Loan affordability and maintaining FCA compliance for lenders
A key role of the Financial Conduct Authority is to ensure responsible lending. To achieve this it must consider both suitability and loan affordability for consumers. This is why FCA compliance for lenders is of great importance.
The formal rules on responsible lending are set out in CONC 5. The publication was first published by the Office of Fair Trading in 2010. The updated version followed the year after entitled “Irresponsible Lending Guidance.”
The publication looks at all aspects of both consumer and lender conduct. This includes how a consumer enters into an agreement and how the lender must act in response. Some of the key aspects are creditworthiness, affordability and risk management.
What are the obligations of the lender?
Once a consumer applies for credit the lender has certain responsibilities imposed on it. For example, it should first conduct a credit reference search. This is usually done through a credit reference agency such as Experian or Equifax.
This initial search will give the lender an idea of the consumer’s repayment history. It may show that the consumer has failed to meet repayments in the past. Or it may confirm that they have a more responsible attitude to lending.
To encourage responsible lending and FCA Compliance, the FCA have adopted and embraced clear guidelines. For example, a lender shouldn’t encourage a consumer to enter into a credit agreement. Nor should it accept an application which it believes is misleading or untrue.
Consumers may sometimes exaggerate their annual income in order to get credit. It remains the lender’s responsibility to identify these.
If a lender is unable to approve an application then it must tell the consumer why. The consumer might then want to look at their credit record to establish the reason. Full credit reports are available for a nominal amount – usually around £2.00.
The FCA have also issued guidance on vulnerable consumers. These are set out in CONC 2.10. A consumer might be vulnerable for various reasons e.g. disability, incapacity and so on. Affordability tools will often identify these areas.
The guidance also highlights the difference between mental “capacity” and mental “health”. The two are quite distinct. Mental “capacity” is whether a person has the ability to understand and consider information. Mental “health” doesn’t mean the consumer can’t make an informed decision. That said, in either case, the lender must consider the consumer’s ability to decide. This has to have a holistic approach.
Creditworthiness of the customer
In their Business Plan 2015/6, the FCA announced an intention to research creditworthiness. See: Creditworthiness and affordability: common misunderstandings
CONC 5 addresses the issue of creditworthiness. This requires the lender to ensure that consumers can meet repayments as and when they fall due. Should they fail to do so then this will impact on their credit score.
CONC 6.2 then goes on to look at the lender’s responsibility as regards credit limits. This works alongside CONC 5 on the issue of creditworthiness. It’s for the lender to establish whether repayments are affordable for the consumer.
This information is available in CONC 5.2.4G. That said, it’s also expected that the consumer undertake their own checks too. Lenders should ensure that loan affordability tools are available for consumers to use. These are also available online and are free to use.
It is also important to note that the FCA do not enforce strict rules. More particularly they provide clear ‘guidance’ for lenders. That said, all lenders remain accountable for their own actions.
Should they choose to operate outside of FCA compliance guidance then it is a matter for them to self-regulate. The FCA reiterate the point throughout their publications. This is particularly true of credit searches. Whilst the FCA ‘recommend’ they be undertaken, they do not ‘insist’ on it. Each lender must make its own decisions and policies.
This is also true of CONC 5.2.1R. This relates to creditworthiness on the basis of obtaining enough information. The FCA do not enforce any strict ruling on what is adequate. Instead, they ask each lender to make their own decision whilst remaining accountable.
This includes consideration of the consumer’s financial situation. This does not have to be a detailed projection. The only desirable outcome is that customers avoid unaffordable borrowing.
CONC 5.2.3G requests that lenders consider any future changes. These might include employment trends, significant financial events or even attitude to lending. Much of this will, of course, depend on the type and amount of credit. Risk has to remain proportionate.
The FCA also lend advice regarding ‘known’ consumers. These may have banked with the lender for many years. In these cases, the lender might exercise discretion.
They may be comfortable with previous transactions and not feel a credit search necessary. The FCA do not dictate whether this is right or wrong. This decision must rest with the lender.
Other lending scenarios and loan affordability guidance
With regard to joint borrowers, the FCA have also amended their initial guidance. In CONC 5.2.4G it recommends that each lender assesses both borrowers against affordability. This seems quite reasonable given that each is liable for the loan.
Various questions arise out of this. Could one borrower afford repayments on their own? (If, for example, they separated). Do they both share the same understanding of the terms and conditions? Do they both have mental capacity? What if the financial position were to change for just one party? Again, the risk must remain proportionate.
It is evident that the FCA remain committed to their key principles. As well as their Business Plan they continue to undertake valuable research. This, in turn, adds clarity to their expectations of regulated firms. It also ensures that customers continue to receive a high level of service from lenders.
It is also clear that loan affordability remains a key concern. Combined with responsible lending, solid guidance and support, consumers can expect clarity. Looking to the future, it seems the FCA will continue to work with both consumers and lenders.
Evidence also suggests that irresponsible lending will decrease. This has to be encouraging news for all. Consumers will be able to make informed decisions, such as using a loan affordability calculator. And also, lenders should see fewer defaults and over time also better credit ratings for their loan customers. There’s definitely much to look forward to.
FCA compliance summary
Maintaining FCA compliance may have posed some difficulties to lenders recently. Yet it’s important to note that with these guidelines in place, both lenders and consumers are protected.