Consumer Credit and the FCA: one year on

Speech by Martin Wheatley, Chief Executive of the FCA, delivered at Money Advice Scotland, Edinburgh. This is the text of the speech as drafted, which may differ from the delivered version.

As important as it is for regulators to be seen to be active in this space, the true benchmark for success is trajectory. Not quantum. In other words, the core question here is not just: to what extent can you 'manage' an industry, or audit it, if you like? But actually to what extent can you support it to deliver improved outcomes for both consumers, as well as firms?

12 months on

Good morning everyone and my thanks to Money Advice Scotland for organising this morning’s event. It’s a pleasure to join you.

The theme for today’s conference: ‘one year of the FCA regime, credit where credit is due?’ – is, I think, a useful one to reflect on this morning. Albeit, I notice it does come with the challenge of a question mark.

And for me, that caveat is a telling one, in as much as it demonstrates the profound complexity of assessing an industry where there are, frankly, significant extremes in terms of customer experience.

So, on the one hand, we know consumer credit firms often fulfil an invaluable social function. But on the other, we clearly have some very well documented abuses.

All of which, of course, reflects the fact that this is an industry that incorporates a very broad church of firms, as well as business models. You have the most significant global players. Universal banks for example. You have mid-cap payday lenders, debt management companies and the like.

And, at the other end of the spectrum, you have local businesses, sometimes one or two man bands, who’ll be providing health, building, education services and so on and so forth.

So, this is a uniquely cosmopolitan industry. One that is difficult, frankly, to objectively define in terms of key characteristics – other than by the fact that all these firms need a consumer credit licence to operate.

And this is one of the reasons why, for a long time actually, there has been considerable discussion over where responsibility for its regulation should lie.

Now that debate was resolved last year when the FCA took on that responsibility.

And, very nearly 12 months on, we’ve seen significant regulatory activity across two broad priority areas: policy making and operational.

So, on the former, what you’ve had is a range of interventions, often highly visible, on issues like: competition work in the UK’s credit card market; redress exercises in the payday and debt management space; new rules on credit broking; work on unauthorised trading, limits on the use of continuous payments authorities and roll-overs, and so on and so forth

While on the latter, operational priority, you’ve had the start of a process of manoeuvring some 50,000 consumer credit firms from interim permission – so from their temporary ‘licences to operate’ so to speak – through to full, regulatory authorisation.

Now that, frankly, is not a simple logistical process. Nor a casual one. So it’s not a regulatory exercise akin to dipping sheep. It has to involve real confidence in the ability of firms to meet regulatory rules, as well as to demonstrate fairness to customers.

You want to know, for example, what the business models of firms look like in the marketplace? How do they make their money? Are the products they sell socially useful? And certainly, you want to know what their customers’ outcomes are like? Positive or negative.

The compromise here, of course, such as it is, is that this all takes time. By its nature this has to be a rigorous assessment. So, what we’re seeing now, effectively, is the start of a two-year, staged process whereby firms are being moved in tranches from interim permission to full authorisation. Starting with those that seem to pose the greatest risk to consumers, like profit-seeking debt management firms.

And for me, this risk reduction point is a significant one. Because as important as it is for regulators to be seen to be active in this space, the true benchmark for success is trajectory. Not quantum.

In other words, the core question here is not just: to what extent can you ‘manage’ an industry, or audit it, if you like? But actually to what extent can you support it to deliver improved outcomes for both consumers, as well as firms?

And that is particularly true, I would argue, of the consumer credit industry, which provides financial life lines to millions, yes. But is also, at least in part, a product of a world that is continually stress testing our collective ability to delay purchasing gratification.

So, when you look to assess today’s theme, positive policy influence on consumer credit is, for me, the key benchmark here for success.

And I want to argue that the transfer of the industry across to the FCA, from the OFT as it was, has indeed opened up this possibility for moving things forward, particularly in core policy areas like overdrafts and pay day lending.

Greater power and sophistication

Let me start with the most basic lever of policy improvement here: the FCA regulatory reach as compared to previous structures.

Certainly, under the OFT we know there was this more limited, reactive mandate. It did not have the regulatory toolkit or breadth of ability to censure. Nor room to assess firms against principles. Whereas the FCA has much greater flexibility of operation and policy.

All of which is, of course, important. But in terms of day-to-day consumer outcomes, is only part of the improvement equation. Alongside the stick, if you like, there has to be some variety of means by which policy makers can positively interrogate the potential challenges locked in to a sector.

And certainly, there has to an approach that goes beyond ex-post enforcement action, otherwise you simply end up stumbling from one problem to another.

So, for me, perhaps the most significant step forward over the last year for the consumer credit industry has been its more forward-looking regulatory context. There is, if you like, now the potential for long run solutions that not only support consumers. But also actually provide the future possibility of a more resilient and trusted industry.

So, looking ahead to 10, 15 years’ time, say, you begin to create the prospect, at least, that you might not get this Pavlovian response to consumer credit that tends to dominate the public debate today.

The key question here, of course, is how this might be achieved – other than through traditional regulatory activity, which, although important, should not necessarily be the beginning and end of your solution architecture.

And there are two key, linked areas I want to look at this morning in this context: first the importance of gaining deep knowledge of a sector – so its consumers, its product business models, its reward structures and the like – in order to drive the most effective policy making decisions.

Second, understanding how real people interact with markets, so particularly using areas like behavioural economics to improve outcomes.

Pay-day cap and number crunching

Let me start with the former, 'knowing your customer' so to speak, where there has been a lot of momentum over the past year, particularly in areas like high-cost, short-term credit.

So, yesterday, for example, we published a comprehensive thematic report into the way the pay-day industry treats customers in arrears, which (although positive in some respects) should certainly be a wake-up call to many of the key players there. 

We’re also rolling out, with support from Money Advice Scotland, a UK wide network to develop a stronger assessment of what is currently affecting consumers in the credit space. Indeed Scotland will be the first ‘hub’.

But even before that, we have seen very important pieces of economic work into policy areas like the price cap that simply weren’t possible even just five years ago. 

Indeed, thanks to what is, effectively, a cocktail of advances in areas like technology, big data and econometric modelling, we are now in a position to understand areas like pay-day with far greater sophistication than ever before.

So, while complex econometric work might appear technical and esoteric to some (welcome to my world) it does actually have the potential to unlock many of the most significant policy challenges of our day.

If we want to, for example, we can now mimic the modelling that firms themselves use to analyse – and monetise – their customers. And, in turn, develop a far more sophisticated understanding of how individual businesses and markets are making their decisions.

And, as it turns out, when we started our price-cap work on the high-cost, short term credit industry last year, we found many firms were willing to make a loss on the first loan – on the basis that the hook has been dangled and, in all probability, that the customer will return to them for a second, third, fourth (or more) loans where the margins are greater (because the risk of customers defaulting on the loan are much smaller).

So, after assessing loan and repayment information for some 7m borrowers, we were able to build up a detailed picture here of borrowing patterns, costs and financial circumstances in this market.

And there were interesting results. So, that analysis showed that, on average, payday customers are taking out some six loans a year. Those users also tended to be younger than the UK average.

And, interestingly, applicants who were narrowly successful in applying for a loan, against those who narrowly failed, were (over time) some four per cent more likely to exceed their overdraft limit every month.

So, some useful stats here for policy makers. Yet arguably the most important step forward for consumers and industry, has been what this data and processing power allows us to do next - in terms of testing potential interventions. In effect, offering us the possibility of running sophisticated simulations of the impact of alternative price caps on the market.

In other words, we were able to model what happens to borrowers as you raise or lower a theoretical price cap level, as well as monitor issues like firm exits; the viability of the market under different scenarios; and the potential risk of vulnerable people turning to unlicensed lenders.

This, in turn of course, allowed us to narrow down the solution architecture more effectively and set a more authoritative cap level. So, in this case, the proposal was for a 0.8% initial cost cap per day, £15 default fee cap, and total cost cap of 100%. Saving pay day consumers, on average, an estimated £180 a year, or £157m in aggregate, while firms’ revenue was modelled to fall by some £220m a year.

Now, time will tell just how far reaching this impact is. But whether you agree with the fundamental principle of price caps or not, it’s frankly impossible to argue we’re not better placed to set them today than we were five years ago.

In fact, I’d argue that, almost overnight, economic analysis, technology and data has become an imperative in terms of addressing that critical question for today: how do you make sure regulatory intervention becomes socially useful intervention? Not just mere ‘activity’. Indeed, we've already taken action against four firms for breaching the cap.

Behavioural economics – overdrafts

It is typically middle-aged consumers, with higher incomes, who tend to pay the most overdraft charges, switch the least and, in turn, benefit the most from text alerts and apps. So, this is not just a low-income policy challenge, although the personal impact here on poorer consumers will clearly be felt more keenly. Overdraft charges are actually affecting swathes of middle-Britain.

And this brings me on to the second area I want to look at this morning: our understanding of how real people interact with the consumer credit market.

So, one of the criticisms of policy making in the past – not just in regulation but actually across the spectrum – has been that it fails to reference human fallibility.

There has been an assumption of rationality, if you like. The famous ‘homo-economicus’ who reads terms and conditions, makes optimal purchasing decisions, has perfect knowledge of the market and so on and so forth.

Clearly, of course, none of us exhibit this behaviour. Even the most financially savvy consumers. Yet, for a long time, policy makers have relied on classical interpretations of economics to guide interventions, particularly in areas like mandated disclosure. 

In fact, as Omri Ben-Shahar and Carl Schneider argued in their book More than You Wanted to Know – ‘no kind of regulation is more common, or less useful, than mandated disclosure’.

Now, there are good arguments here over the extent to which that is, or is not true. There is certainly an importance difference, I’d argue, between useful, well designed disclosure and what effectively is white noise.

And this is an area where the FCA has been driving global policy forward over the last year or so. Indeed, we today published a report[1] into the impact of annual summaries, text alerts and mobile banking apps in the personal current account industry.  

The results make interesting reading. So actually, despite the fact banks have voluntarily sent out annual account summaries for some three years now (on the back of pressure from policy makers to help customers manage account costs and to encourage switching) the evidence here suggests those policy goals are not being achieved.

In fact, statistical analysis of some 300m plus observations, shows annual summaries, which are often long and imply no clear action, have (perhaps unsurprisingly) no influence at all on consumer behaviour in terms of avoiding overdraft charges, improving balance levels, or prompting switching between providers.

By way of contrast however, text alerts and mobile banking apps seem to reduce the amount of unarranged overdraft charges incurred by customers by some 5pc to 8pc. While for those who take advantage of both, the effect is much larger (a 24pc reduction) because information is received direct to phones and can of course, in turn, be acted on immediately through the same device.

On top of this, the other great advantage seems to be that text alerts and banking apps also encourage customers to shift their balances from no, or low credit interest accounts.

What might be more of a surprise to some, however, is that our analysis has shown that it is typically middle-aged consumers, with higher incomes, who tend to pay the most overdraft charges, switch the least and, in turn, benefit the most from text alerts and apps.

So, this is not just a low-income policy challenge, although the personal impact here on poorer consumers will clearly be felt more keenly. Overdraft charges are actually affecting swathes of middle-Britain.

In other words, this is as much a middle-class issue as anything. Busy, distracted households – not always keeping day-to-day watch over their accounts – are often more likely to slip into unarranged overdraft by accident. And there may also be less motivation to take avoidance action because they feel less financially affected by charges.

Now, the key question here, of course, is what next? And for regulators, the challenge goes back to that core debate for this morning – how do you improve the environment going forward and not just get lost in the business of day-to-day management.

So, the possibilities that today’s research looks at our areas including:

• targeting annual summaries to people with clear financial management issues and setting out clear actions for them to take;
• customers opting out of text alerts, rather than opting in, if they’ve had a history of difficulty in managing their finances;
• and certainly looking in more depth at how technological innovation can support improved outcomes – an area the FCA is already very actively engaged on with industry.

Industry in the middle of great change

So, to go back to that question today: one year of the FCA, credit where credit is due? I’d say actually, there has been some very significant progress. For the first time, you have this deep insight into not just the industry itself, but its customers.

Achieving that has brought real challenges for us as a regulator and demanded fresh thinking and a different approach which in turn is beginning to drive policy-making that does, potentially at least, offer up the opportunity for real change for consumers and firms.

Now, this is caveated, of course, by the fact that the challenges facing consumer credit are both broad and deep – as yesterday’s thematic review showed – so a degree of patience is needed here. Certainly, there is no room or reason for complacency. Nor is it feasible to expect a world free from misconduct – it is simply not in human nature.

But we are, I would argue, today in a far more promising context than we were 12 months ago. In 10, 15 years’ time, the public debate over consumer credit may well, indeed, not be dominated by that Pavlovian reaction.

Certainly, there’s now this sense that we’re in the middle of a period of significant cultural change, with the large majority of the industry now recognising the importance of moving things forward.

And yesterday’s thematic review from the FCA, on forbearance and arrears, seems to me a useful indicator here of that direction of travel. So, although, yes, you have issues. The broad picture is of a sector that’s beginning to appreciate the importance of placing consumer outcomes at the centre of debates around business strategy.

In other words, what we’re seeing here is a positive response to the regulatory agenda across many firms.

The challenge, of course, is to move the rest forward with the same enthusiasm and pace.