Responsible Lending as an Emerging International Norm

The International Association of Consumer Law, with participants present from six continents, has been meeting at Brunel University in West London the last few days, hearing presentations from regulators, industry representatives, consumer advocates, and academics.   http://qwww.brunel.ac.uk/bls/research/events/ne_41734   Not surprisingly, regulation of consumer credit has been a prime focus, giving some perspective on US struggles to achieve more effective consumer financial protection. 

Professor Iain Ramsay of the University of Kent in the UK reported on initiatives for international cooperation to enhance consumer financial protection.   The G20, World Bank, Financial Stability Board, and Organization for Economic Co-operation and Development are all on board with this goal, seeing it as an essential part of a program to ensure that the international financial system is safe and sound.  The OECD is expected to issue draft principles of consumer financial protection soon, and comments will be invited.  Given the primarily prudential role of these organizations, balance from other sectors will be important.

Ramsay raised an underlying and overlooked question:   what is the economic and social value of consumer credit?

 A conventional view is that it permits income smoothing over time, to make lifecycle planning more effective.  Part of this view has been that even the poor can benefit.  On the other hand, a more critical view is that consumer credit often in fact serves a function of providing “loans for wages” in the face of stagnant, inadequate income to provide for a basic lifestyle within any given nation. 

 Even when a financial product appears to be for the purpose of income smoothing, thus facilitating material prosperity, it will not in fact achieve this purpose if it is unaffordable and thus unsustainable.  Ramsay noted that a norm in favor of responsible lending is thus gaining traction internationally, but he also cautioned that it won’t become a reality until it is embedded in corporate and regulatory culture.

 Industry and many governments still adhere to information and education as the main techniques of consumer protection, despite mounting evidence of their minimal effectiveness.  A prime example of old-fashioned thinking was a presentation at the conference by a civil servant sent by the UK Coalition government to mouth some cant about empowering consumers to exercise choice responsibly by giving them better disclosure of terms, but with no appreciation that the complexity of products often makes understandable disclosure impossible.

 A much more sophisticated perspective was given by Maria Lissowska, an official of the European Commission’s Financial Services Redress Unit as well as economics professor at the Warsaw School of Economics, who began by reporting that a survey of European consumers found that 20% got wrong a question about what is the most favorable interest rate on a deposit account, !%, 2%, 3% or 4%.   Adding to the problem of lack of understanding of information, she said, are the phenomena of information overload, overconfidence, inertia about switching, and framing effects of emotional advertising appeals.

 The European Consumer Credit Directive, implemented by most member countries as of a year ago, calls for an assessment of creditworthiness before credit extension, but there is debate among European lawyers about whether a negative assessment requires denial of the loan or only a warning.  Some EU countries are nonetheless insisting on both an assessment of ability to pay and provision of a suitable financial product.  Professor Gail Pearson of the University of Sydney credited having these requirements in place in Australia with preventing the recent financial crisis from having as severe an impact on consumers there, compared to in the US and Europe.  She said it also helped that prudential regulation had already been separated from consumer protection, a change only now being implemented in the US under Dodd-Frank, with the creation of the Consumer Financial Protection Bureau.

While refraining from making unsustainable loans is the essence of responsible lending, information is still a complementary strategy.  A point made repeatedly at the IACL meeting at Brunel is that information should be understandable, and it can’t be understandable without product simplification.

An interesting approach to information is to demand that credit providers be able to demonstrate, through independent testing, that their customers understand their financial products.  Robin Simpson, a senior policy advisor for Consumer International, reported on the G20 project on consumer financial protection priniciples and on CI’s submission, which emphasizes this point, calling for national regulators to audit industry testing of comprehensibility.   http://www.consumersinternational.org/media/669846/cifinancialreport2011execsummary.pdf  This is a method that does not stifle creation of new financial products that are beneficial to consumers or force regulators to “run after the market,” as Lissowska put it.  It also involves taking consumers as they are, rather than expecting them to undertake courses of study to avoid unsuitable, complex financial products that even regulators have trouble understanding.

The “loans for wages” type of financial product inevitably draws a huge amount of regulatory attention.  In the US, payday lending is the most obvious example.   The phenomenon exists nearly everywhere.  For example, Claudia Lima Marques of the Federal University of Rio Grande do Sul, Brazil, discussed research evidence that 51% of consumers in her country have a need for “end of month” credit, which is provided at a legally capped rate of 30% APR, with payments withheld from future pay.  The interest rate cap under the Brazilian Consumer Credit Code limits the damage of borrowing to make ends meet, but an idea being discussed in that country is a seven-day waiting period for new credit. 

In parts of Northern Europe, text message (SMS for Short Message Service) credit has become the rage, at disclosed rates of 1000% APR or more.  Information does not seem to be having any impact.  A common use of this short-term credit is to buy a few more beers at a bar late at night.   Estonia attempted to address this credit product using a complex judicially-applied test of credit “contrary to good morals,” with subjective and objective elements.  Professor Karin Sein of the University of Tartu explained that this judicial regulation has not slowed the industry down in Estonia, but in Finland an administrative measure cutting off access to text message credit at night has had much more impact.   The comparison illustrates that effective prevention is often the best regulatory strategy, rather than deterrence through after-the-fact enforcement. 

 The developing world’s issues also provide yet another model of consumer credit and consumer law more generally.  Dr. Sothi Rachagan, vice president for academic affairs at Nilai University College, Malaysia, closed the conference with a presentation on a “consumer rights” perspective on consumer law, which involves a bottom-up demand for the right to consume safely and to organize consumer associations with rights to appear in court or in tribunals that address consumer complaints.  Participation in consumer society thus becomes a means of organization of civil society, also contributing to development that benefits consumers.   Under this approach, consumer law and development go hand in hand.  Also, a prime measure of effectiveness of consumer laws is reduction of poverty, a measure by which China and India have been success stories in recent decades, with still of course a ways to go.   Broadening the point for the developing world, a good test of consumer laws is whether they contribute to general prosperity.