In late July, the FCA published a long awaited consultation CP17/27 on the proposed changes to its rules and guidance on assessing creditworthiness in consumer credit. A number of new provisions are proposed, including the introduction of a definition of affordability risk, how and when firms should use customer income and expenditure information and strengthened rules on policies and procedures.
Reviewing the current creditworthiness rules in CONC has been on the FCA's radar for some time. For the past two years, they have been undertaking research to establish how firms have been interpreting and applying their rules and guidance on creditworthiness, which includes the requirement to assess affordability – a borrower-focussed test. The focus has mostly been on ensuring that firms are taking appropriate steps to assess affordability in addition to their creditworthiness checks.
What the FCA found
Most firms do consider affordability in some form and appear to have implemented relevant processes; but
There was evidence of some firms’ over compliance (burdensome procedures) and under compliance (insufficient checks) with the rules
The FCA are seeking to clarify their expectations and improve transparency so that firms are clearer about their obligations. They do not intend to change their current approach – high level principles are preferred with an emphasis on proportionality and a focus on outcomes, rather than process.
They also state that:
they want to avoid being prescriptive because the consumer credit market is so broad and varied;
an affordability assessment is “not an exact science"; and
there are benefits that automation and technology bring to lending decisions and they do not want to discourage their use.
Key Proposed Changes – more prescriptive?
That said, we think the changes go much further than clarifying the existing rules. The FCA are proposing new and more prescriptive requirements which firms will need to carefully consider. This is probably inevitable, even if it was not the intention.
The key proposed changes can be grouped broadly into the following areas: (1) technical changes to the scope of the CONC 5 requirements (2) introduction of a definition of affordability risk (3) factors that should be used when designing affordability checks (4) the role of income and expenditure in assessing creditworthiness and affordability (5) assumptions to be used (6) assessing creditworthiness where there is a guarantor and (7) expectations with regard to firms' policies and procedures.
What is affordability risk?
The proposed new definition of affordability risk is set out in CONC 5.2A.9(2) and 10. A firm must assess the risk to the customer not being able to make repayments:
as they fall due over the life of the credit agreement, and within a reasonable period (in the case of an open end agreement);
wholly out of income, unless the customer has clearly indicated an intention to repay using savings or other assets;
without having to borrow to meet the repayments, or being unable to meet other financial commitments; and
without the repayments having a significant negative impact on the customer’s overall financial situation.
Importantly, the FCA says that only the borrower's individual income can be used in the assessment and not household income. We think this could have an impact on various segments of society such as homemakers, those living with a relative or parent or simply a spouse that is currently not working, for example who may have either very low or no personal income, yet household income may be high. This is likely to represent a significant departure from current industry practice, at least in some sectors, where household income is usually considered as part of the assessment.
Firms can consider income from jointly held savings or assets if the borrower is likely to have access to those funds to make repayments, but this will still impact those segments where the household income consists solely of one members' salary and there is no other income or assets.
Policies, Procedures and Lending Decisions
The FCA proposes to introduce additional rules in relation to policies and procedures in connection with assessing creditworthiness and affordability. Firms must be able to demonstrate that these (1) are in writing and (2) have been approved by their senior personnel or governing body and (3) are periodically reviewed to ensure they remain effective.
Firms are also expected to have an audit trail for all lending decisions – for both new customer approvals and for significant increases in credit. In particular, firms who offer running account credit products such as credit cards will need to consider how they will evidence this requirement for accounts that may be open for many years, and where numerous credit limit increases have been granted during that time.
Responses to the consultation are due by 31 October 2017. Finalised rules will be published in a Policy Statement, expected in Q2 2018.