The colpo grosso of business loans

Legal Insight

October 2018

George Psarakis LL.M. (mult.), PgCert

Republished from Naftemporiki

Summary: One of the biggest problems facing businesses today is the ballooning of their debt to credit institutions. Much of this problem stems from the increase or maintenance of unchanged lending rates of credit institutions in the decade 2009-2018. This article analyzes the problem in relation to the illegal and abusive practice of banks to vary lending rates based on vague and unverifiable criteria.

One of the biggest problems facing firms today is the ballooning of their debt to credit institutions. Much of this problem stems from the increase or maintenance of unchanged lending rates by lending institutions over the decade 2009-2018. Although key benchmark interest rates (ECB, EURIBOR) have been falling continuously since the end of 2008, banks' business lending rates have followed a stable path in some cases and even a reverse path in others. This has naturally resulted in companies being asked today to settle amounts that are disproportionate to their actual borrowing costs and in any case contrary to banking supervisory law and consumer protection law. In particular:

1. According to a relevant decision of the Bank of Greece in 2004 (BANKING AND CREDIT COMMITTEE 178/19-7-2004), all credit institutions should apply to variable-rate loans, including business loans, interest rate indicators of a broadly disseminated nature and in relation to the banks' funding needs, such as the ECB's intervention rates, Euribor, bond yields, short-term securities, etc. These indicators could be set as a base rate on which it was possible to agree any margin the parties wished. Therefore, if a business loan was granted at a variable interest rate of Euribor3m + 3% margin, for example, the borrower was able to check the current interest rate of his contract every day by himself by simply consulting a financial newspaper to find out the Euribor3m and then adding the 3% margin. The credit institutions, however, overwhelmingly ignored this mandatory decision by the Bank of Greece and continued to apply their own interest rates as the base rate of the variable rate. Other banks called it the 'basic lending rate', others the 'basic lending rate' and so on. The logic was as follows: each bank periodically set its own base rate, at its own unaudited discretion, on the basis of which the variable interest rate on all business loans was changed. By increasing the base rate by, for example, 0,5 %, the bank could increase its income by millions of euros, because its own base rate was automatically linked to all the floating-rate business loans granted. 

2. Of course, one could argue that in a free economy, once the parties have agreed on the specific interest rate, the borrower cannot subsequently "take back his signature". The problem, however, does not lie in the original agreement, which indeed cannot be verified in a free economy, where the borrower has the ability to compare and choose the bank that provides the lowest lending rate. The problem arises after the contract is concluded and throughout the life of the loan. The bank, having now tied the borrower-customer, can unilaterally increase its base rate and thus the interest rate on all its variable-rate loans. 

3. Another objection would be that the banks changed their base lending rates on the basis of the cost of money and market conditions, as was also stipulated in the loan agreements (the agreements also mentioned other factors such as, for example, inflation fluctuations, general and specific credit risk, conditions of competition between credit institutions, etc.). The crisis and the problems faced by our country and our credit system have increased the cost of borrowing, which should therefore be passed on to borrowers. However, none of the factors mentioned in the contracts were quantifiable so that the borrower would know at any time the interest rate of his contract. There are credit institutions where the abuse of these contractual terms is blatant: in parallel with the rapid fall in ECB interest rates, they increased their own base rates or reduced the base rates but increased the margin (!) as a counterpart. For example, a particular credit institution at a final Euribor3m + 2% in 2010, due to a reduction of the base rate in the following years, increased the margin by 3%, resulting in the final floating rate remaining almost at the same level. 

4. Everything we mention here is known to the credit institutions and indeed sanctions have been imposed by the Bank of Greece which have been confirmed by the Council of State. By way of example, we refer to the decision 2857/2015 of the Council of State which ruled on the legality of a relevant fine for a variable interest rate clause which was used by a systemic credit institution in its contracts and which linked the interest rate to the cost of money, the fluctuation of inflation, the general and specific credit risk, etc. The relevant clause was therefore considered unlawful because of the provision in the loan agreement of vague and general criteria as factors affecting the change in the interest rate which the average trader cannot understand and calculate.

5. Moreover, we conclude that this practice is illegal, taking into account the law of consumer protection. Since it has already been ruled by the Plenary of the Supreme Court (decision 13/2015) that the business borrower is also a consumer, we can easily apply this law also in cases of granting business loans. Therefore, Greek and EU legislation prohibits the use of interest rate clauses that are not transparent and whose fluctuation cannot be easily controlled by the borrower. And, of course, a bank base rate which varies according to vague criteria such as 'cost of money' or 'market and competitive conditions' cannot be said to be easily controllable by the borrower. And on this point, we have dozens of Greek court decisions, as well as recommendations from the Consumer Ombudsman, which accept these claims.

6. The big question that immediately comes to the reader's mind is this: let's say we accept the illegality of this particular floating rate agreement, what is the result? Here opinions are divided. One view accepts that the original agreed interest rate should be recalculated on the basis of the fluctuations in the ECB's intervention rate, which is considered to be an objective rate for measuring the cost of borrowing for credit institutions. The other view is that the loans should be converted into interest-free loans and that the credit institution should be obliged to repay the interest received in the meantime. The interest-free or not of these loans is expected to be decided by the European Court of Justice in case C-125/18. 

7. Behind this latter view of imposing the penalty of the interest-free loan on the bank is the following reasoning: if the only sanction for credit institutions that violate the above legal framework is the application of the ECB's interest rate fluctuations, which they were obliged to apply from the outset anyway (they would mainly apply ECB or Euribor rates), which credit institution, as a rationally thinking financial undertaking, would decide not to violate the law? Since even in cases where the borrower would take legal action (rarely), the result would be to apply what should have been applied from the outset (Banco Español de Crédito judgment, European Court of Justice). In other words, this approach may encourage the credit institution 'simply to try its luck by including as many unfair terms in the contract as possible and hoping that a significant proportion of them will escape the attention of the national judge' (Opinion of the Advocate General of the Court of Justice of the European Union - Case C-618/10).

8. The Greek courts have so far adopted the first solution and adjusted the interest rates based on the changes in the ECB's intervention rate, i.e. downwards (see for example Athens Court of Appeal 5180/2014). This calculation, however, still results in a great benefit for the borrower, if we take into account that on the one hand this adjustment is made over a period of about 10 years, and on the other hand that business loans involve large amounts of borrowing and therefore high interest rates. For example, on a loan using a mutual account of EUR 500,000, the amount of interest for a 10-year period, without capital payment, at a reference rate that has remained unchanged since 2009 at 8%, amounts to EUR 400,000. However, if it is adjusted to take account of changes in the ECB interest rate, the interest benefit is approximately EUR 160 000, which would have to be repaid by the credit institution to the borrower.