The Financial Conduct Authority (FCA) has issued a warning to the high-cost short-term credit (HCSTC) sector amid a rise in complaints about unaffordable loans.

The FCA has said it has sent a so-called “Dear CEO” letter to providers of high-cost short-term credit asking them to assess whether their creditworthiness assessments are compliant and whether borrowers should be reimbursed. It has also told lenders to inform it immediately if the cost of compensating customers with grievances will leave firms unable to meet their financial commitments.

Sean Kulan, Client Partner (Consumer Credit) at Huntswood, said “Today’s call-to-action from the FCA demonstrates that payday lenders must be more proactive in their approach to dealing with customer complaints and understanding their legacy issues. As a matter of urgency, lenders should reassess their operational procedures and seek a forensic understanding of their overall financial exposure and the ability to continue to redress consumer complaints. Firms must also assess their ‘business as usual’ lending activity to determine whether creditworthiness assessments are compliant in their current form and take remedial action where necessary to safeguard the future of the industry.”

The FCA Letter is as follows:

Dear CEO,

Firms should take prompt action to:

•Assess their lending activity to determine whether creditworthiness assessments are compliant. If deficiencies are found firms should take remedial action to ensure on-going lending activity is compliant and consider whether proactive redress may be required; and

•Inform the FCA if they are unable (now or in the future) to meet their financial commitments because of any remediation costs.

I am writing to you regarding the issues surrounding the increase in complaints about unaffordable lending (including complaints about a ‘chain’ of loans over an extended period) and to set out how we expect HCSTC firms to manage the impact.

Firms’ complaint-handling procedures should ensure that they can improve the way in which they handle complaints, in the light of relevant determinations by the Financial Ombudsman Service (‘the Ombudsman’) of complaints about the firm.

We note that the Ombudsman has recently published four examples of determinations of individual complaints about payday loans to illustrate its approach to the issues raised in those complaints. For an example, click here.  If relevant, firms should take these examples of determinations into account as part of establishing their own effective procedures for complaints handling (see DISP 1.3.1R).

Where firms identify recurring or systemic problems in their provision of a financial service, which could include problems in relation to the carrying out of affordability assessments, the firms should ascertain the scope and severity of the consumer detriment that might have arisen, and consider whether it is fair and reasonable for the firm to proactively undertake a redress or remediation exercise, which may include contacting customers who have not complained. In this regard firms are reminded of the requirement in DISP 1.3.3R which requires firms to analyse the root causes of complaints and, if necessary, to correct such root causes, i.e. lending practices.

We also remind you that where the Ombudsman makes an award or direction, such as a requirement to reimburse customers, firms must comply promptly.

We expect firms to make appropriate provision for any remediation which may be required, including associated costs (for example, fees to the Ombudsman). If doing so calls into question your firm’s ability both now and in the future to meet its financial commitments as they fall due, you must notify the FCA immediately.

We are also taking the opportunity to remind you of our requirements in respect of affordable lending. We expect the firm to review its current lending processes to ensure it is fully compliant with our rules in CONC. If the firm identifies that its processes do not comply, it should take appropriate steps to address this, which may include considering whether to cease lending until any contraventions are remedied. If the firm becomes aware or has information which reasonably suggests that there are significant breaches of our rules, it must inform the FCA immediately. The firm should explain what steps it plans to take to address the issue.

We would highlight in particular the risks in relation to repeat borrowing. These were flagged in our price cap proposals in CP14/10, in July 2014, in which we said that we were concerned that repeat borrowing could indicate a pattern of dependency on HCSTC that is harmful to the borrower. We noted that rigorous affordability assessments were key to avoiding harm in this area, and firms should ensure they are making responsible assessments of the sustainability of borrowing.

We have recently published a policy statement (PS18/19) with amended rules and guidance on assessing affordability in consumer credit. These come into force on 1 November. The new rules clarify our expectations, but they do not fundamentally alter the requirements that firms have had to comply with since we took over regulation of consumer credit in 2014. Firms will, though, need to review their policies and procedures, and how these have been implemented, to ensure that they are compliant, and can evidence this. They should also keep their policies and procedures under review to monitor compliance on an ongoing basis.

A summary of our new rules and guidance is in the Annex to this letter.

Yours faithfully,

Jonathan Davidson, Director of Supervision – Retail and Authorisations