EASTERN EUROPE: Loans Make the Middle Class Poor

Published on IPS, by Claudia Ciobanu, Oct. 29, 2009.

BUCHAREST, Oct 29 (IPS) – Low-income Eastern Europeans contracting easy consumer loans in the mid- 2000s are now falling below poverty lines.

Ioana Damian, a 47-year old social worker from Bucharest, has a monthly salary of 1,600 RON, the equivalent of 380 euros. As she ruffles through the pile of bills on the kitchen table in front of her, she lists the amounts she has to pay out every month: 90 euros for a bank loan she took out to install a new heating system in the house; 50 more euros in interest for current expenses loans she contracted in years she could not make ends meet; and another 80 euros for a loan from the union she is affiliated with …

… Credits can make poor people poorer, warns Douhomir Minev’s research.  

People turning to banks in moments of desperation often do not fully understand the conditions in their loan contracts. And the banks make little effort to make the loan contracts transparent.

“It is true that the average consumer lacks the financial culture to grasp all the costs,” Aleskandar Vasilev told IPS. “Many people do not distinguish simple from compound interest rates, and make their decision to take a loan based on the wrong calculations. Indeed, there are also many service fees that add to the cost of the loan. Everything is put on notice boards in small font in banks, so it is the borrower’s responsibility to read through them and the contract before signing.”

In a report on financial services in Eastern Europe published this year (Diagnostic Review of Consumer Protection and Financial Capability), the World Bank notes that “most of the risk exposures associated with the latest credit boom period were assumed primarily by households,” and calls on governments and banks in the region to take measures to remedy the “power, information and resource imbalances which place consumers at a disadvantage vis-à-vis financial institutions.”

More transparency from the banks could be beneficial for people like Ioana Damian, who says she was affected by unexpected increases in interest rates on her loans over the past year (Romanian banks toughened credit conditions and marginally increased rates on existing loans to stabilise themselves in the current financial crisis).

“I need such crafted calculations to manage from month to month that any additional expense can bring me down,” Damian said. “So, when the banks increased the interest rates over this past year, even if the increases were of just 10-20 euros, this really hit me.

“I am now considering taking an overdraft, just to be able to pay off accumulated debts,” she added.

Getting deeper and deeper into a spiral of debts is certainly not the solution for people like Damian. But, with governments slashing budget expenses and businesses cutting costs across the region in response to the financial crisis, there is hardly an alternative.

According to Minev, the recovery plans for the crisis can provide opportunities to address poverty and social exclusion. However, for this the recovery plans need to be much more radical than the ones currently being promoted by Bulgarian and Romanian politicians.

“Recovery plans which focus on the regulation and monitoring of the banking system -such as the Bulgarian Recovery Plan – do not analyse the real causes of the crisis,” the economist says.

“Financial reporting and the tax system require the same set of measures as the ones applied to the banking sector,” Minev argues. In turn, this would lead to shutting down of the channels through which illicit money is drained out of the economy, which can result in “a huge and continuous flow of recovery funds without the need to increase ‘budget restrictions’, to further reduce the funds for social services or to ‘tighten the belts’ of those who can hardly breathe anyway.” END/2009. (full text).

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