Ben Cuzzupe, Peter Norwood: Crunch time for consumer credit in Europe

As the cost of living crisis bites, working class Europeans are increasingly getting into problematic debt.

Ben Cuzzupe is an Editor and Communications Officer at Finance Watch. Peter Norwood is a Senior Research and Advocacy Officer at Finance Watch.

Cross-posted from the Green European Journal

Picture by Eden, Janine and Jim

EUROPEANS are increasingly feeling the impact of the cost-of-living crisis, with vulnerable households being impacted. Estimates show that approximately 60 percent of German households will have to use all of their available income, if not more, for mere subsistence, all while the CEO of Deutsche Bank recently stated that a substantial number of Germans are currently living off their savings. Moreover, the latest Eurostat data shows that around 21 per cent of the EU population is now at risk of poverty and social exclusion.

As European citizens are facing this challenge to make ends meet, an increasing number of Europeans are seeking consumer credit to help them get by. The German credit rating agency Schufa, for example, has observed a substantial increase in buy-now-pay-later spending in Germany and the Federal Working Group for Debt Counseling in Germany is observing a “significant increase” in over-indebted households in Germany.

Similar situations have been witnessed in other parts of Europe as well. The rate of borrowing is a staggering 63 per cent in Greece, followed by Italy, and Poland (between 40 per cent and 41 per cent) and France (36 per cent).

As inflation across the largest EU member states is now at the highest it has been for decades, the European Central Bank is rapidly increasing interest rates in an attempt to keep the worst of inflation at bay. In a crude reality for people with existing debt, consumers with variable interest rate loans are facing higher borrowing costs on top of higher energy and food costs, increasing the risk of default.

As households’ disposable income faces pressures on multiple fronts, many are facing increasing challenges to maintain their standard of living. As more are pushed towards vulnerability, they look at the financial services market for financing solutions for their everyday expenses. While households should dictate their own way out of strained financial situations, it is imperative that customers seeking consumer credit or financial investments are protected from ending up with a financial service which makes their situation not better but worse.

In the consumer credit market, the promise of easy and quick credit, including buy-now-pay-later schemes, can often overshadow big risks that can lead to over-indebtedness. Already facing inflationary pressures, the most vulnerable in our society cannot afford to be ensnared in questionable debt obligations and unregulated, new financial products such as buy-now-pay-later arrangements or crypto assets.

As the cost of living crisis mounted, Belgian Prime Minister Alexander De Croo warned that “the next 5 to 10 winters” will be “difficult to face”. This outlook now that European policymakers must chart a path to protect people navigating their way out of fiscal difficulty.

Avoiding the barbed-wire ladder

Households with more income have more options and viable paths to maintain their standard of living faced with price rises. Simply spending less or finding a new income stream or just changing a few components of their current living arrangements will suffice. Others do not have these choices. Many already feel the worst of the inflationary pressures, creating a rising stress which causes many individuals to make hasty financial decisions. They do not feel enabled to check if rungs on the ladder to financial freedom are covered in barbed wire.

Unregulated retail investment products can entice consumers looking for quick and high returns to boost their income levels. Recent years, for example, saw consumers turn to crypto assets. These products are largely unregulated and were aggressively advertised on social media, including by influencers promising consumers fast and high returns.

Many advertisements for these assets suggest that there are gains to be made, without mentioning the serious risks of losing a lot of money. Bitcoin, the flagship crypto asset was worth nearly 54,000 euros at its November 2021 peak. In less than a year, following the collapse of the crypto exchange FTX in November 2022, it fell to a low of around 16,000 euros at the end of 2022.

Buy-now-pay-later schemes offer similar promises, immediate access to consumer products, from household appliances to childrens’ toys, with repayment on a delayed timeframe. Buy-now-pay-later arrangements often are interest-free. However, they possess a fixed repayment schedule, which is generally several weeks or months, and in some cases involve very high late payment fees for missed payments.

Research is finding more and more Europeans are using buy-now-pay-later products to purchase items online, with a 60 per cent increase between 2019 and 2021. The industry has scope to further expand, with one Deloitte report suggesting traditional financial services providers such as banks could seek to join existing fin tech players in the growing market.

For many, the priority is making ends meet this week or month. When a week or month where they cannot meet the repayment schedule comes along, all of a sudden there may be various consequences, such as late payment fees and severe credit score impacts. As most buy-now-pay-later users take out multiple arrangements and other debt obligations at the same time, these consequences are exacerbated.

It is the same scenario – there is a ladder out of precariousness. Under pressure, many do not notice that the rungs are covered in barbed wire.

Safer and Fairer Financial Services

Because of all of this, regulation must be put in place to protect consumers from taking out financial services which rather than improve their financial situation, make it worse. At the European level, there are numerous regulations across this area.

First, there is the Consumer Credit Directive, which is the EU directive regulating the EU consumer credit market. Currently in the final stages of review by EU policymakers, the rules currently in place date from 2008. With the increase of consumers seeking debt to finance their livelihoods, it is absolutely essential that the directive protects vulnerable consumers.

Lower income consumers are the most impacted by the current cost-of-living crisis. As highlighted in a recent Finance Watch study on the EU consumer credit market, this consumer group is most likely to purchase new and unregulated credit products which are of small value.

These products, however, are the riskiest as they are associated with high costs and fees, especially in relation to the low incomes of vulnerable consumers. To avoid these consumers falling into a situation where their economic burden gets even heavier, it is essential that these new credit products are brought into scope of the CCD. Moreover, the creditworthiness assessment rules that creditors must adhere to should be sufficiently robust to ensure that credit is not mis-sold.

Vulnerable consumers resorting to borrowing to make ends meet can quickly find themselves in a debt spiral with long-term negative consequences if lending practices and credit products are not adequately regulated. Member states have a duty to ensure that the vulnerable in our society have access to adequate government support schemes such as energy price caps, indexing of salaries or benefits on inflation instead of allowing consumers for whom consumer credit is not suitable to fall into over-indebtedness.

Effective debt relief measures are needed for the rising number of existing borrowers who are unable to repay their loans due to the inflationary pressures and rising interest rates. Therefore, the new CCD rules should oblige creditors to consider affordable and sustainable forbearance measures such as the reduction of the loan’s interest rate before initiating any enforcement proceedings against struggling borrowers.

As with many EU rules, certain matters remain at the discretion of individual countries. With the Consumer Credit Directive, current discussions by EU policymakers suggest that the question of whether the CCD rules are applied to deferred debit cards will be at the discretion of the Member States at national level.

Another key set of rules can be found in the Distance Marketing of Consumer Financial Services Directive (DMFSD), which aims to ensure that consumers purchasing financial services at a distance such as via the internet are protected. Initially adopted in 2002, changes are now needed to capture the consumer protection risks that have emerged in recent years in the increasingly digitalised retail financial services market.

The DMFSD provides two key functions. One, it acts as a safety net providing consumer protection for new financial services products coming onto the market, which are not as of yet covered by product-specific legislation. Secondly, it fills regulatory gaps which exist in current product-specific legislation.

The issue is, however, that the DMFSD currently lacks key consumer protection measures, such as advertising rules. The recent case of crypto assets, for example, shows the importance of having robust advertising rules in place for financial services that newly emerge on the market and are not (yet) covered by existing regulations. With the high degree of aggressive and misleading advertising in connection with these assets, it has led to a mis-selling of assets to many who are not suited in their financial situation.

EU policymakers should use the opportunity the ongoing review of the DMFSD presents to fill the key gaps in the consumer protection regulatory framework for unregulated financial services products to ensure that consumers are sufficiently protected.

Finally, another key retail financial services initiative currently on the EU legislative agenda is the EU’s Retail Investment Strategy. The goal of this EU initiative is to ensure consumers who invest in capital markets are better protected and have access to better quality products that are regulated by better rules.

Important improvements for this initiative would be, for example, ensuring there are simple and cost-efficient products which are safe and suitable. This would ensure wider access and use of safe products for consumers. In addition, inducements should be banned to guarantee quality of advice and remove conflicts of interest. Moreover, the initiative should be used to introduce shorter retail investor pre-contractual information documents that easily and clearly explain the key product features.

This is the scale of the challenge ahead for European policymakers. As the vulnerable are making critical decisions just to make it through the next month, it is more important than ever that the European retail financial services market is safe and fair.

Where monthly budgets are already stretched by inflation on groceries and energy bills, mis-selling of financial services and the financial losses and indebtedness as a result of it, come with severe consequences for households under financial stress. The reviews of the EU consumer credit legislation is a golden opportunity to create a safe and fair retail financial services market, and are part of the key measures needed to protect citizens in these difficult economic times.

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