Position paper of the European Federation of Building Societies on the European Commission consultation on responsible lending and borrowing

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1 Europäische Bausparkassenvereinigung Fédération Européenne d Epargne et de Crédit pour le Logement European Federation of Building Societies Brussels, 3 September 2009 Position paper of the European Federation of Building Societies on the European Commission consultation on responsible lending and borrowing The European Federation of Building Societies presents the following comments on the consultation on responsible lending and borrowing: General comments We are amazed to find the lack of cogency in the European Commission s approach precisely in the field of the regulation of mortgage credit. Whereas with the publication of the Green Paper on mortgage credit in summer 2005 and the publication of the cost-benefit study on the integration of EU mortgage credit the focus was still on the creation of a European internal market in housing credit, this concept does not arise at all in the Internal Market DG s present consultation document. The Green Paper on mortgage credit in the EU had already dealt mainly with the regulation of consumer protection to justify the creation of a European internal market (on 8 out of 15 pages). In the current consultation document, the Commission now invokes the global financial crisis, which originated in defective retail lending practices in the USA and the UK, in order to put forward regulations exclusively in the field of consumer protection via a second approach, without there being any obvious need for pan-european regulation. As a first conclusion, the recommendation should be made to legislators in the States concerned to solve the problems of deficient provisions and supervision standards where they have arisen and not at European level. Already in September 2005, the European Federation of Building Societies issued a grave warning concerning the results and conclusions of the cost-benefit analysis carried out on behalf of the European Commission by the consultancy firm London Economics. In this study, concrete benefits were calculated for the European Commission which were to arise from the integration of a European mortgage credit market. The European Commission even used these purported growth figures in press statements and to justify further action. The basis of these growth figures was a comparison of individual EU Member States concerning product diversity and supply with the British market. In this study, alleged product innovations, which for the most part were clones of US lending practices, were proposed as promoting integration. Conservative markets in Continental Europe were reproached for having nothing on offer for the sub-prime segment. In addition, the restrictions of the loan-to-value ratio to 60% or 80% were described as restricting growth. Despite the criticism expressed by the entire credit industry of the suppositions of this consultant, the European Commission assumed its forecasted growth in gross national product and private consumption to be correct and used it to justify the need for harmonisation measures in the field of mortgage credit. The same consultant was even

2 subsequently awarded two further contracts for studies in this field on behalf of the European Commission. The objections of the European credit industry to the presentation of the British mortgage credit market as an example for the EU as a whole were subsequently disregarded by the European Commission. The current financial market crisis shows how justified the objections shared by the European Federation of Building Societies were. It is precisely the sub-prime lenders, the refinancing of mortgage loans by means of securitisation and high loan-to-value ratios of up to 120% which led to the collapse of the American, British and Irish mortgage credit markets. For this reason, especially those EU Member States for which the London Economics study had claimed that enormous pent-up demand still existed concerning the range of mortgage credit products, prove to be particularly stable and secure in the crisis. In this connection, the current considerations on the regulation of responsible lending simply seem grotesque. If the European Commission is not prepared to take the smoothly functioning conservative markets, as in France, Austria and Germany for example, as a model for the European market, it should at least learn from the financial market crisis and assess the Anglo-American financing techniques, sub-prime loans and high loan-to-value ratios more critically. In this connection, it is incomprehensible that precisely the principle of responsible lending, which derives from common law, and which, moreover, did not avert the financial crisis in the UK, is being invoked as a patent solution to prevent future financial market crises. Finally, the assertion is made in the justification in the consultation paper that the field of advertising and marketing of mortgage credit is not regulated in European law. This is incorrect, as the Directive (84/450/EEC) of 10 September 1984 relating to the approximation of the laws, regulations and administrative provisions concerning misleading advertising, the Directive (2005/29/EC) concerning unfair commercial practices and the Directive (2002/65/EC) concerning the distance marketing of financial services very definitely do apply to mortgage credit too. The reference in the introduction to the consultation document that provisions and fees paid to intermediaries and bank client-facing staff must be made transparent is totally incomprehensible. This would only make sense for independent intermediaries (brokers). In the case of tied intermediaries, there is no conflict of interests with the consumer on account of the contractual relationship with the respective financial services provider alone. It would not occur to anyone to demand disclosure of the salary of the bank employee. Question 1 Do you have evidence of misleading or unfair advertising or marketing practices with regard to mortgage and consumer credit? In the already highly regulated and conservative Continental European markets, we are unaware of misleading through unfair advertising or marketing measures with regard to mortgage and consumer credit. Any abuse in the application for consumer credit should be a thing of the past following the implementation of the Consumer Credit Directive. In this connection, the warning should be issued once again against providing non-deposit-taking institutions from EU Member States with unrestricted access to the markets of other Member States by means of a possible European passport. Precisely this consideration is to be found in the study on non-deposit-taking credit institutions drawn up for the European Commission, in which a European passport for these lenders with their not insignificant share in the responsibility for the sub-prime 2

3 crisis, is discussed and proposed. We understand responsible lending to mean that precisely these suppliers of credit, which on account of the refinancing by means of securitisation for example have lower standards of care in relation to the quality of the credit transaction, should also be subject to the same strict banking supervision requirements as every other credit institution, for the benefit of consumers and the stability of the financial markets. Question 2 What are your views on the development of risk guidelines? The development of risk guidelines for certain products possibly makes sense in the securities and investment sector. In the case of a standard annuity loan with fixed interest agreement, such guidelines would be pointless, however. The meaning of the concept of risk used by the European Commission is unclear in this connection. The perception of risks will turn out to be different in the Member States. In some countries, consumers are well informed of the advantages and disadvantages of certain products, insofar as these are customary on their market. On the other hand, the same products are largely unknown in other countries and consumers are therefore unaccustomed to dealing with these products. Furthermore, the risk behaviour of consumers bears the stamp of culture, tradition and other factors influencing the market, such as for example in mortgage credit by lending limits, quality of housing, trends in housing prices, foreclosure procedures, inflation, tax conditions, etc. Saving-for-home ownership in particular is a simple, transparent product. Maximum security in terms of planning and interest rate results from setting the saving rates and the fixed interest rate for the loan. Equity financing is a particularly low-risk product, so there would be little point in risk guidelines here. The risk in the case of a standard loan contract can generally lie at most in the ability to repay the loan and the interest rate agreed. The risk of whether the consumer is permanently in a position to meet his commitments arising from the loan contract on a regular basis is ultimately a matter for his own estimation. The risk of job loss, change in marital status, etc. can be neither forecasted for the future nor borne by the credit institution. Furthermore, particular risks for the borrower lie in variable interest-rate loans or in loans denominated in foreign currency. Question 3 In your view, are there certain (categories of) credit products that are inherently unsuitable for sale to retail borrowers? Would you welcome a set of standardised or certified credit products to be offered to consumers? Already in 2005, the European Federation of Building Societies criticised the content of the study undertaken by the consultancy firm London Economics for the European Commission on the costs and benefits of integration of European mortgage markets. In this study, which subsequently was also used by the European Commission to justify further measures, raising the loan-to-value ratio to up to 120% in line with the British example in particular is propagated. In the view of the consultancy firm, this would have led to increased borrowing, greater private consumption and accordingly in total to more growth for the EU. In the European Commission press statement of 13 September 2005, these growth figures were cited with a view to possible follow-up measures to the 3

4 White Paper on the integration of EU mortgage credit markets. Only now does the European Commission present the view in the present consultation paper that high loan-to-value ratios ultimately contributed to the current crisis. We concur with this conclusion and refer to the loan-tovalue ratios existing for Bausparkassen, which are limited to 80% of the collateral value in Germany and Austria, for example. The corresponding specifications of European law are to be found in Annex 6 under the standardised approach of Directive 2006/48/EC. 1 In the past the European Federation of Building Societies repeatedly argued in favour of consideration of adequate equity in the financing of home ownership. However, we expressly reject the approach of product regulation by means of standardisation or certification of credit products. In 2005, the Directorate-General for Consumer Protection already published a study on the need for standardised financial services products, drawn up by Charles River Associates (CRA). According to this study, the standardisation of financial services products would lead to a considerable reduction in product diversity. This would be counter to the aims of the European internal market. The question also arises concerning the certification of financial services products of which authority should be competent at European level. Furthermore, such certification would give rise to a multitude of legal follow-up problems (liability consequences for the certifying authority, interventions in free competition, etc.). Question 4 For mortgage credit, what are your views on the criteria to be used in assessing suitability such as loan-to-income ratios or loan-to-value ratios? The creditworthiness assessment is already today comprehensively practised by credit institutions ultimately there is an interest in the repayment of loan debt and also enshrined in many legal systems. In 17 Member States, there are already binding provisions or voluntary codes of conduct on requirements for the assessment of creditworthiness. To list a few examples, mention is made of France, where case-law exists on the assessment of the ability of a consumer to repay his loan, which must be disclosed to the consumer. In Germany, a provision on the assessment of creditworthiness in the case of large exposures is currently being extended to all credits. In Hungary, there is a requirement to examine reliability of a customer to make regular payment and the valuation of the property. Question 5 How should the lender or credit intermediary demonstrate or document the adequacy of the creditworthiness and suitability assessment? Under supervision law, the lender is already today in many cases required under national law (e.g. in Germany) to document the relevant creditworthiness assessments internally. We reject the assessment of the suitability of the product for the respective consumer for the reasons set out above. 1 The covered bond is defined in accordance with point 68(d). Under these specifications, covered bonds are only those secured by loans financing up to 80% of the value of the pledged property. 4

5 Question 6 Do you think that these advice standards would be appropriate in an EU context? Are there others that should be considered? What would be the most appropriate means to introduce and enforce the application of advice standards? Please explain. The reputed advice standards listed here failed to ensure in the United Kingdom and Ireland, in which some of them are applied, that borrowers took decisions commensurate with the risk. Moreover, the standards listed on page 9 of the consultation document are not advice standards but mostly additional services which are necessary prior to the contract on account of the particularities in the individual Member States. Furthermore, the introduction of advice standards may lead to problems as advising specific products or types of products encroaches on the principle that customers should take decisions under their own responsibility. Consumers should rather receive all necessary information and explanations to be able to take such a decision. In addition, taking a decision under one s own responsibility is essential for the conclusion of an effective contractual relationship. On this account alone, a consumer must work on the assumption that, with knowledge and understanding of all important information, he can decide independently on what he considers the most suitable product for himself. We therefore advocate information standards and the duty to provide explanations. Furthermore, the duty to provide advice may entail the risk of disproportionate claims for damages, so credit institutions would have to proceed more restrictively in their lending. The special regulations governing the standards for intermediaries in the United Kingdom and Ireland therefore mostly result in the formation of a sector of brokers in these two States which in each case assess and select different credit products for the consumer. This service for the consumer is accordingly subject in part to the specifications outlined here. In the case of the sale of mortgage loans via tied intermediaries, for example, these potential conflicts of interests do not arise. We therefore reject the mandatory specification of advice standards. With the compulsory introduction of a duty of advice, existing distribution channels, such as Internet banking for example, could no longer be used. Already in the context of the discussion on the Consumer Credit Directive, the European Parliament and the European Council, for understandable reasons, pronounced themselves by majority against a duty of advice. Question 7 Apart from a focus on financial education, are there any measures that could be taken to encourage responsible borrowing? It is true that the European Commission consultation bears the title Public consultation on responsible lending and borrowing in the EU, but the content of the corresponding passage on responsible borrowing in this consultation document is sparse. The European Federation of Building Societies welcomes the efforts of the European Commission to initiate concrete measures in the field of financial education. The members of the European Federation of Building Societies have already long been committed to financial education at national level. For instance, special school brochures have been drawn up in which pupils can become more familiar with the subject of housing finance. The members of the European Federation of Building Societies also inform large sectors of the population via national information campaigns and publications. Overindebtedness arising from irresponsible borrowing is less widespread in mortgage credit than in consumer credit. The decision 5

6 to buy a property and to finance it extends over a protracted period of time in which the consumer as a rule weighs up all the options. This may be different in the case of consumer credit, for example to finance consumer goods (television, car, etc.), where consumers are more likely to take spontaneous decisions. Through the existing legal provisions and the self-commitment entered into by the credit sector, it is already ensured that customers receive sufficient advice and information. In our opinion, extending the duties of information and advice for the credit sector by law entails additional effort and higher costs. For customers, additional information is not necessarily beneficial. Rather, there is a risk of overburdening the customer with information. Transparency and clarity of credit products may suffer from this. Question 8 Do you consider that the scope of the definition of credit intermediary as set out in the Consumer Credit Directive could also be applied to the mediation of credit not covered by that directive? Would it be appropriate to differentiate between full-time credit intermediaries and persons who offer credit intermediation on an incidental basis? Please explain why (not). The definition set out in Article 3(f) of the Consumer Credit Directive (2008/48/EC) is very wide. As in Article 2(7) of the Insurance Mediation Directive (2002/92/EC), it is necessary to concentrate on the differences between a tied and an independent intermediary (broker) for a possible European horizontal regulation of credit intermediaries. The sphere of interests is different for these two types of intermediaries as far as the consumer is concerned. Whereas the independent intermediary, i.e. the traditional broker, acts in the interests of the consumer and accordingly also concludes a corresponding advisory contract with him, the tied intermediary acts in the interests and on behalf of his principal (credit institution). In the case of tied intermediaries, there is therefore no conflict of interests with the consumer, since he only offers products from the product range of the credit institution. The situation of the traditional broker is different; he selects the appropriate product for the consumer from a large number of products and proposes it to the consumer. If the broker were in addition to receive a fee from the credit institution for this mediation, this gives rise to the risk of a conflict of interests. Only this would need to be regulated by law. There is no point in treating tied intermediaries differently from bank employees who also mediate in products of only this one credit institution on behalf of this institution. This differentiation has a similar effect with regard to liability. Whereas in the case of negligent advice from a broker the consumer has redress only in relation to the broker s assets, in the case of defective advice on the part of a tied intermediary, as a rule action against the underlying credit institution is possible. Indemnity insurance is therefore only necessary for the mediation via a broker. To avoid distortions of competition and legal problems, we therefore advocate as a matter of urgency creating a possible regulation similar to the provisions of the Insurance Mediation Directive. In view of the widespread practice of offering a comprehensive advisory approach and of offering insurance and financial products from a one-stop-shop, it would lead to enormous difficulties for the financial services provider and the mediation sector if different requirements were to apply for intermediaries who mediate in insurance than for credit mediation. Furthermore, an additional distinction between full-time and part-time intermediaries could at the most make sense insofar as full-time intermediaries must be competent for the entire product range, assume extended liability and as a rule live from the mediation as a main occupation. 6

7 Intermediaries acting on an incidental basis as a sideline require the duty of identification, qualifications and documentation, but not full liability which as a rule should be assumed by the undertaking. Question 9 Do you think policymakers should make distinctions between credit intermediaries in terms of the products they sell (mortgage, consumer credit, point of sale credit)? Should credit intermediaries be treated differently in terms of the status of their relationship with lenders (tied versus untied intermediaries)? Please explain your answer. We do not consider there to be any point in distinctions in terms of products. In practice, a large number of intermediaries are not specialised in specific types of products, but provide mediation for a wide range of products. As already explained in the answer to question 8, it is essential to differentiate between tied intermediaries and independent intermediaries (brokers) with regard to the sphere of interests and accordingly the consumer s need for protection. Independent intermediaries claim to be independent of an individual supplier of products and to seek out the best solution for the customer from the plethora of the market supply. Here the customer has the expectation that the independent intermediary has the expertise to compare different products in the interest of the customer and also to act accordingly. In contrast to this is the so-called tied agent. The latter, identifiably for the customer, offers the products of a single supplier. The customer therefore does not expect any independent advice covering all marketable products, but chooses the intermediary because he has the corresponding confidence in him and the product supplier. If the product supplier is a specialised credit institution, such as a building society, the customer has already also made a deliberate choice in advance concerning a product. There is no identifiable conflict of interests here, since the intermediary does not make a choice of supplier or product on the basis of a fee. Furthermore, we point out that the credit intermediary largely operates in the national environment and regulation at European level is unnecessary. Different mediation traditions, which have already led in some Member States to differentiated regulations, such as in the United Kingdom, are not comparable with markets like those in Eastern Europe. For this reason too, regulation of intermediaries should take place at national level. Question 10 Could you give examples of cases of misconduct, mis-selling or any other instances of consumer detriment linked to credit intermediaries in your country? We are unaware of any allegations of misconduct by intermediaries. Misconduct or mis-selling can be avoided provided that the credit intermediary does not approve the credit himself. It is current practice in Germany, for example, that the credit institution, according to its lending guidelines, is the final body to approve the credit. 7

8 Question 11 Does the regulatory patchwork for credit intermediaries present a problem, in your view? The differing specifications to date under European law for credit intermediaries have not been an impediment for day-to-day practice in national business so far. The situation would be different if new horizontal credit mediation rules were proposed which were not consistent with existing specifications of the Investment Services Directive or the Insurance Mediation Directive. In this connection, we call once again on the European Commission to devise any planned pan-european rules for credit intermediaries on the lines of the provisions of the Insurance Mediation Directive. Furthermore, a large number of quality assurance instruments are already applied in practice. Further regulation of the sector would therefore not represent a significant improvement for customers, but above all generate additional costs. These conversion costs would be priced into the financial products and therefore increase the price of credit products for customers. The consumer can no longer differentiate which costs arise from the duty of regulation or the competitiveness of a product (risk of excessively large fees). Rationalisation constraints possibly reduce the quality of the product and advice with increased use of standard rather than individual offers. Question 12 What would be the most appropriate way to address potential conflicts of interest, particularly with regard to the fee/bonus/commission structures? Should any measures in this regard apply to bank client-facing staff as well as intermediaries? It should first of all be pointed out that the forms of remuneration via fee structures do not necessarily contain only disadvantages such as potential conflicts of interests, but also have the advantage of offering credit intermediaries incentives to make known a wide diversity of products on the market to consumers and thereby to encourage them to make private investments. Fee structures are appropriate to revive the market, promote product diversity and competition and as a result bring about lower prices. Therefore, it should be assessed to what extent potential conflicts of interests of credit intermediaries on the EU markets have in fact led to bad or wrong advice.. It is in fact more a matter of the benefits arising from fees for consumers outweighing the potential disadvantages. In this connection, it should be pointed out that conflicts of interests potentially may arise only in the case of independent intermediaries (brokers) (see the replies to questions 8 and 9). For this reason, possibly informing the consumer on the remuneration paid by the lender to the broker can also only be considered in this concrete case. The disclosure of fees paid to the tied intermediary has no impact on the contractual relationship between the borrower and the lender. It can make no difference whether the credit institution pays its staff a salary or remunerates them under a commercial agent agreement depending on the performance of the intermediary. Ultimately mediation especially for housing loans is still determined to a large extent by the personal confidence of the customer in the intermediary. Moreover, in the case of members of the EFBS, the decision on whether to grant a loan is taken not by the credit intermediary but by the building society (in the back office). 8

9 From the reasons stated, we see no need for regulation. Question 13 What are your views on the registration and supervision of credit intermediaries? With regard to the question of registration and supervision of credit intermediaries, we refer to the previous replies. The European Federation of Building Societies is of the opinion that the corresponding provisions of the Insurance Mediation Directive should be adopted in a horizontal Credit Intermediary Directive. In this respect, it should be ensured that there is a certain preservation of the status quo for intermediaries already active and trained. Question 14 What are your views on prudential and professional requirements for credit intermediaries (such as minimum capital, professional indemnity insurance, educational or professional qualifications)? Here too, we refer to our previous replies. We advocate that any horizontal provisions for credit intermediaries should be devised along the lines of the provisions of the Insurance Mediation Directive. This also applies for the training and qualification of intermediaries. The compulsory introduction of indemnity insurance only makes sense for independent intermediaries (brokers), as they act in a contractual relationship with the consumer. In the case of tied intermediaries, the possibility exists for recourse against the credit institution. This is not the case with brokers. Question 15 How do you think the activities of credit intermediaries could be brought within existing complaints and out-of-court redress mechanisms? The existing ombudsman systems already today deal with complaints arising from mediation by credit intermediaries. This is not the case for brokers, as they are not directly assigned to a financial services institution. 9