Many EU countries are currently debating whether or not to cap interest rates for non-bank lenders. However, before politicians make a too-hasty decision on capping interest rates at certain percentage, they would be well advised to study the report “Price rules in consumer credit, should the EU act?” from the European Credit Research Institute (ECRI) as well as the EU Commission’s latest European Economic Forecast. The findings of these publications strongly suggest that financial inclusion should form the main focus for any policy change – not an arbitrarily chosen percentage.
The World Bank defines financial inclusion as “individuals have access to useful and affordable financial products and services that meet their needs – transactions, payments, savings, credit and insurance – delivered in a responsible and sustainable way”. For individuals to have access to financial services, they need a transaction account as the starting point to build a financial track record or file.
Having a transaction account does not automatically guarantee access to financial services; banks might consider particular individuals as having too high a risk profile because of insufficient data in their financial record.
Lending that leads to financial inclusion has a positive effect on people’s lives.
While there are several very unpleasant cases of pay-day lenders charging interest rates and fees that ruin borrowers, such loans are often intended to finance non-essential purposes, such as buying presents, pub visits or gambling.
However, as the ECRI rightly states in its report:
Given that price rules aim at increasing consumer protection, the rules could be considered successful if they contribute to consumer welfare. Therefore, are excluded consumers who did not use an alternative source of funding better off? The answer may depend on the purpose of the subprime loan. If the purpose had to do with paying for essential goods or services (education, health bills, late utility bills, etc.), then the impact of the new price rules could be considered negative.
Consider the case of a family needing a car to bring the children to school before going to work. Given their income and spending profile, the parents cannot afford to buy a brand-new car, but a small used car in a price range of between EUR 3,000 and EUR 5,000 would be manageable. Just because this family does not have a full financial track record, should it be excluded from access to financial services and the possibility of building a better future for themselves?
While non-bank lenders charge a high interest rate on such loans, this is mainly because the loan package is “all-inclusive”, i.e. all fees, transaction costs etc. are included in the interest rate applied. Similar loans from banks (if the borrower is lucky enough to secure one), may have a lower interest rate attached, but this is only because the fees are applied in addition to the rate of interest charged.
One of the main drivers for financial inclusion is economic growth, something that has been barely evident since the financial crisis of 2008.
As discussed in our previous newsletter, the ECB has expanded its balance sheet significantly during the last 3-4 years and will continue to do so with additional purchases of bonds. The question is: how much does this monetary policy actually effect economic growth in the EU?
Table 1 EU Economic Forecast autumn 2019 growth and inflation rates
The EU Commission has just published its European Economic Forecast Autumn 2019, the headline numbers of which are listed in Table 1, above. Despite the ECB’s expansive monetary policy, the Commission’s forecasts are not very optimistic:
“The European and world economy have weakened over the past year. Europe has seen a sharp slowdown in external demand and a contraction in manufacturing, which is starting to spill over to other parts of the economy…… GDP growth is unlikely to rebound swiftly. The fact that growth is no longer expected to rebound meaningfully in the next two years is a major shift compared to previous forecasts”
It is quite clear that overall EU growth will remain sluggish over the forecasted period, with the only growth rates of any significance coming from Eastern Europe, as the region’s economies continue to catch up with their western counterparts, closing the GDP gap with Germany and especially countries like France and Italy.
Likewise, the Commission is not expecting any expansion in lending to the domestic non-financial sector measured as a percentage of GDP.
For the expanding economies in the EU, this is naturally cause for concern, as they need increased lending to keep pace with advancing growth rates. However, in its Autumn report, the Commission, with reference to the ECB Bank Lending Survey, points out that:
“euro area banks reported that credit standards (loan approval criteria) eased slightly for loans to enterprises and for loans to households for house purchases, driven by competition and in spite of the continued tightening contribution of risk perceptions related to the economic outlook. Credit standards continued to tighten for consumer credit.”
In other words, banks continue to lend to big companies – which are mainly in Western Europe – as well as issue mortgage loans to households that are already financially included. At the same time, the Commission notes that:
“Meanwhile, debt market funding for enterprises continued to expand in the euro area, although at a slower pace than in previous years, around 5% in October on an annual basis. The high level of corporate debt remains a concern, particularly in segments such as leveraged loans, low-credit quality borrowers and highly-leveraged enterprises.”
The ECB balance-sheet expansion, and its buying of bonds at a rate of EUR 20 billion per month; slow growth; no increase in lending from the financial sector except to buy property; funding big corporations with the issuance of corporate debt of low credit-quality loans – all this seems a far-from-ideal combination to extract the EU from the current low-growth environment.
This economic regime and the stagnation in consumer credit issuance make it difficult to achieve financial inclusion for those individuals that are not already part of the financial “system”.
Quantrom promotes lending to individuals that need financial inclusion. However, Quantrom does NOT invest in any type or form of pay-day loans. You can invest in alternative lending with Quantrom P2P Lending DAC by subscribing to our profit participation note on our website: Quantrom.com or Quantrom.dk (Danish version) where more information for investors is also available.
Gustav Jensen Tony Jønsson
Managing Director and Partner Partner