EU non-bank lender proposals are credit-positive but add costs
The credit quality of lending-focused EU non-bank financial institutions (NBFIs) could be strengthened by increased supervision to address non-bank lending risks, particularly from digital lending by companies new to the market, Fitch Ratings says.
Proposals made by the European Banking Authority would, if implemented, harmonise prudential requirements and supervision for non-bank lending, forcing big tech and fintech lenders to operate to the same regulatory standards as traditional NBFIs.
However, the extra supervision could add to NBFIs’ costs, reducing their cost advantage over banks and potentially increasing the attractiveness of obtaining a banking licence.
The proposals were in response to the European Commission’s call for technical advice following the publication of its digital finance strategy for the EU in September 2020. The proposals aim to improve the supervision of non-bank lenders to mitigate macro- and micro-prudential risks, and to strengthen consumer protection and anti-money laundering rules.
In particular, the proposals aim to harmonise prudential supervision, which is currently fragmented across the EU. For example, supervision in Denmark is mostly limited to licensing, financial reporting and adherence to the Consumer Credit Directive (CDD), while supervision in France, Norway and Spain is more akin to quasi bank-like regulation.
A more harmonised approach could clarify how non-bank consumer lenders with pan-European digital lending channels are supervised. These often operate in several countries, reflecting the limited non-prime consumer lending opportunities in some of their home markets and the relatively low cost of entering new markets with online lending.
The proposals include harmonising and strengthening the authorisation requirements in the CCD and Mortgage Credit Directive, and clarifying the prudential consolidation rules and duties of home and host regulators for cross-border lending. This should support cross-border lending growth and strengthen non-bank lenders’ credit profiles through improved reporting and adherence to compliance requirements.
Similarly, the proposal to widen the scope of the CCD to include buy-now-pay-later loans, crowdfunding and credit provided by pawnshops should help level the playing field by consistently applying the ‘same activity, same risk, same rule’ principle.
Traditional non-bank lenders’ competitive position should improve relative to new entrants if more recent business models, such as peer-to-peer and marketplace lenders, big tech lenders and buy-now-pay-later platforms, are subjected to the same, or similar, prudential requirements. Peer-to-peer and marketplace lenders are not currently subject to CCD requirements in France, for instance.
However, even if the proposals are fully adopted, we expect the practical implementation at national level to vary widely. In particular, directives concerning consumer protection and provisions relating to out-of-court or in-court settlements would need national legislation to take legal effect.
Some of the proposals could have meaningful cost implications for non-bank lenders, notably the proposal to strengthen the ‘requirements for creditworthiness assessment’ and the potential introduction of a ‘minimum harmonisation framework’ for non-bank lenders.
An enhanced creditworthiness assessment could increase costs by 0.5% of outstanding credits for non-bank lenders, compared with 0.1% for banks, according to a CCD impact study by the European Commission in 2021. The study also concluded that the enhanced creditworthiness assessment could lead non-bank lenders to lower interest rates for borrowers by 3%, compared with a 1% reduction by banks.
Many firms will have to weigh up the pros and cons of operating as non-bank lenders, if the proposals go ahead. The existing advantages include lower regulatory costs and less stringent, or no prudential capital requirements, while the main disadvantage is not having access to deposit funding.
If the proposals go ahead, a tightening of regulatory requirements that leads to a material increase in operating expense bases could lead some issuers to apply for a banking licence. Rising interest rates and inconsistent access to capital markets for many sub-investment grade issuers could also act as incentives to take this course.