Financial Regulation: a preliminary consideration of the Government's proposals - Treasury Contents


Examination of Witness (Quesitons 489-511)

Q489 <Chair: Thank you very much for coming along today. We recognise there is a limit to what can come before us. We are very happy to take further written evidence. Could you begin by giving your view about how consumer credit should be regulated?

Mr Sklaroff: We have a well-developed system already in the UK for regulating consumer credit and it is, as we speak, undergoing a radical revision. We have a new European directive that is due to be implemented; the deadline is next February. That follows very quickly on the heels of a revision to the UK's own Consumer Credit Act. The regime as we currently have it has introduced, just in the last two to three years, a very large number of new features, in particular with regard to conduct of business, and the way that companies providing credit should communicate with their customers—explain prices to their customers, and set out information and the new rights for customers to change their minds if they do not wish to take up the credit that has been offered, and so on.

That regime at the moment is run in the UK by the Office of Fair Trading, and the Government has, of course, indicated that it wishes to consult on the question of whether in future the regime for retail consumer credit should be transferred from the OFT to the new CPMA. Up until several weeks ago, it was saying that its mind was not yet made up on that matter, and that that it would wish to be persuaded that there were very clear and well-defined benefits to be had from making that change before it would wish to do it. It recognised, very fairly, that there were issues of disruption and so on with any kind of regulatory change. However, it seems to me that the announcements made just a few weeks ago concerning the future of the OFT itself—both as a competition authority and in terms of its various responsibilities for consumer protection in the UK—to some extent pre-empt that debate about what should happen to consumer credit. It would seem very odd, if the OFT was losing its other consumer protection responsibilities, for something different to somehow be done with consumer credit. So, as a working hypothesis, we are assuming that consumer credit is at some stage going to be transferred to the new CPMA.

That gives rise to a number of concerns. I should perhaps say, first of all, that we have no ideological or principled objection to that change taking place. Our concerns are very much to do with the practicalities, both of the transition and of the nature of any new regime. Despite the fact that there has been a very great deal of change, as I've just said, in the existing UK regime, nothing is perfect and, of course, it is possible to come up with a list of things that one would like to see changed in any new regime. My slight concern is that the regulation of retail consumer credit may be seen—and this is certainly not what anyone has said on the record—by the Government as, in some sense, a residual issue to be dealt with once the rest of the regulatory architecture dealing with prudential issues, and so on, has been set up. I think my strong plea to those concerned is that it not be treated as a residual, and that it be dealt with, as it should be, as a very major task and a very important economic task in its own right. Therefore, the design of any new system needs to begin right now and quite a lot of resource is going to be required to ensure that the transition is successful.

Q490 <Chair: What is your preference for that design?

Mr Sklaroff: We think that any new system should be, above all else, clear and predictable, and we would say that one of the problems with the existing system is that it isn't always clear and predictable. By that I mean that because of the way in which the existing regulators interact in the consumer credit market, it is not always possible for companies or customers to predict exactly how the regulatory system will apply in any given case. So I think my top-line plea would be for a system that was clear and predictable.

I think we would also suggest that a new system has to focus very clearly on the important aspects of the market. At the moment, the Office of Fair Trading licenses something like 100,000 entities for credit purposes. Most of those are not providing credit in any normally accepted sense of the expression "credit". Perhaps 4,000 of them are, to some extent or other, in the actual credit business, and even of the 4,000, most of them are not full-scale credit companies. So I think if one is looking at a new regime one would wish to look at that number and say: is there not an argument for focusing more directly on what I think we would all recognise as the provision of credit to the end customer?

Q491 <Chair: Before I pass the questioning over to John Thurso, could I ask you one very general question, since you have an interesting and unusual perspective on what is going on in the economy? Could you give us a view about what the market is like for your industry at the moment, because it is a very good barometer of the recovery?

Mr Sklaroff: Yes. We do represent a very wide range of markets—everything from leasing railway rolling stock at one end, to the provision of consumer credit at the other, so I think we are just such a barometer. Certainly in the consumer credit markets, just starting there, we have seen a considerable reduction in the amount of business being written over the last three years in the context of the credit crunch and the recession.

Q492 <Chair: Can you put a percentage on it?

Mr Sklaroff: A 25% reduction in new business in our markets—that isn't the whole of the UK credit market, obviously—in consumer credit over that period.

Q493 <Chair: And some recovery?

Mr Sklaroff: We have seen some recovery in some areas. In particular, the motor credit market has done relatively rather well over the last year or so, although there are concerns, looking at the state of the economy going forward. But it's also true that in the asset finance markets we have seen a considerable reduction in the amount of new business being written over the last few years, and in that space—and I know it isn't really the focus of the Committee's inquiry today—our concern is that, particularly in the small business sector, businesses are less able to reinvest in new equipment coming out of the economy than was the case in either of the last two recessions. So we do have a concern there.

Chair:> It's a small aspect of a very big picture that we're getting from a lot of people.

Mr Sklaroff: Indeed.

Chair:> John Thurso.

Q494 <John Thurso: I want to follow up on some of the points you have just made, but first can I ask you about the Financial Ombudsman Service, which currently provides redress for both OFT-regulated and FSA-regulated firms? Do you think the Ombudsman Service role should be reviewed as part of the restructuring and, if you do, what would you like to see?

Mr Sklaroff: I think it should be reviewed as part of the restructuring. I should say I have been encouraged by what the new Chief Ombudsman has been saying, in terms of her approach to the role of the ombudsman, in recent weeks and months. Our view is that the ombudsman needs to focus on being a genuinely impartial complaint-handling organisation, where people can go and get redress if they feel they have a complaint, without straying into the territory of consumer advocacy. The difficulty with straying into that territory, however tempting it may be, is that it begins to undermine impartiality, and I think it's very important for the ombudsman that it is seen as impartial by all parties to any given complaint.

Our concerns with the existing ombudsman regime also relate to the efficiency with which they process cases—and I know, again, this is something the Chief Ombudsman is taking very seriously, and we have had discussions with her about it—and the length of time it takes to process a complaint once it goes to the ombudsman. There are also some issues, certainly historically, concerning the consistency or otherwise with which similar kinds of cases are adjudicated by the ombudsman. All these things are well-known issues, and we are in discussion with the ombudsman about them, but I do think, going back to your question, that it is important, as part of this really quite radical change to the consumer credit regulatory scene that is being talked about, that the role of the ombudsman be looked at in the context I've been describing.

Q495 <John Thurso: Thanks. You have touched on this a bit already but I'd like to flesh it out a bit. On the changes—the moves from the OFT to the CPMA—virtually all the written and oral evidence that we have received from organisations has pretty strong support for the move. As you've said, to a certain extent, it is becoming academic because it's a bit difficult to leave something when you've demolished it, kind of thing.

Mr Sklaroff: It's a bit difficult to see how, yes.

John Thurso:> You voiced concerns, and you have fleshed those out a little bit, around the practicalities and the nature, and so on. But can I ask you to look at the other side? What do you think could be the benefits of such a move, particularly in your sphere?

Mr Sklaroff: I think the benefits fall in two broad categories. I think the first and perhaps most obvious is that—as has already been said—there are many regulated companies that at the moment are regulated, both by the OFT and by the FSA in the conduct of business space for different aspects of their business. For those companies there is obviously an efficiency gain to be had or to be aimed at from bringing the regulatory regimes together. So I think there is a clear argument there; many others have made that argument. I think the second set of potential benefits are the ones I was talking about earlier, which are to do with: how can we improve the current system? How can we take the opportunity of designing a new system to see whether we can't design out some of the dysfunctions in the existing system? I've mentioned one or two of them already to do with predictability, clarity and focus. Also I think there is an issue about resourcing. I think it is to the credit of the OFT at the moment, it is a relatively—

Chair:> Order, order. It is 11.00 o'clock.

Two minutes' silence observed for Armistice Day.
<

Chair:> Thank you, everybody. Do continue.

Mr Sklaroff: I think I was just about to make a comparison of running costs between the OFT and the FSA. At the moment, the OFT's annual running costs are about £50 million per annum. The FSA is about nine times that; it's about £450 million. That is perhaps a misleading comparison to some extent, because they are running different kinds of regimes, but there is an issue about having the right kind of resource in the new regulator in order to deal with the very particular issues arising in the credit markets. While it is a financial service, credit is a fundamentally different kind of financial service from most of the others that the FSA is used to dealing with at the moment in the retail space. We would wish to be reassured that the CPMA, if that is the destination for this regulatory function, is properly equipped with people who will understand the needs of the market, and will be able to interact with the market and take sufficient information from it to regulate it effectively.

Q496 <John Thurso: Given when you put your evidence to us, and given that, as you say, over the last couple of years there have been quite a lot of changes, and in light of the fact that we probably already have a decision—we just haven't recognised it yet—if there is anything that you would like to add in writing, then I think that would be very useful.

Mr Sklaroff: I would be very happy to do that.

Q497 <John Thurso: Can I move on from that to the question of cost, which you have mentioned already and clearly signalled? The particular question is about compliance costs and whether you think, first of all, there is a danger that these will rise as a result of a move—they never seem to go down when they move. Secondly, do you think there are one-off costs involved in the changes? Perhaps you could talk a little bit about the costs.

Mr Sklaroff: I'm very happy to. We have an estimate of the cost of introducing the consumer credit directive, which is what we're doing at the moment. That is within the existing structure, and that estimate is somewhere up to £500 million as a one-off cost for the introduction of that new set of rules around the sale of credit.

Q498 <Chair: That is pretty large.

Mr Sklaroff: That is a very large sum of money. It is a worryingly large sum of money, but I think it's not a misleading sum of money, because it does show the pre-existing complexity of the regime that sits around consumer credit in the UK. So, for any further change, I would be surprised if the transitional costs were of an order of magnitude different from that, shall we say. So, there is a big concern about transitional costs, plus all the usual problems about regulatory uncertainty. The UK is already seen internationally as a very expensive market in which to do retail credit business, and I think this further change is unlikely to make that a better picture.

In terms of the regulator, and the compliance costs with the new system, as I think the Chairman has discovered in asking this question of previous speakers, there is rather a patchy amount of evidence available for how much things cost at the moment. In recent years, the FSA has done some analysis itself of how much its existing regulatory system costs, and from time to time aspects of the OFT's regime have been looked at. None of them are exactly additive, so it's difficult to say. But picking up your question, my concern is that it has been inevitably the case each time the FSA, as presently constituted, has produced a new rulebook that the regulatory and compliance costs associated with that part of the market have risen. I think one of our other pleas, which we're certainly discussing with the Government, is that it is not assumed that if consumer credit moves into the CPMA, all it will need is its own rulebook. One has seen versions of that statement from time to time.

That would be wrong on two grounds: one is the cost ground, because I think that would be the wrong way to go; the other is that it isn't like the other financial services currently regulated by the FSA and it needs some proper attention. Given that we have—whatever it is—37 years now of statute law governing this in the UK, and given the fact that that statute law is heavily embedded with other statutes dealing with other aspects of consumer protection, I'm afraid that simply writing a new rulebook is not going to turn the trick.

Chair:> Mark Garnier.

Q499 <Mark Garnier: Thank you, Chairman. A little earlier, in response to the Chairman's question, you talked about the fact that the current economic cycle has resulted in a downturn in consumer credit. But you also said in your written evidence that "the sheer volume of this new regulation has contributed to the shrinkage of the UK consumer credit market". Can you rationalise how much of the shrinkage has been down to regulation and how much has been down just to an economic downturn?

Mr Sklaroff: The honest answer is no. I can't actually say, "X% was this, x% was that." What I do know, from conversations with many companies in this market, is that the increasing regulatory costs have become a more and more important factor. Indeed, comparisons made between the UK market and other European markets by people who are active in both rather reinforce that.

Q500 <Mark Garnier: Maybe a way of looking at it that might be more illustrative is: how many participants in the consumer credit market have withdrawn from the market because the costs have become too much for them to bear and they've closed down?

Mr Sklaroff: We continue to see announcements—and there was another one this week—of companies withdrawing from at least some of the consumer credit markets. It is often the case that when you ask them, "Why have you done this?" they will say that of course there are economic circumstances here, and of course there are issues about the nature of the market, but that regulatory costs, of one sort or another, are a major part in their decision and they just cannot operate profitably in some of those markets. My personal concern about this is that some of those markets are precisely those sections of the population most in need of help and support during a difficult economic time, and those markets are becoming thinner and thinner and thinner. Hence my concern—and we have aired this with the Government and publicly—about ideas such as interest rate caps and so on in some of those markets; they risk having precisely the opposite effect from that intended.

Q501 <Mark Garnier: I wanted to go on to that, in fact. At the end of the day, the interest rate you charge to customers is ultimately the most determining factor as to whether people take out credit. One of the problems that we see is that the poorer you are, the lower your credit rating, and therefore the higher the interest rate you tend to be charged. I've always had a problem trying to rationalise that in one respect, although my background is in investment banking so I completely understand why it is done. Do you not think that lenders do have a social and moral obligation to make sure that consumers are charged an affordable rate of interest?

Mr Sklaroff: I think there is a moral obligation to ensure that consumers are charged an appropriate rate of interest, and I think the question then becomes: what does one mean by appropriate? "Appropriate", for a company that wishes to remain in business, has to mean, apart from other things, a rate for the risk. The company has to take a prudent view of what the risks are of default in a particular market, and it has to price the products accordingly. Of course, it is physically possible for a Government or a regulator to intervene in markets—and this happens in many overseas markets—and set caps and control those costs, but what tends to happen is that either other costs in the credit market rise to compensate for the fact that you can't actually price for the risk in the market you're operating in, or people withdraw altogether. It was interesting that that was one of the conclusions drawn by the Office of Fair Trading when they recently looked at the UK short-term credit market. They explored whether interest rate capping in that market would be a socially useful thing to do, and the conclusion they came to was that those markets are, first of all, as an observation, already very thin, in the sense that there are very few commercial participants in them. If you intervened in those markets by capping rates, you might very well drive some of the few companies left out of those markets, meaning that the individuals who used to use the services of those companies would have no recourse other than the illegal market.

Q502 <Mark Garnier: It is clear that we were underpricing risk, which led to part of the banking collapse. Do you think we're possibly overpricing it now?

Mr Sklaroff: I think not. I think what has happened is that, during the last three years, companies and individuals have had to take a rational look at what they can afford. From the point of view of a company, as I'm saying, what they can afford means, "Is this market"—whatever the market is—"something in which I can make a reasonable return, while attracting a reasonable number of customers with a reasonably low rate of default? If the answer to that is no, then I may wish to look somewhere else". On the other hand, consumers have clearly, and we see this in our own figures, been rebalancing the extent to which they are using credit products in, on the face of it, a rational way.

Q503 <Mark Garnier: Part of the new regulatory regime is going to be the Financial Policy Committee. Martin Lewis, when he gave evidence to us earlier, already said that he sees that that could be a problem for a certain core of people who need credit who may find it more difficult to get to it, because, of course, as soon as you get the FPC intervening in liquidity, that is where it is going to hit first. Do you agree with those views?

Mr Sklaroff: I think there are some concerns, not just on that score, but more generally on possible regulatory interventions in the credit markets having precisely that adverse effect. I think what one has to be clear about is what problem one is trying to solve. For example, if the problem—and it is a very big and difficult problem—is poverty, defined in a certain way, it isn't necessarily the case that the obvious lever to use to address that is a further piece of regulation in the consumer credit markets. Sometimes I feel that when one sees the debates round these issues, they are as much to do with the very real problem of poverty as they are to do with what an appropriate regulatory structure for consumer credit would be. The risk is—and I think Martin Lewis was drawing attention to this—that very well-intentioned regulatory interventions in the consumer credit markets might make things worse for the people that those markets currently serve.

Chair:> Stewart Hosie, you wanted to come in quickly before we move to Andy Love.

Q504 <Stewart Hosie: A quick question. Mark's first question there was about the balance between the recession and the burden of regulation. Looking at the growth around the fall in new credit, it is going south in every category apart from car finance; that is quite startling. Looking to the future, do you think that this is going to pick up or stay flat, or do you think we'll see further falls? Where do you think it is going?

Mr Sklaroff: I think there has certainly been something of a medium-term resetting of the market. I think that is undoubtedly the case. It depends how far forward you look, obviously. I think there are some markets that are showing no signs of recovery, and it is a matter of sheer speculation as to whether they will. I think as things gradually get better in the economy, it is possible to imagine that new capital will come back into some of those markets. But I think your question encapsulates very well one of our big concerns about all the talk that is going on about a further change in consumer credit regulation. It would be very easy, for very good and praiseworthy reasons, to break the last straw on the camel's back here and entrench a situation that is a much smaller market, a much more highly polarised market, a market in which lower income people find it next to impossible to get legal credit.

Q505 <Stewart Hosie: The question I have is—assuming that's not the most positive answer for the near future, I think we can agree that—do you see the pressures on growth, or the suppression of growth, primarily being led by unemployment, wage freezes, tax allowance freezes, inflation and VAT rises, or do you see the suppression primarily being led by new regulation?

Mr Sklaroff: It's both.

Q506 <Stewart Hosie: It is a combination of both?

Mr Sklaroff: It is definitely both. It's a combination of both, because all the factors you've listed are exactly the things that my members talk to me about on a regular basis—all of the above. So, people are concerned about what is the short to medium-term prospect for the economy, for unemployment, for consumer spending—all those things—because these are the markets that are very important to my members. But they're also very worried about the implications of these new regulatory plans, not because there is any—as I said earlier—ideological objection to the move from organisation A to organisation B as the lead regulator, but because of what that might mean in terms of uncertainty and costs.

Chair:> Andy Love.

Q507 <Mr Love: Can I return to the vexed subject you touched upon earlier of interest rate caps? A lot of people think it's a no-brainer, including quite a lot of Members of the House of Commons. There are early-day motions relating to this topic. Indeed, I think there is even a prospective ten-minute rule Bill relating to this issue.

Mr Sklaroff: There is, yes.

Q508 <Mr Love: The OFT earlier on, as you mentioned, decided in terms of short-term credit, where there are very high interest rates, not to introduce that. They were looking at credit cards. Is it a no-brainer that interest rate caps would help the consumer?

Mr Sklaroff: It isn't a no-brainer because the evidence shows that there are unintended consequences that arise in markets where these kinds of caps are put in place. As indeed was said in the debate in Westminster Hall earlier this week, there is quite a lot of evidence from other parts of the world about what happens when you put in these kinds of interest rate caps. Although that shows on the one hand that it is physically possible to put them in place, you then have to look at what the consequences are.

On the consequences, first of all, any cap is often seen by the market as a kind of official rate, so you get a move to the cap. So, perversely, you get the effect of an increase in costs in the market that you're targeting. Secondly, going back to what we were talking about earlier, you get an effect where if a company is unable to cover its risks, if it knows that default rates, for example, in a particular market are simply not going to be covered by the interest rate that it's allowed to charge, it then has two choices. It can either get out of that market altogether, and there is evidence that that happens in some cases.

Q509 <Mr Love: Let me just stop you there, because I think that's where the public find it difficult. When you're charging 200%, 250%, 300%— I don't expect that will happen in terms of credit cards, but it certainly happens in terms of home credit and pay-day loans—when you're charging that level of interest, people find it difficult to understand that companies will turn round and say they're not making a profit. Is there evidence to suggest that there is that withdrawal from the marketplace by the companies who are offering these services?

Mr Sklaroff: There is. In fact, there is a certain amount of evidence from some geographically very close European markets about what happens when you put in place these kinds of caps. For example, in the Netherlands, there is now a very scanty market indeed for loans below the level of about €2,500, simply because, under the regulatory structure that exists there, it is very difficult for a company to operate profitably, for the reasons we've just been discussing—that you can't charge an appropriate level of interest for the risks in the market. Of course, you have the choice of moving out of the market, because you can't cover your costs properly. The other choice is you cross-subsidise from somewhere else, which means that prices somewhere else in your market will have to rise to cover that. Obviously, where you come down with that choice will depend upon the size of company you are, and how many different markets you are operating in. But the net effect of all this is often higher prices for a larger number of people and less credit available in the target markets, which seem to us to be perverse consequences from what would otherwise be a well-intentioned regulatory intervention.

Q510 <Mr Love: When they looked at this before, they came up with a series of recommendations, the main one of which—and certainly the one that I can remember—was to try and increase competition, particularly in home credit, where there seems to be a distinct lack of competition. There are a couple of companies that dominate the marketplace. Will that help the consumer in these circumstances, and how do your members, since it's mostly your members that are in these marketplaces, look on—

Mr Sklaroff: Just to clarify that, we have very few members in that marketplace. I think we have one member who is in that short-term lending market; most of our members are in other parts of the market. But to answer your question, I think it goes back to the discussion we were just having about the economy. To some extent, the number of people who are willing to enter those markets will depend a little bit upon the state of the economy, whether there is a perception of a growing propensity for people to buy consumer goods using credit, and so on and so forth, and also the issue we're discussing, regulation. Unfortunately, the effect of some of the kinds of regulation currently being debated would, almost inevitably, be that there would be even fewer companies in those markets.

Q511 <Mr Love: Finally, because I do think we can only take this so far, I will give you the example of my own constituency. I was invited by an American company, recently arrived in this country, that provides primarily pay-day loans and their standard product charges an interest rate, I think, of 350%. I have several pawnbrokers; I have several people who will take goods in lieu of cash and, again, charge. There doesn't seem to be a lack of competition in the marketplace in my constituency for people who need that short-term money, yet it doesn't seem to have done anything to reduce the interest rate. How do we reduce the very high charges that are currently being experienced by consumers?

Mr Sklaroff: Going back to what I was saying before, we have very few members in those markets. But on your general point, I think, to be honest, there is a problem—and other people have said this too—in using the APR as the way in which you compare credit products. I think Martin Lewis himself made this point when he was giving evidence to the Committee. If you are talking about a short-term loan, the issue for the person taking out the loan is affordability. If I'm borrowing a very small sum of money, £200, and I'm going to pay it back with £20 in four weeks' time, that is a very high APR but, of course, is the annual rate the way of measuring the cost of that loan? So I think there is a problem with the APR. In fact, it's one of the things that we and others are talking to the OFT about at the moment—whether there is some other way of giving an accurate view of how much this is costing you. That is crucial; it must be open and honest, but on the other hand, we should not get into this territory where you are comparing apples and oranges.

Chair:> Thank you very much for giving evidence today. Please feel that this is part of a dialogue, and if there are further points you want to make, please put them on paper, and we will be very interested to take a look at them.


 
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