Unsolicited credit may be road to ruin

The crackdown on lending practices follows research into consumer attitudes, which revealed that most people did notwant unsolicited credit, writes Laura Slattery

After months of battling to stop long-term overdrafts from teetering over the agreed limit, salvation arrives in the post: a card from a financial institution you have never been a customer of declaring that you have been pre-approved for a loan of €10,000 at a "competitive" rate of 8.9 per cent APR.

The money is just a phone call away.

It is exactly these types of unsolicited pre-approved credit offers that the Irish Financial Services Regulatory Authority (IFSRA) is trying to ban. And about time too, according to the Consumers' Association, which has welcomed the proposals in IFSRA's draft consumer protection code.

"Unsolicited pre-approved credit has been adding to and fuelling the serious problem with indebtedness that we have in Ireland today," says Mr Dermott Jewell, chief executive of the Consumers' Association.

Under IFSRA's proposals, financial institutions or any regulated firm will be prohibited from offering unsolicited pre-approved credit facilities to customers either in writing, by telephone or by email, while credit card providers will be banned from increasing a customer's credit card limit unless the customer requests an increase.

IFSRA's crackdown on lending practices follows its research into consumer attitudes to unsolicited pre-approved credit, which revealed that 86 per cent of people believed that unsolicited pre-approved loans encouraged them to borrow more than they needed.

Only 15 per cent of those surveyed thought unsolicited pre-approved credit was a good idea.

Of those who had taken financial institutions up on an unsolicited credit offer, 70 per cent had not shopped around for a better interest rate before borrowing.

"Customers can still ring up and get approval straight away. It's the unsolicited element that we are taking out," says Ms Mary O'Dea, IFSRA's consumer director.

In other words, the regulator is trying to remove temptation being spoon fed to credit-hungry consumers who can soon become credit-dependent, with penal interest rates leaving them unable to get back in the black.

Credit institutions that send unsolicited pre-approved loan offers to people who are not and never have been their customers are engaging in irresponsible lending.

This is because in order to check a consumer's credit record, which is stored at the Irish Credit Bureau, credit institutions must first obtain the person's permission. If they don't, they should have no way of knowing if the person has a good credit history or if they have a chronic debt problem.

"They might not appear to be vulnerable. It is quite a significant number of people in full-time employment, in well-paid full-time employment, who accept these offers and add to their indebtedness," says Mr Jewell.

"There's always an element of choice, but it's about making the correct choice. When pre-approved loans are on offer, a level of choice is effectively taken out of their hands. There are too many people out there who are unable to say 'no, I don't want it, no, I don't need it'."

The credit providers are deliberately encouraging the mismanaging of household finances by offering unsolicited loans, Mr Jewell adds.

"There is a lack of judgment on the part of the credit providers. The main motivation for them is to increase profits through the accumulation of interest payments and charges."

Among the institutions likely to be affected by IFSRA's proposed ban on unsolicited pre-approved credit are Bank of Ireland Group, Permanent TSB and credit card provider MBNA.

Bank of Ireland is the most active institution in terms of issuing unsolicited credit, with pre-approved loans available to online customers, a facility allowing customers to extend their overdraft at ATMs, and a direct mail marketing campaign.

A spokesman for Permanent TSB says the bank has offered unsolicited pre-approved credit from time to time, although it is not a central part of its marketing strategy.

MBNA sends out fliers advertising personal loans to its credit card customers. However, a spokeswoman says people still have to go through an approval process. The card provider is also in the habit of increasing credit limits without asking the customer first.

"There is a scoring procedure," says the spokeswoman. "We would look at someone's spending pattern and when they pay off the balance and whether or not they are a good customer."

On one level, it makes sense for consumers struggling to clear an unwieldy overdraft or credit card balance to take up an unsolicited loan offer, as the interest charged on the loan may be lower.

While overdrafts and credit cards are designed for short-term borrowing, personal loans can be spread over terms of five years, thus resulting in lower monthly repayments.

This could be a good solution for people on low incomes who just can't clear the existing debt and make ends meet. But for people on average to high incomes who simply don't have the discipline to rein in spending on luxury goods, converting to a personal loan could be a false economy.

If a €10,000 loan with an interest rate of 8.9 per cent is repaid over five years, the monthly repayments will be just over €200. But the total interest charged over the five years will be a hefty €2,338 - quite a price tag for an offer that you didn't need enough to seek out yourself.

Unexpected events such as illness or redundancy can get in the way of a clean repayment plan, leaving borrowers exposed to late payment charges, nasty letters from debt collection agencies and legal action. With no fresh income, consumers may be forced to borrow more to get out of the mess.

"It's daisy chain credit," says Mr Paul Joyce, a researcher with the Free Legal Advice Centres (FLAC). "We know from talking to the Money Advice and Budgeting Service (MABS) that there are people who run a number of credit cards simultaneously and that it can mask a very difficult financial situation," he says.

According to FLAC, there is anecdotal evidence that unsolicited credit limit increases tend to be offered to cardholders who have slipped up on their repayments in the past, thus accruing interest and profit for card providers.

Earlier this month, the Central Bank warned of the "heightened vulnerability" of households to interest rate increases or job losses, noting that for the first time Irish people now have more debt than they are able to pay back from disposable income.

For every €1 of after-tax income in 2004, Irish people owed €1.20. A decade ago, people owed just 48 cents for every €1 in after-tax income.

The Central Bank figures are "frightening", according to Mr Joyce. "Obviously there are economists who say that we can bear that, but the evidence from MABS is that there is a group of people in difficulty. A rise in interest rates or any kind of recession means that group will get wider." Enforcement of the new rules is the key to keeping consumer debt under control, he adds.

IFSRA has the power to fine financial institutions in breach of the consumer protection code up to €5 million. However, the administrative sanctions procedures have yet to be finalised and it is possible that lenders who break the rules will merely be given a formal warning.

Slaps on the wrist won't stop the problem of spiralling debts, says Mr Joyce. "Unless regulation has sufficient teeth, scant attention is paid to it."