The FCA’s thematic review on early arrears management in unsecured lending has painted a varied picture across the industry in relation to the treatment of individuals in arrears.
Indeed, various organisations are now calling for a “breathing space” which would see customers given a grace period from which to start to put their finances back on track in the event they are experiencing genuine financial difficulty.
With access to credit being widespread (not to mention the sheer variety of customers’ individual circumstances and reasons for seeking it), the risk of customer detriment is very real if an arrears situation is not identified and actions are not taken to mitigate the risk of detriment.
Early Identification remains the key
The issue of a customer entering an arrears situation can be complex and multi-faceted (both within the secured and unsecured markets), however, early identification is undoubtedly key. With an increasing array of consumer data available, firms should consider how they are using this data to assess individual customers’ circumstances. With this in mind, how does your arrears handling policy link to your broader conduct risk framework?
The FCA has published an occasional paper on the very topic of financial distress (OP20), which looks specifically at how the industry can “predict which consumer credit users will suffer distress”. One method (which combined objective and subjective measures of financial distress) from the paper found that 17% of people with outstanding consumer credit debts are in moderate to severe financial distress.
Given the continued growth of the consumer credit market within the UK (and the notable size of the population deemed to be in financial distress), firms should be even more aware of the potential for an increased number of consumers to enter into an arrears situation. Firms should have plans and procedures in place to be able to identify these consumers and support them in mitigating the risk of a serious arrears situation arising.
Fees and charges should be fair and not automatically bundled
Within the consumer credit market, the regulator has focused closely on fees and charges for customers who enter arrears. The read-across from the issue of auto capitalisation of mortgage arrears to other unsecured and secured debts is one which firms should take seriously and start to identify whether such practices are still occurring across broader product suites.
Where fees have been applied incorrectly or cannot be justified given the consumer’s circumstances, firms are likely to be in breach of CONC 7.6 under the continuous payment authority rules and should consider actions to ensure that consumers have not been incorrectly charged.
Persistent debt is a lagging indicator – how can the focus shift to early intervention?
The regulator’s recent focus on persistent debt, following on from the credit card market study, is further evidence that the FCA is moving towards mandating support for customers who have long-term debt within the cards market and are unable to complete repayment of outstanding balances. The pressure for firms is now being applied at both ends of the arrears spectrum. The regulator is keen that firms identify consumers in financial difficulty early and apply appropriate forbearance techniques. If this does not occur and consumers remain in long-term financial distress, the regulator is showing that it will mandate new behavioural techniques and forbearance strategies on behalf of firms.
The FCA is also working closely with the PRA to look at the wider macroeconomic environment, which has seen the sustained growth of consumer credit within the marketplace. Both affordability and creditworthiness are key areas of focus and the regulator has announced this in its recent business plan. It has committed to review the point-of-sale procedures within the marketplace as part of an upcoming thematic review and is also looking closely at product suitability (focusing on the motor finance market with an initial emphasis on Personal Contract Plans or PCP).
There can be no doubt that getting this right at the front-end in terms of sales and product suitability is key to preventing potential difficulty arising further down the line. This is an example of early intervention, deeming that the customer is not suitable for the particular product at the outset using the data available within their business to make an informed and upfront decision.
Given the increased focus, what steps can firms take?
There are a series of powerful tools already in firms’ armouries, including outcomes testing, which can be risk-based and look at the population of consumers with the highest risk of detriment. This will ultimately help firms determine whether they are treating customers fairly. Outcomes testing will also support in stress testing your firm’s systems, policies, procedures, staff training and performance management, ensuring they are working together effectively to ensure the holistic fair treatment of customers. A recent Huntswood article outlines five areas we believe firms should consider.
Ensuring you are well equipped to deal fairly with customers who are in financial distress or arrears will remain a key focus area for the FCA across the marketplace. Firms should use key risk indicators (for example, a customer’s debt to income ratio) to continually assess an individual’s circumstances and take action where necessary to reduce the risk of a serious arrears situation materialising.
Given the regulator’s continued focus in this area, firms should actively consider their approach to assessing individual customer circumstances, thinking about how they can best use the data available to plan mitigation techniques accordingly. Firms taking a proactive approach in this area can ensure they treat their arrears customers fairly from the moment they begin to experience difficulty.
Matthew Drage – Head of Regulatory Development at Huntswood