Posted: 22nd November 2013
In March 2013, the Office of Fair Trading (OFT) published its review into affordability in the pay day lending industry. Since then, the issue of affordability has gained prominence across the consumer credit industry. Now, with the publication of the Financial Conduct Authority’s (FCA) full consultation and draft rules for consumer credit, affordability of financial products for consumers is at the heart of the regulator’s approach in consumer credit.
When the FCA came into being in April 2013 it stated it would tackle problems early on before mass consumer detriment results. In the eyes of the FCA poor affordability assessments lead to customer detriment. Going forward therefore the FCA requires the potential for customer detriment to be considered as part of an affordability assessment. That means that sometimes the right decision may well be not to lend.
Assessing affordability effectively is important from a regulatory and customer perspective. However, from a commercial perspective it is vital to firms’ business going forward. A robust affordability assessment incorporates a full understanding of income and expenditure. By tackling this at the outset, some firms can expect to reduce the number of customers who fall into arrears in the early part of agreements. The consequence of this is a reduction in resource allocated to collections activity and a fundamental decrease in default rate. This is all whilst achieving better customer outcomes.
In CP13/10 the FCA states that the OFT affordability guidance is sound, but too few firms implement it. Therefore, the FCA is putting the OFT guidance into its rules and guidance, and will enforce them with the full weight of its powers.
Should you lend?
Firms must make an appropriate assessment of the borrower’s ability to repay the loan. Use appropriate systems, credit scoring, credit risk assessment and check the payment history of the customer with the firm. The process should also include a robust income and expenditure analysis which incorporates all income with essential and non-essential expenditure using a common sense approach. Engage with customers and challenge them to think through their current budget arrangements, ideally with a budget planner.
Can the customer afford to borrow?
Some firms upsell credit to customers who can initially afford a lower level of borrowing. If a customer reliably repays debt on a lower level of repayment, but is upsold to a more expensive product and moves into arrears, can your current monitoring systems flag this? Are you aware when your customers are falling into arrears? While upselling credit is not banned, firms should monitor trends in customers going into arrears after an upselling strategy has been used.
The affordability assessment at point of sale should be followed up with appropriate outcomes testing to check if the loan is affordable. This provides evidence that the firm not only has an appropriate affordability assessment, but that this assessment is fit for purpose given the product and customer base.
Effective affordability checks combine credit check, evidence-based income assessment and evidence-based expenditure assessment, where available. In our experience working with currently FCA regulated firms, problems have arisen when they rely too heavily on adherence to process rather than achieving the right customer outcome.
A conversational approach to compliance with affordability, incorporating an appropriate income and expenditure tool, achieves the best outcomes, allowing appropriate decisions to be made on both sides. This activity should be completed every time a new loan is issued, or an existing loan is restructured, rolled over or changed.
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