Debt Management

DM 17

Written evidence submitted by Which?

Summary

1 Which? welcomes the opportunity to submit evidence to the BIS committee inquiry. In this document, we mainly address three issues. These are: unauthorised overdraft charges, debt management company practices and payday loans.

2 We believe that there are substantial sources of consumer harm present in these markets. We have argued that:

· the high level of charges levied on unauthorised overdrafts are unfair and disproportionate

· the move to daily charging structures reduces the level of control for vulnerable consumers to stop charges escalating

· existing loopholes in the regulation around Unfair Terms in Consumer Contracts need to be closed - we have proposed a solution for this

· the powers of the Financial Conduct Authority to tackle excessive charges need to be clarified

· there need to be clearer rules on the operations of debt management companies tackling very high fees, the practice of front-loading fees, commission-led sales and cashback offers

· payday loan companies must stop the harmful practices of rolling over loans and aggressively marketing further loans

· consumer protection needs to be strengthened and a greater obligation be placed on debt management companies and high cost credit providers to direct borrowers to unbiased and affordable sources of debt advice

Provision of credit facilities: Unauthorised overdraft charges

3 Which? believes that the Government needs to take greater legislative action to address consumer concerns over the high cost of unauthorised overdraft charges (UOCs). Banks and building societies see UOCs as an important stream of income and will continue to do so, especially in times of low interest rates. There is therefore little incentive for banks to address the situation and reduce the cost of unauthorised overdrafts to consumers.

4 As a result of the very high fees that are being charged to consumers, we urge the Government to consider unauthorised overdraft charges as part of the high cost credit market and include them in their forthcoming inquiry into this sector.

5 The financial interest banks have in high UOCs means that market driven initiatives cannot work. Whilst banks have, in response to the consultation, argued that competitive pressures would result in better outcomes, we believe that little substantial improvements have taken place in recent months and years.

6 Competitive pressures cannot and will not work because UOCs are not the basis on which banks compete. Consumers seeking to open a bank account primarily consider factors such as monthly fees, the interest rate earned on accounts in credit and additional services such as insurance. This is also reflected in the way current accounts are marketed and advertised by banks - little emphasis is given to UOCs. As a result, UOCs are likely to be of secondary importance to consumers, especially if they aren’t immediately aware of the high cost involved.

7 We agree that some progress has been made in terms of making UOCs more transparent and consumers are becoming increasingly aware of the high cost of using unauthorised overdraft facilities. However, Which? strongly believes that UOCs are too high and unnecessarily penalise consumers that are already vulnerable.

8 In addition, consumers that find themselves trapped in a spiral of UOCs are unlikely to be able to switch current accounts unless they can secure a significant overdraft facility on the new account. We believe that this is a serious impediment to consumer choice and blocks off one of the ways in which consumers could work off their debt by seeking out a current account with more favourable conditions on UOCs.

9 Which? wants charges to be proportionate to the cost incurred by banks in providing this facility. Despite having asked banks to justify their charges, we have not received an explanation of the relation between charges and costs to banks.

10 Charges should also be clearly laid out and structured in a simple way. We have noticed that in some cases banks have charging structures that are layered and complex thus adding costs on top of the charges for using an unauthorised overdraft (eg. paid item fees, unpaid item fees, interest rates added on top of overdraft usage fee). This makes it hard for consumers to work out how much exactly they will be paying for using an unauthorised overdraft or to compare how much they would pay at another bank.

11 Some banks do not charge if consumers go overdrawn by a small amount and others have reduced their charges for unpaid items. Despite these small improvements, there has been a proliferation in daily charges, which is of particular concern to vulnerable consumers on low incomes, who might not be able to pay money into the account to get out of the overdraft. Whilst maximum levels are applied in most cases, these maxima are often too high and could affect consumers’ ability to get out of the overdraft fast.

12 We believe that the charges on using overdraft facilities are often disproportionate. Halifax currently charge up to £155 per month for some of their accounts, the RBS and Natwest charge up to £186 on most of their accounts while Barclays customers could find themselves owing up to £132 to their bank in some months [1] .

13 Often, the maximum charge per month only applies to the daily charges. This means that consumers could still be paying more than the maximum if they continue to make payments from their current account, as unpaid and paid item fees are likely to be charged. Santander, for instance, charges £25 for paid and unpaid items regardless of the value of the payment on some of its current accounts. Clydesdale Bank and Yorkshire Bank charge the same amount for paid items and as much as £35 for bounced payments.

14 Despite the multitude of charges that are already being levied on consumers that use unauthorised overdrafts, some banks continue to also charge high interest rates on the value by which consumers go overdrawn. Lloyds TSB charges between 12.43% and 19.28% EAR, Nationwide charge 18.90 EAR and Yorkshire Bank and Clydesdale Bank both charge 29.99% EAR.

15 Only one bank and one building society offer the ability for consumers to opt-in/opt-out of having an unauthorised overdraft on all of their accounts. [2] We believe that it would be advantageous to consumers if more banks offered this facility on their accounts. In the US, rules were introduced during 2010 by the Federal Reserve which only allow banks to process ATM and debit card transactions which would take the consumer into an overdraft (or over their overdraft limit) if consumers have specifically opted-in. [3]

Changes to the Unfair Terms in Consumer Contracts Regulation (UTCCRs)

16 The Supreme Court decision in the bank charges case exposed an unexpected legal loophole under the UTCCRs and significantly clipped the wings of the OFT and other regulators. Contrary to the generally held view that only the ‘main price’ payable under a contract was protected from a fairness assessment, the Supreme Court’s decision indicates all and any prices are now protected. This is contrary to the underlying policy of the UTCCRs which was to protect consumers from unfair terms hidden in contractual small print.

17 Which? believes the UTCCRs should be amended to ensure the previous position is restored – a move that would not impose a significant regulatory burden as it represents the basis on which most, if not all, companies have been operating. Neither would it represent a form of price control – it simply allows terms to be assessed for fairness and thus provides an incentive for businesses to adopt their own fair pricing structures.

18 The implications of the Supreme Court’s decision reach far beyond UOCs. Which? believes that the UTTCRs should be amended to ensure the loophole is closed in respect of all consumer contracts. However, we recognise the issue has arisen most significantly in relation to bank charges and that it may be desirable to address that first. If a narrower solution is favoured by Government then it should be introduced on the understanding this is the first step of a multi-stage process. We therefore suggest two potential options (set out in Annex 1) for change:

> one simple amendment to limit the changes to financial services contracts and to ensure minimal disruption to the current operation of the UTCCRs;

> a second which represents a more prudent policy position on which to legislate in respect of all consumer contracts.

The role of the FCA

19 The Independent Commission on Banking (ICB) recommended that the FCA should take a stronger role in promoting competition. The ICB noted that the FCA "would have the ability to tackle unarranged overdraft charges, where it was ultimately judged that the OFT’s power under the relevant part of general consumer law did not give it scope to make a substantive assessment of the issue." [4]

20 We agree that it is essential for the FCA to be able to limit ancillary/default charges if it is to take an effective approach to competition. These ‘behind-the-scenes’ prices can lead to a substantial risk of weakening of effective competition between firms, in particular reducing direct price competition as apparently low ‘headline’ prices mask the true costs once ancillary / default charges are accounted for. Discovering the ‘true’ price raises consumers’ search costs, especially if price structures are frequently altered. This will distort consumer decisions leading to inefficient economic outcomes. A regulator with a clear competition mandate would ensure that consumers can be confident that once they have entered into a contract, they will not be subjected to any unexpected charges or, if they are, such charges are fair and proportionate.

21 The section on pricing in the FCA Approach Document sets out the regulator’s view:

"The government has said that the FCA will not be an economic regulator in the sense of prescribing returns for financial products or services. The FCA will, however, be interested in prices because prices and margins can be key indicators of whether a market is competitive. Where its powers allow, the FCA will take into consideration more positively the cost of products or services in making judgements about whether consumers are being fairly treated.

"Where competition is impaired, price intervention by the FCA may be one of a number of tools necessary to protect consumers. This would involve the FCA making judgements about the value for money of products.

"The FCA will thus consider exercising its powers to take action where costs or charges are excessive."

22 However as our barrister, John Odgers, notes:

"It is not clear whether, by not including in the Bill any specific provisions relating to price intervention, the Government intends the regulators to enjoy no such powers or whether it considers that price intervention is permissible under these rule-making powers.

"It seems to me to be desirable that a power of price intervention should be spelled out, if it is intended. Financial services regulators have not in this jurisdiction previously exercised that type of power, and might in future be loath to do so without a specific statutory authority, as the use of such a power would be particularly likely to attract a challenge."

We would therefore welcome clarification from the Government on this matter. If the legislation is not clarified then we see significant risks of another legal issue similar to the bank charges case, where it is necessary to go through a long and expensive legal process to define the regulator’s powers.

Debt management companies

23 Which? believes it is important that independent, affordable and regulated support mechanisms are available to those that are in debt and that struggle financially. We are however concerned that some consumers may be lured into using debt management companies (DMCs) by the promise of having their debt written off in a fast and easy way.

24 Many DMCs have sprung up in recent years but their rise has been accompanied by mis-selling, cold-calling, mis-leading advertisements and inflated claims. Worst of all, many of these companies charge high fees for their service, which could aggravate the woes of those that are in debt. By paying a substantial sum of money to DMCs, less can be contributed to paying off debt, which could potentially lengthen the repayment period. It could also result in individual voluntary agreements (IVA) being rejected by creditors as creditors usually insist on a minimum ‘hurdle rate’ of repayment.

25 We believe that this is a serious problem as the ‘next best’ solution offered by commercial debt management companies would usually be a debt management plan (DMP), which could last decades. Unlike IVAs, which usually involve a partial debt write-off, the DMP option only reschedules the debt repayment, therefore potentially resulting in much higher interest payments over the term of the rescheduled loan.

26 Further research conducted by Which? Money at the end of last year revealed that many DMCs charged fees of potentially more than half of customers’ debt repayment in the first year. Monthly debt repayment charges usually represented about 17% of the repayment value. Some companies charge a minimum monthly amount for their services, which could be particularly detrimental to those who can afford to repay relatively small amounts of money.

27 Front-loading of fees is another issue that Which? believes needs to be tackled effectively. Some DMCs use the first few months’ repayment to recoup some or all of the fees they are owed. This means that borrowers could be spending at least some of their repayments on paying fees before they even get to repaying any of their debts. This could push consumers’ further into arrears, causing damage to the individual’s credit file and increasing the debt owed to creditors.

28 Which? is concerned that the practice of front-loading could also encourage mis-selling. Because fees are front-loaded and DMCs recoup a large chunk of their money in the first few months of the repayment plan, they still make a substantial profit from borrowers even if the plan fails. There is a clear risk in this structure that DMCs will set the monthly repayments at a higher level than the borrower can afford. They thereby maximise their own gains and increase the risk of the repayment plan failing. If the plan fails, DMCs can move borrowers into an IVA and charge them for switching.

29 Which? is also concerned about the potential proliferation of commission-led sales. We have seen evidence of DMCs offering high commission payments to financial advisers for receiving referrals. We believe that this practice needs to be stopped as it encourages financial advisers to refer borrowers to potentially expensive debt solutions rather than pointing them towards free or affordable sources of help.

30 We have also seen examples of debt management companies offering cashback to borrowers via the website Quidco. These cashback deals could potentially encourage consumers to take out debt management solutions that are not in their best interest and that cost a lot of money. We found that one offer for £25 cashback on Quidco’s website did not give any details about the DMC offering the deal. The company, Money Advice Group, would in fact keep the first month’s repayment and all but £1 in the second month. It would then charge a monthly fee of at least £37.50 for the rest of the repayment period. We believe that this and similar deals offers very poor value and could lure in debtors that are desperate to get hold of some cash.

Payday loans

31 Whilst payday loans remain a niche credit market, the value of payday loans taken out by borrowers has increased from £1.2bn in 2009 to £1.9bn in 2010, suggesting that more consumers are turning to this form of credit. As lending criteria have been tightened and the rising cost of living is putting more and more households under financial pressure, it is important that the Government and regulators take steps to strengthen consumer protection in this sector.

32 When we investigated eight online payday loan companies a few months ago, we found significant problems with the lenders in terms of the marketing materials they sent out, inappropriate and unsolicited increased loan offers and unrequested roll-overs.

33 One of the main problems was not only the sheer volume of marketing that was sent to borrowers but also the nature of the marketing. Our researcher received 47 emails from third parties in just a few days after having applied for a loan. They also received numerous text messages and phone calls. All of these communications promoted further payday loans, impaired credit loans and claims management services. None of the communications aimed at helping the consumer resolve their debt problems by informing them about available debt advice or other debt solutions.

34 Some payday loan companies also made unfair comparisons to unsecured bank loans on their websites, comparing the actual interest paid (in £) for their 30-day loans with the interest paid over the term of an unsecured loan, despite the fact that the latter are for a term of 3 to 5 years. We believe that this type of comparison is grossly misleading and might not be properly understood by borrowers who believe they are getting a better deal by taking out a payday loan.

35 Furthermore, we found that some companies charge the same amount of interest regardless of whether the customer is borrowing it for 14 days or 31 days. In the case of Payday UK, £25 worth of interest was charged for £100 borrowed regardless of the term - over 14 days this represented an APR of 16,203%.

36 A further problem that needs to be addressed is the endemic practice of rolling over loans at the end of the borrowing term. Payday loan companies often argue that their high APRs are justified because the loans are only meant to be taken out for the short-term. However, our research uncovered that some payday loan companies actively encourage borrowers to extend the loan they’ve taken out. The company Paydayloan states ‘loan extension guaranteed’ on its website while Payday UK repeatedly contacted our researcher to offer extensions on their loan.

37 Which? is also concerned about the level of the subsequent loans that are available to borrowers, which might encourage some people to take out more than they can afford to repay. One company offered a £1,200 loan to our researcher when they revisited the website, although they initially only took out £100. Payday UK stated that if our researcher paid back the loan, they’d be eligible for £250 on the second, £440 on the third and £630 on the third loan. Quickquid has continued to send out researcher email advertisements offering up to £1,500, even though he had initially applied for just one £100 loan several months ago.

38 We believe that this practice is irresponsible and is encouraging further debt rather than helping people resolve their problems. Payday loans should be considered as a last resort for those that need to repay a bill but cannot access credit. They should under no circumstance result in more debt and protracted interest payments. Guaranteed increases in the amount borrowed and aggressive marketing of roll-overs however achieve the contrary. They make a product that should only be used for short-term borrowing resemble much closer traditional unsecured loans but at a much higher APR than normal.

Annex 1 – proposed amendments to the UTCCRs

1. We believe the following simple amendment to the Unfair Terms in Consumer Contract Regulations 1999 would close the loophole with respect to financial services (as was suggested in the Private Members Bill proposed by Lorely Burt MP [5] ):

(1) After regulation 6(1), insert-

(2) "(1A) Paragraph 2 shall not apply to a contract for the supply of personal financial services, including all such contracts currently in force."

(3) After regulation 6(2), insert-

(a) "(3) In so far as it is in plain intelligible language, the assessment of fairness of a term in a contract for the supply of personal financial services shall not relate-

(b) to the definition of the main subject matter of the contract, or

(c) to the adequacy of the main price or remuneration, as against the goods or services supplied in exchange.

(4) When assessing whether a charge is or is not a main price or remuneration within the meaning of paragraph 3(b), account shall be taken of all the relevant circumstances at the time the contract was concluded, including whether the imposition of the charge is contingent on other uncertain events and whether the charge is likely to have been considered by the consumer prior to concluding the contract.

(5) Where a term of a contract for the supply of personal financial services provides for the charging of a consumer and the circumstances in which that charge can be imposed are not certain to arise during the term of the contract, then such price or remuneration shall not fall within the main price or remuneration for the purposes of this regulation.

(6) In any proceedings in which reliance is placed on this regulation, a charge shall be assumed not to be the main price or remuneration, as against the goods or services supplied in exchange, unless the contrary is proved."

2. Given the breadth of consumer contracts to which the UTCCRs apply, Which? believes a slightly different approach is appropriate for a wider solution and suggests a price should only be exempt from a fairness assessment if:

Ø the circumstances in which that price may be levied will definitely arise during the course of the contract; or

Ø it is the only price that could be payable by the consumer under the contract.

providing that price is one

Ø on which the business typically competes i.e. the headline/advertised/shop window price (as judged on the basis of the business’ marketing strategy and commercial practices); or

Ø that is otherwise prominently provided in good time to consumers prior to conclusion of the contract.

15 November 2011