martes, octubre 22, 2019

About the EBA guidelines on Loan Origination and monitoring


The European Banking authority (EBA) is about to issue a set of guidelines on loan origination and monitoring with a very broad scope of application. In fact, Numeral 12 of the draft signals EBA’s intention to make all the rules in Section 5 (all rules pertaining to Loan Origination Procedures) applicable, inter-alia, to all creditors as defined in literal (b) of the Consumer Credit Directive. Put simply, that would entail that any natural or legal person who grants or promises to grant consumer credit in the course of his/her trade, business or profession in the European Union would be subject to the rules governing loan origination procedures as set out in the guidelines.

I tend to think that such a broad scope of application raises the question of whether the EBA is exceeding its mandate under regulation No. 1093/2010, but at first glance that seems to be a rather complex matter that merits its own write-up and that could well be the subject of lively discussion amongst esteemed colleagues in the near future. Given that this new set of guidelines will also apply to Fintech firms in the credit space, I would like to focus on what I see as the substantive aspect of the matter: What do these guidelines mean for consumer credit providers who rely on automated decisions/processes for loan origination? I confess I am skeptical: I have argued in the past that the EBA did no favors to Fintech and open banking by issuing a set of regulatory technical standards that are not technologically neutral nor business-model neutral and that seem to cater directly to the talking points of certain actors who have little incentives to embrace the open-banking ethos of the PSD2.

Susanne Grohé from Aderhold (One of Europe´s most Fintech-savvy law-firms) hinted at one of the major shortcomings of the guidelines by suggesting that they appear to follow the premise that the use of technology in loan origination is merely a risk factor, dismissing the fact that technology has contributed and can further contribute to building more robust loan origination processes. I concur: The EBA displayed that sort of tech-adverse tendency in the RTS on Strong customer authentication and I believe it made that mistake again with this new set of guidelines. In this note, I would like to contribute to that discussion by pointing out some very specific rules proposed by the draft guidelines that are particularly problematic for consumer credit providers that heavily rely on automation in their loan origination processes. Let´s take a look:

Rule Number
Why is it problematic?
Institutions and creditors should have a sufficiently comprehensive view of the borrower’s financial position, including an accurate and up-to-date comprehensive view of all the borrower’s credit commitments (single customer view)
This rule is problematic on two counts: It is rather vague in the sense that it does not specify whether the comprehensive view in question must also include all borrower’s credit commitments with third parties, for example. If the latter is the correct interpretation, then the rule is even more problematic because it somehow assumes that consumer credit providers across the European Union are able to access some kind of database of outstanding credit commitments that is updated in real time by all consumer credit providers as they issue new credit to their borrowers. Such a database is a good idea perhaps, but it has not yet come to exist, so it is not reasonable to require consumer credit providers to be aware of all the credit commitments of a potential loan applicant with a good degree of certainty .
Institutions and creditors should apply metrics and parameters to have an accurate single customer view that enables the assessment of the borrower’s ability to service and repay all its financial commitments. 

This rule significantly worsens the problem that I mentioned immediately above. Not only does it presuppose an omniscient single customer view but it goes to the extent of requiring creditors to have a proper assessment of the borrower’s ability to service all its financial commitments.

Again, consumer credit providers would only be able to comply with this rule if they had access to some kind of omniscient database that would enable a view of all financial commitments of all potential applicants at any given time. That is in the realm of science fiction at the moment.

Arguably, the consumer credit provider could request this information directly from loan applicants, but it is very optimistic (to say the least) to think that consumer credit providers will be able to build accurate affordability analyses based exclusively on information provided by loan applicants who have a vested interested in getting a positive credit decision. Even if we assume zero cases of bad faith credit applications (where loan applicants hide any outstanding financial commitments, for example) the question is: How are consumer credit providers supposed to verify the information provided by the applicants? Should they make use of the omniscient database that seems to exist only in the imagination of the drafters?

The decision to approve or decline the loan application (credit decision), should be taken by the relevant credit decision-making body in accordance with the policies and proceduresand governance arrangements as set out in Section 4.3.
This rule seems to be oblivious to the fact that many consumer credit providers automate their credit decisions. In fact, this rule is so anachronistic that it seems to betray a sort of deeply rooted belief that credit decisions can only be made by some kind of hyper-enlightened credit committee that takes a look at every applicant’s paperwork and issues sentences with unimpeachable wisdom. Even worse, this rule seems to betray the assumption that committees take better decisions than, say, adequately programmed machines. This is one of the rules where the tech-adverse (or should we say tech-oblivious?) attitude pointed out by Susanne is particularly clear. 
Credit decision should be well documented, provide a record of views and reservations, especially any dissenting views, of the credit decision-making body members’. In case of a decision to approve the loan application, the credit decision should contain the information on the key features of a loan being offered to the borrower, including information on the amortisation, price, covenants and required collaterals. Such credit decision should be also the basis of the loan agreement.
Once again, this rule is baffling because it double downs on the problem that I mentioned immediately above. The underlying assumption that all credit decisions are made (or should be made) by human members of collegiate decision-making bodies is even clearer in this wording.

So, how did the EBA fare this time? I suppose it is not entirely fair to judge them merely on the merits of the first draft of the guidelines, but the consultation paper seems to betray the same brick-and-mortar worldview that permeated the Regulatory Technical standards for SCA. Let’s remember that the European Commission did ask them in the past to amend their RTS on SCA to ensure that non-compliance by banks did not prevent AISPs and PISPs from offering their services to end-users.

This brick-and-mortar worldview is pervasive in these guidelines for loan origination and is clearly palpable in some of the rules that I listed above, which seem to be drafted with insufficient awareness of the current state of affairs of the very phenomenon they intend to regulate. If one is to regulate credit decisions in the 21st century, it is important to bear in mind that many (if not most) consumer credit providers automate their credit decisions and that AI will play a very important role in loan origination in the near future. More importantly, any regulatory effort in the 21st century should take into account that artificial intelligence might just be a powerful tool to overcome decision biases and to achieve economies of scale in many realms. Financial inclusion by means of access to credit, for example, will be much harder to scale up if regulation doubles-down on the strange notion that there must be a human revising every single credit decision in order to ensure its conformity with any standard, be it a responsible lending standard or a credit policy.

I submit that these draft guidelines are pernicious in one very critical way: They anchor the loan origination process in the past by conceiving it as the by-product of some kind of microcosm where the only right decisions are made by committees of the wise.

Disclaimer: The opinions expressed by the author in this article are strictly personal and do not reflect the official position of the Mash Group or any of its directors or employees. Any threatened law-suits, hate-mail or angry rebuttals in response to this write-up are ideally to be addressed to the author directly, in the comments. :)

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