Car loans have been shown to preclude borrowers from obtaining credit cards even when the individual’s credit rating is excellent. Borrowers with a fluctuating income or revenue from several sources are struggling to fit the eligibility criteria which focuses on a consistent single income. Even newly qualified professionals who haven’t been in their job a sufficient length of time can be denied credit while at the other end of the spectrum those nearing retirement are also being excluded.
In each of these cases, the individuals concerned fail to meet the affordability criteria put in place following the financial crisis which was designed to both reduce the credit risk to the lender and to protect consumers from harm. In its latest report on ‘Assessing Credit Worthiness in Consumer Credit’ PS 18/19 (July 2018), the FCA describes both credit risk and affordability as “elements of credit worthiness” that should not be mutually exclusive and that creditworthiness cannot be achieved using a credit risk assessment alone: “an adequate assessment of affordability is needed”.
In order to deal with this issue, new rules will come into effect from 1 November 2018 following Consultation Paper CP17/27 which will be published in the Consumer Credit sourcebook (CONC) that cover both risk and affordability. It advocates a proportionate approach to give firms the freedom to assess consumer credit applications by exercising their judgement more freely in a bid to deal with the problem of ‘false negatives’ or those instances when people who can afford credit are denied it.
In Policy Statement 18/19 guidance is given on how firms can begin to assess affordability in this more lenient way. The main change is to Reasonable and Proportionate Assessment. This states that a full income and expenditure assessment may not be required for ‘non-prime’ borrowers as they may “comfortably be able to afford the particular credit commitment, given the amount and duration of the credit”. Because of this, discretion can be exercised by considering relevant factors such as “the cost of the credit (in absolute terms and relative to the borrower’s financial situation)…[and] default charges and other adverse consequences if the borrower misses repayments or under-pays.” There have been some concerns that this could require case-by-case assessments yet, while this approach, cannot be applied across a product line, it can be applied to a specific cohort.
The rules also change the obligations on how firms can assess income and expenditure.
- Establishing income – if it is obvious the credit is affordable firms will no longer be under a compunction to establish the borrower’s income or disposable income but should be able to demonstrate that “affordability was obvious”. There is no longer a need to establish exactly what the borrower earns and the firm can “rely on an estimate, for example a minimum amount or a range” although it would need to verify this information. Fluctuations in income can also be accommodated for business borrowers.
- Variety of income – assessment will no longer be restricted to one defined income such as salary or wages and “can include income from savings, or income from another person (such as where household finances are pooled)”. This and other non-earned income “that could be used for repayments” can now be included “provided expenditure commitments are obtained”.
- Establishing expenditure –Non-discretionary expenditure may also be estimated.
- Other commitments – financial commitments need not preclude the loan for instance in if the borrower is sharing an obligation with another person or using a debt management plan. The guidance states that “firms can also take into account a likely reduction in non-discretionary expenditure where there is evidence that the customer can easily exit from a contractual commitment and intends to do so” meaning firms are no longer required to automatically include other obligations if there is evidence those will be coming to an end.
These changes are to be welcomed, enabling firms to be more flexible in terms of how they evaluate affordability. Yet to be effective, the new rules will require access to additional data on borrowers to provide a more holistic profile. That could prove something of a stumbling block as the FCA acknowledges: “Consumers may experience harm if this information is not shared effectively, or is not of good quality, or if there are significant gaps”. Those gaps are already in evidence causing some to warn that changes must be made in terms of data access.
The StepChange debt charity suggests there are large differences in the data held by Credit Reference Agencies (CRAs), for instance, and that “even if the lender uses more than one CRA, it is unlikely they will be able to get a full picture of the potential borrower’s situation as some lenders only report to one”. Moreover, some CRAs are operating 1-2 months behind so are unable to provide real-time information. It has called upon the FCA to address this issue by mandating real-time data sharing across high cost short term credit market and moots the possibility of “bringing together all the data into one single CRA”.
Others have gone yet further and are calling for additional data sources to become available. The FCA concedes that “new information sources that might be shared to improve lenders’ visibility on customers’ income and expenditure, including HMRC tax data, council tax and rental payment information” could help lenders to assess affordability more accurately. To this end, a consultation on how to improve access to data is planned for early 2019 as specified in the FCA Business Plan 2018/19.
For the firms expected to comply with the new affordability requirements from November that may offer little comfort. They will have to rely upon their own criteria to verify affordability in the absence of any structured access to additional data sources. Consequently, while the relaxation of the regulations and incorporation of ‘obvious’ affordability is a step in the right direction, its effects are unlikely to be felt for some time. Firms will still need to tread cautiously because of the need to substantiate the ‘obvious’ claim. Yet there’s little doubt that we are moving towards a more borrower-focused lending model. One that will enable lenders to exercise their discretion more freely and which should mean those entitled to credit are no longer refused it.