Living on debt row – how effective will the FCA be in tackling the inherent challenges of high-cost credit?

Posted: 13th June 2018

The FCA has announced new proposals designed to protect consumers who use high-cost credit products. The changes that the FCA is consulting on follow on from its in-depth review into the high-cost credit sector. This blog summarises the proposed changes and explores the perceived effectiveness of these proposed solutions at combatting consumer harm. We also examine whether, in reality, these proposals represent a radical change to existing requirements.

What is clear from this paper, is the fact that the regulator now has a much deeper understanding of the diversity of the high-cost credit sector and the very different risks that the sub-sectors represent to consumers. Consequently, the proposed remedies differ by sub-sector and represent a shift away from a ‘one size fits all’ approach to regulation.

There are however some commonalities across the various proposals for the different high-cost credit sectors, including the desire to:

• Address information asymmetries and ensure consumers understand product benefits and associated risks;
• Support consumers to understand alternative options from the same provider or the wider market;
• Mitigate behavioural biases which can lead to poor decision making;
• Ensure consumers utilise products for the purpose for which they were intended; and
• Increase consumer control in relation to levels of debt they take on.

RISKS TO CONSUMERS

Below we consider the risks to consumers which the FCA perceives and hopes to address through its proposals.

Addressing cost concerns

The FCA is concerned that the costs for consumers using high-cost credit is, as the name suggests, high. However, it is not just high interest rates which result in customers repaying significant amounts. The FCA has noted that costs can increase with the addition of add-on products and high retail pricing on the goods bought using credit facilities, resulting in interest being payable on a larger amount of credit.

One of the solutions the FCA has proposed to address high-costs is a price cap. The FCA intends to undertake a full investigation into the appropriateness and structure of any cap it imposes and will commence this work immediately. The regulator has welcomed views from firms on less interventionist options which may help combat the harm it seeks to address. Price caps bring their own risks, potentially decreasing pricing competitiveness between providers who are more inclined to set their prices at the cap level. We would encourage firms to express their views on the effectiveness of a cap in their responses to the consultation.

The FCA has also expressed concerns that customers using high-cost credit do not shop around or consider alternative (and potentially cheaper) sources of credit. While the FCA’s research indicates that customers using high-cost credit facilities do have access to some other lines of credit, these alternatives may not be appropriate or offer the same benefits in terms of flexibility and affordable regular repayments.

Improving transparency

To address the perceived risks relating to add-on products, the FCA has proposed a point of sale ban. The FCA is concerned that consumers do not always understand the benefits of add-on products. The regulator believes that deferring the sale of these products, plus requiring firms to provide more transparent information to customers on the product benefits will help consumers make more informed choices. This is similar to the approach the FCA took in the motor sector in relation to the provision of GAP insurance. It will be interesting to see whether this strategy reduces the uptake of this product and increases customer understanding, particularly given the fact that the FCA comments in the consultation that its supervisory and authorisations work has already helped to improve transparency of information in certain high-cost credit sectors. This has however had a limited impact given these consumers’ behavioural biases.

There are also concerns about the risks (and ultimate costs) associated with repeated and long-term use of what are designed to be short-term products. There are some concerns that customers are encouraged to borrow more, risking overburdening. Where customers do request additional finance, there is a concern that customers do not understand their options and, in particular, the differences in the cost of refinancing an existing loan (which will keep weekly payments low) and entering into a new loan which will run concurrently. To combat this risk, the FCA proposes to introduce additional disclosure requirements at point of sale so that customers better understand the costs and risks involved with the various options relating to additional borrowing. Will this effectively reduce refinancing which is typically more-costly overall for a consumer? Given consumer biases and the focus on the lowest weekly cost rather than overall cost, it remains to be seen.

Clarity of credit promotions

In relation to firms who offer credit promotions, such as Buy Now Pay Later (BNPL), to ensure consumers fully understand the risk of incurring large sums of back dated interest if they do not repay the total amount within the interest free period, firms will be required to issue a notification to customers before the interest free period expires to remind the customers of the consequences of not repaying in full before the expiry date.

The FCA will not be prescriptive on when such a notification should be issued. Firms should be prepared to justify their reminder strategy; too early and the consequences may seem too far off to be given appropriate consideration, too late and customers may not be in a position to get funds together to repay at short notice, even if they want to. Perhaps a more effective strategy would be to regularly encourage customers to make smaller regular payments to ensure they can clear the balance in full in the initial period and do not incur interest charges.

Extension of existing requirements in other sectors to the high-cost credit market

The FCA also proposes to extend the current rules imposed on credit card providers (with some minor adaptions) in relation to credit limit increases, earlier intervention for customers who are suffering financial difficulties and rules on dealing with customers in persistent debt to catalogue credit and store card providers. This should not be entirely unexpected for these firms given the significant read across between how credit card products and other forms of running account credit work and the risks they present to consumers. We expect that the trend to impose existing requirements on comparable market sectors is likely to continue, therefore we would encourage firms to read the consultation in its entirety to determine whether there is read across from other sectors to their own.

Do the proposals represent a radical shift in regulatory requirements?

On the whole, no. They represent good practice in line with the FCA’s Principles for Businesses. While the potential price cap is a significant move, the proposals for other sectors do not represent a wholesale change to the rule book. The requirement for firms to be transparent about the benefits, costs and risks associated with their products, to promote appropriate options to customers, to provide clear, unambiguous information and to act to support customers in difficulties, is not new.

Whilst it remains true, that some firms in the high-cost credit sector are still not adhering to the principles of treating customers fairly, our experience from our work with firms in this sector is a real will to do the right thing by customers by making fundamental changes to their business models and assurance structures to secure better outcomes for consumers.

It is apparent however, that this will require sustained effort and commitment to embed these changes over a longer period; the onus is now on the rest of the market to follow suit and meet the standards that other firms are setting or risk facing scrutiny as an outlier.