Business, Innovation and Skills CommitteeWritten evidence submitted by the Financial Conduct Authority

We welcome the Committee’s inquiry into payday lending, which comes as we are consulting on the detailed proposals for regulating consumer credit. As the Committee is aware, regulation of consumer credit transfers to the FCA from the Office of Fair Trading (OFT) on 1 April 2014.

The consultation closes on 3 December, after which we will consider all the evidence we have received. We will publish our response next year.

Below we give a brief overview of our proposed rules for high-cost short-term credit, and then respond to the questions the Committee set out in its email of 12 November 2013.

Proposed Rules for High-cost, Short-term Credit including Payday Lending

We are proposing specific new rules for high-cost, short-term credit to help those consumers most at risk of harm from poor business practices. The specific interventions are set out below:

Affordability checks:

We are proposing to take across the OFT’s affordability guidance and implement it in our rules. The rules state that a lender should, depending on the type, amount and cost of credit, consider a number of factors which include: the financial position of the customer; their credit history; the customer’s financial commitments including other debts, rent, utilities and other major outgoings; any future financial commitments; any future change in circumstances; and the vulnerability of the customer.

Although we will allow firms to adopt an affordability test suitable to their business, we will check higher-risk firms at point of authorisation to see if they have the right systems in place to satisfy us that they can and do adequately assess affordability. We will continue to monitor this through supervisory visits and our requirements that firms report data to us.

We will generally assess firms’ affordability procedures in terms of outcomes. For example, if we see a firm with a relatively high number of defaults, forbearance or rollovers, we will review the firm’s procedures and take appropriate action to correct it.

Rollovers:

We propose to cap the number of times a loan can be rolled over to two. Lenders will also have to be able to prove that rolling a loan over even once is in their customer’s best interest. The customer will have to agree to the rollover, and they will be given information on where to get free debt advice.

We are consulting on making payday lenders report the number of loans they rollover to us, so we can monitor compliance. Lenders must keep files on each customer and how they justified each rollover. If we see evidence of high number of rollovers, we have the ability to review files or test the firm’s procedures. We can then take appropriate action.

Continuous Payment Authorities (CPA):

At present, firms can repeatedly access customers’ bank accounts through a CPA. We propose restricting the use of this kind of payment so the lender can only make two attempts to withdraw money, and only to allow them to take full payment. This should force lenders to make better lending decisions because they won’t be able to easily take money from customers who can’t afford the loan. Lenders will also have to provide adequate explanations including how to cancel the CPA, how they will use the CPA and whether further attempts may be made to collect payment.

As part of the consultation we have received feedback that we should be more prescriptive in making lenders give, for example, three days’ notice before accessing a borrower’s account. We will consider this as part of the consultation.

Advertising:

Adverts often make borrowing look easy, when paying a loan back is going to be tough for some. We propose making payday loan adverts include a warning reminding potential customers that many people don’t pay back loans on time and that this can lead to serious money problems. Adverts will also include a line directing customers to free, independent debt advice. What’s more, where adverts are misleading and breach our rules, we have the power to ban them.

Cap on the cost of credit:

In addition, the Government has recently announced it will legislate to give us a duty to cap the cost of credit by January 2015. As we set out in our consultation paper, we need to carry out more work before we can consult on an appropriate type and level of cap.

As part of our cost benefit analysis on the proposals in our consultation paper, we commissioned an independent analysis, which suggests that these measures are likely to be good for consumers overall. It notes that the current payday loan market is worth £2.0 to £2.2 billion and our proposals could lead to an initial reduction in payday lending of between £625 million and £750 million, as firms no longer lend to customers who were only profitable to them through rollovers and repeated use of CPAs. The initial shock to lending volumes may partially recover in time as surviving lenders re-orientate their business models away from multiple rollovers and CPA use and begin to serve new customers. There is evidence that this has happened in the USA when rollover limits for payday lending have been imposed, with new lenders eventually emerging focused on higher quality loan books.

How can the FCA Stop Payday Lenders From Making Loans That Cannot be Paid off on Time but can be Paid off After Two Rollovers?

One of the aims of our proposals is to ensure that firms only lend in the first place to borrowers who can afford it.

Affordability assessments themselves must be based on consumers paying back their loan in the agreed timeframe, not including rollovers. Where we find that firms are rolling over a high proportion of loans, we will take that as an indication that their affordability assessments may be inadequate. Where, through our supervisory activity or our authorisation process, we find firms are not lending affordably or rolling over a high proportion of loans, we will not hesitate to take action. For example, we may require the firm to make changes, reject its application for authorisation, stop it from lending, fine it, or in the most serious cases take action against individuals within the firm.

We are consulting on our proposal for a maximum of two rollovers, but this must be seen in the context of our broader approach to affordability on re-financing. Our proposed rules on rollovers (which go beyond current requirements and so will come into effect on 1 July 2014) will mean that loans can only be extended where the customer has agreed to the extension and only after the lender is satisfied that it is in the customer’s best interest to do so.

There may be some instances where rolling over is best for consumers, for example to avoid default charges where there are unexpected short term cash flow issues. However, there are also clear downsides of rolling over—namely large increases in the overall debt burden. A firm should engage with a customer who cannot repay on time and consider whether forbearance is the more appropriate solution.

It is difficult to conceive of any circumstances where more than two rollovers could be in the customer’s interests, bearing in mind the large increase in costs from the interest. Consequently, this measure supports our wider supervisory approach on affordability.

The OFT Review found many firms relied on successive rollovers as part of their business model. We will be looking at how firms lend and how they rollover and any possible breaches of the proposed rules through our supervisory work. The caps on rollovers (and CPAs) should also help by making it difficult for businesses to base their models on unaffordable borrowing and incentivise firms to lend affordably in the first place.

We have said that we would be interested to hear further evidence from firms, consumer groups and consumers about whether one rollover may be a more appropriate cap to prevent escalating costs.

How Will the FCA Stop Excessive use of Continuous Payment Authorities?

We know that some lenders will access a customer’s bank account repeatedly in one day. The lender will often begin by trying to take the full amount they are owed, but if this fails they try again, perhaps only taking £10. If that attempt is successful, they keep on requesting payments, until the customer’s account is empty. We do not believe this practice could ever be in the customer’s interests since it takes control of their account away from them.

But CPAs offer an automated, hassle free way for the majority of customers to pay off their loans with minimal effort, with low collection costs for firms that, if increased, will ultimately be passed on to customers.

There may be occasions, due to short term cash flow issues, where a full payment cannot be made on the first attempt. For example, a customer may be paid later than they were expecting. A second attempt at full payment allows another opportunity once those temporary issues have passed, avoiding unnecessary default.

If after two attempts the CPA cannot be met, then the benefits of automated collection are outweighed by the likelihood that a customer faces problems in repaying. We have added to our draft rules the OFT’s provisions concerning continuous payment authorities, including a draft rule that a firm must not use a CPA where the customer has provided reasonable evidence of being in financial difficulties. At that point or where the firm has been unable to recover the whole amount owing at the end of day following the due date, the firm should contact the customer to discuss the situation, repayment and, if there are problems with repayment, consider forbearance.

In summary, a CPA can be a helpful tool if there are no repayment problems, but is a poor one if there are. Our proposal seeks to tackle the problems without undermining the benefits.

As with rollovers, abuse of CPAs also means some firms have been able to make a profit without checking whether their customers can afford the loan as they know they can continually scrape the account for repayments before other bills are paid off. Limiting the use of CPAs should make them consider more closely their original lending decision.

Does the FCA Have Plans to Mandate Real-Time Data Sharing?

There has been some debate about whether we should create a real-time regulatory database, as is the case in Florida and a number of other places. The Florida regulator has capped the number of payday loans a customer can enter into at any one time. Online lenders (but not high-street lenders) must use the database to ascertain whether a potential customer already has a loan.

At the moment in the UK, many lenders use one or more credit reference agencies. Most credit reference agencies collate information relevant to the financial standing of customers from a variety of sources which may form the basis, or part of the basis, of the lender’s assessment of whether a customer is able to afford a loan. This information is generally updated every month. Short-term lenders have indicated that they require a more regularly refreshed service, possibly with data updated daily. Such a service could help facilitate firms’ assessment of affordability. In their evidence to you the members of the industry noted that some of them are engaged in discussions with credit reference agencies.

Lenders currently only have access to the data that has been made available to the particular credit reference agency or agencies that they have sought information from. The Steering Committee on Reciprocity (SCOR) sets rules on how member agencies share information. We have said that we would like SCOR to identify and remove any blockages faced by lenders and credit reference agencies in sharing real-time data with the rest of the credit market as a matter of urgency.

We are aware that progress in this area has been slow in the past. If the market can’t deliver on data sharing, and we conclude that we are best placed to ensure that real-time data-sharing takes place, we will not hesitate to take action.

How Will the FCA Monitor Compliance?

Historically, monitoring of consumer credit firms by OFT has primarily involved responding to external stakeholder intelligence and customer complaints. Whilst there has been proactive issues-based work in the past, it has been difficult for the previous regulator to spot problems posed by individual firms as the firms have no obligation to regularly report data for analysis.

The intelligence the OFT holds will transfer to us and from 1 April 2014 we will be dedicating resources to take forward enforcement action if we have evidence that the OFT’s (pre April 2014) or FCA’s (post April 2014) requirements have been breached.

We are also considering the areas that will be the focus of our first “thematic reviews” from 1 April 2014. These involve visiting and collecting data from a number of firms. We have used evidence from previous thematic reviews to take both supervisory and enforcement action against firms. We will do so again in consumer credit if that is appropriate. The work will also inform how we supervise individual firms, what we look for in our authorisations process, and our future policy work.

We will be requiring all consumer credit firms to apply for authorisation. In addition to the areas that the OFT would consider as part of its licensing regime, our authorisations teams will look at firms’ business plans, financial and other resources, management systems and controls, and business models. We will also scrutinise key individuals within a firm. This process will begin in late 2014, and will screen out poor practice, reducing the potential for future consumer detriment.

Once authorised, all consumer credit firms will for the first time have to regularly submit data to us on their activities. We are consulting on making payday lenders submit data to us every six months, including product sales and the number of loans they rollover.

This data will give us insight into the types of customer using this product, and will help us assess which firms are posing the greatest risk to our objective to protect consumers, or to our other statutory objectives. We can then take a proportionate approach, with our supervision teams focusing their resources on the highest risk areas. Over an appropriate period of time we will revisit firms, and examine whether their systems and controls are having the desired outcomes for consumers.

Where we have concerns about a firm, our supervisors have powers to direct the firm to make changes. In the most serious cases, we also have strong enforcement powers. Our enforcement teams can seek to impose tougher penalties to demonstrate to other firms the cost of non-compliance.

Should There be any Additional Caps on High-Cost Short-Term Credit?

The Government has announced that it intends to legislate to give us a duty to implement a cap on the cost of credit. Where previously our work would have had to start by demonstrating that a cap would be a proportionate measure in the market, we will now focus on what kind and level of cap is appropriate for the UK market.

3 December 2013