Regulation of consumer credit market
Regulation of consumer credit market to ensure this market works well is one of the key priorities mentioned in the Financial Conduct Authority's (FCA) Business Plan for this year. Since last September the FCA has been looking closely at the development of the unsecured credit market to assess how it could regulate this sector going forward. On 2 February 2021 it published the final report on its review of the change and innovation in the unsecured credit market (the Woolard Review).
This note provides an overview of the current key challenges in this market for lenders and the recommendations made in the Woolard Review. It also discusses the possible impact that firms should be aware of and thinking about on their businesses to assess what action plan, if any, they may need to put in place to meet future regulatory requirements deriving from this review.
In September 2020 the FCA's Board asked outgoing CEO Chris Woolard to conduct a review into change and innovation in the unsecured consumer credit market, and how regulation can support a healthy unsecured consumer credit market. On 2 November 2020 the FCA issued a Call for Input, the structure of which followed the four themes of the review: drivers and use of credit; change and innovation in the supply of credit; the role of regulation in unsecured credit markets; and the impact of COVID-19 and the FCA's response. The Woolard Review considered the responses to the Call for Input together with various research, interviews and roundtables that the FCA undertook during the course of the review.
- Key challenges to this market
- While innovation can bring significant benefits, it can also pose potential consumer harms if not regulated properly. Regulatory oversight is needed to ensure that the product develops in a way which is beneficial to the end consumer.
- Newly emerging products, such as online lenders, unregulated buy now pay later (BNPL) products and advances to employees, are being promoted as an alternative to high cost credit. Some of these are akin to payday day lending, which already came under close scrutiny by the regulator.
- The FCA is particularly concerned with the growth of the BNPL market which are currently exempt from regulation. These products carry high risks and are often not perceived as credit products by consumers who can use them irresponsibly. The cohort of users of this product are already in financial difficulty and absence of any regulation of this market poses significant potential for consumer harm.
- Online lending often is not suitable for some consumers, especially who are vulnerable and need more support in making an informed decision to borrow.
- Taking from the experience of the pandemic the FCA had to act quickly to provide short term support to consumers to enable them to recover while not having an impact on their credit file. 'Masking' of credit files was needed as a blunt solution to protect consumers’ credit files from a situation out of their control, but more refined approaches were not available at the time. This had a negative impact on access to credit as lenders couldn't have a full picture of the consumer. Therefore, any alternative approaches to the 'masking' of credit files, including temporary markers, would need to be effective and responsive to a range of circumstances in the future.
- There is currently a perception that consumers receive inconsistent outcomes from different lenders when seeking forbearance; whereas consumers should expect the same outcomes regardless of what particular product they have or which lender they are with. Further COVID crisis and impact continue in the new year, which may require a rapid response from the regulator in a similar way it did in 2020. A more prescriptive and consistent forbearance may be needed to ensure consumers in financial difficulties can benefit from this as quickly as possible.
- This further warrants a need for lenders and the Credit Reference Agencies (CRAs) to work together to achieve consistency and fair outcome for consumers in the delivery and reporting of forbearance.
Outcome focused regulation
- Regulation should focus not just on affordability, but on conduct across the lifetime of the product.
- A sustainable market needs to be underpinned by regulation focused on outcomes and how consumers really use credit. Equivalent approaches and protections must be ensured where consumers use particular products as substitutes or where similar harms are present. For example, repeat use of fixed-term loans has led to loans being used in a similar way to revolving credit and with similar risks, without the same level of protection as for revolving credit.
- To achieve a more outcomes-focused regulation across the whole customer journey, changes will be needed to both the Consumer Credit Act 1974 (CCA) and the FCA Handbook.
- Key Recommendations
Changes to the perimeter
- As a matter of urgency, to bring BNPL products that are currently unregulated within the FCA's regulatory framework. HM Treasury has already confirmed that the government will legislate in imminent future to bring this into effect. An appropriate regulatory framework should be developed but it should not include other non-financial organisations that rely on the current exemption, including healthcare services and sport clubs.
More consistent approach to forbearance
- To create a more prescriptive and consistent approach to forbearance. Building on the temporary guidance in 2020, policies should be developed and overall approach to forbearance should be reviewed. This should look to set out clear outcomes for the forbearance process and firms’ responsibilities in achieving these.
- Further a review should be conducted on how forbearance is reflected in credit information and how this affects decisions made by lenders and consumers. To set clear outcomes for what reporting of arrears, default and forbearance should achieve for lenders and consumers in both the short-term and longer-term.
Outcome focused regulation
- To take an outcome based approach to regulating the credit market and set out clearly what the market should be achieving at each stage of the consumer journey and lifecycle of a product and how regulation can support that. These outcomes should be made public to ensure firms have clarity around the direction of future regulatory initiatives.
- The FCA should review repeat lending and evaluate if changes to legislation are needed to secure consumer protection. It should also explore if additional protections or guidance are needed on relending on fixed-term loans.
- The FCA must engage with the Treasury to prioritise the work on CCA reform.
- Possible Challenges and Impact from these changes
- While certain work is clearly very urgent, particularly BNPL and the response to Covid-19, delivery of the overall package recommended in the Woolard Review will take time. The FCA may put in place a programme to deliver the recommended reforms. New and updated FCA rules and guidance may emerge, but none of it is clear at this stage. Firms should monitor this development to see how this will affect their businesses, policies and procedures.
- BNPL lenders who are currently offering unregulated products should start developing action plans to put in place policies and processes to comply with regulation of these products. This may include reviewing customer terms and conditions, agreements and carrying out due diligence of the current systems and controls around affordability assessment, product governance and financial promotion.
- Although it appears that wider regulation of the Employer Salary Advance Schemes (ESAS) is not imminent, lenders currently offering them should be alive to the fact that the FCA may be monitoring this market closely and that they may need to revisit their sales processes and policies to make sure they are fit to achieve good consumer outcome.
- Lenders offering products online or digitally should bear in mind the suitability of the delivery of these products for certain cohort of consumers, especially who are vulnerable. The FCA may provide guidance on digital design in near future. Lenders may need to review their customer journey and digital platforms to ensure that key information doesn't get lost and that consumers are well informed and remain in control of their decision making.
- In light of the COVID crisis firms are having to keep their forbearance procedures under constant review. However, the FCA may revise its rules and guidance to drive greater consistency in the type of support firms offer consumers struggling to pay. This may mean forbearance rules may become more prescriptive than they currently are and firms may be required to overhaul their entire forbearance policies and procedures to meet future regulatory expectation. A drive towards cultural change and more proactive approach to forbearance may be needed. Firms may also need to review their current arrangements for reporting forbearance to CRAs and whether these are consistent and adequate.
- Repeat lending remains the focus of the regulator and new rules may emerge to afford maximum protection to consumers. Lenders should monitor any relevant developments in this space together with any possible interventions on relending of fixed term loans.
- The focus going forward is achieving fair outcome for consumers at each stage of the customer journey and life cycle of a product. In addition to making sure products are affordable, lenders need to focus on meeting consumers' needs for as long as they hold the product. Firms need to consider whether their existing TCF/conduct risk Framework and reporting is providing senior managers with clear line of sight and understanding of the whole customer journey and life cycle
HOW WE CAN HELP
- FCA Authorisation
- Regulatory change impact assessment
- Regulatory Change Transformation
- Product Governance Review
- Regulatory Health Check
- Product Life Cycle Review
- Assessment of TCF and Conduct Risk Frameworks
- Reviews and assessment of customer journeys
- Horizon scanning
- Reviews/assessment of affordability and collections processes