The Unfairness of Personalized Credit Pricing
The availability of vast amounts of personal data on consumers and machine learning software that allows for consumers to be scored for underwriting purposes enables modern-day lenders to engage in individualized (personalized) price discrimination at scale.
Personalized credit pricing involves charging two borrowers of equal credit risk for whom the lender incurs the same costs to serve two different prices for the same credit product. Whereas in the case of uniform pricing, the lender would charge these borrowers the same price (typically their cost of servicing plus an identical profit mark-up), in the case of personalized credit pricing, the lender sets the price using each borrower’s estimated willingness-to-pay (WTP). Consequently, if borrower A’s WTP is higher than borrower B’s (and both exceed the cost to serve), borrower A will pay a higher price than borrower B due to the higher profit mark-up charged by the lender.
Too High a Price?
Can the lender really set the price according to a borrower’s WTP or is it constrained by European Union consumer law? In a new working paper, I try to answer this question. The short answer: it depends on the national supplementary law, the bargaining power of borrower A and a host of other circumstances.
Legal scholars and economists disagree sharply on the desirability of the practice from a societal point of view. Using welfare economics, some argue that the lenders and certain consumers (through cross-subsidization) enjoy a greater economic surplus, while others argue that all consumers lose out. The legal debate has focused on the application of EU anti-discrimination and data protection law to the differential treatment of consumers. The paper concentrates on a different aspect: the limit of the lender’s pricing discretion. One contribution of the paper is to take a closer look at the application of the Unfair Contract Terms Directive (UCTD), the Consumer Credit Directive (CCD) and the Proposal for a Directive on Consumer Credits (CCD 2021) in practice. To illustrate the application of the Directives, the paper analyzes the national systems of the Netherlands and the United Kingdom.
Ex Ante and Ex Post Protection
In consumer credit markets, lenders have some pricing discretion. Unlike price regulation in certain other industries (eg electricity markets), price regulation in consumer credit is characterized by the primacy of private ordering: supply and demand determine the price of credit. Furthermore, there are no rules limiting the profits of lenders or the allocation of those profits across the individual transactions that constitute the lenders’ loan portfolios.
However, there are two types of regulatory safeguards that limit this discretion. First, several Member States have introduced price caps on interest rates and other price components, which are a form of ex ante protection. The CCD 2021 seeks to harmonize this protection by requiring all Member States to take measures to prevent excessive pricing, which may take the form of price caps. Second, the UCTD’s unfairness assessment and lists allow courts to strike down individual price clauses in credit agreements that are considered unfair, which is a form of ex post protection.
The Unfairness of Price Terms
The paper analyzes the case law of the Court of Justice of the European Union (CJEU) to understand when a personalized price term could be unfair, looking at the three key criteria (significant imbalance, good faith and transparency) and in particular the first two. To assess the imbalance, the CJEU has introduced complementary law as a primary reference point (CJEU Aziz, CJEU Constructora Principado) and market practices (CJEU Banco Primus), the amount of the loan and the services provided (CJEU Gyula Kiss, CJEU Profi Credit Polska) as auxiliary reference points. To assess good faith, the CJEU applies an objective test involving a hypothetical lender, while simultaneously considering the particularities of the actual lender (CJEU Andriciuc) and the bargaining power of the actual consumer (CJEU BNP Paribas).
The analysis leads to two main conclusions. First, although the case law of the CJEU concerns mortgageagreements, its considerations are applicable to personalized price terms in unsecured credit agreements. Second, the case law reveals that the actual price is only one element in the assessment of unfairness under the UCTD, which has an extremely open texture due to its wide catalogue of circumstances. Navigating this texture is particularly difficult when the borrower could be considered (financially) vulnerable based on personal characteristics. These characteristics could be considered by the court as evidence of the borrower’s bargaining power that informs the assessment of good faith, which in turn means that an otherwise fair price term could be considered unfair. Without clear guidance, the resulting uncertainty threatens business models that rely on personalized pricing and cross-subsidies to widen access to credit. The paper therefore reiterates the need for more empirical studies of the practice.
Melvin Tjon Akon is a PhD Candidate at Leiden University, Netherlands.
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