During spring 2019, the Finnish Parliament agreed upon capping the effective interest rate of unsecured loans at 20%. The aim is to rein consumers’ growing indebtedness and increase transparency in lending. The new legislation comes into effect on September 1, 2019 and concerns all new unsecured loans issued after the date.
The new legislation is estimated to lower the lenders’ net interest incomes. In addition, the lenders face direct costs by implementing necessary changes to their IT systems and processes. Despite the obvious negative impact the new legislative landscape creates to lenders, the change also creates an opportunity to redesign the customer experience of their lending products.
In the Digital Age that we are living in, consuming is easier than ever. Goods and services are available 24/7 through digital channels, and as payments are embedded in digital purchasing journeys, spending has become invisible. At the same time new lenders with aggressive growth ambitions have entered the market and are offering tempting avenues to fulfill dreams along the digital journeys. Hence, it is easy to generate debt without immediate notice, especially if one’s capabilities in financial literacy are limited.
Indebtedness is a growing problem in Finland. In June 2019, there were 328 700 Finns who had a payment default entry. The figure has grown 23 % since 2010. The problem is worst with Finns in their thirties, of which 13 % have a payment default mark. Indebtedness rates are growing in all age groups above 30 years. Statistics show correlation between factors like low education, workforce exclusion and payment defaults.
Annual change % of unsecured credits credit volume from 2010 – present in Finland (Source: Bank of Finland)
Measures are taken to solve the problem. The Bank of Finland is emphasizing the importance of financial literacy and the debate on how to include it in schools’ teaching programs is accelerating. Banks and fintechs are providing more and more digital tools for personal financial management. Consensus about creating a positive credit registry has almost been reached and practical work can hopefully be started soon.
The next concrete measure is a law to cap the effective interest rates of all unsecured loans to 20 % p.a. In addition, other than interest-related costs will be capped at max. 0.01 % per day per issued loan and cannot be more that €150 per year. Also, changing the payback schedule will be capped at €5 per change and €20 per year. The new regulation becomes effective for all new unsecured loans issued after September 1st, 2019.
Creditors have seen good progress in their credit volumes in the last ten years. In recent years especially unsecured loans have gained popularity among Finns and the growth rate has been double-digit. The regulator has remarked this development and noticed that the source for a payment default entry is often an unsecured loan. This has led to accumulated handling in judicial system.
Previous regulation regarding consumer credits was made in 2013, at which time authorities wanted to regulate so called payday loans. Credits lower than 2 000€ were capped to 50% p.a. As a result, creditors started to issue loans above 2000€ to avoid the cap.
In the new regulation all consumer credits are treated equally, without credit limit restrictions. By doing so the authorities enable one consumer protection act to be in force for all consumer credits. The previous legislation did not factually restrain creditors pricing because it was based on annual percentage rate. The problem with annual percentage rate is, however, that it is defined loosely and is open for interpretation. The current state of legislation appears to favor bigger consumer credits.
A clear pricing model makes it easier for consumers and authorities to compare and interpret actual credit costs. The new regulation is expected to simplify especially costs related to different kind of fees, because the regulation sets a fee cap. Credit card products are expected to suffer from the change most.
The authorities expect rather strict enforcement of the legislation to ease monitoring of creditors. The new regulation aligns that if creditors have not complied with claims, consumers are not obligated to pay any fees or interest accrued from their credits. It remains unclear how authorities will monitor the creditors.
Then new regulation is set to affect primarily high cost consumer credits and to ease the consumer’s position in the lending market. High cost credits are mainly granted by smaller creditors. This kind of players will get hit hard and must consider their existence. Established creditors, on the other hand, will face a drop in their incomes. New pricing models mean transaction-based fees will diminish and incomes lean more towards interest income. The Finnish industry trustee, Finanssiala ry, expects its members’ incomes to drop by 20 M€ in 2020. In the long run the impact will be even bigger, since more profitable credit pools will gradually be replaced by credits with the new conditions and lower interest rates.
The regulation also causes creditors direct costs related to the change. First, creditors must ensure their pricing and strategy are compliant with the legislation. When incomes drop, creditors must consider how to make their business more efficient, since profitability will drop after the new legislation. Process automation is the rational way to decrease costs related to internal processes.
Incumbent banks are often criticized for complex and opaque pricing by their customers. The total price is often a sum of multiple small fees causing difficulties for the customers to predict their overall costs. This is also one of the avenues leveraged by challenger banks like Revolut and N26 in their go-to-market strategies.
The new legislation enforces incumbent banks to re-think their pricing strategies. This creates the banks a great opportunity to design truly customer-centric pricing models, not limiting only to unsecured lending, but the entire customer relationship. The new legislation will limit the opportunities of the lenders focusing purely on high-risk customer segments. Incumbent banks typically serve multiple segments in multiple life events. Therefore, the banks are in a good position to leverage the new legislation and outperform many of their challengers by focusing on the customer lifetime value (CLV) in covering their lost net interest incomes. There is for sure still room in the market for fair and responsible lenders, who are able to stand by their customers and support their long-term financial wellbeing. Transparent pricing, which reflects the added value, is a key element in creating lifetime customer relationships.
According to creditors, the new regulation is still inadequate and certain details need to be clarified (e.g. which fees and value-added services are in the scope of the regulation and which are not). Discussion between the different parties will continue and most probably we will see some adjustments in the regulation still. However, as banks have multiple options on how to maneuver as the changes take place, they must now actively observe how the markets will react, and be ready to act when the time comes.
Bank of Finland
Finnish Guarantee Foundation
Finnish consumer protection act
Jani Ristimäki, Manager, BearingPoint Digital & Strategy
Mikael Lankinen, Business Consultant, BearingPoint Financial Services & Regulation