On 1 April 2014, the FCA published its research into “Consumer Credit and Consumers in Vulnerable Circumstances”.Customer Segmentation
This coincided with the publication of the FCA’s Business Plan and Risk Review for 2014/2015, both of which centre on the fair treatment of consumers and the need for cultural change to ensure that customers are truly at the heart of financial service businesses.
The research, whilst recognising the importance of consumer credit in the UK economy, suggests a concern about consumers getting into financial difficulties by overstretching themselves. It identifies that the key contributors of unmanageable debt are (a) a change in circumstances and (b) high levels of accumulated debt. These, when linked with customers on low incomes, reduce the consumer’s ability to deal with high levels of debt.
The focus of the research was to understand those consumers more at risk of unmanageable debt. The research has led to the FCA segmenting customers using consumer credit products as follows:
- Survival borrowers – described as having “no option” but to borrow due to very tight finances and lack of income. These customers tend to favour catalogue credit and home credit due to ease of access and low weekly payments. They are less likely to use the more mainstream forms of credit.
- Lifestyle borrowers – described as generally having sufficient income to meet day-to-day needs but use credit for larger purchases or one-off events. They also use catalogue credit and home credit but for different reasons to the survival borrowers.
- Reluctant borrowers - described as tending to limit their use of credit and focus on paying back existing debts which often come from more mainstream sources e.g. bank loans/credit cards.
Across all customer groups, the FCA found that choice of credit is heavily influenced by behavioural biases and preferences. The research suggests that many customers focusing on flexibility, familiarity and control rather than the price and that a lack of access to alternative forms of credit (actual or perceived) also plays a role. As a result of this consumer behaviour, customers in all groups can find that there are high costs associated with their credit use.
The paper also seeks to define vulnerability. Unsurprisingly, the paper notes that, as this a such a subjective term, it can be difficult to define. However, the FCA states that “most users of consumer credit may be regarded as vulnerable to some degree because of their financial circumstance. We consider a vulnerable customer to be someone who, due to their personal circumstances, is especially susceptible to detriment”. This “definition” is clearly very wide and may include all customers at some stage of their consumer credit journey.
The research highlights that vulnerability and detriment may manifest themselves in different ways – e.g. customers choosing the wrong product, paying higher prices, failing to obtain products which meet their needs. The most significant detriment arises when customers get into a situation where their debt levels are unmanageable. Consumers are most at risk of this where their debt to income ratios are high and they then experience a change in circumstance.
The FCA expresses a real concern about high levels of debt and states that there is a strong correlation between low income and high debt. This is made worse when consumers have little or no savings, have a limited access to credit and find that their income is volatile. Customers with mental health problems are also at risk of over-indebtedness.
Individual and Behavioural Factors
The FCA found that customers do not shop around and lack the confidence when engaging with financial products and debt solutions.
The research suggests that those consumers on the lowest incomes use credit to survive and to pay for everyday essentials. Consumers tend to prefer flexible repayments and like to have control. For this reason they may move away from the more traditional type of lender and favour those lenders that recognise the difficultly of customers maintaining regular payments.
The FCA is concerned that the perceived lack of transparency around the fees and charges for unauthorised overdrafts is more likely to affect vulnerable customers. The FCA is committed to reviewing overdrafts as part of its Business Plan and Risk Outlook.
The research also suggests that whilst debt advice is important to customers, not all customers are aware of how they can obtain this advice.
How does this Research Impact You?
The FCA has expressed concern about the high levels of indebtedness in the UK and the risk of it continuing to grow. The launch of a market study into credit cards as well as a proposed competition review of overdrafts shows that the FCA is keen to tackle issues which, in its view, are increasing the risk of over-indebtedness for consumers.
The research highlights the customers most at risk of vulnerability and detriment. Given the link to low income, high debt levels and lack of savings, it is difficult not to see how this research will link into the creditworthiness assessment required under CONC 5.2.1R and 5.2.2R. The ongoing work by the FCA in this area is likely to shape how lenders meet that assessment in the future. The drive to ensure that customers are signposted to free debt advice is also likely to require lenders to make changes to their processes and customer communications to ensure that this is achieved.
The FCA is committed to publishing an Occasional Paper later this year to explore this research further. This will be supported by substantial qualitative research with customers and will then shape the ways in which the industry needs to work with the FCA to address the issues identified.