Blow for Japan’s consumer finance sector

Japan’s consumer finance sector faces another setback after a Supreme Court ruling that is likely to increase the reimbursements companies have to make to borrowers for what previous court rulings have deemed to be excessive interest charges.

The court said on Friday that Eiwa, an unlisted consumer finance company, must add a 5 per cent annual payment to the interest it will repay two borrowers who claim they overpaid on their debt.

The ruling adds to the woes of the sector, which has been battered by excess interest claims, and could lead to further losses if additional provisions are required against future claims.

Consumer finance companies have set aside tens of billions of dollars in reserves against excess interest payment claims, following a Supreme Court ruling last January that effectively invalidated interest above 20 per cent.

Since most consumer finance companies have charged interest closer to 30 per cent, the court’s decision has led to a flood of litigation by borrowers claiming they paid too much interest.

The top five moneylenders alone last year booked reserves of about Y1,800bn, which led to total net losses of Y1,797.6bn in the year to March 2007.

Although the level of reserves the top companies have set aside was forecast to cover five years’ worth of claims, growing interest repayment claims by borrowers are fuelling fears that moneylenders will have to increase provisions further.

The number of claims has continued to rise – after hitting a record Y24bn ($196m) in March – and analysts believe the number could have hit another record in June. The situation has been aggravated by moves by the public health and pension offices to encourage borrowers who fall back on their health insurance payments and pension contributions to claim excess payment.

Since consumer finance companies have already been adding interest on their excess interest repayments in cases that go to court, it is difficult to imagine that the latest Supreme Court ruling will dramatically increase excess interest payments, said Norimasa Ejiri, analyst at Merrill Lynch.

However, since it is not clear whether such additional interest is included in repayments made in cases settled out of court, there is a risk that excess interest payments will rise further, he said.

The consumer finance industry, which must lower rates to 20 per cent and under in less than three years, has tightened lending standards, in a move thought to be increasing bankruptcies.

According to Teikoku Data Bank, bankruptcies among companies with less than Y10m in capital rose 35 per cent in June.

“There are signs that a consumer finance legislation-induced credit crunch has already started,” Tim Marrable, director of research at KBC Securities, said in a recent report.

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