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Charlie McC REEVY
European Commissioner for Internal Market and Services
Public Hearing on "Responsible Lending and Borrowing"
Brussels , 3 September 2009
Ladies and gentlemen,
It is a pleasure to be here this morning to open what promises to be an interesting and lively event on a very important subject. Lending and borrowing are at the heart of what the financial system is supposed to do. Credit means trust. It oils the wheels of industry, and allows citizens to own their own homes, make essential purchases and control their day to day cashflow. But the trust to lend money can be only maintained if it is done in a sustainable, responsible way. That is what is in the interests of borrowers, the intermediaries they deal with, lenders, and society as a whole.
Across Europe, the consequences of the inflated lending of recent years are being sorely felt. Spain; the UK; Hungary; the Baltic States; and my own country. Many people took out loans based on self-deception: an overly optimistic outlook for their future earnings and future property prices. The cost of the over-extended lending boom is now being borne by borrowers and taxpayers alike.
So what, if anything, should we do about it at a European level? After all, lenders say that they already act in their own interests by lending responsibly, as they don't want to have to deal with defaulting borrowers. Borrowers say it's not their fault that they took out such large loans, they didn't understand what they were signing up to and, anyway, had thought they would be able to meet their repayments. Intermediaries say they were playing an essential role in the process, helping consumers to find their way through the maze of financial products, and did not exploit borrowers as their colleagues in the US may have done.
Each of these opinions have merit. But that doesn't take away from the fact that irresponsible lending happens in the EU, and it is up to policy makers to look at what can be done to prevent it. We all know that lending conditions have tightened considerably over the last year. Indeed the biggest current complaint is probably about a lack of credit rather than too much. But we have to look forward. Markets and the economy will pick up. Lenders will take the padlocks off their lending books. We have to be ready for that day. To ensure that we don’t repeat the mistakes of the past .
Restoring consumer trust
Since the financial crisis hit, policy makers and central banks have focused primarily on restoring stability and liquidity to the financial system, and on making the necessary changes to supervisory structures. This was what was needed as an urgent response to the financial crisis. But now, the time has surely come to concentrate on restoring trust in the financial system. First and foremost between Europe's citizens and the financial institutions they deal with. Responsible lending and borrowing has an important role to play in this.
Borrowers need to be able to trust that they can make an informed decision based on the information they are given. They need to have confidence that the advice they are given is driven by their best interests, not the commission the advisor can earn. They need to be able to assume that their interlocutor is professional, has sufficient expertise, and is adequately supervised. Unfortunately at the moment, this is not always the case. And these problems are where the Commission is currently focusing its attention.
Consultation on responsible lending – building on work already done
Of course many of the issues we are discussing today are not new. The European Commission has been looking at the whole area of lending for many years now. As far as consumer credit is concerned, the adoption of the Consumer Credit Directive last year was a turning point. It is now at the critical implementation phase in the Member States.
On mortgage credit, the Commission has spent many years looking at how the market works and identifying areas where EU action could potentially bring benefits. Our White Paper on Mortgage Credit in 2007 set the scene for many of the developments we are talking about now. In some areas, such as information disclosure, work is at an advanced stage. Over the last year, we have been conducting comprehensive consumer testing of the European Standardised Information Sheet for Home Loans, or ESIS, and have been able to identify a clear way forward in improving the usefulness and relevance of the ESIS for borrowers. From this work, one of the key messages has been that the identification of potential risks is vitally important to borrowers. We have worked hard to find ways to present these risks in a way that people understand.
In its approach to credit, particularly mortgage credit, the European Commission has in the past, rightly in my view, concentrated on finding ways to get rid of obstacles to the internal market. And we will continue to see this as the overriding driver for any action at EU level. The financial crisis has shown so bluntly, that even if loans are granted to borrowers at a local or regional level, the funding of these loans by lenders may well have cross-border or global implications.
The topics you will be discussing today transcend national borders, and are of crucial importance for borrowers and lenders, throughout the EU. Information disclosure. Advice. Creditworthiness and suitability. The role played by credit intermediaries and non-banks. These are also the subjects we raised in the consultation on responsible lending and borrowing which closed last week. We have had a large number of responses, and anticipate that more will come through in the coming days. Although it is too early to have analysed the responses in full, it is clear that these subjects have struck a chord with a great many stakeholders, from consumer and family groups to the different types of lenders and from trade unions to intermediaries. This is also borne out by the large number of attendees here today. We will be looking in great detail at the consultation responses, and listening closely to the input we receive today before making our minds up on what the best way forward is for many of the issues under discussion. This is the “better regulation” way. Even in times of crisis.
Capital treatment for real estate lending
Of course, irresponsible lending does not just have an impact on individual borrowers and households. It poses a much wider challenge to the financial system and to society as a whole.
The extent of incurred and further expected losses by credit institutions related to real estate markets is unprecedented. And these losses have not been adequately reflected in the levels of economic and regulatory capital of the banks concerned. We have had to ask questions about both the capacity of the institutions to implement sound risk management practices and about whether the current regulatory treatment related to real estate lending is prudentially sound.
It is clear that borrowers have found it difficult to assess the risks involved in taking on large loans. And that some players may have had an incentive in encouraging them to do so. These are the consumer protection issues that are the focus of today's discussions.
But there is also a prudential element to be considered. I believe that the current regulatory treatment of mortgages has played an important role in encouraging aggressive mortgage lending practices. The differing national options that Member States had for calculating minimum capital requirements for banks’ mortgage lending may also have contributed to the problem.
In view of all this, the Commission intends to propose standardising and adjusting the conditions for the application of the regulatory capital treatment for residential real estate lending. We want to make it more conservative and prudent. We have to reflect the fact that the value of real estate can go down as well as up.
Foreign exchange lending
There is one additional specific risk factor that deserves close attention, which is the exchange rate risk in case of mortgage lending provided in a different currency than the currency of the borrower's primary source of income.
Foreign currency home loans are a particular concern because they have the potential to expose private households to foreign exchange risk to a dangerous extent. Your average household will not usually have other savings available to bridge the currency gap.
I believe that it is now appropriate to consider specific and penal capital requirements to discourage credit institutions - throughout the credit cycle - from granting excessive foreign currency loans to private households. This should be especially the case where the Loan-to-Value of such loans exceeds a low and conservative level, and where the household concerned does not have a sufficient source of income in the relevant foreign currency.
To this end, I have put out to consultation my proposal to impose additional and specific capital requirements for loans for residential property that are denominated in a currency other than that of the income of the borrower. These specific incremental capital requirements would only apply to loans granted after the implementation date of these requirements.
Borrowers also need to get a much better understanding of the risks associated with foreign currency loans. In the consumer testing of the ESIS I mentioned earlier, we have tested possible risk warnings and information on foreign currency loans. The initial feedback by consumers has been very good and we hope to incorporate these warnings into a revised ESIS.
When we refer to responsible lending, we do not just mean the period up to the signing of a credit contract. It is equally important that lenders have a responsible attitude to the management of their relationship with borrowers on an ongoing basis. Where mortgage lending is concerned, foreclosures should absolutely be the last resort. Not only because they may have a seriously detrimental impact on the living conditions of the affected people. If foreclosures are carried out on a wider scale, they can put further downward pressure on property prices, causing additional problems for lenders and can spread to other borrowers in the neighbourhood.
We have conducted research with Member States to take stock of the situation as regards defaults and foreclosures. And to get an overview of the various approaches being taken by public authorities and lenders to avoid foreclosure. We will be publishing a report on this by the end of the year.
Today’s hearing will be very valuable in adding to our knowledge of many issues surrounding responsible lending, and will complement the consultation that has just closed. And to help us in our considerations of a sustainable framework for responsible lending. But I want, in conclusion, to be clear about three things:-
First, Financial regulation is no substitute for financial education. That’s why, without much encouragement from anyone, I initiated a financial education initiative towards the beginning of my term as Commissioner: Without much encouragement if I may so from the Brussels corridors. I hope that that initiative will not be abandoned but I am not naïve: Rules and regulation carries much more appeal for many career bureaucrats. The truth is that most regulation has produced such copious volumes of risk warnings that the average consumer is turned off from reading them. At an early stage in life very consumer needs to be alerted to the basic risks inherent in borrowing and in investing. And needs to be equipped with the questions to ask and the sensitivity analyses techniques that they should perform before entering into a commitment.
Second, financial regulation is no substitute for properly resourced supervisors and effective supervision. There has been no shortage of reports flowing into supervisors offices or tools available to supervisors to monitor banks' behaviour over the past decade: It is legitimate to ask what use they made of this information and what tools they deployed to tame the excesses that occurred. The answer is that they closed their eyes and hoped for the best. I publicly warned of the dangers of the securitization market well before this crisis blew up. I also warned of the risks arising from the conflicts of interest in the credit rating agencies' business models. But there was little or no support from others for action to be taken back then. The mistakes that were made must be learnt and re-learnt and must be embedded in Member States' financial education programmes for not just the years – but the decades ahead. Unless that happens, in a decade or two's time, the very same or similar mistakes will re-occur. Nothing is more certain than that.
I hope you find the discussions interesting and stimulating, and thank you for your continued support and involvement.