The legal framework of consumer credit bureaus and credit scoring in the European Union: pitfalls and challenges - overindebtedness, responsible lending, market integration, and fundamental rights.

Author:Ferretti, Federico
Position:Symposium: Credit Reporting and Credit Scoring

    The integration of European Union (EU) credit markets is crucial for the efficient functioning of the EU financial system, for the EU economy as a whole, and for the full achievement of the four freedoms guaranteed by the EU's internal market. (1) Neither the consumer nor the mortgage-credit markets are an exception to this need for integration, and EU policymakers are paying increased attention to them. Concurrently, the market for loans available to consumers--both consumer loans and mortgage-credit loans--has grown rapidly in the last decade across the EU and is becoming increasingly sophisticated. However, the development of retail and mortgage-credit markets has increasingly left European consumers in debt. This growth of consumer indebtedness is becoming a concern for national and EU policymakers alike.

    The ongoing, global credit and financial crisis has raised important issues regarding: the protection of consumers in financial markets; the scope, amount, and effectiveness of regulation in financial markets; and the need for additional safeguards to stem the social problems that the crisis has exacerbated. consumers are still bearing the costs of the financial-market failures, as evidenced by policy documents revealing the severe consequences not only for individual homeowners losing their homes in foreclosure procedures, but also for society as a whole, considering "their impact on financial and social stability." (2) Moreover, a large number of member states have imposed austerity measures as a core strategy to overcome the current debt crisis. Nonperforming personal and mortgage loans are expected to remain at high levels or even increase, indicating that overindebtedness is likely to persist or intensify. Therefore, the promotion of responsible lending and borrowing policies to limit the overindebtedness of European consumers is high on the EU agenda, alongside the advancement of measures for the cross-border provision of credit and the abolition of obstacles to the free movement of goods, persons, services, and capital in order to achieve further integration. (3) Likewise, European policymakers closely scrutinize the relationship between borrowers and financial institutions.

    Responsible lending and borrowing is a recent policy in the EU. Documents reveal that the EU's policy makes reference to the delivery of responsible and reliable markets--as well as to the restoration of consumer confidence--where credit products are appropriate for consumers' needs and are tailored to their ability to repay debts. (4) The policy envisages a framework that could "ensure that all lenders and intermediaries act in a fair, honest and professional manner, before, during and after the lending transaction." (5) Similarly, it is expected that in order to obtain credit, "consumers should provide relevant, complete and accurate information on their financial conditions." (6) They are also "encouraged to make informed and sustainable borrowing decisions." (7) The European Commission recently consulted all stakeholders on responsible lending and borrowing in the EU to find measures to adequately assess--by all appropriate means--borrowers' creditworthiness before granting them a loan, in order to tackle overindebtedness. (8) The consultation covered, among other things: the advertising and marketing of credit products; the information provided to borrowers prior to granting any loans; ways to assess product suitability and borrower creditworthiness; advice standards; responsible borrowing; and issues relating to the framework for credit intermediaries. (9)

    At present, consumer-credit data sharing and database consultation at the national level are the available market solutions before granting loans to individuals. At the same time--considering the integration of retail credit markets and the harmonization of the rules governing them--the EU requires full compliance with its existing legal framework, especially its data-protection rules. (10) Against that background, this Article aims to present the legal framework of EU consumer-credit information and scoring systems under a single retail credit market while attempting to identify pitfalls and challenges ahead.

    So far, the EU presents a fragmented picture; credit bureaus operate nationally with isolated and limited cross-border initiatives. Credit bureaus are present in most EU member states, but institutional structures vary depending on their policy objectives and the functions they perform in each economy and society. Examples of these policy objectives are: the stability of the member states' financial systems; the fight against consumer overindebtedness; and risk-management in the interest of the profitability of the retail-credit industry. In the EU, there are both public and private credit bureaus, distinguished by the role of credit-information providers. While the former are institutionally designed to address the stability of the financial system and to monitor the indebtedness of consumer households, the latter offer risk-management tools to the market to enhance economic efficiency and the profitability of credit providers. This holds true regardless of whether the credit bureaus are banks lending money from third-party depositors, or any other entity doing business through the provision of credit in return for a profit. (11)

    First, this Article will review the function of consumer-information sharing and scoring within the EU context. Then, it will present the corresponding institutional arrangements and laws in an attempt to understand if they provide sufficient protection for consumers vis-a-vis responsible lending policies, as well as established fundamental rights and principles enshrined in EU law. Because important legal rights and liberties are involved, this Article ultimately takes the stance that the function of credit bureaus should be to inform the design and use of the underlying information and scoring systems, as well as the institutional form they take. Whether credit bureaus perform a public function or a function in the private interest of credit providers, this distinction makes a very important difference in policy, legal, and institutional terms.


    Economic theory has long stressed the importance of information in credit markets. Scholars have created a large body of theoretical studies aimed at demonstrating that asymmetric information between borrowers and lenders creates problems regarding bad debt, moral hazard, and adverse selection. They suggest that lack of information on borrowers can prevent the efficient allocation of credit in a market, and one way lenders can improve their knowledge of borrowers is through observation of clients over time. (12)

    Lenders evaluate credit applications and creditworthiness by pooling their own credit information about customers or applicants into centralized databases managed by third-party providers--credit bureaus. Thus, credit bureaus play a pivotal role as a borrower-discipline device because borrowers know that a default in repayment compromises their reputation with all potential lenders in the market. The result for the borrower is credit with more costly terms, or the inability to get credit entirely. According to this economic theory, information sharing makes it easier to predict with a certain degree of confidence the future payment behavior of applicants, allowing lenders to attract good borrowers and offering them better terms and conditions. In turn, this promotes market competition that could ultimately result in benefits to consumers. (13)

    Information sharing has also been examined in the context of market competition and the entry of new market players, particularly foreign lenders. In fact, the problem of asymmetric information and adverse selection becomes greater for new market entrants. This is particularly relevant for the creation of the single market in the EU and the cross-border entry of market players from other member states, or the cross-border provision of financial services by lenders established in other member states. In addition to the competitive disadvantages related to the possibility of incorrectly estimating a borrower's credit risk, new market entrants are likely to attract those who were rejected by existing lenders in the market if they do not have relevant information about the borrowers. These circumstances have provoked recent literature to conclude that information sharing, market structure, and competitive conduct are intrinsically intertwined in the financial services market. From the standpoint of industrial organizations, the availability of information shared within the sector can affect not only a foreign lender's choice to enter another jurisdiction, but also the mode of so doing; whether through the cross-border provision of services, by setting up branches or subsidiaries, or through mergers and acquisitions. (14)

    In addition, credit-reporting systems are instrumental tools in expanding the breadth and depth of financial markets and in strengthening the financial system. They reduce transaction costs, loan-processing costs, and the time required to process applications. Credit-reporting systems improve lenders' client-portfolio quality by monitoring it and identifying potential problems. They also provide cost-efficient, standardized, and objective criteria for credit analysis; facilitate distant transactions (including e-finance or Internet transactions); provide opportunities for new financial products to reach consumers; and enable lenders to serve consumers who would be underserved or ignored otherwise. All of these aspects, in turn, result in the development and sale of new products as well as tailored pricing, targeting, and marketing that ultimately contribute to the lenders' profitability. (15)

    Take, for example, the securitization of...

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