However there has always been some uncertainty in the market as to exactly what should be done, and how far a funder needs to delve into their potential customer's financial position in order to establish whether they can truly afford the finance on offer.
It is clear that many organisations approach the issue differently. That could be down to variations in the type of finance product on offer, or the sector of the market that is targeted. Firms serving sub prime borrowers may approach affordability from a different perspective than those aiming at prime customers. However it is evident that variants exist in businesses that are in the same market, targeting the same consumer groups. Some clarity on what is expected by the regulator would undoubtedly be welcome.
The FCA has recently issued a Consultation Paper (CP17/27) in respect of proposed changes to its rules and guidance in this area but at the outset they acknowledge that they do not propose any fundamental deviation from their overall approach which is rooted in proportionality. In some respects it must be a good thing that regulated firms are allowed to decide what is appropriate to the nature of their business and their targeted audience. Indeed the FCA consider that being too prescriptive could have harmful consequences and impact on the cost and availability of credit and lead to excluding customers who could actually afford to repay. There is also an underlying risk that greater prescription as to what is required will lead to a box ticking approach with a lack of analysis of the information being provided. However it is debatable whether the proposed new rules and guidance actually provide any more certainty than at present which could mean the current discrepancies in approach taken by firms remain at play.
The FCA consider that "Creditworthiness" is made up of 2 constituent parts:-
Credit Risk which is the lender focused test that the customer may not repay the credit;
- Affordability which is the borrower focused test on how difficult it may be for the customer to actually repay the credit.
Whilst the 2 parts overlap, the FCA want to ensure that affordability is assessed appropriately when it isn’t aligned with credit risk. Whilst firms will be motivated to ensure the credit risk in a particular deal is low, it is believed the incentive to satisfy themselves as to the customer's affordability is weak.
On an analysis of the recent growth of consumer credit lending, particular increases are apparent in motor finance, credit cards and personal loans. The FCA's Occasional Paper 20 found that people in financial distress are typically younger, with lower incomes, less likely to be employed and have higher debt to income ratios. So, debt to income ratio is deemed a crucial factor in affordability assessment.
With that background the proposal in CP17/27 is as follows:-
A firm must make a reasonable assessment of the customer's creditworthiness before making a regulated credit agreement;
Creditworthiness includes both credit risk to the lender and affordability for the customer;
Affordability is the risk to the customer of not being able to make repayments:-
As they fall due over the life of the credit agreement;
Wholly out of income (unless the customer has clearly indicated an intention to repay using savings or other assets);
Without the customer having to borrow to meet the repayments;
- Without the customer failing to make another payment the customer is obliged to make;
Without the repayments having significant negative impact on the customer's overall financial situation.
In respect of income and expenditure it is proposed:-
A firm must take reasonable steps to determine the amount or make a reasonable assessment of (i) the customer's income during the term of the agreement and (ii) customer's current non discretionary expenditure.
Where it is reasonably foreseeable that there is likely to be a reduction in the customer's income or an increase in the customer's non discretionary expenditure during the term of the agreement which could have a material impact on affordability risk, the firm must take reasonable steps to estimate the amount of that reduction and/or increase.
It is the combined total of 1 and 2 above that must be taken into account in determining affordability.
"Non discretionary expenditure" includes (i) payments needed to meet priority debts; (ii) other essential living expenses; (iii) other expenditure which it is hard to reduce to give a basic quality of life; (iv) payments the customer has a statutory or contractual obligation to make such as council tax and mortgage repayments; and (v) spending on behalf of other individuals such as dependants, so childcare and schooling costs should also be taken into account.
These proposals suggest income and expenditure will have a far greater part to play going forward but there is an exception. If the firm can demonstrate that it is obvious in the circumstances of a particular case that the customer is able to make the repayments in accordance with the affordability criteria so that the income and expenditure assessment above would be disproportionate, then there is no need to go down that route. In addition there will be a specific rule that the extent and scope of a credit worthiness assessment will depend on and be proportionate to the individual circumstances of any given case.
So when might a firm avoid assessing income and expenditure? The FCA give an example where a relatively small amount of credit is offered to a customer who shows no signs of financial difficulties and in relation to whom no adverse information is apparent from the application or a CRA check. They also suggest that the need for a more detailed and rigorous assessment may be high where the total value of the customer's debts relative to the customers income is high. They don't think it is appropriate to mandate the use of ratios or thresholds to determine debt v income.
What is done to verify this information is down to the firm to determine. Customer self certification is unlikely to be good enough, but CRA information based on current account turnover might be enough. We therefore end up in a position where there is an express obligation on a firm to test income and expenditure in certain situations, but when that is necessary and what information needs to be obtained are to be determined by the firm . However as always, the firm will be motivated by the fact that, if challenged, it needs to be able to demonstrate to the FCA that it made a reasonable assessment in the circumstances of that particular case.
It's clear the FCA want the ability to supervise the market in this area more effectively. Going forward they will be able to request details of a firm's policies and procedures on creditworthiness (which must be in writing). A firm must be able to demonstrate how those policies have been implemented in any individual case, including maintaining sufficient records of the transaction to justify consumer outcomes. Firms should also assess and periodically review those procedures and address any deficiencies. To some extent that is just an extension of what is already contained in SYSC but it nonetheless emphasises the fact that the FCA intend to monitor this area closely going forward.
The consultation paper is open for comments until 31 October 2017.