The days may now be lighter, but the nights are still far too long and sleepless for many as they contemplate the heavy burden of the cost of living. With energy bills rising, inflation soaring and individuals and businesses facing growing economic pressures, the months ahead look challenging. In many jurisdictions there has therefore been heightened regulatory scrutiny on how financial institutions are dealing with borrowers in financial difficulty.
When looking at the statements and criticisms’ that the regulators have made, what institutions themselves have self-identified, the issues revolve around five key themes:
- Vulnerable customers.
- Due diligence / understanding customers.
In this global briefing note we bring together regulatory developments in a number of jurisdictions under these themes which in turn provide a useful checklist for institutions to utilise, mitigating potential conduct risk challenges.
01. Vulnerable customers
Unsurprisingly given the current economic conditions regulators have continued their regulatory scrutiny on institutions’ treatment of vulnerable (or potentially vulnerable) customers. Regulators may be mindful that the squeeze on household finances could push more people into vulnerability and the risks of financial exclusion are set to intensify. Financial institutions should be mindful of the following points:
- The Financial Conduct Authority (FCA) has issued guidance on actions firms should take to understand the needs of vulnerable customers to make sure they are treated fairly. The FCA views vulnerability as a spectrum of risk with a vulnerable customer being anyone who, due to their personal circumstances, is especially susceptible to harm. Anyone can find themselves in vulnerable circumstances at any time.
- The FCA has provided guidance on the ways in which lenders can help customers worried about or struggling with mortgage payments because of the rising cost of living, noting that some firms such as lenders who are also current account and credit card providers may have more data than others and more scope to identify those who are more vulnerable to payment difficulty.
- Recent enforcement action from the FCA has illustrated in particular:
- The need for the customer journey to take into consideration customers who are or become vulnerable for example, by affording additional time to customers to provide income and expenditure information (on the basis of which the bank must carry out its affordability assessment) and to understand communications and make decisions.
- The importance of taking steps to ensure compliance with the banks’ own vulnerable customer policies as well as the relevant regulation, for instance by having robust processes in place to identify vulnerability characteristics and / or to record information that could indicate vulnerability on the customer’s file and also taking steps to monitor compliance.
- The FCA expects that firms will identify customers in vulnerable circumstances and provide them with products and tools to help them manage their finances and signpost the customer to professional external advice (for example, with regards to mental health). The FCA wants to see consumer journeys for new and existing customers that are clear, transparent, and accessible – including to consumers with characteristics of vulnerability.
- The new Consumer Duty (Duty) increases the emphasis on delivering good outcomes and treating customers fairly. Under the Duty firms are required more than ever to consider the characteristics of vulnerability. The FCA’s final guidance provides that the regulator will “expect consumers with characteristics of vulnerability to benefit from the overall improvements in outcomes delivered as a result of the new Duty”. The Duty makes clear reference to the fact that firms need to pay attention to the needs of customers with characteristics of vulnerability and there is an expectation that firms proactively identify the outcomes for different groups of customers, in particular vulnerable customers, as part of their target market analysis. Products and services should be designed to meet different needs and characteristics with appropriate features built in, e.g. forbearance, flexibility, more time to make a decision.
- The key policy priorities of the Consumer Financial Protection Bureau (CFPB) are the relief for consumers facing hardship due to the COVID-19 pandemic and the related economic crisis and racial equity.
- The US Department of Justice (DOJ) has made announcements regarding “redlining” cases and settlements with a combined $75 million in relief for communities that have been the victims of lending discrimination.
- Most cases close with negotiated settlements that often involve the assessment of a financial penalty as well as commitments on the part of the settling institution to, among other things, develop products more suited to the credit needs and circumstances of low-income minority borrowers. Since 2021, the DOJ has required lenders to invest more than $9 million in community partnerships, targeted advertising and outreach, and consumer education initiatives to benefit communities of color.
- The CFPB has prioritized two types of modern-day redlining: digital redlining, including bias in algorithms and technologies marketed as artificial intelligence (AI), and exclusionary conduct by mortgage lenders, including those by non-banks. The CFPB has recently indicated that a third category – discriminatory targeting, which is also known as reverse redlining -- marks the next phase of the agency’s efforts. Discriminatory targeting is the act of directing predatory products or practices at certain groups, neighborhoods, or parts of a community. The CFPB views the Equal Credit Opportunity Act’s prohibition on discrimination as applying to any aspect of a credit transaction, which means it covers every part a person’s dealings with a creditor.
- There is a requirement under the Code of Banking Practice, endorsed by the Hong Kong Monetary Authority (HKMA), to pay special attention to the needs of vulnerable groups to ensure fair and equitable treatment of customers.
- The Monetary Authority of Singapore (MAS) expects banks to have in place processes to monitor the credit conditions of individual loans.
- Institutions have been criticised by the MAS for failing to establish indicators to identify and place borrowers from vulnerable sectors / with weak financials on a watch-list.
- The MAS has highlighted the need for banks to perform credit stress tests on vulnerable sectors on a timely basis.
- The China Banking and Insurance Regulatory Commission (CBIRC) and its local offices have issued several notices recently in April 2023 requiring banks to provide more lending support to micro and small enterprises in financial difficulty, including, for example, expanding loan coverage, adjusting interest rate and bank fees, granting loan renewal and relaxing requirements on security.
- Whilst there has not yet been a significant uptick in enforcement action, some recent enforcement action has focussed on the operation of business models that were specifically designed to avoid consumer protections for financially vulnerable consumers under Australia’s credit legislation. These practices included arrangements with consumers that were deliberately structured to avoid mandatory credit caps, the consequence of which was consumers paying five times more for everyday goods such as mobile phones and white goods.
- With regards to vulnerable customers, Australian financial/credit institutions are grappling with how it can support customers who are the victims of domestic and family violence (DFV) and the regulators are increasingly focussed on women’s financial safety. A report released in late 2022 by the Centre for Women’s Economic Safety outlines one solution that organisations should adopt into the design of its products and services to support victims of DFV - we expect to see more from the industry this year.
- Since 2014, a specific banking offer has been available for people in a situation of financial fragility to limit the costs in the event of a payment incident.
- A client is considered vulnerable in the following instances if he/she:
- accumulates 5 irregularities or payment incidents during the same month;
- has an over-indebtedness file being processed;
- is registered for 3 consecutive months in the Banque de France file centralizing check payment incidents.
- Credit should not be presented as an easily consumable product, so the French legislator has endeavoured to regulate advertising to restrict credit solicitation and the risks of over-indebtedness, especially regarding vulnerable customers.
- The Autorité de Contrôle Prudentiel et de Resolution (ACPR) and Autorité des Marchés Financiers (AMF) have published a paper containing recommendations on marketing practices for financial products aimed at vulnerable ageing people. For example, the recommendations introduce "vulnerability advisers", a collective approach to detecting vulnerability, training for advisors, and enhanced internal controls.
- The ACPR Sanctions Committee as well as the civil courts are very strict in their rulings when it comes to failing to inform vulnerable populations, as well as taking their specific needs into account.
02. Due diligence / understanding customers
Due diligence / understanding customers has always been an important exercise but arguably has become even more important given the current economic climate. Thorough due diligence reviews of borrowers ensures that the loan does not involve legal risks of which the lender is unaware that could endanger the repayment of the loan.
When dealing with customers in financial difficulty, the FCA expects firms to engage effectively with customers so they can understand the customer’s personal circumstances including whether the customer is a vulnerable customer. Firms need to obtain sufficient information to allow them to attempt to agree an appropriate course of action given the customer’s personal circumstances (otherwise it may enter into an inappropriate or unsustainable arrangement which could result in a worsening of the customer’s financial position). Recent enforcement action has illustrated various failings including:
- Income and expenditure assessments indicating that repayments are unaffordable for the customer where the financial institution fails to explore why.
- Financial institutions making inadequate notes of their customers’ circumstances.
- Financial institutions not revisiting affordability when there has been a change in customer circumstances.
According to the FCA's finalised guidance on the Duty, the consumer understanding outcome requires firms to give consumers the information they need, at the right time, in a way they can understand. Among other things the FCA guidance includes suggestions on how firms should support customer understanding, including “use plain and intelligible language”, “make key information prominent and easy to identify” and “avoid providing too much information”.
A key trend in the United States concerns the use of automated systems to conduct due diligence. These systems, including those sometimes marketed as artificial intelligence (AI), have become increasingly common. As such the Civil Rights Division of the DOJ, the CFPB, the Federal Trade Commission, and the U.S. Equal Employment Opportunity Commission have recently released a joint statement outlining a commitment to enforce their respective laws and regulations.
This joint statement follows a series of CFPB actions to ensure advanced technologies do not violate the rights of consumers. Specifically, the CFPB has taken steps to protect consumers from:
- Black box algorithms: In a May 2022, circular the CFPB advised that when the technology used to make credit decisions is too complex, opaque, or new to explain adverse credit decisions, companies cannot claim that same complexity or opaqueness as a defense against violations of the Equal Credit Opportunity Act.
- Algorithmic marketing and advertising: In August 2022, the CFPB issued an interpretive rule stating when digital marketers are involved in the identification or selection of prospective customers or the selection or placement of content to affect consumer behavior, they are typically service providers under the Dodd-Frank Act. When their actions, such as using an algorithm to determine who to market products and services to, violate federal consumer financial protection law, they can be held accountable.
- Abusive use of AI technology: In April 2023, the CFPB issued a policy statement to explain abusive conduct. The statement is about unlawful conduct in consumer financial markets generally, but the prohibition would cover abusive uses of AI technologies to, for instance, obscure important features of a product or service or leverage gaps in consumer understanding.
- Digital redlining: As discussed above, the CFPB has prioritized digital redlining, including bias in algorithms and technologies marketed as AI. As part of this effort, the CFPB is working with federal partners to protect homebuyers and homeowners from algorithmic bias within home valuations and appraisals through rulemaking.
- Repeat offenders’ use of AI technology: The CFPB has proposed a registry to detect repeat offenders. The registry would require covered non-banks to report certain agency and court orders connected to consumer financial products and services. The registry would allow the CFPB to track companies whose repeat offenses involved the use of automated systems.
- The CFPB will also release a white paper discussing the current chatbot market and the technology’s limitations, its integration by financial institutions, and the ways the CFPB is already seeing chatbots interfere with consumers’ ability to interact with financial institutions.
- A key provision in the Treating Customers Fairly (TCF) Charter is that services and products should be designed to meet the needs of customers.
- The MAS has found instances of inappropriate regulatory credit grades being assigned.
- CBIRC has imposed significant fines of approximately RMB 388 million (USD 56.6 million) on five commercial banks (including a foreign-invested bank) for a variety of failures including extending loans to incompetent borrowers which are restricted or prohibited from borrowing money from banks, such as real estate enterprises, highly polluting enterprises, local government financing platforms or the lending banks’ related persons.
- Fines have also been imposed for a variety of other failures including inadequate due diligence in reviewing loan applications and problematic loan approval processes.
- The CIBRC has required banks to enhance their risk management processes when conducting internet lending business.
- Banks should urge their clients to strengthen the ESG risk management terms in their loan contracts.
- In February 2023, the Australian Securities and Investments Commission (ASIC) warned all businesses that it will be targeting predatory lending practices, high-cost credit, debt management and debt collection misconduct as part of its continuing focus on protecting consumers from financial harm.
- The lending bank must be able to explain why the proposed credit agreement is suited to the borrower’s needs and financial situation, and prove that the borrower’s attention has been drawn to the essential characteristics of the credit offered (rate, duration, cost, mode of operation) and its consequences on his/her financial situation, including in the event of default. In particular, the lender must verify the solvency of the borrower from sufficient information, including information provided by the borrower at the request of the lender. As part of this verification exercise, it is mandatory for the lending bank to inspect the national file of personal loan repayment incidents.
- It should be noted that in France, the benchmark ceiling for the debt service-to-income ratio for residential real estate loans has been raised in 2021 from 33% to 35%.
- Banks should be mindful of the ACPR’s guide on Business Practices and Customer Protection. In addition, they should also be aware of the regular surveys that the ACPR circulates so as to collect:
- data on identification and activity;
- statistical data on the business activity of institutions subject to supervision;
- information relating to business practices and dedicated resources; and
- information relating to the internal control framework.
As more customers find themselves in financial difficulty regulators will be paying particularly close attention as to whether financial institutions are properly considering and utilising forbearance options which will help customers come through difficult periods.
The FCA’s recent guidance for firms supporting mortgage borrowers impacted by rising living costs includes details of flexibility firms have when providing forbearance and the scope firms have to vary contract terms for borrowers who want to reduce monthly payments. Firms should also consider prospective forbearance for those who expect to experience payment difficulties including where payment has not yet been missed. Recent FCA enforcement action has illustrated various failings including:
- Customers who may have benefited from a temporary payment concession not receiving any concession.
- Even after payment arrangements are repeatedly broken by the customer and it is clear that the customer is unable to continue with the arrangement, the bank does not explore why or consider alternative arrangements for the customer.
- Focussing on collecting payments in the short term rather than agreeing sustainable forbearance arrangements.
The FCA has recently issued a consultation seeking to incorporate its coronavirus tailored support guidance into those parts of its Handbook dealing with consumer credit and mortgages. Strengthening Protections for Borrowers in Financial Difficulty: Consumer Credit and Mortgages. Among other things the FCA is consulting on a requirement that firms should take reasonable steps to ensure that forbearance measures put in place remain appropriate. It is also consulting on guidance that what is considered reasonable steps will depend on the customer’s circumstances and the nature of the forbearance provided.
- Whilst the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) (which was implemented in response to the COVID-19 pandemic) has not been extended to cover the cost of living crisis, CFPB examiners have identified unfair acts or practices and Regulation X policy and procedure violations for failure to provide consumers with CARES Act forbearances.
- Whilst the COVID-19 forbearance scheme has not been extended to the cost of living crisis, the TCF Charter provides for the fair treatment of customers at all stages of the relationship.
- The MAS Code of Consumer Banking Practice includes provisions that a bank must treat borrowers with dignity and respect. This prohibits collection methods that may embarrass customers or put a customer’s job at risk.
- Principles on fair dealing and treating customers fairly should be embedded into banks’ operational processes for mortgage business, for example proposals seeking to change the pricing or terms of a mortgage should explicitly include considerations on fair dealing.
- CBIRC and its local offices have issued several notices recently requiring the banks to provide more lending support to the micro and small enterprises in financial difficulty, including, for example, expanding loan coverage, adjusting interest rate and bank fees, granting loan renewal and relaxing requirements on security.
- The Australian licensing regime was changed in July 2021 to require debt management and collection services to be licensed under the credit regime. One of the consequences of this is that, from September 2022, they must comply with prescriptive guidance on when and how to remediate customers who suffer loss as a result of poor debt management practices. We are yet to see any regulatory action by ASIC in this regard, given its relatively recent introduction, but we expect to do so in the coming months.
- A borrower facing difficulty whilst repaying a lender may ask a judge to suspend his/her obligations, even if a clause provides for the immediate payment of all remaining instalments in the event of default.
- For example, a delay has been granted by the Court to borrowers facing a lay-off, unless they have sufficient personal assets to be able to meet their commitments, or in the event of financial difficulties linked to their state of health.
- Civil courts have granted delays to borrowers facing difficulties such as lay-offs, or financial difficulties linked to their state of health.
- Customers in over-indebtedness can also benefit from new instalments to retrieve a healthy financial situation.
Irish playwright George Bernard Shaw once said that, “the single biggest problem in communication is the illusion that it has taken place.” Inconsistent and informal communication among lenders and their loan customers is an area that has often been identified as a weakness for many financial institutions.
Although the FCA’s rules do not require mortgage firms to proactively identify and contact borrowers at risk of payment shortfall, firms are encouraged to think about what they can do to meet the FCA’s expectations to support customers that need help including identifying those who are vulnerable to payment difficulty and/or generic outreach communications. Firms should also ensure that they are clear in their communications about the credit file implications of any support they offer. Recent enforcement action has illustrated various failings in respect of communications with borrowers including:
- Not notifying or a delay in notifying the customer that they are in arrears.
- A contact strategy which was not sufficiently risk based and which did not appropriately take into account different customer indicators such as vulnerability or characteristics such as being self-employed or having irregular payment patterns.
- Financial institutions and others should evaluate advertising and marketing claims for language that suggests that the company puts consumers’ interests ahead of their own unless it is strictly true. Intermediaries should exercise particular care about their marketing, including the efficacy of any disclaimers of acting in the consumers’ interests.
- It is unlawful for any provider or service provider of consumer financial products or services to engage in unfair, deceptive, or abusive acts or practices (UDAAP) - this includes their communications.
- Financial institutions must explain clearly and provide the key features, risk and terms of their products before entering into a loan agreement.
- All banks should be mindful of the Code of Banking Practice which is intended to increase transparency in the provision of banking services.
- All financial promotions to be fair, reasonable and not misleading.
- The MAS has found instances of uneven practices on what banks consider to be key information and how such information is presented to customers.
- The proposed amendments to the so-called “four cornerstone lending management regulations” provide that banks shall specify in loan contracts the liquidated damages that may apply to the borrower and the sanction measures that may be taken by the bank if the borrower fails to use the loan proceeds for the designated purposes.
- The keystone of French lending regulation is borrower information. The lender must make the borrower aware of the scope of his / her commitment and its consequences by providing a comprehensive information sheet. In the event of a dispute, it is up to the lending bank to prove that it has fulfilled its duty to inform the borrower of all the risks taken.
- French law prohibits deceptive commercial practices. The ACPR has also issued a recommendation regarding communications through social media. All communications must be loyal, transparent, and not deceiving.
- Communication monitoring is subject to increased regulation and attention from both the European and French authorities with the view to improving transparency and information to clients. Disciplinary, administrative and civil law sanctions may arise in cases of infringement. Codes of conduct and customary practices should also be taken into account as part of good practice.
After the loan is approved, a financial institution has to retain the borrower until the loan becomes due, which might not be for several years which often presents an issue. The reason for this is that typically an institution’s focus is on developing customer relationships, building the opportunity pipeline, getting the loan on the books as quickly as possible and then moving onto the next customer. However, in a difficult economic environment the need to monitor customers becomes even more acute. Institutions have placed more and more reliance on technology to help them monitor customers but this has also presented problems.
The FCA has highlighted the importance of good risk management principles and practices including firms having effective monitoring processes in place. Recent enforcement action has illustrated various failings including:
- Automated systems not identifying early enough when customers have fallen into arrears.
- Over reliance on manual processes to correct known glitches or failures in automated systems.
- Inadequate formal testing of customer call handling (in respect of single customer interactions rather than taking a holistic, end-to-end view of the whole customer experience in the arrears collections process).
- Not distributing sufficiently widely management information regarding the monitoring of customer communications.
- Banks should closely monitor regulatory enforcement actions containing UDAAP claims, identify and act on red flags, and remain focussed on key issues, including whether discrimination is potentially unfair and whether algorithms are potentially disruptive.
- The TCF Charter provides for the fair treatment of customers at all stages of the relationship.
- Banks should establish an independent unit that conducts ‘post mortems’ on non-performing loans to identify the reasons for non-performance and determine if pre-emptive action could have been taken.
- Fines have been imposed for a variety of failures including failures in monitoring the use of advanced loan proceeds.
- Banks need to be mindful of filing a reimbursement report. In particular:
- If a borrower is late in repaying a loan (taken by an individual for non-professional purposes), or a situation of over-indebtedness arises, a bank must make a notification on the Personal Credit Redemption Incidents (PKI) file.
- Borrowers can be enrolled in the National Register of Household Credit Repayment Incidents (FICP) if one of the following credit refund incidents occurs:
- lack of payment of 2 consecutive monthly instalments;
- non-payment for more than 60 days of non-monthly maturity;
- authorized overdraft misused, if, after a formal notice from the bank, the borrower have not regularized the situation within 60 days for an amount at least equal to €500;
- non-repayment of amounts outstanding after formal notice to pay from the lender.
- The lender must notify borrower of his / her intention to register him / her with the Banque de France for the FICP; unless he / she regularizes his / her situation in the next 30 calendar days.
- At the end of this period, and unless regularized or an amicable agreement has been reached, the lender informs the borrower by mail of his / her enrolment in the PKI.
- The registration may be challenged and can be settled by the Banking Ombudsman (mediator).
- Banque de France has published a paper on optimal monitoring of long-term loan contracts, that contains best practices.
- The European Banking Authority published a guideline specifying the internal governance arrangements for granting and monitoring credit facilities throughout their lifecycle. These guidelines also introduce requirements for an assessment of a borrower’s creditworthiness.
- Firms should be mindful that more developments are expected in the coming months.
Many of the above points are probably transferable to firms in different jurisdictions and therefore can make a useful practical checklist for firms.
- What processes have been put in place to identify vulnerability characteristics and to record information that could indicate vulnerability on the customer’s file? How is this being monitored?
- What specific processes have been put in place to support victims of domestic and family violence?
- What training has been put in place to help staff detect vulnerability?
- Are affordability assessments revised when customer circumstances change?
- Are adequate notes of customers’ circumstances being made?
- Is “plain and intelligible language” being used in documentation?
- Is the technology being used to make credit decisions too complex, opaque, or new to explain adverse credit decisions?
- Is there bias in any algorithms and technologies being used?
- Are temporary payment concessions being granted to those who may benefit from them?
- Where payment arrangements are being broken does the bank explore why or consider alternative arrangements?
- Are customers notified without delay when they are in arrears?
- Is customer call handling being formally tested?
- Has consideration been given to establishing an independent unit that conducts ‘post mortems’ on non-performing loans?
- How good is the management information on customer communications and is it being distributed to the right people in the business?
- Could any enhancements be made to governance arrangements in respect of customer treatment with a view to delivering good outcomes for borrowers?
- How would you evidence compliance with regulatory requirements in the event of a complaint, enquiry or investigation?