On the 31st July 2017, the Financial Conduct Authority (FCA) published the outcome of its review into high-cost credit, which includes its assessment of the effectiveness of the ‘payday loan’ price cap.
The review has evidenced that the FCA’s regulation of high-cost short-term credit (often known as ‘payday lending’) has delivered substantial benefits to consumers.
The review found that:
- 760,000 borrowers in this market are saving a total of £150m per year
- Firms are much less likely to lend to customers who cannot afford to repay
- Debt charities are seeing far fewer clients with debt problems linked to high-cost short-term credit.
This has led to the decision by the FCA to leave the existing payday loan price cap in place, and to review it again in 2020.
Andrew Bailey, Chief Executive of the FCA, said:
“…There is more that we can do, and this review is about identifying the areas where consumers may be suffering harm so that we can focus our efforts accordingly.
“In particular, the nature and extent of the problems that we have found with unarranged overdrafts mean that maintaining the status quo is not an option. We are now working to resolve these issues while preserving the parts of the market that consumers find useful.”
The FCA has also published a consultation on creditworthiness. The consultation comes “in light of concerns about the risk of potential harm to consumers from poor culture and practice by firms”.
Due to some remaining uncertainties within parts of the market, the FCA is proposing a number changes to further clarify its stance and expectations on firms.
High Cost Short-term credit
The FCA has identified several issues which could cause potential consumer harm within the high cost, short-term credit market. They intend to publish a consultation paper on some of their forthcoming proposed changes in spring 2018. It has been noted in the Feedback Statement that the FCA are particularly concerned about the rent-to-own market, home collected credit and catalogue credit. There are also wider concerns about consumers’ long-term indebtedness.
Assessing Creditworthiness in Consumer Credit
The FCA is clear that it does not think the basic approach to creditworthiness needs any fundamental changes, though it does feel that it is important to clarify in its rules:
- The distinction between affordability and credit risk
- The factors that should be used when designing affordability checks (that are appropriate and proportionate in relation to individual lending decisions)
- The appropriate role of income and expenditure information in lending decisions and
- The FCA’s expectations around firms’ policies and procedures (which should focus on outcomes, having regard to the risks of the credit, and customer characteristics)
The Meaning of Affordability
The FCA will clarify that creditworthiness includes both credit risk to the lender and affordability for the borrower. Lenders will be required to consider the risk to the customer of not being able to make the repayments:
- As they fall due over the life of the credit agreement, and within a reasonable period in the case of an open-end agreement
- Wholly out of income - unless the customer has clearly indicated an intention to repay using savings or other assets (this means the customer’s income)
- Without the customer having to borrow to meet the repayments or being unable to meet other financial commitments, and;
Without the repayments having a significant negative impact on the customer’s overall financial situation.
Income and Expenditure
The rules will make it clear that a firm does not need to estimate or establish the customer’s income (or disposable income) where it can demonstrate that it is obvious in the circumstances that the credit is affordable.
Where this is not the case, the lender will be required to take income into account in the assessment. This could include firms using estimates based on employment status or using Credit Reference Agency data. Firms will need to show they made a reasonable assessment in the circumstances. Where firms are required to establish or estimate income, they must also establish or estimate disposable income - unless it is clear this would have no impact on affordability.
A new rule will specify that the extent and scope of a creditworthiness assessment in a case - and the steps needed to ensure the assessment is reasonable - depend on, and are proportionate to, the individual circumstances.
The volume and content of information that must be considered when assessing creditworthiness will depend on the affordability risk. However, the firm would need to be able to demonstrate, if challenged, that it had a reasonable basis for its view and that this was based on sufficient information.
Open-end and running account credit
Currently, for an open-end agreement, such as a credit card, a firm should make a reasonable assumption about how long the credit facility is likely to be for. This will be made into a rule.
There is a linked provision for running account credit – which will also be made a rule.
When a firm assesses ‘affordability’ and sets a credit limit, it should satisfy itself on the customer’s ability to repay using many different assumptions. The firm should assume that the customer draws down the full credit limit on day one, and repays by equal instalments over a reasonable period.
The firm should consider the typical period of repayment for a fined-sum loan for the same amount. Firms will also need to make reasonable assumptions about likely further drawdowns and repayments over the likely period.
Policies and procedures
Firms’ policies and procedures will need to be in writing and must set out the principal factors to be considered when assessing creditworthiness. These will have to be approved by the firm’s personnel or governing body.
There will also be additional requirements which build on the obligations under SYSC – which will require firms to assess and periodically review the effectiveness of their policies and procedures for creditworthiness assessments, and the firm’s compliance with these and consumer credit requirements.
Firms will need to maintain sufficient records of transactions and maintain robust governance arrangements.
CONSIDERATIONS FOR CONSUMER CREDIT FIRMS
At this stage, firms should be considering both papers and reviewing them to identify any risks or gaps in their current processes. Firms have until 31st October 2017 to respond to the consultation and we would encourage firms to do this. The FCA is expected to release a policy statement following the consultation in the first half of 2018.
Now the FCA has provided a view on its future direction of travel, firms within the rent-to-own, home-collected credit and catalogue credit sectors should expect enhanced focus and scrutiny from the regulator in the near term. This doesn’t mean that other areas of the market are exempt from future scrutiny. All firms should be reviewing their business models and current policies and procedures in the context of the evolving regulatory environment and FCA concerns to gain assurance that they are well prepared for scrutiny.
In particular, given the FCA has proposed clearer expectations on assessment of creditworthiness and affordability and the need to consider both aspects in the context of customer base and business model, firms should begin to consider whether any changes will need to be made to their existing policies and procedures in this area.