Workshop 7 "Can Risk-based Pricing Work in the Absence of Comprehensive Credit Reporting?" Introduction abstract by Melina Mouzouraki INTRODUCTORY REMARKS (By Melina Mouzouraki, Attorney of law, Legal Adviser of EKPIZO Consumers’ Association, and chairperson of the workshop) Risk-based pricing stands as the modern tool to restrict the impact of unsafe claims to the level of the interest rate. The risk of non-payment is individualized on the basis of the characteristics (in market terms credit reporting) of the borrower. Thus, the cost that eventual non-perfomance of the credit contract has for the bank is passed to those categories of borrowers, to which it mainly belongs. And vice-versa : those who do not have characteristics of a bad debtor enjoy credit at the price that they deserve, without being asked to pay – in fact, to subsidize- the credit granted to some other borrowers. This mechanism has advantages for some borrowers, but disadvantages for some others. Those who have the characteristics for a good prognosis regarding the fulfillment of their contractual obligations, can have access to credit at favorable interest rates. Banks can have expectations for a further market share of consumers who, without being in pressing need for credit, are currently discouraged by the high cost of credit. And vice-versa once more: The most vulnerable categories of consumers vis-à-vis the risk of non-payment are asked to bear the consequences of non-payment. Since the cost of non-payment is not shared among all, but to only some categories of borrowers, they who fall into these categories will certainly be called to pay a higher interest rate. In all probability, it will be those categories which are in the most pressing need for such credit. This system appears indeed to be fair. But this is so, only if the subjects are categories of borrowers (One takes what one deserves on the basis of the category one belongs). Nevertheless, if the subjects are persons, then the system is discriminatory and unfair. At the level of persons, the above approach goes against the principle of equality : in the same financial and credit market conditions, some borrowers pay the use of money much higher. Unfairness is even more obvious for a borrower who took credit on a significantly higher interest rate due to his characteristics, but fulfilled his contractual obligations on time. Risk-based pricing and responsible lending have one common and one competitive feature. The common feature is the necessity to have access to the personal data of the interested borrower in order to have his capacity to fulfill his obligations measured. Personal data are the basis on which both approaches work on. The competitive feature is that the eventually high risk does not lead to the discouragement of the interest borrower to take the credit, as the principle of responsible lending would suggest, but the raise of the interest rate. Everybody can have expectations to take credit, but some on an extortionate rate. In the model of risk-based pricing, information and private data, but also their evaluation –categorization take acquire enormous importance, because they determine the value of the product (credit). They get incorporated in the product (credit) and they co-define it. Credit does not exist as such, but is understood in relation to the characteristics of the borrower to who it is addressed. The management of the information and personal data by both contractual parties is central for the following reasons: First of all, because the kind of information that the lenders will choose in order to form the categories will define the cost that the borrower will be asked to pay. The latter has the interest to know at the highest possible level the information that the lender regards as important and the value it gives to such information (scoring). This is necessary for reasons on transparency in the market. The borrower has the further interest that the information which affects the interest rate proposed to him is in fact right and proper for this function. If not, the borrower is charged more with no reason. Moreover, the borrower has the interest to emphasize to the lender the importance of information and personal data that lower the unfavorable significance of other information. Similarly, the lender has the interest (and the obligation) to have accurate information with regard to the borrower, so that the latter is placed in right according to the lender category of risk. The time of collection of information, the period of retention of information, the legal requirements for the accuracy of reports and regulation of eventual disputes are some other important issues related to the credit reporting. In the absence of accurate personal data, in the absence of the choice of the right and proper data for the determination of the risk and in the absence of transparency in the market, the model of individualized determination of the cost of credit will produce distortions in the credit market. Instead of showing off the positive elements of this system, such distortions will intensify its inherent unfairness. This is why this model has to be clearly confined and controlled, especially through the enforcement of the principles of responsible lending and the prevention of the exploitation of the more vulnerable categories of borrowers by the provision of maximum interest rates. ID: 37243 Author(s): iff Publication date: 28/04/06     Introduction abstract by Melina Mouzouraki (10994 Bytes)

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