Payday lending compliance review – an end to “instant credit”? – Update

Introduction

The rise of payday lending has seemed unstoppable. The market has risen from an estimated £900 million in 2008/09 to a top end of £2.2 billion in 2011/12, a figure likely to be outstripped in 2012/13. Whilst the market has shown a clear and steady appetite for this type of short term loan facility the FCA, OFT and politicians have short term lenders firmly in their sights.

The OFT’s final report on payday lending compliance came down hard on payday lenders, stating that the sector was a top priority, that enforcement action would occur, and that further action may be taken. The FCA has followed up on this promise, publishing specific proposals for regulating what it describes as “high-cost short-credit providers” in its publication explaining its proposed regime for consumer credit when it eventually takes over the role of the OFT in 2014. Such “high-cost short-credit” loans are, in simple terms, defined as those loans which the APR is equal to or exceeds 100%, the credit is due to be repaid or substantially repaid within a maximum of 12 months and are not secured by a mortgage, charge or pledge.

Payday lenders have also become a significant political issue, with both government and opposition parties criticising the operations of certain products and lenders, and proposing additional areas in which lenders can expect new regulation. Most notably, the government has announced that it intends for the FCA to use its current powers to cap the total cost of payday credit (i.e. a cap on both the interest and charges payable under a payday loan). This cap is yet to be decided.

This article, an update to our previous article, looks at the proposals of both the OFT and FCA, whilst considering the future developments that may occur in this industry. Although clearly directed at the payday sector, the standards expected could as easily be adapted and applied to other credit scenarios.

Affordability

A central plank of both the OFT’s expectations and the FCA’s proposals is that of affordability. The Consumer Credit Act 1974 (the “Act”), as replicated in the FCA’s Consumer Credit sourcebook (“CONC”), provides that before making a regulated consumer credit agreement the creditor must undertake an assessment of the creditworthiness of the debtor. This assessment must be based on sufficient information obtained from the debtor where appropriate and a credit reference agency where necessary.

OFT guidance makes it clear that creditors must also assess affordability, that is, each borrower’s ability to repay in a sustainable manner. The OFT, put simply, has serious concerns about whether creditors are gathering enough information to make a reliable assessment or properly checking the information they do get. In light of their expectations a credit reference check alone is unlikely to be sufficient. Equally unlikely is simply asking borrowers to self declare their income without verifying it or seeking evidence of outgoings to determine levels of disposable income.

The FCA draft rules show that it will transpose the OFT’s guidance into FCA handbook so as to make the adequate affordability assessments a binding requirement. In their proposals they explicitly state that a lender will be expected to base their assessment on the impact of the credit on the borrower’s financial situation (both current and future), their ability to repay the loan, and the existing and future financial commitments a borrower has made known to the lender.

It is clear that the “rollover culture” is not met with approval by both the FCA and the OFT. The FCA has stated that it wishes to cap the number of times a high-cost short-term loan can be rolled over. Data analysis from Europe Economics suggests that a number of firms’ business models are based upon generating revenue from rollovers and default charges. The FCA has major concerns that the “simple and easy process” of rollovers often has “significant” costs attached to it, and that lenders were not being sufficiently clear with borrowers in difficulty as to the risks and costs of rolling over the loan. To this effect the FCA intends to restrict lenders to a maximum of two rollovers per loan, thereby adopting a stricter stance than the Consumer Finance Association Code of Conduct. It is felt that this offers both lenders and borrowers sufficient flexibility to deal with short term reductions in a borrower’s income but prevent individuals in financial difficulty being placed in a worse off situation. Where a loan is to be extended this can only occur where the borrower has agreed to the extension and the lender is satisfied that the extension is in the best interests of the borrower.

Forbearance is urged where financial difficulty is experienced and surely an inability to repay on time is evidence of such difficulty. As an alternative to ‘rollovers’, both the FCA and OFT have suggested that a fairer solution would be to suspend interest and charges and offer to negotiate a repayment plan.

Furthermore, the Treasury has recently announced that “the government will legislate to introduce a cap on the cost of payday loans”, indicating that they are “going to have a cap on the total cost of credit…not just the interest fee, but also the arrangement fees as well as the penalty fees”. This marks a significant intervention by the government into the consumer credit industry. The approach is similar to that of the Australian government, which the Treasury press release specifically refers to, indicating that a very similar implementation may occur. This approach is somewhat surprising given that the FCA stated in their October 2013 consultation paper that the research conducted on the benefits of a price cap on total cost was “ambiguous” and therefore unsuitable for justifying such an intrusive proposition. The FCA had “committed to undertake further research once [they] begin regulating credit firms”; however it appears as though the government wishes to accelerate this timetable.

These measures are indeed concerning - and not only for payday lending. It does not take any large leap of the imagination to see that similar standards might be applied in situations such as applying for a credit card in store.

Advertising

The OFT claims a pattern of advertising exists in the industry that emphasises speed and easy access to cash. This was said to be at the expense of giving borrowers balanced information about the cost of lending, the risks if things go wrong and the consequences of non payment including the operation of any continuous payment authority.

However, it is debateable whether there is any requirement to provide this information in advertisements. So long as the rules of the Consumer Credit (Advertisements) Regulations 2010 are followed, including plain and intelligible language and a sufficiently prominent representative example where called for, with no misleading statements or omissions, then the legal obligations of the advertiser should be met.

The FCA is seeking to alter this position. They have recognised that payday loans are not required to give risk warnings and that this is a “significant concern” as many borrowers are unaware of the risks and costs associated with not paying back a loan on time. The FCA is therefore proposing that all financial promotions for high-cost short-term loans carry a specific warning signposting consumers to the Money Advice Service, regardless of whether they trigger the CCD pricing disclosure.

Additionally, both the FCA and OFT will seek to clamp down on misleading adverts. In particular those suggesting “no credit checks” and “instant cash” will need to be wholly capable of substantiating such claims and ensuring that such practices are appropriate, particularly in light of the requirement to adequately investigate creditworthiness. The push for quicker payout contributes to irresponsible lending, to the detriment of borrowers – and it is this conduct which may put credit licences in jeopardy. The FCA has also created draft rules within CONC stating that where a financial promotion includes any incentive, including statements about the speed or ease of processing of a loan, this will trigger a requirement for that financial promotion to specify the typical APR of the loan. It is hoped that such a measure will increase disclosures by market participants.

Adequate explanations

It is a requirement of the Act for an adequate explanation of certain matters to be given before the credit agreement is entered into. The OFT emphasise that all of the required information must be explained to all borrowers, for all loans, including repeat business. The FCA is incorporating such guidance into the FCA Handbook. This has to be coupled with a meaningful opportunity for borrowers to ask questions. Although for online agreements a FAQ document may provide a useful starting point, it is not an adequate substitute for providing borrowers with the ability to ask their own questions.

Debt collection

A key proposal of the FCA is that firms be restricted to two unsuccessful CPAs over the course of a high-cost short-term loan. Both the FCA and the OFT have observed that current practices in relation to debt collection methods are encouraging insufficient affordability assessments and the unfair treatment of borrowers in financial difficulty. Both bodies acknowledge that if affordability assessments are emphasised many of the problems associated with debt collection could be avoided, but for this emphasis to be increased limits must be placed upon the manner in which firms may attempt to recover payments.

The limit upon unsuccessful CPAs stems from the FCA’s view that many firms are making repeated, and sometimes unexpected, requests to a borrower’s bank so as to maximise their recovery from a borrower in default. The firm’s hope is that, through multiple requests, they will be able to obtain funds as soon as they enter the borrower’s account, regardless of the impact this may have on the borrower’s ability to pay other debts. The FCA believes that where a CPA is unsuccessful, especially if there is a pattern of previous unsuccessful CPAs, it is evidence of a borrower being in financial difficulty and therefore the firm should seek to discuss the issue with the borrower rather than repeatedly trying to maximise their own recovery at the expense of the borrower’s interests.

Debt collection practices must follow and be fully compliant with OFT revised debt collection guidance, guidance which is to be repeated by the FCA in 2014. It will be recalled that the revised guidance paid particular attention to the use of continuous payment authorities and the occasions on which they could be used, the information the debtors must be provided including the circumstances and manner in which they may be cancelled.

The OFT has previously expressed that fees and charges levied on accounts in arrears must reflect actual and necessary costs – this is unlikely to change under the FCA as this appears to be no more than a repetition on the bar against penalties. Furthermore, there is the need for lenders to have in place adequate and appropriate policies and procedures which must be followed. Relevant staff must be trained on relevant procedures and adequately supervised.

Consultation for referral to Competition Commission

In June 2013 the OFT referred the payday lending market to the Competition Commission for investigation. The Competition Commission is now carrying out its own comprehensive investigation, to see if any features of this market prevent, restrict or distort competition and, if so, what action might be taken to remedy them. The issues statement in relation to this investigation identifies the key areas which the inquiry is examining but it expressly notes that the statement does not imply that the Inquiry Group has yet identified any concerns.

The Inquiry Group will perform a detailed probe of the sector and activities for up to 2 years, following which the Competition Commission has wide powers to recommend an array of remedies designed to change behaviours and practices within the sector.