Financial consumer protection and the European Social Model
Why is financial consumer protection important?
The financial crisis of 2007-2008 played a particularly important role in highlighting the importance of financial consumer protection on both a European and a global level. While in the decades preceding the crisis, the establishment of a more liberal regulatory environment centered on boosting the market activity of financial institutions seemed like the obvious solution to handling financial markets, the downsides of such a laissez-faire approach became apparent afterwards. An excessively lenient regulatory environment may be detrimental to financial institutions themselves in the long run if it encourages market activity that risks potentially loss-making long-term operation for the benefits of a momentary market position. However, consumers – and indirectly, the whole of society – are the ones who have to endure the most serious disadvantages, as a looser regulatory environment enables financial institutions to establish and employ contract terms that might otherwise be considered unfair and might cause harm to financial consumers. Finally, a malfunctioning financial intermediary system and consumers’ loss of confidence might cause significant imbalance in the functioning of the economy as a whole. Considering these issues, we can establish that the crisis – and in particular, its consequences affecting lending – played a key role in financial consumer protection becoming a key area of consumer protection law over the last decade at both EU and national level.
A few words about EU financial consumer protection
The regulatory background of financial consumer protection at EU level includes the Directives 93/13/EEC on unfair terms in consumer contracts, 2008/48/EC on credit agreements for consumers and 2005/29/EC concerning unfair business-to-consumer commercial practices in the internal market. The case law of the European Court of Justice is also of particular importance in the area.
According to Directives 93/13/EEC and 2008/48/EC, a consumer is a natural person who, in transactions covered by the Directives, is acting for purposes which are outside his trade, business or profession. In addition to defining the concept of the consumer, the question of whether a specific consumer behavior deserves special protection is a matter of particular importance for the application of the law. The case law of the Court of Justice (similarly to French and English law) follows the model of the reasonable average consumer: according to Directive 2005/29/EC, such a consumer is reasonably well-informed and reasonably observant and circumspect, taking into account social, cultural and linguistic factors; therefore, he is able to make rational decisions based on the information at his disposal. This approach has been heavily criticized by literature as an overly simplistic theoretical construct that requires an excessive level of rationality and information without considering the actual behavior of individual consumers. Even the European Parliament voiced criticism of this concept of the average consumer: according to its resolution on a strategy for strengthening the rights of vulnerable consumers, dated 22 May 2012, “the notion of an ‘average consumer’ lacks the flexibility needed to adapt to specific cases and sometimes does not correspond to real-life situations”.
The model of the average consumer utilized by German judicial practice could prove a viable alternative: according to this approach, the consumer must be provided extraordinary protection, since even in the case of minimally misleading or deceptive conduct on behalf of the service provider, they cannot be considered to be able to make rational decisions. At the same time, even though it follows the stricter model of the reasonable consumer, the case law of the European Court of Justice seems to recognize that the consumer, even if he is reasonably observant and circumspect, is disadvantaged in terms of both negotiating power and the level of information compared to the service provider. This disadvantage is especially apparent in the market of financial services, as financial institutions typically offer complex services, often with opaque conditions and cost structures. This issue is made particularly problematic by the low level of financial literacy: the vast majority of consumers have limited knowledge in the area and no real ability to enforce their interests.
This unbalanced situation justifies the particular emphasis on providing extensive and sufficiently detailed information in the area of financial consumer protection. For example, consumers applying for credit must be properly informed about the important terms, costs and other obligations; this information must be clear and understandable and the offer made by the service provider must be transparent and comparable in order to allow consumers to make their decision on the use of a certain financial service with a full knowledge of the facts. The Court of Justice interprets the requirement of clarity and understandability broadly: in addition to examining the linguistic clarity of a specific consumer financial contract, national courts are also required to assess whether the contract provides the consumer with all the information necessary to enable them to assess the advantages and disadvantages of the transaction and the economic risks arising from it.
How can consumer protection – and more specifically, financial consumer protection – be linked to the social policy of the European Union?
The previously mentioned 22 May 2012 resolution of the European Parliament dealt with the most problematic areas of consumer protection: among these, the resolution places particular emphasis on financial consumer protection. The European Parliament emphasized that consumers must be protected via the provision of sufficient information and the regulation of financial markets, as the complexity of these markets may lead to any consumer becoming vulnerable. Furthermore, this extraordinary complexity can push certain consumers into excessive debt. According to an earlier survey of the websites of financial institutions and firms by the European Commission, 70% of the websites surveyed have included advertisements and product information containing basic errors, and provided misleading information about costs. With this in mind, the European Parliament stressed that the financial services industry should do more to provide clear and simple information on the nature of the products and services they provide.
Two observations should be made: firstly, the category of vulnerable consumers – developed by the case law of the European Court of Justice and later appearing in the Directive on unfair business-to-consumer commercial practices – provides additional protection to those consumers who are particularly vulnerable to a specific market practice or product due to “their mental or physical infirmity, age or credulity”. The vulnerability category used by EU Directives is largely static in nature: a consumer is either considered vulnerable in every business-to-consumer interaction or not vulnerable at all. Secondly, as the European Parliament explicitly mentions, financial markets are so complicated and the service providers operating in these markets offer their services with such complex terms and conditions that, in practice, consumers are generally unable to meet the standard of a reasonable and well-informed 'average consumer'. In this area, vulnerability appears to be a more dynamic category, which would be a better match for the concept of ‘situational vulnerability’ developed by literature: in the context of financial consumer protection, this approach would mean that any consumer could be considered vulnerable with regard to the particularities of a specific business-to-consumer interaction.
In this context, it is worth returning to the resolution of the European Parliament which states: “the widely used concept of vulnerable consumers is based on the notion of vulnerability as endogenous […] whereas the concept of vulnerable consumers should also include consumers in a situation of vulnerability, meaning consumers who are placed in a state of temporary powerlessness resulting from a gap between their individual state and characteristics on the one hand, and their external environment on the other hand, taking into account criteria such as education, social and financial situation (for example over-indebtedness), access to the internet, etc.; whereas all consumers, at some point in their life, can become vulnerable because of external factors and their interactions with the market or because they have difficulties in accessing and comprehending relevant consumer information and therefore need special protection”.
This vulnerability may not only have serious consequences for individual consumers, but for society as a whole, as exemplified by the massive and systemic increase in household foreign-currency debt in Hungary following the 2008 financial crisis. This case showed that a general lack of financial awareness and prudence and the inadequacy of information concerning financial services can lead to individual consumers suffering significant financial and non-financial losses, which, in turn, leads to a systemic decrease in the overall level of consumer welfare that affects the whole of society. The example of the Hungarian foreign-currency loan crisis seems particularly relevant in light of a recent preliminary judgment by the European Court of Justice: in its judgment dated 5 June 2019 – made on request of a Hungarian court – the ECJ stated that the provisions of Directive 91/13/EEC on unfair terms in consumer contracts do not necessarily preclude Member State legislation under which a loan agreement is not invalid if it is denominated in foreign currency but does not indicate the exchange rate applicable, stipulating instead that that rate will be set by the lender in a separate document after the agreement has been concluded. This decision seems to be indicative of a trend that shows the reluctance of the Court of Justice to pressure member states into increasing their level of financial consumer protection.
In light of these observations, one could argue that the extension of the additional protection against commercial practices – provided only to a strictly limited group of consumers in other areas of consumer protection regulation – to all consumers in the field of financial consumer protection would be justified. Such an increase in the level of protection, however, could potentially upset the fragile balance between internal market freedoms and consumer protection objectives. For this reason, the European Union seems reluctant to raise the level of consumer protection. It would also be important to promote financial literacy, which would require the development of up-to-date financial education and awareness programmes: through the use of its education and training policy instruments, the European Union could promote the availability of these programmes across all member states.