There has been considerable media coverage this week of a letter sent to the heads of some of the UK’s biggest High Cost Short Term Credit (HCSTC) lenders after the FCA demanded that they investigate whether compensation was due to customers, and remediation be carried out on current customers. The letter, addressed from Jonathan Davidson, the FCA’s director of supervision for retail and authorisations, comes as a prelude to new industry regulations coming into force on November 1st that will force all creditors to consider consumer’s ability to afford a loan before they are accepted for credit.
Affordability, in the context of a loan, concerns itself with the ability of the recipient to manage the repayments. While the FCA quite clearly state that “while we recognise that there will always be some loans that turn out to be unaffordable, for example because of the impact of unforeseen circumstances”, within the vast majority of loans, it is possible through rigorous due diligence to build a picture of a customer’s financial health, their income and expenditure, disposable income, and whether they will be able to afford a loan, and its repayments. As the letter goes on to say,“..firms maintaining effective policies and procedures in line with the above requirements should aim to eliminate lending that is predictably unaffordable, minimising the risk of financial distress to consumers.”
What is most pressing for the recipients of the new communique from the FCA is the mention of them of remediating their current client stock, with the possibility that there may be the need to compensate clients who have loans or other credit that was sold to them prior to the introduction of the new regulations.
The FCA has, to date, been extremely vocal in its call for all firms involved in the issuing of credit to be far more responsive in their considerations of customer affordability. With the November 1st deadline only a matter of weeks away, firms should have clear policies and procedures in place for determining discretionary spend which could be spent on loans. This is to date, however, the most vocal that the regulator has been in its requirement for firms to remediate current customers.
In the letter, Davidson states, “Where firms identify recurring or systemic problems in their provision of a financial service, which could include problems in relation to the carrying out of affordability assessments, the firms should ascertain the scope and severity of the consumer detriment that might have arisen.”
Having identified any potential issue firms must analyse what the underlying cause of the loan being approved was, and also to inform the FCA “immediately” should the cost of reimbursing customers leave it unable to fulfil their financial obligations.
In what is sure to capture the attention of “CEOs”, Davidson finishes the letter with a stark reminder to all that they should review their current lending practices to ensure that they are compliant with new affordability rules and if they do not, “should take appropriate steps to address this, which may include considering whether to cease lending until any contraventions are remedied.”
Affordability & Wonga
On reading this one’s mind immediately wanders to the fate of Wonga, who called in administrators a month ago. As we wrote about recently, Wonga could potentially still be operating if it had behaved like a business building for the future, rather than market share in anticipation of an IPO. Affordability was never an issue for the payday lender, and it payed the ultimate penalty.
It could be this was the underlying threat that Davidson intended. Or more likely, a final desperate plea for all lenders to get their houses in order.
Current HCSTC’s would do well to take-heed though. Where Wonga is no longer operating, hundreds still operate in the market. But the high volume, low margin model, means that any period where they are not operating would be potentially devastating to their business model. What would be even more critical would be if hundreds, or thousands of customers, demanded compensation for loans that were unaffordable. We saw a whole cottage industry spring up around the possibility of compensation against Wonga. The same happening to a smaller rival could be a similar nail in the coffin.
Loan companies and financial institutions should as a minimum be thinking about the policies, procedures, and technologies that can be used to negate the impact of the affordability rules. After all, the time taken and resource required to understand an individual’s discretionary spend is substantially more than a few questions on a web browser.
In the next article in our series, we’ll look at potential solutions to this conundrum.