In 2010, ECRC partner, iff together with the economic research institute ZEW, conducted research into the subject of interest rate restrictions in the EU on behalf of DG Internal Market and Services of the European Commission.
The report was published on the Commission’s website last week and the authors will be issuing a joint-press release in the coming days.
The report can be found at the following link, alongside a short consultation document on the study which the Commission has also prepared (Period of consultation runs until 22.3.2011):
http://ec.europa.eu/internal_market/finservices-retail/credit/mortgage_en.htm#studies
The final report as a PDF document is also attached below.
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Here are the initial observations made by iff concerning the publication of its report.
Interest rate restrictions have a legitimate role to play in EU consumer credit markets and their downsides have been exaggerated in the past.
The iff hopes that stakeholders and regulators will now be in a better position to lead more constructive debates on details of when such a policy tool is appropriate and how these should be set rather than continuously argue about their lack of legitimacy and anachronism with modern credit markets . Not only do they exist in over half of the EU Member States but the report finds previous fears concerning interest rate restrictions (IRR) have been exaggerated. In their study on Interest rate restrictions in the EU, co-authors iff and ZEW provide an overview of the different types of interest rate restrictions that exist in the EU, giving details on how those Member States apply them and explaining how analysis of their effects allows to draw an overall positive balance as to their general usefulness both as a policy measure protecting consumers and as a suitable tool for sustainable credit markets.
Interest Rate Restrictions (IRR) refer to all legal rules that limit, directly (e.g. ceilings) or indirectly (e.g. rules on the calculation of compound interest), the price of credit contracts. Alongside all the 27 EU Member States that subscribe to the principle of 'good morals' or 'fairness' (explicitly or implicitly incriminating the intentional exploitation of the weakness of another person through extortionate pricing), and all but two countries who have set maximum limits in relation to default interest, ceilings on contractual interest are used, in one form or another, in 14 EU Member States. Relative ceilings, the most common form where the maximum authorised interest rate is based on a reference rate exist in the larger economies (France, Germany, Italy) just like in the smaller ones (Slovakia, Slovenia), irrespective of geography (Spain, Netherlands, Poland, Portugal). Furthermore, Member States have usually opted for applying more than one interest rate ceiling in their national credit markets, and the spread of these ceilings is quite broad, ranging from as high as 453% p.a. for a small loan in Slovenia to a cap of 13.2% p.a. for a long-term loan there, while in France the ceilings for the different forms of credit ranged from 5.7% p.a. to 21.6% p.a. as of March 2010.
While the study was carried out as part of the Commission’s White Paper on the Integration of EU Mortgage Markets, the findings and their implications clearly show that the subject of rate ceilings are primarily directed at shorter term unsecured consumer credit markets, with less relevance to mortgage markets.
“Too many people imagine ceilings as crude devices, from another era, arbitrarily imposed on to markets with heavy distorting consequences. Findings of the study indicate that this is far from being the case in Europe” says Sebastien Clerc-Renaud from the Hamburg-based institute iff.
Firstly, the majority of EU Member States applying relative rate ceilings are found to have a system that sets these based on rates observed in the credit markets in practice, usually via a multiplication coefficient applied to average rates, and secondly the report finds that concerns that ceilings would reduce access to credit are over-reliant on US based studies where ceilings are typically of a less sophisticated nature and have been introduced at very low levels. While assessment of the hypotheses relating to volumes of credit and existence of certain credit types is made particularly difficult by institutional and cultural factors as simple as different national attitudes towards credit, IRR do shape the supply side of the credit market in the sense that they affect high-cost credit. This may challenge the economic viability of certain forms of credit extension that are unable to operate in an environment of interest rate caps, and may affect credit access by those parts of the population which are considered to be high-risk and which demand small-amount credit, however this reduced access may or may not be an objective of a government’s policy.
The extent to which both intended and unintended effects materialise depends on a number of factors, and most significantly on whether or not the mechanism and administration of the ceilings ensure that these are set at an appropriate level and do not restrict access to affordable and responsible credit.
“It’s about the level at which the ceiling is set. The art or science of this policy issue revolves around establishing an interest rate ceiling sufficiently high to permit borrowers with little security to obtain access to credit but sufficiently low so that lenders do not lend to the most fragile borrowers whose precarious position would be made worse by a larger amount of interest to repay” commented Clerc-Renaud, iff.
The research also dismisses a number of widely accepted but unproven claims with regard to the effects such ceilings may have. For example, the report finds that there is 'no convincing' evidence to support the argument that introducing ceilings leads to a growth in illegal lending or would force people into arrears and default on bill repayments.
The conclusions of the hypotheses of the research are shown below:
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Plausible
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- IRR reduce credit access, in particular for low-income borrowers.
- Without IRR, more product types exist in the market.
- IRR lead to increased charges as providers will try to compensate the reduced interest revenues by increased charges.
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Inconclusive
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- IRR lead to credit from non-bank sources, such as paying bills late.
- IRR lead to a substantial illegal market in lending.
- The lack of IRR has particularly adverse effects on default rates/overindebtedness in the presence of negative shocks (e.g. recessions) to the economy.
- The average consumer – or even more so: low-risk consumer – would be granted cheaper credit in the presence of IRR.
- IRR represent barriers to consumer credit market integration.
- IRR lead to a convergence of all consumer credit interest rates at the level of the interest rate cap.
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Unlikely
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- IRR lead to a decline in the volumes of consumer credit granted.
- The lack of IRR leads to a higher level of over-indebtedness.
- IRR lead to lower levels of competition in the consumer credit industry.
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The limited scope of credit affected by IRR and the limited barrier to cross border trade which these represent where they exist would suggest a weak case in favour of harmonisation of such rules in the EU. However, if regulation were to be deemed necessary by the European Commission, the authors of the report stress that it should be modern and adequate for market conditions. Among the recommendations made, objective market-related ceilings would be preferable to more subjective rules in terms of self-execution. The report also stresses the importance of monitoring market developments and ensuring that the rules always carefully observe the impact they have on the distribution of certain regulated products. The report furthermore suggests that differentiation of ceilings through the segmentation of credit markets (by marketing practice, product, duration, amount etc.) would appear to be the more promising approach to take going forward. The case of France in 2010 also shows how a usury ceiling regime, subject to unintended effects over time and concern about the use of revolving credit, can be modified to respond to evolving market realities.
The report and Commission consultation on the study is expected to raise numerous responses from the industry, and findings have already informed political discussions in a UK Parliamentary motion on this exact issue being held today, the 3 February. Whether the EU will play a special role in providing a common framework to help govern interest rate ceilings and their equivalent is unclear, but this report will hopefully encourage discussions in the EU and elsewhere, to move away from past polemic and antagonism, by focusing instead on factual debate on details.
Comments by iff alone.
The iff/ZEW (2010): Study on interest rate restrictions in the EU, Final Report for the EU Commission DG Internal Market and Services, Project No. ETD/2009/IM/H3/87, Brussels/Hamburg/Mannheim, is available from the European Commission website: http://ec.europa.eu/internal_market/finservices-retail/credit/mortgage_en.htm#studies. |
