Challenges for the regulator - consumer credit, long-term savings and an ageing population

Speaker: Andrew Bailey[1], Chief Executive
Event: City Banquet, Mansion House, London
Delivered: 4 October 2017
Note: this is the speech as drafted and may differ from the delivered version

Highlights

• Andrew’s speech sets out some of the challenges for the FCA as a financial conduct regulator by focusing on three big areas: consumer credit; long-term savings and retirement provision; and other impacts of an ageing population
• The FCA alone cannot create an appropriate system for the sustainable supply of credit but has already started discussions with other stakeholders to see what may be possible. 
• The FCA will publish its pension strategy later this year setting out for the first time the FCA’s assessment of the major regulatory issues in the sector.

Lord Mayor, it is a great pleasure to be at Mansion House once more. You are generous to say that you look forward to an evening of regulators speaking. And who doesn’t?

I want to start by thanking you for all that you have done to support the City in your term of office. Amongst your hectic schedule, you fitted in a visit to the FCA in Tower Hamlets, for which we are very grateful. This is the last year in which I can say that, because next year we will be moving to Newham, to the Olympic Park to be precise. We will be next door to the Olympic Pool, so miscreants should be aware that enforcement will take on a new meaning with the penalty of walking the plank, also known as the high diving board.

I am asked from time to time to explain the difference between the FCA and the PRA. From next year it will be easy, just look at our neighbours. Let’s start with the PRA, in the quiet environs of Moorgate. The neighbours include the Institute of Chartered Accountants of England and Wales. In my time at the PRA, the CEO of the Institute, Michael Izza, would come round for tea, with a few friends. We would discuss burning issues of the day – IFRS9, IFRS17, Solvency II and accounting. Passions would run high. Now let’s move to the FCA from next year. Our neighbours will include West Ham United. My research tells me that the Chief Executive will also bring some friends round to see us, on average 56,972 of them. Whether we will discuss MIFID II remains to be seen.

Just over 90 years ago John Maynard Keynes wrote an essay on The End of Laissez-Faire. In it he commented that:

‘To suggest social action for the public good to the City of London is like discussing the origin of species with a bishop sixty years ago. The first reaction is not intellectual, but moral. An orthodoxy is in question, and the more persuasive the arguments the graver the offence.’

Keynes was writing about a past era, when the economy functioned more in the absence of public policy institutions. That era was brought to an end by the First World War. As Keynes reflected, from then on public policy came more into prominence. Today we do discuss public policy in the City of London, as we should.

This evening I want to focus on some of the big public policy issues that we at the FCA face as a financial conduct regulator. Parliament has given the FCA an overarching objective to ensure that markets function well. Sitting behind that are three operational objectives:

• ensuring market integrity
• appropriate consumer protection
• promoting competition in the interests of consumers

I want next to set out a number of big developments which provide important backdrop to the challenges we face.

The first big development has been slower economic growth in major economies since the financial crisis, including slower productivity growth. The response has included accommodative monetary policy and a pronounced fall in real interest rates. This has supported activity, albeit with lower growth rates. It has also reduced debt servicing costs but raised the bar in terms of the savings rate required to produce a given return at much lower real interest rates. Put simply, the cost of debt has gone down, creating an incentive to borrow, while the cost of accumulating assets to support notably retirement income has gone up.

Meanwhile, for some, the growth of the so-called gig economy has led to more unpredictable income flows, and a demand to borrow in order to smooth the pattern of income.

Also we have continued, at least until recently, to see a substantial increase in longevity, part of the ageing of the population, which puts pressure on traditional models of pension saving.

Alongside all of this has been a marked acceleration in the pace of technological innovation affecting the provision of financial services which has fundamentally changed service delivery and access to finance, but also opened up generational and other divides in the availability of benefits of this innovation.

These trends and developments are fundamental and inevitable in the sense that we can’t stop them and nor should we. It feels a little bit like the revisionist view of King Canute, which is that he didn’t think he could stop the tide coming in; rather, he sought to demonstrate that for all his authority it would happen – in his case demonstrating the limits of kingship. We have much more modest ambition, but these are the powerful forces that are operating around us.

I want to set out some of the challenges for the FCA as financial conduct regulator by focusing on three big areas: consumer credit; long-term savings and retirement provision; and other impacts of an ageing population.

Consumer Credit 

Starting with consumer credit, the Bank of England’s Financial Policy Committee in our latest assessment has highlighted that the rapid growth of this area of lending stands out against a generally benign overall credit environment. While it is not a material risk to economic growth as a whole, compared to mortgage lending defaults are more likely in a severe economic downturn, posing risks to lenders. There are also risks to consumers, which is where the FCA comes in.

Consumer credit is not a monolith, but rather a series of markets. The total stock of consumer credit in the UK is around £200bn. The rate of growth has come off a bit of late but remains just under 10% on a twelve month basis. Of the £200bn, about £68bn is credit card debt, £58bn is outstanding in motor finance and about £15bn is in various forms of higher cost credit. Overdraft credit by the main high street banks is around £7bn. The rest is mostly unsecured personal loans.

We are not at all complacent about the overall consumer credit situation, but I don’t regard, for instance, the shift to PCP based lending as per se bad. It seems to me to recognise the nature of a car as an asset, that is, consumers are comfortable renting rather than owning the car. That said, there are issues that we seek to understand on the terms of such lending and how well they are understood by consumers, so we are not complacent on such terms.

Consumer credit is not a monolith, but rather a series of markets

Turning to high cost credit, and the range of lending products for those who are less well-off and with worse credit scores, I would stress that credit has a role to play, for instance in smoothing more erratic incomes. Nonetheless we are concerned about the cost and terms of such credit and the propensity for over-indebtedness. And these things are linked. Some of the terms encourage over-indebtedness with little or no incentive to pay down debts. A good example of this is credit cards. They are used by a large number of people as a means of short term borrowing to enable payments for goods and services. For the majority, our work has found that competition operates fairly well. There is no shortage of credit card providers.

However, we identified that around five million people experience real difficulties in paying off their balance, and credit cards have become a source of long-term expensive debt, something for which they were not designed. And, it is not untypical for such consumers to be paying around £2.50 in interest and charges for every pound of balance they repay. Firms can lack incentives to tackle this as these customers are profitable.

We have proposed a set of measures designed to reduce the number of people with persistent credit card debt, and re-balance incentives including greater control over credit limit increases and ensuring that firms intervene to help such customers, including options to switch to cheaper loans and cancel debt. We want people to get assistance much earlier. However, we have stopped short of introducing a cap on charges. Why? Credit cards are a form of revolving credit, and we do not see it as practical to implement a cap in the way that is by comparison straightforward for fixed sum payday loans.

The objective of preventing problem debt emerging explains why we have renewed the set of measures that together form the payday cap. Our assessment of the first two years of its operation indicated that it has saved up to 760,000 people around £150m per year in charges and significantly reduced lending for those who could not afford to repay. Consumers who have been turned down for payday loans during the cap period more often than not (63% to be precise) told us they were better off as a result, few told us they turned to other high-cost products and we have not seen strong evidence of declined customers resorting to illegal money lenders.

Sometimes a cap or limit on cost is appropriate, other times it seems more appropriate to use nudges and targeted transparency to change practices

Other recent investigative work by the FCA has focused on the rent-to-own sector where we have taken action through authorisation and supervision, but we remain concerned about high costs and the lack of viable alternatives for this particularly vulnerable group of customers.

In another area of consumer credit we regard many unarranged overdraft charges as high and complex, often higher than the payday cap. Many consumers don’t seem to know the cost implications of using unarranged overdrafts – or even that they have used them at all. We wonder about the role of a so-called unarranged product in today’s banking market and are assessing whether fundamental change is needed to this aspect of current account services.

In the area of home-collected, or door-step lending, we are concerned that poor lending decisions and sales and collection practices may cause increasing financial distress to vulnerable consumers, who may carry debt for long periods at high cost.

Finally, we are looking at how catalogue credit is used and how credit-offers and the potential risks relating to repayment options are explained to customers. We are also looking at firms’ arrears charging policies and practices and income from arrears and fees.

I want to finish on consumer credit with three broad and important points:

• First, we use a range of policy tools. Sometimes a cap or limit on cost is appropriate, other times it seems more appropriate to use nudges and targeted transparency to change practices.
• Second, it is important that we understand the business models of firms, not because we want to dictate them, and firms must earn a return on capital, but understanding business models is important to see into the balance of returns from products and groups of customers, and to allow us to challenge and achieve our statutory objectives.
• Third, on high cost credit, it is important that credit is sensibly available to those with lower incomes and means. It can smooth income flows and enable the purchase of household appliances etc.

I am not convinced that we have an appropriate system in this country for the sustainable supply of such credit. The FCA alone cannot make this happen, but we have started discussions using our ability to convene to see what might be possible and how stakeholders could work together. I would strongly encourage participation. We could do something here for the public good.

Long-term Saving and Retirement

Another major development of recent times has been the switch from a combination of state and employer responsibility for long-term saving and pension provision to individual responsibility accompanied by greater choice. The post-war model was for social security systems and defined benefit pension schemes to reinforce a fairly stable pattern of life cycle saving by prescribing the rate and duration of saving for retirement and the age of retirement.

This pattern changed first in the accumulation phase, with the switch from defined benefit to defined contribution, and more recently in the decumulation phase with the ending of compulsory annuitisation and subsequently the introduction of pension freedoms. Greater flexibility is sensible given the greater uncertainty around working lives and longevity.

It also makes sense to look at the role of housing as an investment. The post-war model of saving to complete home ownership during the working life and then preserve it into retirement is becoming more flexible. We can see some benefit to this, and have made changes that help firms offer a wider range of lifetime mortgages. We think there is more we can do, and have published proposals that would make it easier to lend affordably to older consumers, with the borrower committing to pay the monthly interest and the loan eventually being repaid by sale of the property.

But there is a clear risk that the savings rate for retirement is for many people too low to meet their expectations of retirement. DC accumulation rates are typically lower than DB rates of the past, and this is compounded by low real interest rates. Auto-enrolment and workplace pensions help in this respect, but the challenge remains.

We intend to publish our pension strategy later this year, setting out for the first time our assessment of the major regulatory issues in the sector.

In the provision of financial services, flexibility and choice can on occasion be the companion of complexity. To give an example, the transfer of a pension saving from a DB to DC scheme is one of the most complex transactions an individual can undertake, with a genuinely high degree of uncertainty around some of the key variables that drive outcomes. In our supervision work, we see good practice, and we see bad practice. We act on the latter.

We are very active in the area of long-term savings and pensions and over the past two years we have implemented a number of major Government pensions policy reforms which support greater flexibility. As a consequence more flexible drawdown is now increasingly popular. Reforms of Workplace Pensions have supported consumers directly, for example by capping exit charges and establishing a new guidance service – Pension Wise.

Our attention has turned more recently towards retirement income products, drawdown and non-workplace pensions. We intend to publish our pension strategy later this year, setting out for the first time our assessment of the major regulatory issues in the sector.

The other major area of attention is the advice market, which is of course crucial given the greater flexibility open to individuals. Let me start with a recent history. The Financial Services Authority, our predecessor body, undertook the Retail Distribution Review, which had two main effects. First, it prohibited advisers from receiving commissions set by product providers when recommending their products. Second, it increased the level of professional standards for advisers. I would submit that both of these outcomes were sensible. Were there other outcomes? Yes, and I am quite prepared to recognise that there are concerns about a gap in the advice market. I think that gap is probably exacerbated by low interest rates, which mean that the cost of advice looks less favourable when compared to returns. And this probably has more of an effect in areas where the fixed cost of advice – which is inevitable – looks unfavourable relative to the smaller amount of investment involved.

What are we doing about this? Two things will I hope help here. First, the FCA is providing all the support it can to innovation in the supply of advice through Project Innovate and the Sandbox. Second, with the Treasury and with the help of the practitioners, we have undertaken the review of financial advice, FAMR. The aim of FAMR was to explore ways in which Government, industry and regulators can stimulate the development of a market which delivers affordable and accessible financial advice and guidance to everyone, at all stages of their lives.

As part of this, it is important that we do all that we can to provide clarity on the boundary between advice and more general guidance.  I strongly agree that the more uncertain the boundary, the more advisers will rationally aim to keep away from going nearer to it, something that is not helpful. We are currently consulting on proposed changes to our guidance on this boundary to give firms more clarity. My commitment is that the work on this important issue will go on until firms can operate successfully to the benefit of consumers using common sense and good rules of thumb.

Ageing and Financial Services 

Let me now turn to the third, and closely linked, subject of the provision of financial services to an ageing population. Two weeks ago we published a major study on this subject which is designed to provoke thought, and identify solutions to problems where those are needed.

Consumers are being asked to take responsibility for increasingly complex financial decisions in later life, including planning for retirement and periods of ill health. The pace of change is rapid, and this is reflected in wider societal and technological developments that are changing how consumers transact, access and use financial services. Two examples of this change are relevant, and present difficult challenges for firms and public policy. The first is the switch from physical to online and digital access to financial services, which has undoubtedly gained pace. With this have come challenges for sections of the population, including many older people, feeling unsure and unable to use new technology. We have to balance this against the benefits of change, which are of course very real. Second, increasingly firms have access to Big Data to manage customer risk and pricing. There are many good aspects to this, but also some dangers, which can be exploited. An example here is using information to identify and exploit customers who are less likely to monitor the market to get the best pricing. Older people can be among these groups. We have seen it happen.

Consumers are being asked to take responsibility for increasingly complex financial decisions in later life, including planning for retirement and periods of ill health

In our study, we identified a range of issues facing older consumers. These included understanding the vulnerability and specific needs of older consumers. Second, we considered the challenges faced by older consumers in retail banking, including examining existing industry initiatives. Next, we looked at third party access and how firms could help older consumers manage their finances more easily and safely when using a third party. Fourth, we looked at upper age limits and product innovation in the mortgages sector and whether they meet the needs of older consumers. This included identifying barriers to product or service development to facilitate positive innovation to support older consumers. Fifth, we considered whether consumers can access regulated financial advice that is clear, accurate and appropriate when looking to fund their long-term care needs.

This list is almost certainly not complete in terms of the issues connected with an ageing population, but we think it gets to the heart of the big issues. And, it underlines just how important the subject is for financial conduct.

Conclusion

Lord Mayor, I have tried to paint a pretty big landscape of important issues. I think that if Keynes could see this landscape, he would understand that the public interest is a strong feature of financial services and the City.

public interest is a strong feature of financial services and the City

But we cannot take this for granted. I don’t think public interest had the same profile in the years before the financial crisis. Social norms change, as do attitudes to regulation. It is important that we properly explain these issues, and in doing so we explain how they shape the public interest in finance, and how they fit into the FCA’s statutory objectives. 

But, if I can tell you one thing from experience of the last year or so, the FCA is a fascinating place to be and I think we can serve the public interest better by getting to grips with these big issues.

Thank you.