Risk appetite: the credit industry bares its teeth

Dec 1, 2024

6

min read

There has been a lot of talk in recent weeks indicating that too much regulation has been constraining the financial services sector, with possible negative consequences for economic growth. If only needless bureaucracy could be swept away and the ‘animal spirits’ of the market released, economic growth would be boosted to the benefit of all.

The Chancellor’s speech to the Mansion House¹ on 14th November, and her subsequent remit letter to the Financial Conduct Authority set the general tone:

“It was right that successive governments made regulatory changes after the Global Financial Crisis… to ensure that regulation kept pace with the global economy of the time… but it is important that we learn the lessons of the past. These changes have resulted in a system which sought to eliminate risk taking. That has gone too far.”

However, the Chancellor’s speech was primarily concerned with issues of investment and pensions reform, and her remit letter to the FCA² was balanced:

“While pursuing your operational objectives of securing an appropriate degree of protection for consumers, protecting and enhancing the integrity of the financial system, and promoting competition in the interest of consumers, you should also consider how you can enable informed and responsible risk-taking by authorised firms and customers.”

Nevertheless, the result has been for the FCA to open discussions about its ‘risk appetite’ and the consumer credit industry has already started to bare its teeth in these.

Just six days after the Mansion House dinner, the Director General of the Finance and Leasing Association (‘FLA’), Stephen Haddrill, gave evidence to the House of Lords Financial Services Regulation Committee³. He took little time to complain about the responsible lending requirements for his members:

“I particularly want to mention…we have had a 30% reduction in lending to the less well off, the non-prime sector. Those people particularly need credit to manage the course of their lives, and they have been seriously disadvantaged as a result of that. Since 2019, when the responsible lending regulations came in, instead of turning down some 60% of applications from that sector of the population, firms have been turning down about 80%. Some of those definitely should have been turned down—I accept that entirely—but I think it has gone too far and needs to be reversed.”

It isn’t immediately obvious which responsible lending requirements the FLA are referring to here as these were originally put in place by the FCA in 2014 when it translated the Office of Fair Trading’s previous Irresponsible Lending Guidance into rules. However, the FCA did update those rules in November 2018 , including by⁴:

1. Clarifying that a firm did not need to estimate or establish the customer’s disposable income where it could demonstrate that it was obvious that the credit was affordable.

2. Providing a new definition of ‘affordability risk’, in “terms of the risk to the customer of not being able to make repayments or of these having a significant negative effect on their overall financial situation.”

3. Making it clear that a firm shouldn’t lend, or “significantly increase” the amount of credit or the credit limit, unless it had carried out a creditworthiness assessment in accordance with FCA rules and had proper regard to it in respect of affordability. This was implicit in the previous rules but was made explicit. Whilst the FCA did not define what constituted a “significant increase”, it did clarify that this could occur because of several separate increases which were not significant in themselves.

4. In circumstances where it was not obvious that the credit would be affordable, an assessment of the borrower’s income and expenditure was required. When conducting these, firms needed to take account of “reasonably foreseeable” changes in disposable income if these were likely to “materially affect” the assessment. The FCA also clarified its definition of “non-discretionary expenditure” to include obligations which may have been made with other people in the household (e.g., to pay towards their share of household bills) or other non-contractual or statutory obligations, such as payments being made on Debt Management Plans.

The FCA also wrote a "Portfolio letter" in March 2019⁵ warning high-cost lenders of their apparent disregard for trapping people in spirals of repeat lending, which indicated it would step up its supervisory and enforcement work in these areas.

None of the 2018 changes, nor the supervisory focus on lenders trapping people in a spiral of increasing indebtedness, appeared particularly contentious to us at the time (or now). It is difficult to see how either could have resulted in a contraction of responsible lending to lower-income or ‘non-prime’ groups. It is to be hoped they reduced lending of the clearly irresponsible kind.

The FLA seems to be arguing that its members are responsible lenders whilst seeking to get rid of the rules that require them to be so. Past evidence indicates that unless such rules are in place, many lenders are predatory in their behaviour. If the FLA is correct in its assessment that the changes to the regulations directly led to such a dramatic reduction in lending, then it would indicate that irresponsible lending was rife prior to their introduction.

But the FLA is guilty of disregarding changes in wider economic conditions which have been of much greater importance. Since 2019, these include the Covid pandemic - which hit lower income households particularly hard - and one of the worst cost-of-living crises in living memory. Both of these came on the heels of a lengthy period of austerity since the Financial Crisis of 2007/08 that had already shattered the financial resilience of lower income households. It is hardly surprising – and very little to do with regulation - that far fewer of those households can now afford to take out credit.

The FLA, however, views the regulatory changes of 2018 as the only possible culprit. In their evidence session in the Lords, the FLA not only criticised the FCA’s creditworthiness and affordability rules but also called for the Financial Ombudsman Service to be reformed and placed under closer control by the FCA, and for complaints to the Ombudsman to be time limited. They also bemoaned the recent Court of Appeal judgment concerning the illegality of secret commissions in the motor finance sector.

Such a blinkered approach from some quarters of the credit industry is to be expected. High-cost lenders have never been interested in addressing poverty, only in exploiting it.

More worrying, however, are recent indications that the FCA is taking these calls to water down consumer protections seriously.

A speech given by the FCA’s Executive Director for Markets - Sarah Pritchard -on 28th November⁶ welcomed government’s commitment to put in place a new National Financial Inclusion Strategy, and, rightly, emphasised the importance of regulatory interventions to secure fair value for customers – referencing the FCA’s work to curb excessive overdraft charges and high unarranged overdraft fees.

But the speech also included these remarks concerning Buy Now Pay Later:

“..as we design the regulatory framework for Buy Now Pay Later (BNPL) – which we have long called for – we’ll seek feedback on how to design appropriate consumer protections with flexibility for firms to grow and innovate.

BNPL products can offer real value to people at critical points in their lives, and we need to think carefully about affordability rules – setting them too high risks excluding people from the benefits of BNPL credit.

So, we will use this as an opportunity to examine our risk appetite, as directed in our remit letter.”

This should be of extreme concern to everyone who remains committed to responsible lending.

Neither the forthcoming regulation of BNPL nor the National Financial Inclusion Strategy should be used as a trojan horses to unwind vital protections in the consumer credit market.