Introduction
The CAB service is a network of 432 independent advice centres providing free, confidential and impartial information, advice and advocacy from over 3,000 locations in England, Wales and Northern Ireland. It provides free, independent, confidential and impartial advice to everyone on their rights and responsibilities. It values diversity, promotes equality and challenges discrimination.
In 2007/08 the CAB service dealt with 5.5 million enquiries of which 1.7 million related to debt problems. We estimate that around 520,000 people received advice about one or more debt problems from the CAB service in this year. Around 900,000 of these debt enquiries related specifically to consumer credit agreements. We believe that this experience makes us well placed to comment on both consumer debt and consumer credit regulation.
Citizens Advice has for some time been concerned about the number of cases of apparent irresponsible lending amongst the debt problems of CAB clients. We have recently provided the OFT with a large number of qualitative reports highlighting cases where lenders granted credit that appeared to be unaffordable or otherwise unsuitable for the needs of the borrower. We do not intend to provide further evidence in this response, but we invite the OFT to request further evidence from us as the irresponsible lending project continues.
Additional point on scope
In broad terms, Citizens Advice strongly supports the wider scope approach described in the consultation paper. However we do not believe that the question of scope is just about which areas of business activity to include or not include in this project. Instead the key question about the scope of this project is what it hopes to achieve in the end.
Here paragraphs 4.37 & 4.38 state that the outcome of the project will be guidance on minimum standards below which businesses may be considered to be acting irresponsibly. But this is clearly not an outcome but an output. The outcome rests in the future behaviour of credit businesses and hence the experience (and arguably the behaviour) of credit consumers. So a key area that the irresponsible lending project needs to consider is the relationship between output and outcome; between regulatory guidance about standards of conduct and the actual effect this has on the behaviour of market participants.
An important point here is that the new section 25 (2B) does not sit in a vacuum but follows on from previous attempts to deal with the question of irresponsible lending under the old section 25. For instance, the existing non status lending guidance is explicitly concerned with irresponsible lending practices, as the consultation paper points out. It is therefore arguable that the new section 25 (2B) does no more than make an explicit reference to a set of business practices that were already capable of scrutiny by the OFT. So why did Parliament feel the need to enact the new irresponsible lending provision?
Again it is arguable that this part of the 2006 Act reflected growing public concern about levels of over indebtedness and the role of poor lending practices in this. Put bluntly the non status guidance and the regulatory approaches connected to it had failed to address the sort of irresponsible lending practices that Citizens Advice Bureaux and others were regularly seeing across all sections of the consumer credit market. If this was not the case there would be no need for an irresponsible lending project now.
So constructive critical reflection of past approaches must be a fundamental part of the scope of the current project. Indeed it would seem that a good starting point for the irresponsible lending project would be to ask how the outputs arising from this project be different from what has come before.
Regulatory focus and compliance by firms
In outline we believe that the most significant difference should be a move away from focusing solely or even mainly on the regulatory guidance itself. Instead the focus should be on the critical process through which firms adapt the guidance to their own practices and procedures at each stage in the transaction process. The OFT perhaps has a history of producing (sometimes very good) guidance to license holders but then assuming that this is being complied with unless complaints for consumers suggest otherwise. Instead the onus should be on firms to demonstrate that they are complying with ‘responsible lending’ principles through the quality of their written policies and procedures.
This is broadly the approach taken by the FSA in the mortgage conduct of business responsible lending rules (MCOB 11.3) where lenders are required to produce a written responsible lending policy. This idea seems to have great force, but has not been universally successful perhaps in part because the rules give lenders too much room to decide they factors they will take into account in setting their policy.
In this respect it is interesting that the FSA’s own responsible lending project recently concluded that minimum standards set out in MCOB 11.3 were not always being translated into the sort of conduct that the high level principle demanded. For instance, the FSA project found that the responsible lending policies of some firms were ‘too vague and of little practical use’. If anything this highlights even further why the regulatory focus must be on the way firms adapt their practices to rules and guidance and also that the process of adaptation requires something more than mere compliance.
The FSA responsible lending project also highlights the importance of compliance monitoring. Guidance can be clear and comprehensive, firms can develop paper policies showing how they will adapt their procedures to the guidance, and yet in reality the way consumers experience problems in the market does not change. We believe that the OFT will need to pay particular attention to the issue of compliance, given that resources for consumer credit licensing are limited and the spread of license holders very wide.
Of course complaints data will continue to be important and we have no doubt that well drafted guidance will help consumers and their advisers to spot and challenge bad practice (a key benefit of the debt collection guidance).
However we believe that firms should also be required to demonstrate how they will comply with any regulatory guidance on an ongoing basis. There follows from this an argument that firms should be required to publicly demonstrate how their policies and practices guarantee they will not engage in irresponsible lending. To support this the OFT should develop measurable compliance criteria against which firms would report their performance.
In the absence of any requirements by lenders to demonstrate how will avoid irresponsible lending behaviour, the OFT will only become aware of practices leading to irresponsible lending by observing the resulting detriment experienced by consumers; by which time regulatory action will be too late.
So in summary Citizens Advice;
- Agrees that the irresponsible lending project should have a wider scope
- Would be concerned if the project saw production of new guidance as a final output
- Believes that the key focus of the project should instead be on the way that firms demonstrate that they are adapting their practices and procedures to the guidance
- Believes that success is also likely to depend on the OFT developing an effective compliance monitoring strategy that is robust over time given the resources available.
We will now answer the specific consultation questions.
Question 1: Do you agree with the OFT initial view that the scope should cover all stages of a lending transaction
Citizens Advice believes that a key part of the project must be to improve the quality of lending decisions with respect to assessing whether credit is affordable and suitable for the needs of borrowers. By necessity this means examining the underwriting practices of lenders and we would argue that the growing levels of over indebtedness that the CAB service has seen over the last ten years justifies rigorous scrutiny as to why these processes have failed to prevent cases of apparent irresponsible lending.
In this respect we would point out that previous approaches to regulating lending practices have been to set out some high level principles about checking affordability while allowing lenders great flexibility as to how they incorporate these principles into their business practices. Whether it is the FSA responsible lending rules, OFT guidance or industry trade association code commitments, the question of avoiding irresponsible lending has arguably been a sophisticated version of the old canard that lenders will not lend to people that they do not think will pay them back.
That said, more recently we have seen some sections of the credit market take the initiative by updating their underwriting practices to better predict clients at risk of over indebtedness. The greater use of behavioural data by credit card providers is a particularly welcome development, as is the recent banking code commitment for subscribers to take a more pro-active role in spotting at risk borrowers. However, at the same time we continue to see examples of very poor lending by mainstream lenders across a range of product lines. To us this suggests that current industry initiatives have not yet gone far enough and that there is a need for a regulatory response in two main ways.
Firstly we believe that regulators need to require lenders to do more to demonstrate that they are not lending irresponsibly in the ways described above.
Secondly we believe that regulators will need to be more prescriptive in setting the parameters of responsible lending practice. For the irresponsible lending project this might include asking questions like:
- Should the regulator be driving best practice rather than minimum standards. If so how can this be done
- Do requirements on lenders to check affordability and suitability need to be stated in more precise terms than ‘parables’ in high level guidance. If so, how will guidance drill down to create concrete procedural duties for lenders.
- If so, how would these duties vary for different product types and sizes. If avoiding irresponsible lending means focusing on the risks faced by consumers (rather than just commercial risks to lenders) then what would a proper system of risk based regulation look like.
- If established, how would the responsible lending concerns of this system this be squared with concerns about transaction costs (for lenders and consumers) and consumer preferences for convenient access to credit when they need it.
- If the answers to these questions add up to a definition of irresponsible lending, how will the OFT ensure that examples of bad practice can be spotted and challenged effectively.
In highlighting our concerns about irresponsible lending, Citizens Advice has often concentrated of cases where the credit was unaffordable for the borrower at the outset and the lender should have realised this had they properly used the information about the borrower available to them at that time. Some of the most shocking examples of irresponsible lending fall into these categories, particularly where borrowers have been able to build up huge debts across very many products, often using one credit line to pay down the balance on the next.
While we still seeing examples of this we are hopeful that recent industry initiatives and this OFT project will combine to make these sort of cases very much less common in the future. Indeed we see very large multiple debt cases as a bellwether of change in lending practices. Obviously current market conditions will play a part here, but if CABx begin to report an upsurge of such cases in the future it would very likely signal that the policy intention of section 25 (2B) had been very badly missed.
Our experience of dealing with consumer credit debt suggests that while cases of catastrophic failure from the outset are relatively uncommon, consumers are often caught out by their inability to assess their vulnerability to debt over time. A snap shot of a borrower’s circumstances at the time credit is taken out may suggest that the product is affordable and suitable, but these circumstances might change for a number of reasons. Major life changing events can obviously undermine ability to repay credit, but so can more minor events that reduce income or increase expenditure. Taking on more credit will also likely increase the borrower’s vulnerability to debt being the consequence of any change in circumstances.
The key question here is to who should be responsible for assessing these types of vulnerability, borrowers, lenders or both. When talk turns to responsible lending you can be sure that the lenders will turn talk to the need for borrowers to be more responsible. Of course it is an unarguably correct principle that borrowers need to take responsibility but what does this mean in terms of the behaviour of concrete real life borrowers? Answering this is clearly important if borrowers are to become knowledgeable about credit risk over time and therefore more responsible in their credit purchasing decisions.
Part of this involves looking at the capability of borrowers to understand both financial products and their own financial lives. Improving the ‘innate’ capacity of consumers before they even enter credit markets is arguably relevant to this project but is also being dealt with elsewhere. However improving the ability of consumers to understand the nature of credit commitments once they have decided to enter the market should be very much within the scope of this project.
Here we would argue that the decision to enter credit markets does not start at the point that a borrower actually executes a credit agreement but at the time that they start seriously thinking about taking out credit. So the way that credit products are promoted and credit sales conducted is clearly relevant to the ability of borrowers to make responsible decisions. Again there are two broad aspects to this.
The first is about fair dealing and consumer protection from unfair dealing. CAB evidence about irresponsible lending will sometimes also highlight high pressure selling, misleading advice or misleading information. It is clear that irresponsible lending and other forms of mis-selling and mis-information are linked. Unfair practices, agreements or promotions are all potentially subject to consumer protection measures (UTCCR’s, CPR’s) that have their own guidance and enforcement regimes. However we believe that guidance from this project would also be useful in re-enforcing the effectiveness of these sources og consumer protection in dealing with credit problems. More specifically, the Consumer Credit Act 2006 introduces the unfair credit relationships test and specific guidance on how potentially unfair sales, advice and information practices relate to irresponsible lending is also needed.
The second is a wider point about creating what we would call a climate of responsibility in consumer credit markets. We would argue that credit businesses have enormous power to encourage and enable responsible borrowing through creating a transaction environment which focuses on suitable and sustainable credit use rather than purely selling credit. Such an environment might have some of the following features:
- A recognition from lenders that they are likely to have a better appreciation of a borrower’s vulnerability to debt than the borrower will themselves.
- That consumers need time to think about the suitability and affordability of credit products. Consumers do value convenience and speed of access but this needs to be tempered by time and help to understand the possible risks.
- Borrowers may need tools to understand what is affordable and what is not. The OFT may well decide that it would not be appropriate for lenders to check the borrowers’ income and expenditure commitments in every sale. But we believe lenders should be required to encourage borrowers to better understand this themselves, including (indeed especially) at the point of sale.
- In a climate of responsibility lenders might be expected to help their customers with adequate advice and explanation about product features and whether this is suitable for the borrowers needs. Compare this ideal to the horrible history of payment protection insurance sales.
- Likewise one might expect credit promotions to better highlight the risks as well as the benefits of credit and to sell products on their merit rather than by offering inducements.
In summary, we believe that all these of elements of support, advice, information, promotion and underwriting need to be brought together to form a transaction environment that prioritises responsible credit use. Put more simply, we believe that UK consumer credit markets need a proper selling regime that is significantly different from the current over reliance on contractual information. Therefore setting the foundations for such a selling regime should be the aim, scope and main outcome of the irresponsible lending project.
Question 2: Are there any other factors which you believe should be included within the scope of the project.
For similar reasons to those set out above we believe that the OFT should also consider how the post contract behaviour of lenders can also influence the way consumers act in credit markets. CABx have reported many cases of borrowers entering into unwise credit agreements in an attempt to deal with firm pressure to repay debts owed elsewhere. Therefore we would support the inclusion of account management in the wider scope.
Please also see our comments on the scope of the project with regard to outcomes set out above.
Question 3: Are there any factors which you think should not be included…
Citizens Advice believes that all of the factors listed by the OFT should be included within the scope of the project.
Question 4: Do you have any other comments or suggestions on scope…
We have answered this question in our introductory remarks at the start of this response.
Question 5: Do you agree or have any comments or suggestions relating to the proposed methodology.
We have answered this question in our earlier comments on scope, regulatory focus and compliance by firms.
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