FCA identify significant concerns in second charge mortgage lending practices
The FCA have written to the chief executives of all second charge lenders asking them to review their mortgage lending processes and confirm to the FCA, by 1 May 2018, that they are lending responsibly and that their firms have processes, systems and controls in place to ensure this.
The FCA have reminded firms that the framework introduced in March 2016 as a result of implementation of the Mortgage Credit Directive for both first and second charge lending was designed to prevent a return to poor lending practices seen during the run up to the financial crisis. This outcome is intended to be achieved by putting consideration of affordability for the borrower at the heart of any lending decision.
However, the FCA’s recent review of the second charge mortgage sector has identified significant issues that led FCA to conclude that second charge lenders might not always be lending responsibly, leading to potential customer harm. The FCA’s concerns particularly relate to the following areas:
1. Overall Affordability Assessment: Since March 2016, all new regulated mortgage applications became subject to the affordability requirements set out in MCOB rules which must be followed for both first and second charge mortgages. The FCA found examples where firms were not basing lending decisions on income and expenditure assessments as prescribed. The FCA are concerned with lending decision based mainly or solely on equity, debt to income ratios or income multiples.
MCOB allows lenders to generally rely on any evidence of income or information on expenditure provided by the customer unless, taking a common sense view, it has reason to doubt the evidence or information. The FCA found that income and expenditure calculations sometimes produced disposable income figures that didn’t seem plausible when taking into account an applicant’s credit profile. Also, the FCA found that it was very difficult in some cases to follow how a firm had carried out affordability stress testing.
The FCA have asked firms to review and advise (by 1st May) whether the firm’s affordability calculation is at the heart of each lending decision and that the calculation itself takes into due consideration the credit profile of an applicant.
2. Income Assessment: The FCA found that income assessment for self-employed customers was often very poorly handled. In some cases, FCA were unable to identify the source from where the underwriters of firms had obtained the figures used for net income.
FCA have asked firms to review their method of calculating net income for different types of customers to ensure the figures are credible and verifiable.
3. Expenditure Assessment: FCA have found that firms are not always using realistic assumptions for expenditure assessment, a practice that was particularly evident when customers were consolidating a number of debts. Also, there was a lack of controls in place to identify where the use of modelling statistics had produced a figure that was not plausible or appropriate to the customer’s profile. They observed that this was most obvious in the figures used for housekeeping (food and washing), essential travel costs, as well as a number of areas of the basic quality of living costs.
4. Oversight Arrangement: FCA have observed that some firms’ quality assurance and oversight arrangements were not fully capable of identifying unaffordable loans and associated risk. They found that some of the oversight arrangements appeared to be overly focused on establishing whether documents had been sent out or received, without monitoring the quality and effectiveness of the firm’s affordability assessment.
5. Financial Crime: The FCA identified instances in which firms were vulnerable to fraud by accepting evidence of income that could easily be manipulated by the customer. They have warned that firms should be aware that where the FCA find a firm’s systems and controls to be inadequate and insufficient to protect itself from becoming a party to financial crime, they will consider taking action against the firm and its senior management.
The FCA have asked firms to conduct a review to assess whether their procedures and systems and controls are suitable to ensure that they can lend responsibly and confirm this to the FCA no later than 1 May 2018. Firms must ensure that they would be able to evidence this review and the firm’s compliance with regulatory requirements to the FCA upon request.
FCA’s view of today’s consumer credit landscape
Consumer credit is an important part of FCA’s supervisory and policy business plan as the regulator continues to work through issues that are perceived to be present in the industry.
Andrew Bailey, the CEO of FCA delivered a speech at the Finance & Leasing Association (FLA) on 27 February, focused on the consumer credit market sector. He began by pointing out that, in recent years, the UK has seen a strong growth in consumer credit, and particularly among younger people.
Mr Bailey said that there is an emerging picture of a case for possible intervention in a number of markets but also a recognition of the limits of what can be achieved through traditional regulatory interventions alone. Looking at the shape of the overall market and considering how choices for consumers might be widened is therefore important context. In particular, he said, that in certain parts of the market the FCA will seek to intervene to encourage alternatives to high-cost credit, particular those from the ‘mid-cost’ market.
He clarified that the principles of the FCA approach in dealing with consumer credit will be underpinned by:
• The FCA authorise, supervise and enforce against their existing rules – FCA have already taken significant action where firms have not met the rulebook including creditworthiness and treating customers fairly.
• FCA are prepared to intervene and propose new rules where they have found evidence that markets are not working well for consumers.
• FCA can promote competition and innovation in the interest of consumers by encouraging new business models that better serve consumers, and addressing rules that might be preventing markets from working as well as they could.
• FCA can work with others to influence the demand in markets thinking about what drives demand for high-cost credit, the alternatives and how consumers can build basic financial resilience.
In conclusion, he said that the agenda the FCA now see on consumer credit is a lot bigger than the one they had visualised in 2014 when taking over the responsibility for supervising the sector. This, he felt, was a product of experience as well as a reflection of just how important Consumer Credit is to our society. It certainly merits careful attention by all key participants including the regulator.
FCA statement on proposals to introduce a wider public register
The FCA and Prudential Regulation Authority (PRA) currently maintain a public Financial Services Register, “the FS Register”, of the firms they regulate and the individuals who have been approved by them.
In July 2017, the FCA published proposals to extend the Senior Managers and Certification Regime (SM&CR) to all regulated firms. Under these proposals, the FCA will only approve the most senior individuals within firms. This means that only Senior Managers will appear on the FS Register. Firms will remain responsible for assessing the fitness and propriety of their employees and ‘certifying’ certain individuals who are not classified as Senior Managers under SM&CR, but who play important decision-making roles within firms and they can have a significant impact on customers, firms and market integrity.
In response to these proposals, the FCA received substantial feedback on the public value of the FCA maintaining a central public record of certification employees and other important individuals in firms regulated by the FCA who will no longer appear on the FS Register. This includes non-executive directors, financial advisers, traders and portfolio managers.
The FCA have listened to this feedback and have decided to consult on a policy proposal to address this feedback by the summer of 2018. In addition, the FCA have planned to issue an update on their work to improve the usability of the FS register, which will incorporate feedback from the Work and Pensions Select Committee.
FCA’s concerns regarding quality of regulatory returns
Andrew Baily, the CEO of the FCA, has written to all firms to take steps for ensuring accuracy of the regulatory returns submitted by them to FCA. He has stated that the data in prudential regulatory returns are important for firms and the FCA. However, a significant number of firms submit returns that contain inaccurate and/or incomplete data.
The FCA use returns to assess prudential risk as the information helps them in understanding firms’ business models, financial positions and risk exposures. FCA also use the data to identify trends within and across sectors. The analysis of returns is used for making key decisions by the FCA and, therefore, it is vital that data are accurate and complete.
The information contained in these returns also forms an integral part of firms’ risk management frameworks. As such, part of FCA’s assessment of the quality of firms’ risk management is influenced by the quality of the regulatory data submitted.
The most common issues the FCA have observed with returns include:
• Failure to complete the underlying templates within the common reporting (COREP) submissions due to inadequate understanding of the prudential rules
• Failure to submit certain returns, such as the Financial Reporting (FINREP) return
• The total sum of risk exposures across various risk categories (market and credit risk for example) is not calculated correctly, leading to an inaccurate figure for firms’ capital requirements
• Inconsistent completion of COREP returns. European Banking Authority (EBA) validation rules dictate that certain data points submitted across different templates within COREP should show identical values or equal the sum of a number of other values, and
• Not reporting cumulatively (on a year-to-date basis) on the FSA002 Income Statement.
The FCA have asked the chief executives of IFPRU and BIPRU firms to review their firm’s regulatory reporting practices to ensure that they are fit for purpose, comply with the relevant reporting provisions and produce materially accurate data.
Mr Bailey has warned that, without prejudice to FCA’s ongoing supervisory function, they will, as of 1 October 2018, review a sample of firms’ returns and if they find that firms continue to submit materially inaccurate, incomplete and/or poor quality data, they will consider next steps to improve the standards of returns.
Implications of Fin-Tech developments for banks and regulators
The Basel Committee on Banking Supervision (BCBS) published a paper in February 2018 setting out the findings of the task force set up by them to provide insight into the fast-growing adoption of financial technology in financial services sector and, more specifically, to explore its implications for banks and bank supervisors.
According to the paper, the fast pace of change in fintech makes assessing the potential impact on banks and their business models challenging. While some market observers estimate that a significant portion of banks’ revenues, especially in retail banking, is at risk over the next 10 years, others claim that banks will be able to absorb or out-compete the new competitors, while improving their own efficiency and capabilities.
The analysis presented in this paper considered several scenarios and assessed their potential future impact on the banking industry. A common theme across the various scenarios is that banks will find it increasingly difficult to maintain their current operating models, given technological change and customer expectations. Industry experts opine that the future of banking will increasingly involve a battle for the customer relationship. To what extent incumbent banks or new fintech entrants will own the customer relationship varies across each scenario. However, the current position of incumbent banks will be challenged in almost every scenario.
The emergence of fintech is only the latest wave of innovation to affect the banking industry. While banks have undergone various technology-enabled innovation phases before, fintech has the potential to lower barriers of entry to the financial services market and elevate the role of data as a key commodity, and drive the emergence of new business models. As a result, the scope and nature of banks’ risks and activities are rapidly changing and rules governing them may need to evolve as well. These developments may indeed prove to be more disruptive than previous changes in the banking industry, although as with any forecast, this is in no way certain.
Given the uncertainty of these factors, the BCBS recognises that it should first contribute to a common understanding of risks and opportunities associated with fintech in the banking sector by describing observed practices before engaging in the determination of the need for any defined requirements or technical recommendations. The BCBS also acknowledges that fintech-related issues cut across various sectors with jurisdiction-specific institutional and supervisory arrangements that remain outside the scope of its bank-specific mandate.