September 2018
In July last year, the FCA published CP17/27 in which it clarified its expectations of how firms should be assessing creditworthiness.
At the end of July this year, it published its policy statement on this subject (PS18/19), together with updated rules and guidance , where it's aim is to address any misunderstandings leading to under-compliance with the rules, or firms having procedures which may be unnecessarily costly or restrictive. The new rules come into effect on 1 November 2018.
The changes are directly relevant to consumer credit lenders and peer-to-peer (P2P) platforms, but they may also be of interest to other consumer credit firms.
Creditworthiness comprises credit risk (to the firm) and affordability (for the borrower), but here the FCA is looking to protect consumers from the harm that can arise when they are granted credit that is predictably unaffordable at the point it is taken out. At the same time, they want consumers to be able to access credit where it is affordable.
The changes
The aim of the rules is for firms to make a reasonable assessment, not just of whether the customer will repay, but also of their ability to repay affordably and without this significantly affecting their wider financial situation. This should minimise the risk of harm through financial distress to customers.
The FCA wants to avoid being too prescriptive, as this could have harmful unintended consequences, including for the cost and availability of credit.
Firms may use a variety of methods and processes to assess credit risk and affordability. They may be assessed together, or separately, and processes may be integrated or sequential. All of these can deliver good outcomes for customers when done well.
The FCA is very clear that it does not want to discourage the use and development of automated systems that may provide more reliable results, rather than asking the customer for large amounts of information or documentation. Where processes are automated, there is an expectation that firms will have the appropriate policies and procedures to ensure they can adequately manage any risks associated with those processes. The same applies if the firm relies to a significant extent on data or information from Credit Reference Agencies (CRAs) or other third parties.
Although it is possible to apply metrics that can help firms to assess credit risk, that is, the probability of default, there are no established metrics that can provide certainty of affordability at loan origination.
The assessment of creditworthiness is not an exact science and the FCA recognises that affordable loans can become unaffordable due to a change in the client’s circumstances or wider economic events. It may also be affected by how the credit agreement is operated and how they organise their finances, which may be influenced by behavioural biases for example. The effectiveness of the policies and procedures, and the firm’s compliance with the rules, should be reviewed periodically, and amended where required. Records of each transaction where credit is granted should be kept by the firm to enable the FCA to monitor adherence.
In the main, the changes are as proposed in CP17/27, however, there are some aspects where the FCA has amended its original proposals in light of views and evidence from stakeholders to include: allowing other income to be taken into account and that income is not limited to earned income, a clarification of the meaning of non-discretionary expenditure, the treatment of business lending and the assumptions to be used for assessing affordability in relation to credit cards and other running-account credit.
Action required
Firms that are affected by these changes will need to review their policies and procedures considering the new rules and guidance, and make changes where needed.
As ever, if you are a firm looking for support in respect of meeting your compliance responsibilities, please feel free to get in touch with the team either by calling direct on 0207 033 8899 or by emailing enquiries@fiba.org.uk