FCA’s Analysis: Can a consumer’s financial distress be predicted?

The FCA have published, in August 2016, an Occasional Paper which analyses the typical features and characteristics of consumer credit users who are likely to suffer financial distress.

Individuals with outstanding consumer credit debts hold, on average, consumer credit debts equivalent to 14% of their gross annual individual income or 12% of their household income. Ranking individuals by the ratio of their consumer credit debts relative to income (DTI ratio), the study finds that the top 10% of individuals with outstanding consumer credit debts, who hold approximately a third of total debt balances, have consumer credit debts that are over 38% of their gross annual individual income or 31% of their annual household income. These debts are equivalent to over 3.1 months of individual income or 2.5 months of household income before tax.

Using a broader measure of financial distress the paper estimates that 17% of individuals with outstanding consumer credit debt, or 7% of those holding a consumer credit product, face moderate or severe financial distress. This is a large number of individuals, approximately 2.2 million and compared to other individuals, those in financial distress are typically younger, with lower income and higher DTI ratios. They also have noticeably worse self-reported measures of well-being.

Accordingly the research concludes that DTI ratio is a strong predictor of future financial distress, even after controlling for ‘life events’ that may cause financial distress, such as becoming unemployed. The top 10% of individuals by DTI ratio are much more likely to suffer financial distress than other individuals. And those who hold the majority of their debts in higher-cost products are substantially more likely to experience financial distress than holders of other forms of credit, such as personal loans.

This research shows the risks of financial distress vary predictably depending on an individual’s circumstances. Individuals in financial distress are typically younger, with lower income, less likely to be employed and exhibit higher debt-to-income ratios than individuals who are not in financial distress but do have consumer credit debts. The paper suggests that affordability policies should be tailored to the products that people apply for and to applicants’ circumstances, especially by considering their DTI ratio.

 

Do you carry out sufficient Due Diligence before Outsourcing Consumer Credit Activities?

The Lending Standards Board (LSB) published a report in August 2016 on the findings of its themed review of third party outsourcing.

The objectives of the review were to assess the adequacy of Lending Code subscribers’ systems, processes and controls to ensure that where processes are outsourced, the Lending Code is complied with, and that any breaches are identified, reported and remedied. A key element of this framework is the detailed due diligence process with a view to ensuring that the systems, processes and frameworks are in place and each subscriber clearly understands how the outsourced service is being fulfilled and is able to manage this successfully.

The review was limited to assessing outsourced arrangements within the UK and the LSB feels that the overseas risk is much greater than domestic outsourcing and the use of third party suppliers will, therefore, continue to be an area for inclusion in the LSB’s new oversight strategy, through its focus on customer outcomes at the relationship meetings and the research projects.

At the time of the review the Lending Code was still in existence and so the objective and scope of the review is very much focussed towards adherence with Lending Code requirements. Since completion of the review, the Lending Code has been superseded by the Standards of Lending Practice (SLP). The LSB says that the assessment undertaken and findings from this review remain relevant in the context of the SLP and it is its expectation that any comments or recommendations can be applied following implementation of the new SLP.

The new SLP is explicit in the requirement for registered firms to ensure that where any part of the credit process/lifecycle is outsourced they should undertake effective and robust due diligence and exercise effective ongoing oversight.

Competition Shortcomings in Retain Financial Markets

The Competition and Markets Authority (CMA) has published in August 2016 the final report of its retail banking market investigation, which sets out its analysis of the shortcomings of competition in the markets for current accounts for personal customers and for banking services to small businesses. A short overview of the CMA’s findings and proposals has been published including a list of the main remedies with their approximate commencement dates.

The CMA concludes that older and larger banks, which still account for the large majority of the retail banking market, do not have to work hard enough to win and retain customers and it is difficult for new and smaller providers to attract customers. The CMA says that these failings are having a pronounced effect on certain groups of customers, particularly overdraft users and smaller businesses. They also mean that the sector is still not as innovative or competitive as it needs to be. The CMA’s integrated package of remedies consists of four elements, firstly three cross-cutting foundation measures, which can be summarised as follows:

  • Open Banking Standard: the CMA is requiring the largest retail banks in both the UK and Northern Ireland to develop and adopt an application programming interface (API) banking standard so as to share information to a specified timetable and requiring it to be an open standard so as to enable it to be widely accessible. The CMA requires the banks to release the least sensitive information, for example about prices, terms and conditions and branch location, by the end of March 2017. It expects that all aspects of an open banking standard for sharing transaction data would be up and running by early 2018 at the latest;
  • Service quality information: the CMA is requiring banks to display prominently a number of core indicators of service quality. Data will be collected twice a year on a standardised basis, so that customers can easily compare across banks. The CMA says that the Financial Conduct Authority (FCA) is best placed to work with banks to develop and test which specific additional measures of service quality would be most useful, and then to put these measures in place, and it is making a recommendation to that effect;
  • Customer prompts: the CMA is requiring banks to send out suitable periodic and event-based prompts such as on the closure of a local branch or an increase in charges, to remind their customers to review whether they are getting the best value and switch banks if not. The CMA recommends that the FCA should undertake a programme of randomised controlled trials (RCTs) to identify which prompts are likely to be most effective in changing customer behaviour. The CMA will also be requiring business current account (BCA) providers to send prompts to those SMEs not covered by the FCA’s powers.

 

The other elements of proposed remedies include:

  • Additional measures to make current account switching work better, including building on and improving the existing current account switching service and requiring that customers of all current account providers are able to get a copy of their transaction history after account closure;
  • A set of measures aimed at personal current account overdraft users. These will include requiring banks to alert their customers, for example by sending a text message, when they are going into unarranged overdraft and informing customers of a grace period during which they have an opportunity to avoid charges;
  • A set of measures targeted at the specific problems in SME banking, making it easier for SMEs to compare different providers and reducing the hold that incumbent banks have in the market for business current account BCAs and SME loans.

The CMA has since published a timetable for implementation of the remedies. This gives the statutory deadline for implementing remedial action as 8 February 2017. The CMA intends to publish informal consultations on draft undertakings and orders between now and November 2016. The draft order/undertakings will be published for formal consultation in November/December 2016.

The FCA have published an alert (in August 2016) to highlight some of the risks arising from authorised firms accepting business from unauthorised introducers/lead generators and/or other authorised firms (the introducer).

The FCA are very concerned at the increase they have seen in cases in which the introducer has an inappropriate influence on how the authorised firm carries out its business, in particular where the introducer influences the product choice. They also have concerns where the authorised firm delegates regulated activities, for example, by outsourcing their advice process to unauthorised entities or to other authorised firms that do not have the relevant permissions, or are not their appointed representatives.

The alert details the areas of concern the FCA have identified and also lists warning signs which firms should consider if they accepting customer introductions from introducers. According to the FCA, it is essential that firms maintain full and complete ownership of the advisory process between themselves and their customer, and any regulated advice a firm provides must meet the requirements set out in the FCA Handbook.

Firms have been advised to:

• Carry out robust due diligence on the introducers they transact with;
• Have in place a robust vetting procedure to ensure that introductions have been sourced legitimately;
• Regularly review and ensure that their systems and controls are adequate to demonstrate that they have full and complete ownership of the advice they are providing;
• Only recommend products that they understand fully;
• Provide independent advice to customers introduced (“independent” in this context means independence from the issuer or product provider);
• Not allow another entity, whether or not it is regulated, to use the firm’s reference number on the firm’s behalf unless they are satisfied that it is being used appropriately;
• Only delegate the performance of regulated activities to other authorised firms that have the required permissions or who are the firm’s appointed representatives, with appropriate monitoring.

The FCA have published an alert (in August 2016) to highlight some of the risks arising from authorised firms accepting business from unauthorised introducers/lead generators and/or other authorised firms (the introducer).

The FCA are very concerned at the increase they have seen in cases in which the introducer has an inappropriate influence on how the authorised firm carries out its business, in particular where the introducer influences the product choice. They also have concerns where the authorised firm delegates regulated activities, for example, by outsourcing their advice process to unauthorised entities or to other authorised firms that do not have the relevant permissions, or are not their appointed representatives.

The alert details the areas of concern the FCA have identified and also lists warning signs which firms should consider if they accepting customer introductions from introducers. According to the FCA, it is essential that firms maintain full and complete ownership of the advisory process between themselves and their customer, and any regulated advice a firm provides must meet the requirements set out in the FCA Handbook.

Firms have been advised to:

  • Carry out robust due diligence on the introducers they transact with;
  • Have in place a robust vetting procedure to ensure that introductions have been sourced legitimately;
  • Regularly review and ensure that their systems and controls are adequate to demonstrate that they have full and complete ownership of the advice they are providing;
  • Only recommend products that they understand fully;
  • Provide independent advice to customers introduced (“independent” in this context means independence from the issuer or product provider);
  • Not allow another entity, whether or not it is regulated, to use the firm’s reference number on the firm’s behalf unless they are satisfied that it is being used appropriately;
  • Only delegate the performance of regulated activities to other authorised firms that have the required permissions or who are the firm’s appointed representatives, with appropriate monitoring.

UK Financial Sector’s Future Post- Brexit?

A webpage has been published by the House of Lords EU Sub-committee on Financial Affairs announcing the launch of an enquiry into Brexit and financial services in the UK. The Committee is focusing its work on the consequences of the referendum result for financial services and potential future arrangements and it proposes to look into the following areas in particular:

  • The reaction of financial services firms to the outcome of the EU referendum result
  • The possibility of relocation of financial services firms from the UK
  • Critical priorities for the UK financial services sector in both the withdrawal negotiations and in negotiating a future relationship for the UK with the EU
  • ‘Equivalence’ rights to access the EU Single Market for the UK
  • Financial regulatory cooperation between the UK and the EU under different models of EU membership
  • A potential free trade agreement and the UK’s financial sector
  • Potential transitional arrangements
  • The importance of the financial passport for firms operating in the UK
  • Risks for retail customers and investors
  • Considerations for non-EU firms wishing to gain access to the EU via the EU’s equivalence regime

Challenges in Adoption of Basel III/ CRD IV Standards by Banks

(This news item is of interest to banks, building societies and large investment firms only)

In an update provided by the Basel Committee on Banking Supervision to the G20 Leaders in August 2016, further progress has been reported towards implementing the Basel III framework since last year’s report. The report confirmed that all 27 Basel Committee member jurisdictions now have final risk-based capital rules, LCR (Liquidity Coverage Ratio) regulations and capital conservation buffers in force. Further, 24 member jurisdictions have issued final rules for the countercyclical capital buffers and 23 have issued final or draft rules for their D-SIBs (Domestic systemically important banks) framework. With regard to the G-SIB (Global systemically important banks) framework, all members that are home jurisdictions to G-SIBs have implemented the Basel framework for G-SIBs. Members continue their efforts to implement other Basel III standards, including the leverage ratio and the NSFR, which are due by January 2018.

This has provided transparency on the timeliness of implementation and has complemented the Committee’s quantitative impact study (QIS) work on banks’ readiness to meet the Basel framework’s minimum standards. Graph 1 below shows the progress made by member jurisdictions in implementing Basel standards since 2011.

The implementation of Basel III capital and liquidity standards into domestic regulations has generally been timely thus far. However, a significant number of revised Basel standards await transposition into domestic regulations over the next couple of years and, while still committed to implementing them, some jurisdictions report challenges in meeting the agreed implementation deadlines for these standards. These include:

  • Margin requirements for non-centrally cleared derivatives (by September 2016)
  • The revised Pillar 3 framework (by end-2016)
  • The standardised approach for measuring counterparty credit risk (by January 2017)
  • Capital requirements for central counterparty exposures (by January 2017)
  • Capital requirements for equity investments in funds (by January 2017).

The reported challenges relate in part to domestic legislative or rule-making processes. In addition, some jurisdictions report that banks face difficulties in adjusting their information systems to meet and report on the new requirements.

The Committee will continue to monitor closely the timeliness of implementation, and report on progress to the G20. Delayed implementation may have implications for the level playing field and puts unnecessary pressure on jurisdictions that have implemented the standards based on the agreed timelines. A concurrent implementation of global standards is all the more important as many jurisdictions serve as hosts to internationally active banks.

Crowdfunding: FCA and PRA to address issues raised by Treasury Select Committee

The House of Commons Treasury Select Committee announced in August 2016 the publication of responses from Tracey McDermott, former acting Chief Executive of the Financial Conduct Authority (FCA), and Andrew Bailey, former Deputy Governor for Prudential Regulation, Bank of England, and former Chief Executive of the Prudential Regulation Authority (PRA), to a number of questions on crowdfunding regulation.

The Chairman of the Select Committee, Andrew Tyrie has commented in a press release that, on the basis of this correspondence, the risks associated with crowdfunding platforms appear to be restricted to those individuals and entities who use these platforms to lend or invest. Mr Tyrie has said that while Government policies to promote the crowdfunding sector may have the right intention to increase competition in the SME lending market, the tax incentives may be encouraging some consumers to use inappropriate products. He said that the FCA “needs to be alert to these risks” and the Government “may need to reconsider these tax incentives”.

The tax incentives here refer to the tax breaks allowed by HMRC for investing in unlisted, small companies through authorised Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS)