Consultation response:

FCA Proposals for a price cap

on high-cost short-term credit

Response by the Money Advice Trust Date: AUGUST 2014

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Contents

Page 2 Contents

Page 3 Introduction / About the Money Advice Trust

Page 4 Introductory comment

Page 7 Responses to individual questions

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Introduction

About the Money Advice Trust The Money Advice Trust is a charity founded in 1991 to help people across the UK tackle their debts and manage their money wisely. The Trust’s main activities are giving advice, supporting advisers and improving the UK’s money and debt environment. We give advice to around 140,000 people every year through National Debtline and around 30,000 businesses through Business Debtline. We support advisers by providing training through Wiseradviser, innovation and infrastructure grants. We use the intelligence and insight gained from these activities to improve the UK’s money and debt environment by contributing to policy developments and public debate around these issues. We help approximately one million people per annum through our direct advice services and by supporting advisers through training, tools and information. Public disclosure Please note that we consent to the public disclosure of this response.

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Introductory comment We welcome the FCA consultation into imposing a cap on the cost of credit for high-cost short-term credit (HCSTC). This forms part of a range of interventions that the FCA have put into place to ensure that lenders only lend to those who can afford it, and that people who need debt advice are given the help they need instead. Whilst we welcome the cap and strongly support any provisions that will enhance consumer protection and bring down the costs of borrowing, points we wish to highlight include the following.

1. Concern that the proposed cap will still result in consumer detriment We want to see protection for vulnerable consumers against excessive fees and charges, and protection against penalties for default. We are concerned by the levels of financial distress reported by borrowers, and in particular the FCA’s conclusion that harm is caused to borrowers who only just qualified for high-cost short-term credit. Whilst overall, the FCA’s proposals are to be commended, this evidence, coupled with our own experience with clients, leads us to question whether the cap goes far enough. According to the FCA, since applying for a loan, 50% of applicants reported experiencing financial distress and 44% missed at least one bill payment. The CMA in their extensive research reported similar trends. We know from the calls we receive at National Debtline that in many cases people turn to payday loans in an attempt to solve their financial problems and to cover household bills. In 2007, as the financial crisis began, we took just 465 calls for help with payday loans, but that figure has soared to close to 21,000 in 2013, accounting for nearly 12% of our callers. Many of our callers say they have been given access to credit they can’t afford to repay, been given multiple loans from the same or different providers and have faced unacceptable collection practices. In our experience taking out more credit can often make a situation spiral rapidly, generate a demand for more loans in a vain attempt to keep afloat and put off the day when people have to seek help to deal with their debts. We note that the proposed cap would mean that 11% of (or 116,000) people per year would no longer be eligible for loans under the proposals. However, this still leaves a considerable number who report experiencing financial distress and missed bill payments still eligible for high-cost short-term credit. We also note that the cap on the cost of loans at 100% of the amount borrowed will still see vulnerable consumers owing high amounts. Users of the National Debtline online service My

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Money Steps are reported in the last twelve months as having payday loans with an average amount owed of £1,740.27 (although some of this amount will already include interest and charges). Clearly, if it is possible under the cap to charge up to double this amount in total, then this would be extremely difficult for our clients whose incomes are insufficient to cover such amounts by next payday. The FCA, in determining the level of the cap is required to strike a balance between its consumer protection role and its competition duty. In doing so, it is important that the consumer protection role is not underplayed.

2. Risks of regulatory arbitrage must be monitored and managed The FCA needs to be vigilant to ensure that its model does not lead lenders to shift to charges which fall outside the cap or to change their business models to include new types of fees and charges that are not transparent to consumers. Any move by lenders to shift to high-interest alternative lending markets that carry a high risk of further consumer detriment such as log-book lending via bills of sale or high-cost instalment loans offered over a longer period should be resisted. Equally, the risk of organisations moving off-shore, particularly online providers who are most heavily used by younger borrowers, so as to avail themselves of more favourable regulatory regimes must be managed.

• We would urge the FCA to ensure the risks of regulatory arbitrage are managed and kept under regular review. This should form a component of the review of the cap.

• Related to this, we would also urge the FCA to consider the risk of consumer detriment caused by firms developing products which have deliberately been designed to include longer loan repayment terms that fall outside the FCA high-cost credit definition.

• The FCA should also work towards developing increased transparency in relation to how the total cost for credit is displayed to potential customers. The costs and charges must be displayed in a meaningful way so that consumers can compare products and assess the true costs of the products on offer.

3. Vulnerable consumers should continue to be signposted to free debt advice

Rather than take out more credit or turn to illegal loan sharks to help pay household and other bills, people should be encouraged to seek free debt advice sooner rather than later. Free, independent debt advice can help to put people in control of their debts longer-term, and support them in improving their budgeting skills. We applaud the measures already put in place by the FCA by way of the risk warning that must be displayed on financial promotions and the requirement to send a more specific information sheet with details of sources of free debt advice before a loan is refinanced. However, more needs to be done to ensure that lenders refer potential borrowers to sources of free debt advice In particular.

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• High-cost short-term loan companies should refer applicants to free debt advice – not to brokers – if they are turned down for credit.

• We would like to see all high-cost short-term lenders treating customers with financial difficulties sympathetically and fairly, following the rules to refer struggling borrowers to sources of free debt advice, accepting offers of payment that people can afford and freezing any interest and default charges.

4. Real-time data sharing

We have long been concerned that some extremely poor lending decisions are being made that are not taking into account consumers’ ability to pay or the affordability of the loan. With regard to the current database proposal, we are not convinced that there is a need to wait until November 2014 to assess further progress in this area before the FCA takes action. We are also not convinced that it is acceptable for only 90% of lenders to be participating. This should not be left as an optional business decision for individual lenders. Preferable solutions would include the following.

• A single national database with compulsory participation. We are pleased to see that the FCA has not ruled this out if there is widespread evidence of lender non-compliance.

• Ultimately we would like to see a comprehensive real-time database of loans supervised by the FCA which all lenders are required to use, that records all loans, and helps deal with the problem of multiple lending to people who cannot afford to pay. Whilst a real-time data-base is not in itself an all-encompassing solution to this problem, it would be a step in the right direction.

• The database should be done in conjunction with reform and tightening of the CONC lending rules for assessing affordability to ensure these are functioning as intended.

5. Need for clarity on the review process

We would like to see a commitment from the FCA to continually review the cap and to reduce it if necessary. It is not clear from the consultation how the review will be conducted or its remit, or how the FCA will measure the success of the proposals in relation to the market and the effect on consumers. We feel that two years is too long to wait to review impact and would urge the FCA to do the following.

• Confirm that the terms of any review process will go wider than the direct impacts of the cap, to capture any dynamic effects.

• Clarify how charities, consumers groups and others will feed into the review of the impact of the cap on a regular basis. Any review will need to be very careful in setting its parameters.

• Consider consumer behaviour and the impact on escalating debts in particular as part of the review, not just the cap itself.

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Responses to individual questions Question 1 – Do you have any comments on our general approach to developing our proposals for the price cap? The FCA approach appears to have been rigorous and comprehensive. It is very helpful that the FCA has been able to work closely with the CMA and share the data collected by the CMA for its market study into the payday industry. We are hopeful that the cap will help to restrict the amount of debt owed and will hopefully reduce the effects of debts being inflated through the use of roll overs and through the addition of interest and charges to outstanding debts. It remains to be seen whether the proposals go far enough to protect those in debt and financial difficulties. The cap on the cost of loans at 100% of the amount borrowed will still see vulnerable consumers owing high amounts. Users of the National Debtline online service My Money Steps are reported in the last twelve months as having payday loans with an average amount owed of £1,740.27 (although some of this amount will already include interest and charges). Clearly, if it is possible under the cap to charge up to double this amount in total, then this would be extremely difficult for our clients whose incomes are insufficient to cover such amounts by next payday. The paper sets out the following conclusion at point 5.4. “The total cost cap limits escalating interest, fees and charges, mitigating debt spirals.” We are not convinced that the cap will protect our clients from what the FCA terms “debt spirals” as interest and default charges are still extremely high. However, when combined with a limit on roll overs and the protections on the use of continuous payment authorities, the effects should be of some benefit. Clearly a review and possible adjustment to the cap will be vital to ensure that there are not unintended consequences and that the protections for vulnerable consumers have the desired effect. The cap may only be able to help protect some of those consumers already in debt and with poor credit scores. This is because, under the proposals, they are less likely to obtain a loan in the first place.

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Question 2 – Do you have any comments on the proposed price cap structure? We would suggest that the proposed price cap structure creates a good starting point. Whilst the 100% cap is to be commended for its simplicity, this type of loan still represents a very high-cost form of credit. A cap is not going to eradicate the problems of taking out what is still a very expensive loan, but should be looked at as part of the range of other measures being taken by the FCA and the CMA such as limiting roll overs and addressing affordability. Its success will also depend upon how rigorously the cap is enforced and supervised alongside the FCA rules. It is vital to be able to review the effects and the cap needs to be flexible enough to change if not having desired effect or if pitched at wrong level. We therefore welcome the FCA plan to carry out a review of the price cap in two years’ time. However, this may need to be brought forward if there are clear unintended consequences that are manifested in a shorter time period. Any review will need to be very careful in setting its parameters. It is not clear how the FCA will measure the success of the proposals in relation to the market and the effect on consumers. We would suggest that any review needs to consider consumer behaviour and the impact on escalating debts in particular, not just the cap itself. It seems reasonable to apply the price cap to new borrowing made on or after the implementation date of 2nd January 2015. We welcome the decision to apply the price cap to any modified agreements from that date, including loans that are rolled over.

We also welcome the FCA attempt to encompass all types of incidental brokerage, debt collection and ancillary charges into the cap as widely and comprehensively as possible. We are slightly confused by the brokerage provisions. The paper states at point 5.69. “The price cap applies to any brokerage charges where the lender receives all or part of the brokerage charge and also where the broker is a member of the lender’s group.” We take it that therefore brokerage charges made by brokers where the lender does not receive any of the brokerage charge and/or is not a member of the lender’s group will not be covered. We would welcome clarification as to how such broker fees will be addressed, if they do not fall within the price cap.

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Question 3 – Do you have any comments on the price cap levels? The paper sets out under point 5.19 as follows. “We do not think it is desirable to leave consumers entirely without the option of using HCSTC. Our model estimates complete market closure at 0.4% and we consider that at levels below 0.8%, given that our models are estimates and have some uncertainty, there is a risk that fewer than three firms would remain. This risk is greater at lower levels of cap. At an initial cost cap level of 0.8%, we can be more confident that the three largest firms will continue to offer HCSTC, particularly as we would expect all firms to respond to the cap to limit the impact on them, and reduce the risk of exit.” We do have some concerns that the FCA must ensure that their decision causes the least consumer detriment. As we have said, we are concerned that the price cap is set too high to protect vulnerable consumers who will still face the consequences of a very high interest rate and set of charges. We are concerned in particular about the levels of default charges allowed under the cap. The FCA states in point 5.43 of the paper that: “The CMA has found that customer demand is particularly insensitive to fees and charges incurred if customers do not repay their loan in full on time. Customers tend to be less aware of these potential costs of borrowing than they are of the headline interest rate when choosing providers. The CMA has proposed a remedy to improve the transparency of default charges, and customers’ understanding of these charges. Our simple default cap structure should support the CMA’s goal of improved understanding of default fees.” We would suggest that if it is the case that customer demand is not sensitive to fees and charges that may be added if they do not pay back on time, then it is unlikely that this will be improved by the requirement to include such charges on the CMA proposed online comparison site.

We stated in our response to the CMA “Investigation into payday lending: notice of possible remedies” consultation paper: “We would suggest that unless substantial promotion and advertising budgets are put in place, that an independent short-term high-cost credit comparison site would not have the hoped for effect on competition.”

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We also argued:

“We would like to see a clamp down on excessive charges at point of sale, and throughout the lifetime of the loan, particularly those that are added when borrowers are in financial difficulty.”

We would like to see clarification as to how default fees and charges will be treated under the rules when a consumer seeks free, independent debt advice. We would like to see it made plain how the following conflicts should be interpreted. The Payday Charter1 states a commitment to:

“Freeze interest and charges if you make repayments under a reasonable repayment plan or after a maximum of 60 days of non-payment.”

However, we would suggest that if this is still being adhered to by those payday lenders that signed up to the charter, that this is too lengthy a timescale. Under the proposed cap lenders could still add interest and default charges where they should be frozen because people are in financial difficulties.

Whereas CONC 7.3.4 states: “A firm must treat customers in default or in arrears difficulties with forbearance and due consideration.” Forbearance is defined in CONC guidance as follows: “Examples of treating a customer with forbearance would include the firm doing one or more of the following, as may be relevant in the circumstances: (1) considering suspending, reducing, waiving or cancelling any further interest or charges (for example, when a customer provides evidence of financial difficulties and is unable to meet repayments as they fall due or is only able to make token repayments, where in either case the level of debt would continue to rise if interest and charges continue to be applied);” CONC 7.7.5 also states: “A firm must not impose charges on customers in default or arrears difficulties unless the charges are no higher than necessary to cover the reasonable costs of the firm.” 1 http://www.cfa-uk.co.uk/assets/files/PD&STL_Charter.pdf

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We are concerned that lenders will charge “up to the cap” rather than to cover their reasonable costs. It is not clear whether lenders who are not party to the Charter will be able to charge for interest and charges for a longer period up to the cap limit, because they are not subject to the 60 day limit for freezing interest and charges. This would clearly create an anomaly. We think the FCA needs to clarify these issues or be at risk of effectively rewarding bad practice. Question 4 – Do you agree with our proposals on repeat borrowing? We cannot comment on whether the FCA conclusion that the most appropriate way to deal with repeat borrowing is to apply the price cap in the same way as for a first loan is correct. Whilst this may bring down the costs of borrowing for repeat borrowers, there are clearly wider considerations and possible remedies that also need to be considered. We welcome the intention to use a range of tools to deal with the detriment caused by repeat borrowing such as strengthening and enforcing the affordability requirements and using forensic supervision of individual firms. However, we would suggest further thought is given to capping the number of times a borrower can borrow in a given period either from the same firm or any firm which is the model in some states in the USA. The FCA paper states at point 5.73 that this would be: “..a very stringent measure and we are not proposing it at this time.” We are not convinced that a full explanation as to why such a measure is too stringent for the FCA to consider at this time or what the drawbacks of such an approach would be, are fully set out in the paper. We share the FCA concerns that have been identified in relation to the risk of inappropriate repeat lending which is used to “game our refinancing/rollover cap rules”. The debt advice sector has long been voicing concerns about the affordability of repeat borrowing as many clients have a number of loans outstanding by the time they seek advice and would welcome immediate action in this area. The FCA concerns are set out in point 5.75 of the paper. “We are also considering if we need to change our rules to deal with inappropriate repeat lending which could be used to game our refinancing/rollover cap rules. If a loan is paid back and then a new loan is taken out, our rules do not define this as refinancing and the refinancing cap does not apply. We understand that some firms are repeat lending within

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periods as short as 20 minutes after the first loan has been paid off – this could be causing detrimental cycles of dependency on repeat borrowing that we need to address.” We hope that the FCA looks into possible rule changes to deal with this threat as soon as possible. Question 5 – Do you have any comments on the scope of the price cap? We understand that the FCA is considering whether the price cap should be extended to other products. We also understand that the FCA is proposing to exclude other forms of high-cost credit from the cap where they are already excluded from the current definition,2 but that it is intended that this should be kept under review. We would suggest that the FCA should give early consideration to the consumer detriment in these areas and would strongly support an early evaluation as to whether a similar or the same cap would be appropriate.

We would also urge the FCA to consider the risk of consumer detriment caused by firms developing products which have deliberately been designed to include longer loan repayment terms that fall outside the FCA high-cost credit definition. We can see that it is difficult to extend the definition to cover such loans because of the principle that the cap should cover short-term products. However, again, it is vital that the FCA considers whether it can put in place similar rules to those covering high cost short term credit to deal with the potential harm caused to consumers by a lengthy high interest loan. Question 6 – Do you have any comments on our proposed Handbook rules? We do not have any comments on the proposed Handbook rules. These appear to reflect the policy intentions. The FCA makes the point that a total cost cap of 100% of the amount borrowed including interest, fees and charges is easy to understand. However, we would only point out that, in practice, it will be very difficult indeed for a consumer or individual to work out if their loan terms in relation to interest and charges has contravened the price cap. In cases where there has been a default, the consumer would need to know what they had been charged over the whole lifetime of the loan in total to work this out. This would surely only be possible at the end of the transactions, and would rely on people keeping paperwork

2 5.60: This includes home‑collected credit, pawn broking, log book loans and overdraft charges) and open‑ended running account credit (most of which e.g. credit cards are excluded because they are open‑ended and not substantially repayable in 12 months).

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and so on. This will be a very complex area and consumer groups are likely to find it difficult to identify breaches either. There will therefore need to be rigorous and constant monitoring by FCA expert staff in this area to ensure that firms comply as part of proactive firm supervision. Question 7 – Do you agree with our proposals on unenforceability? We support the FCA proposals on unenforceability. The proposals should act as an incentive on lenders to make sure that they comply with the price cap provisions if any agreements found to be in breach, are irredeemably unenforceable against borrowers. We also welcome the proposal that the whole of the agreement will be unenforceable and not just any element in breach of the price cap. However, we are confused as to the meaning of point 6.6. “The consumer under an agreement which breaches the rules can elect not to perform the agreement (i.e. not to repay the loan with charges), and if so the lender has to repay all charges but the consumer has to repay the loan.” This section appears to make the lender liable for the charges on the loan but the consumer still liable to repay the money borrowed. If the lender cannot enforce the loan against the consumer and cannot use any “repayment obligations” such as direct debits or continuous payment authorities, then what will happen if the consumer fails to pay the amount of the original loan? Our understanding of the Consumer Credit Act 1974 provisions on irredeemable enforceability are that the borrower can retain the money borrowed on an unsecured credit agreement and cannot be compelled to make any further payments. As well as looking at unenforceability of agreements, we suggest that the FCA sets out further consequences for lenders for failure to comply. Will there be sanctions against the lender? Presumably the lender’s authorisation would be immediately under threat? Is there a possibility of criminal charges?

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Question 8 – Do you agree that we should prevent UK‑based debt administrators from enforcing HCSTC agreements on behalf of ECD lenders which include charges in excess of the price cap? We agree that the FCA should act to prevent UK based debt collectors from enforcing high-cost short-term credit agreements that exceed the cap. We understand that this may occur when companies are set up elsewhere in the EU to avoid the need to comply with UK regulation but can still lend to UK customers from an EU base. Clearly, this falls short of the FCA preference to have powers to intervene when a lender in another member state establishes a loan operation targeting UK customers with a view to avoiding more stringent UK rules. We hope that this situation is resolved and that the FCA is able to obtain greater powers in this area. It is clearly unacceptable that actions by unscrupulous companies can undermine the powers and intentions of the regulator to provide consumer protection in this area. Otherwise, we can foresee issues in the future where companies deliberately try to avoid the price cap rules by acting in this way. Question 9 – Do you have any comments on the proposed approach to data sharing? We would like to see a comprehensive real-time database of loans supervised by the FCA which all lenders are required to use, and records all loans, and helps deal with the problem of multiple lending to people who cannot afford to pay. We have long been concerned, along with other consumer groups that some extremely poor lending decisions are being made in this area that are not taking into account consumers’ ability to pay or the affordability of the loan. Whilst it is not an all-encompassing solution to this problem, it is vital that a real-time database is put into place at the earliest opportunity. This should be done in conjunction with reform and tightening of the CONC lending rules for assessing affordability to ensure these are functioning as intended. There has already been a substantial delay in the database being set up. We are concerned that under current plans there will be a variety of industry based schemes that all have different rules and processes. Not all lenders will be signed up, so coverage is neither comprehensive, nor is it compulsory for lenders to join a particular scheme. In some cases data is not updated in “real time” but overnight.

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We are also concerned by the acknowledgment in point 7.24 of the paper that there no database will have full coverage of all the available data. “In the rest of the consumer credit market, industry best practice is for lenders to share their data with at least two CRAs. In practice, payment performance information in the mainstream market is largely shared among all the mainstream CRAs. This is not the case in the HCSTC market where CRAs only have access to the real‑time data that is reported to them by the firms that use their services. Consequently no real‑time database has full coverage of all the available data.” It is also not clear that any of the schemes will be required to report directly to the FCA or that the FCA will have a monitoring role to ensure that the schemes are functioning properly and as required.

We would strongly support a regulatory solution where the FCA establishes a regulatory database and controls the implementation and reporting and monitoring functions from a single comprehensive entity. It should be mandatory for all lenders to use the database for lending decisions. From point 7.30 in the paper, we understand the FCA is looking for the following action by November 2014. “We expect to see the vast majority of firms in this market participating in real‑time data sharing by November, and the vast majority of loans being reported in real‑time. By vast majority we mean greater than 90% of current market participants by market share and by volume of loans. In order to improve the coverage of real‑time databases, firms will also need to share data with more than one CRA. We will request information from firms and CRAs in order to get an accurate picture of whether these standards have been met by November.”

We are not convinced of the need to wait until November 2014 to assess further progress in this area before the FCA takes action. We are also not convinced that it is acceptable for only 90% of lenders to be participating. This should not be left as an optional business decision for individual lenders. A single national database with compulsory participation would be preferable in our view. We are pleased to see that the FCA has not ruled this out if there is widespread evidence of lender non-compliance. Question 10 – Do you agree with the costs and benefits identified? We agree that the cap will on balance provide more benefits to consumers and will outweigh the costs both for those that still get loans and those that do not.

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From the FCA Consumer Survey Analysis, it is clear that in many cases the reasons identified by consumers for seeking a payday loan are to do with paying household bills, rent or mortgage payments, living expenses or unexpected expenses such as car repairs. In some cases the need was identified as to replace broken household items such as washing machines. It is particularly concerning to see people attempting to help their own debt problems by using a payday loan to clear other debts. We would suggest that they would be much better served by seeking debt advice instead. In these cases, we would agree that the applicants in these cases needed to access free debt advice rather than to try to deal with their situation by taking out a new expensive loan that in many cases would be likely to exacerbate their debt situation, and put off the day when the inevitable financial collapse occurs. This chimes with the experience of debt advice providers who find that taking out a series of payday loans and dealing with continuous payment authorities tip the client over the edge and forces them to seek advice.

We want to see sources of affordable credit and savings made widely available so that social lenders such as credit unions can offer a real alternative to taking out high-cost credit. We also need to make sure the safety net afforded by local welfare assistance schemes is in place so that our clients on very low incomes can access financial help with unexpected household expenses. We would also suggest exploring whether banks and other high street lenders can help to develop short-term lending alternatives. We would suggest looking at the model in Australia outlined below. An innovative response from the banking industry would be to look at the example of Australia where the National Australia Bank has partnered with The Good Shepherd Microfinance and the Australian Government to offer a range of shop-front community finance products such as Good Money,3 and the No Interest Loan Scheme4 which is the Australian equivalent of the social fund budgeting loan scheme. This partnership also offers low-interest loans for low-income households through the StepUP5 scheme. We want to include a savings element into budgets for people in debt which will encourage financial health for people over the longer term and provide a cushion to help with repairs and unexpected costs without resorting to further borrowing.

3 http://goodshepherdmicrofinance.org.au/services/good-money 4 http://goodshepherdmicrofinance.org.au/services/no-interest-loan-scheme-nils 5 http://goodshepherdmicrofinance.org.au/services/stepup-low-interest-loans

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Question 11 – Do you agree with our assessment of the impacts of our proposals on the protected groups? Are there any others we should consider? We very much support the FCA policy goal identified in this section. “The key policy goals of this proposal are to protect consumers from getting into debt spirals and making credit more affordable.” We very much hope that this is the effect of the price cap policy in practice. In our opinion it is vital that people at risk of debt spirals are offered free, independent debt advice rather than access to unaffordable credit. Whilst we recognise the progress the FCA has made in this area, we still feel that there is more to be done as outlined in our response. We would tend to agree with the FCA assessment of the impacts of the proposals on protected groups. Whether the FCA is accurate in its assessment of the impact on those groups who disproportionately use high street stores, e.g. women and BME groups will depend upon whether the FCA is accurate in its overall assumption that: “…firms on the high street would develop dynamic responses to the cap and will continue to offer HCSTC.” Presumably this is a prediction that can be reviewed in the light of future evidence about what happens to high street HCSTC providers in practice. We have not identified any further impacts of the FCA proposals on protected groups that have not already been considered. For more information on our response, please contact: Meg van Rooyen, Policy Manager megvanrooyen@moneyadvicetrust.org 0121 410 6260

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The Money Advice Trust 21 Garlick Hill London EC4V 2AU Tel: 020 7489 7796 Fax: 020 7489 7704 Email: info@moneyadvicetrust.org www.moneyadvicetrust.org