SENATE OF THE CZECH NATIONAL PARLIAMENT Loan Providers and Unfair Business Practice

1. SENATE OF THE CZECH NATIONAL PARLIAMENTLoan Providers and Unfair Business Practice An international perspective 9th April 2008

2. Policis • UK based economic and social researcher company • Specialising in: • Research to support Government policy formulation • Credit and financial services markets • Consumer protection issues, particularly for low-income and vulnerable consumers • Have conducted number of research projects on the impact of regulation on national credit markets • Have helped inform framing of consumer credit legislation for regulators in European, US, Asian and Australian markets

3. Regulators across the world face similar challenges in regulating credit markets • Credit recognised as a force for economic growth and wealth creation • But Governments concerned to ensure consumers are adequately protected • Main concerns: • Unfair lender practice • Irresponsible lending • High cost of credit for some borrowers • Over-indebtedness • Insolvency • Impact of debt problems on individuals and families • Cost to the state of financial breakdown

4. Different governments have adopted different approaches Aim Regulatory approaches Transparencyon pricing and contract terms • Principles • Control of presentation • Closely specified formulae • Broad duty to avoid unfair / bad practice • Prohibition of specific behaviours Increase consumer protection • Self regulation, codes of practice • Mandated compliance to specified formula Promote best lender practice Encourage responsible lending • Broad duty to lend responsibly • Promote efficient data sharing to support lenders’ decisions • Lending limits • Make lenders bear risk of default on demonstrably irresponsible lending • Promote competition Reduce cost of credit • Price controls Light touch Tight

5. Regulatory regimes in USA and Japan • USA • US-wide market in banking & credit cards - sold across State borders • Otherwise, regulatory control devolved to individual States - resulting in a diverse ‘patchwork’ of different rules (some States with rate ceilings, others without) • Recent regulations designed to address rapid growth of high cost “payday lending”: • Trend has been to ‘control and regulate’ rather than simply ‘ban’ high cost lending • Also rules to outlaw bad and unfair practice • Japan • Rate ceiling introduced in 1980s at 109% APR and progressively tightened since • Further recent legislation to address over-indebtedness, bankruptcy, aggressive collection practices and debt-related suicides • 2007 saw introduction of tightest regulatory regime in any advanced economy: • Sharp tightening of rate ceiling • Scope of rate ceiling widened to incorporate penalty charges for missed/late payments • Introduction of cap on amount of credit an individual allowed to borrow • Increased powers of supervision and enforcement for regulators

6. Regulatory regimes in the three largest credit markets in Europe • France and Germany have long-established rate ceilings set at low levels • Differences in emphasis and focus between Germany and France have produced very different outcomes for consumers and credit markets • France focuses on ‘price controls’ and the ‘management of over-indebtedness’ • Germany focuses on ‘price transparency’ and the ‘prevention of default’ • French regime ‘highly specified’ with delinquency and over-indebtedness regime managed directly by Banque de France • UK and Germany rely on tradition of ‘self regulation’ and ‘principle-based’ approach to regulation • UK has the most ‘market-based’ approach to regulation in Europe: • No rate ceiling • Licensing system (lenders licensed as “fit”) • No restrictions on lending models • Requirement to lend ‘responsibly’ and credit agreements subject to ‘unfair credit test’

7. ‘Tight’ regulatory frameworks and ‘price controls’ restrict credit supply and, ultimately, harm consumers • Tight regulatory frameworks tend to result in: • Restriction of credit supply – lenders withdraw from the market or serve only ‘low risk’ market segments • Credit exclusion – usually of lower-income and higher-risk borrowers • Credit markets with narrow range of lending models • ‘Credit exclusion’ creates hardship, especially for those with no savings: • Demand for credit (i.e. need to borrow) remarkably consistent across Europe • Consumers unable to manage peaks of expenditure or cash flow difficulties • Consumers unable to spread cost of major purchases • The resulting ‘vacuum’ tends be filled by unregulated lenders: • ‘Unregulated’ = ‘illegal’ • Very high cost • Use of intimidation and violence • Damaging for individuals and communities • Often run by criminal networks • The larger the vacuum the more attractive to organised crime

8. In Japan, introduction of tight regulatory regime has resulted in consumer lending falling by two thirds in two years Loan applications and new customer numbers Jan 06 – Nov 07 Loan acceptance ratio on consumer lending Jan 06 to Nov 07 Source: “Big Four” Consumer Finance houses: Acom, Promise, Aiful, Takefuji

9. Bankruptcies, which had been falling, have risen sharply as credit was withdrawn from high risk borrowers and small businesses in JapanBankruptcy numbers for self-employed individuals Jan 06 – 07 200 180 160 140 120 100 '000 80 60 40 20 0 Jul-05 Jul-06 Jul-07 Apr-05 Oct-05 Apr-06 Oct-06 Apr-07 Oct-07 Jan-05 Jun-05 Jan-06 Jun-06 Jan-07 Jun-07 Mar-05 Mar-06 Mar-07 Feb-05 Feb-06 Feb-07 Nov-05 Nov-06 Nov-07 Aug-05 Sep-05 Dec-05 Aug-06 Sep-06 Dec-06 Aug-07 Sep-07 Dec-07 May-05 May-06 May-07 Source: Teikoku Databank Money Lending Business Law introduces sharply reduced rate ceiling and lending limits

10. 250 200 150 100 50 0 First six months of 2006 First six months of 2007 Illegal lending has risen rapidly following the credit crunch in Japan; and is much higher in markets with rate caps (i.e. France and Germany) Incidence of illegal lending in France, Germany, UK among the credit impaired Incidence of illegal lending in France, Germany, UK among those experiencing credit refusals No’s of Illegal lending cases in Japan First six months 2006 and 2007 9% 14% 8% 12% 7% 10% 6% 8% 5% 4% 6% 3% 4% 2% 2% 1% 0% 0% France Germany UK France Germany UK Base: Credit impaired Source: Taylor Nelson Research for Policis 2004 Base: Those who have been refused a loan Source: Taylor Nelson Research for Policis 2004 Source: Japanese National Police Agency

11. ‘Price controls’ do not necessarily reduce the cost of credit for high-risk borrowers and may lead to higher total charges • Lenders simply restructure products and pricing to get round ceilings: • Cost of credit is transferred from ‘up-front’ interest rates to ‘add on’ service and default charges • Outcome is less price ‘transparency’ • High risk borrowers: • Are excluded from market or driven towards unsuitable products • Will tend to pay more for credit overall (because they miss payments) • Have greater exposure to lender sanctions and punitive debt recovery

12. ‘Price controls’ do not prevent problem debt: they can make it worse • Rate ceilings do not prevent over-indebtedness: • In Germany, over-indebtedness has risen steadily over a decade despite low levels of credit default • In France, problem debt has risen sharply in line with the expansion of ‘revolving’ credit facilities; large numbers of borrowers shut out of the financial system • In UK, serious problem debt is low and has trended downwards during a long period of credit market growth (albeit with sharp rise in recent months from a low base) • The implications of problem debt are more serious in tightly-regulated markets: • Lenders less sympathetic to difficulties and act more quickly to recover debt • Credit problems more likely to lead to insolvency • In markets with price controls, borrowers are more likely to prioritise debt repayments over other areas of spending: • De-prioritise ‘essentials’ such as food and clothing • Creates fuel poverty • Undermines security

13. 250 200 Mortgages in arrears by 6-12 months 150 Mortgages in arrears by over 100 12 months 50 Repossessions 0 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Source: Council of Mortgage Lenders In the UK, the indicators of problem debt have trended downwards over a long period UK over-indebtedness trends County Court Judgements and Money Claims UK over-indebtedness trends Mortgage arrears and repossession trends 4m 3.5m 3m 2.5m CCJs 2m Money claims 1.5m 1m 0.5m 0 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Source: Department for Constitutional Affairs, The Registry Trust Ltd

14. 100% 100% 90% 90% 80% 80% 70% 70% 60% 60% 50% 50% 40% 40% 30% 30% 20% 20% 10% 10% 0% 0% France Germany UK France Germany UK Aggressive ‘debt-collection’ and resort to ‘legal sanctions’ are more common in countries with price controls % agreeing that lenders are supportive and understanding in the event of difficulties %of respondents agreeing that lenders are aggressive in recovering their debt Source: Taylor Nelson Sofres Research for Policis 2004 Base: Low income borrowers with payment difficulties

15. To get the right balance, regulators need to understand the implications of different regulatory approaches • ‘Lighter-touch’ regulatory frameworks for credit markets result in: • More vibrant and faster growing credit markets • Increased consumer behaviour • Stimulus to economic growth • Higher GDP • Increased competition associated with faster growing credit markets results in: • Greater innovation and a more diverse range of lending models • Most effective route to reduced prices

16. Lightly regulated, fast growing credit markets stimulate consumption and boost economic growth Credit Market Growth and Personal Prosperity Annualised growth rate consumer credit per head and gross national income per head, 1995 - 2006, France, Germany, UK 12% 10% Annualised growth in consumer credit per capita 8% 6% Annualised growth in gross national income per capita 4% 2% 0% France Germany UK Source: Australian Reserve Bank, OECD, Central banks, Cofidis

17. 25% 40% 35% 20% 30% Average APR Average APR 25% pertaining in pertaining in 15% states states 20% Average rate Average Ceiling ceiling in states 10% in states 15% 10% 5% 5% 0% 0% Lowest 10 11 to 20 21 to 30 31 to 40 Highest No ceiling Lowest 10 11 to 20 21 to 30 31 to 40 No ceiling ‘Competition’ is the most effective way to reduce credit prices US $3,000 36 month loan for new automobile in 1971 US $12,000 36 month loan for new automobile 2003 Source: National Commission on Consumer Finance 1971 Source: Bankrate.com 2003

18. Significant social and economic risks associated with credit market regulation • Debate around credit market regulation and consumer protection often high profile • Vulnerable borrowers and low income consumers are most exposed to unfair practices; and tend to pay highest cost for credit • High potential for ‘regulatory interventions’ to cause ‘unintended consequences’ in the market • Appealing and populist ‘solutions’ (such as rate ceilings) can harm the interests of the very consumers they are designed to protect • Credit market regulation has a major impact beyond the credit market itself; and has role to play in influencing progress towards wider economic and social goals