Speech by Jonathan Davidson, Director of Supervision – retail and authorisations at the FCA, at Credit Summit in London.
Speaker: Jonathan Davidson, Director of Supervision – retail and authorisations
Event: Credit Summit, London
Delivered on: 30 March 2017
Note: this is the speech as drafted and may differ from delivered version
- The consumer credit market is constantly changing in line with the society it serves.
- We have to keep building and rebuilding our understanding of consumer behaviour in order to maintain a model of credit regulation that works for the long term.
- Since taking over the regulation of consumer credit, we, together with industry we have made significant progress in driving up standards in the sector.
- Culture plays a crucial role in determining good outcomes for consumers. Customer wellbeing should be at the heart of decision-making in firms.
- Dialogue with firms is hugely impactful in informing our thinking. It is vital that the channels of communication between the industry and the FCA remain open.
Thank you for inviting me this morning.
I’m grateful for the opportunity to speak to you about the FCA’s view of the consumer credit market today.
As society changes, the industry that serves it changes too. And it follows that the regulation of that industry must also change.
Throughout all this, open dialogue across the sector is essential.
It’s not just for the regulator to think about the implications of change. It has to be part of the culture of our sector that we all – regulator and regulated – take responsibility.
I will return to the topic of culture later in my speech but first I want to talk about some of the changes the sector has seen and what they mean.
This week marks the third anniversary of the FCA taking over the regulation of consumer credit from the Office of Fair Trading.
Over that time we’ve seen our industry evolve and change in significant ways – from the new rules under which firms operate to cultural changes that have fundamentally altered the way that great parts of the sector work.
But I’d like to start by taking a step further back in time.
Although it only came under the FCA’s remit three years ago, the consumer credit sector has served the needs of society for far longer.
Indeed, the industry, albeit in a less sophisticated form, has a history stretching back thousands of years.
So I’d like to take a moment to consider our place in what is, by any account, an ancient story.
An (ancient) history of credit
Mesopotamia, known as one of the cradles of civilisation, was a pioneer of innovation and development, counting the invention of the wheel, the development of writing and the demarcation of time into hours, minutes, and seconds among its achievements.
But it was also pioneering in some of the ways it managed indebtedness amongst its people, with rulers from 2,400 BC onwards regularly annulling the population’s personal and agrarian ‘barley’ debts for their first full year of rule.
However, society’s attitude to debt, including the availability and usage of credit and the associated attitudes to forbearance, is constantly shifting.
Jumping forward a few thousand years to the 19th century, those of us familiar with Charles Dickens will be aware of the dim view that Victorian society took of those who lived ‘beyond their means’.
And, far from being shown forbearance, or in the case of Mesopotamia having their debt cancelled altogether, debtors were imprisoned and kept in squalid conditions.
Even as recently as the post-war period, borrowing money still carried a heavy social stigma.
So, while the development of the ‘hire purchase’ model fuelled the post-war boom of the 1950s, it was very limited in scope and its availability restricted by the social and gender prejudices of the time.
The landscape today
Arriving more or less at the present day and we see the landscape has changed once again.
In 2017 consumer credit is a highly developed and innovative market, where it is not so much gender that determines availability of credit as creditworthiness checks.
From credit cards to rent-to-own to peer-to-peer, consumers now have more options than ever before when it comes to borrowing money.
In fact, the use of consumer credit in the UK has become so ubiquitous that 60% of adults now have credit cards and 40% are defined as overdraft users.
And the uses of credit are growing.
For UK consumers, purchase funded by credit is often an alternative way to enjoy an asset that they might otherwise only be able to rent (such as a home) or to bring forward the purchase of an asset that they otherwise would need to save for.
This feature of UK society is particularly striking when we compare ourselves to other European economies. Although similar to the UK in many respects, Germany has relatively low household debt, and home ownership amongst the German population is lower than in the UK.
We can also see a similar pattern for other assets: according to the Finance and Leasing Association, in 2016 alone UK households borrowed a record £31.6 billion to buy cars, a 12% increase on the previous year.
Part of this is cultural: I imagine that the majority of us in the room today grew up with the aspiration of owning the roof over our heads. This was considered, after all, as fundamental a milestone as learning to drive, getting your first job or getting married.
But it also has to do with our attitude towards debt: borrowing in the UK is simply more common, and more socially acceptable, than in many other large economies.
Use of debt to meet unexpected emergencies is also widespread. Many Britons don’t save for a rainy day anymore and StepChange estimates that over 2.5 million people are now using credit cards just to meet everyday living costs and emergency expenses.
Meanwhile, 16 million people in the UK have savings of less than £100.
Risks to consumers and the role of the regulator
The uses of debt I’ve described are not necessarily a bad thing. But they do create risks for consumers that need to be managed.
Which is where we come in.
Since taking on responsibility for consumer credit in 2014, we’ve embarked on a programme of activity focused on three big themes: affordability, treatment of customers in financial difficulties and the risks to consumers inherent in business models.
Let me start with affordability.
We know that firms are generally good at assessing credit risk. This is unsurprising when you consider that customers who do not repay loans tend to be very expensive for firms.
But under our rules it isn’t enough to just consider whether a consumer will be able to repay a loan. We must also ask if they will suffer financial distress and experience an undue level of discomfort in doing so, including if they prioritise their credit debts over other essential bills for things like utilities. And if they are unable to service or repay the debt, will they lose an asset that is vital to their well-being, like their car or the roof over their heads?
Firms have fewer commercial incentives in this area, which makes the role of culture especially important.
For this reason we implemented rules that require firms to consider whether a loan is affordable. As you would expect, given that these rules apply to one of the most fundamental parts of any lender’s business, we have been in close discussion with firms to help them understand our expectations in this area.
To this end we published a ‘common misunderstandings’ document to help firms navigate our rules, which I understand firms have found very useful. We also undertook a review of how firms across the market carry out affordability assessments. We have now almost completed this work and intend to publish more in the coming months.
This leads me on to the second core theme.
Our Thematic Review on the treatment of customers in arrears last year showed that while there are some encouraging signs of change taking place, there are also a number of areas where there is a real need for improvement.
This, too, comes down to culture.
We have found that firms who make consumer wellbeing a priority are able to agree sustainable repayment solutions with their customers. For those firms that don’t, the focus is on getting payment as quickly as possible instead, causing distress and even greater debt problems.
The basic principle is this: when firms make fair treatment of customers a core part of their business philosophy, fair consumer outcomes will follow. We expect to see firms acting on this principle.
The last theme I’d like to mention here is risks arising from business models, including how business models evolve to ensure firm’s incentives are aligned with the needs of the consumers they serve.
This has been a key consideration in our supervisory work.
The case of some of the high-cost short-term credit firms we were seeing a couple of years ago is instructive here.
It’s hard to see how a model that offers multiple rollovers, imposes multiple default charges and prioritises repayment through repeated continuous payment authority attempts could be in a consumer’s interest.
In some cases firms could still make a profit even where the customer ultimately defaulted on the loan. That’s why we introduced new rules and took strong supervisory action in this area.
But it’s not just about high-cost short-term credit. We have concerns that other high cost products and markets could be contributing to significant consumer detriment as well. This is why we have undertaken to carry out a review into high cost credit more generally. I’ll say more about this in a minute.
Our Authorisations and Supervision work has also focused on the quality of advice provided by debt management firms.
We expect firms to give appropriate advice and recommend the best solution for the consumer, not the option that generates the most profit for the firm. This is particularly important when you consider that these firms are often dealing with vulnerable customers.
As a high risk sector, we’ve long focused attention on the potential of debt management firms to cause harm to consumers.
When done right, debt management firms provide a valuable service.
But the risk in the business model is that revenues and profits are increased by having more customers on debt management plans rather than providing advice that might leave the consumer better off.
Given these risks, our authorisations process has focused on the standards of advice, the incentive schemes for staff and the degree to which firms check to see that debt management plans remain appropriate.
Our refusal to authorise PDHL last year showed that firm practices which pose a high risk to consumers, particularly those in vulnerable circumstances, will not be tolerated.
In high risk cases, the robust processes and standards we have in place around authorisations mean it has taken some time for firms to demonstrate that they meet the required standards.
So far, eight providers of debt management plans have met our conditions and been authorised. We are working closely with the debt management firms not yet authorised, and are trying to ensure that firms have a clear understanding of where they stand in the process and against our standards.
We should all be proud of the significant progress we’ve made, collectively, in driving up standards in the sector.
From a rigorous authorisations process which has seen over 35,000 firms demonstrate that they meet our standards, to the cap on payday lending charges, it’s fair to say we’ve been busy over the last three years.
And I am pleased to say that the industry has also played its part.
We should all be proud of the significant progress we’ve made, collectively, in driving up standards in the sector.
Firms are now much more aware of our expectations and act on them accordingly.
Both firms entering the regime at the authorisations gateway and those whose activity we supervise on an ongoing basis demonstrate that principles like Treating Customers Fairly, or TCF, are now a meaningful consideration in how they do business.
For the majority of the 50,000 consumer credit firms that were invited to apply for authorisation, the process has now been completed. And while some firms chose to opt out, and some didn’t meet our standards and were refused, many firms fundamentally improved their models, leading to better outcomes for consumers as a result.
So, much has already been achieved for the benefit of consumers, firms and markets.
But, as my earlier history lesson showed, the consumer credit industry is constantly changing in line with the society that it serves.
Which means it is paramount that the FCA remains a forward-looking regulator. We aim not just to keep up with the changes but wherever possible to anticipate the risks that those changes can raise.
The review of retained provisions of the Consumer Credit Act review, for example, is an opportunity to continue the development of an effective and proportionate regulatory regime which ensures appropriate protections for consumers. We will shortly be publishing a Feedback Statement that will summarise responses to the Call for Input from last year, and outlines how we will be approaching the review.
With annual growth rates running at over 10%, ongoing innovation in the sector and rapidly evolving business models it will be no surprise that we are keeping a close eye on industry developments.
There are a number of core questions occupying our thinking, and we’re keen to engage with you on their implications.
Affordability and vulnerable consumers
The first question is whether the growth in lending brings with it unacceptable risks to affordability.
Commentators have pointed out that much of the increase is in areas with low default levels, implying that risks to affordability for the average consumer of credit are not significant. This is an analysis that is – at a high level – hard to disagree with. We know that very few people fail to repay their loans or end up in arrears. Most people who use credit do so without any problems.
What you don’t see from the headline figures, however, are the pressures faced by non-prime consumers and it’s crucial we look beneath the numbers at those smaller, but higher-risk, areas of consumer credit.
Sectors like high-cost short-term credit, rent-to-own and sub-prime broking, while relatively small, still require the continued vigilance of the regulator to ensure consumers don’t suffer detriment.
This distinction between the macro and micro issues in the consumer credit market help explain why we choose to focus our efforts where we do.
I don’t need to lecture anyone in this room about the important social function consumer credit fulfils, or its broad economic benefits as both a borrowing and a transactional medium.
But, as we all know, some users of credit are both vulnerable and highly indebted. For these consumers, consumer credit can have a pernicious effect.
That’s one of the reasons why consumer vulnerability was one of the central themes in our recent consultation on the FCA’s future Mission. We are currently considering responses to the consultation and will be publishing the Mission itself next month. We also intend to say more about our strategic approach to regulating consumer credit in the near future.
Growth and change and in the car finance market
Our analysis has showed us that changes to the car financing model have played a major role in the rapid growth in lending figures.
The biggest of these changes has been the shift towards Personal Contract Plans (PCPs), and the lower monthly payments required by these plans have acted as a significant driver of growth in car sales and financing volumes.
Relevant here is not just the question of affordability, but also whether consumers are able to compare and choose effectively between financing options. The range of products available means that consumers’ choices are not always straightforward and they may have to take account of a number of variables in order to determine the most suitable product for their circumstances. These variables will depend on their attitude towards ownership of the vehicle at the end of the contract and the amount they want to pay on a monthly basis.
So you can see that there is a lot to think about in assessing whether consumers are achieving good outcomes in the car finance sector.
This is clearly front and centre of our thinking as the regulator, but it’s also something that should be impacting the decisions made in the sector. Once again, the key to this is an industry culture that puts consumer wellbeing at its heart.
The waterbed effect
I’d like to turn now to another notable feature of the modern consumer credit landscape: the growing interdependence of markets and products.
Products do not exist in isolation from each other. Indeed, many consumers have ‘portfolios of debt’, that is, they use several different types of credit, each potentially with very different costs, characteristics and uses. Some consumers have multiple providers of the same kind of credit, such as credit cards.
Our Call for Input on High Cost Credit, which closed last month, is looking at high-cost products as a whole as well as overdrafts to build a full picture of how these are used, whether they cause detriment and to which consumers.
This includes a review of the payday loan price cap. This will include examining if there is any evidence that the price cap has caused consumers to turn to other sources of credit, or even to illegal money lenders.
This is the so-called ‘waterbed’ effect our CEO Andrew Bailey has spoken of.
Two years on from the introduction of the price cap it appears to have lessened many of the immediate problems for payday users, but it makes sense to review the effectiveness of this measure now.
Reviewing the payday cap in the context of related high-cost markets, such as overdrafts, allows us to understand how interdependent these products really are. We also want to understand how consumers interact with such products, and where their use can lead to bad outcomes such as long term indebtedness and damage to a customer’s credit rating, without prospect of improvement.
The end result will be a clearer picture of the market overall and, ultimately, more joined-up protection for consumers.
We expect to publish findings on the review of the payday cap in the summer and at the same time outline the next stage for our review of High Cost Credit products more broadly, which we expect to run from 2017 onwards.
Unsuitable use of debt
It’s perfectly likely that a consumer’s debt portfolio will include products which provide flexible, appropriate means of meeting short-term emergencies and spreading out the cost of purchases.
However, these same products can become extremely expensive and difficult to repay if used as longer-term sources of credit. This is something we saw in the findings of our Credit Card Market Study, published last year.
The profile of consumers who use credit card debt in this way, making very low repayments and consequently incurring high costs, is varied.
Some of these customers are on the edge of their finances, unable to do more than make minimum repayments. Others are not in financial difficulty but have rather ‘drifted’ into persistent debt through slow repayment of debt.
Whatever the reason, these customers are profitable and so firms do little to intervene.
While we will continue to take action to understand and mitigate against this type of risk, it is beholden on industry to consider and address these problems themselves.
After all, firms see these patterns of consumer behaviour themselves directly and we expect this exposure to drive attitudes and culture accordingly.
Affordability and appropriate forbearance: moving forward
The interdependence of debt markets throws up some big questions for the industry about the meaning and definition of affordability and appropriate forbearance, none of which have easy answers.
For example, affordability and creditworthiness may not be the same thing.
Consumers will often prioritise paying back a loan on a home or car, even if this makes meeting obligations on other forms of debt challenging.
This essentially makes these assets look more affordable than they are, yet this won’t necessarily become obvious until it translates into the poor credit performance of other debts.
It is also worth noting that if the value of homes or cars falls into negative equity the seeming creditworthiness could shift quite quickly and dramatically.
On forbearance, our recent work on customers in early stages of arrears showed that firms are making encouraging progress.
With affordability relatively hard to define in absolute terms, this, again, comes down to culture. And those firms that put consumer wellbeing front and centre of their business models are not only more likely to be compliant, they will also be better business propositions. As I mentioned before, we plan to say more on the assessment of affordability soon.
The culture of the consumer credit industry
So, both industry and regulator face a number of important issues that we need to address together.
We aim to be forward-looking and pre-emptive, and expect industry culture to follow suit, with consumers always at the heart of decision-making.
Indeed, we are far more interested in ensuring that consumers get good outcomes from their encounters with credit firms than we are in looking for technical breaches or minor errors to punish.
Firms who show that principles like TCF are integral to their business will generate far less regulatory concern with us than firms who focus on doing the bare minimum to see what they can get away with.
The unique culture of a firm shapes the decisions its employees make, ultimately leading to behaviours that determine the conduct, either good or poor, of that organisation. This can lead to good or poor outcomes for consumers at the other end.
It is pertinent to mention here the forthcoming extension of the Accountability Regime (also known as the Senior Managers and Certification Regime, or SMCR), which will include consumer credit firms.
The Regime is designed to ensure that individuals, as well as firms, are accountable for the way that they conduct themselves.
Senior managers will be expected to take reasonable steps to ensure that the areas under their remit are conducted appropriately and that people whose conduct has a major impact on consumer outcomes are fit and proper.
Employees who have an impact on consumer outcomes will also be held to account for their conduct by being subject to conduct rules.
All of which means that when things go wrong the SMCR will enable us to hold individuals to account.
We will consult on our proposals this summer, with the intention that the Regime will start from 2018.
We have to keep building and rebuilding our understanding of consumer behaviour in order to understand how best to work in their interests.
To close I’d like to reiterate what I said at the start of this speech.
The FCA will continue to be a proactive regulator, demanding high standards of conduct from industry and never flinching from our responsibility to protect consumers and enhance the integrity of the market.
But this has to be a conversation, not a monologue.
Dialogue with firms is hugely impactful in informing our thinking, and it is vital that the channels of communication between the industry and the FCA remain open.
Last month’s Live & Local in Glasgow, our regional roadshow, shows our belief in the value of open discussion with firms, and our commitment to working with industry, not against it.
We won’t shy away from improving existing rules, removing unnecessary rules and imposing new rules where they are needed.
And we will remain open to ideas.
In an industry that is constantly adapting to serve the changing needs of society, we have to keep building and rebuilding our understanding of consumer behaviour in order to understand how best to work in their interests.
That means not just looking at the next set of projects and problems to solve, but also maintaining a model of credit regulation that can adapt to the challenges of the future.
Ultimately, the continued success of the sector relies on us – the regulator and regulated – working together to secure the outcomes we all seek: a flourishing, innovative sector that puts customers front and centre.
I look forward to working with you to achieve that.