Implementation
Following the FCA’s publication of Policy Statement 18/19 in July 2018 setting out new rules relating to creditworthiness assessments in consumer credit CONC 5.2A was updated yesterday to incorporate the new rules.
Applicability
The creditworthiness rule change applies to:
- Unsecured consumer credit lenders;
- Guarantor loan providers;
- Open-end and running-account credit providers; and
- P2P platforms.
So, what has changed in practice?
Prior to 1st November 2018 the creditworthiness assessment in CONC 5.2.1 set out the requirement on lenders to conduct a creditworthiness assessment prior to making a regulated credit agreement. In the revised CONC 5.2A.5 the FCA expressly set out that a creditworthiness assessment must consist of an assessment “…in respect of affordability risk.” The advancement of the FCA’s consumer protection operational objective is apparent in this revision at it clarifies that a creditworthiness assessment should not solely be focused on credit risk to the lender but also factor in affordability risk to the borrower.
Affordability risk assessment
The revised rules codifies a two component view of creditworthiness – one consisting of credit risk (i.e. the risk that the customer will not make repayments under the agreement by their due dates or, in other words, the commercial risk to the lender) and the other consisting of affordability risk (i.e. the risk to the customer of not being able to make repayments under the agreement).
The revised CONC 5.2A.10 makes it clearer that the affordability element of a creditworthiness assessment should assess the customers ability to make repayments under the agreement. This revised wording is a lot clearer that the previous version in CONC 5.2.4(2), namely “The risk of credit not being sustainable directly relates to the amount of credit granted and the total charge for credit relative to the customer’s financial situation.” It is to be noted that where CONC 5.2.4 under the previous rules had the status of being guidance the revised CONC 5.2A.10 has the status of being a rule.
The revised CONC 5.2A.12 sets out the factors that lenders should take into account in conducting an affordability risk assessment, namely the ability of the customer to make repayments under the credit agreement from their income, savings or assets without the customer having to borrow to meet repayments or making repayments at the expense of contractual (i.e. rent, mortgage, car repayments etc.) or statutory obligations (e.g. council tax) and without the repayments having a significant adverse impact on the customer’s financial situation. In other words, the revised creditworthiness assessment rules require lenders to have a good understanding of customers’ financial position (at point of sale) and foreseeable changes to their financial position in order to determine whether the customer can afford the credit.
Some elements of the new CONC 5.2A.12 were present in the previous CONC 5.3.1 such as the requirement to assess that a borrow can sustainably make repayments under the credit agreement on time and without having to borrow to meet repayments. However, the status of CONC 5.3.1 was previously guidance and has now been given the status of a rule.
To take it a step further, the new rules require lenders, in circumstances where the customer proposes to pay the credit using savings or other assets, to ascertain the purpose of the savings or assets, the liquidity of the savings or assets (i.e. their availability to be used to make repayments) and whether the use of those savings or assets to repay the credit would have any significant adverse impact on the customer’s financial situation.
Income and expenditure assessment
The new rules require lenders to carry out an income and expenditure assessment unless it is obvious in the circumstances of the particular case that the customer is able to afford to make repayments from their income, savings or assets without it undermining their ability to maintain contractual or statutory obligations and without it having significant adverse impact on them. Where a lender opts to rely on this exception to conducting an income and expenditure assessment the burden of proof will be on the lender to demonstrate, if challenged (for example, by the FCA), that the absence of affordability risk to the borrower was obvious and an income and expenditure assessment would have been disproportionate.
Where customer affordability is not obvious the new rules require lenders to conduct an income and expenditure assessment. Lenders would need to verify statements of income made by customers by obtaining independent information such as credit reference agency data or documentation from a third party (e.g. an employer) to substantiate current income. The expenditure element of the income and expenditure assessment under the new rules requires lenders to take into account the customer’s non-discretionary expenditure that is relevant to the circumstances of the customer. This can extend beyond just priority debts, essential living expenses, contractual and statutory obligations to include the non-discretionary expenditure for other persons whose financial obligations the customer meets wholly or in part.
Running-account credit
Under the previous guidance (CONC 5.3.1(8)) running-account credit providers were required to base an affordability assessment on the consideration that the customer would repay the maximum amount of credit under the agreement within a reasonable period. A change under the new rules (CONC 5.2A.27) is that (1) it changes the status of the previous guidance into a rule and specifies that lenders’ affordability assessment should assume that the borrower will drawdown the credit limit at the earliest opportunity and repay in equal instalments over a reasonable period of time which, similar to the previous guidance, should be the typical period of time required for repayment under a fixed-sum unsecured personal loan for the same amount as the credit limit.
The above methodology also applies in relation to increasing the credit limit that applies to an existing running-account credit agreement, namely lenders should base an affordability assessment on the assumption that the customer will drawdown the entire balance up to the increased credit limit at the earliest opportunity and repay in equal instalments.
Guarantor loans
The new rules do not modify lenders’ requirements to assess the potential for the guarantor’s commitments under the credit agreement to adversely impact the guarantor’s financial situation.
The new rules add that the above assessment must be based on sufficient information. This can be information that the lender is privy to at point of sale or information the lender obtains from the borrower on behalf of the guarantor, from the guarantor themselves or from a credit reference agency. The new addition emphasises the importance of creditworthiness assessments or financial assessments to be undertaken on an informed basis to minimise the potential for adverse consumer outcomes (to borrowers and guarantors).
P2P agreements
The new rules (CONC 5.5A.6 & CONC 5.5A.11) applies the two-component view of creditworthiness assessment (i.e. consisting of credit risk and affordability risk) to P2P providers and emphasises the importance of affordability risk assessment.
Proportionality
Similar to the previous CONC 5.2, the revised rules maintain the principle of proportionality which is underlying in the affordability assessment lenders are required to undertake. In practice this means that the factors which lenders take into account in assessing affordability risk, including the information that lenders rely upon, should be proportionate to the specific characteristics of the proposed credit agreement and the circumstances of the customer.
Compliance Framework
Where the previous rules (CONC 5.3.2) required lenders to have creditworthiness assessment related policies and procedures the new rules go further and contains express provisions requiring lenders to have a documented compliance framework which consists of creditworthiness assessment related policies and procedures that sets out the firm’s creditworthiness assessment process, arrangements to review and sign-off the firm’s creditworthiness assessment process and arrangements to monitor the effectiveness of the creditworthiness assessment related policies and procedures, the customer outcomes achieved and set out arrangements to address any deficiencies in the policies and procedures.
For more information, please contact Jourdain, at Jourdain.Tambo@consumercreditcompliance.co.uk or call 01423 522599.