A financial system to support the recovery

Speaker: Charles Randell, Chair
Event: Virtual roundtable of bank chairs hosted by UK Finance
Delivered: 16 June 2020
Note: this is the speech as drafted and may differ from the delivered version

Highlights:

• The coronavirus (Covid-19) crisis shows we need to reassess our approach to consumer debt, high risk retail investments and financial exclusion
• We need a robust framework for dealing with small business loans which turn out to be unaffordable
• UK financial markets and businesses are well placed to help the country and the world recapitalise
• The FCA has worked with pace and pragmatism in the crisis and will make these ways of working its new normal as it transforms for the future.

Since the start of the coronavirus pandemic I’ve discussed with a number of those present how financial services firms, regulators, the government and the voluntary sector have been working together to keep the financial system operating, get businesses through the lockdown, and consumers through the crisis.

We don’t agree about everything, but we agree on a lot. And we agree first and foremost that we all owe our gratitude to tens of thousands of people who work in financial services up and down the country and who have been on the front line. The people who have kept bank branches and ATMs open, cash circulating and payments flowing. The people who have manned the phones under enormous pressure to help hundreds of thousands of people manage their debt burdens and keep their businesses afloat. The people who have kept key systems resilient.

To everyone on this front line I want to say: thank you.

As we move into the next phase of this crisis, we don’t know how quickly the economy will recover. That will be determined more by decisions about public health and fiscal and monetary policy than by financial conduct regulation. But it’s not too early to start to discuss what kind of financial system we need for the recovery, and what kind of financial conduct regulator we need to support that system.

The consequences of coronavirus

The pandemic has already exposed some stark truths. We have too much debt. We don’t save enough. When people do save, they are too often persuaded to buy unsuitable investments. We still work in analogue ways when the future is digital. All of this was true before, but the scale of these challenges has appeared with a speed and severity beyond anything I had imagined.

Debt

Let’s start with debt, and first, business debt.

Over 800,000 businesses have taken on debt under government backed schemes.[1] The FCA doesn’t regulate most business lending, but we adjusted our rules so lenders could lend quickly to small businesses while maintaining essential protections for businesses in distress. We did this after listening to the government, the Bank of England, lenders and small business representatives about the urgent need to provide this support. Individual creditworthiness checks would have slowed the process down so much that many fundamentally healthy businesses would have gone under before they got the support they needed.

But it has to be emphasised – and then emphasised again - that these are loans, not grants. It’s an inescapable fact that some of the debt that businesses have incurred in the crisis will turn out to be unaffordable. Tackling this overhang of debt quickly and fairly will be essential: it must not become a drag on the recovery. Lenders and regulators, and the government and the British Business Bank as the authorities standing behind the loans, will need to apply a shared understanding of how to treat borrowers in difficulty. Lenders will need to scale their arrears handling functions quickly, and invest in training and controls. There needs to be an appropriate dispute resolution system, and we are working with the Financial Ombudsman Service and the Business Banking Resolution Service to ensure that there is capacity to deal with the volumes we may see. The FCA needs to play its part in this process, in a spirit of transparency and pragmatism. We can’t allow this to become a replay of the 2008 crisis where the treatment of some small business borrowers did such serious damage to people and to trust in financial services.

Second, personal debt. It’s right that borrowers in difficulty have been able to defer their interest payments to see them through the short term. But in the longer term their debt burden will have increased. Last year I expressed concern[2] about the number of people with very little financial resilience, as a result of high debt, low savings or both. Going into this crisis one in eight Britons had no savings at all and 8.3 million people were already overindebted. I highlighted the fact that a recession would increase demand for debt advice and mean that firms would need to scale up their arrears handling in order to treat struggling customers fairly. I also worried that existing public policy tools weren’t adequate to deal with a large number of people who could not pay their bills even after receiving appropriate advice and forbearance.

All of those issues are here, now, and the bills to everyone for dealing with them are starting to come in[3]. We need to tackle this legacy, but we also need to take this opportunity to look to the future and ask ourselves some fundamental questions about the role of debt and saving in our society. 

Investments

Can the financial services industry, the government, the Money and Pensions Service and the FCA together guide consumers to make better decisions about debt and saving in the future? In an age of one-click loans on your smartphone, are there more sustainable models of personal lending that society should support better? Can we make better use of behavioural insights to ensure advertisers reflect the reality that lives can be ruined by unaffordable debt, show the right information better, and create processes that lead to better choices? And ultimately, since many borrow by necessity rather than choice, should policymakers fill more gaps in income through social provision, rather than expecting them to be filled by private debt?

We need to reduce harmful borrowing. But we also need to make it easy for people to save into simple products that meet their needs. With policy rates at all time lows, there will be continuing pressure on investment returns. So it will be more important than ever for ordinary retail investors to have access to investments which are good value for money: which help savers achieve a return that can beat inflation cheaply and without taking on more risk than they can afford. The experience of the last several months has added to the questions we have had about the value provided by some investment products, including those marketed through long and expensive distribution chains.

And we need to guide and educate people to diversify their savings well, be sceptical of projected returns, and understand what they can afford to lose. People will keep searching for higher rates and, if things stay as they are, some may keep falling for promises that are too good to be true. Coronavirus has shown that high risk investments are exactly that. All too often we hear that it is the people who were least suited to invest in them who have been lured in by an illusion of security, pinned their hopes on unrealistic promises and lost all their savings. We are already seeing speculative leveraged property investments failing. Investors in higher risk assets who hold them through unlisted structures face additional perils: the absence of normal market discipline, the illiquidity of their investments, and in some cases their low position in the capital structure and the highly concentrated nature of the risks. 

Capital needs to flow to finance the recovery, including to new, innovative and entrepreneurial businesses. But it needs to be provided in a way that is consistent with consumer protection. I said last year[2] that some unlisted and illiquid investments should have little or no place in the savings plans of most individual savers. I also said that policymakers need to consider further restrictions on the sale of high cost, risky and illiquid investments. I questioned whether advice to purchase these investments should continue to be allowed to the same extent as today - and continue to be covered in the same way by the Financial Services Compensation Scheme (FSCS). And I also welcomed the Treasury’s review of the Innovative Finance ISA policy, to help establish whether some ordinary retail investors mistakenly believe that these investments are endorsed by the authorities and, therefore, underestimate their risk.

Coronavirus has reinforced my concerns. As we assess the fallout of the pandemic, we need to be open to redesigning the system so that it better protects ordinary retail investors from investments which are highly unlikely to be suitable for them, and ensures that firms which market unsuitable investments don’t pass the bill for their misconduct on to well-run firms through the FSCS. The FSCS Compensation Costs levy is already at an unacceptable level; and I am sorry to say that it is likely to increase, as some firms will fail during this crisis.

We need a framework to stop social media platforms and search engines from promoting unsuitable investments, including scams, to ordinary retail consumers. It is frankly absurd that the FCA is paying hundreds of thousands of pounds to Google to warn consumers against investment advertisements from which Google is already receiving millions in revenue.

We will be saying more about the issue of high risk investments in the near future. 

Digitisation

Advertising harmful products online is one of the huge challenges that the digitisation of financial services brings. Another is the risk of financial exclusion of people who are not online.

Coronavirus has accelerated the move away from cash to other forms of payment and, despite great efforts to keep them open, reduced access to bank branches. If fewer and fewer consumers use bank branches and ATMs, the cost of each consumer who does use those facilities increases. When social distancing is over, we will see whether the move by many more consumers to contactless payment and online banking is permanent. If so, there are some communities and vulnerable consumers who will need continued support. 

This is not just about rural communities and elderly consumers – financial exclusion takes many forms. Society needs to decide which organisations should be charged with continuing to provide the financial services certain communities need, and how to fund them sustainably.

The challenging environment for banks’ net interest income over the coming years, if a low policy rate continues to prevail, can only increase the risks of financial exclusion. Because often at the heart of these difficulties lies the free-if-in-credit banking model. Banks subsidise parts of their services out of the margin between the higher interest they receive on the loans they make and the interest they pay out on their float of low interest (or no interest) current accounts. Rather than finding a sustainable model for charging for those services as an industry, individual banks may continue to withdraw services they regard as unprofitable but which are lifelines for some of their customers.

As we think about the kind of financial system and regulator we need for the recovery, it’s clear that a lot of effort will be consumed by these issues: unaffordable debt in a society that is not saving enough, expensive and high risk investments, and financial exclusion, including the financial and social costs of managing the transition between physically and digitally delivered services. Our business plan for this year - which we decided before the pandemic hit – includes these issues as business priorities[4]. We will give more details on how we will be tackling these critical areas as the year progresses.

A financial system for the recovery

But these issues will also bring opportunities. For firms which can provide equity for recovering businesses and new ventures, large and small. For firms which can develop more sustainable credit products coupled with savings. For firms which can offer low cost diversified investments. For firms which can provide cost-effective services to meet the needs of communities and consumers who can’t do everything online.

The best firms in the industry have a unique opportunity to build on the trust they have deservedly earned from treating their customers fairly and responding swiftly to this crisis. The opportunities for UK financial services will be global. Governments and businesses all over the world will need to rebuild their finances. There will be demand for the capital and for the intermediation services which a global financial centre like United Kingdom’s can provide. The rebuilding of the global economy will need deep and liquid wholesale markets and investment expertise, playing to the UK’s strengths. We understand how important wholesale markets are for price discovery and liquidity, enabling both institutional investors and retail consumers to make and access investments. That’s why we did not move to ban short selling in UK markets in response to coronavirus. And it’s clear that more and more investors want to make sustainable investment choices to help to address the climate emergency. The FCA will help these markets continue to develop with proportionate regulation, informed by our close relationships with business, consumer representatives and the global regulatory community.

A financial conduct regulator for the recovery

Against this background, the demands on the FCA will be large. To meet them, as I’ve said before, the FCA needs to change. The change needs to be ambitious. So the last of our business priorities in our business plan this year is the transformation of the FCA.

Lessons of the last seven years

In its first seven years, the FCA made important reforms across the whole waterfront of financial services. The Retail Distribution Review removed some of the poor incentives in the investment distribution and advice sector. Reforms to the affordability of mortgage borrowing. Reforms of individual accountability through the Senior Managers and Certification Regime. The FCA has taken on significant new responsibilities, including the regulation of consumer credit, and addressed some of the most harmful business models in that sector. The number of firms it regulates has more than doubled. 

There have been some great successes - and we continue to learn lessons where things could have been done better. The failure of individual firms will always be a feature of our world: we do not seek to operate a zero failure regime, and with nearly 60,000 firms such a regime would not be possible, even if it were desirable. 

But fundamentally, the regulatory approach is in some ways the same today as it was in 2013, or possibly even 2003 or 1993. We make rules, some of which are termed ‘principles’ but are nevertheless rules, supplemented in some cases by guidance. Most of these rules are directed to inputs rather than outputs, to the actions which firms must or must not take, rather than the outcomes that their customers experience. Supervisors seek to intervene when firms don’t follow the rules, and in cases of serious misconduct we take enforcement action.

This approach has at least five shortcomings.

First, it assumes that if firms follow the rules, the result will be good for consumers and markets. But rules directed to inputs do not guarantee the right outputs, particularly when you add the complexities of consumer decision-making and a rapidly changing world into the mix. Saying 'capital at risk' at the end of an investment advertisement usually means a firm is following the rules – but this phrase is not adequate to distinguish between a highly speculative get-rich-quick scheme and a well-run diversified listed equities fund. Rules about inputs also tend to be detailed but remain open to interpretation, and some firms choose to navigate their way through to maximising their own profits, rather than doing the right thing for the customer.

Secondly, it assumes that the regulator is always in a position to judge whether firms are following the rules and to intervene in a timely way. With around 60,000 authorised firms, that’s a challenge. The FCA is reassessing where we don’t have enough timely and relevant data to identify whether firms are following the rules or how much harm they might generate, and whether we can be smarter with the data we have to drive our interventions more effectively.

Thirdly, our rules tend to assume a consumer journey which is no longer typical – if it ever was. A journey where the consumer receives product information, diligently reads risk warnings and other key information, and rationally assesses their decision. Today people take many important financial decisions in a few minutes or less after using a search engine or comparison site to identify a product and scrolling rapidly down reams of information on a mobile phone without reading it. The microscopic print of the warnings on television advertisements or posters on the tube for doubtful products are the best illustrations of how ineffective and out of date some of our regulation has become. The information asymmetry between firms and their customers is simply too huge. 

Fourthly, ordinary retail consumers are sometimes offered a bewildering array of products, some of which are likely to be unsuitable for them. FCA authorised firms should not be facilitating the offering of high risk products to ordinary retail consumers who cannot afford the risk of loss. That’s why we have banned the marketing of speculative minibonds. But I believe that the regulation of authorised firms in this area is still not where it needs to be for the future. And in addition to stamping out these behaviours by FCA authorised firms, we also need better tools to stamp out the marketing of scams online by unauthorised firms.

And finally, all too often, the polluter doesn’t pay. The cost of bad behaviour by firms which then fail is usually mutualised through the FSCS, rather than borne by the wrongdoers. 

An ambition for the future

I believe that the financial conduct regulator we need for the recovery should be one that fundamentally changes this picture. First, the FCA should focus more on consumer outcomes and it should require firms to do the same – and to show that they are doing it: just as we’ve asked investment managers to report annually on the value of their products.

To achieve this, the FCA will need to ensure it collects the right data from firms, and join it up with a cross-organisational intelligence strategy to intervene more promptly. We need to think more often in terms of an end-to-end system of regulation and supervision, and less in terms of individual functions and activities.

Secondly, we need to challenge ourselves to be as clear as we can about the outcomes we want to see, and to deliver those outcomes promptly. The coronavirus pandemic has shown that the FCA is at its best when it has a clear task and a clear deadline and sets about that task with an empowered and cross-disciplinary team. We need to ensure that we work in that way in normal times.

Thirdly, we need to ensure our rules and our supervisory approach do more to correct the huge information asymmetry that exists between many financial firms and their customers. Enforcing requirements about the consumer journey that reflect the real world. Using the same behavioural insights to drive good outcomes as bad actors use to rip people off. Stopping harmful sludge practices that deter consumers from shopping around, switching or claiming on their insurance. We can do some of this through our existing rule-making powers, but I believe there may need to be changes in our regulatory perimeter: in particular changes which restrict the availability of high risk products to ordinary retail consumers.

Fourthly, we need to redesign the system to ensure that the polluting firms in the financial sector pay, not those who have behaved well. Capital requirements and professional indemnity insurance for firms need to be proportionate to the risks they present to consumers. 

These changes will require significant investment and take a number of years to implement. But I believe that they can deliver much better outcomes for consumers. They can also reduce the amount paid by the firms which deliver these good outcomes for the failures of the firms which don’t, and thereby reduce the total cost of regulation.

This is the course we had already set for ourselves last year, and which I summarised in my foreword to our Annual Report in July 2019[5]. We will need to carry this transformation process forward in order to ensure that we can do everything within our power to support the recovery while protecting those who need our help.

The challenges of the pandemic are daunting, but this crisis presents us with opportunities too. Opportunities to reshape our financial system to make it fit for the recovery and provide more sustainable investment and credit in the years beyond. Opportunities for the United Kingdom’s wholesale markets and investment expertise to help rebuild the finances of governments and businesses all over the world. And for the FCA, the opportunity to drive forward our transformation, building on the ways of working we have demonstrated in this crisis – and making them our new normal.