The Financial Inclusion Centre responded to two important consultation papers which formed part of the FCA’s High Cost Credit Review. These covered overdrafts (CP18/13) and rent-to-own, home collected credit (doorstep lending), catalogue credit and store cards, and alternatives to high-cost credit (CP18/12).
We commended the additional research and analysis the FCA has undertaken to help us understand the scale and nature of the detriment experienced by vulnerable people who have to use unarranged overdrafts. We also support many of the proposals in CP18/13. No doubt, some consumers will benefit from these measures and act more effectively in the market. Moreover, the supply side measures proposed should have some effect on making current account providers behave more responsibly.
But, considering the overall package we are not convinced that these measures go far enough. We are, of course, interested in making the current account market work for all consumers. However, our focus is on the detriment experienced by the most vulnerable households – in particular, the harm experienced by groups of households with protected characteristics which the FCA’s excellent analysis has highlighted.
The nature and extent of financial harm and discrimination in the overdraft market
The FCA’s new research exposes the extent of financial harm faced by vulnerable households as a result of practices by banks and building societies. These households are facing a serious form of financial discrimination.
Charges on unarranged overdrafts are significantly higher than on arranged overdrafts. Borrowers in more deprived areas are less likely to have an arranged overdraft in place and, when they do, they have a lower overdraft limit. Households in more deprived areas of the country are much more likely to have to use unarranged overdraft than other consumers. These borrowers tend to:
- have lower incomes;
- be from Black, Asian and minority ethnic (BAME) communities; and
- have a higher probability of being vulnerable due to poor health or a disability.
The fact that these households are more likely to be harmed by high unarranged charges is perhaps not surprising. After all, we know these households are disproportionately likely to be poor and have low levels of financial resilience. But the extent of the harm revealed by the FCA’s analysis is shocking. To summarise the findings from CP18/13:
- People living in more deprived areas are 70% more likely to use an unarranged overdraft than those living in the least deprived areas. They also tend to use that unarranged facility more frequently. The repeated use of unarranged overdrafts by many vulnerable people suggests their incomes are so low that they regularly run out of money. The FCA research confirms a clear link between unarranged overdraft use and vulnerability.
- They are paying twice as much in charges and fees as those living in less deprived areas.
- Banks are making over 10 times as much (per £ lent) from unarranged overdrafts as from arranged overdrafts. Unarranged overdrafts account for, on average, around 30% of all overdraft revenues. Tellingly, the FCA sees firms using unarranged overdraft fees as a source of revenues to fund other parts of their current account business. In other words, the most vulnerable borrowers including those with protected characteristics are cross-subsidising better off households. This is a significant recognition by the FCA.
- The majority of fees levied are concentrated on only 1.5% of customers who pay on average £450 a year in unarranged overdraft charges. To put this into context, third decile gross household incomes in the UK are around £340 a week. So, lower income households could be losing more than a week’s income due to high overdraft charges.
- Charging structures are asymmetric and cause significant harm to vulnerable borrowers. Fixed fees mean that a small amount of additional borrowing on an overdraft can lead to significant additional charges.
- People living in the most deprived areas are also more likely to be hit by refused payment fees. On average, they pay 3.5 times as much each year in refused payment fees as those in less deprived areas. These refused payment fees are also highly concentrated with 10% charged for declined transactions – the majority of charges paid by 1.2% of consumers.
- Historically, banks justified the higher level of costs and fees by the fact that unarranged overdrafts were more expensive to operate. But, as the FCA now points out, because of technology, there is no longer any justification for banks to have such different levels of fees and charges on arranged and unarranged overdrafts.
Better off, ‘lower risk’ consumers can switch away to better deals. That option is just not open to the most vulnerable households. Moreover, they are more likely to be hit by unforeseen events out of their control which push them into debt. They are already struggling to make ends meet with little room to reduce spending any further, or do not have savings to fall back on. In effect, these consumers are a captive market and are being exploited by the use of indefensible charging practices.
The conclusion must be that banks are exploiting the vulnerability of groups who are in effect a captive market with few realistic options to take their business elsewhere or qualify for other more affordable forms of consumer credit. New technology means the unfair treatment of vulnerable households through the imposition of such high costs cannot be justified. These groups are being exploited to cross subsidise better-off households.
Overall, the package of remedies does not go far enough to protect vulnerable households – particularly those groups with protected characteristics. Therefore, we make a number of calls on the FCA:
- Price caps: we call on the FCA to undertake to cap interest rates and other charges (such as refused payment fees) on overdrafts. We suggest a daily interest cap with a backstop cost ceiling is the most appropriate method.
- Interim consumer protection measures: the fact that banks impose such high costs on vulnerable borrowers (who are by definition already in financial difficulty) is surely in contravention of the key regulatory principle which requires firms to act in the interests of customers and treat customers fairly. Indeed, these charges must exacerbate the financial difficulty borrowers face. Until a cap on interest rates and fees is introduced, the FCA should target its supervisory activities to ensure that banks are treating vulnerable borrowers fairly. In practice, that means using supervisory powers to stop the use of these charging practices now. This would be a particularly good opportunity for the FCA to use its temporary product intervention powers.
- Greater transparency: we have long argued for the introduction of financial inclusion legislation similar to the US Community Reinvestment Act (CRA) and Homeowners Mortgage Disclosure Act (HMDA). We advocate greater transparency on how well individual financial institutions perform against financial inclusion metrics. Our understanding is that due to legal constraints contained in FSA 2012/ FSMA 2000, we would need new legislation to force publication at the level of individual financial institution. We urge the FCA to communicate to HM Treasury the benefits of greater transparency. In the meantime, we would urge the FCA to build on its important Financial Lives initiative and publish more granular data on which communities are facing high levels of financial exclusion and discrimination.
Our response can be found here: FCA CP18 13 Financial Inclusion Centre submission
 For example, see: https://www.ons.gov.uk/peoplepopulationandcommunity/personalandhouseholdfinances/expenditure/adhocs/006770grosshouseholdincomebyincomedecilegroupukfinancialyearending2016
RENT-TO-OWN, HOME COLLECTED CREDIT, CATALOGUE CREDIT AND STORE CARDS, AND ALTERNATIVES TO HIGH COST CREDIT
As with the work on overdrafts, we commended the level of additional research and analysis the FCA has undertaken to help us understand the scale and nature of the detriment experienced by vulnerable people who are targeted by suppliers of various forms of high-cost/ sub-prime credit.
We very much support many of the proposals in CP18/12 aimed at improving the information provided to consumers in these markets. No doubt, some consumers will benefit from these measures and act more effectively in the market.
Moreover, the supply side measures proposed to influence the behaviour of high-cost/sub-prime credit suppliers could have some effect on making them behave more responsibly.
But, considering the overall package we are not convinced that these measures go far enough. The FCA seems to see its role in being a referee, or creating a level playing field, between consumers and suppliers in the market rather than making the market work. Regulators are best placed to make this market work – not consumers.
The nature and extent of financial harm in the sub prime lending market
The analysis in the Equality and Diversity Assessment shows how much detriment groups with protected characteristics experience given their reliance on high cost, high risk, poor value products such as RTO, door step lending, and catalogue lending. We make a similar point in our response to CP18/13. The poorest, disabled, and BAME households are more likely to be paying unjustifiably high prices for consumer credit due to circumstances beyond their control.
The margins on extended warranties sold with RTO products are extremely high. The FCA’s own analysis found that providers are making profits of £25m-£40m a year on £40m-£45m of sales. Claims ratios are low. Only £4 is paid out for every £10 in premiums paid – this is a very poor value product and looks like it is being sold to many consumers who do not need it.
As FCA analysis shows, the median level of debt held by rent to own and home credit borrowers more than doubled in two years; the median level of debt held by catalogue borrowers has not risen so much but it still grew by 30% over two years. This could be exacerbated by a range of external factors. The continued squeeze on wages and the roll out of universal credit (UC) are major concerns. We have already seen evidence that households with UC are much more likely to be in rent arrears than households generally. Nearly three-quarters of households on Universal Credit are in rent arrears compared to 26% of all households. Similarly, households on UC are more likely to have debt problems than households on legacy benefits.
However, many of the more complex UC cases have yet to be rolled out – households on existing benefits or tax credits will be transferred from July 2019. The FCA’s interventions in the payday lending market has resulted in a much better functioning market and has helped promote more sustainable borrowing. But, we are concerned that these improvements may not be sustained. We fear that the UC roll out – along with the continued squeeze on wages – will leave growing numbers of households vulnerable to being targeted by the high-cost/ sub-prime consumer credit industry (regardless of which form it takes).
We argue that the overall primary objectives for this review should be to:
- Reduce the cost of credit paid by consumers
- Reduce the amount of high-cost/sub-prime credit used by consumers, and ensure that credit is used sustainably
- Force lenders to treat consumers fairly
- Ensure consumers get redress and are protected from the consequences of tougher regulation
In order to achieve a well-functioning consumer credit market, we need to change the default setting from the current setting in which credit is aggressively sold by suppliers to one in which consumer credit is actively and knowingly bought by consumers.
To achieve this, we call for:
- Consistent regulation: we need a consistent approach to regulating high-cost/ sub-prime consumer credit. Therefore, we call on the FCA to cap costs in these sectors and bring in a general rule that no borrower should repay more than twice the original amount borrowed – regardless of the form of consumer credit.
- Limits on loan refinancing: we support the proposals in this condoc to improve the way information is provided to borrowers. But, this will not be enough to constrain supplier/ intermediary behaviours or promote sustainable borrowing. Therefore, there is a need to limit the number of times loans are refinanced.
- Change the default setting: as a general principle, we should move towards a system where consumers have to proactively ask for credit limit increases, refinancing, or to be contacted by credit suppliers or intermediaries. We must change the default setting in the consumer credit market away from one where consumer credit is sold to one where consumers actively buy consumer credit.
- Product governance: the FCA needs to make greater use of its product governance powers – particular the temporary product intervention powers to constrain the market and protect vulnerable consumers until a wider, more permanent set of reforms are introduced.
- Greater transparency: the FCA has been producing some excellent analysis recently – for example, the analysis to support the payday lending review and now this analysis to support the high-cost/sub-prime credit review. Furthermore, the Financial Lives initiative has added significantly to the corpus of research on financial behaviours and vulnerability. We would urge the FCA now to use the schedule for the roll-out of UC to monitor and supervise the behaviours of high-cost/ sub-prime credit providers located in those areas which have already seen a roll out of UC and which are about to see a roll out over the rest of 2018 and during 2019.
- Reviewing the FSCS: although not covered in this consultation process, we also urge the FCA to urgently review the remit of the Financial Services Compensation Scheme to ensure that consumer credit firms are covered. As the recent experience with Wonga shows, consumers who are entitled to redress may not get that redress once secured and preferential creditors are paid. There is a risk that this will be repeated with other firms in the high-cost/ sub-prime sector as regulation takes effect.
- Debt buying/ debt collection: as the example of payday lending shows, regulation has consequences. Analysis revealed that much of the revenues were dependent on inherently detrimental business models. As a result, many firms have exited the market and/ or debt books have been sold on or collections outsourced. The activity of buying loan books and debt collection has not received enough scrutiny. Payday lenders, RTO, and doorstep lenders have been guilty of some egregious practices. But, at least they are relatively well known and in the public eye. This is not the case with firms which buy debts or collect debts on behalf of another firm. We call on the FCA to review these activities to establish whether firms are appropriately regulated and are treating borrowers fairly.
Our submission can be found here: FCA CP18 12 FInancial Inclusion Centre submission