Debt Management

DM 10

Written evidence submitted by Consumer Focus

About Consumer Focus

Consumer Focus is the statutory consumer champion for England, Wales, Scotland and (for postal consumers) Northern Ireland.

We operate across the whole of the economy, persuading businesses, public services and policy makers to put consumers at the heart of what they do.

Consumer Focus tackles the issues that matter to consumers, and aims to give people a stronger voice. We don’t just draw attention to problems – we work with consumers and with a range of organisations to champion creative solutions that make a difference to consumers’ lives.

We welcome this Committee’s inquiry into these issues. The Government’s response to the consultation on managing debt and personal insolvency is long overdue.

The consultation paper itself was poorly formulated, asking wide ranging and unfocused questions making it challenging to understand the thinking behind the proposals on deregulation for example.

Since the closure of the consultation in December 2010 the detriment experienced by consumers in this market has worsened – with higher rates of indebtedness, insolvency and repossessions [1] . In contrast, the high cost credit market appears in rude health.

Competition in the market is high yet this competition has neither driven down prices nor eliminated some truly shocking bad practice. Indeed, annual percentage rates (APRs) have risen, as has consumers’ reliance on high cost debt to make ends meet.

In our response we highlight our key concerns with the market. A copy of our full response to the BIS consultation is available on our website [2] ; however we wish to focus on high cost credit, credit scoring and the commitment to end unfair bank and financial transaction charges.

High cost credit  

Improving the provision of affordable credit is vital to solving detriment in this area. We recognise that third sector providers such as credit unions and community-based finance initiatives have an important role to play, but they are still marginal providers and would need substantial investment to have the capacity to meet the demand.

It is mainstream financial services providers that currently have the scale and reach to provide access to affordable credit. We have recently published research into this issue Affordable Credit – Lessons from overseas [1] . For this research we asked the Personal Finance Research Centre to examine options for making better provision of affordable credit for those on low incomes, especially drawing on experience in other countries. The research found greater willingness from mainstream financial institutions in other countries to provide lending to low income consumers. The findings provide food for thought in terms of lessons for the UK. The Committee may wish to examine this research.

The debate around high cost credit continues to centre on the hotly-contested issue of interest rate caps and the potential consequences. We welcome the Government announcement that it will commission research on this topic. Yet, beyond that debate we need a wider discussion about what responsibility mainstream lenders have to provide affordable, safe and trustworthy credit products to low income consumers.

In terms of the current provision, there is undoubtedly a need to improve practice within this area. With regard to payday loans, the consumers in our study found that the rigour of the application process varied between lenders. Some of the borrowers felt that their lender would lend to ‘almost anyone’. [2]

We have significant concerns that Payday Loans providers are not complying with obligations around responsible lending, most notably on affordability checks and ensuring loans do not ‘rollover’ causing an unbearable burden on consumers in financial difficulty.

To protect borrowers we suggest:

– limiting the number of rollovers or repeat loans to five per household per year by clarifying the Office of Fair Trading (OFT) irresponsible lending guidance

– effective affordability checks (for first and additional loans)

– limiting loan values by income (for first and additional loans)

– information sharing between lenders to prevent multiple loans

Following publication of our report Keeping the Plates Spinning [3] , the industry established a forum to draw up a Code of Practice. A Lending Code for Small Cash Advances was drawn up and the Consumer Finance Association launched it in July 2011. While the Code made some progress that will be helpful for consumers, it did not address key issues for the protection of vulnerable consumers which our research had identified.

Research by Which? and Citizen’s Advice has found evidence of widespread problems in this market and we welcome the announcement by the Minister Ed Davey of a compliance review in this area. However while compliance with existing regulation is a key concern, the rules do not address the key problems.

The willingness of industry to work on self regulation is strong but it is doubtful that the measures we would like to see put in place will be achieved by any voluntary Code. We consider that consumers are only likely to get the full level of protection they need from regulatory measures to both limit the number of loans/rollovers and to oblige the industry to undertake appropriate credit checking activities.

Lord Turner, Chair of the Financial Services Authority (FSA) has suggested that competition-based solutions, although a critical component of any healthy financial system, may be ‘less powerful in financial services than has been conventionally assumed’.

According to Lord Turner: ‘if both policymakers and existing markets are imperfect, the appropriate response might seem to be to concentrate policy initiatives on making markets more competitive. It is unclear, however, that this will be as powerful a lever as often supposed. In retail financial services it is, for instance, notable that some of our greatest concerns about high distribution margins and inappropriate advice have arisen in activities characterised by huge numbers of competitive firms’.

That is to say, competition should be seen in terms of the plurality of approaches and providers: it should not be assessed, and is unlikely to deliver significant consumer benefits, if it simply means an increased proliferation of market entrants operating according to a conventional and broadly similar banking model.

These words must be heeded in relation to the high cost credit market.

Credit scoring and its impact on consumers  

Consumer Focus calls for greater transparency around credit scoring. Credit reference agencies’ (CRAs) power to analyse consumers’ wider data in determining credit worthiness has grown beyond the value that their analysis provides in ensuring responsible lending.

Firstly, checks by lenders on borrowers should primarily be about affordability, not credit scoring. Affordability is about the impact of the loan on the borrower’s ‘overall financial well-being’ [1] . This assessment should look at the following variables:

– Lenders to be required to obtain evidence on the consumer’s income and expenditure to show they could repay the loan at the current rate and under a stress test scenario

– Whether the consumer has any other loans, or liabilities

– Any county court order, defaults or insolvency records

– Finally, a more thorough analysis of a consumers credit behaviour

The first three only require the provision of the most basic information by CRAs. The fourth one, in essence, is trying to understand the consumer and their attitude towards borrowing and repayment, beyond credit defaults.

It is only when a consumer has no, or a limited, track record with that bank that additional data and analysis by the CRA is justified. Any assessment by the CRA, or indeed the lender, should not be given undue emphasis when put alongside the other three variables that detail both affordability and attitude towards repayment.

Consumer Focus understands that credit reference information is already accessed and used by utility companies to varying degrees. Our recent report on data sharing in energy shows there are concerns about the potential for errors and misuse of data. [2] Energy suppliers already hold substantial information about their customers and it is imperative that this data is used responsibly.

It is essential that any new data sharing from other institutions is sufficiently robust to be fair to consumers. They must make sure any data shared on consumers is up-to-date, accurate and any debts outstanding are not disputed by the consumer.

There is growing concern that consumers with a ‘low credit score’ may come under increasing pressure from suppliers to sign up to prepay tariffs. Furthermore, there may be moves by suppliers to introduce differential pricing policies for credit customers, influenced by their credit history. These two issues may become increasing important ahead of the roll out of smart meters and the introduction of the Green Deal.

Additionally, we are eager to understand whether the widespread use of credit referencing data could have an impact on the level of competition and choice offered to consumers with poor credit reference histories.

Another area of concern for consumers is how credit scores are determined, CRAs analysis and scoring criteria has public policy consequences and can cause significant consumer detriment. There is little evidence that CRAs’ analysis is more accurate at predicting defaults than affordability assessments.

Defaults are mostly the result of unexpected economic shocks to consumers – either personal or due to wider economic conditions and therefore CRA scores do not predict such future behaviour. [3]

Consumer Focus believes that the criteria that informs credit worthiness assessments needs to be subject to oversight. The collection and analysis of an array of data needs to be democratically legitimised and consulted on with society more widely. There are huge consequences for consumers that need to be considered and weighed against other public policy goals.

There are wider issues around data sharing that are beyond the scope of the Information Commissioners’ Office’s (ICOs) powers. Currently, the only forum to discuss data sharing practices is the Steering Committee on Reciprocity. This has a poor track record on consumer representation and engagement. We believe the following examples prove greater engagement is needed to ensure the public policy implications of data sharing are fully explored.

– Switching current accounts

Consumer Focus investigated switching in the personal current account  (PCA) market to look at whether it was likely to influence competition among banks and affect unfair charges. Our research shows that 11 per cent of those who had thought about switching current accounts decided not to, due to fears about the effects on their personal credit rating.

The fears are predictably strong for younger consumers who rely on a good credit score in order to obtain mortgage credit. Following investigations with the CRAs we have been informed that this is not a criteria used in all credit scoring. However, we are unable to confirm this categorically as the CRAs do not reveal their methodology for credit scoring. We recommend the committee investigate this matter further.

– Multiple loan searches

Similarly shopping around for loans can have an impact on credit ratings. Yet many products are rate-for-risk, so without applying you cannot know the rate. Consumer Focus wrote to the ‘standing committee on reciprocity’ to make clear our concerns. [4]

Consumers need to have the guarantee that sharing more of their data does not mean they are scored down because they search for the best deal. Moving to quotation searches, which do not leave a footprint, as a default across the industry rather than as a rarely exercised option is an obvious solution. It would appear some firms such as Nationwide offer such credit products that complete ‘soft’ checks that do not leave a mark on the credit file. Yet, our understanding is that credit checks for other cards do not offer that method of credit scoring, and so discourage ‘shopping around’ for the best deal.

– Consumers ability to see, understand and challenge the data (or analysis) on their credit worthiness and consumer control about the sharing of data.

Consumers are not given sufficient control over the sharing of their information, nor to the uses to which such information will be put. Under the current Lending Code guidance if the customer does not give permission to share information about the day-to-day running of their account, there are 11 other ways of permission being implied on the basis of the Information Commissioner’s guidance, including through the terms and conditions in an opening pack. That is not sufficient protection or choice from the consumer’s perspective and it needs amending. Permission must be sought in relation to each disclosure and how that data will be used.

Commitment to end unfair bank and financial transaction charges  

We strongly supported this coalition pledge set out in the Programme for Government document. However from recent announcements in the Lords it seems likely that the Government is looking for industry led concessions with regulation and legislation put on hold. We withhold judgement while we wait to see the Government’s proposals.

What the evidence does show is that it is highly unlikely that the OFT-led reform programme is capable of eliminating the evident detriment caused to some of the poorest and most vulnerable consumers in the UK.

Further action is needed to remove these punitive charges which mean low income consumers pay more for banking services than other groups, effectively excluding them from the full benefits of transactional banking.

Background  

Studies have found that becoming included in the banking system had psychological benefits, boosting self-esteem and building people’s confidence as money managers. [1]

However, the 2008 Market Study and follow up report in 2009, as well as the Competition Commission’s investigation into the Northern Ireland current account market provide ample evidence of the unfairness of unauthorised overdraft charges (UOCs). The Financial Inclusion Taskforce has found the poorest are £140 worse off when they get a bank account. Furthermore, our own research with low income consumers has found these charges discourage entrance into mainstream banking, including Basic Bank Accounts and creates mistrust in mainstream banking providers.

The banks still accrue around £2 billion in 2010 from UOCs, down from £2.7 billion in 2006 [2] . Despite radical changes to the charging methodology, these charges still provide a substantial portion of the banks revenue from the current account market and will continue to do so. Indeed, there is the potential for these charges to increase as the recession bites. It is vital to once and for all address these charges.

OFT action  

OFT took legal action on UOCs to see whether it could assess bank charges for fairness when the charging structure was not transparent. The Supreme Court ruled on the test case on unauthorised overdraft charges in November 2009. It ruled that the fairness of these charges could not be challenged on the basis proposed.

While the Supreme Court decision did leave room for the OFT to take a different legal route it choose not to pursue the case. Without the legal route to judging the fairness of charges, the OFT has relied on voluntary action by the banks to ensure improved market competition eradicates consumer detriment, namely on transparency of charges and enhancing control.

In its March 2010 paper the OFT claimed that, in light of its efforts to improve the clarity of costs of current accounts, banks have lowered unpaid item charges since its original report in 2008, falling from £34 to £17 on average in three years [1] .

However, charges have shifted from unpaid item charges to a whole host of more complicated penalty charging structures. Such variables include: days beyond the limit per month; amount beyond the limit; payments when overdrawn; and percentage of transactions that bounce. Some banks now have monthly caps limiting some of the most punitive charges. Others still have moved to high daily amounts (Halifax – £5 a day) for any use of UOCs, while the likes of Lloyds bank now have an additional £5 charge for any use of overdraft facilities per month on top of specific charges.

Thus, there is a wide diversity of charges that may well have reduced the worst cases of unfair charges but also reapportioned the cost in potentially worse ways for many consumers.

The greater complexity makes it even harder for consumers to choose. We do however welcome the banks agreement to ‘pre-notify all fees and charges’ and offer an annual summary of charges to consumers in 2011.

As well as endemic complexity, it is very difficult to fathom and compare the actual expense of different accounts, since that assessment is based on future behaviour consumers may not be able to predict. This prevents low income consumers’ engagement with the market. [2]

Finally, the methods put in place to aid consumer comprehension of such charges have not been effective. The OFT notes in its September 2010 report that the scenario testing documents, aimed to enhance transparency of charges and enable switching are difficult to find on the banks’ websites. [3] There is also the related issue of the quality of the information provided to consumers.

We have yet to see any evidence from the OFT, Consumer Direct or the banks about how many consumers have used the charging scenarios either on the web, phone or face-to-face to inform switching decisions and their views of its usefulness. We believe to assess whether the scenario testing is working there should be an evaluation with consumers.

While there are proposals from the Vickers report to improve this, with for example the MiData work stream to enhance the power of price comparison sites, this will take years to develop and its effectiveness is unproven. Furthermore, as the Independent Commission on Banking (ICB) paper notes, inertia is engrained in the system, with very few consumers having switched or even considering switching. More generally, the ICB reforms were aimed at the mainstream section of the PCA market that do not pay UOCs and little attention was directed at helping lower income consumers in its final report.

The current state of affairs is that charges are difficult to predict, so meaningful comparisons – based on future behaviour that you do not predict – are impossible. Determining value at the lower end of the market is so confusing consumers are not increasingly inclined to switch. Thus, transparency has not improved.

Control  

We are aware that there are certain providers who have started to provide the possibility of ‘opt-out’ or ‘opt-in’ accounts. However, these have not performed in a way that resolves the issue of detriment from unfair charges, and nor has it placed the power back in the hands of consumers.

Barclays have produced an ‘opt-in’ account. Its charges, as part of the ‘Personal Reserve’ which is exempt from a UOC facility, do marginally improve transparency since it is a single £22 charge for five days. Yet, it is unlikely to reduce the overall cost burden for consumers, when compared to its UOC charges. It would appear the Nationwide account reserve limit works on a similar basis. We are unaware of any meaningful means to opt-out of any charges associated with overdrafts apart from moving to a Basic Bank Account, which in turn still allows Unpaid Item Charges (HSBC exempted).

We are also aware of some movement on alerts, such as text messages to consumers showing them they are near their limit. These moves are welcome and we would welcome this facility being prescribed as a minimum standard moving forward.

The impact however, we believe to be limited. Consumers need to be offered a meaningful way to avoid charges, if their finances are in a difficult or unpredictable state. The current design of Direct Debits, with originators ‘pulling’ funds, often with variable sums on differing days adds to the difficulty for consumers of managing their money to avoid such charges. No PCAs currently allow consumers this control to avoid charges and none are likely to moving forward.

Once again therefore, the OFT reforms have not been sufficient.

Impact of reforms

The 2008 OFT report highlighted that 'although over half of the interviewees had experienced insufficient funds charges, almost none had anticipated going overdrawn, having payments rejected, or paying bank charges. The conclusion of the psychological analysis was that some consumers are overconfident when it comes to their finances and probably underestimate the cost of banking' [1] .

These empirical lessons from behavioural economics need to be reflected in the public policy debates. Consumers are poor at anticipating their use of UOCs, are overconfident and fail to engage with the market. Future policy moves to enhance switching (from the ICB) are unlikely to improve the market place for this section of the population.

Many of the transparency reforms have made pricing yet more complex and the scenario testing documents are unlikely to have aided many consumers to switch or predict charges. Finally, on control it is clear that text alerts are a welcome addition, but are insufficient to deal with the consumer detriment.

No accounts offer meaningful control to turn off UOCs and for those with minimal funds even a text is unlikely to aid them if a large Direct Debit has just been withdrawn from their account leaving them without sufficient funds.

14 November 2011

114

 

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