Datio in Solutum (2). Competition

by Steven van Groningen on 11 February, 2016

Recently I was asked by a television station to confirm that we, in anticipation of the Darea in Plata law, had increased the down payment for our standard mortgage loans from 15% to 35% (40% in EUR). I did this and explained the reasons why. I also explained them in a previous post. This became news, as if such a move was totally unexpected, and drew a series of comments and reactions.

The initiators of the law didn’t comment on my motivation/argumentation. Consistent with their earlier behavior, they preferred not to be bothered by facts and logic and to follow their long standing practice of insulting and threatening their opponents.

It was almost comical to see the statement of one of the supporters of the Darea in Plata law: he had notified the Competition Council. As if the Competition Council doesn’t read the papers and needs encouragement to follow what is happening in one of the most important sectors of the economy.

Darea in Plata will reduce competition

Instead, maybe he should have asked the Competition Council to express an opinion on the Darea in Plata law itself. If the Competition Council would analyse the potential impact of this law, which I warmly recommend them to do, they might conclude that one of its effects is that it will reduce the competition between banks.

Mobility Encourages Competition

An important element in stimulating competition in any sector is the ease with which a consumer can move from one provider to another. This is valid in any industry, banking included. There are specific regulations, including EU Directives, that aim to makes it easier for consumers to switch banks. The easier it is to switch for consumers, the more competition between banks is stimulated. Logic.

Darea in Plata Hampers Mobility

What is now the effect of Darea in Plata on all this? 67% the total loans to individuals in romania are mortgage or home equity loans. When a person contracts such a loan, he/she has the obligation to repay it, including interest, and responds with all his belongings. In these circumstances, banks have worked with down payments from about 5-15%. If and when Darea in Plata comes into force, all new mortgage and home equity loans will be asset-based financings in which the risk of the bank is linked exclusively to the value of the asset. This is a totally different risk profile which will force banks to adjust their risk policies. As I explained here, this will increase the need for down payments.

Refinancing Anyone?

It is not very difficult to see that those who took loans with lower down payments (5-20%) will not be able to get refinancing unless they meet the new criteria (say 35-40% down payment). Very few consumers will be in the position to make an early repayment of  20% of the value of their loan in order to refinance.

So, Darea in Plata basically makes it impossible of anyone who took a loan from a bank before Darea in Plata to refinance this loan and will lock more than 450,000 Romanians in with their loans at their existing bank. No refinancing possible. Please come back in 10 years or so.

Who seems afraid of the Competition Council?

So, I am not afraid that the Competition Council will look at the fact that banks increase down payments. This is a matter of cause and effect and pure logic. I am afraid the Competition Council will not be asked by the initiators to express an opinion on the Darea in Plata law. If they were, they would certainly come to the conclusion that this is bad for competition.

Due process, including impact study is needed.

As before, there are reasons, good reasons, why no country in the world has legislated a “hard” datio in solutum. If we want to consider being the first in the world to do so, we better think this through. At least we might ask Parliament to respect the law and to produce an impact study and ask relevant stakeholders, including the Competition Council, to express an opinion.

Romanian version is available here.

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Datio in Solutum (1). Down Payments

by Steven van Groningen on 5 February, 2016

Datio in Solutum is a Latin legal term. It means “giving in payment” and it refers to the situation in which someone with financial difficulties and debts gives something else he owns instead of money to repay his debts. An example I remember from not too long ago in Romania was a bank that could not repay its depositors and offered to large depositors the ownership of their branches instead of their deposits.

Darea in Plata

At this moment the discussion in Romania is not about a bank that offers a depositor real estate instead of his money, but about bank clients who transfer the ownership of their apartment or house to the bank as repayment for their loans. This could be an acceptable solution if both parties would agree to this but that is not what the legislator intends. The proposed law – unsurprisingly called Darea in Plata – would give anybody with a loan that is guaranteed with a mortgage on a house, apartment or piece of land the right to repay the loan in full by transferring the ownership of the guarantee to the bank, at any time, regardless of the value of the loan.

Nowhere in the World

Although, as the London Economics study prepared for the European Commission suggests,  the principle of Datio in Solutum is centuries old, and many countries acknowledge it as a method of voluntary debt settlement, no country in the world has implemented this as a mandatory solution (a so called “strong” datio in solutum). The only country that has implemented a form of “weak” datio in solutum is Spain and this is extremely limited in its application.

In the USA are examples of mortgage contracts where payment in kind is included in the contract but this is in no way imposed by law.

What is the Impact ?

So, Romania intends to become the first country in the world to introduce a “hard” datio in solutum. You might wonder why, if this is such a good idea, no country in the world has introduced this. You also might expect that the initiators have produced an impact study showing all the pros and cons of such an approach …

Indeed, a major criticism has been that no impact study whatsoever was made and that the law was rushed through Parliament for reasons that I can guess, but am not going to comment on.

There are many aspects of this law that deserve a bit of attention and if I find the time I’ll write about these.

Credit Risk

For now, let’s consider what will change in the relationship between bank and borrowers in case this law would come into effect.

Until now, a bank grants a loan to a person and that person is obliged to repay the full value of the loan and interest. The borrower is personally liable for this and if he does not pay his creditors can gain access to his assets through legal procedures. Before granting a loan bank will analyse the financial situation and history of the borrower and assess the risk of non-payment. On the basis of this the bank will be willing to lend a certain amount under certain conditions to the borrower.

Under the proposed Darea in Plata law this all changes. The borrower can at any time repay the loan by transferring the ownership of the house/apartment to the bank. So, when assessing the risk, the bank needs to look at the risk that the borrower will stop repaying and “send the keys to the bank”. This risk depends mainly on the value of the apartment in relationship to the outstanding of the loan and less if the borrower can pay or not.

From Lending to Asset Financing

Simply put, the bank doesn’t grant a loan to an individual anymore, but finances an asset, and the main risk is not the individual borrower and his or her financial situation, but the value of the asset. This is a totally different risk and it would be naive to think that this would not be expressed in the terms and conditions of mortgage loans.

In order to assess this risk, the bank will look especially at the value of the financed apartment/house and make an assessment of the potential fluctuations in value and the discount that needs to be applied if the bank would have to sell the asset, once given in payment. There are all sorts of methods for this and there is no need to go into this now.

Down Payments

This is the simple reason why we decided to increase the standard down payment for mortgage loans from 15% to 35%. This is a simple matter of cause and effect. If the risk is increased, the prudent thing is to take measures to limit the risk to acceptable levels. That is what banking is about and what the bank I referred to at the beginning of the this post did not do very well.

Is This What We Need?

Increasing the down payment will limit access to mortgage financing in Romania. The effects of this can be dramatic in a country that has already the lowest number of m2 per inhabitant in Europe, where access for young families to good housing is limited and too many of them leave the country to search for a better life abroad.

Whose Interests?

The initiators of the Darea in Plata law are apparently not bothered by such details and see no need to address these by producing an impact study. According to Law 24/2000 on the legislative technique norms, any law draft must be accompanied by impact studies, along with the memorandum of reasons and the substantiation report. One might be forgiven for wondering whose interests these parliamentarians represent.

As always, this post expresses my personal views.

Romanian version is available here.


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