolvency law would do so in pursuit of this aim, thus leaving the debtor’s interests in a fresh start a secondary aim or even side effect only.29 It is doubtful whether this view was correct under the old regime. Be that as it may, the legislature decided, in 2001, to waive the requirement that debtors must be able to pay for the costs of insolvency proceedings, thereby extending the availability of debt relief to those natural persons who needed it most urgently.30 At least, since then there seems to be no valid basis for the assumption that debt relief was available only in cases where it worked in favour of the creditors. Rather, the interests of debtors in being granted a fresh start seem now to be an aim of insolvency proceedings in its own right. A second point of amendment has been the number of years it takes until debt relief can be granted. Under the original regime, this period was seven years. In 2002, the period was reduced to six years.31 In 2014, a more refined system has been introduced; debt relief can be granted: – after three years if the debtor managed to pay off 35% of his debts and the costs of the proceedings within this period32; – after five years if the debtor paid the costs of the proceedings; – after six years if the debtor failed to qualify for earlier debt relief.33

28 29 30 31 32

Ganter and Lohmann, supra note 20, §1 InsO at 104. Ibid, §1 InsO at 20; 98 f. InsOÄndG 26 October 2001. Ibid, 26 October 2002. It is estimated that, with costs, the debtor would have to pay about 50% of his debts to benefit from the threeyears rule and that this rule would therefore not become practically relevant: debtors who are able to pay off 50% of their debts will be able to settle out of court. 33 S. 300 InsO.

212

11

An Analysis of the German Legal Framework and the (Limited) Influence of EU Law

11.2.1.4 Requirements and Effects of Debt Relief Debt relief will be granted if the following requirements are met: – the debtor has applied for insolvency proceedings, and these have been opened; – the debtor has put in an application for debt relief; – a term of six years or five years or three years has passed; – no well-founded application for refusal of debt relief has been received. There are many reasons why debt relief can be refused (ss. 287a, 300(3), 290(1), 296(1), 296(2)(3), 297, 297a, 298 Insolvency Act): – debt relief has been granted within a ten-year period prior to the new application; – debt relief has been refused within a five-year period prior to the new application on the basis of the debtor having committed an insolvency-related crime; – debt relief has been refused within a three-year period prior to the new application on the grounds that the debtor has failed to collaborate duly (in respect of information duties or his duty to work) during or after insolvency proceedings; – the debtor has been found guilty of having committed a criminal act related to insolvency within a five-year period before applying for insolvency proceedings or in the course of insolvency proceedings; – the debtor has in writing submitted wrong information in respect of his financial situation with a view to obtaining credit or social benefits or with a view to avoiding having to make payments to governmental institutions; – the debtor has voluntarily or negligently accumulated inappropriate debts or wasted money or delayed the opening of necessary insolvency proceedings within a three-year period prior to applying for insolvency proceedings; – the debtor fails to honour any duties to give information or assist otherwise under the insolvency act; – the debtor makes, knowingly or with gross negligence, wrong statements about his financial situation within the insolvency proceedings; – the debtor violates his duty to take on appropriate work; – the debtor fails to honour any of his duties under the insolvency act in the course of insolvency proceedings; – the debtor fails to give account of his performance of duties in the course of insolvency proceedings; – the debtor fails to pay the minimum fee to the insolvency trustee (unless the duty to pay the costs of the proceedings has been postponed). Once debt relief has been granted it can be repelled within one year if it comes to light that the debtor has intentionally breached his obligations under the Insolvency Act or that the debtor has been found guilty of having committed a crime connected to bankruptcy within

213

Holger Sutschet

the course of insolvency proceedings or if the debtor, intentionally or with gross negligence, failed to honour his obligations to give information after debt relief has been granted (s.303 Insolvency Act). The effect of debt relief is to extinguish the creditor’s rights, allowing the debtor a fresh start without debts. However, some kinds of debts are excluded from debt relief34: – debts resulting from wilful misconduct; – debts from outstanding maintenance; – tax debts if the debtor has been convicted for committing a tax crime; – debts from penalties; – debts from non-interest loans that have been granted to cover the costs of insolvency proceedings. Some authors claim that these exemptions constitute a serious threat to the overall aim of personal insolvency.35 In particular, the inclusion of maintenance debts and tax debts in the catalogue of exempted debts will practically exclude a large number of debtors from the benefit of debt relief: after successful completion of insolvency proceedings they will still have more debts than they can repay from their income. Also, the requirement that tax debtors must have been convicted to exempt tax debts from debt relief is claimed to create an incentive for tax authorities to initiate criminal proceedings against debtors.36

11.2.2

Responsible Lending

11.2.2.1 Consumer Credit As far as consumer credits are concerned, the consumer credit directive has been implemented in German law by ss.491 ff. of the German civil code (Bürgerliches Gesetzbuch, BGB), s.18(2) of the Banking Act (Kreditwesengesetz – KWG) and s.2(3) of the Payment Services Supervision Act (Zahlungsdiensteaufsichtsgesetz). The latter provisions state that credit institutions and payment services providers, respectively, assess the creditworthiness of the consumer in case of consumer credits. The basis for the assessment can be information provided by the consumer and, if necessary, information obtained from organisations that specialise in providing credit information. Data protection rules are not affected by this provision. S.18(2) KWG also introduces a duty to reassess the creditworthiness in case

34 §302 InsO. 35 Schmerbach, ‘Gesetz zur Verkürzung des Restschuldbefreiungsverfahrens und zur Stärkung der Gläubigerrechte verabschiedet – Ende gut, alles gut?’, Neue Zeitschrift für Insolvenz- und Sanierungsrecht, 2013, p. 566 ff. 36 D. Pehl, in: E. Braun (ed.), Insolvenzordnung, 6th edn., C.H. Beck, München, 2014, §302 Rn. 5.

214

11

An Analysis of the German Legal Framework and the (Limited) Influence of EU Law

of a significant increase in the credit sum and a duty to update the information in any case of amendments to the credit sum. Scholars disagree about the legal nature of the bank’s obligation to carry out a creditworthiness assessment. At least until recently it was the majority’s opinion that this obligation is a public law duty only.37 As a result of this a breach of this duty could only trigger any remedies laid down in the KWG itself. The sanction system of the KWG, however, is minimalistic. Under s.6(3) KWG the financial supervisory authority (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin) can take such measures in respect of institutions and their chairmen as are necessary and appropriate to avoid infringements of the duties under the KWG or to discontinue any bad practices that otherwise may obstruct the proper dealing with banking transactions. BaFin hardly ever makes use of the powers that they are given under this provision, and no single case is known where this instrument had been used in respect of banks’ duties under s.18(2) KWG.38 There are no other sanctions in the KWG for the infringement of the duty to assess the consumer creditworthiness. While the duty to check the financial situation of a borrower under s.18(1) KWG (which relates to credits for more than €750.000) can lead to the imposition a fine, this sanction is confined to s.18(1) KWG but does not apply to a breach of the duty under s.18(2). The view of what at least until recently was the minority is that the duty to carry out the creditworthiness assessment under s.18(2) KWG is a duty owed to the debtor, and so is by nature either a private law duty or a duty with both public and private law character.39

37 Schürnbrand, in: Münchener Kommentar zum BGB, 6th edn., C.H. Beck, München, 2012, §491a, p. 62; Schürnbrand, ‘Das neue Recht der Verbraucherkredite und der verbundenen Verträge’, in: Bankrechtstag 2009, S. 173, p. 183 f.; Schürnbrand, ‘Die Neuregelung des Verbraucherdarlehensrechts’, Zeitschrift für Bankrecht und Bankwirtschaft (ZBB), 2008, pp. 383, 388f.; Herresthal, ‘Die Verpflichtung zur Bewertung der Kreditwürdigkeit und zur angemessenen Erläuterung nach der neuen Verbraucherkreditrichtlinie 2008/48/EG’, Zeitschrift für Wirtschafts- und Bankrecht (WM), 2009, pp. 1176, 1178; Nobbe, ‘Neuregelungen im Verbraucherkreditrecht’, Zeitschrift für Wirtschafts- und Bankrecht (WM), 2011, pp. 625, 629 f.; Rösler and Werner, ‘Erhebliche Neuerungen im zivilen Bankrecht: Umsetzung von Verbraucherkredit- und Zahlungsdiensterichtlinie’, Zeitschrift für Bank- und Kapitalmarktrecht (BKR), 2009, pp. 1, 3; Wittig and Wittig, ‘Das neue Verbraucherdarlehensrecht – Schritte zur Vermeidung der Privatinsolvenz?’, Zeitschrift für das gesamte Insolvenzrecht (ZInsO), 2009, pp. 633, 639; Freitag, in: Staudinger (ed.), Kommentar zum BGB, Sellier – de Gruyter, Berlin, 2011, §488 Rn. 36; P. Buck-Heeb, ‘Kreditberatung, Finanzierungsberatung’, Zeitschrift für Bank- und Kapitalmarktrecht (BKR), 2014, p. 221. 38 See Chapter 10, around note 13. 39 Ady and Paetz, ‘Die Umsetzung der Verbraucherkreditrichtlinie in deutsches Recht und besondere verbraucherpolitische Aspekte’, Zeitschrift für Wirtschafts- und Bankrecht (WM) 2009, pp. 1061, 1067; Heße and Niederhofer, ‘Die Eigenverantwortung des Darlehensnehmers und die Erläuterungspflicht des Darlehensgebers nach §491a Abs. 3 BGB’, Monatsschrift für deutsches Recht (MDR) 2010, pp. 968, 972; Hofmann, ‘Die Pflicht zur Bewertung der Kreditwürdigkeit’, Neue Juristische Wochenschrift (NJW) 2010, pp. 1782, 1784 f.; Grunewald, Festschrift für Uwe H. Schneider zum 70. Geburtstag, Otto Schmidt Verlag, Köln, 2011, S. 401, 403 ff.; Knops, ‘Der Verbraucherkredit zwischen Privatautonomie und Maximalharmonisierung’, in: Bankrechtstag 2009, S. 195, 223; Rott, Terryn and Twigg-Flesner, ‘Kreditwürdigkeitsprüfung: Verbraucherschutzverhinderung durch Zuweisung zum Öffentlichen Recht?’, Verbraucher und Recht (VuR) 2011, p. 163.

215

Holger Sutschet

According to this view, breach of this duty entitles the debtor to damages. As a result, the creditor would have to put the debtor in the situation he would have been in had the duty not been breached. Under this theory the debtor could claim that, had the creditor carried out the creditworthiness assessment (properly), either the creditor or the debtor would not have entered into the loan agreement. Hence the creditor has to pay for every loss suffered by the debtor as a result of having entered into the contract. This does not only include costs and interest but can also extend to the loan itself.40 Also, if the debtor became insolvent as a consequence of taking out the loan the creditor would have to pay for any loss resulting from the insolvency. This argument now continues in the different views on the recent CJEU case LCL Le Crédit Lyonnais.41 In this case, the CJEU has pointed out that the creditor’s obligation, prior to conclusion of the agreement, to assess the borrower’s creditworthiness is intended to protect consumers against the risks of over-indebtedness and bankruptcy’.42 This passage is relied on by the pro-private-law party to insist that the assessment is not a public law duty (only) but is owed to the borrower, thereby entitling him to remedies in case of breach of this duty.43 The opponents, however, still insist that the duty to carry out the creditworthiness assessment is a public law duty only and that the only effect the CJEU decision in LCL Crédit Lyonnaise should have is to reconsider the sanction system under the KWG.44 Interestingly, German law makes a distinction between loans on one side and other financial accommodation on the other side. While the duty to carry out the creditworthiness assessment in the case of loans has been made part of the bank supervision regime, the same duty in respect to other financial accommodations has been made part of the German civil code (s.509 BGB). The legislature has justified this distinction on the grounds that no supervisory regime exists in respect of other financial accommodation.45 Commentators have concluded that, while s.18(2) KWG lies in the public interest only, s.509 BGB introduces a duty to carry out the creditworthiness assessment in the interests of the debtor. As a result, the debtor is entitled to damages in case of breach of this duty.46 40 41 42 43

See Schürnbrand (2012), supra note 37, §509 at 9. CJEU C-565/12 (LCL Le Crédit Lyonnais SA v. Fesih Kalhan). Ibid, at 42. Rott, ‘Verbraucherschutz durch Prüfung der Kreditwürdigkeit’, Europäisches Wirtschafts- und Steuerrecht (EWS) 2014, pp. 201, 202 f.; Maier, ‘Anmerkung zu einer Entscheidung des EuGH, Urt. V. 27 March 2014 (C-565/12) – Zur Pflicht des Kreditgebers, die Kreditwürdigkeit des Kreditnehmers zu prüfen’, Verbraucher und Recht (VuR) 2015, p. 21; Barta and Braune, ‘Schadensersatz als Rechtsfolge der unzureichenden Prüfung der Kreditwürdigkeit des Verbrauchers – Konsequenzen aus der Entscheidung des EuGH in Sachen Le Crédit Lyonnais SA/Fesih Kalhan für das Verständnis des deutschen Rechts’, Zeitschrift für Bank- und Kapitalmarktrecht (BKR) 2014, pp. 324, 329f.; Freitag, ‘EuGH: Vertragsrechtliche Folgen der Verletzung der Pflicht zur Bonitätsprüfung’, Kommentierte BGH-Rechtsprechung (LMK) 2014, p. 358906. 44 Herresthal, ‘Unionsrechtliche Vorgaben zur Sanktionierung eines Verstoßes gegen die Kreditwürdigkeitsprüfung’, Europäische Zeitschrift für Wirtschaftsrecht (EuZW) 2014, pp. 497, 500. 45 BT-Drs. 16/11643, p. 95f. 46 Schürnbrand (2012), supra note 37, §509 at 7.

216

11

An Analysis of the German Legal Framework and the (Limited) Influence of EU Law

Following the decision of the CJEU in CA CF SA,47 the burden of proof for the risk assessment having been carried out lies with the bank (while prior to this decision it was thought to lie with the consumer48). 11.2.2.2 Mortgage In respect of the mortgage credit directive (MCD), it was to be expected that Articles 1820 of that directive would trigger rules on the creditworthiness assessment different from the provisions that implement the consumer credit directive (CCD). However, the argument between scholars about the nature of the duty to carry out the creditworthiness assessment was likely to extend to the MCD as well,49 especially in light of recital 83: “Member States may decide to transpose certain aspects covered by this Directive in national law by prudential law, for example the creditworthiness assessment of the consumer, while others are transposed by civil or criminal law, for example the obligations relating to responsible borrowers”. The legislature, however, has now come up with a bill seeking to implement the MCD under which a new regime will be introduced: the duty to carry out a creditworthiness assessment will be made part of private law (BGB) in respect of both consumer credits and mortgage credits. The new provision of §505b BGB will in future apply to consumer credits and mortgage credits respectively, setting out the requirements for the basis of the creditworthiness assessments. The provision makes it very clear that this duty of the lender is a much more serious one in cases of mortgage credits than in cases of consumer credits. In cases of consumer credits, the creditworthiness assessment can be carried out on the basis of information provided by the consumer alone; only when ‘necessary’ does the lender need to obtain further information provided by a specialist finance information provider such as SCHUFA.50 There is no duty on the part of the lender to check the correctness of any information obtained by the consumer or third parties. In cases of mortgage credits, the creditworthiness assessment has to be carried out on the basis of necessary, sufficient and appropriate information about income, expenditures and other financial and economic circumstances of the debtor. In doing so, the lender has to appropriately consider all factors that are relevant to the question of whether the debtor will be able to repay the loan. The assessment may not be based solely on the assumption that the value of the property will rise or exceed the loan. The necessary information has 47 Judgment of 18 December 2014 in Case 449/13, CA Consumer Finance SA v. Ingrid Bakkaus, Charline Bonato and Florian Bonato. 48 See Schürnbrand, in: Münchener Kommentar zum BGB, 7th edn., C.H.Beck, München, 2016, §509 at 8. 49 See Rott, ‘Die neue Immobiliarkredit-Richtlinie 2014/17/EU und ihre Auswirkungen auf das deutsche Recht’, Zeitschrift für Bank- und Kapitalmarktrecht (BKR) 2015, 8, 11; P. Buck-Heeb, ‘Kreditberatung, Finanzierungsberatung’, Zeitschrift für Bank- und Kapitalmarktrecht (BKR) 2014, pp. 221, 222. 50 SchuFa stands for ‘Schutzgemeinschaft für allgemeine Kreditsicherung’ (protective association for general credit security).

217

Holger Sutschet

to be obtained using relevant internal and external sources, part of which is information provided by the debtor. The lender is under a duty to appropriately check the correctness of any such information, where necessary by looking at documents that can be checked independently.51 11.2.2.3 Paradigm Change in Respect of the Sanction System While the rules on the basis for the creditworthiness assessment in cases of mortgage credits are much stricter than in cases of consumer credits, it is to be noted that the new regime will make the duty to carry out the creditworthiness assessment part of the civil code, thus making the duty a private law duty in both cases of loans. Under the old regime, this duty was – according to the majority view – just a public interest duty, breach of which did not give rise to any rights of the consumer. Under the proposed new regime52 the bank will have to carry out a creditworthiness assessment in each case of loan (consumer credit and mortgage credit). The bank may grant a loan only if – in case of a consumer credit, the risk assessment reveals no material doubts as to the consumer being able to repay the credit; – in case of a mortgage, the risk assessment has the result that the consumer is likely to repay the loan. A new provision will specifically set out the sanctions in case of infringements of the duty to carry out the risk assessment. The effect will be, first, that any contractual interest rate will be lowered to match the general market interest rate (in case of a fixed interest rate) or to the refinance interest rate (in case of a variable interest rate); second, that the consumer is entitled to terminate the contract without notice and without any obligation to pay any sums in respect of premature termination; third, if the consumer breaches any of his duties under the loan contract, the lender cannot bring any claims on this basis if the breach has its cause in a circumstance that, had the creditworthiness assessment been carried out correctly, would have had the result that the contract must not have been concluded.53 What the legislature intends to achieve with this last remedy is not obvious. To begin with, the wording of the provision is flawed. If there exists a circumstance that makes it likely that the consumer will not be able to repay the loan (in case of a mortgage) or that sheds material doubt on his ability to do so (in case of a consumer credit) then the bank must not grant the loan. Hence, this circumstance is not one that would have had the result that the contract must not have been concluded, but it is a circumstance that actually had 51 §55b 2, 3 BGB (new). 52 Entwurf eines Gesetzes zur Umsetzung der Wohnimmobilienkreditrichtlinie, Bundestags-Drucksache 18/5922. 53 S.505d Civil Code (Bürgerliches Gesetzbuch, BGB).

218

11

An Analysis of the German Legal Framework and the (Limited) Influence of EU Law

this result. It seems that the legislature has mixed up the questions whether it was allowed to enter into the contract and whether parties did enter into the contract. Apart from that, it seems that this provision will not give the consumer the right not to pay the credit back (as may be assumed from an English contract law perspective). Under German law, there is a sharp distinction between primary rights under a contract (that which has been promised) and secondary rights (damages in case of breach). As the new provision will only deal with secondary rights, the creditor’s primary contractual right to be paid back the loan will not be affected. Hence, the only result of the provision will be that the lender will not be able to claim any damages on top of this. Having said this, the explanatory notes of the bill are less clear on this point. They state that the new provision will strike out any rights of the creditor in case of delay or failure to repay. ‘Any such rights’ cover not only the secondary right to be paid damages in case of non-payment but also the primary contractual right to be paid back the loan. Looking at the wording of the new s.505d(2) BGB on the one side and the explanatory notes on the other side, it seems that the legislature has failed to appreciate the doctrinal difference between primary and secondary obligations. Although it is desirable that this was clarified before enactment, this is very unlikely to happen, given that the new regime must be in place by March 2016. Most likely, it will then be left for the courts to sort out whether or not creditors who failed to (correctly) carry out the necessary creditworthiness assessment will be able to claim their money back. While the proposed remedial regime is to some extent unclear, it is to be noted that this new development will not be less than a paradigm change, at least in the eyes of the majority of scholars. Under the existing regime, the duty to carry out a creditworthiness assessment lies only in the public interest; thus, breach of this duty will enable the supervisory authority to take action, but does not bring about any claims on the part of the consumers. Under the proposed new regime, this duty will lie in the consumers’ interest, giving them certain rights in case of breach. The legislature explains this change with his duty to establish an effective remedial system. Under the CJEU ruling in Credit Lyonnais,54 it has become doubtful whether a regime of duties in the public interest only, sanctioned by supervisory instruments, will do. Also, the legislature now submits that a private law duty would be systematically more sound and preferable for consumer policy reasons.55 11.2.2.4 The Supervisory Regime As set out above, the legislature, when implementing the CCD, made it obligatory for banks to carry out a creditworthiness assessment; this duty was made part of the Banking Act. As a consequence of this, it was part of the supervisory regime (only). More generally,

54 See supra note 41. 55 Bundestag-Drucksache 18/5922, p. 62.

219

Holger Sutschet

the supervisory institution (BaFin) overlooks under this Act the proper working of banks in respect of points of general interest, chiefly, their duty to ensure that they are always sufficiently capitalised. Under this regime, supervision of the duty to carry out the creditworthiness assessment is certainly not the main focus of the supervisory authority. However, the legislature has recently strengthened the supervisory focus on consumer rights. In 2013 a new provision was introduced whose effect is to allow single consumers and consumer associations to initiate a complaint procedure in case of misbehaviour by banks.56 On receipt of such a complaint, the BaFin must respond within an appropriate period. The BaFin may ask the accused bank what they have to say about the complaint. At the same time, a consumer council within BaFin was established whose function is to advise BaFin.57 The consumer council consists of twelve members, appointed by the federal ministry. There shall be appropriate participation of academia, consumer protection associations, alternative dispute resolution providers and the federal ministry of justice and consumer protection. Both provisions seek to strengthen the supervisory regime by focussing more strongly on consumers. Especially employing consumer associations to this end might prove to be fruitful as the same measure has turned out to be very efficient in the field of abuse of standard terms. With effect from 10 July 2015, the rights of the supervisory institution (BaFin) have been further strengthened. According to a new provision in the Finance Services Supervision Act (Finanzdienstleistungsaufsichtsgesetz), the supervision authority may take any action that is necessary to prevent and remedy serious shortcomings that are relevant to consumers if such general action seems necessary in the interest of consumer protection.58 ‘Shortcoming’ in this sense is a serious, permanent or repeated infringement of consumer protection laws that, according to its kind and extent, can compromise or put at risk the interests of consumers generally.59 The explanatory notes add that it is, in particular, a shortcoming if a bank or other finance provider ignores a relevant decision of the Supreme Court for Civil Matters (Bundesgerichtshof).60 This is quite remarkable because, as a matter of fact, such decisions do only have binding effects on the parties to the court proceedings. Banks are generally not concerned at all with decisions of the Supreme Court as such (unless they are a party to the court proceedings themselves). It is only the statutory law that is binding on financial services providers, not the interpretation of the law by the Supreme Court. Hence, in principle, these providers are free not to follow such interpretations and cannot be taken to infringe the law solely on the basis of applying an interpretation different from that applied by the Supreme Court. If the supervisory authority were to impose sanctions 56 57 58 59 60

§4b FinDAG. §8a FinDAG. §4(1a) FinDAG. §4(1a) Finanzdienstleistungsaufsichtsgesetz. Bundestag – Drucksache 18/3994, p. 36.

220

11

An Analysis of the German Legal Framework and the (Limited) Influence of EU Law

or to apply other measures in cases where banks do not follow the decisions of the Supreme Court, it remains to be seen whether or not courts would follow the approach taken in the explanatory notes. The new provision of the Finance Services Supervision Act reflects the aim of the government laid down in the coalition agreement61 to make collective consumer protection one of the supervisory topics of the BaFin.62 However, a duty to react in cases where there are signs of repeated infringements as envisaged in the coalition agreement does not seem to have been introduced with the recent amendments of the supervisory regime. The explanatory notes of the Act emphasise that the supervision authority acts in the public interest only and that any infringements of individual rights cannot be taken up via this route.63 But also general infringements, even if they occur repeatedly, only give the supervisory authority a right to react; nowhere in the legal framework is there any mention of a duty to react.

11.3

11.3.1

The (Limited) Influence of EU Law

Responsible Lending

EU law has a big impact in respect of the German rules on responsible lending. Traditionally, the relationship between the lender and the borrower is regarded to fall under ordinary contract law principles. Thus, information duties and other pre-contractual duties will not easily be recognised. The basic principle applicable to contracts in general is that every party has to look after their own interests themselves before and when entering into a contract.64 This doctrinal view is closely linked to the classical liberal approach the BGB (drafted between 1874 and 1896) takes. According to this principle, duties owed to the other party in respect of this decision-making process can arise only exceptionally. Such an exception can exist where an information deficit exists and where it would be considered unfair if the party who has the relevant information would not share their knowledge with the other party. In respect of consumer credits specifically, the application of the general rule leads to the conclusion that it is for the borrower to assess his ability to repay any loans he wishes to take out. As all circumstances relevant to this assessment fall within his

61 62 63 64

Deutschlands Zukunft gestalten, Koalitionsvertrag zwischen CDU, CSU und SPD (2013), p. 87f. See supra note 60, p. 29. Ibid, p. 37. Bundesgerichtshof, 7 April 1992, Neue Juristische Wochenschrift (NJW), 1992, 1820; P. Buck-Heeb, ‘Aufklärungs- und Beratungspflichten bei Kreditverträgen – Verschärfungen durch die EuGH-Rechtsprechung und die Wohnimmobilienkredit-Richtlinie’, Zeitschrift für Bank- und Kapitalmarktrecht (BKR), 2015, p. 177.

221

Holger Sutschet

sphere there is no information deficit that the lender ought to redeem. Hence, no such duties can arise under the normal German doctrinal pre-contractual regime. It is but for the EU rules that such duties on the part of the lender had to be and were introduced. Still, as shown above,65 the German approach was a reluctant one insofar as the nature of these duties was considered to be a public interest duty only, thus limiting the sanctions to supervisory measures (rather than giving the borrowers any contractual rights). The recent paradigm change, leading to a contractual sanction system in cases of breach of the duty to carry out a creditworthiness assessment, has also been triggered by EU law, in particular by the mortgage credit directive66 and the ECJ case law67 on the aim of the creditworthiness assessment under the CCD.

11.3.2

Insolvency

As for insolvency proceedings, the Council regulation on insolvency proceedings68 deals only with recognition of decisions made in insolvency proceedings within the EU. There are, however, no common substantial rules as to, for example, the availability of debt relief or the number of years it takes for debt relief to be granted. This lack of a harmonised approach has led to a phenomenon called ‘insolvency tourism’: people from country A may relocate to country B for as long as it takes under the insolvency regime of that country to be granted debt relief, returning to country A after debt relief has been granted in country B (which will then be recognised by country A).69 However, the number of insolvency tourists seems to be very low: it has been submitted that – according to unofficial numbers – only 134 German debtors have relocated to England and Wales for this purpose in 2012.70 Against this background, any changes that the legislature has made to the rules on personal insolvency were not triggered by EU law, not even in the indirect way in which they were triggered by the recognition of decisions of insolvency courts in other EU countries. Thus, it seems that no harmonisation between the EU member states will happen as a consequence of EU-wide recognition.

65 Around supra note 37. 66 Directive 2014/17/EU on credit agreements for consumers relating to residential immovable property, OJ L 60, 28 February 2014, pp. 34-85. 67 See supra note 41. 68 Council regulation (EC) No 1346/2000 of 29 May 2000 on insolvency proceedings, OJ L 160, 30 June 2000, pp. 1-18. 69 See, e.g., BGH Neue Juristische Wochenschrift (NJW) 2002, 960 (where a German debtor obtained debt relief in France). 70 H. Allemand, S. Baister, P. Kuglarz, et al., ‘Mindeststandards für Enschuldungsverfahren in Europa?’, Neue Zeitschrift für Insolvenz- und Sanierungsrecht 2014, Vols. 1-2, n. 2, p. 1.

222

11

11.4

An Analysis of the German Legal Framework and the (Limited) Influence of EU Law Conclusion

Some features of the German system might be regarded as ‘best practices’. The system of responsible lending is now built on two pillars: supervision, on the one hand, and contract law sanctions, on the other hand. The supervisory system is an authority supervision system, but has an element of use of knowledge of private entities (single and collectively) built in. The contract law sanctions system is composed of lowering interest rates, giving a right to premature termination and denying claims for damages. As for the insolvency regime, the German system offers debt relief to all insolvent debtors (even if they cannot pay the costs of the proceedings) and has, to some extent, a sophisticated system of time periods leading to debt relief, depending on the debtor’s ability to pay the costs of proceedings and/or a certain percentage of their debts. There are, however, some areas where room for improvement can be identified. First, the absence of a general definition of over-indebtedness makes it difficult to ascertain exactly how many cases of over-indebtedness exist, what their reasons are, how severe they are and how best to tackle them. Introducing a general framework for collection and analysis of data and providing guidance through agencies might help. Second, the causes of over-indebtedness and the remedies available do not seem to work most effectively. While there is a system in place to ensure responsible lending, this system will prevent only those consumers from taking out credit who are unlikely to repay the loan as assessed before the loan is granted; in other words, loans must not be given if it was a miscalculation on the part of the consumer to ask for them. Miscalculations, however, account for only about 10% of all cases of over-indebtedness. While it is certainly worth tackling these cases, rules on responsible lending, however well drafted, will not help in the majority of cases of over-indebtedness where the cause is unemployment, illness, divorce or separation or failed self-employment. In this respect one needs to think about other solutions, such as a mandatory insurance system. Third, the insolvency regime, while certainly consumer-friendly in many respects, fails to some extent to achieve its aim, which is to grant a fresh start to consumers. Looked at it from this perspective, the recent development of extending the scope of rights that are exempted from debt relief is a step in the wrong direction. It will not help creditors either: if debtors feel that initiating insolvency proceedings will not really help them in the long term because of high debts surviving debt relief, they may not even start the proceedings, thus remaining in a situation where they are most unlikely to repay any amount of their debts to any of their creditors.

223

Part IV Greece

12

The Dimensions of the Crisis and the Response of Greek Private Law – A General Overview

Georgios Mentis*

12.1

Introduction

It is more than obvious that the financial crisis in Greece still prevails, creating an extraordinary and unforeseen (if one looks back at the times of euphoria, namely the decade 2000-2009) emergency situation with legal, economic and social dimensions, which is not expected to be easily overcome.1 It is a fact that loans to households in Greece, including housing loans and credit cards, increased rapidly and rather irrationally during the decade 2000-2009, after the introduction of the Euro. The average Greek consumer owed banks approximately €1,700 in 2000, and in 2009 this figure reached approximately €14,900 (an increase of approximately 800%! See Table 12.1). Did this happen without the knowledge and support of the European banking system? In comparison, the average German consumer had a debt of about €11,300 in 2000 and of about €12,700 in 2009 (an increase of 13%; see Table 12.2 below). What is more, we face an absurd and unreasonable result: the average Greek consumer in 2009 has a higher banking debt than the average German consumer, even though the average income of the Greek consumer is less than 40% of that of the German consumer (see Table 12.3).

* 1

Dr Georgios Mentis is Assistant Professor in Law, Law Faculty, University of Athens, Attorney in the Athens Bar Association. Concerning the legal aspects of the Greek crisis see Mentis and Pantazatou, in Micklitz and Domurath (eds.), Consumer Debt and Social Exclusion in Europe, Burlington, Ashgate, 2015, Part II, Chapter 3, Country Report Greece, p. 29 et seq; Mentis, Άμυνα και ελευθέρωση του υπερχρεωμένου οφειλέτη (Defense and Release of an Over-indebted Debtor – the Way to a New Seisachtheia between Civil Law and the New Insolvency Law), Athens, P.N. Sakkoulas, 2012, p. 73 et seq; Mantzoufas, Οικονομική Κρίση και Σύνταγμα (The Economic Crisis at the Greek Constitution), Athens-Saloniki, Sakkoulas, 2014, p. 105 et seq. See also Study on means to protect consumers in financial difficulty, Final Report, , 2012, p. 51 et seq. Concerning the economic and social consequences see Tsamourgelis, Ο ρόλος των τραπεΦών και του ευρώ στην ευρωπαϊκή και ελληνική κρίση (The Role of Banks and of Euro in the European and Greek Crisis), Athens, Papazisis Editions, 2016, p. 171 et seq.

227

Georgios Mentis

Table 12.1 Loans in Greece (2000-2009) Year

Total amount of loans

Loans to enterprises

2000

59,330.0

2001

Loans to households Total amount

Housing loans

Consumer credit

Other

42,360.3

16,969.7

11,271.8

5,511.4

186.5

74,027.4

50,198.7

23,828.7

15,652.2

7,852.0

324.5

2002

86,510.5

55,012.2

31,498.3

21,224.7

9,755.4

518.2

2003

101,178.10

60,979.3

40,198.8

26,534.2

12,409.6

1,255.0

2004

123,993.8

71,433.0

52,560.8

34,052.2

17,053.8

1,454.8

2005

149,903.2

81,009.5

68,893.7

45,419.8

21,825.10

1,648.8

2006

179,452.3

93,575.8

85,876.5

57,145.0

26,596.6

2,134.9

2007

215,405.2

111,288.8

104,116.4

69,363.3

31,942.40

2,810.7

2008

225,052.9

107,849.8

117,203.0

77,700.0

36,435.0

3,068.0

2009

249,677.0

130,043.0

119,635.0

80,559.0

36,044.0

3,032.0

In million Euros. Source: Economic Bulletin (Στατιστικό Δελτίο Οικονομικής Συγκυρίας), Bank of Greece.

Table 12.2 Loans in Germany (2000-2009) Year

Total amount of loans

Loans to enterprises

2000

2,186,000.0

1,280,500.0

905,500.0

683,000.0

222,600.0

2001

2,235,700.0

1,309,000.0

926,700.0

704,300.0

222,400.0

2002

2,240,800.0

1,291,300.0

949,500.0

725,100.0

224,300.0

2003

2,241,200.0

1,265,600.0

975,600.0

744,700.0

230,900.0

2004

2,223,800.0

1,224,400.0

999,400.0

762,400.0

237,000.0

2005

2,226,300.0

1,213,400.0

1,012,900.0

778,900.0

234,000.0

2006

2,241,900.0

1,218,500.0

1,023,400.0

795,000.0

228,400.0

2007

2,288,800.0

1,273,600.0

1,015,200.0

791,600.0

223,700.0

2008

2,357,500.0

1,346,100.0

1,011,400.0

787,300.0

224,000.0

2009

2,357,600.0

1,340,100.0

1,017,500.0

790,000.0

227,500.0

In million Euros. Source: Monthly Report of Deutsche Bundesbank.

228

Loans to households Total amount

Housing Consumer credit loans

12

The Dimensions of the Crisis and the Response of Greek Private Law – A General Overview

Table 12.3 Loans per inhabitant (on average) Year

Greece

Germany

2000

1,696.97

11,318.75

2001

2,382.87

11,583.75

2002

3,149.83

11,868.75

2003

4,019.88

12,195.0

2004

5,256.08

12,492.50

2005

6,889.37

12,661.25

2006

8,587.65

12,792.50

2007

10,411.64

12,690.0

2008

11,720.30

12,642.50

2009

14,954.37

12,718.75

In Euros.

The introduction of a completely different currency (which was totally strange to the Greek consumers), namely the Euro, together with the multiplication of loans and the ease of lending, followed by massive advertising and by a complete lack of control of creditworthiness ability2 – despite the existence of an organized credit bureau – in a mode completely different from that in the past, led to overconsumption and over-indebtedness, which had already occurred before the financial crisis.3 The financial crisis undoubtedly worsened the situation, given that many consumers lost their jobs (the ‘official’ unemployment rate in Greece stands at approximately 30%, compared with just 10% in 2008)4 or a major part of their salaries or pensions (these reduced by 40%-50% on average).5 As a result, Greek debtors could not pay off their loans anymore, although they were repaying them with great difficulty in any case even before the financial crisis.

2 3 4 5

Association of Greek Employed Consumers, , last accessed February 2016. See also Tsamourgelis, supra note 1, p. 122 et seq. Brissimis, Garganas and Hall, Consumer Credit in an Era of Financial Liberalisation: an Overreaction to Repressed Demand?, Bank of Greece, Working Paper 148, October 2012, p. 11. See Eurostat Data, . See the decisions of the Council of the State (Conseil d’ Etat, Συμβούλιο της Επικρατείας, Symvoulio tis Epikrateias) Nos. 1116 and 1117/2014 (Greek language).

229

Georgios Mentis

12.2

The Implementation of Directive 2008/48 EU

During the financial crisis, Directive 2008/48 EU was implemented in Greek legislation with the Common Ministerial Decision Z1-699/2010.6 The Greek implementation contains a very interesting new regulation – similar to the Swiss one (Konsumentenkreditgesetz): Article 8 of the Common Ministerial Decision Z1-699/2010 provides the debtor’s discharge from any interest (or other cost) in case of irresponsible credit (in case of violation of the obligation to assess the consumer’s creditworthiness). The creditor maintains his claim for the loan principal.

12.3

Newcomer: Legislation on Consumers’ Insolvency

Furthermore, the financial crisis was the catalyst that led to the introduction in Greece of the law relating to consumers’ insolvency or private persons’ or households’ or non-merchants’ insolvency (Law 3869/2010) in the year 2010. This law did not exist in Greece until then, since its establishment was unnecessary given the low and reasonable lending before 2000. The recent model of ‘development’ (based on the increase in demand, consumption, indebtedness in order to consume, over-indebtedness in order to over-consume) also needs a mechanism of discharge of the over-debts in order to create new incentives for new consumption. The Consumers’ Insolvency Law (3869/2010, as amended and currently in force) provides discharge of the debtor in three years7 after compliance with the instalments programme arranged by the Court.8 In case of serious problems (such as unemployment, illhealth, etc.) the Court will indicate a grace period or zero payments (null-plan).9 In addition, the law provides for some over-indebted debtors, under certain conditions,10 to protect 6

For more on this topic see Pelleni-Papageorgiou, Ζητήματα από τις νέες ρυθμίσεις για τις συμβάσεις καταναλωτικής πίστης (Aspects of the New Regulation on Consumer Credit Contracts), Athens, A. Sakkoulas, 2012, p. 223 et seq; Mentis, supra note 1, p. 32 et seq; Tassikas, Η υποχρέωση του πιστωτικού φορέα για αξιολόγηση της πιστοληπτικής ικανότητας του καταναλωτή (Τhe Obligation of the Credit Institution to Assess the Creditworthiness of the Consumer), Nomiko Vima 59 (2011), p. 2284 et seq; Bartsoka, Υπεύθυνος δανεισμός και επεξεργασία δεδομένων προσωπικού χαρακτήρα (Responsible Credit and the Processing of Personal Data), Athens, A. Sakkoulas, 2014, p. 40 et seq. 7 For the time being (January 2016), according to the recent amendment Law 4346/2015, the release period is three years. At first the corresponding period of debts’ settlement was four years and then, according to the amendment Law 4161/2013, from three to five years, at the Court’ s discretion. 8 For this law see Kritikos, Ρύθμιση οφειλών υπερχρεωμένων φυσικών προσώπων (Regulation of Over-indebted Physical Persons’ Debts), Athens, Dikaio kai Oikonomia P.N. Sakkoulas, 2012; Venieris and Katsas, Εφαρμογή του ν. 3869/2010 για τα υπερχρεωμένα φυσικά πρόσωπα (Implementation of the Law Nr 3869/2010 for the Over-indebted Physical Persons), Athens, Nomiki Vivliothiki, 2016; Mentis, supra note 1, p. 149 et seq. 9 Magistrate Court of Kavala 161/2012, NOMOS Data Base. 10 If (a) the property serves as the principal residence of the debtor, (b) the monthly family income does not exceed the reasonable living expenses plus 70%, (c) the taxable value of the property does not exceed the

230

12

The Dimensions of the Crisis and the Response of Greek Private Law – A General Overview

their homes (whether under mortgage or not) from the auction by paying for up to twenty years, or in some cases up to thirty-five years, an amount more or less equal to the value of the house11 in instalments and at a relatively low interest rate. More than 200,000 applications for such debt regulation have been filed in Courts until today and are still pending. Because of the congestion in litigation procedures, hearings were usually scheduled after many years (2030!), and until then the debtor would demand from the Court temporary injunction, which would suspend enforcement procedures and indicate low monthly instalments. For that reason, a new Law (4346/2015) has been introduced to accelerate the procedure, which, however, is being stalled by practical difficulties (insufficient staff). In addition to the non-merchants’ insolvency, other laws (such as Law 4161/2013, Facilitation of cooperative debtors) provided further legal paths to cooperative debtors who fulfilled a series of strict conditions (concerning their income, the value of their assets, the reduction of their income since 2009, etc.) in order to ask credit institutions (creditor) for an extrajudicial settlement of their mortgage loans. If the debtor fulfilled all the conditions provided by the Law, the credit institution was legally obliged to accept the settlement. The programme of facilitation gave the debtor a grace period of up to forty-eight months, during which the debtor had to pay reduced monthly instalments (equal to 30% of the debtor’s monthly family income). This measure was in force until the end of 2014, but turned out to be less effective because of the strict and unrealistic conditions it stiplulated. According to Law 4224/2013, as amended and supplemented by Law 4281/2014 and by Credit and Insurance Committee Decision 116/25 August 2015, the Banking Code of Conduct was introduced for the management of non-performing private debt. This Code establishes general principles of conduct for the lender and the borrower in order to select an appropriate regulation of the arrears of the collaborative borrower (extension of debt, reduction in the interest rate, grace period, datio in solutum, etc.). Law 4224/2013 is not binding on banks and constitutes a kind of soft law. Regardless of the Law concerning the households’ insolvency, because of the financial crisis the Greek legislature introduced in 2009 (which was extended since then every year until 31 December 2013) suspension of the auctions (auction moratorium) carried out by

amount of €180,000 plus €40,000 for a married debtor plus €20,000 per child and up to three children and (d) the debtor can be characterized as ‘cooperative’, according to the Bank Code of Conduct, issued by the Bank of Greece, then the debtor can ask for protection of his/her home. It should be mentioned that the taxable value of an apartment in a middle-class neighbourhood of a big city (e.g. Athens, Thessaloniki, Patra, Larissa, Iraklion) does not exceed 1,500 Euros/sq.m. This means that for a family with two children an apartment of a maximum of 170 m2 (approximately) could be protected, if the other conditions are also fulfilled. 11 This provision applies to the applications submitted from 1 January 2016 onwards. The previous legislation provided that the debtors would pay up to 80% of the taxable value of their home, and before that up to 85% of the commercial value of their property.

231

Georgios Mentis

credit institutions for debts that did not exceed €200,000. Furthermore, through various legislative acts, a general suspension of the auction of a debtor’s (either a merchant or a private person) main residence was established, provided that the value of the house did not exceed a particular limit (for instance, concerning the house of a married debtor with two kids, this value limit amounts to approximately €400,000). If the value of the house exceeds this amount, the auction is not suspended. This measure expired on 31 December 2013, and its extension was in doubt under the pressure of the representatives of the creditors’ states and organizations (‘Troika’). In 2014 the suspension conditions became stricter (Law 4161/2013). For the time being, the last suspension of executions expired on 31 October 2015, but this time the suspension was also the result of the capital controls (18 July 2015, Official Government Gazette Α’ 84/18 July 2015, amended through various acts till today, but still in force). There is no other legal protection of consumers from evictions.

12.4

Over-Indebtedness and the Good Faith Principle

The Courts, and many authors as well, accept that in some cases the judicial exercise of the creditor’s right to require its full claim is prohibited during the crisis by virtue of the general principle of good faith, according to Article 28112 of the Greek Civil Code (prohibition of abuse of right), if it leads to the debtor’s economic disaster without serving any reasonable interest of the creditor.13 It is disputed whether the good faith principle (see also Arts. 28814 and 38815 of the Greek Civil Code, clausula rebus sic stantibus, unforeseen change of circumstances) may even lead to a haircut of the debt.16 12 “Article 281 – Abuse of right. The exercise of a right shall be prohibited if such exercise obviously exceeds the limits imposed by good faith or morality or by the social or economic purpose of the right.” 13 See Areios Pagos 1352/2011, Data Base NOMOS. Mentis, supra note 1, p. 142 et seq. 14 “Article 288 – A debtor shall be bound to perform the undertaking in accordance with the requirements of good faith taking also into consideration business usages (similar to §242 BGB).” 15 “Article 388 – Unforeseeable change of circumstances. If having regard to the requirements of good faith and business usages the circumstances on which the parties had based the conclusion of a bilateral agreement have subsequently changed on exceptional grounds that could not have been foreseen and the performance due by the debtor taking also into consideration the counter-performance has as a result of the change become excessively onerous, the Court may at the request of the debtor and according to its appreciation reduce the debtor’s performance to the appropriate extent or decide the dissolution of the contract in whole or with regard to its non performed part. If the dissolution of the contract has been decided the obligations to perform arising therefrom shall be extinguished and the contracting parties shall be reciprocally obligated to restitute the performances by which each benefited pursuant to the provisions governing enrichment without just cause.” 16 Mentis, supra note 1, p. 136 et seq; Dellios, Εκκρεμείς τραπεΦικές πιστωτικές συμβάσεις σε περιόδους οικονομικής κρίσης (Pending Bank Credit Contracts in Times of Economic Crisis), Chronika Idiotikou Dikaiou (2012), p. 245 et seq; Doris, Η δικαστική διάπλαση του περιεχομένου εκκρεμών συμβάσεων σε περιόδους οικονομικής κρίσης (The Judicial Adjustment of Pending Contracts in Times of Economic Crisis), Chronika Idiotikou Dikaiou (2012), p. 241 et seq.

232

12

The Dimensions of the Crisis and the Response of Greek Private Law – A General Overview

It seems to me that there are no other solutions except the following two: a. A direct haircut of debts, which means an open reduction of the sum due. This haircut could be calculated according to the difficulties of each debtor, could be conditional, which means under the condition that the debtor really pays the reduced debt, and could be based on the good faith principle or on a new debt-reduction legislation. b. An indirect haircut of debts coming through long extension of debts and serious reduction of the interest rate.

12.5

Concluding Remarks: In Other Words

The economies of today are increasingly building their existence on an (unknown)overestimated future.17 That is why they prefer the second way, the way of hidden haircuts. I strongly believe that the days of the overestimation of the future, the days of overproduction and overconsumption are behind us. We need a new concept, a new human metron, a new human balance between yesterday, today and tomorrow.

17 See Joseph Vogl, Das Gespenst des Kapitals (The Specter of Capital), 2nd ed., Zurich, Diaphanes Verlag, 2011, p. 115 et seq.

233

13

(Failure to Set up an Efficient) Out-of-Court System to Deal with Debtors in Financial Distress in Greece

Melina J. Mouzouraki*

13.1

Introduction

It is about forty years since Europe developed an economic model where credit became widely available to the vast majority of consumers. Along with credit came the problem of consumers’ over-indebtedness. Some European governments took initiatives to deal with this problem by adopting legal frameworks for debt adjustment and debt relief. Following the recession of the 1990s, some European jurisdictions took a more proactive approach in this area in the form of financial education, money and budgeting advice policies. In some other European countries, whose financial markets opened their heavenly doors to the credit paradise at a later stage, the extremely rapid build-up of household debt in the years after 2000 triggered unprecedented financial distress after the global financial crisis. Consumer insolvency is thus recognized as a systemic risk. Moreover, the financial crisis in 2007/2008 showed that consumer protection in some financial markets (clearly in the US) was highly deficient in the run-up to the crisis. If consumers in the US had been better protected against predatory lending practices and mis-selling of credit products, especially mortgage products, the whole sub-prime market would not have developed as it did.1

* 1

Lawyer and legal adviser of the Hellenic Consumers’ Association E.K.PI.ZO. As the World Bank’s Insolvency and Creditor/Debtor Regimes Task Force stated in its January 2011 meeting: “One of the lessons from the recent financial crisis was the recognition of the problem of consumer insolvency as a systemic risk and the consequent need for the modernization of domestic laws and institutions to enable jurisdictions to deal effectively and efficiently with the risks of individual over indebtedness.”

235

Melina J. Mouzouraki

13.2

The Greek Case

Greece has been struggling since 2009 to deal with its deep economic crisis. Its economy has reduced by 25%. Unemployment has risen rapidly and currently persists at the extraordinary rate of 25%. Household budgets are blown away, because of income cuts and unemployment, and the social welfare state is falling apart. An important part of Greek society lives below the poverty threshold, or faces the immediate threat of falling below it.2 Already in the years that preceded the onset of the crisis, indeed for ten years prior to it, the credit industry was allowed to expand credit in geometric progression – with no restrictions. This expansion took place without any care for mis-selling, inappropriate selling of financial products or any mechanism for provision of financial advice to consumers. The problem of over-borrowing and over-indebtedness inevitably assumed significant dimensions. In many households, the economic crisis created an unbridgeable gap between the era of carefree credit expansion and private consumption and the new reality. Even households that had prudently managed their finances face difficulties in fulfilling their financial obligations. The future income that was used by both borrowers and lenders as the basis for the credit or mortgage is no longer there and is unlikely to be in the time scale of the repayment of the loans. The values of the assets have considerably fallen during the last few years.3 This specifically concerns a sub-group of consumers of credit, namely those who borrowed heavily to purchase or improve their family home after the year 2005, when real estate values rose significantly. Another specific group of credit is related to the loans denominated in foreign currency which were launched by creditors in the market in the years 2007-2009.4 In the light of this situation, a national strategy to assist consumers in financial distress – due to be in place along with the credit expansion to reduce its expected side effects – should be adopted and implemented as rapidly as possible.

2

3

4

The over-indebtedness of European households: updated mapping of the situation, nature and causes, effects and initiatives for alleviating its impact – Country report: Greece. Study conducted in 2013 by Civic Consulting for the European Commission, Directorate General Health and Consumers. Bank of Greece, Annual Report of February 2015 regarding the year 2014: the values of real property fell during 2014 by 7.5% in relation to the year 2013, whereas the fall was at 10.9% during the year 2014 in relation to 2012, and 11.7% during 2012 in relation to 2011 (pp. 93-95). This case concerns around 60.000 borrowers that have Swiss francs denominated loans. The borrowers have seen their loans inflate as a result of the Swiss franc gaining significant strength against the euro. Some borrowers have filed lawsuits against the creditors disputing the legality of loans in foreign currency, as well as the lack of proper information at the pre-contractual stage as to the inherent risk in the fluctuation of the currency. Nevertheless, such legal cases have had, to date, rather poor results. Meanwhile, creditors in Greece are not willing to share the loss and only accept to come to short-term forbearance arrangements with the borrowers.

236

13

(Failure to Set up an Efficient) Out-of-Court System to Deal with Debtors in Financial Distress in Greece

13.3

Need for a Holistic Policy to Assist Consumers in Financial Distress

It is widely accepted that a multipronged approach is required to prevent consumer detriment in financial services. Such an approach is also required when treatment of overindebtedness is discussed.5 This approach needs to engage all possible tools to empower the consumer at every stage of his or her relationship with a financial product – i.e. during the first stage, when a consumer wishes to acquire a new financial product; during the second stage, which is the actual acquisition; during the third stage, while the consumer holds the product (e.g. a loan); and at the final stage when the product matures or undergoes involuntary liquidation. I fully endorse the recommendations made by the 2014 London Economics Study on “Consumer Protection Aspects of Financial Services” to strengthen consumer protection in the area of financial services,6 some of which I hereby state in brief: a. Benefits of providing lifelong financial education are recognized for individuals, for society and for the economy.7 Indeed, European and international institutions call for better financial education and improved financial literacy, and improved financial information provision. Similar issues are addressed by the 2014-2020 Consumer Program8; b. Provision of accurate, simple, comparable information concerning financial products to reduce the information asymmetry between consumers and financial service providers; c. National authorities should adopt a proactive approach to ensure that financial markets work well. National authorities should make regular use of (a) consumer satisfaction surveys and (b) mystery shopper exercises to gather actual information on the behaviour of sellers of financial products (see, for example, the Financial Conduct Authority in the UK). Regulators should also prohibit retail financial products that they view as being too complex for consumers to be able to understand or as being too risky for

5

6

7 8

According to the conclusions and recommendations included in the Opinion of the European Economic and Social Committee on “Consumer Protection and appropriate treatment of over-indebtedness” (2014/C 311/060 “If over-indebtedness is to be properly addressed, education, prevention and appropriate measures for reintegrating over-indebted people into normal life is needed. To this end, an overall perspective of the issue of household over-indebtedness and effective measures are essential.” Study on Consumer Protection Aspects of Financial Service, requested by the European Parliament’s Committee on Internal Market and Consumer Protection, London Economics. February 2014 Executive Summary pages 10-17. Communication from the Commission on Financial Education (COM/2007/0808/FINAL). In this communication, the Commission defined the principles for the provision of high-quality financial education schemes. Regulation (EU) No 254/2014 of the European Parliament and of the Council of 26 February on a multiannual consumer program for the years 2014-2020 and repealing Decision no 1926/2006/EC.

237

Melina J. Mouzouraki

d.

e. f.

g.

consumers. For example, in 2010 the Swedish FSA (Finansinspektion) introduced guidelines limiting mortgages to a maximum loan-to-value (LTV) ratio of 85%; Sanctions (financial penalties, probation to undertake certain activities for a certain period, etc.) for misbehaviour or inappropriate behaviour by sellers of retail financial products should be made more exacting so as to increase the deterrence effect and incentivize financial firms to treat their customers fairly and honestly. Financial institutions should also be systematically liable for adequately compensating consumers who suffered detriment as a result of inappropriate behaviour of financial institutions; Consumers should have access to an independent, fast, efficient and inexpensive dispute resolution mechanism to address any unresolved disputes with financial institutions; A system should be in place where consumers have access to free, independent, nationwide, high-quality financial advice (including money, budgeting, debt aspects); and Last but most important, consumers should have access throughout the EU to easy, fair and cost-efficient exit mechanisms that allow them to escape from over-indebtedness and be given a second chance, i.e. a legally binding framework for debt relief. Such a system has undisputable salutary effects for creditors, debtors and society as a whole.

An efficient debt-adjustment and debt-relief formal framework is of utmost importance also because all the other above-mentioned policy measures, useful and beneficial as they may be, cannot prevent consumers, even those with developed financial literacy, from taking erroneous decisions in financial markets. Indeed, behavioural science has revealed systematic and persistent psychological biases and mental shortcuts that consumers use in making welfare-jeopardizing decisions and predictions when borrowing. If these forces cannot be controlled or counteracted, as behavioural economics suggests, perhaps consumer bankruptcy systems can only offer effective relief as opposed to effective treatment of overindebtedness biases.9

13.4

The Current Greek Policy to Assist Consumers in Financial Distress – Lacunae Thereof

In response to the inability of overwhelming numbers of debtors to repay their debts, the Greek government adopted in 2010 a formal insolvency procedure for natural persons,10 following the example of existing European legal traditions. The framework adopted is court oriented and was very much welcome by a needy society. Since January 2011, 9

Jason Kilborn, Behavioral Economics, Overindebtedness & Comparative Consumer Bankruptcy: Searching for Causes and Evaluating Solutions, Emory Bankruptcy Developments Journal, 2005, Vol. 22, p. 44. 10 Law 3869/2010, as amended by Laws 4161/13, 4336/2015 and 4346/2015.

238

13

(Failure to Set up an Efficient) Out-of-Court System to Deal with Debtors in Financial Distress in Greece

approximately 180,000 debtors have applied to the Greek courts seeking debt adjustment and debt relief, as the case may be. The Greek legislator adopted the basic principles of a fresh start to be earned by the debtor in a payment period, which was initially set at four years. The Greek regulator also provided for the right of the debtor to keep his or her primary residence, on the condition that he or she pays to the creditors in an extended repayment period of approximately twenty years a total sum almost equal to the value of the home. The Greek regulator combined the need to give incentives to the over-indebted to be socially integrated, seek work and keep up payments to the creditors with the local culture of home ownership in Greece (the response of Greek citizens to the complete lack of social policy in housing). While no other policy was put in place to manage the debt crisis, and until such a policy was put in place, the Greek parliament voted for a moratorium on foreclosures of debtors’ dwellings (irrespective of the amount of debt), as well as on any real property regarding debts up to €200,000. The moratorium was not extended after 2014. The law was amended twice during the last four months of 2015. Against the reasoning of recent guidelines and reports on international insolvency matters, which highlight the advantages of an efficient and inclusive framework of insolvency of natural persons,11 Greece, deciding under the close supervision of the quartet representing the interest of its international creditors in the third assistance package (IMF, ECB, ESM and the European Commission), chose to make the law on debt adjustment and debt relief more bureaucratic, costly, less accessible and less attractive to the over-indebted natural persons. The modified version of the law rules out the possibility of exempting the debtor’s primary residence from liquidation, except for a transitory phase of the next three years, i.e. up to 2018 and under very severe conditions. A legal framework on court-centred debt relief should clearly not and cannot be the only tool to deal with over-indebtedness for any country, especially for a society that is confronted with a situation as acute as the one in Greece. As stated above, a broad and differentiated policy is needed to deal with the different ‘phases and faces’ of the debt problem. The burden of management of excessive debt and of the difficulty or inability to repay cannot be borne by the judicial system of the country. Moreover, an essential aspect of the design of a regime of formal insolvency is its interaction with informal systems for resolving financial distress amicably.12 Advantages

11 Several international reports point to the advantages of a non-burdensome and least bureaucratic insolvency procedure, for example, World Bank Report on the Treatment of the Insolvency of Natural Persons, 2013. See also Jason Kilborn, Expert Recommendations and the Evolution of European Best Practices in the Treatment of Over-indebtedness, 1984-2010 (21 August 2010), available at: . 12 See supra note 11, Conclusions of the World Bank report.

239

Melina J. Mouzouraki

inter alia include avoiding stigma, low cost relative to formalized insolvency proceedings and better outcomes for creditors. Although the data on the debts in arrears, business debts, as well as household debts, both mortgages and consumer credit, have been accruing at a frenzied speed, calling loudly for urgent mobilization of all stakeholders for a consensual national policy on debt management, national authorities in Greece have proved unable to draw up a plan to assist debtors in financial difficulties. Debtors, guarantors and their families have been left alone to understand, evaluate and negotiate accommodations offered by the lenders. In fact, since 2007, lenders have been offering standard temporary accommodations, most typically ‘interest-only’ or less-than-interest-only, payments, or a payment moratorium of a limited period, such as a six months or one or two years, subject to review and renewal. The longer these temporary arrangements subsisted, the more likely it was that eventually the lender would seek a larger payment that the borrower would simply not be in a position to make, given that in the recession, borrowers’ economic circumstances have, generally speaking, tended to deteriorate or to stagnate rather than to improve. The lenders have not been willing to offer repayment plans that would take into account the financial situation of the debtor specifically, and certainly have not been offering a write-down of the debt, including mortgage debt, to serviceable levels, even if a specific case strongly pointed to this.13 Faced with a complete lack of free debt advice (except for the heroic low-budgeted non-governmental associations, especially consumer associations, which have been continuously providing advice services to consumers), and lacking the resources to access professional advice, debtors have been clueless about which repayment arrangement best suits their interests, are lost in the labyrinth of the legal and economic effects of the presented ways to deal with their debts and fight shy of negotiating even if they sense that a proposed arrangement does not meet their payment capacity. They have therefore either accepted repayment plans that, at the end of the period agreed, only raised the amount of debt owed or simply chose to abandon their affairs and faced debt cancellation and legal action against them.

13.4.1

The Government Council for the Private Debt Management

In this context, in 2013, a law was adopted setting up a “Government Council for the Private Debt Management”, with the ambitious goals (a) of shaping policies regarding organizing 13 It is not astonishing that creditors had the same behaviour in other European countries facing debt problems, such as Ireland. Evidence is shown in the “Study of legal protections available for consumers of credit and other financial services in Ireland – Redressing the Imbalance”, published in March 2014 by FLAC.

240

13

(Failure to Set up an Efficient) Out-of-Court System to Deal with Debtors in Financial Distress in Greece

a mechanism of efficient management of non-serviced private debts, (b) of forming proposals to speed up procedures regarding debts in arrears and ameliorate the legal framework regarding purchase of real property and (c) of creating a network of debt management advice services.14 The law also provided for the publication of a Code of Conduct for the Management of non-serviced private debts to be issued by the Bank of Greece. Little, if any, action has been taken since 2013 towards realizing the above goals, except for the Code of Conduct. The latter, although adopted in August 2014 with the aim of entering into force as soon as possible, after several delays and postponements, came into effect only very recently, since 1 January 2016.15

13.4.2

The Code of Conduct – “the Cooperative Borrower”

Strikingly similar to the Bank of Ireland’s Code of Conduct on Mortgage Arrears,16 the basic purpose of the Greek Code of Conduct is to oblige the creditor to ensure that it has an accurate account of the borrower’s financial details in the form of an up-to-date Standard Financial Statement before it assesses how an arrears case might be resolved by putting in place an alternative repayment arrangement. A new legal figure comes into life in the debt management procedure: ‘the cooperative borrower’ (an obvious transplant of the slightly different Irish notion of ‘cooperating borrower’). The cooperative borrower is defined as one who fulfills the following obligations, specifically to (a) give the lender his full and updated contact details, (b) be available to make contacts and respond honestly to all communications from the lender, (c) provide to the lender all information the lender requires, (d) notify any significant change in his or her financial situation (income and assets) and (e) consent to the forming by the lender of an alternative arrangement or repayment plan. The timeline specified for applying with the above obligations of the borrower is set at fifteen working days. The procedure includes five stages: Stage 1: Communication with the borrower; Stage 2: Obtaining the financial information; Stage 3: Assessment of the data obtained by the borrower as well as by any other source; Stage 4: The offer of the appropriate arrangement or final repayment plan; and Stage 5: Procedure of complaints.

14 Law 4224/2013 “Government Council for the Management of Private Debt, as amended by Art. 107 para.1d Law 4316/2014, Law Gazette A 270/24 December 2014 and Art. 12 para. 2 of Law 4281/2014, Official Gazette A 160/8 August 2014. 15 Decision 27/2014 of the Commission on Credit and Insurance Issues, Bank of Greece (Official Gazette 2289/27 August 2014). 16 Central Bank of Ireland, Code of Conduct on Mortgage Arrears.

241

Melina J. Mouzouraki

In Stage 4, the lender proposes one or more alternative arrangements or repayment plans. When assessing the suitability of each possible solution, the lender is required to take into account the current supervision requirements, and the guidelines of Act 42/30 May 2014 of the Bank of Greece based on defined and transparent criteria set in this Act. Actually, this Act, endorsed three months before the Code, reflects that what the Bank of Greece and its Code is focusing on is the assessment of the risks, i.e. the promotion of a procedure of restructuring of the outstanding debts so as to support the lender’s portfolio categorizations, assessment and creditworthiness. Consumer interests are not in focus. This is among other things that are reflected in the omission and the failure to include representation of the consumer’s voice and interests in any instance of the procedure in the Code and its supervision by the Bank of Greece. It is also reflected by the fact that the Bank of Greece monitors the application of the procedure, but is clearly not involved in assessing whether the actual proposal made by the lender to the ‘cooperative’ borrower is actually appropriate or not or whether there could be a more suitable repayment plan or arrangement. An obligation of the lender is provided in the Code to inform the borrower that he or she is allowed to consult an advice agency. This is quite ironic, though, since, as already stated, there is no mechanism of debt advice put in place by the authorities, except for debt advice offered by consumer associations on a voluntary basis in some of the major Greek cities.

13.4.3

Failure to Include an Appeals Mechanism

At first glance, the Code seems to expand the range of alternative repayment arrangements that a lender is obliged to consider in respect of a borrower in arrears. Significant new options include split mortgages and reducing the principal sum to be paid (in other words, debt write-down). Indeed, the Code could help in debt management, if the lenders, who have the responsibility of proposing to the debtor repayment solutions, do respond to this responsibility proposing realistic, viable and tailor-made forbearance arrangements. Nevertheless, there are no adequate and efficient provisions adopted that guarantee that this will be the case. The proposed repayment arrangement or solution is not the object of supervision by the Bank of Greece or anybody else. The Bank of Greece monitors the application of the procedure and is clearly not involved in the actual proposal. The lender only has the obligation to inform the borrower of the reasons why a particular arrangement is considered to be appropriate and sustainable for his or her circumstances, but not why specific options that were examined were ruled out. Under the Code, after receiving the lender’s proposed plan, the borrower has the right to draft his or her own proposed arrangement or plan and

242

13

(Failure to Set up an Efficient) Out-of-Court System to Deal with Debtors in Financial Distress in Greece

notify it to the lender, but the lack of transparency as to the specific data, criteria and assessment tools on which the proposal of the lender is based impedes the borrower in disputing the assessment made by the lender. Moreover, in the code a right of the borrower to file a complaint after receiving the final proposal by the lender is provided, but this right is restricted to disputing the procedure itself and to whether the borrower is rightly or not characterized as ‘non-cooperative’. The borrower cannot dispute or argue on the assessment or the sustainability and viability of his or her case.17 After the procedure has failed, the borrower has the right to seek the intervention of the Consumers’ Ombudsman, as provided in the Code of Conduct. Again, this right cannot lead to any substantial change in the debtors’ case: The Consumer Ombudsman can only mediate to reach an amicable settlement, and cannot lead to any binding result. Thus, taking into account that the amicable settlement will have failed in the previous stages of the procedure, in which the proposed short-term or long-term forbearance arrangement though explained will not have been accepted by the borrower, low expectations rest for the involvement of the Consumer Ombudsman. It is, therefore, crucial to stress that borrowers should have the right of appeal to an independent third party not just on compliance with the mechanics of the Code of Conduct process, but also on the suitability of the final proposed arrangement or permanent repayment plan of the lender. In case of debt cancellation after the end of the process, consumers should have the right to appeal to a court against the misapplication of the due process, both procedurally and in essence, regarding the fairness and justification of the alternative arrangements proposed by the creditor. Indeed, a lender’s decision not to offer appropriate short-term or long-term forbearance arrangements to a borrower in arrears must be open to challenge, if the requirements of fair procedures are to be satisfied. Unless a proper appeals mechanism is put in place, the Code is rendered into nothing but a set of guidelines in a process that must be followed by lenders but where the outcomes of the process may not be effectively challenged by borrowers.18

13.4.4

The Issue of Multiple Creditors Is Not Addressed

For the vast majority of borrowers, debts involve several lenders. No out-of-court debt management system can make any serious impact, unless it provides for the communication and common workout by the multiple lenders of a common assessment repayment plan 17 See supra note 13. 18 Ibid.

243

Melina J. Mouzouraki

to be proposed to the borrower. The Code does not address this highly important issue. Ignoring the complexity necessarily involved in resolving the problem of multiple debt, the Code merely includes in its text the eight principles proposed by the International Association of Restructuring, Insolvency and Bankruptcy Professionals (INSOL) in case of multi-creditors. These principles state that all relevant creditors should be prepared to cooperate with each other to allow for a ‘standstill period’, during which they should agree to refrain from taking any steps to enforce their claims against their debt, and further state what all the relevant creditors would be expected to do. However, no initiative has been known to have been considered regarding any means of cooperating or communicating among creditors vis-à-vis the borrower under the Code. In that case, a borrower with more than one creditor lacks the incentive to cooperate under the Code since he logically expects that the short-term or long-term forbearance proposal will not take into account the claims of the competitive creditors.

13.4.5

Inappropriate Involvement of the Notion of ‘Cooperative Borrower’ under the Code in the Formal Insolvency Procedure

The Code provides that a lender is not allowed to cancel a debt unless it has sought and failed to conclude with the borrower an out-of-court consensual debt arrangement plan, who is then named as ‘non-cooperative’. The notion of ‘non-cooperative’, which is thus primarily adopted and used in this out-of-court consensual procedure of debt arrangement, is most unfortunately, carried and used in the legal framework of the insolvency procedure of law on debt adjustment and debt relief. It is actually transformed into an entry barrier: Article 9 paragraph 2 states that to be entitled to an exemption from liquidation of the primary residence, “the applicant debtor must be a co-operative borrower, according to the Code of Conduct, where applicable”. Additionally, to apply for the procedure of debt relief of small debt (Art. 5a para. 1 of Law 3869/2010 as amended), the debtor must prove that “he is co-operative according to the Code of Conduct”. The out-of-court debt management system has a logic different from that governing the formal insolvency procedure in court. The first is consensual and driven mainly by the creditor. The second does not require any consensus and serves a broader goal of debt relief if the case is accepted and the debtor is in a situation of permanent inability to pay his or her debts, irrespective of internal criteria and assessment of the creditors. If the debtor knew or even thought that responding to the communication of the creditor under the Code is actually defining his or her right to protection of primary residence under the Law on Debt Relief (Law 3869/2010), he or she would respond to the Code not by choice (to manage his or her debts amicably), but by fear of sanctions. The creditor would have an important additional power, namely to use the out-of-court amicable procedure of the

244

13

(Failure to Set up an Efficient) Out-of-Court System to Deal with Debtors in Financial Distress in Greece

Code to broaden his information on the borrower or to undermine the possibility of the borrower to have access to the formal insolvency procedure provided in law.

13.4.6

The Way Ahead for Greece – The Elements Needed for an Efficient Out-of-Court Debt Management

Northern European jurisdictions that promote informal arrangements between creditors and borrowers rely on the provision of extended, free, high-quality debt advice to borrowers. In these countries, the importance of such advice in the interest of citizens’ well-being, with substantial benefits for individuals, families, communities, government, industry and society as a whole, has been affirmed.19 Without such advice, over-indebted people cannot navigate the labyrinth of complex legal provisions and financial elements. Networks of money and debt advice in the UK, Austria, Germany and the Scandinavian countries ensure that the interests of borrowers are reflected in the repayment plans and that they are in a position to negotiate such plans. They also assist borrowers and their households in better managing their income and expenses, encouraging financially capable behaviours. The networks of advice not only address those who actually seek advice and assistance, but also target the latent demand that emanates from individuals or households who are facing debt problems but, for one reason or another, are not actively seeking advice. The quality of the advisers is certified by competent bodies that are responsible for ensuring that the advisers meet certain criteria provided in law. Advisers are centrally monitored by umbrella organizations.20 Irrespective of the model of advice (by the state, by consumer associations, etc.), such a network is urgently needed in countries like Greece. European countries would benefit by common rules and minimum standards set by the European institutions as to the provision of money and debt advice to natural persons. International and European organizations promoting consumers’ interests could work together with the European institutions in this respect and assist national structures, such as consumers’ associations, in a bottomup approach.21 To date, a considerable number and variety of debt-management companies, lawyers and accountants are active in debt management in Greece. No criteria are set as to their protocol and way of working with over-indebted consumers. Several complaints related to low quality, inadequacy and high charges have been filed against such companies in the

19 Financial Capability Strategy for the UK. 20 See, for example, ASB Schuldnerberatung Austria. 21 European Consumer Debt Net (ECDN) is an umbrella organization of national structures active in money and debt advice.

245

Melina J. Mouzouraki

General Secretariat for Consumer Affairs (currently a Directorate General of the Ministry of Development). Moreover, debtors’ behaviour and circumstances should be monitored. Demographic information and statistics should be collected by an approved official mechanism and made public. Research should be conducted on important issues related to all phases of debt management, compliance, creditor behaviour, debt collection issues, debtor rehabilitation issues and others. Without transparent and reliable information, and without indepth qualitative studies, the policies in place cannot be adjusted so as to better address the ever-changing conditions of the debtors and the need for a better way to manage debts. Appropriate funding should be ensured. Lenders should be asked and expected to contribute to a fund that would raise the necessary resources for the funding of the network of advice centres nationwide, the funding of the necessary research and the monitoring of the efficiency of the policy applied. Without a system of free and high-quality advice and with a weak social welfare state, in a recession-hit economy, borrowers in arrears are terribly exposed. Since August 2015, a new legislative framework for foreclosures has been adopted. Foreclosure procedure is designed so as to end within eight months, during which period any legal arguments and disputes raised by the debtor in justice must have been concluded. No guarantee as to a minimum value of the property under forced sale is set in the new law.

13.5

Brief Conclusion

Greece and other countries that need to build or ameliorate their policies in debt management can draw inspiration from the work done in other European countries that have dealt with over-indebtedness long before the Greek debt trap. Best practices adapted to local culture can help significantly. International cooperation is accessible. European policy on consumer affairs also aims at empowering consumers vis-à-vis financial service providers. Greek society urgently needs a full-range, well-resourced strategy both to protect, to the extent possible, consumers facing the prospect of financial distress and to treat consumers experiencing it. This should be understood as an important parameter for the way out of the economic crisis.

246

14

The Greek Regulatory Framework on Responsible Lending

Christina Livada*

14.1

14.1.1

The Over-Indebtedness of Consumers

The Complexity of the Essential Elements of Over-Indebtedness

Over-indebtedness occurs when a person borrows beyond his means or when there is a situation in which a consumer does not have sufficient funds or disposable income to cover his economic obligations,1 irrespective of whether these obligations arise from a credit agreement(s) or from current economic liabilities of his household (e.g. payment of accounts and tax liabilities). The definition of both the notions ‘inability’ to cover economic obligations and ‘disposable income’ is crucial in the framework of regulatory intervention aimed at addressing over-indebtedness. More specifically, with regard to what constitutes ‘inability’, it is important to determine i. whether real weakness of repayment is required or whether the situation in which handling the debt is overwhelming for the consumer could be considered sufficient to conclude that there is inability for someone to cover his economic obligations, ii. when it can be considered that weakness to repay has occurred, and iii. on the basis of what criteria this weakness is calculated (e.g. what is considered for the purposes of calculation: the total assets of the person concerned or his net income only).2 On the other hand, the ‘disposable income’ of the consumer, i.e. the income remaining after the fundamentals have been covered (e.g. food, shelter, clothing), is directly linked * 1

2

Lecturer, Law School, National and Kapodistrian University of Athens. See Finlay, Consumer Credit Fundamentals (Palgrave Macmillan, 2009), 2nd edition, 73; Περάκη, «Η αρχή του «υπεύθυνου δανεισμού» και η πρόσφατη κοινοτική Οδηγία για την καταναλωτική πίστη», 3 Χρηματοπιστωτικό Δίκαιο (2009), 352, where the author mentions that the notion of consumer overindebtedness should not be confused with the notion of over-indebtedness in the framework of corporate insolvency law. For the latter, see Περάκη, Πτωχευτικό Δίκαιο (Νομική Βιβλιοθήκη, 2012), 117; Γκόρτσο, «Δίκαιο προστασίας του καταναλωτή χρηματοπιστωτικών υπηρεσιών: περιεχόμενο και ιδιαιτερότητες», 2 Χρηματοπιστωτικό Δίκαιο (2007), 165; Λιβαδά, Το νέο ευρωπαϊκό ρυθμιστικό πλαίσιο για την καταναλωτική πίστη (Νομική Βιβλιοθήκη, 2008), 27. See Γκόρτσο, supra note 1, 164.

247

Christina Livada to the determination of the costs of his living.3 In Greek law the term “reasonable living expenses” is found in the Code of Conduct of Law 4224/2013 for the management of loans in arrears and non-performing loans of individuals and enterprises.4 It lays down general principles of conduct and introduces best practices aimed at enhancing mutual confidence, ensuring engagement and information exchange between borrowers and lending institutions, so that each party can weigh the benefits or consequences of alternative forbearance or resolution and closure solutions for loans in arrears whereby the loan agreement has not been terminated, with the ultimate goal of working out the most appropriate solution for the case in question. Within the aforementioned framework, credit institutions should – under the conditions prescribed – design and evaluate viable arrears resolution solutions. Credit institutions are required to take into consideration the repayment capacity – current and future, as estimated on the basis of conservative and plausible assumptions – of each borrower, including his or her level of reasonable living expenses. The calculation of reasonable living expenses for individuals is based on data provided by the Household Budget Survey, which is conducted annually by the Hellenic Statistical Authority.5 However, reasonable living expenses cannot and should not be identified with disposable income, especially concerning the stage where the consumer is searching for credit. The context of the above-mentioned code of conduct for the management of non-performing loans is completely different from the situation where the consumer is looking for credit. Thus, the criteria to be used to assess his creditworthiness may differ significantly depending on whether the consumer is already a borrower or not. In other words, although

3

4 5

See Finlay, supra note 1, 75, who poses the question whether, for example, a car is an essential item of expenditure and, if so, what type of car and so on. See also European Commission Report “on the operation of directive 87/102/EEC for the approximation of the laws, regulations and administrative provisions of the Member States concerning consumer credit”, COM (95), 117 final, 11 May 1995, para. 368, 94, Council Resolution on consumer credit and indebtedness of 2001 (OJ C 364, 20 December 2001, para. 9 and especially para. 15, Department of Trade and Industry, Fair, Clear and Competitive, the Consumer Credit Market in the 21st Century [White Paper, 2003], 75). Official Gazette B 2289/27 August 2014 (under B. Definitions) at . The reasonable living expenses according to the methodology used by the Household Budget Survey are divided into four categories. By way of mere indication, the basic expenses of the first category included in the basket of households’ reasonable living expenses are the following: all expenses related to food, clothing and footwear; all residence-related expenses; all expenses linked to transportation, maintenance and repair of means of transport as well as the insurance premium of the car-motorcycle; all expenses for the use of urban and extra-urban transport services; expenses related to the repair and maintenance of durable household goods; all consumables for usual household consumption; expenses and services for individual hygiene and beauty treatment and other personal items; as well as expenses related to pets, expenses related to information and education, telephony and postal services, health-related items and services, training services, social protection services; and expenses for other financial services. See: (available only in Greek).

248

14

The Greek Regulatory Framework on Responsible Lending

the reasonable living expenses may provide useful guidance to the creditors, they should not be the sole criterion to be used to evaluate the disposable income of a potential borrower. Clearly, both notions of ‘inability’ and ‘disposable income’ may vary significantly, depending on the approach taken, the market concerned and/or the parameters on the basis of which they are determined each time, resulting in a difficulty to set commonly accepted criteria.

14.1.2

The Correlation between Over-Indebtedness and Responsible Lending

The correlation between over-indebtedness and responsible lending is not always evident despite the tendency to consider that they are directly linked.6 This is due to difficulties in the precise determination of the reasons that led to over-indebtedness in the first place, considering that it is not always easy to identify them or that over-indebtedness is the result of a combination of causes. However, the systematic identification of those causes is very important to legislate efficiently and rationally against over-indebtedness. As an illustration of the above, it is noted that a person’s over-indebtedness may arise from external causes, such as an unforeseen and substantive change of circumstances in his life (e.g. severe illness, sudden loss of job), or from a general crisis, such as the fiscal crisis of the past years in Greece, which may negatively alter the facts (e.g. fixed income and employment, tax liabilities) on which the consumer and the creditor were based, if the debtor had concluded a credit agreement(s).7 In this case, it is generally accepted that this ex post over-indebtedness is not the responsibility of either party since the events that led to it are beyond their control.8 6

7 8

See in detail Feretti, “The over-indebtedness of European consumers: time for a ‘fresh-start’ of the EU policy and legal agenda?” 11(4) European Review of Contract Law (2015), 5-11, who correctly states (at 9), “As surprising may be, the major causes for consumer over-indebtedness were already acknowledged in the literature, but they have been left unattended by policy-makers as if only excessive borrowing or lending were to be accountable.” See also Fairweather, “The development of responsible lending in the UK consumer credit regime”, in Devenney and Kenny (Eds.), Consumer Credit, Debt and Investment in Europe (CUP, 2012), 86. See Finlay, supra note 1, 73. See also the explanatory memorandum of the Swiss federal law concerning consumer credit (Message concernant la modification de la loi fédérale sur le crédit à la consommation, 14 December 1998, FF 1999, p. 2879 ss.), para. 142.2, p. 2891. A solution to deal partially with this contingency is provided by the Swiss regulation to tackle over-indebtedness in the framework of the law on consumer protection. In particular, it is provided that the examination of the consumer’s creditworthiness for the conclusion of a credit agreement is calculated for a maximum period of thirty-six months independently of the agreed duration of the credit agreement, which may be longer (see Loi sur le crédit à la consommation, Art. 28 para. 4). This regulation does not exclude the occurrence of an unforeseen event during the credit agreement; however, the likelihood of over-indebtedness is statistically restricted. According to the Swiss legislature, the longer the duration of the credit agreement, the lower the probability of a ‘precise’ forecast and the higher the statistical probability of a change in the data that both the creditor and the consumer knew at the conclusion of the credit agreement. On the other hand, this regulation may be problematic because it may have as a result the excessive restriction of consumers from access to credit, while such an

249

Christina Livada

On the other hand, over-indebtedness may also occur because the consumer undertook more debt than he could afford, as the average consumer tends to be over-optimistic with regard to his future revenues or because he does not always behave in a rational way.9 Another reason could be that the creditor did not provide him with the appropriate information concerning the cost of the credit granted to him and the risks inherent to it or that the creditor did not assess the consumer’s creditworthiness soundly or that a combination of these factors was responsible. In these cases, regulatory measures, such as the legislative establishment of the principle of responsible lending10 may play a significant role in the prevention of over-indebtedness. In any case, for the adoption of efficient rules in the framework of regulatory intervention exercised to address over-indebtedness, the interests of both parties (creditor and borrower) should be taken into account together with a responsible approach on the part of both parties to the granting or undertaking of credit by avoiding strict measures that do not allow for any flexibility. In addition, the more precise and sound the identification of the reasons leading or potentially leading to over-indebtedness is, the easier it will be to exercise efficient regulatory intervention, as is the case for regulatory intervention in general. The adverse effects of over-indebtedness, whose growing trend in the past years11 has been a cause for serious concern, have economic, social, psychological and legal dimensions, which are assessed and addressed in different ways, depending on the characteristics, culture and traditions prevailing in each society and each market, as well as on the political and legal approach adopted each time.12 Those effects are not limited to the consumer himself, approach is not suitable for mortgage credit, where the loans have a generally long duration (far more than thirty-six months). See also Giannone, Lenza and Reichlin, Business Cycles in the Euro Area (ECB Working Paper Series, No 1010, February 2009), 21, available at: . 9 See Message concernant la modification de la loi fédérale sur le crédit à la consommation, 14 December 1998, FF 1999, under 122, p. 2889, Commission Staff Working Paper, Impact Assessment, Accompanying Document to the Proposal for a Directive of the European Parliament and of the Council on Credit Agreements Relating to Residential Property (SEC, 2011, 356), Vol. II, 203; Financial Services Authority, Mortgage Market Review: Responsible Lending (Financial Services Authority, 2010) 10/16, 57 (): “But the level of mis-buying also highlights that some consumers are failing to properly engage and that we cannot rely on all consumers to be able to protect their own best interests.” 10 Another measure that may affect responsible lending is the structure of remuneration policies of the staff involved in the granting of credit, in the sense that the structure of remuneration should not encourage excessive risk-taking. For this purpose, and apart from the detailed rules of Directive 2013/36/EU on remuneration policies of credit institutions and the delegated legal acts issued or to be issued, specific provisions were included in Directive 2014/17/EU “on credit agreements for consumers relating to residential immovable property …” (Art. 7 and recital 35). See also FinCoNet, FinCoNet Report on Responsible Lending – Review of Supervisory Tools for Suitable Consumer Lending Practices (July 2014), 58-75. 11 See Commission Staff Working Paper, supra note 9, 37-43; Finlay, supra note 1, 10. 12 See in detail a study of the European Commission entitled: Towards a common operational European definition of over-indebtedness, February 2008, p. 33 ss. See also Ryder, Griffiths and Singh, Commercial Law. Principles and Policy (CUP, 2012), 504; Wilson, “Responsible lending or restricting lending practices? Bal-

250

14

The Greek Regulatory Framework on Responsible Lending

but are extended to his family and his broader social environment, and additionally to the State,13 which is often obliged to take measures of a social nature and grant social allowances.

14.1.3

The Quite Recent Liberalization of Consumer Credit in Greece

In Greece, consumer credit was liberalized in 2003, that is, quite recently in comparison with other member states. The liberalization took place in view i. of the need to adapt the conditions of financing to the monetary policy conditions in the Eurosystem pursuant to the principle of an open market economy with free competition and ii. of the perspective to activate an interbank database containing information of credit nature.14 The liberalization process of the Greek financial sector took place gradually,15 beginning during the 1980s and gaining momentum in the 1990s. Until then, the financial system had been heavily regulated by governmental administrative rules (“interest rates were set at administered levels and credit was channelled to the economy through investment requirements imposed on banks as regards the financing mainly of the public sector and a complicated reserve/rebate system as regards the financing of the private sector”).16 According to the Bank of Greece Governor’s Act 2523/2003, which amended the previous Act 1955/1991 in relation to the granting of credit from credit institutions operating in Greece,17 the granting of credit to natural persons with a view to purchasing goods and services and to covering personal needs is permitted without restrictions or special condi-

13

14

15

16 17

ancing concerns regarding over-indebtedness with addressing financial exclusion”, in Kelly-Louw, Nehf and Rott (Eds.), The Future of Consumer Credit Regulation (Ashgate, 2008), 95. See Report of the European Commission, supra note 3, para. 376, 110, Message concernant la modification de la loi fédérale sur le crédit à la consommation, 14 December 1998, FF 1999, under para. 122, p. 2891. For the consequences of over-indebtedness, see indicatively, Σταθόπουλος, «Ρύθμιση οφειλών υπερχρεωμένων φυσικών προσώπων (Ν 3869/2010)», 2 Χρηματοπιστωτικό Δίκαιο (2011), 181. See the Bank of Greece Governor’s Act 2523/2003 “Amendment of the provisions of the Bank of Greece Governor’s Act 1955/2 July 1991, as they stand, with respect to the consumer credit and the loans granted to natural persons for the coverage of personal needs”, Official Gazette Α΄ 158/25 June 2003, preamble. In particular, pursuant to the Bank of Greece Governor’s Act 2286/1994, the annual overall financing limit was eight million drachma (around €23.500) per person from the same credit institution for concrete categories of financing (Bank of Greece Governor’s Act 2286/1994 “Amendment of the provisions of the Bank of Greece Governor’s Act 1955/2 July 1991 concerning consumer credit and the granting of credit to natural persons for the coverage of personal needs” Official Gazette Α΄ 9/7 February 1994). The above annual overall financing limit increased with another Bank of Greece Governor’s Act 2360/1995 until the complete liberalization in 2003. See Brissimis, Garganas and Hall, Consumer Credit in an era of Financial Liberalization: an Overreaction to Repressed Demand? (Bank of Greece Working Paper 148, October 2012), 10. Bank of Greece Governor’s Act 1955/1991 “Rules applying to the granting of credit in drachma from credit institutions operating in Greece”, Official Gazette Α΄ 105.

251

Christina Livada

tions in relation to the amount, the interest rate, the process and the format of financing. Furthermore, financing is provided in accordance with banking criteria that relate mainly to the creditworthiness assessment of borrowers. These criteria are adopted by and apply to every credit institution. The above liberalization in combination with an environment of declining interest rates due to the gradual convergence towards the levels of EU interest rates in the same period led to a credit boom in consumer loans since the mid-1990s, with an average growth rate of consumer loans of 41.4% from 1991 to 1999 and 27.1% from 2000 to 2010.18 These percentages decreased significantly as a result of the international financial crisis and the current fiscal crisis in Greece.19 Furthermore, the percentages of non-performing loans and over-indebtedness increased significantly in an environment that was characterized, among others, by the absence of a specific regulatory framework to tackle over-indebtedness. Under these circumstances, the need to take efficient measures for the prevention and remediation of over-indebtedness became imperative.

14.2

14.2.1

The Requirement of Responsible Lending under Greek Law

An Overview of the Current Legal Framework

The rules of substantive law in relation to the granting of credit and the obligations of credit institutions and creditors in general towards consumers are included in the Joint Ministerial Decision Ζ1-699/2010, through which Directive 2008/48/EC was transposed into Greek law.20 The said Joint Ministerial Decision repealed the previous F1-983/1991, through which the first in this field Council Directive 87/102/EEC was transposed into Greek law.21 18 See Brissimis, Garganas and Hall, supra note 16, 9-10. 19 Ibid, 14, 34. 20 Joint Ministerial Decision Ζ1-699/2010 “Adaptation of the Greek legislation to the Directive 2008/48/EC of the European Parliament and of the Council of 23 April 2008 on credit agreements for consumers and repealing Council Directive 87/102/EEC, which was published in the Official Journal of the European Union, L 133 of 22 May 2008”, Official Gazette Β΄ 917/23 June 2010, as it was amended by Ministerial Decision Ζ1111, Official Gazette Β 627/7 March 2012 and Directive 2008/48/EC of the European Parliament and of the Council of 23 April 2008 on credit agreements for consumers and repealing Council Directive 87/102/EEC, O.J. L 133/22 May 2008, 66-92, respectively. See also Corrigendum to Directive 2008/48/EC, O.J. L 199/31 July 2010, 40-42 and O.J. L 207/11 August 2009, 14. 21 About Council Directive 87/102/EEC, which was amended by Directive 90/88/EEC and Directive 98/7/EC, see Χριστιανός, Κοινοτικό δίκαιο προστασίας του καταναλωτή (εκδ. Αντ. Ν. Σάκκουλα, 1997), 105; Κλαβανίδου, Καταναλωτικά Δάνεια. Ένταξη στο νομικό πλαίσιο των καταναλωτικών πιστωτικών συμβάσεων και πρακτικές εκφάνσεις (εκδ. Σάκκουλα, 1997), 95; Πελλένη-Παπαγεωργίου, Ζητήματα από τις νέες ρυθμίσεις για τις συμβάσεις καταναλωτικής πίστης (εκδ. Αντ. Ν. Σάκκουλα, 2012), 7-12; Weatherill, EU Consumer Law and Policy (Edward Elgar Publishing, 2005), 86; Rosenthal, Guide to Consumer Credit Law and Practice

252

14

The Greek Regulatory Framework on Responsible Lending

The Joint Ministerial Decision Z1-699/2010, in consistency with Directive 2008/48/EC, contains provisions on – the information to be provided to the consumer from the creditor22 to address the issue of information asymmetry, the existence of which between the creditor and the consumer is commonly accepted;23 – certain contractual rights of the consumer such as the right of withdrawal and the right of early repayment, regulating the way they can be exercised and their legal consequences in the framework of consumer credit; and – the establishment of the creditworthiness assessment requirement in order to prevent over-indebtedness. The scope of application of the Decision covers consumer credit as defined in Directive 2008/48/EC and in particular credit agreements involving a total amount of credit of over €200 and less than €75,000.24 On the contrary, in Greece there has been no specific regulatory framework in place for home loans up to now. However, following the publication of Directive 2014/17/EU “on credit agreements for consumers relating to residential

(Butterworths, 2002), 300; Paisant, “Le credit à la consommation dans l’ Union Européenne: Le droit communautaire”, in Imsand (Ed.), La nouvelle loi fédérale sur le credit à la consommation (CEDIDAC, 2002), 3; Dutoit, “La transposition de la Directive 87/102/CEE sur le credit à la consommation ou l’apparition d’ un kaleidoscope”, in Imsand (Ed.), La nouvelle loi fédérale sur le credit à la consommation (CEDIDAC, 2002), 15; Reich, “From contract to trade practices law: protection of consumers’ economic interests by the EC”, in Wilhelmsson (Ed.) Perspectives of Critical Contract Law (Dartmouth Pub Co, 1993), 84; Campens, “Services financiers de détail et protection des consommateurs: l’approche communautaire”, 3 Revue européenne de droit de la consommation (2003), 171. 22 The relevant detailed provisions vary depending on the category of the credit agreement offered, the way the credit is offered and the stage of the transaction (pre-contractual, contractual and during the contract). The information to be provided includes: (i) certain standard information that should be depicted in the advertisement when the latter gives an indication of an interest rate or other figures relating to the cost of credit, (ii) a detailed set of pre-contractual information that must be provided to a borrower in “good time” before the conclusion of the credit agreement, which is standardized and must be disclosed in a format known as the Standard European Consumer Credit Information Sheet (“SECCI”), (iii) information to be contained in the credit agreement itself and (iv) information to be provided during the credit agreement on specific issues. The creditor is also required to provide “adequate explanations” to the consumer before the agreement is concluded so as to enable him to assess whether the credit is adapted to his needs and financial situation. 23 See indicatively Grundmann, Kerber and Weatherill (Eds.), Party Autonomy and the Role of Information in the Internal Market (Walter de Gruyter, 2001), 21; Calais-Auloy and Steinmetz, Droit de la consommation (Dalloz, 2006), 53; Γκόρτσο, supra note 1, 163; Δέλλιο, Προστασία των καταναλωτών και σύστημα ιδιωτικού δικαίου. Τόμος ΙΙ. Ο δικαστικός έλεγχος του περιεχομένου των καταναλωτικών συμβάσεων και τα όριά του (Εκδ. Σάκκουλα, 2001), 31; Δέλλιο, Προστασία των καταναλωτών και σύστημα ιδιωτικού δικαίου. Τόμος Ι. Ο καταναλωτής ως υποκείμενο έννομης προστασίας (Εκδ. Σάκκουλα, 2005), 295; Λιβαδά, supra note 1, 13; Wein, “Information problems and market failure: the perspective of Economics”, in Grundmann, Kerber and Weatherill (Eds.), Party Autonomy and the Role of Information in the Internal Market (Walter de Gruyter, 2001), 82; Cartwright, Banks, Consumers and Regulation (Hart, 2004), 51. 24 See in detail Joint Ministerial Decision, Art. 2 and Directive 2008/48/EC, Art. 2 respectively.

253

Christina Livada immovable property (…)”,25 the law for its transposition into the Greek legal order is under preparation.

14.2.2

The Content of the Responsible Lending Principle

The responsible lending principle – as it currently stands in Greek law – consists mainly26 of the legislative requirement for the creditor to assess the creditworthiness of the consumer. The assessment of creditworthiness is to take place both before the conclusion of the credit agreement and before any significant increase in the total amount of credit after the conclusion of the credit agreement.27 The main pillars of the obligation of assessment are, in both cases, pursuant to paragraph 1 of Article 8 of Joint Ministerial Decision Z1-699/2010: – sufficient information obtained from the consumer by the creditor, and – consultation of the relevant database,28 pursuant to the specific provisions on the supervision of credit and financial institutions. The information to be obtained from the consumer by the creditor shall be provided before the conclusion of the contract. The creditor shall also take into account any additional information he may possess in the framework of a long-term contractual relationship he may have with the consumer.29 It is also worth noting that, according to Greek legislation (Joint Decision Ζ1-699/2010, Art. 8 para. 1), the consultation of the database is mandatory, whereas the respective provision of paragraph 1 of Article 8 of the Directive provides that the consultation of the relevant database is made “where necessary”, obviously at the discretion of the creditor. As a general remark, it should be pointed out that in the above-mentioned provision of Article 8 (paras. 1-2) neither the content of the information to be obtained from the 25 OJ L 60/34. 26 See Chapter 2, under Section 2.2. 27 See Joint Decision, Art. 8 para. 1-2. See also Directive 2008/48/EC, Art. 8. For the difference between the assessment of creditworthiness and of affordability, see in detail Fairweather, supra note 7, 93-99. 28 See also Art. 9 of Joint Decision Z1-699/2010 on the database access. In Greece, nearly all Greek banks cofunctioned to create Tiresias, a company entrusted with the development and management of a reliable Credit Profile Databank. Tiresias was formally founded on September 1997 as a non-profit organization and has been operating as a joint stock (SA) company, yet fully maintaining the philosophy of a genuine non-profit organization while securing the necessary preconditions for its further development. Today, Tiresias specializes in the collection and supply of credit profile data on corporate entities and private individuals and the operation of a risk consolidation system regarding consumer credit. Additionally, the company develops inter-banking information systems and provides information and communication services to all parties concerned. See in detail: . See also Καλλιμόπουλο, «Ανάκληση συναίνεσης του υποκειμένου περί επεξεργασίας δεδομένων προσωπικού χαρακτήρα (γνωμ.)», 3 Χρηματοπιστωτικό Δίκαιο (2010) 285. 29 Joint Ministerial Decision Z1-699/2010, Art. 8 para. 1.

254

14

The Greek Regulatory Framework on Responsible Lending

consumer in order for the creditor to be able to assess his creditworthiness nor any restrictions of the creditor for the granting of credit in case of negative assessment are determined in a precise way.30 Thus, in relation to both the information the creditor shall require and the consultation of the database, the creditor shall be responsible, and he shall determine the appropriate enquiry. The burden of proof that he took all the necessary actions in accordance with the facts of each case lies with the creditor. The counterargument that could be raised is that the detailed determination of the above obligations is not consistent with the personalized treatment, which should be adopted for each individual consumer.31 In view of this, the creditor should be free to judge in each case what kind of information he needs to obtain from the consumer and to what extent, depending on the profile of the consumer and the risks inherent in the specific credit to be provided. It is also worth noting that the creditworthiness assessment is an ‘obligation of means’ and not an ‘obligation of result’.32 The responsibility of the creditor is not linked with the avoidance of over-indebtedness of the consumer, but with the examination of all the means he has at the time of conducting the assessment of his creditworthiness. The assessment should be done by showing due diligence on a case-by-case basis.33

14.3

Concluding Remarks: The Legal Consequences of the Creditworthiness Assessment and the Sanctions to Be Imposed in Case of Infringement

A different issue is the lack of guidance to the creditor after he has performed the creditworthiness assessment and, in particular, in the case of a negative result.34 The discretion allowed to the creditor from Article 8 paragraphs 1-2 of Joint Decision Z1-699/2010 is 30 On the contrary, in the respective provisions of Directive 2014/17/EU the above issues are more specifically addressed. See Chapter 2, under Section 2.2.2. 31 See Directive 2008/48/EC, recital 26. 32 See the initial proposal for a Directive of the European Parliament and of the Council on the harmonization of the laws, regulations and administrative provisions of the Member States concerning credit for consumers (COM 2002, 443 final), explanatory memorandum, under Art. 9, OJ C 331/31 December 2002, p. 211: “The principle of ‘responsible lending’ represents an obligation to consult centralised databases and to examine the replies provided by the consumer or the guarantor, to request the provision of sureties, to check the data supplied by credit intermediaries and to select the type of credit to be offered. It is not an obligation targeted at obtaining results such as the existence or otherwise of fault on the part of the consumer. Similar rules requiring caution call, moreover, for an assessment of the facts and for an examination on a case-by-case basis, preferably by the legal authorities.” 33 See also Finlay, supra note 1, 138: “Presented with a single person’s details, it is impossible to say with certainty whether or not they will repay any credit advanced to them. Therefore, credit managers attempt to estimate the likelihood of repayment.” 34 See also Chapter 2, under Section 2.2.2 on the issue that positive creditworthiness assessment does not mean, on a reversed reading, obligation of the creditor to provide the credit.

255

Christina Livada

quite large. On the one hand, it is reasonably argued that it is doubtful that the creditor should deny access to credit to a consumer only on the basis of his negative creditworthiness assessment, particularly when this is done for reasons concerning not the security of the creditor but rather the security of the consumer.35 On that note, denial of access to credit for the above-mentioned reasons could be considered, on the basis of Greek law, as an infringement of personality rights and of the constitutionally guaranteed economic freedom.36 In the same view, the creditor should have the right of choice to address the issue on the basis of the results of the assessment he makes and the risk of each consumer and either deny the credit or warn the consumer about his reduced creditworthiness.37 On the other hand, according to the author, the creditor should deny the credit in case the consumer does not fulfil the conditions. This view is based mainly on the indirect link the European legislature makes between the creditworthiness assessment and the granting of credit. In particular, according to recital 26 of Directive 2008/48/EC, “In the expanding credit market, in particular, it is important that creditors should not engage in irresponsible lending or give out credit without prior assessment of creditworthiness, and the Member States should carry out the necessary supervision to avoid such behaviour and should determine the necessary means to sanction creditors in the event of their doing so.” Thus, the combined need to avoid irresponsible lending and granting of credit without prior control of the creditworthiness within the spirit of these provisions leads to the denial of credit in such a case.38 In this sense, a simple warning to the consumer does not seem sufficient. However, irrespective of the approach taken, the ambiguous and general wording of the rule, to the extent that the obligation of the creditor following the creditworthiness assessment is not determined, allows various interpretations. This is against the security of law both for the creditor, who does not know his obligations exactly, and for the consumer, who does not know his rights exactly.39 This issue is not resolved with the sanctions imposed according to the Greek law in case of infringement of Article 8 of Joint Decision Z1-699/2010. Pursuant to paragraph 3 of Article 8 of Joint Decision Z1-699/2010, in case of culpable infringement of the obligation to assess the creditworthiness of the consumer, the legal

35 See Περάκη, supra note 1, 357-358. 36 Ibid and Τασίκα, «Η υποχρέωση του πιστωτικού φορέα για αξιολόγηση της πιστοληπτικής ικανότητας του καταναλωτή στην παροχή καταναλωτικής πίστης», Νομικό Βήμα 59 (2011), 2293, 2299; ΠελλένηΠαπαγεωργίου, supra note 21, 222. See also Feretti, supra note 6, 19. 37 See Περάκη, supra note 1, 356. 38 See Λιβαδά, supra note 1, 325 and Μεντή, Άμυνα & ελευθέρωση του υπερχρεωμένου οφειλέτη (Δίκαιο & Οικονομία, Π.Ν. Σάκκουλα, 2012), 33. 39 Up to now, there is no case law relevant to this issue that could clarify the exact legislative requirements arising from the said provisions. On the contrary, Directive 2014/17/EU (Art. 18 para. 5) is much more clear in this respect. See Chapter 2, under Section 2.2.

256

14

The Greek Regulatory Framework on Responsible Lending

consequence in relation to the civil liability of the creditor40 is the discharge of the consumer from the total cost of the credit, including interest, and the obligation for him to repay only the capital, according to the instalment provided for in the credit agreement.41 It is correctly maintained that, for the application of this provision, the culpable infringement of the obligation of the creditor is not sufficient, as there should also exist weakness of repayment on the part of the consumer.42 Given that the content of the creditor’s obligations is subject to different interpretations as mentioned above, the sanction laid down in paragraph 3 of Article 8 does not apply indisputably in the case of granting credit to a consumer with negative creditworthiness.43 As a result of the vagueness of the law concerning the requirement, the conditions that should be fulfilled for the imposition of the legal consequences in case of its infringement are also vague. Responsible for the observance of Joint Ministerial Decision Z1-699/2010 is the Minister of Economy, Development and Tourism.44 The administrative sanctions to be imposed in case the provisions of the said Decision are infringed are those provided for in Article 13A of Law 2251/1994 on consumer protection.45 In particular, according to paragraph 2 of the said Article, subject to the stipulations of the Penal Code, the Market Code and stipulations of other special laws applicable on suppliers violating the stipulations of this law, there is a fine imposed, following a decision by the Minister of Development, amounting to a minimum of €1,500 and rising up to €1 million. If more than three decisions imposing a fine on a supplier have been issued, the maximum amount of the fine is doubled,

40 See in detail Πελλένη-Παπαγεωργίου, supra note 21, 229-238. 41 The discharge of the consumer from paying the interest results in the credit agreement becoming interestfree. According to one view, since in para. 3 of Art. 8 there is no specific reference, the discharge covers also the interest on deferred payment. See Πελλένη-Παπαγεωργίου, supra note 21, 225. 42 See Μεντή, supra note 38, 35. On this provision in general, see also the same author (ibid), 32 and ΠελλένηΠαπαγεωργίου, supra note 21, 223. 43 On the contrary, according to Πελλένη-Παπαγεωργίου, supra note 21, 223, the infringement of the creditworthiness assessment requirement consists either in the carrying out of insufficient control or in the granting of credit despite the negative creditworthiness of the consumer. 44 See Joint Ministerial Decision Ζ1-699/2010, Art. 22 para. 3. For the powers of the Minister in this respect see paras. 6-8 of the same Article. 45 See Joint Ministerial Decision Article 22 paras. 4-5.

257

Christina Livada

and the Minister of Development may order the temporary ceasing of the operation of his business or part of it over a period ranging from three months to one year.46

46 Furthermore, pursuant to para. 5 of the same Article, if the stipulations of this Article are violated, the Minister of Development may, considering the nature and graveness of the violation, as well as its repercussions on the broader consuming public, publicize, through the press or any other means available, the sanctions imposed as per the above paras. 2 and 3, as well as the restraining measures taken under the law in force by the competent administrative authorities or by suppliers with regard to the sale of consumer products in the internal market. Finally, in para. 6 it is provided that if the stipulations of this Article are violated by credit institutions or businesses or organizations operating in the financial sector of the economy, which are supervised by the Bank of Greece, the sanctions applied according to this law are imposed following an opinion given by the Bank of Greece. This opinion is granted after a relevant application of the General Secretary of Consumer Affairs within two months from the submission of the application. If this deadline lapses with no action, administrative sanctions are imposed without the above opinion. Issues pertaining to the application of this paragraph and any other relevant details are settled with a decision of the Minister of Development.

258

15

Key Elements of the Greek Legal Framework on Insolvency of Natural Persons

Theodor G. Katsas*

15.1

15.1.1

Introductory Remarks

Objectives of an Insolvency Regime for Over-Indebted Individuals

The design of an insolvency regime for natural persons is by no means a monolithic concept.1 Financial distress can manifest itself in very different forms, insolvency can arise from a diverse range of causes and policymakers might select from a range of very different approaches to combating one or another form or degree of financial distress. Regimes for providing insolvency relief to natural persons are usually compared to regimes for providing social assistance (welfare), especially to the impoverished.2 Although insolvency and social support regimes can work in tandem, these systems are designed with distinct goals in mind. Most of the goals of insolvency regimes are economic in focus, avoiding waste and enhancing productivity; the legal regime for addressing the insolvency of natural persons represents, to a certain degree, an extension of the legal enforcement system, in particular

* 1

2

Lecturer, Faculty of Law, Democritus University, Thrace. Venieris/Katsas/-Katsas, Law Nr. 3869/2010 on the insolvency of over-indebted individuals, 3rd edition (2016), p. 12 ff.; Oren Bar-Gill, Seduction by Plastic, 98 Northwestern University Law Review 1373 (2004), Russell B. Korobkin & Thomas S. Ulen, Law and Behavioral Science: Removing the Rationality Assumption from Law and Economics, 88 California Law Review 1051 (2000); Jon D. Hanson & Douglas A. Kysar, Taking Behavioralism Seriously: The Problem of Market Manipulation, 74 New York University Law Review 630 (1999); Christine Jolls, Cass R. Sunstein, & Richard Thaler, A Behavioral Approach to Law and Economics, 50 Stanford Law Review 1471 (1998), Kilborn, 14 Columbia Journal of European Law p. 563 ff.; NiemiKiesiläinen, 57 Osgoode Hall Law Journal, p. 410. Niemi – Kiesiläinen/Ramsay/Whitford, in Niemi–Kiesiläinen/Ramsay/Whitford (Eds.), Consumer Bankruptcy in Global Perspective (2003), p. 14. Sullivan/Warren/Westbrook, As We Forgive Our Debtors: Bankruptcy and Consumer Credit in America (1989), p. 216. Norberg, 76 American Bankruptcy Institute Law Review p. 415. Κohte/Ahrens/Grote, Verfahrens-, Kostenstündung, Restschuldbefreiung und Verbraucherinsolvenzverfahren, Kommentar4 (2009), Vor § 286, αρ. 3 ff.; Niemi – Kiesiläinen, 57 Osgoode Hall Law Journal p. 410. World Bank, Report on the Treatment of Insolvency of Natural Persons, p. 10 ff.; Venieris/Katsas/-Katsas, Law Nr. 3869/2010 on the insolvency of over-indebted individuals, 3rd edition (2016), p. 12 ff.

259

Theodor G. Katsas

the procedural regime regarding the enforcing of debt claims and property rights. On the other hand, the structures and goals of social assistance regimes are generally driven by humanitarian concerns for social solidarity and social planning, often whether or not this has any positive economic impact on any segment of society.3 While some of the goals of insolvency also involve a wish to relieve suffering, goals relating to economic efficiency are (at least) equally as prominent. Social assistance systems are generally designed to ensure that every member of society has access to a baseline level of resources to meet their basic needs such as food, shelter and health care. Insolvency regimes are less like social assistance, and more like social insurance, designed specifically to support individuals with unmanageable debt and prevent unnecessary suffering and social exclusion. Lack of resources to meet basic needs may well lead to problems managing debt, but these two problems do not always appear together.4 An insolvency regime serves mainly individuals who do not suffer from a long-term disability or general surfeit of resources and who thus do not need affirmative social support. Insolvency regimes are designed primarily and work best for individuals who are capable of producing enough income to support themselves and their families, but are overwhelmed by a debt burden that saps their initiative and depresses their productive capacity. The goal of an insolvency regime is not to receive financial or other resources but to stop counterproductive debt collection. Fundamentally, the core distinction between regimes to combat poverty and insolvency is that the problem of poverty cannot be ‘solved’ in one procedure for any given individual, whereas the practical problems of insolvency can be solved in one procedure.

15.1.2

The Introduction of a Special Regime for Over-Indebted Individuals in Greece (Law 3869/2010)

The introduction of a specialized legal regime on bankruptcy (of natural persons) represents a very recent, though by all means necessary, development in the Greek legal framework on insolvency.5 Prior to the introduction of Law 3869/2010 the Greek policymaker had

3 4 5

Ibid. Ibid. Rokas N., Metarrithmistikes Taseis sto Ptwcheutiko Dikaio Enopsei kai tis Oikonomikis Krisis, Εpitheorisi Εmporikou Dikaiou 2010, p. 275; Chrisodoulou, H Rithmisi ton Ofeilwn Iperhrewmenwn Fysikwn Proswpwn Simfwna me ton N. 3869/2010 – ermhneutiki proseggisi, Dikaio Epixeiriseon kai Etairion 2011, p. 293 ff.; Perakis, H Diadikasia tou N. 3869/2010 gia ti Rithmisi twn ofeilwn fysikwn proswpwn ws sullogiki diadikasia, Dikaio Epixeiriseon kai Etairion 2011, pp. 400-401; Igglezakis Ι., Yperhrewsi twn Katanalwtwn kai Ptwheutiko Dikaio, Εpiskopisi Εmporikou Dikaiou 2003, p. 597; Roussos, H Pistwtiki Karta- Nomothetikes kai Nomologiakes Exelixeis (N. 3862/2010 & AP 652/2010), Efarmoges Astikou Dikaiou 2011, p. 800 ff.; Kritikos, Rithmisi ton ofeilon Iperxreomenon fisikon prosopon 2011, 15 ff.; Stathopoulos, Xrimatopistotiko Dikaio 2011, p. 181 ff.

260

15

Key Elements of the Greek Legal Framework on Insolvency of Natural Persons

chosen to deal with the challenges of personal financial distress through the common rules on the enforcement of judgments and contracts (Art. 288, 388 Greek Civil Code) and other claims, as well as through an aggressive and thorough legal regime of what might be called ‘consumer protection’.6 Such a system was, however, not tailored to the challenges of insolvency since it also protects small businesses.7 Law 3869/2010 focuses primarily on managing, rather than preventing, the occurrence of the debtor’s financial distress and eventually insolvency. The core provisions of Law 3869/2010 do not pursue a redistribution of resources away from creditors; they prompt creditors to accept reality and stop the wasteful and destructive continuing pursuit of chimerical returns and provide relief to debtors in need, especially with respect to the protection of their right to maintain their primary residence. The principal purpose of Law 3869/2010 is to re-establish the debtor’s economic capability.8 Such a rehabilitation requires that the debtor be freed from excessive debt. The extent of the discharge is dependent on the discretion of the Court. In principle, the ‘regular’ discharge of the debtor is not “straight,” since the debtor is usually required to pay part of their debts according to a payment plan before receiving a discharge (see Art. 8 Law 3869/2010). Only recently has the Greek policymaker moved away from requiring payment plans of all debtors, offering an immediate “straight” discharge to the most impecunious debtors (see Art. 5a Law 3869/2010).9

15.2

15.2.1

Core Provisions of Law 3869/2010

Rationae materiae and personae (Art. 1 Law 3869/2010)

Article 1 Law 3869/2010 draws a distinction between “business” and “non-business” debtors: according to paragraph 1 of Article 1, the insolvency regime for natural persons 6 7 8

9

Venieris/Katsas/-Katsas, Law Nr. 3869/2010 on the insolvency of over-indebted individuals, 3rd edition (2016), p. 75 ff. Ibid. Rokas N., Metarrithmistikes Taseis sto Ptwcheutiko Dikaio Enopsei kai tis Oikonomikis Krisis, Εpitheorisi Εmporikou Dikaiou 2010, p. 275; Chrisodoulou, H Rithmisi ton Ofeilwn Iperhrewmenwn Fysikwn Proswpwn Simfwna me ton N. 3869/2010 – ermhneutiki proseggisi, Dikaio Epixeiriseon kai Etairion 2011, p. 293 ff.; Perakis, H Diadikasia tou N. 3869/2010 gia ti Rithmisi twn ofeilwn fysikwn proswpwn ws sullogiki diadikasia, Dikaio Epixeiriseon kai Etairion 2011, pp. 400-401; Igglezakis Ι., Yperhrewsi twn Katanalwtwn kai Ptwheutiko Dikaio, Εpiskopisi Εmporikou Dikaiou 2003, p. 597; Roussos, H Pistwtiki Karta- Nomothetikes kai Nomologiakes Exelixeis (N. 3862/2010 & AP 652/2010), Efarmoges Astikou Dikaiou 2011, p. 800 ff.; Kritikos, Rithmisi ton ofeilon Iperxreomenon fisikon prosopon 2011, 15 ff.; Stathopoulos, Rithmisi Ofeilwn Yperhrewmenwn Fysikwn Proswpwn (N. 3869/2010), Xrimatopistotiko Dikaio 2011, p. 181 ff. Venieris/Katsas/-Katsas, Law Nr. 3869/2010 on the insolvency of over-indebted individuals, 3rd edition (2016), Tsiafoutis, H Nea Diadikasia tis Taheias dieuthetisis Mikroofeilwn symfwna me to arthro 5a tou N. 3869/2010, Xrimatopistotiko Dikaio 2015, p. 171 ff.

261

Theodor G. Katsas

is applicable to debts of individuals who (a) do not have the legal capacity to apply for (corporate) bankruptcy and (b) have, by no fraudulent intention, permanent and general inability to pay their debts. Under Article 1 paragraph 1 of Law 3869/2010, debtors without the legal capacity to file for bankruptcy include natural persons who do not qualify as “merchants” according to the Greek Commercial Code. The distinction between “merchants” and “non-merchants” is not directly related to the differentiation between “consumers” and “non-consumers”. According to the broad definition of the term ‘consumer’ under Article 2 of Law 2251/1994,10 a merchant may under Greek Law qualify as a “consumer” and yet not be eligible for bankruptcy under Article 1 paragraph 1 of Law 3869/2010. In this respect, the distinction between “consumer” and “non-consumer” is not critical for the scope of application of the insolvency regime for natural persons under Greek Law.11 The rationae materiae of Law 3869/2010 encompasses debts that have been undertaken during the last year before the submission of the discharging application, including tax and debts due to the state and organizations of local authorities, public law corporate bodies and charges and contributions towards social security funds (Art. 1 paras. 2 and 3 of Law 3869/2010). The inclusion of tax and debts towards the state and public legal entities has been a recent addition to the legal framework on the insolvency of over-indebted individuals. From a comparative point of view, taxes and other government claims are excluded from discharge in many countries, apparently because taxes and government debts are part of the fundamental obligation of citizens to support their society; these are not simple debts arising in bilateral relations in the marketplace, but rather higher-order debts owed as a whole to support the operation of government.12 However, there is a growing trend in recent years to discharge over-indebted individuals for taxes and other government debts for two main reasons: First, taxes are often among the largest debts contributing to a debtor’s insolvency; if government debts are not subject to discharge, the entire insolvency relief system is undermined.13 More and more legislatures have accepted that, if they are willing to force ‘ordinary’ creditors to forego their legitimate claims against debtors, then the state, too, should be willing to play by the same rules and support the relief system, at least for non-punitive debts like taxes and fees. Second, if taxes are not excluded from discharge, they are probably also entitled to a privilege that entitles them to payment before any other creditor. This has been criticized as

10 Venieris/Katsas/-Venieris, Law Nr. 3869/2010 on the insolvency of over-indebted individuals, 3rd edition, (2016), p. 105 ff. 11 Ibid. 12 World Bank, Report on the Treatment of Insolvency of Natural Persons, p. 119 ff.; Venieris/Katsas/-Katsas, Law Nr. 3869/2010 on the insolvency of over-indebted individuals, 3rd edition (2016), p. 50 ff. 13 World Bank, Report on the Treatment of Insolvency of Natural Persons, p. 119 ff.; Venieris/Katsas/-Katsas, Law Nr. 3869/2010 on the insolvency of over-indebted individuals, 3rd edition, (2016), pp. 32 ff., 50 ff.

262

15

Key Elements of the Greek Legal Framework on Insolvency of Natural Persons

being unfair to other creditors.14 In this respect the Greek policymaker has included (Art. 1 para. 2 of Law 3869/2010) a provision for the discharge of the debtor from government debts. Maintenance obligations to children and former spouses are exempted from the scope of the discharge (Art. 1 para. 4 of Law 3869/2010). Such an exemption is common in several other legislations, for reasons of fundamental public policy: The creditors in family support claims are regarded as most sensitive to disruptions; depriving family members of their claims to necessary support would endanger their basic welfare and undermine a public policy of family support. Fines and other sanctions are also excluded from the scope of the discharge, as well as other liabilities that are a consequence of an act of crime (Art. 1 para. 4 of Law 3869/2010). The underlying policy for such an exclusion concerns proper allocation of responsibility. Insolvency relief is designed to offer relief to “honest but unfortunate” debtors; debts related to fines are regarded as not falling within this paradigm and therefore qualify as non-market-based.

15.2.2

Access to the Insolvency Regime

The regular discharge of the debtor follows a formal insolvency proceeding before court (Arts. 4-8 of Law 3869/2010). An attempt for voluntary conciliation between creditors and debtors was obligatory under the previous insolvency regime for natural persons; however, it has proven elusive, as creditors have shown very little interest in active and constructive engagement in such processes.15 The relevant statistics have shown that the success ratio of the voluntary conciliation (either in court or out of court) was a mere 0.02%.16 Under the current insolvency regime, the debtor may negotiate with his creditor an agreement on the settlement of his debt. However, this procedure is not formally regulated under Law 3869/2010, and therefore it does not fall under the regime of a collective procedure, where equal and non-discriminating treatment of creditors is required. In practice, it is not easy for debtors to reach voluntary settlements with all their creditors, even by means of active mediation, since the primary reasons for a non-successful voluntary settlement in and out of court remain steadily present: Some creditors will inevitably demand enforcement of their claims and make negotiations impossible, vetoing negotiated approaches. Among these, some public creditors, including tax and governmental authorities, will be generally reluctant to accept negotiated approaches. Finally, financial institutions (e.g. banks and insurance companies) may have few incentives to engage in 14 World Bank, Report on the Treatment of Insolvency of Natural Persons, p. 10 ff.; Venieris/Katsas/-Katsas, Law Nr. 3869/2010 on the insolvency of over-indebted individuals, 3rd edition, (2016), p. 12 especially. 15 Venieris/Katsas/-Katsas, Law Nr. 3869/2010 on the insolvency of over-indebted individuals, 3rd edition (2016), p. 41 ff. 16 Ibid, pp. 41, 42.

263

Theodor G. Katsas

meaningful restructuring negotiations because of the impact of regulations imposing requirements for writing off debts and deducting losses.17 The court-based procedure for the regular discharge of the debtor is multi-tracked. The debtor is obliged to file a petition that includes not only a debt settlement scheme, but also a complete documentation on the nature and the course of his debt (e.g. declaration that the property and creditors lists, every relevant document about his property, his income status, his creditors and their claims, etc.), as defined by the Common Ministerial Act 7534/2015. Since the insolvency regime represents a collective procedure, the debt settlement scheme proposed by the debtor should include all creditors. The completion of the filing is to a certain extent dependent on the discretion of the debtor’s creditors.18 Sometimes, important creditors, such as tax authorities, major banks or debt collection agencies that have brought a large number of claims, are in delay when it comes to the provision of the necessary documentation to the debtors, even though the Law provides fines for such delay (see Art. 2 para. 4 of Law 3869/2010). In addition, there is also the problem of informational asymmetry between debtors and creditors, as well as lack of information by creditors of the debtor’s circumstances and situation. Both factors, when combined with the filtering process on behalf of the secretariat, make access to the courtbased procedure difficult for the debtor and create social costs. These include error costs in determining the validity of debts and levels of repayment and costs to creditors, debtors and third parties. The secretariat of the court examines the completeness of the filed petition. Should the petition lack the necessary documentation, the secretariat shall not proceed with the setting of a hearing date for the petition and shall request the debtor to provide the necessary documentation within ten working days from the submission of the petition (Art. 2 para. 2 of Law 3869/2010). Should the debtor fail to complete his petition within the given time, the petition is to be archived without any further legal consequences (Art. 4 para. 4 of Law 3869/2010). The procedure before the court’s secretariat was introduced very recently and was originally conceived as a response to the (bureaucratic) problems caused by the overload of petitions for insolvency, for which a hearing date was defined by the court’s secretariat without any screening as to whether the petition was formally admissible or not. The lack of a screening process has led to an overload of petitions, thus delaying significantly the hearing of the petitions – sometimes by over seven years!19 The inability of the courts’

17 World Bank, Report on the Treatment of Insolvency of Natural Persons, p. 44 ff.; Venieris/Katsas/-Katsas, Law Nr. 3869/2010 on the insolvency of over-indebted individuals, 3rd edition (2016), p. 32 ff. 18 Venieris/Katsas/-Venieris, Law Nr. 3869/2010 on the insolvency of over-indebted individuals, 3rd edition (2016), p. 272 ff. 19 Venieris/Katsas/-Katsas, Law Nr. 3869/2010 on the insolvency of over-indebted individuals, 3rd edition (2016), p. 49 ff.

264

15

Key Elements of the Greek Legal Framework on Insolvency of Natural Persons

bureaucracy to provide for a timely outcome for the petitions for insolvency has led to considerable social costs. On the one hand, the rehabilitation of debtors has been delayed considerably, and on the other hand, as the status of interim measures remained active until the discussion date of the petition, the creditors (e.g. financial institutions) were not in a position to negotiate their portfolio of non-performing loans.20 On the basis of the empirical fact21 that a vast number of petitions are dismissed before court for formal reasons (e.g. lack of documentation, errors regarding the description of the factual settings, etc.), the Greek policymaker invested the courts’ secretariat with the authority to screen the submitted petitions. Such a process should consist solely in a formal control of the petition’s documentation in order to secure its completeness. However, Article 4 paragraph 2 of Law 3869/2010 in conjunction with the Common Ministerial Act 7534/2015 not only makes direct reference to the control of the petition’s content by the secretariat, but, in addition, requires an extensive list of documents, which makes access to the insolvency regime more difficult than originally planned. The screening procedure has already been extensively criticized by the jurisprudence.22

15.2.3

Procedural Aspects of the Insolvency Regime

The hearing of the petition for insolvency is set obligatorily within six months of its date of formal approval by the court’s secretariat (Art. 4 para. 3 sent. 1 of Law 3869/2010). The hearing date of the settlement plan is set obligatorily within two months of the date of the formal approval of the petition for insolvency (Art. 4 para. 2 sent. 3 of Law 3869/2010). As already mentioned, in view of the overload of filed petitions, the courts are rarely in a position to set such a short hearing date. The debtor must deliver the petition (by a bailiff) to the creditors within fifteen days from the date of its formal approval (Art. 5 para. 1 of Law 3869/2010). The creditors have access to all the documents submitted to the court by the debtor (Art. 5 para. 1 of Law 3869/2010). At the hearing date of the settlement plan, the creditors shall express their views on the settlement plan. If all creditors agree with the proposed plan or if none of the creditors object to it, it is assumed that the settlement plan was accepted, and it is validated by the court. If creditors representing more than one half of the total amount of debts, including all secured creditors and at least one half of labour claims, agree with the settlement plan, the court may substitute the consent of the rest of the creditors who disagree and accept that a compromise and settlement has occurred (Art. 7 para. 2 of Law 3869/2010). The substitution of the creditors’ consent is not allowed when (a) the claim of the creditor who 20 Ibid, p. 42-43. 21 Ibid, p. 44 ff. 22 Ibid, p. 272 ff.

265

Theodor G. Katsas

objects is not satisfied to the same extent as that of others or (b) if the objecting creditor proves that had the procedure gone on to the third stage of judicial settlement and debt discharge it would recover a higher amount of the debt or (c) if the claim of the objecting creditor is contested by the debtor or by any other creditor (Art. 7 para. 3 of Law 3869/2010). It is not allowed for creditors to charge the debtor for judicial expenses for the procedure of the achievement of the in-court compromise (Art. 7 para. 4 of Law 3869/2010). In case the settlement plan is not accepted by the creditors, or the requirements for the substitution of consent of the creditors are not met, the procedures for the judicial debt discharge are activated. Upon examination of the criteria of the Law, the court shall proceed with issuing its ruling on the petition. If a debtor’s petition is rejected, a new petition cannot be submitted in less than one year (Art. 1 para. 2 of Law 3869/2010).

15.2.4

Payment Plan and Liquidation of the Debtor’s Assets

Most natural person debtors have little of value in available assets and, whatever the form and extent of the discharge, most insolvency systems envision an ‘earned start’ for natural persons rather than a simple ‘fresh start’ with no contribution on behalf of the debtors. The Greek Law is no exception to this trend. However, the concept of an ‘earned start’ creates further questions as to how to determine fair and reasonable payment expectations with respect to appropriate baseline expenses. Some of the most difficult questions arise in the context of formulating a payment plan, especially the twin issues of how long debtors should be required to toil for the benefit of their creditors and how much debtors should be required to pay during that period. Once a payment plan is established, an effective insolvency regime must regulate the effective monitoring of the debtor’s compliance and the possibility of alteration to the payment plan in case of changed circumstances. The duration of a payment plan is dependent on the goals of imposing a payment plan on debtors in exchange for a promise of insolvency relief. Practice in many countries has indicated that plans longer than three years produce more failure than success. On the other hand, a payment plan needs to be based on an assessment of the income that the debtor is going to generate during the implementation period of the plan. This requires calculations of both current and projected income of the debtor. Incentives to productivity of debtors are also important to encourage natural person debtors to be active. The Greek insolvency system for natural persons combines both liquidation and payment plans: Article 8 paragraphs 1 and 2 of Law 3869/2010 requires both liquidation of debtors’ (non-exempt) assets owned and a four-year payment plan. The setting of the amount shall take into consideration the spousal contribution to the family income, in conjunction with the personal circumstances of the debtor and his family as well as the

266

15

Key Elements of the Greek Legal Framework on Insolvency of Natural Persons

basic (reasonable) expenses of the debtor. In designing the regulation of payment plans, the court takes into account that debtors need to be able to retain sufficient funds to cover at least their basic (reasonable) expenses and those of their dependants. The appropriate measure of sacrifice to be demanded of debtors in exchange for whatever relief an insolvency system offers is unavoidably an inherently political decision, which the courts have to make. In selecting an optimal approach to the Greek Law, attempts to combine both rules and discretionary elements have been made. All creditors are ranked pari passu. In exceptional cases (e.g. permanent unemployment or severe health problems of the debtor), the court can define zero-amount payments (Art. 8 of Law 3869/2010). In such cases the court shall set a new hearing date in order to modify the monthly payment plan. The new hearing date cannot be set sooner than five months from the date of the first ruling. The court’s judgment is directly enforceable, and no suspension can be granted. In addition, no judicial expenses can be claimed. The amount of settlement may be modified by new court ruling should subsequent facts come to light or changes in the debtor’s property or income status take place. During the period of the settlement, the debtor has the duty of care to make a reasonable effort to find a job and to inform the court about any changes concerning his address, his employer and any substantial improvement in his income or assets. If the court rules that liquidation of the property of the debtor is required, it proceeds with the appointment of a liquidator. Secured creditors are satisfied according to their privilege from the product of the liquidation. The debtor is entitled to file for an exemption of his primary residence from the property under liquidation, under the prerequisites of Article 9 paragraph 2 of Law 3869/2010. The liquidation of the debtor’s property and assets follows the rulings of the corporate insolvency code, which apply mutatis mutandis in this case.23

15.3

Interim Measures and Suspension of Individual Claims

The formal approval of the debtor’s petition is followed by an automatic suspension of all individual claims against the debtor until the hearing date of the payment settlement or of the petition for insolvency (Art. 4 para. 5 of Law 3869/2010). Any alteration of the debtor’s assets during this time is also prohibited. After the period thereof, the debtor, or anybody else having legal interest, can apply for provisional remedies suspending any measures of procedural enforcement against the debtor provided that the petition is likely to be successful and that it is probable that the debtor will suffer substantial damage if the suspension is not granted (Art. 6 paras.1 and 2 of Law 3869/2010). The suspension is

23 Ibid, p. 37 ff.

267

Theodor G. Katsas

granted for a period of six months, after which the debtor or any other person with legitimate interest needs to file for an extension of the suspension.

15.4

The “Straight Discharge” Procedure (Art. 5a of Law 3869/2010)

One of the most pressing problems is the treatment of debtors who possess no disposable assets and cannot generate any significant income in the near future. Such debtors are commonly referred to as ‘NINAs’ (No Income, No Assets) and face great difficulties to cover their basic needs. Since these debtors produce no value for creditors, insolvency systems tend to reduce the formalities and expenses of insolvency proceedings in order to assist in the resolution of this problem. The most effective form of relief in such cases is a “straight” discharge of debt, which provides an immediate fresh start for the debtor, without any payment plan.24 Under Greek Law (Art. 5a para. 1 of Law 3869/2010), a “straight” discharge of a debtor is provided under the following conditions: (a) the debtor does not possess any immovable property and has not proceeded to any transaction regarding such property within three years prior to the submission of the petition for insolvency, (b) the liquid assets of the debtor (including cash deposits in credit institutions) are not higher than €1,000, (c) the total amount of indebtedness is not higher than €20,000, (d) there are no secured creditors, (e) the debtor’s income during the last year before the filing of the petition amounts to zero, (f) the debts to be settled are not excluded from the scope of application of Law 3869/2010 and (g) the debtor qualifies as “cooperative” under the Code of Conduct for debtors issued by the Bank of Greece. Should the above-mentioned conditions be present during the time of submission of the petition for insolvency under Article 5a of Law 3869/2010 and remain unchanged at the time of the hearing date of the petition, the court may issue a judgment ordering the straight discharge of the debtor from the totality of his debt, without any payment obligation towards his creditors (Art. 5a paras. 1 and 2 of Law 3869/2010). The straight discharge is conditional on the eventuality that no (material) change in the debtor’s assets or income shall take place during the next eighteen months from the issuance of the relevant court judgment. The monitoring of this condition is attributed mainly to the debtor, who is obligated to inform the court and the creditors every three months of the development of his assets and income.

24 World Bank, Report on the Treatment of Insolvency of Natural Persons, p. 115 ff.; Venieris/Katsas/-Katsas, Law Nr. 3869/2010 on the insolvency of over-indebted individuals, 3rd edition (2016), p. 75 ff.; Tsiafoutis, H Nea Diadikasia tis Taheias dieuthetisis Mikroofeilwn symfwna me to arthro 5a tou N. 3869/2010, Xrimatopistotiko Dikaio 2015, p. 171 ff.

268

15

15.5

Key Elements of the Greek Legal Framework on Insolvency of Natural Persons Protection of the Debtor’s Primary Residence

An important aspect of an insolvency system refers to the exemption of the debtor’s assets from the liquidation process (see in more detail Chapter 16). The notion of exempting some of the debtor’s property from liquidation is related to the discharge principle and the notion of the fresh start. Debtors who receive a discharge and obtain a fresh start should be provided with sufficient property to meet the minimum domestic needs for themselves and their families. There are three basic approaches to deciding which property may be exempted: the first approach is to set aside a range of assets with a value up to a specified limit that the debtor may seek to get exempted from liquidation. Another approach sets out categories of particular assets (and values for these assets) that the debtor may seek to get exempted. The burden is on the debtor to establish an exemption for these assets. The third approach is based on a more general standard: Most of the property is exempt from liquidation, and the burden is on the liquidator or system administrator to object to the exemption of the assets. The Greek Law on insolvency of natural persons has followed the second approach and introduced an “earned” exemption of the primary residence from the liquidation process. Under the previous version of Article 9 paragraph 2 of Law 3869/2010,25 the debtor was entitled to submit a liquidation proposal asking for the immovable property secured in rem or not, which served as a primary residence, to be exempted from liquidation provided that the value of the property did not exceed in area the tax-free limit for primary residence acquisition predicted in provisions in force by 50%. In this case, the court would order the debtor to pay a total amount of up to 80% of the (objective) value of the primary residence in order to exempt it from the liquidation. The payment settlement may provide a grace period. However, the payment plan could not exceed a twenty-year period. The debtor’s failure to fulfil the terms of the payment plan enabled the creditor(s) to initiate enforcement proceedings against the debtor. The introduction of Law 4336/2015 and 4346/2015 has altered the conditions for the exemption of the primary residence. The exemption of the primary residence now takes into consideration (a) the objective value of the primary residence, (b) the debtor’s income and (c) the level of his indebtedness (Art. 9 para. 2 of Law 3869/2010). More precisely, a primary residence is exempted from liquidation only if (a) the debtor’s monthly family income does not exceed the reference point set by the reasonable living expenses, increased by 70%, (b) the (objective) value of the residence at the time of the hearing date of the 25 See Venieris/Katsas/-Venieris, Law Nr. 3869/2010 on the insolvency of over-indebted individuals, 3rd edition (2016), p. 600 ff.; Arvanitakis, Skepseis gia th Legomenh “Katholikotita” tis Diadikasias Rithmisews twn Ofeilwn Yperhrewmenwn Fysikwn Proswpwn, Epitheorisi Politikis Dikonomias 2012, p. 223 ff.; Perakis, Ptocheutiko Dikaio 2012, p. 469; Kiouptsidou – Stratoudaki, H Apofasi Dieuthetisis Ofeilwn kata to N. 3869/2010, Armenopoulos 2010, p. 1493.

269

Theodor G. Katsas

petition for insolvency is not higher than (i) €180,000 for the (non-married) debtor and (ii) 220,000 for a married couple increased by €20,000 for every child. The Greek insolvency regime for natural persons does not deviate from the principle of “earned” exemption of the primary residence from the liquidation. The payment plan is defined by the judge, calculated on the basis of the average fluctuating or fixed residential mortgage loan rate and within a period that does not exceed thirty-five years. The overall amount to be paid by the debtor should not be lower than the amount that would be distributed to the creditors in case of foreclosure sale (Art. 9 para. 2 of Law 3869/2010). In case the debtor is in a state of inability to make monthly payments, he may apply to the Greek State for support on the monthly payment of the debt settlement plan. In any case, the debtor is obliged to pay 5% of his income if the latter amounts to €8,000, and 10% of the difference if his income is higher than €8,000.26 If during the payment period the debtor sells his primary residence at a price that exceeds the settled debt, then 50% of the excess amount is distributed to the guarantors and preferential creditors. The latest regime on the exemption of primary residence from liquidation has met with scepticism from jurisprudence.27 The protection regime draws a distinction between debtors on the basis of their creditworthiness. In case the settlement plan proposed by the debtor cannot be sustained, the debtor is not entitled to an exemption of his residence from liquidation.28 Moreover, the discretionary power of the court regarding the definition of the payment plan is reduced. Last but not least, there are technical difficulties with the definition of the payment scheme by the debtor, which render the access to the protective regime difficult.

26 According to the Common Ministerial Act No. 130377/16 December 2015. 27 Venieris/Katsas/-Venieris, Law Nr. 3869/2010 on the insolvency of over-indebted individuals, 3rd edition (2016), p. 600 ff. 28 Similar to the Irish Bankruptcy Act, where the debtor may agree to a schedule of mortgage payments with the credit institutions and the Official Assignee.

270

16

Private Insolvency Legislation and the Protection of the Principal Residence

Viktoras Tsiafoutis*

16.1

Introduction

Despite the fact that during the last decades the pacta sunt servada principle is strongly under question, through the bankruptcy legislation in several Member States, the idea of protecting the debtor’s principal residence is not being discussed to the extent it should be. It is generally believed that bankruptcy procedures mean liquidation of all the debtor’s assets, including all immovable property and his family house.1 Perhaps this perception is based on the general idea of creditors’ satisfaction in commercial bankruptcy. Some measures taken in several European countries against foreclosures, in recent years, had a strictly temporary character, as they tried to tackle the consequences of financial crisis, especially homelessness. In most cases, such as in Ireland2 or Spain,3 enforcement measures against primary residence were suspended for a certain period. In Greece, foreclosures from banking institutions, for debts of less than €200,000, were forbidden shortly after the Lehman Brothers collapse, in 2009,4 and this suspension was renewed until the end of 2013. The main characteristic of this initiative was that all immovable properties were protected.5 It was in 2010, when the Greek law on bankruptcy of natural persons was introduced, that the notion of principal residence was connected to insolvency liquidations procedures.6 Contrary to the primary residence notion, which serves tax purposes, principal residence means the real estate in which the debtor and his family live. Article 9 paragraph 2 of Law 3869/2010 provided that the debtor could ask the court to exclude his principal residence

* 1

2 3 4 5 6

Lawyer, Legal Advisor at consumer association EKPIZO. For a comparative report of insolvency laws shortly before the severe consequences of the crisis and the austerity measures taken, see Ramsay, Different systems of treatment of over-indebtedness in EU: commonalities and differences, Regional and local treatment, prevention and assessment of over-indebtedness, European Conference Report 30.9-1.10/2010 (Namur – Belgium). London Economics, Study on means to protect consumers in financial difficulty: Personal bankruptcy, datio in solutum of mortgages, and restrictions on debt collection abusive practices, 2012, 130. EUI, The Over-indebtedness of European Consumers – a View from Six Countries, 2014, 158. Αrt. 5 ΠΝΠ 16 September 2009 (ΦΕΚ 181Α/16 September 2009). For 2014, only principal residence was protected. In addition to the so-called “nonseizable” for the primary residence, see below, chapter 2 para. e.

271

Viktoras Tsiafoutis

from the liquidation of his property, as long as he paid a total amount that did not exceed a percentage of its value. On the one hand, the court is obliged to accept the debtor’s request for protection, provided that he fulfills the requirements for accepting his application. On the other hand, if he does not pay what is set by the court, creditors are able to take enforcement measures against his house. Both literature and jurisprudence welcomed the principle of residence protection as a provision that was juris-politically and socially necessary, rejecting any arguments for possible unconstitutionality. On the contrary, several constitutional provisions are considered to be the basis for the justification of home protection. Moreover, there are strong arguments in favor of the protection of a debtor’s house based on general civil law provisions about transactional good faith. Besides, private (or often called civil) insolvency legislation is considered to be a specialization of good faith. As a result, soon after the law came into force, the main subject of the discussion turned out to be the price that the debtor had to pay to keep his home. The legal certainty provided by Article 9 paragraph 2, as mentioned above, was under question by the national legislature with the last (third) amendment of the provision in 2015. Nevertheless, it is important to examine the chronology of the provision in order to understand substantially the primary residence protection principle, its added value and its limitations.

16.2

16.2.1

Law 3869/2010: Purpose and Meaning and the Position of the Primary Residence Protection Provision in the System of the Law

The Principle of Debt Discharge

It is accepted that Law 3869/2010 constitutes specific bankruptcy legislation on the threshold of civil law. It is one of the two chapters of insolvency law that is complementary to the second one, namely business bankruptcy.7 In addition, it features some genuine insolvency law characteristics, the most important of which is probably the principle of collective satisfaction of creditors.8 However, the main and essential difference relating to the commercial bankruptcy is its purpose. While in the case of the insolvency code the main purpose of a business 7

8

Mentis G. Άμυνα και απελευθέρωση του υπερχρεωμένου οφειλέτη (Defence and Release of the over-indebted debtor), 2012, 160. Katsas in Venieris I. and Katsas T., Η εφαρμογή του Ν.3869/2010 για τα υπερχρεωμένα φυσικά πρόσωπα, 2013, 16 (Enforcement of Law 3869/2010 for Over-indebted Individuals). Psichomanis S. Πτωχευτικό Δίκαιο, 2011, 509 (Insolvency Law, 2011, 509), Perakis Η. διαδικασία του Ν. 3869/2010 για τη ρύθμιση οφειλών υπερχρεωμένων φυσικών προσώπων ως συλλογική διαδικασία (The Law 3869/2010 procedure for the over-indebted individuals debt settlement as a collective procedure), ΔΕΕ 2011, 400 et seq.

272

16

Private Insolvency Legislation and the Protection of the Principal Residence

bankruptcy is creditors’ maximum possible satisfaction, Law 3869/2010 focuses on the natural person’s debt settlement in order to enable such a person, after fulfilling his obligations in accordance with the court, to reintegrate socially and economically and to make a fresh start.9 Therefore, the bankruptcy purpose shifts from creditors’ satisfaction to debtors’ discharge. It has also been argued, mainly in response to the objections raised on the law’s possible unconstitutionality, that its provisions ensure the protection of the debtor’s basic constitutional rights. In particular, the law’s purpose is none other than the realization of the State’s obligation to protect the personality and his value (Art. 2 para. 1 and 106 para. 2 Const.), in the social rule of law context (Art. 25 para. 1a Const.).10 This is achieved by allowing the debtor to have his debt discharged, after a few years, as defined in the court settlement. This settlement, defined by Article 8, is the product of balancing the debtor’s and his family’s income and expenses to ensure decent living as nonnegotiable.11 It is in this balancing, which has not been easily implemented by the Greek courts, that the protection of the aforementioned constitutional rights is founded. Without it, the debtor’s discharge would retreat in front of the creditors’ maximum possible satisfaction, and the subjection to the law’s provisions would lose its meaning for the debtor.

9

See Explanatory report for Law 3869/2010. “the main difference between this procedure and the commercial bankruptcy is their purpose. While the latter aims basically at creditors’ satisfaction with often fatal consequences for the enterprise, these provisions aim to the reintegration of the over-indebted citizen in economic and social life by regaining economic freedom following the discharge from the debts he does not have the ability to repay. In this regard, the creditors’ collective satisfaction aims to a potential second chance for the over-indebted individual in order to make a fresh economic start, without the burden of the past and with the potential to be discharged from his obligations, if for a particular period he has exhausted the possibilities to satisfy his creditors. The creditors’ satisfaction (even partial) from the debtor’s income for a particular period emerges as a tussle and service to the debtor in order to achieve the beneficial effect of the debt discharge by the end of that period.” For the importance of the notion of “fresh start”, see Civil Consulting, The overindebtedness of European households: updated mapping of the situation, nature and causes, effects and initiatives for alleviating its impact, 2013, 249. 10 Kritikos A. Ρύθμιση των οφειλών υπερχρεωμένων φυσικών προσώπων (Debt arrangement for over-indebted individuals), 2014, 3. See also in the Explanatory report: “For the individual, the potential of the debt settlement, by achieving a debt discharge finds its legitimacy directly in the actual social rule of law that demands the citizen not to be abandoned in an impasse and without prospect situation from which creditors cannot benefit either. However, such a debt discharge does not cease to widely serve the general interest, as the citizens essentially regain by these proceedings their purchase power and promote the economic and social activity.” 11 Civic Consulting, as above, 249, Tsiafoutis V. Βιοτικές ανάγκες του αιτούντος τη ρύθμιση των οφειλών του (Ν. 3869/2010) και της οικογένειάς του – Μια προσέγγιση του κόστους Φωής, Χρονικά Ιδιωτικού Δικαίου (The subsistence needs of the applicant for a debt settlement (Law 3869/2010) and his family – A cost of living approach, Private Law Chronicles), 2012, 699 et seq.

273

Viktoras Tsiafoutis

16.2.2

The Relation with the Transactional Good Faith

It is therefore clear that the judicial proceedings of Law 3869/2010 are regulative: Provided that the debtor cumulatively meets the essential requirements defined in Article 1 paragraph 1, the court settles under the law provisions’ contracts in a way that the debtor’s and creditors’ rights and obligations are balanced.12 On the one hand, the debtor will be obliged to make payments on the basis of his financial ability and the particular circumstances of his life, and on the other hand, the creditors will receive the maximum possible amount, either from the debtor’s income or from his property, without his being condemned to extreme poverty and penury until he is able to make a full repayment. The regulatory nature of Article 8’s provision (as well as that of Article 9 mentioned below) is one of the two connecting links to the 288 Civil Code provision.13 The second and most important link is established by the terms of the regulation, that apart from the fact that they ensure the protection of the constitutional rights, they appear to promote the transactional good faith in the overindebted natural persons’ debt settlement.14 In accordance with Article 288 Civil Code, “The debtor has the obligation to meet the provision in accordance to good faith, taking into account the honest practices.” The principle of good faith and honest practices established on the provision form a general clause of mandatory rules. According to jurisprudence, the good faith herein signifies the exercise of honesty and fairness in transactions (objective or transactional good faith). It is essentially a juridical and ethical principle on the basis of which the content of a contract is open to review.15 Therefore, the obligatory relation becomes socially oriented, as it is imperative to take into account the other party’s interest in order to balance the counterparties’ rights and obligations.16 The general clause of transactional good faith functions either complementarily or correctively. In the last case, the court regulates the contract by changing the provision in such a way that it responds to good faith and balances the counterparties’ rights and obligations. Especially in cases of loan debts, changes in the debtor’s financial or real situation could overturn the contract’s legal foundation to such an extent that the provision regulation in accordance with good faith is necessary.17 Even in cases where there is no causal connection between the change and the repayment inability, because, for example, the inability is of a small extent or would anyway occur or when there has been no change, i.e. normally at

12 13 14 15

EUI, op. cit., 36. Mentis, op. cit., 182, 224-225. Ibid, 225. Dellios H. Καλή πίστη και γενικοί όροι συναλλαγών (Good faith and general contract terms), Νομικό Βήμα 2003, 218. 16 Stathopoulos M. General Contract Law, 84. 17 Mentis, op. cit., 111 et seq.

274

16

Private Insolvency Legislation and the Protection of the Principal Residence

“overcharging” contracts18 through revolving credit, the corrective implementation of Civil Code 288 cannot be excluded if it is proved that the bank did not fulfill its obligations following its main contract obligations (credit supply) to provide and inform, in the context of the relationship of trust with the debtor-consumer.19 Therefore, despite Law 3869/2010’s strong and self-reliant nature, it would not be bold to say that it essentially constitutes the 288 Civil Code specialization at a collective process level20 and within a specific subjective and objective scope. While traders are under the 288 Civil Code, even if default of payments is anticipated, the provisions of Law 3869/2010 are applicable only to natural persons who have no insolvency capacity and have already been overindebted. Thus, we understand that the 288 Civil Code’s scope is relatively wider than Article 1 of Law 3869/2010. To implement the two settlement proceedings, the debtor’s nonfraudulent conduct is an imperative common requirement. However, whether Law 3869/2010 constitutes a specialization for a specific debtor’s profile or is faintly connected to the 288 Civil Code, the insolvency law operates under the cover of the transactional good faith concept, resulting in its implementation in order to close the gaps and interpret the law’s provisions.21

16.2.3

Article 9 Paragraph 2

The introduction of Law 3869/2010 in the Greek legal order in 2010 brought an important innovation in civil insolvency law at the European level. As in any European legislation, the court settlement of the debtor’s debts provides two basic debt repayment proceedings:

18 Ibid, 70. 19 Mentis is endorsing the bank’s obligation to refuse granting credit to a noncreditworthy client. Mentis, op. cit., 54. Regarding the mortgage credit, this aspect is justified by the 2014/17/EU Directive (Art. 18, para. 5, case. a). For the bank–client relation of trust and the ensuing obligations from the recent jurisprudence, see indicatively Athene’s Court of Appeal 4617/2012 ΔΕΕ 12/2012. In fact, the consumer receives generally asymmetric information, as he lacks awareness, organization, alternatives, and rational behavior (Dellios, op. cit., 220-223). The consequence of asymmetric information is the need to specify the protection obligation clause on behalf of the bank, which out of necessity includes information about the risks that may arise during the execution of the provision. Thus, the bank has the obligation to enlighten when it is obvious that the client does not realize the risks arising from the intended transaction or when the bank acknowledges certain facts that would deter the client, if he were aware of them, from proceeding to its conclusion. (See Ψυχομάνη, ΤραπεΦικό δίκαιο, Δίκαιο ΤραπεΦικών Συμβάσεων (Banking Law, Banking Contract Law) General Part, 2008, 31 et seq.) It is also an important obligation of the bank to protect the clients’ interests by acting appropriately, warning them, or refraining from acts that could harm them. (Ψυχομάνης, ΤραπεΦικό δίκαιο, Δίκαιο ΤραπεΦικών Συμβάσεων [Banking Law, Banking Contract Law] Issue Ι, 2008, p. 31 et seq., 69 et seq). 20 Katiforis Η. δικονομία της ρύθμισης οφειλών υπερχρεωμένων φυσικών προσώπων (The civil procedure of the over-indebted individuals’ debt settlement), 2013, 3. 21 Katsas, op. cit., 32.

275

Viktoras Tsiafoutis the payments defined in Article 8 paragraph 2 or 5 for a three-year period22 and also the liquidation of the appropriate property in accordance with Article 1 paragraph 1.23 Law 3869/2010 was innovative because it predicted the principal residence’s exemption from liquidation, under terms and procedure that do not harm the creditors’ interests.24 Prior to the amendment of Law 4336/2015, which will be discussed later, Article 9 paragraph 2 was formulated as follows: The debtor may submit a liquidation proposal asking for the immovable property secured in rem or not, which serves as a principal residence, to be exempted from the foreclosure sale provided that it does not exceed in area the tax-free limit for principal residence acquisition predicted in provisions in force increased by fifty percent.25 In this case the court settles the satisfaction of creditors’ demands, a total amount up to eighty per cent of the principal residence objective value. The settlement could provide a grace period. The debt repayment is at a rate which does not exceed that of informed debt or the residential mortgage loan’s average fluctuating rate in force according to the Bank of Greece statistical bulletin during the last month for which it is measured, adjusted to the reference rate of the European Central Bank’s main refinancing operations and without compound interest. The creditors’ demands that have the immovable property secured in rem are preferentially satisfied by the debtor’s payments based on this paragraph. To determine the repayment period of the defined amortization debt, it is taken into account the contract 22 As the provision was amended by Law 4336/2015. Until then, the period was from three to five years, according to the amendment of Law 4161/2013. 23 “If there is property liquidable, the foreclosure sale of which is deemed to be necessary for the creditors’ satisfaction or when the court deems necessary to monitor and assist in the execution of the debt settlement terms for the debtor’s discharge or the protection of creditor’s interests, a liquidator is designated. As liquidator may be designated the person suggested by the creditors representing the majority of credits or a person from the register of experts defined in Art. 371 Code of Civil Procedure. The liquidator’s task is what the designation ruling defines and, in any case, the management of the debtor’s property, its statutory assurance in the interest of the creditors, its appropriate foreclosure sale, the preferential satisfaction of the creditors who have a security in rem in the foreclosed object and the proportionate satisfaction of the non-secured in rem creditors. The Bankruptcy Code provisions regarding the administrator (trustee) in the bankruptcy shall apply mutatis mutandis for the liquidator. The objects defined as non seizable, under Art. 953 Code of Civil Procedure provisions are exempted from the debtor’s liquidable property. Creditors’ demands are satisfied in accordance to the Civil Code of Procedure.” See Dellios Η. εξαίρεση της κύριας ή της μοναδικής κατοικίας του οφειλέτη από τη ρευστοποίηση της περιουσίας του κατά το άρθρο 9 παρ. 2 του N. 3869/2010 για τη ρύθμιση των οφειλών υπερχρεωμένων φυσικών προσώπων (The debtor’s principal or sole residence exemption from his property liquidation in accordance with article 9 para. 2 of the Law 3869/2010 for the over-indebted individuals’ debt settlement), ΧρηΔικ 2010 (Financial Law 2010), 256 et seq. 24 See in the Explanatory report: “(the bill) ensures the protection of the debtors’ principal residence by an innovative settlement, since it enables them to exempt the residence from their property liquidation. Under the terms and proceedings that do not harm creditors’ interests.” 25 That is €300,000 for the unmarried debtor increased by €50,000 for the marital and €25,000 for each child.

276

16

Private Insolvency Legislation and the Protection of the Principal Residence

duration under which the credits were granted to the debtor. However, it cannot exceed a twenty year period, unless the contract duration under which the credits were granted to the debtor was longer than twenty years, therefore the cantonal judge may specify a longer duration which cannot, however, exceed a thirty five year period. Debtor’s failure to fulfill the obligations imposed pursuant to this paragraph allows the creditor to initiate enforcement proceedings against the debtor and his principal residence. A complaint against this settlement cannot be filed, unless there is a delay in payment up to four months. If the debtor resides in an immovable property of different owner and his marital does not own an immovable property that can be used as a residence, then the current paragraph’s provisions are implemented for the debtor’s sole immovable property that can be used as a residence.26

16.2.4

Enforcement Proceedings in Question: The datio in solutum Principle and the Mortgage Credit Directive

Partly because of the financial crisis, in recent years there has been a debate at the European level on alternative forms of outstanding residential mortgage loan settlement, within the context of the general response to the household overindebtedness.27 At the heart of this debate are both the debtor’s need not to be a prisoner of unsustainable debt, especially when the circumstances under which he undertook this debt have changed, and also the tendency to avoid the extreme measure of foreclosure of the principal residence. In this regard, the concepts of datio in solutum, forbearance toward the debtor and settlement of any remaining amount after the foreclosure play a more central role. a. The core of the datio in solutum principle is the connection of mortgage debt to the principal residence’s commercial value, providing to the debtor the major advantage of nonliquidation of the rest of his property. In mortgage loans, the debtor who cannot repay his mortgage debt is exempted from it if the mortgaged immovable property is delivered to the creditors.28 At the same time, the debtor’s and creditor’s sharing of consequences deriving from the poor estimate that led to the granting of a residential mortgage loan and also from the unforeseen changes in the property value and the debtor’s creditworthiness constitutes a juris-political basis for the settlement.29 More-

26 As it was amended by Law 4161/2013. At first, the debtor was obliged to repay up to 85% of the commercial value in a twenty-year period. 27 European Commission, Towards a common operational European definition of over-indebtedness, 2007. 28 London Economics, op. cit, 6. 29 Ibid, 210.

277

Viktoras Tsiafoutis over, this is how the principle of responsible lending is being effectively served.30 It is no coincidence that the recent directive 2014/17/EU on mortgage credit explicitly promotes the datio in solutum principle.31 The main disadvantage of the datio in solutum principle for the debtor is the loss of his principal residence and the fact that results in the remission of the mortgage loans only and therefore the rest of the debtor’s property risks being liquidated if the debt originates from consumer credit products. The principal residence protection in accordance with Article 9 paragraph 2, as mentioned, is in fact an excellent provision in the chapter of the debtor’s assets liquidation due to bankruptcy, to satisfy any kind of nonexcluded debt. In this light, there is no question for these two proceedings to be coincided. However, Article 9’s settlement appears to borrow the principal’s general idea, not as a provision instead of financial payment but as a financial payment instead of provision through enforced foreclosure and even on the basis of the connection between outstanding debt and property value.32 b. At the same time, the European legislature explicitly states in the 2014/17/EU the principle of forbearance before foreclosure proceedings (Art. 28 para. 1). Generally, the creditor’s forbearance toward the debtor who runs into debt repayment difficulties signifies avoiding the enforcement proceedings by a debt settlement in order for the debt to be sustainable.33 In the Greek legal order, the Bank of Greece (BoG) Code of Conduct constitutes a specialization of the forbearance principal. It is worth noticing that the regulations suggested by the Code include the partial debt forgiveness (partial debt cancellation so that the remaining can be repaid on the basis of the debtor’s ability) and the trade down (swap to a residential mortgage loan of lesser value). c. The Article 28 paragraph 6 stipulates that after foreclosure proceedings if outstanding debt remains, the Member States shall take measures to facilitate the repayment to protect the consumers.

16.2.5

The Protection as a Constitutional Obligation of the State

It has been argued, mainly by the jurisprudence, that the juris-political basis for the principal residence protection are the constitutional imperatives for the housing protection

30 Regarding the value of the immovable property to be ensured, it should be noted that according to Art. 18 para. 3 of the Directive 2014/17/EU for credit mortgage, the evaluation of creditworthiness does not rely mainly on the acceptance that the value of the residential immovable property is higher than the amount of credit or that the value is going to increase, unless the credit contract aims at the construction or renovation of this immovable property. 31 Art. 28 para. 4 (in the form of nonresource loans) as well as rec. 27 εδ. ε. 32 EUI, op. cit., 117 et seq. 33 London Economics, op. cit., 16.

278

16

Private Insolvency Legislation and the Protection of the Principal Residence

(Const. 17 para. 1) and the care for the acquisition of a house (Const. 21. para. 1). However, this aspect does not appear to be correct, as in the first case we refer to the property right protected against expropriation, requisition etc., while in the second case we refer to State policies to facilitate specific categories of citizens to acquire a residence.34 It could be possibly easier to seek justification in the constitutional obligation of the State to ensure the human dignity (Const. 2), and therefore the right to housing, although it is argued that human dignity does not necessarily imply home ownership, as the latter does not constitute a nonseizable asset, in accordance with Article 953 of the Civil Code of Procedure.35 However, it should be noted that, even under certain preconditions, the Greek legislation provides the nonseizable status for the primary residence. More precisely, in accordance with Article 14 paragraph 11 of Law 2251/1994 for the consumer protection, the debtor’s sole residence foreclosure is prohibited for consumer products debts if (a) the demand does not exceed the amount of €20,000, (b) a consensual mortgage on the property is not written, and (c) the debtor is unable to meet his obligations. In any case, the fact that the dignity is ensured even without a home ownership does not exclude the residence protection within the bankruptcy proceedings in the context of constitutional imperatives if carried out in a way that does not affect either the equality of all citizens before the Constitution (Const. 4), thus covering even those who do not own a principal residence, or the creditors’ interests (Const. 17). The residence exemption from liquidation could have its direct legal ground to the Constitution, since the persistence to a revenue method resulting in the loss of debtor’s family residence cannot be justified, when such a result can be avoided by a similar, if not better, revenue effect.36 The expulsion from the residence and its financial, social and psychological consequences for the debtor, especially in a social environment where the feeling of family home ownership is strong,37 cannot be constitutionally forborne when the debtor’s permanent inability to fulfill his obligations is nonfraudulent.

16.2.6

The Relation of Articles 8 and 9

Following the Law 3869/2010 proceedings, the debtor will not be discharged from his debts if the creditors are not appropriately satisfied; however, Articles 8 and 9 define the exact limit for this satisfaction that ensures the debtor’s right to a decent living (Art. 8 paras. 2 and 5) and also the foreclosure sale of just the appropriate assets (Art. 9 para. 1). 34 35 36 37

Dagtoglou D. Ατομικά Δικαιώματα (Individual rights), 2005, 1032 et seq. and 1237. Dellios, op. cit., 296. Mentis, op. cit., 179. According to Eurostat, 74.8% of the Greek population live in an owner-occupied residence ().

279

Viktoras Tsiafoutis

In fact, Article 9 paragraph 1 provision defining the foreclosure sale of the liquidated property that is considered to result in creditors’ satisfaction appears, at first, to aim at more efficient liquidity creation in favor of creditors. However, it cannot be ruled out that its implementation is oriented towards balancing the parties’ rights and obligations. The two articles are interdependent: If the creditors are satisfied with Articles 8’s repayments, then the property liquidation is not necessary and vice versa.38 The debtor’s debt discharge occurs after the proper fulfillment of the Article 8 paragraph 2 or 5 court settlement and not by any payment that is defined for the debtor’s principal or sole residence protection.39 Hence, Article 9’s provision at first is not as strongly regulative as that of Article 8. However, it serves the purpose of the 288 Civil Code compensatory justice at two levels: First, it restores in a reasonable way the creditors’ rights, utilizing the liquidated property to their satisfaction, and, second, it ensures the debtor’s dignity since he would not lose all his assets but only those that will create substantial liquidity,40 while he can keep his residence. In fact, Article 9 paragraph 2 on court settlement is originally regulative: Essentially, the debtor repurchases his residence through a residential mortgage loan, the principal amount of which does not exceed 80% of its objective value. Thus, the two provisions, irrespective of each one’s severity, is better to be seen as parts of a whole that serves the 288 Civil Code regulatory/discharging purpose.

16.2.7

The Provision of Article 9 Paragraph 2: Complementary to Article 8 or Right “Buyout”?

The provision for the protection of the debtor’s residence appears to be at first out of the concept of settlement and discharge defined by Article 8 and the remaining of Article 9’s paragraphs. It gives the impression that it is a “buyout” of the debtor’s right to keep his residence,41 an additional advantage for the overindebted debtor who meets the preconditions of Article 1, without being strongly stated but under the form of the exemption at the chapter of his property liquidation. However, one must not be disoriented by the provision’s exceptional nature; it still aims at the settlement of the remaining debts following the Article 8 court settlement. As the theory suggests, new debts cannot be primarily created, but the protection price is shared among the creditors by the preferential satisfaction of

38 Venieris, op. cit., 409. If the debtor’s property is sufficient for his full debt repayment, a contract settlement in accordance with Art. 8 para. 2 or 5 may not be ordered, but the discharge could be achieved after the foreclosure proceedings. 39 Art. 11 para. 2 Law 3869/2010. See Kritikos, op. cit., 386; Dellios, op. cit., 296 et seq.; Venieris, op. cit., 515 et seq. It is accepted by jurisprudence and theory that nonfulfillment of the terms for the principal residence protection may not result in the discharge loss but in the immovable property’s loss. 40 Kritikos, op. cit., 317. 41 Dellios, op. cit., 296 et seq.

280

16

Private Insolvency Legislation and the Protection of the Principal Residence

the guarantees.42 The difference lies in the shift of the juris-political-based projection of constitutional rights and good faith from the debt discharge to residence protection. In Article 9 paragraph 2, the exempted immovable property’s objective value plays the same compensatory role as the debtor’s income, the product of his property liquidation, and the obligation for income increase and financial change information in Articles 8 and 9 paragraphs 1 and 3. Thus, the good faith deriving from 288 Civil Code constitutes a coherent factor of the two settlements.

16.2.8

The Protection as a Good Faith Obligation: The Balancing of Interests

As already mentioned, the principal residence exemption from the “bankrupted” property liquidation, as Constitutional and 288 Civil Code projection, should balance the debtor’s and creditor’s interests. It should be noted that in Law 3869/2010 residence protection is an additional source for debt repayment. Therefore, the creditors’ satisfaction comes from three sources: (a) proportionally for three years, based on the debtor’s income and his reasonable living expenses,43 (b) the liquidation of the appropriate property (Art. 9 para. 1), and (c) the repayment of the additional debt for the protection of his principal residence (Art. 9 para. 2). Apart from bankruptcy proceedings, the creditors cannot be satisfied from the debtor’s salary or pension.44 It is also provided that deposit accounts up to €1,250 are nonseizable.45 Therefore, creditors’ repayment comes in fact only by property (movable and immovable) foreclosure sale.46 Especially for the immovable property, which in the vast majority of household overindebtedness cases is the only possible source of liquidity, the Code of Civil Procedure provides the following: Until the end of 2015 the former Code of Civil Procedure was still in force and the first offered price in the foreclosure sale could not be lower than the immovable property’s objective value, whereas from 1 January 2016 its commercial value will be the first offered price.47 In the case of two consecutive ineffective foreclosure sales, the court may order a new one at a price equal to or lower than the first offer. The protection price should be determined in the sense of serving the balancing of the aforementioned interests. Under the provision’s former wording, for the requests submitted 42 Kritikos, op. cit., 336. 43 As the provision of Art. 8 para. 2 was amended by Law 4336/2015. 44 The salary/pension is fully nonseizable for individual creditors (Art. 982 para. 2 Code of Civil Procedure) and up to €1,000 for the State (Art. 31 para. 1 εδ. β ΚΕΔΕ). 45 Art. 31 para. 2 ΚΕΔΕ. 46 Venieris I. Κριτική αποτίμηση της διαδικασίας του Ν. 3869/2010 (“τα υπερχρεωμένα νοικοκυριά”) και της αναμόρφωσής της με το Ν.4161/2013, Η αντιμετώπιση της αφερεγγυότητας (A critical evaluation of the Law 3869/2010 evaluation (“the over-indebted households”) and its reformation by Law 4161/2013, Dealing with insolvency), 23rd Hellenic Conference on Commercial Law, 2013, 316. 47 Former and new Art. 995 para. 1 Code of Civil Procedure.

281

Viktoras Tsiafoutis

before 31 December 2015, the interest-bearing repayment of 80% of the objective value is likely to create greater liquidity compared with a foreclosure sale’s effect (in accordance with the former Art. 995 para. 1 of Code of Civil Procedure), especially considering the property market stagnation. In fact, this “residential mortgage loans” repayment would take place within years, while the foreclosure sale price should be repaid immediately. For this reason, Article 17 defines that Article 30 paragraph 10 of Law 2789/2000 is implemented in the case of financial institutions’ demands, which are canceled by this law.48 The canceled amount is deducted from the gross usage revenue during which the cancellation is effected to determine the taxable gain.

16.2.9

Principal Residence Protection and Moral Hazard

The institutions’ representatives’ (quartet) main argument during the negotiations with the Greek government about the restriction of the Article 9 paragraph 2 protection was the moral hazard for the financial system that arises by such protective provisions.49 More specifically, the question is whether the protection of the principal residence can lead debtors to payment default50 in order to benefit from their inclusion to Law 3869/2010. On the contrary, the risk of foreclosure is considered to apply the right amount of pressure to the debtors so that they fulfill their obligations. Actually, the moral hazard concept is a theoretical construction that cannot be easily proved and that in any case is firmly criticized, especially when it comes to mortgage credit.51 The law itself strenuously excludes its abusive use: Only debtors who have gone into permanent inability to fulfill their obligations in a nonfraudulent way are under its provisions (Art. 1). Therefore, debtors who have the financial ability to pay but prefer to file for bankruptcy cannot be subjected to the law’s provisions. In addition, those who went into payment difficulty in an abusive way – even if the payment difficulty is real – are excluded from the law’s scope. Therefore, a double safeguard against moral hazard is established.52 Moreover, it could be argued that during the first two years of the law’s implementation, the aforementioned question arose due to long-term hearings defined by the court, and as a result, the debtor did not make a payment until the discussion of his request. However, the 2013 amendment excluded any abusive use of the law, as the debtor was obliged to

48 “The relevant cancellation is going to burden the usage during which it will occur. All taxes proportionate to the canceled interests and paid by credit institutions to the State are offset with unpaid taxes within the usage during which the cancellation will take place.” 49 See indicatively IMF, Working Paper: Resolving Residential Mortgage Distress: Time to Modify?, 2014. 50 Even if they take on more debts than they are able to repay, see Civil Consulting, op. cit., 167. 51 Civil Consulting, op. cit., 168. 52 Venieris, 2013, 332 et seq.

282

16

Private Insolvency Legislation and the Protection of the Principal Residence

make an advance payment since he submitted his request, whereas a preliminary discussion takes place prior to the discussion of the request, during which the court investigates whether the parties agree on a compromise; otherwise, payments are defined according to the debtor’s ability (Art. 5 para. 2) until the main discussion.53 Law 4336/2015 attempts to address the question of long-term hearings, mainly by recruiting cantonal judges and secretarial staff.54

16.3

The Principal Residence Protection Price Level (under the Previous Regime)

The question about the percentage of the principal residence value that must be repaid for its protection arose from the first instant of the law’s implementation. Under the initial wording, it has been argued, both in jurisprudence and in theory, that the percentage of the value – initially the commercial value – should be at least 85% (and higher). On the other hand, it has been argued that the wording “up to total amount” refers to a scale from 0% to 85%. Regarding the first aspect, both theory and jurisprudence suggested, reluctantly at first and more strenuously afterwards, especially after the provision’s amendment, that reasons relating to the debtor may lead the judge to order a lower percentage, mainly by proportionate implementation of Article 8 paragraph 5.55 The payment of a certain amount for the protection of his principal or sole residence should not depend only on immovable property value in cases in which even the settlement’s upper time limit does not permit the debtor to make payments.56 A part of the jurisprudence considers Article 9 paragraph 2 to aim at the protection of the constitutional right of housing, besides dignity and economic freedom.57 This aspect’s juris-political core was the argument that the provision’s implementation on the basis of exactly 80% or 85% in the cases defined by Article 8 paragraph 5 would cancel the law’s aim to protect the dignity, the property, and economic 53 EUI, op. cit., 35. 54 Art. 4 of Law 4336/2015. 55 According to the provision of Art. 8 para. 5, “In cases of exceptional circumstances, such as chronic unemployment without debtor’s blame, severe health problems, insufficient income for the debtor’s minimum subsistence needs or other reasons of similar severity, low or zero monthly payments are defined by the ruling, the court may order by the same ruling a new hearing, not sooner than five months, in order to reassess the monthly payments.” 56 Psichomanis, op. cit,, 65 note 83 (however, see his comments prior to the amendment, 533, note 893 for the “buyout”), Mentis, op. cit., 178, note 363, Venieris under strict preconditions, 2013, 467 et seq., Katiforis, under Art. 8 para. 5 preconditions and in relation to the immovable property value, 26, Papastamou G. and Spyrakos P. Οι τροποποιήσεις του Ν. 3869/2010 για τη ρύθμιση οφειλών υπερχεωμένων φυσικών προσώπων με το Ν. 4161/2013 (The amendments of Law 3869/2010 about the over-indebted individuals’ debt settlement by Law 4161/2013), Νομικό Βήμα 2013, 1790. 57 For indicative jurisprudence, see Venieris, op. cit., 465 et seq.

283

Viktoras Tsiafoutis

freedom. This teleological interpretation mainly tried to lift the conflict that considered or implied to arise: Since the court settlement aiming to debt discharge provides even zero payments for debtors who lack basic income, combined with any health problems or family needs, such a protection should also be provided for the principal or sole residence protection. A series of criteria have been accepted in the jurisprudence, which defines the potential need for a smaller-than-the-upper-level payment and also the payment’s level usually in cumulative concurrent cases: (a) the debtor’s age deprives him of the ability to make longterm payments, according to ruling reasoning58; (b) a low income; (c) his personal situation (for example, health problems) and (d) his and his family’s subsistence needs and the potential for income improvement. An additional parameter taken into account following the amendment by Law 4161/2013 is the lower commercial value in relation to the objective value. In the opposite direction, it has been argued that the principal residence protection price cannot be lower than 80%. According to this view, the residence exemption from liquidation functions as an additional right, the “buyout” of which is evaluated on the basis of its value,59 as the rent depends on the value of the lease. In the same spirit, it is argued that the price of the right “buyout” must be equivalent to a potential foreclosure sale effect.60 As will be noted below, the 2015 amendments are in accordance with this argument. The Supreme Court also addressed the issue and argued that the payment for the residence protection is, in principle, independent of the debtor’s financial abilities.61 However, such a thesis should not be perceived in an absolute way but only as a general rule, exceptions of which occur if the provision is implemented in the framework of the transactional good faith. Such a case could constitute exceptionally low income or health problems, in combination with only consumer credit nonmortgage debts, where the creditor seems more appropriate to share the cost.62

58 After the amendment by Law 4346/2015, the debtors of this category may not be able to keep their residence, as they will lack repayment ability (v. inf. ch. 4). 59 Dellios, op. cit., 2010, 298. 60 Kritikos, op. cit., 337 et seq. 61 Supreme Court, 1226/2014, Επιθεώρηση Πολιτικής Δικονομίας (Civil Procedure Inspection), 2014, 633 with Katiforis’ comments. 62 Papastamou/Spyrakos, op. cit., 1799.

284

16

16.4

16.4.1

Private Insolvency Legislation and the Protection of the Principal Residence

The Amendment of laws 4336/2015 and 4346/2015

The New Principal Residence Protection Framework

The changes induced by Laws 4336/2015 and 4346/2015 are the example of a devastating amendment of an exceptionally valuable provision. The first law canceled the only precondition for the residence exemption from liquidation, which is the tax-free limit for principal residence acquisition increased by 50%, and instead three criteria were established that would be defined by a subsequent law: (a) the immovable property’s objective value, (b) the debtor’s income, and (c) his debt level. Ultimately, Law 4346/2015 does not provide a debt limit; however, a highly problematic provision, both in terms of wording and substance, was introduced. More precisely, the new paragraph 2 defines that until 31 December 2018 the debtor may submit a liquidation proposal and a debt settlement plan to the court, asking for any immovable property secured in rem or not to be exempted from the foreclosure sale. Therefore, in the next three years, the continuous protection is limited, without any future prediction beyond that period. The principal residence (and not the only63) may be protected only if the debtor’s monthly available family income does not exceed the reasonable living expenses increased by 70%, the objective value of the principal residence during the discussion of the request does not exceed €180,000 for the unmarried debtor,64 and the debtor is a cooperative borrower, according to the Bank of Greece (BoG) Code of Conduct.65 As for the exemption price, it should be noted that the aforementioned debt settlement plan appears to replace the payment of 80% of the protected immovable property’s objective value. The prospective amount that the creditors could receive in case of public enforcement is set as the lower limit. To calculate the upper limit, the new concept of the debtor’s maximum repayment ability is introduced.66 If the maximum repayment ability is not sufficient to cover the amount that would result from the foreclosure sale, then the debtor will not be able to keep his residence. A special category of debtors will be assisted for the repayment as follows: Until December 31, 2018, the debtor may apply to the Greek State for a partial payment of the monthly payment of the debt settlement plan, in cases in which the debtor meets

63 V. sup., ch. 2. 64 Increased by €40,000 for the married debtor and by €20,000 per child and up to three children. 65 That is, he responds to the banks’ calls and letters, and he provides in time true and accurate information about his assets and his income, etc. (according to the definition given by Law 4224/2013). 66 The provision, which is monumentally vague and ill-formulated, authorized the Bank of Greece (BoG) to adopt an act that shall define the proceedings and the criteria for defining the debtor’s maximum repayment ability, the amount that the creditors would receive in case of enforcement, as well as the potential creditors’ loss (Π.Ε.Ε. 54/15 December 2015).

285

Viktoras Tsiafoutis

cumulatively the following preconditions: (a) this specific immovable property serves as a principal residence; (b) the monthly available family income is below or equal to the reasonable living expenses defined in Article 5 paragraph 3 of this; (c) the objective value of the principal residence during the discussion of the request does not exceed €120,000 for the unmarried debtor, increased by €40,000 for the married debtor and by €20,000 per child and up to three children; (d) the borrower is cooperative, under the Banking Code of Conduct, where it is applied; and (e) he has a real inability to make monthly payments. In any case, the debtor is obliged to pay 5% of his income if the income is up to €8,000 and 10% of the difference if the income is higher than €8,000.67 These payments – which would be defined by the judge as the provision implies – should be calculated by the average fluctuating or fixed residential mortgage loan rate and within a period that does not exceed thirty-five years. The creditors’ demands are satisfied by the debtor’s payments on the basis of this paragraph by proportionate implementation of Article 974 and the subsequent Code of Civil Procedure. If during the repayment period of the debt settlement plan the debtor sells his principal residence and the selling price exceeds the settled debt as defined by a court order, for which a mortgage was written on the principal residence, then half the difference is shared in favor of guarantees and preferential creditors. In any case, each creditor’s share shall not exceed the amount to be received under the debt settlement plan.

16.4.2

The Purpose and the Grey Area of the New Settlement

i. Regardless of the technical legislative defects, the provision’s rationale remains unclear. Under the aforementioned wording, the principal residence exemption from liquidation was not an option but an obligation for the judge, provided that the debtor meets the substantive preconditions and the criterion of the property’s objective value is satisfied. The debtor should make the corresponding payment in return. Otherwise, he would not lose his debt discharge, but the creditors would have the right to initiate the enforcement proceedings. Under the new wording, it is not clear whether the judge is obliged to exempt the immovable property from liquidation by amending the debtor’s settlement plan, in order not to affect the creditors’ interests, or he could reject the exemption proposal on the grounds that the debtor’s repayment ability does not meet the amount to be received by the creditors in the event of enforcement. Whether the debtor is able to meet its financial obligations cannot be safely identified during the discussion of the case by using creditworthiness rating methods. The debtor does not apply for a new loan in the banking market; he tries to keep his residence within bankruptcy proceedings. Ultimately, what the previous wording was clear about now 67 According to the Common Ministerial Act No. 130377/16 December 2015.

286

16

Private Insolvency Legislation and the Protection of the Principal Residence

appears confusing and misleading: The debtors should have neither low nor high income to keep their residence. ii. If, therefore, the second interpretation is valid, then the debtor’s ability to keep his residence, which was binding for the court, turns into a peculiar evaluation of “creditworthiness” rating, amid bankruptcy status. If the sustainability of the settlement plan, which appears to be a kind of quasi “residential mortgage loan,” cannot be ensured, then the debtor does not have the right to keep his residence.68 A small margin of flexibility is provided by the BoG’s relevant act, which defines that the maximum repayment ability increases if the debtor is committed to reducing his living expenses to keep his residence. iii. The more vulnerable debtors’ categories should face difficulties in order to respond to the settlement plan as no grace period is provided. As a result, (a) a minimum payment should be made since the beginning of the settlement, and (b) this payment should coincide with the parallel settlement of Article 8 paragraph 2. Any potential advantage deriving from the calculation based on commercial value, which amid economic crisis would be lower than the commercial value, should be at risk as the judge no longer has the ability to define a lower amount for the protection under the aforementioned strict preconditions.

16.5

Concluding Remarks

The evolution of the provision cannot offer safe conclusions for its use as a best practice model as it has been amended three times in just five years. Nevertheless, it can offer not only some very useful thoughts concerning the theoretical ground on which the protection of primary residence can find its place in a bankruptcy procedure, but also interesting ideas on how such a system could function. Indeed, Law 3869/2010 is an insolvency procedure, where the purpose of debtor’s property liquidation is not only the creditors’ satisfaction, but also to ensure debtor’s dignity on many levels, one of which is protecting his dwelling, by managing, more or less successfully, to balance the counterparties’ interests. The main issues that puzzled the national legislature, since 2010, were (a) the criteria that a debtor should meet to have the right to keep his home, (b) the price level that he should pay, and (c) whether the court is obliged to set this price, when the criteria are met, irrespective of the debtor’s payment ability, or is free to decide on the debtor’s ability to pay, or, in other words, if it is worth protecting his residence.

68 Similar to the Irish Bankruptcy Act, where the debtor may be able to agree a schedule of mortgage payments with banks and the Official Assignee, where such payments are within the Reasonable Living Expenses approved by him. Besides, the Official Assignee may not sell the family home without firstly obtaining permission from the High Court.

287

Viktoras Tsiafoutis

Although it is fair that very expensive real estates should not be protected, income criteria seem to lack justification since the inability to pay caused by the bad faith of the debtor is already excluded from the scope of the law (Art. 1 para. 1). In addition, the creation of a link between the protection price level and the amount that the creditors could receive in case of compulsory enforcement strengthens creditors’ interests, but may leave no space for a more forbearing implementation of the provision in some exceptional cases. Finally, the introduction of the notion of payment ability in a bankruptcy procedure might turn rather problematic, preventing debtors with very low income from saving their house, even with the financial help of their close relatives or friends. In any case, Greek insolvency legislation has already opened the way for discussion concerning overindebted natural persons’ right to keep their home.

288

Part V Italy

17

The Dimension of Over-Indebtedness in Italy and the Characteristics of the Over-Indebted Households

Luisa Anderloni and Daniela Vandone*

17.1

Introduction

This chapter provides an overview of over-indebtedness in Italy from an economic perspective. In Section 17.2, we focus on the definition and measurement of over-indebtedness and we highlight the need to account for different variables in order to capture the multidimensional nature of the phenomenon. In Section 17.3, we depict the overall economic and financial situation of Italian households as it is reported by the Bank of Italy and the Italian Statistic Institute. In Section 17.4, we provide a literature review of empirical papers focussing on nature and causes of over-indebtedness. In Section 17.5, we present our analysis based on a sample of 1,933 Italian households and aimed at identifying the characteristics of households that are over-indebted or at risk of over-indebtedness. Specifically, in Section 17.5 we describe the sample, in Section 17.5.1 we build a financial vulnerability index that adds different profiles of financial distress, in Section 17.5.2 we use a linear regression model to analyse explanatory variables of financial vulnerability and in Section 17.5.3 we use a principal components analysis to group households according to their financial vulnerability characteristics. Section 17.6 concludes the discussion.

17.2

Definition and Measures of Over-Indebtedness

According to the Italian Law 3/2012 concerning the insolvency of individuals, overindebtedness is defined as “a situation of persistent imbalance between obligations and assets that can be promptly liquidated, as well as the inability to regularly fulfil the obligations”. The definition is broad in terms and includes all the criteria that identify a situation of over-indebtedness, which, according to the European Commission study on overindebtedness (European Commission, 2008), are as follows: (i) the focus is at household

*

Professors, Department of Economics, Management and Quantitative Methods, Università degli Studi di Milano.

291

Luisa Anderloni and Daniela Vandone

level; (ii) financial commitments include not only debt with financial intermediaries – i.e. mortgages and consumer credit commitments – but also utility and telephone bills, rent payments and other recurring expenses; (iii) financial difficulties are ongoing rather than one-off occurrences; (iv) the balance sheet of the household is illiquid: no possibility to borrow more or sell assets in order to solve the situation; (v) the household is unable to meet the commitments without lowering its minimum living standard. The over-indebtedness definition is undoubtedly meaningful and able to capture the multidimensional nature of the phenomenon. However, it is difficult to find a unique measure that identifies households that are in such a situation. For this reason, empirical studies normally use more practical definition and, in turn, measures of over-indebtedness (BIS, 2010; Keese, 2009; Betti et al., 2007; D’Alessio and Iezzi, 2013; European Commission, 2008, 2010). Among economic indicators, the most frequently used measure of over-indebtedness are the debt service-to-income ratio, the debt-to-income ratio, the debt-to-asset ratio, data on arrears or formal debt settlement, self-assessments by households and mix of different variables. The debt service-to-income ratio, defined as the total monthly debt payment divided by the gross monthly income, is an indicator of the burden that debt holdings represent to current income. The debt-to-income ratio combines stock and flow variables to provide insights into households financial risk exposure to interest rate increase. The debt-to-asset ratio provides information related to the capacity of the total stock of assets to pay back debt. These three ratios are commonly used by central banks to analyse the impact of households financial fragility on the stability of financial systems when adverse macroeconomic shocks occur, such as increase in interest rates, increase in unemployment rate and house price decrease (Ampudia et al., 2014; Albacete and Lindner, 2013; Hlaváč et al., 2013). These indicators are straightforward to calculate, given the availability of data at microlevel. However, they may underestimate the size of the phenomenon as they refer only to financial debt. Conversely, as clearly stated in the EU definition, over-indebtedness is a more comprehensive phenomenon. For instance, these measures do not account for households that are over-indebted because of being unable to meet other commitments, such as paying utility bills and housing rental, but do not hold debt because, for example, they have no access to financial credit. The dynamic of those ratios may also be misleading: A reduction in the outstanding debt-to-income ratio, instead of being a positive signal of reduction in the risk of over-indebtedness, might be due to a cutback in credit and might be accompanied by a downturn in the economy with a consequent higher exposure to financial vulnerability (like after the 2008 crises). Besides economic indicators based on financial debt, other data can contribute to measure over-indebtedness and give a more comprehensive picture of the phenomenon.

292

17

The Dimension of Over-Indebtedness in Italy and the Characteristics of the Over-Indebted Households

Those indicators can be grouped into objective indicators, such as statistics on arrears (for example, arrears on financial debt, utilities, rent etc.) or statistics on formal debt settlement (for example, number of debt write-off), and subjective indicators, usually reported in surveys and representing self-assessments by households, such as the inability to make ends meet, cope with an unexpected expense or go without specialised medical care, as well as arrears in paying utility bills or rent. Different variables can also be combined to build ratios that accounts for the multidimensional nature of over-indebtedness (Anderloni et al., 2012). The main issue related to the possibility to use meaningful data is the availability of appropriate datasets. In Europe, the most complete and publicly available dataset that collects information on socio-demographic and economic variables at households level is the Households Finance and Consumption Survey (HFCS), first released in 2013. Other well-known local dataset are the British Household Panel Survey (BHPS – UK), the Survey on Household Finances (EFF – Spain) and the Survey on Household Income and Wealth (SHIW – Italy). Researchers use also proprietary datasets to analyse specific issues.

17.3

The Italian Households Financial and Economic Situation

In the last few years, the issue of households’ over-indebtedness has gained relevance in Italy as well as in Europe because of the worsening in the economic and financial situation of households. Indeed, since the 2008 crisis, a growing number of families are facing difficulties in repaying secured or unsecured debt, have arrears in paying utility bills or rent, and are unable to make ends meet or to cope with unexpected expenses. The Italian Statistic Institute (ISTAT), in its Survey on Living Conditions and Income Distribution, and the Bank of Italy, in its Annual Reports and its Surveys on Household Income and Wealth, provide insights of this worsening trend. In 2013, 28.4% of Italian households are at risk of poverty or social exclusion (24.7% in 2009); in the same period the median income reduced from €24,544.00 to €24,214.00. The number of households facing financial difficulties is rising: In particular, 40.3% of households say they are not able to face significant, unexpected expenses (31.9% in 2008), 14.3% of households declared getting into arrears on the payment of mortgages, rent, utilities and other bills (11.9% in 2008), while 19.1% of households said they were not able to heat their homes adequately (10.9% in 2008). Furthermore, in 2012 35.8% of households declared that their income is not enough to make ends meet, compared with 29.9% in 2010 and 24.3% in 2004. The average household equivalent income contracted by about 10.7% between 2008 and 2012; the decline is stronger among households whose equivalent income is already lower, thus further increasing their financial vulnerability. In the same period, the house-

293

Luisa Anderloni and Daniela Vandone

holds’ saving rate continues to diminish, falling to 11.4% of disposable income in 2012. The proportion of households with debts contracted to 27.7% in 2011, for the first time after a rising trend under way since 2000, although the decline is modest, i.e. 0.1% compared with 2011; however, the share of loans undergoing repayment problems remains slightly above 10% in the 2014 (Bank of Italy, Annual Reports and Surveys). Bank of Italy is also reporting data that provide insights on households financial overindebtedness. The median debt-to-income ratio increases from 45.3% in 2008 to 65.9% in 2012 (the mean ratio increases from 114.5% to 144.8% in the same period). Financially vulnerable households, defined by Bank of Italy as “those with debt services payment greater than 30% of disposable income (net of interest payment) and below-median income” accounted for 13.2% of indebted households in 2012, compared with 10.1% in 2010. Table 17.1 provides an overview of the debt-to-income ratio and its relations with the characteristics and conditions of borrowers. Table 17.1 Debt-to-income ratio (%) Debt-to-income ratio (mean values)

Debt-to-income ratio (median values)

Male

142.9

67.9

Female

150.6

63.0

Up to 34 years

190.0

87.5

35-44

173.1

95.2

45-54

155.7

71.7

55-64

99.4

38.2

More than 64

81.9

28.9

149.2

22.6

Primary school

85.4

35.1

Middle school

123.4

55.3

High school

167.4

74.4

University degree

148.2

112.1

Employed

133.1

69.4

Self-employed

199.2

93.0

Unemployed

109.0

41.4

Gender

Age

Education No qualification

Work status

294

17

The Dimension of Over-Indebtedness in Italy and the Characteristics of the Over-Indebted Households Debt-to-income ratio (mean values)

Debt-to-income ratio (median values)

1

171.1

65.9

2

113.9

38.4

3

161.4

70.6

4

121.2

74.4

More than 4

192.3

94.8

Quintile 1

116.3

43.4

Quintile 2

231.2

191.9

Quintile 3

116.3

81.0

Quintile 4

133.4

58.1

Quintile 5

137.3

47.3

Quintile 1

343.8

71.4

Quintile 2

144.7

54.9

Quintile 3

160.3

65.4

Quintile 4

143.2

74.5

Quintile 5

128.5

67.1

Total

144.8

65.9

Number of households members

Household net wealth

Household income

Source: Bank of Italy, Survey on Households Income and Wealth, 2014.

In a cross-country perspective, the situation of Italian families, in terms of net financial wealth and disposable income, is better than in many other countries of the Euro area, although it is still worse than those of other major economic areas such as the United Kingdom and the United States (Figure 17.1). As far as liabilities are concerned, Italian families are less exposed than are other countries, traditionally characterized by high level of participation in the credit market (Figure 17.2).

17.4

Over-Indebtedness: Literature Review

Over-indebtedness and financial vulnerability can be caused by different drivers which, most of the time, interact with each other. It can be generated by excessive levels of debt held by households in relation to current and future earnings, which may be linked to individuals’ inability to process effectively information available and, as a result, to evaluate

295

Luisa Anderloni and Daniela Vandone

Figure 17.1 Net financial wealth to disposable income

Source: Computations on Bank of Italy, Annual Reports.

Figure 17.2 Debt to income

Source: Computations on Bank of Italy, Annual Reports.

the consequences of indebtedness, as well as to lack of information transparency that hinders well-informed decision making. Over-indebtedness may also be driven by factors such as low income and wealth levels, life-style behaviours that, either due to irresponsibility or short-sightedness, lead a household to unsustainable expenditure or non-optimal money management, adverse events that may negatively affect their financial situation and/or

296

17

The Dimension of Over-Indebtedness in Italy and the Characteristics of the Over-Indebted Households

absence of financial instruments (for example, life or accident insurance policies) that enable households to manage risk more effectively. Studying over-indebtedness and the risk of over-indebtedness of the household sector from an economic perspective in principle is relevant for at least three reasons, both at macroeconomic and microeconomic levels. First, households’ consumption are influenced by their solvency position, thereby affecting the overall economic activity and growth. Second, vulnerable households pose a threat to the financial stability due to their tight linkages (for example, secured and unsecured debt) to financial institutions. Third, vulnerability may affect EU households’ well-being under many perspectives such as physical and mental health, life quality, and social and financial exclusion. There is a substantial empirical literature that uses data from surveys on households and focusses on the determinants of household debt burden and financial distress and the characteristics of households that are over-indebted or at risk of over-indebtedness. Del Rio and Young (2008) look at the relationship between households’ vulnerability and unsecured borrowing using microdata from the BHPS. The authors use a self-reported indicator of financial distress and analyse the probability of households who hold unsecured debt, reporting problems with repayment. While the proportion of households reporting debt problems did not change much between 1995 and 2000, they find that there were significant changes in their socio-economic characteristics, specifically an increase in unsecured debt taken on by young households with a high debt–income ratio, which, in turn, made them more vulnerable to potential shocks in their income or to increases in interest rates. May et al. (2004) investigate the affordability of debt for homeowners and renters, both in terms of the amount of household income that is devoted to servicing debts and households’ perceptions of whether their debts are a problem. They find that, while the vast majority of debt is owed by homeowners with mortgages, debt problems are concentrated among renters, who are consistently more likely to report problems servicing their unsecured debt than are homeowners. Moreover, households with both high levels of income gearing and high debt in relation to housing assets are more likely to face debt problems. Duygan and Grant (2006) analyse how a propensity to fall into arrears on mortgages and unsecured loans is affected by an adverse shock to the household’s income and how the response to these adverse events varies across countries and depends on local financial and judicial institutions. They find that adverse shocks, such as unexpected changes in income, increase the incidence of arrears, although its extent depends crucially on the cost of default. Christelis et al. (2010) analyse the financial fragility of Europeans aged 65 and over and describe how this fragility varies across countries, age groups, health status and other socio-economic variables. They report that the stock of accumulated debt, the time to maturity, the availability of collateral and the weight of instalment payments in disposable income represent an element of household financial fragility. Magri et al. (2011), using EU-SILC data for a selection of European countries between 2005 and 2008,

297

Luisa Anderloni and Daniela Vandone

analyse the characteristics of households that hold a higher amount of consumer credit. They find that a share of households, ranging from 8% to 16% across countries, who borrow in the consumer credit market are poor in income, which is relevant since they are more at risk of financial fragility given their inability to face unexpected expenses with their income and/or wealth. Other studies in recent years indicate growing groups of households for which the repayment of consumer credit has become more and more a burden (Observatoire del Crédits aux Mènages, 2008, 2009; Bank of England, 2010; International Monetary Fund, 2013). Albacete and Lindner (2013), using three different definition of vulnerability, look at the determinants of households financial fragility in Austria and find that having a nonmortgage debt has a positive significant correlation with household vulnerability. Other authors, Brown and Taylor (2008) and Fay et al. (2002), analyse the empirical determinants of debt burden, default and bankruptcy using household level data as well as proposing different socio-demographic and economic explanatory variables according to the aim and nature of the analysis. While all the above studies analyse financial problems related to loan commitments, Worthington (2006) and Bridges and Disney (2004) focus on a slightly different objective. In particular, rather than focussing on more acute events such as debt insolvency, Worthington (2006) examines a mild form of financial distress: the inability to engage in basic social activities such as meals with family and friends, nights out and holidays. The author finds that financial distress is very much a function of the demographic and socio-economic characteristics of households and, to a lesser extent, their debt portfolio; however, all the variables that identify financial distress are empirically analysed by the authors in different regressions and this prevents obtaining information on the overall degree of household financial distress since the case of households that give up one social activity or all of them differs. Bridges and Disney (2004) focus on the characteristics of low-income families that have problems of arrears and default in loan commitments as well as in other different areas, such as payment for housing and utilities. In their analysis, the authors combine the arrears data in order to examine how the aggregate level of arrears is associated with different household characteristics and show that credit use and accumulation of arrears differ between single parents and couples with children, and also between homeowners and renters. They also show that loans from finance companies pose repayment difficulties for almost one in five families, primarily tenants. There are also a growing number of studies that focus specifically on behavioural factors as drivers of over-indebtedness and financial fragility. The underlying idea is that individual financial choices are influenced not only by socio-demographic and economic variables, but also by psychological factors, which may induce individuals to behave in a way that conflicts with traditional notions of economic rationality (Meier and Sprenger, 2010; Zermatten et al., 2005; Franken et al., 2008; Strack et al., 2006). Specifically, one of the main aspects that are found to influence household decision making is the so-called

298

17

The Dimension of Over-Indebtedness in Italy and the Characteristics of the Over-Indebted Households

“hyperbolic discount”: individuals tend to systematically overvalue immediate costs and benefits and undervalue those in the future. The reason is that households’ preferences are not time-consistent, or vice versa as posited by traditional economic models, and they give greater importance to present events in comparison with those in the future. The hyperbolic discount factor pushes individuals, at the time they have to decide whether to purchase on credit terms or not, to opt for immediate purchase. This effect explains why individuals choose “buy now, pay later” solutions that bring immediate gratification at a future cost: Individuals adopt impatient, short-sighted behaviour patterns that make it difficult for them to be fully aware of the consequences of their spending decisions for the sustainability of personal debt (Meier and Sprenger, 2007; Meier and Sprenger, 2010; Siemens, 2007; Anderloni and Vandone, 2010). In the field of psychology, the notion of hyperbolic discount has been linked to impulsivity (Wittmann and Paulus, 2008; Martin and Potts, 2009; Potts et al., 2006; Franken et al., 2008; Zermatten et al., 2005). In an interdisciplinary study, Ottaviani and Vandone (2011) estimate the role of emotional factors in determining household participation in the debt market on a sample of households that underwent the Iowa Gambling Task while electro-dermal responses were recorded. The results revealed the significant influence of individuals’ impulsivity in making debt decisions, after controlling for traditional socio-demographic and economic variables. Interestingly, impulsivity predicted consumer credit, but it was not significantly associated with mortgages.

17.5

Our Analysis

In this section, we use microdata at household level to analyse the characteristics of Italian households that are over-indebted or at risk of over-indebtedness. To this end we first propose an indicator of financial vulnerability to jointly analyse different features of household over-indebtedness. We then investigate the determinants of the financial vulnerability index using a linear regression model, and, finally, we use a cluster analysis to aggregate individuals with similar characteristics. Our dataset is from ANIA (Associazione Nazionale delle Imprese di Assicurazione)1. A total number of 1,933 Italian households make up the sample, which is representative of the population with reference to a number of socio-demographic and economic parameters.

1

ANIA, with its foundation “Forum Ania Consumatori” aimed at building a systematic dialogue between Italian Insurance Companies and Italian Consumer Associations, in 2009 started developing with Università degli Studi di Milano a research project with the goal to analyse the possible factors that determine the financial fragility of Italian families, their evolution over time, as well as the ability of Italian households to manage risks and to protect their standard of living.

299

Luisa Anderloni and Daniela Vandone

The survey was conducted by GF Eurisko during Spring 2013; the respondent is the head of household, defined as the person primarily responsible for household financial decisions. We are the authors of the questionnaire, which includes questions related to sociodemographic, economic and financial characteristics of Italian households (for example, geographic area, size of place of residence, age, gender, married status, number of household members, income level, amount and type of financial and real wealth, indebtedness and employment conditions). Other questions address more directly households’ financial fragility by capturing the congruousness of income in relation to monthly expenditure, the capacity to save, the level of difficulty in meeting food and clothing costs, the capacity to face unexpected expenses, changes in households’ economic situations over the last twelve months and expectations for the future, and the occurrence of adverse events, such as job loss, illness, death and invalidity, that may cause a reduction in income and/or an increase in unexpected expenses. There are also questions that focus on the financial literacy of the households, given that financial literacy deficiencies can affect individuals’ day-today money management, ability to put in place savings or insurance solutions designed to safeguard their financial future and capacity to understand risks and consequences of borrowing decisions. Table 17.2 presents some descriptive statistics of our sample. The sample is for the most part made up of persons who are married or living together (68.0%) and have children (55%). On the basis of the size of real and financial assets, respondents were classified into four wealth groups: main market (54.9%); middle market (27.1%); mass affluent (14.5%) and affluent (3.6%). As for debt, of the sample, 46.9% of households had no debt liabilities, while 38.8% had mortgages and 61.2% had consumer credit. As regards economic and financial difficulties, 26.1% of household heads were unable to cope with a substantial unexpected payment of €750, 49.2% had difficulty, while the remaining 24.6%, i.e. those in conditions of economic comfort, had no problems. Moreover, 41.4% of respondents declared being in arrears on the rent, 31.8% had payment arrears on gas and electricity bills, while 21.1% and 33.4% had past due positions on mortgages and loans, respectively. Difficulties appear also in the fact that 8.5% of respondents declared that they have “a lot of problems” in making ends meet, while 21.2% experienced serious difficulties and 46.5% said that they have some problems in “getting to the end of the month”. Only 1.8% of respondents declared having a financial condition that allowed them to make ends meet without any difficulty and thus allowing them to save quite a bit. With regards to adverse events causing an unexpected fall in income or rise in expenses, 25.8% said this was due to cuts in working times, or job loss (18%). Other adverse events with significant shares were illness (12.5%), caring for the elderly (7%), and invalidity (5.2%).

300

17

The Dimension of Over-Indebtedness in Italy and the Characteristics of the Over-Indebted Households

Table 17.2 Characteristics of the sample Variable

% Variable

Marital status

% Variable

Debt

Unexpected expense

Single

8.7 Yes

53.1 Very easily

Live-in partner

6.7 No

46.9 Easily

Married

%

68.0

5.6 19.0

With some difficulties

31.8

With great difficulty

17.4

Widower

7.2 Type of debt

Separate

4.2 Secured

38.8 No

Divorced

5.2 Unsecured

61.2

Children

Wealth

Shopping for food

18.4

Yes

55.0 Main market

54.9 Buying essential clothing

29.7

No

45.0 Middle market

27.1 Paying gas, electricity, phone bills, etc.

31.8

14.5 Paying the rent

41.4

26.1

Difficulties

Mass affluent Gender

Affluent

Male

78.8

Female

21.2 End of the month

3.6 Paying the mortgage Paying off other loans

Very easily Age Below 30

Easily

12.4 With difficulty

41 to 50

27.6 With great difficulty

51 to 65 over 65

17.5.1

33.4

1.6 Adverse shocks

1.6 With some difficulties

31 to 40

21.1

22.3 Job loss

18.0

46.5 Reduction in working hours

25.8

21.2 Elderly care

7.0

8.5 Illness

12.5

36.7

Death

4.6

21.7

Disability

5.2

Accident

4.2

Separation, divorce

2.2

The Financial Vulnerability Index

Given that over-indebtedness is a multidimensional phenomenon, we build a financial vulnerability index that reflects the overall vulnerability of a household, which comes from the overlap of different components: expenditure vulnerability, income and saving vulnerability, and commercial and financial loan commitments vulnerability. The strength of

301

Luisa Anderloni and Daniela Vandone

this indicator is that by adding different profiles of financial distress, we can measure the different degree of household vulnerability. To this end, we first identify those variables that specifically address household financial vulnerability; some of them are self-reported,2 while others are more “objective”.3 From a statistical point of view, all these aspects of the financial distress are managed using a principal components analysis (PCA), with the aim to check for a reduced number of appropriate combinations of the original variables that summarize the households’ vulnerability from different perspectives. Qualitative replies were converted into quantitative data by assigning each one with a vulnerability score (for a detailed description of the methodology, see Anderloni et al., 2012). In Table 17.3, we present the results of the PCA. In the upper part of the table, we report the eigenvalues associated to each component, the percentage of variability explained by each component and the associated cumulative percentage in the last column. It emerges that the first factor explains more than 50% of the phenomenon while all the others seem to play a less relevant role. In the lower part of the table, instead, we report the eigenvectors associated to each eigenvalue. The first vector, which is associated to the more relevant component, indicates that all the variables taken into account for the construction of the indicator of financial vulnerability – with the exception of the one relating to access to credit (loan rejection) – have substantially the same statistical importance. The second component, instead, presents a remarkable value for the loan rejection variable, with relatively lower weights for the others. All the other components are more complicated in terms of an economic interpretation and, in any case, jointly explain a limited quantity of variability. In terms of interpretation, we explain the first component as an indicator of financial vulnerability, and, interestingly, all the variables but loan rejection seem to be important with the same magnitude. The PCA analysis thus provides a clear message indicating that the broad and complex phenomenon of households’ financial vulnerability cannot be confined to a single variable that in general in the literature is associated to the financial debt.

2 3

Self-reported variables: “Is your household’s monthly income enough for you to get through the month?”; “Are you able to cope with an unexpected expense of 750 euros today?” As far as “objective” variables are concerned, we consider whether application for bank credit was turned down; whether over the last twelve months the household had problems even once in shopping for food, buying essential clothing, paying utility bills, rent, or paying off loans or mortgages; whether such difficulties turned into objectively real problems in the form of late or non-payment. We finally consider the decision to go without specialised medical care.

302

17

The Dimension of Over-Indebtedness in Italy and the Characteristics of the Over-Indebted Households

Table 17.3 Principal components analysis Component

Eigenvalue

Explained variability (%)

Cumulative (%)

Comp1

3.314

55.2

55.2

Comp2

0.929

15.5

70.7

Comp3

0.648

10.8

81.5

Comp4

0.550

9.2

90.7

Comp5

0.338

5.6

96.3

Comp6

0.221

3.7

100

Principal components (eigenvectors) Variable

Comp1

Comp2

Comp3

Comp4

Comp5

Comp6

Loan rejection

0.217

0.908

0.308

0.173

0.066

-0.014

Ends meet

0.434

-0.158

0.475

-0.292

-0.690

0.016

Unexp expenses

0.440

-0.239

0.388

-0.240

0.704

0.215

Difficulties

0.485

-0.003

-0.388

-0.093

0.94

-0.796

Arrears

0.425

0.180

-0.644

-0.248

-0.101

0.548

Medical care

0.396

-0.249

-0.015

0.870

-0.069

0.139

Such strong evidence allows us to define the financial vulnerability index as a function of the following factors: congruousness of income and monthly expenses, capacity to cope with unexpected expenses, difficulties, arrears and decision to go without specialised medical care. Using the factors scores as weights reported in Table 17.3, we construct a financial vulnerability index for each individual i as follows: Financial vulnerability index =

where Xpi is the standardized value for the pth variable and ap is its corresponding factor score. A variable with a higher score is associated with a higher level of financial vulnerability and vice versa. For the sake of convenience and immediacy in the interpretation, we rescaled the indicator to obtain 0 as the starting value (minimum vulnerability). Table 17.4 reports the descriptive statistics of the financial vulnerability index, and Figure 17.3 reports its distribution.

303

Luisa Anderloni and Daniela Vandone

Table 17.4 Descriptive statistics of the financial vulnerability index Variable

Observations

Financial vulnera- 1,933 bility index

Mean

Standard deviation

Median

3.164

2.085

2.662

Figure 17.3 Distribution of the financial vulnerability index

The distribution of the index is asymmetrical, with a reduced frequency for very low values, an increase around average vulnerability levels and a progressively decreasing frequency for higher vulnerability levels. It is worth noting that only around zero the index can be considered an indicator of economic and financial well-being: in fact, only those households with an index below 1 – corresponding to 5.5% of the sample – are able to make ends meet or face up to an unexpected expense easily or very easily and do not have problems in covering expenses and paying bills. Conversely, the rest of the sample presents elements of vulnerability, which are rapidly growing; for example, at the median index value (2.662) are the corresponding high percentages of households that have problems getting to the end of the month (75%). In addition, 23% of households with a median index are in no way capable

304

17

The Dimension of Over-Indebtedness in Italy and the Characteristics of the Over-Indebted Households

of facing an unexpected expense, while more than 74% would be able to bear the cost but would find it difficult. Of the sample, 10% has a vulnerability index exceeding 7.5. At this level, vulnerability is an extremely serious problem. They are families that, in most cases, are in arrears with paying utility bills, rent or loan instalments; cannot cope with an unexpected expense and, in almost all cases, have to give up medical specialist they needed because they are not sustainable economically.

17.5.2

The Multivariate Analysis

In this section, we investigate the determinants of the financial vulnerability index. We use a linear regression model where the financial vulnerability index is the dependent variable and the structure of the regressors can be seen as follows: FVIi = β0 + β1FDi + β2FLi+β3ISi + β4Oi + εi where FDi indicates a set of variables aimed at describing the effects of financial debt on the vulnerability of i-th household; equivalently, FLi measures the impact of financial literacy, ISi accounts for income and negative shocks affecting the households, while Oi contains all the other variables included to model all the other aspects of the vulnerability that are not of direct interest in the paper. The βs are the related coefficient and εi is the residual term. All the estimates are performed by OLS with standard errors robust to heteroscedasticity. We propose different specifications to check for the robustness of the results. Results are shown in Table 17.5. The results of the estimation procedures in Table 17.5 show that there is a clear evidence that an increase in the debt servicing-to-income ratio raises household financial vulnerability. In particular, the presence of debt in the form of consumer credit is associated with a greater degree of financial vulnerability, and this confirms the results of several empirical studies that observe that consumer credit is, in some cases, used as a supplementary source of income to get to the end of the month, thus compensating the inadequacy of the economic and financial situation (Albecete and Lindner 2013; Bank of England, 2010; Cavalletti et al., 2012; International Monetary Fund, 2013). This is consistent with economic theories saying that debt is used to smooth consumption over time; problems raises if expectations of income increase to repay these debt do not realize. Another important driver of risk of over-indebtendess is job loss or reduction in working hours.

305

Luisa Anderloni and Daniela Vandone

Table 17.5 Linear regression – dependent variable: financial vulnerability index Variables Debt service to income (log)

(1)

(2)

(3)

(4)

(5)

0.048***

0.049***

0.044***

0.044***

0.022

Consumer credit (dummy)

0.320*

Interaction debt-unsecured debt

0.074

Financial literacy

0.135*

0.133*

0.138*

Impulsivity

0.135*

0.137*

0.053

0.053

Job loss

0.488***

0.487***

0.481***

Other shocks

0.473***

0.469***

0.464***

Wealth

0.355***

0.355***

0.333***

0.332***

0.331***

Income

0.3991***

0.386***

0.351***

0.351***

0.332***

Single

0.030

0.016

0.077

0.079

0.094

Widower

0.057

0.043

0.022

0.017

0.003

Separate

0.007

0.013

0.017

0.020

0.031

Divorced

0.037

0.018

0.020

0.024

0.047

0.122***

0.127***

0.128***

0.127***

0.128***

0.313*

0.330*

0.324*

0.325*

Age group: 40-49

0.093

0.071

0.071

0.071

Age group: 50-64

0.206

0.187

0.185

0.174

0.319*

0.350**

0.347**

0.336*

Children number Age

0.419**

Age group: under 30 (ref. age 30-39)

Age group: over 65 Gender (female)

0.013

0.001

0.0012

0.014

0.022

Years of education

0.015

0.016

0.013

0.013

0.012

Home ownership

0.067

0.056

0.027

0.025

0.007

Home rent

0.289**

0.287**

0.264**

0.265**

0.263**

North-west

0.152

0.157

0.166

0.166

0.161

North-east

0.156

0.161

0.161

0.161

0.160

South

0.079

0.078

0.090

0.089

0.093

5.825***

7.264***

6.517***

6.494***

6.135***

1,681

1,681

1,681

1,681

1,681

0.204

0.204

0.219

0.219

0.221

Insurance policy Constant Observations 2

R

0.018

Robust standard errors in parentheses: *** p