Consumer Credit and Responsible Lending- a consumer perspective from the UK

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1 Consumer Credit and Responsible Lending- a consumer perspective from the UK IBA conference, Buenos Aires, 14 October 2008 Sarah O Neill, Head of Policy, Consumer Focus Scotland Introduction Credit is good for consumers and necessary to sustain the modern economy. It is now a part of everyday life for most of us, helping us to budget and to cope with emergencies or cash flow problems. It allows us to borrow in times of need and repay through smaller affordable repayments or deferring repayment to a time when our financial circumstances are better. Most people use credit sensibly - it only becomes a problem when it turns into unmanageable debt. This has an adverse impact on the borrowers themselves, and also on lenders and society as a whole. Over-indebtedness can cause borrowers to suffer from stress, depression and mental health problems. It can lead to homelessness, crime and violence. It can make it hard for people to get a job or a home, and access to future credit will be restricted. Over-indebtedness brings major costs to the state as a whole to the health service, housing authorities, legal aid and advice services, and the stress and consequent absenteeism has an impact on productivity. Over-indebtedness impacts on creditors by increasing the costs of chasing and writing off bad debts management and administrative time, the cost of employing debt collectors and lawyers, and going to court where necessary. This 1

2 is a huge cost - in 2003, the UK government estimated the cost of recovering 2.5% of current outstanding unsecured consumer credit to be approx 6-800m. 1 In the current credit crunch, we are all paying as a society for the irresponsible actions of some financial institutions - both at home and elsewhere. As a result, it is now becoming more and more difficult to get credit - people can t get mortgages, harder to get loans. This is not good for consumers - we need to find a balance where creditors lend responsibly and provide consumers with the money they need without either creditors or consumers taking on too much risk. It is best for everyone- both creditor and debtor- if lending is done responsibly in the first place. Most major lenders are fairly responsible, but there have been regular reports from advice agencies in the UK of people on welfare benefits being offered large sums on credit. Consumer credit in the UK Since the introduction of the Consumer Credit Act 1974, the consumer credit market has changed fundamentally. The single biggest change has been the huge rise in use of credit cards and amount owed on them. The UK has the most developed credit card market in Europe, accounting for around a third of all EU transactions 2 - e-commerce is a major driver in take up and use of credit cards credit cards (growth from 1 in 1971) Recent review of Consumer Credit Act comes from Europe- new directive forthcoming. In 2008, total UK personal debt stands at nearly 1.4 trillion an increase of nearly ten per cent on 2006, of which total lending secured on homes stands at 1.2 trillion. The level of secured debt as a percentage of disposable income reached 126 per cent in the third quarter of 2006, while unsecured debt as a percentage of disposable income amounted to 26 per cent. This is a 1 Source: Fair, Clear and Competitive: the Consumer Credit Market in the 21 st Century, Department for Trade and Industry, December Competition in UK Banking A report to the Chancellor of the Exchequer, Don Cruickshank, 2000 report 2

3 considerable increase on the levels of 76 per cent and 15 per cent respectively in the late1980s (P.92, Financial Risk Outlook, Financial Services Authority 2007) Much of the massive increase in total personal debt can be attributed to the housing market- growth in house prices and dependency on property, but still mush of this is unsecured. The average household debt including mortgages in May 2008 was 57,4208. (Debt Statistics, Credit Action, May 2008) In 2006/7, Citizens Advice Bureaux in England and Wales received record numbers of debt enquiries a total of 1.7 million, an increase of 20 per cent over the year and double the figure of ten years ago. Debt is now the number one issue the bureaux advise people on; accounting for one in three of all enquiries. CAS figures- consumer debt single biggest issue-60,870-14% of all enquiries, up by 4% on the previous year. Why? partly irresponsible lending. Of course, this must be balanced by responsible borrowing- consumers have a responsibility to ensure they do not take on too much debt. But financial products are complex and some groups are particularly vulnerable, and need to be protected. The credit market has changed so much over 30 years, it is no longer adequate to do its job. Need for greater protection for consumers Act. We want consumers to have access to legal money lending at reasonable rates - not pushed into the hands of illegal moneylenders (those without a credit licence). Scale of the problem 2007/8 CABx gave advice on over 900,000 consumer credit and debt problems- 140,000 credit card debts alone. 3

4 Most people can pay their debts their problems start with changes in their circumstances. However, irresponsible lending can exacerbate debt problemsover 30% of debt clients said debt problems were due to over commitment. CAS research -34% of debt clients mentioned access to credit as a reason for their debt. Concerns of UK government about levels of over-indebtedness- published Action Plan in 2004 for tackling the problem- since then it has produced annual reports on progress. Strategy includes taking action to: Provide access to affordable credit Improve financial capability Encourage saving and asset ownership Tackle poverty Strengthen consumer protection- ensuring that consumers receive appropriate information, that responsible lending is underpinned, that malpractice is prevented and borrowers have access to redress Enforcement against illegal loan sharks and oppressive debt collectors Provide debt advice Things have gone too far the other way following the credit crunch banks are becoming risk averse- in mortgages, but even more so in relation to personal loans/overdrafts/credit cards. Bank of England figures show that the average interest rate on a 5000 loan has risen by more than 3%; on a loan by 2%. The banks are factoring in the impact of the economic downturn on the ability of customers to keep up payments. This makes sense, but causes a problem if it goes too far- exacerbating the downturn by restricting credit and making it more expensive. Banks see this as reflecting the increased risks of lending, but it means they will only lend to the minority of borrowers who are seen to be a good risk. 4

5 What is irresponsible consumer lending? Irresponsible lending can take many forms, but in essence it is about treating customers unfairly, as well as irresponsibly. It can include a failure to provide clear and well presented information on products and interest rates, making it difficult for customers to make decisions or compare between credit cards or other products. Perhaps a more obvious example of irresponsible lending is lending money to people who may not be in a position to pay it back. It may include failing to check a customer s credit rating/poor information sharing and other commitments before lending them more money. Specific practices include: Unsolicited credit offers Automatic raising of credit limit on credit and store cards and overdraft facilities. Encouraging people to transfer balances on credit cards by offering low introductory interest rates and higher credit limits Reducing the minimum payment on credit cards Unsolicited issuing of credit card cheques In the UK, advice agencies have pointed to many examples of this in the past. there were regular reports of retailers giving people huge amounts of credit on the spot, and of unsolicited approaches by banks to take out loans; some where banks convince people that the loan is in their best interests and that they can afford to pay it, encouraging people to increase their loans. Recent changes in the law and regulatory practices, notably the CCA 2006, have been aimed at cracking down on such behaviour. Recent anecdotal evidence from CABx- fewer instances of some of the above, but now banks responses to people who cannot afford their current loans is to push them to take out consolidation loans- clients have no choice but to accept 5

6 this, or they will lose their bank accounts.- now becoming unaffordable. There are also examples of people who can t afford consolidation loans- the response of their bank is to increase overdraft facilities - which the client used to pay off the loan repayments and now they can t pay off the overdraft. Banking code- revised version was published in March Includes a fairness commitment that banks will treat customers fairly and reasonably: Clear and not misleading advertising and promotional literature Clear information about accounts and services/terms and conditions/interest rates Keeping people informed -Regular statements/ information about changes Will lend responsibly Dealing with problems/financial difficulty quickly and sympathetically Well informed confident consumers are crucial to the economy. What is responsible lending? Responsible lending is an attitude, an ethos, rather than just a list of individual practices, or following the rules and regulations. In a nutshell, it is about treating customers fairly, a concept promoted by the UK Financial Services Authority, which regulates financial services, including mortgages (but not consumer credit), in the UK. The FSA s treating customers fairly guidelines are aimed at achieving six consumer outcomes : Outcome 1: Consumers can be confident that they are dealing with firms where the fair treatment of customers is central to the corporate culture. Outcome 2: Products and services marketed and sold in the retail market are designed to meet the needs of identified consumer groups and are targeted accordingly. 6

7 Outcome 3: Consumers are provided with clear information and are kept appropriately informed before, during and after the point of sale. Outcome 4: Where consumers receive advice, the advice is suitable and takes account of their circumstances. Outcome 5: Consumers are provided with products that perform as firms have led them to expect, and the associated service is of an acceptable standard and as they have been led to expect. Outcome 6: Consumers do not face unreasonable post-sale barriers imposed by firms to change product, switch provider, submit a claim or make a complaint. 3 Appropriateness of a product to a particular borrower will depend on their individual circumstances, needs and financial situation. Importance of making sure customers always enter credit agreements only where the lender is sure the loan is affordable and suitable for each individual customer. New initiatives- improving use of shared data, Banking Code guidance- requires subscribers to contact customers who seem to be getting into trouble. These will help, but also need OFT project on defining irresponsible lending as an unfair practice under s25cca- good time to consider essential elements of good lending practice. Responsible lending is about more than just lending responsibly- about taking a wider view of what can be done to minimize exposure to risk of debt, while trying to reduce financial and human costs when things go wrong. Lenders could offer better and cheaper protection products. The could help borrowers to be more responsible in purchasing decisions- looking more closely at marketing material and post contract information. Are borrowers being told what they really need to know and being given honest information about what to expect? 3 Treating customers fairly towards fair outcomes for consumers; Financial Services Authority, July

8 Are they given adequate information/tools to make their own assessment of whether credit is affordable and suitable for their own needs? Lenders response to people getting into financial difficulties can have a major impact on how difficult a situation people with debt get into. Lenders (or collection agents) can make things worse by adding unnecessary charges, or placing debtors under so much pressure they have no chance to try and put things right. They need help and support to get debt problems under control. They are less likely to make right choices if their requests for help are met with inflexible and aggressive collection practices. CAB evidence says this is often what happens.- where people s circumstances have changed, they need to be given some leeway/help. There is also a need for Full information sharing between lenders as exists I relation to mortgages. Anti-competitive practices Within the industry, a clear example of this is the current rules on early settlement of agreements. These make it expensive and uneconomic for a borrower to settle a loan early. (Over 40% of people pay loans off early at present). Extortionate credit laws are ineffective Current extortionate credit laws are not working to protect consumers. Interest can be as high as 900%, and the current legislation has achieved only 10 successful cases in 30 years. 8

9 Credit licensing could be more effective Revocation of a licence takes time and may not always be the most appropriate course of action. Need for improved redress for consumers Financial Ombudsman Service doesn t cover all credit lending, making it difficult for some people to obtain redress. New ADR process to deal with unfair credit practices The old system wasn t working- people were frightened to go to court, put off by the cost and formality. Proposed new ADR system (whatever form it takes, but likely to be Financial Ombudsman Service) should ensure that people have access to affordable and accessible means of challenging unfair agreements. ADR needs to deal with both individual problems and service failure, to ensure consumers don t continue to be affected by poor practices. But what still needs to be done? While we very much welcome the proposals, we think they could go further in certain ways. Two examples are:- Licensing The White Paper says the licence fee period will be indefinite, rather than required to review every 5 years as at present. We think the amount set should be high enough to support the cost of policing the market. A dramatic rise in licence fees is needed to directly fund trading standards in order to vastly improve policing of predatory lenders - this should help decrease over- 9

10 indebtedness levels. We also want to see stricter controls on entrants and those renewing applications for licences. Credit licence fees are among the lowest by a large margin of licensing systems. Currently, credit licence fees range from 110 for sole traders and 275 for partnerships and limited companies.(gone up to 380 sole- 725 partnerships) FSA application fees for mortgage lenders, advisers and brokers and general insurance range from 500 for small firms to 25,000 for large businesses. Further annual fees are then payable and the amount charged depends on the type of business. Credit fees should be based on criteria such as the risk the firm or sector poses to consumer, problem sectors could be charged higher fees e.g. debt collectors, the work involved to monitor and enforce unfair practices and the annual income or amount loaned by the business. Interest rates While we understand the DTI s reasoning in not introducing a fixed interest rate ceiling as detailed in the White Paper, we would like to see OFT guidance on a floating interest rate ceiling. This approach is more flexible to deal with market conditions and would be underpinned by OFT powers such as fines. We envisage a floating ceiling which: Will float with interest rates e.g. anything more than 12% of the market rate is usury in Germany Will vary for different products and sectors Is a band of say 5-10% rather than a line Is not automatically illegal but creates a presumption of unfairness which will be more flexible than a rigid cap and take into account factors like risk, 10

11 individual circumstances such as the lack of sophistication of the borrower. Sanctions/ The role of the regulator in addressing responsible lending. Credit has become so commonplace many consumers do not consider it to be a risk- this is a problem. It is very clear that responsible borrowing must go hand in hand with responsible lending. CAS research- the moost vulnerable need to be protected; temptation not put in their way. There is a role for regulators, although self-regulation is preferable - codes of practice etc. Responsible lending is in lenders interests at the end of the day. Information asymmetry between consumers and lenders- there is therefore a need for regulation to protect consumers. The move to principles-based regulation appears slow; implementation of Treating Customers Fairly has been slow to respond to market innovation, complexity and the displacement of risk within the financial system As more and more people experience credit and debt problems, there is mroe evidence of unfair practices and consequences. Policy makers response- CCA 2006 etc- is to encourage more responsible lending. Credit card cheques- up to date position following 2006 consultation, the industry agreed to introduce a credit card cheque summary box from end of This gives the consumer key information in a consistent and concise format, which should help to ensure consumers understand implications of using credit card cheques rather than other forms of credit. Sanctions- FSA/unfair credit agreements. Unfair Commercial Practices Directive. 11