Getting affordability right in consumer credit

Speech by Jonathan Davidson, Director of Supervision – Retail and Authorisations at the FCA, at Credit Summit, London.

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Speaker: Jonathan Davidson, Director of Supervision - Retail and Authorisations
Location:Credit Summit, London
Delivered on: 15 March 2018

Note: This is the text of the speech as drafted, which may differ from the delivered version.


  • A firm whose business model is predicated on selling products to customers who can’t afford to repay them is not acceptable, nor is it a sustainable long-term strategy.
  • The financial situation for some is precarious, which means firms not only need to consider whether a customer has a history of repaying, but whether they are likely to be able to do so in the future.
  • A successful business model relies on having a healthy firm culture.

Thank you for inviting me today to speak. The consumer credit sector is by far and away our largest sector in terms of number of firms with almost 40,000 firms registered with the FCA. And as a sector you have been growing – according to the Bank of England, consumer credit grew 9.3% over the last year.

This growth has been attracting a lot of attention. Which is not surprising given the link between excessive debt and the last financial crisis. Credit losses led to the near collapse of many lenders. Of course, we know it is vitally important to ensure that you as lenders are prudentially sound because you provide a key service to retail consumers and businesses. And when I say we, I mean the PRA and the FCA, because the FCA oversees the vast majority of firms in the consumer credit sector for prudential purposes.

The good news is that my overall sense is that the sector has not reached levels of debt which are likely harmful to you as lenders. And we have looked at some of the key markets including credit card and car finance markets, more on which later. We have also seen progress by your sector in addressing conduct issues – you are aware of a number of high-profile redress schemes.

So today, I want to speak less about you and more about your customers. You, the consumer credit sector, serve around 39 million people. We use your services extensively whether it is to borrow to finance a car, a computer, a sofa, to make ends meet towards the end of the month or to tide us over an unexpected and temporary drop in income. You are part of everyday life for most of us and by and large you do a good job for us, your customers.

But we also need to recognise that excessive debt can be as harmful to the borrower as it is to the lender.

After all, none of us can forget the context in which we are operating. Total credit lending to individuals is currently very close to its September 2008 peak. The circumstances are different now than 10 years ago, but there are still worrying numbers of householders who may still be in too deep. For example, 1 in 5 mortgages today are interest only mortgages, many of which were made at the height of the credit boom to borrowers with little equity in their homes and not a lot of disposable income. And they won’t mature until about 2032.

We also know that there are a number of customers out there who are vulnerable to any changes in their circumstances, and to changes to the external economic environment. They might be able to just about afford any loans you grant them today, but it is far from certain that they will be able to do so in the future.

A business model that is predicated on selling products to customers who can’t afford to repay them is not acceptable.

A business model that is predicated on selling products to customers who can’t afford to repay them is not acceptable. We will take action against firms who run their businesses this way. The £14.8 million paid out by BrightHouse last year shows how seriously we take this. And it’s not just unacceptable, it is unsustainable – the reputation damage of running a business of this kind will see confidence, and customers, drain away.

Having a healthy, sustainable business is what I want to focus my talk on today. I think there is more we can do together to consider marginal consumers, and to act now to pre-empt future harm. I want you as an industry to think strategically about the issues facing your customers. This is the right thing to do, not only for your customers, but for the future of your businesses. After all, thinking strategically about consumers leads to better innovation and greater sustainability.

I will raise three questions in my talk today:

1. What are the warning signs of future problems that you might want to think about as an industry?

2. What are the key issues we are still seeing in relation to creditworthiness and affordability?

3. How can firms pre-empt issues by fostering a healthy, sustainable business model and culture?

Warning signs

Most borrowers can still comfortably afford their credit. But it’s most – not all. The Bank of England’s Financial Stability Report last year noted that consumer credit has grown rapidly and that, relative to incomes, household debt is high. And there are a significant number of households that are in so deep that the slightest sign of rough weather could see them in over their heads.

This can be seen, for instance, in the motor finance sector. This morning we published an update on the motor finance sector, which has grown rapidly: for example, the number of motor finance agreements for new and used cars has grown from around 1.2m in 2008 to around 2.3m in 2017.

The good news is that most of this growth has been to lower credit risk consumers. However, we are also seeing that arrears and default rates, while still low, are on the rise, particularly for higher credit risk consumers. This is despite favourable credit and economic conditions, which begs the question: if we’re seeing this pattern now, what would happen if there was an economic downturn?

We are also seeing younger people borrowing a lot more relative to their incomes than my, baby boomer, generation. Why is this? It’s because of:

  • More student borrowing. Our financial lives survey showed that 30% of 25-34 year olds have a Student Loan Company loan. The higher cost of getting onto the housing ladder.
  • Shifting patterns of savings, borrowing and consumption. You don’t need to wait, you can have it now.

Among 25-34 year olds, 19% have no savings whatsoever, and a further 30% have less than a £1000 saved to use on a rainy day. Indeed, 36% had been overdrawn in the last 12 months.

At the same time, the number of self-employed people in the UK has risen by more than 1.5m since the turn of the century (a 45% increase), and more than 900 thousand people currently are on zero-hours contracts. The gig economy is growing strongly.

So the financial situation for some is precarious.

And we are seeing the potential for further rises in interest rates which could have a significant impact on the cost of debt. There has been a fair amount of attention given to this – particularly in the mortgage world. Our financial lives survey showed that among those who pay mortgage or rent, one in six state that they would struggle if monthly payments increased by less than £50. This equates to 10% of all UK adults. Of these, over a third state they would struggle with even the smallest increase of a pound or two. An unaffordable increase in mortgage payments or rent will of course also have an immediate impact on a consumer’s ability to pay their consumer credit debt.

Finally, and not talked about enough is that we have been seeing, and could see more, spikes in the cost of living. This has been driven in part by a falling pound, driving up the cost of imports such as food and energy. The Office of National Statistics’ figures show that prices including those of staples such as food and transport have grown faster than wages over the past year, putting pressure on households.

You might say that managing the impact of changes in the economic environment on the public is a societal issue and a matter for the government. It is a matter for the government, but it is also a matter for us as a regulator, and as you can see from these examples, a strategic issue for you as the industry.

Getting affordability right

Just because the credit performance is good on certain kinds of debts, doesn’t mean there aren’t problems elsewhere in the customer’s cocktail of debts.

I have talked a lot over the last few years about the importance of getting affordability checks right to prevent harm coming to your customers. The key point for today is that a credit check is not the same as an affordability check.

A few months ago, I was in Liverpool and visited a community centre where they were using a former youth club as a drop in centre for people in financial difficulties. One of the key things I learned was that a lot of the conversations were about how to prioritise payments to creditors. What would be the consequences of prioritising one debt versus another? How could they keep the computer for the kids to do their homework? How could they avoid destroying their credit rating? And I realised that just because the credit performance is good on certain kinds of debts, doesn’t mean there aren’t problems elsewhere in the customer’s cocktail of debts.

And there is more to think about yet. A typical credit check is backward looking. It relies on the future looking much like the past. So, if your customer has not had much debt and a history of meeting their obligations in the past then the assumption is that they will continue to do so in the future.

Given what I have just said about the potential rough weather that some of your customers may face in the future, I hope you can see why a backward-looking credit check isn’t enough. Will the customer be able to repay without causing them wider financial difficulties?

Our rules set this out; that you need to consider the potential for credit to adversely impact the customer’s financial situation – in other words, that the debt will be affordable. We are not overly prescriptive on how you do this. Our CONC handbook requires you to consider likely changes to customer’s situation during the duration of their credit. Our guidance to firms highlights areas for you to consider – including the future financial commitments of the customers, and the future changes in their circumstances.

By comparison, in the mortgage world, we are more prescriptive, and require that firms do an income and expenditure assessment, and test affordability of loans against future interest rate rises. This makes sense, given the length of time that you have to pay off a mortgage and the potential for rates to change over time.

So, what is the relative impact of affordability checks in the mortgage world compared to the consumer credit world?

We see that see that in the months after taking out a mortgage a typical customer significantly increases their consumer credit debt. We’ve seen a trend that households, on average, are £1100 further in debt a year after they’ve taken out a mortgage. I wonder why this is. Are consumers getting smaller mortgages than previously, while borrowing more from other credit providers, because of lower affordability checks in consumer credit? And, if so, is this right?

It seems like common sense to ask and answer questions like:

  • What might happen if rates rise?
  • What might happen if the cost of living rises?
  • Are there indicators that a customers’ circumstances – for example their job situation – could change?

However, I fear that common sense might not be that common. We have seen a lot of firms not doing affordability checks or just doing credit checks.

Although I have mentioned the rules, I hope that you also apply common sense and a forward-looking mindset. Which brings me to my final set of thoughts – about having a healthy forward-looking and customer-focused culture and approach to strategy and business model.

Healthy business models, strategy and culture

I know there are thoughtful leaders in the consumer credit industry, and we have seen this in some of the innovative products you’ve delivered to your customers. The growth of PCP contracts in the motor finance market is a good example of an innovation that has had a significant impact. These contracts don’t require the customer to repay the whole cost of the car over the life of the loan. They also provide flexibility at the end of the agreement by offering the option to return the car, buy it or use any equity built up in the purchase of a new one.

So financing of car ownership has become more affordable, allowing more consumers to have more expensive cars. Indeed, the number of point-of-sale consumer motor finance agreements for new and used cars has nearly doubled from around 1.2m in 2008 to around 2.3m in 2017.

This type of innovation, and business model diversity, paints a really attractive picture of your industry.

It is important to me that we continue this innovation in the sector, and this is why we are not in the business of specifying your business models or strategies. But they do affect the outcomes for consumers and markets so we do care deeply about them; we want to understand them and we want to make sure that they don’t cause harm.

A successful business model also relies on having a healthy firm culture. You need staff that are encouraged to be curious and questioning. Without this, firms might not realise that their business models are unsustainable and can lead not only to reputational damage, but also to the kinds of costly interventions we have been making.

What do I mean by unsustainable business models? A key observation and concern for us is that there are some business models for which customers who can’t afford to repay the principal are profitable, sometimes very profitable. This can lead to outcomes which are unhealthy for the customers. A few examples:

In the realm of high cost short term credit it turned out that you could charge an interest rate so high that customers struggled to ever escape the burden of debt. So we imposed a cap on interest rates and default charges. The high cost short term credit sector is now a lot smaller.

In the credit card market, we have found that some customers were well-nigh perpetually in debt. We found more than 3 million credit cardholders with a total of 4 million accounts in ‘persistent debt’ – paying more in interest and charges than they have repaid of their borrowing over an 18 month period. This is an expensive way to carry longer-term borrowing and can hide underlying financial difficulty. However, firms currently have few incentives to help these customers because they are profitable.

So, we have introduced significant new rules that will mean that both firms and customers are encouraged to avoid credit card debt becoming persistent in the first place, and customers who cannot afford to repay more quickly are given help. We expect customer savings as a result of our new rules to peak at between £310m and £1.3bn a year in lower interest charges.

So I have spoken about the importance of being smart about your business model and culture. What I haven’t spoken about is our proposed rules in relation to culture.

The proposed Senior Managers and Certification Regime introduces five conduct rules. Like our rules on affordability, I don’t think they are overly prescriptive; they represent the minimum standard for the behaviour of individuals.

The five conduct rules are that all financial services employees:

  • Act with integrity
  • Act with due care, skill and diligence
  • Be open and cooperative with the FCA, the PRA and other regulators
  • Pay due regard to the interests of customers and treat them fairly
  • Observe proper standards of market conduct

So you can see these are not detailed prescriptions of what to do. In fact, I like to call the SMCR the Accountability regime because it is designed to promote a culture of accountability. I hope that everyone will pause and think about whether what they are doing is right, not just tick the compliance boxes.

A healthy culture can lead to a healthy business.

The accountability regime also, in effect, says that leaders have to be clear on what they are accountable for. More importantly, they should take reasonable steps to make sure that they and those they lead do the right thing. I think a firm which has this kind of culture would see considering what harm might come from a business model to be common sense.

Feedback from many banks that have already implemented the Accountability Regime is that it has created a lot of helpful clarity on who is responsible for what and some robust and healthy conversations about real business issues. So a healthy culture can lead to a healthy business.


Which brings me back to the key point of my remarks today.

We at the FCA often talk about firms putting customers front and centre of what they do.

What does this mean in practice?

It isn’t about another compliance box to tick – a checkbox that says ‘customer wellbeing’. What it means is using common sense and judgement. It means having due regard for the circumstances of the consumers you serve. And it means thinking not only about whether a customer has a history of meeting their obligations, but also whether they are likely to be able to do so in the future.

Because, ultimately, harm coming to consumers means harm coming your way as well – be it through action on our part, or action taken by consumers themselves who vote with their feet. And a business model based on customers who can’t afford to pay you back is hardly a long-term strategy for success.

We all want the same thing – a healthy, sustainable market that serves the consumers who buy from it.

Consumer credit today is a strong performing, growing and innovative sector. I very much hope that as a sector, you will do the work now, to ensure that it also has a healthy future.