Credit card affordability and responsible lending

Posted: 18th August 2016

“About two million cardholders are in arrears or default. A further two million are carrying persistent debt” (Credit Card Market Study MS14 / 6.3)

Credit cards provide an important function and, if used responsibly, are a very useful tool for huge numbers of people (there are some 30 million cardholders in the UK). For many people, however, credit cards are tricky to manage and they find themselves getting into difficulties.

Should credit card providers do more to help those who struggle with managing their accounts, and help them avoid problem debt? There are several ways that firms can deliver good customer outcomes – and meet regulatory requirements while delivering tangible business benefits.

Consumer credit providers already need to have clear and effective procedures for dealing with customers who fall into arrears. But prevention is better than cure and the term Responsible Lending, as brought into focus by the recent Credit Card Market Study, provides the answer. 

Affordability

When assessing whether a customer can afford a product, the FCA sourcebook - CONC 5.2.3 - sets out the key factors that firms can check, including income and other commitments. The list isn’t prescriptive (or exhaustive) because firms are expected to understand their business well enough to establish their own robust procedures.

Responsible Lending includes weighing up whether your customer will be worse off in the long-run by taking your product, i.e. the customer outcome.

Helping customers understand the commitment

By considering customer outcomes, firms can help their customers understand what managing a credit card really means on a day-to-day basis and build good habits that will last for years.

The FCA’s recent Credit Card Market Study (MS 14 / 6.3) says that 1.6 million customers consistently make only the minimum repayments on their credit cards. On current repayment patterns and assuming no further borrowing, 5.1 million accounts will take more than ten years to clear the balance. This can create issues further down the line if the balance remains high and financial difficulty strikes from another direction (for example, unforeseen job loss).

Making minimum payments does not reduce the debt within what most people would call a reasonable period. Firms are well placed to help customers understand how to avoid long-term, persistent debt. 

What do firms tell customers about minimum payments at the point of sale? If the information leaves any customer thinking this is all they need to pay, then it’s not doing its job. The customer should understand clearly that this is not enough to run the account responsibly. For example, at the end of a 0% interest promotional period where minimum payment would make sense, do you remind customers that they may need to increase their payment in order to begin clearing the capital?

More than just the ability to pay

The FCA’s recent Occasional Paper 20 explores whether it’s possible to predict which consumer credit users will suffer financial distress in the future. The paper broadly concludes that people with a high debt to income ratio (DTI) are most susceptible to future financial problems.

Finding the DTI Ratio from credit searches and customers’ income and expenditure details could be key to deciding whether issuing a credit card to any given individual is likely to cause problems later on.

Are we saying that customers with a high DTI Ratio should be turned down flat? Not necessarily – but for some people that might be the best thing to do; as the FCA points out, it’s about affordability, not just creditworthiness.

Lending is an ongoing activity - so is responsiblity

For credit cards, lending is not a one-time event; in a sense, it occurs every time the card is used - and all the time there is an outstanding balance. Therefore, the need for Responsible Lending also continues beyond the initial lending decision.

So, to further support customers, firms could proactively help them manage their accounts on an on-going basis. 

Where there are already signs of actual or possible repayment difficulties, CONC 6.7.2R requires firms to monitor a customer's repayment record and take appropriate action. CONC 1.3G lists seven indicators that a customer is in financial difficulty. Again, could firms help customers avoid financial difficulties in the first place? Think about how you could stand out from the crowd by going the extra mile to help customers avoid problem debt altogether – where that is within your power. Some possibilities are:

• Keeping an eye on how the balance is progressing - Is it going down, remaining static or increasing? How quickly is it increasing? Where the balance is not reducing, calling the customer might bring potential issues to light early on. It could also show customers that you’re on their side and they’ll be less likely to fear opening your letters if difficulties do arise
• Checking the types of transactions that the card is being used for - Cash withdrawals via credit card might indicate that the customer is starting to experience difficulty. Firms already monitor usage patterns in fraud prevention strategies: could this be used for just seeing how the customer is getting on?
• Reminders of the commitment involved in running a credit card - Where the balance is significantly higher than was envisaged at the outset, a quick call to review affordability might pre-empt problems
• Assessing affordability when offering to increase the credit limit on a customer’s card - Increasing the balance on an existing credit card equates to offering a new credit facility and should carry the same obligation to check affordability as there was at the outset
• Consider implementing a plan for periodic affordability checks, irrespective of any warning signals - This could provide comfort for you and your customers

Great customer relationships

Developing positive strategies like these could really enhance your customers’ trust in your firm; giving them confidence that you are approachable should they experience difficulties later on.

Opening this type of dialogue with your customers at the outset of their agreements and periodically stepping in when concerns over their use of credit arise will enable you to show that you were there every step of the way and did all you could to help manage their credit card wisely.