I wrote last weekend about consumer credit's importance to the UK economy, and how regulatory responsibility for it is effectively split across the UK's twin peaks structure.
Here's a thoughtful piece from my colleague Darren Castle, examining the FCA's update on motor finance...
On 15 March, the FCA issued this update on its review of the motor finance sector. The update provided some good news for the industry, but also a clear picture of the higher risk areas in which the FCA is still to conclude its work.
Ever since the FCA announced the review in its Business Plan for 2017/18 there have been quiet but constant murmurs that one potential outcome will be an industry wide remediation exercise centred on Personal Contract Purchase (PCP) agreements. It will be as comforting to motor finance providers as it is disappointing to Claims Management Companies that the FCA’s update does nothing to suggest that the sale of PCPs will be the next big redress scheme to hit the financial services industry. In fact, the FCA highlighted the flexibility that PCPs provide to consumers, and the lower monthly costs that are available because of the design of PCPs, through which part of the purchase price for the car is deferred until the end of the agreement.
Based on a sample of firms that represent over half the market, the FCA has also concluded that asset valuations and risk management processes are robust. It did not identify any material risks associated with the setting of Guaranteed Future Values (GVFs) and a potential severe fall in used car values.
In addition, the FCA emphasised that most of the recent growth in motor finance has been to lower credit risk customers who are less likely to face payment difficulties.
However, the FCA also highlighted three areas of on-going work, about which firms should be very mindful:
1. There are some potential concerns about the commission structures in place between lenders and dealers (brokers). For some arrangements, a significant portion of the commission paid by lenders to dealers is directly linked to the interest rate paid by consumers. Essentially, dealers are paid more the higher the interest rate charged to customers, even if those customers potentially qualify for a lower rate. The difference in commission between the lowest and highest interest rates can also be substantial. In the next phase of its work, the FCA will undertake assessments of firms’ systems and controls related to commission structures and dealer incentives. In the meantime, firms should pay regard to the proposed new rules and guidance in the FCA’s consultation paper in July 2017 on staff incentives, remuneration and performance management in consumer credit.
2. Unsurprisingly, the FCA has found that motor finance agreements for customers with lower credit ratings have experienced higher levels of arrears and defaults. As a result, the FCA is undertaking further work to assess the adequacy of affordability assessments, particularly those in relation to consumers with lower credit ratings. Firms should pay due regard to the FCA’s consultation paper in July 2017 on assessing creditworthiness in consumer credit. This paper makes it clear that the FCA expects affordability assessments to be more robust for customers who pose higher affordability risk due to their existing indebtedness or previous financial difficulties
3. The FCA is also undertaking some mystery shopping activity to assess the extent to which customers are given clear, timely and transparent information at the point of taking out finance.
Overall, there are not too many surprises here. The further work on affordability will rightly be concentrated on those lenders whose customers are non-prime. And the focus on commission structures is no different from the regulator’s interest in remuneration structures across the entire retail financial services industry.
As it makes up such a large part of the overall consumer credit landscape, the motor finance industry is certain to remain under regulatory scrutiny for some time yet and we await with interest the completion of the FCA’s current review in September 2018.
In July 2017, we set out our plans to put the spotlight on motor finance and highlighted the key questions we wanted to answer. We have a range of work underway to build a stronger understanding of this market and how consumers engage with motor finance firms, from carrying out detailed analysis of millions of credit files to a mystery shopping exercise.