Policy and Risk Outlook
The Financial Inclusion Centre today (11th August 2016) publishes its second annual Policy and Risk Outlook which identifies nearly 30 major policy issues and risks which need to be addressed if financial markets are to work for society.
The resilience, efficiency and conduct of the UK financial services industry is critical to the economic well-being of UK households, the ‘real economy’, current and future generations.
Retail financial services has historically been the focus of consumer group and media scrutiny. A litany of financial misselling scandals (now costing £50bn according to the latest tally) has left a legacy of mistrust and low levels of confidence in the industry. On the face of it, there have been improvements in the conduct of firms in retail financial services. But serious concerns remain about the dominant culture. All this is bad enough in its own right but a wider cause for concern given how much consumers are expected to rely on retail financial services in the future.
Households are expected to use financial products and services to build financial resilience and long term financial security. But, much of the industry has not adapted to the new economic and financial reality forged by low returns, technological change, more realistic regulation, changing labour markets, and squeezed household finances. The industry is becoming less relevant for growing numbers of economically vulnerable households.
Financial services isn’t just a pure consumer issue. Financial services already play a significant role in meeting public policy needs such as housing, retirement incomes, long term care, and social security replacement. This role is expected to increase over the years as policymakers attempt to transfer risk and responsibility for meeting these needs to citizens. But, the financial services industry isn’t ‘fit-for-purpose’ to provide the products and services people need.
Sitting behind retail financial services are the huge wholesale and institutional financial markets and financial infrastructures. These markets and infrastructures are of national economic interest.
We have only begun to understand the conduct failures in these critically important markets. Our analysis suggests that inefficiencies and market failure (such as resource misallocation and poor investment performance which undermines retirement incomes) in these sectors have a greater impact on the economic welfare of households and the real economy than retail financial services. Despite their importance, wholesale and institutional financial markets receive comparatively little scrutiny from civil society.
Behaviour and activities in financial markets continue to create systemic risks and threaten economic resilience. Financial markets can exacerbate regional, intra and inter-generational economic inequality.
Market failure doesn’t just harm consumers, it can harm the interests of firms – for example, high charges on investment funds extract value from consumers’ savings and reduce the amount of investment capital that reaches firms. Market short-termism affects the ability of firms to invest for the long term.
That is the state of play now. Financial markets and services are not working well for society. There is much to be done to remedy existing failures. But, more challenges lie ahead. The environment in which financial services operates is being reshaped by a range of powerful external forces creating a range of risks and challenges for the industry and its customers.
It is important that consumer groups, civil society, policymakers, regulators and, of course, the industry itself understand the current and emerging risks and policy issues. To identify the major risks and policy issues we used a two stage process:
- We analysed the forces shaping the environment for the financial services industry ie. socio-economic, demographic, technological, commercial, and political factors; and
- Applied four tests to assess how well financial services will respond to these challenges and identify which sectors and activities create the greatest risks for consumers and the real economy.
From this process, nearly 30 risks and issues emerged. To provide some structure, we have grouped these into the following areas:
- Retail financial services including financial inclusion.
- Wholesale/ institutional markets, and financial infrastructures.
- Major areas of public policy in which financial services has a role.
- How regulatory and public policy is developed.
Much more work now needs to be done to develop the robust policies to address the risks and issues identified here. As a small, non-profit organisation we have limited resources so would welcome the opportunity to work with other civil society organisations, regulators and progressive firms in the industry to make markets work better.
The Policy and Risk Outlook can be found here: Financial Inclusion Centre policy and risk outlook 2016 final
Better and Brighter – Responsible Rent to Own alternatives
Today, The Financial Inclusion Centre publishes a new report into the Rent to Own (RTO) sector. Over 400,000 households, almost exclusively on low incomes and reliant to some degree on benefits, take out expensive credit to spread the cost of purchasing consumer goods from furniture and large household items such as cookers and washing machines to electrical items such as TVs and computers.
The report describes the detriment faced by vulnerable consumers using the sector and makes a number of recommendations to encourage the development of a socially responsible alternative RTO sector.
The sector has proven to be recession proof, more than doubling in size over the last five years since the onset of the economic crisis and is dominated by just three providers – BrightHouse, by far the most well recognised and largest firm, PerfectHome, and non-store based provider Buy As You View. Over the last five years, annual gross profit within the sector has grown by 139% from £127 million to £303 million.
RTO providers can be found on the high streets of our more deprived communities. There are now 373 RTO stores, spread across the country – a figure that has grown by 140% from 155 stores in 2008. According to BrightHouse there is a potential market for 650 stores across the UK.
The typical RTO customer profile is a young female lone parent, living in rented accommodation and almost exclusively from low income households that are wholly or partly reliant on welfare benefits. There are a range of detrimental practices found within the RTO industry, including:
- RTO agreements are expensive and price transparency is poor –with interest rates reaching 99.9% APR and charges for additional cover, the cost of goods can almost triple.
- Customer experience high levels of financial difficulties –with roughly half having some degree of late payment and failing repay.
- High numbers of customers have their goods taken back – with over 10% of customers having their goods repossessed.
- Poor value and often unnecessary bolt-on service cover, warranties and insurances– with at least 85% of BrightHouse customers estimated to purchase such services.
- The market structures make customers exposed to over-charging and poor practices– with few choices consumers are therefore more vulnerable to over-charging and unfair activities.
- RTO is inappropriate for a proportion of customers –with firms found not to be considering user’s financial circumstances.
Such issues have placed the industry firmly under the spotlight of policy makers and the regulator, with the Financial Conduct Authority (FCA) set to outline new rules in 2016 giving greater protection for vulnerable consumers as well as creating a more level playing field for better value alternatives.
In response, over the last few years a number of social businesses have responded by developing alternatives to compete with the RTO retailers. These combine some of the more ‘positive’ characteristics of the RTO model that appeal to consumers but delivered in a way that designs out some of the more harmful aspects. By doing so, these alternatives are able to generate significant cost savings for low income customers and thus help avoid paying a poverty premium for their essential goods.
The report contains a number of case studies of RTO alternatives run locally and nationally that offer differing delivery models.
Delivery model options:
The five case studies demonstrate just how different the delivery models can be and highlight the particular challenges which need to be addressed if the alternative sector is grow. The key issues are:
Credit provision – who will deliver the lending facility.
In-house loan delivery directly by the social RTO firm – This requires the creation of new lending vehicles with effort and time to obtain regulatory permissions and raising of capital finances.
Outsource credit delivery to an existing social lender – Partnering with an existing affordable credit provider (typically a credit union or CDFI) can benefit from its ability to raise capital, its existing lending track record/infrastructure and user’s access to other financial services. Yet, it can be more restrictive, being tied to certain lending criteria, approaches or risk appetites.
No matter who provides the borrowing, three important lessons have emerged:
- The consumer’s selection of the goods and their credit application/decision needs to be seamless, even if it is actually operated by two different entities.
- The loan process needs to be straightforward and decisioning making needs to be made almost immediately through the social lender’s own systems.
- Some degree of automation and access to credit scoring/reference data is important and therefore the selected credit provider will require appropriately developed IT technology.
Lending capital – who provides the capital for lending and who shoulders the lending risk.
If the credit provision is undertaken in-house or via a franchise model, significant capital will need to be secured. Equally, an outsourced credit partner could still require external capital to be raised depending on their available funds and willingness to lend for this type of purpose/product.
Moreover, lending risk could be shared by establishing either ‘ring-fenced’ lending capital or an underwriting agreement to cover potential defaults. This gives greater flexibility to lend to ‘those in the grey area’ who might ordinarily be too risky for the social lender’s traditional credit assessment.
Delivery outlet – how will household goods and lending be promoted and accessed by customers.
Retail shop – for some, creating a high street retail outlet that mimics the look of BrightHouse is seen as essential. The main consideration is the huge start-up and ongoing operational costs and whether it can be financially viable from the income generated primarily from product mark-up.
Online provision – websites enabling product selection and ordering combined with loan application and assessment should be an essential aspect of any RTO alternative. Whether this is the sole route to market or one of many channels is the key consideration with the choice set in the context of the target customer and their ability to access a purely online facility.
Catalogue delivery – a complementary brochure is also very important, particularly with a restricted access model focused on social housing residents. Consideration also needs to be given to a telephone-based facility that enables customers to both apply for credit and place orders.
Product operations – who manages the stock, order delivery and customer relationship.
Developing in-house product operations – this option is particularly challenging as it needs extensive scale and volumes to make it financially viable and significant upfront / ongoing costs.
Outsourcing by partnering with an existing RTO provider – the far easier option would be to piggy backing on an existing RTO alternative and utilising their supply chains – either by working with a formal franchise (e.g. Smarterbuys or Coop Electical) or a particular scheme (e.g. Fair For You). However, this may limit the scope for product tailoring and reduce income generation.
Creating direct arrangements with individual suppliers – either local/regional businesses (e.g. Furniture 4U) or national firms/manufactures (e.g. Fair For You). This enables the selection of certain product lines based on quality and income generation potential and could also be attractive from a local economic development and employment perspective.
Customer base – should it provide open access to all or be restricted to certain users.
Open access – with the need for scale and volume an open access model would appear to provide the greatest scope for financial sustainability.
Restricted access – this model is often found amongst social housing providers delivering a RTO alternative specifically for their residents and is confined primarily from a wish to focus resources only at their own users. Alternatively, this could still be achieved through an open access model but with the ring-fencing of funds for specific groups of users.
By exploring the current crop of social providers offering RTO alternatives, it is clear that there is no single approach that offers the perfect delivery solution. Instead, there are a number of delivery considerations that can developed to best match the specific local circumstances and aspirations. One common feature of all the featured case studies is the need to involve a range of stakeholders. Partnerships are needed to bring together local authorities, social housing providers and other third-sector organisations looking to address this issue.
Ultimately, it is hoped that the research stimulates debate, providing further focus on the rationale for intervention in this market and providing a starting point for anyone considering the various options for which type of RTO alternative offers the most appropriate solution.
Summary Report can be accessed here – Better and Brighter – Responsible RTO Alternatives (Summary 150316)
Full Report can be accessed here – Better and Brighter – Responsible RTO Alternatives (Full Report 150316)
Payday lending: fixing a broken market
Sponsored by the ACCA, the objectives of the report were to: develop a detailed understanding of the business models underpinning UK payday lending; inform the debate about the level and structure of the new charge cap; and examine which other regulatory interventions may be necessary to create a small-sum lending market which allows lenders to innovate and also delivers good outcomes for borrowers.
Payday lending is currently causing enormous consumer detriment and harm, often to people who are among the most beleaguered and vulnerable in our society. In 2012 borrowers spent over £900m on payday loans, with £450m spent on loans which were subsequently ‘rolled over’.
The evidence presented in this report suggests that existing online payday lending business models are reliant on repeat borrowing for their profitability. Consumer detriment, in the forms of default, repeat borrowing and the taking of multiple loans from different lenders, appears to play a highly profitable role in existing business models.
It seems that many payday loans serve only to increase the likelihood of future indebtedness. Many payday borrowers would have been better off without these loans.
Allowing capital to flow into the development of products which cause consumer detriment also carries a high opportunity cost. True innovation is stifled and products capable of answering consumers’ needs cannot be developed. This issue is of increasing importance and relevance to all of us; unless an economic miracle occurs, a growing proportion of our population will need to seek recourse to the high-cost credit sector.
Appropriate regulation has the potential to fix the payday lending market, which is currently failing due to asymmetric information, detrimental practices and behaviours, and poor product design. The new cap on the total cost of credit, in particular, could transform this industry. Not only will this protect vulnerable consumers, the constraints it will place on the business models of payday lenders should clear space to allow community lenders to grow and offer fair, affordable loans to more households.
The FCA now has a unique opportunity to enable the high-cost credit sector to evolve into a sector which is genuinely ‘fit for purpose’.
The full report can be found here: Payday lending full report
A Business Case -Financial impact of debt advice for social landlords
The Financial Inclusion Centre has been commissioned to undertake an exciting new longitudinal research with six of the of the country’s most established housing associations to analyse the effectiveness of a range of debt advice interventions on the rent arrears and behaviour of indebted social housing residents… Read More/Download Report
Debt and The Family: Debt and Household Incomes
This report looks at the position of the two main groups of households who seem most at risk… Read More/Download Report
Debt and the Family. Debt and the Generations
This report (published November 2011) looks at the impact of debt on different generations of households… Read More/Download Report
Does Debt Advice Pay? A business case for social landlords
The Financial Inclusion Centre (FIC) has been commissioned to evaluate the effectiveness of providing access to debt advice to residents and to establish whether there is a business case for improving direct access to debt advice… Read More/Download Report
Money Mentors Schools Programme 2010
Money Mentors is a programme run by London Citizens to improve the financial capability of teenagers. This includes teaching skills such as budgeting, managing finances and understanding concepts such as credit and debt… Read More/Download Report
The Real Cost of Christmas – Assessing the impact of illegal money lending on consumers
15 January 2010
Today, Circle Anglia published a new report produced by The Financial Inclusion Centre on the potential impact of illegal loan shark lending on vulnerable consumers at Christmas… Read More/Download Report
Feast to Famine
The report, commissioned by Consumer Focus, sets out how consumers on low incomes with no savings are being hit hardest as high street lending dries up – and many will be forced to borrow from unregulated, sub-prime money lenders unless Government makes new, affordable forms of credit available…Read More/Download Report
Are Banks and building societies playing fair?
The report demonstrates the extent to which lenders used the dramatic cut in interest rates in 2008 to increase the margins on mortgages, overdrafts and credit cards…Read More/Download Report
Reforming the Financial System
In light of the ongoing financial crisis, this new report sets out the need for radical reform of the financial services industry and puts forward proposals for that reform… Read More/Download Report
Northern Ireland consumers pay more for insurance
The Consumer Council of Northern Ireland commissioned the Centre to investigate whether Northern Ireland consumers are paying more for insurance… Read More/Download Report
The Perfect Storm: The Credit Crunch hits home
Our findings and recommendations for lenders and government to protect consumers from the impact of the credit crunch… Read More/Download Report