Developing trends in consumer credit

The Competition and Markets Authority (the CMA) and the Financial Conduct Authority (the FCA) have both recently published significant papers for the consumer credit industry. The papers focus on the use of consumer credit in the retail banking sphere and by vulnerable customers. This article highlights some of the important findings and what it means for banks and consumer credit firms.

On August 9, 2016, the CMA published its final report following its investigation into the retail banking market (Making banks work harder for you). The CMA’s paper tackles some of the major problems with the retail banking industry, finding that:

• Traditional, long-standing banks accounting for the large majority of retail banking in the UK ‘do not work hard enough to win and retain customers’
• So-called ‘challenger’ banks find it hard to attract customers.

In particular, the CMA’s paper found that these two problems led to a significant disadvantage for certain groups of customers, particularly overdraft users and smaller businesses.

In relation to the use of unauthorised overdrafts (a type of consumer credit product), the CMA’s paper found that banks make £1.2 billion a year from unarranged overdraft charges. In addition, charging structures for overdrafts were found to be complicated, making it hard for customers to compare providers. The CMA found that customers were concerned that switching banks could reduce their overdraft limit with a new bank and that many customers underestimated their overdraft use.

The CMA has also published an ‘ambitious, wider-ranging and integrated package of reforms’ aimed at remedying some of the problems found in the retail banking industry. In relation to overdrafts, UK banks will be required to:

• Set up overdraft alerts (to be implemented by Q1 2018)
• Allow customers grace periods, to provide them with an opportunity to avoid charges (to be implemented by Q1 2018)
• Impose a maximum monthly charge on overdrafts, taking together all unarranged overdraft charges including debit interest and unpaid items fees (to be implemented by Q3 2017)
• Improve the account opening and switching process by providing a decision to the customer on their overdraft before switching (to be implemented by Q1 2018).

The CMA has asked the FCA to undertake further research on the reforms set out above, as part of its work to safeguard responsible lending.

The FCA has found that around 2.2 million people in the UK using a consumer credit product suffer financial distress. The FCA’s Occasional Paper 20 “Can we predict which consumer credit users will suffer financial distress” (OP20) aims to analyse the prevalence of financial distress, how it is related to consumer credit use and whether financial distress can be predicted.

The FCA considers that customers suffer financial distress “when they face financial and non-financial difficulties from repaying their outstanding debts”, which can be assessed using objective measures such as whether a customer misses repayments or subjective measures, such as the customer’s experiences and ability to manage their finances.

Interestingly the FCA, which has taken on the responsibility for regulating 50,000 consumer credit firms, asks fundamental questions such as “is consumer credit debt bad?” The paper considers behavioural biases which have played into social discourse on the use of credit, and questions the role of credit in society.

OP20 makes the point that “financial distress” is necessarily subjective, and that determining an “appropriate” level of debt will clearly vary from customer to customer. OP20 suggests that assessments of financial distress amongst borrowers should be sufficiently flexible to cover idiosyncratic issues amongst populations of borrowers.

OP20 found that, when examining subjective measures of financial distress, approximately half (49 per cent) of individuals with outstanding consumer credit debts do not consider keeping up with repayments a burden, but that 17 per cent of individuals with outstanding consumer credit debts face moderate or severe financial distress.

The demographic of a target customer profile will also have an impact on the likelihood of a firm’s customers experiencing financial distress. The FCA found that individuals in financial distress were typically younger, with lower income, less likely to be employed and exhibited higher debt-to-income ratios. They were also more likely to hold products with a higher cost (such as payday loans).

OP20 also provides consumer credit firms with a variety of potential predictors of financial distress, all of which can be used by lenders when carrying out a creditworthiness assessment on customers.

Retail banks will need to implement the measures set out in the CMA’s paper during the course of 2017. Consumer credit firms more generally should consider the risks and problems identified by the CMA relating to the use of unauthorised overdrafts, in particular, the prevalence of hidden or non-transparent fees and lack of a grace period for customers to avoid charges.

Consumer credit firms (including and in particular, banks) may want to consider whether some of the measures could be implemented more widely than the use of unauthorised overdrafts. In addition, such firms should monitor the FCA’s further research to determine whether these measures could be imposed on consumer credit firms more widely as part of the FCA’s statutory objective relating to consumer protection.

In light of the findings of OP20, consumer credit firms should evaluate whether their lending policies are likely to lead to financial distress for customers. Firms may wish to reconsider their approach to creditworthiness more generally, given the detailed rules on the subject, and the continued ‘soft guidance’ on this theme from the FCA.

One of the clearest indicators determining whether a lending policy is appropriate is whether an individual is being provided with “unaffordable” credit. Additionally and, as a result of OP20, a firm’s lending policy should also consider whether the provision of a loan or other form of consumer credit could lead to, or worsen, a customer’s financial distress. These factors will also be important in assessing the effectiveness of a firm’s debt collection practices. Senior management should demonstrate engagement with this issue, given the real potential for poor customer outcomes.

Boards of consumer credit lenders and retail banks should ensure that the effectiveness of lending policies and debt collection processes form part of the management information flowing to senior management, to ensure that any evidence of lending to vulnerable customers (such as those in financial distress) is dealt with at board level.
Banks and consumer credit firms should also monitor the FCA’s findings on its recent Call for Input on the retained provision of the Consumer Credit Act 1974.