Today, the FCA has published its long-awaited Consultation Paper (CP) Assessing Creditworthiness in Consumer Credit, which seeks to clarify what the regulator expects of firms when assessing creditworthiness and affordability. The FCA believes this is in line with its commitment to improved transparency (as set out in its Mission) and that it will make it easier to supervise the credit markets.
Alongside this consultation, the FCA has also published:
- A Feedback Statement on its recent Call for Input on High Cost Credit (and review of the High Cost, Short-Term (HCST) credit cap)
- An Occasional Paper (OP28) Preventing financial stress by predicting unaffordable consumer credit agreements : An applied framework.
- Assessing creditworthiness in consumer credit: Research findings
- A new web page on motor finance
This email provides an overview of the FCA’s consultation on Assessing Creditworthiness and its new web-page on motor finance.
A separate email will be circulated today with details of the FCA’s Feedback Statement on High Cost Credit.
The FLA’s Regulatory Reform Working Group meetings on 6 September and 4 October will consider these papers in detail and the FLA’s response. If you would like to attend, please contact Hanifa.Teladia@fla.org.uk
What is the FCA seeking to do?
The FCA sees ‘creditworthiness’ as comprising credit risk and affordability and wants to ensure that appropriate account is taken of affordability where it is not fully aligned with credit risk. The FCA’s research has confirmed that most firms do consider affordability in some form and that the majority of existing processes appear appropriate. The FCA says that most firms believe they are compliant with CONC, but are looking for reassurance of this and would welcome greater clarity. However, the FCA found that practice varies considerably, with evidence of under-compliance as well as firms with unnecessarily costly or restrictive processes.
The FCA has proposed new rules which are aimed at clarifying its expectations, but it does not believe that its basic approach to creditworthiness (focusing on high-level principles and proportionality) needs fundamental change. As the credit market is ‘so broad and varied’, the regulator is not minded to prescribe what checks should be made and what information should be obtained/verified – either in general or across particular sectors. The FCA is very clear that it does not want to be too prescriptive, as this could have unintended consequences for the cost and availability of credit. The FCA says that firms will need to take a proportionate approach, which looks at the costs and risks of the credit for the customer and the probability they may suffer harm as a result of the credit.
In the CP, the FCA says that greater prescription could lead to a ‘box ticking’ approach rather than a proper assessment of the individual customer’s affordability.
The new rules are intended to make clear:
- The distinction between affordability and credit risk: there will be a new definition of ‘affordability risk’.
- Factors which should be used when designing affordability checks
- The appropriate role of income and expenditure information in lending decisions, and
- The regulator’s expectations of firms’ policies and procedures, which should focus on outcomes.
The FCA refers to the variety of methods currently in use to assess credit risk and affordability – both automated and manual. While they do not discourage automated processes, they say that where firms use them they must have appropriate policies and procedures in place to manage the risks. A similar approach is expected where firms are using credit reference agency (CRA) data and modelling as part of underwriting decision-making.
The FCA makes it clear that it is focusing on credit which is ‘profitable but unaffordable’ and that the new rules are aimed at making lenders look at the customer’s wider financial situation. But the aim is not to promote cumbersome assessment processes, and the regulator notes that using ONS data can sometimes be a more reliable means of assessing affordability. The FCA believes its proposals should result in minimal additional costs for firms.
What did the FCA’s research find?
The FCA’s research found that:
- 96% of firms use CRAs, 48% use two or three CRAs, and 54% use three or more CRA products.
- 74% of firms always take account of individual income but 10% (mainly larger firms) never do so.
- Where firms do take income into account, 74% verify it.
- 69% of firms always take account of individual expenditure and 41% verify it.
- 81% of firms use information about employment status.
The FCA’s research also found that the majority of consumer credit customers were either not in financial distress or were at low risk of financial distress, and that only 7% of customers were in severe financial distress.
The FCA notes the research should be treated as ‘indicative’ only, due to the sample size.
The FCA’s findings also highlighted the wide variety of behaviour between sectors and according to whether the market was prime or non-prime. Also relevant was the amount of credit applied for, duration, distribution channel and how long the firm had been established. Firms serving prime customers were more readily able to rely on CRA data than non-prime lenders – where credit files could often be ‘thin’.
Proposed rule changes
A summary of all the changes can be found in Table 2 on page 25 of the CP and include the following:
The FCA intends to apply a single creditworthiness requirement to all firms. There are currently some firms who are subject to a parallel obligation to assess the potential for the credit commitments to negatively affect the customer’s financial situation – which the FCA now sees as ‘complex’ and ‘confusing’. However, non-commercial agreements and small borrower-lender-supplier agreements for restricted use credit will be excluded as they were initially included within the CONC creditworthiness regime as an oversight. The rules will also be applied, without limitation, to agreements to finance payments arising on, or connected with, a person’s death.
Transitional provisions are proposed to deal with applications which are already underway when the new rules come into force.
Under the current regime, a lender must make a reasonable assessment of creditworthiness when granting credit or significantly increasing the amount of credit or credit limit. The FCA does not intend to prescribe what is ‘significant’ but the regulator will make it clear that a significant increase can be made up of a number of separate increases, which may collectively be significant.
Meaning of affordability
The FCA will clarify that creditworthiness includes both credit risk to the lender and affordability for the borrower. Lenders will be required to consider the risk to the customer of not being able to make the repayments:
- As they fall due over the life of the credit agreement, and within a reasonable period in the case of an open-end agreement.
- Wholly out of income, unless the customer has clearly indicated an intention to repay using savings or other assets. (This means the customer’s income)
- Without the customer having to borrow to meet the repayments or being unable to meet other financial commitments, and
- Without the repayments having a significant negative impact on the customer’s overall financial situation.
Changes are also proposed to the Glossary Terms ‘sustainable debt’ and ‘unsustainable debt’ which are used in CONC 6.7.
Income and Expenditure
The rules will make it clear that a firm does not need to estimate or establish the customer’s income (or disposable income) where it can demonstrate that it is obvious in the particular circumstances that the credit is affordable. This could arise, for example, where a small amount of credit is offered to a customer who shows no signs of financial difficulties, and no adverse information appears via a CRA check. Where this is not the case, the lender will be required to take income into account in the assessment. This could include firms using estimates based on employment status or using CRA data. Firms will need to show they made a reasonable assessment in the circumstances. Where firms are required to establish or estimate income, they must also establish or estimate disposable income unless it is clear this would have no impact on affordability.
A new rule will specify that the extent and scope of a creditworthiness assessment in a particular case – and the steps needed to ensure the assessment is reasonable – depend on, and are proportionate to, the individual circumstances. The volume and content of information that must be taken into account when assessing creditworthiness will depend on the affordability risk.
Open-end and running account credit
Currently, for an open-end agreement, such as a credit card, a firm should make a reasonable assumption about how long the credit facility is likely to be for. This will be made into a rule. There is a linked provision for running-account credit – which will also be made a rule. When a firm assesses affordability and sets a credit limit, it should satisfy itself on the customer’s ability to repay using a number of different assumptions. The firm should assume that the customer draws down the full credit limit on day one and repays by equal instalments over a reasonable period. The firm should consider the typical period of repayment for a fined-sum loan for the same amount. Firms will also need to make reasonable assumptions about likely further drawdowns and repayments over the likely period.
As well as assessing the borrower’s creditworthiness, the lender will need to assess the potential for the commitments under the credit agreement to have a significant negative effect on the guarantor’s financial situation. This assessment does not need to be as detailed as that undertaken for the borrower, but it should have sufficient depth and scope, taking into account the obligations which might fall to the guarantor.
The FCA also proposes corresponding changes to the requirements on P2P platforms – which would require the platforms to make a creditworthiness assessment as an important consumer protection. Such assessments will also be required when there are significant increases in the amount of credit/credit limit provided.
Policies and procedures
Firms’ policies and procedures will need to be in writing and must set out the principal factors to be taken into account when assessing creditworthiness. These will have to be approved by the firm’s personnel or governing body. There will also be additional requirements which build on the obligations under SYSC – which will require firms to assess and periodically review the effectiveness of their policies and procedures for creditworthiness assessments and the firm’s compliance with these and CONC requirements. Firms will need to maintain sufficient records of transactions and maintain robust governance arrangements.
Accessing and using data
Taking into account the extensive use made of CRA data as part of the credit application process, the FCA has invited feedback on a range of issues including the development of CRA products, the fact that not all data is shared across the three major CRAs leading to inconsistencies, how quickly the information is updated, and the differences in how firms report data across the CRAs.
Alongside the documents on high cost credit and affordability, the FCA has today launched a new web-page on motor finance. The first post is a two-page document summarising the exploratory work already underway in this market.
The FCA says (as they did in their recent Annual Plan) that they are looking at the market to “develop their understanding of these products and how they are sold” and to assess whether consumers are at risk of harm. They say their work is designed to “help them answer these questions” and decide what further interventions may be necessary. They note that the risk to consumers from PCP is “more limited” (than for lenders) but may be “heightened where there has been an inadequate assessment of affordability or a lack of clarity for the customer”. They note that lenders may apply price and commission caps to dealers, and that manufacturers may support the market. They say that, as some of these factors may not apply in the used car market, there may be a greater risk that finance is used to generate a margin. They also point out that the car finance market covers a wide range of products other than PCP and that it is important customers understand the features of the products they are buying.
The FCA says their further work in the motor finance market will cover responsible lending and affordability, dealer commission arrangements, customer information, and RV risk. All of these areas are of course included in the work programme on motor finance recently agreed by the Motor Finance Division Management Committee.
The FCA say they will next publish an update on their motor finance work in Q1 2018.
We will be responding to the credit-worthiness consultation by the FCA’s deadline of 31 October 2017. We’ve had a conference call with the FCA today and regular discussions will be held over the consultation period on different aspects of the consultation.
If you have comments on the proposals, we are very keen to hear these. We are also organising meetings on 6 September and 4 October when members can discuss the changes in more detail (see above).