The latest figures on the cost of living in the UK show inflation is now at around 10% as measured by the Consumer Prices Index, and interest rates at 2.25%, as at the end of September 2022. The rate of inflation is the highest it has been for forty years and the Bank of England is forecasting inflation could rise above 13%. The June 2022 Financial Stability Policy Summary issued by the Financial Policy Committee comments that the global economic outlook has deteriorated materially with an outlook of considerable uncertainty. What this means is rising prices, reduced growth and tightening credit conditions which place additional pressures on UK households and businesses.
The role of credit is vital in helping to manage short term spikes in spending and smooth costs over time. It is a vital part of the UK economy. However, the tipping point between credit being a facilitator in the financial system to being an unaffordable burden is the current focus of regulators as the cost-of-living rises.
The 2022 Joseph Rowntree Foundation Poverty report estimates just over a third of people in the poorest fifth of households have liquid savings of less than £250 compared with 1 in 6 of the overall population.
The question is how long the current crisis will persist. The BOE’s Monetary Policy Committee report for August 2022 expects inflation will be back to within its 2% target in the next two years. That may be too long for many households or businesses.
What are the causes?
The causes of the increases in the costs of consumer goods are well documented such as supply chain bottle necks and the war in Ukraine. Wholesale energy prices increased rapidly in 2021 and rose sharply after Russia invaded Ukraine. UK consumers saw this flow through to domestic prices in April 2022 when prices rose by 54% after the energy price cap was adjusted. This further increased in October, resulting in a price increase of 80%. Although the government has introduced the Energy Bill Relief Scheme to help businesses, there is no price cap for non-domestic energy prices which is likely to mean the price increases paid by businesses will be significant and will need to be either absorbed or passed on to consumers.
What does this mean for consumers?
The pressure on UK households is already visible in press reports of families going without or cutting spending as inflation rises. Average two-year mortgage rates are the highest they been for nearly 14 years and look set to increase further. The Retail Sales Index data shows retail sales (excluding automotive fuel) were down 5.0% by Volume in August 2022 (year on year), as customers cut back on major purchases, such as white goods . For prime consumers, cutting expenditure on non-essential items may be sufficient.
Typically, consumers will cut non-essential items before defaulting on credit or lending commitments with mortgage payment defaults being the last resort. The figures for customers in arrears as at Q2 2022 show 74,540 homeowners’ mortgages in arrears of 2.5% or more of the outstanding balance as at end of June 2022 which is a reduction in numbers from the previous year. The next two quarters may well see this trend reversed.
But for vulnerable households, those with low financial resilience or already in fuel poverty, the choices may be very difficult particularly over the coming autumn and winter. Recent press reports argue that 18 million families could be in fuel poverty this winter . The Government announced a range of support measures for consumers such as an upfront discount on energy bills in October, but it is unclear how much of an impact this will have.
Consumers may turn to short term borrowing. However, in the subprime sector, regulatory action to stop unaffordable lending at high interest rates means there is a shorter supply of available credit. Evidence from Citizens Advice found consumers are starting to pay for Buy Now Pay Later purchases with other credit sources. There is a potential for a significant increase in consumers either borrowing or not being able to repay credit which has driven the FCAs recent actions to communicate its concerns to firms with a particular focus on secured and unsecured lending and debt advice.
Regulatory expectations
The FCA’s recent Dear CEO letter to 3500 lenders and unregulated BNPL firms sets expectations by reminding firms of their obligations to lend affordably, treat consumers who fall behind on payments with forbearance, understand their individual financial circumstances and develop sustainable repayment plans. The FCA updated its guidance on treating vulnerable consumers in 2021 – taking extra care to ensure people with a vulnerability do not get a worse outcome and published areas of good practice more recently, with reference to the cost of living crisis. In addition, we are seeing communications emphasise the role of the new Consumer Duty in improving outcomes.
The FCA has also been working with MoneyHelper to urge consumers to seek early advice on managing their finances and to seek help if they are experiencing difficulties. Further, the energy regulatory OfGem is reminding customers that energy providers must offer consumers plans they can afford.
The FCA has also reminded firms of its guidance on tailored support for borrowers in financial difficulty which it issued during the pandemic and has reminded lenders that they should provide support to struggling borrowers, tailored to their specific circumstances, and only charging fees which are fair and which cover the firm’s costs.
Recent FCA Portfolio supervision letters for Debt Advice firms and Mainstream Consumer Finance Lenders remind firms to adhere to standards set out in the Tailored Support Guidance for those borrowers in financial difficulty, to lend affordably, and manage conflicts of interests between the firm’s own interests and those of its consumers, for example, arrangements with third parties that are profitable for the firm but not always suitable for its customers.
The FCA is reminding firms to look ahead and plan for a sudden influx of consumers wanting support. Firms need to be operationally ready to address demand, for example increasing operational capacity to manage consumer calls. This is a clear reference to the new Consumer Duty and the obligation to avoid reasonably foreseeable harm for retail consumers by spotting a possible issue, in this case demand for support, and planning ahead.
The FCA acknowledges there is insufficient capacity of quality debt advice in the market and is encouraging innovative ways to support the need for debt advice and customer support. For example, one of the firms accepted into the FCA’s Regulatory Sandbox in 2022 was Fair4All Finance, a firm which is working with organisations to pilot the No interest Loan Scheme (NILS) to customers in vulnerable circumstances. It provides an option to customers who need finance but are unable to access or afford existing forms of credit, yet can afford to repay the capital of the loan. There is also an opportunity to look at innovative ‘robo’ solutions and make sure there is plenty of information for consumers to access.
The portfolio letter for Lifetime mortgage firms also has focus on operational readiness to manage increased demand and reminds firms to carefully look at advice in a rising interest rate environment. Again, the link here to the Consumer Duty is to anticipate issues consumers may face and take action.
The new Consumer Duty final rules and guidance published in July will also serve as a reminder to firms to think about the cost of living crisis as part of their implementation plans. The Consumer Duty is aimed at raising standards for consumers, firms may need to revisit those plans to address the shift in financial conditions many consumers may find themselves in. For example, not just thinking about the impact on consumers with lending products, but also on other products where consumers may wish to switch, cancel or postpone payments.
As firms may look to cut costs, they need to be mindful of the FCA’s responsibilities to monitor consumer access to services such as access to cash through branches. The FCA has communicated its intentions to intervene where services are cut without sufficient access to alternatives.
What does this mean for firms?
The FCA is sending out a clear message that it expects firms to meet standards and think ahead. The FCA’s communications are now front running aspects of the new Consumer Duty which means firms need to be thinking about where standards need to change now. It is therefore a priority area of focus.
Of course, the pandemic has given firms the opportunity to learn some lessons, for example, designing and costing forbearance options which are then consistently implemented; having consistent approaches to the same consumers across the organisation; and having sufficient MI and QA to identify any areas which need improvements.
It is important to consider how the ‘cost of living crisis’ is potentially more open ended than the ‘pandemic’ which was time limited to the extent that there was an effective vaccine in development. This allowed firms and government to set in motion forbearance and support with a clearer view of the exit for customers and the economy. In contrast, the current crisis does not benefit from a similar ‘off-ramp’, we do not know the timing and nature of resolution of the conflict in Ukraine, nor the full extent inflationary pressures and a recession might have on consumers and businesses.
Therefore when firms offer customer support it arguably comes with additional risks and consideration when compared to the pandemic. For example, if a customer is given an extended payment holiday on their credit card, there is a greater risk that come the end of the forbearance period, they are unable to return to making repayments which could result in a poor outcome for the customer and firm.
To help firms in the secured and unsecured lending and credit sectors to think about what it means for them, here are some key questions to ask:
Product, services and communications
- Have you appropriately considered Financial inclusion? Are lending practices and product features helping consumers and small businesses manage through difficult times rather than resulting in customers without access to essential financial services?
- How do you ensure that you understand customers and how they behave and develop strategies to help overcome those behaviours?
- Do you need to adjust your affordability criteria to take account of the cost-of-living increases?
- Is information available and accessible to your consumers? For example, access to information about product options, helplines, other resources like debt advice, to ensure customers are effectively directed to money guidance, free debt advice or helplines such as the Samaritans, where appropriate.
Customer support
- What types of support or forbearance can be offered? How does this impact cashflow? How is the support offered monitored to ensure it remains suitable to each customer’s circumstances?
- Have you anticipated demand for services and planned accordingly? What services may come under pressure if there is an increase in customers making contact for help and how can services be augmented?
- What additional staff training might be needed?
- Are you satisfied you can identify and address the needs of vulnerable customers?
Business impact and control environment
- Is there a potential for increased internal or external fraud and do fraud controls need to be re-examined?
- What additional costs does the current economic environment place on the firms’ own finances and how can those costs be managed?
- What is the impairments profile for existing loan books and what impact does any change have?
Of course, all financial sector firms could feel some impact and not all impacts will be driven by regulatory focus. For example, managing pressure to match deals available elsewhere, increased interest rates or costs of funding can all put a strain on a firm’s finances. Rigorous financial analysis, cash flow analysis and planning enable financial issues to be mitigated.
The FCA will also be increasingly focused on financial resilience of solo-regulated firms. The FCA will be looking to understand if they have safeguards in place to ensure they are financially resilient and have adequate wind-down plans in place should they exhibit characteristics of financial weakness, even for those firms providing consumer credit and who are not subject to strict prudential requirements.
Reputational risk or the risk of negative publicity can be very damaging. For example, social media or press can quickly escalate stories which present a firm in a negative way, particularly where treatment of vulnerable consumers is concerned. Being quick to identify and respond with a thought-out communications plan is key to managing reputational risks.
This combination of factors, encompassing: additional customer needs; financial pressures; as well as regulatory pressure, all against a backdrop of economic uncertainty, means it is more important than ever for firms to ensure they have robust procedures and controls in place and operational planning capability to navigate through these challenging times as successfully as possible.