Matthew Drage:

Hello and welcome to this Huntswood podcast. So it's fair to say that the consumer credit sector is by far and away the largest sector in terms of the number of firms which the Financial Conduct Authority regulates. Outstanding consumer credit lending in the UK alone rose to £225 billion last year, and there are now more than five million individuals saddled with over £10,000 worth of personal debt. Now, there is no escaping that the market has changed, driven in part by change in regulation, technology and consumer needs and wants, and this has presented its own challenges for firms.

Matthew Drage:

Now, zoning in on the topic of affordability, and in particular responsible lending, I'm pleased to be joined today by Paul Dyer, Head of Regulatory Risk Insurance at Huntswood.

Paul Dyer:

Hi, Matt.

Matthew Drage:

And Richard Brown, Technical Advisor at Huntswood.

Richard Brown:

Hi, Matt.

Matthew Drage:

My name is Matt Drage, Director at Huntswood. So I wanted to kick off by just asking you first, Paul, as a former CRO at the FCA, how'd you think the FCA's view on the consumer credit market has evolved over the past few years.

Paul Dyer:

Thanks Matt. Yeah, without a doubt, this is a very critical sector. There are 40,000 firms registered with the FCA, which makes it the largest sector, one way or another, that they have responsibility for. It arguably also has some of the biggest potential for longterm harm and benefit for consumers. And I think the FCA has been pretty consistent in recognizing the need as well as the risk. I think I saw some research recently that prior to 2020 lending to high-risk customers grew by 20% annually, according to Credit Ratings Agency data. So as well as the fact that there are a lot of firms, there's a lot of potential for harm and benefits.

Paul Dyer:

It's also growing year on year. It typically deals with customers who could be exhibiting financial distress, which again is a major focus of the FCA. Also worth noting, I think, that the market is changing the whole time, whether it's change in regulation, and the FCA inherited through the Consumer Credit Act a whole load of regulation that doesn't necessarily fit along with some of the other ways it works, changing technology and a very evolving customer need and understanding, particularly as we're seeing at the moment with the current crisis. So, one way or another, it's clearly in the headlights of the FCA.

Matthew Drage:

Thanks, Paul. And just, Richard, I wanted to focus a little bit in on your experience supporting clients, in particular around the topic of affordability. So we know, looking at those credit lending volumes, that it's increasing, and as Paul mentioned, by far and away the greatest number of firms the FCA regulates, are you okay just to give our listeners a quick insight into how the FCA's take on affordability and its thinking into affordability has evolved over the past few years?

Richard Brown:

Yeah. So the FCA has been paying a lot of attention to this market over the last couple of years, and it's fair to say, when I conducted my first skilled personal review back in 2016, how many conversations I had then with the FCA and their knowledge and experience, it has really advanced over especially the last couple of years. We've seen, or I've seen, a lot of evidence that the FCA is really homing in on very, very core parts of responsible lending and the use of customer data and what they do with that data.

Richard Brown:

But yeah, predominantly in the last couple of years, it's been spent, myself and working with FCA and firms, in the high cost, short term credit market. Payday lenders, of which we've seen many disappear from the market, but still a lot of players within that sector at the moment. But for me it kind of started quite significantly from when the DSEO letter landed in 2018, where the FCA really set up their expectations of firms. And really from that it's evolved from lots of contact from the FCA to these firms and eventually moving on to skilled personal reviews, which we've seen in abundance over the last couple of years.

Richard Brown:

I think what's interesting is that the FCA has spent a lot of attention, as I said, on payday lenders, but we're now starting to see signs of them moving on from that sector. Still focused, but potentially moving on to motor finance.

Matthew Drage:

Then in terms of the FCA's view on affordability, so what do they expect from lenders when it comes to the checks that they're undertaking? Because this is a topical area, and we know obviously different firms take very different views on the checks and the level of checks required to evidence that a loan is affordable; what's your view, based on what you've seen within the market, Richard, on best practice.

Richard Brown:

Yeah, I mean if you take it back to your question of what the regulator expects, so I think the FCA has been very clear in terms of what their expectations are, the risks that they've seen within the market and how they expect firms to assess affordability, but they still talk very much of a proportionate checks basis. So to some extent they haven't really honed in on what that exactly looks like, but it can be very difficult from business to business and customer to customer. The likes of a proportionate check for a new customer who's borrowing a very small amount of money is very different from someone who's borrowing a large amount of money, for example. But the FCA expects the firms to have these robust policies and processes in place around how you do proportionate checks. This information you can go back on for firms. I cited there the DSEO letter in 2018, which is actually a really good letter to have a look back on, because it really sets out the FCA's expectations around what does responsible lending look like, but it also gives some expectations that the FCA expects firms to regularly review policies and processes when it comes to lending.

Richard Brown:

But in the conversations I've had with the FCA, they're very much looking at evidence based information when doing affordability checks, be that bank statements, payslips, looking at CRA data, but really the more the customer borrows, or the greater the amount, the expectation there is that the check should also ramp up at that point in time as well. So potentially looking at more data sources.

Matthew Drage:

And Paul, back in 2018 the FCA updated its rules around affordability, in particular. And what were your key takeaways from that update when you were at the FCA?

Paul D:

Well, I think Richard's spot on, and when I think back to 2018, the message that I think we were really trying to put out there was a firm whose business model was predicated on selling products to customers who potentially can't afford to repay them isn't acceptable. They'd seen a number of examples where this was being done. And I think with firms knowing that was the case, and as well as the impact on the customers, it's the fact that it isn't a sustainable longterm strategy. So hence this term of responsible lending and firms needing to take responsibility if their decisions came about.

Paul Dyer:

As Richard said, this goes beyond the needs to consider whether a customer has a history of repaying, but whether really they're likely to do it in the future. The consumer credit handbook requires firms to consider likely changes to customer situation during the whole duration of the credit, but I think really that's been kind of put to the forefront by the FCA in recent times.

Matthew Drage:

I've heard a lot in the market around creditworthiness and then affordability on the other hand, and I think the FCA has been at pains to say that they are very separate things and you should treat them in isolation and separately when you do assess creditworthiness and affordability. I mean, Richard, can you give us a flavor of just what's gone wrong for firms in the past where they might've made a mistake when it came to their affordability checks, and what have the repercussions been for them?

Richard Brown:

Yeah, I certainly can, Matt. So in terms of what the expectations are on firms, I think what I've seen in my experience is that unquestionably firms just haven't gone far enough in terms of what they do at the point of affordability checks. Now, that could be as significant as not obtaining income and expenditure evidence, not taking into consideration CRA data, but it can also be quite granular, I mentioned the word granular earlier, in terms of some of the failings that firms have come across. And by granular, it's potentially something on CRA data where the firm's interpreted to be X number and the FCA think it's Y number based on their experience. And this is more and more what I'm seeing the FCA focus on, is those really granular rules, if you like, in responsible lending policies and processes, and they're really homing in on those little pieces that don't in the great scheme of things seem like a lot, but actually is clearly on the FCA's radar. And they do have quite a big impact from a lending perspective.

Matthew Drage:

And what happens where firms have gotten this wrong in the past? What do you see as the typical regulatory action that's taken or the approach that the FCA take to where they uncover issues around affordability checks, for example?

Richard Brown:

Yeah. So I think where they've got it wrong in the past, the expectation from the FCA is very clear that going forward firms need to review policies and processes and bring them up to standard based on rules or requirements from the FCA, but also the [inaudible 00:09:59] as well. The biggest impact we're finding with firms is the back book review that the FCA in most cases, or if not all cases I've worked on, expect you to go back and remediate all the way back to 2014. That's the area that's quite challenging for firms, and admittedly, where we've seen firms go into administration because of the size and scope of the past business review.

Richard Brown:

What's I suppose an important point on that is the FCA will expect you to apply today's standards retrospectively. And the main reason for that, I think, and I think Paul alluded to it earlier, is that the FCA don't really see that their rules have changed since 2014. I think in their view they've provided the sector with clarity and guidance, that actually the fundamental rules in the consumer credit handbook haven't changed since 2014. Or even, if you take it back to the Office of Fair Trading days when consumer credit firms were regulated by the OFT, they were the same rules that were enforced then. So the FCA's view is, "Well, the rules haven't really changed over time," so hence why past business reviews are always taking firms back to 2014 when the FCA became in charge of authorizing these firms.

Matthew Drage:

And one of the words I hear quite a lot discussed when it comes to affordability is proportionate; the checks should be proportionate, [inaudible 00:11:25] in particular. And can you just give our listeners a flavor of how proportionality might differ depending on the type of borrowing the clients, for example, if you could give a flavor on that, that'd be fantastic.

Richard Brown:

Yeah. So I think it's in its simplest form, a customer who's new to you, and let's say for example it's a payday lender scenario, if the customer's new and they want £50 pounds, in that type of scenario it's arguable you could apply a very proportionate approach to very limited information you'd obtain on that customer. It's almost a test to see how that customer performs. That's not to say you don't do any checks, but you might want to look at a payslip, for example, or a bank statement, and maybe overlay that with Credit Reference Agency data. Then that customer comes back a second time, a third time, a fourth time, and the amounts typically increase at that point. That's when we say really that firms should be looking to ramp up their checks at that point in time. So that's really around getting more information externally. So again, it could be bank statements if you hadn't previously got that, or just relying a lot more on the Credit Reference Agency data that you're seeing and checking for things like mortgage default, number of credit lines they have externally, and just seeing wherever there's been a variation since the last time you checked that with that customer, if you did those checks prior.

Matthew Drage:

And one of the areas that I know has developed quite quickly over the past few years is open banking and the ability to harness the power of the data alongside the CRA data. How are you seeing that clients are responding to the use of open banking data as part of their affordability assessment.

Richard Brown:

So yeah, it's a really good question, and a very interesting point at the moment because I'm having this conversation with a lot of firms. Some are advocates of open banking and some just simply won't touch it because they believe it effectively doesn't really work or isn't really a very useful tool from an affordability point of view. But what I find is quite interesting here is that the FCA really, really like open banking. And I can't stress that enough, that when I talk to them, talk to the FCA, or I hear them talking, they do cite open banking as a very effective tool to assess somebody's ability to repay a loan, but also to build up a very good picture of that customer's finances.

Richard Brown:

I've seen it in operation, in a number of firms, and my own personal view is that it works really, really well, but like with anything, it requires a lot of time and effort to make sure it works effectively, because the level of data that you're getting in, it's not necessarily black and white, it takes a lot of interpretation and analysis of specific datas. So is it an income? Is it an expenditure? If it's an expenditure, is it discretionary spend? So it can be quite challenging to get it to work within the business and all that analysis that needs to be done up front. But it's such a powerful tool because it just tells you so much about that customer. And it really, really supports vulnerability as well, which is another area that, as we all know, the FCA is very focused on. So specifically there, it's a very good tool for identifying the likes of gambling, potentially even addictions to alcohol. So it really can flag certain vulnerabilities quite clearly as well. So it's a very, very powerful tool.

Matthew Drage:

And just honing in on vulnerability in particular, it's interesting that, prior to 2020, lending to high risk customers was evidenced by the FCA to grow 20% year on year. So just a question for Paul in terms of how is the regulator at the moment tackling the issue whereby clearly lending to customers, especially at this time of COVID, is more necessary, you could argue, than ever before to help customers survive. But actually how do they balance their responsibility when it comes to financial distress and ensuring that actually they don't potentially look to alternative sources of credit?

Paul Dyer:

Well, I think this is a huge concern, and I think it's one where we haven't yet even begun to see the repercussions, to be honest with you, Matt. And we've seen some short term measures come out in very quick succession from the FCA for pretty much all sectors. The current conditions have exacerbated the potential vulnerability, putting more people in distress and at the risk of distress. I think one of the concerns they have is the provision of responsible lending, making credit available, at a time when actually even the providers of that credit themselves, the firms in the market, may be going under some stress because of economic conditions. So they want to try and make sure that the supply and demand are balanced correctly. I think there's an expectation at the moment that with the markets the way they are, the number of firms over time will fail naturally. It's a really risky period.

Paul Dyer:

But to be honest with you, Andrew Bailey, I think, gave a speech about 18 months ago that summarized their priorities one way or another, which is that firms need to take the right steps to ensure they lend responsibility, no matter what the conditions. They need to understand any conflicts of interest, particularly at times when the distress is potentially high. They need to make sure that actually the information provided to potential customers helps them make the right decision one way or another, so they're informed. And they have to be thinking about affordability, which means that actually, when you're doing your valuation, when you're doing your assessment before you extend the credit, or even when the client's on the books, you understand whether actually the risk is increasing, decreasing or crystallizing. But you're spot that the current conditions, and we've seen the regulatory interaction as a result, there's more of it, the regulator's churning changes through at a much faster pace, this is a period of change.

Matthew Drage:

And Richard, just building on Paul's point there around the change we're seeing within the industry, where do you think the spotlight is at the moment? I mean, consumer finance is such a broad church, effectively, all the way from high cost credit, high cost short term credit, logbook lenders, guarantor lenders. I mean, it's a really diverse area. Where do you feel that the spotlight is shifting to at the moment, just based on the changing economic environment, the changing priorities from the regulators, and its own priorities in protecting the customer in particular?

Richard Brown:

Yeah, I think the key word there is protecting the customer. So if I think right now the FCA is spending, as Paul said, a lot of time in producing material that supports firms understand what they can do. So the guidance that was issued following COVID, it was out incredibly quick for what we typically see from the regulators, it shows how focused they are on this area in terms of protecting customers and really setting out those expectations of firms. From a firm angle though, I think I'm seeing and I'm hearing a lot of challenges in terms of lending and responsible lending. There's a lot of nervousness. So I think it's fair to say the FCA wants the market to be very strong and buoyant and lending at this point of time, but companies are telling me they're very nervous about lending, specifically around ... you know, we talk about these affordability checks and assessing somebody's ability to repay, when the chances are some of these sectors, their typical customer works in industries where salaries have been impacted. So in terms of income, there's a high chance or probability of being furloughed, or even losing their job. Expenditure, having an impact in that respect.

Richard Brown:

So what we're seeing in companies, a certain element of nervousness, which has led them to restrict lending to a lot of people. We even see firms that are currently not lending to anybody at the moment, just because they just don't know how you can safely lend to somebody. And the nervousness really comes about from future repercussions. They're very nervous about complaints being logged against them for not lending or not carrying out the right proportionate checks at this point in time, putting the onus back on a firm, saying, "You should have known that I didn't have a job or I had a reduced income." But also the element of worry around CMCs, and we have already started to CMCs complaining with COVID related complaint points, and we can only see that getting worse and worse. So it's almost like a self defense move that they're restricting lending quite significantly. And the unfortunate reality is that means that some people will just not be lent to at this point in time, rightly or wrongly.

Matthew Drage:

And Paul, just on that point, I mean, we've obviously seen the FCA move at real pace with regards to payment holidays, payment deferrals; what's your take, is this just the start of things as the FCA see it? I mean, we're still waiting for some of the broader economic indicators to come out on how the economy's faring at the moment, I mean, is this just the start that we're seeing from the FCA in terms of its payment holidays, payment deferral tactics that it's using within the sector?

Paul Dyer:

I think that's the million dollar question, to be honest with you, Matt. A lot of firms that I speak to I think are anticipating or even proactively taking steps to make sure that, one way or another, they're in control of what happens next. That could be extending some of these periods for their customers, having enhanced due diligence on those extensions when they give them out. I've heard speak of up to six months in some cases where firms are thinking, "Actually we may not be properly out of this for that period of time." And to be honest with you, it pleases me when I do hear a firm's taking their own destiny into their hands, rather than waiting to be told what to do. But I can see the uncertainty.

Paul Dyer:

The other things the FCA is also talking about, I guess, at the same time, as you've heard talk around culture quite a lot. And the FCA saying that successful business models rely on having a healthy [inaudible 00:22:16] culture, they're going to be focusing on that more. That goes to how firms treat staff, the way they make decisions and their broader conduct, which I think we'll see taking much more of a prominent place in the future. They're also increasing their emphasis on product value. To a certain extent it's couched in old TCF, treating customers fairly, language, but relates to the firm's ability to justify value for money. I think in the recent COVID letters that went out, talking around the consultation around the payment holidays, they indicated there was a paragraph in there, hidden towards the back, around product value. I think their thinking is that with interest rates at a historical low, rates of interest on savings are obviously low, linked to that, that maybe there should be some movement on the interest rates associated with types of credit. I'm not entirely convinced that that is as simple as it sounds. I know it's a very complex business. But you can see their thinking is starting to turn to broader aspects than just the responsible lending in terms of affordability checks. So I think there's a lot more to come, one way or another, Matt.

Matthew Drage:

And just as we look to wrap up today, I just wanted to focus in on key takeaways for our listeners. So Richard, just starting with you, if there was one key takeaway around getting this right in terms of affordability, responsible lending and good customer outcomes, what would be your key takeaway for our listeners?

Richard Brown:

Yeah, I think I've spoken a little bit about the DSEO letter that came out in 2018, and when I'm talking to clients I often refer them back to that. Because I think that it sets up some really good expectations of what the FCA expects you to be doing as a business. So it talks about complaint handling, learning from complaints and putting those back into the business in terms of your policies and processes. But it also does set out some pretty good expectations from responsible lending and what the checks look like. And obviously there's an associated policy statement alongside that. So I think if there's any doubt, take it back to that point and then work forward in terms of the steps that you should be doing as a business.

Matthew Drage:

And Paul, given the uncertainty in the marketplace at the moment around COVID in particular and around responsible lending in the current environment, what would your key takeaway be for our listeners today as well?

Paul Dyer:

Well, I think if I were to reflect on some of the conversations I've had with our clients' firms out there, with you and with Richard as well, I think there's a couple of things really. Embrace the regulatory interaction. So, one way or another, there is increased regulatory interaction, there is a lot going on, and the regulator's trying to learn as much as it's trying to do the right thing. So, where you can, embrace that. Think through and plan for the worse; much better to be in control of your own destiny and to think about things before they're done to you, in effect. Make sure your controls are robust. So, now more than ever, the risk is there, as well as the potential opportunities, so making sure your controls work. And finally, evidence robust decision-making. Whatever you do, make sure that the decision was appropriately challenged and it's captured in a way that if you need to, you can go back and evidence it.

Matthew Drage:

Great. Thanks very much, Paul and Richard, for joining today. Now, if you found this podcast insightful or would like to hear more from our experts and guests, just keep an eye on our website or subscribe to our channel on your favorite streaming platform. Alternatively, just head over to huntswood.com/insights. You can sign up to our mailing list and we'll make sure we keep you up to date with our white papers, blogs, videos, and yes, you've got it, more podcasts. We're always covering a wide range of topics and we want to give you pragmatic insight and guidance on how to drive better outcomes for your business and your customers. Thanks very much for listening.