Kristiina Pralla: the main threat to the credit market is conscientious debtors, it's them whose freedom should be limited


Hardly any of the debtors would think it right for the lender to simply take money out of their account and give nothing in return. So how can it be right for an individual to simply take money from a lender?


A few days ago, a series of articles entitled 'The Power of Debt' was brought to the public's attention, centred on a criticism of the failing loan recovery process. The series of articles targets debt collection agencies, high-speed lenders and savings and loan associations as rogue traders whose main aim is to defraud and fleece debtors. Courts, bailiffs and other public authorities are accused of standing silently by and contributing to excessive unfair treatment of debtors.


Debtors, on the other hand, are portrayed as victims caught in the cogs of an unfair system. The fact that it is these same problem debtors who have caused the whole situation is ignored. However, debt recovery through the courts and debt collection agencies is a direct consequence of the debtor's delinquent behaviour.


Let's limit the right of natural persons

In a free society, there must be freedom to make agreements and to trust that the agreements made will be honoured. This freedom extends to both natural and legal persons. Corporate lenders have the right to expect performance of contracts and the right to be protected by the judicial system if a natural person fails to perform. The natural person is ultimately free to decide whether or not to enter into a loan contract. This freedom is inevitably accompanied by an obligation to make an adequate assessment of one's ability to pay. As a general rule, an adult person must be able to manage his or her own finances. The responsibility for financial planning cannot simply be shifted to the lenders.


Why should a lender assume that every natural person is totally unthinking and inadequate in making financial decisions? Why must solutions be sought through further regulation of lenders? Would it not be more sensible, in order to solve the problem of bad loans, to introduce legal restrictions on the right of natural persons to take out loans?


It all starts with the debtor

The story of all bad debt recovery starts with the debtor deciding, for one reason or another, to take out a (quick) loan. The debtor approaches the lender and enters into a contract to obtain the loan. The lender promises to give the money to the debtor. The debtor promises to repay the loan. The lender hands over the promised money to the debtor. The debtor spends the money and then concludes that the loan cannot be repaid.


A situation arises where the lender has kept his promise but the debtor has not. Failure to repay the loan will inevitably lead to an unfair situation that needs to be resolved somehow. In a democratic society, it is not acceptable for a debtor to take someone else's money and not give it back. The lender's money, as private property, is protected by law for both natural and legal persons. Hardly any of the debtors would think it right if the lender simply took money from their account and gave nothing in return. So how can it be right for a natural person to simply take money from a lender?


The lender's interest is to recover the money. This is why, in practice, lenders often try to reach some sort of agreement with the debtor as a first step. Repayment is much more likely if the debtor is genuinely prepared to work for it. Lenders only turn to the court system as a last resort - when an agreement with the debtor does not lead to repayment, or when no agreement can be reached at all.


Court proceedings are a risk for the lender

It must be understood that court proceedings are both time- and money-consuming for creditors. An accelerated procedure for an order for payment is quicker, whereas an action can take years. Moreover, court proceedings do not guarantee practical results for the creditor. The lender cannot get his money back through the courts if the debtor has no money.


In addition, the lender (in the absence of the debtor's assets) is de facto left with all the legal costs (in particular the court fees and legal costs), even if the court orders the debtor to pay them. Put simply, the process for recovering bad debts is as follows. The debtor borrows but does not repay. The lender is left without his money and has to pay more to get a court order, or enforcement order. Even then, the lender may not get his money back if the debtor has no money or manages to hide his money.


Consequently, the lender who kept his promises and handed over the money to the debtor ends up with a long nose. The debtor, in return, simply spent the debtors' money, without any counter-performance on his part.


The debtor does not have to get the money for free or what is interest and what is late payment? Why do they exist?

Interest is the income the lender earns from making money available to the debtor. The lender cannot use the money it has given to the debtor. The debtor compensates the lender for the loss of the use of this money by paying interest. Interest is therefore considered as an inducement for the lender to extend credit. Interest is the compensation for the debtor's delay in using the lender's money, i.e. his delay in repaying the loan. The lender cannot use its own money if the debtor breaks the agreement and does not repay the money on time. The idea of the delay is to compensate the lender for the debtor's late repayment of the money. On the other hand, a late payment charge is supposed to motivate the debtor to repay the loan more quickly in order to avoid an increase in the late payment charge.


In the context of fast loans, the main problem is considered to be the level of interest and late payment rates. Essentially, interest and default rates reflect the degree of risk of the loan issued. It is generally accepted that the granting of high-speed loans is risky for the lender because of the large number of problem borrowers. The lender must therefore take into account the possibility of the loan going bad at the time the loan is granted. Therefore, both the interest rate and the amount of interest and late payment are of central importance for lenders. Without interest and interest on arrears, it makes no sense for any lender to grant a loan and run the risk that the debtor will not repay the loan. The amount of interest and late payment claims is therefore causally linked to the degree of risk of the loan. The higher the risk, the higher the compensation (i.e. interest and late payment) for granting the loan. As is well known, there are no free lunches. This is clearly true in the lending business. At the end of the day, the lending business (like any other business) is about making a profit.


In the meantime, let's take a real-life example of an employment relationship. Every working person wants to be paid for their work. Both the amount of the salary and the due date for payment are agreed in the employment contract. The employee keeps his promise and goes to work every day for a month. Can the employer withhold pay if he feels after a month that the agreed amount is too high? Does the employee have to work for free because the employer has no money? What if the employer asks nicely? Or if the employer otherwise goes bankrupt?


In the functioning of a society, performance and payback play an important role. Obviously, most people are not prepared to work for someone else for free as their main activity. Why should it be someone else?


A mortgage hedges the lender's risks

Lending against real estate collateral as a blatantly unfair behaviour towards the debtor is a major criticism of the credit market. In essence, however, the mortgage is a guarantee by the lender in case the debtor defaults on the loan. In such a case, the creditor can demand the realisation of the mortgage, i.e. the sale of the property. The proceeds of the sale go to the lender to cover the debtor's loan. The mortgage allows debtors to borrow more money because it gives the lender the certainty that the loan obligation will be met (in the worst case, at the expense of the collateral).


The practical problem starts with the difference between the market value of the mortgaged property and the sale price. In an ideal world, the market value is equal to the sale price. The problem arises when the alleged market price is significantly higher than the sale price. Certainly, the debtor cannot be blamed for having an interest in selling the property for the maximum possible price. In practice, however, the market will make its own corrections.


There is no point in having a mortgage if the mortgaged property cannot be sold. Take, for example, a situation in which the debtor enters into a loan agreement with the lender, together with an immediate enforcement agreement. The debtor receives the borrowed money, spends it but is unable to repay it. The lender has no other way of recovering his money than by selling the mortgaged property. The value of the property is estimated by the debtor at EUR 100 000. The highest bid in the auction is EUR 60 000.


The debtor's interest is to find a new buyer willing to pay a higher price. The lender's interest is to recover at least part of the money lent. This leaves the lender's interest. The mortgage to secure the loan cannot be a sham and cannot depend on what the debtor considers to be a fair sale price for the property. The whole point of creating a mortgage is to enable the loan to be discharged at the expense of the security. It is precisely in return for the possibility of realising the collateral that the lender is willing to take a greater risk and make a larger amount of credit available to the debtor.


How to help someone who buries their head in the sand instead of looking for a solution?

Some debtors who get stuck with repaying their fast loans start to ignore their obligations in practice. Debtors remain unavailable to lenders, debt collectors and the courts, and thus fail to defend their rights. Judgments in absentia are a way for the court to satisfy a lender's claim without the debtor's involvement if the debtor has avoided court proceedings.


Under the law, the factual allegations made by the plaintiff (the lender) are deemed to be accepted by the defendant (the debtor) when a judgment is given in default. These factual allegations also include the terms of the loan agreements, including the rate of interest and interest on arrears. This raises the question of whether the court really has to actively defend the rights of a debtor who does nothing to defend his own rights. Where is the real crux of the problem? In the case law or in the debtor's failure to address the problem?


Should the legislator intervene and how much?

From the articles published so far, the message is that state intervention is needed to resolve the situation, in particular changes in legislation and selective state control of lenders. In other words, the legislator should, as it were, write the terms of the loan contract into law, while limiting interest and default rates in a debtor-friendly way. Then, without specifying the conditions, an unspecified state body should carry out random checks to ensure that lenders are concluding contracts with debtors on the prescribed terms.


Once again, however, the debtor himself will be completely sidelined. This is despite the fact that taking out a loan is often an irresponsible and ill-considered decision on the part of the debtor. It remains to be seen how more specific consumer credit regulation will address the inability of problem debtors to adequately assess their own creditworthiness. A debtor with no income will not be able to repay a loan even if the default rate is 8% instead of 24%.


Why does the debtor not have to think about it? Why should a problem debtor think about his creditworthiness when most of the responsibility for borrowing money is shifted to the lenders?


It is important to underline here that individual debtors do in fact have considerable legal protection in the credit market. Standard terms that unfairly disadvantage the debtor are null and void. According to the case-law of the Supreme Court, a statutory default interest rate of more than three times the legal interest rate (24%) is presumed to be unfair to the individual debtor. The annual percentage rate of charge for consumer credit agreements is limited to three times the average rate of charge for consumer loans granted by credit institutions to private individuals over the last six months, as published by Eesti Pank. As of today, the average annual percentage rate of charge on consumer loans is 16.3%, i.e. the maximum annual percentage rate of charge on a consumer credit contract can be 48.9%.


If the debtor is in a situation that is completely hopeless, it is possible to turn over a new leaf. Any natural person can (for a fee of €10) apply to the court for a declaration of bankruptcy if the debt is at least €1,000. The debtor does not necessarily need to obtain separate legal assistance to file for bankruptcy. With a discharge procedure, a debtor can be fully discharged within 3-4 years. However, at the end of the discharge procedure, creditors will lose a significant part of the money they have borrowed as well as their own claims for interest and interest arrears.


In conclusion

Of course, the situation with regard to the problem areas in the credit market is not completely black and white. There are undoubtedly situations in practice where the debtor has suffered injustice to a greater or lesser extent. There is always a way to improve any system, be it debt collection services, judicial debt recovery or enforcement by bailiffs.


However, it is not possible to overlook the debtors themselves, who, by their own ill-considered financial behaviour, put themselves in a situation of de facto insolvency and trigger the whole chain of debt recovery. However, a debtor's irresponsible financial behaviour cannot be solved by a witch-hunt on lenders, the judiciary, the legislator or anyone else. A debtor who does not take responsibility for his own actions will always look elsewhere for the culprit.


The opinion piece was published in the opinion section of Eesti Päevaleht newspaper on 26 September 2022. a.