The menace of over-indebtedness for the EU’s middle class

Employment & Income,Inclusive Economy28 Apr 2015Andrea Falanga

Since the outbreak of the financial crisis, the financial and indebtedness status of European households has significantly changed. To protect the middle class from over-indebtedness, policies are required at European level.

After Lehman Brothers’ bankruptcy, the breakdown of financial markets caused significant losses for investors with savings in risky assets. These investment decisions were often based on bad, or at least incautious, advice from financial experts. 1 During its second phase, the crisis hit some European countries and their efforts at debt management harder than others. The resulting cuts in public expenditures and the welfare state weakened the financial situation of Greeks in particular but also, though less dramatically, of the people of other EU countries like Spain and Italy. In Greece, GDP fell by almost 25% between 2008 and 2013, and government expenditure fell by 15% between 2009 and 2013. Currently, Europe’s economic future remains uncertain and even strong economic areas are suffering from low growth, unemployment and deflation. Germany’s GDP growth rate was at 0.4% in 2012 and 0.1% in 2013 (but rose to 1.5% in 2014) and the consumer price index is expected to have fallen by 0.3% on an annual basis in January 2015. Deflation does not reduce household consumption immediately, but may push firms to neither borrow nor invest, which could be dangerous even in the medium term.

Over-indebtedness after the crisis

The crisis has certainly had negative effects on EU households’ indebtedness. The European Financial Inclusion Network (EFIN) and stakeholders involved in a recent study for the European Commission agreed that weak macroeconomic conditions are an important driver of over-indebtedness. 2 Over-indebtedness is very difficult to define. It can be described as a situation in which the debt burden is structurally unsustainable, given a household’s wealth and income (e.g. it is impossible for a household to maintain a minimum standard of living and fulfil its repayment obligations), but this does not mean that debt problems are solely a consequence of macroeconomic factors.

According to EFIN members, some non-regulated non-banking credit providers usually lend money after a poor creditworthiness assessment, especially in Eastern European and the UK, US and Ireland. They indicated that, in these areas, mortgages would often be provided purely on the basis of the house’s value, without taking account of the household’s income capacity. Furthermore, bad financial decisions can of course simply stem from a borrower’s imprudence or lack of knowledge. In fact, debt problems are often caused by the imprudence of both the borrower and of the lender, the nature of financial markets (e.g. a non-competitive equilibrium that translates into lack of transparency), unexpected events (e.g. a divorce, unforeseen expenses) and macroeconomic factors, making it impossible to estimate the weight of each variable.

European households’ indebtedness

Determining the impact of the crisis on middle class indebtedness is not easy on the basis of the available data. The relationship between households’ income (or wealth) and their debt burden proves to be quite ambiguous. Establishing whether Europeans are making the right decisions to face financial weaknesses or not is even more complex. The income share allocated to savings in Italy decreased during the country’s toughest economic period between 2011-2012, while it has increased again over the last couple of years. In the initial phase of the crisis, Italians tried to maintain the same lifestyle, but due to continued hardship decided to reduce their spending, as the end of economic turbulence was nowhere in sight.

It is, however, impossible to generalize these considerations. For instance indebtedness has specific features in each country, as studies by Eurostat, ECB and Eurobarometer show.8 Some EU member states (e.g. Austria) have a low level of over-indebtedness and indebtedness measures, while others (e.g. Cyprus) are in the opposite situation. For a third group of countries (including the Netherlands), the indicators are contradictory, making it futile to draw conclusions. 3

There are major differences in cultural attitudes: in some countries, people feel guilty about going into debt, while in others (e.g. the UK) it is very easy to get credit within short timeframes and without collateral. In the above study commissioned by the European Commission (CPEC, 2013), a Czech stakeholder said that the attitude to debt in the Czech Republic was very conservative compared to ‘Western countries’, while a Bulgarian interviewee said “People are not ashamed if they have a loan that they cannot afford to pay back”.

Regulations can be similarly diverse across EU member states. For example, approximately only half of member states (including Belgium and France) have a ceiling for APR (the annual percentage rate of interest linked to credit), which can limit the probability of becoming over-indebted. By comparison, the regulatory framework in the US before the crisis allowed people to acquire more and more credit, even if they couldn’t afford it. All these factors create major differences between countries regarding the value of over-indebtedness indicators.

What could be done at national and EU level?

The variables mentioned above may suggest that over-indebtedness should be addressed at national level. In the highly interrelated economies of the European Union, which often share the same currency, policies should however be inspired by common principles laid down in European directives. EU directives, of course, require long discussion and intense mediation. However, in the absence of consistent European measures, member states can already take effective steps. Intervening in the cultural sphere within a reasonable timeframe may be arduous, but just making some potentially ‘toxic’ financial products less convenient for providers could be a good start.

For example, particularly in the case of short-term lending, the fees, penalties and other surcharges linked to delayed debt payments might allow lenders to make profits, even if this means the borrower becomes insolvent. This situation should be avoided (e.g. by capping these commissions), in order to encourage lenders to give credit only when borrowers can reasonably be expect to fulfil their obligations.

Broadly speaking, if a better economic equilibrium were reached at European level, this would improve the situation for many households. Unfortunately, the mandates of EU institutions do not permit them to pursue effective expansionary policies. Furthermore, the rules and decisions that member states have agreed to adopt severely limit their own capacity to implement the same policies. The controversial 3% threshold established by the Maastricht Treaty is incompatible with government expenditure that brings the deficit-GDP ratio slightly below the limit in growth periods. When the cycle reverses, in fact, policymakers in countries in this situation cannot attempt to boost the economy without failing to respect the threshold.

Moreover, policymakers at both national and EU level have shown little courage in cutting unnecessary expenses, as any household does when it is in trouble, and directing funds to growth-producing investments. This is supported by what European Central Bank President Marion Draghi has often said in public, when calling for rules for economic reforms. 4 The necessary reforms are not the same for each member state, but every European citizen has experienced problems related to excessive, useless, inefficient or poorly directed public spending. Measures needed to break the stalemate may be unpleasant for some actors involved. In particular, member states will have to relinquish some sovereignty to the EU if it plans to promote effective economic policies, but many are not willing to relinquish that authority. Yet a crisis can only become a development opportunity if it makes people change their mind and habits: that is the only way to overcome it and move forward.


  1. It is difficult to assess the amounts involved exactly, since falling prices and volatility in stock exchanges turn into losses only after assets are actually sold. Only a small percentage of Europeans purchased Lehman holdings instead, usually through a fund. In this respect, too, a reliable global estimation is not available, but there are several individual cases that can be drawn on (see for example here).
  2. CPEC (2013). The Over-indebtedness of European Households: Updated mapping of the situation, nature and causes, effects and initiatives for alleviating its impact – Part 1: Synthesis of findings, commissioned by DG SANCO, European Commission;
  3. Eurostat (2014). Economic strain, module of European Survey on Income and Living Conditions; ECB (2013). The Eurosystem Household Finance and Consumption Survey: Results from the first wave, Statistics paper series no. 2, April 2013; TNS Opinion & Social (2010). Eurobarometer 74,1: Poverty and Social Exclusion, European Commission;
  4. See for instance here.