Consumer Credit Act brings more protection for consumers

The new Consumer Credit Act came into effect on 1 January of this year. The act introduces new obligations for banks and financial institutions granting loans, credit or similar financial services. The act implements EU Consumer Credit Directive (No. 2008/48/EC), which aims at unifying the legislation in EU countries and strengthening consumer protection. Among other things, financial institutions are required to provide more information about credit conditions and will bear more responsibility for assessing the creditworthiness of persons applying for loans.

The act aims at remedying the information asymmetry between creditors and debtors

Increasing consumer protection is a trend discernible in a number of EU directives and regulatory activities. In the case of consumer credit, this protection is motivated by asymmetry regarding information and expertise, which puts consumers at a disadvantage compared to financial service providers. The data on personal bankruptcies occurring in the Czech Republic last year show that more protection for consumers is overdue. The bankruptcies frequently happened because creditworthiness was not assessed correctly, the ability to pay was overestimated, and the consumers were not able to bear the burden of debt and repay the loans they had taken out. Strict sanctions introduced by the new legislation should regulate some non-banking institutions which have been granting loans quite wildly and were subject to almost no regulation.

A very interesting reversal occurred in the area of information asymmetry during the last decade. Most papers and textbooks on economics written before the current economic crisis state that it is clients who clearly benefit from information asymmetry in a credit relationship because only they know the motives for applying for a loan and their current financial situation, so they can use this knowledge to obtain an unfair advantage. Recently, however, clients are believed to suffer from asymmetric information. Nowadays, almost everyone is free to lend money. It is extremely simple to advertise and promote credit products on the Internet and by e-mail. The general boom of credit financing means that living an indebted life is no longer the exclusive privilege of educated or affluent people. Now it also appeals to the masses, and people can hardly find their bearings in the chaotic offer of credit services.


This is why I am happy that the understanding of information asymmetry has completely changed. From now on, financial service providers are obliged to supply their clients with all important information in a comprehensible manner and to assess whether they are creditworthy.
Credit providers are at an advantage because they have more expertise, and they also determine the credit conditions, the presentation of offered products and the form of provided information.

The act precisely defines the information duty of financial service providers

The new Consumer Credit Act contains a detailed and exhaustive list of information that the creditor is obliged to share with the consumer in various phases of their cooperation:

In the promotional campaign, which contains information about the cost of the advertised loan – the required information includes e.g. the annual percentage rate, the interest rate, information about other fees related to the loan, the amount of instalments, the total amount of the loan, the total amount payable by the consumer and information on the obligation to conclude supplementary insurance along with the credit contract if it is a prerequisite for receiving the loan.

Before the credit contract is concluded – in addition to information required in the promotional campaign: information on the frequency and number of payments, fees for account(s) maintenance, interest rate applicable for late payments, the right to withdraw from the contract, the right to repay the credit prematurely, etc. The information must be provided in writing (or in another permanent way) well ahead of concluding the credit contract, and all information must have the same visibility. For this end, providers can use the four-page form in the annex to the act. In addition to the required information, the creditor must provide adequate information so the consumer can decide whether the proposed contract corresponds to their needs and financial situation.

In the credit contract – in addition to the above: information on the possibility to settle disputes out of court or the indication of the supervisory authority.

Although there may seem to be some overlapping of the required information, the failure to provide some of it can result in sanctions stipulated by the law up to CZK 500,000 or CZK 5,000,000. If the required information fails to be mentioned in the credit contract, interest can be calculated using the CNB discount rate – retroactively from the beginning of the contract.
 
In their own interest, creditors must assess the creditworthiness of applicants

A new obligation imposed on financial institutions by the Consumer Credit Act is the assessment of creditworthiness (i.e. the ability of the consumer to repay the loan) with due care before the contract is concluded. In the case of non-compliance, the institution can face a fine of up to CZK 2 million.

The creditor should use information obtained from the consumer and from relevant registers that make it possible to assess creditworthiness. The consumer, in turn, is obliged to provide the creditor with complete, accurate and true information. Unlike the aforementioned information which financial institutions are legally obliged to share, the act does not define the structure of information that can be requested from the consumers to assess their creditworthiness. A typical consumer might provide widely differing answers to questions such as “Which consumer loans do you have?” and “Have you purchased any household equipment on instalments?”. For this reason, the importance of credit bureaus as a source of objective information on client debt will increase.
Domestic credit bureaus such as the Bank (BRKI) and Non-Bank Client Information Register (NRKI) or Solus have strengthened their position during the crisis, becoming an indispensable part of the approval process at all serious financial institutions (e.g. BRKI and NRKI witnessed an increase in the number of members to 46 companies). While previously companies divided their attention equally between existing and new clients, during the crisis they shifted their focus to the maximization of earnings from their existing client portfolio. The implication for the BRKI and NRKI was a significant increase in the number of queries regarding payments of existing loans. While in 2008 register members filed more queries about new clients than verification queries, in 2010 there were five times more verification queries than queries on new clients.
 
Investigating past issues is not enough

The Czech media interpret the obligation to assess the creditworthiness of clients as the ability to prove some basic assessment of clients in debtor registers – meaning debtors in the negative sense of the word, i.e. defaulting clients. Simply put: clients who had problems repaying their loans will perhaps have an even bigger problem because they will not be granted another loan.

The primary intent of the directive proposers was to prevent financial institutions from deliberately overburdening clients with debt – both clients who have already defaulted on their instalments and those who have been duly repaying their loans, but for whom a new loan might be more than they can reasonably handle. It is easy to understand that checking the database of “sinners” only addresses historical creditworthiness, not the current situation of the client or even future behaviour. Current BRKI and NRKI statistics show that even trouble-free customers can end up having problems. This risk increases for clients with five or more credit contracts (where the default risk can be up to three times higher than for a client with two contracts) or for clients who have exhausted their credit card limit or overdraft (risk up to eight times higher than for a client who has exhausted at most one half of the limit).

An objective assessment of risks entails an examination of all the consumer’s existing obligations and of the complete credit history in external databases that contain positive as well as negative credit history. After all, Czech as well as EU legal experts share this interpretation of the obligation to assess creditworthiness. The Consumer Credit Directive, however, discusses this obligation in general terms only. The reason is that types of credit bureaus vary in EU countries (only negative, positive and negative, private, state-run, completely or partly owned by financial companies), and French-speaking and Scandinavian countries in particular only have negative databases for historical reasons. Therefore, each EU country is free to specify this part of the directive as it sees fit. On the other hand, the Czech Republic (as well as several other EU countries) has two successful parallel private credit bureaus – purely negative and positive/negative. In order not to violate fair market conditions, the general formulation was maintained in the Czech legislation.

Nevertheless, various discussions among economists and lawyers show that a credit provider that would only formally check the applicant in dubious debtor databases (there are many of those on the Czech market, unfortunately) would face a risk of losing a potential dispute with a client-debtor. Last year, in some countries that have a more advanced retail credit market than the CR (namely Germany), there were the first cases in which clients won such disputes and the credit companies were in essence convicted of “deliberately overburdening them with debt”. These are the first isolated cases, but it is obvious that precedents in this area would have a fatal impact on the credit market. Similarly, various consumer organizations and associations in Great Britain, France and Germany in particular exert strong pressure on financial institutions to disclose their internal scoring models or entries used in algorithms and their impact on the final decision to approve or reject a loan application.
 
The act expands sharing of information among EU countries

Another area addressed in the CCD is the cross-border data exchange, or “non-discriminatory access to information from foreign credit bureaus”. In plain terms, this means that a Czech citizen living in another EU country who applies for a consumer loan there should not face different (worse) conditions than a citizen of that particular country who has a similar risk profile. For the financial institution to be able to assess the creditworthiness of this Czech citizen, it needs to know their credit history, which requires access to the data from a Czech credit bureau.

However, in terms of technology, methodology and processes, it is not feasible for all financial institutions in the EU to become members of all the credit bureaus in the EU. Besides occasionally accessing data about foreigners, they would have to regularly submit information about the payment discipline of their own clients. For this reason, the European credit bureaus were forced to come up with an idea for implementing this legislative intention. The BRKI and NRKI registers, which are members of the Association of Consumer Credit Information Suppliers (ACCIS) through CCB, are adopting the principle of “indirect access” to registers. This means that in neighbouring countries (where cross-border loans are relevant), bilateral agreements should be signed by credit bureaus. Based on these contracts, registers can provide information about the citizens of their countries to foreign financial institutions which submit a query at a credit bureau in their own country, and this credit bureau in turn requests information from its contractual partner. For example, the BRKI and NRKI registers are preparing bilateral agreements with Slovak, German, Austrian and Polish registers.
 
Supplementary charts and other information
Table/chart – personal bankruptcies in 2010
 
 
 
Caption
The number of personal bankruptcies and applications for personal bankruptcies in 2010 – both are significantly increasing. Personal bankruptcies are often a result of the inability to repay an excessive volume of loans. In 2010, the average number of bankruptcies declared per month was 517.
 
Info box with additional information
Loans not covered by the Consumer Credit Act
- loans lower than CZK 5,000 or higher than CZK 1.88 million
- loans for financing housing, secured by real estate
- leasing financing
- loans granted without interest or other payments
- loans with a low annual percentage rate granted to a company’s own employees
- loans for security trades

Info box with additional information
Sanctions for non-compliance with legal requirements faced by financial institutions
Up to CZK 500,000 – for the failure to provide requested information about the loan in the promotional campaign
Up to CZK 5,000,000 – for the failure to provide requested information about the loan before the contract is concluded
Up to CZK 2,000,000 – for an insufficient assessment of creditworthiness before the contract is concluded
Interest be computed using the CNB discount rate for the whole loan – if the credit contract fails to contain all information required by the law and the consumer brings this to the attention of the creditor
 
Table/chart – loans at risk, September 2010
 
 
Caption
The share of loans at risk in 2010 according to the statistics and methodology of the Bank and Non-Bank Client Information Registers. This means the share of instalments that are three and more months overdue in the total volume of loans, including interest.